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 JUNE 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 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 August 8, 2005
(Title of Class) 3,100,021 shares
Transitional Small Business Disclosure Format: Yes [ ] No [X]
1
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-QSB
QUARTER ENDED JUNE 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
June 30, 2005 and December 31, 2004.............................................. 4
Consolidated Statements of Income for the Three and Six Months
Ended June 30, 2005 and June 30, 2004............................................ 5
Consolidated Statement of Changes in Stockholders' Equity
for the Six Months Ended June 30, 2005........................................... 6
Consolidated Statements of Cash Flow for the Six Months Ended
June 30, 2005 and June 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
June 30, 2005 December 31, 2004
------------- -----------------
(Unaudited)
ASSETS
Cash and cash equivalents:
Cash on hand and due from banks ................................................ $ 4,119,737 $ 4,685,913
Overnight deposits with FHLB ................................................... 445,554 52,646
------------- -----------------
Total cash and cash equivalents ................................................ 4,565,291 4,738,559
Securities AFS ................................................................ 43,909,279 40,233,035
Securities HTM ................................................................. 1,800,000 1,800,000
Loans held for sale ............................................................ 1,403,899 1,095,660
Loans receivable, net of allowance for loan losses of $1,362,223 and
$1,213,938 as of June 30, 2005 and December 31, 2004, respectively ........... 204,795,111 195,387,937
Foreclosed real estate and other repossessed assets ............................ 245,264 28,907
Real estate held for investment ................................................ 344,941 562,758
Federal Home Loan Bank stock, at cost .......................................... 4,765,000 4,666,100
Premises and equipment ......................................................... 7,125,593 6,793,998
Accrued interest receivable .................................................... 1,319,107 1,034,695
Intangible assets .............................................................. 2,704,682 2,855,568
Goodwill ....................................................................... 1,049,854 1,049,854
Other assets ................................................................... 2,500,365 2,553,063
------------- -----------------
Total assets ................................................................... $ 276,528,386 $ 262,800,134
============= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits ....................................................................... $ 182,747,919 $ 182,489,148
Advances from borrowers for taxes and insurance ................................ 342,848 44,590
Federal Home Loan Bank advances & Note Payable ................................. 54,175,223 56,001,396
Accrued expenses and other liabilities ......................................... 2,873,320 2,488,711
------------- -----------------
Total liabilities .............................................................. 240,139,310 241,023,845
------------- -----------------
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; 3,100,021 and 1,659,480 shares issued
and outstanding, respectively)................................................ 31,000 1,659,480
Additional paid-in capital ..................................................... 23,490,134 5,356,782
Retained earnings, restricted .................................................. - 5,152,000
Retained earnings ............................................................. 14,400,336 9,635,580
Unallocated ESOP ............................................................... (1,356,270) -
Accumulated other comprehensive loss............................................ (176,124) (27,553)
------------- -----------------
Total stockholders' equity ..................................................... 36,389,076 21,776,289
------------- -----------------
Total liabilities and stockholders' equity ..................................... $ 276,528,386 $ 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 Six Months
Ended June 30, Ended June 30,
----------------------- -------------------------
2005 2004 2005 2004
----------- ---------- ----------- ----------
(Unaudited) (Unaudited)
Interest income:
Interest and fees on loans ........................................... $ 3,255,421 $2,776,110 $ 6,352,148 $5,450,389
Interest and dividends on investments ................................ 404,016 432,009 745,660 788,676
Interest on mortgage-backed securities ............................... 63,386 53,278 130,103 113,502
----------- ---------- ----------- ----------
Total interest income ................................................ 3,722,823 3,261,397 7,227,911 6,352,567
----------- ---------- ----------- ----------
Interest expense:
Interest on deposits ................................................. 1,026,234 845,945 2,007,172 1,659,352
Interest on borrowings ............................................... 617,737 658,415 1,235,713 1,289,621
----------- ---------- ----------- ----------
Total interest expense ............................................... 1,643,971 1,504,360 3,242,885 2,948,973
----------- ---------- ----------- ----------
Net interest income .................................................. 2,078,852 1,757,037 3,985,026 3,403,594
Provision for loan losses ............................................ 183,000 65,000 262,258 146,000
----------- ---------- ----------- ----------
Net interest income after provision for loan losses .................. 1,895,852 1,692,037 3,722,768 3,257,594
----------- ---------- ----------- ----------
Non Interest income:
Service charges and other fees ....................................... 253,903 245,662 485,324 488,724
Mortgage banking activities .......................................... 108,999 106,529 227,687 249,855
Gain on sale of available-for-sale investments ....................... 13,127 95,669 13,127 95,669
Net gain on sale of premises and equipment,
real estate owned and other repossessed assets ..................... (13,958) 16,556 (18,865) (6,329)
Other ................................................................ (11,910) 29,843 10,157 50,100
Insurance & Brokerage Commissions .................................... 748,477 715,126 1,480,531 1,469,050
----------- ---------- ----------- ----------
Total other income ................................................... 1,098,638 1,209,385 2,197,961 2,347,069
----------- ---------- ----------- ----------
Non interest expenses:
Compensation and employee benefits ................................... 1,569,472 1,497,284 3,133,756 2,985,982
SAIF Insurance Premiums .............................................. 6,408 9,090 12,897 14,962
Advertising .......................................................... 34,927 68,574 74,784 124,742
Occupancy ............................................................ 311,651 331,061 626,651 657,204
Amortization of intangible assets .................................... 80,305 77,824 150,886 155,187
Service Bureau Charges ............................................... 84,753 78,845 174,716 162,009
Insurance & Brokerage Commission Expense ............................. 317,704 318,852 598,203 634,413
Professional Services ................................................ 81,260 43,146 139,916 119,699
Donation to First Federal Community Foundation ....................... 679,940 - 679,940 -
Other ............................................................... 280,295 323,158 567,148 617,760
----------- ---------- ----------- ----------
Other expenses ....................................................... 3,446,715 2,747,834 6,158,897 5,471,958
----------- ---------- ----------- ----------
Income before income tax expense ..................................... (452,225) 153,588 (238,168) 132,705
Income tax expense ................................................... (151,919) 51,084 (79,873) 44,605
----------- ---------- ----------- ----------
Net income ........................................................... $ (300,306) $ 102,504 $ (158,295) $ 88,100
=========== ========== =========== ==========
Per share data:
Basic earnings per share ............................................. $ (0.09) $ 0.03 $ (0.06) $ 0.03
Weighted average number of shares outstanding ........................ 3,100,021 3,065,203 2,379,751 3,064,858
Diluted earnings per share ........................................... $ (0.09) $ 0.03 $ (0.06) $ 0.03
Weighted average number of shares outstanding, including dilutive
stock options ...................................................... 3,114,215 3,090,025 2,407,168 3,089,149
Dividends per common share ........................................... $ 0.050 $ 0.027 $ 0.055 $ 0.095
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 SIX MONTHS ENDED JUNE 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) 723,997 - - - (1,822)
Proceeds from stock offering, net of
related expenses of $1,036,653
and issuance of 1,699,869 shares
of common stock ($0.01 par) 16,999 15,945,038 - - - 15,962,037
Stock donated to First Federal
Community Foundation pursuant
to conversion (33,997 shares) 340 339,630 - - - 339,970
Purchase of shares for ESOP
(138,709 shares) - - - (1,387,090) - (1,387,090)
Common stock held by ESOP
committed to be released
(3,082 shares) - (3,082) - 30,820 - 27,738
Net loss for the period - - (158,295) - - (158,295)
Changes in unrealized gain
on available-for-sale securities
of subsidiary - - - - (148,571) (148,571)
Total comprehensive income - - - - - (306,866)
Dividends declared - - (228,949) - - (228,949)
----------- ------------- ----------- ------------ ------------- -----------
Balance $ 31,000 $ 23,490,134 $14,400,336 $ (1,356,270) $ (176,124) $36,389,076
=========== ============= =========== ============ ============= ===========
6
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
For Six Months Ended
June 30,
--------------------------------
2005 2004
------------ ------------
(Unaudited)
Cash flows from operating activities:
Net income ..................................................................... $ (158,295) $ 185,049
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization............................................... 398,214 377,301
Provision for Loan Loss..................................................... 262,258 146,000
Amortization and accretion on securities.................................... 79,998 207,552
Originations of loans held for sale ........................................ (9,096,285) (11,231,391)
Principal amount of loans sold.............................................. 8,788,046 11,628,116
Purchase of real estate held for sale....................................... (30,416) -
Proceeds from sale of real estate........................................... 246,340 -
Loss on sale of real estate held for investment............................. 1,893 -
Change in accrued interest receivable....................................... (284,412) (28,238)
Change in other assets...................................................... 52,698 -
Change in accrued expenses and other liabilities............................ 461,146 (810,943)
Stock donated to charitable foundation...................................... 339,970 -
Shares held by ESOP committed to be released................................ 27,738 -
------------ ------------
Net cash provided by (used in) operating activities ............................ 1,088,893 473,446
------------ ------------
Net (Increase) decrease in loans ............................................... (9,669,432) (22,486,704)
Proceeds from maturity of available-for-sale securities....................... 5,545,075 12,776,041
Proceeds from sale of real estate owned, other repossessed assets............. (216,357) 167,672
Purchase of securities available for sale..................................... (9,526,425) (26,530,690)
Purchase of Federal Home Loan Bank Stock...................................... (98,900) (106,300)
Purchase of InsuranCenter of Alpena........................................... (111,173) (111,563)
Purchase of premises and equipment ........................................... (578,923) (874,532)
------------ ------------
Net cash provided by (used in) investing activities ............................ (14,656,135) (37,166,076)
------------ ------------
Net Increase (decrease) in deposits .......................................... 258,771 17,474,248
Dividend paid on common stock ................................................ (228,949) (129,307)
Net increase (decrease) in advances from borrowers............................ 298,258 298,695
Additions to advances from Federal Home Loan Bank and Notes Payable.......... 6,500,000 -
Repayments of Federal Home Loan Bank advances and Notes Payable............... (8,215,000) 16,144,623
Proceeds from exercise of stock options ...................................... - 18,013
Net proceeds from stock offering.............................................. 15,962,037 -
Merger of Alpena Bancshares, MHC.............................................. 207,769 -
Cash paid for fractional shares in conversion................................. (1,822) -
Purchase of shares for ESOP................................................... (1,387,090) -
------------ ------------
Net cash provided by (used in) financing activities ............................ 13,393,974 33,806,272
------------ ------------
Net increase (decrease) in cash and cash equivalents............................ (173,268) (2,886,358)
Cash and cash equivalents at beginning of period................................ 4,738,559 6,705,125
------------ ------------
Cash and cash equivalents at end of period...................................... $ 4,565,291 $ 3,818,767
============ ============
Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes ................................... $ - $ 17,785
============ ============
Cash paid during the period for interest ....................................... $ 3,249,174 $ 2,879,942
============ ============
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 June 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 six
months ended June 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 June 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 June 30, 2005
included the following:
Annual constant prepayment speed (CPR): 9.99%
Weighted average life remaining (in months): 46.4
Discount rate used: 8.00%
At the June 30, 2005, we calculated the value of our mortgage servicing
rights to be $1.6 million. The book value of our mortgage servicing rights as of
June 30, 2005 was $796,000 which was $804,000 less than the independent
valuation and $64,000 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 has 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 June 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 June
30, 2005, it was determined that there was no impairment of the customer list,
the Blue Cross 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
need to reduce the recorded value of those intangible assets, which would
increase expense and reduce our earnings.
In connection with branch offices that were acquired over the last decade,
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 related to 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, the Company 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 the Company were
sold to investors. As a result of the conversion and stock offering, Alpena
Bancshares, M.H.C. ceased to exist and its net assets of $207,000 were
transferred into First Federal of Northern Michigan. The Company was succeeded
by First Federal of Northern Michigan Bancorp, Inc., a Maryland corporation and
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 the Company 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 June 14, 2005, the Company declared a cash dividend on its common
stock, payable on or about July 22, 2005, to shareholders of record as of June
30, 2005, equal to $0.05 per share. The dividend on all shares outstanding
totaled $155,001.
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 June 30, 2005 the
Company had outstanding stock options for 48,800 shares with a weighted exercise
price of $5.69 compared to outstanding options for 23,711 shares at a weighted
exercise price of $10.60 at December 31, 2004. During the six months ended June
30, 2005, the Board of Directors granted no options nor were there any options
for shares exercised. At June 30, 2005, options had exercise prices ranging
between $5.21 - $7.44 per share and a weighted average remaining contractual
life of 1.22 years.
For the six months ended June 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 six months ended June 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 Ended
June 30, 2005
------------------------------------------------
Bank ICA Eliminations Total
--------- ------- ------------ ----------
INTEREST INCOME $ 3,723 $ 1 $ (1) $ 3,723
INTEREST EXPENSE 1,645 - (1) 1,644
--------- ------- ------------ ----------
NET INTEREST INCOME - Before provision for loan losses 2,078 1 - 2,079
PROVISION FOR LOAN LOSSES 183 - - 183
--------- ------- ------------ ----------
NET INTEREST INCOME - After provision for loan losses 1,895 1 - 1,896
OTHER INCOME 349 750 - 1,099
OPERATING EXPENSES 2,729 718 - 3,447
--------- ------- ------------ ----------
INCOME - Before federal income tax (485) 33 - (452)
FEDERAL INCOME TAX (162) 10 - (152)
--------- ------- ------------ ----------
NET INCOME $ (323) $ 23 $ - $ (300)
========= ======= ============ ==========
DEPRECIATION AND AMORTIZATION $ 164 $ 32 $ - $ 196
========= ======= ============ ==========
ASSETS $ 273,344 $ 3,533 $ (349) $ 276,528
========= ======= ============ ==========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ - $ - $ - $ -
Intangible assets - - - -
Property and equipment 249 - - 249
--------- ------- ------------ ----------
TOTAL $ 249 $ - $ - $ 249
========= ======= ============ ==========
For the Three Months Ended
June 30, 2004
------------------------------------------------
Bank ICA Eliminations Total
--------- ------- ------------ ----------
INTEREST INCOME $ 3,262 $ 1 $ (1) $ 3,262
INTEREST EXPENSE 1,505 - (1) 1,504
--------- ------- ------------ ----------
NET INTEREST INCOME - Before provision for loan losses 1,757 1 - 1,758
PROVISION FOR LOAN LOSSES 65 - - 65
--------- ------- ------------ ----------
NET INTEREST INCOME - After provision for loan losses 1,692 1 - 1,693
OTHER INCOME 485 723 - 1,208
OPERATING EXPENSES 2,082 666 - 2,748
--------- ------- ------------ ----------
INCOME - Before federal income tax 95 58 - 153
FEDERAL INCOME TAX 31 20 - 51
--------- ------- ------------ ----------
NET INCOME $ 64 $ 38 $ - $ 102
========= ======= ============ ==========
DEPRECIATION AND AMORTIZATION $ 226 $ 31 $ - $ 257
========= ======= ============ ==========
ASSETS $ 253,196 $ 3,452 $ (616) $ 256,032
========= ======= ============ ==========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ - $ - $ - $ -
Intangible assets 47 - - 47
Property and equipment 794 13 - 807
--------- ------- ------------ ----------
TOTAL $ 841 $ 13 $ - $ 854
========= ======= ============ ==========
12
For the Six Months Ended
June 30, 2005
------------------------------------------------
Bank ICA Eliminations Total
--------- ------- ------------ ----------
INTEREST INCOME $ 7,228 $ 4 $ (4) $ 7,228
INTEREST EXPENSE 3,247 - (4) 3,243
--------- ------- ------------ ----------
NET INTEREST INCOME - Before provision for loan losses 3,981 4 - 3,985
PROVISION FOR LOAN LOSSES 262 - - 262
--------- ------- ------------ ----------
NET INTEREST INCOME - After provision for loan losses 3,719 4 - 3,723
OTHER INCOME 714 1,484 - 2,198
OPERATING EXPENSES 4,735 1,424 - 6,159
--------- ------- ------------ ----------
INCOME - Before federal income tax (302) 64 - (238)
FEDERAL INCOME TAX (101) 21 - (80)
--------- ------- ------------ ----------
NET INCOME $ (201) $ 43 $ - $ (158)
========= ======= ============ ==========
DEPRECIATION AND AMORTIZATION $ 324 $ 64 $ - $ 388
========= ======= ============ ==========
ASSETS $ 273,317 $ 3,533 $ (349) $ 276,528
========= ======= ============ ==========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ - $ - $ - $ -
Intangible assets - - - -
Property and equipment 589 9 - 598
--------- ------- ------------ ----------
TOTAL $ 589 $ 9 $ - $ 598
========= ======= ============ ==========
For the Six Months Ended
June 30, 2005
------------------------------------------------
Bank ICA Eliminations Total
--------- ------- ------------ ----------
INTEREST INCOME $ 6,353 $ 3 $ (3) $ 6,353
INTEREST EXPENSE 2,952 - (3) 2,949
--------- ------- ------------ ----------
NET INTEREST INCOME - Before provision for loan losses 3,401 3 - 3,404
PROVISION FOR LOAN LOSSES 146 - - 146
--------- ------- ------------ ----------
NET INTEREST INCOME - After provision for loan losses 3,255 3 - 3,258
OTHER INCOME 869 1,477 - 2,346
OPERATING EXPENSES 4,132 1,340 - 5,472
--------- ------- ------------ ----------
INCOME - Before federal income tax (8) 140 - 132
FEDERAL INCOME TAX (3) 47 - 44
--------- ------- ------------ ----------
NET INCOME $ (5) $ 93 $ - $ 88
========= ======= ============ ==========
DEPRECIATION AND AMORTIZATION $ 357 $ 62 $ - $ 419
========= ======= ============ ==========
ASSETS $ 253,196 $ 3,452 $ (616) $ 256,032
========= ======= ============ ==========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ - $ - $ - $ -
Intangible assets 47 - - 47
Property and equipment 934 19 - 953
--------- ------- ------------ ----------
TOTAL $ 981 $ 19 $ - $ 1,000
========= ======= ============ ==========
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 following the stock offering.
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.
SUBSEQUENT EVENTS -
Frozen Pension Plan. On April 29, 2005 the Board of Directors voted to
freeze the defined contribution retirement plan as to current participants and
excluded from the plan any new employees hired after July 1, 2004. This change
took place effective July 1, 2005 and is expected to save the Company in excess
of $139,000 for the remaining 6 months of calendar year 2005.
Discretionary Profit Sharing Contribution. In lieu of the retirement
benefit from the frozen pension plan, the Company has announced that it will
implement a discretionary profit sharing contribution of 4% of July 1, 2005 -
December 31, 2005 wages for each employee as of December 1, 2005. For calendar
year 2005 this benefit is expected to cost the Company an estimated $68,000.
14
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
AND SUBSIDIARIES
PART E - 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 June 30, 2005 and December 31, 2004, and the results of operations
for the three and six month periods ended June 30, 2005 and 2004. This
discussion should be read in conjunction with the interim financial statements
and footnotes included herein.
OVERVIEW
Operating results decreased by $402,800 to a net loss of $300,300 for the
quarter ended June 30, 2005, from net income of $102,500 for the quarter ended
June 30, 2004. The Bank's return on average assets (ROA) for the twelve months
ended June 30, 2005 was 25 basis points compared to 36 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 depreciation in earnings are
primarily a result of our contribution of cash and stock to First Federal
Community Foundation, a reduction in income generated from mortgage banking
activities, and the increase in provision for loan losses.
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.
MORTGAGE BANKING - The Company generated lower income from mortgage
banking activity for the six month period ended June 30, 2005 when compared to
the same period in 2004. The volume of mortgage loan originations declined from
$31.2 million through the second quarter of 2004, of which $13.5 million were
sold, to $27.6 million through the second quarter of 2005, of which $10.4
million were sold. This decrease in mortgage loans sold contributed to an
overall decrease of $22,000 in mortgage banking activities from $250,000 through
the second quarter 2004 to $228,000 through the second quarter 2005.
PROVISION FOR LOAN LOSSES - The Bank's provision for loan losses increased
$118,000 from $65,000 for the quarter ended June 30, 2004 to $183,000 for the
quarter ended June 30, 2005.
During the quarter ended June 30, 2005, the Company's net interest margin
(NIM), which represents net interest income divided by average interest earning
assets, increased from 3.05% for the quarter ended June 30, 2004 to 3.21% for
the quarter ended June 30, 2005, a 16 basis point increase. The increase is
primarily a result of lower cost of funds associated with FHLB advances. Through
the second quarter of 2005, the Bank was able to reduce the overall cost of
funds from 2.90% as of June 30, 2004 to 2.87% as of June 30, 2005, a reduction
in the cost of funds of 3 basis points. As the cost of funds decreased, the Bank
also saw the yield on interest earning assets increase from 5.73% at June 30,
2004 to 5.81% at June 30, 2005, an 8 basis point increase in the overall yield
to the Bank. This increase can be attributed to the net effect of 2 items: the
yield on the non-mortgage portfolio which increased 56 basis points from 6.11%
at June 30, 2004 to 6.67% at June 30, 2005, and the yield on the mortgage loan
portfolio which decreased 46 basis points from 6.60% at June 30, 2004 to 6.14%
at June 30 2005. Compared to the quarter ended June 30, 2004, the Bank saw an
increase in average interest earning assets of $30.9 million.
15
FINANCIAL CONDITION
ASSETS: Total assets increased $13.7 million, or 5.2%, to $276.5 million at June
30, 2005 from $262.8 million at December 31, 2004. Cash and cash equivalents
decreased by $173,000, or 3.7%, to $4.6 million at June 30, 2005 from $4.7
million at December 31, 2004. Investment securities available for sale increased
$3.7 million, or 8.7%, in the first six months of 2005. The increase in bonds
beyond premium amortizations and discount accretions was the result $225,000 of
unrealized loss on available for sale securities, $655,000 of mortgage-backed
securities payments received, and net investing activities of $4.7 million in
agency securities. Net loans receivable increased $9.4 million, or 4.8%, to
$204.8 million at June 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. The mortgage portfolio saw a slight increase of $2.2 million or
2.0%.
LIABILITIES: Deposits increased $259,000, or .01%, to $182.7 million at June 30,
2005 from $182.5 million at December 31, 2004. Borrowings, consisting mainly of
Federal Home Loan Bank advances, decreased $1.8 million, or 3.0%, to $54.2
million at June 30, 2005 from $56.0 million at December 31, 2004. The Bank,
through an infusion of capital of $11.5 million from the Company, paid down
overnight advances as a temporary alternative to purchasing low-yielding
investment securities, but also borrowed as needed to fund the $9.4 million loan
growth experienced for the quarter ended June 30, 2005, resulting in the net
decrease of borrowed funds of $1.8 million for the first six months of 2005.
EQUITY: Stockholders' equity increased by $14.6 million, or 67.1%, to $36.4
million at June 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 of stock and reorganization, less costs
of conversion.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2005 COMPARED TO THREE MONTHS ENDED JUNE 30, 2004
GENERAL: Net income decreased by $499,800 to a loss of $300,300 for the three
months ended June 30, 2005 from a profit of $199,500 for the same period ended
June 30, 2004. The loss for the three month period was primarily due to the
one-time contribution of cash and stock to First Federal Community Foundation,
the increase in net interest margin (NIM), the decrease in mortgage banking
activities, and the increase in provision for loan loss.
INTEREST INCOME: Interest income was $3.7 million for the three months ended
June 30, 2005, compared to $3.2 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 in adjustable rate loans. Adjustable rate commercial loans, which are tied
to the prime rate, generated an additional $105,000 in interest income for the
quarter ended June 30, 2005 as compared to the same quarter a year ago, due in
part to an increase in average balance of $2.9 million and in part to an
increase in the prime rate of 225 basis points from 4.00% at June 30, 2004 to
6.25% at June 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 June 30, 2005 as compared to the same period one year ago.
INTEREST EXPENSE: Interest expense was $1.6 million for the three month period
ended June 30, 2005, compared to $1.5 million for the same period in 2004. The
9.3% increase in interest expense was attributable to an increased cost of funds
on interest-bearing deposits for the period ended June 30, 2005 compared to June
30, 2004. The average balance of interest-bearing deposits increased by $23.6
million or 15.6% when compared to June 30, 2004 and the cost of those deposits
increased by 11 basis points. While the average balance of FHLB borrowings
decreased from $57.3 million for the period ended June 30, 2004 to $51.0 million
for the period ended June 30, 2005, the cost of those borrowings increased by 24
basis points, due primarily to rate increases which were offset in part by
maturing long-term advances which were replaced by relatively lower cost of
funds advances.
16
NET INTEREST INCOME: Net interest income increased to $2.1 million for the three
month period ended June 30, 2005 compared to $1.7 million for the same period in
2004. For the three months ended June 30, 2005, average interest-earning assets
increased $26.9 million, or 11.8%, when compared to the same period in 2004.
Average interest-bearing liabilities increased $17.2 million, or 8.2%, for the
same period. The yield on average interest-earning assets increased to 5.86% for
the three month period ended June 30, 2005 from 5.67% for the same period ended
in 2004 as the cost of average interest-bearing liabilities increased to 2.88%
from 2.85% for the three month period ended June 30, 2005 and June 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 25 basis points to 3.28% for the three month period ended
June 30, 2005, from 3.05% for same period in 2004.
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 $183,000 for the three month period ended
June 30, 2005 and $65,000 for the comparable period in 2004. The increase in the
provision is the result of a specific charge-off of a portion of a commercial
loan. Historically, the Bank has had a relatively low experience of
delinquencies and non-performing commercial loans as compared to the Bank's
other loan portfolios. This first commercial charge-off resulted in an increase
to the delinquency factors applied to the entire commercial loan portfolio.
NON INTEREST INCOME: Other income was $1.1 million for the three month period
ended June 30, 2005, a decrease of $110,800 or 9.2%, from the same period in
2004. The primary reason for the decrease was an $82,500 decrease in gain on
sale of available for sale securities from the three month period ended June 30,
2004 to the same period in 2005.
NON INTEREST EXPENSE: Other expenses were $3.4 million for the three month
period ended June 30, 2005, a $698,900 or 25.4% 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.
INCOME TAXES: Federal income taxes decreased to a benefit of $152,000 for the
three month period ended June 30, 2005 compared to an expense of $51,000 for the
same period in 2004. The decrease for the three month period was attributable to
a decline in pre-tax income.
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 2005 COMPARED TO SIX MONTHS ENDED JUNE 30, 2004
GENERAL: Net income decreased $246,400 to a loss of $158,300 for the six months
ended June 30, 2005 from a profit of $88,100 for the same period ended June 30,
2004. While net interest income was higher than the same period one year earlier
by $465,200, non-interest income was lower by $149,100. Non-interest expense
increased $687,000 primarily due to the $679,940 one-time contribution to the
First Federal Community Foundation. The income tax expense for the six months
ended June 30, 2005 decreased by $124,500 as compared to the same period in
2004.
INTEREST INCOME: Interest income was $7.2 million for the six months ended June
30, 2005, compared to $6.4 million for the comparable period in 2004. The
increase of $875,000, or 13.8%, in interest income for the six month period from
the prior year 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 $235,900 in
interest income for the period ended June 30, 2005 as compared to the same
period a year ago, due in part to an increase in average balance of $4.65
million and in part to an increase
17
in prime rate of 225 basis points from 4.0% at June 30, 2004 to 6.25% at June
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 quarter ended June 30,
2005 as compared to the same period one year ago.
INTEREST EXPENSE: Interest expense was $3.2 million for the six month period
ended June 30, 2005 compared to $2.9 million for the same period in 2004. The
9.97% increase in interest expense was attributable to an increased cost of
funds on interest-bearing deposits for the period ended June 30, 2005 compared
to June 30, 2004. The average balance of interest-bearing deposits increased by
$23.9 million or 16.1% when compared to June 30, 2004 and the cost of those
deposits increased by 10 basis points. The average balance of FHLB borrowings
increased from $52.7 million for the period ended June 30, 2004 to $53.1 million
for the period ended June 30, 2005, while the cost of those borrowings decreased
by 19 basis points, due primarily to maturing advances which were replaced by
lower cost of funds advances.
NET INTEREST INCOME: Net interest income increased by $581,400 for the six month
period ended June 30, 2005 compared to the same period in 2004. For the six
months ended June 30, 2005, average interest-earning assets increased $30.9
million, or 14.1% when compared to the same period in 2004. Average
interest-bearing liabilities increased $24.2 million, or 11.9% for the same
period. The yield on average interest-earning assets increased to 5.81% for the
six month period ended June 30, 2005 from 5.73% for the same period ended in
2004 while the cost of average interest-bearing liabilities declined to 2.87%
from 2.90% for the six month period ended June 30, 2005 and June 30, 2004,
respectively. The net result of the 8 basis point increase in asset yields and 3
basis point decrease in the cost of funds was a net interest rate margin
increase of 16 basis points to 3.21% for the six month period ended June 30,
2005, from 3.05% 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.
JUNE 30, DECEMBER 31,
2005 2004
-------- ------------
(Dollars in thousands)
Total non-accrual loans (1) ................................................ $ 1,051 $ 478
-------- ------------
Accrual loans delinquent 90 days or more:
One- to four-family residential .......................................... 1,114 960
Other real estate loans .................................................. 106 -
Consumer/Commercial ...................................................... 320 280
-------- ------------
Total accrual loans delinquent 90 days or more ........................ $ 1,540 $ 1,240
-------- ------------
Total nonperforming loans (2) .............................................. 2,591 1,718
Total real estate owned-Residential Mortgages (3) .......................... 183 9
Total real estate owned-Consumer and other (3) ............................. 62 20
======== ============
Total nonperforming assets ................................................. $ 2,836 $ 1,747
======== ============
Total nonperforming loans to loans receivable .............................. 1.27% 0.87%
Total nonperforming assets to total assets ................................. 1.03% 0.66%
(1) For the Six months ended June 30, 2005 and the twelve months ended
December 31, 2004, the interest that would have been reported was $ 36,877
and $75,307 respectively were these loans not in non-accrual status.
(2) All 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.
18
PROVISION FOR LOAN LOSSES: The provision for loan losses amounted to $262,300
for the six month period ended June 30, 2005 and $146,000 for the comparable
period in 2004. At June 30, 2005, the percent of nonperforming loans increased
to 127 basis points from 87 basis points at December 31, 2004. As a percent of
total assets, nonperforming loans increased to 103 basis points at June 30, 2005
from 66 basis points at December 31, 2004.
NON INTEREST EXPENSE: Non interest expense was $6.2 million for the six month
period ended June 30, 2005, a $687,000 or 12.55% 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.
INCOME TAXES: Federal income taxes decreased to a benefit of $79,900 for the six
month period ended June 30, 2005 compared to an expense of $44,600 for the same
period in 2004. The decrease for the six month period was attributable to a
decrease in pre-tax income.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of funds are 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 Company is required to maintain
sufficient levels of liquidity as defined by the OTS regulations. This
requirement may be varied at the direction of the OTS. Regulations currently in
effect require that the Company must maintain sufficient liquidity to ensure its
safe and sound operation. The Company's objective for liquidity is to be above
20%. Liquidity as of June 30, 2005 was $82.2 million, or 42.4%, compared to
$83.4 million, or 47.6% at December 31, 2004. The levels of these assets are
dependent on the Company's operating, financing, lending and investing
activities during any given period. The liquidity calculated by the Company
includes additional borrowing capacity available with the FHLB. This borrowing
capacity is based on the FHLB stock owned by the Bank along with pledged
collateral. As of June 30, 2005, the Bank had unused borrowing capacity totaling
$41.8 million at the FHLB based on the FHLB stock ownership.
The Company intends to retain for its portfolio certain originated residential
mortgage loans (primarily adjustable rate, balloon and shorter term fixed rate
mortgage loans) and to generally sell the remainder in the secondary market. The
Company will from time to time participate in or originate commercial real
estate loans, including real estate development loans. During the six month
period ended June 30, 2005 the Company originated $27.6 million in residential
mortgage loans, of which $17.2 million were retained in portfolio while the
remainder were sold in the secondary market or are being held for sale. This
compares to $31.3 million in originations during the first six months of 2004 of
which $17.8 million were retained in portfolio. The Company also originated
$19.2 million of commercial loans and $6.1 million of consumer loans in the
first six months of 2005 compared to $16.6 million of commercial loans and $9.5
million of consumer loans for the same period in 2004. Of total loans
receivable, excluding loans held for sale, mortgage loans comprised 54.5% and
56.1%, commercial loans 33.0% and 31.0% and consumer loans 12.5 % and 13.0% at
June 30, 2005 and December 31, 2004, respectively.
At June 30, 2005, the Company had outstanding loan commitments of $51.9 million.
These commitments included $14.5 million for permanent one-to-four family
dwellings, $8.5 million for non-residential loans, $2.6 million of undisbursed
loan proceeds for construction of one-to-four family dwellings, $8.5 million of
undisbursed lines of credit on home equity loans, $1.4 million of unused credit
card lines and $12.4 million of unused commercial lines of credit, $2.2 million
of undisbursed, Commercial construction, $105,000 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 June 30, 2005 deposits funded 66.1% 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 June 30, 2005 totaled $60.9
million. Management believes that a significant portion of such deposits will
remain with the Company. 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 June 30, 2005 the Company
had $53.0 million in FHLB advances. FHLB borrowings as a percentage of total
assets were 19.2% at June 30, 2005 as compared to 20.8% at December 31, 2004.
The Company has sufficient available collateral to obtain additional advances of
$6.2 million. When this is combined with current FHLB stock ownership the
Company could obtain up to an additional $41.8 million in advances from the
FHLB.
Stockholders' equity at June 30, 2005 was $36.4 million, or 13.2% 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 the OTS
regulations. The Bank exceeded all regulatory capital requirements at June 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 June 30, 2005:
Minimum
Regulatory To Be Well
Actual Minimum Capitalized
--------------- ---------------------- -------------------
Amount Ratio Amount Ratio Amount Ratio
------- ----- ------- ----------- ------- ------
(Dollars in Thousands)
Capital Requirements:
Tangible equity capital $31,921 11.70% $ 4,094 1.50% $ 5,458 2.00%
Tier 1 (Core) capital $31,921 11.70% $10,916 4.00% $13,645 5.00%
Total risk-based capital $33,355 17.91% $14,895 8.00% $18,619 10.00%
Tier 1 risk-based capital $31,921 17.14% $ 7,448 4.00% $11,171 6.00%
20
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-QSB
QUARTER ENDED JUNE 30, 2005
PART E - 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 has been no change in the Company's internal control over the financial
reporting during the Company's second quarter of fiscal year 2005 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 JUNE 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 June
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 used
to pay down variable rate FHLB advances until the proceeds
could be more effectively deployed.
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 JUNE 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: /a/Martin A. Thomson
---------------------------------------------
Martin A. Thomson
President and Chief Executive Officer
Date: August 12, 2005
By: /s/Amy E. Essex
----------------------------------------------
Amy E. Essex, Chief Financial Officer
(Principal Financial and Accounting Officer)
Date: August 12, 2005
23
EXHIBIT INDEX
EXHIBIT NUMBER 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