10-Q 1 v318531_10q.htm FORM 10-Q

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2012

 

Commission file number: 001-35072

 

ATLANTIC COAST FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

Maryland 65-1310069

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer Identification No.)

10151 Deerwood Park Blvd

Building 200, Suite 100

Jacksonville, Florida

32256
(Address of principal executive offices) (Zip Code)

 

Registrant's telephone number, including area code: (800) 342-2824

 

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES
x NO ¨.

 

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).

YES x NO ¨.

 

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

 

Large Accelerated Filer ¨    Accelerated Filer ¨    Non-Accelerated Filer ¨    Smaller Reporting Company x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES ¨ NO x.

 

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

 

Class Outstanding at August 7, 2012
Common Stock, $0.01 Par Value 2,629,061 shares

 

 
 

 

ATLANTIC COAST FINANCIAL CORPORATION

 

Form 10-Q Quarterly Report

 

Table of Contents

  

    Page Number
     
  PART I. FINANCIAL INFORMATION  
     
Item 1. Financial Statements 3
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 52
Item 3. Quantitative and Qualitative Disclosures about Market Risk 75
Item 4. Controls and Procedures 77
     
  PART II.  OTHER INFORMATION  
     
Item 1. Legal Proceedings 78
Item 1A. Risk Factors 78
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 81
Item 3. Defaults upon Senior Securities 81
Item 4. Mine Safety Disclosures 81
Item 5. Other Information 81
Item 6. Exhibits 81
     
Form 10-Q Signature Page 82
     
Ex-31.1 Section 302 Certification of CEO 83
Ex-31.2 Section 302 Certification of CFO 84
Ex-32 Section 906 Certification of CEO and CFO 85

 

 
 

 

Item 1 Financial Statements Part I Financial Information  

ATLANTIC COAST FINANCIAL CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in Thousands, Except Share Information)

(unaudited)

 

   June 30, 2012   December 31, 2011 
ASSETS          
Cash and due from financial institutions  $6,206   $8,696 
Short-term interest-earning deposits   58,566    32,321 
Total cash and cash equivalents   64,772    41,017 
Securities available for sale   146,383    126,821 
Loans held for sale   57,806    61,619 
Loans, net of allowance of $12,339 at June 30, 2012 and $15,526 at December 31, 2011   455,480    505,707 
Federal Home Loan Bank stock, at cost   7,781    9,600 
Land, premises and equipment, net   14,798    14,954 
Bank owned life insurance   15,552    15,320 
Other real estate owned   7,708    5,839 
Accrued interest receivable   2,154    2,443 
Other assets   6,100    5,647 
           
Total assets  $778,534   $788,967 
           
LIABILITIES AND STOCKHOLDERS' EQUITY          
Deposits          
Non-interest-bearing demand  $40,538   $34,586 
Interest-bearing demand   77,066    76,811 
Savings and money market   193,838    199,334 
Time   189,039    197,680 
Total deposits   500,481    508,411 
Securities sold under agreements to repurchase   92,800    92,800 
Federal Home Loan Bank advances   135,000    135,000 
Accrued expenses and other liabilities   6,263    6,462 
Total liabilities   734,544    742,673 
           
Commitments and contingent liabilities   -    - 
           
Preferred stock: $0.01 par value; 25,000,000 shares authorized at June 30, 2012 and December 31, 2011, none issued   -    - 
Common stock: $0.01 par value; 100,000,000 shares authorized, shares issued 2,629,061 at June 30, 2012 and at December 31, 2011   26    26 
Additional paid in capital   56,341    56,186 
Common stock held by:          
Employee stock ownership plan (ESOP) shares of 89,819 at June 30, 2012 and 92,214 at December 31, 2011   (1,925)   (1,977)
Benefit plans   (525)   (351)
Retained earnings (deficit)   (12,411)   (7,706)
Accumulated other comprehensive income related to AFS securities   2,484    116 
Total stockholders' equity   43,990    46,294 
           
Total liabilities and stockholders' equity  $778,534   $788,967 

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

3
 

 

ATLANTIC COAST FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in Thousands, Except Share Information)

(unaudited)

 

   Three months ended June 30,   Six months ended June 30, 
   2012   2011   2012   2011 
Interest and dividend income                    
Loans, including fees  $7,730   $8,330   $15,603   $16,892 
Securities and interest-earning deposits in other financial institutions   893    1,301    1,770    2,532 
Total interest and dividend income   8,623    9,631    17,373    19,424 
                     
Interest expense                    
Deposits   998    1,585    2,243    3,274 
Federal Home Loan Bank advances   1,326    1,426    2,651    2,837 
Securities sold under agreements to repurchase   1,195    1,195    2,392    2,368 
Other borrowings   -    -    -    216 
Total interest expense   3,519    4,206    7,286    8,695 
                     
Net interest income   5,104    5,425    10,087    10,729 
                     
Provision for loan losses   3,741    2,967    7,216    5,764 
                     
Net interest income after provision for loan losses   1,363    2,458    2,871    4,965 
                     
Non-interest income                    
Service charges and fees   786    912    1,570    1,826 
Gain on sale of loans held for sale   381    412    1,118    807 
Gain on sale of securities available for sale   -    590    -    722 
Other than temporary impairment loss:                    
Total impairment gain (loss)   -    1    -    (276)
Portion of (gain) loss recognized in other comprehensive income   -    (76)   -    90 
Net impairment loss recognized in earnings   -    (75)   -    (186)
Bank owned life insurance earnings   116    189    232    377 
Interchange fees   408    395    812    644 
Other   108    132    222    255 
Total non-interest income   1,799    2,555    3,954    4,445 
Non-interest expense                    
Compensation and benefits   2,434    2,718    4,624    6,689 
Occupancy and equipment   517    582    1,033    1,165 
FDIC insurance premiums   272    176    547    572 
Foreclosed assets, net   79    191    (74)   150 
Data processing   340    398    670    792 
Outside professional services   694    654    1,468    1,143 
Collection expense   635    637    1,121    1,536 
Other   1,037    1,174    1,991    2,302 
Total non-interest expense   6,008    6,530    11,380    14,349 
                     
Loss before income tax expense   (2,846)   (1,517)   (4,555)   (4,939)
                     
Income tax expense   150    -    150    - 
                     
Net loss  $(2,996)  $(1,517)  $(4,705)  $(4,939)
                     
Loss per common share:                    
Basic  $(1.20)  $(0.61)  $(1.89)  $(1.98)
Diluted  $(1.20)  $(0.61)  $(1.89)  $(1.98)

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

4
 

 

ATLANTIC COAST FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in Thousands, Except Share Information)

(unaudited)

 

   Three months ended June 30,   Six months ended June 30, 
   2012   2011   2012   2011 
   (Dollars in Thousands) 
Net loss  $(2,996)  $(1,517)  $(4,705)  $(4,939)
Other comprehensive income (loss):                    
Change in securities available for sale:                    
Unrealized holding gains (losses) arising during the period   1,647    1,370    2,368    1,354 
Less reclassification adjustments for (gains) losses recognized in income   -    (590)   -    (722)
Net unrealized gains   1,647    780    2,368    632 
Income tax effect   -    -    -    - 
Net of tax effect   1,647    780    2,368    632 
Other-than-temporary-impairment on available-for-sale debt securities recorded in other comprehensive income   -    (1)   -    276 
Less other-than-temporary-impairment on available-for-sale debt securities associated with credit loss realized in income   -    (75)   -    (186)
Income tax effect   -    -    -    - 
Net of tax effect   -    (76)   -    90 
                     
Total other comprehensive income   1,647    704    2,368    722 
                     
Comprehensive loss  $(1,349)  $(813)  $(2,337)  $(4,217)

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

5
 

 

ATLANTIC COAST FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

 

(Dollars in Thousands, Except Share Information)

(unaudited)

  

                       ACCUMULATED         
       ADDITIONAL   UNEARNED       RETAINED   OTHER         
   COMMON   PAID IN   ESOP   BENEFIT   EARNINGS   COMPREHENSIVE   TREASURY   TOTAL 
   STOCK   CAPITAL   SHARES   PLANS   (DEFICIT)   INCOME (LOSS)   STOCK   EQUITY 
For the six months ended June 30, 2011                                        
                                         
Balance at January 1, 2011  $148   $61,406   $(1,397)  $(88)  $2,581   $1,941   $(19,800)  $44,791 
                                         
Second-step conversion and offering   (122)   (5,249)   (684)   (1)   -    -    19,800    13,744 
                                         
ESOP shares earned, 2,395 shares   -    (30)   52    -    -    -    -    22 
                                         
Management restricted stock expense   -    59    -    -    -    -    -    59 
                                         
Shares relinquished   -    -    -    (1)   -    -    -    (1)
                                         
Stock options expense   -    31    -    -    -    -    -    31 
                                         
Shares purchased for and distributions from Rabbi Trust   -    (15)   -    (333)   -    -    -    (348)
                                         
Net loss   -    -    -    -    (4,939)   -    -    (4,939)
Other comprehensive income (loss)                                        
Net change in unrealized losses on securities available-for-sale net of reclassification and taxes   -    -    -    -    -    722    -    722 
                                         
Balance at June 30, 2011  $26   $56,202   $(2,029)  $(423)  $(2,358)  $2,663   $-   $54,081 

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

6
 

 

ATLANTIC COAST FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

 

(Dollars in Thousands, Except Share Information)

(unaudited)

 

                       ACCUMULATED     
       ADDITIONAL   UNEARNED       RETAINED   OTHER     
   COMMON   PAID IN   ESOP   BENEFIT   EARNINGS   COMPREHENSIVE   TOTAL 
   STOCK   CAPITAL   SHARES   PLANS   (DEFICIT)   INCOME (LOSS)   EQUITY 
For the six months ended June 30, 2012                                   
                                    
Balance at January 1, 2012  $26   $56,186   $(1,977)  $(351)  $(7,706)  $116   $46,294 
                                    
ESOP shares earned, 2,395 shares   -    (47)   52    -    -    -    5 
                                    
Management restricted stock expense   -    16    -    -    -    -    16 
                                    
Stock options expense   -    18    -    -    -    -    18 
                                    
Shares purchased for and distributions from Rabbi Trust   -    168    -    (174)   -    -    (6)
                                    
Net loss   -    -    -    -    (4,705)   -    (4,705)
Other comprehensive income (loss)                                   
Net change in unrealized losses on securities available-for-sale net of reclassification and taxes   -    -    -    -    -    2,368    2,368 
                                    
Balance at June 30, 2012  $26   $56,341   $(1,925)  $(525)  $(12,411)  $2,484   $43,990 

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

7
 

 

ATLANTIC COAST FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS 

(Dollars in Thousands)

(unaudited)

 

  

   For the Six Months Ended June 30, 
  2012   2011 
Cash flows from operating activities           
Net loss  $(4,705)  $(4,939)
Adjustments to reconcile net loss to to net cash from operating activities:          
Provision for loan losses   7,216    5,764 
Gain on sale of loans held for sale   (1,118)   (807)
Loans purchased / originated for sale   (402,660)   (298,291)
Proceeds from residential loan sales   406,117    295,812 
Proceeds from SBA loan sales   4,296    - 
Foreclosed assets, net   (74)   150 
Gain on sale of securities available for sale   -    (722)
Other than temporary impairment loss on AFS securities   -    186 
Loss on disposal of equipment   5    - 
ESOP compensation expense   5    22 
Share-based compensation expense   34    90 
Accretion of discounts on securities and loans   313    618 
Depreciation expense   395    524 
Net change in accrued interest receivable   290    417 
Net change in cash surrender value of bank owned life insurance   (232)   (377)
Net change in other assets   (454)   2,196 
Net change in accrued expenses and other liabilities   (199)   13 
Net cash from operating activites   9,229    656 
           
Cash flows from investing activities          
Proceeds from maturities and payments of securites available for sale   16,016    21,214 
Proceeds from the sales of securities available for sale   -    45,453 
Purchase of securities available for sale   (33,823)   (42,329)
Proceeds from sales of portfolio loans   -    623 
Net change in portfolio loans   34,902    12,448 
Expenditures on premises and equipment   (245)   (150)
Proceeds from sales of premises and equipment   -    5 
Redemption of FHLB stock   1,819    698 
Proceeds from the sale of other real estate owned   3,792    2,232 
Net cash from investing activities   22,461    40,194 

 

The accompanying notes are an integral part of these unaudited consolidated financial statements. 

 

8
 

 

ATLANTIC COAST FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in Thousands)

(unaudited)

 

  

   For the Six Months Ended June 30, 
   2012   2011 
         
Cash flows from financing activities          
Net decrease in deposits  $(7,930)  $(30,971)
Proceeds from FHLB advances   -    50,950 
Repayment of FHLB advances   -    (49,950)
Proceeds from other borrowings   -    3,309 
Repayment of other borrowings   -    (8,309)
Proceeds from sale of stock in second-step conversion and offering   -    13,744 
Treasury stock repurchased   -    - 
Share based compensation items   -    (1)
Shares purchased for and distributions from Rabbi Trust   (5)   (348)
Net cash (used in) from financing activities   (7,935)   (21,576)
           
Net change in cash and cash equivalents   23,755    19,274 
           
Cash and equivalents beginning of period   41,017    8,550 
           
Cash and equivalents at end of period  $64,772   $27,824 
           
Supplemental information:          
Interest paid  $7,311   $8,714 
Income tax paid   -    - 
           
Supplemental noncash disclosures:          
Loans transferred to other real estate  $5,587   $1,411 
Loans transferred to held for sale   2,823    - 

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

9
 

 

ATLANTIC COAST FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2012

(Unaudited)

 

NOTE 1. BASIS OF PRESENTATION

 

The accompanying unaudited condensed consolidated financial statements include Atlantic Coast Financial Corporation (or the “Company”) and its wholly owned subsidiary, Atlantic Coast Bank (the “Bank”). All significant inter-company balances and transactions have been eliminated in consolidation. The principal activity of the Company is the ownership of the Bank’s common stock, as such, the terms “Company” and “Bank” may be used interchangeably throughout this Form 10-Q.

 

The accompanying condensed consolidated balance sheet as of December 31, 2011, which was derived from our audited financial statements, and the unaudited condensed consolidated financial statements for the six months ended June 30, 2012 and 2011 have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions for Form 10-Q. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (all of which are normal and recurring in nature) considered necessary for (i) a fair presentation and (ii) to make such statements not misleading, have been included. Operating results for the six months ended June 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012. The 2011 Atlantic Coast Federal Corporation consolidated financial statements, as presented in the Company’s Annual Report on Form 10-K, should be read in conjunction with these statements.

 

On February 3, 2011, the second step conversion of Atlantic Coast Federal, MHC into a stock holding company structure and related stock offering of Atlantic Coast Financial Corporation was completed. As a result of the second step conversion, Atlantic Coast Financial Corporation, a Maryland corporation, became the holding company for the Bank. As part of the second step conversion, Atlantic Coast Federal Corporation, a Federal corporation, was merged into Atlantic Coast Financial Corporation, with Atlantic Coast Financial Corporation as the surviving entity. In connection with the conversion, the Company sold 1,710,857 shares of common stock at $10 per share, inclusive of 68,434 shares issued to the Atlantic Coast Financial Corporation employee stock ownership plan (“ESOP”). In addition, pursuant to an exchange ratio of 0.1960, the Company exchanged 4,687,466 shares of common stock held by stockholders of Atlantic Coast Federal Corporation, the predecessor of the Company, for 918,324 shares of Atlantic Coast Financial Corporation common stock, net of fractional shares. As a result of the stock sale and exchange the Company had 2,629,181 shares of common stock issued and outstanding as of February 3, 2011. The reorganization was accounted for as a change in corporate form with no resulting change in the historical basis of the Company’s assets, liabilities and equity. Direct offering costs totaling $2.7 million were deducted from the proceeds of the shares sold in the offering. Net proceeds of $14.4 million were raised in the stock offering, which included $684,000 loaned by the Company to a trust for the ESOP enabling it to purchase 68,434 shares of common stock in the stock offering for allocation under such plan.

 

Certain items in the prior period financial statements have been reclassified to conform to the current presentation. The reclassifications have no effect on net income or stockholders’ equity as previously reported.

 

10
 

 

NOTE 2. USE OF ESTIMATES

 

To prepare financial statements in conformity with accounting principles generally accepted in the United States of America requires that management make estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ. Estimates associated with the allowance for loan losses, realization of deferred tax assets and the fair values of securities and other financial instruments are particularly susceptible to material change in the near term.

 

NOTE 3. IMPACT OF CERTAIN ACCOUNTING PRONOUNCEMENTS

 

In May 2011, the FASB issued ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. ASU 2011-04 results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. GAAP and IFRSs. The new guidance was effective for interim and annual periods beginning after December 15, 2011. Adoption of this new guidance did not affect the Company’s financial condition or results of operations.

 

In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes stockholders’ equity. The new guidance was effective for interim and annual periods beginning after December 15, 2011. Adoption of this new guidance did not affect the Company’s financial condition or results of operations.

 

11
 

 

NOTE 4. AVAILABLE FOR SALE SECURITIES

 

The following table summarizes the amortized cost and fair value of the available-for-sale investment securities and the corresponding amounts of unrealized gains and losses therein:

 

 

   Amortized
Cost
   Unrealized
Gains
   Unrealized
Losses
   Fair Value 
  (Dollars in Thousands) 
June 30, 2012     
State and municipal  $944   $33   $(19)  $958 
Mortgage-backed securities residential   94,298    2,514    (13)   96,799 
Collateralized mortgage obligations U.S. Govt.   48,657    124    (155)   48,626 
                     
   $143,899   $2,671   $(187)  $146,383 

 

   Amortized
Cost
   Unrealized
Gains
   Unrealized
Losses
   Fair Value 
  (Dollars in Thousands) 
December 31, 2011     
State and municipal  $944   $28   $(42)  $930 
Mortgage-backed securities residential   75,824    290    (25)   76,089 
Collateralized mortgage obligations U.S. Govt.   49,937    135    (270)   49,802 
                     
   $126,705   $453   $(337)  $126,821 

 

12
 

 

NOTE 4. AVAILABLE FOR SALE SECURITIES (continued)

 

The amortized cost and fair value of debt securities segregated by contractual maturity as of June 30, 2012, is shown below. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately.

 

   June 30, 2012 
   (Dollars in Thousands) 
   Amortized   Fair 
   Cost   Value 
Due in one year or less  $-   $- 
Due from one to five years   -    - 
Due from five to ten years   944    958 
Due after ten years   -    - 
Mortgage-backed securities - residential   94,298    96,799 
Collateralized mortgage obligations - U.S. Government   48,657    48,626 
           
Total  $143,899   $146,383 

 

The following table summarizes the investment securities with unrealized losses at June 30, 2012 and December 31, 2011, aggregated by investment category and length of time in a continuous unrealized loss position:

 

           (Dollars in Thousands)         
   Less than 12 Months   12 Months or More   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
Description of Securities  Value   Losses   Value   Losses   Value   Losses 
June 30, 2012                              
State and municipal  $-   $-   $442   $(19)  $442   $(19)
Mortgage-backed securities - residential   5,110    (13)   -    -    5,110    (13)
Collateralized mortgage obligations - U.S. Govt.   16,859    (67)   5,926    (88)   22,785    (155)
                               
Total  $21,969   $(80)  $6,368   $(107)  $28,337   $(187)
                               
December 31, 2011                              
State and municipal  $-   $-   $419   $(42)  $419   $(42)
Mortgage-backed securities - residential   5,088    (25)   -    -    5,088    (25)
Collateralized mortgage obligations - U.S. Govt.   28,845    (152)   5,455    (118)   34,300    (270)
                               
Total  $33,933   $(177)  $5,874   $(160)  $39,807   $(337)

 

13
 

 

NOTE 4. AVAILABLE FOR SALE SECURITIES (continued)

 

Other-Than-Temporary-Impairment

 

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation.

 

As of June 30, 2012 the Company’s security portfolio consisted of 39 securities, 13 of which were in an unrealized loss position. Nearly all unrealized losses were related to debt securities whose underlying collateral is residential mortgages. However, all of these securities were issued by government sponsored organizations as discussed below.

 

At June 30, 2012, $145.4 million, or approximately 99% of the debt securities held by the Company were issued by U.S. government-sponsored entities and agencies, primarily Fannie Mae, Freddie Mac and Ginnie Mae, institutions which the government has affirmed its commitment to support. Because the decline in fair value is attributable to changes in interest rates and illiquidity, and not credit quality, and because the Company does not have the intent to sell these securities and it is likely it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at June 30, 2012.

 

As of June 30, 2011 the Company had OTTI of $186,000, all of which was related to the credit loss for which other-than-temporary impairment was previously recognized.

 

Proceeds from sales, payments, maturities and calls of securities available for sale were $16.0 million and $66.7 million for the six months ended June 30, 2012 and 2011, respectively. Gross gains of $0 and $851,000 and gross losses of $0 and $129,000 were realized on these sales during the six months ended June 30, 2012 and 2011, respectively. Gains and losses on sales of securities are recorded on the settlement date, which is not materially different from the trade date, and determined using the specific identification method.

 

14
 

 

NOTE 5. LOANS, NET

 

Loans. Following is a comparative composition of net loans as of June 30, 2012 and December 31, 2011:

 

   June 30, 2012   % of total
loans
   December 31,
2011
   % of total
loans
 
   (Dollars in Thousands) 
Real estate loans:                    
One-to-four family  $218,109    47.2%  $241,453    46.9%
Commercial   62,570    13.6%   72,683    14.1%
Other (land and multi-family)   22,487    4.9%   29,134    5.7%
Total real estate loans   303,166    65.7%   343,270    66.7%
                     
Real estate construction loans:                    
One-to-four family   567    0.1%   2,044    0.4%
Commercial   4,036    0.9%   4,083    0.8%
Acquisition and development   -    0.0%   -    0.0%
Total real estate construction loans   4,603    1.0%   6,127    1.2%
                     
Other loans:                    
Home equity   68,767    14.9%   74,199    14.4%
Consumer   63,529    13.8%   67,850    13.2%
Commercial   21,343    4.6%   23,181    4.5%
Total other loans   153,639    33.3%   165,230    32.1%
                     
Total loans   461,408    100%   514,627    100%
                     
Allowance for loan losses   (12,339)        (15,526)     
Net deferred loan costs   6,534         6,730      
Discounts on purchased loans   (123)        (124)     
                     
Loans, net  $455,480        $505,707      

 

15
 

 

NOTE 5. LOANS, NET (continued)

 

The following table presents the contractual aging of the recorded investment in past due loans by class of loans as of June 30, 2012:

 

   Current   30-59 Days
Past Due
   60-89 Days
Past Due
   >90 Days
Past Due
   Total Past
Due
   Total 
   (Dollars in Thousands) 
Real estate loans:                              
One-to-four family  $199,573   $4,768   $909   $12,859   $18,536   $218,109 
Commercial   53,854    737    -    7,979    8,716    62,570 
Other (land and multi-family)   20,964    37    -    1,486    1,523    22,487 
Total real estate loans   274,391    5,542    909    22,324    28,775    303,166 
                               
Real estate construction loans:                              
One-to-four family   567    -    -    -    -    567 
Commercial   1,876    -    -    2,160    2,160    4,036 
Acquisition and development   -    -    -    -    -    - 
Total real estate construction loans   2,443    -    -    2,160    2,160    4,603 
                               
Other loans:                              
Home equity   64,885    1,359    113    2,410    3,882    68,767 
Consumer   61,674    890    225    740    1,855    63,529 
Commercial   18,215    200    10    2,917    3,127    21,343 
Total other loans   144,775    2,449    348    6,067    8,864    153,639 
                               
Total loans  $421,609   $7,991   $1,257   $30,551   $39,799   $461,408 

 

16
 

 

NOTE 5. LOANS, NET (continued)

 

The following table presents the contractual aging of the recorded investment in past due loans by class of loans as of December 31, 2011:

 

   Current   30-59 Days
Past Due
   60-89 Days
Past Due
   >90 Days
Past Due
   Total Past
Due
   Total 
   (Dollars in Thousands) 
Real estate loans:                              
One-to-four family  $221,823   $3,838   $919   $14,873   $19,630   $241,453 
Commercial   62,659    -    106    9,918    10,024    72,683 
Other (land and multi-family)   23,361    606    1,339    3,828    5,773    29,134 
Total real estate loans   307,843    4,444    2,364    28,619    35,427    343,270 
                               
Real estate construction loans:                              
One-to-four family   2,044    -    -    -    -    2,044 
Commercial   1,721    -    -    2,362    2,362    4,083 
Acquisition and development   -    -    -    -    -    - 
Total real estate construction loans   3,765    -    -    2,362    2,362    6,127 
                               
Other loans:                              
Home equity   67,616    2,387    141    4,055    6,583    74,199 
Consumer   64,784    1,563    541    962    3,066    67,850 
Commercial   20,549    -    -    2,632    2,632    23,181 
Total other loans   152,949    3,950    682    7,649    12,281    165,230 
                               
Total loans  $464,557   $8,394   $3,046   $38,630   $50,070   $514,627 

 

17
 

 

NOTE 5. LOANS, NET (continued)

 

Non-performing loans, including non-accrual loans, at June 30, 2012 and December 31, 2011 were $33.1 million (including $2.8 million of non-performing loans in loans held for sale) and $46.6 million, respectively. There were no loans over 90 days past-due and still accruing interest as of June 30, 2012 or December 31, 2011. Non-performing loans include both smaller balance homogeneous loans that are collectively evaluated for impairment and larger individually evaluated loans classified as impaired loans.

 

The following table presents performing and non-performing loans by class of loans as of June 30, 2012:

 

   Performing   Non-performing   Total 
   (Dollars in Thousands) 
Real estate loans:               
One-to-four family  $204,205   $13,904   $218,109 
Commercial   53,317    9,253    62,570 
Other (land and multi-family)   20,878    1,609    22,487 
Total real estate loans   278,400    24,766    303,166 
                
Real estate construction loans:               
One-to-four family   567    -    567 
Commercial   1,876    2,160    4,036 
Acquisition and development   -    -    - 
Total real estate construction loans   2,443    2,160    4,603 
                
Other loans:               
Home equity   66,326    2,441    68,767 
Consumer   62,729    800    63,529 
Commercial   18,426    2,917    21,343 
Total other loans   147,481    6,158    153,639 
                
Total loans  $428,324   $33,084   $461,408 

 

18
 

 

NOTE 5. LOANS, NET (continued)

 

The following table presents performing and non-performing loans by class of loans as of December 31, 2011:

 

   Performing   Non-performing   Total 
   (Dollars in Thousands) 
Real estate loans:               
One-to-four family  $225,345   $16,108   $241,453 
Commercial   58,445    14,238    72,683 
Other (land and multi-family)   23,981    5,153    29,134 
Total real estate loans   307,771    35,499    343,270 
                
Real estate construction loans:               
One-to-four family   2,044    -    2,044 
Commercial   1,721    2,362    4,083 
Acquisition and development   -    -    - 
Total real estate construction loans   3,765    2,362    6,127 
                
Other loans:               
Home equity   70,108    4,091    74,199 
Consumer   66,867    983    67,850 
Commercial   19,501    3,680    23,181 
Total other loans   156,476    8,754    165,230 
                
Total loans  $468,012   $46,615   $514,627 

 

19
 

 

NOTE 5. LOANS, NET (continued)

 

The Company utilizes an internal asset classification system for loans other than consumer and residential loans as a means of reporting problem and potential problem loans. Under the risk rating system, the Company classifies problem and potential problem loans as “Special Mention”, “Substandard”, and “Doubtful” which correspond to risk ratings five, six and seven, respectively. Substandard loans include those characterized by the distinct possibility the Company may sustain some loss if the deficiencies are not corrected. Loans classified as Doubtful, or risk rated seven, have all the weaknesses inherent in those classified Substandard with the added characteristic the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Loans that do not currently expose the Company to sufficient risk to warrant classification in one of the aforementioned categories, but possess weaknesses that deserve management’s close attention are deemed to be Special Mention, or risk rated five. Risk ratings are updated any time the facts and circumstances warrant.

 

The Company evaluates consumer and residential loans based on whether the loans are performing or non-performing as well as other factors. One-to four-family loan balances are charged down by the expected loss amount at the time they become non-performing, which is generally 90 days past due. Consumer loans including automobile, manufactured housing, unsecured, and other secured loans are charged-off, net of expected recovery when the loan becomes significantly past due over a range of up to 180 days, depending on the type of loan.

 

The following table presents the risk category of those loans evaluated by internal asset classification based on the most recent analysis performed and the contractual aging as of June 30, 2012:

 

   Pass   Special
Mention
   Substandard   Doubtful   Total 
   (Dollars in Thousands) 
Real estate loans:                         
Commercial  $44,830   $5,126   $12,614    -   $62,570 
Other (land and multi-family)   13,691    794    8,002    -    22,487 
Total real estate loans   58,521    5,920    20,616    -    85,057 
                          
Real estate construction loans:                         
Commercial   1,876    -    2,160    -    4,036 
Acquisition and development   -    -    -    -    - 
Total real estate construction loans   1,876    -    2,160    -    4,036 
                          
Other loans:                         
Commercial   17,561    41    3,741    -    21,343 
Total other loans   17,561    41    3,741    -    21,343 
                          
Total loans  $77,958   $5,961   $26,517    -   $110,436 

 

20
 

 

NOTE 5. LOANS, NET (continued)

 

The following table presents the risk category of those loans evaluated by internal asset classification based on the most recent analysis performed and the contractual aging as of December 31, 2011:

 

   Pass   Special
Mention
   Substandard   Doubtful   Total 
   (Dollars in Thousands) 
Real estate loans:                         
Commercial  $49,820   $8,568   $14,295   $-   $72,683 
Other ( land and multi-family)   25,037    432    3,665    -    29,134 
Total real estate loans   74,857    9,000    17,960    -    101,817 
                          
Real estate construction loans:                         
Commercial   1,721    -    2,362    -    4,083 
Acquisition and development   -    -    -    -    - 
Total real estate construction loans   1,721    -    2,362    -    4,083 
                          
Other loans:                         
Commercial   19,352    -    3,829    -    23,181 
Total other loans   19,352    -    3,829    -    23,181 
                          
Total loans  $95,930   $9,000   $24,151   $-   $129,081 

 

21
 

 

NOTE 5. LOANS, NET (continued)

 

When establishing the allowance for loan losses, management categorizes loans into risk categories generally based on the nature of the collateral and the basis of repayment. These risk categories and the relevant risk characteristics are as follows:

 

Real estate loans

 

·One-to-four family residential loans have historically had less risk than other loan types as they tend to be smaller balance loans without concentrations to a single borrower or group of borrowers. Repayment depends on the individual borrower’s capacity. Given the deterioration in the market value of residential real estate in the markets we serve, there is a greater risk of loss if actions such as foreclosure or short sale become necessary to collect the loan and private mortgage insurance was not purchased. In addition, depending on the state in which the collateral is located, the risk of loss may increase, due to the time required to complete the foreclosure process.

 

·Commercial real estate loans generally have greater credit risks compared to one- to four- family residential real estate loans, as they usually involve larger loan balances secured by non-homogeneous or specific use properties. Repayment of these loans typically relies on the successful operation of a business or the generation of lease income by the property and is therefore more sensitive to adverse conditions in the economy and real estate market.

 

·Other real estate loans include loans secured by multi-family residential real estate and land. Generally these loans involve a greater degree of credit risk than residential real estate loans; land loans due to the lack of cash flow and reliance on borrower’s capacity and multi-family loans due the reliance on the successful operation the project. Both loan types are also more sensitive to adverse economic conditions.

 

Real estate construction loans

 

·Real estate construction loans, including one- to four-family, commercial and acquisition and development loans generally have greater credit risk than traditional one- to four-family residential real estate loans. The repayment of these loans can be dependent on the sale of the property to third parties or the successful completion of the improvements by the builder for the end user. In the event a loan is made on property that is not yet approved for the planned development, there is the risk that approvals will not be granted or will be delayed. Construction loans also run the risk that improvements will not be completed on time or accordance with specifications and projected costs.

 

22
 

 

NOTE 5. LOANS, NET (continued)

 

Other loans

 

·Home equity loans and home equity lines are similar to one-to-four family residential loans and generally carry less risk than other loan types as they tend to be smaller balance loans without concentrations to a single borrower or group or borrowers. However, similar to one-to-four family residential loans, risk of loss is higher due to the deterioration in value of the real estate market.

 

·Consumer loans tend to be secured by depreciating collateral, including cars and mobile homes, or are unsecured and may carry more risk than real estate secured loans. Consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.

 

·Commercial loans are secured by business assets or may be unsecured and repayment is directly dependent on the successful operation of the borrower’s business and the borrower’s ability to convert the assets to operating revenue and possess greater risk than most other types of loans should the repayment capacity of the borrower not be adequate.

 

23
 

 

NOTE 5. LOANS, NET (continued)

 

Activity in the allowance for loan losses for the three months ended June 30, 2012 was as follows:

 

   Beginning
Balance
   Charge Offs   Recoveries   Provisions   Ending
Balance
 
   (Dollars in Thousands) 
Real estate loans:                         
One-to-four family  $5,730   $(3,184)  $215   $2,013   $4,773 
Commercial   2,066    (1)   -    (109)   1,956 
Other (land and multi-family)   810    (684)   -    587    713 
Total real estate loans   8,606    (3,869)   215    2,490    7,442 
                          
Real estate construction loans:                         
One-to-four family   2    -    -    (2)   - 
Commercial   -    (202)   -    210    8 
Acquisition and development   -    -    -    -    - 
Total real estate construction loans   2    (202)   -    208    8 
                          
Other Loans:                         
Home equity   3,132    (915)   58    910    3,186 
Consumer   1,049    (297)   92    189    1,032 
Commercial   727    -    -    (56)   671 
Total other loans   4,908    (1,212)   150    1,043    4,889 
                          
Total loans  $13,516   $(5,283)  $365   $3,741   $12,339 

 

24
 

 

NOTE 5. LOANS, NET (continued)

 

Activity in the allowance for loan losses for the three months ended June 30, 2011 was as follows:

 

   Beginning
Balance
   Charge Offs   Recoveries   Provisions   Ending
Balance
 
   (Dollars in Thousands) 
Real estate loans:                         
One-to-four family  $5,725   $(1,993)  $110   $2,060   $5,902 
Commercial   2,530    (177)   21    300    2,674 
Other (land and multi-family)   1,214    (54)   1    21    1,182 
Total real estate loans   9,469    (2,224)   132    2,381    9,758 
                          
Real estate construction loans:                         
One-to-four family   102    -    -    (4)   98 
Commercial   147    -    -    (7)   140 
Acquisition and development   -    -    -    -    - 
Total real estate construction loans   249    -    -    (11)   238 
                          
Other Loans:                         
Home equity   1,886    (635)   20    678    1,949 
Consumer   1,594    (195)   71    (544)   926 
Commercial   365    (15)   -    463    813 
Total other loans   3,845    (845)   91    597    3,688 
                          
Total loans  $13,563   $(3,069)  $223   $2,967   $13,684 

 

25
 

 

NOTE 5. LOANS, NET (continued)

 

Activity in the allowance for loan losses for the six months ended June 30, 2012 was as follows:

 

   Beginning
Balance
   Charge Offs   Recoveries   Provisions   Ending
Balance
 
   (Dollars in Thousands) 
Real estate loans:                         
One-to-four family  $6,030   $(4,301)  $471   $2,573   $4,773 
Commercial   3,143    (2,138)   2    949    1,956 
Other (land and multi-family)   1,538    (1,585)   -    760    713 
Total real estate loans   10,711    (8,024)   473    4,282    7,442 
                          
Real estate construction loans:                         
One-to-four family   120    -    -    (120)   - 
Commercial   -    (202)   -    210    8 
Acquisition and development   -    -    -    -    - 
Total real estate construction loans   120    (202)   -    90    8 
                          
Other Loans:                         
Home equity   3,125    (2,044)   71    2,034    3,186 
Consumer   885    (780)   172    755    1,032 
Commercial   685    (71)   2    55    671 
Total other loans   4,695    (2,895)   245    2,844    4,889 
                          
Total loans  $15,526   $(11,121)  $718   $7,216   $12,339 

 

26
 

 

NOTE 5. LOANS, NET (continued)

 

Activity in the allowance for loan losses for the six months ended June 30, 2011 was as follows:

 

   Beginning
Balance
   Charge Offs   Recoveries   Provisions   Ending
Balance
 
   (Dollars in Thousands) 
Real estate loans:                         
One-to-four family  $5,860   $(3,399)  $251   $3,190   $5,902 
Commercial   2,443    (177)   21    387    2,674 
Other (land and multi-family)   1,019    (103)   34    232    1,182 
Total real estate loans   9,322    (3,679)   306    3,809    9,758 
                          
Real estate construction loans:                         
One-to-four family   18    -    -    80    98 
Commercial   37    -    -    103    140 
Acquisition and development   -    -    -    -    - 
Total real estate construction loans   55    -    -    183    238 
                          
Other Loans:                         
Home equity   1,663    (1,741)   24    2,003    1,949 
Consumer   1,922    (444)   125    (677)   926 
Commercial   382    (15)   -    446    813 
Total other loans   3,967    (2,200)   149    1,772    3,688 
                          
Total loans  $13,344   $(5,879)  $455   $5,764   $13,684 

 

27
 

NOTE 5. LOANS, NET (continued)

 

The following table presents ending balances for allowance for loan losses and loans based on impairment method as of June 30, 2012:

 

   Individually
evaluated for
impairment
   Collectively
evaluated for
impairment
   Total Ending
Balance
 
       (Dollars in
Thousands)
     
     
Allowance for loan losses:               
Real estate loans:               
One-to-four family  $1,292   $3,481   $4,773 
Commercial   1,717    239    1,956 
Other (land and multi-family)   89    624    713 
Total real estate loans   3,098    4,344    7,442 
Real estate construction loans:               
One-to-four family   -    -    - 
Commercial   -    8    8 
Acquisition and development   -    -    - 
Total real estate construction loans   -    8    8 
Other Loans:               
Home equity   357    2,829    3,186 
Consumer   55    977    1,032 
Commercial   345    326    671 
Total other loans   757    4,132    4,889 
Total ending allowance balance   3,855    8,484    12,339 
                
Loans:               
Real estate loans:               
One-to-four family   10,196    207,913    218,109 
Commercial   15,734    46,836    62,570 
Other (land and multi-family)   3,942    18,545    22,487 
Total real estate loans   29,872    273,294    303,166 
Real estate construction loans:               
One-to-four family   -    567    567 
Commercial   2,110    1,926    4,036 
Acquisition and development   -    -    - 
Total real estate construction loans   2,110    2,493    4,603 
Other Loans:               
Home equity   2,837    65,930    68,767 
Consumer   521    63,008    63,529 
Commercial   3,783    17,560    21,343 
Total other loans   7,141    146,498    153,639 
Total ending loans balance  $39,123   $422,285   $461,408 

 

28
 

 

NOTE 5. LOANS, NET (continued)

 

The following table presents ending balances for allowance for loan losses and loans based on impairment method as of December 31, 2011:

  

   Individually
Evaluated For
Impairment
   Collectively
Evaluated For
Impairment
   Total Ending
Balance
 
       (Dollars in
Thousands)
     
             
Allowance for loan losses:               
Ending allowance balance attributable to loans:               
Real estate loans:               
One-to-four family  $1,514   $4,516   $6,030 
Commercial   2,891    252    3,143 
Other (land and multi-family)   895    643    1,538 
Total real estate loans   5,300    5,411    10,711 
Real estate construction loans:               
One-to-four family   116    4    120 
Commercial   -    -    - 
Acquisition and development   -    -    - 
Total real estate construction loans   116    4    120 
Other Loans:               
Home equity   40    3,085    3,125 
Consumer   154    731    885 
Commercial   347    338    685 
Total other loans   541    4,154    4,695 
Total ending allowance balance  $5,957   $9,569   $15,526 
Loans:               
Real estate loans:               
One-to-four family  $11,221   $230,232   $241,453 
Commercial   19,323    53,360    72,683 
Other (land and multi-family)   6,414    22,720    29,134 
Total real estate loans   36,958    306,312    343,270 
Real estate construction loans:               
One-to-four family   455    1,589    2,044 
Commercial   2,362    1,721    4,083 
Acquisition and development   -    -    - 
Total real estate construction loans   2,817    3,310    6,127 
Other Loans:               
Home equity   1,959    72,240    74,199 
Consumer   319    67,531    67,850 
Commercial   4,049    19,132    23,181 
Total other loans   6,327    158,903    165,230 
Total ending loans balance  $46,102   $468,525   $514,627 

 

29
 

 

NOTE 5. LOANS, NET (continued)

 

Loans for which the concessions have been granted as a result of the borrower’s financial difficulties are considered troubled debt restructurings (“TDRs”). These concessions, which in general are applied to all categories of loans, may include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, or a combination of these or other actions intended to maximize collection.

 

For homogenous loan categories, such as one-to-four family residential loans and home equity loans, the amount of impairment resulting from the modification of the loan terms is calculated in aggregate by category of loan. The resulting impairment is included in the general component of the allowance for loan losses. If an individual homogenous loan defaults under terms of the TDR and becomes non-performing, the Bank follows its usual practice of charging the loan down to its estimated fair value and the charge-off is considered as a factor in determining the amount of the general component of the allowance for loan losses.

 

For larger non-homogeneous loans, each loan that is modified is evaluated individually for impairment based on either discounted cash flow or, for collateral dependent loans, the appraised value of the collateral less selling costs. The amount of the impairment, if any, is recorded as a specific reserve in the allowance for loan loss reserve. There was an allocated allowance for loan losses for loans individually evaluated for impairment of approximately $3.9 million and $6.0 million at June 30, 2012 and December 31, 2011, respectively.

 

Loans modified as TDRs with market rates of interest are classified as impaired loans in the year of restructure and until the loan has performed for 12 months in accordance with the modified terms. The assessment of market rate of interest for homogenous TDR loans is done based on the weighted average rates those loans compared to prevailing interest rates at the time of restructure. TDRs classified as impaired loans as of June 30, 2012 and December 31, 2011 were as follows:

 

   June 30,
2012
   December 31,
2011
 
   (Dollars in Thousands) 
Real Estate          
One-to-four family  $9,392   $9,081 
Commercial   4,674    3,941 
Other (Land & multi-family)   1,772    3,260 
           
Construction          
Construction - One-to-four family   -    455 
Construction - Commercial   -    - 
Construction - Acquisition & Development   -    - 
           
Other Loans          
Home Equity   2,806    1,923 
Consumer   521    319 
Commercial   847    358 
           
Total  $20,012   $19,337 

 

30
 

 

 

NOTE 5. LOANS, NET (continued)

 

There were no commitments to lend additional amounts on TDRs as of June 30, 2012 and December 31, 2011.

 

The Company is proactive in modifying residential and home equity loans in early stage delinquency because we believe modifying the loan prior to it becoming non-performing results in the least cost to the Bank. The Bank also modifies larger commercial and commercial real estate loans as TDRs rather than pursuing other means of collection when it believes the borrower is committed to the successful repayment of the loan and the business operations are likely to support the modified loan terms.

 

The following tables present information on troubled debt restructurings and subsequent defaults during the six months ended June 30, 2012:

 

   Number of
Contracts
   Pre-Modification Outstanding
Recorded Investments
   Post-Modification Outstanding
Recorded Investments
 
   (Dollars in Thousands) 
Troubled Debt Restructuring:               
Real estate loans:               
One-to-four family   20   $2,740   $2,141 
Commercial   4    587    577 
Other   6    655    497 
                
Other loans:               
Home equity   11    1,280    1,090 
Consumer   4    313    312 
Commercial   1    46    41 
                
Total   46   $5,621   $4,658 

 

   Number of Contracts   Recorded Investments 
   (Dollars in Thousands) 
Troubled Debt Restructuring That Subsequently Defaulted:          
Real estate loans:          
Other   2   $315 
           
Total   2   $315 

 

31
 

 

NOTE 5. LOANS, NET (continued)

 

The following table presents information about impaired loans as of June 30, 2012:

 

   Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
 
       (Dollars in
Thousands)
     
With no related allowance recorded:               
Real estate loans:               
One-to-four family  $-   $-   $- 
Commercial   7,428    9,156    - 
Other (land and multi-family)   1,329    1,951    - 
Total real estate loans   8,757    11,107    - 
                
Real estate construction loans:               
One-to-four family   -    -    - 
Commercial   2,110    5,619    - 
Acquisition and development   -    -    - 
Total real estate construction loans   2,110    5,619    - 
                
Other loans:               
Home equity   -    -    - 
Consumer   -    -    - 
Commercial   518    518    - 
Total other loans   518    518    - 
                
Total  $11,385   $17,244   $- 
                
With an allowance recorded:               
Real estate loans:               
One-to-four family  $10,196   $10,302   $1,292 
Commercial   8,306    8,306    1,717 
Other (land and multi-family)   2,613    2,815    89 
Total real estate loans   21,115    21,423    3,098 
                
Real estate construction loans:               
One-to-four family   -    -    - 
Commercial   -    -    - 
Acquisition and development   -    -    - 
Total real estate construction loans   -    -    - 
                
Other loans:               
Home equity   2,837    2,808    357 
Consumer   521    521    55 
Commercial   3,265    3,265    345 
Total other loans   6,623    6,594    757 
                
Total  $27,738   $28,017   $3,855 

 

32
 

 

NOTE 5. LOANS, NET (continued)

 

The following table presents information about impaired loans as of December 31, 2011:

 

   Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
 
   (Dollars in Thousands) 
With no related allowance recorded:               
Real estate loans:               
One-to-four family  $-   $-   $- 
Commercial   5,073    6,544    - 
Other (land and multi-family)   2,742    2,742    - 
Total real estate loans   7,815    9,286    - 
                
Real estate construction loans:               
One-to-four family   -    -    - 
Commercial   2,362    5,669    - 
Acquisition and development   -    -    - 
Total real estate construction loans   2,362    5,669    - 
                
Other loans:               
Home equity   -    -    - 
Consumer   -    -    - 
Commercial   713    713    - 
Total other loans   713    713    - 
                
Total  $10,890   $15,668   $- 
                
With an allowance recorded:               
Real estate loans:               
One-to-four family  $11,221   $11,267   $1,514 
Commercial   14,250    14,250    2,891 
Other (land and multi-family)   3,672    4,172    895 
Total real estate loans   29,143    29,689    5,300 
                
Real estate construction loans:               
One-to-four family   455    455    116 
Commercial   -    -    - 
Acquisition and development   -    -    - 
Total real estate construction loans   455    455    116 
                
Other loans:               
Home equity   1,959    1,959    40 
Consumer   319    319    154 
Commercial   3,336    3,336    347 
Total other loans   5,614    5,614    541 
                
Total  $35,212   $35,758   $5,957 

 

33
 

 

NOTE 5. LOANS, NET (continued)

 

The following table presents interest income on impaired loans by class of loans for the three months ended June 30, 2012:

 

 

   Average
Balance
   Interest
Income
Recognized
   Cash Basis
Interest
Income
Recognized
 
   (Dollars in Thousands) 
Real estate loans:               
One-to-four family  $10,880   $155   $- 
Commercial   15,350    210    - 
Other (land and multi-family)   5,203    29    - 
Total real estate loans   31,433    394    - 
                
Real estate construction loans:               
One-to-four family   -    -    - 
Commercial   2,236    -    - 
Acquisition and development   -    -    - 
Total real estate construction loans   2,236    -    - 
                
Other loans:               
Home equity   2,673    37    - 
Consumer   475    11    - 
Commercial   3,812    16    - 
Total other loans   6,960    64    - 
                
Total loans  $40,629   $458   $- 

 

34
 

 

NOTE 5. LOANS, NET (continued)

 

The following table presents interest income on impaired loans by class of loans for the three months ended June 30, 2011:

 

   Average
Balance
   Interest
Income
Recognized
   Cash Basis
Interest
Income
Recognized
 
   (Dollars in Thousands) 
Real estate loans:               
One-to-four family  $13,210   $79   $- 
Commercial   20,016    136    - 
Other ( land and multi-family)   5,290    48    - 
Total real estate loans   38,516    263    - 
                
Real estate construction loans:               
One-to-four family   229    -    - 
Commercial   2,133    -    - 
Acquisition and development   -    (16)   - 
Total real estate construction loans   2,361    (16)   - 
                
Other loans:               
Home equity   1,526    13    - 
Consumer   251    7    - 
Commercial   3,122    39    - 
Total other loans   4,899    59    - 
                
Total loans  $45,776   $306   $- 

 

35
 

 

NOTE 5. LOANS, NET (continued)

 

The following table presents interest income on impaired loans by class of loans for the six months ended June 30, 2012:

 

   Average
Balance
   Interest
Income
Recognized
   Cash Basis
Interest
Income
Recognized
 
   (Dollars in Thousands) 
Real estate loans:               
One-to-four family  $10,709   $233   $- 
Commercial   17,529    271    - 
Other (land and multi-family)   5,179    60    - 
Total real estate loans   33,417    564    - 
                
Real estate construction loans:               
One-to-four family   228    -    - 
Commercial   2,236    -    - 
Acquisition and development   -    -    - 
Total real estate construction loans   2,464    -    - 
                
Other loans:               
Home equity   2,398    65    - 
Consumer   420    17    - 
Commercial   3,917    23    - 
Total other loans   6,735    105    - 
                
Total loans  $42,616   $669   $- 

 

36
 

 

NOTE 5. LOANS, NET (continued)

 

The following table presents interest income on impaired loans by class of loans for the six months ended June 30, 2011:

 

   Average
Balance
   Interest
Income
Recognized
   Cash Basis
Interest
Income
Recognized
 
   (Dollars in Thousands) 
Real estate loans:               
One-to-four family  $13,210   $239   $- 
Commercial   20,016    282    - 
Other ( land and multi-family)   5,290    85    - 
Total real estate loans   38,516    606    - 
                
Real estate construction loans:               
One-to-four family   229    -    - 
Commercial   2,133    -    - 
Acquisition and development   -    -    - 
Total real estate construction loans   2,362    -    - 
                
Other loans:               
Home equity   1,526    32    - 
Consumer   251    10    - 
Commercial   3,122    84    - 
Total other loans   4,899    126    - 
                
Total loans  $45,777   $732   $- 

 

37
 

 

NOTE 5. LOANS, NET (continued)

 

The Company has originated loans with directors and executive officers and their associates. These loans totaled approximately $1.6 million at both June 30, 2012 and December 31, 2011. The activity on these loans during the six month period ended June 30, 2012 and the year ended December 31, 2011 was as follows:

 

   June 30,   December 31, 
   2012   2011 
   (Dollars in Thousands) 
Beginning balance  $1,587   $2,703 
New loans   2    49 
Effect of changes in related parties   71    (1,119)
Repayments   (18)   (46)
Ending balance  $1,642   $1,587 

 

NOTE 6. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE

 

The Company has securities sold under agreements to repurchase with a carrying amount of $92.8 million at June 30, 2012 and December 31, 2011. Under the terms of the agreements the counterparties require that the Company provide additional collateral for the borrowings as protection for their market risk when the fair value of the borrowings exceeds the contractual amounts. As a result, the Company had $119.4 million and $122.2 million in securities posted as collateral for these instruments at June 30, 2012 and December 31, 2011, respectively. The Company will be required to post additional collateral if the gap between the market value of the liability and the contractual amount of the liability increases.

 

Information concerning securities sold under agreements to repurchase as of June 30, 2012 and December 31, 2011 is summarized as follows:

 

   June 30,
2012
   December
31, 2011
 
   (Dollars in Thousands) 
Average daily balance  $92,800   $92,800 
Average interest rate   5.16%   5.16%
Maximum month-end balance during the period  $92,800   $92,800 
Weighted average interest rate at period end   5.16%   5.10%
Weighted average maturity (months)   48    54 

 

The securities sold under agreements to repurchase at June 30, 2012 mature as follows:

 

2012  $- 
2013   - 
2014   26,500 
2015   10,000 
2016   5,000 
Thereafter   51,300 
   $92,800 

 

38
 

 

NOTE 6. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE (continued)

 

Beginning in January 2009, the lender has the option to terminate individual advances in whole the following quarter; there is no termination penalty if terminated by the lender. There have been no early terminations. In the event the Bank’s regulatory capital ratios fall below well-capitalized it may be required to provide additional collateral. In the event the capital ratios fall below adequately capitalized, or the Bank receives a cease and desist order from its primary banking regulator, the counterparty on $77.8 million of the $92.8 million total has the option to call the debt at its fair value. At June 30, 2012, the fair value of that portion of the debt exceeded the carrying value by approximately $12.7 million. At maturity or termination, the securities underlying the agreements will be returned to the Company.

 

Subsequent to June 30, 2012, the Company entered into a revised agreement with the counterparty which eliminated the event of default which gave the counterparty the option to terminate the reverse repurchase agreements at the market value of the debt in the event the Bank becomes less than adequately capitalized or receives a cease and desist order from the Office of the Comptroller of the Currency (“OCC”). Under the terms of the revised agreement the Bank will be required to pledge additional collateral if its capital ratios decrease below regulatory defined levels of well capitalized or adequately capitalized.

 

NOTE 7. FEDERAL HOME LOAN BANK ADVANCES

 

Federal Home Loan Bank (“FHLB”) borrowings were $135.0 million at June 30, 2012 and at December 31, 2011. FHLB advances had a weighted-average maturity of 49 months and a weighted-average rate of 3.88% at June 30, 2012.

 

The Bank was notified in March 2012 that the discount percentages used to determine s excess borrowing capacity with the FHLB of Atlanta were reduced. In addition, during the first half of 2012, prepayments on loans pledged as collateral for the FHLB advances resulted reduced the balances of loans available to be used as collateral. Accordingly, the Bank’s excess borrowing capacity has been reduced by approximately $48.6 million to $15.2 million at June 30, 2012 from $63.8 million at December 31, 2011.

 

39
 

 

NOTE 8. LOSS PER COMMON SHARE

 

Basic loss per common share is computed by dividing net loss by the weighted-average number of common shares outstanding for the period, reduced for average unallocated ESOP shares and average unearned restricted stock awards. Diluted loss per common share is computed by dividing net loss by the average number of common shares outstanding for the period increased for the dilutive effect of unvested stock options and stock awards. The dilutive effect of the unvested stock options and stock awards is calculated under the treasury stock method utilizing the average market value of the Company’s stock for the period. A reconciliation of the numerator and denominator of the basic and diluted loss per common share computation for the three and six months ended June 30, 2012 and 2011 was as follows:

 

   (Dollars in Thousands, except per share data) 
   For the three months   For the six months 
   ended June 30,   ended June 30, 
   2012   2011   2012   2011 
Basic                    
Net loss  $(2,996)  $(1,517)  $(4,705)  $(4,939)
Weighted average common shares outstanding   2,628,969    2,629,006    2,628,969    2,629,033 
Less: Average unallocated ESOP shares   (91,017)   (95,807)   (91,017)   (82,952)
Average director's deferred compensation shares   (39,478)   (45,891)   (40,842)   (45,607)
Average unvested restricted stock awards   (1,242)   (2,809)   (1,317)   (2,972)
                     
Average Shares   2,497,232    2,484,499    2,495,793    2,497,502 
                     
Basic loss per common share  $(1.20)  $(0.61)  $(1.89)  $(1.98)
                     
                     
Diluted                    
Net loss  $(2,996)  $(1,517)  $(4,705)  $(4,939)
                     
Weighted average shares outstanding from above   2,497,232    2,484,499    2,495,793    2,497,502 
Add:Dilutive effects of assumed exercise of stock options   -    -    -    - 
  Dilutive effects of full vesting of stock awards   -    -    -    - 
                     
Average shares and dilutive potential common shares   2,497,232    2,484,499    2,495,793    2,497,502 
                     
Diluted loss per common share  $(1.20)  $(0.61)  $(1.89)  $(1.98)

 

Stock options for shares of common stock were not considered in computing diluted loss per common share for the three and six months ended June 30, 2012 and 2011, respectively. There was no dilutive effect as each period reported a net loss.

 

40
 

 

NOTE 9. FAIR VALUE

 

The Company used the following methods and significant assumptions to estimate fair values:

 

Investment Securities:

The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. During times when trading is more liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.

 

Impaired Loans

The fair values of impaired loans that are collateral dependent are based on a valuation model which incorporates the most current real estate appraisals available, as well as assumptions used to estimate the fair value of all non-real estate collateral as defined in the Bank’s internal loan policy (Level 3 inputs).

 

Other Real Estate Owned

Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned (“OREO”) are measured at fair value, less costs to sell. Fair values are generally based on third party appraisals of the property, resulting in a Level 3 classification. An impairment loss is recognized in cases where the carrying amount exceeds the fair value less costs to sell.

 

41
 

 

 

NOTE 9. FAIR VALUE (continued)

 

Assets and Liabilities Measured on a Recurring Basis

 

Assets and liabilities measured at fair value on a recurring basis are summarized below:

  

   Fair Value Measurements at June 30, 2012 using: 
   Total   Quoted
Prices in
Active
Markets
for
Identical
Assets
(Level 1)
   Significant
Other
Observable
Inputs 
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
   (Dollars in Thousands) 
Assets:                    
Available for sale                    
State and municipal   958    -    958    - 
Mortgage-backed securities – residential   96,799    -    96,799    - 
Collateralized mortgage obligations – U.S. Govt.   48,626    -    48,626    - 

  

   Fair Value Measurements at December 31, 2011 using: 
   Total   Quoted
Prices in
Active
Markets
for
Identical
Assets
(Level 1)
  

Significant

Other

Observable

Inputs

(Level 2)

   Significant
Unobservable
Inputs
(Level 3)
 
   (Dollars in Thousands) 
Assets:                    
Available for sale                    
State and municipal   930    -    930    - 
Mortgage-backed securities – residential   76,089    -    76,089    - 
Collateralized mortgage obligations – U.S. Govt.   49,802    -    49,802    - 

 

42
 

 

NOTE 9. FAIR VALUE (continued)

 

The Company had no assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the six month period ended June 30, 2012. The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2011:

 

   Investment 
   Securities 
   Available-for-sale 
   (Dollars in Thousands) 
Balance of recurring Level 3 assets at January 1, 2011  $6,734 
Total realized and unrealized gains (losses):     
Included in earnings - realized   186 
Included in earnings - unrealized   (186)
Included in other comprehensive income   (12)
Proceeds from maturities and payments, net   - 
Proceeds from sales   (6,722)
Transfers in to level 3   - 
Transfers out of level 3   - 
Balance of recurring Level 3 assets at December 31, 2011  $- 

 

Market conditions for certain debt securities have resulted in unreliable or unavailable fair values, often resulting in transfers in and / or out of Level 3. The Company determined that no debt securities were appropriately evaluated as Level 3 assets as of June 30, 2012 and December 31, 2011.

 

43
 

 

NOTE 9. FAIR VALUE (continued)

 

Assets and liabilities measured at fair value on a non-recurring basis are summarized below:

 

   Fair Value Measurements at June 30, 2012 Using: 
   Total   Quoted
Prices in
Active
Markets
for
Identical
Assets 
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs 
(Level 3)
 
   (Dollars in Thousands) 
Assets:                    
Other real estate owned  $7,708    -    -   $7,708 
Impaired loans – collateral dependent  $3,672    -    -   $3,672 

  

    Quantitative Information about Level 3 Fair Value
Measurements at June 30, 2012:
    Fair Value
Estimate
  Valuation
Techniques
  Unobservable
Input
  Range
(Weighted 
Average)
    (Dollars in Thousands)
                 
Assets:                
                 
Other real estate owned   $ 7,708   Broker Price Opinions, Appraisal of collateral (1), (3)   Liquidation expenses (2)   8% to 10% (8.57%)
                   
Impaired loans – collateral dependent   $ 3,672  

Appraisal of collateral (1)

 

  Appraisal adjustments (2)   0% to 20% (2.19%)
              Liquidation expenses (2)   0% to 10% (8.00%)

  

(1)Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various level 3 inputs which are not identifiable.
(2)Appraisals may be adjusted by management for qualitative factors such as economic conditions and liquidation expenses. The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.
(3)Includes qualitative adjustments by management and estimated liquidation expenses.

 

44
 

 

NOTE 9. FAIR VALUE (continued)

 

   Fair Value Measurements at December 31, 2011 Using: 
   Total   Quoted
Prices in
Active
Markets
for
Identical
Assets 
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs 
(Level 3)
 
   (Dollars in Thousands) 
Assets:                    
Other real estate owned  $5,839   $-   $-   $5,839 
Impaired loans – collateral dependent  $18,006   $-   $-   $18,006 

 

Other Real Estate Owned:

Assets acquired through or in lieu of loan foreclosure are initially recorded at fair value, based on appraisals, less estimated selling costs, at the date of foreclosure, establishing a new cost basis. The fair value of the Company’s other real estate owned is determined using Level 3 inputs which include current and prior appraisals and estimated costs to sell. Changes in fair value are recorded directly as an adjustment to current earnings through non-interest expense. Costs relating to improvement of property may be capitalized, whereas costs relating to the holding of property are expensed.

 

Write-downs on other real estate owned for the three months ended June 30, 2012 and 2011 were $116,000, $27,000, respectively. Write-downs on other real estate owned for the six months ended June 30, 2012 and 2011 were $202,000 and $74,000, respectively.

 

Impaired loans:

Impaired loans which are collateral dependent are measured for impairment using the fair value of the collateral. Collateral dependent loans had a carrying amount of $3.7 million and $18.0 million, net of a valuation allowance of $2.1 million at both June 30, 2012 and December 31, 2011. Provision for loan losses of $(77,000) and $3.3 million was recorded on impaired loans during the three months ended June 30, 2012 and 2011, respectively. Provision for loan losses of $14,000 and $3.8 million was recorded on impaired loans during the six months ended June 30, 2012 and 2011, respectively.

 

45
 

 

NOTE 10. FAIR VALUE OF FINANCIAL INSTRUMENTS

 

Carrying amount and estimated fair value of financial instruments, not previously presented, were as follows:

 

       Fair Value Measurements at June 30, 2012 Using: 
   Carrying
Amount
   Estimated
Fair Value
   Quoted
Prices in
Active
Markets
for
Identical
Assets 
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs 
(Level 3)
 
       (Dollars in Thousands) 
Assets:                         
Cash and due from financial institutions  $6,206   $6,206   $6,206    -    - 
Short-term interest-earning deposits   58,566    58,566    58,566    -    - 
Accrued interest receivable   2,154    2,154    -    2,154    - 
Loans held for sale   57,806    57,947    -    57,947    - 
Loans, net   455,480    462,042    -    458,370    3,672 
Federal Home Loan Bank stock   7,781    7,781    -    -    7,781 
Liabilities:                         
Deposits   500,481    501,123    -    501,123    - 
Securities sold under agreements to repurchase   92,800    108,410    -    108,410    - 
Federal Home Loan Bank advances   135,000    151,703    -    151,703    - 
Accrued interest payable   1,116    1,116    -    1,116    - 

 

46
 

 

NOTE 10. FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)

 

       Fair Value Measurements at December 31, 2011 Using: 
   Carrying
Amount
   Estimated
Fair Value
   Quoted
Prices in
Active
Markets
for
Identical
Assets 
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs 
(Level 3)
 
       (Dollars in Thousands) 
Assets:                         
Cash and due from financial institutions  $8,696   $8,696   $8,696    -    - 
Short-term interest-earning deposits   32,321    32,321    32,321    -    - 
Accrued interest receivable   2,443    2,443    -    2,443    - 
Loans held for sale   61,619    61,619    -    61,619    - 
Loans, net   505,707    543,898    -    525,892    18,006 
Federal Home Loan Bank stock   9,600    9,600    -    -    9,600 
Liabilities:                         
Deposits   508,411    509,388    -    509,388    - 
Securities sold under agreements to repurchase   92,800    108,087    -    108,087    - 
Federal Home Loan Bank advances   135,000    151,517    -    151,517    - 
Accrued interest payable   1,142    1,142    -    1,142    - 

 

The methods and assumptions used to estimate fair value are described below:

 

Carrying amount is the estimated fair value for cash and cash equivalents, accrued interest, demand and savings deposits and variable rate loans or deposits that re-price frequently and fully. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent re-pricing or re-pricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk without considering the need for adjustments for market illiquidity. Fair value of loans held for sale is based on quoted market prices, where available, or is determined based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair value of debt (FHLB advances and securities sold under agreements to repurchase) is based on current rates for similar financing. It was not practicable to determine the fair value of FHLB stock due to restrictions placed on its transferability. Fair value of other borrowings is based on current rates for similar financing. The estimated fair value of other financial instruments and off-balance-sheet loan commitments approximate cost and are not considered significant to this presentation.

 

47
 

 

NOTE 10. FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)

 

The Bank is a member of the Federal Home Loan Bank of Atlanta and as such, is required to maintain a minimum investment in stock of the Federal Home Loan Bank that varies with the level of advances outstanding with the Federal Home Loan Bank. The stock is bought from and sold to the Federal Home Loan Bank based upon its $100 par value. The stock does not have a readily determinable fair value and as such is classified as restricted stock, carried at cost and evaluated for impairment. Accordingly, the stock’s value is determined by the ultimate recoverability of the par value rather than by recognizing temporary declines. The determination of whether the par value will ultimately be recovered is influenced by criteria such as the following: (a) the significance of the decline in net assets of the Federal Home Loan Bank as compared to the capital stock amount and the length of time this situation has persisted, (b) commitments by the Federal Home Loan Bank to make payments required by law or regulation and the level of such payments in relation to the operating performance (c) the impact of legislative and regulatory changes on the customer base of the Federal Home Loan Bank and (d) the liquidity position of the Federal Home Loan Bank. The Company did not consider the Federal Home Loan Bank stock to be impaired at June 30, 2012.

 

NOTE 11. INCOME TAXES

 

The Company considers at each reporting period all available evidence, both positive and negative, to determine whether, based on the weight of that evidence, a valuation allowance is needed to reduce its deferred tax asset to an amount that is more likely than not to be realized. A determination of the need for a valuation allowance for the deferred tax assets is dependent upon management’s evaluation of both positive and negative evidence. Positive evidence includes the probability of achieving forecasted future taxable income, applicable tax strategies and assessments of the current and future economic and business conditions. Negative evidence includes the Company’s cumulative losses and expiring tax credit carryforwards. At June 30, 2012, the Company evaluated the expected realization of its federal and state deferred tax assets which, prior to a valuation allowance, totaled $27.4 million and was primarily comprised of future tax benefits associated with the allowance for loan losses and net operating loss carryforward. Based on this evaluation it was concluded that a valuation allowance continues to be required for the federal deferred tax asset. The realization of the deferred tax asset is dependent upon generating taxable income. The Company also continues to maintain a valuation allowance for the state

deferred tax asset.

 

If the valuation allowance is reduced or eliminated, future tax benefits will be recognized as a reduction to income tax expense which will have a positive non-cash impact on our net income and stockholders’ equity.

 

The Company recorded income tax expense of $150,000 for the six months ended June 30, 2012 related to a recent IRS examination of the 2008 tax return which resulted in the disallowance of certain bad debt expense deductions for which the Company had originally received a credit of $424,000, as compared to $0 for the same period in the prior year. Income tax expense was as follows:

 

   Year to date 
   June 30, 2012   June 30, 2011 
         
Pre-tax loss  $(4,555)  $(4,939)
Effective tax rate   36.5%   40.7%
Tax benefit   (1,663)   (2,011)
Increase in valuation allowance - federal   1,625    1,810 
Increase in valuation allowance - state   188    201 
Income tax expense (benefit)  $150   $- 

 

48
 

 

NOTE 12. REGULATORY SUPERVISION

 

Atlantic Coast Bank actual and required capital levels (in millions) and ratios were:

 

           Required 
           To Be Well 
       Required   Capitalized Under 
       For Capital   Prompt Corrective 
   Actual   Adequacy Purposes   Action 
   Amount   Ratio   Amount   Ratio   Amount   Ratio 
                         
As of June 30, 2012                              
Total capital (to risk weighted assets)  $47.3    10.8%  $34.9    8.0%  $43.7    10.0%
Tier 1 (core) capital (to risk weighted assets)   41.8    9.6%   17.5    4.0%   26.2    6.0%
Tier 1 (core) capital (to adjusted total assets)   41.8    5.4%   31.2    4.0%   39.0    5.0%
                               
As of December 31, 2011                              
Total capital (to risk weighted assets)  $52.0    10.9%  $38.1    8.0%  $47.7    10.0%
Tier 1 (core) capital (to risk weighted assets)   46.0    9.7%   19.1    4.0%   28.6    6.0%
Tier 1 (core) capital (to adjusted total assets)   46.0    5.8%   31.6    4.0%   39.5    5.0%

 

At June 30, 2012 and December 31, 2011, Atlantic Coast Bank was classified as "well capitalized" under prompt corrective action requirements. However, the Bank operates under a Supervisory Agreement with the Office Thrift Supervision (“OTS”), the predecessor to the OCC, entered into in December 2010 and also received an individual minimum capital requirement (“IMCR”) from the OTS on May 13, 2011. Under the IMCR, the Bank agreed to achieve and maintain a Tier 1 leverage ratio of 6.25% at June 30, 2011 and 7% at September 30, 2011. The Bank’s Tier 1 (core) capital to adjusted total assets was 5.36% at June 30, 2012 and therefore the Bank is not in compliance

with the IMCR.

 

In light of the IMCR and the losses the Company has incurred over the past four years, the Company's Board of Directors began a review of strategic alternatives late in 2011, which includes consideration of a potential business combination, rights offering or other capital-raising actions. This process continues, however, there can be no assurances as to the outcome of these actions.

 

On August 10, 2012 the Board of Directors of the Bank agreed to a Consent order (“the Agreement”) with its primary regulator, the OCC. The Agreement does not affect Atlantic Coast Bank’s ability to continue to conduct its banking business with customers in a normal fashion. Banking products and services, hours of operation, internet banking, ATM useage, and FDIC deposit insurance coverage will all be unaffected. Customer deposits remain protected and insured by the FDIC up to $250,000 per depositor. The Agreement provides:

 

•    within 10 days of the date of the Agreement, the Board must establish a compliance committee that will be responsible for monitoring and coordinating the Bank’s adherence to the provisions of the Agreement;

 

•    within 90 days of the date of the Agreement, the Board must develop and submit to the OCC for receipt of supervisory non-objection of at least a two-year strategic plan to achieve objectives for the Bank’s risk profile, earnings performance, growth, balance sheet mix, off-balance sheet activities, liability structure, capital and liquidity adequacy and updating such plan each year by January 31 beginning on January 31, 2014;

 

•    until such time as the OCC provides written supervisory non-objection of the Bank’s strategic plan, the Bank shall not significantly deviate from products, services, asset composition and size, funding sources, structures, operations, policies, procedures and markets of the Bank that existed prior to the Agreement without receipt of prior non-objection from the OCC;

 

•    by December 31, 2012, the Bank must achieve and maintain a total risk based capital of 13% of risk weighted assets and Tier 1 capital of 9% of adjusted total assets;

 

49
 

 

NOTE 12. REGULATORY SUPERVISION (continued)

 

•    within 60 days of the date of the Agreement, the Board shall develop and implement an effective internal capital planning process to assess the Bank’s capital adequacy in relation to its overall risks and to ensure maintenance of appropriate capital levels, which shall be no less than total risk based capital of 13% of risk weighted assets and Tier 1 capital of 9% of adjusted total assets;

 

•    the Bank may not accept, renew or roll over any brokered deposit unless it has applied for and been granted a waiver of this prohibition by the Federal Deposit Insurance Corporation (“FDIC”);

 

•    within 90 days of the date of the Agreement, the Board shall forward to the OCC for receipt of written supervisory non-objection a written capital plan for the Bank covering at least a two year period that achieves and maintains total risk based capital of 13% of risk weighted assets and Tier 1 capital of 9% of adjusted total assets in addition to certain other requirements;

 

•    the Bank may declare or pay a dividend or make a capital distribution only when it is in compliance with its approved capital plan and would remain in compliance with its approved capital plan after payment of such dividends or capital distribution and receives prior written approval of the OCC;

 

•    following receipt of written no supervisory objection of its capital plan, the Board shall monitor the Bank’s performance against the capital plan and shall review and update the plan annually no later than January 31 of each year, beginning with January 31, 2014;

 

•    if the Bank fails to achieve and maintain the required capital ratios by December 31,2012, fails to submit a capital plan within 90 days of the date of the Agreement or fails to implement a written capital plan for which the OCC has provided a written determination of no supervisory objection, then, at the sole discretion of the OCC, the Bank may be deemed undercapitalized for purposes of the Agreement;

 

•    within 30 days of the date of the Agreement, the Board shall revise and maintain a comprehensive liquidity risk management program which assesses on an ongoing basis, the Bank’s current and projected funding needs, and that ensures that sufficient funds or access to funds exist to meet those needs;

 

•    within 60 days of the date of the Agreement, the Board shall revise its problem asset reduction plan (“PARP”) the design of which shall be to eliminate the basis of criticism of those assets criticized as “doubtful”, “substandard” or “special mention” during the OCC’s most recent report of examination as well as any subsequent examination or review by the OCC and any other internal or external loan reviews;

 

•     within 60 days of the date of the Agreement, the Board shall revise its written concentration management program for identifying, monitoring, and controlling risks associated with asset and liability concentrations, including off-balance sheet concentrations;

 

•    the Bank’s concentration management program shall include a contingency plan to reduce or mitigate concentrations deemed imprudent for the Bank’s earnings, capital, or in the event of adverse market conditions, including strategies to reduce the current concentrations to Board established limits and a restriction on purchasing bank owned life insurance (“BOLI”) until such time as the BOLI exposure has been reduced below regulatory guidelines of 25% of total capital;

 

•    the Board shall immediately take all necessary steps to ensure that the Bank management corrects each violation of law, rule or regulation cited in the OCC’s most recent report of examination and within 60 days of the date of the Agreement, the Board shall adopt, implement, and thereafter ensure Bank adherence to specific procedures to prevent future violations and the Bank’s adherence to general procedures addressing compliance management of internal controls and employee education regarding laws, rules and regulations; and

 

50
 

 

•    the Agreement replaces and therefore terminates the Supervisory Agreement entered into between the Bank and the Office of Thrift Supervision on December 10, 2010.

 

As a result of entering into the Agreement to achieve and maintain specific capital levels, the Bank’s capital classification under the Prompt Corrective Action(“PCA”) rules will be lowered to adequately capitalized, notwithstanding actual capital levels that otherwise may be deemed well capitalized under such rules.

 

51
 

 

ATLANTIC COAST FINANCIAL CORPORATION

 

ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Forward-Looking Statements

 

This Form 10-Q contains forward-looking statements which are statements that are not historical or current facts. When used in this filing and in future filings by Atlantic Coast Financial Corporation with the Securities and Exchange Commission, in Atlantic Coast Financial Corporation’s press releases or other public or shareholder communications, or in oral statements made with the approval of an authorized executive officer, the words or phrases, “anticipate,” “would be,” “will allow,” “intends to,” “will likely result,” “are expected to,” will continue,” “is anticipated,” “estimated,” “projected,” or similar expressions are intended to identify, “forward looking statements.” Such statements are subject to risks and uncertainties, including but not limited to changes in economic conditions in Atlantic Coast Financial Corporation’s market area, changes in policies by regulatory agencies, fluctuations in interest rates, demand for loans in Atlantic Coast Financial Corporation’s market area, the availability of liquidity from deposits or borrowings to execute on loan and investing opportunities, changes in the position of banking regulators on the adequacy of the allowance for loan losses, and competition, all or some of which could cause actual results to differ materially from historical earnings and those presently anticipated or projected.

 

Atlantic Coast Financial Corporation wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made, and advise readers that various factors, including regional and national economic conditions, substantial changes in levels of market interest rates, credit and other risks of lending and investing activities, and competitive and regulatory factors, could affect Atlantic Coast Financial Corporation’s financial performance and could cause Atlantic Coast Financial Corporation’s actual results for future periods to differ materially from those anticipated or projected.

 

Atlantic Coast Financial Corporation does not undertake, and specifically disclaims any obligation, to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements.

 

Recent Developments

 

While the Company's capital levels continued to exceed the required minimums of 5% Tier 1 leverage ratio, 6% Tier 1 risk-based capital ratio, and 10% Total risk-based capital ratio, respectively, necessary to be deemed a well-capitalized institution, the Company remained under an Individual Minimum Capital Requirement (“IMCR”) with the OCC during the second quarter of 2012, which mandates that Atlantic Coast Bank must achieve a 7% Tier 1(core) capital ratio. With a Tier 1 core capital ratio of 5.36% as of June 30, 2012, the Bank was not in compliance with the IMCR.

 

In light of the IMCR and the losses the Company has incurred over the past four years, the Company's Board of Directors began a review of strategic alternatives late in 2011, and engaged a financial advisor to assist in the exploration of alternatives to enhance stockholder value. The Company also received approval from the Federal Reserve Board to pursue these strategic alternatives, which include consideration of a potential business combination and a rights offering or other capital-raising actions. This process continues, however, there can be no assurances as to the outcome of these efforts.

 

On August 10, 2012 the Board of Directors of Atlantic Coast Bank, the Company’s wholly-owned banking subsidiary entered into a Consent Order (“the Agreement”) with the OCC. Among other things the Agreement provides that by December 31, 2012 the Bank achieve and maintain total risk based capital of 13% of risk weighted assets and Tier 1 capital of 9% of adjusted total assets. As a result of entering into the Agreement to achieve and maintain specific capital levels, the Bank’s capital classification under the Prompt Corrective Action (“PCA”) rules will be lowered to adequately capitalized, notwithstanding actual capital levels that otherwise may be deemed well capitalized under such rules. See Note 12 to the financial statements contained in this Form 10-Q for further description of the provisions contained in the Agreement.

 

52
 

 

Critical Accounting Policies

 

Certain accounting policies are important to the portrayal of the Company’s financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances, including, but without limitation, changes in interest rates, performance of the economy, financial condition of borrowers and laws and regulations. Management believes that its critical accounting policies include determining the allowance for loan losses, determining fair value of securities available for sale, other real estate owned and accounting for deferred income taxes. These accounting policies are discussed in detail in Note 1 of the Notes to the Consolidated Financial Statements included in Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2011 filed with the Securities and Exchange Commission.

 

Allowance for Loan Losses

 

An allowance for loan losses (“allowance”) is maintained to reflect probable incurred losses in the loan portfolio. The allowance is based on ongoing assessments of the estimated losses incurred in the loan portfolio and is established as these losses are recognized through a provision for loan losses charged to earnings. Generally, loan losses are charged against the allowance when management believes the uncollectibity of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Due to declining real estate values in our markets and the weak United States economy in general, it is likely that impairment reserves on non-performing one-to-four family residential and home equity loans, will not be recoverable and represent a confirmed loss. As a consequence the Company recognizes the charge-off of impairment reserves on non-performing one-to-four family residential and home equity loans in the period the loan is classified as such. This process accelerates the recognition of charge-offs but has no impact on the impairment evaluation process.

 

The reasonableness of the allowance is reviewed and established by management, within the context of applicable accounting and regulatory guidelines, based upon its evaluation of then-existing economic and business conditions affecting the Bank’s key lending areas. Senior credit officers monitor the conditions discussed above continuously and reviews are conducted monthly with the Bank’s senior management and Board of Directors.

 

Management’s methodology for assessing the reasonableness of the allowance consists of several key elements, which include a general loss component by type of loan and specific allowances for identified problem loans. The allowance also incorporates the results of measuring impaired loans.

 

The general loss component is calculated by applying loss factors to outstanding loan balances based on the internal risk evaluation of the loans or pools of loans. Changes to the risk evaluations relative to both performing and non-performing loans affect the amount of this component. Loss factors are based on the Bank’s recent loss experience, current market conditions that may impact real estate values within the Bank’s primary lending areas, and on other significant factors that, in management’s judgment, may affect the ability to collect loans in the portfolio as of the evaluation date. Other significant factors that exist as of the balance sheet date that may be considered in determining the adequacy of the allowance include credit quality trends (including trends in non-performing loans expected to result from existing conditions), collateral values, geographic foreclosure rates, new and existing home inventories, loan volumes and concentrations, specific industry conditions within portfolio segments and recent charge-off experience in particular segments of the portfolio. The impact of the general loss component on the allowance began increasing during 2008 and has continued to increase during each year through the second quarter of 2012. The increase reflected the deterioration of market conditions, and the increase in the recent loan loss experience that has resulted from management’s proactive approach to charging off losses on impaired one- to four-family and home equity loans in the period the impairment is identified.

 

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Management also evaluates the allowance for loan losses based on a review of certain large balance individual loans. This evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows management expects to receive on impaired loans that may be susceptible to significant change. For all specifically reviewed loans where it is probable that the Bank will be unable to collect all amounts due according to the terms of the loan agreement, impairment is determined by computing a fair value based on either discounted cash flows using the loan’s initial interest rate or the fair value of the collateral if the loan is collateral dependent. No specific allowance is recorded unless fair value is less than carrying value. Large groups of smaller balance homogeneous loans, such as individual consumer and residential loans are collectively evaluated for impairment and are excluded from the specific impairment evaluation; for these loans, the allowance for loan losses is calculated in accordance with the general allowance for loan losses policy described above. Accordingly, individual consumer and residential loans are not separately identified for impairment disclosures, unless the loan has been modified as a troubled debt restructuring as discussed below.

 

Loans for which the terms have been modified as a result of the borrower's financial difficulties are classified as troubled debt restructurings ("TDRs"). TDRs are measured for impairment based upon the present value of estimated future cash flows using the loan’s interest rate at inception of the loan or the appraised value of the collateral if the loan is collateral dependent. Impairment of homogenous loans, such as one-to four-family residential loans, that have been modified as TDRs is calculated in the aggregate based on the present value of estimated future cash flows. Loans modified as TDRs with market rates of interest are classified as impaired loans in the year of restructure and until the loan has performed for 12 months in accordance with the modified terms. The assessment of market rate of interest for homogenous TDR loans is done based on the weighted average rates of those loans compared to prevailing interest rates at the time of restructure.

 

Fair Value of Securities Available for Sale

 

Securities available for sale are carried at fair value, with unrealized holding gains and losses reported separately in other comprehensive income (loss), net of tax. The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3).

 

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. In determining OTTI, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at the determination date.

 

When OTTI is determined to have occurred, the amount of the OTTI recognized in earnings depends on whether we intend to sell the security or it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss. If we intend to sell the security or it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss, the OTTI recognized in earnings is equal to the entire difference between its amortized cost basis and its fair value at the balance sheet date. If we do not intend to sell the security and it is not more likely than not that we will be required to sell the security before recovery of its amortized cost basis less any current-period loss, the OTTI is separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized as a charge to earnings. The amount of the OTTI related to other factors is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment. The Company recorded no OTTI for the six months ended June 30, 2012.

 

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Other Real Estate Owned

 

Assets acquired through or in lieu of loan foreclosure are initially recorded at fair value, less estimated selling costs, at the date of foreclosure, establishing a new cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Costs relating to improvement of property are capitalized, whereas costs relating to the holding of property are expensed.

 

Deferred Income Taxes

 

After converting to a federally chartered savings association, Atlantic Coast Bank became a taxable organization. Income tax expense (benefit) is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary difference between carrying amounts and tax basis of assets and liabilities, computed using enacted tax rates and operating loss carryforwards. The Company’s principal deferred tax assets result from the allowance for loan losses and operating loss carryforwards. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. The Internal Revenue Code and applicable regulations are subject to interpretation with respect to the determination of the tax basis of assets and liabilities for credit unions that convert charters and become a taxable organization. Since Atlantic Coast Bank’s transition to a federally chartered thrift, the Company has recorded income tax expense based upon management’s interpretation of the applicable tax regulations. Positions taken by the Company in preparing our federal and state tax returns are subject to the review of taxing authorities, and the review by taxing authorities of the positions taken by management could result in a material adjustment to the financial statements.

 

All available evidence, both positive and negative, is considered when determining whether or not a valuation allowance is necessary to reduce the carrying amount to a balance that is considered more likely than not to be realized. The determination of the realizability of deferred tax assets is highly subjective and dependent upon judgment concerning management’s evaluation of such evidence. Positive evidence considered includes the probability of achieving forecasted taxable income and the ability to implement tax planning strategies to accelerate taxable income recognition. Negative evidence includes the Company’s cumulative losses. Following the initial establishment of a valuation allowance, if the Company is unable to generate sufficient pre-tax income in future periods or otherwise fails to meet forecasted operating results, an additional valuation allowance may be required. Any valuation allowance is required to be recorded during the period identified. As of June 30, 2012, the Company had a valuation allowance of $27.4 million for the net deferred tax asset.

 

Comparison of Financial Condition at June 30, 2012 and December 31, 2011

 

General. Total assets decreased $10.4 million, or 1.3%, to $778.5 million at June 30, 2012 as compared to $789.0 million at December 31, 2011. The primary reason for the decrease in assets was a decrease in loans, net of $50.2 million, partially offset by an increase in cash and cash equivalents of $23.8 million and an increase in securities available for sale of $19.6 million as the Company continued to manage its balance sheet consistent with its capital preservation strategy and to increase the Company’s liquidity position. Total deposits decreased $7.9 million, or 1.6%, to $500.5 million at June 30, 2012 from $508.4 million at December 31, 2011. Time deposits decreased by $8.6 million while non-maturing deposits consisting of non-interest bearing and interest bearing demand accounts and savings and money market accounts grew by $711,000 during the six months ended June 30, 2012. Stockholders’ equity decreased by $2.3 million to $44.0 million at June 30, 2012 from $46.3 million at December 31, 2011 due to the net loss of $4.7 million for the six months ended June 30, 2012, offset by an increase in other comprehensive income of $2.4 million.

 

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Following is a summarized comparative balance sheet as of June 30, 2012 and December 31, 2011:

 

   June 30,   December 31,   Increase (decrease) 
   2012   2011   Dollars   Percentage 
   (Dollars in Thousands) 
Assets                    
Cash and cash equivalents  $64,772   $41,017   $23,755    57.9%
Securitites available for sale   146,383    126,821    19,562    15.4%
Loans   467,819    521,233    (53,414)   -10.2%
Allowance for loan losses   12,339    15,526    (3,187)   -20.5%
Loans, net   455,480    505,707    (50,227)   -9.9%
Loans held for sale   57,806    61,619    (3,813)   -6.2%
Other assets   54,093    53,803    290    0.5%
Total assets  $778,534   $788,967   $(10,433)   -1.3%
                     
Liabilities and Stockholders' equity                    
Deposits                    
Non-interest bearing demand  $40,538   $34,586   $5,952    17.2%
Interest bearing demand   77,066    76,811    255    0.3%
Savings and money market   193,838    199,334    (5,496)   -2.8%
Time   189,039    197,680    (8,641)   -4.4%
Total deposits   500,481    508,411    (7,930)   -1.6%
Federal Home Loan Bank advances   135,000    135,000    -    0.0%
Securities sold under agreements to repurchase   92,800    92,800    -    0.0%
Accrued expenses and other liabilities   6,263    6,462    (199)   -3.1%
Total liabilities   734,544    742,673    (8,129)   -1.1%
Stockholders' equity   43,990    46,294    (2,304)   -5.0%
Total liabilities and stockholders' equity  $778,534   $788,967   $(10,433)   -1.3%

 

Cash and cash equivalents. Cash and cash equivalents increased $23.8 million to $64.8 million at June 30, 2012 from $41.0 million at December 31, 2011.

 

Securities available for sale. Securities available for sale was comprised primarily of debt securities of U.S. Government-sponsored enterprises, and mortgage-backed securities. The investment portfolio increased approximately $19.6 million to $146.4 million at June 30, 2012, from $126.8 million at December 31, 2011. As of June 30, 2012, approximately $119.4 million of securities available for sale were pledged as collateral for the securities sold under agreements to repurchase. At June 30, 2012, approximately $145.4 million, or 99%, of the debt securities held by the Company were issued by U.S. government-sponsored entities and agencies, primarily Fannie Mae, Freddie Mac and Ginnie Mae, institutions which the government has affirmed its commitment to support.

 

Loans held for sale. Loans held for sale were comprised primarily of loans secured by one- to four-family residential homes originated internally or purchased from third-party originators. Loans held for sale included $2.9 million of non-performing loans which were sold subsequent to June 30, 2012. Loans held for sale decreased $3.8 million, or 6.2% to $57.8 million at June 30, 2012 as compared to $61.6 million at December 31, 2011 primarily due to a decrease in loan production from our warehouse lending operations. As of June 30, 2012, the weighted average number of days outstanding of loans held for sale was 23 days.

 

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During the six months ended June 30, 2012, the Company originated a total of $402.7 million of loans held for sale, comprised of approximately $23.9 million of one- to four-family residential loans originated internally, and approximately $378.8 million of one- to four-family residential loans purchased from third parties under warehouse loan agreements. Approximately $406.1 million of the one- to four-family residential loans were sold, resulting in a gain of $1.2 million and interest earned of $1.1 million on outstanding balances which was recorded in interest income. The Company intends to continue to focus on opportunities to grow the warehouse line of business in the near future due to its favorable margins and efficient capital usage.

 

Loans. Below is a comparative composition of net loans as of June 30, 2012 and December 31, 2011, excluding loans held for sale:

 

   June 30, 2012   % of total
loans
   December 31,
2011
   % of total
loans
 
   (Dollars in Thousands) 
Real estate loans:                    
One-to-four family  $218,109    47.2%  $241,453    46.9%
Commercial   62,570    13.6%   72,683    14.1%
Other ( land and multi-family)   22,487    4.9%   29,134    5.7%
Total real estate loans   303,166    65.7%   343,270    66.7%
                     
Real estate construction loans:                    
One-to-four family   567    0.1%   2,044    0.4%
Commercial   4,036    0.9%   4,083    0.8%
Acquisition and development   -    0.0%   -    0.0%
Total real estate construction loans   4,603    1.0%   6,127    1.2%
                     
Other loans:                    
Home equity   68,767    14.9%   74,199    14.4%
Consumer   63,529    13.8%   67,850    13.2%
Commercial   21,343    4.6%   23,181    4.5%
Total other loans   153,639    33.3%   165,230    32.1%
                     
Total loans   461,408    100%   514,627    100%
                     
Allowance for loan losses   (12,339)        (15,526)     
Net deferred loan costs   6,534         6,730      
Discounts on purchased loans   (123)        (124)     
                     
Loans, net  $455,480        $505,707      

 

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Total portfolio loans declined $53.2 million, or approximately 10.3%, to $461.4 million at June 30, 2012 as compared to $514.6 million at December 31, 2011 due to increased payoffs of one- to four-family residential and commercial real estate loans during the six months ended June 30, 2012 as a result of increased refinancing in the low interest rate environment along with increased transfers to OREO of non-performing loans. Portfolio loan originations decreased $5.0 million to $13.2 million for the six months ended June 30, 2012 from $18.2 million for the same period in 2011.

 

Small business loan originations, including SBA loans, were $6.9 million during the six months ended June 30, 2012. The Company intends to sell the guaranteed portion of SBA loans upon completion of loan funding to increase non-interest income. The Company plans to continue to expand this business line going forward.

 

Consistent with its capital preservation and risk management policies, the Company does not intend to generally portfolio originated loans, but rather continue to emphasize the sale of mortgages it originates in the secondary market in the near term.

 

The composition of the Bank’s loan portfolio is heavily weighted toward one- to four-family residential loans. As of June 30, 2012, first mortgages (including residential construction loans), second mortgages and home equity loans totaled $287.4 million, or 62.3% of total gross loans. Approximately $42.2 million, or 61.3% of loans recorded as home equity loans are in a first lien position. Accordingly, $260.9 million, or 90.7% of loans collateralized by one- to four-family residential loans were in a first lien position as of June 30, 2012.

 

   Florida   Georgia   Other States   Total 
   (Dollars in Thousands) 
1-4 Family First Mortgages  $144,472   $43,314   $30,323   $218,109 
1-4 Family Second Mortgages   32,601    35,071    1,095    68,767 
1-4 Family Construction Loans   567    -    -    567 
   $177,640   $78,385   $31,418   $287,443 

 

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Allowance for loan losses. The allowance for loan losses was $12.3 million, or 2.64% of total loans at June 30, 2012 compared to $15.5 million or 2.98% of total loans outstanding at December 31, 2011.

 

The allowance for loan losses activity for the six months ended June 30, 2012 and 2011 was as follows:

 

   June 30,   June 30, 
   2012   2011 
         
Balance at beginning of period  $15,526   $13,344 
           
Charge-offs:          
Real Estate Loans          
One-to four-family   4,301    3,399 
Commercial   2,138    177 
Other (Land & Multi-family)   1,585    103 
Real Estate Construction Loans          
Construction One-to four family   -    - 
Construction Commercial   202    - 
Acquistion & Development   -    - 
Other Loans          
Home equity   2,044    1,741 
Consumer   780    444 
Commercial   71    15 
Total charge-offs   11,121    5,879 
           
Recoveries:          
Real Estate Loans          
One-to four-family   471    251 
Commercial   2    21 
Other (Land & Multi-family)   -    34 
Real Estate Construction Loans          
Construction One-to four family   -    - 
Construction Commercial   -    - 
Acquistion & Develpoment   -    - 
Other Loans          
Home equity   71    24 
Consumer   172    125 
Commercial   2    - 
Total recoveries   718    455 
           
Net charge-offs   10,403    5,424 
Provision for loan losses   7,216    5,764 
Balance at end of period  $12,339   $13,684 

 

Net charge-offs in the first half of 2012 increased over the same period in 2011 primarily due to increased sales of non-performing loans. During the six months ended June 30, 2012, the Bank sold, or entered into contracts to sell, approximately $11.0 million of non-performing loans. These transactions have resulted in total charge-offs of approximately $3.6 million and additional provision for loan losses of $1.6 million. The net charge-offs on sales of non-performing loans was comprised of $1.6 million for one-to four-family residential loans and $2.0 million for non- residential commercial real estate loans. The Company seeks to reduce non-performing loans in the least costly way possible, including workout, restructure, short sales and when necessary foreclosure and disposal of collateral. Loans the company holds for sale are recorded at the lower of cost or market and reported as held for sale. As of June 30, 2012, the Company had non-performing loans held for sale of $2.9 million which were sold in July 2012.

 

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Net charge offs for the first half of 2012 also increased over the same period in 2011 due to a $700,000 charge-off of residential land loans. Similar charge-offs in 2011 were $69,000. Finally, net charge-offs for the six months ended June 30, 2012, also increased approximately $1.2 million for the charge-off of collateral dependent loans, the impairment for which had been reserved for in 2011, and the Company had determined no other sources of repayment exist.

 

It is the Company’s policy to charge-off one- to four-family first mortgages and home equity loans to the estimated fair value of the collateral at the time the loan becomes non-performing. Following the same policy the Company charges- off the entire balance of second position home equity loans at the time the loan becomes non-performing. During the six months ended June 30, 2012, charge-offs include partial charge-offs of approximately $2.2 million of one- to four-family first mortgages and home equity loans identified as non-performing, a decrease of $1.0 million as compared to $3.2 million for the same period in the prior year, principally attributable to reduced losses on one-to four family residential mortgages.

 

Non-performing assets:  June 30,   December 31, 
   2012   2011 
   (Dollars in Thousands) 
Real Estate Loans          
One-to-four-family  $13,904   $16,108 
Commercial   9,051    14,238 
Other   1,609    5,153 
           
Construction - One-to-four-family   -    - 
Construction - Commercial   2,362    2,362 
Construction - Acquisition & Development   -    - 
           
Other Loans - Consumer          
Home Equity   2,441    4,091 
Other   800    983 
Commercial   2,917    3,680 
           
Total non-performing loans   33,084    46,615 
Other real estate owned   7,708    5,839 
           
Total non-performing assets  $40,792   $52,454 
           
Non-performing loans to total loans   7.07%   8.94%
Non-performing assets to total assets   5.24%   6.65%

 

Non-performing loans were $33.1 million (including $2.9 million of non-performing loans in loans held for sale sold subsequent to June 30, 2012) or 7.07% of total loans at June 30, 2012 as compared to $46.6 million, or 8.94% of total loans at December 31, 2011. The decrease in non-performing loans was primarily due to the transfer of $5.1 million to other real estate owned, $2.7 million in short sales of residential loans, the sale of a $2.0 million non-performing commercial real estate loan, a charge-down of $1.7 million on another commercial real estate loan under contract for sale in the third quarter, and $1.2 million charged-off related to a residential loan sale that closed in July 2012.

 

During the first six months of 2012 the market for disposing of non-performing assets became more liquid leading to the sales described above. These types of transactions may result in additional losses over the amounts provided for in the allowance for loan losses however the Company continues to attempt to reduce non-performing assets through the least costly means possible. The allowance for loan losses is determined by the information available at the time such determination is made and reflects management’s best estimate of loss.

 

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As of June 30, 2012, total non-performing one- to four-family residential and home equity loans of $16.3 million included $12.9 million of one- to four-family residential loans that had been written-down to the estimated fair value of their collateral at the date that the loan was classified as non-performing. Further declines in the fair value of the collateral, or a decision to sell loans as distressed assets, could result in additional losses. As of June 30, 2012, and December 31, 2011, all non-performing loans were classified as non-accrual, and there were no loans 90 days past due and accruing interest as of June 30, 2012 and December 31, 2011.

 

Other real estate owned increased $1.9 million to $7.7 million at June 30, 2012 as transfers from non-performing loans into other real estate owned of approximately $5.7 million exceeded foreclosed asset sales of $3.8 million during the first six months of 2012.

 

At June 30, 2012 the five largest non-performing loans were as follows. The largest relationship was comprised of loans totaling $6.9 million secured by owner occupied commercial real estate and business assets. The borrower filed Chapter 11 bankruptcy in December 2010. The bankruptcy plan was confirmed in May 2012 and plan payments began in June 2012. The Bank’s second largest relationship was comprised of loans totaling $1.9 million secured by business assets and various properties including an owner occupied commercial building, two retail store locations and five one- to four-family residential lots. The third largest relationship was a $$1.7 million loan secured by a multi-family development adjacent to Disney World in central Florida. The project was halted during construction and is in foreclosure. The fourth largest relationship was comprised of loans totaling $1.7 million secured by a retail shopping center and vacant residential land. The fifth largest relationship was a $1.0 million loan secured by eight condominium units in northeast Florida.

 

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The tables below compare period-end allowance, (which includes the general component which is available for the entire loan portfolio and specific components of the allowance for loan losses) to non-performing loans as of June 30, 2012 and December 31, 2011:

 

   Comparison of Loan Loss Allowance to Non-Performing Loans 
   June 30, 2012 
   Non-
Performing
Loans
   Amount of
Loan Loss 
Allowance
   % of General
and Specific
Loan Loss
Allowance to
Non-
Performing
Loans
 
   (Dollars in Thousands) 
Real Estate Loans               
One-to four-family  $13,904   $4,773    34.33%
Commercial   9,051    1,956    21.61%
Other (land & multi-family)   1,609    713    44.31%
                
Real Estate Construction               
Construction One-to four family   -    -    - 
Construction Commercial   2,362    8    0.34%
Acquistion & Development   -    -    - 
                
Other Loans               
Home Equity   2,441    3,186    130.52%
Consumer   800    1,032    129.00%
Commercial   2,917    671    23.00%
Totals  $33,084   $12,339    37.30%

 

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   Comparison of Loan Loss Allowance to Non-Performing Loans 
   December 31, 2011 
             
   Non-
Performing
Loans
   Amount of
Loan Loss
Allowance
   % of General
and Specific
Loan Loss
Allowance to
Non-
Performing
Loans
 
   (Dollars in Thousands) 
Real Estate Loans               
One-to four-family  $16,108   $6,030    37.43%
Commercial   14,238    3,143    22.07%
Other (land & multi-family)   5,153    1,538    29.85%
                
Real Estate Construction               
Construction One-to four family   -    120    - 
Construction Commercial   2,362    -    0.00%
Acquistion & Development   -    -    - 
                
Other Loans               
Home Equity   4,091    3,125    76.39%
Consumer   983    885    90.03%
Commercial   3,680    685    - 
Totals  $46,615   $15,526    33.31%

 

The percentage of general and specific loan loss allowance to non-performing loans increased at June 30, 2012 as compared to year end 2011, primarily due to the decline in large balance non-performing commercial real estate loans and other commercial real estate loans and therefore a reduction in specific reserves. In addition the general reserve for one-to four family residential loans declined due to reduced delinquencies.

 

Specific reserves of $1.1 million on a commercial real estate loan as of December 31, 2011 were charged-off during the six months ended June 30, 2012 as a result of the Company’s agreement to allow a borrower to sell the income producing collateral in order to settle the loan. Following the charge-off of the specific reserve the remaining non-performing loan balance was $1.3 million. Specific reserves on other commercial real estate loans of approximately $900,000 as of December 31, 2011, were charged off during the first six months of 2012 as the Company determined that collectability on the loans were entirely based on the sale of the collateral.

 

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Impaired Loans. The following table shows impaired loans segregated by performing and non-performing and the associated specific reserve as of June 30, 2012 and December 31, 2011:

 

   June 30, 2012   December 31, 2011 
   Balance   Specific Reserve   Balance   Specific Reserve 
       (Dollars in
Thousands)
         
Performing  $2,575   $-   $179   $- 
                     
Non-performing   16,536    1,839    26,586    4,262 
                     
TDR by category:                    
                     
TDR-performing commercial   5,980    249    6,000    591 
                     
TDR-performing residential   14,032    1,767    13,337    1,104 
                     
Total impaired loans  $39,123   $3,855   $46,102   $5,957 

 

The increase in performing impaired loans was due to one commercial real estate loan.

 

The decline in non-performing impaired loans was primarily due to the transfer of $5.1 million in loans to other real estate owned, the sale of a $2.0 million commercial real estate loan and a charge-down of $1.7 million on another commercial real estate loan under contract for sale in the third quarter.

 

Impaired loans include large non-homogenous loans where it is probable that the Bank will not receive all principal and interest when contractually due. Impaired loans also include troubled debt restructurings (“TDRs”) where the borrower has performed for less than 12 months under the terms of the modification and/or the TDR loan is at less than market rate at the time of restructure. The assessment of market rate of interest for homogenous TDR loans is done based on the weighted average rates of those loans compared to prevailing interest rates at the time of restructure. When a TDR loan with a market rate of interest has performed for over 12 months under terms of the modification it is classified as a performing loan.

 

Troubled debt restructured loans totaled $20.0 million as of June 30, 2012 as compared to $19.3 million at December 31, 2011. Approximately $12.0 million of restructured loans demonstrated 12 months of performance under restructured terms and therefore are reported as performing or were paid off.

 

Deferred Income Taxes. As of both June 30, 2012 and December 31, 2011 the Company concluded that, while improved operating results are expected as the economy begins to improve and the Bank’s non-performing assets decline, the variability of the credit related costs are such that a more likely than not conclusion of realization of the Company’s deferred tax asset could not be supported. Consequently the Company has recorded a valuation allowance of $27.4 million for the full amount of the net federal and state deferred tax assets as of June 30, 2012. Until such time as the Company determines it is more likely than not that it is able to generate taxable income, no tax benefits will be recorded in future periods to reduce net losses before taxes. However, at such time in the future that the Company records taxable income or determines that realization of the deferred tax asset is more likely than not, some or all of the valuation allowance may be available as a tax benefit.

 

64
 

 

Deposits. Total deposits were $500.5 million at June 30, 2012, a decrease of $7.9 million from $508.4 million at December 31, 2011. Non-maturing deposits grew by $711,000 during the first six months of 2012, as the Bank leveraged consumers’ demonstrated preference for shorter duration, more liquid deposit products through targeted marketing promotional campaigns to grow non-maturity deposits. As a result, time deposits decreased by $8.6 million during the same time period. Non-maturing deposits grew modestly to $311.4 million at June 30, 2012, with interest-bearing demand and savings products offered under our successful reward programs experiencing the largest increase in new accounts and households. Time deposits decreased to $189.0 million as of June 30, 2012 primarily due to decreased time deposits acquired through brokers. As a part of its capital preservation strategy, the Bank intentionally lowered rates on time deposits beginning in the second half of 2009 in order to reduce those deposits consistent with loan balance decreases. Management believes near term deposit growth will be moderate with an emphasis on core deposits to match asset growth expectations. Dramatic changes in the short-term interest rate environment could affect the availability of deposits in our local market and therefore cause the Bank to change its strategy to promote time deposit growth in order to meet liquidity needs. Under Atlantic Coast Bank’s Supervisory Agreement with the Office of Thrift Supervision dated December 14, 2010, the Bank may not increase brokered deposits without prior written approval over the agreed upon amount of $52.5 million. At June 30, 2012 the Bank had brokered deposits of $19.5 million.

 

Securities sold under agreements to repurchase. The Bank has $92.8 million of securities sold under agreements to repurchase (“reverse repo”) comprised of structured notes with two different counterparties in amounts totaling $77.8 million and $15.0 million, respectively at June 30, 2012. The individual agreements take the form of term repurchase agreements with maturities beginning in 2014 and final maturities in 2018. The fair value of the securities collateralizing the reverse repos at June 30, 2012 was $119.4 million. The market value of the debt exceeded the principal balance outstanding by $15.6 million.

 

The agreements with the counterparty of the $77.8 million reverse repo contained default conditions which if triggered would materially impact the Bank’s capital and results of operations. The agreements with the counterparty as of the end of the second quarter 2012 gave the counterparty the option to terminate the debt at its market rate in the event the Bank were to become less than adequately capitalized or receive a cease and desist order from the OCC. As of June 30, 2012 the market value of the debt exceeded the principal balance outstanding by $12.7 million.

 

Subsequent to June 30, 2012 the Company entered into a revised agreement with the counterparty which eliminated the event of default which gave the counterparty the option to terminate the reverse repo agreements at the market value of the debt in the event the Bank becomes less than adequately capitalized or receives a cease and desist order from the OCC. Under the terms of the revised agreement the Bank will be required to pledge additional collateral if its capital ratios decrease below regulatory defined levels of well capitalized or adequately capitalized.

 

Information concerning securities sold under agreements to repurchase as of June 30, 2012 is summarized as follows:

 

   (Dollars in Thousands) 
Average daily balance during the period  $92,800 
Average interest rate during the period   5.16%
Maximum month-end balance  $92,800 
Weighted average interest rate at period end   5.16%

 

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Federal Home Loan Bank advances. FHLB advances remained unchanged at $135.0 million at June 30, 2012 as compared to December 31, 2011. FHLB advances had a weighted-average maturity of 49 months and a weighted-average rate of 3.88% at June 30, 2012. The Company was notified in March 2012 that the discount percentages used to determine our excess borrowing capacity with FHLB of Atlanta were reduced. In addition, during the first half of 2012, prepayments on loans pledged collateral as collateral for the FHLB advances resulted in lower balances of loans available to be used as collateral. Accordingly, our excess borrowing capacity was reduced by approximately $48.6 million to $15.2 million at June 30, 2012 from $63.8 million at December 31, 2011. Due to prepayments on loans pledged as collateral for the FHLB advances discussed above, the Company expects to utilize investment securities as collateral for the FHLB advances at some point during the remaining six months of 2012.

 

Stockholders’ equity. Stockholders’ equity decreased by approximately $2.3 million to $44.0 million at June 30, 2012 from $46.3 million at December 31, 2011 due to the net loss of $4.7 million for the six months ended June 30, 2012, offset by an increase in other comprehensive income of $2.4 million.

 

Beginning in 2009 and continuing into 2012, the Company implemented strategies to preserve capital including the suspension of cash dividends and its stock repurchase program. Resumption of these programs is not expected to occur in the near term. The Company’s equity to assets ratio decreased to 5.65% at June 30, 2012, from 5.87% at December 31, 2011. As of June 30, 2012, the Bank was not in compliance with the Individual Minimum Capital Requirement (IMCR) imposed on the Bank by the Office of Thrift Supervision on May 13, 2011. Under the IMCR, the Bank was required to achieve and maintain a Tier 1 leverage ratio of 7.0% as of September 30, 2011. Total risk-based capital to risk-weighted assets was 10.8%, Tier 1 capital to risk-weighted assets was 9.6%, and Tier 1 capital to adjusted total assets was 5.4% at June 30, 2012, respectively. These ratios as of December 31, 2011 were 10.9%, 9.7% and 5.8%, respectively.

 

Comparison of Results of Operations for the Three Months Ended June 30, 2012 and 2011.

 

General. Net loss for the three months ended June 30, 2012, was $3.0 million, as compared to a net loss of $1.5 million for the same period in 2011. The Company's higher net loss for the second quarter of 2012 reflected an increase in provision for loan losses of $774,000, a decrease in non-interest income of $756,000 primarily related to lower gains on the sale of available for sale securities and a decrease in net interest income of $321,000 due to lower average balances of interest-earning assets as well as lower average yields, partially offset by lower non-interest expense of $522,000, primarily in compensation and benefits.

 

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Average Balances, Net Interest Income, Yields Earned and Rates Paid. The following table sets forth certain information for the three months ended June 30, 2012 and 2011. The average yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods presented.

  

   For the three months ended June 30, 
   2012   2011 
   (Dollars in Thousands) 
   Average
Balance
   Interest   Average
Yield  /Cost
   Average
Balance
   Interest   Average
Yield  /Cost
 
INTEREST-EARNING ASSETS                              
Loans receivable(1)  $533,021   $7,730    5.80%  $585,034   $8,330    5.68%
Securites(2)   142,620    828    2.32%   154,086    1,273    3.32%
Other interest-earning assets(3)   65,226    65    0.40%   20,852    28    0.52%
Total interest-earning assets   740,867    8,623    4.64%   759,972    9,631    5.08%
Non-interest earning assets   35,768              47,642           
Total assets  $776,635             $807,614           
                               
INTEREST-BEARING LIABILITIES                              
Savings deposits  $78,982   $86    0.44%  $69,401   $111    0.64%
Interest bearing demand accounts   76,509    84    0.44%   75,325    236    1.24%
Money market accounts   121,899    144    0.48%   116,319    223    0.76%
Time deposits   181,072    684    1.52%   201,811    1,015    2.00%
Securities sold under agreements to repurchase   92,800    1,195    5.16%   92,800    1,195    5.16%
Federal Home Loan Bank advances   135,000    1,326    3.92%   152,225    1,426    3.76%
Other borrowings   -    -    -    34    -    0.00%
Total interest-bearing liabilities   686,262    3,519    2.04%   707,915    4,206    2.36%
Non-interest bearing liabilities   44,332              44,047           
Total liabilities   730,594              751,962           
Stockholders' equity   46,041              55,652           
Total liabilities and stockholders' equity  $776,635             $807,614           
                               
Net interest income       $5,104             $5,425      
Net interest spread             2.60%             2.72%
Net earning assets  $54,605             $52,057           
Net interest margin(4)             2.76%             2.86%
Average interest-earning assets to average interest-bearing liabilities        107.96%             107.35%     

 

(1)Calculated net of deferred loan fees. Nonaccrual loans included as loans carrying a zero yield, includes loans held for sale.
(2)Calculated based on carrying value. Not full tax equivalents, as the numbers would not change materially from those presented in the table.
(3)Includes Federal Home Loan Bank stock at cost and term deposits with other financial institutions.
(4)Net interest income divided by average interest-earning assets.

 

67
 

 

Rate/Volume Analysis. The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities for the three months ended June 30, 2012 as compared to the same period in 2011. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in volume multiplied by the old rate; and (2) changes in rate, which are changes in rate multiplied by the old volume; and (3) changes not solely attributable to rate or volume have been allocated proportionately to the change due to volume and the change due to rate.

 

   Increase/(Decrease)   Total 
   Due to   Increase 
   Volume   Rate   (Decrease) 
   (Dollars in Thousands) 
INTEREST-EARNING ASSETS               
Loans receivable  $(752)  $152   $(600)
Securities   (89)   (356)   (445)
Other interest-earning assets   46    (9)   37 
Total interest-earning assets   (795)   (213)   (1,008)
                
INTEREST-BEARING LIABILITIES               
Savings deposits   14    (38)   (24)
Interest bearing demand accounts   4    (157)   (153)
Money market accounts   10    (89)   (79)
Time deposits   (97)   (234)   (331)
Securities sold under agreements to repurchase   -    -    - 
Federal Home Loan Bank advances   (167)   67    (100)
Other borrowings   -    -    - 
Total interest-bearing liabilities   (236)   (451)   (687)
                
Net interest income  $(559)  $238   $(321)

 

Interest income. Total interest income decreased $1.0 million to $8.6 million for the three months ended June 30, 2012 from $9.6 million for the three months ended June 30, 2011 primarily due to the decrease in interest income on loans and securities. Interest income on loans decreased to $7.7 million for the three months ended June 30, 2012 from $8.3 million for the same period in 2011. This decrease was due to a decline in the average balance of loans, which decreased $52.0 million to $533.0 million for the three months ended June 30, 2012 from $585.0 million for the prior year period, partially offset by an increase in average yield on loans of 12 basis points to 5.80% for the three months ended June 30, 2012. Interest income earned on securities decreased $445,000 to $828,000 for the three months ended June 30, 2012 from $1.3 million for the same period in 2011. This decrease was due to the lower interest rates available on new purchases of securities combined with the decline in the average balance of securities of $11.5 million to $142.6 million for the three months ended June 30, 2012, which resulted in a 100 basis point decline in average yield of securities to 2.32% for the three months ended June 30, 2012. Due to the decline in yield, the decrease in the average balance of interest-earning assets and the mix of interest-earning assets related to our capital preservation strategy, the Company expects interest income to be lower during 2012 as compared to 2011.

 

Interest expense. Interest expense declined by $687,000 to $3.5 million for the three months ended June 30, 2012 from $4.2 million for the three months ended June 30, 2011. The decrease in interest expense for the three months ended June 30, 2012, as compared to the same period in 2011, was due to lower average rates paid on interest-bearing deposits, as well as the decrease in average outstanding balances of time deposits and FHLB advances. The average rate paid on deposits decreased 48 basis points to 0.80% for the three months ended June 30, 2012 as compared to 1.28% for the same period in 2011 due to the low interest rate environment. The average balance of time deposits decreased $20.7 million to $181.1 million for the three months ended June 30, 2012 due to our strategic emphasis on increasing core deposits. The average balance of FHLB advances declined $17.2 million to $135.0 million for the three months ended June 30, 2012 due to repayments.

 

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Net interest income. Net interest income decreased $321,000 to $5.1 million for the three months ended June 30, 2012 from $5.4 million for the three months ended June 30, 2011, due to the decrease in interest income resulting from a reduction in average outstanding interest earning assets and lower average yields earned on those assets partially offset by decreased interest expense on deposits. Our net interest rate spread, which is the difference between the interest rate earned on interest-earning assets and the interest rate paid on interest-bearing liabilities, decreased 12 basis points to 2.60% for the second quarter of 2012 as compared to 2.72% for the same quarter in 2011. For the same comparative periods, our net interest margin, which is net interest income expressed as a percentage of our average interest earning assets, decreased 10 basis points to 2.76% as compared to 2.86% for the same quarter in 2011.

 

Provision for loan losses. Provision for loan losses of $3.7 million and $3.0 million were made during the three months ended June 30, 2012 and 2011, respectively. Net charge-offs for the three months ended June 30, 2012 were $4.9 million as compared to $2.8 million for the same period in 2011 which was the primary cause of the increased provision for loans losses in 2012 as compared to 2011 as additional loss was incurred in the disposal of non-performing loans. Net charge-offs for the three months ended June 30, 2012 included $1.2 million related to the sale of non-performing one- to four-family residential loans, $700,000 related to short sales of one- to four-family residential loans and higher charge-offs of $285,000 on home equity loans. Consistent with the Company’s policy to charge-down one-to four family first mortgages and home equity loans to the estimated fair value of the collateral at the time the loan becomes non-performing, net charge-offs in 2012 included $1.1 million of full and partial charge-offs as compared to $1.9 million for the same period in 2011.

 

Non-interest income. The components of non-interest income for the three months ended June 30, 2012 and 2011 were as follows:

 

       Increase(decrease) 
   2012   2011   Dollars   Percentage 
   (Dollars in Thousands) 
Service charges and fees  $786   $912   $(126)   -13.8%
Gain on sale of loans held for sale   381    412    (31)   -7.5%
Gain (loss) on available for sale securities   -    590    (590)   100.0%
Other than temporary impairment losses   -    (75)   75    100.0%
Bank owned life insurance earings   116    189    (73)   -38.6%
Interchange fees   408    395    13    3.3%
Other   108    132    (24)   -18.2%
   $1,799   $2,555   $(756)   -29.6%

 

Non-interest income for the three months ended June 30, 2012 decreased $756,000 to $1.8 million as compared to $2.6 million for the same three months in 2011. The decrease in non-interest income was primarily due to reductions in gains on sales of investment securities, service charges and fees and bank-owned life insurance. The Company recorded gains of $381,000 on loan sales of $216.8 million for the second quarter of 2012 as compared to gains of $412,000 on loan sales of $172.2 million for the three months ended June 30, 2011.

 

Interchange fees increased as a result of higher volume of transactions associated with our interest-bearing rewards checking program.

 

Services charges and fees, which are earned primarily based on transaction services for deposit account customers decreased as a result of decreased non-sufficient funds (NSF) activity. The Company expects continued decline in NSF fees as compared to 2011.

 

The Company expects to see moderate growth in gains on sales and servicing of SBA loans through the remainder of 2012 from its small business lending group.

 

69
 

 

Non-interest expense. The components of non-interest expense for the three months ended June 30, 2012 and 2011 were as follows:

 

       Increase(decrease) 
   2012   2011   Dollars   Percentage 
   (Dollars in Thousands) 
Compensation and benefits  $2,434   $2,718   $(284)   -10.4%
Occupancy and equipment   517    582    (65)   -11.2%
FDIC insurance premiums   272    176    96    54.5%
Foreclosed assets, net   79    191    (112)   -58.6%
Data processing   340    398    (58)   -14.6%
Outside professional services   694    654    40    6.1%
Collection expense and repossessed                    
asset losses   635    637    (2)   -0.3%
Other   1,037    1,174    (137)   -11.7%
   $6,008   $6,530   $(522)   -8.0%

 

Non-interest expense decreased $522,000 to $6.0 million for the three months ended June 30, 2012 from $6.5 million for the same three months ended June 30, 2011. Non-interest expense for the three months ended June 30, 2012 included lower compensation and benefits expenses as the Company reorganized its mortgage banking operations during 2011, reducing management positions and closing under-performing mortgage origination offices, which reduced non-interest expense by approximately $513,000 since April 2011.

 

Management expects non-interest expenses associated with collection and foreclosure activities will continue at elevated levels primarily as a result of on-going credit issues and the extended time involved in the foreclosure process in Florida.

 

Income tax. The Company recorded income tax expense of $150,000 for the three months ended June 30, 2012 related to a recent IRS examination of the 2008 tax return which resulted in the disallowance of certain bad debt expense deductions for which the Company had originally received a credit of $424,000. The recognition of future tax benefits or the reversal of the valuation reserve is dependent upon the Company’s ability to generate future taxable income.

 

Comparison of Results of Operations for the Six Months Ended June 30, 2012 and 2011.

 

General. Net loss for the six months ended June 30, 2012, was $4.7 million, which was an improvement of $234,000 from a net loss of $4.9 million for the same period in 2011. The Company's lower net loss for the first six months of 2012 reflected lower non-interest expense of $3.0 million, primarily in compensation and benefits, partially offset by the increase in provision for loan losses of $1.5 million, a decrease in net interest income of $642,000 and a decrease in non-interest income of $491,000. The decrease in net interest income was due to lower average balances of interest-earning assets as well as lower average yields.

 

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Average Balances, Net Interest Income, Yields Earned and Rates Paid. The following table sets forth certain information for the six months ended June 30, 2012 and 2011. The average yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods presented.

  

   For the six months ended June 30, 
   2012   2011 
   (Dollars in Thousands) 
   Average
Balance
   Interest   Average
Yield  /Cost
   Average
Balance
   Interest   Average
Yield  /Cost
 
INTEREST-EARNING ASSETS                              
Loans receivable(1)  $547,088   $15,603    5.70%  $587,010   $16,892    5.76%
Securites(2)   137,204    1,653    2.40%   152,211    2,474    3.26%
Other interest-earning assets(3)   62,422    117    0.38%   23,641    58    0.50%
Total interest-earning assets   746,714    17,373    4.66%   762,862    19,424    5.10%
Non-interest earning assets   34,179              48,859           
Total assets  $780,893             $811,721           
                               
INTEREST-BEARING LIABILITIES                              
Savings deposits  $77,267   $192    0.50%  $67,560   $217    0.64%
Interest bearing demand accounts   76,416    222    0.58%   74,311    460    1.24%
Money market accounts   124,286    320    0.52%   117,009    457    0.78%
Time deposits   184,681    1,509    1.64%   211,935    2,140    2.02%
Securities sold under agreements to repurchase   92,800    2,392    5.16%   92,800    2,368    5.10%
Federal Home Loan Bank advances   135,000    2,651    3.92%   149,059    2,837    3.80%
Other borrowings   -    -    -    1,089    216    39.66%
Total interest-bearing liabilities   690,450    7,286    2.12%   713,763    8,695    2.44%
Non-interest bearing liabilities   43,901              43,434           
Total liabilities   734,351              757,197           
Stockholders' equity   46,542              54,524           
Total liabilities and stockholders' equity  $780,893             $811,721           
                               
Net interest income       $10,087             $10,729      
Net interest spread             2.54%             2.66%
Net earning assets  $56,264             $49,099           
Net interest margin(4)             2.70%             2.81%
Average interest-earning assets to average interest-bearing liabilities        108.15%             106.88%     

 

(1)Calculated net of deferred loan fees. Nonaccrual loans included as loans carrying a zero yield, includes loans held for sale.
(2)Calculated based on carrying value. Not full tax equivalents, as the numbers would not change materially from those presented in the table.
(3)Includes Federal Home Loan Bank stock at cost and term deposits with other financial institutions.
(4)Net interest income divided by average interest-earning assets.

 

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Rate/Volume Analysis. The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities for the six months ended June 30, 2012 as compared to the same period in 2011. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in volume multiplied by the old rate; and (2) changes in rate, which are changes in rate multiplied by the old volume; and (3) changes not solely attributable to rate or volume have been allocated proportionately to the change due to volume and the change due to rate.

 

   Increase/(Decrease)   Total 
   Due to   Increase 
   Volume   Rate   (Decrease) 
   (Dollars in Thousands) 
INTEREST-EARNING ASSETS               
Loans receivable  $(1,140)  $(149)  $(1,289)
Securities   (226)   (595)   (821)
Other interest-earning assets   76    (17)   59 
Total interest-earning assets   (1,290)   (761)   (2,051)
                
INTEREST-BEARING LIABILITIES               
Savings deposits   29    (54)   (25)
Interest bearing demand accounts   12    (250)   (238)
Money market accounts   27    (164)   (137)
Time deposits   (254)   (377)   (631)
Securities sold under agreements to repurchase   -    23    23 
Federal Home Loan Bank advances   (274)   89    (185)
Other borrowings   (216)   -    (216)
Total interest-bearing liabilities   (676)   (733)   (1,409)
                
Net interest income  $(614)  $(28)  $(642)

 

Interest income. Total interest income decreased $2.0 million to $17.4 million for the six months ended June 30, 2012 from $19.4 million for the six months ended June 30, 2011 primarily due to the decrease in interest income on loans and securities. Interest income on loans decreased to $15.6 million for the six months ended June 30, 2012 from $16.9 million for the same period in 2011. This decrease was due to a decline in the average yield on loans of 6 basis points to 5.70% for the six months ended June 30, 2012 combined with a decline in the average balance of loans, which decreased $39.9 million to $547.1 million for the six months ended June 30, 2012 from $587.0 million for the prior year period. Interest income earned on securities decreased $821,000 to $1.7 million for the six months ended June 30, 2012 from $2.5 million for the same period in 2011. This decrease was due to lower interest rates available on new purchases of securities combined with the decline in the average balance of securities of $15.0 million, to $137.2 million for the six months ended June 30, 2012, which resulted in a 86 basis point decline in average yield of securities to 2.40% for the six months ended June 30, 2012. Due to the decrease in yield, the decrease in the average balance of interest-earning assets and the mix of interest-earning assets related to our capital preservation strategy, the Company expects interest income to be lower during 2012 as compared to 2011.

 

Interest expense. Interest expense declined by $1.4 million to $7.3 million for the six months ended June 30, 2012 from $8.7 million for the six months ended June 30, 2011. The decrease in interest expense for the six months ended June 30, 2012, as compared to the same period in 2011, was due to lower average rates paid on interest-bearing deposits, as well as the decrease in average outstanding balances of time deposits and FHLB advances. The average rate paid on deposits decreased 50 basis points to 0.90% for the six months ended June 30, 2012 as compared to 1.40% for the same period in 2011 due to the low interest rate environment. The average balance of time deposits decreased $27.3 million to $184.7 million for the six months ended June 30, 2012 due to our strategic emphasis on increasing core deposits. The average balance of FHLB advances declined $14.1 million to $135.0 million for the six months ended June 30, 2012 due to repayments.

 

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Net interest income. Net interest income decreased $642,000 to $10.1 million for the six months ended June 30, 2012 from $10.7 million for the six months ended June 30, 2011, primarily due to the decrease in interest income resulting from a reduction in average outstanding interest earning assets and lower average yields earned on those assets partially offset by decreased interest expense on deposits. Our net interest rate spread, which is the difference between the interest rate earned on interest-earning assets and the interest rate paid on interest-bearing liabilities, decreased 12 basis points to 2.54% for the first six months of 2012 as compared to 2.66% for the same period in 2011. For the same comparative periods, our net interest margin, which is net interest income expressed as a percentage of our average interest earning assets, decreased 11 basis points to 2.70% as compared to 2.81% for the same period in 2011.

 

Provision for loan losses. Provision for loan losses of $7.2 million and $5.8 million were made during the six months ended June 30, 2012 and 2011, respectively. Net charge-offs for the six months ended June 30, 2012 were $10.4 million as compared to $5.4 million for the same period in 2011 which was the primary cause of the increased provision for loans losses in 2012 as compared to 2011 as additional loss was incurred in the disposal of non-performing loans. Net charge-offs for the six months ended June 30, 2012 included $1.6 million for an income producing commercial real estate loan, of which $1.1 million had been reserved for in 2011, $900,000 related to collateral dependent loans, $1.2 million related to the sale of non-performing one- to four-family residential loans, $700,000 related to short sales of one- to four-family residential loans, and higher charge-offs of $300,000 on home equity loans. Consistent with the Company’s policy to charge-down one-to four family first mortgages and home equity loans to the estimated fair value of the collateral at the time the loan becomes non-performing, net charge-offs in 2012 included $2.2 million of full and partial charge-offs as compared to $3.2 million for the same period in 2011.

 

Non-interest income. The components of non-interest income for the six months ended June 30, 2012 and 2011 were as follows:

 

       Increase(decrease) 
   2012   2011   Dollars   Percentage 
   (Dollars in Thousands) 
Service charges and fees  $1,570   $1,826   $(256)   -14.0%
Gain on sale of loans held for sale   1,118    807    311    38.5%
Gain (loss) on available for sale securities   -    722    (722)   100.0%
Other than temporary impairment losses   -    (186)   186    100.0%
Bank owned life insurance earings   232    377    (145)   -38.5%
Interchange fees   812    644    168    26.1%
Other   222    255    (33)   -12.9%
   $3,954   $4,445   $(491)   -11.0%

 

Non-interest income for the six months ended June 30, 2012 decreased $491,000 to $4.0 million as compared to $4.4 million for the same six months in 2011. The decrease in non-interest income was primarily due to reductions in gains on sales of investment securities. The increased gain on sales of loans held for sale was primarily the result of our small business lending operations which accounted for $438,000, or all of the increased gain on sale of loans. The Company recorded gains of $1.1 million on loan sales of $406.1 million for the six months ended June 30, 2012 as compared to gains of $807,000 on loan sales of $295.8 million for the six months ended June 30, 2011.

 

Interchange fees increased as a result of higher volume of transactions associated with our interest-bearing rewards checking program.

 

Services charges and fees, which are earned primarily based on transaction services for deposit account customers decreased as a result of decreased non-sufficient funds (NSF) activity. The Company expects continued decline in NSF fees as compared to 2011.

 

The Company expects to see moderate growth in gains on sales and servicing of SBA loans through the remainder of 2012 from its small business lending group.

 

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Non-interest expense. The components of non-interest expense for the six months ended June 30, 2012 and 2011 were as follows:

 

       Increase(decrease) 
   2012   2011   Dollars   Percentage 
   (Dollars in Thousands) 
Compensation and benefits  $4,624   $6,689   $(2,065)   -30.9%
Occupancy and equipment   1,033    1,165    (132)   -11.3%
FDIC insurance premiums   547    572    (25)   -4.4%
Foreclosed assets, net   (74)   150    (224)   -149.3%
Data processing   670    792    (122)   -15.4%
Outside professional services   1,468    1,143    325    28.4%
Collection expense and repossessed asset losses   1,121    1,536    (415)   -27.0%
Other   1,991    2,302    (311)   -13.5%
   $11,380   $14,349   $(2,969)   -20.7%

 

Non-interest expense decreased $2.9 million to $11.4 million for the six months ended June 30, 2012 from $14.3 million for the same six months ended June 30, 2011. Non-interest expense for the six months ended June 30, 2012 included lower compensation and benefits expense. Compensation and benefit costs were elevated in the first six months of 2011, as the Company recorded additional benefit expense of $782,000 related to the restoration of supplemental executive retirement plans that partially vested with the completion of the Company's second-step conversion and offering. Also, the Company reorganized its mortgage banking operations during 2011, reducing management positions and closing under-performing mortgage origination offices, which reduced non-interest expense by approximately $1.0 million since April 2011. Expenses related to certain benefit plans were $349,000 lower for the six months ended June 30, 2012 as compared to the prior period. Expenses related to collection and foreclosed assets decreased due to increased gains on sales of other real estate owned of approximately $224,000.

 

Management expects non-interest expenses associated with collection and foreclosure activities will continue at elevated levels primarily as a result of on-going credit issues and the extended time involved in the foreclosure process in Florida.

 

Income tax. The Company recorded income tax expense of $150,000 for the six months ended June 30, 2012 related to a recent IRS examination of the 2008 tax return which resulted in the disallowance of certain bad debt expense deductions for which the Company had originally received a credit of $424,000. The recognition of future tax benefits or the reversal of the valuation reserve is dependent upon the Company’s ability to generate future taxable income.

 

Liquidity

 

Management maintains a liquidity position it believes will adequately provide funding for loan demand and deposit run-off that may occur in the normal course of business. Atlantic Coast Financial Corporation relies on a number of different sources in order to meet its potential liquidity demands. The primary sources of funds are increases in borrowings, deposit accounts and cash flows from loan payments and securities sales. The scheduled amortization of loans and securities as well as proceeds from borrowings, are predictable sources of funds. In addition held-for-sale loans, principally warehouse loans, repay rapidly with an average duration of less than 30 days, with repayments generally funding advances. Other funding sources, however, such as inflows from new deposits, mortgage prepayments and mortgage loan sales are greatly influenced by market interest rates, economic conditions and competition.

 

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In addition to these primary sources of funds, management has several contingent liquidity sources available to meet potential funding requirements. As of June 30, 2012 and December 31, 2011, the Company had additional borrowing capacity of $15.2 million and $63.8 million, respectively, with the FHLB of Atlanta. During the first six months of 2012 the Company’s borrowing capacity was reduced following a FHLB of Atlanta credit and collateral review. During the second quarter of 2012 the Bank was notified by the Federal Reserve Bank of Atlanta that it is no longer eligible to borrow under the Primary Credit program and that it no longer has daylight overdraft capacity available. The Bank has not participated in these programs in the past. Unpledged marketable investment securities were approximately $22.9 million as of June 30, 2012 and $4.8 million as of December 31, 2011. The Company also utilizes a non-brokered Direct Deposit certificate of deposit listing service to meet funding needs at interest rates equal to or less than local market rates.

 

During the six months ended June 30, 2012, cash and cash equivalents increased $23.8 million from $41.0 million as of December 31, 2011 to $64.8 million as of June 30, 2012. Cash from operating activities of $9.2 million and cash from investing activities of $22.5 million was more than cash used in financing activities of $7.9 million. Primary sources of cash were from sales of loans held for sale of $406.1 million, proceeds from maturities and payments of available-for-sale securities of $16.0 million, net decreases in loans of $34.9 million and proceeds from the sale of other real estate owned of $3.8 million. Primary uses of cash included loans originated for sale of $402.7 million, purchases of available-for-sale securities of $33.8 million and decreases in deposits of $7.9 million.

 

During the six months ended June 30, 2011, cash and cash equivalents increased $19.2 million from $8.6 million as of December 31, 2010, to $27.8 million as of June 30, 2011. Cash from investing activities of $40.2 million and cash from operations of $656,000 was more than cash used in financing activities of $21.6 million. Primary sources of cash were from sales of loans held for sale of $295.8 million, capital contribution as result of the completion of the second-step conversion and offering of $13.8 million, proceeds from maturities and payments of available-for-sale securities of $21.2 million, proceeds from sales of securities available-for-sale of $45.5 million, net decreases in loans of $13.1 million and proceeds from FHLB borrowings of $51.0 million. Primary uses of cash included loans originated for sale of $298.3 million, purchases of available-for-sale securities of $42.3 million, decreases in deposits of $31.0 million, repayments of FHLB borrowings of $50.0 million and repayments of other borrowings of $8.3 million.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The Bank is subject to interest rate risk to the extent that its interest-bearing liabilities, primarily deposits and FHLB advances, re-price more rapidly or at different rates than its interest-earning assets. In order to minimize the potential for adverse effects of material prolonged increases or decreases in interest rates on our results of operations, management has adopted an asset and liability management policy. The board of directors sets the asset and liability policy for the Company, which is implemented by the Asset/Liability Committee.

 

The purpose of the Asset/Liability Committee is to communicate, coordinate and control asset/liability management consistent with our business plan and board approved policies. The Asset/Liability Committee establishes and monitors the volume and mix of assets and funding sources taking into account relative costs and spreads, interest rate sensitivity and liquidity needs. The objectives are to manage assets and funding sources to produce results that are consistent with liquidity, capital adequacy, growth, risk, and profitability goals.

 

The Asset/Liability Committee generally meets at least monthly to review, among other things, economic conditions and interest rate outlook, current and projected liquidity needs and capital position, anticipated changes in the volume and mix of assets and liabilities and interest rate exposure limits versus current projections pursuant to market value of portfolio equity analysis and income simulations. The Asset/Liability Committee recommends appropriate strategy changes based on this review. The Asset/Liability Committee is responsible for reviewing and reporting the effects of the policy implementations and strategies to the board of directors at least quarterly.

 

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A key element of our asset/liability plan is to protect net earnings by managing the maturity or re-pricing mismatch between its interest-earning assets and rate-sensitive liabilities. Historically, the Company has sought to reduce exposure to its earnings through the use of adjustable rate loans and through the sale of certain fixed rate loans in the secondary market, and by extending funding maturities through the use of FHLB advances.

 

Net Portfolio Value. Given the current relatively low level of market interest rates, an NPV calculation for an interest rate decrease of greater than 100 basis points has not been prepared. A basis point equals one-hundredth of one percent, and 100 basis points equals one percent. An increase in interest rates from 3% to 4% would mean, for example, a 100 basis point increase in the “Change in Interest Rates” column below.

 

Net Interest Income Sensitivity. 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 we pay on our interest-bearing liabilities, such as deposits and borrowings. In our model, we estimate what our net interest income would be for a rolling forward twelve-month period using historical data for assumptions such as loan prepayment rates and deposit decay rates, the current term structure for interest rates, and current deposit and loan offering rates. We then calculate what the net interest income would be for the same period in the event of an instantaneous 100, 200 and 300 basis point increase or a 100 basis point decrease in market interest rates.

 

As shown below the Company’s greatest risk is due to a decline in interest rates. This is due to the high level of debt at interest rates well above market. Due to the unusual interest rate environment, this debt is primarily fixed at rates well above market rates for comparable term debt.

 

At June 30, 2012 
                NPV as a Percentage of             
                Present Value of Assets (3)   Net Interest Income 
Change in                           Increase (Decrease) in 
Interest Rates                   Increase   Estimated   Estimated Net Interest 
(basis points)   Estimated   Estimated (Decrease) in NPV       (Decrease)   Net Interest   Income 
(1)   NPV (2)   Amount   Percent   NPV Ratio (4)   (basis points)   Income   Amount   Percent 
    (Dollars in Thousands) 
 +300   $34,335   $(2,701)   (7.29)%    4.44   (15)  $20,379   $1,265    6.62%
 +200    40,225    3,189    8.61   5.10%   51    20,381    1,267    6.63%
 +100    39,581    2,545    6.87%   4.95   37    19,482    368    1.93%
 0    37,036    -    -    4.59%   -    19,114    -    - 
 -100    30,894    (6,142)   (16.58)%   3.83%   (76)   18,697    (417)   (2.18)%

 

 

(1)Assumes an instantaneous uniform change in interest rates at all maturities.
(2)NPV is the discounted present value of expected cash flows from assets, liabilities and off-balance sheet contracts.
(3)Present value of assets represents the discounted present value of incoming cash flows on interest-earning assets.
(4)NPV Ratio represents NPV divided by the present value of assets.

 

Certain shortcomings are inherent in the methodologies used in determining interest rate risk through changes in net portfolio value and net interest income. Modeling changes require making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the net portfolio value and net interest income information presented assume that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assume that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or re-pricing of specific assets and liabilities. Accordingly, although interest rate-risk calculations provide an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results.

 

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ITEM 4. CONTROLS AND PROCEDURES

 

(a) Evaluation of disclosure controls and procedures. As of the end of the period covered by this Quarterly Report on Form 10-Q, the Registrant’s principal executive officer and principal financial officer have concluded that the Registrant’s disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities and Exchange Act of 1934 (the “Exchange Act”)) are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.

 

(b) Changes in internal controls. There were no changes in the Registrant’s internal control over financial reporting (as defined in Rule 13a-15(f)) that occurred during the quarter ended June 30, 2012, that have materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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ATLANTIC COAST FINANCIAL CORPORATION

 

FORM 10-Q

 

June 30, 2012

 

Part II - Other Information

Item 1.Legal Proceedings

The Company is involved in various legal actions and claims arising in the normal course of business. In the opinion of management, these legal actions and claims are not expected to have a material adverse impact on the Company’s financial condition and results of operations.

 

Item 1A.Risk Factors

In addition to the risk factors in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, investors should consider the risk factors below before investing in our common stock.

 

Reductions by the Federal Home Loan Bank of Atlanta (“FHLB”) in the assessed value of loan collateral pledged for the Bank’s FHLB debt and increased prepayment speed of residential loans will likely cause a shortfall in loan collateral and mean that the Bank will have to acquire and pledge investment securities in order to meet collateral requirements which may cause earnings to suffer and reduce total available liquidity.

 

Due to the Bank’s credit rating with the FHLB, the assessed value of loan collateral was decreased during the quarter ended June 30, 2012. In addition the largest loan category pledged as collateral for the FHLB debt, one-to four- family residential mortgages has experienced faster prepayments due to the low mortgage rate environment. The Bank expects that during the third quarter of 2012 the FHLB assessed value of pledged loan balances will fall below the outstanding loan balance resulting in a collateral short fall. In order to meet collateral requirements, the Bank will acquire and pledge collateral eligible securities to the FHLB. Due to current low yields available on such securities as compared to yields available on other interest-earning assets it is likely revenues will be less and earnings will be negatively impacted. Further, pledging investment securities that otherwise could be available for liquidity needs may impact the Bank’s ability to meet loan growth or other liquidity needs.

 

Reduced borrowing capacity with the FHLB and Federal Reserve Bank of Atlanta could impact the Bank’s ability to meet liquidity demands and will require increased investment of readily marketable assets, such as mortgage backed securities in order to maintain a sufficient secondary source of liquidity which may cause earnings to suffer.

 

During the second quarter of 2012, the Bank’s borrowing capacity with the FHLB was reduced following an FHLB of Atlanta credit and collateral review. The Bank’s additional borrowing capacity was reduced to $15.2 million at June 30, 2012.

 

During the second quarter of 2012, the Bank was notified by the Federal Reserve Bank of Atlanta (“FRB”) that it is no longer eligible to borrow under the Primary Lending program and that it no longer has daylight overdraft capacity available. The FRB informed the Bank that it may be eligible to participate in the FRB’s Secondary Lending program when other sources of liquidity are unavailable. The Bank currently does not utilize services of the FRB that would necessitate use of daylight overdrafts, therefore this change is not expected to have a material impact on banking operations. Prior to the notice from the FRB the Bank utilized the FRB Primary Lending in its contingent liquidity but had not borrowed under the program for liquidity or other business purposes. In order to maintain sufficient sources of available liquidity the Bank intends to increase its holdings of readily marketable investment securities such as agency backed mortgage backed securities or increase the balances maintained in cash or cash equivalents. Presently, due to the unusually low interest rate environment such investment will result in lower earnings than available from loans or interest earning assets and will likely result in reduce earnings. Further the Bank may be unable to meet liquidity needs for loan growth demands or unusual levels of deposit withdrawals.

 

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The Bank has entered into a Consent Order with the OCC, which requires the Bank to develop strategic and capital plans to achieve and maintain specific capital levels, to implement liquidity and concentration risk management programs, to revise its problem asset reduction plan and to develop policies and procedures to prevent future violations of law or regulation. While subject to the Consent Order, the Bank’s management and board of directors will be required to focus a substantial amount of time on complying with its terms, which could adversely affect the Company’s financial performance. Non-compliance with the Consent Order may lead to additional corrective actions by the OCC which could negatively impact our operations and financial performance.

 

Effective August 10, 2011, the Bank entered into a Consent Order (the “Agreement”) with the OCC that provides, among other things, that:

 

•  within 10 days of the date of the Agreement, the Board must establish a compliance committee that will be responsible for monitoring and coordinating the Bank’s adherence to the provisions of the Agreement;
 
•  within 90 days of the date of the Agreement, the Board must develop and submit to the OCC for receipt of supervisory non-objection of at least a two-year strategic plan to achieve objectives for the Bank’s risk profile, earnings performance, growth, balance sheet mix, off-balance sheet activities, liability structure, capital and liquidity adequacy and update such plan each year by January 31 beginning on January 31, 2014;

 

• until such time as the OCC provides written supervisory non-objection of the Bank’s strategic plan, the Bank shall not significantly deviate from products, services, asset composition and size, funding sources, corporate structure, operations, policies, procedures and markets of the Bank that existed prior to the Agreement without receipt of prior non-objection from the OCC;

 

• by December 31, 2012, the Bank must achieve and maintain a total risk based capital of 13% of risk weighted assets and Tier 1 capital of 9% of adjusted total assets;

 

• within 60 days of the date of the Agreement, the Board shall develop and implement an effective internal capital planning process to assess the Bank’s capital adequacy in relation to its overall risks and to ensure maintenance of appropriate capital levels, which shall be no less than total risk based capital of 13% of risk weighted assets and Tier 1 capital of 9% of adjusted total assets;

 

• the Bank may not accept, renew or roll over any brokered deposit unless it has applied for and been granted a waiver of this prohibition by the Federal Deposit Insurance Corporation (“FDIC”);

 

• within 90 days of the date of the Agreement, the Board shall forward to the OCC for receipt of written supervisory non-objection a written capital plan for the Bank covering at least a two year period that achieves and maintains total risk based capital of 13% of risk weighted assets and Tier 1 capital of 9% of adjusted total assets in addition to certain other requirements;

 

•  the Bank may declare or pay a dividend or make a capital distribution only when it is in compliance with its approved capital plan and would remain in compliance with its approved capital plan after payment of such dividends or capital distribution and receives prior written approval of the OCC;

 

 

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• following receipt of written no supervisory objection of its capital plan, the Board shall monitor the Bank’s performance against the capital plan and shall review and update the plan annually no later than January 31 of each year, beginning with January 31, 2014;

 
• within 30 days of the date of the Agreement, the Board shall revise and maintain a comprehensive liquidity risk management program which assesses on an ongoing basis, the Bank’s current and projected funding needs, and that ensures that sufficient funds or access to funds exist to meet those needs;

 

• within 60 days of the date of the Agreement, the Board shall revise its problem asset reduction plan (“PARP”) the design of which shall be to eliminate the basis of criticism of those assets criticized as “doubtful”, “substandard” or “special mention” during the OCC’s most recent report of examination as well as any subsequent examination or review by the OCC and any other internal or external loan reviews;

 

•  within 60 days of the date of the Agreement, the Board shall revise its written concentration management program for identifying, monitoring, and controlling risks associated with asset and liability concentrations, including off-balance sheet concentrations;

 

•  the Bank’s concentration management program shall include a contingency plan to reduce or mitigate concentrations deemed imprudent for the Bank’s earnings, capital, or in the event of adverse market conditions, including strategies to reduce the current concentrations to Board established limits and a restriction on purchasing bank owned life insurance (“BOLI”) until such time as the BOLI exposure has been reduced below regulatory guidelines of

25% of total capital;

 

•  the Board shall immediately take all necessary steps to ensure that the Bank management corrects each violation of law, rule or regulation cited in the OCC’s most recent report of examination and within 60 days of the date of the Agreement, the Board shall adopt, implement, and thereafter ensure Bank adherence to specific procedures to prevent future violations and the Bank’s adherence to general procedures addressing compliance management of internal controls and employee education regarding laws, rules and regulations; and

 

•  the Agreement replaces and therefore terminates the Supervisory Agreement entered into between the Bank and the Office of Thrift Supervision on December 10, 2010. 

 

While subject to the Agreement, the Bank’s management and board of directors will be required to focus a substantial amount of time on complying with its terms, which could adversely affect the Company’s financial performance. There is also no guarantee that the Bank will be able to fully comply with the Agreement. In the event the Bank is in material non-compliance with the terms of the Agreement, the OCC has the authority to subject the Bank to additional corrective actions. In particular, if the Bank fails to achieve and maintain a total risk based capital of 13% of risk weighted assets and tier 1 capital of 9% of adjusted total assets by December 31, 2012, fails to submit a capital plan within 90 days of the date of the Agreement, or fails to implement a written capital plan for which the OCC has provided a written determination of no supervisory objection, then at the sole discretion of the OCC, the Bank may be deemed undercapitalized for purposes of the Agreement. If the OCC determines that the Bank is undercapitalized for purposes of the Agreement, it may at its discretion impose additional certain corrective actions on the Bank’s operations that are applicable to undercapitalized institutions. These corrective actions could negatively impact the Bank’s operations and financial performance.

 

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Item 2.Unregistered Sales of Equity Securities and Use of Proceeds

None.

 

Item 3.Defaults Upon Senior Securities

None

 

Item 4.Mine Safety Disclosures

Not applicable

 

Item 5.Other Information

None

 

Item 6.Exhibits
a.Exhibits
31.1Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.Certification of Chief Executive Officer and Chief Financial Officer of Atlantic Coast Financial Corporation pursuant to Section 906

 

101.INSXBRL Instance Document **
101.SCHXBRL Taxonomy Extension Schema Document **
101.CALXBRL Taxonomy Calculation Linkbase Document **
101 DEF XBRL Taxonomy Extension Definition Linkbase Document **
101 LAB XBRL Taxonomy Label Linkbase Document **
101.PREXBRL Taxonomy Presentation Linkbase Document **

 

 

** We have attached these documents formatted in XBRL (Extensible Business Reporting Language) as Exhibit 101 to this report. We advise users of this data that pursuant to Rule 406T of Regulation S-T, this interactive data file is deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.

 

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ATLANTIC COAST FINANCIAL CORPORATION

 

FORM 10-Q

 

June 30, 2012

 

Part II - Other Information

 

Signatures

 

Pursuant to the requirements 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.

 

  ATLANTIC COAST FINANCIAL CORPORATION
  (Registrant)
   
Date:  August 14, 2012 /s/ G. Thomas Frankland
  G. Thomas Frankland, President and Chief
  Executive Officer
  (Principal Executive Officer)
   
Date:  August 14, 2012 /s/ Thomas B. Wagers, Sr.
  Thomas B. Wagers, Sr. Senior Vice–President and
  Chief Financial Officer
  (Principal Financial and Accounting Officer)

 

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