[Letterhead of Luse Gorman Pomerenk & Schick]
(202) 274-2011 rpomerenk@luselaw.com
January 26, 2005
VIA EDGAR
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Securities and Exchange Commission
Division of Corporation Finance
450 Fifth Street, N.W.
Washington, D.C. 20549
Attn.: Barry McCarty, Esq.
Senior Counsel
RE: FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP INC.
(REGISTRATION NO. 333-121178)
REGISTRATION STATEMENT ON FORM SB-2
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Dear Mr. McCarty:
On behalf of First Federal of Northern Michigan Bancorp Inc. (the
"Company") and in accordance with Rule 101 of Regulation S-T, we are hereby
transmitting Pre-effective Amendment No. 1 to the Company's Registration
Statement on Form SB-2 (the "Amended SB-2"). Set forth below are the Company's
responses to the Staff's comment letter dated January 7, 2005, a copy of which
is included in the courtesy copy of the Amended SB-2 forwarded under cover of
this letter. In addition to these revisions, the Company's Prospectus has been
revised in response to comments received from the Office of Thrift Supervision.
The Prospectus also includes a "Recent Developments" section. The Amended SB-2
has been blacklined to reflect changes from the original filing.
1. We have revised the disclosure on the cover page and on page 4
of the Prospectus in response to the comment.
2. We have revised the disclosure in response to the comment to
clarify who has priority rights to purchase the common stock.
3. We have revised the disclosure in response to the comment by
separating into two paragraphs the simultaneous stock offering transaction and
the exchange of existing common stock transaction.
Barry McCarty, Esq.
Senior Counsel
January 26, 2005
Page 2
4. We note the comment and have increased the text size of the
footnotes on pages 41, 42, 46 and 47. Also, we have separated the paragraph on
page 13 into three paragraphs. Additionally, we have reviewed the Prospectus and
broken up certain paragraphs into shorter paragraphs where we believe shorter
paragraphs will assist the reader.
5. The legend on page (iv) has been removed, as requested.
6. The summary of the business operations of the Company and its
principal subsidiary requested by the comment is presented on the two pages
IMMEDIATELY PRECEDING the bullet items that identify the Company's business
strategy. We believe this provides the context requested in the comment. With
respect to additional explanation and quantification for each bullet point of
the business strategy, we have provided a cross-reference to the body of the
Prospectus where this information is provided. We have not repeated text from
the body of the Prospectus in the Summary because it would defeat the purpose of
the Summary and may obscure the salient points presented there.
7. We have supplemented the disclosure on page 5 of the Summary, as
requested in the comment. We note also that the information requested is
presented in the "Overview" section of the Management's Discussion and Analysis.
8. We have supplemented the disclosure on page 5 of the Summary to
discuss how the economics of the Company's operating environment have caused
management to increase higher-yielding commercial business lending and decrease
its portfolio of single-family loans. The additional disclosure notes the impact
of these changes on net interest income and overall operating results.
9. The Company has made three major changes to its operations in
recent years: in 2000, the Company began selling into the secondary mortgage
market substantially all of its fixed-rate residential mortgage loans; in 2001,
the Company began increasing its portfolio of commercial and commercial real
estate loans; and in 2003, the Company began to diversify its sources of
non-interest income by acquiring a licensed insurance agency. These operational
changes, including the years such operational changes were initiated, are
discussed and quantified thoroughly on page 56 under the heading "Business
Strategy." A briefer reference to these matters is provided in the Summary on
page 7 with a cross-reference to the discussion on page 56.
10. As requested in the comment, we have supplemented the disclosure
on page 20 to further discuss the population and economies of the Company's
market area, as well as trends in these areas.
11. We have supplemented the disclosure on page 4, the first page of
the Summary, to include the number of branch locations. We note that this
information is also disclosed on page 5
Barry McCarty, Esq.
Senior Counsel
January 26, 2005
Page 3
under "First Federal of Northern Michigan." We note also that total assets of
the Company are quantified at page 4. Since the number of branch locations and
total assets are not, per se, elements of the Company's Business Strategy (which
begins on page 7), we have chosen not to repeat these facts in that section.
12. We have provided on page 11 of the Summary section, under a
separate heading, a brief discussion of dissenting stockholders' rights of
appraisal, along with a cross-reference to more extensive disclosure on page 146
which also has been supplemented in response to the comment. We note to the
staff that each stockholder will also receive a proxy statement that includes a
section entitled "Dissenters' and Appraisal Rights" that discusses this topic in
detail.
13. We have disclosed on page 12 that neither the Company nor its
affiliates are expected to make further contributions to the foundation after
its initial funding. In further response to the comment, we wish to advise the
staff that the foundation's proposed operating plan has identified several
priority programs for grants, including education, health and human services,
and youth programs. Although these categories constitute the fundamental areas
in which the Foundation is expected to make grants over the long term, the
availability of funds within each area and the size of disbursements in each
area are subject to modification as emphases shift from year to year or when
major projects are undertaken. While management currently projects that the
foundation's individual grants will range in size from $250 to $5,000, and that
total annual disbursements will range from $37,500 to $45,000, we do not think a
discussion of these matters is particularly relevant to an investment decision
in the common stock of the Company.
14. As requested in the comment, we have disclosed on page 12 the
Company's charitable contributions in 2004 and 2003.
15. As noted in the Prospectus under the heading "Historical and Pro
Forma Regulatory Capital Compliance," the Company's savings bank subsidiary,
while currently well-capitalized, is not OVERCAPITALIZED. Consequently, a
portion of the net proceeds of the offering will simply increase the capital
strength and operating flexibility of the institution. Otherwise, as stated in
the Prospectus, the Company will seek expansion opportunities as they arise,
including acquisition of additional branches and/or whole banks. Since it is
impossible to determine when such opportunities may arise, it is not possible to
state definitively when the entirety of the net proceeds will be deployed. As
requested in the comment, we have supplemented the Prospectus accordingly on
pages 36 and 37. Further, we have added a cross-reference to the risk factor on
the reduced return on equity until the net proceeds are fully deployed.
16. We have supplemented the disclosure on page 17 in response to
the comment.
17. We have revised the disclosure on page 18 in response to the
comment.
Barry McCarty, Esq.
Senior Counsel
January 26, 2005
Page 4
18. We have removed the last sentence of the third paragraph under
the heading "Changes in Market Interest Rates Could Adversely Affect Our
Financial Condition and Results of Operations" on page 21, as the concept in the
sentence was fully addressed in the preceding sentence.
19. We have supplemented the disclosure on page 23, as requested in
the comment.
20. We have revised the disclosure on page 23 to quantify the
projected ownership levels of management and employees after the offering.
Additionally, we have added quantitative disclosure on page 20 under the heading
"Our Concentration of Loans in Our Primary Market Area May Increase Our Risk,"
and on page 23 under the heading "Our Failure to Utilize Effectively the Net
Proceeds of the Offering Could Reduce Our Profitability and Our Return on
Stockholders' Equity." We note that of the remaining 13 risk factors discussed
in the Prospectus, each risk factor, other than those pertaining to
non-quantifiable regulatory or market risk, contains quantitative disclosure.
21. The disclosure has been revised on page 28 in response to the
comment. Similar disclosure has also been added to the Recent Developments data
on page 30 of the Prospectus.
22. We have supplemented the disclosure on page 36 in response to
the comment.
23. The Company submits that the first and second reasons given in
the paragraph are not inconsistent. However, we have added the phrase "one- to
four-family residential loan" on page 53 to the second reason for clarification,
as requested in the comment.
24. As discussed with the staff, as an "SB" filer, the Company is
not required to present in its Prospectus a discussion of 2002 operating results
in comparison to 2001 operating results. For consistency, the Company has
removed the 2001 results from its consolidated statements of income, changes in
stockholders' equity and cash flows.
25. We compared the "material estimates" disclosed in Note 1 of the
Consolidated Financial Statements and the Company's critical accounting policies
discussed in MD&A. We also considered the guidance issued by the SEC related to
the definition of a critical accounting policy. Based on these factors, the
Company confirms that the items listed in the Prospectus are its only critical
accounting policies. However, in response to the comment, we have revised the
"material estimates" referred to in the "Use of Estimates" paragraph on F-15 to
match the critical accounting policies listed in the MD&A discussion.
26. We have reviewed Section V of Release Nos. 33-8350/34-48960 and
have supplemented the disclosure on pages 54-57 based on the Release and in
response to the comment. Specifically, the section on Critical Accounting
Policies has been revised to address:
Barry McCarty, Esq.
Senior Counsel
January 26, 2005
Page 5
(i) why management considers each policy critical; (ii) why each accounting
estimate bears the risk of change; and (iii) the relative accuracy of our past
assumptions.
Regarding the staff's comments in bullet-point 2 (selection of different
estimates) and bullet point 5 (other reasonably likely outcomes), we have chosen
not to revise the disclosure for the following reasons:
o DISCUSS WHY YOU COULD HAVE SELECTED ESTIMATES IN THE CURRENT
PERIOD THAT WOULD HAVE HAD A MATERIALLY DIFFERENT IMPACT ON YOUR
FINANCIAL PRESENTATION.
The underlying assumptions and estimates used by the Company are based
on underlying evidential matter. While we could use other estimates that would
have a materially different impact on our financial presentation, we believe
that the use of any such estimates which are not supportable by evidential
matter and which do not factor reasonably likely outcomes, would be a departure
from generally accepted accounting principles.
o INCLUDE QUANTITATIVE DISCLOSURE OF YOUR SENSITIVITY TO CHANGE
BASED ON OTHER OUTCOMES THAT ARE REASONABLY LIKELY TO OCCUR AND
THAT WOULD HAVE A MATERIAL EFFECT ON THE COMPANY.
The underlying assumptions and estimates used by the Company are based
on underlying evidential matter. For example, prevailing economic conditions are
used in the determination of the loss factors used in determining the allowance
for loan losses. Further, actual run-off rates are used to determine whether
intangible assets related to customer lists are impaired. If we believe that
historical and current conditions are not indicative of future trends and
events, the assumptions and estimates are revised accordingly. Therefore, if
other outcomes are reasonably likely to occur, any such reasonably likely
outcome would be factored into our analysis and the amount recorded could be
materially impacted. We feel that the amounts reported in our financial
presentation consider what we believe to be reasonably likely outcomes given
actual results and reasonably likely future events.
27. We note that the Company's average interest rate spread IMPROVED
for each of the last three fiscal years ending December 31, 2003, and decreased
by 12 basis points for the year ended December 31, 2004. Moreover, the Company's
average interest rate spread for the twelve months ended September 30, 2004, was
2.91%, which is only marginally lower than the Company's peer institutions (as
identified in the independent appraisal) and which is HIGHER than the 2.67%
average of Michigan institutions. Accordingly, we believe that the Company is
not subject to "underlying interest rate problems." As stated in the Prospectus
on page 58, in recent years the Company has maintained high levels of liquid
assets expressly for the purpose of REDUCING its interest rate risk, even though
that strategy adversely affects net interest income. In an effort to better
manage interest-rate risk, the Bank has also emphasized the origination and
retention in its portfolio of adjustable-rate residential mortgage loans. In
addition, the Bank has
Barry McCarty, Esq.
Senior Counsel
January 26, 2005
Page 6
increased its emphasis on the originations and retention in portfolio of
commercial real estate and commercial loans. Most of these loans are originated
with adjustable interest rates, which will assist the Bank in managing interest
rate risk. Since 2000, the Bank has sold into the secondary mortgage market all
of its fixed-rate, longer-term (15 years and greater) residential mortgage
loans. The Bank has maintained high levels of liquid assets, such as cash and
cash equivalents, which will permit it to invest in higher-yielding securities
and higher yielding commercial and commercial real estate loans (as loan
opportunities arise) in a rising interest rate environment. The infusion of net
proceeds from the offering can be expected to further reduce the Company's
interest rate risk because most of the proceeds will be deployed into
interest-earning assets and the additional capital will reduce the proportion of
interest-rate sensitive liabilities that are funding assets. We have reviewed
the current disclosure under the heading "Business Strategy," including the
strategy of improving our interest rate spread and earnings by originating
commercial and commercial real estate loans, and we believe that the disclosure
comprehensively addresses how management wishes to position the Company in the
future.
28. We note that "traditional" single-family mortgages still
comprise 53.1% of the Company's total loans at September 30, 2004. Such loans
are expected to remain the largest part of the Company's loan portfolio in the
foreseeable future because of the Company's expertise in this area, because of
the profitability of these loans in relation to the credit risk they present,
and because the Company's principal federal regulator requires that such loans
comprise the largest part of the Company's loan portfolio. Moreover, as
long-term interest rates rise, the Company expects to retain a larger proportion
of single-family mortgages in its portfolio and reduce its mortgage banking
activities. For these reasons, we do not believe it would be appropriate to
discuss this type of lending as a separate line of business. However, we have
expanded the disclosure on page 5 of the Prospectus as requested in the comment
to better describe the evolution of the Company's operations in recent years in
response to the very low long-term interest rates. We also have supplemented the
disclosure on page 5 to quantify the Company's mortgage banking activities as
well as the non-interest income generated by such activities. Finally, we note
that the interest rate risks associated with the Company's mortgage banking
activities are described under the heading "Changes in Market Interest Rates
Could Adversely Affect Our Financial Condition and Results of Operations," in
the Risk Factors section.
29. We have supplemented the disclosure on pages 93 and 94 as
requested in the comment. In addition, we have revised the Notes to the
Consolidated Financial Statements at page F-14 to add a policy note on revenue
recognition for the insurance commissions.
30. As discussed with the staff, the Company has not included the
cumulative gap analysis in its Prospectus because: (1) as an "SB" filer, the
Company is not required to include a cumulative gap analysis; (2) the Company
has provided quantitative analysis of its interest rate risk management on page
58 using the "net portfolio value" approach, which the Company has presented in
previous SEC 1934 Act filings and which the Company believes better reflects the
Barry McCarty, Esq.
Senior Counsel
January 26, 2005
Page 7
Company's interest rate risk; (3) the Company has not generated a cumulative gap
analysis and, in fact, does not manage its interest rate risk using such
analysis; and (4) the Company does not present in its Management's Discussion
and Analysis data that would typically be shown on a cumulative gap analysis.
31. We have supplemented the disclosure on page 65, as requested in
the comment.
32. The sentence including the reference to "imputed interest" has
been removed from page 67, as the Company's reference to "imputed interest" when
discussing other expenses was incorrect. There was no "imputed" interest related
to the acquisition of ICA. There is interest based on a contractual rate on the
note payable issued in connection with the purchase of ICA. This interest is
properly included in the "Other borrowings" portion of Interest Expense in the
Consolidated Statement of Income. No change was required to the Notes to the
Consolidated Financial Statements.
33. We have revised the disclosure on page 71 and in Note 1 to the
Consolidated Financial Statement on page F-18 in response to the comment.
34. As requested in the comment, we have excluded loans held for
sale from the Loan Portfolio Composition table. We have also made conforming
changes elsewhere in the Prospectus.
35. We have supplemented the disclosure on page 72, as requested in
the comment.
36. We have reconciled the table on loan portfolio maturities and
yields and the table on loan portfolio composition.
37. The Company does defer loan origination fees and costs as
required by SFAS 91. Net deferred fees and costs have now been separately
reported in the table on page 77 and the footnote on F-23, as requested in the
comment. A description of the method used to amortize net deferred fees and
costs has been added to Note 1 on page F-12 of the Consolidated Financial
Statements.
38. We have supplemented the disclosure on pages 75 and 76, as
requested in the comment.
39. As stated in Note 1, the Summary of Significant Accounting
Policies, all subsidiaries are wholly owned and all significant inter-company
balances and transactions have been eliminated in the consolidation. As
requested in the comment, we have eliminated from the description of
"substandard" assets the reference to the Company's equity investment in its
subsidiary, FSMC. However, because FSMC's holdings of land and real estate have
themselves been classified as substandard, we have revised the disclosure
relating to these substandard assets
Barry McCarty, Esq.
Senior Counsel
January 26, 2005
Page 8
on page 82. It should be noted that the Company's financial statements include a
reserve with respect to FSMC's held-for-sale real estate holdings.
40. We have supplemented the disclosure on page 90, as requested in
the comment.
41. We have supplemented the disclosure on page 94, as requested in
the comment.
42. We have supplemented the disclosure on page 111, as requested in
the comment.
43. We note for the staff that the "opinion disclosed in the first
partial paragraph on page 126" (page 137 in the amended Prospectus) is not an
opinion to be provided by Luse Gorman Pomerenk & Schick. Rather, the disclosure
in this paragraph relates to the letter provided by RP Financial, LC, the
independent appraiser, and filed as Exhibit 99.4 to the Form SB-2. This
"subscription rights" letter is not a reasoned opinion, but rather, a summary of
RP Financial's view that the subscription rights to be provided to eligible
parties in the transaction have no ascertainable market value. We have reviewed
the letter and believe that the disclosure on page 137 accurately and completely
reflects the language in the letter. We have moved the placement of this
paragraph to the end of the "Material Income Tax Consequences" section of the
Prospectus to clarify that the federal tax opinion is to be provided by Luse
Gorman Pomerenk & Schick, and that the views of RP Financial are not contained
within this federal tax opinion.
44. The Table of Contents of the Consolidated Financial Statements
has been revised in response to the comment.
45. Non-interest bearing deposits were separately disclosed in the
deposit footnote (Note 8). However, as requested in the comment, we have moved
the deposit disclosure to the Statement of Financial Condition on page F-3.
46. In response to the comment, we have moved the activity related
to real estate held for sale from the investing activities section to the
operating section of the Consolidated Statement of Cash Flows.
47. As discussed with the staff, with the exception of subsidiary
InsuranCenter of Alpena ("ICA"), none of the Company's indirect subsidiaries
exceed the revenue threshold that would ordinarily require segment reporting
under SFAS 131. While ICA exceeds the revenue threshold, the Company has not
adopted segment reporting because of SFAS 131's guidance on aggregation. ICA is
an insurance agency and derives all of its revenue from commissions earned on
the sale of insurance products. The Company notes that the products of First
Federal of Northern Michigan (the "Bank") and ICA are financial products, that
both the Bank and ICA operate in regulated industries, and that a significant
portion of the Bank's and ICA's customers are the same. Further, the Bank has
begun offering ICA's insurance products out of its branches.
Barry McCarty, Esq.
Senior Counsel
January 26, 2005
Page 9
As requested in the comment, we have clarified our application of SFAS 131 in
Note 1 on page F-8.
48. We have supplemented the disclosure on page F-9, as requested in
the comment.
49. We have supplemented the disclosure on page F-9, as requested in
the comment.
50. We have supplemented the disclosure on page 54, as requested in
the comment.
51. We have supplemented the disclosure on page F-11, as requested
in the comment.
52. We have supplemented the disclosure on page F-14, as requested
in the comment.
53. We have supplemented the disclosure on page F-14, as requested
in the comment.
54. The Company does not currently purchase servicing assets. We
have removed the reference to purchased servicing assets from page F-14.
55. The table reflecting the PRO FORMA compensation impact of the
Company's options was initially omitted from the Prospectus because the impact
on PRO FORMA net income was less than $1,000 (net of tax). However, as requested
in the comment, we have added the disclosure on page F-16.
56. We have supplemented the disclosure on page F-17, as requested
in the comment.
57. As requested in the comment, we have included the tabular
disclosures required under EITF 03-1 on page F-22 (including data at December
31, 2002). However, since there were no securities with impairment in excess of
12 months as of three reporting periods, a statement (as opposed to a table) has
been included reflecting this fact.
58. As requested in the comment, we have supplemented the disclosure
on page F-14 and on page 82 of the Prospectus with respect to the real estate
held for sale.
59. The disclosed estimate of the weighted average life for the
Company's servicing assets was incorrect. The disclosure has been corrected on
page F-27. The prepayments have been as expected and the Company has not created
a valuation allowance with respect to these assets. Since prepayment activity
(or lack thereof) is disclosed in the valuation allowance, no further discussion
was added with regard to the impact of prepayments on the servicing assets.
60. The Company has engaged a specialist who has completed a formal
valuation analysis as of September 30, 2004. As requested in the comment, the
results of the valuation and the related assumptions used in the valuation have
been added to the footnote on page F-27.
Barry McCarty, Esq.
Senior Counsel
January 26, 2005
Page 10
61. The Company incurred $100,000 of direct acquisition costs
related to the ICA acquisition. These costs included approximately $17,700 for
professional fees related to computing a purchase price, approximately $52,700
for legal fees to review or complete documents used in the purchase and
approximately $29,600 for professional fees to perform due diligence. The
Company capitalized these costs in accordance with SFAS 141, paragraph 24. In
2003, the Company amortized approximately $8,000 of the costs against operating
income. As discussed with the staff, these costs should have been included in
goodwill and not amortized. Accordingly, as discussed with the staff, these
costs will not be amortized in 2004 and will be permanently reclassified to
goodwill. The misstatement in 2003 resulted in an understatement of
approximately $8,000 pre tax. Based on the guidance in SAB Topic:1M, the Company
believes this amount is immaterial and 2003 filings will not be amended. The SAB
Topic:1M analysis is attached to this letter as Exhibit A.
62. We have supplemented the disclosure on page F-30, as requested
in the comment.
63. We have supplemented the disclosure on page F-34, as requested
in the comment.
64. We have supplemented the disclosure on page F-45, as requested
in the comment.
65. The Stock Option Plan allows for stock options and "limit
rights." Since adoption of the plan in the late 1990's, only stock options have
been granted from the plan. The Company has no intention of granting "limited
rights" under the plan. Accordingly, we are deleting the reference to limited
rights in the footnote located on page F-45.
66. We have revised the footnote in the List of Exhibits to clarify
how a reader can obtain access to the appraisal report, as requested in the
comment.
67. We have filed as Exhibit 8 in this amendment the executed legal
opinion.
68. The Amended SB-2 includes the required consent of the
independent auditors.
69. We note the updating requirements of Item 310(g). Please note
that the Company intends to request acceleration of the effectiveness of the
registration statement during the week of February 7, 2005. The staff's efforts
to accommodate this schedule would be appreciated.
Per the staff's closing comments, the Company will reflect the staff's
comments, as applicable, in its next appropriate 1934 Act filing.
Barry McCarty, Esq.
Senior Counsel
January 26, 2005
Page 11
We trust the foregoing is responsive to the staff's comments. Please
call the undersigned at (202) 274-2011 or Steve Lanter at (202) 274-2004 should
you have any questions.
Respectfully,
/s/ Robert B. Pomerenk
Robert B. Pomerenk
Enclosures
cc: David Lyon, Esq.
Rebekah Moore, CPA
Paul Cline, CPA
Martin A. Thomson, President and
Chief Executive Officer
Eric Luse, Esq.
Steve Lanter, Esq.
EXHIBIT A
SAB TOPIC 1: M ANALYSIS
As a supplement to comment 61, the following analysis has been prepared. The
conclusion is that given the quantitative and qualitative impact of the
misstatement, the amount is deemed immaterial.
The misstatement in the financial statements for the year ended December 31,
2003 was an understatement of income of $8,000 pre tax or approximately $5,300
net of tax. The misstatement had a $.0031 (or about one-third of a penny) impact
on basic earnings per share. However, due to rounding, basic earnings per share
would have been $.74 as compared to the $.73 reported. Fully diluted earnings
per share would have been the same as reported or $.73. The misstatement is
approximately .46 % of pre-tax earnings or less than half of one percent. In
addition to the above quantitative analysis, the following qualitative factors
were considered:
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QUALITATIVE FACTOR ANALYSIS/ANSWER
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Does the misstatement arise from an item capable of precise Known error; however, this is the only
measurement (known error) or does it arise from an estimate? negative in the qualitative analysis.
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Does the misstatement mask a change in earnings or other trend? No. Earnings of $1.2 million with or
without the adjustment.
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Does the misstatement hide a failure to meet analysts No. The stock is not actively monitored
consensus expectations for earnings? by analysts and no EPS target is published.
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Does the misstatement change a loss to income or vice versa? No. The restated net income amount would
be $1.214 million vs. $1.209 million.
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Does the misstatement concern a segment or other portion of No.
the registrant's business that has been identified as playing
a significant role in the registrant's operations or
profitability?
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Does the misstatement impact the registrant's compliance with No.
regulatory requirements?
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Does the misstatement impact the registrant's compliance with No.
loan covenants or other contractual requirements?
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Does the misstatement have an effect of increasing No. Income was actually understated.
management's compensation - for example, by satisfying
requirements for the reward of bonuses or other forms of
incentive compensation?
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Does the misstatement involve the concealment of an unlawful No. The issue dealt with the amortization
transaction? of goodwill, which is not allowed.
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