ATLANTIC BANCGROUP, INC.
1315 S. Third Street
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date:
ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2010
| 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 activity is 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 subsidiaries throughout these condensed consolidated financial statements are made using the first-person notations of “we,” “our,” and “us.” Oceanside has formed subsidiaries (“Subsidiaries”) for the sole purpose of holding and managing real estate properties acquired through foreclosure.
The accompanying condensed consolidated financial statements include the accounts of the Holding Company, its wholly-owned subsidiary, Oceanside, and the Subsidiaries. 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 and six months ended June 30, 2010 and 2009, 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, 2009, 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 Action. Effective January 7, 2010, Oceanside entered into a Stipulation to the Issuance of a Consent Order with the Federal Deposit Insurance Corporation (the “FDIC”) and the Florida Office of Financial Regulation (the “OFR”) (“Stipulation”). Pursuant to the Stipulation, Oceanside has consented, without admitting or denying any charges of unsafe or unsound banking practices or violations of law or regulation, to the issuance of a Consent Order by the FDIC and the OFR, also effective as of January 7, 2010 (“Consent Order”).
The Consent Order represents an agreement among Oceanside, the FDIC, and the OFR as to areas of Oceanside’s operations that warrant improvement and presents a plan for making those improvements. The Consent Order imposes no fines or penalties on Oceanside.
Oceanside has evaluated and is responding with enhanced policies, procedures, analyses, and training to address matters enumerated in the Consent Order. In management’s opinion, many of the cited criticisms have been addressed or Oceanside is no longer engaged in the activity.
Oceanside did not meet the April 7, 2010, deadline to raise additional capital as required by the Consent Order. However, on May 10, 2010, Atlantic entered into an agreement to merge into Jacksonville Bancorp, Inc. See Note 12 - Merger for further information regarding the proposed merger.
ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2010
| NOTE 1 - | SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES (Continued) |
On March 26, 2010, the Holding Company entered into a mutual agreement (“Written Agreement”) with the Federal Reserve Bank of Atlanta (the "Reserve Bank") to maintain the financial soundness of the Holding Company so that the Holding Company may serve as a source of strength to Oceanside. The Written Agreement provides for restrictions on dividends declared or paid by the Holding Company, the receipt of dividends or other payments from the Bank, the distribution of interest, principal, or other sums on trust-preferred securities, the guarantee of any debt by the Holding Company and the Subsidiaries, the redemption of stock by the Holding Company, and certain other operating restrictions and reporting requirements.
Liquidity. Atlantic actively manages liquidity. Cash and cash equivalents, which include interest-bearing deposits, totaled $33.1 million at June 30, 2010. In addition to cash and cash equivalents and unpledged investment securities, Atlantic has the following sources of available liquidity at June 30, 2010: lines of credit to purchase federal funds ($9.0 million) and, borrowings at the Federal Reserve discount window ($3.1 million), subject to prior approval and limited to overnight secondary credit. 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), the realization of deferred tax assets, other-than-temporary impairment of securities, and the fair value of financial instruments.
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.
Atlantic has recorded a deferred tax asset (net of valuation allowances) to recognize the future income tax benefit of operating losses incurred for tax years 2009 and 2008, and for the three and six months ended June 30, 2010. Management believes that the tax benefits on the net operating loss carry forwards will be utilized when Atlantic returns to profitability. Generally, the net operating losses can be carried forward for up to 20 years.
On November 6, 2009, the “Worker, Homeownership, and Business Assistance Act of 2009” was signed into law, which relaxed the net operating loss carryback rules. As a result of this law, Atlantic was able to carryback net operating losses to obtain a tax refund of $1.024 million, which was received in April 2010.
ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2010
| NOTE 1 - | SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES (Continued) |
In estimating the carrying value of deferred tax assets, management considered the cumulative loss position, projected taxable income, and available tax strategies in developing the analysis of any required deferred income tax asset valuation as of June 30, 2010 and December 31, 2009.
At June 30, 2010 and December 31, 2009, cumulative losses in recent quarters suggested the need for a valuation allowance. However, management believed that this negative evidence was partially offset by the following positive evidence, which mitigated the need for reducing the carrying value (net of valuation allowances) to zero.
| · | Atlantic has a prior history of taxable earnings prior to losses that began in 2008. Since inception in 1997, Atlantic has reported taxable income in 10 of 12 years through 2008, with cumulative taxable income of nearly $9.0 million through 2008. |
| · | Atlantic has taken steps to improve its net interest margin and reduce operating costs such as payroll, which Atlantic believes will improve its core earnings. Although we cannot assure that these efforts will return us to consistent profitability, internal projections indicate, within the next 2-5 years, our book and taxable income are more likely than not to return to levels approaching those prior to 2008. |
| · | Management has received and considered offers to purchase two of its branch locations and relocate to leased space (or lease-back its existing facilities). While the sale-leaseback would not likely generate significant book income immediately, the taxable income was projected to exceed $1.0 million. |
| · | Management and the Board of Directors have implemented a tax strategy that has generated taxable income of approximately $1.1 million from the liquidation of bank-owned life insurance policies. In the second quarter of 2010, Atlantic received proceeds from the liquidation of the policies of $5.1 million. |
| · | Converting tax-exempt investment income to taxable investment income, which could increase taxable income by almost $1.0 million and book income by $0.4 million. |
| · | Repurchase of junior subordinated debentures at a discount. |
| · | Termination of all or a portion of the Bank’s deferred compensation plan, which would generate up to $1.6 million in book taxable income and reduce the deferred tax asset by $0.6 million. |
Based on the above analysis, management believes it is more likely than not that Atlantic will realize the deferred tax asset of $0.5 million and $0.7 million (net of a valuation allowance of $2.3 million and $2.8 million) at June 30, 2010 and December 31, 2009, respectively, through future operating income and implementation of certain tax strategies.
Reclassifications - - Certain amounts in the prior periods have been reclassified to conform to the presentation for the current period.
New Accounting Guidance - In December 2009, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2009-16, Transfer and Servicing (“Topic 860”) - Accounting for Transfers of Financial Assets (“ASU 09-16”) which amends ASC 860-10, Transfers and Servicing-Overall (“ASC 860-10”) and adds transition paragraphs 860-10-65-3 of ASC 860-10. ASC 860-10 requires more information about transfers of financial assets, including securitization transactions, and where companies have continuing exposure to the risks related to transferred financial assets. It eliminates the concept of a “qualifying special-purpose entity,” changes the requirements for derecognizing financial assets, and requires additional disclosures. ASC 860-10 is effective at the start of a company’s first fiscal year beginning after November 15, 2009. The adoption of ASC 860-10 did not have a material impact on Atlantic’s financial position, results of operations, or cash flows.
In December 2009, the FASB issued ASU 2009-17, Consolidation (“Topic 810”) - Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities (“ASU 09-17”) which amends ASC 810-10, Consolidations-Overall (“ASC 810-10”) and adds transition paragraphs 810-10-65-2 of ASC 810-10. ASC 810-10 changes how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the
ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2010
| NOTE 1 - | SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES (Continued) |
activities of the entity that most significantly impact the entity’s economic performance. ASC 810-10 is effective at the start of a company’s first fiscal year beginning after November 15, 2009. The adoption of ASC 810-10 did not have a material impact on Atlantic’s financial position, results of operations, or cash flows.
In January 2010, the FASB issued the FASB issued ASU 2010-06, Fair Value Measurements and Disclosures (“Topic 820”): Improving Disclosures about Fair Value Measurements, to improve disclosure requirements related to fair value measurements and disclosures. The guidance requires that a reporting entity should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers and that activity in Level 3 should be presented on a gross basis rather than one net number for information about purchases, issuances, and settlements. The guidance also requires that a reporting entity should provide fair value measurement disclosures for each class of assets and liabilities and about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. This guidance is effective for interim and annual reporting periods beginning after December 31, 2009, except for the roll forward of activity in Level 3, which is effective for interim and annual reporting periods beginning after December 31, 2010. Adopting this pronouncement did not have a material effect on the results of operations or financial condition of Atlantic.
In February 2010, the FASB issued ASU 2010-09, Subsequent Events (“Topic 855”): Amendments to Certain Recognition and Disclosure Requirements. The amendments remove the requirement for an SEC registrant to disclose the date through which subsequent events were evaluated as this requirement would have potentially conflicted with SEC reporting requirements. This ASU became effective upon issuance. Removal of the disclosure requirement did not affect the nature or timing of subsequent events evaluations performed by Atlantic.
In July 2010, the FASB issued ASU 2010-20, Receivables (“Topic 310”) - Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses (“ASU 10-20”). ASU 10-20 requires a company to disaggregate new and existing disclosures based on how it develops its allowance for credit losses and how it manages credit exposures. Short-term accounts receivable, receivables measured at fair value or lower of cost or fair value, and debt securities are exempt from the ASU 10-20. For public companies, the amendments that require disclosures as of the end of a reporting period are effective for periods ending on or after December 15, 2010. The amendments that require disclosures about activity that occurs during a reporting period are effective for periods beginning on or after December 15, 2010. Management does not believe that the adoption of this ASU will have a material impact on Atlantic’s financial position, results of operation, or cash flows.
Other: 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 - | REGULATORY OVERSIGHT, CAPITAL ADEQUACY, OPERATING LOSSES, AND MANAGEMENT’S PLANS |
As a result of the extraordinary effects of the worst economic downturn since the Great Depression, the capital of Atlantic and Oceanside have been significantly depleted. The impact of the current financial crisis in the U.S. and abroad is having far-reaching consequences and it is difficult to say at this point when the economy will begin to recover. As a result, we cannot assure you that we will be able to resume profitable operations in the near future, or at all. We have determined that significant additional sources of capital or the implementation of strategies to enhance existing capital will be required for us to resume profitable operations beyond 2010. We continue to explore other options to restructure our balance sheet to generate income and capital.
ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2010
| NOTE 2 - | REGULATORY OVERSIGHT, CAPITAL ADEQUACY, OPERATING LOSSES, AND MANAGEMENT’S PLANS (Continued) |
On May 10, 2010, Jacksonville Bancorp, Inc., the bank holding company for The Jacksonville Bank, and Atlantic announced the signing of a definitive merger agreement providing for the merger of Atlantic into Jacksonville Bancorp, Inc. The completion of this merger would resolve the regulatory and capital challenges that Atlantic faces since Jacksonville Bancorp, Inc. would be the surviving entity. See Note 12 - Merger.
In the event that the merger is not completed, we will continue our efforts to raise additional capital and have identified transactions to increase our capital by approximately $4 million, including eliminating our bank owned life insurance, reducing or eliminating certain retirement benefits, and the potential sale of assets. In order to improve our Tier 1 leverage ratio, we may also shrink our total assets.
The accompanying condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future, and do not include any adjustments to reflect the possible future effects on the recoverability or classification of assets, and the amounts or classification of liabilities that may result from the outcome of any regulatory action, which would affect our ability to continue as a going concern.
In its report dated April 15, 2010, covering our audited consolidated financial statements for the year ended December 31, 2009, our independent registered public accounting firm stated that our net losses raise substantial doubts about our ability to continue as a going concern. In that firm’s opinion, our ability to continue as a going concern is in doubt as a result of the continued deterioration of our loan portfolio and is subject to our ability to service our existing loans in a manner that will return Atlantic to profitability or to identify and consummate a strategic transaction, including the potential sale of Atlantic. If we are not able to successfully accomplish such actions, it is possible that our subsidiary bank may fail and be placed into receivership with the FDIC.
Although the contemplated merger with Jacksonville Bancorp, Inc. (see Note 12 – Merger) is expected to result in our continued operation as a part of Jacksonville Bancorp, Inc. and The Jacksonville Bank, such transaction may prove to be insufficient due to the possible continued decline of the loan portfolio or other losses. If we are, or the surviving entity in the merger is, unable to return to profitability, and if we are unable to identify and execute a viable strategic alternative, we may be unable to continue as a going concern.
| NOTE 3 - | COMPUTATION OF PER SHARE INCOME (LOSSES) |
Basic income (loss) per share amounts are computed by dividing net income (loss) by the weighted average number of common shares outstanding for the three and six months ended June 30, 2010 and 2009. Diluted income (loss) per share 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 2010 or 2009. The following information was used in the computation of income (loss) per share on both a basic and diluted basis for the three and six months ended June 30, 2010 and 2009 (dollars and number of shares in thousands):
| | | Three months ended June 30, | |
| | | 2010 | | | 2009 | |
| Basic and diluted EPS computation: | | | | | | |
| Numerator - Net income (loss) | | $ | 282 | | | $ | 65 | |
| Denominator - Weighted average shares outstanding (rounded) | | | 1,248 | | | | 1,248 | |
| Basic and diluted income (loss) per share | | $ | 0.23 | | | $ | 0.05 | |
ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2010
| NOTE 3 - | COMPUTATION OF PER SHARE INCOME (LOSSES)(Continued) |
| | | Six months ended June 30, | |
| | | 2010 | | | 2009 | |
| Basic and diluted EPS computation: | | | | | | |
| Numerator - Net income (loss) | | $ | (265 | ) | | $ | (3 | ) |
| Denominator - Weighted average shares outstanding (rounded) | | | 1,248 | | | | 1,248 | |
| Basic and diluted income (loss) per share | | $ | (0.21 | ) | | $ | - | |
| NOTE 4 - | INVESTMENT SECURITIES |
Our investment securities, available-for-sale, consist of residential real estate mortgage investment conduits (“REMICs”) and residential mortgage pass-through securities (“MBS”) all of which are issued or guaranteed by U.S. Capital Government agencies such as FNMA, FHLMC, and GNMA. The amortized cost and estimated fair value of instruments in debt and equity securities are as follows (dollars in thousands):
| | | June 30, 2010 | | | December 31, 2009 | |
| | | | | | Gross | | | Gross | | | | | | | | | Gross | | | Gross | | | | |
| | | Amortized | | | Unrealized | | | Unrealized | | | Fair | | | Amortized | | | Unrealized | | | Unrealized | | | Fair | |
| | | Cost | | | Gains | | | Losses | | | Value | | | Cost | | | Gains | | | Losses | | | Value | |
| Available-for-sale | | | | | | | | | | | | | | | | | | | | | | | | |
| REMICs | | $ | 100 | | | $ | 3 | | | $ | - | | | $ | 103 | | | $ | 134 | | | $ | 3 | | | $ | - | | | $ | 137 | |
| MBS | | | 30,024 | | | | 874 | | | | - | | | | 30,898 | | | | 42,428 | | | | 217 | | | | (240 | ) | | | 42,405 | |
| | | | 30,124 | | | | 877 | | | | - | | | | 31,001 | | | | 42,562 | | | | 220 | | | | (240 | ) | | | 42,542 | |
| Held-to-maturity | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| State, county and | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| municipal bonds | | | 14,986 | | | | 107 | | | | (372 | ) | | | 14,721 | | | | 14,989 | | | | 154 | | | | (395 | ) | | | 14,748 | |
| Total investment securities | | $ | 45,110 | | | $ | 984 | | | $ | (372 | ) | | $ | 45,722 | | | $ | 57,551 | | | $ | 374 | | | $ | (635 | ) | | $ | 57,290 | |
Information pertaining to securities with gross unrealized losses at June 30, 2010 and December 31, 2009, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows (dollars in thousands):
| | | Less Than Twelve Months | | | Over Twelve Months | | | Total | |
| | | Gross | | | | | | Gross | | | | | | Gross | | | | |
| | | Unrealized | | | Fair | | | Unrealized | | | Fair | | | Unrealized | | | Fair | |
| | | Losses | | | Value | | | Losses | | | Value | | | Losses | | | Value | |
| June 30, 2010: | | | | | | | | | | | | | | | | | | |
| Available-for-Sale | | | | | | | | | | | | | | | | | | |
| REMICs | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | |
| MBS | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | |
| | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | |
| Held-to-Maturity | | | | | | | | | | | | | | | | | | | | | | | | |
| State, county, and municipal bonds | | $ | (157 | ) | | $ | 5,786 | | | $ | (215 | ) | | $ | 2,882 | | | $ | (372 | ) | | $ | 8,668 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
December 31, 2009: | | | | | | | | | | | | | | | | | | | | | | | | |
| Available-for-Sale | | | | | | | | | | | | | | | | | | | | | | | | |
| REMICs | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | |
| MBS | | | (240 | ) | | | 23,020 | | | | - | | | | - | | | | (240 | ) | | | 23,020 | |
| | | $ | (240 | ) | | $ | 23,020 | | | $ | - | | | $ | - | | | $ | (240 | ) | | $ | 23,020 | |
| Held-to-Maturity | | | | | | | | | | | | | | | | | | | | | | | | |
| State, county, and municipal bonds | | $ | (165 | ) | | $ | 4,763 | | | $ | (230 | ) | | $ | 2,867 | | | $ | (395 | ) | | $ | 7,630 | |
ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2010
| NOTE 4 - | INVESTMENT SECURITIES(Continued) |
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. At June 30, 2010, Atlantic did not have any investment securities deemed other-than-temporarily-impaired debt securities.
The unrealized losses on investment securities were caused by interest rate changes. Temporary net decreases in fair value of securities available-for-sale at June 30, 2010, 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 stockholders’ equity (dollars in thousands):
| | | June 30, | | | December 31, | |
| | | 2010 | | | 2009 | |
| | | | | | | |
| Gross unrealized gains (losses) on investment securities available-for-sale | | $ | 877 | | | $ | (20 | ) |
| Deferred tax benefit (expense) on unrealized gains (losses) | | | (331 | ) | | | 7 | |
| | | $ | 546 | | | $ | (13 | ) |
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 and six months ended June 30, 2010 and 2009 (dollars in thousands):
| | | Three months ended June 30, | |
| | | 2010 | | | 2009 | |
| | | | | | | |
| Unrealized holding gains (losses) on investment securities arising during period | | $ | 669 | | | $ | (156 | ) |
| Less: reclassification adjustment for gains included in net income (loss) | | | - | | | | (11 | ) |
| Other comprehensive income (loss), before income tax expense (benefit) | | | 669 | | | | (167 | ) |
| Income tax benefit (expense) related to items of other comprehensive income (loss) | | | (250 | ) | | | 63 | |
| Other comprehensive income (loss), net of income tax expense (benefit) | | $ | 419 | | | $ | (104 | ) |
| | | | | | | | | |
| | | Six months ended June 30, | |
| | | 2010 | | | 2009 | |
| | | | | | | | | |
| Unrealized holding gains (losses) on investment securities arising during period | | $ | 896 | | | $ | (157 | ) |
| Less: reclassification adjustment for gains included in net income (loss) | | | (21 | ) | | | (56 | ) |
| Other comprehensive income (loss), before income tax expense (benefit) | | | 875 | | | | (213 | ) |
| Income tax benefit (expense) related to items of other comprehensive income (loss) | | | (316 | ) | | | 81 | |
| Other comprehensive income (loss), net of income tax expense (benefit) | | $ | 559 | | | $ | (132 | ) |
Gross gains and losses on sales of investment securities for the three and six months ended June 30, 2010, totaled $-0- and $21,000, respectively. Gross gains and losses on sales of investment securities for the three and six months ended June 30, 2009, totaled $11,000 and $56,000, respectively.
At June 30, 2010, investment securities with an amortized cost of $1.5 million and fair value of $1.4 million were pledged to secure deposits of public funds from the State of Florida and treasury tax and loan deposits with the Federal Reserve. At June 30, 2010, investment securities with an amortized cost of $4.2 million and a fair value of $4.0 million were pledged for the Federal Reserve discount window, investment securities with an amortized cost of $13.6 million and a fair value of $13.9 million were pledged to secure FHLB of Atlanta advances, and investment securities with an amortized cost and a fair value of $3.6 million were pledged to secure a line of credit to purchase federal funds (see Note 7).
ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2010
| NOTE 4 - | 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 June 30, 2010.
The cost and estimated fair value of debt and equity securities at June 30, 2010, by contractual maturities, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties (dollars in thousands).
| | | Securities Available-for-Sale | | | Securities Held-to-Maturity | |
| | | Amortized Cost | | | Fair Value | | | Amortized Cost | | | Fair Value | |
| | | | | | | | | | | | | |
| Due in one year or less | | $ | 36 | | | $ | 37 | | | $ | - | | | $ | - | |
| Due after one through five years | | | 5,580 | | | | 5,908 | | | | 271 | | | | 281 | |
| Due after five through fifteen years | | | 17,105 | | | | 17,470 | | | | 2,918 | | | | 2,916 | |
| Due after fifteen years | | | 7,403 | | | | 7,586 | | | | 11,797 | | | | 11,524 | |
| | | $ | 30,124 | | | $ | 31,001 | | | $ | 14,986 | | | $ | 14,721 | |
Loans consisted of (dollars in thousands):
| | | June 30, | | | December 31, | |
| | | 2010 | | | 2009 | |
| Real estate loans: | | | | | | |
| Construction, land development, and other land | | $ | 29,694 | | | $ | 32,455 | |
| 1-4 family residential: | | | | | | | | |
| Secured by first liens | | | 33,557 | | | | 33,281 | |
| Home equity lines of credit and junior liens | | �� | 21,130 | | | | 23,619 | |
| Multifamily residential | | | 1,525 | | | | 2,902 | |
| Commercial | | | 90,830 | | | | 93,455 | |
| | | | 176,736 | | | | 185,712 | |
| Commercial loans | | | 11,162 | | | | 11,703 | |
| Consumer and other loans | | | 2,995 | | | | 3,315 | |
| Total loan portfolio | | | 190,893 | | | | 200,730 | |
| Less, deferred fees | | | (9 | ) | | | (12 | ) |
| Less, allowance for loan losses | | | (4,996 | ) | | | (6,531 | ) |
| Loans, net | | $ | 185,888 | | | $ | 194,187 | |
A summary of the activity of loans transferred to Other Real Estate Owned follows (dollars in thousands):
| | | For the Three | | | For the Six | | | For the Twelve | |
| | | Months Ended | | | Months Ended | | | Months Ended | |
| | | June 30, 2010 | | | June 30, 2010 | | | December 31, 2009 | |
| | | | | | | | | | |
| Balance, beginning of period | | $ | 2,305 | | | $ | 1,727 | | | $ | 3,421 | |
| Transfers to OREO | | | 929 | | | | 1,881 | | | | 513 | |
| Disposals | | | (737 | ) | | | (1,081 | ) | | | (1,621 | ) |
| Write-downs | | | - | | | | (30 | ) | | | (586 | ) |
| Balance, end of period | | $ | 2,497 | | | $ | 2,497 | | | $ | 1,727 | |
ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2010
| NOTE 6 - | ALLOWANCE FOR LOAN LOSSES |
Our Board of Directors monitors the loan portfolio monthly 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 Six | | | For the Twelve | |
| | | Months Ended | | | Months Ended | | | Months Ended | |
| | | June 30, 2010 | | | June 30, 2010 | | | December 31, 2009 | |
| | | | | | | | | | |
| Balance, beginning of period | | $ | 6,651 | | | $ | 6,531 | | | $ | 3,999 | |
| Provisions charged to operating expenses | | | 90 | | | | 962 | | | | 6,268 | |
| Loans charged-off | | | (1,747 | ) | | | (2,501 | ) | | | (3,761 | ) |
| Recoveries | | | 2 | | | | 4 | | | | 25 | |
| Balance, end of period | | $ | 4,996 | | | $ | 4,996 | | | $ | 6,531 | |
The following is a summary of information pertaining to impaired, nonaccrual, past due, and restructured loans (dollars in thousands):
| | | June 30, | | | December 31, | |
| | | 2010 | | | 2009 | |
| Loans evaluated for impairment with a measured impairment | | $ | 15,644 | | | $ | 16,061 | |
| Loans evaluated for impairment without a measured impairment | | | 12,909 | | | | 14,788 | |
| Total impaired loans | | $ | 28,553 | | | $ | 30,849 | |
| Valuation allowance related to impaired loans | | $ | 3,421 | | | $ | 4,380 | |
| Nonaccrual loans included above in impaired loan totals | | $ | 3,814 | | | $ | 6,715 | |
| Total loans past due ninety days or more and still accruing | | | 2,029 | | | | 8 | |
| Total nonperforming loans (“NPL”) | | | 5,843 | | | | 6,723 | |
Restructured loans (1) | | | 19,462 | | | | 17,372 | |
| Total NPL and restructured loans | | $ | 25,305 | | | $ | 24,095 | |
Restructured loans included in nonaccrual loans above that are | | | | | | | |
| considered troubled debt restructurings | | $ | 1,652 | | | $ | 1,842 | |
| Average nonaccrual loans during the period | | $ | 5,690 | | | $ | 7,031 | |
| (1) | Restructured loans shown here are performing in compliance with modified terms and are not included in the definition of nonperforming loans. |
At June 30, 2010 and December 31, 2009, interest income accrued and recorded on nonaccrual loans totaled $-0- and $40,000, respectively, and interest earned but not recorded on nonaccrual loans at June 30, 2010 and December 31, 2009, was $291,000 and $533,000, respectively. No additional funds are committed to be advanced in connection with nonaccrual loans.
A summary of other borrowings follows (dollars in thousands):
| | | June 30, | | | December 31, | |
| | | 2010 | | | 2009 | |
| Long-term borrowings: | | | | | | |
| FHLB of Atlanta advances | | | | | | |
| Convertible debt | | $ | 2,300 | | | $ | 2,300 | |
| Fixed debt | | | 10,000 | | | | 10,000 | |
| | | | 12,300 | | | | 12,300 | |
| Junior subordinated debentures | | | 3,093 | | | | 3,093 | |
| | | $ | 15,393 | | | $ | 15,393 | |
ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2010
| NOTE 7 - | OTHER BORROWINGS (Continued) |
A summary of the FHLB of Atlanta advances follows (dollars in thousands):
| | Maturity Date | | Interest Rate | | | | | | |
| | | | | | | | | | | |
| Convertible fixed rate debt | 11/17/2010 | | | 4.45 | % | | $ | 2,300 | | | $ | 2,300 | |
| Fixed rate advances | 12/20/2010 | | | 1.91 | % | | | 2,000 | | | | 2,000 | |
| Fixed rate advance | 01/09/2012 | | | 2.30 | % | | | 8,000 | | | | 8,000 | |
| | | | | | | | $ | 12,300 | | | $ | 12,300 | |
| NOTE 8 - | 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 June 30, 2010, consisted of commitments to extend credit approximating $8.8 million and standby letters of credit of $1.2 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.
| NOTE 9 - | REGULATORY CAPITAL |
The Federal Reserve Board and other bank regulatory agencies have adopted risk-based capital guidelines for all banks and for bank holding companies whose consolidated assets are over $500 million. The main objectives of the risk-based capital framework are to provide a more consistent system for comparing capital positions of banking organizations and to take into account the different risks among banking organizations' assets, liabilities, and off-balance sheet items. Bank regulatory agencies have supplemented the risk-based capital standard with a leverage ratio for Tier 1 capital to total reported assets. Failure to meet the capital adequacy guidelines and the framework for prompt corrective actions could initiate actions by the regulatory agencies, which could have a material effect on the consolidated financial statements.
As of June 30, 2010, Oceanside had not reached the capital levels specified in the Consent Order. As of June 30, 2010, there are no conditions or events, since the most recent notification, that management believes have changed the prompt corrective action category.
| | | Actual | | Required by Consent Order |
| | | | | | | |
| Total capital ratio to risk-weighted assets | | | 8.20 | % | | | 11.00 | % |
| Tier 1 capital ratio to risk-weighted assets | | | 6.93 | % | | | - | |
| Tier 1 capital to average assets | | | 4.64 | % | | | 8.00 | % |
ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2010
| NOTE 10 - | FAIR VALUE MEASUREMENTS |
Fair Value Measurements and Disclosure Topic of the ASC defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. This standard also establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair values:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in market that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a company’s own estimates of the assumptions that market participants would use in pricing an asset or liability.
The table below presents the Atlantic’s assets and liabilities measured at fair value on a recurring basis as of June 30, 2010 and December 31, 2009, aggregated by the level in the fair value hierarchy within which those measurements fall (dollars in thousands).
| | | Quoted Prices in Active Markets for Identical Assets | | | Significant Other Observable Inputs | | | Significant Unobservable Inputs | | | | |
| June 30, 2010 | | (Level 1) | | | (Level 2) | | | (Level 3) | | | Total | |
| Assets: | | | | | | | | | | | | |
| Investment securities, available-for-sale | | $ | - | | | $ | 31,001 | | | $ | - | | | $ | 31,001 | |
| Total assets at fair value | | $ | - | | | $ | 31,001 | | | $ | - | | | $ | 31,001 | |
| | | | | | | | | | | | | | | | | |
| December 31, 2009 | | | | | | | | | | | | | | | | |
| Assets: | | | | | | | | | | | | | | | | |
| Investment securities, available-for-sale | | $ | - | | | $ | 42,542 | | | $ | - | | | $ | 42,542 | |
| Total assets at fair value | | $ | - | | | $ | 42,542 | | | $ | - | | | $ | 42,542 | |
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 June 30, 2010 and December 31, 2009 (dollars in thousands).
ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2010
| NOTE 10 - | FAIR VALUE MEASUREMENTS (Continued) |
| | | Quoted Prices in Active Markets for Identical Assets | | | Significant Other Observable Inputs | | | Significant Unobservable Inputs | | | | | | | |
| June 30, 2010 | | (Level 1) | | | (Level 2) | | | (Level 3) | | | Total | | | (Losses) (1) | |
| Assets: | | | | | | | | | | | | | | | |
| Impaired loans, net of | | | | | | | | | | | | | | | |
| direct write-offs | | $ | - | | | $ | - | | | $ | 15,644 | | | $ | 15,644 | | | | |
| Specific valuation allowances | | | - | | | | - | | | | (3,421 | ) | | | (3,421 | ) | | | |
| Impaired loans, net | | | - | | | | - | | | | 12,223 | | | | 12,223 | | | $ | (11 | ) |
| Foreclosed assets | | | - | | | | - | | | | 2,497 | | | | 2,497 | | | | (80 | ) |
| Total assets at fair value | | $ | - | | | $ | - | | | $ | 14,720 | | | $ | 14,720 | | | $ | (91 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| December 31, 2009 | | | | | | | | | | | | | | | | | | | | |
| Assets: | | | | | | | | | | | | | | | | | | | | |
| Impaired loans, net of | | | | | | | | | | | | | | | | | | | | |
| direct write-offs | | $ | - | | | $ | - | | | $ | 16,061 | | | $ | 16,061 | | | | | |
| Specific valuation allowances | | | - | | | | - | | | | (4,380 | ) | | | (4,380 | ) | | | | |
| Impaired loans, net | | | - | | | | - | | | | 11,681 | | | | 11,681 | | | $ | (3,509 | ) |
| Foreclosed assets | | | - | | | | - | | | | 1,727 | | | | 1,727 | | | | (728 | ) |
| Total assets at fair value | | $ | - | | | $ | - | | | $ | 13,408 | | | $ | 13,408 | | | $ | (4,237 | ) |
(1) Gains and losses include write-offs
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 loan impairment accounting guidance. 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 repossession) or fair value written down by estimated selling costs. 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.
The following is a summary of activity of assets and liabilities measured at fair value on a nonrecurring basis (dollars in thousands):
| | | | | | | | | Total | |
| | | | | | | | | | |
| Balance, December 31, 2008 | | $ | 11,333 | | | $ | 3,496 | | | $ | 14,829 | |
| Write-downs | | | (3,509 | ) | | | (586 | ) | | | (4,095 | ) |
| Net transfers in/out Level 3 | | | 3,857 | | | | (1,183 | ) | | | 2,674 | |
| Balance, December 31, 2009 | | | 11,681 | | | | 1,727 | | | | 13,408 | |
| Write-downs | | | (11 | ) | | | (30 | ) | | | (41 | ) |
| Net transfers in/out Level 3 | | | 553 | | | | 800 | | | | 1,353 | |
| Balance, June 30, 2010 | | $ | 12,223 | | | $ | 2,497 | | | $ | 14,720 | |
ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2010
| NOTE 11 - | FAIR VALUE DISCLOSURES |
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Cash and Cash Equivalents - For those short-term instruments, the carrying amount is a reasonable estimate of fair value.
Investment Securities - For securities held as investments, fair value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
Restricted Stock - Fair value of Atlantic’s investment in Federal Home Loan Bank and correspondent banks’ stock is its cost.
Loans Receivable - For loans subject to repricing and loans intended for sale within six months, fair value is estimated at the carrying amount plus accrued interest. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.
Deposit Liabilities - The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of long-term fixed maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.
Other Borrowings - For short-term debt, including accounts and demand notes payable, the carrying amount is a reasonable estimate of fair value. For long-term debt, the fair value is estimated using discounted cash flow analyses based on current incremental borrowing rates for similar types of borrowing arrangements.
Off-Balance Sheet Instruments - - Fair values for off-balance sheet lending commitments are based on rates currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing.
Other - Accrued interest receivable on investment securities and loans and accrued interest payable on deposits and other borrowings are included in investment securities, loans, deposits, and other borrowings, accordingly. The carrying amount is a reasonable estimate of fair value.
The estimated fair values of Atlantic's financial instruments at June 30, 2010 and December 31, 2009, follow (dollars in thousands):
| | | | | | | |
| June 30, 2010 | | | | | | |
| Financial Assets | | | | | | |
| Cash and cash equivalents | | $ | 33,131 | | | $ | 33,131 | |
| Investment securities and accrued interest receivable | | | 46,255 | | | | 45,990 | |
| Restricted stock | | | 1,151 | | | | 1,151 | |
| Loans and accrued interest receivable | | | 186,641 | | | | 181,343 | |
| Total assets valued | | $ | 267,178 | | | $ | 261,615 | |
| | | | | | | | | |
| Financial Liabilities | | | | | | | | |
| Deposits and accrued interest payable | | $ | 246,202 | | | $ | 244,233 | |
| Other borrowings and accrued interest payable | | | 15,609 | | | | 15,609 | |
| Total liabilities valued | | $ | 261,811 | | | $ | 259,842 | |
| | | | | | | | | |
| Off-Balance Sheet Commitments | | $ | 9,976 | | | $ | 9,976 | |
ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2010
| NOTE 11 - | FAIR VALUE DISCLOSURES (Continued) |
| December 31, 2009 | | | | | | |
| Financial Assets | | | | | | |
| Cash and cash equivalents | | $ | 31,083 | | | $ | 31,083 | |
| Investment securities and accrued interest receivable | | | 57,844 | | | | 57,603 | |
| Restricted stock | | | 1,151 | | | | 1,151 | |
| Loans and accrued interest receivable | | | 194,963 | | | | 189,436 | |
| Total assets valued | | $ | 285,041 | | | $ | 279,273 | |
| | | | | | | | | |
| Financial Liabilities | | | | | | | | |
| Deposits and accrued interest payable | | $ | 270,156 | | | $ | 267,996 | |
| Other borrowings and accrued interest payable | | | 15,520 | | | | 15,520 | |
| Total liabilities valued | | $ | 285,676 | | | $ | 283,516 | |
| | | | | | | | | |
| Off-Balance Sheet Commitments | | $ | 10,538 | | | $ | 10,538 | |
There have been no changes since December 31, 2009, in the valuation techniques and related inputs noted herein.
On May 10, 2010, Jacksonville Bancorp, Inc. ("JBI"), the bank holding company for The Jacksonville Bank, and Atlantic announced the signing of a definitive merger agreement providing for the merger of Atlantic into JBI. The merger agreement also contemplates the consolidation of Oceanside into The Jacksonville Bank. Additionally, JBI announced the signing of a stock purchase agreement with four private investors led by CapGen Capital Group IV LP ("CapGen") providing for $30 million in new capital through the sale of newly issued shares of JBI common stock subject to completion of the mergers. The transactions have been approved by the Boards of Directors of each company and are subject to regulatory approval, shareholders' approvals, and other customary conditions. JBI and Atlantic expect to close the transaction in the fourth quarter of 2010.
Under the terms of the merger agreement, Atlantic’s shareholders will receive 0.2 shares of JBI common stock for each share of Atlantic’s common stock. A total of approximately 250,000 shares of JBI common stock is expected to be issued to Atlantic’s shareholders.
Under the merger agreement, if Oceanside sold certain assets prior to the effective time of the merger of Atlantic and JBI, the proceeds from such sale are to be distributed on a pro rata basis to Atlantic’s shareholders as part of the merger consideration. On June 30, 2010, Oceanside Bank sold such assets to an unaffiliated third party in exchange for $700,000 in cash. Based on 1,247,516 shares of Atlantic common stock presently outstanding, Atlantic estimates the per share distribution from the sale will be $0.56112.
| 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 Florida state-chartered banking organization. We also operate branch offices located at 560 Atlantic Boulevard, Neptune Beach, Florida, 13799 Beach Boulevard, Jacksonville, Florida, 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 2010 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 2009 Annual Report on Form 10-K.
Results of Operations
We reported consolidated net income of $282,000 for the three months ended June 30, 2010, after three consecutive quarters of losses stemming from the depressed real estate market and the effects of local, state, and national economic trends. We also experienced increased net interest margins in 2010 compared with 2009. Consolidated net income for the three months ended June 30, 2009 was $65,000. During the second quarter of 2010, net interest income was $2,053,000 versus $1,561,000 second quarter of 2009, reflecting a lower cost of funds of 1.02% and a decreased provision for loan losses. We also expensed deposit insurance assessments of $419,000 in the quarter ended June 30, 2010, as compared with $239,000 in the same period of 2009.
Our net loss for the six months ended June 30, 2010, was $265,000, as compared with a net loss of $3,000 in the same period of 2009. In addition to the items discussed above for the first half of 2010, we continued to improve our liquidity with total cash and cash equivalents, which include interest-bearing deposits, reaching $33.1 million at June 30, 2010, as compared with $31.1 million at December 31, 2009.
Other significant items affecting 2010 results of operations include:
| · | A decrease in net loan exposure from $194.2 million to $185.9 million, a decrease of 4.3%. |
| · | Noninterest expenses, excluding deposit insurance assessments, decreased from $3,403,000 to $3,310,000 for the six months ended June 30, 2009 and 2010, respectively. |
| · | Net interest income before provision for loan losses increased from $3,458,000 in 2009 to $4,198,000 in 2010, an increase of $740,000, or 21.4%, as a result of an increase in our net interest margin from 2.89% in 2009 to 3.29% in 2010. |
| · | Higher provisions for loan losses, which totaled $962,000 for the six months ended June 30, 2010, as compared with $367,000 for the same period of 2009. |
| · | During the first quarter of 2009, Oceanside reported a write-down of $179,000 on its investment in a correspondent bank, Silverton Bank, National Association. Silverton Bank was closed by federal regulators on May 1, 2009. There was no such loss in 2010. |
Financial Condition
The following table shows selected ratios for the periods ended or at the dates indicated (annualized for the three and six months ended June 30, 2010):
| | | Three Months Ended June 30, 2010 | | Six Months Ended June 30, 2010 | | Year Ended December 31, 2009 |
| | | | | | | | | | |
| Return on average assets | | | 0.41 | % | | | -0.19 | % | | | -2.43 | % |
| Return on average equity | | | 11.88 | % | | | -5.60 | % | | | -45.70 | % |
| Interest-rate spread | | | 3.15 | % | | | 3.05 | % | | | 2.92 | % |
| Net interest margin | | | 3.40 | % | | | 3.29 | % | | | 2.98 | % |
| Noninterest expenses to average assets | | | 3.05 | % | | | 2.89 | % | | | 2.85 | % |
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, which totaled $33.1 million at June 30, 2010; |
| · | The repayment of loans, which include loans with a remaining maturity or repricing of one year or less (excluding those in nonaccrual status) totaling $73.3 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, interest-bearing deposits, and investment securities maturing in six months or less) were $24.8 million at June 30, 2010, as compared to $31.7 at December 31, 2009. 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. At June 30, 2010, alternate funding strategies included (dollars in thousands):
| Lines of credit to purchase federal funds: | | | |
| Secured | | $ | 8,000 | |
| Unsecured | | | 1,000 | |
Federal Reserve discount window (1) | | | 3,131 | |
| | | $ | 12,131 | |
(1) Subject to prior approval
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. With the passage of the Wall Street Reform and Consumer Protection Act on July 21, 2010, the FDIC insurance limit of $250,000 per depositor per insured bank has been made permanent. 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.
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 lines of credit to purchase federal funds. 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 $173.3 million at June 30, 2010, and $223.3 million at December 31, 2009, a decrease of 22.4%. This decrease in core deposits was attributed to:
| · | Our liquidity targets were met without renewing higher-priced deposits as they matured and were settled; |
| · | A shift of core deposits (money market and NOW accounts) to higher-priced time deposits, $100,000 and over; and |
| · | The overall reduction in total assets of $23.2 million. |
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. Pursuant to the Consent Order, we are prohibited, throughout the life of the Consent Order, from accepting, renewing, or rolling over any brokered deposits, and must comply with the restrictions on the effective yields on deposits exceeding national averages. Brokered certificates of deposit issued by us totaled $13.2 million at June 30, 2010, and $19.1 million at December 31, 2009, a decrease of 30.9%.
We use our resources principally to fund existing and continuing loan commitments and to purchase investment securities. At June 30, 2010, we had commitments to extend credit totaling $8.8 million, and had issued, but unused, standby letters of credit of $1.2 million for the same period. In addition, scheduled maturities of certificates of deposit during the twelve months following June 30, 2010, total $111.0 million. We believe that resources exist to fund all our anticipated commitments.
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). At June 30, 2010, Oceanside’s actual capital amounts and percentages are presented in the following table (dollars in thousands):
| | | Actual | | Required by Consent Order |
| | | Amount | | | % | | Amount | | | % |
| | | | | | | | | | | | | |
| Total capital to risk-weighted assets | | $ | 15,110 | | | | 8.20 | % | | $ | 20,274 | | | | 11.00 | % |
| Tier 1 capital to risk-weighted assets | | $ | 12,773 | | | | 6.93 | % | | | - | | | | - | |
| Tier 1 capital to average assets | | $ | 12,773 | | | | 4.64 | % | | $ | 22,021 | | | | 8.00 | % |
At June 30, 2010, Oceanside did not meet the required ratios under the Consent Order. Notes 1 and 9 to Condensed Consolidated Financial Statements discuss events that may affect Oceanside’s required level of capital to maintain in the future.
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 month, 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 external loan reviews performed by an independent loan review 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 external loan reviews may differ from the regulatory assessment.
For regulatory and internal reporting purposes, including our ALLL methodology, we track the following loan pools or loan types: commercial real estate, residential real estate, commercial, and consumer and other loans. For regulatory and ALLL purposes, the following summarizes our classified loans at December 31, 2009 and June 30, 2010 (dollars in thousands)
| December 31, 2009 | | Classified Loans | |
| | | Substandard | | | Doubtful | | | Loss | | | Total | |
| Commercial real estate | | $ | 24,552 | | | $ | 1,350 | | | $ | - | | | $ | 25,902 | |
| Residential real estate | | | 4,369 | | | | - | | | | - | | | | 4,369 | |
| Total real estate | | | 28,921 | | | | 1,350 | | | | - | | | | 30,271 | |
| Commercial | | | 494 | | | | - | | | | - | | | | 494 | |
| Consumer and other loans | | | 83 | | | | - | | | | - | | | | 83 | |
| Total | | $ | 29,498 | | | $ | 1,350 | | | $ | - | | | $ | 30,848 | |
| | | | | | | | | | | | | | | | | |
| June 30, 2010 | | | | | | | | | | | | | | | | |
| Commercial real estate | | $ | 23,486 | | | $ | - | | | $ | - | | | $ | 23,486 | |
| Residential real estate | | | 4,484 | | | | - | | | | - | | | | 4,484 | |
| Total real estate | | | 27,970 | | | | - | | | | - | | | | 27,970 | |
| Commercial | | | 520 | | | | - | | | | - | | | | 520 | |
| Consumer and other loans | | | 64 | | | | - | | | | - | | | | 64 | |
| Total | | $ | 28,554 | | | $ | - | | | $ | - | | | $ | 28,554 | |
Other classified assets include other real estate owned and foreclosed assets are considered classified assets, which totaled $1,727,000 and $2,497,000 at December 31, 2009 and June 30, 2010, respectively.
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 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 Six Months Ended June 30,2010 | | | For the Twelve Months Ended December 31,2009 | |
| | | | | | | |
| End of period loans (net of deferred fees) | | $ | 190,884 | | | $ | 200,718 | |
| End of period allowance for loan losses | | $ | 4,996 | | | $ | 6,531 | |
| % of allowance for loan losses to total loans | | | 2.62 | % | | | 3.25 | % |
| Average loans for the period | | $ | 197,115 | | | $ | 206,188 | |
| Net charge-offs as a percentage of average loans | | | | | | | | |
| for the period (annualized for 2010) | | | 2.55 | % | | | 1.81 | % |
| Nonperforming assets: | | | | | | | | |
| Nonaccrual loans | | $ | 3,814 | �� | | $ | 6,715 | |
| Loans past due 90 days or more and still accruing | | | 2,029 | | | | 8 | |
| Nonperforming loans | | | 5,843 | | | | 6,723 | |
| Foreclosed real estate | | | 2,497 | | | | 1,727 | |
| | | $ | 8,340 | | | $ | 8,450 | |
| Nonperforming loans to end of period loans | | | 3.06 | % | | | 3.35 | % |
| Nonperforming assets to period end total assets | | | 3.04 | % | | | 2.84 | % |
At June 30, 2010, we had 67 loans totaling approximately $28.6 million classified as substandard, doubtful, or loss. At June 30, 2010, management had provided specific reserves totaling $3.4 million for loans risk-rated substandard or worse.
Our internally-classified loans decreased 7.4% from December 31, 2009, levels of $30.8 million. Our nonperforming assets also decreased 1.3%, which included an increase in other real estate owned and foreclosed assets of $0.8 million, or 44.6%, and a decrease in nonperforming loans of $0.9 million, or 13.1%, principally due to four loans transferred to other real estate owned.
Included in our total classified loans of $28.6 million, we internally monitor classified loans that we believe continue to meet the regulatory definition of performing loans. While we may experience losses, many of these loans are believed to be well-secured and making payments.
The following summarizes our classified loans by loan pools and the amounts reserved as of December 31, 2009 and June 30, 2010 (dollars in thousands):
| | | Classified Loans | |
| | | Substandard | | | Doubtful | | | Loss | | | Total | |
| December 31, 2009 | | | | | | | | | | | | |
| Loan Balances by Loan Pools | | | | | | | | | | | | |
| Commercial real estate | | $ | 24,552 | | | $ | 1,350 | | | $ | - | | | $ | 25,902 | |
| Residential real estate | | | 4,369 | | | | - | | | | - | | | | 4,369 | |
| Total real estate | | | 28,921 | | | | 1,350 | | | | - | | | | 30,271 | |
| Commercial | | | 494 | | | | - | | | | - | | | | 494 | |
| Consumer and other loans | | | 83 | | | | - | | | | - | | | | 83 | |
| Total loan balances | | $ | 29,498 | | | $ | 1,350 | | | $ | - | | | $ | 30,848 | |
| | | | | | | | | | | | | | | | | |
| ALLL - Reserves by Loan Pools | | | | | | | | | | | | | | | | |
| Commercial real estate | | $ | 3,621 | | | $ | 430 | | | $ | - | | | $ | 4,051 | |
| Residential real estate | | | 2,223 | | | | - | | | | - | | | | 2,223 | |
| Total real estate | | | 5,844 | | | | 430 | | | | - | | | | 6,274 | |
| Commercial | | | 194 | | | | - | | | | - | | | | 194 | |
| Consumer and other loans | | | 63 | | | | - | | | | - | | | | 63 | |
| Total reserves by loan pools | | $ | 6,101 | | | $ | 430 | | | $ | - | | | | 6,531 | |
| Unallocated | | | | | | | | | | | | | | | - | |
| Total ALLL | | | | | | | | | | | | | | $ | 6,531 | |
| | | Classified Loans | |
| | | Substandard | | | Doubtful | | | Loss | | | Total | |
| June 30, 2010 | | | | | | | | | | | | |
| Loan Balances by Loan Pools | | | | | | | | | | | | |
| Commercial real estate | | $ | 23,486 | | | $ | - | | | $ | - | | | $ | 23,486 | |
| Residential real estate | | | 4,484 | | | | - | | | | - | | | | 4,484 | |
| Total real estate | | | 27,970 | | | | - | | | | - | | | | 27,970 | |
| Commercial | | | 520 | | | | - | | | | - | | | | 520 | |
| Consumer and other loans | | | 64 | | | | - | | | | - | | | | 64 | |
| Total loan balances | | $ | 28,554 | | | $ | - | | | $ | - | | | $ | 28,554 | |
| | | | | | | | | | | | | | | | | |
| ALLL - Reserves by Loan Pools | | | | | | | | | | | | | | | | |
| Commercial real estate | | $ | 2,715 | | | $ | - | | | $ | - | | | $ | 2,715 | |
| Residential real estate | | | 2,073 | | | | - | | | | - | | | | 2,073 | |
| Total real estate | | | 4,788 | | | | - | | | | - | | | | 4,788 | |
| Commercial | | | 66 | | | | - | | | | - | | | | 66 | |
| Consumer and other loans | | | 117 | | | | - | | | | - | | | | 117 | |
| Total reserves by loan pools | | $ | 4,971 | | | $ | - | | | $ | - | | | | 4,971 | |
| Unallocated | | | | | | | | | | | | | | | 25 | |
| Total ALLL | | | | | | | | | | | | | | $ | 4,996 | |
Consent Order. The following summarizes the classified loans and assets identified by the FDIC in November 2008 and the timing of the anticipated reductions as required under the Consent Order executed January 7, 2010 (dollars in thousands):
| | | Asset Classifications | |
| | | Substandard | | | Doubtful | | | Loss | | | Total | |
| Loans identified by FDIC in November 2008 Exam | | $ | 23,547 | | | $ | - | | | $ | 1,217 | | | $ | 24,764 | |
| Classified OREO and other assets identified by FDIC in November 2008 Exam | | | 3,042 | | | | - | | | | 781 | | | | 3,823 | |
| Total classified assets identified by FDIC in November 2008 Exam | | $ | 26,589 | | | $ | - | | | $ | 1,998 | | | $ | 28,587 | |
| Classified assets to be eliminated from books within 30 days from receipt of report | | $ | - | | | $ | - | | | $ | 1,998 | | | $ | 1,998 | |
| | | Number of Days from Date of Consent Order | |
| | | (January 7, 2010) | |
| | | 90 Days (March 31, 2010) | | | 180 Days (June 30, 2010) | | | 270 Days | | | 360 Days | |
| Allowable % of classified assets from November 2008 Exam to Tier 1 Capital plus ALLL | | | 100 | % | | | 85 | % | | | 60 | % | | | 50 | % |
| Tier 1 capital plus ALLL at end of quarter | | $ | 19,050 | | | $ | 17,769 | | | | N/A | | | | N/A | |
Target for remaining balance of classified assets under Consent Order based on June 30, 2010 (1) | | $ | 19,050 | | | $ | 15,104 | | | $ | 10,661 | | | $ | 8,885 | |
| Remaining balance of classified assets at end of quarter | | $ | 16,221 | | | $ | 14,105 | | | | N/A | | | | N/A | |
| Percentage | | | 85.1 | % | | | 79.4 | % | | | N/A | | | | N/A | |
| Target has been met | | Yes | | | Yes | | | | N/A | | | | N/A | |
| | (1) | Tier 1 capital plus ALLL calculated at end of period |
The following shows the composition of the assets classified by the FDIC in its November 2008 Exam (dollars in thousands):
| | | Asset Classifications | |
Assets Classified by FDIC in November 2008 Exam | | Substandard | | | Doubtful | | | Loss | | | Total | |
| Commercial real estate | | $ | 19,422 | | | $ | - | | | $ | 1,110 | | | $ | 20,532 | |
| Residential real estate | | | 1,472 | | | | - | | | | - | | | | 1,472 | |
| Total real estate | | | 20,894 | | | | - | | | | 1,110 | | | | 22,004 | |
| Commercial | | | 2,584 | | | | - | | | | 93 | | | | 2,677 | |
| Consumer and other loans | | | 69 | | | | - | | | | 14 | | | | 83 | |
| Total | | | 23,547 | | | | - | | | | 1,217 | | | | 24,764 | |
| Other real estate owned | | | 2,967 | | | | - | | | | 781 | | | | 3,748 | |
| Other foreclosed assets | | | 75 | | | | - | | | | - | | | | 75 | |
| | | $ | 26,589 | | | $ | - | | | $ | 1,998 | | | $ | 28,587 | |
Twelve loan relationships accounted for 95% of the classified loans and 2 foreclosed real estate properties accounted for 85% of the other classified assets. The composition of these loan relationships and other real estate owned (each in excess of $500,000) follows (dollars in thousands):
| | | Classified Loans | | | OREO | |
| Commercial real estate | | $ | 19,989 | | | | 85 | % | | $ | 2,444 | | | | 76 | % |
| Residential real estate | | | 880 | | | | 4 | % | | | 790 | | | | 24 | % |
| Commercial | | | 2,557 | | | | 11 | % | | | - | | | | 0 | % |
| Consumer and other loans | | | - | | | | 0 | % | | | - | | | | 0 | % |
| | | $ | 23,426 | | | | 100 | % | | $ | 3,234 | | | | 100 | % |
Twelve of the classified loans were on nonaccrual status, which amounted to 30% of the classified loans, and six other loans were past due, or 11% of the classified loans. The issues identified by the FDIC that gave rise to the loan classifications included:
| · | Weakening economic conditions in Oceanside’s real estate market, |
| · | Inappropriate concentrations of commercial real estate, which was slightly over the regulatory guidelines at the time of the FDIC November 2008 Exam, |
| · | The likelihood of continued asset deterioration, |
| · | Loans with little or no principal reductions (including interest-only loans), |
| · | Loans originated to renovate or develop real estate where the project had stalled because of the significant downturn in Oceanside’s trade area, |
| · | Slow or stalled sales of real estate collateral, |
| · | Marginal or insufficient collateral coverage, and |
| · | Strained borrower and/or guarantor cash flow and liquidity due to the recent downturn in the economy, the falling stock market, and rising unemployment. |
Since the identification of classified assets by the FDIC in its November 2008 Exam, we have disposed of approximately 58% of the original balances (see below). Of this net reduction, approximately 43% was related to improved performance and risk-rating of the formerly classified loan and approximately 38% was attributable to charge-offs or write-downs taken on the classified assets. Of the $5.5 million of charge-offs and write-downs, 2 loans accounted for $4.2 million and 1 foreclosed real estate project totaled $1.1 million. The largest OREO classified asset, which started out at $2.4 million, has two remaining units under contract for sale at the end of the second quarter of 2010 with no additional losses anticipated. Subsequent to June 30, 2010, one of the two units under contract was sold and closed.
Based on our ongoing monitoring of the classified assets identified by the FDIC, we do not anticipate significant additional losses in excess of the specific reserves at June 30, 2010 (dollars in thousands):
| | | Amount | | | % of Write- downs/Reserves to Total Remaining Balances |
| Remaining balances of loans identified by FDIC in November 2008 Exam | | $ | 11,794 | | | | |
| Direct write-downs | | | - | | | | - | % |
| Subtotal | | | 11,794 | | | | | |
| Specific reserves | | | (898 | ) | | | 8 | % |
| Net | | $ | 10,896 | | | | | |
We are also ahead of the FDIC target of reducing these classified assets to below 85% of Tier 1 capital plus ALLL by reaching 79.4% in less than 180 days from the date of the Consent Order. While we cannot predict whether we will continue to meet these targets, the further reduction in our largest classified OREO project in the third quarter of 2010 should help meet the next target of 60% within 270 days of the Consent Order.
In developing the level of ALLL at each quarter end, we evaluated the substandard loans classified by the FDIC for impairment in the same manner as discussed elsewhere in this filing. Specifically, we obtain updated appraisals or evaluations periodically and assess each quarter any needed reserves as required under ASC 310-10-35 (formerly SFAS No. 114, Accounting by Creditors for Impairment of a Loan). Throughout the quarter, our special assets officer monitors and updates values as needed. Since 6 loan relationships comprise 98% of the remaining classified loan balances of $11.8 million at June 30, 2010, we are able to give substantial attention and consideration of these specific loans in developing our ALLL calculation. Also, because, the balance in these loans classified by the FDIC declined more rapidly than scheduled in the Consent Order, these classified loans represent approximately 41% of the loans evaluated for impairment at June 30, 2010, and the level of specific reserves allocated to these loans of $898,000 was approximately 18% of the total ALLL at June 30, 2010.
Disposition of classified assets identified by FDIC in November 2008 Exam (through June 30, 2010) | | Amount | | | % Composition of Reductions | | % of Remaining to Original Loan Balances |
| Loans upgraded to non-classified status based on payment performance or other reduction(s) in credit weaknesses giving rise to initial classification by FDIC | | $ | 6,296 | | | | 43 | % | | | 26 | % |
| Charged-off or write-downs | | | 5,457 | | | | 38 | % | | | 21 | % |
| Sales of other real estate owned and other foreclosed assets, net of write-downs | | | 3,201 | | | | 22 | % | | | 13 | % |
| Advances, net of repayments | | | (472 | ) | | | -3 | % | | | -2 | % |
| Net reductions | | $ | 14,482 | | | | 100 | % | | | 58 | % |
Additional Disclosures - Higher Risk Loans. Certain types of loans, such as option ARM products, junior lien mortgages, high loan-to-value ratio mortgages, interest only loans (which are generally associated with construction and development loans), subprime loans, and loans with initial teaser rates, can have a greater risk of non-collection than other loans. We have not engaged in the practice of lending in the subprime market or offering loans with initial teaser rates and option ARM products. A summary of our loan portfolio by loan type follows:
| | | As of June 30, 2010 | | | As of December 31, 2009 | |
| | | Amount | | | % of Total | | | Amount | | | % of Total | |
| Real estate loans: | | | | | | | | | | | | |
| Construction, land development, and other land | | $ | 29,694 | | | | 16 | % | | $ | 32,455 | | | | 16 | % |
| 1-4 family residential: | | | | | | | | | | | | | | | | |
| Secured by second liens | | | 33,557 | | | | 18 | % | | | 33,281 | | | | 16 | % |
| Home equity lines of credit and junior liens | | | 21,130 | | | | 11 | % | | | 23,619 | | | | 12 | % |
| Multifamily residential | | | 1,525 | | | | 1 | % | | | 2,902 | | | | 1 | % |
| Commercial | | | 90,830 | | | | 47 | % | | | 93,455 | | | | 47 | % |
| | | | 176,736 | | | | 93 | % | | | 185,712 | | | | 92 | % |
| Commercial loans | | | 11,162 | | | | 5 | % | | | 11,703 | | | | 6 | % |
| Consumer and other loans | | | 2,995 | | | | 2 | % | | | 3,315 | | | | 2 | % |
| Total loan portfolio | | | 190,893 | | | | 100 | % | | | 200,730 | | | | 100 | % |
| Less, deferred fees | | | (9 | ) | | | | | | | (12 | ) | | | | |
| Less, allowance for loan losses | | | (4,996 | ) | | | | | | | (6,531 | ) | | | | |
| Loans, net | | $ | 185,888 | | | | | | | $ | 194,187 | | | | | |
Substantially all our loans are in our trade area and have been affected by economic and real estate trends in North Florida. Our increases in past due loans, nonperforming assets, charge-offs, and allowance for loan losses over historical levels are directly related to declines in real estate activity, collateral values, and other negative economic trends such as rising unemployment and the high level of real estate foreclosures. We monitor a number of key ratios to identify risks and focus management efforts to mitigate our exposure. We monitor loans in excess of federal supervisory loan-to-value limits. Such loans totaled $7.3 million and $9.2 million at June 30, 2010 and December 31, 2009, respectively. Delinquency amounts and delinquency amounts expressed as a percentage of total loan classification are as follows:
| As of June 30, 2010 | | Past Due 30-89 Days and Still Accruing | | | % of Total Loans | | | Past Due 90 or More Days and Still Accruing | | | % of Total Loans | | | Nonaccrual Loans | | | % of Total Loans | | | Total Past Due Loans | | | % of Total Loans | |
| Real estate: | | | | | | | | | | | | | | | | | | | | | | | | |
| Construction, land development and other land | | $ | - | | | | 0.00 | % | | $ | 178 | | | | 0.60 | % | | $ | 61 | | | | 0.21 | % | | $ | 239 | | | | 0.81 | % |
| 1-4 family residential: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Secured by first liens | | | 287 | | | | 0.86 | % | | | 271 | | | | 0.81 | % | | | 2,319 | | | | 6.91 | % | | | 2,877 | | | | 8.58 | % |
| Home equity lines of credit and junior liens | | | 227 | | | | 1.07 | % | | | 566 | | | | 2.68 | % | | | 777 | | | | 3.68 | % | | | 1,570 | | | | 7.43 | % |
| Multifamily residential | | | - | | | | 0.00 | % | | | - | | | | 0.00 | % | | | - | | | | 0.00 | % | | | - | | | | 0.00 | % |
| Commercial | | | 1,871 | | | | 2.06 | % | | | 922 | | | | 1.02 | % | | | 657 | | | | 0.72 | % | | | 3,450 | | | | 3.80 | % |
| Total real estate | | | 2,385 | | | | 1.35 | % | | | 1,937 | | | | 1.10 | % | | | 3,814 | | | | 2.16 | % | | | 8,136 | | | | 4.61 | % |
| Commercial | | | 117 | | | | 1.05 | % | | | 82 | | | | 0.73 | % | | | - | | | | 0.00 | % | | | 199 | | | | 1.78 | % |
| Consumer and other loans | | | 33 | | | | 1.10 | % | | | 10 | | | | 0.33 | % | | | - | | | | 0.00 | % | | | 43 | | | | 1.43 | % |
| Total loans | | $ | 2,535 | | | | 1.33 | % | | $ | 2,029 | | | | 1.06 | % | | $ | 3,814 | | | | 2.00 | % | | $ | 8,378 | | | | 4.39 | % |
| As of December 31, 2009 | | | | | | | | | | | | | | | | | | | | | | | | |
| Real estate: | | | | | | | | | | | | | | | | | | | | | | | | |
| Construction, land development and other land | | $ | 89 | | | | 0.27 | % | | $ | 7 | | | | 0.02 | % | | $ | 2,019 | | | | 6.22 | % | | $ | 2,115 | | | | 6.51 | % |
| 1-4 family residential: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Secured by first liens | | | 154 | | | | 0.46 | % | | | - | | | | 0.00 | % | | | 2,603 | | | | 7.82 | % | | | 2,757 | | | | 8.28 | % |
| Home equity lines of credit and junior liens | | | 570 | | | | 2.41 | % | | | - | | | | 0.00 | % | | | 530 | | | | 2.24 | % | | | 1,100 | | | | 4.65 | % |
| Multifamily residential | | | - | | | | 0.00 | % | | | - | | | | 0.00 | % | | | 1,350 | | | | 46.52 | % | | | 1,350 | | | | 46.52 | % |
| Commercial | | | 543 | | | | 0.58 | % | | | - | | | | 0.00 | % | | | 213 | | | | 0.23 | % | | | 756 | | | | 0.81 | % |
| Total real estate | | | 1,356 | | | | 0.73 | % | | | 7 | | | | 0.00 | % | | | 6,715 | | | | 3.62 | % | | | 8,078 | | | | 4.35 | % |
| Commercial | | | 140 | | | | 1.20 | % | | | - | | | | 0.00 | % | | | - | | | | 0.00 | % | | | 140 | | | | 1.20 | % |
| Consumer and other loans | | | 58 | | | | 1.75 | % | | | 1 | | | | 0.00 | % | | | - | | | | 0.00 | % | | | 59 | | | | 1.75 | % |
| Total loans | | $ | 1,554 | | | | 0.77 | % | | $ | 8 | | | | 0.00 | % | | $ | 6,715 | | | | 3.35 | % | | $ | 8,277 | | | | 4.12 | % |
The following shows the increases (decreases) in delinquent loans at June 30, 2010, as compared with December 31, 2009.
| Increase (Decreases) | | Past Due 30-89 Days and Still Accruing | | | Past Due 90 or More Days and Still Accruing | | | Nonaccrual Loans | | | Total Past Due Loans | |
| Real estate: | | | | | | | | | | | | |
| Construction, land development and other land | | $ | (89 | ) | | $ | 171 | | | $ | (1,958 | ) | | $ | (1,876 | ) |
| 1-4 family residential: | | | | | | | | | | | | | | | | |
| Secured by first liens | | | 133 | | | | 271 | | | | (284 | ) | | | 120 | |
| Home equity lines of credit and junior liens | | | (343 | ) | | | 566 | | | | 247 | | | | 470 | |
| Multifamily residential | | | - | | | | - | | | | (1,350 | ) | | | (1,350 | ) |
| Commercial | | | 1,328 | | | | 922 | | | | 444 | | | | 2,694 | |
| Total real estate | | | 1,029 | | | | 1,930 | | | | (2,901 | ) | | | 58 | |
| Commercial | | | (23 | ) | | | 82 | | | | - | | | | 59 | |
| Consumer and other loans | | | (25 | ) | | | 9 | | | | - | | | | (16 | ) |
| Total loans | | $ | 981 | | | $ | 2,021 | | | $ | (2,901 | ) | | $ | 101 | |
Loans restructured and in compliance with modified terms are commonly referred to as “debt restructurings.” A restructuring of debt constitutes a Troubled Debt Restructuring (“TDR”) if a creditor for economic or legal reasons related to the debtor’s financial difficulties grants a concession to the debtor it would not otherwise consider. A summary of nonperforming assets and restructured loans follows (dollars in thousands):
Analysis of Nonperforming Assets (dollars in thousands):
| | | June 30, | | | December 31, | |
| | | 2010 | | | 2009 | |
| Nonaccrual loans | | | | | | |
| Construction, land development, and other land | | $ | 61 | | | $ | 2,019 | |
| 1-4 family residential: | | | | | | | | |
| Secured by first liens | | | 2,319 | | | | 2,603 | |
| Home equity lines of credit and junior liens | | | 777 | | | | 530 | |
| Multifamily residential | | | - | | | | 1,350 | |
| Commercial | | | 657 | | | | 213 | |
| Total real estate | | | 3,814 | | | | 6,715 | |
| Commercial | | | - | | | | - | |
| Consumer and other loans | | | - | | | | - | |
| Total | | $ | 3,814 | | | $ | 6,715 | |
| | | | | | | | | |
| Loans 90 days or more past due and still on accrual status | | | | | | | | |
| Construction, land development, and other land | | $ | 178 | | | $ | 7 | |
| 1-4 family residential: | | | | | | | | |
| Secured by first liens | | | 271 | | | | - | |
| Home equity lines of credit and junior liens | | | 566 | | | | - | |
| Multifamily residential | | | - | | | | - | |
| Commercial | | | 922 | | | | - | |
| Total real estate | | | 1,937 | | | | 7 | |
| Commercial | | | 82 | | | | - | |
| Consumer and other loans | | | 10 | | | | 1 | |
| Total | | $ | 2,029 | | | $ | 8 | |
| | | | | | | | | |
| Total nonperforming loans | | $ | 5,843 | | | $ | 6,723 | |
| Foreclosed real estate | | | 2,497 | | | | 1,727 | |
| Total nonperforming assets | | $ | 8,340 | | | $ | 8,450 | |
| | | | | | | | | |
| Restructured loans | | | | | | | | |
| 1 to 4 family | | $ | 6,358 | | | $ | 5,968 | |
| All other | | | 13,104 | | | | 11,404 | |
| Total restructured loans | | $ | 19,462 | | | $ | 17,372 | |
| | | | | | | | | |
| Total nonperforming assets and restructured loans | | $ | 27,802 | | | $ | 25,822 | |
| | | | | | | | | |
| Restructured loans included in nonaccrual loans above that are considered troubled debt restructurings | | $ | 1,652 | | | $ | 1,842 | |
| | | | | | | | | |
| Ratios | | | | | | | | |
| Total loans | | $ | 190,884 | | | $ | 200,718 | |
| Total assets | | $ | 274,151 | | | $ | 297,366 | |
| Total nonperforming loans to total loans | | | 3.06 | % | | | 3.35 | % |
| Total nonperforming assets to total assets | | | 3.04 | % | | | 2.84 | % |
| Total nonperforming assets and restructured loans to total assets | | | 10.14 | % | | | 8.68 | % |
We have been consistent in our practice of determining our allowance for loan losses with only minor refinements in establishing reserves for our performing loans. Impaired loans may be assigned a specific reserve and/or charged-down to estimated fair value less costs to liquidate. We consider the following in establishing reserves on loans other than impaired loans:
| · | Recent historical loss data over the past five quarters is used as a starting point for estimating current losses; |
| · | We consider various economic and other qualitative factors affecting loan quality including changes in: |
| | · | the volume (and trends) of delinquent and monitored loans, |
| | · | underlying collateral values, |
| | · | concentrations in risk and levels of concentration risks, |
| | · | quality of internal and external loan reviews, which includes risk-rating our loans according to federal regulatory guidelines, |
| | · | competition and regulatory factors, |
| | · | lending staff experience, |
| | · | business and economic conditions, and |
| · | In developing loss factors, we consider both internal historical data and external data such as changes in leading economic indicators, the consumer price index, delinquencies, employment data, cap rates, occupancy levels, rental rates, and single-family homes and condominium sales prices and sales activity. |
We maintain formal policies that we believe are consistent with federal regulatory guidance for identifying and quantifying risks related to loan quality and other related matters including but not limited to:
| · | the frequency of internal and external loan reviews, |
| · | obtaining appraisals or evaluations for monitored loans, |
| · | classifying loans from accrual to nonaccrual status (which is typically done when a loan reaches 90 days past due unless well-secured and in process of collection), |
| · | recognizing loan charge-offs on impaired loans, and |
| · | exercising judgment in determining the allowance for loan losses consistent with generally accepted accounting principles. |
The following is a summary of the activity in the ALLL for the periods presented below (dollars in thousands):
| | | For the Three Months Ended | | | For the Six Months Ended | | | For the Twelve Months Ended | |
| | | June 30, 2010 | | | June 30, 2010 | | | December 31, 2009 | |
| | | | | | | | | | |
| Allowance for loan losses at beginning of period | | $ | 6,651 | | | $ | 6,531 | | | $ | 3,999 | |
| | | | | | | | | | | | | |
| Charge-offs for the period | | | | | | | | | | | | |
| Construction, land development, and other land | | | (28 | ) | | | (589 | ) | | | (135 | ) |
| 1-4 family residential: | | | | | | | | | | | | |
| Secured by first liens | | | (371 | ) | | | (525 | ) | | | (1,207 | ) |
| Home equity lines of credit and junior liens | | | (685 | ) | | | (685 | ) | | | (110 | ) |
| Multifamily residential | | | (650 | ) | | | (650 | ) | | | (2,040 | ) |
| Commercial | | | - | | | | - | | | | (156 | ) |
| Total real estate | | | (1,734 | ) | | | (2,449 | ) | | | (3,648 | ) |
| Commercial | | | - | | | | - | | | | (39 | ) |
| Consumer and other loans | | | (13 | ) | | | (52 | ) | | | (74 | ) |
| Total charge-offs | | | (1,747 | ) | | | (2,501 | ) | | | (3,761 | ) |
| | | | | | | | | | | | | |
| Recoveries for the period | | | | | | | | | | | | |
| Construction, land development, and other land | | | - | | | | - | | | | - | |
| 1-4 family residential: | | | | | | | | | | | | |
| Secured by first liens | | | - | | | | - | | | | 1 | |
| Home equity lines of credit and junior liens | | | - | | | | - | | | | - | |
| Multifamily residential | | | - | | | | - | | | | - | |
| Commercial | | | - | | | | - | | | | - | |
| Total real estate | | | - | | | | - | | | | 1 | |
| Commercial | | | - | | | | - | | | | 11 | |
| Consumer and other loans | | | 2 | | | | 4 | | | | 13 | |
| Total recoveries | | | 2 | | | | 4 | | | | 25 | |
| Net charge-offs for the period | | | (1,745 | ) | | | (2,497 | ) | | | (3,736 | ) |
| Provision for loan losses for the period | | | 90 | | | | 962 | | | | 6,268 | |
| Allowance for loan losses at end of period | | $ | 4,996 | | | $ | 4,996 | | | $ | 6,531 | |
The following is the allocation of the ALLL for the periods presented (dollars in thousands):
| | | June 30, 2010 | | | December 31, 2009 | |
| | | Reserves for Impaired Loans (1) | | | Reserves for Loss Contingencies (2) | | | Total | | | Reserves for Impaired Loans (1) | | | Reserves for Loss Contingencies (2) | | | Total | |
| Commercial real estate | | $ | 2,498 | | | $ | 217 | | | $ | 2,715 | | | $ | 3,547 | | | $ | 504 | | | $ | 4,051 | |
| Residential real estate | | | 838 | | | | 1,235 | | | | 2,073 | | | | 831 | | | | 1,392 | | | | 2,223 | |
| Total real estate | | | 3,336 | | | | 1,452 | | | | 4,788 | | | | 4,378 | | | | 1,896 | | | | 6,274 | |
| Commercial | | | 10 | | | | 56 | | | | 66 | | | | - | | | | 194 | | | | 194 | |
| Consumer and other loans | | | 75 | | | | 42 | | | | 117 | | | | 2 | | | | 61 | | | | 63 | |
| Unallocated | | | - | | | | 25 | | | | 25 | | | | - | | | | - | | | | - | |
| Totals | | $ | 3,421 | | | $ | 1,575 | | | $ | 4,996 | | | $ | 4,380 | | | $ | 2,151 | | | $ | 6,531 | |
| (1) | Reserves for impaired loans determined under ASC 310-10-35 (formerly SFAS No. 114, Accounting for Creditors for Impairment of a Loan) |
| (2) | Reserves for loss contingencies determined under ASB 450-20 (formerly SFAS No. 5, Accounting for Contingencies) |
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, 2009.
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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 June 30, | |
| | | 2010 | | | 2009 | |
| | | | | | Interest | | | Average | | | | | | Interest | | | Average | |
| | | Average | | | and | | | Yield/ | | | Average | | | and | | | Yield/ | |
| | | Balance | | | Dividends | | | Rate | | | Balance | | | Dividends | | | Rate | |
| Interest-earning assets: | | | | | | | | | | | | | | | | | | |
| Loans | | $ | 194,499 | | | $ | 2,749 | | | | 5.67 | % | | $ | 207,954 | | | $ | 3,098 | | | | 5.98 | % |
| Investment securities and | | | | | | | | | | | | | | | | | | | | | | | | |
interest-bearing deposits (1) | | | 69,652 | | | | 480 | | | | 3.32 | % | | | 60,052 | | | | 305 | | | | 2.71 | % |
| Other interest-earning assets | | | - | | | | - | | | | 0.00 | % | | | - | | | | - | | | | 0.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Total interest-earning assets (1) | | | 264,151 | | | | 3,229 | | | | 5.05 | % | | | 268,006 | | | | 3,403 | | | | 5.24 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Noninterest-earning assets | | | 11,659 | | | | | | | | | | | | 21,239 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total assets | | $ | 275,810 | | | | | | | | | | | $ | 289,245 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Demand, money market | | | | | | | | | | | | | | | | | | | | | | | | |
| and NOW deposits | | $ | 70,826 | | | | 186 | | | | 1.05 | % | | $ | 76,494 | | | | 348 | | | | 1.82 | % |
| Savings | | | 3,281 | | | | 6 | | | | 0.73 | % | | | 2,844 | | | | 7 | | | | 0.99 | % |
| Certificates of deposit | | | 139,939 | | | | 765 | | | | 2.19 | % | | | 139,870 | | | | 1,211 | | | | 3.47 | % |
| Other borrowings | | | 15,394 | | | | 129 | | | | 3.36 | % | | | 15,701 | | | | 143 | | | | 3.65 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total interest-bearing liabilities | | | 229,440 | | | | 1,086 | | | | 1.90 | % | | | 234,909 | | | | 1,709 | | | | 2.92 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Noninterest-bearing liabilities | | | 36,849 | | | | | | | | | | | | 37,450 | | | | | | | | | |
| Stockholders’ equity | | | 9,521 | | | | | | | | | | | | 16,886 | | | | | | | | | |
| Total liabilities and | | | | | | | | | | | | | | | | | | | | | | | | |
| stockholders’ equity | | $ | 275,810 | | | | | | | | | | | $ | 289,245 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest income before | | | | | | | | | | | | | | | | | | | | | | | | |
| provision for loan losses | | | | | | $ | 2,143 | | | | | | | | | | | $ | 1,694 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-rate spread | | | | | | | | | | | 3.15 | % | | | | | | | | | | | 2.32 | % |
Net interest margin (1) | | | | | | | | | | | 3.40 | % | | | | | | | | | | | 2.69 | % |
| Ratio of average interest-earning assets | | | | | | | | | | | | | | | | | | | | | | | | |
| to average interest-bearing liabilities | | | 115.13 | % | | | | | | | | | | | 114.09 | % | | | | | | | | |
| (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. |
| | | For the Six Months Ended June 30, | |
| | | 2010 | | | 2009 | |
| | | | | | Interest | | | Average | | | | | | Interest | | | Average | |
| | | Average | | | and | | | Yield/ | | | Average | | | and | | | Yield/ | |
| | | Balance | | | Dividends | | | Rate | | | Balance | | | Dividends | | | Rate | |
| Interest-earning assets: | | | | | | | | | | | | | | | | | | |
| Loans | | $ | 197,115 | | | $ | 5,574 | | | | 5.70 | % | | $ | 207,619 | | | $ | 6,252 | | | | 6.07 | % |
| Investment securities and | | | | | | | | | | | | | | | | | | | | | | | | |
interest-bearing deposits (1) | | | 72,131 | | | | 971 | | | | 3.25 | % | | | 46,997 | | | | 648 | | | | 3.65 | % |
| Other interest-earning assets | | | - | | | | - | | | | 0.00 | % | | | 1,108 | | | | 1 | | | | 0.18 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Total interest-earning assets (1) | | | 269,246 | | | | 6,545 | | | | 5.05 | % | | | 255,724 | | | | 6,901 | | | | 5.60 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Noninterest-earning assets | | | 11,872 | | | | | | | | | | | | 23,658 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total assets | | $ | 281,118 | | | | | | | | | | | $ | 279,382 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Demand, money market | | | | | | | | | | | | | | | | | | | | | | | | |
| and NOW deposits | | $ | 80,419 | | | | 461 | | | | 1.16 | % | | $ | 65,257 | | | | 558 | | | | 1.72 | % |
| Savings | | | 3,080 | | | | 11 | | | | 0.72 | % | | | 2,893 | | | | 14 | | | | 0.98 | % |
| Certificates of deposit | | | 137,300 | | | | 1,619 | | | | 2.38 | % | | | 141,168 | | | | 2,610 | | | | 3.73 | % |
| Other borrowings | | | 15,394 | | | | 256 | | | | 3.35 | % | | | 16,277 | | | | 261 | | | | 3.23 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total interest-bearing liabilities | | | 236,193 | | | | 2,347 | | | | 2.00 | % | | | 225,595 | | | | 3,443 | | | | 3.08 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Noninterest-bearing liabilities | | | 35,387 | | | | | | | | | | | | 36,903 | | | | | | | | | |
| Stockholders’ equity | | | 9,538 | | | | | | | | | | | | 16,884 | | | | | | | | | |
| Total liabilities and | | | | | | | | | | | | | | | | | | | | | | | | |
| stockholders’ equity | | $ | 281,118 | | | | | | | | | | | $ | 279,382 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest income before | | | | | | | | | | | | | | | | | | | | | | | | |
| provision for loan losses | | | | | | $ | 4,198 | | | | | | | | | | | $ | 3,458 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-rate spread | | | | | | | | | | | 3.05 | % | | | | | | | | | | | 2.52 | % |
Net interest margin (1) | | | | | | | | | | | 3.29 | % | | | | | | | | | | | 2.89 | % |
| Ratio of average interest-earning assets | | | | | | | | | | | | | | | | | | | | | | | | |
| to average interest-bearing liabilities | | | 113.99 | % | | | | | | | | | | | 113.36 | % | | | | | | | | |
| (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 and six months period ended June 30, 2010, compared to the same period in 2009. 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 June 30, | |
| | | 2010 vs. 2009 | |
| | | Increase (Decrease) Due to | |
| | | | | | | | | Rate/ | | | | |
| | | Rate | | | Volume | | | Volume | | | Total | |
| Interest-earning assets: | | | | | | | | | | | | |
| Loans | | $ | (161 | ) | | $ | (201 | ) | | $ | 13 | | | $ | (349 | ) |
| Investment securities and interest-bearing deposits | | | 91 | | | | 65 | | | | 19 | | | | 175 | |
| Other interest-earning assets | | | - | | | | - | | | | - | | | | - | |
| Total interest-earning assets | | | (70 | ) | | | (136 | ) | | | 32 | | | | (174 | ) |
| | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | |
| Demand, money market and NOW deposits | | | (147 | ) | | | (26 | ) | | | 11 | | | | (162 | ) |
| Savings | | | (2 | ) | | | 1 | | | | - | | | | (1 | ) |
| Certificates of deposit | | | (446 | ) | | | 1 | | | | (1 | ) | | | (446 | ) |
| Other borrowings | | | (11 | ) | | | (3 | ) | | | - | | | | (14 | ) |
| Total interest-bearing liabilities | | | (606 | ) | | | (27 | ) | | | 10 | | | | (623 | ) |
| | | | | | | | | | | | | | | | | |
| Net interest income | | $ | 536 | | | $ | (109 | ) | | $ | 22 | | | $ | 449 | |
| | | | | | | | | | | | | | | | | |
| | | Six Months Ended June 30, | |
| | | 2010 vs. 2009 | |
| | | Increase (Decrease) Due to | |
| | | | | | | | | | | Rate/ | | | | | |
| | | Rate | | | Volume | | | Volume | | | Total | |
| Interest-earning assets: | | | | | | | | | | | | | | | | |
| Loans | | $ | (382 | ) | | $ | (317 | ) | | $ | 21 | | | $ | (678 | ) |
| Investment securities and interest-bearing deposits | | | (93 | ) | | | 456 | | | | (40 | ) | | | 323 | |
| Other interest-earning assets | | | (1 | ) | | | (1 | ) | | | 1 | | | | (1 | ) |
| Total interest-earning assets | | | (476 | ) | | | 138 | | | | (18 | ) | | | (356 | ) |
| | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | |
| Demand, money market and NOW deposits | | | (182 | ) | | | 130 | | | | (45 | ) | | | (97 | ) |
| Savings | | | (4 | ) | | | 1 | | | | - | | | | (3 | ) |
| Certificates of deposit | | | (948 | ) | | | (72 | ) | | | 29 | | | | (991 | ) |
| Other borrowings | | | 10 | | | | (14 | ) | | | (1 | ) | | | (5 | ) |
| Total interest-bearing liabilities | | | (1,124 | ) | | | 45 | | | | (17 | ) | | | (1,096 | ) |
| | | | | | | | | | | | | | | | | |
| Net interest income | | $ | 648 | | | $ | 93 | | | $ | (1 | ) | | $ | 740 | |
Comparison of Three Months Ended June 30, 2010 and 2009
Interest Income and Expense
Interest Income. Interest income was $3,229,000 and $3,403,000 for the three months ended June 30, 2010 and 2009, respectively, a decline of $174,000, or 5.1%. The decrease resulted principally from a decrease in yields on average interest-earning assets of 19 basis points and a decrease in average earning assets of $3.9 million, or 1.4%. The declining interest rate environment and the effect of increased nonaccrual loans, restructured loans, and other real estate owned contributed to lower yields on average loans of 5.67% versus 5.98%, a decline of 31 basis points. Average loans, as a percentage of average interest-earning assets, decreased to 73.6% in the second quarter of 2010 as compared with 77.6% in 2009. Active management of our investments and excess funds resulted in an increase in the yield from 2.71% to 3.32%, an increase of 61 basis points, or 22.5%. The percentage of higher yielding average investment securities and interest-bearing deposits to total interest-earning assets rose to 26.4% in 2010 from 22.4% in 2009.
Interest Expense. Interest expense was $1,086,000 and $1,709,000 for the three months ended June 30, 2010 and 2009, respectively. Our average cost of funds for interest-bearing liabilities decreased to 1.90% in 2010 compared with 2.92% over the same period in 2009, an overall decline of 102 basis points. A decrease in average interest-bearing liabilities of $5.5 million, or 2.3%, and 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 2.19% in 2010 and 3.47% in 2009, represented 61.0% of our total interest-bearing liabilities in 2010 as compared with 59.5% in 2009. Interest-bearing demand deposits, with an average cost of funds of 1.05% in 2010 and 1.82% in 2009, represented 30.9% of our total interest-bearing liabilities in 2010 as compared with 32.6% in 2009.
Net Interest Income before Provision for Loan Losses. Net interest income before provision for loan losses was $2,143,000 and $1,694,000 for the three months ended June 30, 2010 and 2009, respectively. The net interest margin for the second quarter of 2010 was 3.40% versus 2.69% in 2009, which reflected a more effective management of our interest-bearing assets and liabilities while maintaining an acceptable liquidity position.
Provision for Loan Losses
We recorded provisions for loan losses totaling $90,000 and $133,000 for the three months ended June 30, 2010 and 2009, respectively, which management considered appropriate after its assessment of the overall quality of the loan portfolio. At June 30, 2010, our reserves were 2.62% of outstanding loans versus 3.25% at June 30, 2009, reflecting net charge-offs of $1.7 million for the quarter. Four loans accounted for 90% of the charge-offs in the quarter. Three loans were transferred to other real estate owned during the quarter.
Noninterest Income and Expenses
Noninterest Income. Total noninterest income decreased by $69,000, or 25.2% for the three months ended June 30, 2010, to $205,000 compared with $274,000 for the same period in 2009. The second quarter of 2010 versus 2009 included a reduction in fees and service charges on deposit accounts of $51,000, or 32.3%, and of other fee income for banking services of $19,000, or 32.2%
Noninterest Expenses. Management has taken steps to reduce noninterest expenses in areas in which it can, while maintaining the safety and soundness of our banking operations. Salaries and employee benefits decreased $70,000, or 9.9%, in the second quarter of 2010 over 2009. Advertising and business development expenses have been reduced, resulting in a decrease in noninterest expenses of $24,000. Pension expense was eliminated as a result of freezing the benefits in anticipation of the merger, resulting in a decrease of $85,000. Other components of noninterest expenses increased $391,000. The more significant increases were:
| · | Increases of $25,000 for processing and settlement fees; |
| · | Higher professional, legal, and audit expenses of $137,000, most of which is attributable to merger-related expenses; |
| · | Increases in OREO and other loan collection expenses of $49,000, net of a $20,000 decrease in the write-down of other real estate owned; and |
| · | Increases in deposit insurance assessments of $180,000. |
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 for 2010 and 2009 and changes in the deferred tax valuation allowance. During the second quarter of 2010, we recognized deferred tax assets of $118,000 as a result of the level of deferred tax asset valuation allowance we considered necessary at June 30, 2010. Tax-exempt income was $160,000 for the second quarter of 2010 as compared with $168,000 in 2009.
An income tax summary follows (dollars in thousands):
| | | Three Months Ended June 30, | |
| | | 2010 | | | 2009 | |
| Book income (loss) before income tax benefit | | $ | 164 | | | $ | (93 | ) |
| Nontaxable interest income, net | | | (160 | ) | | | (168 | ) |
| Estimated taxable gain on bank-owned life insurance | | | 900 | | | | - | |
| Taxable income (loss) | | | 904 | | | | (261 | ) |
| Tax rate | | | 37.6 | % | | | 37.6 | % |
| Income tax (benefit) | | | 340 | | | | (98 | ) |
| Estimated penalty tax on bank-owned life insurance | | | 90 | | | | - | |
| Changes in deferred tax valuation allowance and other, net | | | (548 | ) | | | (60 | ) |
| Benefit for income taxes | | $ | (118 | ) | | $ | (158 | ) |
| Effective rate | | | -72.0 | % | | | 169.9 | % |
Comparison of Six Months Ended June 30, 2010 and 2009
Interest Income and Expense
Interest Income. Interest income was $6,545,000 and $6,901,000 for the six months ended June 30, 2010 and 2009, respectively, a decline of $356,000, or 5.2%. A decrease in yields on average interest-earning assets of 55 basis points more than offset the increase in average earning assets of $13.5 million, or 5.3%. A substantial portion of the increase was due to higher levels of interest-bearing deposits that contributed to the steep decline in yields for investment securities and interest-bearing deposits of 40 basis points. Average loans decreased $10.5 million over 2009, or 5.1%. The declining interest rate environment and the effect of increased nonaccrual loans, restructured loans, and other real estate owned contributed to lower yields on average loans of 5.70% versus 6.07%, a decline of 37 basis points. Average loans, as a percentage of average interest-earning assets, decreased to 73.2% in the first half of 2010 as compared with 81.2% in 2009. The percentage of lower yielding average investment securities and interest-bearing deposits to total interest-earning assets rose to 26.8% in 2010 from 18.4% in 2009.
Interest Expense. Interest expense was $2,347,000 and $3,443,000 for the six months ended June 30, 2010 and 2009, respectively. Our average cost of funds for interest-bearing liabilities decreased to 2.00% in 2010 compared with 3.08% over the same period in 2009, an overall decline of 108 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 2.38% in 2010 and 3.73% in 2009, represented 58.1% of our total interest-bearing liabilities in 2010 as compared with 62.6% in 2009. The decline in average certificates of deposit and other interest-bearing liabilities was offset by increases in our interest-bearing demand deposits, with an average cost of funds of 1.16% in 2010 and 1.72% in 2009, representing 34.0% of our total interest-bearing liabilities in 2010 as compared with 28.9% in 2009.
Net Interest Income before Provision for Loan Losses. Net interest income before provision for loan losses was $4,198,000 and $3,458,000 for the six months ended June 30, 2010 and 2009, respectively. The net interest margin for the first six months of 2010 was 3.29% versus 2.89% in 2009, which reflected a more effective management of our interest-bearing assets and liabilities while maintaining an acceptable liquidity position.
Provision for Loan Losses
We recorded provisions for loan losses totaling $962,000 and $367,000 for the six months ended June 30, 2010 and 2009, respectively, which management considered appropriate after its assessment of the overall quality of the loan portfolio. At June 30, 2010, our reserves were 2.62% of outstanding loans reflecting net charge-offs of $2.5 million. Six loans accounted for 90% of the charge-offs and four loans were transferred to other real estate owned during the six months ended June 30, 2010.
Noninterest Income and Expenses
Noninterest Income. Total noninterest income increased by $77,000, or 23.4% for the six months ended June 30, 2010, to $406,000 compared with $329,000 for the same period in 2009. The first half of 2010 versus 2009 included a reduction in fees and service charges on deposit accounts of $94,000, or 28.8%, and lower realized gain on the sale of securities of $35,000. These decreases were more than offset by a $179,000 loss on restricted stock in 2009 versus no such loss in 2010.
Noninterest Expenses. Management has taken steps to reduce noninterest expenses in areas in which it can while maintaining the safety and soundness of our banking operations. Salaries and employee benefits decreased $100,000, or 6.9%, in the first half of 2010 over 2009. Expenses of bank premises and fixed assets decreased $19,000, or 3.7%. Advertising and business development and pension expenses have been reduced, resulting in a decrease in noninterest expenses of $218,000. Other components of noninterest expenses increased $679,000. The more significant increases were:
| · | Increases of $22,000 for processing and settlement fees; |
| · | Higher professional, legal, and audit expenses of $195,000, most of which is attributable to merger-related expenses; |
| · | Increases in OREO and other loan collection expense and the write-down of other real estate owned of $75,000; and |
| · | Increases in deposit insurance assessments of $387,000. |
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 for 2010 and 2009 and changes in the deferred tax valuation allowance. During the second quarter of 2010, we recognized deferred tax assets of $118,000 as a result of the level of deferred tax asset valuation allowance we considered necessary at June 30, 2010. Tax-exempt income was $320,000 for the first six months of 2010 as compared with $336,000 in 2009.
An income tax summary follows (dollars in thousands):
| | | Six Months Ended June 30, | |
| | | 2010 | | | 2009 | |
| Book loss before income tax benefit | | $ | (383 | ) | | $ | (311 | ) |
| Nontaxable interest income, net | | | (320 | ) | | | (336 | ) |
| Estimated taxable gain on bank-owned life insurance | | | 900 | | | | - | |
| Taxable income (loss) | | | 197 | | | | (647 | ) |
| Tax rate | | | 37.6 | % | | | 37.6 | % |
| Income tax (benefit) | | | 74 | | | | (243 | ) |
| Estimated penalty tax on bank-owned life insurance | | | 90 | | | | - | |
| Changes in deferred tax valuation allowance and other, net | | | (282 | ) | | | (65 | ) |
| Benefit for income taxes | | $ | (118 | ) | | $ | (308 | ) |
| Effective rate | | | 30.8 | % | | | 99.0 | % |
ITEM 4. CONTROLS AND PROCEDURES
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 subsidiaries) 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.
ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES
| Item 1. | Legal Proceedings. |
Periodically, we are parties to or otherwise involved in legal proceedings arising in the normal course of business, such as claims to enforce liens, claims involving the making and servicing of real property loans, and other issues incident to our operations. We do not believe that there are any pending or threatened proceedings against us, which, if determined adversely, would have a material effect on our consolidated financial position, except as noted below.
Consent Order - Effective January 7, 2010, Oceanside, a wholly-owned subsidiary of Atlantic, entered into a Stipulation to the Issuance of a Consent Order (“Stipulation”) with the Federal Deposit Insurance Corporation (the “FDIC”) and the Florida Office of Financial Regulation (the “OFR”) (“Stipulation”). Pursuant to the Stipulation, Oceanside has consented, without admitting or denying any charges of unsafe or unsound banking practices or violations of law or regulation, to the issuance of a Consent Order by the FDIC and the OFR, also effective as of January 7, 2010 (“Consent Order”).
The Consent Order represents an agreement among Oceanside, the FDIC, and the OFR as to areas of Oceanside’s operations that warrant improvement and presents a plan for making those improvements. The Consent Order imposes no fines or penalties on Oceanside.
Pursuant to the Consent Order, Oceanside’s Board of Directors is required to increase its participation in the affairs of Oceanside. This participation shall include comprehensive, documented meetings to be held no less frequently than monthly. Oceanside must also develop, submit for comment to the FDIC and the OFR, and approve a management plan for the purpose of providing qualified management for Oceanside. Prior to the entry of the Consent Order, the Board conducted such meetings, but will now require more detailed management reports. The Board has developed a management plan and evaluated the structure and composition of Oceanside’s current management. The Board has also developed an education plan for itself.
During the life of the Consent Order, Oceanside shall not add any individual to Oceanside’s Board of Directors or employ any individual as a senior executive officer without the prior non-objection of the FDIC and the OFR. Oceanside has been subject to this requirement since 2008; therefore, this requirement will have no affect on Oceanside’s operations.
Within 90 days of the effective date of the Consent Order and, thereafter, during the life of the Consent Order, Oceanside shall achieve and maintain a Tier 1 Leverage Capital Ratio of not less than 8% and a Total Risk Based Capital Ratio of not less than 11%. In the event such ratios fall below such levels, Oceanside shall notify the FDIC and the OFR and shall increase capital in an amount sufficient to reach the required ratios within 90 days of such notice. At March 31 and June 30, 2010, Oceanside’s Tier 1 Leverage Capital Ratio was 4.32% and 4.64%, respectively, and its Total Risk Based Capital Ratio was 7.74% and 8.20%, respectively. We did not meet the April 7, 2010, deadline to raise additional capital as required by the Consent Order. However, our contemplated merger with Jacksonville Bancorp, Inc. (see Note 12 - Merger) is expected to result in our being part of a larger bank, with significantly higher capital ratios. If that merger is not consummated, we will explore other strategic alternatives intended to improve our capital ratios.
Oceanside shall also be required to maintain a fully funded Allowance for Loan and Lease Losses (“ALLL”), the adequacy of which shall be satisfactory to the FDIC and the OFR. The Board of Directors shall review the adequacy of the ALLL and establish a comprehensive policy for determining the adequacy of the ALLL consistent with regulatory policies. A deficiency in the ALLL shall be remedied in the calendar quarter it is discovered. Oceanside’s policy for determining the adequacy of Oceanside’s ALLL and its implementation shall be satisfactory to the FDIC and the OFR as determined at subsequent examinations and/or visitations. Oceanside has always endeavored to maintain a fully funded ALLL. Regulatory review of the ALLL has not always been consistent from examination/visitation to examination/visitation and has not always seemed to be in accordance with generally accepted accounting principles or written regulatory guidance or regulations, so Oceanside anticipates possibly being requested to make further adjustments to the ALLL depending on the affiliation (FDIC or OFR), identity, or
ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES
attitudes of future examination or visitation staff. As of the date of the Consent Order, Oceanside believes its ALLL was compliant with regulatory guidance and consistent with generally accepted accounting principles.
Pursuant to the Consent Order, Oceanside must review, revise, and adopt its written liquidity, contingency funding, and funds management policy to provide effective guidance and control over Oceanside’s funds management activities. Oceanside must also implement effective models for managing liquidity and calculating the liquidity and dependency ratios with monthly reporting to the Board of Directors. Oceanside has revised such policies and is refining its practices and procedures in these areas. Oceanside expects that these actions will improve Oceanside’s liquidity, contingency funding, and funds management practices.
Throughout the life of the Consent Order, Oceanside shall not accept, renew, or rollover any brokered deposit, and comply with the restrictions on the effective yields on deposits exceeding national averages. Oceanside has not accepted, renewed, or rolled over any brokered deposits since July 2009; therefore, that restriction is not expected to alter Oceanside’s current deposit gathering activities. With respect to the yield limitations, it is possible that Oceanside could experience a decrease in deposit inflows, or the migration of current deposits to competitor institutions, if other institutions offer higher interest rates than those permitted to be offered by Oceanside.
While the Consent Order is in effect, Oceanside shall notify the FDIC and the OFR, at least, 60 days prior to undertaking asset growth in excess of 10% or more per annum or initiating material changes in asset or liability composition. Oceanside anticipates no such changes.
While the Consent Order is in effect, Oceanside shall not declare or pay dividends, interest payments on subordinated debentures or any other form of payment representing a reduction in capital without the prior written approval of the FDIC and the OFR. Oceanside has not paid a dividend to Atlantic since April 2009, and Atlantic has not made any payments on its subordinated debt since June 2009. Therefore, this restriction is not expected to affect Oceanside’s operations.
While the Consent Order remains in effect, Oceanside shall, within 30 days of the receipt of any official Report of Examination, eliminate from its books any remaining balance of any assets classified “Loss” and 50% percent of those classified “Doubtful”, unless otherwise approved in writing by the FDIC and the OFR. Within 60 days from the effective date of the Consent Order, Oceanside shall formulate a plan, subject to approval by the FDIC and the OFR, to reduce Oceanside’s risk exposure in each asset, or relationship in excess of $500,000 classified “Substandard” by the FDIC in November 2008. Oceanside had made such adjustments prior to entry of the Consent Order and has been attempting to reduce its risk exposure in all “Substandard” assets. Therefore, these requirements are not expected to affect Oceanside’s operations.
Oceanside shall also reduce the aggregate balance of assets classified “Substandard” by the FDIC in November 2008, in accordance with the following schedule: (i) within 90 days to not more than 100% of Tier 1 capital plus the ALLL; (ii) within 180 days to not more than 85% of Tier 1 capital plus the ALLL; (iii) within 270 days to not more than 60% of Tier 1 capital plus the ALLL; and (iv) within 360 days to not more than 50% of Tier 1 capital plus the ALLL. Oceanside did meet the first target goal (April 7, 2010) as the classified assets cited by the FDIC were $16.2 million at March 31, 2010, or 85.15% of Tier 1 capital plus the ALLL ($19.1 million) and also met the second target goal (July 6, 2010) with classified assets cited by the FDIC of $14.1 million at June 30, 2010, or 79.4% of Tier 1 capital plus the ALLL ($17.8 million). Oceanside anticipates needing to increase its Tier 1 capital or successfully work out an appropriate amount of “Substandard” assets to meet the remaining targeted ratios. Oceanside’s management is actively trying to reduce the amount of “Substandard” assets and the contemplated merger with Jacksonville Bancorp, Inc., is expected to resolve our capital issues.
Beginning with the effective date of the Consent Order, Oceanside shall not extend any credit to, or for the benefit of, any borrower who has a loan that has been charged off or classified “Loss” or “Doubtful” and is uncollected. Additionally, during the life of the Consent Order, Oceanside shall not extend, directly or indirectly, any additional credit to, or for the benefit of, any borrower who has a loan or other extension of credit from Oceanside that has been classified “Substandard”, and is uncollected, unless Oceanside documents that such extension of credit is in Oceanside’s best interest. Prior to, and following, the entry of the Consent Order, Oceanside had, and has, no
ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES
intention of extending credit to such borrowers in violation of these requirement. Accordingly, such requirement will not affect Oceanside’s operations.
Within 30 days from the effective date of the Consent Order, Oceanside will engage a loan review analyst who shall review all loans exceeding $500,000. Oceanside has engaged an outside loan review analyst that is expected to complete its work in 2010. In addition, Oceanside has received input as to the quality of individual loans and its loan portfolio in connection with the due diligence process for the proposed merger with Jacksonville Bancorp,Inc. (see Note 12 - Merger). The results of the due diligence review and the planned outside loan review are expected to assist Oceanside in working out classified assets and may result in positive or negative changes to certain loan classifications.
Within 60 days from the effective date of the Consent Order, Oceanside shall revise, adopt, and implement a written lending, underwriting, and collection policy to provide effective guidance and control over Oceanside’s lending function. In addition, Oceanside shall obtain complete and current documentation for all loans in Oceanside’s loan portfolio. Within 30 days from the effective date of the Consent Order, the Board shall adopt and implement a policy limiting the use of loan interest reserves to certain types of loans. Oceanside has consistently obtained complete and current documentation for its loans. Oceanside has developed the required policies, which are expected to assist management in improving the management of the relevant aspects of Oceanside’s operations.
Within 60 days from the effective date of the Consent Order, Oceanside shall perform a risk segmentation analysis with respect to any other concentration deemed important by Oceanside. The plan shall establish appropriate commercial real estate (“CRE”) lending risk limits and monitor concentrations of risk in relation to capital. In February 2009, the Board of Directors approved a revised CRE policy that called for a quarterly analysis of CRE and other concentrations. The first report was completed as of March 31, 2010, and presented to the Board of Directors at its April 2010 meeting. In addition to enhanced CRE tracking, this report measured concentrations of credit by zip code, risk ratings by zip code, loans by NAICS codes for industry concentrations, payment methods (amortizing, interest only, and other), and home equity lines of credit and home equity loans. This analysis and the cessation of CRE lending in January 2009 did not have any impact on Oceanside’s operations.
Within 30 days from the effective date of the Consent Order, Oceanside shall formulate and fully implement a written plan and a comprehensive budget. Within 60 days from the effective date of the Consent Order, Oceanside shall prepare and submit to the FDIC and the OFR for comment a business strategic plan covering the overall operation of Oceanside. The Bank has prepared a strategic plan and budget and submitted them as required. Since Oceanside has prepared a strategic plan and budget each year since opening, this requirement is not expected to change the nature of Oceanside’s operations.
Within 30 days of the end of each calendar quarter following the effective date of the Consent Order, Oceanside shall furnish written progress reports to the FDIC and the OFR detailing the form, manner, and results of any actions taken to secure compliance. Oceanside has begun preparing and submitting such reports. This is expected to have minimal impact on Oceanside’s operations and financial results.
Written Agreement - On March 26, 2010, Atlantic entered into a mutual agreement (“Written Agreement”) with the Federal Reserve Bank of Atlanta (the "Reserve Bank") to maintain the financial soundness of Atlantic so that Atlantic may serve as a source of strength to Oceanside. Atlantic and the Reserve Bank agree as follows:
| · | Atlantic shall not declare or pay any dividends without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation (the "Director") of the Board of Governors of the Federal Reserve System (the "Board of Governors"). |
| · | Atlantic shall not directly or indirectly take dividends or any other form of payment representing a reduction in capital from the Bank without the prior written approval of the Reserve Bank. |
| · | Atlantic and its nonbank subsidiary shall not make any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without the prior written approval of the Reserve Bank and the Director. |
| · | Atlantic and any nonbank subsidiary shall not, directly or indirectly, incur, increase, or guarantee any debt without the prior written approval of the Reserve Bank. All requests for prior written approval shall contain, but |
ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES
not be limited to, a statement regarding the purpose of the debt, the terms of the debt, and the planned source(s) for debt repayment, and an analysis of the cash flow resources available to meet such debt repayment.
| · | Atlantic shall not, directly or indirectly, purchase or redeem any shares of its stock without the prior written approval of the Reserve Bank. |
| · | In appointing any new director or senior executive officer, or changing the responsibilities of any senior executive officer so that the officer would assume a different senior executive officer position, Atlantic shall comply with the notice provisions of section 32 of the FDI Act (12 U.S.C. § 1831i) and Subpart H of Regulation Y of the Board of Governors (12 C.F.R. §§ 225.71 et seq.). |
| · | Atlantic shall comply with the restrictions on indemnification and severance payments of section 18(k) of the FDI Act (12 U.S.C. § 1828(k)) and Part 359 of the Federal Deposit Insurance Corporation's regulations (12 C.F.R. Part 359). |
| · | Within 30 days after the end of each calendar quarter following the date of this Written Agreement, the board of directors shall submit to the Reserve Bank written progress reports detailing the form and manner of all actions taken to secure compliance with the provisions of this Written Agreement and the results thereof, and a parent company only balance sheet, income statement, and, as applicable, report of changes in stockholders' equity. |
In connection with the contemplated merger between Atlantic and Jacksonville Bancorp, Inc., the following risk factors should be considered, including the risk of:
| | · | unexpected transaction costs, including the costs of integrating operations; |
| | · | that the businesses will not be integrated successfully or that such integration may be more difficult, time-consuming or costly than expected; |
| | · | potential failure to fully or timely realize expected revenues and revenue synergies, including as the result of revenues following the merger being lower than expected; |
| | · | deposit and customer attrition; |
| | · | unexpected operating and other costs, which may differ or change from expectations; |
| | · | customer and employee loss and business disruption, including, without limitation, as the result of difficulties in maintaining relationships with employees; |
| | · | increased competitive pressures and solicitations of customers by competitors; |
| | · | changes in the interest rate environment reducing interest margins; |
| | · | legislation or regulatory changes that adversely affect the business in which the combined company would be engaged; and |
| | · | the difficulties and risks inherent with entering new markets. |
| | Exhibit No. | Description of Exhibit |
| | (a) | Incorporated by reference on Atlantic’s Form 10-KSB for year ended December 31, 1999 |
| | (b) | Incorporated by reference on Atlantic’s Form 10-KSB for year ended December 31, 2000 |
| | (c) | Incorporated by reference on Atlantic’s Form 10-KSB for year ended December 31, 2002 |
| | (d) | Incorporated by reference on Atlantic’s Form 10-KSB for year ended December 31, 2003 |
| | (e) | Incorporated by reference on Atlantic’s Form 10-QSB for quarter ended September 30, 2006 |
| | (f) | Incorporated by reference on Atlantic’s Form 8-K filed January 13, 2010 |
| | (g) | Incorporated by reference on Atlantic’s Form 8-K filed March 31, 2010 |
| | (h) | Incorporated by reference on Atlantic’s Form 8-K filed May 14, 2010 |
ATLANTIC BANCGROUP, INC. AND SUBSIDIARIES
Exhibit No. | | Description of Exhibit |
| | | |
| 2.1 | | Agreement and Plan of Merger by and between Atlantic and Jacksonville Bancorp, Inc., dated May 10, 2010 (h) |
| 3.1 | | Articles of Incorporation (a) |
| 3.2 | | Bylaws (a) |
| 4.1 | | Specimen Stock Certificate (a) |
| 10.1 | | Software License Agreement dated as of October 6, 1997, between Oceanside and File Solutions, Inc. (a) |
| 10.2 | | File Solutions Software Maintenance Agreement dated as of July 15, 1997, between Oceanside and SPARAK Financial Systems, Inc. (a) |
| 10.3 | | Remote Data Processing Agreement dated as of March 3, 1997, between Oceanside and Bankers Data Services, Inc. (a) |
| 10.4 | | Lease dated September 27, 2000, between MANT EQUITIES, LLC and Oceanside (b) |
| 10.5 | | Lease dated August 22, 2002, between PROPERTY MANAGEMENT SUPPORT, INC., and Oceanside (c) |
| 10.6 | | Change in Control Agreement for Barry W. Chandler (e) |
| 10.7 | | Change in Control Agreement for David L. Young (e) |
| 10.8 | | Change in Control Agreement for Grady R. Kearsey (e) |
| 10.9 | | Stipulation to the Issuance of a Consent Order (f) |
| 10.10 | | Written Agreement by and between Atlantic and the Federal Reserve Bank of Atlanta (g) |
| 10.11 | | Shareholders Agreement by and among Atlantic, Jacksonville Bancorp, Inc., and certain Atlantic shareholders, dated May 10, 2010 (h) |
| 14 | | Code of Ethics for Senior Officers Policy (d) |
| | Certifications of Principal Executive Officer required by Rule 13a-14(a)/15d-14(a) under the Exchange Act |
| | Certifications of Principal Financial Officer required by Rule 13a-14(a)/15d-14(a) under the Exchange Act |
| | Certifications of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002 |
| | Certifications of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002 |
In accordance with the requirements of the Securities Exchange Act of 1934, the issuer has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | Atlantic BancGroup, Inc. |
| | |
| | |
Date: August 16, 2010 | /s/ Barry W. Chandler |
| | Barry W. Chandler |
| | President and Principal Executive Officer |
| | |
| | |
| | |
Date: August 16, 2010 | /s/ David L. Young |
| | David L. Young |
| | Executive Vice President, |
| | Principal Financial Officer, and |
| | Corporate Secretary |
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