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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2007
Commission File No: 0-24479
AF Financial Group
(Exact name of small business issuer as specified in its charter)
| Federally Chartered | 56-2098545 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
21 East Ashe Street
West Jefferson, North Carolina 28694
(Address of principal executive offices)
(336) 246-4344
(Issuer’s telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of January 31, 2008 there were 1,050,804 shares of the registrant’s common stock outstanding, $.01 par value.
Transitional Small Business Disclosure Format: Yes ¨ No x
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CONTENTS
Table of Contents
Condensed Consolidated Statements of Financial Condition
As of December 31, 2007 and June 30, 2007
| December 31, 2007 | June 30, 2007 | |||||||
| (Unaudited) | * | |||||||
Assets | ||||||||
Cash and cash equivalents: | ||||||||
Interest-bearing deposits | $ | 500,533 | $ | 5,162,487 | ||||
Noninterest-bearing deposits | 7,270,897 | 6,481,962 | ||||||
Securities available for sale | 23,842,948 | 17,358,676 | ||||||
Federal Home Loan Bank stock | 2,198,300 | 1,388,300 | ||||||
Loans | 215,006,324 | 194,829,571 | ||||||
Less allowance for loan losses | (1,653,849 | ) | (1,641,506 | ) | ||||
Loans receivable, net | 213,352,475 | 193,188,065 | ||||||
Loans held for sale | 981,610 | 2,089,000 | ||||||
Real estate owned | 1,610,000 | 2,226,611 | ||||||
Office properties and equipment, net | 12,232,383 | 12,524,161 | ||||||
Accrued interest receivable on loans | 1,263,398 | 1,088,188 | ||||||
Accrued interest receivable on investment securities | 322,422 | 260,041 | ||||||
Prepaid expenses and other assets | 1,688,685 | 1,542,314 | ||||||
Deferred income taxes, net | 278,119 | 372,428 | ||||||
Goodwill | 1,576,446 | 1,596,446 | ||||||
Total assets | $ | 267,118,216 | $ | 245,278,679 | ||||
Liabilities and Stockholders’ Equity | ||||||||
Liabilities: | ||||||||
Savings deposits | $ | 198,615,794 | $ | 200,451,324 | ||||
Short-term borrowings | 13,531,111 | 531,111 | ||||||
Long-term borrowings | 36,297,108 | 26,410,859 | ||||||
Accounts payable and other liabilities | 2,129,715 | 2,355,366 | ||||||
Total liabilities | 250,573,728 | 229,748,660 | ||||||
Commitments and contingencies | ||||||||
Redeemable Common Stock held by the Employee Stock Ownership Plan (ESOP), net of unearned ESOP shares | 566,100 | 536,222 | ||||||
Stockholders’ equity: | ||||||||
Common stock, par value $.01 per share; authorized 5,000,000 shares; 1,054,644 shares issued and 1,050,804 shares outstanding at December 31, 2007 and June 30, 2007 | 10,546 | 10,546 | ||||||
Additional paid-in capital | 4,743,174 | 4,743,174 | ||||||
Retained earnings, substantially restricted | 11,439,466 | 10,601,674 | ||||||
Accumulated other comprehensive loss | (139,918 | ) | (286,717 | ) | ||||
| 16,053,268 | 15,068,677 | |||||||
Less cost of 3,840 shares of treasury stock | (74,880 | ) | (74,880 | ) | ||||
Total stockholders’ equity | 15,978,388 | 14,993,797 | ||||||
Total liabilities and stockholders’ equity | $ | 267,118,216 | $ | 245,278,679 | ||||
| * | The Condensed Consolidated Statement of Financial Condition as of June 30, 2007 has been derived from audited consolidated financial statements. |
See Notes to Condensed Consolidated Financial Statements
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Condensed Consolidated Statements of Income
For the Three and Six Months Ended December 31, 2007 and 2006
| Three Months Ended December 31, | Six Months Ended December 31, | ||||||||||||
| 2007 | 2006 | 2007 | 2006 | ||||||||||
Interest and dividend income: | |||||||||||||
Loans | $ | 3,996,871 | $ | 3,724,496 | $ | 7,877,908 | $ | 7,405,675 | |||||
Investment securities: | |||||||||||||
Taxable securities | 71,052 | 78,265 | 116,761 | 136,912 | |||||||||
Non-taxable securities | 236,841 | 150,871 | 423,015 | 177,545 | |||||||||
Interest-bearing deposits | 30,307 | 40,652 | 85,772 | 77,508 | |||||||||
Total interest and dividend income | 4,335,071 | 3,994,284 | 8,503,456 | 7,797,640 | |||||||||
Interest expense: | |||||||||||||
Savings deposits | 1,678,653 | 1,506,946 | 3,344,878 | 2,762,577 | |||||||||
Short-term borrowings | 120,783 | 110,100 | 157,818 | 191,062 | |||||||||
Long-term borrowings | 488,743 | 445,091 | 946,807 | 869,293 | |||||||||
Early redemption penalty on trust preferred capital securities | — | — | — | 384,375 | |||||||||
Total interest expense | 2,288,179 | 2,062,137 | 4,449,503 | 4,207,307 | |||||||||
Net interest income | 2,046,892 | 1,932,147 | 4,053,953 | 3,590,333 | |||||||||
Provision for loan losses: | 134,000 | 216,000 | 278,000 | 244,500 | |||||||||
Net interest income after provision for loan losses | 1,912,892 | 1,716,147 | 3,775,953 | 3,345,833 | |||||||||
Noninterest income: | |||||||||||||
Insurance commissions | 672,110 | 612,226 | 1,347,030 | 1,268,620 | |||||||||
Investment commissions | 72,505 | 156,675 | 269,727 | 230,560 | |||||||||
Other | 397,509 | 356,271 | 806,805 | 733,016 | |||||||||
Total noninterest income | 1,142,124 | 1,125,172 | 2,423,562 | 2,232,196 | |||||||||
Noninterest expense: | |||||||||||||
Compensation and employee benefits | 1,617,837 | 1,463,007 | 3,250,667 | 2,908,146 | |||||||||
Occupancy and equipment | 292,997 | 326,551 | 593,032 | 646,348 | |||||||||
Computer processing charges | 133,022 | 102,819 | 253,070 | 223,601 | |||||||||
Gain on sale of REO | — | — | (288,989 | ) | — | ||||||||
Other | 538,607 | 561,766 | 1,067,116 | 1,028,543 | |||||||||
Total noninterest expense | 2,582,463 | 2,454,143 | 4,874,896 | 4,806,638 | |||||||||
Income before income taxes | 472,553 | 387,176 | 1,324,619 | 771,391 | |||||||||
Income taxes: | 124,628 | 127,181 | 405,690 | 313,695 | |||||||||
Net income | $ | 347,925 | $ | 259,995 | $ | 918,929 | $ | 457,696 | |||||
Other comprehensive gain, net of tax: | |||||||||||||
Unrealized gain on securities, net of tax | 199,294 | 46,564 | 146,799 | 17,344 | |||||||||
Comprehensive income | $ | 547,219 | $ | 306,559 | $ | 1,065,728 | $ | 475,040 | |||||
Basic earnings per share | $ | 0.33 | $ | 0.25 | $ | 0.87 | $ | 0.44 | |||||
Diluted earnings per share | $ | 0.33 | $ | 0.25 | $ | 0.87 | $ | 0.44 | |||||
Basic weighted average shares outstanding | 1,050,804 | 1,050,804 | 1,050,804 | 1,050,804 | |||||||||
Diluted weighted average shares outstanding | 1,050,804 | 1,052,033 | 1,050,804 | 1,051,567 | |||||||||
Cash dividends declared per share | $ | 0.05 | $ | 0.05 | $ | 0.10 | $ | 0.10 | |||||
See Notes to Condensed Consolidated Financial Statements
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Condensed Consolidated Statements of Cash Flows (unaudited)
For the Six Months Ended December 31, 2007 and 2006
| Six Months Ended December 31, | ||||||||
| 2007 | 2006 | |||||||
Cash flows from operating activities | ||||||||
Net income | $ | 918,929 | $ | 457,696 | ||||
Adjustments to reconcile net income to net cash provided (used) by operating activities: | ||||||||
Provision for loan losses | 278,000 | 244,500 | ||||||
Depreciation and amortization | 511,958 | 541,291 | ||||||
Loss on disposal of fixed assets | 2,164 | 14,012 | ||||||
Gain on loans held for sale | (11,941 | ) | (20,085 | ) | ||||
Proceeds from loans held for sale | 9,057,341 | 7,392,045 | ||||||
Origination of loans held for sale | (7,938,010 | ) | (8,518,560 | ) | ||||
Amortization of deferred loan fees | (65,275 | ) | (68,743 | ) | ||||
Gain on sale of REO | (288,989 | ) | — | |||||
Change in operating assets and liabilities: | ||||||||
Accrued interest receivable | (237,591 | ) | (304,077 | ) | ||||
Accrued interest payable | 61,425 | 43,162 | ||||||
Prepaid expenses and other assets | (205,305 | ) | 127,634 | |||||
Accounts payable and other liabilities | (367,659 | ) | (919,090 | ) | ||||
Net cash provided (used) by operating activities | 1,715,047 | (1,010,215 | ) | |||||
Cash flows from investing activities | ||||||||
Increase in Federal Home Loan Bank stock | (810,000 | ) | — | |||||
Purchases of securities available for sale | (7,148,428 | ) | (14,565,602 | ) | ||||
Proceeds from principal repayment and maturities of securities available for sale | 902,283 | 124,600 | ||||||
Recovery in insurance agency assets | 20,000 | — | ||||||
Net originations of loans receivable | (20,669,135 | ) | (4,380,731 | ) | ||||
Proceeds from sale of REO | 1,197,600 | — | ||||||
Purchases of office properties and equipment | (160,429 | ) | (309,827 | ) | ||||
Net cash used in investing activities | (26,668,109 | ) | (19,131,560 | ) | ||||
Cash flows from financing activities | ||||||||
Net increase (decrease) in savings deposits | (1,754,947 | ) | 19,625,593 | |||||
Short-term borrowings (repayments), net | 13,000,000 | (501,217 | ) | |||||
Long-term borrowings (repayments), net | 9,886,249 | (106,379 | ) | |||||
Dividends paid | (51,259 | ) | (51,258 | ) | ||||
Net cash provided by financing activities | 21,080,043 | 18,966,739 | ||||||
Net decrease in cash and cash equivalents | (3,873,019 | ) | (1,175,036 | ) | ||||
Cash and cash equivalents: | ||||||||
Beginning | 11,644,449 | 11,008,660 | ||||||
Ending | $ | 7,771,430 | $ | 9,833,624 | ||||
See Notes to Condensed Consolidated Financial Statements
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Nature of Business
AF Financial Group (the “Company”) is a federally chartered thrift holding company which owns 100% of the common stock of AF Bank (the “Bank”), AF Insurance Services, Inc. (an independent insurance agency) and Ashe Lane Capital Trust (a Delaware business trust). AF Bank conducts business from its main office located in West Jefferson, North Carolina, with branches in Boone, Jefferson, Sparta, Warrensville, and West Jefferson, North Carolina. Headquartered in West Jefferson, North Carolina, AF Insurance Services, Inc. has branches in Boone, Elkin, Jefferson, Lenoir, Sparta, West Jefferson, and North Wilkesboro, North Carolina.
Note 2. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements (except for the condensed consolidated statement of financial condition at June 30, 2007, which is derived from audited consolidated financial statements) have been prepared in accordance with accounting principles generally accepted in the United States (“US GAAP”) for interim financial information and with the instructions to Form 10-QSB of Regulation S-B. Accordingly, they do not include all of the information and footnotes required by US GAAP for complete financial statements. In the opinion of management, all adjustments (none of which were other than normal recurring accruals) necessary for a fair presentation of the financial position and results of operations for the periods presented have been included. The results of operations for the three and six month periods ended December 31, 2007 are not necessarily indicative of the results of operations that may be expected for the Company’s fiscal year ending June 30, 2008.
The Company’s accounting policies are set forth in Note 1 of the Notes to Consolidated Financial Statements in the Company’s 2007 audited consolidated financial statements, which are included in the Company’s Annual Report on Form 10-KSB for the year ended June 30, 2007. This quarterly report should be read in conjunction with such annual report.
Note 3. Earnings Per Share
Basic earnings per share amounts are based on the weighted average shares of common stock outstanding. Diluted earnings per share assumes the exercise or issuance of all potential common stock instruments such as options, unless the effect is antidilutive (to reduce a loss or increase earnings per share). Earnings per share have been calculated in accordance with Statement of Position 93-6 “Employers’ Accounting for Employee Stock Ownership Plans” and Statement of Financial Accounting Standards No. 128 “Earnings Per Share.”
Earnings per share have been computed using the weighted average number of shares of common stock and potentially dilutive common stock equivalents outstanding as follows:
| Three Months Ended December 31, | Six Months Ended December 31, | |||||||
| 2007 | 2006 | 2007 | 2006 | |||||
Weighted average shares outstanding | 1,050,804 | 1,050,804 | 1,050,804 | 1,050,804 | ||||
Potentially dilutive effect of stock options | — | 1,229 | — | 763 | ||||
Weighted average shares outstanding, including potentially dilutive effect of stock options | 1,050,804 | 1,052,033 | 1,050,804 | 1,051,567 | ||||
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Note 4. Dividends Declared
On December 21, 2007, the Board of Directors of the Company declared a dividend of $0.05 a share for stockholders of record as of January 4, 2008 and payable on January 18, 2008. The dividends declared were accrued and reported in accounts payable and other liabilities in the December 31, 2007 Condensed Consolidated Statement of Financial Condition. AsheCo, MHC, the mutual holding company, waived the receipt of dividends declared by the Company.
Note 5. Stockholders’ Equity
| Common Stock | Additional Paid-in Capital | Retained Earnings | Accumulated Other Comprehensive Income (Loss) | Treasury Stock | Total Stockholders’ Equity | |||||||||||||||||
Balance, June 30, 2007 | $ | 10,546 | $ | 4,743,174 | $ | 10,601,674 | $ | (286,717 | ) | $ | (74,880 | ) | $ | 14,993,797 | ||||||||
Transfer to redeemable common stock net of unearned ESOP shares | — | — | (29,878 | ) | — | — | (29,878 | ) | ||||||||||||||
Cash dividend, $.10 per share | — | — | (51,259 | ) | — | — | (51,259 | ) | ||||||||||||||
Net income | — | — | 918,929 | — | — | 918,929 | ||||||||||||||||
Unrealized holding gain arising during period, net of tax of $94,309 | — | — | — | 146,799 | — | 146,799 | ||||||||||||||||
Balance, December 31, 2007 | $ | 10,546 | $ | 4,743,174 | $ | 11,439,466 | $ | (139,918 | ) | $ | (74,880 | ) | $ | 15,978,388 | ||||||||
Note 6. Stock Options
The Company’s stockholders approved the Bank’s Stock Option Plan on December 8, 1997. The stock option plan provides for the issuance of up to 21,707 stock options to certain officers and directors in the form of incentive stock options or non-incentive stock options. No options have been granted since December 8, 1997.
At December 31, 2006, 13,604 options were granted at an exercise price of $18.50, of which 13,604 options were fully vested and exercisable. All outstanding options expired during the six months ended December 31, 2007.
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Note 7. Subordinated Debt
The Company participated in a $5,000,000 subordinated debt floating rate security transaction on July 3, 2007. The subordinated debt has floating rate of LIBOR plus 1.72% and matures on September 6, 2017. The debt has been recorded as a liability in the Company’s consolidated financial statements. The Company infused the $5,000,000 proceeds into the Bank, where it was added to Tier 1 capital for regulatory reporting purposes.
Note 8. Impaired Loans
SFAS No. 114, “Accounting by Creditors for Impairment of a Loan”, as amended by SAFS No. 118, “Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosure”, requires that the Company establish specific allowance on impaired loans and disclosure of the Bank’s method of accounting for interest income on impaired loans. The Company considers all loans delinquent more than 90 days to be impaired and such loans amounted to $669,187 and $3,102,283 at December 31, 2007 and December 31, 2006, respectively. In addition, management determined that eight loans totaling $770,360 at December 31, 2007 that were not 90 days or more delinquent were impaired. Management performed an impairment analysis on the impaired loans and has determined that although these loans at December 31, 2007 are primarily collateral dependent, the underlying collateral value is less than the carrying value of the loans. As a result, the Company has determined that a specific allowance of $133,279 is required as of December 31, 2007. Management determined that a specific allowance of $220,000 was required as of December 31, 2006. The Company established reserves for uncollectible interest totaling $22,057 and $61,219 at December 31, 2007 and 2006, respectively.
The effect of not recognizing interest income on non accrual loans in accordance with the original terms totaled approximately $57,652 and $141,844 during the six months ended December 31, 2007 and 2006, respectively. Interest income actually recognized on a cash basis on impaired loans during the six months ended December 31, 2007 and 2006 was $1,080 and $28,710, respectively.
Note 9. Segment Reporting
The Company has additional reportable segments: AF Bank and AF Insurance Services, Inc. AF Bank is a federally chartered stock savings bank. The principal activities of the Bank consist of obtaining savings deposits and providing credit to customers in its primary market area. AF Insurance Services, Inc. provides insurance services. Information about reportable segments, and reconciliation of such information to the consolidated financial statements as of and for the three and six months ended December 31, 2007 and 2006 is as follows (dollars in thousands):
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Note 9. Segment Reporting, continued
| AF Financial Group | AF Bank | AF Insurance Services, Inc. | Inter- segment Elimination | Consolidated Totals | ||||||||||||||
Three Months Ended December 31, 2007 | ||||||||||||||||||
Interest income | $ | — | $ | 4,336 | $ | — | $ | (1 | ) | $ | 4,335 | |||||||
Interest expense | 182 | 2,100 | 7 | (1 | ) | 2,288 | ||||||||||||
Net interest income | (182 | ) | 2,236 | (7 | ) | — | 2,047 | |||||||||||
Provision for loan losses | — | 134 | — | — | 134 | |||||||||||||
Net interest income after provision | (182 | ) | 2,102 | (7 | ) | — | 1,913 | |||||||||||
Non-interest income | — | 505 | 683 | (46 | ) | 1,142 | ||||||||||||
Non-interest expense | 14 | 2,019 | 595 | (46 | ) | 2,582 | ||||||||||||
Income (loss) before income taxes | (196 | ) | 588 | 81 | — | 473 | ||||||||||||
Income taxes | (62 | ) | 155 | 32 | — | 125 | ||||||||||||
Net income (loss) | $ | (134 | ) | $ | 433 | $ | 49 | $ | — | $ | 348 | |||||||
Assets | $ | 350 | $ | 265,292 | $ | 2,243 | $ | (767 | ) | $ | 267,118 | |||||||
| AF Financial Group | AF Bank | AF Insurance Services, Inc. | Inter- segment Elimination | Consolidated Totals | ||||||||||||||
Three Months Ended December 31, 2006 | ||||||||||||||||||
Interest income | $ | — | $ | 3,995 | $ | — | $ | (1 | ) | $ | 3,994 | |||||||
Interest expense | 93 | 1,959 | 11 | (1 | ) | 2,062 | ||||||||||||
Net interest income | (93 | ) | 2,036 | (11 | ) | — | 1,932 | |||||||||||
Provision for loan losses | — | 216 | — | — | 216 | |||||||||||||
Net interest income after provision | (93 | ) | 1,820 | (11 | ) | — | 1,716 | |||||||||||
Non-interest income | — | 533 | 634 | (42 | ) | 1,125 | ||||||||||||
Non-interest expense | 17 | 1,932 | 547 | (42 | ) | 2,454 | ||||||||||||
Income (loss) before income taxes | (110 | ) | 421 | 76 | — | 387 | ||||||||||||
Income taxes | (35 | ) | 133 | 29 | — | 127 | ||||||||||||
Net income (loss) | $ | (75 | ) | $ | 288 | $ | 47 | $ | — | $ | 260 | |||||||
Assets | $ | 330 | $ | 246,248 | $ | 2,142 | $ | (712 | ) | $ | 248,008 | |||||||
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Note 9. Segment Reporting, continued
| AF Financial Group | AF Bank | AF Insurance Services, Inc. | Inter- segment Elimination | Consolidated Totals | ||||||||||||||
Six Months Ended December 31, 2007 | ||||||||||||||||||
Interest income | $ | — | $ | 8,505 | $ | — | $ | (2 | ) | $ | 8,503 | |||||||
Interest expense | 362 | 4,073 | 16 | (2 | ) | 4,449 | ||||||||||||
Net interest income | (362 | ) | 4,432 | (16 | ) | — | 4,054 | |||||||||||
Provision for loan losses | — | 278 | — | — | 278 | |||||||||||||
Net interest income after provision | (362 | ) | 4,154 | (16 | ) | — | 3,776 | |||||||||||
Non-interest income | — | 1,147 | 1,392 | (115 | ) | 2,424 | ||||||||||||
Non-interest expense | 23 | 3,769 | 1,198 | (115 | ) | 4,875 | ||||||||||||
Income (loss) before income taxes | (385 | ) | 1,532 | 178 | — | 1,325 | ||||||||||||
Income taxes | (124 | ) | 460 | 70 | — | 406 | ||||||||||||
Net income (loss) | $ | (261 | ) | $ | 1,072 | $ | 108 | $ | — | $ | 919 | |||||||
Assets | $ | 350 | $ | 265,292 | $ | 2,243 | $ | (767 | ) | $ | 267,118 | |||||||
| AF Financial Group | AF Bank | AF Insurance Services, Inc. | Inter- segment Elimination | Consolidated Totals | ||||||||||||||
Six Months Ended December 31, 2006 | ||||||||||||||||||
Interest income | $ | — | $ | 7,800 | $ | — | $ | (2 | ) | $ | 7,798 | |||||||
Interest expense | 600 | 3,586 | 23 | (2 | ) | 4,207 | ||||||||||||
Net interest income | (600 | ) | 4,214 | (23 | ) | — | 3,591 | |||||||||||
Provision for loan losses | — | 245 | — | — | 245 | |||||||||||||
Net interest income after provision | (600 | ) | 3,969 | (23 | ) | — | 3,346 | |||||||||||
Non-interest income | — | 1,021 | 1,308 | (97 | ) | 2,232 | ||||||||||||
Non-interest expense | 34 | 3,789 | 1,081 | (97 | ) | 4,807 | ||||||||||||
Income (loss) before income taxes | (634 | ) | 1,201 | 204 | — | 771 | ||||||||||||
Income taxes | (202 | ) | 437 | 79 | — | 314 | ||||||||||||
Net income (loss) | $ | (432 | ) | $ | 764 | $ | 125 | $ | — | $ | 457 | |||||||
Assets | $ | 330 | $ | 246,248 | $ | 2,142 | $ | (712 | ) | $ | 248,008 | |||||||
Note 10. Reclassifications
Certain amounts in the December 2007 financial statements have been reclassified to conform to the December 2006 presentation. The reclassification had no effect on net income or stockholders’ equity, as previously reported.
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| Item 2. | Management’s Discussion and Analysis |
This Form 10-QSB contains certain forward-looking statements consisting of estimates with respect to the financial condition, results of operations and other business of the Company, that are subject to various factors which could cause actual results to differ materially from the estimates. These factors include: changes in national and regional economic conditions, as well as market conditions; the development of an interest rate environment that adversely affects the interest rate spread or other income anticipated from the Company’s operations and investments; our ability to offer new products and increase lower cost core deposits; and depositor and borrower preferences. The Company disclaims any obligation to publicly announce future events or developments that may affect the forward-looking statements contained herein.
Overview
AF Financial Group (the “Company”) is a federally chartered thrift holding company that owns 100% of the common stock of AF Bank (the “Bank”), AF Insurance Services, Inc. (an independent insurance agency) and Ashe Lane Capital Trust (a Delaware business trust). The Company has no operations and conducts no business of its own other than ownership of its subsidiaries. The Bank is a federally chartered stock savings bank which was chartered in 1939 and the historical operations of AF Bank have been to provide fixed-rate loans for the residents of Ashe County, North Carolina. Over the past several years, we have expanded our market area to include Alleghany, Caldwell, Surry, Watauga and Wilkes counties and have diversified our product lines by engaging in non-residential mortgage and non-mortgage lending and offering insurance and uninsured investment products. In July 1997, we started offering traditional property and casualty, life and health insurance products through AF Insurance Services, Inc., headquartered in West Jefferson, North Carolina and operating in Boone, Elkin, Jefferson, Lenoir, Sparta, West Jefferson and North Wilkesboro, North Carolina.
During the fourth quarter of the 2005 fiscal year, AF Financial Group dissolved its broker/dealer subsidiary, AF Brokerage, Inc. We continue to offer the same level of service through a third party relationship that AF Bank has entered into with LaSalle Street Securities. This structure allows us to offer a full array of investment products, including fixed-rate and variable annuities and mutual funds while reducing expenses associated with maintaining an independent broker/dealer registration. This third party relationship operates as a division of AF Bank under the name AF Investments.
On July 10, 2006, Ashe Lane Capital Trust, a Delaware business trust formed by the Company, completed the sale of $5.0 million of floating rate capital securities. The issuance was priced at LIBOR plus 150 basis points. At approximately the same time the Company paid off the existing $5.0 million 10.25% fixed-rate capital securities. The Company had to pay a $384,375 early redemption penalty for paying off the 10.25% issuance. Management believes that the Company will recapture the penalty amount within three years by recognizing a decrease in interest costs.
One initiative that management and the board of directors believe is a focal point of our continued success is developing methods and products that better serve our customers so that we can maintain a loyal customer base. To accomplish this we are continuing to develop products and services that help create a unique financial experience to make banking easier and more convenient for our customers.
Another initiative that management and the board of directors believe is important is to reduce operating expenses whenever and wherever possible, which in turn will increase our shareholders’ return. One step we are taking to accomplish this is to offer to purchase all shares of our common stock held by our shareholders who own 99 or fewer shares as of the close of business on December 13, 2007 (the “Odd Lot Offer”).
In the Odd Lot Offering, we are offering to purchase these shares of common stock at $20.00 per share in cash. This price represents a $7.00 or 54% premium over the last share sales price of our common stock ($13.00) as reported on the OTC Bulletin Board on the last trade prior to the close of business on
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December 13, 2007. In addition to the $20.00 per share price we are offering a $50.00 bonus for all properly executed tender offers received prior to the expiration date of February 15, 2008. We anticipate that the stock purchased will be included in treasury stock and all costs associated with the offer will added to treasury stock and not expensed.
The purpose of the Odd Lot Offer is to reduce the number of persons owning shares of our common stock. If, after completion of the Odd Lot Offer, we have fewer than 300 shareholders of record, as calculated under the rules and regulations of the Securities Exchange Act of 1934 (the “Exchange Act”), the Board of Directors intends to deregister the Company’s common stock with the Securities and Exchange Commission (“SEC”) and become a private company. One result of the Company “going private” would be that we would no longer have to file periodic reports with the SEC, as required under the Exchange Act, including, among other reports, annual reports on Forms 10-KSB and quarterly reports on Forms 10-QSB. In addition, we would not be subject to the SEC’s proxy rules. The Board of Directors estimates that this could result in a significant cost savings to the Company and allow management to focus on its regular business activities. If the Odd Lot Offer is unsuccessful in lowing the number of shareholders to fewer than 300, the Board may consider another type transaction to achieve the Company’s goal of “going private”.
Our operating results are primarily dependent upon net interest income, fees and charges and insurance commissions. Net interest income is the difference between interest earned on loans and investments and the interest paid on savings deposits and our borrowings. Our primary interest-earning asset is our loan portfolio representing 80.5% of total assets. Our net interest income is affected by changes in economic conditions that influence market interest rates and to a large extent by monetary actions by the Federal Reserve. We have reduced the exposure to rising rates by limiting the term or the time to reprice the loans that we retain in our portfolio. At December 31, 2007, we had approximately $65.8 million in loans priced at prime or a margin thereto which provides for adjusting rates immediately when market rates change. In a rising rate environment, our ability to make immediate rate adjustments on our loans priced at prime and our ability to move our deposit mix to less interest rate sensitive products allows us to increase our net interest margin. However, we believe that the stabilization of interest rates by the Federal Reserve will have a more positive impact on our net income than continued rate adjustments.
Net income for the three-month period ended December 31, 2007 increased $87,930 to $347,925 compared to net income of $259,995 during the same period in 2006. Net income for the six-month period ended December 31, 2007 increased $461,233 to $918,929 for the six months ended December 31, 2007 compared to net income of $457,696 for the six months ended December 31, 2006. The increase in net income during the three-month period was primarily attributable to an increase in net interest income and a decrease in provision for loan losses partially offset by an increase in noninterest expense. The increase in net income during the six-month period was primarily attributable to an increase in net interest income, a decrease in the early redemption penalty on trust preferred capital securities and the gain on sale of REO partially offset by an increase in the provision for loan losses and an increase in noninterest expense.
The housing market has been shrinking since mid-2005 and the rate of nationwide mortgage delinquencies and foreclosures has been rising. With most of our loans concentrated in residential mortgage loans a decline in the local housing market could adversely affect the values of our real estate collateral. We have underwriting and credit monitoring procedures and credit policies, that we believe are appropriate to minimize this risk. In addition, we have not made any subprime mortgage loans, which is a primary driver in the increased rate of mortgage delinquencies and foreclosures. Such precautions, however, may not prevent unexpected losses that could adversely affect results of operations.
Critical Accounting Policies and Estimates
The notes to our audited consolidated financial statements for the year ended June 30, 2007 included in the AF Financial Group 2007 Annual Report on Form 10-KSB contain a summary of our significant accounting policies. We believe that our policies with respect to the methodology for our determination of the
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allowance for loan losses, the fair value of mortgage servicing assets and asset impairment judgments, including the recoverability of goodwill, involve a higher degree of complexity and require management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain conditions and circumstances. Changes in these judgments, assumptions or estimates could cause reported results to differ materially. These critical policies and their application are periodically reviewed with the Audit Committee and our Board of Directors. We consider the following accounting policies to be most critical in their potential effect on our financial position or results of operations:
Allowance for Loan Losses
The Allowance for Loan Losses (“ALL”) is established through a provision for loan losses based on our evaluation of the risks inherent in AF Bank’s loan portfolio, prior loss history and the regional economy. The ALL is maintained at an amount we consider adequate to cover loan losses which are deemed probable and estimable. The allowance is based upon a number of factors, including asset classifications, economic trends, industry experience and trends, industry and geographic concentrations, estimated collateral values, our assessment of the credit risk inherent in the portfolio, historical loan loss experience, and AF Bank’s underwriting policies.
All loans not considered impaired are assigned an allowance percentage requirement based on the type of underlying collateral and payment terms. Furthermore, all loans are evaluated individually and are assigned a credit grade using such factors as the borrower’s cash flow, the value of the collateral and the strength of any guarantee. Loans identified as having weaknesses, or adverse credit grades, are assigned a higher allowance percentage requirement than loans where no weaknesses are identified. We routinely monitor our loan portfolio to determine if a loan is deteriorating, therefore requiring a higher allowance requirement. Factors we consider are payment status, collateral value and the probability of collecting scheduled principal and interest payments when due.
The allowance percentage requirement changes from period to period as a result of a number of factors, including: changes in the mix of types of loans; changes in credit grades within the portfolio, which arise from a deterioration or an improvement in the performance of the borrower; changes in the historical loss percentages and delinquency trends; current charge offs and recoveries; changes in the amounts of loans outstanding; and economic factors in market area.
Although we believe that we have established and maintained the ALL at adequate levels, future adjustments may be necessary if economic, real estate and other conditions differ substantially from the current operating environment. We will continue to monitor and modify our ALL as conditions dictate.
Mortgage Servicing Assets
Mortgage servicing assets represent the present value of the future net servicing fees from servicing mortgage loans sold to the secondary market. The most critical accounting policy associated with mortgage servicing is the methodology used to determine the fair value of mortgage servicing assets, which requires the development of a number of assumptions, including anticipated loan principal amortization and prepayments of principal. The value of mortgage servicing rights is significantly affected by mortgage interest rates available in the marketplace that influence the speed of mortgage loan prepayments. During periods of declining interest rates, the value of mortgage servicing assets generally declines due to increasing prepayments attributable to increased mortgage refinance activity. Conversely, during periods of rising interest rates, the value of servicing assets generally increases due to reduced refinance activity. We amortize mortgage servicing assets over the estimated period that servicing income is expected to be received based on estimates of the amount and timing of future cash flows. The amount and timing of servicing asset amortization is adjusted quarterly based on actual results and updated projections. The servicing assets are assessed for impairment quarterly based on their fair value. The Company recognized no impairment during the six months ended December 31, 2007.
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Goodwill
We evaluate the carrying value of goodwill annually by comparing the fair value of each reporting segment to the respective total equity at that level. Impairment would then be determined if the equity exceeds the fair value of the reporting unit. This evaluation is subjective as it requires material estimates that may be susceptible to significant change. Goodwill is recorded in our reportable segment, AF Insurance Services, Inc.
Comparison of Financial Condition at December 31, 2007 and June 30, 2007:
Total assets increased by $21.8 million, or 8.9%, to $267.1 million at December 31, 2007 from $245.3 million at June 30, 2007. The increase in assets was primarily the result of an increase of $20.1 million, or 10.4%, in net loans and an increase of $6.5 million, or 37.4%, in securities available for sale.
Securities available for sale increased $6.5 million, or 37.4%, to $23.8 million at December 31, 2007 from $17.4 million at June 30, 2007. This increase was due to the purchase of investments totaling $7.1 million and a $241,108 increase in market value partially offset by the maturity of $800,000 of securities available for sale and $102,283 proceeds received from principal payments on mortgage backed securities. The investments purchased were investment grade municipal bonds. The municipal bonds are general obligation bonds and the interest income is exempt for federal income taxes. Management decided to purchase the municipal bonds due to the interest rate spread available on the bonds versus the current and predicted cost of funds. At December 31, 2007, our investment portfolio had $229,807 in net unrealized losses as compared to net unrealized losses of $470,915 at June 30, 2007.
Net loans increased $20.2 million, or 10.4%, to $213.4 million at December 31, 2007 from $193.2 million at June 30, 2007. The increase in net loans receivable is primarily due to the increase in mortgage loans during the three months ended December 31, 2007. Mortgage loans increased $16.5 million from $157.3 million at June 30, 2007 to $173.8 million at December 31, 2007. As part of our interest rate risk management strategy we do not keep long term fixed rate loans in our portfolio. The mortgage loans that we keep are primarily loans that permit us to re-price the loan at an interval of ten years or less. The increase in mortgage loans is the result of expanding relationships with existing customers and the strong second home market in the areas in which we operate.
The following table sets forth the composition of our mortgage and other loan portfolios in dollar amounts and percentages at the dates indicated.
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| At December 31, 2007 | At June 30, 2007 | |||||||||||
| Amount | % of Total | Amount | % of Total | |||||||||
| (Dollars in thousands) | ||||||||||||
Mortgage loans: | ||||||||||||
One-to four-family | $ | 104,627 | 49.04 | % | $ | 93,771 | 48.54 | % | ||||
Multi-family | 3,300 | 1.55 | % | 3,279 | 1.70 | % | ||||||
Non-residential | 21,619 | 10.13 | % | 25,233 | 13.06 | % | ||||||
Land | 28,031 | 13.14 | % | 21,779 | 11.27 | % | ||||||
Construction | 16,259 | 7.62 | % | 13,190 | 6.83 | % | ||||||
Total mortgage loans | $ | 173,836 | 81.48 | % | $ | 157,252 | 81.40 | % | ||||
Other loans: | ||||||||||||
Commercial | $ | 30,833 | 14.45 | % | $ | 26,848 | 13.90 | % | ||||
Consumer loans | 10,656 | 4.99 | % | 10,993 | 5.69 | % | ||||||
Total other loans | $ | 41,489 | 19.44 | % | $ | 37,841 | 19.59 | % | ||||
Gross loans | $ | 215,325 | 100.92 | % | $ | 195,093 | 100.99 | % | ||||
Less: | ||||||||||||
Unearned discounts and net deferred loan fees | $ | 319 | 0.15 | % | $ | 263 | 0.14 | % | ||||
Allowance for loan losses | 1,654 | 0.77 | % | 1,642 | 0.85 | % | ||||||
| 1,973 | 0.92 | % | 1,905 | 0.99 | % | |||||||
Loans, net | $ | 213,352 | 100.00 | % | $ | 193,188 | 100.00 | % | ||||
Real estate owned decreased by $616,611 to $1.6 million at December 31, 2007. The decrease is primarily the result of the Bank selling a commercial property held as real estate owed during the six months ended December 31, 2007, resulting in a gain of $288,989. This decrease was partially offset by the addition of two properties with a total value of $292,000. These two properties were added to real estate owned as a result of foreclosure proceedings. The remaining real estate owned represents property from one lending relationship. The loans are recorded in real estate owned at the quick sale appraised value as of December 31, 2007.
Savings deposits decreased by $1.8 million, or 0.9%, from $200.5 million at June 30, 2007 to $198.6 million at December 31, 2007. We believe that the decrease in deposits is attributable to normal fluctuations in our commercial checking accounts.
Short-term borrowings increased $13.0 million to $13.5 million at December 31, 2007 from $531,111 at June 30, 2007. Long-term borrowings increased $9.9 million, or 37.4%, to $36.3 million at December 31, 2007 from $26.4 million at June 30, 2007. The increase in short-term borrowings was due to the Company obtaining short term FHLB advances to fund the $20.2 million increase in net loans and to offset the $1.8 million decrease in savings deposits. The increase in long-term borrowings is the result of the subordinated debt issue that the Company participated in during the six months ended December 31, 2007 and additional FHLB advances. The proceeds from the subordinated debt issuance were infused into the Bank where it was added to Tier 1 capital for regulatory reporting purposes.
The Bank’s level of non-performing loans, defined as loans past due 90 days or more and impaired loans, decreased to $1,439,547, or 0.54% of total assets, at December 31, 2007 compared to $3,102,283, or 1.3% of total assets, at December 31, 2006. The decrease in the level of non-performing loans is primarily due to one nonresidential mortgage lending relationship that was over 90 days delinquent as of December 31, 2006 that was moved to real estate owned during the quarter ended March 31, 2007. The Bank recognized total charge-
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offs of $270,459 during the three months ended December 31, 2007 compared to total charge-offs of $40,887 during the three months ended December 31, 2006. Total recoveries decreased to $4,803 for the six months ended December 31, 2007 from $16,587 for the six months ended December 31, 2006. The Bank recognized net charge-offs of approximately $265,656 during the six months ended December 31, 2007 compared to net charge-offs of $24,300 for the six months ended December 31, 2006.
The ALL to total non-performing assets totaled 54.23% at December 31, 2007 compared to 48.82% at June 30, 2007. The ALL to total non-performing loans totaled 114.89% at December 31, 2007 compared to 142.83% at June 30, 2007. The decrease in the ALL to total non-performing loan percentages was primarily attributable to an increase in non-performing loans during the six months ended December 31, 2007 partially offset by a decrease in real estate owned during the same time period. Non-performing loans totaled $1,156,240 at June 30, 2007 compared to $1,439,547 at December 31, 2007. Real estate owned totaled $1,610,000 at December 31, 2007 compared to $2,226,611 million at June 30, 2007. Due to the change in the mix of loans and based upon a detailed analysis of the overall quality of our loan portfolio, we made a $278,000 provision to the ALL during the six-month period ended December 31, 2007. The ALL to total loans totaled 0.77% at December 31, 2007 and 0.85% at June 30, 2007.
The following table sets forth activity in the Bank’s ALL at or for the dates indicated.
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| For the Six Months Ended December 31, 2007 | For the Six Months Ended December 31, 2006 | |||||||
| (Dollars in thousands) | ||||||||
Balance at beginning of year | $ | 1,642 | $ | 1,568 | ||||
Provision for loan losses | 278 | 245 | ||||||
Charge-offs: | ||||||||
One- to four-family residential | (40 | ) | (4 | ) | ||||
Multi-family residential | — | — | ||||||
Non-residential and land | — | — | ||||||
Construction | (55 | ) | — | |||||
Commercial | (125 | ) | — | |||||
Consumer loans | (51 | ) | (37 | ) | ||||
Total charge-offs | (271 | ) | (41 | ) | ||||
Recoveries: | ||||||||
One- to four-family residential | — | 6 | ||||||
Multi-family residential | — | — | ||||||
Non-residential and land | — | — | ||||||
Construction | — | — | ||||||
Commercial | 3 | — | ||||||
Consumer loans | 2 | 10 | ||||||
Total recoveries | 5 | 16 | ||||||
Balance at end of period | $ | 1,654 | $ | 1,788 | ||||
| At December 31, 2007 | At June 30, 2007 | |||||||
Total loans outstanding | $ | 215,325 | $ | 195,093 | ||||
Allowance for loan losses | $ | 1,654 | $ | 1,642 | ||||
Allowance for loan losses to total loans at end of period | 0.77 | % | 0.85 | % | ||||
Allowance for loan losses to total non-performing assets at end of period | 54.23 | % | 48.82 | % | ||||
Allowance for loan losses to total non-performing loans at end of period | 114.89 | % | 142.83 | % | ||||
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Comparison of Operating Results for the Three and Six Months Ended December 31, 2007 and 2006:
Net income for the three-month period ended December 31, 2007 increased $87,930 to $347,925 compared to net income of $259,995 during the same period in 2006. Net income for the six-month period ended December 31, 2007 increased $461,233 to $918,929 for the six months ended December 31, 2007 compared to net income of $457,696 for the six months ended December 31, 2006. The increase in net income during the three-month period was primarily attributable to an increase in net interest income and a decrease in provision for loan losses partially offset by an increase in noninterest expense. The increase in net income during the six-month period was primarily attributable to an increase in net interest income, a decrease in the early redemption penalty on trust preferred capital securities and the gain on sale of REO partially offset by an increase in the provision for loan losses and an increase in noninterest expense.
Interest Income. Interest income increased by $340,787, or 8.5%, from $3,994,284 for the three-month period ended December 31, 2006 to $4,335,071 for the three-month period ended December 31, 2007. Interest income increased by $705,816, or 9.1%, from $7,797,640 for the six-month period ended December 31, 2006 to $8,503,456 for the six-month period ended December 31, 2007. Interest income from loans increased $272,375, or 7.3%, from $3,724,496 for the three-month period ended December 31, 2006 to $3,996,871 for the three-month period ended December 31, 2007. Interest income from loans increased $472,233, or 6.4%, from $7,405,675 for the six-month period ended December 31, 2006 to $7,877,908 for the six-month period ended December 31, 2007. The increases in interest income from loans for the three and six month periods were attributable to an increase in the outstanding loan balances. Total loans increased $15.1 million from $200.2 million at December 31, 2006 to $215.3 million at December 31, 2007.
Interest income from investment securities increased $78,757, or 34.4%, from $229,136 for the three-month period ended December 31, 2006 to $307,893 for the three-month period ended December 31, 2007. Interest income from investment securities increased $225,319, or 71.7%, from $314,457 for the six-month period ended December 31, 2006 to $539,776 for the six-month period ended December 31, 2007. The increases in interest income from investment securities for the three and six month periods were attributable to the purchase of $7.1 million of mutual bonds during the six month period ended December 31, 2007.
Interest Expense. Interest expense increased by $226,042, or 11.0%, to $2,288,179 for the three-month period ended December 31, 2007 from $2,062,137 for the three months ended December 31, 2006. Interest expense increased by $242,196, or 5.8%, to $4,449,503 for the six-month period ended December 31, 2007 from $4,207,307 for the six-month period ended December 31, 2007. The increase in interest expense for the three-month period ended December 31, 2007 is primarily due to an increase in interest expense on savings deposits. The increase in interest expense for the six-month period ended December 31, 2007 is primarily due to an increase in interest expense on savings deposits partially offset by the $384,375 decrease in early redemption penalty on trust preferred capital securities.
Interest expense on savings deposits increased $171,707, or 11.4%, from $1,506,946 for the three months ended December 31, 2006 to $1,678,653 for the three months ended December 31, 2007. Interest expense on savings deposits increased $582,301 from $2,762,577 for the six months ended December 31, 2006 to $3,344,878 for the six months ended December 31, 2007. The increase was primarily attributable to an increase of the weighted average rate paid on deposits. The weighted average rate paid on savings deposits increased .11% from 3.22% at December 31, 2006 to 3.33% at December 31, 2007.
During the six-month period ended December 31, 2006, the Company paid off a $5.0 million 10.25% fixed-rate trust preferred capital securities issuance and paid a $384,375 early redemption penalty. This penalty was expensed during the six months ended December 31, 2006. We did not have a similar expense during the six months ended December 31, 2007.
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Net Interest Income. Net interest income increased by $114,745, or 5.9%, from $1,932,147 for the three- month period ended December 31, 2006 to $2,046,892 for the three-month period ended December 31, 2007. Net interest income increased by $463,620, or 12.9%, from $3,590,333 for the six-month period ended December 31, 2006 to $4,053,953 for the six-month period ended December 31, 2007. The increases in net interest income during the three and six month periods ended December 31, 2007 is the result of the increase in outstanding loan balances and the reduction of the early redemption penalty on trust preferred capital securities partially offset by an increase in interest expense. We do not believe that there has been a material change in interest rate risk from the end of our most recent fiscal year.
Provision for Loan Losses. The provision for loan losses charged to earnings is an amount sufficient to bring the allowance for loan losses to an estimated balance considered adequate to absorb probable losses on existing loans that may become uncollectible. Loans are charged off against the allowance when we believe collection is unlikely. The allowance for loan losses changes from period to period as a result of a number of factors, including: changes in the mix of types of loans; changes in credit grades within the portfolio, which arise from a deterioration or an improvement in the performance of the borrower; changes in the historical loss percentages and delinquency trends; current charge-offs and recoveries; and changes in the amounts of loans outstanding. The net change in all of the components results in the provision for loan losses. We had no significant changes in any of the factors mentioned above during the six months ended December 31, 2007.
All loans not considered impaired in the portfolio are assigned an allowance percentage requirement based on the type of underlying collateral and payment terms. Furthermore, all loans are evaluated individually and are assigned a credit grade using such factors as the borrower’s cash flow, the value of the collateral and the strength of any guarantee. Loans identified as having weaknesses, or adverse credit grades, are assigned a higher allowance percentage requirement than loans where no weaknesses are identified. We routinely monitor our loan portfolio to determine if a loan is deteriorating, therefore requiring a higher allowance requirement. Factors we consider are payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Although we believe that we have established and maintained the ALL at adequate levels, future adjustments may be necessary if economic, real estate and other conditions differ substantially from the current operating environment.
We made a $134,000 provision to the ALL during the three-month period ended December 31, 2007, compared to a provision for loan losses of $216,000 made during the three-month period ended December 31, 2006. We made a $278,000 provision to the ALL during the six-month period ended December 31, 2007, compared to a provision for loan losses of $244,500 made during the six-month period ended December 31, 2006. During the six-month period ended December 31, 2007, we had net charge-offs of $265,656. We made additional provisions to the ALL during the three and six month periods ended December 31, 2007 based upon an analysis of the quality of our loan portfolio. Future loan loss provision requirements are uncertain. At December 31, 2007, our level of ALL amounted to $1,653,849, or 0.77% of total loans, as compared to $1,641,506 of ALL, or 0.85% of total loans at June 30, 2007, which we believe is adequate to absorb any probable losses inherent in our loan portfolio. The decrease in the percentage of ALL to total loans during the period is primarily due to an increase of net charge-offs and an increase in net loans.
Noninterest Income. Noninterest income increased by $16,952, or 1.5%, from $1,125,172 for the three- month period ended December 31, 2006 to $1,142,124 for the three months ended December 31, 2007. Noninterest income increased by $191,366, or 8.6%, from $2,232,196 for the six-month period ended December 31, 2006 to $2,423,562 for the six months ended December 31, 2007. The increases in noninterest income during the three and six month periods ended December 31, 2007 were primarily attributable to increases in insurance commission income. The increase in commission income from insurance is due to increases in sales volume.
Non-Interest Expense. Non-interest expense increased by $128,320, or 5.2%, from $2,454,143 for the three months ended December 31, 2006 to $2,582,463 for the three months ended December 31, 2007. The
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increases in non-interest expense for the three-month period ended December 31, 2007 is primarily attributable to an increase in compensation and employee benefits. Non-interest expense increased by $68,258, or 1.4%, from $4,806,638 for the six months ended December 31, 2006 to $4,874,896 for the six months ended December 31, 2007. The increases in non-interest expense for the six-month period ended December 31, 2007 is primarily attributable to an increase in compensation and employee benefits partially offset by a gain on sale of REO. The increase in the gain on sale of REO is due to a gain of $288,989 recognized on the sale of one commercial property that was sold during the six months ended December 31, 2007. Compensation and employee benefits increased $154,830, or 10.6%, from $1,463,007 for the three months ended December 31, 2006 to $1,617,837 for the three months ended December 31, 2007. Compensation and employee benefits increased $342,521, or 11.8%, from $2,908,146 for the six months ended December 31, 2006 to $3,250,667 for the six months ended December 31, 2007. Compensation and employee benefits increased during the three and six month period ended December 31, 2007 primarily due to the compensation paid to commissioned noninsured investment and insurance salespeople. As commission income increases, compensation and employee benefits will also increase due to the commission pay structure of our insurance and investment salespeople.
Income Taxes.Income taxes resulted from applying normal, expected tax rates on income earned during the three and six months ended December 30, 2007 and 2006. The income tax expense was $124,628 for the three months ended December 31, 2007 compared to the income tax expense of $127,181 for the three months ended December 31, 2006. The income tax expense was $405,690 for the six months ended December 31, 2007 compared to the income tax expense of $313,695 for the six months ended December 31, 2006. The effective tax rate for the three and six month periods ended December 31, 2007 and 2006 were lower than the effective tax rate for the three and six month periods ended December 31, 2006 due to the purchase of $7.1 million in municipal bonds during the six month period ended December 31, 2007. The municipal bonds are general obligation bonds and the interest income is exempt from federal income taxes thus reducing the overall effective tax rate.
Capital Resources and Liquidity:
The term “liquidity” generally refers to an organization’s ability to generate adequate amounts of funds to meet its needs for cash. More specifically, for financial institutions, liquidity ensures that adequate funds are available to meet deposit withdrawals, fund loan demand and capital expenditure commitments, maintain reserve requirements, pay operating expenses, and provide funds for debt service, dividends to stockholders, and other institutional commitments. The Company’s primary sources of funds consist of deposits, borrowings, repayment and prepayment of loans, sales and participations of loans, maturities of securities and interest-bearing deposits, and funds provided from operations. While scheduled repayments of loans and maturities of securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by the general level of interest rates, economic conditions, and competition. The Company uses its liquid resources primarily to fund existing and future loan commitments, to fund net deposit outflows, to invest in other interest-earning assets, to maintain liquidity, and to meet operating expenses. For additional information about cash flows from the Company’s operating, financing and investing activities, see “Condensed Consolidated Statements of Cash Flow.”
Liquidity management is both a daily and long-term function of management. If we require funds beyond our ability to generate them internally, we believe we could borrow additional funds from the FHLB and use the wholesale deposit markets. At December 31, 2007, we had borrowings of $39.0 million from the FHLB with $13.0 million included in short-term borrowings and $26.0 million included in long-term borrowings. The Bank also maintains borrowing agreements with the FRB of Richmond, Virginia.
The Company anticipates that it will have sufficient funds available to meet its current loan origination commitments. Certificates of deposit scheduled to mature in less than one year totaled $115.3 million at December 31, 2007. Based upon historical experience, we believe that a significant portion of such deposits will remain with the Bank.
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As of December 31, 2007, cash and cash equivalents, a significant source of liquidity, totaled $7.8 million. The OTS regulations require the Company to maintain sufficient liquidity to ensure its safe and sound operation. Given our level of liquidity and our ability to borrow from the FHLB, we believe that we will have sufficient funds available to meet anticipated future loan commitments, unexpected deposit withdrawals, and other cash requirements. We do not anticipate any financial or insurance acquisitions at this time.
Capital management is another important daily and long-term function of management. While we currently meet all regulatory capital levels, we monitor this level on an ongoing basis. Our principal goals related to capital management are to provide an adequate return to shareholders while retaining a sufficient foundation from which to support future growth and to comply with all regulatory guidelines.
Off Balance-Sheet Arrangements:
The Company does not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company’s financial condition, revenues or expenses, results of operations, liquidity, capital resources or expenditures that are material to investors.
New Accounting Pronouncements:
In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets—an amendment of FASB Statement No. 140.” This Statement amends FASB No. 140,“Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” with respect to the accounting for separately recognized servicing assets and servicing liabilities. SFAS No. 156 requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract; requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable; permits an entity to choose its subsequent measurement methods for each class of separately recognized servicing assets and servicing liabilities; at its initial adoption, permits a one-time reclassification of available-for-sale securities to trading securities by entities with recognized servicing rights, without calling into question the treatment of other available-for-sale securities under Statement 115, provided that the available-for-sale securities are identified in some manner as offsetting the entity’s exposure to changes in fair value of servicing assets or servicing liabilities that a servicer elects to subsequently measure at fair value; and requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the statement of financial position and additional disclosures for all separately recognized servicing assets and servicing liabilities. An entity should adopt SFAS No. 156 as of the beginning of its first fiscal year that begins after September 15, 2006. We adopted SFAS No. 156 during the six months ended December 31, 2007 and SFAS No. 156 did not have a material impact on our financial position, results of operations and cash flows.
In September 2006, the FASB issued SFAS 157, “Fair Value Measurements.” SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principals (GAAP), and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements. Accordingly, this Statement does not require any new fair value measurements. However, for some entities, the application of this Statement will change current practice. The Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those years. We do not expect the adoption of SFAS 157 to have a material impact on our financial statements.
The FASB has issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” This statement permits entities to choose to measure many financial instruments and certain other items at
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fair value. The objective of this standard is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This statement is effective as of the beginning of fiscal years beginning after November 15, 2007, with early adoption permitted under certain circumstances. We are currently evaluating the impact of SFAS 159 on our financial statements.
In June 2006, the FASB issued FASB Interpretation (FIN) No. 48, “Accounting for Uncertainty in Income Taxes”,an interpretation of FASB Statement No. 109. FIN 48 addresses the recognition and measurement of certain tax positions taken in the financial statements of a business enterprise. It also includes certain financial statement disclosures around uncertain tax positions. FIN 48 is effective for fiscal years beginning after December 15, 2006. We adopted FIN 48 during the six months ended December 31, 2007. FIN 48 did not have a material impact on our financial statements.
| Item 3. | Controls and Procedures |
The Company maintains a system of internal controls and procedures designed to provide reasonable assurance as to the reliability of our published financial statements and other disclosures included in this report. The Company’s Board of Directors, operating through its Audit Committee, which is composed entirely of independent outside directors, provides oversight of the Company’s financial reporting process.
Management, including the Company’s President and Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report. Based upon that evaluation, the President and Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective, in all material respects, to ensure that information required to be disclosed in the reports the Company files and submits under the Exchange Act is recorded, processed, summarized and reported as and when required and that the controls and procedures ensure that such information is accumulated and communicated to the Company’s management as appropriate to allow timely decisions regarding required disclosure.
There have been no changes in the Company’s internal control over financial reporting identified in connection with the evaluation that occurred during the Company’s last fiscal quarter that has materially affected, or that is reasonably likely to materially affect, the Company’s internal control over financial reporting.
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| Item 4. | Submission of Matters to a Vote of Security Holders |
The Company held its Annual Meeting of Shareholders (“Meeting”) on November 5, 2007. All of the proposals submitted to the shareholders at the Meeting were approved. The proposals submitted to shareholders and the tabulation of votes for each proposal is as follows:
| 1. | Election of four candidates to the Board of Directors, each to serve for a term of three years. |
The number of votes cast with respect to this matter was as follows:
Nominee | For | Withheld | Broker Non-Votes | |||
Karen P. Powell | 929,228 | 500 | 121,076 | |||
Jimmy D. Reeves | 928,728 | 1,000 | 121,076 | |||
Jerry L. Roten | 929,178 | 550 | 121,076 | |||
Michael M. Sherman | 929,228 | 500 | 121,076 |
The following six directors were not up for reelection; however, they remain on the board to serve their existing term: Wayne R. Burgess, Jan R. Caddell, Kenneth R. Greene, Claudia L. Kelley, Donald R. Moore and Robert E. Washburn.
| 2. | Ratification of the appointment of Dixon Hughes PLLC as independent auditors for fiscal year ending June 30, 2008. |
The number of votes cast with respect to this matter was as follows:
For | Against | Abstained | Broker Non-Votes | |||
898,278 | — | — | 152,526 |
| Item 6. | Exhibits |
Exhibits
| 2.1 | Agreement and Plan of Reorganization dated September 15, 1997 by and among Ashe Federal Bank, AF Bankshares, Inc. and Ashe Interim Savings Bank (Incorporated by reference to Exhibit 2.1 of the Registration Statement on Form 8- A, as filed with the SEC on June 16, 1998 (the “Form 8-A”)). | |
| 3.1 | Federal Stock Charter of the Company (Incorporated by reference to Exhibit 3.1 of the Form 8-A). | |
| 3.2 | Bylaws of the Company (Incorporated by reference to Exhibit 3.2 of the Form 8- A). | |
| 4.1 | Common Stock Certificate of the Company (Incorporated by reference to Exhibit 4.3 of the Form 8-A). | |
| 10.1 | Employee Stock Ownership Plan of Ashe Federal Bank (Incorporated by reference to Exhibit 10.4 of the 1998 Form 10-KSB). | |
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| 10.2 | Amendment No. 1 to the Employee Stock Ownership Plan of AF Bank (Incorporated by reference to Exhibit 10.5 of the 2003 Form 10-KSB). | |
| 10.3 | Amendment No. 2 to the Employee Stock Ownership Plan of AF Bank (Incorporated by reference to Exhibit 10.6 of the 2003 Form 10-KSB). | |
| 10.4 | Amendment No. 3 to the Employee Stock Ownership Plan of AF Bank (Incorporated by reference to Exhibit 10.7 of the 2003 Form 10-KSB). | |
| 10.5 | Amendment No. 4 to the Employee Stock Ownership Plan of AF Bank (Incorporated by reference to Exhibit 10.7 of the 2003 Form 10-KSB). | |
| 10.6 | Salary Continuation Agreement between AF Bankshares, Inc. and Melanie Paisley Miller dated April 15, 2002 (Incorporated by reference to Exhibit 10.10 of the 2003 Form 10-KSB). | |
| 10.7 | Amended and Restated Retirement Plan for Board Members of AF Bank (Incorporated by reference to Exhibit 10 of the Form 8-K filed with the SEC on October 26, 2005). | |
| 11.0 | See Note 1 to the Consolidated Financial Statements included in the 2007 Form 10-KSB. | |
| 31.1 | Rule 13a-14(a)/15d-14(a) Certifications | |
| 32.1 | Section 1350 Certifications | |
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In accordance with the requirements of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| AF Financial Group | ||||
| Dated: February 13, 2008 | By: | /s/ Melanie P. Miller | ||
| Melanie P. Miller | ||||
| Chief Financial Officer, Executive Vice President, Secretary, Treasurer | ||||
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