0001144204-11-017550.txt : 20110328 0001144204-11-017550.hdr.sgml : 20110328 20110328151538 ACCESSION NUMBER: 0001144204-11-017550 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 20101231 FILED AS OF DATE: 20110328 DATE AS OF CHANGE: 20110328 FILER: COMPANY DATA: COMPANY CONFORMED NAME: First Federal of Northern Michigan Bancorp, Inc. CENTRAL INDEX KEY: 0001128227 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 383567362 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-31957 FILM NUMBER: 11715404 BUSINESS ADDRESS: STREET 1: 100 SOUTH SECOND AVENUE CITY: ALPNEA STATE: MI ZIP: 49707 BUSINESS PHONE: (989) 356-9041 MAIL ADDRESS: STREET 1: 100 SOUTH SECOND AVENUE CITY: ALPENA STATE: MI ZIP: 49707 FORMER COMPANY: FORMER CONFORMED NAME: ALPENA BANCSHARES INC DATE OF NAME CHANGE: 20001114 10-K 1 v215653_10k.htm Unassociated Document
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K

x
Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 
For the Fiscal Year Ended December 31, 2010
 
OR
¨
Transition Report Pursuant to 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 Number)
 
 
100 S. Second Avenue, Alpena, Michigan
49707
(Address of Principal Executive Offices)
Zip Code
 
(989) 356-9041
(Registrant's telephone number)

Securities Registered Pursuant to Section 12(b) of the Act:
Common Stock, par value $.01 per share
  
The Nasdaq Stock Market LLC
(Title of Class)
  
(Name of Exchange of Which Registered)

Securities Registered Pursuant to Section 12(g) of the Act:
None

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past twelve 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
YES ¨.   NO ¨.

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or nay amendments to this Form 10-K.  x.

Indicate by check mark whether the registrant is a large accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  ¨
Accelerated filer ¨
Non-Accelerated filer ¨
Smaller reporting company x
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). YES ¨.   NO x. 

Indicate by check mark if the registrant is a well-know seasoned issuer, as defined in Rule 405 of the Securities Act. YES ¨.  NO x. 

The aggregate market value of the voting stock held by non-affiliates of the registrant, computed by reference to the last sale price on June 30, 2010 ($2.44 per share) was $6.3 million.

As of March 25, 2011, there were issued and outstanding 2,884,049 shares of the registrant's common stock.

DOCUMENTS INCORPORATED BY REFERENCE

 
1.
Proxy Statement for the 2011 Annual Meeting of Stockholders (Parts I and III).
 
2.
Annual Report to Shareholders for the Year Ended December 31, 2010 (Part II).
 
 
 
 
 
TABLE OF CONTENTS

PART I
      
       
ITEM 1
BUSINESS
   3
ITEM 1A
RISK FACTORS
   34
ITEM 1B
UNRESOLVED STAFF COMMENTS
   38
ITEM 2
PROPERTIES
   38
ITEM 3
LEGAL PROCEEDINGS
   38
ITEM 4
[REMOVED AND RESERVED]
   38
       
PART II
      
       
ITEM 5
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
   39
ITEM 6
SELECTED FINANCIAL DATA
   39
ITEM 7
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
   39
ITEM 7A
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
   39
ITEM 8
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
   39
ITEM 9
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
   39
ITEM 9A
CONTROLS AND PROCEDURES
   39
ITEM 9B
OTHER INFORMATION
   40
       
PART III
      
       
ITEM 10
DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
   40
ITEM 11
EXECUTIVE COMPENSATION
   40
ITEM 12
SECURITY OWNERSHIP OF CERTAIN BEENFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
   41
ITEM 13
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
   41
ITEM 14
PRINCIPAL ACCOUNTANT FEES AND SERVICES
   41
       
PART IV
      
       
ITEM 15
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
   41
 
SIGNATURES
   42
 
 
2
 
 
PART I

ITEM 1.
BUSINESS

Private Securities Litigation Reform Act Safe Harbor Statement

This Annual Report on Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1955, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” ”expect,” “will,” “may,” and words of similar meaning.   These forward-looking statements include, but are not limited to:

 
·
statements of our goals, intentions and expectations;

 
·
statements regarding our business plans, prospects, growth and operating strategies;

 
·
statements regarding the asset quality of our loan and investment portfolios; and

 
·
estimates of our risks and future costs and benefits.

These forward-looking statements are based on our current beliefs and expectations and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. We are under no duty to and do not take any obligation to update any forward-looking statements after the date of this Form 10-K.

The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:

 
·
general economic conditions, either nationally or in our market areas, that are worse than expected;

 
·
competition among depository and other financial institutions;

 
·
inflation and changes in the interest rate environment that reduce our margins or reduce the fair value of financial instruments;

 
·
adverse changes in the securities markets;

 
·
changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees and capital requirements;

 
·
our ability to enter new markets successfully and capitalize on growth opportunities;

 
·
our ability to successfully integrate acquired entities;

 
·
changes in consumer spending, borrowing and savings habits;

 
·
changes in accounting policies and practices, as may be adopted by the regulatory agencies, the Financial Accounting Standards Board, the Securities and Exchange Commissions and the Public Company Accounting Oversight Board;

 
·
changes in our organization, compensation and benefit plans;

 
·
changes in our financial condition or results or operations that reduce capital available to pay dividends;

 
·
regulatory changes or actions; and

 
·
changes in the financial condition or future prospects of issuers of securities that we own.

 
3
 
 
Because of these and a wide variety of other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements.
 
First Federal of Northern Michigan Bancorp, Inc.

First Federal of Northern Michigan Bancorp, Inc. is a Maryland corporation that owns all of the outstanding shares of common stock of First Federal of Northern Michigan.  At December 31, 2010, First Federal of Northern Michigan Bancorp, Inc. had consolidated assets of $215.7 million, deposits of $155.5 million and stockholders’ equity of $23.2 million.  As of December 31, 2010, First Federal of Northern Michigan Bancorp, Inc. had 2,884,049 shares of common stock issued and outstanding.  First Federal of Northern Michigan Bancorp, Inc.’s executive offices are located at 100 South Second Avenue, Alpena, Michigan 49707. Its phone number at that address is (989) 356-9041.

The Company also maintains a website at www.first-federal.com that includes important information on our Company, including a list of our products and services, branch locations and current financial information. In addition, we make available, without charge, through our website, a link to our filings with the SEC, including copies of annual reports on Form 10-K, quarterly reports in Form 10-Q, current reports in Form 8-K, and amendments to these filings, if any. Information on our website should not be considered a part of this Annual Report.

First Federal of Northern Michigan

First Federal of Northern Michigan is a full-service, community-oriented savings bank that provides financial services to individuals, families and businesses from eight full-service facilities located in Alpena, Cheboygan, Emmett, Iosco, Otsego, Montmorency and Oscoda Counties, Michigan.  First Federal of Northern Michigan was chartered in 1957, and reorganized into the mutual holding company structure in 1994. In 2000, First Federal of Northern Michigan became the wholly owned subsidiary of Alpena Bancshares, Inc., our predecessor company, and in April 2005 we completed our “second step” mutual-to-stock conversion and formed our current ownership structure.

First Federal of Northern Michigan’s business consists primarily of accepting deposits from the general public and investing those deposits, together with funds generated from operations and borrowings, in one- to four-family residential mortgage loans, commercial real estate loans, commercial business loans, consumer loans and in investment securities and mortgage-backed securities.

First Federal of Northern Michigan’s executive offices are located at 100 South Second Avenue, Alpena, Michigan 49707. Its phone number at that address is (989) 356-9041.

Market Area and Competition

First Federal of Northern Michigan conducts operations through its main office in Alpena, Michigan, which is located in the northeastern lower peninsula of Michigan, and through its seven other branch offices in Michigan.  The population of Alpena County, from which the majority of our deposits are drawn, has decreased approximately 5.4% since 2000, and currently is approximately 30,000. The population of our primary market area, which includes Alpena County and seven surrounding counties, was approximately 180,000 according to the 2010 census, a decrease of just over 10% from the estimated 2008 population of approximately 182,000.   Household income for the counties which  comprised our market area in 2009  ranged from approximately $32,000 to $37,000, with the exception of Otsego County, where 2009 household income was approximately $43,000. Household income for our entire market area was below the national level of $50,221 and the state of Michigan level of $45,254, reflecting the largely rural nature of our market area and the absence of more densely populated urban and suburban areas.  Household income levels are not expected to increase in our market area in the near future.  The unemployment rate in our primary market area was 14.8% at December 31, 2010, compared to 9.4% nationally and 10.6% for the state of Michigan.

Alpena is the largest city located in the northeastern lower peninsula of Michigan.  This area has long been associated with agricultural, wood and concrete industries.  Tourism has also been a major industry in our primary market area.  All of these industries tend to be seasonal and are strongly affected by state and national economic conditions.

Major employers in our primary market area include various public schools and governmental agencies, Alpena Regional Medical Center, Besser Company (a manufacturer of concrete products equipment), Lafarge Corporation (a limestone mining and cement producer), Panel Processing (a peg board manufacturer), Treetops Sylvan Resort (an operator of resort properties), Garland Resort (an operator of resort properties and golf courses), Otsego Memorial Hospital, Cheboygan Memorial Hospital, Decorative Panels International (a hardboard manufacturer), OMNI   Metalcraft Corp. (a diversified manufacturer), and various other small companies.

 
4
 
 
As of December 31, 2010, First Federal of Northern Michigan was the only thrift institution headquartered in our market area.  We encounter strong competition both in attracting deposits and in originating real estate and other loans.  Our most direct competition for deposits has historically come from commercial banks, other savings institutions, and credit unions in our market area.  Competition for loans comes from such financial institutions. We expect continued strong competition in the foreseeable future, including the “super-regional” banks currently in our markets, from internet banks, and from credit unions in many of our markets.  We compete for savings deposits by offering depositors a high level of personal service and a wide range of competitively priced financial products.  We compete for real estate loans primarily on the basis of the interest rates and fees we charge and through advertising.  Strong competition for deposits and loans may limit our ability to grow and may adversely affect our profitability in the future.

Lending Activities

General.  The largest part of our loan portfolio is mortgage loans secured by one- to four-family residential real estate.  In recent years, we have sold into the secondary mortgage market most of the fixed-rate conventional one- to four-family mortgage loans that we originate that have terms of 15 years or more.  We retain the servicing on a majority of the mortgage loans that we sell.  To a lesser extent, we also originate commercial loans, commercial real estate loans and consumer loans.  At December 31, 2010, we had total loans of $160.2 million, of which $71.7 million, or 44.8% were one- to four-family residential real estate mortgage loans, $57.5 million, or 35.9% were commercial real estate loans, and $8.8 million, or 5.5%, were commercial loans.  Other loans consisted primarily of home equity loans, which totaled $16.6 million, or 10.3% of total loans, construction loans which totaled $3.5 million or 2.2% of total loans, and other consumer loans which totaled $2.1 million, or 1.3% of total loans.
 
One- to Four-Family Residential Real Estate Lending.  Our primary lending activity consists of originating one- to four-family owner-occupied residential mortgage loans, virtually all of which are collateralized by properties located in our market area. We also originate one- to four-family loans that pay interest only during the initial construction period (which generally does not exceed twelve months) and then pay interest and principal for the remainder of the loan term. We generally sell into the secondary mortgage market most of our one- to four-family fixed-rate mortgage loans with terms of 15 years or more and retain the loan servicing on a majority of these mortgage loans.  One- to four-family residential mortgage loans are underwritten and originated according to policies and guidelines established by the secondary mortgage market agencies and approved by our Board of Directors.  We utilize existing liquidity, deposits, loan repayments, and Federal Home Loan Bank advances to fund new loan originations.

We currently offer fixed rate one- to four-family residential mortgage loans with terms ranging from 15 to 30 years.  One- to four-family residential mortgage loans often remain outstanding for significantly shorter periods than their contractual terms because borrowers may refinance or prepay loans at their option.  The average length of time that our one- to four-family residential mortgage loans remain outstanding varies significantly depending upon trends in market interest rates and other factors.  In recent years, the average maturity of our mortgage loans has decreased significantly because of the declining trend in market interest rates and the unprecedented volume of refinancing activity resulting from such interest rate decreases.  Accordingly, estimates of the average length of one- to four-family loans that remain outstanding cannot be made with any degree of certainty.

Originations of fixed rate mortgage loans are regularly monitored and are affected significantly by the level of market interest rates, our interest rate gap position, and loan products offered by our competitors. Our fixed rate mortgage loans amortize on a monthly basis with principal and interest due each month.  To make our loan portfolio less interest rate sensitive, fixed-rate loans originated with terms of 15 years or greater are generally underwritten to secondary mortgage market standards and sold.  Adjustable rate mortgage loans are generally underwritten to secondary mortgage market standards, but are retained in our loan portfolio.

We have in the past originated some fixed-rate loans that are generally amortized over 15 years but that have “balloon payments” that are due upon the maturity of the loan in five years.  As a general rule, we no longer originate this type of mortgage loan. Upon maturity, existing balloon mortgage loans are either underwritten as fixed-rate loans and sold in the secondary mortgage market or rewritten as adjustable rate mortgages at current market rates.  While the majority of our balloon mortgage loans amortize over 15 years, some amortize over 10 or 30 years, and a limited number amortize over five years.

 
5
 
 
Our one- to four-family residential mortgage loans customarily include due-on-sale clauses, which are provisions giving us the right to declare a loan immediately due and payable in the event, among other things, that the borrower sells or otherwise disposes of the underlying real property serving as security for the loan.  Due-on-sale clauses are an important means of adjusting the rates on our fixed-rate mortgage loan portfolio, and we have generally exercised our rights under these clauses.

Regulations limit the amount that a savings institution may lend relative to the appraised value of the real estate securing the loan, as determined by an appraisal at the time of loan origination.  Such regulations permit a maximum loan-to-value ratio of 100% for residential property and 90% for all other real estate loans. Our lending policies limit the maximum loan-to-value ratio on fixed-rate loans without private mortgage insurance to 80% of the lesser of the appraised value or the purchase price of the property serving as collateral for the loan.

We make one- to four-family real estate loans with typical loan-to-value ratios of up to 90%.  However, for one- to four-family real estate loans with loan-to-value ratios of between 80% and 90%, we may require the borrower to purchase private mortgage insurance. In 2005 we began making 80/20 loans and interest-only loans subject to Board-approved dollar limits to limit risk exposure. In late 2007 these products were eliminated; however, at December 31, 2010 approximately $674,000 of these products remained in our portfolio. We require fire and casualty insurance, flood insurance when applicable, as well as title insurance, on all properties securing real estate loans made by us.

Commercial Real Estate Lending.  We also originate commercial real estate loans. At December 31, 2010, we had a total of 230 loans secured primarily by commercial real estate properties, unimproved vacant land and, to a limited extent, multifamily properties.  Our commercial real estate loans are secured by income-producing properties such as office buildings, retail buildings, restaurants and motels. A majority of our commercial real estate loans are secured by properties located in our primary market area, although at December 31, 2010 we did have $9.9 million in commercial real estate loans located in states other than Michigan. We have originated commercial construction loans that are originated as permanent loans but are interest-only during the initial construction period, which generally does not exceed nine months.  At December 31, 2010, our commercial real estate loans, excluding commercial construction, totaled  $57.7 million, or 36.0% of our total loans, and had an average principal balance of approximately $322,000.  The terms of each loan are negotiated on a case-by-case basis, although such loans typically amortize over 15 years and have a three- or five-year balloon feature.  An origination fee of 0.5% to 1.0% is generally charged on commercial real estate loans.  We generally make commercial real estate loans up to 75% of the appraised value of the property securing the loan.

At December 31, 2010, our largest commercial real estate relationship consisted of eight loans having a total principal balance of $2.9 million, which were all performing according to their terms as of December 31, 2010. This loan relationship is secured by five pieces of commercial real estate. Our largest single commercial real estate loan was a loan of $3.6 million, of which $1.5 million has been participated to other banks, leaving a net exposure on our books of $2.1 million.  This loan is secured by a residential real-estate property, furniture, fixtures and all other assets.  At December 31, 2010, this loan was performing according to its terms.

Commercial real estate loans generally carry higher interest rates and have shorter terms than those on one- to four-family residential mortgage loans.  However, loans secured by commercial real estate generally involve a greater degree of credit risk than one- to four-family residential mortgage loans and carry larger loan balances.  This increased credit risk is a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties, and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by commercial real estate is typically dependent upon the successful operation of the business or the related real estate property.  If the cash flow from the business operation is reduced, the borrower’s ability to repay the loan may be impaired. This may be particularly true in the early years of the business operation when the risk of failure is greatest. Many of our commercial real estate loans have been made to borrowers whose business operations are untested, which increases our risk.

Consumer and Other Loans.  We originate a variety of consumer and other loans, including loans secured by savings accounts, new and used automobiles, mobile homes, boats, recreational vehicles, and other personal property.  As of December 31, 2010, consumer and other loans totaled $18.7 million, or 11.7% of our total loan portfolio.  At such date, $431,000, or 0.3% of our consumer loans, were unsecured.  As of December 31, 2010, home equity loans totaled $16.6 million, or 10.3% of our total loan portfolio, and automobile loans totaled $1.0 million, or 0.7% of our total loan portfolio.  We originate automobile loans directly to our customers and have no outstanding agreements with automobile dealerships to generate indirect loans.

 
6
 
 
Our procedures for underwriting consumer loans include an assessment of an applicant’s credit history and the ability to meet existing obligations and payments on the proposed loan.  Although an applicant’s creditworthiness is a primary consideration, the underwriting process also includes a comparison of the value of the collateral security, if any, to the proposed loan amount.

Consumer loans generally entail greater risk than residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that tend to depreciate rapidly, such as automobiles, mobile homes, boats and recreational vehicles.  In addition, the repayment of consumer loans depends on the borrower’s continued financial stability, as repayment is more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy than a single family mortgage loan.

Commercial Loans. At December 31, 2010, we had $8.8 million in commercial loans which amounted to 5.5% of total loans.  We make commercial business loans primarily in our market area to a variety of professionals, sole proprietorships and small businesses.  Commercial lending products include term loans and revolving lines of credit.  The maximum amount of a commercial business loan is our loans-to-one-borrower limit, which was $3.6 million at December 31, 2010.  Such loans are generally used for longer-term working capital purposes such as purchasing equipment or furniture.  Commercial loans are made with either adjustable or fixed rates of interest.  Variable rates are generally based on the prime rate, as published in The Wall Street Journal, plus a margin.  Fixed rate commercial loans are set at a margin above the Federal Home Loan Bank comparable advance rate.

When making commercial loans, we consider the financial statements of the borrower, our lending history with the borrower, the debt service capabilities of the borrower, the projected cash flows of the business and the value of the collateral.  Commercial loans are generally secured by a variety of collateral, primarily accounts receivable, inventory and equipment, and are supported by personal guarantees.  Depending on the collateral used to secure the loans, commercial loans are typically made in amounts of up to 75% of the value of the collateral securing the loan.

Commercial loans generally have greater credit risk than residential mortgage loans.  Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment or other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial loans generally are made on the basis of the borrower’s ability to repay the loan from the cash flow of the borrower’s business.  As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself.  If the cash flow from the business operation is reduced, the borrower’s ability to repay the loan may be impaired. This may be particularly true in the early years of the business operation when the risk of failure is greatest. Moreover, any collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value.  We seek to minimize these risks through our underwriting standards.  At December 31, 2010, our largest commercial loan was a $2.4 million commercial participation loan collateralized by manufacturing equipment and a related plant facility.  At December 31, 2010, the outstanding balance was $2.3 million and the loan was performing according to its repayment terms.

Construction Loans.  We originate construction loans to local home builders in our market area, generally with whom we have an established relationship, and to individuals engaged in the construction of their residences.  We also originate loans for the construction of commercial buildings and, to an extent, participate in construction loan projects originated by other lenders. Our construction loans totaled $3.4 million, or 2.1% of our total loan portfolio, at December 31, 2010.

Our construction loans to home builders are repaid on an interest-only basis for the term of the loan (which is generally six to 12 months), with interest calculated on the amount disbursed to the builders based upon a percentage of completion of construction.  These loans typically have a maximum loan-to-value ratio of 80%, based on the appraised value.  Interest rates are fixed during the construction phase of the loan.  Loans to builders are made on either a pre-sold or speculative (unsold) basis.  Most of our construction loans to individuals who intend to occupy the completed dwelling are originated via a “one-step closing” process, whereby the construction phase and end-financing are handled with one loan closing.  Prior to funding a construction loan, we require an appraisal of the property from a qualified appraiser approved by us, and all appraisals are reviewed by us.

Construction lending exposes us to greater credit risk than permanent mortgage financing because of the inherent difficulty in estimating both a property’s value at completion of the project and the estimated cost of the project. If the estimate of construction costs is inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the project. If the estimate of value upon completion is inaccurate, the value of the property may be insufficient to assure full repayment. Projects  may also be jeopardized by disagreements between borrowers and builders and by the failure of builders to pay subcontractors. Loans to builders to construct homes for which no purchaser has been identified carry more risk because the repayment of the loan depends on the builder’s ability to sell the property prior to the time that the construction loan is due.  We have attempted to minimize these risks by, among other things, limiting our residential construction lending primarily to residential properties in our market area and generally requiring personal guarantees from the principals of corporate borrowers.

 
7
 
 
Loan Portfolio Composition.  The following table sets forth the composition of our loan portfolio by type of loan at the dates indicated.
 
    
At December 31,
  
   
2010
    
2009
    
2008
    
2007
    
2006
  
   
Amount
    
Percent
    
Amount
    
Percent
    
Amount
    
Percent
    
Amount
    
Percent
    
Amount
    
Percent
  
               
(Dollars in thousands)
  
                                                             
Real estate loans:
                                                            
Residential Mortgages:
                                                            
1-4 Family Mortgages
  $ 68,298       42.7 %   $ 77,851       44.4 %   $ 87,179       44.0 %   $ 91,433       44.5 %   $ 93,520       44.1 %
Purchased Mortgage In-State
    3,243       2.0 %     3,342       1.9 %     3,802       1.9 %     4,531       2.2 %     4,635       2.2 %
Purchased Mortgage Out-of-State
    -       0.0 %     -       0.0 %     358       0.2 %     1,302       0.6 %     1,335       0.6 %
1-4 Familly Construction
    156       0.1 %     427       0.2 %     1,025       0.5 %     2,108       1.0 %     3,120       1.5 %
Home Equity/Junior Liens
    16,547       10.3 %     18,732       10.7 %     22,303       11.3 %     24,095       11.7 %     24,868       11.7 %
Nonresidential Mortgages:
                                                                                
Nonresidential
    43,580       27.3 %     43,446       24.8 %     42,526       21.5 %     44,634       21.7 %     44,212       20.8 %
Purchased Nonresidential In-State
    4,232       2.6 %     3,894       2.2 %     257       0.1 %     -       0.0 %     942       0.4 %
Purchased Nonresidential Out-of-State
    9,928       6.2 %     8,428       4.8 %     3,141       1.6 %     1,295       0.6 %     120       0.1 %
Nonresidential Construction
    1,498       0.9 %     2,816       1.6 %     6,635       3.3 %     6,184       3.0 %     6,286       3.0 %
Purchased Construction In-State
    -       0.0 %     -       0.0 %     -       0.0 %     -       0.0 %     -       0.0 %
Purchased Construction Out-of-State
    1,772       1.1 %     3,792       2.2 %     9,781       4.9 %     4,920       2.4 %     -       0.0 %
Non real estate loans:
                                                                                
Commercial Loans
    7,382       4.6 %     7,035       4.0 %     15,816       8.0 %     19,181       9.3 %     24,606       11.6 %
Purchased Commerical Loans In-State
    1,466       0.9 %     2,838       1.6 %     1,804       0.9 %     1,387       0.7 %     3,603       1.7 %
Purchased Commerical Loans Out-of State
    -       0.0 %     -       0.0 %     -       0.0 %     -       0.0 %     -       0.0 %
Consumer and other loans
    2,118       1.3 %     2,553       1.5 %     3,564       1.8 %     4,555       2.3 %     4,688       2.2 %
                                                                                 
Total Loans
  $ 160,220       100.00 %   $ 175,154       100.00 %   $ 198,191       100.00 %   $ 205,625       100.00 %   $ 211,935       100.00 %
                                                                                 
Other items:
                                                                                
Unadvanced construction loans
    -               -               -               -               -          
Deferred loan origination costs
    31               12               13               13               20          
Deferred loan origination fees
    (276 )             (287 )             (287 )             (292 )             (358 )        
Allowance for loan losses
    (2,831 )             (3,660 )             (5,647 )             (4,013 )             (2,079 )        
                                                                                 
Total loans, net
  $ 157,144                $ 171,219                $ 192,270                $ 201,333                $ 209,518             
 
Loan Portfolio Maturities and Yield.  The following table summarizes the scheduled repayments of our loan portfolio at December 31, 2010. Demand loans, loans having no stated repayment or maturity, and overdraft loans are reported as being due in one year or less.
 
 
8
 
  
          
Purchased Mortgage
    
Purchased Mortgage
    
1-4 Family
  
   
1-4 Family Mortgage
    
In-State
    
Out-of State
    
Construction
  
         
Weighted
          
Weighted
          
Weighted
          
Weighted
  
         
Average
          
Average
          
Average
          
Average
  
   
Amount
    
Rate
    
Amount
    
Rate
    
Amount
    
Rate
    
Amount
    
Rate
  
Due During the Years
                                                
Ending December 31,
                                                
2011
   $ 778       4.53 %   $ -       0.00 %   $ -       0.00 %   $ 156       5.50 %
2012
    276       7.23 %     -       0.00 %     -       0.00 %     -       0.00 %
2013
     1,271       6.19 %     -       0.00 %     -       0.00 %     -       0.00 %
2014 to 2015
     751       6.80 %     -       0.00 %     -       0.00 %     -       0.00 %
2016 to 2020
    8,028       5.91 %     -       0.00 %     -       0.00 %     -       0.00 %
2021 to 2025
    9,141       6.58 %     -       0.00 %     -       0.00 %     -       0.00 %
2026 and beyond
    48,053       6.34 %     3,243       3.87 %     -       0.00 %     -       0.00 %
                                                                 
Total
   $ 68,298       6.30 %   $ 3,243       3.87 %   $ -       0.00 %   $ 156       5.50 %

                            
Purchased Nonresidential
    
Purchased Nonresidential
  
   
Home Equity/Junior Liens
    
Nonresidential
    
In-State
    
Out-of-State
  
         
Weighted
          
Weighted
          
Weighted
          
Weighted
  
         
Average
          
Average
          
Average
          
Average
  
   
Amount
    
Rate
    
Amount
    
Rate
    
Amount
    
Rate
    
Amount
    
Rate
  
Due During the Years
                                                
Ending December 31,
                                                
2011
   $ 1,601       4.70 %   $ 14,360       6.14 %   $ -       0.00 %   $ 2,085       5.58 %
2012
     830       5.62 %     11,570       7.02 %     -       0.00 %     -       0.00 %
2013
     713       6.24 %     8,156       6.70 %     234       6.34 %     2,000       0.00 %
2014 to 2015   
    909       7.15 %     7,034       6.26 %     3,998       5.53 %     3,968       6.14 %
2016 to 2020   
    5,325       6.03 %     1,180       5.80 %     -       0.00 %     -       0.00 %
2021 to 2025   
    5,435       5.42 %     -       0.00 %     -       0.00 %     -       0.00 %
2026 and beyond   
    1,734       4.05 %     1,280       6.71 %     -       0.00 %     1,875       5.16 %
                                                                 
Total 
  $ 16,547       5.73 %   $ 43,580       6.51 %   $ 4,232       5.58 %   $ 9,928       6.01 %

    
Nonresidential
    
Purchased Construction
    
Purchased Construction
              
   
Construction
    
In-State
    
Out-of-State
    
Commercial Loans
  
         
Weighted
          
Weighted
          
Weighted
          
Weighted
  
         
Average
          
Average
          
Average
          
Average
  
   
Amount
    
Rate
    
Amount
    
Rate
    
Amount
    
Rate
    
Amount
    
Rate
  
Due During the Years
                                                
Ending December 31,
                                                
2011
   $ 1,498       6.06 %   $ -       0.00 %   $ 1,482       8.35 %   $ 2,063       5.72 %
2012
     -       0.00 %     -       0.00 %     -       0.00 %     1,097       5.64 %
2013
     -       0.00 %     -       0.00 %     -       0.00 %     294       6.55 %
2014 to 2015   
    -       0.00 %     -       0.00 %     290       9.38 %     2,423       6.66 %
2016 to 2020   
    -       0.00 %     -       0.00 %     -       0.00 %     1,505       6.05 %
2021 to 2025   
    -       0.00 %     -       0.00 %     -       0.00 %     -       0.00 %
2026 and beyond 
    -       0.00 %     -       0.00 %     -       0.00 %     -       0.00 %
                                                                 
Total   
  $ 1,498       6.06 %   $ -       0.00 %   $ 1,772       8.87 %   $ 7,382       5.81 %

    
Purchased Commercial
    
Purchased Commercial
    
Consumer
              
   
Loans In-State
    
Loans Out-of State
    
& Other Loans
    
Total
  
         
Weighted
          
Weighted
          
Weighted
          
Weighted
  
         
Average
          
Average
          
Average
          
Average
  
   
Amount
    
Rate
    
Amount
    
Rate
    
Amount
    
Rate
    
Amount
    
Rate
  
Due During the Years
                                                
Ending December 31,
                                                
2011
   $ 1,041       2.09 %   $ -       0.00 %   $ 414       7.83 %   $ 25,478       6.03 %
2012
     -       0.00 %     -       0.00 %     160       8.37 %     13,933       6.44 %
2013
     425       6.34 %     -       0.00 %     253       7.94 %     13,346       6.65 %
2014 to 2015   
    -       0.00 %     -       0.00 %     242       7.64 %     19,615       7.01 %
2016 to 2020   
    -       0.00 %     -       0.00 %     908       9.47 %     16,946       6.20 %
2021 to 2025   
    -       0.00 %     -       0.00 %     141       8.13 %     14,717       6.21 %
2026 and beyond
    -       0.00 %     -       0.00 %     -       0.00 %     56,185       6.12 %
                                                                 
Total 
  $ 1,466       3.32 %   $ -       0.00 %   $ 2,118       8.69 %   $ 160,220       6.27 %
 
 
9
 
 
Fixed- and Adjustable-Rate Loans.  The following table sets forth the scheduled repayments of   fixed- and adjustable-rate loans at December 31, 2010 that are contractually due after December 31, 2011.

   
Due After December 31, 2011
  
   
Fixed
    
Adjustable
    
Total
  
      (In thousands)  
                   
Residential Mortgages:
                  
1-4 Family Mortgages 
  $ 33,657     $ 33,863     $ 67,520  
Purchased Mortgage In-State
    -       3,243       3,243  
Purchased Mortgage Out-of-State   
    -       -       -  
1-4 Family Construction
    -       -       -  
Home Equity/Junior Liens       
    7,672       7,274       14,946  
Nonresidential Mortgages:
                        
Nonresidential           
    16,232       12,988       29,220  
Purchased Nonresidential In-State     
    3,753       479       4,232  
Purchased Nonresidential Out-of-State
     4,326       3,517       7,843  
Nonresidential Construction       
    -       -       -  
Purchased Construction In-State
    -       -       -  
Purchased Construction Out--State
    -       290       290  
Non real estate loans:
                        
Commercial Loans
    3,347       1,972       5,319  
Purchased Commerical Loans In-State   
    425       -       425  
Purchased Commerical Loans Out-of-State 
    -       -       -  
Consumer and other loans       
    1,320       384       1,704  
                         
Total Loans           
  $ 70,732     $ 64,010     $ 134,742  

Loan Originations, Purchases, Sales and Servicing.  While we originate both fixed-rate and adjustable-rate loans, our ability to generate each type of loan depends upon borrower demand, market interest rates, borrower preference for fixed- versus adjustable-rate loans, and the interest rates offered on each type of loan by other lenders in our market area. These lenders include competing banks, savings banks, credit unions, internet lenders, mortgage banking companies and life insurance companies that may also actively compete for local commercial real estate loans. Loan originations are derived from a number of sources, including real estate agent referrals, existing customers, borrowers, builders, attorneys, our directors, walk-in customers and our own commercial sales force.  Upon receiving a loan application, we obtain a credit report and employment verification to verify specific information relating to the applicant’s employment, income, and credit standing.  In the case of a real estate loan, we obtain a determination of value of the real estate intended to collateralize the proposed loan.  Our residential mortgage lending limits vary by residential mortgage officer but range from $150,000 to $250,000. While certain Senior Bank Officers have residential lending limits up to $400,000, the Officer Loan Committee generally approves residential loans from $250,000 to $400,000 while requests from $400,000 to $500,000 will receive approval from Senior Loan Committee. Residential loan requests over $500,000 must be approved by the Board of Directors. Secured consumer lending limits by officer range from $25,000 to $150,000. For secured commercial loans, the limits range from $250,000 to $400,000.

A commercial commitment letter specifies the terms and conditions of the proposed loan including the amount of the loan, interest rate, amortization term, a brief description of the required collateral, and required insurance coverage.  Commitments are typically issued for 15-day periods.  The borrower must provide proof of fire and casualty insurance on the property serving as collateral, which must be maintained during the full term of the loan.  A title insurance policy is required on all real estate loans.  At December 31, 2010, we had outstanding loan commitments of $27.2 million, including unfunded commitments under lines of credit and commercial and standby letters of credit.

Our loan origination and sales activity may be adversely affected by a rising interest rate environment that typically results in decreased loan demand, while declining interest rates may stimulate increased loan demand. Accordingly, the volume of loan originations, the mix of fixed- and adjustable-rate loans, and the profitability of this activity can vary from period to period.  One- to four-family residential mortgage loans are generally underwritten to investor guidelines, and closed on standard investor documents.  We currently sell loans to Freddie Mac. If such loans are sold, the sales are conducted using standard investor purchase contracts and master commitments as applicable. The majority of one- to four-family mortgage loans that we have sold to investors have been sold on a non-recourse basis, whereby foreclosure losses are generally the responsibility of the purchaser and not First Federal of Northern Michigan.

 
10
 
 
We are a qualified loan servicer for Freddie Mac.  Our policy has historically been to retain the servicing rights for all conforming loans sold, and to continue to collect payments on the loans, maintain tax escrows and applicable fire and flood insurance coverage, and supervise foreclosure proceedings if necessary.  We retain a portion of the interest paid by the borrower on the loans as consideration for our servicing activities.

We require appraisals of real property securing loans.  Appraisals are performed by independent appraisers, who are approved by our Board of Directors annually.  We require fire and extended coverage insurance in amounts adequate to protect our principal balance.  Where appropriate, flood insurance is also required.  Private mortgage insurance is required for most residential mortgage loans with loan-to-value ratios greater than 80%.
 
Loan Origination Fees and Costs.  In addition to interest earned on loans, we generally receive fees in connection with loan originations.  Such loan origination fees, net of costs to originate, are deferred and amortized using an interest method over the contractual life of the loan.  Fees deferred are recognized into income immediately upon prepayment or subsequent sale of the related loan.  At December 31, 2010, we had $245,000 of net deferred loan origination fees.  Such fees vary with the volume and type of loans and commitments made and purchased, principal repayments, and competitive conditions in the mortgage markets, which in turn respond to the demand and availability of money.  In addition to loan origination fees, we also generate other income through the sales and servicing of mortgage loans, late charges on loans, and fees and charges related to deposit accounts.  We recognized fees and service charges of $804,000, $869,000 and $942,000 for the years ended December 31, 2010, 2009 and 2008, respectively.

To the extent that originated loans are sold with servicing retained, we capitalize a mortgage servicing asset at the time of the sale in accordance with applicable accounting standards (FASB ASC 860, “Transfers and Servicing ”).  The capitalized amount is amortized thereafter (over the period of estimated net servicing income) as a reduction of servicing fee income.  The unamortized amount is fully charged to income when loans are prepaid.  Originated mortgage servicing rights with an amortized cost of $960,000 were included in other assets at December 31, 2010.

 
11
 
 
Origination, Purchase and Sale of Loans.  The table below shows our loan originations, purchases, sales, and repayments of loans for the periods indicated.
 
   
Years Ended December 31,
  
   
2010
    
2009
    
2008
  
   
(In Thousands)
  
                   
Loans receivable at beginning of period
  $ 175,154     $ 198,191     $ 205,625  
                         
Originations:
                        
Real estate:
                        
Residential 1-4 family
     47,838       58,909       30,187  
Commercial and Multi-family
     14,841       17,254       24,191  
Consumer
     3,660       3,894       6,543  
Total originations
     66,339       80,057       60,921  
                         
Loan purchases:
                        
Residential 1-4 family
     -       -       -  
Commercial
    -       4,914       5,177  
Total loan purchases
     -       4,914       5,177  
                         
Loan sales
     (42,151 )     (49,545 )     (11,641 )
Transfer of loans to foreclosed assets
     (2,080 )     (6,382 )     (2,916 )
Repayments
     (37,042 )     (52,081 )     (58,975 )
                         
Total loans receivable at end of period
  $ 160,220     $ 175,154     $ 198,191  
 
Delinquent Loans, Other Real Estate Owned and Classified Assets

Collection Procedures.  Our general collection procedures provide that when a commercial loan becomes 10 days past due and when a mortgage or consumer loan become 15 days past due, a computer-generated late charge notice is sent to the borrower requesting payment. If delinquency continues, a second delinquent notice is mailed when the loan continues past due for 30 days.  If a loan becomes 60 days past due, the loan becomes subject to possible legal action.  We will generally send a “due and payable” letter upon a loan becoming 60 days delinquent.  This letter grants the mortgagor 30 days to bring the account paid to date prior to the start of any legal action.  If not paid, foreclosure proceedings are initiated after this 30-day period.  To the extent required by regulations of the Department of Housing and Urban Development (“HUD”), generally within 30 days of delinquency, a Section 160 HUD notice is given to the borrower which provides access to consumer counseling services.  General collection procedures may vary with particular circumstances on a loan by loan basis.  Also, collection procedures for Freddie Mac serviced loans follow the Freddie Mac guidelines which are different from our general procedures.

Loans Past Due and Non-Performing Assets.  Loans are reviewed on a regular basis and are placed on non-accrual status when, in the opinion of management, the collection of additional interest is doubtful or when extraordinary efforts are required to collect the debt.  Interest accrued and unpaid at the time a loan is placed on non-accrual status is charged against interest income.

Real estate acquired by us as a result of foreclosure or by deed in lieu of foreclosure is deemed real estate owned (“REO”) until such time as it is sold.  In general, we consider collateral for a loan to be “in-substance” foreclosed if: (i) the borrower has little or no equity in the collateral; (ii) proceeds for repayment of the loan can be expected to come only from the operation or sale of the collateral; and (iii) the borrower has either formally or effectively abandoned control of the collateral, or retained control of the collateral but is unlikely to be able to rebuild equity in the collateral or otherwise repay the loan in the foreseeable future.  Cash flow attributable to in-substance foreclosures is used to reduce the carrying value of the collateral.

When collateral, other than real estate, securing commercial and consumer loans is acquired as a result of delinquency or other reasons, it is classified as Other Repossessed Assets (“ORA”) and recorded at the lower of cost or fair market value until it is disposed of.

 
12
 
 
When collateral is acquired or otherwise deemed REO/ORA, it is recorded at the lower of the unpaid principal balance of the related loan or its estimated net realizable value.  This write down is recorded against the allowance for loan losses.  Periodic future valuations are performed by management, and any subsequent decline in fair value is charged to operations.  At December 31, 2010, we held $2.8 million in properties that were classified REO and $20,000 in assets classified as ORA.

Delinquent Loans.  The following table sets forth certain information with respect to our loan portfolio delinquencies at the dates indicated.
 
   
Loan Delinquent For
              
   
60-89 Days
    
90 Days and Over
    
Total
  
   
Number
    
Amount
    
Number
    
Amount
    
Number
    
Amount
  
   
( Dollars In Thousands)
  
At December 31, 2010
                                    
Residential Mortgages           
    23     $ 2,056       34     $ 2,434       57     $ 4,490  
Commercial Mortgages           
    3       488       8       784       11       1,272  
Construction               
    -       -       2       1,772       2       1,772  
Commercial               
    1       6       -       -       1       6  
Consumer               
    10       122       9       207       19       329  
Total               
    37     $ 2,672       53     $ 5,197       90       7,869  
                                                 
At December 31, 2009
                                                
Residential Mortgages           
    22     $ 1,819       23     $ 1,719       45     $ 3,538  
Commercial Mortgages           
    7       1,125       12       3,705       19       4,830  
Construction               
    2       1,255       1       290       3       1,545  
Commercial               
    3       402       1       80       4       482  
Consumer               
    14       226       14       135       28       361  
Total               
    48     $ 4,827       51     $ 5,929       99       10,756  
                                                 
At December 31, 2008
                                                
Residential Mortgages           
    26     $ 2,513       13     $ 766       39     $ 3,279  
Commercial Mortgages           
    8       1,359       6       5,879       14       7,238  
Construction               
    -       -       2       1,980       2       1,980  
Commercial               
    1       95       1       72       2       167  
Consumer               
    26       155       10       66       36       221  
Total               
    61     $ 4,122       32     $ 8,763       93       12,885  
                                                 
At December 31, 2007
                                                
Residential Mortgages       
    24     $ 1,315       6     $ 532       30     $ 1,847  
Commercial Mortgages       
    1       797       -       -       1       797  
Construction               
    -       -       -       -       -       -  
Commercial               
    -       -       1       100       1       100  
Consumer               
    19       181       10       45       29       226  
Total               
    44     $ 2,293       17     $ 677       61       2,969  
                                                 
At December 31, 2006
                                                
Residential Mortgages           
    22     $ 1,218       9     $ 645       31     $ 1,863  
Commercial Mortgages           
    1       636       2       221       3       857  
Construction               
    1       74       -       -       1       74  
Commercial               
    6       317       10       540       16       857  
Consumer               
    17       105       9       84       26       189  
Total               
    47     $ 2,350       30     $ 1,490       77       3,839  
 
 
13
 
 
Nonperforming Assets. The following table sets forth the amounts and categories of our non-performing assets at the dates indicated.

    
At December 31,
  
   
2010
    
2009
    
2008
    
2007
    
2006
  
   
(Dollars in thousands)
  
                               
Non-Accrual Loans:
                              
Residential Mortgage
   $ 3,114     $ 2,944     $ 1,876     $ 697     $ 670  
Commercial Mortgage
     1,148       2,204       4,002       3,825       1,395  
Construction
    -       1,433       3,469       3,475       -  
Purchased Out-of-State
     1,772       2,113       1,980       -       -  
Commercial
     -       96       535       433       364  
Consumer and other
     206       157       90       29       61  
                                         
Total non-accrual loans
   $ 6,240     $ 8,947     $ 11,952     $ 8,459     $ 2,490  
                                         
Accrual loans delinquent 90 days or more:
                                        
Residential Mortgage
     282       89       128       532       645  
Commercial Mortgage
     82       2,696       72       -       221  
Construction
     -       -       -       -       -  
Purchased Out-of-State
     -       -       -       -       -  
Commercial
     -       -       -       100       540  
Consumer and other
     2       54       17       45       84  
Total accrual loans delinquent 90 days or more
  $ 366     $ 2,839     $ 217     $ 677     $ 1,490  
                                         
Total nonperforming loans (1)
   $ 6,606     $ 11,786     $ 12,169     $ 9,136     $ 3,980  
                                         
Real Estate Owned and Other Repossessed Assets:
                                        
Residential Mortgage
     494       584       686       872       437  
Commercial Mortgage
     2,304       2,985       882       406       -  
Construction
     -       -       -       -       -  
Commercial
     -       -       -       -       -  
Consumer and other
     20       11       70       2       38  
                                         
Total real estate owned and other repossesed assets (2)
   $ 2,818     $ 3,580     $ 1,638     $ 1,280     $ 475  
Total nonperforming assets
   $ 9,424     $ 15,366     $ 13,807     $ 10,416     $ 4,455  
                                         
Total nonperforming loans to total loans receivable
     4.37 %     6.73 %     6.14 %     4.54 %     1.90 %
Total nonperforming assets to total assets
     4.13 %     6.58 %     5.57 %     4.15 %     1.59 %
 
 
(1) 
All of our loans delinquent 90 days or more are classified as nonperforming.
 
(2) 
Represents the net book value of property acquired by us 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.
 
Interest income that would have been recorded for the year ended December 31, 2010, had non-accruing loans been current according to their original terms amounted to $612,000.  Interest of $57,000 was recognized on these impaired loans prior to placing them on non-accrual status, and is included in net income for the year ended December 31, 2010.

Classification of Assets.  Our policies, consistent with regulatory guidelines, provide for the classification of loans and other assets such as debt and equity securities and real estate held for sale considered by the Office of Thrift Supervision to be of lesser quality as “substandard,” “doubtful,” or “loss” assets.  An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the savings institution will sustain “some loss” if the deficiencies are not corrected.  Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard,” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.”  Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.  Assets that do not expose the savings institution to risk sufficient to warrant classification in one of the aforementioned categories, but which possess some weaknesses, are required to be designated “special mention” by management.  Loans designated as special mention are generally loans that, while current in required payments, have exhibited some potential weaknesses that, if not corrected, could increase the level of risk in the future.

 
14
 
 
The allowance for loan losses represents amounts that have been established to recognize losses inherent in the loan portfolio that are both probable and reasonably estimable at the date of the financial statements.  When we classify problem assets as loss, we charge-off such amount.  Our determination as to the classification of our assets and the amount of our loss allowances are subject to review by our regulatory agencies, which can order the establishment of additional loss allowances. Management regularly reviews our asset portfolio to determine whether any assets require classification in accordance with applicable regulations.  On the basis of management’s review of our assets at December 31, 2010, classified assets consisted of substandard assets of $16.5 million. There were no assets classified as doubtful or loss at December 31, 2010.
 
Allowance for Loan Losses. We provide for loan losses based on the allowance method.  Accordingly, all loan losses are charged to the related allowance and all recoveries are credited to it.  Additions to the allowance for loan losses are provided by charges to income based on various factors which, in management’s judgment, deserve current recognition in estimating probable losses.  Management regularly reviews the loan portfolio and makes provisions for loan losses in order to maintain the allowance for loan losses in accordance with accounting principles generally accepted in the United States of America.  The allowance for loan losses consists of amounts specifically allocated to non-performing loans and other criticized or classified loans (if any) as well as general allowances determined for each major loan category.  Commercial loans and loans secured by commercial real estate are evaluated individually for impairment. Other smaller-balance, homogeneous loan types, including loans secured by one- to four-family residential real estate and consumer installment loans, are evaluated for impairment on a collective basis.  After we establish a provision for loans that are known to be non-performing, criticized or classified, we calculate percentage loss factors to apply to the remaining categories within the loan portfolio to estimate probable losses inherent in these categories of the portfolio.  When the loan portfolio increases, therefore, the percentage calculation results in a higher dollar amount of estimated probable losses than would be the case without the increase, and when the loan portfolio decreases, the percentage calculation results in a lower dollar amount of estimated probable losses than would be the case without the decrease.  These percentage loss factors are determined by management based on our historical loss experience and credit concentrations for the applicable loan category, which may be adjusted to reflect our evaluation of levels of, and trends in, delinquent and non-accrual loans, trends in volume and terms of loans, and local economic trends and conditions.

 
15
 
 
We consider commercial and commercial real estate loans and construction loans to be riskier than one- to four-family residential mortgage loans.  Commercial and commercial real estate loans have greater credit risks compared to one- to four-family residential mortgage loans, as they typically involve large loan balances concentrated with single borrowers or groups of related borrowers.  In addition, the payment experience on loans secured by income-producing properties typically depends on the successful operation of the related real estate project and thus may be subject to a greater extent to adverse conditions in the real estate market and in the general economy.  Construction loans have greater credit risk than permanent mortgage financing because of the inherent difficulty in estimating both a property’s value at completion of the project and the estimated cost of the project.  If the estimate of construction costs is inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the project. If the estimate of value upon completion is inaccurate, the value of the property may be insufficient to assure full repayment. Projects also may be jeopardized by disagreements between borrowers and builders and by the failure of builders to pay subcontractors. Loans to builders to construct homes for which no purchaser has been identified carry more risk because the repayment of the loan depends on the builder’s ability to sell the property prior to the time that the construction loan is due.  The increased risk characteristics associated with commercial real estate and land loans and construction loans are considered by management in the evaluation of the allowance for loan losses and generally result in a larger loss factor applied to these segments of the loan portfolio in developing an estimate of the required allowance for loan losses. We intend to increase our originations of commercial and commercial real estate loans, and we intend to retain these loans in our portfolio.  Because these loans entail significant additional credit risks compared to one- to four-family residential mortgage loans, an increase in our origination (and retention in our portfolio) of these types of loans would, in the absence of other offsetting factors, require us to make additional provisions for loan losses.

The carrying value of loans is periodically evaluated and the allowance is adjusted accordingly.  While management uses the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the information used in making the evaluations.  In addition, as an integral part of their examination process, our regulatory agencies periodically review the allowance for loan losses.  Such agencies may require us to recognize additions to the allowance based on their judgments of information available to them at the time of their examination.
 
 
16
 
 
Analysis of the Allowance for Loan Losses.  The following table sets forth the activity on our allowance for loan losses for the periods indicated.
 
   
For the Years Ended December 31,
  
   
2010
    
2009
    
2008
    
2007
     2006  
   
(Dollars in thousands)
              
                               
Allowance at beginning of period 
   $ 3,660     $ 5,647     $ 4,013     $ 2,079     $  1,416  
                                         
(Charge-offs):
                                        
Real Estate:
                                        
Residential Mortgages           
    (258 )     (362 )     (342 )     (225 )     44  
Nonresidential Real Estate:
                                        
Commercial Mortgages
    (198 )     (4,903 )     (2,023 )     (59 )     -  
Purchased In-State           
    -       (2,482 )     -       -       -  
Purchased Out-of-State         
    (314 )     -       -       -       -  
Construction             
    (751 )     -       -       -       -  
Purchased In-State           
    -       -       -       -       -  
Purchased Out-of-State         
    (262 )     -       -       -       -  
Non Real Estate Loans:
                                        
Commercial               
    -       (246 )     (331 )     (4 )     1  
Consumer and other
    (319 )     (254 )     (141 )     (190 )     163  
Total charge offs           
    (2,102 )     (8,247 )     (2,837 )     (478 )     208  
                                         
Recoveries:
                                        
Real Estate:
                                        
Residential Mortgages           
    2       -       -       1       -  
Purchased In-State           
    -       -       -       -       -  
Purchased Out-of-State         
    -       -       -       -       -  
Nonresidential Real Estate:
                                        
Commercial Mortgages
    85       -       -       -       -  
Purchased In-State           
    -       -       -       -       -  
Purchased Out-of-State         
    -       -       -       -       -  
Construction             
    60       -       -       -       -  
Purchased In-State           
    -       -       -       -       -  
Purchased Out-of-State   
     -       -       -       -       -  
Non Real Estate Loans:
                                        
Consumer and other
    25       64       50       34       20  
Total recoveries               
    172       64       50       35       20  
                                         
Net (charge offs) recoveries
    (1,930 )     (8,183 )     (2,787 )     (443 )     188  
Provision for loan losses
    1,101       6,196       4,421       2,377       851  
                                         
Balance at end of year 
   $ 2,831     $ 3,660     $ 5,647     $ 4,013     $  2,079  
                                         
Ratios:
                                        
Net Charge-offs to average loans outstanding (annualized) 
     1.14 %     4.58 %     -1.40 %     0.21 %     0.08 % 
                                         
Allowance for loan loss to non-performing loans at end of period   
     42.85 %     31.05 %     46.41 %     43.93 %     52.24 % 
                                         
Allowance for loan losses to total loans at end of period 
     1.77 %     2.09 %     2.85 %     1.95 %     0.98 % 
 
 
17
 
 
Allocation of Allowance for Loan Losses.  The following table sets forth the allowance for loan losses allocated by loan category, the total loan balances by category, and the percent of loans in each category to total loans at the dates indicated.  The allowance for loan losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories.
 
   
At December 31
  
   
2010
    
2009
    
2008
  
   
Allowance
for Loan
Losses
    
Percent of
Loans in
Each
Category to
Total Loans
    
Allowance
for Loan
Losses
    
Percent of
Loans in
Each
Category to
Total Loans
    
Allowance
for Loan
Losses
    
Percent of
Loans in
Each
Category to
Total Loans
  
                                     
Residential Mortgages:
                                    
1 - 4 family residential
   $ 519       42.7 %   $ 634       44.4 %   $ 967       44.0 %
Purchased Mortgages In-State
     17       2.0 %     12       1.9 %     11       1.9 %
Purchased Mortgages Out-of-State
     -       0.0 %     -       0.0 %     1       0.2 %
1 - 4 family construction
     -       0.1 %     3       0.2 %     5       0.5 %
Home Equity & Junior Liens
     228       10.3 %     214       10.7 %     231       11.3 %
Nonresidential Mortgages:
                                                
Nonresidential
     967       27.3 %     1,055       24.9 %     1,768       21.5 %
Purchased Nonresidential In-State
     94       2.6 %     140       2.2 %     3       0.1 %
Purchased Nonresidential Out-of-State
     220       6.2 %     175       4.8 %     14       1.6 %
Construction
     245       0.9 %     647       1.6 %     7       3.3 %
Purchased Construction In-State
     -       0.0 %     -       0.0 %     -       0.0 %
Purchased Construction Out-of-State
     290       1.1 %     350       2.2 %     740       4.9 %
Non Real Estate Loans:
                                                
Commercial
     192       4.6 %     316       4.0 %     1,795       8.0 %
Purchased Commercial In-State
     -       0.9 %     73       1.6 %     18       0.9 %
Purchased Commercial Out-of-State
     -       0.0 %     -       0.0 %     32       0.0 %
Consumer
     59       1.3 %     41       1.5 %     55       1.8 %
Total      
  $ 2,831       100.0 %   $ 3,660       100.0 %   $ 5,647       100.0 %

   
At December 31
  
   
2007
    
2006
  
   
Allowance 
for Loan
Losses
    
Percent of
Loans in
Each
Category to
Total Loans
    
Allowance
 for Loan
Losses
    
Percent of
Loans in
Each
Category to
Total Loans
  
Residential Mortgages:
                        
One to four family residental
   $ 787       44.5 %   $ 182       44.1 %
Purchased Mortgages In-State
     5       2.2 %     3       2.2 %
Purchased Mortgages Out-of-State
     1       0.6 %     1       0.6 %
1 - 4 family construction
     14       1.0 %     6       1.5 %
Home Equity & Junior Liens
     171       11.7 %     433       11.7 %
Nonresidential Mortgages:
                                
Nonresidential
     1,374       21.7 %     761       20.9 %
Purchased Nonresidential In-State
     -       0.0 %     16       0.4 %
Purchased Nonresidential Out-of-State
     5       0.6 %     2       0.1 %
Construction
     18       3.0 %     108       3.0 %
Purchased Construction In-State
     -       0.0 %     -       0.0 %
Purchased Construction Out-of-State
     22       2.4 %     -       0.0 %
Non Real Estate Loans:
                                
Commercial
     1,529       9.3 %     423       11.6 %
Purchased Commercial In-State
     9       0.7 %     62       1.7 %
Purchased Commercial Out-of-State
     14       0.0 %     -       0.0 %
Consumer
     64       2.3 %     82       2.2 %
Total      
  $ 4,013       100.0 %   $ 2,079       100.0 %
 
 
18
 
 
Mortgage Banking Activities

Our mortgage banking activities involve the origination and subsequent sale into the secondary mortgage market of one- to four-family residential mortgage loans. When loans are sold into the secondary market, we generally retain the rights to service those loans thereby maintaining our customer relationships. We intend to use these customer relationships to cross-sell additional products and services. Loans that we sell are originated using the same personnel and the same underwriting policies as loans that we maintain in our portfolio. The decision whether to sell a loan is dependent upon the type of loan product and the term of the loan. In recent years, we have sold most of our fixed-rate one- to four-family residential loans with maturities of 15 years or greater, and have retained servicing on most of these loans. For a brief period we sold some mortgage loans servicing-released to be able to offer additional products to our customers, however, we currently do not sell loans servicing-released.

Mortgage servicing involves the administration and collection of home loan payments. When we acquire mortgage servicing rights through the origination of mortgage loans and the subsequent sale of those loans with servicing rights retained, we allocate a portion of the total cost of the mortgage loans to the mortgage servicing rights based on their relative fair value. As of December 31, 2010, we were servicing loans sold to third parties totaling $144.9 million, and the mortgage servicing rights associated with such loans had a book value, at such date, of $960,000.  Generally, the value of mortgage servicing rights increases as interest rates rise and decreases as interest rates fall, because the estimated life and estimated income from the underlying loans increase with rising interest rates and decrease with falling interest rates.

Insurance Brokerage Activities

In March 2003, we acquired InsuranCenter of Alpena (“ICA”), a licensed insurance agency, to increase and diversify our sources of non-interest income. In April 2008, ICA sold to a non-related third party the rights to service certain health insurance contracts and collect commissions on the contracts written through the local Chambers of Commerce. This sale resulted in a nominal gain to us, but reduced health insurance revenues. The sale also reduced non-interest expenses and amortization of intangibles.

On February 27, 2009, we sold the majority of the assets of ICA. We retained the residual income stream associated with the April 2008 sale of its wholesale Blue Cross/Blue Shield override business to the third party. The results of operations of ICA are presented separately in our consolidated financial statements as “discontinued operations” through the date of sale.  We continue to collect the residual revenue stream associated with this sale through FFNM Agency, the successor company to ICA.

See “-Subsidiary Activity” for a further discussion of ICA and FFNM Agency.

Real Estate Development Activities

On a limited basis, we have purchased real estate for development through our subsidiary Financial Services & Mortgage Corporation.  See "—Subsidiary Activity" for a discussion of our real estate development subsidiary, Financial Services & Mortgage Corporation. The last such purchase was a 37 acre lot which we purchased in 1994 for $130,000. As of December 31, 2010, we had sold 39 of the 43 lots comprising this property and two of the smaller lots had been combined into one lot, so that at December 31, 2010 four lots remained unsold.  Our investment in land and real estate is “held for sale” and separately stated in the statement of financial condition, net of any allowance for impairment. Management actively marketed the property by using local real estate agents to facilitate the sale of these properties.  For reporting purposes, this investment is considered “impaired” under the definition in FASB ASC 360-10, Accounting for Impairment or Disposal of Long-Lived Assets.  Accordingly, the investment is recorded at the lower of its cost or fair value less cost to sell, which may include realtor commissions, legal and title transfer fees, and closing costs that must be incurred before legal title can be transferred.

Annually, management uses recent sales of comparable property to determine estimated future cash flows.  The estimated future cash flows are used as the “fair value.”  The fair value, less cost to sell, is compared to the net carrying amount.  If the fair value, less cost to sell, exceeds the recorded amount, a loss is recognized.  Losses recognized for the initial and subsequent write-down to fair value, less cost to sell, are recognized in the “gain (loss) on the sale of real estate” line in the statement of income. A gain is recognized for any subsequent increase in fair value, less cost to sell, but not in excess of the cumulative loss previously recognized.  A gain or loss not previously recognized that results from the sale of the property are recognized at the date of sale.

 
19
 
 
At December 31, 2010, our investment in these properties was approximately $28,000, which was net of an allowance of $137,000.   The last four lots were sold in January 2011 at a loss of less than $1,000.
 
Investment Activities

Our investment securities portfolio comprises U.S. Government, state agency and municipal obligations, mortgage-backed securities, Federal Home Loan Bank stock, and other investments of which $35.3 million, or  93.3%, was available-for-sale and $2.5 million, or 6.7%, of the total portfolio was classified as held-to-maturity.  At December 31, 2010, we had no investments in unrated securities.  At December 31, 2010, $8.7 million, or 23.0% of our investment portfolio was scheduled to mature in less than five years, and $28.9 million, or 77.0%, was scheduled to mature in over five years.  At December 31, 2010, $2.8 million, or 7.7% of our investment portfolio was scheduled to mature in less than one year.

At December 31, 2010, we held U.S. Government and state agency obligations and municipal obligations classified as available-for-sale, with a fair market value of $9.6 million.  While these securities generally provide lower yields than other investments such as mortgage-backed securities, our current investment strategy is to maintain investments in such instruments to the extent appropriate for liquidity purposes, as collateral for borrowings, and for prepayment protection.

We invest in mortgage-backed securities in order to: generate positive interest rate spreads with minimal administrative expense; lower credit risk as a result of the guarantees provided by Ginnie Mae and, to a lesser extent, Fannie Mae and Freddie Mac; supplement local loan originations; reduce interest rate risk exposure; and increase liquidity.  Our mortgage-backed securities portfolio consists of pass-through certificates.  At December 31, 2010, mortgage-backed securities totaled $25.7 million, or 67.9% of total investments.  At December 31, 2010, 3.0% of our mortgage-backed securities were secured by balloon loans.  All of our pass-through certificates are insured or guaranteed by Freddie Mac, Ginnie Mae or Fannie Mae.  Our policy is to hold mortgage-backed securities as available for sale.

We have interests in pools of single-family mortgages in which the principal and interest payments are passed from the mortgage originators, through intermediaries (generally government-sponsored agencies) that pool and repackage loans and sell the participation interest in the form of securities, to investors.  These government-sponsored agencies include Freddie Mac, Ginnie Mae, or Fannie Mae. The underlying pool of mortgages can be comprised of either fixed-rate mortgage loans or adjustable-rate mortgage loans.  The interest rate risk characteristics of the underlying pool of mortgages, i.e., fixed-rate or adjustable rate, are shared by the investors in that pool.
 
During 2010 the Company restructured its investment portfolio by selling 16 bonds, mostly issued by  Freddie Mac (FHLMC) and Fannie Mae (FNMA).   Although these bonds have government guarantees, they are only implied guarantees, hence the bonds are not truly backed by the full faith and credit of the United States.   The bonds sold were replaced with Ginnie Mae (GNMA) bonds, which are supported by the full faith and credit of the United States government. By selling the FNMA and FHLMC bonds the Company was able to accomplish two things:
 
 
·
Reduce its overall credit risk in the investment portfolio.
 
 
·
Improve its risk-based capital position as bonds sold were 20% risk-weighted while the replacement bonds are 0% risk-weighted.
 
The Company concluded this move was prudent and necessary due to the following reasons:
 
 
·
Because of the timing of the restructuring, the Company was able to capture some previously unrealized gains.
 
 
·
The Company did forego a higher yield (approximately 10bps), but was able to minimize the yield loss by buying longer-term GNMA’s, which was possible because of the minimal level of interest-rate risk inherent in the Company’s balance sheet.
 
Our investment policy also permits investment in corporate debt obligations. Although corporate bonds may offer higher yields than U.S. Treasury or agency securities of comparable duration, corporate bonds also have a higher risk of default due to possible adverse changes in the creditworthiness of the issuer.

 
20
 
 
We are required under federal regulations to maintain a minimum amount of liquid assets that may be invested in specified short term securities and certain other investments.  We generally have maintained a portfolio of liquid assets that exceeds regulatory requirements.  Liquidity levels may be increased or decreased depending upon the yields on investment alternatives and upon management’s judgment as to the attractiveness of the yields then available in relation to other opportunities and its expectation of the level of yield that will be available in the future, as well as management’s projections as to the short term demand for funds to be used in our loan origination and other activities.

FASB ASC 320-10 requires that, at the time of purchase, we designate a security as held to maturity, available for sale, or trading, depending on our ability and intent.  Securities available for sale are reported at fair value.  As of December 31, 2010, all of our investment securities were designated as available for sale except for $2.5 million in municipal bond investments designated as held to maturity.

Investment Securities Portfolio.  The following table sets forth the composition of our investment securities portfolio at the dates indicated.

    
At December 31,
  
   
2010
    
2009
    
2008
  
   
Amortized
    
Fair
    
Amortized
    
Fair
    
Amortized
    
Fair
  
   
Cost
    
Value
    
Cost
    
Value
    
Cost
    
Value
  
   
(In Thousands)
  
                                     
Debt Securities:
                                    
U.S. Government and agency obligations
  $ 4,518     $ 4,562     $ 8,220     $ 8,257     $ 5,680     $ 5,768  
State agency and municipal obligations
     7,395       7,641       11,798       12,143       7,942       7,924  
                                                 
Corporate bonds and other obligations
     -       -       1,000       1,002       1,500       1,504  
                                                 
Mortgage-backed securities:
                                                
Pass-through securities:
                                                
Fannie Mae
     296       306       8,579       8,887       9,468       9,733  
Freddie Mac
     1,078       1,095       4,823       4,922       4,419       4,516  
Ginnie Mae
     24,310       24,291       2,577       2,588       164       167  
                                                 
Total debt securities
     37,597       37,895       36,997       37,799       29,173       29,612  
                                                 
Marketable equity securities
    3       1       3       4       3       2  
                                                 
Total equity securities
     3       1       3       4       3       2  
                                                 
Total investment securities
   $ 37,600     $ 37,896     $ 37,000     $ 37,803     $ 29,176     $ 29,614  

Portfolio Maturities and Yields.  The composition and maturities of the investment securities portfolio at December 31, 2010 are summarized in the following table. Maturities are based on the final contractual payment dates, and do not reflect the impact of prepayments or early redemptions that may occur. State and municipal securities yields have not been adjusted to a tax-equivalent basis.

 
21
 
 
    
At December 31, 2010
  
         
More than One Year
    
More than Five Years
              
   
One Year or Less
    
Through Five years
    
Through Ten Years
    
More than Ten Years
    
Total Securities
  
         
Weighted
          
Weighted
          
Weighted
          
Weighted
                
Weighted
  
   
Amortized
    
Average
    
Amortized
    
Average
    
Amortized
    
Average
    
Amortized
    
Average
    
Amortized
    
Fair
    
Average
  
   
Cost
    
Yield
    
Cost
    
Yield
    
Cost
    
Yield
    
Cost
    
Yield
    
Cost
    
Value
    
Yield
  
      (Dollars in Thousands)  
Debt Securities:
                                                                  
U.S. Government and agency securities
   $ 518       5.63 %   $ 2,500       1.75 %   $ 1,500       3.41 %   $ -       0.00 %   $ 4,518     $ 4,562       2.75 %
State agency and municipal obligations
     2,376       4.28 %     2,182       3.89 %     981       4.36 %     1,856       4.73 %     7,395       7,641       4.29 %
                                                                                         
Mortgage-backed securities
                                                                                        
Fannie Mae
     -       0.00 %     -       0.00 %     296       4.50 %     -       0.00 %     296       306       4.50 %
Freddie Mac
     1       6.00 %     1,066       4.36 %     11       1.85 %     -       0.00 %     1,078       1,095       4.33 %
Ginnie Mae
     -       0.00 %     13       5.00 %     96       3.41 %     24,201       4.12 %     24,310       24,291       4.11 %
                                                                                         
Total debt securities
     2,895               5,761               2,884               26,057               37,597       37,895          
                                                                                         
Marketable equity securities:
                                                                                        
Common Stock
     -       0.00 %     -       0.00 %     -       0.00 %     3       0.00 %     3       1       0.00 %
                                                              0.00 %                     0.00 %
Total investment securities
   $ 2,895             $ 5,761             $ 2,884             $ 26,060             $ 37,600     $ 37,896          
 
Sources of Funds

General.  Deposits are the major source of our funds for lending and other investment purposes.  We generate deposits from our eight full-service offices in Alpena, Mio, Cheboygan, Oscoda, Lewiston, Alanson and Gaylord.  In addition to deposits, we derive funds from borrowings, proceeds from the settlement of loan sales, the amortization and prepayment of loans and mortgage-backed securities, the maturity of investment securities, and operations.  Scheduled loan principal repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are influenced significantly by general interest rates and market conditions.  Borrowings are used on a short-term basis to compensate for reductions in the availability of funds from other sources or on a longer term basis for general business purposes.  We currently are managing liquidity levels and loan funding primarily through secondary mortgage market sales and Federal Home Loan Bank advances.

Deposits.  We generate deposits primarily from our market area by offering a broad selection of deposit instruments including NOW accounts, regular savings, money market deposits, term certificate accounts and individual retirement accounts.  Deposit account terms vary according to the minimum balance required, the period of time during which the funds must remain on deposit, and the interest rate, among other factors.  The rate of interest which we must pay is not established by regulatory authority.  The asset/liability committee regularly evaluates our internal cost of funds, surveys rates offered by competing institutions, reviews the cash flow requirements for lending and liquidity, and executes rate changes when deemed appropriate.  We have sought to decrease the risk associated with changes in interest rates by offering competitive rates on some deposit accounts and by pricing certificates of deposit to provide customers with incentives to choose certificates of deposit with longer maturities. We also attract non-interest bearing commercial deposit accounts from our commercial borrowers and offer a competitive non-deposit sweep product that is not insured by the FDIC. In recent periods, we generally have not obtained funds through brokers or through a solicitation of funds outside our market area.  At December 31, 2010 we had no brokered deposits.  We offer a limited amount of certificates of deposit in excess of $100,000 which may have negotiated rates.  Future liquidity needs are expected to be satisfied through the use of Federal Home Loan Bank borrowings as necessary. Management does not generally plan on paying above-market rates on deposit products, although from time-to-time we may do so as liquidity needs dictate.

 
22
 
 
The following table sets forth the distribution of total deposit accounts, by account type, at the dates indicated.
 
    
At December 31,
  
   
2010
    
2009
    
2008
  
               
Weighted
                
Weighted
                
Weighted
  
         
Percent
    
Average
          
Percent
    
Average
          
Percent
    
Average
  
   
Amount
    
of Total
    
Interest Rate
    
Amount
    
of Total
    
Interest Rate
    
Amount
    
of Total
    
Interest Rate
  
                                                       
                                                       
Non-interest-bearing 
   $ 10,349       6.66 %  
NA
     $ 11,074       7.00 %  
NA
     $ 10,410       6.28 %  
NA
  
NOW accounts
     16,935       10.89 %     0.39 %     16,298       10.31 %     0.39 %     14,652       8.84 %     0.33 %
Passbook 
     16,785       10.80 %     0.05 %     15,722       9.95 %     0.05 %     14,857       8.96 %     0.15 %
Money market accounts
     27,172       17.48 %     1.21 %     20,794       13.15 %     1.21 %     19,394       11.70 %     2.66 %
                                                                         
Time deposits that mature:
                                                                        
Less than 12 months
     52,059       33.49 %     2.47 %     60,552       38.30 %     2.47 %     68,753       41.47 %     3.72 %
Within 12-36 months
     24,371       15.68 %     2.79 %     29,739       18.81 %     2.79 %     34,429       20.77 %     3.95 %
Beyond 36 months
     7,795       5.01 %     3.30 %     3,921       2.48 %     3.30 %     3,283       1.98 %     3.78 %
Jumbo
     -       0.00 %     0.00 %     -       0.00 %     0.00 %     -       0.00 %     0.00 %
                                                                         
Total deposits
   $ 155,466       100.00 %     1.89 %   $ 158,100       100.00 %     1.89 %   $ 165,778       100.00 %     2.79 %
 
Time Deposit Rates.  The following table sets forth time deposits classified by rates as of the dates indicated (see Note 7 to our consolidated financial statements contained within Exhibit 13 for a more detailed breakdown by rate range):

   
At December 31,
  
Rate
  
2010
    
2009
    
2008
  
   
(In Thousands)
  
0.50 percent to 0.99 percent
   $ 9,852     $ 5,926     $ -  
1.00 percent to 1.99 percent
     35,119       32,658       8,577  
2.00 percent to 2.99 percent
     26,573       24,116       11,776  
3.00 percent to 3.99 percent
     8,718       15,629       42,403  
4.00 percent to 4.99 percent
     3,488       11,912       38,278  
5.00 percent to 8.99 percent
     475       3,971       5,431  
    $ 84,225     $ 94,212     $ 106,465  

Time Deposit Maturities.  The following table sets forth the amount and maturities of time deposits at December 31, 2010.
 
         
1 - Less
    
2 - Less
    
3 - Less
    
5 years
        
   
Less Than
    
than 2
    
than 3
    
than 5
    
and
        
Rate
  
One Year
    
Years
    
Years
    
Years
    
Greater
    
Total
  
                                     
0.50 percent to 0.99 percent
   $ 6,931     $ 2,921     $ -     $ -     $ -     $ 9,852  
1.00 percent to 1.99 percent
     28,038       6,125       671       271       14       35,119  
2.00 percent to 2.99 percent
     9,952       5,038       3,560       6,045       1,978       26,573  
3.00 percent to 3.99 percent
     4,399       434       1,855       1,460       570       8,718  
4.00 percent to 4.99 percent
     2,272       824       262       46       84       3,488  
5.00 percent to 8.99 percent
     467       -       -       -       8       475  
    $ 52,059     $ 15,342     $ 6,348     $ 7,822     $ 2,654     $ 84,225  
 
As of December 31, 2010, the aggregate amount of outstanding certificates of deposit in amounts greater than or equal to $100,000 was $26.7 million. The following table sets forth the maturity of those certificates as of December 31, 2010.

 
23
 
 
   
Certificates of Deposit
  
Maturity Period
  
in excess of $100,000
  
   
(In thousands)
  
       
Three months or less
   $ 2,900  
Three through six months
     2,607  
Six through twelve months
     11,545  
Over twelve months
     9,650  
         
Total
   $ 26,702  
 
Borrowings.  Our borrowings consist primarily of advances from the Federal Home Loan Bank of Indianapolis.  At December 31, 2010, we had access to additional Federal Home Loan Bank advances of up to $17.8 million, based upon pledged collateral.  The following table sets forth information concerning balances and interest rates on our Federal Home Loan Bank advances and other borrowings at the dates and for the periods indicated.
 
   
Years Ended December 31,
  
   
2010
    
2009
    
2008
  
   
(Dollars in Thousands)
  
                   
Balance at end of period
   $ 29,000     $ 45,031     $ 40,969  
Average balance during period
     38,187       41,782       47,075  
Maximum outstanding at any month end
     45,825       46,750       48,900  
Weighted average interest rate at end of period
     2.23 %     3.13 %     4.22 %
Average interest rate during period
     2.86 %     3.69 %     4.27 %
 
Subsidiary Activity

First Federal of Northern Michigan Bancorp, Inc.’s only direct subsidiary is First Federal of Northern Michigan (the Bank).

First Federal of Northern Michigan (the Bank) has two wholly owned subsidiaries as of December 31, 2010. First Federal of Northern Michigan and these subsidiaries have been consolidated in the financial statements and all inter-company balances and transactions have been eliminated in consolidation.

One subsidiary, Financial Services & Mortgage Corporation, leases, sells, develops and maintains real estate properties. For reporting purposes, Financial Services & Mortgage Corporation is included in our banking segment. As of December 31, 2010, First Federal of Northern Michigan’s investment in Financial Services & Mortgage Corporation was $310,000. The primary asset of the subsidiary is an investment in land and real estate.  See "Real Estate Development Activities.”  At December 31, 2010, Financial Services & Mortgage Corporation owned four developed building sites which were being offered for sale. These lots were sold in January 2011.  Financial Services & Mortgage Corporation is not currently a party to any agreement that is material to First Federal of Northern Michigan Bancorp, Inc. on a consolidated basis.

First Federal of Northern Michigan’s second subsidiary, FFNM Agency, Inc., collects the residual income stream associated with the April 2008 sale of the Company’s  wholesale health insurance override business to a third party. FFNM Agency is the successor company to the InsuranCenter of Alpena (“ICA”). On February 27, 2009, we sold the majority of the assets of ICA. The results of operations of ICA are presented separately in our consolidated financial statements as “discontinued operations.”

Personnel

As of December 31, 2010, First Federal of Northern Michigan had 75 full-time and 19 part-time employees.  None of the Bank's employees is represented by a collective bargaining group.  The Bank believes its relationship with its employees to be good.  First Federal of Northern Michigan Bancorp, Inc., FFNM Agency, Inc. and FSMC have no separate employees.

 
24
 
 
SUPERVISION AND REGULATION

General

As a federally chartered savings bank, First Federal of Northern Michigan is regulated and supervised by the Office of Thrift Supervision and the Federal Deposit Insurance Corporation.  This regulation and supervision establishes a comprehensive framework of activities in which we may engage, and is intended primarily for the protection of the Federal Deposit Insurance Corporation’s deposit insurance funds and depositors.  Under this system of federal regulation, financial institutions are periodically examined to ensure that they satisfy applicable standards with respect to their capital adequacy, assets, management, earnings, liquidity and sensitivity to market interest rates.  After completing an examination, the federal agency critiques the financial institution’s operations and assigns its rating (known as an institution’s CAMELS ratings).  Under federal law, an institution may not disclose its CAMELS rating to the public.  First Federal of Northern Michigan also is a member of, and owns stock in, the Federal Home Loan Bank of Indianapolis, which is one of the twelve regional banks in the Federal Home Loan Bank System.  First Federal of Northern Michigan also is regulated, to a lesser extent, by the Board of Governors of the Federal Reserve System, governing reserves to be maintained against deposits and other matters.  The Office of Thrift Supervision examines First Federal of Northern Michigan and prepares reports for consideration by our board of directors on any operating deficiencies.  First Federal of Northern Michigan’s relationship with our depositors and borrowers also is regulated to a great extent by both federal and state laws, especially in matters concerning the ownership of deposit accounts and the form and content of our loan documents.

There can be no assurance that changes to existing laws, rules and regulations, or any other new laws, rules or regulations, will not be adopted in the future, which could make compliance more difficult or expensive or otherwise adversely affect our business, financial condition or prospects.  Any change in these laws or regulations, or in regulatory policy, whether by the Federal Deposit Insurance Corporation, the Office of Thrift Supervision or Congress, could have a material adverse impact on our business, financial condition or operations.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) made extensive changes in the regulation of federal savings banks such as First Federal of Northern Michigan.  Under the Dodd-Frank Act, the Office of Thrift Supervision will be eliminated.  Responsibility for the supervision and regulation of federal savings banks will be transferred to the Office of the Comptroller of the Currency, which is the agency that is currently primarily responsible for the regulation and supervision of national banks.  The Office of the Comptroller of the Currency will assume responsibility for implementing and enforcing many of the laws and regulations applicable to federal savings banks. The transfer of regulatory functions will take place over a transition period of up to one year from the Dodd-Frank Act enactment date of July 21, 2010, subject to a possible six-month extension.  At the same time, responsibility for the regulation and supervision of savings and loan holding companies, such as First Federal of Northern Michigan Bancorp, Inc. will be transferred to the Federal Reserve Board, which currently supervises bank holding companies.
 
Additionally, the Dodd-Frank Act creates a new Consumer Financial Protection Bureau as an independent bureau of the Federal Reserve Board.  The Consumer Financial Protection Bureau will assume responsibility for the implementation of the federal financial consumer protection and fair lending laws and regulations, a function currently assigned to prudential regulators, and will have authority to impose new requirements.  However, institutions of less than $10 billion in assets, such as First Federal of Northern Michigan, will continue to be examined for compliance with consumer protection and fair lending laws and regulations by, and be subject to the primary enforcement authority of, their prudential regulator rather than the Consumer Financial Protection Bureau.
 
In addition to eliminating the Office of Thrift Supervision and creating the Consumer Financial Protection Bureau, the Dodd-Frank Act, among other things, directs changes in the way that institutions are assessed for deposit insurance, mandates the imposition of consolidated capital requirements on savings and loan holding companies, requires originators of securitized loans to retain a percentage of the risk for the transferred loans, regulatory rate-setting for certain debit card interchange fees, repeals restrictions on the payment of interest on commercial demand deposits and contains a number of reforms related to mortgage originations.  Many of the provisions of the Dodd-Frank Act are subject to delayed effective dates and/or require the issuance of implementing regulations.  Their impact on operations can not yet be fully assessed.  However, there is significant possibility that the Dodd-Frank Act will, at a minimum, result in increased regulatory burden, compliance costs and interest expense for First Federal of Northern Michigan Bancorp, Inc. and First Federal of Northern Michigan.
 
Certain of the regulatory requirements that are applicable to First Federal of Northern Michigan and First Federal of Northern Michigan Bancorp, Inc. are described below. This description of statutes and regulations is not intended to be a complete explanation of such statutes and regulations and their effects on First Federal of Northern Michigan and First Federal of Northern Michigan Bancorp. Inc. and is qualified in its entirety by reference to the actual statutes and regulations.

Federal Banking Regulation

Business Activities.  A federal savings bank derives its lending and investment powers from the Home Owners’ Loan Act, and the regulations of the Office of Thrift Supervision.  Under these laws and regulations, First Federal of Northern Michigan may invest in mortgage loans secured by residential and commercial real estate, commercial business and consumer loans, certain types of debt securities and certain other loans and assets.  First Federal of Northern Michigan also may establish subsidiaries that may engage in activities not otherwise permissible for First Federal of Northern Michigan directly, including real estate investment, securities brokerage and insurance agency services.
 
The Dodd-Frank Act authorizes the payment of interest on business demand deposits effective July 11, 2011.
 
Capital Requirements.  Office of Thrift Supervision regulations require savings banks to meet three minimum capital standards:  a 1.5% tangible capital ratio, a 4% leverage ratio (3% for institutions receiving the highest CAMELS rating) and an 8% risk-based capital ratio.  The prompt corrective action standards discussed below, in effect, establish a minimum 2% tangible capital standard.

The risk-based capital standard for savings banks requires the maintenance of Tier 1 (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100%, assigned by the Office of Thrift Supervision capital regulation based on the risks inherent in the type of asset. Core capital is defined as common stockholders’ equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries, less intangibles other than certain mortgage servicing rights and credit card relationships. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, allowance for loan and lease losses up to a maximum of 1.25% of risk-weighted assets, and up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital.

 
25
 
 
Additionally, a savings association that retains credit risk in connection with an asset sale may be required to maintain regulatory capital because of the recourse back to the savings association. In assessing an institution’s capital adequacy, the OTS takes into consideration not only thee numeric factors but also qualitative factors as well, and has the authority to establish higher capital requirements for individual associations where necessary.
 
At December 31, 2010, First Federal of Northern Michigan’s capital exceeded all applicable requirements. The following table sets forth the Bank’s capital position at December 31, 2010 and 2009, as compared to the minimum capital requirements.
 
   
At December 31,
  
   
2010
    
2009
  
         
Percent
          
Percent
  
   
Amount
    
of Assets
    
Amount
    
of Assets
  
         
(Dollars in Thousands)
  
Equity capital
  $ 22,272       10.4 %   $ 22,119       9.5 %
                                 
Tangible Capital Requirement:
                                
Tangible capital level
    20,931       9.8 %     20,239       8.8 %
Requirement
    3,214       1.5 %     3,470       1.5 %
Excess
    17,717       8.3 %     16,769       7.3 %
                                 
Core Capital Requirement:
                                
Core capital level
    20,931       9.8 %     20,239       8.8 %
Requirement
    8,570       4.0 %     9,255       4.0 %
Excess
    12,361       5.8 %     10,984       4.8 %
                                 
Risk-based Capital Requirement:
                                
Risk-based capital level
    22,763       15.6 %     22,304       13.6 %
Requirement
    11,693       8.0 %     13,153       8.0 %
Excess
    11,070       7.6 %     9,151       5.6 %

Loans to One Borrower.  A federal savings bank generally may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of unimpaired capital and surplus on an unsecured basis.  An additional amount may be loaned, equal to 10% of unimpaired capital and surplus, if the loan is secured by readily marketable collateral, which generally does not include real estate.  As of December 31, 2010, First Federal of Northern Michigan was in compliance with the loans-to-one-borrower limitations.

Qualified Thrift Lender Test. As a federal savings bank, First Federal of Northern Michigan is subject to a qualified thrift lender, or “QTL,” test.  Under the QTL test, First Federal of Northern Michigan must maintain at least 65% of its “portfolio assets” in “qualified thrift investments” in at least nine months of the most recent 12-month period.  “Portfolio assets” generally means total assets of a savings institution, less the sum of specified liquid assets up to 20% of total assets, goodwill and other intangible assets, and the value of property used in the conduct of the institution’s business.

“Qualified thrift investments” include various types of loans made for residential and housing purposes, investments related to such purposes, including certain mortgage-backed and related securities, and loans for personal, family, household and certain other purposes up to a limit of 20% of portfolio assets.  “Qualified thrift investments” also include 100% of an institution’s credit card loans, education loans and small business loans.  First Federal of Northern Michigan also may satisfy the QTL test by qualifying as a “domestic building and loan association” as defined in the Internal Revenue Code of 1986.

A savings bank that fails the QTL test must operate under specified restrictions.  The Dodd-Frank Act made noncompliance with the QTL test potentially subject to agency enforcement action for violation of law.  At December 31, 2010, First Federal of Northern Michigan maintained approximately 85.9% of its portfolio assets in qualified thrift investments, and therefore satisfied the QTL test.
 
 
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Capital Distributions. Office of Thrift Supervision regulations govern capital distributions by a federal savings bank, which include cash dividends, stock repurchases and other transactions charged to the institution’s capital account.  A savings bank must file an application for approval of a capital distribution if:

 
·
the total capital distributions for the applicable calendar year exceed the sum of the savings bank’s net income for that year to date plus the savings bank’s retained net income for the preceding two years;
 
 
·
the savings bank would not be at least adequately capitalized following the distribution;
 
 
·
the distribution would violate any applicable statute, regulation, agreement or Office of Thrift Supervision-imposed condition; or
 
 
·
the savings bank is not eligible for expedited treatment of its filings.
 
Even if an application is not otherwise required, every savings bank that is a subsidiary of a holding company must still file a notice with the Office of Thrift Supervision at least 30 days before the board of directors declares a dividend or approves a capital distribution.

The Office of Thrift Supervision may disapprove a notice or application if:

 
·
the savings bank would be undercapitalized following the distribution;
 
 
·
the proposed capital distribution raises safety and soundness concerns; or
 
 
·
the capital distribution would violate a prohibition contained in any statute, regulation or agreement.
 
In addition, the Federal Deposit Insurance Act provides that an insured depository institution shall not make any capital distribution if after making such distribution the institution would be undercapitalized.
 
Liquidity.  A federal savings bank is required to maintain a sufficient amount of liquid assets to ensure its safe and sound operation.

Community Reinvestment Act and Fair Lending Laws.  All savings banks have a responsibility under the Community Reinvestment Act and related regulations of the Office of Thrift Supervision to help meet the credit needs of their communities, including low- and moderate-income neighborhoods.  In connection with its examination of a federal savings bank, the Office of Thrift Supervision is required to assess the savings bank’s record of compliance with the Community Reinvestment Act.  In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes.  A savings bank’s failure to comply with the provisions of the Community Reinvestment Act could, at a minimum, result in regulatory restrictions on its activities.  The failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions by the Office of Thrift Supervision, as well as other federal regulatory agencies and the Department of Justice.  First Federal of Northern Michigan received an “Outstanding” Community Reinvestment Act rating in its two most recent federal examination.

Transactions with Related Parties.  A federal savings bank’s authority to engage in transactions with its “affiliates” is limited by Office of Thrift Supervision regulations and Regulation W of the Federal Reserve Board, which implements Sections 23A and 23B of the Federal Reserve Act.  The term “affiliates” for these purposes generally means any company that controls or is under common control with an institution.  First Federal of Northern Michigan Bancorp, Inc. and its non-savings institution subsidiaries will be affiliates of First Federal of Northern Michigan.  In general, transactions with affiliates must be on terms that are as favorable to the savings bank as comparable transactions with non-affiliates.  In addition, certain types of these transactions are restricted to an aggregate percentage of the savings bank’s capital.  Collateral in specified amounts must usually be provided by affiliates in order to receive loans from the savings bank.  In addition, Office of Thrift Supervision regulations prohibit a savings bank from lending to any of its affiliates that are engaged in activities that are not permissible for bank holding companies and from purchasing the securities of any affiliate, other than a subsidiary.
 
 
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First Federal of Northern Michigan’s authority to extend credit to its directors, executive officers and 10% stockholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O of the Federal Reserve Board. Among other things, these provisions require that extensions of credit to insiders (i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features, and (ii) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of First Federal of Northern Michigan’s capital.  In addition, extensions of credit in excess of certain limits must be approved by First Federal of Northern Michigan’s board of directors.

Enforcement.  The Office of Thrift Supervision has primary enforcement responsibility over federal savings banks and has the authority to bring enforcement action against all “institution-affiliated parties,” including stockholders, attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an institution.  Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors of the savings bank, receivership, conservatorship or the termination of deposit insurance.  Civil penalties cover a wide range of violations and actions, and range up to $25,000 per day, unless a finding of reckless disregard is made, in which case penalties may be as high as $1 million per day.  The Federal Deposit Insurance Corporation also has the authority to recommend to the Director of the Office of Thrift Supervision that enforcement action be taken with respect to a particular savings bank.  If action is not taken by the Director, the Federal Deposit Insurance Corporation has authority to take action under specified circumstances.
 
The Office of the Comptroller of the Currency will assume the Office of Thrift Supervision’s enforcement authority over federal savings banks as part of the Dodd-Frank restructuring.
 
Standards for Safety and Soundness.  Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions.  These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation, and other operational and managerial standards as the agency deems appropriate.  The federal banking agencies adopted Interagency Guidelines Prescribing Standards for Safety and Soundness to implement the safety and soundness standards required under federal law.  The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired.  The guidelines address internal controls and information systems, internal audit systems, credit underwriting, loan documentation, interest rate risk exposure, asset growth, compensation, fees and benefits.  If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard.  If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to submit a compliance plan.

Prompt Corrective Action Regulations.  Under the prompt corrective action regulations, the Office of Thrift Supervision is required and authorized to take supervisory actions against undercapitalized savings banks. For this purpose, a savings bank is placed in one of the following five categories based on the savings bank’s capital:
 
·
well-capitalized (at least 5% leverage capital, 6% tier 1 risk-based capital and 10% total risk-based capital);
 
 
·
adequately capitalized (at least 4% leverage capital, 4% tier 1 risk-based capital and 8% total risk-based capital);
 
 
·
undercapitalized (less than 3% leverage capital, 4% tier 1 risk-based capital or 8% total risk-based capital);
 
 
·
significantly undercapitalized (less than 3% leverage capital, 3% tier 1 risk-based capital or 6% total risk-based capital); or
 
 
·
critically undercapitalized (less than 2% tangible capital).
 
Generally, the Office of Thrift Supervision is required to appoint a receiver or conservator for a savings bank that is “critically undercapitalized.”  The regulation also provides that a capital restoration plan must be filed with the Office of Thrift Supervision within 45 days of the date a savings bank receives notice that it is “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.”  In addition, numerous mandatory supervisory actions become immediately applicable to the savings bank, including, but not limited to, restrictions on growth, investment activities, capital distributions and affiliate transactions.  The Office of Thrift Supervision may also take any one of a number of discretionary supervisory actions against undercapitalized savings banks, including the issuance of a capital directive and the replacement of senior executive officers and directors.
 
 
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At December 31, 2010, First Federal of Northern Michigan met the criteria for being considered “well-capitalized.”

Insurance of Deposit Accounts. First Federal of Northern Michigan is a member of the Deposit Insurance Fund, which is administered by the FDIC. Deposit accounts at First Federal of Northern Michigan are insured by the FDIC, up to a maximum of $250,000 for each separately insured depositor and for self-directed retirement accounts. That level of coverage was made permanent by the Dodd-Frank Act.  In addition pursuant to the Dodd-Frank Act, certain noninterest-bearing transaction accounts maintained with depository institutions are fully insured regardless of the dollar amount until December 31, 2012.

The FDIC imposes an assessment against all depository institutions for deposit insurance.  That assessment is based on the risk category of the institution and, prior to 2009, ranged from five to 43 basis points of the institution's deposits. On February 27, 2009, the FDIC issued a final rule that altered the way it calculates federal deposit insurance assessment rates beginning in the second quarter of 2009.  Under the rule, the FDIC first establishes an institution's initial base assessment rate according to the institution’s risk classification, which is determined through examination and other supervisory information, this initial base assessment rate ranges, depending on the risk category of the institution, from 12 to 45 basis points. The FDIC then adjusts the initial base assessment (higher or lower) to obtain the total base assessment rate. The adjustments to the initial base assessment rate are based upon an institution's levels of unsecured debt, secured liabilities and brokered deposits. The total base assessment rates, including possible adjustments, range from 7 to 77.5 basis points of the institution's deposits.

On May 22, 2009, the FDIC issued a final rule that, due to stress on the Deposit Insurance Fund, imposed a special five basis point assessment on each FDIC-insured depository institution's assets, minus its Tier 1 capital on June 30, 2009, which was collected on September 30, 2009. The special assessment was capped at 10 basis points of an institution's domestic deposits.  That special assessment for First Federal of Northern Michigan amounted to $108,000.
 
The FDIC subsequently adopted a rule pursuant to which all insured depository institutions were required to prepay their estimated assessments for the fourth quarter of 2009, and for all of 2010, 2011 and 2012.  The estimated prepayment assumed a 5% annual growth rate and a 3 basis point assessment increase in 2011 and 2012.  That pre-payment, which was due on December 30, 2009, amounted to $1.4 million for First Federal of Northern Michigan.  The pre-payment has been recorded as a prepaid expense at December 31. 2009 and will be amortized to expense over three years.
 
Most recently, the Dodd-Frank Act required the FDIC to revise its assessment procedures to base it on average total assets less tangible capital, rather than deposits.  The FDIC has issued a final rule that will implement that directive effective April 1, 2011.
 
In addition to the FDIC assessments, the Financing Corporation (“FICO”) is authorized to impose and collect, with the approval of the FDIC, assessments for anticipated payments, issuance costs and custodial fees on bonds issued by the FICO in the 1980s to recapitalize the former Federal Savings and Loan Insurance Corporation. The bonds issued by the FICO are due to mature in 2017 through 2019. For the quarter ended December 31, 2010, the annualized FICO assessment was equal to 1.04 basis points of domestic deposits maintained at an institution.
 
Insurance of deposits may be terminated by the FDIC upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. We do not currently know of any practice, condition or violation that might lead to termination of our deposit insurance.
 
 
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Prohibitions Against Tying Arrangements.  Federal savings banks are prohibited, subject to some exceptions, from extending credit to or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the savings bank or its affiliates or not obtain services of a competitor of the savings bank.

Federal Home Loan Bank System.  First Federal of Northern Michigan is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks.  The Federal Home Loan Bank System provides a central credit facility primarily for member institutions.  As a member of the Federal Home Loan Bank of Indianapolis, First Federal of Northern Michigan is required to acquire and hold shares of capital stock in the Federal Home Loan Bank in specified amounts.  As of December 31, 2010, First Federal of Northern Michigan was in compliance with this requirement.
 
Other Regulations
 
Interest and other charges collected or contracted for by First Federal of Northern Michigan are subject to state usury laws and federal laws concerning interest rates.  First Federal of Northern Michigan’s operations are also subject to federal laws applicable to credit transactions, such as the:
 
 
·
Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
 
 
·
Home Mortgage Disclosure Act, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
 
 
·
Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
 
 
·
Fair Credit Reporting Act, governing the use and provision of information to credit reporting agencies;
 
 
·
Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;
 
 
·
Truth in Savings Act; and
 
 
·
rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.
 
The operations of First Federal of Northern Michigan also are subject to the:
 
 
·
Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;
 
 
·
Electronic Funds Transfer Act and Regulation E promulgated thereunder, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services;
 
 
·
Check Clearing for the 21st Century Act (also known as “Check 21”), which gives “substitute checks,” such as digital check images and copies made from that image, the same legal standing as the original paper check;
 
 
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·
Title III of The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (referred to as the “USA PATRIOT Act”), which significantly expanded the responsibilities of financial institutions, including savings and loan associations, in preventing the use of the American financial system to fund terrorist activities.  Among other provisions, the USA PATRIOT Act and the related regulations of the OTS require savings associations operating in the United States to develop new anti-money laundering compliance programs, due diligence policies and controls to ensure the detection and reporting of money laundering. Such required compliance programs are intended to supplement existing compliance requirements, also applicable to financial institutions, under the Bank Secrecy Act and the Office of Foreign Assets Control regulations; and
 
 
·
The Gramm-Leach-Bliley Act, which places limitations on the sharing of consumer financial information by financial institutions with unaffiliated third parties. Specifically, the Gramm-Leach-Bliley Act requires all financial institutions offering financial products or services to retail customers to provide such customers with the financial institution’s privacy policy and provide such customers the opportunity to “opt out” of the sharing of certain personal financial information with unaffiliated third parties.
 
Federal Reserve System

Federal Reserve Board regulations require savings banks to maintain non-interest-earning reserves against their transaction accounts, such as negotiable order of withdrawal and regular checking accounts.  At December 31, 2010, First Federal of Northern Michigan was in compliance with these reserve requirements.  The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy liquidity requirements imposed by the Office of Thrift Supervision.
 
The USA PATRIOT Act

The USA PATRIOT Act gives the federal government new powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing and broadened anti-money laundering requirements.  Certain provisions of the Act impose affirmative obligations on a broad range of financial institutions, including federal savings banks, like First Federal of Northern Michigan.  These obligations include enhanced anti-money laundering programs, customer identification programs and regulations relating to private banking accounts or correspondence accounts in the United States for non-United States persons or their representatives (including foreign individuals visiting the United States).

First Federal of Northern Michigan has established policies and procedures to ensure compliance with the USA PATRIOT Act’s provisions, and the impact of the USA PATRIOT Act on our operations has not been material.
 
Holding Company Regulation

First Federal of Northern Michigan Bancorp, Inc. is a unitary savings and loan holding company, subject to regulation and supervision by the Office of Thrift Supervision.  The Office of Thrift Supervision has enforcement authority over First Federal of Northern Michigan Bancorp, Inc. and its non-savings institution subsidiaries.  Among other things, this authority permits the Office of Thrift Supervision to restrict or prohibit activities that are determined to be a risk to First Federal of Northern Michigan.  Pursuant to the Dodd-Frank Act regulatory restructuring, the Office of Thrift Supervision’s jurisdiction over savings and loan holding companies will be transferred to the Federal Reserve Board on July 21, 2011, subject to a possible six month extension.

Under prior law, a unitary savings and loan holding company generally had no regulatory restrictions on the types of business activities in which it could engage, provided that its subsidiary savings association was a qualified thrift lender.  The Gramm-Leach-Bliley Act, however, restricts unitary savings and loan holding companies not existing on, or applied for before, May 4, 1999, to those activities permissible for financial holding companies or for multiple savings and loan holding companies.  First Federal of Northern Michigan Bancorp, Inc. is not a grandfathered unitary savings and loan holding company and, therefore, is limited to the activities permissible for financial holding companies or for multiple savings and loan holding companies.  A financial holding company may engage in activities that are financial in nature, including underwriting equity securities and insurance, incidental to financial activities or complementary to a financial activity.  A multiple savings and loan holding company is generally limited to activities permissible for bank holding companies under Section 4(c)(8) of the Bank Holding Company Act, subject to the prior approval of the Office of Thrift Supervision, and certain additional activities authorized by Office of Thrift Supervision regulations.
 
 
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Federal law prohibits a savings and loan holding company, directly or indirectly, or through one or more subsidiaries, from acquiring control of another savings institution or holding company thereof, without prior written approval of the Office of Thrift Supervision.  It also prohibits the acquisition or retention of, with specified exceptions, more than 5% of the equity securities of a company engaged in activities that are not closely related to banking or financial in nature or acquiring or retaining control of an institution that is not federally insured.  In evaluating applications by holding companies to acquire savings institutions, the Office of Thrift Supervision must consider the financial and managerial resources and future prospects of the savings institution involved, the effect of the acquisition on the risk to the insurance fund, the convenience and needs of the community and competitive factors.
 
Unlike bank holding companies, savings and loan holding companies are not currently subject to specific regulatory capital requirements.  The Dodd-Frank Act, however, requires the Federal Reserve Board to promulgate consolidated capital requirements for depository institution holding companies that are no less stringent, both quantitatively and in terms of components of capital, than those applicable to institutions themselves.  That will eliminate the inclusion of certain instruments from tier 1 capital, such as trust preferred securities, that are currently includable for bank holding companies.  There is a five year transition period from the July 21, 2010 date of enactment of the Dodd-Frank Act before the capital requirements will apply to savings and loan holding companies.  Also, the Federal Reserve Board’s existing consolidated capital requirements for bank holding companies generally do not apply to holding companies of less than $500 million in consolidated assets.  It is possible that a similar approach will be taken toward the savings and loan holding company capital requirements.
 
The Dodd-Frank Act also extends the “source of strength” doctrine to savings and loan holding companies.  The regulatory agencies must promulgate regulations implementing the “source of strength” policy that requires holding companies act as a source of strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of financial stress.
 
Sarbanes-Oxley Act of 2002

The Sarbanes-Oxley Act of 2002 was enacted in response to public concerns regarding corporate accountability. The stated goals of the Sarbanes-Oxley Act are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies, and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The Sarbanes-Oxley Act generally applies to all companies that file or are required to file periodic reports with the SEC, under the Securities Exchange Act of 1934.

The Sarbanes-Oxley Act includes very specific additional disclosure requirements and new corporate governance rules requiring the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules, and mandates further studies of certain issues by the SEC.  The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees.

Federal Securities Laws

First Federal of Northern Michigan Bancorp, Inc.’s common stock is registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934.  First Federal of Northern Michigan Bancorp, Inc. is subject to the information, proxy solicitation, insider trader restrictions and other requirements under the Securities Exchange of 1934.

First Federal of Northern Michigan Bancorp, Inc. common stock held by persons who are affiliates (generally officers, directors and principal stockholders) of First Federal of Northern Michigan Bancorp, Inc. may not be resold without registration or unless sold in accordance with certain resale restrictions.  If First Federal of Northern Michigan Bancorp, Inc. meets specified current public information requirements, each affiliate of First Federal of Northern Michigan Bancorp, Inc. is able to sell in the public market, without registration, a limited number of shares in any three-month period.

TAXATION

Federal Taxation

General.  First Federal of Northern Michigan Bancorp, Inc. and First Federal of Northern Michigan are subject to federal income taxation in the same general manner as other corporations, with some exceptions discussed below.  The following discussion of federal taxation is intended only to summarize material federal income tax matters and is not a comprehensive description of the tax rules applicable to First Federal of Northern Michigan Bancorp, Inc. and First Federal of Northern Michigan.
 
 
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Method of Accounting.  For federal income tax purposes, First Federal of Northern Michigan currently reports its income and expenses on the accrual method of accounting and uses a tax year ending December 31 for filing its consolidated federal income tax returns.  The Small Business Protection Act of 1996 eliminated the use of the reserve method of accounting for bad debt reserves by savings institutions, effective for taxable years beginning after 1995.

Bad Debt Reserves.  Prior to the Small Business Protection Act of 1996, First Federal of Northern Michigan was permitted to establish a reserve for bad debts for tax purposes and to make annual additions to the reserve.  These additions could, within specified formula limits, be deducted in arriving at First Federal of Northern Michigan’s taxable income.  As a result of the Small Business Protection Act, First Federal of Northern Michigan must use the specific charge-off method in computing its bad debt deduction for tax purposes.

Deferred Tax Asset Valuation. The Company records a valuation allowance against its deferred tax assets if it believes, based on available evidence, that it is “more likely than not” that the future tax assets recognized will not be realized before their expiration. Realization of the Company’s deferred tax assets is primarily dependent upon the generation of a sufficient level of future taxable income. At December 31, 2010 the Company had a valuation allowance against its deferred tax assets of $3.2 million.

Taxable Distributions and Recapture.  Prior to the Small Business Protection Act of 1996, bad debt reserves created prior to 1988 were subject to recapture into taxable income if First Federal of Northern Michigan failed to meet certain thrift asset and definitional tests.  The Small Business Protection Act of 1996 eliminated these thrift-related recapture rules.  However, under current law, pre-1988 reserves remain subject to tax recapture should First Federal of Northern Michigan make certain distributions from its tax bad debt reserve or cease to maintain a bank charter.  At December 31, 2010, First Federal of Northern Michigan’s total federal pre-1988 reserve was approximately $60,000.  This reserve reflects the cumulative effects of federal tax deductions by First Federal of Northern Michigan for which    no federal income tax provision has been made.

Minimum Tax.  The Internal Revenue Code of 1986, as amended, imposes an alternative minimum tax at a rate of 20% on a base of regular taxable income plus certain tax preferences (“alternative minimum taxable income” or “AMTI”).  The alternative minimum tax is payable to the extent such AMTI is in excess of an exemption amount.  Net operating losses can, in general, offset no more than 90% of AMTI.  Certain payments of alternative minimum tax may be used as credits against regular tax liabilities in future years. First Federal of Northern Michigan has not been subject to the alternative minimum tax and has no such amounts available as credits for carryover.

Net Operating Loss Carryovers.  A financial institution may carry back net operating losses to the preceding two taxable years and forward to the succeeding 20 taxable years.  At December 31, 2010, First Federal of Northern Michigan had a net operating loss of approximately $7.6 million which it may carry forward for federal income tax purposes.

Corporate Dividends.  We may exclude from our income 100% of dividends received from First Federal of Northern Michigan as a member of the same affiliated group of corporations.

The federal income tax returns of First Federal of Northern Michigan Bancorp, Inc. and its predecessor, Alpena Bancshares, Inc. have not been audited by the Internal Revenue Service in the last five fiscal years.

State and Local Taxation

During 1999, the State of Michigan enacted legislation that resulted in elimination of the Michigan single business tax by gradually phasing it out over the next 23 years.  On August 9, 2006, the Michigan Legislature approved the repeal of the Michigan SBT for tax years beginning after December 31, 2007. The Michigan SBT has been replaced with the Michigan Business Tax (MBT). Financial Institutions are subject to a component of the MBT, the Financial Institutions Tax, which is based on capital rather than taxable earnings.
 
 
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Other applicable state taxes include generally applicable sales, use and real property taxes.

As a Maryland business corporation, First Federal of Northern Michigan Bancorp, Inc. is required to file   annual returns with and pay annual fees to the State of Maryland.

ITEM 1A.               RISK FACTORS

An investment in our common stock involves risk. You should carefully consider the risks described below and all other information contained in this annual report on Form 10-K before you decide to buy our common stock. It is possible that risks and uncertainties not listed below may arise or become material in the future and affect our business.

A Prolonged Economic Downturn, Especially One Affecting Our Geographic Market Area, Could Continue to Materially Affect our Business and Financial Results.

The United States economy entered a recession in the fourth quarter of 2007.  Our principal market area, Northern Michigan, has also experienced an economic downturn, which has been more severe than than in the United States generally. Throughout the course of 2008, 2009 and 2010, economic conditions continued to worsen, due in large part to the fallout from the collapse of the sub-prime mortgage market. While we did not originate or invest in sub-prime mortgages, our lending business is tied, in large part, to the housing market.  Declines in home prices, increases in foreclosures and higher unemployment have adversely affected the credit performance of real estate-related loans, resulting in the write-down of asset values. The continuing housing slump also has resulted in reduced demand for the construction of new housing, further declines in home prices, and increased delinquencies on our construction, residential and commercial mortgage loans. Further, the ongoing concern about the stability of the financial markets in general has caused many lenders to reduce or cease providing funding to borrowers. These conditions may also cause a further reduction in loan demand, and increases in our non-performing assets, net charge-offs and provisions for loan losses.

The Company's success depends primarily on the general economic conditions of the State of Michigan and the specific local markets in which the Company operates. The local economic conditions in these local markets have a significant impact on the demand for the Company’s products and services as well as the ability of the Company’s customers to repay loans, the value of the collateral securing loans and the stability of the Company's deposit funding sources. Economic conditions experienced in the State of Michigan have been more adverse than in the United States generally, and these conditions are not expected to significantly improve in the near future. Unemployment has increased significantly. A further economic downturn or continued weak business environment within Michigan could further negatively impact household and corporate incomes.  A majority of the Company's loans are to individuals and businesses in Michigan. Consequently, any further or prolonged decline in Michigan’s economy could have a materially adverse effect on the Company's financial condition and results of operations. A significant further decline or a prolonged period without improvement in general economic conditions, whether caused by recession, inflation, unemployment, changes in securities markets, acts of terrorism, other international or domestic occurrences or other factors could impact these local economic conditions and, in turn, have a material adverse effect on the Company's financial condition and results of operations.
 
Future Changes in Interest Rates Could Reduce Our Profits.

Our ability to make a profit largely depends on our net interest income, which could be negatively affected by changes in interest rates.  Net interest income is the difference between:
 
 
·
the interest income we earn on our interest-earning assets, such as loans and securities; and

 
·
the interest expense we pay on our interest-bearing liabilities, such as deposits and borrowings.

The rates we earn on our assets and the rates we pay on our liabilities are generally fixed for a contractual period of time. Like many savings institutions, our liabilities generally have shorter contractual maturities than our assets.  This imbalance can create significant earnings volatility, because market interest rates change over time.  In a period of rising interest rates, the interest income earned on our assets may not increase as rapidly as the interest paid on our liabilities.  In a period of declining interest rates, the interest income earned on our assets may decrease more rapidly than the interest paid on our liabilities, as borrowers prepay mortgage loans, and mortgage-backed securities and callable investment securities are called or prepaid thereby requiring us to reinvest those cash flows at lower interest rates.  See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Management of Interest Rate Risk.”
 
 
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In addition, changes in interest rates can affect the average life of loans and mortgage-backed and related securities. A reduction in interest rates results in increased prepayments of loans and mortgage-backed and related securities, as borrowers refinance their debt in order to reduce their borrowing costs. This creates reinvestment risk, which is the risk that we may not be able to reinvest prepayments at rates that are comparable to the rates we earned on the prepaid loans or securities. Additionally, increases in interest rates may decrease loan demand and/or make it more difficult for borrowers to repay adjustable-rate loans.
 
Changes in interest rates also affect the current fair value of our interest-earning securities portfolio. Generally, the value of securities moves inversely with changes in interest rates.  At December 31, 2010, the fair value of our available-for-sale securities portfolio, consisting of agency securities, mortgage-backed securities, corporate debt obligations and municipal obligations, totaled $35.3 million. Unrealized net gains on these available-for-sale securities totaled $221,000 at December 31, 2010 and are reported as a separate component of stockholders’ equity. Decreases in the fair value of securities available for sale in future periods would have an adverse effect on stockholders’ equity.
 
We evaluate interest rate sensitivity using income simulation models that estimate the change in our net interest income over a range of interest rate scenarios. Net income at risk measures the risk of a decline in earnings due to potential short-term and long-term changes in interest rates. At December 31, 2010, the latest date for which such information is available, in the event of an immediate 200 basis point increase in interest rates, the model projects that we would experience a 0.29% decrease in net interest income over the following 24 months, assuming a static balance sheet environment.
 
As a Result of Our Previous Emphasis on Originating Commercial Real Estate and Commercial Business Loans, Our Credit Risk Has and Will Continue to Increase.  Continued Weakness or a Deeper Downturn in the Real Estate Market and Local Economy Could Adversely Affect Our Earnings.

At December 31, 2010, our portfolio of commercial real estate loans totaled $57.7 million, or 36.0% of our total loans, our portfolio of commercial business loans totaled $8.8 million, or 5.5% of our total loans, and our portfolio of commercial construction loans totaled $3.3 million or 2.0% of our total loans. These loans have increased as a percentage of our total loan portfolio in recent years and generally have more risk than one- to four-family residential mortgage loans. Because the repayment of commercial real estate and commercial business loans depends on the successful management and operation of the borrower’s properties or related businesses, repayment of such loans can be affected by adverse conditions in the real estate market or the local economy.  Many of our borrowers also have more than one commercial real estate or commercial business loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to significantly greater risk of loss compared to an adverse development with respect to a one- to four-family residential mortgage loan.  Finally, if we foreclose on a commercial real estate or commercial business loan, our holding period for the collateral, if any, typically is longer than for one- to four-family residential mortgage loans because there are fewer potential purchasers of the collateral. Because we plan to continue to increase our originations of these loans, it may be necessary to increase the level of our allowance for loan losses because of the increased risk characteristics associated with these types of loans. Any such increase to our allowance for loan losses would adversely affect our earnings.
 
We Have Participated in Commercial Real Estate, Residential Real Estate and Construction Loans Secured by Real Estate Located Outside of Michigan, Which Expose Us to Increased Lending Risks.

Beginning in 2007, because of weak market conditions and weak demand for loans in our primary market area, and in an effort to diversify our loan portfolio, we began participating in commercial real estate, residential real estate and construction loans originated by other financial institutions and secured by real estate located outside of Michigan. As of December 31, 2010, $11.7 million of our loans were participations in commercial real estate and construction loans secured by real estate outside of Michigan.  As of December 31, 2010 $1.8 million of these loans were considered non-performing.  Of our $2.1 million in loan charge-offs in 2010, $575,000 were loans secured by real estate located outside of Michigan.  Such loans expose us to increased lending risk because, unlike loans that we originate in our market, we may be unfamiliar with the collateral securing such loans and the market conditions affecting the borrower, and we generally do not have face-to-face contact with the borrowers on such loans.
 
 
35
 
 
If Our Allowance for Loan Losses is Not Sufficient to Cover Actual Loan Losses, Our Earnings Could Decrease.

We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the amount of the allowance for loan losses, we review our loans and our loss and delinquency experience, and we evaluate economic conditions.  If our assumptions are incorrect, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in additions to our allowance. Our allowance for loan losses was 1.77% of total loans and 42.85% of non-performing loans at December 31, 2010, compared to 2.09% of total loans and 31.05% of non-performing loans at December 31, 2009.  Material additions to our allowance could materially decrease our net income.
 
In addition, bank regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory authorities may have a material adverse effect on our financial condition and results of operations.
 
Financial Reform Legislation Recently Enacted by Congress Will, Among Other Things, Eliminate the Office of Thrift Supervision, Tighten Capital Standards, Create a New Consumer Financial Protection Bureau and Result in New Laws and Regulations That Are Expected to Increase Our Costs of Operations.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), will significantly change the current bank regulatory structure and affect the lending, investment, trading and operating activities of financial institutions and their holding companies.  The Dodd-Frank Act will eliminate our current primary federal regulator, the Office of Thrift Supervision, and require the Bank to be regulated by the Office of the Comptroller of the Currency (the primary federal regulator for national banks). The Dodd-Frank Act also authorizes the Board of Governors of the Federal Reserve System to supervise and regulate all savings and loan holding companies, like the Company, in addition to bank holding companies which it currently regulates.  Bank holding companies with assets of less than $500 million are exempt from these capital requirements.  These capital requirements are substantially similar to the capital requirements currently applicable to the Bank, as described in “Supervision and Regulation—Federal Banking Regulation—Capital Requirements.”  The Dodd-Frank Act also requires the Federal Reserve Board to set minimum capital levels for bank holding companies that are as stringent as those required for insured depository institutions, and the components of Tier 1 capital would be restricted to capital instruments that are currently considered to be Tier 1 capital for insured depository institutions.  Under the Dodd-Frank Act, the proceeds of trust preferred securities are excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010 by bank or savings and loan holding companies with less than $15 billion of assets.  Savings and loan holding companies are subject to a five year transition period before the holding company capital requirements will become applicable.  The legislation also establishes a floor for capital of insured depository institutions that cannot be lower than the standards in effect today, and directs the federal banking regulators to implement new leverage and capital requirements within 18 months that take into account off-balance sheet activities and other risks, including risks relating to securitized products and derivatives.

The Dodd-Frank Act also creates a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws.  The Consumer Financial Protection Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions such as the Bank, including the authority to prohibit “unfair, deceptive or abusive” acts and practices.  The Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets.  Banks and savings institutions with $10 billion or less in assets will be examined by their applicable bank regulators.  The new legislation also weakens the federal preemption available for national banks and federal savings associations, and gives state attorneys general the ability to enforce applicable federal consumer protection laws.

In addition, the Dodd-Frank Act will increase stockholder influence over boards of directors by requiring companies to give stockholders a non-binding vote on executive compensation (although the Company will not be subject to this requirement until 2013) and so-called “golden parachute” payments, and by authorizing the Securities and Exchange Commission to promulgate rules that would allow stockholders to nominate and solicit votes for their own candidates using a company’s proxy materials.  The legislation also directs the Federal Reserve Board to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded or not.

It is difficult to predict at this time what impact the new legislation and implementing regulations will have on community banks, including the lending and credit practices of such banks.  Moreover, many of the provisions of the Dodd-Frank Act are not yet in effect, and the legislation requires various federal agencies to promulgate numerous and extensive implementing regulations over the next several years.  Although the substance and scope of these regulations cannot be determined at this time, it is expected that the legislation and implementing regulations, particularly those provisions relating to the new Consumer Financial Protection Bureau and mutual holding company dividend waivers, will increase our operating and compliance costs and restrict our ability to pay dividends, respectively.

Changes in laws and regulations and the cost of regulatory compliance with new laws and regulations may adversely affect our operations and our income.
 
 
36
 
 
Strong Competition Within Our Market Area May Limit Our Growth and Profitability.
 
We face substantial competition in all phases of our operations from a variety of different competitors. Our future growth and success will depend on our ability to compete effectively in this highly competitive environment. We compete for deposits, loans and other financial services with numerous Michigan-based banks, thrifts, credit unions and other financial institutions as well as other entities which provide financial services. Some of these competitors are not subject to the same regulatory restrictions, have advantages of scale due to their size, or have cost advantages due to their tax status.  Our profitability depends upon our continued ability to successfully compete in our market area.  The greater resources and deposit and loan products offered by some of our competitors may limit our ability to increase our interest-earning assets.
    
Our Future Growth May Require Us to Raise Additional Capital in the Future, But That Capital May Not Be Available When It Is Needed.

We are required by regulatory authorities to maintain adequate levels of capital to support our operations. We believe that our current capital levels will satisfy our regulatory requirements for the foreseeable future. We may at some point, however, need to raise additional capital to support our continued growth. Our ability to raise additional capital will depend, in part, on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we may be unable to raise additional capital, if and when needed, on terms acceptable to us, or at all. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired. In addition, if we decide to raise additional equity capital, your interest in our common stock could be diluted.
 
We Have Suspended our Common Stock Cash Dividend.
 
We suspended our quarterly dividend effective for the quarter ended December 31, 2008. We are dependent primarily upon the Bank for our earnings and funds to pay dividends on our common stock. The payment of dividends also is subject to legal and regulatory restrictions. Any reinstatement of dividends in the future will depend, in large part, on the Bank's earnings, capital requirements, financial condition and other factors considered by our Board of Directors.
 
 
37
 
 
ITEM 1B.               UNRESOLVED STAFF COMMENTS

None

ITEM 2.                  PROPERTIES

As of December 31, 2010, First Federal of Northern Michigan owned its main office and all of its branch offices.   The following is a list of our locations:
 
Main Office
  
Main Office – Annex Building
     
100 South Second Avenue
  
123 S Second Ave
Alpena, Michigan 49707
  
Alpena, MI 49707
     
Branch Offices
    
     
300 South Ripley Boulevard
  
2885 South County Road #489
Alpena, Michigan  49707
  
Lewiston, Michigan  49756
     
6232 River Street
  
308 North Morenci
Alanson, Michigan 49706
  
Mio, Michigan  48647
     
101 South Main Street
  
201 North State Street
Cheboygan, Michigan  49721
  
Oscoda, Michigan  48750
     
1000 South Wisconsin
    
Gaylord, Michigan  49735
    
 
ITEM 3.                  LEGAL PROCEEDINGS

The Company and the Bank are periodically involved in claims and lawsuits that are incident to their business.  At December 31, 2010, neither the Company nor the Bank was involved in any claims or lawsuits material to their respective businesses.

ITEM 4.                  REMOVED AND RESERVED
 
 
38
 
 
PART II
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 
(a)
First Federal of Northern Michigan Bancorp, Inc.’s common stock is traded on the Nasdaq Capital Market under the symbol “FFNM.”

As of December 31, 2010 there were 2,884,049 shares of First Federal of Northern Michigan Bancorp, Inc. common stock outstanding. At December 31, 2010, First Federal of Northern Michigan Bancorp, Inc. had approximately 600 stockholders of record. The remaining information required by this item  is incorporated by reference to Exhibit 13, the Company’s Annual Report to Stockholders.

No equity securities were sold during the year ended December 31, 2010 that were not registered under the Securities Act.

 
(b)
Not Applicable

 
(c)
First Federal of Northern Michigan Bancorp, Inc. did not repurchase any of its equity securities  during the quarter ended December 31, 2010.

ITEM 6.
SELECTED FINANCIAL DATA
 
Not required for smaller reporting companies.

ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Information contained in the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations"   is incorporated by reference to Exhibit 13, the Company's Annual Report to Stockholders.

ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not required for smaller reporting companies.

ITEM 8.                  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Information contained in the section captioned “Financial Statements” is incorporated by reference to Exhibit 13, the Company’s Annual Report to Shareholders.

ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None

ITEM 9A.               CONTROLS AND PROCEDURES

 
(a)
Evaluation of Disclosure 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.
 
 
39
 

 
(b)
Management’s Annual Report on Internal Control over Financial Reporting
 
Management of First Federal of Northern Michigan Bancorp, Inc. and subsidiaries (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s system of internal control is designed under the supervision of management, including our Chief Executive Officer and Chief Financial Officer, to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles (“GAAP”).
 
Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures are made only in accordance with the authorization of management and the Board of Directors; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on our financial statements.
 
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections on any evaluation of effectiveness to future periods are subject to the risk that the controls may become inadequate because of changes in conditions or that the degree of compliance with policies and procedures may deteriorate.
 
As of December 31, 2010, management assessed the effectiveness of the Company’s internal control over financial reporting based upon the framework established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based upon its assessment, management believes that the Company’s internal control over financial reporting as of December 31, 2010 is effective using these criteria. This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission applicable to smaller reporting companies that permit the Company to provide only management’s report in this annual report.
 
 
(c)
Changes in Internal Control over Financial Reporting

There has been no change in the Company’s internal control over the financial reporting during the Company’s fourth quarter of fiscal year 2010 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

ITEM 9B.               OTHER INFORMATION

None.
 
PART III

ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS,  AND CORPORATE GOVERNANCE

Information concerning directors and executive officers is incorporated herein by reference from the Company’s Proxy Statement, specifically the section captioned "Proposal I—Election of Directors."

ITEM 11.                EXECUTIVE COMPENSATION

Information concerning executive compensation is incorporated herein by reference from the Company’s Proxy Statement, specifically the section captioned "Proposal I—Election of Directors.”
 
 
40
 
 
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

Information concerning security ownership of certain owners and management is incorporated herein by reference from the Company’s Proxy Statement, specifically the Section captioned “Proposal I – Election of Directors.”

ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

Information concerning relationships and transactions is incorporated herein by reference from the Company's Proxy Statement, specifically the section captioned “Transactions with Certain Related Persons”.
 
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES

Information concerning principal accountant fees and services is incorporated herein by reference to the Company’s Proxy Statement, specifically the section captioned “Proposal II – Ratification of Appointment of Auditors.”
 
PART IV
 
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
  

The exhibits filed as a part of this form 10-K are as follows:
 
3.1
Articles of Incorporation of First Federal of Northern Michigan Bancorp, Inc.*
3.2
Bylaws of First Federal of Northern Michigan Bancorp, Inc.*
4
Form of Common Stock Certificate of First Federal of Northern Michigan Bancorp, Inc.*
10.1
Change in Control Agreements*
10.2
1996 Stock Option Plan*
10.3
1996 Recognition and Retention Plan*
10.4
2006 Stock-Based Incentive Plan**
13
Annual Report to Shareholders
14
Code of Ethics ***
21 
Subsidiaries of Registrant
23 
Consent of Plante & Moran PLLC
31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 
Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 
Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 

*
Incorporated by reference to the Registration Statement on Form SB-2 of First Federal of Northern Michigan Bancorp, Inc. (Registration No. 333-121178), originally filed with the Commission on December 10, 2004.
**
Incorporate by reference to the Definitive Proxy materials filed on April 10, 2006 (No. 000-31957).
***
Incorporated by reference to the Annual Report on Form 10-K of Alpena Bancshares, Inc. filed with the Commission on March 30, 2004 (Registration No. 000-31957).
 
 
41
 
 
SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
 
 
By:  
/s/Michael W. Mahler
   
Michael W. Mahler
   
Chief Executive Officer
     
   
Date:  March 25, 2011

Pursuant to the requirements of the Securities Exchange of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
 
By:
/s/Michael W. Mahler
By:  
/s/Amy E. Essex
 
Michael W. Mahler, Director and
  
Amy E. Essex, Chief Financial Officer, Treasurer and
 
Chief Executive Officer
  
Corporate Secretary
 
(Principal Executive Officer)
  
(Principal Financial and Accounting Officer)
Date:   March 25, 2011
  
Date:  March 25, 2011

By:
/s/Martin A. Thomson
By:  
/s/Keith Wallace
 
Martin A. Thomson, Chairman
  
Keith Wallace, Director
       
Date:  March 25, 2011
  
Date:  March 25, 2011

By:
/s/GaryVanMassenhove
By:  
/s/Thomas R. Townsend
 
Gary VanMassenhove, Director
  
Thomas R. Townsend, Director
     
Date:  March 25, 2011
  
Date:  March 25, 2011

By:
/s/James C. Rapin
 
James C. Rapin, Director
   
Date:  March 25, 2011
 
 
42
 
EX-13 2 v215653_ex13.htm Unassociated Document

EXBIT 13

2010 ANNUAL REPORT TO STOCKHOLDERS

 
 
 

FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.

2010

ANNUAL REPORT

March 25, 2011

 
 
 


Dear Fellow Shareholder,

What a difference a year makes!  A year ago we were coming off the most challenging year in the history of the First Federal of Northern Michigan.  While we were confident a year ago that the worst was behind us and that 2010 would be a turn-around year, it remained to be seen.  Fast forward to today.  The core profitability of the Bank has never been stronger.  The profitability in 2010 was driven by fundamental changes that began in late 2007.  Consider that in 2010 we were able to produce income and still absorb inflated levels of expense related to both collection actions and the onerous costs of Bank-owned properties and their disposition.  In line with our expectations, we saw marked improvement in our asset quality metrics in 2010, which resulted in dramatically lower loan loss reserve requirements in 2010 when compared to the years of 2007 through 2009.  I am not suggesting that we are ready to start patting ourselves on the back for a job well done, but we have made excellent progress and it began to prove itself out in 2010.  Turning around a thousand foot vessel (with reference to the large Great Lakes freighters that we often see in this part of the world) takes a lot of work and time.  For us this is an apt analogy.  We began to turn in a different direction in 2007 when we grew concerned about the housing bubble and the economic outlook.  Our focus since then has not been misguided.  The changes have started to produce meaningful improvements to the core profitability of our Bank.  The improvements to the earnings profile which have taken place over the last few years are centered around the four focus areas that were delineated in last year’s shareholder letter.  They included:

Ø Rehabilitating or liquidating non-performing assets;
  
Ø Increasing our net interest margin (NIM);
Ø Growing non-interest income;
  
Ø Reducing controllable expenses.

Non-Performing Assets (NPAs)
This was an area of focus because stock price and the level of NPAs are inversely related.  Reducing NPAs would improve earnings thereby helping our stock price.  Among the key NPA measures is the Texas Ratio which is the relationship between NPAs and the Bank’s tangible capital plus allowance for loan losses.  Our level of NPAs and Texas Ratio decreased from $15.4 million and 64.29%, respectively, at the start of the year to $9.4 million and 39.66% at the end of the year.  For the 131 Michigan banks, the mean Texas Ratio was 44.18% (as of December 31, 2010).  We made great progress on this initiative in 2010.

Net Interest Margin (NIM)
We finished 2009 with a NIM for the year of 3.26%.  For 2010, our NIM rose to 3.78%.  This was a 52 basis point improvement year over year.  When added to the 33 basis point improvement from 2008 to 2009, that is an 85 basis point improvement since the start of 2009.  This was accomplished by changing the mix of our deposits and increasing our core deposits by $11.0 million over the last two years.  In addition, we successfully established floors on our variable rate loans as they were rewritten at maturity.  For the 4th quarter of 2010 our NIM was 3.93%.  We are starting 2011 with a margin near 4.00%. As an institution, our margin has never been higher. This improvement will result in more sustainable levels of profitability for quarters to come.

Non-Interest Income
The Bank has continued to leverage a core competency in this historically low interest rate environment.  In 2010 we originated $47.8 million in mortgage loans (average loan size $105,000), as compared to 2009 mortgage production of $58.9 million.  However, while production levels were 20% lower in 2010 with many homeowners having already refinanced in 2009, we experienced a slight increase in mortgage-related fees and income which was the result of setting and achieving higher gain on sale requirements.  More importantly, we refinanced many loans originated at competitive banks and credit unions, thereby improving our market share in several markets.

Reducing Controllable Expenses
In spite of deep cuts in 2008 and 2009, we continued to focus on controlling the expenses where we have direct control, including employment, professional services and occupancy-related costs.  In 2010 we reduced these expenses by $152,800. These reductions partially offset inflated 2010 costs related to collection activities, reduced real estate values and other expenses related to taking back or owning real estate.

There are still challenges that lie ahead.  Commercial loan demand is weak; our planned growth in 2011 will come at the expense of our competition.  The commercial real estate (CRE) sector is still depressed with inventory levels of unsold commercial properties exceeding the demand of buyers.  It may take years before all of the unsold properties are reabsorbed productively into the marketplace.  On the mortgage side, there are a large number of households that have kept their mortgages paid current through unemployment benefits which are now exhausted.  Any movement of this group toward delinquency could potentially stall or delay the recovery in the housing sector and the economy.  Lastly, government reform in the wake of a financial crisis we did nothing to create will unfairly burden the Bank by heaping new regulatory costs upon us while limiting fees we can charge to consumers for the services and products we provide to them.
 
 
 
 

In spite of these forward-looking challenges, the Board, senior management and I are pleased with where we are today and the progress we made in 2010.  Our results reflect process improvements and a disciplined approach that began four years ago.  We are encouraged that only a single commercial loan (with a balance of $9,400) that we have underwritten since 2008 has been charged off.  Our philosophy with regard to balance sheet diversification and underwriting changes has helped keep our problems contained.  Our performance metrics are trending in a manner consistent with our expectations.  The changes we have made and progress achieved are important in our continued efforts to build accountability, confidence and to restore the value that has been lost.  We have navigated through one of the most challenging economic periods since the Great Depression and have come through not only as a survivor but poised to take advantage of this unique operating environment.  While we still expect that the hard-to-control collection and Bank-owned property expenses will continue, at reduced levels, into the foreseeable future, the improved profitability profile of the Bank better positions us to absorb these inflated and hard-to-control expenses.  We have a strong capital position, are not tethered by TARP strings, and have established a much better framework to operate from as we move ahead.  In 2011 and beyond we will look to build upon the momentum that was created in 2010.

Michael W. Mahler
President and Chief Executive Officer
 
 
 
 

Selected Consolidated Financial and Other Data of the Company

Set forth below are selected financial and other data of First Federal of Northern Michigan Bancorp, Inc. (the “Company”). This information is derived in part from and should be read in conjunction with the Consolidated Financial Statements of the Company and the notes thereto presented elsewhere in this Annual Report. The information at December 31, 2010 and December 31, 2009 and for the years ended December 31, 2010 and 2009 is derived in part from the audited consolidated financial statements of the Company that appear in this Annual Report. The information for the years ended December 31, 2008, 2007, and 2006 is derived in part from audited consolidated financial statements that do not appear in this Annual Report.

Financial condition data:
                              
   
For Years Ended December 31,
  
   
2010
    
2009
    
2008
    
2007
    
2006
  
   
(In thousands)
  
Total assets
   $ 215,733     $ 233,506     $ 247,672     $ 250,831     $ 280,959  
Loans receivable, net
     157,144       171,219       192,270       201,333       209,518  
Loans held for sale
     -       52       107       -       72  
Investment securities
     37,821       37,641       29,687       23,451       44,850  
Cash and cash equivalents
     1,963       3,099       3,471       5,341       4,993  
Deposits
     155,466       158,100       165,778       157,833       170,530  
FHLB advances and note payable
     29,000       45,031       40,969       52,684       66,042  
Repo Sweep agreements
     6,172       5,408       9,447       6,637       6,528  
Stockholders' equity
     23,236       23,052       29,419       32,503       35,453  
                                         
Operating data:
                                        
   
At December 31,
  
   
2010
    
2009
    
2008
    
2007
    
2006
  
   
(In thousands)
  
Interest income
   $ 11,447     $ 12,442     $ 13,967     $ 16,200     $ 17,170  
Interest expense
     3,447       5,088       7,130       8,437       8,548  
                                         
Net interest income
     8,000       7,354       6,837       7,763       8,622  
Provision for loan losses
     1,101       6,196       4,421       2,377       851  
                                         
Net interest income after provision for loan losses
     6,899       1,158       2,416       5,386       7,771  
Other income (loss):
                                        
Service charges and fees
     804       869       942       911       1,044  
Mortgage banking activities
     1,438       1,414       432       418       344  
Net gain (loss) on sale of investment securities
     546       -       6       (97 )     (45 )
Gain (loss) on sale of real estate
     (43 )     20       22       (40 )     4  
Other non-interest income
     301       102       95       64       103  
Insurance & brokerage commissions
     159       170       180       180       180  
                                         
Total other income
     3,205       2,575       1,677       1,436       1,630  
Other expenses
     9,866       9,360       8,874       9,313       8,761  
                                         
Income (loss) from continuing operations before income tax expense (benefit)
     238       (5,627 )     (4,781 )     (2,491 )     640  
Income tax expense (benefit) from continuing operations
     -       1,090       (1,601 )     (908 )     164  
Net income (loss) from continuing operations
     238       (6,717 )     (3,180 )     (1,583 )     476  
Loss from discontinued operations, net of tax benefit
     -       (46 )     (61 )     (17 )     (13 )
Net income (loss)
   $ 238     $ (6,763 )   $ (3,241 )   $ (1,600 )   $ 463  
 
 
 
 

Key Financial Ratios and Other Data:
                              
   
For Years Ended December 31,
  
   
2010
    
2009
    
2008
    
2007
    
2006
  
Performance Ratios:
                              
                               
Return on average assets
     0.10 %     -2.80 %     -1.30 %     -0.60 %     0.16 %
Return on average equity
     0.99 %     -23.21 %     -10.05 %     -4.84 %     1.35 %
Average interest rate spread
     3.60 %     2.97 %     2.51 %     2.68 %     2.83 %
Dividend payout ratio
     0.00 %     0.00 %     N/M ***     N/M ***     133.33 %
Dividends per share
   $ 0.00     $ 0.00     $ 0.15     $ 0.20     $ 0.20  
Net interest margin
     3.78 %     3.26 %     2.93 %     3.13 %     3.24 %
Efficiency ratio (Bank)
     102.76 %     252.19 %     104.54 %     101.18 %     89.37 %
Non-interest expense to average total assets
     4.33 %     3.88 %     3.56 %     4.45 %     4.04 %
Average interest-earning assets to average interest-bearing liabilities
     111.20 %     113.32 %     113.85 %     113.65 %     112.99 %
                                         
Asset Quality Ratios:
                                        
                                         
Non-performing assets to total assets
     4.37 %     6.58 %     5.57 %     4.15 %     1.59 %
Non-performing loans to total loans
     4.13 %     6.73 %     6.14 %     4.54 %     1.90 %
Allowance for loan losses to nonperforming loans
     42.85 %     31.05 %     46.41 %     43.93 %     52.24 %
Allowance for loan losses to total loans
     1.77 %     2.09 %     2.85 %     1.95 %     0.98 %
                                         
Capital Ratios:
                                        
                                         
Equity to total assets at end of period
     10.77 %     9.87 %     11.88 %     12.96 %     12.62 %
Average equity to average assets
     10.47 %     12.07 %     12.44 %     12.38 %     12.07 %
Risk-based capital ratio (Bank only)
     15.57 %     13.58 %     15.75 %     16.27 %     17.07 %
                                         
Other Data:
                                        
Number of full service offices
     8       8       8       9 **     10 *

*as of December 31, 2006. In February 2007, the Bank closed a branch to reduce its full-service offices to 9.
**as of December 31, 2007. In February 2008, the Bank closed a branch to reduce its full-service offices to 8.
***Not meaningful

 
 
 

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview
 
First Federal of Northern Michigan (the “Bank”), the Company’s principal operating subsidiary, is a full-service, community-oriented savings bank whose primary lending activity is the origination of one- to four-family residential real estate mortgages, commercial real estate loans, commercial loans and consumer loans.  As of December 31, 2010, $71.7 million, or 44.8%, of our total loan portfolio consisted of one- to four-family residential real estate loans, $61.0 million, or 38.0%, and $8.8 million, or 5.5%, of our total loan portfolio consisted of commercial mortgage loans and commercial loans, respectively, and $18.7 million, or 11.7%, of our total loan portfolio consisted of consumer and other loans. In recent years, commercial mortgage loans and commercial loans have grown as a percentage of our loan portfolio for three reasons. First, we have increased our emphasis on originating these loans, which generally have higher interest rates compared to one- to four-family residential real estate loans.  In addition, most of these loans are originated with adjustable interest rates, which assist us in managing interest rate risk. Finally, most of our one- to four-family residential mortgage loan customers prefer fixed-rate loans in the low interest rate environment that has prevailed over the last several years. Since we sell into the secondary mortgage market a majority of the fixed-rate one- to four-family residential mortgage loans that we originate, one- to four-family residential real estate loans have decreased as a percentage of our total loan portfolio.

Our results of operations depend primarily on our net interest income, which is the difference between the  interest income we receive on our interest-earning assets, such as loans and securities, and the interest expense we pay on our deposits and borrowings.  Our results of operations are also affected by non-interest income and non-interest expense, the provision for loan losses and income tax expense.  Non-interest income consists primarily of banking fees, service charges, insurance commissions, mortgage banking activities and security transactions.  Our non-interest expense consists primarily of salaries and employee benefits, FDIC insurance premiums, occupancy and office expenses, advertising and promotion expense, data processing expenses and expenses related to troubled credits and repossessed properties.

 Our results of operations are significantly affected by general economic and competitive conditions, and particularly changes in market interest rates, government policies and actions of regulatory authorities.  Numerous factors that are beyond our control can cause market interest rates to increase or decline.  In addition, we are unable to predict future changes in government policies and actions of regulatory authorities that could have a material impact on our financial performance.  As a result, we believe that changes in market interest rates, government policies and actions of regulatory authorities represent the primary uncertainties in predicting our future performance.
 
Business Strategy
 
Operating as a Community Savings Bank.  We are committed to meeting the financial needs of the communities in which we operate. Our branch network of eight offices enhances our ability to serve these communities. We provide a broad range of individualized consumer and business financial services.  We believe that we can be more effective in servicing our customers than many of our non-local competitors because our employees and senior management are able to respond promptly to customer needs and inquiries.  Our ability to provide these services is enhanced by the experience of our senior management, which has an average of 19 years’ experience in the financial services industry.

Increasing Our Commercial Real Estate and Commercial Lending.  Beginning in 2001, we began to increase our originations of commercial real estate and commercial loans. At December 31, 2010, loans secured by commercial real estate totaled $61.0 million, or 38.0% of our total loan portfolio, and commercial loans totaled $8.8 million, or 5.5% of our total loan portfolio. Commercial real estate and commercial loans generally are originated with higher interest rates compared to one- to four-family residential real estate loans and, therefore, have a positive effect on our net interest rate spread and net interest income.  In addition, most of these loans are originated with adjustable interest rates, which assists us in managing interest rate risk.  We believe that our branch network will enable us to continue to increase our commercial and commercial real estate loan portfolio without significant additional fixed costs.  As market conditions allow, we will continue to originate these types of loans in the future to viable borrowers and retain them in our portfolio. However, in 2011, in light of the continued difficult operating environment in our market area, we expect our focus will continue to be more on credit quality than on origination of new loans.  In 2007 we began participating, on a limited basis, in commercial opportunities outside of our market areas and, in some cases, outside of the State or Michigan to help mitigate the geographic risk of lending only in Michigan. We had no new out-of-state commercial participations in 2010.
 
 
 
 

Increasing Our Share of Lower-Cost Deposits.   In past years our cost of funds has been relatively high as we accepted higher-cost long-term certificates of deposit to fund our long-term assets such as one- to four-family residential mortgage loans. As we have increased our origination of shorter-term commercial real estate and commercial loans, most of which are originated with adjustable interest rates, we have decreased our need for higher-cost long-term certificates of deposit. We intend to continue to lower our cost of funds by increasing our share of lower-cost short-term certificates of deposit and lower-cost money market deposits. We typically are not a market leader in deposit rates, although from time-to-time we do offer higher rates as liquidity needs dictate. We also intend to continue to market our non-interest-bearing checking accounts in conjunction with our focus on commercial business lending.  We grew our core deposits by $7.5 million in 2010.

Maintaining High Asset Quality and Capital Strength.  We are committed to conservative loan underwriting standards and procedures, and we primarily originate loans secured by real estate.  As a result, we have historically experienced low levels of late payments and losses on loans. However, during the economic recession that continued to deepen in 2009 and 2010, we have seen delinquency trends increase despite our conservative underwriting practices due to declining economic conditions and increasing unemployment in our market area. Despite the increase in delinquency trends, at December 31, 2010, our ratio of non-performing assets to total assets was 4.37% as compared to 6.58% at December 31, 2009.  At December 31, 2010, our ratio of equity to assets was 10.77%.  Despite losses over the years from 2007 to 2009, our Bank has regulatory capital at levels in excess of regulatory requirements and is categorized as “well capitalized.”

Managing Our Interest Rate Risk Exposure by Selling Fixed-Rate Residential Real Estate Loans.  Historically, most borrowers have preferred long-term, fixed-rate residential real estate loans when, as now, market interest rates are at relatively low levels.  These loans expose us to interest rate risk because our liabilities, consisting primarily of deposits, have relatively short maturities.  In order to better match the maturities of our loan portfolio to the maturities of our deposits in the current low interest rate environment, we have sold substantially all of the fixed-rate, one- to four-family residential real estate loans with maturities of 15 years or more that we have originated since 2002, and we intend to continue this practice for so long as interest rates remain at relatively low levels.
 
Comparison of Financial Condition at December 31, 2010 and 2009

Total assets decreased $17.8 million, or 7.6%, to $215.7 million at December 31, 2010 from $233.5 million at December 31, 2009.  Net loans decreased $14.1 million, or 8.2% to $157.1 million at December 31, 2010 from $171.2 million at December 31, 2009.  Mortgage loan originations decreased by $11.1 million to $47.8 million in 2010 from $58.9 million in 2009. During that time period, our mortgage loan portfolio decreased $9.9 million, or 12.2%, to $71.7 million. The decrease in the portfolio was due to our continued focus on selling lower rate mortgage loans into the secondary market where possible. The commercial loan portfolio decreased 3.2% to $69.9 million at December 31, 2010 from $72.2 million at December 31, 2009 due in part to normal principal pay downs but also to net commercial loan charge-offs of $1.4 million in 2010.   Cash and cash equivalents decreased by $1.1 million, or 35.5%, to $2.0 million at December 31, 2010 from $3.1 million at December 31, 2009.  Investment securities increased $180,000, or 0.5%, to $37.8 million at December 31, 2010 from $37.6 million at December 31, 2009.

Deposits decreased $2.6 million, or 1.7%, to $155.5 million at December 31, 2010 from $158.1 million at December 31, 2009. This decrease was due in large part to our “liquid” certificate of deposit accounts. As these deposits matured and were set to reprice lower, some moved into our money market product, but some left the Bank.   Our focus in 2010 continued to be on building deposit relationships rather than attracting higher-cost non-core certificate of deposit accounts, although from time-to-time we offered higher rates as liquidity needs dictated.  REPO Sweep accounts increased $764,000, or 14.1% to $6.2 million at December 31, 2010 from $5.4 million at December 31, 2009. Borrowings, consisting primarily of FHLB advances, decreased $16.0 million, or 35.6%, to $29.0 million at December 31, 2010 from $45.0 million at December 31, 2009 as our asset base decreased over that same time period..

Stockholders’ equity increased $184,000, or 0.8%, to $23.2 million at December 31, 2010 from $23.1 million   at December 31, 2009.   The increase was mainly a result of our net income for the year of $238,000.
 
 
 
 

Comparison of Operating Results for the Years Ended December 31, 2010 and 2009
 
General.  Net income from continuing operations increased to $238,000 for the year ended December 31, 2010 from a loss of $6.7 million for the year ended December 31, 2009. Net interest income before provision for loan losses was $646,000 higher in 2010 than in 2009, due in large part to our increased net interest margin year over year. The provision for loan losses was $5.1 million lower in 2010 than in 2009, resulting in net interest income after provision for loan losses which was $5.7 million higher in 2010 than in 2009. Non-interest income related to continuing operations was $630,000 higher in 2010 than in 2009. Non-interest expenses related to continuing operations were $506,000 higher in 2010 than in 2009 due in large part to a continued decline in market values on real estate owned.

Interest Income.  Interest income decreased by $995,000, or 8.0%, to $11.4 million for the year ended December 31, 2010 from $12.4 million for the year ended December 31, 2009.  The decrease was primarily due to a decrease in the average balance of our loan portfolio of $20.4 million, or 10.8%, year over year.  The average balance of our non-mortgage loans, principally commercial loans and consumer loans, decreased by $11.7 million, or 11.3%, to $91.5 million for the twelve months ended December 31, 2010 from $103.1 million for the twelve months ended December 31, 2009. The average yield on our commercial loans increased 40 basis points and the average yield on our consumer loans decreased 17 basis points from 2009 to 2010. The average balance of our one- to four-family residential mortgage loans decreased to $77.3 million for the year ended December 31, 2010 from $86.0 million for the year ended December 31, 2009, while the average yield on such loans decreased slightly to 6.22% from 6.25%.

Interest Expense.  Interest expense decreased to $3.4 million for the year ended December 31, 2010 from $5.1 million for the year ended December 31, 2009, due primarily to an  $8.9 million, or 4.5%, decrease in the average balance of interest bearing liabilities. The average balance of interest-bearing deposits decreased by $4.2 million from 2009 to 2010, while the average cost of those deposits decreased 73 basis points to 1.58% for 2010 from 2.31% for 2009, reflecting a continued decline in market interest rates during 2010. The average balance of   FHLB borrowings decreased $3.6 million from 2009 to 2010 while the cost of those borrowings decreased from 3.79% to 2.90% year over year.  During 2010 certain high-cost FHLB bank advances matured and were paid off with available cash, leaving a balance of lower costing advances.  The average balance of REPO Sweep accounts decreased $1.1 million year over year, while the average cost of these accounts increased 9 basis points from 0.38% for 2009 to 0.47% for 2010.

Net Interest Income.  Net interest income increased to $8.0 million for the year ended December 31, 2010 from $7.4 million for the year ended December 31, 2009.  The increase was primarily due to an increase of 63 basis points in our average interest rate spread to 3.60% for the year ended December 31, 2010 from 2.97% for the year ended December 31, 2009.

Provision for Loan Losses.  We recorded a provision for loan losses of $1.1 million for the year ended December 31, 2010 compared to a provision of $6.2 million for the year ended December 31, 2009.  We had net charge-offs of $1.9 million and $8.2 million during 2010 and 2009, respectively.  The decrease from 2009 to 2010 was reflective of the decline in our non-performing loans.  The allowance for loan losses was $2.8 million, or 1.77% of total loans at December 31, 2010, compared to $3.7 million, or 2.09% of total loans at December 31, 2009.  The level of the allowance is based on estimates, and ultimate losses may vary from estimates.  Total non-performing loans were $6.6 million at December 31, 2010 and $11.8 million at December 31, 2009. Management has developed an aggressive plan for 2011 and beyond designed to continue to reduce the level of non-performing loans and other non-performing assets.

Non-Interest Income.  Non-interest income related to continuing operations increased to $3.2 million for the year ended December 31, 2010 from $2.6 million for the year ended December 31, 2009.  This increase was primarily the result of an increase of $545,000 in gain on sale of investment securities to $546,000 for the year ended December 31, 2010 as compared to $1,000 for the year ended December 31, 2009. Service charges and other fees decreased $65,000 from $869,000 in 2009 to $804,000 in 2010, due in large part to a decrease in insufficient funds fees, which we expect to continue into 2011 due to regulatory changes relating to overdraft fees.

Non-Interest Expense.  Non-interest expense related to continuing operations increased to $9.9 million for the year ended December 31, 2010 from $9.4 million for the year ended December 31, 2009. FDIC premiums decreased  $114,000 to $366,000 in 2010 from $480,000 in 2009, due in part to a decrease in deposits year over year and in part to an FDIC special assessment of $108,0000 paid during 2009. Other expense increased $755,000 to $2.5 million in 2010 from $1.7 million in 2009, due mainly to increased expenses associated with our real estate owned, including costs to repossess and repair properties and declines in the market value of many of these properties due to continued declining real estate market values in  2010.   Professional fees decreased by $53,000 to $425,000 for the year ended December 31, 2010 from $478,000 for the year ended December 31, 2009 due in part to non-recurring fees incurred during 2009.

Income Taxes.  Federal income taxes related to losses from continuing operations decreased to an expense of  $0 for the year ended December 31, 2010 from $1.1 million for the year ended December 31, 2009.

 
 
 
  
Average Balance Sheet

The following tables set forth average balance sheets, average yields and costs, and certain other information for the periods indicated.  No tax-equivalent yield adjustments were made, as the effect thereof was not material.  All average balances are daily average balances.  Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield.  The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.
 
         
Average Consolidated Statements of Condition
        
         
For Years Ended December 31,
        
   
As of December 31, 2010
    
2010
    
2009
    
2008
  
                           
Average
                
Average
                
Average
  
         
Yield /
    
Average
          
Yield /
    
Average
          
Yield /
    
Average
          
Yield /
  
   
Balance
    
Rate
    
Balance
    
Interest
    
Rate
    
Balance
    
Interest
    
Rate
    
Balance
    
Interest
    
Rate
  
               
(In thousands)
    
(In thousands)
    
(In thousands)
  
Interest-earning assets:
                                                                  
Mortgage loans
               $ 77,280     $ 4,806           $ 86,015     $ 5,372           $ 94,787     $ 5,969        
Non-mortgage loans
                 91,470       5,327             103,134       5,732             104,983       6,619        
Loans
   $ 157,144       5.83 %     168,750       10,133       6.00 %     189,149       11,104       5.87 %     199,770       12,588       6.30 %
Mortgage-backed securities
     25,684       2.65 %     18,973       648       3.42 %     13,714       577       4.21 %     10,071       421       4.18 %
Other Investment securities
     12,137       3.43 %     16,940       568       3.35 %     18,316       646       3.53 %     16,423       671       4.09 %
Investment securities
     37,821       2.89 %     35,913       1,216       3.39 %     32,030       1,223       3.82 %     26,494       1,092       4.12 %
Other investments
     4,826       1.47 %     7,151       98       1.37 %     4,784       115       2.40 %     8,387       297       3.54 %
Total interest earning assets
     199,791       5.17 %     211,814       11,447       5.41 %     225,963       12,442       5.51 %     234,651       13,967       5.95 %
                                                                                         
Non Interest Earning Assets
     15,942               15,809                       15,417                       14,709                  
Total Assets
   $ 215,733             $ 227,623                     $ 241,380                     $ 249,360                  
                                                                                         
Interest bearing liabilities:
                                                                                        
Savings Deposits
   $ 16,785       0.05 %   $ 16,053     $ 8       0.06 %   $ 15,123     $ 17       0.12 %   $ 15,071     $ 25       0.18 %
Money market/NOW accounts
     44,107       0.46 %     41,845       324       0.76 %     36,558       384       1.04 %     28,889       415       1.43 %
Certificates of deposit
     84,225       1.94 %     88,379       1,964       2.22 %     98,772       3,056       3.09 %     107,213       4,457       4.16 %
Total Interest bearing deposits
     145,117       1.27 %     146,277     $ 2,296       1.57 %     150,453     $ 3,457       2.30 %     151,173     $ 4,897       3.24 %
Borrowed funds
     35,172       2.00 %     44,211       1,151       2.60 %     48,942       1,631       3.33 %     55,104       2,233       4.05 %
Total Interest bearing liabilities
     180,289       1.41 %     190,488       3,447       1.81 %     199,395       5,088       2.55 %     206,277       7,130       3.44 %
                                                                                         
Non interest bearing liabilities
     12,208               13,312                       12,848                       10,849                  
                                                                                         
Total liabilities
     192,497               203,800                       212,243                       217,126                  
Stockholders' equity
     23,236               23,823                       29,137                       32,234                  
                                                                                         
Total Liabilities & stockholders' equity
   $ 215,733             $ 227,623                     $ 241,380                     $ 249,360                  
                                                                                         
Net interest income
                     $ 8,000                     $ 7,354                     $ 6,837          
                                                                                         
Interest rate spread
       3.76 %                     3.60 %                     2.97 %                     2.51 %
                                                                                         
Net interest-earning assets
                   $ 21,326                     $ 26,568                     $ 28,374                  
                                                                                         
Net interest margin (1)
       3.89 %                     3.78 %                     3.26 %                     2.93 %
                                                                                         
Average interest-earning assets
                                                                                        
to average interest-bearing liabilities
       110.82 %                     111.20 %                     113.32 %                     113.76 %
                                                                                         
   
(1) Net interest margin represents net interest income divided by the interest-earning assets.
  
 
Rate/Volume Analysis

The following table sets forth certain information regarding changes in interest income and interest expense of the Company during the periods indicated.  For each category of interest-earning assets and interest-bearing liabilities, information is provided in each category with respect to (i) changes attributable to changes in volume (change in volume multiplied by prior rate), (ii) changes in rates (changes in rate multiplied by prior average volume), and (iii) the net change.  Changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.
 
 
 
 

   
Year ended December 31, 2010
  
   
Compared to
  
   
Year ended December 31, 2009
  
   
Increase (Decrease) Due to:
  
   
Volume
    
Rate
    
Total
  
   
(In thousands)
  
Interest-earning assets:
                  
Loans receivable
   $ (1,245 )   $ 274     $ (971 )
Investment securities
     146       (154 )   $ (8 )
Other investments
     44       (60 )   $ (16 )
                         
Total interest-earning assets
     (1,055 )     60       (995 )
                         
Interest-bearing liabilities:
                        
Savings Deposits
     1       (10 )     (9 )
Money Market/NOW accounts
     73       (133 )     (60 )
Certificates of Deposit
     (392 )     (700 )     (1,092 )
Deposits
     (318 )     (843 )     (1,161 )
Borrowed funds
     (185 )     (295 )     (480 )
                         
Total interest-bearing liabilities
     (503 )     (1,138 )     (1,641 )
                         
Change in net interest income
   $ (552 )   $ 1,198     $ 646  
 
   
Year ended December 31, 2009
  
   
Compared to
  
   
Year ended December 31, 2008
  
   
Increase (Decrease) Due to:
  
   
Volume
    
Rate
    
Total
  
   
(In thousands)
  
Interest-earning assets:
                  
Loans receivable
   $ (665 )   $ (819 )   $ (1,484 )
Investment securities
     293       (160 )   $ 133  
Other investments
     4       (178 )   $ (174 )
                         
Total interest-earning assets
     (368 )     (1,157 )     (1,525 )
                         
                         
Interest-bearing liabilities:
                        
Savings Deposits
     1       (8 )     (7 )
Money Market/NOW accounts
     15,196       (15,228 )     (32 )
Certificates of Deposit
     (401 )     (1,000 )     (1,401 )
Deposits
     14,796       (16,236 )     (1,440 )
Borrowed funds
     (350 )     (252 )     (602 )
                         
Total interest-bearing liabilities
     14,446       (16,488 )     (2,042 )
                         
Change in net interest income
   $ (14,814 )   $ 15,331     $ 517  
 
Management of Interest Rate Risk

Qualitative Analysis.  Our most significant form of market risk is interest rate risk.  The general objective of our interest rate risk management is to determine the appropriate level of risk given our business strategy, and then manage that risk in a manner that is consistent with our policy to reduce the exposure of our net interest income to changes in market interest rates.  First Federal of Northern Michigan’s asset/liability management committee (“ALCO”), which consists of senior management, evaluates the interest rate risk inherent in our assets and liabilities, our operating environment and capital and liquidity requirements, and modifies our lending, investing and deposit-taking strategies accordingly.  The Board of Directors reviews the ALCO’s activities and strategies, the effect of those strategies on our net interest margin, and the effect that changes in market interest rates would have on the economic value of our loan and securities portfolios, as well as the intrinsic value of our deposits and borrowings.

We actively evaluate interest rate risk in connection with our lending, investing and deposit-taking activities.  Generally, our loans, which represent the significant majority of our assets, have longer-terms to maturity than our deposits, which represent the significant majority of our liabilities. As of December 31, 2010, $134.7 million, or 84.1% of our loan portfolio, consisted of loans that mature or reprice after December 31, 2011.  In contrast, as of December 31, 2010, $52.1 million, or 61.8% of our time deposits as of that date, consisted of deposits that mature or reprice in less than one year.

In an effort to manage interest rate risk, we have increased our focus on the origination and retention in our portfolio of adjustable-rate residential mortgage loans.  In addition, we have increased the origination and retention in our portfolio of commercial real estate and commercial loans, since most of these loans are originated with adjustable interest rates.  In the current low interest rate environment, we also have generally sold into the secondary mortgage market all of the fixed-rate, longer-term (15 years or more) residential mortgage loans that we originate, generally on a servicing-retained basis. Finally, we have primarily invested in short- and medium-term securities and have maintained high levels of liquid assets, such as cash and cash equivalents.  Shortening the average maturity of our interest-earning assets through these strategies helps us to better match the maturities and interest rates of our assets and liabilities, thereby reducing the exposure of our net interest income to changes in market interest rates.  Maintaining high levels of liquid assets also permits us to invest in higher-yielding securities and loans when market interest rates increase. However, these strategies can be expected to adversely affect net interest income if long-term interest rates remain at low levels. We expect that as long-term interest rates rise, as we expect, we will reduce our mortgage-banking operations, and will retain in our portfolio a larger percentage of the one- to four-family loans that we originate.
 
 
 
 
 
Quantitative Analysis.  We evaluate interest rate sensitivity using a model that estimates the change in our net portfolio value (“NPV”) over a range of interest rate scenarios.  NPV is the discounted present value of expected cash flows from assets, liabilities and off-balance sheet contracts.  In calculating changes in NPV, we assume estimated loan prepayment rates, reinvestment rates and deposit decay rates that we judge most likely based on historical experience during prior interest rate changes.

The table below sets forth, as of December 31, 2010, the estimated changes in our NPV that would result from the designated instantaneous changes in the U.S. Treasury yield curve. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results.
 
Change in Interest
              
NPV as a Percentage of Present Value of Assets (3)
  
Rates (basis points)
        
Estimated Increase (Decrease) in NPV
          
Increase (Decrease)
  
(1)
  
Estimated NPV (2)
    
Amount
    
Percent
    
NPV Ratio (4)
    
(basis points)
  
   
(Dollars in thousands)
                    
                               
+300
     27,191       (4,671 )     -15.0 %     12.39 %     (161 )
+200
     30,753       (1,109 )     -3.0 %     13.73 %     (28 )
+100
     31,520       (342 )     -1.0 %     13.95 %     (6 )
+50
     31,442       (420 )     -1.0 %     13.89 %     (12 )
—
     31,862       —       —       14.01 %     —  
-50
     32,025       162       1.0 %     14.03 %     2  
-100
     32,125       263       1.0 %     14.04 %     4  

 
(1)
Assumes an instantaneous uniform change in interest rates at all maturities.
 
(2)
NPV is the discounted present value of expected cash flows from assets, liabilities and off-balance sheet contracts.
 
(3)
Present value of assets represents the discounted present value of incoming cash flows on interest-earning assets.
 
(4)
NPV Ratio represents NPV divided by the present value of assets.
 
The table set forth above indicates that at December 31, 2010, in the event of an immediate 100 basis point decrease in interest rates, we would be expected to experience a 1% increase in NPV and a 4 basis point increase in NPV ratio. In the event of an immediate 200 basis point increase in interest rates, we would be expected to experience a 3% decrease in NPV and a 28 basis point decrease in NPV ratio.

Certain shortcomings are inherent in the methodology used in the above interest rate risk measurements.  Modeling changes in NPV and net interest income requires making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. The NPV and net interest income table presented above assumes that the composition of our interest-rate sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and, accordingly, the data do not reflect any actions management may undertake in response to changes in interest rates.  The table also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or the repricing characteristics of specific assets and liabilities. Accordingly, although the NPV and net interest income table provides an indication of our sensitivity to interest rate changes at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results.
 
 
 
 
 
Cash Flows
 
Cash flows provided by operations were $3.5 million in 2010 as compared to cash used in operations of $1.0 million in 2009 due to net earnings in 2010 as compared to net loss in 2009, partially offset by a decrease in prepaid FDIC premiums and other assets year over year. Cash flows provided by investing activities increased from $8.3 million in 2009 to $13.2 million in 2010 mainly due to a net decrease in our investment portfolio year over year. Cash used in financing activities increased from $7.7 million in 2009 to $17.9 million in 2010 due primarily to the decrease in our outstanding Federal Home Loan Bank (FHLB) advances. As our loan and investment portfolios decreased we paid down FHLB advances and improved our net interest margin.
 
Liquidity and Capital Resources
 
The overall objective of our liquidity management is to ensure the availability of sufficient cash funds to meet all financial commitments and to take advantage of investment opportunities.  We manage liquidity in order to meet deposit withdrawals on demand or at contractual maturity, to repay borrowings as they mature, and to fund new loans and investments as opportunities arise.

Our primary sources of funds are deposits, principal and interest payments on loans and securities, and, to a lesser extent, borrowings (Federal Home Loan Bank advances), the proceeds from maturing securities and short-term investments, and the proceeds from the sales of loans and securities.  The scheduled amortization of loans and securities, as well as proceeds from borrowings, are predictable sources of funds.  Other funding sources, however, such as deposit inflows, mortgage prepayments, mortgage loan sales and mortgage-backed securities sales are greatly influenced by market interest rates, economic conditions and competition.

Liquidity represents the amount of our assets that can be quickly and easily converted into cash without significant loss.  Our most liquid assets are cash, short-term U.S. Government securities and U.S. Government agency or government-sponsored enterprise securities.  We are required to maintain sufficient levels of liquidity as defined by the Office of Thrift Supervision regulations.  Current regulations require that we maintain sufficient liquidity to ensure our safe and sound operation.  Our current objective is to maintain liquid assets equal to at least 20% of total deposits and Federal Home Loan Bank borrowings due in one year or less.  Liquidity as of December 31, 2010 was $35.4 million, or 28.5% of total deposits and Federal Home Loan Bank borrowings due in one year or less, compared to $27.5 million, or 22.0% of this amount at December 31, 2009.  The levels of liquidity are dependent on our operating, financing, lending and investing activities during any given period. Our calculation of liquidity includes additional borrowing capacity available with the Federal Home Loan Bank.  As of December 31, 2010, we had unused borrowing capacity of $17.8 million.  We can pledge additional collateral in the form of investment securities and certain loans to increase our borrowing capacity.
 
We currently retain in our portfolio all adjustable-rate residential mortgage loans, short-term balloon mortgage loans and fixed-rate residential mortgage loans with maturities of less than 15 years, and generally sell the remainder in the secondary mortgage market.  We also originate for retention in our loan portfolio, commercial and commercial real estate loans, including real estate development loans.  During the year ended December 31, 2010, we originated $47.8 million of one- to four-family residential mortgage loans, of which $5.6 million were retained in our portfolio and the remainder were sold into the secondary mortgage market or are being held for sale.  This compares to $58.9 million of one- to four-family originations during the year ended December 31, 2009, of which $9.4 million were retained in our portfolio.  At December 31, 2010, we had outstanding loan commitments of $27.2 million.  These commitments included $11.1 million for permanent one- to four-family residential mortgage loans, $1.0 million for non-residential loans, $92,000 of undisbursed loan proceeds for construction of one- to four-family residences, $4.2 million of undisbursed lines of credit on home equity loans, $1.2 million of unused credit card lines, $7.3 million of unused commercial lines of credit, and $847,000 of undisbursed commercial construction loans, unused bounce protection.of $1.5 million and letters of credit of $5,000.

Deposits are a primary source of funds for use in lending and for other general business purposes.  At December 31, 2010, deposits funded 72.1% of our total assets compared to 67.7% at December 31, 2009.  Certificates of deposit scheduled to mature in less than one year at December 31, 2010 totaled $52.1 million.  We believe that a significant portion of such deposits will remain with us.  We monitor the deposit rates offered by competitors in our market area, and we set rates that take into account the prevailing market conditions along with our liquidity position.  Moreover, we currently believe that the growth in assets is not expected to require significant in-flows of liquidity.  As such, we do not expect to be a market leader in rates paid for liabilities.

Borrowings may be used to compensate for seasonal or other reductions in normal sources of funds or for deposit outflows at more than projected levels.  Borrowings also may be used on a longer-term basis to support increased lending or investment activities.  At December 31, 2010, we had $29.0 million in Federal Home Loan Bank advances and no outstanding advances at the Federal Reserve Discount Window.  Total borrowings as a percentage of total assets were 13.4% at December 31, 2010 compared to 19.3% at December 31, 2009.
 
 
 
 
 
As of December 31, 2010, management was not aware of any known trends, events or uncertainties that have or are reasonably likely to have a material impact on our liquidity.  As of December 31, 2010, we had no material commitments for capital expenditures.

Our cash flows are derived from operating activities, investing activities and financing activities as reported in our Consolidated Statement of Cash Flows included with our Consolidated Financial Statements.

First Federal of Northern Michigan is subject to federal regulations that impose minimum capital requirements.  At December 31, 2010, we exceeded all applicable capital requirements.

Critical Accounting Policies

Our accounting and reporting policies are prepared in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry.  We consider accounting policies that require significant judgment and assumptions by management that have, or could have, a material impact on the carrying value of certain assets or on income to be critical accounting policies.  Changes in underlying factors, assumptions or estimates could have a material impact on our future financial condition and results of operations.  Based on the size of the item or significance of the estimate, the following accounting policies are considered critical to our financial results.

Allowance for Loan Losses.  The allowance for loan losses is calculated with the objective of maintaining an allowance sufficient to absorb estimated probable loan losses.  Management’s determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective, as it requires an estimate of the loss content for each risk rating and for each impaired loan, an estimate of the amounts and timing of expected future cash flows, and an estimate of the value of collateral.

We have established a systematic method of periodically reviewing the credit quality of the loan portfolio in order to establish an allowance for losses on loans.  The allowance for losses on loans is based on our current judgments about the credit quality of individual loans and segments of the loan portfolio.  The allowance for losses on loans is established through a provision for loan losses based on our evaluation of the losses inherent in the loan portfolio, and considers all known internal and external factors that affect loan collectibility as of the reporting date.  Our evaluation, which includes a review of all loans on which full collectibility may not be reasonably assured, considers among other matters, the estimated net realizable value or the fair value of the underlying collateral, economic conditions, historical loan loss experience, our knowledge of inherent losses in the portfolio that are probable and reasonably estimable and other factors that warrant recognition in providing an appropriate loan loss allowance.  Management believes this is a critical accounting policy because this evaluation involves a high degree of complexity and requires us to make subjective judgments that often require assumptions or estimates about various matters.

The analysis of the allowance for loan losses has two components: specific and general allocations.  Specific allocations are made for loans that are determined to be impaired.  Impairment is measured by determining the present value of expected future cash flows or, for collateral-dependent loans, the fair value of the collateral adjusted for market conditions and selling expenses.  The general allocation is determined by segregating the remaining loans by type of loan, risk weighting (if applicable) and payment history.  We also analyze delinquency trends, general economic conditions and geographic and industry concentrations.  This analysis establishes factors that are applied to the loan groups to determine the amount of the general reserve.  The principal assumption used in deriving the allowance for loan losses is the estimate of loss content for each risk rating. To illustrate, if recent loss experience dictated that the projected loss ratios would be increased by 10% (of the estimate) across all risk ratings, the allocated allowance as of December 31, 2010 would have changed by approximately $275,000.  Actual loan losses may be significantly more than the allowances we have established, which could have a material negative effect on our financial results.
 
 
 
 
 
Mortgage Servicing Rights. We sell to investors a portion of our originated one- to four-family residential real estate mortgage loans.  When we acquire mortgage servicing rights through the origination of mortgage loans and sale of those loans with servicing rights retained, we allocate a portion of the total cost of the mortgage loans to the mortgage servicing rights based on their relative fair value. As of December 31, 2010, we were servicing loans sold to others totaling $144.9 million. We amortize capitalized mortgage servicing rights as a reduction of servicing fee income in proportion to, and over the period of, estimated net servicing income by use of a method that approximates the level-yield method.  We periodically evaluate capitalized mortgage servicing rights for impairment using a model that takes into account several variables including expected prepayment speeds and prevailing interest rates.  If we identify impairment, we charge the amount of the impairment to earnings by establishing a valuation allowance against the capitalized mortgage servicing rights asset.  The primary risk of material changes to the value of the servicing rights resides in the potential volatility in the economic assumptions used, particularly the prepayment speed. We monitor this risk and adjust the valuation allowance as necessary to adequately record any probable impairment in the portfolio. Management believes the estimation of these variables makes this a critical accounting policy. For purposes of measuring impairment, the mortgage servicing rights are stratified based on financial asset type and interest rates. In addition, we obtain an independent third-party valuation of the mortgage servicing portfolio on a quarterly basis.  In general, the value of mortgage servicing rights increases as interest rates rise and decreases as interest rates fall. This is because the estimated life and estimated income from a loan increase as interest rates rise and decrease as interest rates fall. The key economic assumptions made in determining the fair value of the mortgage servicing rights at December 31, 2010 included the following:

Annual constant prepayment speed (CPR):
                       15.7 %
Weighted average life remaining (in months):
     246  
Discount rate used:
     8.0 %

At the December 31, 2010 valuation, we calculated the value of our mortgage servicing rights to be $1.3 million  and the weighted average life remaining of those rights was 40 months.  The book value of our mortgage servicing rights as of December 31, 2010 was $960,000 which was less than the independent valuation: therefore there was no need to establish a valuation allowance.

Impairment of Intangible Assets. On June 12, 2003, we acquired 100% of the stock of the InsuranCenter of Alpena (ICA).  We allocated the excess of the purchase price paid over the fair value of net assets acquired to intangible assets, including goodwill.  On February 27, 2009 the Company sold the majority of the assets of ICA.  The remaining goodwill on our books of $600,000 related to certain assets of the Company that were not sold in the sale of ICA. We allocated the goodwill between the assets sold and the assets retained and determined a value of the assets that remained of $600,000. Since the $600,000 allocation relates to a finite life asset, we re-characterized the goodwill as an amortizable intangible and began amortizing the asset in March 2009. The intangible asset was analyzed for impairment at December 31, 2010.

We have in the past purchased a branch or branches from other financial institutions.  Our analysis of these branch acquisitions led us to conclude that in each case, we acquired a business and therefore, the excess of purchase price over fair value of net assets acquired has been allocated to core deposit intangible assets.  Our conclusion was based on the fact that in each case we acquired employees, customers and branch facilities. The expected life for core deposit intangibles is based on the type of products acquired in an acquisition.  The amortization periods range from 10 to 15 years and are based on the expected life of the products.  The expected life was determined based on an analysis of the life of similar products within the Company and local competition in the markets where the branches were acquired.  The core deposit intangibles are amortized on a straight line basis.  The core deposit intangible is analyzed annually for impairment.

Valuation of Deferred Tax Assets.  The Company records a valuation allowance if it believes, based on available evidence, that it is “more likely than not” that the future tax assets recognized will not be realized before their expiration. Realization of the Company’s deferred tax assets is primarily dependent upon the generation of a sufficient level of future taxable income.

At December 31, 2010 and 2009, management did not believe it was more likely than not that all of the deferred tax assets would be realized. Accordingly, at December 31, 2010 and 2009 a valuation allowance of $3.2 million and $3.4 million was recorded, respectively. The net deferred tax asset recorded at December 31, 2010 and 2009 was $659,000 and $559,000.
 
 
 
 
 
Off-Balance Sheet Arrangements

In the ordinary course of business, First Federal of Northern Michigan is a party to credit-related financial instruments with off-balance-sheet risk to meet the financing needs of its customers.  These financial instruments include commitments to extend credit and letters of credit.  First Federal of Northern Michigan follows the same credit policies in making off-balance sheet commitments as it does for on-balance-sheet instruments.
 
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  The commitments for equity lines of credit may expire without being drawn upon.  Therefore, the total commitment amounts do not necessarily represent future cash requirements.  The amount of collateral obtained, if it is deemed necessary by First Federal of Northern Michigan, is based on management’s credit evaluation of the customer.
 
Unfunded commitments under construction lines of credit for residential and commercial properties and commercial lines of credit are commitments for possible future extensions of credit to existing customers, for which funds have not been advanced by First Federal of Northern Michigan.
 
At December 31, 2010 and December 31, 2009, First Federal of Northern Michigan had $13.0 million and   $12.0 million, respectively, of commitments to grant loans, $14.1 million and $14.0 million, respectively, of unfunded commitments under lines of credit and $5,000 and $5,000, respectively, of letters of credit.  See Note 11 of the Notes to the Consolidated Financial Statements.
 
Safe Harbor Statement

When used in this annual report or future filings by First Federal of Northern Michigan Bancorp, Inc. with the Securities and Exchange Commission, in the Company’s press releases or other public or stockholder communications, or in oral statements made with the approval of an authorized executive officer, the words or phrases “would be,” “will allow,” “intends to,” “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project,” or similar expressions are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.

The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made, and to advise readers that various factors, including regional and national economic conditions, changes in levels of market interest rates, credit and other risks of lending and investment activities and competitive and regulatory factors, could affect the Company’s financial performance and could cause the Company’s actual results for future periods to differ materially from those anticipated or projected.

The Company does not undertake, and specifically disclaims any obligation, to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements.
 
Impact of Inflation and Changing Prices

The financial statements and related notes of First Federal of Northern Michigan Bancorp, Inc. have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).  GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration for changes in the relative purchasing power of money over time due to inflation.  The impact of inflation is reflected in the increased cost of our operations.  Unlike industrial companies, our assets and liabilities are primarily monetary in nature.  As a result, changes in market interest rates have a greater impact on performance than the effects of inflation.

 
 
 

DIRECTORS AND EXECUTIVE OFFICERS OF
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
AND FIRST FEDERAL OF NORTHERN MICHIGAN

 
Directors -

Martin A. Thomson has been Chairman of the Board of Directors since May 2008.  He was President and Chief Executive Officer of the Company and Bank from May 2001.  In January 2006, Mr. Thomson relinquished the position of President and in May 2008 relinquished the position of Chief Executive Officer and assumed the role of  Chairman of the Board of Directors of the Company and Bank. Mr. Thomson previously held the position of President and Chief Executive Officer of Presque Isle Electric and Gas Co-op, Onaway, Michigan.  Mr. Thomson has been a director of the Bank since 1986, and a director of the Company since its formation in November 2000.

James C. Rapin  has been a director of the Bank since 1985, and a director of the Company since its formation in November 2000.   He was Chairman of the Board of Directors of the Company and the Bank from March 2002 until May 2008.  Mr. Rapin retired as a pharmacist with LeFave Pharmacy, Alpena, Michigan in 2004.

Keith D. Wallace is a senior attorney with the law firm of Isackson, Wallace and Pfiefer,  P.C., located in Alpena, Michigan.  Mr. Wallace has been a director of the Bank since 1988, and a director of the Company since its formation in November 2000.

Gary C. VanMassenhove is a partner in VanMassenhove, Kearly, Taphouse & Faulman, CPAs.  Mr. VanMassenhove has been a Certified Public Accountant for 40 years.  He has been a director of the Company and the Bank since September 2001.

Thomas R. Townsend is the President of the R.A. Townsend Co., a plumbing, heating and air conditioning distributor located in Alpena, Michigan, where he has been employed for the past 33 years.  Mr. Townsend has been a director of the Company and the Bank since April 2002.

Michael W. Mahler was named President and Chief Executive Officer of the Company and the Bank in May 2008. He was named President and Chief Operating Officer of the Company and the Bank in January 2006. Prior to that appointment, since November 2004, Mr. Mahler served as Executive Vice President of the Company and the Bank and had served, since November 2002, as Chief Financial Officer. From September 2000 until November 2002, Mr. Mahler was Corporate Controller at Besser Company, Alpena, Michigan, an international producer of concrete products equipment. From 1990 until 2000, Mr. Mahler was employed at LTV Steel Company, East Chicago, Indiana where he served in financial roles of increasing responsibility and served, from 1997 until 2000, as Controller for a northeast Michigan division. Mr. Mahler has been a Director of the Bank since January 2006 and of the Company since May 2008.

Executive Officers Who Are Not Directors-

Amy E. Essex was named Chief Financial Officer, Treasurer and Corporate Secretary of the Company and the Bank in January 2006. Ms. Essex had served as Chief Financial Officer of the Company and the Bank since November 2004 and prior to that appointment, since March 2003, served as the Internal Auditor and Compliance Officer for Alpena Bancshares, Inc. Prior to March 2003, Ms. Essex spent eight years as the Director of Tax and Risk for Besser Company, Alpena, Michigan. Ms. Essex is a certified public accountant.

Jerome W. Tracey was named Executive Vice President and Chief Lending Officer of the Company and the Bank in January 2006. Mr. Tracey had served as Senior Vice President, Senior Lender of the Company and the Bank since September 2001 and served as Vice President of Commercial Services since joining the Bank in November 1999.  Prior to joining the Bank, Mr. Tracey served as Vice President of Commercial Lending for National City Bank, Alpena, Michigan, a position    he held since 1996.  Mr. Tracey has been in the banking profession since 1981.
 
 
 
 

Senior Management Team of the Bank -

Michael W. Mahler, Jerome W. Tracey, Amy E. Essex, Joseph W. Gentry II, Kathleen  R. Brown, Linda K. Sansom,  Gregory S. Matthews, Julie A. Curtis

STOCKHOLDER INFORMATION 
  
The Annual Meeting of Stockholders will be held at 1:00 p.m., May 18, 2011 at the Thunder Bay National Marine Sanctuary, 500 W. Fletcher St., Alpena, MI  49707.

Stock Listing

The Company's common stock is traded on the Nasdaq Capital Market under the symbol “FFNM”.

Price Range of Common Stock

The following sets forth the quarterly high and low closing price per share and cash dividends declared during each of the four quarters in 2010 and 2009.

   
Market Price
        
Quarter Ended
  
           High           
    
           Low           
    
Cash Dividends Declared
  
                   
December 31, 2010
   $ 2.99     $ 2.39     $ -  
September 30, 2010
   $ 2.75     $ 2.05     $ -  
June 30, 2010
   $ 2.44     $ 1.38     $ -  
March 31, 2010
   $ 1.80     $ 1.13     $ -  
December 31, 2009
   $ 2.15     $ 1.21     $ -  
September 30, 2009
   $ 2.15     $ 1.81     $ -  
June 30, 2009
   $ 2.20     $ 0.70     $ -  
March 31, 2009
   $ 2.35     $ 0.66     $ -  

 
 
 
 
Special Counsel
 
Luse Gorman Pomerenk & Schick, PC
5335 Wisconsin Avenue, N.W.
Suite 400
Washington, D.C.  20015
 
Market Makers
 
Raymond James & Associates, Inc.
222 South Riverside Plaza
7th Floor
Chicago, IL 60606
312-655-3000
 
Stifel Nicolaus
237 Park Avenue
8th Floor
New York, NY 10017
212-847-6500
 
Keefe, Bruyette & Woods
787 7th Avenue
4th Floor
New York, NY 10019
212-887-7777
 
FIG Partners, LLC
1175 Peachtree St. NE
100 Colony Sq, Suite 2250
Atlanta, GA 30361
866-344-2657
  
Independent Auditor
 
Plante & Moran, PLLC
2601 Cambridge Ct.  Suite 500
Auburn Hills, MI 48326
 
Transfer Agent
 
Registrar and Transfer Company
10 Commerce Drive
Cranford, NJ 07016
800-346-6084

Annual Report on Form 10-K

A copy of the Company's Form 10-K for the year ended December 31, 2010 will be furnished without charge upon written request to:  Amy E. Essex, Chief Financial Officer, Treasurer and Corporate Secretary, First Federal of Northern Michigan Bancorp, Inc., 100 S. Second Avenue, Alpena, Michigan 49707.
 
 
 
 
 
First Federal of Northern Michigan Bancorp, Inc.  and Subsidiaries
 

 
Contents
   
Report Letter
2
   
Consolidated Financial Statements
  
   
Balance Sheet
3
   
Statement of Operations
4
   
Statement of Changes in Stockholders’ Equity
5
   
Statement of Cash Flows
6
   
Notes to Consolidated Financial Statements
7
 
 
1
 

Report of Independent Registered Public Accounting Firm
 
Board of Directors
First Federal of Northern Michigan Bancorp, Inc.
 
We have audited the consolidated balance sheet of First Federal of Northern Michigan Bancorp, Inc. as of December 31, 2010 and 2009 and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for each year in the two-year period ended December 31, 2010.  These consolidated financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
 
We conducted our audits in accordance with auditing standards established by the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement.  The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of First Federal of Northern Michigan Bancorp, Inc. as of December 31, 2010 and 2009 and the consolidated results of their operations and their cash flows for each year in the two-year period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America.
 
/s/ Plante & Moran, PLLC
 
Auburn Hills, Michigan
March 25, 2011
 
 
2
 

First Federal of Northern Michigan Bancorp, Inc.  and Subsidiaries
 
Consolidated Balance Sheet
(000s omitted, except per share data)

   
December 31
  
   
2010
    
2009
  
Assets
Cash and cash equivalents
   $ 1,890     $ 2,583  
Overnight deposits with Federal Home Loan Bank
     73       516  
                 
Total cash and cash equivalents
     1,963       3,099  
                 
Securities available for sale (Note 2)
     35,301       33,713  
Securities held to maturity (Note 2)
     2,520       3,928  
Loans - Net (Note 3)
     157,144       171,219  
Loans held for sale
     -       52  
Federal Home Loan Bank stock
     3,775       4,197  
Property and equipment (Note 4)
     6,027       6,564  
Foreclosed real estate
     2,818       3,580  
Accrued interest receivable
     1,231       1,230  
Prepaid FDIC insurance premiums
     967       1,315  
Intangible assets (Note 6)
     627       920  
Deferred tax asset
     659       559  
Other assets (Note 5)
     2,701       3,130  
Total assets
   $ 215,733     $ 233,506  
                 
Liabilities and Stockholders' Equity
Liabilities
                
Non-interest bearing deposits
   $ 10,349     $ 11,074  
Interest-bearing deposits (Note 7)
     145,117       147,026  
Advances from Federal Home Loan Bank (Note 8)
     29,000       44,400  
Note payable (Note 9)
     -       631  
REPO sweep accounts
     6,172       5,408  
Accrued expenses and other liabilities (Note 13)
     1,859       1,915  
Total liabilities
     192,497       210,454  
                 
Stockholders' Equity (Note 12)
                
Common stock ($0.01 par value 20,000,000 shares authorized 3,191,799 shares issued)
     32       32  
Additional paid-in capital
     23,822       23,723  
Retained earnings
     2,238       2,000  
Treasury stock at cost (307,750 shares)
     (2,964 )     (2,964 )
Unearned compensation
     (38 )     (162 )
Accumulated other comprehensive income
     146       423  
Total stockholders' equity
     23,236       23,052  
Total liabilities and stockholders' equity
   $ 215,733     $ 233,506  

See Notes to Consolidated
Financial Statements.

 
3
 

First Federal of Northern Michigan Bancorp, Inc.  and Subsidiaries
 
Consolidated Statement of Operations
(000s omitted, except per share data)

   
Year Ended December 31
  
   
2010
    
2009
  
             
Interest Income
            
Loans, including fees
   $ 10,133     $ 11,104  
Investments
                
Taxable
     480       548  
Tax-exempt
     186       213  
Mortgage-backed securities
     648       577  
Total interest income
     11,447       12,442  
Interest Expense
                
Deposits (Note 8)
     2,296       3,457  
Borrowings
     1,151       1,631  
Total interest expense
     3,447       5,088  
Net Interest Income - Before provision for loan losses
     8,000       7,354  
Provision for Loan Losses (Note 3)
     1,101       6,196  
Net Interest Income - After provision for loan losses
     6,899       1,158  
Other Income
                
Service charges and other fees
     804       869  
Net gain on sale of investments
     546       -  
Net gain on sale of loans
     597       585  
Loan servicing fees
     841       829  
Insurance and brokerage commissions
     159       170  
Other
     258       122  
Total other income
     3,205       2,575  
Operating Expenses
                
Compensation and employee benefits (Note 13)
     4,682       4,735  
FDIC insurance premiums
     366       480  
Amortization of intangible assets
     292       273  
Advertising
     136       117  
Occupancy and equipment
     1,156       1,202  
Data processing service bureau
     314       335  
Professional fees
     425       478  
Other
     2,495       1,740  
Total operating expenses
     9,866       9,360  
Income (loss) from continuing operations - before federal income tax expense
     238       (5,627 )
Income tax expense from continuing operations (Note 10)
     -       1,090  
Net income (loss) from continuing operations
     238       (6,717 )
Loss from discontinued operations, net of tax benefit of $24 (Note 15)
     -       (46 )
Net income (loss)
   $ 238     $ (6,763 )
                 
Per Share Data
                
Income (loss) per share from continuing operations
                
Basic
   $ 0.08     $ (2.33 )
Diluted
   $ 0.08     $ (2.33 )
Loss per share from discontinued operations
                
Basic
   $ -     $ (0.01 )
Diluted
   $ -     $ (0.01 )
Net income (loss) per share
                
Basic
   $ 0.08     $ (2.34 )
Diluted
   $ 0.08     $ (2.34 )

See Notes to Consolidated
Financial Statements.

 
4
 

First Federal of Northern Michigan Bancorp, Inc.  and Subsidiaries
 
Consolidated Statement of Changes in Stockholders’ Equity
(000s omitted)

   
Shares
    
Common
Stock
    
Treasury
Stock
    
Additional
Paid-in
Capital
    
Unearned
Compensation
    
Retained
Earnings
    
Unallocated
ESOP Shares
    
Accumulated
Other
Comprehensive
Income (Loss)
    
Total
Stockholders'
Equity
  
                                                       
Balance - January 1, 2009
     3,192     $ 32     $ (2,964 )   $ 24,306     $ (290 )   $ 8,763     $ (765 )   $ 337     $ 29,419  
                                                                         
Comprehensive income (loss):
                                                                        
Net loss
     -       -       -       -       -       (6,763 )     -       -       (6,763 )
Other comprehensive income:
                                                                        
Unrealized appreciation on available-for-sale securities - Net of tax of $44
     -       -       -       -       -       -       -       86       86  
                                                                         
Total comprehensive loss
                                                                     (6,677 )
                                                                         
ESOP common stock committed to be released
     -       -       -       (666 )     -       -       765       -       99  
Stock options/MRP shares expensed
     -       -       -       83       128       -       -       -       211  
                                                                         
Balance - December 31, 2009
     3,192       32       (2,964 )     23,723       (162 )     2,000       -       423       23,052  
                                                                         
Comprehensive income (loss):
                                                                        
Net income
     -       -       -       -       -       238       -       -       238  
Other comprehensive income:
                                                                        
Unrealized depreciation on available-for-sale securities - Net of tax of ($143)
     -       -       -       -       -       -       -       (277 )     (277 )
                                                                         
Total comprehensive income
                                                                     (39 )
                                                                         
Stock options/MRP shares expensed
     -       -       -       99       124       -       -       -       223  
                                                                         
Balance - December 31, 2010
     3,192     $ 32     $ (2,964 )   $ 23,822     $ (38 )   $ 2,238     $ -     $ 146     $ 23,236  

See Notes to Consolidated
Financial Statements.

 
5
 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Consolidated Statement of Cash Flows
(000s omitted, except per share data)

   
Year Ended December 31
  
   
2010
    
2009
  
Cash Flows from Operating Activities
            
Net income (loss)
   $ 238     $ (6,763 )
Adjustments to reconcile net income (loss) to cash from operating activities:
                
Depreciation and amortization
     802       835  
Provision for loan losses
     1,101       6,196  
Amortization and accretion on securities
     143       82  
Gain on sale of investment securities
     (546 )     -  
ESOP contribution
     -       99  
Stock options/awards
     223       211  
Gain on sale of loans held for sale
     (597 )     (585 )
Gain on sale of property and equipment
     (10 )     (5 )
Originations of loans held for sale
     (42,151 )     (49,858 )
Proceeds from sale of loans held for sale
     42,800       50,497  
Net change in:
                
Accrued interest receivable
     (1 )     239  
Other assets
     1,457       (2,730 )
Prepaid FDIC insurance premiums
     348       (1,315 )
Accrued expenses and other liabilities
     (56 )     276  
Deferred income tax expense (benefit)
     (202 )     1,775  
Net cash provided by (used in) operating activities
     3,549       (1,046 )
                 
Cash Flows from Investing Activities
                
Net decrease in loans
     12,974       14,856  
Proceeds from maturity of securities
     15,951       13,890  
Proceeds from sale of securities available-for-sale
     14,426       -  
Net change in discontinued operations
     -       1,534  
Proceeds from sale of property and equipment
     31       11  
Purchase of securities available for sale
     (30,574 )     (21,795 )
Proceeds from sale of Federal Home Loan Bank stock
     422       -  
Purchase of premises and equipment
     (14 )     (167 )
Net cash provided by investing activities
     13,216       8,329  
                 
Cash Flows from Financing Activities
                
Net decrease in deposits
     (2,634 )     (7,678 )
Net increase (decrease) in Repo Sweep Accts
     764       (4,039 )
Additions to advances from FHLB and Notes Payable
     23,025       85,180  
Repayments of advances from FHLB and Notes Payable
     (39,056 )     (81,118 )
Net cash used in financing activities
     (17,901 )     (7,655 )
                 
Net Decrease in Cash and Cash Equivalents
     (1,136 )     (372 )
                 
Cash and Cash Equivalents - Beginning of year
     3,099       3,471  
                 
Cash and Cash Equivalents - End of year
   $ 1,963     $ 3,099  
                 
Supplemental Cash Flow and Noncash Information
                
Cash (refunded) paid for income taxes
   $ (638 )   $ 15  
Cash paid for interest on deposits and borrowings
     3,575       5,284  
Transfer of loans to real estate owned & other repossessed assets
     2,080       6,382  

 
See Notes to Consolidated
Financial Statements.

 
6
 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 1 - Summary of Significant Accounting Policies
 
Nature of Operations – First Federal of Northern Michigan Bancorp, Inc. (the “Company”) and its subsidiary, First Federal of Northern Michigan (the “Bank”), conduct operations in the northeastern lower peninsula of Michigan.  The Company’s primary services include accepting deposits, making commercial, consumer and mortgage loans, and engaging in mortgage banking activities.
 
Discontinued Operations – In accordance with FASB ASC 360-10, Accounting for Impairment or Disposal of Long-Lived Assets, on February 27, 2009 the Company announced that it had sold the InsuranCenter of Alpena. Accordingly, the results of operations of the InsuranCenter through that date are removed from the detail line items in the Company’s consolidated Statement of Operations and presented separately as “discontinued operations.” Please refer to Note 15 to the Company’s Consolidated Financial Statements for additional information.
 
Principles of Consolidation - The consolidated financial statements include the accounts of First Federal of Northern Michigan Bancorp, Inc., First Federal of Northern Michigan, and the Bank’s wholly owned subsidiaries, Financial Services & Mortgage Corporation (“FSMC”) and FFNM Agency.  FSMC invests in real estate, which includes leasing, selling, developing, and maintaining real estate properties.  The main activity of FFNM Agency is to collect the stream of income associated with the sale of the Blue Cross/Blue Shield override business to an outside party and, to a lesser extent, the collection of commissions for the sale of non-insured investment products. All significant intercompany balances and transactions have been eliminated in the consolidation.
 
Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period.  Actual results could differ from those estimates.  Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, and the valuation of investment securities, intangible and deferred tax assets, and mortgage servicing rights.
 
 
7
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 1 - Summary of Significant Accounting Policies (Continued)
 
Significant Group Concentrations of Credit Risk - Most of the Company’s activities are with customers located within the northeastern lower peninsula of Michigan.  Note 2 discusses the types of securities in which the Company invests.  Note 3 discusses the types of lending in which the Company engages.  The Company does not have any significant concentrations to any one industry or customer.
 
Cash and Cash Equivalents - For the purpose of the consolidated statements of cash flows, cash and cash equivalents include cash and balances due from depository institutions and federal funds sold and interest bearing deposits in other depository institutions which mature within ninety days when purchased.
 
Securities – Debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. Securities not classified as held to maturity, including equity securities with readily determinable fair values, are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income net of applicable income taxes.
 
Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities.  Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses.  In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.  Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
 
Federal Home Loan Bank Stock – Federal Home Loan Bank (FHLB) Stock is carried at cost and is held to allow the Bank to conduct business with the entity.  The Federal Home Loan Bank sells and purchases its stock at par; therefore cost approximates fair market value.
 
 
8
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 1 - Summary of Significant Accounting Policies (Continued)
 
Mortgage Banking Activities – The Company routinely sells to investors its originated long-term residential fixed-rate mortgage loans. Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income.

Mortgage loans held for sale are generally sold with the mortgage servicing rights retained by the Company. The carrying value of mortgage loans sold is reduced by the cost allocated to the associated mortgage servicing rights. Gains or losses on sales of mortgage loans are recognized based on the difference between the selling price and the carrying value of the related mortgage loans sold.
 
The Company enters into commitments to originate loans whereby the interest rate on the loan is determined prior to funding, also known as rate lock commitments. Rate lock commitments on residential mortgage loans that are intended to be sold are considered to be derivatives. Fair value is based on fees currently charged to enter into similar agreements. The fair value of rate lock commitments was insignificant at December 31, 2010 and 2009.
 
The Company uses forward contracts as part of its mortgage banking activities. Forward contracts provide for the delivery of financial instruments at a specified future date and at a specified price or yield. The fair value of forward contracts was insignificant at December 31, 2010 and 2009.
 
Loans - The Company grants mortgage, commercial, and consumer loans to customers.  Loans are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans.  Interest income is accrued on the unpaid principal balance.  Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield over the contractual life of the loan.
 
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans.  Interest income is accrued on the unpaid principal balance.  Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method.

 
9
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 1 - Summary of Significant Accounting Policies (Continued)

The accrual of interest on loans is discontinued at the time the loan is 90 days’ delinquent unless the credit is well-secured and in process of collection.  In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.

All interest accrued but not collected, for loans that are placed on nonaccrual or charged off, is reversed against interest income.  The interest on these loans is accounted for on the cash basis or cost recovery method, until qualifying for return to accrual.  Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
 
Allowance for Loan Losses - The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings.  Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed.  Subsequent recoveries, if any, are credited to the allowance.
 
The allowance for loan losses is evaluated on a regular basis by management and is based on management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions.  This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of specific and general components. The specific component relates to loans that are classified as doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors.
 
 
10
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 1 - Summary of Significant Accounting Policies (Continued)
 
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.  Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due.  Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.  Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

Large groups of homogeneous loans are collectively evaluated for impairment.  The Company does not separately identify individual consumer and residential loans for impairment disclosures until a loss is imminent.
 
Loan Servicing – Servicing assets are recognized as separate assets when rights are acquired through the sale of originated residential mortgage loans. Capitalized servicing rights are reported in other assets and are amortized against non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights into tranches based on predominant characteristics, such as interest rate, loan type and investor type. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or on a valuation model that calculates the present value of estimated future net servicing income using market based assumptions. Temporary impairment is recognized through a valuation allowance for an individual stratum to the extent that fair value is less than the capitalized amount for the stratum. If it is later determined that all or a portion of the temporary impairment no longer exists, the valuation allowance is reduced through a recovery of income. An other-than-temporary impairment results in a permanent reduction to the carrying value of the servicing asset.
 
 
11
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 1 - Summary of Significant Accounting Policies (Continued)

Servicing income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal, or a fixed amount per loan and are recorded as income when earned. The amortization of mortgage servicing rights is netted against loan servicing fee income.
 
Loans Held for Sale - The Bank routinely sells to investors its long-term fixed rate residential mortgages.  These loans are identified as held for sale and are accounted for at the lower of cost or market on an aggregate basis.  Net unrealized losses, if any, are recognized in a valuation allowance by charges to income.
 
Foreclosed Assets - Foreclosed real estate held for sale is carried at the lower of fair value minus estimated costs to sell, or cost. Costs of holding foreclosed real estate are charged to expense in the current period, except for significant property improvements, which are capitalized. Valuations are periodically performed by management and an allowance is established by a charge to non-interest expense if the carrying value exceeds the fair value minus estimated costs to sell. Foreclosed real estate is classified as other real estate owned. The net income from operations of foreclosed real estate held for sale is reported in non-interest income.

Property and Equipment - These assets are recorded at cost, less accumulated depreciation.  The Bank uses the straight-line method of recording depreciation for financial reporting.  The depreciable lives used by the Company are:  land improvements 7-10 years, buildings 7-40 years and equipment 3-10 years.  Maintenance and repairs are charged to expense and improvements are capitalized.

 
12
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 1 - Summary of Significant Accounting Policies (Continued)
 
Intangible Assets – The Company has in the past purchased a branch or branches from other financial institutions.  The analysis of these branch acquisitions led the Company to conclude that in each case, we acquired a business and therefore, the excess of purchase price over fair value of net assets acquired has been allocated to core deposit intangible assets.  The conclusion was based on the fact that in each case we acquired employees, customers and branch facilities. The expected life for core deposit intangibles is based on the type of products acquired in an acquisition.  The amortization periods range from 10 to 15 years and are based on the expected life of the products.  The expected life was determined based on an analysis of the life of similar products within the Company and local competition in the markets where the branches were acquired.  The core deposit intangibles are amortized on a straight line basis.  The core deposit intangible is analyzed quarterly for impairment.
 
On June 12, 2003, First Federal of Northern Michigan acquired 100% of the stock of the InsuranCenter of Alpena (ICA).
 
On February 27, 2009 the Company announced that it had sold the majority of the assets of the InsuranCenter of Alpena.
 
At the time of the sale, goodwill of $600,000 continued to be recorded related to certain assets of the Company that were not sold in the sale of ICA. The assets retained relate to a future stream of commissions. Under an agreement, the Company will receive a portion of the override commission through April, 2014. Management computed an estimated cash flow on this commission using a 6.0% discount rate and determined a fair value of $600,000. Since the $600,000 allocation of fair value relates to a finite life asset, the Company re-characterized the goodwill as an amortizable intangible and began amortizing the asset in March, 2009.
 
Income Taxes - Deferred income tax assets and liabilities are recognized for temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

 
13
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 1 - Summary of Significant Accounting Policies (Continued)
 
The Company records a valuation allowance if it believes, based on available evidence, that it is “more likely than not” that the future tax assets recognized will not be realized before their expiration. Realization of the Company’s deferred tax assets is primarily dependent upon the generation of a sufficient level of future taxable income.

At December 31, 2010 and 2009, management did not believe it was more likely than not that all of the deferred tax assets would be realized. Accordingly, at December 31, 2010 and 2009 a valuation allowance of $3.2 million and $3.4 million was recorded, respectively. The net deferred tax asset recorded at December 31, 2010 and 2009 was $659,000 and $559,000.  See Note 10 for additional information.

Off Balance Sheet Instruments - In the ordinary course of business, the Company has entered into commitments to extend credit, including commitments under credit card arrangements, commercial letters of credit and standby letters of credit.  For letters of credit, a liability is recorded for the fair value of the obligation undertaken in issuing the guarantee.

Comprehensive Income - Accounting principles generally require that recognized revenue, expenses, gains, and losses be included in net income.  Certain changes in assets and liabilities, however, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component in the equity section of the consolidated statement of financial condition.  Such items, along with net income, are components of comprehensive income.
 
Stock-Based Compensation – The Company applies the recognition and measurement of stock-based compensation accounting rules for stock-based compensation which is referred to as the fair value method.  Compensation cost is based on the fair value of the equity issued to employees.  The Company recognizes compensation expense related to stock-based compensation over the period the services are performed.  The Company granted no options in 2010 and 2009.  Compensation costs charged to earnings were $223,000 and $211,000 in 2010 and 2009, respectively.

 
14
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 1 - Summary of Significant Accounting Policies (Continued)
 
Earnings Per Common Share - Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period.  Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance.  Potential common shares that may be issued by the Company relate solely to outstanding stock options and are determined using the treasury stock method. Approximately 149,000 and 115,000 options were not considered for dilution in 2010 and 2009, respectively, based on the options being underwater at both December 31, 2010 and 2009 and based on the Company’s net loss for 2009.

Earnings per common share have been computed based on the following:
 
   
December 31,
  
   
2010
    
2009
  
             
Net income (loss) from continuing operations
   $ 238     $ (6,717 )
Net loss from discontinued operations
     -       (46 )
Net income (loss)
   $ 238     $ (6,763 )
                 
Average number of common shares outstanding
     2,884,049       2,884,249  
Effect of dilutive options
     -       -  
Average number of common shares outstanding used to calculate diluted earnings per common share
     2,884,049       2,884,249  

 
15
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 1 - Summary of Significant Accounting Policies (Continued)
 
Recent Accounting Pronouncements - In July 2010, FASB issued ASU No. 2010-20 “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses”.  The standard requires the Company to expand disclosures about the credit quality of our loans and the related reserves against them.  The additional disclosures will include details on our past due loans and credit quality indicators.  For public entities, ASU 2010-20 disclosures of period-end balances are effective for interim and annual reporting periods ending on or after December 15, 2010 and are included in Note 3 of the financial statements.  Disclosures related to activity that occurs during the reporting period are required for interim and annual reporting periods beginning on or after December 15, 2010.  The Company will adopt the disclosures related to the activity that occurs during the reporting period beginning with our March 31, 2011 consolidated financial statements.

In January 2010, the FASB issued ASU No. 2010-06 “Fair Value Measurements and Disclosures (Topic 820) — Improving Disclosures about Fair Value Measurements.”  ASU 2010-06 amends the fair value disclosure guidance.  The amendments include new disclosures and changes to clarify existing disclosure requirements.  ASU 2010-06 was effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements of Level 3 fair value measurements.  Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years.  The impact of ASU 2010-06 on the Company’s disclosures is reflected in Note 14 of the consolidated financial statements.
 
Note 2 - Securities
 
Investment securities have been classified according to management’s intent.  The carrying value and estimated fair value of securities are as follows:
 
   
December 31, 2010
  
   
Amortized
Cost
    
Gross
Unrealized
Gains
    
Gross
Unrealized
Losses
    
Market
Value
  
                         
Securities Available for Sale
                        
U.S. Treasury securities and obligations of U.S. government corporations and agencies
   $ 4,518     $ 44     $ -       4,562  
Municipal notes
     4,875       171       -       5,046  
Mortgage-backed securities
     25,684       83       (75 )     25,692  
Equity securities
     3       -       (2 )     1  
                                 
Total
   $ 35,080     $ 298     $ (77 )   $ 35,301  
                                 
Securities Held to Maturity
                                
Municipal notes
   $ 2,520     $ 90     $ (15 )   $ 2,595  
                                 
   
December 31, 2009
  
   
Amortized
Cost
    
Gross
Unrealized
Gains
    
Gross
Unrealized
Losses
    
Market
Value
  
                                 
Securities Available for Sale
                                
U.S. Treasury securities and obligations of U.S. government corporations and agencies
   $ 8,220     $ 37     $ -       8,257  
Municipal notes
     7,870       183       -       8,053  
Corporate securities
     1,000       2       -       1,002  
Mortgage-backed securities
     15,979       419       (1 )     16,397  
Equity securities
     3       1       -       4  
                                 
Total
   $ 33,072     $ 642     $ (1 )   $ 33,713  
                                 
Securities Held to Maturity
                                
Municipal notes
   $ 3,928     $ 159     $ (3 )   $ 4,090  
 
 
16
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 2 - Securities (Continued)
 
The amortized cost and estimated market value of securities at December 31, 2010, by contractual maturity, are shown below.  Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.  Securities with no specified maturity date are separately stated:
 
   
December 31, 2010
  
   
Amortized
Cost
    
Market
Value
  
             
Available For Sale:
            
             
Due in one year or less
   $ 2,809     $ 2,836  
Due after one year through five years
     4,292       4,390  
Due in five year through ten years
     1,851       1,903  
Due after ten years
     441       479  
                 
Subtotal
     9,393       9,608  
                 
Equity securities
     3       1  
Mortgage-backed securities
     25,684       25,692  
                 
Total
   $ 35,080     $ 35,301  
                 
Held To Maturity
                
Due in one year or less
   $ 85     $ 86  
Due after one year through five years
     390       414  
Due in five year through ten years
     630       663  
Due after ten years
     1,415       1,432  
                 
Total
   $ 2,520     $ 2,595  
 
At December 31, 2010 and 2009, securities with a carrying value and fair value of $27,824,000 and $24,265,000, respectively, were pledged to secure REPO Sweep accounts, FHLB advances and borrowings from the Federal Reserve discount window.
 
Gross proceeds from the sale of available-for-sale securities for the years ended December 31, 2010 and 2009 were $14,426,000 and $0, respectively, resulting in gross gains of $546,000 and $0, respectively and gross losses of $0 and $0, respectively.  The tax provision applicable to these net realized gains amounted to $186,000 and $0, respectively.
 
 
17
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 2 - Securities (Continued)
 
The following is a summary of temporarily impaired investments that have been impaired for less than and more than twelve months as of December 31, 2010 and 2009:
 
   
December 31, 2010
    
December 31, 2009
  
         
Gross
Unrealized
Losses
          
Gross
Unrealized
Losses
          
Gross
Unrealized
Losses
          
Gross
Unrealized
Losses
  
   
Fair Value
    
<12
months
    
Fair Value
    
> 12
months
    
Fair Value
    
<12 months
    
Fair Value
    
> 12
months
  
Available For Sale:
                                                
U.S. Treasury securities and obligations of U.S. government corporations and agencies
   $ -     $ -     $ -     $ -     $ -     $ -     $ -     $ -  
Corporate and other securities
     -       -       -       -       -       -       -       -  
Municipal notes
     -       -       -       -       -       -       -       -  
Mortgage-backed securities
     12,626       (75 )     -       -       -       -       13       (1 )
Equity securities
     3       (2 )     -       -       -       -       -       -  
Total Securities available for sale
   $ 12,629     $ (77 )   $ -     $ -     $ -     $ -     $ 13     $ (1 )
Held to Maturity:
                                                                
Municipal notes
     382       (13 )     28       (2 )     -       -       27       (3 )
Total Securities held to maturity
   $ 382     $ (13 )   $ 28     $ (2 )   $ -     $ -     $ 27     $ (3 )
 
The unrealized losses on the securities held in the portfolio are not considered other than temporarily impaired (OTTI) and have not been recognized into income. This decision is based on the Company’s ability and intent to hold any potentially impaired security until maturity. The performance of the security is based on the contractual terms of the agreement, the extent of the impairment and the financial condition and credit quality of the issuer. The decline in market value is considered temporary and a result of changes in interest rates and other market variables.
 
As of December 31, 2010 and 2009, there were 16 and 3 securities in an unrealized loss position, respectively.
 
Note 3 - Loans
 
Loans at December 31, 2010 and 2009 are summarized as follows:
 
   
December 31
  
   
2010
    
2009
  
             
Real estate loans - One- to four-family residential
   $ 71,697     $ 81,620  
Commercial loans:
                
Secured by real estate
     61,010       62,376  
Other
     8,848       9,873  
Total commercial loans
     69,858       72,249  
Consumer loans:
                
Secured by real estate
     16,547       18,732  
Other
     2,118       2,553  
Total consumer loans
     18,665       21,285  
Total gross loans
     160,220       175,154  
Less:
                
Net deferred loan fees
     245       275  
Allowance for loan losses
     2,831       3,660  
Total loans - net
   $ 157,144     $ 171,219  
 
Final loan maturities and rate sensitivity of the loan portfolio are as follows:
 
   
December 31, 2010
  
   
Less Than
One Year
    
One Year
to Five
Years
    
After
Five
Years
    
Total
  
                         
Loans at fixed interest rates
   $ 15,802     $ 28,790     $ 41,941     $ 86,533  
Loans at variable interest rates
     9,676       18,105       45,906       73,687  
                                 
Total
   $ 25,478     $ 46,895     $ 87,847     $ 160,220  

 
18
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 3 - Loans (Continued)
 
Certain directors and executive officers of the Company were loan customers during 2010 and 2009.  Such loans were made in the ordinary course of business and do not involve more than a normal risk of collectibility.  An analysis of aggregate loans outstanding to directors and executive officers for the years ended December 31, 2010 and 2009 are as follows:
 
   
December 31
  
   
2010
    
2009
  
             
Aggregate balance - Beginning of Period
   $ 3,931     $ 4,428  
New loans
     1,010       2,379  
Repayments
     (1,584 )     (2,876 )
                 
Aggregate balance - End of Period
   $ 3,357     $ 3,931  
 
The following table illustrates the contractual aging of the recorded investment in past due loans by class of loans as of December 31, 2010:
 
                                       
Recorded
  
                                       
Investment > 90
  
   
30 - 59 Days
    
60 - 89 Days
    
Greater than 90
    
Total
          
Total Financing
    
Days and
  
   
Past Due
    
Past Due
    
Days
    
Past Due
    
Current
    
Receivables
    
Accruing
  
                                           
2010
                                          
                                           
Commercial Real Estate:
                                          
Commercial Real Estate - construction
   $ -     $ -     $ 1,772     $ 1,772     $ 1,498     $ 3,270     $ -  
Commercial Real Estate - other
     891       488       784       2,163       55,577       57,740       82  
Commercial - non real estate
     -       6       -       6       8,842       8,848       -  
                                                         
Consumer:
                                                        
Consumer - Real Estate
     650       108       205       963       15,584       16,547       -  
Consumer - Other
     27       14       2       43       2,075       2,118       2  
                                                         
Residential:
                                                        
Residential
     3,919       2,056       2,434       8,409       63,288       71,697       282  
Total
   $ 5,487     $ 2,672     $ 5,197     $ 13,356     $ 146,864     $ 160,220     $ 366  
  
 
19
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 3 - Loans (Continued)
 
The Bank uses an eight tier risk rating system to grade its commercial loans. The grade of a loan may change during the life of the loans. The risk ratings are described as follows:
 
Risk Grade 1 (Excellent) - Prime loans based on liquid collateral, with adequate margin or supported by strong financial statements. Probability of serious financial deterioration is unlikely. High liquidity, minimum risk, strong ratios, and low handling costs are common to these loans. This classification also includes all loans secured by certificates of deposit or cash equivalents.

Risk Grade 2 (Good) - Desirable loans of somewhat less stature than Grade 1, but with strong financial statements. Probability of serious financial deterioration is unlikely. These loans possess a sound repayment source (and/or a secondary source).  These loans represent less than the normal degree of risk associated with the type of financing contemplated.

Risk Grade 3 (Satisfactory) - Satisfactory loans of average risk – may have some minor deficiency or vulnerability to changing economic conditions, but still fully collectible. There may be some minor weakness but with offsetting features or other support readily available. These loans present a normal degree of risk associated with the type of financing. Actual and projected indicators and market conditions provide satisfactory assurance that the credit shall perform in accordance with agreed terms.

Risk Grade 4 (Acceptable) - Loans considered satisfactory, but which are of slightly “below average” credit risk due to financial weaknesses or uncertainty. The loans warrant a somewhat higher than average level of monitoring to insure that weaknesses do not advance.  The level of risk is considered acceptable and within normal underwriting guidelines, so long as the loan is given the proper level of management supervision.

Risk Grade 4.5 (Monitored) - Loans are considered “below average” and monitored more closely due to some credit deficiency that poses additional risk but is not considered adverse to the point of being a “classified” credit.  Possible reasons for additional monitoring may include characteristics such as temporary negative debt service coverage due to weak economic conditions, borrower may have experienced recent losses from operations, declining equity and/or increasing leverage, or marginal liquidity that may affect long-term sustainability.  Loans of this grade have a higher degree of risk and warrant close monitoring to insure against further deterioration.

Risk Grade 5 (Other Assets Especially Mentioned) (OAEM) - Loans which possess some credit deficiency or potential weakness, which deserve close attention, but which do not yet warrant substandard classification. Such loans pose unwarranted financial risk that, if not corrected, could weaken the loan and increase risk in the future.

Risk Grade 6 (Substandard) -  Loans are “substandard” whose full, final collectability does not appear to be a matter of serious doubt, but which nevertheless portray some form of well defined weakness that requires close supervision by Bank management. The noted weaknesses involve more than normal banking risk. One or more of the following characteristics may be exhibited in loans classified Substandard: (1) Loans  possess a defined credit weakness and the likelihood that the loan shall be paid from the primary source of repayment is uncertain; (2) Loans are not adequately protected by the current net worth and/or paying capacity of the obligor; (3) primary source of repayment is gone, and the Bank is forced to rely on a secondary source of repayment such as collateral liquidation or guarantees; (4) distinct possibility that the Bank shall sustain some loss if deficiencies are not corrected; (5) unusual courses of action are needed to maintain a high probability of repayment; (6) the borrower is not generating enough cash flow to repay loan principal, however, continues to make interest payments; (7) the Bank is forced into a subordinated or unsecured position due to flaws in documentation; (8) loans have been restructured so that payment schedules, terms, and collateral represent concessions to the borrower when compared to normal loan terms; (9) the Bank is contemplating foreclosure or legal action due to the apparent deterioration in the loan; or (10) there is a significant deterioration in the market conditions and the borrower is highly vulnerable to these conditions.

Grade 7 (Doubtful) - Loans have all the weaknesses of those classified Substandard. Additionally, however, these weaknesses make collection or liquidation in full, based on existing conditions, improbable. Loans in this category are typically not performing in conformance with established terms and conditions. Full repayment is considered “Doubtful”, but extent of loss is not currently determinable.

Risk Grade 8 (Loss) - Loans are considered uncollectible and of such little value, that continuing to carry them as an asset on the Bank’s financial statements is not feasible.
 
 
20
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 3 - Loans (Continued)
 
The following table presents the risk category of loans by class of loans based on the most recent analysis performed and the contractual aging as of December 31, 2010:
 
   
Commercial Real Estate
    
Commercial Real Estate
        
 Loan Grade
  
Construction
    
Other
    
Commercial
  
                   
1-2
   $ -     $ -     $ 5  
3
     70       12,411       2,958  
4
     1,428       33,754       5,631  
5
     -       3,245       248  
6
     1,772       8,330       6  
7
     -       -       -  
8
     -       -       -  
Total
   $ 3,270     $ 57,740     $ 8,848  
 
For residential real estate and other consumer credit the Company also evaluates credit quality based on the aging status of the loan and by payment activity.  Loans 60 or more days past due are monitored by the collection committee.
 
The following tables present the risk category of loans by class based on the most recent analysis performed as of December 31, 2010:
 
   
Residential
  
       
Grade
      
       
Pass
   $ 68,301  
Special Mention
     -  
Substandard
     3,396  
    Total
   $ 71,697  

   
Consumer -
        
   
Real Estate
    
Consumer - Other
  
             
Performing
   $ 16,341     $ 2,116  
Nonperforming
     206       2  
     Total
   $ 16,547     $ 2,118  
   
 
21
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 3 - Loans (Continued)
 
The following table presents the recorded investment in non-accrual loans by class as of December 31, 2010:
 
   
2010
  
       
Commercial Real Estate:
      
Commercial Real Estate - construction
   $ 1,772  
Commercial Real Estate - other
     1,148  
Commercial
     -  
         
Consumer:
        
Consumer - real estate
     206  
Consumer - other
     -  
         
Residential:
        
Residential
     3,114  
         
Total
   $ 6,240  
 
Information about impaired loans as of and for the year ended December 31, 2009 is as follows:
 
   
2009
  
Impaired loans without a  valuation allowance
   $ 3,502  
Impaired loans with a valuation allowance
     2,344  
Total impaired loans
   $ 5,846  
Valuation allowance related to impaired loans
   $ 743  
Total non-accrual loans
   $ 8,947  
Total loans past-due ninety days or more and still accruing
   $ 2,839  

   
2009
  
Average investment in impaired loans
   $ 14,914  
Interest income recognized on impaired loans
   $ -  
Interest income recognized on a cash basis on impaired loans
   $ -  
 
No additional funds are committed to be advanced in connection with impaired loans.
  
 
22
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 3 - Loans (Continued)
 
The Bank has classified approximately $740,000 of its impaired loans as troubled debt restructuring as of December 31, 2010.
 
For the majority of the Bank’s impaired loans, the Bank will apply the observable market price methodology. However, the Bank may also utilize a measurement incorporating the present value of expected future cash flows discounted at the loan’s effective rate of interest. To determine observable market price, collateral asset values securing an impaired loan are periodically evaluated. Maximum time of re-evaluation is every 12 months. In this process, third party evaluations are obtained and heavily relied upon. Until such time that updated evaluations are received, the Bank may discount the collateral value used.
 
The Bank uses the following guidelines as stated in policy to determine when to realize a charge-off, whether a partial or full loan balance. A charge down in whole or in part is realized when unsecured consumer loans, credit card credits and overdraft lines of credit reach 90 days delinquency. At 120 days delinquent, secured consumer loans are charged down to the value of collateral, if repossession of the collateral is assured and/or in the process of repossession.  Consumer mortgage loan deficiencies are charged down upon the sale of the collateral or sooner upon the recognition of collateral deficiency. Commercial credits are charged down at 90 days delinquency, unless an established and approved work-out plan is in place or litigation of the credit will likely result in recovery of the loan balance.  Upon notification of bankruptcy, unsecured debt is charged off. Additional charge-off may be realized as further unsecured positions are recognized.
 
 
23
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 3 - Loans (Continued)
 
The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2010:
 
                     
Average
    
Interest
  
   
Unpaid Principal
    
Recorded
    
Related
    
Recorded
    
Income
  
   
Balance
    
Investment
    
Allowance
    
Investment
    
Recognized
  
2010
                              
                               
With no related allowance recorded:
                              
Commercial
   $ -     $ -     $ -     $ -     $ -  
Commercial Real Estate - Construction
     -       -       -       -       -  
Commercial Real Estate - Other
     822       674       -       -       -  
Consumer - Real Estate
     124       123       -       193       -  
Consumer - Other
     -       -       -       -       -  
Residential
     1,842       1,770       -       1,803       -  
                                         
With a specific allowance recorded:
                                        
Commercial
     -       -       -       -       -  
Commercial Real Estate - Construction
     3,449       1,772       305       1,805       -  
Commercial Real Estate - Other
       586       474       89       1,132       -  
Consumer - Real Estate
     83       83       25       14       -  
Consumer - Other
     -       -       -       -       -  
Residential
     1,416       1,344       165       1,330       -  
                                         
Totals:
                                        
Commercial
   $ -     $ -     $ -     $ -     $ -  
Commercial Real Estate - Construction
   $ 3,449     $ 1,772     $ 305     $ 1,805     $ -  
Commercial Real Estate - Other
   $ 1,408     $ 1,148     $ 89     $ 1,132     $ -  
Consumer - Real Estate
   $ 207     $ 206     $ 25     $ 207     $ -  
Consumer - Other
   $ -     $ -     $ -     $ -     $ -  
Residential
   $ 3,258     $ 3,114     $ 165     $ 3,133     $ -  
  
The ALLL has a direct impact on the provision expense. An increase in the ALLL is funded through recoveries and provision expense.
 
 
24
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 3 - Loans (Continued)
 
Activity in the allowance for loan and lease losses was as follows for the year ended December 31, 2010:
 
   
Commercial
    
Commercial
          
Consumer
                          
   
Construction
    
Real Estate
    
Commercial
    
Real Estate
    
Consumer
    
Residential
    
Unallocated
    
Total
  
2010
                                                
                                                 
Allowance for credit losses:                                                                
Beginning Balance
   $ 997     $ 1,513     $ 245     $ 211     $ 45     $ 649     $ -     $ 3,660  
Charge-offs
     (1,013 )     (512 )     -       (220 )     (99 )     (258 )     -       (2,102 )
Recoveries
     60       85       -       14       11       2       -       172  
Provision
     491       195       (53 )     223       102       143       -       1,101  
Ending Balance
   $ 535     $ 1,281     $ 192     $ 228     $ 59     $ 536     $ -     $ 2,831  
                                                                 
Ending balance: individually evaluated for impairment
   $ 305     $ 89     $ -     $ 25     $ -     $ 165     $ -     $ 584  
                                                                 
Ending balance: loans collectively evaluated for impairment
   $ 230     $ 1,192     $ 192     $ 203     $ 59     $ 371     $ -     $ 2,247  
                                                                 
Ending balance: loans acquired with deteriorated credit quality
   $ -     $ -     $ -     $ -     $ -     $ -     $ -     $ -  
                                                                 
Financing Receivables:
                                                                
Ending Balance
   $ 3,270     $ 57,740     $ 8,848     $ 16,547     $ 2,118     $ 71,697     $ -     $ 160,220  
                                                                 
Ending balance: individually evaluated for impairment
   $ 1,772     $ 1,148     $ -     $ 206     $ -     $ 3,114     $ -     $ 6,240  
                                                                 
Ending balance: loans collectively evaluated for impairment
   $ 1,498     $ 56,592     $ 8,848     $ 16,341     $ 2,118     $ 68,583     $ -     $ 153,980  
                                                                 
Ending balance: loans acquired with deteriorated credit quality
   $ -     $ -     $ -     $ -     $ -     $ -     $ -     $ -  
 
   
Year Ended
December 31
  
   
2009
  
Balance - Beginning of period
   $ 5,647  
         
Provision for losses
     6,196  
Charge-offs
     (8,247 )
Recoveries
     64  
         
Balance - End of period
   $ 3,660  
 
 
25
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 4 - Property and Equipment
 
A summary of property and equipment is as follows:
 
   
December 31
  
   
2010
    
2009
  
             
Land
   $ 1,188     $ 1,198  
Land improvements
     214       221  
Buildings
     6,470       6,528  
Equipment
     3,573       3,570  
                 
Total property and equipment
     11,445       11,517  
                 
Accumulated depreciation
     5,418       4,953  
                 
Net property and equipment
   $ 6,027     $ 6,564  
 
Depreciation expense was $509,000 and $562,000 for the periods ended December 31, 2010 and 2009, respectively.
 
Note 5 - Servicing
 
Loans serviced for others are not included in the accompanying consolidated statement of financial condition.  The unpaid principal balances of mortgage and other loans serviced for others were approximately $144,948,000 and $140,562,000 at December 31, 2010 and 2009, respectively.
 
The balance of capitalized servicing rights, net of valuation allowance, is included in other assets at December 31, 2010 and 2009.
 
The key economic assumptions used in determining the fair value of the mortgage servicing rights are as follows:
 
   
December 31,
  
   
2010
    
2009
  
Annual constant prepayment speed (CPR)
     15.67 %     17.23 %
Weighted average life (in months)
     246       249  
Discount rate
     7.96 %     8.17 %
 
The fair value of our mortgage servicing rights was estimated to be $1,251,000 and $1,144,000 and the weighted average life remaining of those rights was 40 months and 37 months at December 31, 2010 and December 31, 2009, respectively.
 
26
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 5 – Servicing (Continued)
 
The following table summarizes mortgage servicing rights capitalized and amortized, along with the aggregate activity in related valuation allowances:
 
   
December 31
  
   
2010
    
2009
  
             
Balance, beginning of period
   $ 730     $ 430  
Originated mortgage servicing rights capitalized
     536       584  
Amortization of mortgage servicing rights
     (306 )     (284 )
Balance - end of period
     960       730  
Valuation allowances:
                
Balance at beginning of year
     -       -  
Additions
     -       -  
Reductions
     -       -  
Write-downs
     -       -  
                 
Balance, end of year (net of allowances)
   $ 960     $ 730  
 
Note 6 - Intangible Assets
 
Intangible assets of the Company are summarized as follows:
 
   
December 31, 2010
  
   
Gross Carrying
Amount
    
Accumulated
Amortization
    
Net Carrying
Amount
  
Amortized intangible assets:
                  
Core deposit
   $ 3,081     $ 2,841     $ 240  
Commission residual
     600       213       387  
Total
   $ 3,681     $ 3,054     $ 627  

   
December 31, 2009
  
   
Gross Carrying
Amount
    
Accumulated
Amortization
    
Net Carrying
Amount
  
Amortized intangible assets:
                  
Core deposit
   $ 3,081     $ 2,664     $ 417  
Commission residual
     600       97       503  
Total
   $ 3,681     $ 2,761     $ 920  
  
 
27
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 6 - Intangible Assets (continued)
 
Amortization expense was $293,000 and $273,000 for the periods ended December 31, 2010 and 2009, respectively.
 
As discussed in Note 1, on February 27, 2009 the Company announced that it had sold the majority of the assets of the InsuranCenter of Alpena. The Company allocated the goodwill between the assets sold and the assets retained.
 
The assets retained relate to a future stream of commissions related to the override commission discussed earlier. Under an agreement, the Company will receive a portion of the override commission through April, 2014. Management computed an estimated cash flow on this commission and using a 6.0% discount rate determined a fair value of $600,000. Since the $600,000 allocation of fair value relates to a finite life asset, the Company re-characterized the goodwill as an amortizable intangible and began amortizing the asset in March, 2009. The remaining estimated life as of December 31, 2010 is 3.3 years and the asset will be amortized straight-line through April 1, 2014, or approximately $9,700 per month.

The remaining amortization period for the core deposit intangible as of December 31, 2010 is 1.4 years. The core deposit intangible will be amortized straight-line through May, 2012 or approximately $14,700 per month.
 
 
28
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 7 - Deposits
 
Deposit accounts, by type and range of rates, consist of the following:
 
   
December 31
  
   
2010
    
2009
  
Account Type
            
             
NOW accounts and MMDA
   $ 44,107     $ 37,092  
Regular savings accounts
     16,785       15,722  
                 
Total
     60,892       52,814  
Certificate of Deposit Rates
                
                 
0.50 percent to 0.99 percent
     9,852       5,926  
1.00 percent to 1.99 percent
     35,119       32,658  
2.00 percent to 2.99 percent
     26,573       24,116  
3.00 percent to 3.99 percent
     8,718       15,629  
4.00 percent to 4.99 percent
     3,488       11,912  
5.00 percent to 8.99 percent
     475       3,971  
                 
Total certificate of deposits
     84,225       94,212  
                 
Total interest-bearing deposits
   $ 145,117     $ 147,026  
 
Certificates of deposit $100,000 or greater at December 31, 2010 and 2009 were $26,702,000 and $31,642,000, respectively.

The following table sets forth the amount and maturities of certificates of deposit:
 
   
December 31, 2010
  
   
Amount Due
  
Rate
  
Less than
1 Year
    
1-2
Years
    
2-3
Years
    
3-5
Years
    
Greater
than
5 Years
    
Total
  
0.50 percent to
                                    
0.99 percent
   $ 6,931     $ 2,921     $ -     $ -     $ -     $ 9,852  
1.00 percent to
                                                
1.99 percent
     28,038       6,125       671       271       14       35,119  
2.00 percent to
                                                
2.99 percent
     9,952       5,038       3,560       6,045       1,978       26,573  
3.00 percent to
                                                
3.99 percent
     4,399       434       1,855       1,460       570       8,718  
4.00 percent to
                                                
4.99 percent
     2,272       824       262       46       84       3,488  
5.00 percent to
                                                
8.99 percent
     467       -       -       -       8       475  
Total
   $ 52,059     $ 15,342     $ 6,348     $ 7,822     $ 2,654     $ 84,225  
  
 
29
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
  
Note 7 – Deposits (continued)
 
Interest expense on deposits is summarized as follows:
  
   
Year Ended December 31
  
   
2010
    
2009
  
                 
NOW and MMDAs
   $ 324     $ 384  
Regular savings
     8       17  
Certificates of deposit
     1,964       3,056  
                 
Total
   $ 2,296     $ 3,457  
 
Deposits from related parties held by the Bank at December 31, 2010 and 2009 amounted to $989,000 and $617,000, respectively.
 
Note 8 - Federal Home Loan Bank and Federal Reserve Advances
 
The Bank has advances from the Federal Home Loan Bank. Interest rates range from 0.50% to 3.81% with a weighted average interest rate of 2.23%. These advances contain varying maturity dates through December 30, 2013 with a weighted average maturity of approximately 19 months. The advances are collateralized by approximately $48,338,000 and $58,846,000 of mortgage loans as of December 31, 2010 and 2009, respectively.  In addition, at December 31, 2010 and 2009, securities with a carrying value of $16,843,000 and $16,256,000, respectively, were pledged as collateral for Federal Home Loan Bank advances. Available borrowings with the Federal Home Loan Bank at December 31, 2010 totaled $46,797,000, of which $29,000,000 was outstanding.
 
 
30
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 8 - Federal Home Loan Bank  and Federal Reserve Advances (continued)
 
The advances are subject to prepayment penalties subject to the provisions and conditions of the credit policy of the Federal Home Loan Bank.  Future maturities of the advances are as follows:
 
December 31, 2010
  
Years Ending
December 31
  
Amount
    
Weighted Average 
Interest Rate
  
             
2011
   $ 7,500       1.24  
2012
     17,000       2.37  
2013
     4,500       3.34  
Total
   $ 29,000       2.23  
 
Variable rate advances totaled $2,000,000 at December 31, 2010.
 
In 2009, the Bank entered into a discount window loan agreement with the Federal Reserve Bank that allows for advances up to seventy-five percent of the collateral balance. As of December 31, 2010, these advances are secured by investment securities with a fair value of approximately $3,800,000 and are generally due within 28 days from the date of the advance. The interest rate on the advances is based on the quoted federal reserve discount window rate (effective rate of 0.75 percent as of December 31, 2010).  At December 31, 2010 and 2009,  the Bank had $0 outstanding in advances.
 
Note  9 - Note Payable
 
In connection with the purchase of ICA, an unsecured note payable was issued to an individual, payable in annual installments of $180,000, including interest at 5.5 percent.  In January 2010, the balance of the note of $631,000 was fully paid by the Company.
 
 
31
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 10 - Federal Income Tax
 
The analysis of the consolidated provision for federal income tax is as follows:
 
   
Year Ended December 31
  
   
2010
    
2009
  
             
Continuing operations:
            
Current provision
   $ 201     $ (685 )
Deferred benefit
     ( 201 )     1,775  
      -          
Total from continuing operations
   $ -     $ 1,090  
                 
Discontinued operations
     -       (24 )
                 
Total
   $ -     $ 1,066  
 
The Company has net operating loss carryforwards of approximately  $7.6 million generated from December 31, 2007 through December 31, 2009 that are available to reduce total taxable income through the years ending December 31, 2029.
 
A reconciliation of the federal income tax expense and the amount computed by applying the statutory federal income tax rate (34 percent) to income before federal income tax is as follows:
 
   
Year Ended December 31
  
   
2010
    
2009
  
Tax at statutory rate
   $ 81     $ (1,913 )
Increase (decrease) from:
                
Change in valuation allowance
     (167 )     3,372  
ESOP expense
     -       (235 )
Tax-exempt interest
     (60 )     (81 )
Other
     146       (53 )
                 
Total income tax expense
   $ -     $ 1,090  
 
32
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 10 - Federal Income Tax (Continued)
 
The net deferred tax asset was comprised of the following temporary differences:
 
   
December 31
  
   
2010
    
2009
  
Deferred tax assets:
            
Allowance for loan losses
   $ 327     $ 660  
Valuation allowance for real estate held for sale
     538       136  
Non-accrual loan interest
     87       12  
Directors' benefit plan
     347       361  
Net operating loss carryforward
     2,572       2,773  
Investment in  subsidiary
     784       784  
Other
     257       384  
                 
Total deferred tax assets
     4,912       5,110  
                 
Less: valuation allowance
     3,205       3,372  
                 
Deferred tax liabilities:
                
Mortgage servicing rights
     327       248  
Partnership losses
     121       113  
Unrealized gain on available-for-sale securities
     75       218  
Depreciation
     308       361  
Other
     217       239  
                 
Total deferred tax liabilities
     1,048       1,179  
                 
Net deferred tax asset
   $ 659     $ 559  
 
For tax years beginning prior to January 1, 1996, a qualified thrift institution was allowed a bad debt deduction for tax purposes based on a percentage of taxable income or on actual experience.  The Bank used the percentage of taxable income method through December 31, 1995.
 
 
33
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 10 - Federal Income Tax (Continued)
 
A deferred tax liability has not been recognized for the tax bad debt base year reserves of the Bank.  The base year reserves are the balance of reserves as of December 31, 1987.  At December 31, 2010 and 2009, the amount of those reserves was approximately $60,000.  The amount of the unrecognized deferred tax liability at December 31, 2010 and 2009 was approximately $20,000.
 
Note 11 - Off Balance Sheet Risk Commitments and Contingencies
 
Credit-Related Financial Instruments - The Company is a party to credit-related financial instruments with off balance sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include commitments to extend credit, standby letters of credit, and commercial letters of credit.  Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statement of financial condition.
 
The Company’s exposure to credit loss is represented by the contractual amount of these commitments.  The Company follows the same credit policies in making commitments as it does for on-balance-sheet instruments.
 
The following financial instruments were outstanding whose contract amounts represent credit risk:
 
   
December 31
  
   
2010
    
2009
  
                 
Commitments to grant loans
   $ 13,019     $ 12,000  
Unfunded commitments under lines of credit
     14,138       13,976  
Commercial and standby letters of credit
     5       5  
 
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for equity lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Company, is based on management's credit evaluation of the customer.
 
 
34
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 11 - Off Balance Sheet Risk Commitments and Contingencies (Continued)
 
Unfunded commitments under commercial lines of credit, revolving credit lines, and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. In most cases, these lines of credit are collateralized and usually do not contain a specified maturity date and may not be drawn upon to the total extent to which the Company is committed.

Commercial and standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those letters of credit are primarily used to support public and private borrowing arrangements. Essentially all letters of credit issued have expiration dates within one year.  Under ASC 840-10-25-34, fees earned on commercial and standby letters of credit are required to be deferred over the contractual life of the letter of credit.  The Company determined that the fair value of guarantees on standby letters of credit has an immaterial effect on the financial results at December 31, 2010 and 2009.

To reduce credit risk related to the use of credit-related financial instruments, the Company generally holds collateral supporting those commitments if deemed necessary. The amount and nature of the collateral obtained is based on the Company's credit evaluation of the customer. Collateral held varies, but may include cash, securities, accounts receivable, inventory, property, plant, equipment, and real estate.

If the counterparty does not have the right and ability to redeem the collateral or the Company is permitted to sell or repledge the collateral on short notice, the Company records the collateral in its balance sheet at fair value with a corresponding obligation to return it.
  
 
35
 
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
 
Note 11 - Off Balance Sheet Risk Commitments and Contingencies (continued)
 
Legal Contingencies – At December 31, 2010, there were no material pending legal proceedings to which the Company is a party or to which any of its property was subject, except for proceedings which arise in the ordinary course of business.  In the opinion of management, pending legal proceedings will not have a material effect on the consolidated financial position or results of operation of the Company.

Note 12- Stockholders’ Equity
 
Payment of dividends on the common stock is subject to determination and declaration by the Board of Directors and depends on a number of factors, including capital requirements, regulatory limitation on payment of dividends, the Bank’s results of operations and financial condition, tax considerations, and general economic conditions.
 
The Bank is subject to various regulatory capital requirements administered by the OTS.  Failure to meet certain capital requirements can initiate certain mandatory and possibly additional discretionary action by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off balance sheet items as calculated under regulatory accounting practices.  The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators regarding components, risk-weightings, and other factors.
 
During the most recent regulatory examination, the OTS categorized the Bank as “well-capitalized” per definition of 12 CFR Section 565.4(b)(1).  To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, tier 1 risk based, and tangible equity ratios as set forth in the table below.  There are no conditions or events since that notification that management believes have changed the Bank’s categorization.  Consolidated data has not been disclosed as the amounts and ratios are not significantly different.
 
36
 
 
  
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
  
Note 12 Stockholders’ Equity (continued)

   
Actual
    
For Capital
Adequacy Purposes
    
To be Categorized as
Well-Capitalized Under
Prompt Corrective
Action Provisions
  
   
Amount
    
Ratio
    
Amount
    
Ratio
    
Amount
    
Ratio
  
   
(Dollars in Thousands)
  
                                     
December 31, 2010
                                    
Total capital (to risk-
                                    
weighted assets)
   $ 22,763       15.6 %   $ 11,693       8.0 %   $ 14,617       10.0 %
Tier 1 capital (to risk-
                                                
weighted assets)
   $ 20,931       14.3 %   $ 5,847       4.0 %   $ 8,770       6.0 %
Tangible capital (to
                                                
tangible assets)
   $ 20,931       9.8 %   $ 3,214       1.5 %   $ 4,285       2.0 %
                                                 
December 31, 2009
                                                
Total capital (to risk-
                                                
weighted assets)
   $ 22,304       13.6 %   $ 13,153       8.0 %   $ 16,442       10.0 %
Tier 1 capital (to risk-
                                                
weighted assets)
   $ 20,239       12.3 %   $ 6,577       4.0 %   $ 9,865       6.0 %
Tangible capital (to
                                                
tangible assets)
   $ 20,239       8.8 %   $ 3,470       1.5 %   $ 4,627       2.0 %
 
Reconciliation of the Bank’s GAAP to Regulatory Capital:

   
December 31
  
   
      2010      
    
      2009      
  
             
GAAP Capital
   $ 22,272     $ 22,119  
Reconciling items:
                
Less: Investment in and advances to
                
nonincludable subsidaries
     (310 )     (311 )
Core deposit and other intangible assets
     (627 )     (920 )
Disallowed deferred tax asset
     (258 )     (226 )
Unrealized gain on securities
                
available for sale
     (146 )     (423 )
                 
Tangible and core capital
     20,931       20,239  
                 
Allowable unrealized gain on
                
securities available for sale
     -       1  
General valuation allowance
     1,832       2,064  
                 
Risk Based Capital
   $ 22,763     $ 22,304  
 
 
37
 
  
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
  
Note 13 - Employee Benefit Plans
 
Defined Benefit Pension Plan
 
The Bank is a participant in the multiemployer Financial Institutions Retirement Fund (FIRF or the “Plan”), which covers substantially all of its officers and employees.  The defined benefit plan covers all employees who have completed one year of service, attained age 21, and worked at least 1,000 hours during the year.  Normal retirement age is 65, with reduced benefits available at age 55.  The Bank’s contributions are determined by FIRF and generally represent the normal cost of the Plan.  Specific Plan assets and accumulated benefit information for the Bank’s portion of the Plan are not available.  Under the Employee Retirement Income Security Act of 1974 (ERISA), a contributor to a multiemployer pension plan may be liable in the event of complete or partial withdrawal for the benefit payments guaranteed under ERISA.  Effective July 1, 2005 the plan was frozen as to current participants and any new employees hired after July 1, 2004 were excluded from the plan. The expense of the Plan allocated to the Bank was $58,000 and $36,000 for the years ended December 31, 2010 and 2009, respectively.
 
401(k) Savings Plan
 
The Bank has a Section 401(k) savings plan covering substantially all of its employees who meet certain age and service requirements.  Contributions to the plan by the Bank are discretionary in nature in such amounts determined by the Board of Directors. The expense under the plan for both the years ended December 31, 2010 and 2009 was $0.
 
Nonqualified Deferred Compensation Plan
 
The Bank has a nonqualified deferred compensation plan for certain of its directors.  Through 1998, each eligible director could voluntarily defer all or part of his or her director’s fees to participate in the program.  The plan is currently unfunded and amounts deferred are unsecured and remain subject to claims of the Bank’s general creditors.
 
Directors are paid once they reach normal retirement age or sooner for reason of death, total disability, or termination.  The Bank may terminate the plan at any time.  The amount recorded under the plan totaled approximately $819,000 and $850,000 at December 31, 2010 and 2009, respectively.  The expense under the plan for the years ended December 31, 2010 and 2009 was $54,000 and $98,000, respectively.
 
 
38
 
  
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
  
Note 13 - Employee Benefit Plans (Continued)
 
Employee Stock Ownership Plan
 
Effective January 1, 1994, the Bank implemented an employee stock ownership plan (ESOP).  The ESOP covers substantially all employees who have completed one year of service, attained age 21, and worked at least 1,000 hours during the year.  To fund the ESOP, the Bank borrowed $480,000 from an outside party to purchase 48,000 shares of the Company’s common stock at $10 per share.  The ESOP note was payable quarterly with interest at the prime rate and was retired in 1999.  All of the 1994 shares were allocated as of December 31, 1999.  Compensation expense is measured by the fair value of ESOP shares allocated to participants during a fiscal year.
 
Pursuant to the 2005 second-step conversion and stock offering, the shareholders of the Company approved the purchase of 8% of shares sold in the stock offering by the ESOP. The Company provided a loan to the ESOP, which was used to purchase 138,709 shares of the Company’s common stock in the stock offering at $10 per share. The loan bears interest at a rate equal to the current prime rate, adjustable on January 1 of each year and provides for repayment of principal over the 15 year term of the loan.  Since the Company provided the loan to the ESOP, the note receivable is not included in the Company’s balance sheet. Accordingly, the Company did not recognize interest income on the loan.
 
The Company makes annual contributions to the ESOP sufficient to support the debt service of the loan. The loan is secured by the shares purchased, which are held in a suspense account for allocation among the participants as the loan is paid. Dividends paid on unallocated shares are not considered dividends for financial reporting purposes and are used to pay principal and interest on the ESOP loan. Dividends on allocated shares are charged to retained earnings.
 
The Board of Directors of the Company authorized prepayments of principal on the ESOP loan of $715,000 in 2009.  The loan was paid in full as of December 31, 2009.
 
 
39
 
  
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
  
Note 13 - Employee Benefit Plans (Continued)
 
Compensation expense is recognized for the ESOP equal to the average fair value of shares committed to be released for allocation to participant accounts. Any difference between the average fair value of shares committed to be released for allocation and the ESOP’s original acquisition cost is charged or credited to stockholders’ equity (additional paid-in capital). During the years ended December 31, 2010 and 2009, respectively, 7,391 and 833 shares were sold into the open market. Total compensation expense for the years ended December 31, 2010 and 2009 was $0 and $99,000, respectively.
 
Shares held by the ESOP include the following:
 
   
December 31
  
   
2010
    
2009
  
                                                                 
Allocated
     152,156       182,570  
Unallocated
     -       -  
Total
     152,156       182,570  
 
There were 23,023 and 2,173 shares distributed to ESOP participants in 2010 and 2009, respectively.
 
The cost of unallocated ESOP shares (shares not yet released for allocation) is reflected as a reduction of stockholders’ equity. As of December 31, 2009 all shares in the plan were allocated due to the prepayment of the ESOP loan.
 
Stock-Based Compensation Plans
 
The Company’s 1996 Stock Option Plan (the “1996 Plan”), which was approved by shareholders, permits the grant of share options to its employees for up to 127,491 shares of common stock  (retroactively adjusted for the exchange ratio applied in the Company’s 2005 stock offering and related second-step conversion). The Company’s 2006 Stock-Based Incentive Plan (the “2006 Plan”), which was approved by the shareholders on May 17, 2006, permits the award of up to 242,740 shares of common stock of which the maximum number to be granted as Stock Options is 173,386 and the maximum that can be granted as Restricted Stock Awards is 69,354. Option awards are granted with an exercise price equal to the market price of the Company’s stock at the date of grant; those option awards generally vest based on five years of continual service and have ten year contractual terms. Certain options provide for accelerated vesting if there is a change in control (as defined in the Plans).  Shares issued under the Plan and exercised pursuant to the exercise of the stock option plan may be either authorized but unissued shares or reacquired shares held by the Company as treasury stock.
 
 
40
 
  
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
  
Note 13 - Employee Benefit Plans (Continued)
 
Stock Options - A summary of option activity under the Plan during the years ended December 31, 2010 and 2009 is presented below:

 
               
Weighted-Average
        
         
Weighted-
    
Remaining
        
         
Average
    
Contractual Term
    
Aggregate
  
Options
  
Shares
    
Exercise Price
    
(Years)
    
Intrinsic Value
  
                         
Outstanding at January 1, 2009
     192,132     $ 9.48       7.5       -  
                                 
Granted in 2009
     -     $ 0.00                  
                                 
Exercised in 2009
     -     $ 0.00                  
                                 
Forfeited or Expired in 2009
     (4,000 )   $ 9.57                  
                                 
Outstanding at December 31, 2009
     188,132     $ 9.47       6.3       -  
                                 
Granted in 2010
     -     $ 0.00                  
                                 
Exercised in 2010
     -     $ 0.00                  
                                 
Forfeited or expired in 2010
     (2,000 )   $ 9.54                  
                                 
Oustanding at December 31, 2010
     186,132     $ 9.47       5.3       -  
                                 
Options Exercisable at December 31, 2010
     148,774     $ 9.46       5.2       -  
 
At December 31, 2010, 52,300 shares were available for future granting of options.
 
 
41
 
  
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
  
Note 13 - Employee Benefit Plans (Continued)
 
The aggregate intrinsic value of outstanding options shown in the table above represents the total pretax intrinsic value (i.e. the difference between the Company’s closing stock price of $2.80 on December 31, 2010 and the exercise price times the number of shares) that would have been received by the option holder had all option holders exercised their options on December 31, 2010.  The amount changes based on the fair market value of the stock.
 
As of December 31, 2010 there was $32,000 of total unrecognized compensation cost, net of expected forfeitures, related to nonvested options under the Plan. That cost is expected to be recognized over a weighted-average period of 0.5 years. The total fair value of shares vested during the year ended December 31, 2010 and 2009 was $70,000 and $60,000, respectively.
 
A summary of the status of the Company’s nonvested options as of December 31, 2010 and 2009 and changes during the years then  ended is presented below:
 
         
Weighted-Average
  
         
Grant-Date
  
Nonvested Shares
  
       Shares       
    
Fair Value
  
             
Nonvested at January 1, 2009
     111,774     $ 2.11  
                 
Granted
     -     $ 0.00  
                 
Vested
     (36,368 )   $ 2.11  
                 
Forfeited
     (1,930 )   $ 2.10  
                 
Nonvested at December 31, 2009
     73,476     $ 2.11  
                 
Granted
     -       -  
                 
Vested
     (34,118 )   $ 2.11  
                 
Forfeited
     (2,000 )   $ 2.10  
                 
Nonvested at December 31, 2010
     37,358     $ 2.11  
 
 
42
 
  
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
  
Note 13 - Employee Benefit Plans (Continued)
 
Restricted Stock Awards – The Company did not grant any award shares during the years ended December 31, 2010 and 2009. Compensation expense for 2010 and 2009 related to awards granted under this plan was $124,000 and $128,000.
 
The shares vest over a five year service period. As of December 31, 2010 there was $38,000 of unrecognized compensation cost related to nonvested restricted stock awards under the Plan.
 
The following table summarizes the activity of restricted stock awards under the Plan during the years ended December 31, 2010 and 2009:
 
   
        2010        
    
        2009        
  
             
Beginning of period
     26,000       38,850  
                 
Granted
     -       0  
                 
Vested
     (12,750 )     (12,850 )
                 
Forfeited
     (200 )     0  
                 
Nonvested, end of period
     13,050       26,000  
 
At December 31, 2010, 5,234 shares were available for future grants of award shares.
 
Note 14 - Fair Values Measurements
 
Accounting standards require certain assets and liabilities be reported at fair value on the financial statements and provide a framework for establishing that fair value.  The framework for determining fair value is based on a hierarchy that prioritizes the inputs and valuation techniques used to measure fair value.

The following tables present information about the Company’s assets measured at fair value on a recurring basis at December 31, 2010 and 2009, and the valuation techniques used by the Company to determine those fair values.

 
43
 
  
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
  
Note 14 - Fair Values Measurements (Continued)
 
Assets and Liabilities Measured at Fair Value on a Recurring Basis at December 31, 2010
(in Thousands)
 
   
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
    
Significant
Other
Observable
Inputs
(Level 2)
    
Significant
Unobservable
Inputs
(Level 3)
    
Balance at
December 31,
2010
  
Assets
                        
Investment securities- available-for-sale:
                        
US Treasury securities and obligations of U.S. government corporations and agencies
   $ -     $ 4,562     $ -     $ 4,562  
Municipal notes
     -       5,046       -       5,046  
Mortgage-backed securities
     -       25,692       -       25,692  
Equity securities
     -       1       -       1  
                                 
Total investment securities - available-for-sale
   $ -     $ 35,301     $ -     $ 35,301  
       
Assets and Liabilities Measured at Fair Value on a Recurring Basis at December 31, 2009
(in Thousands)
  
   
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
    
Significant
Other
Observable
Inputs
(Level 2)
    
Significant
Unobservable
Inputs
(Level 3)
    
Balance at
December 31,
2009
  
Assets
                        
Investment securities- available-for-sale:
                        
US Treasury securities and obligations of U.S. government corporations and agencies
   $ -     $ 8,257     $ -     $ 8,257  
Municipal notes
     -       8,053       -       8,053  
Corporate securities
     -       1,002       -       1,002  
Mortgage-backed securities
     -       16,397       -       16,397  
Equity securities
     -       4       -       4  
                                 
Total investment securities - available-for-sale
   $ -     $ 33,713     $ -     $ 33,713  

In general, fair values determined by Level 1 inputs use quoted prices in active markets for identical assets or liabilities that the Corporation has the ability to access.

Fair values determined by Level 2 inputs use other inputs that are observable, either directly or indirectly.  These Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals.
 
 
44
 
  
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
  
Note 14 - Fair Values Measurements (Continued)
 
Level 3 inputs are unobservable inputs, including inputs that are available in situations where there is little, if any, market activity for the related asset.  These Level 3 fair value measurements are based primarily on management’s own estimates using pricing models, discounted cash flow methodologies, or similar techniques taking into account the characteristics of the asset.

In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest level input that is significant to the valuation. The Company’s assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each asset or liability.

The Company also has assets that under certain conditions are subject to measurement at fair value on a nonrecurring basis. These assets include impaired loans and other real estate owned.  The Company has estimated the fair values of these assets based primarily on Level 3 inputs as described above.
 
 
45
 
  
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
  
Note 14 - Fair Values Measurements (Continued)
 
Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2010

   
Balance at
December 31,
2010
    
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
    
Significant
Other
Observable
Inputs (Level
2)
    
Significant
Unobservable
Inputs (Level
3)
    
Change in fair
value for the
twelve-month
period ended
December 31,
2010
  
                               
Impaired loans accounted for under FASB ASC 310-10
   $ 2,920     $ -     $ -     $ 2,920     $ 878  
                                         
Other real estate owned -residential mortgages
   $ 514     $ -     $ -     $ 514     $ 68  
                                         
Other Real estate owned - commercial
   $ 2,569     $ -     $ -     $ 2,569     $ 830  
                                         
Total change in fair value
                                   $ 1,776  

Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2009

   
Balance at
December 31,
2009
    
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
    
Significant
Other
Observable
Inputs (Level
2)
    
Significant
Unobservable
Inputs (Level
3)
    
Change in fair
value for the
twelve-month
period ended
December 31,
2009
  
                               
Impaired loans accounted for under FASB ASC 310-10
   $ 5,846     $ -     $ -     $ 5,846     $ 3,584  
                                         
Other real estate owned -residential mortgages
   $ 584     $ -     $ -     $ 584     $ 11  
                                         
Other Real estate owned - commercial
   $ 2,996     $ -     $ -     $ 2,996     $ 955  
                                         
Total change in fair value
                                   $ 4,550  

The Company does not record loans at fair value on a recurring basis.  However, on occasion, a loan is considered impaired and an allowance for loan loss is established.  A loan is considered impaired when it is probable that all of the principal and interest under the original terms of the loan may not be collected.  Once a loan is identified as individually impaired, management measures the impairment in accordance with FASB ASC 310-10, Accounting by Creditors for Impairment of a Loan.  In accordance with FASB ASC 820-10, Fair Value Measurements, impaired loans where an allowance is established based on fair value of collateral require classification in the fair value hierarchy.  When fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2.  When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired value as nonrecurring Level 3.
 
 
46
 
  
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
  
Note 14 - Fair Values Measurements (Continued)
 
Other real estate owned assets are reported in the above nonrecurring table at initial recognition of impairment and on an ongoing basis until recovery or charge-off. At the time of foreclosure or repossession, real estate owned and repossessed assets are adjusted to fair value less costs to sell upon transfer of the loans to real estate owned and repossessed assets, establishing a new cost basis. At that time, they are reported in the Company’s fair value disclosures in the above nonrecurring table.

The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation.  Fair value is best determined based on quoted market prices.  However, in many instances, there are no quoted market prices for the Company’s various financial instruments.  In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques.  Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows.  Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Certain financial instruments and all nonfinancial instruments are excluded from disclosure.  Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments:
 
Cash and Cash Equivalents - The carrying amounts of cash and short-term instruments approximate fair values.
 
 
47
 
  
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
  
Note 14 - Fair Values of Financial Instruments (Continued)
 
Securities - Fair values for securities, excluding Federal Home Loan Bank stock, are based on quoted market prices.  The carrying value of Federal Home Loan Bank stock approximates fair value based on the redemption provisions of the Federal Home Loan Bank.
 
Loans Held for Sale - Fair values of mortgage loans held for sale are based on commitments on hand from investors or prevailing market prices.
 
Loans Receivable - For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values.  Fair values for certain mortgage loans (e.g., one- to four-family residential), credit card loans, and other consumer loans are based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted for differences in loan characteristics.  Fair values for other loans (e.g., commercial real estate and investment property mortgage loans, commercial, and industrial loans) are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.  Fair values for nonperforming loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.
 
Deposit Liabilities - The fair values disclosed for demand deposits (e.g., interest and noninterest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts).  The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date.  Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
 
REPO Sweep Accounts - The fair values disclosed for REPO Sweeps are equal to the amount payable on demand at the reporting date (i.e., their carrying amounts).
 
Long-term Borrowings - The fair values of the Company’s long-term borrowings are estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.
 
 
48
 
  
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
  
Note 14 - Fair Values of Financial Instruments (Continued)
 
Accrued Interest - The carrying amounts of accrued interest approximate fair value.

The estimated fair values and related carrying or notional amounts of the Company’s financial instruments are as follows:
 
   
December 31, 2010
    
December 31, 2009
  
   
Carrying
Amounts
    
Estimated
Fair Value
    
Carrying
Amounts
    
Estimated
Fair Value
  
                         
Financial assets:
                        
Cash and cash equivalents
   $ 1,963     $ 1,963     $ 3,099     $ 3,099  
Securities available for sale
     35,301       35,301       33,713       33,713  
Securities held to maturity
     2,520       2,595       3,928       4,084  
Loans and loans held for sale - Net
     157,144       157,629       171,271       171,544  
Federal Home Loan Bank stock
     3,775       3,775       4,197       4,197  
Accrued interest receivable
     1,231       1,231       1,230       1,230  
                                 
Financial liabilities:
                                
Customer deposits
     155,466       157,463       158,100       159,081  
Federal Home Loan Bank advances
     29,000       29,657       44,400       45,552  
Note payable
     -       -       631       634  
REPO sweep accounts
     6,172       6,172       5,408       5,408  
Accrued interest payable
     194       194       322       322  
 
Note 15 – Discontinued Operations
 
On February 27, 2009 the Company announced that it had sold the majority of the assets of the InsuranCenter of Alpena. Accordingly, the financial position and results of operations of the InsuranCenter of Alpena are removed from the detail line items in the Company’s financial statements and presented separately as “discontinued operations.”

As of February 27, 2009 all assets and liabilities of the InsuranCenter were disposed of.
 
 
49
 
  
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
  
Note 15 – Discontinued Operations (Continued)
 
The condensed income statement (unaudited) for the two months ended December 31, 2009 for the InsuranCenter of Alpena is as follows:
 
   
        2009        
  
       
Interest income
   $ -  
Interest expense
     -  
Net interest income
     -  
         
Noninterest income
     210  
Noninterest expenses
     280  
         
Loss before taxes
     (70 )
Income tax benefit
     (24 )
Net loss
   $ (46 )
 
Note 16 - Restrictions on Dividends
 
OTS regulations impose limitations upon all capital distributions including cash dividends.  The total amount of dividends that may be paid is generally limited to the sum of the net profits of the bank for the preceding three years.  An application to and the approval of the OTS is required prior to any capital distribution if the institution does not meet the criteria for “expedited treatment” of applications under OTS regulations.  If an application is not required, the institution must still provide prior notice to the OTS of the capital distribution.  In the event the Bank’s capital falls below its regulatory requirements or the OTS notifies it that it was in need of more than normal supervision, the Bank’s ability to make capital distributions could be restricted.  In addition, the OTS could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the OTS determines that such distribution would constitute an unsafe or unsound practice.  At December 31, 2010 and 2009, the Bank had $0 in retained earnings available for the payment of dividends to the Company.
 
 
50
 
  
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
  
Note 17 - Parent-Only Financial Statements
 
The following represents the condensed financial statements of First Federal of Northern Michigan Bancorp, Inc. (“Parent”) only.  The Parent-only financial information should be read in conjunction with the Company’s consolidated financial statements.
 
The condensed balance sheet is as follows:
 
   
December 31
  
   
        2010        
    
        2009        
  
             
Assets
            
             
Cash at subsidiary bank
   $ 424     $ 517  
Investment in subsidiary
     22,272       22,119  
Deferred Tax Asset
     318       318  
Other assets
     222       98  
                 
Total assets
   $ 23,236     $ 23,052  
                 
Liabilities and Stockholders' Equity
                
                 
Liabilities
   $ -     $ -  
Stockholders' equity
     23,236       23,052  
                 
Total liabilities and stockholders' equity
   $ 23,236     $ 23,052  
 
The condensed statement of operations for the years ended are as follows:
 
   
December 31
  
   
        2010        
    
        2009        
  
             
Operating income
   $ -     $ -  
Operating expense
     192       186  
                 
Loss before income taxes and equity in undistributed net income of subsidiary
     (192 )     (186 )
                 
Income tax benefit
     -       (290 )
                 
Loss before equity in undistributed loss of subsidiary
     (192 )     (476 )
                 
Equity in undistributed net income (loss) of subsidiary
     430       (6,287 )
                 
Net income (loss)
   $ 238     $ (6,763 )
 
 
51
 
  
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
  
Note 17 - Parent-Only Financial Statements (Continued)
 
The condensed statement of cash flows for the years ended is as follows:
 
   
December 31
  
   
2010
    
2009
  
             
Cash Flows from Operating Activities
            
Net income (loss)
   $ 238     $ (6,763 )
Adjustments to reconcile net income (loss) to net cash from operating activities:
                
Stock-based compensation plans
   $ 223     $ 99  
Equity in undistributed net (income) loss of subsidiary
     (430 )     6,287  
Net change in other assets
     (124 )     267  
                 
Net cash used in operating activities
     (93 )     (110 )
                 
Cash Flows from Financing Activities
                
  ESOP Loan Repayment
     -       211  
                 
Net cash provided by financing activities
     -       211  
                 
Net Increase  (Decrease) in Cash
     (93 )     101  
                 
Cash - Beginning of year
     517       416  
                 
Cash - End of year
   $ 424     $ 517  
 
Note 18 – Segment Reporting
 
The Company’s principal activities include banking and, prior to February 2009,  the sale of insurance products through its wholly owned subsidiary, ICA. The Company sold the majority of the assets of ICA in February 2009 (see Note 1).  The Bank provides financial products including retail and commercial loans as well as retail and commercial deposits.  ICA received commissions from the sale of various insurance products including health, life, and property.  The segments were determined based on the nature of the products provided to customers.
 
 
52
 
  
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
  
Note 18 – Segment Reporting (Continued)
 
The financial information for each operating segment is reported on the basis used internally to evaluate performance and allocate resources.  The allocations have been consistently applied for all periods presented.  Revenues and expenses between affiliates have been transacted at rates that unaffiliated parties would pay.  The only transaction between the segments related to a deposit on behalf of ICA included in the Bank.  The interest income and interest expense for this transaction has been eliminated.  All other transactions are with external customers.  The performance measurement of the operating segments is based on the management structure of the Company and is not necessarily comparable with similar information for any other financial institution.  The information presented is also not necessarily indicative of the segment’s financial condition and results of operations if they were independent entities.

As noted above, the majority of the assets of the Company’s segment, ICA, were sold on February 27, 2009; therefore no segment information is reported for the year ended December 31, 2010.
 
   
For Year Ended
  
   
December 31, 2009
  
   
Bank
    
ICA
    
Eliminations
    
Total
  
Interest Income
   $ 12,442     $ 4     $ (4 )   $ 12,442  
Interest Expense
     5,092       -       (4 )     5,088  
Net Interest Income - Before provision for loan losses
     7,350       4       -       7,354  
Provision for Loan Losses
     6,196       -       -       6,196  
Net Interest Income - After provision for loan losses
     1,154       4       -       1,158  
Other Income
     2,198       252       -       2,785  
Operating Expenses
     8,941       294       -       9,640  
Loss - Before federal income tax
     (5,589 )     (38 )     -       (5,697 )
Federal Income Tax
     1,079       (13 )     -       1,066  
Net Loss
   $ (6,668 )   $ (25 )   $ -     $ (6,763 )
                                 
Depreciation and amortization
   $ 824     $ 47     $ -     $ 871  
Assets
   $ 234,069     $ -     $ -     $ 234,069  
Expenditures related to long-lived assets:
                                
Property and equipment
     276       -       -       276  
Total
   $ 276     $ -     $ -     $ 276  
 
 
53
 
  
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2010 and 2009
(000s omitted, except per share data)
  
Note 19 - Quarterly Results of Operations (Unaudited)
 
The following tables summarize the Company’s quarterly results for the fiscal years ended December 31, 2010 and 2009:
 
   
For the Three-Month Period Ending
  
   
March 31,
2010
    
June 30,
2010
    
September 30,
2010
    
December 31,
2010
  
Interest income
   $ 2,882     $ 2,884     $ 2,907     $ 2,774  
Interest expense
     956       900       851       740  
Net interest income
     1,926       1,984       2,056       2,034  
Provision for loan losses
     11       595       353       142  
Other income
     578       1,265       717       645  
Other expenses
     2,189       2,437       2,348       2,892  
Income (loss) - before income tax expense or benefit
     304       217       72       (355 )
Income tax expense (benefit)
     102       (102 )     -       -  
Net income (loss)
   $ 202     $ 319     $ 72     $ (355 )
                                 
Net income (loss) per share
                                
Basic
   $ 0.07     $ 0.11     $ 0.02     $ (0.12 )
Diluted
   $ 0.07     $ 0.11     $ 0.02     $ (0.12 )
                                 
Weighted average number of shares outstanding - basic and dilutive
     2,884       2,884       2,884       2,884  
Cash dividends declared per common share
   $ -     $ -     $ -     $ -  
                                 
   
For the Three-Month Period Ending
  
   
March 31,
2009
    
June 30,
2009
    
September 30,
2009
    
December 31,
2009
  
Interest income
   $ 3,291     $ 3,185     $ 3,111     $ 2,855  
Interest expense
     1,489       1,309       1,218       1,072  
Net interest income
     1,802       1,876       1,893       1,783  
Provision for loan losses
     264       252       2,977       2,703  
Other income
     798       764       491       522  
Other expenses
     2,138       2,346       2,076       2,800  
Income (loss) from continuing operations - before income tax expense or benefit
     198       42       (2,669 )     (3,198 )
Income tax expense (benefit) from continuing operations
     51       -       1,149       (110 )
Net income (loss) from continuing operations
     147       42       (3,818 )     (3,088 )
Loss from discontinued operations, net of tax benefit
     (46 )     -       -       -  
Net income (loss)
   $ 101     $ 42     $ (3,818 )   $ (3,088 )
                                 
Income (loss) per share from continuing operations
                                
Basic
   $ 0.05     $ 0.01     $ (1.32 )   $ (1.07 )
Diluted
   $ 0.05     $ 0.01     $ (1.32 )   $ (1.07 )
Income (loss) per share from discontinued operations
                                
Basic
   $ (0.01 )   $ -     $ -     $ -  
Diluted
   $ (0.01 )   $ -     $ -     $ -  
Net income (loss) per share
                                
Basic
   $ 0.04     $ 0.01     $ (1.32 )   $ (1.07 )
Diluted
   $ 0.04     $ 0.01     $ (1.32 )   $ (1.07 )
                                 
Weighted average number of shares outstanding - basic and dilutive
     2,884       2,884       2,884       2,884  
Cash dividends declared per common share
   $ -     $ -     $ -     $ -  
 
 
54
 
  
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EXHIBIT 21

SUBSIDIARIES OF THE REGISTRANT
 
 
 
 
 
EXHIBIT 21

Subsidiaries of the Registrant

Parent Company
  
Subsidiary Companies
  
State of Incorporation
         
First Federal of Northern Michigan Bancorp, Inc.
  
First Federal of Northern Michigan
  
Federal
         
First Federal of Northern Michigan
  
Financial Services and Mortgage Corporation
  
Michigan
         
First Federal of Northern Michigan
  
FFNM Agency, Inc
  
Michigan
 
 
 
 
 
 EX-23 5 v215653_ex23.htm Unassociated Document
 
EXHIBIT 23

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 
 
 

EXHIBIT 23 –

Consent of Independent Registered Public Accounting Firm

We hereby consent to the incorporation by reference into the Registration Statement on Form S-8 for the Company's 1996 Stock Option Plan and 1996 Recognition and Retention Plan (Registration No. 333-83198) of our report dated March 25, 2011 relating to the consolidated financial statements of First Federal of Northern Michigan Bancorp, Inc. as of December 31, 2010 which appear in this Form 10-K of First Federal of Northern Michigan Bancorp, Inc. for the year ended December 31, 2010.

/s/ Plante & Moran, PLLC

Auburn Hills, Michigan
March 25, 2011

 
 
 
 
 EX-31.1 6 v215653_ex31-1.htm
 
Exhibit 31.1

FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-K
 
Year Ended December 31, 2010
 
Certification of Chief Executive Officer

Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Michael W. Mahler, certify that:
 
(1)
I have reviewed this annual report on Form 10-K of First Federal of Northern Michigan Bancorp, Inc.;

(2)
Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

(3)
Based on my knowledge, the financial statements and other financial information included in this annual report fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

(4)
The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have:
 
 
a)
Designed such disclosure controls and procedures, or caused such disclosure controls procedures to be designed under our supervision,  to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
 
 
b)
designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
 
c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
 
d)
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over reporting; and
 
(5)
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

 
a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 
b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
 
March 25, 2011
/s/ Michael W. Mahler
Date
Michael W. Mahler
 
Chief Executive Officer

 
 
 
EX-31.2 7 v215653_ex31-2.htm
 
Exhibit 31.2
 
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
 
FORM 10-K
 
Year Ended December 31, 2010
 
Certification of Chief Financial Officer

Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Amy E. Essex, certify that:
 
(1) 
I have reviewed this annual report on Form 10-K of First Federal of Northern Michigan Bancorp, Inc.;

(2)
Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

(3)
Based on my knowledge, the financial statements and other financial information included in this annual report fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

(4)
The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have:
 
 
a)
Designed such disclosure controls and procedures, or caused such disclosure controls procedures to be designed under our supervision,  to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
 
 
b)
designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
 
c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
 
d)
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over reporting; and
 
(5)
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

 
a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 
b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
 
March 25, 2011
/s/ Amy E. Essex
Date
Amy E. Essex
 
Chief Financial Officer, Treasurer, and Corporate Secretary

 
 
 
EX-32.1 8 v215653_ex32-1.htm
 
EXHIBIT 32.1

STATEMENT FURNISHED PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

The undersigned, Michael W. Mahler, is the Chief Executive Officer of First Federal of Northern Michigan Bancorp, Inc. (the “Company”).

This statement is being furnished in connection with the filing by the Company of the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 (the “Report”).

By execution of this statement, I certify that to the best of my knowledge:

 
A)
the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a) or 78o(d)) and

 
B)
the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of the dates and for the periods covered by the Report.

This statement is authorized to be attached as an exhibit to the Report so that this statement will accompany the Report at such time as the Report is filed with the Securities and Exchange Commission pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350.  It is not intended that this statement be deemed to be filed for purposes of the Securities Exchange Act of 1934, as amended.

March 25, 2011
  
/s/ Michael W. Mahler
Dated
  
Michael W. Mahler

 
 
 
EX-32.2 9 v215653_ex32-2.htm
 
EXHIBIT 32.2

STATEMENT FURNISHED PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002,

The undersigned, Amy E. Essex, is the Chief Financial Officer of First Federal of Northern Michigan Bancorp, Inc. (the “Company”).

This statement is being furnished in connection with the filing by the Company of the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 (the “Report”).

By execution of this statement, I certify that to the best of my knowledge:

 
A)
the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a) or 78o(d)) and

 
B)
the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of the dates and for the periods covered by the Report.

This statement is authorized to be attached as an exhibit to the Report so that this statement will accompany the Report at such time as the Report is filed with the Securities and Exchange Commission pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350.  It is not intended that this statement be deemed to be filed for purposes of the Securities Exchange Act of 1934, as amended.

March 25, 2011
  
/s/ Amy E. Essex
Dated
  
Amy E. Essex