Unassociated Document

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 March 31, 2011

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 May 2, 2011
(Title of Class)
 2,884,049 shares
 
 
 

 

FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-Q
Quarter Ended March 31, 2011

INDEX

 
  PAGE  
PART I – FINANCIAL INFORMATION
ITEM 1  -   UNAUDITED FINANCIAL STATEMENTS        
Consolidated Balance Sheet at March 31, 2011 and December 31, 2010
    3  
Consolidated Statements of Income for the Three Months Ended March 31, 2011 and March 31, 2010
    4  
Consolidated Statement of Changes in Stockholders’ Equity for the Three Months Ended March 31, 2011
    5  
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2011 and March 31, 2010
    6  
Notes to Unaudited Consolidated Financial Statements
    7  
         
ITEM 2  -   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
    23  
         
ITEM 3 -    QUALITITATIVE AND QUANITIATIVE DISCLOSURES ABOUT MARKET RISK
    30  
         
ITEM 4  -   CONTROLS AND PROCEDURES
    30  
         
Part II -     OTHER INFORMATION
 
ITEM 1  -   LEGAL PROCEEDINGS
    31  
ITEM 1A - RISK FACTORS
    31  
ITEM 2 -    UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF  PROCEEDS
    31  
ITEM 3 -    DEFAULTS UPON SENIOR SECURITIES
    31  
ITEM 4 -    [REMOVED AND RESERVED]
    31  
ITEM 5 -    OTHER INFORMATION
    31  
ITEM 6 -    EXHIBITS
    31  
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

  
   
March 31, 2011
   
December 31, 2010
 
   
(Unaudited)
       
ASSETS
           
Cash and cash equivalents:
           
Cash on hand and due from banks
  $ 3,541,896     $ 1,889,999  
Overnight deposits with FHLB
    313,959       72,658  
Total cash and cash equivalents
    3,855,856       1,962,657  
Securities AFS
    38,809,481       35,301,238  
Securities HTM
    2,520,000       2,520,000  
Loans held for sale
    152,237       -  
Loans receivable, net of allowance for loan losses of $2,631,993 and $2,831,332 as of March 31, 2011 and December 31, 2010, respectively
    151,255,315       157,143,918  
Foreclosed real estate and other repossessed assets
    3,186,668       2,818,343  
Federal Home Loan Bank stock, at cost
    3,775,400       3,775,400  
Premises and equipment
    5,982,768       6,026,793  
Accrued interest receivable
    1,146,752       1,230,938  
Intangible assets
    554,193       627,306  
Prepaid FDIC Premiums
    900,140       967,143  
Deferred Tax Asset
    603,082       659,194  
Other assets
    2,702,714       2,700,034  
Total assets
  $ 215,444,605     $ 215,732,964  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Liabilities:
               
Deposits
  $ 156,231,755     $ 155,465,896  
Advances from borrowers for taxes and insurance
    316,969       130,030  
Federal Home Loan Bank Advances
    28,000,000       29,000,000  
REPO Sweep Accounts
    5,753,871       6,172,362  
Accrued expenses and other liabilities
    1,646,240       1,728,735  
                 
Total liabilities
    191,948,835       192,497,023  
                 
Stockholders' equity:
               
Common stock ($0.01 par value 20,000,000 shares authorized 3,191,799 shares issued)
    31,918       31,918  
Additional paid-in capital
    23,838,758       23,822,152  
Retained earnings
    2,398,765       2,238,064  
Treasury stock at cost (307,750 shares)
    (2,963,918 )     (2,963,918 )
Unearned compensation
    (15,043 )     (38,382 )
Accumulated other comprehensive income
    205,290       146,107  
Total stockholders' equity
    23,495,770       23,235,941  
                 
Total liabilities and stockholders' equity
  $ 215,444,605     $ 215,732,964  
  

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
 
   
Ended March 31,
 
   
2011
   
2010
 
   
(Unaudited)
 
Interest income:
           
Interest and fees on loans
  $ 2,273,320     $ 2,540,413  
Interest and dividends on investments
               
Taxable
    94,815       132,563  
Tax-exempt
    40,328       52,812  
Interest on mortgage-backed securities
    183,366       156,533  
Total interest income
    2,591,829       2,882,321  
                 
Interest expense:
               
Interest on deposits
    437,253       637,824  
Interest on borrowings
    168,074       318,582  
Total interest expense
    605,327       956,406  
                 
Net interest income
    1,986,502       1,925,915  
Provision for loan losses
    67,358       11,088  
Net interest income after provision for loan losses
    1,919,144       1,914,827  
                 
Non-interest income:
               
Service charges and other fees
    164,491       204,174  
Mortgage banking activities
    235,983       248,092  
Gain on sale of available-for-sale investments
    -       49,430  
Net gain (loss) on sale of premises and equipment, real estate owned and other repossessed assets
    (8,675 )     11,176  
Other
    57,553       65,613  
Total non-interest income
    449,352       578,485  
                 
Non-interest expense:
               
Compensation and employee benefits
    1,168,936       1,170,942  
FDIC Insurance Premiums
    71,217       94,200  
Advertising
    23,021       19,889  
Occupancy
    270,042       312,576  
Amortization of intangible assets
    73,113       73,113  
Service bureau charges
    76,206       79,582  
Professional services
    87,577       103,111  
Other
    437,683       335,683  
Total non-interest expense
    2,207,795       2,189,096  
                 
Income before income tax expense
    160,701       304,216  
Income tax expense
    -       101,913  
                 
Net Income
  $ 160,701     $ 202,303  
                 
Per share data:
               
Net Income per share
               
Basic
  $ 0.06     $ 0.07  
Diluted
  $ 0.06     $ 0.07  
                 
Weighted average number of shares outstanding
               
Basic
    2,884,049       2,884,249  
Including dilutive stock options
    2,884,049       2,884,249  
Dividends per common share
  $ -     $ -  

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
   
Comprehensive
       
   
Stock
   
Stock
   
Capital
   
Compensation
   
Earnings
   
Income
   
Total
 
                                           
Balance at December 31, 2010
  $ 31,918     $ (2,963,918 )   $ 23,822,152     $ (38,382 )   $ 2,238,064     $ 146,107     $ 23,235,941  
                                                         
Stock Options/MRP shares expensed
    -       -       16,606       23,339       -       -       39,945  
                                                         
Stock Options/MRP shares forteited
    -       -       -       -       -       -       -  
                                                         
Net income for the period
    -       -       -       -       160,701       -       160,701  
                                                         
Change in unrealized gain:
                                                       
on available-for-sale securities(net of tax of 30,488)
    -       -       -       -       -       59,183       59,183  
                                                         
Total comprehensive income     -       -       -       -       -       -       219,884  
                                                       
Balance at March 31, 2011
  $ 31,918     $ (2,963,918 )   $ 23,838,758     $ (15,043 )   $ 2,398,765     $ 205,290     $ 23,495,770  

See accompanying notes to the consolidated financial statements.
 
 
5

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

    
   
For Three Months Ended
 
   
March 31,
 
   
2011
   
2010
 
   
(Unaudited)
 
Cash Flows from Operating Activities:
           
Net income
  $ 160,701     $ 202,303  
Adjustments to reconcile net income to net cash from operating activities:
               
 Depreciation and amortization
    181,356       207,170  
 Provision for loan loss
    67,358       11,088  
 Amortization and accretion on securities
    70,989       31,596  
 Gain on sale of investment securities
    -       (49,430 )
 Stock awards/options
    39,945       52,804  
 Gain on sale of loans held for sale
    (94,940 )     (93,199 )
 Originations of loans held for sale
    (6,846,031 )     (6,947,064 )
 Proceeds from sale of loans held for sale
    6,788,734       7,013,633  
 Gain on sale of fixed assets
    (990 )     -  
 Loss/(gain) on sale of repossessed assets
    8,932       (11,176 )
Net change in:
               
 Accrued interest receivable
    84,186       (201 )
 Other assets
    (410,427 )     (70,889 )
 Prepaid FDIC insurance premiums
    67,003       89,760  
 Deferred income tax benefit
    56,112       100,704  
 Accrued expenses and other liabilities
    (82,493 )     (226,169 )
Net cash provided by operating activities
    90,435       310,930  
                 
Cash Flows from Investing Activities:
               
 Net decrease in loans
    5,821,245       2,760,929  
 Proceeds from maturity and sale of available-for-sale securities
    2,414,843       5,249,241  
 Proceeds from sale of property and equipment
    1,480       -  
 Purchase of securities
    (5,904,403 )     (4,597,624 )
 Purchase of premises and equipment
    (64,708 )     (6,086 )
Net cash provided by investing activities
    2,268,457       3,406,460  
                 
Cash Flows from Financing Activities:
               
 Net increase (decrease) in deposits
    765,859       (1,487,622 )
 Net (decrease) increase in Repo Sweep accounts
    (418,491 )     189,000  
 Net increase in advances from borrowers
    186,939       171,100  
 Additions to advances from Federal Home Loan Bank and notes payable
    3,350,000       10,025,000  
 Repayments of Federal Home Loan Bank advances and notes payable
    (4,350,000 )     (12,855,927 )
Net cash used for financing activities
    (465,693 )     (3,958,449 )
                 
Net increase (decrease) in cash and cash equivalents
    1,893,199       (241,059 )
Cash and cash equivalents at beginning of period
    1,962,657       3,099,058  
Cash and cash equivalents at end of period
  $ 3,855,856     $ 2,857,999  
                 
Supplemental disclosure of cash flow information:
               
Cash refunded during the period for income taxes
  $ (41,000 )   $ -  
Cash paid during the period for interest
  $ 608,921     $ 1,006,607  

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, 2010.
 
All adjustments, consisting only of normal recurring adjustments, which in the opinion of management are necessary for a fair presentation of financial position, results of operations and cash flows, have been made. The results of operations for the three months ended March 31, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011.

Note 2— 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 FFNM Agency, Inc. 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 to the Grotenhuis Group (as discussed further below). All significant intercompany balances and transactions have been eliminated in the consolidation.

Note 3—SECURITIES

Investment securities have been classified according to management’s intent. The carrying value and estimated fair value of securities are as follows:
 
   
March 31, 2011
 
   
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
(Losses)
   
Market
Value
 
   
(in thousands)
 
Securities Available for Sale
                       
                         
U.S. Government and agency obligations
  $ 8,108     $ 42     $ -       8,150  
Municipal obligations
    4,888       174       -       5,062  
Mortgage-backed securities
    25,500       137       (41 )     25,596  
Equity investments
    2       -       (1 )     1  
                                 
Total
  $ 38,498     $ 353     $ (42 )   $ 38,809  
                                 
Securities Held to Maturity
                               
Municipal notes
  $ 2,520     $ 130     $ (2 )   $ 2,648  

 
7

 
 
    December 31, 2010   
   
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
(Losses)
   
Market
Value
 
   
(in thousands)
 
Securities Available for Sale
                       
U.S. Government and agency obligations
  $ 4,518     $ 44     $ -       4,562  
Municipal obligations
    4,875       171       -       5,046  
Mortgage-backed securities
    25,684       83       (75 )     25,692  
Equity investments
    3       -       (2 )     1  
                                 
Total
  $ 35,080     $ 298     $ (77 )   $ 35,301  
                                 
Securities Held to Maturity
                               
Municipal notes
  $ 2,520     $ 90     $ (15 )   $ 2,595  
 
The amortized cost and estimated market value of securities at March 31, 2011, by contract maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities with no specified maturity date are separately stated.

   
March 31, 2011
 
   
Amortized
Cost
   
Market
Value
 
   
(in thousands)
 
Available For Sale:
           
Due in one year or less
  $ 1,552     $ 1,564  
Due after one year through five years
    6,887       6,983  
Due in five year through ten years
    4,116       4,169  
Due after ten years
    441       496  
                 
Subtotal
    12,996       13,212  
                 
Equity securities
    2       1  
Mortgage-backed securities
    25,500       25,596  
                 
Total
  $ 38,498     $ 38,809  
                 
Held To Maturity:
               
Due in one year or less
  $ 85     $ 86  
Due after one year through five years
    390       414  
Due in five year through ten years
    630       670  
Due after ten years
    1,415       1,478  
                 
Total
  $ 2,520     $ 2,648  
 
At March 31, 2011 and December 31, 2010, securities with a fair value of $30,576,905 and $31,378,639, respectively, were pledged to secure our REPO sweep accounts, FHLB advances and our line of credit at the Federal Reserve.
 
Gross proceeds from the sale of securities for the three months ended March 31, 2011 and 2010 were $0 and $1,100,000, respectively, resulting in gross gains of $0 and $49,000, respectively and gross losses of $0 and $0, respectively.
 
 
8

 
 
The following is a summary of temporarily impaired investments that have been impaired for less than and more than twelve months as of March 31, 2011 and December 31, 2010:

   
March 31, 2011
 
         
Gross
Unrealized
Losses
         
Gross
Unrealized
Losses
 
   
Fair Value
   
<12
months
   
Fair Value
   
> 12
months
 
   
(in thousands)
 
Available For Sale:
                       
U.S. Government and agency obligations
  $ -     $ -     $ -     $ -  
Municipal obligations
    -       -       -       -  
Mortgage-backed securities
    12,513       (41 )     -       -  
Equity securities
    2       (1 )     -       -  
                                 
Total
  $ 12,515     $ (42 )   $ -     $ -  
                                 
Held to Maturity:
                               
Municipal notes
  $ -     $ -     $ 28     $ (2 )
 
   
December 31, 2010
 
           
Gross
Unrealized
Losses
           
Gross
Unrealized
Losses
 
   
Fair Value
   
<12
months
   
Fair Value
   
> 12 months
 
   
(in thousands)
 
Available For Sale:
                               
U.S. Government and agency obligations
  $ -     $ -     $ -     $ -  
Municipal obligations
    -       -       -       -  
Mortgage-backed securities
    12,626       (75 )     -       -  
Equity securities
    3       (2 )     -       -  
                                 
Total
  $ 12,626     $ (77 )   $ -     $ -  
                                 
Held to Maturity:
                               
Municipal notes
  $ 382     $ (13 )   $ 28     $ (2 )
 
The unrealized losses on the securities held in the portfolio are not considered other than temporary and have not been recognized into income. This decision is based on the Company’s ability and intent to hold any potentially impaired security until maturity. The performance of the security is based on the contractual terms of the agreement, the extent of the impairment and the financial condition and credit quality of the issuer. The decline in market value is considered temporary and a result of changes in interest rates and other market variables.
 
 
9

 
 
Note 4—LOANS AND ALLOWANCE FOR LOAN LOSSES

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

   
At March 31,
   
At December 31,
 
   
2011
   
2010
 
   
(in thousands)
 
Real estate loans:
           
Residential mortgage
  $ 68,603     $ 71,697  
Commercial loans:
               
Secured by real estate
    59,165       61,010  
Other
    8,658       8,848  
Total commercial loans
    67,823       69,858  
                 
Consumer loans:
               
Secured by real estate
    15,739       16,547  
Other
    1,981       2,118  
                 
Total consumer loans
    17,720       18,665  
Total gross loans
  $ 154,146     $ 160,220  
Less:
               
Net deferred loan fees
    (259 )     (245 )
Allowance for loan losses
    (2,632 )     (2,831 )
                 
Total loans, net
  $ 151,255     $ 157,144  
 
The following table illustrates the contractual aging of the recorded investment in past due loans by class of loans as of March 31, 2011 and December 31, 2010:
 
As of March 31, 2011
 
                                       
Recorded
 
                                       
Investment > 90
 
   
30 - 59 Days
   
60 - 89 Days
   
Greater than 90
   
Total
         
Total Financing
   
Days and
 
   
Past Due
   
Past Due
   
Days
   
Past Due
   
Current
   
Receivables
   
Accruing
 
                                           
Commercial Real Estate:
                                         
Commercial Real Estate - construction
  $ -     $ -     $ 1,772     $ 1,772     $ 70     $ 1,842     $ -  
Commercial Real Estate - other
    1,127       600       376       2,103       55,220       57,323       -  
Commercial - non real estate
    -       -       -       -       8,658       8,658       -  
                                                         
Consumer:
                                                       
Consumer - Real Estate
    599       14       173       786       14,953       15,739       -  
Consumer - Other
    11       16       13       40       1,941       1,981       39  
                                                         
Residential:
                                                       
Residential
    5,473       -       2,378       7,851       60,752       68,603       774  
Total
  $ 7,210     $ 630     $ 4,712     $ 12,552     $ 141,594     $ 154,146     $ 813  

As of December 31, 2010
 
                                       
Recorded
 
                                       
Investment > 90
 
   
30 - 59 Days
   
60 - 89 Days
   
Greater than 90
   
Total
         
Total Financing
   
Days and
 
   
Past Due
   
Past Due
   
Days
   
Past Due
   
Current
   
Receivables
   
Accruing
 
                                           
Commercial Real Estate:
                                         
Commercial Real Estate - construction
  $ -     $ -     $ 1,772     $ 1,772     $ 1,498     $ 3,270     $ -  
Commercial Real Estate - other
    891       488       784       2,163       55,577       57,740       82  
Commercial - non real estate
    -       6       -       6       8,842       8,848       -  
                                                         
Consumer:
                                                       
Consumer - Real Estate
    650       108       205       963       15,584       16,547       -  
Consumer - Other
    27       14       2       43       2,075       2,118       2  
                                                         
Residential:
                                                       
Residential
    3,919       2,056       2,434       8,409       63,288       71,697       282  
Total
  $ 5,487     $ 2,672     $ 5,197     $ 13,356     $ 146,864     $ 160,220     $ 366  
 
 
10

 
 
The Bank uses an eight tier risk rating system to grade its commercial loans. The grade of a loan may change during the life of the loans. The risk ratings are described as follows:
 
Risk Grade 1 (Excellent) - Prime loans based on liquid collateral, with adequate margin or supported by strong financial statements. Probability of serious financial deterioration is unlikely. High liquidity, minimum risk, strong ratios, and low handling costs are common to these loans. This classification also includes all loans secured by certificates of deposit or cash equivalents.

Risk Grade 2 (Good) - Desirable loans of somewhat less stature than Grade 1, but with strong financial statements. Probability of serious financial deterioration is unlikely. These loans possess a sound repayment source (and/or a secondary source). These loans represent less than the normal degree of risk associated with the type of financing contemplated.
 
Risk Grade 3 (Satisfactory) - Satisfactory loans of average risk – may have some minor deficiency or vulnerability to changing economic conditions, but still fully collectible. There may be some minor weakness but with offsetting features or other support readily available. These loans present a normal degree of risk associated with the type of financing. Actual and projected indicators and market conditions provide satisfactory assurance that the credit shall perform in accordance with agreed terms.
  
Risk Grade 4 (Acceptable) - Loans considered satisfactory, but which are of slightly “below average” credit risk due to financial weaknesses or uncertainty. The loans warrant a somewhat higher than average level of monitoring to insure that weaknesses do not advance. The level of risk is considered acceptable and within normal underwriting guidelines, so long as the loan is given the proper level of management supervision.
 
Risk Grade 4.5 (Monitored) - Loans are considered “below average” and monitored more closely due to some credit deficiency that poses additional risk but is not considered adverse to the point of being a “classified” credit. Possible reasons for additional monitoring may include characteristics such as temporary negative debt service coverage due to weak economic conditions, borrower may have experienced recent losses from operations, declining equity and/or increasing leverage, or marginal liquidity that may affect long-term sustainability. Loans of this grade have a higher degree of risk and warrant close monitoring to insure against further deterioration.
 
Risk Grade 5 (Other Assets Especially Mentioned) (OAEM) - Loans which possess some credit deficiency or potential weakness, which deserve close attention, but which do not yet warrant substandard classification. Such loans pose unwarranted financial risk that, if not corrected, could weaken the loan and increase risk in the future.
 
Risk Grade 6 (Substandard) - Loans are “substandard” whose full, final collectability does not appear to be a matter of serious doubt, but which nevertheless portray some form of well defined weakness that requires close supervision by Bank management. The noted weaknesses involve more than normal banking risk. One or more of the following characteristics may be exhibited in loans classified Substandard: (1) Loans possess a defined credit weakness and the likelihood that the loan shall be paid from the primary source of repayment is uncertain; (2) Loans are not adequately protected by the current net worth and/or paying capacity of the obligor; (3) primary source of repayment is gone, and the Bank is forced to rely on a secondary source of repayment such as collateral liquidation or guarantees; (4) distinct possibility that the Bank shall sustain some loss if deficiencies are not corrected; (5) unusual courses of action are needed to maintain a high probability of repayment; (6) the borrower is not generating enough cash flow to repay loan principal, however, continues to make interest payments; (7) the Bank is forced into a subordinated or unsecured position due to flaws in documentation; (8) loans have been restructured so that payment schedules, terms, and collateral represent concessions to the borrower when compared to normal loan terms; (9) the Bank is contemplating foreclosure or legal action due to the apparent deterioration in the loan; or (10) there is a significant deterioration in the market conditions and the borrower is highly vulnerable to these conditions.
 
 
11

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

Risk Grade 8 (Loss) - Loans are considered uncollectible and of such little value, that continuing to carry them as an asset on the Bank’s financial statements is not feasible.
 
The following table presents the risk category of loans by class of loans based on the most recent analysis performed and the contractual aging as of March 31, 2011 and December 31, 2010:
 
As of March 31, 2011
 
   
Commercial Real Estate
   
Commercial Real Estate
       
Loan Grade
 
Construction
   
Other
   
Commercial
 
                   
1-2
  $ -     $ -     $ 4  
3
    70       13,099       2,388  
4
    -       32,411       6,093  
5
    -       3,223       173  
6
    1,772       8,590       -  
7
    -       -       -  
8
    -       -       -  
Total
  $ 1,842     $ 57,323     $ 8,658  

As of December 31, 2010
 
                   
   
Commercial Real Estate
   
Commercial Real Estate
       
Loan Grade
 
Construction
   
Other
   
Commercial
 
                   
1-2
  $ -     $ -     $ 5  
3
    70       12,411       2,958  
4
    1,428       33,754       5,631  
5
    -       3,245       248  
6
    1,772       8,330       6  
7
    -       -       -  
8
    -       -       -  
Total
  $ 3,270     $ 57,740     $ 8,848  

For residential real estate and other consumer credit the Company also evaluates credit quality based on the aging status of the loan and by payment activity. Loans 60 or more days past due are monitored by the collection committee.
     
The following tables present the risk category of loans by class based on the most recent analysis performed as of March 31, 2011 and December 31, 2010:
 
As of March 31, 2011
 
As of December 31, 2010
 
               
   
Residential
     
Residential
 
               
Grade
     
Grade
     
               
Pass
  $ 64,997  
Pass
  $ 68,301  
Special Mention
    -  
Special Mention
    -  
Substandard
    3,606  
Substandard
    3,396  
Total
  $ 68,603  
   Total
  $ 71,697  
 
 
12

 
  
As of March 31, 2011
 
             
   
Consumer -
       
   
Real Estate
   
Consumer - Other
 
             
Performing
  $ 15,546     $ 1,961  
Nonperforming
    193       20  
Total
  $ 15,739     $ 1,981  
 
As of December 31, 2010
 
             
   
Consumer -
       
   
Real Estate
   
Consumer - Other
 
             
Performing
  $ 16,341     $ 2,116  
Nonperforming
    206       2  
Total
  $ 16,547     $ 2,118  

The following table presents the recorded investment in non-accrual loans by class as of March 31, 2011 and December 31, 2010:
 
   
As of
 
   
March 31, 2011
 
       
Commercial Real Estate:
     
Commercial Real Estate - construction
  $ 1,772  
Commercial Real Estate - other
    1,261  
Commercial
    -  
         
Consumer:
       
Consumer - real estate
    158  
Consumer - other
    15  
         
Residential:
       
Residential
    2,832  
         
Total
  $ 6,038  

   
As of
 
   
December 31, 2010
 
       
Commercial Real Estate:
     
Commercial Real Estate - construction
  $ 1,772  
Commercial Real Estate - other
    1,148  
Commercial
    -  
         
Consumer:
       
Consumer - real estate
    206  
Consumer - other
    -  
         
Residential:
       
Residential
    3,114  
         
Total
  $ 6,240  

The Bank has classified approximately $1,368,000 of its impaired loans as troubled debt restructurings as of March 31, 2011.
 
 
13

 
 
For the majority of the Bank’s impaired loans, the Bank will apply the observable market price methodology. However, the Bank may also utilize a measurement incorporating the present value of expected future cash flows discounted at the loan’s effective rate of interest. To determine observable market price, collateral asset values securing an impaired loan are periodically evaluated. Maximum time of re-evaluation is every 12 months. In this process, third party evaluations are obtained and heavily relied upon. Until such time that updated evaluations are received, the Bank may discount the collateral value used.
 
The Bank uses the following guidelines as stated in policy to determine when to realize a charge-off, whether a partial or full loan balance. A charge down in whole or in part is realized when unsecured consumer loans, credit card credits and overdraft lines of credit reach 90 days delinquency. At 120 days delinquent, secured consumer loans are charged down to the value of collateral, if repossession of the collateral is assured and/or in the process of repossession. Consumer mortgage loan deficiencies are charged down upon the sale of the collateral or sooner upon the recognition of collateral deficiency. Commercial credits are charged down at 90 days delinquency, unless an established and approved work-out plan is in place or litigation of the credit will likely result in recovery of the loan balance. Upon notification of bankruptcy, unsecured debt is charged off. Additional charge-off may be realized as further unsecured positions are recognized.
 
 
14

 
 
The following table presents loans individually evaluated for impairment by class of loans as of March 31, 2011 and December 31, 2010:
 
As of March 31, 2011
 
                     
Average
   
Interest
 
   
Unpaid Principal
   
Recorded
   
Related
   
Recorded
   
Income
 
   
Balance
   
Investment
   
Allowance
   
Investment
   
Recognized
 
                               
With no related allowance recorded:
                             
Commercial
  $ -     $ -     $ -     $ -     $ -  
Commercial Real Estate - Construction
    -       -       -       -       -  
Commercial Real Estate - Other
    584       465       -       478       -  
Consumer - Real Estate
    61       59       -       60       -  
Consumer - Other
    15       15       -       16       -  
Residential
    1,449       1,377       -       1,269       -  
                                         
With a specific allowance recorded:
                                       
Commercial
    -       -       -       -       -  
Commercial Real Estate - Construction
    3,449       1,772       305       3,449       -  
Commercial Real Estate - Other
    836       796       108       812       -  
Consumer - Real Estate
    99       99       9       99       -  
Consumer - Other
    -       -       -       -       -  
Residential
    1,551       1,455       221       1,456       -  
                                         
Totals:
                                       
Commercial
  $ -     $ -     $ -     $ -     $ -  
Commercial Real Estate - Construction
  $ 3,449     $ 1,772     $ 305     $ 1,772     $ -  
Commercial Real Estate - Other
  $ 1,420     $ 1,261     $ 108     $ 1,290     $ -  
Consumer - Real Estate
  $ 160     $ 158     $ 9     $ 159     $ -  
Consumer - Other
  $ 15     $ 15     $ -     $ 16     $ -  
Residential
  $ 3,000     $ 2,832     $ 221     $ 2,725     $ -  

As of December 31, 2010
 
                     
Average
   
Interest
 
   
Unpaid Principal
   
Recorded
   
Related
   
Recorded
   
Income
 
   
Balance
   
Investment
   
Allowance
   
Investment
   
Recognized
 
                               
With no related allowance recorded:
                             
Commercial
  $ -     $ -     $ -     $ -     $ -  
Commercial Real Estate - Construction
    -       -       -       -       -  
Commercial Real Estate - Other
    822       674       -       -       -  
Consumer - Real Estate
    124       123       -       193       -  
Consumer - Other
    -       -       -       -       -  
Residential
    1,842       1,770       -       1,803       -  
                                         
With a specific allowance recorded:
                                       
Commercial
    -       -       -       -       -  
Commercial Real Estate - Construction
    3,449       1,772       305       1,805       -  
Commercial Real Estate - Other
    586       474       89       1,132       -  
Consumer - Real Estate
    83       83       25       14       -  
Consumer - Other
    -       -       -       -       -  
Residential
    1,416       1,344       165       1,330       -  
                                         
Totals:
                                       
Commercial
  $ -     $ -     $ -     $ -     $ -  
Commercial Real Estate - Construction
  $ 3,449     $ 1,772     $ 305     $ 1,805     $ -  
Commercial Real Estate - Other
  $ 1,408     $ 1,148     $ 89     $ 1,132     $ -  
Consumer - Real Estate
  $ 207     $ 206     $ 25     $ 207     $ -  
Consumer - Other
  $ -     $ -     $ -     $ -     $ -  
Residential
  $ 3,258     $ 3,114     $ 165     $ 3,133     $ -  

The ALLL has a direct impact on the provision expense. An increase in the ALLL is funded through recoveries and provision expense.
 
 
15

 
 
Activity in the allowance for loan and lease losses was as follows for the quarter and year ended March 31, 2011 and December 31, 2010, respectively:
 
Allowance for Credit Losses and Recorded Investment in Financing Receivables
For the Three Months Ended March 31, 2011

   
Commercial
     Commercial          
Consumer
                         
   
Construction
   
Real Estate
   
Commercial
 <