EXBIT 13
2010 ANNUAL REPORT TO STOCKHOLDERS
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
2010
ANNUAL REPORT
March 25, 2011
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Dear Fellow Shareholder,
What a difference a year makes! A year ago we were coming off the most challenging year in the history of the First Federal of Northern Michigan. While we were confident a year ago that the worst was behind us and that 2010 would be a turn-around year, it remained to be seen. Fast forward to today. The core profitability of the Bank has never been stronger. The profitability in 2010 was driven by fundamental changes that began in late 2007. Consider that in 2010 we were able to produce income and still absorb inflated levels of expense related to both collection actions and the onerous costs of Bank-owned properties and their disposition. In line with our expectations, we saw marked improvement in our asset quality metrics in 2010, which resulted in dramatically lower loan loss reserve requirements in 2010 when compared to the years of 2007 through 2009. I am not suggesting that we are ready to start patting ourselves on the back for a job well done, but we have made excellent progress and it began to prove itself out in 2010. Turning around a thousand foot vessel (with reference to the large Great Lakes freighters that we often see in this part of the world) takes a lot of work and time. For us this is an apt analogy. We began to turn in a different direction in 2007 when we grew concerned about the housing bubble and the economic outlook. Our focus since then has not been misguided. The changes have started to produce meaningful improvements to the core profitability of our Bank. The improvements to the earnings profile which have taken place over the last few years are centered around the four focus areas that were delineated in last year’s shareholder letter. They included:
Ø Rehabilitating or liquidating non-performing assets; | Ø Increasing our net interest margin (NIM); | |
Ø Growing non-interest income; | Ø Reducing controllable expenses. |
Non-Performing Assets (NPAs)
This was an area of focus because stock price and the level of NPAs are inversely related. Reducing NPAs would improve earnings thereby helping our stock price. Among the key NPA measures is the Texas Ratio which is the relationship between NPAs and the Bank’s tangible capital plus allowance for loan losses. Our level of NPAs and Texas Ratio decreased from $15.4 million and 64.29%, respectively, at the start of the year to $9.4 million and 39.66% at the end of the year. For the 131 Michigan banks, the mean Texas Ratio was 44.18% (as of December 31, 2010). We made great progress on this initiative in 2010.
Net Interest Margin (NIM)
We finished 2009 with a NIM for the year of 3.26%. For 2010, our NIM rose to 3.78%. This was a 52 basis point improvement year over year. When added to the 33 basis point improvement from 2008 to 2009, that is an 85 basis point improvement since the start of 2009. This was accomplished by changing the mix of our deposits and increasing our core deposits by $11.0 million over the last two years. In addition, we successfully established floors on our variable rate loans as they were rewritten at maturity. For the 4th quarter of 2010 our NIM was 3.93%. We are starting 2011 with a margin near 4.00%. As an institution, our margin has never been higher. This improvement will result in more sustainable levels of profitability for quarters to come.
Non-Interest Income
The Bank has continued to leverage a core competency in this historically low interest rate environment. In 2010 we originated $47.8 million in mortgage loans (average loan size $105,000), as compared to 2009 mortgage production of $58.9 million. However, while production levels were 20% lower in 2010 with many homeowners having already refinanced in 2009, we experienced a slight increase in mortgage-related fees and income which was the result of setting and achieving higher gain on sale requirements. More importantly, we refinanced many loans originated at competitive banks and credit unions, thereby improving our market share in several markets.
Reducing Controllable Expenses
In spite of deep cuts in 2008 and 2009, we continued to focus on controlling the expenses where we have direct control, including employment, professional services and occupancy-related costs. In 2010 we reduced these expenses by $152,800. These reductions partially offset inflated 2010 costs related to collection activities, reduced real estate values and other expenses related to taking back or owning real estate.
There are still challenges that lie ahead. Commercial loan demand is weak; our planned growth in 2011 will come at the expense of our competition. The commercial real estate (CRE) sector is still depressed with inventory levels of unsold commercial properties exceeding the demand of buyers. It may take years before all of the unsold properties are reabsorbed productively into the marketplace. On the mortgage side, there are a large number of households that have kept their mortgages paid current through unemployment benefits which are now exhausted. Any movement of this group toward delinquency could potentially stall or delay the recovery in the housing sector and the economy. Lastly, government reform in the wake of a financial crisis we did nothing to create will unfairly burden the Bank by heaping new regulatory costs upon us while limiting fees we can charge to consumers for the services and products we provide to them.
In spite of these forward-looking challenges, the Board, senior management and I are pleased with where we are today and the progress we made in 2010. Our results reflect process improvements and a disciplined approach that began four years ago. We are encouraged that only a single commercial loan (with a balance of $9,400) that we have underwritten since 2008 has been charged off. Our philosophy with regard to balance sheet diversification and underwriting changes has helped keep our problems contained. Our performance metrics are trending in a manner consistent with our expectations. The changes we have made and progress achieved are important in our continued efforts to build accountability, confidence and to restore the value that has been lost. We have navigated through one of the most challenging economic periods since the Great Depression and have come through not only as a survivor but poised to take advantage of this unique operating environment. While we still expect that the hard-to-control collection and Bank-owned property expenses will continue, at reduced levels, into the foreseeable future, the improved profitability profile of the Bank better positions us to absorb these inflated and hard-to-control expenses. We have a strong capital position, are not tethered by TARP strings, and have established a much better framework to operate from as we move ahead. In 2011 and beyond we will look to build upon the momentum that was created in 2010.
Michael W. Mahler
President and Chief Executive Officer
Selected Consolidated Financial and Other Data of the Company
Set forth below are selected financial and other data of First Federal of Northern Michigan Bancorp, Inc. (the “Company”). This information is derived in part from and should be read in conjunction with the Consolidated Financial Statements of the Company and the notes thereto presented elsewhere in this Annual Report. The information at December 31, 2010 and December 31, 2009 and for the years ended December 31, 2010 and 2009 is derived in part from the audited consolidated financial statements of the Company that appear in this Annual Report. The information for the years ended December 31, 2008, 2007, and 2006 is derived in part from audited consolidated financial statements that do not appear in this Annual Report.
For Years Ended December 31, | ||||||||||||||||||||
2010 | 2009 | 2008 | 2007 | 2006 | ||||||||||||||||
(In thousands) | ||||||||||||||||||||
Total assets | $ | 215,733 | $ | 233,506 | $ | 247,672 | $ | 250,831 | $ | 280,959 | ||||||||||
Loans receivable, net | 157,144 | 171,219 | 192,270 | 201,333 | 209,518 | |||||||||||||||
Loans held for sale | - | 52 | 107 | - | 72 | |||||||||||||||
Investment securities | 37,821 | 37,641 | 29,687 | 23,451 | 44,850 | |||||||||||||||
Cash and cash equivalents | 1,963 | 3,099 | 3,471 | 5,341 | 4,993 | |||||||||||||||
Deposits | 155,466 | 158,100 | 165,778 | 157,833 | 170,530 | |||||||||||||||
FHLB advances and note payable | 29,000 | 45,031 | 40,969 | 52,684 | 66,042 | |||||||||||||||
Repo Sweep agreements | 6,172 | 5,408 | 9,447 | 6,637 | 6,528 | |||||||||||||||
Stockholders' equity | 23,236 | 23,052 | 29,419 | 32,503 | 35,453 | |||||||||||||||
Operating data: | ||||||||||||||||||||
At December 31, | ||||||||||||||||||||
2010 | 2009 | 2008 | 2007 | 2006 | ||||||||||||||||
(In thousands) | ||||||||||||||||||||
Interest income | $ | 11,447 | $ | 12,442 | $ | 13,967 | $ | 16,200 | $ | 17,170 | ||||||||||
Interest expense | 3,447 | 5,088 | 7,130 | 8,437 | 8,548 | |||||||||||||||
Net interest income | 8,000 | 7,354 | 6,837 | 7,763 | 8,622 | |||||||||||||||
Provision for loan losses | 1,101 | 6,196 | 4,421 | 2,377 | 851 | |||||||||||||||
Net interest income after provision for loan losses | 6,899 | 1,158 | 2,416 | 5,386 | 7,771 | |||||||||||||||
Other income (loss): | ||||||||||||||||||||
Service charges and fees | 804 | 869 | 942 | 911 | 1,044 | |||||||||||||||
Mortgage banking activities | 1,438 | 1,414 | 432 | 418 | 344 | |||||||||||||||
Net gain (loss) on sale of investment securities | 546 | - | 6 | (97 | ) | (45 | ) | |||||||||||||
Gain (loss) on sale of real estate | (43 | ) | 20 | 22 | (40 | ) | 4 | |||||||||||||
Other non-interest income | 301 | 102 | 95 | 64 | 103 | |||||||||||||||
Insurance & brokerage commissions | 159 | 170 | 180 | 180 | 180 | |||||||||||||||
Total other income | 3,205 | 2,575 | 1,677 | 1,436 | 1,630 | |||||||||||||||
Other expenses | 9,866 | 9,360 | 8,874 | 9,313 | 8,761 | |||||||||||||||
Income (loss) from continuing operations before income tax expense (benefit) | 238 | (5,627 | ) | (4,781 | ) | (2,491 | ) | 640 | ||||||||||||
Income tax expense (benefit) from continuing operations | - | 1,090 | (1,601 | ) | (908 | ) | 164 | |||||||||||||
Net income (loss) from continuing operations | 238 | (6,717 | ) | (3,180 | ) | (1,583 | ) | 476 | ||||||||||||
Loss from discontinued operations, net of tax benefit | - | (46 | ) | (61 | ) | (17 | ) | (13 | ) | |||||||||||
Net income (loss) | $ | 238 | $ | (6,763 | ) | $ | (3,241 | ) | $ | (1,600 | ) | $ | 463 |
Key Financial Ratios and Other Data: | ||||||||||||||||||||
For Years Ended December 31, | ||||||||||||||||||||
2010 | 2009 | 2008 | 2007 | 2006 | ||||||||||||||||
Performance Ratios: | ||||||||||||||||||||
Return on average assets | 0.10 | % | -2.80 | % | -1.30 | % | -0.60 | % | 0.16 | % | ||||||||||
Return on average equity | 0.99 | % | -23.21 | % | -10.05 | % | -4.84 | % | 1.35 | % | ||||||||||
Average interest rate spread | 3.60 | % | 2.97 | % | 2.51 | % | 2.68 | % | 2.83 | % | ||||||||||
Dividend payout ratio | 0.00 | % | 0.00 | % | N/M | *** | N/M | *** | 133.33 | % | ||||||||||
Dividends per share | $ | 0.00 | $ | 0.00 | $ | 0.15 | $ | 0.20 | $ | 0.20 | ||||||||||
Net interest margin | 3.78 | % | 3.26 | % | 2.93 | % | 3.13 | % | 3.24 | % | ||||||||||
Efficiency ratio (Bank) | 102.76 | % | 252.19 | % | 104.54 | % | 101.18 | % | 89.37 | % | ||||||||||
Non-interest expense to average total assets | 4.33 | % | 3.88 | % | 3.56 | % | 4.45 | % | 4.04 | % | ||||||||||
Average interest-earning assets to average interest-bearing liabilities | 111.20 | % | 113.32 | % | 113.85 | % | 113.65 | % | 112.99 | % | ||||||||||
Asset Quality Ratios: | ||||||||||||||||||||
Non-performing assets to total assets | 4.37 | % | 6.58 | % | 5.57 | % | 4.15 | % | 1.59 | % | ||||||||||
Non-performing loans to total loans | 4.13 | % | 6.73 | % | 6.14 | % | 4.54 | % | 1.90 | % | ||||||||||
Allowance for loan losses to nonperforming loans | 42.85 | % | 31.05 | % | 46.41 | % | 43.93 | % | 52.24 | % | ||||||||||
Allowance for loan losses to total loans | 1.77 | % | 2.09 | % | 2.85 | % | 1.95 | % | 0.98 | % | ||||||||||
Capital Ratios: | ||||||||||||||||||||
Equity to total assets at end of period | 10.77 | % | 9.87 | % | 11.88 | % | 12.96 | % | 12.62 | % | ||||||||||
Average equity to average assets | 10.47 | % | 12.07 | % | 12.44 | % | 12.38 | % | 12.07 | % | ||||||||||
Risk-based capital ratio (Bank only) | 15.57 | % | 13.58 | % | 15.75 | % | 16.27 | % | 17.07 | % | ||||||||||
Other Data: | ||||||||||||||||||||
Number of full service offices | 8 | 8 | 8 | 9 | ** | 10 | * |
*as of December 31, 2006. In February 2007, the Bank closed a branch to reduce its full-service offices to 9.
**as of December 31, 2007. In February 2008, the Bank closed a branch to reduce its full-service offices to 8.
***Not meaningful
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
First Federal of Northern Michigan (the “Bank”), the Company’s principal operating subsidiary, is a full-service, community-oriented savings bank whose primary lending activity is the origination of one- to four-family residential real estate mortgages, commercial real estate loans, commercial loans and consumer loans. As of December 31, 2010, $71.7 million, or 44.8%, of our total loan portfolio consisted of one- to four-family residential real estate loans, $61.0 million, or 38.0%, and $8.8 million, or 5.5%, of our total loan portfolio consisted of commercial mortgage loans and commercial loans, respectively, and $18.7 million, or 11.7%, of our total loan portfolio consisted of consumer and other loans. In recent years, commercial mortgage loans and commercial loans have grown as a percentage of our loan portfolio for three reasons. First, we have increased our emphasis on originating these loans, which generally have higher interest rates compared to one- to four-family residential real estate loans. In addition, most of these loans are originated with adjustable interest rates, which assist us in managing interest rate risk. Finally, most of our one- to four-family residential mortgage loan customers prefer fixed-rate loans in the low interest rate environment that has prevailed over the last several years. Since we sell into the secondary mortgage market a majority of the fixed-rate one- to four-family residential mortgage loans that we originate, one- to four-family residential real estate loans have decreased as a percentage of our total loan portfolio.
Our results of operations depend primarily on our net interest income, which is the difference between the interest income we receive on our interest-earning assets, such as loans and securities, and the interest expense we pay on our deposits and borrowings. Our results of operations are also affected by non-interest income and non-interest expense, the provision for loan losses and income tax expense. Non-interest income consists primarily of banking fees, service charges, insurance commissions, mortgage banking activities and security transactions. Our non-interest expense consists primarily of salaries and employee benefits, FDIC insurance premiums, occupancy and office expenses, advertising and promotion expense, data processing expenses and expenses related to troubled credits and repossessed properties.
Our results of operations are significantly affected by general economic and competitive conditions, and particularly changes in market interest rates, government policies and actions of regulatory authorities. Numerous factors that are beyond our control can cause market interest rates to increase or decline. In addition, we are unable to predict future changes in government policies and actions of regulatory authorities that could have a material impact on our financial performance. As a result, we believe that changes in market interest rates, government policies and actions of regulatory authorities represent the primary uncertainties in predicting our future performance.
Business Strategy
Operating as a Community Savings Bank. We are committed to meeting the financial needs of the communities in which we operate. Our branch network of eight offices enhances our ability to serve these communities. We provide a broad range of individualized consumer and business financial services. We believe that we can be more effective in servicing our customers than many of our non-local competitors because our employees and senior management are able to respond promptly to customer needs and inquiries. Our ability to provide these services is enhanced by the experience of our senior management, which has an average of 19 years’ experience in the financial services industry.
Increasing Our Commercial Real Estate and Commercial Lending. Beginning in 2001, we began to increase our originations of commercial real estate and commercial loans. At December 31, 2010, loans secured by commercial real estate totaled $61.0 million, or 38.0% of our total loan portfolio, and commercial loans totaled $8.8 million, or 5.5% of our total loan portfolio. Commercial real estate and commercial loans generally are originated with higher interest rates compared to one- to four-family residential real estate loans and, therefore, have a positive effect on our net interest rate spread and net interest income. In addition, most of these loans are originated with adjustable interest rates, which assists us in managing interest rate risk. We believe that our branch network will enable us to continue to increase our commercial and commercial real estate loan portfolio without significant additional fixed costs. As market conditions allow, we will continue to originate these types of loans in the future to viable borrowers and retain them in our portfolio. However, in 2011, in light of the continued difficult operating environment in our market area, we expect our focus will continue to be more on credit quality than on origination of new loans. In 2007 we began participating, on a limited basis, in commercial opportunities outside of our market areas and, in some cases, outside of the State or Michigan to help mitigate the geographic risk of lending only in Michigan. We had no new out-of-state commercial participations in 2010.
Increasing Our Share of Lower-Cost Deposits. In past years our cost of funds has been relatively high as we accepted higher-cost long-term certificates of deposit to fund our long-term assets such as one- to four-family residential mortgage loans. As we have increased our origination of shorter-term commercial real estate and commercial loans, most of which are originated with adjustable interest rates, we have decreased our need for higher-cost long-term certificates of deposit. We intend to continue to lower our cost of funds by increasing our share of lower-cost short-term certificates of deposit and lower-cost money market deposits. We typically are not a market leader in deposit rates, although from time-to-time we do offer higher rates as liquidity needs dictate. We also intend to continue to market our non-interest-bearing checking accounts in conjunction with our focus on commercial business lending. We grew our core deposits by $7.5 million in 2010.
Maintaining High Asset Quality and Capital Strength. We are committed to conservative loan underwriting standards and procedures, and we primarily originate loans secured by real estate. As a result, we have historically experienced low levels of late payments and losses on loans. However, during the economic recession that continued to deepen in 2009 and 2010, we have seen delinquency trends increase despite our conservative underwriting practices due to declining economic conditions and increasing unemployment in our market area. Despite the increase in delinquency trends, at December 31, 2010, our ratio of non-performing assets to total assets was 4.37% as compared to 6.58% at December 31, 2009. At December 31, 2010, our ratio of equity to assets was 10.77%. Despite losses over the years from 2007 to 2009, our Bank has regulatory capital at levels in excess of regulatory requirements and is categorized as “well capitalized.”
Managing Our Interest Rate Risk Exposure by Selling Fixed-Rate Residential Real Estate Loans. Historically, most borrowers have preferred long-term, fixed-rate residential real estate loans when, as now, market interest rates are at relatively low levels. These loans expose us to interest rate risk because our liabilities, consisting primarily of deposits, have relatively short maturities. In order to better match the maturities of our loan portfolio to the maturities of our deposits in the current low interest rate environment, we have sold substantially all of the fixed-rate, one- to four-family residential real estate loans with maturities of 15 years or more that we have originated since 2002, and we intend to continue this practice for so long as interest rates remain at relatively low levels.
Comparison of Financial Condition at December 31, 2010 and 2009
Total assets decreased $17.8 million, or 7.6%, to $215.7 million at December 31, 2010 from $233.5 million at December 31, 2009. Net loans decreased $14.1 million, or 8.2% to $157.1 million at December 31, 2010 from $171.2 million at December 31, 2009. Mortgage loan originations decreased by $11.1 million to $47.8 million in 2010 from $58.9 million in 2009. During that time period, our mortgage loan portfolio decreased $9.9 million, or 12.2%, to $71.7 million. The decrease in the portfolio was due to our continued focus on selling lower rate mortgage loans into the secondary market where possible. The commercial loan portfolio decreased 3.2% to $69.9 million at December 31, 2010 from $72.2 million at December 31, 2009 due in part to normal principal pay downs but also to net commercial loan charge-offs of $1.4 million in 2010. Cash and cash equivalents decreased by $1.1 million, or 35.5%, to $2.0 million at December 31, 2010 from $3.1 million at December 31, 2009. Investment securities increased $180,000, or 0.5%, to $37.8 million at December 31, 2010 from $37.6 million at December 31, 2009.
Deposits decreased $2.6 million, or 1.7%, to $155.5 million at December 31, 2010 from $158.1 million at December 31, 2009. This decrease was due in large part to our “liquid” certificate of deposit accounts. As these deposits matured and were set to reprice lower, some moved into our money market product, but some left the Bank. Our focus in 2010 continued to be on building deposit relationships rather than attracting higher-cost non-core certificate of deposit accounts, although from time-to-time we offered higher rates as liquidity needs dictated. REPO Sweep accounts increased $764,000, or 14.1% to $6.2 million at December 31, 2010 from $5.4 million at December 31, 2009. Borrowings, consisting primarily of FHLB advances, decreased $16.0 million, or 35.6%, to $29.0 million at December 31, 2010 from $45.0 million at December 31, 2009 as our asset base decreased over that same time period..
Stockholders’ equity increased $184,000, or 0.8%, to $23.2 million at December 31, 2010 from $23.1 million at December 31, 2009. The increase was mainly a result of our net income for the year of $238,000.
Comparison of Operating Results for the Years Ended December 31, 2010 and 2009
General. Net income from continuing operations increased to $238,000 for the year ended December 31, 2010 from a loss of $6.7 million for the year ended December 31, 2009. Net interest income before provision for loan losses was $646,000 higher in 2010 than in 2009, due in large part to our increased net interest margin year over year. The provision for loan losses was $5.1 million lower in 2010 than in 2009, resulting in net interest income after provision for loan losses which was $5.7 million higher in 2010 than in 2009. Non-interest income related to continuing operations was $630,000 higher in 2010 than in 2009. Non-interest expenses related to continuing operations were $506,000 higher in 2010 than in 2009 due in large part to a continued decline in market values on real estate owned.
Interest Income. Interest income decreased by $995,000, or 8.0%, to $11.4 million for the year ended December 31, 2010 from $12.4 million for the year ended December 31, 2009. The decrease was primarily due to a decrease in the average balance of our loan portfolio of $20.4 million, or 10.8%, year over year. The average balance of our non-mortgage loans, principally commercial loans and consumer loans, decreased by $11.7 million, or 11.3%, to $91.5 million for the twelve months ended December 31, 2010 from $103.1 million for the twelve months ended December 31, 2009. The average yield on our commercial loans increased 40 basis points and the average yield on our consumer loans decreased 17 basis points from 2009 to 2010. The average balance of our one- to four-family residential mortgage loans decreased to $77.3 million for the year ended December 31, 2010 from $86.0 million for the year ended December 31, 2009, while the average yield on such loans decreased slightly to 6.22% from 6.25%.
Interest Expense. Interest expense decreased to $3.4 million for the year ended December 31, 2010 from $5.1 million for the year ended December 31, 2009, due primarily to an $8.9 million, or 4.5%, decrease in the average balance of interest bearing liabilities. The average balance of interest-bearing deposits decreased by $4.2 million from 2009 to 2010, while the average cost of those deposits decreased 73 basis points to 1.58% for 2010 from 2.31% for 2009, reflecting a continued decline in market interest rates during 2010. The average balance of FHLB borrowings decreased $3.6 million from 2009 to 2010 while the cost of those borrowings decreased from 3.79% to 2.90% year over year. During 2010 certain high-cost FHLB bank advances matured and were paid off with available cash, leaving a balance of lower costing advances. The average balance of REPO Sweep accounts decreased $1.1 million year over year, while the average cost of these accounts increased 9 basis points from 0.38% for 2009 to 0.47% for 2010.
Net Interest Income. Net interest income increased to $8.0 million for the year ended December 31, 2010 from $7.4 million for the year ended December 31, 2009. The increase was primarily due to an increase of 63 basis points in our average interest rate spread to 3.60% for the year ended December 31, 2010 from 2.97% for the year ended December 31, 2009.
Provision for Loan Losses. We recorded a provision for loan losses of $1.1 million for the year ended December 31, 2010 compared to a provision of $6.2 million for the year ended December 31, 2009. We had net charge-offs of $1.9 million and $8.2 million during 2010 and 2009, respectively. The decrease from 2009 to 2010 was reflective of the decline in our non-performing loans. The allowance for loan losses was $2.8 million, or 1.77% of total loans at December 31, 2010, compared to $3.7 million, or 2.09% of total loans at December 31, 2009. The level of the allowance is based on estimates, and ultimate losses may vary from estimates. Total non-performing loans were $6.6 million at December 31, 2010 and $11.8 million at December 31, 2009. Management has developed an aggressive plan for 2011 and beyond designed to continue to reduce the level of non-performing loans and other non-performing assets.
Non-Interest Income. Non-interest income related to continuing operations increased to $3.2 million for the year ended December 31, 2010 from $2.6 million for the year ended December 31, 2009. This increase was primarily the result of an increase of $545,000 in gain on sale of investment securities to $546,000 for the year ended December 31, 2010 as compared to $1,000 for the year ended December 31, 2009. Service charges and other fees decreased $65,000 from $869,000 in 2009 to $804,000 in 2010, due in large part to a decrease in insufficient funds fees, which we expect to continue into 2011 due to regulatory changes relating to overdraft fees.
Non-Interest Expense. Non-interest expense related to continuing operations increased to $9.9 million for the year ended December 31, 2010 from $9.4 million for the year ended December 31, 2009. FDIC premiums decreased $114,000 to $366,000 in 2010 from $480,000 in 2009, due in part to a decrease in deposits year over year and in part to an FDIC special assessment of $108,0000 paid during 2009. Other expense increased $755,000 to $2.5 million in 2010 from $1.7 million in 2009, due mainly to increased expenses associated with our real estate owned, including costs to repossess and repair properties and declines in the market value of many of these properties due to continued declining real estate market values in 2010. Professional fees decreased by $53,000 to $425,000 for the year ended December 31, 2010 from $478,000 for the year ended December 31, 2009 due in part to non-recurring fees incurred during 2009.
Income Taxes. Federal income taxes related to losses from continuing operations decreased to an expense of $0 for the year ended December 31, 2010 from $1.1 million for the year ended December 31, 2009.
Average Balance Sheet
The following tables set forth average balance sheets, average yields and costs, and certain other information for the periods indicated. No tax-equivalent yield adjustments were made, as the effect thereof was not material. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.
Average Consolidated Statements of Condition | ||||||||||||||||||||||||||||||||||||||||||||
For Years Ended December 31, | ||||||||||||||||||||||||||||||||||||||||||||
As of December 31, 2010 | 2010 | 2009 | 2008 | |||||||||||||||||||||||||||||||||||||||||
Average | Average | Average | ||||||||||||||||||||||||||||||||||||||||||
Yield / | Average | Yield / | Average | Yield / | Average | Yield / | ||||||||||||||||||||||||||||||||||||||
Balance | Rate | Balance | Interest | Rate | Balance | Interest | Rate | Balance | Interest | Rate | ||||||||||||||||||||||||||||||||||
(In thousands) | (In thousands) | (In thousands) | ||||||||||||||||||||||||||||||||||||||||||
Interest-earning assets: | ||||||||||||||||||||||||||||||||||||||||||||
Mortgage loans | $ | 77,280 | $ | 4,806 | $ | 86,015 | $ | 5,372 | $ | 94,787 | $ | 5,969 | ||||||||||||||||||||||||||||||||
Non-mortgage loans | 91,470 | 5,327 | 103,134 | 5,732 | 104,983 | 6,619 | ||||||||||||||||||||||||||||||||||||||
Loans | $ | 157,144 | 5.83 | % | 168,750 | 10,133 | 6.00 | % | 189,149 | 11,104 | 5.87 | % | 199,770 | 12,588 | 6.30 | % | ||||||||||||||||||||||||||||
Mortgage-backed securities | 25,684 | 2.65 | % | 18,973 | 648 | 3.42 | % | 13,714 | 577 | 4.21 | % | 10,071 | 421 | 4.18 | % | |||||||||||||||||||||||||||||
Other Investment securities | 12,137 | 3.43 | % | 16,940 | 568 | 3.35 | % | 18,316 | 646 | 3.53 | % | 16,423 | 671 | 4.09 | % | |||||||||||||||||||||||||||||
Investment securities | 37,821 | 2.89 | % | 35,913 | 1,216 | 3.39 | % | 32,030 | 1,223 | 3.82 | % | 26,494 | 1,092 | 4.12 | % | |||||||||||||||||||||||||||||
Other investments | 4,826 | 1.47 | % | 7,151 | 98 | 1.37 | % | 4,784 | 115 | 2.40 | % | 8,387 | 297 | 3.54 | % | |||||||||||||||||||||||||||||
Total interest earning assets | 199,791 | 5.17 | % | 211,814 | 11,447 | 5.41 | % | 225,963 | 12,442 | 5.51 | % | 234,651 | 13,967 | 5.95 | % | |||||||||||||||||||||||||||||
Non Interest Earning Assets | 15,942 | 15,809 | 15,417 | 14,709 | ||||||||||||||||||||||||||||||||||||||||
Total Assets | $ | 215,733 | $ | 227,623 | $ | 241,380 | $ | 249,360 | ||||||||||||||||||||||||||||||||||||
Interest bearing liabilities: | ||||||||||||||||||||||||||||||||||||||||||||
Savings Deposits | $ | 16,785 | 0.05 | % | $ | 16,053 | $ | 8 | 0.06 | % | $ | 15,123 | $ | 17 | 0.12 | % | $ | 15,071 | $ | 25 | 0.18 | % | ||||||||||||||||||||||
Money market/NOW accounts | 44,107 | 0.46 | % | 41,845 | 324 | 0.76 | % | 36,558 | 384 | 1.04 | % | 28,889 | 415 | 1.43 | % | |||||||||||||||||||||||||||||
Certificates of deposit | 84,225 | 1.94 | % | 88,379 | 1,964 | 2.22 | % | 98,772 | 3,056 | 3.09 | % | 107,213 | 4,457 | 4.16 | % | |||||||||||||||||||||||||||||
Total Interest bearing deposits | 145,117 | 1.27 | % | 146,277 | $ | 2,296 | 1.57 | % | 150,453 | $ | 3,457 | 2.30 | % | 151,173 | $ | 4,897 | 3.24 | % | ||||||||||||||||||||||||||
Borrowed funds | 35,172 | 2.00 | % | 44,211 | 1,151 | 2.60 | % | 48,942 | 1,631 | 3.33 | % | 55,104 | 2,233 | 4.05 | % | |||||||||||||||||||||||||||||
Total Interest bearing liabilities | 180,289 | 1.41 | % | 190,488 | 3,447 | 1.81 | % | 199,395 | 5,088 | 2.55 | % | 206,277 | 7,130 | 3.44 | % | |||||||||||||||||||||||||||||
Non interest bearing liabilities | 12,208 | 13,312 | 12,848 | 10,849 | ||||||||||||||||||||||||||||||||||||||||
Total liabilities | 192,497 | 203,800 | 212,243 | 217,126 | ||||||||||||||||||||||||||||||||||||||||
Stockholders' equity | 23,236 | 23,823 | 29,137 | 32,234 | ||||||||||||||||||||||||||||||||||||||||
Total Liabilities & stockholders' equity | $ | 215,733 | $ | 227,623 | $ | 241,380 | $ | 249,360 | ||||||||||||||||||||||||||||||||||||
Net interest income | $ | 8,000 | $ | 7,354 | $ | 6,837 | ||||||||||||||||||||||||||||||||||||||
Interest rate spread | 3.76 | % | 3.60 | % | 2.97 | % | 2.51 | % | ||||||||||||||||||||||||||||||||||||
Net interest-earning assets | $ | 21,326 | $ | 26,568 | $ | 28,374 | ||||||||||||||||||||||||||||||||||||||
Net interest margin (1) | 3.89 | % | 3.78 | % | 3.26 | % | 2.93 | % | ||||||||||||||||||||||||||||||||||||
Average interest-earning assets | ||||||||||||||||||||||||||||||||||||||||||||
to average interest-bearing liabilities | 110.82 | % | 111.20 | % | 113.32 | % | 113.76 | % | ||||||||||||||||||||||||||||||||||||
(1) Net interest margin represents net interest income divided by the interest-earning assets. |
Rate/Volume Analysis
The following table sets forth certain information regarding changes in interest income and interest expense of the Company during the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided in each category with respect to (i) changes attributable to changes in volume (change in volume multiplied by prior rate), (ii) changes in rates (changes in rate multiplied by prior average volume), and (iii) the net change. Changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.
Year ended December 31, 2010 | ||||||||||||
Compared to | ||||||||||||
Year ended December 31, 2009 | ||||||||||||
Increase (Decrease) Due to: | ||||||||||||
Volume | Rate | Total | ||||||||||
(In thousands) | ||||||||||||
Interest-earning assets: | ||||||||||||
Loans receivable | $ | (1,245 | ) | $ | 274 | $ | (971 | ) | ||||
Investment securities | 146 | (154 | ) | $ | (8 | ) | ||||||
Other investments | 44 | (60 | ) | $ | (16 | ) | ||||||
Total interest-earning assets | (1,055 | ) | 60 | (995 | ) | |||||||
Interest-bearing liabilities: | ||||||||||||
Savings Deposits | 1 | (10 | ) | (9 | ) | |||||||
Money Market/NOW accounts | 73 | (133 | ) | (60 | ) | |||||||
Certificates of Deposit | (392 | ) | (700 | ) | (1,092 | ) | ||||||
Deposits | (318 | ) | (843 | ) | (1,161 | ) | ||||||
Borrowed funds | (185 | ) | (295 | ) | (480 | ) | ||||||
Total interest-bearing liabilities | (503 | ) | (1,138 | ) | (1,641 | ) | ||||||
Change in net interest income | $ | (552 | ) | $ | 1,198 | $ | 646 |
Year ended December 31, 2009 | ||||||||||||
Compared to | ||||||||||||
Year ended December 31, 2008 | ||||||||||||
Increase (Decrease) Due to: | ||||||||||||
Volume | Rate | Total | ||||||||||
(In thousands) | ||||||||||||
Interest-earning assets: | ||||||||||||
Loans receivable | $ | (665 | ) | $ | (819 | ) | $ | (1,484 | ) | |||
Investment securities | 293 | (160 | ) | $ | 133 | |||||||
Other investments | 4 | (178 | ) | $ | (174 | ) | ||||||
Total interest-earning assets | (368 | ) | (1,157 | ) | (1,525 | ) | ||||||
Interest-bearing liabilities: | ||||||||||||
Savings Deposits | 1 | (8 | ) | (7 | ) | |||||||
Money Market/NOW accounts | 15,196 | (15,228 | ) | (32 | ) | |||||||
Certificates of Deposit | (401 | ) | (1,000 | ) | (1,401 | ) | ||||||
Deposits | 14,796 | (16,236 | ) | (1,440 | ) | |||||||
Borrowed funds | (350 | ) | (252 | ) | (602 | ) | ||||||
Total interest-bearing liabilities | 14,446 | (16,488 | ) | (2,042 | ) | |||||||
Change in net interest income | $ | (14,814 | ) | $ | 15,331 | $ | 517 |
Management of Interest Rate Risk
Qualitative Analysis. Our most significant form of market risk is interest rate risk. The general objective of our interest rate risk management is to determine the appropriate level of risk given our business strategy, and then manage that risk in a manner that is consistent with our policy to reduce the exposure of our net interest income to changes in market interest rates. First Federal of Northern Michigan’s asset/liability management committee (“ALCO”), which consists of senior management, evaluates the interest rate risk inherent in our assets and liabilities, our operating environment and capital and liquidity requirements, and modifies our lending, investing and deposit-taking strategies accordingly. The Board of Directors reviews the ALCO’s activities and strategies, the effect of those strategies on our net interest margin, and the effect that changes in market interest rates would have on the economic value of our loan and securities portfolios, as well as the intrinsic value of our deposits and borrowings.
We actively evaluate interest rate risk in connection with our lending, investing and deposit-taking activities. Generally, our loans, which represent the significant majority of our assets, have longer-terms to maturity than our deposits, which represent the significant majority of our liabilities. As of December 31, 2010, $134.7 million, or 84.1% of our loan portfolio, consisted of loans that mature or reprice after December 31, 2011. In contrast, as of December 31, 2010, $52.1 million, or 61.8% of our time deposits as of that date, consisted of deposits that mature or reprice in less than one year.
In an effort to manage interest rate risk, we have increased our focus on the origination and retention in our portfolio of adjustable-rate residential mortgage loans. In addition, we have increased the origination and retention in our portfolio of commercial real estate and commercial loans, since most of these loans are originated with adjustable interest rates. In the current low interest rate environment, we also have generally sold into the secondary mortgage market all of the fixed-rate, longer-term (15 years or more) residential mortgage loans that we originate, generally on a servicing-retained basis. Finally, we have primarily invested in short- and medium-term securities and have maintained high levels of liquid assets, such as cash and cash equivalents. Shortening the average maturity of our interest-earning assets through these strategies helps us to better match the maturities and interest rates of our assets and liabilities, thereby reducing the exposure of our net interest income to changes in market interest rates. Maintaining high levels of liquid assets also permits us to invest in higher-yielding securities and loans when market interest rates increase. However, these strategies can be expected to adversely affect net interest income if long-term interest rates remain at low levels. We expect that as long-term interest rates rise, as we expect, we will reduce our mortgage-banking operations, and will retain in our portfolio a larger percentage of the one- to four-family loans that we originate.
Quantitative Analysis. We evaluate interest rate sensitivity using a model that estimates the change in our net portfolio value (“NPV”) over a range of interest rate scenarios. NPV is the discounted present value of expected cash flows from assets, liabilities and off-balance sheet contracts. In calculating changes in NPV, we assume estimated loan prepayment rates, reinvestment rates and deposit decay rates that we judge most likely based on historical experience during prior interest rate changes.
The table below sets forth, as of December 31, 2010, the estimated changes in our NPV that would result from the designated instantaneous changes in the U.S. Treasury yield curve. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results.
Change in Interest | NPV as a Percentage of Present Value of Assets (3) | |||||||||||||||||||
Rates (basis points) | Estimated Increase (Decrease) in NPV | Increase (Decrease) | ||||||||||||||||||
(1) | Estimated NPV (2) | Amount | Percent | NPV Ratio (4) | (basis points) | |||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
+300 | 27,191 | (4,671 | ) | -15.0 | % | 12.39 | % | (161 | ) | |||||||||||
+200 | 30,753 | (1,109 | ) | -3.0 | % | 13.73 | % | (28 | ) | |||||||||||
+100 | 31,520 | (342 | ) | -1.0 | % | 13.95 | % | (6 | ) | |||||||||||
+50 | 31,442 | (420 | ) | -1.0 | % | 13.89 | % | (12 | ) | |||||||||||
— | 31,862 | — | — | 14.01 | % | — | ||||||||||||||
-50 | 32,025 | 162 | 1.0 | % | 14.03 | % | 2 | |||||||||||||
-100 | 32,125 | 263 | 1.0 | % | 14.04 | % | 4 |
(1) | Assumes an instantaneous uniform change in interest rates at all maturities. |
(2) | NPV is the discounted present value of expected cash flows from assets, liabilities and off-balance sheet contracts. |
(3) | Present value of assets represents the discounted present value of incoming cash flows on interest-earning assets. |
(4) | NPV Ratio represents NPV divided by the present value of assets. |
The table set forth above indicates that at December 31, 2010, in the event of an immediate 100 basis point decrease in interest rates, we would be expected to experience a 1% increase in NPV and a 4 basis point increase in NPV ratio. In the event of an immediate 200 basis point increase in interest rates, we would be expected to experience a 3% decrease in NPV and a 28 basis point decrease in NPV ratio.
Certain shortcomings are inherent in the methodology used in the above interest rate risk measurements. Modeling changes in NPV and net interest income requires making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. The NPV and net interest income table presented above assumes that the composition of our interest-rate sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and, accordingly, the data do not reflect any actions management may undertake in response to changes in interest rates. The table also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or the repricing characteristics of specific assets and liabilities. Accordingly, although the NPV and net interest income table provides an indication of our sensitivity to interest rate changes at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results.
Cash Flows
Cash flows provided by operations were $3.5 million in 2010 as compared to cash used in operations of $1.0 million in 2009 due to net earnings in 2010 as compared to net loss in 2009, partially offset by a decrease in prepaid FDIC premiums and other assets year over year. Cash flows provided by investing activities increased from $8.3 million in 2009 to $13.2 million in 2010 mainly due to a net decrease in our investment portfolio year over year. Cash used in financing activities increased from $7.7 million in 2009 to $17.9 million in 2010 due primarily to the decrease in our outstanding Federal Home Loan Bank (FHLB) advances. As our loan and investment portfolios decreased we paid down FHLB advances and improved our net interest margin.
Liquidity and Capital Resources
The overall objective of our liquidity management is to ensure the availability of sufficient cash funds to meet all financial commitments and to take advantage of investment opportunities. We manage liquidity in order to meet deposit withdrawals on demand or at contractual maturity, to repay borrowings as they mature, and to fund new loans and investments as opportunities arise.
Our primary sources of funds are deposits, principal and interest payments on loans and securities, and, to a lesser extent, borrowings (Federal Home Loan Bank advances), the proceeds from maturing securities and short-term investments, and the proceeds from the sales of loans and securities. The scheduled amortization of loans and securities, as well as proceeds from borrowings, are predictable sources of funds. Other funding sources, however, such as deposit inflows, mortgage prepayments, mortgage loan sales and mortgage-backed securities sales are greatly influenced by market interest rates, economic conditions and competition.
Liquidity represents the amount of our assets that can be quickly and easily converted into cash without significant loss. Our most liquid assets are cash, short-term U.S. Government securities and U.S. Government agency or government-sponsored enterprise securities. We are required to maintain sufficient levels of liquidity as defined by the Office of Thrift Supervision regulations. Current regulations require that we maintain sufficient liquidity to ensure our safe and sound operation. Our current objective is to maintain liquid assets equal to at least 20% of total deposits and Federal Home Loan Bank borrowings due in one year or less. Liquidity as of December 31, 2010 was $35.4 million, or 28.5% of total deposits and Federal Home Loan Bank borrowings due in one year or less, compared to $27.5 million, or 22.0% of this amount at December 31, 2009. The levels of liquidity are dependent on our operating, financing, lending and investing activities during any given period. Our calculation of liquidity includes additional borrowing capacity available with the Federal Home Loan Bank. As of December 31, 2010, we had unused borrowing capacity of $17.8 million. We can pledge additional collateral in the form of investment securities and certain loans to increase our borrowing capacity.
We currently retain in our portfolio all adjustable-rate residential mortgage loans, short-term balloon mortgage loans and fixed-rate residential mortgage loans with maturities of less than 15 years, and generally sell the remainder in the secondary mortgage market. We also originate for retention in our loan portfolio, commercial and commercial real estate loans, including real estate development loans. During the year ended December 31, 2010, we originated $47.8 million of one- to four-family residential mortgage loans, of which $5.6 million were retained in our portfolio and the remainder were sold into the secondary mortgage market or are being held for sale. This compares to $58.9 million of one- to four-family originations during the year ended December 31, 2009, of which $9.4 million were retained in our portfolio. At December 31, 2010, we had outstanding loan commitments of $27.2 million. These commitments included $11.1 million for permanent one- to four-family residential mortgage loans, $1.0 million for non-residential loans, $92,000 of undisbursed loan proceeds for construction of one- to four-family residences, $4.2 million of undisbursed lines of credit on home equity loans, $1.2 million of unused credit card lines, $7.3 million of unused commercial lines of credit, and $847,000 of undisbursed commercial construction loans, unused bounce protection.of $1.5 million and letters of credit of $5,000.
Deposits are a primary source of funds for use in lending and for other general business purposes. At December 31, 2010, deposits funded 72.1% of our total assets compared to 67.7% at December 31, 2009. Certificates of deposit scheduled to mature in less than one year at December 31, 2010 totaled $52.1 million. We believe that a significant portion of such deposits will remain with us. We monitor the deposit rates offered by competitors in our market area, and we set rates that take into account the prevailing market conditions along with our liquidity position. Moreover, we currently believe that the growth in assets is not expected to require significant in-flows of liquidity. As such, we do 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 also may be used on a longer-term basis to support increased lending or investment activities. At December 31, 2010, we had $29.0 million in Federal Home Loan Bank advances and no outstanding advances at the Federal Reserve Discount Window. Total borrowings as a percentage of total assets were 13.4% at December 31, 2010 compared to 19.3% at December 31, 2009.
As of December 31, 2010, management was not aware of any known trends, events or uncertainties that have or are reasonably likely to have a material impact on our liquidity. As of December 31, 2010, we had no material commitments for capital expenditures.
Our cash flows are derived from operating activities, investing activities and financing activities as reported in our Consolidated Statement of Cash Flows included with our Consolidated Financial Statements.
First Federal of Northern Michigan is subject to federal regulations that impose minimum capital requirements. At December 31, 2010, we exceeded all applicable capital requirements.
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 estimates about various matters.
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, 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. To illustrate, if recent loss experience dictated that the projected loss ratios would be increased by 10% (of the estimate) across all risk ratings, the allocated allowance as of December 31, 2010 would have changed by approximately $275,000. 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 of mortgage loans and sale of those 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 December 31, 2010, we were servicing loans sold to others totaling $144.9 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 December 31, 2010 included the following:
Annual constant prepayment speed (CPR): | 15.7 | % | ||
Weighted average life remaining (in months): | 246 | |||
Discount rate used: | 8.0 | % |
At the December 31, 2010 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 40 months. The book value of our mortgage servicing rights as of December 31, 2010 was $960,000 which was less than the independent valuation: therefore there was no need to establish a valuation allowance.
Impairment of Intangible Assets. On June 12, 2003, we acquired 100% of the stock of the InsuranCenter of Alpena (ICA). We allocated the excess of the purchase price paid over the fair value of net assets acquired to intangible assets, including goodwill. On February 27, 2009 the Company sold the majority of the assets of ICA. The remaining goodwill on our books of $600,000 related to certain assets of the Company that were not sold in the sale of ICA. We allocated the goodwill between the assets sold and the assets retained and determined a value of the assets that remained of $600,000. Since the $600,000 allocation relates to a finite life asset, we re-characterized the goodwill as an amortizable intangible and began amortizing the asset in March 2009. The intangible asset was analyzed for impairment at December 31, 2010.
We have in the past purchased a branch or branches from other financial institutions. Our analysis of these branch acquisitions led us to conclude that in each case, we acquired a business and therefore, the excess of purchase price over fair value of net assets acquired has been allocated to core deposit intangible assets. Our conclusion was based on the fact that in each case we acquired employees, customers and branch facilities. The expected life for core deposit intangibles is based on the type of products acquired in an acquisition. The amortization periods range from 10 to 15 years and are based on the expected life of the products. The expected life was determined based on an analysis of the life of similar products within the Company and local competition in the markets where the branches were acquired. The core deposit intangibles are amortized on a straight line basis. The core deposit intangible is analyzed annually for impairment.
Valuation of Deferred Tax Assets. The Company records a valuation allowance if it believes, based on available evidence, that it is “more likely than not” that the future tax assets recognized will not be realized before their expiration. Realization of the Company’s deferred tax assets is primarily dependent upon the generation of a sufficient level of future taxable income.
At December 31, 2010 and 2009, management did not believe it was more likely than not that all of the deferred tax assets would be realized. Accordingly, at December 31, 2010 and 2009 a valuation allowance of $3.2 million and $3.4 million was recorded, respectively. The net deferred tax asset recorded at December 31, 2010 and 2009 was $659,000 and $559,000.
Off-Balance Sheet Arrangements
In the ordinary course of business, First Federal of Northern Michigan is a party to credit-related financial instruments with off-balance-sheet risk to meet the financing needs of its customers. These financial instruments include commitments to extend credit and letters of credit. First Federal of Northern Michigan follows the same credit policies in making off-balance sheet commitments as it does for on-balance-sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for equity lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by First Federal of Northern Michigan, is based on management’s credit evaluation of the customer.
Unfunded commitments under construction lines of credit for residential and commercial properties and commercial lines of credit are commitments for possible future extensions of credit to existing customers, for which funds have not been advanced by First Federal of Northern Michigan.
At December 31, 2010 and December 31, 2009, First Federal of Northern Michigan had $13.0 million and $12.0 million, respectively, of commitments to grant loans, $14.1 million and $14.0 million, respectively, of unfunded commitments under lines of credit and $5,000 and $5,000, respectively, of letters of credit. See Note 11 of the Notes to the Consolidated Financial Statements.
Safe Harbor Statement
When used in this annual report or future filings by First Federal of Northern Michigan Bancorp, Inc. with the Securities and Exchange Commission, 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.
Impact of Inflation and Changing Prices
The financial statements and related notes of First Federal of Northern Michigan Bancorp, Inc. have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration for changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than the effects of inflation.
DIRECTORS AND EXECUTIVE OFFICERS OF
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
AND FIRST FEDERAL OF NORTHERN MICHIGAN
Directors -
Martin A. Thomson has been Chairman of the Board of Directors since May 2008. He was President and Chief Executive Officer of the Company and Bank from May 2001. In January 2006, Mr. Thomson relinquished the position of President and in May 2008 relinquished the position of Chief Executive Officer and assumed the role of Chairman of the Board of Directors of the Company and Bank. Mr. Thomson previously held the position of President and Chief Executive Officer of Presque Isle Electric and Gas Co-op, Onaway, Michigan. Mr. Thomson has been a director of the Bank since 1986, and a director of the Company since its formation in November 2000.
James C. Rapin has been a director of the Bank since 1985, and a director of the Company since its formation in November 2000. He was Chairman of the Board of Directors of the Company and the Bank from March 2002 until May 2008. Mr. Rapin retired as a pharmacist with LeFave Pharmacy, Alpena, Michigan in 2004.
Keith D. Wallace is a senior attorney with the law firm of Isackson, Wallace and Pfiefer, P.C., located in Alpena, Michigan. Mr. Wallace has been a director of the Bank since 1988, and a director of the Company since its formation in November 2000.
Gary C. VanMassenhove is a partner in VanMassenhove, Kearly, Taphouse & Faulman, CPAs. Mr. VanMassenhove has been a Certified Public Accountant for 40 years. He has been a director of the Company and the Bank since September 2001.
Thomas R. Townsend is the President of the R.A. Townsend Co., a plumbing, heating and air conditioning distributor located in Alpena, Michigan, where he has been employed for the past 33 years. Mr. Townsend has been a director of the Company and the Bank since April 2002.
Michael W. Mahler was named President and Chief Executive Officer of the Company and the Bank in May 2008. He was named President and Chief Operating Officer of the Company and the Bank in January 2006. Prior to that appointment, since November 2004, Mr. Mahler served as Executive Vice President of the Company and the Bank and had served, since November 2002, as Chief Financial Officer. From September 2000 until November 2002, Mr. Mahler was Corporate Controller at Besser Company, Alpena, Michigan, an international producer of concrete products equipment. From 1990 until 2000, Mr. Mahler was employed at LTV Steel Company, East Chicago, Indiana where he served in financial roles of increasing responsibility and served, from 1997 until 2000, as Controller for a northeast Michigan division. Mr. Mahler has been a Director of the Bank since January 2006 and of the Company since May 2008.
Executive Officers Who Are Not Directors-
Amy E. Essex was named Chief Financial Officer, Treasurer and Corporate Secretary of the Company and the Bank in January 2006. Ms. Essex had served as Chief Financial Officer of the Company and the Bank since November 2004 and prior to that appointment, since March 2003, served as the Internal Auditor and Compliance Officer for Alpena Bancshares, Inc. Prior to March 2003, Ms. Essex spent eight years as the Director of Tax and Risk for Besser Company, Alpena, Michigan. Ms. Essex is a certified public accountant.
Jerome W. Tracey was named Executive Vice President and Chief Lending Officer of the Company and the Bank in January 2006. Mr. Tracey had served as Senior Vice President, Senior Lender of the Company and the Bank since September 2001 and served as Vice President of Commercial Services since joining the Bank in November 1999. Prior to joining the Bank, Mr. Tracey served as Vice President of Commercial Lending for National City Bank, Alpena, Michigan, a position he held since 1996. Mr. Tracey has been in the banking profession since 1981.
Senior Management Team of the Bank -
Michael W. Mahler, Jerome W. Tracey, Amy E. Essex, Joseph W. Gentry II, Kathleen R. Brown, Linda K. Sansom, Gregory S. Matthews, Julie A. Curtis
STOCKHOLDER INFORMATION
The Annual Meeting of Stockholders will be held at 1:00 p.m., May 18, 2011 at the Thunder Bay National Marine Sanctuary, 500 W. Fletcher St., Alpena, MI 49707.
Stock Listing
The Company's common stock is traded on the Nasdaq Capital Market under the symbol “FFNM”.
Price Range of Common Stock
The following sets forth the quarterly high and low closing price per share and cash dividends declared during each of the four quarters in 2010 and 2009.
Market Price | ||||||||||||
Quarter Ended | High | Low | Cash Dividends Declared | |||||||||
December 31, 2010 | $ | 2.99 | $ | 2.39 | $ | - | ||||||
September 30, 2010 | $ | 2.75 | $ | 2.05 | $ | - | ||||||
June 30, 2010 | $ | 2.44 | $ | 1.38 | $ | - | ||||||
March 31, 2010 | $ | 1.80 | $ | 1.13 | $ | - | ||||||
December 31, 2009 | $ | 2.15 | $ | 1.21 | $ | - | ||||||
September 30, 2009 | $ | 2.15 | $ | 1.81 | $ | - | ||||||
June 30, 2009 | $ | 2.20 | $ | 0.70 | $ | - | ||||||
March 31, 2009 | $ | 2.35 | $ | 0.66 | $ | - |
Special Counsel Luse Gorman Pomerenk & Schick, PC 5335 Wisconsin Avenue, N.W. Suite 400 Washington, D.C. 20015 Market Makers Raymond James & Associates, Inc. 222 South Riverside Plaza 7th Floor Chicago, IL 60606 312-655-3000 Stifel Nicolaus 237 Park Avenue 8th Floor New York, NY 10017 212-847-6500 Keefe, Bruyette & Woods 787 7th Avenue 4th Floor New York, NY 10019 212-887-7777 FIG Partners, LLC 1175 Peachtree St. NE 100 Colony Sq, Suite 2250 Atlanta, GA 30361 866-344-2657 | Independent Auditor Plante & Moran, PLLC 2601 Cambridge Ct. Suite 500 Auburn Hills, MI 48326 Transfer Agent Registrar and Transfer Company 10 Commerce Drive Cranford, NJ 07016 800-346-6084 |
Annual Report on Form 10-K
A copy of the Company's Form 10-K for the year ended December 31, 2010 will be furnished without charge upon written request to: Amy E. Essex, Chief Financial Officer, Treasurer and Corporate Secretary, First Federal of Northern Michigan Bancorp, Inc., 100 S. Second Avenue, Alpena, Michigan 49707.
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Contents | |
Report Letter | 2 |
Consolidated Financial Statements | |
Balance Sheet | 3 |
Statement of Operations | 4 |
Statement of Changes in Stockholders’ Equity | 5 |
Statement of Cash Flows | 6 |
Notes to Consolidated Financial Statements | 7 |
1
Report of Independent Registered Public Accounting Firm
Board of Directors
First Federal of Northern Michigan Bancorp, Inc.
We have audited the consolidated balance sheet of First Federal of Northern Michigan Bancorp, Inc. as of December 31, 2010 and 2009 and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for each year in the two-year period ended December 31, 2010. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards established by the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of First Federal of Northern Michigan Bancorp, Inc. as of December 31, 2010 and 2009 and the consolidated results of their operations and their cash flows for each year in the two-year period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America.
/s/ Plante & Moran, PLLC
Auburn Hills, Michigan
March 25, 2011
2
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Consolidated Balance Sheet |
(000s omitted, except per share data) |
December 31 | ||||||||
2010 | 2009 | |||||||
Assets | ||||||||
Cash and cash equivalents | $ | 1,890 | $ | 2,583 | ||||
Overnight deposits with Federal Home Loan Bank | 73 | 516 | ||||||
Total cash and cash equivalents | 1,963 | 3,099 | ||||||
Securities available for sale (Note 2) | 35,301 | 33,713 | ||||||
Securities held to maturity (Note 2) | 2,520 | 3,928 | ||||||
Loans - Net (Note 3) | 157,144 | 171,219 | ||||||
Loans held for sale | - | 52 | ||||||
Federal Home Loan Bank stock | 3,775 | 4,197 | ||||||
Property and equipment (Note 4) | 6,027 | 6,564 | ||||||
Foreclosed real estate | 2,818 | 3,580 | ||||||
Accrued interest receivable | 1,231 | 1,230 | ||||||
Prepaid FDIC insurance premiums | 967 | 1,315 | ||||||
Intangible assets (Note 6) | 627 | 920 | ||||||
Deferred tax asset | 659 | 559 | ||||||
Other assets (Note 5) | 2,701 | 3,130 | ||||||
Total assets | $ | 215,733 | $ | 233,506 | ||||
Liabilities and Stockholders' Equity | ||||||||
Liabilities | ||||||||
Non-interest bearing deposits | $ | 10,349 | $ | 11,074 | ||||
Interest-bearing deposits (Note 7) | 145,117 | 147,026 | ||||||
Advances from Federal Home Loan Bank (Note 8) | 29,000 | 44,400 | ||||||
Note payable (Note 9) | - | 631 | ||||||
REPO sweep accounts | 6,172 | 5,408 | ||||||
Accrued expenses and other liabilities (Note 13) | 1,859 | 1,915 | ||||||
Total liabilities | 192,497 | 210,454 | ||||||
Stockholders' Equity (Note 12) | ||||||||
Common stock ($0.01 par value 20,000,000 shares authorized 3,191,799 shares issued) | 32 | 32 | ||||||
Additional paid-in capital | 23,822 | 23,723 | ||||||
Retained earnings | 2,238 | 2,000 | ||||||
Treasury stock at cost (307,750 shares) | (2,964 | ) | (2,964 | ) | ||||
Unearned compensation | (38 | ) | (162 | ) | ||||
Accumulated other comprehensive income | 146 | 423 | ||||||
Total stockholders' equity | 23,236 | 23,052 | ||||||
Total liabilities and stockholders' equity | $ | 215,733 | $ | 233,506 |
See Notes to Consolidated
Financial Statements.
3
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Consolidated Statement of Operations |
(000s omitted, except per share data) |
Year Ended December 31 | ||||||||
2010 | 2009 | |||||||
Interest Income | ||||||||
Loans, including fees | $ | 10,133 | $ | 11,104 | ||||
Investments | ||||||||
Taxable | 480 | 548 | ||||||
Tax-exempt | 186 | 213 | ||||||
Mortgage-backed securities | 648 | 577 | ||||||
Total interest income | 11,447 | 12,442 | ||||||
Interest Expense | ||||||||
Deposits (Note 8) | 2,296 | 3,457 | ||||||
Borrowings | 1,151 | 1,631 | ||||||
Total interest expense | 3,447 | 5,088 | ||||||
Net Interest Income - Before provision for loan losses | 8,000 | 7,354 | ||||||
Provision for Loan Losses (Note 3) | 1,101 | 6,196 | ||||||
Net Interest Income - After provision for loan losses | 6,899 | 1,158 | ||||||
Other Income | ||||||||
Service charges and other fees | 804 | 869 | ||||||
Net gain on sale of investments | 546 | - | ||||||
Net gain on sale of loans | 597 | 585 | ||||||
Loan servicing fees | 841 | 829 | ||||||
Insurance and brokerage commissions | 159 | 170 | ||||||
Other | 258 | 122 | ||||||
Total other income | 3,205 | 2,575 | ||||||
Operating Expenses | ||||||||
Compensation and employee benefits (Note 13) | 4,682 | 4,735 | ||||||
FDIC insurance premiums | 366 | 480 | ||||||
Amortization of intangible assets | 292 | 273 | ||||||
Advertising | 136 | 117 | ||||||
Occupancy and equipment | 1,156 | 1,202 | ||||||
Data processing service bureau | 314 | 335 | ||||||
Professional fees | 425 | 478 | ||||||
Other | 2,495 | 1,740 | ||||||
Total operating expenses | 9,866 | 9,360 | ||||||
Income (loss) from continuing operations - before federal income tax expense | 238 | (5,627 | ) | |||||
Income tax expense from continuing operations (Note 10) | - | 1,090 | ||||||
Net income (loss) from continuing operations | 238 | (6,717 | ) | |||||
Loss from discontinued operations, net of tax benefit of $24 (Note 15) | - | (46 | ) | |||||
Net income (loss) | $ | 238 | $ | (6,763 | ) | |||
Per Share Data | ||||||||
Income (loss) per share from continuing operations | ||||||||
Basic | $ | 0.08 | $ | (2.33 | ) | |||
Diluted | $ | 0.08 | $ | (2.33 | ) | |||
Loss per share from discontinued operations | ||||||||
Basic | $ | - | $ | (0.01 | ) | |||
Diluted | $ | - | $ | (0.01 | ) | |||
Net income (loss) per share | ||||||||
Basic | $ | 0.08 | $ | (2.34 | ) | |||
Diluted | $ | 0.08 | $ | (2.34 | ) |
See Notes to Consolidated
Financial Statements.
4
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Consolidated Statement of Changes in Stockholders’ Equity |
(000s omitted) |
Shares | Common Stock | Treasury Stock | Additional Paid-in Capital | Unearned Compensation | Retained Earnings | Unallocated ESOP Shares | Accumulated Other Comprehensive Income (Loss) | Total Stockholders' Equity | ||||||||||||||||||||||||||||
Balance - January 1, 2009 | 3,192 | $ | 32 | $ | (2,964 | ) | $ | 24,306 | $ | (290 | ) | $ | 8,763 | $ | (765 | ) | $ | 337 | $ | 29,419 | ||||||||||||||||
Comprehensive income (loss): | ||||||||||||||||||||||||||||||||||||
Net loss | - | - | - | - | - | (6,763 | ) | - | - | (6,763 | ) | |||||||||||||||||||||||||
Other comprehensive income: | ||||||||||||||||||||||||||||||||||||
Unrealized appreciation on available-for-sale securities - Net of tax of $44 | - | - | - | - | - | - | - | 86 | 86 | |||||||||||||||||||||||||||
Total comprehensive loss | (6,677 | ) | ||||||||||||||||||||||||||||||||||
ESOP common stock committed to be released | - | - | - | (666 | ) | - | - | 765 | - | 99 | ||||||||||||||||||||||||||
Stock options/MRP shares expensed | - | - | - | 83 | 128 | - | - | - | 211 | |||||||||||||||||||||||||||
Balance - December 31, 2009 | 3,192 | 32 | (2,964 | ) | 23,723 | (162 | ) | 2,000 | - | 423 | 23,052 | |||||||||||||||||||||||||
Comprehensive income (loss): | ||||||||||||||||||||||||||||||||||||
Net income | - | - | - | - | - | 238 | - | - | 238 | |||||||||||||||||||||||||||
Other comprehensive income: | ||||||||||||||||||||||||||||||||||||
Unrealized depreciation on available-for-sale securities - Net of tax of ($143) | - | - | - | - | - | - | - | (277 | ) | (277 | ) | |||||||||||||||||||||||||
Total comprehensive income | (39 | ) | ||||||||||||||||||||||||||||||||||
Stock options/MRP shares expensed | - | - | - | 99 | 124 | - | - | - | 223 | |||||||||||||||||||||||||||
Balance - December 31, 2010 | 3,192 | $ | 32 | $ | (2,964 | ) | $ | 23,822 | $ | (38 | ) | $ | 2,238 | $ | - | $ | 146 | $ | 23,236 |
See Notes to Consolidated
Financial Statements.
5
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Consolidated Statement of Cash Flows |
(000s omitted, except per share data) |
Year Ended December 31 | ||||||||
2010 | 2009 | |||||||
Cash Flows from Operating Activities | ||||||||
Net income (loss) | $ | 238 | $ | (6,763 | ) | |||
Adjustments to reconcile net income (loss) to cash from operating activities: | ||||||||
Depreciation and amortization | 802 | 835 | ||||||
Provision for loan losses | 1,101 | 6,196 | ||||||
Amortization and accretion on securities | 143 | 82 | ||||||
Gain on sale of investment securities | (546 | ) | - | |||||
ESOP contribution | - | 99 | ||||||
Stock options/awards | 223 | 211 | ||||||
Gain on sale of loans held for sale | (597 | ) | (585 | ) | ||||
Gain on sale of property and equipment | (10 | ) | (5 | ) | ||||
Originations of loans held for sale | (42,151 | ) | (49,858 | ) | ||||
Proceeds from sale of loans held for sale | 42,800 | 50,497 | ||||||
Net change in: | ||||||||
Accrued interest receivable | (1 | ) | 239 | |||||
Other assets | 1,457 | (2,730 | ) | |||||
Prepaid FDIC insurance premiums | 348 | (1,315 | ) | |||||
Accrued expenses and other liabilities | (56 | ) | 276 | |||||
Deferred income tax expense (benefit) | (202 | ) | 1,775 | |||||
Net cash provided by (used in) operating activities | 3,549 | (1,046 | ) | |||||
Cash Flows from Investing Activities | ||||||||
Net decrease in loans | 12,974 | 14,856 | ||||||
Proceeds from maturity of securities | 15,951 | 13,890 | ||||||
Proceeds from sale of securities available-for-sale | 14,426 | - | ||||||
Net change in discontinued operations | - | 1,534 | ||||||
Proceeds from sale of property and equipment | 31 | 11 | ||||||
Purchase of securities available for sale | (30,574 | ) | (21,795 | ) | ||||
Proceeds from sale of Federal Home Loan Bank stock | 422 | - | ||||||
Purchase of premises and equipment | (14 | ) | (167 | ) | ||||
Net cash provided by investing activities | 13,216 | 8,329 | ||||||
Cash Flows from Financing Activities | ||||||||
Net decrease in deposits | (2,634 | ) | (7,678 | ) | ||||
Net increase (decrease) in Repo Sweep Accts | 764 | (4,039 | ) | |||||
Additions to advances from FHLB and Notes Payable | 23,025 | 85,180 | ||||||
Repayments of advances from FHLB and Notes Payable | (39,056 | ) | (81,118 | ) | ||||
Net cash used in financing activities | (17,901 | ) | (7,655 | ) | ||||
Net Decrease in Cash and Cash Equivalents | (1,136 | ) | (372 | ) | ||||
Cash and Cash Equivalents - Beginning of year | 3,099 | 3,471 | ||||||
Cash and Cash Equivalents - End of year | $ | 1,963 | $ | 3,099 | ||||
Supplemental Cash Flow and Noncash Information | ||||||||
Cash (refunded) paid for income taxes | $ | (638 | ) | $ | 15 | |||
Cash paid for interest on deposits and borrowings | 3,575 | 5,284 | ||||||
Transfer of loans to real estate owned & other repossessed assets | 2,080 | 6,382 |
See Notes to Consolidated
Financial Statements.
6
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 1 - Summary of Significant Accounting Policies
Nature of Operations – First Federal of Northern Michigan Bancorp, Inc. (the “Company”) and its subsidiary, First Federal of Northern Michigan (the “Bank”), conduct operations in the northeastern lower peninsula of Michigan. The Company’s primary services include accepting deposits, making commercial, consumer and mortgage loans, and engaging in mortgage banking activities.
Discontinued Operations – In accordance with FASB ASC 360-10, Accounting for Impairment or Disposal of Long-Lived Assets, on February 27, 2009 the Company announced that it had sold the InsuranCenter of Alpena. Accordingly, the results of operations of the InsuranCenter through that date are removed from the detail line items in the Company’s consolidated Statement of Operations and presented separately as “discontinued operations.” Please refer to Note 15 to the Company’s Consolidated Financial Statements for additional information.
Principles of Consolidation - The consolidated financial statements include the accounts of First Federal of Northern Michigan Bancorp, Inc., First Federal of Northern Michigan, and the Bank’s wholly owned subsidiaries, Financial Services & Mortgage Corporation (“FSMC”) and FFNM Agency. FSMC invests in real estate, which includes leasing, selling, developing, and maintaining real estate properties. The main activity of FFNM Agency is to collect the stream of income associated with the sale of the Blue Cross/Blue Shield override business to an outside party and, to a lesser extent, the collection of commissions for the sale of non-insured investment products. All significant intercompany balances and transactions have been eliminated in the consolidation.
Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, and the valuation of investment securities, intangible and deferred tax assets, and mortgage servicing rights.
7
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 1 - Summary of Significant Accounting Policies (Continued)
Significant Group Concentrations of Credit Risk - Most of the Company’s activities are with customers located within the northeastern lower peninsula of Michigan. Note 2 discusses the types of securities in which the Company invests. Note 3 discusses the types of lending in which the Company engages. The Company does not have any significant concentrations to any one industry or customer.
Cash and Cash Equivalents - For the purpose of the consolidated statements of cash flows, cash and cash equivalents include cash and balances due from depository institutions and federal funds sold and interest bearing deposits in other depository institutions which mature within ninety days when purchased.
Securities – Debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. Securities not classified as held to maturity, including equity securities with readily determinable fair values, are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income net of applicable income taxes.
Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
Federal Home Loan Bank Stock – Federal Home Loan Bank (FHLB) Stock is carried at cost and is held to allow the Bank to conduct business with the entity. The Federal Home Loan Bank sells and purchases its stock at par; therefore cost approximates fair market value.
8
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 1 - Summary of Significant Accounting Policies (Continued)
Mortgage Banking Activities – The Company routinely sells to investors its originated long-term residential fixed-rate mortgage loans. Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income.
Mortgage loans held for sale are generally sold with the mortgage servicing rights retained by the Company. The carrying value of mortgage loans sold is reduced by the cost allocated to the associated mortgage servicing rights. Gains or losses on sales of mortgage loans are recognized based on the difference between the selling price and the carrying value of the related mortgage loans sold.
The Company enters into commitments to originate loans whereby the interest rate on the loan is determined prior to funding, also known as rate lock commitments. Rate lock commitments on residential mortgage loans that are intended to be sold are considered to be derivatives. Fair value is based on fees currently charged to enter into similar agreements. The fair value of rate lock commitments was insignificant at December 31, 2010 and 2009.
The Company uses forward contracts as part of its mortgage banking activities. Forward contracts provide for the delivery of financial instruments at a specified future date and at a specified price or yield. The fair value of forward contracts was insignificant at December 31, 2010 and 2009.
Loans - The Company grants mortgage, commercial, and consumer loans to customers. Loans are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield over the contractual life of the loan.
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method.
9
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 1 - Summary of Significant Accounting Policies (Continued)
The accrual of interest on loans is discontinued at the time the loan is 90 days’ delinquent unless the credit is well-secured and in process of collection. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.
All interest accrued but not collected, for loans that are placed on nonaccrual or charged off, is reversed against interest income. The interest on these loans is accounted for on the cash basis or cost recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Allowance for Loan Losses - The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and is based on management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
The allowance consists of specific and general components. The specific component relates to loans that are classified as doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors.
10
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 1 - Summary of Significant Accounting Policies (Continued)
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.
Large groups of homogeneous loans are collectively evaluated for impairment. The Company does not separately identify individual consumer and residential loans for impairment disclosures until a loss is imminent.
Loan Servicing – Servicing assets are recognized as separate assets when rights are acquired through the sale of originated residential mortgage loans. Capitalized servicing rights are reported in other assets and are amortized against non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights into tranches based on predominant characteristics, such as interest rate, loan type and investor type. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or on a valuation model that calculates the present value of estimated future net servicing income using market based assumptions. Temporary impairment is recognized through a valuation allowance for an individual stratum to the extent that fair value is less than the capitalized amount for the stratum. If it is later determined that all or a portion of the temporary impairment no longer exists, the valuation allowance is reduced through a recovery of income. An other-than-temporary impairment results in a permanent reduction to the carrying value of the servicing asset.
11
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 1 - Summary of Significant Accounting Policies (Continued)
Servicing income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal, or a fixed amount per loan and are recorded as income when earned. The amortization of mortgage servicing rights is netted against loan servicing fee income.
Loans Held for Sale - The Bank routinely sells to investors its long-term fixed rate residential mortgages. These loans are identified as held for sale and are accounted for at the lower of cost or market on an aggregate basis. Net unrealized losses, if any, are recognized in a valuation allowance by charges to income.
Foreclosed Assets - Foreclosed real estate held for sale is carried at the lower of fair value minus estimated costs to sell, or cost. Costs of holding foreclosed real estate are charged to expense in the current period, except for significant property improvements, which are capitalized. Valuations are periodically performed by management and an allowance is established by a charge to non-interest expense if the carrying value exceeds the fair value minus estimated costs to sell. Foreclosed real estate is classified as other real estate owned. The net income from operations of foreclosed real estate held for sale is reported in non-interest income.
Property and Equipment - These assets are recorded at cost, less accumulated depreciation. The Bank uses the straight-line method of recording depreciation for financial reporting. The depreciable lives used by the Company are: land improvements 7-10 years, buildings 7-40 years and equipment 3-10 years. Maintenance and repairs are charged to expense and improvements are capitalized.
12
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 1 - Summary of Significant Accounting Policies (Continued)
Intangible Assets – The Company has in the past purchased a branch or branches from other financial institutions. The analysis of these branch acquisitions led the Company to conclude that in each case, we acquired a business and therefore, the excess of purchase price over fair value of net assets acquired has been allocated to core deposit intangible assets. The conclusion was based on the fact that in each case we acquired employees, customers and branch facilities. The expected life for core deposit intangibles is based on the type of products acquired in an acquisition. The amortization periods range from 10 to 15 years and are based on the expected life of the products. The expected life was determined based on an analysis of the life of similar products within the Company and local competition in the markets where the branches were acquired. The core deposit intangibles are amortized on a straight line basis. The core deposit intangible is analyzed quarterly for impairment.
On June 12, 2003, First Federal of Northern Michigan acquired 100% of the stock of the InsuranCenter of Alpena (ICA).
On February 27, 2009 the Company announced that it had sold the majority of the assets of the InsuranCenter of Alpena.
At the time of the sale, goodwill of $600,000 continued to be recorded related to certain assets of the Company that were not sold in the sale of ICA. The assets retained relate to a future stream of commissions. Under an agreement, the Company will receive a portion of the override commission through April, 2014. Management computed an estimated cash flow on this commission using a 6.0% discount rate and determined a fair value of $600,000. Since the $600,000 allocation of fair value relates to a finite life asset, the Company re-characterized the goodwill as an amortizable intangible and began amortizing the asset in March, 2009.
Income Taxes - Deferred income tax assets and liabilities are recognized for temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
13
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 1 - Summary of Significant Accounting Policies (Continued)
The Company records a valuation allowance if it believes, based on available evidence, that it is “more likely than not” that the future tax assets recognized will not be realized before their expiration. Realization of the Company’s deferred tax assets is primarily dependent upon the generation of a sufficient level of future taxable income.
At December 31, 2010 and 2009, management did not believe it was more likely than not that all of the deferred tax assets would be realized. Accordingly, at December 31, 2010 and 2009 a valuation allowance of $3.2 million and $3.4 million was recorded, respectively. The net deferred tax asset recorded at December 31, 2010 and 2009 was $659,000 and $559,000. See Note 10 for additional information.
Off Balance Sheet Instruments - In the ordinary course of business, the Company has entered into commitments to extend credit, including commitments under credit card arrangements, commercial letters of credit and standby letters of credit. For letters of credit, a liability is recorded for the fair value of the obligation undertaken in issuing the guarantee.
Comprehensive Income - Accounting principles generally require that recognized revenue, expenses, gains, and losses be included in net income. Certain changes in assets and liabilities, however, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component in the equity section of the consolidated statement of financial condition. Such items, along with net income, are components of comprehensive income.
Stock-Based Compensation – The Company applies the recognition and measurement of stock-based compensation accounting rules for stock-based compensation which is referred to as the fair value method. Compensation cost is based on the fair value of the equity issued to employees. The Company recognizes compensation expense related to stock-based compensation over the period the services are performed. The Company granted no options in 2010 and 2009. Compensation costs charged to earnings were $223,000 and $211,000 in 2010 and 2009, respectively.
14
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 1 - Summary of Significant Accounting Policies (Continued)
Earnings Per Common Share - Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options and are determined using the treasury stock method. Approximately 149,000 and 115,000 options were not considered for dilution in 2010 and 2009, respectively, based on the options being underwater at both December 31, 2010 and 2009 and based on the Company’s net loss for 2009.
Earnings per common share have been computed based on the following:
December 31, | ||||||||
2010 | 2009 | |||||||
Net income (loss) from continuing operations | $ | 238 | $ | (6,717 | ) | |||
Net loss from discontinued operations | - | (46 | ) | |||||
Net income (loss) | $ | 238 | $ | (6,763 | ) | |||
Average number of common shares outstanding | 2,884,049 | 2,884,249 | ||||||
Effect of dilutive options | - | - | ||||||
Average number of common shares outstanding used to calculate diluted earnings per common share | 2,884,049 | 2,884,249 |
15
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 1 - Summary of Significant Accounting Policies (Continued)
Recent Accounting Pronouncements - In July 2010, FASB issued ASU No. 2010-20 “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses”. The standard requires the Company to expand disclosures about the credit quality of our loans and the related reserves against them. The additional disclosures will include details on our past due loans and credit quality indicators. For public entities, ASU 2010-20 disclosures of period-end balances are effective for interim and annual reporting periods ending on or after December 15, 2010 and are included in Note 3 of the financial statements. Disclosures related to activity that occurs during the reporting period are required for interim and annual reporting periods beginning on or after December 15, 2010. The Company will adopt the disclosures related to the activity that occurs during the reporting period beginning with our March 31, 2011 consolidated financial statements.
In January 2010, the FASB issued ASU No. 2010-06 “Fair Value Measurements and Disclosures (Topic 820) — Improving Disclosures about Fair Value Measurements.” ASU 2010-06 amends the fair value disclosure guidance. The amendments include new disclosures and changes to clarify existing disclosure requirements. ASU 2010-06 was effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements of Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The impact of ASU 2010-06 on the Company’s disclosures is reflected in Note 14 of the consolidated financial statements.
Note 2 - Securities
Investment securities have been classified according to management’s intent. The carrying value and estimated fair value of securities are as follows:
December 31, 2010 | ||||||||||||||||
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Market Value | |||||||||||||
Securities Available for Sale | ||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies | $ | 4,518 | $ | 44 | $ | - | 4,562 | |||||||||
Municipal notes | 4,875 | 171 | - | 5,046 | ||||||||||||
Mortgage-backed securities | 25,684 | 83 | (75 | ) | 25,692 | |||||||||||
Equity securities | 3 | - | (2 | ) | 1 | |||||||||||
Total | $ | 35,080 | $ | 298 | $ | (77 | ) | $ | 35,301 | |||||||
Securities Held to Maturity | ||||||||||||||||
Municipal notes | $ | 2,520 | $ | 90 | $ | (15 | ) | $ | 2,595 | |||||||
December 31, 2009 | ||||||||||||||||
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Market Value | |||||||||||||
Securities Available for Sale | ||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies | $ | 8,220 | $ | 37 | $ | - | 8,257 | |||||||||
Municipal notes | 7,870 | 183 | - | 8,053 | ||||||||||||
Corporate securities | 1,000 | 2 | - | 1,002 | ||||||||||||
Mortgage-backed securities | 15,979 | 419 | (1 | ) | 16,397 | |||||||||||
Equity securities | 3 | 1 | - | 4 | ||||||||||||
Total | $ | 33,072 | $ | 642 | $ | (1 | ) | $ | 33,713 | |||||||
Securities Held to Maturity | ||||||||||||||||
Municipal notes | $ | 3,928 | $ | 159 | $ | (3 | ) | $ | 4,090 |
16
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 2 - Securities (Continued) |
The amortized cost and estimated market value of securities at December 31, 2010, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities with no specified maturity date are separately stated:
December 31, 2010 | ||||||||
Amortized Cost | Market Value | |||||||
Available For Sale: | ||||||||
Due in one year or less | $ | 2,809 | $ | 2,836 | ||||
Due after one year through five years | 4,292 | 4,390 | ||||||
Due in five year through ten years | 1,851 | 1,903 | ||||||
Due after ten years | 441 | 479 | ||||||
Subtotal | 9,393 | 9,608 | ||||||
Equity securities | 3 | 1 | ||||||
Mortgage-backed securities | 25,684 | 25,692 | ||||||
Total | $ | 35,080 | $ | 35,301 | ||||
Held To Maturity | ||||||||
Due in one year or less | $ | 85 | $ | 86 | ||||
Due after one year through five years | 390 | 414 | ||||||
Due in five year through ten years | 630 | 663 | ||||||
Due after ten years | 1,415 | 1,432 | ||||||
Total | $ | 2,520 | $ | 2,595 |
At December 31, 2010 and 2009, securities with a carrying value and fair value of $27,824,000 and $24,265,000, respectively, were pledged to secure REPO Sweep accounts, FHLB advances and borrowings from the Federal Reserve discount window.
Gross proceeds from the sale of available-for-sale securities for the years ended December 31, 2010 and 2009 were $14,426,000 and $0, respectively, resulting in gross gains of $546,000 and $0, respectively and gross losses of $0 and $0, respectively. The tax provision applicable to these net realized gains amounted to $186,000 and $0, respectively.
17
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 2 - Securities (Continued)
The following is a summary of temporarily impaired investments that have been impaired for less than and more than twelve months as of December 31, 2010 and 2009:
December 31, 2010 | December 31, 2009 | |||||||||||||||||||||||||||||||
Gross Unrealized Losses | Gross Unrealized Losses | Gross Unrealized Losses | Gross Unrealized Losses | |||||||||||||||||||||||||||||
Fair Value | <12 months | Fair Value | > 12 months | Fair Value | <12 months | Fair Value | > 12 months | |||||||||||||||||||||||||
Available For Sale: | ||||||||||||||||||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | ||||||||||||||||
Corporate and other securities | - | - | - | - | - | - | - | - | ||||||||||||||||||||||||
Municipal notes | - | - | - | - | - | - | - | - | ||||||||||||||||||||||||
Mortgage-backed securities | 12,626 | (75 | ) | - | - | - | - | 13 | (1 | ) | ||||||||||||||||||||||
Equity securities | 3 | (2 | ) | - | - | - | - | - | - | |||||||||||||||||||||||
Total Securities available for sale | $ | 12,629 | $ | (77 | ) | $ | - | $ | - | $ | - | $ | - | $ | 13 | $ | (1 | ) | ||||||||||||||
Held to Maturity: | ||||||||||||||||||||||||||||||||
Municipal notes | 382 | (13 | ) | 28 | (2 | ) | - | - | 27 | (3 | ) | |||||||||||||||||||||
Total Securities held to maturity | $ | 382 | $ | (13 | ) | $ | 28 | $ | (2 | ) | $ | - | $ | - | $ | 27 | $ | (3 | ) |
The unrealized losses on the securities held in the portfolio are not considered other than temporarily impaired (OTTI) and have not been recognized into income. This decision is based on the Company’s ability and intent to hold any potentially impaired security until maturity. The performance of the security is based on the contractual terms of the agreement, the extent of the impairment and the financial condition and credit quality of the issuer. The decline in market value is considered temporary and a result of changes in interest rates and other market variables.
As of December 31, 2010 and 2009, there were 16 and 3 securities in an unrealized loss position, respectively.
Note 3 - Loans
Loans at December 31, 2010 and 2009 are summarized as follows:
December 31 | ||||||||
2010 | 2009 | |||||||
Real estate loans - One- to four-family residential | $ | 71,697 | $ | 81,620 | ||||
Commercial loans: | ||||||||
Secured by real estate | 61,010 | 62,376 | ||||||
Other | 8,848 | 9,873 | ||||||
Total commercial loans | 69,858 | 72,249 | ||||||
Consumer loans: | ||||||||
Secured by real estate | 16,547 | 18,732 | ||||||
Other | 2,118 | 2,553 | ||||||
Total consumer loans | 18,665 | 21,285 | ||||||
Total gross loans | 160,220 | 175,154 | ||||||
Less: | ||||||||
Net deferred loan fees | 245 | 275 | ||||||
Allowance for loan losses | 2,831 | 3,660 | ||||||
Total loans - net | $ | 157,144 | $ | 171,219 |
Final loan maturities and rate sensitivity of the loan portfolio are as follows:
December 31, 2010 | ||||||||||||||||
Less Than One Year | One Year to Five Years | After Five Years | Total | |||||||||||||
Loans at fixed interest rates | $ | 15,802 | $ | 28,790 | $ | 41,941 | $ | 86,533 | ||||||||
Loans at variable interest rates | 9,676 | 18,105 | 45,906 | 73,687 | ||||||||||||
Total | $ | 25,478 | $ | 46,895 | $ | 87,847 | $ | 160,220 |
18
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 3 - Loans (Continued)
Certain directors and executive officers of the Company were loan customers during 2010 and 2009. Such loans were made in the ordinary course of business and do not involve more than a normal risk of collectibility. An analysis of aggregate loans outstanding to directors and executive officers for the years ended December 31, 2010 and 2009 are as follows:
December 31 | ||||||||
2010 | 2009 | |||||||
Aggregate balance - Beginning of Period | $ | 3,931 | $ | 4,428 | ||||
New loans | 1,010 | 2,379 | ||||||
Repayments | (1,584 | ) | (2,876 | ) | ||||
Aggregate balance - End of Period | $ | 3,357 | $ | 3,931 |
The following table illustrates the contractual aging of the recorded investment in past due loans by class of loans as of December 31, 2010:
Recorded | ||||||||||||||||||||||||||||
Investment > 90 | ||||||||||||||||||||||||||||
30 - 59 Days | 60 - 89 Days | Greater than 90 | Total | Total Financing | Days and | |||||||||||||||||||||||
Past Due | Past Due | Days | Past Due | Current | Receivables | Accruing | ||||||||||||||||||||||
2010 | ||||||||||||||||||||||||||||
Commercial Real Estate: | ||||||||||||||||||||||||||||
Commercial Real Estate - construction | $ | - | $ | - | $ | 1,772 | $ | 1,772 | $ | 1,498 | $ | 3,270 | $ | - | ||||||||||||||
Commercial Real Estate - other | 891 | 488 | 784 | 2,163 | 55,577 | 57,740 | 82 | |||||||||||||||||||||
Commercial - non real estate | - | 6 | - | 6 | 8,842 | 8,848 | - | |||||||||||||||||||||
Consumer: | ||||||||||||||||||||||||||||
Consumer - Real Estate | 650 | 108 | 205 | 963 | 15,584 | 16,547 | - | |||||||||||||||||||||
Consumer - Other | 27 | 14 | 2 | 43 | 2,075 | 2,118 | 2 | |||||||||||||||||||||
Residential: | ||||||||||||||||||||||||||||
Residential | 3,919 | 2,056 | 2,434 | 8,409 | 63,288 | 71,697 | 282 | |||||||||||||||||||||
Total | $ | 5,487 | $ | 2,672 | $ | 5,197 | $ | 13,356 | $ | 146,864 | $ | 160,220 | $ | 366 |
19
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 3 - Loans (Continued)
The Bank uses an eight tier risk rating system to grade its commercial loans. The grade of a loan may change during the life of the loans. The risk ratings are described as follows:
Risk Grade 1 (Excellent) - Prime loans based on liquid collateral, with adequate margin or supported by strong financial statements. Probability of serious financial deterioration is unlikely. High liquidity, minimum risk, strong ratios, and low handling costs are common to these loans. This classification also includes all loans secured by certificates of deposit or cash equivalents.
Risk Grade 2 (Good) - Desirable loans of somewhat less stature than Grade 1, but with strong financial statements. Probability of serious financial deterioration is unlikely. These loans possess a sound repayment source (and/or a secondary source). These loans represent less than the normal degree of risk associated with the type of financing contemplated.
Risk Grade 3 (Satisfactory) - Satisfactory loans of average risk – may have some minor deficiency or vulnerability to changing economic conditions, but still fully collectible. There may be some minor weakness but with offsetting features or other support readily available. These loans present a normal degree of risk associated with the type of financing. Actual and projected indicators and market conditions provide satisfactory assurance that the credit shall perform in accordance with agreed terms.
Risk Grade 4 (Acceptable) - Loans considered satisfactory, but which are of slightly “below average” credit risk due to financial weaknesses or uncertainty. The loans warrant a somewhat higher than average level of monitoring to insure that weaknesses do not advance. The level of risk is considered acceptable and within normal underwriting guidelines, so long as the loan is given the proper level of management supervision.
Risk Grade 4.5 (Monitored) - Loans are considered “below average” and monitored more closely due to some credit deficiency that poses additional risk but is not considered adverse to the point of being a “classified” credit. Possible reasons for additional monitoring may include characteristics such as temporary negative debt service coverage due to weak economic conditions, borrower may have experienced recent losses from operations, declining equity and/or increasing leverage, or marginal liquidity that may affect long-term sustainability. Loans of this grade have a higher degree of risk and warrant close monitoring to insure against further deterioration.
Risk Grade 5 (Other Assets Especially Mentioned) (OAEM) - Loans which possess some credit deficiency or potential weakness, which deserve close attention, but which do not yet warrant substandard classification. Such loans pose unwarranted financial risk that, if not corrected, could weaken the loan and increase risk in the future.
Risk Grade 6 (Substandard) - Loans are “substandard” whose full, final collectability does not appear to be a matter of serious doubt, but which nevertheless portray some form of well defined weakness that requires close supervision by Bank management. The noted weaknesses involve more than normal banking risk. One or more of the following characteristics may be exhibited in loans classified Substandard: (1) Loans possess a defined credit weakness and the likelihood that the loan shall be paid from the primary source of repayment is uncertain; (2) Loans are not adequately protected by the current net worth and/or paying capacity of the obligor; (3) primary source of repayment is gone, and the Bank is forced to rely on a secondary source of repayment such as collateral liquidation or guarantees; (4) distinct possibility that the Bank shall sustain some loss if deficiencies are not corrected; (5) unusual courses of action are needed to maintain a high probability of repayment; (6) the borrower is not generating enough cash flow to repay loan principal, however, continues to make interest payments; (7) the Bank is forced into a subordinated or unsecured position due to flaws in documentation; (8) loans have been restructured so that payment schedules, terms, and collateral represent concessions to the borrower when compared to normal loan terms; (9) the Bank is contemplating foreclosure or legal action due to the apparent deterioration in the loan; or (10) there is a significant deterioration in the market conditions and the borrower is highly vulnerable to these conditions.
Grade 7 (Doubtful) - Loans have all the weaknesses of those classified Substandard. Additionally, however, these weaknesses make collection or liquidation in full, based on existing conditions, improbable. Loans in this category are typically not performing in conformance with established terms and conditions. Full repayment is considered “Doubtful”, but extent of loss is not currently determinable.
Risk Grade 8 (Loss) - Loans are considered uncollectible and of such little value, that continuing to carry them as an asset on the Bank’s financial statements is not feasible.
20
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 3 - Loans (Continued)
The following table presents the risk category of loans by class of loans based on the most recent analysis performed and the contractual aging as of December 31, 2010:
Commercial Real Estate | Commercial Real Estate | |||||||||||
Loan Grade | Construction | Other | Commercial | |||||||||
1-2 | $ | - | $ | - | $ | 5 | ||||||
3 | 70 | 12,411 | 2,958 | |||||||||
4 | 1,428 | 33,754 | 5,631 | |||||||||
5 | - | 3,245 | 248 | |||||||||
6 | 1,772 | 8,330 | 6 | |||||||||
7 | - | - | - | |||||||||
8 | - | - | - | |||||||||
Total | $ | 3,270 | $ | 57,740 | $ | 8,848 |
For residential real estate and other consumer credit the Company also evaluates credit quality based on the aging status of the loan and by payment activity. Loans 60 or more days past due are monitored by the collection committee.
The following tables present the risk category of loans by class based on the most recent analysis performed as of December 31, 2010:
Residential | ||||
Grade | ||||
Pass | $ | 68,301 | ||
Special Mention | - | |||
Substandard | 3,396 | |||
Total | $ | 71,697 |
Consumer - | ||||||||
Real Estate | Consumer - Other | |||||||
Performing | $ | 16,341 | $ | 2,116 | ||||
Nonperforming | 206 | 2 | ||||||
Total | $ | 16,547 | $ | 2,118 |
21
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 3 - Loans (Continued)
The following table presents the recorded investment in non-accrual loans by class as of December 31, 2010:
2010 | ||||
Commercial Real Estate: | ||||
Commercial Real Estate - construction | $ | 1,772 | ||
Commercial Real Estate - other | 1,148 | |||
Commercial | - | |||
Consumer: | ||||
Consumer - real estate | 206 | |||
Consumer - other | - | |||
Residential: | ||||
Residential | 3,114 | |||
Total | $ | 6,240 |
Information about impaired loans as of and for the year ended December 31, 2009 is as follows:
2009 | ||||
Impaired loans without a valuation allowance | $ | 3,502 | ||
Impaired loans with a valuation allowance | 2,344 | |||
Total impaired loans | $ | 5,846 | ||
Valuation allowance related to impaired loans | $ | 743 | ||
Total non-accrual loans | $ | 8,947 | ||
Total loans past-due ninety days or more and still accruing | $ | 2,839 |
2009 | ||||
Average investment in impaired loans | $ | 14,914 | ||
Interest income recognized on impaired loans | $ | - | ||
Interest income recognized on a cash basis on impaired loans | $ | - |
No additional funds are committed to be advanced in connection with impaired loans.
22
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 3 - Loans (Continued)
The Bank has classified approximately $740,000 of its impaired loans as troubled debt restructuring as of December 31, 2010.
For the majority of the Bank’s impaired loans, the Bank will apply the observable market price methodology. However, the Bank may also utilize a measurement incorporating the present value of expected future cash flows discounted at the loan’s effective rate of interest. To determine observable market price, collateral asset values securing an impaired loan are periodically evaluated. Maximum time of re-evaluation is every 12 months. In this process, third party evaluations are obtained and heavily relied upon. Until such time that updated evaluations are received, the Bank may discount the collateral value used.
The Bank uses the following guidelines as stated in policy to determine when to realize a charge-off, whether a partial or full loan balance. A charge down in whole or in part is realized when unsecured consumer loans, credit card credits and overdraft lines of credit reach 90 days delinquency. At 120 days delinquent, secured consumer loans are charged down to the value of collateral, if repossession of the collateral is assured and/or in the process of repossession. Consumer mortgage loan deficiencies are charged down upon the sale of the collateral or sooner upon the recognition of collateral deficiency. Commercial credits are charged down at 90 days delinquency, unless an established and approved work-out plan is in place or litigation of the credit will likely result in recovery of the loan balance. Upon notification of bankruptcy, unsecured debt is charged off. Additional charge-off may be realized as further unsecured positions are recognized.
23
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 3 - Loans (Continued)
The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2010:
Average | Interest | |||||||||||||||||||
Unpaid Principal | Recorded | Related | Recorded | Income | ||||||||||||||||
Balance | Investment | Allowance | Investment | Recognized | ||||||||||||||||
2010 | ||||||||||||||||||||
With no related allowance recorded: | ||||||||||||||||||||
Commercial | $ | - | $ | - | $ | - | $ | - | $ | - | ||||||||||
Commercial Real Estate - Construction | - | - | - | - | - | |||||||||||||||
Commercial Real Estate - Other | 822 | 674 | - | - | - | |||||||||||||||
Consumer - Real Estate | 124 | 123 | - | 193 | - | |||||||||||||||
Consumer - Other | - | - | - | - | - | |||||||||||||||
Residential | 1,842 | 1,770 | - | 1,803 | - | |||||||||||||||
With a specific allowance recorded: | ||||||||||||||||||||
Commercial | - | - | - | - | - | |||||||||||||||
Commercial Real Estate - Construction | 3,449 | 1,772 | 305 | 1,805 | - | |||||||||||||||
Commercial Real Estate - Other | 586 | 474 | 89 | 1,132 | - | |||||||||||||||
Consumer - Real Estate | 83 | 83 | 25 | 14 | - | |||||||||||||||
Consumer - Other | - | - | - | - | - | |||||||||||||||
Residential | 1,416 | 1,344 | 165 | 1,330 | - | |||||||||||||||
Totals: | ||||||||||||||||||||
Commercial | $ | - | $ | - | $ | - | $ | - | $ | - | ||||||||||
Commercial Real Estate - Construction | $ | 3,449 | $ | 1,772 | $ | 305 | $ | 1,805 | $ | - | ||||||||||
Commercial Real Estate - Other | $ | 1,408 | $ | 1,148 | $ | 89 | $ | 1,132 | $ | - | ||||||||||
Consumer - Real Estate | $ | 207 | $ | 206 | $ | 25 | $ | 207 | $ | - | ||||||||||
Consumer - Other | $ | - | $ | - | $ | - | $ | - | $ | - | ||||||||||
Residential | $ | 3,258 | $ | 3,114 | $ | 165 | $ | 3,133 | $ | - |
The ALLL has a direct impact on the provision expense. An increase in the ALLL is funded through recoveries and provision expense.
24
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 3 - Loans (Continued)
Activity in the allowance for loan and lease losses was as follows for the year ended December 31, 2010:
Commercial | Commercial | Consumer | ||||||||||||||||||||||||||||||
Construction | Real Estate | Commercial | Real Estate | Consumer | Residential | Unallocated | Total | |||||||||||||||||||||||||
2010 | ||||||||||||||||||||||||||||||||
Allowance for credit losses: | ||||||||||||||||||||||||||||||||
Beginning Balance | $ | 997 | $ | 1,513 | $ | 245 | $ | 211 | $ | 45 | $ | 649 | $ | - | $ | 3,660 | ||||||||||||||||
Charge-offs | (1,013 | ) | (512 | ) | - | (220 | ) | (99 | ) | (258 | ) | - | (2,102 | ) | ||||||||||||||||||
Recoveries | 60 | 85 | - | 14 | 11 | 2 | - | 172 | ||||||||||||||||||||||||
Provision | 491 | 195 | (53 | ) | 223 | 102 | 143 | - | 1,101 | |||||||||||||||||||||||
Ending Balance | $ | 535 | $ | 1,281 | $ | 192 | $ | 228 | $ | 59 | $ | 536 | $ | - | $ | 2,831 | ||||||||||||||||
Ending balance: individually evaluated for impairment | $ | 305 | $ | 89 | $ | - | $ | 25 | $ | - | $ | 165 | $ | - | $ | 584 | ||||||||||||||||
Ending balance: loans collectively evaluated for impairment | $ | 230 | $ | 1,192 | $ | 192 | $ | 203 | $ | 59 | $ | 371 | $ | - | $ | 2,247 | ||||||||||||||||
Ending balance: loans acquired with deteriorated credit quality | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | ||||||||||||||||
Financing Receivables: | ||||||||||||||||||||||||||||||||
Ending Balance | $ | 3,270 | $ | 57,740 | $ | 8,848 | $ | 16,547 | $ | 2,118 | $ | 71,697 | $ | - | $ | 160,220 | ||||||||||||||||
Ending balance: individually evaluated for impairment | $ | 1,772 | $ | 1,148 | $ | - | $ | 206 | $ | - | $ | 3,114 | $ | - | $ | 6,240 | ||||||||||||||||
Ending balance: loans collectively evaluated for impairment | $ | 1,498 | $ | 56,592 | $ | 8,848 | $ | 16,341 | $ | 2,118 | $ | 68,583 | $ | - | $ | 153,980 | ||||||||||||||||
Ending balance: loans acquired with deteriorated credit quality | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - |
Year Ended December 31 | ||||
2009 | ||||
Balance - Beginning of period | $ | 5,647 | ||
Provision for losses | 6,196 | |||
Charge-offs | (8,247 | ) | ||
Recoveries | 64 | |||
Balance - End of period | $ | 3,660 |
25
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 4 - Property and Equipment
A summary of property and equipment is as follows:
December 31 | ||||||||
2010 | 2009 | |||||||
Land | $ | 1,188 | $ | 1,198 | ||||
Land improvements | 214 | 221 | ||||||
Buildings | 6,470 | 6,528 | ||||||
Equipment | 3,573 | 3,570 | ||||||
Total property and equipment | 11,445 | 11,517 | ||||||
Accumulated depreciation | 5,418 | 4,953 | ||||||
Net property and equipment | $ | 6,027 | $ | 6,564 |
Depreciation expense was $509,000 and $562,000 for the periods ended December 31, 2010 and 2009, respectively.
Note 5 - Servicing
Loans serviced for others are not included in the accompanying consolidated statement of financial condition. The unpaid principal balances of mortgage and other loans serviced for others were approximately $144,948,000 and $140,562,000 at December 31, 2010 and 2009, respectively.
The balance of capitalized servicing rights, net of valuation allowance, is included in other assets at December 31, 2010 and 2009.
The key economic assumptions used in determining the fair value of the mortgage servicing rights are as follows:
December 31, | ||||||||
2010 | 2009 | |||||||
Annual constant prepayment speed (CPR) | 15.67 | % | 17.23 | % | ||||
Weighted average life (in months) | 246 | 249 | ||||||
Discount rate | 7.96 | % | 8.17 | % |
The fair value of our mortgage servicing rights was estimated to be $1,251,000 and $1,144,000 and the weighted average life remaining of those rights was 40 months and 37 months at December 31, 2010 and December 31, 2009, respectively.
26
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 5 – Servicing (Continued)
The following table summarizes mortgage servicing rights capitalized and amortized, along with the aggregate activity in related valuation allowances:
December 31 | ||||||||
2010 | 2009 | |||||||
Balance, beginning of period | $ | 730 | $ | 430 | ||||
Originated mortgage servicing rights capitalized | 536 | 584 | ||||||
Amortization of mortgage servicing rights | (306 | ) | (284 | ) | ||||
Balance - end of period | 960 | 730 | ||||||
Valuation allowances: | ||||||||
Balance at beginning of year | - | - | ||||||
Additions | - | - | ||||||
Reductions | - | - | ||||||
Write-downs | - | - | ||||||
Balance, end of year (net of allowances) | $ | 960 | $ | 730 |
Note 6 - Intangible Assets
Intangible assets of the Company are summarized as follows:
December 31, 2010 | ||||||||||||
Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | ||||||||||
Amortized intangible assets: | ||||||||||||
Core deposit | $ | 3,081 | $ | 2,841 | $ | 240 | ||||||
Commission residual | 600 | 213 | 387 | |||||||||
Total | $ | 3,681 | $ | 3,054 | $ | 627 |
December 31, 2009 | ||||||||||||
Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | ||||||||||
Amortized intangible assets: | ||||||||||||
Core deposit | $ | 3,081 | $ | 2,664 | $ | 417 | ||||||
Commission residual | 600 | 97 | 503 | |||||||||
Total | $ | 3,681 | $ | 2,761 | $ | 920 |
27
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 6 - Intangible Assets (continued)
Amortization expense was $293,000 and $273,000 for the periods ended December 31, 2010 and 2009, respectively.
As discussed in Note 1, on February 27, 2009 the Company announced that it had sold the majority of the assets of the InsuranCenter of Alpena. The Company allocated the goodwill between the assets sold and the assets retained.
The assets retained relate to a future stream of commissions related to the override commission discussed earlier. Under an agreement, the Company will receive a portion of the override commission through April, 2014. Management computed an estimated cash flow on this commission and using a 6.0% discount rate determined a fair value of $600,000. Since the $600,000 allocation of fair value relates to a finite life asset, the Company re-characterized the goodwill as an amortizable intangible and began amortizing the asset in March, 2009. The remaining estimated life as of December 31, 2010 is 3.3 years and the asset will be amortized straight-line through April 1, 2014, or approximately $9,700 per month.
The remaining amortization period for the core deposit intangible as of December 31, 2010 is 1.4 years. The core deposit intangible will be amortized straight-line through May, 2012 or approximately $14,700 per month.
28
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 7 - Deposits
Deposit accounts, by type and range of rates, consist of the following:
December 31 | ||||||||
2010 | 2009 | |||||||
NOW accounts and MMDA | $ | 44,107 | $ | 37,092 | ||||
Regular savings accounts | 16,785 | 15,722 | ||||||
Total | 60,892 | 52,814 | ||||||
Certificate of Deposit Rates | ||||||||
0.50 percent to 0.99 percent | 9,852 | 5,926 | ||||||
1.00 percent to 1.99 percent | 35,119 | 32,658 | ||||||
2.00 percent to 2.99 percent | 26,573 | 24,116 | ||||||
3.00 percent to 3.99 percent | 8,718 | 15,629 | ||||||
4.00 percent to 4.99 percent | 3,488 | 11,912 | ||||||
5.00 percent to 8.99 percent | 475 | 3,971 | ||||||
Total certificate of deposits | 84,225 | 94,212 | ||||||
Total interest-bearing deposits | $ | 145,117 | $ | 147,026 |
Certificates of deposit $100,000 or greater at December 31, 2010 and 2009 were $26,702,000 and $31,642,000, respectively.
The following table sets forth the amount and maturities of certificates of deposit:
December 31, 2010 | ||||||||||||||||||||||||
Amount Due | ||||||||||||||||||||||||
Rate | Less than 1 Year | 1-2 Years | 2-3 Years | 3-5 Years | Greater than 5 Years | Total | ||||||||||||||||||
0.50 percent to | ||||||||||||||||||||||||
0.99 percent | $ | 6,931 | $ | 2,921 | $ | - | $ | - | $ | - | $ | 9,852 | ||||||||||||
1.00 percent to | ||||||||||||||||||||||||
1.99 percent | 28,038 | 6,125 | 671 | 271 | 14 | 35,119 | ||||||||||||||||||
2.00 percent to | ||||||||||||||||||||||||
2.99 percent | 9,952 | 5,038 | 3,560 | 6,045 | 1,978 | 26,573 | ||||||||||||||||||
3.00 percent to | ||||||||||||||||||||||||
3.99 percent | 4,399 | 434 | 1,855 | 1,460 | 570 | 8,718 | ||||||||||||||||||
4.00 percent to | ||||||||||||||||||||||||
4.99 percent | 2,272 | 824 | 262 | 46 | 84 | 3,488 | ||||||||||||||||||
5.00 percent to | ||||||||||||||||||||||||
8.99 percent | 467 | - | - | - | 8 | 475 | ||||||||||||||||||
Total | $ | 52,059 | $ | 15,342 | $ | 6,348 | $ | 7,822 | $ | 2,654 | $ | 84,225 |
29
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 7 – Deposits (continued)
Interest expense on deposits is summarized as follows:
Year Ended December 31 | ||||||||
2010 | 2009 | |||||||
NOW and MMDAs | $ | 324 | $ | 384 | ||||
Regular savings | 8 | 17 | ||||||
Certificates of deposit | 1,964 | 3,056 | ||||||
Total | $ | 2,296 | $ | 3,457 |
Deposits from related parties held by the Bank at December 31, 2010 and 2009 amounted to $989,000 and $617,000, respectively.
Note 8 - Federal Home Loan Bank and Federal Reserve Advances
The Bank has advances from the Federal Home Loan Bank. Interest rates range from 0.50% to 3.81% with a weighted average interest rate of 2.23%. These advances contain varying maturity dates through December 30, 2013 with a weighted average maturity of approximately 19 months. The advances are collateralized by approximately $48,338,000 and $58,846,000 of mortgage loans as of December 31, 2010 and 2009, respectively. In addition, at December 31, 2010 and 2009, securities with a carrying value of $16,843,000 and $16,256,000, respectively, were pledged as collateral for Federal Home Loan Bank advances. Available borrowings with the Federal Home Loan Bank at December 31, 2010 totaled $46,797,000, of which $29,000,000 was outstanding.
30
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 8 - Federal Home Loan Bank and Federal Reserve Advances (continued)
The advances are subject to prepayment penalties subject to the provisions and conditions of the credit policy of the Federal Home Loan Bank. Future maturities of the advances are as follows:
December 31, 2010 | ||||||||
December 31 | Amount | Weighted Average Interest Rate | ||||||
2011 | $ | 7,500 | 1.24 | |||||
2012 | 17,000 | 2.37 | ||||||
2013 | 4,500 | 3.34 | ||||||
Total | $ | 29,000 | 2.23 |
Variable rate advances totaled $2,000,000 at December 31, 2010.
In 2009, the Bank entered into a discount window loan agreement with the Federal Reserve Bank that allows for advances up to seventy-five percent of the collateral balance. As of December 31, 2010, these advances are secured by investment securities with a fair value of approximately $3,800,000 and are generally due within 28 days from the date of the advance. The interest rate on the advances is based on the quoted federal reserve discount window rate (effective rate of 0.75 percent as of December 31, 2010). At December 31, 2010 and 2009, the Bank had $0 outstanding in advances.
Note 9 - Note Payable
In connection with the purchase of ICA, an unsecured note payable was issued to an individual, payable in annual installments of $180,000, including interest at 5.5 percent. In January 2010, the balance of the note of $631,000 was fully paid by the Company.
31
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 10 - Federal Income Tax
The analysis of the consolidated provision for federal income tax is as follows:
Year Ended December 31 | ||||||||
2010 | 2009 | |||||||
Continuing operations: | ||||||||
Current provision | $ | 201 | $ | (685 | ) | |||
Deferred benefit | ( 201 | ) | 1,775 | |||||
- | ||||||||
Total from continuing operations | $ | - | $ | 1,090 | ||||
Discontinued operations | - | (24 | ) | |||||
Total | $ | - | $ | 1,066 |
The Company has net operating loss carryforwards of approximately $7.6 million generated from December 31, 2007 through December 31, 2009 that are available to reduce total taxable income through the years ending December 31, 2029.
A reconciliation of the federal income tax expense and the amount computed by applying the statutory federal income tax rate (34 percent) to income before federal income tax is as follows:
Year Ended December 31 | ||||||||
2010 | 2009 | |||||||
Tax at statutory rate | $ | 81 | $ | (1,913 | ) | |||
Increase (decrease) from: | ||||||||
Change in valuation allowance | (167 | ) | 3,372 | |||||
ESOP expense | - | (235 | ) | |||||
Tax-exempt interest | (60 | ) | (81 | ) | ||||
Other | 146 | (53 | ) | |||||
Total income tax expense | $ | - | $ | 1,090 |
32
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 10 - Federal Income Tax (Continued)
The net deferred tax asset was comprised of the following temporary differences:
December 31 | ||||||||
2010 | 2009 | |||||||
Allowance for loan losses | $ | 327 | $ | 660 | ||||
Valuation allowance for real estate held for sale | 538 | 136 | ||||||
Non-accrual loan interest | 87 | 12 | ||||||
Directors' benefit plan | 347 | 361 | ||||||
Net operating loss carryforward | 2,572 | 2,773 | ||||||
Investment in subsidiary | 784 | 784 | ||||||
Other | 257 | 384 | ||||||
Total deferred tax assets | 4,912 | 5,110 | ||||||
Less: valuation allowance | 3,205 | 3,372 | ||||||
Deferred tax liabilities: | ||||||||
Mortgage servicing rights | 327 | 248 | ||||||
Partnership losses | 121 | 113 | ||||||
Unrealized gain on available-for-sale securities | 75 | 218 | ||||||
Depreciation | 308 | 361 | ||||||
Other | 217 | 239 | ||||||
Total deferred tax liabilities | 1,048 | 1,179 | ||||||
Net deferred tax asset | $ | 659 | $ | 559 |
For tax years beginning prior to January 1, 1996, a qualified thrift institution was allowed a bad debt deduction for tax purposes based on a percentage of taxable income or on actual experience. The Bank used the percentage of taxable income method through December 31, 1995.
33
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 10 - Federal Income Tax (Continued)
A deferred tax liability has not been recognized for the tax bad debt base year reserves of the Bank. The base year reserves are the balance of reserves as of December 31, 1987. At December 31, 2010 and 2009, the amount of those reserves was approximately $60,000. The amount of the unrecognized deferred tax liability at December 31, 2010 and 2009 was approximately $20,000.
Note 11 - Off Balance Sheet Risk Commitments and Contingencies
Credit-Related Financial Instruments - 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, standby letters of credit, and commercial letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statement of financial condition.
The Company’s exposure to credit loss is represented by the contractual amount of these commitments. The Company follows the same credit policies in making commitments as it does for on-balance-sheet instruments.
The following financial instruments were outstanding whose contract amounts represent credit risk:
December 31 | ||||||||
2010 | 2009 | |||||||
$ | 13,019 | $ | 12,000 | |||||
Unfunded commitments under lines of credit | 14,138 | 13,976 | ||||||
Commercial and standby letters of credit | 5 | 5 |
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for equity lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Company, is based on management's credit evaluation of the customer.
34
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 11 - Off Balance Sheet Risk Commitments and Contingencies (Continued)
Unfunded commitments under commercial lines of credit, revolving credit lines, and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. In most cases, these lines of credit are collateralized and usually do not contain a specified maturity date and may not be drawn upon to the total extent to which the Company is committed.
Commercial and standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those letters of credit are primarily used to support public and private borrowing arrangements. Essentially all letters of credit issued have expiration dates within one year. Under ASC 840-10-25-34, fees earned on commercial and standby letters of credit are required to be deferred over the contractual life of the letter of credit. The Company determined that the fair value of guarantees on standby letters of credit has an immaterial effect on the financial results at December 31, 2010 and 2009.
To reduce credit risk related to the use of credit-related financial instruments, the Company generally holds collateral supporting those commitments if deemed necessary. The amount and nature of the collateral obtained is based on the Company's credit evaluation of the customer. Collateral held varies, but may include cash, securities, accounts receivable, inventory, property, plant, equipment, and real estate.
If the counterparty does not have the right and ability to redeem the collateral or the Company is permitted to sell or repledge the collateral on short notice, the Company records the collateral in its balance sheet at fair value with a corresponding obligation to return it.
35
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 11 - Off Balance Sheet Risk Commitments and Contingencies (continued)
Legal Contingencies – At December 31, 2010, there were no material pending legal proceedings to which the Company is a party or to which any of its property was subject, except for proceedings which arise in the ordinary course of business. In the opinion of management, pending legal proceedings will not have a material effect on the consolidated financial position or results of operation of the Company.
Note 12- Stockholders’ Equity
Payment of dividends on the common stock is subject to determination and declaration by the Board of Directors and depends on a number of factors, including capital requirements, regulatory limitation on payment of dividends, the Bank’s results of operations and financial condition, tax considerations, and general economic conditions.
The Bank is subject to various regulatory capital requirements administered by the OTS. Failure to meet certain capital requirements can initiate certain mandatory and possibly additional discretionary action by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators regarding components, risk-weightings, and other factors.
During the most recent regulatory examination, the OTS categorized the Bank as “well-capitalized” per definition of 12 CFR Section 565.4(b)(1). To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, tier 1 risk based, and tangible equity ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed the Bank’s categorization. Consolidated data has not been disclosed as the amounts and ratios are not significantly different.
36
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 12 Stockholders’ Equity (continued)
Actual | For Capital Adequacy Purposes | To be Categorized as Well-Capitalized Under Prompt Corrective Action Provisions | ||||||||||||||||||||||
Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||||||
(Dollars in Thousands) | ||||||||||||||||||||||||
December 31, 2010 | ||||||||||||||||||||||||
Total capital (to risk- | ||||||||||||||||||||||||
weighted assets) | $ | 22,763 | 15.6 | % | $ | 11,693 | 8.0 | % | $ | 14,617 | 10.0 | % | ||||||||||||
Tier 1 capital (to risk- | ||||||||||||||||||||||||
weighted assets) | $ | 20,931 | 14.3 | % | $ | 5,847 | 4.0 | % | $ | 8,770 | 6.0 | % | ||||||||||||
Tangible capital (to | ||||||||||||||||||||||||
tangible assets) | $ | 20,931 | 9.8 | % | $ | 3,214 | 1.5 | % | $ | 4,285 | 2.0 | % | ||||||||||||
December 31, 2009 | ||||||||||||||||||||||||
Total capital (to risk- | ||||||||||||||||||||||||
weighted assets) | $ | 22,304 | 13.6 | % | $ | 13,153 | 8.0 | % | $ | 16,442 | 10.0 | % | ||||||||||||
Tier 1 capital (to risk- | ||||||||||||||||||||||||
weighted assets) | $ | 20,239 | 12.3 | % | $ | 6,577 | 4.0 | % | $ | 9,865 | 6.0 | % | ||||||||||||
Tangible capital (to | ||||||||||||||||||||||||
tangible assets) | $ | 20,239 | 8.8 | % | $ | 3,470 | 1.5 | % | $ | 4,627 | 2.0 | % |
Reconciliation of the Bank’s GAAP to Regulatory Capital:
December 31 | ||||||||
2010 | 2009 | |||||||
GAAP Capital | $ | 22,272 | $ | 22,119 | ||||
Reconciling items: | ||||||||
Less: Investment in and advances to | ||||||||
nonincludable subsidaries | (310 | ) | (311 | ) | ||||
Core deposit and other intangible assets | (627 | ) | (920 | ) | ||||
Disallowed deferred tax asset | (258 | ) | (226 | ) | ||||
Unrealized gain on securities | ||||||||
available for sale | (146 | ) | (423 | ) | ||||
Tangible and core capital | 20,931 | 20,239 | ||||||
Allowable unrealized gain on | ||||||||
securities available for sale | - | 1 | ||||||
General valuation allowance | 1,832 | 2,064 | ||||||
Risk Based Capital | $ | 22,763 | $ | 22,304 |
37
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Defined Benefit Pension Plan
The Bank is a participant in the multiemployer Financial Institutions Retirement Fund (FIRF or the “Plan”), which covers substantially all of its officers and employees. The defined benefit plan covers all employees who have completed one year of service, attained age 21, and worked at least 1,000 hours during the year. Normal retirement age is 65, with reduced benefits available at age 55. The Bank’s contributions are determined by FIRF and generally represent the normal cost of the Plan. Specific Plan assets and accumulated benefit information for the Bank’s portion of the Plan are not available. Under the Employee Retirement Income Security Act of 1974 (ERISA), a contributor to a multiemployer pension plan may be liable in the event of complete or partial withdrawal for the benefit payments guaranteed under ERISA. Effective July 1, 2005 the plan was frozen as to current participants and any new employees hired after July 1, 2004 were excluded from the plan. The expense of the Plan allocated to the Bank was $58,000 and $36,000 for the years ended December 31, 2010 and 2009, respectively.
401(k) Savings Plan
The Bank has a Section 401(k) savings plan covering substantially all of its employees who meet certain age and service requirements. Contributions to the plan by the Bank are discretionary in nature in such amounts determined by the Board of Directors. The expense under the plan for both the years ended December 31, 2010 and 2009 was $0.
Nonqualified Deferred Compensation Plan
The Bank has a nonqualified deferred compensation plan for certain of its directors. Through 1998, each eligible director could voluntarily defer all or part of his or her director’s fees to participate in the program. The plan is currently unfunded and amounts deferred are unsecured and remain subject to claims of the Bank’s general creditors.
Directors are paid once they reach normal retirement age or sooner for reason of death, total disability, or termination. The Bank may terminate the plan at any time. The amount recorded under the plan totaled approximately $819,000 and $850,000 at December 31, 2010 and 2009, respectively. The expense under the plan for the years ended December 31, 2010 and 2009 was $54,000 and $98,000, respectively.
38
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 13 - Employee Benefit Plans (Continued)
Employee Stock Ownership Plan
Effective January 1, 1994, the Bank implemented an employee stock ownership plan (ESOP). The ESOP covers substantially all employees who have completed one year of service, attained age 21, and worked at least 1,000 hours during the year. To fund the ESOP, the Bank borrowed $480,000 from an outside party to purchase 48,000 shares of the Company’s common stock at $10 per share. The ESOP note was payable quarterly with interest at the prime rate and was retired in 1999. All of the 1994 shares were allocated as of December 31, 1999. Compensation expense is measured by the fair value of ESOP shares allocated to participants during a fiscal year.
Pursuant to the 2005 second-step conversion and stock offering, the shareholders of the Company approved the purchase of 8% of shares sold in the stock offering by the ESOP. The Company provided a loan to the ESOP, which was used to purchase 138,709 shares of the Company’s common stock in the stock offering at $10 per share. The loan bears interest at a rate equal to the current prime rate, adjustable on January 1 of each year and provides for repayment of principal over the 15 year term of the loan. Since the Company provided the loan to the ESOP, the note receivable is not included in the Company’s balance sheet. Accordingly, the Company did not recognize interest income on the loan.
The Company makes annual contributions to the ESOP sufficient to support the debt service of the loan. The loan is secured by the shares purchased, which are held in a suspense account for allocation among the participants as the loan is paid. Dividends paid on unallocated shares are not considered dividends for financial reporting purposes and are used to pay principal and interest on the ESOP loan. Dividends on allocated shares are charged to retained earnings.
The Board of Directors of the Company authorized prepayments of principal on the ESOP loan of $715,000 in 2009. The loan was paid in full as of December 31, 2009.
39
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Compensation expense is recognized for the ESOP equal to the average fair value of shares committed to be released for allocation to participant accounts. Any difference between the average fair value of shares committed to be released for allocation and the ESOP’s original acquisition cost is charged or credited to stockholders’ equity (additional paid-in capital). During the years ended December 31, 2010 and 2009, respectively, 7,391 and 833 shares were sold into the open market. Total compensation expense for the years ended December 31, 2010 and 2009 was $0 and $99,000, respectively.
Shares held by the ESOP include the following:
December 31 | ||||||||
2010 | 2009 | |||||||
Allocated | 152,156 | 182,570 | ||||||
Unallocated | - | - | ||||||
Total | 152,156 | 182,570 |
There were 23,023 and 2,173 shares distributed to ESOP participants in 2010 and 2009, respectively.
The cost of unallocated ESOP shares (shares not yet released for allocation) is reflected as a reduction of stockholders’ equity. As of December 31, 2009 all shares in the plan were allocated due to the prepayment of the ESOP loan.
Stock-Based Compensation Plans
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). Shares issued under the Plan 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.
40
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 13 - Employee Benefit Plans (Continued)
Stock Options - A summary of option activity under the Plan during the years ended December 31, 2010 and 2009 is presented below:
Weighted-Average | ||||||||||||||||
Weighted- | Remaining | |||||||||||||||
Average | Contractual Term | Aggregate | ||||||||||||||
Options | Shares | Exercise Price | (Years) | Intrinsic Value | ||||||||||||
Outstanding at January 1, 2009 | 192,132 | $ | 9.48 | 7.5 | - | |||||||||||
Granted in 2009 | - | $ | 0.00 | |||||||||||||
Exercised in 2009 | - | $ | 0.00 | |||||||||||||
Forfeited or Expired in 2009 | (4,000 | ) | $ | 9.57 | ||||||||||||
Outstanding at December 31, 2009 | 188,132 | $ | 9.47 | 6.3 | - | |||||||||||
Granted in 2010 | - | $ | 0.00 | |||||||||||||
Exercised in 2010 | - | $ | 0.00 | |||||||||||||
Forfeited or expired in 2010 | (2,000 | ) | $ | 9.54 | ||||||||||||
Oustanding at December 31, 2010 | 186,132 | $ | 9.47 | 5.3 | - | |||||||||||
Options Exercisable at December 31, 2010 | 148,774 | $ | 9.46 | 5.2 | - |
At December 31, 2010, 52,300 shares were available for future granting of options.
41
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 13 - Employee Benefit Plans (Continued)
The aggregate intrinsic value of outstanding options shown in the table above represents the total pretax intrinsic value (i.e. the difference between the Company’s closing stock price of $2.80 on December 31, 2010 and the exercise price times the number of shares) that would have been received by the option holder had all option holders exercised their options on December 31, 2010. The amount changes based on the fair market value of the stock.
As of December 31, 2010 there was $32,000 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 0.5 years. The total fair value of shares vested during the year ended December 31, 2010 and 2009 was $70,000 and $60,000, respectively.
A summary of the status of the Company’s nonvested options as of December 31, 2010 and 2009 and changes during the years then ended is presented below:
Weighted-Average | ||||||||
Grant-Date | ||||||||
Nonvested Shares | Shares | Fair Value | ||||||
Nonvested at January 1, 2009 | 111,774 | $ | 2.11 | |||||
Granted | - | $ | 0.00 | |||||
Vested | (36,368 | ) | $ | 2.11 | ||||
Forfeited | (1,930 | ) | $ | 2.10 | ||||
Nonvested at December 31, 2009 | 73,476 | $ | 2.11 | |||||
Granted | - | - | ||||||
Vested | (34,118 | ) | $ | 2.11 | ||||
Forfeited | (2,000 | ) | $ | 2.10 | ||||
Nonvested at December 31, 2010 | 37,358 | $ | 2.11 |
42
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Restricted Stock Awards – The Company did not grant any award shares during the years ended December 31, 2010 and 2009. Compensation expense for 2010 and 2009 related to awards granted under this plan was $124,000 and $128,000.
The shares vest over a five year service period. As of December 31, 2010 there was $38,000 of unrecognized compensation cost related to nonvested restricted stock awards under the Plan.
The following table summarizes the activity of restricted stock awards under the Plan during the years ended December 31, 2010 and 2009:
2010 | 2009 | |||||||
Beginning of period | 26,000 | 38,850 | ||||||
Granted | - | 0 | ||||||
Vested | (12,750 | ) | (12,850 | ) | ||||
Forfeited | (200 | ) | 0 | |||||
Nonvested, end of period | 13,050 | 26,000 |
At December 31, 2010, 5,234 shares were available for future grants of award shares.
Note 14 - Fair Values Measurements
Accounting standards require certain assets and liabilities be reported at fair value on the financial statements and provide a framework for establishing that fair value. The framework for determining fair value is based on a hierarchy that prioritizes the inputs and valuation techniques used to measure fair value.
The following tables present information about the Company’s assets measured at fair value on a recurring basis at December 31, 2010 and 2009, and the valuation techniques used by the Company to determine those fair values.
43
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 14 - Fair Values Measurements (Continued)
Assets and Liabilities Measured at Fair Value on a Recurring Basis at December 31, 2010 (in Thousands) | ||||||||||||||||
Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Balance at December 31, 2010 | |||||||||||||
Assets | ||||||||||||||||
Investment securities- available-for-sale: | ||||||||||||||||
US Treasury securities and obligations of U.S. government corporations and agencies | $ | - | $ | 4,562 | $ | - | $ | 4,562 | ||||||||
Municipal notes | - | 5,046 | - | 5,046 | ||||||||||||
Mortgage-backed securities | - | 25,692 | - | 25,692 | ||||||||||||
Equity securities | - | 1 | - | 1 | ||||||||||||
Total investment securities - available-for-sale | $ | - | $ | 35,301 | $ | - | $ | 35,301 |
Assets and Liabilities Measured at Fair Value on a Recurring Basis at December 31, 2009 (in Thousands) | ||||||||||||||||
Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Balance at December 31, 2009 | |||||||||||||
Assets | ||||||||||||||||
Investment securities- available-for-sale: | ||||||||||||||||
US Treasury securities and obligations of U.S. government corporations and agencies | $ | - | $ | 8,257 | $ | - | $ | 8,257 | ||||||||
Municipal notes | - | 8,053 | - | 8,053 | ||||||||||||
Corporate securities | - | 1,002 | - | 1,002 | ||||||||||||
Mortgage-backed securities | - | 16,397 | - | 16,397 | ||||||||||||
Equity securities | - | 4 | - | 4 | ||||||||||||
Total investment securities - available-for-sale | $ | - | $ | 33,713 | $ | - | $ | 33,713 |
In general, fair values determined by Level 1 inputs use quoted prices in active markets for identical assets or liabilities that the Corporation has the ability to access.
Fair values determined by Level 2 inputs use other inputs that are observable, either directly or indirectly. These Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals.
44
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 14 - Fair Values Measurements (Continued)
Level 3 inputs are unobservable inputs, including inputs that are available in situations where there is little, if any, market activity for the related asset. These Level 3 fair value measurements are based primarily on management’s own estimates using pricing models, discounted cash flow methodologies, or similar techniques taking into account the characteristics of the asset.
In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest level input that is significant to the valuation. The Company’s assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each asset or liability.
The Company also has assets that under certain conditions are subject to measurement at fair value on a nonrecurring basis. These assets include impaired loans and other real estate owned. The Company has estimated the fair values of these assets based primarily on Level 3 inputs as described above.
45
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 14 - Fair Values Measurements (Continued)
Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2010
Balance at December 31, 2010 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Change in fair value for the twelve-month period ended December 31, 2010 | ||||||||||||||||
Impaired loans accounted for under FASB ASC 310-10 | $ | 2,920 | $ | - | $ | - | $ | 2,920 | $ | 878 | ||||||||||
Other real estate owned -residential mortgages | $ | 514 | $ | - | $ | - | $ | 514 | $ | 68 | ||||||||||
Other Real estate owned - commercial | $ | 2,569 | $ | - | $ | - | $ | 2,569 | $ | 830 | ||||||||||
Total change in fair value | $ | 1,776 |
Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2009
Balance at December 31, 2009 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Change in fair value for the twelve-month period ended December 31, 2009 | ||||||||||||||||
Impaired loans accounted for under FASB ASC 310-10 | $ | 5,846 | $ | - | $ | - | $ | 5,846 | $ | 3,584 | ||||||||||
Other real estate owned -residential mortgages | $ | 584 | $ | - | $ | - | $ | 584 | $ | 11 | ||||||||||
Other Real estate owned - commercial | $ | 2,996 | $ | - | $ | - | $ | 2,996 | $ | 955 | ||||||||||
Total change in fair value | $ | 4,550 |
The Company does not record loans at fair value on a recurring basis. However, on occasion, a loan is considered impaired and an allowance for loan loss is established. A loan is considered impaired when it is probable that all of the principal and interest under the original terms of the loan may not be collected. Once a loan is identified as individually impaired, management measures the impairment in accordance with FASB ASC 310-10, Accounting by Creditors for Impairment of a Loan. In accordance with FASB ASC 820-10, Fair Value Measurements, impaired loans where an allowance is established based on fair value of collateral require classification in the fair value hierarchy. When fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired value as nonrecurring Level 3.
46
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 14 - Fair Values Measurements (Continued)
Other real estate owned assets are reported in the above nonrecurring table at initial recognition of impairment and on an ongoing basis until recovery or charge-off. At the time of foreclosure or repossession, real estate owned and repossessed assets are adjusted to fair value less costs to sell upon transfer of the loans to real estate owned and repossessed assets, establishing a new cost basis. At that time, they are reported in the Company’s fair value disclosures in the above nonrecurring table.
The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based on quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Certain financial instruments and all nonfinancial instruments are excluded from disclosure. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.
The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments:
Cash and Cash Equivalents - The carrying amounts of cash and short-term instruments approximate fair values.
47
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 14 - Fair Values of Financial Instruments (Continued)
Securities - Fair values for securities, excluding Federal Home Loan Bank stock, are based on quoted market prices. The carrying value of Federal Home Loan Bank stock approximates fair value based on the redemption provisions of the Federal Home Loan Bank.
Loans Held for Sale - Fair values of mortgage loans held for sale are based on commitments on hand from investors or prevailing market prices.
Loans Receivable - For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for certain mortgage loans (e.g., one- to four-family residential), credit card loans, and other consumer loans are based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted for differences in loan characteristics. Fair values for other loans (e.g., commercial real estate and investment property mortgage loans, commercial, and industrial loans) are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for nonperforming loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.
Deposit Liabilities - The fair values disclosed for demand deposits (e.g., interest and noninterest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
REPO Sweep Accounts - The fair values disclosed for REPO Sweeps are equal to the amount payable on demand at the reporting date (i.e., their carrying amounts).
Long-term Borrowings - The fair values of the Company’s long-term borrowings are estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.
48
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 14 - Fair Values of Financial Instruments (Continued)
Accrued Interest - The carrying amounts of accrued interest approximate fair value.
The estimated fair values and related carrying or notional amounts of the Company’s financial instruments are as follows:
December 31, 2010 | December 31, 2009 | |||||||||||||||
Carrying Amounts | Estimated Fair Value | Carrying Amounts | Estimated Fair Value | |||||||||||||
Financial assets: | ||||||||||||||||
Cash and cash equivalents | $ | 1,963 | $ | 1,963 | $ | 3,099 | $ | 3,099 | ||||||||
Securities available for sale | 35,301 | 35,301 | 33,713 | 33,713 | ||||||||||||
Securities held to maturity | 2,520 | 2,595 | 3,928 | 4,084 | ||||||||||||
Loans and loans held for sale - Net | 157,144 | 157,629 | 171,271 | 171,544 | ||||||||||||
Federal Home Loan Bank stock | 3,775 | 3,775 | 4,197 | 4,197 | ||||||||||||
Accrued interest receivable | 1,231 | 1,231 | 1,230 | 1,230 | ||||||||||||
Financial liabilities: | ||||||||||||||||
Customer deposits | 155,466 | 157,463 | 158,100 | 159,081 | ||||||||||||
Federal Home Loan Bank advances | 29,000 | 29,657 | 44,400 | 45,552 | ||||||||||||
Note payable | - | - | 631 | 634 | ||||||||||||
REPO sweep accounts | 6,172 | 6,172 | 5,408 | 5,408 | ||||||||||||
Accrued interest payable | 194 | 194 | 322 | 322 |
Note 15 – Discontinued Operations
On February 27, 2009 the Company announced that it had sold the majority of the assets of the InsuranCenter of Alpena. Accordingly, the financial position and results of operations of the InsuranCenter of Alpena are removed from the detail line items in the Company’s financial statements and presented separately as “discontinued operations.”
As of February 27, 2009 all assets and liabilities of the InsuranCenter were disposed of.
49
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 15 – Discontinued Operations (Continued)
The condensed income statement (unaudited) for the two months ended December 31, 2009 for the InsuranCenter of Alpena is as follows:
2009 | ||||
Interest income | $ | - | ||
Interest expense | - | |||
Net interest income | - | |||
Noninterest income | 210 | |||
Noninterest expenses | 280 | |||
Loss before taxes | (70 | ) | ||
Income tax benefit | (24 | ) | ||
Net loss | $ | (46 | ) |
Note 16 - Restrictions on Dividends
OTS regulations impose limitations upon all capital distributions including cash dividends. The total amount of dividends that may be paid is generally limited to the sum of the net profits of the bank for the preceding three years. An application to and the approval of the OTS is required prior to any capital distribution if the institution does not meet the criteria for “expedited treatment” of applications under OTS regulations. If an application is not required, the institution must still provide prior notice to the OTS of the capital distribution. In the event the Bank’s capital falls below its regulatory requirements or the OTS notifies it that it was in need of more than normal supervision, the Bank’s ability to make capital distributions could be restricted. In addition, the OTS could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the OTS determines that such distribution would constitute an unsafe or unsound practice. At December 31, 2010 and 2009, the Bank had $0 in retained earnings available for the payment of dividends to the Company.
50
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 17 - Parent-Only Financial Statements
The following represents the condensed financial statements of First Federal of Northern Michigan Bancorp, Inc. (“Parent”) only. The Parent-only financial information should be read in conjunction with the Company’s consolidated financial statements.
The condensed balance sheet is as follows:
December 31 | ||||||||
2010 | 2009 | |||||||
Assets | ||||||||
Cash at subsidiary bank | $ | 424 | $ | 517 | ||||
Investment in subsidiary | 22,272 | 22,119 | ||||||
Deferred Tax Asset | 318 | 318 | ||||||
Other assets | 222 | 98 | ||||||
Total assets | $ | 23,236 | $ | 23,052 | ||||
Liabilities and Stockholders' Equity | ||||||||
Liabilities | $ | - | $ | - | ||||
Stockholders' equity | 23,236 | 23,052 | ||||||
Total liabilities and stockholders' equity | $ | 23,236 | $ | 23,052 |
The condensed statement of operations for the years ended are as follows:
December 31 | ||||||||
2010 | 2009 | |||||||
Operating income | $ | - | $ | - | ||||
Operating expense | 192 | 186 | ||||||
Loss before income taxes and equity in undistributed net income of subsidiary | (192 | ) | (186 | ) | ||||
Income tax benefit | - | (290 | ) | |||||
Loss before equity in undistributed loss of subsidiary | (192 | ) | (476 | ) | ||||
Equity in undistributed net income (loss) of subsidiary | 430 | (6,287 | ) | |||||
Net income (loss) | $ | 238 | $ | (6,763 | ) |
51
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 17 - Parent-Only Financial Statements (Continued)
The condensed statement of cash flows for the years ended is as follows:
December 31 | ||||||||
2010 | 2009 | |||||||
Cash Flows from Operating Activities | ||||||||
Net income (loss) | $ | 238 | $ | (6,763 | ) | |||
Adjustments to reconcile net income (loss) to net cash from operating activities: | ||||||||
Stock-based compensation plans | $ | 223 | $ | 99 | ||||
Equity in undistributed net (income) loss of subsidiary | (430 | ) | 6,287 | |||||
Net change in other assets | (124 | ) | 267 | |||||
Net cash used in operating activities | (93 | ) | (110 | ) | ||||
Cash Flows from Financing Activities | ||||||||
ESOP Loan Repayment | - | 211 | ||||||
Net cash provided by financing activities | - | 211 | ||||||
Net Increase (Decrease) in Cash | (93 | ) | 101 | |||||
Cash - Beginning of year | 517 | 416 | ||||||
Cash - End of year | $ | 424 | $ | 517 |
Note 18 – Segment Reporting
The Company’s principal activities include banking and, prior to February 2009, the sale of insurance products through its wholly owned subsidiary, ICA. The Company sold the majority of the assets of ICA in February 2009 (see Note 1). The Bank provides financial products including retail and commercial loans as well as retail and commercial deposits. ICA received 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.
52
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
Note 18 – Segment Reporting (Continued)
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 related 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.
As noted above, the majority of the assets of the Company’s segment, ICA, were sold on February 27, 2009; therefore no segment information is reported for the year ended December 31, 2010.
For Year Ended | ||||||||||||||||
December 31, 2009 | ||||||||||||||||
Bank | ICA | Eliminations | Total | |||||||||||||
Interest Income | $ | 12,442 | $ | 4 | $ | (4 | ) | $ | 12,442 | |||||||
Interest Expense | 5,092 | - | (4 | ) | 5,088 | |||||||||||
Net Interest Income - Before provision for loan losses | 7,350 | 4 | - | 7,354 | ||||||||||||
Provision for Loan Losses | 6,196 | - | - | 6,196 | ||||||||||||
Net Interest Income - After provision for loan losses | 1,154 | 4 | - | 1,158 | ||||||||||||
Other Income | 2,198 | 252 | - | 2,785 | ||||||||||||
Operating Expenses | 8,941 | 294 | - | 9,640 | ||||||||||||
Loss - Before federal income tax | (5,589 | ) | (38 | ) | - | (5,697 | ) | |||||||||
Federal Income Tax | 1,079 | (13 | ) | - | 1,066 | |||||||||||
Net Loss | $ | (6,668 | ) | $ | (25 | ) | $ | - | $ | (6,763 | ) | |||||
Depreciation and amortization | $ | 824 | $ | 47 | $ | - | $ | 871 | ||||||||
Assets | $ | 234,069 | $ | - | $ | - | $ | 234,069 | ||||||||
Expenditures related to long-lived assets: | ||||||||||||||||
Property and equipment | 276 | - | - | 276 | ||||||||||||
Total | $ | 276 | $ | - | $ | - | $ | 276 |
53
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries |
Notes to Consolidated Financial Statements |
December 31, 2010 and 2009 |
(000s omitted, except per share data) |
The following tables summarize the Company’s quarterly results for the fiscal years ended December 31, 2010 and 2009:
For the Three-Month Period Ending | ||||||||||||||||
March 31, 2010 | June 30, 2010 | September 30, 2010 | December 31, 2010 | |||||||||||||
Interest income | $ | 2,882 | $ | 2,884 | $ | 2,907 | $ | 2,774 | ||||||||
Interest expense | 956 | 900 | 851 | 740 | ||||||||||||
Net interest income | 1,926 | 1,984 | 2,056 | 2,034 | ||||||||||||
Provision for loan losses | 11 | 595 | 353 | 142 | ||||||||||||
Other income | 578 | 1,265 | 717 | 645 | ||||||||||||
Other expenses | 2,189 | 2,437 | 2,348 | 2,892 | ||||||||||||
Income (loss) - before income tax expense or benefit | 304 | 217 | 72 | (355 | ) | |||||||||||
Income tax expense (benefit) | 102 | (102 | ) | - | - | |||||||||||
Net income (loss) | $ | 202 | $ | 319 | $ | 72 | $ | (355 | ) | |||||||
Net income (loss) per share | ||||||||||||||||
Basic | $ | 0.07 | $ | 0.11 | $ | 0.02 | $ | (0.12 | ) | |||||||
Diluted | $ | 0.07 | $ | 0.11 | $ | 0.02 | $ | (0.12 | ) | |||||||
Weighted average number of shares outstanding - basic and dilutive | 2,884 | 2,884 | 2,884 | 2,884 | ||||||||||||
Cash dividends declared per common share | $ | - | $ | - | $ | - | $ | - | ||||||||
For the Three-Month Period Ending | ||||||||||||||||
March 31, 2009 | June 30, 2009 | September 30, 2009 | December 31, 2009 | |||||||||||||
Interest income | $ | 3,291 | $ | 3,185 | $ | 3,111 | $ | 2,855 | ||||||||
Interest expense | 1,489 | 1,309 | 1,218 | 1,072 | ||||||||||||
Net interest income | 1,802 | 1,876 | 1,893 | 1,783 | ||||||||||||
Provision for loan losses | 264 | 252 | 2,977 | 2,703 | ||||||||||||
Other income | 798 | 764 | 491 | 522 | ||||||||||||
Other expenses | 2,138 | 2,346 | 2,076 | 2,800 | ||||||||||||
Income (loss) from continuing operations - before income tax expense or benefit | 198 | 42 | (2,669 | ) | (3,198 | ) | ||||||||||
Income tax expense (benefit) from continuing operations | 51 | - | 1,149 | (110 | ) | |||||||||||
Net income (loss) from continuing operations | 147 | 42 | (3,818 | ) | (3,088 | ) | ||||||||||
Loss from discontinued operations, net of tax benefit | (46 | ) | - | - | - | |||||||||||
Net income (loss) | $ | 101 | $ | 42 | $ | (3,818 | ) | $ | (3,088 | ) | ||||||
Income (loss) per share from continuing operations | ||||||||||||||||
Basic | $ | 0.05 | $ | 0.01 | $ | (1.32 | ) | $ | (1.07 | ) | ||||||
Diluted | $ | 0.05 | $ | 0.01 | $ | (1.32 | ) | $ | (1.07 | ) | ||||||
Income (loss) per share from discontinued operations | ||||||||||||||||
Basic | $ | (0.01 | ) | $ | - | $ | - | $ | - | |||||||
Diluted | $ | (0.01 | ) | $ | - | $ | - | $ | - | |||||||
Net income (loss) per share | ||||||||||||||||
Basic | $ | 0.04 | $ | 0.01 | $ | (1.32 | ) | $ | (1.07 | ) | ||||||
Diluted | $ | 0.04 | $ | 0.01 | $ | (1.32 | ) | $ | (1.07 | ) | ||||||
Weighted average number of shares outstanding - basic and dilutive | 2,884 | 2,884 | 2,884 | 2,884 | ||||||||||||
Cash dividends declared per common share | $ | - | $ | - | $ | - | $ | - |
54