SECURITIES AND EXCHANGE COMMISSION 

Washington, D.C. 20549 

 

FORM 10-K

 

Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Fiscal Year Ended December 31, 2014

OR

Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the transition period from _______________ to ______________________

 

Commission File Number: 000-31957

 

FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

 

Maryland   32-0135202
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification Number)
     
100 S. Second Avenue, Alpena, Michigan   49707
(Address of Principal Executive Offices)   Zip Code

 

(989) 356-9041

(Registrant’s telephone number)

 

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

 

Securities Registered Pursuant to Section 12(g) of the Act: 

None

 

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

 

Indicate by check mark if the registrant in not required to file reports pursuant to Section 13 or 15(d) of the Act.     YES  ☐     NO  ☒

 

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past twelve months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. 

YES  ☒     NO  ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 

YES  ☒     NO  ☐

 

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

 

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

 

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

 

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

 

The aggregate market value of the voting stock held by non-affiliates of the registrant, computed by reference to the last sale price on June 30, 2014 ($6.05 per share) was $15.4 million.

 

As of March 30, 2015, there were issued and outstanding 4,034,764 shares of the registrant’s common stock.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

1.Proxy Statement for the 2014 Annual Meeting of Stockholders (Parts I and III).
2.Annual Report to Shareholders for the Year Ended December 31, 2014 (Part II).

 

 

 
 

 

TABLE OF CONTENTS
      
PART I     
      
ITEM 1  BUSINESS 3
ITEM 1A  RISK FACTORS 35
ITEM 1B  UNRESOLVED STAFF COMMENTS 35
ITEM 2  PROPERTIES 35
ITEM 3  LEGAL PROCEEDINGS 35
ITEM 4  MINE SAFETY DISCLOSURES 35
      
PART II     
      
ITEM 5  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES 35
ITEM 6  SELECTED FINANCIAL DATA 36
ITEM 7  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 36
ITEM 7A  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 36
ITEM 8  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 36
ITEM 9  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 36
ITEM 9A  CONTROLS AND PROCEDURES 36
ITEM 9B  OTHER INFORMATION 37
      
PART III     
      
ITEM 10  DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE 37
ITEM 11  EXECUTIVE COMPENSATION 37
ITEM 12  SECURITY OWNERSHIP OF CERTAIN BEENFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS 37
ITEM 13  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE 37
ITEM 14  PRINCIPAL ACCOUNTANT FEES AND SERVICES 37
      
PART IV     
      
ITEM 15  EXHIBITS AND FINANCIAL STATEMENT SCHEDULES 38
   SIGNATURES 39

 

2
 

 

PART I

 

ITEM 1. BUSINESS

 

Private Securities Litigation Reform Act Safe Harbor Statement

 

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

 

·statements of our goals, intentions and expectations;
·statements regarding our business plans, prospects, growth and operating strategies;
·statements regarding the asset quality of our loan and investment portfolios; and
·estimates of our risks and future costs and benefits.

 

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

 

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

 

·general economic conditions, either nationally or in our market areas, that are worse than expected;
·competition among depository and other financial institutions;
·inflation and changes in the interest rate environment that reduce our margins or reduce the fair value of financial instruments;
·adverse changes in the securities markets;
·changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees and capital requirements;
·our ability to enter new markets successfully and capitalize on growth opportunities;
·our ability to successfully integrate acquired entities;
·changes in consumer spending, borrowing and savings habits;
·changes in accounting policies and practices, as may be adopted by the regulatory agencies, the Financial Accounting Standards Board, the Securities and Exchange Commission and the Public Company Accounting Oversight Board;
·changes in our organization, compensation and benefit plans;
·changes in our financial condition or results or operations that reduce capital available to pay dividends;
·regulatory changes or actions; and
·changes in the financial condition or future prospects of issuers of securities that we own.

 

Because of these and a wide variety of other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements.

 

3
 

 

First Federal of Northern Michigan Bancorp, Inc.

 

First Federal of Northern Michigan Bancorp, Inc. is a Maryland corporation that owns all of the outstanding shares of common stock of First Federal of Northern Michigan. At December 31, 2014, we had consolidated assets of $325.8 million, deposits of $270.7 million and stockholders’ equity of $30.5 million. As of December 31, 2014, First Federal of Northern Michigan Bancorp, Inc. had 4,034,764 shares of common stock issued and outstanding. Our executive offices are located at 100 South Second Avenue, Alpena, Michigan 49707. Our phone number at that address is (800) 498-0013.

 

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

 

First Federal of Northern Michigan

 

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

 

In August 2014 we completed our merger with Alpena Banking Corporation and its subsidiary Bank of Alpena, a Michigan chartered bank located in Alpena, Michigan.

 

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

 

First Federal of Northern Michigan’s executive offices are located at 100 South Second Avenue, Alpena, Michigan 49707. Its phone number at that address is (800) 498-0013.

 

Market Area and Competition

 

First Federal of Northern Michigan conducts operations through its main office in Alpena, Michigan, which is located in the northeastern lower peninsula of Michigan, and through its seven other branch offices in Michigan. According to the Michigan Senate, the population of Alpena County, from which the majority of our deposits are drawn, has decreased approximately 7.0% since 2000, and currently is approximately 30,000. The population of our primary market area, which includes Alpena County and seven surrounding counties, was estimated to be approximately 155,000 in 2013, a decrease of 1.1% from approximately 157,000 according to the 2010 census conducted by United States Census Bureau. Median household income for the counties which comprised our market area in 2013 ranged from approximately $33,200 to $50,900, which represented moderate increases from 2010 levels in most counties in our market area. Median household income for our entire market area was below the national level of $53,046 and below the Michigan level of $48,411 in all but one county in our market area, reflecting the largely rural nature of our market area and the absence of more densely populated urban and suburban areas. Household income levels are not expected to increase substantially in our market area in the near future. The unemployment rate in our primary market, Alpena County, was 6.4% for December 2014, and ranged from 6.4% to 12.0% across the rest of our primary market area, as compared to 6.7% nationally and 8.4% for Michigan (all numbers not seasonally adjusted).

 

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

 

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

 

4
 

 

As of December 31, 2014, First Federal of Northern Michigan was the only thrift institution headquartered in our market area. We encounter strong competition both in attracting deposits and in originating residential and commercial real estate and other loans. Our most direct competition for deposits has historically come from commercial banks, other savings institutions, and credit unions in our market area. Competition for loans comes from such financial institutions. We expect continued strong competition in the foreseeable future, including the “super-regional” banks currently in our markets, from internet banks, and from credit unions in many of our markets. We compete for savings deposits by offering depositors a high level of personal service and a wide range of competitively priced financial products. We compete for real estate loans primarily on the basis of the interest rates and fees we charge and through advertising. Strong competition for deposits and loans may limit our ability to grow and may adversely affect our profitability in the future.

 

Lending Activities

 

General. The largest part of our loan portfolio is mortgage loans secured by one- to four-family residential real estate. In recent years, we have sold most of the fixed-rate conventional one- to four-family mortgage loans that we originate that have terms of 15 years or more. We retain the servicing on a majority of the mortgage loans that we sell. To a lesser extent, we also originate commercial loans, commercial real estate loans and consumer loans. At December 31, 2014, we had total loans of $165.3 million, of which $71.8 million, or 43.5%, were one- to four-family residential real estate mortgage loans, $63.6 million, or 38.5%, were commercial real estate loans, and $19.0 million, or 11.5%, were commercial loans. Other loans consisted primarily of home equity loans, which totaled $9.5 million, or 5.8%, of total loans, and other consumer loans which totaled $1.4 million, or 0.9% of total loans.

 

One- to Four-Family Residential Real Estate Lending. Our primary lending activity consists of originating one- to four-family owner-occupied residential mortgage loans, virtually all of which are collateralized by properties located in our market area. We also originate one- to four-family construction loans that pay interest only during the initial construction period (which generally does not exceed twelve months) and then pay interest and principal for the remainder of the loan term. To address interest rate risk we generally sell most of our one- to four-family fixed-rate mortgage loans with terms of 15 years or more and retain the loan servicing on a majority of these mortgage loans. Fixed-rate loans with terms of 15 years or less are either sold into the secondary market or, in some cases, retained in our portfolio. Adjustable rate mortgage loans are generally underwritten to secondary market mortgage standards, but are retained in our loan portfolio. One- to four-family residential mortgage loans are underwritten and originated according to policies and guidelines established by the secondary mortgage market agencies and approved by our Board of Directors. We utilize existing liquidity, deposits, loan repayments, and Federal Home Loan Bank advances to fund new loan originations.

 

We currently offer fixed rate one- to four-family residential mortgage loans with terms ranging from 15 to 30 years. One- to four-family residential mortgage loans often remain outstanding for significantly shorter periods than their contractual terms because borrowers may refinance or prepay loans at their option. The average length of time that our one- to four-family residential mortgage loans remain outstanding varies significantly depending upon trends in market interest rates and other factors. In recent years, the average maturity of our mortgage loans has decreased significantly because of the declining trend in market interest rates and the unprecedented volume of refinancing activity resulting from such interest rate decreases.

 

Originations of one- to four fixed-rate mortgage loans are regularly monitored and are affected significantly by the level of market interest rates, our interest rate gap position, and loan products offered by our competitors. Our fixed rate mortgage loans amortize on a monthly basis with principal and interest due each month.

 

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

 

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

 

5
 

 

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

 

Generally, we make one- to four-family mortgage loans with loan-to-value ratios of up to 90%. However, for one- to four-family real estate loans with loan-to-value ratios of between 80% and 90%, we may require the borrower to purchase private mortgage insurance. In 2005 we began making 80/20 loans and interest-only loans subject to Board-approved dollar limits to limit risk exposure. In late 2007 these products were eliminated; however, at December 31, 2014 approximately $315,000 of these products remained in our portfolio. We require fire and casualty insurance, flood insurance when applicable, as well as title insurance, on all properties securing real estate loans made by us.

 

Commercial Real Estate Lending. We originate commercial real estate loans. At December 31, 2014, we had a total of 265 loans secured primarily by commercial real estate properties, unimproved vacant land and, to a limited extent, multifamily properties. Our commercial real estate loans are secured by income-producing properties such as office buildings, retail buildings, restaurants and motels. A majority of our commercial real estate loans are secured by properties located in our primary market area, although at December 31, 2014 we had $2.3 million in commercial real estate loans located outside of Michigan. We have originated commercial construction loans that are originated as permanent loans but are interest-only during the initial construction period, which generally does not exceed nine months. At December 31, 2014, our commercial real estate loans, totaled $63.6 million, or 38.5% of our total loans, and had an average principal balance of approximately $239,000. The terms of each loan typically amortize over 15 years and have a three- or five-year balloon feature. An origination fee of 0.5% to 1.0% is generally charged on commercial real estate loans. We generally make commercial real estate loans up to 75% of the appraised value of the property securing the loan.

 

At December 31, 2014, our largest commercial real estate relationship consisted of two loans with a total principal balance of $4.0 million, which was performing according to its repayment terms as of December 31, 2014. This loan relationship is secured by two pieces of commercial real estate. Our largest single commercial real estate loan had an outstanding balance of $3.1 million, which was performing according to its repayment terms as of December 31, 2014.

 

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

 

Consumer and Other Loans. We originate a variety of consumer and other loans, including loans secured by savings accounts, new and used automobiles, mobile homes, boats, recreational vehicles, and other personal property. As of December 31, 2014, consumer and other loans totaled $10.9 million, or 6.6% of our total loan portfolio. At such date, $147,000, or 0.09% of our consumer loans, were unsecured. As of December 31, 2014, home equity loans totaled $9.5 million, or 5.8% of our total loan portfolio, and automobile loans totaled $630,000, or 0.4% of our total loan portfolio. We originate automobile loans directly to our customers and have no outstanding agreements with automobile dealerships to generate indirect loans.

 

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

 

6
 

 

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

 

Commercial Loans. At December 31, 2014, we had $19.0 million in commercial loans which amounted to 11.5% of total loans. We make commercial loans primarily in our market area to a variety of professionals, sole proprietorships and small businesses. Commercial lending products include term loans and revolving lines of credit. The maximum amount of a commercial loan is our loans-to-one-borrower limit, which was $4.8 million at December 31, 2014. Such loans are generally used for longer-term working capital purposes such as purchasing equipment or furniture. Commercial loans are made with either adjustable or fixed rates of interest. Variable rates are generally based on the prime rate, as published in The Wall Street Journal, plus a margin. Fixed rate commercial loans are set at a margin above the Federal Home Loan Bank comparable advance rate.

 

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

 

Commercial loans generally have greater credit risk than residential mortgage loans. Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment or other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial loans generally are made on the basis of the borrower’s ability to repay the loan from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself. If the cash flow from the business operation is reduced, the borrower’s ability to repay the loan may be impaired. This may be particularly true in the early years of the business operation when the risk of failure is greatest. Moreover, any collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value. We seek to minimize these risks through our underwriting standards. At December 31, 2014, our largest commercial loan was a $2.2 million commercial term loan and was collateralized by equipment and inventory of a supermarket. At December 31, 2014, the outstanding balance was $1.5 million and the loan was performing according to its repayment terms.

 

Construction Loans. We originate construction loans to local home builders in our market area, generally with whom we have an established relationship, and to individuals engaged in the construction of their residences. We also originate loans for the construction of commercial buildings and, to a lesser extent, participate in construction loan projects originated by other lenders. Our construction loans totaled $2.2 million, or 1.3% of our total loan portfolio, at December 31, 2014.

 

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

 

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

 

7
 

 

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

 

   At December 31,
   2014  2013  2012  2011  2010
   Amount  Percent  Amount  Percent  Amount  Percent  Amount  Percent  Amount  Percent
   (dollars in thousands)
                               
Real estate loans:                              
Residential Mortgages:                              
1-4 Family Mortgages  $68,355    41.4%  $60,750    44.0%  $63,867    45.3%  $64,177    45.0%  $68,298    42.7%
Purchased Mortgage In-State   1,300    0.8%   1,506    1.2%   1,711    1.3%   1,924    1.3%   3,243    2.0%
1-4 Family Construction   2,173    1.3%   1,583    1.1%   962    0.7%   498    0.3%   156    0.1%
Home Equity/Junior Liens   9,502    5.7%   8,730    6.3%   10,409    7.4%   13,395    9.4%   16,547    10.3%
Nonresidential Mortgages:                                                  
Nonresidential   54,908    33.2%   41,090    29.8%   40,992    29.1%   44,020    30.9%   43,580    27.3%
Purchased Nonresidential In-State   4,993    3.0%   6,886    5.0%   4,553    3.2%   2,130    1.5%   4,232    2.6%
Purchased Nonresidential Out-of-State   2,262    1.4%   3,750    2.7%   6,882    4.9%   7,788    5.5%   9,928    6.2%
Nonresidential Construction   1,443    0.9%       0.0%   1,458    1.0%   91    0.1%   1,498    0.9%
Purchased Construction In-State       0.0%       0.0%   615    0.4%       0.0%       0.0%
Purchased Construction Out-of-State       0.0%   173    0.1%   173    0.1%   173    0.1%   1,772    1.1%
Non real estate loans:                                                  
Commercial Loans   17,361    10.5%   12,164    8.8%   7,769    5.5%   6,621    4.6%   7,382    4.6%
Purchased Commercial Loans In-State   1,639    1.0%   287    0.2%   333    0.2%   381    0.3%   1,466    0.9%
Consumer and other loans   1,403    0.8%   1,165    0.8%   1,258    0.9%   1,477    1.0%   2,118    1.3%
                                                   
Total Loans  $165,339    100.00%  $138,084    100.00%  $140,982    100.00%  $142,675    100.00%  $160,220    100.00%
                                                   
Other items:                                                  
Deferred loan origination costs   226         179         15         14         31      
Deferred loan origination fees   (489)        (476)        (335)        (287)        (276)     
Allowance for loan losses   (1,429)        (1,472)        (1,750)        (1,518)        (2,831)     
                                                   
Total loans, net  $163,647        $136,315        $138,912        $140,884        $157,144      

 

8
 

 

Loan Portfolio Maturities and Yield. The following table summarizes the scheduled repayments of our loan portfolio at December 31, 2014. Demand loans, loans having no stated repayment or maturity, and overdraft loans are reported as being due in one year or less.

 

                   
         Purchased Mortgage  1-4 Family
   1-4 Family Mortgage  In-State  Construction
      Weighted     Weighted     Weighted
      Average     Average     Average
   Amount  Rate  Amount  Rate  Amount  Rate
   (dollars in thousands)
                   
Due During the Years Ending December 31,                   
2015   $380    8.43%  $    0.00%  $2,112    4.12%
2016    141    6.98%       0.00%   61    3.63%
2017    226    6.08%       0.00%       0.00%
2018 to 2019     2,483    5.79%       0.00%       0.00%
2020 to 2024     5,565    5.31%       0.00%       0.00%
2025 to 2029    25,750    4.44%   22    2.85%       0.00%
2030 and beyond     33,810    4.68%   1,278    2.56%       0.00%
                                
Total    $68,355    4.71%  $1,300    2.56%  $2,173    4.10%

 

               Purchased Nonresidential
   Home Equity/Junior Liens  Nonresidential  In-State
      Weighted     Weighted     Weighted
      Average     Average     Average
   Amount  Rate  Amount  Rate  Amount  Rate
   (dollars in thousands)
                  
Due During the Years Ending December 31,                    
2015   $118    5.27%  $5,379    6.74%  $20    7.48%
2016    337    6.50%   6,313    6.01%   785    4.66%
2017    505    5.52%   13,738    5.63%   1,370    4.75%
2018 to 2019    1,338    4.80%   14,631    5.50%   180    4.75%
2020 to 2024    4,389    5.73%   7,443    5.33%   1,697    4.75%
2025 to 2029    2,802    4.16%   2,854    5.11%   941    5.75%
2030 and beyond    13    5.25%   4,550    6.16%       0.00%
                                
Total    $9,502    5.15%  $54,908    5.73%  $4,993    4.94%

 

   Purchased Nonresidential  Nonresidential      
   Out-of-State  Construction  Commercial Loans
      Weighted     Weighted     Weighted
      Average     Average     Average
   Amount  Rate  Amount  Rate  Amount  Rate
   (dollars in thousands)
                  
Due During the Years Ending December 31,                    
2015   $    0.00%  $1,443    5.25%  $6,025    5.13%
2016        0.00%       0.00%   2,327    5.54%
2017        0.00%       0.00%   2,013    5.53%
2018 to 2019          0.00%       0.00%   4,055    5.13%
2020 to 2024         0.00%       0.00%   2,941    5.18%
2025 to 2029        0.00%       0.00%       0.00%
2030 and beyond    2,262    5.75%       0.00%       0.00%
                                
Total    $2,262    5.75%  $1,443    5.25%  $17,361    5.24%

 

   Purchased Commercial  Consumer      
   Loans In-State  & Other Loans  Total
      Weighted     Weighted     Weighted
      Average     Average     Average
   Amount  Rate  Amount  Rate  Amount  Rate
   (dollars in thousands)
                  
Due During the Years Ending December 31,                   
2015   $    0.00%  $57    8.29%  $15,534    5.66%
2016    1,408    3.50%   153    8.33%   11,525    5.56%
2017        0.00%   512    6.63%   18,364    5.59%
2018 to 2019    231    4.75%   407    5.63%   23,325    5.42%
2020 to 2024        0.00%   233    5.19%   22,268    5.34%
2025 to 2029        0.00%   28    5.50%   32,397    4.51%
2030 and beyond        0.00%   13    18.00%   41,926    4.84%
                                
Total   $1,639    3.68%  $1,403    6.44%  $165,339    5.13%

 

9
 

 

Fixed- and Adjustable-Rate Loans. The following table sets forth the scheduled repayments of fixed- and adjustable-rate loans at December 31, 2014 that are contractually due after December 31, 2015.

 

   Due After December 31, 2015
   Fixed  Adjustable  Total
   (dollars in thousands)
          
Residential Mortgages:               
1-4 Family Mortgages  $38,808   $29,229   $68,037 
Purchased Mortgage In-State       1,300    1,300 
Home Equity/Junior Liens   3,049    6,335    9,384 
Nonresidential Mortgages:               
Nonresidential   33,839    15,690    49,529 
Purchased Nonresidential In-State   3,246    1,726    4,972 
Purchased Nonresidential Out-of-State   2,262        2,262 
Non real estate loans:               
Commercial Loans   8,770    2,566    11,336 
Purchased Commerical Loans In-State   1,639        1,639 
Consumer and other loans   1,121    225    1,346 
                
      Total Loans  $92,734   $57,071   $149,805 

 

Loan Originations, Purchases, Sales and Servicing. While we originate both fixed-rate and adjustable-rate loans, our ability to generate each type of loan depends upon borrower demand, market interest rates, borrower preference for fixed- versus adjustable-rate loans, and the interest rates offered on each type of loan by other lenders in our market area. These lenders include competing banks, savings banks, credit unions, internet lenders, mortgage banking companies and life insurance companies that may also actively compete for local commercial real estate loans. Loan originations are derived from a number of sources, including real estate agent referrals, existing customers, borrowers, builders, attorneys, our directors, walk-in customers and our own sales force. Upon receiving a loan application, we obtain a credit report and employment verification to verify specific information relating to the applicant’s employment, income, and credit standing. In the case of a real estate loan, we obtain a determination of value of the real estate intended to collateralize the proposed loan. Our residential mortgage officers have residential mortgage lending authority up to $150,000. While certain Senior Bank Officers have residential lending limits up to $400,000, the Officer Loan Committee generally approves residential loans from $150,000 to $500,000, while requests over $500,000 must be approved by the Board of Directors. Secured consumer lending limits by officer range from $25,000 to $50,000, while certain Senior Bank Officers have secured consumer lending limits up to $150,000. For secured commercial loans, the limits range from $100,000 to $400,000. Senior Loan Committee generally approves secured commercial loans from $400,000 to $500,000, while requests over $500,000 must be approved by the Board of Directors.

 

A commercial commitment letter specifies the terms and conditions of the proposed loan including the amount of the loan, interest rate, amortization term, a brief description of the required collateral, and required insurance coverage. Commitments are typically issued for 15-day periods. The borrower must provide proof of fire and casualty insurance on the property serving as collateral, which must be maintained during the full term of the loan. A title insurance policy is required on all real estate loans. At December 31, 2014, we had outstanding loan commitments of $24.2 million, including unfunded commitments under lines of credit and commercial and standby letters of credit.

 

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

 

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

 

10
 

 

We require appraisals of real property securing loans. Appraisals are performed by independent appraisers, who are approved by our Board of Directors annually. We require fire and extended coverage insurance in amounts adequate to protect our principal balance. Where appropriate, flood insurance is also required. Private mortgage insurance is required for most residential mortgage loans with loan-to-value ratios greater than 80%.

 

Loan Origination Fees and Costs. In addition to interest earned on loans, we generally receive fees in connection with loan originations. Such loan origination fees, net of costs to originate, are deferred and amortized using an interest method over the contractual life of the loan. Fees deferred are recognized into income immediately upon prepayment or subsequent sale of the related loan. At December 31, 2014, we had $263,000 of net deferred loan origination fees. Such fees vary with the volume and type of loans and commitments made and purchased, principal repayments, and competitive conditions in the mortgage markets, which in turn respond to the demand and availability of money. In addition to loan origination fees, we also generate other income through the sales and servicing of mortgage loans, late charges on loans, and fees and charges related to deposit accounts. We recognized fees and service charges of $807,000 and $857,000 for the years ended December 31, 2014 and 2013, respectively.

 

To the extent that originated loans are sold with servicing retained, we capitalize a mortgage servicing asset at the time of the sale in accordance with applicable accounting standards (ASC 860, “Transfers and Servicing”). The capitalized amount is amortized thereafter (over the period of estimated net servicing income) as a reduction of servicing fee income. The unamortized amount is fully charged to income when loans are prepaid. Originated mortgage servicing rights with an amortized cost of $710,000 were included on our balance sheet at December 31, 2014.

 

Origination, Purchase and Sale of Loans. The table below shows our loan originations, purchases, sales, and repayments of loans for the periods indicated.

 

   Years Ended December 31,
   2014  2013  2012
   (dollars in thousands)
          
Loans receivable at beginning of period  $138,084   $140,982   $142,675 
Loans acquired in merger   29,142         
                
Originations:               
Real estate:               
Residential 1-4 family   25,250    28,776    52,387 
Commercial and Multi-family   23,889    33,260    18,182 
Consumer   2,306    1,639    2,040 
Total originations   51,445    63,675    72,609 
                
Loan purchases:               
Commercial   2,000    2,844    6,538 
Total loan purchases   2,000    2,844    6,538 
                
Loan sales   (13,833)   (17,776)   (36,529)
Transfer of loans to foreclosed assets   (1,562)   (1,486)   (1,823)
Repayments   (39,937)   (50,155)   (42,488)
                
Total loans receivable at end of period  $165,339   $138,084   $140,982 

  

Delinquent Loans, Other Real Estate Owned and Classified Assets

 

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

 

11
 

 

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

 

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

 

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

 

When collateral is acquired or otherwise deemed REO/ORA, it is recorded at the lower of the unpaid principal balance of the related loan or its estimated net realizable value. This write down is recorded against the allowance for loan losses. Periodic future valuations are performed by management, and any subsequent decline in fair value is charged to operations. At December 31, 2014, we held $2.0 million in properties that were classified REO and $860,000 in assets classified as ORA.

 

12
 

 

Delinquent Loans. The following table sets forth certain information with respect to our loan portfolio delinquencies at the dates indicated.

 

      At December 31,
   2014  2013  2012  2011  2010
   (dollars in thousands)
                
Non-Accrual Loans:                         
Residential Mortgage  $750   $651   $1,810   $2,420   $3,114 
Commercial Mortgage   486    13    821    356    1,148 
Purchased Mortgage Out-of-State       1,441    2,030         
Construction                    
Purchased Construction Out-of-State       173    173    173    1,772 
Commercial   77                 
Consumer and other   25    7    29    152    206 
                          
Total non-accrual loans (*)  $1,338   $2,285   $4,863   $3,101   $6,240 
                          
Accrual loans delinquent 90 days or more:                         
Residential Mortgage   312    24    61    238    282 
Commercial Mortgage                   82 
Construction                    
Purchased Construction Out-of-State                    
Commercial                    
Consumer and other   3    2    6        2 
Total accrual loans delinquent 90 days or more  $315   $26   $67   $238   $366 
                          
Total nonperforming loans (*)(1)  $1,653   $2,311   $4,930   $3,339   $6,606 
                          
Real Estate Owned and Other Repossessed Assets:                         
Residential Mortgage   356    285    957    1,086    494 
Commercial Mortgage   391    472    309    1,015    2,304 
Purchased Mortgage Out-of-State   1,216                     
Construction                    
Commercial                    
Consumer and other   860    1,023    1,121    1,307    20 
                          
Total real estate owned and other repossessed assets (2)  $2,823   $1,780   $2,387   $3,408   $2,818 
Total nonperforming assets (*)  $4,476   $4,091   $7,317   $6,747   $9,424 
                          
                          
Total nonperforming loans to total originated loans receivable   1.00%   1.67%   3.50%   2.37%   4.12%
Total nonperforming assets to total assets   1.37%   1.95%   3.42%   3.11%   4.37%

 

(*) Totals include non-performing loans and assets acquired on August 8, 2014 with the merger.
(1) All of our loans delinquent 90 days or more are classified as nonperforming.
(2) Represents the net book value of property acquired by us through foreclosure or deed in lieu of foreclosure.
  Upon acquisition, this property is recorded at the lower of its fair market value or the principal balance of the related loan.

 

Nonperforming Assets. The following table sets forth the amounts and categories of our non-performing assets at the dates indicated.

 

   Loan Delinquent For      
   60-89 Days  90 Days and Over  Total
   Number  Amount  Number  Amount  Number  Amount
   ( dollars in thousands)
    
At December 31, 2014                  
Residential Mortgages   11   $802    9   $847    20   $1,649 
Commercial Mortgages   3    323    6    93    9    416 
Purchased Out-of-State Commercial Mortgages                        
Construction                        
Purchased Out-of-State Construction                        
Commercial   1    40    1    104    2    144 
Consumer   1    4    4    42    5    46 
Total   16   $1,169    20   $1,086    36    2,255 

 

13
 

 

   Loan Delinquent For      
   60-89 Days  90 Days and Over  Total
   Number  Amount  Number  Amount  Number  Amount
   ( dollars in thousands)
At December 31, 2013                  
Residential Mortgages   9  $ 393    5  $ 353    14  $ 746  
Purchased In-State                        
Purchased In-State                        
Purchased In-State                        
Commercial   1    20            1    20 
Purchased In-State                        
Total   15   $993    8   $1,969    23    2,962 
                               
                               
At December 31, 2012                              
Residential Mortgages   11   $796    10   $1,198    21   $1,994 
Purchased In-State                        
Purchased In-State                        
Purchased In-State                        
Commercial                        
Purchased In-State                        
Total   13   $1,341    17   $1,672    30    3,013 
                               
                               
At December 31, 2011                              
Residential Mortgages   16   $1,501    23   $1,969    39   $3,470 
Purchased In-State                        
Purchased In-State                        
Purchased In-State                        
Purchased In-State                        
Total   26   $1,928    30   $2,515    56    4,443 
                               
                               
At December 31, 2010                              
Residential Mortgages   23   $2,056    34   $2,434    57   $4,490 
Purchased In-State                        
Purchased In-State                        
Purchased In-State                        
Purchased In-State                        
Total   37   $2,672    53   $5,197    90    7,869 

  

Interest income that would have been recorded for the year ended December 31, 2014, had non-accruing loans been current according to their original terms amounted to $159,000. Interest of $4,000 was recognized on these impaired loans prior to placing them on non-accrual status, and is included in net income for the year ended December 31, 2014.

 

The following table displays the unpaid principal balance and number of loans classified as troubled debt restructurings, including those acquired in the merger with Bank of Alpena, as of the dates indicated:

 

   Troubled Debt Restructurings
   as of December 31,  as of December 31,  as of December 31,
   2014  2013  2012
   (dollars in thousands)
                   
   Number of  Unpaid rincipal  Number of  Unpaid rincipal  Number of  Unpaid rincipal
   Contracts  Balance  Contracts  Balance  Contracts  Balance
                   
Commercial - Construction      $    1   $173    1   $173 
Commercial Real Estate - Other   11   $2,624    6   $3,725    6   $3,872 
Commercial - non real estate   2   $196       $       $ 
Residential   6   $520    2   $267       $ 
                               
Total   19   $3,340    9   $4,165    7   $4,045 

 

14
 

 

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

 

The allowance for loan losses represents amounts that have been established to recognize losses inherent in the loan portfolio that are both probable and reasonably estimable at the date of the financial statements. When we classify problem assets as loss, we charge-off such amount. Our determination as to the classification of our assets and the amount of our loss allowances are subject to review by our regulatory agencies, which can order the establishment of additional loss allowances. Management regularly reviews our asset portfolio to determine whether any assets require classification in accordance with applicable regulations. On the basis of management’s review of our assets at December 31, 2014, classified assets consisted of substandard assets of $6.7 million. There was one assets classified as doubtful and no assets classified as loss at December 31, 2014.

 

We classify our assets pursuant to criteria similar to the classification structure provided in the OCC regulations. The following table sets forth the aggregate amount of our internally classified assets at the dates indicated.

 

   At December 31,
   2014  2013  2012  2011  2010
   (dollars in thousands)
                
                
Substandard assets  $5,896   $5,662   $13,008   $16,435   $15,974 
Doubtful assets   9                 
Loss assets                    
  Total classified assets  $5,905   $5,662   $13,008   $16,435   $15,974 

  

Allowance for Loan Losses. We provide for loan losses based on the allowance method. Accordingly, all loan losses are charged to the related allowance and all recoveries are credited to it. Additions to the allowance for loan losses are provided by charges to income based on various factors which, in management’s judgment, deserve current recognition in estimating probable losses. Management regularly reviews the loan portfolio and makes provisions for loan losses in order to maintain the allowance for loan losses in accordance with accounting principles generally accepted in the United States of America. The allowance for loan losses consists of amounts specifically allocated to non-performing loans and other criticized or classified loans (if any) as well as general allowances determined for each major loan category. Commercial loans and loans secured by commercial real estate are evaluated individually for impairment. Other smaller-balance, homogeneous loan types, including loans secured by one- to four-family residential real estate and consumer installment loans, are evaluated for impairment on a collective basis. After we establish a provision for loans that are known to be non-performing, criticized or classified, we calculate percentage loss factors to apply to the remaining categories within the loan portfolio to estimate probable losses inherent in these categories of the portfolio. When the loan portfolio increases, therefore, the percentage calculation results in a higher dollar amount of estimated probable losses than would be the case without the increase, and when the loan portfolio decreases, the percentage calculation results in a lower dollar amount of estimated probable losses than would be the case without the decrease. These percentage loss factors are determined by management based on our historical loss experience and credit concentrations for the applicable loan category, which may be adjusted to reflect our evaluation of levels of, and trends in, delinquent and non-accrual loans, trends in volume and terms of loans, and local economic trends and conditions.

 

15
 

 

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

 

The carrying value of loans is periodically evaluated and the allowance is adjusted accordingly. While management uses the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the information used in making the evaluations. In addition, as an integral part of their examination process, our regulatory agencies periodically review the allowance for loan losses. Such agencies may require us to recognize additions to the allowance based on their judgments of information available to them at the time of their examination.

 

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Analysis of the Allowance for Loan Losses. The following table sets forth the activity on our allowance for loan losses for the periods indicated.

 

   For the Years Ended December 31,
   2014  2013  2012  2011  2010
   (dollars in thousands)
                
Allowance at beginning of period  $1,472   $1,750   $1,518   $2,831   $3,660 
                          
(Charge-offs):                         
Real Estate:                         
      Residential Mortgages   (177)   (464)   (840)   (1,119)   (258)
Nonresidential Real Estate:                         
      Commercial Mortgages   (16)   (85)   (265)   (334)   (198)
      Purchased In-State                    
      Purchased Out-of-State   (225)   (589)       (93)   (314)
      Construction   (12)               (751)
      Purchased In-State                    
      Purchased Out-of-State                   (262)
Non Real Estate Loans:                         
      Commercial                  (6)    
      Consumer and other   (38)   (53)   (131)   (192)   (319)
             Total charge offs   (468)   (1,191)   (1,236)   (1,744)   (2,102)
                          
Recoveries:                         
Real Estate:                         
      Residential Mortgages   55    120    65    25    2 
Nonresidential Real Estate:                         
      Commercial Mortgages   54    114    10    79    85 
      Construction                   60 
Non Real Estate Loans:                         
      Commercial      2            1     
      Consumer and other   30    42    26    42    25 
             Total recoveries     141    276    101    147    172 
                          
Net (charge offs) recoveries   (327)   (915)   (1,135)   (1,597)   (1,930)
Provision for loan losses   284    637    1,367    284    1,101 
                          
Balance at end of year  $1,429   $1,472   $1,750   $1,518   $2,831 
                          
Ratios:                         
Net Charge-offs to average loans outstanding (annualized)   0.23%   0.64%   0.79%   1.02%   1.14%
                         
Allowance for loan loss to non-performing loans at end of period   86.45%   63.70%   35.50%   45.46%   87.70%
                          
Allowance for loan losses to total loans at end of period   1.05%   1.07%   1.24%   1.06%   1.98%

 

Allocation of Allowance for Loan Losses. The following table sets forth the allowance for loan losses allocated by loan category, the total loan balances by category, and the percent of loans in each category to total loans at the dates indicated. The allowance for loan losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories.

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   At December 31
   2014  2013  2012
   Allowance for Loan Losses  Percent of Loans in Each Category to Total Loans  Allowance for Loan Losses  Percent of Loans in Each Category to Total Loans  Allowance for Loan Losses  Percent of Loans in Each Category to Total Loans
   (dollars in thousands)
Residential Mortgages:                  
   1 - 4 family residential  $860    45.3%  $773    44.0%  $894    45.3%
   Purchased Mortgages In-State   9    1.0%   11    1.2%   12    1.3%
   1 - 4 family construction       1.3%       1.1%       0.7%
   Home Equity & Junior Liens   33    5.7%   62    6.3%   99    7.4%
Nonresidential Mortgages:                              
   Nonresidential   307    28.7%   319    29.8%   453    29.1%
   Purchased Nonresidential In-State       3.6%       5.0%   50    3.2%
   Purchased Nonresidential Out-of-State       1.7%   125    2.7%   76    4.9%
   Construction   8    1.1%       0.0%   57    1.0%
   Purchased Construction In-State       0.0%       0.0%       0.4%
   Purchased Construction Out-of-State       0.0%   48    0.1%   7    0.1%
Non Real Estate Loans:                              
   Commercial     94    9.5%   63    8.8%   66    5.5%
   Purchased Commercial In-State       1.2%       0.2%   3    0.2%
   Consumer   19    0.9%   21    0.8%   33    0.9%
   Unallocated     99    0.0%   50    0.0%       0.0%
      Total  $1,429    100.0%  $1,472    100.0%  $1,750    100.0%

 

   At December 31
   2011  2010
   Allowance for Loan Losses  Percent of Loans in Each Category to Total Loans  Allowance for Loan Losses  Percent of Loans in Each Category to Total Loans
   (dollars in thousands)
Residential Mortgages:            
   One to four family residential  $858    45.0%  $519    42.7%
   Purchased Mortgages In-State   12    1.3%   17    2.0%
   1 - 4 family construction       0.3%       0.1%
   Home Equity & Junior Liens   146    9.4%   228    10.3%
Nonresidential Mortgages:                    
   Nonresidential   320    30.9%   967    27.3%
   Purchased Nonresidential In-State   16    1.5%   94    2.6%
   Purchased Nonresidential Out-of-State   57    5.5%   220    6.2%
   Construction   3    0.1%   245    0.9%
   Purchased Construction In-State       0.0%       0.0%
   Purchased Construction Out-of-State   7    0.1%   290    1.1%
Non Real Estate Loans:                    
   Commercial     50    4.6%   192    4.6%
   Purchased Commercial In-State   3    0.3%       0.9%
   Consumer   46    1.0%   59    1.3%
      Total  $1,518    100.0%  $2,831    100.0%

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Mortgage Banking Activities

 

Our mortgage banking activities involve the origination and subsequent sale of one- to four-family residential mortgage loans. When loans are sold, we generally retain the rights to service those loans thereby maintaining our customer relationships. We intend to use these customer relationships to cross-sell additional products and services. Loans that we sell are originated using the same personnel and the same underwriting policies as loans that we maintain in our portfolio. The decision whether to sell a loan is dependent upon the type of loan product and the term of the loan. In recent years, we have sold most of our fixed-rate one- to four-family residential loans with maturities of 15 years or greater, and have retained servicing on most of these loans.

 

Mortgage servicing involves the administration and collection of home loan payments. When we acquire mortgage servicing rights through the origination of mortgage loans and the subsequent sale of those loans with servicing rights retained, we allocate a portion of the total cost of the mortgage loans to the mortgage servicing rights based on their relative fair value. As of December 31, 2014, we were servicing mortgage loans sold to third parties totaling $125.4 million, and the mortgage servicing rights associated with such loans had a book value, net of valuation reserve, at such date of $710,000. Generally, the value of mortgage servicing rights increases as interest rates rise and decreases as interest rates fall, because the estimated life and estimated income from the underlying loans increase with rising interest rates and decrease with falling interest rates.

 

Insurance Brokerage Activities

 

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

 

On February 27, 2009, we sold the majority of the assets of ICA. We retained the residual income stream associated with the April 2008 sale of its wholesale Blue Cross/Blue Shield override business to the third party. The final installment of the residual revenue stream associated with this sale through FFNM Agency, the successor company to ICA, was received in April of 2014. As of December 31, 2014 this subsidiary has been dissolved.

 

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

 

Investment Activities

 

Our investment securities portfolio is comprised of U.S. Government, state agency and municipal obligations, and mortgage-backed securities, of which $120.0 million, or 99.3%, was classified as available-for-sale, and $790,000, or 0.1%, of the total portfolio was classified as held-to-maturity. At December 31, 2014, we had no investments in unrated securities. At December 31, 2014, $44.2 million, or 36.6% of our investment portfolio was scheduled to mature in less than five years, and $12.5 million, or 10.4%, of our investment portfolio was scheduled to mature in over five years. At December 31, 2014, $5.1 million, or 4.3% of our investment portfolio was scheduled to mature in less than one year.

 

At December 31, 2014, we held U.S. Government and state agency obligations and municipal obligations classified as available-for-sale, with a fair market value of $54.4 million. While these securities generally provide lower yields than other investments such as mortgage-backed securities, our current investment strategy is to maintain investments in such instruments to the extent appropriate for liquidity purposes, as collateral for borrowings, and for prepayment protection.

 

We invest in mortgage-backed securities in order to: generate positive interest rate spreads with minimal administrative expense; lower credit risk as a result of the guarantees provided by Ginnie Mae and, to a lesser extent, Fannie Mae and Freddie Mac; supplement local loan originations; reduce interest rate risk exposure; and increase liquidity. Our mortgage-backed securities portfolio consists of pass-through certificates. At December 31, 2014, the fair market value of mortgage-backed securities totaled $64.0 million, or 53.0% of total investments. All of our pass-through certificates are insured or guaranteed by Freddie Mac, Ginnie Mae or Fannie Mae. Our policy is to hold mortgage-backed securities as available-for-sale.

 

We have interests in pools of single-family mortgages in which the principal and interest payments are from the mortgage originators, through intermediaries (generally government-sponsored agencies) that pool and repackage loans and sell the participation interest in the form of securities, to investors. These government-sponsored agencies include Freddie Mac, Ginnie Mae, or Fannie Mae. The underlying pool of mortgages can be comprised of either fixed-rate mortgage loans or adjustable-rate mortgage loans. The interest rate risk characteristics of the underlying pool of mortgages, i.e., fixed-rate or adjustable rate, are shared by the investors in that pool.

 

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Our investment policy also permits investment in corporate debt obligations. Although corporate bonds may offer higher yields than U.S. Treasury or agency securities of comparable duration, corporate bonds also have a higher risk of default due to possible adverse changes in the creditworthiness of the issuer.

 

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

 

ASC 320-10 requires that, at the time of purchase, we designate a security as held to maturity, available for sale, or trading, depending on our ability and intent. Securities available for sale are reported at fair value. As of December 31, 2014, all of our investment securities were designated as available for sale except for $790,000 in municipal bond investments designated as held to maturity.

 

At December 31, 2014 we had no investment in a single company or entity (other than an agency of the U.S. Government or U.S. Government-sponsored enterprise) that had an aggregate book value in excess of 10% of our equity.

 

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

 

   At December 31,
   2014  2013  2012
   Amortized  Fair  Amortized  Fair  Amortized  Fair
   Cost  Value  Cost  Value  Cost  Value
   (dollars in thousands)
Debt Securities:                  
U.S. Government and agency obligations  $31,221   $31,223   $7,111   $7,042   $9,181   $9,247 
                               
Municipal obligations   23,684    24,041    15,949    16,009    12,758    13,328 
                               
Corporate bonds and other obligations   1,549    1,561    1,085    1,097    1,135    1,150 
                               
Mortgage-backed securities:                              
Pass-through securities:                              
Fannie Mae   29,760    29,856    11,052    10,941    6,486    6,587 
Freddie Mac   21,068    21,166    2,989    2,940    4,045    4,110 
Ginnie Mae   12,820    13,025    14,667#   14,722    18,370    18,911 
                               
Total debt securities   120,102    120,871    52,853    52,751    51,975    53,333 
                               
Marketable equity securities                              
Common stock   3    5    3    7    3    1 
                               
Total equity securities   3    5    3    7    3    1 
                               
Total investment securities  $120,105   $120,876   $52,856   $52,758   $51,978   $53,334 

  

Portfolio Maturities and Yields. The composition and maturities of the investment securities portfolio at December 31, 2014 are summarized in the following table. Maturities are based on the final contractual payment dates, and do not reflect the impact of prepayments or early redemptions that may occur. State and municipal securities yields have not been adjusted to a tax-equivalent basis.

 

20
 

 

   At December 31, 2014
         More than One Year  More than Five Years               
   One Year or Less  Through Five years  Through Ten Years  More than Ten Years  Total Securities
      Weighted     Weighted     Weighted     Weighted        Weighted
   Amortized  Average  Amortized  Average  Amortized  Average  Amortized  Average  Amortized  Fair  Average
   Cost  Yield  Cost  Yield  Cost  Yield  Cost  Yield  Cost  Value  Yield
   (dollars in thousands)
Debt Securities:                                 
U.S. Government and agency securities  $2,571    1.83%  $25,649    1.57%  $3,002    2.38%  $    0.00%  $31,222   $31,223    1.67%
                                                       
State agency and municipal obligations   994.03    2.45%   13,379    2.30%   7,939    2.99%   1,372    4.35%   23,684    24,041    2.65%
                                                        
Corporate bonds and other obligations   1,549    6.06%       0.00%       0.00%       0.00%   1,549    1,561    6.06%
                                                        
Mortgage-backed securities                                                       
     Fannie Mae       0.00%   199    4.13%   12,088    2.69%   17,474    3.02%   29,761    29,856    2.90%
     Freddie Mac   6    5.00%   3    1.63%   6,268    3.01%   14,791    3.19%   21,068    21,166    3.13%
     Ginnie Mae   2    5.00%   26    3.13%   934    4.00%   11,858    3.16%   12,820    13,025    3.22%
                                                        
Total debt securities   5,122         39,255         30,231         45,495         120,103    120,871      
                                                        
Marketable equity securities:                                                       
Common Stock       0.00%       0.00%       0.00%   2    0.00%   2    5    0.00%
                                                        
 Total investment securities  $5,122        $39,255        $30,231        $45,497        $120,105   $120,876      

 

 

   At December 31, 2013
         More than One Year  More than Five Years               
   One Year or Less  Through Five years  Through Ten Years  More than Ten Years  Total Securities
      Weighted     Weighted     Weighted     Weighted        Weighted
   Amortized  Average  Amortized  Average  Amortized  Average  Amortized  Average  Amortized  Fair  Average
   Cost  Yield  Cost  Yield  Cost  Yield  Cost  Yield  Cost  Value  Yield
   (dollars in thousands)
Debt Securities:                                 
                                 
U.S. Government and agency securities  $2,009    3.13%  $4,103    2.03%  $999    2.19%  $    0.00%  $7,111   $7,042    2.36%
                                                          
State agency and municipal obligations   2,871    4.68%   5,782    2.54%   5,761    2.17%   1,535    4.32%   15,949    16,009    2.96%
                                                        
Corporate bonds and other obligations       0.00%   1,085    6.90%       0.00%       0.00%   1,085    1,097    6.90%
                                                        
Mortgage-backed securities                                                       
Fannie Mae       0.00%   83    4.50%   10,969    2.49%       0.00%   11,052    10,941    2.50%
Freddie Mac       0.00%   4    1.63%   2,234    2.73%   751    0.00%   2,989    2,940    2.80%
Ginnie Mae       0.00%   44    3.39%       0.00%   14,623    3.40%   14,667    14,722    3.40%
                                                        
Total debt securities   4,880         11,102         19,963         16,909         52,853    52,751      
                                                        
Marketable equity securities:                                                       
Common Stock       0.00%       0.00%       0.00%   3    0.00%   3    7    0.00%
                                                        
Total investment securities  $4,880        $11,102        $19,963        $16,912        $52,856   $52,758      

  

Sources of Funds

 

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

 

21
 

 

Deposits. We generate deposits primarily from our market area by offering a broad selection of deposit instruments including NOW accounts, regular savings, money market deposits, term certificate accounts and individual retirement accounts. Deposit account terms vary according to the minimum balance required, the period of time during which the funds must remain on deposit, and the interest rate, among other factors. The rate of interest which we must pay is not established by regulatory authority. The asset/liability committee regularly evaluates our internal cost of funds, surveys rates offered by competing institutions, reviews the cash flow requirements for lending and liquidity, and executes rate changes when deemed appropriate. We have sought to decrease the risk associated with changes in interest rates by offering competitive rates on some deposit accounts and by pricing certificates of deposit to provide customers with incentives to choose certificates of deposit with longer maturities. We also attract non-interest bearing commercial deposit accounts from our commercial borrowers and offer a competitive non-deposit sweep product that is not insured by the FDIC. In recent periods, we generally have not obtained funds through brokers or through a solicitation of funds outside our market area. At December 31, 2014 we had $1.2 million in brokered deposits from CDAR’s and ICS sweep program. We offer a limited amount of certificates of deposit in excess of $100,000 which may have negotiated rates. Future liquidity needs are expected to be satisfied through the both the use of Federal Home Loan Bank 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 or as a means of managing our interest rate risk profile.

 

The following table sets forth the distribution of total deposit accounts, by account type, at the dates indicated.

 

   At December 31,
   2014  2013  2012
         Weighted        Weighted        Weighted
        Average      Average       Average
   Amount  Percent of Total  Interest Rate  Amount  Percent of Total  Interest Rate  Amount  Percent of Total  Interest Rate
   (dollars in thousands)
                            
Non-interest-bearing  $56,032    20.71%    NA    $21,047    13.15%    NA    $21,067    13.30%    NA  
NOW accounts   63,770    23.55%   0.33%   22,794    14.24%   0.21%   19,531    12.33%   0.21%
Passbook   29,846    11.02%   0.05%   22,037    13.77%   0.05%   19,867    12.55%   0.05%
Money market accounts   44,165    16.31%   0.14%   27,428    17.14%   0.22%   24,687    15.59%   0.22%
                                              
Time deposits that mature:                                             
  Less than 12 months   39,149    14.46%   0.68%   32,952    20.59%   0.85%   39,161    24.73%   1.08%
  Within 12-36 months   22,853    8.44%   1.03%   24,273    15.17%   1.33%   28,701    18.13%   1.60%
  Beyond 36 months   14,919    5.51%   1.85%   9,498    5.94%   2.10%   5,336    3.37%   2.21%
  Jumbo         0.00%   0.00%       0.00%   0.00%       0.00%   0.00%
                                              
Total deposits  $270,734    100.00%   0.47%  $160,029    100.00%   0.68%  $158,350    100.00%   0.87%

 

Time Deposit Rates. The following table sets forth time deposits classified by rates as of the dates indicated (see Note 8 to our consolidated financial statements contained within Exhibit 13 for a more detailed breakdown by rate range):

 

   At December 31,
Rate  2014  2013  2012
   (dollars in thousands)
0.10 percent to 0.99 percent  $42,302   $40,259   $42,698 
1.00 percent to 1.99 percent   27,362    17,715    15,962 
2.00 percent to 2.99 percent   6,092    7,130    10,746 
3.00 percent to 3.99 percent   1,050    1,486    3,398 
4.00 percent to 4.99 percent   115    133    394 
   $76,921   $66,723   $73,198 

 

Time Deposit Maturities. The following table sets forth the amount and maturities of time deposits at December 31, 2014.

 

   Less Than  1 - Less than 2  2- Less than 3  3- Less than 5  5- Less and   
Rate  One Year  Years  Years  Years  Greater  Total
   (dollars in thousands)
0.10 percent to 0.99 percent  $33,161   $8,214   $532   $395   $   $42,302 
1.00 percent to 1.99 percent   1,419    6,884    6,398    12,394    267    27,362 
2.00 percent to 2.99 percent   4,022    696    47    323    1,004    6,092 
3.00 percent to 3.99 percent   502        12    536        1,050 
4.00 percent to 4.99 percent   45    17    53            115 
   $39,149   $15,811   $7,042   $13,648   $1,271   $76,921 

 

As of December 31, 2014, the aggregate amount of outstanding certificates of deposit in amounts greater than or equal to $100,000 was $28.1 million. The following table sets forth the maturity of those certificates as of December 31, 2014.

 

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   Certificates of Deposit
Maturity Period  in excess of $100,000
   (dollars in thousands)
    
Three months or less  $5,572 
Three through six months   2,639 
Six through twelve months   6,966 
Over twelve months   12,970 
      
Total  $28,147 

 

Borrowings. Our borrowings consist primarily of advances from the Federal Home Loan Bank of Indianapolis. At December 31, 2014, we had access to additional Federal Home Loan Bank advances of up to $27.2 million, based upon pledged collateral. The following table sets forth information concerning balances and interest rates on our Federal Home Loan Bank advances and other borrowings at the dates and for the periods indicated.

 

   Years Ended December 31,
   2014  2013  2012
   (dollars in thousands)
          
Balance at end of period  $22,885   $24,813   $26,358 
Average balance during period   23,497    24,065    31,260 
Maximum outstanding at any month end   25,236    25,313    35,600 
Weighted average interest rate at end of period   1.17%   1.00%   1.46%
Average interest rate during period   1.12%   1.25%   1.88%

 

Subsidiary Activity

 

First Federal of Northern Michigan Bancorp, Inc.’s only direct subsidiary is First Federal of Northern Michigan.

 

First Federal of Northern Michigan’s wholly owned subsidiary, Financial Services & Mortgage Corporation has been consolidated in the financial statements with all inter-company balances and transactions being eliminated in consolidation.

 

Financial Services & Mortgage Corporation’s primary business is to lease, sell, develop and maintains real estate properties. For reporting purposes, Financial Services & Mortgage Corporation is included in our banking segment. As of December 31, 2014, First Federal of Northern Michigan’s investment in Financial Services & Mortgage Corporation was $92,000. Financial Services & Mortgage Corporation is not currently a party to any agreement that is material to First Federal of Northern Michigan Bancorp, Inc. on a consolidated basis.

 

FFNM Agency, Inc., collects the residual income stream associated with the April 2008 sale of the Company’s wholesale health insurance override business to a third party. FFNM Agency is the successor company to the InsuranCenter of Alpena (“ICA”). On February 27, 2009, we sold the majority of the assets of ICA. Due to the expiration of the residual income stream in April of 2014 this subsidiary was dissolved as of December 31, 2014.

 

Subsequent to December 31, 2014, First Federal of Northern Michigan formed another subsidiary, FFNM Financial Service, Inc. The principal business of FFNM Financial Services, Inc. is to collect commissions associated with a wealth management program that is offered by an independent investment consultant. The subsidiary formation was completed by January 31, 2015.

 

Personnel

 

As of December 31, 2014, First Federal of Northern Michigan had 83 full-time and 18 part-time employees. None of the Bank’s employees are represented by a collective bargaining group. The Bank believes its relationship with its employees to be good. First Federal of Northern Michigan Bancorp, Inc., FFNM Agency, Inc. and FSMC have no separate employees.

 

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SUPERVISION AND REGULATION

 

General

 

As a federal savings bank, First Federal of Northern Michigan is subject to examination and regulation by the Office of the Comptroller of the Currency (“OCC”), and is also subject to examination by the Federal Deposit Insurance Corporation (“FDIC”). Prior to July 21, 2011, the Office of Thrift Supervision was First Federal of Northern Michigan’s primary federal regulator. However, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which is discussed further below, eliminated the Office of Thrift Supervision and transferred the Office of Thrift Supervision’s functions relating to federal savings banks, including rulemaking authority, to the OCC, effective July 21, 2011. The federal system of regulation and supervision establishes a comprehensive framework of activities in which First Federal of Northern Michigan may engage and is intended primarily for the protection of depositors and the FDIC’s Deposit Insurance Fund.

 

First Federal of Northern Michigan also is regulated to a lesser extent by the Board of Governors of the Federal Reserve System, or the “Federal Reserve Board”, which governs the reserves to be maintained against deposits and other matters. In addition, First Federal of Northern Michigan is a member of and owns stock in the Federal Home Loan Bank of Indianapolis, which is one of the twelve regional banks in the Federal Home Loan Bank System. First Federal of Northern Michigan’s relationship with its depositors and borrowers also is regulated to a great extent by federal law and, to a lesser extent, state law, including in matters concerning the ownership of deposit accounts and the form and content of First Federal of Northern Michigan’s loan documents.

 

As a savings and loan holding company, First Federal of Northern Michigan Bancorp, Inc. is subject to examination and supervision by, and is required to file certain reports with, the Federal Reserve Board. The Office of Thrift Supervision’s functions relating to savings and loan holding companies were transferred to the Federal Reserve Board on July 21, 2011 pursuant to the Dodd-Frank Act regulatory restructuring. First Federal of Northern Michigan Bancorp is also subject to the rules and regulations of the Securities and Exchange Commission under the federal securities laws.

 

Set forth below are certain material regulatory requirements that are applicable to First Federal of Northern Michigan and First Federal of Northern Michigan Bancorp. This description of statutes and regulations is not intended to be a complete description of such statutes and regulations and their effects on First Federal of Northern Michigan and First Federal of Northern Michigan Bancorp. Any change in these laws or regulations, whether by Congress or the applicable regulatory agencies, could have a material adverse impact on First Federal of Northern Michigan Bancorp, First Federal of Northern Michigan and their operations.

 

Dodd-Frank Act

 

The Dodd-Frank Act made significant changes to the regulatory structure for depository institutions and their holding companies, as well as changes that affect the lending, investments and other operations of all depository institutions. The Dodd-Frank Act required the Federal Reserve Board to set minimum capital levels for both bank holding companies and savings and loan holding companies that are as stringent as those required for the insured depository subsidiaries, and the components of Tier 1 capital for holding companies were restricted to capital instruments that were then currently considered to be Tier 1 capital for insured depository institutions. The legislation also established a floor for capital of insured depository institutions that cannot be lower than the standards in effect upon passage, and directed the federal banking regulators to implement new leverage and capital requirements that take into account off-balance sheet activities and other risks, including risks relating to securitized products and derivatives.

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

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The Dodd-Frank Act broadened the base for FDIC insurance assessments. Assessments are now based on the average consolidated total assets less tangible equity capital of a financial institution, rather than on total deposits. The legislation also permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor. The Dodd-Frank Act increased stockholder influence over boards of directors by requiring companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments. The legislation also directs the Federal Reserve Board to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded or not. Further, the legislation requires that originators of securitized loans retain a percentage of the risk for transferred loans, directs the Federal Reserve Board to regulate pricing of certain debit card interchange fees and contains a number of reforms related to mortgage originations.

Federal Banking Regulation

 

Business Activities. A federal savings bank derives its lending and investment powers from the Home Owners’ Loan Act, and the regulations of the OCC. Under these laws and regulations, First Federal of Northern Michigan may invest in mortgage loans secured by residential and commercial real estate, commercial business and consumer loans, certain types of debt securities and certain other loans and assets. First Federal of Northern Michigan also may establish subsidiaries that may engage in activities not otherwise permissible for First Federal of Northern Michigan directly, including real estate investment, securities brokerage and insurance agency services.

 

Capital Requirements. OCC regulations require savings banks to meet three minimum capital standards: a 1.5% tangible capital ratio, a 4% leverage ratio (3% for institutions receiving the highest CAMELS rating) and an 8% risk-based capital ratio. The prompt corrective action standards discussed below, in effect, establish a minimum 2% tangible capital standard.

 

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

 

Additionally, a savings association that retains credit risk in connection with an asset sale may be required to maintain regulatory capital because of the recourse back to the savings association. In assessing an institution’s capital adequacy, the OCC takes into consideration not only the numeric factors but also qualitative factors as well, and has the authority to establish higher capital requirements for individual associations where necessary.

 

In July 2013, the Office of the Comptroller of the Currency and the other federal bank regulatory agencies issued a final rule that will revise their leverage and risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. Among other things, the rule establishes a new common equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets), increases the minimum Tier 1 capital to risk-based assets requirement (from 4% to 6% of risk-weighted assets) and assigns a higher risk weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property. The final rule also requires unrealized gains and losses on certain “available-for-sale” securities holdings to be included for purposes of calculating regulatory capital requirements unless a one-time opt-in or opt-out is exercised. The rule limits a banking organization’s capital distributions and certain discretionary bonus payments to executive officers if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements. The final rule also implements the Dodd-Frank Act’s directive to apply to savings and loan holding companies consolidated capital requirements that are not less stringent than those applicable to their subsidiary institutions. The final rule is effective January 1, 2015. The “capital conservation buffer” will be phased in from January 1, 2016 to January 1, 2019, when the full capital conservation buffer will be effective.

 

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At December 31, 2014, First Federal of Northern Michigan’s capital exceeded all applicable requirements. The following table sets forth the Bank’s capital position at December 31, 2014 and 2013, as compared to the minimum capital requirements.

 

   At December 31,
   2014  2013
             
      Percent     Percent
   Amount  of Assets  Amount  of Assets
   (dollars in thousands)
Equity capital  $29,731    9.2%  $22,701    10.9%
                     
Tangible Capital Requirement:                    
     Tangible capital level   27,662    8.5%   22,563    10.8%
     Requirement   4,857    1.5%   3,137    1.5%
     Excess   22,805    7.0%   19,426    9.3%
                     
Core Capital Requirement:                    
     Core capital level   27,662    8.5%   22,563    10.8%
     Requirement   12,953    4.0%   8,366    4.0%
     Excess   14,709    4.5%   14,197    6.8%
                     
Risk-based Capital Requirement:                    
     Risk-based capital level   29,091    16.9%   24,033    17.9%
     Requirement   13,778    8.0%   10,748    8.0%
     Excess   15,313    8.9%   13,285    9.9%

 

Loans to One Borrower. A federal savings bank generally may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of unimpaired capital and surplus on an unsecured basis. An additional amount may be loaned, equal to 10% of unimpaired capital and surplus, if the loan is secured by readily marketable collateral, which generally does not include real estate. As of December 31, 2014, First Federal of Northern Michigan was in compliance with the loans-to-one-borrower limitations.

 

Qualified Thrift Lender Test. As a federal savings bank, First Federal of Northern Michigan is subject to a qualified thrift lender, or “QTL,” test. Under the QTL test, First Federal of Northern Michigan must maintain at least 65% of its “portfolio assets” in “qualified thrift investments” in at least nine months of the most recent 12-month period.

 

A savings bank that fails the QTL test must operate under specified restrictions. The Dodd-Frank Act made noncompliance with the QTL test potentially subject to agency enforcement action for a violation of law. At December 31, 2014, First Federal of Northern Michigan maintained approximately 67.4% of its portfolio assets in qualified thrift investments, and therefore satisfied the QTL test.

 

Capital Distributions. OCC regulations govern capital distributions by a federal savings bank, which include cash dividends, stock repurchases and other transactions charged to the institution’s capital account. A savings bank must file an application for approval of a capital distribution if:

 

·the total capital distributions for the applicable calendar year exceed the sum of the savings bank’s net income for that year to date plus the savings bank’s retained net income for the preceding two years;
   
·the savings bank would not be at least adequately capitalized following the distribution;
   
·the distribution would violate any applicable statute, regulation, agreement or Office of the Comptroller of the Currency-imposed condition; or
   
·the savings bank is not eligible for expedited treatment of its filings.
   

Even if an application is not otherwise required, every savings bank that is a subsidiary of a savings and loan holding company, such as First Federal of Northern Michigan, must still file a notice with the Federal Reserve Board at least 30 days before the board of directors declares a dividend or approves a capital distribution.

 

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A notice or application related to a capital distribution may be disapproved if: 

 

·the federal savings bank would be undercapitalized following the distribution;
   
·the proposed capital distribution raises safety and soundness concerns; or
   
·the capital distribution would violate a prohibition contained in any statute, regulation or agreement.

In addition, the Federal Deposit Insurance Act provides that an insured depository institution shall not make any capital distribution if, after making such distribution, the institution would fail to meet any applicable regulatory capital requirement. A federal savings bank also may not make a capital distribution that would reduce its regulatory capital below the amount required for the liquidation account established in connection with its conversion to stock form.

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

Transactions with Related Parties. A federal savings bank’s authority to engage in transactions with its “affiliates” is limited by Office of the Comptroller of the Currency regulations and Regulation W of the Federal Reserve Board, which implements Sections 23A and 23B of the Federal Reserve Act. The term “affiliates” for these purposes generally means any company that controls or is under common control with an institution. First Federal of Northern Michigan Bancorp, Inc. and its non-savings institution subsidiaries will be affiliates of First Federal of Northern Michigan. In general, transactions with affiliates must be on terms that are as favorable to the savings bank as comparable transactions with non-affiliates. In addition, certain types of these transactions are restricted to an aggregate percentage of the savings bank’s capital. Collateral in specified amounts must usually be provided by affiliates in order to receive loans from the savings bank. In addition, Office of the Comptroller of the Currency regulations prohibit a savings bank from lending to any of its affiliates that are engaged in activities that are not permissible for bank holding companies and from purchasing the securities of any affiliate, other than a subsidiary.

First Federal of Northern Michigan’s authority to extend credit to its directors, executive officers and 10% stockholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O of the Federal Reserve Board. Among other things, these provisions require that extensions of credit to insiders (i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features, and (ii) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of First Federal of Northern Michigan’s capital. In addition, extensions of credit in excess of certain limits must be approved by First Federal of Northern Michigan’s Board of Directors.

Enforcement. The OCC has primary enforcement responsibility over federal savings banks and has the authority to bring enforcement action against all “institution-affiliated parties,” including stockholders, attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors of the savings bank, receivership, conservatorship or the termination of deposit insurance. Civil penalties cover a wide range of violations and actions, and range up to $25,000 per day, unless a finding of reckless disregard is made, in which case penalties may be as high as $1 million per day. The FDIC also has the authority to recommend to the Director of the Office of the Comptroller of the Currency that enforcement action be taken with respect to a particular savings bank. If action is not taken by the Director, the Federal Deposit Insurance Corporation has authority to take action under specified circumstances.

27
 

Standards for Safety and Soundness. Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions. These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation, and other operational and managerial standards as the agency deems appropriate. The federal banking agencies adopted Interagency Guidelines Prescribing Standards for Safety and Soundness to implement the safety and soundness standards required under federal law. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. The guidelines address internal controls and information systems, internal audit systems, credit underwriting, loan documentation, interest rate risk exposure, asset growth, compensation, fees and benefits. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard. If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to submit a compliance plan.

Federal Insurance of Deposit Accounts. First Federal of Northern Michigan is a member of the Deposit Insurance Fund, which is administered by the Federal Deposit Insurance Corporation. Deposit accounts in First Federal of Northern Michigan are insured up to a maximum of $250,000 for each separately insured depositor.

The Federal Deposit Insurance Corporation imposes an assessment for deposit insurance on all depository institutions. Under the Federal Deposit Insurance Corporation’s risk-based assessment system, insured institutions are assigned to risk categories based on supervisory evaluations, regulatory capital levels and certain other factors. An institution’s assessment rate depends upon the category to which it is assigned and certain adjustments specified by Federal Deposit Insurance Corporation regulations, with less risky institutions paying lower rates. Assessment rates (inclusive of possible adjustments) currently range from 2 ½ to 45 basis points of each institution’s total assets less tangible capital. The Federal Deposit Insurance Corporation may increase or decrease the scale uniformly, except that no adjustment can deviate more than two basis points from the base scale without notice and comment rulemaking. The Federal Deposit Insurance Corporation’s current system represents a change, required by the Dodd-Frank Act, from its prior practice of basing the assessment on an institution’s volume of deposits.

In addition to the Federal Deposit Insurance Corporation assessments, the Financing Corporation is authorized to impose and collect, through the Federal Deposit Insurance Corporation, assessments for anticipated payments, issuance costs and custodial fees on bonds issued by the Financing Corporation in the 1980s to recapitalize the former Federal Savings and Loan Insurance Corporation. The bonds issued by the Financing Corporation are due to mature in 2017 through 2019. For the quarter ended December 31, 2014, the annualized Financing Corporation assessment was equal to 0.62 basis points of total assets less tangible capital.

The Dodd-Frank Act increased the minimum target Deposit Insurance Fund ratio from 1.15% of estimated insured deposits to 1.35% of estimated insured deposits. The Federal Deposit Insurance Corporation must seek to achieve the 1.35% ratio by September 30, 2020. Insured institutions with assets of $10 billion or more are supposed to fund the increase. The Dodd-Frank Act eliminated the 1.5% maximum fund ratio, instead leaving it to the discretion of the Federal Deposit Insurance Corporation and the Federal Deposit Insurance Corporation has exercised that discretion by establishing a long-term fund ratio of 2%.

The Federal Deposit Insurance Corporation has authority to increase insurance assessments. Any significant increases would have an adverse effect on the operating expenses and results of operations of First Federal of Northern Michigan. Management cannot predict what assessment rates will be in the future.

Insurance of deposits may be terminated by the Federal Deposit Insurance Corporation upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. Management of First Federal of Northern Michigan does not know of any practice, condition or violation that may lead to termination of our deposit insurance.

Prompt Corrective Action. The “prompt corrective action” provisions of the FDIA create a statutory framework that applies a system of both discretionary and mandatory supervisory actions indexed to the capital level of FDIC-insured depository institutions. These provisions impose progressively more restrictive constraints on operations, management, and capital distributions of the institution as its regulatory capital decreases, or in some cases, based on supervisory information other than the institution’s capital level. This framework and the authority it confers on the federal banking agencies supplement other existing authority vested in such agencies to initiate supervisory actions to address capital deficiencies. Moreover, other provisions of law and regulation employ regulatory capital level designations the same as or similar to those established by the prompt corrective action provisions both in imposing certain restrictions and limitations and in conferring certain economic and other benefits upon institutions. These include restrictions on brokered deposits, limits on exposure to interbank liabilities, determination of risk-based FDIC deposit insurance premium assessments, and action upon regulatory applications

28
 

The recently proposed rules that would increase regulatory capital requirements would adjust prompt corrective categories accordingly. See “- Capital Requirements” above.

 

Prohibitions Against Tying Arrangements. Federal savings banks are prohibited, subject to some exceptions, from extending credit to or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the savings bank or its affiliates or not obtain services of a competitor of the savings bank.

 

Federal Home Loan Bank System. First Federal of Northern Michigan is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank System provides a central credit facility primarily for member institutions. As a member of the Federal Home Loan Bank of Indianapolis, First Federal of Northern Michigan is required to acquire and hold shares of capital stock in the Federal Home Loan Bank in an amount equal to at least 1% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year, or 1/20 of its borrowings from the Federal Home Loan Bank, whichever is greater. As of December 31, 2014, First Federal of Northern Michigan was in compliance with this requirement.

 

Qualified Mortgages and Retention of Credit Risk. The Consumer Financial Protection Bureau has issued a rule designed to clarify for lenders how they can avoid legal liability under the Dodd-Frank Act, which would hold lenders accountable for ensuring a borrower’s ability to repay a mortgage. Loans that meet this “qualified mortgage“ definition will be presumed to have complied with the new ability-to-repay standard. Under the Consumer Financial Protection Bureau’s rule, a “qualified mortgage” loan must not contain certain specified features, including:

 

·excessive upfront points and fees (those exceeding 3% of the total loan amount, less “bona fide discount points” for prime loans);

 

·interest-only payments;

 

·negative-amortization; and

 

·terms longer than 30 years.

 

Also, to qualify as a “qualified mortgage,” a borrower’s total monthly debt-to-income ratio may not exceed 43%. Lenders must also verify and document the income and financial resources relied upon to qualify the borrower for the loan and underwrite the loan based on a fully amortizing payment schedule and maximum interest rate during the first five years, taking into account all applicable taxes, insurance and assessments. The Consumer Financial Protection Bureau’s rule on qualified mortgages could limit our ability or desire to make certain types of loans or loans to certain borrowers, or could make it more expensive/and or time consuming to make these loans, which could limit our growth or profitability.

 

In addition, the Dodd-Frank Act requires the regulatory agencies to issue regulations that require securitizers of loans to retain not less than 5% of the credit risk for any asset that is not a “qualified residential mortgage.” The regulatory agencies have issued a proposed rule to implement this requirement. The Dodd-Frank Act provides that the definition of “qualified residential mortgage” can be no broader than the definition of “qualified mortgage” issued by the Consumer Financial Protection Bureau for purposes of its regulations (as described above). Although the final rule with respect to the retention of credit risk has not yet been issued, the final rule could have a significant effect on the secondary market for loans and the types of loans we originate, and restrict our ability to make loans.

 

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Other Regulations

Interest and other charges collected or contracted for by First Federal of Northern Michigan are subject to state usury laws and federal laws concerning interest rates. First Federal of Northern Michigan’s operations are also subject to federal laws applicable to credit transactions, such as the:

·Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
   
·Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
   
·Fair Credit Reporting Act, governing the use and provision of information to credit reporting agencies;
   
·Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;
   
·Truth in Savings Act; and
   
·rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.
   

The operations of First Federal of Northern Michigan also are subject to the:

·Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;
   
·Electronic Funds Transfer Act and Regulation E promulgated thereunder, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services;
   
·Check Clearing for the 21st Century Act (also known as “Check 21”), which gives “substitute checks,” such as digital check images and copies made from that image, the same legal standing as the original paper check;
   
·Title III of The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (referred to as the “USA PATRIOT Act”), which significantly expanded the responsibilities of financial institutions, including savings and loan associations, in preventing the use of the American financial system to fund terrorist activities. Among other provisions, the USA PATRIOT Act and the related regulations of the OCC require savings associations operating in the United States to develop new anti-money laundering compliance programs, due diligence policies and controls to ensure the detection and reporting of money laundering. Such required compliance programs are intended to supplement existing compliance requirements, also applicable to financial institutions, under the Bank Secrecy Act and the Office of Foreign Assets Control regulations; and
   
·The Gramm-Leach-Bliley Act, which places limitations on the sharing of consumer financial information by financial institutions with unaffiliated third parties. Specifically, the Gramm-Leach-Bliley Act requires all financial institutions offering financial products or services to retail customers to provide such customers with the financial institution’s privacy policy and provide such customers the opportunity to “opt out” of the sharing of certain personal financial information with unaffiliated third parties.
   

Federal Reserve System

 

Federal Reserve Board regulations require savings banks to maintain non-interest-earning reserves against their transaction accounts, such as negotiable order of withdrawal and regular checking accounts. At December 31, 2014, First Federal of Northern Michigan was in compliance with these reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy liquidity requirements imposed by the Office of the Comptroller of the Currency.

 

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The USA PATRIOT Act

 

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

 

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

 

Holding Company Regulation

 

Pursuant to the Dodd-Frank Act, as of July 21, 2011, the Federal Reserve Board succeeded the Office of Thrift Supervision as the regulator for savings and loan holding companies, such as First Federal of Northern Michigan Bancorp, Inc.

 

General. First Federal of Northern Michigan Bancorp, Inc. is a non-diversified unitary savings and loan holding company within the meaning of the Home Owners’ Loan Act. As such, First Federal of Northern Michigan Bancorp, Inc. is registered with the Federal Reserve Board and subject to examination and supervision by the Federal Reserve Bank of Chicago. First Federal of Northern Michigan Bancorp, Inc. is subject to the Federal Reserve Board regulations (including applicable regulations of the former Office of Thrift Supervision), and reporting requirements. In addition, the Federal Reserve Board has enforcement authority over First Federal of Northern Michigan Bancorp, Inc. and its non-insured subsidiaries. Among other things, this authority permits the Federal Reserve Board to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings institution.

 

Savings and loan holding companies have not historically been subjected to consolidated regulatory capital requirements. However, the Dodd-Frank Act required the Federal Reserve Board to set for all depository institution holding companies minimum consolidated capital levels that are as stringent as those required for the insured depository subsidiaries. The previously discussed final rule regarding regulatory capital requirements implements the Dodd-Frank Act as to savings and loan holding companies. Consolidated regulatory capital requirements identical to those applicable to the subsidiary depository institutions will apply to savings and loan holding companies as of January 1, 2015. As is the case with institutions themselves, the capital conservation buffer will be phased in between 2016 and 2019.

 

The Federal Reserve Board has issued a policy guidance regarding the payment of dividends by bank holding companies that it has made applicable to savings and loan holding companies as well. In general, the Federal Reserve Board’s policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. Federal Reserve Board guidance provides for prior regulatory review of capital distributions in certain circumstances such as where the company’s net income for the past four quarters, net of dividends previously paid over that period, is insufficient to fully fund the dividend or the company’s overall rate of earnings retention is inconsistent with the company’s capital needs and overall financial condition. The ability of a holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. These regulatory policies could affect our ability to pay dividends or otherwise engage in capital distributions.

 

The Dodd-Frank Act also extends the “source of strength” doctrine to savings and loan holding companies. The regulatory agencies must issue regulations requiring that all bank and savings and loan holding companies serve as a source of strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of financial stress. 

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Permissible Activities. Under present law, the business activities of First Federal of Northern Michigan Bancorp, Inc. are generally limited to those activities permissible for financial holding companies under Section 4(k) of the Bank Holding Company Act of 1956, as amended, or for multiple savings and loan holding companies. A financial holding company may engage in activities that are financial in nature, including underwriting equity securities and insurance as well as activities that are incidental to financial activities or complementary to a financial activity. A multiple savings and loan holding company is generally limited to activities permissible for bank holding companies under Section 4(c)(8) of the Bank Holding Company Act, subject to the prior approval of the Federal Reserve Board, and certain additional activities authorized by Federal Reserve Board regulations.

Federal law prohibits a savings and loan holding company, including First Federal of Northern Michigan Bancorp, Inc., directly or indirectly, or through one or more subsidiaries, from acquiring more than 5% of another savings institution or holding company thereof, without prior written approval of the Federal Reserve Bank of Chicago. It also prohibits the acquisition or retention of, with certain exceptions, more than 5% of a non-subsidiary company engaged in activities that are not closely related to banking or financial in nature, or acquiring or retaining control of an institution that is not federally insured. In evaluating applications by holding companies to acquire savings institutions, the Federal Reserve Bank of Chicago must consider the financial and managerial resources, future prospects of the company and institution involved, the effect of the acquisition on the risk to the federal deposit insurance fund, the convenience and needs of the community and competitive factors.

 

The Federal Reserve Bank of Chicago is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions:

 

the approval of interstate supervisory acquisitions by savings and loan holding companies; and

 

(i)the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisition.

The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.

 

Sarbanes-Oxley Act of 2002

 

The Sarbanes-Oxley Act of 2002 addresses, among other things corporate governance, auditing and accounting, executive compensation and enhanced and timely disclosures of corporate information. We have existing policies, procedures and systems designed to comply with these regulations, and we review and document such policies, procedures and systems to ensure continued compliance with these regulations.

Federal Securities Laws

 

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

 

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

 

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TAXATION

 

Federal Taxation

 

General. First Federal of Northern Michigan Bancorp, Inc. and First Federal of Northern Michigan are subject to federal income taxation in the same general manner as other corporations, with some exceptions discussed below. The following discussion of federal taxation is intended only to summarize material federal income tax matters and is not a comprehensive description of the tax rules applicable to First Federal of Northern Michigan Bancorp, Inc. and First Federal of Northern Michigan.

 

Method of Accounting. For federal income tax purposes, First Federal of Northern Michigan currently reports its income and expenses on the accrual method of accounting and uses a tax year ending December 31 for filing its consolidated federal income tax returns. The Small Business Protection Act of 1996 eliminated the use of the reserve method of accounting for bad debt reserves by savings institutions, effective for taxable years beginning after 1995.

 

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

 

Deferred Tax Asset Valuation. The Company records a valuation allowance against its deferred tax assets if it believes, based on available evidence, that it is “more likely than not” that the future tax assets recognized will not be realized before their expiration. Realization of the Company’s deferred tax assets is primarily dependent upon the generation of a sufficient level of future taxable income. At December 31, 2014 the Company had a valuation allowance against its deferred tax assets of $3.1 million.

 

Taxable Distributions and Recapture. Prior to the Small Business Protection Act of 1996, bad debt reserves created prior to 1988 were subject to recapture into taxable income if First Federal of Northern Michigan failed to meet certain thrift asset and definitional tests. The Small Business Protection Act of 1996 eliminated these thrift-related recapture rules. However, under current law, pre-1988 reserves remain subject to tax recapture should First Federal of Northern Michigan make certain distributions from its tax bad debt reserve or cease to maintain a bank charter. At December 31, 2014, First Federal of Northern Michigan’s total federal pre-1988 reserve was approximately $60,000. This reserve reflects the cumulative effects of federal tax deductions by First Federal of Northern Michigan for which no federal income tax provision has been made.

 

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

 

Net Operating Loss Carryovers. A financial institution may carry back net operating losses to the preceding five taxable years and forward to the succeeding 20 taxable years. At December 31, 2014, First Federal of Northern Michigan had a net operating loss of approximately $12.3 million which it may carry forward for federal income tax purposes until 2034.

 

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

 

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

 

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State and Local Taxation

 

We are subject to the Michigan Business Tax (MBT). Financial Institutions are subject to a component of the MBT, the Financial Institutions Tax, which is based on capital rather than taxable earnings.

 

Other applicable state taxes include generally applicable sales, use and real property taxes.

 

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

 

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ITEM 1A. RISK FACTORS

 

Not required for smaller reporting companies. 

ITEM 1B. UNRESOLVED STAFF COMMENTS

None

 

ITEM 2. PROPERTIES

 

As of December 31, 2014, First Federal of Northern Michigan owned its main office and all of its branch offices. The following is a list of our locations:

Main Office  
   
100 South Second Avenue  
Alpena, Michigan 49707  
   
Branch Offices  
   
468 North Ripley Boulevard 2885 South County Road #489
Alpena, Michigan 49707 Lewiston, Michigan 49756
   
6232 River Street 308 North Morenci
Alanson, Michigan 49706 Mio, Michigan 48647
   
101 South Main Street 201 North State Street
Cheboygan, Michigan 49721 Oscoda, Michigan 48750
   
1000 South Wisconsin  
Gaylord, Michigan 49735  

ITEM 3. LEGAL PROCEEDINGS

      

We are periodically involved in claims and lawsuits that are incident to their business. At December 31, 2014, we are not involved in any claims or lawsuits material to their respective businesses.

  

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

(a) First Federal of Northern Michigan Bancorp, Inc.’s common stock is traded on the Nasdaq Capital Market under the symbol “FFNM.”
   
As of March 27, 2015 there were 4,034,764 shares of First Federal of Northern Michigan Bancorp, Inc. common stock outstanding. At December 31, 2014, First Federal of Northern Michigan Bancorp, Inc. had approximately 600 stockholders of record. The remaining information required by this item is incorporated by reference to Exhibit 13, the Company’s Annual Report to Stockholders.
   
No equity securities were sold during the year ended December 31, 2014 that were not registered under the Securities Act.
   
(b) Not Applicable
   
(c)  First Federal of Northern Michigan Bancorp, Inc. did not repurchase any of its equity securities during the quarter ended December 31, 2014.

 

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ITEM 6. SELECTED FINANCIAL DATA

 

Not required for smaller reporting companies.

 

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

 

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

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not required for smaller reporting companies.

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

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

 

ITEM 9.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON

ACCOUNTING AND FINANCIAL DISCLOSURE

   

None

 

ITEM 9A. CONTROLS AND PROCEDURES

 

(a)Evaluation of Disclosure Controls and Procedures

 

Under the supervision and with the participation of our management, including the Company’s Chief Executive Officer and VP – Director of Financial Reporting and 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 and 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, 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.

(b)Management’s Annual Report on Internal Control over Financial Reporting

Management of First Federal of Northern Michigan Bancorp, Inc. and subsidiaries (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s system of internal control is designed under the supervision of management, including our Chief Executive Officer and VP – Director of Financial Reporting and Accounting, to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles (“GAAP”).

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Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures are made only in accordance with the authorization of management and the Board of Directors; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on our financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections on any evaluation of effectiveness to future periods are subject to the risk that the controls may become inadequate because of changes in conditions or that the degree of compliance with policies and procedures may deteriorate.

As of December 31, 2014, management assessed the effectiveness of the Company’s internal control over financial reporting based upon the framework established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based upon its assessment, management believes that the Company’s internal control over financial reporting as of December 31, 2014 is effective using these criteria.

This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission applicable to smaller reporting companies that permit the Company to provide only management’s report in this annual report.

(c)Changes in Internal Control over Financial Reporting

 

There has been no change in the Company’s internal control over the financial reporting during the Company’s fourth quarter of fiscal year 2014 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

ITEM 9B. OTHER INFORMATION

 

None. 

PART III

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE

 

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

 

ITEM 11. EXECUTIVE COMPENSATION

 

Information concerning executive compensation is incorporated herein by reference from the Company’s Proxy Statement, specifically the section captioned “Proposal I—Election of Directors.”

 

ITEM 12.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS

AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

  

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

 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

 

Information concerning relationships and transactions is incorporated herein by reference from the Company’s Proxy Statement, specifically the section captioned “Transactions with Certain Related Persons”.

 

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

Information concerning principal accountant fees and services is incorporated herein by reference to the Company’s Proxy Statement, specifically the section captioned “Proposal II – Ratification of Appointment of Auditors.”

 

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PART IV

 

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

    

    The exhibits filed as a part of this form 10-K are as follows:

  

3.1 Articles of Incorporation of First Federal of Northern Michigan Bancorp, Inc.*
3.2 Bylaws of First Federal of Northern Michigan Bancorp, Inc.*
4 Form of Common Stock Certificate of First Federal of Northern Michigan Bancorp, Inc.*
10.1 Change in Control Agreements*
10.2 1996 Stock Option Plan*
10.3 2006 Stock-Based Incentive Plan**
13 Annual Report to Shareholders
14 Code of Ethics ***
21 Subsidiaries of Registrant
23 Consent of Plante & Moran PLLC
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101 INS XBRL Taxonomy Extension Schema
101 SCH XBRL Taxonomy Extension Calculation Linkbase
101 CAL XBRL Taxonomy Extension Label Linkbase
101 DEF XBRL Taxonomy Extension Definition Linkbase
101 LAB XBRL Taxonomy Extension Label Linkbase
101 PRE XBRL Taxonomy Extension Presentation Linkbase
     
* Incorporated by reference to the Registration Statement on Form SB-2 of First Federal of Northern Michigan Bancorp, Inc. (Registration No. 333-121178), originally filed with the Commission on December 10, 2004.
** Incorporate by reference to the Definitive Proxy materials filed on April 10, 2006 (No. 000-31957).
*** Incorporated by reference to the Annual Report on Form 10-K of Alpena Bancshares, Inc. filed with the Commission on March 30, 2004 (Registration No. 000-31957).

 

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SIGNATURES

 

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

 

FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.

 

      By: /s/Michael W. Mahler
        Michael W. Mahler
        Chief Executive Officer
         
        Date: March 30, 2015

  

Pursuant to the requirements of the Securities Exchange of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

 

By: /s/Michael W. Mahler   By: /s/Eileen M. Budnick
  Michael W. Mahler, Director and     Eileen M. Budnick, VP- Director of Financial Reporting &
  Chief Executive Officer     Accounting, Treasurer & Corporate Secretary
  (Principal Executive Officer)     (Principal Financial and Accounting Officer)
       
Date: March 30, 2015     Date: March 30, 2015

 

By: /s/Martin A. Thomson   By: /s/Thomas R. Townsend
  Martin A. Thomson, Chairman     Thomas R. Townsend, Director
         
Date: March 30, 2015     Date: March 30, 2015

 

By: /s/GaryVanMassenhove   By: /s/James E. Kraenzlein
  Gary VanMassenhove, Director     James E. Kraenzlein, Director
       
Date: March 30, 2015     Date: March 30, 2015

 

By: /s/Timothy E. Fitzpatrick   By: /s/Christopher B. McCoy
  Timothy E. Fitzpatrick, Director     Christopher B. McCoy, Director
         
Date: March 30, 2015     Date: March 30, 2015

 

 

By: /s/Richard L. Crittenden   By: /s/Eric G. Smith
  Richard L. Crittenden, Director     Eric G. Smith, Director
         
Date: March 30, 2015     Date: March 30, 2015

  

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