SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549


FORM
10-K





x
            Annual
      Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
      1934


For the
Fiscal Year Ended December 31, 2009


OR


 ̈
            Transition
      Report Pursuant to 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.
      Employerincorporation
      or organization)
              Identification
      Number)





100 S. Second Avenue, Alpena,
      Michigan
                49707(Address
      of Principal Executive Offices)
                Zip
      Code





(989)
356-9041


(Registrant's
telephone number)





Securities
Registered Pursuant to Section 12(b) of the Act:


Common Stock, par value $.01 per
      share
              
              The Nasdaq Stock Market
  LLC(Title
      of Class)
              
              (Name
      of Exchange of Which
Registered)





Securities
Registered Pursuant to Section 12(g) of the Act:


None





Indicate
by check mark whether the registrant (1) filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past
twelve 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
o.





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 o.   NO
o.





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of the registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or nay amendments to
this Form 10-K.  x.





Indicate
by check mark whether the registrant is a large 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  o
              Accelerated
      filer oNon-Accelerated
      filer  o
              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 by Rule
12b-2 of the Exchange Act).   YES o.   NO
x.





Indicate
by check mark if the registrant is a well-know seasoned issuer, as defined in
Rule 405 of the Securities Act.    YES o.   NO x.





The
aggregate market value of the voting stock held by non-affiliates of the
registrant, computed by reference to the last sale price on June 30, 2009 ($2.20
per share) was $5.5 million.





As of
March 31, 2010, there were issued and outstanding 2,884,249 shares of the
registrant's common stock.





DOCUMENTS
INCORPORATED BY REFERENCE





1.
            Proxy
      Statement for the 2010 Annual Meeting of Stockholders (Parts I
      and  III).


2.
            Annual
      Report to Shareholders for the Year Ended December 31, 2009 (Part
      II).







TABLE OF
CONTENTS





PART IITEM
      1
                      BUSINESS
                      3ITEM
      1A
                      RISK
      FACTORS
                      33ITEM
      1B
                      UNRESOLVED
      STAFF COMMENTS
                      37ITEM
      2
                      PROPERTIES
                      37ITEM
      3
                      LEGAL
      PROCEEDINGS
                      37ITEM
      4
                      SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY HOLDERS
                      38PART IIITEM
      5
                      MARKET
      FOR COMMON EQUITY, RELATED STOCKHODLER MATTERS AND REGISTRANT’S PURCHASES
      OF EQUITY SECURITIES
                      38ITEM
      6
                      SELECTED
      FINANCIAL DATA
                      38ITEM
      7
                      MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS
                      38ITEM
      7A
                      QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
                      38ITEM
      8
                      FINANCIAL
      STATEMENTS AND SUPPLEMENTARY DATA
                      38ITEM
      9
                      CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE
                      38ITEM 9A(T)
                      CONTROLS
      AND PROCEDURES
                      39ITEM
      9B
                      OTHER
      INFORMATION
                      40PART IIIITEM
      10
                      DIRECTORS,
      EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
                      40ITEM
      11
                      EXECUTIVE
      COMPENSATION
                      40ITEM
      12
                      SECURITY
      OWNERSHIP OF CERTAIN BEENFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS
                      40ITEM
      13
                      CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
      INDEPENDENCE
                      40ITEM
      14
                      PRINCIPAL
      ACCOUNTANT FEES AND SERVICES
                      40PART IVITEM
      15
                      EXHIBITS
                      41SIGNATURES


2




PART I





ITEM
1. BUSINESS





Private
Securities Litigation Reform Act Safe Harbor Statement





This Annual Report on Form 10-K
contains forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995, which can be identified by the use of words such
as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,”
”expect,” “will,” “may,” and words of similar meaning.   These
forward-looking statements include, but are not limited to:





·
            statements
      of our goals, intentions and
expectations;





·
            statements
      regarding our business plans, prospects, growth and operating
      strategies;





·
            statements
      regarding the asset quality of our loan and investment portfolios;
      and





·
            estimates
      of our risks and future costs and
benefits.





These forward-looking statements are
based on our current beliefs and expectations and are inherently subject to
significant business, economic and competitive uncertainties and contingencies,
many of which are beyond our control. In addition, these forward-looking
statements are subject to assumptions with respect to future business strategies
and decisions that are subject to change. We are under no duty to and do not
take any obligation to update any forward-looking statements after the date of
this Form 10-K.





The following factors, among others,
could cause actual results to differ materially from the anticipated results or
other expectations expressed in the forward-looking statements:





·
            general
      economic conditions, either nationally or in our market areas, that are
      worse than expected;





·
            competition
      among depository and other financial
  institutions;





·
            inflation
      and changes in the interest rate environment that reduce our margins or
      reduce the fair value of financial
instruments;


·
              adverse
      changes in the securities
markets;





·
            changes
      in laws or government regulations or policies affecting financial
      institutions, including changes in regulatory fees and capital
      requirements;





·
            our
      ability to enter new markets successfully and capitalize on growth
      opportunities;





·
            our
      ability to successfully integrate acquired
  entities;





·
            changes
      in consumer spending, borrowing and savings
  habits;





·
            changes
      in accounting policies and practices, as may be adopted by the regulatory
      agencies, the Financial Accounting Standards Board, the Securities and
      Exchange Commissions and the Public Company Accounting Oversight
      Board;





·
            changes
      in our organization, compensation and benefit
  plans;





·
            changes
      in our financial condition or results of operations that reduce capital
      available to pay dividends;





·
            regulatory
      changes or actions; and





·
            changes
      in the financial condition or future prospects of issuers of securities
      that we own.


3


Because
of these and a wide variety of other uncertainties, our actual future results
may be materially different from the results indicated by these forward-looking
statements.




First
Federal of Northern Michigan Bancorp, Inc.





First
Federal of Northern Michigan Bancorp, Inc. is a Maryland corporation that owns
all of the outstanding shares of common stock of First Federal of Northern
Michigan.  At December 31, 2009, First Federal of Northern Michigan
Bancorp, Inc. had consolidated assets of $233.5 million, deposits of $158.1
million and stockholders’ equity  of $23.1 million.  As of
December 31, 2009, First Federal of Northern Michigan Bancorp, Inc. had
2,884,249 shares of common stock issued and outstanding.  First
Federal of Northern Michigan Bancorp, Inc.’s executive offices are located at
100 South Second Avenue, Alpena, Michigan 49707. Its phone number at that
address is (989) 356-9041.





The
Company also maintains a website at www.first-federal.com
that includes important information on our Company, including a list of our
products and services, branch location and current financial information. In
addition, we make available, without charge, through our website, a link to our
filings with the SEC, including copies of annual reports on Form 10-K, quarterly
reports in Form 10-Q, current reports in Form 8-K, and amendments to these
filings, if any. Information on our website should not be considered a part of
this Annual Report.





First
Federal of Northern Michigan





First
Federal of Northern Michigan is a full-service, community-oriented savings bank
that provides financial services to individuals, families and businesses from
eight full-service facilities located in Alpena,
Cheboygan, Emmett, Iosco, Otsego, Montmorency and Oscoda
Counties, Michigan.  First Federal of Northern Michigan was chartered
in 1957, and reorganized into the mutual holding company structure in 1994. In
2000, First Federal of Northern Michigan became the wholly owned subsidiary of
Alpena Bancshares, Inc., our predecessor company, and in April 2005 we completed
our “second step” mutual-to-stock conversion and formed our current ownership
structure.





First
Federal of Northern Michigan’s business consists primarily of accepting deposits
from the general public and investing those deposits, together with funds
generated from operations and borrowings, in one- to four-family residential
mortgage loans, commercial real estate loans, commercial business loans,
consumer loans and in investment securities and mortgage-backed
securities.





First
Federal of Northern Michigan’s executive offices are located at 100 South Second
Avenue, Alpena, Michigan 49707. Its phone number at that address is (989)
356-9041.





Market
Area and Competition





First
Federal of Northern Michigan conducts operations through its main office in
Alpena, Michigan, which is located in the northeastern lower peninsula of
Michigan, and through its seven other branch offices in Michigan.  The
population of Alpena County, from which the majority of our deposits are drawn,
has decreased approximately 5.7% since 2000, and currently is approximately
30,000. The population of our primary market area, which includes Alpena County
and seven surrounding counties, was approximately 182,000 in 2008, and has
remained relatively stable from 2000 to 2008, but decreased by approximately
1,400, or less than 1%, from 2007 to 2008.  The latest available per
capita income for our market area was $28,551, which was 22.2% less than the
national level, and 15.5% less than the state of Michigan as a whole, reflecting
the largely rural nature of our market area and the absence of more densely
populated urban and suburban areas.  Per capita income levels are not
expected to increase in our market area in the near future.  The
unemployment rate in our primary market area was 15.2% at December 31, 2009,
compared to 10.0 nationally and 14.5% for the state of Michigan.





Alpena is
the largest city located in the northeastern lower peninsula of
Michigan.  This area has long been associated with agricultural, wood
and concrete industries.  Tourism has also been a major industry in
our primary market area.  All of these industries tend to be seasonal
and are strongly affected by state and national economic
conditions.





Major
employers in our primary market area include various public schools and
governmental agencies, Alpena Regional Medical Center, Besser Company (a
manufacturer of concrete products equipment), Lafarge Corporation (a limestone
mining and cement producer), Panel Processing (a peg board manufacturer),
Treetops Sylvan Resort (an operator of resort properties), Garland Resort (an
operator of resort properties and golf courses), Otsego Memorial Hospital,
Cheboygan Memorial Hospital, Decorative Panels International (a hardboard
manufacturer), OMNI   Metalcraft Corp. (a diversified
manufacturer), and various other small companies.


4


As of
December 31, 2009, First Federal of Northern Michigan was the only thrift
institution headquartered in our market area.  We encounter strong
competition both in attracting deposits and in originating real estate and other
loans.  Our most direct competition for deposits has historically come
from commercial banks, other savings institutions, and credit unions in our
market area.  Competition for loans comes from such financial
institutions. We expect continued strong competition in the foreseeable future,
including the “super-regional” banks currently in our markets, from internet
banks, and from credit unions in many of our markets.  We compete for
savings deposits by offering depositors a high level of personal service and a
wide range of competitively priced financial products.  In recent
years, additional strong competition for deposits has come from securities
brokers.  We compete for real estate loans primarily on the basis of
the interest rates and fees we charge and through advertising.  Strong
competition for deposits and loans may limit our ability to grow and may
adversely affect our profitability in the future.





Lending
Activities





General.The
largest part of our loan portfolio is mortgage loans secured by one- to
four-family residential real estate.  In recent years, we have sold
into the secondary mortgage market most of the fixed-rate conventional one- to
four-family mortgage loans that we originate that have terms of 15 years or
more.  We retain the servicing on a majority of the mortgage loans
that we sell.  To a lesser extent, we also originate commercial loans,
commercial real estate loans and consumer loans.  At December 31,
2009, we had total loans of $175.2 million, of which $81.2 million, or 46.3%
were one- to four-family residential real estate mortgage loans, $430,000, or
0.2% of total loans, were residential construction loans, $55.8 million, or
31.9% were commercial real estate loans, and $9.9 million, or 5.6%, were
commercial loans.  Other loans consisted primarily of home equity
loans, which totaled  $18.7 million, or 10.7% of total loans,
commercial construction loans which totaled $6.6 million or 3.8% of total loans,
and other consumer loans which totaled $2.6 million, or 1.5% of total
loans.





One- to
Four-Family Residential Real Estate Lending.Our primary
lending activity consists of originating one- to four-family owner-occupied
residential mortgage loans, virtually all of which are collateralized by
properties located in our market area. We also originate one- to four-family
loans that pay interest only during the initial construction period (which
generally does not exceed twelve months) and then pay interest and principal for
the remainder of the loan term. We generally sell into the secondary mortgage
market most of our one- to four-family fixed-rate mortgage loans with terms of
15 years or more and retain the loan servicing on a majority of these mortgage
loans.  One- to four-family residential mortgage loans are
underwritten and originated according to policies and guidelines established by
the secondary mortgage market agencies and approved by our Board of
Directors.  We utilize existing liquidity, deposits, loan repayments,
and Federal Home Loan Bank advances to fund new loan originations.





We
currently offer fixed rate one- to four-family residential mortgage loans with
terms ranging from 15 to 30 years.  One- to four-family
residential mortgage loans often remain outstanding for significantly shorter
periods than their contractual terms because borrowers may refinance or prepay
loans at their option.  The average length of time that our one- to
four-family residential mortgage loans remain outstanding varies significantly
depending upon trends in market interest rates and other factors.  In
recent years, the average maturity of our mortgage loans has decreased
significantly because of the declining trend in market interest rates and the
unprecedented volume of refinancing activity resulting from such interest rate
decreases.  Accordingly, estimates of the average length of one- to
four-family loans that remain outstanding cannot be made with any degree of
certainty.





Originations
of fixed rate mortgage loans are regularly monitored and are affected
significantly by the level of market interest rates, our interest rate gap
position, and loan products offered by our competitors. Our fixed rate mortgage
loans amortize on a monthly basis with principal and interest due each
month.  To make our loan portfolio less interest rate sensitive,
fixed-rate loans originated with terms of 15 years or greater are generally
underwritten to secondary mortgage market standards and
sold.  Adjustable rate mortgage loans are generally underwritten to
secondary mortgage market standards, but are retained in our loan
portfolio.





We have
in the past originated some fixed-rate loans that are generally amortized over
15 years but that have “balloon payments” that are due upon the maturity of the
loan in five years.  As a general rule, we no longer originate this
type of mortgage loans. Upon maturity, existing balloon mortgage loans are
either underwritten as fixed-rate loans and sold in the secondary mortgage
market or rewritten as adjustable rate mortgages at current market
rates.  While the majority of our balloon mortgage loans amortize over
15 years, some amortize over 10 or 30 years, and a limited number amortize over
five years.


5


Our one-
to four-family residential mortgage loans customarily include due-on-sale
clauses, which are provisions giving us the right to declare a loan immediately
due and payable in the event, among other things, that the borrower sells or
otherwise disposes of the underlying real property serving as security for the
loan.  Due-on-sale clauses are an important means of adjusting the
rates on our fixed-rate mortgage loan portfolio, and we have generally exercised
our rights under these clauses.





Regulations
limit the amount that a savings institution may lend relative to the appraised
value of the real estate securing the loan, as determined by an appraisal at the
time of loan origination.  Such regulations permit a maximum
loan-to-value ratio of 100% for residential property and 90% for all other real
estate loans. Our lending policies limit the maximum loan-to-value ratio on
fixed-rate loans without private mortgage insurance to 90% of the lesser of the
appraised value or the purchase price of the property serving as collateral for
the loan.





We make
one- to four-family real estate loans with typical loan-to-value ratios of up to
90%.  However, for one- to four-family real estate loans with
loan-to-value ratios of between 80% and 90%, we may require the total loan
amount to be covered by private mortgage insurance. In 2005 we began making
80/20 loans and interest-only loans subject to Board-approved dollar limits to
limit risk exposure. In late 2007 these products were eliminated; however, at
December 31, 2009 approximately $1.1 million of these products remain in our
portfolio. We require fire and casualty insurance, flood insurance when
applicable, as well as title insurance, on all properties securing real estate
loans made by us.





Commercial
Real Estate Lending.We also originate commercial real estate
loans. At December 31, 2009, we had a total of 209 loans secured primarily by
commercial real estate properties, unimproved vacant land and, to a limited
extent, multifamily properties.  Our commercial real estate loans are
secured by income-producing properties such as office buildings, retail
buildings, restaurants and motels. A majority of our commercial real estate
loans are secured by properties located in our primary market area, although at
December 31, 2009 we did have $8.4 million in commercial real estate loans
located in states other than Michigan. We have originated commercial
construction loans that are originated as permanent loans but are interest-only
during the initial construction period, which generally does not exceed nine
months.  At December 31, 2009, our commercial real estate loans,
excluding commercial construction, totaled $55.7 million, or 31.9% of our total
loans, and had an average principal balance of approximately
$309,000.  The terms of each loan are negotiated on a case-by-case
basis, although such loans typically amortize over 15 years and have a three- or
five-year balloon feature.  An origination fee of 0.5% to 1.0% is
generally charged on commercial real estate loans.  We generally make
commercial real estate loans up to 75% of the appraised value of the property
securing the loan.





At
December 31, 2009, our largest commercial real estate relationship consisted of
two loans having a total principal balance of $2.6 million, which were
performing according to their terms as of December 31, 2009. This loan
relationship is secured by three pieces of commercial real-estate. Our largest
single commercial real estate loan was a commercial construction loan of $2.1
million, of which $1.0 million has been charged off.  This loan is
secured by a residential real-estate condominium complex which was still under
construction at December 31, 2009.  At December 31, 2009, this loan
was in non-accrual status due to insufficient cash flows to meet future payment
obligations.





Commercial
real estate loans generally carry higher interest rates and have shorter terms
than those on one- to four-family residential mortgage
loans.  However, loans secured by commercial real estate generally
involve a greater degree of credit risk than one- to four-family residential
mortgage loans and carry larger loan balances.  This increased credit
risk is a result of several factors, including the concentration of principal in
a limited number of loans and borrowers, the effects of general economic
conditions on income producing properties, and the increased difficulty of
evaluating and monitoring these types of loans. Furthermore, the repayment of
loans secured by commercial real estate is typically dependent upon the
successful operation of the business or the related real estate
property.  If the cash flow from the business operation is reduced,
the borrower’s ability to repay the loan may be impaired. This may be
particularly true in the early years of the business operation when the risk of
failure is greatest. Many of our commercial real estate loans have been made to
borrowers whose business operations are untested, which increases our
risk.





Consumer and
Other Loans.We originate a variety of consumer and other
loans, including loans secured by savings accounts, new and used automobiles,
mobile homes, boats, recreational vehicles, and other personal
property.  As of December 31, 2009, consumer and other loans totaled
$21.3 million, or 12.2% of our total loan portfolio.  At such date,
$498,000, or 0.3% of our consumer loans, were unsecured.  As of
December 31, 2009, home equity loans totaled $18.7 million, or 10.7% of our
total loan portfolio, and automobile loans totaled $1.5 million, or 0.9% of our
total loan portfolio.  We originate automobile loans directly to our
customers and have no outstanding agreements with automobile dealerships to
generate indirect loans.


6


Our
procedures for underwriting consumer loans include an assessment of an
applicant’s credit history and the ability to meet existing obligations and
payments on the proposed loan.  Although an applicant’s
creditworthiness is a primary consideration, the underwriting process also
includes a comparison of the value of the collateral security, if any, to the
proposed loan amount.





Consumer
loans generally entail greater risk than residential mortgage loans,
particularly in the case of consumer loans that are unsecured or secured by
assets that tend to depreciate rapidly, such as automobiles, mobile homes, boats
and recreational vehicles.  In addition, the repayment of consumer
loans depends on the borrower’s continued financial stability, as repayment is
more likely to be adversely affected by job loss, divorce, illness or personal
bankruptcy than a single family mortgage loan.





Commercial
Loans. At December 31, 2009, we had $9.9 million in commercial loans
which amounted to 5.6% of total loans.  We make commercial business
loans primarily in our market area to a variety of professionals, sole
proprietorships and small businesses.  Commercial lending products
include term loans and revolving lines of credit.  The maximum amount
of a commercial business loan is our loans-to-one-borrower limit, which was $4.5
million at December 31, 2009.  Such loans are generally used for
longer-term working capital purposes such as purchasing equipment or
furniture.  Commercial loans are made with either adjustable or fixed
rates of interest.  Variable rates are generally based on the prime
rate, as published in The Wall
Street Journal,plus a margin.  Fixed rate commercial loans are
set at a margin above the Federal Home Loan Bank comparable advance
rate.





When
making commercial loans, we consider the financial statements of the borrower,
our lending history with the borrower, the debt service capabilities of the
borrower, the projected cash flows of the business and the value of the
collateral.  Commercial loans are generally secured by a variety of
collateral, primarily accounts receivable, inventory and equipment, and are
supported by personal guarantees.  Depending on the collateral used to
secure the loans, commercial loans are typically made in amounts of up to 75% of
the value of the collateral securing the loan.





Commercial
loans generally have greater credit risk than residential mortgage
loans.  Unlike residential mortgage loans, which generally are made on
the basis of the borrower’s ability to make repayment from his or her employment
or other income, and which are secured by real property whose value tends to be
more easily ascertainable, commercial loans generally are made on the basis of
the borrower’s ability to repay the loan from the cash flow of the borrower’s
business.  As a result, the availability of funds for the repayment of
commercial loans may depend substantially on the success of the business
itself.  If the cash flow from the business operation is reduced, the
borrower’s ability to repay the loan may be impaired. This may be particularly
true in the early years of the business operation when the risk of failure is
greatest. Moreover, any collateral securing the loans may depreciate over time,
may be difficult to appraise and may fluctuate in value.  We seek to
minimize these risks through our underwriting standards.  At December
31, 2009, our largest commercial loan was a $2.4 million commercial
participation loan collateralized by manufacturing equipment and a related plant
facility.  At December 31, 2009, the outstanding balance was $2.4
million and the  loan was performing according to its repayment
terms.





Construction
Loans.We originate construction loans to local home builders
in our market area, generally with whom we have an established relationship, and
to individuals engaged in the construction of their residences.  We
also originate loans for the construction of commercial buildings and, to an
extent, participate in construction loan projects originated by other lenders.
Our construction loans totaled $7.0 million, or 4.0% of our total loan
portfolio, at December 31, 2009.





Our
construction loans to home builders are repaid on an interest-only basis for the
term of the loan (which is generally six to 12 months), with interest calculated
on the amount disbursed to the builders based upon a percentage of completion of
construction.  These loans typically have a maximum loan-to-value
ratio of 80%, based on the appraised value.  Interest rates are fixed
during the construction phase of the loan.  Loans to builders are made
on either a pre-sold or speculative (unsold) basis.  Most of our
construction loans to individuals who intend to occupy the completed dwelling
are originated via a “one-step closing” process, whereby the construction phase
and end-financing are handled with one loan closing.  Prior to funding
a construction loan, we require an appraisal of the property from a qualified
appraiser approved by us, and all appraisals are reviewed by us.





Construction
lending exposes us to greater credit risk than permanent mortgage financing
because of the inherent difficulty in estimating both a property’s value at
completion of the project and the estimated cost of the project. If the estimate
of construction costs is inaccurate, we may be required to advance funds beyond
the amount originally committed to permit completion of the project. If the
estimate of value upon completion is inaccurate, the value of the property may
be insufficient to assure full repayment. Projects also may be jeopardized by
disagreements between borrowers and builders and by the failure of builders to
pay subcontractors. Loans to builders to construct homes for which no purchaser
has been identified carry more risk because the repayment of the loan depends on
the builder’s ability to sell the property prior to the time that the
construction loan is due.  We have attempted to minimize these risks
by, among other things, limiting our residential construction lending primarily
to residential properties in our market area and generally requiring personal
guarantees from the principals of corporate borrowers.


7




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




At
      December 31,2009
                                    
                                    
                                    2008
                                    
                                    
                                    2007
                                    
                                    
                                    2006
                                    
                                    
                                    2005Amount
                                    
                                    
                                    Percent
                                    
                                    
                                    Amount
                                    
                                    
                                    Percent
                                    
                                    
                                    Amount
                                    
                                    
                                    Percent
                                    
                                    
                                    Amount
                                    
                                    
                                    Percent
                                    
                                    
                                    Amount
                                    
                                    
                                    Percent(Dollars
      in thousands)Real
      estate loans:Residential
      Mortgages:1-4
      Family Mortgages
                                    
                                    $
                                    77,851
                                    
                                    
                                    
                                    44.4
                                    %
                                    
                                    $
                                    87,179
                                    
                                    
                                    
                                    44.0
                                    %
                                    
                                    $
                                    91,433
                                    
                                    
                                    
                                    44.5
                                    %
                                    
                                    $
                                    93,520
                                    
                                    
                                    
                                    44.1
                                    %
                                    
                                    $
                                    91,979
                                    
                                    
                                    
                                    45.3
                                    %Purchased
      Mortgage In-State
                                    
                                    
                                    3,342
                                    
                                    
                                    
                                    1.9
                                    %
                                    
                                    
                                    3,802
                                    
                                    
                                    
                                    1.9
                                    %
                                    
                                    
                                    4,531
                                    
                                    
                                    
                                    2.2
                                    %
                                    
                                    
                                    4,635
                                    
                                    
                                    
                                    2.2
                                    %
                                    
                                    
                                    6,702
                                    
                                    
                                    
                                    3.3
                                    %Purchased
      Mortgage Out-of-State
                                    
                                    
                                    -
                                    
                                    
                                    
                                    0.0
                                    %
                                    
                                    
                                    358
                                    
                                    
                                    
                                    0.2
                                    %
                                    
                                    
                                    1,302
                                    
                                    
                                    
                                    0.6
                                    %
                                    
                                    
                                    1,335
                                    
                                    
                                    
                                    0.6
                                    %
                                    
                                    
                                    1,361
                                    
                                    
                                    
                                    0.7
                                    %1-4
      Familly Construction
                                    
                                    
                                    427
                                    
                                    
                                    
                                    0.2
                                    %
                                    
                                    
                                    1,025
                                    
                                    
                                    
                                    0.5
                                    %
                                    
                                    
                                    2,108
                                    
                                    
                                    
                                    1.0
                                    %
                                    
                                    
                                    3,120
                                    
                                    
                                    
                                    1.5
                                    %
                                    
                                    
                                    5,989
                                    
                                    
                                    
                                    3.0
                                    %Home
      Equity/Junior Liens
                                    
                                    
                                    18,732
                                    
                                    
                                    
                                    10.7
                                    %
                                    
                                    
                                    22,303
                                    
                                    
                                    
                                    11.3
                                    %
                                    
                                    
                                    24,095
                                    
                                    
                                    
                                    11.7
                                    %
                                    
                                    
                                    24,868
                                    
                                    
                                    
                                    11.7
                                    %
                                    
                                    
                                    21,238
                                    
                                    
                                    
                                    10.5
                                    %Nonresidential
      Mortgages:Nonresidential
                                    
                                    
                                    43,446
                                    
                                    
                                    
                                    24.9
                                    %
                                    
                                    
                                    42,526
                                    
                                    
                                    
                                    21.5
                                    %
                                    
                                    
                                    44,634
                                    
                                    
                                    
                                    21.7
                                    %
                                    
                                    
                                    44,212
                                    
                                    
                                    
                                    20.9
                                    %
                                    
                                    
                                    40,270
                                    
                                    
                                    
                                    19.7
                                    %Purchased
      Nonresidential In-State
                                    
                                    
                                    3,894
                                    
                                    
                                    
                                    2.2
                                    %
                                    
                                    
                                    257
                                    
                                    
                                    
                                    0.1
                                    %
                                    
                                    
                                    -
                                    
                                    
                                    
                                    0.0
                                    %
                                    
                                    
                                    942
                                    
                                    
                                    
                                    0.4
                                    %
                                    
                                    
                                    1,000
                                    
                                    
                                    
                                    0.5
                                    %Purchased
      Nonresidential Out-of-State
                                    
                                    
                                    8,428
                                    
                                    
                                    
                                    4.8
                                    %
                                    
                                    
                                    3,141
                                    
                                    
                                    
                                    1.6
                                    %
                                    
                                    
                                    1,295
                                    
                                    
                                    
                                    0.6
                                    %
                                    
                                    
                                    120
                                    
                                    
                                    
                                    0.1
                                    %
                                    
                                    
                                    -
                                    
                                    
                                    
                                    0.0
                                    %Nonresidential
      Construction
                                    
                                    
                                    2,816
                                    
                                    
                                    
                                    1.6
                                    %
                                    
                                    
                                    6,635
                                    
                                    
                                    
                                    3.3
                                    %
                                    
                                    
                                    6,184
                                    
                                    
                                    
                                    3.0
                                    %
                                    
                                    
                                    6,286
                                    
                                    
                                    
                                    3.0
                                    %
                                    
                                    
                                    4,041
                                    
                                    
                                    
                                    2.0
                                    %Purchased
      Construction In-State
                                    
                                    
                                    -
                                    
                                    
                                    
                                    0.0
                                    %
                                    
                                    
                                    -
                                    
                                    
                                    
                                    0.0
                                    %
                                    
                                    
                                    -
                                    
                                    
                                    
                                    0.0
                                    %
                                    
                                    
                                    -
                                    
                                    
                                    
                                    0.0
                                    %
                                    
                                    
                                    -
                                    
                                    
                                    
                                    0.0
                                    %Purchased
      Construction Out-of-State
                                    
                                    
                                    3,792
                                    
                                    
                                    
                                    2.2
                                    %
                                    
                                    
                                    9,781
                                    
                                    
                                    
                                    4.9
                                    %
                                    
                                    
                                    4,920
                                    
                                    
                                    
                                    2.4
                                    %
                                    
                                    
                                    -
                                    
                                    
                                    
                                    0.0
                                    %
                                    
                                    
                                    -
                                    
                                    
                                    
                                    0.0
                                    %Non
      real estate loans:Commercial
      Loans
                                    
                                    
                                    7,035
                                    
                                    
                                    
                                    4.0
                                    %
                                    
                                    
                                    15,816
                                    
                                    
                                    
                                    8.0
                                    %
                                    
                                    
                                    19,181
                                    
                                    
                                    
                                    9.3
                                    %
                                    
                                    
                                    24,606
                                    
                                    
                                    
                                    11.6
                                    %
                                    
                                    
                                    23,926
                                    
                                    
                                    
                                    11.8
                                    %Purchased
      Commerical Loans In-State
                                    
                                    
                                    2,838
                                    
                                    
                                    
                                    1.6
                                    %
                                    
                                    
                                    1,804
                                    
                                    
                                    
                                    0.9
                                    %
                                    
                                    
                                    1,387
                                    
                                    
                                    
                                    0.7
                                    %
                                    
                                    
                                    3,603
                                    
                                    
                                    
                                    1.7
                                    %
                                    
                                    
                                    1,732
                                    
                                    
                                    
                                    0.9
                                    %Purchased
      Commerical Loans Out-of-State
                                    
                                    
                                    -
                                    
                                    
                                    
                                    0.0
                                    %
                                    
                                    
                                    -
                                    
                                    
                                    
                                    0.0
                                    %
                                    
                                    
                                    -
                                    
                                    
                                    
                                    0.0
                                    %
                                    
                                    
                                    -
                                    
                                    
                                    
                                    0.0
                                    %
                                    
                                    
                                    -
                                    
                                    
                                    
                                    0.0
                                    %Consumer
      and other loans
                                    
                                    
                                    2,553
                                    
                                    
                                    
                                    1.5
                                    %
                                    
                                    
                                    3,564
                                    
                                    
                                    
                                    1.8
                                    %
                                    
                                    
                                    4,555
                                    
                                    
                                    
                                    2.3
                                    %
                                    
                                    
                                    4,688
                                    
                                    
                                    
                                    2.2
                                    %
                                    
                                    
                                    4,669
                                    
                                    
                                    
                                    2.3
                                    %Total
      Loans
                                    
                                    $
                                    175,154
                                    
                                    
                                    
                                    100.00
                                    %
                                    
                                    $
                                    198,191
                                    
                                    
                                    
                                    100.00
                                    %
                                    
                                    $
                                    205,625
                                    
                                    
                                    
                                    100.00
                                    %
                                    
                                    $
                                    211,935
                                    
                                    
                                    
                                    100.00
                                    %
                                    
                                    $
                                    202,907
                                    
                                    
                                    
                                    100.00
                                    %Other
      items:Unadvanced
      construction loans
                                    
                                    
                                    -
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    -Deferred
      loan origination costs
                                    
                                    
                                    12
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    13
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    13
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    20
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    28Deferred
      loan origination fees
                                    
                                    
                                    (287
                                    )
                                    
                                    
                                    
                                    
                                    
                                    
                                    (287
                                    )
                                    
                                    
                                    
                                    
                                    
                                    
                                    (292
                                    )
                                    
                                    
                                    
                                    
                                    
                                    
                                    (358
                                    )
                                    
                                    
                                    
                                    
                                    
                                    
                                    (336
                                    )Allowance
      for loan losses
                                    
                                    
                                    (3,660
                                    )
                                    
                                    
                                    
                                    
                                    
                                    
                                    (5,647
                                    )
                                    
                                    
                                    
                                    
                                    
                                    
                                    (4,013
                                    )
                                    
                                    
                                    
                                    
                                    
                                    
                                    (2,079
                                    )
                                    
                                    
                                    
                                    
                                    
                                    
                                    (1,416
                                    )Total
      loans, net
                                    
                                    $
                                    171,219
                                    
                                    
                                    
                                    
                                    
                                    
                                    $
                                    192,270
                                    
                                    
                                    
                                    
                                    
                                    
                                    $
                                    201,333
                                    
                                    
                                    
                                    
                                    
                                    
                                    $
                                    209,518
                                    
                                    
                                    
                                    
                                    
                                    
                                    $
                                    201,183




Loan Portfolio
Maturities and Yield.  The following table summarizes the
scheduled repayments of our loan portfolio at December 31, 2009. Demand loans,
loans having no stated repayment or maturity, and overdraft loans are reported
as being due in one year or less.


8





1-4 Family Mortgage
                    
                    
                    Purchased Mortgage In-State
                    
                    
                    Purchased Mortgage Out-of State
                    
                    
                    1-4 Family ConstructionWeighted
                    
                    
                    
                    
                    
                    Weighted
                    
                    
                    
                    
                    
                    Weighted
                    
                    
                    
                    
                    
                    WeightedAverage
                    
                    
                    
                    
                    
                    Average
                    
                    
                    
                    
                    
                    Average
                    
                    
                    
                    
                    
                    AverageAmount
                    
                    
                    Rate
                    
                    
                    Amount
                    
                    
                    Rate
                    
                    
                    Amount
                    
                    
                    Rate
                    
                    
                    Amount
                    
                    
                    RateDue
      During the YearsEnding
      December 31,2010
                    
                    $
                    1,274
                    
                    
                    
                    6.01
                    %
                    
                    $
                    -
                    
                    
                    
                    0.00
                    %
                    
                    $
                    -
                    
                    
                    
                    0.00
                    %
                    
                    $
                    427
                    
                    
                    
                    6.04
                    %2011
                    
                    
                    389
                    
                    
                    
                    7.78
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %2012
                    
                    
                    444
                    
                    
                    
                    7.38
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %2013
      to 2014
                    
                    
                    2,446
                    
                    
                    
                    6.34
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %2015
      to 2019
                    
                    
                    9,411
                    
                    
                    
                    5.92
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %2020
      to 2024
                    
                    
                    9,933
                    
                    
                    
                    6.61
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %2024
      and beyond
                    
                    
                    53,954
                    
                    
                    
                    6.50
                    %
                    
                    
                    3,342
                    
                    
                    
                    4.02
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %Total
                    
                    $
                    77,851
                    
                    
                    
                    6.18
                    %
                    
                    $
                    3,342
                    
                    
                    
                    4.02
                    %
                    
                    $
                    -
                    
                    
                    
                    0.00
                    %
                    
                    $
                    427
                    
                    
                    
                    6.04
                    %




Home Equity/Junior Liens
                    
                    
                    Nonresidential
                    
                    
                    Purchased Nonresidential In-State
                    
                    
                    Purchased Nonresidential Out-of-StateWeighted
                    
                    
                    
                    
                    
                    Weighted
                    
                    
                    
                    
                    
                    Weighted
                    
                    
                    
                    
                    
                    WeightedAverage
                    
                    
                    
                    
                    
                    Average
                    
                    
                    
                    
                    
                    Average
                    
                    
                    
                    
                    
                    AverageAmount
                    
                    
                    Rate
                    
                    
                    Amount
                    
                    
                    Rate
                    
                    
                    Amount
                    
                    
                    Rate
                    
                    
                    Amount
                    
                    
                    RateDue
      During the YearsEnding
      December 31,2010
                    
                    $
                    145
                    
                    
                    
                    6.97
                    %
                    
                    $
                    15,835
                    
                    
                    
                    5.38
                    %
                    
                    $
                    -
                    
                    
                    
                    0.00
                    %
                    
                    $
                    4,140
                    
                    
                    
                    5.33
                    %2011
                    
                    
                    1,716
                    
                    
                    
                    5.21
                    %
                    
                    
                    10,127
                    
                    
                    
                    6.83
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %2012
                    
                    
                    1,026
                    
                    
                    
                    5.70
                    %
                    
                    
                    8,523
                    
                    
                    
                    6.93
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %2013
      to 2014
                    
                    
                    1,425
                    
                    
                    
                    6.67
                    %
                    
                    
                    6,798
                    
                    
                    
                    6.61
                    %
                    
                    
                    3,792
                    
                    
                    
                    5.50
                    %
                    
                    
                    2,382
                    
                    
                    
                    7.25
                    %2015
      to 2019
                    
                    
                    5,464
                    
                    
                    
                    6.16
                    %
                    
                    
                    1,289
                    
                    
                    
                    6.61
                    %
                    
                    
                    102
                    
                    
                    
                    7.58
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %2020
      to 2024
                    
                    
                    7,485
                    
                    
                    
                    5.75
                    %
                    
                    
                    -
                    
                    
                    
                    5.75
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %2024
      and beyond
                    
                    
                    1,471
                    
                    
                    
                    3.82
                    %
                    
                    
                    874
                    
                    
                    
                    7.94
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %
                    
                    
                    1,906
                    
                    
                    
                    5.23
                    %Total
                    
                    $
                    18,732
                    
                    
                    
                    5.81
                    %
                    
                    $
                    43,446
                    
                    
                    
                    6.10
                    %
                    
                    $
                    3,894
                    
                    
                    
                    6.35
                    %
                    
                    $
                    8,428
                    
                    
                    
                    5.85
                    %




Nonresidential Construction
                  
                  
                  Purchased Construction In-State
                  
                  
                  Purchased Construction Out-of-State
                  
                  
                  Commercial LoansWeighted
                  
                  
                  
                  
                  
                  Weighted
                  
                  
                  Weighted
                  
                  
                  
                  
                  
                  WeightedAverage
                  
                  
                  
                  
                  
                  Average
                  
                  
                  Average
                  
                  
                  
                  
                  
                  AverageAmount
                  
                  
                  Rate
                  
                  
                  Amount
                  
                  
                  Rate
                  
                  
                  Amount
                  
                  
                  Rate
                  
                  
                  Amount
                  
                  
                  RateDue
      During the YearsEnding
      December 31,2010
                  
                  $
                  1,433
                  
                  
                  
                  4.97
                  %
                  
                  $
                  -
                  
                  
                  
                  0.00
                  %
                  
                  $
                  -
                  
                  
                  
                  0.00
                  %
                  
                  $
                  1,712
                  
                  
                  
                  7.94
                  %2011
                  
                  
                  1,383
                  
                  
                  
                  3.90
                  %
                  
                  
                  -
                  
                  
                  
                  0.00
                  %
                  
                  
                  1,823
                  
                  
                  
                  8.35
                  %
                  
                  
                  1,207
                  
                  
                  
                  5.42
                  %2012
                  
                  
                  -
                  
                  
                  
                  0.00
                  %
                  
                  
                  -
                  
                  
                  
                  0.00
                  %
                  
                  
                  -
                  
                  
                  
                  0.00
                  %
                  
                  
                  765
                  
                  
                  
                  6.71
                  %2013
      to 2014
                  
                  
                  -
                  
                  
                  
                  0.00
                  %
                  
                  
                  -
                  
                  
                  
                  0.00
                  %
                  
                  
                  1,969
                  
                  
                  
                  8.18
                  %
                  
                  
                  506
                  
                  
                  
                  8.03
                  %2015
      to 2019
                  
                  
                  -
                  
                  
                  
                  0.00
                  %
                  
                  
                  -
                  
                  
                  
                  0.00
                  %
                  
                  
                  -
                  
                  
                  
                  0.00
                  %
                  
                  
                  2,845
                  
                  
                  
                  5.42
                  %2020
      to 2024
                  
                  
                  -
                  
                  
                  
                  0.00
                  %
                  
                  
                  -
                  
                  
                  
                  0.00
                  %
                  
                  
                  -
                  
                  
                  
                  0.00
                  %
                  
                  
                  -
                  
                  
                  
                  0.00
                  %2024
      and beyond
                  
                  
                  -
                  
                  
                  
                  0.00
                  %
                  
                  
                  -
                  
                  
                  
                  0.00
                  %
                  
                  
                  -
                  
                  
                  
                  0.00
                  %
                  
                  
                  -
                  
                  
                  
                  0.00
                  %Total
                  
                  $
                  2,816
                  
                  
                  
                  4.44
                  %
                  
                  $
                  -
                  
                  
                  
                  0.00
                  %
                  
                  $
                  3,792
                  
                  
                  
                  8.26
                  %
                  
                  $
                  7,035
                  
                  
                  
                  6.25
                  %




Purchased Commercial Loans In-State
                    
                    
                    Purchased Commercial Loans Out-of State
                    
                    
                    Consumer & Other Loans
                    
                    
                    TotalWeighted
                    
                    
                    
                    
                    
                    Weighted
                    
                    
                    
                    
                    
                    Weighted
                    
                    
                    
                    
                    
                    WeightedAverage
                    
                    
                    
                    
                    
                    Average
                    
                    
                    
                    
                    
                    Average
                    
                    
                    
                    
                    
                    AverageAmount
                    
                    
                    Rate
                    
                    
                    Amount
                    
                    
                    Rate
                    
                    
                    Amount
                    
                    
                    Rate
                    
                    
                    Amount
                    
                    
                    RateDue
      During the YearsEnding
      December 31,2010
                    
                    $
                    2,371
                    
                    
                    
                    3.73
                    %
                    
                    $
                    -
                    
                    
                    
                    0.00
                    %
                    
                    $
                    432
                    
                    
                    
                    7.88
                    %
                    
                    $
                    27,769
                    
                    
                    
                    5.89
                    %2011
                    
                    
                    -
                    
                    
                    
                    0.00
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %
                    
                    
                    250
                    
                    
                    
                    8.45
                    %
                    
                    
                    16,895
                    
                    
                    
                    6.34
                    %2012
                    
                    
                    -
                    
                    
                    
                    0.00
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %
                    
                    
                    287
                    
                    
                    
                    8.75
                    %
                    
                    
                    11,045
                    
                    
                    
                    6.87
                    %2013
      to 2014
                    
                    
                    467
                    
                    
                    
                    6.34
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %
                    
                    
                    323
                    
                    
                    
                    7.24
                    %
                    
                    
                    20,108
                    
                    
                    
                    6.61
                    %2015
      to 2019
                    
                    
                    -
                    
                    
                    
                    0.00
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %
                    
                    
                    1,019
                    
                    
                    
                    9.12
                    %
                    
                    
                    20,130
                    
                    
                    
                    6.28
                    %2020
      to 2024
                    
                    
                    -
                    
                    
                    
                    0.00
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %
                    
                    
                    242
                    
                    
                    
                    8.32
                    %
                    
                    
                    17,660
                    
                    
                    
                    6.05
                    %2024
      and beyond
                    
                    
                    -
                    
                    
                    
                    0.00
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %
                    
                    
                    -
                    
                    
                    
                    0.00
                    %
                    
                    
                    61,547
                    
                    
                    
                    6.04
                    %Total
                    
                    $
                    2,838
                    
                    
                    
                    4.16
                    %
                    
                    $
                    -
                    
                    
                    
                    5.98
                    %
                    
                    $
                    2,553
                    
                    
                    
                    8.64
                    %
                    
                    $
                    175,154
                    
                    
                    
                    6.37
                    %


9


Fixed- and
Adjustable-Rate Loans.  The following table sets forth the
scheduled repayments of   fixed- and adjustable-rate loans at
December 31, 2009 that are contractually due after December 31,
2010.





Due After December 31, 2010Fixed
                  
                  
                  Adjustable
                  
                  
                  Total(In
      thousands)Residential
      Mortgages:1-4
      Family Mortgages
                  
                  $
                  38,286
                  
                  
                  $
                  38,291
                  
                  
                  $
                  76,577Purchased
      Mortgage In-State
                  
                  
                  -
                  
                  
                  
                  3,342
                  
                  
                  
                  3,342Purchased
      Mortgage Out-of-State
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -1-4
      Family Construction
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Home
      Equity/Junior Liens
                  
                  
                  9,833
                  
                  
                  
                  8,754
                  
                  
                  
                  18,587Nonresidential
      Mortgages:Nonresidential
                  
                  
                  22,205
                  
                  
                  
                  5,406
                  
                  
                  
                  27,611Purchased
      Nonresidential In-State
                  
                  
                  3,894
                  
                  
                  
                  -
                  
                  
                  
                  3,894Purchased
      Nonresidential Out-of-State
                  
                  
                  3,332
                  
                  
                  
                  956
                  
                  
                  
                  4,288Nonresidential
      Construction
                  
                  
                  -
                  
                  
                  
                  1,383
                  
                  
                  
                  1,383Purchased
      Construction In-State
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Purchased
      Construction Out--State
                  
                  
                  2,552
                  
                  
                  
                  1,240
                  
                  
                  
                  3,792Non
      real estate loans:Commercial
      Loans
                  
                  
                  3,390
                  
                  
                  
                  1,933
                  
                  
                  
                  5,323Purchased
      Commerical Loans In-State
                  
                  
                  467
                  
                  
                  
                  -
                  
                  
                  
                  467Purchased
      Commerical Loans Out-of-State
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Consumer
      and other loans
                  
                  
                  1,702
                  
                  
                  
                  419
                  
                  
                  
                  2,121Total
      Loans
                  
                  $
                  85,661
                  
                  
                  $
                  61,724
                  
                  
                  $
                  147,385





Loan
Originations, Purchases, Sales and Servicing.While we
originate both fixed-rate and adjustable-rate loans, our ability to generate
each type of loan depends upon borrower demand, market interest rates, borrower
preference for fixed- versus adjustable-rate loans, and the interest rates
offered on each type of loan by other lenders in our market area. These lenders
include competing banks, savings banks, credit unions, internet lenders,
mortgage banking companies and life insurance companies that may also actively
compete for local commercial real estate loans. Loan originations are derived
from a number of sources, including real estate agent referrals, existing
customers, borrowers, builders, attorneys, our directors, walk-in customers and
our own commercial sales force.  Upon receiving a loan application, we
obtain a credit report and employment verification to verify specific
information relating to the applicant’s employment, income, and credit
standing.  In the case of a real estate loan, we obtain a
determination of value of the real estate intended to collateralize the proposed
loan.  Our residential mortgage lending limits vary by residential
mortgage officer but range from $150,000 to $250,000. While certain Senior Bank
Officers have residential lending limits up to $400,000, the Officer Loan
Committee generally approves residential loans from $250,000 to $400,000 while
requests from $400,000 to $500,000 will receive approval from Senior Loan
Committee. Residential loan requests over $500,000 must be approved by the Board
of Directors. Secured consumer lending limits by officer range from $25,000 to
$150,000. For secured commercial loans, the limits range from $250,000 to
$400,000.





A
commercial commitment letter specifies the terms and conditions of the proposed
loan including the amount of the loan, interest rate, amortization term, a brief
description of the required collateral, and required insurance
coverage.  Commitments are typically issued for 15-day
periods.  The borrower must provide proof of fire and casualty
insurance on the property serving as collateral, which must be maintained during
the full term of the loan.  A title insurance policy is required on
all real estate loans.  At December 31, 2009, we had outstanding loan
commitments of $26.0 million, including unfunded commitments under lines of
credit and commercial and standby letters of credit.


10


Our loan
origination and sales activity may be adversely affected by a rising interest
rate environment that typically results in decreased loan demand, while
declining interest rates may stimulate increased loan demand. Accordingly, the
volume of loan originations, the mix of fixed- and adjustable-rate loans, and
the profitability of this activity can vary from period to
period.  One- to four-family residential mortgage loans are generally
underwritten to investor guidelines, and closed on standard investor
documents.  We currently sell loans to Freddie Mac. If such loans are
sold, the sales are conducted using standard investor purchase contracts and
master commitments as applicable. The majority of one- to four-family mortgage
loans that we have sold to investors have been sold on a non-recourse basis,
whereby foreclosure losses are generally the responsibility of the purchaser and
not First Federal of Northern Michigan.





We are a
qualified loan servicer for Freddie Mac.  Our policy has historically
been to retain the servicing rights for all conforming loans sold, and to
continue to collect payments on the loans, maintain tax escrows and applicable
fire and flood insurance coverage, and supervise foreclosure proceedings if
necessary.  We retain a portion of the interest paid by the borrower
on the loans as consideration for our servicing activities.





We
require appraisals of real property securing loans.  Appraisals are
performed by independent appraisers, who are approved by our Board of Directors
annually.  We require fire and extended coverage insurance in amounts
adequate to protect our principal balance.  Where appropriate, flood
insurance is also required.  Private mortgage insurance is required
for most residential mortgage loans with loan-to-value ratios greater than
80%.




Loan Origination
Fees and Costs.In addition to interest earned on loans, we
generally receive fees in connection with loan originations.  Such
loan origination fees, net of costs to originate, are deferred and amortized
using an interest method over the contractual life of the loan.  Fees
deferred are recognized into income immediately upon prepayment or subsequent
sale of the related loan.  At December 31, 2009, we had $275,000 of
net deferred loan origination fees.  Such fees vary with the volume
and type of loans and commitments made and purchased, principal repayments, and
competitive conditions in the mortgage markets, which in turn respond to the
demand and availability of money.  In addition to loan origination
fees, we also generate other income through the sales and servicing of mortgage
loans, late charges on loans, and fees and charges related to deposit
accounts.  We recognized fees and service charges of $869,000,
$942,000 and $911,000 for the years ended December 31, 2009, 2008 and 2007,
respectively.





To the
extent that originated loans are sold with servicing retained, we capitalize a
mortgage servicing asset at the time of the sale in accordance with applicable
accounting standards (FASB ASC 860, “Transfers and Servicing ”).  The
capitalized amount is amortized thereafter (over the period of estimated net
servicing income) as a reduction of servicing fee income.  The
unamortized amount is fully charged to income when loans are
prepaid.  Originated mortgage servicing rights with an amortized cost
of $730,000 were included in other assets at December 31, 2009.




11





Origination,
Purchase and Sale of Loans.  The table below
shows our loan originations, purchases, sales, and repayments of loans for the
periods indicated.  In 2009, we purchased $4.9 million in commercial
real estate loan participations, all of which were located in the State of
Michigan.





Years Ended December 31,2009
                  
                  
                  2008
                  
                  
                  2007(In
      Thousands)Loans
      receivable at beginning of period
                  
                  $
                  198,191
                  
                  
                  $
                  205,625
                  
                  
                  $
                  211,935Originations:Real
      estate:Residential
      1-4 family
                  
                  
                  58,909
                  
                  
                  
                  30,187
                  
                  
                  
                  31,496Commercial
      and Multi-family
                  
                  
                  17,254
                  
                  
                  
                  24,191
                  
                  
                  
                  21,644Consumer
                  
                  
                  3,894
                  
                  
                  
                  6,543
                  
                  
                  
                  9,035Total
      originations
                  
                  
                  80,057
                  
                  
                  
                  60,921
                  
                  
                  
                  62,175Loan
      purchases:Residential
      1-4 family
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Commercial
                  
                  
                  4,914
                  
                  
                  
                  5,177
                  
                  
                  
                  11,125Total
      loan purchases
                  
                  
                  4,914
                  
                  
                  
                  5,177
                  
                  
                  
                  11,125Loan
      sales
                  
                  
                  (49,545
                  )
                  
                  
                  (11,641
                  )
                  
                  
                  (16,287
                  )Transfer
      of  loans to foreclosed assets
                  
                  
                  (6,382
                  )
                  
                  
                  (2,916
                  )
                  
                  
                  (1,807
                  )Repayments
                  
                  
                  (52,081
                  )
                  
                  
                  (58,975
                  )
                  
                  
                  (61,516
                  )Total
      loans receivable at end of period
                  
                  $
                  175,154
                  
                  
                  $
                  198,191
                  
                  
                  $
                  205,625





Delinquent
Loans, Other Real Estate Owned and Classified Assets





Collection
Procedures.Our general collection procedures provide that
when a commercial loan becomes 10 days past due and when a mortgage or consumer
loan become 15 days past due, a computer-generated late charge notice is sent to
the borrower requesting payment. If delinquency continues, a second delinquent
notice is mailed when the loan continues past due for 30 days.  If a
loan becomes 60 days past due, the loan becomes subject to possible legal
action.  We will generally send a “due and payable” letter upon a loan
becoming 60 days delinquent.  This letter grants the mortgagor 30 days
to bring the account paid to date prior to the start of any legal
action.  If not paid, foreclosure proceedings are initiated after this
30-day period.  To the extent required by regulations of the
Department of Housing and Urban Development (“HUD”), generally within 30 days of
delinquency, a Section 160 HUD notice is given to the borrower which provides
access to consumer counseling services.  General collection procedures
may vary with particular circumstances on a loan by loan basis.  Also,
collection procedures for Freddie Mac serviced loans follow the Freddie Mac
guidelines which are different from our general procedures.





Loans Past Due
and Non-Performing Assets.Loans are reviewed on a regular
basis and are placed on non-accrual status when, in the opinion of management,
the collection of additional interest is doubtful or when extraordinary efforts
are required to collect the debt.  Interest accrued and unpaid at the
time a loan is placed on non-accrual status is charged against interest
income.





Real
estate acquired by us as a result of foreclosure or by deed in lieu of
foreclosure is deemed real estate owned (“REO”) until such time as it is
sold.  In general, we consider collateral for a loan to be
“in-substance” foreclosed if: (i) the borrower has little or no equity in the
collateral; (ii) proceeds for repayment of the loan can be expected to come only
from the operation or sale of the collateral; and (iii) the borrower has either
formally or effectively abandoned control of the collateral, or retained control
of the collateral but is unlikely to be able to rebuild equity in the collateral
or otherwiserepay the
loan in the foreseeable future.  Cash flow attributable to
in-substance foreclosures is used to reduce the carrying value of the
collateral.


12




When
collateral, other than real estate, securing commercial and consumer loans is
acquired as a result of delinquency or other reasons, it is classified as Other
Repossessed Assets (“ORA”) and recorded at the lower of cost or fair market
value until it is disposed of.





When
collateral is acquired or otherwise deemed REO/ORA, it is recorded at the lower
of the unpaid principal balance of the related loan or its estimated net
realizable value.  This write down is recorded against the allowance
for loan losses.  Periodic future valuations are performed by
management, and any subsequent decline in fair value is charged to
operations.  At December 31, 2009, we held $3.6 million in properties
that were classified REO and $11,000 in assets classified as ORA.





Delinquent
Loans.  The following
table sets forth certain information with respect to our loan portfolio
delinquencies at the dates indicated.





Loan
      Delinquent For60-89 Days
                          
                          
                          90 Days and Over
                          
                          
                          TotalNumber
                          
                          
                          Amount
                          
                          
                          Number
                          
                          
                          Amount
                          
                          
                          Number
                          
                          
                          Amount(
      Dollars In Thousands)At December 31, 2009Residential
      Mortgages
                          
                          
                          19
                          
                          
                          $
                          1,456
                          
                          
                          
                          1
                          
                          
                          $
                          89
                          
                          
                          
                          20
                          
                          
                          $
                          1,545Commercial
      Mortgages
                          
                          
                          7
                          
                          
                          
                          1,125
                          
                          
                          
                          3
                          
                          
                          
                          2,696
                          
                          
                          
                          10
                          
                          
                          
                          3,821Construction
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -Commercial
                          
                          
                          3
                          
                          
                          
                          402
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          3
                          
                          
                          
                          402Consumer
                          
                          
                          13
                          
                          
                          
                          192
                          
                          
                          
                          9
                          
                          
                          
                          54
                          
                          
                          
                          22
                          
                          
                          
                          246Total
                          
                          
                          42
                          
                          
                          $
                          3,175
                          
                          
                          
                          13
                          
                          
                          $
                          2,839
                          
                          
                          
                          55
                          
                          
                          
                          6,014At December 31, 2008Residential
      Mortgages
                          
                          
                          26
                          
                          
                          $
                          2,513
                          
                          
                          
                          2
                          
                          
                          $
                          128
                          
                          
                          
                          28
                          
                          
                          $
                          2,641Commercial
      Mortgages
                          
                          
                          5
                          
                          
                          
                          736
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          5
                          
                          
                          
                          736Commercial
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          1
                          
                          
                          
                          72
                          
                          
                          
                          1
                          
                          
                          
                          72Consumer
                          
                          
                          26
                          
                          
                          
                          155
                          
                          
                          
                          8
                          
                          
                          
                          17
                          
                          
                          
                          34
                          
                          
                          
                          172Total
                          
                          
                          57
                          
                          
                          $
                          3,404
                          
                          
                          
                          11
                          
                          
                          $
                          217
                          
                          
                          
                          68
                          
                          
                          
                          3,621At December 31, 2007Residential
      Mortgages
                          
                          
                          24
                          
                          
                          $
                          1,315
                          
                          
                          
                          6
                          
                          
                          $
                          532
                          
                          
                          
                          30
                          
                          
                          $
                          1,847Commercial
      Mortgages
                          
                          
                          1
                          
                          
                          
                          797
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          1
                          
                          
                          
                          797Construction
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -Commercial
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          1
                          
                          
                          
                          100
                          
                          
                          
                          1
                          
                          
                          
                          100Consumer
                          
                          
                          19
                          
                          
                          
                          181
                          
                          
                          
                          10
                          
                          
                          
                          45
                          
                          
                          
                          29
                          
                          
                          
                          226Total
                          
                          
                          44
                          
                          
                          $
                          2,293
                          
                          
                          
                          17
                          
                          
                          $
                          677
                          
                          
                          
                          61
                          
                          
                          
                          2,969At December 31, 2006Residential
      Mortgages
                          
                          
                          22
                          
                          
                          $
                          1,218
                          
                          
                          
                          9
                          
                          
                          $
                          645
                          
                          
                          
                          31
                          
                          
                          $
                          1,863Commercial
      Mortgages
                          
                          
                          1
                          
                          
                          
                          636
                          
                          
                          
                          2
                          
                          
                          
                          221
                          
                          
                          
                          3
                          
                          
                          
                          857Construction
                          
                          
                          1
                          
                          
                          
                          74
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          1
                          
                          
                          
                          74Commercial
                          
                          
                          6
                          
                          
                          
                          317
                          
                          
                          
                          10
                          
                          
                          
                          540
                          
                          
                          
                          16
                          
                          
                          
                          857Consumer
                          
                          
                          17
                          
                          
                          
                          105
                          
                          
                          
                          9
                          
                          
                          
                          84
                          
                          
                          
                          26
                          
                          
                          
                          189Total
                          
                          
                          47
                          
                          
                          $
                          2,350
                          
                          
                          
                          30
                          
                          
                          $
                          1,490
                          
                          
                          
                          77
                          
                          
                          
                          3,839At December 31, 2005Residential
      Mortgages
                          
                          
                          24
                          
                          
                          $
                          1,375
                          
                          
                          
                          19
                          
                          
                          $
                          1,684
                          
                          
                          
                          43
                          
                          
                          $
                          3,059Commercial
      Mortgages
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          4
                          
                          
                          
                          670
                          
                          
                          
                          4
                          
                          
                          
                          670Construction
                          
                          
                          1
                          
                          
                          
                          341
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          1
                          
                          
                          
                          341Commercial
                          
                          
                          8
                          
                          
                          
                          506
                          
                          
                          
                          2
                          
                          
                          
                          115
                          
                          
                          
                          10
                          
                          
                          
                          621Consumer
                          
                          
                          23
                          
                          
                          
                          197
                          
                          
                          
                          13
                          
                          
                          
                          185
                          
                          
                          
                          36
                          
                          
                          
                          382Total
                          
                          
                          56
                          
                          
                          $
                          2,419
                          
                          
                          
                          38
                          
                          
                          $
                          2,654
                          
                          
                          
                          94
                          
                          
                          
                          5,073


13


Nonperforming
Assets.The following
table sets forth the amounts and categories of our non-performing assets at the
dates indicated.





At December 31,2009
                        
                        
                        2008
                        
                        
                        2007
                        
                        
                        2006
                        
                        
                        2005(Dollars
      in thousands)Non-Accrual
      Loans:Residential
      Mortgage
                        
                        $
                        2,944
                        
                        
                        $
                        1,876
                        
                        
                        $
                        697
                        
                        
                        $
                        670
                        
                        
                        $
                        308Commercial
      Mortgage
                        
                        
                        2,204
                        
                        
                        
                        4,002
                        
                        
                        
                        3,825
                        
                        
                        
                        1,395
                        
                        
                        
                        1,006Construction
                        
                        
                        1,433
                        
                        
                        
                        3,469
                        
                        
                        
                        3,475
                        
                        
                        
                        -
                        
                        
                        
                        -Purchased
      Out-of-State
                        
                        
                        2,113
                        
                        
                        
                        1,980
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -Commercial
                        
                        
                        96
                        
                        
                        
                        535
                        
                        
                        
                        433
                        
                        
                        
                        364
                        
                        
                        
                        -Consumer
      and other
                        
                        
                        157
                        
                        
                        
                        90
                        
                        
                        
                        29
                        
                        
                        
                        61
                        
                        
                        
                        39Total
      non-accrual loans
                        
                        $
                        8,947
                        
                        
                        $
                        11,952
                        
                        
                        $
                        8,459
                        
                        
                        $
                        2,490
                        
                        
                        $
                        1,353Accrual
      loans delinquent 90 days or more:Residential
      Mortgage
                        
                        
                        89
                        
                        
                        
                        128
                        
                        
                        
                        532
                        
                        
                        
                        645
                        
                        
                        
                        1,684Commercial
      Mortgage
                        
                        
                        2,696
                        
                        
                        
                        72
                        
                        
                        
                        -
                        
                        
                        
                        221
                        
                        
                        
                        670Construction
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -Purchased
      Out-of-State
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -Commercial
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        100
                        
                        
                        
                        540
                        
                        
                        
                        115Consumer
      and other
                        
                        
                        54
                        
                        
                        
                        17
                        
                        
                        
                        45
                        
                        
                        
                        84
                        
                        
                        
                        185Total
      accrual loans delinquent 90 days or more
                        
                        $
                        2,839
                        
                        
                        $
                        217
                        
                        
                        $
                        677
                        
                        
                        $
                        1,490
                        
                        
                        $
                        2,654Total
      nonperforming loans (1)
                        
                        $
                        11,786
                        
                        
                        $
                        12,169
                        
                        
                        $
                        9,136
                        
                        
                        $
                        3,980
                        
                        
                        $
                        4,007Real
      Estate Owned and Other Repossessed Assets:Residential
      Mortgage
                        
                        
                        584
                        
                        
                        
                        686
                        
                        
                        
                        872
                        
                        
                        
                        437
                        
                        
                        
                        427Commercial
      Mortgage
                        
                        
                        2,985
                        
                        
                        
                        882
                        
                        
                        
                        406
                        
                        
                        
                        -
                        
                        
                        
                        -Construction
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -Commercial
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -Consumer
      and other
                        
                        
                        11
                        
                        
                        
                        70
                        
                        
                        
                        2
                        
                        
                        
                        38
                        
                        
                        
                        8Total
      real estate owned and other repossesed assets (2)
                        
                        $
                        3,580
                        
                        
                        $
                        1,638
                        
                        
                        $
                        1,280
                        
                        
                        $
                        475
                        
                        
                        $
                        435Total
      nonperforming assets
                        
                        $
                        15,366
                        
                        
                        $
                        13,807
                        
                        
                        $
                        10,416
                        
                        
                        $
                        4,455
                        
                        
                        $
                        4,442Total
      nonperforming loans to total loans receivable
                        
                        
                        6.73
                        %
                        
                        
                        6.14
                        %
                        
                        
                        4.54
                        %
                        
                        
                        1.90
                        %
                        
                        
                        1.97
                        %Total
      nonperforming assets to total assets
                        
                        
                        6.58
                        %
                        
                        
                        5.57
                        %
                        
                        
                        4.15
                        %
                        
                        
                        1.59
                        %
                        
                        
                        1.57
                        %





(1)
            All
      of our loans delinquent 90 days or more are classified as
      nonperforming.


(2)
            Represents
      the net book value of property acquired by us through foreclosure or deed
      in lieu of foreclosure.
              Upon
      acquisition, this property is recorded at the lower of its fair market
      value or the principal balance of the related
  loan.




Interest income that would have been
recorded for the year ended December 31, 2009, had non-accruing loans been
current according to their original terms amounted to
$527,000.  Interest of $270,000 was recognized on these loans and is
included in net income for the year ended December 31, 2009.





Classification of
Assets.Our policies, consistent with regulatory guidelines,
provide for the classification of loans and other assets such as debt and equity
securities and real estate held for sale considered by the Office of Thrift
Supervision to be of lesser quality as “substandard,” “doubtful,” or “loss”
assets.  An asset is considered “substandard” if it is inadequately
protected by the current net worth and paying capacity of the obligor or of the
collateral pledged, if any. “Substandard” assets include those characterized by
the “distinct possibility” that the savings institution will sustain “some loss”
if the deficiencies are not corrected.  Assets classified as
“doubtful” have all of the weaknesses inherent in those classified
“substandard,” with the added characteristic that the weaknesses present make
“collection or liquidation in full,” on the basis of currently existing facts,
conditions, and values, “highly questionable and improbable.”  Assets
classified as “loss” are those considered “uncollectible” and of such little
value that their continuance as assets without the establishment of a specific
loss reserve is not warranted.  Assets that do not expose the savings
institution to risk sufficient to warrant classification in one of the
aforementioned categories, but which possess some weaknesses, are required to be
designated “special mention” by management.  Loans designated as
special mention are generally loans that, while current in required payments,
have exhibited some potential weaknesses that, if not corrected, could increase
the level of risk in the future.


14


When we
classify assets as either substandard or doubtful, we allocate a portion of the
related general loss allowances to such assets as deemed prudent by
management.  The allowance for loan losses represents amounts that
have been established to recognize losses inherent in the loan portfolio that
are both probable and reasonably estimable at the date of the financial
statements.  When we classify problem assets as loss, we charge-off
such amount.  Our determination as to the classification of our assets
and the amount of our loss allowances are subject to review by our regulatory
agencies, which can order the establishment of additional loss allowances.
Management regularly reviews our asset portfolio to determine whether any assets
require classification in accordance with applicable regulations.  On
the basis of management’s review of our assets at December 31, 2009, classified
assets consisted of substandard assets of $18.1 million. There were no assets
classified as doubtful or loss at December 31, 2009.





We classify our assets pursuant to
criteria similar to the classification structure provided in the OTS
regulations.  The following table sets forth the aggregate amount of
our internally classified assets at the dates indicated.





At December 31,2009
                      
                      
                      2008
                      
                      
                      2007(In
      Thousands)Substandard
      assets
                      
                      $
                      18,141
                      
                      
                      $
                      19,409
                      
                      
                      $
                      14,362Doubtful
      assets
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Loss
      assets
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Total
      classified assets
                      
                      $
                      18,141
                      
                      
                      $
                      19,409
                      
                      
                      $
                      14,362





Our
investment in land and real estate at December 31, 2009 was classified as
substandard by the Office of Thrift Supervision due to slower than expected
sales of building lots and condominium units.  This project (Wyndham
Garden Estates) is an upscale condominium community comprised of 25
single-family building lots and 18 planned condominium units located in Alpena,
Michigan.  At December 31, 2009, all but five of the residential lots
had been developed and sold and all condominium units were
sold.  Although sales of the remaining lots have been slow, management
believes this is  still a viable project in a desirable
location.  At December 31, 2009, our investment in these properties
was approximately $73,000, which is net of an allowance of $128,000 to record
the investment at the lower of cost or fair value, less cost to sell. For
reporting purposes, this investment is considered “impaired” under the
definition of FASB ASC 360-10, Accounting for Impairment or
Disposal of Long-Lived Assets.





Allowance for
Loan Losses.We provide for loan losses based on the allowance
method.  Accordingly, all loan losses are charged to the related
allowance and all recoveries are credited to it.  Additions to the
allowance for loan losses are provided by charges to income based on various
factors which, in management’s judgment, deserve current recognition in
estimating probable losses.  Management regularly reviews the loan
portfolio and makes provisions for loan losses in order to maintain the
allowance for loan losses in accordance with accounting principles generally
accepted in the United States of America.  The allowance for loan
losses consists of amounts specifically allocated to non-performing loans and
other criticized or classified loans (if any) as well as general allowances
determined for each major loan category.  Commercial loans and loans
secured by commercial real estate are evaluated individually for impairment.
Other smaller-balance, homogeneous loan types, including loans secured by one-
to four-family residential real estate and consumer installment loans, are
evaluated for impairment on a collective basis.  After we establish a
provision for loans that are known to be non-performing, criticized or
classified, we calculate percentage loss factors to apply to the remaining
categories within the loan portfolio to estimate probable losses inherent in
these categories of the portfolio.  When the loan portfolio increases,
therefore, the percentage calculation results in a higher dollar amount of
estimated probable losses than would be the case without the increase, and when
the loan portfolio decreases, the percentage calculation results in a lower
dollar amount of estimated probable losses than would be the case without the
decrease.  These percentage loss factors are determined by management
based on our historical loss experience and credit concentrations for the
applicable loan category, which may be adjusted to reflect our evaluation of
levels of, and trends in, delinquent and non-accrual loans, trends in volume and
terms of loans, and local economic trends and conditions.


15


We
consider commercial and commercial real estate loans and construction loans to
be riskier than one- to four-family residential mortgage
loans.  Commercial and commercial real estate loans have greater
credit risks compared to one- to four-family residential mortgage loans, as they
typically involve large loan balances concentrated with single borrowers or
groups of related borrowers.  In addition, the payment experience on
loans secured by income-producing properties typically depends on the successful
operation of the related real estate project and thus may be subject to a
greater extent to adverse conditions in the real estate market and in the
general economy.  Construction loans have greater credit risk than
permanent mortgage financing because of the inherent difficulty in estimating
both a property’s value at completion of the project and the estimated cost of
the project.  If the estimate of construction costs is inaccurate, we
may be required to advance funds beyond the amount originally committed to
permit completion of the project. If the estimate of value upon completion is
inaccurate, the value of the property may be insufficient to assure full
repayment. Projects also may be jeopardized by disagreements between borrowers
and builders and by the failure of builders to pay subcontractors. Loans to
builders to construct homes for which no purchaser has been identified carry
more risk because the repayment of the loan depends on the builder’s ability to
sell the property prior to the time that the construction loan is
due.  The increased risk characteristics associated with commercial
real estate and land loans and construction loans are considered by management
in the evaluation of the allowance for loan losses and generally result in a
larger loss factor applied to these segments of the loan portfolio in developing
an estimate of the required allowance for loan losses. We intend to increase our
originations of commercial and commercial real estate loans, and we intend to
retain these loans in our portfolio.  Because these loans entail
significant additional credit risks compared to one- to four-family residential
mortgage loans, an increase in our origination (and retention in our portfolio)
of these types of loans would, in the absence of other offsetting factors,
require us to make additional provisions for loan losses.





The carrying value of loans is
periodically evaluated and the allowance is adjusted
accordingly.  While management uses the best information available to
make evaluations, future adjustments to the allowance may be necessary if
conditions differ substantially from the information used in making the
evaluations.  In addition, as an integral part of their examination
process, our regulatory agencies periodically review the allowance for loan
losses.  Such agencies may require us to recognize additions to the
allowance based on their judgments of information available to them at the time
of their examination.





Analysis of the
Allowance for Loan Losses.  The following
table sets forth the activity on our allowance for loan losses for the periods
indicated.





For the Years Ended December 31,2009
                
                
                2008
                
                
                2007
                
                
                2006
                
                
                2005(Dollars
      in thousands)Allowance
      at beginning of period
                
                $
                5,647
                
                
                $
                4,013
                
                
                $
                2,079
                
                
                $
                1,416
                
                
                $
                1,214Charge-offs:Real
      Estate:Residential
      Mortgages
                
                
                362
                
                
                
                342
                
                
                
                225
                
                
                
                44
                
                
                
                21Nonresidential
      Real Estate:Commercial
      Mortgages
                
                
                4,903
                
                
                
                2,023
                
                
                
                59
                
                
                
                -
                
                
                
                -Purchased
      Out-of-State
                
                
                2,482
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Non
      Real Estate Loans:Commercial
                
                
                246
                
                
                
                331
                
                
                
                4
                
                
                
                1
                
                
                
                57Consumer
      and other
                
                
                254
                
                
                
                141
                
                
                
                190
                
                
                
                163
                
                
                
                171Total
      charge offs
                
                
                8,247
                
                
                
                2,837
                
                
                
                478
                
                
                
                208
                
                
                
                249Recoveries:Real
      Estate:Residential
      Mortgages
                
                
                -
                
                
                
                -
                
                
                
                1
                
                
                
                -
                
                
                
                -Non
      Real Estate Loans:Consumer
      and other
                
                
                64
                
                
                
                50
                
                
                
                34
                
                
                
                20
                
                
                
                83Total
      recoveries
                
                
                64
                
                
                
                50
                
                
                
                35
                
                
                
                20
                
                
                
                83Net
      (charge offs) recoveries
                
                
                8,183
                
                
                
                2,787
                
                
                
                443
                
                
                
                188
                
                
                
                166Provision
      for loan losses
                
                
                6,196
                
                
                
                4,421
                
                
                
                2,377
                
                
                
                851
                
                
                
                368Balance
      at end of year
                
                $
                3,660
                
                
                $
                5,647
                
                
                $
                4,013
                
                
                $
                2,079
                
                
                $
                1,416Ratios:Net
      Charge-offs to average loans outstanding (annualized)
                
                
                4.58
                %
                
                
                1.40
                %
                
                
                0.21
                %
                
                
                0.08
                %
                
                
                0.08
                %Allowance
      for loan loss to non-performing loans at end of period
                
                
                31.05
                %
                
                
                46.41
                %
                
                
                43.93
                %
                
                
                52.24
                %
                
                
                35.34
                %Allowance
      for loan losses to total loans at end of period
                
                
                2.09
                %
                
                
                2.85
                %
                
                
                1.95
                %
                
                
                0.98
                %
                
                
                0.70
                %


16


Allocation of
Allowance for Loan Losses.The following table sets forth the
allowance for loan losses allocated by loan category, the total loan balances by
category, and the percent of loans in each category to total loans at the dates
indicated.  The allowance for loan losses allocated to each category
is not necessarily indicative of future losses in any particular category and
does not restrict the use of the allowance to absorb losses in other
categories.




At December 312009
                    
                    
                    2008
                    
                    
                    2007Allowance
                      for Loan
                      Losses
                    
                    
                    Percentof
                      Loansin
                      Each
                      Categoryto
                      TotalLoans
                    
                    
                    Allowance
                      for Loan
                      Losses
                    
                    
                    Percentof
                      Loansin
                      Each
                      Categoryto
                      TotalLoans
                    
                    
                    Allowance
                      for Loan
                      Losses
                    
                    
                    Percentof
                      Loansin
                      Each
                      Categoryto
                      TotalLoansResidential
      Mortgages:1 -
      4 family residental
                    
                    $
                    634
                    
                    
                    
                    44.4
                    %
                    
                    $
                    967
                    
                    
                    
                    44.0
                    %
                    
                    $
                    787
                    
                    
                    
                    44.5
                    %Purchased
      Mortgages In-State
                    
                    
                    12
                    
                    
                    
                    1.9
                    %
                    
                    
                    11
                    
                    
                    
                    1.9
                    %
                    
                    
                    5
                    
                    
                    
                    2.2
                    %Purchased
      Mortgages Out-of-State
                    
                    
                    -
                    
                    
                    
                    0.0
                    %
                    
                    
                    1
                    
                    
                    
                    0.2
                    %
                    
                    
                    1
                    
                    
                    
                    0.6
                    %1 -
      4 family construction
                    
                    
                    3
                    
                    
                    
                    0.2
                    %
                    
                    
                    5
                    
                    
                    
                    0.5
                    %
                    
                    
                    14
                    
                    
                    
                    1.0
                    %Home
      Equity & Junior Liens
                    
                    
                    214
                    
                    
                    
                    10.7
                    %
                    
                    
                    231
                    
                    
                    
                    11.3
                    %
                    
                    
                    171
                    
                    
                    
                    11.7
                    %Nonresidential
      Mortgages:Nonresidential
                    
                    
                    1,055
                    
                    
                    
                    24.9
                    %
                    
                    
                    1,768
                    
                    
                    
                    21.5
                    %
                    
                    
                    1,374
                    
                    
                    
                    21.7
                    %Purchased
      Nonresidential In-State
                    
                    
                    140
                    
                    
                    
                    2.2
                    %
                    
                    
                    3
                    
                    
                    
                    0.1
                    %
                    
                    
                    -
                    
                    
                    
                    0.0
                    %Purchased
      Nonresidential Out-of-State
                    
                    
                    175
                    
                    
                    
                    4.8
                    %
                    
                    
                    14
                    
                    
                    
                    1.6
                    %
                    
                    
                    5
                    
                    
                    
                    0.6
                    %Construction
                    
                    
                    647
                    
                    
                    
                    1.6
                    %
                    
                    
                    7
                    
                    
                    
                    3.3
                    %
                    
                    
                    18
                    
                    
                    
                    3.0
                    %Purchased
      Construction In-State
                    
                    
                    -
                    
                    
                    
                    0.0
                    %
                    
                    
                    -
                    
                    
                    
                    0.0
                    %
                    
                    
                    -
                    
                    
                    
                    0.0
                    %Purchased
      Construction Out-of-State
                    
                    
                    350
                    
                    
                    
                    2.2
                    %
                    
                    
                    740
                    
                    
                    
                    4.9
                    %
                    
                    
                    22
                    
                    
                    
                    2.4
                    %Non
      Real Estate Loans:Commercial
                    
                    
                    316
                    
                    
                    
                    4.0
                    %
                    
                    
                    1,795
                    
                    
                    
                    8.0
                    %
                    
                    
                    1,529
                    
                    
                    
                    9.3
                    %Purchased
      Commercial In-State
                    
                    
                    73
                    
                    
                    
                    1.6
                    %
                    
                    
                    18
                    
                    
                    
                    0.9
                    %
                    
                    
                    9
                    
                    
                    
                    0.7
                    %Purchased
      Commercial Out-of-State
                    
                    
                    -
                    
                    
                    
                    0.0
                    %
                    
                    
                    32
                    
                    
                    
                    0.0
                    %
                    
                    
                    14
                    
                    
                    
                    0.0
                    %Consumer
                    
                    
                    41
                    
                    
                    
                    1.5
                    %
                    
                    
                    55
                    
                    
                    
                    1.8
                    %
                    
                    
                    64
                    
                    
                    
                    2.3
                    %Total
                    
                    $
                    3,660
                    
                    
                    
                    100.0
                    %
                    
                    $
                    5,647
                    
                    
                    
                    100.0
                    %
                    
                    $
                    4,013
                    
                    
                    
                    100.0
                    %





At December 312006
                                                
                                                
                                                2005Allowance
                                                  for Loan
                                                  Losses
                                                
                                                
                                                Percentof
                                                  Loansin
                                                  Each
                                                  Categoryto
                                                  TotalLoans
                                                
                                                
                                                Allowance
                                                  for Loan
                                                  Losses
                                                
                                                
                                                Percentof
                                                  Loansin
                                                  Each
                                                  Categoryto
                                                  TotalLoansResidential
      Mortgages:One
      to four family residental
                                                
                                                $
                                                182
                                                
                                                
                                                
                                                44.1
                                                %
                                                
                                                $
                                                169
                                                
                                                
                                                
                                                45.3
                                                %Purchased
      Mortgages In-State
                                                
                                                
                                                3
                                                
                                                
                                                
                                                2.2
                                                %
                                                
                                                
                                                4
                                                
                                                
                                                
                                                3.3
                                                %Purchased
      Mortgages Out-of-State
                                                
                                                
                                                1
                                                
                                                
                                                
                                                0.6
                                                %
                                                
                                                
                                                1
                                                
                                                
                                                
                                                0.7
                                                %1 -
      4 family construction
                                                
                                                
                                                6
                                                
                                                
                                                
                                                1.5
                                                %
                                                
                                                
                                                11
                                                
                                                
                                                
                                                3.0
                                                %Home
      Equity & Junior Liens
                                                
                                                
                                                433
                                                
                                                
                                                
                                                11.7
                                                %
                                                
                                                
                                                386
                                                
                                                
                                                
                                                10.5
                                                %Nonresidential
      Mortgages:Nonresidential
                                                
                                                
                                                761
                                                
                                                
                                                
                                                20.9
                                                %
                                                
                                                
                                                431
                                                
                                                
                                                
                                                19.7
                                                %Purchased
      Nonresidential In-State
                                                
                                                
                                                16
                                                
                                                
                                                
                                                0.4
                                                %
                                                
                                                
                                                11
                                                
                                                
                                                
                                                0.5
                                                %Purchased
      Nonresidential Out-of-State
                                                
                                                
                                                2
                                                
                                                
                                                
                                                0.1
                                                %
                                                
                                                
                                                -
                                                
                                                
                                                
                                                0.0
                                                %Construction
                                                
                                                
                                                108
                                                
                                                
                                                
                                                3.0
                                                %
                                                
                                                
                                                43
                                                
                                                
                                                
                                                2.0
                                                %Purchased
      Construction In-State
                                                
                                                
                                                -
                                                
                                                
                                                
                                                0.0
                                                %
                                                
                                                
                                                -
                                                
                                                
                                                
                                                0.0
                                                %Purchased
      Construction Out-of-State
                                                
                                                
                                                -
                                                
                                                
                                                
                                                0.0
                                                %
                                                
                                                
                                                -
                                                
                                                
                                                
                                                0.0
                                                %Non
      Real Estate Loans:Commercial
                                                
                                                
                                                423
                                                
                                                
                                                
                                                11.6
                                                %
                                                
                                                
                                                256
                                                
                                                
                                                
                                                11.8
                                                %Purchased
      Commercial In-State
                                                
                                                
                                                62
                                                
                                                
                                                
                                                1.7
                                                %
                                                
                                                
                                                18
                                                
                                                
                                                
                                                0.9
                                                %Purchased
      Commercial Out-of-State
                                                
                                                
                                                -
                                                
                                                
                                                
                                                0.0
                                                %
                                                
                                                
                                                -
                                                
                                                
                                                
                                                0.0
                                                %Consumer
                                                
                                                
                                                82
                                                
                                                
                                                
                                                2.2
                                                %
                                                
                                                
                                                86
                                                
                                                
                                                
                                                2.3
                                                %Total
                                                
                                                $
                                                2,079
                                                
                                                
                                                
                                                100.0
                                                %
                                                
                                                $
                                                1,416
                                                
                                                
                                                
                                                100.0
                                                %


17


Mortgage
Banking Activities





Our
mortgage banking activities involve the origination and subsequent sale into the
secondary mortgage market of one- to four-family residential mortgage loans.
When loans are sold into the secondary market, we generally retain the rights to
service those loans thereby maintaining our customer relationships. We intend to
use these customer relationships to cross-sell additional products and services.
Loans that we sell are originated using the same personnel and the same
underwriting policies as loans that we maintain in our portfolio. The decision
whether to sell a loan is dependent upon the type of loan product and the term
of the loan. In recent years, we have sold most of our fixed-rate one- to
four-family residential loans with maturities of 15 years or greater, and have
retained servicing on most of these loans. For a brief period we sold some
mortgage loans servicing-released to be able to offer additional products to our
customers, however, we currently do not sell loans
servicing-released.





Mortgage
servicing involves the administration and collection of home loan payments. When
we acquire mortgage servicing rights through the origination of mortgage loans
and the subsequent sale of those loans with servicing rights retained, we
allocate a portion of the total cost of the mortgage loans to the mortgage
servicing rights based on their relative fair value. As of December 31,
2009, we were servicing loans sold to third parties totaling $140.6 million, and
the mortgage servicing rights associated with such loans had a book value, at
such date, of $730,000.  Generally, the value of mortgage servicing
rights increases as interest rates rise and decreases as interest rates fall,
because the estimated life and estimated income from the underlying loans
increase with rising interest rates and decrease with falling interest
rates.





Insurance
Brokerage Activities





In March
2003, we acquired InsuranCenter of Alpena (“ICA”), a licensed insurance agency,
to increase and diversify our sources of non-interest income. In April 2008, ICA
sold to a non-related third party the rights to service certain health insurance
contracts and collect commissions on the contracts written through the local
Chambers of Commerce. This sale resulted in a nominal gain to us, but reduced
health insurance revenues. The sale also reduced non-interest expenses and
amortization of intangibles.





On
February 27, 2009, we sold the majority of the assets of  ICA. We
retained the residual income stream associated with the April 2008 sale of its
wholesale Blue Cross/Blue Shield override business to the third party. The
financial position and results of operations of ICA are presented separately in
our consolidated financial statements as “discontinued operations.” We continue
to collect the residual revenue stream associated with this sale through FFNM
Agency, the successor company to ICA.





See
“-Subsidiary Activity” for a further discussion of ICA and FFNM
Agency.





Real
Estate Development Activities





On a limited basis, we have purchased
real estate for development through our subsidiary Financial Services &
Mortgage Corporation.  See "—Subsidiary Activity" for a discussion of
our real estate development subsidiary, Financial Services & Mortgage
Corporation. The last such purchase was a 37 acre lot which we purchased in 1994
for $130,000. As of December 31, 2009, we had sold 37 of the 43 lots comprising
this property and two of the smaller lots had been combined into one lot, so
that at December 31, 2009 five lots remained unsold.  Our investment
in land and real estate is “held for sale” and separately stated in the
statement of financial condition, net of any allowance for impairment.
Management is actively marketing the property by using local real estate agents
to facilitate the sale of these properties.  For reporting purposes,
this investment is considered “impaired” under the definition in FASB ASC
360-10, Accounting for Impairment or Disposal of Long-Lived
Assets.  Accordingly, the investment is recorded at the lower of its
cost or fair value less cost to sell, which may include realtor commissions,
legal and title transfer fees, and closing costs that must be incurred before
legal title can be transferred.





Annually, management uses recent
sales of comparable property to determine estimated future cash
flows.  The estimated future cash flows are used as the “fair
value.”  The fair value, less cost to sell, is compared to the net
carrying amount.  If the fair value, less cost to sell, exceeds the
recorded amount, a loss is recognized.  Losses recognized for the
initial and subsequent write-down to fair value, less cost to sell, are
recognized in the “gain (loss) on the sale of real estate” line in the statement
of income. A gain is recognized for any subsequent increase in fair value, less
cost to sell, but not in excess of the cumulative loss previously
recognized.  A gain or loss not previously recognized that results
from the sale of the property are recognized at the date of sale.





At
December 31, 2009, our investment in these properties was approximately $73,000,
which was net of an allowance of $128,000.


18


Investment
Activities





Our
investment securities portfolio comprises U.S. Government, state agency and
municipal obligations, mortgage-backed securities, Federal Home Loan Bank stock,
and other investments.  At December 31, 2009, we had no investments in
unrated securities.  At December 31, 2009, $22.0 million, or 59.6% of
our investment portfolio was scheduled to mature in less than five years, and
$15.0 million, or 40.4%, was scheduled to mature in over five
years.  At December 31, 2009, $4.2 million, or 11.4% of our investment
portfolio was scheduled to mature in less than one year.





At
December 31, 2009, we held U.S. Government and state agency obligations and
municipal obligations classified as available-for-sale, with a fair market value
of $16.3 million.  While these securities generally provide lower
yields than other investments such as mortgage-backed securities, our current
investment strategy is to maintain investments in such instruments to the extent
appropriate for liquidity purposes, as collateral for borrowings, and for
prepayment protection.





We invest
in mortgage-backed securities in order to: generate positive interest rate
spreads with minimal administrative expense; lower credit risk as a result of
the guarantees provided by Freddie Mac, Fannie Mae and Ginnie Mae; supplement
local loan originations; reduce interest rate risk exposure; and increase
liquidity.  Our mortgage-backed securities portfolio consists of
pass-through certificates.  At December 31, 2009, mortgage-backed
securities totaled $16.4 million, or 43.6% of total investments.  At
December 31, 2009, 24.0% of our mortgage-backed securities were secured by
balloon loans.  All of our pass-through certificates are insured or
guaranteed by Freddie Mac, Ginnie Mae or Fannie Mae.  Our policy is to
hold mortgage-backed securities as available for sale.





We have
interests in pools of single-family mortgages in which the principal and
interest payments are passed from the mortgage originators, through
intermediaries (generally government-sponsored agencies) that pool and repackage
loans and sell the participation interest in the form of securities, to
investors.  These government-sponsored agencies include Freddie Mac,
Ginnie Mae, or Fannie Mae.  The underlying pool of mortgages can be
comprised of either fixed-rate mortgage loans or adjustable-rate mortgage
loans.  The interest rate risk characteristics of the underlying pool
of mortgages, i.e.,
fixed-rate or adjustable rate, are shared by the investors in that
pool.





Our
investment policy also permits investment in corporate debt obligations.
Although corporate bonds may offer higher yields than U.S. Treasury or agency
securities of comparable duration, corporate bonds also have a higher risk of
default due to possible adverse changes in the creditworthiness of the
issuer.





We are
required under federal regulations to maintain a minimum amount of liquid assets
that may be invested in specified short term securities and certain other
investments.  We generally have maintained a portfolio of liquid
assets that exceeds regulatory requirements.  Liquidity levels may be
increased or decreased depending upon the yields on investment alternatives and
upon management’s judgment as to the attractiveness of the yields then available
in relation to other opportunities and its expectation of the level of yield
that will be available in the future, as well as management’s projections as to
the short term demand for funds to be used in our loan origination and other
activities.





FASB ASC
320-10 requires that, at the time of purchase, we designate a security as held
to maturity, available for sale, or trading, depending on our ability and
intent.  Securities available for sale are reported at fair
value.  As of December 31, 2009, all of our investment securities were
designated as available for sale except for $3.9 million in municipal bond
investments designated as held to maturity.


19


Investment
Securities Portfolio.The
following table sets forth the composition of our investment securities
portfolio at the dates indicated.





At December 31,2009
                  
                  
                  2008
                  
                  
                  2007Amortized
                  
                  
                  Fair
                  
                  
                  Amortized
                  
                  
                  Fair
                  
                  
                  Amortized
                  
                  
                  FairCost
                  
                  
                  Value
                  
                  
                  Cost
                  
                  
                  Value
                  
                  
                  Cost
                  
                  
                  Value(In
      Thousands)Debt
      Securities:U.S.
      Government and agency obligations
                  
                  $
                  8,220
                  
                  
                  $
                  8,257
                  
                  
                  $
                  5,680
                  
                  
                  $
                  5,768
                  
                  
                  $
                  18,477
                  
                  
                  $
                  18,514State
      agency and municipal obligations
                  
                  
                  11,798
                  
                  
                  
                  12,137
                  
                  
                  
                  7,942
                  
                  
                  
                  7,924
                  
                  
                  
                  3,600
                  
                  
                  
                  3,623Corporate
      bonds and other obligations
                  
                  
                  1,000
                  
                  
                  
                  1,002
                  
                  
                  
                  1,500
                  
                  
                  
                  1,504
                  
                  
                  
                  -
                  
                  
                  
                  -Mortgage-backed
      securities:Pass-through
      securities:Fannie
      Mae
                  
                  
                  8,579
                  
                  
                  
                  8,887
                  
                  
                  
                  9,468
                  
                  
                  
                  9,733
                  
                  
                  
                  -
                  
                  
                  
                  -Freddie
      Mac
                  
                  
                  4,823
                  
                  
                  
                  4,922
                  
                  
                  
                  4,419
                  
                  
                  
                  4,516
                  
                  
                  
                  1,076
                  
                  
                  
                  1,054Ginnie
      Mae
                  
                  
                  2,577
                  
                  
                  
                  2,588
                  
                  
                  
                  164
                  
                  
                  
                  167
                  
                  
                  
                  197
                  
                  
                  
                  197Total
      debt securities
                  
                  
                  36,997
                  
                  
                  
                  37,793
                  
                  
                  
                  29,173
                  
                  
                  
                  29,612
                  
                  
                  
                  23,350
                  
                  
                  
                  23,388Marketable
      equity securitiesCommon
      stock
                  
                  
                  3
                  
                  
                  
                  4
                  
                  
                  
                  3
                  
                  
                  
                  2
                  
                  
                  
                  3
                  
                  
                  
                  87Total
      equity securities
                  
                  
                  3
                  
                  
                  
                  4
                  
                  
                  
                  3
                  
                  
                  
                  2
                  
                  
                  
                  3
                  
                  
                  
                  87Total
      investment securities
                  
                  $
                  37,000
                  
                  
                  $
                  37,797
                  
                  
                  $
                  29,176
                  
                  
                  $
                  29,614
                  
                  
                  $
                  23,353
                  
                  
                  $
                  23,476




Portfolio Maturities and
Yields.  The composition and maturities of the investment
securities portfolio at December 31, 2009 are summarized in the following table.
Maturities are based on the final contractual payment dates, and do not reflect
the impact of prepayments or early redemptions that may occur. State and
municipal securities yields have not been adjusted to a tax-equivalent
basis.





At December 31, 2009More than One Year
                
                
                More than Five YearsOne Year or Less
                
                
                Through Five years
                
                
                Through Ten Years
                
                
                More than Ten Years
                
                
                Total SecuritiesWeighted
                
                
                
                
                
                Weighted
                
                
                
                
                
                Weighted
                
                
                
                
                
                Weighted
                
                
                
                
                
                
                
                
                WeightedAmortized
                
                
                Average
                
                
                Amortized
                
                
                Average
                
                
                Amortized
                
                
                Average
                
                
                Amortized
                
                
                Average
                
                
                Amortized
                
                
                Fair
                
                
                AverageCost
                
                
                Yield
                
                
                Cost
                
                
                Yield
                
                
                Cost
                
                
                Yield
                
                
                Cost
                
                
                Yield
                
                
                Cost
                
                
                Value
                
                
                Yield(Dollars
      in Thousands)Debt
      Securities:U.S.
      Government and agency securities
                
                $
                -
                
                
                
                0.00
                %
                
                $
                8,220
                
                
                
                2.61
                %
                
                $
                -
                
                
                
                0.00
                %
                
                $
                -
                
                
                
                0.00
                %
                
                $
                8,220
                
                
                $
                8,257
                
                
                
                2.61
                %State
      agency and municipal obligations
                
                
                1,587
                
                
                
                2.88
                %
                
                
                6,885
                
                
                
                4.12
                %
                
                
                1,536
                
                
                
                3.94
                %
                
                
                1,789
                
                
                
                4.73
                %
                
                
                11,797
                
                
                
                12,137
                
                
                
                4.02
                %Corporate
      bonds and other obligations
                
                
                -
                
                
                
                0.00
                %
                
                
                1,000
                
                
                
                5.72
                %
                
                
                -
                
                
                
                0.00
                %
                
                
                -
                
                
                
                0.00
                %
                
                
                1,000
                
                
                
                1,002
                
                
                
                5.72
                %Mortgage-backed
      securitiesFannie
      Mae
                
                
                2,157
                
                
                
                4.00
                %
                
                
                -
                
                
                
                0.00
                %
                
                
                2,684
                
                
                
                4.20
                %
                
                
                3,738
                
                
                
                5.29
                %
                
                
                8,579
                
                
                
                8,887
                
                
                
                4.63
                %Freddie
      Mac
                
                
                468
                
                
                
                3.50
                %
                
                
                1,726
                
                
                
                4.36
                %
                
                
                13
                
                
                
                2.63
                %
                
                
                2,616
                
                
                
                4.63
                %
                
                
                4,823
                
                
                
                4,922
                
                
                
                4.42
                %Ginnie
      Mae
                
                
                -
                
                
                
                0.00
                %
                
                
                -
                
                
                
                0.00
                %
                
                
                138
                
                
                
                4.40
                %
                
                
                2,440
                
                
                
                3.58
                %
                
                
                2,578
                
                
                
                2,588
                
                
                
                3.62
                %Total
      debt securities
                
                
                4,212
                
                
                
                
                
                
                
                17,831
                
                
                
                
                
                
                
                4,371
                
                
                
                
                
                
                
                10,583
                
                
                
                
                
                
                
                36,997
                
                
                
                37,793Marketable
      equity securities:Common
      Stock
                
                
                -
                
                
                
                0.00
                %
                
                
                -
                
                
                
                0.00
                %
                
                
                -
                
                
                
                0.00
                %
                
                
                3
                
                
                
                0.00
                %
                
                
                3
                
                
                
                4
                
                
                
                0.00
                %0.00
                %
                
                
                
                
                
                
                
                
                
                
                0.00
                %Total
      investment securities
                
                $
                4,212
                
                
                
                
                
                
                $
                17,831
                
                
                
                
                
                
                $
                4,371
                
                
                
                
                
                
                $
                10,586
                
                
                
                
                
                
                $
                37,000
                
                
                $
                37,797


20


Sources
of Funds





General.Deposits
are the major source of our funds for lending and other investment
purposes.  We generate deposits from our eight full-service offices in
Alpena, Mio, Cheboygan, Oscoda, Lewiston, Alanson and Gaylord.  In
addition to deposits, we derive funds from borrowings, proceeds from the
settlement of loan sales, the amortization and prepayment of loans and
mortgage-backed securities, the maturity of investment securities, and
operations.  Scheduled loan principal repayments are a relatively
stable source of funds, while deposit inflows and outflows and loan prepayments
are influenced significantly by general interest rates and market
conditions.  Borrowings are used on a short-term basis to compensate
for reductions in the availability of funds from other sources or on a
longerterm basis
for general business purposes.  We currently are managing liquidity
levels and loan funding primarily through secondary mortgage market sales and
Federal Home Loan Bank advances.





Deposits.
We generate deposits primarily from our market area by offering a broad
selection of deposit instruments including NOW accounts, regular savings, money
market deposits, term certificate accounts and individual retirement
accounts.  Deposit account terms vary according to the minimum balance
required, the period of time during which the funds must remain on deposit, and
the interest rate, among other factors.  The rate of interest which we
must pay is not established by regulatory authority.  The
asset/liability committee regularly evaluates our internal cost of funds,
surveys rates offered by competing institutions, reviews the cash flow
requirements for lending and liquidity, and executes rate changes when deemed
appropriate.  We have sought to decrease the risk associated with
changes in interest rates by offering competitive rates on some deposit accounts
and by pricing certificates of deposit to provide customers with incentives to
choose certificates of deposit with longer maturities. We also attract
non-interest bearing commercial deposit accounts from our commercial borrowers
and offer a competitive sweep product that is not insured by the FDIC. In recent
periods, we generally have not obtained funds through brokers or through a
solicitation of funds outside our market area.  At December 31, 2009
we had no brokered deposits.  We offer a limited amount of
certificates of deposit in excess of $100,000 which may have negotiated
rates.  Future liquidity needs are expected to be satisfied through
the use of Federal Home Loan Bank borrowings as necessary. Management does not
generally plan on paying above-market rates on deposit products, although from
time-to-time we may do so as liquidity needs dictate.





The following table sets forth the
distribution of total deposit accounts, by account type, at the dates
indicated.




At December 31,2009
                      
                      
                      2008
                      
                      
                      2007Weighted
                      
                      
                      
                      
                      
                      
                      
                      
                      Weighted
                      
                      
                      
                      
                      
                      
                      
                      
                      WeightedPercent
                      
                      
                      Average
                      
                      
                      
                      
                      
                      Percent
                      
                      
                      Average
                      
                      
                      
                      
                      
                      Percent
                      
                      
                      AverageAmount
                      
                      
                      of
      Total
                      
                      
                      Interest
      Rate
                      
                      
                      Amount
                      
                      
                      of
      Total
                      
                      
                      Interest
      Rate
                      
                      
                      Amount
                      
                      
                      of
      Total
                      
                      
                      Interest
      RateNon-interest-bearing
                      
                      $
                      11,074
                      
                      
                      
                      7.00
                      %
                      
                      NA
                      
                      
                      $
                      10,410
                      
                      
                      
                      6.28
                      %
                      
                      NA
                      
                      
                      $
                      10,186
                      
                      
                      
                      6.45
                      %
                      
                      NANOW
      accounts
                      
                      
                      16,298
                      
                      
                      
                      10.31
                      %
                      
                      
                      0.39
                      %
                      
                      
                      14,652
                      
                      
                      
                      8.84
                      %
                      
                      
                      0.33
                      %
                      
                      
                      15,135
                      
                      
                      
                      9.59
                      %
                      
                      
                      0.32
                      %Passbook
                      
                      
                      15,722
                      
                      
                      
                      9.95
                      %
                      
                      
                      0.05
                      %
                      
                      
                      14,857
                      
                      
                      
                      8.96
                      %
                      
                      
                      0.15
                      %
                      
                      
                      15,964
                      
                      
                      
                      10.11
                      %
                      
                      
                      0.30
                      %Money
      market accounts
                      
                      
                      20,794
                      
                      
                      
                      13.15
                      %
                      
                      
                      1.21
                      %
                      
                      
                      19,394
                      
                      
                      
                      11.70
                      %
                      
                      
                      2.66
                      %
                      
                      
                      11,116
                      
                      
                      
                      7.04
                      %
                      
                      
                      2.61
                      %Time
      deposits that mature:Less
      than 12 months
                      
                      
                      60,552
                      
                      
                      
                      38.30
                      %
                      
                      
                      2.47
                      %
                      
                      
                      68,753
                      
                      
                      
                      41.47
                      %
                      
                      
                      3.72
                      %
                      
                      
                      77,275
                      
                      
                      
                      48.96
                      %
                      
                      
                      4.37
                      %Within
      12-36 months
                      
                      
                      29,739
                      
                      
                      
                      18.81
                      %
                      
                      
                      2.79
                      %
                      
                      
                      34,429
                      
                      
                      
                      20.77
                      %
                      
                      
                      3.95
                      %
                      
                      
                      24,944
                      
                      
                      
                      15.80
                      %
                      
                      
                      4.68
                      %Beyond
      36 months
                      
                      
                      3,921
                      
                      
                      
                      2.48
                      %
                      
                      
                      3.30
                      %
                      
                      
                      3,283
                      
                      
                      
                      1.98
                      %
                      
                      
                      3.78
                      %
                      
                      
                      3,213
                      
                      
                      
                      2.04
                      %
                      
                      
                      4.22
                      %Jumbo
                      
                      
                      -
                      
                      
                      
                      0.00
                      %
                      
                      
                      0.00
                      %
                      
                      
                      -
                      
                      
                      
                      0.00
                      %
                      
                      
                      0.00
                      %
                      
                      
                      -
                      
                      
                      
                      0.00
                      %
                      
                      
                      0.00
                      %Total
      deposits
                      
                      $
                      158,100
                      
                      
                      
                      100.00
                      %
                      
                      
                      1.89
                      %
                      
                      $
                      165,778
                      
                      
                      
                      100.00
                      %
                      
                      
                      2.79
                      %
                      
                      $
                      157,833
                      
                      
                      
                      100.00
                      %
                      
                      
                      3.19
                      %


21


Time Deposit
Rates.  The following table sets forth time deposits classified
by rates as of the dates indicated (see Note 8 to our consolidated financial
statements contained within Exhibit 13) for a more detailed breakdown by rate
range):





At December 31,Rate
                  
                  2009
                  
                  
                  2008
                  
                  
                  2007(In Thousands)0.50 percent to 0.99 percent
                  
                  $
                  5,926
                  
                  
                  $
                  -
                  
                  
                  $
                  -1.00
      percent to 1.99 percent
                  
                  
                  32,658
                  
                  
                  
                  8,577
                  
                  
                  
                  -2.00
      percent to 2.99 percent
                  
                  
                  24,116
                  
                  
                  
                  11,776
                  
                  
                  
                  11,3463.00
      percent to 3.99 percent
                  
                  
                  15,629
                  
                  
                  
                  42,403
                  
                  
                  
                  11,9774.00
      percent to 4.99 percent
                  
                  
                  11,912
                  
                  
                  
                  38,278
                  
                  
                  
                  70,9005.00
      percent to 8.99 percent
                  
                  
                  3,971
                  
                  
                  
                  5,431
                  
                  
                  
                  11,209$
                  94,212
                  
                  
                  $
                  106,465
                  
                  
                  $
                  105,432





Time Deposit
Maturities.  The following
table sets forth the amount and maturities of time deposits at December 31,
2009.





1 - Less
                        
                        
                        2 - Less
                        
                        
                        3 - Less
                        
                        
                        5 yearsLess Than
                        
                        
                        than 2
                        
                        
                        than 3
                        
                        
                        than 5
                        
                        
                        andRate
                        
                        One Year
                        
                        
                        Years
                        
                        
                        Years
                        
                        
                        Years
                        
                        
                        Greater
                        
                        
                        Total0.50
      percent to 0.99 percent
                        
                        $
                        5,926
                        
                        
                        $
                        -
                        
                        
                        $
                        -
                        
                        
                        $
                        -
                        
                        
                        $
                        -
                        
                        
                        $
                        5,9261.00
      percent to 1.99 percent
                        
                        
                        28,203
                        
                        
                        
                        4,455
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        32,6582.00
      percent to 2.99 percent
                        
                        
                        7,171
                        
                        
                        
                        10,448
                        
                        
                        
                        1,793
                        
                        
                        
                        3,809
                        
                        
                        
                        895
                        
                        
                        
                        24,1163.00
      percent to 3.99 percent
                        
                        
                        7,568
                        
                        
                        
                        4,529
                        
                        
                        
                        440
                        
                        
                        
                        2,522
                        
                        
                        
                        570
                        
                        
                        
                        15,6294.00
      percent to 4.99 percent
                        
                        
                        8,382
                        
                        
                        
                        2,235
                        
                        
                        
                        900
                        
                        
                        
                        264
                        
                        
                        
                        131
                        
                        
                        
                        11,9125.00
      percent to 8.99 percent
                        
                        
                        3,303
                        
                        
                        
                        492
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        176
                        
                        
                        
                        3,971$
                        60,553
                        
                        
                        $
                        22,159
                        
                        
                        $
                        3,133
                        
                        
                        $
                        6,595
                        
                        
                        $
                        1,772
                        
                        
                        $
                        94,212





As of December 31, 2009, the aggregate
amount of outstanding certificates of deposit in amounts greater than or equal
to $100,000 was $31.6 million. The following table sets forth the maturity of
those certificates as of December 31, 2009.





Certificates of DepositMaturity Period
                    
                    in excess of $100,000(In thousands)Three
      months or less
                    
                    $
                    6,666Three
      through six months
                    
                    
                    8,243Six
      through twelve months
                    
                    
                    7,239Over
      twelve months
                    
                    
                    9,494Total
                    
                    $
                    31,642


22


Borrowings.Our
borrowings consist primarily of advances from the Federal Home Loan Bank of
Indianapolis.  At December 31, 2009, we had access to additional
Federal Home Loan Bank advances of up to $10.6 million, based upon pledged
collateral.  The following table sets forth information concerning
balances and interest rates on our Federal Home Loan Bank advances and other
borrowings at the dates and for the periods indicated.





Years Ended December 31,2009
                  
                  
                  2008
                  
                  
                  2007(Dollars in Thousands)Balance
      at end of period
                  
                  $
                  45,031
                  
                  
                  $
                  40,969
                  
                  
                  $
                  52,684Average
      balance during period
                  
                  
                  41,782
                  
                  
                  
                  47,075
                  
                  
                  
                  54,425Maximum
      outstanding at any month end
                  
                  
                  46,750
                  
                  
                  
                  48,900
                  
                  
                  
                  66,850Weighted
      average interest rate at end of period
                  
                  
                  3.13
                  %
                  
                  
                  4.22
                  %
                  
                  
                  4.68
                  %Average
      interest rate during period
                  
                  
                  3.69
                  %
                  
                  
                  4.27
                  %
                  
                  
                  4.78
                  %





Subsidiary
Activity





First
Federal of Northern Michigan Bancorp, Inc.’s only direct subsidiary is First
Federal of Northern Michigan.





First Federal of Northern Michigan has
two wholly owned subsidiaries as of December 31, 2009. First Federal of Northern
Michigan and these subsidiaries have been consolidated in the financial
statements and all inter-company balances and transactions have been eliminated
in consolidation.





One
subsidiary, Financial Services & Mortgage Corporation, leases, sells,
develops and maintains real estate properties. For reporting purposes, Financial
Services & Mortgage Corporation is included in our banking segment. As of
December 31, 2009, First Federal of Northern Michigan’s investment in Financial
Services & Mortgage Corporation was $293,000. The primary asset of the
subsidiary is an investment in land and real estate.  See "Real Estate
Development Activities.”  At December 31, 2009, Financial Services
& Mortgage Corporation owned five developed building sites which were being
offered for sale.  Financial Services & Mortgage Corporation is
not currently a party to any agreement that is material to First Federal of
Northern Michigan Bancorp, Inc. on a consolidated basis.





First
Federal of Northern Michigan’s second subsidiary, FFNM Agency, Inc., collects
the residual income stream associated with the April 2008 sale of the
Company’s  wholesale health insurance override business to a third
party. FFNM Agency is the successor company to the InsuranCenter of Alpena
(“ICA”). On February 27, 2009, we sold the majority of the assets of ICA. The
financial position and results of operations of ICA are presented separately in
our consolidated financial statements as “discontinued operations.”





Personnel





As of
December 31, 2009, First Federal of Northern Michigan had 76 full-time and 22
part-time employees.  None of the Bank's employees is represented by a
collective bargaining group.  The Bank believes its relationship with
its employees to be good.  First Federal of Northern Michigan Bancorp,
Inc., FFNM Agency, Inc. and FSMC have no separate employees.




23




SUPERVISION
AND REGULATION


General





As a
federally chartered savings bank, First Federal of Northern Michigan is
regulated and supervised by the Office of Thrift Supervision and the Federal
Deposit Insurance Corporation.  This regulation and supervision
establishes a comprehensive framework of activities in which we may engage, and
is intended primarily for the protection of the Federal Deposit Insurance
Corporation’s deposit insurance funds and depositors.  Under this
system of federal regulation, financial institutions are periodically examined
to ensure that they satisfy applicable standards with respect to their capital
adequacy, assets, management, earnings, liquidity and sensitivity to market
interest rates.  After completing an examination, the federal agency
critiques the financial institution’s operations and assigns its rating (known
as an institution’s CAMELS ratings).  Under federal law, an
institution may not disclose its CAMELS rating to the public.  First
Federal of Northern Michigan also is a member of, and owns stock in, the Federal
Home Loan Bank of Indianapolis, which is one of the twelve regional banks in the
Federal Home Loan Bank System.  First Federal of Northern Michigan
also is regulated, to a lesser extent, by the Board of Governors of the Federal
Reserve System, governing reserves to be maintained against deposits and other
matters.  The Office of Thrift Supervision examines First Federal of
Northern Michigan and prepares reports for consideration by our board of
directors on any operating deficiencies.  First Federal of Northern
Michigan’s relationship with our depositors and borrowers also is regulated to a
great extent by both federal and state laws, especially in matters concerning
the ownership of deposit accounts and the form and content of our loan
documents.





There can
be no assurance that changes to existing laws, rules and regulations, or any
other new laws, rules or regulations, will not be adopted in the future, which
could make compliance more difficult or expensive or otherwise adversely affect
our business, financial condition or prospects.  Any change in these
laws or regulations, or in regulatory policy, whether by the Federal Deposit
Insurance Corporation, the Office of Thrift Supervision or Congress, could have
a material adverse impact on our business, financial condition or
operations.





Certain
of the regulatory requirements that are applicable to First Federal of Northern
Michigan and First Federal of Northern Michigan Bancorp, Inc. are described
below. This description of statutes and regulations is not intended to be a
complete explanation of such statutes and regulations and their effects on First
Federal of Northern Michigan and First Federal of Northern Michigan Bancorp.
Inc. and is qualified in its entirety by reference to the actual statutes and
regulations.





Proposed
Federal Legislation





Legislation has been introduced in the
United States Senate and House of Representatives that would implement sweeping
changes to the current banking regulatory structure described in this section. A
bill passed by the House would eliminate First Federal of Northern Michigan’s
current primary federal regulator, the OTS, by merging the OTS into the
Comptroller of the Currency (the primary federal regulator for national banks).
The House legislation would authorize the Comptroller of the Currency to charter
state banks, which would be under the supervision of the Division of Thrift
Supervision of the Comptroller of the Currency. The House bill would also
establish a Financial Stability Oversight Council and grant the Board of
Governors of the Federal Reserve System exclusive authority to regulate all bank
and thrift holding companies.  If the House bill is enacted, First
Federal of Northern Michigan Bancorp, Inc. would become a holding company
subject to supervision by the Federal Reserve Board as opposed to the OTS, and
would become subject to the Federal Reserve’s regulations.





The Senate proposal would remove bank
and bank holding company regulatory powers from the Board of Governors of the
Federal Reserve System with respect to banks with assets of less than $50
billion, and merge the OTS into the Office of the Comptroller of the Currency.
Under this proposal, federal savings banks and savings and loan holding
companies that were regulated by the OTS would become subject to supervision and
regulation by the Office of the Comptroller of the Currency, while
state-chartered banks, thrifts and their holding companies with assets below $50
billion would be regulated by the Federal Deposit Insurance
Corporation.





Both the House bill and Senate proposal
would establish new government bureaucracies empowered to write consumer
protection rules, and in certain cases, to conduct examinations and implement
enforcement actions with respect thereto. We believe the creation of such
consumer protection bureaucracies will result in an increase in our compliance
costs.





Federal
Banking Regulation





Business
Activities.A federal savings bank derives its lending and
investment powers from the Home Owners’ Loan Act, and the regulations of the
Office of Thrift Supervision.  Under these laws and regulations, First
Federal of Northern Michigan may invest in mortgage loans secured by residential
and commercial real estate, commercial business and consumer loans, certain
types of debt securities and certain other loans and assets.  First
Federal of Northern Michigan also may establish subsidiaries that may engage in
activities not otherwise permissible for First Federal of Northern Michigan
directly, including real estate investment, securities brokerage and insurance
agency services.


24






Capital
Requirements.  Office of Thrift Supervision regulations require
savings banks to meet three minimum capital standards:  a 1.5%
tangible capital ratio, a 4% leverage ratio (3% for institutions receiving the
highest CAMELS rating) and an 8% risk-based capital ratio.  The prompt
corrective action standards discussed below, in effect, establish a minimum 2%
tangible capital standard.





The
risk-based capital standard for savings banks requires the maintenance of Tier 1
(core) and total capital (which is defined as core capital and supplementary
capital) to risk-weighted assets of at least 4% and 8%, respectively. In
determining the amount of risk-weighted assets, all assets, including certain
off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100%,
assigned by the Office of Thrift Supervision capital regulation based on the
risks inherent in the type of asset. Core capital is defined as common
stockholders’ equity (including retained earnings), certain noncumulative
perpetual preferred stock and related surplus and minority interests in equity
accounts of consolidated subsidiaries, less intangibles other than certain
mortgage servicing rights and credit card relationships. The components of
supplementary capital currently include cumulative preferred stock, long-term
perpetual preferred stock, mandatory convertible securities, subordinated debt
and intermediate preferred stock, allowance for loan and lease losses up to a
maximum of 1.25% of risk-weighted assets, and up to 45% of net unrealized gains
on available-for-sale equity securities with readily determinable fair market
values. Overall, the amount of supplementary capital included as part of total
capital cannot exceed 100% of core capital.





Additionally,
a savings association that retains credit risk in connection with an asset sale
may be required to maintain regulatory capital because of the recourse back to
the savings association. In assessing an institution’s capital adequacy, the OTS
takes into consideration not only thee numeric factors but also qualitative
factors as well, and has the authority to establish higher capital requirements
for individual associations where necessary.





At
December 31, 2009, First Federal of Northern Michigan’s capital exceeded all
applicable requirements. The following table sets forth the Bank’s capital
position at December 31, 2009 and 2008, as compared to the minimum capital
requirements.





At December 31,2009
                            
                            
                            2008Percent
                            
                            
                            
                            
                            
                            PercentAmount
                            
                            
                            of Assets
                            
                            
                            Amount
                            
                            
                            of Assets(Dollars
      in Thousands)Equity
      capital
                            
                            $
                            22,119
                            
                            
                            
                            9.5
                            %
                            
                            $
                            28,320
                            
                            
                            
                            11.4
                            %Tangible Capital
    Requirement:Tangible
      capital level
                            
                            
                            20,239
                            
                            
                            
                            8.8
                            %
                            
                            
                            24,886
                            
                            
                            
                            10.2
                            %Requirement
                            
                            
                            3,470
                            
                            
                            
                            1.5
                            %
                            
                            
                            3,655
                            
                            
                            
                            1.5
                            %Excess
                            
                            
                            16,769
                            
                            
                            
                            7.3
                            %
                            
                            
                            21,260
                            
                            
                            
                            8.7
                            %Core Capital Requirement:Core
      capital level
                            
                            
                            20,239
                            
                            
                            
                            8.8
                            %
                            
                            
                            24,886
                            
                            
                            
                            10.2
                            %Requirement
                            
                            
                            9,255
                            
                            
                            
                            4.0
                            %
                            
                            
                            9,476
                            
                            
                            
                            4.0
                            %Excess
                            
                            
                            10,984
                            
                            
                            
                            4.8
                            %
                            
                            
                            15,213
                            
                            
                            
                            6.2
                            %Risk-based Capital
    Requirement:Risk-based
      capital level
                            
                            
                            22,304
                            
                            
                            
                            13.6
                            %
                            
                            
                            27,079
                            
                            
                            
                            15.8
                            %Requirement
                            
                            
                            13,153
                            
                            
                            
                            8.0
                            %
                            
                            
                            13,757
                            
                            
                            
                            8.0
                            %Excess
                            
                            
                            9,151
                            
                            
                            
                            5.6
                            %
                            
                            
                            13,239
                            
                            
                            
                            7.8
                            %





Loans to One
Borrower. A
federal savings bank generally may not make a loan or extend credit to a single
or related group of borrowers in excess of 15% of unimpaired capital and surplus
on an unsecured basis.  An additional amount may be loaned, equal to
10% of unimpaired capital and surplus, if the loan is secured by readily
marketable collateral, which generally does not include real
estate.  As of December 31, 2009, First Federal of Northern Michigan
was in compliance with the loans-to-one-borrower limitations.





Qualified Thrift
Lender Test.As a federal savings
bank, First Federal of Northern Michigan is subject to a qualified thrift
lender, or “QTL,” test.  Under the QTL test, First Federal of Northern
Michigan must maintain at least 65% of its “portfolio assets” in “qualified
thrift investments” in at least nine months of the most recent 12-month
period.  “Portfolio assets” generally means total assets of a savings
institution, less the sum of specified liquid assets up to 20% of total assets,
goodwill and other intangible assets, and the value of property used in the
conduct of the institution’s business.


25





“Qualified
thrift investments” include various types of loans made for residential and
housing purposes, investments related to such purposes, including certain
mortgage-backed and related securities, and loans for personal, family,
household and certain other purposes up to a limit of 20% of portfolio
assets.  “Qualified thrift investments” also include 100% of an
institution’s credit card loans, education loans and small business
loans.  First Federal of Northern Michigan also may satisfy the QTL
test by qualifying as a “domestic building and loan association” as defined in
the Internal Revenue Code of 1986.





A savings
bank that fails the QTL test must either convert to a bank charter or operate
under specified restrictions.  At December 31, 2009, First Federal of
Northern Michigan maintained approximately 87.3% of its portfolio assets in
qualified thrift investments, and therefore satisfied the QTL test.





Capital
Distributions.Office of Thrift
Supervision regulations govern capital distributions by a federal savings bank,
which include cash dividends, stock repurchases and other transactions charged
to the institution’s capital account.  A savings bank must file an
application for approval of a capital distribution if:





·
            the
      total capital distributions for the applicable calendar year exceed the
      sum of the savings bank’s net income for that year to date plus the
      savings bank’s retained net income for the preceding two
      years;




·
            the
      savings bank would not be at least adequately capitalized following the
      distribution;




·
            the
      distribution would violate any applicable statute, regulation, agreement
      or Office of Thrift Supervision-imposed condition;
  or




·
            the
      savings bank is not eligible for expedited treatment of its
      filings.




Even if
an application is not otherwise required, every savings bank that is a
subsidiary of a holding company must still file a notice with the Office of
Thrift Supervision at least 30 days before the board of directors declares a
dividend or approves a capital distribution.





The
Office of Thrift Supervision may disapprove a notice or application
if:





·
            the
      savings bank would be undercapitalized following the
      distribution;




·
            the
      proposed capital distribution raises safety and soundness concerns;
      or




·
            the
      capital distribution would violate a prohibition contained in any statute,
      regulation or agreement.




In
addition, the Federal Deposit Insurance Act provides that an insured depository
institution shall not make any capital distribution if after making such
distribution the institution would be undercapitalized.




Liquidity.  A
federal savings bank is required to maintain a sufficient amount of liquid
assets to ensure its safe and sound operation





Community
Reinvestment Act and Fair Lending Laws.  All savings banks have
a responsibility under the Community Reinvestment Act and related regulations of
the Office of Thrift Supervision to help meet the credit needs of their
communities, including low- and moderate-income neighborhoods.  In
connection with its examination of a federal savings bank, the Office of Thrift
Supervision is required to assess the savings bank’s record of compliance with
the Community Reinvestment Act.  In addition, the Equal Credit
Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in
their lending practices on the basis of characteristics specified in those
statutes.  A savings bank’s failure to comply with the provisions of
the Community Reinvestment Act could, at a minimum, result in regulatory
restrictions on its activities.  The failure to comply with the Equal
Credit Opportunity Act and the Fair Housing Act could result in enforcement
actions by the Office of Thrift Supervision, as well as other federal regulatory
agencies and the Department of Justice.  First Federal of Northern
Michigan received an “Outstanding” Community Reinvestment Act rating in its most
recent federal examination.


26





Transactions with
Related Parties.  A federal savings bank’s authority to engage
in transactions with its “affiliates” is limited by Office of Thrift Supervision
regulations and Regulation W of the Federal Reserve Board, which implements
Sections 23A and 23B of the Federal Reserve Act.  The term
“affiliates” for these purposes generally means any company that controls or is
under common control with an institution.  First Federal of Northern
Michigan Bancorp, Inc. and its non-savings institution subsidiaries will be
affiliates of First Federal of Northern Michigan.  In general,
transactions with affiliates must be on terms that are as favorable to the
savings bank as comparable transactions with non-affiliates.  In
addition, certain types of these transactions are restricted to an aggregate
percentage of the savings bank’s capital.  Collateral in specified
amounts must usually be provided by affiliates in order to receive loans from
the savings bank.  In addition, Office of Thrift Supervision
regulations prohibit a savings bank from lending to any of its affiliates that
are engaged in activities that are not permissible for bank holding companies
and from purchasing the securities of any affiliate, other than a
subsidiary.





First
Federal of Northern Michigan’s authority to extend credit to its directors,
executive officers and 10% stockholders, as well as to entities controlled by
such persons, is currently governed by the requirements of Sections 22(g)
and 22(h) of the Federal Reserve Act and Regulation O of the Federal Reserve
Board. Among other things, these provisions require that extensions of credit to
insiders (i) be made on terms that are substantially the same as, and follow
credit underwriting procedures that are not less stringent than, those
prevailing for comparable transactions with unaffiliated persons and that do not
involve more than the normal risk of repayment or present other unfavorable
features, and (ii) not exceed certain limitations on the amount of credit
extended to such persons, individually and in the aggregate, which limits are
based, in part, on the amount of First Federal of Northern Michigan’s
capital.  In addition, extensions of credit in excess of certain
limits must be approved by First Federal of Northern Michigan’s board of
directors.





Enforcement.  The
Office of Thrift Supervision has primary enforcement responsibility over federal
savings banks and has the authority to bring enforcement action against all
“institution-affiliated parties,” including stockholders, attorneys, appraisers
and accountants who knowingly or recklessly participate in wrongful action
likely to have an adverse effect on an institution.  Formal
enforcement action may range from the issuance of a capital directive or cease
and desist order to removal of officers and/or directors of the savings bank,
receivership, conservatorship or the termination of deposit
insurance.  Civil penalties cover a wide range of violations and
actions, and range up to $25,000 per day, unless a finding of reckless disregard
is made, in which case penalties may be as high as $1 million per
day.  The Federal Deposit Insurance Corporation also has the authority
to recommend to the Director of the Office of Thrift Supervision that
enforcement action be taken with respect to a particular savings
bank.  If action is not taken by the Director, the Federal Deposit
Insurance Corporation has authority to take action under specified
circumstances.





Standards for
Safety and Soundness.  Federal law requires each federal
banking agency to prescribe certain standards for all insured depository
institutions.  These standards relate to, among other things, internal
controls, information systems and audit systems, loan documentation, credit
underwriting, interest rate risk exposure, asset growth, compensation, and other
operational and managerial standards as the agency deems
appropriate.  The federal banking agencies adopted Interagency
Guidelines Prescribing Standards for Safety and Soundness to implement the
safety and soundness standards required under federal law.  The
guidelines set forth the safety and soundness standards that the federal banking
agencies use to identify and address problems at insured depository institutions
before capital becomes impaired.  The guidelines address internal
controls and information systems, internal audit systems, credit underwriting,
loan documentation, interest rate risk exposure, asset growth, compensation,
fees and benefits.  If the appropriate federal banking agency
determines that an institution fails to meet any standard prescribed by the
guidelines, the agency may require the institution to submit to the agency an
acceptable plan to achieve compliance with the standard.  If an
institution fails to meet these standards, the appropriate federal banking
agency may require the institution to submit a compliance plan.





Prompt Corrective
Action Regulations.  Under the prompt
corrective action regulations, the Office of Thrift Supervision is required and
authorized to take supervisory actions against undercapitalized savings banks.
For this purpose, a savings bank is placed in one of the following five
categories based on the savings bank’s capital:


·
            well-capitalized
      (at least 5% leverage capital, 6% tier 1 risk-based capital and 10% total
      risk-based capital);




·
            adequately
      capitalized (at least 4% leverage capital, 4% tier 1 risk-based capital
      and 8% total risk-based capital);




·
            undercapitalized
      (less than 3% leverage capital, 4% tier 1 risk-based capital or 8% total
      risk-based capital);


27


·
            significantly
      undercapitalized (less than 3% leverage capital, 3% tier 1 risk-based
      capital or 6% total risk-based capital);
or




·
            critically
      undercapitalized (less than 2% tangible
  capital).




Generally,
the Office of Thrift Supervision is required to appoint a receiver or
conservator for a savings bank that is “critically
undercapitalized.”  The regulation also provides that a capital
restoration plan must be filed with the Office of Thrift Supervision within 45
days of the date a savings bank receives notice that it is “undercapitalized,”
“significantly undercapitalized” or “critically undercapitalized.”  In
addition, numerous mandatory supervisory actions become immediately applicable
to the savings bank, including, but not limited to, restrictions on growth,
investment activities, capital distributions and affiliate
transactions.  The Office of Thrift Supervision may also take any one
of a number of discretionary supervisory actions against undercapitalized
savings banks, including the issuance of a capital directive and the replacement
of senior executive officers and directors.





At
December 31, 2009, First Federal of Northern Michigan met the criteria for being
considered “well-capitalized.”





Insurance of
Deposit Accounts.First Federal of
Northern Michigan is a member of the Deposit Insurance Fund, which is
administered by the FDIC. Deposit accounts at First Federal of Northern Michigan
are insured by the FDIC, generally up to a maximum of $100,000 for each
separately insured depositor and up to a maximum of $250,000 for self-directed
retirement accounts. However, the FDIC increased the deposit insurance available
on all deposit accounts to $250,000, effective until December 31,
2013.  In addition, certain noninterest-bearing transaction accounts
maintained with financial institutions participating in the FDIC’s Temporary
Liquidity Guarantee Program are fully insured regardless of the dollar amount
until June 30, 2010. First Federal of Northern Michigan has opted to participate
in the FDIC’s Temporary Liquidity Guarantee Program.  See “—Temporary
Liquidity Guarantee Program.”




The FDIC
imposes an assessment against all depository institutions for deposit insurance.
This assessment is based on the risk category of the institution and, prior to
2009, ranged from five to 43 basis points of the institution’s
deposits.  On February 27, 2009, the FDIC published a final rule
raising the current deposit insurance assessment rates to a range from 12 to 45
basis points beginning April 1, 2009.




On
May 22, 2009, the FDIC issued a final rule that imposed a special 5 basis points
assessment on assets less Tier 1 capital as of June 30, 2009, and was paid to
the FDIC on September 30, 2009.  The cost of this special assessment
to First Federal of Northern Michigan, was $108,000.




On
November 12, 2009, the FDIC adopted a final rule amending the assessment
regulations to require insured depository institutions to prepay their quarterly
risk-based assessments for the fourth quarter of 2009, and for all of 2010,
2011, and 2012, on December 30, 2009. This final rule resulted in the Company
prepaying FDIC assessments in the amount of $1.4 million.




Insurance of deposits may be terminated
by the FDIC upon a finding that an institution has engaged in unsafe or unsound
practices, is in an unsafe or unsound condition to continue operations or has
violated any applicable law, regulation, rule, order or condition imposed by the
FDIC. We do not currently know of any practice, condition or violation that
might lead to termination of our deposit insurance.




In addition to the FDIC assessments,
the Financing Corporation (“FICO”) is authorized to impose and collect, with the
approval of the FDIC, assessments for anticipated payments, issuance costs and
custodial fees on bonds issued by the FICO in the 1980s to recapitalize the
former Federal Savings and Loan Insurance Corporation. The bonds issued by the
FICO are due to mature in 2017 through 2019. For the quarter ended December 31,
2009, the annualized FICO assessment was equal to 1.10 basis points for each
$100 in domestic deposits maintained at an institution.





Temporary
Liquidity Guarantee Program.  On October 14, 2008, the FDIC
announced a new program – the Temporary Liquidity Guarantee
Program.  This program has two components. One guarantees newly issued
senior unsecured debt of a participating organization, up to certain limits
established for each institution, issued between October 14, 2008 and June 30,
2009. The FDIC will pay the unpaid principal and interest on an FDIC -guaranteed
debt instrument upon the uncured failure of the participating entity to make a
timely payment of principal or interest in accordance with the terms of the
instrument.  The guarantee will remain in effect until June 30, 2012.
In return for the FDIC’s guarantee, participating institutions will pay the FDIC
a fee based on the amount and maturity of the debt.  First Federal of
Northern Michigan opted to participate in this component of the Temporary
Liquidity Guarantee Program, but had no such unsecured debt during this time
period.


28


The other component of the program
provides full federal deposit insurance coverage for non-interest bearing
transaction deposit accounts, regardless of dollar amount, until June 30, 2010.
An annualized 20 basis point assessment on balances in noninterest-bearing
transaction accounts that exceed the existing deposit insurance limit of
$250,000 will be assessed on a quarterly basis to insured depository
institutions that have not opted out of this component of the Temporary
Liquidity Guarantee Program.  First Federal of Northern Michigan opted
to participate in this component of the Temporary Liquidity Guarantee
Program.





U.S. Treasury’s
Troubled Asset Relief Program Capital Purchase Program.The Emergency
Economic Stabilization Act of 2008 was enacted in October 2008 and provides the
U.S. Secretary of the Treasury with broad authority to implement certain actions
to help restore stability and liquidity to U.S. markets. One of the provisions
resulting from the legislation is the U.S. Treasury’s Capital Purchase Program
(“CPP”) under the Troubled Asset Relief Program.  CPP provides direct
equity investment in perpetual preferred stock by the U.S. Treasury in qualified
financial institutions. The program is voluntary and requires an institution to
comply with a number of restrictions and provisions, including limits on
executive compensation, stock redemptions and dividends.  The CPP
provides for a minimum investment of one percent of total risk-weighted assets
and a maximum investment equal to the lesser of three percent of total
risk-weighted assets or $25 billion. Participation in the program is not
automatic and is subject to approval by the U.S. Treasury.  First
Federal of Northern Michigan Bancorp, Inc. opted not to participate in the
CPP.




Prohibitions
Against Tying Arrangements.  Federal savings
banks are prohibited, subject to some exceptions, from extending credit to or
offering any other service, or fixing or varying the consideration for such
extension of credit or service, on the condition that the customer obtain some
additional service from the savings bank or its affiliates or not obtain
services of a competitor of the savings bank.





Federal Home Loan
Bank System.  First Federal of Northern Michigan is a member of
the Federal Home Loan Bank System, which consists of 12 regional Federal Home
Loan Banks.  The Federal Home Loan Bank System provides a central
credit facility primarily for member institutions.  As a member of the
Federal Home Loan Bank of Indianapolis, First Federal of Northern Michigan is
required to acquire and hold shares of capital stock in the Federal Home Loan
Bank in an amount equal to at least 1% of the aggregate principal amount of its
unpaid residential mortgage loans and similar obligations at the beginning of
each year, or 1/20 of its borrowings from the Federal Home Loan Bank, whichever
is greater.  As of December 31, 2009, First Federal of Northern
Michigan was in compliance with this requirement.





Other
Regulations




Interest
and other charges collected or contracted for by First Federal of Northern
Michigan are subject to state usury laws and federal laws concerning interest
rates.  First Federal of Northern Michigan’s operations are also
subject to federal laws applicable to credit transactions, such as
the:




·
            Truth-In-Lending
      Act, governing disclosures of credit terms to consumer
      borrowers;




·
            Home
      Mortgage Disclosure Act, requiring financial institutions to provide
      information to enable the public and public officials to determine whether
      a financial institution is fulfilling its obligation to help meet the
      housing needs of the community it
serves;




·
            Equal
      Credit Opportunity Act, prohibiting discrimination on the basis of race,
      creed or other prohibited factors in extending
  credit;




·
            Fair
      Credit Reporting Act, governing the use and provision of information to
      credit reporting agencies;




·
            Fair
      Debt Collection Act, governing the manner in which consumer debts may be
      collected by collection agencies;




·
            Truth
      in Savings Act; and




·
            rules
      and regulations of the various federal agencies charged with the
      responsibility of implementing such federal
  laws.


29


The
operations of First Federal of Northern Michigan also are subject to
the:




·
            Right
      to Financial Privacy Act, which imposes a duty to maintain confidentiality
      of consumer financial records and prescribes procedures for complying with
      administrative subpoenas of financial
records;




·
            Electronic
      Funds Transfer Act and Regulation E promulgated thereunder, which govern
      automatic deposits to and withdrawals from deposit accounts and customers’
      rights and liabilities arising from the use of automated teller machines
      and other electronic banking
services;




·
            Check
      Clearing for the 21st
      Century Act (also known as “Check 21”), which gives “substitute checks,”
      such as digital check images and copies made from that image, the same
      legal standing as the original paper
check;




·
            Title
      III of The Uniting and Strengthening America by Providing Appropriate
      Tools Required to Intercept and Obstruct Terrorism Act of 2001 (referred
      to as the “USA PATRIOT Act”), which significantly expanded the
      responsibilities of financial institutions, including savings and loan
      associations, in preventing the use of the American financial system to
      fund terrorist activities.  Among other provisions, the USA
      PATRIOT Act and the related regulations of the OTS require savings
      associations operating in the United States to develop new anti-money
      laundering compliance programs, due diligence policies and controls to
      ensure the detection and reporting of money laundering. Such required
      compliance programs are intended to supplement existing compliance
      requirements, also applicable to financial institutions, under the Bank
      Secrecy Act and the Office of Foreign Assets Control regulations;
      and




·
            The
      Gramm-Leach-Bliley Act, which places limitations on the sharing of
      consumer financial information by financial institutions with unaffiliated
      third parties. Specifically, the Gramm-Leach-Bliley Act requires all
      financial institutions offering financial products or services to retail
      customers to provide such customers with the financial institution’s
      privacy policy and provide such customers the opportunity to “opt out” of
      the sharing of certain personal financial information with unaffiliated
      third parties.





Federal
Reserve System





Federal
Reserve Board regulations require savings banks to maintain non-interest-earning
reserves against their transaction accounts, such as negotiable order of
withdrawal and regular checking accounts.  At December 31,
2009,  First Federal of Northern Michigan was in compliance with these
reserve requirements.  The balances maintained to meet the reserve
requirements imposed by the Federal Reserve Board may be used to satisfy
liquidity requirements imposed by the Office of Thrift Supervision.





The
USA PATRIOT Act





The USA
PATRIOT Act gives the federal government new powers to address terrorist threats
through enhanced domestic security measures, expanded surveillance powers,
increased information sharing and broadened anti-money laundering
requirements.  Certain provisions of the Act impose affirmative
obligations on a broad range of financial institutions, including federal
savings banks, like First Federal of Northern Michigan.  These
obligations include enhanced anti-money laundering programs, customer
identification programs and regulations relating to private banking accounts or
correspondence accounts in the United States for non-United States persons or
their representatives (including foreign individuals visiting the United
States).





First
Federal of Northern Michigan has established policies and procedures to ensure
compliance with the USA PATRIOT Act’s provisions, and the impact of the USA
PATRIOT Act on our operations has not been material.


30





Holding
Company Regulation





First
Federal of Northern Michigan Bancorp, Inc. is a unitary savings and loan holding
company, subject to regulation and supervision by the Office of Thrift
Supervision.  The Office of Thrift Supervision has enforcement
authority over First Federal of Northern Michigan Bancorp, Inc. and its
non-savings institution subsidiaries.  Among other things, this
authority permits the Office of Thrift Supervision to restrict or prohibit
activities that are determined to be a risk to First Federal of Northern
Michigan.





Under
prior law, a unitary savings and loan holding company generally had no
regulatory restrictions on the types of business activities in which it could
engage, provided that its subsidiary savings association was a qualified thrift
lender.  The Gramm-Leach-Bliley Act, however, restricts unitary
savings and loan holding companies not existing on, or applied for before, May
4, 1999, to those activities permissible for financial holding companies or for
multiple savings and loan holding companies.  First Federal of
Northern Michigan Bancorp, Inc. is not a grandfathered unitary savings and loan
holding company and, therefore, is limited to the activities permissible for
financial holding companies or for multiple savings and loan holding
companies.  A financial holding company may engage in activities that
are financial in nature, including underwriting equity securities and insurance,
incidental to financial activities or complementary to a financial
activity.  A multiple savings and loan holding company is generally
limited to activities permissible for bank holding companies under Section
4(c)(8) of the Bank Holding Company Act, subject to the prior approval of the
Office of Thrift Supervision, and certain additional activities authorized by
Office of Thrift Supervision regulations.





Federal
law prohibits a savings and loan holding company, directly or indirectly, or
through one or more subsidiaries, from acquiring control of another savings
institution or holding company thereof, without prior written approval of the
Office of Thrift Supervision.  It also prohibits the acquisition or
retention of, with specified exceptions, more than 5% of the equity securities
of a company engaged in activities that are not closely related to banking or
financial in nature or acquiring or retaining control of an institution that is
not federally insured.  In evaluating applications by holding
companies to acquire savings institutions, the Office of Thrift Supervision must
consider the financial and managerial resources and future prospects of the
savings institution involved, the effect of the acquisition on the risk to the
insurance fund, the convenience and needs of the community and competitive
factors.





Sarbanes-Oxley
Act of 2002





The
Sarbanes-Oxley Act of 2002 was enacted in response to public concerns regarding
corporate accountability. The stated goals of the Sarbanes-Oxley Act are to
increase corporate responsibility, to provide for enhanced penalties for
accounting and auditing improprieties at publicly traded companies, and to
protect investors by improving the accuracy and reliability of corporate
disclosures pursuant to the securities laws. The Sarbanes-Oxley Act generally
applies to all companies that file or are required to file periodic reports with
the SEC, under the Securities Exchange Act of 1934.





The
Sarbanes-Oxley Act includes very specific additional disclosure requirements and
new corporate governance rules requiring the SEC and securities exchanges to
adopt extensive additional disclosure, corporate governance and other related
rules, and mandates further studies of certain issues by the SEC.  The
Sarbanes-Oxley Act represents significant federal involvement in matters
traditionally left to state regulatory systems, such as the regulation of the
accounting profession, and to state corporate law, such as the relationship
between a board of directors and management and between a board of directors and
its committees.





Federal
Securities Laws





First
Federal of Northern Michigan Bancorp, Inc.’s common stock is registered with the
Securities and Exchange Commission under the Securities Exchange Act of
1934.  First Federal of Northern Michigan Bancorp, Inc. is subject to
the information, proxy solicitation, insider trader restrictions and other
requirements under the Securities Exchange of 1934.





First
Federal of Northern Michigan Bancorp, Inc. common stock held by persons who are
affiliates (generally officers, directors and principal stockholders) of First
Federal of Northern Michigan Bancorp, Inc. may not be resold without
registration or unless sold in accordance with certain resale
restrictions.  If First Federal of Northern Michigan Bancorp, Inc.
meets specified current public information requirements, each affiliate of First
Federal of Northern Michigan Bancorp, Inc. is able to sell in the public market,
without registration, a limited number of shares in any three-month
period.


31





TAXATION





Federal
Taxation





General.  First
Federal of Northern Michigan Bancorp, Inc. and First Federal of Northern
Michigan are subject to federal income taxation in the same general manner as
other corporations, with some exceptions discussed below.  The
following discussion of federal taxation is intended only to summarize material
federal income tax matters and is not a comprehensive description of the tax
rules applicable to First Federal of Northern Michigan Bancorp, Inc. and First
Federal of Northern Michigan.





Method of
Accounting.  For federal
income tax purposes, First Federal of Northern Michigan currently reports its
income and expenses on the accrual method of accounting and uses a tax year
ending December 31 for filing its consolidated federal income tax
returns.  The Small Business Protection Act of 1996 eliminated the use
of the reserve method of accounting for bad debt reserves by savings
institutions, effective for taxable years beginning after 1995.





Bad Debt
Reserves.  Prior to the Small Business Protection Act of 1996,
First Federal of Northern Michigan was permitted to establish a reserve for bad
debts for tax purposes and to make annual additions to the
reserve.  These additions could, within specified formula limits, be
deducted in arriving at First Federal of Northern Michigan’s taxable
income.  As a result of the Small Business Protection Act, First
Federal of Northern Michigan must use the specific charge off method in
computing its bad debt deduction for tax purposes.





Deferred Tax
Asset Valuation.The Company records a valuation allowance against its
deferred tax assets if it believes, based on available evidence, that it is
“more likely than not” that the future tax assets recognized will not be
realized before their expiration. Realization of the Company’s deferred tax
assets is primarily dependent upon the generation of a sufficient level of
future taxable income.At
December 31, 2009 the Company had a valuation allowance against its deferred tax
assets of  $3.4 million.





Taxable
Distributions and Recapture.  Prior to the Small Business
Protection Act of 1996, bad debt reserves created prior to 1988 were subject to
recapture into taxable income if First Federal of Northern Michigan failed to
meet certain thrift asset and definitional tests.  The Small Business
Protection Act of 1996 eliminated these thrift-related recapture
rules.  However, under current law, pre-1988 reserves remain subject
to tax recapture should First Federal of Northern Michigan make certain
distributions from its tax bad debt reserve or cease to maintain a bank
charter.  At December 31, 2009, First Federal of Northern Michigan’s
total federal pre-1988 reserve was approximately $60,000.  This
reserve reflects the cumulative effects of federal tax deductions by First
Federal of Northern Michigan for which    no federal income
tax provision has been made.





Minimum
Tax.  The Internal Revenue Code of 1986, as amended, imposes an
alternative minimum tax at a rate of 20% on a base of regular taxable income
plus certain tax preferences (“alternative minimum taxable income” or
“AMTI”).  The alternative minimum tax is payable to the extent such
AMTI is in excess of an exemption amount.  Net operating losses can,
in general, offset no more than 90% of AMTI.  Certain payments of
alternative minimum tax may be used as credits against regular tax liabilities
in future years. First Federal of Northern Michigan has not been subject to the
alternative minimum tax and has no such amounts available as credits for
carryover.





Net Operating
Loss Carryovers.  A financial institution may carry back net
operating losses to the preceding five taxable years and forward to the
succeeding 20 taxable years.  At December 31, 2009, First Federal of
Northern Michigan had a net operating loss of approximately 8.2 million which it
may carry back and/or forward for federal income tax purposes.





Corporate
Dividends.  We may exclude from our income 100% of dividends
received from First Federal of Northern Michigan as a member of the same
affiliated group of corporations.





The
federal income tax returns of First Federal of Northern Michigan Bancorp, Inc.
and its predecessor, Alpena Bancshares, Inc. have not been audited by the
Internal Revenue Service in the last five fiscal years.





State
and Local Taxation





During
1999, the State of Michigan enacted legislation that resulted in elimination of
the Michigan single business tax by gradually phasing it out over the next 23
years.  On August 9, 2006, the Michigan Legislature approved the
repeal of the Michigan SBT for tax years beginning after December 31, 2007. The
Michigan SBT has been replaced with the Michigan Business Tax (MBT). Financial
Institutions are subject to a component of the MBT, the Financial Institutions
Tax, which is based on capital rather than taxable earnings.


32





Other
applicable state taxes include generally applicable sales, use and real property
taxes.





As a
Maryland business corporation, First Federal of Northern Michigan Bancorp, Inc.
is required to file annual returns with and pay annual fees to  the State
of Maryland.


ITEM 1A.  RISK FACTORS





An investment in our common stock
involves risk. You should carefully consider the risks described below and all
other information contained in this annual report on Form 10-K before you decide
to buy our common stock. It is possible that risks and uncertainties not listed
below may arise or become material in the future and affect our
business.





The
United States Economy Is In Recession. The Economic Recession Has Already
Affected Our Business and Results of Operations.  A Prolonged Economic
Downturn, Especially One Affecting Our Geographic Market Area, Could Continue to
Materially Affect our Business and Financial Results.





The
United States economy entered a recession in the fourth quarter of
2007.  The economy in our principal market area, Northern Michigan, is
similarly in a recession. Throughout the course of 2008 and 2009, economic
conditions continued to worsen, due in large part to the fallout from the
collapse of the sub-prime mortgage market. While we did not originate or invest
in sub-prime mortgages, our lending business is tied, in large part, to the
housing market.  Declines in home prices, increases in foreclosures
and higher unemployment have adversely affected the credit performance of real
estate-related loans, resulting in the write-down of asset values. The
continuing housing slump also has resulted in reduced demand for the
construction of new housing, further declines in home prices, and increased
delinquencies on our construction, residential and commercial mortgage loans.
Further, the ongoing concern about the stability of the financial markets in
general has caused many lenders to reduce or cease providing funding to
borrowers. These conditions may also cause a further reduction in loan demand,
and increases in our non-performing assets, net charge-offs and provisions for
loan losses.





The Company's success depends primarily
on the general economic conditions of the State of Michigan and the specific
local markets in which the Company operates. The local economic conditions in
these local markets have a significant impact on the demand for the Company’s
products and services as well as the ability of the Company’s customers to repay
loans, the value of the collateral securing loans and the stability of the
Company's deposit funding sources. Economic conditions experienced in the State
of Michigan have been more adverse than in the United States generally, and
these conditions are not expected to significantly improve in the near
future.Unemployment
has increased significantly. A further economic downturn or continued weak
business environment within Michigan could further negatively impact household
and corporate incomes.  A majority of the Company's loans are to
individuals and businesses in Michigan. Consequently, any further or prolonged
decline in Michigan’s economy could have a materially adverse effect on the
Company's financial condition and results of operations. A significant further
decline or a prolonged period of the lack of improvement in general economic
conditions, whether caused by recession, inflation, unemployment, changes in
securities markets, acts of terrorism, other international or domestic
occurrences or other factors could impact these local economic conditions and,
in turn, have a material adverse effect on the Company's financial condition and
results of operations.





Future
Changes in Interest Rates Could Reduce Our Profits





Our
ability to make a profit largely depends on our net interest income, which could
be negatively affected by changes in interest rates.  Net interest
income is the difference between:




·
            the
      interest income we earn on our interest-earning assets, such as loans and
      securities; and





·
            the
      interest expense we pay on our interest-bearing liabilities, such as
      deposits and borrowings.





The rates
we earn on our assets and the rates we pay on our liabilities are generally
fixed for a contractual period of time. Like many savings institutions, our
liabilities generally have shorter contractual maturities than our
assets.  This imbalance can create significant earnings volatility,
because market interest rates change over time.  In a period of rising
interest rates, the interest income earned on our assets may not increase as
rapidly as the interest paid on our liabilities.  In a period of
declining interest rates, the interest income earned on our assets may decrease
more rapidly than the interest paid on our liabilities, as borrowers prepay
mortgage loans, and mortgage-backed securities and callable investment
securities are called or prepaid thereby requiring us to reinvest those cash
flows at lower interest rates.  See “Management’s Discussion and
Analysis of Financial Condition and Results of Operations — Management of
Interest Rate Risk.”


33


In
addition, changes in interest rates can affect the average life of loans and
mortgage-backed and related securities. A reduction in interest rates results in
increased prepayments of loans and mortgage-backed and related securities, as
borrowers refinance their debt in order to reduce their borrowing costs. This
creates reinvestment risk, which is the risk that we may not be able to reinvest
prepayments at rates that are comparable to the rates we earned on the prepaid
loans or securities. Additionally, increases in interest rates may decrease loan
demand and/or make it more difficult for borrowers to repay adjustable-rate
loans.




Changes
in interest rates also affect the current fair value of our interest-earning
securities portfolio. Generally, the value of securities moves inversely with
changes in interest rates.  At December 31, 2009, the fair value of
our available-for-sale securities portfolio, consisting of agency securities,
mortgage-backed securities, corporate debt obligations and municipal
obligations, totaled $37.8 million. Unrealized net gains on these
available-for-sale securities totaled $641,000 at December 31, 2009 and are
reported as a separate component of stockholders’ equity. Decreases in the fair
value of securities available for sale in future periods would have an adverse
effect on stockholders’ equity.




We
evaluate interest rate sensitivity using income simulation models that estimate
the change in our net interest income over a range of interest rate scenarios.
Net income at risk measures the risk of a decline in earnings due to potential
short-term and long term changes in interest rates. At December 31, 2009, the
latest date for which such information is available, in the event of an
immediate 200 basis point increase in interest rates, the model projects that we
would experience an 8.0% decrease in net interest income over the following 12
months.




As
a Result of Our Previous Emphasis on Originating Commercial Real Estate and
Commercial Business Loans, Our Credit Risk Has and Will Continue to
Increase.  Continued Weakness or a Deeper Downturn in the Real Estate
Market and Local Economy Could Adversely Affect Our Earnings.





At
December 31, 2009, our portfolio of commercial real estate loans totaled $55.8
million, or 31.9% of our total loans, our portfolio of commercial business loans
totaled $9.9 million, or 5.6% of our total loans, and our portfolio of
commercial construction loans totaled $6.6 million or 3.8% of our total loans.
These loans have increased as a percentage of our total loan portfolio in recent
years and generally have more risk than one- to four-family residential mortgage
loans. Because the repayment of commercial real estate and commercial business
loans depends on the successful management and operation of the borrower’s
properties or related businesses, repayment of such loans can be affected by
adverse conditions in the real estate market or the local
economy.  Many of our borrowers also have more than one commercial
real estate or commercial business loan outstanding with us. Consequently, an
adverse development with respect to one loan or one credit relationship can
expose us to significantly greater risk of loss compared to an adverse
development with respect to a one- to four-family residential mortgage
loan.  Finally, if we foreclose on a commercial real estate or
commercial business loan, our holding period for the collateral, if any,
typically is longer than for one- to four-family residential mortgage loans
because there are fewer potential purchasers of the collateral. Because we plan
to continue to increase our originations of these loans, it may be necessary to
increase the level of our allowance for loan losses because of the increased
risk characteristics associated with these types of loans. Any such increase to
our allowance for loan losses would adversely affect our earnings.




We Have Participated
in Commercial Real Estate, Residential Real Estate and Construction Loans
Secured by Real Estate Located Outside of Michigan, Which Expose Us to Increased
Lending Risks
  Beginning
in 2007, because of weak market conditions and weak demand for loans in our
primary market area, and in an effort to diversify our loan portfolio, we began
participating in commercial real estate, residential real estate and
construction loans originated by other financial institutions and secured by
real estate located outside of Michigan. As of December 31, 2009, $12.2 million
of our loans were participations in commercial real estate and construction
loans secured by real estate located outside of Michigan. As of December 31,
2009, $2.1 million of these loans were considered non-performing. Of our $8.2
million in loan charge-offs in 2009, $2.5 million were loans secured by real
estate located outside of Michigan. Such loans expose us to increased lending
risks because, unlike loans that we originate in our market area, we may be
unfamiliar with the collateral securing such loans and the market conditions
affecting the borrower, and we generally do not have face-to-face contact with
the borrowers on such loans.


If
Our Allowance for Loan Losses is Not Sufficient to Cover Actual Loan Losses, Our
Earnings Could Decrease.





We make
various assumptions and judgments about the collectability of our loan
portfolio, including the creditworthiness of our borrowers and the value of the
real estate and other assets serving as collateral for the repayment of many of
our loans. In determining the amount of the allowance for loan losses, we review
our loans and our loss and delinquency experience, and we evaluate economic
conditions.  If our assumptions are incorrect, our allowance for loan
losses may not be sufficient to cover losses inherent in our loan portfolio,
resulting in additions to our allowance. Our allowance for loan losses was 2.09%
of total loans and 31.05% of non-performing loans at December 31, 2009, compared
to 2.85% of total loans and 46.41% of non-performing loans at December 31,
2008.  Material additions to our allowance could materially decrease
our net income.




In
addition, bank regulators periodically review our allowance for loan losses and
may require us to increase our provision for loan losses or recognize further
loan charge-offs. Any increase in our allowance for loan losses or loan
charge-offs as required by these regulatory authorities may have a material
adverse effect on our financial condition and results of
operations.


34


Future Legislative or Regulatory
Actions Responding to Financial and Market Weakness Could Affect Us
Adversely. There Can Be
No Assurance that Actions of the U.S. Government, Federal Reserve and Other
Governmental and Regulatory Bodies For the Purpose of Stabilizing the Financial
Markets Will Achieve the Intended Effect.





In response to the financial crises
affecting the banking system and financial markets, the U.S. Congress has passed
legislation and the U.S. Treasury has promulgated programs designed to purchase
assets from, provide equity capital to, and guarantee the liquidity of the
financial services industry.  Specifically, Congress adopted the
Emergency Economic Stabilization Act of 2008, under which the U.S. Treasury has
the authority to expend up to $700 billion to assist in stabilizing and
providing liquidity to the U.S. financial system. On October 14, 2008, the
U.S. Treasury announced the Capital Purchase Program, under which it will
purchase up to $250 billion of non-voting senior preferred shares of certain
qualified financial institutions in an attempt to encourage financial
institutions to build capital to increase the flow of financing to businesses
and consumers and to support the economy. In addition, Congress temporarily
increased FDIC deposit insurance from $100,000 to $250,000 per depositor through
December 31, 2013. The FDIC has also announced the creation of the
Temporary Liquidity Guarantee Program which is intended to strengthen confidence
and encourage liquidity in financial institutions by temporarily guaranteeing
newly issued senior unsecured debt of participating organizations and providing
full insurance coverage for noninterest-bearing transaction deposit accounts
(such as business checking accounts, interest-bearing transaction accounts
paying 50 basis points or less and lawyers’ trust accounts), regardless of
dollar amount until December 31, 2009.  Finally, in February
2009, the American Recovery and Reinvestment Act of 2009 was enacted, which is
intended to expand and establish government spending programs and provide
certain tax cuts to stimulate the economy. The U.S. government continues to
evaluate and develop various programs and initiatives designed to stabilize the
financial and housing markets and stimulate the economy, including the
U.S. Treasury’s recently announced Financial Stability Plan and the
recently announced foreclosure prevention program.





The potential exists for additional
federal or state laws and regulations regarding lending and funding practices
and liquidity standards, and bank regulatory agencies are expected to be active
in responding to concerns and trends identified in examinations, and the
issuance of many formal enforcement orders is expected.  Actions taken
to date, as well as potential actions, may not have the beneficial effects that
are intended, particularly with respect to the extreme levels of volatility and
limited credit availability currently being experienced.  In addition,
new laws, regulations, and other regulatory changes will increase our costs of
regulatory compliance and of doing business, and otherwise affect our
operations. Our FDIC insurance premiums have increased, and are expected to
continue to increase, because market developments have significantly depleted
the insurance fund of the FDIC and reduced the ratio of reserves to insured
deposits. New laws, regulations, and other regulatory changes, along with
negative developments in the financial services industry and the credit markets,
may significantly affect the markets in which we do business, the markets for
and value of our loans and investments, and our ongoing operations, costs and
profitability.





Lack
of Consumer Confidence in Financial Institutions May Decrease Our Level of
Deposits.





Our level of deposits may be affected
by lack of consumer confidence in financial institutions, which has resulted in
large numbers of depositors unwilling to maintain deposits that are not insured
by the Federal Deposit Insurance Corporation. In some cases, depositors have
withdrawn deposits and invested uninsured funds in investments perceived as
being more secure, such as securities issued by the U.S. Treasury. These
consumer preferences may force us to pay higher interest rates to retain
deposits and may constrain liquidity as we seek to meet funding needs caused by
reduced deposit levels.





Strong
Competition Within Our Market Area May Limit Our Growth and
Profitability.




We face
substantial competition in all phases of our operations from a variety of
different competitors. Our future growth and success will depend on our ability
to compete effectively in this highly competitive environment. We compete for
deposits, loans and other financial services with numerous Michigan-based banks,
thrifts, credit unions and other financial institutions as well as other
entities which provide financial services. Some of these competitors are not
subject to the same regulatory restrictions, have advantages of scale due to
their size, or have cost advantages due to their tax status.  Our
profitability depends upon our continued ability to successfully compete in our
market area.  The greater resources and deposit and loan products
offered by some of our competitors may limit our ability to increase our
interest-earning assets.


35


Recent
Negative Developments in the Financial Services Industry And the Credit Markets
May Subject Us to Additional Regulation.





As a
result of the recent financial crisis, the potential exists for the promulgation
of new federal or state laws and regulations regarding lending and funding
practices and liquidity standards, and bank regulatory agencies are expected to
be active in responding to concerns and trends identified in examinations, which
are expected to result in the issuance of many formal enforcement orders.
Negative developments in the financial services industry and the credit markets,
and the impact of new legislation in response to these developments, may
negatively affect our operations by restricting our business operations,
including our ability to originate or sell loans and pursue business
opportunities. Compliance with such regulation also will likely increase our
costs.





Our
Future Growth May Require Us to Raise Additional Capital in the Future, But That
Capital May Not Be Available When It Is Needed.





We are
required by regulatory authorities to maintain adequate levels of capital to
support our operations. We believe that our current capital levels will satisfy
our regulatory requirements for the foreseeable future. We may at some point,
however, need to raise additional capital to support our continued growth. Our
ability to raise additional capital will depend, in part, on conditions in the
capital markets at that time, which are outside our control, and on our
financial performance. Accordingly, we may be unable to raise additional
capital, if and when needed, on terms acceptable to us, or at all. If we cannot
raise additional capital when needed, our ability to further expand our
operations through internal growth and acquisitions could be materially
impaired. In addition, if we decide to raise additional equity capital, your
interest in our common stock could be diluted.





Our
Expenses Will Increase as a Result of Increases in FDIC Insurance
Premiums.





The FDIC imposes an assessment against
institutions for deposit insurance. Federal law requires that the designated
reserve ratio for the deposit insurance fund be established by the FDIC at 1.15%
to 1.50% of estimated insured deposits. If this reserve ratio drops below 1.15%
or the FDIC expects it to do so within six months, the FDIC must, within 90
days, establish and implement a plan to restore the designated reserve ratio to
1.15% of estimated insured deposits within five years (absent extraordinary
circumstances).





Recent bank failures coupled with
deteriorating economic conditions have significantly reduced the deposit
insurance fund’s reserve ratio. As of June 30, 2009, the designated reserve
ratio was 0.40% of estimated insured deposits at March 31, 2009. On February 27,
2009, the FDIC issued a final rule that alters the way the FDIC calculates
federal deposit insurance assessment rates. Under the rule, the FDIC first
establishes an institution’s initial base
assessment rate. This initial base assessment rate ranges from 12 to 45 basis
points, depending on the risk category of the institution. The FDIC then adjusts
the initial base assessment (higher or lower) to obtain the total base
assessment rate. The adjustments to the initial base assessment rate are based
upon on institution’s levels of unsecured debt, secured liabilities, and
brokered deposits. The total base assessment rate ranges from 7 to 77.5 basis
points of the institution’s deposits. Additionally, on May 22, 2009 the FDIC
issued a final rule that imposed a special 5 basis point assessment on each
FDIC-insured depository institution’s assets, minus Tier 1 capital as of June
30, 2009, which was paid on September 30, 2009. The special assessment was
capped at 10 basis points of an institution’s domestic deposits. This special
assessment resulted in additional non-interest expense of  $108,000
during 2009.





The FDIC has adopted a final rule
pursuant  to which all insured depository institutions prepaid their
estimated assessments for the fourth quarter of 2009, and for all of 2010, 2011
and 2012. Under the rule, this prepayment was due on December 30, 2009. The
assessment rate for the fourth quarter of 2009 and for 2010 was based on the
institution’s total base assessment rate for the third quarter of 2009, modified
to assume that the assessment rate in effect on September 30, 2009 had been in
effect for the entire third quarter, and the assessment rate for 2011 and 2012
will be equal to the modified third quarter assessment rate plus an additional 3
basis points. In addition, each institution’s base assessment rate for each
period was calculated using its third quarter assessment base, adjusted
quarterly for an estimated 5% annual growth rate in the assessment base through
the end of 2012. Our initial prepayment amount was approximately $1.4 million,
of which $1.3 million existed at December 31, 2009.





The Emergency Economic Stabilization
Act of 2008 temporarily increased the limit on FDIC insurance coverage for
deposits to $250,000, which was further extended through December 31, 2013. The
FDIC also took action to provide federal insurance coverage for newly-issued
senior unsecured debt and non interest-bearing transaction and certain NOW
accounts in excess of the $250,000 limit, for which institutions will be
assessed additional premiums.


36


These actions will significantly
increase our non-interest expense in 2010 and in future years as long as the
premiums are in place.




We
Have Suspended our Common Stock Cash Dividend.




We
suspended our quarterly dividend effective for the quarter ended December 31,
2008. We are dependent primarily upon the Bank for our earnings and funds to pay
dividends on our 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 our Board of Directors.





ITEM
1B.             UNRESOLVED STAFF
COMMENTS





None





ITEM
2.                PROPERTIES





As of
December 31, 2009, First Federal of Northern Michigan owned its main office and
all of its branch offices.  At December 31, 2009, the aggregate net
book value of our premises and equipment was $6.6 million, net of $5.0 million
of depreciation.  The following is a list of our
locations:




Main Office
                      
                      Main Office – Annex Building100
      South Second Avenue
                      
                      123
      S Second AveAlpena,
      Michigan 49707
                      
                      Alpena,
      MI 49707Branch Offices300
      South Ripley Boulevard
                      
                      2885
      South County Road #489Alpena,
      Michigan  49707
                      
                      Lewiston,
      Michigan  497566232
      River Street
                      
                      308
      North MorenciAlanson,
      Michigan 49706
                      
                      Mio,
      Michigan  48647101
      South Main Street
                      
                      201
      North State StreetCheboygan,
      Michigan  49721
                      
                      Oscoda,
      Michigan  487501000
      South Wisconsin
                      
                      11874
      U.S. 23 South (1)Gaylord,
      Michigan  49735
                      
                      Ossineke,
      Michigan  49766











(1)
            This
      branch was closed on February, 16, 2007. The property has been listed for
      sale.





ITEM
3.                LEGAL
PROCEEDINGS





The
Company and the Bank are periodically involved in claims and lawsuits that are
incident to their business.  At December 31, 2009, neither the Company
nor the Bank was involved in any claims or lawsuits material to their respective
businesses.


37





ITEM
4.                SUBMISSION OF MATTERS TO A
VOTE OF SECURITY HOLDERS





No
matters were submitted during the fourth quarter of the year ended December 31,
2009 to a vote of security holders.





PART
II





ITEM
      5.
            MARKET FOR COMMON
      EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS ISSUER PURCHASES OF
      EQUITY SECURITIES





(a)
            First
      Federal of Northern Michigan Bancorp, Inc.’s common stock is traded on the
      Nasdaq Capital Market under the symbol
“FFNM.”





As of
December 31, 2009 there were 2,884,249 shares of First Federal of Northern
Michigan Bancorp, Inc. common stock outstanding. At December 31, 2009, First
Federal of Northern Michigan Bancorp, Inc. had approximately 600 stockholders of
record. The remaining information required by this item is incorporated by
reference to Exhibit 13, the Company’s Annual Report to
Stockholders.





No equity
securities were sold during the year ended December 31, 2009 that were not
registered under the Securities Act.





(b)
            Not
      Applicable





(c)
            First
      Federal of Northern Michigan Bancorp, Inc. did not repurchase any of its
      equity securities  during the quarter ended December 31,
      2009.





ITEM
      6.
            SELECTED FINANCIAL
      DATA





Not
required for smaller reporting companies.





ITEM
      7.
            MANAGEMENT'S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      PERATIONS





Information
contained in the section captioned "Management's Discussion and Analysis of
Financial Condition and Results of Operations"   is incorporated
by reference to Exhibit 13, the Company's Annual Report to
Stockholders.





ITEM
      7A.
            QUANTITATIVE AND
      QUALITATIVE DISCLOSURES ABOUT MARKET
RISK





Not
required for smaller reporting companies.





ITEM
      8.
            FINANCIAL STATEMENTS
      AND SUPPLEMENTARY DATA





Information
contained in the section captioned “Financial Statements” is incorporated by
reference to Exhibit 13, the Company’s Annual Report to
Shareholders.





ITEM
      9.
            CHANGES IN AND
      DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE





None


38





ITEM
      9A(T).
            CONTROLS AND
      PROCEDURES





(a)
            Evaluation
      of Disclosure Controls and
Procedures





Under the
supervision and with the participation of our management, including the
Company’s Chief Executive Officer and Chief Financial Officer, the Company
evaluated the effectiveness of the design and operation of its disclosure
controls and procedures (as defined in Rule 13a-15(e) and 15d–15(e) under the
Securities Exchange Act of 1934) as of the end of the period covered by this
report.  Based upon that evaluation, the Chief Executive Officer and
Chief Financial Officer concluded that, as of the end of the period covered by
this report, the Company’s disclosure controls and procedures were effective to
ensure that information required to be disclosed in the reports the Company
files or submits under the Securities Exchange Act of 1934, is recorded,
processed, summarized and reported, within the time periods specified by the
SEC’s rules and forms and in timely alerting them to material information
relating to the Company (or its consolidated subsidiaries) required to be
included in its periodic SEC filings.





(b)
            Management’s
      Annual Report on Internal Control over Financial
  Reporting




Management
of First Federal of Northern Michigan Bancorp, Inc. and subsidiaries (the
“Company”) is responsible for establishing and maintaining adequate internal
control over financial reporting. The Company’s system of internal control is
designed under the supervision of management, including our Chief Executive
Officer and Chief Financial Officer, to provide reasonable assurance regarding
the reliability of our financial reporting and the preparation of the Company’s
financial statements for external reporting purposes in accordance with U.S.
generally accepted accounting principles (“GAAP”).




Our
internal control over financial reporting includes policies and procedures that
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect transactions and dispositions of assets; provide reasonable
assurances that transactions are recorded as necessary to permit preparation of
financial statements in accordance with GAAP, and that receipts and expenditures
are made only in accordance with the authorization of management and the Board
of Directors; and provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the Company’s
assets that could have a material effect on our financial
statements.




Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Projections on any evaluation of effectiveness
to future periods are subject to the risk that the controls may become
inadequate because of changes in conditions or that the degree of compliance
with policies and procedures may deteriorate.




As of
December 31, 2009, management assessed the effectiveness of the Company’s
internal control over financial reporting based upon the framework established
in Internal Control – Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Based upon its assessment,
management believes that the Company’s internal control over financial reporting
as of December 31, 2009 is effective using these criteria. This annual report
does not include an attestation report of the Company’s registered public
accounting firm regarding internal control over financial reporting.
Management’s report was not subject to attestation by the Company’s registered
public accounting firm pursuant to temporary rules of the Securities and
Exchange Commission that permit the Company to provide only management’s report
in this annual report.


39





(c)
            Changes
      in Internal Control over Financial
Reporting





There has been no change in the
Company’s internal control over the financial reporting during the Company’s
fourth quarter of fiscal year 2009 that has materially affected, or is
reasonably likely to materially affect, the Company’s internal control over
financial reporting.





ITEM
      9B.
            OTHER
      INFORMATION





None.





PART
III





ITEM
      10.
            DIRECTORS, EXECUTIVE
      OFFICERS,  AND CORPORATE
  GOVERNANCE





Information
concerning directors and executive officers is incorporated herein by reference
from the Company’s Proxy Statement, specifically the section captioned "Proposal
I—Election of Directors."





ITEM
      11.
            EXECUTIVE
      COMPENSATION





Information
concerning executive compensation is incorporated herein by reference from the
Company’s Proxy Statement, specifically the section captioned "Proposal
I—Election of Directors.”





ITEM
      12.
            SECURITY OWNERSHIP OF
      CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
      MATTERS





Information concerning security
ownership of certain owners and management is incorporated herein by reference
from the Company’s Proxy Statement, specifically the Section captioned “Proposal
I – Election of Directors.”





ITEM
      13.
            CERTAIN RELATIONSHIPS
      AND RELATED TRANSACTIONS AND DIRECTOR
  INDEPENDENCE





Information
concerning relationships and transactions is incorporated herein by reference
from the Company's Proxy Statement, specifically the section captioned
“Transactions with Certain Related Persons”.





ITEM
      14.
            PRINCIPAL ACCOUNTANT
      FEES AND SERVICES





Information
concerning principal accountant fees and services is incorporated herein by
reference to the Company’s Proxy Statement, specifically the section captioned
“Proposal II – Ratification of Appointment of Auditors.”




40




PART IV





ITEM
      15.
            EXHIBITS





The
exhibits filed as a part of this form 10-K are as follows:





3.1
                  Articles
      of Incorporation of First Federal of Northern Michigan Bancorp,
      Inc.*3.2
                  Bylaws
      of First Federal of Northern Michigan Bancorp, Inc.*4
                  Form
      of Common Stock Certificate of First Federal of Northern Michigan Bancorp,
      Inc.*10.1
                  Change
      in Control Agreements*10.2
                  1996
      Stock Option Plan*10.3
                  1996
      Recognition and Retention Plan*10.4
                  2006
      Stock-Based Incentive Plan**13
                  Annual
      Report to Shareholders14
                  Code
      of Ethics ***21
                  Subsidiaries
      of Registrant23
                  Consent
      of Plante & Moran PLLC31.1
                  Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 200231.2
                  Certification
      of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 200232.1
                  Certification
      of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley
      Act of 200232.2
                  Certification
      of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002





*
            Incorporated
      by reference to the Registration Statement on Form SB-2 of First Federal
      of Northern Michigan Bancorp, Inc. (Registration No. 333-121178),
      originally filed with the Commission on December 10,
  2004.**
            Incorporate
      by reference to the Definitive Proxy materials filed on April 10, 2006
      (No. 000-31957).***
            Incorporated
      by reference to the Annual Report on Form 10-K of Alpena Bancshares, Inc.
      filed with the Commission on March 30, 2004 (Registration No.
      000-31957).




41


SIGNATURES





Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.





FIRST
      FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.By:
                  /s/Michael W. MahlerMichael
      W. MahlerChief
      Executive OfficerDate:  March
      31, 2010


Pursuant
to the requirements of the Securities Exchange of 1934, this report has been
signed below by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.





By:
                  /s/Michael W. Mahler
                  
                  By:
                  /s/Amy E. EssexMichael
      W. Mahler, Director and
                  
                  
                  Amy
      E. Essex, Chief Financial Officer, Treasurer andChief
      Executive Officer
                  
                  
                  Corporate
      Secretary(Principal
      Executive Officer)
                  
                  
                  (Principal
      Financial and Accounting Officer)Date:  March
      31, 2010
                  
                  
                  Date:  March
      31, 2010By:
                  /s/Martin A. Thomson
                  
                  By:
                  /s/Keith WallaceMartin
      A. Thomson, Chairman
                  
                  
                  Keith
      Wallace, DirectorDate:  March
      31, 2010
                  
                  
                  Date:  March
      31, 2010By:
                  /s/GaryVanMassenhove
                  
                  By:
                  /s/Thomas R. TownsendGary
      VanMassenhove, Director
                  
                  
                  Thomas
      R. Townsend, DirectorDate:  March
      31, 2010
                  
                  
                  Date:  March
      31, 2010By:
                  /s/James C. RapinJames
      C. Rapin, DirectorDate:  March
      31, 2010


42