First Federal of Northern Michigan Bancorp, Inc. 10-K

 

 

EXHIBIT 13

 

2014 ANNUAL REPORT TO STOCKHOLDERS

 

 

FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.

 

2014

 

ANNUAL REPORT

 

March 27, 2015

 

 

Selected Consolidated Financial and Other Data of the Company

 

Set forth below are selected financial and other data of First Federal of Northern Michigan Bancorp, Inc. (the “Company”). This information is derived in part from and should be read in conjunction with the Consolidated Financial Statements of the Company and the notes thereto presented elsewhere in this Annual Report. The information at and for the years ended December 31, 2014 and December 31, 2013 is derived in part from the audited consolidated financial statements of the Company that appear in this Annual Report. The information at and for the years ended December 31, 2012, 2011, and 2010 is derived in part from audited consolidated financial statements that do not appear in this Annual Report.

 

		At December 31,
Financial condition data:		2014				2013				2012				2011				2010
Total assets		$	325,867			$	209,657			$	213,834			$	217,045			$	215,733
Loans receivable, net			163,647				136,315				138,912				140,884				157,144
Loans held for sale			88				175				79				—				—
Investment securities			120,758				52,613				53,109				55,484				37,821
Cash and cash equivalents			11,254				2,766				2,752				2,749				1,963
Deposits			270,734				160,029				158,350				150,649				155,466
FHLB advances			22,885				24,813				26,358				34,500				29,000
Repo Sweep agreements			—				—				3,183				5,592				6,172
Stockholders' equity			30,536				23,525				24,435				24,568				23,236

		For the Years Ended December 31,
Operating data:		2014				2013				2012				2011				2010
														(In thousands)
Interest income		$	9,100			$	8,319			$	9,243			$	10,390			$	11,447
Interest expense			1,082				1,150				1,654				2,262				3,447
Net interest income			8,018				7,169				7,589				8,128				8,000
Provision for loan losses			2014				2013				2012				2011				2010
Net interest income after provision for loan losses			6,004				5,156				5,577				6,117				5,990
Other income (loss):
Service charges and fees			807				857				760				730				804
Mortgage banking activities			472				585				1,243				969				1,438
Net gain on sale of investment securities			(4	)			—				47				—				546
Gain (loss) on sale of real estate			(76	)			3				(3	)			(51	)			(43	)
Bargain purchase gain			1,982				—				—				—				—
Other non-interest income			180				194				80				126				301
Insurance & brokerage commissions			117				126				149				158				159
Total other income			3,478				1,765				2,276				1,932				3,205
Other expenses			8,963				8,242				8,712				9,034				9,866
Income (loss) before income tax expense (benefit)			519				(1,321	)			(859	)			(985	)			(671	)
Income tax expense			—				—				—				—				—
Net income (loss)		$	519			$	(1,321	)		$	(859	)		$	(985	)		$	(671	)

 

			For the Years Ended December 31,
Performance Ratios:			2014				2013				2012				2011				2010
Return on average assets			0.87	%			0.03	%			-0.10	%			0.34	%			0.10	%
Return on average equity			8.42	%			0.22	%			-0.85	%			3.07	%			0.99	%
Average interest rate spread			3.18	%			3.54	%			3.65	%			3.88	%			3.60	%
Dividend payout ratio			11.01	%			105.35	%			0.00	%			0.00	%			0.00	%
Dividends per share		$	0.08			$	0.02			$	0.00			$	0.00			$	0.00
Net interest margin			3.31	%			3.64	%			3.78	%			4.02	%			3.78	%
Efficiency ratio (Bank)			78.24	%			98.00	%			101.55	%			90.06	%			102.76	%
Texas ratio (Bank)			17.02	%			17.02	%			30.83	%			28.28	%			39.66	%
Non-interest expense to average total assets			3.36	%			3.78	%			3.94	%			4.14	%			4.33	%
Average interest-earning assets to average interest-bearing liabilities			128.81	%			118.10	%			115.88	%			112.59	%			111.20	%
			At December 31,
Asset Quality Ratios:			2014				2013				2012				2011				2010
Non-performing assets to total assets			1.52	%			1.95	%			3.42	%			3.11	%			4.37	%
Non-performing loans to total loans			1.30	%			1.68	%			3.50	%			2.34	%			4.13	%
Allowance for loan losses to nonperforming loans			66.82	%			63.65	%			35.50	%			45.47	%			42.85	%
Allowance for loan losses to total loans			0.86	%			1.07	%			1.24	%			1.07	%			1.77	%
Capital Ratios:
Equity to total assets at end of period			9.37	%			11.22	%			11.43	%			11.32	%			10.77	%
Average equity to average assets			10.27	%			11.43	%			11.63	%			11.06	%			10.47	%
Risk-based capital ratio (Bank only)			16.89	%			17.89	%			17.36	%			17.20	%			15.57	%
Other Data:
Number of full service offices			8				8				8				8				8

 

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Overview

 

First Federal of Northern Michigan (the “Bank”), the Company’s principal operating subsidiary, is a full-service, community-oriented savings bank whose primary lending activity is the origination of one- to four-family residential real estate mortgages, commercial real estate loans, commercial loans, and consumer loans. As of December 31, 2014, $71.8 million, or 43.5%, of our total loan portfolio consisted of one- to four-family residential real estate loans, $63.6 million, or 38.5%, and $19.0 million, or 11.5%, of our total loan portfolio consisted of commercial mortgage loans and commercial loans, respectively, and $10.9 million, or 6.6%, of our total loan portfolio consisted of consumer and other loans. In recent years, commercial mortgage loans and commercial loans have grown as a percentage of our loan portfolio for three reasons. First, we have increased our emphasis on originating these loans, which generally have higher interest rates compared to one- to four-family residential real estate loans. In addition, most of these loans are originated with adjustable interest rates, which assist us in managing interest rate risk. Finally, most of our one- to four-family residential mortgage loan customers prefer fixed-rate loans in the low interest rate environment that has prevailed over the last several years. In spite of the fact of selling a majority of the fixed-rate one- to four-family residential mortgage loans that we originate, one- to four-family residential real estate loans have increased as a percentage of our total loan portfolio.

 

Our results of operations depend primarily on our net interest income, which is the difference between the interest income we receive on our interest-earning assets, such as loans and securities, and the interest expense we pay on our deposits and borrowings. Our results of operations are also affected by non-interest income and non-interest expense, the provision for loan losses and income tax expense. Non-interest income consists primarily of banking fees, service charges, insurance commissions, mortgage banking activities and security transactions. Our non-interest expense consists primarily of salaries and employee benefits, FDIC insurance premiums, occupancy and office expenses, advertising and promotion expense, data processing expenses and expenses related to troubled credits and repossessed properties.

 

Our results of operations are significantly affected by general economic and competitive conditions, and particularly changes in market interest rates, government policies and actions of regulatory authorities. Numerous factors that are beyond our control can cause market interest rates to increase or decline. In addition, we are unable to predict future changes in government policies and actions of regulatory authorities that could have a material impact on our financial performance. As a result, we believe that changes in market interest rates, government policies and actions of regulatory authorities represent the primary uncertainties in predicting our future performance.

 

Business Strategy

 

Operating as a Community Savings Bank. We are committed to meeting the financial needs of the communities in which we operate. Our branch network of eight offices enhances our ability to serve these communities. We provide a broad range of individualized consumer and business financial services. We believe that we can be more effective in servicing our customers than many of our non-local competitors because our employees and senior management are able to respond promptly to customer needs and inquiries. Our ability to provide these services is enhanced by the experience of our senior management, which has an average of 26 years experience in the financial services industry.

 

In August 2014, we consummated our merger with Bank of Alpena, (“Alpena”), resulting in an increase to stockholders equity of $7.0 million during 2014.

 

Restoring our Balance Sheet. Beginning in 2001, we began to increase our originations of commercial real estate and commercial loans, resulting in significant organic loan growth in the years from 2004 through 2006. In contrast, beginning in 2008, due to severely deteriorating economic conditions we began to see a decline in loan balances and an increase in charge-offs, which decreased our asset base. As a result of our merger with Bank of Alpena, our total assets grew to $325.6 million as of December 31, 2014. Total loans increased $27.3 million, or 19.7% to $165.3 million as of December 31, 2014 from $138.1 million as of December 31, 2013. We are seeing signs of economic recovery in our markets and have devoted staff and resources to allow for continued growth of our balance sheet in 2015 and beyond.

 

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Increasing Our Share of Lower-Cost Deposits. In past years our cost of funds has been relatively high as we accepted higher-cost long-term certificates of deposit to fund our long-term assets such as one- to four-family residential mortgage loans. As we have increased our origination of shorter-term commercial real estate and commercial loans, most of which are originated with adjustable interest rates, we have decreased our need for higher-cost long-term certificates of deposit. We intend to continue to lower our cost of funds by increasing our share of lower-cost deposit products in the form of savings, checking and money market deposits. We typically are not a market leader in deposit rates, although from time-to-time we do offer higher rates as liquidity needs dictate. We also intend to continue to market our non-interest-bearing checking accounts in conjunction with our focus on commercial business lending. We grew the average balance of core deposits, non-maturity deposit accounts, by $78.7 million in 2014. This growth is attributed to the merger and implementing a sales calling program, in which we target area businesses and municipalities to gain core deposit relationships and a reclassification of funds previously maintained in non-core deposit products.

 

Maintaining High Asset Quality and Capital Strength. We are committed to conservative loan underwriting standards and procedures, and we primarily originate loans secured by real estate. As a result, we have historically experienced low levels of late payments and losses on loans. However, during the economic recession of recent years, we saw delinquency trends increase despite our conservative underwriting practices due to declining economic conditions and increasing unemployment in our market area. In 2014 we saw an improvement in delinquency patterns as evidenced by improvements in our asset quality ratios: at December 31, 2014, our ratio of non-performing assets to total assets was 1.03% as compared to 1.95% at December 31, 2013. We continue to maintain a strong capital base. At December 31, 2014, our total risk-based capital ratio was 16.9%, a decrease from 17.9% at December 31, 2013 and well in excess of the regulatory requirements to be categorized as “well capitalized.”

 

Managing Our Interest Rate Risk Exposure by Selling Fixed-Rate Residential Real Estate Loans. Historically, most borrowers have preferred long-term, fixed-rate residential real estate loans when, as now, market interest rates are at relatively low levels. These loans expose us to interest rate risk because our liabilities, consisting primarily of deposits, have relatively short maturities. In order to better match the maturities of our loan portfolio to the maturities of our deposits in the current low interest rate environment, we sell substantially all of the fixed-rate, one- to four-family residential real estate loans with maturities of 15 years or more that we have originated since 2002. Beginning in late 2012 we began placing certain 15 year fixed residential real estate loans into our portfolio in an effort to rebuild our balance sheet and increase net interest income, however we continue to sell most loans with terms longer than 15 years into the secondary market to minimize interest rate risk.

 

Comparison of Financial Condition at December 31, 2014 and 2013

 

Total assets increased $116.0 million, or 55.3%, to $325.6 million at December 31, 2014 from $209.7 million at December 31, 2013. Net loans increased $27.3 million, or 20.1% to $163.6 million at December 31, 2014 from $136.3 million at December 31, 2013. Mortgage loan originations decreased $3.5 million to $25.3 million in 2014 from $28.8 million in 2013. During that time period, our mortgage loan portfolio increased $8.0 million to $71.8 million at December 31, 2014 from $63.8 million as of December 31, 2013, as a result of loans acquired in the merger. The commercial loan portfolio increased 28.4% to $82.6 million at December 31, 2014 from $64.4 million at December 31, 2013. Cash and cash equivalents increased $8.5 million to $11.3 million at December 31, 2014 from $2.8 million at December 31, 2013. Deposits held at other financial institutions increased $8.4 million as a result of investing in certificates of deposit with the cash acquired in the merger. Investment securities increased $68.1 million, or 129.5%, to $120.8 million at December 31, 2014 from $52.6 million at December 31, 2013.

 

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Deposits increased $110.7 million, or 69.2%, to $270.7 million at December 31, 2014 from $160.0 million at December 31, 2013. This increase was due in large part to $95.8 million in deposits acquired in the merger, of which $29.4 million was placed in our interest bearing commercial checking and $33.0 million in our non-interest-bearing commercial checking accounts. Our focus in 2014 continued to be on building deposit relationships rather than attracting higher-cost non-core certificate of deposit accounts. Borrowings, consisting primarily of FHLB advances, decreased $1.9 million, or 7.8%, to $22.9 million at December 31, 2014 from $24.8 million at December 31, 2013 as we replaced borrowings with deposits.

 

Stockholders’ equity increased $7.0 million, or 29.8%, to $30.5 million at December 31, 2014 from $23.5 million at December 31, 2013. The increase was mainly a result of the $7.1 million in equity acquired from Bank of Alpena in the merger, $2.2 million in net income for the year, and an increase of $591,000 in net unrealized gain on investment securities, with dividends paid of $247,000 partially offsetting these increases.

 

Comparison of Operating Results for the Years Ended December 31, 2014 and 2013

 

General. Net income increased to $2.2 million for the year ended December 31, 2014 from $55,000 for the year ended December 31, 2013. Net interest income before provision for loan losses increased $849,000 to $8.0 million in 2014 from $7.2 million in 2013, due in large part to the increase in interest earning assets for the year. The provision for loan losses was $353,000 lower in 2014 than in 2013, resulting in net interest income after provision for loan losses being $1.2 million higher in 2014 than in 2013. Non-interest income was $1.7 million higher in 2014 than in 2013, and non-interest expense was $721,000 higher in 2014 than in 2013.

 

Interest Income. Interest income increased $781,000, or 9.4%, to $9.1 million for the year ended December 31, 2014 from $8.2 million for the year ended December 31, 2013. The increase was primarily due to an increase in the average balance of our interest earning assets of $45.5 million, or 23.1%, year over year. The average balance of our one- to four-family residential mortgage loans increased $1.8 million, or 2.7%, to $67.1 million for the year ended December 31, 2014 from $65.3 million for the year ended December 31, 2013, while the average yield on such loans decreased to 4.67% from 5.11%. The average balance of our non-mortgage loans, principally commercial loans and consumer loans, increased $7.4 million, or 9.9%, to $82.2 million for the twelve months ended December 31, 2014 from $74.8 million for the twelve months ended December 31, 2013. The average yield on our commercial loans decreased five basis points and the average yield on our consumer loans decreased 18 basis points from 2013 to 2014. The average balance of our investment securities, excluding mortgage-backed securities, increased $15.8 million, or 70.5%, to $38.2 million for the year ended December 31, 2014 from $22.4 million for the year ended December 31, 2013, while the average yield on these investments decreased to 2.00% from 2.24%. In addition, the average balance of our mortgage-backed securities increased $11.2 million, or 38.0%, to $40.8 million for the year ended December 31, 2014 from $29.5 million for the year ended December 31, 2013, with an average yield increase of 25 basis points to 1.88% from 1.63%.

 

Interest Expense. Interest expense decreased to $1.1 million for the year ended December 31, 2014 from $1.2 million for the year ended December 31, 2013, due primarily to a $26.1 million, or 38.2%, increase in the average balance of lower costing core deposits accounts year over year. The average balance of interest-bearing deposits increased $26.1 million from 2014 to 2013, while the average cost of those deposits decreased nine basis points to 0.51% for 2014 from 0.60% for 2013, reflecting a continued decline in market interest rates during 2014. The average balance of FHLB borrowings decreased $646,000 from 2014 to 2013 while the cost of those borrowings decreased to 1.11% from 1.92% year over year as we were able to pay off high-cost maturing advances with deposits or replace them with lower-cost advances due to the rate environment. The average balance of REPO Sweep accounts decreased $4.0 million, or 100.0% year over year, as a result of the discontinuation of this product as of December 31, 2013.

 

Net Interest Income. Net interest income increased to $8.0 million for the year ended December 31, 2014 from $7.2 million for the year ended December 31, 2013. The increase was primarily due to an increase of $45.5 million in the average balance of our interest earning assets. While the average balance increased we experienced a decrease of 36 basis points in our average interest rate spread to 3.18% for the year ended December 31, 2014 from 3.54% for the year ended December 31, 2013.

 

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Provision for Loan Losses. We recorded a provision for loan losses of $284,000 for the year ended December 31, 2014 compared to $637,000 for the year ended December 31, 2013. We had net charge-offs of $362,000 and $915,000 during 2014 and 2013, respectively. Included in our net charge-offs for 2013 is a partial charge-off of $589,000, related to a single loan that became troubled at the end of 2012. Our provision is based on management’s review of the components of the overall loan portfolio, the status of non-performing loans and various subjective factors. For 2014, the provision was significantly lower than 2013 due to the following factors: our provision for loan losses is based on a twelve-quarter rolling average of actual net charge-offs adjusted for various environmental factors for each pool of loans in our portfolio. As our charge-off history on commercial loans improved in 2014 as compared to recent prior years, lower loss factors were applied to those pools of loans to establish an adequate reserve. In addition, asset quality metrics improved in 2014. In contrast, in 2013, the Company charged off $915,000 in loans, including $344,000 of residential mortgage loans which required a comparatively higher provision than the current year.

 

Non-Interest Income. Non-interest income increased to $3.5 million for the year ended December 31, 2014 from $1.8 million for the year ended December 31, 2013. The 2014 results reflect a bargain purchase gain of $2.0 million related to the acquisition that closed in August 2014. This increase was partially offset by decreases of $113,000 in mortgage banking activities and a loss on sale of real estate owned and other repossessed assets of $79,000 which was recorded in 2014. In 2014 we retained in our portfolio approximately $11.4 million of 10- and 15-year fixed residential mortgages in our portfolio, rather than selling them, which reduced mortgage banking activities income. Non-interest income is detailed in the table presented below:

 

		For years ended December 31,
		2014				2013				Change from 2014 to 2013
		(dollars in thousands)
Service charges and other fees		$	807			$	857				(5.83	%)
Net gain on sale of investments			(4	)			—				0.00	%
Net gain on sale of loans			206				235				(12.34	%)
Net gain/(loss) on sale of real estate owned
and other repossessed assets			(76	)			3				2,633.33	%
Loan servcing fees			266				350				(24.00	%)
Insurance and brokerage commissions			117				126				(7.14	%)
Bargain purchase gain			1,982				—				0.00	%
Other			180				194				(7.22	%)
		$	3,478			$	1,765				97.05	%

 

Non-Interest Expense. Non-interest expense increased to $9.0 million for the year ended December 31, 2014 from $8.2 million for the year ended December 31, 2013. The year over year increase related primarily to increases in compensation and employee benefits of $307,000, occupancy of $121,000, and merger related expenses of $183,000. These increases were partially offset by a decrease in collection loan activity expenses of $85,000 for 2014. Non-interest expense is detail in the table presented below:

 

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

						For years ended December 31,
						2014				2013				Change from 2014 to 2013
						(dollars in thousands)
Compensation and employee benefits						$	4,961			$	4,654				6.60	%
FDIC premiums							207				184				12.50	%
Amortization of intangible assets							145				119				21.85	%
Advertising							183				130				40.77	%
Occupancy and equipment							1,032				911				13.28	%
Data processing service bureau							345				301				14.62	%
Professional fees							393				427				(7.96	%)
Collection activity							68				153				(55.56	%)
Real estate and other repossessed assets							272				245				11.02	%
Merger related expenses							266				83				220.48	%
Other							1,091				1,035				5.41	%
						$	8,963			$	8,242				8.75	%

 

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Income Taxes. The Company had no federal income expense for 2014 and 2013 as a result of the valuation allowance against the Company’s deferred tax assets. See Critical Accounting Policies section for discussion on valuation of deferred tax assets.

 

Average Balance Sheet. The following tables set forth average balance sheets, average yields and costs, and certain other information for the periods indicated. No tax-equivalent yield adjustments were made, as the effect thereof was not material. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.

 

		As of December 31, 2014								For Years Ended December 31, 2014												Average Consolidated Statements of Condition For Years Ended December 31, 2013												Average Consolidated Statements of Condition For Years Ended December 31, 2012
																		Average												Average												Average
						Yield /				Average								Yield /				Average								Yield /				Average								Yield /
		Balance				Rate				Balance				Interest				Rate				Balance				Interest				Rate				Balance				Interest				Rate
														(In thousands)												(In thousands)												(In thousands
Interest-earning assets:
Mortgage loans										$	67,057			$	3,133							$	65,297			$	3,338							$	67,151			$	3,708
Non-mortgage loans											82,232				4,260								74,813				3,865								75,640				4,220
Loans			163,735				4.80	%			149,289				7,393				4.95	%			140,110				7,203				5.14	%			142,791				7,928				5.55	%
Mortgage-backed securities			63,648				2.65	%			40,760				767				1.89	%			29,540				480				1.63	%			29,002				621				2.14	%
Other Investment securities			57,110				1.60	%			39,656				766				1.93	%			22,401				502				2.24	%			24,352				566				2.32	%
Investment securities			120,758				2.16	%			80,416				1,533				1.91	%			51,941				982				1.89	%			53,354				1,187				2.22	%
Other investments			19,683				0.71	%			12,632				174				1.39	%			4,759				134				2.83	%			4,412				128				2.90	%
Total interest-earning assets			304,176				3.47	%			242,337				9,100				3.76	%			196,810				8,319				4.23	%			200,557				9,243				4.62	%
Non interest-earning assets			21,691								56,314												16,261												16,544
Total Assets		$	325,867							$	298,651											$	213,071											$	217,101
Interest-bearing liabilities:
Savings Deposits			29,846				0.05	%		$	26,279			$	13				0.06	%		$	21,630			$	11				0.06	%		$	18,784				9				0.06	%
Money market/NOW accounts			107,935				0.27	%			68,206				141				0.21	%			46,765				97				0.21	%			43,634				94				0.21	%
Certificates of deposit			76,921				1.00	%			70,228				664				0.95	%			70,217				718				1.02	%			74,966				931				1.24	%
Total interest-bearing deposits			214,702				0.50	%			164,713			$	818				0.51	%			138,612			$	826				0.61	%			137,384				1,034				0.75	%
Borrowed funds			22,885				1.17	%			23,422				264				1.11	%			28,035				324				1.14	%			35,694				620				1.74	%
Total interest-bearing liabilities			237,587				0.57	%			188,135				1,082				0.58	%			166,647				1,150				0.69	%			173,078				1,654				0.96	%
Non interest-bearing liabilities			57,744								82,204												22,043												18,729
Total liabilities			295,331								270,339												188,690												191,807
Stockholders' equity			30,536								28,312												24,381												25,294
Total liabilities & stockholders' equity		$	325,867							$	298,651											$	213,071											$	217,101
Net interest income														$	8,018											$	7,169											$	7,589
Interest rate spread							2.90	%											3.18	%											3.54	%											3.66	%
Net interest-earning assets										$	54,202											$	30,163											$	27,479
Net interest margin (1)							3.02	%											3.30	%											3.64	%											3.80	%
Average interest-earning assets to average interest-bearing liabilities																			128.81	%											118.10	%											115.88	%

 

(1) Net interest margin represents net interest income divided by the interest-earning assets

 

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Rate/Volume Analysis

 

The following table sets forth certain information regarding changes in interest income and interest expense of the Company during the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided in each category with respect to (i) changes attributable to changes in volume (change in volume multiplied by prior rate), (ii) changes in rates (changes in rate multiplied by prior average volume), and (iii) the net change. Changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.

 

		Year ended December 31, 2014 Compared to Year ended December 31, 2013 Increase (Decrease) Due to:
		Volume				Rate				Total
						(In thousands)
Interest-earning assets:
Loans receivable		$	483			$	(293	)		$	190
Investment securities			542				9			$	551
Other investments			147				(107	)		$	40
Total interest-earning assets			1,172				(391	)			781
Interest-bearing liabilities:
Savings Deposits			2				—				2
Money Market/NOW accounts			44				(1	)			43
Certificates of Deposit			—				(53	)			(53	)
Deposits			46				(54	)			(8	)
Borrowed funds			(51	)			(9	)			(60	)
Total interest-bearing liabilities			(5	)			(63	)			(68	)
Change in net interest income		$	1,177			$	(328	)		$	849

 

		Year ended December 31, 2013 Compared to Year ended December 31, 2012 Increase (Decrease) Due to:
		Volume				Rate				Total
						(In thousands)
Interest-earning assets:
Loans receivable		$	(154	)		$	(571	)		$	(725	)
Investment securities			(33	)			(172	)		$	(205	)
Other investments			10				(4	)		$	6
Total interest-earning assets			(177	)			(747	)			(924	)
Interest-bearing liabilities:
Savings Deposits			—				2				2
Money Market/NOW accounts			6				(3	)			3
Certificates of Deposit			(66	)			(147	)			(213	)
Deposits			(60	)			(148	)			(208	)
Borrowed funds			(210	)			(86	)			(296	)
Total interest-bearing liabilities			(270	)			(234	)			(504	)
Change in net interest income		$	93			$	(513	)		$	(420	)

 

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Management of Interest Rate Risk

 

Qualitative Analysis. Our most significant form of market risk is interest rate risk. The general objective of our interest rate risk management is to determine the appropriate level of risk given our business strategy, and then manage that risk in a manner that is consistent with our policy to reduce the exposure of our net interest income to changes in market interest rates. First Federal of Northern Michigan’s asset/liability management committee (“ALCO”), which consists of senior management and one member of the board of directors, evaluates the interest rate risk inherent in our assets and liabilities, our operating environment and capital and liquidity requirements, and modifies our lending, investing and deposit-taking strategies accordingly. The Board of Directors reviews the ALCO’s activities and strategies, the effect of those strategies on our net interest margin, and the effect that changes in market interest rates would have on the economic value of our loan and securities portfolios, as well as the intrinsic value of our deposits and borrowings.

 

We actively evaluate interest rate risk in connection with our lending, investing and deposit-taking activities. Generally, our loans, which represent the significant majority of our assets, have longer-terms to maturity than our deposits, which represent the significant majority of our liabilities. As of December 31, 2014, $124.5 million, or 91.4% of our loan portfolio, consisted of loans that mature or reprice after December 31, 2015. In contrast, as of December 31, 2014, $39.1 million, or 50.9% of our time deposits as of that date, consisted of deposits that mature or reprice in less than one year.

 

In an effort to manage interest rate risk, we have increased our focus on the origination and retention in our portfolio of adjustable-rate residential mortgage loans. In addition, we have increased the origination and retention in our portfolio of commercial real estate and commercial loans, since most of these loans are originated with adjustable interest rates. In the current low interest rate environment, we generally have sold all of the fixed-rate, longer-term (15 years or more) residential mortgage loans that we originate on a servicing-retained basis. In 2014, we determined to retain in portfolio $11.4 million of 10- and 15-year fixed rate residential mortgage loans. Finally, we have primarily invested in short- and medium-term securities and have maintained high levels of liquid assets, such as cash and cash equivalents. Shortening the average maturity of our interest-earning assets through these strategies helps us to better match the maturities and interest rates of our assets and liabilities, thereby reducing the exposure of our net interest income to changes in market interest rates. Maintaining high levels of liquid assets also permits us to invest in higher-yielding securities and loans when market interest rates increase. However, these strategies can be expected to adversely affect net interest income if long-term interest rates remain at low levels. As long-term interest rates rise, as we expect will happen, we will reduce our mortgage-banking operations, and will retain in our portfolio a larger percentage of the one- to four-family loans that we originate.

 

Quantitative Analysis. The Company uses two primary measurement techniques to identify and manage its interest rate risk:

 

—

Net Interest Income (NII) simulation

 

—

Economic Value of Equity (EVE)

 

Net Interest Income Simulation Model: The Company uses a NII simulation model to analyze the sensitivity of net interest income to changing interest rates. The model is based on contractual and assumed cash flows and repricing characteristics for all of the Company’s financial instruments and incorporates market-based assumptions regarding the effect of changing interest rates on the prepayment rates of certain assets and liabilities. The model also includes management’s projections of the future volume and pricing of each of the product lines offered by the Company as well as other pertinent assumptions. Actual results may differ from these simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and management strategies.

 

The Company’s interest rate risk exposure is currently evaluated by measuring the anticipated change in net interest income over a 24-month horizon assuming a -100bp, 100bp, 200bp, 300bp and 400bp parallel ramped decrease or increase in interest rates. The Fed Funds interest rate, targeted by the Federal Reserve at a range of 0% to 0.25% is currently set at a level that would be negative in parallel ramped decrease scenarios, therefore those scenarios were omitted from the interest rate risk analysis at December 31, 2014.

 

At December 31, 2014, the Company’s interest rate risk profile reflects a neutral position. The following table shows the Company’s estimated net interest income sensitivity profile and ALCO policy limits as of December 31, 2014.

 

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Dynamic Balance Sheet - RAMP
Rate Changes:			0 BP				- 100 BP				+ 100 BP				+200 BP				+300 BP				+400 BP
$ Change in NII		$	18,428			$	17,873			$	19,003			$	19,333			$	19,623			$	19,797
% Change in NII							-3.01	%			3.12	%			4.91	%			6.49	%			7.43	%
Policy Limits							+/-5	%			+/-5	%			+/-10	%			+/-15	%			+/-20	%

  

The 24-months net interest income at risk reported as of December 31, 2014 for all scenarios presented shows that the Company’s overall risk to changes in interest rates is low. Given that the duration of our assets is longer than that of our liabilities, the scenarios shown illustrate that a rising rate environment has a neutral to slightly positive impact on our net interest income. The impact illustrated is well within Board set limits.

 

Certain shortcomings are inherent in the methodology used in the above interest rate risk measurements. Modeling changes in net interest income requires making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. The net interest income table presented above assumes that the composition of our interest-rate sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and, accordingly, the data do not reflect any actions management may undertake in response to changes in interest rates. The table also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or the repricing characteristics of specific assets and liabilities. Accordingly, although the net interest income table provides an indication of our sensitivity to interest rate changes at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results. As a means of validation and testing of our assumptions a back test is performed annually to compare actual results to the predicted results.

 

Economic Value of Equity: The Company also uses EVE as a measurement tool in managing interest rate risk. Whereas the net interest income simulation model highlights exposure over a relatively short time horizon, the EVE analysis incorporates all cash flows over the estimated remaining life of all balance sheet positions. The EVE of the balance sheet, at a point in time, is defined as the discounted present value of asset cash flows less the discounted value of liability cash flows. The sensitivity of EVE to changes in the level of interest rates is a measure of longer-term interest rate risk. EVE values only the current balance sheet and does not incorporate the growth assumptions used in the earnings simulation model. As with the earnings simulation model, assumptions about the timing and variability of existing balance sheet cash flows are critical in the EVE analysis. Particularly important are assumptions driving prepayments and the expected changes in balances and pricing of transaction deposit portfolios. The following table shows the Company’s EVE sensitivity profile as of December 31, 2014.

 

Rate Changes:			0 BP				+ 100 BP				+200 BP				+300 BP				+400 BP
$ Change in Equity		$	51,821			$	54,565			$	56,505			$	58,027			$	59,352
% Change in Equity							5.30	%			9.04	%			11.98	%			14.53	%
Policy Limits							+/-10	%			+/-15	%			+/-20	%			+/-25	%

 

The EVE at risk profile shows slight to moderate asset sensitivity from market rate increases.

 

Cash Flows

 

Cash flows provided by operations were $1.7 million for 2014 compared to $2.0 million for 2013. Cash flows used for investing activities were $5.8 million in 2014 as compared to cash flows provided by investing activities of $1.1 million in 2013. The change year over year was due in large part to the purchase of available-for-sale securities as a result of increased cash on hand following the merger. Cash provided by financing activities was $12.8 million in 2014 as compared to cash used in financing activities of $3.1 million in 2013, due primarily to the increased growth of deposits, subsequent to the merger, and the continued decrease in our outstanding Federal Home Loan Bank (FHLB) advances year over year in 2014.

 

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Liquidity and Capital Resources

 

The overall objective of our liquidity management is to ensure the availability of sufficient cash funds to meet all financial commitments and to take advantage of investment opportunities. We manage liquidity in order to meet deposit withdrawals on demand or at contractual maturity, to repay borrowings as they mature, and to fund new loans and investments as opportunities arise.

 

Our primary sources of funds are deposits, principal and interest payments on loans and securities, and, to a lesser extent, borrowings (Federal Home Loan Bank advances), the proceeds from maturing securities and short-term investments, and the proceeds from the sales of loans and securities. The scheduled amortization of loans and securities, as well as proceeds from borrowings, are predictable sources of funds. Other funding sources, however, such as deposit inflows, mortgage prepayments, mortgage loan sales and mortgage-backed securities sales are greatly influenced by market interest rates, economic conditions and competition.

 

Liquidity represents the amount of our assets that can be quickly and easily converted into cash without significant loss. Our most liquid assets are cash, short-term U.S. Government securities and U.S. Government agency or government-sponsored enterprise securities. We are required to maintain sufficient levels of liquidity as defined by the Office of the Comptroller of the Currency regulations. Current regulations require that we maintain sufficient liquidity to ensure our safe and sound operation. Our current objective is to maintain liquid assets equal to at least 20% of total deposits and Federal Home Loan Bank borrowings due in one year or less. Liquidity as of December 31, 2014 was $146.5 million, or 62.9% of total deposits and Federal Home Loan Bank borrowings due in one year or less, compared to $53.4 million, or 42.4% of this amount at December 31, 2013. The levels of liquidity are dependent on our operating, financing, lending and investing activities during any given period. Our calculation of liquidity includes additional borrowing capacity available with the Federal Home Loan Bank. As of December 31, 2014, we had unused borrowing capacity of $33.5 million.

 

We currently retain in our portfolio all adjustable-rate residential mortgage loans, short-term balloon mortgage loans and fixed-rate residential mortgage loans with maturities of less than 15 years, and generally sell the remainder. We also originate for retention in our loan portfolio, commercial and commercial real estate loans, including real estate development loans. During the year ended December 31, 2014, we originated $25.3 million of one- to four-family residential mortgage loans, of which $11.4 million were retained in our portfolio and the remainder were sold. This compares to $28.8 million of one- to four-family originations during the year ended December 31, 2013, of which $11.7 million were retained in our portfolio. At December 31, 2014, we had outstanding loan commitments of $24.2 million. These commitments included $2.0 million for permanent one- to four-family residential mortgage loans, $3.7 million for non-residential loans, $2.2 million of undisbursed loan proceeds for construction of one- to four-family residences, $5.2 million of undisbursed lines of credit on home equity loans, $590,000 of unused credit card lines, $7.5 million of unused commercial lines of credit, and $1.2 million for commercial loans, unused bounce protection of $1.7 million and letters of credit of $134,000.

 

Deposits are a primary source of funds for use in lending and for other general business purposes. At December 31, 2014, deposits funded 83.1% of our total assets compared to 76.3% at December 31, 2013. Certificates of deposit scheduled to mature in less than one year at December 31, 2014 totaled $39.1 million. We believe that a significant portion of such deposits will remain with us. We monitor the deposit rates offered by competitors in our market area, and we set rates that take into account the prevailing market conditions along with our liquidity position.

 

Borrowings may be used to compensate for seasonal or other reductions in normal sources of funds or for deposit outflows at more than projected levels. Borrowings also may be used on a longer-term basis to support increased lending or investment activities. At December 31, 2014, we had $22.9 million in Federal Home Loan Bank advances and no outstanding advances at the Federal Reserve Discount Window. Total borrowings as a percentage of total assets were 7.0% at December 31, 2014 compared to 11.8% at December 31, 2013.

 

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

As of December 31, 2014, management was not aware of any known trends, events or uncertainties that have or are reasonably likely to have a material impact on our liquidity. As of December 31, 2014, we had no material commitments for capital expenditures.

 

Our cash flows are derived from operating activities, investing activities and financing activities as reported in our Consolidated Statement of Cash Flows included with our Consolidated Financial Statements.

 

Our total stockholders’ equity was $30.5 million at December 31, 2014 and $23.5 million at December 31, 2013, an increase of $7.0 million year over year, resulting from net income of $2.2 million and $7.1 million of acquired equity in the merger. The Company’s ratio of equity to assets decreased to 9.4% as of December 31, 2014 from 11.2% as of December 31, 2013. Federal bank regulatory agencies have set capital adequacy standards for Total Risk Based Capital, Tier 1 Risk Based Capital, and Leverage Capital. These regulatory standards require banks to maintain Leverage and Tier 1 ratios of at least 4% and a Total Capital ratio of at least 8% to be adequately capitalized. The regulatory agencies consider a bank to be “well capitalized” if its Total Risk Based Capital is at least 10% of Risk Weighted Assets, Tier 1 Capital is at least 6% of Risk Weighted Assets, Leverage Capital Ratio is at least 5%, and the Bank is not subject to any written agreements or orders issued by the FDIC pursuant to Section 8 of the Federal Deposit Insurance Act.

 

The following table summarizes the capital ratios of the Company:

 

		At December 31,								Minimum to be
		2014				2013				Well Capitalized
Tier 1 Leverage Ratio			8.59	%			10.75	%			5.00	%
Tier 1 Risk-Based Capital			16.14	%			16.79	%			6.00	%
Total Risk-Based Capital			16.96	%			17.89	%			10.00	%

  

At December 31, 2014 and December 31, 2013, the Bank exceeded the minimum capital requirements to be considered “well capitalized.” See Note 12 to our financial statements for further information.

 

Critical Accounting Policies

 

Our accounting and reporting policies are prepared in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. We consider accounting policies that require significant judgment and assumptions by management that have, or could have a material impact on the carrying value of certain assets or on income to be critical accounting policies. Changes in underlying factors, assumptions or estimates could have a material impact on our future financial condition and results of operations. Based on the size of the item or significance of the estimate, the following accounting policies are considered critical to our financial results.

 

Allowance for Loan and Lease Losses (ALLL). The ALLL is calculated with the objective of maintaining an allowance sufficient to absorb estimated probable loan losses. Management’s determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective, as it requires an estimate of the loss content for each risk rating and for each impaired loan, an estimate of the amounts and timing of expected future cash flows, and an estimate of the value of collateral.

 

We have established a systematic method of periodically reviewing the credit quality of the loan portfolio in order to establish an allowance for losses on loans. The allowance for losses on loans is based on our current judgments about the credit quality of individual loans and segments of the loan portfolio. The allowance for losses on loans is established through a provision for loan losses based on our evaluation of the losses inherent in the loan portfolio, and considers all known internal and external factors that affect loan collectability as of the reporting date. Our evaluation, which includes a review of all loans on which full collectability may not be reasonably assured, considers among other matters, the estimated net realizable value or the fair value of the underlying collateral, economic conditions, historical loan loss experience, our knowledge of inherent losses in the portfolio that are probable and reasonably estimable and other factors that warrant recognition in providing an appropriate loan loss allowance. Management believes this is a critical accounting policy because this evaluation involves a high degree of complexity and requires us to make subjective judgments that often require assumptions or estimates about various matters.

 

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The analysis of the ALLL has two components: specific and general allocations. Specific allocations are made for loans that are determined to be impaired. Impairment is measured by determining the present value of expected future cash flows or, for collateral-dependent loans, the fair value of the collateral adjusted for market conditions and selling expenses. The general allocation is determined by segregating the remaining loans by type of loan, risk weighting (if applicable) and payment history. We also analyze delinquency trends, general economic conditions and geographic and industry concentrations. This analysis establishes factors that are applied to the loan groups to determine the amount of the general reserve. The principal assumption used in deriving the ALLL is the estimate of loss content for each risk rating. To illustrate, if recent loss experience dictated that the projected loss ratios would be increased by 10% (of the estimate) across all risk ratings, the allocated allowance as of December 31, 2014 would have changed by approximately $130,000. Actual loan losses may be significantly more than the allowances we have established, which could have a material negative effect on our financial results.

 

Mortgage Servicing Rights. We sell to investors a portion of our originated one- to four-family residential real estate mortgage loans. When we acquire mortgage servicing rights through the origination of mortgage loans and sale of those loans with servicing rights retained, we allocate a portion of the total cost of the mortgage loans to the mortgage servicing rights based on their relative fair value. As of December 31, 2014, we were servicing mortgage loans sold to others totaling $125.4 million. We amortize capitalized mortgage servicing rights as a reduction of servicing fee income in proportion to, and over the period of, estimated net servicing income by use of a method that approximates the level-yield method. We periodically evaluate capitalized mortgage servicing rights for impairment using a model that takes into account several variables including expected prepayment speeds and prevailing interest rates. If we identify impairment, we charge the amount of the impairment to earnings by establishing a valuation allowance against the capitalized mortgage servicing rights asset. The primary risk of material changes to the value of the servicing rights resides in the potential volatility in the economic assumptions used, particularly the prepayment speed. We monitor this risk and adjust the valuation allowance as necessary to adequately record any probable impairment in the portfolio. Management believes the estimation of these variables makes this a critical accounting policy. For purposes of measuring impairment, the mortgage servicing rights are stratified based on financial asset type and interest rates. In addition, we obtain an independent third-party valuation of the mortgage servicing portfolio on a quarterly basis. In general, the value of mortgage servicing rights increases as interest rates rise and decreases as interest rates fall. This is because the estimated life and estimated income from a loan increase as interest rates rise and decrease as interest rates fall. The key economic assumptions made in determining the fair value of the mortgage servicing rights at December 31, 2014 included the following:

 

		December 31,
		2014				2013
Annual constant prepayment speed (CPR)			11.46	%			10.27	%
Weighted average life (in months)			244				244
Discount rate			9.38	%			9.26	%

 

As of the December 31, 2013 valuation, we determined that the book value of our mortgage servicing rights asset associated with sold 20-year fixed-rate loans was no longer $19,200 more than the independent valuation; therefore the $19,200 valuation reserve that was established against that tranche of loans as of December 31, 2012 was reversed. As of December 31, 2014 there was no need to establish a valuation allowance against the mortgage servicing asset.

 

Impairment of Intangible Assets. On June 12, 2003, we acquired 100% of the stock of the InsuranCenter of Alpena (ICA). We allocated the excess of the purchase price paid over the fair value of net assets acquired to intangible assets, including goodwill. On February 27, 2009 the Company sold the majority of the assets of ICA. The remaining goodwill on our books of $600,000 related to certain assets of the Company that were not sold in the sale of ICA. We allocated the goodwill between the assets sold and the assets retained and determined a value of the assets that remained of $600,000. Since the $600,000 allocation relates to a finite life asset, we re-characterized the goodwill as an amortizable intangible and began amortizing the asset in March 2009. The intangible asset was fully amortized in April of 2014, and as a result this subsidiary was dissolved as of December 31, 2014.

 

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Upon completion of our merger, on August 8, 2014, with Alpena, we established a core deposit intangible asset of $1.4 million, which represents the value of the depositor relationships that were acquired. The core deposit intangible is an amortizable asset that will be recognized on an accelerated basis over a 10 year period. The Company evaluates the carrying value on an annual basis for impairment.

 

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

 

At December 31, 2014 and 2013, management did not believe it was more likely than not that all of the deferred tax assets would be realized. Accordingly, at December 31, 2014 and 2013 a valuation allowance of $3.1 million and $3.2 million was recorded, respectively. The net deferred tax asset recorded at December 31, 2014 and 2013 was $851,000 and $799,000. See Note 10 for additional information.

 

Off-Balance Sheet Arrangements

 

In the ordinary course of business, First Federal of Northern Michigan is a party to credit-related financial instruments with off-balance-sheet risk to meet the financing needs of its customers. These financial instruments include commitments to extend credit and letters of credit. First Federal of Northern Michigan follows the same credit policies in making off-balance sheet commitments as it does for on-balance-sheet instruments.

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for equity lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by First Federal of Northern Michigan, is based on management’s credit evaluation of the customer.

 

Unfunded commitments under construction lines of credit for residential and commercial properties and commercial lines of credit are commitments for possible future extensions of credit to existing customers, for which funds have not been advanced by First Federal of Northern Michigan.

 

At December 31, 2014 and December 31, 2013, First Federal of Northern Michigan had $9.0 million and $5.9 million, respectively, of commitments to grant loans, $15.0 million and $12.9 million, respectively, of unfunded commitments under lines of credit and $134,000 and $59,000, respectively, of letters of credit. See Note 11 of the Notes to the Consolidated Financial Statements.

 

Safe Harbor Statement

 

When used in this annual report or future filings by First Federal of Northern Michigan Bancorp, Inc. with the Securities and Exchange Commission, 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.

 

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

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.

 

Impact of Inflation and Changing Prices

 

The financial statements and related notes of First Federal of Northern Michigan Bancorp, Inc. have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration for changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than the effects of inflation.

 

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Report of Independent Registered Public Accounting Firm

 

Board of Directors 

First Federal of Northern Michigan Bancorp, Inc.

 

We have audited the consolidated balance sheet of First Federal of Northern Michigan Bancorp, Inc. as of December 31, 2014 and 2013 and the related consolidated statements of operations and comprehensive income, changes in stockholders’ equity, and cash flows for each year in the two-year period ended December 31, 2014. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with auditing standards established by the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of First Federal of Northern Michigan Bancorp, Inc. as of December 31, 2014 and 2013 and the consolidated results of its operations and its cash flows for each year in the two-year period ended December 31, 2014, in conformity with accounting principles generally accepted in the United States of America.

 

/s/ Plante & Moran, PLLC 

Auburn Hills, Michigan 

March 27, 2015

 

 

First federal of northern Michigan bancorp, inc. and subsidiaries

2014 Annual Report

 

Consolidated Balance Sheet 

(000s omitted, except per share data)

 

		December 31,
		2014				2013
Assets
Cash and cash equivalents		$	11,205			$	2,760
Overnight deposits with Federal Home Loan Bank			267				6
Total cash and cash equivalents			11,472				2,766
Deposits held in other financial institutions			8,429				—
Securities available for sale, at fair value (Note 3)			119,968				50,358
Securities held to maturity (Note 3)			790				2,255
Loans - net (Note 4)			163,647				136,315
Loans held for sale			88				175
Federal Home Loan Bank stock			2,591				3,266
Property and equipment (Note 5)			6,336				5,203
Assets held for sale - net			478				—
Foreclosed real estate and other repossessed assets			2,823				1,780
Accrued interest receivable			986				745
Intangible assets (Note 7)			1,286				40
Deferred tax asset (Note 10)			851				799
Originated mortgage servicing right - net (Note 6)			710				860
Bank owned life insurance			4,727				4,610
Other assets			685				485
Total assets		$	325,867			$	209,657
Liabilities and Stockholders' Equity
Liabilities
Non-interest bearing deposits		$	56,032			$	21,047
Interest-bearing deposits (Note 8)			214,702				138,982
Advances from Federal Home Loan Bank (Note 9)			22,885				24,813
Accrued expenses and other liabilities (Note 13)			1,712				1,290
Total liabilities			295,331				186,132
Stockholders' Equity (Note 12)
Common stock ($0.01 par value 20,000,000 shares authorized, 4,034,764 and 3,191,799
shares issued and outstanding) - at December 31, 2014 and 2013 , respectively			40				32
Additional paid-in capital			28,264				23,854
Retained earnings			4,765				2,763
Treasury stock at cost (307,750 shares) - at December 31, 2014 and 2013 , respectively			(2,964	)			(2,964	)
Accumulated other comprehensive income (loss)			431				(160	)
Total stockholders' equity			30,536				23,525
Total liabilities and stockholders' equity		$	325,867			$	209,657

 

 

First federal of northern Michigan bancorp, inc. and subsidiaries

2014 Annual Report

 

Consolidated Statement of Operations and Comprehensive Income 

(000s omitted, except per share data)

 

		Year Ended December 31,
		2014				2013
Interest Income
Loans, including fees		$	7,394			$	7,203
Investments
Taxable			781				484
Tax-exempt			158				151
Mortgage-backed securities			767				481
Total interest income			9,100				8,319
Interest Expense
Deposits (Note 8)			818				826
Borrowings			264				324
Total interest expense			1,082				1,150
Net Interest Income - Before provision for loan losses			8,018				7,169
Provision for Loan Losses (Note 4)			284				637
Net Interest Income - After provision for loan losses			7,734				6,532
Other Income
Service charges and other fees			807				857
Net loss on sale of investments			(4	)			—
Net gain on sale of loans			206				235
Net (loss) gain on sale of real estate owned and other repossessed assets			(76	)			3
Loan servicing fees			266				350
Insurance and brokerage commissions			117				126
Bargain purchase gain (Note 2)			1,982				—
Other			180				194
Total other income			3,478				1,765
Operating Expenses
Compensation and employee benefits (Note 13)			4,961				4,654
FDIC insurance premiums			207				184
Amortization of intangible assets			146				119
Advertising			183				130
Occupancy and equipment			1,032				911
Data processing service bureau			345				301
Professional fees			393				427
Collection activity			68				153
Real estate owned & other repossessed assets			272				245
Merger related expenses			266				83
Other			1,090				1,035
Total operating expenses			8,963				8,242
Income - before income tax expense			2,249				55
Income tax expense (Note 10)			—				—
Net income		$	2,249			$	55
Other Comprehensive Income (Loss):
Unrealized gain (loss) on securities available for sale - net of tax			594				(907	)
Reclassification adjustment for losses realized in earnings - net of tax			(3	)			—
Comprehensive Income (Loss)		$	2,840			$	(852	)
Per Share Data
Net income per share
Basic		$	0.70			$	0.02
Diluted		$	0.70			$	0.02
Dividends per common share		$	0.08			$	0.02

  

 

First federal of northern Michigan bancorp, inc. and subsidiaries

2014 Annual Report

  

Consolidated Statement of Changes in Stockholders’ Equity 

(000s omitted)

 

		Shares				Common Stock				Treasury Stock				Additional Paid-in Capital				Retained Earnings				Accumulated Other Comprehensive Income (Loss)				Total Stockholders' Equity
Balance - January 1, 2013			3,192			$	32			$	(2,964	)		$	23,854			$	2,766			$	747		$	24,435
Net income			—				—								—				55				—			55
Other comprehensive loss			—				—								—				—				(907	)		(907	)
Common dividend declared, $0.02 per share			—				—								—				(58	)			—			(58	)
Balance - December 31, 2013			3,192				32				(2,964	)			23,854				2,763				(160	)		23,525
Net income			—				—								—				2,249				—			2,249
Exchange of Alpena Banking Corp Stock (842,965 shares issued)			843				8								4,410				—				—			4,418
Other comprehensive income			—				—								—				—				591			591
Common dividend declared, $0.08 per share			—				—								—				(247	)			—			(247	)
Balance - December 31, 2014			4,035			$	40			$	(2,964	)		$	28,264			$	4,765			$	431		$	30,536

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

  

Consolidated Statement of Cash Flows 

(000s omitted, except per share data)

 

		Year Ended December 31
		2014				2013
Cash Flows from Operating Activities
Net income (loss)		$	2,249			$	55
Adjustments to reconcile net income (loss) to cash from operating
activities:
Depreciation and amortization			483				401
Provision for loan losses			284				637
Accretion of acquired loans			(89	)			—
Amortization and accretion on securities			578				551
Bargain purchase gain from bank acquisition			(1,982	)			—
Loss on sale of investment securities			4				—
Gain on sale of loans held for sale			(206	)			(235	)
Loss (Gain) on sale of property and equipment			23				(12	)
Loss (Gain) on sale of real estate owned and other repossessed assets			4				(3	)
Originations of loans held for sale			(13,833	)			(17,383	)
Proceeds from sale of loans held for sale			14,126				17,522
Net change in:
Accrued interest receivable			(25	)			225
Prepaid FDIC insurance premiums			—				583
Bank owned life insurance			(117	)			(135	)
Other assets			128				73
Accrued expenses and other liabilities			86				(236	)
Net cash provided by operating activities			1,713				2,043
Cash Flows from Investing Activities
Net cash received in bank acquisition			41,650				—
Net decrease in loans			3,740				474
Net increase in deposits at other institutions			(7,189	)			—
Proceeds from maturity of securities			14,843				14,441
Proceeds from sale of securities available-for-sale			730				—
Proceeds from sale of FHLB stock			831				—
Proceeds from sale of property and equipment			3				59
Proceeds from sale of of real estate owned and other repossessed assets			556				2,097
Purchase of securities available for sale			(60,636	)			(15,872	)
Purchase of premises and equipment			(306	)			(139	)
Net cash (used in) provided by investing activities			(5,778	)			1,060
Cash Flows from Financing Activities
Net increase in deposits			14,919				1,679
Dividends paid on common stock			(247	)			(58	)
Net decrease in Repo Sweep Accts			—				(3,183	)
Net increase in advances from borrowers			28				18
Advances from FHLB			17,955				47,005
Repayments of advances from FHLB			(19,884	)			(48,550	)
Net cash provided by (used in) financing activities			12,771				(3,089	)
Net Increase in Cash and Cash Equivalents			8,706				14
Cash and Cash Equivalents - Beginning of year			2,766				2,752
Cash and Cash Equivalents - End of year		$	11,472			$	2,766
Supplemental Cash Flow and Noncash Information
Net cash paid for income taxes		$	20			$	—
Cash paid for interest on deposits and borrowings			1,076				1,161
Transfer of loans to real estate owned & other repossessed assets			1,562				1,486

  

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

  

Note 1 - Summary of Significant Accounting Policies

 

Nature of Operations – First Federal of Northern Michigan Bancorp, Inc. (the “Company”) and its subsidiary, First Federal of Northern Michigan (the “Bank”), conduct operations in the northeastern lower peninsula of Michigan. The Company’s primary services include accepting deposits, making commercial, consumer and mortgage loans, and engaging in mortgage banking activities.

 

Principles of Consolidation - The consolidated financial statements include the accounts of First Federal of Northern Michigan Bancorp, Inc., First Federal of Northern Michigan, and the Bank’s wholly owned subsidiary, Financial Services & Mortgage Corporation (“FSMC”). FSMC invested in real estate, which includes leasing, selling, developing, and maintaining real estate properties. The 2014 activity of FFNM Agency, Inc. was to collect the stream of income associated with the sale of the Blue Cross/Blue Shield override business to an outside party and, to a lesser extent, the collection of commissions for the sale of non-insured investment products. The final override commission payment was collected in April of 2014 and as a result, this subsidiary was dissolved as of December 31, 2014. All significant intercompany balances and transactions have been eliminated in the consolidation.

 

Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan and lease loss (“ALLL”), the valuation of investment securities, intangible and deferred tax assets, and mortgage servicing rights.

 

Significant Concentrations of Credit Risk - Most of the Company’s activities are with customers located within the northeastern lower peninsula of Michigan. Note 3 discusses the types of securities in which the Company invests. Note 4 discusses the types of lending in which the Company engages. The Company does not have any significant concentrations to any one industry or customer.

 

Cash and Cash Equivalents - For the purpose of the consolidated statements of cash flows, cash and cash equivalents include cash and balances due from depository institutions and federal funds sold and interest bearing deposits in other depository institutions which mature within ninety days when purchased.

 

Securities – Debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. Securities not classified as held to maturity, including equity securities with readily determinable fair values, are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income net of applicable income taxes. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities.

 

Management evaluates securities for other-than-temporary impairment (“OTTI”) on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. When evaluating investment securities consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, whether the market decline was affected by macroeconomic conditions and whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, or U.S. Government sponsored enterprises, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition. The assessment of whether another-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

 

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

  

When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis. If an entity intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment. If a security is determined to be other-than-temporarily impaired, but the entity does not intend to sell the security, only the credit portion of the estimated loss is recognized in earnings, with the other portion of the loss recognized in other comprehensive income.

 

Federal Home Loan Bank Stock – Federal Home Loan Bank (FHLB) Stock is carried at cost and is held to allow the Bank to conduct business with the entity. Federal Home Loan Bank sells and purchases its stock at par; therefore cost approximates fair market value.

 

Mortgage Banking Activities – The Company routinely sells to investors its originated long-term residential fixed-rate mortgage loans. Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income.

 

Mortgage loans held for sale are generally sold with the mortgage servicing rights retained by the Company. The carrying value of mortgage loans sold is reduced by the cost allocated to the associated mortgage servicing rights. Gains or losses on sales of mortgage loans are recognized based on the difference between the selling price and the carrying value of the related mortgage loans sold.

 

The Company enters into commitments to originate loans whereby the interest rate on the loan is determined prior to funding, also known as rate lock commitments. Rate lock commitments on residential mortgage loans that are intended to be sold are considered to be derivatives. Fair value is based on fees currently charged to enter into similar agreements. The fair value of rate lock commitments was insignificant at December 31, 2014 and 2013.

 

The Company uses forward contracts as part of its mortgage banking activities. Forward contracts provide for the delivery of financial instruments at a specified future date and at a specified price or yield. The fair value of forward contracts was insignificant at December 31, 2014 and 2013.

 

Originated Loans - The Company grants mortgage, commercial, and consumer loans to customers. Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding unpaid principal balances adjusted for charge-offs, the ALLL, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield over the contractual life of the loan.

 

The accrual of interest on loans is discontinued at the time the loan is 90 days delinquent unless the credit is well-secured and in process of collection. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.

 

All interest accrued but not collected, for loans that are placed on nonaccrual or charged off, is reversed against interest income. The interest on these loans is accounted for on the cash basis or cost recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

 

  

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

Loans Acquired in a Business Combination – Loans acquired in a business combination (acquired loans) consist of loans acquired on August 8, 2014 in the merger with Bank of Alpena. Acquired loans are recorded at fair value as of the acquisition date without a carryover of the associated allowance for loan losses related to these loans, through a fair value discount that was, in part, attributed to credit quality. The estimate of the expected credit losses was determined based on due diligence performed by executive and senior management of the Company. The fair value discount was recorded as a reduction to the acquired loans’ outstanding principal balance in the consolidated financial statements on the merger date.

 

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

The Company accounts for acquired loans, which are recorded at fair value at acquisition, in accordance with ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (ASC 310-30). Under the provisions of ASC 310-30, the Company evaluated each loan individually and determined that loans with an outstanding principal balance of $5.9 million exhibited deteriorated credit quality, and therefore, met the criteria set forth in ASC 310-30. None of the loans acquired were classified as debt securities.

 

In accordance with ASC 310-30 with Company elected to evaluate each loan individually for expected future cash flows. Loans will be removed from the acquired loan segment in the event of sale, foreclosure, pay off or being written off as uncollectable. The Company estimates the cash flow to be collected over the remaining life of the loan on a quarterly basis based on a set of assumptions including expectations as to default rates, prepayment rates, and expected loss rates. The Company makes numerous assumptions, interpretations and judgments using internal and third-party credit quality information when determining the probability of collecting all contractual required payments. This is a point in time assessment and inherently subjective due to the nature of the available information and judgment involved.

 

The calculation of the fair value of the acquired loans entails estimating the amount and timing of cash flows attributable to both principal and interest expected to be collected on each individual loan, and then discounting those cash flows at a market interest rate. The excess of a loan’s expected cash flow at the acquisition date over its estimated fair value is commonly referred to as “accretable yield”, which is recognized into interest income over the remaining life of the loan on a level-yield basis. The difference between an individual loan’s contractual required principal and interest as of the merger date and the expected cash flows as of the same date is commonly referred to as “nonaccretable difference”, which includes an estimate of future credit losses expected to be incurred over the remaining life of the loan and interest payments that are not expected to be collected. A decrease to the expected cash flows of a loan in subsequent periods will require the Company to record a provision for loan loss. Improvements to expected cash flows of a loan in subsequent periods will result in reversing a portion of the nonaccretable difference, which is then classified as a part of the accretable yield and subsequently recognized into interest income over the estimated remaining life of the loan. A loan will be removed from the acquired loan segment through any one of the following avenues, foreclosed, paid off or written off.

 

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

 

The allowance consists of specific and general components. The specific component relates to loans that are classified as doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors.

 

  

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Large groups of homogeneous loans are collectively evaluated for impairment. The Company does not separately identify individual consumer and residential loans for impairment disclosures until a loss is imminent.

 

Troubled debt restructuring of loans is undertaken to improve the likelihood that the loan will be repaid in full under the modified terms in accordance with a reasonable repayment schedule. All modified loans are evaluated to determine whether the loans should be reported as a Troubled Debt Restructure (TDR). A loan is a TDR when the Company, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower by modifying or renewing a loan that the Company would not otherwise consider. To make this determination, the Company must determine whether (a) the borrower is experiencing financial difficulties and (b) the Company granted the borrower a concession. This determination requires consideration of all of the facts and circumstances surrounding the modification. An overall general decline in the economy or some deterioration in a borrower’s financial condition does not automatically mean the borrower is experiencing financial difficulties.

 

Loan Servicing – Servicing assets are recognized as separate assets when rights are retained through the sale of originated residential mortgage loans. Capitalized servicing rights are reported in other assets and are amortized against non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights into tranches based on predominant characteristics, such as interest rate, loan type and investor type. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or on a valuation model that calculates the present value of estimated future net servicing income using market based assumptions. Temporary impairment is recognized through a valuation allowance for an individual stratum to the extent that fair value is less than the capitalized amount for the stratum. If it is later determined that all or a portion of the temporary impairment no longer exists, the valuation allowance is reduced through a recovery of income. An other-than-temporary impairment results in a permanent reduction to the carrying value of the servicing asset. Servicing income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal, or a fixed amount per loan and are recorded as income when earned. The amortization of mortgage servicing rights is netted against loan servicing fee income.

 

Foreclosed Assets (Including Other Real Estate Owned) - Foreclosed real estate held for sale is carried at the lower of fair value minus estimated costs to sell. Costs of holding foreclosed real estate are charged to expense in the current period, except for significant property improvements, which are capitalized. Valuations are periodically performed by management and an allowance is established by a charge to non-interest expense if the carrying value exceeds the fair value minus estimated costs to sell. Foreclosed real estate is classified as other real estate owned. The net income from operations of foreclosed real estate held for sale is reported in non-interest income.

 

Property and Equipment - These assets are recorded at cost, less accumulated depreciation. The Bank uses the straight-line method of recording depreciation for financial reporting. The depreciable lives used by the Company are: land improvements 7-10 years, buildings 7-40 years and equipment 3-10 years. Maintenance and repairs are charged to expense and improvements are capitalized.

 

  

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

Bank Owned Life Insurance - The Bank has purchased life insurance policies on certain key officers. Bank-owned life insurance is recorded at its cash surrender value, or the amount that can be realized.

 

Intangible Assets – The Company has in the past purchased one or more branches from other financial institutions. The analysis of these branch acquisitions led the Company to conclude that in each case, we acquired a business and therefore, the purchase price generally includes the intangible value of the depositor relationships acquired, referred to as core deposit intangible assets. The expected life for core deposit intangible asset is based on the type of products acquired. The amortization periods range from 10 to 15 years and are based on the expected life of the products and relationships. The expected life was determined based on an analysis of the life of similar products within the Company and local competition in the markets where the branches were acquired. The core deposit intangible assets, related to branch purchases, were amortized on a straight line basis.

 

In conjunction with the merger with Bank of Alpena, the Company established a $1.4 million core deposit intangible asset. This intangible asset is being amortized over a 10 year period on an accelerated basis. The core deposit intangible is analyzed quarterly for impairment.

 

On June 12, 2003, First Federal of Northern Michigan acquired 100% of the stock of the InsuranCenter of Alpena (ICA).

 

On February 27, 2009 the Company announced that it had sold the majority of the assets of the InsuranCenter of Alpena.

 

At the time of the sale, goodwill of $600 continued to be recorded relating to certain assets of the Company that were not sold in the sale of ICA. The assets retained relate to a future stream of commissions. Management computed an estimated cash flow on this commission using a 6.0% discount rate and determined a fair value of $600. Since the $600 allocation of fair value relates to a finite life asset, the Company re-characterized the goodwill as an amortizable intangible and began amortizing the asset in March, 2009. Pursuant to the agreement, the Company received the final override commission payment in April, 2014.

 

Income Taxes - Deferred income tax assets and liabilities are recognized for temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

 

The Company records a valuation allowance if it believes, based on available evidence, that it is “more likely than not” that the future tax assets recognized will not be realized before their expiration. Realization of the Company’s deferred tax assets is primarily dependent upon the generation of a sufficient level of future taxable income.

 

At December 31, 2014 and 2013, management did not believe it was more likely than not that all of the deferred tax assets would be realized. Accordingly, at December 31, 2014 and 2013 a valuation allowance of $3.1 million and $3.2 million was recorded, respectively.

 

The net deferred tax asset recorded at December 31, 2014 and 2013 was $851 and $799. See Note 10 for additional information.

 

Off Balance Sheet Instruments - In the ordinary course of business, the Company has entered into commitments to extend credit, including commitments under credit card arrangements, commercial letters of credit and standby letters of credit. For letters of credit, a liability is recorded for the fair value of the obligation undertaken in issuing the guarantee.

 

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

Comprehensive Income - Accounting principles generally require that recognized revenue, expenses, gains, and losses be included in net income. Certain changes in assets and liabilities, however, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component in the equity section of the consolidated statement of financial condition. Such items, along with net income, are components of comprehensive income.

 

Accumulated other comprehensive income consists solely of unrealized gains and losses on available for sale securities, reported net of tax of $222 and ($83) at December 31, 2014 and December 31, 2013, respectively.

 

Stock-Based Compensation – The Company’s stock based compensation plans are described in detail in Note 12 (Employee Benefit Plans). Compensation expense is recognized for stock options and unvested (restricted) stock awards issued to employees, based on the fair value of these awards at the date of grant. A Black Scholes model is utilized to estimate the fair value of stock options, while the market price of the Company’s common shares at the date of grant is used to estimate the fair value of unvested (restricted) stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period for stock option awards and as the unvested period for nonvested (restricted) stock awards. Certain of theCompany’s share-based awards contain terms that provide for a graded vesting schedule whereby portions of the award vest in increments over the requisite service period.

 

The Company granted no options in 2014 and 2013. Compensation costs related to stock options charged to earnings were $0 in 2014 and 2013, respectively.

 

Earnings Per Common Share – Basic earnings per common share is computed by dividing net income by the average number of common shares outstanding during the period. The Company uses the treasury stock method to compute diluted earnings per share, which assumes that proceeds from the assumed exercise of stock options would be used to purchase common stock at the average market price during the period. As of December 31, 2014, 136,030 options were not considered dilutive, due to the fact that the option price exceeded the fair value of the shares.

 

Earnings per common share have been computed based on the following:

 

		December 31,
		2014				2013
Net income		$	2,249			$	55
Average number of common shares outstanding			3,218,926				2,884,049
Effect of dilutive options			—				—
Average number of common shares outstanding used to calculate diluted earnings per common share			3,218,926				2,884,049

  

 

Recent Accounting Pronouncements - The Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2014-09 (ASU 2014-09), “Revenue from Contracts with Customers (Topic 606)”. ASU 2014-09 adopts a standardized approach for revenue recognition and was a joint effort with the International Accounting Standards Board (IASB). The new revenue recognition standard is based on a core principle of recognizing revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 does not apply to financial instruments. ASU 2014-09 is effective for public entities for reporting periods beginning after December 15, 2016 (therefore, for the year ending December 31, 2017 for the Company). Early implementation is not allowed for public companies. Management is currently assessing the impact to the Company’s consolidated financial statements.

 

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

The Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-04, Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40) – Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. The ASU clarifies that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. The ASU is effective for public entities for reporting beginning after December 15, 2014 (therefore, for the year ending December 31, 2015 for the Company). The ASU can be adopted using either a modified retrospective transition method or a prospective transition method. Adoption of this update is not expected to have a material effect on the consolidated financial statements.

 

Note 2 - 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 business combination 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 December 31, 2014 and the identifiable assets acquired and liabilities assumed at their estimated fair values. A bargain purchase gain resulted from the business combination due to the fair value of the net assets acquired exceeding the value of the stock issued as consideration in the transaction. These fair value measurements are based on third-party valuations 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.

 

  

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

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 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 results of operations for the year ended December 31, 2014 include the operating results of the combined entities cfor the 143 days subsequent to the Merger Date. Alpena’s results of operations prior to the Merger Date are not included in the Company’s consolidated statement of comprehensive income.

 

We incurred merger related expenses of $266 during 2014. These expenses were for professional services such as legal, accounting and contractual arrangements for consulting services.

 

The following table provides the pro forma information for the results of operations for the years ended December 31, 2014 and 2013, 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. In addition, the $266 in merger-related costs noted above are included in each period presented. Further operating cost savings are expected along with additional business synergies as a result of the merger which are not presented in the pro forma amounts. 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 Year Ended
		December 31,
		2014				2013
Net interest income		$	9,554			$	9,602
Non-interest income			3,631				2,079
Non-interest expense			10,502				11,064
Net income			2,316				190
Net income per basic and diluted share			0.72				0.07
Weighted average shares outstanding			3,219				2,884

 

  

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

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.

 

		Acquired Impaired				Acquired Non-Impaired				Acquired Total
		(in thousands)
Real estate loans:
Residential mortgages		$	397			$	6,992			$	7,389
Commercial Loans:
Construction - real estate			—				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				1,567				1,598
Other			—				750				750
Total consumer loans			30				2,318				2,348
Total Loans at acqusition date		$	4,698			$	28,353			$	33,051

 

		Acquired Impaired				Acquired Non-Impaired				Acquired Total
		(in thousands)
Loans acquired- contractual required payments		$	5,930			$	28,587			$	34,517
Non accretable difference			(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

 

  

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

Note 3 – Securities

 

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

 

		December 31, 2014
		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Market Value
Securities Available for Sale
U.S. Treasury securities and obligations of U.S. government corporations and agencies		$	31,221			$	58			$	(57	)		$	31,222
Municipal notes			22,894				369				(129	)			23,134
Corporate securities			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 notes		$	790			$	118			$	—			$	908
			December 31, 2013
			Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Market Value
Securities Available for Sale
U.S. Treasury securities and obligations of  U.S. government corporations and agencies		$	7,111			$	36			$	(105	)		$	7,042
Municipal notes			13,694				216				(301	)			13,609
Corporate securities			1,085				12				—				1,097
Mortgage-backed securities			28,708				279				(384	)			28,603
Equity securities			3				4				—				7
Total		$	50,601			$	547			$	(790	)		$	50,358
Securities Held to Maturity
Municipal notes		$	2,255			$	145			$	—			$	2,400

 

The amortized cost and estimated market value of securities at December 31, 2014, by contractual 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.

 

  

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

		December 31, 2014
		Amortized Cost				Market Value
Available For Sale:
Due in one year or less		$	5,069			$	5,092
Due after one year through five years			38,827				38,843
Due in five year through ten years			10,478				10,562
Due after ten years			1,290				1,420
Subtotal			55,664				55,917
Equity securities			3				5
Mortgage-backed securities			63,648				64,046
Total		$	119,315			$	119,968
Held To Maturity
Due in one year or less		$	45			$	45
Due after one year through five years			200				218
Due in five year through ten years			315				365
Due after ten years			230				280
Total		$	790			$	908

 

At December 31, 2014 and 2013, securities with a fair value of $35.0 million and $36.0 million, respectively, were pledged to FHLB advances and borrowings from the Federal Reserve discount window.

 

Gross proceeds from the sale of available-for-sale securities for the years ended December 31, 2014 and 2013 were $730 and $0, respectively, resulting in gross gains of $1 and $0, respectively, and gross losses of $5 and $0, respectively. The tax benefit applicable to the net realized loss amounted to $2 and $0, respectively.

 

The following is a summary of securities that had unrealized losses at December 31, 2014 and 2013. The information is presented for securities that have been in an unrealized loss position for less than 12 months and for more than 12 months. At December 31, 2014, the Company held 72 securities with unrealized losses totaling $303. At December 31, 2013 there were 39 securities with unrealized losses totaling $790.

 

There are temporary reasons why securities may be valued at less than amortized cost. Temporary reasons are that the current levels of interest rates as compared to the coupons on the securities held by the Company are higher and impairment is not due to credit deterioration. The Company has the intent and the ability to hold these securities until their value recovers, which may be until maturity.

 

		December 31, 2014																December 31, 2013
						Gross Unrealized Losses								Gross Unrealized Losses								Gross Unrealized Losses								Gross Unrealized Losses
		Fair Value				Less than 12 months				Fair Value				12 months or longer				Fair Value				Less than 12 months				Fair Value				12 months or longer
Available For Sale:
U.S. Treasury securities and obligations of U.S. government corporations and agencies		$	13,672			$	(28	)		$	971			$	(29	)		$	—			$	—			$	894			$	(105	)
Corporate and other securities
Municipal notes			9,506				(54	)			4,039				(75	)			7,902				(243	)			1,668				(58	)
Mortgage-backed securities			9,923				(31	)			4,666				(86	)			14,471				(334	)			2,052				(50	)
Equity securities			—				—				—				—				—				—				—				—
Total Securities available for sale		$	33,101			$	(113	)		$	9,676			$	(190	)		$	22,373			$	(577	)		$	4,614			$	(213	)
Held to Maturity:
Municipal notes			—				—				—				—				—				—				—				—
Total Securities held to maturity		$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	—

  

  

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

On a quarterly basis, the Company performs a comprehensive security-level impairment assessment on all securities in an unrealized loss position to determine if other-than-temporary impairment (“OTTI”) exists. An unrealized loss exists when the current fair value of an individual security is less than its amortized cost basis. For debt securities, an OTTI loss must be recognized for a debt security in an unrealized loss position if the Company intends to sell the security or it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis. In this situation, the amount of loss recognized in income is equal to the difference between the fair value and the amortized cost basis of the individual security. If the Company does not expect to sell the security, the Company must evaluate the expected cash flows to be received to determine if a credit loss has occurred. If a credit loss is present, only the amount of impairment associated with the credit loss is recognized in income. The portion of the unrealized loss relating to other factors, such as liquidity conditions in the market or changes in market interest rates, is recorded in other comprehensive income.

 

The security-level assessment is performed on each security, regardless of the classification of the security as available for sale or held to maturity. The assessments are based on the nature of the securities, the financial condition of the issuer, the extent and duration of the securities, the extent and duration of the loss and the intent and whether management intends to sell or it is more likely than not that it will be required to sell a security before recovery of its amortized cost basis, which may be maturity. For those securities for which the assessment shows the Company will recover the entire cost basis, management does not intend to sell these securities and it is not more likely than not that the Company will be required to sell them before the anticipated recovery of the amortized cost basis, the gross unrealized losses are recognized in other comprehensive income, net of tax.

 
Management does not believe that the investment securities that were in an unrealized loss position as of December 31, 2014 represent an other-than-temporary impairment. Total gross unrealized losses were primarily attributable to changes in interest rates, relative to when the investment securities were purchased, and not due to the credit quality of the investment securities. The Company does not intend to sell the investment securities that were in an unrealized loss position and it is not more likely than not that the Company will be required to sell the investment securities before recovery of their amortized cost bases, which may be at maturity.

 

Note 4 – Loans

 

Loans at December 31, 2014 and 2013 are summarized as follows:

 

		December 31
		2014				2013
Real estate loans - One- to four-family residential		$	71,828			$	63,839
Commercial loans:
Secured by real estate			63,606				51,899
Other			19,000				12,451
Total commercial loans			82,606				64,350
Consumer loans:
Secured by real estate			9,502				8,730
Other			1,403				1,165
Total consumer loans			10,905				9,895
Total gross loans			165,339				138,084
Less:
Net deferred loan fees			263				297
Allowance for loan losses			1,429				1,472
Total loans - net		$	163,647			$	136,315

 

   

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

As of December 31, 2014 the total outstanding balance and carrying value of acquired impaired loans was $5.2 million and $4.7 million, respectively. Changes to the accretable yield for acquired impaired loans were as follows as of December 31, 2014:

 

		Acquired Impaired Non- Accretable				Acquired Non- Impaired Accretable				Acquired Total
Beginning of year		$	—			$	—			$	—
Net discount associated with acquired loans			(1,456	)			(234	)			(1,690	)
Accretion of discount for credit spread			—				26				26
Loans paid off through December 31, 2014			224				—				224
		$	(1,232	)		$	(208	)		$	(1,440	)

 

Final loan maturities and rate sensitivity of the loan portfolio are as follows:

 

		December 31, 2014
		Less Than One Year				One Year to Five Years				After Five Years				Total
Originated Loans:
Loans at fixed interest rates		$	3,983			$	31,560			$	50,507			$	86,050
Loans at variable interest rates			7,731				8,381				34,035				50,147
Total		$	11,714			$	39,941			$	84,542			$	136,197
		December 31, 2014
			Less Than One Year				One Year to Five Years				After Five Years				Total
Acquired Loans :
Loans at fixed interest rates		$	1,796			$	9,502			$	1,165			$	12,463
Loans at variable interest rates			2,024				3,773				10,882				16,679
Total		$	3,820			$	13,275			$	12,047			$	29,142

 

Certain directors and executive officers of the Company were loan customers of the Bank during 2014 and 2013. Such loans were made in the ordinary course of business and do not involve more than a normal risk of collectability. An analysis of aggregate loans outstanding to directors and executive officers for the years ended December 31, 2014 and 2013 are as follows:

 

		December 31,
		2014				2013
Aggregate balance - Beginning of Period		$	3,168			$	3,340
New loans			1,070				2,524
Repayments			(1,135	)			(2,491	)
Net change in directors and officers(1)			3,134				(205	)
Aggregate balance - End of Period		$	6,237			$	3,168

 

(1) Represents the addition or removal of new officer and directors during the year.

 

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

The following tables illustrate the contractual aging of the recorded investment in past due loans by class of loans as of December 31, 2014 and 2013:

 

						As of December 31, 2014
		30 - 59 Days Past Due				60 - 89 Days Past Due				Greater than 90 Days				Total Past Due				Current				Total Loans		Recorded Investment > 90 Days andAccruing
Originated Loans:
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
		30 - 59 Days Past Due				60 - 89 Days Past Due				Greater than 90 Days				Total Past Due				Current				Total Loans				Recorded Investment > 90 Days and Accruing
Acquired Loans:
Commercial Real Estate:
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

 

						As of December 31, 2013
		30 - 59 Days Past Due				60 - 89 Days Past Due				Greater than 90 Days				Total Past Due				Current				Total Loans				Recorded Investment > 90 Days and Accruing
Commercial Real Estate:
Commercial Real Estate - construction		$	—			$	—			$	173			$	173			$	—			$	173			$	—
Commercial Real Estate - other			—				521				1,441				1,962				49,764				51,726				—
Commercial - non real estate			33				20				—				53				12,398				12,451				—
Consumer:
Consumer - Real Estate			54				55				—				109				8,621				8,730				—
Consumer - Other			—				4				2				6				1,159				1,165				2
Residential:
Residential			1,973				393				353				2,719				61,120				63,839				24
Total		$	2,060			$	993			$	1,969			$	5,022			$	133,062			$	138,084			$	26

 

  

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

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.

 

  

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

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.

 

The following tables present the risk category of loans by class of loans based on the most recent analysis performed as of December 31, 2014 and 2013:

 

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

 

As of December 31, 2014
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

 

As of December 31, 2013
				Commercial Real Estate				Commercial Real Estate
Loan Grade				Construction				Other				Commercial
	1-2			$	—			$	—			$	—
	3				—				16,187				5,602
	4				—				27,789				6,699
	5				—				4,835				45
	6				173				2,915				105
	7				—				—				—
	8				—				—				—
	Total			$	173			$	51,726			$	12,451

 

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

For residential real estate and other consumer credit the Company also 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.

 

The following tables present the risk category of loans by class based on the most recent analysis performed as of December 31, 2014 and 2013.

 

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

 

As of December 31, 2013
						Consumer -
		Residential				Real Estate				Consumer - Other
Loan Grade:
Pass		$	63,164			$	8,723			$	1,163
Special Mention			—				7				2
Substandard			675
Total		$	63,839			$	8,730			$	1,165

 

 

 

The following tables present the recorded investment in non-accrual loans by class as of December 31, 2014 and 2013:

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

As of December 31
		2014				2013
Originated Loans:
Commercial Real Estate:
Commercial Real Estate - construction		$	—			$	173
Commercial Real Estate - other			486				1,454
Commercial			77				—
Consumer:
Consumer - real estate			25				7
Consumer - other			—				—
Residential:
Residential			750				651
Total		$	1,338			$	2,285

 

The following tables present loans individually evaluated for impairment by class of loans as of December 31, 2014

and 2013:

 

														For the Twelve Months Ended
Impaired Loans														December 31,
As of December 31, 2014														2014
		Unpaid Principal				Recorded				Related				Average				Interest
		Balance				Investment				Allowance				Recorded				Income
														Investment				Recognized
With no related allowance recorded:
Commercial		$	—			$	—			$	—			$	—			$	—
Commercial Real Estate - Construction			—				—				—				—				—
Commercial Real Estate - Other			1,431				1,430				—				1,482				84
Consumer - Real Estate			26				24				—				26				—
Consumer - Other			—				—				—				—				—
Residential			781				618				—				635				14
With a specific allowance recorded:
Commercial			—				—				—				—				—
Commercial Real Estate - Construction			—				—				—				—				—
Commercial Real Estate - Other			386				386				10				393				18
Consumer - Real Estate			—				—				—				—				—
Consumer - Other			—				—				—				—				—
Residential			—				—				—				—				—
Totals:
Commercial		$	—			$	—			$	—			$	—			$	—
Commercial Real Estate - Construction		$	—			$	—			$	—			$	—			$	—
Commercial Real Estate - Other		$	1,817			$	1,816			$	10			$	1,875			$	102
Consumer - Real Estate		$	26			$	24			$	—			$	26			$	—
Consumer - Other		$	—			$	—			$	—			$	—			$	—
Residential		$	781			$	618			$	—			$	635			$	14

 

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

														For the Twelve Months Ended
Impaired Loans														December 31,
As of December 31, 2013														2013
		Unpaid Principal				Recorded				Related				Average				Interest
		Balance				Investment				Allowance				Recorded				Income
														Investment				Recognized
With no related allowance recorded:
Commercial		$	—			$	—			$	—			$	—			$	—
Commercial Real Estate - Construction			—				—				—				—				—
Commercial Real Estate - Other			1,789				1,788				—				1,894				104
Consumer - Real Estate			8				7				—				7				—
Consumer - Other			—				—				—				—				—
Residential			954				722				—				727				6
With a specific allowance recorded:
Commercial			—				—				—				—				—
Commercial Real Estate - Construction			1,589				173				48				173				—
Commercial Real Estate - Other			3,980				3,391				182				3,397				94
Consumer - Real Estate			—				—				—				—				—
Consumer - Other			—				—				—				—				—
Residential			53				30				5				30				—
Totals:
Commercial		$	—			$	—			$	—			$	—			$	—
Commercial Real Estate - Construction		$	1,589			$	173			$	48			$	173			$	—
Commercial Real Estate - Other		$	5,769			$	5,179			$	182			$	5,291			$	198
Consumer - Real Estate		$	8			$	7			$	—			$	7			$	—
Consumer - Other		$	—			$	—			$	—			$	—			$	—
Residential		$	1,007			$	752			$	5			$	757			$	6

 

As of December 31, 2014 no additional funds are committed to be advanced in connection with impaired loans.

 

A restructuring of debt constitutes a troubled debt restructuring (“TDR”) if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. That concession either stems from an agreement between the creditor and the debtor or is imposed by law or a court. The Company adheres to ASC 310-40, Troubled Debt Restructurings by Creditors, to determine whether a TDR applies in a particular instance. Prior to loans being modified and classified as a TDR, specific reserves are generally assessed, as most of these loans have been specifically allocated for as part of the Company’s normal loan loss provisioning methodology. The Company allocated $10 and $230 reserves for the TDR loans at December 31, 2014 and December 31, 2013, respectively. The Company classifies all TDR loans as impaired loans in the table above.

 

The following table summarizes the loans that were modified as a TDR during the period ended December 31, 2014 and 2013.

 

For the Twelve Months Ended

December 31, 2014

Pre-Modification

Post-Modification

Troubled Debt Restructurings That Subsequently Defaulted

Number of

Outstanding Recorded

Outstanding Recorded

Number of

Recorded

Contracts

Investments

Investment

Contracts

Investment

Commercial Real Estate - Construction

—

$

—

$

—

—

$

—

Commercial Real Estate - Other

—

—

—

—

—

Commercial - non real estate

—

—

—

—

—

Residential

—

—

—

—

—

Total

—

$

—

$

—

—

$

—

 

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

For the Twelve Months Ended
December 31, 2013
														Troubled Debt Restructurings
						Pre-Modification				Post-Modification				That Subsequently Defaulted
		Number of				Outstanding Recorded				Outstanding Recorded				Number of				Recorded
		Contracts				Investments				Investment				Contracts				Investment
Commerical Real Estate - Construction			—			$	—			$	—				—			$	—
Commercial Real Estate - Other			1				412				412				—				—
Consumer - Real Estate			—				—				—				—				—
Residential			2				337				337				—				—
Total			3			$	749			$	749				—			$	—

 

A modification of a loan constitutes a TDR when a borrower is experiencing financial difficulty and the modification constitutes a concession. The Company offers various types of concessions when modifying a loan, however, forgiveness of principal is rarely granted. Commercial loans modified in a TDR often involve temporary interest-only payments, term extensions, and converting revolving credit lines to term loans.

 

Additional collateral, a co-borrower, or a guarantor may be requested. Commercial mortgage and construction loans modified in a TDR often involve reducing the interest rate for the remaining term of the loan, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, or substituting or adding a new borrower or guarantor.

 

Loans modified in a TDR may be on non-accrual status and partial charge-offs have in some cases already been taken against the outstanding loan balance. As a result, loans modified in a TDR for the Company may have the financial effect of increasing the specific allowance associated with the loan. The allowance for impaired loans that have been modified in a TDR is measured based on the estimated fair value of the collateral, less any selling costs, if the loan is collateral dependent or on the present value of expected future cash flows discounted at the loan’s effective interest rate if the loan is performing in accordance with the modified terms. Management exercises significant judgment in developing these estimates.

 

The regulatory guidance requires loans to be accounted for as collateral-dependent loans when borrowers have filed Chapter 7 bankruptcy, the debt has been discharged and the borrower has not reaffirmed the debt, regardless of the delinquency status of the loan. The filing of bankruptcy by the borrower is evidence of financial difficulty and the discharge of the obligation by the bankruptcy court is deemed to be a concession granted to the borrower.

 

At December 31, 2014, there were no additional commitments to lend additional funds to the related debtors whose terms have been modified in a TDR.

 

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 ALLL has a direct impact on the provision expense. An increase in the ALLL is funded through recoveries and provision expense.

 

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

  

Activity in the ALLL was as follows for the years ended December 31, 2014 and 2013:

 

For the Year Ended December 31, 2014
		Commercial				Commercial								Consumer
		Construction				Real Estate				Commercial				Real Estate				Consumer				Residential				Unallocated				Total
Allowance for credit losses:
Beginning Balance		$	48			$	444			$	63			$	62			$	21			$	784			$	50			$	1,472
Charge-offs			(12	)			(241	)			—				(14	)			(24	)			(177	)			—				(468	)
Recoveries			—				54				2				30				—				55				—				141
Provision			(28	)			50				29				(45	)			22				207				49				284
Ending Balance		$	8			$	307			$	94			$	33			$	19			$	869			$	99			$	1,429
Ending balance: individually evaluated for impairment		$	—			$	10			$	—			$	—			$	—			$	—			$	—			$	10
Ending balance: loans collectively evaluated for impairment		$	8			$	297			$	94			$	33			$	19			$	869			$	99			$	1,419
Loans:
Ending Balance		$	1,443			$	62,163			$	19,000			$	9,502			$	1,403			$	71,828			$	—			$	165,339
Ending balance: individually evaluated for impairment		$	—			$	1,816			$	—			$	24			$	—			$	618			$	—			$	2,458
Ending balance: loans collectively evaluated for impairment		$	1,443			$	44,492			$	14,544			$	7,778			$	1,158			$	64,324			$	—			$	133,739
Acquired loans not subject to loan loss reserve		$	—			$	15,855			$	4,456			$	1,700			$	245			$	6,886			$	—			$	29,142

 

 

For the Year Ended December 31, 2013
		Commercial Construction				Commercial Real Estate				Commercial				Consumer Real Estate				Consumer				Residential				Unallocated				Total
Allowance for credit losses:
Beginning Balance		$	64			$	579			$	69			$	99			$	33			$	906			$	—			$	1,750
Charge-offs			—				(674	)			—				(40	)			(13	)			(464	)			—				(1,191	)
Recoveries			—				114				—				36				6				120				—				276
Provision			(16	)			425				(6	)			(33	)			(5	)			222				50				637
Ending Balance		$	48			$	444			$	63			$	62			$	21			$	784			$	50			$	1,472
Ending balance: individually evaluated for impairment		$	48			$	182			$	—			$	—			$	—			$	5			$	—			$	235
Ending balance: loans collectively evaluated for impairment		$	—			$	262			$	63			$	62			$	21			$	779			$	50			$	1,237
Loans:
Ending Balance		$	173			$	51,726			$	12,451			$	8,730			$	1,165			$	63,839			$	—			$	138,084
Ending balance: individually evaluated for impairment		$	173			$	5,179			$	—			$	7			$	—			$	752			$	—			$	6,111
Ending balance: loans collectively evaluated for impairment		$	—			$	46,547			$	12,451			$	8,723			$	1,165			$	63,087			$	—			$	131,973

 

 

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

Note 5 - Property and Equipment

 

A summary of property and equipment is as follows:

		December 31,
		2014				2013
Land		$	1,271			$	1,071
Land improvements			195				182
Buildings			7,058				6,237
Equipment			3,959				3,523
Total property and equipment			12,483				11,013
Accumulated depreciation			6,147				5,810
Net property and equipment		$	6,336			$	5,203

 

Depreciation expense was $337 and $283 for the periods ended December 31, 2014 and 2013, respectively.

 

Note 6 – Servicing

 

Loans serviced for others are not included in the accompanying consolidated balance sheet. The unpaid principal balances of mortgage and other loans serviced for others were approximately $125.4 million and $131.7 million at December 31, 2014 and 2013, respectively. The key economic assumptions used in determining the fair value of the mortgage servicing rights are as follows:

 

		December 31,
		2014				2013
Annual constant prepayment speed (CPR)			11.46	%			10.27	%
Weighted average life (in months)			244				244
Discount rate			9.38	%			9.26	%

 

 

The fair value of our mortgage servicing rights was estimated to be $1.0 million and $1.1 million at December 31, 2014 and December 31, 2013, respectively. At December 31, 2012 a valuation allowance of $19 was established against the mortgage servicing rights associated with our 20-year fixed-rate sold loans. Based on decreased prepayment speeds within the 20-year fixed rate tranche, the valuation allowance was removed in 2013.

  

 

 

The following table summarizes mortgage servicing rights capitalized and amortized, along with the aggregate activity in related valuation allowances:

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

  

		December 31,
		2014				2013
Balance - beginning of period:		$	860			$	1,035
Originated mortgage servicing rights capitalized			111				151
Amortization of mortgage servicing rights			(261	)			(326	)
Balance - end of period			710				860
Valuation allowances:
Balance - beginning of period			—				(19	)
Reductions			—				19
Balance - end of period (net of allowances)		$	710			$	860

 

Note 7 - Intangible Assets

 

Intangible assets of the Company are summarized as follows:

 

		December 31, 2014
		Gross Carrying Amount				Accumulated Amortization				Net Carrying Amount
Amortized intangible assets:
Core deposit (merger)			1,392				106			$	1,286
Core deposit (purchase)		$	25			$	25				—
Commission residual			600				600				—
Total		$	2,017			$	731			$	1,286
			December 31, 2013
			Gross Carrying Amount				Accumulated Amortization				Net Carrying Amount
Amortized intangible assets:
Core deposit		$	25			$	24			$	1
Commission residual			600				561				39
Total		$	625			$	585			$	40

 

Amortization expense was $146 and $118 for the periods ended December 31, 2014 and 2013, respectively.

 

In accordance with the merger with Bank of Alpena in 2014, the Company recorded $1.4 million in core deposit intangible assets.

 

The estimated future amortization expense on core deposit intangible assets for the years ending after December 31, 2014 are as follows:

 

				Amortization
				Expense
	2015			$	243
	2016				217
	2017				192
	2018				167
	2019				141
	Thereafter				326
	Total			$	1,286

 

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

Note 8 - Deposits

 

Deposit accounts, by type and range of rates, consist of the following:

 

		December 31,
		2014				2013
Account Type
NOW accounts and MMDA		$	107,935			$	50,222
Regular savings accounts			29,846				22,037
Total			137,781				72,259
Certificate of Deposit Rates
0.10 percent to 0.99 percent			42,302				40,259
1.00 percent to 1.99 percent			27,362				17,715
2.00 percent to 2.99 percent			6,092				7,130
3.00 percent to 3.99 percent			1,050				1,486
4.00 percent to 4.99 percent			115				133
Total certificate of deposits			76,921				66,723
Total interest-bearing deposits		$	214,702			$	138,982

 

Certificates of deposit $100 or greater at December 31, 2014 and 2013 were $28.1 million and $22.9 million, respectively.

 

The following table sets forth the amount and maturities of certificates of deposit:

 

		December 31, 2014
		Amount Due
Rate		Less than 1 Year				1-2 Years				2-3 Years				3-5 Years				Greater than 5 Years				Total
0.10 percent to 0.99 percent		$	33,161			$	8,214			$	532			$	395			$	—			$	42,302
1.00 percent to 1.99 percent			1,419				6,884				6,398				12,394				267				27,362
2.00 percent to 2.99 percent			4,022				696				47				323				1,004				6,092
3.00 percent to 3.99 percent			502				—				12				536				—				1,050
4.00 percent to 4.99 percent			45				17				53				—				—				115
Total		$	39,149			$	15,811			$	7,042			$	13,648			$	1,271			$	76,921

 

Interest expense on deposits is summarized as follows:

 

		Year Ended December 31,
		2014				2013
NOW and MMDAs		$	141			$	98
Regular savings			13				11
Certificates of deposit			664				717
Total		$	818			$	826

 

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

Deposits from related parties held by the Bank at December 31, 2014 and 2013 amounted to $13.3 million and $632, respectively.

 

Note 9 - Federal Home Loan Bank and Federal Reserve Advances

 

The Bank has advances from the Federal Home Loan Bank of Indianapolis. Interest rates range from 0.32% to 2.21% with a weighted average interest rate of 1.17%. These advances contain varying maturity dates through January 3, 2023 with a weighted average maturity of approximately 27 months. The advances are collateralized by approximately $48.9 million and $49.6 million of mortgage loans as of December 31, 2014 and 2013, respectively. In addition, at December 31, 2014 and 2013, securities with a carrying value of $21.2 million and $20.4 million, respectively, were pledged as collateral for Federal Home Loan Bank advances. Available borrowings with the Federal Home Loan Bank at December 31, 2014 totaled $56.4 million, of which $22.9 million was outstanding.

The advances are subject to prepayment penalties subject to the provisions and conditions of the credit policy of the Federal Home Loan Bank. Future maturities of the advances are as follows:

 

 

December 31, 2014
Years Ending December 31				Amount				Weighted Average Interest Rate
	2015			$	4,890				.71
	2016				8,561				1.10
	2017				4,362				1.70
	2018				3,303				1.10
	2019				1,460				1.56
	Thereafter				309				1.61
	Total			$	22,885				1.17

 

 

 

 

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

The Bank had $0 and $1.5 million of variable rate advances outstanding as of December 31, 2014 and 2013, respectively.

 

In 2009, the Bank entered into a discount window loan agreement with the Federal Reserve Bank that allows for advances up to seventy-five percent of the collateral balance. As of December 31, 2014, these advances are secured by investment securities with a fair value of approximately $8.7 million and are generally due within 28 days from the date of the advance. The interest rate on the advances is based on the quoted Federal Reserve discount window rate (effective rate of 0.75 percent as of December 31, 2014). At December 31, 2014 and 2013, the Bank had no outstanding advances.

 

Note 10 - Federal Income Tax

 

Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be reversed.

 

The Company and the Bank file a consolidated Federal income tax return. The analysis of the consolidated provision for federal income tax is as follows:

 

		Year Ended December 31,
		2014				2013
Current provision		$	—			$	—
Deferred benefit			807				(57	)
Change in valuation allowance			(807	)			57
Total		$	—			$	—

 

A reconciliation of the federal income tax expense and the amount computed by applying the statutory federal income tax rate (34 percent) to income before federal income tax is as follows:

 

		Year Ended December 31,
		2014				2013
Tax expense at statutory rate		$	765			$	19
Increase (decrease) from:
Change in valuation allowance, including bargain purchase gain			(807	)			57
Tax-exempt interest			(52	)			(52	)
Other			94				(24	)
Total income tax expense		$	—			$	—

 

 

 

The net deferred tax asset was comprised of the following temporary differences:

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

		December 31,
		2014				2013
Deferred tax assets:
Acquired loans		$	565			$	—
Other real estate owned			202				92
Non-accrual loan interest			155				49
Directors’ benefit plan			251				272
Net operating loss carryforward			4,177				3,684
Investment in subsidiary			—				784
Net deferred loan origination fees			89				101
Unrealized loss on available-for-sale securities			—				83
Other			90				246
Total deferred tax assets			5,529				5,311
Less: valuation allowance			3,090				3,223
Deferred tax liabilities:
Allowance for loan losses			306				322
Mortgage servicing rights			242				292
Partnership losses			132				124
Unrealized gain on available-for-sale securities			222				—
Depreciation			115				344
Core deposit intangible			437				—
Other			134				207
Total deferred tax liabilities			1,588				1,289
Net deferred tax asset		$	851			$	799

 

The Company has net operating loss carryforwards of approximately $12.3 million generated from December 31, 2007 through December 31, 2014 that are available to reduce total taxable income through the years ending December 31, 2033.

 

For tax years beginning prior to January 1, 1996, a qualified thrift institution was allowed a bad debt deduction for tax purposes based on a percentage of taxable income or on actual experience. The Bank used the percentage of taxable income method through December 31, 1995.

 

A deferred tax liability has not been recognized for the tax bad debt base year reserves of the Bank. The base year reserves are the balance of reserves as of December 31, 1987. At December 31, 2014 and 2013, the amount of those reserves was approximately $60. The amount of the unrecognized deferred tax liability at December 31, 2014 and 2013 was approximately $20.

 

Note 11 – Off-Balance Sheet Risk Commitments and Contingencies

 

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, standby letters of credit, and commercial letters of credit. These financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statement of financial condition.

 

The Bank’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of these commitments. The Company follows the same credit policies in making commitments as it does for on-balance-sheet instruments. The following financial instruments were outstanding whose contract amounts represent credit risk:

 

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

		December 31,
		2014				2013
Commitments to grant loans		$	9,020			$	5,936
Unfunded commitments under lines of credit			15,022				12,940
Commercial and standby letters of credit			134				59

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for equity lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Company, is based on management’s credit evaluation of the customer.

 

Unfunded commitments under commercial lines of credit, revolving credit lines, and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. In most cases, these lines of credit are collateralized and usually do not contain a specified maturity date and may not be drawn upon to the total extent to which the Company is committed.

 

Commercial and standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those letters of credit are primarily used to support public and private borrowing arrangements. Essentially all letters of credit issued have expiration dates within one year. Fees earned on commercial and standby letters of credit are required to be deferred over the contractual life of the letter of credit. The Company determined that the fair value of guarantees on standby letters of credit has an immaterial effect on the financial results at December 31, 2014 and 2013.

 

To reduce credit risk related to the use of credit-related financial instruments, the Company generally holds collateral supporting those commitments if deemed necessary. The amount and nature of the collateral obtained is based on the Company’s credit evaluation of the customer. Collateral held varies, but may include cash, securities, accounts receivable, inventory, property, plant, equipment, and real estate.

 

If the counterparty does not have the right and ability to redeem the collateral or the Company is permitted to sell or repledge the collateral on short notice, the Company records the collateral in its balance sheet at fair value with a corresponding obligation to return it.

 

Various legal claims also arise from time to time in the normal course of business, which, in the opinion of management, will have no material effect on the Company’s financial statements.

 

Note 12 - Stockholders’ Equity

 

Payment of dividends on the common stock is subject to determination and declaration by the Board of Directors and depends on a number of factors, including capital requirements, regulatory limitation on payment of dividends, the Bank’s results of operations and financialcondition, tax considerations, and general economic conditions.

 

The Bank is subject to various regulatory capital requirements administered by the Office of the Comptroller of the Currency (OCC). Failure to meet certain capital requirements can initiate certain mandatory and possibly additional discretionary action by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators regarding components, risk-weightings, and other factors.

 

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

During the most recent regulatory examination, the OCC categorized the Bank as “well-capitalized” per definition of 12 CFR Section 565.4(b)(1). To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, tier 1 risk based, and tangible equity ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed the Bank’s categorization. Consolidated data has not been disclosed as the amounts and ratios are not significantly different.

 

In 2013 the federal banking agencies issued revisions to the existing capital rules to incorporate certain changes to the Basel capital framework, including Basel III and other elements. The intent is to strengthen the definition of regulatory capital, increase risk-based capital requirements, and make selected changes to the calculation of risk-weighted assets. Beginning January 1, 2015, banks transitioned to the new rules and will report results with the first call report of 2015. As part of the new rules there are several provisions affecting the Company, such as the implementation of a new common tier ratio, the start of a capital conservation buffer, and increased prompt corrective action capital adequacy thresholds.

 

		Actual								For Capital Adequacy Purposes								To be Categorized as Well-Capitalized Under Prompt Corrective Action Provisions
		Amount				Ratio				Amount				Ratio				Amount				Ratio
		(Dollars in Thousands)
December 31, 2014
Total capital (to risk-weighted assets)		$	29,092				16.9	%		$	13,778				8.0	%		$	17,223				10.0	%
Tier 1 capital (to risk-weighted assets)		$	27,662				16.1	%		$	6,889				4.0	%		$	10,334				6.0	%
Tangible capital (to tangible assets)		$	27,662				8.5	%		$	4,858				1.5	%		$	6,477				2.0	%
December 31, 2013
Total capital (to risk-weighted assets)		$	24,033				17.9	%		$	10,748				8.0	%		$	13,436				10.0	%
Tier 1 capital (to risk-weighted assets)		$	22,563				16.8	%		$	5,374				4.0	%		$	8,061				6.0	%
Tangible capital (to tangible assets)		$	22,563				10.8	%		$	3,137				1.5	%		$	4,183				2.0	%

 

Note 13 - Employee Benefit Plan

 

Defined Benefit Pension Plan

 

The Bank is a participant in the multiemployer Financial Institutions Retirement Fund (FIRF or the “Plan”), which covers substantially all of its officers and employees. The defined benefit plan covers all employees who have completed one year of service, attained age 21, and worked at least 1,000 hours during the year. Normal retirement age is 65, with reduced benefits available at age 55. The Bank’s contributions are determined by FIRF and generally represent the normal cost of the Plan. Specific Plan assets and accumulated benefit information for the Bank’s portion of the Plan are not available. Under the Employee Retirement Income Security Act of 1974 (ERISA), a contributor to a multiemployer pension plan may be liable in the event of complete or partial withdrawal for the benefit payments guaranteed under ERISA. Effective July 1, 2005 the plan was frozen as to current participants and any new employees hired after July 1, 2004 were excluded from the plan. The expense of the Plan allocated to the Bank was $103 and $72 for the years ended December 31, 2014 and 2013, respectively.

 

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

  

401(k) Savings Plan

 

The Bank has a 401(k) savings plan covering substantially all of its employees who meet certain age and service requirements. Contributions to the plan by the Bank are discretionary in nature in such amounts determined by the Board of Directors. The expense under the plan for the years ended December 31, 2014 and 2013 was $96 and $89, respectively.

 

Nonqualified Deferred Compensation Plan

 

The Bank has a nonqualified deferred compensation plan for certain of its directors. Through 1998, each eligible director could voluntarily defer all or part of his or her director’s fees to participate in the program. The plan is currently unfunded and amounts deferred are unsecured and remain subject to claims of the Bank’s general creditors.

 

Directors are paid once they reach normal retirement age or sooner for reason of death, total disability, or termination. The Bank may terminate the plan at any time. The amount recorded under the plan totaled approximately $738 and $801 at December 31, 2014 and 2013, respectively. The expense under the plan for the years ended December 31, 2014 and 2013 was $73 and $78, respectively.

 

Employee Stock Ownership Plan

 

Effective January 1, 1994, the Bank implemented an employee stock ownership plan (ESOP). The ESOP covers substantially all employees who have completed one year of service, attained age 21, and worked at least 1,000 hours during the year. To fund the ESOP, the Bank borrowed $480 from an outside party to purchase 48,000 shares of the Company’s common stock at $10 per share. The ESOP note was payable quarterly with interest at the prime rate and was retired in 1999. All of the 1994 shares were allocated as of December 31, 1999. Compensation expense is measured by the fair value of ESOP shares allocated to participants during a fiscal year.

 

Pursuant to the 2005 second-step conversion and stock offering, the shareholders of the Company approved the purchase of 8% of shares sold in the stock offering by the ESOP. The Company provided a loan to the ESOP, which was used to purchase 138,709 shares of the Company’s common stock in the stock offering at $10 per share. The loan bore interest at a rate equal to the current prime rate, adjustable on January 1 of each year and provided for repayment of principal over the 15 year term of the loan. Since the Company provided the loan to the ESOP, the note receivable was not included in the Company’s balance sheet. Accordingly, the Company did not recognize interest income on the loan.

 

The Company made annual contributions to the ESOP sufficient to support the debt service of the loan. The loan was secured by the shares purchased, which were held in a suspense account for allocation among the participants as the loan is paid. Dividends paid on unallocated shares were not considered dividends for financial reporting purposes and were used to pay principal and interest on the ESOP loan. Dividends on allocated shares are charged to retained earnings.

 

The loan was paid in full as of December 31, 2009.

 

Compensation expense is recognized for the ESOP equal to the average fair value of shares committed to be released for allocation to participant accounts. Any difference between the average fair value of shares committed to be released for allocation and the ESOP’s original acquisition cost is charged or credited to stockholders’ equity (additional paid-in capital). During the years ended December 31, 2014 and 2013, respectively, 0 and 2,793 shares were sold into the open market and no shares were purchased from the open market. Total compensation expense was $0 for both the years ended December 31, 2014 and 2013.

 

As of December 31, 2014 this benefit plan was terminated and funds have been distributed to the participants or rolled over into an individual retirement accounts (IRA) or the 401(k) plan savings plan.

 

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

Stock-Based Compensation Plans

 

The Company’s 1996 Stock Option Plan (the “1996 Plan”), which was approved by shareholders, permits the grant of stock options to its directors and employees for up to 127,491 shares of common stock (retroactively adjusted for the exchange ratio applied in the Company’s 2005 stock offering and related second-step conversion). The Company’s 2006 Stock-Based Incentive Plan (the “2006 Plan”), which was approved by the shareholders on May 17, 2006, permits the award of up to 242,740 shares of common stock of which the maximum number to be granted as Stock Options is 173,386 and the maximum that can be granted as Restricted Stock Awards is 69,354. Option awards are granted with an exercise price equal to the market price of the Company’s stock at the date of grant; those option awards 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). Shares issued under the Plan and exercised pursuant to the exercise of the stock option plan may be either authorized but unissued shares or reacquired shares held by the Company as treasury stock.

 

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

Stock Options - A summary of option activity under the Plans during the years ended December 31, 2014 and 2013 is presented below:

 

Options		Shares				Weighted- Average Exercise Price				Weighted-Average Remaining Contractual Term (Years)				Aggregate Intrinsic Value
Outstanding at January 1, 2013			167,620			$	9.53				3.38				—
Granted			—			$	0.00
Exercised			—			$	0.00
Forfeited or Expired			(17,590	)		$	9.60
Outstanding at December 31, 2013			150,030			$	9.52				2.40				—
Granted			—			$	0.00
Exercised			—			$	0.00
Forfeited or expired			(14,000	)		$	9.30
Oustanding at December 31, 2014			136,030			$	9.54				1.40				—
Options Exercisable at December 31, 2014			136,030			$	9.54				1.40				—

 

There were 63,256 shares available for future granting of options as of December 31, 2014.

 

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 $5.49 on December 31, 2014 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 December 31, 2014. The amount changes based on the fair market value of the stock. This value was $0.00 at both December 31, 2014 and 2013. The exercise prices for the stock options range from $9.07 to $9.65 per share.

 

As of December 31, 2014, the total compensation cost of the Plans was fully recognized. The total fair value of shares vested during the year ended December 31, 2014 and 2013 was $0 and $0, respectively. Compensation expense for 2014 and 2013 related to options granted under this plan was $0 and $0, respectively.

 

All stock options were fully vested at December 31, 2014 and 2013, respectively.

 

Restricted Stock Awards – The Company did not grant any award shares during the years ended December 31, 2014 and 2013. Compensation expense for 2014 and 2013 related to awards granted under this plan was $0 and $0, respectively.

 

The shares vest over a five year service period. As of December 31, 2014, the total compensation cost of the Plan was fully recognized. In addition, there were no restricted stock awards under the plan that were unvested at December 31, 2014 and 2013, respectively.

 

There were 5,304 shares available for future grants of award shares at December 31, 2014.

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

Note 14 - Fair Value Measurements

 

Accounting standards require certain assets and liabilities be reported at fair value in the financial statements and provide a framework for establishing that fair value. The framework for determining fair value is based on a hierarchy that prioritizes the inputs and valuation techniques used to measure fair value.

 

The following tables present information about the Company’s assets measured at fair value on a recurring basis at December 31, 2014 and 2013 and the valuation techniques used by the Company to determine those fair values.

 

In general, fair values determined by Level 1 inputs use quoted prices in active markets for identical assets that the Company has the ability to access.

 

Fair values determined by Level 2 inputs use other inputs that are observable, either directly or indirectly. These Level 2 inputs include quoted prices for similar assets in active markets and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals.

 

Level 3 inputs are unobservable inputs, including inputs that are available in situations where there is little, if any, market activity for the related asset. These Level 3 fair value measurements are based primarily on management’s own estimates using pricing models, discounted cash flow methodologies, or similar techniques taking into account the characteristics of the asset.

 

In instances whereby inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest level input that is significant to the valuation. The Company’s assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each asset.

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis 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)				Balance at December 31, 2014
Investment securities - available-for-sale:
U.S. Treasury securities and obligations of U.S. government corporations and agencies		$	—			$	31,223			$	—			$	31,223
Municipal notes			—				23,133				—				23,133
Corporate securities			—				1,561								1,561
Mortgage-backed securities			—				64,046				—				64,046
Equity securities			5				—				—				5
Total investment securities - available-for-sale		$	5			$	119,963			$	—			$	119,968

 

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis at December 31, 2013
		Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)				Balance at December 31, 2013
Investment securities - available-for-sale:
U.S. Treasury securities and obligations of U.S. government corporations and agencies		$	—			$	7,042			$	—			$	7,042
Municipal notes			—				13,609				—				13,609
Corporate securities			—				1,097								1,097
Mortgage-backed securities			—				28,603				—				28,603
Equity securities			7				—				—				7
Total investment securities - available-for-sale		$	7			$	50,351			$	—			$	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.

 

There were no transfers between Levels 1 and 2 of the fair value hierarchy during the years ended December 31, 2014 and 2013. For the available for sale securities, the Company obtains fair value measurements from an independent third-party service.

 

The Company also has assets that under certain conditions are subject to measurement at fair value on a nonrecurring basis. These assets include impaired loans (see Note 4) and other real estate owned.

 

The change in fair value of impaired loans is recorded through the ALLL. The Company estimates the fair value of impaired loans based on Level 3 inputs which include the present value of expected future cash flows using management’s best estimate of key assumptions. These assumptions include future payment ability, timing of payment streams, and estimated realizable values of available collateral (typically based on outside appraisals).

 

Other real estate owned assets are reported in the following table at initial recognition of impairment and on an ongoing basis until recovery or charge-off. At the time of foreclosure or repossession, real estate owned and repossessed assets are adjusted to fair value less estimated costs to sell, establishing a new cost basis. At that time, they are reported in the Company’s fair value disclosures in the following nonrecurring tables:

 

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

  

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)
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

 

 

Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2013
		Balance at December 31, 2013				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Impaired loans accounted for under FASB ASC 310-10		$	5,122			$	—			$	—			$	5,122
Other real estate owned -residential mortgages			285				—				—				285
Other real estate owned - commercial			472				—				—				472
Other repossessed assets			1,023				—				—				1,023
Total assets at fair value on a non-recurring basis														$	6,902

 

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

  

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.

 

Securities - Fair values of securities are based on quoted market prices. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

 

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 other loans are estimated using discounted cash flow analysis, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values of nonperforming loans are estimated using discounted cash flow analysis or underlying collateral values, where applicable.

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.

 

Deposit Liabilities - The fair values disclosed for demand deposits 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.

Other Financial Instruments - The fair value of other financial instruments, including loan commitments and unfunded letters of credit, based on discounted cash flow analyses, is not material.

 

 

 

The estimated fair values and related carrying amounts of the Company’s financial instruments as of December 31, 2014 and 2013 are as follows:

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

December 31, 2014		Carrying Value				Level 1				Level 2				Level 3				Total Estimated Fair Value
		(dollars in thousands)
Financial assets:
Cash and cash equivalents		$	11,254			$	11,254			$	—			$	—			$	11,254
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			163,646				—				—				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

 

December 31, 2013		Carrying Value				Level 1				Level 2				Level 3				Total Estimated Fair Value
		(dollars in thousands)
Financial assets:
Cash and cash equivalents		$	2,766			$	2,766			$	—			$	—			$	2,766
Securities available for sale			50,358				—				50,358				—				50,358
Securities held to maturity			2,255				—				2,400				—				2,400
Loans held for sale			175												178				178
Loans receivable - net			136,315				—				—				135,172				135,172
Federal Home Loan Bank stock			3,266				—				3,266				—				3,266
Accrued interest receivable			745				—				—				745				745
Financial liabilities:
Customer deposits			160,029				—				160,784				—				160,784
Federal Home Loan Bank advances			24,813				—				24,458				—				24,458
Accrued interest payable			89				—				—				89				89

 

Note 15 - Restrictions on Dividends

 

Dividends paid by the Bank are the primary source of funds available to the Company for payment of dividends to shareholders and for other working capital needs. The payment of dividends by the Bank to the Company is subject to restrictions by the Office of the Comptroller of Currency (OCC). These restrictions generally limit dividends to the current and prior two years’ retained earnings. In addition to these restrictions, as a practical matter, dividend payments cannot reduce regulatory capital levels below the Bank’s regulatory capital requirements and minimum regulatory guidelines. Future dividend payments by the Company will be based on future earnings and the approval of the OCC.

 

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 
Note 16 - Parent-Only Financial Statements

 

The following represents the condensed financial statements of First Federal of Northern Michigan Bancorp, Inc. (“Parent”) only. The Parent-only financial information should be read in conjunction with the Company’s consolidated financial statements.

Condensed parent company financial statements, which include transactions with the subsidiary, are as follows (000s omitted):

 

		December 31,
		2014				2013
Assets
Cash at subsidiary bank		$	481			$	510
Investment in subsidiary			29,731				22,701
Deferred tax asset			318				318
Other assets			6				1
Total assets		$	30,536			$	23,530
Liabilities and Stockholders’ Equity
Liabilities		$	—			$	5
Stockholders’ equity			30,536				23,525
Total liabilities and stockholders’ equity		$	30,536			$	23,530

 

		December 31,
		2014				2013
Operating income		$	—			$	—
Dividend income			500				—
Operating expense			(271	)			(249	)
Income (Loss) before income taxes and equity in undistributed net income of subsidiary bank			229				(249	)
Income tax benefit			—				—
Income (Loss) before equity in undistributed loss of subsidiary bank			229				(249	)
Equity in undistributed net income of subsidiary bank			2,020				304
Net income		$	2,249			$	55

 

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

  

Statements of Operations:

 

		December 31,
		2014				2013
Cash Flows from Operating Activities
Net income		$	2,249			$	55
Adjustments to reconcile net income to net cash from operating activities:
Dividend from subsidiary bank		$	500
Stock options/awards			—				—
Equity in undistributed net income of subsidiary bank			(2,520	)			(304	)
Net change in other liabilities			(6	)			1
Net change in other assets			(5	)			(1	)
Cash Flows from Financing Activities
Dividends paid			(247	)			(58	)
Net cash used in operating activities			(2,278	)			(362	)
Net Decrease in Cash			(29	)			(307	)
Cash - Beginning of year			510				817
Cash - End of year		$	481			$	510

 

 

First federal of northern Michigan bancorp, inc. and subsidiaries Notes to consolidated financial statements – December 31, 2014 and 2013 (000’s omitted), except per share data

2014 Annual report

 

Note 17 - Quarterly Results of Operations (Unaudited)

 

The following tables summarize the Company’s quarterly results for the fiscal years ended December 31, 2014 and 2013:

 

		For the Three-Month Period Ending
		March 31, 2014				June 30, 2014				September 30, 2014				December 31, 2014
Interest income		$	2,045			$	2,025			$	2,387			$	2,643
Interest expense			249				259				270				304
Net interest income			1,796				1,766				2,117				2,339
Provision for loan losses			16				—				257				11
Other income			336				344				2,224				574
Other expenses			1,895				2,016				2,470				2,582
Income - before income tax expense			221				94				1,614				320
Income tax expense			—				—				—				—
Net income		$	221			$	94			$	1,614			$	320
Net income per share
Basic		$	0.08			$	0.03			$	0.48			$	0.11
Diluted		$	0.08			$	0.03			$	0.48			$	0.11
Weighted average number of shares outstanding - basic and dilutive			2,884				2,884				3,370				3,019
Cash dividends declared per common share		$	0.020			$	0.020			$	0.020			$	0.020

 

		For the Three-Month Period Ending
		March 31, 2013				June 30, 2013				September 30, 2013				December 31, 2013
Interest income		$	2,085			$	2,095			$	2,065			$	2,074
Interest expense			321				285				274				270
Net interest income			1,764				1,810				1,791				1,804
Provision for loan losses			144				196				32				265
Other income			440				465				459				401
Other expenses			1,992				2,082				2,036				2,132
Income (loss) - before income tax expense (benefit)			68				(3	)			182				(192	)
Income tax expense			—				—				—				—
Net income (loss)		$	68			$	(3	)		$	182			$	(192	)
Net income (loss) per share
Basic		$	0.02			$	—			$	0.06			$	(0.07	)
Diluted		$	0.02			$	—			$	0.06			$	(0.07	)
Weighted average number of shares outstanding - basic and dilutive			2,884				2,884				2,884				2,884
Cash dividends declared per common share		$	—			$	—			$	—			$	0.020

 

 

Stockholder information

2014 Annual report

  

Annual Stockholder Meeting

 

The Annual Meeting of Stockholders will be held at 1:00 p.m., May 13, 2015 at the Art in the Loft, 109 N. Second Ave. Suite 300, Alpena, MI 49707.

 

Stock Listing

 

The Company’s common stock is traded on the NASDAQ Capital Market under the symbol “FFNM”.

 

Price Range of Common Stock

 

The following sets forth the quarterly high and low closing price per share and cash dividends declared during each of the four quarters in 2014 and 2013.

 

 

								Market Price
												Cash Dividend
Quarter Ended				High				Low				Declared
	December 31, 2014			$	5.80			$	4.70			$	0.020
	September 30, 2014			$	6.20			$	5.33			$	0.020
	June 30, 2014			$	6.12			$	4.82			$	0.020
	March 31, 2014			$	5.40			$	4.88			$	0.020
	December 31, 2013			$	5.72			$	4.71			$	0.020
	September 30, 2013			$	4.47			$	4.20			$	—
	June 30, 2013			$	4.65			$	3.40			$	—
	March 31, 2013			$	4.79			$	4.24			$	—

 

Special Counsel   Luse Gorman, PC 5335 Wisconsin Avenue, N.W. Suite 780 Washington, D.C. 20015   Market Maker   Raymond James & Associates, Inc. 222 South Riverside Plaza 7th Floor Chicago, IL 60606 312-655-3000

Independent Auditor   Plante & Moran, PLLC 2601 Cambridge Ct. Suite 500 Auburn Hills, MI 48326     Transfer Agent   Computershare Investor Services 211 Quality Circle Suite 210 College Station, TX 77845 800-368-5948

 

Annual Report on Form 10-K

 

A copy of the Company’s Form 10-K for the year ended December 31, 2014 will be furnished without charge upon written request to: Eileen M. Budnick, VP- Director of Financial Reporting & Accounting, Treasurer and Corporate Secretary, First Federal of Northern Michigan Bancorp, Inc., 100 S. Second Avenue, Alpena, Michigan 49707.

 

 

directors and exectuive officer of first federal of northern michigan bancorp, inc. and first federal of northern michigan

2014 Annual report

 

 

Directors

 

Martin A. Thomson has been Chairman of the Board of Directors since May 2008. He was President and Chief Executive Officer of the Company and Bank from May 2001. In January 2006, Mr. Thomson relinquished the position of President and in May 2008 relinquished the position of Chief Executive Officer and assumed the role of Chairman of the Board of Directors of the Company and Bank. Mr. Thomson previously held the position of President and Chief Executive Officer of Presque Isle Electric and Gas Co-op., Onaway, Michigan. Mr. Thomson has been a director of the Bank since 1986, and a director of the Company since its formation in November 2000.

 

Gary C. VanMassenhove is a Certified Public Accountant at Straley, Lamp and Kraenzlein, CPA firm. Mr. VanMassenhove has been a Certified Public Accountant for 44 years. He has been a director of the Company and the Bank since September 2001.

 

Thomas R. Townsend is the President of the R.A. Townsend Co., a plumbing, heating and air conditioning distributor located in Alpena, Michigan, where he has been employed for the past 37 years. Mr. Townsend has been a director of the Company and the Bank since April 2002.

 

James E. Kraenzlein is a partner in Straley, Lamp and Kraenzlein CPA firm. Mr. Kraenzlein has been a Certified Public account for 18 years. He has been a director of the Company since June 2013.

 

Timothy E. Fitzpatrick is the President of WMCR, Inc., a restaurant holding company located in Alpena, Michigan, where he has been employed for the past 35 years. Mr. Fitzpatrick has been a director of the Company since August 2014.

 

Christopher B. McCoy is the President of Magnaloy Coupling, a manufacturing company that produces a light weight, heavy-duty flexible drive coupling, located in Alpena Michigan, where he has been employed for the past 38 years. Mr. McCoy has been a director of the Company since August 2014.

 

Eric G. Smith is the President of Panel Processing, a panel fabricating plant located in Alpena Michigan, where he has been employed for the past 23 years. Mr. Smith is a Certified Public Accountant and has been a director of the Company since August 2014.

 

Richard L. Crittenden is the President of DeVere Construction Co., a general contractor and construction management company located in Alpena Michigan, where he has been employed for the past 35 years. Mr. Crittenden has been a director of the Company since August 2014.

 

Michael W. Mahler currently serves as the Chief Executive Officer of the Company and the Bank. In May 2008 he was named President and Chief Executive Officer of the Company and the Bank. Preceding that appointment, beginning in January 2006, he served as the President and Chief Operating Officer of the Company and the Bank. Prior to that designation, since November 2004, Mr. Mahler served as Executive Vice President of the Company and the Bank and had served, since November 2002, as Chief Financial Officer. From September 2000 until November 2002, Mr. Mahler was Corporate Controller at Besser Company, Alpena, Michigan, an international producer of concrete products equipment. From 1990 until 2000, Mr. Mahler was employed at LTV Steel Company, East Chicago, Indiana where he served in financial roles of increasing responsibility and served, from 1997 until 2000, as Controller for a northeast Michigan division. Mr. Mahler has been a Director of the Bank since January 2006 and of the Company since May 2008.

 

 

directors and exectuive officer of first federal of northern michigan bancorp, inc. and first federal of northern michigan

2014 Annual report

 

Executive Officers Who Are Not Directors

 

Craig A. Kus was named President and Chief Operating Officer of the Company and Bank in August 2014. Prior to joining the Bank, Mr. Kus served as the President and Chief Executive Officer of the Bank of Alpena and Alpena Banking Corporation, Alpena Michigan, a position he held since the bank’s inception in 2001. Mr. Kus has been in the banking profession since 1977.

  

Jerome W. Tracey was named Executive Vice President, of the Company, and Chief Lending Officer of the Bank in January 2006. Mr. Tracey had served as Senior Vice President, Senior Lender of the Company and the Bank since September 2001 and served as Vice President of Commercial Services since joining the Bank in November 1999. Prior to joining the Bank, Mr. Tracey served as Vice President of Commercial Lending for National City Bank, Alpena, Michigan, a position he held since 1996. Mr. Tracey has been in the banking profession since 1981.

 

Eileen M. Budnick was named VP- Director of Financial Reporting & Accounting, Treasurer and Corporate Secretary of the Company and the Bank in May 2013. Mrs. Budnick had served as Controller of the Bank since April 2008 and had served, since February 2007, as Assistant Controller, and prior to that appointment served, since February 2002, as a staff accountant for the Bank. Prior to February 2002, Mrs. Budnick was employed at Alpena Alcona Area Credit Union serving in various banking positions since September 1993.

 

Executive Management of the Bank

 

Michael W. Mahler, Craig A. Kus, Jerome W. Tracey, Eileen M. Budnick, and Joseph P. Garber

 

Officers of the Bank

 

Michael W. Mahler, Craig A. Kus, Jerome W. Tracey, Eileen M. Budnick, Joseph P. Garber, Joseph W. Gentry II, Kathleen R. Brown, Linda K. Sansom, Jerome P. Schmidt, Steven T. Mousseau and Tifanie A. Tremble.

 

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