UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2006
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
(Address of Principal Executive Offices) (Zip Code)
(703) 391-1300
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ X ] No [__]
Indicate by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [__] Accelerated filer [__] Non- accelerated filer [X]
Indicate by check mark whether the Registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act):
Yes [__] No [ X ]
At May 10, 2006, there were 3,020,934 shares of the registrant's Common
Stock, par value $0.01 per share outstanding
GREATER ATLANTIC FINANCIAL CORP.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2006
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE NO.
- ------------------------------ --------
Item 1. Condensed Financial Statements (Unaudited)
Consolidated Statements of Financial Condition at March 31, 2006 and September 30, 2005 ..........................3
Consolidated Statements of Operations
for the three and six months ended March 31, 2006 and March 31, 2005..............................................4
Consolidated Statements of Comprehensive Income (Loss)
for the six months ended March 31, 2006 and March 31, 2005 .......................................................5
Consolidated Statements of Changes in Stockholders' Equity
for the six months ended March 31, 2006 and March 31, 2005........................................................5
Consolidated Statements of Cash Flows
for the six months ended March 31, 2006 and March 31, 2005........................................................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....................................................26
Item 4. Controls and Procedures.......................................................................................28
PART II. OTHER INFORMATION
- ---------------------------
Item 1. Legal Proceedings...........................................................................................28
Item 1A. Risk Factors................................................................................................28
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.................................................30
Item 3. Defaults Upon Senior Securities.............................................................................30
Item 4. Submission of Matters to a Vote of Security Holders.........................................................30
Item 5. Other Information...........................................................................................30
Item 6. Exhibits....................................................................................................30
SIGNATURES.............................................................................................................31
CERTIFICATIONS.........................................................................................................32
2
GREATER ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
March 31, September 30,
----------------------------------
2006 2005
------------------------------------------------------------------------------------------------------------
(Unaudited)
(Dollars in Thousands)
Assets
Cash and cash equivalents $ 2,073 $ 2,291
Interest bearing deposits 7,329 4,411
Investment securities
Available-for-sale 93,441 107,829
Held-to-maturity 6,298 7,969
Loans held for sale 3,473 9,517
Loans receivable, net 193,637 194,920
Accrued interest and dividends receivable 1,964 1,746
Deferred income taxes 2,104 1,974
Federal Home Loan Bank stock, at cost 2,388 2,503
Other real estate owned - 232
Premises and equipment, net 2,984 4,198
Goodwill 956 956
Prepaid expenses and other assets 1,522 2,263
-------------------------------------------------------------------------------------------------------------
Total assets $318,169 $340,809
=============================================================================================================
Liabilities and stockholders' equity
Liabilities
Deposits $231,191 $237,794
Advance payments from borrowers for taxes and insurance 340 268
Accrued expenses and other liabilities 750 1,248
Advances from the FHLB and other borrowings 64,331 76,479
Junior subordinated debt securities 9,383 9,378
------------------------------------------------------------------------------------------------------------
Total liabilities 305,995 325,167
------------------------------------------------------------------------------------------------------------
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; 3,020,934 shares outstanding 30 30
Additional paid-in capital 25,228 25,228
Accumulated deficit (11,836) (8,521)
Accumulated other comprehensive loss (1,248) (1,095)
------------------------------------------------------------------------------------------------------------
Total stockholders' equity 12,174 15,642
------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $318,169 $340,809
============================================================================================================
See accompanying notes to consolidated financial statements
3
GREATER ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended Six Months Ended
March 31, March 31,
------------------------------------------------------------
2006 2005 2006 2005
------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Data)
Interest income
Loans $ 3,521 $ 2,966 $ 7,061 $ 6,269
Investments 1,201 1,175 2,400 2,277
------------------------------------------------------------------------------------------------------------------
Total interest income 4,722 4,141 9,461 8,546
------------------------------------------------------------------------------------------------------------------
Interest expense
Deposits 1,890 1,512 3,654 3,026
Borrowed money 993 1,162 2,091 2,465
------------------------------------------------------------------------------------------------------------------
Total interest expense 2,883 2,674 5,745 5,491
------------------------------------------------------------------------------------------------------------------
Net interest income 1,839 1,467 3,716 3,055
Provision for loan losses 3 1 74 3
------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 1,836 1,466 3,642 3,052
------------------------------------------------------------------------------------------------------------------
Noninterest income
Fees and service charges 538 214 1,027 449
Gain on sale of loans 657 1,249 1,465 2,327
Gain on sale of investment securities - - - 538
(Loss) gain on derivatives 113 519 184 882
Gain on sale of foreclosed real estate - - 65 -
Gain on sale of branches - 414 - 683
Other operating income 31 17 46 33
------------------------------------------------------------------------------------------------------------------
Total noninterest income 1,339 2,413 2,787 4,912
------------------------------------------------------------------------------------------------------------------
Noninterest expense
Compensation and employee benefits 1,997 1,330 4,013 2,561
Occupancy 435 434 853 895
Professional services 423 291 785 511
Advertising 355 579 890 1,138
Deposit insurance premium 25 21 53 32
Furniture, fixtures and equipment 265 284 516 583
Data processing 251 313 507 637
Other operating expenses 609 562 2,127 1,081
------------------------------------------------------------------------------------------------------------------
Total noninterest expense 4,360 3,814 9,744 7,438
------------------------------------------------------------------------------------------------------------------
Net (loss) income before income tax provision (1,185) 65 (3,315) 526
Income tax provision - - - -
------------------------------------------------------------------------------------------------------------------
Net (loss) income $ (1,185) $ 65 $ (3,315) $ 526
==================================================================================================================
Earnings (loss) per common share
Basic $ (0.39) $ 0.02 $ (1.10) $ 0.17
Diluted $ (0.39) $ 0.02 $ (1.10) $ 0.17
Weighted average common shares outstanding
Basic 3,020,934 3,012,434 3,020,934 3,012,434
Diluted 3,020,934 4,405,827 3,020,934 4,407,266
See accompanying notes to consolidated financial statements
4
GREATER ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
Six months ended March 31,
-------------------------------------
2006 2005
-------------------------------------------------------------------------------------------
(In Thousands)
-------------------------------------------------------------------------------------------
Net (loss) earnings $ (3,315) $ 526
-------------------------------------------------------------------------------------------
Other comprehensive (loss) income, net of tax
Unrealized (loss) gain on securities (153) (77)
-------------------------------------------------------------------------------------------
Other comprehensive (loss) income (153) (77)
-------------------------------------------------------------------------------------------
Comprehensive (loss) income $ (3,468) $ 449
===========================================================================================
GREATER ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED)
FOR THE SIX MONTHS ENDED MARCH 31, 2006 AND 2005
- ------------------------------------------------------------------------------------------------------------------------------
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, 2004 $- $ 30 $ 25,152 $ (6,963) $ (1,079) $ 17,140
Option compensation - - 53 - - 53
Other comprehensive loss - - - - (77) (77)
Net income for the period - - - 526 - 526
- ------------------------------------------------------------------------------------------------------------------------------
Balance at March 31, 2005 $- $ 30 $ 25,205 $ (6,437) $ (1,156) $ 17,642
==============================================================================================================================
Balance at September 30, 2005 $- $ 30 $ 25,228 $ (8,521) $ (1,095) $ 15,642
Other comprehensive loss - - - - (153) (153)
Net loss for the period - - - (3,315) - (3,315)
- ------------------------------------------------------------------------------------------------------------------------------
Balance at March 31, 2006 $- $ 30 $ 25,228 $(11,836) $ (1,248) $ 12,174
==============================================================================================================================
See accompanying notes to consolidated financial statements
5
GREATER ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six months ended March 31,
------------------------------------
2006 2005
- ----------------------------------------------------------------------------------------------------------------
(In Thousands)
Cash flow from operating activities
Net income (loss) $ (3,315) $ 526
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities
Provision for loan loss 74 3
Amortization of loan acquisition adjustment (26) (14)
Depreciation and amortization 419 511
Option compensation - 53
Net gain on sale of mortgage-backed securities - (538)
(Gain) loss on derivatives (184) (882)
Amortization of investment security premiums 442 448
Amortization of mortgage-backed securities premiums 371 430
Amortization of deferred fees (286) (336)
Discount accretion net of premium amortization (135) (197)
Amortization of convertible preferred stock costs 5 5
Gain on sale of loans held for sale (1,465) (2,327)
Gain on sale of foreclosed real estate (65) -
Gain on sale of fixed assets (26) -
(Increase) decrease in assets
Disbursements for origination of loans (91,477) (124,870)
Proceeds from sales of loans 98,987 121,109
Accrued interest and dividend receivable (218) 249
Prepaid expenses and other assets 697 (184)
Deferred loan fees collected, net of deferred costs incurred 163 90
Increase (decrease) in liabilities
Accrued expenses and other liabilities (314) (1,553)
- ----------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 3,647 (7,477)
- ----------------------------------------------------------------------------------------------------------------
Continued
6
GREATER ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) - (CONTINUED)
Six months ended March 31,
-----------------------------------
2006 2005
- -----------------------------------------------------------------------------------------------------------
(In Thousands)
Cash flow from investing activities
Net decrease in loans $ 1,492 $ 40,032
Disposal of premises and equipment 811 1,981
Purchases of investment securities (7,707) (9,208)
Proceeds from repayments of investment securities 8,401 10,806
Purchases of mortgage-backed securities - (24,224)
Proceeds from repayments of mortgage-backed securities 14,322 18,656
Proceeds from the sale of mortgage-backed securities - 22,802
Proceeds from the sale of foreclosed assets 297 -
Purchases of FHLB stock (1,800) (3,009)
Proceeds from sale of FHLB stock 1,915 4,456
- -----------------------------------------------------------------------------------------------------------
Net cash provided investing activities 17,731 62,292
- -----------------------------------------------------------------------------------------------------------
Cash flow from financing activities
Net decrease in deposits (6,603) (28,899)
Net advances from FHLB - (10,200)
Net borrowings on reverse repurchase agreements (12,148) (12,197)
Increase (decrease) in advance payments by borrowers
for taxes and insurance 73 (6)
- -----------------------------------------------------------------------------------------------------------
Net cash used in financing activities (18,678) (51,302)
- -----------------------------------------------------------------------------------------------------------
Increase in cash and cash equivalents 2,700 3,513
- -----------------------------------------------------------------------------------------------------------
Cash and cash equivalents, at beginning of period 6,702 10,603
- -----------------------------------------------------------------------------------------------------------
Cash and cash equivalents, at end of period $ 9,402 $ 14,116
===========================================================================================================
See accompanying notes to consolidated financial statements
7
GREATER ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INFORMATION AS OF MARCH 31, 2006 AND THE SIX 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. Certain information and note
disclosures normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States of America
have been omitted pursuant to the rules and regulations of the Securities and
Exchange Commission ("SEC") with respect to interim financial reporting. All
adjustments (consisting of normal recurring adjustments) which, in the opinion
of management, are necessary to a fair presentation of the results for the
interim periods presented have been made. It is recommended that these unaudited
consolidated financial statements be read in conjunction with the audited
consolidated financial statements and notes thereto included in the
Corporation's Annual Report on Form 10-K for the year ended September 30, 2005.
The results of operations for the three months or the six months ended March 31,
2006 are not necessarily indicative of the results of operations that may be
expected for the year ending September 30, 2006 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. An analysis of the change in the allowance for loan losses follows:
At or for the six months ended
March 31,
-------------------------------------
2006 2005
---------------------------------------------------------------------------------------------
(Dollars in Thousands)
Balance at beginning of period $ 1,212 $ 1,600
Provisions 74 3
Total charge-offs (57) (60)
Total recoveries 21 9
---------------------------------------------------------------------------------------------
Net charge-offs (36) (51)
---------------------------------------------------------------------------------------------
Balance at end of period $ 1,250 $ 1,552
=============================================================================================
Ratio of net charge-offs during the period
to average loans outstanding during the period 0.02% 0.02%
=============================================================================================
Allowance for loan losses to total non-performing
loans at end of period 86.45% 100.39%
=============================================================================================
Allowance for loan losses to total loans 0.62% 0.71%
=============================================================================================
(3) REGULATORY MATTERS
The capital distribution regulation of the OTS requires that the bank
provide the applicable OTS Regional Director with a 30-day advance written
notice of all proposed capital distributions whether or not advance approval is
required. The bank paid dividends of $655,000 to the company during the year
ended September 30, 2005 and $327,000 to the company during the six months ended
March 31, 2006.
8
GREATER ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INFORMATION AS OF MARCH 31, 2006 AND THE SIX 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 March 31, 2006, the bank was classified as a
well-capitalized financial institution.
The following presents the bank's capital position at March 31, 2006:
---------------------------------------------------------------------------------------------------------------
Required Required Actual Actual Surplus
Balance Percent Balance Percent
---------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Leverage $15,862 5.00% $20,212 6.37% $4,350
Tier 1 Risk-based $12,182 6.00% $20,099 9.90% $7,917
Total Risk-based $20,303 10.00% $21,349 10.52% $1,046
===============================================================================================================
(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 to employees from 76,667 to 225,000 shares and amended again effective
March 15, 2002, to increase the number of options available for grant to
employees from 225,000 to 350,000 shares 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 March 31,
2006, 94,685 warrants were issued.
The following summary represents the activity under the Plan:
---------------------------------------------------------------------------------------------------------------
Number of Exercise Expiration
Shares Price Date
---------------------------------------------------------------------------------------------------------------
Balance outstanding and exercisable at September 30, 2003 190,000
Options granted 36,000 $ 8.50 10-20-2013
---------------------------------------------------------------------------------------------------------------
Balance outstanding and exercisable at September 30, 2004 226,000
Options granted 104,000 $ 6.75 10-6-2014
Options exercised (8,500) $ 4.00
Options expired (55,500) $ 6.52
---------------------------------------------------------------------------------------------------------------
Balance outstanding and exercisable at September 30, 2005 266,000
Options granted -
---------------------------------------------------------------------------------------------------------------
Balance outstanding and exercisable at March 31, 2006 266,000
===============================================================================================================
The company has elected to present in the notes of the consolidated
financial statements the impact to net income and earnings per share of
estimating the fair value of each option on the date of grant using the
Black-Scholes option-pricing model. No options were granted during the six
months ended March 31, 2006. The Company has elected to continue to disclose in
the notes to the consolidated financial statements under SFAS 148, ACCOUNTING
FOR STOCK-BASED COMPENSATION - TRANSITION AND DISCLOSURE, AN AMENDMENT OF SFAS
123. If the Company had determined the cost for its stock options based on the
fair value method at the grant date under SFAS 123, ACCOUNTING FOR STOCK-BASED
COMPENSATION, the Company's pro forma net income and earnings per share for the
six months ended March 31, 2006 and 2005 would have been the amounts shown
below. The company has adopted SFAS 123R which requires the fair value method be
used to account for stock based compensation and the recognition of the fair
value of stock options as compensation expense in the financial statements
effective after October 1, 2005.
9
GREATER ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INFORMATION AS OF MARCH 31, 2006 AND THE SIX 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.
Six months ended
March 31,
----------------------
2005
-------------------------------------------------------------------------------------------------
(In Thousands, except per share data)
Net earnings (loss) $ 526
Deduct: Total stock-based employee compensation expense (318)
-------------------------------------------------------------------------------------------------
Pro forma net earnings (loss) attributable to common stockholders $ 208
=================================================================================================
Earnings (loss) per common share
Basic $ 0.17
Diluted $ 0.17
Earnings (loss) per common share, pro forma
Basic $ 0.07
Diluted $ 0.05
(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 six months ended March 31, 2006 and
2005. The effect of the conversion of preferred securities and the impact of
stock options were antidilutive for the period ended March 31, 2006.
Six months ended March 31,
-----------------------------------
2006 2005
----------------------------------------------------------------------------------------------------------
(Dollars in Thousands, except per share data)
Net earnings $ (3,315) $ 526
Effect of conversion of preferred securities 203 203
Diluted earnings (3,112) 729
Weighted average common shares outstanding 3,020,934 3,012,434
Effect of conversion of preferred securities 1,371,429 1,371,429
Common stock equivalents due to dilutive effect of stock options 9,509 23,404
Total weighted average common shares and common
share equivalents outstanding 4,401,872 4,407,266
Basic earnings per common share $ (1.10) $ 0.17
Diluted earnings per common share $ (1.10) $ 0.17
10
GREATER ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INFORMATION AS OF MARCH 31, 2006 AND THE SIX 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 consumers
and small businesses with deposit products such as demand, transaction, and
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 sale into the secondary
market with servicing released or for the Bank's portfolio. However, the
activities in the mortgage-banking segment were discontinued on March 29, 2006.
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
Mortgage Reportable Intersegment
For the six months ended March 31, Banking Banking Segments Eliminations Total
- --------------------------------------------------------------------------------------------------------------------
(In Thousands)
Net interest income: (1)
2006 $ 3,602 $ 40 $ 3,642 $ - $ 3,642
2005 $ 2,978 $ 74 $ 3,052 $ - $ 3,052
Noninterest income:
2006 $ 572 $ 2,222 $ 2,794 $ (7) $ 2,787
2005 $ 2,586 $ 2,346 $ 4,932 $ (20) $ 4,912
Noninterest expense:
2006 $ 5,154 $ 4,597 $ 9,751 $ (7) $ 9,744
2005 $ 4,985 $ 2,473 $ 7,458 $ (20) $ 7,438
Net income (loss):
2006 $ (979) $(2,336) $ (3,315) $ - $ (3,315)
2005 $ 579 $ (53) $ 526 $ - $ 526
Segment assets:
2006 $319,706 $ 3,599 $323,305 $ (5,136) $ 318,169
2005 $378,747 $13,653 $392,400 $(10,378) $ 382,022
(1) Segment net interest income reflects income after provisions for loan
losses.
11
GREATER ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INFORMATION AS OF MARCH 31, 2006 AND THE SIX MONTHS THEN ENDED IS UNAUDITED
In 2004, the bank entered into a management agreement with the manager
of GAMC, its mortgage-banking subsidiary. Under the management agreement the
manager was to reimburse operating expenses equal to approximately 100% of any
operating loss in return for an increase in his share of net earnings from 40%
to 80%. Reflected in the mortgage banking non-interest expense of $2.5 million
for 2005 is a reduction of $972,000 provided by the manager of the mortgage
company.
Under the management agreement, if GAMC sustained losses in excess of
the amount in the escrow, and the manager did not restore those losses within 15
days of demand, GAMC's recourse was to terminate the agreement. At June 30,
2005, the $1,300,000 in the escrow had been depleted, the manager contributed
$108,000 to GAMC to make up the deficiency and the agreement was continued for
three months.
During the three months ended September 30, 2005, the losses at GAMC
continued and reached approximately $993,000. Because the escrow account was
depleted and the manager had not posted sufficient collateral to securitize the
account receivable due from him, the Bank's earnings were reduced by the
$993,000 loss.
Due to the unprofitable operations of GAMC, the company recognized an
additional loss of $1.3 million for the six months ended March 31, 2006. In
addition to the loss from operations, a non-recurring pre-tax impairment charge
of $996,000 was recorded for the six months ended March 31, 2006 and included in
other operating expenses in the consolidated statements of operations. That
charge requires a write down of long-lived assets by recording an impairment
charge due to the discontinuance of operations effective March 29, 2006.
(7) RECENT ACCOUNTING STANDARDS
In April 2003, the FASB issued Statement No. 149, Amendment of
Statement 133 on Derivative Instruments and Hedging Activities. This Statement
amends and clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives) and for hedging activities
under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging
Activities. We adopted the use of this accounting statement in July 2003.
In December 2003, the FASB issued FIN No. 46R, "Consolidation of
Variable Interest Entities," an interpretation of Accounting Research Bulletin
No. 51. FIN No. 46R requires that variable interest entities be consolidated by
a company if that company is subject to a majority of the risk of loss from the
variable interest entity's activities or is entitled to receive a majority of
the entity's residual returns or both. FIN 46R also requires disclosure about
variable interest entities that companies are not required to consolidate but in
which a company has a significant variable interest. The consolidation
requirements must be adopted no later than the beginning of the first fiscal
year or interim period beginning after March 15, 2004. The adoption of FIN No.
46R did not have a material impact on the Corporation's results of operations,
financial position or cash flows.
The Financial Accounting Standards Board ("FASB") issued Statement of
Financial Accounting Standard ("SFAS") No. 123 (Revised 2004) ("SFAS No. 123R"),
"Share-Based Payment," in December 2004. SFAS No. 123R is a revision of FASB
Statement 123, "Accounting for Stock-Based Compensation" and supersedes APB
Opinion No. 25, "Accounting for Stock Issued to Employees," and its related
implementation guidance. The Statement focuses primarily on accounting for
transactions in which an entity obtains employee services in share-based payment
transactions. SFAS No. 123R requires a public entity to measure the cost of
employee services received in exchange for an award of equity instruments based
on the grant-date fair value of the award (with limited exceptions). That cost
will be recognized over the period during which an employee is required to
provide service in exchange for the award. This statement is effective as of the
beginning of the first annual reporting period that begins after June 15, 2005
and the Company adopted the standard in the first quarter of fiscal 2006. The
adoption of this statement did not have a material impact on its consolidated
financial position or results of operations.
12
GREATER ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INFORMATION AS OF MARCH 31, 2006 AND THE SIX MONTHS THEN ENDED IS UNAUDITED
(8) JUNIOR SUBORDINATED DEBT SECURITIES
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, retaining
an option to call the securities 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 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 retained 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 the bank to increase its capital position.
(9) DERIVATIVE FINANCIAL INSTRUMENTS
Beginning in fiscal 2002, the bank utilized derivative financial
instruments to hedge its interest rate risk. Beginning in 2002, the Bank adopted
statement of Financial Accounting Standard No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"), as amended, 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 has entered into various interest-rate swaps that total $24
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 1.67% - 3.79%, and expires between three months and 4
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 are capped between 5.00% - 8.00%. The
bank accounts for these derivatives, under the guidelines of SFAS 133, as
amended.
Realized and unrealized gains and losses on those derivatives which
meet hedge accounting requirements are deferred and recognized when the hedge
transaction occurs. In the event hedge accounting requirements are not met gains
and losses on such instruments are included currently in the statement of
operations. During the six months ended March 31, 2006 and 2005 the instruments
did not meet hedge accounting requirements. The statements of operations include
net gains of $184,000 and of $882,000 for the six months ended March 31, 2006
and 2005, respectively.
13
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.
MORTGAGE BANKING ACTIVITIES
The company adopted new accounting requirements relating to SFAS No.
149 which requires that mortgage loan commitments related to loans originated
for sale be accounted for as derivative instruments. In addition, forward loan
sale agreements also meet the definition of a derivative instrument under SFAS
No. 133.
Our mortgage banking activities include loans in our pipeline (from
application through sale). Loans in our pipeline are considered commitments once
the customers accept a rate lock. In a rate lock commitment, clients while in
the process of obtaining approval for residential loans can, at their own
determination, fix or "lock in" the rate on the loan. Those commitments are
generally for periods of 30 to 90 days and are at market rates. We generally
enter into forward sales contracts on rate lock commitments on either a best
efforts or mandatory basis. Those types of activities will decline when compared
to other periods because we have discontinued operations of the mortgage banking
subsidiary effective March 29, 2006.
Mortgage loans originated and intended for sale are carried at the
lower of aggregate cost or market value. To deliver closed loans and to control
interest rate risk prior to sale, the company enters into agreements to sell the
loans while the loans are still in the pipeline. Loan commitments related to the
origination of mortgage loans held for sale and the corresponding sales
contracts are considered derivative instruments. At March 31, 2006, the bank had
$3.5 million of loans held for sale that were originated for sale to investors.
Loans held for sale as of March 31, 2006 have declined when compared to other
periods since we have discontinued operations of the mortgage banking
subsidiary. The value of the interest rate locks and related forward commitments
were immaterial to the financial statements at March 31, 2006.
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. Greater
Atlantic Bank is a member of the Federal Home Loan Bank system and its 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 six Greater Atlantic Bank branches located throughout the
greater Washington, D.C./Baltimore metropolitan area.
14
The profitability of the company 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 consist mainly of
interest paid on deposits and borrowings. Non-interest income consists primarily
of gain on sales of loans, derivatives and available-for-sale investments and
service charge fees for deposits and loans.
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.
At March 31, 2006 the company's total assets were $318.2 million,
compared to the $340.8 million held at September 30, 2005, representing a
decrease of 6.64%. Both the bank's overall asset size and customer base
decreased during the period and that decline is reflected in the consolidated
statements of financial condition and statements of operations. Net loans
receivable at March 31, 2006 were $193.6 million, a decrease of $1.3 million or
0.66% from the $194.9 million held at September 30, 2005. The decrease in loans
consisted primarily of consumer home equity, commercial business and commercial
real estate. That decrease was offset in part by increases in single family and
construction and land loans. At March 31, 2006, investment securities were $99.7
million, a decrease of $16.1 million or 13.87% from the $115.8 million held at
September 30, 2005. Deposits at March 31, 2006 were $231.2 million, a decrease
of $6.6 million from the $237.8 million held at September 30, 2005.
On February 22, 2006, the company announced that it had engaged Sandler
O'Neill & Partners, L.P. to advise and assist the Company in evaluating the
financial aspects of all strategic alternatives available, including remaining
independent.
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 those 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 those
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.
15
COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED
MARCH 31, 2006 AND MARCH 31, 2005
NET INCOME. For the three months ended March 31, 2006, the company had
net loss of $1.2 million or $0.39 per diluted share, compared to earnings of
$65,000 or $0.02 per diluted share for the three months ended March 31, 2005.
The decline in earnings of $1.3 million over the comparable period one-year ago
was primarily the result of an increase in non-interest expense, a decrease in
non-interest income and an increase in the provision for loan losses. Those
declines were partially offset by an increase in net interest income.
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 March 31, 2006 2005 Amount %
- ---------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Interest income:
Loans $ 3,521 $ 2,966 $ 555 18.71%
Investments 1,201 1,175 26 2.21
- ---------------------------------------------------------------------------------------------------------------------
Total 4,722 4,141 581 14.03
- ---------------------------------------------------------------------------------------------------------------------
Interest expense:
Deposits 1,890 1,512 378 25.00
Borrowings 993 1,162 (169) (14.54)
- ---------------------------------------------------------------------------------------------------------------------
Total 2,883 2,674 209 7.82
- ---------------------------------------------------------------------------------------------------------------------
Net interest income $ 1,839 $ 1,467 $ 372 25.36%
=====================================================================================================================
The increase in net interest income during the six months ended March
31, 2006, resulted primarily from a 77 basis point increase in net interest
margin (net interest income divided by average interest-earning assets) from
1.58% for the six months ended March 31, 2005 to 2.35% for the six months ended
March 31, 2006, offset in part by a $57.9 million decrease in the bank's
interest-earning assets. Contributing to the increase in the net interest margin
was a $66,000 reduction in interest expense resulting from payments made on
certain interest rate swap and cap agreements compared to a charge of $202,000
in the comparable period one year ago. That increase in net interest margin also
resulted from increasing the average yield on interest-earning assets by 73
basis points more than the increase in the average cost on interest-bearing
liabilities and was partially offset by average interest earning assets
decreasing by $2.4 million more than the decline in average interest bearing
liabilities.
INTEREST INCOME. Interest income for the three months ended March 31,
2006 increased $581,000 compared to the three months ended March 31, 2005,
primarily as a result of an increase of 157 basis points in the average yield
earned on interest earning assets. That increase was partially offset by a
decrease of $57.9 million in the average outstanding balances of loans and
investment securities.
16
INTEREST EXPENSE. The $209,000 increase in interest expense for the
three months ended March 31, 2006 compared to the 2005 period was principally
the result of an 84 basis point increase in the cost of funds on average
deposits and borrowed funds. That increase in the cost of funds was partially
offset by a $55.5 million decrease in average deposits and borrowed funds. The
increase in interest expense on deposits was primarily due to a 111 basis point
increase in rates paid on deposits,. The increase in expense was primarily due
to higher rates paid on interest-bearing demand deposits, savings accounts and
certificates and elevated pricing on new and renewed time deposits. That
increase was partially offset by a decrease of $35.4 million in average deposits
from $248.9 million for the three months ended March 31, 2005 to $213.5 million
for the three months ended March 31, 2006.
The decrease in interest expense on borrowings for the three months
ended March 31, 2006, when compared to the 2005 period was principally the
result of a $20.0 million decrease in average borrowed funds, partially offset
by a 25 basis point increase in the cost of borrowed funds. The components
accountable for the decrease of $169,000 in interest expense on borrowings were
a $225,000 decrease relating to average volume, partially offset by a $56,000
increase relating to average cost.
17
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 MARCH 31,
--------------------------------------------------------------------------------
2006 2005
--------------------------------------------------------------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
BALANCE EXPENSE RATE BALANCE EXPENSE RATE
--------------------------------------------------------------------------------
ASSETS: (DOLLARS IN THOUSANDS)
Interest-earning assets:
Real estate loans $ 100,268 $ 1,796 7.16% $ 107,218 $ 1,650 6.16%
Consumer loans 66,793 1,153 6.90 72,377 886 4.90
Commercial business loans 33,891 572 6.75 41,014 430 4.19
---------- --------- ------- ---------- -------- -------
Total loans 200,952 3,521 7.01 220,609 2,966 5.38
Investment securities 66,487 809 4.87 69,743 583 3.34
Mortgage-backed securities 45,913 392 3.42 80,913 592 2.93
---------- --------- ------- ---------- -------- -------
Total interest-earning assets 313,352 4,722 6.03 371,265 4,141 4.46
--------- ------- -------- -------
Non-earning assets 14,464 16,873
---------- ----------
Total assets $ 327,816 $ 388,138
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
Savings accounts $ 5,365 12 0.89 $ 10,466 24 0.92
Now and money market accounts 73,306 600 3.27 61,443 226 1.47
Certificates of deposit 134,784 1,278 3.79 176,982 1,262 2.85
---------- --------- ------- ---------- -------- -------
Total deposits 213,455 1,890 3.54 248,891 1,512 2.43
FHLB advances 46,157 565 4.90 44,722 483 4.32
Other borrowings 39,339 428 4.35 60,807 679 4.47
---------- --------- ------- ---------- -------- -------
Total interest-bearing
liabilities 298,951 2,883 3.86 354,420 2,674 3.02
--------- ------- -------- -------
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits 14,927 14,458
Other liabilities 470 1,612
---------- ----------
Total liabilities 314,348 370,490
Stockholders' equity 13,468 17,648
---------- ----------
Total liabilities and
stockholders' Equity $ 327,816 $ 388,138
========== ==========
Net interest income $ 1,839 $ 1,467
========== ==========
Interest rate spread 2.17% 1.44%
======== =======
Net interest margin 2.35% 1.58%
======== =======
18
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
MARCH 31, 2006 COMPARED TO
MARCH 31, 2005
-----------------------------------------------
CHANGE ATTRIBUTABLE TO
-----------------------------------------------
VOLUME RATE TOTAL
-----------------------------------------------
(IN THOUSANDS)
Real estate loans $ (107) $ 253 $ 146
Consumer loans (68) 335 267
Commercial business loans (75) 217 142
---------------- -------------- --------------
Total loans (250) 805 555
Investments (27) 253 226
Mortgage-backed securities (256) 56 (200)
---------------- -------------- --------------
Total interest-earning assets $ (533) $ 1,114 $ 581
================ ============== ==============
Savings accounts $ (12) $ (-) $ (12)
Now and money market accounts 44 330 374
Certificates of deposit (301) 317 16
---------------- -------------- --------------
Total deposits (269) 647 378
FHLB advances 15 67 82
Other borrowings (240) (11) (251)
---------------- -------------- --------------
Total interest-bearing liabilities (494) 703 209
================ ============== ==============
Change in net interest income $ (39) $ 411 $ 372
================ ============== ==============
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 and
assigns to them a reserve percentage that reflects the industry standard.
Management then looks at its classified assets, which are loans 30 days or more
delinquent, and classifies those loans as special mention, substandard, doubtful
or loss based on the performance of the loans. Those classified loans are then
individually evaluated for impairment and measured by either the present value
of expected future cash flows, the loan's observable market price, or the fair
value of the collateral. They are then segmented by type and assigned a reserve
percentage that reflects the underlying quality of the loan. 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 $1.4 million or 0.45% of total assets at
March 31, 2006, with $1.4 million classified as substandard, $27,000 classified
as doubtful and none classified as loss, compared to $1.5 million or 0.40%
classified as non-performing at March 31, 2005. Non-performing assets decreased
$100,000 from the comparable period one year ago, and the company increased the
provision for loan losses by $2,000. The decrease in non-performing assets from
the year ago period was due to the decrease of the outstanding balance of the
bank's residential real estate loans offset by an increase of one of the bank's
commercial business loans. The increase in provision was due primarily to the
increase in the required provision for that loan.
NON-INTEREST INCOME. Non-interest income decreased $1.1 million during
the quarter ended March 31, 2006, over the comparable period one year ago. That
decrease was primarily the result of decreases totaling $1.4 million in, gain on
sale of loans, gains on derivatives, a decline in other operating income and
service fees on deposits. Those decreases in income were partially offset by
increases of $362,000 in service fees on loans. The reduced level of gain on
19
sale of loans during the quarter ended March 31, 2006 resulted from lower than
anticipated loan origination and sales volumes at the bank's mortgage banking
subsidiary, lower margins than those obtained in the year-ago period and the
discontinued operations of the mortgage company effective March 29, 2006. The
decrease in other operating income reflects the gain recognized one year ago
from the sale of the bank's Winchester, Virginia branch.
The following table presents a comparison of the components of
non-interest income.
Difference
--------------------------------------
Three Months Ended March 31, 2006 2005 Amount %
- -------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Non-interest income:
Gain on sale of loans $ 657 $ 1,249 $ (592) (47.40)%
Service fees on loans 439 77 362 470.13
Service fees on deposits 99 137 (38) (27.74)
Gain (loss) on sale of investment - - - -
securities
Gain (loss) on derivatives 113 519 (406) (78.23)
Other operating income 31 431 (400) (92.81)
- -------------------------------------------------------------------------------------------------------------------
Total non-interest income $ 1,339 $ 2,413 $ (1,074) (44.51)%
===================================================================================================================
NON-INTEREST EXPENSE. Non-interest expense increased $546,000 from $3.8
million for the three months ended March 31, 2005 to $4.4 million for the three
months ended March 31 in the current year. The increase was primarily
attributable to a $398,000 increase in the mortgage company's non-interest
expense from that incurred in the comparable period one year ago. The increase
in non-interest expense at the mortgage company level was primarily $504,000 in
compensation, of which $401,000 was an expense reimbursement by the manager one
year ago with no comparable reimbursement for the three months ended March 31,
2006, and was coupled with increases in professional services, occupancy,
furniture fixtures and equipment, data processing and other operating expenses.
The increases identified above were partially offset by a decrease in
advertising. The increase of $149,000 in the bank's non-interest expense was
distributed over various non-interest expense categories with the primary
contributors being compensation and advertising.
The following table presents a comparison of the components of
non-interest expense.
Difference
---------------------------------
Three Months Ended March 31, 2006 2005 Amount %
- ---------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Non-interest expense:
Compensation and employee benefits $ 1,997 $ 1,330 $ 667 50.15%
Occupancy 435 434 1 00.23
Professional services 423 291 132 45.36
Advertising 355 579 (224) (38.69)
Deposit insurance premium 25 21 4 19.05
Furniture, fixtures and equipment 265 284 (19) (6.69)
Data processing 251 313 (62) (19.81)
Other operating expense 609 562 47 8.36
- ---------------------------------------------------------------------------------------------------------------------
Total non-interest expense $ 4,360 $ 3,814 $ 546 14.32%
=====================================================================================================================
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 2006 with existing net operating losses
carried forward from prior years. The company believes that it will generate
taxable income in the foreseeable future, which will assure the use of existing
net operating losses.
20
Contractual Obligations and Off-Balance Sheet Financing Arrangements
The following table summarizes the bank's contractual obligations at
March 31, 2006 and the effect those obligations are expected to have on the
bank's liquidity and cash flows in future periods.
- -----------------------------------------------------------------------------------------------------------------
Less Than One Two - Three Four - Five After Five
Total Year Years Years Years
- -----------------------------------------------------------------------------------------------------------------
(In thousands)
FHLB Advances (1) $ 38,000 $ 7,000 $ 6,000 $ - $ 25,000
Reverse repurchase agreements 26,331 26,331 - - -
Operating leases 5,158 1,017 2,078 1,502 561
- -----------------------------------------------------------------------------------------------------------------
Total obligations $ 69,489 $ 34,348 $ 8,078 $ 1,502 $ 25,561
=================================================================================================================
(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) $ 134,238 $ 101,818 $ 26,936 $ 5,391 $ 93
Loan originations 28,187 28,187 - - -
Unfunded lines of credit 112,785 112,785 - - -
Standby letters of credit 96 96 - - -
- -----------------------------------------------------------------------------------------------------------------
Total $ 275,306 $ 242,886 $ 26,936 $ 5,391 $ 93
=================================================================================================================
(1) The company expects to retain maturing deposits or replace amounts
maturing with comparable certificates of deposits based on current market
interest rates.
COMPARISON OF RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED
MARCH 31, 2006 AND MARCH 31, 2005
NET INCOME. For the six months ended March 31, 2006, the company had
net loss of $3.3 million or $1.10 per diluted share compared to net earnings of
$526,000 or $0.17 per diluted share for the six months ended March 31, 2005. The
decline in earnings of $3.8 million over the comparable period one-year ago was
primarily the result of an increase in non-interest expense, a decrease in
non-interest income and an increase in the provision for loan losses. Those
declines were partially offset by an increase in net interest income.
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.
21
The following table presents a comparison of the components of interest
income and expense and net interest income.
Difference
- -----------------------------------------------------------------------------------------------------------------------
Six Months Ended March 31, 2006 2005 Amount %
- -----------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Interest income:
Loans $ 7,061 $ 6,269 $792 12.63%
Investments 2,400 2,277 123 5.40
- -----------------------------------------------------------------------------------------------------------------------
Total 9,461 8,546 915 10.71
- -----------------------------------------------------------------------------------------------------------------------
Interest expense:
Deposits 3,654 3,026 628 20.75
Borrowings 2,091 2,465 (374) (15.17)
- -----------------------------------------------------------------------------------------------------------------------
Total 5,745 5,491 254 4.63
- -----------------------------------------------------------------------------------------------------------------------
Net interest income $ 3,716 $ 3,055 $661 21.64%
=======================================================================================================================
The increase in net interest income during the six months ended March
31, 2006, resulted primarily from a 73 basis point increase in net interest
margin (net interest income divided by average interest-earning assets) from
1.59% for the six months ended March 31, 2005 to 2.32% for the six months ended
March 31, 2006, offset in part by a $64.7 million decrease in the bank's
interest-earning assets. Contributing to the increase in the net interest margin
was a $107,000 reduction in interest expense resulting from payments made on
certain interest rate swap and cap agreements compared to a charge of $508,000
in the comparable period one year ago. That increase in net interest margin also
resulted from the average yield on interest-earning assets increasing 68 basis
points more than the increase in the average cost on interest-bearing
liabilities and was partially offset by average interest earning assets
decreasing by $741,000 more than the decline in average interest bearing
liabilities.
INTEREST INCOME. Interest income for the six months ended March 31,
2006 increased $915,000 compared to the six months ended March 31, 2005,
primarily as a result of a 147 basis point increase in the average yield earned
on interest earning assets. That increase was partially offset by a decrease of
$64.7 million in the average outstanding balances of loans and securities.
INTEREST EXPENSE. The $254,000 increase in interest expense for the six
months ended March 31, 2006 compared to the 2005 period was principally the
result of a 79 basis point increase in the cost of funds on average deposits and
borrowed funds. That increase in the cost of funds was partially offset by a
$64.0 million decrease in average deposits and borrowed funds. The increase in
interest expense on deposits was primarily due to a 107 basis point increase in
rates paid on deposits. The increase in expense was primarily due to higher
rates paid on interest-bearing demand deposits, savings accounts and
certificates and elevated pricing on new and renewed time deposits. That
increase was partially offset by a decrease of $44.5 million in average deposits
from $259.1 million for the six months ended March 31, 2005 to $214.6 million
for the six months ended March 31, 2006.
The decrease in interest expense on borrowings for the six months ended
March 31, 2006, when compared to the 2005 period, was principally the result of
a $19.4 million decrease in average borrowed funds and was partially offset by a
14 basis point increase in the cost of borrowed funds. Components accountable
for the decrease of $374,000 in interest expense on borrowings were a $454,000
decrease relating to average volume, offset in part by an $80,000 increase
relating to average cost.
22
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 SIX MONTHS ENDED MARCH 31,
--------------------------------------------------------------------------------
2006 2005
--------------------------------------------------------------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
BALANCE EXPENSE RATE BALANCE EXPENSE RATE
--------------------------------------------------------------------------------
ASSETS: (DOLLARS IN THOUSANDS)
Interest-earning assets:
Real estate loans $ 101,567 $ 3,605 7.10% $ 110,915 $ 3,497 6.31%
Consumer loans 67,719 2,269 6.70 72,794 1,718 4.72
Commercial business loans 34,891 1,187 6.80 43,473 1,054 4.85
------------ ----------- ------------ ------------ ------------- ------------
Total loans 204,177 7,061 6.92 227,182 6,269 5.52
Investment securities 66,339 1,589 4.79 70,791 1,092 3.09
Mortgage-backed securities 49,880 811 3.25 87,135 1,185 2.72
------------ ----------- ------------ ------------ ------------- ------------
Total interest-earning assets 320,396 9,461 5.91 385,108 8,546 4.44
------------ ------------ ------------- ------------
Non-earning assets 15,566 19,320
-------------- ------------
Total assets $ 335,962 $ 404,428
============== ============
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
Savings accounts $ 6,058 28 0.92 $ 11,803 56 0.95
Now and money market accounts 71,264 1,123 3.15 67,121 456 1.36
Certificates of deposit 137,253 2,503 3.65 180,201 2,514 2.79
------------ ----------- ------------ ------------ ------------- ------------
Total deposits 214,575 3,654 3.41 259,125 3,026 2.34
FHLB advances 48,442 1,179 4.87 45,405 972 4.28
Other borrowings 42,100 912 4.33 64,558 1,493 4.63
------------ ----------- ------------ ------------ ------------- ------------
Total interest-bearing liabilities 305,117 5,745 3.77 369,088 5,491 2.98
------------ ------------ ------------- ------------
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits 15,297 14,978
Other liabilities 1,034 1,651
-------------- ------------
Total liabilities 321,448 385,717
Stockholders' equity 14,514 18,711
-------------- ------------
Total liabilities and stockholders'
equity $ 335,962 $ 404,428
============== ============
Net interest income $ 3,716 $ 3,055
============ =============
Interest rate spread 2.14% 1.46%
============ ============
Net interest margin 2.32% 1.59%
============ ============
23
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.
SIX MONTHS ENDED
MARCH 31, 2006 COMPARED TO
MARCH 31, 2005
-----------------------------------------------
CHANGE ATTRIBUTABLE TO
-----------------------------------------------
VOLUME RATE TOTAL
-----------------------------------------------
(IN THOUSANDS)
Real estate loans $ (295) $ 403 $ 108
Consumer loans (120) 671 551
Commercial business loans (208) 341 133
---------------- -------------- --------------
Total loans (623) 1,415 792
Investments (69) 566 497
Mortgage-backed securities (507) 133 (374)
---------------- -------------- --------------
Total interest-earning assets $ (1,199) $ 2,114 $ 915
================ ============== ==============
Savings accounts $ (27) $ (1) $ (28)
Now and money market accounts 28 639 667
Certificates of deposit (599) 588 (11)
---------------- -------------- --------------
Total deposits (598) 1,226 628
FHLB advances 65 142 207
Other borrowings (519) (62) (581)
---------------- -------------- --------------
Total interest-bearing liabilities (1,052) 1,306 254
================ ============== ==============
Change in net interest income $ (147) $ 808 $ 661
================ ============== ==============
PROVISION FOR LOAN LOSSES. Non-performing assets were $1.4 million or
0.45% of total assets at March 31, 2006, with $1.4 million classified as
substandard, $27,000 classified as doubtful and none classified as loss,
compared to $1.5 million or 0.40% classified as non-performing at March 31,
2005. Non-performing assets decreased $100,000 from the comparable period one
year ago, and the bank increased its provision for loan losses by $71,000. The
decrease in non-performing assets from the year ago period was due to the
decrease of the outstanding balance of the bank's residential real estate loans,
offset in part by an increase of one of the bank's commercial business loans.
The increase in provision was due primarily to the increase in the required
provision for that loan.
NON-INTEREST INCOME. Non-interest income decreased $2.1 million during
the six months ended March 31, 2006, over the comparable period one year ago.
That decrease was primarily the result of decreases totaling $2.9 million in
gain on sale of loans, gains on derivatives, gain on sale of investment
securities and declines in other operating income and service fees on deposits.
Those decreases in income were partially offset by increases of $680,000 and
$65,000, respectively, in service fees on loans and gain on sale of real estate
owned. The reduced level of gain on sale of loans during the six months ended
March 31, 2006 resulted from lower than anticipated loan origination and sales
volumes at the bank's mortgage banking subsidiary, lower margins than those
obtained in the year-ago period and the discontinuance of operations of the
mortgage company effective March 29, 2006. The decrease in other operating
income reflects the $682,000 gain recognized one year ago from the sale of the
bank's Washington, D.C. and Winchester, Virginia branches, totaling.
24
The following table presents a comparison of the components of
non-interest income.
Difference
- ------------------------------------------------------------------------------------------------------------------
Six Months Ended March 31, 2006 2005 Amount %
- ------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Non-interest income:
Gain on sale of loans $ 1,465 $ 2,327 $ (862) (37.04)%
Service fees on loans 824 144 680 472.22
Service fees on deposits 203 305 (102) (33.44)
Gain on sale of investment securities - 538 (538) (100.00)
Gain on derivatives 184 882 (698) (79.14)
Gain on sale of real estate owned 65 - 65 N/A
Other operating income 46 716 (670) (93.58)
- ------------------------------------------------------------------------------------------------------------------
Total non-interest income $ 2,787 $ 4,912 $ (2,125) (43.26)%
==================================================================================================================
NON-INTEREST EXPENSE. Non-interest expense increased $2.3 million from
$7.4 million for the six months ended March 31, 2005 to $9.7 million for the six
months ended March 31 in the current year. The increase was primarily
attributable to a $2.1 million increase in the mortgage company's non-interest
expense from that incurred in the comparable period one year ago. The increase
in non-interest expense at the mortgage company level was primarily a
non-recurring pre-tax impairment charge of $996,000 recorded in other operating
expenses, $1.2 million in compensation, of which $972,000 was an expense
reimbursement by the manager one year ago with no comparable reimbursement for
the six months ended March 31, 2006, and was coupled with increases in
professional services, occupancy and furniture fixtures and equipment. The
impairment charge requires a write down of long-lived assets by recording a
charge due to the anticipated discontinuance of operations. Accordingly, at
March 31, 2006, the Company set up a reserve for loss and charged $1.3 million
against earnings to account for the funds that were to have been contributed to
the mortgage company by the manager. The increases identified above were
partially offset by decreases in advertising and data processing totaling
$504,000. The increase of $169,000 in the bank's non-interest expense was
distributed over various non-interest expense categories with the major
contributors being compensation and advertising.
The following table presents a comparison of the components of
non-interest expense.
Difference
- -----------------------------------------------------------------------------------------------------------------------
Six Months Ended March 31, 2006 2005 Amount %
- -----------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Noninterest expense:
Compensation and employee benefits $ 4,013 $ 2,561 $ 1,452 56.70%
Occupancy 853 895 (42) (4.69)
Professional services 785 511 274 53.62
Advertising 890 1,138 (248) (21.79)
Deposit insurance premium 53 32 21 65.63
Furniture, fixtures and equipment 516 583 (67) (11.49)
Data processing 507 637 (130) (20.41)
Other operating expense 2,127 1,081 1,046 96.76
- -----------------------------------------------------------------------------------------------------------------------
Total noninterest expense $ 9,744 $ 7,438 $ 2,306 31.00%
=======================================================================================================================
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 2006 with existing net operating losses
carried forward from prior years. The company believes that it will generate
taxable income in the foreseeable future, which will assure the use of existing
net operating losses.
25
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 March 31, 2006, cash and cash equivalents, interest bearing deposits
and securities available-for-sale totaled $102,843 million or 32.32% of total
assets.
The primary investing activities of the bank are the origination of
consumer loans, residential one- to four-family loans, commercial business
loans, commercial real estate loans, and real estate construction and
development loans and the purchase of United States Treasury and agency
securities, mortgage-backed and mortgage-related securities and other investment
securities. During the six months ended March 31, 2006, the bank's loan
purchases and originations totaled $46.2 million. Purchases of United States
Treasury and agency securities, mortgage-backed and mortgage related securities
and other investment securities totaled $7.7 million for the six months ended
March 31, 2006.
The bank has other sources of liquidity if a need for additional funds
arises. At March 31, 2006, the bank had $38.0 million in advances outstanding
from the FHLB and had an additional overall borrowing capacity from the FHLB of
$24.5 million. Depending on market conditions, the pricing of deposit products
and the pricing of FHLB advances, the bank may continue to rely on FHLB
borrowings to fund asset growth.
At March 31, 2006, 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 $141.1 million. The 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 March 31, 2006, totaled
$101.8 million. Based upon experience, management believes the majority of
maturing deposits 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 those 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
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. In
general, market risk reflects 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
26
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.
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 the 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 March 31, 2006, we held an aggregate notional value of $30 million of caps
and $24 million of swaps that pay-a fixed interest rate. None of the interest
rate caps had strike rates that were in effect at March 31, 2006, 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.
The following table, which is based on information that we provide to
the Office of Thrift Supervision, presents the change in our net portfolio value
at December 31, 2005 that would occur in the event of an immediate change in
interest rates based on Office of Thrift Supervision assumptions, with no effect
given to any steps that we might take to counteract that change.
Net Portfolio Value Net Portfolio Value as % of
(Dollars in thousands) Portfolio Value of Assets
----------------------------------------------- ----------------------------------
Basic Point ("bp")
Change in Rates $Amount $Change % Change NPV Ratio Change (bp)
- -------------------------- -------------- ----------------- -------------- ---------------- ----------------
+300 29,139 -1,092 -4% 8.70% -8bp
+200 30,288 156 1% 8.98% 19bp
+100 30,460 228 1% 8.92% 14bp
0 30,231 - - 8.79% -
-100 28,551 -1,680 -6% 8.26% -52bp
-200 26,778 -3,453 -11% 7.73% -106bp
The Office of Thrift Supervision uses various assumptions in assessing
interest rate risk. Those assumptions relate to interest rates, loan prepayment
rates, deposit decay rates and the market values of certain assets under
differing interest rate scenarios, among others. As with any method of measuring
interest rate risk, certain shortcomings are inherent in the methods of analyses
presented in the foregoing tables. For example, although certain assets and
27
liabilities may have similar maturities or periods to repricing, they may react
in different degrees to changes in market interest rates. Also, the interest
rates on certain types of assets and liabilities may fluctuate in advance of
changes in market interest rates, while interest rates on other types may lag
behind changes in market rates. Additionally, certain assets, such as
adjustable-rate mortgage loans, have features that restrict changes in interest
rates on a short-term basis and over the life of the asset. Further, in the
event of a change in interest rates, expected rates of prepayments on loans and
early withdrawals from certificates could deviate significantly from those
assumed in calculating the table. Prepayment rates can have a significant impact
on interest income. Because of the large percentage of loans and mortgage-backed
securities we hold, rising or falling interest rates have a significant impact
on the prepayment speeds of our earning assets that in turn affect the rate
sensitivity position. When interest rates rise, prepayments tend to slow. When
interest rates fall, prepayments tend to rise. Our asset sensitivity would be
reduced if prepayments slow and vice versa. While we believe these assumptions
to be reasonable, there can be no assurance that assumed prepayment rates will
approximate actual future mortgage-backed security and loan repayment activity.
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 performed within the period, the chief executive and chief financial
officers of the Company concluded that the Company's disclosure controls and
procedures were effective.
(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 1A. Risk Factors
OUR INCREASED EMPHASIS ON COMMERCIAL AND CONSTRUCTION LENDING MAY EXPOSE US TO
INCREASED LENDING RISKS.
At March 31, 2006, our loan portfolio consisted of $23.0 million, or
11.35% of commercial real estate loans, $34.7 million, or 17.13% of construction
and land development loans and $32.5 million, or 16.02% of commercial business
loans. We intend to increase our emphasis on these types of loans. These types
of loans generally expose a lender to greater risk of non-payment and loss than
one- to four-family residential mortgage loans because repayment of the loans
often depends on the successful operation of the property, the income stream of
the borrowers and, for construction loans, the accuracy of the estimate of the
property's value at completion of construction and the estimated cost of
construction. Such loans typically involve larger loan balances to single
borrowers or groups of related borrowers compared to one- to four-family
residential mortgage loans. Commercial business loans expose us to additional
risks since they typically are made on the basis of the borrower's ability to
make repayments from the cash flow of the borrower's business and are secured by
non-real estate collateral that may depreciate over time. In addition, since
such loans generally entail greater risk than one- to four-family residential
mortgage loans, we may need to increase our allowance for loan losses in the
future to account for the likely increase in probable incurred credit losses
associated with the growth of such loans. Also, many of our commercial and
construction borrowers have more than one loan outstanding with us.
Consequently, an adverse development with respect to one loan or one credit
relationship can expose us to a significantly greater risk of loss compared to
an adverse development with respect to a one- to four-family residential
mortgage loan.
28
STRONG COMPETITION WITHIN OUR MARKET AREA COULD HURT OUR ABILITY TO COMPETE AND
COULD SLOW OUR GROWTH.
We face intense competition both in making loans and attracting
deposits. This competition has made it more difficult for us to make new loans
and has occasionally forced us to offer higher deposit rates. Price competition
for loans and deposits might result in us earning less on our loans and paying
more on our deposits, which reduces net interest income. Some of the
institutions with which we compete have substantially greater resources and
lending limits than we have and may offer services that we do not provide. We
expect competition to increase in the future as a result of legislative,
regulatory and technological changes and the continuing trend of consolidation
in the financial services industry. Our profitability depends upon our continued
ability to compete successfully in our market area.
AN INCREASE IN LOAN PREPAYMENTS AND ON PREPAYMENT OF LOANS UNDERLYING
MORTGAGE-BACKED SECURITIES AND SMALL BUSINESS ADMINISTRATION CERTIFICATES MAY
ADVERSELY AFFECT OUR PROFITABILITY.
Prepayment rates are affected by consumer behavior, conditions in the
housing and financial markets, general economic conditions and the relative
interest rates on fixed-rate and adjustable-rate mortgage loans. Although
changes in prepayment rates are, therefore, difficult for us to predict,
prepayment rates tend to increase when market interest rates decline relative to
the rates on the prepaid instruments.
We recognize our deferred loan origination costs and premiums paid on
originating these loans by adjusting our interest income over the contractual
life of the individual loans. As prepayments occur, the rate at which net
deferred loan origination costs and premiums are expensed accelerates. The
effect of the acceleration of deferred costs and premium amortization may be
mitigated by prepayment penalties paid by the borrower when the loan is paid in
full within a certain period of time, which varies between loans. If prepayment
occurs after the period of time when the loan is subject to a prepayment
penalty, the effect of the acceleration of premium and deferred cost
amortization is no longer mitigated.
We recognize premiums we pay on mortgage-backed securities and Small
Business Administration Certificates as an adjustment from interest income over
the life of the security based on the rate of repayment of the securities.
Acceleration of prepayment on the loans underlying a mortgage-backed security or
small business administration certificate shortens the life of the security,
increases the rate at which premiums are expensed and further reduces interest
income.
We may not be able to reinvest loan and security prepayments at rates
comparable to the prepaid instruments particularly in periods of declining
interest rates.
WE OPERATE IN A HIGHLY REGULATED ENVIRONMENT AND WE MAY BE ADVERSELY AFFECTED BY
CHANGES IN LAWS AND REGULATIONS.
The bank is subject to extensive regulation, supervision and
examination by the Office of Thrift Supervision and by the Federal Deposit
Insurance Corporation, as insurer of its deposits. Such regulation and
supervision govern the activities in which the bank and the company may engage,
and are intended primarily for the protection of the insurance fund and for the
depositors and borrowers of the bank. The regulation and supervision by the
Office of Thrift Supervision and the Federal Deposit Insurance Corporation are
not intended to protect the interests of investors in the common stock of the
company. Regulatory authorities have extensive discretion in their supervisory
and enforcement activities, including the imposition of restrictions on our
operations, the classification of our assets and determination of the level of
our allowance for loan losses. Any change in such regulation and oversight,
whether in the form of regulatory policy, regulations, legislation or
supervisory action, may have a material impact on our operations.
A BREACH OF INFORMATION SECURITY COULD NEGATIVELY AFFECTS OUR EARNINGS.
Increasingly, we depend upon data processing, communication and
information exchange on a variety of computing platforms and networks and over
the Internet. We cannot be certain all our systems are entirely free from
vulnerability to attack, despite safeguards we have instituted. In addition, we
rely on the services of a variety of vendors to meet data processing and
communication needs. If information security is breached, information can be
lost or misappropriated, resulting in financial loss or costs to us or damages
to others. These costs or losses could materially exceed the amount of insurance
coverage, if any, which would adversely affect our earnings.
29
WE ARE SUBJECT TO HEIGHTENED REGULATORY SCRUTINY WITH RESPECT TO BANK SECRECY
AND ANTI-MONEY LAUNDERING STATUTES AND REGULATIONS.
Recently, regulators have intensified their focus on the USA PATRIOT
Act's anti-money laundering and Bank Secrecy Act compliance requirements. There
is also increased scrutiny of our compliance with the rules enforced by the
Office of Foreign Assets Control. In order to comply with regulations,
guidelines and examination procedures in this area, we have been required to
adopt new policies and procedures and to install new systems. We cannot be
certain that the policies, procedures and systems we have in place are flawless.
Therefore, there is no assurance that in every instance we are in full
compliance with these requirements.
FAILURE TO PAY INTEREST ON OUR DEBT MAY ADVERSELY IMPACT US.
Deferral of interest payments where allowed on our convertible
preferred securities may affect our ability to issue additional debt.
ITEM 2. Unregistered Sales of Equity 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
(a) Greater Atlantic Financial Corp. annual Stockholder's Meeting
was held on March 29, 2006.
(b) Omitted per instructions
(c) A brief description of each matter voted upon at the Annual
Stockholder's Meeting held on March 29, 2006 and number of
votes cast for, against or withheld
1. Election of Directors.
Votes For Votes Against Votes Withheld
--------- ------------- --------------
Paul Cinquegrana 2,288,295 0 301,214
Jeffrey W. Ochsman 2,347,174 0 242,335
In addition to Paul Cinquegrana and Jeffrey W. Ochsman the terms of
office of Directors Jeffrey M. Gitelman, Sidney M. Bresler, Charles W.
Calomiris, Carroll E. Amos and James B. Vito continued after the
meeting.
2. Election of BDO Seidman, LLP as Independent Auditor.
Votes For Votes Against Votes Withheld
--------- ------------- --------------
2,444,101 136,908 8,500
ITEM 5. Other Information
Not applicable.
ITEM 6. Exhibits
(a) Exhibits
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
30
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: May 12, 2006
31