UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2008
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _____________ to _____________
Commission File Number 000-31957
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
(Exact name of registrant as specified in its charter)
MARYLAND 32-0135202
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 S. SECOND AVENUE, ALPENA, MICHIGAN 49707
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (989) 356-9041
NONE
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, a non-accelerated filer, or a smaller reporting company.
See the definitions of "large accelerated filer," "accelerated filer" and
"smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [ ]
Non-accelerated filer [ ] Smaller reporting company [X]
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X].
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.
Common Stock, Par Value $0.01 Outstanding at May 10, 2008
(Title of Class) 2,884,249 shares
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-Q
QUARTER ENDED MARCH 31, 2008
INDEX
PAGE
----
PART I -- FINANCIAL INFORMATION
ITEM 1 - UNAUDITED FINANCIAL STATEMENTS
Consolidated Balance Sheet at March 31, 2008 and December 31, 2007.... 3
Consolidated Statements of Income for the Three Months Ended March 31,
2008 and March 31, 2007............................................ 4
Consolidated Statement of Changes in Stockholders' Equity for the
Three Months Ended March 31, 2008.................................. 5
Consolidated Statements of Cash Flows for the Three Months Ended March
31, 2008 and March 31, 2007........................................ 6
Notes to Unaudited Consolidated Financial Statements.................. 7
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS............................................. 15
ITEM 3 - QUANTITATIVE AND QUALITITIVE DISCLOSURE OF MARKET RISK.......... 20
ITEM 4T - CONTROLS AND PROCEDURES........................................ 21
Part II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS.............................................. 22
ITEM 1A - RISK FACTORS................................................... 22
ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS..... 22
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES................................. 22
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............. 22
ITEM 5 - OTHER INFORMATION............................................... 22
ITEM 6 - EXHIBITS........................................................ 22
Section 302 Certifications
Section 906 Certifications
When used in this Form 10-Q or future filings by First Federal of Northern
Michigan Bancorp, Inc. (the "Company") with the Securities and Exchange
Commission ("SEC"), in the Company's press releases or other public or
stockholder communications, or in oral statements made with the approval of an
authorized executive officer, the words or phrases "would be," "will allow,"
"intends to," "will likely result," "are expected to," "will continue," "is
anticipated," "estimate," "project," or similar expressions are intended to
identify "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995.
The Company wishes to caution readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made, and to advise
readers that various factors, including regional and national economic
conditions, changes in levels of market interest rates, credit and other risks
of lending and investment activities and competitive and regulatory factors,
could affect the Company's financial performance and could cause the Company's
actual results for future periods to differ materially from those anticipated or
projected.
The Company does not undertake, and specifically disclaims any obligation, to
update any forward-looking statements to reflect occurrences or unanticipated
events or circumstances after the date of such statements.
2
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
December 31,
March 31, 2008 2007
-------------- -------------
(Unaudited)
ASSETS
Cash and cash equivalents:
Cash on hand and due from banks .................... $ 2,683,164 $ 3,567,858
Overnight deposits with FHLB ....................... 2,690,261 1,772,999
------------ -------------
Total cash and cash equivalents .................... 5,373,425 5,340,857
Securities AFS ..................................... 20,178,351 20,680,913
Securities HTM ..................................... 3,074,788 2,770,000
Loans held for sale ................................ 501,719 --
Loans receivable, net of allowance for loan losses
of $3,974,892 and $4,013,454 as of March 31, 2008
and December 31, 2007, respectively ............. 195,558,269 201,333,427
Foreclosed real estate and other repossessed
assets .......................................... 1,130,671 1,279,543
Federal Home Loan Bank stock, at cost .............. 4,196,900 4,196,900
Premises and equipment ............................. 7,369,632 7,619,016
Accrued interest receivable ........................ 1,641,106 1,699,706
Intangible assets .................................. 1,968,733 2,093,735
Goodwill ........................................... 1,408,604 1,396,854
Other assets ....................................... 2,352,301 2,420,340
------------ -------------
Total assets ....................................... $244,754,498 $ 250,831,292
============ =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits ........................................... $163,146,423 $ 164,469,673
Advances from borrowers for taxes and insurance .... 173,757 729
Federal Home Loan Bank advances and Note Payable ... 48,099,195 52,683,795
Accrued expenses and other liabilities ............. 871,009 1,173,550
------------ -------------
Total liabilities .................................. 212,290,384 218,327,747
------------ -------------
Stockholders' equity:
Common stock ($0.01 par value 20,000,000 shares
authorized 3,191,999 shares issued) ............. 31,920 31,920
Additional paid-in capital ......................... 24,339,439 24,327,466
Retained earnings .................................. 12,240,496 12,416,364
Treasury stock at cost (307,750 shares) ............ (2,963,918) (2,963,918)
Unallocated ESOP ................................... (933,541) (958,651)
Unearned compensation .............................. (381,598) (414,549)
Accumulated other comprehensive income ............. 131,316 64,913
------------ -------------
Total stockholders' equity ......................... 32,464,114 32,503,545
------------ -------------
Total liabilities and stockholders' equity ......... $244,754,498 $ 250,831,292
============ =============
See accompanying notes to consolidated financial statements.
3
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
For the Three Months
Ended March 31,
-----------------------
2008 2007
---------- ----------
(Unaudited)
Interest income:
Interest and fees on loans ......................... 3,274,547 3,585,927
Interest and dividends on investments .............. 276,577 499,352
Interest on mortgage-backed securities ............. 38,400 44,969
---------- ----------
Total interest income .............................. 3,589,524 4,130,248
---------- ----------
Interest expense:
Interest on deposits ............................... 1,294,452 1,431,910
Interest on borrowings ............................. 572,919 802,086
---------- ----------
Total interest expense ............................. 1,867,371 2,233,996
---------- ----------
Net interest income ................................ 1,722,153 1,896,251
Provision for loan losses .......................... 24,970 85,629
---------- ----------
Net interest income after provision for loan
losses .......................................... 1,697,183 1,810,622
---------- ----------
Non Interest income:
Service charges and other fees ..................... 226,175 197,015
Mortgage banking activities ........................ 104,806 87,884
Gain on sale of available-for-sale investments ..... 16,052 --
Net gain (loss) on sale of premises and equipment,
real estate owned and other repossessed assets... (2,801) (1,833)
Other .............................................. 23,030 11,929
Insurance & Brokerage Commissions .................. 610,031 692,819
---------- ----------
Total non interest income .......................... 977,293 987,814
---------- ----------
Non interest expenses:
Compensation and employee benefits ................. 1,477,437 1,568,828
SAIF Insurance Premiums ............................ 19,188 5,500
Advertising ........................................ 39,646 40,519
Occupancy .......................................... 345,377 367,617
Amortization of intangible assets .................. 125,002 124,881
Service Bureau Charges ............................. 82,369 75,945
Insurance & Brokerage Commission Expense ........... 223,876 240,800
Professional Services .............................. 92,347 80,279
Other .............................................. 316,813 285,331
---------- ----------
Total non interest expenses ........................ 2,722,055 2,789,699
---------- ----------
Income (loss) before income tax benefit ............ (47,579) 8,737
Income tax benefit ................................. (15,923) (13,023)
---------- ----------
Net income (loss) .................................. $ (31,656) $ 21,760
========== ==========
Per share data:
Basic earnings (loss) per share .................... $ (0.01) $ 0.01
Weighted average number of shares outstanding ...... 2,884,249 3,033,303
Diluted earnings (loss) per share .................. $ (0.01) $ 0.01
Weighted average number of shares outstanding,
including dilutive stock options ................ 2,884,249 3,034,309
Dividends per common share ......................... $ 0.050 $ 0.050
See accompanying notes to consolidated financial statements.
4
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP INC. AND SUBSIDIARIES
Consolidated Statement of Changes in Stockholders' Equity (Unaudited)
Accumulated
Additional Other
Common Treasury Paid-in Unearned Retained Unallocated Comprehensive
Stock Stock Capital Compensation Earnings ESOP Income Total
------- ----------- ----------- ------------ ----------- ----------- ------------- -----------
Balance at December 31,
2007 ............... $31,920 $(2,963,918) $24,327,466 $(414,549) $12,416,364 $(958,651) $ 64,913 $32,503,545
Stock Options/Awards
Expensed ........... -- -- 18,050 32,951 -- -- -- 51,001
Unallocated ESOP ...... -- -- (6,077) -- -- 25,110 -- 19,033
Net loss for the
period ............. -- -- -- -- (31,656) -- -- (31,656)
Changes in unrealized
gain:
on available-for-
sale securities
(net of tax of
$34,208) ........... -- -- -- -- -- -- 66,403 66,403
-----------
Total comprehensive
income ............. -- -- -- -- -- -- -- 34,747
Dividends declared .... -- -- -- -- (144,212) -- -- (144,212)
------- ----------- ----------- --------- ----------- --------- -------- -----------
Balance at March 31,
2008 ............... $31,920 $(2,963,918) $24,339,439 $(381,598) $12,240,496 $(933,541) $131,316 $32,464,114
======= =========== =========== ========= =========== ========= ======== ===========
5
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
For Three Months Ended
March 31,
---------------------------
2008 2007
------------ ------------
(Unaudited)
Cash flows from operating activities:
Net income (loss) ................................... $ (31,656) $ 21,761
Adjustments to reconcile net income (loss) to net cash
from operating activities:
Depreciation and amortization ..................... 273,742 276,520
Provision for loan loss ........................... 24,970 85,629
Amortization and accretion on securities .......... 3,018 10,615
Gain on sale of securities ........................ (16,052) --
Originations of loans held for sale ............... (2,960,216) (3,123,990)
Principal amount of loans sold .................... 2,458,497 3,023,913
Change in accrued interest receivable ............. 58,600 54,869
Change in other assets ............................ 334,869 31,069
Change in accrued expenses and other liabilities .. (336,747) 458,076
Stock options/awards expensed ..................... 51,001 52,605
------------ ------------
Net cash provided by (used in) operating activities .. (139,974) 891,067
------------ ------------
Net decrease in loans ............................. 5,750,188 4,602,749
Proceeds from maturity and sale of
available-for-sale securities .................. 11,633,088 4,180,313
Purchase of securities ............................ (11,321,671) --
Purchase of premises and equipment ................ (29,063) (187,579)
------------ ------------
Net cash provided by investing activities ............ 6,032,542 8,595,483
------------ ------------
Net decrease in deposits .......................... (1,323,250) (3,895,919)
Dividend paid on common stock ..................... (144,212) (149,575)
ESOP shares committed to be released .............. 19,033 23,029
Net increase in advances from borrowers ........... 173,029 146,364
Additions to advances from Federal Home Loan Bank
and notes payable .............................. 5,000,000 12,500,000
Repayments of Federal Home Loan Bank advances and
notes payable .................................. (9,584,600) (17,950,000)
Purchase of treasury shares ....................... -- (358,485)
------------ ------------
Net cash provided used in financing activities ....... (5,860,000) (9,684,586)
------------ ------------
Net increase (decrease) in cash and cash
equivalents ....................................... 32,568 (198,036)
Cash and cash equivalents at beginning of period ..... 5,340,857 4,992,801
------------ ------------
Cash and cash equivalents at end of period ........... $ 5,373,425 $ 4,794,765
============ ============
Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes ......... $ -- $ --
============ ============
Cash paid during the period for interest ............. $ 1,983,895 $ 2,233,311
============ ============
See accompanying notes to the consolidated financial statements.
6
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.
The accompanying consolidated financial statements have been prepared on an
accrual basis of accounting and include the accounts of First Federal of
Northern Michigan Bancorp, Inc. and its wholly owned subsidiary, First Federal
of Northern Michigan (the "Bank") and the Bank's wholly owned subsidiaries
Financial Service and Mortgage Corporation ("FSMC") and the InsuranCenter of
Alpena ("ICA"). FSMC invests in real estate that includes leasing, selling,
developing, and maintaining real estate properties. ICA is a licensed insurance
agency engaged in the business of property, casualty and health insurance. All
significant intercompany balances and transactions have been eliminated in the
consolidation.
These interim financial statements are prepared without audit and reflect
all adjustments, which, in the opinion of management, are necessary to present
fairly the consolidated financial position of the Company at March 31, 2008, and
its results of operations and statement of cash flows for the periods presented.
All such adjustments are normal and recurring in nature. The accompanying
consolidated financial statements do not purport to contain all the necessary
financial disclosures required by generally accepted accounting principles that
might otherwise be necessary and should be read in conjunction with the
consolidated financial statements and notes thereto of the Company included in
the Annual Report for the year ended December 31, 2007. Results for the three
months ended March 31, 2008 are not necessarily indicative of the results that
may be expected for the year ending December 31, 2008.
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. Historically, we believe our estimates and
assumptions have proven to be relatively accurate.
7
The analysis of the allowance for loan losses has two components: specific
and general allocations. Specific allocations are made for loans that are
determined to be impaired. Impairment is measured by determining the present
value of expected future cash flows or, for collateral-dependent loans, the fair
value of the collateral adjusted for market conditions and selling expenses. The
general allocation is determined by segregating the remaining loans by type of
loan, risk weighting (if applicable) and payment history. We also analyze
delinquency trends, which have remained stable, general economic conditions and
geographic and industry concentrations. This analysis establishes factors that
are applied to the loan groups to determine the amount of the general reserve.
The principal assumption used in deriving the allowance for loan losses is the
estimate of loss content for each risk rating. As an example, if recent loss
experience dictated that the projected loss ratios would be changed by 10% (of
the estimate) across all risk ratings, the allocated allowance as of March 31,
2008 would have changed by approximately $389,000. Actual loan losses may be
significantly more than the allowances we have established, which could have a
material negative effect on our financial results.
Mortgage Servicing Rights. We sell to investors a portion of our originated
one- to four-family residential real estate mortgage loans. When we acquire
mortgage servicing rights through the origination and sale of mortgage loans
with servicing rights retained, we allocate a portion of the total cost of the
mortgage loans to the mortgage servicing rights based on their relative fair
value. As of March 31, 2008, we were servicing loans sold to others totaling
$130.6 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 March 31, 2008
included the following:
Annual constant prepayment speed (CPR): 13.45%
Weighted average life remaining (in months): 242
Discount rate used: 9.00%
At the March 31, 2008 valuation, we calculated the value of our mortgage
servicing rights to be $1.1 million and the weighted average life remaining of
those rights was 40 months. The book value of our mortgage servicing rights as
of March 31, 2008 was $472,000 which was $628,000 less than the independent
valuation, so there was no need to establish a valuation allowance.
Impairment of Intangible Assets. Goodwill arising from business
acquisitions represents the value attributable to unidentifiable intangible
elements in the business acquired. The fair value of goodwill is dependent upon
many factors, including our ability to provide quality, cost-effective services
in the face of competition. Because of these many factors, management believes
this is a critical accounting policy. A decline in earnings as a result of
business or market conditions or a run-off of customers over sustained periods
could lead to an impairment of goodwill that could adversely affect earnings in
future periods.
A significant portion of our intangible assets, including goodwill, relates
to the acquisition premiums recorded with the purchase of the ICA and certain
branches over the last several years. Intangible assets are reviewed
periodically for impairment by comparing the fair value of the intangible asset
to the book value of the intangible asset. If the book value is in excess of the
fair value, impairment is indicated and the intangibles must be written down to
their fair value.
8
In connection with our acquisition in 2003 of ICA, we allocated the excess
of the purchase price paid over the fair value of net assets acquired to
intangible assets, including goodwill. These intangible assets included the ICA
customer list and a third-party contract to which ICA is a party. Using
historical cash flows the customer list was assigned a value of $890,000 and the
exclusive contract was valued at $597,000. Both assigned values were arrived at
based on a discounted cash flow (DCF) analysis that assumed a 20 year life or 5%
runoff of revenue each year. The analysis projected net income which was
discounted back to present with a discount rate of 12%. The expected life was
determined using historical runoff rates experienced by ICA before acquisition
which were less than 5% per year. From the date of acquisition through April 30,
2005 we amortized the value assigned to the customer list and contract over a
period of 20 years.
Effective May 1, 2005, one of the former owners of ICA retired, requiring
an evaluation of the impact that this retirement could have on both the customer
list intangible and an exclusive Blue Cross-Blue Shield ("BCBS") contract.
Management determined that the retirement could open the door for BCBS to
re-negotiate the exclusive contract, including the possibility that the contract
could be terminated. In addition, Management considered the possibility that the
customer base could deteriorate as a result of the retirement. Management made
assumptions based on this uncertainty and estimated the impact this could have
on long-term cash flows. Management did not believe there was uncertainty with
respect to near-term cash flows. Based on the guidance of SFAS 142, Management
prospectively changed the amortization for these assets based on our new
expectations. At that point, the remaining useful life of the assets was
determined to be 10 years. Despite the decrease in estimated useful lives, cash
flows from these assets have not deteriorated.
Effective January 1, 2006 the exclusive third-party contract with BCBS was
terminated. Prior to January 1, 2006, the ICA exclusive agent contract with BCBS
entitled ICA to an override commission of 1.9% on all health premiums written
through local Chambers of Commerce in Northeast Michigan. On any health
insurance contracts in place as of December 31, 2005, ICA will continue to
receive the 1.9% commission; however, there will be no new groups added to this
program effective January 1, 2006. At that point, due to the uncertainty of
potential run-off of customer accounts, management decreased the estimated
useful life to 5 years beginning January 1, 2006. However, given the amount of
actual override commissions received, management did not anticipate a decrease
in cash flows in the near term.
Goodwill was created in both the 2003 ICA transaction and the 2005 customer
list purchase. Goodwill will not be amortized but tested annually for
impairment. Annual tests of impairment have included obtaining third party sales
multiple information for comparable companies. The mean of the multiples is
applied to annual net sales of ICA and added to the value of tangible assets
less current liabilities. This value is then compared to the current book value
of Goodwill, Intangibles, and Investment in ICA. Each year this analysis has
indicated no impairment of Goodwill exists. The $900,000 of payments made under
the earn-out agreement in the ICA transaction were added to goodwill as was
$59,000 in earn-out payments accrued in 2007 and 2006 related to the 2005
customer list purchase.
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
quarterly for impairment.
FAS 157 -- Fair Value Measurements. The following tables present
information about the Company's assets and liabilities measured at fair value on
a recurring basis at March 31, 2008, and the valuation techniques used by the
Company to determine those fair values.
In general, fair values determined by Level 1 inputs use quoted prices in
active markets for identical assets or liabilities that the Company 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.
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 or liability.
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.
9
Disclosures concerning assets and liabilities measured at fair value are as
follows:
ASSETS AND LIABILITIES MEASURED AT FAIR VALUE ON A RECURRING BASIS AT
MARCH 31, 2008
(DOLLARS IN THOUSANDS)
QUOTED PRICES
IN ACTIVE SIGNIFICANT
MARKETS FOR OTHER SIGNIFICANT
IDENTICAL OBSERVABLE UNOBSERVABLE BALANCE AT
ASSETS (LEVEL 1) INPUTS (LEVEL 2) INPUTS (LEVEL 3) MARCH 31, 2008
---------------- ---------------- ---------------- --------------
ASSETS
Investment securities- available-for-sale $20,178 $-- $-- $20,178
LIABILITIES
None
The Company also has assets that under certain conditions are subject to
measurement at fair value on a non-recurring basis. These assets include
held-to-maturity investments and loans. For the assets valued using Level 3
inputs, the Company has estimated the fair value using Level 3 inputs using
discounted cash flow projections. For the three months ended March 31, 2008 the
Company recognized a non-cash impairment charge of $79,000 to adjust these
assets to their estimated fair values.
ASSETS MEASURED AT FAIR VALUE ON A NONRECURRING BASIS
(DOLLARS IN THOUSANDS)
QUOTED PRICES TOTAL
IN ACTIVE SIGNIFICANT LOSSES FOR
MARKETS FOR OTHER SIGNIFICANT THE PERIOD
BALANCE IDENTICAL OBSERVABLE UNOBSERVABLE ENDED
AT MARCH ASSETS INPUTS INPUTS MARCH 31,
31, 2008 (LEVEL 1) (LEVEL 2) (LEVEL 3) 2008
-------- ------------- ----------- ------------ ----------
ASSETS
Investments- held-to-maturity $3,075 $-- $3,075 $ -- $ --
Impaired loans accounted for
under FAS 114 $8,300 $-- $8,300 (79)
----------
$(79)
Impaired loans accounted for under FAS 114 categorized as Level 3 assets
consist of non-homogeneous loans that are considered impaired. The Company
estimates the fair value of the loans based on the present value of expected
future cash flows using management's best estimate of key assumptions. The
assumptions include future payment ability, timing of payment streams, and
estimated realizable values of available collateral (typically baaed on outside
appraisals).
Other assets, including bank-owned life insurance, goodwill, intangible
assets and other assets acquired in business combinations, are also subject to
periodic assessments under other accounting principles generally accepted in the
United States of America. These assets are not considered financial instruments.
Effective February 12, 2008, the FASB issued a staff position, FSP FAS 157-2,
which delayed the applicability of FAS 157 to non-financial instruments.
Accordingly, these assets have been omitted from the above disclosures.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2007, the FASB issued FAS No. 141 (revised 2007), Business
Combinations ("FAS 141(R)"), which establishes principles and requirements for
how an acquirer recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed, and any non-controlling
interest in an acquiree, including the recognition and measurement of goodwill
acquired in a business combination. FAS No. 141(R) is effective for fiscal years
beginning on or after December 15, 2008. Earlier adoption is prohibited. The
Company is currently evaluating the impact the adoption of this standard will
have on the Company's results of operations.
In December 2007, the FASB issued FAS No. 160, Non-controlling Interests in
Consolidated Financial Statements -- an amendment of ARB No. 51. FAS No. 160
amends ARB No. 51 to establish
10
accounting and reporting standards for the non-controlling interest in a
subsidiary and for the deconsolidation of a subsidiary. It clarifies that a
non-controlling interest in a subsidiary, which is sometimes referred to as
minority interest, is an ownership interest in the consolidated entity that
should be reported as equity in the consolidated financial statements. Among
other requirements, this statement requires consolidated net income to be
reported at amounts that include the amounts attributable to both the parent and
the non-controlling interest. It also requires disclosure, on the face of the
consolidated income statement, of the amounts of consolidated net income
attributable to the parent and to the non-controlling interest. FAS No. 160 is
effective for fiscal years beginning on or after December 15, 2008. Earlier
adoption is prohibited. The Company is currently evaluating the impact the
adoption of this standard will have on the Company's results of operations.
In June 2007, the FASB ratified Emerging Issues Task Force Issue No. 06-11
("EITF 06-11"), Accounting for Income Tax Benefits of Dividends on Share-Based
Payment Awards. EITF 06-11 applies to share-based payment arrangements with
dividend protection features that entitle employees to receive (a) dividends on
equity-classified non-vested shares, (b) dividend equivalents on
equity-classified non-vested share units, or (c) payments equal to the dividends
paid on the underlying shares while an equity-classified share option is
outstanding, when those dividends or dividend equivalents are charged to
retained earnings under FAS No. 123R, Share-Based Payment, and result in an
income tax deduction for the employer. A consensus was reached that a realized
income tax benefit from dividends or dividend equivalents that are charged to
retained earnings and are paid to employees for equity-classified non-vested
equity shares, non-vested equity share units, and outstanding equity share
options should be recognized as an increase in additional paid-in capital. EITF
06-11 is effective for fiscal years beginning after December 15, 2007, and
interim periods within those fiscal years. The Company is currently evaluating
the impact the adoption of this standard will have on the Company's results of
operations.
In March 2008, the FASB issued FAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities, to require enhanced disclosures about
derivative instruments and hedging activities. The new standard has revised
financial reporting for derivative instruments and hedging activities by
requiring more transparency about how and why an entity uses derivative
instruments, how derivative instruments and related hedged items are accounted
for under FAS No. 133, Accounting for Derivative Instruments and Hedging
Activities; and how derivative instruments and related hedged items affect an
entity's financial position, financial performance, and cash flows. FAS No. 161
requires disclosure of the fair values of derivative instruments and their gains
and losses in a tabular format. It also requires entities to provide more
information about their liquidity by requiring disclosure of derivative features
that are credit risk-related. Further, it requires cross-referencing within
footnotes to enable financial statement users to locate important information
about derivative instruments. FAS No. 161 is effective for financial statements
issued for fiscal years and interim periods beginning after November 15, 2008,
with early application encourage. The Company is currently evaluating the impact
the adoption of this standard will have on the Company's results of operations.
NOTE 2 -- DIVIDENDS.
Payment of dividends on the common stock is subject to determination and
declaration by the Board of Directors and depends upon a number of factors,
including capital requirements, regulatory limitations on the payment of
dividends, the Company's results of operations and financial condition, tax
considerations and general economic conditions.
On March 19, 2008, the Company declared a cash dividend on its common
stock, payable on or about April 18, 2008, to shareholders of record as of March
31, 2008, equal to $0.05 per share. The dividend on all shares outstanding
totaled $144,212.
11
NOTE 3 -- 1996 STOCK OPTION PLAN, 1996 RECOGNITION AND RETENTION PLAN AND 2006
STOCK-BASED INCENTIVE PLAN.
Effective January 1, 2006, the Company adopted Statement of Financial
Accounting Standard (SFAS) No. 123 (Revised) "Shareholder Based Payments", which
requires that the grant-date fair value of awarded stock options be expensed
over the requisite service period. The Company's 1996 Stock Option Plan (the
"1996 Plan"), which was approved by shareholders, permits the grant of share
options to its employees for up to 127,491 shares of common stock (retroactively
adjusted for the exchange ratio applied in the Company's 2005 stock offering and
related second-step conversion). The Company's 2006 Stock-Based Incentive Plan
(the "2006 Plan"), which was approved by the shareholders on May 17, 2006,
permits the award of up to 242,740 shares of common stock of which the maximum
number to be granted as Stock Options is 173,386 and the maximum that can be
granted as Restricted Stock Awards is 69,354. Option awards are granted with an
exercise price equal to the market price of the Company's stock at the date of
grant; those option awards generally vest based on five years of continual
service and have ten year contractual terms. Certain options provide for
accelerated vesting if there is a change in control (as defined in the Plans).
During the three months ended March 31, 2008 the Company awarded no shares
under the Recognition and Retention Plan ("RRP"). Shares issued under the RRP
and exercised pursuant to the exercise of the stock option plan may be either
authorized but unissued shares or reacquired shares held by the Company as
treasury stock.
STOCK OPTIONS - A summary of option activity under the Plan during the
three months ended March 31, 2008 is presented below:
Weighted-
Average
Remaining
Weighted- Contractual Aggregate
Average Term Intrinsic
Options Shares Exercise Price (Years) Value
- ------------------------------ ------- -------------- ----------- ---------
Outstanding at January 1, 2008 196,992 $9.48
Granted 0 N/A
Exercised 0 N/A
Forfeited or expired (4,060) $9.55
Outstanding at March 31, 2008 192,932 $9.48 8.04 $0
Exercisable at March 31, 2008 49,760 $9.27 7.61 $0
A summary of the status of the Company's nonvested shares as of March 31,
2008, and changes during the quarter ended March 31, 2008, is presented below:
Weighted-
Average
Grant-Date
Nonvested Shares Shares Fair Value
- ---------------------------- ------- ----------
Nonvested at January 1, 2008 154,400 $2.10
Granted 0 N/A
Vested (7,168) $1.94
Forfeited (4,060) $2.22
Nonvested at March 31, 2008 143,172 $2.11
As of March 31, 2008 there was $270,000 of total unrecognized compensation
cost, net of expected forfeitures, related to nonvested options under the Plan.
That cost is expected to be recognized over a weighted-average period of 3.2
years. The total fair value of shares vested during the three months ended March
31, 2008 was $14,294.
12
RESTRICTED STOCK AWARDS - As of March 31, 2008 there was $382,000 of
unrecognized compensation cost related to nonvested restricted stock awards
under the plan. That cost is expected to be recognized over a weighted-average
period of 3.2 years.
NOTE 4 -- COMMITMENTS TO EXTEND CREDIT
The Company is a party to credit-related financial instruments with
off-balance sheet risk in the normal course of business to meet the financing
needs of its customers. These financial instruments include commitments to
extend credit, stand by letters of credit, and commercial lines of credit. Such
commitments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amounts recognized in the consolidated balance sheet. The
Company's exposure to credit loss is represented by the contracted amount of
these commitments. The Company follows the same credit policies in making
commitments as it does for on-balance sheet instruments.
At March 31, 2008, the Company had outstanding commitments to originate
loans of $39.3 million. These commitments included $9.1 million for permanent
one-to-four family dwellings, $8.2 million for non-residential loans, $270,000
of undisbursed loan proceeds for construction of one-to-four family dwellings,
$6.9 million of undisbursed lines of credit on home equity loans, $1.4 million
of unused credit card lines, $11.3 million of unused commercial lines of credit,
$390,000 of undisbursed commercial construction, $180,000 of unused Letters of
Credit and $1.6 million in unused Bounce Protection.
NOTE 5 -- SUBSEQUENT EVENTS
On March 4, 2008, the Company announced that its wholly owned
subsidiary, the InsuranCenter of Alpena ("ICA"), intended to sell to the
Grotenhuis Group (a managing agent for Blue Cross Blue Shield of Michigan) the
rights to service insurance contracts and collect commissions on such contracts
written through local Chambers of Commerce located in an 11-county area in
northeast Michigan. The purchase closed effective April 1, 2008. As part of the
transaction, certain employees of ICA transferred to the Grotenhuis Group to
service the contracts. The Company expects to record a nominal gain in
connection with the sale, which represents $273,000 of the intangible assets
discussed in Note 1.
NOTE 6 -- SEGMENT REPORTING
The Company's principal activities include banking through its wholly owned
subsidiary, First Federal of Northern Michigan, and the sale of insurance
products through its indirect wholly owned subsidiary, ICA, purchased in 2003.
The Bank provides financial products including retail and commercial loans as
well as retail and commercial deposits. ICA receives commissions from the sale
of various insurance products including health, life, and property. The segments
were determined based on the nature of the products provided to customers.
The financial information for each operating segment is reported on the
basis used internally to evaluate performance and allocate resources. The
allocations have been consistently applied for all periods presented. Revenues
and expenses between affiliates have been transacted at rates that unaffiliated
parties would pay. The only transaction between the segments thus far relates to
a deposit on behalf of ICA included in the Bank. The interest income and
interest expense for this transaction has been eliminated. All other
transactions are with external customers. The performance measurement of the
operating segments is based on the management structure of the Company and is
not necessarily comparable with similar information for any other financial
institution. The information presented is also not necessarily indicative of the
segment's financial condition and results of operations if they were independent
entities.
13
For the Three Months Ended
March 31, 2008
(Dollars in Thousands)
-------------------------------------------
Bank ICA Eliminations Total
-------- ------ ------------ --------
INTEREST INCOME $ 3,589 $ 9 $ (9) $ 3,589
INTEREST EXPENSE 1,874 2 (9) 1,867
-------- ------ ----- --------
NET INTEREST INCOME - Before provision for loan losses 1,715 7 -- 1,722
PROVISION FOR LOAN LOSSES 25 -- -- 25
-------- ------ ----- --------
NET INTEREST INCOME - After provision for loan losses 1,690 7 -- 1,697
OTHER INCOME 366 611 -- 977
OPERATING EXPENSES 2,072 650 -- 2,722
-------- ------ ----- --------
LOSS - Before federal income tax (16) (32) -- (48)
FEDERAL INCOME TAX (5) (11) -- (16)
-------- ------ ----- --------
NET LOSS $ (11) $ (21) $ -- $ (32)
======== ====== ===== ========
DEPRECIATION AND AMORTIZATION $ 188 $ 86 $ -- $ 274
======== ====== ===== ========
ASSETS $240,386 $5,187 $(819) $244,754
======== ====== ===== ========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ -- $ -- $ -- $ --
Intangible assets -- -- -- --
Property and equipment 29 -- -- 29
-------- ------ ----- --------
TOTAL $ 29 $ -- $ -- $ 29
======== ====== ===== ========
For the Three Months Ended
March 31, 2007
(Dollars in Thousands)
-------------------------------------------
Bank ICA Eliminations Total
-------- ------ ------------ --------
INTEREST INCOME $ 4,130 $ 6 $ (6) $ 4,130
INTEREST EXPENSE 2,237 3 (6) 2,234
-------- ------ ----- --------
NET INTEREST INCOME - Before provision for loan losses 1,893 3 -- 1,896
PROVISION FOR LOAN LOSSES 85 -- -- 85
-------- ------ ----- --------
NET INTEREST INCOME - After provision for loan losses 1,808 3 -- 1,811
OTHER INCOME 294 694 -- 988
OPERATING EXPENSES 2,109 681 -- 2,790
-------- ------ ----- --------
INCOME - Before federal income tax (7) 16 -- 9
FEDERAL INCOME TAX (19) 6 -- (13)
-------- ------ ----- --------
NET INCOME $ 12 $ 10 $ -- $ 22
======== ====== ===== ========
DEPRECIATION AND AMORTIZATION $ 191 $ 86 $ -- $ 277
======== ====== ===== ========
ASSETS $268,006 $4,507 $(645) $271,868
======== ====== ===== ========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ -- $ -- $ -- $ --
Intangible assets -- -- -- --
Property and equipment 47 16 -- 63
-------- ------ ----- --------
TOTAL $ 47 $ 16 $ -- $ 63
======== ====== ===== ========
14
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
AND SUBSIDIARIES
PART I - FINANCIAL INFORMATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion compares the consolidated financial condition of the
Company at March 31, 2008 and December 31, 2007, and the results of operations
for the three-month periods ended March 31, 2008 and 2007. This discussion
should be read in conjunction with the interim financial statements and
footnotes included herein.
OVERVIEW
For the quarter ended March 31, 2008, the Company had a net loss of
$32,000, or $0.01 per basic and diluted share, compared to earnings of $22,000,
or $0.01 per basic and diluted share, for the year earlier period, a decrease of
$54,000.
Total assets decreased by $6.0 million, or 2.4%, from $250.8 million as of
December 31, 2007 to $244.8 million as of March 31, 2008. Investment securities
available for sale decreased by $503,000 and net loans receivable decreased $5.8
million during this time period. Total deposits decreased $1.3 million from
December 31, 2007 to March 31, 2008 while Federal Home Loan Bank advances
decreased by $4.6 million and equity decreased slightly by $39,000.
COMPARISON OF FINANCIAL CONDITION AT MARCH 31, 2008 AND DECEMBER 31, 2007
ASSETS: Total assets decreased $6.0 million, or 2.4%, to $244.8 million at March
31, 2008 from $250.8 million at December 31, 2007. Investment securities
available for sale decreased $503,000, or 2.4% from December 31, 2007 to March
31, 2008. During the three months ended March 31, 2008, $11.5 million in
callable agency securities were called due to the interest rate environment. We
replaced $11.3 million of those securities with new securities at lower yields.
Net loans receivable decreased $5.8 million, or 2.9%, to $195.6 million at March
31, 2008 from $201.3 million at December 31, 2007. The decrease in net loans was
attributable primarily to the payoff of mortgage and consumer loans.
LIABILITIES: Deposits decreased $1.3 million, or 1.0%, to $163.1 million at
March 31, 2008 from $164.5 million at December 31, 2007. The decrease was
primarily in certificate of deposit balances, reflecting continued competition
for deposits and increased pressure on market deposit rates. Total FHLB advances
decreased $4.6 million to $48.1 million from December 31, 2007 to March 31, 2008
due in part to the maturity of investment securities, but also due to payoff of
mortgage and consumer portfolio loans, the proceeds of which were used to pay
down advances.
EQUITY: Stockholders' equity was $32.5 million at both March 31, 2008 and
December 31, 2007. The net loss for the period of $32,000 was offset by a gain
in value of the investment portfolio.
15
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2008 COMPARED TO THREE MONTHS ENDED MARCH 31, 2007
GENERAL: Net income decreased by $54,000 to a loss of $32,000 for the three
months ended March 31, 2008 from $22,000 for the same period ended March 31,
2007. The major factors affecting earnings during the quarter were a decrease of
$174,000 in net interest income and a decrease in non interest income of
$11,000, partially offset by a decrease of $68,000 in non interest expense from
the quarter ended March 31, 2007 to the quarter ended March 31, 2008.
INTEREST INCOME: Interest income was $3.6 million for the three months ended
March 31, 2008, compared to $4.1 million for the comparable period in 2007. The
average balance of interest earning assets decreased by $27.6 million from
$259.8 million for the three months ended March 31, 2007 to $232.2 million for
the three months ended March 31, 2008 and the average yield on interest earning
assets decreased over that same time period from 6.43% to 6.19%. This was
primarily attributable to a decrease in the average balance of our investment
portfolio of $21.3 million and a decrease in the average yield on that portfolio
three-month period over three-month period. While we did experience an increase
in the yield on our mortgage loan portfolio from 6.15% to 6.36% from the quarter
ended March 31, 2007 to the same period in March 2008, the average balance of
our mortgage loans portfolio decreased by $6.4 million to $96.8 million during
that time period.
INTEREST EXPENSE: Interest expense was $1.9 million for the three-month period
ended March 31, 2008, compared to $2.2 million for the same period in 2007. The
decrease in interest expense was mainly attributable to a decrease in the
average balance of FHLB borrowings of $13.6 million for the quarter ended March
31, 2008 as compared to the quarter ended March 31, 2007, and a decrease in the
cost of those borrowings of 49 basis points period over period. The decrease in
the cost of these funds was due to a prime rate decrease of 300 basis points
from March 31, 2007 to March 31, 2008. In addition, the cost of our certificates
of deposit decreased 15 basis points from the quarter ended March 31, 2007 to
the same period in 2008 while the average balance of those deposits decreased by
$6.2 million three-month period over three-month period.
NET INTEREST INCOME: Net interest income decreased to $1.7 million for the
three-month period ended March 31, 2008 from $1.8 million for the same period in
2007. For the three months ended March 31, 2008, average interest-earning assets
decreased $27.6 million, or 10.6%, when compared to the same period in 2007.
Average interest-bearing liabilities decreased $24.8 million, or 11.2%, to
$203.8 million for the quarter ended March 31, 2008 from $229.6 million for the
quarter ended March 31, 2007. The yield on average interest-earning assets
decreased to 6.19% for the three month period ended March 31, 2008 from 6.43%
for the same period ended in 2007. In addition, the cost of average
interest-bearing liabilities decreased to 3.66% from 3.93% for the three month
periods ended March 31, 2008 and 2007, respectively. Our interest rate spread
increased by 3 basis points to 2.53% while our net interest margin increased by
2 basis points to 2.98% for the three month period ended March 31, 2008 from
2.96% for same period in 2007.
16
DELINQUENT LOANS AND NONPERFORMING ASSETS. The following table sets forth
information regarding loans delinquent 90 days or more and real estate
owned/other repossessed assets of the Bank at the dates indicated. As of the
dates indicated, the Bank did not have any material restructured loans within
the meaning of SFAS 15.
MARCH 31, DECEMBER 31,
2008 2007
--------- ------------
(Dollars in thousands)
------------------------
Total non-accrual loans ............................ $ 9,216 $ 8,459
------- -------
Accrual loans delinquent 90 days or more:
One- to four-family residential ................. -- 532
Other real estate loans ......................... -- --
Consumer/Commercial ............................. 480 145
------- -------
Total accrual loans delinquent 90 days or
more $ 480 $ 677
------- -------
Total nonperforming loans (1) ...................... 9,696 9,136
Total real estate owned-residential mortgages (2) .. 1,131 872
Total real estate owned-Consumer and other (2) ..... 8 408
======= =======
Total nonperforming assets ......................... $10,835 $10,416
======= =======
Total nonperforming loans to loans receivable ...... 4.85% 4.54%
Total nonperforming assets to total assets ......... 4.43% 4.15%
(1) All of the Bank's loans delinquent more than 90 days are classified as
nonperforming.
(2) Represents the net book value of property acquired by the Bank through
foreclosure or deed in lieu of foreclosure. Upon acquisition, this property
is recorded at the lower of its fair market value or the principal balance
of the related loan.
PROVISION FOR LOAN LOSSES: The allowance for loan losses is established through
a provision for loan losses charged to earnings. Loan losses are charged against
the allowance when management believes the uncollectibility of a loan balance is
confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and
is based upon management's periodic review of the collectibility of the loans in
light of historical experience, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower's ability to repay, estimated
value of any underlying collateral and prevailing economic conditions. This
evaluation is inherently subjective, as it requires estimates that are
susceptible to significant revision as more information becomes available. The
provision for loan losses amounted to $25,000 for the three month period ended
March 31, 2008 and $86,000 for the comparable period in 2007. The ratio of
nonperforming loans to total loans was 4.85% and 4.54% at March 31, 2008 and
December 31, 2007, respectively. As a percent of total assets, nonperforming
loans increased to 4.43% at March 31, 2008 from 4.15% at December 31, 2007.
Total nonperforming assets increased by $419,000 from December 31, 2007 to March
31, 2008.
NON INTEREST INCOME: Non interest income was $977,000 for the three month period
ended March 31, 2008, a decrease of $11,000 or 1.0%, from the same period in
2007. The primary reasons for the decrease was a decrease of $83,000 in
Insurance & Brokerage Commission due mainly to a loss in insurance contingency
income quarter over quarter and the loss of a large commercial insurance
customer. This decrease was partially offset by increases period over period of
$29,000 in Service Charges and Other Fees (due mainly to increases in customer
usage of our Bounce protection program), $17,000 in Mortgage Banking Activities
income and $16,000 in Gain on Disposal of Investment Securities (called
securities).
NON INTEREST EXPENSE: Non interest expense was $2.7 million for the three month
period ended March 31, 2008, a $68,000 or 2.4% decrease from the same period in
2007. The decrease was primarily due to decreases in Compensation and Employee
Benefits of $91,000 and Occupancy Expense of $22,000, partially offset by a
$31,000 increase in Other Expenses mainly associated with our repossessed
assets.
INCOME TAXES: The Company had a federal income tax benefit of $16,000 for the
three months ended March 31, 2008 due to the net loss of the period, compared to
a federal income tax benefit of $13,000 for the same period in 2007.
17
LIQUIDITY
The Company's current liquidity position is more than adequate to fund expected
asset growth. The Company's primary sources of funds are deposits, FHLB
advances, proceeds from principal and interest payments, prepayments on loans
and mortgage-backed and investment securities and sale of long-term fixed-rate
mortgages into the secondary market. While maturities and scheduled amortization
of loans and mortgage-backed securities are a predictable source of funds,
deposit flows, mortgage prepayments and sale of mortgage loans into the
secondary market are greatly influenced by general interest rates, economic
conditions and competition.
Liquidity represents the amount of an institution's assets that can be quickly
and easily converted into cash without significant loss. The most liquid assets
are cash, short-term U.S. Government securities, U.S. Government agency
securities and certificates of deposit. The Company is required to maintain
sufficient levels of liquidity as defined by OTS regulations. This requirement
may be varied at the direction of the OTS. Regulations currently in effect
require that the Bank must maintain sufficient liquidity to ensure its safe and
sound operation. The Company's objective for liquidity is to be above 20%.
Liquidity as of March 31, 2008 was $66.5 million, or 38.5% compared to $57.3
million, or 32.1% at December 31, 2007. The levels of these assets are dependent
on the Company's operating, financing, lending and investing activities during
any given period. The liquidity calculated by the Company includes additional
borrowing capacity available with the FHLB. This borrowing capacity is based on
the FHLB stock owned by the Bank along with pledged collateral. As of March 31,
2008, the Bank had unused borrowing capacity totaling $36.2 million at the FHLB
based on the FHLB stock ownership.
The Company intends to retain for its portfolio certain originated residential
mortgage loans (primarily adjustable rate, balloon and shorter term fixed rate
mortgage loans) and to generally sell the remainder in the secondary market. The
Bank will from time to time participate in or originate commercial real estate
loans, including real estate development loans. During the three month period
ended March 31, 2008, the Company originated $6.4 million in residential
mortgage loans, of which $3.1 million were retained in portfolio while the
remainder were sold in the secondary market or are being held for sale. This
compares to $6.2 million in originations during the first three months of 2007
of which $3.2 million were retained in portfolio. The Company also originated
$4.8 million of commercial loans and $1.4 million of consumer loans in the first
three months of 2008 compared to $5.1 million of commercial loans and $2.6
million of consumer loans for the same period in 2007. Of total loans
receivable, excluding loans held for sale, mortgage loans comprised 47.9% and
49.8%, commercial loans 38.5% and 36.1% and consumer loans 13.6% and 14.1% at
March 31, 2008 and March 31, 2007, respectively.
Deposits are a primary source of funds for use in lending and for other general
business purposes. At March 31, 2008 deposits funded 66.7% of the Company's
total assets compared to 65.6% at December 31, 2007. Certificates of deposit
scheduled to mature in less than one year at March 31, 2008 totaled $71.2
million. Management believes that a significant portion of such deposits will
remain with the Bank. The Bank monitors the deposit rates offered by competition
in the area and sets rates that take into account the prevailing market
conditions along with the Bank's liquidity position. Moreover, management
believes that the growth in assets is not expected to require significant
in-flows of liquidity. As such, the Bank does not expect to be a market leader
in rates paid for liabilities.
Borrowings may be used to compensate for seasonal or other reductions in normal
sources of funds or for deposit outflows at more than projected levels.
Borrowings may also be used on a longer-term basis to support increased lending
or investment activities. At March 31, 2008 the Company had $48.1 million in
FHLB advances. FHLB borrowings as a percentage of total assets were 19.7% at
March 31, 2008 as compared to 21.0% at December 31, 2007. The Company has
sufficient available collateral to obtain additional advances of $10.8 million.
When this is combined with current FHLB stock ownership the Company could obtain
up to an additional $36.2 million in advances from the FHLB.
18
CAPITAL RESOURCES
Stockholders' equity at March 31, 2008 was $32.5 million, or 13.3% of total
assets, compared to $32.5 million, or 13.0% of total assets, at December 31,
2007 (See "Consolidated Statement of Changes in Stockholders' Equity"). The Bank
is subject to certain capital-to-assets levels in accordance with OTS
regulations. The Bank exceeded all regulatory capital requirements at March 31,
2008. The following table summarizes the Bank's actual capital with the
regulatory capital requirements and with requirements to be "Well Capitalized"
under prompt corrective action provisions, as of March 31, 2008:
Regulatory Minimum to be
Actual Minimum Well Capitalized
--------------- --------------- ----------------
Amount Ratio Amount Ratio Amount Ratio
------- ----- ------- ----- ------- -----
Dollars in Thousands
Tangible Capital (to
tangible assets) $27,406 11.38% $ 3,613 1.50% $ 4,817 2.00%
Tier 1 (Core) capital (to risk -
weighted assets) $27,406 11.38% $ 9,634 4.00% $12,043 5.00%
Total risk-based capital (to risk-
weighted assets) $29,631 16.86% $14,063 8.00% $17,579 10.00%
Tier 1 risk-based capital (to
tangible assets) $27,406 15.59% $ 7,031 4.00% $10,547 6.00%
19
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-Q
QUARTER ENDED MARCH 31, 2008
PART I - FINANCIAL INFORMATION
ITEM 3. QUANTITATIVE AND QUALITITIVE DISCLOSURES ABOUT MARKET RISK
General. Because the majority of our assets and liabilities are sensitive to
changes in interest rates, our most significant form of market risk is interest
rate risk. We are vulnerable to an increase in interest rates to the extent that
our interest-bearing liabilities mature or reprice more quickly than our
interest-earning assets. As a result, a principal part of our business strategy
is to manage interest rate risk and limit the exposure of our net interest
income to changes in market interest rates.
Our interest rate sensitivity is monitored through the use of a net interest
income simulation model, which generates estimates of the change in our net
interest income over a range of interest rate scenarios. The modeling assumes
loan prepayment rates, reinvestment rates and deposit decay rates based on
historical experience and current economic conditions.
Net Portfolio Value. The Office of Thrift Supervision (the "OTS") requires the
computation of amount by which the net present value of an institution's cash
flow from assets, liabilities and off-balance sheet items (the institution's net
portfolio value or "NPV") would change in the event of a range of assumed
changes in market interest rates. The OTS simulation model uses a discounted
cash flow analysis and an option-based pricing approach to measuring the
interest rate sensitivity of net portfolio value. The Office of Thrift
Supervision provides us with the results of the interest rate sensitivity model,
which is based on information we provide to the OTS to estimate the sensitivity
of our net portfolio value.
Net Interest Income. In addition to NPV calculations, we analyze our sensitivity
to changes in interest rates though an outsourced net interest income model. Net
interest income is the difference between the interest income we earn on our
interest-earning assets, such as loans and securities, and the interest we pay
on our interest-bearing liabilities, such as deposits and borrowings. In our
model, we estimate what our net interest income would be for a twelve-month
period using historical data for assumptions such as loan prepayment rate and
deposit decay rates, the current term structure for interest rates, and current
deposit and loan offering rates. The model then calculates what the net interest
income would be for the same period in the event of an instantaneous 200 basis
point increase or decrease in market interest rates.
As of March 31, 2008, our exposure to interest rate risk has not changed
substantially from disclosures included in the Annual Report on Form 10-K for
the period ended December 31, 2007, as filed with the SEC.
20
ITEM 4T. CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management, including
the Company's Chief Executive Officer and Chief Financial Officer, the Company
evaluated the effectiveness of the design and operation of its disclosure
controls and procedures (as defined in Rule 13a-15(e) and 15d--15(e) under the
Securities Exchange Act of 1934) as of the end of the period covered by this
report. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that, as of the end of the period covered by this
report, the Company's disclosure controls and procedures were effective to
ensure that information required to be disclosed in the reports the Company
files or submits under the Securities Exchange Act of 1934 (1) is recorded,
processed, summarized and reported, within the time periods specified by the
SEC's rules and forms, and (2) is accumulated and communicated to the Company's
management, including its principal executive and principal financial officers,
as appropriate, to allow timely decisions regarding required disclosure.
There has been no change in the Company's internal control over the financial
reporting during the Company's first quarter of fiscal year 2008 that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
21
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-Q
QUARTER ENDED MARCH 31, 2008
PART II -- OTHER INFORMATION
Item 1 - Legal Proceedings:
There are no material legal proceedings to which the Company is a party
or of which any of its property is subject. From time to time the
Company is a party to various legal proceedings incident to its
business.
Item 1A - Risk Factors:
Not applicable
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds:
(a) Not applicable
(b) Not applicable
(c) Not applicable
Item 3 - Defaults upon Senior Securities:
Not applicable.
Item 4 - Submission of Matters to a Vote of Security Holders:
Not applicable
Item 5 - Other Information:
Not applicable
Item 6 - Exhibits
Exhibit 31.1 Certification by Chief Executive Officer pursuant to
section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 31.2 Certification by Chief Financial Officer pursuant to
section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1 Statement of Chief Executive Officer furnished pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.2 Statement of Chief Financial Officer furnished pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
22
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-Q
QUARTER ENDED MARCH 31, 2008
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FIRST FEDERAL OF NORTHERN MICHIGAN
BANCORP, INC.
By: /s/ Martin A. Thomson
-------------------------------------
Martin A. Thomson
Chief Executive Officer
Date: May 13, 2008
By: /s/ Amy E. Essex
-------------------------------------
Amy E. Essex, Chief Financial Officer
(Principal Financial and Accounting
Officer)
Date: May 13, 2008
23