ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES
MARCH 31, 2009
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES
General - - Atlantic BancGroup, Inc. (the “Holding Company”) is a bank holding company registered with the Federal Reserve and owns 100% of the outstanding stock of Oceanside Bank (“Oceanside”). Oceanside is a Florida state-chartered commercial bank, which opened July 21, 1997. Oceanside’s deposits are insured by the Federal Deposit Insurance Corporation. The Holding Company’s primary business activities are the operation of Oceanside, and it operates in only one reportable industry segment, banking. Collectively, the entities are referred to as “Atlantic.” References to Atlantic, Oceanside, and the Subsidiary throughout these condensed consolidated financial statements are made using the first-person notations of “we,” “our,” and “us.” In 2008, Oceanside formed and began operating a subsidiary, S. Pt. Properties, Inc. (the “Subsidiary”), for the sole purpose of managing a single real estate property acquired through foreclosure.
The accompanying condensed consolidated financial statements include the accounts of the Holding Company, its wholly-owned subsidiary, Oceanside, and the Subsidiary. All significant intercompany accounts and transactions have been eliminated in consolidation. The accounting and reporting policies of Atlantic conform with accounting principles generally accepted in the United States of America and to general practices within the banking industry.
Our condensed consolidated financial statements for the three months ended March 31, 2009 and 2008, have not been audited and do not include information or footnotes necessary for a complete presentation of consolidated financial condition, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States of America. In management’s opinion, the accompanying condensed consolidated financial statements contain all adjustments, which are of a normal recurring nature, necessary for a fair presentation. Our results of operations for the interim periods are not necessarily indicative of the results that may be expected for an entire year. The accounting policies followed by us are set forth in the consolidated financial statements for the year ended December 31, 2008, and are incorporated herein by reference.
Oceanside, through four banking offices, provides a wide range of banking services to individual and corporate customers primarily in East Duval and Northeast St. Johns counties of Florida. We are subject to regulations of certain federal and state regulatory agencies and, accordingly, we are examined by those agencies. As a consequence of the extensive regulation of commercial banking activities, our business is particularly susceptible to being affected by federal and state legislation and regulations.
Regulatory Oversight . As described in Form 10-K for the year ended December 31, 2008, Oceanside Bank is currently undergoing an FDIC regulatory examination and the final results are unknown. As noted herein, federal and state regulatory examinations may result in enforcement actions that include recognition of additional losses, stricter capital and liquidity thresholds, and other restrictions. At this time, management cannot predict the outcome of the current FDIC examination.
Capital Adequacy . During 2008, the FDIC issued guidance to institutions with significant concentrations of commercial real estate (“CRE”) loans, particularly construction and development (“C&D”) loans. The FDIC strongly recommended that, as market conditions warrant, institutions with CRE concentrations (particularly in C&D lending) increase capital to provide ample protection from unexpected losses if market conditions deteriorate further. Other recommendations for managing CRE concentrations included:
| | · | Ensure that loan loss allowances are appropriately strong. |
| | · | Manage C&D and CRE loan portfolios closely. |
| | · | Manage interest reserve and loan extension accommodations, reflecting the borrower’s condition accurately in loan ratings and documented reviews. |
| | · | Maintain updated financial and analytical information. |
| | · | Bolster the loan workout infrastructure. |
In light of the current economic environment, management is pursuing a number of sources for raising additional capital. However, current market conditions for banking institutions, the overall uncertainty in financial markets, and Atlantic’s depressed stock price are significant barriers to obtaining non-dilutive capital.
ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2009
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES (Continued)
Liquidity. Atlantic actively manages liquidity. Cash and cash equivalents at December 31, 2008, were $23.9 million. In addition to cash and cash equivalents and un-pledged investment securities, Atlantic has the following sources of available liquidity at March 31, 2009: lines of credit to purchase federal funds ($11.5 million), Federal Reserve discount window ($3.1 million), FDIC Temporary Liquidity Guarantee Program ($4.8 million), and Federal Home Loan Bank of Atlanta ($10.6 million). Other funding sources include brokered deposits, which currently represent less than 13% of total deposits. Based on current and expected liquidity needs and sources, management expects Atlantic to be able to meet its obligations.
Use of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, valuation of other real estate owned (or foreclosed assets), and the realization of deferred tax assets.
The determination of the adequacy of the allowance for loan losses and the valuation of foreclosed assets is based on estimates that may be affected by significant changes in the economic environment and market conditions. In connection with the determination of the estimated losses on loans and the valuation of foreclosed assets, management obtains independent appraisals for significant collateral.
Our loans are generally secured by specific items of collateral including real property, consumer assets, and business assets. Although we have a diversified loan portfolio, a substantial portion of our debtors’ ability to honor their contracts is dependent on local, state, and national economic conditions that may affect the value of the underlying collateral or the income of the debtor.
While management uses available information to recognize losses on loans and to value foreclosed assets, further reductions in the carrying amounts of loans and foreclosed assets may be necessary based on changes in economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the estimated losses on loans and carrying value of foreclosed assets. Such agencies may require us to recognize additional losses based on their judgments about information available to them at the time of their examination.
Management’s determination of the realization of deferred tax assets is based upon management’s judgment of various future events and uncertainties, including the timing, nature, and amount of future income earned by certain subsidiaries and the implementation of various plans to maximize realization of deferred tax assets. Management believes that the Company will generate sufficient operating earnings to realize the deferred tax benefits.
Fair Value of Financial Instruments - Financial instruments consist of cash, due from banks, federal funds sold, investment securities, restricted stock, loans receivable, accrued interest receivable, deposits, other borrowings, accrued interest payable, and off-balance sheet commitments such as commitments to extend credit and standby letters of credit. On an interim basis, we consider the cost of providing estimated fair values by each class of financial instrument to exceed the benefits derived.
Reclassifications - - Certain amounts in the prior periods have been reclassified to conform to the presentation for the current period.
Recent Accounting Pronouncements - SFAS No 141, “Business Combinations (Revised 2007).” SFAS 141R replaces SFAS 141, “Business Combinations,” and applies to all transactions and other events in which one entity obtains control over one or more other businesses. SFAS 141R requires an acquirer, upon initially obtaining control of another entity, to recognize the assets, liabilities and any non-controlling interest in the acquiree at fair value as of the acquisition date. Contingent consideration is required to be recognized and measured at fair value on the date of acquisition rather than at a later date when the amount of that consideration may be determinable beyond a reasonable doubt. This fair value approach replaces the cost-allocation process required under SFAS 141 whereby the cost of an acquisition was allocated to the individual assets acquired and liabilities assumed based on their
ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2009
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES (Continued)
estimated fair value. SFAS 141R requires acquirers to expense acquisition-related costs as incurred rather than allocating such costs to the assets acquired and liabilities assumed, as was previously the case under SFAS 141. Under SFAS 141R, the requirements of SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities,” would have to be met in order to accrue for a restructuring plan in purchase accounting. Pre-acquisition contingencies are to be recognized at fair value, unless it is a non-contractual contingency that is not likely to materialize, in which case, nothing should be recognized in purchase accounting, and, instead, that contingency would be subject to the probable and estimable recognition criteria of SFAS 5, “Accounting for Contingencies.” SFAS 141R is expected to have a significant impact on Atlantic’s accounting should it enter into any business combinations closing after January 1, 2009.
SFAS No. 160, “Noncontrolling Interest in Consolidated Financial Statements, an amendment of ARB Statement No. 51.” SFAS 160 amends Accounting Research Bulletin (ARB) No. 51, “Consolidated Financial Statements,” to establish accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 clarifies that a non-controlling interest in a subsidiary, which is sometimes referred to as a minority interest, is an ownership interest in the consolidated entity that should be reported as a component of equity in the consolidated financial statements. Among other requirements, SFAS 160 requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the non-controlling interest. It also requires disclosure, on the face of the consolidated income statement, of the amounts of consolidated net income attributable to the parent and to the non-controlling interest. SFAS 160 became effective for Atlantic on January 1, 2009. The adoption of this statement did not have a significant impact on Atlantic’s financial statements.
SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles.” SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States (the GAAP hierarchy). The hierarchical guidance provided by SFAS 162 did not have a significant impact on Atlantic’s financial statements.
A variety of proposed or otherwise potential accounting standards are currently under study by standard-setting organizations and various regulatory agencies. Because of the tentative and preliminary nature of these proposed standards, management has not determined whether implementation of such proposed standards would be material to Atlantic’s consolidated financial statements.
NOTE 2 - COMPUTATION OF PER SHARE EARNINGS (LOSSES)
Basic earnings (losses) per share (“EPS”) amounts are computed by dividing net income (loss) by the weighted average number of common shares outstanding for the three months ended March 31, 2009 and 2008. Diluted EPS is computed by dividing net income (loss) by the weighted average number of shares and all dilutive potential shares outstanding during the period. We have no dilutive potential shares outstanding for 2009 or 2008. The following information was used in the computation of EPS on both a basic and diluted basis for the three months ended March 31, 2009 and 2008 (dollars and number of shares in thousands):
| | | Three Months Ended March 31, | |
| | | 2009 | | | 2008 | |
| Basic and diluted EPS computation: | | | | | | |
| Numerator - Net income (loss) | | $ | (68 | ) | | $ | 47 | |
| Denominator - Weighted average shares outstanding (rounded) | | | 1,248 | | | | 1,248 | |
| Basic and diluted earnings (losses) per share | | $ | (0.05 | ) | | $ | 0.04 | |
ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2009
NOTE 3 - INVESTMENT SECURITIES
The amortized cost and estimated fair value of instruments in debt and equity securities are as follows (dollars in thousands):
| | | March 31, 2009 | | | December 31, 2008 | |
| | | | | | Gross | | | Gross | | | | | | | | | Gross | | | Gross | | | | |
| | | Amortized | | | Unrealized | | | Unrealized | | | Fair | | | Amortized | | | Unrealized | | | Unrealized | | | Fair | |
| | | Cost | | | Gains | | | Losses | | | Value | | | Cost | | | Gains | | | Losses | | | Value | |
| Available-for-sale | | | | | | | | | | | | | | | | | | | | | | | | |
| U.S. Government-sponsored agency securities | | $ | 190 | | | $ | 3 | | | $ | - | | | $ | 193 | | | $ | 2,700 | | | $ | 5 | | | $ | (6 | ) | | $ | 2,699 | |
| Mortgage-backed securities | | | 17,993 | | | | 20 | | | | (70 | ) | | | 17,943 | | | | 12,171 | | | | 40 | | | | (40 | ) | | | 12,171 | |
| | | | 18,183 | | | | 23 | | | | (70 | ) | | | 18,136 | | | | 14,871 | | | | 45 | | | | (46 | ) | | | 14,870 | |
| Held-to-maturity | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| State, county and municipal bonds | | | 15,535 | | | | 110 | | | | (1,077 | ) | | | 14,568 | | | | 15,536 | | | | 133 | | | | (771 | ) | | | 14,898 | |
| Total investment securities | | $ | 33,718 | | | $ | 133 | | | $ | (1,147 | ) | | $ | 32,704 | | | $ | 30,407 | | | $ | 178 | | | $ | (817 | ) | | $ | 29,768 | |
Management evaluates securities for other-than-temporary impairment at least on a monthly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) the intent and ability of Atlantic to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
The unrealized losses on investment securities were caused by interest rate changes. Temporary net decreases in fair value of securities available-for-sale at March 31, 2009, are regarded as an adjustment to stockholders' equity. The estimated fair value of investment securities is determined on the basis of market quotations. The following is a summary of the effects on the Condensed Consolidated Statement of Stockholders’ Equity at March 31, 2009 and December 31, 2008 (dollars in thousands):
| | | March 31, | | | December 31, | |
| | | 2009 | | | 2008 | |
| | | | | | | |
| Gross unrealized losses on investment securities available-for-sale | | $ | (47 | ) | | $ | (1 | ) |
| Deferred tax benefit on unrealized losses | | | 18 | | | | - | |
| Balance | | $ | (29 | ) | | $ | (1 | ) |
The following presents the net change in unrealized gains or losses on investment securities available-for-sale that are shown as a component of stockholders’ equity and comprehensive income (loss) for the three months ended March 31, 2009 and 2008 (dollars in thousands):
| | | Three Months Ended March 31, | |
| | | 2009 | | | 2008 | |
| | | | | | | |
| Unrealized holding gains (losses) on investment securities arising during period | | $ | (1 | ) | | $ | 564 | |
| Less: reclassification adjustment for gains included in net income (loss) | | | (45 | ) | | | - | |
| Other comprehensive income (loss), before income taxes (benefits) | | | (46 | ) | | | 564 | |
| Income tax expense related to items of other comprehensive income | | | 18 | | | | (213 | ) |
| Other comprehensive income (loss), net of income tax (benefits) | | $ | (28 | ) | | $ | 351 | |
Gross gains and losses on sales of investment securities for the three months ended March 31, 2009, totaled $45,000 and $-0-, respectively. There were no sales of investment securities during the same period of 2008.
At March 31, 2009, held-to-maturity investment securities with an amortized cost of $863,000 and fair value of $875,000 were pledged to secure deposits of public funds from the State of Florida and treasury tax and loan deposits with the Federal Reserve. At March 31, 2009, held-to-maturity investment securities with an amortized cost of $4.2 million and a fair value of $3.7 million were pledged for other borrowings.
ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2009
NOTE 3 - INVESTMENT SECURITIES (Continued)
There were no securities of a single issuer, which are non-governmental or non-government sponsored, that exceeded 10% of stockholders’ equity at March 31, 2009.
NOTE 4 - LOANS
Loans consisted of (dollars in thousands):
| | | March 31, | | | December 31, | |
| | | 2009 | | | 2008 | |
| Real estate loans: | | | | | | |
| Construction, land development, and other land | | $ | 34,378 | | | $ | 39,135 | |
| 1-4 family residential | | | 59,667 | | | | 57,814 | |
| Multifamily residential | | | 4,679 | | | | 4,481 | |
| Commercial | | | 91,416 | | | | 88,762 | |
| | | | 190,140 | | | | 190,192 | |
| Commercial loans | | | 12,381 | | | | 13,314 | |
| Consumer and other loans | | | 4,990 | | | | 3,548 | |
| Total loan portfolio | | | 207,511 | | | | 207,054 | |
| Less, deferred fees | | | (23 | ) | | | (25 | ) |
| Less, allowance for loan losses | | | (4,062 | ) | | | (3,999 | ) |
| Loans, net | | $ | 203,426 | | | $ | 203,030 | |
During the three months ended March 31, 2009 and 2008, Oceanside transferred loans with carrying values (net of charge-offs and participations) totaling $324,000 and $5,189,000, respectively, to other real estate owned (foreclosed properties or assets). Proceeds (net of participations) from the sale of foreclosed properties totaled $1,346,000 and $620,000, respectively, for the same periods. Gross losses of $115,000 and gross gains of $54,000 for a net loss of $61,000 were recorded on sales of foreclosed properties for the first quarter of 2009. No gains or losses were reported for the same period of 2008. Expenses totaling $74,000 and $92,000, respectively, were recorded in 2009 and 2008 on foreclosed assets.
NOTE 5 - ALLOWANCE FOR LOAN LOSSES
Our Board of Directors monitors the loan portfolio quarterly in order to enable it to evaluate the adequacy of the allowance for loan losses. We maintain the allowance for loan losses at a level that we believe to be sufficient to absorb probable losses inherent in the loan portfolio. Activity in the allowance for loan losses follows (dollars in thousands):
| | | For the Three | | | For the Twelve | |
| | | Months Ended | | | Months Ended | |
| | | March 31, 2009 | | | December 31, 2008 | |
| | | | | | | |
| Balance, beginning of period | | $ | 3,999 | | | $ | 2,169 | |
| Provisions charged to operating expenses | | | 234 | | | | 4,424 | |
| Loans charged-off | | | (171 | ) | | | (2,615 | ) |
| Recoveries | | | - | | | | 21 | |
| | | | | | | | | |
| Balance, end of period | | $ | 4,062 | | | $ | 3,999 | |
We had twelve loans totaling $7,292,000 at March 31, 2009, categorized as nonaccrual, and nine loans totaling $5,459,000 categorized as nonaccrual at December 31, 2008. We had specific allowances for losses on nonaccrual loans of $274,000 and $385,000 at March 31, 2009 and December 31, 2008, respectively.
ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2009
NOTE 5 - ALLOWANCE FOR LOAN LOSSES (Continued)
We had loans past due 90 days or more and still accruing interest totaling $18,000 and $1,656,000 at March 31, 2009 and December 31, 2008, respectively. Loans over 90 days past due that are well secured and in process of collection remain on accrual status in accordance with regulatory guidelines.
NOTE 6 - LONG-TERM BORROWINGS
A summary of long-term borrowings follows (dollars in thousands):
| | | March 31, | | | December 31, | |
| | | 2009 | | | 2008 | |
| | | | | | | |
| FHLB of Atlanta advances | | $ | 14,300 | | | $ | 6,300 | |
| Junior subordinated debentures | | | 3,093 | | | | 3,093 | |
| | | | | | | | | |
| Total long-term borrowings | | $ | 17,393 | | | $ | 9,393 | |
During the first quarter of 2009, we borrowed an additional $8.0 million from the FHLB of Atlanta. A summary of the FHLB of Atlanta advances follows (dollars in thousands):
| | | | | | | March 31, | | | December 31, | |
| | Maturity Date | | Interest Rate | | | 2009 | | | 2008 | |
| | | | | | | | | | | |
| Convertible fixed rate debt | 11/17/2010 | | 4.45% | | | $ | 2,300 | | | $ | 2,300 | |
| Fixed rate advances | 12/20/2010 | | 1.91%-2.07% | | | | 4,000 | | | | 4,000 | |
| Fixed rate advance | 01/09/2012 | | 2.30% | | | | 8,000 | | | | - | |
| | | | | | | | $ | 14,300 | | | $ | 6,300 | |
NOTE 7 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
We are a party to credit-related financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit, standby letters of credit, and commercial letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the statements of financial condition. Our exposure to credit loss is represented by the contractual amount of these commitments. We follow the same credit policies in making commitments as we do for on-balance sheet instruments. Financial instruments at March 31, 2009, consisted of commitments to extend credit approximating $13.1 million and standby letters of credit of $1.7 million.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for equity lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by us, is based on our credit evaluation of the customer.
ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2009
NOTE 8 - REGULATORY CAPITAL
Oceanside is required to maintain certain minimum regulatory capital requirements. The following is a summary at March 31, 2009 (before the loss on write-down of restricted stock in Silverton Bank), of the regulatory capital requirements and actual capital on a percentage basis for Oceanside:
| | | | | | Regulatory Requirement | |
| | | | | | For Capital | | | For Well- | |
| | | Actual | | | Adequacy | | | Capitalized | |
| | | | | | | | | | |
| Total capital ratio to risk-weighted assets | | 10.48% | | | 8.00% | | | 10.00% | |
| Tier 1 capital ratio to risk-weighted assets | | 9.22% | | | 4.00% | | | 6.00% | |
| Tier 1 capital to average assets | | 7.21% | | | 4.00% | | | 5.00% | |
As previously mentioned in Note 1, Oceanside is undergoing an FDIC examination. Given the current banking environment (which includes concerns over CRE concentrations, liquidity, loan losses, and capital), regulatory agencies are addressing these issues with enforcement actions ranging from a written agreement (either informal or formal) that would preclude Oceanside from being considered well-capitalized to the restriction or prohibition of certain activities by Atlantic or Oceanside. If Oceanside was deemed a less than well-capitalized institution, the banking regulators would likely require Atlantic and Oceanside to submit a plan for restoring Oceanside to an acceptable capital category.
Subsequent to the filing of Oceanside’s Call Report for the quarter ended March 31, 2009, Oceanside realized a loss on restricted stock of $112,000 (net of income tax benefit). For regulatory reporting purposes, Oceanside will report the loss in the second quarter of 2009 as this subsequent event became known after the financial statements of Oceanside were filed with the regulators. Accordingly, the risk-based capital ratios have not been revised. The effect on the risk-based capital ratios ranged from 0.04% to 0.05% and were not material (see Note 10).
NOTE 9 - FAIR VALUE MEASUREMENTS
On January 1, 2008, Atlantic adopted Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements; accordingly, the standard does not require any new fair value measurements of reported balances.
SFAS 157 emphasizes that fair value is market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, SFAS 157 establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Level 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).
Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchange rates and yield curves that are observable at commonly quoted intervals.
Level 3 inputs are unobservable inputs for the asset or liabilities, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. In instances where more than one level of input exists for assets or liabilities, the lowest level of input that is significant to the fair value measurement in its entirety will be used in determining the fair value hierarchy. Atlantic’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.
ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2009
NOTE 9 - FAIR VALUE MEASUREMENTS (Continued)
The table below presents the Atlantic’s assets and liabilities measured at fair value on a recurring basis as of March 31, 2009, aggregated by the level in the fair value hierarchy within which those measurements fall.
| | | Quoted Prices | | | Significant | | | | | | | |
| | | in Active | | | Other | | | Significant | | | | |
| | | Markets for | | | Observable | | | Unobservable | | | | |
| | | Identical Assets | | | Inputs | | | Inputs | | | | |
| | | (Level 1) | | | (Level 2) | | | (Level 3) | | | Total | |
| Assets (dollars in thousands): | | | | | | | | | | | | |
| Investment securities, available-for-sale | | $ | - | | | $ | 18,136 | | | $ | - | | | $ | 18,136 | |
| | | | | | | | | | | | | | | | | |
| Total assets at fair value | | $ | - | | | $ | 18,136 | | | $ | - | | | $ | 18,136 | |
Securities available-for-sale – The fair value of securities available for sale equals quoted market prices, if available. If quoted market prices are not available, fair value is determined using quoted market prices for similar securities. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange. Level 2 securities include mortgage-backed securities, other pass-through securities and collateralized mortgage obligations of government sponsored entities (GSE’s) and private issuers and obligations of states and political subdivisions.
Certain other assets are measured at fair value on a nonrecurring basis. These adjustments to fair value usually result from application of lower of cost or fair value accounting or write-downs of individual assets due to impairment. For assets measured at fair value on a nonrecurring basis, the following table provides the level of valuation assumptions used to determine each adjustment and the carrying value of the related individual assets at December 31, 2008.
| | | Quoted Prices | | | Significant | | | | | | | |
| | | in Active | | | Other | | | Significant | | | | |
| | | Markets for | | | Observable | | | Unobservable | | | | |
| | | Identical Assets | | | Inputs | | | Inputs | | | | |
| | | (Level 1) | | | (Level 2) | | | (Level 3) | | | Total | |
| Assets (dollars in thousands): | | | | | | | | | | | | |
| Impaired loans, net of direct write-off and specific valuation allowances | | $ | - | | | $ | - | | | $ | 7,018 | | | $ | 7,018 | |
| Foreclosed assets | | | - | | | | - | | | | 2,388 | | | | 2,388 | |
| | | | | | | | | | | | | | | | | |
| Total assets at fair value | | $ | - | | | $ | - | | | $ | 9,406 | | | $ | 9,406 | |
Loans – Nonrecurring fair value adjustments to loans reflect full or partial write-downs that are based on the loan’s observable market price or current appraised value of the collateral in accordance with SFAS 114, Accounting by Creditors for Impairment of a Loan. Since the market for impaired loans is not active, loans subjected to nonrecurring fair value adjustments based on the loan’s observable market price are generally classified as Level 2. Loans subjected to nonrecurring fair value adjustments based on the current appraised value of the collateral may be classified as Level 2 or Level 3 depending on the type of asset and the inputs to the valuation. When appraisals are used to determine impairment and these appraisals are based on a market approach incorporating a dollar-per-square-foot multiple, the related loans are classified as Level 2. If the appraisals require significant adjustments to market-based valuation inputs or apply an income approach based on unobservable cash flows to measure fair value, the related loans subjected to nonrecurring fair value adjustments are typically classified as Level 3 due to the fact that Level 3 inputs are significant to the fair value measurement.
Foreclosed assets – These assets are reported at the lower of the loan carrying amount at foreclosure (or repossessions) or fair value written down by estimated cost to sale. Fair value is based on third party appraisals for other real estate owned and other independent sources for repossessed assets, considering the assumptions in the valuation, and are considered Level 2 or Level 3 inputs.
ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2009
NOTE 10 - SUBSEQUENT EVENT
After Oceanside Bank had filed its Call Report for the first quarter of 2009, the FDIC announced that a bridge bank was created to take over the operations of Silverton Bank, National Association, Atlanta, Georgia, after the Office of the Comptroller of the Currency (“OCC”) closed the bank on May 1, 2009. The OCC appointed the FDIC as receiver. The newly created bank is Silverton Bridge Bank, National Association. Silverton Bank was a commercial bank that provided correspondent banking services to approximately 1,400 client banks in 44 states, and operated six regional offices. To solidify and enhance our correspondent banking relationship with Silverton Bank, we were asked to purchase Silverton Bank restricted stock totaling $179,000, which is now impaired.
Retroactive to March 31, 2009, Oceanside elected to write-down all the Silverton Bank common stock. This write-down of $112,000 (net of income tax benefit of $67,000) caused a swing from net earnings of $44,000 to the net loss of $68,000 reported for the quarter ended March 31, 2009. Management anticipates experiencing no other losses due to its relationship with Silverton Bank.
| MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Overview
Commercial Banking Operations. Atlantic, through its wholly-owned subsidiary, Oceanside, conducts commercial banking business consisting of attracting deposits and applying those funds to the origination of commercial, consumer, and real estate loans (including commercial loans collateralized by real estate) and purchases of investments. Our profitability depends primarily on net interest income, which is the difference between interest income generated from interest-earning assets (principally loans, investments, and federal funds sold), less the interest expense incurred on interest-bearing liabilities (customer deposits and borrowed funds). Net interest income is affected by the relative amounts of interest-earning assets and interest-bearing liabilities, and the interest rate earned and paid on these balances. Net interest income is dependent upon Oceanside’s interest-rate spread, which is the difference between the average yield earned on its interest-earning assets and the average rate paid on its interest-bearing liabilities. When interest-earning assets approximate or exceed interest-bearing liabilities, any positive interest rate spread will generate net interest income. The interest rate spread is impacted by interest rates, deposit flows, and loan demand. Additionally, and to a lesser extent, our profitability is affected by such factors as the level of noninterest income and expenses, the provision for loan losses, and the effective income tax rate. Noninterest income consists primarily of service fees on deposit accounts and mortgage banking fees. Noninterest expense consists of compensation and employee benefits, occupancy and equipment expenses, deposit insurance premiums paid to the FDIC, and other operating expenses.
Our corporate offices are located at 1315 South Third Street, Jacksonville Beach, Florida. This location is also our main banking office for Oceanside, which opened July 21, 1997, as a state-chartered banking organization. We also operate branch offices located at 560 Atlantic Boulevard, Neptune Beach, Florida, 13799 Beach Boulevard, and 1790 Kernan Boulevard South, Jacksonville, Florida.
Forward-looking Statements
When used in this Form 10-Q, the words or phrases “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project,” or similar expressions are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties including changes in economic conditions in our market area, changes in policies by regulatory agencies, fluctuations in interest rates, demand for loans in our market area and competition, that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. We caution readers not to place undue reliance on any such forward-looking statements, which speak only as to the date made. We advise readers that the factors listed above, as well as others, could affect our financial performance and could cause our actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements. We do not undertake, and specifically disclaim any obligation, to publicly release the result of any revisions, which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements, or to reflect the occurrence of anticipated or unanticipated events.
Future Accounting Requirements
There are currently no pronouncements issued or that are scheduled for implementation during 2009 that are expected to have any significant impact on our accounting policies.
Impact of Inflation
The consolidated financial statements and related data presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurements of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, substantially all of our assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on our performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services, since such prices are affected by inflation to a larger extent than interest rates. As discussed previously, we seek to manage the relationships between interest-sensitive assets and liabilities in order to protect against wide interest rate fluctuations, including those resulting from inflation.
Critical Accounting Policies
Our accounting and reporting policies are in accordance with U.S. generally accepted accounting principles (“GAAP”), and they conform to general practices within the banking industry. We use a significant amount of judgment and estimates based on assumptions for which the actual results are uncertain when we make the estimations. We have identified our policy covering the allowance for loan losses as being particularly sensitive in terms of judgments and the extent to which significant estimates are used. For more information on this critical accounting policy, please refer to our 2008 Annual Report on Form 10-K.
Results of Operations
Our net loss for the three months ended March 31, 2009, after recording a loss of $112,000 on restricted stock (net of income tax benefit), was $68,000, as compared with net income of $47,000, as reported in the same period of 2008. Average earning assets remained steady for the first three months of 2009 versus the same period of 2008. An overview of the more significant matters affecting our results of operations follows:
| · | Average loans for the three months ended March 31, 2009, were higher than the first quarter of 2008 by $5.6 million, or 2.8%. Interest bearing deposits increased $6.8 million, or 3.5%, and non-interest bearing deposits increased $6.9 million, or 24.9%. While we experienced year-to-year growth from the first quarter of 2008 to the first quarter of 2009, we do not expect this trend to continue throughout 2009. Loan and deposit growth from December 31, 2008 to March 31, 2009, totaled 0.2% and 0.6%, respectively. |
| · | Net interest income (before provision for loan losses) increased $32,000, or 1.8%, for the three months ended March 31, 2009, over the same period in 2008. This increase is due primarily to yields on interest earning assets decreasing at a slower pace than yields on deposits and other borrowings, resulting in improved net interest margins. |
| · | Our results for 2009 included additional reserves set aside to offset loan charge-offs and recent real estate foreclosures. The provision for loan losses for the first three months of 2009 totaled $234,000, rising 4.5% over first quarter 2008 levels. |
| · | Total noninterest expenses decreased $9,000, or 0.5%, for the three months ended March 31, 2009, over the same period in 2008. Decreases in salaries, employee benefits, and directors’ fees were largely offset by increases in data processing, software, and communications expense. |
Financial Condition
The following table shows selected ratios for the periods ended or at the dates indicated (annualized for the three months ended March 31, 2009):
| | Three months | | Year Ended |
| | Ended | | December 31, |
| | March 31, 2009 | | 2008 |
| | | | |
| Return on average assets | -0.10% | | -0.74% |
| Return on average equity | -1.63% | | -10.37% |
| Interest-rate spread | 2.75% | | 2.55% |
| Net interest margin | 3.11% | | 3.03% |
| Noninterest expenses to average assets | 2.71% | | 2.94% |
Liquidity and Capital Resources
Liquidity Management. Liquidity management involves monitoring the sources and uses of funds in order to meet our day-to-day cash flow requirements while maximizing profits. Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss and to raise additional funds by increasing liabilities. Liquidity management is made more complicated because different statements of financial condition components are subject to varying degrees of management control. For example, the timing of maturities of the investment portfolio is very predictable and subject to a high degree of control at the time investment decisions are made. However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control. Asset liquidity is provided by cash and assets that are readily marketable, which can be pledged, or which will mature in the near future. Liability liquidity is provided by access to core funding sources, principally the ability to generate customer deposits in our market area. In addition, liability liquidity is provided through the ability to borrow against approved lines of credit (federal funds purchased) from correspondent banks and to borrow on a secured basis through securities sold under agreements to repurchase.
We expect to meet our liquidity needs with:
| · | Available cash, including both interest and noninterest-bearing balances, and federal funds sold, which totaled $23.9 million at March 31, 2009; |
| · | The repayment of loans, which include loans with a remaining maturity of one year or less (excluding those in nonaccrual status) totaling $43.4 million; |
| · | Proceeds of unpledged securities available-for-sale and principal repayments from mortgage-backed securities; |
| · | Retention of and growth in deposits; and, |
| · | If necessary, borrowing against approved lines of credit and other alternative funding strategies. |
Short-Term Investments. Short-term investments, which consist of federal funds sold and interest-bearing deposits, were $-0- at March 31, 2009, as compared to $100,000 at December 31, 2008. We regularly review our liquidity position and have implemented internal policies that establish guidelines for sources of asset-based liquidity and limit the total amount of purchased funds used to support the statement of financial condition and funding from non-core sources. To further enhance our liquidity, we have developed alternative funding strategies that have been approved by our Board of Directors. Alternate funding strategies include (dollars in thousands):
| Lines of credit to purchase federal funds | | $ | 11,500 | |
| Federal Reserve discount window | | | 3,131 | |
| FDIC Temporary Liquidity Guarantee Program | | | 4,841 | |
| Federal Home Loan Bank of Atlanta | | | 10,635 | |
| | | $ | 30,107 | |
Emergency Economic Stabilization Act of 2008. In October 2008, the Emergency Economic Stabilization Act of 2008 (“EESA”) was signed into law. The EESA temporarily revises the federal deposit insurance laws by increasing the basic deposit insurance coverage from $100,000 to $250,000 per depositor. This revision is currently effective through December 31, 2009. The EESA also authorized the United States Department of the Treasury to implement programs to provide financial assistance and/or support to financial institutions. We have not participated in any such programs.
Temporary Liquidity Guarantee Program. In order to promote financial stability in the economy, the FDIC adopted the Temporary Liquidity Guarantee Program (“TLGP”) on October 13, 2008. Participation in the program is voluntary. However, once participation is elected, it can not be revoked. We have chosen to participate in the Transaction Account Guarantee Program component of the TLGP. Under the Transaction Account Guarantee Program, the FDIC will fully insure funds held in noninterest-bearing transaction accounts. Noninterest-bearing transaction accounts are ones that do not accrue or pay interest and for which the institution does not require an advance notice of withdrawal. Also covered are interest on lawyers’ trust accounts and negotiable order of withdrawal (NOW) accounts with interest rates lower than 50 basis points. These revisions are only effective through December 31, 2009.
Deposits and Other Sources of Funds. In addition to deposits, the sources of funds available for lending and other business purposes include loan repayments, loan sales, securities sold under agreements to repurchase, and advances under approved borrowings from the Federal Home Loan Bank of Atlanta. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows are influenced significantly by general interest rates and money market conditions. Borrowings may be used on a short-term basis to compensate for reductions in other sources, such as deposits at less than projected levels.
Core Deposits. Core deposits, which exclude certificates of deposit of $100,000 or more, provide a relatively stable funding source for our loan portfolio and other earning assets. We had core deposits totaling $197.2 million at March 31, 2009, and $188.1 million at December 31, 2008, an increase of 4.9%. We anticipate that a stable base of deposits will be our primary source of funding to meet both short-term and long-term liquidity needs in the future.
Customers with large certificates of deposit tend to be extremely sensitive to interest rate levels, making these deposits less reliable sources of funding for liquidity planning purposes than core deposits. Some financial institutions acquire funds in part through large certificates of deposit obtained through brokers. These brokered deposits have been historically expensive and unreliable as long-term funding sources. More recently, the brokered funds have become less expensive than local deposits. Brokered certificates of deposit issued by us totaled $30.3 million at March 31, 2009, and $26.3 million at December 31, 2008, an increase of 15.2%. The increase in brokered deposits resulted from a $5.0 million acquisition at the end of March 2009, for the purpose of providing liquidity to repay $7.0 million in brokered deposits maturing in April 2009.
We use our resources principally to fund existing and continuing loan commitments and to purchase investment securities. At March 31, 2009, we had commitments to extend credit totaling $13.1 million, and had issued, but unused, standby letters of credit of $1.7 million for the same period. In addition, scheduled maturities of certificates of deposit during the twelve months following March 31, 2009, total $103.7 million. We believe that adequate resources exist to fund all our anticipated commitments, and, if so desired, that we can adjust the rates and terms on certificates of deposit and other deposit accounts to retain deposits in a changing interest rate environment.
Capital. We are subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective actions, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. FDIC’s Prompt Corrective Action regulations are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy require us to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average assets (as defined in the regulations). Management believes, as of March 31, 2009, that we met all minimum capital adequacy requirements to which we are subject.
As of the most recent reporting period for the quarter ended March 31, 2009, Oceanside’s ratios exceeded the minimum levels for the well-capitalized category. An institution must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following tables. At March 31, 2009, Oceanside’s actual capital amounts and percentages are presented in the following table (dollars in thousands):
| | | Actual | | | Minimum(1) | | | Well-Capitalized(2) | |
| | | Amount | | | % | | | Amount | | | % | | | Amount | | | % | |
| | | | | | | | | | | | | | | | | | | |
| Total capital to risk-weighted assets | | $ | 22,014 | | | | 10.48 | % | | $ | 16,802 | | | | 8.00 | % | | $ | 21,003 | | | | 10.00 | % |
| Tier 1 capital to risk-weighted assets | | $ | 19,371 | | | | 9.22 | % | | $ | 8,401 | | | | 4.00 | % | | $ | 12,602 | | | | 6.00 | % |
| Tier 1 capital to average assets | | $ | 19,371 | | | | 7.21 | % | | $ | 10,748 | | | | 4.00 | % | | $ | 13,435 | | | | 5.00 | % |
| (1) | The minimum required for adequately capitalized purposes. |
| (2) | To be "well-capitalized" under the FDIC's Prompt Corrective Action regulations for banks. |
There are no conditions or events since March 31, 2009, that management believes have changed Oceanside’s category (see Notes 8 and 10 to Condensed Consolidated Financial Statements).
Asset Quality
We have developed policies and procedures for evaluating the overall quality of our credit portfolio and the timely identification of potential problem loans. Our judgment as to the adequacy of the allowance is based upon a number of assumptions about future events that we believe to be reasonable, but which may or may not be valid. Thus, there can be no assurance that charge-offs in future periods will not exceed the allowance for loan losses or that additional increases in the loan loss allowance will not be required.
Asset Classification. Commercial banks are required to review and, when appropriate, classify their assets on a regular basis. The State of Florida and the FDIC have the authority to identify problem assets and, if appropriate, require them to be classified or require a harsher classification than management has assessed. There are three classifications for problem (or classified) assets: substandard, doubtful, and loss. Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values questionable, and there is a high possibility of loss. An asset classified as loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. If an asset or portion thereof is classified as loss, the insured institution establishes a specific reserve for the full amount of the portion of the asset classified as loss. All or a portion of general loss allowances established to cover possible losses related to assets classified as substandard or doubtful may be included in determining an institution's regulatory capital, while specific valuation allowances for loan losses generally do not qualify as regulatory capital.
Assets that do not warrant classification in the aforementioned categories, but possess weaknesses, are classified by us as special mention and monitored. We also monitor other loans based on a variety of factors and internally designate these loans as watch list loans.
Management monitors our loan portfolio throughout the month for classification changes. Each quarter, we perform a detailed internal review to determine an appropriate level of reserves to set aside for probable losses in our loan portfolio. We supplement our internal reviews with semiannual external loan review performed by an independent public accounting firm. The regulatory agencies also have the authority to require additional levels of reserves if they deem necessary despite management’s best efforts to establish an appropriate level of reserves consistent with generally accepted accounting principles. Sometimes our collective assessments from internal and loan reviews may differ from the regulatory assessment.
Allowance for Loan Losses. The allowance for loan losses is established through a provision for loan losses charged against income. Loans are charged against the allowance when we believe that the collectibility of principal is unlikely. The provision is an estimated amount that we believe will be adequate to absorb probable losses inherent in the loan portfolio based on evaluations of its collectibility. The evaluations take into consideration such factors as changes in the nature and volume of the portfolio, overall portfolio quality, specific problem loans and commitments, and current anticipated economic conditions that may affect the borrower's ability to pay. While we use the best information available to recognize losses on loans, future additions to the provision may be necessary based on changes in economic conditions. A summary of balances in the allowance for loan losses and key ratios follows (dollars in thousands):
| | | For the Three | | | For the Twelve | |
| | | Months Ended | | | Months Ended | |
| | | March 31, 2009 | | | December 31, 2008 | |
| | | | | | | |
| End of period loans (net of deferred fees) | | $ | 207,488 | | | $ | 207,029 | |
| End of period allowance for loan losses | | $ | 4,062 | | | $ | 3,999 | |
| % of allowance for loan losses to total loans | | | 1.96 | % | | | 1.93 | % |
| Average loans for the period | | $ | 207,280 | | | $ | 203,675 | |
| Net charge-offs as a percentage of average loans for the period (annualized for 2009) | | | 0.33 | % | | | 1.27 | % |
| Nonperforming assets: | | | | | | | | |
| Nonaccrual loans | | $ | 7,292 | | | $ | 5,459 | |
| Loans past due 90 days or more and still accruing | | | 18 | | | | 1,656 | |
| Foreclosed real estate | | | 2,338 | | | | 3,421 | |
| Other repossessed assets | | | 50 | | | | 75 | |
| | | $ | 9,698 | | | $ | 10,611 | |
| Nonaccrual loans to period end loans | | | 3.51 | % | | | 2.64 | % |
| Nonperforming assets to period end total assets | | | 3.49 | % | | | 3.96 | % |
At March 31, 2009, we had 45 loans totaling approximately $23.2 million classified as substandard and three loans totaling approximately $3.3 million classified as doubtful. We had no loans classified as loss at March 31, 2008. At March 31, 2009, management had provided specific reserves totaling $1.5 million for loans risk-rated substandard or lower.
Our internally-classified loans declined $2.0 million from December 31, 2008, levels of $28.5 million. We also reported a net decline in total nonperforming assets of $913,000, or 8.6%, principally from sales of other real estate owned that resulted in a net loss of $61,000 for the quarter ended March 31, 2009.
Interest Rate Risk
Our asset base is exposed to risk including the risk resulting from changes in interest rates and changes in the timing of cash flows. We monitor the effect of such risks by considering the mismatch of the maturities of our assets and liabilities in the current interest rate environment and the sensitivity of assets and liabilities to changes in interest rates. We have considered the effect of significant increases and decreases in interest rates and believe such changes, if they occurred, would be manageable, and would not affect our ability to hold our assets as planned. However, we would be exposed to significant market risk in the event of significant and prolonged interest rate changes.
Quantitative and Qualitative Disclosures about Market Risk
Market risk is the risk of loss from adverse changes in market prices and rates. Our market risk arises primarily from interest rate risk inherent in our lending and deposit-taking activities. We have little or no risk related to trading accounts, commodities or foreign exchange.
We do not engage in trading or hedging activities and do not invest in interest-rate derivatives or enter into interest- rate swaps. We actively monitor and manage interest-rate risk exposure. The primary objective in managing interest-rate risk is to limit, within established guidelines, the adverse impact of changes in interest rates on our net interest income and capital, while adjusting our asset-liability structure to obtain the maximum yield-cost spread on that structure. We rely primarily on the asset-liability structure to control interest-rate risk. However, a sudden and substantial change in interest rates could adversely impact our earnings, to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent, or on the same basis. There have been no significant changes in our market risk exposure since December 31, 2008.
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Average Balances, Income and Expenses, and Rates
The following table depicts, for the periods indicated, certain information related to our average statements of financial condition and our average yields on assets and average costs of liabilities. Such yields are derived by dividing income or expense by the average balance of the corresponding assets or liabilities. Average balances have generally been derived from daily averages (dollars in thousands):
| | | For the Three Months Ended March 31, | |
| | | 2009 | | | 2008 | |
| | | | | | | | | Average | | | | | | | | | Average | |
| | | Average | | | and | | | Yield/ | | | Average | | | and | | | Yield/ | |
| | | Balance | | | Dividends | | | Rate | | | Balance | | | Dividends | | | Rate | |
| Interest-earning assets: | | | | | | | | | | | | | | | | | | |
| Loans | | $ | 207,280 | | | $ | 3,154 | | | | 6.17 | % | | $ | 201,648 | | | $ | 3,630 | | | | 7.24 | % |
Investment securities and interest-bearing deposits (1) | | | 33,796 | | | | 343 | | | | 5.33 | % | | | 40,776 | | | | 458 | | | | 5.52 | % |
| Other interest-earning assets | | | 2,228 | | | | 1 | | | | 0.18 | % | | | 944 | | | | 8 | | | | 3.41 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Total interest-earning assets (1) | | | 243,304 | | | | 3,498 | | | | 6.00 | % | | | 243,368 | | | | 4,096 | | | | 6.94 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Noninterest-earning assets | | | 26,124 | | | | | | | | | | | | 16,418 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total assets | | $ | 269,428 | | | | | | | | | | | $ | 259,786 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Demand, money market, and NOW deposits | | $ | 53,894 | | | | 210 | | | | 1.58 | % | | $ | 40,888 | | | | 303 | | | | 2.98 | % |
| Savings | | | 2,942 | | | | 7 | | | | 0.96 | % | | | 2,937 | | | | 10 | | | | 1.37 | % |
| Certificates of deposit | | | 142,480 | | | | 1,399 | | | | 3.98 | % | | | 148,690 | | | | 1,860 | | | | 5.03 | % |
| Other borrowings | | | 16,860 | | | | 118 | | | | 2.84 | % | | | 19,893 | | | | 191 | | | | 3.86 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total interest-bearing liabilities | | | 216,176 | | | | 1,734 | | | | 3.25 | % | | | 212,408 | | | | 2,364 | | | | 4.48 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Noninterest-bearing liabilities | | | 36,354 | | | | | | | | | | | | 28,317 | | | | | | | | | |
| Stockholders’ equity | | | 16,898 | | | | | | | | | | | | 19,061 | | | | | | | | | |
| Total liabilities and stockholders’ equity | | $ | 269,428 | | | | | | | | | | | $ | 259,786 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest income before provision for loan losses | | | | | | $ | 1,764 | | | | | | | | | | | $ | 1,732 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-rate spread | | | | | | | | | | | 2.75 | % | | | | | | | | | | | 2.46 | % |
Net interest margin (1) | | | | | | | | | | | 3.11 | % | | | | | | | | | | | 3.03 | % |
| Ratio of average interest-earning assets to average interest-bearing liabilities | | | 112.55 | % | | | | | | | | | | | 114.58 | % | | | | | | | | |
| (1) | Tax-exempt income has been adjusted to a tax-equivalent basis using an incremental rate of 37.6% for purposes of computing the average yield/rate. |
Analysis of Changes in Net Interest Income
The following table sets forth, on a taxable equivalent basis, the effect which varying levels of interest-earning assets and interest-bearing liabilities and the applicable interest rates had on changes in net interest income for the three months periods ended March 31, 2009, compared to the same period in 2008. For purposes of this table, changes which are not solely attributable to volume or rate are allocated to volume and rate on a pro rata basis (dollars in thousands):
| | | Three Months Ended March 31, | |
| | | 2009 vs. 2008 | |
| | | Increase (Decrease) Due to | |
| | | | | | | | | Rate/ | | | | |
| | | Rate | | | Volume | | | Volume | | | Total | |
| Interest-earning assets: | | | | | | | | | | | | |
| Loans | | $ | (532 | ) | | $ | 101 | | | $ | (45 | ) | | $ | (476 | ) |
| Investment securities and interest-bearing deposits | | | (19 | ) | | | (95 | ) | | | (1 | ) | | | (115 | ) |
| Other interest-earning assets | | | (8 | ) | | | 11 | | | | (10 | ) | | | (7 | ) |
| Total interest-earning assets | | | (559 | ) | | | 17 | | | | (56 | ) | | | (598 | ) |
| | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | |
| Demand, money market and NOW deposits | | | (141 | ) | | | 96 | | | | (48 | ) | | | (93 | ) |
| Savings | | | (3 | ) | | | - | | | | - | | | | (3 | ) |
| Certificates of deposit | | | (385 | ) | | | (77 | ) | | | 1 | | | | (461 | ) |
| Other borrowings | | | (50 | ) | | | (29 | ) | | | 6 | | | | (73 | ) |
| Total interest-bearing liabilities | | | (579 | ) | | | (10 | ) | | | (41 | ) | | | (630 | ) |
| | | | | | | | | | | | | | | | | |
| Net interest income | | $ | 20 | | | $ | 27 | | | $ | (15 | ) | | $ | 32 | |
Comparison of Three Months Ended March 31, 2009 and 2008
Interest Income and Expense
Interest Income. Interest income was $3,498,000 and $4,096,000 for the three months ended March 31, 2009 and 2008, respectively. A decrease in yields on average interest-earning assets of 94 basis points resulted in an overall decrease in interest income of $598,000, or 14.6%. The decrease in yields was the result of the declining interest rate environment and the effect of increased nonaccrual loans and other real estate owned, which grew by 80% in the past year. Average loans, as a percentage of average interest-earning assets, increased to 85.2% in the first quarter of 2009 as compared with 82.9% in 2008.
We saw a shift in the percentage of average investment securities to total interest-earning assets decrease to 13.9% in 2009 from 16.7% in 2008, while the percentage of average other interest-earning assets to total average interest-earning assets was 0.9% in 2009 and 0.4% in 2008. The decline in investment securities was principally due to sales of investment securities in the last two quarters ended March 31, 2009, which also reduced interest income on investment securities for the three months ended March 31, 2009, compared with the same period in 2008.
Interest Expense. Interest expense was $1,734,000 and $2,364,000 for the three months ended March 31, 2009 and 2008, respectively. Our average cost of funds (interest-bearing liabilities) decreased to 3.25% in 2009 compared with 4.48% over the same period in 2008, an overall decline of 123 basis points. A shift in the mix of our interest-bearing deposits, along with decreases in the overall interest rates in our market area, contributed to the decrease in our cost of funds. Certificates of deposit, with an average cost of funds of 3.98% in 2009 and 5.03% in 2008, represented 65.9% of our total interest-bearing liabilities in 2009 as compared with 70.0% in 2008. The decline in average certificates of deposit and other interest-bearing liabilities were more than offset by increases in our interest-bearing demand deposits, with an average cost of funds of 1.58% in 2009 and 2.98% in 2008, representing 24.9% of our total interest-bearing liabilities in 2009 as compared with 19.3% in 2008.
With the recent changes in FDIC-insured levels for certain deposits, we have seen a shift from customer repurchase agreements (short-term other borrowings) into interest-bearing demand deposits. For the first quarter of 2009, we had no short-term other borrowings versus $14.5 million in the same period of 2008.
Net Interest Income before Provision for Loan Losses. Net interest income before provision for loan losses was $1,764,000 and $1,732,000 for the three months ended March 31, 2009 and 2008, respectively. The net interest margin for the first quarter of 2009 was 3.11%, which was an improvement over the net interest margin in 2008 of 3.03%.
Provision for Loan Losses
We recorded provisions for loan losses totaling $234,000 and $224,000 for the three months ended March 31, 2009 and 2008, respectively, which management considered appropriate after its assessment of the overall quality of the loan portfolio.
Noninterest Income and Expenses
Noninterest Income. Total noninterest income decreased by $221,000, or 80.0% for the three months ended March 31, 2009, to $55,000 compared with $276,000 for the same period in March 31, 2008. Fees and service charges on deposit accounts decreased $21,000, or 10.5%, in 2009 versus the same period in 2008, primarily due to decreased NSF, credit card, and referral fees. Non-interest income further decreased in 2009 versus the same period in 2008 as a result of net losses on the sale of real estate owned in 2009 of $61,000 and loss on restricted stock of $179,000, (as discussed in Notes 8 and 10 to the Condensed Consolidated Financial Statements), which was partially offset by realized gains on the sale of investment securities of $45,000. There were no sales of such assets in 2008.
Noninterest Expenses. Management has taken steps to reduce noninterest expenses in areas in which it can without significantly affecting the safety and soundness of our banking operations. Salaries and employee benefits decreased $60,000, or 7.5%, in the first quarter of 2009 over 2008. Expenses of bank premises and fixed assets decreased $17,000, or 6.2%. Other components of noninterest expenses increased $68,000, or 9.1%. The more significant increases were:
| · | Higher data processing, software, and communications expense of $13,000; |
| · | Increases in legal, auditing, and consulting fees of $10,000; |
| · | Increases in pension expense of $13,000; |
| · | Increases in other real estate owned expenses of $35,000 from higher costs associated with carrying foreclosed properties; |
| · | Increases in regulatory assessments of $23,000; and |
| · | Increases in advertising and marketing expense of $10,000. |
These increases were partially offset by the following decreases:
| · | Printing, stationary, supplies and postage expense that decreased by $13,000; and |
| · | Directors’ fees that were $26,000 in 2008 have been eliminated in 2009. |
FDIC assessment rates increased during the first quarter of 2009 due to an interim rule approved by the FDIC in December 2008, which raised assessment rates uniformly by 7 basis points annually for the first quarter of 2009 only. Additionally, assessments rates have increased due to the establishment of the Temporary Liquidity Guarantee Program (TLGP), which temporarily guarantees qualifying senior debt issued by participating FDIC-insured institutions and certain holding companies, as well as qualifying transaction account deposits. We anticipate the FDIC assessments may increase throughout 2009.
Benefit for Income Taxes. The effective tax rates differ from the federal and state statutory rates of 37.6% principally due to nontaxable investment income. Tax-exempt income was $168,000 for the first quarter of 2009 as compared with $170,000 in 2008.
An income tax summary follows (dollars in thousands):
| | | Three Months Ended March 31, | |
| | | 2009 | | | 2008 | |
| | | | | | | |
| Book loss before income tax benefit | | $ | (218 | ) | | $ | (28 | ) |
| Nontaxable interest income, net | | | (168 | ) | | | (170 | ) |
| Other, net | | | (14 | ) | | | - | |
| Taxable loss | | $ | (400 | ) | | $ | (198 | ) |
| Tax rate | | | 37.6 | % | | | 37.6 | % |
| Benefit for income taxes | | $ | (150 | ) | | $ | (75 | ) |
| Effective rate | | | 68.8 | % | | | 267.9 | % |
Background of Internal Controls and Internal Audits. Oceanside is the sole financial subsidiary of Atlantic. Oceanside has extensive policies and operating procedures in place for loans, operations, accounting, and compliance. All audits, whether internal or external, are reported directly to the joint Audit Committee of Oceanside and Atlantic and subsequently to the Boards of Directors of Oceanside and Atlantic.
The joint Audit Committee of Oceanside and Atlantic maintains an audit calendar prepared by the internal auditor for planning purposes. This audit calendar is submitted to the Boards of Oceanside and Atlantic for approval.
Atlantic engages an external certified public accounting firm registered with the Public Company Accounting Oversight Board (“PCAOB”) to annually perform an independent audit, conducted in accordance with generally accepted auditing standards adopted by the PCAOB.
Periodically, Oceanside and Atlantic undergo regulatory examinations that include tests of the policies and operating procedures for loans, operations, accounting, and compliance. The results of these examinations are presented by the regulators to the Boards of Oceanside and Atlantic.
Evaluation of Disclosure Controls and Procedures. Atlantic's Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of Atlantic's disclosure controls and procedures (as such term is defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”). Based on that evaluation, such officers have concluded that, as of the Evaluation Date, Atlantic's disclosure controls and procedures are effective in bringing to their attention, on a timely basis, material information relating to Atlantic (including its consolidated subsidiary) required to be included in Atlantic's periodic filings under the Exchange Act.
Changes in Internal Controls. Since the Evaluation Date, there have not been any significant changes in Atlantic's internal controls or in other factors that could significantly affect those controls.
