-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, KMJJvUeakhcEDIPHHytR9LXpYgvAKDhgSSGBCCGK665Z2/Jo/2E0mdnyZ0y+3g0a WdaHzXVJoD+A4sP7EpjX6Q== 0000950124-06-001569.txt : 20060329 0000950124-06-001569.hdr.sgml : 20060329 20060329151110 ACCESSION NUMBER: 0000950124-06-001569 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20051231 FILED AS OF DATE: 20060329 DATE AS OF CHANGE: 20060329 FILER: COMPANY DATA: COMPANY CONFORMED NAME: First Federal of Northern Michigan Bancorp, Inc. CENTRAL INDEX KEY: 0001128227 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 383567362 FILING VALUES: FORM TYPE: 10KSB SEC ACT: 1934 Act SEC FILE NUMBER: 000-31957 FILM NUMBER: 06718389 BUSINESS ADDRESS: STREET 1: 100 SOUTH SECOND AVENUE CITY: ALPNEA STATE: MI ZIP: 49707 BUSINESS PHONE: (989) 356-9041 MAIL ADDRESS: STREET 1: 100 SOUTH SECOND AVENUE CITY: ALPENA STATE: MI ZIP: 49707 FORMER COMPANY: FORMER CONFORMED NAME: ALPENA BANCSHARES INC DATE OF NAME CHANGE: 20001114 10KSB 1 k02777e10ksb.txt ANNUAL REPORT FOR THE FISCAL YEAR ENDED 12/31/05 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-KSB [X] Annual Report Under to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Fiscal Year Ended December 31, 2005 OR [ ] Transition Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from _______________ to ______________________ COMMISSION FILE NUMBER: 000-31957 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. (Exact name of registrant as specified in its charter) MARYLAND 32-0135202 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number)
100 S. SECOND AVENUE, ALPENA, MICHIGAN 49707 (Address of Principal Executive Offices) Zip Code
(989) 356-9041 (Registrant's telephone number) Securities Registered Pursuant to Section 12(b) of the Act: NONE Securities Registered Pursuant COMMON STOCK, PAR VALUE $.01 PER SHARE to Section 12(g) of the Act: (Title of Class) Check whether the issuer is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. [ ]. Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past twelve months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. 1. YES X . NO . ----- ----- Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [X]. Indicate by check mark whether the Registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). [ ]. The Registrant's revenues for the year ended December 31, 2005 were $15.1 million. The aggregate market value of the voting stock held by non-affiliates of the Registrant, computed by reference to the last sale price on March 15, 2006 ($9.28 per share) was $25.9 million. As of March 15, 2006, there were issued and outstanding 3,120,344 shares of the Registrant's common stock. DOCUMENTS INCORPORATED BY REFERENCE 1. Proxy Statement for the 2006 Annual Meeting of Stockholders (Parts I and III). 2. Annual Report to Shareholders for the Year Ended December 31, 2005 (Part II). Transitional Small Business Disclosure Format YES . NO X . ----- ----- PART I ITEM 1. DESCRIPTION OF BUSINESS FORWARD-LOOKING STATEMENTS This Annual Report contains certain "forward-looking statements" which may be identified by the use of words such as "believe," "expect," "anticipate," "should," "planned," "estimated" and "potential." Examples of forward-looking statements include, but are not limited to, estimates with respect to our financial condition, results of operations and business that are subject to various factors which could cause actual results to differ materially from these estimates and most other statements that are not historical in nature. These factors include, but are not limited to, general and local economic conditions, changes in interest rates, deposit flows, demand for mortgage, commercial and other loans, real estate values, competition, changes in accounting principles, policies, or guidelines, changes in legislation or regulation, and other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing products and services. FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. First Federal of Northern Michigan Bancorp, Inc. is a Maryland corporation that owns all of the outstanding shares of common stock of First Federal of Northern Michigan. At December 31, 2005, First Federal of Northern Michigan Bancorp, Inc. had consolidated assets of $282.8 million, deposits of $188.7 million and stockholders' equity of $36.7 million. As of December 31, 2005, First Federal of Northern Michigan Bancorp, Inc. had 3,115,510 shares of common stock issued and outstanding. FIRST FEDERAL OF NORTHERN MICHIGAN First Federal of Northern Michigan is a full-service, community-oriented savings bank that provides financial services to individuals, families and businesses from ten full-service facilities located in Alpena, Antrim, Cheboygan, Emmett, Iosco, Otsego, Montmorency and Oscoda Counties, Michigan. First Federal of Northern Michigan was chartered in 1957, and reorganized into the mutual holding company structure in 1994. First Federal of Northern Michigan became the wholly owned subsidiary of Alpena Bancshares, Inc., the predecessor company to First Federal of Northern Michigan Bancorp, Inc., in November 2000. First Federal of Northern Michigan's business consists primarily of accepting deposits from the general public and investing those deposits, together with funds generated from operations and borrowings, in one- to four-family residential mortgage loans, commercial real estate loans, commercial business loans, consumer loans and in investment securities and mortgage-backed securities. MARKET AREA AND COMPETITION First Federal of Northern Michigan conducts operations through its main office in Alpena, Michigan, which is located in the northeastern lower peninsula of Michigan, and through its nine other branch offices in Michigan. The population of Alpena (city and township), from which the majority of our deposits is drawn, has decreased since 2000, and currently is approximately 21,000. The population of our primary market area, which includes Alpena County and seven surrounding counties, is approximately 187,000, and increased by 2.2% from 2000 to 2004. The population of our primary market area is expected to increase by 2.1% by 2009. Per capita income in our market area was $20,386 in 2004, which was 15.4% less than the national level, and 16.7% less than the state of Michigan as a whole, reflecting the largely 2 rural nature of our market area and the absence of more densely populated urban and suburban areas. Growth in per capita income in our market area is projected to increase only modestly over the next five years. The unemployment rate in our primary market area was 6.9% at December 31, 2005, compared to 4.9% nationally and 6.7% for the state of Michigan. Alpena is the largest city located in the northeastern lower peninsula of Michigan. This area has long been associated with agricultural, wood and concrete industries. Tourism has also been a major industry in our primary market area. All of these industries tend to be seasonal and are strongly affected by state and national economic conditions. Major employers in our primary market area include various public schools and governmental agencies, Alpena Regional Medical Center, Besser Company (a manufacturer of concrete products equipment), Lafarge Corporation (a limestone mining and cement producer), Treetops Sylvan Resort (an operator of resort properties), Garland Resort (an operator of resort properties), Otsego Memorial Hospital, Community Memorial Hospital, Decorative Panels International (a hardboard manufacturer), OMNI Metalcraft Corp. (a diversified manufacturer), Great Lakes Tissue (a paper manufacturer) and various other small companies. As of December 31, 2005, First Federal of Northern Michigan was the only thrift institution headquartered in our market area. We encounter strong competition both in attracting deposits and in originating real estate and other loans. Our most direct competition for deposits has historically come from commercial banks, other savings institutions, and credit unions in our market area. Competition for loans comes from such financial institutions as well as mortgage banking companies. We expect continued strong competition in the foreseeable future, including increased competition from "super-regional" banks entering the market by purchasing other financial institutions. Many such institutions have greater financial and marketing resources than we have. We compete for savings deposits by offering depositors a high level of personal service and a wide range of competitively priced financial services. In recent years, additional strong competition for deposits has come from securities brokers. We compete for real estate loans primarily on the basis of the interest rates and fees we charge and through advertising. Strong competition for deposits and loans may limit our ability to grow and may adversely affect our profitability in the future. LENDING ACTIVITIES GENERAL. The largest part of our loan portfolio is mortgage loans secured by one- to four-family residential real estate. In recent years, we have sold into the secondary mortgage market most of the fixed-rate conventional one- to four-family mortgage loans that we originate that have terms of 15 years or more. We retain the servicing on a majority of the mortgages that we sell. To a lesser extent, we also originate commercial loans, commercial real estate loans and consumer loans. At December 31, 2005, we had total loans of $202.6 million, of which $100.0 million, or 49.3%, were one-to four-family residential real estate mortgage loans, $40.2 million, or 19.9%, were commercial real estate loans, and $26.7 million, or 13.1%, were commercial loans. Other loans consisted primarily of consumer loan, which totaled $25.9 million, or 12.8% of total loans, and construction loans, which totaled $10.0 million or 4.9% of total loans. ONE- TO FOUR-FAMILY RESIDENTIAL REAL ESTATE LENDING. Our primary lending activity consists of originating one- to four-family owner-occupied residential mortgage loans, virtually all of which are collateralized by properties located in our market area. We also originate one- to four-family loans that pay interest only during the initial construction period (which generally does not exceed twelve months) and then pay interest and principal for the remainder of the loan term. We generally sell into the secondary mortgage market all of our one- to four-family fixed-rate mortgage loans with terms of 15 years or more and retain the loan servicing on a majority of these mortgage loans. One- to four-family residential mortgage loans are underwritten and originated according to policies and guidelines established by the secondary mortgage market agencies and approved by our Board of Directors. We utilize existing liquidity, savings deposit growth, loan repayments, and Federal Home Loan Bank advances to fund new loan originations. We currently offer fixed rate one- to four-family residential mortgage loans with terms ranging from 15 to 30 years. One- to four-family residential mortgage loans often remain outstanding for significantly shorter periods than their contractual terms because borrowers may refinance or prepay loans at their option. The average length of time that our one- to four-family residential mortgage loans remain outstanding varies significantly depending upon trends in market interest rates and other factors. In recent years, the average maturity of our mortgage loans has decreased significantly because of the declining trend in market interest rates and the unprecedented volume of refinancing activity 3 resulting from such interest rate decreases. Accordingly, estimates of the average length of one- to four-family loans that remain outstanding cannot be made with any degree of certainty. Originations of fixed rate mortgage loans are regularly monitored and are affected significantly by the level of market interest rates, our interest rate gap position, and loan products offered by our competitors. Our fixed rate mortgage loans amortize on a monthly basis with principal and interest due each month. To make our loan portfolio less interest rate sensitive, loans originated with terms of 15 years or greater are generally underwritten to secondary mortgage market standards and sold. Balloon mortgage loans with five-year terms and adjustable rate mortgage loans are generally underwritten to secondary mortgage market standards, but are retained in our loan portfolio. We originate some fixed-rate loans that are generally amortized over 15 years but that have "balloon payments" that are due upon the maturity of the loan in five years. Upon maturity, the balloon mortgage loans are either underwritten as fixed-rate loans and sold in the secondary mortgage market or renewed at current market rates for an additional five-year term. While the majority of our balloon mortgage loans amortize over 15 years, some amortize over 10 or 30 years, and a limited number amortize over five years. Our one- to four-family residential mortgage loans customarily include due-on-sale clauses, which are provisions giving us the right to declare a loan immediately due and payable in the event, among other things, that the borrower sells or otherwise disposes of the underlying real property serving as security for the loan. Due-on-sale clauses are an important means of adjusting the rates on our fixed-rate mortgage loan portfolio, and we have generally exercised our rights under these clauses. Regulations limit the amount that a savings institution may lend relative to the appraised value of the real estate securing the loan, as determined by an appraisal at the time of loan origination. Such regulations permit a maximum loan-to-value ratio of 100% for residential property and 90% for all other real estate loans. Our lending policies limit the maximum loan-to-value ratio on fixed-rate loans without private mortgage insurance to 90% of the lesser of the appraised value or the purchase price of the property serving as collateral for the loan. We make one- to four-family real estate loans with loan-to-value ratios of up to 90%. However, for one- to four-family real estate loans with loan-to-value ratios of between 80% and 90%, we may require the total loan amount to be covered by private mortgage insurance. In 2005 we began making 80/20 loans and interest-only loans subject to Board-approved dollar limits to limit risk exposure. We require fire and casualty insurance, flood insurance when applicable, as well as title insurance, on all properties securing real estate loans made by us. Beginning in November 2004 we initiated a "skip pay" program for customers with seasoned loans and with an exemplary past payment history. Under this program, for a fee, the customer may choose to skip a residential mortgage payment or a home equity line of credit payment. The program generated $35,000 in fee income in 2005. COMMERCIAL REAL ESTATE LENDING. We also originate commercial real estate loans. At December 31, 2005, we had a total of 191 loans secured primarily by commercial real estate properties, unimproved vacant land and, to a limited extent, multifamily properties. Our commercial real estate loans are secured by income-producing properties such as office buildings, retail buildings and motels. Substantially all of our commercial real estate loans are secured by properties located in our primary market area. We have originated commercial construction loans that are originated as permanent loans but are interest-only during the initial construction period, which generally does not exceed nine months. At December 31, 2005, our commercial real estate loans totaled $40.3 million, or 19.84% of our total loans, and had an average principal balance of $210,995. The terms of each loan are negotiated on a case-by-case basis, although such loans typically amortize over 15 years and have a three- or five-year balloon feature. An origination fee of 0.5% to 1.0% is generally charged on commercial real estate loans. We generally make commercial real estate loans up to 75% of the appraised value of the property securing the loan. Our largest commercial real estate loan had a principal balance of $1.5 million and was secured by a commercial building and all corporate assets of the borrower. At December 31, 2005, this loan was performing according to its repayment terms. Commercial real estate loans generally carry higher interest rates and have shorter terms than those on one- to four-family residential mortgage loans. However, loans secured by commercial real estate generally involve a greater degree of credit risk than one- to four-family residential mortgage loans and carry larger loan balances. This increased credit risk is a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties, and the increased difficulty of 4 evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by commercial real estate is typically dependent upon the successful operation of the business or the related real estate property. If the cash flow from the business operation is reduced, the borrower's ability to repay the loan may be impaired. This may be particularly true in the early years of the business operation when the risk of failure is greatest. Many of our commercial real estate loans have been made to borrowers whose business operations are untested, which increases our risk. CONSUMER AND OTHER LOANS. We originate a variety of consumer and other loans, including loans secured by savings accounts, new and used automobiles, mobile homes, boats, recreational vehicles, and other personal property. As of December 31, 2005, consumer and other loans totaled $25.9 million, or 12.8% of our total loan portfolio. At such date, $891,500, or 3.4% of our consumer loans, were unsecured. As of December 31, 2005, home equity loans totaled $8.4 million, or 3.2% of our total loan portfolio, and automobile loans totaled $3.3 million, or 1.3% of our total loan portfolio. We originate automobile loans directly to our customers and have no outstanding agreements with automobile dealerships to generate indirect loans. Our procedures for underwriting consumer loans include an assessment of an applicant's credit history and the ability to meet existing obligations and payments on the proposed loan. Although an applicant's creditworthiness is a primary consideration, the underwriting process also includes a comparison of the value of the collateral security, if any, to the proposed loan amount. Consumer loans generally entail greater risk than residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that tend to depreciate rapidly, such as automobiles, mobile homes, boats and recreational vehicles. In addition, the repayment of consumer loans depends on the borrower's continued financial stability, as repayment is more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy than a single family mortgage loan. COMMERCIAL LOANS. At December 31, 2005, we had $26.7 million in commercial loans which amounted to 13.1% of total loans. We make commercial business loans primarily in our market area to a variety of professionals, sole proprietorships and small businesses. Commercial lending products include term loans and revolving lines of credit. The maximum amount of a commercial business loan is our loans-to-one-borrower limit, which was $4.8 million at December 31, 2005. Such loans are generally used for longer-term working capital purposes such as purchasing equipment or furniture. Commercial loans are made with either adjustable or fixed rates of interest. Variable rates are generally based on the prime rate, as published in The Wall Street Journal, plus a margin. Fixed rate commercial loans are set at a margin above the Federal Home Loan Bank comparable advance rate. When making commercial loans, we consider the financial statements of the borrower, our lending history with the borrower, the debt service capabilities of the borrower, the projected cash flows of the business and the value of the collateral. Commercial loans are generally secured by a variety of collateral, primarily accounts receivable, inventory and equipment, and are supported by personal guarantees. Depending on the collateral used to secure the loans, commercial loans are made in amounts of up to 75% of the value of the collateral securing the loan. Commercial loans generally have greater credit risk than residential mortgage loans. Unlike residential mortgage loans, which generally are made on the basis of the borrower's ability to make repayment from his or her employment or other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial loans generally are made on the basis of the borrower's ability to repay the loan from the cash flow of the borrower's business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself. If the cash flow from the business operation is reduced, the borrower's ability to repay the loan may be impaired. This may be particularly true in the early years of the business operation when the risk of failure is greatest. Many of our commercial loans have been made to borrowers whose business operations are untested, which increases our risk. Moreover, any collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value. We seek to minimize these risks through our underwriting standards. At December 31, 2005, our largest commercial loan was a $1.0 million loan for the borrower's working capital purposes secured by fixed assets located in our primary market area. This loan was performing according to its repayment terms at December 31, 2005. CONSTRUCTION LOANS. We originate construction loans to local home builders in our market area, generally with whom we have an established relationship, and to individuals engaged in the construction of their residence. Our 5 construction loans totaled $10.0 million, or 4.9% of our total loan portfolio, at December 31, 2005. To a lesser extent, we also originate commercial construction loans. Our construction loans to home builders are repaid on an interest-only basis for the term of the loan (which is generally six to 12 months), with interest calculated on the amount disbursed to the builders based upon a percentage of completion of construction. These loans have a maximum loan-to-value ratio of 80%, based on the appraised value. Interest rates are fixed during the construction phase of the loan. Loans to builders are made on either a pre-sold or speculative (unsold) basis. Construction loans to individuals who intend to occupy the completed dwelling are terminated and replaced with a new permanent loan at the end of the construction period. The permanent loans are generally originated pursuant to the same policy guidelines regarding loan-to-value ratios and interest rates that are used in connection with loans secured by one- to four-family residential real estate. Prior to funding a construction loan, we require an appraisal of the property from a qualified appraiser approved by us, and all appraisals are reviewed by us. Construction lending exposes us to greater credit risk than permanent mortgage financing because of the inherent difficulty in estimating both a property's value at completion of the project and the estimated cost of the project. If the estimate of construction costs is inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the project. If the estimate of value upon completion is inaccurate, the value of the property may be insufficient to assure full repayment. Projects also may be jeopardized by disagreements between borrowers and builders and by the failure of builders to pay subcontractors. Loans to builders to construct homes for which no purchaser has been identified carry more risk because the repayment of the loan depends on the builder's ability to sell the property prior to the time that the construction loan is due. We have attempted to minimize these risks by, among other things, limiting our construction lending primarily to residential properties in our market area and generally requiring personal guarantees from the principals of corporate borrowers. LOAN PORTFOLIO COMPOSITION. The following table sets forth the composition of our loan portfolio by type of loan at the dates indicated.
At December 31, --------------------------------------------------------------------------------------------- 2005 2004 2003 2002 2001 ----------------- ----------------- ----------------- ----------------- ----------------- Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent -------- ------- -------- ------- -------- ------- -------- ------- -------- ------- (Dollars in thousands) Real estate loans: Residential mortgage ............. $100,042 49.3% $102,600 52.1% $ 94,988 57.7% $101,943 66.9% $132,491 74.9% Commercial mortgage .............. 40,270 19.8% 29,690 15.1% 29,452 17.9% 20,369 13.4% 14,152 8.0% Construction ..................... 10,030 4.9% 8,906 4.5% 5,907 3.6% 2,946 1.9% 3,036 1.7% Non real estate loans ............... Commercial ....................... 26,658 13.1% 30,174 15.3% 13,495 8.2% 7,528 4.9% 6,052 3.4% Consumer and other loans ......... 25,907 12.8% 25,544 13.0% 20,895 12.7% 19,587 12.9% 21,172 12.0% -------- ------ -------- ------ -------- ----- -------- ----- -------- ----- Total Loans ...................... $202,907 100.00% $196,914 100.00% $164,737 100.0% 152,373 100.0% $176,903 100.0% ====== ====== ===== ===== ===== Other items: Unadvanced construction loans .... -- -- -- -- -- Deferred loan origination costs .. 28 37 28 -- -- Deferred loan origination fees ... (336) (349) (269) (110) (68) Allowance for loan losses ........ (1,416) (1,214) (1,036) (922) (689) -------- -------- -------- -------- -------- Total loans, net ................. $201,183 $195,388 $163,460 $151,341 $176,146 ======== ======== ======== ======== ========
LOAN MATURITY AND YIELD SCHEDULE. The following table summarizes the scheduled repayments of our loan portfolio at December 31, 2005. Demand loans, loans having no stated repayment or maturity, and overdraft loans are reported as being due in one year or less. 6
Residential Mortgage Commercial Mortgage Construction -------------------- ------------------- ------------------ Weighted Weighted Weighted Average Average Average Amount Rate Amount Rate Amount Rate -------- -------- ------- -------- ------- -------- (Dollars in thousands) Due During the Years Ending December 31, 2006 ............... $ 2,138 6.59% $ 2,685 7.43% $10,004 7.19% 2007 ............... 3,430 6.22% 1,776 6.69% -- 0.00% 2008 ............... 12,188 5.99% 8,549 6.94% -- 0.00% 2009 to 2010 ....... 6,264 6.18% 25,556 7.39% 26 7.75% 2011 to 2015 ....... 6,823 6.28% 1,052 5.96% -- 0.00% 2016 to 2020 ....... 17,861 5.70% 652 7.38% -- 0.00% 2020 and beyond .... 51,338 5.82% -- 0.00% -- 0.00% -------- ---- ------- ---- ------- ---- Total ........... $100,042 5.91% $40,270 7.23% $10,030 7.19% ======== ======= ======= Commercial Consumer and Other Total ------------------ ------------------ ------------------- Weighted Weighted Weighted Average Average Average Amount Rate Amount Rate Amount Rate ------- -------- ------- -------- -------- -------- (Dollars in thousands) Due During the Years Ending December 31, 2006 ............... $14,980 7.59% $ 850 7.04% $ 30,657 7.36% 2007 ............... 1,241 7.20% 1,126 8.07% 7,573 6.77% 2008 ............... 5,135 6.96% 4,426 7.70% 30,298 6.67% 2009 to 2010 ....... 4,165 6.72% 8,366 7.52% 44,377 7.18% 2011 to 2015 ....... 659 6.90% 6,089 7.26% 14,623 6.69% 2016 to 2020 ....... -- 0.00% 2,034 7.59% 20,547 5.94% 2020 and beyond .... 478 7.39% 3,016 7.43% 54,832 5.92% ------- ---- ------- ---- -------- ---- Total ........... $26,658 7.29% $25,907 7.49% $202,907 6.62% ======= ======= ========
FIXED-AND ADJUSTABLE-RATE LOAN SCHEDULE. The following table sets forth the scheduled repayments of fixed- and adjustable-rate loans at December 31, 2005 that are contractually due after December 31, 2006.
Due After December 31, 2006 -------------------------------- Fixed Adjustable Total -------- ---------- -------- (In thousands) Residential mortgage .. $ 57,810 $40,094 $ 97,904 Commercial mortgage ... 26,249 11,335 $ 37,584 Construction .......... 26 -- $ 26 Commercial ............ 7,132 4,546 $ 11,678 Consumer and other .... 24,635 422 $ 25,057 -------- ------- -------- Total loans ........ $115,852 $56,397 $172,249 ======== ======= ========
LOAN ORIGINATIONS, PURCHASES, SALES AND SERVICING. While we originate both fixed-rate and adjustable-rate loans, our ability to generate each type of loan depends upon borrower demand, market interest rates, borrower preference for fixed- versus adjustable-rate loans, and the interest rates offered on each type of loan by other lenders in our market area. These lenders include competing banks, savings banks, credit unions, mortgage banking companies and life insurance companies that may also actively compete for local commercial real estate loans. Loan originations are derived from a number of sources, including real estate agent referrals, existing customers, borrowers, builders, attorneys, our directors and walk-in customers. Upon receiving a loan application, we obtain a credit report and employment verification to verify specific information relating to the applicant's employment, income, and credit standing. In the case of a real estate loan, we obtain a determination of value of the real estate intended to collateralize the proposed loan. Our lending limits vary by officer experience but range from $50,000 to $359,650. The loan committee must approve any loan from $359,650 up to $400,000, and any loan request over $400,000 must be approved by our Board of Directors. Consumer lending limits by officer range from $15,000 to $200,000. For secured commercial loans, the limit ranges from $150,000 to $400,000. A commercial commitment letter specifies the terms and conditions of the proposed loan including the amount of the loan, interest rate, amortization term, a brief description of the required collateral, and required insurance coverage. Commitments are typically issued for 15-day periods. The borrower must provide proof of fire and casualty insurance on the property serving as collateral, which insurance must be maintained during the full term of the loan. A title insurance policy is required on all real estate loans. At December 31, 2005, we had outstanding loan commitments of $36.6 million, including unfunded commitments under lines of credit and commercial and standby letters of credit. 7 Our loan origination and sales activity may be adversely affected by a rising interest rate environment that typically results in decreased loan demand, while declining interest rates may stimulate increased loan demand. Accordingly, the volume of loan originations, the mix of fixed- and adjustable-rate loans, and the profitability of this activity can vary from period to period. One- to four-family residential mortgage loans are generally underwritten to current Freddie Mac seller/servicer guidelines, and closed on standard Freddie Mac documents. If such loans are sold, the sales are conducted using standard Freddie Mac purchase contracts and master commitments as applicable. All one- to four-family mortgage loans that we have sold to Freddie Mac have been sold on a non-recourse basis, whereby foreclosure losses are generally the responsibility of the purchaser and not First Federal of Northern Michigan. We are a qualified loan servicer for Freddie Mac. Our policy has been to retain the servicing rights for all conforming loans sold, and to continue to collect payments on the loans, maintain tax escrows and applicable fire and flood insurance coverage, and supervise foreclosure proceedings if necessary. We retain a portion of the interest paid by the borrower on the loans as consideration for our servicing activities. We require appraisals of real property securing loans. Appraisals are performed by independent appraisers, who are approved by our Board of Directors annually. We require fire and extended coverage insurance in amounts adequate to protect our principal balance. Where appropriate, flood insurance is also required. Private mortgage insurance is required for most residential mortgage loans with loan-to-value ratios greater than 80%. LOAN ORIGINATION FEES AND COSTS. In addition to interest earned on loans, we generally receive fees in connection with loan originations. Such loan origination fees, net of costs to originate, are deferred and amortized using an interest method over the contractual life of the loan. Fees deferred are recognized into income immediately upon prepayment or subsequent sale of the related loan. At December 31, 2005, we had $308,000 of net deferred loan origination fees. Such fees vary with the volume and type of loans and commitments made and purchased, principal repayments, and competitive conditions in the mortgage markets, which in turn respond to the demand and availability of money. In addition to loan origination fees, we also generate other income through the sales and servicing of mortgage loans, late charges on loans, and fees and charges related to deposit accounts. We recognized fees and service charges of $1,030,000, $1,012,000 and $801,000 the years ended December 31, 2005, 2004 and 2003, respectively. To the extent that originated loans are sold with servicing retained, we capitalize a mortgage servicing asset at the time of the sale in accordance with applicable accounting standards (Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities"). The capitalized amount is amortized thereafter (over the period of estimated net servicing income) as a reduction of servicing fee income. The unamortized amount is fully charged to income when loans are prepaid. Originated mortgage servicing rights with an amortized cost of $751,000 were included in other assets at December 31, 2005. 8 ORIGINATION, PURCHASE AND SALE OF LOANS. The table below shows our loan originations, purchases, sales, and repayments of loans for the periods indicated.
YEARS ENDED DECEMBER 31, ------------------------------ 2005 2004 2003 -------- -------- -------- (In Thousands) Loans receivable at beginning of period ..... $196,914 $164,496 $152,263 Originations: Real estate: Residential 1-4 family ................ 54,767 60,361 132,146 Commercial and Multi-family ........... 35,454 32,837 35,004 Consumer ................................. 12,569 17,901 18,176 -------- -------- -------- Total originations .................... 102,790 111,099 185,326 -------- -------- -------- Loan purchases .............................. 8,149 11,715 -- -------- -------- -------- Loan sales .................................. (20,070) (24,362) (81,510) Transfer of mortgage loans to foreclosed real estate ................ (695) (79) (441) Repayments .................................. (84,181) (65,955) (91,142) -------- -------- -------- Total loans receivable at end of period .. $202,907 $196,914 $164,496 ======== ======== ========
DELINQUENT LOANS, OTHER REAL ESTATE OWNED AND CLASSIFIED ASSETS COLLECTION PROCEDURES. Our general collection procedures provide that before a mortgage, consumer or commercial loan becomes 16 days past due, a computer-generated late charge notice is sent to the borrower requesting payment. If delinquency continues, a second delinquent notice is mailed when the loan continues past due for 30 days. If a loan becomes 60 days past due, the loan becomes subject to possible legal action. We will generally send a "due and payable" letter upon a loan becoming 60 days delinquent. This letter grants the mortgagor 30 days to bring the account paid to date prior to the start of any legal action. If not paid, foreclosure proceedings are initiated after this 30-day period. To the extent required by regulations of the Department of Housing and Urban Development ("HUD"), generally within 45 days of delinquency, a Section 160 HUD notice is given to the borrower which provides access to consumer counseling services. General collection procedures may vary with particular circumstances on a loan by loan basis. Also, collection procedures for Freddie Mac serviced loans follow the Freddie Mac guidelines which are different from our general procedures. LOANS PAST DUE AND NON-PERFORMING ASSETS. Loans are reviewed on a regular basis and are placed on non-accrual status when, in the opinion of management, the collection of additional interest is doubtful or when extraordinary efforts are required to collect the debt. Interest accrued and unpaid at the time a loan is placed on non-accrual status is charged against interest income. Real estate acquired by us as a result of foreclosure or by deed in lieu of foreclosure is deemed real estate owned ("REO") until such time as it is sold. In general, we consider collateral for a loan to be "in-substance" foreclosed if: (i) the borrower has little or no equity in the collateral; (ii) proceeds for repayment of the loan can be expected to come only from the operation or sale of the collateral; and (iii) the borrower has either formally or effectively abandoned control of the collateral, or retained control of the collateral but is unlikely to be able to rebuild equity in the collateral or otherwise repay the loan in the foreseeable future. Cash flow attributable to in-substance foreclosures is used to reduce the carrying value of the collateral. 9 When collateral, other than real estate, securing commercial and consumer loans is acquired as a result of delinquency or other reasons, it is classified as Other Repossessed Assets ("ORA") and recorded at the lower of cost or fair market value until it is disposed of. When collateral is acquired or otherwise deemed REO/ORA, it is recorded at the lower of the unpaid principal balance of the related loan or its estimated net realizable value. This write down is recorded against the allowance for loan losses. Periodic future valuations are performed by management, and any subsequent decline in fair value is charged to operations. At December 31, 2005, we held $435,000 in properties that were classified REO/ORA. DELINQUENT LOANS. The following table sets forth certain information with respect to our loan portfolio delinquencies at the dates indicated.
Loan Delinquent For ---------------------------------- 60-89 Days 90 Days and Over Total --------------- ---------------- --------------- Number Amount Number Amount Number Amount ------ ------ ------ ------ ------ ------ (Dollars In Thousands) At December 31, 2005 Residential Mortgages .. 24 $1,375 19 $1,684 43 $3,059 Commercial Mortgages ... -- -- 4 670 4 670 Construction ........... 1 341 -- -- 1 341 Commercial ............. 8 506 2 115 10 621 Consumer ............... 23 197 13 185 36 382 --- ------ --- ------ --- ------ Total ............... 56 $2,419 38 $2,654 94 $5,073 === ====== === ====== === ====== At December 31, 2004 Residential Mortgages .. 6 $1,045 16 $ 960 22 $2,005 Commercial Mortgages ... -- -- -- -- -- -- Construction ........... -- -- -- -- -- -- Commercial ............. 2 195 1 105 3 300 Consumer ............... 5 179 16 175 21 354 --- ------ --- ------ --- ------ Total ............... 13 $1,419 33 $1,240 46 $2,659 === ====== === ====== === ====== At December 31, 2003 Residential Mortgages .. 23 $1,248 10 $ 617 33 $1,865 Commercial Mortgages ... -- -- 1 77 1 77 Construction ........... 1 43 -- -- 1 43 Commercial ............. 3 221 -- -- 3 221 Consumer ............... 12 90 11 134 23 224 --- ------ --- ------ --- ------ Total ............... 39 $1,602 22 $ 828 61 $2,430 === ====== === ====== === ======
10 NONPERFORMING ASSETS. The following table sets forth the amounts and categories of our non-performing assets at the dates indicated. At each date presented, we had no troubled debt restructurings (loans for which a portion of interest or principal has been forgiven and loans modified at interest rates materially less than current market rates).
AT DECEMBER 31, ----------------------------------------- 2005 2004 2003 2002 2001 ------ ------ ------ ------ ----- (Dollars in thousands) Non-Accrual Loans delinquent 90 days or more: Residential Mortgage ............................... 308 21 245 366 -- Commercial Mortgage ................................ 1,006 442 1,040 -- -- Construction ....................................... -- -- -- -- -- Commercial ......................................... -- -- -- -- -- Consumer and other ................................. 39 15 6 261 -- ------ ------ ------ ------ ----- Total non-accrual loans delinquent 90 days or more .... $1,353 $ 478 $1,291 $ 627 $ -- ------ ------ ------ ------ ----- Accrual loans delinquent 90 days or more: Residential Mortgage ............................... 1,684 960 617 566 475 Commercial Mortgage ................................ 670 -- -- -- -- Construction ....................................... -- -- 77 -- -- Commercial ......................................... 115 105 -- 152 -- Consumer and other ................................. 185 175 134 89 201 ------ ------ ------ ------ ----- Total accrual loans delinquent 90 days or more .. $2,654 $1,240 $ 828 $ 807 $ 676 ------ ------ ------ ------ ----- Total nonperforming loans (1) ......................... $4,007 $1,718 $2,119 $1,434 $ 676 ====== ====== ====== ====== ===== Real Estate Owned and Other Repossessed Assets: Residential Mortgage ............................... 427 9 199 101 167 Commercial Mortgage ................................ -- -- -- -- -- Construction ....................................... -- -- -- -- -- Commercial ......................................... -- -- -- -- -- Consumer and other ................................. 8 20 -- 27 30 ------ ------ ------ ------ ----- Total real estate owned (2) ........................... $ 435 $ 29 $ 199 $ 128 $ 197 ====== ====== ====== ====== ===== Total nonperforming assets ............................ $4,442 $1,747 $2,318 $1,562 $ 873 ====== ====== ====== ====== ===== Total nonperforming loans to net loans receivable ..... 1.97% 0.87% 1.28% 0.94% 0.38% Total nonperforming assets to total assets ............ 1.57% 0.66% 1.04% 0.68% 0.36%
(1) All of our loans delinquent 90 days or more are classified as nonperforming. (2) Represents the net book value of property acquired by us through foreclosure or deed in lieu of foreclosure. Upon acquisition, this property is recorded at the lower of its fair market value or the principal balance of the related loan. 11 CLASSIFICATION OF ASSETS. Our policies, consistent with regulatory guidelines, provide for the classification of loans and other assets such as debt and equity securities and real estate held for sale considered by the Office of Thrift Supervision to be of lesser quality as "substandard," "doubtful," or "loss" assets. An asset is considered "substandard" if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. "Substandard" assets include those characterized by the "distinct possibility" that the savings institution will sustain "some loss" if the deficiencies are not corrected. Assets classified as "doubtful" have all of the weaknesses inherent in those classified "substandard," with the added characteristic that the weaknesses present make "collection or liquidation in full," on the basis of currently existing facts, conditions, and values, "highly questionable and improbable." Assets classified as "loss" are those considered "uncollectible" and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets that do not expose the savings institution to risk sufficient to warrant classification in one of the aforementioned categories, but which possess some weaknesses, are required to be designated "special mention" by management. Loans designated as special mention are generally loans that, while current in required payments, have exhibited some potential weaknesses that, if not corrected, could increase the level of risk in the future. When we classify assets as either substandard or doubtful, we allocate a portion of the related general loss allowances to such assets as deemed prudent by management. The allowance for loan losses represents amounts that have been established to recognize losses inherent in the loan portfolio that are both probable and reasonably estimable at the date of the financial statements. When we classify problem assets as loss, we charge-off such amount. Our determination as to the classification of our assets and the amount of our loss allowances are subject to review by our regulatory agencies, which can order the establishment of additional loss allowances. Management regularly reviews our asset portfolio to determine whether any assets require classification in accordance with applicable regulations. On the basis of management's review of our assets at December 31, 2005, classified assets consisted of substandard assets of $3.0 million, doubtful assets of $105,000 and no assets classified as loss. We classify our assets pursuant to criteria similar to the classification structure provided in the OTS regulations. The following table sets forth the aggregate amount of our internally classified assets at the dates indicated.
AT DECEMBER 31, ------------------------------------------ 2005 2004 2003 2002 2001 ------ ------ ------ ------ ------ (In Thousands) Substandard assets .......... $3,045 $1,847 $2,295 $1,263 $2,198 Doubtful assets ............. 105 105 105 370 -- Loss assets ................. -- -- -- -- -- ------ ------ ------ ------ ------ Total classified assets .. $3,150 $1,952 $2,400 $1,633 $2,198 ====== ====== ====== ====== ======
Our investment in land and real estate at December 31, 2005 was classified as substandard by the Office of Thrift Supervision due to slower than expected sales of building lots and condominium units. This project (Wyndham Garden Estates) is an upscale condominium community comprised of 25 single-family building lots and 18 planned condominium units located in Alpena, Michigan. At December 31, 2005, all but six of the residential lots had been developed and sold and all condominium units were completed and all but one had been sold. Management believes this is a viable project with development and sales ongoing. At December 31, 2005, our investment in these properties was approximately $352,000, which is net of an allowance of $100,000 to record the investment at the lower of cost or fair value, less costs to sell. For reporting purposes, this investment is considered "impaired" under the definition of SFAS 144, Accounting for Impairment or Disposal of Long-Lived Assets. ALLOWANCE FOR LOAN LOSSES. We provide for loan losses based on the allowance method. Accordingly, all loan losses are charged to the related allowance and all recoveries are credited to it. Additions to the allowance for loan losses 12 are provided by charges to income based on various factors which, in management's judgment, deserve current recognition in estimating probable losses. Management regularly reviews the loan portfolio and makes provisions for loan losses in order to maintain the allowance for loan losses in accordance with accounting principles generally accepted in the United States of America. The allowance for loan losses consists of amounts specifically allocated to non-performing loans and other criticized or classified loans (if any) as well as general allowances determined for each major loan category. Commercial loans and loans secured by commercial real estate are evaluated individually for impairment. Other smaller-balance, homogeneous loan types, including loans secured by one- to four-family residential real estate and consumer installment loans, are evaluated for impairment on a collective basis. After we establish a provision for loans that are known to be non-performing, criticized or classified, we calculate percentage loss factors to apply to the remaining categories within the loan portfolio to estimate probable losses inherent in these categories of the portfolio. When the loan portfolio increases, therefore, the percentage calculation results in a higher dollar amount of estimated probable losses than would be the case without the increase, and when the loan portfolio decreases, the percentage calculation results in a lower dollar amount of estimated probable losses than would be the case without the decrease. These percentage loss factors are determined by management based on our historical loss experience and credit concentrations for the applicable loan category, which may be adjusted to reflect our evaluation of levels of, and trends in, delinquent and non-accrual loans, trends in volume and terms of loans, and local economic trends and conditions. We consider commercial and commercial real estate loans and construction loans to be riskier than one- to four-family residential mortgage loans. Commercial and commercial real estate loans have greater credit risks compared to one- to four-family residential mortgage loans, as they typically involve large loan balances concentrated with single borrowers or groups of related borrowers. In addition, the payment experience on loans secured by income-producing properties typically depends on the successful operation of the related real estate project and thus may be subject to a greater extent to adverse conditions in the real estate market and in the general economy. Construction loans have greater credit risk than permanent mortgage financing because of the inherent difficulty in estimating both a property's value at completion of the project and the estimated cost of the project. If the estimate of construction costs is inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the project. If the estimate of value upon completion is inaccurate, the value of the property may be insufficient to assure full repayment. Projects also may be jeopardized by disagreements between borrowers and builders and by the failure of builders to pay subcontractors. Loans to builders to construct homes for which no purchaser has been identified carry more risk because the repayment of the loan depends on the builder's ability to sell the property prior to the time that the construction loan is due. The increased risk characteristics associated with commercial real estate and land loans and construction loans are considered by management in the evaluation of the allowance for loan losses and generally result in a larger loss factor applied to these segments of the loan portfolio in developing an estimate of the required allowance for loan losses. We intend to increase our originations of commercial and commercial real estate loans, and we intend to retain these loans in our portfolio. Because these loans entail significant additional credit risks compared to one- to four-family residential mortgage loans, an increase in our origination (and retention in our portfolio) of these types of loans would, in the absence of other offsetting factors, require us to make additional provisions for loan losses. The carrying value of loans is periodically evaluated and the allowance is adjusted accordingly. While management uses the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the information used in making the evaluations. In addition, as an integral part of their examination process, our regulatory agencies periodically review the allowance for loan losses. Such agencies may require us to recognize additions to the allowance based on their judgments of information available to them at the time of their examination ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES. The following table sets forth the activity on our allowance for loan losses for the periods indicated. 13
FOR THE YEARS ENDED DECEMBER 31, ------------------------------------------- 2005 2004 2003 2002 2001 ------ ------ ------ ------ ------- (Dollars in thousands) Allowance at beginning of period .......................... $1,214 $1,036 $ 922 $ 689 $ 649 ------ ------ ------ ------ ------- Charge-offs: Residential Mortgages .................................. 21 12 28 36 52 Commercial Mortgages ................................... -- -- -- 8 -- Construction ........................................... -- -- -- -- -- Commercial ........................................... 57 -- -- -- -- Consumer and other ..................................... 171 179 187 190 237 ------ ------ ------ ------ ------- Total charge offs ................................... 249 191 215 234 289 Recoveries: Residential Mortgages .................................. -- 1 -- -- 8 Commercial Mortgages ................................... -- -- -- -- -- Construction ........................................... -- -- -- -- -- Commercial ........................................... -- -- -- -- -- Consumer and other ..................................... 83 45 62 52 66 ------ ------ ------ ------ ------- Total recoveries ................................... 83 46 62 52 74 Net (charge offs) recoveries .............................. 166 145 153 182 215 Provision for loan losses ................................. 368 323 267 415 255 ------ ------ ------ ------ ------- Balance at end of year .................................... $1,416 $1,214 $1,036 $ 922 $ 689 ====== ====== ====== ====== ======= Ratios: Net Charge-offs to average loans outstanding (annualized) ............................... 0.08% 0.07% 0.10% 0.12% 0.12% Allowance for loan loss to non-performing loans at end of period ................................. 35.34% 70.67% 48.90% 62.77% 101.92% Allowance for loan losses to total loans at end of period ................................. 0.70% 0.62% 0.63% 0.61% 0.39%
MORTGAGE BANKING ACTIVITIES Our mortgage banking activities involve the origination and subsequent sale into the secondary mortgage market of one- to four-family residential mortgage loans. When loans are sold into the secondary market, we generally retain the rights to service those loans thereby maintaining our customer relationships. We intend to use these customer relationships to cross-sell additional products and services. Loans that we sell are originated using the same personnel and the same underwriting policies as loans that we maintain in our portfolio. The decision whether to sell a loan is dependent upon the type of loan product and the term of the loan. In recent years, we have sold most of our fixed-rate one- to four-family residential loans with maturities of 15 years or greater, and have retained servicing on all of these loans. Mortgage servicing involves the administration and collection of home loan payments. When we acquire mortgage servicing rights through the origination of mortgage loans and the subsequent 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, 2005, we were servicing loans sold to third parties totaling $139.1 million, and the mortgage servicing rights associated with such loans had a book value, at such date, of $751,000. Generally, the value of mortgage servicing rights increases as interest rates rise and decreases as interest rates fall, because the estimated life and estimated income from the underlying loans increase with rising interest rates and decrease with falling interest rates. INSURANCE BROKERAGE ACTIVITIES 14 In March 2003, we acquired ICA, a licensed insurance agency, to increase and diversify our sources of non-interest income. ICA sells life, property, casualty and health insurance products and, to a lesser extent, non-insured investment products. All of these products are sold on an agency basis only. Unlike First Federal of Northern Michigan's net interest income and loan and deposit fee income, which are subject to and largely dependent on swings in market interest rates, the commissions earned on the sales of insurance and investment products generally are not affected by interest rate movements. As such, we expect the income contributed by ICA to add stability to our non-interest income specifically and net income generally. ICA sells life, property, casualty and health insurance products to First Federal of Northern Michigan's borrower customers and others. For example, we routinely offer credit life insurance sold through ICA to all borrower customers of First Federal of Northern Michigan, and we expect that borrower customers will be a significant source of business for ICA in the future. In addition, ICA offers workers' compensation insurance, key-man life insurance and property and casualty insurance to our commercial borrowers, which often are small businesses, and we expect this activity to increase as we increase our origination of commercial and commercial real estate loans. Conversely, we expect to provide the community bank services of First Federal of Northern Michigan to the existing insurance clients of ICA. Finally, ICA and First Federal of Northern Michigan are now able to jointly offer complementary products, including Health Savings Accounts (HSAs) and High Deductible Health Insurance Plans (HDHPs) to customers of both entities and the public in general. An HSA is a tax-free savings account established by an eligible individual or by an employer for an eligible employee that works like an IRA, except that the money is intended to be used for qualified health care costs. An HSA plan combines an HDHP with a tax-deductible savings account. An HSA plan can result in lower health insurance premiums coupled with tax savings, enabling many people to substantially cut their health care cost. HSA-qualified health insurance typically costs 10-50% less than traditional full coverage health insurance because of the higher policy deductibles. HSA assets are required by Federal law to be held by a qualified trustee or custodian. First Federal of Northern Michigan has recently completed the requirements to become a qualified HSA custodian and ICA is able to offer HDHPs through Blue Cross/Blue Shield. All of the revenue from our insurance segment is derived through sales commissions calculated as a percentage of the premium paid for the insurance product or the dollar value of the investment product. Generally, commission rates vary in amount depending on the type of insurance or investment product sold, as well as the volume and profitability to the underwriter of the business placed with it by ICA during specific periods. Sales commissions on insurance products generally are collected from the underwriter of the insurance and not from the insureds. Sales commissions on investment products generally are collected from the individual investor. In recent years, approximately 75% of ICA's revenues have been derived from the sale of Blue Cross/Blue Shield health insurance products. For the twelve months ended December 31, 2005, 31% of ICA's health insurance revenues were generated through an exclusive Blue Cross/Blue Shield contract under which business members of 11 chambers of commerce in our market area use ICA as their insurance agency. ICA earns a 1.9% commission on insurance products sold to business members of the chambers of commerce, and earns a 7% commission on insurance products sold to others. ICA has been operating under this exclusive contract since 1988. The contract provides for an indefinite term, though it may be terminated by either party on 60 days notice. Blue Cross/Blue Shield may revise the schedule of commissions under the contract no more frequently than annually. Effective January 1, 2006, this exclusive contract was terminated. However, ICA will continue to receive commissions on insurance products sold through the chambers of commerce prior to the termination and can continue to sell health insurance products to non-chamber of commerce customers. The insurance brokerage industry generally and ICA's activities specifically are affected by premium rate levels in the industry and available insurance capacity, since commissions generally are related to the premiums paid by insureds. Revenue is also affected by fluctuations in retained limits, insured values, the development of new products, markets and services, and the volume of business from new and existing clients. ICA has operated in Alpena, Michigan since its inception in 1984 and currently employs six insurance agents. See "--Subsidiary Activity" for a further discussion of ICA. ICA also currently employs a broker that sell non-insured investment products in one of the branch offices of First Federal of Northern Michigan. REAL ESTATE DEVELOPMENT ACTIVITIES 15 On a limited basis, we have purchased real estate for development through our subsidiary Financial Services & Mortgage Corporation. See "--Subsidiary Activity" for a discussion of our real estate development subsidiary, Financial Services & Mortgage Corporation. The last such purchase was a 37 acre lot which we purchased in 1994 for $130,000. As of December 31, 2005, we had sold 36 of the 43 lots comprising this property and two of the smaller lots had been combined into one lot, so that at December 31, 2005 six lots remained unsold. Our investment in land and real estate is "held for sale" and separately stated in the statement of financial condition, net of any allowance for impairment. Management is actively marketing the property by using local real estate agents to facilitate the sale of these properties. For reporting purposes, this investment is considered "impaired" under the definition in SFAS 144, Accounting for Impairment or Disposal of Long-Lived Assets. Accordingly, the investment is recorded at the lower of its cost or fair value less cost to sell, which may include realtor commissions, legal and title transfer fees, and closing costs that must be incurred before legal title can be transferred. Quarterly, management uses recent sales of comparable property to determine estimated future cash flows. The estimated future cash flows are used as the "fair value." The fair value, less cost to sell, is compared to the net carrying amount. If the fair value, less cost to sell, exceeds the recorded amount, a loss is recognized. Losses recognized for the initial and subsequent write-down to fair value, less cost to sell, are recognized in the "gain (loss) on the sale of real estate" line in the statement of income. A gain is recognized for any subsequent increase in fair value, less cost to sell, but not in excess of the cumulative loss previously recognized. A gain or loss not previously recognized that results from the sale of the property is recognized at the date of sale. At December 31, 2005, our investment in these properties was approximately $352,000, which was net of an allowance of $100,000. At December 31, 2005, management prepared an analysis by obtaining an updated fair value, less cost to sell, on these properties. Based on the analysis, no further impairment or loss was identified and the allowance remained at $100,000. INVESTMENT ACTIVITIES Our investment securities portfolio comprises U.S. Government and state agency obligations and municipal obligations, mortgage-backed securities, Federal Home Loan Bank stock, corporate bonds and other investments. At December 31, 2005, we had no investments in unrated securities. At December 31, 2005, $52.1 million, or 95.2% of our investment portfolio was scheduled to mature in less than five years, and $3.8 million, or 6.8%, was scheduled to mature in over five years. At December 31, 2005, $9.2 million, or 16.7% of our investment portfolio was scheduled to mature in less than one year. At December 31, 2005, we held U.S. Government and state agency obligations and municipal obligations classified as available-for-sale, with a fair market value of $48.8 million. While these securities generally provide lower yields than other investments such as mortgage-backed securities, our current investment strategy is to maintain investments in such instruments to the extent appropriate for liquidity purposes, as collateral for borrowings, and for prepayment protection. We invest in mortgage-backed securities in order to: generate positive interest rate spreads with minimal administrative expense; lower credit risk as a result of the guarantees provided by Freddie Mac, Fannie Mae and Ginnie Mae; supplement local loan originations; reduce interest rate risk exposure; and increase liquidity. Our mortgage-backed securities portfolio consists of pass-through certificates. At December 31, 2005, mortgage-backed securities totaled $6.3 million, or 2.2% of total assets. At December 31, 2005, 66.8% of our mortgage-backed securities were secured by balloon loans. All of our pass-through certificates are insured or guaranteed by Freddie Mac, Ginnie Mae or Fannie Mae. Our policy is to hold mortgage-backed securities as available for sale. We have interests in pools of single-family mortgages in which the principal and interest payments are passed from the mortgage originators, through intermediaries (generally government-sponsored agencies) that pool and repackage loans and sell the participation interest in the form of securities, to investors. These government-sponsored agencies include Freddie Mac, Ginnie Mae, or Fannie Mae. The underlying pool of mortgages can be comprised of either fixed-rate mortgage loans or adjustable-rate mortgage loans. The interest rate risk characteristics of the underlying pool of mortgages, i.e., fixed-rate or adjustable rate, are shared by the investors in that pool. 16 Our investment policy also permits investment in corporate debt obligations. Although corporate bonds may offer higher yields than U.S. Treasury or agency securities of comparable duration, corporate bonds also have a higher risk of default due to possible adverse changes in the creditworthiness of the issuer. We are required under federal regulations to maintain a minimum amount of liquid assets that may be invested in specified short term securities and certain other investments. We generally have maintained a portfolio of liquid assets that exceeds regulatory requirements. Liquidity levels may be increased or decreased depending upon the yields on investment alternatives and upon management's judgment as to the attractiveness of the yields then available in relation to other opportunities and its expectation of the level of yield that will be available in the future, as well as management's projections as to the short term demand for funds to be used in our loan origination and other activities. SFAS No. 115 requires that, at the time of purchase, we designate a security as held to maturity, available for sale, or trading, depending on our ability and intent. Securities available for sale are reported at fair value. As of December 31, 2005, all of our investment securities were designated as available for sale except for a $1.8 million state municipal bond investment designated as held to maturity. Investment Securities Portfolio. The following table sets forth the composition of our investment securities portfolio at the dates indicated.
AT DECEMBER 31, --------------------------------------------------------------- 2005 2004 2003 ------------------- ------------------- ------------------- Amortized Fair Amortized Fair Amortized Fair Cost Value Cost Value Cost Value --------- ------- --------- ------- --------- ------- (In Thousands) Debt Securities: U.S. Government and agency obligations ....... $43,825 $43,260 $27,954 $27,862 $16,700 $17,067 State agency and municipal obligations .............. 5,595 5,525 5,994 5,974 3,900 3,960 ------- ------- ------- ------- ------- ------- Corporate bonds and other obligations .............. -- -- -- -- 6,163 6,148 ------- ------- ------- ------- ------- ------- Mortgage-backed securities: Pass-through securities: Fannie Mae ............... 675 634 851 824 982 942 Freddie Mac .............. 3,698 3,559 4,722 4,666 5,940 5,855 Ginnie Mae ............... 2,086 2,057 2,552 2,556 521 537 ------- ------- ------- ------- ------- ------- Total debt securities ....... 55,879 55,035 42,073 41,882 34,206 34,509 ------- ------- ------- ------- ------- ------- Marketable equity securities Common stock ................ 2 163 2 184 17 161 ------- ------- ------- ------- ------- ------- Total equity securities ..... 2 163 2 184 17 161 ------- ------- ------- ------- ------- ------- Total interest securities ... $55,881 $55,198 $42,075 $42,066 $34,223 $34,670 ======= ======= ======= ======= ======= =======
17 Portfolio Maturities and Yields. The composition and maturities of the investment securities portfolio at December 31, 2005 are summarized in the following table. Maturities are based on the final contractual payment dates, and do not reflect the impact of prepayments or early redemptions that may occur. State and municipal securities yields have not been adjusted to a tax-equivalent basis.
AT DECEMBER 31, 2005 ------------------------------------------------------------------ More than One Year More than Five Years One Year or Less Through Five years Through Ten Years -------------------- -------------------- -------------------- Weighted Weighted Weighted Amortized Average Amortized Average Amortized Average Cost Yield Cost Yield Cost Yield --------- -------- --------- -------- --------- -------- (Dollars in Thousands) DEBT SECURITIES: U.S. Government and agency securities ........................... $7,509 3.49% $36,316 5.01% $ -- 0.00% State agency and municipal obligations .......................... 1,792 2.47% 2,228 4.18% 275 3.84% ------ ---- ------- ---- ---- ---- Corporate bonds and other obligations ... -- 0.00% -- 0.00% -- 0.00% ------ ---- ------- ---- ---- ---- Mortgage-backed securities Fannie Mae ........................... -- 0.00% 675 3.50% -- 0.00% Freddie Mac .......................... -- 0.00% 3,536 3.65% 129 4.00% Ginnie Mae ........................... -- 0.00% -- 0.00% 37 5.38% ------ ---- ------- ---- ---- ---- Total debt securities ................... 9,301 42,755 441 ------ ------- ---- MARKETABLE EQUITY SECURITIES: Common Stock ............................ -- 0.00% -- 0.00% -- 0.00% ------ ------- ---- Total investment securities ................ $9,301 $42,755 $441 ====== ======= ==== AT DECEMBER 31, 2005 ----------------------------------------------------- More than Ten Years Total Securities -------------------- ------------------------------ Weighted Weighted Amortized Average Amortized Fair Average Cost Yield Cost Value Yield --------- -------- --------- ------- -------- (Dollars in Thousands) DEBT SECURITIES: U.S. Government and agency securities ........................... $ -- 0.00% $43,825 $43,260 3.57% State agency and municipal obligations .......................... 1,300 4.78% 5,595 5,525 3.75% ------ ---- ------- ------- Corporate bonds and other obligations ... -- 0.00% -- -- 0.00% ------ ---- ------- ------- ---- Mortgage-backed securities Fannie Mae ........................... -- 0.00% 675 634 3.50% Freddie Mac .......................... 32 4.48% 3,698 3,559 3.67% Ginnie Mae ........................... 2,049 3.61% 2,086 2,057 3.64% ------ ---- ------- ------- ---- Total debt securities ................... 3,381 55,879 55,035 ------ ------- ------- MARKETABLE EQUITY SECURITIES: Common Stock ............................ 2 0.00% 2 163 0.00% ------ ------- ------- ---- Total investment securities ................ $3,383 $55,881 $55,198 ====== ======= =======
SOURCES OF FUNDS GENERAL. Deposits are the major source of our funds for lending and other investment purposes. We generate deposits from our ten full-service offices in Alpena, Ossineke, Mio, Cheboygan, Oscoda, Lewiston, Mancelona, Alanson and Gaylord. In addition to deposits, we derive funds from borrowings, proceeds from the settlement of loan sales, the amortization and prepayment of loans and mortgage-backed securities, the maturity of investment securities, and operations. Scheduled loan principal repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are influenced significantly by general interest rates and market conditions. Borrowings are used on a short-term basis to compensate for reductions in the availability of funds from other sources or on a longer term basis for general business purposes. We currently are managing liquidity levels and loan funding primarily through secondary mortgage market sales. DEPOSITS. We generate deposits primarily from our market area by offering a broad selection of deposit instruments including NOW accounts, regular savings, money market deposits, term certificate accounts and individual retirement accounts. Deposit account terms vary according to the minimum balance required, the period of time during which the funds must remain on deposit, and the interest rate, among other factors. The maximum rate of interest which we must pay is not established by regulatory authority. The asset/liability committee regularly evaluates our internal cost of funds, surveys rates offered by competing institutions, reviews the cash flow requirements for lending and liquidity, and executes rate changes when deemed appropriate. We have sought to decrease the risk associated with changes in interest rates by offering competitive rates on some deposit accounts and by pricing certificates of deposit to provide customers with incentives to choose certificates of deposit with longer maturities. We also attract non-interest bearing commercial deposit accounts from our commercial borrowers and offer a competitive sweep product that is not insured by the FDIC. In recent periods, we generally have not obtained funds through brokers or through a solicitation of funds outside our market area. However, at December 31, 2005, we had $600,000 of brokered deposits. We offer a limited amount of certificates of deposit in excess of $100,000 which may have negotiated rates. Future liquidity needs are expected to be satisfied through the use of Federal Home Loan Bank borrowings as necessary. Management does not generally plan on paying above market rates on deposit products. 18 The following table sets forth the distribution of total deposit accounts, by account type, at the dates indicated.
At December 31, ------------------------------------------------------------------------- 2005 2004 ----------------------------------- ----------------------------------- Weighted Weighted Percent Average Percent Average Amount of Total Interest Rate Amount of Total Interest Rate -------- -------- ------------- -------- -------- ------------- (Dollars in thousands) Non-interest-bearing ........ $ 10,878 5.76% NA $ 10,929 5.99% NA NOW accounts ................ 16,620 8.81% 0.32% 19,664 10.78% 0.34% Passbook .................... 21,853 11.58% 0.30% 25,039 13.72% 0.30% Investment sweep account .... 5,250 2.78% 3.14% 3,147 1.72% 1.45% Money market accounts ....... 11,544 5.12% 1.53% 16,837 9.22% 1.64% Time deposits that mature: Less than 12 months ...... 82,397 43.66% 3.63% 32,224 17.66% 2.05% Within 12-36 months ...... 30,324 16.07% 3.17% 60,894 33.37% 2.24% Beyond 36 months ......... 8,554 4.53% 4.16% 11,436 6.27% 3.36% Jumbo .................... 1,315 0.70% 4.26% 2,319 1.27% 5.46% -------- ------ ---- -------- ------ ---- Total deposits .............. $188,735 100.00% 2.56% $182,489 100.00% 1.64% ======== ====== ==== ======== ====== ==== At December 31, ----------------------------------- 2003 ----------------------------------- Weighted Percent Average Amount of Total Interest Rate -------- -------- ------------- (Dollars in thousands) Non-interest-bearing ........ $ 7,282 4.80% NA NOW accounts ................ 13,596 8.96% 0.35% Passbook .................... 25,851 17.04% 0.30% Investment sweep account .... 2,987 1.97% 0.73% Money market accounts ....... 11,613 7.66% 1.22% Time deposits that mature: Less than 12 months ...... 41,943 27.65% 1.49% Within 12-36 months ...... 31,934 21.05% 2.27% Beyond 36 months ......... 13,524 8.91% 4.74% Jumbo .................... 2,972 1.96% 5.79% -------- ------ ---- Total deposits .............. $151,702 100.00% 1.62% ======== ====== ====
TIME DEPOSIT RATES. The following table sets forth time deposits classified by rates as of the dates indicated (see Note 8 to our consolidated financial statements contained within Exhibit 13) for a more detailed breakdown by rate range):
At December 31, ----------------------------- Rate 2005 2004 2003 ---- -------- -------- ------- (In Thousands) Less than 2% $ 7,443 $ 22,980 $26,192 2.00 percent to 2.99 percent 20,199 24,924 14,384 3.00 percent to 3.99 percent 59,350 33,124 15,349 4.00 percent to 4.99 percent 25,470 10,227 12,498 5.00 percent to 6.99 percent 8,667 12,869 18,768 7.00 percent to 8.99 percent 1,461 2,749 3,183 -------- -------- ------- $122,590 $106,873 $90,374 ======== ======== =======
TIME DEPOSIT MATURITIES. The following table sets forth the amount and maturities of time deposits at December 31, 2005.
1 - Less 2 - Less 3 - Less 5 years Less Than than 2 than 3 than 5 and Rate One Year Years Years Years Greater Total ---- --------- -------- -------- -------- ------- -------- Less than 2% $ 7,426 $ 17 $ -- $ -- $ -- $ 7,443 2.00 percent to 2.99 percent 18,248 368 652 773 158 20,199 3.00 percent to 3.99 percent 34,788 18,367 5,933 90 172 59,350 4.00 percent to 4.99 percent 19,793 3,684 211 1,347 435 25,470 5.00 percent to 6.99 percent 2,757 725 921 3,691 573 8,667 7.00 percent to 8.99 percent -- 147 -- 1,314 -- 1,461 ------- ------- ------ ------ ------ -------- $83,012 $23,308 $7,717 $7,215 $1,338 $122,590 ======= ======= ====== ====== ====== ========
As of December 31, 2005, the aggregate amount of outstanding certificates of deposit in amounts greater than or equal to $100,000 was $30.2 million. The following table sets forth the maturity of those certificates as of December 31, 2005.
Certificates Maturity Period of Deposit --------------- -------------- (In thousands) Three months or less ....... $ 6,069 Three through six months ... 1,567 Six through twelve months .. 12,045 Over twelve months ......... 10,485 ------- Total ...................... $30,166 =======
BORROWINGS. Our borrowings consist primarily of advances from the Federal Home Loan Bank of Indianapolis. At December 31, 2005, we had access to additional Federal Home Loan Bank advances of up to $25.4 million. The following table sets forth information concerning balances and interest rates on our Federal Home Loan Bank advances and other borrowings at the dates and for the periods indicated.
Years Ended December 31, --------------------------- 2005 2004 2003 ------- ------- ------- (Dollars in Thousands) Balance at end of period $54,405 $56,001 $47,159 Average balance during period $51,627 $54,473 $49,594 Maximum outstanding at any month end $61,440 $63,758 $49,802 Weighted average interest rate at end of period 4.40% 4.50% 5.25% Average interest rate during period 4.51% 3.71% 4.73%
20 SUBSIDIARY ACTIVITY First Federal of Northern Michigan Bancorp, Inc.'s only direct subsidiary is First Federal of Northern Michigan. First Federal of Northern Michigan has two wholly owned subsidiaries. First Federal of Northern Michigan and these subsidiaries have been consolidated in the financial statements and all inter-company balances and transactions have been eliminated in consolidation. One subsidiary, Financial Services & Mortgage Corporation, leases, sells, develops and maintains real estate properties. For reporting purposes, Financial Services & Mortgage Corporation is included in our banking segment. As of December 31, 2005, First Federal of Northern Michigan's investment in Financial Services & Mortgage Corporation was $487,000. The primary asset of the subsidiary is an investment in land and real estate. See "Real Estate Development Activities." At December 31, 2005, Financial Services & Mortgage Corporation owned six developed building sites and one condominium, all of which were being offered for sale. Financial Services & Mortgage Corporation is not currently a party to any agreement that is material to First Federal of Northern Michigan Bancorp, Inc. on a consolidated basis. First Federal of Northern Michigan's second subsidiary, ICA, is a licensed insurance agency engaged in the business of property, casualty and health insurance sales. ICA currently employs one broker that sell non-insured investment products in one branch office of First Federal of Northern Michigan. First Federal of Northern Michigan acquired ICA in June 2003 for $2.87 million. ICA's revenues are derived from the sale of life insurance, property and casualty insurance and health insurance. At December 31, 2005, life insurance revenues represented 6% of sales, property and casualty insurance revenues represented 21% of sales and health insurance sales represented 72% of sales. At December 31, 2005, 31% of the health insurance sales resulted from a contract under which 11 chambers of commerce in 10 surrounding counties offer their constituents the opportunity to purchase group health plans through ICA. This contract was terminated effective January 1, 2006, however ICA will continue to receive commissions on polices sold under this contract prior to December 31, 2005 and can continue to sell health products to non-chamber of commerce customers. As part of the acquisition of ICA, First Federal of Northern Michigan entered into an employment agreement with one of ICA's former owners, which was set to expire in February 2006. However the former employee terminated the contract effective May 1, 2005. In addition, First Federal of Northern Michigan entered into an "earn out" agreement with one of the former ICA owners that pays up to $300,000 per year if certain net sales goals are achieved. One $300,000 payment was made in February 2004, the second in February 2005, and the final payment was made in January 2006. PERSONNEL As of December 31, 2005, the Bank had 86 full-time and 23 part-time employees. None of the Bank's employees is represented by a collective bargaining group. The Bank believes its relationship with its employees to be good. ICA had 19 full-time and 1 part-time employees as of the same date. First Federal of Northern Michigan Bancorp, Inc. and FSMC have no separate employees. SUPERVISION AND REGULATION GENERAL As a federally chartered savings bank, First Federal of Northern Michigan is regulated and supervised by the Office of Thrift Supervision and the Federal Deposit Insurance Corporation. This regulation and supervision establishes a comprehensive framework of activities in which we may engage, and is intended primarily for the protection of the Federal Deposit Insurance Corporation's deposit insurance funds and depositors. Under this system of federal regulation, financial institutions are periodically examined to ensure that they satisfy applicable standards with respect to their 21 capital adequacy, assets, management, earnings, liquidity and sensitivity to market interest rates. After completing an examination, the federal agency critiques the financial institution's operations and assigns its rating (known as an institution's CAMELS). Under federal law, an institution may not disclose its CAMELS rating to the public. First Federal of Northern Michigan also is a member of, and owns stock in, the Federal Home Loan Bank of Indianapolis, which is one of the twelve regional banks in the Federal Home Loan Bank System. First Federal of Northern Michigan also is regulated, to a lesser extent, by the Board of Governors of the Federal Reserve System, governing reserves to be maintained against deposits and other matters. The Office of Thrift Supervision examines First Federal of Northern Michigan and prepares reports for consideration by our board of directors on any operating deficiencies. First Federal of Northern Michigan's relationship with our depositors and borrowers also is regulated to a great extent by both federal and state laws, especially in matters concerning the ownership of deposit accounts and the form and content of our loan documents. There can be no assurance that changes to existing laws, rules and regulations, or any other new laws, rules or regulations, will not be adopted in the future, which could make compliance more difficult or expensive or otherwise adversely affect our business, financial condition or prospects. Any change in these laws or regulations, or in regulatory policy, whether by the Federal Deposit Insurance Corporation, the Office of Thrift Supervision or Congress, could have a material adverse impact on our business, financial condition or operations. FEDERAL BANKING REGULATION BUSINESS ACTIVITIES. A federal savings bank derives its lending and investment powers from the Home Owners' Loan Act, and the regulations of the Office of Thrift Supervision. Under these laws and regulations, First Federal of Northern Michigan may invest in mortgage loans secured by residential and commercial real estate, commercial business and consumer loans, certain types of debt securities and certain other loans and assets. First Federal of Northern Michigan also may establish subsidiaries that may engage in activities not otherwise permissible for First Federal of Northern Michigan directly, including real estate investment, securities brokerage and insurance agency services. CAPITAL REQUIREMENTS. Office of Thrift Supervision regulations require savings banks to meet three minimum capital standards: a 1.5% tangible capital ratio, a 4% leverage ratio (3% for institutions receiving the highest CAMELS rating) and an 8% risk-based capital ratio. The prompt corrective action standards discussed below, in effect, establish a minimum 2% tangible capital standard. The risk-based capital standard for savings banks requires the maintenance of Tier 1 (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100%, assigned by the Office of Thrift Supervision capital regulation based on the risks inherent in the type of asset. Core capital is defined as common stockholders' equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries, less intangibles other than certain mortgage servicing rights and credit card relationships. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, allowance for loan and lease losses up to a maximum of 1.25% of risk-weighted assets, and up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital. At December 31, 2005, First Federal of Northern Michigan's capital exceeded all applicable requirements. The following table sets forth the Bank's capital position at December 31, 2005 and 2004, as compared to the minimum capital requirements. 22
AT DECEMBER 31, ----------------------------------------- 2005 2004 ------------------- ------------------- Percent Percent Amount of Assets Amount of Assets ------- --------- ------- --------- (Dollars in Thousands) Equity capital ................... $36,650 12.97% $21,777 8.29% Tangible Capital Requirement: Tangible capital level ........ 32,181 11.54% 17,140 6.64% Requirement ................... 4,175 1.50% 3,873 1.50% ------- ----- ------- ----- Excess ........................ 28,006 10.04% 13,267 5.14% Core Capital Requirement: Core capital level ............ 32,181 11.54% 17,140 6.64% Requirement ................... 11,134 4.00% 10,327 4.00% ------- ----- ------- ----- Excess ........................ 21,047 7.54% 6,813 2.64% Risk-based Capital Requirement: Risk-based capital level ...... 33,669 18.03% 18,436 10.68% Requirement ................... 14,937 8.00% 13,806 8.00% ------- ----- ------- ----- Excess ........................ 18,732 10.03% 4,630 2.68%
LOANS TO ONE BORROWER. A federal savings bank generally may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of unimpaired capital and surplus on an unsecured basis. An additional amount may be loaned, equal to 10% of unimpaired capital and surplus, if the loan is secured by readily marketable collateral, which generally does not include real estate. As of December 31, 2005, First Federal of Northern Michigan was in compliance with the loans-to-one-borrower limitations. QUALIFIED THRIFT LENDER TEST. As a federal savings bank, First Federal of Northern Michigan is subject to a qualified thrift lender, or "QTL," test. Under the QTL test, First Federal of Northern Michigan must maintain at least 65% of its "portfolio assets" in "qualified thrift investments" in at least nine months of the most recent 12-month period. "Portfolio assets" generally means total assets of a savings institution, less the sum of specified liquid assets up to 20% of total assets, goodwill and other intangible assets, and the value of property used in the conduct of the institution's business. "Qualified thrift investments" include various types of loans made for residential and housing purposes, investments related to such purposes, including certain mortgage-backed and related securities, and loans for personal, family, household and certain other purposes up to a limit of 20% of portfolio assets. "Qualified thrift investments" also include 100% of an institution's credit card loans, education loans and small business loans. First Federal of Northern Michigan also may satisfy the QTL test by qualifying as a "domestic building and loan association" as defined in the Internal Revenue Code of 1986. A savings bank that fails the QTL test must either convert to a bank charter or operate under specified restrictions. At December 31, 2005, First Federal of Northern Michigan maintained approximately 94.4% of its portfolio assets in qualified thrift investments, and therefore satisfied the QTL test. CAPITAL DISTRIBUTIONS. Office of Thrift Supervision regulations govern capital distributions by a federal savings bank, which include cash dividends, stock repurchases and other transactions charged to the institution's capital account. A savings bank must file an application for approval of a capital distribution if: - the total capital distributions for the applicable calendar year exceed the sum of the savings bank's net income for that year to date plus the savings bank's retained net income for the preceding two years; 23 - the savings bank would not be at least adequately capitalized following the distribution; - the distribution would violate any applicable statute, regulation, agreement or Office of Thrift Supervision-imposed condition; or - the savings bank is not eligible for expedited treatment of its filings. Even if an application is not otherwise required, every savings bank that is a subsidiary of a holding company must still file a notice with the Office of Thrift Supervision at least 30 days before the board of directors declares a dividend or approves a capital distribution. The Office of Thrift Supervision may disapprove a notice or application if: - the savings bank would be undercapitalized following the distribution; - the proposed capital distribution raises safety and soundness concerns; or - the capital distribution would violate a prohibition contained in any statute, regulation or agreement. LIQUIDITY. A federal savings bank is required to maintain a sufficient amount of liquid assets to ensure its safe and sound operation. COMMUNITY REINVESTMENT ACT AND FAIR LENDING LAWS. All savings banks have a responsibility under the Community Reinvestment Act and related regulations of the Office of Thrift Supervision to help meet the credit needs of their communities, including low- and moderate-income neighborhoods. In connection with its examination of a federal savings bank, the Office of Thrift Supervision is required to assess the savings bank's record of compliance with the Community Reinvestment Act. In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. A savings bank's failure to comply with the provisions of the Community Reinvestment Act could, at a minimum, result in regulatory restrictions on its activities. The failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions by the Office of Thrift Supervision, as well as other federal regulatory agencies and the Department of Justice. First Federal of Northern Michigan received a "Satisfactory" Community Reinvestment Act rating in its most recent federal examination. TRANSACTIONS WITH RELATED PARTIES. A federal savings bank's authority to engage in transactions with its "affiliates" is limited by Office of Thrift Supervision regulations and Regulation W of the Federal Reserve Board, which implements Sections 23A and 23B of the Federal Reserve Act. The term "affiliates" for these purposes generally means any company that controls or is under common control with an institution. First Federal of Northern Michigan Bancorp, Inc. and its non-savings institution subsidiaries will be affiliates of First Federal of Northern Michigan. In general, transactions with affiliates must be on terms that are as favorable to the savings bank as comparable transactions with non-affiliates. In addition, certain types of these transactions are restricted to an aggregate percentage of the savings bank's capital. Collateral in specified amounts must usually be provided by affiliates in order to receive loans from the savings bank. In addition, Office of Thrift Supervision regulations prohibit a savings bank from lending to any of its affiliates that are engaged in activities that are not permissible for bank holding companies and from purchasing the securities of any affiliate, other than a subsidiary. First Federal of Northern Michigan's authority to extend credit to its directors, executive officers and 10% stockholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O of the Federal Reserve Board. Among other things, these provisions require that extensions of credit to insiders (i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features, and (ii) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of First Federal of Northern Michigan's capital. In addition, 24 extensions of credit in excess of certain limits must be approved by First Federal of Northern Michigan's board of directors. ENFORCEMENT. The Office of Thrift Supervision has primary enforcement responsibility over federal savings banks and has the authority to bring enforcement action against all "institution-affiliated parties," including stockholders, attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors of the savings bank, receivership, conservatorship or the termination of deposit insurance. Civil penalties cover a wide range of violations and actions, and range up to $25,000 per day, unless a finding of reckless disregard is made, in which case penalties may be as high as $1 million per day. The Federal Deposit Insurance Corporation also has the authority to recommend to the Director of the Office of Thrift Supervision that enforcement action be taken with respect to a particular savings bank. If action is not taken by the Director, the Federal Deposit Insurance Corporation has authority to take action under specified circumstances. STANDARDS FOR SAFETY AND SOUNDNESS. Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions. These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation, and other operational and managerial standards as the agency deems appropriate. The federal banking agencies adopted Interagency Guidelines Prescribing Standards for Safety and Soundness to implement the safety and soundness standards required under federal law. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. The guidelines address internal controls and information systems, internal audit systems, credit underwriting, loan documentation, interest rate risk exposure, asset growth, compensation, fees and benefits. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard. If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to submit a compliance plan. PROMPT CORRECTIVE ACTION REGULATIONS. Under the prompt corrective action regulations, the Office of Thrift Supervision is required and authorized to take supervisory actions against undercapitalized savings banks. For this purpose, a savings bank is placed in one of the following five categories based on the savings bank's capital: - well-capitalized (at least 5% leverage capital, 6% tier 1 risk-based capital and 10% total risk-based capital); - adequately capitalized (at least 4% leverage capital, 4% tier 1 risk-based capital and 8% total risk-based capital); - undercapitalized (less than 3% leverage capital, 4% tier 1 risk-based capital or 8% total risk-based capital); - significantly undercapitalized (less than 3% leverage capital, 3% tier 1 risk-based capital or 6% total risk-based capital); or - critically undercapitalized (less than 2% tangible capital). Generally, the Office of Thrift Supervision is required to appoint a receiver or conservator for a savings bank that is "critically undercapitalized." The regulation also provides that a capital restoration plan must be filed with the Office of Thrift Supervision within 45 days of the date a savings bank receives notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." In addition, numerous mandatory supervisory actions become immediately applicable to the savings bank, including, but not limited to, restrictions on growth, investment activities, capital distributions and affiliate transactions. The Office of Thrift Supervision may also take any one of a number of discretionary supervisory actions against undercapitalized savings banks, including the issuance of a capital directive and the replacement of senior executive officers and directors. 25 At December 31, 2005, First Federal of Northern Michigan met the criteria for being considered "well-capitalized." INSURANCE OF DEPOSIT ACCOUNTS. Deposit accounts in First Federal of Northern Michigan are insured by the Savings Association Insurance Fund of the Federal Deposit Insurance Corporation, generally up to a maximum of $100,000 per separately insured depositor. First Federal of Northern Michigan's deposits, therefore, are subject to Federal Deposit Insurance Corporation deposit insurance assessments. The Federal Deposit Insurance Corporation has adopted a risk-based system for determining deposit insurance assessments. The Federal Deposit Insurance Corporation is authorized to raise the assessment rates as necessary to maintain the required ratio of reserves to insured deposits of 1.25%. In addition, all Federal Deposit Insurance Corporation-insured institutions must pay assessments to the Federal Deposit Insurance Corporation at an annual rate of approximately .0212% of insured deposits to fund interest payments on federal agency bonds maturing in 2017 that were issued to recapitalize the predecessor to the Savings Association Insurance Fund. On February 15, 2006, federal legislation to reform federal deposit insurance was enacted. This new legislation requires, among other things, the merger of the Savings Association Insurance Fund and the Bank Insurance Fund into a unified insurance deposit fund and an increase in the amount of federal deposit insurance coverage from $100,000 to $130,000 (with a cost of living adjustment to become effective in five years). The Act also requires the reserve ratio to be modified to provide for a range between 1.15% and 1.50% of estimated insured deposits. The new legislation requires the Federal Deposit Insurance Corporation to issue regulations implementing the law. The changes required by the law will not become effective until final regulations have been issued, which must be no later than 270 days from the date of the enactment of the legislation. PROHIBITIONS AGAINST TYING ARRANGEMENTS. Federal savings banks are prohibited, subject to some exceptions, from extending credit to or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the savings bank or its affiliates or not obtain services of a competitor of the savings bank. FEDERAL HOME LOAN BANK SYSTEM. First Federal of Northern Michigan is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank System provides a central credit facility primarily for member institutions. As a member of the Federal Home Loan Bank of Indianapolis, First Federal of Northern Michigan is required to acquire and hold shares of capital stock in the Federal Home Loan Bank in an amount equal to at least 1% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year, or 1/20 of its borrowings from the Federal Home Loan Bank, whichever is greater. As of December 31, 2005, First Federal of Northern Michigan was in compliance with this requirement. FEDERAL RESERVE SYSTEM Federal Reserve Board regulations require savings banks to maintain non-interest-earning reserves against their transaction accounts, such as negotiable order of withdrawal and regular checking accounts. At December 31, 2005, First Federal of Northern Michigan was in compliance with these reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy liquidity requirements imposed by the Office of Thrift Supervision. THE USA PATRIOT ACT The USA PATRIOT Act gives the federal government new powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing and broadened anti-money laundering requirements. Certain provisions of the Act impose affirmative obligations on a broad range of financial institutions, including federal savings banks, like First Federal of Northern Michigan. These obligations include 26 enhanced anti-money laundering programs, customer identification programs and regulations relating to private banking accounts or correspondence accounts in the United States for non-United States persons or their representatives (including foreign individuals visiting the United States). First Federal of Northern Michigan has established policies and procedures to ensure compliance with the USA PATRIOT Act's provisions, and the impact of the USA PATRIOT Act on our operations has not been material. PRIVACY REQUIREMENTS OF THE GRAMM-LEACH-BLILEY ACT The Gramm-Leach-Bliley Act of 1999 provided for sweeping financial modernization for commercial banks, savings banks, securities firms, insurance companies, and other financial institutions operating in the United States. Among other provisions, the Gramm-Leach-Bliley Act places limitations on the sharing of consumer financial information with unaffiliated third parties. Specifically, the Gramm-Leach-Bliley Act requires all financial institutions offering financial products or services to retail customers to provide such customers with the financial institution's privacy policy and provide such customers the opportunity to "opt out" of the sharing of personal financial information with unaffiliated third parties. HOLDING COMPANY REGULATION First Federal of Northern Michigan Bancorp, Inc. is a unitary savings and loan holding company, subject to regulation and supervision by the Office of Thrift Supervision. The Office of Thrift Supervision has enforcement authority over First Federal of Northern Michigan Bancorp, Inc. and its non-savings institution subsidiaries. Among other things, this authority permits the Office of Thrift Supervision to restrict or prohibit activities that are determined to be a risk to First Federal of Northern Michigan. Under prior law, a unitary savings and loan holding company generally had no regulatory restrictions on the types of business activities in which it could engage, provided that its subsidiary savings association was a qualified thrift lender. The Gramm-Leach-Bliley Act, however, restricts unitary savings and loan holding companies not existing on, or applied for before, May 4, 1999, to those activities permissible for financial holding companies or for multiple savings and loan holding companies. First Federal of Northern Michigan Bancorp, Inc. is not a grandfathered unitary savings and loan holding company and, therefore, is limited to the activities permissible for financial holding companies or for multiple savings and loan holding companies. A financial holding company may engage in activities that are financial in nature, including underwriting equity securities and insurance, incidental to financial activities or complementary to a financial activity. A multiple savings and loan holding company is generally limited to activities permissible for bank holding companies under Section 4(c)(8) of the Bank Holding Company Act, subject to the prior approval of the Office of Thrift Supervision, and certain additional activities authorized by Office of Thrift Supervision regulations. Federal law prohibits a savings and loan holding company, directly or indirectly, or through one or more subsidiaries, from acquiring control of another savings institution or holding company thereof, without prior written approval of the Office of Thrift Supervision. It also prohibits the acquisition or retention of, with specified exceptions, more than 5% of the equity securities of a company engaged in activities that are not closely related to banking or financial in nature or acquiring or retaining control of an institution that is not federally insured. In evaluating applications by holding companies to acquire savings institutions, the Office of Thrift Supervision must consider the financial and managerial resources and future prospects of the savings institution involved, the effect of the acquisition on the risk to the insurance fund, the convenience and needs of the community and competitive factors. 27 SARBANES-OXLEY ACT OF 2002 The Sarbanes-Oxley Act of 2002 was enacted in response to public concerns regarding corporate accountability. The stated goals of the Sarbanes-Oxley Act are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies, and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The Sarbanes-Oxley Act generally applies to all companies that file or are required to file periodic reports with the SEC, under the Securities Exchange Act of 1934. The Sarbanes-Oxley Act includes very specific additional disclosure requirements and new corporate governance rules requiring the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules, and mandates further studies of certain issues by the SEC. The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees. FEDERAL SECURITIES LAWS First Federal of Northern Michigan Bancorp, Inc.'s common stock is registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934. First Federal of Northern Michigan Bancorp, Inc. is subject to the information, proxy solicitation, insider trader restrictions and other requirements under the Securities Exchange of 1934. First Federal of Northern Michigan Bancorp, Inc. common stock held by persons who are affiliates (generally officers, directors and principal stockholders) of First Federal of Northern Michigan Bancorp, Inc. may not be resold without registration or unless sold in accordance with certain resale restrictions. If First Federal of Northern Michigan Bancorp, Inc. meets specified current public information requirements, each affiliate of First Federal of Northern Michigan Bancorp, Inc. is able to sell in the public market, without registration, a limited number of shares in any three-month period. TAXATION FEDERAL TAXATION GENERAL. First Federal of Northern Michigan Bancorp, Inc. and First Federal of Northern Michigan are subject to federal income taxation in the same general manner as other corporations, with some exceptions discussed below. The following discussion of federal taxation is intended only to summarize material federal income tax matters and is not a comprehensive description of the tax rules applicable to First Federal of Northern Michigan Bancorp, Inc. and First Federal of Northern Michigan. METHOD OF ACCOUNTING. For federal income tax purposes, First Federal of Northern Michigan currently reports its income and expenses on the accrual method of accounting and uses a tax year ending December 31 for filing its consolidated federal income tax returns. The Small Business Protection Act of 1996 eliminated the use of the reserve method of accounting for bad debt reserves by savings institutions, effective for taxable years beginning after 1995. BAD DEBT RESERVES. Prior to the Small Business Protection Act of 1996, First Federal of Northern Michigan was permitted to establish a reserve for bad debts for tax purposes and to make annual additions to the reserve. These additions could, within specified formula limits, be deducted in arriving at First Federal of Northern Michigan's taxable income. As a result of the Small Business Protection Act, First Federal of Northern Michigan must use the specific charge off method in computing its bad debt deduction for tax purposes. TAXABLE DISTRIBUTIONS AND RECAPTURE. Prior to the Small Business Protection Act of 1996, bad debt reserves created prior to 1988 were subject to recapture into taxable income if First Federal of Northern Michigan failed to meet 28 certain thrift asset and definitional tests. The Small Business Protection Act of 1996 eliminated these thrift-related recapture rules. However, under current law, pre-1988 reserves remain subject to tax recapture should First Federal of Northern Michigan make certain distributions from its tax bad debt reserve or cease to maintain a bank charter. At December 31, 2005, First Federal of Northern Michigan's total federal pre-1988 reserve was approximately $60,000. This reserve reflects the cumulative effects of federal tax deductions by First Federal of Northern Michigan for which no federal income tax provision has been made. MINIMUM TAX. The Internal Revenue Code of 1986, as amended, imposes an alternative minimum tax at a rate of 20% on a base of regular taxable income plus certain tax preferences ("alternative minimum taxable income" or "AMTI"). The alternative minimum tax is payable to the extent such AMTI is in excess of an exemption amount. Net operating losses can, in general, offset no more than 90% of AMTI. Certain payments of alternative minimum tax may be used as credits against regular tax liabilities in future years. First Federal of Northern Michigan has not been subject to the alternative minimum tax and has no such amounts available as credits for carryover. NET OPERATING LOSS CARRYOVERS. A financial institution may carry back net operating losses to the preceding two taxable years and forward to the succeeding 20 taxable years. At December 31, 2005, First Federal of Northern Michigan had no net operating loss carryforwards for federal income tax purposes. CORPORATE DIVIDENDS. We may exclude from our income 100% of dividends received from First Federal of Northern Michigan as a member of the same affiliated group of corporations. The federal income tax returns of First Federal of Northern Michigan Bancorp, Inc. and its predecessor, Alpena Bancshares, Inc. have not been audited by the Internal Revenue Service in the last five fiscal years. STATE AND LOCAL TAXATION During 1999, the State of Michigan enacted legislation that resulted in elimination of the Michigan single business tax by gradually phasing it out over the next 23 years. Public Act 115 reduces the single business tax rate by 0.1% annually beginning January 1, 1999. First Federal of Northern Michigan files Michigan Single Business Tax (SBT) returns, and in 2005 was subject to tax at a rate equal to 1.9% of taxable income. For this purpose, "taxable income" generally means federal taxable income, subject to certain adjustments to arrive at an adjusted tax base. First Federal of Northern Michigan was audited by the State of Michigan in 2001 for the tax years 1997 through 2000. No material adjustments were found. Other applicable state taxes include generally applicable sales, use and real property taxes. As a Maryland business corporation, First Federal of Northern Michigan Bancorp, Inc. is required to file annual returns with the State of Maryland. 29 ITEM 2. DESCRIPTION OF PROPERTY As of December 31, 2005, First Federal of Northern Michigan owned its main office and all of its branch offices except for the Lewiston branch office. At December 31, 2005, the aggregate net book value of our premises and equipment was $7.4 million, net of $3.2 million of depreciation. The following is a list of our locations: MAIN OFFICE 100 South Second Avenue Alpena, Michigan 49707 BRANCH OFFICES 300 South Ripley Boulevard Alpena, Michigan 49707 6230 River Street Alanson, Michigan 49706 101 South Main Street Cheboygan, Michigan 49721 1000 South Wisconsin Gaylord, Michigan 49735 4236 Salling Street(1) Lewiston, Michigan 49756 625 North Williams Street Mancelona, Michigan 49659 308 North Morenci Mio, Michigan 48647 201 North State Street Oscoda, Michigan 48750 11874 U.S. 23 South Ossineke, Michigan 49766 INSURANCENTER OF ALPENA 123 S. Second Avenue Alpena, Michigan 49707 - ---------- (1) Month-to-month lease. ITEM 3. LEGAL PROCEEDINGS The Company and the Bank are periodically involved in claims and lawsuits that are incident to their business. At December 31, 2005, neither the Company nor the Bank was involved in any claims or lawsuits material to their respective businesses. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted during the fourth quarter of the year ended December 31, 2005 to a vote of security holders. 30 PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The following table sets forth the quarterly high and low sales price per share during each of the four quarters in 2004 and 2005. High and low per share price and cash dividend declared data for the quarters ended December 31, 2005, September 30, 2005, and June 30, 2005 reflect the 1.8477 for 1 stock split which occurred as of the close of business on April 1, 2005 upon consummation of the second-step mutual to stock conversion and related stock offering. As of December 31, 2005 there were 3,115,510 shares of First Federal of Northern Michigan Bancorp, Inc. common stock outstanding. At December 31, 2005, First Federal of Northern Michigan Bancorp, Inc. had approximately 600 stockholders of record.
Market Price Cash --------------- Dividends Quarter Ended High Low Declared ------------- ------ ------ --------- December 31, 2005 $ 9.50 $ 8.70 $0.050 September 30, 2005 $ 9.59 $ 9.10 $0.050 June 30, 2005 $10.15 $ 8.30 $0.050 March 31, 2005 $27.00 $18.50 $0.100 December 31, 2004 $27.00 $16.30 $0.100 September 30, 2004 $17.75 $15.60 $0.100 June 30, 2004 $23.56 $17.50 $0.050 March 31, 2004 $25.00 $20.00 $0.125
Payment of dividends on First Federal of Northern Michigan Bancorp, Inc.'s common stock is subject to determination and declaration by the Board of Directors and depends on a number of factors, including capital requirements, regulatory limitations on the payment of dividends, the results of operations and financial condition, tax considerations and general economic conditions. No assurance can be given that dividends will be declared or, if declared, what the amount of dividends will be, or whether such dividends will continue. The Company did not repurchase any of its shares in 2005. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Information contained in the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations" is incorporated by reference to Exhibit 13, the Company's Annual Report to Stockholders. ITEM 7. FINANCIAL STATEMENTS Information contained in the section captioned "Financial Statements" is incorporated by reference to Exhibit 13, the Company's Annual Report to Shareholders. ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None 31 ITEM 8A. CONTROLS AND PROCEDURES Under the supervision and with the participation of our management, including the Company's Chief Executive Officer and Chief Financial Officer, the Company evaluated the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company's disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports the Company files or submits under the Securities Exchange Act of 1934 (1) is recorded, processed, summarized and reported, within the time periods specified by the SEC's rules and forms, and (2) is accumulated and communicated to the Company's management, including its principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosure. There has been no change in the Company's internal control over the financial reporting during the Company's fourth quarter of fiscal year 2005 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. ITEM 8B. OTHER INFORMATION None. PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACTT Information concerning directors and executive officers is incorporated herein by reference from the Company's Proxy Statement, specifically the section captioned "Proposal I--Election of Directors." ITEM 10. EXECUTIVE COMPENSATION Information concerning executive compensation is incorporated herein by reference from the Company's Proxy Statement, specifically the section captioned "Proposal I--Election of Directors." ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS Information concerning security ownership of certain owners and management is incorporated herein by reference from the Company's Proxy Statement, specifically the Section captioned "Proposal I - Election of Directors." ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information concerning relationships and transactions is incorporated herein by reference from the Company's Proxy Statement, specifically the section captioned "Transactions with Certain Related Persons". 32 ITEM 13. EXHIBITS The exhibits filed as a part of this form 10-KSB are as follows: 3.1 Articles of Incorporation of First Federal of Northern Michigan Bancorp, Inc.* 3.2 Bylaws of First Federal of Northern Michigan Bancorp, Inc.* 4 Form of Common Stock Certificate of First Federal of Northern Michigan Bancorp, Inc.* 10.1 Change in Control Agreements* 10.2 1996 Stock Option Plan* 10.3 1996 Recognition and Retention Plan* 13 Annual Report to Shareholders 14 Code of Ethics ** 21 Subsidiaries of Registrant 23 Consent of Plante & Moran PLLC 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
- ---------- * Incorporated by reference to the Registration Statement on Form SB-2 of First Federal of Northern Michigan Bancorp, Inc. (Registration No. 333-121178), originally filed with the Commission on December 10, 2004. ** Incorporated by reference to the Annual Report on Form 10-KSB of Alpena Bancshares, Inc. filed with the Commission on March 30, 2004 (Registration No. 000-31957). ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Information concerning principal accountant fees and services is incorporated herein by reference to the Company's Proxy Statement, specifically the section captioned "Proposal II - Ratification of Appointment of Auditors." 33 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. By: /s/ Martin A. Thomson ------------------------------------ Martin A. Thomson Chief Executive Officer Date: March 28, 2006 ---------------------------------- Pursuant to the requirements of the Securities Exchange of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. By: /s/ Martin A. Thomson By: /s/ Amy E. Essex --------------------------------- ------------------------------------ Martin A. Thomson, Director and Amy E. Essex, Chief Financial Chief Executive Officer Officer, Treasurer and Corporate (Principal Executive Officer) Secretary (Principal Financial and Accounting Officer) Date: March 28, 2006 Date: March 28, 2006 By: /s/ James Rapin By: /s/ Keith Wallace --------------------------------- ------------------------------------ James Rapin, Chairman Keith Wallace, Director Date: March 28, 2006 Date: March 28, 2006 By: /s/ Gary VanMassenhove By: /s/ Thomas R. Townsend --------------------------------- ------------------------------------ Gary VanMassenhove, Director Thomas R. Townsend, Director Date: March 28, 2006 Date: March 28, 2006 34 Exhibit Index
Exhibit No. Description - ----------- ----------- 3.1 Articles of Incorporation of First Federal of Northern Michigan Bancorp, Inc.* 3.2 Bylaws of First Federal of Northern Michigan Bancorp, Inc.* 4 Form of Common Stock Certificate of First Federal of Northern Michigan Bancorp, Inc.* 10.1 Change in Control Agreements* 10.2 1996 Stock Option Plan* 10.3 1996 Recognition and Retention Plan* 13 Annual Report to Shareholders 14 Code of Ethics ** 21 Subsidiaries of Registrant 23 Consent of Plante & Moran PLLC 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
- ---------- * Incorporated by reference to the Registration Statement on Form SB-2 of First Federal of Northern Michigan Bancorp, Inc. (Registration No. 333-121178), originally filed with the Commission on December 10, 2004. ** Incorporated by reference to the Annual Report on Form 10-KSB of Alpena Bancshares, Inc. filed with the Commission on March 30, 2004 (Registration No. 000-31957). EX-13 2 k02777exv13.txt ANNUAL REPORT TO SHAREHOLDERS Exhibit 13 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. 2005 ANNUAL REPORT MARCH 31, 2006 (FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. LOGO) March 31, 2006 Dear Shareholders: Two solid building blocks were cemented in place in the Company's foundation during the past year. First, a second- step conversion and stock offering were completed effective April 1, 2005, providing the necessary capital to support our continued growth and a bright future. And second, by promoting several members of our management, we have the increased bench strength to take on the challenges of banking for the next decade. Our people are our most important asset. STOCK CONVERSION - A total of 1,699,869 shares of common stock were sold to investors at $10.00 per share, which represented the ownership interest of Alpena Bancshares, MHC in Alpena Bancshares, Inc. (ABI). A new stock holding company was formed, First Federal of Northern Michigan Bancorp, Inc. (the Company), which trades on the NASDAQ exchange under the symbol FFNM, and is the parent of First Federal of Northern Michigan (the Bank), a federal savings bank. As a result of the conversion existing shares of stock in ABI were exchanged for 1.8477 shares of FFNM stock. We established a charitable foundation, First Federal Community Foundation, as a part of the conversion and funded the foundation with a combination of cash and stock to carry on philanthropic efforts in the communities we serve. - Our mission is very clear. It is imperative for the future of the Company and the Bank that we deploy the new capital timely and wisely. Our growing Commercial Services area of the Bank can now continue to recruit new business clients and support the growing needs of existing customers. The Bank's $20 million of internal loan growth in 2005 will utilize some of the new capital, but we will not rest thinking that is all we need to do. We will continue to look for outside opportunities. BENCH STRENGTH - You will be pleased to know that we have taken a major step in strengthening our Executive Management Team at the Company and Bank effective January 25, 2006. The following appointments and promotions were made from within: Michael W. Mahler was named President and Chief Operating Officer; Jerome W. Tracey was named Executive Vice President and Chief Lending Officer; and Amy E. Essex, Chief Financial Officer was given the added responsibilities of Treasurer and Corporate Secretary. In addition, the following appointments were made at the Bank level: Julie A. Curtis was named Vice President, Commercial Services Manager and Josh A. Lucas was named Assistant Vice President, Retail Banking Manager. These appointments, along with other existing managers, give us the talent, enthusiastic energy and dedicated spirit we need to take the Company and the Bank to the next level. - In the Bank's subsidiary insurance agency, the InsuranCenter of Alpena (ICA), Sandra Grant was appointed President and Mark Boyk was appointed Chief Operating Officer. Sandy and Mark each have long tenure in leadership positions with ICA and have made the transition since we purchased ICA in June 2003 a smooth one. Our management has been working closely with ICA management to integrate both entities in a manner that best serves both sets of customers. Setting aside the contribution to the Foundation, the Company's 2005 net income was more than double 2004 results. The sustainable improvement was based upon containing expenses while growing the size of the Bank. I am extremely proud of our Board of Directors and Management for their efforts in planning, then implementing our roadmap to the future. We are well on our way toward meeting the goals established as part of the conversion process, and thereby enhancing shareholder value. Respectfully yours, /s/ Martin A. Thomson - ------------------------------------- Martin A. Thomson Chief Executive Officer 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. 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.
FOR YEARS ENDED DECEMBER 31, ---------------------------------------------------- 2005 2004 2003 2002 2001 -------- -------- -------- -------- -------- (IN THOUSANDS) TOTAL ASSETS ..................... $282,575 $262,800 $223,923 $228,808 $241,472 LOANS RECEIVABLE, NET ............ 201,183 195,388 163,460 150,799 178,037 LOANS HELD FOR SALE .............. -- 1,096 931 542 1,891 INVESTMENT SECURITIES ............ 55,187 42,033 34,670 46,944 23,212 DEPOSITS ......................... 188,735 182,489 151,702 156,092 166,538 FHLB ADVANCES & NOTE PAYABLE ..... 54,405 56,001 47,159 48,414 52,120 STOCKHOLDERS' EQUITY ............. 36,650 21,777 21,951 21,747 20,597
OPERATING DATA:
AT DECEMBER 31, ----------------------------------------------- 2005 2004 2003 2002 2001 ------- ------- ------- ------- ------- (IN THOUSANDS) INTEREST INCOME .......................................... $15,076 $13,278 $13,350 $14,499 $17,586 INTEREST EXPENSE ......................................... 6,706 6,202 6,455 8,342 11,439 ------- ------- ------- ------- ------- NET INTEREST INCOME ................................... 8,370 7,076 6,895 6,157 6,147 PROVISION FOR LOAN LOSSES ................................ 368 323 267 415 255 ------- ------- ------- ------- ------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES ... 8,002 6,753 6,628 5,742 5,892 ------- ------- ------- ------- ------- OTHER INCOME (LOSS): SERVICE CHARGES AND FEES ................................. 1,030 1,012 801 818 740 MORTGAGE BANKING ACTIVITIES .............................. 482 579 1,563 1,401 1,352 NET GAIN ON SALE OF INVESTMENT SECURITIES ................ 13 103 320 65 183 GAIN (LOSS) ON SALE OF REAL ESTATE ....................... (45) (47) 7 (17) (107) LOSS ON ABANDONMENT OF FIXED ASSETS ...................... -- -- -- 2 (88) OTHER NON-INTEREST INCOME ................................ 37 97 255 116 125 INSURANCE & BROKERAGE COMMISSIONS ........................ 2,941 2,967 2,480 -- -- ------- ------- ------- ------- ------- TOTAL OTHER INCOME .................................... 4,458 4,711 5,426 2,385 2,205 ------- ------- ------- ------- ------- OTHER EXPENSES ........................................... 11,815 10,856 10,327 7,072 6,166 ------- ------- ------- ------- ------- INCOME BEFORE INCOME TAX EXPENSE ...................... 645 608 1,727 1,055 1,931 INCOME TAX EXPENSE ....................................... 203 204 518 285 646 ------- ------- ------- ------- ------- NET INCOME ............................................ $ 442 $ 404 $ 1,209 $ 770 $ 1,285 ======= ======= ======= ======= =======
KEY FINANCIAL RATIOS AND OTHER DATA:
FOR YEARS ENDED DECEMBER 31, ----------------------------------------------- 2005 2004 2003 2002 2001 ------- ------- ------- ------- ------- PERFORMANCE RATIOS: RETURN ON AVERAGE ASSETS .............................. 0.16% 0.17% 0.53% 0.33% 0.51% RETURN ON AVERAGE EQUITY .............................. 1.49% 1.91% 5.52% 3.68% 6.52% AVERAGE INTEREST RATE SPREAD .......................... 2.97% 2.88% 3.00% 2.50% 2.30% DIVIDEND PAYOUT RATIO ................................. 142.86% 153.85% 30.36% 47.01% 28.02% DIVIDENDS PER SHARE ................................... $ 0.20 $ 0.20 $ 0.27 $ 0.27 $ 0.27 NET INTEREST MARGIN ................................... 3.30% 3.10% 3.26% 2.78% 2.60% EFFICIENCY RATIO ...................................... 85.07% 96.38% 88.02% 87.54% 76.04% NON-INTEREST EXPENSE TO AVERAGE TOTAL ASSETS .......... 4.32% 4.39% 4.53% 3.01% 2.47% AVERAGE INTEREST-EARNING ASSETS TO AVERAGE INTEREST-BEARING LIABILITIES ....................... 112.34% 108.08% 108.69% 107.42% 104.66% ASSET QUALITY RATIOS: NON-PERFORMING ASSETS TO TOTAL ASSETS ................. 1.57% 0.66% 1.04% 0.68% 0.36% NON-PERFORMING LOANS TO TOTAL LOANS ................... 1.99% 0.87% 1.28% 0.94% 0.38% ALLOWANCE FOR LOAN LOSSES TO NONPERFORMING ASSETS ..... 35.33% 72.37% 48.89% 62.76% 101.92% ALLOWANCE FOR LOAN LOSSES TO TOTAL LOANS .............. 0.70% 0.61% 0.63% 0.61% 0.39% CAPITAL RATIOS: EQUITY TO TOTAL ASSETS AT END OF PERIOD ............... 12.96% 8.29% 9.80% 9.50% 8.53% AVERAGE EQUITY TO AVERAGE ASSETS ...................... 10.87% 8.82% 9.62% 8.90% 7.88% RISK-BASED CAPITAL RATIO (BANK ONLY) .................. 16.82% 10.51% 11.96% 15.95% 13.11% OTHER DATA: NUMBER OF FULL SERVICE OFFICES ........................ 10 10 8 9 9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL First Federal of Northern Michigan 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, 2005, $106.0 million, or 52.3%, of our total loan portfolio consisted of one- to four-family residential real estate loans, $44.3 million, or 21.8%, and $ 26.7 million, or 13.1%, of our total loan portfolio consisted of commercial mortgage loans and commercial loans, respectively, and $25.9 million, or 12.8%, 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 two 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 assists us in managing interest rate risk. Second, 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. Since we sell into the secondary mortgage market 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 decreased 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 and gains (losses) on sales of loans and securities available for sale. Our non-interest expense consists primarily of salaries and employee benefits, occupancy and office expenses, advertising and promotion expense and data processing expenses. As the holding company of a federally chartered savings bank, 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 10 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 11 years' experience in the financial services industry. INCREASING OUR COMMERCIAL REAL ESTATE AND COMMERCIAL LENDING. Beginning in 2001, we began to increase our originations of commercial real estate and commercial loans. At December 31, 2005, loans secured by commercial real estate totaled $44.3 million, or 21.8% of our total loan portfolio, and commercial loans totaled $26.7 million, or 13.1% of our total loan portfolio. We intend to emphasize the origination of these types of loans in the future and retain them in our portfolio. Commercial real estate and commercial loans generally are originated with higher interest rates compared to one- to four-family residential real estate loans and, therefore, have a positive effect on our net interest rate spread and net interest income. In addition, most of these loans are originated with adjustable interest rates, which assists us in managing interest rate risk. We believe that our 10-branch network will enable us to continue to increase our commercial and commercial real estate loan portfolio without significant additional fixed costs. INCREASING OUR SHARE OF LOWER-COST DEPOSITS. In past years our cost of funds has been relatively high as we accepted higher-costing 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 commercial real estate and commercial loans, most of which are originated with adjustable interest rates, we have decreased our need for higher-costing long-term certificates of deposit. We intend to lower our cost of funds by increasing our share of lower-cost short-term certificates of deposit and lower-cost money market deposits. We also intend to continue to market our non-interest-bearing checking accounts in conjunction with our focus on commercial business lending. INCREASING AND DIVERSIFYING OUR SOURCES OF NON-INTEREST INCOME. In June 2003, we acquired the InsuranCenter of Alpena ("ICA"), a licensed insurance agency engaged in the business of property, casualty and health insurance, in an effort to increase and diversify our sources of non-interest income. In 2005 ICA's operations provided us with $2.9 million of income, representing 66.0% of total non-interest income. In 2005, property commissions on insurance sales represented approximately 21% of ICA's revenues, commissions on life insurance sales represented approximately 6% of revenues and commissions on health insurance sales represented approximately 72% of revenues. In November 2005, the Company acquired several large group customers from another insurance agent for approximately $564,000. The entire amount of the purchase was assigned to a customer list intangible asset and is being amortized over five years. The purchase included the issuance of a note payable in the amount of $383,000, discussed in Note 10, with the remainder being paid in cash. 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 consistently experienced low levels of late payments and losses on loans. At December 31, 2005, our ratio of non-performing assets to total assets was 1.57%. At December 31, 2005, our ratio of equity to assets was 12.96%. 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 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 have sold 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, and we intend to continue this practice for so long as interest rates remain at relatively low levels. However, as interest rates rise in future periods as we expect, we anticipate deploying our existing cash and cash equivalents, as well as the net proceeds from our 2005 stock offering, to increase the origination, and retention, of one-to four-family residential mortgage loans in our portfolio. COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2005 AND 2004 Total assets increased $19.8 million, or 7.2%, to $282.6 million at December 31, 2005 from $262.8 million at December 31, 2004. Net loans increased $5.8 million, or 2.33% to $201.2 million at December 31, 2005 from $195.4 million at December 31, 2004. The increase in net loans was mainly the result of the Company's commercial lending activities. The commercial loan portfolio grew 14.1% to $71.0 million at December 31, 2005 from $61.0 million at December 31, 2004. The continued growth of the commercial loan portfolio was the result of the Bank's increased emphasis on growing this portfolio, supported by the hiring of two new commercial lenders, one in early in 2003, and the other in mid 2004, as well as the hiring of a commercial credit analyst in 2003. Mortgage lending originations declined in 2005 to total originations of $54.8 million from $60.4 million in 2004. In 2003 mortgage lending activity reflected the results of high volume loan refinances which resulted from historically low market interest rates. This refinance activity slowed significantly in 2004 and 2005 as historically low rates began to slowly rise. Cash and cash equivalents increased slightly by $100,000, or 1.0%, to $4.8 million at December 31, 2005 from $4.7 million at December 31, 2004. Investment securities increased $13.2 million, or 31.3%, to $55.2 million at December 31, 2005 from $42.0 million at December 31, 2004 as we increased our investment portfolio as an alternative to funding loans due to slow mortgage loan originations. Deposits increased $6.2 million, or 3.4%, to $188.7 million at December 31, 2005 from $182.5 million at December 31, 2004. This growth reflected success in attracting deposits through various time deposit promotions despite increased competitive pressures on rates. However we did not experience the rate of deposit growth we experienced in 2004. Borrowings, consisting primarily of FHLB advances, decreased $1.6 million, or 2.9%, to $54.4 million at December 31, 2005 from $56.0 million at December 31, 2004 as we paid down overnight advances with the proceeds of our stock offering and then re-borrowed during the year to fund loan growth and investment purchases in a year with lower than expected deposit growth Stockholders' equity increased $14.8 million, or 41.0% to $36.7 million at December 31, 2005 from $21.8 million at December 31, 2004. The increase was mainly a result of raising $15.6 million in capital, after expenses, in our second-step mutual-to-stock conversion and related stock offering which closed on April 1, 2005 and net income for the year of $442,000. These increases in equity were offset by lower other comprehensive income resulting from the decline in value of available for sale (AFS) securities and to dividends paid of $540,000. COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004 GENERAL. Net income increased to $442,000 for the twelve months ended December 31, 2005 from $404,000 million for the twelve months ended December 31, 2004. Notably, in April, 2005, in connection with our stock offering, we made a one time charitable contribution of $680,000 in cash and Company stock to our newly created First Federal Community Foundation. Absent this one time contribution, our results from operations showed significant improvement from 2004 to 2005. In 2005 we achieved a $1.2 million increase over 2004 in net interest income after provision for loan loss. This was offset by a decrease in other income of $250,000 year over year, due mainly to decreases of $98,000 and $90,000 respectively in mortgage banking activities and gain on sale of AFS investments, and an increase of $958,000 in other expense, of which $680,000 was the one-time contribution to the charitable foundation. We also experienced a $286,000 increase in salaries and benefits year over year. INTEREST INCOME. Interest income increased by $1.8 million, or 13.5%, to $15.1 million for the twelve months ended December 31, 2005 from $13.3 million for the twelve months ended December 31, 2004. The increase was primarily due to the growth in our commercial loan portfolio of $10 million during the year ended December 31, 2005, which caused an overall increase in the yield on our loan portfolio to 6.51% for the twelve months ended December 31, 2005 from 6.36% for the twelve months ended December 31, 2004. The average balance of our loan portfolio increased by $21.0 million, or 11.6%, to $202.0 million for the twelve months ended December 31, 2005 from $181.0 million for the twelve months ended December 31, 2004. The average balance of non-mortgage loans, principally commercial loans and consumer loans, increased by $17.2 million, or 23.0%, to $91.9 million for the twelve months ended December 31, 2005 from $74.7 million for the twelve months ended December 31, 2004. The average yield on our commercial loans and consumer loans increased 100 basis points and 30 basis points, respectively, for the twelve months ended December 31, 2005 from the twelve months ended December 31, 2004. The average balance of our one- to four-family residential mortgage loans also increased to $110.1 million for the twelve months ended December 31, 2005 from $106.3 million for the twelve months ended December 31, 2004, while the average yield on such loans decreased to 6.13% from 6.48%. INTEREST EXPENSE. Interest expense increased to $6.7 million for the twelve months ended December 31, 2005 from $6.2 million for the twelve months ended December 31, 2004, due primarily to an increase in the average balance of interest bearing liabilities of $14M from December 2004 to December 2005. Higher interest rates paid on our deposits in 2005 also contributed to the increase in interest expense year over year. The average cost of deposits for the twelve months ended December 31, 2005 increased to 2.47% from 2.29% for the twelve months ended December 31, 2004. The average cost of borrowings decreased to 4.55% for the twelve months ended December 31, 2005 from 4.67% for the twelve months ended December 31, 2004. The increase in the average cost of deposits reflected higher market interest rates, while the decrease in the average cost of borrowings also reflected an increase in market rates, but was offset by maturing higher-cost FHLB advances which re-priced at lower rates. NET INTEREST INCOME. Net interest income increased to $8.4 million for the twelve months ended December 31, 2005 from $7.1 million for the twelve months ended December 31, 2004. The increase in net interest income was the result of an increase in net average interest earning assets to $28.0 million from $17.2 million combined with an increase in our average interest rate spread to 2.97% for the twelve months ended December 31, 2005 from 2.88% for the twelve months ended December 31, 2004. PROVISION FOR LOAN LOSSES. We recorded a provision for loan losses of $368,000 for the twelve months ended December 31, 2005 compared to a provision of $323,000 for the twelve months ended December 31, 2004. We had net charge-offs of $249,000 and $144,500 during the twelve months ended December 31, 2005 and 2004, respectively. We used the same methodology and generally similar assumptions in assessing the allowance for both periods. The allowance for loan losses was $1.4 million, or 0.70% of total loans at December 31, 2005, compared to $1.2 million, or 0.61% of total loans at December 31, 2004. The level of the allowance is based on estimates, and ultimate losses may vary from the estimates. Although total non-performing loans increased $2.3 million to $4.0 million from $1.7 million from December 31, 2004 to December 31, 2005, management believes the provision for loan loss is adequate. The two areas of increase in nonperforming loans were non-accrual loans, the increase in which represents mostly well-collateralized mortgage and commercial real-estate loans, and accrual loans delinquent more than 90 days, the increase in which also represents mostly well-collateralized commercial real estate loans. NON-INTEREST INCOME. Non-interest income decreased to $4.5 million for the twelve months ended December 31, 2005 from $4.7 million for the twelve months ended December 31, 2004. The decrease was primarily attributable to our mortgage banking activities, which decreased $98,000 to $ 482,000 from $580,000 as loan refinances continued to slow due to the gradual increase in market interest rates in 2005 after reaching record lows in 2003 and early 2004. The $98,000 decrease reflected a decrease of $103,000 in gain on the sale of mortgages offset by a marginal increase of $11,000 in revenues associated with mortgage servicing rights. Our gain on the sale of investment securities decreased to $13,000 for the twelve months ended December 31, 2005 from $103,000 for the twelve months ended December 31, 2004 as we sold less investments at a gain in 2005 due to market conditions. NON-INTEREST EXPENSE. Non-interest expense increased to $11.8 million for the twelve months ended December 31, 2005 from $10.9 million for the twelve months ended December 31, 2004. The main reason for increased expense year over year was the one-time charitable contribution in 2005 of $680,000 in cash and Company stock to the First Federal Community Foundation which was established in connection with our April 2005 stock offering. Compensation and employee benefits increased to $6.3 million for the twelve months ended December 31, 2005 from $6.0 million for the twelve months ended December 31, 2004. The increase in employee compensation and benefits was mainly the result of $180,000 in compensation costs related to the Employee Stock Ownership Plan (ESOP). The 15 year amortization period for the ESOP loan, which was used to purchase shares for the ESOP in the April 2005 stock offering, would have resulted in the release of 9,245 shares of stock by the ESOP and compensation of approximately $83,000 in 2005. However, the Board of Directors of the Company approved the release of an additional 10,770 shares, resulting in total 2005 ESOP expense of $180,000. INCOME TAXES. Federal income taxes decreased slightly to $203,000 for the twelve months ended December 31, 2005 from $204,000 for the twelve months ended December 31, 2004. The effective tax rate was 31.5% and 33.5% for 2005 and 2004, respectively. The reduction in the effective tax rate was a result of a higher level of tax-exempt interest in 2005 than in 2004. 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.
AVERAGE CONSOLIDATED STATEMENTS OF CONDITION FOR YEARS ENDED DECEMBER 31, -------------------------------------------------------- 2005 2004 AT --------------------------- --------------------------- 12/31/2005 AVERAGE AVERAGE YIELD / AVERAGE YIELD / AVERAGE YIELD / RATE BALANCE INTEREST RATE BALANCE INTEREST RATE ---------- -------- -------- ------- -------- -------- ------- (IN THOUSANDS) (IN THOUSANDS) INTEREST-EARNING ASSETS: MORTGAGE LOANS .............................. $110,071 $ 6,747 $106,338 $ 6,887 NON-MORTGAGE LOANS .......................... 91,903 6,403 74,672 4,626 -------- ------- -------- ------- LOANS ....................................... $201,183 6.64% $201,974 $13,150 6.51% $181,010 $11,513 6.36% MORTGAGE-BACKED SECURITIES (1) .............. 6,250 3.40% 7,386 248 3.36% 6,986 166 2.38% INVESTMENT SECURITIES ....................... 48,937 3.90% 39,873 1,450 3.64% 35,480 918 2.59% -------- -------- ------- -------- ------- INVESTMENT SECURITIES ....................... $ 55,187 3.84% $ 47,259 $ 1,698 3.59% $ 42,458 $ 1,443 3.40% OTHER INVESTMENTS ........................... 5,047 4.05% 5,491 228 4.15% 6,436 322 5.00% -------- ------ -------- ------- ------ -------- ------- TOTAL INTEREST EARNING ASSETS ............... $261,417 6.00% $254,724 $15,076 5.92% $229,904 $13,278 5.78% ------ ------ NON INTEREST EARNING ASSETS ................. 21,358 18,482 17,345 -------- -------- -------- TOTAL ASSETS ................................ $282,775 $273,206 $247,249 ======== ======== ======== INTEREST-BEARING LIABILITIES: SAVINGS DEPOSITS ............................ $ 27,103 0.30% $ 27,982 177 0.63% $ 27,615 66 0.24% MONEY MARKET/NOW ACCOUNTS ................... 28,164 1.53% 33,421 288 0.86% 30,777 256 0.83% CERTIFICATES OF DEPOSIT ..................... 122,590 3.63% 113,989 3,873 3.40% 99,857 3,294 3.30% -------- ------ -------- ------- ------ -------- ------- ------ TOTAL DEPOSITS ........................... $177,857 2.79% $175,392 $ 4,338 2.47% $158,249 $ 3,616 2.29% BORROWED FUNDS .............................. 54,403 4.69% 51,346 2,368 4.67% 54,473 2,586 4.67% -------- ------ -------- ------- ------ -------- ------- ------ TOTAL INTEREST BEARING LIABILITIES .......... $232,260 3.24% $226,742 $ 6,706 2.94% $212,722 $ 6,202 2.90% NON-INTEREST BEARING LIABILITIES ............ 13,866 16,780 12,713 -------- -------- -------- TOTAL LIABILITIES ........................ $246,126 $243,522 $225,435 STOCKHOLDERS' EQUITY ........................ 36,649 29,684 21,814 -------- -------- -------- TOTAL LIABILITIES & STOCKHOLDERS' EQUITY .... $282,775 $273,206 $247,249 ======== ======== ======== NET INTEREST INCOME ......................... $ 8,370 $ 7,076 ======= ======= INTEREST RATE SPREAD ........................ 2.76% 2.98% 2.88% ====== ====== ====== NET INTEREST - EARNING ASSETS ............... $ 27,982 $ 17,182 ======== ======== NET INTEREST MARGIN (1) ..................... 3.12% 3.30% 3.10% ====== ====== ====== AVERAGE INTEREST-EARNING ASSETS TO AVERAGE INTEREST-BEARING LIABILITIES .. 112.55% 112.34% 108.08% ====== ====== ======
- ---------- (1) NET INTEREST MARGIN REPRESENTS NET INTEREST INCOME DIVIDED BY THE INTEREST-EARNING ASSETS. 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, 2005 COMPARED TO YEAR ENDED DECEMBER 31, 2004 INCREASE (DECREASE) DUE TO: ---------------------------- VOLUME RATE TOTAL ------ ---- ------ (IN THOUSANDS) INTEREST-EARNING ASSETS: LOANS RECEIVABLE .................... $1,595 $ 41 $1,636 INVESTMENT SECURITIES ............... 170 84 $ 255 OTHER INVESTMENTS ................... (97) 3 $ (94) ------ ---- ------ TOTAL INTEREST-EARNING ASSETS ....... 1,668 129 1,798 ------ ---- ------ INTEREST-BEARING LIABILITIES: SAVINGS DEPOSITS ....................... 1 111 112 MONEY MARKET/NOW ACCOUNTS .............. 23 9 32 CERTIFICATES OF DEPOSIT ............... 481 97 578 ------ ---- ------ DEPOSITS ............................ 505 217 722 BORROWED FUNDS ...................... (153) (65) (218) ------ ---- ------ TOTAL INTEREST-BEARING LIABILITIES .. 352 152 504 ------ ---- ------ CHANGE IN NET INTEREST INCOME .......... $1,317 $(23) $1,294 ====== ==== ======
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, 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, 2005, $172.2 million, or 84.9% of our loan portfolio, consisted of loans that mature or reprice during the year ending December 31, 2007 and beyond. In contrast, as of December 31, 2005, $83.0 million, or 44.0% of our deposits as of that date, consisted of deposits that mature or reprice in less than one year. In an effort to better 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 also have generally sold into the secondary mortgage market all of the fixed-rate, longer-term (15 years or more) residential mortgage loans that we originate, generally on a servicing-retained basis. 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. We expect that as long-term interest rates rise, as we expect, 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. We evaluate interest rate sensitivity using a model that estimates the change in our net portfolio value ("NPV") over a range of interest rate scenarios. NPV is the discounted present value of expected cash flows from assets, liabilities and off-balance sheet contracts. In calculating changes in NPV, we assume estimated loan prepayment rates, reinvestment rates and deposit decay rates that seem most likely based on historical experience during prior interest rate changes. The table below sets forth, as of December 31, 2005, the estimated changes in our NPV that would result from the designated instantaneous changes in the U.S. Treasury yield curve. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results.
NPV AS A PERCENTAGE OF PRESENT ESTIMATED INCREASE VALUE OF ASSETS (3) (DECREASE) IN NPV ----------------------------------- CHANGE IN INTEREST ------------------ INCREASE (DECREASE) RATES (BASIS POINTS) (1) ESTIMATED NPV (2) AMOUNT PERCENT NPV RATIO (4) (BASIS POINTS) - ------------------------ ----------------- -------- ------- ------------- ------------------- (DOLLARS IN THOUSANDS) +300 $29,908 ($8,962) -23% 10.91% (261) +200 33,433 (5,437) -14% 11.99% (153) +100 36,507 (2,363) 60% 12.88% (64) -- 38,870 -- 13.52% -- -100 39,462 592 2% 13.60% 8 -200 38,891 21 0% 13.32% (20)
(1) Assumes an instantaneous uniform change in interest rates at all maturities. (2) NPV is the discounted present value of expected cash flows from assets, liabilities and off-balance sheet contracts. (3) Present value of assets represents the discounted present value of incoming cash flows on interest-earning assets. (4) NPV Ratio represents NPV divided by the present value of assets. The table set forth above indicates that at December 31, 2005, in the event of an immediate 100 basis point decrease in interest rates, we would be expected to experience a 2% increase in NPV and an 8 basis point increase in NPV ratio. In the event of an immediate 200 basis point increase in interest rates, we would be expected to experience a 14% decrease in NPV and a 153 basis point decrease in NPV ratio. Certain shortcomings are inherent in the methodology used in the above interest rate risk measurements. Modeling changes in NPV and 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 NPV and 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 NPV and 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. 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, U.S. Government agency or government-sponsored enterprise securities and certificates of deposit. We are required to maintain sufficient levels of liquidity as defined by the Office of Thrift Supervision 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, 2005 was $77.8 million, or 39.27% of total deposits and Federal Home Loan Bank borrowings due in one year or less, compared to $76.4 million, or 40.02% of this amount at December 31, 2004. 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, 2005, we had unused borrowing capacity of $25.6 million. We can pledge additional collateral in the form of investment securities to increase our borrowing capacity. 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 in the secondary mortgage market. We also originate for retention in our loan portfolio, commercial and commercial real estate loans, including real estate development loans. During the twelve months ended December 31, 2005, we originated $54.2 million one- to four-family residential mortgage loans, of which $33.1 million were retained in our portfolio and the remainder were sold into the secondary mortgage market or are being held for sale. This compares to $58.6 million one- to four-family originations during the twelve months ended December 31, 2004, of which $35.6 million were retained in our portfolio. At December 31, 2005, we had outstanding loan commitments of $36.6 million. These commitments included $7.5 million for permanent one- to four-family residential mortgage loans, $3.7 million for non-residential loans, $2.4 million of undisbursed loan proceeds for construction of one- to four-family residences, $8.1 million of undisbursed lines of credit on home equity loans, $1.5 million of unused credit card lines, $11.3 million of unused commercial lines of credit, and $2.1 million of undisbursed commercial construction loans. Deposits are a primary source of funds for use in lending and for other general business purposes. At December 31, 2005, deposits funded 66.8% of our total assets compared to 69.4% at December 31, 2004. Certificates of deposit scheduled to mature in less than one year at December 31, 2005 totaled $83.0 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. Moreover, we currently believe that the growth in assets is not expected to require significant in-flows of liquidity. As such, we do not expect to be a market leader in rates paid for liabilities. Borrowings may be used to compensate for seasonal or other reductions in normal sources of funds or for deposit outflows at more than projected levels. Borrowings also may be used on a longer-term basis to support increased lending or investment activities. At December 31, 2005, we had $52.9 million in Federal Home Loan Bank advances. Total borrowings as a percentage of total assets were 19.3% at December 31, 2005 compared to 21.3% at December 31, 2004. As of December 31, 2005, 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, 2005, 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. First Federal of Northern Michigan is subject to federal regulations that impose minimum capital requirements. At December 31, 2005, we exceeded all applicable capital requirements. CRITICAL ACCOUNTING POLICIES Our accounting and reporting policies are prepared in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. We consider accounting policies that require significant judgment and assumptions by management that have, or could have, a material impact on the carrying value of certain assets or on income to be critical accounting policies. Changes in underlying factors, assumptions or estimates could have a material impact on our future financial condition and results of operations. Based on the size of the item or significance of the estimate, the following accounting policies are considered critical to our financial results. ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is calculated with the objective of maintaining an allowance sufficient to absorb estimated probable loan losses. Management's determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective, as it requires an estimate of the loss content for each risk rating and for each impaired loan, an estimate of the amounts and timing of expected future cash flows, and an estimate of the value of collateral. We have established a systematic method of periodically reviewing the credit quality of the loan portfolio in order to establish an allowance for losses on loans. The allowance for losses on loans is based on our current judgments about the credit quality of individual loans and segments of the loan portfolio. The allowance for losses on loans is established through a provision for loan losses based on our evaluation of the losses inherent in the loan portfolio, and considers all known internal and external factors that affect loan collectibility as of the reporting date. Our evaluation, which includes a review of all loans on which full collectibility may not be reasonably assured, considers among other matters, the estimated net realizable value or the fair value of the underlying collateral, economic conditions, historical loan loss experience, our knowledge of inherent losses in the portfolio that are probable and reasonably estimable and other factors that warrant recognition in providing an appropriate loan loss allowance. Management believes this is a critical accounting policy because this evaluation involves a high degree of complexity and requires us to make subjective judgments that often require assumptions or estimates about various matters. Historically, we believe our estimates and assumptions have proven to be relatively accurate. For example, over the past five years, our provision for loan losses as a percentage of average loans outstanding has ranged from 0.06% to 0.25%, while our net charge-offs as a percentage of average loans outstanding has ranged from 0.04% to 0.12%. Nevertheless, because a small number of non-performing loans could result in net charge-offs significantly in excess of the estimated losses inherent in our loan portfolio, you should not place undue reliance on the accuracy of past estimates. The analysis of the allowance for loan losses has two components: specific and general allocations. Specific allocations are made for loans that are determined to be impaired. Impairment is measured by determining the present value of expected future cash flows or, for collateral-dependent loans, the fair value of the collateral adjusted for market conditions and selling expenses. The general allocation is determined by segregating the remaining loans by type of loan, risk weighting (if applicable) and payment history. We also analyze delinquency trends, which have remained stable, general economic conditions and geographic and industry concentrations. This analysis establishes factors that are applied to the loan groups to determine the amount of the general reserve. The principal assumption used in deriving the allowance for loan losses is the estimate of loss content for each risk rating. To illustrate, if recent loss experience dictated that the projected loss ratios would be changed by 10% (of the estimate) across all risk ratings, the allocated allowance as of December 31, 2004 would have changed by approximately $100,000. 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, 2005, we were servicing loans sold to others totaling $139.1 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, 2005 included the following: Annual constant prepayment speed (CPR): 8.23% Weighted average life remaining (in months): 249 Discount rate used: 8.50%
At the December 31, 2005 valuation, we calculated the value of our mortgage servicing rights to be $1.7 million and the weighted average life remaining of those rights was 55 months. The book value of our mortgage servicing rights as of December 31, 2005 was $751,000 which was $917,000 less than the independent valuation. Because the fair value exceeded the book value, there was no need to establish a valuation allowance. IMPAIRMENT OF INTANGIBLE ASSETS. Goodwill arising from business acquisitions represents the value attributable to unidentifiable intangible elements in the business acquired. The fair value of goodwill is dependent upon many factors, including our ability to provide quality, cost-effective services in the face of competition. Because of these many factors, management believes this is a critical accounting policy. A decline in earnings as a result of business or market conditions or a run-off of insurance customers over sustained periods could lead to an impairment of goodwill that could adversely affect earnings in future periods. A significant portion of our intangible assets, including goodwill, relates to the acquisition premiums recorded with the purchase of the InsuranCenter of Alpena ("ICA") and certain branches over the last several years. Intangible assets are reviewed periodically for impairment by comparing the fair value of the intangible asset to the book value of the intangible asset. If the book value is in excess of the fair value, impairment is indicated and the intangibles must be written down to their fair value. In connection with our acquisition in 2003 of ICA, we allocated the excess of the purchase price paid over the fair value of net assets acquired to intangible assets, including goodwill. These intangible assets included the ICA customer list and a third-party contract to which ICA is a party. From the date of acquisition through April 30, 2005 we amortized the value assigned to the customer and contract over a period of 20 years. On May 1, 2005 the former owner of ICA retired. As a result, the amortization period for these intangible assets was reduced to a 10-year period beginning May 1, 2005. The amortization period for the third-party contract was further reduced to 5 years effective January 1, 2006. See "Subsequent Events" below. Goodwill is not amortized. The impairment test of goodwill and identified intangible assets that have an indefinite useful life, performed as of December 31, 2005 and December 31, 2004 in accordance with SFAS No. 142, did not indicate that an impairment charge was required. If, through testing, we determine that there is impairment based, for example, on significant runoff of the customer list or material changes to the third party contract, then we may need to reduce the recorded value of those intangible assets, which would increase expense and reduce our earnings. In connection with branch offices that were acquired over the last decade, we assigned the excess of the purchase price over the fair value of the assets acquired to core deposit intangible. The core deposit intangible is tested periodically for impairment. Our original estimates related to the expected life of the deposits have proven to be relatively accurate as evidenced by the fact that no impairment has been recorded. If we determine through testing that a significant portion of the acquired customers no longer do business with us, then the asset would be deemed to be impaired thereby requiring a charge to earnings to the extent appropriate given all of the known factors. We amortize core deposit intangibles over a period of between 10 and 15 years. 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 letter 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, 2005 and December 31, 2004, First Federal of Northern Michigan had $15.8 million and $25.7 million, respectively, of commitments to grant loans, $20.8 million and $16.6 million, respectively, of unfunded commitments under lines of credit and $25,000 and $35,000, respectively, of letters of credit. See Note 12 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. 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. SUBSEQUENT EVENTS Effective January 1, 2006 the exclusive third-party contract between ICA and Blue Cross Blue Shield of Michigan has been terminated. Prior to January 1, 2006 the ICA exclusive agent contract with Blue Cross Blue Shield entitled ICA to an override commission of 2.5% on all health premiums written through local Chambers of Commerce in Northeast Michigan. On any health insurance contracts in place as of December 31, 2005, ICA will continue to receive the 2.5% commission, however there will be no new groups added to this program effective January 1, 2006. Management considered the potential affect this could have on ICA health insurance commissions in future years and made the decision to reduce the amortization period of the third-party contract intangible asset to 5 years effective January 1, 2006. DIRECTORS AND EXECUTIVE OFFICERS OF FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. AND FIRST FEDERAL OF NORTHERN MICHIGAN DIRECTORS - James C. Rapin was elected as the Chairman of the Board of Directors of the Company and the Bank in March 2002. He has been a director of the Bank since 1985, and a director of the Company since its formation in November 2000, and had been Vice Chairman of the Board since April 2001. Mr. Rapin is a pharmacist with LeFave Pharmacy, Alpena, Michigan. Martin A. Thomson was named Acting President and Chief Executive Officer of the Company and Bank in May 2001 and later named President and Chief Executive Officer in October 2001. In January 2006, Mr. Thomson relinquished the position of President, but remains with the Company and the Bank as Chief Executive Officer and Director. 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. Keith D. Wallace is the senior partner of the law firm of Isackson and Wallace, P.C., located in Alpena, Michigan. Mr. Wallace has acted as general counsel to the Bank since 1988. Mr. Wallace has been a director of the Bank since 1988, and a director of the Company since its formation in November 2000. Gary C. VanMassenhove is a partner in VanMassenhove, Kearly, Taphouse & Faulman, CPAs. Mr. VanMassenhove has been a Certified Public Accountant for 31 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 26 years. Mr. Townsend has been a director of the Company and the Bank since April 2002. EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS- Michael W. Mahler was named President and Chief Operating Officer of the Company and the Bank in January 2006. Prior to that appointment, 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. Amy E. Essex was named Chief Financial Officer, Treasurer and Corporate Secretary of the Company and the Bank in January 2006. Ms. Essex had served as Chief Financial Officer of the Company and the Bank since November 2004 and prior to that appointment, since March 2003, served as the Internal Auditor and Compliance Officer for Alpena Bancshares, Inc. Prior to March 2003, Ms. Essex spent eight years as the Director of Tax and Risk for Besser Company, Alpena, Michigan, an international producer of concrete products equipment. Ms. Essex is a certified public accountant. Jerome W. Tracey was named Executive Vice President and Chief Lending Officer of the Company and 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. Joseph W. Gentry II was named Vice President, Human Resources of the Bank in February 2002, after serving as Director of Human Resources since joining the Bank in October 2001. Prior to joining the Bank, Mr. Gentry served as Manager - Industrial Relations / Safety for Lafarge - Presque Isle Corporation, producer of chemical grade and aggregate limestone for the construction and building materials market, since 1991, and was employed by Besser Company, an international producer of concrete products equipment, from 1973 to 1991 as Personnel Manager / Safety Director. All previous employers are in the Alpena, Michigan area. Mr. Gentry has taught economics at Alpena Community College as an adjunct professor for the past 16 years. SENIOR MANAGEMENT TEAM OF THE BANK - Martin A. Thomson, Michael W. Mahler, Jerome W. Tracey, Amy E. Essex, Joseph W. Gentry II, Kathleen R. Brown MANAGEMENT TEAM - INSURANCENTER OF ALPENA - Michael W. Mahler, Sandra Grant, Mark Boyk, Donna M. Tucker, Mary Kollen, Debbie Wardman STOCKHOLDER INFORMATION The Annual Meeting of Stockholders will be held at 1:00 p.m., May 17, 2006 at the Thunder Bay Recreational Center, 701 Woodward Avenue, Alpena, Michigan. Stock Listing The Company's common stock is traded on Nasdaq National Market under the symbol "FFNM". Price Range of Common Stock The following sets forth the quarterly high and low sales price per share during each of the four quarters in 2004 and 2005. High & low per share price and cash dividend declared data for the quarters ended December 31, 2005, September 30, 2005 and June 30, 2005 reflect the 1.8477 for 1 stock split which occurred as of the close of business on April 1, 2005 upon consummation of the second-step mutual to stock conversion and related stock offering.
Market Price --------------- Quarter Ended High Low Cash Dividends Declared ------------- ------ ------ ----------------------- December 31, 2005 $ 9.50 $ 8.70 $0.050 September 30, 2005 $ 9.59 $ 9.10 $0.050 June 30, 2005 $10.15 $ 8.30 $0.050 March 31, 2005 $27.00 $18.50 $0.100 December 31, 2004 $27.00 $16.30 $0.100 September 30, 2004 $17.75 $15.60 $0.100 June 30, 2004 $23.56 $17.50 $0.050 March 31, 2004 $25.00 $20.00 $0.125
SPECIAL COUNSEL Luse Gorman Pomerenk & Schick, PC 5335 Wisconsin Avenue, N.W. Suite 400 Washington, D.C. 20015 INDEPENDENT AUDITOR Plante & Moran, PLLC 2601 Cambridge Ct. Suite 500 Auburn Hills, Michigan 48326 TRANSFER AGENT Registrar and Transfer Company 10 Commerce Drive Cranford, New Jersey 07016 800-346-6084 ANNUAL REPORT ON FORM 10-KSB A copy of the Company's Form 10-KSB for the year ended December 31, 2005 will be furnished without charge upon written request to: Amy E. Essex, Chief Financial Officer, Treasurer and Corporate Secretary, First Federal of Northern Michigan Bancorp, Inc. 100 S. Second Avenue, Alpena, Michigan 49707. FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
CONTENTS -------- REPORT LETTER 2 CONSOLIDATED FINANCIAL STATEMENTS Statement of Financial Condition 3 Statement of Income 4 Statement of Changes in Stockholders' Equity 5 Statement of Cash Flows 6 Notes to Consolidated Financial Statements 7
1 Report of Independent Registered Public Accounting Firm Board of Directors First Federal of Northern Michigan Bancorp, Inc. We have audited the consolidated statement of financial condition of First Federal of Northern Michigan Bancorp, Inc. as of December 31, 2005 and 2004 and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each year in the two-year period ended December 31, 2005. 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. An audit 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, 2005 and 2004 and the consolidated results of their operations and their cash flows for each year in the two-year period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America. Auburn Hills, Michigan March 3, 2006 2 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. CONSOLIDATED STATEMENT OF FINANCIAL CONDITION (000S OMITTED, EXCEPT PER SHARE DATA)
December 31 ------------------- 2005 2004 -------- -------- ASSETS Cash and cash equivalents $ 4,498 $ 4,686 Overnight deposits with Federal Home Loan Bank 282 53 -------- -------- Total cash and cash equivalents 4,780 4,739 Securities available for sale (Note 2) 53,412 40,233 Securities held to maturity (Note 2) 1,775 1,800 Loans - Net (Note 3) 201,183 195,388 Loans held for sale -- 1,096 Foreclosed assets 435 29 Real estate held for sale (Note 4) 352 563 Federal Home Loan Bank stock 4,765 4,666 Property and equipment (Note 5) 7,392 6,794 Accrued interest receivable 1,602 1,035 Intangible assets (Note 7) 3,089 2,856 Goodwill 1,349 1,049 Other assets (Note 6) 2,641 2,552 -------- -------- Total assets $282,775 $262,800 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Non-interest bearing deposits $ 10,878 $ 10,929 Interest bearing deposits (Note 8) 177,857 171,560 Advances from borrowers for taxes and insurance 28 45 Advances from Federal Home Loan Bank (Note 9) 52,925 54,750 Note payable (Note 10) 1,478 1,251 Accrued expenses and other liabilities (Note 14) 2,960 2,488 -------- -------- Total liabilities 246,126 241,023 STOCKHOLDERS' EQUITY (Note 13) Common stock - $0.01 par value 20,000,000 shares authorized and : $1.00 par value 20,000,000 authorized, respectively Issued and outstanding - 3,115,100 at December 31, 2005 and 1,659,480 shares at December 31, 2004 31 1,659 Additional paid-in capital 23,560 5,357 Retained earnings - Restricted -- 5,152 Retained earnings 14,703 9,636 Unallocated ESOP shares (Note 14) (1,187) -- Accumulated other comprehensive income (loss) (458) (27) -------- ------- Total stockholders' equity 36,649 21,777 -------- -------- Total liabilities and stockholders' equity $282,775 $262,800 ======== ========
See Notes to Consolidated Financial Statements. 3 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. CONSOLIDATED STATEMENT OF INCOME (000S OMITTED, EXCEPT PER SHARE DATA)
Year Ended December 31 ---------------------- 2005 2004 ------- ------- INTEREST INCOME Loans, including fees $13,150 $11,513 Investments 1,678 1,530 Mortgage-backed securities 248 235 ------- ------- Total interest income 15,076 13,278 INTEREST EXPENSE Deposits (Note 8) 4,339 3,616 Other borrowings 2,367 2,586 ------- ------- Total interest expense 6,706 6,202 ------- ------- NET INTEREST INCOME - Before provision for loan losses 8,370 7,076 PROVISION FOR LOAN LOSSES (NOTE 3) 368 323 ------- ------- NET INTEREST INCOME - After provision for loan losses 8,002 6,753 OTHER INCOME (EXPENSES) Service charges and other fees 1,030 1,012 Net gain on sale of loans 248 350 Loan servicing fees 234 229 Insurance and brokerage commissions 2,941 2,967 Other 5 153 ------- ------- Total other income 4,458 4,711 OPERATING EXPENSES Compensation and employee benefits (Note 14) 6,315 6,029 Amortization of intangible assets 331 293 Advertising 197 240 Occupancy and equipment 1,307 1,264 Data processing service bureau 350 339 Professional fees 233 202 Insurance and brokerage commission 1,169 1,264 Donation to First Federal Community Foundation 680 -- Other 1,233 1,225 ------- ------- Total operating expenses 11,815 10,856 ------- ------- INCOME - Before federal income tax 645 608 FEDERAL INCOME TAX (Note 11) 203 204 ------- ------- NET INCOME $ 442 $ 404 ======= ======= PER SHARE DATA Basic earnings per share $ 0.14 $ 0.13 Fully diluted earnings per share 0.14 0.13 Dividends per common share 0.20 0.20
See Notes to Consolidated Financial Statements. 4 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (000S OMITTED)
Accumulated Additional Other Total Common Paid-in Retained Unallocated Comprehensive Stockholders' Shares Stock Capital Earnings ESOP Shares Income (Loss) Equity ------ ------ ---------- -------- ----------- ------------- ------------- BALANCE - January 1, 2004 1657 $1,657 $ 5,338 $14,661 $ -- $ 295 $21,951 Comprehensive income: Net income -- -- -- 404 -- -- 404 Other comprehensive income: Unrealized appreciation on available-for- sale securities - Net of tax of $131 -- -- -- -- -- (254) (254) Less reclassification adjustment for realized gains included in net income - Net of tax of $35 -- -- -- -- -- (68) (68) ------- Total comprehensive income 82 Stock options exercised 2 2 19 -- -- -- 21 Dividends declared -- -- -- (277) -- -- (277) ----- ------ ------- ------- ------- ----- ------- BALANCE - December 31, 2004 1,659 1,659 5,357 14,788 -- (27) 21,777 Comprehensive income: Net income -- -- -- 442 -- -- 442 Other comprehensive income: Unrealized appreciation on available-for- sale securities - Net of tax of $217 -- -- -- -- -- (422) (422) Less reclassification adjustment for realized gains included in net income - Net of tax of $4 -- -- -- -- -- (9) (9) ------- Total comprehensive income 11 Merger of Alpena Bancshares, MHC (920) (920) 1,128 -- -- -- 208 Exchange of Common Stock in reorganization 627 (726) 724 -- -- -- (2) Proceeds of stock offering net of expenses 1,700 17 15,943 -- -- -- 15,960 Stock donated to First Federal Community Foundation 34 1 339 -- -- -- 340 Stock options exercised 22 -- 120 -- -- -- 120 Tax benefit on stock options exercised -- -- 29 -- -- -- 29 Retired stock (7) -- (60) -- -- -- (60) Unallocated ESOP -- -- -- -- (1,387) -- (1,387) ESOP common stock committed to be released -- -- (20) 13 200 -- 193 Dividends declared -- -- -- (540) -- -- (540) ----- ------ ------- ------- ------- ----- ------- BALANCE - December 31, 2005 3,115 $ 31 $23,560 $14,703 $(1,187) $(458) $36,649 ===== ====== ======= ======= ======= ===== =======
See Notes to Consolidated Financial Statements. 5 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (000S OMITTED, EXCEPT PER SHARE DATA) See Notes to Consolidated Financial Statements.
Year Ended December 31 ---------------------- 2005 2004 -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 442 $ 404 Adjustments to reconcile net income to cash from operating activities: Depreciation and amortization 852 766 Provision for loan losses 368 323 Amortization and accretion on securities 156 360 Gain on sale of investment securities (13) (103) ESOP contribution 180 -- Stock donation to charitable foundation 340 -- Gain on sale of loans held for sale (248) (362) Originations of loans held for sale (18,789) (23,813) Proceeds from sale of loans held for sale 20,133 24,010 Purchase of real estate held for sale (902) (124) Proceeds from sale of real estate 703 -- (Gain) loss on sale of real estate 3 -- (Gain) loss on fixed assets -- 47 Change in accrued interest receivable (567) 31 Change in other assets (74) (478) Change in accrued expenses and other liabilities 893 (44) Change in deferred income taxes (200) -- -------- -------- Net cash provided by operating activities 3,277 1,017 CASH FLOWS FROM INVESTING ACTIVITIES Net increase in loans (6,163) (32,251) Proceeds from maturity of available-for-sale securities -- 10,694 Proceeds from sale of securities available-for-sale 7,562 19,213 Purchase of securities available for sale (21,511) (36,216) Purchase of securities held to maturity -- (1,800) Purchase of Federal Home Loan Bank stock (99) (206) Purchase of insurance related businesses (526) (300) Purchase of premises and equipment (1,119) (1,335) -------- -------- Net cash used for investing activities (21,856) (42,201) CASH FLOWS FROM FINANCING ACTIVITIES Net increase (decrease) in deposits 6,245 30,787 Dividends paid on common stock (540) (277) Net increase (decrease) in advances from borrowers (17) (51) Additions to advances from FHLB and Notes Payable 10,925 11,455 Repayments of advances from FHLB and Notes Payable (12,861) (2,718) Net proceeds from stock offering 15,960 -- Cash paid for fractional shares in stock offering (2) -- Purchase of shares for ESOP (1,387) -- Merger of Alpena Bancshares, M.H.C 208 -- Proceeds from exercise of stock options 120 21 Shares retired (60) -- Tax benefit on stock options exercised 29 -- -------- -------- Net cash provided by (used for) financing activities 18,620 39,217 -------- -------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 41 (1,967) CASH AND CASH EQUIVALENTS - Beginning of year 4,739 6,706 -------- -------- CASH AND CASH EQUIVALENTS - End of year $ 4,780 $ 4,739 ======== ======== SUPPLEMENTAL CASH FLOW AND NONCASH INFORMATION Cash paid for income taxes $ 327 $ 435 Cash paid for interest on deposits and borrowings 6,501 6,049 Stock donated to charitable foundation 340 -- Note issued in connection with purchase of insurance related business 338 --
See Notes to Consolidated Financial Statements. 6 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) 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 Bank is primarily engaged in the business of attracting deposits from the general public in its market area and investing those deposits in one- to four-family residential real estate mortgages and, to a lesser extent, commercial real estate loans and consumer loans. 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 subsidiaries, Financial Services & Mortgage Corporation ("FSMC") and InsuranCenter of Alpena. ("ICA"). FSMC invests in real estate, which includes leasing, selling, developing, and maintaining real estate properties. ICA is a licensed insurance agency engaged in the business of property, casualty, and health insurance. All significant intercompany balances and transactions have been eliminated in the consolidation. REORGANIZATION - Alpena Bancshares, Inc., the predecessor company to First Federal of Northern Michigan Bancorp, Inc. was formed on November 14, 2000 pursuant to a plan of reorganization adopted by the Bank and its stockholders. Pursuant to the reorganization, each share of First Federal Savings and Loan Association of Alpena stock held by existing stockholders of the Bank was exchanged for a share of common stock of Alpena Bancshares, Inc., by operation of law. The reorganization had no financial statement impact and is reflected for all prior periods presented. Prior to April 1, 2005 approximately 56 percent of the Company's capital stock was owned by Alpena Bancshares M.H.C., a mutual holding company. The remaining 44 7 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) percent of the Company's stock was owned by the general public, including the Bank's Employee Stock Ownership Plan. On April 1, 2005 the Company completed the second-step mutual-to-stock conversion of Alpena Bancshares, M.H.C. in which shares representing Alpena Bancshares, M.H.C.'s ownership interest in Alpena Bancshares, Inc. were sold to investors in a public offering. A total of 1,699,869 shares of First Federal of Northern Michigan Bancorp, Inc. common stock were sold at $10.00 per share. In addition, each outstanding share of common stock of Alpena Bancshares, Inc. held by the general public as of the close of trading on April 1, 2005 received 1.8477 shares of First Federal of Northern Michigan Bancorp, Inc. common stock, plus cash in lieu of any fractional shares at the rate of $10.00 per share. The Company also issued 33,997 shares of common stock and contributed $339,997 in cash to First Federal Community Foundation, a new charitable foundation established in the conversion. NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) As a result of these transactions, Alpena Bancshares, M.H.C. ceased to exist and its remaining net assets of $207,000 were transferred into First Federal of Northern Michigan Bancorp, Inc., a Maryland company, the successor to Alpena Bancshares, Inc. All references to the number of shares outstanding for purposes of calculating per share amounts for the period ending December 31, 2004 have been adjusted to give retroactive recognition to the exchange ratio of 1.8477 applied in the conversion. CASH AND CASH EQUIVALENTS - For presentation purposes on both the consolidated statement of financial condition and the consolidated statement of cash flows, the Bank considers all highly liquid debt 8 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) instruments purchased with a maturity of three months or less to be cash equivalents. SECURITIES - Securities classified as available for sale are reported at quoted market value or market value for comparable securities which represents fair value, with unrealized gains and losses, net of related deferred income taxes, included in equity as a component of accumulated other comprehensive income. Gains or losses on the sale of securities and the amount reclassified out of accumulated other comprehensive income are computed based on the adjusted cost of the specific security sold. Mortgage backed securities are all issued by government sponsored agencies such as Freddie Mac and Fannie Mae. Securities classified as held to maturity are carried at cost. Federal Home Loan Bank stock is considered restricted investment security and is carried at cost. SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK - Most of the Company's activities are with customers located within the northeastern lower peninsula of Michigan. Note 2 discusses the types of securities in which the Company invests. Note 3 discusses the types of lending in which the Company engages. The Company does not have any significant concentrations to any one industry or customer. LOANS - The Company grants mortgage, commercial, and consumer loans to customers. Loans are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, 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. 9 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) 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, NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 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. ALLOWANCE FOR LOAN LOSSES - The allowance for loan losses 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 allowance for loan losses 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. 10 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) The allowance consists of specific, general and unallocated components. The specific components relates to loans that are classified as either 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 that the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management's estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. 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 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 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 11 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) 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. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures. LOANS HELD FOR SALE - The Bank routinely sells to investors its long-term fixed rate residential mortgages. These loans are identified as held for sale and are accounted for at the lower of cost or market on an aggregate basis. The lower of cost or market allowance for loans held for sale was $0 at December 31, 2005 and 2004. FORECLOSED ASSETS - Assets acquired in settlement of loans are recorded at the lower of the loan balance or fair value, minus estimated costs to sell, plus capital improvements made thereafter to facilitate sale. Adjustments are made to reflect declines, if any, in the fair value below the recorded amounts. Costs of holding real estate acquired in settlement of loans are charged to expense currently. REAL ESTATE HELD FOR SALE - Real estate held for sale is comprised of developed vacant residential lots and completed condominiums in a subdivision located in Alpena, Michigan. For reporting purposes, these properties are included in the Banking segment. These properties are considered "impaired" under the definition in SFAS 144, Accounting for Impairment or Disposal of Long-Lived Assets. Accordingly, the properties are recorded at the lower of its cost or fair value less cost to sell. Costs to sell are the incremental direct costs to transact a sale, that is, the costs that result directly from and are essential to a sale transaction and that would not have been incurred 12 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) by the entity had the decision to sell not been made. Those costs include realtor commissions, legal and title transfer fees, and closing costs that must be incurred before legal title can be transferred. Quarterly, management uses recent sales of comparable property to determine estimated future cash flows. The estimated future cash flows are used as the "fair value". The fair value, less costs to sell, is compared to the net carrying amount. If NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) the fair value less cost to sell exceeds the recorded amount, a loss is recognized. Losses recognized for the initial and subsequent write-down to fair value less cost to sell are recognized in the gain (loss) on the sale of real estate line in the statement of income. A gain is recognized for any subsequent increase in fair value less cost to sell, but not in excess of the cumulative loss previously recognized. A gain or loss not previously recognized that results from the sale of the property is recognized at the date of sale. 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. INTANGIBLE ASSETS - In connection with the purchase of certain branches, the excess of purchase price over fair value of net assets acquired has been allocated to core deposit intangible assets. The expected life for core deposit intangibles is based on the type of products acquired in an acquisition. The amortization periods range from 10 to 15 years and are based on the expected life of the products. The expected life was determined based on an analysis of 13 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) the life of similar products within the Company and local competition in the markets where the branches were acquired. The core deposit intangibles are amortized on a straight line basis. The core deposit intangible is quarterly analyzed for impairment. On June 12, 2003, First Federal of Northern Michigan acquired 100% of the stock of the InsuranCenter of Alpena (ICA). The purchase price was $2,866,400. There is a provision for an earn-out payment for the former owners who remain with the organization, of up to $300,000 per year for three years if specific net sales levels are achieved. For the years ended December 31, 2005, 2004 and 2003, the net sales level was achieved and the earn-out payment was added to the cost of the acquisition and recorded as goodwill. After allocating the purchase price to the tangible assets the remainder was allocated to the intangible assets. The primary intangible assets are a customer list and an exclusive contract with BCBS, a health insurance company based in Michigan. The exclusive contract provides for a commission of approximately two percent related to all insurance premiums collected by ICA sold through a 10 county Chamber of Commerce group. The intangible asset recorded for this exclusive contract applies to all existing healthcare customers obtained through the group and is in effect for as long as those customers remain with the ICA. NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Using historical cash flows the customer list was assigned a value of $890,000 and the exclusive contract was valued at $597,000. Both assigned values were arrived at based on a discounted cash flow (DCF) analysis that assumed a 20 year life or 5% runoff of revenue each year. The analysis projected net income which was discounted 14 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) back to present with a discount rate of 12%. The expected life was determined using historical runoff rates experienced by ICA before acquisition which were less than 5% per year. Thus far the actual runoff since acquisition has been lower than 5% per year. Effective May 1, 2005 the estimated life of the exclusive contract with BCBS was reduced to 10 years to reflect the resignation of one of the former owners of ICA and the establishment of a 10 year consulting contract between this former employee and ICA. Effective January 1, 2006, based on this resignation, the exclusive contract with BCBS does not apply to new business and management adjusted the estimated useful life to five years. The value assigned to the non-compete agreement received in connection with the purchase of the ICA was $200,000. This agreement is being amortized over a 10 year period. The monthly amortization for this expense equates to $1,700 per month. These amortization expenses will be recorded in non-interest expenses on a monthly basis. In December 2005, the Company purchased a customer list from an insurance agency for approximately $564,000. The entire amount of the purchase was assigned to a customer list intangible and is being amortized over five years. The purchase included the issuance of a note payable in the amount of $338,000 discussed in Note 10 and the remaining payment was made in cash. GOODWILL - Goodwill was created in the ICA transaction. Goodwill will not be amortized but tested annually for impairment. The $900,000 of payments made under the earn-out agreement were added to goodwill. INCOME TAXES - The Company records income tax expense based on the amount of taxes due on its tax return plus deferred taxes 15 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) computed based on the expected future tax consequences of temporary differences between the carrying amounts and tax bases of assets and liabilities, using enacted tax rates. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. INSURANCE AND BROKERAGE COMMISSIONS - Insurance and brokerage commissions received are recognized over the life of the related insurance contracts as premiums are paid and commissions are earned. NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) SERVICING - Servicing assets are recognized as separate assets when rights are acquired through sale of financial assets. Capitalized servicing rights are reported in other assets and are amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing assets are evaluated for impairment quarterly based on the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights by predominant characteristics, such as interest rates and terms. Fair value is determined using prices for similar assets with similar characteristics, when available, or based on discounted cash flows using market-based assumptions. 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. OFF BALANCE SHEET INSTRUMENTS - In the ordinary course of business, the Corporation has entered into commitments to extend credit, 16 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) 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. OTHER 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. 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 losses, and the valuation of goodwill, mortgage servicing rights and other intangible assets. STOCK COMPENSATION PLAN - The Company has a stock-based employee compensation plan, which is described more fully in Note 12. The Company accounts for this plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net 17 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. There were no options granted in 2005 and 2004. The Company's as reported and pro forma information, including stock based compensation expense as if the fair value based method had been applied:
December 31, ------------- 2005 2004 ----- ----- As reported net income available to common shareholders $ 442 $ 404 Less: stock-based compensation expense determined under fair value method, net of tax -- 1 ----- ----- Pro forma net income $ 442 $ 403 ===== ===== As reported earnings per share $0.14 $0.13 Proforma earnings per share $0.14 $0.13 As reported earnings per diluted share $0.14 $0.13 Pro forma earnings per diluted share $0.14 $0.13
EARNINGS PER COMMON SHARE - Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options and are determined using the treasury stock method. 18 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) Earnings per common share have been computed based on the following:
December 31, ----------------------- 2005 2004 ---------- ---------- Net income $ 442 $ 404 ========== ========== Average number of common shares outstanding 3,094,960 3,065,318 Effect of dilutive options 11,461 22,355 ---------- ---------- Average number of common shares outstanding used to calculate diluted earnings per common share 3,106,421 3,087,673 ========== ==========
19 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) RECENT ACCOUNTING PRONOUNCEMENTS - In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No. 123(R), Accounting for Stock-Based Compensation ("SFAS 123R"). SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized as expense in the income statement based on their fair values. Prior to SFAS 123R, only certain pro forma disclosures of fair value were required. The amount of compensation is measured at the fair value of the options when granted, and this cost is expensed over the required service period, which is normally the vesting period of the options. SFAS 123R will apply to awards granted or modified after January 1, 2006. Compensation cost will also be recorded for prior option grants that vest after the date of adoption. The future effect of the adoption of the new accounting principle on results of operations will depend on the level of future option grants, the vesting period for those grants, and the fair value of the options granted at such future date. Existing options that are scheduled to vest after the adoption date are expected to result in additional compensation expense of approximately $5,000 in 2006. RECLASSIFICATIONS - Certain items in the 2004 financial statements have been reclassified to conform to the 2005 presentation format. 20 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) NOTE 2 - INVESTMENT 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, 2005 --------------------------------------------- Gross Gross Amortized Unrealized Unrealized Market Cost Gains Losses Value --------- ---------- ---------- ------- SECURITIES AVAILABLE FOR SALE U.S. Treasury securities and obligations of U.S. government corporations and agencies $43,825 $ 2 $566 $43,261 Municipal notes 3,820 -- 82 3,738 Mortgage-backed securities 6,459 5 214 6,250 Other securities 2 161 -- 163 ------- ---- ---- ------- Total $54,106 $168 $862 $53,412 ======= ==== ==== ======= SECURITIES HELD TO MATURITY Municipal notes $ 1,775 $ 20 $ 8 $ 1,787 ======= ==== ==== =======
December 31, 2004 --------------------------------------------- Gross Gross Amortized Unrealized Unrealized Market Cost Gains Losses Value --------- ---------- ---------- ------- SECURITIES AVAILABLE FOR SALE U.S. Treasury securities and obligations of U.S. government corporations and agencies $27,954 $ 51 $143 27,862 Municipal notes 4,194 20 72 4,142 Mortgage-backed securities 8,125 17 97 8,045 Other securities 2 182 -- 184 ------- ---- ---- ------- Total $40,275 $270 $312 $40,233 ======= ==== ==== ======= SECURITIES HELD TO MATURITY Municipal notes $ 1,800 $ 33 $ -- $ 1,833 ======= ==== ==== =======
21 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) NOTE 2 - INVESTMENT SECURITIES (CONTINUED) The amortized cost and estimated market value of securities at December 31, 2005, 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. Securities with no specified maturity date are separately stated:
December 31, 2005 ------------------- Amortized Market Cost Value --------- ------- AVAILABLE FOR SALE: Due in one year or less $ 9,276 $ 9,174 Due after one year through five years 38,369 37,825 ------- ------- Subtotal 47,645 46,999 Equity securities 2 163 Mortgage-backed securities 6,459 6,250 ------- ------- Total $54,106 $53,412 ======= ======= HELD TO MATURITY Due in one year or less $ 25 $ 25 Due after one year through five years 175 173 Due in five year through ten years 275 271 Due after ten years 1,300 1,318 ------- ------- Total $ 1,775 $ 1,787 ======= =======
At December 31, 2005 and 2004, securities with a carrying value and fair value of $10,729,000 and $8,931,000, respectively, were pledged to secure certain deposit accounts and FHLB advances. Gross proceeds from the sale of available-for-sale securities for the years ended December 31, 2005 and 2004 were $7,562,000 and 22 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) $19,213,000, respectively, resulting in gross gains of $13,000 and $178,000, respectively and gross losses of $0 and $75,000, respectively. 23 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) NOTE 2 - INVESTMENT SECURITIES (CONTINUED) The following is a summary of temporarily impaired investments that have been impaired for less than and more than twelve months as of December 31, 2005 and 2004:
December 31, 2005 December 31, 2004 ---------------------------------------------- ---------------------------------------------- Gross Gross Gross Gross Unrealized Unrealized Unrealized Unrealized Losses Losses Losses Losses < 12 > 12 < 12 > 12 Fair Value months Fair Value months Fair Value months Fair Value months ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- U.S. Treasury securities and obligations of U.S. government corporations and agencies $22,713 $240 $15,546 $326 $12,812 $143 $ -- $ -- Municipal notes 767 8 3,737 82 1,411 45 2,371 27 Mortgage-backed securities 4,707 12 1,180 202 820 4 5,317 93 ------- ---- ------- ---- ------- ---- ------ ---- Total $28,187 $260 $20,463 $610 $15,043 $192 $7,688 $120 ======= ==== ======= ==== ======= ==== ====== ====
The Company does not believe that the unrealized losses as of December 31, 2005 and 2004 represent other-than-temporarily impairment. The unrealized losses reported for the above securities relate primarily to changes in interest rates. Individually, the losses were less than 3.0% or less of their respective amortized cost basis. The Company has both the intent and ability to hold the investment securities contained in the previous table for a time necessary to recover the amortized cost. 24 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) NOTE 3 - LOANS Loans at December 31, 2005 and 2004 are summarized as follows:
December 31 ------------------- 2005 2004 -------- -------- Real estate loans - One- to four-family residential $106,031 $110,402 Commercial loans: Secured by real estate 44,311 30,794 Other 26,658 30,174 -------- -------- Total commercial loans 70,969 60,968 Consumer loans 25,907 25,544 -------- -------- Total gross loans 202,907 196,914 Less net deferred fees (costs) 308 312 Less allowance for loan losses 1,416 1,214 -------- -------- Total loans - Net $201,183 $195,388 ======== ========
Final loan maturities and rate sensitivity of the loan portfolio are as follows:
December 31, 2005 ----------------------------------------- One Year After Less Than to Five Five One Year Years Years Total --------- -------- ------- -------- Loans at fixed interest rates $17,885 $76,830 $50,358 $145,073 Loans at variable interest rates 12,772 4,995 40,067 57,834 ------- ------- ------- -------- Total $30,657 $81,825 $90,425 $202,907 ======= ======= ======= ========
25 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) NOTE 3 - LOANS (CONTINUED) Certain directors and executive officers of the Company were loan customers during 2005 and 2004. Such loans were made in the ordinary course of business and do not involve more than a normal risk of collectibility. An analysis of aggregate loans outstanding to directors and executive officers for the years ended December 31, 2005 and 2004 is as follows:
December 31 ---------------- 2005 2004 ------- ------ Aggregate balance - Beginning of Period $ 2,068 $1,832 New loans 2,036 381 Repayments (1,448) (145) ------- ------ Aggregate balance - End of Period $ 2,656 $2,068 ======= ======
An analysis of the allowance for loan losses is as follows:
Year Ended December 31 --------------- 2005 2004 ------ ------ Balance - Beginning of period $1,214 $1,036 Provision for losses 368 323 Loans - Charged off (249) (191) Recoveries 83 46 ------ ------ Balance - End of period $1,416 $1,214 ====== ======
26 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) NOTE 3 - LOANS (CONTINUED) The following is a summary of information pertaining to impaired, non-accrual and delinquent loans:
December 31 --------------- 2005 2004 ------ ------ Impaired loans without a valuation allowance $ 345 $ -- Impaired loans with a valuation allowance 660 441 ------ ------ Total impaired loans $1,005 $ 441 ====== ====== Valuation allowance related to impaired loans $ 43 $ 51 Total non-accrual loans $1,353 $ 478 Total loans past-due ninety days or more and still accruing $2,654 $1,240
Year Ended December 31 ----------- 2005 2004 ---- ---- Average investment in impaired loans $798 $965 ==== ==== Interest income recognized on impaired loans $ -- $ -- ==== ==== Interest income recognized on a cash basis on impaired loans $ -- $ -- ==== ====
27 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) NOTE 4 - REAL ESTATE HELD FOR SALE Management is actively marketing the real estate by using local real estate agents to facilitate the sale of these properties. The real estate held for sale is determined to be impaired and is recorded at the lower of cost or fair value less costs to sell. The valuation allowance on this project was determined based on recent sales of comparable real estate and existing real estate listings. Losses recognized for the initial and subsequent write-down to fair value less cost to sell are recognized in the "gain (loss) on the sale of real estate" line in the statement of income. The activity in the allowance is as follows:
Year Ended December 31 ----------- 2005 2004 ---- ---- Valuation allowances: Balance at beginning of year $121 $121 Additions -- -- Reductions 21 -- ---- ---- Balance at end of year $100 $121 ==== ====
NOTE 5 - PROPERTY AND EQUIPMENT A summary of property and equipment is as follows:
December 31 ---------------- 2005 2004 ------- ------ Land $ 1,251 $1,251 Land improvements 181 121 Buildings 5,487 4,495 Equipment 3,671 3,867 ------- ------ Total property and equipment 10,590 9,734 Less accumulated depreciation 3,198 2,940 ------- ------ Net property and equipment $ 7,392 $6,794 ======= ======
28 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) Depreciation expense was $521,000 and $527,000 for the periods ended December 31, 2005 and 2004, respectively. NOTE 6 - SERVICING Loans serviced for others are not included in the accompanying consolidated statement of financial condition. The unpaid principal balances of mortgage and other loans serviced for others were approximately $139,132,000 and $139,304,000 at December 31, 2005 and 2004, respectively. The balance of capitalized servicing rights, net of valuation allowance, is included in other assets at December 31, 2005 and 2004. The key economic assumptions used in determining the fair value of the mortgage servicing rights are as follows:
December 31, ------------ 2005 2004 ---- ----- Annual constant prepayment speed (CPR) 8.23% 11.91% Weighted average life (in months) 249 250 Discount rate 8.50% 7.50%
We estimated the fair value of our mortgage servicing rights to be $1,668,000 and $1,502,000 and the weighted average life remaining of those rights was 55 months and 52 months at December 31, 2005 and 2004, respectively. The following summarizes mortgage servicing rights capitalized and amortized, along with the aggregate activity in related valuation allowances: 29 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA)
December 31 ------------- 2005 2004 ----- ----- Carrying amount - Beginning of year $ 860 $ 984 Originated mortgage servicing rights capitalized 178 196 Amortization of mortgage servicing rights (287) (320) ----- ----- Subtotal 751 860 Valuation allowances: Balance at beginning of year -- -- Additions -- -- Reductions -- -- Write-downs -- -- ----- ----- Balance at end of year $ 751 $ 860 ===== =====
30 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) NOTE 7 - INTANGIBLE ASSETS Intangible assets of the Company are summarized as follows:
December 31, 2005 -------------------------------------------- Gross Carrying Accumulated Net Carrying Amount Amortization Amount -------------- ------------ ------------ Amortized intangible assets: Customer list $1,454 $ 159 $1,295 Customer contract 597 100 497 Core deposit 3,081 1,927 1,154 Non-compete covenant 200 57 143 ------ ------ ------ Total $5,332 $2,243 $3,089 ====== ====== ======
December 31, 2004 -------------------------------------------- Gross Carrying Accumulated Net Carrying Amount Amortization Amount -------------- ------------ ------------ Amortized intangible assets: Customer list $ 890 $ 82 $ 808 Customer contract 597 55 542 Core deposit 3,081 1,739 1,342 Non-compete covenant 200 36 164 ------ ------ ------ Total $4,768 $1,912 $2,856 ====== ====== ======
Amortization expense was $331,000 and $293,000 for the periods ended December 31, 2005 and 2004, respectively. 31 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) NOTE 7 - INTANGIBLE ASSETS (CONTINUED) Amortization periods for the major classes of intangible assets and in total are as follows as of December 31, 2005.
Amortization Period Amortizable Intangible (In years) - ---------------------- ------------------- Customer list 6.9 Customer contract 5.0 Core deposit 8.4 Non-compete covenant 7.2 --- 9.4 ===
The expected amortization expense related to intangibles as of December 31, 2005 is as follows:
Year Ended December 31 Annual Amortization - ---------------------- ------------------- 2006 $500 2007 493 2008 490 2009 490 2010 481
32 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) NOTE 8 - DEPOSITS Deposit accounts, by type and range of rates, consist of the following:
December 31 ------------------- 2005 2004 -------- -------- Account Type NOW accounts and MMDA $ 28,164 $ 36,501 Regular savings accounts 27,103 28,186 -------- -------- Total 55,267 64,687 Certificate of Deposit Rates 0.50 percent to 1.99 percent 7,443 22,980 2.00 percent to 2.99 percent 20,199 24,924 3.00 percent to 3.99 percent 59,350 33,124 4.00 percent to 4.99 percent 25,470 10,227 5.00 percent to 6.99 percent 8,667 12,869 7.00 percent to 8.99 percent 1,461 2,749 -------- -------- Total certificate of deposits 122,590 106,873 -------- -------- Total deposits $177,857 $171,560 ======== ========
Certificates of deposit $100,000 or greater at December 31, 2005 and 2004 were $30,166,000 and $23,417,000, respectively. The amounts is excess of $100,000 are not federally insured. 33 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) NOTE 8 - DEPOSITS (CONTINUED) The following table sets forth the amount and maturities of certificates of deposit:
December 31, 2005 Amount Due ---------------------------------------------------------- Greater Less than 1-2 2-3 3-5 than Rate 1 Year Years Years Years 5 Years Total - --------------- --------- ------- ------ ------ ------- -------- 0.50 percent to 1.99 percent $ 7,426 $ 17 $ -- $ -- $ -- $ 7,443 2.00 percent to 2.99 percent 18,248 368 652 773 158 20,199 3.00 percent to 3.99 percent 34,788 18,367 5,933 90 172 59,350 4.00 percent to 4.99 percent 19,793 3,684 211 1,347 435 25,470 5.00 percent to 6.99 percent 2,757 725 921 3,691 573 8,667 7.00 percent to 8.99 percent -- 147 -- 1,314 -- 1,461 ------- ------- ------ ------ ------ -------- Total $83,012 $23,308 $7,717 $7,215 $1,338 $122,590 ======= ======= ====== ====== ====== ========
Interest expense on deposits is summarized as follows:
Year Ended December 31 --------------- 2005 2004 ------ ------ NOW and MMDAs $ 288 $ 256 Regular savings 177 66 Certificates of deposit 3,874 3,294 ------ ------ Total $4,339 $3,616 ====== ======
Deposits from related parties held by the Bank at December 31, 2005 and 2004 amounted to $462,000 and $564,000, respectively. 34 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) NOTE 9 - FEDERAL HOME LOAN BANK ADVANCES Advances outstanding from the Federal Home Loan Bank (FHLB) bear interest that is payable monthly. Pursuant to blanket collateral agreements with the FHLB, advances are collateralized by one- to four-family whole mortgage loans, government agency securities, and highly rated private mortgage-backed securities. The FHLB requires eligible collateral to have a market value equal to 145 percent of advances. The carrying value of loans pledged to secure these advances was approximately $79,264,000 and $91,101,000 at December 31, 2005 and 2004, respectively. 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, 2005 December 31, 2004 - -------------------------------------- -------------------------------------- Weighted Weighted Years Ending Average Years Ending Average December 31 Amount Interest Rate December 31 Amount Interest Rate - ------------ ------- ------------- ------------ ------- ------------- 2006 $18,925 3.75 2005 $22,250 4.04 2007 2,500 4.28 2006 6,000 2.89 2008 12,500 4.55 2008 7,500 4.78 2009 1,000 3.40 2009 1,000 3.4 2010 18,000 5.49 2010 18,000 5.49 ------- ------- Total $52,925 4.55 Total $54,750 4.48 ======= =======
35 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) NOTE 10 - NOTE PAYABLE In connection with the purchase of ICA, an unsecured note payable was issued to an individual, payable in annual installments of $180,000, including interest at 5.5 percent. Future maturities of the note are as follows:
Years Ending December 31 Amount - ------------ ------ 2006 $ 117 2007 124 2008 130 2009 138 2010 146 Thereafter 485 ------ Total $1,140 ======
In connection with the purchase of an existing book of insurance business by ICA, a two-year unsecured note payable was issued to an individual, with the first annual payment of $190,000 and the second annual payment of $179,000, both payments including interest at 6.0 percent. Future maturities of the note are as follows:
Years Ending December 31, Amount - ------------ ------ 2006 $169 2007 169 ---- Total $338 ====
36 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) NOTE 11 - FEDERAL INCOME TAX The analysis of the consolidated provision for federal income tax is as follows:
Year Ended December 31 ------------ 2005 2004 ----- ---- Current provision $ 403 $204 Deferred provision (credit) (200) -- ----- ---- Total $ 203 $204 ===== ====
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 ------------- 2005 2004 ----- ----- Tax at statutory rate $ 219 $ 207 Nontaxable dividend (1) (18) Tax-exempt interest (36) (11) Other 21 26 ----- ----- Federal income tax $ 203 $ 204 ===== ===== Effective Tax Rate 31.5% 33.6% ===== =====
37 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) NOTE 11 - FEDERAL INCOME TAX (CONTINUED) The net deferred tax liability was comprised of the following temporary differences:
December 31 --------------- 2005 2004 ------ ------ Deferred tax assets: Allowance for loan losses $ 444 $ 358 Valuation allowance for real estate held for sale 34 41 Unrealized loss on available-for-sale securities 221 14 Other 3 98 Contributions Carryover 180 -- Directors' benefit plan 335 222 ------ ------ Total deferred tax assets 1,217 733 Valuation allowance for deferred tax assets -- Deferred tax liabilities: Mortgage servicing rights 255 293 Partnership losses 84 74 Depreciation 540 579 Other 284 140 ------ ------ Total deferred tax liabilities 1,163 1,086 ------ ------ Net deferred tax asset (liability) $ 54 $ (353) ====== ======
The contribution carryforward relates to $529,000 in contributions that were not deductible in 2005. This carryforward expires in 2010. For tax years beginning prior to January 1, 1996, a qualified thrift institution was allowed a bad debt deduction for tax purposes based 38 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) on a percentage of taxable income or on actual experience. The Bank used the percentage of taxable income method through December 31, 1995. NOTE 11 - FEDERAL INCOME TAX (CONTINUED) 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, 2005 and 2004, the amount of those reserves was approximately $60,000. The amount of the unrecognized deferred tax liability at December 31, 2005 and 2004 was approximately $20,000. NOTE 12 - OFF BALANCE SHEET RISK COMMITMENTS AND CONTINGENCIES CREDIT-RELATED FINANCIAL INSTRUMENTS - 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. Such commitments 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 Company's exposure to credit loss 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: 39 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA)
December 31 ----------------- 2005 2004 ------- ------- Commitments to grant loans $15,772 $25,710 Unfunded commitments under lines of credit 20,843 16,641 Commercial and standby letters of credit 25 35
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. 40 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) NOTE 12 - OFF BALANCE SHEET RISK COMMITMENTS AND CONTINGENCIES (CONTINUED) 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. These lines of credit are collateralized 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. The Company generally holds collateral supporting those commitments if deemed necessary. COLLATERAL REQUIREMENTS - To reduce credit risk related to the use of credit-related financial instruments, the Company might deem it necessary to obtain collateral. 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, and equipment, and real estate. If the counterparty does not have the right and ability to redeem the collateral or if the Company is permitted to sell or repledge the collateral on short notice, the Company records the collateral in its statement of financial condition at fair value with a corresponding obligation to return it. NOTE 13 - STOCKHOLDERS' EQUITY Payment of dividends on the common stock is subject to determination and declaration by the Board of Directors and 41 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) depends on a number of factors, including capital requirements, regulatory limitation on payment of dividends, the Bank's results of operations and financial condition, tax considerations, and general economic conditions. For the quarter ended March 31, 2005, the Bank filed a notice with the Office of Thrift Supervision (OTS) and the Federal Deposit Insurance Company (FDIC) requesting approval to waive payment of cash dividends to Alpena Bancshares M.H.C. (the "M.H.C.") (majority stockholder of the Company). The OTS and FDIC did not object to the dividend waiver request. NOTE 13 - STOCKHOLDERS' EQUITY (CONTINUED) In 2005, in connection with the second-step conversion of Alpena Bancshares, M.H.C., the dividends previously waived by the M.H.C. were permanently forgiven and $5,512,000 in restricted retained earnings related to the waived dividends were transferred to unrestricted retained earnings. The Bank is subject to various regulatory capital requirements administered by the OTS. 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 42 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) regulators regarding components, risk-weightings, and other factors. During the most recent regulatory examination, the OTS 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.
To be Categorized as Well-Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions --------------- ----------------- ---------------------- Amount Ratio Amount Ratio Amount Ratio ------- ----- ------- ----- ------- ----- (Dollars in Thousands) December 31, 2005: Total capital (to risk- weighted assets) $33,669 18.03% $14,937 8.00% $18,671 10.00% Tier 1 capital (to risk- weighted assets) $32,181 17.24% $ 7,468 4.00% $11,202 6.00% Tangible capital (to tangible assets) $32,181 11.56% $ 4,175 1.50% $ 5,567 2.00% December 31, 2004: Total capital (to risk- weighted assets) $18,436 10.68% $13,806 8.00% $17,258 10.00% Tier 1 capital (to risk- weighted assets) $17,140 9.93% $ 6,903 4.00% $10,355 6.00% Tangible capital (to tangible assets) $17,140 6.64% $ 3,873 1.50% $ 5,164 2.00%
43 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) NOTE 13 - STOCKHOLDERS' EQUITY (CONTINUED) Reconcilliation of GAAP to Regulatory Capital
December 31 ----------------- 2005 2004 ------- ------- GAAP Capital $36,649 $21,777 Reconciling items: Less: Investment in and advances to nonincludable subsidaries (487) (759) Less: Goodwill and other intangible assets (4,439) (3,905) Unrealized (gain) loss on securities available for sale 458 27 Disallowed mortgage servicing rights -- -- ------- ------- Tangible and core capital 32,181 17,140 Allowable unrealized (gain) loss on securities available for sale 72 82 General valuation allowance 1,416 1,214 ------- ------- Risk Based Capital $33,669 $18,436 ======= =======
NOTE 14 - EMPLOYEE BENEFIT PLANS RETIREMENT PLANS 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 44 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) 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. The Bank was fully funded in the Plan as of December 31, 2005 and 2004. 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 for the years ended December 31, 2005 and 2004 was $252,000 and $392,000, respectively. NOTE 14 - EMPLOYEE BENEFIT PLANS (CONTINUED) The Bank has a Section 401(k) savings plan covering substantially all of its employees who meet certain age and service requirements. The Company matches a certain percentage of participant deferrals. Additional contributions may be made as approved by the Board of Directors. For the calendar year ended December 31, 2005 the Bank's Board of Directors approved a discretionary profit sharing payment under this plan of 4% of each eligible employee's wages for the period from July 1, 2005 through December 31, 2005. The expense under the plan for the years ended December 31, 2005 and 2004 was $136,000 and $71,000, respectively. The Bank has a nonqualified deferred compensation plan for its directors. Through 1998, each 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 $719,000 and $654,000 at December 31, 2005 and 2004, respectively. The expense under the plan for the years ended 45 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) December 31, 2005 and 2004 was $102,000 and $59,000, 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 $480,000 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. 46 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) NOTE 14 - EMPLOYEE BENEFIT PLANS (CONTINUED) 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 bears interest at the rate of 5.75 percent and provides for repayment of principal over the 15 year term of the loan. Since the Company is providing the loan to the ESOP, the note receivable is not included in the Company's balance sheet. Accordingly, the Company did not recognize interest income on the loan. In 2005, however, the Board of Directors of the Company authorized a prepayment of principal on the ESOP loan. The scheduled maturities of the loan are as follows:
Year Ended December 31 Principal Amount - ----------- ---------------- 2006 $ 71 2007 75 2008 80 2009 84 2010 89 Thereafter 769 ------ Total $1,168 ======
The Company makes annual contributions to the ESOP sufficient to support the debt service of the loan. The loan is secured by the shares purchased, which are held in a suspense account for allocation among the participations as the loan is paid. Dividends 47 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) paid on unallocated shares are not considered dividends for financial reporting purposes and are used to pay principal and interest on the ESOP loan. Dividends on allocated shares are charged to retained earnings. 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). Total compensation expense for the year ended December 31, 2005 was $180,000. 48 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) NOTE 14 - EMPLOYEE BENEFIT PLANS (CONTINUED) Shares held by the ESOP include the following:
2005 2004 ------- ------ Allocated 42,281 42,281 Unallocated 138,709 -- ------- ------ Total 180,990 42,281
The cost of unallocated ESOP shares (shares not yet released for allocation) is reflected as a reduction of stockholders' equity. The fair value of the unallocated shares was approximately $1,214,000 at December 31, 2005. STOCK OPTION PLAN The 1996 stock option plan for certain employees and nonemployee directors authorized the grant of stock options to purchase 69,000 shares of common stock of the Company. Pursuant to the stock option plan, grants may be made of incentive stock options and nonstatutory stock options. Simultaneously with the grant of stock options, the Company may grant limited rights. The limited rights may be exercised only in the event of a change in control. The Company has not issued limited rights under this plan and and has no intention to do so under this plan. Nonemployee directors are only eligible to receive nonstatutory options. Under the terms of the plan, incentive stock options have been granted at fair market value as of the date of the grant that are exercisable any time prior to 10 years from the grant date. The incentive stock options vest ratably over a five year period. Nonstatutory fully vested stock options have been granted at fair market value on the date the option is granted and are exercisable prior to 10 years from the date of grant. As discussed in Note 1, the Company reorganized in 2005. 49 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) Therefore, all references to the number of shares outstanding and related exercise prices have been adjusted to give retroactive recognition to the exchange ratio of 1.8477 applied in the conversion. NOTE 14 - EMPLOYEE BENEFIT PLANS (CONTINUED) The following is a summary of activity for stock options:
December 31 -------------------------------------------- 2005 2004 -------------------- -------------------- Weighted Weighted Average Average Number of Exercise Number of Exercise Shares Price Shares Price --------- -------- --------- -------- Options outstanding at beginning of period 48,800 $5.69 53,604 $5.72 Options granted -- -- -- Options exercised (22,310) 5.41 (3,695) 5.77 Options forfeited (1,848) 7.44 (1,109) 7.44 ------- ------ Options outstanding at end of period 24,642 5.80 48,800 5.69 ======= ====== Exercisable at end of period 20,208 5.63 44,365 5.51
50 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) Information pertaining to options outstanding is as follows:
December 31, 2005 ------------------------------------------------------------------------------------- Options Outstanding Options Exerciseable ----------------------------------------- ----------------------------------------- Weighted- Weighted- Average Weighted- Average Weighted- Remaining Average Remaining Average Exercise Number Contractual Exercise Number Contractual Exercise Prices ($) Outstanding Life (in years) Price Exercisable Life (in years) Price - ---------- ----------- --------------- --------- ----------- --------------- --------- 5.21 7,945 0.44 $5.21 7,945 0.44 $5.21 5.41 11,155 0.29 5.41 9,306 0.29 5.41 7.44 5,542 6.24 7.44 2,957 6.24 7.44 ------ ------ Total 24,642 1.68 $5.80 20,208 1.22 $5.63 ====== ======
51 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) NOTE 15 - FAIR VALUES OF FINANCIAL INSTRUMENTS The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based on quoted market prices. However, in many instances, there are no quoted market prices for the Company's various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. SFAS 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company. 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 for securities, excluding Federal Home Loan Bank stock, are based on quoted market prices. The carrying value of Federal Home Loan Bank stock approximates fair value based on the redemption provisions of the Federal Home Loan Bank. LOANS HELD FOR SALE - Fair values of mortgage loans held for sale are based on commitments on hand from investors or prevailing market prices. 52 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) LOANS RECEIVABLE - For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for certain mortgage loans (e.g., one- to four-family residential), credit card loans, and other consumer loans are based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted for differences in loan characteristics. Fair values for other loans (e.g., commercial real estate and investment property mortgage loans, commercial, and industrial loans) are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for nonperforming loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable. DEPOSIT LIABILITIES - The fair values disclosed for demand deposits (e.g., interest and noninterest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the NOTE 15 - FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED) 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 LONG-TERM BORROWINGS - The fair values of the Company's long-term borrowings are estimated using discounted cash flow analyses based on the Company's current incremental borrowing rates for similar types of borrowing arrangements. 53 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) ACCRUED INTEREST - The carrying amounts of accrued interest approximate fair value. The estimated fair values and related carrying or notional amounts of the Company's financial instruments are as follows:
December 31, 2005 December 31, 2004 --------------------- --------------------- Carrying Estimated Carrying Estimated Amounts Fair Value Amounts Fair Value -------- ---------- -------- ---------- Financial assets: Cash and cash equivalents $ 4,780 $ 4,780 $ 4,739 $ 4,739 Securities 55,187 55,199 42,033 42,066 Loans and loans held for sale - Net 201,183 198,112 196,484 196,416 Federal Home Loan Bank stock 4,765 4,765 4,666 4,666 Accrued interest receivable 1,602 1,602 1,035 1,035 Financial liabilities: Customer deposits 188,735 189,090 182,489 183,774 Advances from borrowers for taxes and insurance 28 28 45 45 Federal Home Loan Bank advances 52,925 52,461 54,750 54,286 Note payable 1,478 1,476 1,251 1,249 Accrued interest payable 686 686 481 481
54 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) NOTE 16 - RESTRICTIONS ON DIVIDENDS OTS regulations impose limitations upon all capital distributions including cash dividends. The total amount of dividends that may be paid is generally limited to the sum of the net profits of the bank for the preceding three years. An application to and the approval of the OTS is required prior to any capital distribution if the institution does not meet the criteria for "expedited treatment" of applications under OTS regulations. If an application is not required, the institution must still provide prior notice to the OTS of the capital distribution. In the event the Bank's capital falls below its regulatory requirements or the OTS notifies it that it was in need of more than normal supervision, the Bank's ability to make capital distributions could be restricted. In addition, the OTS could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the OTS determines that such distribution would constitute an unsafe or unsound practice. At December 31, 2005 and 2004, the Bank's retained earnings available for the payment of dividends totaled $1,661,000 and $1,038,000, respectively. NOTE 17 - 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. The condensed balance sheet is as follows: 55 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA)
December 31 ----------------- 2005 2004 ------- ------- ASSETS Cash at subsidiary bank $ 2,642 $ 128 Investment in subsidiary 33,839 21,470 Other assets 409 179 ------- ------- Total assets $36,890 $21,777 ======= ======= LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities $ 241 $ -- Stockholders' equity 36,649 21,777 ------- ------- Total liabilities and stockholders' equity $36,890 $21,777 ======= =======
NOTE 17 - PARENT-ONLY FINANCIAL STATEMENTS (CONTINUED) The condensed statement of operations for the years ended are as follows:
December 31 ------------ 2005 2004 ----- ---- Operating income $ 350 $411 Operating expense 799 89 ----- ---- Income (loss) before income taxes and equity in undistributed net income of subsidiary (449) 322 Income tax benefit 268 30 ----- ---- Income (loss) before equity in undistributed net income of subsidiary (181) 352 Equity in undistributed net income of subsidiary 623 52 ----- ---- Net income $ 442 $404 ===== ====
56 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) NOTE 17 - PARENT-ONLY FINANCIAL STATEMENTS (CONTINUED) The condensed statement of cash flows for the years ended is as follows:
December 31 ---------------- 2005 2004 -------- ----- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 442 $ 404 Adjustments to reconcile net income to net cash from operating activities: Equity in undistributed net income of subsidiary (623) (52) Stock donation to charitable foundation 340 -- Net change in other assets (201) (135) Net change in other liabilities 241 19 -------- ----- Net cash provided by operating activities 199 236 CASH FLOWS FROM INVESTING ACTIVITIES Capitalization of subsidiary (12,013) -- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from exercise of stock options 120 21 Tax benefits of stock options exercised 29 -- Stock retired (60) Net proceeds from stock conversion 15,960 -- Merger of Alpena Bancshares, Inc. and M.H.C 206 -- Purchase of shares for ESOP (1,387) -- Dividends paid (540) (277) -------- ----- Net cash provided (used) in financing activities 14,328 (256) -------- ----- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 2,514 (20) CASH AND CASH EQUIVALENTS - Beginning of year 128 148 -------- ----- CASH AND CASH EQUIVALENTS - End of year $ 2,642 $ 128 ======== =====
57 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) NOTE 18 - SEGMENT REPORTING The Company's principal activities include banking and the sale of insurance products through its wholly owned subsidiary, ICA, purchased in 2003. The Bank provides financial products including retail and commercial loans as well as retail and commercial deposits. ICA received commissions from the sale of various insurance products including health, life, and property. The segments were determined based on the nature of the products provided to customers. The financial information for each operating segment is reported on the basis used internally to evaluate performance and allocate resources. The allocations have been consistently applied for all periods presented. Revenues and expenses between affiliates have been transacted at rates that unaffiliated parties would pay. The only transaction between the segments thus far relates to a deposit on behalf of the ICA included in the Bank. The interest income and interest expense for this transaction has been eliminated. All other transactions are with external customers. The performance measurement of the operating segments is based on the management structure of the Company and is not necessarily comparable with similar information for any other financial institution. The information presented is also not necessarily indicative of the segment's financial condition and results of operations if they were independent entities. 58 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) NOTE 18 - SEGMENT REPORTING (CONTINUED)
For Year Ended December 31, 2005 ------------------------------------------- Bank ICA Eliminations Total -------- ------ ------------ -------- INTEREST INCOME $ 15,076 $ 10 $ (10) $ 15,076 INTEREST EXPENSE 6,716 -- (10) 6,706 -------- ------ ----- -------- NET INTEREST INCOME - Before provision for loan losses 8,360 10 -- 8,370 PROVISION FOR LOAN LOSSES 368 -- -- 368 -------- ------ ----- -------- NET INTEREST INCOME - After provision for loan losses 7,992 10 -- 8,002 OTHER INCOME 1,511 2,947 -- 4,458 OPERATING EXPENSES 8,994 2,821 -- 11,815 -------- ------ ----- -------- INCOME - Before federal income tax 509 136 -- 645 FEDERAL INCOME TAX 160 43 -- 203 -------- ------ ----- -------- NET INCOME $ 349 $ 93 $ -- $ 442 ======== ====== ===== ======== DEPRECIATION AND AMORTIZATION $ 677 $ 175 $ -- $ 852 ======== ====== ===== ======== ASSETS $278,684 $4,416 $(325) $282,775 ======== ====== ===== ======== EXPENDITURES RELATED TO LONG-LIVED ASSETS: Goodwill $ -- $ 300 $ -- $ 300 Intangible assets -- 555 -- 555 Property and equipment 1,107 12 -- 1,119 -------- ------ ----- -------- TOTAL $ 1,107 $ 867 $ -- $ 1,974 ======== ====== ===== ========
For Year Ended December 31, 2004 ------------------------------------------- Bank ICA Eliminations Total -------- ------ ------------ -------- INTEREST INCOME $ 13,278 $ 9 $ (9) $ 13,278 INTEREST EXPENSE 6,211 -- (9) 6,202 -------- ------ ----- -------- NET INTEREST INCOME - Before provision for loan losses 7,067 9 -- 7,076 PROVISION FOR LOAN LOSSES 323 -- -- 323 -------- ------ ----- -------- NET INTEREST INCOME - After provision for loan losses 6,744 9 -- 6,753 OTHER INCOME 1,733 2,978 -- 4,711 OPERATING EXPENSES 8,071 2,785 -- 10,856 -------- ------ ----- -------- INCOME - Before federal income tax 406 202 -- 608 FEDERAL INCOME TAX 136 68 -- 204 -------- ------ ----- -------- NET INCOME $ 270 $ 134 $ -- $ 404 ======== ====== ===== ======== DEPRECIATION AND AMORTIZATION $ 641 $ 125 $ -- $ 766 ======== ====== ===== ======== ASSETS $259,858 $3,677 $(735) $262,800 ======== ====== ===== ======== EXPENDITURES RELATED TO LONG-LIVED ASSETS: Goodwill $ -- $ 300 $ -- $ 300 Intangible assets 47 -- -- 47 Property and equipment 1,294 41 -- 1,335 -------- ------ ----- -------- TOTAL $ 1,341 $ 341 $ -- $ 1,682 ======== ====== ===== ========
59 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2005 AND 2004 (000S OMITTED, EXCEPT PER SHARE DATA) NOTE 19 - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) The following tables summarize the Company's quarterly results for the fiscal years ended December 31, 2005 and 2004:
For the Three-Month Period Ending --------------------------------------------------- March 31, June 30, September 30, December 31, 2005 2005 2005 2005 --------- -------- ------------- ------------ Interest income $3,505 $3,723 $3,899 $3,949 Interest expense 1,599 1,644 1,683 1,780 ------ ------ ------ ------ Net interest income 1,906 2,079 2,216 2,169 Provision for losses on loans 79 183 4 102 Other income 1,099 1,098 1,156 1,105 Other expenses 2,712 3,446 2,822 2,835 ------ ------ ------ ------ Income - Before income taxes 214 (452) 546 337 Federal income taxes 72 (152) 183 100 ------ ------ ------ ------ Net income $ 142 $ (300) $ 363 $ 237 ====== ====== ====== ====== Basic earnings per share $ 0.04 $(0.09) $ 0.12 $ 0.07 Fully diluted earnings per share $ 0.04 $(0.09) $ 0.12 $ 0.07 Weighted average number of shares outstanding 3,065 3,100 3,101 3,112 Weighted average number of shares outstanding, including dilutive stock options 3,089 3,114 3,111 3,111 Cash dividends declared per common share $0.054 $0.050 $0.050 $0.050
For the Three-Month Period Ending --------------------------------------------------- March 31, June 30, September 30, December 31, 2004 2004 2004 2004 --------- -------- ------------- ------------ Interest income $3,091 $3,261 $3,446 $3,480 Interest expense 1,445 1,504 1,622 1,631 ------ ------ ------ ------ Net interest income 1,646 1,757 1,824 1,849 Provision for losses on loans 81 65 68 109 Other income 1,138 1,209 1,252 1,112 Other expenses 2,724 2,748 2,641 2,743 ------ ------ ------ ------ Income - Before income taxes (21) 153 367 109 Federal income taxes (7) 51 123 37 ------ ------ ------ ------ Net income $ (14) $ 102 $ 244 $ 72 ====== ====== ====== ====== Basic earnings per share $(0.00) $ 0.03 $ 0.08 $ 0.02 Fully diluted earnings per share $(0.00) $ 0.03 $ 0.08 $ 0.02 Weighted average number of shares outstanding 3,065 3,065 3,065 3,065 Weighted average number of shares outstanding, including dilutive stock options 3,088 3,089 3,088 3,089 Cash dividends declared per common share $0.068 $0.027 $0.054 $0.054
60 EX-21 3 k02777exv21.txt SUBSIDIARIES OF REGISTRANT . . . EXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT
PARENT COMPANY SUBSIDIARY COMPANIES STATE OF INCORPORATION -------------- -------------------- ---------------------- First Federal of Northern Michigan First Federal of Northern Michigan Federal Bancorp, Inc. First Federal of Northern Michigan Financial Services and Mortgage Michigan Corporation First Federal of Northern Michigan InsuranCenter of Alpena Michigan
EX-23 4 k02777exv23.txt CONSENT OF PLANTE & MORAN PLLC EXHIBIT 23 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We hereby consent to the incorporation by reference into the Registration Statement on Form S-8 for the Company's 1996 Stock Option Plan and 1996 Recognition and Retention Plan (Registration No. 333-83198) of our report dated March 3, 2006 relating to the consolidated financial statements of First Federal of Northern Michigan Bancorp, Inc. as of December 31, 2005 which appear in this Form 10-KSB of First Federal of Northern Michigan Bancorp, Inc. for the year ended December 31, 2005. Plante & Moran, PLLC Auburn Hills, Michigan March 28, 2006 EX-31.1 5 k02777exv31w1.txt CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 EXHIBIT 31.1 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. FORM 10-KSB YEAR ENDED DECEMBER 31, 2005 CERTIFICATION OF CHIEF EXECUTIVE OFFICER Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 I, Martin A. Thomson, certify that: (1) I have reviewed this annual report on Form 10-KSB of First Federal of Northern Michigan Bancorp, Inc.; (2) Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; (3) Based on my knowledge, the financial statements and other financial information included in this annual report fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; (4) The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over reporting; and (5) The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. March 28, 2006 /s/ Martin A. Thomson Date ---------------------------------------- Martin A. Thomson Chief Executive Officer EX-31.2 6 k02777exv31w2.txt CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 EXHIBIT 31.2 FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. FORM 10-KSB YEAR ENDED DECEMBER 31, 2005 CERTIFICATION OF CHIEF FINANCIAL OFFICER Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 I, Amy E. Essex, certify that: (1) I have reviewed this annual report on Form 10-KSB of First Federal of Northern Michigan Bancorp, Inc.; (2) Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; (3) Based on my knowledge, the financial statements and other financial information included in this annual report fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; (4) The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over reporting; and (5) The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. March 28, 2006 /s/ Amy E. Essex Date ---------------------------------------- Amy E. Essex Chief Financial Officer, Treasurer, and Corporate Secretary EX-32.1 7 k02777exv32w1.txt CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 906 EXHIBIT 32.1 STATEMENT FURNISHED PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002, The undersigned, Martin A. Thomson, is the Chief Executive Officer of First Federal of Northern Michigan Bancorp, Inc. (the "Company"). This statement is being furnished in connection with the filing by the Company of the Company's Annual Report on Form 10-KSB for the year ended December 31, 2005 (the "Report"). By execution of this statement, I certify that to the best of my knowledge: A) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a) or 78o(d)) and B) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of the dates and for the periods covered by the Report. This statement is authorized to be attached as an exhibit to the Report so that this statement will accompany the Report at such time as the Report is filed with the Securities and Exchange Commission pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350. It is not intended that this statement be deemed to be filed for purposes of the Securities Exchange Act of 1934, as amended. March 28, 2006 /s/ Martin A. Thomson Dated ---------------------------------------- Martin A. Thomson EX-32.2 8 k02777exv32w2.txt CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 906 EXHIBIT 32.2 STATEMENT FURNISHED PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002, The undersigned, Amy E. Essex, is the Chief Financial Officer of First Federal of Northern Michigan Bancorp, Inc. (the "Company"). This statement is being furnished in connection with the filing by the Company of the Company's Annual Report on Form 10-KSB for the year ended December 31, 2005 (the "Report"). By execution of this statement, I certify that to the best of my knowledge: A) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a) or 78o(d)) and B) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of the dates and for the periods covered by the Report. This statement is authorized to be attached as an exhibit to the Report so that this statement will accompany the Report at such time as the Report is filed with the Securities and Exchange Commission pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350. It is not intended that this statement be deemed to be filed for purposes of the Securities Exchange Act of 1934, as amended. March 28, 2006 /s/ Amy E. Essex Dated ---------------------------------------- Amy E. Essex -----END PRIVACY-ENHANCED MESSAGE-----