SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2006
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from ____________________ to ____________________
Commission File Number 000-31957
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
(Exact name of registrant as specified in its charter)
MARYLAND 32-0135202
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 S. SECOND AVENUE, ALPENA, MICHIGAN 49707
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (989) 356-9041
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports) and (2) has been subject to such filing requirements for the past 90
days. Yes X No
----- -----
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes No X
----- -----
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.
Common Stock, Par Value $0.01 Outstanding at August 11, 2006
(Title of Class) 3,034,999 shares
Transitional Small Business Disclosure Format: Yes No X .
----- -----
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-QSB
QUARTER ENDED JUNE 30, 2006
INDEX
PART I - FINANCIAL INFORMATION
PAGE
----
ITEM 1 - UNAUDITED FINANCIAL STATEMENTS
Consolidated Balance Sheet at
June 30, 2006 and December 31, 2005....................... 3
Consolidated Statements of Income for the Three and Six
Months Ended June 30, 2006 and June 30, 2005.............. 4
Consolidated Statement of Changes in Stockholders' Equity
for the Six Months Ended June 30, 2006.................... 5
Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 2006 and June 30, 2005..................... 6
Notes to Unaudited Consolidated Financial Statements......... 7
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION..................................... 15
ITEM 3 - CONTROLS AND PROCEDURES......................................... 21
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS............................................... 22
ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS..... 22
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES................................. 22
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............. 22
ITEM 5 - OTHER INFORMATION............................................... 23
ITEM 6 - EXHIBITS ....................................................... 23
Section 302 Certifications
Section 906 Certifications
When used in this Form 10-QSB or future filings by First Federal of Northern
Michigan Bancorp, Inc. (the "Company") with the Securities and Exchange
Commission ("SEC"), in the Company's press releases or other public or
stockholder communications, or in oral statements made with the approval of an
authorized executive officer, the words or phrases "would be," "will allow,"
"intends to," "will likely result," "are expected to," "will continue," "is
anticipated," "estimate," "project," or similar expressions are intended to
identify "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995.
The Company wishes to caution readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made, and to advise
readers that various factors, including regional and national economic
conditions, changes in levels of market interest rates, credit and other risks
of lending and investment activities and competitive and regulatory factors,
could affect the Company's financial performance and could cause the Company's
actual results for future periods to differ materially from those anticipated or
projected.
The Company does not undertake, and specifically disclaims any obligation, to
update any forward-looking statements to reflect occurrences or unanticipated
events or circumstances after the date of such statements.
2
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
June 30, 2006 December 31, 2005
------------- -----------------
(Unaudited)
ASSETS
Cash and cash equivalents:
Cash on hand and due from banks ......................................... $ 4,653,707 $ 4,497,629
Overnight deposits with FHLB ............................................ 217,403 281,565
------------ ------------
Total cash and cash equivalents ......................................... 4,871,110 4,779,194
Securities AFS .......................................................... 46,467,162 53,411,609
Securities HTM .......................................................... 1,775,000 1,775,000
Loans held for sale ..................................................... 355,500 --
Loans receivable, net of allowance for loan losses of $1,523,138 and
$1,415,764 as of June 30, 2006 and December 31, 2005, respectively ... 209,527,136 201,183,076
Foreclosed real estate and other repossessed assets ..................... 667,142 434,823
Real estate held for investment ......................................... 135,543 352,136
Federal Home Loan Bank stock, at cost ................................... 4,765,000 4,765,000
Premises and equipment .................................................. 7,888,294 7,392,207
Accrued interest receivable ............................................. 1,262,096 1,601,691
Intangible assets ....................................................... 2,839,224 3,088,986
Goodwill ................................................................ 1,349,854 1,349,854
Other assets ............................................................ 2,366,900 2,641,195
------------ ------------
Total assets ............................................................ $284,269,961 $282,774,771
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits ................................................................ $186,441,637 $188,734,743
Advances from borrowers for taxes and insurance ......................... 373,105 27,709
Federal Home Loan Bank advances and Note Payable ........................ 59,916,334 54,403,622
Accrued expenses and other liabilities .................................. 2,113,781 2,959,111
------------ ------------
Total liabilities ....................................................... 248,844,857 246,125,185
------------ ------------
Commitments and contingencies ........................................... -- --
Stockholders' equity:
Common stock ($0.01 par value 20,000,000 shares authorized
3,190,999 and 3,115,510 shares issued, respectively) ................. 31,909 31,155
Treasury stock at cost (114,167 shares) ................................. (1,144,199) --
Additional paid-in capital .............................................. 24,238,787 23,560,462
Unearned compensation ................................................... (590,018) --
Retained earnings ....................................................... 14,703,744 14,703,130
Unallocated ESOP ........................................................ (1,138,232) (1,186,940)
Accumulated other comprehensive loss ................................. (676,887) (458,221)
------------ ------------
Total stockholders' equity .............................................. 35,425,104 36,649,586
------------ ------------
Total liabilities and stockholders' equity .............................. $284,269,961 $282,774,771
============ ============
See accompanying notes to consolidated financial statements.
3
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
For the Three Months For the Six Months
Ended June 30, Ended June 30,
----------------------- -----------------------
2006 2005 2006 2005
---------- ---------- ---------- ----------
(Unaudited) (Unaudited)
Interest income:
Interest and fees on loans ............................. $3,607,804 3,255,421 $7,024,417 $6,352,148
Interest and dividends on investments .................. 547,520 404,016 1,109,331 745,660
Interest on mortgage-backed securities ................. 53,014 63,386 107,989 130,103
---------- ---------- ---------- ----------
Total interest income .................................. 4,208,338 3,722,823 8,241,737 7,227,911
---------- ---------- ---------- ----------
Interest expense:
Interest on deposits ................................... 1,326,612 1,026,234 2,566,522 2,007,172
Interest on borrowings ................................. 757,110 617,737 1,426,457 1,235,713
---------- ---------- ---------- ----------
Total interest expense ................................. 2,083,722 1,643,971 3,992,979 3,242,885
---------- ---------- ---------- ----------
Net interest income .................................... 2,124,617 2,078,852 4,248,758 3,985,026
Provision for loan losses .............................. 133,000 183,000 202,500 262,258
---------- ---------- ---------- ----------
Net interest income after provision for loan losses .... 1,991,617 1,895,852 4,046,258 3,722,768
---------- ---------- ---------- ----------
Non Interest income:
Service charges and other fees ......................... 283,984 253,903 521,130 485,324
Mortgage banking activities ............................ 93,590 108,999 166,393 227,687
Gain (loss) on sale of available-for-sale securities ... (43,565) -- (43,565) 13,127
Net gain on sale of premises and equipment,
real estate owned and other repossessed assets ...... 1,750 (13,958) 4,006 (18,865)
Other .................................................. 1,708 (11,910) 46,928 10,157
Insurance and brokerage commissions .................... 738,417 748,477 1,507,071 1,480,531
---------- ---------- ---------- ----------
Total other income ..................................... 1,075,884 1,085,511 2,201,963 2,197,961
---------- ---------- ---------- ----------
Non interest expenses:
Compensation and employee benefits ..................... 1,614,006 1,569,472 3,158,906 3,133,756
SAIF Insurance Premiums ................................ 6,045 6,408 12,453 12,897
Advertising ............................................ 81,623 34,927 132,712 74,784
Occupancy .............................................. 332,806 311,651 702,087 626,651
Amortization of intangible assets ...................... 124,880 80,305 249,761 150,886
Service bureau charges ................................. 91,591 84,753 177,872 174,716
Insurance and brokerage commission expense ............. 279,133 317,704 547,240 598,203
Professional services .................................. 75,083 81,260 160,418 139,916
Donation to First Federal Community Foundation ......... -- 679,940 -- 679,940
Other .................................................. 314,513 280,295 639,373 567,148
---------- ---------- ---------- ----------
Other expenses ......................................... 2,919,681 3,446,715 5,780,823 6,158,897
---------- ---------- ---------- ----------
Income before income tax expense ....................... 147,820 (452,225) 467,398 (238,168)
Income tax expense ..................................... 49,310 (151,919) 156,680 (79,873)
---------- ---------- ---------- ----------
Net income ............................................. $ 98,510 $ (300,306) $ 310,718 $ (158,295)
========== ========== ========== ==========
Per share data:
Basic earnings per share ............................... $ 0.03 $ (0.09) $ 0.10 $ (0.06)
Weighted average number of shares outstanding .......... 3,136,545 3,100,021 3,126,700 2,379,751
Diluted earnings per share ............................. $ 0.03 $ (0.09) $ 0.10 $ (0.06)
Weighted average number of shares outstanding,
including dilutive stock options .................... 3,137,591 3,114,215 3,127,667 2,407,168
Dividends per common share ............................. $ 0.050 $ 0.050 $ 0.100 $ 0.104
See accompanying notes to consolidated financial statements.
4
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED)
Additional
Issued Common Treasury Paid-in Unearned
Shares Stock Stock Capital Compensation
--------- ------- ----------- ----------- ------------
Balance at December 31, 2005 ................ 3,115,510 $31,155 $ -- $23,560,462 $ --
Stock options exercised (18,560 shares) ..... 18,560 186 -- 98,764 --
Retired Stock (6,321 shares) ................ (6,321) (64) -- (60,302) --
Treasury Stock at cost (114,167 shares) ..... -- -- (1,144,199) -- --
Stock Options/Awards Expensed ............... -- -- -- 19,586 20,344
MRP shares awarded (63,250 shares) .......... 63,250 632 609,730 (610,362)
Unallocated ESOP ............................ -- -- -- (4,625) --
Net income for the period ................... -- -- -- -- --
Changes in unrealized loss:
on available-for-sale securities
(net of tax of $112,646) ................. -- -- -- -- --
Total comprehensive income .................. -- -- -- -- --
Tax benefit on stock options exercised ...... -- -- -- 15,171 --
Dividends declared .......................... -- -- -- -- --
--------- ------- ----------- ----------- ---------
Balance at June 30, 2006 .................... 3,190,999 $31,909 $(1,144,199) $24,238,787 $(590,018)
========= ======= =========== =========== =========
Accumulated
Other
Retained Unallocated Comprehensive
Earnings ESOP Income (Loss) Total
----------- ----------- ------------- -----------
Balance at December 31, 2005 ................ $14,703,130 (1,186,940) (458,221) $36,649,586
Stock options exercised (18,560 shares) ..... -- -- -- 98,950
Retired Stock (6,321 shares) ................ -- -- -- (60,365)
Treasury Stock at cost (114,167 shares) ..... -- -- -- (1,144,199)
Stock Options/Awards Expensed ............... -- 39,930
MRP shares awarded (63,250 shares) .......... --
Unallocated ESOP ............................ -- 48,708 -- 44,083
Net income for the period ................... 310,718 -- -- 310,718
Changes in unrealized loss:
on available-for-sale securities
(net of tax of $112,646) ................. -- -- (218,666) (218,666)
-----------
Total comprehensive income .................. -- -- -- 92,052
Tax benefit on stock options exercised ...... -- -- -- 15,171
Dividends declared .......................... (310,104) -- -- (310,104)
----------- ----------- --------- -----------
Balance at June 30, 2006 .................... $14,703,744 $(1,138,232) $(676,887) $35,425,104
=========== =========== ========= ===========
See accompanying notes to consolidated financial statements
5
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
For Six Months Ended
June 30,
--------------------------
2006 2005
----------- ------------
(Unaudited)
Cash flows from operating activities:
Net income .................................................................. $ 310,718 $ (158,295)
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization ......................................... 515,325 398,214
Provision for loan loss ............................................... 202,500 262,258
Amortization and accretion on securities .............................. 45,539 93,126
(Gain) loss on sale of securities ..................................... 43,565 (13,128)
Originations of loans held for sale ................................... (6,790,664) (9,096,285)
Principal amount of loans sold ........................................ 6,435,164 8,788,046
Purchase of real estate held for sale ................................. -- (30,416)
Proceeds from sale of real estate held for investment ................. 217,666 246,340
Gain on sale of real estate held for investment ....................... (233,392) (214,464)
Loss on sale of premises and equipment ................................ 2,643 --
Change in accrued interest receivable ................................. 339,595 (284,412)
Change in other assets ................................................ 386,940 52,698
Change in accrued expenses and other liabilities ...................... (830,159) 461,146
Stock donated to charitable foundation ................................ -- 339,970
----------- ------------
Net cash provided by operating activities ................................... 645,440 844,798
----------- ------------
Net Increase in loans ....................................................... (8,546,560) (9,669,432)
Proceeds from maturity and sale of available-for-sale securities ......... 8,500,237 5,545,075
Purchase of securities available for sale ................................ (1,976,205) (9,526,425)
Purchase of Federal Home Loan Bank Stock ................................. -- (98,900)
Purchase of premises and equipment ....................................... (764,293) (578,923)
----------- ------------
Net cash used in investing activities ....................................... (2,786,821) (14,328,605)
----------- ------------
Net Increase (decrease) in deposits ...................................... (2,293,106) 258,771
Dividend paid on common stock ............................................ (310,104) (228,949)
ESOP shares committed to be released ..................................... 44,083 27,738
Net increase in advances from borrowers .................................. 345,396 298,258
Additions to advances from Federal Home Loan Bank and notes payable ..... 9,630,000 6,500,000
Repayments of Federal Home Loan Bank advances and notes payable .......... (4,117,288) (8,326,173)
Stock retired ............................................................ (60,365) --
Proceeds from exercise of stock options .................................. 98,950 --
Stock Options/Awards expensed ............................................ 39,930 --
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)
Purchase of treasury shares .............................................. (1,144,199) --
----------- ------------
Net cash provided by financing activities ................................... 2,233,297 13,310,539
----------- ------------
Net increase (decrease) in cash and cash equivalents ........................ 91,916 (173,268)
Cash and cash equivalents at beginning of period ............................ 4,779,194 4,738,559
----------- ------------
Cash and cash equivalents at end of period .................................. $ 4,871,110 $ 4,565,291
=========== ============
Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes ................................ $ 273,790 $ --
=========== ============
Cash paid during the period for interest .................................... $ 4,026,602 $ 3,249,174
=========== ============
See accompanying notes to the consolidated financial statements
6
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.
The accompanying consolidated financial statements have been prepared on an
accrual basis of accounting and include the accounts of First Federal of
Northern Michigan Bancorp, Inc. and its wholly owned subsidiary, First Federal
of Northern Michigan (the "Bank") and the Bank's 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, 2006, and
its results of operations and statement of cash flows for the periods presented.
All such adjustments are normal and recurring in nature. The accompanying
consolidated financial statements do not purport to contain all the necessary
financial disclosures required by generally accepted accounting principles that
might otherwise be necessary and should be read in conjunction with the
consolidated financial statements and notes thereto of the Company included in
the Annual Report for the year ended December 31, 2005. Results for the six
months ended June 30, 2006 are not necessarily indicative of the results that
may be expected for the year ending December 31, 2006.
CRITICAL ACCOUNTING POLICIES
Our accounting and reporting policies are prepared in accordance with
accounting principles generally accepted in the United States of America and
conform to general practices within the banking industry. We consider accounting
policies that require significant judgment and assumptions by management that
have, or could have, a material impact on the carrying value of certain assets
or on income to be critical accounting policies. Changes in underlying factors,
assumptions or estimates could have a material impact on our future financial
condition and results of operations. Based on the size of the item or
significance of the estimate, the following accounting policies are considered
critical to our financial results.
ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is calculated with
the objective of maintaining an allowance sufficient to absorb estimated
probable loan losses. Management's determination of the adequacy of the
allowance is based on periodic evaluations of the loan portfolio and other
relevant factors. However, this evaluation is inherently subjective, as it
requires an estimate of the loss content for each risk rating and for each
impaired loan, an estimate of the amounts and timing of expected future cash
flows, and an estimate of the value of collateral.
We have established a systematic method of periodically reviewing the
credit quality of the loan portfolio in order to establish an allowance for
losses on loans. The allowance for losses on loans is based on our current
judgments about the credit quality of individual loans and segments of the loan
portfolio. The allowance for losses on loans is established through a provision
for loan losses based on our evaluation of the losses inherent in the loan
portfolio, and considers all known internal and external factors that affect
loan collectibility as of the reporting date. Our evaluation, which includes a
review of all loans on which full collectibility may not be reasonably assured,
considers among other matters, the estimated net realizable value or the fair
value of the underlying collateral, economic conditions, historical loan loss
experience, our knowledge of inherent losses in the portfolio that are probable
and reasonably estimable and other factors that warrant recognition in providing
an appropriate loan loss allowance. Management believes this is a critical
accounting policy because this evaluation involves a high degree of complexity
7
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. For example, over the past
five years, our provision for loan losses as a percentage of average loans
outstanding has ranged from 0.06% to 0.25%, while our net charge-offs as a
percentage of average loans outstanding has ranged from 0.04% to 0.12%.
Nevertheless, because a small number of non-performing loans could result in net
charge-offs significantly in excess of the estimated losses inherent in our loan
portfolio, you should not place undue reliance on the accuracy of past
estimates.
The analysis of the allowance for loan losses has two components: specific
and general allocations. Specific allocations are made for loans that are
determined to be impaired. Impairment is measured by determining the present
value of expected future cash flows or, for collateral-dependent loans, the fair
value of the collateral adjusted for market conditions and selling expenses. The
general allocation is determined by segregating the remaining loans by type of
loan, risk weighting (if applicable) and payment history. We also analyze
delinquency trends, which have remained stable, general economic conditions and
geographic and industry concentrations. This analysis establishes factors that
are applied to the loan groups to determine the amount of the general reserve.
The principal assumption used in deriving the allowance for loan losses is the
estimate of loss content for each risk rating. As an example, if recent loss
experience dictated that the projected loss ratios would be changed by 10% (of
the estimate) across all risk ratings, the allocated allowance as of June 30,
2006 would have changed by approximately $135,000. Actual loan losses may be
significantly more than the allowances we have established, which could have a
material negative effect on our financial results.
MORTGAGE SERVICING RIGHTS. We sell to investors a portion of our originated
one- to four-family residential real estate mortgage loans. When we acquire
mortgage servicing rights through the origination of mortgage loans and sale of
those loans with servicing rights retained, we allocate a portion of the total
cost of the mortgage loans to the mortgage servicing rights based on their
relative fair value. As of June 30, 2006, 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, 2006 included the following:
Annual constant prepayment speed (CPR): 7.84%
Weighted average life remaining (in months): 248
Discount rate used: 8.50%
At the June 30, 2006 valuation, we calculated the value of our mortgage
servicing rights to be $1.6 million and the weighted average life remaining of
those rights was 57 months. The book value of our mortgage servicing rights as
of June 30, 2006 was $680,000 which was $950,000 less than the independent
valuation, so there was no need to establish a valuation allowance.
8
IMPAIRMENT OF INTANGIBLE ASSETS. Goodwill arising from business acquisitions
represents the value attributable to unidentifiable intangible elements in the
business acquired. The fair value of goodwill is dependent upon many factors,
including our ability to provide quality, cost-effective services in the face of
competition. Because of these many factors, management believes this is a
critical accounting policy. A decline in earnings as a result of business or
market conditions or a run-off of insurance customers over sustained periods
could lead to an impairment of goodwill that could adversely affect earnings in
future periods.
A significant portion of our intangible assets, including goodwill, relates
to the acquisition premiums recorded with the purchase of the InsuranCenter of
Alpena ("ICA") and certain branches over the last several years. Intangible
assets are reviewed periodically for impairment by comparing the fair value of
the intangible asset to the book value of the intangible asset. If the book
value is in excess of the fair value, impairment is indicated and the
intangibles must be written down to their fair value.
In connection with our acquisition in 2003 of ICA, we allocated the excess
of the purchase price paid over the fair value of net assets acquired to
intangible assets, including goodwill. These intangible assets included the ICA
customer list and a third-party contract to which ICA is a party. From the date
of acquisition through April 30, 2005 we amortized the value assigned to the
customer list and third party contract over a period of 20 years. On May 1, 2005
the former owner of ICA retired. As a result, the amortization period for these
intangible assets was reduced to a 10-year period beginning May 1, 2005.
Effective January 1, 2006, the exclusive third-party contract between ICA and
Blue Cross Blue Shield of Michigan was terminated. Prior to January 1, 2006 the
ICA exclusive agent contract with Blue Cross Blue Shield entitled ICA to an
override commission of 1.9% on all health premiums written through local
Chambers of Commerce in Northeast Michigan. On any health insurance contracts in
place as of December 31, 2005, ICA will continue to receive the 1.9% commission;
however, there will be no new groups added to this program effective January 1,
2006. Management considered the potential effect this could have on ICA health
insurance commissions in future years and made the decision to reduce the
amortization period of the third-party contract intangible asset to 5 years
effective January 1, 2006.
Goodwill is not amortized. The impairment test of goodwill and identified
intangible assets that have an indefinite useful life, performed as of June 30,
2006, and December 31, 2005 in accordance with SFAS No. 142, did not indicate
that an impairment charge was required. If, through testing, we determine that
there is impairment based, for example, on significant runoff of the customer
list or material changes to the third party contract, then we may 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 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.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 2006, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard No. 156, Accounting for Servicing of
Financial Assets - an amendment of FASB Statement No. 140. SFAS 156 amends SFAS
Statement No.140, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities", with respect to the accounting for
separately recognized servicing assets and servicing liabilities. The Statement
addresses the recognition and measurement of separately recognized servicing
assets and liabilities and provides an approach to simplify efforts to obtain
hedge-like (offset) accounting. SFAS 156 will be adopted by the Company January
1, 2007 as required by the statement. The Company does not believe adoption of
SFAS 156 will have a material effect on the financial position, results of
operations, or cash flows.
9
In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 (FIN
48), which clarifies the accounting for uncertainty in tax positions. This
Interpretation requires that the Company recognize in the financial statements
the impact of a tax position if that position is more likely than not to be
sustained on audit based on technical merits of the position. The provisions of
FIN 48 are effective as of the beginning of the Company's 2007 fiscal year, with
the cumulative effect of the change in accounting principle recorded as an
adjustment to operating retained earnings. The Company is currently evaluating
the impact of adopting FIN 48 on its financial statements.
NOTE 2--REORGANIZATION.
On April 1, 2005 we consummated the second-step mutual-to-stock conversion
of Alpena Bancshares, M.H.C., in which shares of common stock representing
Alpena Bancshares, M.H.C.'s ownership interest in Alpena Bancshares, Inc. were
sold to investors. As a result of the conversion and stock offering, Alpena
Bancshares, M.H.C. ceased to exist and Alpena Bancshares, Inc. was succeeded by
First Federal of Northern Michigan Bancorp, Inc., a Maryland corporation and new
holding company for First Federal of Northern Michigan.
The plan of conversion and reorganization of Alpena Bancshares, M.H.C. and
the issuance and contribution of cash and common stock to First Federal
Community Foundation, a charitable foundation we established in connection with
the reorganization, 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 Alpena Bancshares,
Inc. 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 Alpena Bancshares, Inc. common stock. Cash was issued in lieu
of any fractional shares. The share exchange occurred on April 1, 2005.
Any reference in this report to the number of shares outstanding for the
six months ended June 30, 2005 for purposes of calculating per share earnings
and to dividends per share for the same period has been adjusted to give
retroactive recognition to the exchange ratio applied in the second-step
conversion.
NOTE 3--DIVIDENDS.
Payment of dividends on the common stock is subject to determination and
declaration by the Board of Directors and depends upon a number of factors,
including capital requirements, regulatory limitations on the payment of
dividends, the Company's results of operations and financial condition, tax
considerations and general economic conditions.
On June 13, 2006, the Company declared a cash dividend on its common stock,
payable on or about August 21, 2006, to shareholders of record as of June 30,
2006, equal to $0.05 per share. The dividend on all shares outstanding totaled
$154,087.
NOTE 4--1996 STOCK OPTION PLAN AND 1996 RECOGNITION AND RETENTION PLAN
Effective January 1, 2006, the Company adopted Statement of Financial
Accounting Standard (SFAS) No. 123 (Revised) "Shareholder Based Payments", which
requires that the grant-date fair value of awarded stock options be expensed
over the requisite service period. The Company's 1996 Stock Option Plan (the
"1996 Plan"), which was approved by shareholders, permits the grant of share
options to its employees for up to 127,491 shares of common stock (retroactively
adjusted for the exchange ratio applied in the Company's 2005 stock offering and
related second-step conversion). The Company's 2006 Stock-Based Incentive Plan
(the "2006 Plan"), which was approved by the shareholders on May 17, 2006,
permits the award of up to 242,740 shares of common stock of which the maximum
number to be granted as Stock Options is 173,386 and the maximum that can be
granted as Restricted Stock Awards is 69,354. Option awards are granted with an
exercise price equal to the market price of the Company's stock at the date of
grant; those option awards
10
generally vest based on five years of continual service and have ten year
contractual terms. Certain options provide for accelerated vesting if there is a
change in control (as defined in the Plans).
The fair value of each option award is estimated on the date of grant using
the Black-Scholes valuation method that uses the assumptions noted in the
following table. The weighted average fair value of options granted during the
six months ended June 30, 2006 was $2.49 per option granted. Expected
volatilities are based on historical volatility of the Company's stock. The
Company uses historical data to estimate option exercise and employee
termination within the valuation model. The expected term of options granted is
derived from the output of the valuation model and represents the period of time
that options granted are expected to be outstanding. The risk-free rate for
periods within the contractual life of the option is based on the U.S. Treasury
yield in effect at the time of the grant.
2006
----
Expected Volatility 20%
Expected dividends 2.1%
Expected term (in years) 8.0
Risk-free rate 4.75%
A summary of option activity under the Plan during the six months ended
June 30, 2006 is presented below:
Weighted-Average
Weighted- Remaining
Average Contractual Term Aggregate
Options Shares Exercise Price (Years) Intrinsic Value
------- ------- -------------- ---------------- ---------------
Outstanding at January 1, 2006 24,642 $6.36
Granted 198,240 $9.56
Exercised (18,560) $5.41
Forfeited or expired (540) $5.41
Outstanding at June 30, 2006 203,782 $8.67 8.13 $181,366
Exercisable at June 30, 2006 4,433 $5.87 1.91 $ 14,762
A summary of the status of the Company's nonvested shares as of June 30,
2006, and changes during the quarter ended June 30, 2006, is presented below:
Weighted-Average
Grant-Date
Nonvested Shares Shares Fair Value
---------------------------- ------- ----------------
Nonvested at January 1, 2006 2,218 $5.21
Granted 198,240 $9.56
Vested (1,109) $5.21
Forfeited 0
Nonvested at June 30, 2006 199,349 $9.51
11
As of June 30, 2006 there was $1,063,213 of total unrecognized compensation
cost related to nonvested share-based compensation arrangements under the Plan.
That cost is expected to be recognized over a weighted-average period of 4.7
years. The total fair value of shares vested during the six months ended June
30, 2006 was $1,198.
During the three months ended June 30, 2006 the Company awarded 63,250
shares under the Recognition and Retention Plan ("RRP"). Shares issued under the
RRP and exercised pursuant to the exercise of the stock option plan may be
either authorized but unissued shares or reacquired shares held by the Company
as treasury stock.
NOTE 5 - COMMITMENTS TO EXTEND CREDIT
The Company is a party to credit-related financial instruments with
off-balance sheet risk in the normal course of business to meet the financing
needs of its customers. These financial instruments include commitments to
extend credit, stand by letters of credit, and commercial lines of credit. Such
commitments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amounts recognized in the consolidated balance sheet. The
Company's exposure to credit loss is represented by the contracted amount of
these commitments. The Company follows the same credit policies in making
commitments as it does for on-balance sheet instruments.
At June 30, 2006, the Company had outstanding commitments to originate
loans of $54.2 million. These commitments included $6.9 million for permanent
one-to-four family dwellings, $25.6 million for non-residential loans, $1.5
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,
$1.6 million of unused credit card lines, $7.4 million of unused commercial
lines of credit, $826,000 of undisbursed commercial construction, $110,000 of
unused Letters of Credit and $1.7 million in unused Bounce Protection.
NOTE 6 - SEGMENT REPORTING
The Company's principal activities include banking and the sale of
insurance products through its wholly owned subsidiary, ICA. The Bank provides
financial products including retail and commercial loans as well as retail and
commercial deposits. ICA receives commissions from the sale of various insurance
products including health, life, and property. The segments were determined
based on the nature of the products provided to customers.
The financial information for each operating segment is reported on the
basis used internally to evaluate performance and allocate resources. The
allocations have been consistently applied for all periods presented. Revenues
and expenses between affiliates have been transacted at rates that unaffiliated
parties would pay. The only transaction between the segments thus far relates to
a deposit on behalf of the ICA included in the Bank. The interest income and
interest expense for this transaction has been eliminated. All other
transactions are with external customers. The performance measurement of the
operating segments is based on the management structure of the Company and is
not necessarily comparable with similar information for any other financial
institution. The information presented is also not necessarily indicative of the
segment's financial condition and results of operations if they were independent
entities.
12
NOTE 6 - SEGMENT REPORTING (CONTINUED)
For the Three Months Ended
June 30, 2006
(Dollars in Thousands)
-------------------------------------------
Bank ICA Eliminations Total
-------- ------ ------------ --------
INTEREST INCOME $ 4,209 $ 3 $ (3) $ 4,209
INTEREST EXPENSE 2,083 5 (3) 2,085
-------- ------ ----- --------
NET INTEREST INCOME - Before provision for loan losses 2,126 (2) -- 2,124
PROVISION FOR LOAN LOSSES 132 -- -- 132
-------- ------ ----- --------
NET INTEREST INCOME - After provision for loan losses 1,994 (2) -- 1,992
OTHER INCOME 336 740 -- 1,076
OPERATING EXPENSES 2,195 725 -- 2,920
-------- ------ ----- --------
INCOME - Before federal income tax 136 13 -- 149
FEDERAL INCOME TAX 46 4 -- 50
-------- ------ ----- --------
NET INCOME $ 90 $ 9 $ -- $ 99
======== ====== ===== ========
DEPRECIATION AND AMORTIZATION $ 172 $ 86 $ -- $ 258
======== ====== ===== ========
ASSETS $280,378 $4,464 $(572) $284,270
======== ====== ===== ========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ -- $ -- $ -- $ --
Intangible assets -- -- -- --
Property and equipment 292 18 -- 310
-------- ------ ----- --------
TOTAL $ 292 $ 18 $ -- $ 310
======== ====== ===== ========
For the Three Months Ended
June 30, 2005
(Dollars in Thousands)
-------------------------------------------
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
======== ====== ===== ========
13
NOTE 6 - SEGMENT REPORTING (CONTINUED)
For the Six Months Ended
June 30, 2006
(Dollars in Thousands)
-------------------------------------------
Bank ICA Eliminations Total
-------- ------ ------------ --------
INTEREST INCOME $ 8,242 $ 7 $ (7) $ 8,242
INTEREST EXPENSE 4,000 -- (7) 3,993
-------- ------ ----- --------
NET INTEREST INCOME - Before provision for loan losses 4,242 7 -- 4,249
PROVISION FOR LOAN LOSSES 202 -- -- 202
-------- ------ ----- --------
NET INTEREST INCOME - After provision for loan losses 4,040 7 -- 4,047
OTHER INCOME 692 1,510 -- 2,202
OPERATING EXPENSES 4,334 1,447 -- 5,781
-------- ------ ----- --------
INCOME - Before federal income tax 398 70 -- 468
FEDERAL INCOME TAX 133 24 -- 157
-------- ------ ----- --------
NET INCOME $ 265 $ 46 $ -- $ 311
======== ====== ===== ========
DEPRECIATION AND AMORTIZATION $ 343 $ 172 $ -- $ 515
======== ====== ===== ========
ASSETS $280,378 $4,464 $(572) $284,270
======== ====== ===== ========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ -- $ -- $ -- $ --
Intangible assets -- -- -- --
Property and equipment 748 21 -- 769
-------- ------ ----- --------
TOTAL $ 748 $ 21 $ -- $ 769
======== ====== ===== ========
For the Six Months Ended
June 30, 2005
(Dollars in Thousands)
-------------------------------------------
Bank ICA Eliminations Total
-------- ------ ------------ --------
INTEREST INCOME
INTEREST EXPENSE $ 7,228 $ 4 $ (4) $ 7,228
NET INTEREST INCOME - Before provision for loan losses 3,247 -- (4) 3,243
-------- ------ ----- --------
PROVISION FOR LOAN LOSSES 3,981 4 -- 3,985
NET INTEREST INCOME - After provision for loan losses 262 -- -- 262
-------- ------ ----- --------
OTHER INCOME 3,719 4 -- 3,723
OPERATING EXPENSES 714 1,484 -- 2,198
INCOME - Before federal income tax 4,735 1,424 -- 6,159
-------- ------ ----- --------
FEDERAL INCOME TAX (302) 64 -- (238)
NET INCOME (101) 21 -- (80)
-------- ------ ----- --------
$ (201) $ 43 $ -- $ (158)
======== ====== ===== ========
DEPRECIATION AND AMORTIZATION
ASSETS $ 324 $ 64 $ -- $ 388
======== ====== ===== ========
EXPENDITURES RELATED TO LONG-LIVED ASSETS: $273,344 $3,533 $(349) $276,528
======== ====== ===== ========
Goodwill
Intangible assets $ -- $ -- $ -- $ --
Property and equipment -- -- -- --
TOTAL 589 9 -- 598
-------- ------ ----- --------
$ 589 $ 9 $ -- $ 598
======== ====== ===== ========
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 financial condition of the Company
consolidated with its wholly owned direct and indirect subsidiaries at June 30,
2006 and December 31, 2005, and the results of operations for the three- and
six-month periods ended June 30, 2006 and 2005. This discussion should be read
in conjunction with the interim financial statements and footnotes included
herein.
OVERVIEW
For the quarter ended June 30, 2006, the Company's earnings were $98,500
compared to a net loss of $300,300 for the year earlier period, an increase of
$398,800. However, in the quarter ended June 30, 2005, the Company made a
one-time charitable contribution of $679,940 (approximately $449,000 after tax)
to the First Federal Community Foundation. Absent the after-tax effect of this
charitable contribution, net income for the quarter ended June 30, 2006 would
have been approximately $50,000 lower than for the same period in 2005. The
Company sold bonds at a loss of $43,000 in the quarter ended June 30, 2006,
which accounts for most of the decline in net income quarter over quarter.
The Bank's Return on Average Assets (ROA) for the trailing twelve months
ended June 30, 2006 was 37 basis points compared to 25 basis points for the same
period one year earlier. Management uses ROA as a tool to measure the
performance of the Bank. ROA is reviewed on a trailing twelve-month basis each
month by management and the Board of Directors.
CAPITAL EXPENDITURES
On August 31, 2005 the Company broke ground on a new bank branch to replace
an existing leased branch in Lewiston, Michigan. As of June 30, 2006, the
Company had expended $1,063,478 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 opened for business
on June 26, 2006, will further enhance its expansion into the Lewiston market.
FINANCIAL CONDITION
ASSETS: Total assets increased $1.5 million, or 0.53%, to $284.3 million at June
30, 2006 from $282.8 million at December 31, 2005. Investment securities
available for sale decreased $6.9 million, or 13.0%, from December 31, 2005 to
June 30, 2006. During the quarter ended June 30, 2006, the Company sold $7.0
million in low-yielding investment securities at a realized loss of
approximately $43,000. The proceeds from the sale of the investment securities
were used to pay off high cost FHLB advances and the Company expects that by the
end of calendar 2006, this strategy will result in approximately $45,000 in
pre-tax earnings. Net loans receivable increased $8.3 million, or 4.15%, to
$209.5 million at June 30, 2006 from $201.2 million at December 31, 2005. The
growth in net loans was attributable primarily to growth in the commercial loan
portfolios.
LIABILITIES: Deposits decreased $2.3 million or 1.21% to $186.4 million at June
30, 2006 from $188.7 million at December 31, 2005. This decrease was the result
of the maturity of a $600,000 brokered CD pool and decreases of $1.4 million in
statement savings accounts, $1.1 million in commercial sweep accounts, and $2.5
million in CD balances, partially offset by increases of $600,000 in demand
deposit accounts and $2.7 million in money market balances. Despite the pay down
of FHLB advances from the sale of investment securities during the quarter, FHLB
advances increased $5.6 million, or 10.64%, to $58.6 million at June 30, 2006
from $52.9 million at December 31, 2005 to fund loan growth and the decline in
deposits.
EQUITY: Stockholders' equity decreased by $1.2 million, or 3.38%, to $35.4
million at June 30, 2006. Net earnings for the quarter of $98,500 were offset by
a dividend declaration of $154,100 and loss in value of available-for-sale
securities of $179,000. The loss in value of these securities was due to changes
in
15
interest rates and was not considered by management to be other than temporary.
In addition, the Company repurchased 114,167 shares of its common stock in the
current quarter which will more than offset 63,250 restricted shares granted to
key managers under the 2006 Stock-Based Incentive Plan approved by the
shareholders at the Company's annual meeting on May 17, 2006.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2006 COMPARED TO THREE MONTHS ENDED JUNE 30, 2005
GENERAL: Net income increased by $398,800 to $98,500 for the three months ended
June 30, 2006 from a loss of $300,300 for the quarter ended June 30, 2005.
However, in the quarter ended June 30, 2005, the Company made a one-time
charitable contribution of $679,940 (approximately $449,000 after tax) to the
First Federal Community Foundation. Absent the after-tax effect of this
charitable contribution, net income for the quarter ended June 30, 2006 would
have been approximately $50,000 lower than for the same period in 2005. As
discussed above in the "Assets" section, the Company sold bonds at a loss of
$43,000 in the quarter ended June 30, 2006 which accounted for most of the
decline in net income quarter over quarter.
INTEREST INCOME: Interest income was $4.2 million for the three months ended
June 30, 2006, compared to $3.7 million for the comparable period in 2005. The
increase 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 $346,000 in interest income for the quarter ended June 30, 2006 as
compared to the same quarter a year ago, due in part to an increase in average
balance of $12.7 million and in part to an increase in prime rate of 200 basis
points from 6.25% at June 30, 2005 to 8.25% at June 30, 2006. An increase in
yield on other adjustable-rate loans, consisting primarily of adjustable
mortgage and HELOCs, also contributed to the increase in interest income for the
quarter ended June 30, 2006 as compared to the same period one year ago.
INTEREST EXPENSE: Interest expense was $2.1 million for the three month period
ended June 30, 2006, compared to $1.6 million for the quarter ended June 30,
2005. The 26.75% increase in interest expense was attributable to an increased
cost of funds of 68 basis points on interest bearing deposits for the period
ended June 30, 2006 compared to the three months ended June 30, 2005. In
addition, the average balance of FHLB borrowings increased from $52.1 million
for the quarter ended June 30, 2005 to $60.9 million for the quarter ended June
30, 2006, while the cost of those borrowings increased by 20 basis points due to
market interest rate increases.
NET INTEREST INCOME: Net interest income was maintained at $2.1 million for the
three month period ended June 30, 2006 compared to the same period in 2005. For
the three months ended June 30, 2006, average interest-earning assets increased
$14.2 million, or 5.6% when compared to the same period in 2005. Average
interest-bearing liabilities increased $9.0 million, or 4.0% for the same
period. The yield on average interest-earning assets increased to 6.28% for the
three month period ended June 30, 2006 from 5.86% for the same period ended in
2005 while the cost of average interest-bearing liabilities increased to 3.51%
from 2.88%. The net interest rate margin decreased to 3.18% for the three month
period ended June 30, 2006, from 3.28% for same period in 2005.
PROVISION FOR LOAN LOSSES: The allowance for loan losses is established through
a provision for loan losses charged to earnings. Loan losses are charged against
the allowance when management believes the uncollectibility of a loan balance is
confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and
is based upon management's periodic review of the collectibility of the loans in
light of historical experience, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower's ability to repay, estimated
value of any underlying collateral and prevailing economic conditions. This
evaluation is inherently subjective, as it requires estimates that are
susceptible to significant revision as more information becomes available. The
provision for loan losses amounted to $133,000 for the three month period ended
June 30, 2006 and $183,000 for the comparable period in 2005 when the Bank
experienced its first commercial charge-off.
16
NONINTEREST INCOME: Noninterest income was $1.1 million for both the three month
period ended June 30, 2006, and for the same period in 2005. Quarter over
quarter, the Company experienced a decline in mortgage banking activities income
of $15,000 and a decline in insurance brokerage commissions of $10,000. In
addition the Company realized a $43,500 loss on sale of investment securities
(as explained above) during the quarter ended June 30, 2006. However, quarter
over quarter, the Company experienced increases of $30,000 in service charges
and other fees.
NONINTEREST EXPENSE: Noninterest expenses were $2.9 million for the three month
period ended June 30, 2006, a $527,000 or 15.3% decrease from the same period in
2005. The decrease was primarily due to the $679,940 one-time contribution to
the First Federal Community Foundation in the quarter ended June 30, 2005. Also,
during the quarter ended June 30, 2006, as required by Statement of Financial
Accounting Standard (SFAS) No. 123 (Revised), the Company began expensing stock
options and stock awards granted to employees and directors during the quarter,
resulting in additional compensation expense of approximately $40,000 for the
quarter. In addition, amortization of intangible assets increased by $45,000, as
a result of the reduction of the amortization period of the ICA third-party
contract intangible asset to five years effective January 1, 2006, and as a
result of the December 2005 acquisition by ICA of a book of insurance business
which created an amortizable intangible asset. Lastly, the Company increased
advertising quarter over quarter by $47,000 in an effort to maintain market
share.
INCOME TAXES: Federal income taxes increased to $49,300 (33.4% of income) for
the three month period ended June 30, 2006 compared to a tax benefit of $152,000
(33.6% of the net loss) for the same period in 2005. The increase for the three
month period was attributable to an increase in pre-tax income.
SIX MONTHS ENDED JUNE 30, 2006 COMPARED TO SIX MONTHS ENDED JUNE 30, 2005
GENERAL: Net income increased by $469,000 to $311,000 for the six months ended
June 30, 2006 from a loss of $158,300 for the six months ended June 30, 2005. As
discussed above, the increase in earnings period over period was primarily
attributable to the one-time contribution of $679,940 (approximately $449,000
after tax) to the First Federal Community Foundation.
INTEREST INCOME: Interest income was $8.2 million for the six months ended June
30, 2006, compared to $7.2 million for the comparable period in 2005. The
increase of $1.0 million 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 $675,000 in interest income for the six months ended June 30, 2006 as
compared to the same period a year ago, due in part to an increase in average
balance of $12.7 million and in part to an increase in prime rate of 200 basis
points from 6.25% at June 30, 2005 to 8.25% at June 30, 2006. An increase in
yield on other adjustable rate loans, consisting primarily of adjustable
mortgage and HELOCs, also contributed to the increase in interest income for
the six months ended June 30, 2006 as compared to the same period one year ago.
INTEREST EXPENSE: Interest expense was $3.9 million for the six-month period
ended June 30, 2006, compared to $3.2 million for the same period in 2005. The
23.13% increase in interest expense was attributable to an increased cost of
funds on interest bearing deposits for the period ended June 30, 2006 compared
to June 30, 2005. The year-to-date average balance of interest-bearing deposits
increased by $4.1 million or 2.4% when compared to the six months ended June 30,
2005 and the cost of those deposits increased by 58 basis points. The
year-to-date average balance of FHLB borrowings increased from $54.3 million for
the six-month period ended June 30, 2005 to $58.7 million for the six-month
period ended June 30, 2006, while the cost of those borrowings increased by 24
basis points due to market interest rate increases.
NET INTEREST INCOME: Net interest income increased by $264,000 for the six-month
period ended June 30, 2006 compared to the same period in 2005. For the six
months ended June 30, 2006, average interest-earning assets increased $17.2
million, or 6.9% when compared to the same period in 2005. Average
interest-bearing liabilities increased $8.9 million, or 3.9% for the same
period. The yield on average interest-earning assets increased to 6.20% for the
six month period ended June 30, 2006 from 5.81% for the same period ended in
2005 while the cost of average interest-bearing liabilities increased to 3.40%
from 2.87%. The net interest rate
17
margin decreased to 3.20% for the six month period ended June 30, 2006, from
3.21% for same period in 2005. Again, as stated in the quarter to quarter
analysis, the Company's cost of funds was increasing at a more rapid rate than
its asset yields. The Company continues to focus on relationship building in
terms of deposit gathering, with emphasis on commercial and personal demand
accounts, as opposed to a reliance on CD deposits, which generally carry a
higher cost of funds.
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 by 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,
2006 2005
-------- ------------
(Dollars in thousands)
-----------------------
Total non-accrual loans ................................ $1,779 $1,353
------ ------
Accrual loans delinquent 90 days or more:
One- to four-family residential ..................... 592 1,684
Other real estate loans ............................. 841 670
Consumer/Commercial ................................. 693 300
------ ------
Total accrual loans delinquent 90 days or more ... $2,126 $2,654
------ ------
Total nonperforming loans (1) .......................... 3,905 4,007
Total real estate owned-residential mortgages (2) ...... 657 427
Total real estate owned-Consumer and other (2) ......... 10 8
====== ======
Total nonperforming assets ............................. $4,572 $4,442
====== ======
Total nonperforming loans to loans receivable .......... 1.85% 1.97%
Total nonperforming assets to total assets ............. 1.55% 1.57%
(1) All of the Bank's loans delinquent more than 90 days are classified as
nonperforming.
(2) Represents the net book value of property acquired by the Bank through
foreclosure or deed in lieu of foreclosure. Upon acquisition, this property
is recorded at the lower of its fair market value or the principal balance
of the related loan.
PROVISION FOR LOAN LOSSES: The provision for loan losses amounted to $202,500
for the six-month period ended June 30, 2006 and $262,300 for the comparable
period in 2005 when the Bank experienced its first commercial charge-off. At
June 30, 2006 the percent of nonperforming loans decreased to 185 basis points
from 197 basis points at December 31, 2005. As a percent of total assets,
nonperforming loans decreased to 155 basis points at June 30, 2006 from 157
basis points at December 31, 2005.
NONINTEREST INCOME: Noninterest income was $2.2 million for the six-month period
ended June 30, 2006, and for the same period in 2005. While the total amount did
not change period over period, there was some shifting among the components of
noninterest income. Income from mortgage banking activities continued to decline
as mortgage origination activity slowed. The Company has become more reliant in
2006 on service charge and other fee income, including overdraft privileges and
skip-a-pay fees.
NONINTEREST EXPENSE: Noninterest expense was $5.8 million for the six-month
period ended June 30, 2006, a $378,000 or 6.14% decrease from the same period in
2005. The main reason for the decrease was the $679,940 one-time contribution to
the First Federal Community Foundation for the six month period ended June 30,
2005. Costs that increased period over period include: advertising $57,000;
occupancy $75,000 (due to increased heating costs and additional costs
associated with the new branch in Cheboygan which opened in mid-2005);
amortization of intangible assets $99,000; and other expense $72,000.
18
INCOME TAXES: Federal income taxes increased to $156,700 (33.5% of income) for
the six month period ended June 30, 2006 compared to a tax benefit of $79,900
(33.5% of net loss) for the same period in 2005. The increase for the six month
period was attributable to an increase in pre-tax income.
LIQUIDITY
The Company's current liquidity position is more than adequate to fund expected
asset growth. The Company's primary sources of funds are deposits, FHLB
advances, proceeds from principal and interest payments and prepayments on loans
and mortgage-backed and investment securities and sale of long-term fixed-rate
mortgages into the secondary market. While maturities and scheduled amortization
of loans and mortgage-backed securities are a predictable source of funds,
deposit flows, mortgage prepayments and sale of mortgage loans into the
secondary market are greatly influenced by general interest rates, economic
conditions and competition.
Liquidity represents the amount of an institution's assets that can be quickly
and easily converted into cash without significant loss. The most liquid assets
are cash, short-term U.S. Government securities, U.S. Government agency
securities and certificates of deposit. The Company is required to maintain
sufficient levels of liquidity as defined by 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, 2006 was $64.3 million, or 33.9%, compared to
$77.8 million, or 39.3% at December 31, 2005. The levels of these assets are
dependent on the Company's operating, financing, lending and investing
activities during any given period. The liquidity calculated by the Company
includes additional borrowing capacity available with the FHLB. This borrowing
capacity is based on the FHLB stock owned by the Bank along with pledged
collateral. As of June 30, 2006, the Bank had unused borrowing capacity totaling
45.2 million at the FHLB based on the FHLB stock ownership.
The Company intends to retain for the 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.
During the six-month period ended June 30, 2006 the Company originated $17.2
million in residential mortgage loans, of which $10.9 million were retained in
portfolio while the remainder were sold in the secondary market or are being
held for sale. This compares to $27.1 million in originations during the first
six months of 2005 of which $18.1 million were retained in portfolio. The
Company also originated $12.6 million of commercial loans and $8.3 million of
consumer loans in the first six months of 2006 compared to $21.5 million of
commercial loans and $6.2 million of consumer loans for the same period in 2005.
Of total loans receivable, excluding loans held for sale, mortgage loans
comprised 49.4% and 52.3%, commercial loans 37.3% and 35.0% and consumer loans
13.3% and 12.8% at June 30, 2006 and December 31, 2005 respectively.
Deposits are a primary source of funds for use in lending and for other
general business purposes. At June 30, 2006 deposits funded 65.6% of the
Company's total assets compared to 66.8% at December 31, 2005. Certificates of
deposit scheduled to mature in less than one year at June 30, 2006 totaled $88.1
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. While management
believes that the expected growth in assets is not expected to require
significant in-flows of liquidity, market conditions have forced us, in some
instances, to be a market leader in rates paid for deposit liabilities to
maintain current deposit levels and fund loan growth without having to rely
heavily on more costly FHLB advances.
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, 2006, the Company had $58.6 million in
FHLB advances. FLHB borrowings as a percentage of total assets were 20.6% at
June 30, 2006 as compared to 18.7% at December 31, 2005. The Company has
sufficient available collateral to obtain additional advances of $13.9
19
million. When this is combined with current FHLB stock ownership the Company
could obtain up to an additional $45.2 million in advances from the FHLB.
CAPITAL RESOURCES
Stockholders' equity at June 30, 2006 was $35.4 million, or 12.85% of total
assets, compared to $36.6 million, or 13.0% of total assets, at December 31,
2005 (See "Consolidated Statement of Changes in Stockholders' Equity"). The Bank
is subject to certain capital-to-assets levels in accordance with the OTS
regulations. The Bank exceeded all regulatory capital requirements at June 30,
2006. The following table summarizes the Bank's actual capital with the
regulatory capital requirements and with requirements to be "Well Capitalized"
under prompt corrective action provisions, as of June 30, 2006:
Regulatory Minimum to be
Actual Minimum Well Capitalized
--------------- --------------- ----------------
Amount Ratio Amount Ratio Amount Ratio
------- ----- ------- ----- ------- ------
Dollars in Thousands
Tangible Capital (to
tangible assets) $30,151 10.74% $ 4,211 1.50% $ 5,615 2.00%
Tier 1 (Core) capital (to risk -
weighted assets) $30,151 10.74% $11,230 4.00% $14,038 5.00%
Total risk-based capital (to risk-
weighted assets) $31,738 16.43% $15,454 8.00% $19,318 10.00%
Tier 1 risk-based capital (to
tangible assets) $30,151 15.61% $ 7,727 4.00% $11,591 6.00%
20
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-QSB
QUARTER ENDED JUNE 30, 2006
PART I - FINANCIAL INFORMATION
ITEM 3 - CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management, including
the Company's Chief Executive Officer and Chief Financial Officer, the Company
evaluated the effectiveness of the design and operation of its disclosure
controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934) as of the end of the period covered by this
report. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that, as of the end of the period covered by this
report, the Company's disclosure controls and procedures were effective to
ensure that information required to be disclosed in the reports the Company
files or submits under the Securities Exchange Act of 1934, is recorded,
processed, summarized and reported, within the time periods specified by the
SEC's rules and forms and in timely alerting them to material information
relating to the Company (or its consolidated subsidiaries) required to be
included in its periodic SEC filings.
There has been no change in the Company's internal control over the financial
reporting during the Company's second quarter of fiscal year 2006 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, 2006
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings:
There are no material legal proceedings to which the Company is a party or
of which any of its property is subject. From time to time the Company is a
party to various legal proceedings incident to its business.
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds:
Issuer Purchases of Equity Securities
On May 17, 2006 the Company announced a share repurchase program
authorizing the repurchase of up to 156,000 shares of the Company's
outstanding common stock. All repurchases under the Company's share
repurchase program are transacted in the open market and are within the
scope of Rule 10b-18, which provides a safe harbor for purchases in a given
day if an issuer of equity securities satisfies the manner, timing, price
and volume conditions of the rule when repurchasing its own common shares
in the open market. The following table summarizes the Company's share
repurchase activity for the three months ended June 30, 2006.
Total Number of
Shares Purchased Maximum Number of
Total Number Average as Part of Publicly Shares that May Yet Be
of Shares Price Paid Announced Plans Purchased Under the
Period Purchased per Share or Programs Plans or Programs
------ ------------ ---------- ------------------- ----------------------
4/1/2006 to 4/30/2006 -- -- -- N/A
5/1/2006 to 5/31/2006 1,762 9.90 1,762 154,238
6/1/2006 to 6/30/2006 112,405 10.02 112,405 41,833
Total 114,167 10.02 114,167
Item 3 - Defaults upon Senior Securities:
Not applicable.
Item 4 - Submission of Matters to a Vote of Security Holders:
The annual meeting of the shareholders of the Company was held on May 17,
2006. The results of the vote were as follows:
1. The following individuals were elected as directors for a three (3)
year term:
Votes For Votes Withheld
--------- --------------
Gary C. VanMassenhove 2,581,318 386,523
Thomas R. Townsend 2,581,336 386,505
22
2. The approval of the First Federal of Northern Michigan Bancorp, Inc.
2006 Stock-Based Incentive Plan:
Broker
For Against Abstain Nonvote
--------- ------- ------- -------
Number of Votes 1,174,182 882,895 26,107 884,657
3. The ratification of the appointment of Plante & Moran, PLLC as
independent auditors of the Company for the fiscal year ending
December 31, 2006:
For Against Abstain
--------- ------- -------
Number of Votes 2,680,841 164,293 122,707
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
23
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-QSB
QUARTER ENDED JUNE 30, 2006
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FIRST FEDERAL OF NORTHERN MICHIGAN
BANCORP, INC.
By: /s/ Martin A. Thomson
------------------------------------
Martin A. Thomson
Chief Executive Officer
Date: August 14, 2006
By: /s/ Amy E. Essex
------------------------------------
Amy E. Essex, Chief Financial
Officer
(Principal Financial and Accounting
Officer)
Date: August 14, 2006
24
EXHIBIT INDEX
Exhibits Description
-------- -----------
31.1 Exhibit 31.1 Certification by Chief Executive Officer pursuant to
section 302 of the Sarbanes-Oxley Act of 2002
31.2 Exhibit 31.2 Certification by Chief Financial Officer pursuant to
section 302 of the Sarbanes-Oxley Act of 2002
32.1 Exhibit 32.1 Statement of Chief Executive Officer furnished pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Exhibit 32.2 Statement of Chief Financial Officer furnished pursuant
Section 906 of the Sarbanes-Oxley Act of 2002
25