SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

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

For the Fiscal Year Ended December 31, 2008

OR

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

For the transition period from                      to                     

FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.

(Exact name of registrant as specified in its charter)

Maryland		32-0135202
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

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

(989) 356-9041

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

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

     Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES o. NO þ.

     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 þ. 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 registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ.

      Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o		Accelerated filer o		Non-accelerated filer   o (Do not check if a smaller reporting company)		Smaller reporting company þ

     Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). YES o. NO þ.

     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, 2008 ($5.99 per share) was $15.3 million.

     As of March 27, 2009, there were issued and outstanding 2,884,249 shares of the registrant’s common stock.

   1. Proxy Statement for the 2009 Annual Meeting of Stockholders (Parts I and III).

   2. Annual Report to Shareholders for the Year Ended December 31, 2008 (Part II).

 

 

TABLE OF CONTENTS

PART I
ITEM 1 BUSINESS			3
ITEM 1A RISK FACTORS			29
ITEM 1B UNRESOLVED STAFF COMMENTS			33
ITEM 2 PROPERTIES			33
ITEM 3 LEGAL PROCEEDINGS			33
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS			33
PART II
ITEM 5 MARKET FOR COMMON EQUITY, RELATED STOCKHODLER MATTERS AND SMALL BUSINESS ISSUER OURCHASES OF EQUITY SECURITIES			34
ITEM 6 SELECTED FINANCIAL DATA			34
ITEM 7 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			34
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			34
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA			34
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE			34
ITEM 9A CONTROLS AND PROCEDURES			34
ITEM 9A(T) CONTROLS AND PROCEDURES			35
ITEM 9B OTHER INFORMATION			35
PART III
ITEM 10 DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE			36
ITEM 11 EXECUTIVE COMPENSATION			36
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BEENFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS			36
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE			36
ITEM 14 PRINCIPAL ACCOUNTANT FEES AND SERVICES			36
ITEM 15 EXHIBITS			36
EX-13
EX-21
EX-23
EX-31.1
EX-31.2
EX-32.1
EX-32.2

PART I

ITEM 1. BUSINESS

Forward-Looking Statements

     This Annual Report contains certain “forward-looking statements” which may be identified by the use of words such as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated” and “potential.” Examples of forward-looking statements include, but are not limited to, estimates with respect to our financial condition, results of operations and business that are subject to various factors which could cause actual results to differ materially from these estimates and most other statements that are not historical in nature. These factors include, but are not limited to, general and local economic conditions, changes in interest rates, deposit flows, demand for mortgage, commercial and other loans, real estate values, competition, changes in accounting principles, policies, or guidelines, changes in legislation or regulation, and other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing products and services.

     As used in this Form 10-K, unless we specify otherwise, “we,” “us,” “our” and similar terms refer to First Federal of Northern Michigan, the wholly owned savings bank subsidiary of First Federal of Northern Michigan Bancorp, Inc. as indicated by the context.

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, 2008, First Federal of Northern Michigan Bancorp, Inc. had consolidated assets of $247.7 million, deposits of $165.8 million and stockholders’ equity of $29.4 million. As of December 31, 2008, 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.

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 (city and township), from which the majority of our deposits is drawn, has decreased 6.7% since 2000, and currently is approximately 20,000. The population of our primary market area, which includes Alpena County and seven surrounding counties, is approximately 184,000, and increased by less than 1.0% from 2000 to 2007. The population of our primary market area decreased by approximately 2,700 or 1.4% from 2006 to 2007. Per capita income in our market area was $28,551 in 2006, 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. Growth in per capita income in our market area is projected to increase only modestly over the next five years. The unemployment rate in our primary market area was 12.0% at December 31, 2008, compared to 7.2% nationally and 10.2% 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, Community Memorial Hospital, Decorative Panels International (a hardboard manufacturer), OMNI Metalcraft Corp. (a diversified manufacturer), and various other small companies.

     As of December 31, 2008, 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 as well as mortgage banking companies. 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, 2008, we had total loans of $198.2 million, of which $91.3 million, or 46.1%, were one- to four-family residential real estate mortgage loans, $43.8 million, or 22.0%, were commercial real estate loans, and $30.2 million, or 15.2%, were commercial loans. Other loans consisted primarily of home equity loans, which totaled $22.3 million, or 11.3% of total loans, construction loans which totaled $7.0 million or 3.6% of total loans, and other consumer loans which totaled $3.6 million, or 1.8% 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.

     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. 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, 2008, we had a total of 180 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 car washes. Substantially all of our commercial real estate loans are secured by properties located in our primary market area. 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, 2008, our commercial real estate loans totaled $49.8 million, or 25.1% of our total loans, and had an average principal balance of approximately $243,000. 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, 2008, our largest commercial real estate relationship consisted of two loans having a total principal balance of $5.5 million, of which $1.4 million has been charged off. These loans were secured by two commercial buildings and all corporate assets of the borrower. At December 31, 2008, these loans were 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. Some 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, 2008, consumer and other loans totaled $25.9 million, or 13.1% of our total loan portfolio. At such date, $597,000, or 0.2% of our consumer loans, were unsecured. As of December 31, 2008, home equity loans totaled $8.7 million, or 4.4% of our total loan portfolio, and automobile loans totaled $2.4 million, or 1.2% 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.

     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, 2008, we had $30.2 million in commercial loans which amounted to 15.2% 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 $4.6 million at December 31, 2008. 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. Some of our commercial loans have been made to borrowers whose business operations are untested, which increases our risk. 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, 2008, our largest commercial loan was a $2.4 million commercial construction participation loan for the construction of a manufacturing plant and purchase of related equipment. At December 31, 2008 the outstanding balance was $2.1 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 residence. We also originate loans for the construction of commercial buildings. Our construction loans totaled 7.0 million, or 3.6% of our total loan portfolio, at December 31, 2008.

     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, to a lesser extent, on a 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 construction lending primarily to residential properties in our market area and generally requiring personal guarantees from the principals of corporate borrowers.

     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,
		2008								2007								2006								2005								2004
		Amount				Percent				Amount				Percent				Amount				Percent				Amount				Percent				Amount				Percent
		(Dollars in thousands)
Real estate loans:
Residential mortgage		$	91,339				46.1	%		$	97,266				47.3	%		$	99,490				46.9	%		$	100,042				49.3	%		$	102,600				52.1	%
Commercial mortgage			43,774				22.0	%			44,634				21.7	%			45,274				21.4	%			40,270				19.8	%			29,690				15.1	%
Construction			7,038				3.6	%			8,292				4.0	%			9,406				4.4	%			10,030				4.9	%			8,906				4.5	%
Home Equity/Junior Liens			22,303				11.3	%			24,095				11.7	%			24,868				11.7	%			21,238				10.5	%			19,927				10.1	%
Non real estate loans
Commercial			30,173				15.2	%			26,783				13.0	%			28,209				13.3	%			26,658				13.1	%			30,174				15.3	%
Consumer and other loans			3,564				1.8	%			4,555				2.3	%			4,688				2.3	%			4,669				2.4	%			5,617				2.9	%
Total Loans		$	198,191				100.0	%		$	205,625				100.0	%		$	211,935				100.0	%		$	202,907				100.0	%		$	196,914				100.0	%
Other items:
Deferred loan origination costs			13								13								20								28								37
Deferred loan origination fees			(287	)							(292	)							(358	)							(336	)							(349	)
Allowance for loan losses			(5,647	)							(4,013	)							(2,079	)							(1,416	)							(1,214	)
Total loans, net		$	192,270							$	201,333							$	209,518							$	201,183							$	195,388

     Loan Portfolio Maturities and Yield. The following table summarizes the scheduled repayments of our loan portfolio at December 31, 2008. Demand loans, loans having no stated repayment or maturity, and overdraft loans are reported as being due in one year or less.

		Residential Mortgage								Commercial Mortgage								Construction								HomeEquity/Junior Liens
						Weighted								Weighted								Weighted								Weighted
						Average								Average								Average								Average
		Amount				Rate				Amount				Rate				Amount				Rate				Amount				Rate
(Dollars in thousands)
Due During the Years Ending December 31,
2009		$	3,558				5.13	%		$	6,038				6.01	%		$	6,524				5.33	%		$	95				6.32	%
2010			1,158				7.05	%			9,240				6.81	%			—				0.00	%			245				7.05	%
2011			457				7.73	%			9,358				6.98	%			514				3.93	%			1,989				5.14	%
2012 to 2013			2,792				6.50	%			16,228				7.13	%			—				0.00	%			2,441				5.95	%
2014 to 2018			9,030				6.12	%			1,935				7.21	%			—				0.00	%			5,819				6.60	%
2019 to 2023			8,577				6.59	%			94				6.00	%			—				0.00	%			8,993				5.27	%
2023 and beyond			65,767				6.40	%			881				7.25	%			—				0.00	%			2,721				4.62	%
Total		$	91,339				6.36	%		$	43,774				6.81	%		$	7,038				5.25	%		$	22,303				5.75	%

		Commercial								Consumer and Other								Total
						Weighted								Weighted								Weighted
						Average								Average								Average
		Amount				Rate				Amount				Rate				Amount				Rate
Due During the Years Ending December 31,
2009		$	15,371				4.41	%		$	465				8.66	%		$	32,051				5.64	%
2010			4,176				4.31	%			301				8.72	%			15,120				6.34	%
2011			4,057				6.11	%			458				8.23	%			16,833				6.57	%
2012 to 2013			2,446				6.85	%			655				7.60	%			24,562				6.63	%
2014 to 2018			2,595				6.31	%			1,303				8.70	%			20,682				6.62	%
2019 to 2023			—				0.00	%			382				8.12	%			18,046				5.63	%
2023 and beyond			1,528				5.16	%			—				0.00	%			70,897				6.14	%
Total		$	30,173				4.75	%		$	3,564				8.58	%		$	198,191				6.37	%

     Fixed- and Adjustable-Rate Loans. The following table sets forth the scheduled repayments of fixed- and adjustable-rate loans at December 31, 2008 that are contractually due after December 31, 2009.

		Due After December 31, 2009
		Fixed				Adjustable				Total
		(In thousands)
Residential mortgage		$	41,362			$	46,419			$	87,781
Commercial mortgage			35,674				2,062			$	37,736
Construction			514				—			$	514
Home Equity/Junior Liens			13,494				8,714			$	22,208
Commercial			7,371				7,431			$	14,802
Consumer and other			2,668				431			$	3,099
Total loans		$	101,083			$	65,057			$	166,140

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 and walk-in customers. 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 $75,000 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, 2008, we had outstanding loan commitments of $32.1 million, including unfunded commitments under lines of credit and commercial and standby letters of credit.

     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 to Freddie Mac and Taylor, Bean & Whitaker. 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 have recently begun to sell loans to Taylor, Bean & Whitaker on a servicing-released basis to be able to offer additional product choices to our customers.

     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, 2008, we had $274,000 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 $942,000, $911,000 and $1,044,000 for the years ended December 31, 2008, 2007 and 2006, 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 (Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”). 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 $430,000 were included in other assets at December 31, 2008.

     Origination, Purchase and Sale of Loans. The table below shows our loan originations, purchases, sales, and repayments of loans for the periods indicated. In 2008, we purchased $5.2 million in commercial real estate loan participations.

		Years Ended December 31,
		2008				2007				2006
		(In Thousands)
Loans receivable at beginning of period		$	205,625			$	211,935			$	202,907
Originations:
Real estate:
Residential 1-4 family			30,187				31,496				33,371
Commercial and Multi-family			24,191				21,644				23,760
Consumer			6,543				9,035				15,992
Total originations			60,921				62,175				73,123
Loan purchases			5,177				11,125				4,625
Loan sales			(11,641	)			(16,287	)			(14,632	)
Transfer of mortgage loans to foreclosed real estate			(8,251	)			(1,719	)			(703	)
Repayments			(53,640	)			(61,604	)			(53,385	)
Total loans receivable at end of period		$	198,191			$	205,625			$	211,935

Delinquent Loans, Other Real Estate Owned and Classified Assets

     Collection Procedures. Our general collection procedures provide that when a mortgage, consumer or commercial loan becomes 10 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 otherwise repay the loan in the foreseeable future. Cash flow attributable to in-substance foreclosures is used to reduce the carrying value of the collateral.

     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, 2008, we held $1.6 million in properties that were classified REO and $70,000 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 For
		60-89 Days												90 Days and Over								Total
		Number				Amount								Number				Amount				Number				Amount
		( Dollars In Thousands)
At December 31, 2008
Residential Mortgages			26				2,513								2				128				28				2,641
Commercial Mortgages			5				736								—				—				5				736
Construction			—				—								—				—				—				—
Commercial			—				—								1				72				1				72
Consumer			26				155								8				17				34				172
Total			57			$	3,404								11			$	217				68				3,621
At December 31, 2007
Residential Mortgages			24				1,315								6				532				30				1,847
Commercial Mortgages			1				797								—				—				1				797
Construction			—				—								—				—				—				—
Commercial			—				—								1				100				1				100
Consumer			19				181								10				45				29				226
Total			44			$	2,293								17			$	677				61				2,969
At December 31, 2006
Residential Mortgages			22				1,218								9				645				31				1,863
Commercial Mortgages			1				636								2				221				3				857
Construction			1				74								—				—				1				74
Commercial			6				317								10				540				16				857
Consumer			17				105								9				84				26				189
Total			47			$	2,350								30			$	1,490				77				3,839
At December 31, 2005
Residential Mortgages			24				1,375								19				1,684				43				3,059
Commercial Mortgages			—				—								4				670				4				670
Construction			1				341								—				—				1				341
Commercial			8				506								2				115				10				621
Consumer			23				197								13				185				36				382
Total			56			$	2,419								38			$	2,654				94				5,073
At December 31, 2004
Residential Mortgages			6			$	1,045								16			$	960				22			$	2,005
Commercial Mortgages			—				—								—				—				—				—
Construction			—				—								—				—				—				—
Commercial			2				195								1				105				3				300
Consumer			5				179								16				175				21				354
Total			13			$	1,419								33			$	1,240				46			$	2,659

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

		At December 31,
		2008				2007				2006				2005				2004
		(Dollars in thousands)
Non-Accrual Loans delinquent 90 days or more:
Residential Mortgage			1,876				697				670				308				21
Commercial Mortgage			4,002				3,825				1,395				1,006				442
Construction			3,469				3,475				—				—				—
Commercial			2,515				433				364				—				—
Consumer and other			90				29				61				39				15
Total non-accrual loans delinquent 90 days or more		$	11,952			$	8,459			$	2,490			$	1,353			$	478
Accrual loans delinquent 90 days or more:
Residential Mortgage			128				532				645				1,684				960
Commercial Mortgage			72				—				221				670				—
Construction			—				—				—				—				—
Commercial			—				100				540				115				105
Consumer and other			17				45				84				185				175
Total accrual loans delinquent 90 days or more		$	217			$	677			$	1,490			$	2,654			$	1,240
Total nonperforming loans (1)		$	12,169			$	9,136			$	3,980			$	4,007			$	1,718
Real Estate Owned and Other Repossessed Assets:
Residential Mortgage			686				872				437				427				9
Commercial Mortgage			882				406				—				—				—
Construction			—				—				—				—				—
Commercial			—				—				—				—				—
Consumer and other			70				2				38				8				20
Total real estate owned and other repossesed assets (2)		$	1,638			$	1,280			$	475			$	435			$	29
Total nonperforming assets		$	13,807			$	10,416			$	4,455			$	4,442			$	1,747
Total nonperforming loans to net loans receivable			6.14	%			4.54	%			1.90	%			1.97	%			0.87	%
Total nonperforming assets to total assets			5.57	%			4.15	%			1.59	%			1.57	%			0.66	%

     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.

     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, 2008, classified assets consisted of substandard assets of $17.7 million. There were no assets classified as doubtful or loss at December 31, 2008.

     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,
		2008				2007				2006
		(In Thousands)
Substandard assets		$	19,409			$	14,362			$	14,027
Doubtful assets			—				—				244
Loss assets			—				—				—
Total classified assets		$	19,409			$	14,362			$	14,271

     Our investment in land and real estate at December 31, 2008 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, 2008, 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 a still a viable project in a desirable location. At December 31, 2008, 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 SFAS 144, 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.

     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,
		2008				2007				2006				2005				2004
		(Dollars in thousands)
Allowance at beginning of period		$	4,013			$	2,079			$	1,416			$	1,214			$	1,036
Charge-offs:
Residential Mortgages			342				225				44				21				12
Commercial Mortgages			2,023				59				—				—				—
Commercial			331				4				1				57				—
Consumer and other			141				190				163				171				179
Total charge offs			2,837				478				208				249				191
Recoveries:
Residential Mortgages			—				1				—				—				1
Consumer and other			50				34				20				83				45
Total recoveries			50				35				20				83				46
Net charge offs (recoveries)			2,787				443				188				166				145
Provision for loan losses			4,421				2,377				851				368				323
Balance at end of year		$	5,647			$	4,013			$	2,079			$	1,416			$	1,214
Ratios:
Net Charge-offs to average loans outstanding (annualized)			1.40	%			0.21	%			0.08	%			0.08	%			0.07	%
Allowance for loan loss to non-performing loans at end of period			46.41	%			43.93	%			22.76	%			35.34	%			70.67	%
Allowance for loan losses to total loans at end of period			2.85	%			1.95	%			0.98	%			0.70	%			0.62	%

     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 31
		2008								2007								2006
						Percent of								Percent								Percent
						Loans in								of Loans								of Loans in
						Each								in Each								Each
						Category				Allowance				Category				Allowance				Category
		Allowance for				to Total				for Loan				to Total				for Loan				to Total
		Loan Losses				Loans				Losses				Loans				Losses				Loans
Real Estate Loans:
One to four family residental		$	1,185				46.1	%		$	793				47.3	%		$	175				46.9	%
Commercial		$	1,666				22.0	%		$	1,374				21.7	%		$	846				21.4	%
Construction		$	12				3.6	%		$	32				4.0	%		$	17				4.4	%
Home Equity & Junior Liens		$	215				11.3	%		$	171				11.7	%		$	429				11.7	%
Non Real Estate Loans:
Commercial business loans		$	2,515				15.2	%		$	1,579				13.0	%		$	527				13.3	%
Consumer		$	54				1.8	%		$	64				2.3	%		$	85				2.3	%
Total		$	5,647				100.0	%		$	4,013				100.0	%		$	2,079				100.0	%

		At December 31
		2005								2004
						Percent of								Percent of
						Loans in								Loans in
						Each								Each
						Category				Allowance				Category
		Allowance for				to Total				for Loan				to Total
		Loan Losses				Loans				Losses				Loans
Real Estate Loans:
One to four family residental		$	168				49.3	%		$	126				52.1	%
Commercial		$	457				19.8	%		$	300				15.1	%
Construction		$	17				4.9	%		$	11				4.5	%
Home Equity & Junior Liens		$	383				10.5	%		$	361				10.1	%
Non Real Estate Loans:
Commercial business loans		$	302				13.1	%		$	305				15.3	%
Consumer		$	89				2.4	%		$	111				2.9	%
Total		$	1,416				100.0	%		$	1,214				100.0	%

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 all of these loans until late 2006 when we began selling some mortgage loans servicing-released to be able to offer additional products to our customers.

     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, 2008, we were servicing loans sold to third parties totaling $127.9 million, and the mortgage servicing rights associated with such loans had a book value, at such date, of $430,000. 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. ICA sells life, property, casualty and health insurance products and, to a lesser extent, non-insured investment products. All of these products are sold on an agency basis only.

     All of the revenue from our insurance segment is derived through sales commissions calculated as a percentage of the premium paid for the insurance product or the dollar value of the investment product. Generally, commission rates vary in amount depending on the type of insurance or investment product sold, as well as the volume and profitability to the underwriter of the business placed with it by ICA during specific periods. Sales commissions on insurance products generally are collected from the underwriter of the insurance and not from the insureds. Sales commissions on investment products generally are collected from the individual investor.

     In April 2008, ICA sold to the Grotenhuis Group (a managing agent for Blue Cross/Blue Shield of Michigan) the rights to service 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 Grotenhuis Group. The financial position and results of operations of ICA are presented separately in our consolidated financial statements as “discontinued operations.”

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

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, 2008, 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, 2008 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 SFAS 144, 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 is recognized at the date of sale.

     At December 31, 2008, our investment in these properties was approximately $73,000, which was net of an allowance of $128,000. At December 31, 2008, management prepared an analysis based on the February 26, 2008 selling price of a lot. Based on the analysis and recent lot sale, an additional impairment of $16,000 was identified.

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, 2008, we had no investments in unrated securities. At December 31, 2008, $18.6 million, or 63.7% of our investment portfolio was scheduled to mature in less than five years, and $10.6 million, or 36.3%, was scheduled to mature in over five years. At December 31, 2008, $4.6 million, or 15.8% of our investment portfolio was scheduled to mature in less than one year.

     At December 31, 2008, we held U.S. Government and state agency obligations and municipal obligations classified as available-for-sale, with a fair market value of $5.8 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, 2008, mortgage-backed securities totaled $14.1 million, or 41.6% of total investments. At December 31, 2008, 45.3% 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.

     SFAS No. 115 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, 2008, all of our investment securities were designated as available for sale except for $4.0 million in municipal bond investments designated as held to maturity.

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

		At December 31,
		2008								2007								2006
		Amortized				Fair				Amortized				Fair				Amortized				Fair
		Cost				Value				Cost				Value				Cost				Value
		(In Thousands)
Debt Securities:
U.S. Government and agency obligations		$	5,680			$	5,768			$	18,477			$	18,514			$	36,271			$	35,902
State agency and municipal obligations			7,942				7,924				3,600				3,623				3,771				3,789
Corporate bonds and other obligations			1,500				1,504				—				—				—				—
Mortgage-backed securities:
Pass-through securities:
Fannie Mae			9,468				9,733				—				—				576				539
Freddie Mac			4,419				4,516				1,076				1,054				3,007				2,888
Ginnie Mae			164				167				197				197				1,622				1,594
Total debt securities			29,173				29,612				23,350				23,388				45,247				44,712
Marketable equity securities
Common stock			3				2				3				87				3				171
Total equity securities			3				2				3				87				3				171
Total investment securities		$	29,176			$	29,614			$	23,353			$	23,476			$	45,250			$	44,883