SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from ___________________ to ___________________
Commission File Number 000-31957
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
(Exact name of registrant as specified in its charter)
MARYLAND 32-0135202
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 S. SECOND AVENUE, ALPENA, MICHIGAN 49707
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (989) 356-9041
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports) and (2) has been subject to such filing requirements for the past 90
days. Yes X No
--- ---
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes No X .
--- ---
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.
Common Stock, Par Value $0.01 Outstanding at November 10, 2006
(Title of Class) 3,034,999 shares
Transitional Small Business Disclosure Format: Yes No X .
--- ---
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-QSB
QUARTER ENDED SEPTEMBER 30, 2006
INDEX
PAGE
----
PART I - FINANCIAL INFORMATION
ITEM 1 - UNAUDITED FINANCIAL STATEMENTS
Consolidated Balance Sheet at
September 30, 2006 and December 31, 2005.................. 3
Consolidated Statements of Income for the Three and Nine
Months Ended September 30, 2006 and September 30, 2005.... 4
Consolidated Statement of Changes in Stockholders' Equity
for the Nine Months Ended September 30, 2006 ............. 5
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 2006 and September 30, 2005............ 6
Notes to Unaudited Consolidated Financial Statements......... 7
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION................. 15
ITEM 3 - CONTROLS AND PROCEDURES......................................... 21
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS............................................... 22
ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS..... 22
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES................................. 22
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............. 22
ITEM 5 - OTHER INFORMATION............................................... 22
ITEM 6 - EXHIBITS ....................................................... 22
Section 302 Certifications
Section 906 Certifications
When used in this Form 10-QSB or future filings by First Federal of Northern
Michigan Bancorp, Inc. (the "Company") with the Securities and Exchange
Commission ("SEC"), in the Company's press releases or other public or
stockholder communications, or in oral statements made with the approval of an
authorized executive officer, the words or phrases "would be," "will allow,"
"intends to," "will likely result," "are expected to," "will continue," "is
anticipated," "estimate," "project," or similar expressions are intended to
identify "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995.
The Company wishes to caution readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made, and to advise
readers that various factors, including regional and national economic
conditions, changes in levels of market interest rates, credit and other risks
of lending and investment activities and competitive and regulatory factors,
could affect the Company's financial performance and could cause the Company's
actual results for future periods to differ materially from those anticipated or
projected.
The Company does not undertake, and specifically disclaims any obligation, to
update any forward-looking statements to reflect occurrences or unanticipated
events or circumstances after the date of such statements.
2
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
September 30, 2006 December 31, 2005
------------------ -----------------
(Unaudited)
ASSETS
Cash and cash equivalents:
Cash on hand and due from banks .................................... $ 4,709,368 $ 4,497,629
Overnight deposits with FHLB ....................................... 180,555 281,565
------------ ------------
Total cash and cash equivalents .................................... 4,889,923 4,779,194
Securities AFS ..................................................... 46,581,044 53,411,609
Securities HTM ..................................................... 1,775,000 1,775,000
Loans held for sale ................................................ 391,000 --
Loans receivable, net of allowance for loan losses of $1,688,563
and $1,415,764 as of September 30, 2006 and December 31, 2005,
respectively .................................................... 211,564,574 201,183,076
Foreclosed real estate and other repossessed assets ................ 406,505 434,823
Real estate held for investment .................................... 135,543 352,136
Federal Home Loan Bank stock, at cost .............................. 4,361,500 4,765,000
Premises and equipment ............................................. 8,090,543 7,392,207
Accrued interest receivable ........................................ 2,040,808 1,601,691
Intangible assets .................................................. 2,714,344 3,088,986
Goodwill ........................................................... 1,349,854 1,349,854
Other assets ....................................................... 2,068,118 2,641,195
------------ ------------
Total assets ....................................................... $286,368,756 $282,774,771
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits ........................................................... $181,182,119 $188,734,743
Advances from borrowers for taxes and insurance .................... 194,098 27,709
Federal Home Loan Bank advances and Note Payable ................... 67,026,334 54,403,622
Accrued expenses and other liabilities ............................. 2,426,917 2,959,111
------------ ------------
Total liabilities .................................................. 250,829,468 246,125,185
------------ ------------
Commitments and contingencies ...................................... -- --
Stockholders' equity:
Common stock ($0.01 par value 20,000,000 shares authorized
3,190,999 and 3,115,510 shares issued, respectively) ............ 31,910 31,155
Additional paid-in capital ......................................... 24,261,081 23,560,462
Retained earnings .................................................. 14,877,649 14,703,130
Treasury stock at cost (156,000 shares) ............................ (1,565,359) --
Unallocated ESOP ................................................... (1,116,293) (1,186,940)
Unearned compensation .............................................. (559,503) --
Accumulated other comprehensive loss ............................... (390,197) (458,221)
------------ ------------
Total stockholders' equity ......................................... 35,539,288 36,649,586
------------ ------------
Total liabilities and stockholders' equity ......................... $286,368,756 $282,774,771
============ ============
See accompanying notes to consolidated financial statements.
3
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
----------------------- -------------------------
2006 2005 2006 2005
---------- ---------- ----------- -----------
(Unaudited) (Unaudited)
Interest income:
Interest and fees on loans ............................ $4,045,724 3,395,050 $11,070,141 $ 9,747,198
Interest and dividends on investments ................. 508,482 444,203 1,617,813 1,189,863
Interest on mortgage-backed securities ................ 48,621 59,803 156,610 189,906
---------- ---------- ----------- -----------
Total interest income ................................. 4,602,827 3,899,056 12,844,564 11,126,967
---------- ---------- ----------- -----------
Interest expense:
Interest on deposits .................................. 1,426,972 1,127,496 3,993,494 3,134,668
Interest on borrowings ................................ 826,375 555,162 2,252,832 1,790,875
---------- ---------- ----------- -----------
Total interest expense ................................ 2,253,347 1,682,658 6,246,326 4,925,543
---------- ---------- ----------- -----------
Net interest income ................................... 2,349,480 2,216,398 6,598,238 6,201,424
Provision for loan losses ............................. 216,357 3,800 418,857 266,058
---------- ---------- ----------- -----------
Net interest income after provision for loan losses ... 2,133,123 2,212,598 6,179,381 5,935,366
---------- ---------- ----------- -----------
Non interest income:
Service charges and other fees ........................ 280,096 262,239 801,226 747,563
Mortgage banking activities ........................... 72,779 155,811 239,172 383,498
Gain (loss) on sale of available-for-sale securities .. -- -- (43,565) 13,128
Net gain (loss) on sale of premises and equipment,
real estate owned and other repossessed assets ..... (6,971) (7,746) (2,965) (26,611)
Other ................................................. 32,863 20,555 79,791 30,712
Insurance and brokerage commissions ................... 712,119 724,993 2,219,190 2,205,524
---------- ---------- ----------- -----------
Total non interest income ............................. 1,090,886 1,155,852 3,292,849 3,353,813
---------- ---------- ----------- -----------
Non interest expense:
Compensation and employee benefits .................... 1,518,219 1,571,682 4,677,125 4,705,438
SAIF Insurance Premiums ............................... 5,877 5,913 18,330 18,810
Advertising ........................................... 64,924 58,635 197,636 133,419
Occupancy ............................................. 326,637 340,841 1,028,724 967,492
Amortization of intangible assets ..................... 124,881 85,149 374,642 236,035
Service bureau charges ................................ 93,970 87,348 271,842 262,064
Insurance and brokerage commission expense ............ 252,757 290,261 799,997 888,464
Professional services 38,134 40,845 198,552 180,761
Donation to First Federal Community Foundation ........ -- -- -- 679,940
Other ................................................. 309,680 341,708 949,054 908,856
---------- ---------- ----------- -----------
Total non interest expense ............................ 2,735,079 2,822,382 8,515,902 8,981,279
---------- ---------- ----------- -----------
Income before income tax expense ...................... 488,930 546,068 956,328 307,900
Income tax expense .................................... 163,275 182,723 319,955 102,850
---------- ---------- ----------- -----------
Net income ............................................ $ 325,655 $ 363,345 $ 636,373 $ 205,050
========== ========== =========== ===========
Per share data:
Basic earnings per share .............................. $ 0.11 $ 0.12 $ 0.21 $ 0.07
Weighted average number of shares outstanding ......... 3,039,173 3,100,511 3,097,204 3,088,961
Diluted earnings per share ............................ $ 0.11 $ 0.12 $ 0.21 $ 0.07
Weighted average number of shares outstanding,
including dilutive stock options ................... 3,040,130 3,110,617 3,098,168 3,106,686
Dividends per common share ............................ $ 0.050 $ 0.050 $ 0.150 $ 0.154
See accompanying notes to consolidated financial statements.
4
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED)
Additional
Issued Common Treasury Paid-in Unearned
Shares Stock Stock Capital Compensation
--------- ------- ----------- ----------- ------------
Balance at December 31, 2005 ............. 3,115,510 $31,155 $ -- $23,560,462 --
Stock options exercised (18,560 shares) .. 18,560 186 -- 98,764 --
Retired Stock (6,321 shares) ............. (6,321) (63) -- (60,302) --
Treasury Stock at cost (114,167 shares) .. -- -- (1,565,359) -- --
Stock Options/Awards Expensed ............ -- -- -- 44,192 50,859
MRP shares awarded (63,250 shares) ....... 63,250 632 -- 609,730 (610,362)
Unallocated ESOP ......................... -- -- -- (6,936) --
Net income for the period ................ -- -- -- -- --
Changes in unrealized loss:
on available-for-sale securities
(net of tax of $35,042) ............... -- -- -- -- --
Total comprehensive income ............... -- -- -- -- --
Tax benefit on stock options exercised ... -- -- -- 15,171 --
Dividends declared ....................... -- -- -- -- --
--------- ------- ----------- ----------- ---------
Balance at September 30, 2006 ............ 3,190,999 $31,910 $(1,565,359) $24,261,081 $(559,503)
========= ======= =========== =========== =========
Accumulated
Other
Retained Unallocated Comprehensive
Earnings ESOP Income (Loss) Total
----------- ----------- ------------- -----------
Balance at December 31, 2005 ............. $14,703,130 (1,186,940) (458,221) $36,649,586
Stock options exercised (18,560 shares) .. -- -- -- 98,950
Retired Stock (6,321 shares) ............. -- -- -- (60,365)
Treasury Stock at cost (114,167 shares) .. -- -- -- (1,565,359)
Stock Options/Awards Expensed ............ -- -- -- 95,051
MRP shares awarded (63,250 shares) ....... -- -- -- --
Unallocated ESOP ......................... -- 70,647 -- 63,711
Net income for the period ................ 636,373 -- -- 636,373
Changes in unrealized loss:
on available-for-sale securities
(net of tax of $35,042) ............... -- -- 68,024 68,024
-----------
Total comprehensive income ............... -- -- -- 704,397
Tax benefit on stock options exercised ... -- -- -- 15,171
Dividends declared ....................... (461,854) -- -- (461,854)
----------- ----------- --------- -----------
Balance at September 30, 2006 ............ $14,877,649 $(1,116,293) $(390,197) $35,539,288
=========== =========== ========= ===========
See accompanying notes to consolidated financial statements.
5
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
For the Nine Months Ended
September 30,
---------------------------
2006 2005
------------ ------------
(Unaudited)
Cash flows from operating activities:
Net income .................................................................. $ 636,373 $ 205,050
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization ............................................ 778,455 619,541
Provision for loan loss .................................................. 418,857 266,058
Amortization and accretion on securities ................................. 64,961 127,058
(Gain) loss on sale of securities ........................................ 43,565 (13,128)
Originations of loans held for sale ...................................... (10,484,134) (16,538,548)
Principal amount of loans sold ........................................... 10,093,134 17,437,708
Purchase of real estate held for sale .................................... -- (61,504)
Proceeds from sale of real estate held for sale .......................... 912,590 246,340
Gain on sale of real estate held for investment .......................... (1,412) 2,801
Proceeds from Sale of Premises & Equipment ............................... -- 6,500
Loss on sale of premises and equipment ................................... 3,309 25,717
Change in accrued interest receivable .................................... (439,117) (548,375)
Change in other assets ................................................... 553,231 (420,572)
Change in accrued expenses and other liabilities ......................... (532,194) 600,442
Stock Options/Awards expensed ............................................ 95,051 --
Stock donated to charitable foundation ................................... -- 339,970
------------ ------------
Net cash provided by operating activities ................................... 2,142,669 2,295,058
------------ ------------
Net Increase in loans .................................................... (10,800,355) (4,956,562)
Proceeds from maturity and sale of available-for-sale securities ......... 8,801,285 6,068,772
Purchase of securities available for sale ................................ (1,976,205) (13,517,560)
Purchase of Federal Home Loan Bank Stock ................................. -- (98,900)
Proceeds from Sale of Federal Home Loan Bank Stock ....................... 403,500 --
Purchase of premises and equipment ....................................... (1,771,725) (746,355)
------------ ------------
Net cash used in investing activities ....................................... (5,343,500) (13,250,605)
------------ ------------
Net Increase (decrease) in deposits ...................................... (7,552,624) 11,614,274
Dividend paid on common stock ............................................ (461,854) (384,508)
ESOP shares committed to be released ..................................... 63,711 55,476
Net increase in advances from borrowers .................................. 166,389 170,576
Additions to advances from Federal Home Loan Bank and notes payable ..... 19,240,000 6,500,000
Repayments of Federal Home Loan Bank advances and notes payable .......... (6,617,288) (19,500,000)
Stock retired ............................................................ (60,365) --
Proceeds from exercise of stock options .................................. 98,950 60,370
Net proceeds from stock offering ......................................... -- 15,959,762
Merger of Alpena Bancshares, MHC ......................................... -- 207,769
Cash paid for fractional shares in conversion ............................ -- (1,823)
Purchase of shares for ESOP .............................................. -- (1,387,090)
Purchase of treasury shares .............................................. (1,565,359) --
------------ ------------
Net cash provided by financing activities ................................... 3,311,560 13,294,806
------------ ------------
Net increase (decrease) in cash and cash equivalents ........................ 110,729 2,339,259
Cash and cash equivalents at beginning of period ............................ 4,779,194 4,738,559
------------ ------------
Cash and cash equivalents at end of period .................................. $ 4,889,923 $ 7,077,818
============ ============
Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes ................................ $ 363,790 $ 176,300
============ ============
Cash paid during the period for interest .................................... $ 6,193,470 $ 4,880,075
============ ============
See accompanying notes to the consolidated financial statements
6
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.
The accompanying consolidated financial statements have been prepared on an
accrual basis of accounting and include the accounts of First Federal of
Northern Michigan Bancorp, Inc., and its wholly owned subsidiary, First Federal
of Northern Michigan (the "Bank") and its wholly owned subsidiaries Financial
Service and Mortgage Corporation ("FSMC") and the InsuranCenter of Alpena
("ICA"). FSMC invests in real estate that includes leasing, selling, developing,
and maintaining real estate properties. ICA is a licensed insurance agency
engaged in the business of property, casualty and health insurance. All
significant intercompany balances and transactions have been eliminated in the
consolidation.
These interim financial statements are prepared without audit and reflect
all adjustments, which, in the opinion of management, are necessary to present
fairly the consolidated financial position of the Company at September 30, 2006,
and its results of operations and statement of cash flows for the periods
presented. All such adjustments are normal and recurring in nature. The
accompanying consolidated financial statements do not purport to contain all the
necessary financial disclosures required by generally accepted accounting
principles that might otherwise be necessary and should be read in conjunction
with the consolidated financial statements and notes thereto of the Company
included in the Annual Report for the year ended December 31, 2005. Results for
the three and nine months ended September 30, 2006 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2006.
CRITICAL ACCOUNTING POLICIES
Our accounting and reporting policies are prepared in accordance with
accounting principles generally accepted in the United States of America and
conform to general practices within the banking industry. We consider accounting
policies that require significant judgment and assumptions by management that
have, or could have, a material impact on the carrying value of certain assets
or on income to be critical accounting policies. Changes in underlying factors,
assumptions or estimates could have a material impact on our future financial
condition and results of operations. Based on the size of the item or
significance of the estimate, the following accounting policies are considered
critical to our financial results.
Allowance for Loan Losses. The allowance for loan losses is calculated with
the objective of maintaining an allowance sufficient to absorb estimated
probable loan losses. Management's determination of the adequacy of the
allowance is based on periodic evaluations of the loan portfolio and other
relevant factors. However, this evaluation is inherently subjective, as it
requires an estimate of the loss content for each risk rating and for each
impaired loan, an estimate of the amounts and timing of expected future cash
flows, and an estimate of the value of collateral.
We have established a systematic method of periodically reviewing the
credit quality of the loan portfolio in order to establish an allowance for
losses on loans. The allowance for losses on loans is based on our current
judgments about the credit quality of individual loans and segments of the loan
portfolio. The allowance for losses on loans is established through a provision
for loan losses based on our evaluation of the losses inherent in the loan
portfolio, and considers all known internal and external factors that affect
loan collectibility as of the reporting date. Our evaluation, which includes a
review of all loans on which full collectibility may not be reasonably assured,
considers among other matters, the estimated net realizable value or the fair
value of the underlying collateral, economic conditions, historical loan loss
experience, our knowledge of inherent losses in the portfolio that are probable
and reasonably estimable and other factors that warrant recognition in providing
an appropriate loan loss allowance. Management believes this is a critical
accounting policy because this evaluation involves a
7
high degree of complexity and requires us to make subjective judgments that
often require assumptions or estimates about various matters. Historically, we
believe our estimates and assumptions have proven to be relatively accurate.
The analysis of the allowance for loan losses has two components: specific
and general allocations. Specific allocations are made for loans that are
determined to be impaired. Impairment is measured by determining the present
value of expected future cash flows or, for collateral-dependent loans, the fair
value of the collateral adjusted for market conditions and selling expenses. The
general allocation is determined by segregating the remaining loans by type of
loan, risk weighting (if applicable) and payment history. We also analyze
delinquency trends, which have remained stable, general economic conditions and
geographic and industry concentrations. This analysis establishes factors that
are applied to the loan groups to determine the amount of the general reserve.
The principal assumption used in deriving the allowance for loan losses is the
estimate of loss content for each risk rating. As an example, if recent loss
experience dictated that the projected loss ratios would be changed by 10% (of
the estimate) across all risk ratings, the allocated allowance as of September
30, 2006 would have changed by approximately $158,000. Actual loan losses may be
significantly more than the allowances we have established, which could have a
material negative effect on our financial results.
Mortgage Servicing Rights. We sell to investors a portion of our originated
one- to four-family residential real estate mortgage loans. When we acquire
mortgage servicing rights through the origination and sale of mortgage loans
with servicing rights retained, we allocate a portion of the total cost of the
mortgage loans to the mortgage servicing rights based on their relative fair
value. As of September 30, 2006, we were servicing loans sold to others totaling
$137.7 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 September 30,
2006 included the following:
Annual constant prepayment speed (CPR): 10.70%
Weighted average life remaining (in months): 248
Discount rate used: 8.50%
At the September 30, 2006 valuation, we calculated the value of our
mortgage servicing rights to be $1.4 million and the weighted average life
remaining of those rights was 49 months. The book value of our mortgage
servicing rights as of September 30, 2006 was $643,000 which was $748,000 less
than the independent valuation, so there was no need to establish a valuation
allowance.
Impairment of Intangible Assets. Goodwill arising from business
acquisitions represents the value attributable to unidentifiable intangible
elements in the business acquired. The fair value of goodwill is dependent upon
many factors, including our ability to provide quality, cost-effective services
in the face of competition. Because of these many factors, management believes
this is a critical accounting policy. A decline in earnings as a result of
business or market conditions or a run-off of insurance customers over sustained
periods could lead to an impairment of goodwill that could adversely affect
earnings in future periods.
8
A significant portion of our intangible assets, including goodwill, relates
to the acquisition premiums recorded with the purchase of the InsuranCenter of
Alpena ("ICA") and certain branches over the last several years. Intangible
assets are reviewed periodically for impairment by comparing the fair value of
the intangible asset to the book value of the intangible asset. If the book
value is in excess of the fair value, impairment is indicated and the
intangibles must be written down to their fair value.
In connection with our acquisition in 2003 of ICA, we allocated the excess
of the purchase price paid over the fair value of net assets acquired to
intangible assets, including goodwill. These intangible assets included the ICA
customer list and a third-party contract to which ICA is a party. From the date
of acquisition through April 30, 2005 we amortized the value assigned to the
customer list and contract over a period of 20 years. On May 1, 2005 the former
owner of ICA retired. As a result, the amortization period for these intangible
assets was reduced to a 10 year period beginning May 1, 2005. Effective January
1, 2006, the exclusive third-party contract between ICA and Blue Cross Blue
Shield of Michigan was terminated. Prior to January 1, 2006 the ICA exclusive
agent contract with Blue Cross Blue Shield entitled ICA to an override
commission of 1.9% on all health premiums written through local Chambers of
Commerce in Northeast Michigan. On any health insurance contracts in place as of
December 31, 2005, ICA will continue to receive the 1.9% commission; however,
there will be no new groups added to this program effective January 1, 2006.
Management considered the potential effect this could have on ICA health
insurance commissions in future years and made the decision to reduce the
amortization period of the third-party contract intangible asset to 5 years
effective January 1, 2006.
Goodwill is not amortized. The impairment test of goodwill and identified
intangible assets that have an indefinite useful life, performed as of September
30, 2006 and December 31, 2005 in accordance with SFAS No. 142, did not indicate
that an impairment charge was required. If, through testing, we determine that
there is impairment based, for example, on significant runoff of the customer
list or material changes to the third-party contract, then we may determine to
reduce the recorded value of those intangible assets, which would increase
expense and reduce our earnings.
In connection with branch office acquisitions, we assigned the excess of
the purchase price over the fair value of the assets acquired to a core deposit
intangible. The core deposit intangible is tested periodically for impairment.
Our original estimates for the expected life of the deposits have proven to be
relatively accurate as evidenced by the fact that no impairment has been
recorded. If we determine through testing that a significant portion of the
acquired customers no longer do business with us, then the asset would be deemed
to be impaired thereby requiring a charge to earnings to the extent appropriate
given all of the known factors. We amortize core deposit intangibles over a
period of between 10 and 15 years.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 2006, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard No. 156, Accounting for Servicing of
Financial Assets - an amendment of FASB Statement No. 140. SFAS 156 amends SFAS
Statement No.140, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities", with respect to the accounting for
separately recognized servicing assets and servicing liabilities. The Statement
addresses the recognition and measurement of separately recognized servicing
assets and liabilities and provides an approach to simplify efforts to obtain
hedge-like (offset) accounting. SFAS 156 will be adopted by the Company January
1, 2007 as required by the statement. The Company does not believe adoption of
SFAS 156 will have a material effect on the financial position, results of
operations, or cash flows.
In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 (FIN
48), which clarifies the accounting for uncertainty in tax positions. This
Interpretation requires that the Company recognize in the financial statements
the impact of a tax position if that position is more likely than not to be
sustained on audit based on technical merits of the position. The provisions of
FIN 48 are effective as of the beginning of the Company's 2007 fiscal year, with
the cumulative effect of the change in accounting principle recorded as an
adjustment to operating retained earnings. The Company is currently evaluating
the impact of adopting FIN 48 on its financial statements.
9
NOTE 2--REORGANIZATION.
On April 1, 2005, we consummated the second-step mutual-to-stock conversion
of Alpena Bancshares, M.H.C., in which shares of common stock representing
Alpena Bancshares, M.H.C.'s ownership interest in Alpena Bancshares, Inc. were
sold to investors. As a result of the conversion and stock offering, Alpena
Bancshares, M.H.C. ceased to exist and Alpena Bancshares, Inc. was succeeded by
First Federal of Northern Michigan Bancorp, Inc., a Maryland corporation and new
holding company for First Federal of Northern Michigan.
The plan of conversion and reorganization of Alpena Bancshares, M.H.C. and
the issuance and contribution of cash and common stock to First Federal
Community Foundation, a charitable foundation established by the Company, were
approved by the stockholders of Alpena Bancshares, Inc. and the members of
Alpena Bancshares, M.H.C. on March 23, 2005.
First Federal of Northern Michigan Bancorp, Inc. accepted orders to
purchase 1,699,869 shares of common stock at a purchase price of $10.00 per
share. As a part of the conversion, public stockholders of the Company as of the
consummation date received 1.8477 shares of First Federal of Northern Michigan
Bancorp, Inc. common stock in exchange for each of their existing shares of
Company common stock. Cash was issued in lieu of any fractional shares. The
share exchange occurred on April 1, 2005.
Any references in this report to the number of shares outstanding for the
nine months ended September 30, 2005 for purposes of calculating per share
earnings and to dividends per share for the same period has been adjusted to
give retroactive recognition to the exchange ratio applied in the conversion.
NOTE 3--DIVIDENDS.
Payment of dividends on the common stock is subject to determination and
declaration by the Board of Directors and depends upon a number of factors,
including capital requirements, regulatory limitations on the payment of
dividends, the Company's results of operations and financial condition, tax
considerations and general economic conditions.
On September 19, 2006, the Company declared a cash dividend on its common
stock, payable on or about October 20, 2006, to shareholders of record as of
September 30, 2006, equal to $0.05 per share. The dividend on all shares
outstanding totaled $151,750.
NOTE 4--1996 STOCK OPTION PLAN, 1996 RECOGNITION AND RETENTION PLAN AND 2006
STOCK-BASED INCENTIVE PLAN.
Effective January 1, 2006, the Company adopted Statement of Financial
Accounting Standard (SFAS) No. 123 (Revised) "Shareholder Based Payments", which
requires that the grant-date fair value of awarded stock options be expensed
over the requisite service period. The Company's 1996 Stock Option Plan (the
"1996 Plan"), which was approved by shareholders, permits the grant of share
options to its employees for up to 127,491 shares of common stock (retroactively
adjusted for the exchange ratio applied in the Company's 2005 stock offering and
related second-step conversion). The Company's 2006 Stock-Based Incentive Plan
(the "2006 Plan"), which was approved by the shareholders on May 17, 2006,
permits the award of up to 242,740 shares of common stock of which the maximum
number to be granted as Stock Options is 173,386 and the maximum that can be
granted as Restricted Stock Awards is 69,354. Option awards are granted with an
exercise price equal to the market price of the Company's stock at the date of
grant; those option awards generally vest based on five years of continual
service and have ten year contractual terms. Certain options provide for
accelerated vesting if there is a change in control (as defined in the Plans).
The fair value of each option award is estimated on the date of grant using
the Black-Scholes valuation method that uses the assumptions noted in the
following table. The weighted average fair value of options granted during the
nine months ended September 30, 2006 was $2.49 per option granted. Expected
volatilities are based on historical volatility of the Company's stock. The
Company uses historical data to estimate option exercise and employee
termination within the valuation model. The expected term of options
10
granted is derived from the output of the valuation model and represents the
period of time that options granted are expected to be outstanding. The
risk-free rate for periods within the contractual life of the option is based on
the U.S. Treasury yield in effect at the time of the grant.
2006
----
Expected Volatility 20%
Expected dividends 2.1%
Expected term (in years) 8.0
Risk- free rate 4.75%
A summary of option activity under the Plan during the nine months ended
September 30, 2006 is presented below:
Weighted- Weighted-Average
Average Remaining Aggregate
Exercise Contractual Intrinsic
Options Shares Price Term (Years) Value
--------------------------------- ------- --------- ---------------- ---------
Outstanding at January 1, 2006 24,642 $6.36
Granted 198,990 $9.56
Exercised (18,560) $5.41
Forfeited or expired (540) $5.41
Outstanding at September 30, 2006 204,532 $9.50 9.57 $ 0
Exercisable at September 30, 2006 4,433 $5.87 5.49 $ 8,467
A summary of the status of the Company's nonvested shares as of September 30,
2006, and changes during the quarter ended September 30, 2006, is presented
below:
Weighted-Average
Grant-Date
Nonvested Shares Shares Fair Value
------------------------------- ------- ----------------
Nonvested at January 1, 2006 2,218 $1.93
Granted 198,990 $2.49
Vested (1,109) $1.93
Forfeited 0
Nonvested at September 30, 2006 200,099 $2.49
As of September 30, 2006 there was $1,009,975 of total unrecognized
compensation cost related to nonvested share-based compensation arrangements
under the Plan. That cost is expected to be recognized over a weighted-average
period of 4.7 years. The total fair value of shares vested during the nine
months ended September 30, 2006 was $2,140.
11
During the three months ended September 30, 2006 the Company awarded no
shares under the Recognition and Retention Plan ("RRP"). Shares issued under the
RRP and exercised pursuant to the exercise of the stock option plan may be
either authorized but unissued shares or reacquired shares held by the Company
as treasury stock.
NOTE 5 - COMMITMENTS TO EXTEND CREDIT
The Company is a party to credit-related financial instruments with
off-balance sheet risk in the normal course of business to meet the financing
needs of its customers. These financial instruments include commitments to
extend credit, stand by letters of credit, and commercial lines of credit. Such
commitments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amounts recognized in the consolidated balance sheet. The
Company's exposure to credit loss is represented by the contracted amount of
these commitments. The Company follows the same credit policies in making
commitments as it does for on-balance sheet instruments.
At September 30, 2006, the Company had outstanding commitments to originate
loans of $30.4 million. These commitments included $9.2 million for permanent
one-to-four family dwellings, $4.1 million for non-residential loans, $665,000
of undisbursed loan proceeds for construction of one-to-four family dwellings,
$8.3 million of undisbursed lines of credit on home equity loans, $589,000 of
unused credit card lines, $4.4 million of unused commercial lines of credit,
$1.3 million of undisbursed commercial construction, $5,000 of unused Letters of
Credit and $1.8 million in unused Bounce Protection.
NOTE 6 - SUBSEQUENT EVENTS
Following a management evaluation of the Company's operations from both a
financial and customer service perspective, the Board of Directors approved the
closure of the Company's branch office in Ossineke, Michigan effective February
17, 2007. The branch accounts for about 7% of the Company's deposits. Due to the
close proximity of this branch to the Company's two Alpena, Michigan branches,
management believes that most of the deposits will be retained by the Company.
The Company owns and intends to sell this branch facility which has an estimated
fair market value that exceeds book value. Management believes the costs to exit
this market will be minimal.
NOTE 7 - SEGMENT REPORTING
The Company's principal activities include banking through its wholly owned
subsidiary, First Federal of Northern Michigan, and the sale of insurance
products through its indirect wholly owned subsidiary, ICA, purchased in 2003.
The Bank provides financial products including retail and commercial loans as
well as retail and commercial deposits. ICA receives commissions from the sale
of various insurance products including health, life, and property. The segments
were determined based on the nature of the products provided to customers.
The financial information for each operating segment is reported on the
basis used internally to evaluate performance and allocate resources. The
allocations have been consistently applied for all periods presented. Revenues
and expenses between affiliates have been transacted at rates that unaffiliated
parties would pay. The only transaction between the segments thus far relates to
a deposit on behalf of ICA included in the Bank. The interest income and
interest expense for this transaction has been eliminated. All other
transactions are with external customers. The performance measurement of the
operating segments is based on the management structure of the Company and is
not necessarily comparable with similar information for any other financial
institution. The information presented is also not necessarily indicative of the
segment's financial condition and results of operations if they were independent
entities.
12
NOTE 7 - SEGMENT REPORTING (CONTINUED)
For the Three Months Ended
September 30, 2006
(Dollars in Thousands)
-------------------------------------------
Bank ICA Eliminations Total
-------- ------ ------------ --------
INTEREST INCOME $ 4,602 $ 8 $ (8) $ 4,602
INTEREST EXPENSE 2,256 5 (8) 2,253
-------- ------ ----- --------
NET INTEREST INCOME - Before provision for loan losses 2,346 3 -- 2,349
PROVISION FOR LOAN LOSSES 217 -- -- 217
-------- ------ ----- --------
NET INTEREST INCOME - After provision for loan losses 2,129 3 -- 2,132
OTHER INCOME 377 714 -- 1,091
OPERATING EXPENSES 2,042 693 -- 2,735
-------- ------ ----- --------
INCOME - Before federal income tax 465 24 -- 489
FEDERAL INCOME TAX 156 8 -- 163
-------- ------ ----- --------
NET INCOME $ 309 $ 16 $ -- $ 326
======== ====== ===== ========
DEPRECIATION AND AMORTIZATION $ 177 $ 86 $ -- $ 263
======== ====== ===== ========
ASSETS $282,694 $4,475 $(712) $286,457
======== ====== ===== ========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ -- $ -- $ -- $ --
Intangible assets -- -- -- --
Property and equipment 447 -- -- 447
-------- ------ ----- --------
TOTAL $ 447 $ -- $ -- $ 447
======== ====== ===== ========
For the Three Months Ended
September 30, 2005
(Dollars in Thousands)
-------------------------------------------
Bank ICA Eliminations Total
-------- ------ ------------ --------
INTEREST INCOME $ 3,899 $ 3 $ (3) $ 3,899
INTEREST EXPENSE 1,686 -- (3) 1,683
-------- ------ ----- --------
NET INTEREST INCOME - Before provision for loan losses $ 2,213 3 -- 2,216
PROVISION FOR LOAN LOSSES 4 -- -- 4
-------- ------ ----- --------
NET INTEREST INCOME - After provision for loan losses 2,209 3 -- 2,212
OTHER INCOME 430 726 -- 1,156
OPERATING EXPENSES 2,125 697 -- 2,822
-------- ------ ----- --------
INCOME - Before federal income tax 514 32 -- 546
FEDERAL INCOME TAX 172 11 -- 183
-------- ------ ----- --------
NET INCOME $ 342 $ 21 $ -- $ 363
======== ====== ===== ========
DEPRECIATION AND AMORTIZATION $ 176 $ 56 $ -- $ 232
======== ====== ===== ========
ASSETS $273,782 $3,542 $(476) $276,848
======== ====== ===== ========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ -- $ -- $ -- $ --
Intangible assets -- -- -- --
Property and equipment 146 2 -- 148
-------- ------ ----- --------
TOTAL $ 146 $ 2 $ -- $ 148
======== ====== ===== ========
13
For the Nine Months Ended
September 30, 2006
(Dollars in Thousands)
-------------------------------------------
Bank ICA Eliminations Total
-------- ------ ------------ --------
INTEREST INCOME $ 12,844 $ 15 $ (15) $ 12,844
INTEREST EXPENSE 6,246 15 (15) 6,246
-------- ------ ----- --------
NET INTEREST INCOME - Before provision for loan losses 6,598 -- -- 6,598
PROVISION FOR LOAN LOSSES 419 -- -- 419
-------- ------ ----- --------
NET INTEREST INCOME - After provision for loan losses 6,179 -- -- 6,179
OTHER INCOME 1,069 2,224 -- 3,293
OPERATING EXPENSES 6,376 2,140 -- 8,516
-------- ------ ----- --------
INCOME - Before federal income tax 872 84 -- 956
FEDERAL INCOME TAX 292 28 -- 320
-------- ------ ----- --------
NET INCOME $ 580 $ 56 $ -- $ 636
======== ====== ===== ========
DEPRECIATION AND AMORTIZATION $ 520 $ 258 $ -- $ 778
======== ====== ===== ========
ASSETS $282,694 $4,475 $(712) $286,457
======== ====== ===== ========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ -- $ -- $ -- $ --
Intangible assets -- -- -- --
Property and equipment 1,195 21 -- 1,216
-------- ------ ----- --------
TOTAL $ 1,195 $ 21 $ -- $ 1,216
======== ====== ===== ========
For the Nine Months Ended
September 30, 2006
(Dollars in Thousands)
-------------------------------------------
Bank ICA Eliminations Total
-------- ------ ------------ --------
INTEREST INCOME $ 11,127 $ 7 $ (7) $ 11,127
INTEREST EXPENSE 4,933 -- (7) 4,926
-------- ------ ----- --------
NET INTEREST INCOME - Before provision for loan losses 6,194 7 -- 6,201
PROVISION FOR LOAN LOSSES 266 -- -- 266
-------- ------ ----- --------
NET INTEREST INCOME - After provision for loan losses 5,928 7 -- 5,935
OTHER INCOME 1,144 2,210 -- 3,354
OPERATING EXPENSES 6,860 2,121 -- 8,981
-------- ------ ----- --------
INCOME - Before federal income tax 212 96 -- 308
FEDERAL INCOME TAX 71 32 -- 103
-------- ------ ----- --------
NET INCOME $ 141 $ 64 $ -- $ 205
======== ====== ===== ========
DEPRECIATION AND AMORTIZATION $ 500 $ 120 $ -- $ 620
======== ====== ===== ========
ASSETS $273,782 $3,542 $(476) $276,848
======== ====== ===== ========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ -- $ -- $ -- $ --
Intangible assets -- -- -- --
Property and equipment 735 11 -- 746
-------- ------ ----- --------
TOTAL $ 735 $ 11 $ -- $ 746
======== ====== ===== ========
14
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
AND SUBSIDIARIES
PART I - FINANCIAL INFORMATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion compares the consolidated financial condition of the
Company at September 30, 2006 and December 31, 2005, and the results of
operations for the three- and nine-month periods ended September 30, 2006 and
2005. This discussion should be read in conjunction with the interim financial
statements and footnotes included herein.
OVERVIEW
For the quarter ended September 30, 2006, the Company's earnings were
$326,000 compared to earnings of $363,000 for the year earlier period, a
decrease of $38,000. Year to date 2006 net income was $636,000 compared to the
first nine months of 2005 when net income was $205,000.
The Bank's Return on Average Assets (ROA) for the trailing twelve months
ended September 30, 2006 was 34 basis points compared to 30 basis points for the
same period one year earlier. Management uses ROA as a tool to measure the
performance of the Bank. ROA is reviewed on a trailing twelve month basis each
month by management and the Board of Directors.
CAPITAL EXPENDITURES
On August 31, 2005 the Company broke ground on a new bank branch to replace an
existing leased branch in Lewiston, Michigan. As of September 30, 2006 the
Company had expended approximately $1.2 million on the new branch, including the
cost of the land and expects to expend approximately $5,000 more to complete the
project. The new branch, which opened for business on June 26, 2006, will
further enhance the Company's expansion into the Lewiston market.
FINANCIAL CONDITION
ASSETS: Total assets increased $3.6 million, or 1.3%, to $286.4 million at
September 30, 2006 from $282.8 million at December 31, 2005. Investment
securities available for sale decreased $6.8 million, or 12.8%, from December
31, 2005 to September 30, 2006, due to the sale of $7.0 million of low-yielding
investment securities during the nine month period ended September 30, 2006. Net
loans receivable increased $10.4 million, or 5.2%, to $211.6 million at
September 30, 2006 from $201.2 million at December 31, 2005. The growth of net
loans was attributable primarily to growth in the commercial loan portfolios.
LIABILITIES: Deposits decreased $7.6 million, or 4.0%, to $181.2 million at
September 30, 2006 from $188.7 million at December 31, 2005. The decrease was
primarily in statements savings and CD balances reflecting continued competition
for deposits and increased pressure on market deposit rates. Despite the pay
down of FHLB advances from the sale of investment securities during the nine
month period ended September 30, 2006, FHLB advances increased $12.7 million, or
23.2%, to $67.0 million at September 30, 2006 from $54.4 million at December 31,
2005 to fund loan growth and the decline in deposits.
EQUITY: Stockholders' equity decreased by $1.1 million, or 3.0%, to $35.5
million at September 30, 2006 from $36.7 million at December 31, 2005. Net
earnings for the quarter of $326,000 were partially offset by a dividend
declaration of $151,750. During the quarter there was a decrease in the loss in
value of securities available for sale of $287,000. In addition, during the
quarter the Company repurchased an additional 41,833 shares of its common stock
at an aggregate cost of $421,000 concluding the stock repurchase that was
announced and commenced during the previous quarter.
15
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2006 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2005
GENERAL: Net income decreased by $38,000 to $326,000 for the three months ended
September 30, 2006 from $363,000 for the same period ended September 30, 2005.
During the quarter ended September 30, 2006 the Company collected a large
non-accrual commercial loan relationship which resulting in an additional
$287,000 in interest income and late fees for the quarter. The provision for
loan loss for the quarter ended September 30, 2006 was $216,000 as compared to
$4,000 for the same quarter in 2005.
INTEREST INCOME: Interest income was $4.6 million for the three months ended
September 30, 2006, compared to $3.9 million for the comparable period in 2005.
The increase in interest income quarter over quarter was due primarily to the
collection of a large commercial non-accrual loan relationship which resulted in
an additional $279,000 in interest income for the quarter. In addition, the
average balances of non-mortgage loans increased $15.2 million from September
30, 2005 to September 30, 2006, reflecting the Company's continued emphasis on
commercial lending. The yield on those loans increased from 7.17% to 7.81% over
the same period, reflecting higher market interest rates. Offsetting increased
commercial loan average balances was a decline in the average balance of
mortgage loans of $7.0 million from September 30, 2005 to September 2006,
resulting in lower mortgage loan interest income quarter over quarter as
mortgage loan originations have slowed and we continue to sell longer term
mortgage loans into the secondary market.
INTEREST EXPENSE: Interest expense was $2.3 million for the three month period
ended September 30, 2006, compared to $1.7 million for the same period in 2005.
The 33.9% increase in interest expense was mainly attributable to an increase in
the average balance of FHLB borrowings of $15.4 million for the quarter ended
September 30, 2005 as compared to the quarter ended September 30, 2005 and the
an increase in the cost of those borrowings of 54 basis points from the period
ended September 30, 2005 versus the quarter ended September 30, 2006 due to
market interest rate increases. In addition, the cost of interest bearing
deposits increased 80 basis points from the quarter ended September 30, 2005 to
the same period in 2006.
NET INTEREST INCOME: Net interest income increased to $2.3 million for the three
month period ended September 30, 2006 compared to $2.2 million for the same
period in 2005. For the three months ended September 30, 2006, average
interest-earning assets increased $8.7 million, or 3.4%, when compared to the
same period in 2005. Average interest-bearing liabilities increased $11.7
million, or 5.2%, to $238.2 million for the quarter ended September 30, 2006
from $226.5 million for the quarter ended September 30, 2005. The yield on
average interest-earning assets increased to 6.84% for the three month period
ended September 30, 2006 from 6.00% for the same period ended in 2005 as the
cost of average interest-bearing liabilities increased to 3.73% from 2.93% for
the three month periods ended September 30, 2006 and September 30, 2005,
respectively. The increase in yields on interest earning assets exceeded the
impact of the increase in the cost of funds creating an increase in the net
interest margin of 8 basis points to 3.52% for the three month period ended
September 30, 2006 from 3.44% for same period in 2005.
PROVISION FOR LOAN LOSSES: The allowance for loan losses is established through
a provision for loan losses charged to earnings. Loan losses are charged against
the allowance when management believes the uncollectibility of a loan balance is
confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and
is based upon management's periodic review of the collectibility of the loans in
light of historical experience, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower's ability to repay, estimated
value of any underlying collateral and prevailing economic conditions. This
evaluation is inherently subjective, as it requires estimates that are
susceptible to significant revision as more information becomes available. The
provision for loan losses amounted to $216,000 for the three month period ended
September 30, 2006 and $4,000 for the comparable period in 2005. During the
quarter ended September 30, 2005 loan balances had declined, resulting in the
lower required provision in that quarter. In addition, during the quarter ended
September 30, 2006, the Company increased its reserves on certain commercial and
mortgage loans based on deterioration of those credits during the quarter.
16
NON INTEREST INCOME: Non interest income was $1.0 million for the three month
period ended September 30, 2006, a decrease of $65,000 or 5.6%, from the same
period in 2005. The primary reasons for the decrease were an $83,000 decrease in
mortgage banking activities partially offset by an increase in service charges
and other fees of $18,000 for the three month period ended September 30, 2006 as
compared to the same period in 2005.
NON INTEREST EXPENSE: Non interest expense was $2.7 million for the three month
period ended September 30, 2006, an $87,000 or 3.1% decrease from the same
period in 2005. The decrease was primarily due to decreases of $53,000 in
compensation and employee benefits, $38,000 in insurance and brokerage
commission expense and $14,000 in occupancy expenses partially offset by an
increase of $40,000 in amortization of intangible assets due to the acceleration
of the amortization period of some of the ICA intangible assets.
INCOME TAXES: Federal income taxes decreased to $163,000 for the three month
period ended September 30, 2006 compared to $183,000 for the same period in
2005. The decrease for the three month period was attributable to a decrease in
pre-tax income.
NINE MONTHS ENDED SEPTEMBER 30, 2006 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2005
GENERAL: Net income increased $431,000 to $636,000 for the nine months ended
September 30, 2006 from $205,000 for the same period ended September 30, 2005.
The increase in earnings period over period was primarily attributable to the
one-time charitable contribution of $679,940 (approximately $449,000 after tax)
to the First Federal Community Foundation which decreased earnings during the
nine months ended September 30, 2005 and the collection of $287,000
(approximately $191,000 after tax) in interest and late charges on a non-accrual
commercial loan relationship during the nine months ended September 30, 2006.
The income tax expense for the nine months ended September 30, 2006 increased by
$217,000 as compared to the same period in 2005 due to the increase in pre-tax
income period over period.
INTEREST INCOME: Interest income was $12.9 million for the nine months ended
September 30, 2006, compared to $11.1 million for the comparable period in 2005.
This increase of $1.7 million, or 15.4%, in interest income was due to an
increase in average balances of commercial loans, an increase in the average
balance and yield on non-mortgage loans (mainly adjustable rate commercial
loans) and the collection of a large commercial non-accrual relationship.
INTEREST EXPENSE: Interest expense was $6.2 million for the nine month period
ended September 30, 2006 compared to $4.9 million for the same period in 2005.
The 26.8% increase in interest expense was attributable to an increased cost of
funds on interest-bearing deposits and FHLB advances for the period ended
September 30, 2006 compared to September 30, 2005, as well as an increase in the
average balance of FHLB advances period over period. The average balance of
interest-bearing deposits decreased by $1.4 million or 7.9% for the nine months
ended September 30, 2006 when compared to the year earlier period while the cost
of those deposits increased by 64 basis points. The average balance of FHLB
borrowings increased from $52.1 million for the period ended September 30, 2005
to $60.2 million for the period ended September 30, 2006, while the cost of
those borrowings increased by 37 basis points, due primarily to due to market
interest rate increases.
NET INTEREST INCOME: Net interest income increased by $397,000 for the nine
month period ended September 30, 2006 compared to the same period in 2005. For
the nine months ended September 30, 2006, average interest-earning assets
increased $14.3 million, or 5.7% when compared to the same period in 2005.
Average interest-bearing liabilities increased $9.8 million, or 4.3% for the
same period. The yield on average interest-earning assets increased to 6.34% for
the nine month period ended September 30, 2006 from 5.87% for the same period
ended in 2005. The cost of average interest-bearing liabilities increased to
3.52% from 2.89% for the nine month periods ended September 30, 2006 and
September 30, 2005, respectively. The net result of the 47 basis point increase
in asset yields and 63 basis point increase in the cost of funds was a net
interest rate margin decrease of 5 basis points to 3.23% for the nine month
period ended September 30, 2006, from 3.28% for the same period in 2005.
17
DELINQUENT LOANS AND NONPERFORMING ASSETS. The following table sets forth
information regarding loans delinquent 90 days or more and real estate
owned/other repossessed assets of the Bank at the dates indicated. As of the
dates indicated, the Bank did not have any material restructured loans within
the meaning of SFAS 15.
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------- ------------
(Dollars in thousands)
Total non-accrual loans ................................ $1,353 $1,353
------ ------
Accrual loans delinquent 90 days or more:
One- to four-family residential ..................... 706 1,684
Other real estate loans ............................. 1,475 670
Consumer/Commercial ................................. 633 300
------ ------
Total accrual loans delinquent 90 days or more ... $2,814 $2,654
------ ------
Total nonperforming loans (1) .......................... 4,167 4,007
Total real estate owned-residential mortgages (2) ...... 397 427
Total real estate owned-Consumer and other (2) ......... 6 8
====== ======
Total nonperforming assets ............................. $4,570 $4,442
====== ======
Total nonperforming loans to loans receivable .......... 1.97% 1.97%
Total nonperforming assets to total assets ............. 1.60% 1.57%
(1) All of the Bank's loans delinquent more than 90 days are classified as
nonperforming.
(2) Represents the net book value of property acquired by the Bank through
foreclosure or deed in lieu of foreclosure. Upon acquisition, this
property is recorded at the lower of its fair market value or the
principal balance of the related loan.
PROVISION FOR LOAN LOSSES: The provision for loan losses amounted to $419,000
for the nine month period ended September 30, 2006 and $266,000 for the
comparable period in 2005. The ratio of nonperforming loans to total loans was
197 basis points at both September 30, 2006 and December 31, 2005. As a percent
of total assets, nonperforming loans increased to 160 basis points at September
30, 2006 from 157 basis points at December 31, 2005. Total nonperforming assets
increased only slightly by $128,000 from December 31, 2005 to September 30, 2006
and management believes the provision for loan loss is adequate.
NON INTEREST INCOME: Non interest income was $3.3 million for the nine month
period ended September 30, 2006, a decrease of $61,000 or 1.8%, from the same
period in 2005. The primary reasons for the decrease were a $144,000 decrease in
mortgage banking activities where we continue to experience declining mortgage
loan demand and a $57,000 increase in loss on sale of investment securities due
to management's decision to sell investment securities at a loss to pay down
FHLB borrowings, offset by an increase in service charges and other fees of
$54,000 and an increase in other income of $49,000 for the nine month period
ended September 30, 2006 as compared to the same period in 2005.
NON INTEREST EXPENSE: Non interest expense was $8.5 million for the nine month
period ended September 30, 2006, a $465,000 or 5.2% decrease from the same
period in 2005. The decrease was primarily due to the $679,940 one-time
contribution to the First Federal Community Foundation in the nine month period
ended September 30, 2005 offset by a $139,000 increase in amortization of
intangible assets from the nine month period ended September 30, 2005 to the
comparable period in 2006.
INCOME TAXES: Federal income tax expense increased to $320,000 for the nine
months ended September 30, 2006 compared to $103,000 for the same period in
2005. The increase for the nine month period was attributable to an increase in
pre-tax income.
18
LIQUIDITY
The Company's current liquidity position is more than adequate to fund expected
asset growth. The Company's primary sources of funds are deposits, FHLB
advances, proceeds from principal and interest payments, prepayments on loans
and mortgage-backed and investment securities and sale of long-term fixed-rate
mortgages into the secondary market. While maturities and scheduled amortization
of loans and mortgage-backed securities are a predictable source of funds,
deposit flows, mortgage prepayments and sale of mortgage loans into the
secondary market are greatly influenced by general interest rates, economic
conditions and competition.
Liquidity represents the amount of an institution's assets that can be quickly
and easily converted into cash without significant loss. The most liquid assets
are cash, short-term U.S. Government securities, U.S. Government agency
securities and certificates of deposit. The Company is required to maintain
sufficient levels of liquidity as defined by OTS regulations. This requirement
may be varied at the direction of the OTS. Regulations currently in effect
require that the Bank must maintain sufficient liquidity to ensure its safe and
sound operation. The Company's objective for liquidity is to be above 20%.
Liquidity as of September 30, 2006 was $55.7 million, or 29.3% compared to $83.1
million, or 43.4% at December 31, 2005. The levels of these assets are dependent
on the Company's operating, financing, lending and investing activities during
any given period. The liquidity calculated by the Company includes additional
borrowing capacity available with the FHLB. This borrowing capacity is based on
the FHLB stock owned by the Bank along with pledged collateral. As of September
30, 2006, the Bank had unused borrowing capacity totaling $20.4 million at the
FHLB based on the FHLB stock ownership.
The Company intends to retain for its portfolio certain originated residential
mortgage loans (primarily adjustable rate, balloon and shorter term fixed rate
mortgage loans) and to generally sell the remainder in the secondary market. The
Bank will from time to time participate in or originate commercial real estate
loans, including real estate development loans. During the nine month period
ended September 30, 2006 the Company originated $24.5 million in residential
mortgage loans, of which $15.1 million were retained in portfolio while the
remainder were sold in the secondary market or are being held for sale. This
compares to $42.2 million in originations during the first nine months of 2005
of which $26.7 million were retained in portfolio. The Company also originated
$17.9 million of commercial loans and $12.7 million of consumer loans in the
first nine months of 2006 compared to $28.4 million of commercial loans and
$10.0 million of consumer loans for the same period in 2005. Of total loans
receivable, excluding loans held for sale, mortgage loans comprised 48.4% and
52.3%, commercial loans 37.6% and 35.0% and consumer loans 14.0% and 12.8% at
September 30, 2006 and December 31, 2005, respectively.
Deposits are a primary source of funds for use in lending and for other general
business purposes. At September 30, 2006 deposits funded 63.2% of the Company's
total assets compared to 66.8% at December 31, 2005. Certificates of deposit
scheduled to mature in less than one year at September 30, 2006 totaled $60.8
million. Management believes that a significant portion of such deposits will
remain with the Bank. The Bank monitors the deposit rates offered by competition
in the area and sets rates that take into account the prevailing market
conditions along with the Bank's liquidity position. Moreover, management
believes that the growth in assets is not expected to require significant
in-flows of liquidity. As such, the Bank does not expect to be a market leader
in rates paid for liabilities.
Borrowings may be used to compensate for seasonal or other reductions in normal
sources of funds or for deposit outflows at more than projected levels.
Borrowings may also be used on a longer-term basis to support increased lending
or investment activities. At September 30, 2006 the Company had $65.7 million in
FHLB advances. FHLB borrowings as a percentage of total assets were 22.9% at
September 30, 2006 as compared to 18.7% at December 31, 2005. The Company has
sufficient available collateral to obtain additional advances of $5.4 million.
When this is combined with current FHLB stock ownership the Company could obtain
up to an additional $25.8 million in advances from the FHLB.
19
CAPITAL RESOURCES
Stockholders' equity at September 30, 2006 was $35.6 million, or 12.4% of total
assets, compared to $36.6 million, or 13.0% of total assets, at December 31,
2005 (See "Consolidated Statement of Changes in Stockholders' Equity"). The Bank
is subject to certain capital-to-assets levels in accordance with OTS
regulations. The Bank exceeded all regulatory capital requirements at September
30, 2006. The following table summarizes the Bank's actual capital with the
regulatory capital requirements and with requirements to be "Well Capitalized"
under prompt corrective action provisions, as of September 30, 2006:
Regulatory Minimum to be
Actual Minimum Well Capitalized
--------------- --------------- ----------------
Amount Ratio Amount Ratio Amount Ratio
------- ----- ------- ----- ------- -----
Dollars in Thousands
Tangible Capital (to tangible
assets) $30,620 10.84% $ 4,238 1.50% $ 5,651 2.00%
Tier 1 (Core) capital (to risk
- weighted assets) $30,620 10.84% $11,302 4.00% $14,128 5.00%
Total risk-based capital (to
risk- weighted assets) $32,381 16.77% $15,446 8.00% $19,308 10.00%
Tier 1 risk-based capital (to
tangible assets) $30,620 15.86% $ 7,723 4.00% $11,585 6.00%
20
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-QSB
QUARTER ENDED SEPTEMBER 30, 2006
PART I - FINANCIAL INFORMATION
ITEM 3 - CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management, including
the Company's Chief Executive Officer and Chief Financial Officer, the Company
evaluated the effectiveness of the design and operation of its disclosure
controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934) as of the end of the period covered by this
report. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that, as of the end of the period covered by this
report, the Company's disclosure controls and procedures were effective to
ensure that information required to be disclosed in the reports the Company
files or submits under the Securities Exchange Act of 1934, is recorded,
processed, summarized and reported, within the time periods specified by the
SEC's rules and forms and in timely alerting them to material information
relating to the Company (or its consolidated subsidiaries) required to be
included in its periodic SEC filings.
There were no significant changes made in the Company's internal control over
financial reporting or in other factors that could significantly affect the
Company's internal controls over financial reporting during the period covered
by this report that has materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial reporting.
21
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-QSB
QUARTER ENDED SEPTEMBER 30, 2006
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings:
There are no material legal proceedings to which the Company is a
party or of which any of its property is subject. From time to time
the Company is a party to various legal proceedings incident to its
business.
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds:
Issuer Purchases of Equity Securities
On May 17, 2006 the Company announced a share repurchase program
authorizing the repurchase of up to 156,000 shares of the Company's
outstanding common stock. All repurchases under the Company's share
repurchase program are transacted in the open market and are within
the scope of Rule 10b-18, which provides a safe harbor for purchases
in a given day if an issuer of equity securities satisfies the manner,
timing, price and volume conditions of the rule when repurchasing its
own common shares in the open market. The share repurchase program was
concluded in the three month period ended September 30, 2006. The
following table summarizes the Company's share repurchase activity for
the three months ended September 30, 2006.
Total Number of
Shares Purchased as Maximum Number of
Part of Publicly Shares that May Yet Be
Total Number of Average Price Paid Announced Plans or Purchased Under the
Period Shares Purchased per Share Programs Plans or Programs
--------------------- ---------------- ------------------ ------------------- ----------------------
7/1/2006 to 7/31/2006 41,833 10.07 41,833 --
8/1/2006 to 8/31/2006 -- -- -- --
9/1/2006 to 9/30/2006 -- -- -- --
------ ----- ------
Total 41,833 10.07 41,833
====== ===== ======
Item 3 - Defaults upon Senior Securities:
Not applicable.
Item 4 - Submission of Matters to a Vote of Security Holders:
Not applicable
Item 5 - Other Information:
Not applicable
Item 6 - Exhibits
Exhibit 31.1 Certification by Chief Executive Officer pursuant to
section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 31.2 Certification by Chief Financial Officer pursuant to
section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1 Statement of Chief Executive Officer furnished pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.2 Statement of Chief Financial Officer furnished pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
22
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-QSB
QUARTER ENDED SEPTEMBER 30, 2006
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FIRST FEDERAL OF NORTHERN MICHIGAN
BANCORP, INC.
By: /s/ Martin A. Thomson
------------------------------------
Martin A. Thomson
Chief Executive Officer
Date: November 14, 2006
By: /s/ Amy E. Essex
------------------------------------
Amy E. Essex, Chief
Financial Officer
(Principal Financial and Accounting
Officer)
Date: November 14, 2006
23
EXHIBIT INDEX
Exhibit No. Description of Exhibits
----------- -----------------------
31.1 Certification by Chief Executive Officer pursuant to section 302
of the Sarbanes-Oxley Act of 2002
31.2 Certification by Chief Financial Officer pursuant to section 302
of the Sarbanes-Oxley Act of 2002
32.1 Statement of Chief Executive Officer furnished pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
32.2 Statement of Chief Financial Officer furnished pursuant to Section
906 of the Sarbanes-Oxley Act of 2002