Edgar Filing: First Federal of Northern Michigan Bancorp, Inc.

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, 2011

¨	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 x 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 9, 2011
(Title of Class)	2,884,049 shares

FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.

FORM 10-Q

Quarter Ended September 30, 2011

INDEX

	PAGE
PART I – FINANCIAL INFORMATION
ITEM 1 - UNAUDITED FINANCIAL STATEMENTS
Consolidated Balance Sheet at September 30, 2011 and December 31, 2010	3
Consolidated Statements of Income for the Three and Nine Months
Ended September 30, 2011 and September 30, 2010	4
Consolidated Statement of Changes in Stockholders’ Equity
for the Nine Months Ended September 30, 2011	5
Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 2011 and September 30, 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 – QUANTITATIVE AND QUALITIATIVE 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.

PART I - FINANCIAL INFORMATION

ITEM 1 - FINANCIAL STATEMENTS

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Consolidated Balance Sheet

	September 30, 2011			December 31, 2010
	(Unaudited)
ASSETS
Cash and cash equivalents:
Cash on hand and due from banks	$	8,049,998		$	1,889,999
Overnight deposits with FHLB		49,255			72,658
Total cash and cash equivalents		8,099,253			1,962,657
Securities AFS		50,088,379			35,301,238
Securities HTM		2,485,000			2,520,000
Loans held for sale		616,748			-
Loans receivable, net of allowance for loan losses of $1,654,364 and $2,831,332 as of September 30, 2011 and December 31, 2010, respectively		141,296,254			157,143,918
Foreclosed real estate and other repossessed assets		4,459,351			2,818,343
Federal Home Loan Bank stock, at cost		3,266,100			3,775,400
Premises and equipment		5,931,999			6,026,793
Accrued interest receivable		1,170,671			1,230,938
Intangible assets		407,968			627,306
Prepaid FDIC premiums		802,780			967,143
Deferred tax asset		330,386			659,194
Other assets		2,840,209			2,700,034
Total assets	$	221,795,098		$	215,732,964

LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits	$	152,814,940		$	155,465,896
Advances from borrowers for taxes and insurance		221,753			130,030
Federal Home Loan Bank Advances		33,000,000			29,000,000
REPO Sweep Accounts		9,417,231			6,172,362
Accrued expenses and other liabilities		1,756,116			1,728,735

Total liabilities		197,210,040			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		23,852,021			23,822,152
Retained earnings		2,896,221			2,238,064
Treasury stock at cost (307,750 shares)		(2,963,918	)		(2,963,918	)
Unearned compensation		(556	)		(38,382	)
Accumulated other comprehensive income		769,372			146,107
Total stockholders' equity		24,585,058			23,235,941

Total liabilities and stockholders' equity	$	221,795,098		$	215,732,964

See accompanying notes to consolidated financial statements.

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,
	2011			2010			2011			2010
	(Unaudited)						(Unaudited)
Interest income:
Interest and fees on loans	$	2,196,300		$	2,590,033		$	6,786,817		$	7,683,432
Interest and dividends on investments
Taxable		151,190			107,003			380,407			346,409
Tax-exempt		39,735			40,738			120,074			152,005
Interest on mortgage-backed securities		200,442			168,757			583,510			490,603
Total interest income		2,587,667			2,906,531			7,870,808			8,672,449

Interest expense:
Interest on deposits		381,124			560,106			1,226,252			1,799,663
Interest on borrowings		183,030			291,228			523,785			908,467
Total interest expense		564,154			851,334			1,750,037			2,708,130

Net interest income		2,023,513			2,055,197			6,120,771			5,964,319
Provision for loan losses		(67,079	)		352,711			(18,959	)		958,639
Net interest income after provision for loan losses		2,090,592			1,702,486			6,139,730			5,005,680

Non-interest income:
Service charges and other fees		197,267			206,024			542,986			609,538
Mortgage banking activities		218,671			447,319			637,116			1,010,634
Gain on sale of investments		-			-			-			496,817
Net gain (loss) on sale of premises and equipment,		(802	)		-			(544	)		9,423
Net gain (loss) on sale real estate owned and other repossessed assets		(7,680	)		(1,147	)		(54,368	)		43,298
Other		61,846			65,267			186,447			391,603
Total non-interest income		469,302			717,463			1,311,637			2,561,312

Non-interest expense:
Compensation and employee benefits		1,128,911			1,203,326			3,457,099			3,568,567
FDIC Insurance Premiums		54,061			88,820			176,448			277,368
Advertising		30,924			42,320			87,763			98,312
Occupancy		264,703			277,658			802,398			878,471
Amortization of intangible assets		73,113			73,113			219,338			219,338
Service bureau charges		69,383			71,230			224,881			236,926
Professional services		108,471			79,008			329,619			331,210
Other		595,593			512,725			1,495,664			1,363,511
Total non-interest expense		2,325,161			2,348,200			6,793,210			6,973,703

Income before income tax expense		234,733			71,750			658,157			593,289
Income tax expense		-			-			-			-

Net Income	$	234,733		$	71,750		$	658,157		$	593,289

Per share data:										$	-
Net income per share
Basic	$	0.08		$	0.02		$	0.23		$	0.21
Diluted	$	0.08		$	0.02		$	0.23		$	0.21
Weighted average number of shares outstanding
Basic and diluted		2,884,049			2,884,249			2,884,049			2,884,049
Dividends per common share	$	-		$	-		$	-		$	-

See accompanying notes to consolidated financial statements.

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

Treasury Stock at Cost		-		-			-		-			-		-		-

Stock-based compensation		-		-			29,869		37,826			-		-		67,695

Net income for the period		-		-			-		-			658,157		-		658,157

Change in unrealized gain: on available-for-sale securities (net of tax of $321,076)		-		-			-		-			-		623,265		623,265

Total comprehensive income		-		-			-		-			-		-		1,281,422

Balance at September 30, 2011	$	31,918	$	(2,963,918	)	$	23,852,021	$	(556	)	$	2,896,221	$	769,372	$	24,585,058

See accompanying notes to the consolidated financial statements.

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Consolidated Statement of Cash Flows

	For Nine Months Ended
	September 30,
	2011			2010
	(Unaudited)
Cash Flows from Operating Activities:
Net income	$	658,157		$	593,289
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization		525,446			608,538
Provision for loan loss		(18,959	)		958,639
Amortization and accretion on securities		209,583			93,265
Gain on sale of investment securities		-			(496,817	)
Stock-based compensation		67,695			166,055
Gain on sale of loans held for sale		(255,770	)		(436,243	)
Originations of loans held for sale		(18,479,727	)		(30,128,868	)
Proceeds from sale of loans held for sale		18,118,749			29,784,734
Loss (Gain) on sale of fixed assets		544			(9,423	)
Loss (Gain) on sale of real estate owned and other repossessed assets		54,368			(43,298	)
Net change in:
Accrued interest receivable		60,267			17,156
Other assets		(461,249	)		(1,108,485	)
Prepaid FDIC insurance premiums		164,363			263,703
Deferred income tax expense		328,808			66,336
Accrued expenses and other liabilities		27,381			(384,078	)
Net cash provided by (used in) operating activities		999,656			(55,497	)

Cash Flows from Investing Activities:
Net decrease in loans (loans originated, net of principal payments)		12,853,481			8,576,460
Proceeds from maturity and sale of available-for-sale securities		9,390,032			22,347,073
Proceeds from sale of property and equipment		1,780			30,874
Proceeds from sale of real estate and other repossessed assets		1,317,766			1,026,224
Purchase of securities		(23,407,417	)		(21,553,359	)
Purchase of premises and equipment		(213,638	)		(12,160	)
Proceeds from redemption of Federal Home Loan Bank Stock		509,300			-
Net cash provided by investing activities		451,304			10,415,112

Cash Flows from Financing Activities:
Net decrease in deposits		(2,650,956	)		(1,548,973	)
Net increase in Repo Sweep accounts		3,244,869			979,108
Net increase in advances from borrowers		91,723			101,808
Advances from Federal Home Loan Bank and notes payable		8,350,000			12,925,000
Repayments of Federal Home Loan Bank advances and notes payable		(4,350,000	)		(20,955,927	)
Net cash provided by (used in) financing activities		4,685,636			(8,498,984	)

Net increase in cash and cash equivalents		6,136,596			1,860,631
Cash and cash equivalents at beginning of period		1,962,657			3,099,058
Cash and cash equivalents at end of period	$	8,099,253		$	4,959,689

Supplemental disclosure of cash flow information:
Cash paid during the period for
Interest	$	1,783,848		$	2,796,474
Income taxes		-			-
Transfers of loans to foreclosed real estate and repossessed assets		3,013,142			1,257,767

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 and nine months ended September 30, 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 (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. 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:

	September 30, 2011
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Market Value
	(in thousands)
Securities Available for Sale
U.S. Government and agency obligations	$	11,777	$	139	$	-			11,916
Municipal obligations		6,935		413		-			7,348
Mortgage-backed securities		30,208		646		(31	)		30,823
Equity securities		2		-		(1	)		1

Total	$	48,922	$	1,198	$	(32	)	$	50,088

Securities Held to Maturity
Municipal obligations	$	2,485	$	203	$	-		$	2,688

	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 securities		3		-		(2	)		1

Total	$	35,080	$	298	$	(77	)	$	35,301

Securities Held to Maturity
Municipal obligations	$	2,520	$	90	$	(15	)	$	2,595

The amortized cost and estimated market value of securities at September 30, 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.

	September 30, 2011
	Amortized Cost		Market Value
	(in thousands)
Available For Sale:
Due in one year or less	$	1,972	$	1,993
Due after one year through five years		9,806		10,013
Due in five year through ten years		6,531		6,770
Due after ten years		403		488

Subtotal		18,712		19,264

Equity securities		2		1
Mortgage-backed securities		30,208		30,823

Total	$	48,922	$	50,088

Held To Maturity:
Due in one year or less	$	90	$	91
Due after one year through five years		395		425
Due in five year through ten years		645		707
Due after ten years		1,355		1,465

Total	$	2,485	$	2,688

At September 30, 2011 and December 31, 2010, securities with a carrying value and fair value of $33,126,000 and $34,336,000, respectively, were pledged to secure certain deposit 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, 2011 and 2010 were $0 and $10,354,000, respectively, resulting in gross gains of $0 and $497,000, respectively and gross losses of $0 and $0, respectively.

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, 2011 and December 31, 2010:

	September 30, 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		4,274		(31	)		-		-
Equity securities		-		-			2		(1	)

Total	$	4,274	$	(31	)	$	2	$	(1	)

Held to Maturity:
Municipal obligations	$	-	$	-		$	-	$	-

	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	$	12,629	$	(77	)	$	-	$	-

Held to Maturity:
Municipal obligations	$	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.

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,
	2011			2010
	(in thousands)
Real estate loans:
Residential mortgage	$	65,582		$	71,697
Commercial loans:
Secured by real estate		54,695			61,010
Other		7,380			8,848
Total commercial loans		62,075			69,858

Consumer loans:
Secured by real estate		14,147			16,547
Other		1,410			2,118

Total consumer loans		15,557			18,665
Total gross loans	$	143,214		$	160,220
Less:
Net deferred loan fees		(264	)		(245	)
Allowance for loan losses		(1,654	)		(2,831	)

Total loans, net	$	141,296		$	157,144

The following table illustrates the contractual aging of the recorded investment in past due loans by class of loans as of September 30, 2011 and December 31, 2010:

As of September 30, 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	$	-	$	-	$	173	$	173	$	88	$	261	$	-
Commercial Real Estate - other		59		1		251		311		54,123		54,434		-
Commercial - non real estate		11		-		-		11		7,369		7,380		-

Consumer:
Consumer - Real Estate		454		16		68		538		13,609		14,147		-
Consumer - Other		20		1		6		27		1,383		1,410		5

Residential:
Residential		2,627		1,541		2,261		6,429		59,153		65,582		259
Total	$	3,171	$	1,559	$	2,759	$	7,489	$	135,725	$	143,214	$	264

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

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. In any tables presented subsequently, Risk Grade 4.5 credits are included with Risk Grade 4 credits.

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.

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 as of September 30, 2011 and December 31, 2010:

As of September 30, 2011
	Commercial Real Estate		Commercial Real Estate
Loan Grade	Construction		Other		Commercial

1-2	$	-	$	-	$	21
3		88		10,787		2,378
4		-		30,969		4,676
5		-		4,366		-
6		173		8,312		305
7		-		-		-
8		-		-		-
Total	$	261	$	54,434	$	7,380

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 September 30, 2011 and December 31, 2010:

As of September 30, 2011			As of December 31, 2010
	Residential			Residential

Grade			Grade

Pass	$	62,697	Pass	$	68,301
Special Mention		-	Special Mention		-
Substandard		2,885	Substandard		3,396
Total	$	65,582	Total	$	71,697

As of September 30, 2011
	Consumer -
	Real Estate		Consumer - Other

Performing	$	14,057	$	1,400
Nonperforming		90		10
Total	$	14,147	$	1,410

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 September 30, 2011 and December 31, 2010:

	As of
	September 30, 2011

Commercial Real Estate:
Commercial Real Estate - construction	$	173
Commercial Real Estate - other		251
Commercial		-

Consumer:
Consumer - real estate		90
Consumer - other		5

Residential:
Residential		2,625

Total	$	3,144

	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 key features of the Company’s loan modifications are determined on a loan-by-loan basis. Generally, our restructurings have related to interest rate reductions and loan term extensions. In the past the Company has granted reductions in interest rates, payment extensions and short-term payment forbearances as a means to maximize collectability of troubled credits. The Company has not forgiven principal to date, although this would be considered if necessary to ensure the long-term collectability of the loan. The Company’s loan modifications are typically short-term in nature, although the Company would consider a long-term modification to ensure the long-term collectability of the credit. In general, a borrower must make at least six consecutive timely payments before the Company would consider a return of a restructured loan to accruing status in accordance with Federal Deposit Insurance Corporation guidelines regarding restoration of credits to accrual status.

The Bank has classified approximately $1,407,000 of its impaired loans as troubled debt restructurings as of September 30, 2011, as noted in the table below:

As of September 30, 2011

			Pre-Modification		Post-Modification
	Number of		Outstanding Recorded		Outstanding Recorded
	Contracts		Investments		Investment

Troubled Debt Restructurings

Commercial Real Estate - Construction		-		-		-
Commercial Real Estate - Other		3		1,488		1,407
Commercial - non real estate		-		-		-
Residential		-		-		-

	Number of
	Contracts		Recorded Investment
Troubled Debt Restructurings That Subsequently Defaulted

Commercial Real Estate - Construction		-		-
Commercial Real Estate - Other		-		-
Commercial - non real estate		-		-
Residential		-		-

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 delinquency, 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-offs may be realized as further unsecured positions are recognized.

The following tables present loans individually evaluated for impairment by class of loans as of September 30, 2011 and December 31, 2010:

As of September 30, 2011
							Average		Interest
	Unpaid Principal		Recorded		Related		Recorded		Income
	Balance		Investment		Allowance		Investment		Recognized

With no related allowance recorded:
Commercial	$	-	$	-	$	-	$	-	$	-
Commercial Real Estate - Construction		173		173		-		286		-
Commercial Real Estate - Other		881		881		-		883		-
Consumer - Real Estate		81		80		-		83		-
Consumer - Other		6		5		-		6		-
Residential		2,044		1,950		-		1,967		-

With a specific allowance recorded:
Commercial		-		-		-		-		-
Commercial Real Estate - Construction		-		-		-		-		-
Commercial Real Estate - Other		777		777		27		781		-
Consumer - Real Estate		11		10		2		10		-
Consumer - Other		-		-		-		-		-
Residential		676		675		189		675		-

Totals:
Commercial	$	-	$	-	$	-	$	-	$	-
Commercial Real Estate - Construction	$	173	$	173	$	-	$	286	$	-
Commercial Real Estate - Other	$	1,658	$	1,658	$	27	$	1,664	$	-
Consumer - Real Estate	$	92	$	90	$	2	$	93	$	-
Consumer - Other	$	6	$	5	$	-	$	6	$	-
Residential	$	2,720	$	2,625	$	189	$	2,642	$	-

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		-		667		-
Consumer - Real Estate		124		123		-		193		-
Consumer - Other		-		-		-		-		-
Residential		1,842		1,770		-		1,803		-