UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

xQUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2013

 

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

 

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

 

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

 

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

 

Indicate by check mark whether the registrant is a shell company (as defined 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 May 10, 2013
(Title of Class) 2,884,049 shares

 

 
 

 

FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.

FORM 10-Q

Quarter Ended March 31, 2013

 

INDEX

 

PAGE
PART I – FINANCIAL INFORMATION  
ITEM 1  -  UNAUDITED FINANCIAL STATEMENTS  
Consolidated Balance Sheet at March 31, 2013 and December 31, 2012 3
Consolidated Statements of Income and Comprehensive Income for the Three Months Ended March 31, 2013 and March 31, 2012 4
Consolidated Statement of Changes in Stockholders’ Equity for the Three Months Ended March 31, 2013 5
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2013 and March 31, 2012 6
Notes to Unaudited Consolidated Financial Statements 7
   
ITEM 2  -  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 23
   
ITEM 3 - QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK 29
   
ITEM 4  -  CONTROLS AND PROCEDURES 29
   
Part II  -  OTHER INFORMATION  
ITEM 1  -  LEGAL PROCEEDINGS 30
ITEM 1A - RISK FACTORS 30
ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF  PROCEEDS 30
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES 30
ITEM 4 - MINE SAFETY DISCLOSURES 30
ITEM 5 - OTHER INFORMATION 30
ITEM 6 – EXHIBITS 30
Section 302 Certifications  
Section 906 Certifications  

 

When used in this Form 10-Q 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

 

   March 31, 2013   December 31, 2012 
   (Unaudited)     
ASSETS          
Cash and cash equivalents:          
Cash on hand and due from banks  $1,960,216   $2,732,109 
Overnight deposits with FHLB   21,420    19,701 
Total cash and cash equivalents   1,981,636    2,751,810 
Securities AFS   51,903,448    50,763,551 
Securities HTM   2,345,000    2,345,000 
Loans held for sale   115,000    78,712 
Loans receivable, net of allowance for loan losses of $1,674,842 and $1,749,915 as of March  31, 2013 and December 31, 2012, respectively   137,583,927    138,911,989 
Foreclosed real estate and other repossessed assets   2,405,141    2,387,307 
Federal Home Loan Bank stock, at cost   3,266,100    3,266,100 
Premises and equipment   5,323,453    5,394,412 
Accrued interest receivable   1,034,410    970,450 
Intangible assets   128,670    158,316 
Prepaid FDIC premiums   540,372    582,945 
Deferred tax asset   382,241    330,831 
Originated mortgage servicing rights (net of valuation reserve)   979,961    1,016,070 
Bank owned life insurance   4,507,642    4,474,563 
Other assets   362,202    402,091 
Total assets  $212,859,203   $213,834,146 
           
LIABILITIES AND STOCKHOLDERS' EQUITY          
Liabilities:          
Deposits  $158,177,800   $158,350,134 
Advances from borrowers for taxes and insurance   304,638    132,823 
Advances from Federal Home Loan Bank   24,862,885    26,357,962 
REPO sweep accounts   3,865,981    3,183,351 
Accrued expenses and other liabilities   1,245,267    1,375,093 
           
Total liabilities   188,456,572    189,399,363 
           
Stockholders' equity:          
Common stock ($0.01 par value 20,000,000 shares authorized 3,191,799 shares issued)   31,918    31,918 
Additional paid-in capital   23,853,891    23,853,891 
Retained earnings   2,833,814    2,766,170 
Treasury stock at cost (307,750 shares)   (2,963,918)   (2,963,918)
Accumulated other comprehensive income   646,926    746,723 
Total stockholders' equity   24,402,631    24,434,783 
           
Total liabilities and stockholders' equity  $212,859,203   $213,834,146 

 

 

See accompanying notes to consolidated financial statements.

 

3
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Consolidated Statement of Income and Comprehensive Income

 

   For the Three Months 
   Ended March 31, 
   2013   2012 
   (Unaudited) 
Interest income:          
Interest and fees on loans  $1,816,613   $2,040,208 
Interest and dividends on investments          
Taxable   115,329    150,180 
Tax-exempt   37,695    39,073 
Interest on mortgage-backed securities   115,371    179,288 
Total interest income   2,085,008    2,408,749 
           
Interest expense:          
Interest on deposits   221,902    280,544 
Interest on borrowings   99,441    183,634 
Total interest expense   321,343    464,178 
           
Net interest income   1,763,664    1,944,571 
Provision for loan losses   144,074    376,268 
Net interest income after provision for loan losses   1,619,591    1,568,303 
           
Non-interest income:          
Service charges and other fees   192,440    169,953 
Mortgage banking activities   170,432    220,560 
Net income (loss) on sale of premises and equipment, real estate owned and other repossessed assets   6,479    (2,089)
Other   70,992    58,399 
Total non-interest income   440,343    446,823 
           
Non-interest expense:          
Compensation and employee benefits   1,159,257    1,271,958 
FDIC Insurance Premiums   45,699    47,479 
Advertising   38,919    33,115 
Occupancy   233,446    241,916 
Amortization of intangible assets   29,646    73,113 
Service bureau charges   77,494    78,787 
Professional services   72,863    94,735 
Other   334,965    459,548 
Total non-interest expense   1,992,290    2,300,651 
           
Income (loss) before income tax expense or benefit   67,644    (285,526)
Income tax benefit   -    (886,200)
           
Net Income  $67,644   $600,675 
           
Other Comprehensive Income (Loss)          
Net Income  $67,644   $600,675 
Change in unrealized gain (loss) on available-for-sale securities, net of tax ...   (99,797)   59,183 
           
Comprehensive Income (Loss)  $(32,153)  $659,858 
           
Per share data:          
Net Income per share          
Basic  $0.02   $0.21 
Diluted  $0.02   $0.21 
           
Weighted average number of shares outstanding          
Basic   2,884,049    2,884,049 
Including dilutive stock options   2,884,049    2,884,049 
Dividends per common share  $-   $- 

 

 

See accompanying notes to consolidated financial statements.

 

4
 

 

First Federal of Northern Michigan Bancorp Inc. and Subsidiaries

Consolidated Statement of Changes in Stockholders' Equity (Unaudited)

 

                   Accumulated     
           Additional       Other     
   Common   Treasury   Paid-in   Retained   Comprehensive     
   Stock   Stock   Capital   Earnings   Income   Total 
                         
Balance at December 31, 2012   31,918    (2,963,918)   23,853,891    2,766,170    746,723    24,434,784 
                               
Net income   -    -    -    67,644    -    67,644 
                               
Change in unrealized gain on available-for-sale securities (net of tax of $51,411)   -    -    -    -    (99,797)   (99,797)
                               
Balance at March 31, 2013   31,918    (2,963,918)   23,853,891    2,833,814    646,926    24,402,631 

 

See accompanying notes to the consolidated financial statements.

 

5
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Consolidated Statement of Cash Flows

 

   For Three Months Ended 
   March 31, 
   2013   2012 
   (Unaudited) 
Cash Flows from Operating Activities:          
Net income  $67,644   $600,675 
Adjustments to reconcile net income to net cash from operating activities:          
Depreciation and amortization   100,605    156,237 
Provision for loan loss   144,074    376,268 
Amortization and accretion on securities   152,447    112,413 
Stock-based compensation   -    978 
Gain on sale of loans held for sale   (70,471)   (99,903)
Originations of loans held for sale   (4,427,961)   (7,697,851)
Proceeds from sale of loans held for sale   4,462,144    7,491,195 
Loss on sale of fixed assets   -    1,123 
(Gain) loss on sale of real estate owned and other repossessed assets   (6,479)   967 
Net change in:          
Accrued interest receivable   (63,960)   (12,243)
Other assets   76,000    (8,064)
Prepaid FDIC insurance premiums   42,573    44,209 
Bank owned life insurance   (33,079)   - 
Deferred income tax benefit   -    (886,200)
Accrued expenses and other liabilities   (129,826)   (366,221)
Net cash provided by (used in) operating activities   313,711    (286,417)
           
Cash Flows from Investing Activities:          
Net decrease in loans   975,988    654,797 
Proceeds from maturies and calls of available-for-sale securities   3,990,226    3,046,478 
Proceeds from sale of real estate and other repossessed assets   196,645    439,933 
Purchase of securities   (5,433,778)   (3,027,942)
Purchase of premises and equipment   -    (34,487)
Net cash (used in) provided by investing activities   (270,919)   1,078,779 
           
Cash Flows from Financing Activities:          
Net (decrease) increase in deposits   (172,334)   457,260 
Net increase in Repo Sweep accounts   682,630    14,091 
Net increase in advances from borrowers   171,815    175,999 
Advances  from Federal Home Loan Bank   13,930,000    8,075,000 
Repayments of Federal Home Loan Bank advances   (15,425,077)   (9,850,000)
Net cash used in financing activities   (812,966)   (1,127,650)
           
Net decrease in cash and cash equivalents   (770,174)   (335,288)
Cash and cash equivalents at beginning of period   2,751,810    2,749,498 
Cash and cash equivalents at end of period  $1,981,636   $2,414,210 
           
Supplemental disclosure of cash flow information:          
           
Cash paid during the period for interest  $332,503   $484,792 
Transfers of loans to foreclosed real estate and repossessed assets   208,000    649,564 

 

 

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—BASIS OF FINANCIAL STATEMENT PRESENTATION

 

The accompanying unaudited condensed consolidated interim financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and with the instructions to Form 10-Q. Accordingly, certain information and disclosures required by accounting principles generally accepted in the United States of America for complete financial statements are not included herein. The interim financial statements should be read in conjunction with the financial statements of First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries and the notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2012.

 

All adjustments, consisting only of normal recurring adjustments, which in the opinion of management are necessary for a fair presentation of financial position, results of operations and cash flows, have been made. The results of operations for the three months ended March 31, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013.

 

Note 2— 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, Inc. 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 to the Grotenhuis Group (as discussed further below). All significant intercompany balances and transactions have been eliminated in the consolidation.

 

Note 3—SECURITIES

 

Investment securities have been classified according to management’s intent. The carrying value and estimated fair value of securities are as follows:

 

   March 31, 2013 
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
(Losses)
   Market
Value
 
   (in thousands) 
Securities Available for Sale                    
U.S. Government and agency obligations  $7,663   $54   $(6)   7,711 
Municipal obligations   11,510    333    (30)   11,813 
Corporate bonds & other obligations   1,122    17    -    1,139 
Mortgage-backed securities   30,626    653    (41)   31,238 
Equity securities   3    -    (1)   2 
                     
Total  $50,924   $1,057   $(78)  $51,903 
                     
Securities Held to Maturity                    
Municipal obligations  $2,345   $195   $-   $2,540 

 

7
 

 

   December 31, 2012 
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
(Losses)
   Market
Value
 
   (in thousands) 
Securities Available for Sale                    
U.S. Government and agency obligations  $9,181   $66   $-    9,247 
Municipal obligations   10,413    368    (23)   10,758 
Corporate bonds & other obligations   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 obligations  $2,345   $225   $-   $2,570 

 

The amortized cost and estimated market value of securities at March 31, 2013, by contract maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities with no specified maturity date are separately stated.

 

   March 31, 2013 
   Amortized
Cost
   Market
Value
 
   (in thousands) 
Available For Sale:          
Due in one year or less  $2,574   $2,583 
Due after one year through five years   11,425    11,665 
Due in five year through ten years   6,010    6,051 
Due after ten years   286    364 
           
Subtotal   20,295    20,663 
           
Equity securities   3    2 
Mortgage-backed securities   30,626    31,238 
           
Total  $50,924   $51,903 
           
Held To Maturity:          
Due in one year or less  $90   $91 
Due after one year through five years   480    511 
Due in five year through ten years   635    690 
Due after ten years   1,140    1,248 
           
Total  $2,345   $2,540 

 

At March 31, 2013 and December 31, 2012, securities with a carrying value and fair value of $40,289,000 and $44,135,000, respectively, were pledged to secure our REPO sweep accounts, FHLB advances and our line of credit at the Federal Reserve.

 

There were no security sales in either the three months ended March 31, 2013 or 2012.

 

8
 

 

The following is a summary of temporarily impaired investments that have been impaired for less than and more than twelve months as of March 31, 2013 and December 31, 2012:

 

   March 31, 2013 
       Gross 
Unrealized
Losses
       Gross
Unrealized
Losses
 
   Fair Value   <12
months
   Fair Value   > 12
months
 
   (in thousands) 
Available For Sale:                    
U.S. Government and agency obligations  $993   $(6)  $-   $- 
Municipal obligations   4,065    (30)   -    - 
Mortgage-backed securities   7,146    (34)   1,040    (7)
Equity securities   -    -    2    (1)
                     
Total  $12,204   $(70)  $1,042   $(8)
                     
Held to Maturity:                    
Municipal obligations  $-   $-   $-   $- 

 

   December 31, 2012 
       Gross
Unrealized
Losses
       Gross
Unrealized
Losses
 
   Fair Value   <12
months
   Fair Value   > 12
months
 
   (in thousands) 
Available For Sale:                    
U.S. Government and agency obligations  $-   $-   $-   $- 
Municipal obligations   1,537    (23)   -    - 
Mortgage-backed securities   2,725    (13)   1,687    (16)
Equity securities   -    -    1    (2)
                     
Total  $4,262   $(36)  $1,688   $(18)
                     
Held to Maturity:                    
Municipal obligations  $-   $-   $-   $- 

 

The unrealized losses on the securities held in the portfolio are not considered other than temporary 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.

 

9
 

 

Note 4—LOANS AND ALLOWANCE FOR LOAN LOSSES

 

The following table sets forth the composition of our loan portfolio by loan type at the dates indicated.

 

   At March 31,   At December 31, 
   2013   2012 
   (in thousands) 
Real estate loans:          
Residential mortgage  $66,363   $66,539 
Commercial loans:          
Secured by real estate   52,775    54,673 
Other   9,473    8,102 
Total commercial loans   62,248    62,775 
           
Consumer loans:          
Secured by real estate   9,813    10,409 
Other   1,156    1,259 
           
Total consumer loans   10,969    11,668 
Total gross loans  $139,580   $140,982 
Less:          
Net deferred loan fees   (321)   (320)
Allowance for loan losses   (1,675)   (1,750)
           
Total loans, net  $137,584   $138,912 

 

The following table illustrates the contractual aging of the recorded investment in past due loans by class of loans as of March 31, 2013 and December 31, 2012:

 

As of March 31, 2013
                           Recorded 
           Greater than           Total   Investment > 90 
   30 - 59 Days   60 - 89 Days   90 Days   Total       Financing   Days and 
   Past Due   Past Due   Past Due   Past Due   Current   Receivables   Accruing 
   (dollars in thousands) 
                             
Commercial Real Estate:                                   
Commercial Real Estate - construction  $-   $-   $173   $173   $2,445   $2,618   $- 
Commercial Real Estate - other   867    1,112    2,506    4,485    45,672    50,157    - 
Commercial - non real estate   53    -    -    53    9,420    9,473    - 
                                    
Consumer:                                   
Consumer - Real Estate   89    3    -    92    9,721    9,813    - 
Consumer - Other   -    -    6    6    1,150    1,156    6 
                                    
Residential:                                   
Residential   2,052    -    1,455    3,507    62,856    66,363    97 
Total  $3,061   $1,115   $4,140   $8,316   $131,264   $139,580   $103 

 

10
 

 

As of December 31, 2012
                           Recorded 
           Greater than               Investment > 90 
   30 - 59 Days   60 - 89 Days   90 Days   Total       Total Financing   Days and 
   Past Due   Past Due   Past Due   Past Due   Current   Receivables   Accruing 
   (dollars in thousands) 
                             
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 

 

The Bank uses an eight tier risk rating system to grade its commercial loans. The grade of a loan may change during the life of the loans. The risk ratings are described as follows:

 

Risk Grade 1 (Excellent) - Prime loans based on liquid collateral, with adequate margin or supported by strong financial statements. Probability of serious financial deterioration is unlikely. High liquidity, minimum risk, strong ratios, and low handling costs are common to these loans. This classification also includes all loans secured by certificates of deposit or cash equivalents.

 

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

 

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

 

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

 

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

 

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

 

11
 

 

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 table presents the risk category of loans by class of loans based on the most recent analysis performed and the contractual aging as of March 31, 2013 and December 31, 2012:

 

As of March 31, 2013
   Commercial Real Estate   Commercial Real Estate     
Loan Grade  Construction   Other   Commercial 
   (dollars in thousands) 
1-2  $-   $-   $- 
3   1,171    13,102    3,676 
4   1,275    26,539    5,510 
5   -    2,564    96 
6   173    7,951    191 
7   -    -    - 
8   -    -    - 
Total  $2,619   $50,156   $9,473 

 

As of December 31, 2012
   Commercial Real Estate   Commercial Real Estate     
Loan Grade  Construction   Other   Commercial 
   (dollars in thousands) 
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 

 

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.

 

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The following tables present the risk category of loans by class based on the most recent analysis performed as of March 31, 2013 and December 31, 2012.

 

As of March 31, 2013
   (dollars in thousands)    
   Residential     
         
Loan Grade:          
Pass  $64,436      
Special Mention   -      
Substandard   1,927      
   Total  $66,363     

 

   Consumer -     
   Real Estate   Consumer - Other 
   (dollars in thousands) 
Performing  $9,804   $1,150 
Nonperforming   9    6 
Total  $9,813   $1,156 

 

As of  December 31, 2012
         
   Residential     
   (dollars in thousands)     
Loan Grade:          
Pass  $64,668     
Special Mention   -      
Substandard   1,871      
Total  $66,539     

 

   Consumer -     
   Real Estate   Consumer - Other 
   (dollars in thousands) 
Performing  $10,381   $1,253 
Nonperforming   28    6 
Total  $10,409   $1,259 

 

The following table presents the recorded investment in non-accrual loans by class as of March 31, 2013 and December 31, 2012:

 

   As of 
   March 31, 2013   December 31, 2012 
   (dollars in thousands) 
Commercial Real Estate:          
Commercial Real Estate - construction  $173   $173 
Commercial Real Estate - other   2,506    2,851 
Commercial   -    - 
           
Consumer:          
Consumer - real estate   9    28 
Consumer – other   -    1 
           
Residential:          
Residential   1,831    1,810 
           
Total  $4,519   $4,863 

 

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The key features of the Company’s loan modifications are determined on a loan-by-loan basis. Generally, our restructurings have related to interest rate reductions and loan term extensions. In the past the Company has granted reductions in interest rates, payment extensions and short-term payment forbearances as a means to maximize collectability of troubled credits. The Company has not forgiven principal to date, although this would be considered if necessary to ensure the long-term collectability of the loan. The Company’s loan modifications are typically short-term in nature, although the Company would consider a long-term modification to ensure the long-term collectability of the credit. In general, a borrower must make at least six consecutive timely payments before the Company would consider a return of a restructured loan to accruing status in accordance with Federal Deposit Insurance Corporation guidelines regarding restoration of credits to accrual status.

 

The Bank has classified approximately $4,640,000 of its impaired loans as troubled debt restructurings as of March 31, 2013.

 

   Troubled Debt Restructurings   Troubled Debt Restructurings that
Subsequently Defaulted
 
   For the three months ended March 31, 2013   For the three months ended March 31, 2013 
   Number of
Loans
   Pre-modification
outstanding recorded
investment
   Post-modification
outstanding recorded
investment
   Number of Loans   Recorded Investment 
       (dollars in thousands)       (dollars in thousands) 
Troubled Debt Restructurings                         
                          
Commercial Real Estate - Construction   -   $-   $-    -   $- 
Commercial Real Estate - Other   1    412    410    -    - 
Commercial - non real estate   -    -    -    -    - 
Residential   2    331    270    1    190 
Total   3   $743   $680    1   $190 

 

   Troubled Debt Restructurings   Troubled Debt Restructurings that 
   For the three months ended March 31, 2012   For the three months ended March 31, 2012 
   Number of
Loans
   Pre-modification
outstanding recorded
investment
   Post-modification
outstanding recorded
investment
   Number of Loans   Recorded Investment 
       (dollars in thousands)       (dollars in thousands) 
Commercial Loans   -   $-   $-   $-   $- 
Commerical Real Estate - Construction   -    -    -    -    - 
Commercial Real Estate - Other   2    1,628    1,621    -    - 
Consumer - Real Estate   -    -    -    -    - 
Consumer - Other   -    -    -    -    - 
Residential   -    -    -    -    - 
Total   2   $1,628   $1,621    -   $- 

 

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.

 

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The following table presents the loans individually evaluated for impairment by class of loans as of March 31, 2013 and December 31, 2012:

 

               For the Three Months Ended 
Impaired Loans  March 31, 
As of March 31, 2013  2013 
   Unpaid Principal   Recorded   Related   Average   Interest 
   Balance   Investment   Allowance   Recorded   Income 
               Investment   Recognized 
   (dollars in thousands)   (dollars in thousands) 
With no related allowance recorded:                         
Commercial  $-   $-   $-   $-   $- 
Commercial Real Estate - Construction   1,589    173    -    173    - 
Commercial Real Estate - Other   3,196    3,096    -    3,118    24 
Consumer - Real Estate   10    9    -    10    - 
Consumer - Other   -    -    -    -    - 
Residential   1,904    1,601    -    1,751    1 
                          
With a specific allowance recorded:                         
Commercial   -    -    -    -    - 
Commercial Real Estate - Construction   -    -    -    -    - 
Commercial Real Estate - Other   3,607    3,607    48    3,612    19 
Consumer - Real Estate   -    -    -    -    - 
Consumer - Other   1    -    -    1    - 
Residential   309    309    89    309    - 
                          
Totals:                         
Commercial  $-   $-   $-   $-   $- 
Commercial Real Estate - Construction  $1,589   $173   $-   $173   $- 
Commercial Real Estate - Other  $6,803   $6,703   $48   $6,730   $43 
Consumer - Real Estate  $10   $9   $-   $10   $- 
Consumer - Other  $1   $-   $-   $1   $- 
Residential  $2,213   $1,910   $89   $2,060   $1 

 

15
 

 

               For the Twelve  Months Ended 
Impaired Loans  December 31, 
As of December 31, 2012  2012 
            Average   Interest 
   Unpaid Principal   Recorded   Related   Recorded   Income 
   Balance   Investment   Allowance   Investment   Recognized 
   (dollars in thousands)     
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   $- 

  

The Allowance for Loan and Lease Losses 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 quarters ended March 31, 2013 and 2012, respectively:

 

Allowance for Credit Losses and Recorded Investment in Financing Receivables 
For the Three Months Ended March 31, 2013 
   Commercial   Commercial       Consumer                 
   Construction   Real Estate   Commercial   Real Estate   Consumer   Residential   Unallocated   Total 
   (dollars in thousands) 
                                 
Allowance for credit losses:                                        
Beginning Balance  $64   $579   $69   $99   $33   $906   $-   $1,750 
Charge-offs   -    (85)   -    (7)   (6)   (162)   -    (260)
Recoveries   -    10    -    15    4    12    -    41 
Provision   25    5    18    (20)   (5)   121    -    144 
Ending Balance  $89   $509   $87   $87   $26   $877   $-   $1,675 

 

Loan Balances Individually Evaluated for Impairment 
As of March 31, 2013 
   Commercial   Commercial       Consumer                 
   Construction   Real Estate   Commercial   Real Estate   Consumer   Residential   Unallocated   Total 
   (dollars in thousands) 
Ending balance: individually evaluated for impairment  $-   $48   $-   $-   $-   $89   $-   $137 
                                         
Ending balance: loans collectively evaluated for impairment  $89   $461   $87   $87   $26   $788   $-   $1,538 
                                         
Loans:                                        
Ending Balance  $2,618   $50,156   $9,473   $9,813   $1,156   $66,364   $-   $139,580 
                                         
Ending balance: individually evaluated for impairment  $173   $6,703   $-   $9   $-   $1,910   $-   $8,795 
                                         
Ending balance: loans collectively evaluated for impairment  $2,445   $43,453   $9,473   $9,804   $1,156   $64,454   $-   $130,785 

 

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For the Three Months Ended March 31, 2012 
   Commercial   Commercial       Consumer                 
   Construction   Real Estate   Commercial   Real Estate   Consumer   Residential   Unallocated   Total 
   (dollars in thousands) 
                                 
Allowance for credit losses:                                        
Beginning Balance  $10   $393   $53   $146   $46   $870   $-   $1,518 
Charge-offs   -    (55)   -    (19)   (7)   (166)   -    (247)
Recoveries   -    4    -    5    2    5    -    16 
Provision   (10)   173    (12)   (6)   1    230    -    376 
Ending Balance  $-   $515   $41   $126   $42   $939   $-   $1,663 

 

Loan Balances Individually Evaluated for Impairment 
As of March 31, 2012 
   Commercial   Commercial       Consumer                 
   Construction   Real Estate   Commercial   Real Estate   Consumer   Residential   Unallocated   Total 
   (dollars in thousands) 
Ending balance: individually evaluated for impairment  $-   $213   $-   $-   $-   $245   $-   $458 
                                         
Ending balance: loans collectively evaluated for impairment  $-   $302   $41   $126   $42   $694   $-   $1,205 
                                         
Loans:                                        
Ending Balance  $173   $53,140   $7,191   $12,485   $1,359   $66,798   $-   $141,146 
                                         
Ending balance: individually evaluated for impairment  $173   $3,333   $-   $145   $14   $1,966   $-   $5,631 
                                         
Ending balance: loans collectively evaluated for impairment  $-   $49,807   $7,191   $12,340   $1,345   $64,832   $-   $135,515 

 

Note 5—DIVIDENDS

 

We are dependent primarily upon the Bank for our earnings and funds to pay dividends on our common stock. The payment of dividends also is subject to legal and regulatory restrictions. Any payment of dividends in the future will depend, in large part, on the Bank's earnings, capital requirements, financial condition and other factors considered by our Board of Directors.

  

Note 6—STOCK-BASED COMPENSATION

 

Effective January 1, 2006, the Company adopted ASC 718-10, “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 shareholders on May 17, 2006, permits the award of up to 242,740 shares of common stock of which the maximum number to be granted as Stock Options is 173,386 and the maximum that can be granted as Restricted Stock Awards is 69,354. Option awards are granted with an exercise price equal to the market price of the Company’s stock at the date of grant. Those option awards generally vest based on five years of continual service and have ten year contractual terms. Certain options provide for accelerated vesting if there is a change in control (as defined in the Plans).

 

During the three months ended March 31, 2013 no shares were awarded under either the 1996 Plan or the 2006 Plan. Shares issued under the plans and exercised pursuant to the exercise of the stock options awarded under the plans may be either authorized but unissued shares or reacquired shares held by the Company as treasury stock.

 

Stock Options - A summary of option activity under the Plans during the three months ended March 31, 2013 is presented below:

 

17
 

 

           Weighted-Average     
       Weighted-   Remaining     
       Average   Contractual Term   Aggregate 
Options  Shares   Exercise Price   (Years)   Intrinsic Value 
                 
Outstanding at January 1, 2013   167,620   $9.53    3.38   $0 
                     
Granted   0    N/A           
                     
Exercised   0    N/A           
                     
Forfeited or expired   (2,950)  $9.65           
                     
Oustanding at March 31, 2013   164,670   $9.53    3.38   $0 
                     
Options Exercisable at March 31, 2013   164,670   $9.53    3.38   $0 

 

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 $4.68 on March 31, 2013 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 March 31, 2013. The amount changes based on the fair market value of the stock.

 

As of March 31, 2013 the Company had no unrecognized compensation cost related to nonvested options under the Plan. There were no shares which vested during the quarter ended March 31, 2013. In addition, there were no non-vested options as of March 31, 2013.

 

Restricted Stock Awards - As of March 31, 2013 all restricted stock awards have vested; therefore the Company had no unrecognized compensation cost under the Plans.

 

Note 7— 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 March 31, 2013, the Company had outstanding commitments to originate loans of $20.3 million. These commitments included the following:

 

   As of 
   March 31, 2013 
   (in thousands) 
     
Commitments to grant loans  $7,771 
Unfunded commitments under lines of credit   12,437 
Commercial and standby letters of credit   59 

 

Note 8-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. 

 

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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 March 31, 2013 and December 31, 2012, and the valuation techniques used by the Company to determine those fair values.

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis at March 31, 2013 
   Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
   Balance at
March 31,
2013
 
   (dollars in thousands) 
Assets                    
Investment securities- available-for-sale:                    
US Treasury securities and obligations of U.S. government corporations and agencies  $-   $7,711   $-   $7,711 
Municipal obligations   -    11,813    -    11,813 
Corporate bonds   -    1,139    -    1,139 
Mortgage-backed securities   -    31,238    -    31,238 
Equity securities   -    2    -    2 
                     
Total investment securities - available-for-sale  $-   $51,903   $-   $51,903 

 

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
 
   (dollars in thousands) 
Assets                    
Investment securities - available-for-sale:                    
U.S. Treasury securities and obligations of U.S. government corporations and agencies  $-   $9,247   $-   $9,247 
Municipal obligations   -    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 

 

Fair value measurements of U.S. Government agencies and mortgage backed securities 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 from December 31, 2012 to March 31, 2013. For the available for sale securities, the Company obtains fair value measurements from an independent third-party service.

 

19
 

 

The Company has assets that, under certain conditions, are subject to measurement at fair value on a nonrecurring basis. At March 31, 2013 and December 31, 2012, 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. 

 

Assets Measured at Fair Value on a Nonrecurring Basis at March 31, 2013    
   Balance at
March 31, 2013
   Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   Significant Other
Observable Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
   (dollars in thousands) 
Impaired loans accounted for under FASB ASC 310-10  $6,876   $-   $-   $6,876 
                     
Other real estate owned -residential mortgages  $765   $-   $-   $765 
                     
Other Real estate owned - commercial  $520   $-   $-   $519 
                     
Other repossessed assets  $1,121             $1,121 
                     
Total assets at fair value on a non-recurring basis                 $9,281 

 

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)
 
   (dollars in thousands) 
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                 $9,222 

 

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.

 

20
 

 

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.

 

Loans Held For Sale - Fair values of mortgage loans held for sale are based on commitments on hand from investors or prevailing market prices.

 

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.

 

The estimated fair values and related carrying or notional amounts of the Company’s financial instruments are as follows:

 

March 31, 2013  Carrying
Value
   Level 1   Level 2   Level 3   Total
Estimated
Fair Value
 
   (dollars in thousands) 
Financial assets:                         
Cash and cash equivalents  $1,982   $1,982   $-   $-   $1,982 
Securities available for sale   51,903    -    51,903    -    51,903 
Securities held to maturity   2,345    -    2,540    -    2,540 
Loans held for sale   115    -    -    145    145 
Loans receivable - net   137,584    -    -    139,101    139,101 
Federal Home Loan Bank stock   3,266    -    3,266    -    3,266 
Accrued interest receivable   1,034    -    1,034    -    1,034 
                          
Financial liabilities:                         
Customer deposits   158,178    -    159,082    -    159,082 
Federal Home Loan Bank advances   24,863    -    24,886    -    24,886 
REPO sweep accounts   3,866    -    3,866    -    3,866 
Accrued interest payable   89    -    89    -    89 

 

21
 

 

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 

 

22
 

 

FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.

AND SUBSIDIARIES

 

PART Ι - 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 March 31, 2013 and December 31, 2012, and the results of operations for the three-month periods ended March 31, 2013 and 2012. This discussion should be read in conjunction with the interim financial statements and footnotes included herein.

 

OVERVIEW

 

The Company operates as a community-oriented financial institution that accepts deposits from the general public in the communities surrounding its 8 full-service banking offices. The deposited funds, together with funds generated from operations and borrowings, are used by the Company to originate loans. The Company’s principal lending activity is the origination of mortgage loans for the purchase or refinancing of one-to-four family residential properties. The Company also originates commercial and multi-family real estate loans, construction loans, commercial loans, automobile loans, home equity loans and lines of credit, and a variety of other consumer loans.

 

For the quarter ended March 31, 2013, the Company had net income of $68,000, or $0.02 per basic and diluted share, compared to $601,000, or $0.21 per basic and diluted share, for the year earlier period, a decrease of $533,000. The 2012 quarter was impacted by an $866,000 credit to the valuation allowance on its deferred tax asset to income tax expense. See page 27 for further discussion on income taxes.

 

Total assets decreased by $975,000, or 0.5%, from $213.8 million as of December 31, 2012 to $212.9 million as of March 31, 2013. Cash and cash equivalents decreased by $770,000 while investment securities available for sale increased by $1.1 million and net loans receivable decreased $1.3 million during the quarter. Total deposits decreased $172,000 from December 31, 2012 to March 31, 2013 while Federal Home Loan Bank advances decreased by $1.5 million and stockholders’ equity decreased by $32,000.

 

CRITICAL ACCOUNTING POLICIES

 

As of March 31, 2013, there have been no changes in the critical accounting policies as disclosed in the Company’s Form 10-K for the year ended December 31, 2012. The Company’s critical accounting policies are described in the Management’s Discussion and Analysis and financial sections of its 2012 Annual Report. Management believes its critical accounting policies relate to the Company’s allowance for loan losses, mortgage servicing rights, valuation of deferred tax assets and impairment of intangible assets. 

 

COMPARISON OF FINANCIAL CONDITION AT MARCH 31, 2013 AND DECEMBER 31, 2012

 

ASSETS: Total assets decreased $975,000, or 0.5%, to $212.9 million at March 31, 2013 from $213.8 million at December 31, 2012. Net loans receivable decreased $1.3 million, or 1.0%, to $137.6 million at March 31, 2013 from $138.9 million at December 31, 2012, resulting primarily from a decrease of $699,000 and $527,000 in our consumer and commercial loan portfolios, respectfully. Our residential mortgage portfolio remained relatively unchanged period over period. Investment securities AFS increased $1.1 million from $50.8 million at December 31, 2012 to $51.9 million at March 31, 2013, due primarily to purchases of mortgage-backed securities during the period. Cash and cash equivalents decreased $772,000, or 28.3% to $2.0 million at March 31, 2013 from $2.7 million at December 31, 2012.

 

LIABILITIES: Deposits decreased $172,000 to $158.2 million at March 31, 2013 from $158.4 million at December 31, 2012. During this time period, we experienced an increase of $934,000 in our savings, money market and checking accounts, which was more than offset by a decrease of $1.2 million in our certificates of deposit. FHLB advances decreased $1.5 million, or 5.7% to $24.9 million at March 31, 2013 from $26.4 million at December 31, 2012, as proceeds from loan payments and payoffs, as well as cash on hand, were used to pay off maturing advances.

 

23
 

 

EQUITY: Stockholders’ equity decreased slightly and was $24.4 million at March 31, 2013 and December 31, 2012. The decrease was due primarily to net earnings for the three-month period of $68,000 partially offset by a decrease of $100,000 in the unrealized gain on available-for-sale investment securities

 

RESULTS OF OPERATIONS

 

Three Months Ended March 31, 2013 Compared to Three Months Ended March 31, 2012

 

General: Net income decreased by $533,000 to $68,000 for the three months ended March 31, 2013 from $601,000 for the quarter ended March 31, 2012.

 

Interest Income: Interest income decreased to $2.1 million for the three months ended March 31, 2013 from $2.4 million for the comparable period in 2012 as the average balance of interest earning assets decreased by $4.6 million from $200.9 million for the three months ended March 31, 2012 to $196.3 million for the three months ended March 31, 2013 and the average yield on interest earning assets decreased 52 basis points over that same time period from 4.80% to 4.28%. The yield on our mortgage loan portfolio decreased by 59 basis points to 5.14% for the three month period ended March 31, 2013 from 5.73% the year-earlier period, while the average balance of that portfolio remained relatively unchanged at $66.7 million period over period. The average balance of our non-mortgage loan portfolio decreased $887,000 to $74.0 million for the three months ended March 31, 2013 from the 2012 quarter, while the yield on this portfolio decreased 56 basis points to 5.25% from 5.81% period over period. The average balance of our investment portfolio decreased $4.2 million from the three months ended March 31, 2012 to the same period in 2013 while the yield on our investments decreased by 57 basis points period over period as agency securities matured and mortgage backed securities were paid off and replaced with securities with lower yields due to market interest rates.

 

Interest Expense: Interest expense decreased to $321,000 for the three months ended March 31, 2013 from $464,000 for the three months ended March 31, 2012. The decrease was due in part to a $9.1 million decrease in the average balance of our interest-bearing liabilities and a decrease in our overall cost of funds of 27 basis points from 1.05% to 0.78% period over period. Most notably, the average balance of our Federal Home Loan Bank advances decreased $8.2 million for the three-month period ended March 31, 2013 from the same period in 2012. The cost of these advances decreased 59 basis points from 2.06% to 1.47% period over period. In addition, our average balance in certificates of deposit decreased $4.5 million with the cost of these deposits decreasing 24 basis points from 1.33% to 1.09% for the quarter ended March 31, 2012 and March 31, 2013, respectively. For the three month period ended March 31, 2013 the average balance of REPO sweep deposits decreased by $2.0 million when compared to the same period in 2012. These decreases were partially offset by average balance increases of $3.0 million in our money market and NOW accounts and $2.6 million in our savings deposits when comparing the three months ended March 31, 2013 to the same period in 2012.

 

The following table sets forth information regarding the changes in interest income and interest expense of the Bank during the periods indicated.

 

24
 

 

   Three Months Ended March 31, 2013 
   Compared to 
   Three Months Ended March 31, 2012 
   Increase (Decrease) Due to: 
   Volume   Rate   Total 
   (In thousands) 
Interest-earning assets:               
Loans receivable  $(14)  $(210)  $(224)
Investment securities   (24)   (74)  $(98)
Other investments   2    (4)  $(2)
                
Total interest-earning assets   (36)   (288)   (324)
                
Interest-bearing liabilities:               
Savings Deposits   -    -    - 
Money Market/NOW accounts   1    -    1 
Certificates of Deposit   (15)   (45)   (60)
Deposits   (14)   (45)   (59)
Borrowed funds   (91)   7    (84)
                
Total interest-bearing liabilities   (105)   (38)   (143)
                
Change in net interest income  $69   $(250)  $(181)

 

Net Interest Income: Net interest income decreased by $181,000, to $1.8 million for the three months ended March 31, 2013 from $1.9 million for the prior year period. For the three months ended March 31, 2013, average interest-earning assets decreased $4.6 million, or 2.3%, to $196.3 million when compared to the same period in 2012. Average interest-bearing liabilities decreased $9.1 million, or 5.1%, to $168.3 million for the quarter ended March 31, 2013 from $177.4 million for the quarter ended March 31, 2012. While the average balance of interest-bearing deposits decreased significantly the Company saw an increase of $5.9 million of average balances in non interest-bearing deposits for the quarter ended of March 31, 2013 compared to the year earlier period in 2012. The yield on average interest-earning assets decreased to 4.28% for the three month period ended March 31, 2013 from 4.80% for the same period ended in 2012 as we continued to see a decline in loan rates period over period. In addition, the cost of average interest-bearing liabilities decreased to 0.78% from 1.05% for the three month periods ended March 31, 2013 and 2012, respectively. Our interest rate spread decreased by 25 basis points to 3.50% from 3.75% while our net interest margin decreased by 26 basis points to 3.61% for the three-month period ended March 31, 2013 from 3.87% for same period in 2012. In an effort to offset declining levels of net interest income, the Company continues to pursue loan opportunities in our market area with qualified borrowers in addition to seeking continued growth of low cost core deposits. At March 31, 2013 the Company had outstanding loan commitments of $20.3 million. During the three months ended March 31, 2013 the Company grew average interest bearing core deposits by $3.0 million.

 

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 collectability 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.

 

25
 

 

The provision for loan losses for the three-month period ended March 31, 2013 was $144,000, as compared to $376,000 for the three months ended March 31, 2012. Prior to 2012, our provision for loan losses was based on an eight-quarter rolling average of actual net charge-offs adjusted for environmental factors for each segment of loans in our portfolio. Management has decided that eight quarters is no longer reflective of the inherent loss in the loan portfolios. Beginning with the quarter ended March 31, 2012, we began moving towards a twelve-quarter rolling average of actual net charge-offs by adding an additional quarter of net charge-offs each quarter in 2012. By the end of 2012 we were using a twelve-quarter rolling average. During the quarter ended March 31, 2012, we added specific reserves of approximately $200,000 on two commercial credit relationships which were reclassified as Troubled Debt Restructurings. In addition, we recorded specific reserves of approximately $200,000 on several residential mortgage loans which had progressed in the foreclosure process during the quarter. By comparison, the first quarter of 2013 had fewer loans requiring specific reserves along with lower levels of charge-offs. The provision was based on management’s review of the components of the overall loan portfolio, the status of non-performing loans and various subjective factors.

 

The following table sets forth the details of our loan portfolio at the dates indicated:

 

       Delinquent     
   Portfolio   Loans   Non-Accrual 
   Balance   Over 90 Days   Loans 
   (Dollars in thousands) 
At March 31, 2013               
Real estate loans:               
Construction  $4,042   $-   $173 
One - to four - family   64,940    97    1,831 
Commercial Mortgages   50,156    -    2,506 
Home equity lines of credit/ Junior liens   9,813    -    - 
Commercial loans   9,473    -    - 
Consumer loans   1,156    6    9 
                
Total gross loans  $139,580   $103  $4,519 
Less:               
Net deferred loan fees   (321)   (2)   (6)
Allowance for loan losses   (1,675)   -    (246)
Total loans, net  $137,584   $101   $4,267 
                
At December 31, 2012               
Real estate loans:               
Construction  $3,208   $-   $173 
One - to four - family   65,578    61    1,810 
Commercial Mortgages   52,427    -    2,851 
Home equity lines of credit/Junior liens   10,409    -    28 
Commercial loans   8,102    -    - 
Consumer loans   1,258    6    1 
                
Total gross loans  $140,982   $67   $4,863 
Less:               
Net deferred loan fees   (320)   -   (5)
Allowance for loan losses   (1,750)   -    (346)
Total loans, net  $138,912   $67   $4,512 

 

Non Interest Income: Non-interest income was relatively unchanged for the quarters ended March 31, 2013 and 2012. Mortgage banking activities were $50,000 lower for the three months ended March 31, 2013 when compared to the same period a year earlier. This decrease was partially offset by increases of $22,000 in service charge fee income and $19,000 of income related to bank owned life insurance that was purchased during the fourth quarter of 2012.

 

Non Interest Expense: Non interest expense decreased by $308,000 from $2.3 million for the three months ended March 31, 2012 to $2.0 million for the 2013 period. Most notably, other expenses decreased by $125,000 period over period as we experienced an $111,000 decrease in real estate owned expenses related to troubled credits. In addition, compensation and employee benefits decreased $113,000 period over period as we reduced staffing, suspended our accrual of the elective contribution to the Company’s 401(k) plan and reduced health insurance premiums as a result of self insuring deductibles for employee insurance coverage.

 

26
 

 

Income Taxes: For the quarter ended March 31, 2013, the Company recorded no tax expense. By comparison, during the quarter ended March 31, 2012, the Company recorded an income tax benefit of $886,000. The variance of $886,000 relates to the partial recovery, during the 2012 quarter, of a valuation allowance for our Deferred Tax Asset (DTA) that was established in 2009. The valuation allowance was recorded in 2009 against the DTA because management determined that it was more likely than not that some or all of the DTA would not be realized. At March 31, 2012, management reevaluated the Company’s valuation allowance related to its DTA. The analysis of the DTA was made to determine the utilization of those tax benefits based upon projected future taxable income. Based upon management’s determination and in accordance with the generally accepted accounting principles, management concluded that the utilization of this asset was “more likely than not.” Accordingly, as of March 31, 2012, $866,000 of the valuation allowance was credited to income tax expense. Among the criteria that management considered in evaluating the DTA were: improved core profitability of the Bank in 2010 and 2011; substantial improvement in 2010 and 2011 of non-performing asset levels, which were driving losses in prior years; and positive forecast for taxable income looking forward over the next three years. However, during the fourth quarter of 2012 the $866,000 was reversed as a result of management’s reevaluation of the DTA and determination that it was more likely than not that some or all of the DTA would not be realized during the period. Management’s decision to reverse the DTA recovery in the fourth quarter of 2012 was influenced by several factors including a higher than anticipated provision expense recorded throughout the year, lower than expected commercial loan demand and lastly placing two large commercial loans into non-accrual status during the fourth quarter. A valuation allowance of $3.2 million remains on our current DTA as of March 31, 2013.

 

The Company will continue to evaluate the future benefits from these carryforwards and at such time as it becomes “more likely than not” that they would be utilized prior to expiration, the Company will recognize the additional benefits as an adjustment to the valuation allowance. The net operating loss carryforwards expire twenty years from the date they originated. These carryforwards, if not utilized, will fully expire in the year 2032.

 

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 OCC regulations. This requirement may be varied at the direction of the OCC. Regulations currently in effect require that the Bank maintain sufficient liquidity to ensure its safe and sound operation. The Company’s objective for liquidity is to be above 20%. Liquidity as of March 31, 2013 was $55.8 million, or 46.5%, compared to $52.5 million, or 42.5%, at December 31, 2012. 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 pledged collateral. As of March 31, 2013, the Bank had unused borrowing capacity totaling $35.3 million at the FHLB based on pledged collateral.

 

27
 

 

The Company intends to retain for its portfolio certain originated residential mortgage loans (primarily adjustable rate 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 three month period ended March 31, 2013, the Company originated $6.9 million in residential mortgage loans, of which $2.5 million were retained in portfolio while the remainder were sold in the secondary market or are being held for sale. This compares to $11.7 million in originations during the first three months of 2012 of which $4.0 million were retained in portfolio. The Company also originated $6.2 million of commercial loans and $253,000 of consumer loans in the first three months of 2013 compared to $3.0 million of commercial loans and $179,000 of consumer loans for the same period in 2012. Of total loans receivable, excluding loans held for sale, mortgage loans comprised 47.6% and 47.3%, commercial loans 44.6% and 42.9% and consumer loans 7.9% and 9.8% at March 31, 2013 and March 31, 2012, respectively.

 

Deposits are a primary source of ;funds for use in lending and for other general business purposes. At March 31, 2013 deposits funded 74.3% of the Company’s total assets compared to 69.9% at December 31, 2012. Certificates of deposit scheduled to mature in less than one year at March 31, 2013 totaled $35.5 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. Future liquidity needs are expected to be satisfied through the use of FHLB borrowings, as necessary, and through growth in deposits. Management does not generally plan on paying above-market rates on deposit products, although from time-to-time we may do so as liquidity needs dictate.

 

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 March 31, 2013 the Company had $24.9 million in FHLB advances, of which $7.1 million will mature during 2013. FHLB borrowings as a percentage of total assets were 11.7% at March 31, 2013 as compared to 12.3% at December 31, 2012. The Company has sufficient available collateral to obtain additional advances of $35.3 million.

 

CAPITAL RESOURCES

 

Stockholders’ equity at March 31, 2013 was $24.4 million, or 11.5% of total assets, compared to $24.4 million, or 11.4% of total assets, at December 31, 2012 (See “Consolidated Statement of Changes in Stockholders’ Equity”). The Bank is subject to certain capital-to-assets levels in accordance with OCC regulations. The Bank exceeded all regulatory capital requirements at March 31, 2013. 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 March 31, 2013:

 

           Regulatory   Minimum to be 
   Actual   Minimum   Well Capitalized 
   Amount   Ratio   Amount   Ratio   Amount   Ratio 
   Dollars in Thousands 
                         
Tier 1 (Core) capital ( to adjusted assets)  $22,218    10.47%  $8,486    4.00%  $10,608    5.00%
Total risk-based capital ( to risk- weighted assets)  $23,893    17.66%  $10,824    8.00%  $13,530    10.00%
Tier 1 risk-based capital ( to risk weighted assets)  $22,218    16.42%  $5,412    4.00%  $8,118    6.00%
Tangible Capital ( to tangible assets)  $22,218    10.47%  $3,182    1.50%  $4,243    2.00%

 

28
 

 

ITEM 3. QUANTITATIVE AND QUALITITIVE DISCLOSURES ABOUT MARKET RISK

 

Not applicable to smaller reporting companies.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Under the supervision and with the participation of our management, including the Company’s Chief Executive Officer and VP - Director of Financial Reporting & Accounting, 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 VP - Director of Financial Reporting & Accounting 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 (1) is recorded, processed, summarized and reported, within the time periods specified by the SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosure.

 

There has been no change in the Company’s internal control over financial reporting during the Company’s first quarter of 2013 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

29
 

 

FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.

FORM 10-Q

Quarter Ended March 31, 2013

 

PART II – OTHER INFORMATION

 

Item 1 -Legal Proceedings:

 

At March 31, 2013 there were 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 1A -Risk Factors:

Not applicable to smaller reporting companies

 

Item 2 -Unregistered Sales of Equity Securities and Use of Proceeds:

 

(a)Not applicable
(b)Not applicable
(c)Not applicable

 

Item 3 -Defaults upon Senior Securities:

Not applicable.

 

Item 4 -Mine Safety Disclosures

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 VP - Director of Financial Reporting & Accounting 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 VP - Director of Financial Reporting & Accounting furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.

FORM 10-Q

Quarter Ended March 31, 2013

 

SIGNATURES

 

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

 

  FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
       
    By: /s/Michael W. Mahler
      Michael W. Mahler
      President and Chief Executive Officer
       
      Date:  May 10, 2013
       
    By: /s/Eileen M Budnick
      Eileen M. Budnick, VP - Director of Financial
Reporting & Accounting
      (Principal Financial and Accounting Officer)
       
      Date:  May 10, 2013

 

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