EX-13 2 v332798_ex13.htm EXHIBIT 13

 

EXHIBIT 13

 

2012 ANNUAL REPORT TO STOCKHOLDERS

 

 
 

 

FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.

 

2012

 

ANNUAL REPORT

 

March 29, 2013

 

 
 

 

Z:\Vineyard\Live jobs\2013\03 Mar\22 Mar\Shift III\First Federal\Draft\03-Production

 

Dear Fellow Shareholder,

 

Last year’s annual report theme was New Horizons and New Beginnings. I spent considerable time in that letter talking about our new priorities including growing the balance sheet, increasing the level of core deposits, continuing to jettison the non-performing assets and establishing an operational efficiency that will allow for continued financial improvement that ultimately will allow for the restoration of the dividend. One year later these items still represent our focus. What I failed to discuss in last year’s letter was the interconnection between these focus areas and the communities our Bank serves. The cover of this year’s annual report features several of the communities we live, work and operate within. We serve on various community boards, teach Junior Achievement, coach numerous sports and take active roles in many worthwhile initiatives. This is part of the mission we fulfill as a community bank. Before I begin that discussion though, let me take a moment to look backward.

 

The operating environment in 2012 did not meet our expectations in both positive and negative ways. To illustrate:

 

ØMortgage Banking: On the positive side, for the year, our Bank originated $52.4 million dollars in mortgage loans. After a more normalized 2011, we expected more of the same for 2012. However, mortgage rates dipped in the late spring of 2012 and we were operating at capacity for the balance of the year. Mortgage origination volume in 2012 certainly exceeded our expectations.

 

ØMortgage Charge Offs: While we saw improvement year over year in terms of the charge off levels ($1.1 million in 2011 to $775,000 in 2012), the continuation of falling real estate prices negatively impacted us in 2012. While many parts of Michigan and the country have seen some recovery in real estate values, the phrase “appreciating real estate values” has not found its way back into our vocabulary in Northern Michigan as of yet. This was the single biggest factor in the increase in our provision expense of 2012 when compared to the prior year.

 

ØMargin Compression: Another positive was that in 2012 our margins did not get compressed to the extent we thought they would. In spite of lower interest rates during the year, we continued to successfully grow core deposits which helped to offset some of the pressures on the loan pricing side.

 

ØCommercial Loan Originations: We expected to grow net loans in 2012. We were wrong. Demand was more muted than we anticipated. We saw many prospects testing the waters but most were unable or unwilling to “take the next step.” Some of these loan commitments sat on our pipeline for the entire year. Many of those we worked with in 2012 were concerned about the outcome of the November elections along with the fiscal cliff and the impact both of those outcomes might have on the economy. As a result, these same borrowers sat on the sidelines. Finally today we are starting to see some of these deals move ahead.

 

ØAsset Quality: In spite of our provision expense needs in 2012, we have once again made solid progress in this area. Net charge-offs overall declined for the 4th consecutive year (even though Mortgage charge-offs grew) and was at the lowest level in 5 years. In addition, the classified asset ratio declined from 69% to 54% throughout the year. The big disappointment came the very last week of the year when we had to reclassify a large classified commercial relationship into non-performing status. The borrower ran into financial difficulty late in the year. The military is their largest customer. Reductions to defense spending ahead of sequestration (9% automatic Department of Defense cuts) placed this customer in a tenuous position that resulted in the customer no longer being able to service the debt. This added $2 million dollars to our non-performing asset totals in the final week of the year. This was a bitter pill to swallow. This reclassification wiped out the entire year’s improvement to our NPA balances.

 

 
 

 

On a positive note, we continue to see reductions in collection costs and REO / ORA costs. Many of these reductions were the result of declining legal costs along with fewer write downs associated with the liquidation of these assets.

 

Community Focus

 

As I discussed in last year’s letter, the focus shifted more to looking ahead and less on fixing problems. In 2012 that is exactly what we did. Our focus was on growing our balance sheet in order to create value for our shareholders. This is not a “grow at all cost” mentality. Our focus centers on working within our communities to help good customers get better. Our roots as a 56-year-old savings bank center on meeting the needs of the community. When we started in 1957 we were a one-branch bank focused on Alpena, Michigan and making mortgage loans to the community. Today the story is somewhat similar. We now serve the region with 8 full service branches, thereby helping us to meet the needs of several more rural communities throughout our region. In addition to expanding our footprint, we have also expanded our product offerings by getting involved in commercial lending which became a strategic focus in the late 1990’s. Up until then we were primarily a mortgage bank. Our focus is simple; we are here to meet the varied and diverse needs of our communities.

 

To demonstrate our role in the communities we serve consider the following:

 

ØThe Bank originated $52.4 million dollars of mortgages in our market. Of that total, the Bank placed $13.3 million of these community loans into our own portfolio.

 

ØThe Bank originated $18.2 million of commercial loans in our market in 2012.

 

Our support of the communities and borrowers is vital to our community and therefore to our own long term success.

 

It is no mystery that Michigan was hurt hard in the recession. While most of the country endured a recession, the impact was disproportionate on our state. Many would characterize our economy as a depression at the height of the downturn. The markets we serve are very dependent on the economies of the southern part of the state. When Detroit and the entire auto industry fell into chaos, the impact on our communities was magnified. We saw unemployment rates rise to near 30% in some of our markets. In our biggest market (Alpena) the unemployment rate rose above 16%. While this was not a pretty picture, it was the hand we were dealt as a community focused bank.

 

Our response in the years that have followed has been to work with the members of our community that were caught up in the economic tidal wave. We worked with borrowers, where possible, to find a way to help them keep their home, their car or their business.

 

Our help of borrowers took many different forms:

 

ØIn the case of troubled homeowners, we supported them through various government programs including the Home Affordable Modification Program (HAMP) or the Making Home Affordable (MHA) programs. The Bank worked with numerous troubled homeowners over the last several years in an attempt to keep the borrower in their home. This work continues today but at a slower pace as the recovery has begun for our region.

 

ØIn the case of troubled commercial borrowers, we restructured loans with lower rates, longer amortizations or seasonal payments if it made sense. While there are often negative financial implications for the Bank in these cases, in the long run it is often the best choice in terms of helping the borrower manage through the crisis. Through these actions, we saw many distressed borrowers make it through to the improving conditions today.

 

 
 

 

While these situations were hard on all parties, the cooperation in many cases helped our borrowers recover, which in turn helps our communities to recover. This is at the heart of what community banking is all about. That is why our business model is so vital to the well-being of the small communities we serve. Of course we could not save all troubled borrowers. Some could not break away from the inertia of the downward spiral they found themselves caught up in. Among the lessons we learned from this period was that the distant deals that became problematic were made more complicated by the miles that separated us from the borrowers.

 

Our board and staff recognize that while our markets may not be dynamic, fast paced high growth markets, they are still our markets. We understand our markets and the borrowers therein. In 2007 our board elected to no longer get involved in lending out of state no matter how good the business climate was in that particular state or market. Without boots on the ground, we have been reminded how difficult it is to monitor and know the customer. Our focus is on making money in our markets, even challenging markets. Bad markets still have good borrowers. As a community bank, we will continue to focus on those borrowers.

 

Today all of our markets show signs of healing. Some are further along than others but all are improving. The proof of this is found in improving delinquency trends and financial performance of our commercial borrowers. Our business plan is to grow with these customers once again.

 

Over the last five years we have reduced our full time staff by 25% from 92 to 69 while adding only 4 part time employees increasing that total to 23. As a bank, we have never been thinner in terms of our staffing levels. In spite of these cuts, earnings have still been challenged. We know we cannot cut our way to prosperity. Our financial improvement is not only contingent upon the economic recovery of Michigan but also in out ability to grow our Bank. In that spirit, we intend on committing both human and financial capital to technology initiatives in 2013. As customers needs and the way they do business evolves, so must the Bank. Our technology initiatives evolve around both commercial and retail customers. Both of these groups will see new or enhanced product offerings including more robust merchant capture, internet banking, mobile applications, treasury management products, and commercial electronic bill pay to name but a few. Additionally, we will support these technology initiatives by investing in fiber technology. As fiber technology makes its way into northern Lower Michigan, we will embrace it. This will not only allow for more robust speeds to support these enhanced products and services, but also provide for improved redundancy supporting our more robust business continuity and pandemic preparedness goals. We view all of these investments as vital to support these rural evolving communities.

 

Closing thoughts:

 

While the core of this letter centers on meeting the needs of our communities and the interwoven relationship between community success and Bank success, there are still forces coming from outside of the community that can and will impact our communities and our industry. The artificially low interest rate environment, a commitment by the Federal Reserve to hold its target short-term interest rates between 0 - .25% through at least mid 2015, the unresolved debt ceiling debate, an unbalanced federal government budget, sequestration, a new bank regulator to protect consumers (CFPB) and newly proposed bank capital rules are a few of the open items that will play a role in the economic recovery, impacting our industry, our customers and ultimately our shareholders. For our bank, we will continue to focus on those elements within our control ever mindful and considerate of the potential influences of these unknowns. The community bank business model has proven itself time and time again across the decades and in every region of our country. We know our customers. We know our borrowers, their track record, and their character. As a community bank this is vital to our success. We are reminded daily of the benefits of knowing our communities, our customers and their needs. We are positioned and ready to continue to recover with our markets, our friends, our neighbors and our shareholders. We are honored to be a community bank and a participant in the meaningful recovery of all of the communities we serve.

 

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, 2012 and December 31, 2011 and for the years ended December 31, 2012 and 2011 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, 2010, 2009, and 2008 is derived in part from audited consolidated financial statements that do not appear in this Annual Report.

 

 
 

 

   At December 31, 
Financial condition data:  2012   2011   2010   2009   2008 
   (In thousands) 
Total assets  $213,834   $217,045   $215,733   $233,506   $247,672 
Loans receivable, net   138,912    140,884    157,144    171,219    192,270 
Loans held for sale   79    -    -    52    107 
Investment securities   53,109    55,484    37,821    37,641    29,687 
Cash and cash equivalents   2,752    2,749    1,963    3,099    3,471 
Deposits   158,350    150,649    155,466    158,100    165,778 
FHLB advances and note payable   26,358    34,500    29,000    45,031    40,969 
Repo Sweep agreements   3,183    5,592    6,172    5,408    9,447 
Stockholders' equity   24,435    24,568    23,236    23,052    29,419 

 

   For the Years Ended December 31, 
Operating data:  2012   2011   2010   2009   2008 
   (In thousands) 
Interest income  $9,243   $10,390   $11,447   $12,442   $13,967 
Interest expense   1,654    2,262    3,447    5,088    7,130 
                          
Net interest income   7,589    8,128    8,000    7,354    6,837 
Provision for loan losses   1,367    284    1,101    6,196    4,421 
                          
Net interest income after provision for loan losses   6,222    7,844    6,899    1,158    2,416 
Other income (loss):                         
Service charges and fees   760    730    804    869    942 
Mortgage banking activities   1,243    969    1,438    1,414    432 
Net gain (loss) on sale of investment securities   47    -    546    -    6 
Gain (loss) on sale of real estate   (3)   (51)   (43)   20    22 
Other non-interest income   80    126    301    102    95 
Insurance & brokerage commissions   149    158    159    170    180 
                          
Total other income   2,276    1,932    3,205    2,575    1,677 
Other expenses   8,712    9,034    9,866    9,360    8,874 
                          
Income (loss) from continuing operations before income tax expense (benefit)   (214)   742    238    (5,627)   (4,781)
Income tax expense (benefit) from continuing operations   -    -    -    1,090    (1,601)
Net income (loss) from continuing operations   (214)   742    238    (6,717)   (3,180)
Loss from discontinued operations, net of tax benefit   -    -    -    (46)   (61)
Net income (loss)  $(214)  $742   $238   $(6,763)  $(3,241)

 

   For  the Years Ended December 31, 
Performance Ratios:  2012   2011   2010   2009   2008 
                     
Return on average assets     -0.10%   0.34%   0.10%   -2.80%   -1.30%
Return on average equity     -0.85%   3.07%   0.99%   -23.21%   -10.05%
Average interest rate spread   3.65%   3.88%   3.60%   2.97%   2.51%
Dividend payout ratio   N/M    0.00%   0.00%   N/M    N/M 
Dividends per share  $0.00   $0.00   $0.00   $0.00   $0.15 
Net interest margin   3.78%   4.02%   3.78%   3.26%   2.93%
Efficiency ratio (Bank)   101.55%   90.06%   102.76%   252.19%   104.54%
Texas ratio (Bank)   30.83%   28.28%   39.66%   64.29%   45.22%
Non-interest expense to average total assets   3.94%   4.14%   4.33%   3.88%   3.56%
Average interest-earning assets to average interest-bearing liabilities   115.88%   112.59%   111.20%   113.32%   113.85%

 

   At December 31, 
Asset Quality Ratios:  2012   2011   2010   2009   2008 
                     
Non-performing assets to total assets   3.42%   3.11%   4.37%   6.58%   5.57%
Non-performing loans to total loans   3.50%   2.34%   4.13%   6.73%   6.14%
Allowance for loan losses to nonperforming loans   35.50%   45.47%   42.85%   31.05%   46.41%
Allowance for loan losses to total loans   1.24%   1.07%   1.77%   2.09%   2.85%
                          
Capital Ratios:                         
                          
Equity to total assets at end of period   11.43%   11.32%   10.77%   9.87%   11.88%
Average equity to average assets   11.63%   11.06%   10.47%   12.07%   12.44%
Risk-based capital ratio (Bank only)   17.36%   17.20%   15.57%   13.58%   15.75%
                          
Other Data:                         
Number of full service offices   8    8    8    8    8 
                          
N/M - 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, 2012, $66.5 million, or 47.2%, of our total loan portfolio consisted of one- to four-family residential real estate loans, $54.7 million, or 38.8%, and $8.1 million, or 5.7%, of our total loan portfolio consisted of commercial mortgage loans and commercial loans, respectively, and $11.7 million, or 8.3%, 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 21 years experience in the financial services industry.

 

Rebuilding our Balance Sheet. Beginning in 2001, we began to increase our originations of commercial real estate and commercial loans, resulting in significant organic loan growth in the years from 2004 - 2006. In 2007 we began participating, on a limited basis, in commercial opportunities outside of our market areas and, in some cases, outside of Michigan to help mitigate the geographic risk of lending only in Michigan. At December 31, 2005 and 2006, respectively, our total assets were $282.8 million and $281.0 million, the highest levels in our history. Beginning in 2008, due to severely deteriorating economic conditions in our market area, we began to see a both decline in loan balances and an increase in loan charge-offs, which began deteriorating our asset base. At December 31, 2012 our total assets were $213.8 million. We are seeing signs of economic recovery in our markets and have devoted staff and resources to begin the process of rebuilding our balance sheet in 2013 and beyond.

 

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 $11.4 million in 2012.

 

 
 

 

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 saw delinquency trends increase despite our conservative underwriting practices due to declining economic conditions and increasing unemployment in our market area. In 2012 we began to see a gradual improvement in delinquency patterns as evidenced by improvements in our asset quality ratios through the third quarter of 2012. However, at December 31, 2012, our ratio of non-performing assets to total assets was 3.41% as compared to 3.11% at December 31, 2011 due primarily to our placing a $2.0 million commercial loan on non-accrual status in the fourth quarter of 2012. Despite losses over the years from 2007 to 2009, we continue to maintain a strong capital base. At December 31, 2012, our total risk-based capital ratio was 17.4%, an improvement from 17.20% at December 31, 2011 and well in excess of the regulatory requirements to be 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 sell 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. Beginning in late 2012 we began placing certain 15 year fixed residential real estate loans into our portfolio in an effort to rebuild our balance sheet and increase net interest income, however we continue to sell most loans with terms longer than 15 years into the secondary market to minimize interest rate risk.

 

Comparison of Financial Condition at December 31, 2012 and 2011

 

Total assets decreased $3.2 million, or 1.5%, to $213.8 million at December 31, 2012 from $217.0 million at December 31, 2011. Net loans decreased $2.0 million, or 1.4% to $138.9 million at December 31, 2012 from $140.9 million at December 31, 2011. Mortgage loan originations increased by $14.2 million to $52.4 million in 2012 from $38.1 million in 2011. During that time period, our mortgage loan portfolio remained unchanged at $66.5 million, despite placing $8.0 million of high-quality 10- and 15-year fixed rate mortgages into portfolio in 2012. The commercial loan portfolio increased 2.6% to $62.8 million at December 31, 2012 from $61.2 million at December 31, 2011. Cash and cash equivalents increased slightly, to $2.8 million at December 31, 2012 from $2.7 million at December 31, 2011. Investment securities decreased $2.4 million, or 4.3%, to $53.1 million at December 31, 2012 from $55.5 million at December 31, 2011.

 

Deposits increased $7.7 million, or 5.1%, to $158.4 million at December 31, 2012 from $150.6 million at December 31, 2011. This increase was due in large part to the increase in our non interest-bearing demand deposit accounts. Our focus in 2012 continued to be on building deposit relationships rather than attracting higher-cost non-core certificate of deposit accounts. REPO Sweep accounts decreased $2.4 million, or 43.1% to $3.2 million at December 31, 2012 from $5.6 million at December 31, 2011. Borrowings, consisting primarily of FHLB advances, decreased $8.1 million, or 23.6%, to $26.4 million at December 31, 2012 from $34.5 million at December 31, 2011 as we replaced borrowings with deposits.

 

Stockholders’ equity decreased $134,000, or 1.0%, to $24.4 million at December 31, 2012 from $24.6 million at December 31, 2011. The decrease was mainly a result of our net loss for the year of $214,000 partially offset by an increase of $79,000 in net unrealized gain on investment securities.

 

Comparison of Operating Results for the Years Ended December 31, 2012 and 2011

 

General. Net income decreased to a loss of $214,000 for the year ended December 31, 2012 from $742,000 for the year ended December 31, 2011. Net interest income before provision for loan losses was $539,000 lower in 2012 than in 2011, due in large part to a decline in our net interest margin year over year. The provision for loan losses was $1.1 million higher in 2012 than in 2011, resulting in net interest income after provision for loan losses being $1.6 million lower in 2012 than in 2011. Non-interest income was $344,000 higher in 2012 than in 2011, and non-interest expenses which were $322,000 lower in 2012 than in 2011.

 

 
 

 

Interest Income. Interest income decreased by $1.1 million, or 11.0%, to $9.2 million for the year ended December 31, 2012 from $10.4 million for the year ended December 31, 2011. The decrease was primarily due to a decrease in the average balance of our loan portfolio of $2.0 million, or 1.0%, year over year. The average balance of our non-mortgage loans, principally commercial loans and consumer loans, decreased by $6.9 million, or 8.4%, to $75.6 million for the twelve months ended December 31, 2012 from $82.6 million for the twelve months ended December 31, 2011. The average yield on our commercial loans decreased 64 basis points and the average yield on our consumer loans decreased 2 basis points from 2011 to 2012. The average balance of our one- to four-family residential mortgage loans decreased to $67.2 million for the year ended December 31, 2012 from $67.5 million for the year ended December 31, 2011, while the average yield on such loans decreased to 5.52% from 5.94%.

 

Interest Expense. Interest expense decreased to $1.7 million for the year ended December 31, 2012 from $2.3 million for the year ended December 31, 2011, due primarily to a $6.8 million, or 3.8%, decrease in the average balance of interest-bearing liabilities. The average balance of interest-bearing deposits decreased by $5.3 million from 2012 to 2011, while the average cost of those deposits decreased 34 basis points to 0.76% for 2012 from 1.10% for 2011, reflecting a continued decline in market interest rates during 2012. The average balance of FHLB borrowings increased $43,000 from 2012 to 2011 while the cost of those borrowings decreased from 2.18% to 1.92% year over year as we were able to pay off high-cost maturing advances with deposits or replace them with lower-cost advances due to the rate environment. The average balance of REPO Sweep accounts decreased by $1.5 million, or 26.3% year over year, while the average cost of these accounts decreased 18 basis points from 0.39% for 2011 to 0.21% for 2012.

 

Net Interest Income. Net interest income decreased to $7.6 million for the year ended December 31, 2012 from $8.1 million for the year ended December 31, 2011. The decrease was primarily due to a decrease of 20 basis points in our average interest rate spread to 3.65% for the year ended December 31, 2012 from 3.88% for the year ended December 31, 2011.

 

Provision for Loan Losses. We recorded a provision for loan losses of $1.4 million for the year ended December 31, 2012 compared to a provision of $284,000 for the year ended December 31, 2011. We had net charge-offs of $1.1 million and $1.6 million during 2012 and 2011, respectively. Our provision is based on management’s review of the components of the overall loan portfolio, the status of non-performing loans and various subjective factors. For 2011, the provision was significantly lower than 2012 due to the following factors: our provision for loan losses is based on a twelve-quarter rolling average of actual net charge-offs adjusted for various environmental factors for each pool of loans in our portfolio. As our charge-off history on commercial and consumer loans improved in 2011 as compared to recent prior years, lower loss factors were applied to those pools of loans to establish an adequate reserve. In addition, asset quality metrics improved in 2011. These factors enabled us to reverse provision expense recorded during the first three quarters of 2011. In contrast, in 2012, the Company charged off $1.2 million in loans, including $840,000 of residential mortgage loans which required a comparatively higher provision than the previous year.

 

Non-Interest Income. Non-interest income increased to $2.3 million for the year ended December 31, 2012 from $1.9 million for the year ended December 31, 2011. The 2012 results reflected an increase of $274,000 in mortgage banking activities and an increase in gain on sale of available for sale securities of $47,000 as compared to the twelve months ended December 31, 2011. In 2012 we retained in our portfolio approximately $8.0 million of 15-year fixed residential mortgages in our portfolio, rather than selling them into the secondary market, which reduced mortgage banking activities income.

 

Non-Interest Expense. Non-interest expense decreased to $8.7 million for the year ended December 31, 2012 from $9.0 million for the year ended December 31, 2011. The year over year decrease related primarily to a reduction in expenses associated with troubled loans and repossessed properties. Compensation and benefits were higher during both the three-month and twelve-month periods ended December 31, 2011 as compared to the prior-year period related mainly to increase mortgage lender commissions attributable to increased mortgage loan originations year over year.

 

Income Taxes. The Company had no federal income expense for the periods ended December 31, 2012 and 2011 as a result of the valuation allowance against the Company’s deferred tax assets.

 

 
 

 

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, 2012   2012   2011   2010 
                   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            $67,151   $3,708        $67,529   $4,012        $77,280   $4,806      
Non-mortgage loans             75,640    4,220         82,562    4,914         91,470    5,327      
Loans  $138,991    5.09%   142,791    7,928    5.55%   150,091    8,926    5.95%   168,750    10,133    6.00%
Mortgage-backed securities      29,608    3.49%   29,002    621    2.14%   26,543    784    2.95%   18,973    648    3.42%
Other Investment securities   23,501    2.69%   24,352    566    2.32%   19,448    573    2.95%   16,940    568    3.35%
Investment securities   53,109    3.48%   53,354    1,187    2.22%   45,991    1,357    2.95%   35,913    1,216    3.39%
Other investments   3,671    2.88%   4,412    128    2.90%   6,433    107    1.66%   7,151    98    1.37%
Total interest-earning assets   195,771    4.61%   200,557    9,243    4.62%   202,515    10,390    5.14%   211,814    11,447    5.41%
                                                        
Non interest-earning assets   18,063         16,544              15,947              15,809           
Total Assets  $213,834        $217,101             $218,462             $227,623           
                                                        
Interest-bearing liabilities:                                                       
Savings Deposits  $19,867    0.05%  $18,784   $9    0.06%  $17,507   $9    0.06%  $16,053   $8    0.06%
Money market/NOW accounts   44,218    0.22%   43,634    94    0.21%   43,471    158    0.35%   41,845    324    0.76%
Certificates of deposit   73,198    1.44%   74,966    931    1.24%   81,665    1,382    1.69%   88,379    1,964    2.22%
Total interest-bearing deposits   137,283    0.85%   137,384   $1,034    0.75%   142,643   $1,549    1.09%   146,277   $2,296    1.57%
Borrowed funds   29,541    1.59%   35,694    620    1.74%   37,233    713    1.91%   44,211    1,151    2.60%
Total interest-bearing liabilities   166,824    0.98%   173,078    1,654    0.96%   179,876    2,262    1.26%   190,488    3,447    1.81%
                                                        
Non interest-bearing liabilities   22,575         18,729              14,417              13,312           
                                                        
Total liabilities   189,399         191,807              194,293              203,800           
Stockholders' equity   24,435         25,294              24,169              23,823           
                                                        
Total liabilities & stockholders' equity  $213,834        $217,101             $218,462             $227,623           
                                                        
Net interest income                   $7,589             $8,128             $8,000      
                                                        
Interest rate spread        3.63%             3.66%             3.88%             3.60%
                                                        
Net interest-earning assets            $27,479             $22,639             $21,326           
                                                        
Net interest margin (1)        3.78%             3.80%             4.02%             3.78%
                                                        
Average interest-earning assets to average interest-bearing liabilities                       115.88%             112.59%             111.20%

 

 

(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, 2012 
   Compared to 
   Year ended December 31, 2011 
   Increase (Decrease) Due to: 
   Volume   Rate   Total 
   (In thousands) 
Interest-earning assets:               
Loans receivable  $(413)  $(585)  $(998)
Investment securities   27    (196)  $(169)
Other investments   (41)   61   $20 
                
Total interest-earning assets   (427)   (721)   (1,147)
                
Interest-bearing liabilities:               
Savings Deposits   1    -    1 
Money Market/NOW accounts   1    (65)   (64)
Certificates of Deposit   (134)   (318)   (452)
Deposits   (132)   (384)   (515)
Borrowed funds   (33)   (60)   (93)
                
Total interest-bearing liabilities   (165)   (444)   (608)
                
Change in net interest income  $(262)  $(277)  $(539)

 

   Year ended December 31, 2011 
   Compared to 
   Year ended December 31, 2010 
   Increase (Decrease) Due to: 
   Volume   Rate   Total 
   (In thousands) 
Interest-earning assets:               
Loans receivable  $(1,098)  $(109)  $(1,207)
Investment securities   264    (122)  $142 
Other investments   (11)   20   $9 
                
Total interest-earning assets   (845)   (211)   (1,056)
                
Interest-bearing liabilities:               
Savings Deposits   1    -    1 
Money Market/NOW accounts   13    (179)   (166)
Certificates of Deposit   (173)   (409)   (582)
Deposits   (159)   (588)   (747)
Borrowed funds   (253)   (185)   (438)
                
Total interest-bearing liabilities   (412)   (773)   (1,185)
                
Change in net interest income  $(433)  $562   $129 

 

 
 

 

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, 2012, $122.6 million, or 87.0% of our loan portfolio, consisted of loans that mature or reprice after December 31, 2012. In contrast, as of December 31, 2012, $39.2 million, or 53.6% 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 in recent years, we generally have sold into the secondary mortgage market all of the fixed-rate, longer-term (15 years or more) residential mortgage loans that we originate on a servicing-retained basis. In 2012, we determined to keep in portfolio $8.0 million of 15-year fixed-rate residential mortgage loans. 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. As long-term interest rates rise, as we expect will happen, 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. The Company uses two primary measurement techniques to identify and manage its interest rate risk:

 

·Net Interest Income (NII) simulation
·Economic Value of Equity (EVE)

 

Net Interest Income Simulation Model: The Company uses a NII simulation model to analyze the sensitivity of net interest income to changing interest rates. The model is based on contractual and assumed cash flows and repricing characteristics for all of the Company’s financial instruments and incorporates market-based assumptions regarding the effect of changing interest rates on the prepayment rates of certain assets and liabilities. The model also includes management’s projections of the future volume and pricing of each of the product lines offered by the Company as well as other pertinent assumptions. Actual results may differ from these simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and management strategies.

 

The Company’s interest rate risk exposure is currently evaluated by measuring the anticipated change in net interest income over a 24-month horizon assuming a -100bp, 100bp, 200bp, 300bp and 400bp parallel ramped increase in interest rates. The Fed Funds interest rate, targeted by the Federal Reserve at a range of 0% to 0.25% is currently set at a level that would be negative in parallel ramped decrease scenarios, therefore those scenarios were omitted from the interest rate risk analysis at December 31, 2012.

 

 
 

 

At December 31, 2012, the Company’s interest rate risk profile reflects a neutral position. The following table shows the Company’s estimated net interest income sensitivity profile and ALCO policy limits as of December 31, 2012.

 

Dynamic Balance Sheet - RAMP                 
                         
Rate Changes:   0 BP    - 100 BP    + 100 BP    +200 BP    +300 BP    +400 BP 
$ Change in NII  $14,761   $14,689   $14,927   $15,102   $15,348   $15,545 
% Change in NII        -0.48%   1.13%   2.31%   3.98%   5.31%
Policy Limits        +/- 5%   +/- 5%   +/- 10%   +/- 15%   +/- 20%

 

The 24-months net interest income at risk reported as of December 31, 2012 for all scenarios presented shows that the Company’s overall risk to changes in interest rates is low. Given that the duration of our assets is longer than that of our liabilities, the scenarios shown illustrate that a rising rate environment has a neutral to slightly positive impact on our net interest income, i.e. our liabilities will reprice upwards faster than our assets will. However, the impact is well within Board set limits.

 

Certain shortcomings are inherent in the methodology used in the above interest rate risk measurements. Modeling changes in 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 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 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.

 

Economic Value of Equity: The Company also uses EVE as a measurement tool in managing interest rate risk. Whereas the net interest income simulation model highlights exposure over a relatively short time horizon, the EVE analysis incorporates all cash flows over the estimated remaining life of all balance sheet positions. The EVE of the balance sheet, at a point in time, is defined as the discounted present value of asset cash flows less the discounted value of liability cash flows. The sensitivity of EVE to changes in the level of interest rates is a measure of longer-term interest rate risk. EVE values only the current balance sheet and does not incorporate the growth assumptions used in the earnings simulation model. As with the earnings simulation model, assumptions about the timing and variability of existing balance sheet cash flows are critical in the EVE analysis. Particularly important are assumptions driving prepayments and the expected changes in balances and pricing of transaction deposit portfolios. The following table shows the Company’s EVE sensitivity profile as of December 31, 2012.

 

Economic Value of Equity             
                     
Rate Changes:   0 BP    + 100 BP    +200 BP    +300 BP    +400 BP 
$ Change in Equity  $32,824   $34,190   $34,702   $34,803   $24,663 
% Change in Equity        4.16%   5.72%   6.03%   5.60%
Policy Limits        +/- 10%   +/- 15%   +/- 20%   +/- 25%

 

The EVE at risk profile shows slight to moderate asset sensitivity from market rate increases.

 

Cash Flows

 

Cash flows provided by operations were $2.2 million in both 2012 and 2011. Cash flows provided by investing activities were $700,000 in 2012 as compared to cash used in investing activities of $1.6 million in 2011. The change year over year was due in large part to the purchase of bank owned life insurance of $3.0 million and proceeds from the sale of available for sale securities of $1.6 million in 2012. Cash used in financing activities was $2.9 million in 2012 as compared to cash provided by financing activities of $103,000 million in 2011, due primarily to the decrease in our outstanding Federal Home Loan Bank (FHLB) advances in 2012.

 

 
 

 

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 the Comptroller of the Currency 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, 2012 was $52.5 million, or 42.5% of total deposits and Federal Home Loan Bank borrowings due in one year or less, compared to $44.6 million, or 39.9% of this amount at December 31, 2011. 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, 2012, we had unused borrowing capacity of $27.4 million.

 

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, although in 2012 we placed $8.0 million in 15 year fixed-rate residential mortgage loans in our portfolio. 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, 2012, we originated $52.4 million of one- to four-family residential mortgage loans, of which $15.9 million were retained in our portfolio and the remainder were sold into the secondary mortgage market. This compares to $38.1 million of one- to four-family originations during the year ended December 31, 2011, of which $9.3 million were retained in our portfolio. At December 31, 2012, we had outstanding loan commitments of $22.6 million. These commitments included $4.9 million for permanent one- to four-family residential mortgage loans, $2.4 million for non-residential loans, $1.8 million of undisbursed loan proceeds for construction of one- to four-family residences, $4.8 million of undisbursed lines of credit on home equity loans, $566,000 of unused credit card lines, $6.1 million of unused commercial lines of credit, and $300,000 for commercial loans, unused bounce protection.of $1.7 million and letters of credit of $4,000.

 

Deposits are a primary source of funds for use in lending and for other general business purposes. At December 31, 2012, deposits funded 73.7% of our total assets compared to 69.4% at December 31, 2011. Certificates of deposit scheduled to mature in less than one year at December 31, 2012 totaled $39.2 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. As we rebuild our balance sheet in the next few years, the growth in assets may require a more significant in-flow of liquidity than has been necessary over the past few years. As such, we may from time to time be a market leader in rates paid for certain liabilities to fund asset growth.

 

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, 2012, we had $26.4 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 12.3% at December 31, 2012 compared to 15.9% at December 31, 2011.

 

 
 

 

As of December 31, 2012, 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, 2012, 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.

 

Total stockholders’ equity of the Company was $24.4 million at December 31, 2012 and $24.6 million at December 31, 2011, a decrease of $134,000 year over year. The Company’s ratio of equity to assets increased from 11.4% as of December 31, 2011 to 11.6% as of December 31, 2012. Federal bank regulatory agencies have set capital adequacy standards for Total Risk Based Capital, Tier 1 Risk Based Capital, and Leverage Capital. These regulatory standards require banks to maintain Leverage and Tier 1 ratios of at least 4% and a Total Capital ratio of at least 8% to be adequately capitalized. The regulatory agencies consider a bank to be “well capitalized” if its Total Risk Based Capital is at least 10% of Risk Weighted Assets, Tier 1 Capital is at least 6% of Risk Weighted Assets, the Leverage Capital Ratio is at least 5%, and the Bank is not subject to any written agreements or order issued by the FDIC pursuant to Section 8 of the Federal Deposit Insurance Act.

 

The following table summarizes the capital ratios of the Company:

 

   At December 31,   Minimum to be 
   2012   2011   Well Capitalized 
             
Tier 1 Leverage Ratio   10.33%   10.37%   5.00%
                
Tier 1 Risk-Based Capital   16.11%   16.30%   6.00%
                
Total Risk-Based Capital   17.36%   17.20%   10.00%

 

At December 31, 2012 and December 31, 2011, the Bank exceeded the minimum capital requirements to be considered “well capitalized.” See Note 11 to our financial statements for further information.

 

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 collectability as of the reporting date. Our evaluation, which includes a review of all loans on which full collectability 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, 2012 would have changed by approximately $155,000. 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, 2012, we were servicing loans sold to others totaling $140.7 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, 2012 included the following:

 

Annual constant prepayment speed (CPR):   17.9%
Weighted average life remaining (in months):   246 
Discount rate used:   8.1%

 

At the December 31, 2012 valuation we determined that the book value of our mortgage servicing rights asset associated with sold 20-year fixed-rate loans was $19,200 more than the independent valuation; therefore a $19,200 valuation reserve was established against that tranche of loans. There was no need to establish a valuation allowance against the asset related to either the 15- or 30-year fixed-rate sold loan tranches.

 

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 balance of the intangible asset was $154,000 at December 31, 2012, and was evaluated for impairment as of that date.

 

 
 

 

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, 2012 and 2011, management did not believe it was more likely than not that all of the deferred tax assets would be realized. Accordingly, at December 31, 2012 and 2011 a valuation allowance of $3.2 million and $3.0 million was recorded, respectively. The net deferred tax asset recorded at December 31, 2012 and 2011 was $331,000 and $372,000. See Note 9 for additional information.

 

 
 

 

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, 2012 and December 31, 2011, First Federal of Northern Michigan had $9.5 million and $10.3 million, respectively, of commitments to grant loans, $13.1 million and $14.5 million, respectively, of unfunded commitments under lines of credit and $4,000 and $150,000, 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 42 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 35 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.

 

 
 

 

Executive Management of the Bank

 

Michael W. Mahler, Jerome W. Tracey, Amy E. Essex, Gregory S. Matthews

 

Officers 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, Jerome P. Schmidt, Steven T. Mousseau

 

STOCKHOLDER INFORMATION

 

 

 

The Annual Meeting of Stockholders will be held at 1:00 p.m., May 15, 2013 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 2012 and 2011.

 

   Market Price     
Quarter Ended  High   Low   Cash Dividends Declared 
             
December 31, 2012  $5.00   $3.94   $- 
September 30, 2012  $3.96   $3.25   $- 
June 30, 2012  $4.03   $3.30   $- 
March 31, 2012  $4.27   $2.99   $- 
December 31, 2011  $3.66   $2.85   $- 
September 30, 2011  $3.90   $3.40   $- 
June 30, 2011  $3.80   $3.28   $- 
March 31, 2011  $3.93   $2.95   $- 

 

 
 

 

Special Counsel Independent Auditor
   
Luse Gorman Pomerenk & Schick, PC Plante & Moran, PLLC
5335 Wisconsin Avenue, N.W. 2601 Cambridge Ct.  Suite 500
Suite 780 Auburn Hills, Michigan 48326
Washington, D.C.  20015  
  Transfer Agent
Market Makers  
  Registrar and Transfer Company
Raymond James & Associates, Inc. 10 Commerce Drive
222 South Riverside Plaza Cranford, New Jersey 07016
7th Floor 60606 800-346-6084
Chicago, IL  
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  

 

Annual Report on Form 10-K

 

A copy of the Company's Form 10-K for the year ended December 31, 2012 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 and Comprehensive Income 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, 2012 and 2011 and the related consolidated statements of operations and comprehensive income, changes in stockholders’ equity, and cash flows for each year in the two-year period ended December 31, 2012. 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, 2012 and 2011 and the consolidated results of their operations and their cash flows for each year in the two-year period ended December 31, 2012, in conformity with accounting principles generally accepted in the United States of America.

 

/s/ Plante & Moran, PLLC

 

Auburn Hills, Michigan 

March 29, 2013

 

2
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

 

Consolidated Balance Sheet

(000s omitted, except per share data)

 

   December 31 
   2012   2011 
Assets          
Cash and cash equivalents  $2,732   $2,714 
Overnight deposits with Federal Home Loan Bank   20    35 
           
Total cash and cash equivalents   2,752    2,749 
           
Securities available for sale (Note 2)   50,764    53,049 
Securities held to maturity (Note 2)   2,345    2,435 
Loans - net (Note 3)   138,912    140,884 
Loans - held for sale   79    - 
Federal Home Loan Bank stock   3,266    3,266 
Property and equipment (Note 4)   5,394    5,846 
Foreclosed real estate   2,387    3,408 
Accrued interest receivable   970    1,149 
Prepaid FDIC insurance premiums   583    759 
Intangible assets (Note 6)   158    335 
Deferred tax asset   331    372 
Originated mortgage servicing right - net (Note 5)   1,016    993 
Bank owned life insurance   4,475    1,413 
Other assets   402    387 
Total assets  $213,834   $217,045 
           
Liabilities and Stockholders' Equity          
Liabilities          
Non-interest bearing deposits  $21,067   $12,609 
Interest-bearing deposits (Note 7)   137,283    138,040 
Advances from Federal Home Loan Bank (Note 8)   26,358    34,500 
REPO sweep accounts   3,183    5,592 
Accrued expenses and other liabilities (Note 12)   1,508    1,736 
Total liabilities   189,399    192,477 
           
Stockholders' Equity (Note 11)          
Common stock ($0.01 par value 20,000,000 shares authorized          
3,191,799 shares issued)   32    32 
Additional paid-in capital   23,854    23,853 
Retained earnings   2,766    2,980 
Treasury stock at cost (307,750 shares)   (2,964)   (2,964)
Unearned compensation   -   (1)
Accumulated other comprehensive income   747    668 
Total stockholders' equity   24,435    24,568 
Total liabilities and stockholders' equity  $213,834   $217,045 

 

See Notes to Consolidated

Financial Statements.

 

3
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

 

Consolidated Statement of Operations and Comprehensive Income

(000s omitted, except per share data)

 

   Year Ended December 31 
   2012   2011 
         
Interest Income          
Loans, including fees  $7,928   $8,926 
Investments          
Taxable   540    521 
Tax-exempt   154    159 
Mortgage-backed securities   621    784 
Total interest income   9,243    10,390 
Interest Expense          
Deposits (Note 7)   1,034    1,549 
Borrowings   620    713 
Total interest expense   1,654    2,262 
Net Interest Income - Before provision for loan losses   7,589    8,128 
Provision for Loan Losses (Note 3)   1,367    284 
Net Interest Income - After provision for loan losses   6,222    7,844 
Other Income          
Service charges and other fees   760    730 
Net gain on sale of investments   47    - 
Net gain on sale of loans   587    388 
Loan servicing fees   656    581 
Insurance and brokerage commissions   149    158 
Other   77    75 
Total other income   2,276    1,932 
Operating Expenses          
Compensation and employee benefits (Note 12)   4,913    4,622 
FDIC insurance premiums   189    224 
Amortization of intangible assets   177    292 
Advertising   156    134 
Occupancy and equipment   959    1,049 
Data processing service bureau   306    301 
Professional fees   424    433 
Other   1,588    1,979 
Total operating expenses   8,712    9,034 
Income (Loss) - before income tax expense   (214)   742 
Income tax expense (Note 9)   -    - 
Net income (loss)  $(214)  $742 
           
Comprehensive Income (Loss):          
Net Income (Loss)  $(214)  $742 
Change in unrealized gain on available for sale securities, net of tax   79    522 
           
Comprehensive Income (Loss)  $(135)  $1,264 
           
Per Share Data          
Net income (loss) per share          
Basic  $(0.07)  $0.26 
Diluted  $(0.07)  $0.26 
           
Dividends per common share  $-   $- 

 

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		   Accumulated
Other
Comprehensive
Income		   Total
Stockholders'
Equity		 
                                 
Balance - January 1, 2011   3,192   $32   $(2,964)  $23,822   $(38)  $2,238   $146   $23,236 
                                         
Net Income   -    -    -    -    -    742    -    742 
Unrealized depreciation on available-for-sale securities - Net of tax of ($269)   -    -    -    -    -    -    522    522 
                                         
Stock options/MRP shares expensed   -    -    -    31    37    -    -    68 
                                         
Balance - December 31, 2011   3,192    32    (2,964)   23,853   (1)    2,980    668    24,568 
                                         
Net loss   -    -    -    -    -    (214)   -    (214)
Unrealized appreciation on available-for-                                        
sale securities - Net of tax of ($41)   -    -    -    -    -    -    79    79 
Stock options/MRP shares expensed   -    -    -    1    1    -    -    2 
                                         
Balance - December 31, 2012   3,192   $32   $(2,964)  $23,854   $-   $2,766   $747   $24,435 

 

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 
   2012   2011 
Cash Flows from Operating Activities          
Net income (loss)  $(214)  $742 
Adjustments to reconcile net income (loss) to cash from operating          
activities:          
Depreciation and amortization   480    684 
Provision for loan losses   1,367    284 
Amortization and accretion on securities   527    321 
Gain on sale of investment securities   (47)   - 
Stock options/awards   2    68 
Gain on sale of loans held for sale   (587)   (388)
Loss(Gain) on sale of property and equipment   4   (1)
Loss on sale of real estate owned and other repossessed assets   83    48 
Originations of loans held for sale   (35,559)   (28,821)
Proceeds from sale of loans held for sale   36,067    29,209 
Net change in:          
Accrued interest receivable   179    82 
Prepaid FDIC insurance premiums   176    208 
Bank owned life insurance   (61)   - 
Other assets   (37)   (58)
Accrued expenses and other liabilities   (227)   (123)
Deferred income tax benefit - (Note 9)   0   (18)
         
Net cash provided by operating activities   2,153    2,237 
         
Cash Flows from Investing Activities          
Net (increase)decrease in loans   (1,219)   12,518 
Proceeds from maturity of securities   20,494    12,790 
Proceeds from sale of securities available-for-sale   1,600    - 
Proceeds from sale of property and equipment   264    2 
Proceeds from sale of of real estate owned and other repossessed assets   2,761    2,821 
Purchase of securities available for sale   (20,080)   (29,982)
Proceeds from sale of Federal Home Loan Bank stock   -    509 
Purchase of bank owned life insurance   (3,000)   - 
Purchase of premises and equipment   (120)   (212)
           
Net cash provided by (used in) investing activities   700    (1,554)
           
Cash Flows from Financing Activities          
Net increase(decrease) in deposits   7,701    (4,817)
Net decrease in Repo Sweep Accts   (2,409)   (580)
Advances from FHLB   58,815    23,700 
Repayments of advances from FHLB   (66,957)   (18,200)
           
Net cash (used in) provided by financing activities   (2,850)   103 
           
Net Increase in Cash and Cash Equivalents   3    786 
           
Cash and Cash Equivalents - Beginning of year   2,749    1,963 
           
Cash and Cash Equivalents - End of year  $2,752   $2,749 
           
Supplemental Cash Flow and Noncash Information          
Net cash refunded for income taxes  $(15)  $(41)
Cash paid for interest on deposits and borrowings   1,702    2,341 
Transfer of loans to real estate owned & other repossessed assets   1,823    3,459 

 

See Notes to Consolidated

Financial Statements.

 

6
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

(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.

 

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, the valuation of investment securities, intangible and deferred tax assets, and mortgage servicing rights.

 

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.

 

The market value of securities is based on quoted market prices. For securities that do not have readily available market values, estimated market values are calculated based on the market values of comparable securities.

 

7
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

(000s omitted, except per share data)

 

Note 1 - Summary of Significant Accounting Policies (Continued)

 

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 – The Bank is a member of the Federal Home Loan Bank of Indianapolis (FHLBI). Members are required to own a certain amount of stock based on the level of borrowings and other factors. Stock in the FHLBI is recorded at redemption value which approximates fair value. The Company periodically evaluates the FHLBI stock for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income.

 

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, 2012 and 2011.

 

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, 2012 and 2011.

 

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. 

 

8
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

(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.

 

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.

 

9
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

(000s omitted, except per share data)

 

Note 1 - Summary of Significant Accounting Policies (Continued)

 

Troubled debt restructuring of loans is undertaken to improve the likelihood that the loan will be repaid in full under the modified terms in accordance with a reasonable repayment schedule.  All modified loans are evaluated to determine whether the loans should be reported as a Troubled Debt Restructure (TDR).  A loan is a TDR when the Company, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower by modifying or renewing a loan that the Company would not otherwise consider. To make this determination, the Company must determine whether (a) the borrower is experiencing financial difficulties and (b) the Company granted the borrower a concession. This determination requires consideration of all of the facts and circumstances surrounding the modification.  An overall general decline in the economy or some deterioration in a borrower’s financial condition does not automatically mean the borrower is experiencing financial difficulties.

 

Loans Held for Sale - Loans held for sale consist of fixed rate residential mortgage loans with maturities of 15 to 30 years. Such loans are recorded at the lower of aggregate cost or estimated fair value.

 

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.

 

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.

 

Foreclosed Assets (Including Other Real Estate Owned) - 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.

 

10
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

(000s omitted, except per share data)

 

Note 1 - Summary of Significant Accounting Policies (Continued)

 

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.

 

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.

 

Bank Owned Life Insurance - Bank owned life insurance policies are stated at the current cash surrender value of the policy, or the policy death proceeds less any obligation to provide a death benefit to an insured’s beneficiaries if that value is less than the cash surrender value. Increases in the asset value are recorded as earnings in other income.

 

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.

 

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.

 

11
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

(000s omitted, except per share data)

 

Note 1 - Summary of Significant Accounting Policies (Continued)

 

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, 2012 and 2011, management did not believe it was more likely than not that all of the deferred tax assets would be realized. Accordingly, at December 31, 2012 and 2011 a valuation allowance of $3.2 million and $3.0 million was recorded, respectively. The net deferred tax asset recorded at December 31, 2012 and 2011 was $331,000 and $372,000. See Note 9 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. Such financial instruments are recorded when they are funded. Additional information regarding Off Balance Sheet Instruments is included in Note 10 in these Notes to Consolidated Financial Statements.

 

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 2012 and 2011. Compensation costs charged to earnings were $2,000 and $68,000 in 2012 and 2011, respectively.

 

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 reflect 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. As of December 31, 2012 there was no dilution due to the net loss for the year. As of December 31, 2011, 182,682 options were not considered dilutive, due to the fact that the options are underwater.

 

12
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

(000s omitted, except per share data)

 

Note 1 - Summary of Significant Accounting Policies (Continued)

 

Earnings per common share have been computed based on the following:

 

   December 31, 
   2012   2011 
         
Net income (loss)  $(214)  $742 
           
Average number of common shares outstanding   2,884,049    2,884,049 
Effect of dilutive options   -    - 
Average number of common shares outstanding used to calculate diluted earnings per common share   2,884,049    2,884,049 

 

 

Recent Accounting Pronouncements - Accounting Standards Update 2011-05 (ASU 2011-05), “Comprehensive Income” was issued by the Financial Accounting Standards Board (“FASB”) in June 2011. ASU 2011-05 requires an entity to present the total of comprehensive income, the components of comprehensive income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but continuous statements. This standard eliminated the option to present the components of other comprehensive income as a part of the statement of changes in stockholders’ equity. This ASU is effective for fiscal years, and interim periods within those years, beginning after December 31, 2011. The implementation of this standard only changed the presentation of comprehensive income; it did not have an impact on the Company’s financial position or its results of operations. ASU 2011-12 was issued by FASB in December 2011. ASU 2011-12 deferred the requirement to present reclassification adjustments for each component of OCI in both net income and OCI and the face of the financial statements until fiscal years, and interim periods within those fiscal years, beginning after December 15, 2012. The other requirements of ASU 2011-05 were not affected by ASU 2011-12. As a result of adopting ASU 2011-05, the Company is presenting the total of comprehensive income and the components of comprehensive income and other comprehensive income in a single continuous statement.

 

In 2011, the FASB issued Accounting Standards Update (“ASU”) No. 2011-02, A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.  This update applies to all creditors, both public and non-public, and was introduced to provide clarification surrounding troubled debt restructurings (“TDR”).  The primary characteristics that previously caused a restructuring to qualify as a TDR still exist: (1) the restructuring constitutes a concession to the borrower and (2) the borrower is experiencing financial difficulties.  The update provides additional details and examples to provide clarity surrounding these items.  The update also prohibits the use of the effective interest rate test when determining whether the restructuring constitutes a concession.  The update is effective for annual reporting periods ending on or after December 15, 2012 (therefore, December 31, 2012, for the Company).  Lastly, the disclosure requirements set forth by ASU 2010-20 regarding troubled debt restructurings, and later deferred by ASU 2011-1 until December 31, 2012 for the Company, are included in Note 3.  Other than the additional disclosures, these updates did not have a significant impact on the financial statements.

 

In 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820) - Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. This update to Fair Value Measurement (Topic 820) results in common fair value measurement and disclosure requirements in U.S. GAAP and IFRS. The amendments in this update explain how to measure fair value. They do not require additional fair value measurements and are not intended to establish valuation standards or affect valuation practices outside of financial reporting. However, this update does require expanded disclosure related to the nature and significance of inputs that are used in estimating and measuring the fair value of financial instruments. The amendments in this update are to be applied prospectively and are effective for annual reporting periods beginning after December 15, 2011 (therefore, December 31, 2012, for the Company).  This update did not have a significant impact on the financial statements.

 

13
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

(000s omitted, except per share data)

 

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, 2012 
   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  $9,181   $66   $-   $9,247 
Municipal notes   10,413    368    (23)   10,758 
Corporate securities   1,135    15    -    1,150 
Mortgage-backed securities   28,901    736    (29)   29,608 
Equity securities   3    -   (2 )   1 
                     
Total  $49,633   $1,185   $(54)  $50,764 
                     
Securities Held to Maturity                    
Municipal notes  $2,345   $225   $-   $2,570 

 

   December 31, 2011 
   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  $14,756   $108   $(1)  $14,863 
Municipal notes   6,927    361   (12)   7,276 
Mortgage-backed securities   30,350    603    (44)   30,909 
Equity securities   3    -   (2)   1 
                     
Total  $52,036   $1,072   $(59)  $53,049 
                     
Securities Held to Maturity                    
Municipal notes  $2,435   $230   $-   $2,665 

 

14
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

(000s omitted, except per share data)

 

Note 2 - Securities (Continued)

 

The amortized cost and estimated market value of securities at December 31, 2012, 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.

 

   December 31, 2012 
   Amortized
Cost		   Market
Value		 
         
Available For Sale:          
           
Due in one year or less  $1,857   $1,864 
Due after one year through five years   13,981    14,245 
Due in five year through ten years   4,605    4,673 
Due after ten years   286    373 
           
Subtotal   20,729    21,155 
           
Equity securities   3    1 
Mortgage-backed securities   28,901    29,608 
           
Total  $49,633   $50,764 
           
Held To Maturity          
Due in one year or less  $90   $92 
Due after one year through five years   455    486 
Due in five year through ten years   660    726 
Due after ten years   1,140    1,266 
           
Total  $2,345   $2,570 

 

At December 31, 2012 and 2011, securities with a fair value of $44,135,000 and $31,085,000, 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, 2012 and 2011 were $1.6 million and $0, respectively, resulting in gross gains of $54,000 and $0, respectively, and gross losses of $7,000 and $0, respectively. The tax provision applicable to these net realized gains amounted to $16,000 and $0, respectively.

 

15
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

(000s omitted, except per share data)

 

Note 2 - Securities (Continued)

 

The investment securities portfolio is evaluated for impairment throughout the year. Impairment is recorded against individual securities, unless the decrease in fair value is attributable to interest rates or the lack of an active market, and management determines that the Company has the intent and ability to hold the investment for a period of time sufficient to allow for an anticipated recovery in the market value. The fair values of investments with an amortized cost in excess of their fair values at December 31, 2012 and December 31, 2011 are as follows:

 

   December 31, 2012   December 31, 2011 
       Gross
Unrealized
Losses		       Gross
Unrealized
Losses		       Gross
Unrealized
Losses		       Gross
Unrealized
Losses		 
   Fair Value   less than 12
months		   Fair Value   greater than 12
months		   Fair Value   less than 12
months		   Fair Value   greater than 12
months		 
Available For Sale:                                        
U.S. Treasury securities and obligations of U.S. government corporations and agencies  $-   $-   $-   $-   $1,999   $(1)  $-   $- 
Municipal notes   1,537    (23)   -    -    646    (12)   -    - 
Mortgage-backed securities   2,725    (13)   1,687    (16)   8,137    (27)   1,458    (17)
Equity securities   -    -    1    (2)   -    -    1    (2)
Total Securities available for sale  $4,262   $(36)  $1,688   $(18)  $10,782   $(40)  $1,459   $(19)
Held to Maturity:                                        
Municipal notes   -    -    -    -    -    -    -    - 
Total Securities held to maturity  $-   $-   $-   $-   $-   $-   $-   $- 

 

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. The Company has the intent and ability to hold these securities until recovery, which may not be until maturity. The fair value of these securities is expected to recover as the securities approach maturity.

 

As of both December 31, 2012 and 2011, there were 10 securities in an unrealized loss position.

 

16
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

(000s omitted, except per share data)

 

Note 3 - Loans

 

Loans at December 31, 2012 and 2011 are summarized as follows:

 

   December 31 
   2012   2011 
         
Real estate loans - One- to four-family residential  $66,539   $66,599 
Commercial loans:          
Secured by real estate   54,673    54,202 
Other   8,102    7,002 
Total commercial loans   62,775    61,204 
Consumer loans:          
Secured by real estate   10,409    13,395 
Other   1,259    1,477 
Total consumer loans   11,668    14,872 
Total gross loans   140,982    142,675 
Less:          
Net deferred loan fees   320    273 
Allowance for loan losses   1,750    1,518 
Total loans - net  $138,912   $140,884 

 

Final loan maturities and rate sensitivity of the loan portfolio are as follows:

 

   December 31, 2012 
   Less Than
One Year		   One Year
to Five
Years		   After
Five
Years		   Total 
                 
Loans at fixed interest rates  $8,440   $24,634   $45,611   $78,685 
Loans at variable interest rates   9,952    15,581    36,764    62,297 
                     
Total  $18,392   $40,215   $82,375   $140,982 

 

17
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

(000s omitted, except per share data)

 

Note 3 - Loans (Continued)

 

Certain directors and executive officers of the Company were loan customers during 2012 and 2011. 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, 2012 and 2011 are as follows:

 

   December 31 
   2012   2011 
         
Aggregate balance - Beginning of Period  $3,344   $3,357 
           
New loans   1,166    771 
Repayments   (1,170)   (784)
           
Aggregate balance - End of Period  $3,340   $3,344 

 

The following tables illustrate the contractual aging of the recorded investment in past due loans by class of loans as of December 31, 2012 and 2011:

 

As of December 31, 2012
                           Recorded 
                           Investment > 90 
   30 - 59 Days   60 - 89 Days   Greater than 90   Total           Days and 
   Past Due   Past Due   Days   Past Due   Current   Total Loans   Accruing 
                             
Commercial Real Estate:                                   
Commercial Real Estate - construction  $-   $-   $173   $173   $2,073   $2,246   $- 
Commercial Real Estate - other   3,210    540    282    4,032    48,395    52,427    - 
Commercial - non real estate   113    -    -    113    7,989    8,102    - 
                                    
Consumer:                                   
Consumer - Real Estate   59    -    13    72    10,337    10,409    - 
Consumer - Other   11    5    6    22    1,237    1,259    6 
                                    
Residential:                                   
Residential   2,047    796    1,198    4,041    62,498    66,539    61 
Total  $5,440   $1,341   $1,672   $8,453   $132,529   $140,982   $67 

 

18
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

(000s omitted, except per share data)

 

Note 3 - Loans (Continued)

 

As of December 31, 2011
                           Recorded 
                           Investment > 90 
   30 - 59 Days   60 - 89 Days   Greater than 90   Total           Days and 
   Past Due   Past Due   Days   Past Due   Current   Total Loans   Accruing 
                             
Commercial Real Estate:                                   
Commercial Real Estate - construction  $-   $-   $173   $173   $91   $264   $- 
Commercial Real Estate - other   3,808    339    245    4,392    49,546    53,938    - 
Commercial - non real estate   46    29    -    75    6,927    7,002    - 
                                    
Consumer:                                   
Consumer - Real Estate   394    34    128    556    12,839    13,395    - 
Consumer - Other   5    25    -    30    1,447    1,477    - 
                                    
Residential:                                   
Residential   3,055    1,501    1,969    6,525    60,074    66,599    238 
Total  $7,308   $1,928   $2,515   $11,751   $130,924   $142,675   $238 

 

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.

 

19
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

(000s omitted, except per share data)

 

Note 3 - Loans (Continued)

 

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.

 

The following tables present the risk category of loans by class of loans based on the most recent analysis performed as of December 31, 2012 and 2011:

 

20
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

 Notes to Consolidated Financial Statements

December 31, 2012 and 2011

(000s omitted, except per share data)

 

Note 3 - Loans (Continued)

 

As of December 31, 2012
             
   Commercial Real Estate   Commercial Real Estate     
Loan Grade  Construction   Other   Commercial 
             
1-2  $-   $-   $- 
3   615    13,895    2,376 
4   1,458    27,488    5,489 
5   -    2,712    37 
6   173    8,332    200 
7   -    -    - 
8   -    -    - 
Total  $2,246   $52,427   $8,102 

 

As of December 31, 2011
             
   Commercial Real Estate   Commercial Real Estate     
Loan Grade  Construction   Other   Commercial 
             
1-2  $-   $-   $7 
3   -    10,911    2,178 
4   91    31,926    4,512 
5   -    1,078    - 
6   173    10,023    305 
7   -    -    - 
8   -    -    - 
Total  $264   $53,938   $7,002 

 

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, 2012 and 2011:

 

21
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

(000s omitted, except per share data)

 

Note 3 - Loans (Continued)

 

As of December 31, 2012  
   Residential         
             
Loan Grade:             
Pass  $64,669         
Special Mention   -         
Substandard   1,871         
Total  $66,540         

 

   Consumer -     
   Real Estate   Consumer - Other 
         
Performing  $10,381   $1,252 
Nonperforming   28    6 
Total  $10,409   $1,258 

 

As of December 31, 2011  
   Residential         
             
Loan Grade:             
Pass  $63,941         
Special Mention   -         
Substandard   2,658         
Total  $66,599         

 

   Consumer -     
   Real Estate   Consumer - Other 
         
Performing  $13,248   $1,473 
Nonperforming   147    4 
Total  $13,395   $1,477 

 

22
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

(000s omitted, except per share data)

 

Note 3 - Loans (Continued)

 

The following tables present the recorded investment in non-accrual loans by class as of December 31, 2012 and 2011:

 

As of December 31
   2012   2011 
Commercial Real Estate:          
Commercial Real Estate - construction  $173   $173 
Commercial Real Estate - other   2,851    356 
Commercial   -    - 
           
Consumer:          
Consumer - real estate   28    152 
Consumer - other   1    - 
           
Residential:          
Residential   1,810    2,420 
           
Total  $4,863   $3,101 

 

23
 

 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

(000s omitted, except per share data)

 

Note 3 - Loans (Continued)

 

The following tables present loans individually evaluated for impairment by class of loans as of December 31, 2012 and 2011:

 

    For the Twelve  Months Ended  
Impaired Loans   December 31,  
As of December 31, 2012   2012  
    Unpaid Principal     Recorded     Related     Average     Interest  
    Balance     Investment     Allowance     Recorded     Income  
                      Investment     Recognized  
             
With no related allowance recorded:                                        
Commercial   $ -     $ -     $ -     $ -     $ -  
Commercial Real Estate - Construction     1,589       173       -       173       -  
Commercial Real Estate - Other     4,869       4,535       -       5,084       138  
Consumer - Real Estate     33       28       -       34       -  
Consumer - Other     1       1       -       3       -  
Residential     1,365       1,194       -       1,359       -  
                                         
With a specific allowance recorded:                                        
Commercial     -       -       -       -       -  
Commercial Real Estate - Construction     -       -       -       -       -  
Commercial Real Estate - Other     2,138       2,127       101       2,167       80  
Consumer - Real Estate     -       -       -       -       -  
Consumer - Other     -       -       -       -       -  
Residential     616       616       141       642       -  
                                         
Totals:                                        
Commercial   $ -     $ -     $ -     $ -     $ -  
Commercial Real Estate - Construction   $ 1,589     $ 173     $ -     $ 173     $ -  
Commercial Real Estate - Other   $ 7,007     $ 6,662     $ 101     $ 7,251     $ 218  
Consumer - Real Estate   $ 33     $ 28     $ -     $ 34     $ -  
Consumer - Other   $ 1     $ 1     $ -     $ 3     $ -  
Residential   $ 1,981     $ 1,810     $ 141     $ 2,001     $ -  

   

24
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

(000s omitted, except per share data)

 

Note 3 - Loans (Continued)

 

       For the Twelve  Months Ended 
Impaired Loans  December 31, 
As of December 31, 2011  2011 
   Unpaid Principal   Recorded   Related   Average   Interest 
   Balance   Investment   Allowance   Recorded   Income 
               Investment   Recognized 
         
With no related allowance recorded:                         
Commercial  $-   $-   $-   $-   $- 
Commercial Real Estate - Construction   1,589    173    -    469    - 
Commercial Real Estate - Other   626    626    -    509    135 
Consumer - Real Estate   171    152    -    196    - 
Consumer - Other   0    0    -    7    - 
Residential   2,017    1,640    -    1,928    - 
                          
With a specific allowance recorded:                         
Commercial   -    -    -    -    - 
Commercial Real Estate - Construction   -    -    -    516    - 
Commercial Real Estate - Other   1,337    1,128    85    1,039    115 
Consumer - Real Estate   -    -    -    -    - 
Consumer - Other   -    -    -    -    - 
Residential   813    780    199    860    - 
                          
Totals:                         
Commercial  $-   $-   $-   $-   $- 
Commercial Real Estate - Construction  $1,589   $173   $-   $985   $- 
Commercial Real Estate - Other  $1,963   $1,754   $85   $1,548   $250 
Consumer - Real Estate  $171   $152   $-   $196   $- 
Consumer - Other  $-   $-   $-   $7   $- 
Residential  $2,830   $2,420   $199   $2,788   $- 

 

No additional funds are committed to be advanced in connection with impaired loans.

 

The Bank may agree to modify the terms of a loan in order to improve the Bank’s ability to collect amounts due. These modifications may include reduction of the interest rate, extension of the loan term, or in some cases, reduction of the principal balance. Modifications that are performed due to the debtor’s financial difficulties are considered Troubled Debt Restructurings (TDRs). Loans that were classified as TDRs during the year ended December 31, 2012 are as follows:

 

25
 

 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

 (000s omitted, except per share data)

 

Note 3 - Loans (Continued)

 

For the Twelve Months Ended
December 31, 2012
               Troubled Debt Restructurings 
       Pre-Modification   Post-Modification   That Subsequently Defaulted 
   Number
of		   Outstanding
Recorded		   Outstanding
Recorded		   Number
of		   Recorded 
   Contracts   Investments   Investment   Contracts   Investment 
                 
Troubled Debt Restructurings                         
                          
Commercial Real Estate - Construction   -   $-   $-    -   $- 
Commercial Real Estate - Other   -    -    -    1    53 
Commercial - non real estate   4    3,542    2,737    -    - 
Residential   -    -    -    -    - 

 

For the Twelve Months Ended
December 31, 2011
               Troubled Debt Restructurings 
       Pre-Modification   Post-Modification   That Subsequently Defaulted 
   Number
of		   Outstanding
Recorded		   Outstanding
Recorded		   Number
of		   Recorded 
   Contracts   Investments   Investment   Contracts   Investment 
                 
Troubled Debt Restructurings                         
                          
Commerical Real Estate - Construction   -   $-   $-    -   $- 
Commercial Real Estate - Other   3    1,503    1,398    -    - 
Consumer - Real Estate   -    -    -    -    - 
Residential   -    -    -    -    - 

 

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.

 

26
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

(000s omitted, except per share data)

 

Note 3 – Loans (Continued)

 

The ALLL has a direct impact on the provision expense. An increase in the ALLL is funded through recoveries and provision expense.

 

Activity in the allowance for loan and lease losses was as follows for the years ended December 31, 2012 and 2011:

 

For the Year Ended December 31, 2012
   Commercial   Commercial       Consumer                 
   Construction   Real Estate   Commercial   Real Estate   Consumer   Residential   Unallocated   Total 
                                 
Allowance for credit losses:                                        
Beginning Balance  $10   $393   $53   $146   $46   $870   $-   $1,518 
Charge-offs   -    (265)   -    (87)   (44)   (840)   -    (1,236)
Recoveries   -    10    -    16    10    65    -    101 
Provision   54    441    16    24    21    811    -    1,367 
Ending Balance  $64   $579   $69   $99   $33   $906   $-   $1,750 
                                         
Ending balance: individually evaluated for impairment  $-   $101   $-   $-   $-   $141   $-   $242 
                                         
Ending balance: loans collectively evaluated for impairment  $64   $478   $69   $99   $33   $765   $-   $1,508 
                                         
Loans:                                        
Ending Balance  $2,246   $52,427   $8,102   $10,409   $1,259   $66,539   $-   $140,982 
                                         
Ending balance: individually evaluated for impairment  $173   $6,662   $-   $28   $1   $1,810   $-   $8,674 
                                         
Ending balance: loans collectively evaluated for impairment  $2,073   $45,765   $8,102   $10,381   $1,258   $64,729   $-   $132,308 

 

For the Year Ended December 31, 2011
   Commercial   Commercial       Consumer                 
   Construction   Real Estate   Commercial   Real Estate   Consumer   Residential   Unallocated   Total 
                                 
Allowance for credit losses:                                        
Beginning Balance  $535   $1,281   $192   $228   $59   $536   $-   $2,831 
Charge-offs   (93)   (334)   (6)   (166)   (26)   (1,119)   -    (1,744)
Recoveries   -    79    1    31    11    25    -    147 
Provision   (432)   (633)   (134)   53    2    1,428    -    284 
Ending Balance  $10   $393   $53   $146   $46   $870   $-   $1,518 
                                         
Ending balance: individually evaluated for impairment  $-   $85   $-   $-   $-   $199   $-   $284 
                                         
Ending balance: loans collectively evaluated for impairment  $10   $308   $53   $146   $46   $671   $-   $1,234 
                                         
Loans:                                        
Ending Balance  $264   $53,938   $7,002   $13,395   $1,477   $66,599   $-   $142,675 
                                         
Ending balance: individually evaluated for impairment  $173   $1,754   $-   $152   $-   $2,420   $-   $4,499 
                                         
Ending balance: loans collectively evaluated for impairment  $91   $52,184   $7,002   $13,243   $1,477   $64,179   $-   $138,176 

 

27
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

 (000s omitted, except per share data)

 

Note 4 - Property and Equipment

 

A summary of property and equipment is as follows:

 

   December 31 
   2012   2011 
         
Land  $1,112   $1,188 
Land improvements   184    214 
Buildings   6,249    6,483 
Equipment   3,682    3,712 
           
Total property and equipment   11,227    11,597 
           
Accumulated depreciation   5,833    5,751 
           
Net property and equipment  $5,394   $5,846 

 

Depreciation expense was $303,000 and $392,000 for the periods ended December 31, 2012 and 2011, respectively.

 

28
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

 (000s omitted, except per share data)

 

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 $140,676,000 and $143,051,000 at December 31, 2012 and 2011, respectively.

 

The key economic assumptions used in determining the fair value of the mortgage servicing rights are as follows:

 

   December 31, 
   2012   2011 
Annual constant prepayment speed (CPR)   17.86%   17.52%
Weighted average life (in months)   246    246 
Discount rate   8.11%   8.13%

 

The fair value of our mortgage servicing rights was estimated to be $1,046,000 and $1,089,000 at December 31, 2012 and December 31, 2011, respectively. At December 31, 2012 a valuation allowance of $19,000 was established against the mortgage servicing rights associated with our 20-year fixed-rate sold loan portfolio.

 

The following table summarizes mortgage servicing rights capitalized and amortized, along with the aggregate activity in related valuation allowances:

 

   December 31 
   2012   2011 
         
Balance - beginning of period:  $993   $960 
Originated mortgage servicing rights capitalized   426    362 
Amortization of mortgage servicing rights   (384)   (329)
           
Balance - end of period   1,035    993 
           
Valuation allowances:          
Balance - beginning of period   -    - 
Additions   (19)   - 
Reductions   -    - 
Write-downs   -    - 
           
Balance - end of period (net of allowances)  $1,016   $993 

 

29
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

 (000s omitted, except per share data)

 

Note 6 - Intangible Assets

 

Intangible assets of the Company are summarized as follows:

 

   December 31, 2012 
   Gross Carrying
Amount		   Accumulated
Amortization		   Net Carrying
Amount		 
Amortized intangible assets:               
Core deposit  $3,081   $3,078   $3 
Commission residual   600    445    155 
Total  $3,681   $3,523   $158 

 

   December 31, 2011 
   Gross Carrying
Amount		   Accumulated
Amortization		   Net Carrying
Amount		 
Amortized intangible assets:               
Core deposit  $3,081   $3,017   $64 
Commission residual   600    329    271 
Total  $3,681   $3,346   $335 

 

Amortization expense was $177,000 and $292,000 for the periods ended December 31, 2012 and 2011, 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.

 

30
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

 (000s omitted, except per share data)

 

Note 6 - Intangible Assets (Continued)

 

The following table sets forth the amount of remaining amortization for intangibles assets:

 

   For the Year Ended December 31, 
   2013   2014 
         
Core deposit   2    1 
Commission residual   116    39 
Total   118    40 

 

Note 7 - Deposits

 

Deposit accounts, by type and range of rates, consist of the following:

 

   December 31 
   2012   2011 
Account Type          
           
NOW accounts and MMDA  $44,218   $41,795 
Regular savings accounts   19,867    17,873 
           
Total   64,085    59,668 
           
Certificate of Deposit Rates          
           
0.50 percent to 0.99 percent   42,698    38,802 
1.00 percent to 1.99 percent   15,962    18,343 
2.00 percent to 2.99 percent   10,746    16,057 
3.00 percent to 3.99 percent   3,398    4,078 
4.00 percent to 4.99 percent   394    1,092 
           
Total certificate of deposits   73,198    78,372 
           
Total interest-bearing deposits  $137,283   $138,040 

 

Certificates of deposit $100,000 or greater at December 31, 2012 and 2011 were $25,993,000 and $25,499,000, respectively.

 

31
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

 (000s omitted, except per share data)

 

Note 7 – Deposits (Continued)

 

The following table sets forth the amount and maturities of certificates of deposit:

 

   December 31, 2012 
   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  $30,190   $10,916   $1,563   $29   $-   $42,698 
1.00 percent to                              
1.99 percent   3,514    3,540    953    7,831    124    15,962 
2.00 percent to                              
2.99 percent   3,296    1,458    3,961    459    1,572    10,746 
3.00 percent to                              
3.99 percent   1,899    424    484    -    591    3,398 
4.00 percent to                              
4.99 percent   261    -    46    87    -    394 
Total  $39,160   $16,338   $7,007   $8,406   $2,287   $73,198 

 

Interest expense on deposits is summarized as follows:

 

   Year Ended December 31 
   2012   2011 
         
NOW and MMDAs  $95   $159 
Regular savings   10    9 
Certificates of deposit   929    1,381 
           
Total  $1,034   $1,549 

 

Deposits from related parties held by the Bank at December 31, 2012 and 2011 amounted to $1,271,000 and $698,000, respectively.

 

32
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

 (000s omitted, except per share data)

 

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 1.46%. These advances contain varying maturity dates through November 5, 2019 with a weighted average maturity of approximately 26 months. The advances are collateralized by approximately $50,002,000 and $47,802,000 of mortgage loans as of December 31, 2012 and 2011, respectively. In addition, at December 31, 2012 and 2011, securities with a carrying value of $31,713,000 and $19,877,000, respectively, were pledged as collateral for Federal Home Loan Bank advances. Available borrowings with the Federal Home Loan Bank at December 31, 2012 totaled $53,847,000, of which $26,400,000 was outstanding.

 

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, 2012
Years Ending
December 31		  Amount   Weighted Average
Interest Rate		 
         
2013  $14,968    1.52 
2014   553    1.12 
2015   1,162    1.17 
2016   5,572    1.26 
2017   2,983    1.86 
Thereafter   1,120    1.12 
Total  $26,358    1.46 

 

The Bank did not have any variable rate advances as of December 31, 2012 or 2011, respectively.

 

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, 2012, these advances are secured by investment securities with a fair value of approximately $6,698,000 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, 2012). At December 31, 2012 and 2011, the Bank had $0 outstanding in Federal Reserve Bank advances.

 

33
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

 (000s omitted, except per share data)

 

Note 9 - Federal Income Tax

 

Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be reversed. The Company and the Bank file a consolidated Federal income tax return.

 

The analysis of the consolidated provision for federal income tax is as follows:

 

   Year Ended December 31 
   2012   2011 
         
Continuing operations:          
Current provision  $-   $18 
Deferred benefit   -   (18)
           
Total  $-   $- 

 

The following presents a reconciliation of income taxes as shown on the Consolidated Statement of Operations with that which would be computed by applying the statutory Federal tax rate of 34% to income (loss) before taxes in 2012 and 2011.

 

   Year Ended December 31 
   2012   2011 
         
Tax (benefit) expense at statutory rate  $(73)  $252 
Increase (decrease) from:          
Change in valuation allowance   138    (177)
Tax-exempt interest   (52)   (55)
Other   (13)   (20)
           
Total income tax expense  $-   $- 

 

Management monitors changes in tax statutes and regulations and the issuance of judicial decisions to determine the potential impact to uncertain income tax positions. At December 31, 2012 and 2011, the Company had no unrecognized tax benefits recorded. The Company does not expect the amount of unrecognized tax benefits to significantly change within the next twelve months. During 2012 and 2011, there were no material uncertain income tax positions.

 

Management believes that it is more likely than not that a portion of the deferred Federal tax assets will be realized. At December 31, 2012 and 2011 there was $3.2 million and $3.0 million of valuation allowance required. The tax effects of temporary differences that give rise to significant portions of the deferred Federal tax assets and deferred Federal tax liabilities are presented below

 

34
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

 (000s omitted, except per share data)

 

Note 9 - Federal Income Tax (Continued)

 

   December 31 
   2012   2011 
Deferred tax assets:          
Other real estate owned  $96   $185 
Non-accrual loan interest   65    20 
Directors' benefit plan   274    279 
Net operating loss carryforward   3,536    3,320 
Investment in  subsidiary   784    784 
Net deferred loan origination fees   109    93 
Other   192    139 
           
Total deferred tax assets   5,056    4,820 
           
Less: valuation allowance   3,166    3,028 
           
Deferred tax liabilities:          
Allowance for loan losses   158    143 
Mortgage servicing rights   345    338 
Partnership losses   117    118 
Unrealized gain on available-for-sale securities    385    344 
Depreciation   343    287 
Other   211    190 
           
Total deferred tax liabilities   1,559    1,420 
           
Net deferred tax asset  $331   $372 

 

The Company has net operating loss carryforwards of approximately $10.4 million generated from December 31, 2007 through December 31, 2012 that are available to reduce total taxable income through the years ending December 31, 2032.

 

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.

 

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, 2012 and 2011, the amount of those reserves was approximately $60,000. The amount of the unrecognized deferred tax liability at December 31, 2012 and 2011 was approximately $20,000.

 

35
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

(000s omitted, except per share data)

 

Note 10 - Off Balance Sheet Risk Commitments and Contingencies

 

In the normal course of business, the Bank enters into commitments with off-balance sheet risk to meet the financing needs of its customers. These instruments are currently limited to commitments to extend credit and standby letters of credit. Commitments to extend credit involve elements of credit risk and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Bank’s exposure to credit loss in the event of nonperformance by the other party to the commitment is represented by the contractual amount of the commitment. The Bank uses the same credit policies in making commitments as it does for on-balance sheet instruments. Interest rate risk on commitments to extend credit results from the possibility that interest rates may have moved unfavorably from the position of the Bank since the time the commitment was made.

 

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 of 30 to 120 days or other termination clauses and may require payment of a fee. Since some of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

 

The Bank evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained by the Bank upon extension of credit is based on management’s credit evaluation of the applicant. Collateral held is generally single-family residential real estate and commercial real estate. Substantially all of the obligations to extend credit are variable rate. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Standby letters of credit generally are contingent upon the failure of the customer to perform according to the terms of the underlying contract with the third party.

 

A summary of the contractual amount of commitments at December 31, 2012 and 2011 follows:

 

   December 31 
   2012   2011 
         
Commitments to grant loans  $9,498   $9,783 
Unfunded commitments under lines of credit   13,074    14,485 
Commercial and standby letters of credit   4    150 

 

The nature of the Company’s business may result in litigation. Management, after reviewing with counsel all actions and proceedings pending against or involving First Federal of Northern Michigan Bancorp, Inc. and subsidiaries, considers that the aggregate liability or loss, if any, resulting from them will not be material to the Company’s financial position, results of operation or liquidity.

 

36
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

 (000s omitted, except per share data)

 

Note 11 - 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 which were administered by the Office of Thrift Supervision (OTS) until July 21, 2011. Effective that date, supervisory responsibility for federal savings associations was transferred to the Office of the Comptroller of the Currency (OCC). 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 OCC 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.

 

   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, 2012                              
Total capital (to risk- weighted assets)  $23,723    17.4%  $10,930    8.0%  $13,663    10.0%
Tier 1 capital (to risk- weighted assets)  $22,015    16.1%  $5,465    4.0%  $8,198    6.0%
Tangible capital (to  tangible assets)  $22,015    10.3%  $3,197    1.5%  $4,263    2.0%
                               
December 31, 2011                              
Total capital (to risk- weighted assets)  $23,568    17.2%  $10,961    8.0%  $13,702    10.0%
Tier 1 capital (to risk- weighted assets)  $22,334    16.3%  $5,481    4.0%  $8,221    6.0%
Tangible capital (to  tangible assets)  $22,334    10.4%  $3,232    1.5%  $4,309    2.0%

 

37
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

 (000s omitted, except per share data)

 

Note 12 - 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 $87,000 and $81,000 for the years ended December 31, 2012 and 2011, 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 the years ended December 31, 2012 and 2011 was $94,000 and $167,000, respectively.

 

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 $807,000 and $821,000 at December 31, 2012 and 2011, respectively. The expense under the plan for the years ended December 31, 2012 and 2011 was $71,000 and $87,000, respectively.

 

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 bore interest at a rate equal to the current prime rate, adjustable on January 1 of each year and provided for repayment of principal over the 15 year term of the loan. Since the Company provided the loan to the ESOP, the note receivable was not included in the Company’s balance sheet. Accordingly, the Company did not recognize interest income on the loan.

 

38
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

 (000s omitted, except per share data)

 

Note 12 - Employee Benefit Plans (Continued)

 

The Company made annual contributions to the ESOP sufficient to support the debt service of the loan. The loan was secured by the shares purchased, which were held in a suspense account for allocation among the participants as the loan is paid. Dividends paid on unallocated shares were not considered dividends for financial reporting purposes and were used to pay principal and interest on the ESOP loan. Dividends on allocated shares are charged to retained earnings.

 

The loan was paid in full as of December 31, 2009.

 

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, 2012 and 2011, respectively, 13,687 and 13,811 shares were sold into the open market and 15 and 0 shares were purchased from the open market. Total compensation expense was $0 for both the years ended December 31, 2012 and 2011.

 

Shares held by the ESOP include the following:

 

   December 31 
   2012   2011 
         
Allocated   121,608    138,345 
Unallocated   -    - 
Total   121,608    138,345 

 

There were 3,065 and 8 shares distributed to ESOP participants in 2012 and 2011, respectively.

 

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.

 

39
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

 (000s omitted, except per share data)

 

Note 12 - Employee Benefit Plans (Continued)

 

Stock Options - A summary of option activity under the Plan during the years ended December 31, 2012 and 2011 is presented below:

 

           Weighted-Average     
       Weighted-   Remaining     
       Average   Contractual Term   Aggregate 
Options  Shares   Exercise Price   (Years)   Intrinsic Value 
                 
Outstanding at January 1, 2011   186,132   $9.47    5.3    - 
                     
Granted in 2011   -   $0.00           
                     
Exercised in 2011   -   $0.00           
                     
Forfeited or Expired in 2011   (3,450)  $9.54           
                     
Outstanding at December 31, 2011   182,682   $9.47    4.3    - 
                     
Granted in 2012   -   $0.00           
                     
Exercised in 2012   -   $0.00           
                     
Forfeited or expired in 2012   (15,062)  $8.81           
                     
Oustanding at December 31, 2012   167,620   $9.53    3.38    - 
                     
Options Exercisable at December 31, 2012   167,620   $9.53    3.38    - 

 

There were 39,166 shares available for future granting of options as of December 31, 2012.

 

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 $4.60 on December 31, 2012 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, 2012. The amount changes based on the fair market value of the stock. This value was $0.00 at December 31, 2012.

 

As of December 31, 2012, the total compensation cost of outstanding options was fully recognized. The total fair value of shares vested during the year ended December 31, 2012 and 2011 was $4,200 and $137,000, respectively. Compensation expense for 2012 and 2011 related to options granted under this plan was $1,200 and $31,000, respectively.

 

40
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

 (000s omitted, except per share data)

 

Note 12 - Employee Benefit Plans (Continued)

 

A summary of the status of the Company’s nonvested options as of December 31, 2012 and 2011 and changes during the years then ended is presented below:

 

       Weighted-Average 
       Grant-Date 
Nonvested Shares  Shares   Fair Value 
           
Nonvested at January 1, 2011   37,358   $2.11 
           
Granted   -   $0.00 
           
Vested   (36,118)  $2.11 
           
Forfeited   -   $0.00 
           
Nonvested at December 31, 2011   1,240   $2.19 
           
Granted   -   $0.00 
           
Vested   (1,240)  $2.19 
           
Forfeited   -   $0.00 
           
Nonvested at December 31, 2012   0   $0.00 

 

Restricted Stock Awards – The Company did not grant any award shares during the years ended December 31, 2012 and 2011. Compensation expense for 2012 and 2011 related to awards granted under this plan was $1,000 and $37,000, respectively.

 

The shares vest over a five year service period. As of December 31, 2012, the total compensation cost of the Plan was fully recognized.

 

41
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

 (000s omitted, except per share data)

 

Note 12 - Employee Benefit Plans (Continued)

 

The following table summarizes the activity of restricted stock awards under the Plan during the years ended December 31, 2012 and 2011:

 

   For the Year Ended December 31, 
   2012   2011 
         
Beginning of period   300    13,050 
           
Granted   -    - 
           
Vested   (300)   (12,750)
           
Forfeited   -    - 
           
Nonvested, end of period   0    300 

 

There were 5,304 shares available for future grants of award shares at December 31, 2012.

 

Note 13 - Fair Value Measurements

 

The fair value of financial assets and liabilities recorded at fair value is categorized in three levels. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. These levels are as follows:

 

Level 1 — Valuations based on quoted prices in active markets, such as the New York Stock Exchange. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

 

Level 2 — Valuations of assets and liabilities traded in less active dealer or broker markets. Valuations include quoted prices for similar assets and liabilities traded in the same market; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable. Valuations may be obtained from, or corroborated by, third-party pricing services.

 

Level 3 — Assets and liabilities with valuations that include methodologies and assumptions that may not be readily observable, including option pricing models, discounted cash flow models, yield curves and similar techniques. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities, but in all cases are corroborated by external data, which may include third-party pricing services.

 

The following table presents information about the Company’s assets and liabilities measured at fair value on a recurring basis as of December 31, 2012 and 2011, and the valuation techniques used by the Company to determine those fair values.

 

42
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

 (000s omitted, except per share data)

 

Note 13 - Fair Value Measurements (Continued)

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis at December 31, 2012

 

   Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)		   Significant
Other
Observable
Inputs
(Level 2)		   Significant
Unobservable
Inputs
(Level 3)		   Fair Value
as of
December 31,
2012		 
                 
Investment securities – available-for-sale:                    
U.S. Treasury securities and obligations of U.S. government corporations and agencies  $-   $9,247   $-   $9,247 
Municipal notes   -    10,758    -    10,758 
Corporate securities   -    1,150         1,150 
Mortgage-backed securities   -    29,608    -    29,608 
Equity securities   -    1    -    1 
                     
Total investment securities – available-for-sale  $-   $50,764   $-   $50,764 

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis at December 31, 2011

 

   Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)		   Significant
Other
Observable
Inputs
(Level 2)		   Significant
Unobservable
Inputs
(Level 3)		   Fair Value
as of
December 31, 
2011		 
                 
Investment securities - available-for-sale:                    
U.S. Treasury securities and obligations of U.S. government corporations and agencies  $-   $14,863   $-   $14,863 
Municipal notes   -    7,276    -    7,276 
Mortgage-backed securities   -    30,909    -    30,909 
Equity securities   -    1    -    1 
                     
Total investment securities - available-for-sale  $-   $53,049   $-   $53,049 

 

Fair value measurements of U.S. Government agencies, mortgage backed securities and municipal notes use pricing models that vary and may consider various assumptions, including time value, yield curves, volatility factors, prepayment speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures.

 

There were no transfers between Levels 1 and 2 of the fair value hierarchy during the years ended December 31, 2012 and 2011. For the available for sale securities, the Company obtains fair value measurements from an independent third-party service.

 

43
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

 (000s omitted, except per share data)

 

Note 13 - Fair Value Measurements (Continued)

 

The Company has assets that, under certain conditions, are subject to measurement at fair value on a nonrecurring basis. At December 31, 2012 and 2011, such assets consist primarily of impaired loans and other real estate owned. The Company has estimated the fair values of these assets using Level 3 inputs, specifically discounted cash flow projections.

 

The following table presents the balance of assets and liabilities measured at fair value on a nonrecurring basis:

 

Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2012

 

   Balance at
December 31, 2012		   Quoted Prices in
Active Markets for
Identical Assets
(Level 1)		   Significant Other
Observable Inputs
(Level 2)		   Significant
Unobservable Inputs
(Level 3)		 
                 
Impaired loans accounted for under FASB ASC 310-10  $6,835   $-   $-   $6,835 
                     
Other real estate owned -residential mortgages  $947   $-   $-   $947 
                     
Other real estate owned - commercial  $319   $-   $-   $319 
                     
Other repossessed assets  $1,121   $-   $-   $1,121 
                     
Total assets at fair value on a non-recurring basis                 $8,772 

 

44
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

 (000s omitted, except per share data)

 

Note 13 - Fair Value Measurements (Continued)

 

Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2011

 

   Balance at
December 31, 2011		   Quoted Prices in
Active Markets
for Identical
Assets (Level 1)		   Significant Other
Observable
Inputs (Level 2)		   Significant
Unobservable Inputs
(Level 3)		 
                 
Impaired loans accounted for under FASB ASC 310-10  $1,927   $-   $-   $1,927 
                     
Other real estate owned -residential mortgages  $1,087   $-   $-   $1,086 
                     
Other real estate owned - commercial  $1,015   $-   $-   $1,015 
                     
Other repossessed assets  $1,307   $-   $-   $1,307 
                     
Total assets at fair value on a non-recurring basis                 $5,335 

 

Impaired and nonaccrual loans:    Fair value adjustments for these items typically occur when there is evidence of impairment. Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair market value of the collateral. The Company measures fair value based on the value of the collateral securing the loans. Collateral may be in the form of real estate or personal property including equipment and inventory. The vast majority of collateral is real estate. The value of the collateral is determined based on internal estimates as well as third party appraisals or non-binding broker quotes. These measurements were classified as Level 3.

 

Other Real Estate:    Other real estate includes foreclosed assets and properties securing residential and commercial loans. Foreclosed assets are adjusted to fair value less costs to sell upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at lower of carry value or fair value less costs to sell. Fair value is generally based upon internal estimates and third party appraisals or non-binding broker quotes and, accordingly, considered a Level 3 classification

 

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.

 

Investment Securities - Fair value for the Bank’s investment securities was determined using the market value in active markets, where available. When not available, fair values are estimated using the fair value hierarchy. In the fair value hierarchy, Level 2 fair values are determined using observable inputs other than Level 1 market prices, such as quoted prices for similar assets. Level 3 values are determined using unobservable inputs, such as discounted cash flow projections.

 

45
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

 (000s omitted, except per share data)

 

Note 13 - Fair Value Measurements (Continued)

 

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.

 

Federal Home Loan Bank Stock - The carrying value of Federal Home Loan Bank stock approximates fair value based on the redemption provisions of the Federal Home Loan Bank.

 

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.

 

Federal Home Loan Bank Advances - The estimated fair value of the fixed and variable rate Federal Home Loan Bank advances are estimated by discounting the related cash flows using the rates currently available for similarly structured borrowings with similar maturities.

 

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).

 

Accrued Interest - The carrying amounts of accrued interest approximate fair value.

 

46
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

 (000s omitted, except per share data)

 

Note 13 - Fair Value Measurements (Continued)

 

The estimated fair values and related carrying amounts of the Company’s financial instruments as of December 31, 2012 and 2011 are as follows:

 

December 31, 2012  Carrying
Value		   Level 1   Level 2   Level 3   Total
Estimated
Fair Value		 
   (dollars in thousands) 
Financial assets:                         
Cash and cash equivalents  $2,752   $2,752   $-   $-   $2,752 
Securities available for sale   50,764    -    50,764    -    50,764 
Securities held to maturity   2,345    -    2,570    -    2,570 
Loans held for sale   79              84    84 
Loans receivable - net   138,912    -    -    140,877    140,877 
Federal Home Loan Bank stock   3,266    -    3,266    -    3,266 
Accrued interest receivable   970    -    970    -    970 
                          
Financial liabilities:                         
Customer deposits   158,350    -    159,335    -    159,335 
Federal Home Loan Bank advances   26,358    -    26,493    -    26,493 
REPO sweep accounts   3,183    -    3,183    -    3,183 
Accrued interest payable   100    -    100    -    100 

 

December 31, 2011  Carrying
Value		   Total
Estimated
Fair Value		 
   (dollars in thousands) 
         
Financial assets:          
Cash and cash equivalents  $2,749   $2,749 
Securities available for sale   53,049    53,049 
Securities held to maturity   2,435    2,665 
Loans receivable - net   140,884    146,018 
Federal Home Loan Bank stock   3,266    3,266 
Accrued interest receivable   1,149    1,149 
           
Financial liabilities:          
Customer deposits   150,649    151,693 
Federal Home Loan Bank advances   34,500    34,827 
REPO sweep accounts   5,592    5,592 
Accrued interest payable   148    148 

 

47
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

 (000s omitted, except per share data)

 

Note 14 - Restrictions on Dividends

 

Dividends paid by the Bank are the primary source of funds available to the Company for payment of dividends to shareholders and for other working capital needs. The payment of dividends by the Bank to the Company is subject to restrictions by the Office of the Comptroller of Currency (OCC). These restrictions generally limit dividends to the current and prior two years’ retained earnings. In addition to these restrictions, as a practical matter, dividend payments cannot reduce regulatory capital levels below the Company’s regulatory capital requirements and minimum regulatory guidelines. Future dividend payments by the Company will be based on future earnings and the approval of the OCC.

 

Note 15 - 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.

 

Condensed parent company financial statements, which include transactions with the subsidiary, are as follows:

 

Balance Sheets:

 

   December 31 
   2012   2011 
         
Assets
         
Cash at subsidiary bank  $817   $516 
Investment in subsidiary   23,304    23,734 
Deferred tax asset   318    318 
Other assets   -    - 
           
Total assets  $24,439   $24,568 
           
Liabilities and Stockholders' Equity
           
Liabilities  $4   $- 
Stockholders' equity   24,435    24,568 
           
Total liabilities and stockholders' equity  $24,439   $24,568 

 

48
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

 (000s omitted, except per share data)

 

Statements of Operations:

 

   December 31 
   2012   2011 
         
Operating income  $-   $- 
           
Dividend income   500    - 
           
Operating expense   (205)   (199)
           
Income (loss) before income taxes and equity in undistributed net income of subsidiary bank   295    (199)
           
Income tax benefit   -    - 
           
Income (loss) before equity in undistributed loss of subsidiary bank   295    (199)
           
Equity in undistributed net income (loss) of subsidiary bank   (509)   941 
           
Net income (loss)  $(214)  $742 

 

Statements of Cash Flows:

 

   December 31 
   2012   2011 
         
Cash Flows from Operating Activities          
Net income (loss)  $(214)  $742 
Adjustments to reconcile net income (loss) to net cash from operating activities:          
Dividend from subsidiary bank   500    - 
Stock options/awards   2    68 
Equity in undistributed net income of subsidiary bank   9    (941)
Net change in deferred tax assets   -    - 
Net change in other liabilities   4    - 
Net change in other assets   -    223 
           
Net cash provided by (used in) operating activities   515    (650)
           
Net Increase in Cash   301    92 
           
Cash - Beginning of year   516    424 
           
Cash - End of year  $817   $516 

 

49
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

 (000s omitted, except per share data)

 

Note 16 - Quarterly Results of Operations (Unaudited)

 

The following tables summarize the Company’s quarterly results for the fiscal years ended December 31, 2012 and 2011:

 

   For the Three-Month Period Ending 
   March 31,
2012		   June 30,
2012		   September 30,
2012		   December 31,
2012		 
Interest income  $2,409   $2,352   $2,313   $2,169 
Interest expense   464    427    394    369 
Net interest income   1,945    1,925    1,919    1,800 
Provision for loan losses   376    578    234    179 
Other income   447    390    802    637 
Other expenses   2,301    2,143    2,077    2,191 
Income (Loss) - before income tax expense (benefit)   (285)   (406)   410    67 
Income tax (benefit) expense   (886)   (136)   137    885 
Net income (loss)  $601   $(270)  $273   $(818)
                     
Net income (loss) per share                    
Basic  $0.21   $(0.09)  $0.09   $(0.28)
Diluted  $0.21   $(0.09)  $0.09   $(0.28)
                     
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,
2011		   June 30,
2011		   September 30,
2011		   December 31,
2011		 
Interest income  $2,592   $2,691   $2,588   $2,519 
Interest expense   605    581    564    512 
Net interest income   1,987    2,110    2,024    2,007 
Provision for loan losses   67    (19)   (67)   303 
Other income   449    393    469    621 
Other expenses   2,208    2,260    2,325    2,241 
Income - before income tax expense (benefit)   161    262    235    84 
Income tax expense   -    -    -    - 
Net income  $161   $262   $235   $84 
                     
Net income per share                    
Basic  $0.06   $0.09   $0.08   $0.03 
Diluted  $0.06   $0.09   $0.08   $0.03 
                     
Weighted average number of shares outstanding - basic and dilutive   2,884    2,884    2,884    2,884 
Cash dividends declared per common share  $-   $-   $-   $- 

 

50