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 September 30, 2010
 
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 15, 2010
(Title of Class)
2,884,249 shares

 
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-Q
Quarter Ended September 30, 2010
 
INDEX
 
 
PAGE
PART I – FINANCIAL INFORMATION
  
ITEM 1  -  UNAUDITED FINANCIAL STATEMENTS
  
Consolidated Balance Sheet at September 30, 2010 and December 31, 2009
3
Consolidated Statements of Income for the Three and Nine Months
  
Ended September 30, 2010 and September 30, 2009
4
Consolidated Statement of Changes in Stockholders’ Equity
  
for the Nine Months Ended September 30, 2010
5
Consolidated Statements of Cash Flows for the Nine Months Ended
  
September 30, 2010 and September 30, 2009
6
Notes to Unaudited Consolidated Financial Statements
7
   
ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
17
   
ITEM 3 – QUANTITATIVE AND QUALITIATIVE DISCLOSURES ABOUT MARKET RISK
24
   
ITEM 4  - CONTROLS AND PROCEDURES
24
   
Part II  -  OTHER INFORMATION
  
ITEM 1 - LEGAL PROCEEDINGS
25
ITEM 1A - RISK FACTORS
25
ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
25
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
25
ITEM 4 – (REMOVED AND RESERVED
25
ITEM 5 - OTHER INFORMATION
25
ITEM 6 - EXHIBITS
25
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
 
First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries
Consolidated Balance Sheet
 
   
September 30, 2010
    
December 31, 2009
  
   
(Unaudited)
        
ASSETS
            
Cash and cash equivalents:
            
Cash on hand and due from banks
   $ 4,935,335     $ 2,583,131  
Overnight deposits with FHLB
     24,354       515,927  
Total cash and cash equivalents
     4,959,689       3,099,058  
Securities AFS
     34,750,106       33,712,724  
Securities HTM
     2,570,000       3,928,167  
Loans held for sale
     832,347       51,970  
Loans receivable, net of allowance for loan losses of $3,046,058 and
                
$3,660,344 as of September 30, 2010 and December 31, 2009, respectively
     161,684,007       171,219,105  
Foreclosed real estate and other repossessed assets
     3,591,575       3,579,895  
Federal Home Loan Bank stock, at cost
     4,196,900       4,196,900  
Premises and equipment
     6,165,192       6,563,683  
Accrued interest receivable
     1,213,131       1,230,287  
Intangible assets
     700,419       919,757  
Prepaid FDIC premiums
     1,051,147       1,314,850  
Deferred tax asset
     492,899       559,235  
Other assets
     3,461,915       3,130,063  
Total assets
   $ 225,669,327     $ 233,505,694  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
                
Liabilities:
                
Deposits
   $ 156,550,836     $ 158,099,809  
Advances from borrowers for taxes and insurance
     207,227       105,419  
Federal Home Loan Bank advances
     37,000,000       44,400,000  
Note payable
     -       630,927  
REPO sweep accounts
     6,386,899       5,407,791  
Accrued expenses and other liabilities
     1,666,751       1,809,266  
Total liabilities
     201,811,713       210,453,212  
                 
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
     23,796,238       23,722,767  
Retained earnings
     2,593,552       2,000,264  
Treasury stock at cost (307,750 shares
     (2,963,918 )     (2,963,918 )
Unearned compensation
     (69,094 )     (161,678 )
Accumulated other comprehensive income
     468,916       423,127  
Total stockholders' equity
     23,857,614       23,052,482  
                 
Total liabilities and stockholders' equity
   $ 225,669,327     $ 233,505,694  

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,
  
   
2010
    
2009
    
2010
    
2009
  
   
(Unaudited)
    
(Unaudited)
  
Interest income:
                        
Interest and fees on loans
   $ 2,590,033     $ 2,762,789     $ 7,683,432     $ 8,570,404  
Interest and dividends on investments
                                
Taxable
     107,002       154,682       346,409       413,204  
Tax-exempt
     40,739       57,038       152,005       171,584  
Interest on mortgage-backed securities
     168,757       136,177       490,603       430,928  
Total interest income
     2,906,531       3,110,686       8,672,449       9,586,120  
                                 
Interest expense:
                                
Interest on deposits
     560,106       795,356       1,799,663       2,736,532  
Interest on borrowings
     291,228       422,715       908,467       1,279,247  
Total interest expense
     851,334       1,218,071       2,708,130       4,015,779  
                                 
Net interest income
     2,055,197       1,892,615       5,964,319       5,570,341  
Provision for loan losses
     352,711       2,976,642       958,639       3,492,711  
Net interest income (expense) after provision for loan losses
     1,702,486       (1,084,027 )     5,005,680       2,077,630  
                                 
Non Interest income:
                                
Service charges and other fees
     206,024       217,159       609,538       661,488  
Mortgage banking activities
     447,319       244,550       1,010,634       1,167,626  
Gain on sale of available-for-sale investments
     -       -       496,817       1,227  
Net gain (loss) on sale of premises and equipment,
                                
real estate owned and other repossessed assets
     (1,146 )     (2,128 )     52,720       25,350  
Insurance & brokerage commissions
     -       15,157       -       129,798  
Other
     65,267       16,637       391,603       67,997  
Total non interest income
     717,464       491,375       2,561,312       2,053,486  
                                 
Non interest expenses:
                                
Compensation and employee benefits
     1,203,327       1,095,509       3,568,567       3,414,767  
FDIC Insurance premiums
     88,820       106,199       277,368       376,807  
Advertising
     42,320       31,784       98,312       93,655  
Occupancy
     277,658       294,567       878,471       897,054  
Amortization of intangible assets
     73,113       73,113       219,338       199,983  
Service bureau charges
     71,230       76,533       236,926       255,043  
Professional services
     79,008       93,588       331,210       359,711  
Other
     512,725       305,341       1,363,511       962,826  
Total non interest expenses
     2,348,201       2,076,634       6,973,703       6,559,846  
                                 
Income (loss) from continuing operations before income tax benefit
     71,749       (2,669,286 )     593,289       (2,428,731 )
Income tax expense from continuing operations
     -       1,148,845       -       1,200,585  
Net income (loss) from continuing operations
     71,749       (3,818,130 )     593,289       (3,629,316 )
                                 
Loss from discontinued operations, net of income tax benefit
                                
of $43,209
     -       -       -       (83,875 )
Gain on sale of discontinued operations, net of income tax expense
                          
of $19,585
     -       -       -       38,017  
Loss from discontinued operations
     -       -       -       (45,858 )
                                 
Net Income (loss)
   $ 71,749     $ (3,818,130 )   $ 593,289     $ (3,675,174 )
                                 
Per share data:
                                
Income (loss) per share from continuing operations
                                
Basic
   $ 0.02     $ (1.32 )   $ 0.21     $ (1.26 )
Diluted
   $ 0.02     $ (1.32 )   $ 0.21     $ (1.26 )
Loss per share from discontinued operations
                                
Basic
   $ -     $ -     $ -     $ (0.02 )
Diluted
   $ -     $ -     $ -     $ (0.02 )
Net income (loss) per share
                                
Basic
   $ 0.02     $ (1.32 )   $ 0.21     $ (1.27 )
Diluted
   $ 0.02     $ (1.32 )   $ 0.21     $ (1.27 )
                                 
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, 2009
   $ 31,920     $ (2,963,918 )   $ 23,722,767     $ (161,678 )   $ 2,000,263     $ 423,127     $ 23,052,481  
                                                         
Stock-based compensation
    -       -       73,471       92,584       -       -       166,055  
                                                         
Net income for the period
    -       -       -       -       593,289       -       593,289  
                                                         
Change in unrealized gain:
                                                        
on available-for-sale securities
                                                        
(net of tax of $23,588)
     -       -       -       -       -       45,789       45,789  
                                                         
Total comprehensive income
     -       -       -       -       -       -       639,078  
                                                         
Balance at September 30, 2010
   $ 31,920     $ (2,963,918 )   $ 23,796,238     $ (69,094 )   $ 2,593,552     $ 468,916     $ 23,857,614  
 
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,
  
   
2010
    
2009
  
   
(Unaudited)
  
Cash Flows from Operating Activities:
            
Net income (loss)
   $ 593,289     $ (3,675,174 )
Adjustments to reconcile net income (loss) to net cash from operating activities:
          
    Depreciation and amortization
     608,538       624,223  
    Provision for loan loss
     958,639       3,492,711  
    Amortization and accretion on securities
     93,265       50,224  
    Gain on sale of  investment securities
     (496,817 )     (1,227 )
    ESOP contribution
     -       13,122  
    Stock-based compensation
     166,055       158,409  
    Gain on sale of loans held for sale
     (436,243 )     (492,288 )
    Originations of loans held for sale
     (30,128,868 )     (42,604,156 )
    Proceeds from sale of loans held for sale
     29,784,734       43,153,444  
    Gain on sale of fixed assets
     (9,423 )     (47,974 )
Net change in
                
    Accrued interest receivable
     17,156       100,578  
    Other assets
     (125,559 )     (814,186 )
    Prepaid FDIC insurance premiums
     263,703       -  
    Deferred income tax benefit
     66,336       1,117,022  
    Accrued expenses and other liabilities
     (384,078 )     773,590  
                 
Net cash provided by operating activities
     970,727       1,848,318  
                 
Cash Flows from Investing Activities:
                
  Net decrease in loans
     8,576,460       6,694,579  
  Proceeds from maturity and sale of securities
     22,347,073       10,072,221  
  Proceeds from sale of property and equipment
     30,874       1,501,066  
  Net change in discontinued operations
     -       1,533,942  
  Purchase of securities
     (21,553,359 )     (17,226,243 )
  Purchase of premises and equipment
     (12,160 )     (118,810 )
Net cash provided by investing activities
     9,388,888       2,456,755  
                 
Cash Flows from Financing Activities:
                
  Net decrease in deposits
     (1,548,973 )     (9,420,589 )
  Net increase (decrease) in Repo Sweep accounts
     979,108       (2,574,972 )
  Net increase in advances from borrowers
     101,808       84,490  
  Additions to advances  from Federal Home Loan Bank and notes payable .
     12,925,000       55,560,000  
  Repayments of Federal Home Loan Bank advances and notes payable
     (20,955,927 )     (49,147,724 )
Net cash used for financing activities
     (8,498,984 )     (5,498,795 )
                 
Net increase (decrease) in cash and cash equivalents
     1,860,631       (1,193,722 )
Cash and cash equivalents at beginning of period
     3,099,058       3,470,311  
Cash and cash equivalents at end of period
   $ 4,959,689     $ 2,276,589  
                 
Supplemental disclosure of cash flow information:
                
Cash paid during the period for income taxes
   $ -     $ -  
Cash paid during the period for interest
   $ 2,796,474     $ 4,197,740  
 
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, 2009 filed on March 31, 2010 with the Securities and Exchange Commission.

                    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, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010.

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.

In accordance with Statement of Financial Accounting Standard No. 144, 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. In accordance with the Financial Accounting Standard 144 “Accounting for the impairment or Disposal of Long-Lived Assets,” which became effective for the Company on January 1, 2002, the financial position and results of operations of ICA are “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, 2009.

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 recorded a gain of approximately $57,000 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—SECURITIES
 
Investment securities have been classified according to management’s intent.  The carrying value and estimated fair value of securities are as follows:
 
   
September 30, 2010
  
   
Amortized
Cost
    
Gross
Unrealized
Gains
    
Gross
Unrealized
Losses
    
Market
Value
  
   
(in thousands)
  
Securities Available for Sale
                        
                         
U.S. Government and agency obligations
   $ 7,524     $ 109     $ -       7,633  
Municipal obligations
     4,893       271       -       5,164  
Corporate bonds & other obligations
     1,000       14       -       1,014  
Mortgage-backed securities
     20,621       318       1       20,938  
Equity investments
     2       -       1       1  
                                 
Total
   $ 34,040     $ 712     $ 2     $ 34,750  
                                 
Securities Held to Maturity
                                
Municipal notes
   $ 2,570     $ 191     $ -     $ 2,761  
                                 
   
December 31, 2009
  
   
Amortized
Cost
    
Gross
Unrealized
Gains
    
Gross
Unrealized
Losses
    
Market
Value
  
   
(in thousands)
  
Securities Available for Sale
                                
U.S. Government and agency obligations
   $ 8,220     $ 37     $ -       8,257  
Municipal obligations
     7,870       183       -       8,053  
Corporate bonds & other obligations
     1,000       2       -       1,002  
Mortgage-backed securities
     15,979       419       1       16,397  
Equity investments
     3       1       -       4  
                                 
Total
   $ 33,072     $ 642     $ 1     $ 33,713  
                                 
Securities Held to Maturity
                                
Municipal notes
   $ 3,928     $ 159     $ 3     $ 4,084  
 
The amortized cost and estimated market value of securities at September 30, 2010, 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.

   
September 30, 2010
  
   
Amortized
Cost
    
Market
Value
  
   
(in thousands)
  
Available For Sale:
            
Due in one year or less
   $ 3,294     $ 3,347  
Due after one year through five years
     7,795       7,942  
Due in five year through ten years
     1,847       1,951  
Due after ten years
     481       571  
                 
Subtotal
     13,417       13,811  
                 
Equity securities
     2       1  
Mortgage-backed securities
     20,621       20,938  
                 
Total
   $ 34,040     $ 34,750  
                 
Held To Maturity:
                
Due in one year or less
   $ 85     $ 86  
Due after one year through five years
     365       390  
Due in five year through ten years
     630       683  
Due after ten years
     1,490       1,602  
                 
Total
   $ 2,570     $ 2,761  
 
8
 
At September 30, 2010 and December 31, 2009, securities with a carrying value and fair value of $28,764,119 and $24,265,000, 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 nine-months ended September 30, 2010 and 2009 were $10,354,000 and $1,000,000, respectively, resulting in gross gains of $497,000 and $1,000, respectively and gross losses of $0 and $0, respectively.
 
During the nine-month period ended September 30, 2010 the Company restructured its investment portfolio by selling 16 bonds, mostly issued by Freddie Mac (FHLMC) and Fannie Mae (FNMA). Although these bonds have government guarantees, they are only implied guarantees; hence the bonds are not truly backed by the full faith and credit of the United States.   The bonds sold were replaced with GNMA bonds, which are supported by the explicit full faith and credit of the United States government. By selling the municipal, FNMA and FHLMC bonds the Company was able to accomplish two things:
 
 
·
Reduce its overall credit risk in the investment portfolio.
 
·
Improve its risk-based capital position as bonds sold were 20% risk-weighted while the replacement bonds are 0% risk-weighted.

The Company concluded this move was prudent and necessary due to the following reasons:

 
·
Because of the timing of the restructuring, the Company was able to capture some previously unrealized gains.
 
·
The Company did forego a higher yield (approximately 10 basis points), but was able to minimize the yield loss by buying longer-term GNMAs, which was possible because of the minimal level of interest-rate risk inherent in the Company’s balance sheet.

The following is a summary of temporarily impaired investments that have been impaired for less than and more than twelve months as of September 30, 2010 and December 31, 2009:
 
   
September 30, 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
   $ -     $ -     $ -     $ -  
Corporate bonds and other obligations
     -       -       -       -  
Municipal obligations
     -       -       -       -  
Mortgage-backed securities
     1,994       1       -       -  
Equity securities
     -       -       2       1  
                                 
Total
   $ 1,994     $ 1     $ 4     $ 1  
                                 
   
December 31, 2009
  
           
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
   $ -     $ -     $ -     $ -  
Corporate bonds and other obligations
     -       -       -       -  
Municipal obligations
     -       -       13       1  
Mortgage-backed securities
     -       -       -       -  
Equity securities
     -       -       -       -  
                                 
Total
   $ -     $ -     $ 13     $ 1  
                                 
Held to Maturity:
                                
Municipal notes
   $ -     $ -     $ 27     $ 3  
 
9
 
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.

Note 4—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,
  
   
2010
    
2009
  
   
(in thousands)
  
Real estate loans:
            
Residential mortgage
   $ 74,261     $ 81,620  
Commercial loans:
                
Secured by real estate
     62,527       62,376  
Other
     8,574       9,873  
Total commercial loans
     71,101       72,249  
                 
Consumer loans:
                
Secured by real estate
     17,425       18,732  
Other
     2,182       2,553  
                 
Total consumer loans
     19,607       21,285  
Total gross loans
   $ 164,969     $ 175,154  
Less:
                
Net deferred loan fees
     (239 )     (275 )
Allowance for loan losses
     (3,046 )     (3,660 )
                 
Total loans, net
   $ 161,684     $ 171,219  
 
Note 5—DIVIDENDS
 
We suspended our quarterly dividend effective for the quarter ended December 31, 2008. We are dependent primarily upon the Bank for earnings and funds to pay dividends on common stock. The payment of dividends also is subject to legal and regulatory restrictions. 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.
 
Note 6 – STOCK-BASED COMPENSATION

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 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).

10
 
During the three and nine months ended September 30, 2010 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.

Stock Options - A summary of option activity under the Plan during the nine months ended September 30, 2010 is presented below:
             
Weighted-Average
    
         
Weighted-
  
Remaining
    
         
Average
  
Contractual Term
  
Aggregate
Options
  
Shares
    
Exercise Price
  
(Years)
  
Intrinsic Value
                   
Outstanding at January 1, 2010
     188,132     $ 9.47        
                       
Granted
     0       N/A        
                       
Exercised
     0       N/A        
                       
Forfeited or expired
     (2,000 )   $ 9.54        
                       
Oustanding at September 30, 2010
     186,132     $ 9.47  
5.82
  
$0
                       
Options Exercisable at September 30, 2010
     148,774     $ 9.46  
4.38
  
$0
 
A summary of the status of the Company’s nonvested options as of September 30, 2010, and changes during the nine months ended September 30, 2010, is presented below:
 
         
Weighted-Average
  
         
Grant-Date
  
Nonvested Shares
  
Shares
    
Fair Value
  
             
Nonvested at January 1, 2010
     73,476     $ 2.11  
                 
Granted
     0       N/A  
                 
Vested
     (34,118 )   $ 2.11  
                 
Forfeited
     (2,000 )   $ 2.10  
                 
Nonvested at September 30, 2010
     37,358     $ 2.10  
 
As of September 30, 2010 there was $45,000 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 0.7 years. The total fair value of shares vested during the nine months ended September 30, 2010 was $67,608.

Restricted Stock Awards - As of September 30, 2010 there was $76,000 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 0.7 years.
 
Note 7 – 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.
 
11
 
At September 30, 2010, the Company had outstanding commitments to originate loans of $30.6 million. These commitments included $14.9 million for permanent one-to-four family dwellings, $624,000 for non-residential loans, $276,000 of undisbursed loan proceeds for construction of one-to-four family dwellings, $4.3 million of undisbursed lines of credit on home equity loans, $1.1 million of unused credit card lines, $7.0 million of unused commercial lines of credit, $677,000 of undisbursed commercial construction, $5,000 of unused letters of credit and $1.7 million in unused bounce protection.

Note 8 – SEGMENT REPORTING

The Company’s principal activities include banking and, prior to February 2009, the sale of insurance products through its indirect wholly owned subsidiary, ICA. The Company sold the majority of the assets of ICA on February 27, 2009 (see Note 1). The Bank provides financial products including retail and commercial loans as well as retail and commercial deposits.  ICA received commissions from the sale of various insurance products including health, life, and property. The segments were determined based on the nature of the products provided to customers.
 
The financial information for each operating segment is reported on the basis used internally to evaluate performance and allocate resources. The allocations have been consistently applied for all periods presented.  Revenues and expenses between affiliates have been transacted at rates that unaffiliated parties would pay.  The only transaction between the segments related 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 were with external customers.  The information presented is 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 or for the three- or nine-month periods ended September 30, 2010.
 
   
For the Nine Months Ended
  
   
September 30, 2009
  
   
(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  
 
Note 9 - FAIR VALUE MEASUREMENTS

FASB ASC 820-10 – Fair 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, 2010, 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.

12
 
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.

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, 2010
  
(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,
2010
  
Assets
                        
Investment securities- available-for-sale:
                        
US Government & agency obligations
   $ -     $ 7,633     $ -     $ 7,633  
Municipal obligations
     -       5,164       -       5,164  
Corporate bonds & other obligations
     -       1,014       -       1,014  
Mortgage-backed securities
     -       20,938       -       20,938  
Equity investments
     -       1       -       1  
                                 
 Total investment securities - available-for-sale
   $ -     $ 34,750     $ -     $ 34,750  
                                 
Liabilities
                                
None
                                
 
Assets and Liabilities Measured at Fair Value on a Recurring Basis at September 30, 2009
  
(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:
                        
US Government & agency obligations
   $ -     $ 8,257     $ -     $ 8,257  
Municipal obligations
     -       8,053       -       8,053  
Corporate bonds & other obligations
     -       1,002       -       1,002  
Mortgage-backed securities
     -       16,397       -       16,397  
Equity investments
     -       4       -       4  
                                 
Total investment securities - available-for-sale
   $ -     $ 33,713     $ -     $ 33,713  
                                 
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.
 
13
 
Assets Measured at Fair Value on a Nonrecurring Basis at September 30, 2010
  
(in Thousands)
  
   
Balance at
 September 30,
2010
    
Quoted Prices
in Active
Markets for
Identical
Assets 
(Level 1)