SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2007
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ___________ to ___________
Commission File Number 000-31957
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
(Exact name of registrant as specified in its charter)
MARYLAND 32-0135202
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 S. SECOND AVENUE, ALPENA, MICHIGAN 49707
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (989) 356-9041
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports) and (2) has been subject to such filing requirements for the past 90
days. Yes X No
----- -----
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes No X
----- -----
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.
Common Stock, Par Value $0.01 Outstanding at August 8, 2007
(Title of Class) 2,883,749 shares
Transitional Small Business Disclosure Format: Yes No X
----- -----
1
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-QSB
QUARTER ENDED JUNE 30, 2007
INDEX
PAGE
----
PART I -- FINANCIAL INFORMATION
ITEM 1 - UNAUDITED FINANCIAL STATEMENTS
Consolidated Balance Sheet at
June 30, 2007 and December 31, 2006....................... 3
Consolidated Statements of Income for the Three and
Six Months Ended June 30, 2007 and June 30, 2006.......... 4
Consolidated Statement of Changes in Stockholders' Equity
for the Six Months Ended June 30, 2007.................... 5
Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 2007 and June 30, 2006..................... 6
Notes to Unaudited Consolidated Financial Statements......... 7
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION....... 16
ITEM 3 - CONTROLS AND PROCEDURES......................................... 22
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS............................................... 23
ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS..... 23
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES................................. 23
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............. 23
ITEM 5 - OTHER INFORMATION............................................... 23
ITEM 6 - EXHIBITS........................................................ 24
Section 302 Certifications
Section 906 Certifications
When used in this Form 10-QSB or future filings by First Federal of Northern
Michigan Bancorp, Inc. (the "Company") with the Securities and Exchange
Commission ("SEC"), in the Company's press releases or other public or
stockholder communications, or in oral statements made with the approval of an
authorized executive officer, the words or phrases "would be," "will allow,"
"intends to," "will likely result," "are expected to," "will continue," "is
anticipated," "estimate," "project," or similar expressions are intended to
identify "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995.
The Company wishes to caution readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made, and to advise
readers that various factors, including regional and national economic
conditions, changes in levels of market interest rates, credit and other risks
of lending and investment activities and competitive and regulatory factors,
could affect the Company's financial performance and could cause the Company's
actual results for future periods to differ materially from those anticipated or
projected.
The Company does not undertake, and specifically disclaims any obligation, to
update any forward-looking statements to reflect occurrences or unanticipated
events or circumstances after the date of such statements.
2
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
June 30, 2007 December 31, 2006
------------- -----------------
(Unaudited)
ASSETS
Cash and cash equivalents:
Cash on hand and due from banks ........................................ $ 3,224,509 $ 4,159,833
Overnight deposits with FHLB ........................................... 1,224,152 832,968
------------ ------------
Total cash and cash equivalents ........................................ 4,448,661 4,992,801
Securities AFS ......................................................... 31,650,388 43,100,430
Securities HTM ......................................................... 2,795,000 1,750,000
Loans held for sale .................................................... 226,447 72,000
Loans receivable, net of allowance for loan losses of $2,201,398 and
$2,079,069 as of June 30, 2007 and December 31, 2006, respectively .. 204,346,405 209,518,068
Foreclosed real estate and other repossessed assets .................... 561,173 475,312
Real estate held for investment ........................................ 135,543 135,543
Federal Home Loan Bank stock, at cost .................................. 4,196,900 4,196,900
Premises and equipment ................................................. 7,912,082 8,075,238
Accrued interest receivable ............................................ 1,814,879 2,138,667
Intangible assets ...................................................... 2,341,269 2,589,463
Goodwill ............................................................... 1,396,854 1,396,854
Other assets ........................................................... 2,292,532 2,517,548
------------ ------------
Total assets ........................................................... $264,118,133 $280,958,824
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits ............................................................... $169,520,641 $177,057,993
Advances from borrowers for taxes and insurance ........................ 343,473 44,389
Federal Home Loan Bank advances and Note Payable ....................... 48,688,395 66,042,134
Borrowings at fair value ............................................... 9,889,000 --
Accrued expenses and other liabilities ................................. 1,794,055 2,361,573
------------ ------------
Total liabilities ...................................................... 230,235,564 245,506,089
------------ ------------
Stockholders' equity:
Common stock ($0.01 par value 20,000,000 shares authorized
3,190,999 shares issued) ............................................ 31,910 31,910
Additional paid-in capital ............................................. 24,293,617 24,261,737
Retained earnings ...................................................... 14,144,168 14,576,468
Treasury stock at cost (307,750 and 156,000 shares, respectively) ...... (2,963,918) (1,565,359)
Unallocated ESOP ....................................................... (1,009,277) (1,059,130)
Unearned compensation .................................................. (467,950) (528,987)
Accumulated other comprehensive loss ................................... (145,981) (263,904)
------------ ------------
Total stockholders' equity ............................................. 33,882,569 35,452,735
------------ ------------
Total liabilities and stockholders' equity ............................. $264,118,133 $280,958,824
============ ============
See accompanying notes to consolidated financial statements.
3
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
For the Three Months For the Six Months
Ended June 30, Ended June 30,
----------------------- -----------------------
2007 2006 2007 2006
---------- ---------- ---------- ----------
(Unaudited) (Unaudited)
Interest income:
Interest and fees on loans .......................... $3,601,249 $3,607,804 $7,187,176 $7,024,417
Interest and dividends on investments ............... 436,514 547,520 946,363 1,109,331
Interest on mortgage-backed securities .............. 22,235 53,014 69,335 107,989
---------- ---------- ---------- ----------
Total interest income ............................... 4,059,999 4,208,338 8,202,875 8,241,737
---------- ---------- ---------- ----------
Interest expense:
Interest on deposits ................................ 1,377,441 1,326,612 2,809,351 2,566,522
Interest on borrowings .............................. 737,095 757,110 1,539,181 1,426,457
---------- ---------- ---------- ----------
Total interest expense .............................. 2,114,536 2,083,722 4,348,532 3,992,979
---------- ---------- ---------- ----------
Net interest income ................................. 1,945,463 2,124,617 3,854,343 4,248,758
Provision for loan losses ........................... 113,351 133,000 198,980 202,500
---------- ---------- ---------- ----------
Net interest income after provision for loan
losses ........................................... 1,832,112 1,991,617 3,655,363 4,046,258
---------- ---------- ---------- ----------
Non Interest income:
Service charges and other fees ...................... 215,961 283,984 412,975 521,130
Mortgage banking activities ......................... 111,547 93,590 199,430 166,393
Gain (loss) on sale of available-for-sale investments -- (43,565) -- (43,565)
Net gain (loss) on sale of premises and equipment,
real estate owned and other repossessed assets ... (10,585) 1,750 (12,418) 4,006
Other ............................................... 13,409 1,708 25,337 46,928
Net gain on trading activities ...................... 176,424 -- 166,800 --
Insurance & brokerage commissions ................... 649,179 738,417 1,341,998 1,507,071
---------- ---------- ---------- ----------
Total other income .................................. 1,155,934 1,075,884 2,134,123 2,201,963
---------- ---------- ---------- ----------
Non interest expenses:
Compensation and employee benefits .................. 1,522,100 1,614,006 3,090,927 3,158,906
SAIF insurance premiums ............................. 5,366 6,045 10,866 12,453
Advertising ......................................... 44,803 81,623 85,321 132,712
Occupancy ........................................... 376,323 332,806 743,940 702,087
Amortization of intangible assets ................... 123,314 124,880 248,195 249,761
Service bureau charges .............................. 87,640 91,591 163,585 177,872
Insurance & brokerage commission expense ............ 233,398 279,133 474,198 547,240
Professional services ............................... 90,627 75,083 170,906 160,418
Other ............................................... 327,667 314,513 612,998 639,373
---------- ---------- ---------- ----------
Other expenses ...................................... 2,811,238 2,919,681 5,600,937 5,780,823
---------- ---------- ---------- ----------
Income before income tax expense .................... 176,808 147,820 188,549 467,398
Income tax (benefit) expense ........................ 35,143 49,310 23,150 156,680
---------- ---------- ---------- ----------
Net income .......................................... $ 141,665 $ 98,510 $ 165,400 $ 310,718
========== ========== ========== ==========
Per share data:
Basic earnings per share ............................ $ 0.05 $ 0.03 $ 0.06 $ 0.10
Weighted average number of shares outstanding ....... 2,900,329 3,136,545 2,966,449 3,126,700
Diluted earnings per share .......................... $ 0.05 $ 0.03 $ 0.06 $ 0.10
Weighted average number of shares outstanding,
including dilutive stock options ................. 2,899,318 3,137,591 2,965,634 3,127,667
Dividends per common share .......................... $ 0.050 $ 0.05 $ 0.10 $ 0.10
See accompanying notes to consolidated financial statements.
4
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP INC. AND SUBSIDIARIES
Consolidated Statement of Changes in Stockholders' Equity (Unaudited)
Accumulated
Additional Other
Common Treasury Paid-in Unearned Retained Unallocated Comprehensive
Stock Stock Capital Compensation Earnings ESOP Income Total
------- ----------- ----------- ------------ ----------- ----------- ------------- -----------
Balance at December 31,
2006 ................ $31,910 $(1,565,359) $24,284,606 $(551,856) $14,576,468 $(1,059,130) $(263,904) $35,452,735
Cumulative effect of
change in accounting
principal (Note 1)... (303,938) (303,938)
Treasury Stock at Cost
(151,750 shares)..... -- (1,398,559) -- -- -- -- -- (1,398,559)
Stock Options/Awards
Expensed............. -- -- 13,008 83,906 -- -- -- 96,914
Unallocated ESOP........ -- -- (3,997) -- -- 49,853 -- 45,856
Net income for the
period............... -- -- -- -- 165,400 -- -- 165,400
Changes in unrealized
loss:
on available-for-sale
securities (net of
tax of $60,749)...... -- -- -- -- -- -- 117,923 117,923
-----------
Total comprehensive
income............... -- -- -- -- -- -- -- 283,323
Dividends declared...... -- -- -- -- (293,762) -- -- (293,762)
------- ----------- ----------- --------- ----------- ----------- --------- -----------
Balance at June 30,
2007................. $31,910 $(2,963,918) $24,293,617 $(467,950) $14,144,168 $(1,009,277) $(145,981) $33,882,569
======= =========== =========== ========= =========== =========== ========= ===========
See accompanying notes to the consolidated financial statements.
5
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
For Six Months Ended
June 30,
--------------------------
2007 2006
------------ -----------
(Unaudited)
Cash flows from operating activities:
Net income ............................................................... $ 165,400 $ 310,718
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization ......................................... 553,651 515,325
Provision for loan loss ............................................... 198,980 202,500
Amortization and accretion on securities .............................. 13,976 45,539
Loss on sale of securities ............................................ -- 43,565
Net Gain from Trading Activities....................................... (166,800) --
Originations of loans held for sale ................................... (7,247,856) (6,790,664)
Principal amount of loans sold ........................................ 7,093,409 6,435,164
Proceeds from sale of real estate held for sale ....................... 74,138 217,666
Gain on sale of real estate held for investment ....................... (937) (233,392)
Loss on sale of premises and equipment ................................ 24,076 2,643
Change in accrued interest receivable ................................. 323,788 339,595
Change in other assets ................................................ 320,842 386,940
Change in accrued expenses and other liabilities....................... (567,517) (830,159)
Stock options/awards expensed ......................................... 96,914 39,930
------------ -----------
Net cash provided by operating activities ................................ 882,064 685,370
------------ -----------
Net (increase) decrease in loans ...................................... 4,972,683 (8,546,560)
Proceeds from maturity and sale of available-for-sale securities ...... 11,502,911 8,500,237
Purchase of securities ................................................ (1,045,000) (1,976,205)
Purchase of premises and equipment .................................... (325,439) (764,293)
------------ -----------
Net cash provided by (used in) investing activities ...................... 15,105,155 (2,786,821)
------------ -----------
Net Increase in deposits .............................................. (7,537,352) (2,293,106)
Dividend paid on common stock ......................................... (293,762) (310,104)
ESOP shares committed to be released .................................. 45,856 44,083
Net increase in advances from borrowers ............................... 299,084 345,396
Additions to advances from Federal Home Loan Bank and notes payable ... 22,500,000 9,630,000
Repayments of Federal Home Loan Bank advances and notes payable ....... (30,146,626) (4,117,288)
Stock retired ......................................................... -- (60,365)
Proceeds from exercise of stock options ............................... -- 98,950
Purchase of treasury shares ........................................... (1,398,559) (1,144,199)
------------ -----------
Net cash provided by (used in) financing activities ...................... (16,531,359) 2,193,367
------------ -----------
Net increase (decrease) in cash and cash equivalents ..................... (544,140) 91,916
Cash and cash equivalents at beginning of period ......................... 4,992,801 4,779,194
------------ -----------
Cash and cash equivalents at end of period ............................... $ 4,448,661 $ 4,871,110
============ ===========
Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes ............................. $ 165,500 $ --
============ ===========
Cash paid during the period for interest ................................. $ 4,381,252 $ 1,933,984
============ ===========
See accompanying notes to the consolidated financial statements.
6
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.
The accompanying consolidated financial statements have been prepared on an
accrual basis of accounting and include the accounts of First Federal of
Northern Michigan Bancorp, Inc. and its wholly owned subsidiary, First Federal
of Northern Michigan (the "Bank") and the Bank's wholly owned subsidiaries
Financial Service and Mortgage Corporation ("FSMC") and the InsuranCenter of
Alpena ("ICA"). FSMC invests in real estate that includes leasing, selling,
developing, and maintaining real estate properties. ICA is a licensed insurance
agency engaged in the business of property, casualty and health insurance. All
significant intercompany balances and transactions have been eliminated in the
consolidation.
These interim financial statements are prepared without audit and reflect
all adjustments, which, in the opinion of management, are necessary to present
fairly the consolidated financial position of the Company at June 30, 2007, and
its results of operations and statement of cash flows for the periods presented.
All such adjustments are normal and recurring in nature. The accompanying
consolidated financial statements do not purport to contain all the necessary
financial disclosures required by generally accepted accounting principles that
might otherwise be necessary and should be read in conjunction with the
consolidated financial statements and notes thereto of the Company included in
the Annual Report for the year ended December 31, 2006. Results for the three
and six months ended June 30, 2007 are not necessarily indicative of the results
that may be expected for the year ending December 31, 2007.
CRITICAL ACCOUNTING POLICIES
Our accounting and reporting policies are prepared in accordance with
accounting principles generally accepted in the United States of America and
conform to general practices within the banking industry. We consider accounting
policies that require significant judgment and assumptions by management that
have, or could have, a material impact on the carrying value of certain assets
or on income to be critical accounting policies. Changes in underlying factors,
assumptions or estimates could have a material impact on our future financial
condition and results of operations. Based on the size of the item or
significance of the estimate, the following accounting policies are considered
critical to our financial results.
Allowance for Loan Losses. The allowance for loan losses is calculated with
the objective of maintaining an allowance sufficient to absorb estimated
probable loan losses. Management's determination of the adequacy of the
allowance is based on periodic evaluations of the loan portfolio and other
relevant factors. However, this evaluation is inherently subjective, as it
requires an estimate of the loss content for each risk rating and for each
impaired loan, an estimate of the amounts and timing of expected future cash
flows, and an estimate of the value of collateral.
We have established a systematic method of periodically reviewing the
credit quality of the loan portfolio in order to establish an allowance for
losses on loans. The allowance for losses on loans is based on our current
judgments about the credit quality of individual loans and segments of the loan
portfolio. The allowance for losses on loans is established through a provision
for loan losses based on our evaluation of the losses inherent in the loan
portfolio, and considers all known internal and external factors that affect
loan collectibility as of the reporting date. Our evaluation, which includes a
review of all loans on which full collectibility may not be reasonably assured,
considers among other matters, the estimated net realizable value or the fair
value of the underlying collateral, economic conditions, historical loan loss
experience, our knowledge of inherent losses in the portfolio that are probable
and reasonably estimable and other factors that warrant recognition in providing
an appropriate loan loss allowance. Management believes this is a critical
accounting policy because this evaluation involves a high degree of complexity
and requires us to make subjective judgments that often require assumptions or
estimates about various matters. Historically, we believe our estimates and
assumptions have proven to be relatively accurate.
7
The analysis of the allowance for loan losses has two components: specific
and general allocations. Specific allocations are made for loans that are
determined to be impaired. Impairment is measured by determining the present
value of expected future cash flows or, for collateral-dependent loans, the fair
value of the collateral adjusted for market conditions and selling expenses. The
general allocation is determined by segregating the remaining loans by type of
loan, risk weighting (if applicable) and payment history. We also analyze
delinquency trends, which have remained stable, general economic conditions and
geographic and industry concentrations. This analysis establishes factors that
are applied to the loan groups to determine the amount of the general reserve.
The principal assumption used in deriving the allowance for loan losses is the
estimate of loss content for each risk rating. As an example, if recent loss
experience dictated that the projected loss ratios would be changed by 10% (of
the estimate) across all risk ratings, the allocated allowance as of June 30,
2007 would have changed by approximately $205,000. Actual loan losses may be
significantly more than the allowances we have established, which could have a
material negative effect on our financial results.
Mortgage Servicing Rights. We sell to investors a portion of our originated
one- to four-family residential real estate mortgage loans. When we acquire
mortgage servicing rights through the origination and sale of mortgage loans
with servicing rights retained, we allocate a portion of the total cost of the
mortgage loans to the mortgage servicing rights based on their relative fair
value. As of June 30, 2007, we were servicing loans sold to others totaling
$134.0 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 June 30, 2007
included the following:
Annual constant prepayment speed (CPR): 10.14%
Weighted average life remaining (in months): 245
Discount rate used: 8.50%
At the June 30, 2007 valuation, we calculated the value of our mortgage
servicing rights to be $1.4 million and the weighted average life remaining of
those rights was 48 months. The book value of our mortgage servicing rights as
of June 30, 2007 was $550,000 which was $844,000 less than the independent
valuation, so there was no need to establish a valuation allowance.
Impairment of Intangible Assets. Goodwill arising from business
acquisitions represents the value attributable to unidentifiable intangible
elements in the business acquired. The fair value of goodwill is dependent upon
many factors, including our ability to provide quality, cost-effective services
in the face of competition. Because of these many factors, management believes
this is a critical accounting policy. A decline in earnings as a result of
business or market conditions or a run-off of customers over sustained periods
could lead to an impairment of goodwill that could adversely affect earnings in
future periods.
A significant portion of our intangible assets, including goodwill, relates
to the acquisition premiums recorded with the purchase of the ICA and certain
branches over the last several years. Intangible assets are reviewed
periodically for impairment by comparing the fair value of the intangible asset
to the book value of the intangible asset. If the book value is in excess of the
fair value, impairment is indicated and the intangibles must be written down to
their fair value.
8
In connection with our acquisition in 2003 of ICA, we allocated the excess
of the purchase price paid over the fair value of net assets acquired to
intangible assets, including goodwill. These intangible assets included the ICA
customer list and a third-party contract to which ICA is a party. From the date
of acquisition through April 30, 2005 we amortized the value assigned to the
customer list and contract over a period of 20 years. On May 1, 2005 the former
owner of ICA retired. As a result, the amortization period for these intangible
assets was reduced to a 10 year period beginning May 1, 2005. Effective January
1, 2006, the exclusive third-party contract between ICA and Blue Cross Blue
Shield of Michigan was terminated. Prior to January 1, 2006 the ICA exclusive
agent contract with Blue Cross Blue Shield entitled ICA to an override
commission of 1.9% on all health premiums written through local Chambers of
Commerce in Northeast Michigan. On any health insurance contracts in place as of
December 31, 2005, ICA will continue to receive the 1.9% commission; however,
there will be no new groups added to this program effective January 1, 2006.
Management considered the potential effect this could have on ICA health
insurance commissions in future years and made the decision to reduce the
amortization period of the third-party contract intangible asset to 5 years
effective January 1, 2006.
Goodwill is not amortized. The impairment test of goodwill and identified
intangible assets that have an indefinite useful life, performed as of June 30,
2007 and December 31, 2006 in accordance with SFAS No. 142, did not indicate
that an impairment charge was required. If, through testing, we determine that
there is impairment based, for example, on significant runoff of the customer
list or material changes to the third-party contract, then we may determine to
reduce the recorded value of those intangible assets, which would increase
expense and reduce our earnings.
In connection with branch office acquisitions, we assigned the excess of
the purchase price over the fair value of the assets acquired to a core deposit
intangible. The core deposit intangible is tested periodically for impairment.
Our original estimates for the expected life of the deposits have proven to be
relatively accurate as evidenced by the fact that no impairment has been
recorded. If we determine through testing that a significant portion of the
acquired customers no longer do business with us, then the asset would be deemed
to be impaired thereby requiring a charge to earnings to the extent appropriate
given all of the known factors. We amortize core deposit intangibles over a
period of between 10 and 15 years.
Financial Accounting Standard Number 159 -- The Fair Value Option for
Financial Assets and Financial Liabilities. In February 2007, FASB issued FAS
159, The Fair Value Option for Financial Assets and Financial Liabilities. FAS
159 is effective for fiscal years beginning after November 15, 2007. Early
adoption is permitted subject to specific requirements outlined in the new
Statement. Calendar-year companies are able to adopt FAS 159 for their first
quarter 2007 financial statements.
The new Statement allows entities to choose, at specified election dates,
to measure eligible financial assets and liabilities at fair value that are not
otherwise required to be measured at fair value. If a company elects the fair
value option for an eligible item, changes in that item's fair value in
subsequent reporting periods must be recognized in current earnings. FAS 159
also establishes presentation and disclosure requirements designed to draw
comparison between entities that elect different measurement attributes for
similar assets and liabilities.
The Company early adopted FAS 159 and FAS 157 as of January 1, 2007. Upon
adoption of FAS 159, the Company selected the fair value measurement option for
various existing financial assets, including certain "available-for-sale"
securities and putable FHLB advances.
The available-for-sale securities totaled $4.9 million and represented
10.9% of the securities portfolio. The initial fair value measurement of the
securities elected for FAS 159 resulted in a $140,000 pre-tax cumulative-effect
adjustment recorded as a reduction in retained earnings as of January 1, 2007.
Under SFAS 159, this one-time charge will not be recognized in current earnings.
As a result of the fair value measurement election for these securities,
the Company recorded gains in first six months of 2007 of $7,000. The Company
has since sold these investments at a gain of $21,000. The Company intends to
replace these investments with like investments, which will be recorded at fair
value. We
9
believe that the adoption of the standard will have a positive impact on our
ability to manage interest rate risk and potentially benefit interest income
during the remainder of 2007 as well as future periods.
The Company also elected the adoption of FAS 159 for $10.0 million in
putable Federal Home Loan Bank advances. The initial fair value measurement of
the advances resulted in a $320,000 pre-tax, charge to retained earnings. In the
first six month of 2007 the Company recorded $139,000 in pre-tax mark-to-market
gains related to these advances.
The above investment securities and advances were chosen for the fair value
option based on the desire of the Company to improve its net interest margin and
reduce interest rate risk. Subsequent to the adoption of SFAS 159, the Company
plans on repositioning its balance sheet by obtaining new investment securities
and Federal Home Loan Bank advances that improve overall interest rate margin
and mitigate future interest rate risk. The Company anticipates that the
replacement of the securities and advances with new instruments will achieve the
reduced interest rate risk since they will be better matched in relation to
maturity. The new investment securities and advances will both be carried at
fair value. The Company anticipates that by the end of the third calendar
quarter approximately $8.0 to $10.0 million of securities and advances will be
carried at fair value on the balance sheet.
The early adoption of SFAS 159 also allows management more flexibility in
mitigating interest rate risk on subsequent transactions. The Company is
considering the use of the fair value option on future investment security
transactions, loan transactions and the related funding instruments.
The Company will continue to separately recognize interest income and
expense in accordance with existing policies for the items selected.
The following table represents all items in which the fair value option was
elected as of January 1, 2007 and the impact on the financial statements.
Impact on Impact on Impact on
Retained Net Income Net Income
Earnings Three Months Six Months
Effective Ended Ended
Par Value 1/1/2007 6/30/2007 6/30/2007
---------------------- --------- ------------ ----------
(dollars in thousands) (dollars in thousands)
$ 4,856 Investment Securities ($140) $ 21 $ 28
$10,000 FHLB Advances ($320) $155 $139
----- ---- ----
Total ($460) $176 $167
Adjusted for Taxes ($304) $116 $110
Financial Accounting Standard Number 157 Fair Value Measurements. In
September 2006, FASB issued FAS 157, Fair Value Measurements. This statement
establishes a framework for measuring fair value in accordance with generally
accepted accounting principles, clarifies the definition of fair value within
that framework, and expands disclosures about the use of fair value
measurements. FAS 157 is effective for fiscal years beginning after November 15,
2007. Upon adoption of FAS 159, the Company concurrently adopted the provisions
of FAS 157 as of January 1, 2007. Accordingly, the Company has developed a
framework to measure the fair value of financial assets and financial
liabilities and expanded disclosures in accordance with the requirements.
The following information pertains to assets and liabilities measured by
fair value on a recurring basis:
10
Change in fair value Quoted Prices in Significant
Fair Value recognized in other active markets Other Significant
as of income for the six Fair Value as for Indentical Observable Unobservable
January 1, month period ended of June Assets/Liabilities Inputs Inputs
Description 2007 June 30, 2007 30, 2007 (Level 1) (Level 2) (Level 3)
----------- ---------- -------------------- ------------- ------------------ ----------- ------------
(Dollars in thousands)
Investments
accounted for
under FVO $ 4,864 $ 21 $ 0 $ 0
FHLB advances $10,044 $155 $9,889 $9,889
RECENT ACCOUNTING PRONOUNCEMENTS
In March 2006, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard No. 156, Accounting for Servicing of
Financial Assets - an amendment of FASB Statement No. 140. SFAS 156 amends SFAS
Statement No.140, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities", with respect to the accounting for
separately recognized servicing assets and servicing liabilities. The Statement
addresses the recognition and measurement of separately recognized servicing
assets and liabilities and provides an approach to simplify efforts to obtain
hedge-like (offset) accounting. SFAS 156 was adopted by the Company on January
1, 2007 as required by the statement. The adoption of SFAS 156 did not have a
material effect on the financial position, results of operations, or cash flows.
In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes -- an interpretation of FASB Statement No. 109 (FIN
48), which clarifies the accounting for uncertainty in tax positions. This
Interpretation requires that the Company recognize in the financial statements
the impact of a tax position if that position is more likely than not to be
sustained on audit based on technical merits of the position. The provisions of
FIN 48 are effective as of the beginning of the Company's 2007 fiscal year, with
the cumulative effect of the change in accounting principle recorded as an
adjustment to operating retained earnings. The adoption of FIN 48 did not have a
material effect on the financial position, results of operations, or cash flows.
NOTE 2--REORGANIZATION.
On April 1, 2005, we consummated the second-step mutual-to-stock conversion
of Alpena Bancshares, M.H.C., in which shares of common stock representing
Alpena Bancshares, M.H.C.'s ownership interest in Alpena Bancshares, Inc. were
sold to investors. As a result of the conversion and stock offering, Alpena
Bancshares, M.H.C. ceased to exist and Alpena Bancshares, Inc. was succeeded by
First Federal of Northern Michigan Bancorp, Inc., a Maryland corporation and new
holding company for First Federal of Northern Michigan.
The plan of conversion and reorganization of Alpena Bancshares, M.H.C. and
the issuance and contribution of cash and common stock to First Federal
Community Foundation, a charitable foundation established by the Company, were
approved by the stockholders of Alpena Bancshares, Inc. and the members of
Alpena Bancshares, M.H.C. on March 23, 2005.
First Federal of Northern Michigan Bancorp, Inc. accepted orders to
purchase 1,699,869 shares of common stock at a purchase price of $10.00 per
share. As a part of the conversion, public stockholders of the Company as of the
consummation date received 1.8477 shares of First Federal of Northern Michigan
Bancorp, Inc. common stock in exchange for each of their existing shares of
Alpena Bancshares, Inc. common stock. Cash was issued in lieu of any fractional
shares. The share exchange occurred on April 1, 2005.
NOTE 3--DIVIDENDS.
Payment of dividends on the common stock is subject to determination and
declaration by the Board of Directors and depends upon a number of factors,
including capital requirements, regulatory limitations on
11
the payment of dividends, the Company's results of operations and financial
condition, tax considerations and general economic conditions.
On June 12, 2007, the Company declared a cash dividend on its common stock,
payable on or about July 20, 2007, to shareholders of record as of June 30,
2007, equal to $0.05 per share. The dividend on all shares outstanding totaled
$144,187.
NOTE 4--1996 STOCK OPTION PLAN, 1996 RECOGNITION AND RETENTION PLAN AND 2006
STOCK-BASED INCENTIVE PLAN.
Effective January 1, 2006, the Company adopted Statement of Financial
Accounting Standard (SFAS) No. 123 (Revised) "Shareholder Based Payments", which
requires that the grant-date fair value of awarded stock options be expensed
over the requisite service period. The Company's 1996 Stock Option Plan (the
"1996 Plan"), which was approved by shareholders, permits the grant of share
options to its employees for up to 127,491 shares of common stock (retroactively
adjusted for the exchange ratio applied in the Company's 2005 stock offering and
related second-step conversion). The Company's 2006 Stock-Based Incentive Plan
(the "2006 Plan"), which was approved by the shareholders on May 17, 2006,
permits the award of up to 242,740 shares of common stock of which the maximum
number to be granted as Stock Options is 173,386 and the maximum that can be
granted as Restricted Stock Awards is 69,354. Option awards are granted with an
exercise price equal to the market price of the Company's stock at the date of
grant; those option awards generally vest based on five years of continual
service and have ten year contractual terms. Certain options provide for
accelerated vesting if there is a change in control (as defined in the Plans).
During the three months ended June 30, 2007 the Company awarded 5,000
shares under the Recognition and Retention Plan ("RRP"). Shares issued under the
RRP and exercised pursuant to the exercise of the stock option plan may be
either authorized but unissued shares or reacquired shares held by the Company
as treasury stock.
STOCK OPTIONS - A summary of option activity under the Plan during the six
months ended June 30, 2007 is presented below:
Weighted-Average
Weighted- Remaining
Average Contractual Term Aggregate
Options Shares Exercise Price (Years) Intrinsic Value
------- ------- -------------- ---------------- ---------------
Outstanding at January 1, 2007 204,532 $9.50
Granted 5,000 $9.07
Exercised 0 N/A
Forfeited or expired (8,140) $9.54
Oustanding at June 30, 2007 201,392 $9.25 8.61 $ 0
Exercisable at June 30, 2007 43,712 $9.29 7.30 -$11,802
A summary of the status of the Company's nonvested shares as of June
30, 2007, and changes during the six months ended June 30, 2007, is presented
below:
12
Weighted-Average
Grant-Date
Nonvested Shares Shares Fair Value
---------------- ------- ----------------
Nonvested at January 1, 2007 200,099 $2.11
Granted 5,000 $2.07
Vested (39,359) $2.10
Forfeited (8,140) -$2.10
Nonvested at June 30, 2007 157,600 $2.11
As of June 30, 2007 there was $352,000 of total unrecognized compensation
cost, net of expected forfeitures, related to nonvested options under the Plan.
That cost is expected to be recognized over a weighted-average period of 4.45
years. The total fair value of shares vested during the six months ended June
30, 2007 was $82,650.
RESTRICTED STOCK AWARDS - As of June 30, 2007 there was $477,000 of
unrecognized compensation cost related to nonvested restricted stock awards
under the plan.
NOTE 5 -- COMMITMENTS TO EXTEND CREDIT
The Company is a party to credit-related financial instruments with
off-balance sheet risk in the normal course of business to meet the financing
needs of its customers. These financial instruments include commitments to
extend credit, stand by letters of credit, and commercial lines of credit. Such
commitments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amounts recognized in the consolidated balance sheet. The
Company's exposure to credit loss is represented by the contracted amount of
these commitments. The Company follows the same credit policies in making
commitments as it does for on-balance sheet instruments.
At June 30, 2007, the Company had outstanding commitments to originate
loans of $39.2 million. These commitments included $7.5 million for permanent
one-to-four family dwellings, $10.5 million for non-residential loans, $1.0
million of undisbursed loan proceeds for construction of one-to-four family
dwellings, $8.1 million of undisbursed lines of credit on home equity loans,
$1.7 million of unused credit card lines, $6.2 million of unused commercial
lines of credit, $2.3 million of undisbursed commercial construction, $275,000
of unused letters of credit and $1.7 million in unused Bounce Protection.
NOTE 6 -- SUBSEQUENT EVENTS
NONE
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
13
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.
For the Three Months Ended
June 30, 2007
(Dollars in Thousands)
-------------------------------------------
Bank ICA Eliminations Total
-------- ------ ------------ --------
INTEREST INCOME $ 4,060 $ 5 $ (5) $ 4,060
INTEREST EXPENSE 2,118 2 (5) 2,115
-------- ------ ----- --------
NET INTEREST INCOME - Before provision for loan losses 1,942 3 -- 1,945
PROVISION FOR LOAN LOSSES 113 -- -- 113
-------- ------ ----- --------
NET INTEREST INCOME - After provision for loan losses 1,829 3 -- 1,832
OTHER INCOME 499 657 -- 1,156
OPERATING EXPENSES 2,132 679 -- 2,811
-------- ------ ----- --------
INCOME - Before federal income tax 196 (19) -- 177
FEDERAL INCOME TAX 42 (7) -- 35
-------- ------ ----- --------
NET INCOME $ 154 $ (12) $ -- $ 142
======== ====== ===== ========
DEPRECIATION AND AMORTIZATION $ 189 $ 86 $ -- $ 275
======== ====== ===== ========
ASSETS $260,371 $4,468 $(721) $264,118
======== ====== ===== ========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ -- $ -- $ -- $ --
Intangible assets -- -- -- --
Property and equipment 97 7 -- 104
-------- ------ ----- --------
TOTAL $ 97 $ 7 $ -- $ 104
======== ====== ===== ========
For the Three Months Ended
June 30, 2006
(Dollars in Thousands)
-------------------------------------------
Bank ICA Eliminations Total
-------- ------ ------------ --------
INTEREST INCOME $ 4,209 $ 3 $ (3) $ 4,209
INTEREST EXPENSE 2,082 5 (3) 2,084
-------- ------ ----- --------
NET INTEREST INCOME - Before provision for loan losses 2,127 (2) -- 2,125
PROVISION FOR LOAN LOSSES 132 -- -- 132
-------- ------ ----- --------
NET INTEREST INCOME - After provision for loan losses 1,995 (2) -- 1,993
OTHER INCOME 336 740 -- 1,076
OPERATING EXPENSES 2,095 825 -- 2,920
-------- ------ ----- --------
INCOME - Before federal income tax 236 (87) -- 149
FEDERAL INCOME TAX 80 (30) -- 50
-------- ------ ----- --------
NET INCOME $ 156 $ (57) $ -- $ 99
======== ====== ===== ========
DEPRECIATION AND AMORTIZATION $ 171 $ 86 $ -- $ 257
======== ====== ===== ========
ASSETS $280,378 $4,464 $(572) $284,270
======== ====== ===== ========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ -- $ -- $ -- $ --
Intangible assets -- -- -- --
Property and equipment 456 3 -- 459
-------- ------ ----- --------
TOTAL $ 456 $ 3 $ -- $ 459
======== ====== ===== ========
14
For the Six Months Ended
June 30, 2007
(Dollars in Thousands)
-------------------------------------------
Bank ICA Eliminations Total
-------- ------ ------------ --------
INTEREST INCOME $ 8,203 $ 11 $ (11) $ 8,203
INTEREST EXPENSE 4,355 5 (11) 4,349
-------- ------ ----- --------
NET INTEREST INCOME - Before provision for loan losses 3,848 6 -- 3,854
PROVISION FOR LOAN LOSSES 199 -- -- 199
-------- ------ ----- --------
NET INTEREST INCOME - After provision for loan losses 3,649 6 -- 3,655
OTHER INCOME 783 1,351 -- 2,134
OPERATING EXPENSES 4,241 1,360 -- 5,601
-------- ------ ----- --------
INCOME - Before federal income tax 191 (3) -- 188
FEDERAL INCOME TAX 24 (1) -- 23
-------- ------ ----- --------
NET INCOME $ 167 $ (2) $ -- $ 165
======== ====== ===== ========
DEPRECIATION AND AMORTIZATION $ 382 $ 172 $ -- $ 554
======== ====== ===== ========
ASSETS $260,371 $4,468 $(721) $264,118
======== ====== ===== ========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ -- $ -- $ -- $ --
Intangible assets -- -- -- --
Property and equipment 144 23 -- 167
-------- ------ ----- --------
TOTAL $ 144 $ 23 $ -- $ 167
======== ====== ===== ========
For the Six Months Ended
June 30, 2006
(Dollars in Thousands)
-------------------------------------------
Bank ICA Eliminations Total
-------- ------ ------------ --------
INTEREST INCOME $ 8,242 $ 7 $ (7) $ 8,242
INTEREST EXPENSE 3,990 10 (7) 3,993
-------- ------ ----- --------
NET INTEREST INCOME - Before provision for loan losses 4,252 (3) -- 4,249
PROVISION FOR LOAN LOSSES 202 -- -- 202
-------- ------ ----- --------
NET INTEREST INCOME - After provision for loan losses 4,050 (3) -- 4,047
OTHER INCOME 692 1,510 -- 2,202
OPERATING EXPENSES 4,334 1,447 -- 5,781
-------- ------ ----- --------
INCOME - Before federal income tax 408 60 -- 468
FEDERAL INCOME TAX 137 20 -- 157
-------- ------ ----- --------
NET INCOME $ 271 $ 40 $ -- $ 311
======== ====== ===== ========
DEPRECIATION AND AMORTIZATION $ 343 $ 172 $ -- $ 515
======== ====== ===== ========
ASSETS $280,378 $4,464 $(572) $284,270
======== ====== ===== ========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ -- $ -- $ -- $ --
Intangible assets -- -- -- --
Property and equipment 748 21 -- 769
-------- ------ ----- --------
TOTAL $ 748 $ 21 $ -- $ 769
======== ====== ===== ========
15
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
AND SUBSIDIARIES
PART I - FINANCIAL INFORMATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
The following discussion compares the consolidated financial condition of the
Company at June 30, 2007 and December 31, 2006, and the results of operations
for the three- and six-month periods ended June 30, 2007 and 2006. This
discussion should be read in conjunction with the interim financial statements
and footnotes included herein.
OVERVIEW
For the quarter ended June 30, 2007, the Company's earnings were $141,700,
or $0.05 per basic and diluted share, compared to earnings of $98,500, or $0.03
per basic and diluted share, for the year earlier period, an increase of
$43,200.
Total assets decreased by $16.8 million, or 6.0% from December 31, 2006 to
June 30, 2007. Investment securities available for sale decreased by $11.4
million from December 31, 2006 to June 30, 2007. Net loans receivable decreased
$5.2 million during the six months ended June 30, 2007. Total deposits decreased
$7.5 million, or 4.3% from December 31, 2006 to June 30, 2007. Federal Home Loan
Bank advances decreased by $17.4 million from December 31, 2006 to June 30,
2007, which included a reclassification of $10.3 million to a trading account as
part of our early adoption of FAS 159. Equity decreased by $1.6 million, or 4.4%
from December 31, 2006 to June 30, 2007.
COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 2007 AND DECEMBER 31, 2006
ASSETS: Total assets decreased $16.8 million, or 6.0%, to $264.1 million at June
30, 2007 from $280.9 million at December 31, 2006. Investment securities
available for sale decreased $11.5 million, or 26.6% from December 31, 2006 to
June 30, 2007, due to the maturity of $6.6 million in AFS investment securities
during the six months ended June 30, 2007, the proceeds of which were used to
pay-down high-cost FHLB advances, and due to the reclassification of $4.7
million in AFS securities to trading securities in connection with our early
adoption of FAS 159 effective January 1, 2007. As noted above, the trading
securities were subsequently sold during the quarter ended June 30, 2007. Net
loans receivable decreased $5.2 million, or 2.5%, to $204.3 million at June 30,
2007 from $209.5 million at December 31, 2006. The decrease in net loans was
attributable primarily to the payoff of a few large commercial loans.
LIABILITIES: Deposits decreased $7.5 million, or 4.3%, to $169.5 million at June
30, 2007 from $177.1 million at December 31, 2006. The decrease was primarily in
certificate of deposit balances, reflecting continued competition for deposits
and increased pressure on market deposit rates. Total FHLB advances decreased
$7.4 million to $57.5 million at June 30, 2007 from December 31, 2006 due to the
maturity and sale of investment securities, the proceeds of which were used to
pay down advances. At January 1, 2007 we reclassified $10.3 million in FHLB
advances to a trading account in connection with our early adoption of FAS 159.
EQUITY: Stockholders' equity decreased to $33.9 million at June 30, 2007 from
$35.5 million at December 31, 2006, a decline of $1.6 million. During the three
months ended June 30, 2007, the Company repurchased 113,150 shares of its common
stock at a total cost of $1,040,073, concluding its stock repurchase program
which was announced and commenced in March 2007. As a result of this program,
the Company repurchased a total of 151,750 shares at a total cost of $1,398,558.
Dividends
16
were $144,000 and $294,000 for the three and six months ended June 30, 2007,
respectively. As mentioned in the previous quarter, the Company chose to
restructure its balance sheet through an early adoption of FAS 159, resulting in
a $461,000 one-time cumulative-effect adjustment to retained earnings during the
quarter ended March 31, 2007. The unrealized loss on available for sale
securities, net of tax, was $146,000 at June 30, 2007 as compared to $264,000 at
December 31, 2006, an improvement of $118,000. The cumulative loss in value on
securities was due to changes in interest rates and was not considered by
management to be other than temporary.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2007 COMPARED TO THREE MONTHS ENDED JUNE 30, 2006
GENERAL: Net income increased by $43,200 to $141,700 for the three months ended
June 30, 2007 from $98,500 for the same period ended June 30, 2006.
INTEREST INCOME: Interest income decreased to $4.1 million for the three months
ended June 30, 2007 from $4.2 million for the year earlier period, due mainly to
a decrease of $20.4 million in the average balance of interest-earnings assets
to $248.1 million for the three month period ended June 30, 2007 from $268.5
million for the three month period ended June 30, 2006. This was partially
offset by an increase in the yield on interest earning assets of 28 basis points
to 6.56% three month period over three month period.
INTEREST EXPENSE: Interest expense increased to $2.1 million for the three
months ended June 30, 2007 from $2.0 million for the three months ended June 30,
2006. The increase in interest expense for the three month period was due
primarily to an increase in the cost of our certificates of deposits. The cost
of these deposits increased from 3.94% from the three months ended June 30, 2006
to 4.50% for the three months ended June 30, 2007 as lower costing deposits
matured and were re-priced at a higher rate, reflecting continued upward market
pressure on deposit rates. In addition, the cost of our FHLB advances increased
3 basis points from 4.88% for the three months ended June 30, 2006 to 4.91% for
the three months ended June 30, 2007.
NET INTEREST INCOME: Net interest income decreased to $1.9 million for the three
month period ended June 30, 2007 compared to $2.1 million for the same period in
2006. For the three months ended June 30, 2007, average interest-earning assets
decreased $20.4 million, or 7.7%, when compared to the same period in 2006.
Average interest-bearing liabilities decreased $17.9 million, or 7.5%, to $218.9
million for the quarter ended June 30, 2007 from $236.7 million for the quarter
ended June 30, 2006. The yield on average interest-earning assets increased to
6.56% for the three month period ended June 30, 2007 from 6.28% for the same
period ended in 2006 while the cost of average interest-bearing liabilities
increased to 3.86% from 3.51% for the three month periods ended June 30, 2007
and 2006, respectively. The net interest margin decreased to 3.15% for the three
month period ended June 30, 2007 from 3.18% for same period in 2006.
PROVISION FOR LOAN LOSSES: The allowance for loan losses is established through
a provision for loan losses charged to earnings. Loan losses are charged against
the allowance when management believes the uncollectibility of a loan balance is
confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and
is based upon management's periodic review of the collectibility of the loans in
light of historical experience, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower's ability to repay, estimated
value of any underlying collateral and prevailing economic conditions. This
evaluation is inherently subjective, as it requires estimates that are
susceptible to significant revision as more information becomes available. The
provision for loan losses amounted to $113,400 for the three month period ended
June 30, 2007 and $133,000 for the comparable period in 2006. Although the
provision for loan loss was moderately lower in the quarter ended June 30, 2007
than in the year earlier period, the Company does continue to experience a high
level of classified assets due to the current somewhat weak economic conditions
in the northern Michigan market as well as declining real estate values.
Classified assets are monitored quarterly and the loan loss reserve is adjusted
as needed to reflect any changes in the
17
status of classified assets.
NON INTEREST INCOME: Non interest income increased from $1.1 million for the
three months ended June 30, 2006 to $1.2 million for the three months ended June
30, 2007, primarily due to the gain on trading activities associated with our
early adoption of FAS 159, partially offset by decreases in insurance brokerage
income and service charges and other fees.
NON INTEREST EXPENSE: Non interest expense decreased from $2.9 million for the
three months ended June 30, 2006 to $2.8 million for the three months ended June
30, 2007. The decreases period over period were mainly the result of a reduction
in compensation and benefit expenses due to the closure last year of one of our
under-performing branches and other cost-cutting measures, as well as a
reduction in insurance brokerage commission expense.
INCOME TAXES: The Company had a federal income tax expense of $35,100 for the
three months ended June 30, 2007 due to tax-exempt interest income in excess of
pre-tax income, compared to federal income tax expense of $49,300 for the same
period in 2006. Effective for tax years beginning on or after January 1, 2008,
the State of Michigan has repealed the Single Business Tax and replaced it with
the Michigan Business Tax. This change is not expected to materially impact the
Company's earnings.
SIX MONTHS ENDED JUNE 30, 2007 COMPARED TO SIX MONTHS ENDED JUNE 30, 2006
GENERAL: Net income decreased by $145,000 to $165,400 for the six months ended
June 30, 2007 from $310,700 for the same period ended June 30, 2006.
INTEREST INCOME: Interest income remained stable six month period over six month
period, despite a decrease in the average balance of interest-earning assets of
$12.9 million to $253.9 million from the six month period ended June 30, 2006
from the six month period ended June 30, 2007. This was attributable to an
increase in yield on interest earning assets of 29 basis points to 6.49% six
month period over six month period. Notably, the yield on mortgage loans
increased 10 basis points six month period over six month period to 6.19% over
an average balance of $103.2 million while the yield on investment securities
increased 53 basis points to 4.51% over an average balance of $35.3 million.
INTEREST EXPENSE: Interest expense for the six months ended June 30, 2007
increased to $4.3 million from $4.0 million for the six months ended June 30,
2006. The increase in interest expense for the six month period was due
primarily to an increase in the cost of our certificates of deposit. The cost of
these deposits increased from 3.82% for the six months ended June 30, 2006 to
4.51% for the six months ended June 30, 2007, as lower costing deposits matured
and were re-priced at a higher rate, reflecting continued upward market pressure
on deposit rates. In addition, the cost of our FHLB advances increased 20 basis
points from 4.80% for the six months ended June 30, 2006 to 5.00% for the six
months ended June 30, 2007.
NET INTEREST INCOME: Net interest income decreased to $394,000 for the six month
period ended June 30, 2007 compared to the same period in 2006. For the six
months ended June 30, 2007, average interest-earning assets decreased $12.9
million, or 4.8%, when compared to the same period in 2006. Average
interest-bearing liabilities decreased $11.1 million, or 4.7%, to $224.3 million
for the six month period ended June 30, 2007 from $235.4 million for the six
month period ended June 30, 2006. The yield on average interest-earning assets
increased to 6.49% for the six month period ended June 30, 2007 from 6.20% for
the same period ended in 2006 while the cost of average interest-bearing
liabilities increased to 3.90% from 3.40% for the six month periods ended June
30, 2007 and 2006, respectively. The net interest margin decreased to 3.05% for
the six month period ended June 30, 2007 from 3.20% for same period in 2006.
DELINQUENT LOANS AND NONPERFORMING ASSETS. The following table sets forth
information regarding loans delinquent 90 days or more and real estate
owned/other repossessed assets of the Bank at the dates indicated. As of the
dates indicated, the Bank did not have any material restructured loans within
the meaning of SFAS 15.
18
JUNE 30, DECEMBER 31,
2007 2006
-------- ------------
(Dollars in thousands)
Total non-accrual loans ............................... $3,885 $2,490
------ ------
Accrual loans delinquent 90 days or more:
One- to four-family residential .................... 231 645
Other real estate loans ............................ 40 221
Consumer/Commercial ................................ 681 624
------ ------
Total accrual loans delinquent 90 days or more .. $ 952 $1,490
------ ------
Total nonperforming loans (1) ......................... 4,837 3,980
Total real estate owned-residential mortgages (2) ..... 483 437
Total real estate owned-Consumer and other (2) ........ 78 38
====== ======
Total nonperforming assets ............................ $5,398 $4,455
====== ======
Total nonperforming loans to loans receivable ......... 2.34% 1.90%
Total nonperforming assets to total assets ............ 2.04% 1.59%
(1) All of the Bank's loans delinquent more than 90 days are classified as
nonperforming.
(2) Represents the net book value of property acquired by the Bank through
foreclosure or deed in lieu of foreclosure. Upon acquisition, this property
is recorded at the lower of its fair market value or the principal balance
of the related loan.
PROVISION FOR LOAN LOSSES: The provision for loan losses amounted to $198,900
for the six month period ended June 30, 2007 and $202,500 for the comparable
period in 2006. The ratio of nonperforming loans to total loans was 2.34% and
1.90% at June 30, 2007 and December 31, 2006, respectively As a percent of total
assets, nonperforming loans increased to 2.04% at June 30, 2007 from 1.59% at
December 31, 2006. Total nonperforming assets increased to $5.4 million at June
30, 2007 from $4.5 million at December 31, 2006.
NON INTEREST INCOME: Non interest income decreased from $2.2 million for the six
months ended June 30, 2006 to $2.1 million for the six months ended June 30,
2007. The decrease was primarily in the areas of insurance brokerage commission
and service charges and other fees, offset by a gain on trading activities
during the six months ended June 30, 2007.
NON INTEREST EXPENSE: Non interest expense decreased from $5.8 million for the
six months ended June 30, 2006 to $5.6 million for the six months ended June 30,
2007. The decrease period over period was mainly the result of a reduction in
compensation and benefit expenses due to the closure last year of one of our
under-performing branches and other cost-cutting measures, as well as a
reduction in insurance brokerage commission expense.
INCOME TAXES: The Company had a federal income tax expense of $23,100 for the
six months ended June 30, 2007 due to tax-exempt interest income in excess of
pre-tax income, compared to federal income tax expense of $156,700 for the same
period in 2006.
LIQUIDITY
The Company's current liquidity position is expected to be 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
19
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 June 30, 2007 was
$49.5 million, or 30.5% compared to $52.2 million, or 29.5% at December 31,
2006. The levels of these assets are dependent on the Company's operating,
financing, lending and investing activities during any given period. The
liquidity calculated by the Company includes additional borrowing capacity
available with the FHLB. This borrowing capacity is based on the FHLB stock
owned by the Bank along with pledged collateral. As of June 30, 2007, the Bank
had unused borrowing capacity totaling $25.8 million at the FHLB based on the
FHLB stock ownership.
The Company intends to retain for its portfolio certain originated residential
mortgage loans (primarily adjustable rate, balloon and shorter term fixed rate
mortgage loans) and to generally sell the remainder in the secondary market. The
Bank will from time to time participate in or originate commercial real estate
loans, including real estate development loans. During the six month period
ended June 30, 2007 the Company originated $12.1 million in residential mortgage
loans, of which $7.2 million were retained in portfolio while the remainder were
sold in the secondary market or are being held for sale. This compares to $17.2
million in originations during the first six months of 2007 of which $10.0
million were retained in portfolio. The Company also originated $14.9 million of
commercial loans and $5.2 million of consumer loans in the first six months of
2007 compared to $12.6 million of commercial loans and $8.3 million of consumer
loans for the same period in 2006. Of total loans receivable, excluding loans
held for sale, mortgage loans comprised 49.5% and 40.4%, commercial loans 36.1%
and 37.6% and consumer loans 14.4% and 14.0% at June 30, 2007 and June 30, 2006,
respectively.
Deposits are a primary source of funds for use in lending and for other general
business purposes. At June 30, 2007 deposits funded 64.2% of the Company's total
assets compared to 63.0% at December 31, 2006. Certificates of deposit scheduled
to mature in less than one year at June 30, 2007 totaled $80.8 million.
Management believes that a significant portion of such deposits will remain with
the Bank. The Bank monitors the deposit rates offered by competition in the area
and sets rates that take into account the prevailing market conditions along
with the Bank's liquidity position. Moreover, management believes that the
growth in assets is not expected to require significant in-flows of liquidity.
As such, the Bank does not expect to be a market leader in rates paid for
liabilities.
Borrowings may be used to compensate for seasonal or other reductions in normal
sources of funds or for deposit outflows at more than projected levels.
Borrowings may also be used on a longer-term basis to support increased lending
or investment activities. At June 30, 2007 the Company had $57.5 million in FHLB
advances. FHLB borrowings as a percentage of total assets were 21.8% at June 30,
2007 as compared to 15.3% at December 31, 2006. The Company has sufficient
available collateral to obtain additional advances of $16.3 million. When this
is combined with current FHLB stock ownership the Company could obtain up to an
additional $25.8 million in advances from the FHLB.
CAPITAL RESOURCES
Stockholders' equity at June 30, 2007 was $33.9 million, or 12.8% of total
assets, compared to $35.5 million, or 12.6% of total assets, at December 31,
2006 (See "Consolidated Statement of Changes in Stockholders' Equity"). The Bank
is subject to certain capital-to-assets levels in accordance with OTS
regulations. The Bank exceeded all regulatory capital requirements at June 30,
2007. The following table summarizes the Bank's actual capital with the
regulatory capital requirements and with requirements to be "Well Capitalized"
under prompt corrective action provisions, as of June 30, 2007:
20
Regulatory Minimum to be
Actual Minimum Well Capitalized
--------------- --------------- ----------------
Amount Ratio Amount Ratio Amount Ratio
------- ----- ------- ----- ------- -----
Dollars in Thousands
Tier 1 (Core) capital
(to risk - weighted assets) $28,435 10.93% $10,410 4.00% $13,012 5.00%
Total risk-based capital
(to risk - weighted assets) $30,704 16.55% $14,844 8.00% $18,555 10.00%
Tier 1 risk-based capital
(to tangible assets) $28,435 15.32% $ 7,422 4.00% $11,133 6.00%
Tangible Capital
(to tangible assets) $28,435 10.93% $ 3,904 1.50% $ 5,205 2.00%
21
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-QSB
QUARTER ENDED JUNE 30, 2007
PART I - FINANCIAL INFORMATION
ITEM 3 - CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management, including
the Company's Chief Executive Officer and Chief Financial Officer, the Company
evaluated the effectiveness of the design and operation of its disclosure
controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934) as of the end of the period covered by this
report. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that, as of the end of the period covered by this
report, the Company's disclosure controls and procedures were effective to
ensure that information required to be disclosed in the reports the Company
files or submits under the Securities Exchange Act of 1934, is recorded,
processed, summarized and reported, within the time periods specified by the
SEC's rules and forms and in timely alerting them to material information
relating to the Company (or its consolidated subsidiaries) required to be
included in its periodic SEC filings.
There were no significant changes made in the Company's internal control over
financial reporting or in other factors that could significantly affect the
Company's internal controls over financial reporting during the period covered
by this report that has materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial reporting.
22
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-QSB
QUARTER ENDED JUNE 30, 2007
PART II -- OTHER INFORMATION
Item 1 - Legal Proceedings:
There are no material legal proceedings to which the Company is a party
or of which any of its property is subject. From time to time the
Company is a party to various legal proceedings incident to its
business.
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds:
(a) Not applicable
(b) Not applicable
(c) On March 15, 2007 the Company announced a share repurchase
program authorizing the repurchase of up to 151,750 shares of the
Company's outstanding common stock. All repurchases under the
Company's share repurchase program were transacted in the open
market and were within the scope of Rule 10b-18, which provides a
safe harbor for purchases in a given day if an issuer of equity
securities satisfies the manner, timing, price and volume
conditions of the rule when repurchasing its own common shares in
the open market. The following table summarizes the Company's
share repurchase activity for the three months ended June 30,
2007.
Total Number of
Shares Purchased as Maximum Number of
Part of Publicly Shares that May Yet Be
Total Number of Average Price Paid Announced Plans or Purchased Under the
Period Shares Purchased per Share Programs Plans or Programs
-------------------------- ---------------- ------------------ ------------------- ----------------------
4/1/2007 to 4/30/2007 113,150 9.19 -- --
5/1/2007 to 5/31/2007 -- -- -- --
6/1/2007 to 6/30/2007 -- -- -- --
Total 113,150 9.19 -- --
Item 3 - Defaults upon Senior Securities: Not applicable.
Item 4 - Submission of Matters to a Vote of Security Holders:
The annual meeting of the shareholders of the Company was held on May
17, 2006. The results of the vote were as follows:
1. The following individual was elected as director for a three (3)
year term:
Votes For Votes Withheld
--------- --------------
Keith D. Wallace 2,032,171 591,957
2. The ratification of the appointment of Plante & Moran, PLLC as
independent auditors of the Company for the fiscal year ending
December 31, 2007:
For Against Abstain
--------- ------- -------
Number of Votes 2,489,561 111,358 23,209
Item 5 - Other Information: Not applicable
23
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
24
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-QSB
QUARTER ENDED JUNE 30, 2007
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
By: /s/ Martin A. Thomson
--------------------------------------------
Martin A. Thomson
Chief Executive Officer
Date: August 14, 2007
By: /s/ Amy E. Essex
--------------------------------------------
Amy E. Essex, Chief Financial Officer
(Principal Financial and Accounting Officer)
Date: August 14, 2007
25