1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED December 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____________ TO ______________.
COMMISSION FILE NUMBER: 0-26467
GREATER ATLANTIC FINANCIAL CORP.
---------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 54-1873112
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10700 PARKRIDGE BOULEVARD, SUITE P50
RESTON, VIRGINIA 20191 703-391-1300
---------------------- -----------------
(Address of Principal Executive Offices) (Registrant's Telephone
(Zip Code)) Number, Including Area Code)
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date:
At February 11, 2004, there were 3,012,434 shares of the registrant's
Common Stock, par value $0.01 per share outstanding
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GREATER ATLANTIC FINANCIAL CORP.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED DECEMBER 31, 2003
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE NO.
- ------------------------------ --------
Item 1. Financial Statements
Consolidated Statements of Financial Condition
December 31, 2003 (unaudited) and September 30, 2003 (audited)....................................................3
Consolidated Statements of Operations (unaudited)
Three months ended December 31, 2003 and December 31, 2002........................................................4
Consolidated Statements of Comprehensive Income (unaudited)
Three months ended December 31, 2003 and December 31, 2002 .......................................................5
Consolidated Statements of Changes in Stockholders' Equity (unaudited)
Three months ended December 31, 2003 and December 31, 2002........................................................5
Consolidated Statements of Cash Flows (unaudited)
Three months ended December 31, 2003 and December 31, 2002........................................................6
Notes to Consolidated Financial Statements........................................................................8
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.........................14
Item 3. Quantitative and Qualitative Disclosures about Market Risk....................................................22
Item 4. Controls and Procedures.......................................................................................23
PART II. OTHER INFORMATION
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Item 1. Legal Proceedings.............................................................................................23
Item 2. Changes in Securities and Use of Proceeds.....................................................................23
Item 3. Defaults Upon Senior Securities...............................................................................23
Item 4. Submission of Matters to a Vote of Security Holders...........................................................23
Item 5. Other Information.............................................................................................23
Item 6. Exhibits and Reports on Form 8-K..............................................................................23
SIGNATURES.............................................................................................................24
CERTIFICATIONS.........................................................................................................26
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GREATER ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31, September 30,
2003 2003
--------------- ---------------
(Unaudited)
(dollars in thousands)
Assets
Cash and cash equivalents $ 2,199 $ 2,029
Interest bearing deposits 7,896 4,114
Investment securities
Available-for-sale 221,389 211,408
Held-to-maturity 12,570 13,376
Loans held for sale 8,486 6,554
Loans receivable, net 254,555 242,253
Accrued interest and dividends receivable 2,287 2,299
Deferred income taxes 1,520 1,520
Federal Home Loan Bank stock, at cost 6,673 4,340
Premises and equipment, net 8,214 7,948
Goodwill 1,284 1,284
Prepaid expenses and other assets 2,061 2,229
--------------- ---------------
Total assets $529,134 $499,354
=============== ===============
Liabilities and stockholders' equity
Liabilities
Deposits $284,043 $297,876
Advance payments from borrowers for taxes and insurance 118 225
Accrued expenses and other liabilities 1,841 4,318
Advances from the FHLB and other borrowings 212,358 164,635
Guaranteed convertible preferred securities of subsidiary trust 9,361 9,359
--------------- ---------------
Total liabilities 507,721, 476,413
--------------- ---------------
Commitments and contingencies
Stockholders' Equity
Preferred stock $.01 par value - 2,500,000 shares authorized,
none outstanding - -
Common stock, $.01 par value - 10,000,000
shares authorized; 3,012,434 shares outstanding 30 30
Additional paid-in capital 25,152 25,152
Accumulated deficit (948) (268)
Accumulated other comprehensive loss (2,821) (1,973)
--------------- ---------------
Total stockholders' equity 21,413 22,941
--------------- ---------------
Total liabilities and stockholders' equity $529,134 $499,354
=============== ===============
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GREATER ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended
December 31,
------------------------------
2003 2002
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Interest income
Loans $3,142 $3,889
Investments 1,395 1,904
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Total interest income 4,537 5,793
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Interest expense
Deposits 1,467 1,900
Borrowed money 1,660 1,625
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Total interest expense 3,127 3,525
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Net interest income 1,410 2,268
Provision for loan losses 79 647
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Net interest income after provision for loan losses 1,331 1,621
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Noninterest income
Fees and service charges 234 431
Gain on sale of loans 1,956 4,110
Gain on sale of investment securities 312 -
Other operating income 5 4
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Total noninterest income 2,507 4,545
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Noninterest expense
Compensation and employee benefits 1,994 3,225
Occupancy 501 475
Professional services 288 226
Advertising 421 183
Deposit insurance premium 11 11
Furniture, fixtures and equipment 258 268
Data processing 350 315
Other operating expenses 695 759
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Total noninterest expense 4,518 5,462
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(Loss) income before income tax provision (680) 704
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Income tax provision - -
------------- -------------
Net (loss) income $ (680) $ 704
============= =============
(Loss) earnings per common share
Basic $(0.23) $ 0.23
Diluted $(0.23) $ 0.18
Weighted average common shares outstanding
Basic 3,012,434 3,012,434
Diluted 3,012,434 4,408,117
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GREATER ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
- ----------------------------------------------------------------------------------------
Three months ended December 31, 2003 2002
- ----------------------------------------------------------------------------------------
(in thousands)
Net (loss) earnings $ (680) $704
- ----------------------------------------------------------------------------------------
Other comprehensive loss income, net of tax
Unrealized loss on securities (833) (163)
Unrealized loss on hedges (15) (94)
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Other comprehensive loss (848) (257)
- ----------------------------------------------------------------------------------------
Comprehensive (loss) income $ (1,528) $447
========================================================================================
GREATER ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED)
- ------------------------------------------------------------------------------------------------------------------------------
Accumulated
Additional Accumulated Other Total
Preferred Common Paid-in Earnings Comprehensive Stockholders'
Stock Stock Capital (Deficit) Income (Loss) Equity
- ------------------------------------------------------------------------------------------------------------------------------
(in thousands)
Balance at September 30, 2002 $- $ 30 $ 25,152 $ (2,520) $ (2,259) $ 20,403
Other comprehensive loss - - - - (257) (257)
Net earnings for the period - - - 704 - 704
- ----------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 $- $ 30 $ 25,152 $ (1,816) $ (2,516) $ 20,850
============================================================================================================================
Balance at September 30, 2003 $- $ 30 $ 25,152 $ (268) $ (1,973) $ 22,941
Other comprehensive loss - - - - (848) (848)
Net loss for the period - - - (680) (680)
- ----------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2003 $- $ 30 $ 25,152 $ (948) $ (2,821) $ 21,413
============================================================================================================================
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GREATER ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
- --------------------------------------------------------------------------------------------------------------
Three months ended December 31, 2003 2002
- --------------------------------------------------------------------------------------------------------------
(in thousands)
Cash flow from operating activities
Net income $ (680) $ 704
Adjustments to reconcile net income to net cash
provided by operating activities
Provision for loan loss 79 647
Amortization of deposit acquisition adjustment - 23
Amortization of loan acquisition adjustment (7) (7)
Depreciation and amortization 223 217
Proceeds from sale of trading securities (8) -
Net loss on trading securities 8 -
Realized gain on sale of investments (320) -
Amortization of investment security premiums 426 535
Amortization of mortgage-backed securities premiums 418 144
Amortization of deferred fees (98) (78)
Discount accretion net of premium amortization (173) 163
Amortization of convertible preferred stock costs 2 -
Gain on sale of loans held for sale (1,956) (4,110)
(Increase) decrease in assets
Disbursements for origination of loans (108,171) (185,142)
Proceeds from sales of loans 108,196 177,143
Accrued interest and dividend receivable 12 76
Prepaid expenses and other assets 151 (42)
Deferred loan fees collected, net of deferred costs incurred 106 30
Increase (decrease) in liabilities
Accrued expenses and other liabilities (2,478) 413
Income taxes payable - -
- --------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities (4,270) (9,284)
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GREATER ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) - (CONTINUED)
- -------------------------------------------------------------------------------------------------------------
Nine months ended December 31, 2003 2002
- -------------------------------------------------------------------------------------------------------------
(in thousands)
Cash flow from investing activities
Net increase in loans $ (12,209) $ (13,862)
Purchases of premises and equipment (488) (167)
Purchases of investment securities (5,000) (4,711)
Proceeds from sale of investment securities 14,176 -
Proceeds from repayments of investment securities 10,361 10,745
Purchases of mortgage-backed securities (45,621) -
Proceeds from repayments of mortgage-backed securities 15,553 5,577
Purchases of FHLB stock (5,450) (1,305)
Proceeds from sale of FHLB stock 3,118 1,880
- -------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities (25,560) (1,843)
- -------------------------------------------------------------------------------------------------------------
Cash flow from financing activities
Net (decrease) increase in deposits (13,833) 19,661
Net advances from FHLB 43,150 (700)
Net borrowings on reverse repurchase agreements 4,572 (11,671)
Decrease in advance payments by borrowers for taxes and insurance (107) (100)
- -------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by financing activities 33,782 7,190
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Increase (decrease) in cash and cash equivalents 3,952 (3,937)
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Cash and cash equivalents, at beginning of period 6,143 9,358
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Cash and cash equivalents, at end of period $ 10,095 $ 5,421
=============================================================================================================
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GREATER ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INFORMATION AS OF DECEMBER 31, 2003 AND FOR THE THREE MONTHS
THEN ENDED IS UNAUDITED
(1) BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements, which include
the accounts of Greater Atlantic Financial Corp. ("the company") and its wholly
owned subsidiary, Greater Atlantic Bank ("the bank") and its wholly owned
subsidiary, Greater Atlantic Mortgage Corp. ("GAMC"), have been prepared in
accordance with the instructions for Form 10-Q and do not include all of the
disclosures required by generally accepted accounting principles. All
adjustments which, in the opinion of management, are necessary to a fair
presentation of the results for the interim periods presented (consisting of
normal recurring adjustments) have been made. The results of operations for the
three months ended December 31, 2003 are not necessarily indicative of the
results of operations that may be expected for the year ending September 30,
2004 or any future periods.
(2) LOAN IMPAIRMENT AND LOAN LOSSES
In accordance with guidance in the Statements of Financial Accounting
Standards Nos. 114 and 118, the company prepares a quarterly review to determine
the adequacy of the allowance for loan losses and to identify and value impaired
loans. The company at or during the three months ended December 31, 2003 and
2002 identified impaired loans. An analysis of the change in the allowance for
loan losses follows:
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At or for the Three Months Ended December 31, 2003 2002
- ------------------------------------------------------------------------------------------
(dollars in thousands)
Balance at beginning of period $1,550 $1,699
Provisions 79 647
Total charge-offs (136) (625)
Total recoveries 7 11
- ------------------------------------------------------------------------------------------
Net charge-offs (129) (614)
- ------------------------------------------------------------------------------------------
Balance at end of period $1,500 $1,732
==========================================================================================
Ratio of net charge-offs during the period
to average loans outstanding during the period 0.05% 0.21%
==========================================================================================
Allowance for loan losses to total non-performing
loans at end of period 136.49% 81.74%
==========================================================================================
Allowance for loan losses to total loans 0.57% 0.63%
==========================================================================================
(3) REGULATORY MATTERS
The bank qualifies as a Tier 1 institution and may make capital
distributions during a calendar year up to 100% of its net income to date plus
the amount that would reduce by one-half its surplus capital ratio at the
beginning of the calendar year. Any distributions in excess of that amount
require prior notice to the OTS with the opportunity for the OTS to object to
the distribution. A Tier 1 institution is defined as an institution that has, on
a pro forma basis after the proposed distribution, capital equal to or greater
than the OTS fully phased-in capital requirement and has not been deemed by the
OTS to be "in need of more than normal supervision." The bank is currently
classified as a Tier 1 institution for these purposes. The capital distribution
regulation requires that the institution provide the applicable OTS District
Director with a 30-day advance written notice of all proposed capital
distributions whether or not advance approval is required. The bank did not pay
any dividends during the year ended September 30, 2003 or the period ended
December 31, 2003.
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GREATER ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED) INFORMATION AS OF DECEMBER 31, 2003 AND FOR THE
THREE MONTHS THEN ENDED IS UNAUDITED
The Federal Deposit Insurance Corporation Improvement Act of 1991
(FDICIA) created five categories of financial institutions based on the adequacy
of their regulatory capital levels: well capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized and critically
undercapitalized. Under FDICIA, a well-capitalized financial institution is one
with Tier 1 leverage capital of 5%, Tier 1 risk-based capital of 6% and total
risk-based capital of 10%. At December 31, 2003, the bank was classified as a
well-capitalized financial institution. The following presents the bank's
capital position:
- ---------------------------------------------------------------------------------------------------------------
Required Required Actual Actual
At December 31, 2003 Balance Percent Balance Percent Surplus
- ---------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Leverage $26,445 5.00% $32,209 6.09% $5,764
Tier 1 Risk-based $15,067 6.00% $32,209 12.83% $17,142
Total Risk-based $25,111 10.00% $33,631 13.39% $8,520
===============================================================================================================
(4) STOCK OPTIONS
Effective November 14, 1998, the Company established the 1997 Stock
Option and Warrant Plan (the "Plan"). The Plan reserves options for 76,667
shares to employees and warrants for 94,685 shares to stockholders. The Plan was
amended effective March 14, 2000, to increase the number of options available
for grant from 76,667 to 225,000 shares to employees and amended again effective
March 15, 2002, to increase the number of options available for grant from
225,000 to 350,000 shares to employees and to limit its application to officers
and employees. The stock options and warrants vest immediately upon issuance and
carry a maximum term of 10 years. The exercise price for the stock options and
warrants is the fair market value at grant date. As of December 31, 2003, 94,685
warrants were issued.
The following summary represents the activity under the Plan:
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Number Exercise Expiration
of Shares Price Date
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Balance outstanding at September 30, 2001 139,000
Options granted 10,000 $ 5.31 12-14-2010
Options granted 26,000 $ 7.00 1-1-2012
Options granted 20,000 $ 9.00 1-1-2012
Options exercised (5,000) $ 4.00
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Balance outstanding and exercisable at September 30, 2002 190,000
Options granted -
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Balance outstanding and exercisable at September 30, 2003 190,000
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Options granted 36,000 $ 8.50 10-20-2013
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Balance outstanding and exercisable at December 31, 2003 226,000
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====================================================================================================================
The Company has adopted the disclosure only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"), but it continues to measure compensation cost for
the stock options using the intrinsic value method prescribed by APB Opinion No.
25. As allowable under SFAS 123, the Company used the Black-Scholes method to
measure the compensation cost of stock options granted in the first quarter of
fiscal 2004 with the following assumptions: risk free interest rate of 2.37%, a
dividend payout rate of zero, and an expected option life of seven years. The
volatility is 45%. Using those assumptions, the average weighted fair value of
the stock options granted during fiscal 2004 was $3.59.
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GREATER ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED) INFORMATION AS OF DECEMBER 31, 2003 AND FOR THE
THREE MONTHS THEN ENDED IS UNAUDITED
Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
If the Company had elected to recognize compensation cost based on the
value at the grant dates with the method prescribed by SFAS 123, net income
would have been changed to the pro forma amounts indicated below:
- -----------------------------------------------------------------------------------------------------
Three months ended December 31, 2003 2002
- -----------------------------------------------------------------------------------------------------
(in thousands except per
share data)
Net earnings $ (680) $ 704
Deduct: Total stock-based employee compensation expense (129) -
- -----------------------------------------------------------------------------------------------------
Pro forma net earnings attributable to common stockholders (809) 704
=====================================================================================================
Earnings per common share
Basic $ (0.23) $ 0.23
Diluted $ (0.23) $ 0.18
Earnings per common share, pro forma
Basic $ (0.27) $ 0.23
Diluted $ (0.27) $ 0.18
(5) EARNINGS PER SHARE
Earnings per share is based on the weighted average number of shares of
common stock and dilutive common stock equivalents outstanding. Basic earnings
per share includes no dilution and is computed by dividing income available to
common shareholders by the weighted average number of common shares outstanding
for the period. Diluted earnings per share reflects the potential dilution of
securities that could share in the earnings of an entity. The following table
presents a reconciliation between the weighted average shares outstanding for
basic and diluted earnings per share for the three months ended December 31,
2002. The effect of the conversion of preferred securities and the impact of
stock options were antidilutive for the period ended December 31, 2003.
For the Three Months
Ended December 31,
-------------------------
(dollars in thousands except per share amounts) 2002
-----------------------------------------------
-------------------------
Net earnings $704
Effect of conversion of preferred securities 100
Diluted earnings per share 804
Weighted average common shares outstanding 3,012,434
Effect of conversion of preferred securities 1,371,429
Common stock equivalents due to dilutive effect of
stock options 24,254
Total weighted average common shares and common
share equivalents outstanding 4,408,117
Basic earnings (loss) per common share $0.23
Diluted earnings (loss) per common share $(0.23)
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GREATER ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED) INFORMATION AS OF DECEMBER 31, 2003 AND FOR THE
THREE MONTHS THEN ENDED IS UNAUDITED
(6) SEGMENT REPORTING
The company has two reportable segments, banking and mortgage banking.
The bank operates retail deposit branches in the greater Washington,
D.C./Baltimore metropolitan area. The banking segment provides retail consumer
and small businesses with deposit products such as demand, transaction, savings
accounts and certificates of deposit and lending products, such as residential
and commercial real estate, construction and development, consumer and
commercial business loans. Further, the banking segment invests in residential
real estate loans purchased from GAMC and others, and also invests in
mortgage-backed and other securities. The mortgage banking segment activities,
which are conducted principally through GAMC, include the origination of
residential real estate loans either for the bank's portfolio or for sale into
the secondary market with servicing released.
The company evaluates performance based on net interest income, noninterest
income, and noninterest expense. The total of these three items is the
reportable segment's net contribution. The company's reportable segments are
strategic business units that offer different services in different geographic
areas. They are managed separately because each segment appeals to different
markets and, accordingly, requires different technology and marketing
strategies.
Since the company derives a significant portion of its banking revenue
from interest income as offset by interest expense, the segments are reported
below using net interest income. Because the company also evaluates performance
based on noninterest income and noninterest expense, these measures of segment
profit and loss are also presented.
- --------------------------------------------------------------------------------------------------------------------
Total Total
Mortgage Reportable Intersegment Operating
For the Three Months Ended December 31, Banking Banking Segments Eliminations Earnings
- --------------------------------------------------------------------------------------------------------------------
Net interest income: (1)
2003 $ 1,200 $ 131 $ 1,331 $ - $ 1,331
2002 1,401 220 1,621 - 1,621
Noninterest income:
2003 $ 491 $2,020 $ 2,511 $ (4) $ 2,507
2002 269 4,290 4,559 (14) 4,545
Noninterest expense:
2003 $ 2,494 $2,029 $ 4,523 $ 4 $ 4,519
2002 2,343 3,133 5,476 14 5,462
Net income:
2003 $ (802) $ 122 $ (680) $ - $ (680)
2002 (673) 1,377 704 - 704
Segment assets:
2003 $520,768 $ 24,033 $544,801 $ (17,002) $527,799
2002 507,869 28,488 536,357 (25,599) 510,758
(1) Segment net interest income reflects income after provisions for loan losses.
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GREATER ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED) INFORMATION AS OF DECEMBER 31, 2003 AND FOR THE
THREE MONTHS THEN ENDED IS UNAUDITED
(7) RECENT ACCOUNTING STANDARDS
In January 2003, the FASB issued FIN 46 "Consolidation of Variable Interest
Entities" ("FIN 46"). FIN 46 addresses consolidation of variable interest
entities and sets forth guidelines for which such entities qualify for
consolidation. Greater Atlantic Capital Trust, as discussed in Note 8, is a
variable interest entity as defined in FIN 46. Presently, the Company is
reviewing the consolidation requirements of FIN 46 to determine if continued
consolidation of Greater Atlantic Capital Trust will be required. The Company is
required to adopt the provisions of FIN 46 on October 1, 2004.
(8) GUARANTEED CONVERTIBLE PREFERRED SECURITIES OF SUBSIDIARY TRUST
On March 20, 2002, Greater Atlantic Capital Trust I (the, "Trust"), a
Delaware statutory business trust and a wholly owned Trust subsidiary of the
company issued $9.6 million aggregate liquidation amount (963,038 shares) of
6.50% cumulative preferred securities maturing on December 31, 2031, with an
option to call on or after December 31, 2003. Conversion of the preferred
securities into the company's common stock may occur at any time on or after 60
days after the closing of the offering. The company may redeem the preferred
securities, in whole or in part, at any time on or after December 31, 2003.
Distributions on the preferred securities are payable quarterly on March 31,
June 30, September 30 and December 31 of each year beginning on June 30, 2002.
The Trust also issued 29,762 common securities to the company for $297,620. The
company purchased all the shares of the common stock. The proceeds from the sale
of the preferred securities and the proceeds from the sale of the trust's common
securities were utilized to purchase from the company junior subordinated debt
securities of $9,928,000 bearing interest of 6.50% and maturing December 31,
2031. All intercompany interest and equity were eliminated in consolidation.
The Trust was formed for the sole purpose of investing the proceeds from the
sale of the convertible preferred securities in the corresponding convertible
debentures. The Company has fully and unconditionally guaranteed the preferred
securities along with all obligations of the trust related thereto. The sale of
the preferred securities yielded $9.2 million after deducting offering expenses.
The company currently retains approximately $1.5 million of the proceeds for
general corporate purposes, investing the retained funds in short-term
investments. The remaining $8.0 million of the proceeds was invested in Greater
Atlantic Bank to increase its capital position. Initially, these funds were
invested in investment securities. Subsequently, such proceeds were used to fund
new loans.
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GREATER ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -
(CONTINUED) INFORMATION AS OF JUNE 30, 2003 AND FOR THE
NINE MONTHS THEN ENDED IS UNAUDITED
(9) INTEREST RATE EXCHANGE AGREEMENTS
In fiscal 2002, the bank began to utilize derivative financial instruments
to hedge its interest rate risk. The bank does not hold or issue derivative
financial instruments for trading purposes. Beginning in 2002, the bank adopted
statement of Financial Accounting Standard No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133") which requires that an entity
recognize all derivatives as either assets or liabilities and measure those
instruments at fair value. The bank bases the estimated fair values of these
agreements on the cost of interest-rate exchange agreements with similar terms
at available market prices, excluding accrued interest receivable and payable.
However, active markets do not exist for many types of financial instruments.
Consequently, fair values for these instruments must be estimated using
techniques such as discounted cash flow analysis and comparisons to similar
instruments. Estimates developed using these methods are highly subjective and
require judgments regarding significant matters such as the amount and timing of
future cash flows and the selection of discount rates that appropriately reflect
market and credit risks. Changes in these judgments often have a material effect
on the fair value estimates. Since those estimates are made as of a specific
time, they are susceptible to material near term changes.
The bank entered into various interest-rate swaps that total $77 million in
notional principal. The swaps pay a fixed rate with the bank receiving payments
based upon one-to three-month floating rate LIBOR. The capped range is between
1.31% - 4.53%, and expires between 2 and 7 years. The bank also entered into
various interest rate caps that total $30 million in notional principal with
terms between four and ten years that limit the float between a floor of 2.00%,
and capped between 5.00% - 8.00%. The bank accounts for these derivatives as
cash flow hedges, under the guidelines of SFAS 133, whereby the fair value of
these contracts are reflected in other assets with the offset recorded as
accumulated other comprehensive income. At December 31, 2003, the fair value of
those contracts was a loss of $1.2 million.
The following table categorizes interest-rate exchange agreements by the
bank as of December 31, 2003.
- ----------------------------------------------------------------------------------------------------------------------------
Monthly Gross Gross
Total by class type of interest rate Notional Amortized Unrealized Unrealized Estimated
exchange agreements Amount Cost Gains (Losses) Fair Value
- ----------------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Interest rate swaps:
Bank pays fixed, receives variable $ 77,000 $ 166 $ 523 $ (1,506) $ (983)
Interest rate caps:
Interest rate caps purchased 30,000 16 21 (270) (249)
- -----------------------------------------------------------------------------------------------------------------------------
Total $ 107,000 $ 182 $ 544 $ (1,776) $ (1,232)
=============================================================================================================================
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
Consolidated Financial Statements and Notes presented elsewhere in this report.
This report contains forward-looking statements. When used in this 10-Q
report and in future filings by the company with the Securities and Exchange
Commission (the "SEC"), in the company's press releases or other public or
shareholder communications, and in oral statements made with the approval of an
authorized executive officer, 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, among
other things, changes in economic conditions in the company's market area,
changes in policies by regulatory agencies, fluctuations in interest rates,
demand for loans in the company's market area and competition that could cause
actual results to differ materially from historical earnings and those presently
anticipated or projected. The company wishes to advise readers that the factors
listed above could affect the company's financial performance and could cause
the company's actual results for future periods to differ materially from any
opinions or statements expressed with respect to future periods in any current
statements.
The company does not undertake and specifically declines 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.
GENERAL
We are a savings and loan holding company, which was organized in June 1997.
We conduct substantially all of our business through our wholly owned
subsidiary, Greater Atlantic Bank, a federally chartered savings bank, and its
wholly owned subsidiary, Greater Atlantic Mortgage Corp. Greater Atlantic Bank
is a member of the Federal Home Loan Bank system and it's deposits are insured
up to applicable limits by the Savings Association Insurance Fund of the Federal
Deposit Insurance Corporation. We offer traditional banking services to
customers through nine Greater Atlantic Bank branches located throughout the
greater Washington, D.C./Baltimore metropolitan area. We also originate mortgage
loans for sale in the secondary market through Greater Atlantic Mortgage Corp.
The profitability of the company, and more specifically, the profitability
of its primary subsidiary Greater Atlantic Bank, depends primarily on its
non-interest income and net interest income. Net interest income is the
difference between the interest income it earns on its loans and investment
portfolio, and the interest it pays on interest-bearing liabilities, which
consists mainly of interest paid on deposits and borrowings. Non-interest income
consists primarily of gains on sales of loans and available-for-sale
investments, service charge fees and commissions earned by non-bank subsidiaries
The level of its operating expenses also affects the company's
profitability. Operating expenses consist primarily of salaries and employee
benefits, occupancy-related expenses, equipment and technology-related expenses
and other general operating expenses.
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At December 31, 2003 the company's total assets were $529.1 million,
compared to the $499.4 million held at September 30, 2003, representing an
increase of 5.96%. Both the bank's overall asset size and customer base
increased during the period and that growth is reflected in the consolidated
statements of financial condition and statements of operations. Net loans
receivable at December 31, 2003 were $254.6 million, an increase of $12.3
million or 5.08% from the $242.3 million held at September 30, 2003. The
increase in loans consisted primarily of commercial real estate loans and
commercial lines of credit secured by mortgages on residential real estate. At
December 31, 2003, investment securities were $234.0 million, an increase of
$9.2 million or 4.08% from the $224.8 million held at September 30, 2003.
Deposits at December 31, 2003 were $284.0 million, a decrease of $13.8 million,
which resulted primarily from a decrease in certificates of deposit of $17.6
million, offset by increases in savings and transaction accounts of $3.8
million. With the current interest rate environment and marketing efforts by the
bank, we anticipate that trend will continue.
CRITICAL ACCOUNTING POLICIES, ESTIMATES AND JUDGMENTS
The company's financial statements are prepared in accordance with
accounting principles generally accepted in the United States. The preparation
of these financial statements requires management to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenue and
expenses as well as the disclosure of contingent liabilities. Management
continually evaluates its estimates and judgments including those related to the
allowance for loan losses and income taxes. Management bases its estimates and
judgments on historical experience and other factors that are believed to be
reasonable under the circumstances. Actual results may differ from these
estimates under different assumptions or conditions. The company believes that,
of its significant accounting policies, the most critical accounting policies we
apply are those related to the valuation of the loan portfolio.
A variety of factors impact the carrying value of the loan portfolio
including the calculation of the allowance for loan losses, valuation of
underlying collateral, the timing of loan charge-offs and the amount and
amortization of loan fees and deferred origination costs. The allowance for loan
losses is the most difficult and subjective judgment. The allowance is
established and maintained at a level that we believe is adequate to cover
losses resulting from the inability of borrowers to make required payments on
loans. Estimates for loan losses are arrived at by analyzing risks associated
with specific loans and the loan portfolio, current trends in delinquencies and
charge-offs, the views of our regulators, changes in the size and composition of
the loan portfolio and peer comparisons. The analysis also requires
consideration of the economic climate and direction, change in the interest rate
environment, which may impact a borrower's ability to pay, legislation impacting
the banking industry and economic conditions specific to our service area.
Because the calculation of the allowance for loan losses relies on estimates and
judgments relating to inherently uncertain events, results may differ from our
estimates.
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COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED
DECEMBER 31, 2003 AND DECEMBER 31, 2002
NET INCOME. For the three months ended December 31, 2003, the company
had a net loss of $680,000 or $0.23 per diluted share compared to earnings of
$704,000 or $0.18 per diluted share for the three months ended December 31,
2002. The $1.4 million decline in earnings over the comparable period one-year
ago resulted from a decrease of $2.0 million in non-interest income and was
coupled with a decrease of $858,000 in net interest income. Those declines in
income were offset by decreases in non-interest expense and in provision for
loan losses totaling $1.5 million. The decreased provision was due primarily to
a decrease in the required provision related to an impaired commercial business
loan.
NET INTEREST INCOME. An important source of our earnings is net
interest income, which is the difference between income earned on
interest-earning assets, such as loans, investment securities and
mortgage-backed securities, and interest paid on interest-bearing liabilities
such as deposits and borrowings. The level of net interest income is determined
primarily by the relative average balances of interest-earning assets and
interest-bearing liabilities, in combination with the yields earned and rates
paid upon them. The correlation between the re-pricing of interest rates on
assets and on liabilities also influences net interest income.
The following table presents a comparison of the components of interest
income and expense and net interest income.
Difference
- ---------------------------------------------------------------------------------------------------------------------
Three Months Ended December 31, 2003 2002 Amount %
- ---------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Interest income:
Loans $ 3,142 $ 3,889 $ (747) (19.21)%
Investments 1,395 1,904 (509) (26.73)
- ---------------------------------------------------------------------------------------------------------------------
Total 4,537 5,793 (1,256) (21.68)
- ---------------------------------------------------------------------------------------------------------------------
Interest expense:
Deposits 1,467 1,900 (433) (22.79)
Borrowings 1,660 1,625 35 2.15
- ---------------------------------------------------------------------------------------------------------------------
Total 3,127 3,525 (398) (11.29)
- ---------------------------------------------------------------------------------------------------------------------
Net interest income $ 1,410 $ 2,268 $ (858) (37.83)%
=====================================================================================================================
Our decline in net interest income during the quarter ended December
31, 2003, resulted primarily from a 68 basis point decrease in net interest
margin (net interest income divided by average interest-earning assets) from
1.79% for the quarter ended December 31, 2002 to 1.11% for the quarter ended
December 31, 2003, offset in part by a modest $1.2 million increase in the
bank's interest-earning assets. Contributing to the decline in the net interest
margin was a $562,000 charge resulting from payments made on certain interest
rate swap and cap agreements compared to a $381,000 charge in the comparable
period one year ago. That decrease in net interest margin also resulted from the
average yield on interest earning assets declining 54 basis points more than the
average cost on interest bearing liabilities and was coupled with the increase
in the bank's average interest bearing liabilities exceeding the increase in
average interest earning assets by $20.3 million.
Interest Income. Interest income for the three months ended December
31, 2003 decreased $1.3 million compared to the three months ended December 31,
2002, primarily as a result of a decrease of 100 basis points in the average
yield earned on interest earning assets. That decrease was partially offset by
an increase in the average outstanding balances of loans and investment
securities.
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INTEREST EXPENSE. The $398,000 decrease in interest expense for the
three months ended December 31, 2003 compared to the 2002 period was principally
the result of a 46 basis point decrease in the cost of funds on average deposits
and borrowed funds. The decrease in the cost of those funds was partially offset
by a $21.5 million increase in average deposits and borrowed funds. The decrease
in interest expense on deposits was primarily due to an 64 basis point decrease
in rates paid on certificates of deposit, savings and NOW and money market
accounts. That decrease was offset in part by an increase of $2.3 million, in
certificates, savings and NOW and money market accounts from $279.4 million for
the three months ended December 31, 2002 to $281.7 million for the three months
ended December 31, 2003.
The increase in interest expense on borrowings for the three months
ended December 31, 2003 compared to the 2002 period was principally the result
of a $19.2 million increase in average borrowed funds and was partially offset
by a 26 basis point decrease in the cost of borrowed funds. Components
accountable for the increase of $35,000 in interest expense were a $144,000
increase relating to average volume, offset by a $109,000 decrease relating to
average cost. The decrease in rates was primarily due to lower rates paid on
interest-bearing demand deposits and savings accounts and lower pricing on new
and renewed time deposits. The decrease in rates resulted from the Federal
Reserve lowering its benchmark interest rate (overnight bank lending rate)
thirteen times since January 3, 2001 by a total of 5.50% to a low of 1.00%.
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COMPARATIVE AVERAGE BALANCES AND INTEREST INCOME ANALYSIS. The
following table presents the total dollar amount of interest income from average
interest-earning assets and the resultant yields, as well as the interest
expense on average interest-bearing liabilities, expressed both in dollars and
annualized rates. No tax-equivalent adjustments were made and all average
balances are average daily balances. Non-accruing loans have been included in
the tables as loans carrying a zero yield.
FOR THE THREE MONTHS ENDED DECEMBER 31,
--------------------------------------------------------------------------------
2003 2002
--------------------------------------------------------------------------------
AVERAGE INTEREST AVERAGE AVERAGE INTEREST AVERAGE
INCOME/ INCOME/ YIELD/
BALANCE EXPENSE YIELD/ RATE BALANCE EXPENSE RATE
--------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
ASSETS:
Interest-earning assets:
Real estate loans $ 150,602 $ 2,036 5.41% $ 201,562 $ 2,818 5.59%
Consumer loans 65,822 622 3.78 60,888 661 4.34
Commercial business loans 39,907 484 4.85 32,354 410 5.07
-------------- ----------- ------------ ------------- ------------ ---------------
Total loans 256,331 3,142 4.90 294,804 3,889 5.28
Investment securities 143,505 899 2.51 162,120 1,351 3.33
Mortgage-backed securities 107,974 496 1.84 49,724 553 4.45
-------------- ----------- ------------ ------------- ------------ ---------------
Total interest-earning assets 507,810 4,537 3.57 506,648 5,793 4.57
----------- ------------ ------------ ---------------
Non-earning assets 17,201 16,548
-------------- -------------
Total assets $ 525,011 $ 523,196
============== =============
LIABILITIES AND STOCKHOLDERS'
EQUITY:
Interest-bearing liabilities:
Savings accounts $ 10,964 25 0.91 $ 8,349 33 1.58
Now and money market accounts 77,076 208 1.08 74,886 323 1.73
Certificates of deposit 193,683 1,234 2.55 196,184 1,544 3.15
-------------- ----------- ------------ ------------- ------------ ---------------
Total deposits 281,723 1,467 2.08 279,419 1,900 2.72
FHLB advances 116,250 680 2.34 99,919 695 2.78
Other borrowings 88,452 980 4.43 85,607 930 4.35
-------------- ----------- ------------ ------------- ------------ ---------------
Total interest-bearing 486,425 3,127 2.57 464,945 3,525 3.03
liabilities
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits 12,682 24,416
Other liabilities 3,450 13,280
-------------- -------------
Total liabilities 502,557 502,641
Stockholders' equity 22,454 20,555
-------------- -------------
Total liabilities and stockholders'
equity $ 525,011 $ 523,196
============== =============
Net interest income $ 1,410 $ 2 268
============ ==============
Interest rate spread 1.00% 1.54%
=============== ==============
Net interest margin 1.11% 1.79%
=============== ==============
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RATE/VOLUME ANALYSIS. The following table presents certain information
regarding changes in interest income and interest expense attributable to
changes in interest rates and changes in volume of interest-earning assets and
interest-bearing liabilities for the periods indicated. The change in interest
attributable to both rate and volume has been allocated to the changes in rate
and volume on a pro rata basis.
THREE MONTHS ENDED
DECEMBER 31, 2003 COMPARED TO
DECEMBER 31, 2002
-----------------------------------------------
CHANGE ATTRIBUTABLE TO
-----------------------------------------------
VOLUME RATE TOTAL
-----------------------------------------------
(IN THOUSANDS)
Real estate loans $ (712) $ (70) $ (782)
Consumer loans 54 (93) (39)
Commercial business loans 96 (22) 74
---------------- -------------- --------------
Total loans (562) (185) (747)
Investments (155) (297) (452)
Mortgage-backed securities 648 (705) (57)
---------------- -------------- --------------
Total interest-earning assets $ (69) $ (1,187) $ (1,256)
================ ============== ==============
Savings accounts $ 10 $ (18) $ (8)
Now and money market accounts 9 (124) (115)
Certificates of deposit (20) (290) (310)
---------------- -------------- --------------
Total deposits (1) (432) (433)
FHLB advances 114 (129) (15)
Other borrowings 31 19 50
---------------- -------------- --------------
Total interest-bearing liabilities 144 (542) (398)
================ ============== ==============
Change in net interest income $ (213) $ (645) $ (858)
================ ============== ==============
PROVISION FOR LOAN LOSSES. The allowance for loan losses, which is
established through provisions for losses charged to expense, is increased by
recoveries on loans previously charged off and is reduced by charge-offs on
loans. Determining the proper reserve level or allowance involves management's
judgment based upon a review of factors, including the company's internal review
process, which segments the loan portfolio into groups based on loan type.
Management then looks at its classified assets, which are loans 30 days or more
delinquent, and classifies those loans as special mention, substandard or
doubtful, based on the performance of the loans. Those classified loans are then
individually evaluated for impairment. Since the historical three-year loss
experience for the bank is new, those loans that are not classified are not
individually evaluated. Those loans are then segmented by type and assigned a
reserve percentage that reflects the industry loss experience. The loans
individually evaluated for impairment are measured by either the present value
of expected future cash flows, the loan's observable market price, or the fair
value of the collateral. Although management utilizes its best judgment in
providing for probable losses, there can be no assurance that the bank will not
have to increase its provisions for loan losses in the future. An increase in
provision may result from an adverse market for real estate and economic
conditions generally in the company's primary market area, future increases in
non-performing assets or for other reasons which would adversely affect the
company's results of operations.
Non-performing assets were $1.1 million or 0.21% of total assets at
December 31, 2003, compared to $2.1 million or 0.41% at December 31, 2002, with
$844,000 classified as substandard, $255,000 classified as doubtful and none
classified as real estate owned. Non-performing assets decreased $1.0 million
from the comparable period one year ago, coupled with a decrease of $568,000 in
the provision for loan losses. The decrease in non-performing assets from the
year ago period was due to the reduction of the outstanding balance of one of
the bank's commercial business loans. The decrease in provision was due
primarily to a reduction in the required provision for that loan since the bank
is in the process of liquidating that loan from the cash flow of the collateral
securing the loan.
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NON-INTEREST INCOME. Non-interest income decreased $2.0 million during
the three months ended December 31, 2003, over the comparable period one year
ago. That decrease was primarily the result of a decrease in gain on sale of
loans coupled with decreases of $178,000 and $19,000 in service fees on loans
and on deposits, respectively. Those decreases were offset by a increase in gain
on sale of investment securities of $312,000 from the comparable period one year
ago. The level of gain on sale of loans during the three months ended December
31, 2003 resulted from lower than anticipated loan origination and sales volumes
at the bank's mortgage banking subsidiary with margins also being less than
those in the year-ago period. The following table presents a comparison of the
components of non-interest income.
Difference
- -------------------------------------------------------------------------------------------------------------------
Three Months Ended December 31, 2003 2002 Amount %
- -------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Non-interest income:
Gain on sale of loans $ 1,956 $ 4,110 $ (2,154) (52.41)%
Service fees on loans 59 237 (178) (75.11)
Service fees on deposits 175 194 (19) (9.79)
Gain on sale of investment securities 312 - 312 -
Other operating income 5 4 1 25.00
- -------------------------------------------------------------------------------------------------------------------
Total non-interest income $ 2,507 $ 4,545 $ (2,038) (44.84)%
===================================================================================================================
Non-interest expense. Non-interest expense decreased $944,000 from $5.5
million for the three months ended December 31, 2002 to $4.5 million for the
comparable period in the current year. The decrease was primarily attributable
to a $1.1 million decrease in the mortgage company's non-interest expense from
the comparable period one year ago as a result of decreased loan origination and
sales. The increase in the bank's non-interest expense was a modest $151,000
distributed over various non-interest expense categories. The decrease at the
mortgage company level was primarily in compensation, and other operating
expenses, and was offset by increases in professional services, advertising,
occupancy and furniture fixtures and equipment. Mortgage related expenses should
continue to decline because of the lag in timing of such expenses compared to
the decline in origination and sales volumes. The following table presents a
comparison of the components of non-interest expense.
Difference
--------------------------------------------------------------------------------------------------------------------
Three Months Ended December 31, 2003 2002 Amount %
--------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Non-interest expense:
Compensation and employee benefits $ 1,994 $ 3,225 $ (1,231) (38.18)%
Occupancy 501 475 26 5.47
Professional services 288 226 62 27.43
Advertising 421 183 238 130.05
Deposit insurance premium 11 11 - -
Furniture, fixtures and equipment 258 268 (10) (3.73)
Data processing 350 315 35 11.11
Other operating expense 695 759 (64) (8.43)
--------------------------------------------------------------------------------------------------------------------
Total non-interest expense $ 4,518 $ 5,462 $ (944) (17.28)%
====================================================================================================================
INCOME TAXES. The company files a consolidated federal income tax
return with its subsidiaries and computes its income tax provision or benefit on
a consolidated basis. Based on recent tax legislation, the company expects to
offset all taxable income in fiscal 2004 with existing net operating losses
carried forward from prior years. The company believes that it will continue to
generate taxable income for the foreseeable future which will assure the use of
existing net operating losses.
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Contractual Commitments and Obligations
- -----------------------------------------------------------------------------------------------------------------
Less Than One Two - Three Four - Five After Five
Total Year Years Years Years
- -----------------------------------------------------------------------------------------------------------------
(in thousands)
FHLB Advances (1) $ 129,950 $ 104,950 $ - $ - $ 25,000
Reverse repurchase agreements 82,408 82,408 - - -
Operating leases 9,572 1,525 2,693 2,293 3,061
- -----------------------------------------------------------------------------------------------------------------
Total obligations $ 221,930 $ 188,883 $ 2,693 $ 2,293 $ 28,061
=================================================================================================================
(1) The company expects to refinance these short and medium-term obligations under substantially the same terms
and conditions.
Other Commercial Commitments
- -----------------------------------------------------------------------------------------------------------------
Less Than One Two - Three Four - Five After Five
Total Year Years Years Years
- -----------------------------------------------------------------------------------------------------------------
(in thousands)
Certificate of deposit maturities(1) $ 180,410 $ 114,931 $ 44,209 $ 21,177 $ 93
Loan originations 60,233 60,233 - - -
Unfunded lines of credit 98,467 98,467 - - -
Standby letters of credit 349 349 - - -
- -----------------------------------------------------------------------------------------------------------------
Total $ 339,459 $ 273,980 $ 44,209 $ 21,177 $ 93
=================================================================================================================
(1) The company expects to retain maturing deposits or replace amounts maturing with comparable certificates of
deposits based on current market interest rates.
LIQUIDITY AND CAPITAL RESOURCES. The bank's primary sources of funds
are deposits, principal and interest payments on loans, mortgage-backed and
investment securities and borrowings. While maturities and scheduled
amortization of loans are predictable sources of funds, deposit flows and
mortgage prepayments are greatly influenced by general interest rates, economic
conditions and competition. The bank has continued to maintain the levels of
liquid assets as previously required by OTS regulations. The bank manages its
liquidity position and demands for funding primarily by investing excess funds
in short-term investments and utilizing FHLB advances and reverse repurchase
agreements in periods when the bank's demands for liquidity exceed funding from
deposit inflows.
The bank's most liquid assets are cash and cash equivalents and
securities available-for-sale. The levels of those assets are dependent on the
bank's operating, financing, lending and investing activities during any given
period. At December 31, 2003, cash and cash equivalents, interest bearing
deposits and securities available-for-sale totaled $231.9 million or 43.75% of
total assets.
The primary investing activities of the bank are the origination of
residential one- to four-family loans, commercial real estate loans, real estate
construction and development loans, commercial borrowing and consumer loans and
the purchase of United States Treasury and agency securities, mortgage-backed
and mortgage-related securities and other investment securities. During the
three months ended December 31, 2003, the bank's loan purchases and originations
totaled $44.6 million. Purchases of United States Treasury and agency
securities, mortgage-backed and mortgage related securities and other investment
securities totaled $50.6 million for the three months ended December 31, 2003.
The bank has other sources of liquidity if a need for additional funds
arises. At December 31, 2003, the bank had $130.0 million in advances
outstanding from the FHLB and had an additional overall borrowing capacity from
the FHLB of $81.8 million. Depending on market conditions, the pricing of
deposit products and FHLB advances, the bank may continue to rely on FHLB
borrowings to fund asset growth.
At December 31, 2003, the bank had commitments to fund loans and unused
outstanding lines of credit, unused standby letters of credit and undisbursed
proceeds of construction mortgages totaling $159.0 million. The
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bank anticipates that it will have sufficient funds available to meet its
current loan origination commitments. Certificate accounts, including IRA and
Keogh accounts, which are scheduled to mature in less than one year from
December 31, 2003, totaled $41.1 million. Based upon experience, management
believes the majority of maturing certificates of deposit will remain with the
bank. In addition, management of the bank believes that it can adjust the rates
offered on certificates of deposit to retain deposits in changing interest rate
environments. In the event that a significant portion of these deposits are not
retained by the bank, the bank would be able to utilize FHLB advances and
reverse repurchase agreements to fund deposit withdrawals, which would result in
an increase in interest expense to the extent that the average rate paid on such
borrowings exceeds the average rate paid on deposits of similar duration.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In general, market risk is the sensitivity of income to variations in
interest rates and other relevant market rates or prices. The company's market
rate sensitive instruments include interest-earning assets and interest-bearing
liabilities. The company enters into market rate sensitive instruments in
connection with its various business operations, particularly its mortgage
banking activities. Loans originated, and the related commitments to originate
loans that will be sold, represent market risk that is realized in a short
period of time, generally two or three months.
The company's primary source of market risk exposure arises from
changes in United States interest rates and the effects thereof on mortgage
prepayment and closing behavior, as well as depositors' choices ("interest rate
risk"). Changes in those interest rates will result in changes in the company's
earnings and the market value of its assets and liabilities. We expect to
continue to realize income from the differential or "spread" between the
interest earned on loans, securities and other interest-earning assets, and the
interest paid on deposits, borrowings and other interest-bearing liabilities.
That spread is affected by the difference between the maturities and re-pricing
characteristics of interest-earnings assets and interest-bearing liabilities.
Loan volume and yields are affected by market interest rates on loans, and
rising interest rates generally are associated with fewer loan originations.
Management expects that a substantial portion of our assets will continue to be
indexed to changes in market interest rates and we intend to attract a greater
proportion of short-term liabilities, which will help us address our interest
rate risk. The lag in implementation of re-pricing terms on our adjustable-rate
assets may result in a decline in net interest income in a rising interest rate
environment. There can be no assurance that our interest rate risk will be
minimized or eliminated. Further, an increase in the general level of interest
rates may adversely affect the ability of certain borrowers to pay the interest
on and principal of their obligations. Accordingly, changes in levels of market
interest rates, (primarily increases in market interest rates), could materially
adversely affect our interest rate spread, asset quality, loan origination
volume and overall financial condition and results of operations.
Market risk is the risk of loss from adverse changes in market prices
and rates. The company's market risk arises primarily from interest rate risk
inherent in its lending and deposit taking activities. The company has little or
no risk related to trading accounts, commodities or foreign exchange.
To mitigate the impact of changes in market interest rates on our
interest-earning assets and interest-bearing liabilities, we actively manage the
amounts and maturities of these assets and liabilities. A key component of this
strategy is the origination and retention of short-term and adjustable-rate
assets and the origination and sale of fixed-rate loans. We retain short-term
and adjustable-rate assets because they have re-pricing characteristics that
more closely match the re-pricing characteristics of our liabilities.
To further mitigate the risk of timing differences in the re-pricing of
assets and liabilities, our interest-earning assets are matched with
interest-bearing liabilities that have similar re-pricing characteristics. For
example, the interest rate risk of holding fixed-rate loans is managed with
long-term deposits and borrowings, and the risk of holding ARMs is managed with
short-term deposits and borrowings. Periodically, mismatches are identified and
managed by adjusting the re-pricing characteristics of our interest-bearing
liabilities with derivatives, such as interest rate caps and interest rate
swaps.
Through the use of these derivative instruments, management attempts to
reduce or offset increases in interest expense related to deposits and
borrowings. We use interest rate caps and pay-fixed interest rate swaps to
protect against rising interest rates.
The interest rate caps and pay-fixed interest rate swaps are designed
to provide an additional layer of protection should interest rates on deposits
and borrowings rise, by effectively lengthening the re-pricing period. At
December 31, 2003, we held an aggregate notional value of $107 million of caps
and pay-fixed interest rate swaps.
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None of the interest rate caps had strike rates that were in effect at December
31, 2003, as current LIBOR rates were below the strike rates.
We are also striving to increase the proportion of transaction deposits
to total deposits to diminish our exposure to adverse changes in interest rates.
In particular, non-interest-bearing checking accounts and custodial accounts are
less sensitive to interest rate fluctuations and provide a growing source of
non-interest income through depositor and other retail banking fees.
ITEM 4. CONTROLS AND PROCEDURES
(a). Evaluation of disclosure controls and procedures. The company
------------------------------------------------
maintains controls and procedures designed to ensure that information required
to be disclosed in the reports that the company files or submits under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in the rules and forms of the Securities and
Exchange Commission. Based upon their evaluation of those controls and
procedures at December 31, 2003, the Chief Executive and Chief Financial
officers of the company concluded that the company's disclosure controls and
procedures were adequate.
(b). Changes in internal control. The company made no significant
---------------------------
changes in its internal controls or in other factors that could significantly
affect these controls subsequent to the date of the evaluation of those controls
by the Chief Executive and Chief Financial officers.
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
Not applicable.
ITEM 2. Changes in Securities and Use of Proceeds
Not applicable.
ITEM 3. Defaults Upon Senior Securities
Not applicable.
ITEM 4. Submission of Matters to a Vote of Security Holders
Not applicable
ITEM 5. Other Information
Not applicable.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits
11.0 Statement Regarding Computation of Per Share Earnings
31.1 Certification of Chief Executive Officer pursuant to Section 302
of Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section 302
of Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer pursuant to Section 906
of Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to Section 906
of Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
On November 7, 2003 the Company filed a Form 8-K to disclose that the
Company issued a press release to announce the company's annual and
fourth quarter earnings.
24
GREATER ATLANTIC FINANCIAL CORP.
SIGNATURES
Pursuant to the requirement of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
GREATER ATLANTIC FINANCIAL CORP.
(Registrant)
By: /s/ Carroll E. Amos
-----------------------
Carroll E. Amos
President and Chief Executive Officer
By: /s/ David E. Ritter
-----------------------
David E. Ritter
Senior Vice President and Chief Financial Officer
Date: February 13, 2004