UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-Q

x
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2009

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

For the transition period from___________________________ to___________________________

Commission File Number 000-31957

FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
(Exact name of registrant as specified in its charter)

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

100 S. Second Avenue, Alpena, Michigan   49707
   (Address of principal executive offices)       (Zip Code)

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

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

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

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

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

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

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

Common Stock, Par Value $0.01
 
Outstanding at November 16, 2009
(Title of Class)
 
2,884,249 shares

 
 

 

FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-Q
Quarter Ended September 30, 2009

INDEX
 
 
PAGE
PART I – FINANCIAL INFORMATION
 
ITEM 1  - UNAUDITED FINANCIAL STATEMENTS
 
Consolidated Balance Sheet at September 30, 2009 and December 31, 2008
3
Consolidated Statements of Income for the Three and Nine Months
 
Ended September 30, 2009 and September 30, 2008
4
Consolidated Statement of Changes in Stockholders’ Equity
 
for the Nine Months Ended September 30, 2009
5
Consolidated Statements of Cash Flows for the Nine Months Ended
 
September 30, 2009 and September 30, 2008
6
Notes to Unaudited Consolidated Financial Statements
7
   
ITEM 2  -  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
16
   
ITEM 3 – QUANTITATIVE AND QUALITIATIVE DISCLOSURES ABOUT MARKET RISK
23
   
ITEM 4T  -  CONTROLS AND PROCEDURES
23
   
Part II  -  OTHER INFORMATION
 
ITEM 1  -  LEGAL PROCEEDINGS
24
ITEM 1A - RISK FACTORS
24
ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
24
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
24
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
24
ITEM 5 - OTHER INFORMATION
24
ITEM 6 - EXHIBITS
24
Section 302 Certifications
 
Section 906 Certifications
 

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

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

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

 
2

 

PART I - FINANCIAL INFORMATION

ITEM 1 - FINANCIAL STATEMENTS

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Consolidated Balance Sheet


   
September 30, 2009
   
December 31, 2008
 
   
(Unaudited)
       
ASSETS
           
Cash and cash equivalents:
           
Cash on hand and due from banks
  $ 2,212,553     $ 3,097,788  
Overnight deposits with FHLB
    64,036       372,523  
Total cash and cash equivalents
    2,276,589       3,470,311  
Securities AFS
    32,879,094       25,665,178  
Securities HTM
    3,980,434       4,022,235  
Loans held for sale
    50,000       107,000  
Loans receivable, net of allowance for loan losses of $4,309,341 and $5,647,055 as of September 30, 2009 and December 31, 2008, respectively
    178,737,529       192,270,714  
Foreclosed real estate and other repossessed assets
    3,535,684       1,637,923  
Federal Home Loan Bank stock, at cost
    4,196,900       4,196,900  
Premises and equipment
    6,779,358       7,089,746  
Accrued interest receivable
    1,368,598       1,469,176  
Intangible assets
    992,869       1,192,853  
Other assets
    4,613,876       4,939,523  
Assets of discontinued operation
    -       1,610,734  
Total assets
  $ 239,410,931     $ 247,672,293  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Liabilities:
               
Deposits
  $ 156,358,009     165,778,598  
Advances from borrowers for taxes and insurance
    188,965       104,475  
Federal Home Loan Bank Advances
    46,750,000       40,200,000  
Note Payable
    630,927       768,651  
REPO sweep accounts
    6,872,443       9,447,415  
Accrued expenses and other liabilities
    2,651,190       1,877,600  
Liabilities of discontinued operations
    -       76,792  
                 
Total liabilities
    213,451,534       218,253,531  
                 
Stockholders' equity:
               
Common stock ($0.01 par value 20,000,000 shares authorized 3,191,999 shares issued)
    31,920       31,920  
Additional paid-in capital
    24,299,147       24,302,102  
Retained earnings
    5,087,238       8,762,412  
Treasury stock at cost (307,750 shares)
    (2,963,918 )     (2,963,918 )
Unallocated ESOP
    (683,861 )     (764,861 )
Unearned compensation
    (192,839 )     (286,324 )
Accumulated other comprehensive income
    381,710       337,431  
Total stockholders' equity
    25,959,397       29,418,762  
                 
Total liabilities and stockholders' equity
  $ 239,410,931     $ 247,672,293  

See accompanying notes to consolidated financial statements.

 
3

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Consolidated Statement of Income

   
For the Three Months
   
For the Nine Months
 
   
Ended September 30,
   
Ended September 30,
 
   
2009
   
2008
   
2009
   
2008
 
   
(Unaudited)
   
(Unaudited)
 
Interest income:
                       
Interest and fees on loans
  $ 2,762,789     $ 3,156,924     $ 8,570,404     $ 9,575,347  
Interest and dividends on investments
    211,720       248,386       584,788       764,630  
Interest on mortgage-backed securities
    136,177       119,501       430,928       265,793  
Total interest income
    3,110,686       3,524,810       9,586,120       10,605,770  
                                 
Interest expense:
                               
Interest on deposits
    795,356       1,275,690       2,736,532       3,811,954  
Interest on borrowings
    422,715       532,247       1,279,247       1,653,578  
Total interest expense
    1,218,071       1,807,937       4,015,779       5,465,532  
                                 
Net interest income
    1,892,615       1,716,873       5,570,341       5,140,238  
Provision for loan losses
    2,976,642       875,431       3,492,711       1,242,665  
Net interest (expense) income after provision for loan losses
    (1,084,027 )     841,442       2,077,630       3,897,573  
                                 
Non-interest income:
                               
Service charges and other fees
    217,159       245,162       661,488       708,447  
Mortgage banking activities
    244,550       85,665       1,167,626       316,382  
Gain on sale of available-for-sale investments
    -       -       1,227       16,052  
Net gain (loss) on sale of premises and equipment, real estate owned and other repossessed assets
    (2,128 )     5,403       25,350       28,497  
Other
    16,637       18,076       67,997       66,108  
Insurance & brokerage commissions
    15,157       45,000       129,797       135,000  
Total non-interest income
    491,375       399,307       2,053,486       1,270,486  
                                 
Non-interest expenses:
                               
Compensation and employee benefits
    1,095,509       1,203,733       3,414,767       3,654,827  
FDIC insurance premiums
    106,199       33,443       376,807       85,238  
Advertising
    31,784       40,118       93,655       98,914  
Occupancy
    294,567       299,616       897,054       950,952  
Amortization of intangible assets
    73,113       77,122       199,983       231,367  
Service bureau charges
    76,533       72,432       255,043       240,518  
Professional services
    93,588       112,057       359,711       309,231  
Other
    305,341       319,303       962,826       889,820  
Total non-interest expenses
    2,076,634       2,157,824       6,559,846       6,460,867  
                                 
Loss from continuing operations before income tax benefit
    (2,669,286 )     (917,075 )     (2,428,731 )     (1,292,808 )
Income tax expense (benefit) from continuing operations
    1,148,845       (307,073 )     1,200,585       (432,643 )
Net loss from continuing operations
    (3,818,131 )     (610,002 )     (3,629,316 )     (860,165 )
                                 
Loss from discontinued operations, net of income tax benefit of $0, $12,741, $43,209, and $29,745, respectively
    -       (24,733 )     (83,875 )     (57,215 )
Gain on sale of discontinued operations, net of income tax expense of $0, $0, $19,585 and $0, respectively
    -       -       38,017       -  
                                 
Net loss
  $ (3,818,131 )   $ (634,735 )   $ (3,675,174 )   $ (917,380 )
                                 
Per share data:
                               
Loss per share from continuing operations
                               
Basic
  $ (1.32 )   $ (0.21 )   $ (1.26 )   $ (0.30 )
Diluted
  $ (1.32 )   $ (0.21 )   $ (1.26 )   $ (0.30 )
Income (loss) per share from discontinued operations
                               
Basic
  $ -     $ (0.01 )   $ (0.01 )   $ (0.02 )
Diluted
  $ -     $ (0.01 )   $ (0.01 )   $ (0.02 )
Net loss per share
                               
Basic
  $ (1.32 )   $ (0.22 )   $ (1.27 )   $ (0.32 )
Diluted
  $ (1.32 )   $ (0.22 )   $ (1.27 )   $ (0.32 )
                                 
Dividends per common share
  $ -     $ 0.05     $ -     $ 0.15  

See accompanying notes to consolidated financial statements.

 
4

 

First Federal of Northern Michigan Bancorp Inc. and Subsidiaries
Consolidated Statement of Changes in Stockholders' Equity (Unaudited)

                                       
Accumulated
       
               
Additional
                     
Other
       
   
Common
   
Treasury
   
Paid-in
   
Unearned
   
Retained
   
Unallocated
   
Comprehensive
       
   
Stock
   
Stock
   
Capital
   
Compensation
   
Earnings
   
ESOP
   
Income
   
Total
 
                                                 
Balance at December 31, 2008
  $ 31,920     $ (2,963,918 )   $ 24,302,102     $ (286,324 )   $ 8,762,412     $ (764,861 )   $ 337,431     $ 29,418,762  
                                                                 
Stock Options/Awards Expensed
    -       -       64,924       93,485       -       -       -       158,409  
                                                                 
ESOP common stock committed to be released
    -       -       (67,879 )     -       -       81,000       -       13,122  
                                                                 
Net loss for the period
    -       -       -       -       (3,675,174 )     -       -       (3,675,174 )
                                                                 
Changes in unrealized gain:
                                                               
on available-for-sale securities (net of tax of $22,810)
    -       -       -       -       -       -       44,279       44,279  
                                                                 
Total comprehensive loss
    -       -       -       -       -       -       -       (3,630,895 )
                                                                 
Balance at September 30, 2009
  $ 31,920     $ (2,963,918 )   $ 24,299,147     $ (192,839 )   $ 5,087,238     $ (683,861 )   $ 381,710     $ 25,959,397  

See accompanying notes to the consolidated financial statements.

 
5

 

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Consolidated Statement of Cash Flows

   
For Nine Months Ended
 
   
September 30,
 
   
2009
   
2008
 
   
(Unaudited)
 
Cash Flows from Operating Activities:
           
Net loss
  $ (3,675,174 )   $ (917,380 )
Adjustments to reconcile net loss to net cash from operating activities:
               
Depreciation and amortization
    624,223       769,562  
Provision for loan loss
    3,492,711       1,242,665  
Amortization and accretion on securities - net
    50,224       46,831  
Gain on sale of  investment securities
    (1,227 )     (16,052 )
ESOP contribution
    13,122       49,668  
Stock awards/options
    158,409       172,611  
Gain on sale of loans held for sale
    (492,288 )     (86,166 )
Originations of loans held for sale
    (42,604,156 )     (8,800,236 )
Proceeds from sale of loans held for sale
    43,153,444       8,518,680  
Gain on sale of fixed assets
    (47,974 )     (28,496 )
Change in accrued interest receivable
    100,578       113,612  
Change in deferred tax assets
    1,117,022       (612,860 )
Change in other assets
    (814,186 )     (872,642 )
Change in accrued expenses and other liabilities
    773,590       (763,145 )
Net cash provided by (used for) operating activities
    1,848,318       (1,183,348 )
                 
Cash Flows from Investing Activities:
               
Net decrease in loans
    6,694,579       5,595,432  
Proceeds from maturity and sale of available-for-sale securities
    10,072,221       16,270,097  
Proceeds from sale of property and equipment and repossessed assets
    1,501,066       1,522,688  
Net change in discontinued operations
    1,533,942       294,537  
Purchase of securities
    (17,226,243 )     (21,186,165 )
Purchase of premises and equipment
    (118,810 )     (269,109 )
Net cash provided by investing activities
    2,456,755       2,227,480  
                 
Cash Flows from Financing Activities:
               
Net (decrease) increase in deposits
    (9,420,589 )     7,734,741  
Dividend paid on common stock
    -       (432,637 )
Net (decrease) increase in Repo Sweep accounts
    (2,574,972 )     4,145,540  
Net increase in advances from borrowers
    84,490       165,364  
Advances  from Federal Home Loan Bank
    55,560,000       12,200,000  
Repayments of Federal Home Loan Bank advances and notes payable
    (49,147,724 )     (18,915,144 )
Net cash (used for) provided by financing activities
    (5,498,795 )     4,897,864  
                 
Net (decrease) increase in cash and cash equivalents
    (1,193,722 )     5,941,996  
Cash and cash equivalents at beginning of period
    3,470,311       5,340,857  
Cash and cash equivalents at end of period
  $ 2,276,589     $ 11,282,853  
                 
Supplemental disclosure of cash flow information:
               
Cash paid during the period for income taxes
  $ -     $ -  
Cash paid during the period for interest
  $ 4,197,740     $ 5,615,901  

See accompanying notes to the consolidated financial statements.

 
6

 

FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1—BASIS OF FINANCIAL STATEMENT PRESENTATION.

The accompanying unaudited condensed consolidated interim financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and with the instructions to Form 10-Q. Accordingly, certain information and disclosures required by accounting principles generally accepted in the United States of America for complete financial statements are not included herein. The interim financial statements should be read in conjunction with the financial statements of First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries and the notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2008.

All adjustments, consisting only of normal recurring adjustments, which in the opinion of management are necessary for a fair presentation of financial position, results of operations and cash flows, have been made. The results of operations for the three and nine months ended September 30, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009.

In accordance with FASB ASC 855, Subsequent Events, we have evaluated subsequent events though the date of this filing. We do not believe there are any material subsequent events which would require further disclosure.

Note 2— PRINCIPLES OF CONSOLIDATION AND DISCONTINUED OPERATIONS.

The consolidated financial statements include the accounts of First Federal of Northern Michigan Bancorp, Inc., First Federal of Northern Michigan (the “Bank”), and the Bank’s wholly owned subsidiaries, Financial Services & Mortgage Corporation (“FSMC”) and FFNM Agency. FSMC invests in real estate, which includes leasing, selling, developing, and maintaining real estate properties. The main activity of FFNM Agency is to collect the stream of income associated with the sale of the Blue Cross/Blue Shield override business to the Grotenhuis Group (as discussed further below).  All significant intercompany balances and transactions have been eliminated in the consolidation.

On February 27, 2009 First Federal of Northern Michigan Bancorp, Inc.  announced that it had sold the InsuranCenter of Alpena (“ICA”) for $1,635,000. As a result, the financial position and results of operations of ICA are removed from the detail line items in the Company’s condensed consolidated financial statements and presented separately as “discontinued operations.” For further information, please refer to Note 15 of the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.

As a result of the transaction, the Company reduced its full-time employees by 14 positions, or 13% of the Company’s workforce.   The Company expects the sale will reduce its non-interest expense by approximately $1.2 million in fiscal year 2009.

The Company recorded a gain of approximately $38,000, net of tax benefit, upon the closing of the sale. The Company retained the residual income stream associated with the April 2008 sale of its wholesale Blue Cross/Blue Shield override business to the Grotenhuis Group.

 
7

 

Note 3—LOANS.

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

   
At September 30,
   
At December 31,
 
   
2009
   
2008
 
   
(in thousands)
 
Real estate loans:
           
Residential mortgage
  $ 83,135     $ 92,364  
                 
Commercial loans:
               
Secured by real estate
    60,206       49,787  
Other
    17,391       30,173  
Total commercial loans
    77,597       79,960  
                 
Consumer loans:
               
Secured by real estate
    19,778       22,303  
Other
    2,833       3,564  
Total consumer loans
    22,611       25,867  
                 
Total gross loans
  $ 183,343     $ 198,191  
                 
Less:
               
Net deferred loan fees
    (296 )     (274 )
Allowance for loan losses
    (4,309 )     (5,647 )
                 
Total loans, net
  $ 178,738     $ 192,270  

Note 4—DIVIDENDS.

The Company suspended its quarterly dividend effective for the quarter ended December 31, 2008. The Company is dependent primarily upon the Bank for earnings and funds to pay dividends on common stock. Any reinstatement of dividends in the future will depend, in large part, on the Bank's earnings, capital requirements, financial condition and other factors considered by the Board of Directors of the Company.  The payment of dividends also is subject to legal and regulatory restrictions. Any reinstatement of dividends, or stock repurchase, would require regulatory approval for a dividend from the Bank to the Company to fund the liquidity necessary to reinstate dividends or initiate a stock repurchase.  We have made application for such a dividend but have been unsuccessful in getting regulatory approval due to a conservative regulatory posture regarding retaining capital at the Bank level  in this economic environment.

Note 5 – 1996 STOCK OPTION PLAN AND 2006 STOCK-BASED INCENTIVE PLAN.

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

During the three and nine months ended September 30, 2009 the Company awarded no shares under the 2006 Stock-Based Incentive Plan.  Shares issued under the 2006 Plan and exercised pursuant to the exercise of stock options may be either authorized but unissued shares or reacquired shares held by the Company as treasury stock.
 
8

 
 
Stock Options - A summary of option activity under the Plan during the nine months ended September 30, 2009 is presented below:


               
Weighted-Average
       
         
Weighted-
   
Remaining
       
         
Average
   
Contractual Term
   
Aggregate
 
Options
 
Shares
   
Exercise Price
   
(Years)
   
Intrinsic Value
 
                         
Outstanding at January 1, 2009
    192,132     $ 9.48                  
                                 
Granted
    0       N/A                  
                                 
Exercised
    0       N/A                  
                                 
Forfeited or expired
    (3,850 )   $ 9.57                  
                                 
Oustanding at September 30, 2009
    188,282     $ 9.47       6.51     $ 0  
                                 
Options Exercisable at September 30, 2009
    114,806     $ 9.44       6.67     $ 0  

A summary of the status of the Company’s nonvested options as of September  30, 2009, and changes during the nine months ended September 30, 2009, is presented below:

         
Weighted-Average
 
         
Grant-Date
 
Nonvested Shares
 
Shares
   
Fair Value
 
             
Nonvested at January 1, 2009
    111,774     $ 2.11  
                 
Granted
    0       N/A  
                 
Vested
    (36,368 )   $ 2.50  
                 
Forfeited
    (1,930 )   $ 2.10  
                 
Nonvested at September 30, 2009
    73,476     $ 2.12  

As of September 30, 2009 there was $140,000 of total unrecognized compensation cost, net of expected forfeitures, related to nonvested options under the Plans. That cost is expected to be recognized over a weighted-average period of 1.7 years. The total fair value of shares vested during the nine months ended September 30, 2009 was $60,334.

Restricted Stock Awards - As of September 30, 2009 there was $200,000 of unrecognized compensation cost related to nonvested restricted stock awards under the 2006 Plan. That cost is expected to be recognized over a weighted-average period of 1.7 years.

Note 6 – COMMITMENTS TO EXTEND CREDIT

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

At September 30, 2009, the Company had outstanding commitments to originate loans of $29.4 million. These commitments included $9.1 million for permanent one-to-four family dwellings, $3.7 million for non-residential loans, $400,000  of undisbursed loan proceeds for construction of one-to-four family dwellings, $4.5 million of undisbursed lines of credit on home equity loans, $1.2 million of unused credit card lines, $8.7 million of unused commercial lines of credit, $770,000 of undisbursed commercial construction, $5,000 of unused letters of credit and $1.1 million in unused bounce protection.

 
9

 

Note 7 – SEGMENT REPORTING

The Company’s principal activities include banking through its wholly owned subsidiary, First Federal of Northern Michigan, and the sale of insurance products through its indirect 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 receives commissions from the sale of various insurance products including health, life, and property. The segments were determined based on the nature of the products provided to customers.

The financial information for each operating segment is reported on the basis used internally to evaluate performance and allocate resources. The allocations have been consistently applied for all periods presented.  Revenues and expenses between affiliates have been transacted at rates that unaffiliated parties would pay.  The only transaction between the segments thus far relates to a deposit on behalf of 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.

As noted above, the majority of the assets of the Company’s segment, ICA, were sold on February 27, 2009; therefore no segment information is reported for the three-month period ended September 30, 2009.

   
For the Three Months Ended
 
   
September 30, 2008
 
   
(Dollars in Thousands)
 
   
Bank
   
ICA
   
Eliminations
   
Total
 
Interest Income
  $ 3,525     $ 9     $ (9 )   $ 3,525  
Interest Expense
    1,817       -       (9 )     1,808  
Net Interest Income - Before provision for loan losses
    1,708       9       -       1,717  
Provision for Loan Losses
    875       -       -       875  
Net Interest Income - After provision for loan losses
    833       9       -       842  
Other Income
    352       300       -       652  
Operating Expenses
    2,118       330       -       2,448  
Loss -  Before federal income tax benefit
    (933 )     (21 )     -       (954 )
Federal Income Tax expense (benefit)
    (313 )     (7 )     -       (319 )
Net loss
  $ (620 )   $ (14 )   $ -     $ (635 )
                                 
Depreciation and amortization
  $ 186     $ 86     $ -     $ 272  
Assets
  $ 250,044     $ 5,350     $ (1,152 )   $ 254,242  
Expenditures related to long-lived assets:
                               
Goodwill
  $ -     $ -     $ -     $ -  
Intangible assets
    -       -       -       -  
Property and equipment
    141       -       -       141  
Total
  $ 141     $ -     $ -     $ 141  

 
10

 

   
For the Nine Months Ended
 
   
September 30, 2009
 
   
(Dollars in Thousands)
 
   
Bank
   
ICA
   
Eliminations
   
Total
 
Interest Income
  $ 9,586     $ 4     $ (4 )   $ 9,586  
Interest Expense
    4,016       4       (4 )     4,016  
Net Interest Income - Before provision for loan losses
    5,570       -       -       5,570  
Provision for Loan Losses
    3,493       -       -       3,493  
Net Interest Income - After provision for loan losses
    2,078       -       -       2,078  
Other Income
    2,073       191       -       2,264  
Operating Expenses
    6,548       292       -       6,840  
Loss -  Before federal income tax benefit
    (2,397 )     (101 )     -       (2,498 )
Federal Income Tax expense (benefit)
    1,212       (34 )     -       1,178  
Net loss
  $ (3,609 )   $ (67 )   $ -     $ (3,676 )
                                 
Depreciation and amortization
  $ 577     $ 47     $ -     $ 624  
Assets
  $ 239,411     $ -     $ -     $ 239,411  
Expenditures related to long-lived assets:
                               
Goodwill
  $ -     $ -     $ -     $ -  
Intangible assets
    -       -       -       -  
Property and equipment
    119       -       -       119  
Total
  $ 119     $ -     $ -     $ 119  

   
For the Nine Months Ended
 
   
September 30, 2008
 
   
(Dollars in Thousands)
 
   
Bank
   
ICA
   
Eliminations
   
Total
 
Interest Income
  $ 10,606     $ 31     $ (31 )   $ 10,606  
Interest Expense
    5,497       -       (31 )     5,466  
Net Interest Income - Before provision for loan losses
    5,109       31       -       5,140  
Provision for Loan Losses
    1,242       -       -       1,242  
Net Interest Income - After provision for loan losses
    3,867       31       -       3,898  
Other Income
    1,131       1,321       -       2,452  
Operating Expenses
    6,335       1,394       -       7,729  
Loss -  Before federal income tax benefit
    (1,337 )     (42 )     -       (1,379 )
Federal Income Tax expense (benefit)
    (448 )     (14 )     -       (462 )
Net loss
  $ (889 )   $ (28 )   $ -     $ (917 )
                                 
Depreciation and amortization
  $ 561     $ 186     $ -     $ 747  
Assets
  $ 250,044     $ 5,350     $ (1,152 )   $ 254,242  
Expenditures related to long-lived assets:
                               
Goodwill
  $ -     $ -     $ -     $ -  
Intangible assets
    -       -       -       -  
Property and equipment
    268       -       -       268  
Total
  $ 268     $ -     $ -     $ 268  

Note 8 - FAIR VALUE MEASUREMENTS.

FASB ASC 820-10Fair Value Measurements. The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring basis at September 30, 2009, and the valuation techniques used by the Company to determine those fair values.

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

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

Level 3 inputs are unobservable inputs, including inputs that are available in situations where there is little, if any, market activity for the related asset or liability.
 
 
11

 

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

Disclosures concerning assets and liabilities measured at fair value are as follows:

Assets and Liabilities Measured at Fair Value on a Recurring Basis at September 30, 2009
(Dollars in thousands)

   
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   
Significant Other
Observable Inputs
(Level 2)
   
Significant
Unobservable Inputs
(Level 3)
   
Balance at
September 30,
2009
 
Assets:
                       
Investment securities- available-for-sale
  $ -     $ 32,879     $ -     $ 32,879  
Liabilities:
                               
None
                               

The Company also has assets that under certain conditions are subject to measurement at fair value on a non-recurring basis. These assets include non-homogenous loans that are considered impaired and real estate owned. For impaired loans accounted for under FASB ASC 310-10, the Company has estimated the fair value using Level 3 inputs using discounted cash flow projections. Other Real Estate Owned consists of property received in full or partial satisfaction of a receivable. The Company utilizes independent appraisals or broker price opinions to estimate the fair value of these properties.

Assets Measured at Fair Value on a Nonrecurring Basis
(Dollars in thousands)

   
Balance at
September 30,
2009
   
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
   
Significant Other
Observable Inputs
(Level 2)
   
Significant
Unobservable
Inputs (Level 3)
   
Change in fair
value for the three-
month period
ended September
30, 2009
   
Change in fair
value for the
nine-month
period ended
September 30,
2009
 
                                     
Impaired loans accounted for under FASB ASC 310-10
  $ 7,155     $ -     $ -     $ 7,155     $ 911     $ 2,610  
                                                 
Other real estate owned -residential mortgages
  $ 512     $ -     $ -     $ 512     $ 22     $ 59  
                                                 
Other Real estate owned - commercial
  $ 3,023     $ -     $ -     $ 3,023     $ 592     $ 622  
                                                 
Mortgage servicing rights
  $ 703     $ -     $ -     $ 703     $ -     $ -  
                                                 
Mortgage loans held for sale
  $ 50     $ -     $ 50     $ -     $ -     $ -  

Mortgage Servicing Rights: Mortgage servicing rights represent the value associated with servicing residential mortgage loans. The value is determined through a discounted cash flow analysis which uses prepayment speed, interest rate, delinquency level and other assumptions as inputs. All of these assumptions require a significant degree of management judgment. Adjustments are only made when the discounted cash flows are less than the carrying value. As such, the Company classifies mortgage servicing rights as nonrecurring Level 3.

Mortgage Loans Held For Sale: Mortgage loans held for sale are recorded at the lower of carrying value or fair value. The fair value of mortgage loans held for sale is determined through forward commitments which the Company enters to sell these loans to secondary market counterparties.  As such, the Company classifies mortgage loans held for sale as nonrecurring Level 2.

 
12

 

Impaired Loans: The Company does not record loans at fair value on a recurring basis. However, on occasion, a loan is considered impaired and an allowance for loan loss is established.  A loan is considered impaired when it is probable that all of the principal and interest due under the original terms of the loan may not be collected.  Once a loan is identified as individually impaired, management measures impairment in accordance with FASB ASC 310-10, Accounting by Creditors for Impairment of a Loan. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans.  In accordance with FASB ASC 820-10, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.

Other Real Estate Owned: At the time of acquisition, other real estate owned  is recorded at fair value, less estimated costs to sell, which becomes the property's new basis. Subsequent write-downs to reflect declines in value since the time of acquisition may occur from time to time and are recorded in other expense in the consolidated statements of operations. The fair value of the property used at and subsequent to the time of acquisition is typically determined by a third party appraisal of the property (nonrecurring Level 3).

Investment Securities Held to Maturity: The Company does not record investment securities held to maturity at fair value on a recurring basis.  Therefore, when certain securities held to maturity were measured at fair value as discussed below, the Company’s municipal bonds classified as held to maturity are fair valued using a discount rate adjustment technique utilizing an imputed discount rate between current market interest rate spreads and market interest rate spreads at the approximate last date an active market existed for the these securities.  Relevant inputs to the model include market spread data in consideration of credit characteristics, collateral type, credit rating and other relevant features.  Where quoted prices are not available, fair values are measured using independent matrix pricing models, or other model-based valuation techniques such as the present value of future cash flows, requiring adjustments for factors such as prepayment speeds, liquidity risk, default rates, credit loss and the security’s credit rating.  In instances where market action is inactive or inputs to the valuation are more opaque, securities are classified as nonrecurring Level 3 within the valuation hierarchy.  Therefore, when management determines the fair value of an impaired held to maturity security through utilization of this type of model, the Company records the impaired security as nonrecurring Level 3

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.  FASB ASC 825-10 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.

 
13

 

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 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.

REPO Sweep Accounts: The fair values disclosed for REPO Sweeps are equal to the amount payable on demand at the reporting date (i.e., their carrying amounts).

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.

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:

   
September 30, 2009
   
December 31, 2008
 
   
Carrying
Amounts
   
Estimated
Fair Value
   
Carrying
Amounts
   
Estimated
Fair Value
 
                         
Financial assets:
                       
Cash and cash equivalents
  $ 2,277     $ 2,277     $ 3,471     $ 3,471  
Securities available for sale
    32,879     $ 32,879     $ 25,665     $ 25,665  
Securities held to maturity
    3,980       4,127       4,022       3,949  
Loans and loans held for sale - Net
    179,184       179,823       192,377       197,804  
Federal Home Loan Bank stock
    4,197       4,197       4,197       4,197  
Accrued interest receivable
    1,369       1,369       1,469       1,469  
                                 
Financial liabilities:
                               
Customer deposits
    156,358       157,083       165,778       166,931  
Federal Home Loan Bank advances
    46,750       47,436       40,200       41,688  
Note payable
    631       634       769       773  
REPO sweep accounts
    6,872       6,657       9,447       9,447  
Accrued interest payable
    340       340       518       518  

Note 9 – RECENT ACCOUNTING PRONOUNCEMENTS.

In June 2009, the Financial Accounting Standards Board (FASB) issued SFAS No. 168, The FASB Accounting Standards Codification™ and the Hierarchy of Generally Accepted Accounting Principles — a replacement of FASB Statement No. 162. SFAS No. 168 establishes the FASB Accounting Standard Codification™ (Codification) as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with generally accepted accounting principles in the United States (U.S. GAAP). All guidance contained in the Codification carries an equal level of authority. The Codification does not change current U.S. GAAP, but is intended to simplify user access to all authoritative U.S. GAAP by providing all the authoritative literature related to a particular topic in one place. On the effective date of SFAS No. 168, the Codification will supersede all then-existing non-SEC accounting and reporting standards. All other non-grandfathered non-SEC accounting literature not included in the Codification will become non-authoritative. The Codification is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The implementation of the Codification during the quarter ended September 30, 2009 had no impact on the Company’s results of operations or financial position. However, as a result of implementation of the Codification, previous references to new accounting standards and literature are no longer applicable. All future references to authoritative accounting literature in our consolidated financial statements will be referenced in accordance with the Codification.

 
14

 

In April, 2009, the FASB finalized three FASB Staff Positions (“FSPs”) regarding the accounting treatment for investments including mortgage-backed securities. These FSPs changed the method for determining if an other-than-temporary impairment (“OTTI”) exists and the amount of OTTI to be recorded through an entity’s income statement. The changes brought about by the FSPs provide greater clarity and reflect a more accurate representation of the credit and noncredit components of an OTTI event. The three FSPs are as follows:
·
FASB ASC 820-10-65-4,  Fair Value Measurements and Disclosures provides guidelines for making fair value measurements that determine fair value when the volume and activity for assets or liabilities have significantly decreased and identify transactions that are not orderly.
·
FASB ASC 320-10-65,  Investments – Debt and Equity Securities provides additional guidance designed to create greater clarity and consistency in accounting for and presenting impairment losses on securities.
·
FASB ASC 825-10-65, Financial Instruments enhances consistency in financial reporting by increasing the frequency of fair value disclosures.

The adoption of these FSPs did not have a material effect on the Company’s results of operations or financial position.

In May 2009, FASB issued FASB ASC 855, Subsequent Events, which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before the financial statements are issued or are available to be issued. It requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date. FASB ASC 855 is effective for interim or annual financial periods ending after June 15, 2009. The adoption of this standard did not have any impact on the Company’s results of operations or financial position.

 
15

 

FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
AND SUBSIDIARIES

PART Ι  -  FINANCIAL INFORMATION

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

The following discussion compares the consolidated financial condition of the Company at September 30, 2009 and December 31, 2008, and the results of operations for the three- and nine-month periods ended September 30, 2009 and 2008.  This discussion should be read in conjunction with the interim financial statements and footnotes included herein.

OVERVIEW

The Company currently 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, 2009, the Company reported a net loss from continuing operations of $1.5 million compared to a net loss of $610,000 for the year earlier period, a decrease in earnings of $886,000.  For the nine months ended September 30, 2009, the net loss from continuing operations was $1.3 million compared to a net loss of $860,000 for the nine months ended September 30, 2008.

Total assets decreased by $8.3 million, or 3.3%, to $239.4 million from December 31, 2008 to September 30, 2009. Investment securities available for sale increased by $7.2 million from December 31, 2008 to September 30, 2009. Net loans receivable decreased $13.5 million or 7.0% during that same time period. Total deposits decreased $9.4 million, or 5.7% from December 31, 2008 to September 30, 2009 and REPO Sweep accounts decreased by $2.6 million, or 27.3% during that same time period.. Federal Home Loan Bank advances decreased by $6.6 million from December 31, 2008 to September 30, 2009. Equity decreased by $3.5 million, or 11.8% during the nine-month period ended September 30, 2009.

CRITICAL ACCOUNTING POLICIES

As of September 30, 2009, except for the addition of the valuation of deferred tax assets as a critical accounting policy (discussed below), 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, 2008. The Company’s critical accounting policies are described in the Management’s Discussion and Analysis and financial sections of its 2008 Annual Report. Management believes its critical accounting policies relate to the Company’s securities, allowance for loan losses, mortgage servicing rights and intangibles.

Management has determined that the valuation of deferred tax assets represented a critical accounting policy at September 30, 2009. Deferred tax assets and liabilities represent differences between when a tax benefit or expense is recognized for financial reporting purposes and on our tax return. Deferred tax assets are periodically assessed for recoverability. The Company records a valuation allowance if it believes, based on available evidence, that it is “more likely than not” that the future tax assets recognized will not be realized before their expiration. The amount of the deferred tax asset recognized and considered realizable could be reduced if projected taxable income is not achieved due to various factors such as unfavorable business conditions. If projected taxable income is not expected to be achieved, the Company records a valuation allowance to reduce its deferred tax assets to the amount that it believes can be realized in its future tax returns. At September 30, 2009 the Company recorded a valuation allowance of $2.0 million related to its deferred tax assets.

 
16

 

COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2009 AND DECEMBER 31, 2008

ASSETS:   Total assets decreased $8.3 million, or 3.4%, to $239.4 million at September 30, 2009 from $247.7 million at December 31, 2008.  During that nine-month time period the following changes occurred: investment securities available for sale increased $7.2 million, or 28.1%, to $32.9 million; other real estate owned increased $1.9 million, or 115.9%, to $3.5 million; and net loans receivable decreased $13.5 million, or 7.0%, to $178.7 million. Total mortgage loans decreased by $9.2 million, consumer loans decreased by $3.3 million and total commercial loans decreased by $2.4 million as loan originations declined due to weaker economic conditions in our primary lending markets.

LIABILITIES:   Deposits decreased $9.4 million, or 5.7%, to $156.4 million at September 30, 2009 from $165.8 million at December 31, 2008, a time period during which we were not a market-leader in deposit rates except in some longer-term maturities. Most of the decrease was in our certificates of deposit, as some of which were set to renew at lower rates and left the Bank.  During this same time period, Repo sweep accounts decreased $2.6 million as several of our commercial customers reduced the amount on deposit with us due to timing of their expenses, but did not close  accounts. FHLB advances increased $6.6 million, or 16.3%, to $46.8 million at September 30, 2009 from $40.2 million at December 31, 2008 as we replaced lost deposits with borrowings.

EQUITY:   Stockholders’ equity decreased to $26.0 million at September 30, 2009 from $29.4 million at December 31, 2008, a decline of $3.5 million. The decrease in stockholders’ equity was mainly attributable to our net loss for the nine-month period of $3.7 million primarily as a result of a $3.0 million Provision for Loan Losses and a $2.0 million valuation allowance on our deferred tax assets for the nine-month period  The unrealized gain on available for sale securities, net of tax, was $382,000 at September 30, 2009 as compared to $337,000 at December 31, 2008, an increase of $44,000.

RESULTS OF OPERATIONS

Three Months Ended September 30, 2009 Compared to Three Months Ended September 30, 2008

General: Net income from continuing operations decreased by $3.2 million to a net loss of $3.8 million for the three months ended September 30, 2009 from a net loss of $610,000 for the same period ended September 30, 2008.  This decrease was attributable to two main factors: an increase in provision for loan losses of $2.1 million to $3.0 million for the three months ended September 30, 2009 as compared to $875,000 for the same period in 2008 and a valuation allowance of $2.0 million on our deferred tax assets. Partially offsetting these negative factors period over period were an increase in net interest income of $176,000, an increase in non-interest income of $92,000 and a reduction in our non-interest expense of $81,000 period over period.  These factors are all discussed in greater detail below.

Interest Income: Interest income was $3.1 million for the three months ended September 30, 2009, compared to $3.5 million for the comparable period in 2008. The decrease in interest income was due primarily to two factors: a decrease in the average balance of our interest-earning assets due to a reduction in the size of our loan portfolio and a decrease in the yield on interest-earning assets due in part to lower market interest rates.   The average balances of AFS investment securities increased $3.9 million. The average balance of mortgage loans decreased $9.9 million period over period and the average balance of non-mortgage loans decreased $4.0 million quarter over quarter, as we continued to experience a decline in loan originations due to economic conditions in our market areas.

Interest Expense: Interest expense was $1.2 million for the three month period ended September 30, 2009, compared to $1.8 million for the same period in 2008.  The decrease in interest expense for the three-month period was due primarily to a $12.1 million decrease in the average balances of certificates of deposits period over period and a 121 basis point decline in average rate on those deposit due mainly to higher-costing certificates which matured and re-priced lower in the lower market interest rate environment. We experienced a $6.2 million decrease in the average balance of FHLB advances for the three months ended September 30, 2009 when compared to the same period in 2008 and the average rate on those advances decreased 45 basis point to 3.95% for the three-month period ended September 30, 2009 as compared to the year-earlier period.
 
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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, 2009
 
   
Compared to
 
   
Quarter ended September 30, 2008
 
   
Increase (Decrease) Due to:
 
   
Volume
   
Rate
   
Total
 
   
(In thousands)
 
Interest-earning assets:
                 
Loans receivable
  $ (211 )   $ (183 )   $ (394 )
Mortgage-backed securities
    1       15       17  
Investment securities
    (15 )     13     $ (2 )
Other investments
    (50 )     16     $ (34 )
                         
Total interest-earning assets
    (275 )     (139 )     (414 )
                         
Interest-bearing liabilities:
                    -  
Savings Deposits
    -       (2 )     (2 )
Money Market/NOW accounts
    73       (93 )     (21 )
Certificates of Deposit
    (154 )     (269 )     (423 )
Deposits
    (81 )     (364 )     (446 )
Borrowed funds
    (43 )     (101 )     (144 )
                         
Total interest-bearing liabilities
    (124 )     (465 )     (590 )
                         
Change in net interest income
  $ (151 )   $ 326     $ 176  

Net Interest Income: Net interest income increased to $1.9 million for the three month period ended September 30, 2009 compared to $1.7 million for the same period in 2008.  For the three months ended September 30, 2009, average interest-earning assets decreased $15.1 million, or 6.4%, to $222.3 million when compared to the same period in 2008. Average interest-bearing liabilities decreased $11.1 million, or 5.3%, to $197.9 million for the quarter ended September 30, 2009 from $209.0 million for the quarter ended September 30, 2008.  The yield on average interest-earning assets decreased to 5.58% for the three month period ended September 30, 2009 from 5.92% for the same period ended in 2008 due mainly to decreases in the yields on our non-mortgage loans, partially as a result of loans placed on non-accrual status, and due to lower yields on the securities in our investment portfolio due to lower market interest rates. The cost of average interest-bearing liabilities decreased to 2.43% from 3.42% for the three month periods ended September 30, 2009 and September 30, 2008, respectively.  The decrease in asset yields on interest earning assets, offset by a greater decrease in our cost of funds resulted in a increase in our net interest margin of 50 basis points to 3.41% for the three month period ended September 30, 2009 from 2.91% for same period in 2008.

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 amounted to $3.0 million for the three month period ended September 30, 2009 and $875,000 for the comparable period in 2008.  During the quarter ended September 30, 2009, the Company increased its reserves on certain commercial and mortgage loans based on deterioration of those credits during the quarter. In particular, reserves on two large commercial real-estate relationships accounted in large part for the higher provision in the quarter ended September 30, 2009 as compared to the quarter ended September 30, 2008. In addition, due to our recent charge-off history, the loss factor applied to our portfolio of performing loans has increased causing an increase in the overall loan loss reserve.

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

         
Delinquent
       
   
Portfolio
   
Loans
   
Non-Accrual
 
   
Balance
   
Over 90 Days
   
Loans
 
   
(Dollars in thousands)
 
At September 30, 2009
                 
Real