UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

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

For the quarterly period ended March 31, 2015

 

OR

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

 

 

For the transition period from ____________________________ to__________________________

   

Commission File Number 000-31957

 

FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.

(Exact name of registrant as specified in its charter)

   
Maryland 32-0135202
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

 

100 S. Second Avenue, Alpena, Michigan              49707

(Address of principal executive offices)            (Zip Code)

 

Registrant’s telephone number, including area code: (989) 356-9041

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes No

 

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

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

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No

 

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date. 

     
Common Stock, Par Value $0.01   Outstanding at May 13, 2015
(Title of Class)   3,727,014 shares

  

1
 

 

FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.

FORM 10-Q

Quarter Ended March 31, 2015

 

INDEX

         
    PART I – FINANCIAL INFORMATION    
ITEM 1 -   UNAUDITED FINANCIAL STATEMENTS   PAGE
    Consolidated Balance Sheet at March 31, 2015 and December, 31, 2014   3
    Consolidated Statements of Income and Comprehensive Income for the Three Months Ended March 31, 2015 and March 31, 2014   4
    Consolidated Statement of Changes in Stockholders’ Equity for the Three Months Ended March 31, 2015   5
    Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2015 and March 31, 2014   6
    Notes to Unaudited Consolidated Financial Statements   7
         
ITEM 2 -   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS   23
         
ITEM 3 -   QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK   29
         
ITEM 4 -   CONTROLS AND PROCEDURES   29
         
Part II - OTHER INFORMATION    
ITEM 1 -   LEGAL PROCEEDINGS   30
ITEM 1A -   RISK FACTORS   30
ITEM 2 -   UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS   30
ITEM 3 -   DEFAULTS UPON SENIOR SECURITIES   30
ITEM 4 -   MINE SAFETY DISCLOSURES   30
ITEM 5 -   OTHER INFORMATION   30
ITEM 6 -   EXHIBITS   30

 

When used in this Form 10-Q or future filings by First Federal of Northern Michigan Bancorp, Inc. (the “Company”) with the Securities and Exchange Commission (“SEC”), in the Company’s press releases or other public or stockholder communications, or in oral statements made with the approval of an authorized executive officer, the words or phrases “would be,” “will allow,” “intends to,” “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project,” or similar expressions are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.

 

The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made, and to advise readers that various factors, including regional and national economic conditions, changes in levels of market interest rates, credit and other risks of lending and investment activities and competitive and regulatory factors, could affect the Company’s financial performance and could cause the Company’s actual results for future periods to differ materially from those anticipated or projected.

 

The Company does not undertake, and specifically disclaims any obligation, to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements.

 

2
 

 

                 
PART I - FINANCIAL INFORMATION            
             
ITEM 1 - FINANCIAL STATEMENTS            
             
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries            
Consolidated Balance Sheet (in thousands)            
             
    March 31, 2015     December 31, 2014  
    (Unaudited)        
ASSETS            
Cash and cash equivalents:            
Cash on hand and due from banks   $ 19,205     $ 11,205  
Overnight deposits with FHLB     307       267  
Total cash and cash equivalents     19,512       11,472  
                 
Deposits Held in other financial institutions     8,429       8,429  
Securities available for sale     126,305       119,968  
Securities held to maturity     790       790  
Loans held for sale     413       88  
Loans receivable, net of allowance for loan losses of $1,444 and $1,429 as of March 31, 2015 and December 31, 2014, respectively     162,130       163,647  
Foreclosed real estate and other repossessed assets     3,087       2,823  
Federal Home Loan Bank stock, at cost     2,591       2,591  
Premises and equipment     6,294       6,336  
Assets held for sale     271       478  
Accrued interest receivable     1,090       986  
Intangible assets     1,226       1,286  
Deferred tax asset     658       851  
Originated mortgage servicing rights     671       710  
Bank owned life insurance     4,759       4,727  
Other assets     706       685  
Total assets   $ 338,932     $ 325,867  
                 
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY                
Liabilities:                
Deposits   $ 285,472     $ 270,734  
Advances from borrowers for taxes and insurance     406       203  
Advances from Federal Home Loan Bank     20,827       22,885  
Accrued expenses and other liabilities     1,065       1,509  
                 
Total liabilities     307,770       295,331  
                 
Stockholders’ equity:                
Common stock ($0.01 par value 20,000,000 shares authorized 4,034,764 shares issued)     40       40  
Additional paid-in capital     28,264       28,264  
Retained earnings     5,046       4,765  
Treasury stock at cost (307,750 shares)     (2,964 )     (2,964 )
Accumulated other comprehensive income (loss)     776       431  
Total stockholders’ equity     31,162       30,536  
Total liabilities and stockholders’ equity   $ 338,932     $ 325,867  
                 
See accompanying notes to consolidated financial statements.    

 

3
 

 

                 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries            
Consolidated Statement of Income and Comprehensive Income (in thousands)            
    For the Three Months  
    Ended March 31,  
    2015     2014  
    (Unaudited)  
             
Interest income:            
Interest and fees on loans   $ 2,004     $ 1,710  
Interest and dividends on investments                
Taxable     294       151  
Tax-exempt     31       42  
Interest on mortgage-backed securities     288       142  
Total interest income     2,617       2,045  
                 
Interest expense:                
Interest on deposits     235       186  
Interest on borrowings     66       63  
Total interest expense     301       249  
                 
Net interest income     2,316       1,796  
Provision for loan losses     23       16  
Net interest income after provision for loan losses     2,293       1,780  
                 
Non-interest income:                
Service charges and other fees     218       181  
Mortgage banking activities     101       96  
Net income (loss) on sale of premises and equipment, real estate owned and other repossessed assets     91       (5 )
Other     84       64  
Total non-interest income     494       336  
                 
Non-interest expense:                
Compensation and employee benefits     1,419       1,109  
FDIC Insurance Premiums     64       46  
Advertising     44       28  
Occupancy     280       236  
Amortization of intangible assets     61       30  
Service bureau charges     103       62  
Professional services     110       129  
Collection activity     63       18  
Real estate owned & other repossessed assets     18       17  
Other     269       220  
Total non-interest expense     2,431       1,895  
                 
Income before income tax expense     356       221  
Income tax expense            
                 
Net Income   $ 356     $ 221  
                 
Other Comprehensive Income (Loss):                
Unrealized (loss) gain on investment securities - available for sale securities - net of tax   $ 345     $ 273  
Reclassification adjustment for gains realized in earnings - net of tax            
                 
Comprehensive Income (Loss)   $ 701     $ 494  
                 
Per share data:                
Net Income per share                
Basic   $ 0.10     $ 0.08  
Diluted   $ 0.10     $ 0.08  
                 
Weighted average number of shares outstanding                
Basic     3,727       2,884  
Including dilutive stock options     3,727       2,884  
Dividends per common share   $ 0.02     $ 0.02  
                 
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, in thousands)        
                                     
                            Accumulated        
                Additional           Other        
    Common     Treasury     Paid-in     Retained     Comprehensive        
    Stock     Stock     Capital     Earnings     Income     Total  
                                     
Balance at December 31, 2014     40       (2,964 )     28,264       4,765       431       30,536  
                                                 
                                                 
Net income                       356             356  
                                                 
Change in unrealized gain on available-for-sale securities (net of tax of $177)                             345       345  
                                                 
Dividends declared                       (75 )           (75 )
                                                 
Balance at March 31, 2015     40       (2,964 )     28,264       5,046       776       31,162  
                                                 
See accompanying notes to the consolidated financial statements.            

 

5
 

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries  
Consolidated Statement of Cash Flows (in thousands)  
    For Three Months Ended  
    March 31,  
    2015     2014  
    (Unaudited)  
Cash Flows from Operating Activities:            
Net income   $ 356     $ 221  
Adjustments to reconcile net income to net cash from operating activities:                
Depreciation and amortization     155       102  
Provision for loan loss     23       16  
Accretion of acquired loans     (5 )      
Amortization and accretion on securities     227       98  
Gain on sale of loans held for sale     (62 )     (42 )
Gain on sale of property and equipment and asset held for sale     (81 )     (2 )
(Gain) Loss on sale of real estate owned and other repossessed assets     (10 )     7  
Originations of loans held for sale     (3,497 )     (2,524 )
Proceeds from sale of loans held for sale     3,234       2,506  
Net change in:                
Accrued interest receivable     (104 )     (83 )
Other assets     33       (17 )
Bank owned life insurance     (32 )     (29 )
Accrued expenses and other liabilities     (444 )     (107 )
Net cash (used in) provided by operating activities     (207 )     145  
                 
Cash Flows from Investing Activities:                
Net decrease in loans     1,079       728  
Proceeds from maturies and calls of available-for-sale securities     5,287       2,336  
Proceeds from sale of real estate and other repossessed assets     165       80  
Proceeds from sale of property and equipment     288       2  
Purchase of securities     (11,327 )     (8,105 )
Purchase of premises and equipment     (53 )     (28 )
Net cash used in investing activities     (4,561 )     (4,987 )
                 
Cash Flows from Financing Activities:                
Dividends paid on common stock     (75 )     (58 )
Net increase in deposits     14,738       5,691  
Net increase in advances from borrowers     203       170  
Advances from Federal Home Loan Bank           6,980  
Repayments of Federal Home Loan Bank advances     (2,058 )     (7,561 )
Net cash provided by financing activities     12,808       5,223  
                 
Net increase in cash and cash equivalents     8,040       381  
Cash and cash equivalents at beginning of period     11,472       2,766  
Cash and cash equivalents at end of period   $ 19,512     $ 3,147  
                 
Supplemental disclosure of cash flow information:                
                 
Cash refunded for taxes paid   $ 15     $  
Cash paid during the period for interest     302       252  
Transfers of loans to foreclosed real estate and repossessed assets     419       245  
                 
See accompanying notes to the consolidated financial statements.

 

6
 

 

FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1—BASIS OF FINANCIAL STATEMENT PRESENTATION

 

The accompanying unaudited condensed consolidated interim financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and with the instructions to Form 10-Q. Accordingly, certain information and disclosures required by accounting principles generally accepted in the United States of America for complete financial statements are not included herein. The interim financial statements should be read in conjunction with the financial statements of First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries and the notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2014.

 

All adjustments, consisting only of normal recurring adjustments, which in the opinion of management are necessary for a fair presentation of financial position, results of operations and cash flows, have been made. The results of operations for the three months ended March 31, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015.

 

Note 2— PRINCIPLES OF CONSOLIDATION

 

The consolidated financial statements include the accounts of First Federal of Northern Michigan Bancorp, Inc., its wholly owned subsidiary First Federal of Northern Michigan (the “Bank”), and the Bank’s wholly owned subsidiaries, Financial Services & Mortgage Corporation (“FSMC”) and FFNM Financial Services, Inc. FSMC invested in real estate, which includes leasing, selling, developing, and maintaining real estate properties. As of March 31, 2015, FSMC has been dissolved since all real estate properties were sold in 2011. The main activity of FFNM Financial Services, Inc. is to collect commission from the sale of non-insured investment products in resulting from investment advisory services offered in our branch network. All significant intercompany balances and transactions have been eliminated in the consolidation.

 

Note 3 - BUSINESS COMBINATIONS

 

As of August 8, 2014 (“Merger Date”), the Company completed its merger with Alpena Banking Corporation and its wholly owned subsidiary Bank of Alpena (“Alpena”). Alpena had one branch office and $102.9 million in assets as of August 8, 2014. The results of operations due to the merger have been included in the Company’s results since the Merger Date. The merger was effected by the issuance of shares of the Company’s common stock to Alpena Banking Corporation shareholders. Each share of Alpena’s common stock was converted into the right to receive 1.549 shares of the Company’s common stock, with cash paid in lieu of fractional shares. The conversion of Alpena’s shares resulted in the issuance of 842,965 shares of the Company’s common stock.

 

The merger transaction was recorded using the acquisition method of accounting and accordingly, assets acquired, liabilities assumed and consideration exchanged were recorded at estimated fair values on the Merger Date. The following table provides the purchase price calculation as of the Merger Date and the identifiable assets acquired and liabilities assumed at their estimated fair values. These fair value measurements are provisional based on third-party valuations that are currently under review and are subject to refinement for up to one year after the Merger Date based on additional information that may be obtained by us that existed on the Merger Date.

 

7
 

 

         
Purchase Price:      
(000’s omitted)      
       
First Federal of Northern Michigan Bancorp, Inc. common stock issued for Alpena Banking Corporation common shares     843  
         
Price per share, based on First Federal of Northern Michigan Bancorp, Inc. closing price on August 8, 2014   $ 5.59  
         
Total purchase price   $ 4,712  
                         
Preliminary Statement of Net Assets Acquired at Fair Value:                      
                       
Assets                      
Cash and cash equivalents   $ 41,650                  
Securities     24,008                  
Loans     33,051                  
Premises and Equipment     1,667                  
Core Deposit Intangible     1,392                  
Deferred Tax Asset     337                  
Other Assets     467                  
Total Assets   $ 102,572                  
                         
Liabilities                        
Deposits     95,787                  
Other Liabilities     91                  
Total Liabilities   $ 95,878                  
Net Identifiable Assets Acquired           $ 6,694          
Bargain Purchase Gain           $ (1,982 )        

 

The following table provides the pro forma information for the results of operations for the three months ended March 31, 2015 and 2014, as if the merger had occurred on January 1 of each year. These adjustments reflect the impact of certain purchase accounting fair value measurements, primarily on the loan and deposit portfolios of Bank of Alpena. These pro forma results are presented for illustrative purposes only and are not intended to represent or be indicative of the actual results of operations of the combined banking organizations that would have been achieved had the merger occurred at the beginning of each period presented, nor are they intended to represent or be indicative of future results of the Company. 

                 
    For the Three Months Ended  
    March 31,  
    2015     2014  
             
Net interest income   $ 2,316     $ 2,375  
Non-interest income     494       442  
Non-interest expense     2,431       2,543  
Net income     356       227  
Net income per basic and diluted share     0.10       0.06  
Weighted average shares outstanding     3,727       3,727  

 

In most instances, determining the fair value of the acquired assets and assumed liabilities required the Company to estimate the cash flows expected to result from those assets and liabilities and to discount those cash flows at appropriate rates of interest. The most significant of those determinations related to the valuation of acquired loans. For such loans, the excess cash flows expected at merger over the estimated fair value is recognized as interest income over the remaining lives of the loans. The difference between contractually required payments at merger and the cash flows expected to be collected at merger reflects the impact of estimated credit losses and other factors, such as prepayments. In accordance with the applicable accounting guidance for business combinations, there was no carry-over of Alpena’s previously established allowance for loan losses.

 

The acquired loans were divided into loans with evidence of credit quality deterioration, which are accounted for under ASC 310-30 (“acquired impaired”), and loans that do not meet the criteria, which are accounted for under ASC 310-20 (“acquired non-impaired”). In addition, the loans are further categorized into different pools based primarily on the type and purpose of the loan.

 

8
 

 

                         
    Acquired     Acquired     Acquired  
    Impaired     Non-Impaired     Total  
       
Real estate loans:                  
Residential mortgages   $ 397     $ 6,992     $ 7,389  
Commercial Loans:                        
            109       109  
Secured by real estate     3,070       14,721       17,791  
Other     1,201       4,213       5,414  
Total commercial loans     4,271       19,043       23,314  
                         
Consumer loans:                        
Secured by real state     30       1,568       1,598  
Other           750       750  
Total consumer loans     30       2,318       2,348  
                         
Total loans at acquisition date   $ 4,698     $ 28,353     $ 33,051  
                         
    Acquired     Acquired     Acquired  
    Impaired     Non-Impaired     Total  
                         
Loans acquired- contractual required payments   $ 5,930     $ 28,587     $ 34,517  
Non accretable yield     (1,232 )           (1,232 )
Expected cash flows     4,698       28,587       33,285  
Accretable yield           (234 )     (234 )
Carrying balance at acquisition date   $ 4,698     $ 28,353     $ 33,051  

 

Note 4—SECURITIES

 

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

                                 
    March 31, 2015  
   

Amortized

Cost

   

Gross

Unrealized

Gains

   

Gross

Unrealized

(Losses)

   

Market

Value

 
    (in thousands)  
Securities Available for Sale                        

U.S. Treasury securities and obligations of U.S. government corporations and agencies

  $ 36,788     $ 270     $ (14 )     37,044  
Municipal obligations     24,473       464       (20 )     24,917  
Corporate bonds & other obligations     1,532       8             1,540  
Mortgage-backed securities     62,334       567       (103 )     62,798  
Equity securities     3       3             6  
                                 
Total   $ 125,130     $ 1,312     $ (137 )   $ 126,305  
                                 
Securities Held to Maturity                                
Municipal obligations   $ 790     $ 101     $     $ 891  
                                 
    December 31, 2014  
   

Amortized

Cost

   

Gross

Unrealized

Gains

   

Gross

Unrealized

(Losses)

   

Market

Value

 
    (in thousands)  
Securities Available for Sale                                

U.S. Treasury securities and obligations of U.S. government corporations and agencies

  $ 31,221     $ 58     $ (57 )     31,222  
Municipal obligations     22,894       369       (129 )     23,134  
Corporate bonds & other obligations     1,549       12             1,561  
Mortgage-backed securities     63,648       515       (117 )     64,046  
Equity securities     3       2             5  
                                 
Total   $ 119,315     $ 956     $ (303 )   $ 119,968  
                                 
Securities Held to Maturity                                
Municipal obligations   $ 790     $ 118     $     $ 908  

 

9
 

 

The amortized cost and estimated market value of securities at March 31, 2015, by contract maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities with no specified maturity date are separately stated.

                 
    March 31, 2015  
   

Amortized

Cost

   

Market

Value

 
    (in thousands)  
Available For Sale:            
Due in one year or less   $ 6,213     $ 6,237  
Due after one year through five years     38,741       39,055  
Due in five year through ten years     16,549       16,792  
Due after ten years     1,290       1,417  
                 
Subtotal     62,793       63,501  
                 
Equity securities     3       6  
Mortgage-backed securities     62,334       62,798  
                 
Total   $ 125,130     $ 126,305  
                 
Held To Maturity:                
Due in one year or less   $ 45     $ 45  
Due after one year through five years     200       212  
Due in five year through ten years     315       360  
Due after ten years     230       274  
                 
Total   $ 790     $ 891  

 

At March 31, 2015 and December, 31, 2014, securities with a carrying value and fair value of $34,000,000 and $35,000,000, respectively, were pledged to secure FHLB advances and our line of credit at the Federal Reserve.

 

There were no security sales in either the three months ended March 31, 2015 or 2014.

 

The following is a summary of temporarily impaired investments that have been impaired for less than and more than twelve months as of March 31, 2015 and December 31, 2014: 

                               
    March 31, 2015  
         

Gross

Unrealized

Losses

         

Gross

Unrealized

Losses

 
   

Fair

Value

   

<12

months

   

Fair

Value

   

> 12

months

 
    (in thousands)  
Available For Sale:                        

U.S. Treasury securities and obligations of U.S. government corporations and agencies

  $ 2,486     $ (8 )   $ 994     $ (6 )
Municipal obligations     15             2,204       (20 )
Mortgage-backed securities     6,230       (24 )     4,419       (79 )
Equity securities                        
                                 
Total   $ 8,731     $ (32 )   $ 7,617     $ (105 )
                                 
Held to Maturity:                                
Municipal obligations   $     $     $     $  
                                 
    December 31, 2014  
           

Gross

Unrealized

Losses

           

Gross

Unrealized

Losses

 
   

Fair

Value

   

<12

months

   

Fair

Value

   

> 12

months

 
    (in thousands)  
Available For Sale:                                

U.S. Treasury securities and obligations of U.S. government corporations and agencies

  $ 13,672     $ (28 )   $ 971     $ (29 )
Municipal obligations     9,506       (54 )     4,039       (75 )
Mortgage-backed securities     9,923       (31 )     4,666       (86 )
Equity securities                        
                                 
Total   $ 33,101     $ (113 )   $ 9,676     $ (190 )
                                 
Held to Maturity:                                
Municipal obligations   $     $     $     $  

 

10
 

 

The Company held 19 securities with unrealized losses totaling $137,000 and 72 securities with unrealized losses totaling $303,000 at March 31, 2015 and December 31, 2014, respectively. The unrealized losses on the securities held in the portfolio are not considered other than temporary and have not been recognized into income. This decision is based on the Company’s ability and intent to hold any potentially impaired security until maturity. The performance of the security is based on the contractual terms of the agreement, the extent of the impairment and the financial condition and credit quality of the issuer. The decline in market value is considered temporary and a result of changes in interest rates and other market variables.

 

Note 5—LOANS AND ALLOWANCE FOR LOAN LOSSES

 

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

                 
    At March 31,     At December 31,  
    2015     2014  
    (in thousands)  
             
Real estate loans:            
Residential mortgage   $ 73,314     $ 71,828  
Commercial loans:                
Construction - real estate     2,111       1,443  
Secured by real estate     60,703       62,163  
Other     17,067       19,000  
Total commercial loans     79,881       82,606  
                 
Consumer loans:                
Secured by real estate     9,241       9,502  
Other     1,390       1,403  
Total consumer loans     10,631       10,905  
                 
Total gross loans   $ 163,826     $ 165,339  
Less:                
Net deferred loan fees     (252 )     (263 )
Allowance for loan losses     (1,444 )     (1,429 )
                 
Total loans, net   $ 162,130     $ 163,647  

 

As of March 31, 2015 the total outstanding balance and carrying value of acquired impaired loans was $4.4 million and $3.3 million, respectively. Changes to the accretable and non-accretable yield for acquired loans as follows as of March 31, 2015: 

                         
    Acquired     Acquired        
    Impaired     Non-        
    Non-     Imparied     Acquired  
    Accreatable     Accreatable     Total  
                   
December 31, 2014 balance   $ (1,232 )   $ (208 )   $ (1,440 )
Net discount associated with acquired loans                  
Accretion of discount for credit spread           5       5  
Loans paid off through March 31, 2015                  
Loans charged off through March 31, 2015     81             81  
Total   $ (1,151 )   $ (203 )   $ (1,354 )

 

11
 

 

The following table illustrates the contractual aging of the recorded investment in past due loans by class of loans as of March 31, 2015 and December 31, 2014:

                                           
As of March 31, 2015  
                                        Recorded  
                Greater than                       Investment > 90  
Originated Loans:   30 - 59 Days     60 - 89 Days     90 Days     Total           Total     Days and  
    Past Due     Past Due     Past Due     Past Due     Current     Loans     Accruing  
    (dollars in thousands)  
                                           
Commercial Real Estate:                                          
Commercial Real Estate - construction   $     $     $     $     $ 2,111     $ 2,111     $  
Commercial Real Estate - other     760             9       769       44,499       45,268        
Commercial - non real estate     400             15       415       12,613       13,028       15  
                                                         
Consumer:                                                        
Consumer - Real Estate           17       24       41       7,562       7,603       17  
Consumer - Other     9             8       17       1,180       1,197       8  
                                                         
Residential:                                                        
Residential     1,450             298       1,748       65,329       67,077       101  
Total   $ 2,619     $ 17     $ 354     $ 2,990     $ 133,294     $ 136,284     $ 141  
                                                         
As of March 31, 2015  
                                                    Recorded  
                    Greater than                             Investment > 90  
Acquired Loans:   30 - 59 Days     60 - 89 Days     90 Days     Total             Total     Days and  
    Past Due     Past Due     Past Due     Past Due     Current     Loans     Accruing  
    (dollars in thousands)  
                                                         
Commercial Real Estate:                                                        
Commercial Real Estate - construction   $     $     $     $     $     $     $  
Commercial Real Estate - other     317       110       111       538       14,897       15,436        
Commercial - non real estate     88             105       193       3,846       4,039        
                                                         
Consumer:                                                        
Consumer - Real Estate     5                   5       1,633       1,638        
Consumer - Other     13                   13       180       193        
                                                       
Residential:                                                        
Residential     228             285       513       5,724       6,237        
Total   $ 651     $ 110     $ 501     $ 1,262     $ 26,280     $ 27,543     $  
                                                         
As of December 31, 2014  
                                                    Recorded  
                    Greater than                             Investment > 90  
Originated Loans:   30 - 59 Days     60 - 89 Days     90 Days     Total             Total     Days and  
    Past Due     Past Due     Past Due     Past Due     Current     Loans     Accruing  
    (dollars in thousands)  
Commercial Real Estate:                                                        
Commercial Real Estate - construction   $     $     $     $     $ 1,443     $ 1,443     $  
Commercial Real Estate - other     10       195             205       46,103       46,308        
Commercial - non real estate                             14,544       14,544        
                                                         
Consumer:                                                        
Consumer - Real Estate     107       4       7       118       7,684       7,802        
Consumer - Other     3             3       6       1,152       1,158       3  
                                                         
Residential:                                                        
Residential     1,484       746       386       2,616       62,326       64,942       87  
Total   $ 1,604     $ 945     $ 396     $ 2,945     $ 133,252     $ 136,197     $ 90  
                                                         
As of December 31, 2014  
                                                    Recorded  
                    Greater than                             Investment > 90  
Acquired Loans:   30 - 59 Days     60 - 89 Days     90 Days     Total             Total     Days and  
    Past Due     Past Due     Past Due     Past Due     Current     Loans     Accruing  
    (dollars in thousands)  
Commercial Real Estate - construction   $     $     $     $     $     $     $  
Commercial Real Estate - other     125       128       93       346       15,604       15,950        
Commercial - non real estate           40       104       144       4,217       4,361        
                                                         
Consumer:                                                        
Consumer - Real Estate     123                   123       1,609       1,732        
Consumer - Other                             213       213        
                                                         
Residential:                                                        
Residential     147       56       461       664       6,222       6,886       225  
Total   $ 395     $ 224     $ 658     $ 1,277     $ 27,865     $ 29,142     $ 225  

 

12
 

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Risk Grade 6 (Substandard) - Loans are “substandard” whose full, final collectability does not appear to be a matter of serious doubt, but which nevertheless portray some form of well defined weakness that requires close supervision by Bank management. The noted weaknesses involve more than normal banking risk. One or more of the following characteristics may be exhibited in loans classified Substandard: (1) Loans possess a defined credit weakness and the likelihood that the loan shall be paid from the primary source of repayment is uncertain; (2) Loans are not adequately protected by the current net worth and/or paying capacity of the obligor; (3) primary source of repayment is gone, and the Bank is forced to rely on a secondary source of repayment such as collateral liquidation or guarantees; (4) distinct possibility that the Bank shall sustain some loss if deficiencies are not corrected; (5) unusual courses of action are needed to maintain a high probability of repayment; (6) the borrower is not generating enough cash flow to repay loan principal, however, continues to make interest payments; (7) the Bank is forced into a subordinated or unsecured position due to flaws in documentation; (8) loans have been restructured so that payment schedules, terms, and collateral represent concessions to the borrower when compared to normal loan terms; (9) the Bank is contemplating foreclosure or legal action due to the apparent deterioration in the loan; or (10) there is a significant deterioration in the market conditions and the borrower is highly vulnerable to these conditions.

 

Grade 7 (Doubtful) - Loans have all the weaknesses of those classified Substandard. Additionally, however, these weaknesses make collection or liquidation in full, based on existing conditions, improbable. Loans in this category are typically not performing in conformance with established terms and conditions. Full repayment is considered “Doubtful”, but extent of loss is not currently determinable.

 

Risk Grade 8 (Loss) - Loans are considered uncollectible and of such little value, that continuing to carry them as an asset on the Bank’s financial statements is not feasible.

 

13
 

 

The following table presents the risk category of loans by class of loans based on the most recent analysis performed and the contractual aging as of March 31, 2015 and December 31, 2014:

 

As of March 31, 2015  
Originated Loans:                  
    Commercial Real Estate     Commercial Real Estate        
Loan Grade   Construction     Other     Commercial  
                   
1-2   $     $     $ 29  
3           14,912       5,296  
4     2,111       19,574       5,208  
4.5           3,513       1,769  
5           5,506       288  
6           1,763       438  
7                  
8                  
Total   $ 2,111     $ 45,268     $ 13,028  
                         
Acquired Loans:                        
    Commercial Real Estate     Commercial Real Estate          
Loan Grade   Construction     Other     Commercial  
                         
1-2   $     $ 266     $ 1,130  
3           2,579       805  
4           10,644       900  
4.5             330       18  
5           1,008       1,034  
6           608       152  
7           0       0  
8           0       0  
Total   $     $ 15,435     $ 4,039  
                         
As of December 31, 2014  
Originated Loans:                        
    Commercial Real Estate     Commercial Real Estate          
Loan Grade   Construction     Other     Commercial  
                         
1-2   $     $     $ 31  
3           13,565       6,088  
4     1,443       21,757       7,538  
4.5           3,553       252  
5           6,040       635  
6           1,393        
7                  
8                  
Total   $ 1,443     $ 46,308     $ 14,544  
                         
Acquired Loans:                        
    Commercial Real Estate     Commercial Real Estate          
Loan Grade   Construction     Other     Commercial  
                         
1-2   $     $ 280     $ 1,188  
3           2,696       876  
4           10,905       970  
4.5             337       21  
5           1,176       1,150  
6           547       156  
7           9       0  
8                 0  
Total   $     $ 15,950     $ 4,361  

 

For residential real estate and other consumer credit the Company evaluates credit quality based on the aging status of the loan and by payment activity. Loans 60 or more days past due are monitored by the collection committee.

 

14
 

 

The following tables present the risk category of loans by class based on the most recent analysis performed as of March 31, 2015 and December 31, 2014.

                         
As of March 31, 2015
          Consumer -        
    Residential     Real Estate   Consumer - Other  
Originated Loans:                  
Loan Grade:                  
Pass   $ 66,566     $ 7,545     $ 1,197  
Special Mention                  
Substandard     511       58        
Total   $ 67,077     $ 7,603     $ 1,197  
                         
            Consumer -          
    Residential     Real Estate   Consumer - Other  
Acquired Loans:                        
Loan Grade:                        
Pass   $ 5,944     $ 1,628     $ 162  
Special Mention                  
Substandard     293       10       31  
Total   $ 6,237     $ 1,638     $ 193  
                         
As of December 31, 2014
            Consumer -          
    Residential     Real Estate   Consumer - Other  
Originated Loans:                        
Loan Grade:                        
Pass   $ 64,397     $ 7,778     $ 1,155  
Special Mention                  
Substandard     545       24       3  
Total   $ 64,942     $ 7,802     $ 1,158  
                         
            Consumer -          
    Residential     Real Estate   Consumer - Other  
Acquired Loans:                        
Loan Grade:                        
Pass   $ 6,335     $ 1,731     $ 213  
Special Mention                  
Substandard     551       1        
Total   $ 6,886     $ 1,732     $ 213  

 

The following table presents the recorded investment in non-accrual loans by class as of March 31, 2015 and December 31, 2014: 

                 
    As of  
    March 31, 2015     December 31, 2014  
    (in thousands)  
Commercial Real Estate:            
Commercial Real Estate - construction   $     $  
Commercial Real Estate - other     461       486  
Commercial     74       77  
                 
Consumer:                
Consumer - real estate     51       25  
Consumer - other            
                 
Residential:                
Residential     695       750  
                 
Total   $ 1,281     $ 1,338  

 

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

 

The Bank has classified approximately $3.4 million of its impaired loans as troubled debt restructurings as of March 31, 2015.

 

15
 

 

                                         
                      Troubled Debt Restructurings that Subsequently  
    Troubled Debt Restructurings     Defaulted  
    For the three months ended March 31, 2015     For the three months ended March 31, 2015  
          Pre-modification     Post-modification              
    Number of     outstanding recorded     outstanding recorded              
    Loans     investment     investment     Number of Loans     Recorded Investment  
          (dollars in thousands)           (dollars in thousands)  
Troubled Debt Restructurings                              
                               
Commercial Real Estate - Construction         $     $           $  
Commercial Real Estate - Other                              
Commercial - non real estate                              
Residential     1       110       110              
Total     1     $ 110     $ 110           $  
                                         
                            Troubled Debt Restructurings that Subsequently  
    Troubled Debt Restructurings     Defaulted  
    For the three months ended March 31, 2014     For the three months ended March 31, 2014  
            Pre-modification     Post-modification                  
    Number of     outstanding recorded     outstanding recorded                  
    Loans     investment     investment     Number of Loans     Recorded Investment  
            (dollars in thousands)             (dollars in thousands)  
Commerical Real Estate - Construction         $     $           $  
Commercial Real Estate - Other                              
Consumer - Other                              
Residential                              
Total         $     $           $  

 

For the majority of the Bank’s impaired loans, the Bank will apply the observable market price of collateral. However, the Bank may also utilize a measurement incorporating the present value of expected future cash flows discounted at the loan’s effective rate of interest. To determine observable market price, collateral asset values securing an impaired loan are periodically evaluated. Maximum time of re-evaluation is every 12 months. In this process, third party evaluations are obtained and heavily relied upon. Until such time that updated evaluations are received, the Bank may discount the collateral value used.

 

The Bank uses the following guidelines as stated in policy to determine when to realize a charge-off, whether a partial or full loan balance. A charge down in whole or in part is realized when unsecured consumer loans, credit card credits and overdraft lines of credit reach 90 days delinquency. At 120 days delinquent, secured consumer loans are charged down to the value of collateral, if repossession of the collateral is assured and/or in the process of repossession. Consumer mortgage loan deficiencies are charged down upon the sale of the collateral or sooner upon the recognition of collateral deficiency. Commercial credits are charged down at 90 days delinquency, unless an established and approved work-out plan is in place or litigation of the credit will likely result in recovery of the loan balance. Upon notification of bankruptcy, unsecured debt is charged off. Additional charge-off may be realized as further unsecured positions are recognized.

 

The following table presents the loans individually evaluated for impairment by class of loans as of March 31, 2015 and December 31, 2014:

                                         
As of March 31, 2015     2015  
    Unpaid Principal     Recorded     Related     Average     Interest  
    Balance     Investment     Allowance     Recorded     Income  
                      Investment     Recognized  
    (dollars in thousands)     (dollars in thousands)  
With no related allowance recorded:                          
Commercial   $ 15     $ 15     $     $ 15     $  
Commercial Real Estate - Construction                              
Commercial Real Estate - Other     848       847             849       12  
Consumer - Real Estate     43       40             41        
Consumer - Other                              
Residential     639       554             492       3  
                                         
With a specific allowance recorded:                                  
Commercial                              
Commercial Real Estate - Construction                              
Commercial Real Estate - Other     955       955       12       959       12  
Consumer - Real Estate     19       19       19       19        
Consumer - Other                              
Residential     142       140       27       142        
                                         
Totals:                                        
Commercial   $ 15     $ 15     $     $ 15     $  
Commercial Real Estate - Construction   $     $     $     $     $  
Commercial Real Estate - Other   $ 1,803     $ 1,802     $ 12     $ 1,808     $ 24  
Consumer - Real Estate   $ 62     $ 59     $ 19     $ 60     $  
Consumer - Other   $     $     $     $     $  
Residential   $ 781     $ 694     $ 27     $ 634     $ 3  

 

 

16
 

 

                                         
                            For the Three Months Ended  
Impaired Loans     March 31,  
As of December 31, 2014     2014  
    Unpaid Principal     Recorded     Related     Average     Interest  
    Balance     Investment     Allowance     Recorded     Income  
                      Investment     Recognized  
    (dollars in thousands)              
With no related allowance recorded:                          
Commercial   $     $     $     $     $  
Commercial Real Estate - Construction                              
Commercial Real Estate - Other     1,431       1,430             1,595       21  
Consumer - Real Estate     26       24             6        
Consumer - Other                              
Residential     781       618             382       1  
                                         
With a specific allowance recorded:                                  
Commercial                              
Commercial Real Estate - Construction                       173        
Commercial Real Estate - Other     386       386       10       1,840       4  
Consumer - Real Estate                              
Consumer - Other                              
Residential                       30        
                                         
Totals:                                        
Commercial   $     $     $     $     $  
Commercial Real Estate - Construction   $     $     $     $ 173     $  
Commercial Real Estate - Other   $ 1,817     $ 1,816     $ 10     $ 3,435     $ 25  
Consumer - Real Estate   $ 26     $ 24     $     $ 6     $  
Consumer - Other   $     $     $     $     $  
Residential   $ 781     $ 618     $     $ 412     $ 1  

 

The Allowance for Loan and Lease Losses has a direct impact on the provision expense. An increase in the ALLL is funded through recoveries and provision expense.

 

Activity in the allowance for loan and lease losses was as follows for the quarters ended March 31, 2015 and 2014, respectively:

                                                                 
For the Three Months Ended March 31, 2015  
    Commercial     Commercial           Consumer                          
    Construction     Real Estate     Commercial     Real Estate     Consumer     Residential     Unallocated     Total  
          (dollars in thousands)                    
                                                 
Allowance for credit losses:                                                
Beginning Balance   $ 8     $ 307     $ 94     $ 33     $ 19     $ 869     $ 99     $ 1,429  
Charge-offs           (3 )                 (5 )     (36 )           (44 )
Recoveries     12       4       2       4             14             36  
Provision     (5 )     62       9       11       7       (34 )     (27 )     23  
Ending Balance   $ 15     $ 370     $ 105     $ 48     $ 21     $ 813     $ 72     $ 1,444  
                                                                 
                                                                 
For the Three Months Ended March 31, 2014  
    Commercial     Commercial           Consumer                          
    Construction     Real Estate     Commercial     Real Estate     Consumer     Residential     Unallocated     Total  
          (dollars in thousands)                          
                                                                 
Allowance for credit losses:                                                                
Beginning Balance   $ 48     $ 444     $ 63     $ 62     $ 21     $ 784     $ 50     $ 1,472  
Charge-offs           (16 )           (11 )     (6 )     (35 )           (68 )
Recoveries           19             9             10             38  
Provision           (55 )     (2 )     (11 )     1       33       50       16  
Ending Balance   $ 48     $ 392     $ 61     $ 49     $ 16     $ 792     $ 100     $ 1,458  
                                                                 
Loan Balances Individually Evaluated for Impairment  
As of March 31, 2015  
    Commercial     Commercial           Consumer                          
    Construction     Real Estate     Commercial     Real Estate     Consumer     Residential     Unallocated     Total  
          (dollars in thousands)                          
Ending allowance balance: individually evaluated for impairment   $     $ 12     $     $ 19     $     $ 27     $     $ 58  
                                                             
Ending allowance balance: individually evaluated for impairment   $ 15     $ 358     $ 105     $ 29     $ 21     $ 786     $ 72     $ 1,386  
                                                                 
Loans:                                                                
Ending Balance   $ 2,111     $ 60,703     $ 17,067     $ 9,241     $ 1,390     $ 73,314     $     $ 163,826  
                                                               
Ending balance: individually evaluated for impairment   $     $ 1,802     $ 15     $ 59     $     $ 694     $     $ 2,570  
                                                             
Ending balance: loans collectively evaluated for impairment   $ 2,111     $ 43,466     $ 13,013     $ 7,544     $ 1,197     $ 66,383     $     $ 133,714  
                                                             
Acquired loans with deteriorated credit quality not subject to loan loss reserve   $     $ 1,988     $ 866     $ 9     $     $ 422     $     $ 3,285  
                                                             
Other acquired loans not subject to loan loss reserve   $     $ 13,447     $ 3,173     $ 1,629     $ 193     $ 5,815     $     $ 24,257  

 

 

17
 

 

                                                                 
Loan Balances Individually Evaluated for Impairment  
As of March 31, 2014  
    Commercial     Commercial           Consumer                          
    Construction     Real Estate     Commercial     Real Estate     Consumer     Residential     Unallocated     Total  
          (dollars in thousands)                    
Ending allowance balance: individually evaluated for impairment   $ 48     $ 137     $     $     $     $ 5     $     $ 190  
                                                                 
Ending allowance balance: individually evaluated for impairment   $     $ 255     $ 61     $ 49     $ 16     $ 787     $ 100     $ 1,268  
                                                                 
Loans:                                                                
Ending Balance   $ 173     $ 51,382     $ 12,252     $ 8,490     $ 1,171     $ 63,576     $     $ 137,044  
                                                                 
Ending balance: individually evaluated for impairment   $ 173     $ 3,315     $     $ 6     $     $ 405     $     $ 3,899  
                                                                 
Ending balance: loans collectively evaluated for impairment   $     $ 48,067     $ 12,252     $ 8,484     $ 1,171     $ 63,171     $     $ 133,145  

 

Note 6—DIVIDENDS

 

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

 

Note 7—STOCK-BASED COMPENSATION

 

Effective January 1, 2006, the Company adopted ASC 718-10, “Shareholder Based Payments”, which requires that the grant-date fair value of awarded stock options be expensed over the requisite service period. The Company’s 1996 Stock Option Plan (the “1996 Plan”), which was approved by shareholders, permits the grant of share options to its employees for up to 127,491 shares of common stock (retroactively adjusted for the exchange ratio applied in the Company’s 2005 stock offering and related second-step conversion). The Company’s 2006 Stock-Based Incentive Plan (the “2006 Plan”), which was approved by shareholders on May 17, 2006, permits the award of up to 242,740 shares of common stock of which the maximum number to be granted as Stock Options is 173,386 and the maximum that can be granted as Restricted Stock Awards is 69,354. Option awards are granted with an exercise price equal to the market price of the Company’s stock at the date of grant. Those option awards generally vest based on five years of continual service and have ten year contractual terms. Certain options provide for accelerated vesting if there is a change in control (as defined in the Plans).

 

During the three months ended March 31, 2015 no shares were awarded under either the 1996 Plan or the 2006 Plan. Shares issued under the plans and exercised pursuant to the exercise of the stock options awarded under the plans may be either authorized but unissued shares or reacquired shares held by the Company as treasury stock.

 

Stock Options - A summary of option activity under the Plans during the three months ended March 31, 2015 is presented below:

                                 
                Weighted-Average      
          Weighted-     Remaining        
          Average     Contractual Term     Aggregate  
Options   Shares     Exercise Price     (Years)     Intrinsic Value  
                         
Outstanding at January 1, 2015     136,030     $ 9.54       1.4     $ 0  
                                 
Granted     0       N/A                  
                                 
Exercised     0       N/A                  
                                 
Forfeited or expired     (250 )   $ 9.65                  
                                 
Oustanding at March 31, 2015     135,780     $ 9.54       1.1     $ 0  
                                 
Options Exercisable at March 31, 2015     135,780     $ 9.54       1.1     $ 0  

 

The aggregate intrinsic value of outstanding options shown in the table above represents the total pretax intrinsic value (i.e. the difference between the Company’s closing stock price of $5.95 on March 31, 2015 and the exercise price times the number of shares) that would have been received by the option holder had all option holders exercised their options on March 31, 2015. The amount changes based on the fair market value of the stock.

 

18
 

 

As of March 31, 2015 the Company had no unrecognized compensation cost related to nonvested options under the Plan. There were no shares which vested during the quarter ended March 31, 2015. In addition, there were no non-vested options as of March 31, 2015.

 

Restricted Stock Awards - As of March 31, 2015 all restricted stock awards have vested; therefore the Company had no unrecognized compensation cost under the Plans.

 

Note 8— COMMITMENTS TO EXTEND CREDIT

 

The Company is a party to credit-related financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, stand by letters of credit, and commercial lines of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheet. The Company’s exposure to credit loss is represented by the contracted amount of these commitments. The Company follows the same credit policies in making commitments as it does for on-balance sheet instruments.

 

At March 31, 2015, the Company had outstanding commitments to originate loans of $22.2 million. These commitments included the following: 

         
    As of  
    March 31, 2015  
    (in thousands)  
         
Commitments to grant loans   $ 7,586  
Unfunded commitments under lines of credit     14,493  
Commercial and standby letters of credit     134  

 

Note 9— FAIR VALUE MEASUREMENTS

 

The fair value of financial assets and liabilities recorded at fair value is categorized in three levels. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. These levels are as follows:

 

Level 1 — Valuations based on quoted prices in active markets, such as the New York Stock Exchange. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

 

Level 2 — Valuations of assets and liabilities traded in less active dealer or broker markets. Valuations include quoted prices for similar assets and liabilities traded in the same market; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable. Valuations may be obtained from, or corroborated by, third-party pricing services.

 

Level 3 — Assets and liabilities with valuations that include methodologies and assumptions that may not be readily observable, including option pricing models, discounted cash flow models, yield curves and similar techniques. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities, but in all cases are corroborated by external data, which may include third-party pricing services.

 

19
 

 

The following table presents information about the Company’s assets and liabilities measured at fair value on a recurring basis as of March 31, 2015 and December 31, 2014, and the valuation techniques used by the Company to determine those fair values. 

                                 
Assets and Liabilities Measured at Fair Value on a Recurring Basis at March 31, 2015  
   

Quoted

Prices in

Active

Markets for Identical

   

Significant

Other

Observable
Inputs

(Level 2)

   

Significant Unobservable Inputs

(Level 3)

   

Fair Value
as of
March 31,

2015

 
    (dollars in thousands)  
Assets                        
Investment securities- available-for-sale:                        

US Treasury securities and obligations of U.S. government corporations and agencies

  $ 1,285     $ 35,759     $     $ 37,044  
Municipal obligations           22,664       2,253       24,917  
Corporate bonds & other obligations           1,540             1,540  
Mortgage-backed securities           62,798             62,798  
Equity securities           6             6  
                                 
Total investment securities - available-for-sale   $ 1,285     $ 122,767     $ 2,253     $ 126,305  
                                 
Assets and Liabilities Measured at Fair Value on a Recurring Basis at December 31, 2014  
   

Quoted

Prices in

Active

Markets for Identical

   

Significant

Other

Observable
Inputs

(Level 2)

   

Significant Unobservable Inputs

(Level 3)

    Fair Value as
of December
31, 2014
 
    (dollars in thousands)  
Assets                                
Investment securities - available-for-sale:                              
U.S. Treasury securities and obligations of U.S.government corporations and agencies   $ 1,279     $ 5,763     $     $ 7,042  
Municipal obligations           11,317       2,292       13,609  
Corporate bonds & other obligations           1,097             1,097  
Mortgage-backed securities           28,603             28,603  
Equity securities           7             7  
Total investment securities - available-for-sale   $ 1,279     $ 46,787     $ 2,292     $ 50,358  

 

Fair value measurements of U.S. Government agencies and mortgage backed securities use pricing models that vary and may consider various assumptions, including time value, yield curves, volatility factors, prepayment speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures.

 

The Company has assets that, under certain conditions, are subject to measurement at fair value on a nonrecurring basis. At March 31, 2015 and December 31, 2014, such assets consist primarily of impaired loans and other real estate owned. The Company has estimated the fair values of these assets using Level 3 inputs, specifically discounted cash flow projections. 

                                 
Assets Measured at Fair Value on a Nonrecurring Basis at March 31, 2015  
   

Balance at

March 31, 2015

    Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
   

Significant

Other

Observable
Inputs

(Level 2)

   

Significant
Unobservable
Inputs

(Level 3)

    (dollars in thousands)  
Originated Assets:                        
                         
Impaired loans accounted for under FASB ASC 310-10   $ 1,801     $     $     $ 1,801  
Other real estate owned -residential mortgages     591                   591  
Other Real estate owned - commercial     1,636                   1,636  
Other repossessed assets     860                   860  
Total assets at fair value on a non-recurring basis                           $ 4,888  
                                 
Acquired Assets:                                
                                 
Impaired loans accounted for under FASB ASC 310-10   $ 525     $     $     $ 525  
Other real estate owned -residential mortgages                        
Other real estate owned - commercial                        
Other repossessed assets                        
Total assets at fair value on a non-recurring basis                     $ 525  

 

 

20
 

 

                                 
Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2014  
   

Balance at

December 31, 2014

   

Quoted Prices in
Active Markets
for Identical

Assets (Level 1)

   

Significant

Other

Observable
Inputs (Level 2)

    Significant
Unobservable
Inputs (Level 3)
    (dollars in thousands)  
Originated Assets:                                
                                 
Impaired loans accounted for under FASB ASC 310-10   $ 1,806     $     $     $ 1,806  
Other real estate owned -residential mortgages     336                   336  
Other real estate owned - commercial     1,628                   1,628  
Other repossessed assets     860                   860  
Total assets at fair value on a non-recurring basis                           $ 4,630  
                                 
Acquired Assets:                                
                                 
Impaired loans accounted for under FASB ASC 310-10   $ 396     $     $     $ 396  
Other real estate owned -residential mortgages                        
Other real estate owned - commercial                        
Other repossessed assets                        
Total assets at fair value on a non-recurring basis                     $ 396  

 

A loan is considered impaired when, based on current information and events it is probable the Company will be unable to collect all amounts due (both principal and interest) according to the contractual terms of the original loan agreement. Loans identified as impaired are measured using one of three methods: the loan’s observable market price; the fair value of collateral; or the present value of expected future cash flows. For each period presented, no loans were measured using the loan’s observable market price. Collateral may be in the form of real estate and/or business assets such as accounts receivable, inventory or business equipment.

 

Real estate is the collateral for the vast majority of our secured lending. The real estate’s value is based on observable market prices and market values of collateral provided by independent, third-party licensed or certified appraisers, selected from a list of Company-approved appraisers. Appraisals for all types of collateral-dependent loans are typically requested within 30 days of a loan being deemed impaired. The fair value of impaired loans with specific allocations is essentially based on recent real estate appraisals less costs to sell. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Appraised collateral values may be further discounted based on management’s historical knowledge of the property and/or changes in market conditions from the time of valuation or management’s plan for disposal. Subsequent evaluations of collateral are performed on a loan by loan basis as additional facts and circumstances related to the individual credit require, but not less than annually.

 

The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments:

 

Cash and Cash Equivalents - The carrying amounts of cash and short-term instruments approximate fair values.

 

Investment Securities - Fair value for the Bank’s investment securities was determined using the market value in active markets, where available. When not available, fair values are estimated using the fair value hierarchy. In the fair value hierarchy, Level 2 fair values are determined using observable inputs other than Level 1 market prices, such as quoted prices for similar assets. Level 3 values are determined using unobservable inputs, such as discounted cash flow projections.

 

Loans Receivable - For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for certain mortgage loans (e.g., one- to four-family residential), credit card loans, and other consumer loans are based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted for differences in loan characteristics. Fair values for other loans (e.g., commercial real estate and investment property mortgage loans, commercial, and industrial loans) are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for nonperforming loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.

 

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

 

Federal Home Loan Bank Stock - The carrying value of Federal Home Loan Bank stock approximates fair value based on the redemption provisions of the Federal Home Loan Bank.

 

21
 

 

Deposit Liabilities - The fair values disclosed for demand deposits (e.g., interest and noninterest checking, savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.

 

Federal Home Loan Bank Advances - The estimated fair value of the fixed and variable rate Federal Home Loan Bank advances are estimated by discounting the related cash flows using the rates currently available for similarly structured borrowings with similar maturities.

 

Accrued Interest - The carrying amounts of accrued interest approximate fair value.

 

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

                                         
March 31, 2015  

Carrying

Value

  Level 1     Level 2     Level 3     Total
Estimated Fair
Value
 
    (in thousands)  
Financial assets:                              
Cash and cash equivalents   $ 19,512     $ 19,512     $     $     $ 19,512  
Deposits held at other financial institutions     8,429             7,218       1,240       8,458  
Securities available for sale     126,305       1,285       125,020             126,305  
Securities held to maturity     790             891             891  
Loans held for sale     413                   427       427  
Loans receivable - net     162,130                   162,025       162,025  
Federal Home Loan Bank stock     2,591             2,591             2,591  
Accrued interest receivable     1,090                   1,090       1,090  
                                         
Financial liabilities:                                        
Customer deposits     285,472             286,031             286,031  
Federal Home Loan Bank advances     20,827             20,798             20,798  
Accrued interest payable     100                   100       100  
                                         
December 31, 2014  

Carrying

Value

  Level 1     Level 2     Level 3     Total
Estimated Fair
Value
 
    (in thousands)  
Financial assets:                                        
Cash and cash equivalents   $ 11,472     $ 11,472     $     $     $ 11,472  
Deposits held at other financial institutions     8,429             8,424     $       8,424  
Securities available for sale     119,968             119,968             119,968  
Securities held to maturity     790             908             908  
Loans held for sale     88                   90       90  
Loans receivable - net     163,647                   163,690       163,690  
Federal Home Loan Bank stock     2,591             2,591             2,591  
Accrued interest receivable     986                   986       986  
                                         
Financial liabilities:                                        
Customer deposits     270,734             271,200             271,200  
Federal Home Loan Bank advances     22,885             22,696             22,696  
Accrued interest payable     101                   101       101  

 

22
 

 

FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.

AND SUBSIDIARIES

 

PART Ι - FINANCIAL INFORMATION

 

ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion compares the consolidated financial condition of the Company at March 31, 2015 and December 31 2014, and the results of operations for the three-month periods ended March 31, 2015 and 2014. This discussion should be read in conjunction with the interim financial statements and footnotes included herein.

 

OVERVIEW

 

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

 

For the quarter ended March 31, 2015, the Company had net income of $356,000, or $0.10 per basic and diluted share, compared to $221,000, or $0.08 per basic and diluted share, for the year earlier period, an increase of $135,000.

 

Total assets increased $13.0 million, or 4.0%, to $338.9 million as of March 31, 2015 from $325.9 million as of December 31, 2014. Cash and cash equivalents increased $8.0 million, investment securities available for sale increased $6.3 million and net loans receivable decreased $1.5 million during the quarter. Total deposits increased $14.7 million from December 31, 2014 to March 31, 2015 while Federal Home Loan Bank advances decreased $2.1 million and stockholders’ equity increased $626,000.

 

CRITICAL ACCOUNTING POLICIES

 

As of March 31, 2015, there have been no changes in the critical accounting policies as disclosed in the Company’s Form 10-K for the year ended December 31, 2014. The Company’s critical accounting policies are described in the Management’s Discussion and Analysis and financial sections of its 2014 Annual Report. Management believes its critical accounting policies relate to the Company’s allowance for loan losses, mortgage servicing rights, valuation of deferred tax assets and impairment of intangible assets.

 

MERGER

 

We completed the merger with Alpena Banking Corporation and its wholly owned subsidiary Bank of Alpena (“Alpena”), as of August 8, 2014. Alpena had one branch office and $73 million in assets as of December 31, 2013. The merger was effected by the issuance of shares of the Company’s common stock to Alpena Banking Corporation shareholders. Each share of Alpena’s common stock was converted into the right to receive 1.549 shares of the Company’s common stock, with cash paid in lieu of fractional shares. The conversion of Alpena’s shares resulted in the issuance of 842,965 share of the Company’s common stock.

 

23
 

 

The Alpena merger transaction was recorded using the acquisition method of accounting and accordingly, assets acquired, liabilities assumed and consideration exchanged were recorded at estimated fair values on the Merger Date. In most instances, determining the fair value of the acquired assets and assumed liabilities required the Company to estimate the cash flows expected to result from those assets and liabilities and to discount those cash flows at appropriate rates of interest. The most significant of those determinations related to the valuation of acquired loans. For such loans, the excess cash flows expected at merger over the estimated fair value is recognized as interest income over the remaining lives of the loans. The difference between contractually required payments at merger and the cash flows expected to be collected at merger reflects the impact of estimated credit losses and other factors, such as prepayments. In accordance with the applicable accounting guidance for business combinations, there was no carry-over of Alpena’s previously established allowance for loan losses. The acquired loans were divided into loans with evidence of credit quality deterioration, which are accounting for under ASC 310-30 (“acquired impaired”), and loans that do not meet the criteria, which are accounted for under ACC 310-20 (“acquired non-impaired”). In addition, the loans are further categorized into different pools based primarily on the type and purpose of the loan.

 

COMPARISON OF FINANCIAL CONDITION AT MARCH 31, 2015 AND DECEMBER 31, 2014

 

ASSETS: Total assets increased $13.0 million, or 4.0%, to $338.9 million at March 31, 2015 from $325.9 million at December 31, 2014. Cash and cash equivalent increased $8.0 million to $19.5 million at March 31, 2015 from $11.5 million at December 31, 2014. In addition, investment securities AFS increased $6.3 million to $126.3 million at March 31, 2015 from $120.0 million at December 31, 2014, due primarily to net purchases of $9.2 million offset by principal payment received on our mortgage-backed securities during the period. Net loans receivable decreased $1.5 million, or 1.0%, to $162.1 million at March 31, 2015 from $163.6 million at December 31, 2014, resulting primarily from a decrease of $3.0 million in the consumer and commercial loan portfolios. Partially offsetting this decrease was an increase of $1.5 million in mortgage loan portfolio for the three months ended March 31, 2015.

 

LIABILITIES: Deposits increased $14.7 million to $285.5 million at March 31, 2015 from $270.7 million at December 31, 2014. During this time period, we experienced an increase of $14.5 million in our savings, money market and checking accounts and an increase of $816,000 in our non-interest bearing deposit accounts. These increases were partially offset by a decrease of $1.1 million in our certificates of deposit. FHLB advances decreased $2.1 million, or 9.0%, to $20.8 million at March 31, 2015 from $22.9 million at December 31, 2014, as proceeds from loan payments and payoffs, as well as cash on hand, were used to pay off maturing advances.

 

EQUITY: Stockholders’ equity increased $626,000 to $31.2 million at March 31, 2015 from $30.5 million at December 31, 2014. The increase was due to net earnings for the three-month period of $356,000 and an increase of $345,000 in the unrealized gain on available-for-sale investment securities. Partially offsetting these increases was a dividend payment of $75,000.

 

RESULTS OF OPERATIONS

 

Three Months Ended March 31, 2015 Compared to Three Months Ended March 31, 2014

 

General: Net income increased $135,000 to $356,000 for the three months ended March 31, 2015 from $221,000 for the quarter ended March 31, 2014.

 

Interest Income: Interest income increased to $2.6 million for the three months ended March 31, 2015 from $2.0 million for the comparable period in 2014 as the average balance of interest earning assets increased $117.8 million, as a result of the merger with Bank of Alpena in August 2014, to $314.6 million for the three months ended March 31, 2015 from $196.8 million for the three months ended March 31, 2014 while the average yield on interest earning assets decreased 83 basis points to 3.35% from 4.18%. The yield on our mortgage loan portfolio decreased by 44 basis points to 4.44% for the three months period ended March 31, 2015 from 4.88% for the year-earlier period, while the average balance of that portfolio increased $8.4 million, to $72.0 million, period over period. The average balance of our non-mortgage loan portfolio increased $18.8 million to $92.3 million for the three months ended March 31, 2015 from the 2014 quarter, while the yield on this portfolio increased 13 basis points to 5.26% from 5.16% period over period. The average balance of our investment portfolio increased $76.4 million for the three months ended March 31, 2015 compared to the same period in 2014 and the yield on our investments decreased 35 basis points period over period.

 

24
 

 

Interest Expense: Interest expense increased to $301,000 for the three months ended March 31, 2015 from $249,000 for the three months ended March 31, 2014. The increase was due in part to a $71.8 million increase in the average balance of our interest-bearing liabilities, as a result of the merger with Bank of Alpena in August 2014, offset by a decrease in our overall cost of funds of 10 basis points to 0.52% from 0.62% period over period. The average balance of Federal Home Loan Bank advances decreased $1.5 million for the three-month period ended March 31, 2015 from the same period in 2014, while the cost of these advances increased 13 basis points to 1.20% from 1.07% period over period. In addition, our average balance in certificates of deposit increased $10.0 million with the cost of these deposits decreasing one basis point to 0.95% from 0.96% for the quarter ended March 31, 2015 and March 31, 2014, respectively.

 

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

                         
    Three Months Ended March 31, 2015  
    Compared to  
    Three Months Ended March 31, 2014  
    Increase (Decrease) Due to:  
    Volume     Rate     Total  
    (In thousands)  
Interest-earning assets:                  
Loans receivable   $ 342     $ (48 )   $ 294  
Investment securities     331       (38 )   $ 293  
Other investments     46       (60 )   $ (14 )
                         
Total interest-earning assets     719       (146 )     573  
                         
Interest-bearing liabilities:                        
Savings Deposits     1             1  
Money Market/NOW accounts     28             28  
Certificates of Deposit     23       (3 )     20  
Deposits     52       (3 )     49  
Borrowed funds     (4 )     7       3  
                         
Total interest-bearing liabilities     48       4       52  
                         
Change in net interest income   $ 671     $ (150 )   $ 521  

 

Net Interest Income: Net interest income increased $513,000 to $2.3 million from $1.8 million for the three months ended March 31, 2015 and March 31, 2014, respectively, as a result of our merger with Bank of Alpena in August 2014. For the three months ended March 31, 2015, average interest-earning assets increased $117.8 million, or 59.8%, to $314.6 million when compared to the same period in 2014. Average interest-bearing liabilities increased $71.8 million, or 46.3%, to $236.3 million for the quarter ended March 31, 2015 from $164.5 million for the quarter ended March 31, 2014. The average balance of core interest-bearing deposits increased $63.2 million for the three months ended March 31, 2015 compared to the same period in 2014, while the average balance of our certificates of deposit increased $10.0 million period over period. In addition, the average balance of non-interest bearing deposits increased $816,000 for the three-month period ended March 31, 2015 compared to the same period in 2014. The yield on average interest-earning assets decreased to 3.35% for the three month period ended March 31, 2015 from 4.18% for the same period ended in 2014 as we added a net $9.2 million in lower yielding investment securities available for sale during the quarter ended March 31, 2015. In addition, the cost of average interest-bearing liabilities decreased to 0.52% from 0.62% for the three month periods ended March 31, 2015 and 2014, respectively. Our interest rate spread decreased 73 basis points to 2.83% from 3.56% and our net interest margin decreased 70 basis points to 2.96% for the three-month period ended March 31, 2015 from 3.66% for same period in 2014. At March 31, 2015 the Company had outstanding loan commitments of $22.2 million. During the three months ended March 31, 2015 the Company grew average interest bearing core deposits by $14.6 million.

 

Provision for Loan Losses: The allowance for loan losses is established through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

 

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.

 

25
 

 

The provision for loan losses for the three-month period ended March 31, 2015 was $23,000, as compared to $16,000 for the three months ended March 31, 2014. The 2015 provision included a $7,000 expense associated with the charge off of an acquired loan while the amount added to our loan loss reserve remained unchanged at $16,000 quarter over quarter. During the quarter ended March 31, 2015, we increased specific reserves approximately $47,000, mainly through a reduction in our unallocated reserves of $27,000. These specific reserves primarily relate to mortgage and consumer loans within our portfolio. By comparison, the first quarter of 2015 had lower levels of net charge-offs at $810 compared to $30,000 for the same period in the prior year. The provision was based on management’s review of the components of the overall loan portfolio, the status of non-performing loans and various subjective factors.

 

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

                         
          Delinquent        
    Portfolio     Loans     Non-Accrual  
    Balance     Over 90 Days     Loans  
    (Dollars in thousands)  
At March 31, 2015                  
Real estate loans:                  
One - to four - family   $ 73,314     $ 101     $ 695  
Commercial construction real estate     2,111              
Commercial Mortgages     60,703             461  
Home equity lines of credit/ Junior liens     9,241             51  
Commercial loans     17,067       15       74  
Consumer loans     1,390       25        
                         
Total gross loans   $ 163,826     $ 141     $ 1,281  
Less:                        
Net deferred loan fees     (252 )           (1 )
Allowance for loan losses     (1,444 )           (110 )
Total loans, net   $ 162,130     $ 141     $ 1,170  
    &nbs