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FFNM > SEC Filings for FFNM > Form 10-Q on 14-Nov-2012All Recent SEC Filings

Show all filings for FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.

Form 10-Q for FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.


14-Nov-2012

Quarterly Report


ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion compares the consolidated financial condition of the Company at September 30, 2012 and December 31, 2011, and the results of operations for the three- and nine-month periods ended September 30, 2012 and 2011. This discussion should be read in conjunction with the interim financial statements and footnotes included herein.

OVERVIEW

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

For the quarter ended September 30, 2012, the Company reported net income of $273,000, or $0.09 per share, compared to $235,000 or $0.08 per share, for the year earlier period, an increase in earnings of $38,000. For the nine months ended September 30, 2012, net income was $604,000, or $0.21 per share, compared to $658,000, or $0.23 per share, for the nine months ended September 30, 2011.

Total assets decreased by $2.1 million, or 1.0%, to $214.9 million at September 30, 2012 from $217.0 million at December 31, 2011. Investment securities available-for-sale decreased by $565,000, or 1.1%, from December 31, 2011 to September 30, 2012. Net loans receivable decreased $2.5 million, or 1.8%, during that same time period. Foreclosed real estate and other repossessed assets decreased by $1.1 million from December 31, 2011 to September 30, 2012. Total deposits increased $8.0 million, or 5.3% from December 31, 2011 to September 30, 2012 while REPO sweep accounts decreased by $1.3 million, or 24.1%, and Federal Home Loan Bank advances decreased by $9.5 million or 27.5% from December 31, 2011 to September 30, 2012. Equity increased by $724,000, or 3.0%, to $25.3 million during the nine-month period ended September 30, 2012.

CRITICAL ACCOUNTING POLICIES

As of September 30, 2012, there have been no changes in the critical accounting policies as disclosed in the Company's Form 10-K for the year ended December 31, 2011. The Company's critical accounting policies are described in the Management's Discussion and Analysis and financial sections of its 2011 Annual Report. Management believes its critical accounting policies relate to the Company's allowance for loan losses, valuation of deferred tax assets and mortgage servicing rights.

COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2012 AND DECEMBER 31, 2011

ASSETS: Total assets decreased $2.1 million, or 1.0%, to $214.9 million at September 30, 2012 from $217.0 million at December 31, 2011. During that nine-month period the following changes occurred: investment securities available for sale decreased $565,000, or 1.1%, to $52.5 million; cash and cash equivalents increased $536,000 or 19.5% to $3.3 million; and net loans receivable decreased $2.5 million, or 1.8%, to $138.4 million. Mortgage loans decreased by $1.0 million despite our efforts to continue to grow this portfolio by retainingin our portfolio certain high-quality 10- and 15-year fixed rate residential mortgages as opposed to selling them in the secondary market. In addition, our consumer loan portfolio, consisting mainly of home equity loans, decreased by $2.0 million and our commercial loans increased by $778,000.

LIABILITIES: Deposits increased $8.0 million, or 5.3%, to $158.7 million at September 30, 2012 from $150.6 million at December 31, 2011. We experienced increases in the following deposit products as we continued our focus on growing core deposits: $2.5 million in money market accounts; $6.8 million in non-interest bearing checking accounts; $1.5 million in savings deposit accounts; and $1.5 million in NOW accounts. Offsetting these increases were decreases in the following: our certificates of deposit decreased by $1.8 million and our liquid certificates of deposit (from which customers can take a penalty-free withdrawal with seven days advance written notice) decreased by $2.5 million during this time period as we lowered interest rates on those products in step with the market. During this same time period, REPO sweep accounts decreased $1.3 million or 24.1% to $4.2 million due primarily to timing of our customers' cash needs. FHLB advances decreased $9.5 million, or 27.5%, to $25.0 million at September 30, 2012 from $34.5 million at December 31, 2011 due mainly to increases in our deposit base.

EQUITY: Stockholders' equity increased to $25.3 million at September 30, 2012 from $24.6 million at December 31, 2011, an increase of $724,000. The increase in stockholders' equity was mainly attributable to net income for the nine-month period of $604,000 and an increase of $119,000 in the unrealized gain on available for sale securities net of tax from $668,000 at December 31, 2011 to $787,000 at September 30, 2012.

RESULTS OF OPERATIONS

Three Months Ended September 30, 2012 Compared to Three Months Ended September 30, 2011

General: Net income increased by $38,000 to $273,000 for the three months ended September 30, 2012 from $235,000 for the same period ended September 30, 2011.

Interest Income: Interest income was $2.3 million for the three months ended September 30, 2012, compared to $2.6 million for the comparable period in 2011. The decrease in interest income was due primarily to two factors: a decrease in the average balance of our interest-earning assets resulting from a decrease in the size of our loan portfolio and a decrease in the yield on interest-earning assets due primarily to lower market interest rates. The average balance of non-mortgage loans decreased $5.1 million quarter over quarter, as we continued to experience a decline in loan originations due to economic conditions in our market areas. The average balance of mortgage loans increased $2.3 million period over period as we have continued to retain certain 10- and 15-year mortgages in our loan portfolio. The declines in loan portfolios were partially offset by an increase in average balances of AFS investment securities of $3.6 million fro the 2012 period versus the 2011 period. In addition to declines in our loan portfolios, the average yield on our interest-earning assets declined 49 basis points from 5.08% for the three-month period ended September 30, 2011 to 4.59% for the same period in 2012.

Interest Expense: Interest expense was $394,000 for the three-month period ended September 30, 2012, compared to $564,000 for the same period in 2011. The decrease in interest expense for the three-month period was due in part to a $10.7 million decrease in the average balance of our interest-bearing liabilities and a decrease in our overall cost of funds of 32 basis points period over period. Most notably, the average balance of our certificates of deposit decreased $6.5 million from the three-month period ended September 30, 2011 to the same period in 2012 and the cost of those deposits decreased 48 basis points period over period. In addition, the average balance of our FHLB advances decreased $3.5 million from the three-month period ended September 30, 2011 to the same period in 2012 and the cost of our FHLB advances decreased 20 basis points period over period.

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

                                         Quarter ended September 30, 2012
                                                    Compared to
                                         Quarter ended September 30, 2011
                                            Increase (Decrease) Due to:
                                      Volume            Rate            Total
                                              (dollars in thousands)
Interest-earning assets:
Loans receivable                     $     (41 )     $      (160 )     $  (201 )
Investment securities                        1               (85 )     $   (84 )
Other investments                          (10 )              20       $    10
Total interest-earning assets              (50 )            (225 )        (275 )

Interest-bearing liabilities:
Money Market/NOW accounts                    1               (16 )         (15 )
Certificates of Deposit                    (32 )             (85 )        (117 )
Deposits                                   (31 )            (101 )        (132 )
Borrowed funds                             (14 )             (24 )         (38 )
Total interest-bearing liabilities         (45 )            (125 )        (170 )

Change in net interest income        $      (5 )     $      (100 )     $  (105 )

Net Interest Income: Net interest income remained relatively steady at $1.9 million (a slight decrease of $105,000) for the three-month period ended September 30, 2012 as compared to the same period in 2011. For the three months ended September 30, 2012, average interest-earning assets decreased $1.9 million, or 1.0%, to $201.0 million when compared to the same period in 2011. Average interest-bearing liabilities decreased $10.7 million, or 5.9%, to $170.8 million for the quarter ended September 30, 2012 from $181.5 million for the quarter ended September 30, 2011 as we experienced a shift from interest-bearing to non-interest bearing deposits during this time period. The yield on average interest-earning assets decreased to 4.59% for the three month period ended September 30, 2012 from 5.08% for the same period ended in 2011. The cost of average interest-bearing liabilities decreased to 0.91% from 1.23% for the three-month periods ended September 30, 2012 and September 30, 2011, respectively. The net interest margin decreased 17 basis points to 3.81% for the three-month period ended September 30, 2012 from 3.98% for same period in 2011.

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

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

The provision for loan losses for the three-month period ended September 30, 2012 was $234,000 as compared to income of $67,000 for the prior year period. Prior to 2012, our provision for loan losses was based on an eight-quarter rolling average of actual net charge-offs adjusted for environmental factors for each segment of loans in our portfolio. Management has decided that eight quarters is no longer reflective of the inherent loss in the loan portfolios. In 2012, we began moving towards a twelve-quarter rolling average of actual net charge-offs by adding an additional quarter of net charge-offs each quarter in 2012. By the end of 2012 we will be using a twelve-quarter rolling average. The provision was based on management's review of the components of the overall loan portfolio, the status of non-performing loans and various subjective factors.

Non-Interest Income: Non-interest income increased to $803,000 for the three months ended September 30, 2012 from $469,000 for the three months ended September 30, 2011, related primarily to an increase of $223,000 in mortgage banking activities income period over period as mortgage origination activity picked up in the latter part of 2012. Additionally, gain on sale of investments increased by $47,000 period over period as we sold municipal bonds for credit reasons during the quarter ended September 30, 2012. Lastly, other income increased by $58,000 for the three months ended September 30, 2012 compared to the same period in 2011, mainly as the result of a $65,000 settlement of a lawsuit related to a troubled credit.

Non-Interest Expense: Non-interest expense was $2.1 million for the three-month period ended September 30, 2012 as compared to $2.3 million for the same period in 2011. Compensation and employee benefit expense increased by $115,000 period over period due in part to the addition of a commercial lender and Treasury Management professional in late 2011 and due to increased lender commissions as a result of increased mortgage originations period over period. In addition, amortization of intangible assets expense was $43,000 lower period over period and other expenses decreased by $271,000 due mostly to reduced expenses associated with problem loans and bank-owned properties. In addition we experienced decreases in occupancy of $25,000 and professional services of $19,000 during the three months ended September 30, 2012 as compared to the same period in 2011.

Income Taxes: During the first quarter of 2012 management determined that it was more likely than not than the Deferred Tax Assets would be utilized in future years, therefore it reduced the valuation allowance against its Deferred Tax Assets by $866,000. For the three-month period ended September 30, 2012, the Company earned $410,000 of pre-tax profit which resulted in $137,000 in income tax expense, as compared to no federal income tax expense for the same period in 2011, as the income tax expense incurred during the period reduced the Deferred Tax Asset.

Nine Months Ended September 30, 2012 Compared to Nine Months Ended September 30, 2011

General: Net income decreased by $54,000 to $604,000 for the nine months ended September 30, 2012 from $658,000 for the same period ended September 30, 2011. The decrease in earnings period over period was primarily attributable an increase in provision for loan losses of $1.2 million for the nine months ended September 30, 2012 as compared to income of $19,000 for the same period in 2011. The increased provision was partially offset by an increase in non-interest income of $328,000 and a decrease in non-interest expenses of $272,000 period over period.

Interest Income: Interest income was $7.1 million for the nine months ended September 30, 2012, compared to $7.9 million for the comparable period in 2011. This decrease of $798,000, or 10.1%, in interest income was due in large part to decreases of $8.9 million in average balances of mortgage loans period over period. In addition, the average yield on interest earning assets decreased 51 basis points to 4.70% for the nine-month period ended September 30, 2012 as compared to 5.21% for the same period in 2011.

Interest Expense: Interest expense was $1.3 million for the nine-month period ended September 30, 2012 compared to $1.8 million for the same period in 2011. The decrease in interest expense was due primarily to decreases in the average balance of and interest rates on our certificates of deposits period over period. We experienced a $6.8 million decrease in the average balance of certificates of deposits for the nine months ended September 30, 2012 when compared to the same period in 2011 and the average rate on those deposits decreased 50 basis points to 1.26% for the nine-month period ended September 30, 2012 as compared to the year-earlier period. In addition, our cost of funds relating to our FHLB advances decreased 25 basis points to 1.97% nine-month period over nine-month period.

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

                                             Nine Months ended September 30, 2012
                                                          Compared to
                                             Nine Months ended September 30, 2011
                                                  Increase (Decrease) Due to:
                                            Volume              Rate            Total
                                                    (dollars in thousands)
    Interest-earning assets:
    Loans receivable                     $       (391 )     $        (348 )     $ (739 )
    Investment securities                       1,810              (1,878 )        (68 )
    Other investments                             (34 )                43            9
    Total interest-earning assets               1,385              (2,183 )       (798 )

    Interest-bearing liabilities:
    Money Market/NOW accounts                      (4 )               (59 )        (63 )
    Certificates of Deposit                      (105 )              (265 )       (370 )
    Deposits                                     (109 )              (324 )       (433 )
    Borrowed funds                                 35                 (67 )        (32 )
    Total interest-bearing liabilities            (74 )              (391 )       (465 )

    Change in net interest income        $      1,459       $      (1,792 )     $ (333 )

Net Interest Income: Net interest income decreased by $333,000 to $5.8 million for the nine-month period ended September 30, 2012 compared to the same period in 2011. For the nine months ended September 30, 2012, average interest-earning assets decreased $1.0 million, or 0.5%, when compared to the same period in 2011. Average interest-bearing liabilities decreased $5.6 million, or 3.1%, for the same period. The yield on average interest-earning assets decreased to 4.70% for the nine months ended September 30, 2012 from 5.21% for the same period ended in 2011. The average cost of interest-bearing liabilities decreased to 0.98% from 1.30% for the nine month periods ended September 30, 2012 and September 30, 2011, respectively. The net interest rate margin decreased 21 basis points to 3.84% for the nine-month period ended September 30, 2012, from 4.05% for the same period in 2011.

Delinquent Loans and Nonperforming Assets: Nonperforming assets decreased by $1.4 million from December 31, 2011 to September 30, 2012 due primarily to sales of bank-owned properties during the nine months ended September 30, 2012.

                                                                   September 30,      December 31,
                                                                       2012               2011
                                                                       (Dollars in thousands)
Total non-accrual loans                                           $         2,827     $       3,101

Accrual loans delinquent 90 days or more:
One- to four-family residential                                               201               238
Other real estate loans                                                         0                 0
Construction                                                                    0                 0
Purchased Out-of-State                                                          0                 0
Commerical                                                                      -                 0
Consumer & other                                                               15                 -
Total accrual loans delinquent 90 days or more                    $           216     $         238

Total nonperforming loans (1)                                               3,043             3,339
Total real estate owned-residential mortgages (2)                             823             1,087
Total real estate owned-Commercial (2)                                        344             1,015
Total real estate owned-Consumer & other repossessed assets (2)             1,121             1,306
Total nonperforming assets                                        $         5,331     $       6,747

Total nonperforming loans to loans receivable                                2.17 %            2.35 %
Total nonperforming assets to total assets                                   2.48 %            3.11 %

(1) All of the Bank's loans delinquent more than 90 days are classified as nonperforming.

(2) Represents the net book value of property acquired by the Bank through foreclosure or deed in lieu of foreclosure. Upon acquisition, this property is recorded at the lower of its fair market value or the principal balance of the related loan.

Provision for Loan Losses: The provision for loan losses was $1.2 million for the nine-month period ended September 30, 2012 as compared to income of $19,000 for the comparable period in 2011. As discussed above in the discussion for the three-month period ended September 30, 2012, our provision for loan losses is based on an eleven-quarter rolling average of actual net charge-offs adjusted for various environmental factors for each pool of loans in our portfolio. During the nine-month period ended September 30, 2012, we added specific reserves of approximately $170,000 on two commercial credit relationships, one of which was reclassified as Troubled Debt Restructurings, had net charge-offs of approximately $250,000 on commercial credits, increased the general reserve factor applied to the entire portfolio of residential mortgages as a result of increased charge-off history in 2012, and increased our general reserve pool for special mention and substandard commercial credits based on the inherent increased risk in those credits. The provision was based on management's review of the components of the overall loan portfolio, the status of non-performing loans and various subjective factors.

The following table sets forth our delinquent and non-accrual loans at the dates indicated:

                                                                   Delinquent
                                                   Portfolio          Loans          Non-Accrual
                                                    Balance       Over 90 Days          Loans
                                                              (dollars in thousands)
At September 30, 2012
Real estate loans:
Construction                                      $     1,092     $           -     $         173
One - to four - family                                 64,947               201             1,556
Commercial Mortgages                                   53,081                 -               975
Home equity lines of credit/ Junior liens              11,562                 -               122
Commercial loans                                        8,414                 -                 -
Consumer loans                                          1,275                15                 1

Total gross loans                                     140,371               216             2,827
Less:
Net deferred loan fees.                                  (314 )              (1 )              (3 )
Allowance for loan losses                              (1,684 )               -               (76 )
Total loans, net                                  $   138,373     $         215     $       2,748

At December 31, 2011
Real estate loans:
Construction                                      $       762     $           -     $         173
One - to four - family                                 66,101               282             2,420
Commercial Mortgages                                   53,938                82               356
Home equity lines of credit/Junior liens               13,395                 -               148
Commercial loans                                        7,002                 -                 -
Consumer loans                                          1,477                 2                 4

Total gross loans                                     142,675               366             3,101
Less:
Net deferred loan fees                                   (273 )              (1 )              (7 )
Allowance for loan losses                              (1,518 )               -              (261 )
Total loans, net                                  $   140,884     $         365     $       2,833

Non-Interest Income: Non-interest income was $1.6 million for the nine-month period ended September 30, 2012, an increase of $329,000 or 25.1%, from the same period in 2011. The nine-month results in 2012 reflected an increase of $239,000 in mortgage banking activities due to sustained low mortgage rates which have increased refinance activity and also as a result of a small uptick in home sales in our markets, $47,000 gain on sale of investments as a result of the sale of municipal bond due to credit concerns, and a $49,000 increase in other income mainly as the result of receiving settlement proceeds on a lawsuit related to a troubled credit.

Non-Interest Expense: Non-interest expense decreased to $6.5 million for the nine months ended September 30, 2012 from $6.8 million for the nine months ended September 30, 2011. For the nine-month period ended September 30, 2012 we reduced other expense by $312,000 mainly related to lower costs associated with problem loans and bank-owned properties. Period over period we also experienced decreases in occupancy costs of $83,000 due mainly to decreases in depreciation expense and equipment maintenance, amortization of intangible assets of $72,000 and FDIC premiums of $35,000 due in part to improvement in our risk profile. These decreases were partially offset by an increase in compensation and employee expense of $235,000, as we added a commercial lender and Treasury Management professional and as lender commissions increased due to increased mortgage origination activity.

Income Taxes: A valuation allowance is provided against deferred tax assets when it is more likely than not that some or all of the deferred tax asset will not be realized. At March 31, 2012, management evaluated the Company's valuation allowance related to its deferred tax asset. An analysis of the deferred tax asset was made to determine the utilization of those tax benefits based upon projected future taxable income. Based upon management's determination and in accordance with the generally accepted accounting principles, management concluded that the utilization of this asset was "more likely than not." Accordingly, at March 31, 2012, $866,000 of the valuation allowance was credited to income tax expense. Among the criteria that management considered in evaluating the deferred tax asset were: improved core profitability of the Bank in 2010 and 2011; substantial improvement over the past two years in non-performing assets, which were driving losses in prior years; and positive forecast for taxable income looking forward over the next three years. A valuation allowance of $2.2 million remains on $3.4 million of the current deferred tax asset at September 30, 2012.

The valuation of deferred tax assets is a subjective calculation. Management reviewed several factors in determining the value of deferred tax assets the Company expects to realize over the next three years, including:

For the three months ended September 30, 2012, we had pre-tax income of $410,000, and fully expect that trend to continue in future quarters.

The level of our non-performing assets has decreased from $7.9 million at September 30, 2011 to $6.7 million at December 31, 2011 to $5.3 million at September 30, 2012. We expect that trend to continue, which will have a positive impact on earnings in future quarters.

We sold our two largest pieces of REO property at the end of 2011, therefore future earnings will not be burdened with carrying costs on those properties.

As of September 30, 2012 the Company had a net operating loss carryforward for tax purposes of approximately $10.0 million and related deferred tax asset of $3.4 million. The Company will continue to evaluate the future benefits from these carryforwards and at such time as it becomes "more likely than not" that they would be utilized prior to expiration, the Company will recognize the additional benefits as an adjustment to the valuation allowance. The net . . .

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