SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to ______________
Commission File Number 000-31957
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
(Exact name of registrant as specified in its charter)
MARYLAND 32-0135202
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 S. SECOND AVENUE, ALPENA, MICHIGAN 49707
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (989) 356-9041
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceeding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
----- -----
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes No X .
----- -----
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.
Common Stock, Par Value $0.01 Outstanding at November 8, 2005
(Title of Class) 3,111,176 shares
Transitional Small Business Disclosure Format: Yes No X .
----- -----
1
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-QSB
QUARTER ENDED SEPTEMBER 30, 2005
INDEX
PART I - FINANCIAL INFORMATION
Interim Financial Information required by Rule 10-01 of Regulation S-X and Item
303 of Regulation S-B is included in this Form 10-QSB as referenced below:
PAGE
----
ITEM 1 - UNAUDITED FINANCIAL STATEMENTS
Consolidated Balance Sheet at September 30, 2005 and
December 31, 2004......................................... 4
Consolidated Statements of Income for the Three and Nine
Months Ended September 30, 2005 and September 30, 2004.... 5
Consolidated Statement of Changes in Stockholders' Equity
for the Nine Months Ended September 30, 2005 ............. 6
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 2005 and September 30, 2004........... 7
Notes to Unaudited Consolidated Financial Statements......... 8
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION........................................ 15
ITEM 3 - CONTROLS AND PROCEDURES......................................... 21
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS.............................................. 22
ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS..... 22
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES................................. 22
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............. 22
ITEM 5 - OTHER INFORMATION............................................... 22
ITEM 6 - EXHIBITS........................................................ 22
Section 302 Certifications
Section 906 Certifications
When used in this Form 10-QSB or future filings by First Federal of Northern
Michigan Bancorp, Inc. (the "Company") with the Securities and Exchange
Commission ("SEC"), in the Company's press releases or other public or
stockholder communications, or in oral statements made with the approval of an
authorized executive officer, the words or phrases "would be," "will allow,"
"intends to," "will likely result," "are expected to," "will continue," "is
anticipated," "estimate," "project," or similar expressions are intended to
identify "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995.
2
The Company wishes to caution readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made, and to advise
readers that various factors, including regional and national economic
conditions, changes in levels of market interest rates, credit and other risks
of lending and investment activities and competitive and regulatory factors,
could affect the Company's financial performance and could cause the Company's
actual results for future periods to differ materially from those anticipated or
projected.
The Company does not undertake, and specifically disclaims any obligation, to
update any forward-looking statements to reflect occurrences or unanticipated
events or circumstances after the date of such statements.
3
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
September 30, 2005 December 31, 2004
------------------ -----------------
(Unaudited)
ASSETS
Cash and cash equivalents:
Cash on hand and due from banks ................................................. $ 6,626,036 $ 4,685,913
Overnight deposits with FHLB .................................................... 451,782 52,646
------------ ------------
Total cash and cash equivalents ................................................. 7,077,818 4,738,559
Securities AFS .................................................................. 47,175,328 40,233,035
Securities HTM .................................................................. 1,800,000 1,800,000
Loans held for sale ............................................................. 196,500 1,095,660
Loans receivable, net of allowance for loan losses of $1,345,977 and
$1,213,938 as of September 30, 2005 and December 31, 2004, respectively ...... 200,078,441 195,387,937
Foreclosed real estate and other repossessed assets ............................. 463,019 28,907
Real estate held for investment ................................................. 375,121 562,758
Federal Home Loan Bank stock, at cost ........................................... 4,765,000 4,666,100
Premises and equipment .......................................................... 7,124,629 6,793,998
Accrued interest receivable ..................................................... 1,583,070 1,034,695
Intangible assets ............................................................... 2,619,534 2,855,568
Goodwill ........................................................................ 1,049,854 1,049,854
Other assets .................................................................... 2,539,523 2,553,063
------------ ------------
Total assets .................................................................... $276,847,837 $262,800,134
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits ........................................................................ $194,103,422 $182,489,148
Advances from borrowers for taxes and insurance ................................. 215,166 44,590
Federal Home Loan Bank advances & Note Payable .................................. 42,890,222 56,001,396
Accrued expenses and other liabilities .......................................... 3,066,855 2,488,711
------------ ------------
Total liabilities ............................................................... 240,275,665 241,023,845
------------ ------------
Commitments and contingencies ................................................... -- --
Stockholders' equity:
Common stock ($0.01 par value 20,000,000 shares authorized and $1.00 par value
20,000,000 authorized, respectively; 3,111,176 and 1,659,480 shares issued
and outstanding, respectively) .............................................. 31,112 1,659,480
Additional paid-in capital ...................................................... 23,545,034 5,356,782
Retained earnings, restricted ................................................... -- 5,152,000
Retained earnings ............................................................... 14,608,122 9,635,580
Unallocated ESOP ................................................................ (1,325,450) --
Accumulated other comprehensive loss ............................................ (286,646) (27,553)
------------ ------------
Total stockholders' equity ...................................................... 36,572,172 21,776,289
------------ ------------
Total liabilities and stockholders' equity ...................................... $276,847,837 $262,800,134
============ ============
See accompanying notes to consolidated financial statements.
4
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
----------------------- ------------------------
2005 2004 2005 2004
---------- ---------- ----------- ----------
(Unaudited) (Unaudited)
Interest income:
Interest and fees on loans ........................... $3,395,050 $2,996,936 $ 9,747,198 $8,447,329
Interest and dividends on investments ................ 444,203 396,283 1,189,863 1,184,959
Interest on mortgage-backed securities ............... 59,803 52,593 189,906 166,095
---------- ---------- ----------- ----------
Total interest income ................................ 3,899,056 3,445,812 11,126,967 9,798,383
---------- ---------- ----------- ----------
Interest expense:
Interest on deposits ................................. 1,127,496 961,131 3,134,668 2,620,483
Interest on borrowings ............................... 555,162 661,266 1,790,875 1,950,887
---------- ---------- ----------- ----------
Total interest expense ............................... 1,682,658 1,622,397 4,925,543 4,571,370
---------- ---------- ----------- ----------
Net interest income .................................. 2,216,398 1,823,415 6,201,424 5,227,013
Provision for loan losses ............................ 3,800 67,600 266,058 213,600
---------- ---------- ----------- ----------
Net interest income after provision for loan losses .. 2,212,598 1,755,815 5,935,366 5,013,413
---------- ---------- ----------- ----------
Non Interest income:
Service charges and other fees ....................... 262,239 259,934 747,563 748,658
Mortgage banking activities .......................... 155,811 210,836 383,498 460,691
Gain on sale of available-for-sale investments ....... -- 6,968 13,127 102,637
Net gain on sale of premises and equipment,
real estate owned and other repossessed assets .... (7,746) (13,370) (26,611) (19,699)
Other ................................................ 20,555 23,176 30,712 73,276
Insurance & Brokerage Commissions .................... 724,993 764,557 2,205,524 2,233,607
---------- ---------- ----------- ----------
Total other income ................................... 1,155,852 1,252,101 3,353,813 3,599,170
---------- ---------- ----------- ----------
Non interest expenses:
Compensation and employee benefits ................... 1,571,682 1,474,165 4,705,438 4,460,147
SAIF Insurance Premiums .............................. 5,913 5,618 18,810 20,580
Advertising .......................................... 58,635 52,643 133,419 177,385
Occupancy ............................................ 340,841 309,664 967,492 966,868
Amortization of intangible assets .................... 85,149 74,922 236,035 230,109
Service Bureau Charges ............................... 87,348 88,326 262,064 250,335
Insurance & Brokerage Commission Expense ............. 290,261 335,876 888,464 970,289
Professional Services ................................ 40,845 35,728 180,761 155,427
Donation to First Federal Community Foundation ....... -- -- 679,940 --
Other ................................................ 341,708 264,649 908,856 882,409
---------- ---------- ----------- ----------
Other expenses ....................................... 2,822,382 2,641,591 8,981,279 8,113,549
---------- ---------- ----------- ----------
Income before income tax expense ..................... 546,068 366,325 307,900 499,034
Income tax expense ................................... 182,723 122,455 102,850 167,060
---------- ---------- ----------- ----------
Net income ........................................... $ 363,345 $ 243,870 $ 205,050 $ 331,974
========== ========== =========== ==========
Per share data:
Basic earnings per share ............................. $ 0.12 $ 0.08 $ 0.07 $ 0.11
Weighted average number of shares outstanding ........ 3,100,511 3,065,667 3,088,961 3,065,129
Diluted earnings per share ........................... $ 0.07 $ 0.08 $ 0.07 $ 0.11
Weighted average number of shares outstanding,
including dilutive stock options .................. 3,110,617 3,087,906 3,106,686 3,088,735
Dividends per common share ........................... $ 0.050 $ 0.054 $ 0.154 $ 0.149
See accompanying notes to consolidated financial statements.
5
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP INC. AND SUBSIDIARIES
Consolidated Statement of Changes in Stockholders' Equity (Unaudited)
For the Nine months Ended September 30, 2005
Accumulated
Additional Other
Common Paid-in Retained Unallocated Comprehensive
Stock Capital Earnings ESOP Income Total
---------- ----------- ----------- ----------- ------------- -----------
Balance at December 31, 2004 .......... $1,659,480 $ 5,356,782 $14,787,580 $ -- $(27,553) $21,776,289
Merger of Alpena Bancshares, MHC
pursuant to reorganization
(920,000 shares) ................... (920,000) 1,127,769 -- -- -- 207,769
Exchange of common stock pursuant
to reorganization (739,480
shares ($1.00 par) for
1,366,155 shares ($0.01 par) ....... (725,819) 723,996 -- -- -- (1,823)
Proceeds from stock offering, net of
related expenses of $1,038,928
and issuance of 1,699,869 shares
of common stock ($0.01 par) ........ 16,999 15,942,763 -- -- -- 15,959,762
Stock donated to First Federal
Community Foundation pursuant
to conversion (33,997 shares) ...... 340 339,630 -- -- -- 339,970
Stock options exercised (11,155
shares) ............................ 112 60,258 -- -- -- 60,370
Forfeiture of shares in connection
with RRP stock ..................... -- -- -- -- --
Unallocated ESOP ...................... -- -- -- (1,387,090) -- (1,387,090)
Common Stock held by ESOP
committed to be released ........... (6,164) -- 61,640 -- 55,476
Net income for the period ............. -- -- 205,050 -- -- 205,050
Subsidiary retained earnings .......... -- -- -- -- -- --
Changes in unrealized gain
on available-for-sale securities
of subsidiary ...................... -- -- -- -- (259,093) (259,093)
Total comprehensive income ............ -- -- -- -- -- (54,043)
Dividends declared .................... -- -- (384,508) -- -- (384,508)
---------- ----------- ----------- ----------- --------- -----------
Balance at September 30, 2005 ......... $ 31,112 $23,545,034 $14,608,122 $(1,325,450) $(286,646) $36,572,172
========== =========== =========== =========== ========= ===========
6
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
For Nine Months Ended
September 30,
---------------------------
2005 2004
------------ ------------
(Unaudited)
Cash flows from operating activities:
Net income .................................................................. $ 205,050 $ 331,974
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization ............................................ 619,541 627,211
Provision for Loan Loss .................................................. 266,058 213,600
Amortization and accretion on securities ................................. 127,058 308,244
Gain on sale of investment securities .................................... (13,128) (103,000)
Originations of loans held for sale ...................................... (16,538,548) (19,246,947)
Principal amount of loans sold ........................................... 17,437,708 19,521,972
Purchase of real estate held for sale .................................... (61,504) (123,252)
Proceeds from sale of real estate held for sale .......................... 246,340 197,281
Loss on sale of real estate held for investment .......................... 2,801 --
Proceeds from sale of premises and equipment ............................. 6,500 --
Gain (loss) on sale of premises and equipment ............................ 25,717 --
Change in accrued interest receivable & other assets ..................... (968,947) (436,403)
Change in accrued expenses and other liabilities ......................... 600,442 (416,543)
Stock donated to charitable foundation ................................... 339,970 --
ESOP shares committed to be released ..................................... 55,476 --
------------ ------------
Net cash provided by (used in) operating activities ......................... 2,350,534 874,137
------------ ------------
Net (Increase) decrease in loans ............................................ (4,956,562) (23,835,975)
Proceeds from maturity & sale of available-for-sale securities ........... 6,068,772 29,356,390
Purchase of securities available for sale ................................ (13,517,560) (36,188,000)
Purchase of securities held to maturity .................................. -- (1,800,000)
Purchase of Federal Home Loan Bank Stock ................................. (98,900) (157,200)
Purchase of premises and equipment ....................................... (746,355) (1,012,273)
------------ ------------
Net cash provided by (used in) investing activities ......................... (13,250,605) (33,637,058)
------------ ------------
Net Increase (decrease) in deposits ...................................... 11,614,274 30,725,968
Dividend paid on common stock ............................................ (384,508) (203,225)
Net increase (decrease) in advances from borrowers ....................... 170,576 195,950
Additions to advances from Federal Home Loan Bank and Notes Payable ..... 6,500,000 5,000,000
Repayments of Federal Home Loan Bank advances and Notes Payable .......... (19,500,000) (4,855,377)
Proceeds from exercise of stock options .................................. 60,370 18,012
Net proceeds from stock offering ......................................... 15,959,762 --
Merger of Alpena Bancshares, MHC ......................................... 207,769 --
Cash paid for fractional shares in conversion ............................ (1,823) --
Purchase of shares for ESOP .............................................. (1,387,090) --
------------ ------------
Net cash provided by (used in) financing activities ......................... 13,239,330 30,881,328
------------ ------------
Net increase (decrease) in cash and cash equivalents ........................ 2,339,259 (1,881,593)
Cash and cash equivalents at beginning of period ............................ 4,738,559 6,705,125
------------ ------------
Cash and cash equivalents at end of period .................................. $ 7,077,818 $ 4,823,532
============ ============
7
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.
The accompanying consolidated financial statements have been prepared on an
accrual basis of accounting and include the accounts of First Federal of
Northern Michigan Bancorp, Inc., and its wholly owned subsidiary, First Federal
of Northern Michigan (the "Bank") and its wholly owned subsidiaries Financial
Service and Mortgage Corporation ("FSMC") and the InsuranCenter of Alpena
("ICA"). FSMC invests in real estate that includes leasing, selling, developing,
and maintaining real estate properties. ICA is a licensed insurance agency
engaged in the business of property, casualty and health insurance. All
significant intercompany balances and transactions have been eliminated in the
consolidation.
These interim financial statements are prepared without audit and reflect
all adjustments, which, in the opinion of management, are necessary to present
fairly the consolidated financial position of the Company at September 30, 2005,
and its results of operations and statement of cash flows for the periods
presented. All such adjustments are normal and recurring in nature. The
accompanying consolidated financial statements do not purport to contain all the
necessary financial disclosures required by generally accepted accounting
principles that might otherwise be necessary and should be read in conjunction
with the consolidated financial statements and notes thereto of the Company
included in the Annual Report for the year ended December 31, 2004. Results for
the three and nine months ended September 30, 2005 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2005.
CRITICAL ACCOUNTING POLICIES
Our accounting and reporting policies are prepared in accordance with
accounting principles generally accepted in the United States of America and
conform to general practices within the banking industry. We consider accounting
policies that require significant judgment and assumptions by management that
have, or could have, a material impact on the carrying value of certain assets
or on income to be critical accounting policies. Changes in underlying factors,
assumptions or estimates could have a material impact on our future financial
condition and results of operations. Based on the size of the item or
significance of the estimate, the following accounting policies are considered
critical to our financial results.
Allowance for Loan Losses. The allowance for loan losses is calculated with
the objective of maintaining an allowance sufficient to absorb estimated
probable loan losses. Management's determination of the adequacy of the
allowance is based on periodic evaluations of the loan portfolio and other
relevant factors. However, this evaluation is inherently subjective, as it
requires an estimate of the loss content for each risk rating and for each
impaired loan, an estimate of the amounts and timing of expected future cash
flows, and an estimate of the value of collateral.
We have established a systematic method of periodically reviewing the
credit quality of the loan portfolio in order to establish an allowance for
losses on loans. The allowance for losses on loans is based on our current
judgments about the credit quality of individual loans and segments of the loan
portfolio. The allowance for losses on loans is established through a provision
for loan losses based on our evaluation of the losses inherent in the loan
portfolio, and considers all known internal and external factors that affect
loan collectibility as of the reporting date. Our evaluation, which includes a
review of all loans on which full collectibility may not be reasonably assured,
considers among other matters, the estimated net realizable value or the fair
value of the underlying collateral, economic conditions, historical loan loss
experience, our knowledge of inherent losses in the portfolio that are probable
and reasonably estimable and other factors that warrant recognition in providing
an appropriate loan loss allowance. Management believes this is a critical
accounting policy because this evaluation involves a high degree of complexity
8
and requires us to make subjective judgments that often require assumptions or
estimates about various matters. Historically, we believe our estimates and
assumptions have proven to be relatively accurate
The analysis of the allowance for loan losses has two components: specific
and general allocations. Specific allocations are made for loans that are
determined to be impaired. Impairment is measured by determining the present
value of expected future cash flows or, for collateral-dependent loans, the fair
value of the collateral adjusted for market conditions and selling expenses. The
general allocation is determined by segregating the remaining loans by type of
loan, risk weighting (if applicable) and payment history. We also analyze
delinquency trends, which have remained stable, general economic conditions and
geographic and industry concentrations. This analysis establishes factors that
are applied to the loan groups to determine the amount of the general reserve.
The principal assumption used in deriving the allowance for loan losses is the
estimate of loss content for each risk rating.
Mortgage Servicing Rights. We sell to investors a portion of our originated
one- to four-family residential real estate mortgage loans. When we acquire
mortgage servicing rights through the origination and sale of mortgage loans
with servicing rights retained, we allocate a portion of the total cost of the
mortgage loans to the mortgage servicing rights based on their relative fair
value. As of September 30, 2005, we were servicing loans sold to others totaling
$138.2 million. We amortize capitalized mortgage servicing rights as a reduction
of servicing fee income in proportion to, and over the period of, estimated net
servicing income by use of a method that approximates the level-yield method. We
periodically evaluate capitalized mortgage servicing rights for impairment using
a model that takes into account several variables including expected prepayment
speeds and prevailing interest rates. If we identify impairment, we charge the
amount of the impairment to earnings by establishing a valuation allowance
against the capitalized mortgage servicing rights asset. The primary risk of
material changes to the value of the servicing rights resides in the potential
volatility in the economic assumptions used, particularly the prepayment speed.
We monitor this risk and adjust the valuation allowance as necessary to
adequately record any probable impairment in the portfolio. Management believes
the estimation of these variables makes this a critical accounting policy. For
purposes of measuring impairment, the mortgage servicing rights are stratified
based on financial asset type and interest rates. In addition, we obtain an
independent third-party valuation of the mortgage servicing portfolio on a
quarterly basis. In general, the value of mortgage servicing rights increases as
interest rates rise and decreases as interest rates fall. This is because the
estimated life and estimated income from a loan increase as interest rates rise
and decrease as interest rates fall. The key economic assumptions made in
determining the fair value of the mortgage servicing rights at September 30,
2005 included the following:
Annual constant prepayment speed (CPR): 8.74%
Weighted average life remaining of the underlying loans (in months): 251
Discount rate used: 8.00%
At September 30, 2005, we calculated the value of our mortgage servicing
rights to be $1.7 million and the weighted average life remaining of those
rights was 58 months. The book value of our mortgage servicing rights as of
September 30, 2005 was $775,000 which was $925,000 less than the independent
valuation and $85,000 lower than the December 31, 2004 value. Because the fair
value exceeded the book value, there was no need to establish a valuation
allowance.
Impairment of Intangible Assets. Goodwill arising from business
acquisitions represents the value attributable to unidentifiable intangible
elements in the business acquired. The fair value of goodwill is dependent upon
many factors, including our ability to provide quality, cost-effective services
in the face of competition. Because of these many factors, management believes
this is a critical accounting policy.
A significant portion of our intangible assets, including goodwill, relates
to the acquisition premiums recorded with the purchase of the InsuranCenter of
Alpena ("ICA") and certain branches over the last several years. A decline in
earnings as a result of business or market conditions or a run-off of insurance
customers over sustained periods could lead to an impairment of goodwill that
could adversely affect earnings in future periods. Intangible assets are
reviewed periodically for impairment by comparing the fair value of the
intangible asset to the book value of the intangible asset. If the book value is
in excess of the fair value, impairment is indicated and the intangibles must be
written down to their fair value.
9
In connection with our acquisition in 2003 of ICA, we allocated the excess
of the purchase price paid over the fair value of net assets acquired to
intangible assets, including goodwill. These intangible assets included the ICA
customer list and a third-party contract to which ICA is a party. From the date
of acquisition through April 30, 2005 we amortized the value assigned to the
customer list and contract over a period of 20 years. On May 1, 2005 the former
owner of ICA resigned, however the Bank entered into a 10 year consulting
contract with the former owner. As a result, the amortization period for these
intangible assets was reduced to a 10 year period beginning May 1, 2005.
Goodwill is not amortized. The impairment test of goodwill and identified
intangible assets that have an indefinite useful life, performed as of September
30, 2005 and December 31, 2004 in accordance with SFAS No. 142, did not indicate
that an impairment charge was required. Based upon managements' review on
September 30, 2005, it was determined that there was no impairment of the
customer list, the third-party contract or to the true goodwill. If, through
testing, we determine that there is impairment based, for example, on
significant runoff of the customer list or material changes to the third-party
contract, then we may determine to reduce the recorded value of those intangible
assets, which would increase expense and reduce our earnings.
In connection with branch office acquisitions, we assigned the excess of
the purchase price over the fair value of the assets acquired to a core deposit
intangible. The core deposit intangible is tested periodically for impairment.
Our original estimates for the expected life of the deposits have proven to be
relatively accurate as evidenced by the fact that no impairment has been
recorded. If we determine through testing that a significant portion of the
acquired customers no longer do business with us, then the asset would be deemed
to be impaired thereby requiring a charge to earnings to the extent appropriate
given all of the known factors. We amortize core deposit intangibles over a
period of between 10 and 15 years.
NOTE 2--REORGANIZATION.
On April 1, 2005, Alpena Bancshares, Inc. the Company's predecessor,
completed the second-step mutual-to-stock conversion of Alpena Bancshares,
M.H.C., in which shares of common stock representing Alpena Bancshares, M.H.C.'s
ownership interest in Alpena Bancshares, Inc. were sold to investors. As a
result of the conversion and stock offering, Alpena Bancshares, M.H.C. ceased to
exist, its net assets of $207,000 were transferred into First Federal of
Northern Michigan, and First Federal of Northern Michigan Bancorp, Inc. became
the new holding company for First Federal of Northern Michigan. As a result,
First Federal of Northern Michigan Bancorp, Inc. became wholly owned by public
stockholders.
The plan of conversion and reorganization of Alpena Bancshares, M.H.C. and
the issuance and contribution of cash and common stock to First Federal
Community Foundation, a charitable foundation established by the Company, were
approved by the stockholders of Alpena Bancshares, Inc. and the members of
Alpena Bancshares, M.H.C. on March 23, 2005.
First Federal of Northern Michigan Bancorp, Inc. accepted orders to
purchase 1,699,869 shares of common stock at a purchase price of $10.00 per
share. As a part of the conversion, public stockholders of the Company as of the
consummation date received 1.8477 shares of First Federal of Northern Michigan
Bancorp, Inc. common stock in exchange for each of their existing shares of
Company common stock. Cash was issued in lieu of any fractional shares. The
share exchange occurred on April 1, 2005.
As a result of the consummation of the offering, the existing publicly
traded shares of the predecessor company, Alpena Bancshares, Inc., have ceased
trading. First Federal of Northern Michigan Bancorp, Inc.'s common stock began
trading on the Nasdaq National Market under the symbol "FFNM" on April 4, 2005.
All references to the number of shares outstanding for purposes of calculating
per share amounts are revised to give retroactive recognition to the exchange
ratio applied in the conversion.
10
NOTE 3--DIVIDENDS.
Payment of dividends on the common stock is subject to determination and
declaration by the Board of Directors and depends upon a number of factors,
including capital requirements, regulatory limitations on the payment of
dividends, the Company's results of operations and financial condition, tax
considerations and general economic conditions.
On September 13, 2005, the Company declared a cash dividend on its common
stock, payable on or about October 21, 2005, to shareholders of record as of
September 30, 2005, equal to $0.05 per share. The dividend on all shares
outstanding totaled $155,559.
NOTE 4--1996 STOCK OPTION PLAN AND 1996 RECOGNITION AND RETENTION PLAN
As a result of the completion of the second-step conversion and the 1.8477
share exchange ratio in connection with the stock offering, at September 30,
2005 the Company had outstanding stock options for 37,645 shares with a weighted
exercise price of $5.76 compared to outstanding options for 23,711 shares at a
weighted exercise price of $10.60 at December 31, 2004. During the nine months
ended September 30, 2005, the Board of Directors granted no options. On
September 26, 2005 options were exercised for 11,155 shares. At September 30,
2005, options had exercise prices ranging between $5.21 - $7.44 per share and a
weighted average remaining contractual life of 1.11 years.
For the nine months ended September 30, 2005, options for 1,848 shares
(after application of the 1.8477 share exchange ratio as a result of the stock
conversion) were vested. The expense associated with those vested options would
have been $1,040 had the Company elected to adopt FAS 148.
During the nine months ended September 30, 2005 the Company did not award
any shares under the Recognition and Retention Plan ("RRP"). Shares of common
stock granted under the RRP and shares of common stock issued pursuant to the
exercise of stock options under the stock option plan may be acquired by the
Company through open market purchases, from authorized but unissued shares of
common stock or from reacquired shares held by the Company as treasury stock.
NOTE 5 - SEGMENT REPORTING
The Company's principal activities include banking through its wholly owned
subsidiary, First Federal of Northern Michigan (the Bank), and the sale of
insurance products through its indirect wholly owned subsidiary, ICA, purchased
in 2003. The Bank provides financial products including retail and commercial
loans as well as retail and commercial deposits. ICA received commissions from
the sale of various insurance products including health, life, and property. The
segments were determined based on the nature of the products provided to
customers.
The financial information for each operating segment is reported on the
basis used internally to evaluate performance and allocate resources. The
allocations have been consistently applied for all periods presented. Revenues
and expenses between affiliates have been transacted at rates that unaffiliated
parties would pay. The only transaction between the segments thus far relates to
a deposit on behalf of ICA included in the Bank. The interest income and
interest expense for this transaction has been eliminated. All other
transactions are with external customers. The performance measurement of the
operating segments is based on the management structure of the Company and is
not necessarily comparable with similar information for any other financial
institution. The information presented is also not necessarily indicative of the
segment's financial condition and results of operations if they were independent
entities.
11
NOTE 5 - SEGMENT REPORTING (CONTINUED)
For the Three Months September 30, 2005
-------------------------------------------
Bank ICA Eliminations Total
-------- ------ ------------ --------
INTEREST INCOME $ 3,899 $ 3 $ (3) $ 3,899
INTEREST EXPENSE 1,686 -- (3) 1,683
-------- ------ ----- --------
NET INTEREST INCOME - Before provision for loan losses 2,213 3 -- 2,216
PROVISION FOR LOAN LOSSES 4 -- -- 4
-------- ------ ----- --------
NET INTEREST INCOME - After provision for loan losses 2,209 3 -- 2,212
OTHER INCOME 430 726 -- 1,156
OPERATING EXPENSES 2,125 697 -- 2,822
-------- ------ ----- --------
INCOME - Before federal income tax 514 32 -- 546
FEDERAL INCOME TAX 172 11 -- 183
-------- ------ ----- --------
NET INCOME $ 342 $ 21 $ -- $ 363
======== ====== ===== ========
DEPRECIATION AND AMORTIZATION $ 176 $ 56 $ -- $ 232
======== ====== ===== ========
ASSETS $273,782 $3,542 $(476) $276,848
======== ====== ===== ========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ -- $ -- $ -- $ --
Intangible assets -- -- -- --
Property and equipment 146 2 -- 148
-------- ------ ----- --------
TOTAL $ 146 $ 2 $ -- $ 148
======== ====== ===== ========
For the Three Months September 30, 2004
-------------------------------------------
Bank ICA Eliminations Total
-------- ------ ------------ --------
INTEREST INCOME $ 3,445 $ 2 $(2) $ 3,445
INTEREST EXPENSE 1,624 -- (2) 1,622
-------- ------ --- --------
NET INTEREST INCOME - Before provision for loan losses 1,821 2 -- 1,823
PROVISION FOR LOAN LOSSES 68 -- -- 68
-------- ------ --- --------
NET INTEREST INCOME - After provision for loan losses 1,753 2 -- 1,755
OTHER INCOME 487 766 -- 1,253
OPERATING EXPENSES 1,916 725 -- 2,641
-------- ------ --- --------
INCOME - Before federal income tax 324 43 -- 367
FEDERAL INCOME TAX 111 12 -- 123
-------- ------ --- --------
NET INCOME $ 213 $ 31 $-- $ 244
======== ====== === ========
DEPRECIATION AND AMORTIZATION $ 169 $ 39 $-- $ 208
======== ====== === ========
ASSETS $251,153 $3,328 $(5) $254,476
======== ====== === ========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ -- $ -- $-- $ --
Intangible assets -- -- -- --
Property and equipment 37 22 -- 59
-------- ------ --- --------
TOTAL $ 37 $ 22 $-- $ 59
======== ====== === ========
12
For the Nine Months September 30, 2005
-------------------------------------------
Bank ICA Eliminations Total
-------- ------ ------------ --------
INTEREST INCOME $ 11,127 $ 7 $ (7) $ 11,127
INTEREST EXPENSE 4,933 -- (7) 4,926
-------- ------ ----- --------
NET INTEREST INCOME - Before provision for loan losses 6,194 7 -- 6,201
PROVISION FOR LOAN LOSSES 266 -- -- 266
-------- ------ ----- --------
NET INTEREST INCOME - After provision for loan losses 5,928 7 -- 5,935
OTHER INCOME 1,144 2,210 -- 3,354
OPERATING EXPENSES 6,860 2,121 -- 8,981
-------- ------ ----- --------
INCOME - Before federal income tax 212 96 -- 308
FEDERAL INCOME TAX 71 32 -- 103
-------- ------ ----- --------
NET INCOME $ 141 $ 64 $ -- $ 205
======== ====== ===== ========
DEPRECIATION AND AMORTIZATION $ 500 $ 120 $ -- $ 620
======== ====== ===== ========
ASSETS $273,782 $3,542 $(476) $276,848
======== ====== ===== ========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ -- $ -- $ -- $ --
Intangible assets -- -- -- --
Property and equipment 735 11 -- 746
-------- ------ ----- --------
TOTAL $ 735 $ 11 $ -- $ 746
======== ====== ===== ========
For the Nine Months September 30, 2004
-------------------------------------------
Bank ICA Eliminations Total
-------- ------ ------------ --------
INTEREST INCOME $ 9,798 $ 5 $(5) $ 9,798
INTEREST EXPENSE 4,576 -- (5) 4,571
-------- ------ --- --------
NET INTEREST INCOME - Before provision for loan losses 5,222 5 -- 5,227
PROVISION FOR LOAN LOSSES 214 -- -- 214
-------- ------ --- --------
NET INTEREST INCOME - After provision for loan losses 5,008 5 -- 5,013
OTHER INCOME 1,356 2,243 -- 3,599
OPERATING EXPENSES 6,048 2,065 -- 8,113
-------- ------ --- --------
INCOME - Before federal income tax 316 183 -- 499
FEDERAL INCOME TAX 108 59 -- 167
-------- ------ --- --------
NET INCOME $ 208 $ 124 $-- $ 332
======== ====== === ========
DEPRECIATION AND AMORTIZATION $ 526 $ 101 $-- $ 627
======== ====== === ========
ASSETS $251,153 $3,328 $(5) $254,476
======== ====== === ========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ -- $ -- $-- $ --
Intangible assets 47 -- -- 47
Property and equipment 971 41 -- 1,012
-------- ------ --- --------
TOTAL $ 1,018 $ 41 $-- $ 1,059
======== ====== === ========
13
RECENT ACCOUNTING PRONOUNCEMENTS -
In March 2004, the Securities and Exchange Commission issued Staff
Accounting Bulletin (SAB) No. 105, Application of Accounting Principles to Loan
Commitments, which provides guidance regarding loan commitments that are
accounted for as derivative instruments. In this SAB, the Securities and
Exchange Commission determined that an interest rate lock commitment should
generally be valued at zero at inception. The rate locks will continue to be
adjusted for changes in value resulting from changes in market interest rates.
This standard did not have a material effect on our financial condition or
results of operations.
In December 2004, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment"
("Statement No. 123R"), which requires entities to measure the cost of employee
services received in exchange for an award of equity instruments based on the
grant-date fair value of the award (with limited exceptions). The cost is
recognized as an expense over the period during which the employee is required
to provide service in exchange for the award, which is usually the vesting
period. The scope of Statement No. 123R includes the recognition and retention
plan and the stock option plan we expect to adopt in 2006. For shares awarded
under the recognition and retention plan, we will recognize the grant-date fair
value of the shares as compensation expense on a straight-line basis over the
applicable vesting period, which is the same accounting required prior to
Statement No. 123R. For options granted under the stock option plan, we will
recognize the grant-date fair value of the options as compensation expense on a
straight-line basis over the applicable vesting period. This accounting
treatment differs significantly from the previous accounting for fixed stock
options under Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees," which generally required expense recognition only when the
exercise price of the option was less than the market price of the underlying
stock on the grant date. As required by Statement No. 123R, we will estimate the
fair value of our stock options on each grant date, using an appropriate
valuation approach such as the Black-Scholes option pricing model. Statement No.
123R did not change existing accounting principles applicable to employee stock
ownership plans. The provisions of this Statement will be effective for the
Company beginning in the first quarter of 2006. The Company is currently
evaluating the impact this new Standard will have on its financial position,
results of operations or cash flows, although the effect is not expected to be
material.
14
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
AND SUBSIDIARIES
PART I - FINANCIAL INFORMATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion compares the consolidated financial condition of the
Company at September 30, 2005 and December 31, 2004, and the results of
operations for the three- and nine-month periods ended September 30, 2005 and
2004. This discussion should be read in conjunction with the interim financial
statements and footnotes included herein.
OVERVIEW
OPERATING RESULTS: Operating results increased by $119,000 to $363,000 for the
quarter ended September 30, 2005, from $244,000 for the quarter ended September
30, 2004. Year to date 2005 net income was $205,000 compared to the first nine
months of 2004 when net income was $332,000. The Bank's return on average assets
(ROA) for the twelve months ended September 30, 2005 was 30 basis points
compared to 34 basis points for the same period one year earlier. Management
uses ROA as a tool to measure the performance of the Bank. ROA is reviewed on a
trailing twelve-month basis each month by management and the Board of Directors.
The decline in year-to-date earnings can be broken down into two off-setting key
components: our contribution of cash and stock to First Federal Community
Foundation and an increase in our net interest margin.
CONTRIBUTION TO FIRST FEDERAL COMMUNITY FOUNDATION - On April 1, 2005 the
Company made a one-time contribution of cash and common stock to First Federal
Community Foundation totaling $679,940. This contribution was pursuant to the
plan of conversion and reorganization which was approved on March 23, 2005.
NET INTEREST MARGIN - The Company's Net Interest Margin (N.I.M.) which
represents net interest income divided by average interest earning assets
increased to 3.28% for the nine months ended September 2005 from 3.10% for the
nine months ended September 30, 2004. The increase was mainly due to increasing
yields on variable rate loans period over period.
CAPITAL EXPENDITURES: On August 31, 2005 the Company broke ground on a new bank
branch to replace an existing leased branch in Lewiston, Michigan. As of
September 30, 2005 the Company had expended approximately $236,000 on the new
branch, including the cost of the land. The total cost of the construction
project is expected to be approximately $1,130,000. The Company believes that
the new branch, which is expected to open for business in early 2006, will
further enhance its expansion into the Lewiston market.
FINANCIAL CONDITION
ASSETS: Total assets increased $14.0 million, or 5.0%, to $276.8 million at
September 30, 2005 from $262.8 million at December 31, 2004. Cash and cash
equivalents increased by $2.3 million, or 49.4%, to $7.1 million at September
30, 2005 from $4.7 million at December 31, 2004. Investment securities available
for sale increased $6.9 million, or 17.3%, in the first nine months of 2005. The
increase in bonds beyond premium amortizations and discount accretions was the
result of $393,000 of unrealized loss on available for sale securities, $1.2
million of mortgage-backed securities payments received, and net investing
activities of $8.7 million in agency securities. Net loans receivable increased
$4.7 million, or 2.4%, to $200.1 million at September 30, 2005 from $195.4
million at December 31, 2004. The growth of net loans was attributable primarily
to growth in the commercial loan portfolios which grew by $6.3 million during
the period from December 31, 2004 through September 30, 2005. The mortgage loan
portfolio decreased $2.1 million during this same time period, while the
consumer loan portfolio grew by $600,000.
15
LIABILITIES: Deposits increased $11.6 million, or 6.0%, to $194.1 million at
September 30, 2005 from $182.5 million at December 31, 2004. Borrowings,
consisting mainly of Federal Home Loan Bank advances, decreased $13.1 million,
or 23.4%, to $42.9 million at September 30, 2005 from $56.0 million at December
31, 2004. The Bank, through an infusion of capital of $11.5 million from the
Company in the second quarter of 2005, paid down overnight advances as a
temporary alternative to purchasing low-yielding investment securities. In the
quarter ended September 30, 2005, the Company was able to fund securities
purchases of $4.0 million through deposit growth as well as pay down additional
FHLB advances, resulting in the net decrease in borrowed funds of $13.1 million
for the first nine months of 2005.
EQUITY: Stockholders' equity increased by $14.8 million, or 68.0%, to $36.6
million at September 30, 2005 from $21.8 million at December 31, 2004. The
increase in stockholders' equity reflects the issuance of 1,699,869 new shares
at $10.00 per share in the second step conversion and stock offering, less costs
of the transaction.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2005 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2004
GENERAL: Net income increased by $119,000 to $363,000 for the three months ended
September 30, 2005 from $244,000 for the same period ended September 30, 2004.
The increase for the three month period was attributable to an increase in net
interest income after provision for loan loss of $457,000 which was partially
offset by a decrease in non-interest income and an increase in non-interest
expense.
INTEREST INCOME: Interest income was $3.9 million for the three months ended
September 30, 2005, compared to $3.4 million for the comparable period in 2004.
The increase in interest income for the three month period over the prior year
was due to an increase in average balances of commercial loans, and an increase
in yield on adjustable rate loans. Fixed rate commercial mortgage loans
generated an additional $175,000 in interest income for the quarter ended
September 30, 2005 as compared to the same period a year ago due to an increase
in average balance of $7.1 million period over period. Adjustable rate
commercial loans, which are tied to the prime rate, generated an additional
$166,000 in interest income for the quarter ended September 30, 2005 as compared
to the same quarter a year ago, due in part to an increase in average balance of
$4.6 million and in part to an increase in the prime rate of 200 basis points
from 4.75% at September 30, 2004 to 6.75% at September 30, 2005. An increase in
yield on other adjustable rate loans, consisting primarily of adjustable
mortgage and home equity line of credit (HELOC) loans also contributed to the
increase in interest income for the quarter ended September 30, 2005 as compared
to the same period one year ago.
INTEREST EXPENSE: Interest expense was $1.7 million for the three month period
ended September 30, 2005, compared to $1.6 million for the same period in 2004.
The 3.7% increase in interest expense was attributable to an increased cost of
funds on interest-bearing deposits for the period ended September 30, 2005
compared to September 30, 2004. The average balance of interest-bearing deposits
increased by $12.5 million or 7.5% when compared to September 30, 2004 and the
cost of those deposits increased by 5 basis points. The average balance of FHLB
borrowings decreased from $56.7 million for the three month period ended
September 30, 2004 to $47.8 million for the same period ended September 30, 2005
and the cost of those borrowings decreased by 2 basis points, due primarily to
the maturity of high-cost advances.
NET INTEREST INCOME: Net interest income increased to $2.2 million for the three
month period ended September 30, 2005 compared to $1.8 million for the same
period in 2004. For the three months ended September 30, 2005, average
interest-earning assets increased $18.7 million, or 7.8%, when compared to the
same period in 2004. Average interest-bearing liabilities increased $3.6
million, or 1.6%, for the same period. The yield on average interest-earning
assets increased to 6.0% for the three month period ended September 30, 2005
from 5.87% for the same period ended in 2004 as the cost of average
interest-bearing liabilities increased to 2.93% from 2.88% for the three month
periods ended September 30, 2005 and September 30, 2004, respectively. The
increase in yields on interest earning assets exceeded the impact of the
increase in the cost of funds creating an increase in the net interest margin of
24 basis points to 3.44% for the three month period ended September 30, 2005
from 3.20% for same period in 2004.
16
PROVISION FOR LOAN LOSSES: The allowance for loan losses is established through
a provision for loan losses charged to earnings. Loan losses are charged against
the allowance when management believes the uncollectibility of a loan balance is
confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and
is based upon management's periodic review of the collectibility of the loans in
light of historical experience, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower's ability to repay, estimated
value of any underlying collateral and prevailing economic conditions. This
evaluation is inherently subjective, as it requires estimates that are
susceptible to significant revision as more information becomes available. The
provision for loan losses amounted to $4,000 for the three month period ended
September 30, 2005 and $68,000 for the comparable period in 2004. The decrease
in the provision was due to declining loan balances in the quarter ended
September 30, 2005, which resulted in a lower required provision for the
quarter.
NON INTEREST INCOME: Other income was $1.2 million for the three month period
ended September 30, 2005, a decrease of $100,000 or 7.7%, from the same period
in 2004. The primary reason for the decrease was a $55,000 decrease in mortgage
banking activities for the three month period ended September 30, 2005 as
compared to the same period in 2004.
NON INTEREST EXPENSE: Non interest expense was $2.8 million for the three month
period ended September 30, 2005, a $181,000 or 6.8% increase from the same
period in 2004. The increase was primarily due to an increase of $98,000 in
compensation and employee benefits for the three month period ended September
30, 2005 as compared to the same period in 2004.
INCOME TAXES: Federal income taxes increased to $183,000 for the three month
period ended September 30, 2005 compared to $122,000 for the same period in
2004. The increase for the three month period was attributable to an increase in
pre-tax income.
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2005 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2004
GENERAL: Net income decreased $127,000 to $205,000 for the nine months ended
September 30, 2005 from $332,000 for the same period ended September 30, 2004.
While net interest income was higher than the same period one year earlier by
$974,000, non-interest income was lower by $245,000. Non-interest expense
increased $868,000 primarily due to the $679,940 one-time contribution to the
First Federal Community Foundation and a $245,000 increase in compensation and
employee benefits period over period. The income tax expense for the nine months
ended September 30, 2005 decreased by $64,000 as compared to the same period in
2004 due to the decrease in pre-tax income period over period.
INTEREST INCOME: Interest income was $11.1 million for the nine months ended
September 30, 2005, compared to $9.8 million for the comparable period in 2004.
This increase of $1.3 million, or 13.6%, in interest income was due to an
increase in average balances of commercial loans, and an increase in yield in
adjustable rate loans. Adjustable rate commercial loans, which are tied to the
prime rate, generated an additional $400,000 in interest income for the nine
months ended September 30, 2005 as compared to the year earlier, due in part to
an increase in average balance of $4.6 million and in part to an increase in the
prime rate of 200 basis points from 4.75% at September 30, 2004 to 6.75% at
September 30, 2005. An increase in yield on other adjustable rate loans,
consisting primarily of adjustable mortgage and home equity line of credit loans
also contributed to the increase in interest income for the nine months ended
September 30, 2005 as compared to the same period one year earlier.
INTEREST EXPENSE: Interest expense was $4.9 million for the nine month period
ended September 30, 2005 compared to $4.6 million for the same period in 2004.
The 7.8% increase in interest expense was attributable to an increased cost of
funds on interest-bearing deposits for the period ended September 30, 2005
compared to September 30, 2004. The average balance of interest-bearing deposits
increased by $20.1 million or 13.0% when compared to September 30, 2004 and the
cost of those deposits increased by 13 basis points. The average
17
balance of FHLB borrowings decreased from $55.0 million for the period ended
September 30, 2004 to $52.1 million for the period ended September 30, 2005,
while the cost of those borrowings decreased by 1 basis point, due primarily to
maturing advances which were replaced by lower cost of funds advances.
NET INTEREST INCOME: Net interest income increased by $974,000 for the nine
month period ended September 30, 2005 compared to the same period in 2004. For
the nine months ended September 30, 2005, average interest-earning assets
increased $26.8 million, or 11.9% when compared to the same period in 2004.
Average interest-bearing liabilities increased $17.3 million, or 8.2% for the
same period. The yield on average interest-earning assets increased to 5.87% for
the nine month period ended September 30, 2005 from 5.79% for the same period
ended in 2004 while the cost of average interest-bearing liabilities declined to
2.89% from 2.90% for the nine month periods ended September 30, 2005 and
September 30, 2004, respectively. The net result of the 8 basis point increase
in asset yields and 1 basis point decrease in the cost of funds was a net
interest rate margin increase of 18 basis points to 3.28% for the nine month
period ended September 30, 2005, from 3.10% for same period in 2004.
DELINQUENT LOANS AND NONPERFORMING ASSETS. The following table sets forth
information regarding loans delinquent 90 days or more and real estate
owned/other repossessed assets of the Bank at the dates indicated. As of the
dates indicated, the Bank did not have any material restructured loans within
the meaning of SFAS 15.
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------- ------------
(Dollars in thousands)
Total non-accrual loans (1) ........................... $1,154 $ 478
------ ------
Accrual loans delinquent 90 days or more:
One- to four-family residential .................... 832 960
Other real estate loans ............................ 130 --
Consumer/Commercial ................................ 470 280
------ ------
Total accrual loans delinquent 90 days or more .. $1,432 $1,240
------ ------
Total nonperforming loans (2) ......................... 2,586 1,718
Total real estate owned-residential mortgages (3) ..... 385 9
Total real estate owned-Consumer and other (3) ........ 78 20
====== ======
Total nonperforming assets ............................ $3,049 $1,747
====== ======
Total nonperforming loans to loans receivable ......... 1.29% 0.87%
Total nonperforming assets to total assets ............ 1.10% 0.66%
(1) For the nine months ended September 30, 2005 and the twelve months ended
December 31, 2004, the interest that would have been reported was $61,218
and $75,307 respectively were these loans not in non-accrual status.
(2) All of the Bank's loans delinquent more than 90 days are classified as
nonperforming.
(3) Represents the net book value of property acquired by the Bank through
foreclosure or deed in lieu of foreclosure. Upon acquisition, this property
is recorded at the lower of its fair market value or the principal balance
of the related loan.
PROVISION FOR LOAN LOSSES: The provision for loan losses amounted to $266,000
for the nine month period ended September 30, 2005 and $214,000 for the
comparable period in 2004. At September 30, 2005, the percent of nonperforming
loans increased to 129 basis points from 87 basis points at December 31, 2004.
As a percent of total assets, nonperforming loans increased to 110 basis points
at September 30, 2005 from 66 basis points at December 31, 2004. Although total
nonperforming assets increased $1.3 million from December 31, 2004 to September
30, 2005 management believes the provision for loan loss is adequate. The two
main areas of increase in nonperforming assets were non-accrual loans, the
increase in which represents mostly well-collateralized mortgage loans, and
total real estate owned-residential mortgages, which have been written down to
the net realizable value of the collateral.
18
NON INTEREST EXPENSE: Non interest expense was $9.0 million for the nine month
period ended September 30, 2005, an $868,000 or 10.7% increase from the same
period in 2004. The increase was primarily due to the $679,940 one-time
contribution to the First Federal Community Foundation and to a $ 245,000, or
5.5% increase in compensation and employee benefits from the nine month period
ended September 30, 2004 to the comparable period in 2005.
INCOME TAXES: Federal income tax expense decreased to $103,000 for the nine
months ended September 30, 2005 compared to $167,000 for the same period in
2004. The decrease for the nine month period was attributable to a decrease in
pre-tax income.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of funds are the Bank's deposits, FHLB advances,
and proceeds from principal and interest payments and prepayments on loans and
mortgage-backed and investment securities. While maturities and scheduled
amortization of loans and mortgage-backed securities are a predictable source of
funds, deposit flows and mortgage prepayments are greatly influenced by general
interest rates, economic conditions and competition.
Liquidity represents the amount of an institution's assets that can be quickly
and easily converted into cash without significant loss. The most liquid assets
are cash, short-term U.S. Government securities, U.S. Government agency
securities and certificates of deposit. The Bank is required to maintain
sufficient levels of liquidity as defined by OTS regulations. This requirement
may be varied at the direction of the OTS. Regulations currently in effect
require that the Bank must maintain sufficient liquidity to ensure its safe and
sound operation. The Banks's objective for liquidity is to be above 20%.
Liquidity as of September 30, 2005 was $83.1 million, or 43.4%, compared to
$83.4 million, or 47.6% at December 31, 2004. The levels of these assets are
dependent on the Bank's operating, financing, lending and investing activities
during any given period. The liquidity calculated by the Bank includes
additional borrowing capacity available with the FHLB. This borrowing capacity
is based on the FHLB stock owned by the Bank along with pledged collateral. As
of September 30, 2005, the Bank had unused borrowing capacity totaling $53.0
million at the FHLB based on the FHLB stock ownership.
The Bank intends to retain for its portfolio certain originated residential
mortgage loans (primarily adjustable rate, balloon and shorter term fixed rate
mortgage loans) and to generally sell the remainder in the secondary market. The
Bank will from time to time participate in or originate commercial real estate
loans, including real estate development loans. During the nine month period
ended September 30, 2005 the Bank originated $42.3 million in residential
mortgage loans, of which $25.6 million were retained in portfolio while the
remainder were sold in the secondary market or are being held for sale. This
compares to $46.6 million in originations during the first nine months of 2004
of which $27.5 million were retained in portfolio. The Bank also originated
$25.9 million of commercial loans and $9.8 million of consumer loans in the
first nine months of 2005 compared to $26.5 million of commercial loans and
$14.3 million of consumer loans for the same period in 2004. Of total loans
receivable, excluding loans held for sale, mortgage loans comprised 53.7% and
56.1%, commercial loans 33.4% and 31.0% and consumer loans 13.0 % and 13.0% at
September 30, 2005 and December 31, 2004, respectively.
At September 30, 2005, the Bank had outstanding loan commitments of $53.7
million. These commitments included $11.2 million for permanent one-to-four
family dwellings, $14.0 million for non-residential loans, $2.8 million of
undisbursed loan proceeds for construction of one-to-four family dwellings, $8.6
million of undisbursed lines of credit on home equity loans, $1.4 million of
unused credit card lines and $11.7 million of unused commercial lines of credit,
$2.2 million of undisbursed commercial construction, $70,000 of unused Letters
of Credit and $1.7 million in unused bounce protection.
19
Deposits are a primary source of funds for use in lending and for other general
business purposes. At September 30, 2005 deposits funded 70.1% of the Company's
total assets compared to 69.4% at December 31, 2004. Certificates of deposit
scheduled to mature in less than one year at September 30, 2005 totaled $61.4
million. Management believes that a significant portion of such deposits will
remain with the Bank. The Bank monitors the deposit rates offered by competition
in the area and sets rates that take into account the prevailing market
conditions along with the Bank's liquidity position. Moreover, management
believes that the growth in assets is not expected to require significant
in-flows of liquidity. As such, the Bank does not expect to be a market leader
in rates paid for liabilities. Borrowings may be used to compensate for seasonal
or other reductions in normal sources of funds or for deposit outflows at more
than projected levels. Borrowings may also be used on a longer-term basis to
support increased lending or investment activities. At September 30, 2005 the
Bank had $41.8 million in FHLB advances. FHLB borrowings as a percentage of
total assets were 15.1% at September 30, 2005 as compared to 20.8% at December
31, 2004. The Bank has sufficient available collateral to obtain additional
advances of $5.4 million. When this is combined with current FHLB stock
ownership the Bank could obtain up to an additional $53.0 million in advances
from the FHLB.
Stockholders' equity at September 30, 2005 was $36.7 million, or 13.3% of total
assets, compared to $21.8 million, or 8.3% of total assets, at December 31, 2004
(See "Consolidated Statement of Changes in Stockholders' Equity"). The Bank is
subject to certain capital-to-assets levels in accordance with OTS regulations.
The Bank exceeded all regulatory capital requirements at September 30, 2005. The
following table summarizes the Bank's actual capital with the regulatory capital
requirements and with requirements to be "Well Capitalized" under prompt
corrective action provisions, as of September 30, 2005:
Minimum
Regulatory To Be Well
Actual Minimum Capitalized
--------------- --------------- ---------------
Amount Ratio Amount Ratio Amount Ratio
------- ----- ------- ----- ------- -----
(Dollars in Thousands)
Capital Requirements:
Tangible equity capital $32,850 12.03% $ 4,097 1.50% $ 5,462 2.00%
Tier 1 (Core) capital $32,850 12.03% $10,925 4.00% $13,656 5.00%
Total risk-based capital $34,258 18.65% $14,698 8.00% $18,373 10.00%
Tier 1 risk-based capital $32,850 17.88% $ 7,349 4.00% $11,024 6.00%
20
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-QSB
QUARTER ENDED SEPTEMBER 30, 2005
PART I - FINANCIAL INFORMATION
ITEM 3 - CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management, including
the Company's Chief Executive Officer and Chief Financial Officer, the Company
evaluated the effectiveness of the design and operation of its disclosure
controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934) as of the end of the period covered by this
report. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that, as of the end of the period covered by this
report, the Company's disclosure controls and procedures were effective to
ensure that information required to be disclosed in the reports the Company
files or submits under the Securities Exchange Act of 1934, is recorded,
processed, summarized and reported, within the time periods specified by the
SEC's rules and forms and in timely alerting them to material information
relating to the Company (or its consolidated subsidiaries) required to be
included in its periodic SEC filings.
There were no significant changes made in the Company's internal control over
financial reporting or in other factors that could significantly affect the
Company's internal controls over financial reporting during the period covered
by this report that has materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial reporting.
21
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-QSB
QUARTER ENDED SEPTEMBER 30, 2005
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings:
There are no material legal proceedings to which the Company is a
party or of which any of its property is subject. From time to time
the Company is a party to various legal proceedings incident to its
business.
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds:
No equity securities were sold during the quarter ended September 30,
2005 that were not registered under the Securities Act. No repurchases
of common stock were made during the quarter.
Of the net proceeds of approximately $16.0 million from the sale of
common stock, $4.5 million were invested in federal agency
obligations, $8.4 million were used to fund loans and deposit
withdrawals, and the remaining $3.1 million were initially used to pay
down variable rate FHLB advances, but have since been invested in
additional federal agency obligations. In addition, approximately $1.1
million will be used to fund the Bank's new branch in Lewiston.
Item 3 - Defaults upon Senior Securities:
Not applicable.
Item 4 - Submission of Matters to a Vote of Security Holders:
Not applicable
Item 5 - Other Information:
Not applicable
Item 6 - Exhibits and Reports on Form 8-K
Exhibit 31.1 Certification by Chief Executive Officer pursuant to
section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 31.2 Certification by Chief Financial Officer pursuant to
section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1 Statement of Chief Executive Officer furnished pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.2 Statement of Chief Financial Officer furnished pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
22
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-QSB
QUARTER ENDED SEPTEMBER 30, 2005
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FIRST FEDERAL OF NORTHERN MICHIGAN
BANCORP, INC.
By: /s/ Martin A. Thomson
-------------------------------------
Martin A. Thomson
President and Chief Executive Officer
Date: November 14, 2005
By: /s/ Amy E. Essex
-------------------------------------
Amy E. Essex, Chief Financial Officer
(Principal Financial and Accounting
Officer)
Date: November 14, 2005
23
Exhibit Index
Exhibit No. Description
------------ -----------
Exhibit 31.1 Certification by Chief Executive Officer pursuant to section 302
of the Sarbanes-Oxley Act of 2002
Exhibit 31.2 Certification by Chief Financial Officer pursuant to section 302
of the Sarbanes-Oxley Act of 2002
Exhibit 32.1 Statement of Chief Executive Officer furnished pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.2 Statement of Chief Financial Officer furnished pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002