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 June 30, 2007
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 August 13, 2007, there were 3,024,220 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 JUNE 30, 2007
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE NO.
- ------------------------------ --------
Item 1. Condensed Financial Statements (Unaudited)
Consolidated Statements of Financial Condition at June 30, 2007 and September 30, 2006............................3
Consolidated Statements of Operations
for the three and nine months ended June 30, 2007 and June 30, 2006...............................................4
Consolidated Statements of Comprehensive Income (Loss)
for the three and nine months ended June 30, 2007 and June 30, 2006...............................................5
Consolidated Statements of Changes in Stockholders' Equity
for the nine months ended June 30, 2007 and June 30, 2006.........................................................5
Consolidated Statements of Cash Flows
for the nine months ended June 30, 2007 and June 30, 2006.........................................................6
Notes to Consolidated Financial Statements........................................................................8
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.........................15
Item 3. Quantitative and Qualitative Disclosures about Market Risk....................................................27
Item 4. Controls and Procedures.......................................................................................28
PART II. OTHER INFORMATION
- ---------------------------
Item 1. Legal Proceedings...........................................................................................29
Item 1A. Risk Factors.................................................................................................29
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.................................................31
Item 3. Defaults Upon Senior Securities.............................................................................31
Item 4. Submission of Matters to a Vote of Security Holders.........................................................31
Item 5. Other Information...........................................................................................31
Item 6. Exhibits....................................................................................................31
SIGNATURES.............................................................................................................32
CERTIFICATIONS.........................................................................................................33
GREATER ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)
June 30, September 30,
----------------------------------
2007 2006 (a)
------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Assets
Cash and cash equivalents:
Non-interest bearing and vault $ 3,796 $ 2,516
Interest bearing 49,352 17,288
Investment securities
Available-for-sale 54,913 75,461
Held-to-maturity 3,467 4,696
Loans receivable, net 179,072 193,307
Accrued interest and dividends receivable 1,710 2,073
Deferred income taxes 1,949 1,928
Federal Home Loan Bank stock, at cost 1,641 2,388
Premises and equipment, net 2,457 2,764
Goodwill 956 956
Prepaid expenses and other assets 1,578 1,842
------------------------------------------------------------------------------------------------------------
Total assets $ 300,891 $ 305,219
============================================================================================================
Liabilities and Stockholders' equity
Liabilities
Deposits $ 254,397 $ 230,174
Advance payments from borrowers for taxes and insurance 372 270
Accrued expenses and other liabilities 1,465 1,963
Advances from the FHLB and other borrowings 28,649 54,574
Junior subordinated debt securities 9,372 9,388
------------------------------------------------------------------------------------------------------------
Total liabilities 294,255 296,369
------------------------------------------------------------------------------------------------------------
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; 3,024,220 shares outstanding 30 30
Additional paid-in capital 25,273 25,228
Accumulated deficit (17,584) (15,359)
Accumulated other comprehensive loss (1,083) (1,049)
------------------------------------------------------------------------------------------------------------
Total stockholders' equity 6,636 8,850
------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 300,891 $ 305,219
============================================================================================================
(a) Consolidated Statement of Financial Condition as of September 30, 2006 has
been derived from audited consolidated financial statements. See
accompanying notes to consolidated financial statements
3
GREATER ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended Nine Months Ended
June 30, June 30,
- ----------------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Data) 2007 2006 2007 2006
- ----------------------------------------------------------------------------------------------------------------------------
Interest income
Loans $ 3,459 $ 3,426 $ 10,780 $ 10,217
Investments 1,225 1,327 3,302 3,726
- ----------------------------------------------------------------------------------------------------------------------------
Total interest income 4,684 4,753 14,082 13,943
- ----------------------------------------------------------------------------------------------------------------------------
Interest expense
Deposits 2,459 2,030 6,885 5,684
Borrowed money 617 911 2,091 2,878
- ----------------------------------------------------------------------------------------------------------------------------
Total interest expense 3,076 2,941 8,976 8,562
- ----------------------------------------------------------------------------------------------------------------------------
Net interest income 1,608 1,812 5,106 5,381
Provision (recapture) for loan losses (4) 13 289 87
- ----------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 1,612 1,799 4,817 5,294
- ----------------------------------------------------------------------------------------------------------------------------
Noninterest income
Fees and service charges 158 148 465 445
Gain (loss) on derivatives 23 154 (10) 445
Gain on sale of foreclosed real estate - - - 65
Other operating income 5 5 17 25
- ----------------------------------------------------------------------------------------------------------------------------
Total noninterest income 186 307 472 980
- ----------------------------------------------------------------------------------------------------------------------------
Noninterest expense
Compensation and employee benefits 1,082 1,216 3,523 3,502
Occupancy 364 357 1,051 1,008
Professional services 210 281 932 799
Advertising 32 183 102 547
Deposit insurance premium 7 24 36 77
Furniture, fixtures and equipment 128 135 395 415
Data processing 197 235 649 703
Other operating expenses 286 291 826 818
- ----------------------------------------------------------------------------------------------------------------------------
Total noninterest expense 2,306 2,722 7,514 7,869
- ----------------------------------------------------------------------------------------------------------------------------
Loss from continuing operations before income taxes (508) (616) (2,225) (1,595)
Provision for income taxes - - - -
- ----------------------------------------------------------------------------------------------------------------------------
Loss from continuing operations (508) (616) (2,225) (1,595)
Discontinued operations:
Loss from operations - (19) - (2,499)
- ----------------------------------------------------------------------------------------------------------------------------
Net loss $ (508) $ (635) $ (2,225) $ (4,094)
============================================================================================================================
Loss per common share BASIC AND DILUTED:
Continuing operations $ (0.17) $ (0.20) $ (0.74) $ (0.53)
Discontinued operations - (0.01) - (0.83)
- ----------------------------------------------------------------------------------------------------------------------------
Net loss $ (0.17) $ (0.21) $ (0.74) $ (1.36)
============================================================================================================================
Weighted average common shares outstanding
Basic and diluted 3,024,220 3,020,934 3,023,133 3,020,934
See accompanying notes to consolidated financial statements
4
GREATER ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
Three months ended Nine months ended
-----------------------------------------------------------
June 30, June 30,
- ---------------------------------------------------------------------------------------------------------------
(In Thousands) 2007 2006 2007 2006
- ---------------------------------------------------------------------------------------------------------------
Net (loss) earnings $ (508) $ (635) $ (2,225) $ (4,094)
- ---------------------------------------------------------------------------------------------------------------
Other comprehensive (loss) income, net of tax
Unrealized (loss) gain on securities (90) 81 (34) (72)
- ---------------------------------------------------------------------------------------------------------------
Other comprehensive (loss) income (90) 81 (34) (72)
- ---------------------------------------------------------------------------------------------------------------
Comprehensive (loss) income $ (598) $ (554) $ (2,259) $ (4,166)
===============================================================================================================
GREATER ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED)
FOR THE NINE MONTHS ENDED JUNE 30, 2007 AND 2006
- ----------------------------------------------------------------------------------------------------------------------------
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, 2005 (as
restated) $- $ 30 $ 25,228 $ (9,788) $ (1,095) $ 14,375
Other comprehensive loss - - - - (72) (72)
Net loss for the period - - - (4,094) - (4,094)
- ----------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 2006 $- $ 30 $ 25,228 $ (13,882) $ (1,167) $ 10,209
============================================================================================================================
Balance at September 30, 2006 $- $ 30 $ 25,228 $ (15,359) $ (1,049) $ 8,850
Stock option expense - - 22 - - 22
Conversion of trust preferred
securities 23 23
Other comprehensive loss - - - - (34) (34)
Net loss for the period - - - (2,225) - (2,225)
- ----------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 2007 $- $ 30 $ 25,273 $ (17,584) $ (1,083) $ 6,636
============================================================================================================================
See accompanying notes to consolidated financial statements
5
GREATER ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Nine months ended June 30,
------------------------------
2007 2006
- ----------------------------------------------------------------------------------------------------------------
(In Thousands)
Cash flow from operating activities
Net loss $ (2,225) $ (4,094)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities
Provision for loan loss 289 87
Amortization of deferred loan acquisition cost, net 28 (45)
Depreciation and amortization 338 540
Loss (gain) on derivatives 10 (445)
Amortization of investment security premiums 544 606
Amortization of mortgage-backed securities premiums 310 491
Amortization of deferred fees (247) (419)
Discount accretion net of premium amortization 218 (207)
Amortization of convertible preferred stock costs 7 7
Stock option expense 22 -
Gain on sale of loans held for sale - (1,511)
Gain on sale of foreclosed real estate - (65)
Gain on sale of fixed assets - (26)
(Increase) decrease in assets
Disbursements for origination of loans held for sale - (91,477)
Proceeds from sales of loans - 102,218
Accrued interest and dividend receivable 363 (226)
Prepaid expenses and other assets 171 917
Deferred loan fees collected, net of deferred costs incurred 367 297
Increase (decrease) in liabilities
Accrued expenses and other liabilities (415) (300)
- ----------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities (220) 6,348
- ----------------------------------------------------------------------------------------------------------------
Continued
6
GREATER ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) - (CONTINUED)
Nine months ended June 30,
----------------------------
2007 2006
- ------------------------------------------------------------------------------------------------------------
(In Thousands)
Cash flow from investing activities
Net decrease in loans $ 13,580 $ 7,096
Disposal (purchase) of premises and equipment, net (31) 800
Purchases of investment securities - (7,707)
Proceeds from repayments of other investment securities 9,130 12,447
Proceeds from repayments of mortgage-backed securities 11,739 18,884
Proceeds from the sale of foreclosed assets - 297
Purchases of FHLB stock (653) (2,115)
Proceeds from sale of FHLB stock 1,399 2,320
- ------------------------------------------------------------------------------------------------------------
Net cash provided by investing activities 35,164 32,022
- ------------------------------------------------------------------------------------------------------------
Cash flow from financing activities
Net increase (decrease) in deposits 24,223 (17,567)
Net decrease in advances from the FHLB and other borrowings (25,925) (19,709)
Increase in advance payments by borrowers
for taxes and insurance 102 51
- ------------------------------------------------------------------------------------------------------------
Net cash used in financing activities (1,600) (37,225)
- ------------------------------------------------------------------------------------------------------------
Increase in cash and cash equivalents 33,344 1,145
- ------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, at beginning of period 19,804 4,709
- ------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, at end of period $ 53,148 $ 5,854
============================================================================================================
See accompanying notes to consolidated financial statements
7
GREATER ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INFORMATION AS OF JUNE 30, 2007 AND THREE AND THE NINE MONTHS
ENDED JUNE 30, 2007 AND 2006 (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") 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. It is
recommended that these consolidated financial statements be read in conjunction
with the company's Annual Report on Form 10-K for the year ended September 30,
2006. The results of operations for the three months or the nine months ended
June 30, 2007 are not necessarily indicative of the results of operations that
may be expected for the year ending September 30, 2007 or any future periods. In
addition to reclassifications related to discontinued operations, other
reclassifications have been made to prior periods to place them on a basis
comparable with the current period presentation.
(2) BANK MERGER
As previously reported in a Form 8-K filed on April 16, 2007, on April
12, 2007, the company announced that it and Summit Financial Group, Inc.
("Summit") entered into a definitive agreement for the company to merge with and
into Summit and that the bank and Bay-Vanguard Federal Savings Bank
("Bay-Vanguard"), entered into a definitive agreement for Bay-Vanguard to
purchase the bank's branch office in Pasadena, Maryland.
(3) DISCONTINUED OPERATIONS
On March 29, 2006, we began the process of discontinuing the operations
of Greater Atlantic Mortgage Corporations ("GAMC"), the bank's mortgage company
subsidiary. It was determined that this business no longer fit our strategy.
As a result of the above action, we applied discontinued operations
accounting in the third quarter of 2006, as we completed the closing of the GAMC
business. Accordingly, the income statements for all periods have been adjusted.
The reclassification of GAMC's results to discontinued operations primarily
resulted in a reduction to previously reported levels of net interest income, a
reduction in noninterest income and a reduction in noninterest expense. The
table below summarizes GAMC's results which were treated as discontinued
operations for the periods indicated.
Three months Nine months
ended June 30, ended June 30,
------------------- ------------------
2006 2006
- -----------------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Data)
Interest income $ 9 $ 280
Interest expense 25 257
- -----------------------------------------------------------------------------------------
Net interest income (16) 23
Noninterest income 59 2,136
Noninterest expense 62 4,658
- -----------------------------------------------------------------------------------------
Net income (loss) $ (19) $(2,499)
=========================================================================================
Earnings (loss) per share - basic $ (0.01) $ (0.83)
Earnings (loss) per share - diluted (0.01) (0.83)
8
GREATER ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INFORMATION AS OF JUNE 30, 2007 AND THREE AND THE NINE MONTHS
ENDED JUNE 30, 2007 AND 2006 (UNAUDITED)
(4) 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 (also
see page 21 for discussion of non-performing loans):
At or for the nine months
ended June 30,
------------------------------------
2007 2006
- ---------------------------------------------------------------------------------------------
(Dollars in Thousands)
Balance at beginning of period $ 1,330 $ 1,212
Provisions 289 87
Total charge-offs (329) (60)
Total recoveries 632 24
- ---------------------------------------------------------------------------------------------
Net recoveries (charge-offs) 303 (36)
- ---------------------------------------------------------------------------------------------
Balance at end of period $ 1,922 $ 1,263
=============================================================================================
Ratio of net charge-offs (recoveries) during the period
to average loans outstanding during the period (0.16)% 0.02%
=============================================================================================
Allowance for loan losses to total non-performing
loans at end of period 116.18% 110.60%
=============================================================================================
Allowance for loan losses to total loans 1.04% 0.65%
=============================================================================================
9
GREATER ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INFORMATION AS OF JUNE 30, 2007 AND THREE AND THE NINE MONTHS
ENDED JUNE 30, 2007 AND 2006 (UNAUDITED)
The Company considers a loan to be impaired if it is probable that they
will be unable to collect all amounts due (both principal and interest)
according to the contractual terms of the loan agreement. When a loan is deemed
impaired, the Company computes the present value of the loan's future cash
flows, discounted at the effective interest rate. As an expedient, creditors may
account for impaired loans at the fair value of the collateral or at the
observable market price of the loan if one exists. If the present value is less
than the carrying value of the loan, a valuation allowance is recorded. For
collateral dependent loans, the Company uses the fair value of the collateral,
less estimated costs to sell on a discounted basis, to measure impairment.
Our total recorded investment in impaired collateral dependent loans at
June 30, 2007 was $1.3 million and the related allowance associated with
impaired loans was $500,000. There were no impaired loans in the comparable
period one year ago. At June 30, 2007, all impaired loans had a related
allowance and we have not recognized interest income on impaired loans after the
date that the loans were deemed to be impaired.
(5) 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, 2006.
On December 19, 2006, the company issued a news release announcing that
the first quarter distribution on the Greater Atlantic Capital Trust I 6.50%
Cumulative Convertible Trust Preferred Securities scheduled for December 31,
2006, as well as future distributions on the Trust Preferred Securities, will be
deferred. The announcement by the company followed advice received by the bank
that the Office of Thrift Supervision would not approve the bank's application
to pay a cash dividend to the company. Accordingly, the company exercised its
right to defer the payment of interest on its 6.50% Convertible Junior
Subordinated Debentures Due 2031 related to the Trust Preferred Securities, for
an indefinite period (which can be no longer than 20 consecutive quarterly
periods).
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% and an adequately capitalized financial institution is one with
Tier 1 leverage capital of 4%, Tier 1 risk-based capital of 4% and total
risk-based capital of 8%. At June 30, 2007, the bank was classified as an
adequately capitalized financial institution.
There are currently no orders, agreements, recommendations or
understandings with our regulatory agency, which, if implemented, would affect
our liquidity, capital resources, or results of operations. As an adequately
capitalized institution, the Bank cannot issue brokered certificates of deposit
without OTS or FDIC permission. We do not believe that limitation will have a
material impact on the Bank's operations.
The following presents the bank's capital position at June 30, 2007:
- --------------------------------------------------------------------------------------------------------
Required
Percent to be
Required Well Actual Actual Surplus/
Balance Capitalized Balance Percent (Shortfall)
- --------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Leverage $15,006 5.00% $15,462 5.15% $ 456
Tier 1 Risk-based $10,946 6.00% $15,373 8.43% $ 4,427
Total Risk-based $18,243 10.00% $17,295 9.48% $ (948)
========================================================================================================
The company announced on February 20, 2007, that it received a letter
from The Nasdaq Stock Market advising that the Nasdaq Listing Qualifications
Panel had determined to delist the shares of the company from the Nasdaq Global
Market, and suspended trading of the company's shares effective Thursday,
February 22, 2007.
10
GREATER ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INFORMATION AS OF JUNE 30, 2007 AND THREE AND THE NINE MONTHS
ENDED JUNE 30, 2007 AND 2006 (UNAUDITED)
As previously reported, on February 6, 2007, the Company was notified
that the Company's failure to maintain the minimum of $10,000,000 stockholders'
equity requirement for continued listing on the Nasdaq Global Market, as set
forth in Marketplace Rule 4450 (a) (3), served as an additional basis for
delisting the Company's shares from the Nasdaq Global Market. In its SEC Form
10-K for the period ended September 30, 2006, filed on January 31, 2007, the
Company reported stockholders' equity of $8,850,000. Because of the $1,150,000
deficiency in stockholders' equity, the Company did not make a presentation to
the Panel to consider the Company's continued listing on the Nasdaq Global
Market or to transfer its listing to the Nasdaq Capital Market. The Company's
common stock is currently listed on the Pink Sheet under the symbol GAFC.PK.
(6) 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 June 30,
2007, 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, 2005 266,000 $ 6.91
Options granted 12,000 $ 6.00 3-31-2016
Options expired (25,000) $ 8.37
---------------------------------------------------------------------------------------------------------------
Balance outstanding and exercisable at September 30, 2006 253,000 $ 6.72
Options granted -
---------------------------------------------------------------------------------------------------------------
Balance outstanding and exercisable at June 30, 2007 253,000 $ 6.72
===============================================================================================================
The company has adopted the provisions of Statement of Financial
Accounting Standards No. 123R, "Accounting for Stock-Based Compensation" ("SFAS
123R"), to measure compensation cost for stock options effective after October
1, 2005. Prior to its adoption, the company accounted for its options under APB
25 "Accounting for Stock Issued to Employees" with pro forma disclosed. As
allowable under SFAS 123R, the company used the Black-Scholes method to measure
the compensation cost of stock options granted in 2006 with the following
assumptions: risk-free interest rate of 4.88%, a dividend payout rate of zero,
and an expected option life of nine years. The volatility is 32%. Using those
assumptions, the fair value of stock options granted during fiscal 2006 was
$2.92. There were no options granted during the nine months ended June 30, 2007
and 12,000 options, with an estimated fair value of $22,000, were granted during
the nine months ended June 30, 2006.
11
GREATER ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INFORMATION AS OF JUNE 30, 2007 AND THREE AND THE NINE MONTHS
ENDED JUNE 30, 2007 AND 2006 (UNAUDITED)
(7) 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 reflect the potential dilution of
securities that could share in the earnings of an entity. The weighted average
shares outstanding for basic and diluted earnings per share for the nine months
ended June 30, 2007 and 2006 were the same as the effect of the conversion of
preferred securities and the impact of stock options were antidilutive for the
periods ended June 30, 2007 and 2006. The effect of the conversion of the
preferred securities would result in an increase of 1,368,143 in common shares
outstanding.
(8) SEGMENT REPORTING
The company had two reportable segments, banking and mortgage banking
until the mortgage-banking activities conducted in GAMC, to which the
mortgage-banking segment applied, were discontinued effective March 29, 2006.
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 purchased
residential real estate loans , and also invests in mortgage-backed and other
securities.
On March 29, 2006, we began the process of discontinuing the operations
of the bank's subsidiary, GAMC. Because it was unprofitable, it was determined
that this business no longer fit our strategy.
In the third quarter of 2006, we applied discontinued operations
accounting for GAMC. Accordingly, the income statements for all periods have
been restated. The restatements primarily resulted in a reduction to previously
reported levels of net interest income, a reduction in noninterest income and a
reduction in noninterest expense.
(9) RECENT ACCOUNTING STANDARDS
In July 2006, the FASB issued Interpretation (FIN) No. 48, "Accounting
for Uncertainty in Income Taxes" - an Interpretation of SFAS No. 109,
"Accounting for Income Taxes." FIN 48 defines the threshold for recognizing the
benefits of tax return positions in the financial statements as
"more-likely-than-not" to be sustained by a taxing authority. The term
"more-likely-than-not" means a likelihood of more than 50 percent. FIN 48 is
effective for fiscal years beginning after December 15, 2006, with early
application permitted. Any impact from the adoption of FIN 48 will be recorded
directly to the beginning balance of retained earnings and reported as a change
in accounting principle. We are currently evaluating the impact of this
Interpretation, but do not expect it to be material.
On October 1, 2006, we adopted SFAS 156, "Accounting for Servicing of
Financial Assets - an amendment of FASB Statement No.140." SFAS 156 was issued
in March 2006 and requires all newly recognized servicing rights and obligations
to be initially measured at fair value. For each class of separately recognized
servicing rights and obligations retained, we have elected to continue to
account for each under the amortization method which requires us to amortize
servicing assets or liabilities in proportion to and over the periods of
estimated net servicing income or net servicing loss.
12
GREATER ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INFORMATION AS OF JUNE 30, 2007 AND THREE AND THE NINE MONTHS
ENDED JUNE 30, 2007 AND 2006 (UNAUDITED)
In September 2006, the Financial Accounting Standards Board released
Statement No. 157, "Fair Value Measurements" which defines fair value,
establishes a framework for measuring fair value in GAAP, and enhances
disclosures about fair value measurements. This Statement applies when other
accounting pronouncements require fair value measurements; it does not require
new fair value measurements. This Statement is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and
interim periods within those years. While we are currently evaluating the effect
of the guidance contained in this Statement, we do not expect the implementation
to have a material impact on our consolidated financial statements.
In February, 2007, the FASB issued SFAS No. 159, "The Fair Value Option
for Financial Assets and Financial Liabilities," which permits companies to
report certain financial assets and financial liabilities at fair value. SFAS
159 is effective for fiscal years beginning after November 15, 2007. The Company
can elect to apply the standard prospectively and measure certain financial
instruments at fair value beginning January 1, 2008. The Company is currently
evaluating the guidance contained in SFAS 159, and has yet to determine which
assets or liabilities (if any) will be selected. At adoption, the difference
between the carrying amount and the fair value of existing eligible assets and
liabilities selected (if any) would be recognized via a cumulative adjustment to
beginning retained earnings on October 1, 2008.
(10) 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. 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 $9.3 million after deducting offering expenses.
To comply with FIN46, the trust preferred subsidiary was deconsolidated
in 2004, and the related securities have been presented as obligations of the
Company and titled "Junior Subordinated Debt Securities" in the financial
statements.
On December 19, 2006, the Company issued a news release announcing that
the first quarter distribution on the Greater Atlantic Capital Trust I 6.50%
Cumulative Convertible Trust Preferred Securities scheduled for December 31,
2006, as well as future distributions on the Trust Preferred Securities, will be
deferred. The announcement by the Company follows advice received by the bank
from the Office of Thrift Supervision that it would not approve the bank's
application to pay a cash dividend to the Company.
13
GREATER ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INFORMATION AS OF JUNE 30, 2007 AND THREE AND THE NINE MONTHS
ENDED JUNE 30, 2007 AND 2006 (UNAUDITED)
Accordingly, the Company exercised its right to defer the payment of
interest on its 6.50% Convertible Junior Subordinated Debentures Due 2031
related to the Trust Preferred Securities, for an indefinite period (which can
be no longer than 20 consecutive quarterly periods).
The company retained approximately $1.3 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 (also see Note 5 Regulatory Matters).
(11) DERIVATIVE FINANCIAL INSTRUMENTS
During fiscal years 2003 and 2002, the bank entered into various
interest rate caps that total $20 million in notional principal with terms
between five 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 nine months ended June 30, 2007 and 2006 the instruments
did not meet hedge accounting requirements. The statements of operations include
net losses of $10,000 and gains of $445,000 for the nine months ended June 30,
2007 and 2006, respectively.
14
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.
The matters discussed in management's discussion and analysis of
financial condition and results of operations reflects continuing operations,
unless otherwise noted.
MORTGAGE BANKING ACTIVITIES
The bank's mortgage banking activities primarily consisted of
originating mortgage loans secured by single-family properties. Those activities
were conducted in GAMC and were discontinued effective March 29, 2006 as it was
determined that, because it was unprofitable, this business no longer fit our
strategy. Mortgage banking involves the origination and sale of mortgage loans
for the purpose of generating gains on sale of loans and fee income on the
origination of loans, in addition to loan interest income. In recent years, the
volume of GAMC's originations had been declining, resulting in losses from
mortgage banking operations.
In the third quarter of 2006, we applied discontinued operations
accounting for GAMC as we completed closing those operations during the quarter,
and accordingly, the income statements for all periods have been adjusted. The
reclassifications primarily resulted in a reduction to previously reported
levels of net interest income, a reduction in noninterest income and a reduction
in noninterest expense.
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, the bank, a federally chartered savings bank. The bank is a member
of the Federal Home Loan Bank ("FHLB") system and its deposits are insured up to
applicable limits by the Federal Deposit Insurance Corporation. We offer
traditional banking services to customers through the six branches of the bank
located throughout the greater Washington, D.C./Baltimore metropolitan area.
15
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
fees from service charges on 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 June 30, 2007 the company's total assets were $300.9 million,
compared to the $305.2 million held at September 30, 2006, representing a
decrease of 1.42%. The decrease resulted primarily from a decrease in investment
securities and loans receivable and was offset in part by an increase in
interest bearing deposits. The decline in the bank's overall asset size is
reflected in the consolidated statements of financial condition and statements
of operations as we continued to manage its assets and liabilities to maintain
the bank in an adequately capitalized position.
Net loans receivable at June 30, 2007 were $179.1 million, a decrease
of $14.2 million or 7.36% from the $193.3 million held at September 30, 2006.
The decrease in loans consisted primarily of a $6.0 million decline in the
Bank's single family loan portfolio, coupled with a decrease of $8.4 million in
the Bank's consumer loan portfolio. Because the Bank's single family and
consumer loan portfolios consist primarily of adjustable-rate loans, with the
current yield curve, where short-term rates are only slightly lower than rates
for longer terms, customers are able to extend the terms of their mortgages.
Customers are also refinancing away from adjustable-rate loans and into longer
term, fixed-rate loans or curtailing outstanding balances. Multifamily loans
outstanding increased by $3.2 million and commercial real estate loans increased
by $4.4 million during the period. Those increases were offset in part by
decreases of $4.3 million in construction and land loans and $2.2 million in
commercial business loans. The decrease in construction and land loans was
primarily in the single family residential sector of the market. The company
anticipates that lending in that area will continue to decline as a result of
the current slow sales pace occurring in the single family market.
At June 30, 2007, investment securities were $58.4 million, a decrease
of $21.8 million or 27.17% from the $80.2 million held at September 30, 2006.
The cash proceeds from the sale or payoff of investment securities were used to
reduce higher cost wholesale funding, including borrowings, brokered deposits
and wholesale deposits.
Deposits at June 30, 2007 were $254.4 million, an increase of $24.2
million from the $230.2 million held at September 30, 2006. Total deposits have
increased notwithstanding our reduced reliance on brokered deposits and
wholesale deposits, both of which have a higher cost. Those types of deposits
have declined $26.8 million since June 30, 2006 while total retail deposits have
increased $60.5 million. The increase in retail deposits is primarily in
certificates of deposits and money fund accounts which have been obtained
through the Bank's marketing efforts and are at a lower cost than brokered and
wholesale deposits.
On February 22, 2006, the company announced that it had engaged Sandler
O'Neill & Partners, L.P. to advise on the financial aspects of the company's
review of its strategic options and assist the company in evaluating the
financial aspects of all strategic alternatives available.
As previously reported in a Form 8-K filed on April 16, 2007, and noted
previously, on April 12, 2007, the company announced that it and Summit entered
into a definitive agreement for the company to merge with and into Summit and
that the bank and Bay-Vanguard entered into a definitive agreement for
Bay-Vanguard to purchase the bank's branch office in Pasadena, Maryland.
The merger is expected to be completed in the fourth calendar quarter of
2007, subject to regulatory and shareholder approvals. Immediately following the
merger, the bank intends to merge with and into Summit Community Bank.
16
Under the agreement to sell its leased branch office located at 8070
Ritchie Highway, Pasadena, Maryland, to Bay-Vanguard, Bay-Vanguard will pay the
bank an 8.5% premium on the balance of deposits assumed at closing. At June 30,
2007, the deposits at the Pasadena branch office on which the deposit premium
would apply totaled approximately $54.4 million. Bay-Vanguard will also purchase
the branch office's fixed assets, but will not acquire any loans as part of the
transaction. The purchase is expected to be completed during the third calendar
quarter of 2007, and regulatory approval has been obtained.
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 evaluation of the adequacy of the allowance for
loan losses.
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.
COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED
JUNE 30, 2007 AND JUNE 30, 2006
NET INCOME. For the three months ended June 30, 2007, the company had a
net loss of $508,000 or $0.17 per diluted share, compared to a net loss from
continuing operations of $616,000 or $0.20 per diluted share for the three
months ended June 30, 2006. The $108,000 decrease in the net loss over the
comparable period one-year ago was primarily the result of a decrease in
non-interest expense and a decrease in the provision for loan losses. Those
decreases were offset by decreases in net interest income and non-interest
income. The ongoing net losses from continuing operations remain a consistent
problem for management because the loan production needed to maintain the retail
branch network has not been attained. Due to the losses arising from the
operations of GAMC, the bank is currently managing its assets and liabilities to
maintain an adequately capitalized status. Because of the impact on the
risk-based capital requirements, the bank cannot aggressively expand its
commercial loan portfolio. In addition, the resulting reduction in the bank's
loans to one borrower limit makes it difficult to maintain a consistent level of
outstanding loans to larger customers. Those factors have caused earning assets
to decline, impacting earnings. Further, margin pressure from the yield curve,
which had been inverted since the spring of 2006 and remains inverted from three
months to three years and only recently moved to a positive pattern from three
to ten years, presents a very challenging environment in which to seek to
increase our net interest margin.
Accordingly the Company entered into an agreement, to merge with and
into Summit and the bank agreed to sell its Pasadena, Maryland, branch to
Bay-Vanguard. Alternatively, in order for the Company to achieve profitability
it would have had to have sold a sufficient number of branches to increase
capital and reduce overall operating cost.
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
17
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
Net interest income from continuing operations -------------------------------
Three Months Ended June 30, 2007 2006 Amount %
- ---------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Interest income:
Loans $ 3,459 $ 3,426 $ 33 0.96%
Investments 1,225 1,327 (102) (7.69)
- ---------------------------------------------------------------------------------------------------------------------
Total 4,684 4,753 (69) (1.45)
- ---------------------------------------------------------------------------------------------------------------------
Interest expense:
Deposits 2,459 2,030 429 21.13
Borrowings 617 911 (294) (32.27)
- ---------------------------------------------------------------------------------------------------------------------
Total 3,076 2,941 135 4.59
- ---------------------------------------------------------------------------------------------------------------------
Net interest income $ 1,608 $ 1,812 $ (204) (11.26)%
=====================================================================================================================
The decrease in net interest income during the three months ended June
30, 2007, from the comparable period one year ago, resulted primarily from a
$20.9 million decrease in the bank's interest-earning assets coupled with
average interest-earning assets declining by $8.9 million more than the decline
in average interest-bearing liabilities. That decrease was coupled with an 11
basis point decrease in net interest margin (net interest income divided by
average interest-earning assets) from 2.42% for the three months ended June 30,
2006 to 2.31% for the three months ended June 30, 2007. The decrease in net
interest margin also resulted from the average cost on interest-bearing
liabilities increasing by 1 basis point more than the increase in the average
yield on interest-earning assets.
The interest rate environment has been a difficult one for most
financial institutions. With short-term rates close to or at times even higher
than long-term rates, the prospects of expanding interest rate spread and net
interest margin has been difficult at best. We expect the interest rate
environment to remain challenging and we believe it will continue to have an
impact on our net interest margin and net interest rate spread. We also believe,
however, that our strategy of changing the balance sheet from one that was
wholesale oriented, as reflected in the Company's former reliance on brokered
and internet deposits, to one which is more retail oriented, will benefit us
over time. We believe that change will position us to realize a benefit when the
interest rate environment improves. If market interest rates were to rise, given
our asset sensitivity position, we would also expect our net interest margin to
improve. However, in a declining rate environment our interest rate spread and
our net interest income would decline. The Bank continues to monitor the markets
and its interest rate position to alleviate any material changes in net interest
margin.
INTEREST INCOME. Interest income for the three months ended June 30,
2007 decreased $69,000 compared to the three months ended June 30, 2006,
primarily as a result of a $20.9 million decrease in the average balances of
outstanding loans and investment securities. The decreases in those balances
were partially offset by an increase of 38 basis points in the average yield
earned on interest earning assets.
INTEREST EXPENSE. The $135,000 increase in interest expense for the
three months ended June 30, 2007 compared to the 2006 period was principally the
result of a 39 basis point increase in the cost of funds on average deposits and
borrowings. That increase in the cost of funds was partially offset by an $11.9
million decrease in the average amount of deposits and borrowings. The increase
in interest expense on deposits was primarily due to a 56 basis point increase
in rates paid on deposits, primarily due to higher rates paid on
interest-bearing demand deposits and certificates and elevated pricing on new
and renewed time deposits. That increase was coupled with an increase of $12.1
million in the average amount of deposits from $211.7 million for the three
months ended June 30, 2006 to $223.8 million for the three months ended June 30,
2007.
18
The decrease in interest expense on borrowings for the three months
ended June 30, 2007, when compared to the 2006 period, was principally the
result of a $24.0 million decrease in average borrowed funds, partially offset
by a 20 basis point increase in the cost of borrowed funds. The components
accountable for the decrease of $294,000 in interest expense on borrowings were
a $323,000 decrease relating to average volume, partially offset by a $29,000
increase relating to average cost.
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 JUNE 30,
--------------------------------------------------------------------------------
2007 2006
------------------------------------- ------------------------------------------
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 $ 89,172 $ 1,639 7.35% $ 92,623 $ 1,660 7.17%
Consumer loans 53,768 1,068 7.95 64,267 1,207 7.51
Commercial business loans 37,172 752 8.09 32,269 559 6.93
----------- ----------- ----------- ------------ ------------- -------------
Total loans 180,112 3,459 7.68 189,159 3,426 7.24
Investment securities 76,235 979 5.14 69,172 897 5.19
Mortgage-backed securities 21,706 246 4.53 40,572 430 4.24
--------------------------------------------------------------------------------
Total interest-earning assets 278,053 4,684 6.74 298,903 4,753 6.36
----------- ----------- ------------- -------------
Non-earning assets 11,993 11,438
-------------- -------------
Total assets $ 290,046 $310,341
============== =============
LIABILITIES AND STOCKHOLDERS'
EQUITY:
Interest-bearing liabilities:
Savings accounts $ 2,985 7 0.94 $ 4,680 11 0.94
Now and money market accounts 79,542 707 3.56 76,696 658 3.43
Certificates of deposit 141,226 1,745 4.94 130,333 1,361 4.18
----------- ----------- ----------- ------------ ------------- -------------
Total deposits 223,753 2,459 4.40 211,709 2,030 3.84
FHLB advances 31,600 421 5.33 38,568 490 5.08
Other borrowings 13,462 196 5.82 30,461 421 5.53
----------- ----------- ----------- ------------ ------------- -------------
Total interest-bearing
liabilities 268,815 3,076 4.58 280,738 2,941 4.19
----------- ----------- ------------- -------------
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits 12,019 15,107
Other liabilities 2,140 1,165
-------------- -------------
Total liabilities 282,974 297,010
Stockholders' equity 7,072 13,331
-------------- -------------
Total liabilities and
stockholders' Equity $ 290,046 $310,341
============== =============
Net interest income $ 1,608 $ 1,812
============ ==============
Interest rate spread 2.16% 2.17%
=============== ==============
Net interest margin 2.31% 2.42%
=============== ==============
19
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
JUNE 30, 2007 COMPARED TO
JUNE 30, 2006
-----------------------------------------------
CHANGE ATTRIBUTABLE TO
-----------------------------------------------
VOLUME RATE TOTAL
-----------------------------------------------
(IN THOUSANDS)
Real estate loans $ (62) $ 41 $ (21)
Consumer loans (197) 58 (139)
Commercial business loans 85 108 193
---------------- -------------- --------------
Total loans (174) 207 33
Investments 92 (10) 82
Mortgage-backed securities (200) 16 (184)
---------------- -------------- --------------
Total interest-earning assets $ (282) $ 213 $ (69)
================ ============== ==============
Savings accounts $ (4) $ - $ (4)
Now and money market accounts 24 25 49
Certificates of deposit 114 270 384
---------------- -------------- --------------
Total deposits 134 295 429
FHLB advances (89) 20 (69)
Other borrowings (235) 10 (225)
---------------- -------------- --------------
Total interest-bearing liabilities (190) 325 135
================ ============== ==============
Change in net interest income $ (92) $ (112) $ (204)
================ ============== ==============
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. On an annual basis, or
more often if deemed necessary, the bank has contracted with an independent
outside third party to have its loan portfolio reviewed. The focus of their
review is to identify the extent of potential and actual risk in the bank's
commercial loan portfolio, in addition to the bank's underwriting and processing
practices. Observations made regarding the bank's portfolio risk are based upon
review evaluations, portfolio profiles and discussion with the operational
staff, including the line lenders and senior management.
20
Non-performing assets were $1.7 million or 0.55% of total assets at
June 30, 2007, a $512,000 increase from the $1.1 million or 0.38% of total
assets classified as non-performing at June 30, 2006. Of those, $1.4 million
were classified as substandard, and $300,000 were classified as doubtful. Credit
quality at the bank remains strong, with a ratio of non-performing assets to
total assets of 0.55%, and with negligible nonperforming and past-due loans as
reflected in the provision for loan losses which decreased a modest $17,000 from
the year ago period.
NON-INTEREST INCOME. Non-interest income decreased $121,000 during the
three months ended June 30, 2007, over the comparable three months one year ago.
That decrease was primarily the result of a decrease of $131,000 in gains on
derivatives and was partially offset by an increase of $10,000 in deposit fees.
The following table presents a comparison of the components of
non-interest income.
Non-interest income from continuing operations Difference
------------------------------------
Three Months Ended June 30, 2007 2006 Amount %
- -------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Non-interest income:
Service fees on loans $ 42 $ 42 $ - -%
Service fees on deposits 116 106 10 9.43
Gain (loss) on derivatives 23 154 (131) (85.06)
Other operating income 5 5 - -
- -------------------------------------------------------------------------------------------------------------------
Total non-interest income $ 186 $ 307 $ (121) (39.41)%
===================================================================================================================
NON-INTEREST EXPENSE. Non-interest expense decreased $416,000 from $2.7
million for the three months ended June 30, 2006 to $2.3 million for the three
months ended June 30 in the current year. The decrease was distributed over
various non-interest expense categories with the primary contributors being
compensation, advertising, professional services, deposit insurance premiums,
data processing, furniture, fixtures and equipment and other operating expense.
The decreases in those categories of expense were partially offset by an
increase of $7,000 in occupancy expense.
The following table presents a comparison of the components of
non-interest expense.
Non-interest expense from continuing operations Difference
---------------------------------
Three Months Ended June 30, 2007 2006 Amount %
- ---------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Non-interest expense:
Compensation and employee benefits $ 1,082 $ 1,216 $ (134) (11.02)%
Occupancy 364 357 7 1.96
Professional services 210 281 (71) (25.27)
Advertising 32 183 (151) (82.51)
Deposit insurance premium 7 24 (17) (70.83)
Furniture, fixtures and equipment 128 135 (7) (5.19)
Data processing 197 235 (38) (16.17)
Other operating expense 286 291 (5) (1.72)
- ---------------------------------------------------------------------------------------------------------------------
Total non-interest expense $ 2,306 $ 2,722 $ (416) (15.28)%
=====================================================================================================================
INCOME TAXES. The company files a consolidated federal income tax
return with its subsidiaries and computes its income tax provision or benefit on
a consolidated basis. Due to our operating losses, we did not record a provision
for income taxes for the three months ended June 30, 2007 or 2006. The company
believes that it will generate future taxable income through earnings and branch
sales, to assure utilization of a portion of the existing net operating losses.
21
Contractual Obligations and Off-Balance Sheet Financing Arrangements
The following table summarizes the bank's contractual obligations at
June 30, 2007 and the effect those obligations are expected to have on the
bank's liquidity and cash flows in future periods.
-----------------------------------------------------------------------------------------------------------------
Less Than One One - Three Four - Five After Five
Total Year Years Years Years
-----------------------------------------------------------------------------------------------------------------
(In thousands)
FHLB Advances (1) $ 25,000 $ - $ 25,000 $ - $ -
Reverse repurchase agreements 3,649 3,649 - - -
Subordinated debt securities (2) 25,982 655 1,310 1,310 22,707
Operating leases 4,093 1,121 1,944 624 404
-----------------------------------------------------------------------------------------------------------------
Total obligations $ 58,724 $ 5,425 $ 28,254 $ 1,934 $ 23,111
=================================================================================================================
(1) The company expects to refinance these short and medium-term
obligations under substantially the same terms and conditions.
(2) Includes principal and interest due on our junior subordinated debt
securities.
Other Commercial Commitments
-----------------------------------------------------------------------------------------------------------------
Less Than One One - Three Four - Five After Five
Total Year Years Years Years
-----------------------------------------------------------------------------------------------------------------
(In Thousands)
Certificate of deposit maturities (1) $ 146,807 $ 130,791 $ 13,583 $ 2,340 $ 93
Loan originations 6,427 6,427 - - -
Unfunded lines of credit (2) 113,094 113,094 - - -
Standby letters of credit 310 310 - - -
-----------------------------------------------------------------------------------------------------------------
Total $ 266,638 $ 250,622 $ 13,583 $ 2,340 $ 93
=================================================================================================================
(1) The company expects to retain maturing deposits or replace amounts
maturing with comparable certificates of deposit based on current
market interest rates.
(2) Revolving, open-end loans on one-four dwelling units and commercial
lines that mostly remain unfunded.
COMPARISON OF RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED
JUNE 30, 2007 AND JUNE 30, 2006
NET INCOME. For the nine months ended June 30, 2007, the company had a
net loss of $2.2 million or $0.74 per diluted share, compared to a net loss from
continuing operations of $1.6 million or $0.53 per diluted share for the nine
months ended June 30, 2006. The increase in the net loss of $629,000 over the
comparable period one-year ago was primarily the result of decreases in net
interest income and non-interest income and an increase in the provision for
loan losses; those items were partially offset by a decrease in non-interest
expense.
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.
22
The following table presents a comparison of the components of interest
income and expense and net interest income.
Net interest income from continuing operations Difference
-------------------------------
Nine Months Ended June 30, 2007 2006 Amount %
- ---------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Interest income:
Loans $ 10,780 $ 10,217 $ 563 5.51%
Investments 3,302 3,726 (424) (11.38)
- ---------------------------------------------------------------------------------------------------------------------
Total 14,082 13,943 139 1.00
- ---------------------------------------------------------------------------------------------------------------------
Interest expense:
Deposits 6,885 5,684 1,201 21.13
Borrowings 2,091 2,878 (787) (27.35)
- ---------------------------------------------------------------------------------------------------------------------
Total 8,976 8,562 414 4.84
- ---------------------------------------------------------------------------------------------------------------------
Net interest income $ 5,106 $ 5,381 $ (275) (5.11)%
=====================================================================================================================
The decrease in net interest income during the nine months ended June
30, 2007, resulted primarily from a $34.7 million decrease in the bank's
interest-earning assets coupled with a decline in average interest-earning
assets of $8.1 million more than the decline in average interest-bearing
liabilities. That decrease in the bank's interest earning assets was offset in
part by a 16 basis point increase in net interest margin (net interest income
divided by average interest-earning assets) from 2.31% for the nine months ended
June 30, 2006 to 2.47% for the nine months ended June 30, 2007. The increase in
net interest margin resulted from increasing the average yield on
interest-earning assets by 22 basis points more than the increase in the average
cost of interest-bearing liabilities.
INTEREST INCOME. Interest income for the nine months ended June 30,
2007 increased $139,000 compared to the nine months ended June 30, 2006,
primarily as a result of an 82 basis point increase in the average yield earned
on interest earning assets. That increase was partially offset by a $34.7
million decrease in the average outstanding balances of loans and investment
securities.
INTEREST EXPENSE. The $414,000 increase in interest expense for the
nine months ended June 30, 2007 compared to the 2006 period was principally the
result of a 60 basis point increase in the cost of funds on average deposits and
borrowings. That increase in the cost of funds was partially offset by a $26.6
million decrease in the average amount of deposits and borrowings. The increase
in interest expense on deposits was primarily due to a 75 basis point increase
in rates paid on deposits, primarily due to higher rates paid on savings,
interest-bearing demand deposits and certificates, and elevated pricing on new
and renewed time deposits. That increase was partially offset by a decrease of
$226,000 in the average amount of deposits, from $213.6 million for the nine
months ended June 30, 2006 to $213.4 million for the nine months ended June 30,
2007.
The decrease in interest expense on borrowings for the nine months
ended June 30, 2007, when compared to the 2006 period, was principally the
result of a $26.3 million decrease in average borrowed funds, partially offset
by a 47 basis point increase in the cost of borrowed funds. The components
accountable for the decrease of $787,000 in interest expense on borrowings were
a $968,000 decrease relating to average volume, partially offset by a $181,000
increase relating to average cost.
23
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 NINE MONTHS ENDED JUNE 30,
--------------------------------------------------------------------------------
2007 2006
--------------------------------------------------------------------------------
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 $ 91,789 $ 5,052 7.34% $ 93,654 $ 4,995 7.11%
Consumer loans 56,501 3,322 7.84 66,569 3,476 6.96
Commercial business loans 38,880 2,406 8.25 34,017 1,746 6.84
------------ ----------- ---------- ------------ ----------- ------------
Total loans 187,170 10,780 7.68 194,240 10,217 7.01
Investment securities 62,661 2,440 5.19 69,271 2,486 4.79
Mortgage-backed securities 25,796 862 4.46 46,778 1,240 3.53
------------ ----------- ---------- ------------ ----------- ------------
Total interest-earning assets 275,627 14,082 6.81 310,289 13,943 5.99
----------- ---------- ----------- -------------
Non-earning assets 11,595 11,616
-------------- -------------
Total assets $ 287,222 $321,905
============== =============
LIABILITIES AND STOCKHOLDERS'
EQUITY:
Interest-bearing liabilities:
Savings accounts $ 3,124 21 0.90 $ 5,598 39 0.93
Now and money market accounts 78,119 2,075 3.54 73,075 1,781 3.25
Certificates of deposit 132,151 4,789 4.83 134,947 3,864 3.82
------------ ----------- ---------- ------------ ----------- ------------
Total deposits 213,394 6,885 4.30 213,620 5,684 3.55
FHLB advances 35,606 1,422 5.32 45,151 1,668 4.93
Other borrowings 16,227 669 5.50 33,018 1,210 4.89
------------ ----------- ---------- ------------ ----------- ------------
Total interest-bearing
liabilities 265,227 8,976 4.51 291,789 8,562 3.91
----------- ---------- ----------- -------------
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits 11,941 15,234
Other liabilities 2,149 1,048
-------------- -------------
Total liabilities 279,317 308,071
Stockholders' equity 7,905 13,834
-------------- -------------
Total liabilities and
stockholders' Equity $ 287,222 $321,905
============== =============
Net interest income $ 5,106 $ 5,381
============ ==============
Interest rate spread 2.30% 2.08%
=============== ==============
Net interest margin 2.47% 2.31%
=============== ==============
24
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.
NINE MONTHS ENDED
JUNE 30, 2007 COMPARED TO
JUNE 30, 2006
-----------------------------------------------
CHANGE ATTRIBUTABLE TO
-----------------------------------------------
VOLUME RATE TOTAL
-----------------------------------------------
(IN THOUSANDS)
Real estate loans $ (99) $ 156 $ 57
Consumer loans (526) 372 (154)
Commercial business loans 250 410 660
---------------- -------------- --------------
Total loans (375) 938 563
Investments (237) 191 (46)
Mortgage-backed securities (556) 178 (378)
---------------- -------------- --------------
Total interest-earning assets $(1,168) $ 1,307 $ 139
================ ============== ==============
Savings accounts $ (17) $ (1) $ (18)
Now and money market accounts 123 171 294
Certificates of deposit (80) 1,005 925
---------------- -------------- --------------
Total deposits 26 1,175 1,201
FHLB advances (353) 107 (246)
Other borrowings (615) 74 (541)
---------------- -------------- --------------
Total interest-bearing liabilities (942) 1,356 414
================ ============== ==============
Change in net interest income $ (226) $ (49) $ (275)
================ ============== ==============
Non-performing assets were $1.7 million or 0.55% of total assets at
June 30, 2007, an increase of $512,000 from the $1.1 million or 0.38% of total
assets classified as non-performing at June 30, 2006. Of those, $1.4 million
were classified as substandard, and $300,000 were classified as doubtful. The
$202,000 increase in the provision for loan losses from the year ago period was
made primarily as a result of increases in the outstanding balance of the bank's
commercial real estate, and multi-family loans, which are more at risk than
single-family loans, and to provide for the $300,000 of loans receivable that
were classified as doubtful. Those increases were partially offset by decreases
in the provision for the reduction in the outstanding balances of the bank's
single family, construction and land, commercial business and home equity second
trust loans.
NON-INTEREST INCOME. Non-interest income decreased $508,000 during the
nine months ended June 30, 2007, over the comparable nine month period one year
ago. That decrease was primarily the result of a decrease of $455,000 in gains
on derivatives, $65,000 in gain on sale of foreclosed real estate and $8,000 in
loan fees. That decrease was partially offset by an increase of $28,000 in
deposit fees.
The following table presents a comparison of the components of
non-interest income.
Non-interest income from continuing operations Difference
------------------------------------
Nine Months Ended June 30, 2007 2006 Amount %
- -------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Non-interest income:
Service fees on loans $ 128 $ 136 $ (8) (5.88)%
Service fees on deposits 337 309 28 9.06
Gain (loss) on derivatives (10) 445 (455) (102.25)
Gain on sale of foreclosed real estate - 65 (65) (100.00)
Other operating income 17 25 (8) (32.00)
- -------------------------------------------------------------------------------------------------------------------
Total non-interest income $ 472 $ 980 $ (508) (51.84)%
===================================================================================================================
25
NON-INTEREST EXPENSE. Non-interest expense decreased $356,000 from $7.9
million for the nine months ended June 30, 2006 to $7.5 million for the nine
months ended June 30 in the current year. The decrease was distributed over
various non-interest expense categories with the primary contributors being
advertising, deposit insurance premiums, data processing, and furniture,
fixtures and equipment and was partially offset by increases in professional
services, occupancy and compensation and employee benefits.
The following table presents a comparison of the components of
non-interest expense.
Non-interest expense from continuing operations Difference
---------------------------------
Nine Months Ended June 30, 2007 2006 Amount %
- ---------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Non-interest expense:
Compensation and employee benefits $ 3,523 $ 3,502 $ 21 0.60%
Occupancy 1,051 1,008 43 4.27
Professional services 932 799 133 16.65
Advertising 102 547 (445) (81.35)
Deposit insurance premium 36 77 (41) (53.25)
Furniture, fixtures and equipment 395 415 (20) (4.82)
Data processing 649 703 (54) (7.68)
Other operating expense 826 818 8 0.98
- ---------------------------------------------------------------------------------------------------------------------
Total non-interest expense $ 7,514 $ 7,869 $ (355) (4.51)%
=====================================================================================================================
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. We did not record a provision for income taxes for the
nine months ended June 30, 2007 and 2006 due to our operating losses. The
company believes that it will generate future taxable income through earnings
and branch sales, to assure utilization of a certain portion of the existing net
operating losses.
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 continues to maintain the levels of liquid
assets 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 June 30, 2007, cash and cash equivalents, interest bearing deposits
and securities available-for-sale totaled $108.1 million or 35.91% 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 nine months ended June 30, 2007, the bank's loan
originations totaled $58.7 million. The bank did not purchase any United States
Treasury or agency securities, mortgage-backed or mortgage related securities or
other investment securities during the nine months ended June 30, 2007. All of
our investment securities are classified as either available for sale or held to
maturity and for the period ended June 30, 2007 were considered temporarily
impaired. The market value of our investment portfolio is obtained from various
third party brokerage firms and we believe our filing fairly quantifies the
value of those securities. The investments are debt securities that pay
principal and interest monthly to maturity at such time as principal is repaid.
The fluctuation in value of our portfolio is primarily the result of changes in
market rates rather than due to the credit quality of the issuer. The Company
has the ability and liquidity to hold those securities until such time as the
value recovers or the securities mature.
26
The bank has other sources of liquidity if a need for additional funds
arises. At June 30, 2007, the bank had $25.0 million in advances outstanding
from the FHLB and had an additional overall borrowing capacity from the FHLB of
$9.7 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 June 30, 2007, the bank had commitments to fund loans of $3.5
million, unused outstanding lines of credit of $113.1 million, consisting
primarily of equity lines of credit, unused standby letters of credit of
$310,000 and undisbursed proceeds of construction mortgages of $2.9 million.
Unfunded lines of credit have remained relatively constant and have actually
decreased by $2.5 million during the three months ended June 30, 2007. 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 June 30, 2007, totaled $130.8
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. Loans originated, and the
related commitments to originate loans that will be sold, represent market risk
that is realized in a short period of time, generally two or three months.
The company's primary source of market risk exposure arises from
changes in United States interest rates and the effects thereof on mortgage
prepayment and closing behavior, as well as depositors' choices ("interest rate
risk"). Changes in those interest rates will result in changes in the company's
earnings and the market value of its assets and liabilities. We expect to
continue to realize income from the differential or "spread" between the
interest earned on loans, securities and other interest-earning assets, and the
interest paid on deposits, borrowings and other interest-bearing liabilities.
That spread is affected by the difference between the maturities and re-pricing
characteristics of interest-earnings assets and interest-bearing liabilities.
Loan volume and yields are affected by market interest rates on loans, and
rising interest rates generally are associated with fewer loan originations.
Management expects that a substantial portion of our assets will continue to be
indexed to changes in market interest rates and we intend to attract a greater
proportion of short-term liabilities, which will help us address our interest
rate risk. The lag in implementation of re-pricing terms on our adjustable-rate
assets may result in a decline in net interest income in a rising interest rate
environment. There can be no assurance that our interest rate risk will be
minimized or eliminated. Further, an increase in the general level of interest
rates may adversely affect the ability of certain borrowers to pay the interest
on and principal of their obligations. Accordingly, changes in levels of market
interest rates, (primarily increases in market interest rates), could materially
adversely affect our interest rate spread, asset quality, loan origination
volume and overall financial condition and results of operations.
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. 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.
27
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 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 June 30, 2007, we held an
aggregate notional value of $20 million of interest rate caps. None of the
interest rate caps had strike rates that were in effect at June 30, 2007, as
current LIBOR rates were above the strike rate.
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 deposit 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 March 31, 2007 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 20,559 -2,256 -10% 7.23% -63bp
+200 21,538 -1,277 -6% 7.52% -34bp
+100 22,206 -609 -3% 7.70% -16bp
0 22,815 - 7.86% -
-100 22,663 -152 -1% 7.77% -9bp
-200 22,283 -532 -2% 7.61% -25bp
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
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.
The company maintains disclosure controls and procedures that are
designed to ensure that information required to be disclosed by the company in
reports that it files or submits under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported within the time periods specified
in Securities and Exchange Commission rules and regulations and that such
28
information is accumulated and communicated to the company's management,
including the company's Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required disclosure. Because of
the inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that the company's disclosure controls and procedures
will detect or uncover every situation involving the failure of persons within
the company or its subsidiary to disclose material information otherwise
required to be set forth in the company's periodic reports.
In connection with this Form 10-Q, the company's management, with the
participation of its Chief Executive Officer and Chief Financial Officer,
evaluated the company's disclosure controls and procedures as currently in
effect, and such officers have concluded that, as of this date, the company's
disclosure controls and procedures are effective.
Management of the company is also responsible for establishing and
maintaining adequate internal control over financial reporting and control of
the company's assets to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external
purposes in accordance with accounting principles generally accepted in the
United States of America. There were no changes in the company's internal
control over financial reporting during the company's quarter ended June 30,
2007 that have materially affected, or are reasonably likely to materially
affect, the company's internal control over financial reporting.
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 June 30, 2007, our loan portfolio consisted of $32.8 million, or
17.73% of commercial real estate loans, $20.4 million, or 11.02% of construction
and land development loans and $37.6 million, or 20.28% of commercial business
loans. We intend to increase our emphasis on commercial real estate loans and
commercial business loans. Those 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 and the income stream of the borrowers. 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.
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 would reduce 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 continue 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.
29
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. In the current interest rate environment
with the existing yield curve adjustable rate loans prepay because customers can
get a lower fixed rate loan.
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 to 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 AFFECT 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.
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.
30
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.
FAILURE TO REMAIN A WELL CAPITALIZED INSTITUTION.
As a result of recording losses of $5.6 million during the year ended
September 30, 2006, the bank ceased to be considered a well capitalized
institution and is now considered to be an adequately capitalized institution.
As an adequately capitalized institution, the bank cannot issue brokered
certificates of deposit without OTS or FDIC permission, and the OTS can limit
the payment of dividends from the bank to the company. Without the payment of a
dividend from the bank, the company is unable to make a distribution on the
cumulative convertible trust preferred securities. On December 13, 2006, the
bank was advised by the OTS that the OTS would not approve the bank's
application to pay a cash dividend to the company, and the company exercised its
right to defer the next scheduled quarterly distribution on the cumulative
convertible trust preferred securities as well as future distributions.
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 April 25, 2007.
(b) Omitted per instructions
(c) A brief description of each matter voted upon at the Annual
Stockholder's Meeting held on April 25, 2007 and number of
votes cast for, against or withheld
1. Election of Director.
Votes For Votes Against Votes Withheld
--------- ------------- --------------
Sidney M. Bresler 1,920,889 0 502,996
In addition to Sidney M. Bresler the terms of office of Directors Jeffrey W. Ochsman,
Charles W. Calomiris, Carroll E. Amos and James B. Vito continued after the meeting.
2. Ratification of the Selection of BDO Seidman, LLP as Independent Auditor.
Votes For Votes Against Votes Withheld
--------- ------------- --------------
2,254,746 160,439 8,700
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
31
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: August 13, 2007
32