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

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

☒	QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2015

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 ☒ 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	☒
(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 ☒.

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 August 14, 2015
(Title of Class)	3,727,014 shares

FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.

FORM 10-Q

Quarter Ended June 30, 2015

INDEX

PAGE

PART I – FINANCIAL INFORMATION
ITEM 1 - UNAUDITED FINANCIAL STATEMENT		3
	Consolidated Balance Sheet at June 30, 2015 and December 31, 2015	3
	Consolidated Statements of Income and Comprehensive Income for the Three and Six Months Ended June 30, 2015 and June 30, 2014	4
	Consolidated Statement of Changes in Stockholders’ Equity for the Six Months Ended June 30, 2015	5
	Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2015 and June 30, 2014	6
	Notes to Unaudited Consolidated Financial Statements	7

ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL RESULTS OF OPERATIONS		26

ITEM 3 – QUANTITATIVE AND QUALITIATIVE DISCLOSURES ABOUT MARKET RISK		33

ITEM 4 - CONTROLS AND PROCEDURES		33

Part II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS		34
ITEM 1A - RISK FACTORS		34
ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS		34
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES		34
ITEM 4 - MINE SAFTEY DISCLOSURES		34
ITEM 5 - OTHER INFORMATION		34
ITEM 6 - EXHIBITS		34
	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 (in thousands)

	June 30, 2015			December 31, 2014
	(Unaudited)
ASSETS
Cash and cash equivalents:
Cash on hand and due from banks	$	5,332		$	11,205
Overnight deposits with FHLB		59			267
Total cash and cash equivalents		5,391			11,472

Deposits held in other financial institutions		8,428			8,429
Securities available for sale		125,584			119,968
Securities held to maturity		745			790
Loans held for sale		121			88
Loans receivable, net of allowance for loan losses of $1,488 and $1,429 as of June 30, 2015 and December 31, 2014, respectively		165,612			163,647
Foreclosed real estate and other repossessed assets		2,857			2,823
Federal Home Loan Bank stock, at cost		1,636			2,591
Premises and equipment		6,250			6,336
Assets held for sale		271			478
Accrued interest receivable		1,041			986
Intangible assets		1,165			1,286
Deferred tax asset		863			851
Originated mortgage servicing rights		641			710
Bank owned life insurance		4,791			4,727
Other assets		580			685

Total assets	$	325,976		$	325,867


LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Deposits	$	269,979		$	270,734
Advances from borrowers for taxes and insurance		563			203
Advances from Federal Home Loan Bank		23,217			22,885
Accrued expenses and other liabilities		1,148			1,509

Total liabilities		294,907			295,331

Stockholders’ equity:

Common stock ($0.01 par value 20,000,000 shares authorized 4,034,764 shares issued)		40			40
Additional paid-in capital		28,264			28,264
Retained earnings		5,351			4,765
Treasury stock at cost (307,750 shares)		(2,964	)		(2,964	)
Accumulated other comprehensive income		378			431
Total stockholders’ equity		31,069			30,536

Total liabilities and stockholders’ equity	$	325,976		$	325,867

See accompanying notes to consolidated financial statements.

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Consolidated Statement of Income and Comprehensive Income (in thousands)

	For the Three Months						For the Six Months
	Ended June 30,						Ended June 30,
	2015			2014			2015			2014
	(Unaudited)						(Unaudited)

Interest income:
Interest and fees on loans	$	2,033		$	1,691		$	4,038		$	3,401
Interest and dividends on investments
Taxable		327			150			621			300
Tax-exempt		30			41			60			83
Interest on mortgage-backed securities		265			143			553			286
Total interest income		2,655			2,025			5,272			4,070

Interest expense:
Interest on deposits		240			192			475			378
Interest on borrowings		68			67			134			130
Total interest expense		308			259			609			508

Net interest income		2,347			1,766			4,663			3,562
(Recovery of) provision for loan losses		(45	)		—			(22	)		16
Net interest income after provision for loan losses		2,392			1,766			4,685			3,546

Non-interest income:
Service charges and other fees		236			188			454			369
Mortgage banking activities		149			128			250			224
Net gain on sale of securities		1			—			1			—
Net (loss) gain on sale of premises and equipment, real estate owned and other repossessed assets		(1	)		(21	)		90			(26	)
Other		102			49			186			114
Total non-interest income		487			344			981			681

Non-interest expense:
Compensation and employee benefits		1,507			1,110			2,926			2,219
FDIC insurance premiums		55			45			119			91
Advertising		49			44			93			72
Occupancy		267			219			547			456
Amortization of intangible assets		61			10			121			40
Service bureau charges		102			84			205			146
Professional services		137			165			247			294
Collection activity		(6	)		11			57			29
Real estate owned & other repossessed assets		28			12			46			29
Other		299			316			570			535
Total non-interest expense		2,499			2,016			4,931			3,911

Income before income tax expense		380			94			735			316
Income tax expense		—			—			—			—

Net Income	$	380		$	94		$	735		$	316

Other Comprehensive Income:
Unrealized (loss) gain on investment securities - available for sale securities - net of tax		(293	)		161			53		$	434
Reclassification adjustment for gains realized in earnings - net of tax		—			—			—			—

Comprehensive Income	$	87		$	255		$	788		$	750

Per share data:
Net Income per share
Basic	$	0.10		$	0.03		$	0.20		$	0.11
Diluted	$	0.10		$	0.03		$	0.20		$	0.11

Weighted average number of shares outstanding
Basic		3,727,014			2,884,049			3,727,014			2,884,049
Including dilutive stock options		3,727,014			2,884,049			3,727,014			2,884,049
Dividends per common share	$	0.02		$	0.02		$	0.04		$	0.04

See accompanying notes to consolidated financial statements.

First Federal of Northern Michigan Bancorp Inc. and Subsidiaries

Consolidated Statement of Changes in Stockholders’ Equity (Unaudited)

(in thousands)

											Accumulated
						Additional					Other
	Common		Treasury			Paid-in		Retained			Comprehensive
	Stock		Stock			Capital		Earnings			Income			Total

Balance at December 31, 2014		40		(2,964	)		28,264		4,765			431			30,536

Net income		—		—			—		735			—			735

Change in unrealized gain
on available-for-sale securities
(net of tax of $140)		—		—			—		—			(53	)		(53	)

Dividends declared		—		—			—		(149	)		—			(149	)

Balance at June 30, 2015		40		(2,964	)		28,264		5,351			378			31,069

See accompanying notes to the consolidated financial statements.

First Federal of Northern Michigan Bancorp, Inc. and Subsidiaries

Consolidated Statement of Cash Flows (in thousands)

	For Six Months Ended
	June 30,
	2015			2014
	(Unaudited)
Cash Flows from Operating Activities:
Net income	$	735		$	316
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization		313			184
(Recovery of) provision for loan loss		(22	)		16
Accretion of acquired loans		(5	)		—
Amortization and accretion on securities		457			204
Gain on sale of loans held for sale		(139	)		(89	)
Gain on sale of property and equipment and asset held for sale		(81	)		21
Gain on sale of available for sale securities		(1	)		—
(Gain) loss on sale of real estate owned and other repossessed assets		(9	)		6
Originations of loans held for sale		(8,121	)		(5,523	)
Proceeds from sale of loans held for sale		8,227			5,406
Net change in:
Accrued interest receivable		(55	)		31
Other assets		190			(9	)
Bank owned life insurance		(64	)		(58	)
Accrued expenses and other liabilities		(362	)		(47	)
Net cash provided by operating activities		1,064			458

Cash Flows from Investing Activities:
Net (increase) decrease in loans		(2,435	)		965
Proceeds from maturies and calls of available-for-sale securities		14,463			5,570
Proceeds from sale of real estate and other repossessed assets		472			317
Proceeds from sale of available-for-sale securities		1,761			—
Proceeds from sale of property and equipment		288			2
Proceeds from sale of FHLB stock		955			—
Purchase of securities		(22,331	)		(16,186	)
Purchase of premises and equipment		(106	)		(86	)
Net cash used in investing activities		(6,933	)		(9,418	)

Cash Flows from Financing Activities:
Dividends paid on common stock		(149	)		(115	)
Net (decrease) increase in deposits		(755	)		8,970
Net increase in advances from borrowers		360			232
Advances from Federal Home Loan Bank		8,000			12,055
Repayments of Federal Home Loan Bank advances		(7,668	)		(11,711	)
Net cash (used in) provided by financing activities		(212	)		9,431

Net (decrease) increase in cash and cash equivalents		(6,081	)		471
Cash and cash equivalents at beginning of period		11,472			2,766
Cash and cash equivalents at end of period	$	5,391		$	3,237

Supplemental disclosure of cash flow information:

Cash refunded for taxes paid	$	15		$	—
Cash paid during the period for interest		533			509
Transfers of loans to foreclosed real estate and repossessed assets		497			265

See accompanying notes to the consolidated financial statements.

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, 2014.

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 six months ended June 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015.

Note 2 — PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of First Federal of Northern Michigan Bancorp, Inc., its wholly owned subsidiary First Federal of Northern Michigan (the “Bank”), and the Bank’s wholly owned subsidiaries, Financial Services & Mortgage Corporation (“FSMC”) and FFNM Financial Services, Inc. FSMC invested in real estate, which includes leasing, selling, developing, and maintaining real estate properties. FSMC was dissolved in the first quarter of 2015 since all real estate properties were sold in 2011. The main activity of FFNM Financial Services, Inc. is to collect commission from the sale of non-insured investment products resulting from investment advisory services offered in our branch network. All significant intercompany balances and transactions have been eliminated in the consolidation.

Note 3 — BUSINESS COMBINATIONS

As of August 8, 2014 (“Merger Date”), the Company completed its merger with Alpena Banking Corporation and its wholly owned subsidiary Bank of Alpena (“Alpena”). Alpena had one branch office and $102.9 million in assets as of August 8, 2014. The results of operations due to the merger have been included in the Company’s results since the Merger Date. The merger was effected by the issuance of shares of the Company’s common stock to Alpena Banking Corporation shareholders. Each share of Alpena’s common stock was converted into the right to receive 1.549 shares of the Company’s common stock, with cash paid in lieu of fractional shares. The conversion of Alpena’s shares resulted in the issuance of 842,965 shares of the Company’s common stock.

The merger transaction was recorded using the acquisition method of accounting and accordingly, assets acquired, liabilities assumed and consideration exchanged were recorded at estimated fair values on the Merger Date. The following table provides the purchase price calculation as of the Merger Date and the identifiable assets acquired and liabilities assumed at their estimated fair values. These fair value measurements are provisional based on third-party valuations that are currently under review and are subject to refinement for up to one year after the Merger Date based on additional information that may be obtained by us that existed on the Merger Date.

Purchase Price:

(000’s omitted)

First Federal of Northern Michigan Bancorp, Inc. common stock issued for Alpena Banking Corporation common shares		843

Price per share, based on First Federal of Northern Michigan Bancorp, Inc. closing price on August 8, 2014	$	5.59

Total purchase price	$	4,712

Preliminary Statement of Net Assets Acquired at Fair Value:

Assets
Cash and cash equivalents	$	41,650
Securities		24,008
Loans		33,051
Premises and Equipment		1,667
Core Deposit Intangible		1,392
Deferred Tax Asset		337
Other Assets		467
Total Assets	$	102,572
Liabilities
Deposits		95,787
Other Liabilities		91
Total Liabilities	$	95,878
Net Identifiable Assets Acquired			$	6,694
Bargain Purchase Gain			$	(1,982	)

The following table provides the pro forma information for the results of operations for the three and six months ended June 30, 2015 and 2014, as if the merger had occurred on January 1 of each year. These adjustments reflect the impact of certain purchase accounting fair value measurements, primarily on the loan and deposit portfolios of Bank of Alpena. These pro forma results are presented for illustrative purposes only and are not intended to represent or be indicative of the actual results of operations of the combined banking organizations that would have been achieved had the merger occurred at the beginning of each period presented, nor are they intended to represent or be indicative of future results of the Company.

	For the Three Months Ended				For the Six Months Ended
	June 30,				June 30,
	2015		2014		2015		2014

Net interest income	$	2,347	$	2,953	$	4,663	$	5,848
Non-interest income		487		632		981		1,232
Non-interest expense		2,499		3,069		4,931		6,089
Net income		380		476		735		897
Net income per basic and diluted share		0.10		0.17		0.20		0.31
Weighted average shares outstanding		3,727		2,884		3,727		2,884

In most instances, determining the fair value of the acquired assets and assumed liabilities required the Company to estimate the cash flows expected to result from those assets and liabilities and to discount those cash flows at appropriate rates of interest. The most significant of those determinations related to the valuation of acquired loans. For such loans, the excess cash flows expected at merger over the estimated fair value is recognized as interest income over the remaining lives of the loans. The difference between contractually required payments at merger and the cash flows expected to be collected at merger reflects the impact of estimated credit losses and other factors, such as prepayments. In accordance with the applicable accounting guidance for business combinations, there was no carry-over of Alpena’s previously established allowance for loan losses.

The acquired loans were divided into loans with evidence of credit quality deterioration, which are accounted for under ASC 310-30 (“acquired impaired”), and loans that do not meet the criteria, which are accounted for under ASC 310-20 (“acquired non-impaired”). In addition, the loans are further categorized into different pools based primarily on the type and purpose of the loan.

	Acquired		Acquired		Acquired
	Impaired		Non-Impaired		Total

Real estate loans:
Residential mortgages	$	397	$	6,992	$	7,389
Commercial Loans:
		—		109		109
Secured by real estate		3,070		14,721		17,791
Other		1,201		4,213		5,414
Total commercial loans		4,271		19,043		23,314

Consumer loans:
Secured by real state		30		1,568		1,598
Other		—		750		750
Total consumer loans		30		2,318		2,348

Total loans at acquisition date	$	4,698	$	28,353	$	33,051

	Acquired			Acquired			Acquired
	Impaired			Non-Impaired			Total


Loans acquired- contractual required payments	$	5,930		$	28,587		$	34,517
Non accretable yield		(1,232	)		—			(1,232	)
Expected cash flows		4,698			28,587			33,285
Accretable yield		—			(234	)		(234	)
Carrying balance at acquisition date	$	4,698		$	28,353		$	33,051

Note 4 — SECURITIES

Investment securities have been classified according to management’s intent. The carrying value and estimated fair value of securities are as follows:

	June 30, 2015
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Market Value
	(in thousands)
Securities Available for Sale
U.S. Treasury securities and obligations of U.S.
government corporations and agencies	$	33,210	$	157	$	(50	)		33,317
Municipal obligations		27,660		330		(108	)		27,882
Corporate bonds & other obligations		1,514		5		—			1,519
Mortgage-backed securities		62,625		374		(139	)		62,860
Equity securities		3		3		—			6

Total	$	125,012	$	869	$	(297	)	$	125,584

Securities Held to Maturity
Municipal obligations	$	745	$	1	$	—		$	746

	December 31, 2014
		Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Market Value
	(in thousands)
Securities Available for Sale
U.S. Treasury securities and obligations of U.S.
government corporations and agencies	$	31,221	$	58	$	(57	)		31,222
Municipal obligations		22,894		369		(129	)		23,134
Corporate bonds & other obligations		1,549		12		—			1,561
Mortgage-backed securities		63,648		515		(117	)		64,046
Equity securities		3		2		—			5

Total	$	119,315	$	956	$	(303	)	$	119,968

Securities Held to Maturity
Municipal obligations	$	790	$	118	$	—		$	908

The amortized cost and estimated market value of securities at June 30, 2015, 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.

	June 30, 2015
	Amortized Cost		Market Value
	(in thousands)
Available For Sale:
Due in one year or less	$	2,866	$	2,882
Due after one year through five years		41,333		41,520
Due in five year through ten years		16,953		16,995
Due after ten years		1,232		1,321

Subtotal		62,384		62,718

Equity securities		3		6
Mortgage-backed securities		62,625		62,860

Total	$	125,012	$	125,584

Held To Maturity:
Due in one year or less	$	45	$	45
Due after one year through five years		210		210
Due in five year through ten years		335		336
Due after ten years		155		155

Total	$	745	$	746

At June 30, 2015 and December 31, 2014, securities with a carrying value and fair value of $29.9 million and $35.0 million, respectively, were pledged to secure certain deposit accounts, FHLB advances and our line of credit at the Federal Reserve.

For the six months ended June 30, 2015 there were 2 bonds sold with a carrying value of $1.8 million at a gain of $1,000 and there were no sales recorded for the six months ended June 30, 2014.

The following is a summary of securities that had unrealized losses at June 30, 2015 and December 31, 2014. The information is presented for securities that have been in an unrealized loss position for less than 12 months and for more than 12 months. At June 30, 2015 there were 52 securities with unrealized losses totaling $297,000 and at December 31, 2014, the Company held 72 securities with unrealized losses totaling $303,000.

	June 30, 2015
			Gross Unrealized Losses					Gross Unrealized Losses
	Fair Value		<12 months			Fair Value		> 12 months
	(in thousands)
Available For Sale:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies	$	6,344	$	(22	)	$	972	$	(28	)
Municipal obligations		10,227		(80	)		2,196		(28	)
Mortgage-backed securities		13,381		(52	)		4,124		(87	)
Equity securities		—		—			—		—

Total	$	29,952	$	(154	)	$	7,292	$	(143	)

Held to Maturity:
Municipal obligations	$	—	$	—		$	—	$	—

	December 31, 2014
			Gross Unrealized Losses					Gross Unrealized Losses
	Fair Value		<12 months			Fair Value		> 12 months
	(in thousands)
Available For Sale:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies	$	13,672	$	(28	)	$	971	$	(29	)
Municipal obligations		9,506		(54	)		4,039		(75	)
Mortgage-backed securities		9,923		(31	)		4,666		(86	)
Equity securities		—		—			—		—

Total	$	33,101	$	(113	)	$	9,676	$	(190	)

Held to Maturity:
Municipal obligations	$	—	$	—		$	—	$	—

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 5 — LOANS

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

	At June 30,			At December 31,
	2015			2014
	(in thousands)

Real estate loans:
Residential mortgage	$	74,937		$	71,828
Commercial loans:
Construction - real estate		198			1,443
Secured by real estate		63,820			62,163
Other		17,685			19,000
Total commercial loans		81,703			82,606

Consumer loans:
Secured by real estate		9,183			9,502
Other		1,531			1,403
Total consumer loans		10,714			10,905

Total gross loans	$	167,354		$	165,339
Less:
Net deferred loan fees		(254	)		(263	)
Allowance for loan losses		(1,488	)		(1,429	)

Total loans, net	$	165,612		$	163,647

As of June 30, 2015 the total outstanding balance and carrying value of acquired impaired loans was $4.4 million and $3.2 million, respectively. Changes to the accretable and non-accretable yield for acquired loans were as follows as of June 30, 2015:

		Acquired			Acquired
		Impaired			Non-
		Non-			Imparied			Acquired
		Accreatable			Accreatable			Total

December 31, 2014 balance	$	(1,232	)	$	(208	)	$	(1,440	)
Net discount associated with acquired loans		—			—			—
Accretion of discount for credit spread		—			34			34
Transfer from non-accreatable to accreatable		25			(25	)		—
Loans paid off through June 30, 2015		—			—			—
Loans charged off through June 30, 2015		81			—			81
Total	$	(1,126	)	$	(199	)	$	(1,325	)

The following table illustrates the contractual aging of the recorded investment in past due loans by class of loans as of June 30, 2015 and December 31, 2014:

As of June 30, 2015
													Recorded
					Greater								Investment > 90
Originated Loans:	30 - 59 Days		60 - 89 Days		than 90 Days		Total				Total		Days and
	Past Due		Past Due		Past Due		Past Due		Current		Loans		Accruing
	(dollars in thousands)

Commercial Real Estate:
Commercial Real Estate - construction	$	—	$	—	$	—	$	—	$	198	$	198	$	—
Commercial Real Estate - other		595		82		—		677		48,462		49,139		—
Commercial - non real estate		282		—		—		282		13,794		14,076		—

Consumer:
Consumer - Real Estate		36		—		7		43		7,485		7,528		—
Consumer - Other		—		—		6		6		1,361		1,367		6

Residential:
Residential		1,783		231		87		2,101		67,041		69,142		87
Total	$	2,696	$	313	$	100	$	3,109	$	138,341	$	141,450	$	93

As of June 30, 2015
													Recorded
					Greater								Investment > 90
Acquired Loans:	30 - 59 Days		60 - 89 Days		than 90 Days		Total				Total		Days and
	Past Due		Past Due		Past Due		Past Due		Current		Loans		Accruing
	(dollars in thousands)

Commercial Real Estate:
Commercial Real Estate - construction	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Commercial Real Estate - other		209		224		187		620		14,061		14,681		51
Commercial - non real estate		—		398		151		549		3,060		3,609		—

Consumer:
Consumer - Real Estate		—		—		—		—		1,655		1,655		—
Consumer - Other		—		—		—		—		164		164		—
										—
Residential:
Residential		—		223		321		544		5,251		5,795		42
Total	$	209	$	845	$	659	$	1,713	$	24,191	$	25,904	$	93

As of December 31, 2014
													Recorded
					Greater								Investment > 90
Originated Loans:	30 - 59 Days		60 - 89 Days		than 90 Days		Total				Total		Days and
	Past Due		Past Due		Past Due		Past Due		Current		Loans		Accruing
	(dollars in thousands)
Commercial Real Estate:
Commercial Real Estate - construction	$	—	$	—	$	—	$	—	$	1,443	$	1,443	$	—
Commercial Real Estate - other		10		195		—		205		46,103		46,308		—
Commercial - non real estate		—		—		—		—		14,544		14,544		—

Consumer:
Consumer - Real Estate		107		4		7		118		7,684		7,802		—
Consumer - Other		3		—		3		6		1,152		1,158		3

Residential:
Residential		1,484		746		386		2,616		62,326		64,942		87
Total	$	1,604	$	945	$	396	$	2,945	$	133,252	$	136,197	$	90

As of December 31, 2014
													Recorded
					Greater								Investment > 90
Acquired Loans:	30 - 59 Days		60 - 89 Days		than 90 Days		Total				Total		Days and
	Past Due		Past Due		Past Due		Past Due		Current		Loans		Accruing
	(dollars in thousands)
Commercial Real Estate - construction	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Commercial Real Estate - other		125		128		93		346		15,604		15,950		—
Commercial - non real estate		—		40		104		144		4,217		4,361		—

Consumer:
Consumer - Real Estate		123		—		—		123		1,609		1,732		—
Consumer - Other		—		—		—		—		213		213		—

Residential:
Residential		147		56		461		664		6,222		6,886		225
Total	$	395	$	224	$	658	$	1,277	$	27,865	$	29,142	$	225

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 commercial loans by class of loans based on the most recent analysis performed and the contractual aging as of June 30, 2015 and December 31, 2014:

As of June 30, 2015
	Originated Loans:
			Commercial Real Estate		Commercial Real Estate
	Loan Grade		Construction		Other		Commercial

	1-2	$	—	$	700	$	27
	3		—		15,118		5,753
	4		178		22,449		5,837
	4.5		20		3,328		1,670
	5		—		2,811		135
	6		—		4,732		654
	7		—		—		—
	8		—		—		—
	Total	$	198	$	49,138	$	14,076

	Acquired Loans:
			Commercial Real Estate		Commercial Real Estate
	Loan Grade		Construction		Other		Commercial

	1-2	$	—	$	251	$	1,046
	3		—		2,244		860
	4		—		10,202		823
	4.5				472		14
	5		—		736		415
	6		—		777		451
	7		—		0		0
	8		—		0		0
	Total	$	—	$	14,682	$	3,609

As of December 31, 2014
	Originated Loans:
			Commercial Real Estate		Commercial Real Estate
	Loan Grade		Construction		Other		Commercial

	1-2	$	—	$	—	$	31
	3		—		13,565		6,088
	4		1,443		21,757		7,538
	4.5		—		3,553		252
	5		—		6,040		635
	6		—		1,393		—
	7		—		—		—
	8		—		—		—
	Total	$	1,443	$	46,308	$	14,544

	Acquired Loans:
			Commercial Real Estate		Commercial Real Estate
	Loan Grade		Construction		Other		Commercial

	1-2	$	—	$	280	$	1,188
	3		—		2,696		876
	4		—		10,905		970
	4.5				337		21
	5		—		1,176		1,150
	6		—		547		156
	7		—		9		0
	8		—		—		0
	Total	$	—	$	15,950	$	4,361

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 these loans by class based on the most recent analysis performed as of June 30, 2015 and December 31, 2014:

As of June 30, 2015
				Consumer -
		Residential		Real Estate		Consumer - Other
Originated Loans:
Loan Grade:
Pass	$	68,661	$	7,485	$	1,367
Special Mention		—		—		—
Substandard		481		43		—
Total	$	69,142	$	7,528	$	1,367

				Consumer -
		Residential		Real Estate		Consumer - Other
Acquired Loans:
Loan Grade:
Pass	$	5,466	$	1,646	$	137
Special Mention		—		—		—
Substandard		329		9		27
Total	$	5,795	$	1,655	$	164

As of December 31, 2014
				Consumer -
		Residential		Real Estate		Consumer - Other
Originated Loans:
Loan Grade:
Pass	$	64,397	$	7,778	$	1,155
Special Mention		—		—		—
Substandard		545		24		3
Total	$	64,942	$	7,802	$	1,158

				Consumer -
		Residential		Real Estate		Consumer - Other
Acquired Loans:
Loan Grade:
Pass	$	6,335	$	1,731	$	213
Special Mention		—		—		—
Substandard		551		1		—
Total	$	6,886	$	1,732	$	213

The following table presents the recorded investment in non-accrual loans by class as of June 30, 2015 and December 31, 2014:

	As of
	June 30, 2015		December 31, 2014
	(in thousands)
Commercial Real Estate:
Commercial Real Estate - construction	$	—	$	—
Commercial Real Estate - other		437		486
Commercial		72		77

Consumer:
Consumer - real estate		42		25
Consumer - other		—		—

Residential:
Residential		673		750

Total	$	1,224	$	1,338

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 $3.2 million of its impaired loans as troubled debt restructurings as of June 30, 2015. There were no commitments to extend credit to borrowers with loans classified as troubled debt restructurings as of June 30, 2015 and December 31, 2014.

Troubled Debt Restructurings that

Troubled Debt Restructurings
For the three months ended June 30, 2015

Subsequently Defaulted
For the three months ended June 30, 2015

Number of Loans

Pre-modification outstanding recorded investment

Post-modification outstanding recorded investment

Number of Loans

Recorded Investment

(dollars in thousands)

Troubled Debt Restructurings

Commercial Real Estate - Construction

—

Commercial Real Estate - Other

—

Commercial - non real estate

—

Residential

—

Total

—

Troubled Debt Restructurings that

Troubled Debt Restructurings
For the three months ended June 30, 2014

Subsequently Defaulted
For the three months ended June 30, 2014

Number of Loans

Pre-modification outstanding recorded investment

Post-modification outstanding recorded investment

Number of Loans

Recorded Investment

(dollars in thousands)

Commerical Real Estate - Construction

—

Commercial Real Estate - Other

—

Consumer - Other

—

Residential

—

Total

—

							Troubled Debt Restructurings that
	Troubled Debt Restructurings For the six months ended June 30, 2015						Subsequently Defaulted For the six months ended June 30, 2015
	Number of Loans		Pre-modification outstanding recorded investment		Post-modification outstanding recorded investment		Number of Loans		Recorded Investment
			(dollars in thousands)						(dollars in thousands)
Troubled Debt Restructurings

Commerical Real Estate - Construction		—	$	—	$	—		—	$	—
Commercial Real Estate - Other		—		—		—		—		—
Consumer - Real Estate		—		—		—		—		—
Residential		1		110		110		—		—
Total		1		110		110		—		—

Troubled Debt Restructurings that

Troubled Debt Restructurings
For the six months ended June 30, 2014

Subsequently Defaulted
For the six months ended June 30, 2014

Number of Loans

Pre-modification outstanding recorded investment

Post-modification outstanding recorded investment

Number of Loans

Recorded Investment

(dollars in thousands)

(dollars in
thousands)

Commerical Real Estate - Construction

—

Commercial Real Estate - Other

—

Consumer - Real Estate

—

Residential

—

Total

—

For the majority of the Bank’s impaired loans, the Bank will apply the market value of collateral 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 table presents loans individually evaluated for impairment by class of loans as of June 30, 2015 and December 31, 2014:

							For the Three Months Ended				For the Six Months Ended
Impaired Loans							June 30,				June 30,
As of June 30, 2015							2015				2015
	Unpaid						Average		Interest		Average		Interest
	Principal		Recorded		Related		Recorded		Income		Recorded		Income
	Balance		Investment		Allowance		Investment		Recognized		Investment		Recognized
	(dollars in thousands)						(dollars in thousands)				(dollars in thousands)
With no related allowance recorded:
Commercial	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Commercial Real Estate - Construction		—		—		—		—		—		—		—
Commercial Real Estate - Other		793		791		—		801		13		824		25
Consumer - Real Estate		22		20		—		20		—		20		—
Consumer - Other		—		—		—		—		—		—		—
Residential		419		332		—		339		2		341		5

With a specific allowance recorded:
Commercial		—		—		—		—		—		—		—
Commercial Real Estate - Construction		—		—		—		—		—		—		—
Commercial Real Estate - Other		945		945		11		949		12		954		24
Consumer - Real Estate		18		17		17		18		—		18		—
Consumer - Other		6		6		2		6		—		6		—
Residential		227		221		39		223		—		222		—

Totals:
Commercial	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Commercial Real Estate - Construction	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Commercial Real Estate - Other	$	1,738	$	1,736	$	11	$	1,750	$	25	$	1,778	$	49
Consumer - Real Estate	$	40	$	37	$	17	$	38	$	—	$	38	$	—
Consumer - Other	$	6	$	6	$	2	$	6	$	—	$	6	$	—
Residential	$	646	$	553	$	39	$	562	$	2	$	563	$	5

							For the Three Months Ended				For the Six Months Ended
Impaired Loans							June 30,				June 30,
As of December 31, 2014							2014				2014
							Average		Interest		Average		Interest
							Recorded		Income		Recorded		Income
	Balance		Investment		Allowance		Investment		Recognized		Investment		Recognized
	(dollars in thousands)						(dollars in thousands)				(dollars in thousands)
With no related allowance recorded:
Commercial	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Commercial Real Estate - Construction		—		—		—		—		—		—		—
Commercial Real Estate - Other		1,431		1,430		—		1,460		21		1,527		42
Consumer - Real Estate		26		24		—		16		—		16		—
Consumer - Other		—		—		—		—		—		—		—
Residential		781		618		—		553		3		554		4

With a specific allowance recorded:
Commercial		—		—		—		—		—		—		—
Commercial Real Estate - Construction		—		—		—		173		—		173		—
Commercial Real Estate - Other		386		386		10		1,837		4		1,838		9
Consumer - Real Estate		—		—		—		—		—		—		—
Consumer - Other		—		—		—		—		—		—		—
Residential		—		—		—		90		1		90		1

Totals:
Commercial		0		0		0		—		—		0		—
Commercial Real Estate - Construction	$	—	$	—	$	—	$	173	$	—	$	173	$	—
Commercial Real Estate - Other	$	1,817	$	1,816	$	10	$	3,297	$	25	$	3,365	$	51
Consumer - Real Estate	$	26	$	24	$	—	$	16	$	—	$	16	$	—
Consumer - Other	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Residential	$	781	$	618	$	—	$	643	$	4	$	644	$	5

The allowance for loan and lease loss (“ALLL”) has a direct impact on the provision expense. An increase in the ALLL is funded through recoveries and provision expense.

Activity in the allowance for loan and lease losses was as follows for the three and six months ended June 30, 2015 and June 30, 2014, respectively:

Allowance for Credit Losses and Recorded Investment in Financing Receivables
For the Three Months Ended June 30, 2015
	Commercial			Commercial				Consumer
	Construction			Real Estate		Commercial		Real Estate			Consumer			Residential			Unallocated		Total
	(dollars in thousands)

Allowance for credit losses:
Beginning Balance	$	15		$	370	$	105	$	48		$	21		$	813		$	72	$	1,444
Charge-offs		—			—		—		(4	)		(7	)		—			—		(11	)
Recoveries		—			61		2		17			—			20			—		100
Provision		(15	)		61		33		(19	)		4			(113	)		4		(45	)
Ending Balance	$	—		$	492	$	140	$	42		$	18		$	721		$	75	$	1,488

For the Six Months Ended June 30, 2015
	Commercial			Commercial					Consumer
	Construction			Real Estate			Commercial		Real Estate			Consumer			Residential			Unallocated			Total
	(dollars in thousands)

Allowance for credit losses:
Beginning Balance	$	8		$	307		$	94	$	33		$	19		$	869		$	99		$	1,429
Charge-offs		—			(3	)		—		(4	)		(12	)		(36	)		—			(55	)
Recoveries		12			65			4		21			—			34			—			136
Provision		(20	)		123			42		(8	)		12			(146	)		(25	)		(22	)
Ending Balance	$	—		$	492		$	140	$	42		$	18		$	721		$	75		$	1,488

Loan Balances Evaluated for Impairment
As of June 30, 2015
	Commercial		Commercial				Consumer
	Construction		Real Estate		Commercial		Real Estate		Consumer		Residential		Unallocated		Total
	(dollars in thousands)
Allowance for loan losses as of June 30, 2015
Ending balance: individually
evaluated for impairment	$	—	$	11	$	—	$	17	$	2	$	39	$	—	$	69

Ending balance: loans collectively
evaluated for impairment	$	—	$	481	$	140	$	25	$	16	$	682	$	75	$	1,419

Loans as of June 30, 2015
Loans:
Ending Balance	$	198	$	63,820	$	17,685	$	9,183	$	1,531	$	74,937	$	—	$	167,354

Ending balance: individually
evaluated for impairment	$	—	$	1,736	$	—	$	37	$	6	$	553	$	—	$	2,332

Ending balance: loans collectively
evaluated for impairment	$	198	$	47,403	$	14,076	$	7,491	$	1,361	$	68,589	$	—	$	139,118

Acquired loans with deteriorated credit
quality not subject to loan loss reserve	$	—	$	2,015	$	773	$	4	$	—	$	416	$	—	$	3,208

Other acquired loans not subject
to loan loss reserve	$	—	$	12,666	$	2,836	$	1,651	$	164	$	5,379	$	—	$	22,696

Allowance for Credit Losses and Recorded Investment in Financing Receivables
For the Three Months Ended June 30, 2014
	Commercial		Commercial				Consumer
	Construction		Real Estate		Commercial		Real Estate			Consumer			Residential			Unallocated		Total
	(dollars in thousands)

Allowance for credit losses:
Beginning Balance	$	48	$	392	$	61	$	49		$	16		$	792		$	100	$	1,458
Charge-offs		—		—		—		—			(1	)		(10	)		—		(11	)
Recoveries		—		12		—		14			—			14			—		40
Provision		—		22		11		(25	)		1			(13	)		4		—