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 SEPTEMBER 30, 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
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. (Check one):
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 November 14, 2008
(Title of Class) 2,884,249 shares
1
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 2008
INDEX
PAGE
----
PART I -- FINANCIAL INFORMATION
ITEM 1 - UNAUDITED FINANCIAL STATEMENTS
Consolidated Balance Sheet at
September 30, 2008 and December 31, 2007 ................. 3
Consolidated Statements of Income for the Three and Nine
Months Ended September 30, 2008 and September 30, 2007 ... 4
Consolidated Statement of Changes in Stockholders' Equity
for the Nine Months Ended September 30, 2008 ............. 5
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 2008 and September 30, 2007 .......... 6
Notes to Unaudited Consolidated Financial Statements ........ 7
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS .......................................... 17
ITEM 3 - QUANTITATIVE AND QUALITITIVE DISCLOSURES ABOUT MARKET RISK ..... 23
ITEM 4T - CONTROLS AND PROCEDURES ....................................... 24
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS .............................................. 25
ITEM 1A - RISK FACTORS .................................................. 25
ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS .... 25
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES ................................ 25
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ............ 25
ITEM 5 - OTHER INFORMATION .............................................. 25
ITEM 6 - EXHIBITS ....................................................... 25
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
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
September 30, 2008 December 31, 2007
------------------ -----------------
(Unaudited)
ASSETS
Cash and cash equivalents:
Cash on hand and due from banks ......................... $ 4,165,050 $ 3,567,858
Overnight deposits with FHLB ............................ 7,117,803 1,772,999
------------ ------------
Total cash and cash equivalents ......................... 11,282,853 5,340,857
Securities AFS .......................................... 24,218,210 20,680,913
Securities HTM .......................................... 4,074,502 2,770,000
Loans held for sale ..................................... 367,722 --
Loans receivable, net of allowance for loan losses of
$2,791,922 and $4,013,454 as of September 30, 2008 and
December 31, 2007, respectively ...................... 194,495,330 201,333,427
Foreclosed real estate and other repossessed assets ..... 1,537,310 1,279,543
Federal Home Loan Bank stock, at cost ................... 4,196,900 4,196,900
Premises and equipment .................................. 7,230,339 7,619,016
Accrued interest receivable ............................. 1,586,094 1,699,706
Intangible assets ....................................... 1,495,145 2,093,735
Goodwill ................................................ 1,408,604 1,396,854
Other assets ............................................ 2,349,197 2,420,340
------------ ------------
Total assets ............................................ $254,242,206 $250,831,292
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits ................................................ $176,349,954 $164,469,673
Advances from borrowers for taxes and insurance ......... 166,092 729
Federal Home Loan Bank advances and Note Payable ........ 45,968,651 52,683,795
Accrued expenses and other liabilities .................. 410,405 1,173,550
------------ ------------
Total liabilities ....................................... 222,895,102 218,327,747
------------ ------------
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 .............................. 24,377,322 24,327,466
Retained earnings ....................................... 11,066,347 12,416,364
Treasury stock at cost (307,750 shares) ................. (2,963,918) (2,963,918)
Unallocated ESOP ........................................ (883,291) (958,651)
Unearned compensation ................................... (317,486) (414,549)
Accumulated other comprehensive income .................. 36,210 64,913
------------ ------------
Total stockholders' equity .............................. 31,347,104 32,503,545
------------ ------------
Total liabilities and stockholders' equity .............. $254,242,206 $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 For the Nine Months
Ended September 30, Ended September 30,
----------------------- -------------------------
2008 2007 2008 2007
---------- ---------- ----------- -----------
(Unaudited) (Unaudited)
Interest income:
Interest and fees on loans ................... $3,156,924 $3,709,722 $ 9,575,347 $10,896,898
Interest and dividends on investments ........ 248,386 416,676 764,630 1,350,677
Interest on mortgage-backed securities ....... 119,501 13,395 265,793 79,922
---------- ---------- ----------- -----------
Total interest income ........................ 3,524,811 4,139,793 10,605,770 12,327,497
---------- ---------- ----------- -----------
Interest expense:
Interest on deposits ......................... 1,275,690 1,391,569 3,811,954 4,200,920
Interest on borrowings ....................... 532,247 708,554 1,653,578 2,247,734
---------- ---------- ----------- -----------
Total interest expense ....................... 1,807,937 2,100,123 5,465,532 6,448,654
---------- ---------- ----------- -----------
Net interest income .......................... 1,716,874 2,039,670 5,140,238 5,878,843
Provision for loan losses .................... 875,431 110,957 1,242,665 309,937
---------- ---------- ----------- -----------
Net interest income after provision for loan
losses .................................... 841,443 1,928,713 3,897,573 5,568,906
---------- ---------- ----------- -----------
Non Interest income:
Service charges and other fees ............... 245,162 236,870 708,447 649,844
Mortgage banking activities .................. 85,665 77,673 316,382 277,104
(Loss) gain on sale of available-for-sale
investments ............................... -- -- 16,052 (96,655)
Net gain (loss) on sale of premises and
equipment, real estate owned and other
repossessed assets ........................ 5,403 (6,691) 28,497 (19,109)
Other ........................................ 18,076 12,756 67,358 38,094
Insurance & Brokerage Commissions ............ 298,059 701,520 1,315,255 2,043,519
---------- ---------- ----------- -----------
Total non interest income .................... 652,365 1,022,127 2,451,991 2,892,797
---------- ---------- ----------- -----------
Non interest expenses:
Compensation and employee benefits ........... 1,411,486 1,560,340 4,321,082 4,651,267
SAIF Insurance Premiums ...................... 33,443 5,070 85,238 15,936
Advertising .................................. 47,714 75,302 128,860 160,623
Occupancy .................................... 330,703 358,052 1,053,770 1,101,993
Amortization of intangible assets ............ 100,162 122,531 325,327 370,725
Service Bureau Charges ....................... 72,432 73,593 240,518 237,178
Insurance & Brokerage Commission Expense ..... -- 245,193 309,874 719,391
Professional Services ........................ 112,423 76,537 313,789 247,443
Prepayment penalty on FHLB advances .......... -- 171,353 -- 464,240
Other ........................................ 339,993 (128,285) 950,604 948,952
---------- ---------- ----------- -----------
Total non interest expenses .................. 2,448,356 2,559,685 7,729,062 8,917,748
---------- ---------- ----------- -----------
Loss before income tax benefit ............... (954,548) 391,156 (1,379,498) (456,045)
Income tax benefit ........................... (319,814) (48,428) (462,118) (216,753)
---------- ---------- ----------- -----------
Net loss ..................................... $ (634,734) $ 439,584 $ (917,380) $ (239,292)
========== ========== =========== ===========
Per share data:
Basic loss per share ......................... $ (0.22) $ 0.15 $ (0.32) $ (0.08)
Weighted average number of shares
outstanding ............................... 2,884,249 2,884,010 2,884,249 2,938,665
Diluted loss per share ....................... $ (0.22) $ 0.15 $ (0.32) $ (0.08)
Weighted average number of shares outstanding,
including dilutive stock options .......... 2,884,249 2,884,010 2,884,249 2,938,665
Dividends per common share ................... $ 0.05 $ 0.05 $ 0.15 $ 0.15
See accompanying notes to consolidated financial statements.
4
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP INC. AND SUBSIDIARIES
Consolidated Statement of Changes in Stockholders' Equity (Unaudited)
Accumulated
Additional Other
Common Treasury Paid-in Unearned Retained Unallocated Comprehensive
Stock Stock Capital Compensation Earnings ESOP Income Total
------- ----------- ----------- ------------ ----------- ----------- ------------- -----------
Balance at December 31, 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 ... -- -- 75,548 97,063 -- -- -- 172,611
Unallocated ESOP ................ -- -- (25,692) -- -- 75,360 -- 49,668
Net loss for the period ......... -- -- -- -- (917,380) -- -- (917,380)
Changes in unrealized gain:
on available-for-sale
securities (net of tax of
$14,786) ..................... -- -- -- -- -- -- (28,703) (28,703)
-----------
Total comprehensive loss ........ -- -- -- -- -- -- -- (946,083)
Dividends declared .............. -- -- -- -- (432,637) -- -- (432,637)
------- ----------- ----------- --------- ----------- --------- -------- -----------
Balance at September 30, 2008 ... $31,920 $(2,963,918) $24,377,322 $(317,486) $11,066,347 $(883,291) $ 36,210 $31,347,104
======= =========== =========== ========= =========== ========= ======== ===========
See accompanying notes to the consolidated financial statements.
5
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
For Nine Months Ended
September 30,
---------------------------
2008 2007
------------ ------------
(Unaudited)
Cash flows from operating activities:
Net loss ............................................................... $ (917,380) $ (239,292)
Adjustments to reconcile net loss to net cash from operating activities:
Depreciation and amortization ....................................... 769,562 825,067
Provision for loan loss ............................................. 1,242,665 309,937
Amortization and accretion on securities ............................ 46,831 8,834
(Gain) or loss on sale of securities ................................ (16,052) 96,655
Originations of loans held for sale ................................. (8,800,236) (10,595,936)
Principal amount of loans sold ...................................... 8,518,680 10,667,936
Loss or (gain) on sale of real estate held for sale ................. 273,264 (937)
(Gain) or loss on sale of premises and equipment .................... (28,496) 23,041
Change in accrued interest receivable ............................... 113,612 94,333
Change in other assets .............................................. (1,190,965) 165,753
Change in accrued expenses and other liabilities .................... (763,145) (414,099)
Stock options/awards expensed ....................................... 172,611 141,222
------------ ------------
Net cash (used in) provided by operating activities .................... (579,049) 1,082,514
------------ ------------
Net decrease in loans ............................................... 5,595,432 1,665,309
Proceeds from maturity and sale of available-for-sale securities .... 16,270,097 15,577,074
Proceeds from sale of real estate held for investment ............... 919,833 74,138
Proceeds from sale of property & equipment .......................... 243,425 --
Purchase of securities .............................................. (21,186,165) (1,045,000)
Purchase of premises and equipment .................................. (269,109) (852,803)
------------ ------------
Net cash provided by investing activities .............................. 1,573,513 15,418,718
------------ ------------
Net increase (decrease) in deposits ................................. 11,880,281 (10,467,881)
Dividend paid on common stock ....................................... (432,637) (437,975)
ESOP shares committed to be released ................................ 49,668 66,260
Net increase in advances from borrowers ............................. 165,364 47,995
Additions to advances from Federal Home Loan Bank and notes
payable .......................................................... 12,200,000 30,500,000
Repayments of Federal Home Loan Bank advances and notes payable ..... (18,915,144) (36,617,707)
Purchase of treasury shares ......................................... -- (1,398,559)
------------ ------------
Net cash provided by (used in) financing activities .................... 4,947,532 (18,307,867)
------------ ------------
Net increase (decrease) in cash and cash equivalents ................... 5,941,996 (1,806,635)
Cash and cash equivalents at beginning of period ....................... 5,340,857 4,992,801
------------ ------------
Cash and cash equivalents at end of period ............................. $ 11,282,853 $ 3,186,166
============ ============
Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes ........................... $ -- $ 25,000
Cash paid during the period for interest ............................... $ 5,615,901 $ 6,580,063
------------ ------------
See accompanying notes to the consolidated financial statements.
6
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.
The accompanying consolidated financial statements have been prepared on an
accrual basis of accounting and include the accounts of First Federal of
Northern Michigan Bancorp, Inc., and its wholly owned subsidiary, First Federal
of Northern Michigan (the "Bank") and its wholly owned subsidiaries Financial
Service and Mortgage Corporation ("FSMC") and the InsuranCenter of Alpena
("ICA"). FSMC invests in real estate that includes leasing, selling, developing,
and maintaining real estate properties. ICA is a licensed insurance agency
engaged in the business of property, casualty and health insurance. All
significant intercompany balances and transactions have been eliminated in the
consolidation.
These interim financial statements are prepared without audit and reflect
all adjustments, which, in the opinion of management, are necessary to present
fairly the consolidated financial position of the Company at September 30, 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 and nine months ended September 30, 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
7
estimates about various matters. Historically, we believe our estimates and
assumptions have proven to be relatively accurate.
The analysis of the allowance for loan losses has two components: specific
and general allocations. Specific allocations are made for loans that are
determined to be impaired. Impairment is measured by determining the present
value of expected future cash flows or, for collateral-dependent loans, the fair
value of the collateral adjusted for market conditions and selling expenses. The
general allocation is determined by segregating the remaining loans by type of
loan, risk weighting (if applicable) and payment history. We also analyze
delinquency trends, which have remained stable, general economic conditions and
geographic and industry concentrations. This analysis establishes factors that
are applied to the loan groups to determine the amount of the general reserve.
The principal assumption used in deriving the allowance for loan losses is the
estimate of loss content for each risk rating. As an example, if recent loss
experience dictated that the projected loss ratios would be changed by 10% (of
the estimate) across all risk ratings, the allocated allowance as of September
30, 2008 would have changed by approximately $270,280. Actual loan losses may be
significantly more than the allowances we have established, which could have a
material negative effect on our financial results.
Mortgage Servicing Rights. We sell to investors a portion of our originated
one- to four-family residential real estate mortgage loans. When we acquire
mortgage servicing rights through the origination and sale of mortgage loans
with servicing rights retained, we allocate a portion of the total cost of the
mortgage loans to the mortgage servicing rights based on their relative fair
value. As of September 30, 2008, we were servicing loans sold to others totaling
$128.6 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 September 30,
2008 included the following:
Annual constant prepayment speed (CPR): 12.95%
Weighted average life remaining (in months): 241
Discount rate used: 8.00%
At the September 30, 2008 valuation, we calculated the value of our
mortgage servicing rights to be $1.2 million and the weighted average life
remaining of those rights was 42 months. The book value of our mortgage
servicing rights as of September 30, 2008 was $440,000 which was $760,000 less
than the independent valuation, so there was no need to establish a valuation
allowance.
Impairment of Intangible Assets. Goodwill arising from business
acquisitions represents the value attributable to unidentifiable intangible
elements in the business acquired. The fair value of goodwill is dependent upon
many factors, including our ability to provide quality, cost-effective services
in the face of competition. Because of these many factors, management believes
this is a critical accounting policy. A decline in earnings as a result of
business or market conditions or a run-off of insurance customers over sustained
periods could lead to an impairment of goodwill that could adversely affect
earnings in future periods.
8
A significant portion of our intangible assets, including goodwill, relates
to the acquisition premiums recorded with the purchase of the InsuranCenter of
Alpena ("ICA") and certain branches over the last several years. Intangible
assets are reviewed periodically for impairment by comparing the fair value of
the intangible asset to the book value of the intangible asset. If the book
value is in excess of the fair value, impairment is indicated and the
intangibles must be written down to their fair value.
In connection with our acquisition in 2003 of ICA, we allocated the excess
of the purchase price paid over the fair value of net assets acquired to
intangible assets, including goodwill. These intangible assets included the ICA
customer list and a third-party contract to which ICA is a party. From the date
of acquisition through April 30, 2005 we amortized the value assigned to the
customer list and contract over a period of 20 years. 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. On April 1, 2008, the Company, through ICA, sold to the Grotenhuis
Group (a managing agent for Blue Cross Blue Shield of Michigan) for $300,000 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. As part of the transaction, certain employees of ICA
transferred to the Grotenhuis Group to service the contracts. In connection with
this sale, the Company wrote-off the remaining intangible asset related to this
contract, which carried a book value of $273,000.
Goodwill was created in both the 2003 ICA transaction and a 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.
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. Unless
the Company undertakes an acquisition, this standard will not apply.
9
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 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, 2009. 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 has completed its review
and determined its impact is immaterial to the Company's consolidated financial
statements.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements.
SFAS No. 157 enhances existing guidance for measuring assets and liabilities
using fair value. Prior to the issuance of SFAS No. 157, guidance for applying
fair value was incorporated in several accounting pronouncements. SFAS No. 157
provides a single definition of fair value, together with a framework for
measuring it, and requires additional disclosure about the use of fair value to
measure assets and liabilities. SFAS No. 157 also emphasizes that fair value is
a market-based measurement, not an entity-specific measurement, and sets out a
fair value hierarchy with the highest priority being quoted prices in active
markets. Under SFAS No. 157, fair value measurements are disclosed by level
within that hierarchy. While SFAS No. 157 does not add any new fair value
measurements, it does change current practice as follows: (1) a requirement for
an entity to include its own credit standing in the measurement of its
liabilities; (2) a modification of the transaction price presumption; (3) a
prohibition on the use of block discounts when valuing large blocks of
securities for broker-dealers and investment companies; and (4) a requirement to
adjust the value of restricted stock for the effect of the restriction even if
the restriction lapses within one year. SFAS No. 157 was initially effective for
the Company beginning January 1, 2008.
In February 2008, the FASB approved the issuance of FASB Staff Position
(FSP) FAS No. 157-2, Effective Date of FASB Statement No. 157. FSP FAS No. 157-2
allows entities to electively defer the effective date of SFAS No. 157 until
January 1, 2009 for nonfinancial assets and nonfinancial liabilities except
those items recognized or disclosed at fair value on an annual or more
frequently recurring basis. The Company will apply the fair value measurement
and disclosure provisions of SFAS No. 157 to nonfinancial assets and
nonfinancial liabilities effective January 1, 2009. Such is not expected to be
material to our results of operations or financial position.
In October 2008, the FASB approved the issuance of FSP FAS No. 157-3,
Determining the Fair Value of a Financial Asset When the Market for That Asset
Is Not Active. FSP FAS No. 157-3 clarifies the application of SFAS No. 157 in a
market that is not active. FSP FAS No. 157-3 became effective upon issuance,
including prior periods for which financial statements have not been issued,
such as the period ended September 30, 2008. SFAS No. 157 requires the Company
to maximize the use of observable inputs and minimize the use of unobservable
inputs when measuring fair value. As such, it is Company policy to maximize the
use of observable inputs and minimize the use of unobservable inputs when
determining fair value levels for those financial assets for which there exists
an active market. In instances where the market is indicated to be inactive, the
Company incorporates
10
measured risk adjustments which market participants would assume for credit and
liquidity risks when determining fair value levels.
Fair value levels for financial assets in instances where there is limited
or no observable market activity and, thus, are determined upon estimates, are
often derived based on the specific characteristics of the financial asset, as
well as the competitive and economic environment in existence at that particular
time. As a result, fair value levels cannot be measured with certainty and may
not be achieved in a sale of the financial asset. Any pricing model utilized to
determine fair value may contain potential weaknesses and variation in
assumptions utilized, including discount rates, prepayment speeds, default rates
and future cash flow estimates, can result in substantially different estimates
of fair values.
NOTE 2 -- INCOME TAXES
During 2006, the Michigan legislature repealed the Single Business Tax
(SBT) that served as a significant source of revenue for the State and during
2007 enacted the Michigan Business Tax (MBT) as its replacement to take effect
January 1, 2008. Under the MBT, financial institutions are subject to a 0.235%
franchise tax based on net capital. The Company has determined that the impact
of this new taxing structure will be immaterial to the Company's consolidated
financial statements.
NOTE 3 -- FAIR VALUE MEASUREMENTS
Certain assets are recorded at fair value to provide financial statement
users an enhanced understanding of the Company's quality of earnings, with some
assets measured on a recurring basis and others measured on a nonrecurring
basis, with the determination based upon applicable existing accounting n
pronouncements. Accordingly, SFAS No. 157 requires the Company to maximize the
use of observable inputs and minimize the use on unobservable inputs when
measuring fair value. Observable inputs reflect data obtained from independent
sources, while unobservable inputs reflect the Company's market assumptions. A
brief description of each level follows..
Level 1 - 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. Valuation adjustments and block discounts are not
applied to Level 1 instruments. Since valuations are based on quoted prices that
are readily and regularly available in an active market, valuation of these
assets does not entail a significant degree of judgement.
Level 2 - 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 - Fair value drivers for Level 3 inputs are unobservable, 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.
The following table presents the balances of the Company's assets that were
measured at fair value on a recurring basis as of September 30, 2008.
11
ASSETS AND LIABILITIES MEASURED AT FAIR VALUE ON A RECURRING BASIS AT
SEPTEMBER 30, 2008
(DOLLARS IN THOUSANDS)
QUOTED PRICES IN
ACTIVE MARKETS SIGNIFICANT OTHER SIGNIFICANT BALANCE AT
FOR IDENTICAL OBSERVABLE UNOBSERVABLE SEPTEMBER 30,
ASSETS (LEVEL 1) INPUTS (LEVEL 2) INPUTS (LEVEL 3) 2008
---------------- ----------------- ---------------- -------------
ASSETS
Investment securities- available-for-sale $24,218 $-- $-- $24,218
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- and nine- months ended
September 30, 2008, the Company recognized non-cash impairment charges to adjust
these assets to their estimated fair values of $836,000 and $1,320,000,
respectively.
ASSETS MEASURED AT FAIR VALUE ON A NONRECURRING BASIS
(DOLLARS IN THOUSANDS)
TOTAL LOSSES TOTAL LOSSES
QUOTED PRICES SIGNIFICANT FOR THE THREE- FOR THE NINE-
IN ACTIVE OTHER SIGNIFICANT MONTH PERIOD MONTH PERIOD
BALANCE AT MARKETS FOR OBSERVABLE UNOBSERVABLE ENDED ENDED
SEPTEMBER 30, IDENTICAL ASSETS INPUTS INPUTS SEPTEMBER 30, SEPTEMBER 30,
2008 (LEVEL 1) (LEVEL 2) (LEVEL 3) 2008 2008
------------- ---------------- ----------- ------------ -------------- -------------
ASSETS
Investments- held-to-maturity $4,076 $-- $4,076 $ -- $ -- $ --
Impaired loans accounted for
under FAS 114 $7,110 $-- $-- $7,110 836 1,320
---- ------
$836 $1,320
Impaired Loans. 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 due under the original terms of
the loan may not be collected. Once a loan is identified as individually
impaired, management measures impairment in accordance with SFAS No. 114,
Accounting by Creditors for Impairment of a Loan, (SFAS No. 114). The fair value
of impaired loans is estimated using one of several methods, including
collateral value, market value of similar debt, enterprise value, liquidation
value and discounted cash flows. Those impaired loans not requiring an allowance
represent loans for which the fair value of the expected repayments or
collateral exceed the recorded investments in such loans. In accordance with
SFAS No. 157, impaired loans where an allowance is established based on the fair
value of collateral require classification in the fair value hierarchy. The fair
value was calculated based on the fair value of the underlying collateral.
Therefore, these loans were classified within Level 3 of the valuation
hierarchy.
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.
12
NOTE 4 -- 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 September 16, 2008, the Company declared a cash dividend on its common
stock, payable on or about October 17, 2008, to shareholders of record as of
September 30, 2008, equal to $0.05 per share. The dividend on all shares
outstanding totaled $144,212.
NOTE 5 -- 1996 STOCK OPTION PLAN AND 2006 STOCK-BASED INCENTIVE PLAN.
Effective January 1, 2006, the Company adopted Statement of Financial
Accounting Standard (SSFAS) No. 123 (Revised) "Shareholder Based Payments",
which requires that the grant-date fair value of awarded stock options be
expensed over the requisite service period. The Company's 1996 Stock Option Plan
(the "1996 Plan"), which was approved by shareholders, permits the grant of
share options to its employees for up to 127,491 shares of common stock
(retroactively adjusted for the exchange ratio applied in the Company's 2005
stock offering and related second-step conversion). The Company's 2006
Stock-Based Incentive Plan (the "2006 Plan"), which was approved by the
shareholders , 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 to be granted as Restricted Stock Awards is 69,354. Option awards are
granted with an exercise price equal to the market price of the Company's stock
at the date of grant; those option awards generally vest based on five years of
continual service and have ten year contractual terms. Certain options provide
for accelerated vesting if there is a change in control (as defined in the
Plans).
During the three months ended September 30, 2008 the Company awarded no
shares under the 2006 Stock-Based Incentive Plan. Shares issued under the 2006
Plan and exercised pursuant to the exercise of stock options may be either
authorized but unissued shares or reacquired shares held by the Company as
treasury stock.
STOCK OPTIONS - A summary of option activity under the Plan during the nine
months ended September 30, 2008 is presented below:
Weighted-Average
Weighted- Remaining
Average Contractual Term Aggregate
Options Shares Exercise Price (Years) Intrinsic Value
- --------------------------------- ------- -------------- ---------------- ---------------
Outstanding at January 1, 2008 196,992 $9.48
Granted 0 N/A
Exercised 0 N/A
Forfeited or expired (4,710) $9.56
Oustanding at September 30, 2008 192,282 $9.48 7.76 $0
Exercisable at September 30, 2008 79,358 $9.40 7.44 $0
As of September 30, 2008 there was $225,000 of total unrecognized
compensation cost, net of expected forfeitures, related to nonvested options
under the Plans. That cost is expected to be recognized over a weighted-average
period of 3.42 years. The total fair value of shares vested during the nine
months ended September 30, 2008 was $75,611.
RESTRICTED STOCK AWARDS - As of September 30, 2008 there was $327,000 of
unrecognized compensation cost related to nonvested restricted stock awards
under the 2006 Plan.
13
NOTE 6 -- 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, standby letters of credit, and commercial lines of credit. Such
commitments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amounts recognized in the consolidated balance sheet. The
Company's exposure to credit loss is represented by the contracted amount of
these commitments. The Company follows the same credit policies in making
commitments as it does for on-balance sheet instruments.
At September 30, 2008, the Company had outstanding commitments to originate
loans of $26.5 million. These commitments included $6.4 million for permanent
one-to-four family dwellings, $3.7 million for non-residential loans, $1.1
million of undisbursed loan proceeds for construction of one-to-four family
dwellings, $5.7 million of undisbursed lines of credit on home equity loans,
$1.3 million of unused credit card lines, $5.4 million of unused commercial
lines of credit, $1.2 million of undisbursed commercial construction, $5,000 of
unused letters of credit and $1.7 million in unused bounce protection.
NOTE 7 -- SEGMENT REPORTING
The Company's principal activities include banking through its wholly owned
subsidiary, First Federal of Northern Michigan, and the sale of insurance
products through its indirect wholly owned subsidiary, ICA, purchased in 2003.
The Bank provides financial products including retail and commercial loans as
well as retail and commercial deposits. ICA receives commissions from the sale
of various insurance products including health, life, and property. The segments
were determined based on the nature of the products provided to customers.
The financial information for each operating segment is reported on the
basis used internally to evaluate performance and allocate resources. The
allocations have been consistently applied for all periods presented. Revenues
and expenses between affiliates have been transacted at rates that unaffiliated
parties would pay. The only transaction between the segments thus far relates to
a deposit on behalf of ICA included in the Bank. The interest income and
interest expense for this transaction has been eliminated. All other
transactions are with external customers. The performance measurement of the
operating segments is based on the management structure of the Company and is
not necessarily comparable with similar information for any other financial
institution. The information presented is also not necessarily indicative of the
segment's financial condition and results of operations if they were independent
entities.
14
For the Three Months Ended
September 30, 2008
(Dollars in Thousands)
-------------------------------------------
Bank ICA Eliminations Total
-------- ------ ------------ --------
INTEREST INCOME $ 3,525 $ 9 $ (9) $ 3,525
INTEREST EXPENSE 1,817 -- (9) 1,808
-------- ------ ------- --------
NET INTEREST INCOME - Before provision for loan losses 1,708 9 -- 1,717
PROVISION FOR LOAN LOSSES 875 -- -- 875
-------- ------ ------- --------
NET INTEREST INCOME - After provision for loan losses 833 9 -- 842
OTHER INCOME 352 300 -- 652
OPERATING EXPENSES 2,118 330 -- 2,448
-------- ------ ------- --------
LOSS - Before federal income tax benefit (933) (21) -- (954)
FEDERAL INCOME TAX EXPENSE (BENEFIT) (313) (7) -- (319)
-------- ------ ------- --------
NET LOSS $ (620) $ (14) $ -- $ (635)
======== ====== ======= ========
DEPRECIATION AND AMORTIZATION $ 186 $ 86 $ -- $ 272
======== ====== ======= ========
ASSETS $250,044 $5,350 $(1,152) $254,242
======== ====== ======= ========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ -- $ -- $ -- $ --
Intangible assets -- -- -- --
Property and equipment 141 -- -- 141
-------- ------ ------- --------
TOTAL $ 141 $ -- $ -- $ 141
======== ====== ======= ========
For theThree Months Ended
September 30, 2007
(Dollars in Thousands)
-------------------------------------------
Bank ICA Eliminations Total
-------- ------ ------------ --------
INTEREST INCOME $ 4,140 $ 11 $ (11) $ 4,140
INTEREST EXPENSE 2,108 3 (11) 2,100
-------- ------ ----- --------
NET INTEREST INCOME - Before provision for loan losses 2,032 8 -- 2,040
PROVISION FOR LOAN LOSSES 111 -- -- 111
-------- ------ ----- --------
NET INTEREST INCOME - After provision for loan losses 1,921 8 -- 1,929
OTHER INCOME 310 712 -- 1,022
OPERATING EXPENSES 2,371 653 -- 3,024
-------- ------ ----- --------
INCOME (LOSS) - Before federal income tax expesne
(benefit) (140) 67 -- (73)
FEDERAL INCOME TAX EXPESNE (BENEFIT) (71) 23 -- (48)
-------- ------ ----- --------
NET INCOME (LOSS) $ (69) $ 44 $ -- $ (25)
======== ====== ===== ========
DEPRECIATION AND AMORTIZATION $ 186 $ 86 $ -- $ 272
======== ====== ===== ========
ASSETS $258,797 $4,516 $(789) $262,524
======== ====== ===== ========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ -- $ -- $ -- $ --
Intangible assets -- -- -- --
Property and equipment 32 -- -- 32
-------- ------ ----- --------
TOTAL $ 32 $ -- $ -- $ 32
======== ====== ===== ========
15
For the Nine Months Ended
September 30, 2008
(Dollars in Thousands)
-------------------------------------------
Bank ICA Eliminations Total
-------- ------ ------------ --------
INTEREST INCOME $ 10,606 $ 31 $ (31) $ 10,606
INTEREST EXPENSE 5,497 -- (31) 5,466
-------- ------ ------- --------
NET INTEREST INCOME - Before provision for loan losses 5,109 31 -- 5,140
PROVISION FOR LOAN LOSSES 1,242 -- -- 1,242
-------- ------ ------- --------
NET INTEREST INCOME - After provision for loan losses 3,867 31 -- 3,898
OTHER INCOME 1,131 1,321 -- 2,452
OPERATING EXPENSES 6,335 1,394 -- 7,729
-------- ------ ------- --------
LOSS - Before federal income tax benefit (1,337) (42) -- (1,379)
FEDERAL INCOME TAX BENEFIT (448) (14) -- (462)
-------- ------ ------- --------
NET LOSS $ (889) $ (28) $ -- $ (917)
======== ====== ======= ========
DEPRECIATION AND AMORTIZATION $ 561 $ 186 $ -- $ 747
======== ====== ======= ========
ASSETS $250,044 $5,350 $(1,152) $254,242
======== ====== ======= ========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ 12 $ -- $ -- $ 12
Intangible assets -- -- -- --
Property and equipment 269 -- -- 269
-------- ------ ------- --------
TOTAL $ 281 $ -- $ -- $ 281
======== ====== ======= ========
For the Nine Months Ended
September 30, 2007
(Dollars in Thousands)
-------------------------------------------
Bank ICA Eliminations Total
-------- ------ ------------ --------
INTEREST INCOME $ 12,328 $ 22 $ (22) $ 12,328
INTEREST EXPENSE 6,463 8 (22) 6,449
-------- ------ ----- --------
NET INTEREST INCOME - Before provision for loan losses 5,865 14 -- 5,879
PROVISION FOR LOAN LOSSES 310 -- -- 310
-------- ------ ----- --------
NET INTEREST INCOME - After provision for loan losses 5,555 14 -- 5,569
OTHER INCOME 830 2,063 -- 2,893
OPERATING EXPENSES 6,905 2,013 -- 8,918
-------- ------ ----- --------
INCOME (LOSS) - Before federal income tax expense
(benefit) (520) 64 -- (456)
FEDERAL INCOME TAX EXPENSE (BENEFIT) (239) 22 -- (217)
-------- ------ ----- --------
NET INCOME (LOSS) $ (281) $ 42 $ -- $ (239)
======== ====== ===== ========
DEPRECIATION AND AMORTIZATION $ 566 $ 258 $ -- $ 824
======== ====== ===== ========
ASSETS $258,797 $4,516 $(789) $262,524
======== ====== ===== ========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ -- $ -- $ -- $ --
Intangible assets -- -- -- --
Property and equipment 176 23 -- 199
-------- ------ ----- --------
TOTAL $ 176 $ 23 $ -- $ 199
======== ====== ===== ========
16
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
AND SUBSIDIARIES
PART I - FINANCIAL INFORMATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion compares the consolidated financial condition of the
Company at September 30, 2008 and December 31, 2007, and the results of
operations for the three- and nine-month periods ended September 30, 2008 and
2007. This discussion should be read in conjunction with the interim financial
statements and footnotes included herein.
OVERVIEW
For the quarter ended September 30, 2008, the Company reported a net loss
of $635,000 compared to a net loss of $25,000 for the year earlier period, a
decrease in earnings of $610,000. For the nine months ended September 30, 2008,
the net loss was $917,000 compared to a net loss of $239,000 for the nine months
ended September 30, 2007.
Total assets increased by $3.4 million, or 1.4% from December 31, 2007 to
September 30, 2008. Investment securities available for sale increased by $3.5
million from December 31, 2007 to September 30, 2008. Net loans receivable
decreased $6.8 million or 3.4% during that same time period. Total deposits
increased $11.9 million, or 7.2% from December 31, 2007 to September 30, 2008,
while Federal Home Loan Bank advances decreased by $6.5 million from December
31, 2007 to September 30, 2008. Equity decreased by $1.2 million, or 3.6% during
the nine-month period ended September 30, 2008.
COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2008 AND DECEMBER 31, 2007
ASSETS: Total assets increased $3.4 million, or 1.4%, to $254.2 million at
September 30, 2008 from $250.8 million at December 31, 2007. Investment
securities available for sale increased $3.5 million, or 17.1%, from December
31, 2007 to September 30, 2008. Net loans receivable decreased $6.8 million, or
3.4%, to $194.5 million at September 30, 2008 from $201.3 million at December
31, 2007. Total mortgage loans decreased by $4.8 million, consumer loans
decreased by $2.6 million and total commercial loans decreased by $360,000 as
loan originations declined due to weaker economic conditions in our primary
lending markets.
LIABILITIES: Deposits increased $11.9 million, or 7.2%, to $176.3 million at
September 30, 2008 from $164.5 million at December 31, 2007, a time period
during which we were not a market-leader in deposit rates. Over $9 million of
this increase in deposits came was experienced during the three months ended
September 30, 2008. While we were a market leader in rates in some CD maturity
categories during this time period, we attribute the increase, which was
primarily in our money-market and CD products, to depositors seeking safety
rather than rate, and we did not match the high "special rates" that many of our
area competitors were offering. FHLB advances decreased $6.5 million, or 12.6%,
to $45.2 million at September 30, 2008 from $51.7 million at December 31, 2007
due to the pay-down of advances from the maturity of AFS investment securities,
and the influx of deposits.
EQUITY: Stockholders' equity decreased to $31.3 million at September 30, 2008
from $32.5 million at December 31, 2007, a decline of $1.2 million. The decrease
in stockholders' equity was mainly attributable to our net loss for the period
of $910,000 as well as to dividends paid during the period. Dividends were
$433,000 for the nine months ended September 30, 2008, respectively. The
unrealized gain on available for sale securities, net of tax, was $36,200 at
September 30, 2008 as compared to a gain of $64,900 at December 31, 2007, a
decline of $28,700.
17
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2008 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2007
GENERAL: Net income decreased by $610,000 to a net loss of $635,000 for the
three months ended September 30, 2008 from a net loss of $25,000 for the same
period ended September 30, 2007. This decrease was attributable to three
factors: an increase in provision for loan losses of $764,000 to $875,000 for
the three months ended September 30, 2008 as compared to $111,000 for the same
period in 2007; a decrease in net interest income period over period of $323,000
mainly due to a decrease in interest income and a decrease in our net interest
margin; and a decrease in non-interest income of $370,000 period over period.
These three factors were partially offset by a reduction in our non-interest
expense of $576,000 period over period. These factors are all discussed in
greater detail below.
INTEREST INCOME: Interest income was $3.5 million for the three months ended
September 30, 2008, compared to $4.1 million for the comparable period in 2007.
The decrease in interest income was due primarily to two factors: a decrease in
the average balance of our interest-earning assets due to a reduction in the
size of our loan portfolio and a decrease in the yield on interest-earning
assets due in part to lower market interest rates. The average balances of AFS
investment securities decreased $7.9 million as securities matured or were
called and the proceeds were used to pay-down higher-cost FHLB advances, rather
than reinvest in lower-yielding investment securities. The average balance of
mortgage loans decreased $7.7 million period over period and the average balance
of non-mortgage loans decreased $2.8 million quarter over quarter, as we
continued to experience a decline in loan originations due to economic
conditions in our market areas.
INTEREST EXPENSE: Interest expense was $1.8 million for the three month period
ended September 30, 2008, compared to $2.1 million for the same period in 2007.
The decrease in interest expense for the three-month period was due primarily to
decreases in the average balance of and interest rates paid on our Federal Home
Loan Bank Advances period over period. We experienced a $9.6 million decrease in
the average balance of FHLB advances for the three months ended September 30,
2008 when compared to the same period in 2007 and the average rate on those
advances decreased 45 basis point to 4.40% for the three-month period ended
September 30, 2008 as compared to the year-earlier period. In addition, our cost
of funds relating to our certificates of deposit decreased 36 basis points to
4.12% three-month period over three-month period, due mainly to higher-costing
certificates which matured and re-priced lower in the lower market interest rate
environment.
NET INTEREST INCOME: Net interest income decreased to $1.7 million for the three
month period ended September 30, 2008 compared to $2.0 million for the same
period in 2007. For the three months ended September 30, 2008, average
interest-earning assets decreased $9.2 million, or 3.7%, to $237.4 million when
compared to the same period in 2007. Average interest-bearing liabilities
decreased $7.6 million, or 3.5%, to $209.0 million for the quarter ended
September 30, 2008 from $216.6 million for the quarter ended September 30, 2007.
The yield on average interest-earning assets decreased to 5.92% for the three
month period ended September 30, 2008 from 6.69% for the same period ended in
2007 due mainly to decreases in the yields on our non-mortgage loans, increases
in interest reversals on non-performing loans, and investment securities
purchased with yields lower than the securities they replaced in our portfolio
due to declines in market rates of interest. The cost of average
interest-bearing liabilities decreased to 3.42% from 3.83% for the three month
periods ended September 30, 2008 and September 30, 2007, respectively. The
decrease in asset yields on interest earning assets, offset by the decrease in
our cost of funds resulted a decrease in the net interest margin of 41 basis
points to 2.91% for the three month period ended September 30, 2008 from 3.32%
for same period in 2007.
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
18
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 $875,000 for the three month period ended
September 30, 2008 and $111,000 for the comparable period in 2007. During the
quarter ended September 30, 2008, the Company had increased its reserves on
certain commercial and mortgage loans based on deterioration of those credits
during the quarter, particularly one large commercial real-estate loan, which
accounted for the higher provision in the quarter ended September 30, 2008 as
compared to the quarter ended September 30, 2007.
NON INTEREST INCOME: Non interest income was $652,000 for the three month period
ended September 30, 2008, a decrease of $370,000 or 36.2% from the same period
in 2007. The primary reason for the decrease was insurance & brokerage
commission income which was $403,000 lower in the quarter ended September 30,
2008 as compared to the same period a year earlier due to the sale of the
exclusive BCBS contract to Grotenhuis in April 2008.
NON INTEREST EXPENSE: Non interest expense was $2.4 million for the three month
period ended September 30, 2008, a $576,000 or 19.0%, decrease from the same
period in 2007. The decrease was due to $171,000 in prepayment penalties
associated with early pay-off of FHLB advances during the quarter ended
September 30, 2007, and decreases of $245,000 in insurance and brokerage
commission expense related to the sale of the exclusive BCBS contract to
Grotenhuis, $149,000 in compensation and employee benefits, $28,000 in
advertising expense, and $27,000 in occupancy expense.
INCOME TAXES: Federal income taxes decreased to a tax benefit of $320,000 for
the three month period ended September 30, 2008 compared to tax benefit of
$48,000 for the same period in 2007. The decrease for the three month period was
attributable to a decrease in pre-tax income quarter over quarter.
NINE MONTHS ENDED SEPTEMBER 30, 2008 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2007
GENERAL: Net income decreased $678,000 to a net loss of $917,000 for the nine
months ended September 30, 2008 from net loss of $239,000 for the same period
ended September 30, 2007. The decrease in earnings period over period was
primarily attributable to the same three factors as were discussed for the
three-month period comparison: an increase in provision for loan losses of
$933,000 to $1,243,000 for the nine months ended September 30, 2008 as compared
to $310,000 for the same period in 2007; a decrease in net interest income
period over period of $739,000 mainly due to a decrease in interest income and a
decrease in our net interest margin; and a decrease in non-interest income of
$441,000 period over period. These three factors were partially offset by a
reduction in our non-interest expense of $1,200,000 period over period. The
income tax benefit for the nine months ended September 30, 2008 increased by
$245,000 as compared to the same period in 2007 due to the decrease in pre-tax
income period over period.
INTEREST INCOME: Interest income was $10.6 million for the nine months ended
September 30, 2008, compared to $12.3 million for the comparable period in 2007.
This decrease of $1.7 million, or 14.0%, in interest income was due in large
part to a decrease of $17.6 million in average balances of AFS investment
securities to $16.9 million for the nine-month period ended September 30, 2008
compared to $34.6 million for the period ended September 30, 2007. In addition,
the yield on that portfolio decreased 34 basis points to 4.06% period over
period. We also experienced a 125 basis point decrease to 6.42% period over
period in the yield on our non-mortgage loan portfolio, which carried an average
balance of $104.7 million for the nine month period ended September 30. 2008.
INTEREST EXPENSE: Interest expense was $5.5 million for the nine month period
ended September 30, 2008 compared to $6.4 million for the same period in 2007.
The decrease in interest expense was due primarily to decreases in the average
balance of and interest rates on our Federal Home Loan Bank Advances period over
period. We experienced an $11.5 million decrease in the average balance of FHLB
advances for the nine months ended September 30, 2008 when compared to the same
period in 2007 and the average rate on those advances decreased 44 basis points
to 4.50% for the nine-month period ended September 30, 2008 as compared to the
year-earlier period. In addition, our cost of funds relating to our certificates
of deposit decreased 28 basis points to 4.23% nine-month period over nine-month
period, due mainly to higher-costing certificates which matured and re-priced
lower.
19
NET INTEREST INCOME: Net interest income decreased by $739,000 for the nine
month period ended September 30, 2008 compared to the same period in 2007. For
the nine months ended September 30, 2008, average interest-earning assets
decreased $17.3 million, or 6.9%, when compared to the same period in 2007.
Average interest-bearing liabilities decreased $16.2 million, or 7.3% for the
same period. The yield on average interest-earning assets decreased to 6.03% for
the nine month period ended September 30, 2008 from 6.55% for the same period
ended in 2007. The cost of average interest-bearing liabilities decreased to
3.53% from 3.87% for the nine month periods ended September 30, 2008 and
September 30, 2007, respectively. The net result of the 52 basis point decrease
in asset yields and 34 basis point decrease in the cost of funds was a net
interest rate margin decrease of 20 basis points to 2.94% for the nine month
period ended September 30, 2008, from 3.14% for the same period in 2007.
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 context of SFAS 15.
SEPTEMBER 30, DECEMBER 31,
2008 2007
------------- ------------
(Dollars in thousands)
Total non-accrual loans $8,206 $ 8,459
------ -------
Accrual loans delinquent 90 days or more:
One- to four-family residential 92 532
Other real estate loans -- --
Consumer/Commercial 29 145
------ -------
Total accrual loans delinquent 90 days or more $ 121 $ 677
Total nonperforming loans (1) 8,327 9,136
Total real estate owned-residential mortgages (2) 333 872
Total real estate owned-Consumer and other (2) 1,204 408
Total nonperforming assets $9,864 $10,416
====== =======
Total nonperforming loans to loans receivable 4.21% 4.54%
Total nonperforming assets to total assets 3.88% 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 provision for loan losses amounted to $1.2
million for the nine month period ended September 30, 2008 and $310,000 for the
comparable period in 2007. The ratio of nonperforming loans to total loans was
4.21% at September 30, 2008 and 4.54% at December 31, 2007. As a percent of
total assets, nonperforming loans decreased to 3.88% at September 30, 2008 from
4.15% at December 31, 2007. Total nonperforming assets decreased by $552,000
from December 31, 2007 to September 30, 2008.
NON INTEREST INCOME: Non interest income was $2.5 million for the nine month
period ended September 30, 2008, a decrease of $441,000 or 15.2%, from the same
period in 2007. The primary reason for the decrease was a decrease of $728,000
in insurance and brokerage commission income due to the sale of the exclusive
BCBS contract to Grotenhuis in April 2008, partially offset by increases of
$59,000 in service charge and other fee income and a swing of $112,000 in gain
on sale of AFS securities period over period (a net loss of $97,000 for the nine
months ended September 30, 2007 as compared to net gain of $16,000 for the same
period in 2008).
NON INTEREST EXPENSE: Non interest expense was $7.7 million for the nine month
period ended September 30, 2008 as compared to $8.9 million for the nine month
period ended September 30, 2007. The main reasons for the decrease period over
period was $464,000 in prepayment penalties on FHLB advances paid during the
nine months ended September 30, 2007, a $410,000 reduction in insurance
brokerage and commission expense in 2008 due to the sale of the BCBS contract as
described above and a reduction of $330,000 in compensation and employee
benefits period over period due to the closure of an under-performing branch as
well as other cost-cutting measures.
20
INCOME TAXES: Federal income tax benefit increased to $245,000 to $462,000 for
the nine months ended September 30, 2008 from a benefit of $217,000 for the same
period in 2007. The decrease for the nine month period was attributable to a
decrease in pre-tax income period over period.
LIQUIDITY
The Company's current liquidity position is more than adequate to fund expected
asset growth. The Company's primary sources of funds are deposits, FHLB
advances, proceeds from principal and interest payments, prepayments on loans
and mortgage-backed and investment securities and sale of long-term fixed-rate
mortgages into the secondary market. While maturities and scheduled amortization
of loans and mortgage-backed securities are a predictable source of funds,
deposit flows, mortgage prepayments and sale of mortgage loans into the
secondary market are greatly influenced by general interest rates, economic
conditions and competition.
Liquidity represents the amount of an institution's assets that can be quickly
and easily converted into cash without significant loss. The most liquid assets
are cash, short-term U.S. Government securities, U.S. Government agency
securities and certificates of deposit. The Company is required to maintain
sufficient levels of liquidity as defined by OTS regulations. This requirement
may be varied at the direction of the OTS. Regulations currently in effect
require that the Bank must maintain sufficient liquidity to ensure its safe and
sound operation. The Company's objective for liquidity is to be above 20%.
Liquidity as of September 30, 2008 was $37.1 million, or 20.2%, 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 pledged collateral. As of September 30, 2008, the Bank had
unused borrowing capacity totaling $7.7 million at the FHLB based on the pledged
collateral.
The Company intends to retain for its portfolio certain originated residential
mortgage loans (primarily adjustable rate, balloon and shorter term fixed rate
mortgage loans) and to generally sell the remainder in the secondary market. The
Bank will from time to time participate in or originate commercial real estate
loans, including real estate development loans. During the nine month period
ended September 30, 2008 the Company originated $24.3 million in residential
mortgage loans, of which $15.4 million were retained in portfolio while the
remainder were sold in the secondary market or are being held for sale. This
compares to $24.8 million in originations during the first nine months of 2007
of which $12.9 million were retained in portfolio. The Company also originated
$22.6 million of commercial loans and $4.7 million of consumer loans in the
first nine months of 2007 compared to $19.7 million of commercial loans and $7.2
million of consumer loans for the same period in 2007. Of total loans
receivable, excluding loans held for sale, mortgage loans comprised 47.7% and
48.5%, commercial loans 39.1% and 37.3% and consumer loans 13.2% and 14.2% at
September 30, 2008 and December 31, 2007, respectively.
Deposits are a primary source of funds for use in lending and for other general
business purposes. At September 30, 2008 deposits funded 69.4% 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 September 30, 2008 totaled $72.9
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 significant
market leader in rates paid for liabilities.
Borrowings may be used to compensate for seasonal or other reductions in normal
sources of funds or for deposit outflows at more than projected levels.
Borrowings may also be used on a longer-term basis to support increased lending
or investment activities. At September 30, 2008 the Company had $45.2 million in
FHLB advances. FHLB borrowings as a percentage of total assets were 17.8% at
September 30, 2008 as compared to 20.6% at December 31, 2007. The Company has
sufficient available collateral to obtain additional advances of $7.7 million.
21
CAPITAL RESOURCES
Stockholders' equity at September 30, 2008 was $31.3 million, or 12.3% 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 requirements in accordance with OTS
regulations. The Bank exceeded all regulatory capital requirements at September
30, 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 September 30, 2008:
Minimum to be
Regulatory Well
Actual Minimum Capitalized
--------------- --------------- ---------------
Amount Ratio Amount Ratio Amount Ratio
------- ----- ------- ----- ------- -----
Dollars in Thousands
Tier 1 (Core) capital (to adjusted assets) $27,072 10.79% $10,039 4.00% $12,549 5.00%
Total risk-based capital (to risk-weighted assets) $29,241 16.86% $13,877 8.00% $17,346 10.00%
Tier 1 risk-based capital (to risk weighted assets) $27,072 15.61% $ 6,939 4.00% $10,408 6.00%
Tangible Capital (to tangible assets) $27,072 10.79% $ 3,765 1.50% $ 5,019 2.00%
22
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 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 September 30, 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.
23
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, is recorded,
processed, summarized and reported, within the time periods specified by the
SEC's rules and forms and in timely alerting them to material information
relating to the Company (or its consolidated subsidiaries) required to be
included in its periodic SEC filings.
There were no significant changes made in the Company's internal control over
financial reporting or in other factors that could significantly affect the
Company's internal controls over financial reporting during the period covered
by this report that has materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial reporting.
24
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 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
25
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 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/ Michael W. Mahler
------------------------------------
Michael W. Mahler
Chief Executive Officer
Date: November 14, 2008
By: /s/ Amy E. Essex
------------------------------------
Amy E. Essex, Chief Financial Officer
(Principal Financial and Accounting
Officer)
Date November 14, 2008
26