UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 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
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(Address of Principal Executive Offices) (Zip Code)
703-391-1300
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(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12 (b) of the Act:
None
Securities registered pursuant to Section 12 (g) of the Act:
Common Stock, par value $.01 per share
(Title of class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [ ] No [X].
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 of Section 15(d) of the Act. Yes [ ] No [X].
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 disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (ss.299.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act. Yes [ ]. No [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]
The aggregate market value of the voting and non-voting common equity held by
non-affiliates of the Registrant computed by reference to the price at which the
common equity was sold, or the average bid and asked prices of such stock, as of
the last business day of the registrant's most recently completed second fiscal
quarter was $15.7 million.
As of December 21, 2007, there were 3,024,220 shares of the registrant's Common
Stock, par value $0.01 per share, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
None
INDEX
PART I Page
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Item 1. Business....................................................................................... 3
Description of Business........................................................................ 3
Proposed Acquisition........................................................................... 3
Market Area and Competition.................................................................... 3
Market Risk.................................................................................... 3
Lending Activities............................................................................. 4
Mortgage Banking Activities.................................................................... 7
Asset Quality.................................................................................. 7
Allowance for Loan Losses...................................................................... 9
Investment Activities.......................................................................... 11
Sources of Funds............................................................................... 14
Subsidiary Activities.......................................................................... 16
Personnel...................................................................................... 16
Regulation and Supervision..................................................................... 17
Federal and State Taxation..................................................................... 23
Item 1A. Risk Factors................................................................................... 24
Item 1B. Unresolved Staff Comments...................................................................... 26
Item 2. Properties..................................................................................... 27
Item 3. Legal Proceedings.............................................................................. 27
Item 4. Submission of Matters to a Vote of Security Holders............................................ 27
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities.............................................................................. 28
Item 6. Selected Financial Data........................................................................ 29
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation........... 31
Item 7A. Quantitative and Qualitative Disclosures About Market Risk..................................... 49
Item 8. Consolidated Financial Statements and Supplementary Data....................................... 50
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure........... 50
Item 9A. Controls and Procedures........................................................................ 50
Item 9B. Other Information.............................................................................. 51
PART III
Item 10. Directors and Executive Officers of the Registrant............................................. 51
Item 11. Executive Compensation......................................................................... 53
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. 56
Item 13. Certain Relationships and Related Transactions................................................. 59
Item 14. Principal Accountant Fees and Services......................................................... 59
PART IV
Item 15. Exhibits and Financial Statement Schedules..................................................... 59
Signatures ............................................................................................... 60
2
PART I
ITEM 1. BUSINESS
DESCRIPTION OF BUSINESS
We are a savings and loan holding company which was organized in June
1997. We conduct substantially all of our business through our wholly-owned
subsidiary, Greater Atlantic Bank, a federally-chartered savings bank. We offer
traditional banking services to customers through our bank branches located
throughout the greater Washington, DC metropolitan area. We established the
Greater Atlantic Capital Trust I ("Trust") in January 2002 to issue certain
convertible preferred securities which we completed in March 2002.
PROPOSED ACQUISITION
As previously reported in a Form 8-K filed on April 16, 2007, we
announced that the company and Summit Financial Group, Inc., entered into a
definitive agreement for the company to merge with and into Summit. We also
announced that the bank and Bay-Vanguard Federal Savings Bank entered into a
definitive agreement for Bay-Vanguard to purchase the bank's branch office in
Pasadena, Maryland. The sale of the Pasadena branch office was established as a
condition to the completion of the pending merger of the company with and into
Summit Financial Group, Inc.
Originally the merger was expected to be completed in the fourth
calendar quarter of 2007; however, as reported in a Form 8-K filed on December
10, 2007, effective December 6, 2007, the company and Summit amended their
agreement to implement the parties' agreement to extend to March 31, 2008, the
date on which the agreement may be terminated if the merger is not consummated
by that date, subject to regulatory and shareholder approvals. Immediately
following the merger, the bank intends to merge with and into Summit Community
Bank.
Under the agreement to sell its leased branch office located at 8070
Ritchie Highway, Pasadena, Maryland, to Bay-Vanguard, Bay-Vanguard paid the bank
an 8.5% premium on the balance of deposits assumed at closing. At August 24,
2007, the closing date of that transaction, the deposits at our Pasadena branch
office on which the deposit premium would apply totaled approximately $51.5
million with the bank recognizing a gain of $4.3 million. Bay-Vanguard also
purchased the branch office's fixed assets, but did not acquire any loans as
part of the transaction.
MARKET AREA AND COMPETITION
We operate in a competitive environment, competing for deposits and
loans with other thrifts, commercial banks and other financial entities.
Numerous mergers and consolidations involving banks in the market in which we
operate have occurred resulting in an intensification of competition in the
banking industry in our geographic market. Many of the financial intermediaries
operating in our market area offer certain services, such as trust, investment
and international banking services, which we do not offer. In addition, banks
with a larger capitalization than ours, and financial intermediaries not subject
to bank regulatory restrictions, have larger lending limits and are thereby able
to serve the needs of larger customers.
MARKET RISK
Market risk is the risk of loss from adverse changes in market prices
and rates. Our market risk arises primarily from interest-rate risk inherent in
our lending and deposit taking activities. To that end, management actively
monitors and manages interest-rate risk exposure. The measurement of market risk
associated with financial instruments is meaningful only when all related and
offsetting on- and off-balance-sheet transactions are aggregated, and the
resulting net positions are identified. Disclosures about the fair value of
financial instruments, which reflect changes in market prices and rates, can be
found in Note 16 of Notes to Consolidated Financial Statements.
Our primary objective in managing interest-rate risk is to minimize the
adverse impact of changes in interest rates on our net interest income and
capital, while adjusting our asset-liability structure to obtain the maximum
yield-cost spread on that structure. We rely primarily on our asset-liability
structure to control interest-rate risk. However, a sudden and substantial
increase in interest rates may adversely impact our earnings, to the extent that
the interest rates borne by assets and liabilities do not change at the same
speed, to the same extent, or on the same basis.
3
LENDING ACTIVITIES
GENERAL. Net loans receivable at September 30, 2007 were $176.1
million, a decrease of $17.2 million or 8.90% from the $193.3 million held at
September 30, 2006. The decrease in loans consisted of real estate loans secured
by consumer loans, construction and land loans, first mortgages on residential
properties and commercial business loans, offset in part by an increase in
commercial real estate loans and multi-family loans. Because the bank's single
family and consumer loan portfolios consist primarily of adjustable-rate loans,
and with the current yield curve, where short-term rates are only slightly lower
than rates for longer terms, customers are able to refinance and 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. 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.
The following table shows the bank's loan originations, purchases,
sales and principal repayments during the periods indicated:
Year Ended September 30,
-----------------------------------------
2007 2006 2005
---------------------------------------------------------------------------------------------------------
(In Thousands)
Total loans at beginning of period (1) $201,971 $224,733 $262,598
Originations of loans for investment:
Single-family residential 5,169 12,559 6,624
Multifamily 3,215 625 -
Commercial real estate 5,781 9,210 9,977
Construction 6,449 13,089 19,991
Land loans 240 8,494 10,530
Second trust - - -
Commercial business 28,967 21,170 21,083
Consumer 29,604 39,048 44,205
---------------------------------------------------------------------------------------------------------
Total originations and purchases for investment 79,425 104,195 112,410
Loans originated for resale by Greater Atlantic Bank - - -
Loans originated for resale by Greater Atlantic Mortgage - 91,477 276,038
---------------------------------------------------------------------------------------------------------
Total originations 79,425 195,672 388,448
Repayments (98,921) (117,440) (154,263)
Sale of loans originated for resale by Greater Atlantic Mortgage - (100,994) (272,050)
---------------------------------------------------------------------------------------------------------
Net activity in loans (19,496) (22,762) (37,865)
---------------------------------------------------------------------------------------------------------
Total loans at end of period (1) $182,475 $201,971 $224,733
=========================================================================================================
(1) Includes loans held for sale of $9.5 million at September 30, 2005.
4
LOAN PORTFOLIO. The following table sets forth the composition of the bank's loan portfolio in dollar amounts and as a
percentage of the portfolio at the dates indicated.
At September 30,
----------------------------------------------------------------------------------------
2007 2006 2005 2004 2003
----------------- ---------------- ---------------- ----------------- -----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
----------------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Mortgage loans:
Single-family (1) $ 37,972 20.81% $ 43,473 21.52% $ 41,434 19.25% $ 74,620 29.02% $ 95,818 38.20%
Multi-family 3,983 2.18 813 0.40 751 0.35 1,074 0.42 1,445 0.58
Construction 9,939 5.45 14,245 7.05 24,273 11.28 16,696 6.49 11,996 4.78
Commercial real estate 34,984 19.17 28,403 14.06 25,531 11.86 23,023 8.95 20,533 8.19
Land 8,097 4.44 13,829 6.86 18,421 8.55 20,668 8.04 17,258 6.88
----------------- ----------------- ----------------- ---------------- -----------------
Total mortgage loans 94,975 52.05 100,763 49.89 110,410 51.29 136,081 52.92 147,050 58.63
----------------- ----------------- ----------------- ---------------- -----------------
Commercial business and consumer loans:
Commercial business 34,844 19.09 39,794 19.70 35,458 16.47 47,654 18.53 39,043 15.57
Consumer:
Home equity 52,262 28.64 61,031 30.22 69,006 32.06 72,814 28.32 63,888 25.47
Automobile 48 .03 81 .04 100 .05 271 0.11 428 0.17
Other 346 .19 302 .15 274 .13 315 0.12 409 0.16
----------------- ----------------- ----------------- ---------------- -----------------
Total commercial business
and consumer loans 87,500 47.95 101,208 50.11 104,838 48.71 121,054 47.08 103,768 41.37
----------------- ----------------- ----------------- ---------------- -----------------
Total loans 182,475 100.00% 201,971 100.00% 215,248 100.00% 257,135 100.00% 250,818 100.00%
====== ====== ====== ====== ======
Less:
Allowance for loan losses (2,305) (1,330) (1,212) (1,600) (1,550)
Loans in process (4,947) (8,517) (20,386) (10,453) (8,394)
Unearned premium 885 1,183 1,270 1,305 1,379
-------- -------- -------- -------- --------
Loans receivable, net $176,108 $193,307 $194,920 $246,387 $242,253
======== ======== ======== ======== ========
(1) Includes loans secured by second trusts on single-family residential property.
LOAN MATURITY. The following table shows the remaining contractual
maturity of the bank's total loans, net of loans-in-process (LIP) at September
30, 2007. Loans that have adjustable rates are shown as amortizing when the
interest rates are next subject to change. The table does not include the effect
of future principal prepayments.
At September 30, 2007
---------------------------------------------------------------
Multi- Commercial
One- to Family and Business
Four- Commercial and Total Loans,
Family Real Estate Consumer (net of LIP)
---------------------------------------------------------------------------------------------------------
(In Thousands)
Amounts due in:
One year or less $ 20,377 $ 11,762 $ 73,608 $105,747
After one year:
More than one year to three years 8,185 9,881 3,047 21,113
More than three years to five years 1,103 12,547 3,351 17,001
More than five years to 15 years 5,692 5,526 4,192 15,410
More than 15 years 12,980 1,974 3,303 18,257
---------------------------------------------------------------------------------------------------------
Total amount due $ 48,337 $ 41,690 $ 87,501 $177,528
=========================================================================================================
5
The following table sets forth, at September 30, 2007, the dollar
amount of loans contractually due after September 30, 2008, identifying whether
such loans have fixed interest rates or adjustable interest rates. The risk of
default on ARMs the industry is experiencing should not affect our portfolio
because it is a seasoned portfolio. At September 30, 2007, the bank had $13.7
million of construction, acquisition and development, land and commercial
business loans that were contractually due after September 30, 2008.
Due After September 30, 2008
-----------------------------------------------
Fixed Adjustable Total
------------------------------------------------------------------------------------------------------------
(In Thousands)
Real estate loans:
One- to four-family $18,155 $ 9,805 $27,960
Multi-family and commercial 14,944 14,984 29,928
------------------------------------------------------------------------------------------------------------
Total real estate loans 33,099 24,789 57,888
Commercial business and consumer loans 8,431 5,462 13,893
------------------------------------------------------------------------------------------------------------
Total loans $41,530 $30,251 $71,781
============================================================================================================
ONE- TO FOUR-FAMILY MORTGAGE LENDING. The bank currently offers both
fixed-rate and adjustable-rate mortgage ("ARM") loans with maturities of up to
30 years secured by single-family residences, which term includes real property
containing from one to four residences. At September 30, 2007, the bank's one-
to four-family mortgage loans totaled $38.0 million, or 20.81% of total loans.
Of the one- to four-family mortgage loans outstanding at that date, 47.96% were
fixed-rate loans and 52.04% were ARM loans.
CONSTRUCTION AND DEVELOPMENT LENDING. The bank originates construction
and development loans primarily to finance the construction of one- to
four-family, owner-occupied residential real estate properties located in the
bank's primary market area. The bank also originates land loans to local
contractors and developers for the purpose of making improvements thereon,
including small residential subdivisions in the bank's primary market area or
for the purpose of holding or developing land for sale. At September 30, 2007,
construction and development loans (including land loans) totaled $18.0 million,
or 9.89%, of the bank's total loans, of which, land loans totaled $8.1 million
or 4.44% of total loans. Such loans are secured by a lien on the property, are
limited to 75% of the lower of the acquisition price or the appraised value of
the land and have a term of up to three years with a floating interest rate
generally based on the prime rate as reported in THE WALL STREET JOURNAL. All
the bank's land loans are secured by property in its primary market area.
MULTI-FAMILY AND COMMERCIAL REAL ESTATE LENDING. The bank originates
multi-family and commercial real estate loans that are generally secured by five
or more unit apartment buildings and properties used for business purposes such
as small office buildings or retail facilities located primarily in the bank's
market area. The bank's multi-family and commercial real estate underwriting
policies provide that such real estate loans may be made in amounts of up to
75-80% of the appraised value of the property. The bank's multi-family and
commercial real estate loan portfolio at September 30, 2007 was $39.0 million,
or 21.35% of total loans. The largest multi-family or commercial real estate
loan in the bank's portfolio at September 30, 2007, consisted of a $3.9 million
commercial real estate loan secured by real property in Alabama. The property is
a skilled nursing facility on which the bank has participated $2.1 million of
the $6.0 million note to another bank.
COMMERCIAL BUSINESS LENDING. At September 30, 2007, the bank had $34.8
million in commercial business loans which amounted to 19.09% of total loans.
The bank makes commercial business loans primarily in its market area to a
variety of professionals, sole proprietorships and small businesses. The bank
offers a variety of commercial lending products, including term loans for fixed
assets and working capital, revolving lines of credit and letters of credit.
Term loans are generally offered with initial fixed rates of interest for the
first five years and with terms of up to 7 years. Business lines of credit have
adjustable rates of interest with some being payable on demand, and all subject
to annual review and renewal. Business loans with variable rates of interest
adjust on a monthly basis and are generally indexed to the prime rate as
published in THE WALL STREET JOURNAL.
6
CONSUMER LENDING. Consumer loans at September 30, 2007 amounted to
$52.7 million or 28.86% of the bank's total loans, and consisted primarily of
home equity loans, home equity lines of credit, and, to a significantly lesser
extent, secured and unsecured personal loans and loans on new and used
automobiles. These loans are generally made to residents of the bank's primary
market area and generally are secured by real estate, deposit accounts and
automobiles. These loans are typically shorter term and generally have higher
interest rates than one- to four-family mortgage loans.
The bank offers home equity loans and home equity lines of credit
(collectively, "home equity loans"). Most of the bank's home equity loans are
secured by second mortgages on one- to four-family residences located in the
bank's primary market area. At September 30, 2007, those loans totaled $52.3
million or 28.64% of the bank's total loans. Other types of consumer loans
consisted primarily of secured and unsecured personal loans and loans on new and
used automobiles, totaling $394,000, or 0.22% of the bank's total loans and
0.45% of commercial business and consumer loans at September 30, 2007.
MORTGAGE BANKING ACTIVITIES
The bank's mortgage banking activities primarily consisted of
originating mortgage loans secured by single-family properties and were
conducted in Greater Atlantic Mortgage Corporation, a subsidiary of the bank.
That activity was discontinued effective March 29, 2006, because it was
unprofitable, and 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 the mortgage banking
subsidiary's originations had been declining, resulting in losses from mortgage
banking operations.
ASSET QUALITY
DELINQUENT LOANS AND CLASSIFIED ASSETS. Reports listing all delinquent
accounts are generated and reviewed monthly by management and the board of
directors and all loans or lending relationships delinquent 30 days or more and
all real estate owned are reviewed monthly by the board of directors. The
procedures taken by the bank with respect to delinquencies vary depending on the
nature of the loan, the length and cause of delinquency and whether the borrower
has previously been delinquent.
Federal regulations and the bank's asset classification policy require
that the bank utilize an internal asset classification system as a means of
reporting problem and potential problem assets. The bank has incorporated the
internal asset classifications of the Office of Thrift Supervision as a part of
its credit monitoring system. The bank currently classifies problem and
potential problem assets as "Substandard," "Doubtful" or "Loss" assets. An asset
is considered "Substandard" if it is inadequately protected by the current net
worth and paying capacity of the obligor or of the collateral pledged, if any.
"Substandard" assets include those characterized by the "distinct possibility"
that the insured institution will sustain "some loss" if the deficiencies are
not corrected. Assets classified as "Doubtful" have all of the weaknesses
inherent in those classified "Substandard" with the added characteristic that
the weaknesses present make "collection or liquidation in full," on the basis of
currently existing facts, conditions, and values, "highly questionable and
improbable." Assets classified as "Loss" are those considered "uncollectible"
and of such little value that their continuance as assets without the
establishment of a specific loss reserve is not warranted. Assets which do not
currently expose the insured institution to sufficient risk to warrant
classification in one of the aforementioned categories but possess weaknesses
are required to be designated "Special Mention."
The bank's management reviews and classifies the bank's assets on a
regular basis and the board of directors reviews management's reports on a
monthly basis. The bank classifies assets in accordance with the management
guidelines described above. At September 30, 2007, the bank had $4.7 million of
loans designated as Substandard which consisted of one residential loan, three
commercial business loans, two construction development and one land loan. At
that same date, the bank had $675,000 of assets classified as Doubtful,
consisting of one commercial business loan and one construction development
loan. At September 30, 2007, the bank had no loans classified as Loss and one
$887,000 construction loan classified as Special Mention.
7
The following table sets forth delinquencies in the bank's loans as of
the dates indicated.
At September 30,
----------------------------------------------------------------------------------------------------------
2007 2006 2005
---------------------------------- ---------------------------------- ------------------------------------
60 - 89 Days 90 Days or More 60 - 89 Days 90 Days or More 60 - 89 Days 90 Days or More
---------------- ---------------- ----------------- ------------------ ---------------- ------------------
Number Principal Number Principal Number Principal Number Principal Number Principal Number Principal
of Balance of Balance of Balance of Balance of Balance of Balance
Loans of Loans Loans of Loans Loans of Loans Loans of Loans Loans of Loans Loans of Loans
----------------------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Mortgage loans:
Single-family - $ - 2 $ 19 - $ - 2 $ 835 2 $ 168 4 $ 10
Home equity 2 347 - - - - - - - - 2 229
Construction & Land - - 2 1,330 - - 1 31 - - 2 233
Commercial real estate - - - - - - 1 25 - - 1 25
Commercial business - - - - - - 2 216 - - 3 1,105
Consumer - - - - - - 1 3 - - 1 2
-------------------------------------------------------------------------------------------------------------------------------
Total 2 $ 347 4 $1,349 - $ - 7 $ 1,110 2 $ 168 13 $1,604
===============================================================================================================================
NON-PERFORMING ASSETS AND IMPAIRED LOANS. The following table sets
forth information regarding non-accrual loans and real estate owned. The bank's
policy is to cease accruing interest on mortgage loans 90 days or more past due,
to cease accruing interest on consumer loans 60 days or more past due (unless
the loan principal and interest are determined by management to be fully secured
and in the process of collection), and to charge off any accrued and unpaid
interest.
At September 30,
---------------------------------------------
2007 2006 2005 2004 2003
-----------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Loans accounted for on a non-accrual basis
Mortgage loans:
Single-family $ 16 $ - $ 10 $ 563 $ 637
Home equity - - 229 96 -
Commercial real estate - 25 25 29 31
Construction and Land 1,330 31 233 31 34
Commercial business - 216 1,105 228 716
Consumer - 3 2 6 -
-----------------------------------------------------------------------------------------------------------------
Total non-accrual loans 1,346 275 1,604 953 1,418
Accruing loans which are contractually past due 90 days or more 3 835 - - 28
-----------------------------------------------------------------------------------------------------------------
Total of non-accrual and 90 days past due loans 1,349 1,110 1,604 953 1,446
Foreclosed real estate, net - - 232 - -
-----------------------------------------------------------------------------------------------------------------
Total non-performing assets $1,349 $1,110 $1,836 $ 953 $1,446
=================================================================================================================
Non-accrual loans as a percentage of loans
held for investment, net 0.76% 0.14% 0.82% 0.39% 0.59%
=================================================================================================================
Non-accrual and 90 days or more past due loans
as a percentage of loans held for investment, net 0.77% 0.57% 0.82% 0.39% 0.60%
=================================================================================================================
Non-accrual and 90 days or more past due loans
as a percentage of total assets 0.55% 0.36% 0.47% 0.22% 0.29%
=================================================================================================================
Non-performing assets as a percentage of total assets 0.55% 0.36% 0.54% 0.22% 0.29%
=================================================================================================================
8
During the year ended September 30, 2007, the amount of additional
interest income that would have been recognized on non-accrual loans if such
loans had continued to perform in accordance with their contractual terms was
$110,000.
The company considers a loan to be impaired if it is probable that the
company 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 alternative, 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
September 30, 2007 was $2.5 million and the related allowance associated with
impaired loans was $627,000. There were no impaired loans in the comparable
period one year ago. At September 30, 2007, all impaired loans had a related
allowance.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established through a provision for
loan losses based on management's evaluation of the risks inherent in its loan
portfolio and the general economy. The allowance for loan losses is maintained
at an amount management considers adequate to cover estimated losses in loans
receivable which are deemed probable and estimable based on information
currently known to management. The allowance is based upon a number of factors,
including current economic conditions, actual loss experience and industry
trends. In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the bank's allowance for loan losses.
Such agencies may require the bank to make additional provisions for estimated
loan losses based upon their judgment about information available to them at the
time of their examination. There can be no assurance that the bank will not
sustain credit losses in future periods, which could be substantial in relation
to the size of the allowance. As of September 30, 2007, the bank's allowance for
loan losses amounted to $2.3 million or 1.26% of total loans. The allowance for
loan losses to total non-performing loans at September 30, 2007 was 170.87%; as
a percentage of total loans, the allowance was increased 60 basis points when
compared to September 30, 2006. A $685,000 provision for loan losses was
recorded during the year ended September 30, 2007, compared to a provision of
$126,000 during the year ended September 30, 2006. The $559,000 increase in the
provision for loan losses from the year ago period resulted from the increase in
non-performing assets, an increase in the outstanding balance of the bank's
commercial real estate loans and an increase of $3.9 million in loans classified
as substandard each of which requires an additional allocation of the bank's
overall provision. Those were coupled with an increase of $356,000 in loans
classified as doubtful. That increase in provision for those loans was offset
with an overall decline in the size of the bank's loan portfolio. On an annual
basis, or more often if deemed necessary, the bank had 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 evaluating the 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. However,
because we entered into a definitive agreement for the company to merge with
Summit, and based on the due diligence performed by Summit, it was deemed
unnecessary to enter into such a contract for the fiscal year ended September
30, 2007.
9
The following table sets forth activity in the bank's allowance for
loan losses for the periods indicated. Where specific loan loss reserves have
been established, any differences between the loss allowances and the amount of
loss realized has been charged or credited to current operations.
Year Ended September 30,
------------------------------------------------------------
2007 2006 2005 2004 2003
-----------------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Balance at beginning of period $ 1,330 $ 1,212 $ 1,600 $ 1,550 $ 1,699
Provisions 685 126 219 209 855
Charge-offs:
Mortgage loans:
Single-family 128 - 33 20 162
Commercial real estate - - - - 22
Commercial business 210 78 584 177 828
Consumer 15 2 8 3 8
-----------------------------------------------------------------------------------------------------------------------------
Total charge-offs 353 80 625 200 1,020
Recoveries:
Mortgage loans:
Single-family 8 2 2 29 6
Commercial real estate - - - - -
Commercial business 635 69 15 10 4
Consumer - 1 1 2 6
-----------------------------------------------------------------------------------------------------------------------------
Total recoveries 643 72 18 41 16
Net charge-offs (recoveries) (290) 8 607 159 1,004
-----------------------------------------------------------------------------------------------------------------------------
Balance at end of period $ 2,305 $ 1,330 $ 1,212 $ 1,600 $ 1,550
=============================================================================================================================
Ratio of net charge-offs (recoveries) during the period (0.16)% 0.00% 0.28% 0.06% 0.36%
to average loans outstanding during the period
=============================================================================================================================
Allowance for loan losses to total non-performing
loans at end of period 170.87% 119.82% 75.56% 167.89% 109.31%
=============================================================================================================================
Allowance for loan losses to total loans 1.26% 0.66% 0.56% 0.62% 0.62%
=============================================================================================================================
10
The following table sets forth the bank's allowance for loan losses in
each of the categories listed and the percentage of loans in each category to
total loans. Management believes that the allowance can be allocated by category
only on an approximate basis. The allocation of the allowance to each category
is not necessarily indicative of future losses and does not restrict the use of
the allowance to absorb losses in any other categories.
At September 30,
-----------------------------------------------------------------------------------------------------
2007 2006 2005 2004 2003
-------------------- -------------------- -------------------- ------------------- ------------------
Percent of Percent of Percent of Percent of Percent of
Loans in Loans in Loans in Loans in Loans in
Each Each Each Each Each
Category Category Category Category Category
to Total to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
- ------------------------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Mortgage loans:
Single-family $ 21 20.81% $ 177 21.52% $ 35 19.25% $ 110 29.02% $ 141 38.20%
Multi-family 30 2.18 6 0.40 6 0.35 8 0.42 11 0.58
Construction 177 5.45 67 7.05 72 11.28 78 6.49 80 4.78
Commercial real estate 350 19.17 286 14.06 328 11.86 233 8.95 208 8.19
Land 562 4.44 109 6.86 155 8.55 175 8.04 132 6.88
- ------------------------------------------------------------------------------------------------------------------------------------
Total mortgage loans 1,140 52.05 645 49.89 596 51.29 604 52.92 572 58.63
- ------------------------------------------------------------------------------------------------------------------------------------
Commercial and Consumer:
Commercial 959 19.09 525 19.70 407 16.47 515 18.53 770 15.57
Consumer:
Home equity 131 28.64 152 30.22 195 32.06 213 28.32 159 25.47
Automobile 6 0.22 6 0.19 5 0.18 9 0.23 13 0.33
- ------------------------------------------------------------------------------------------------------------------------------------
Total commercial and
consumer loans 1,096 47.95 683 50.11 607 48.71 737 47.08 942 41.37
- ------------------------------------------------------------------------------------------------------------------------------------
Unallocated 69 N/A 2 N/A 9 N/A 259 N/A 36 N/A
- ------------------------------------------------------------------------------------------------------------------------------------
Total $2,305 100.00% $1,330 100.00% $1,212 100.00% $1,600 100.00% $1,550 100.00%
====================================================================================================================================
INVESTMENT ACTIVITIES
The investment policy of the bank, as approved by the board of
directors, requires management to maintain adequate liquidity and generate a
favorable return on investments to complement the bank's lending activities
without incurring undue interest rate and credit risk. The bank primarily
utilizes investments in securities for liquidity management, as a source of
income and as a method of deploying excess funds not utilized for investment in
loans. The bank does not hold any securities bought and held principally for
sale in the near term, which would be, classified as held for trading.
At September 30, 2007, the bank had invested $16.5 million in
mortgage-backed securities, or 6.71% of total assets, of which $16.3 million
were classified as available-for-sale and $207,000 were classified as
held-to-maturity. This portfolio is seasoned with no purchases during fiscal
year 2007. Investments in mortgage-backed securities involve a risk that actual
prepayments will be greater than estimated prepayments over the life of the
security, which may require adjustments to the amortization of any premium or
accretion of any discount relating to such instruments thereby changing the net
yield on such securities. There is also reinvestment risk associated with the
cash flows from such securities or in the event such securities are redeemed by
the issuer. In addition, the market value of such securities may be adversely
affected by changes in interest rates.
11
The following table sets forth information regarding the amortized cost
and estimated market value of the bank's investment portfolio at the dates
indicated.
At September 30,
-------------------------------------------------------------------------------
2007 2006 2005
-------------------------- ------------------------ ---------------------------
Estimated Estimated Estimated
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
---------------------------------------------------------------------------------------------------------------
(In Thousands)
Available-for-sale:
Corporate debt securities $ 7,300 $ 6,748 $ 7,280 $ 7,142 $ 6,736 $ 6,736
CMOs 7,191 7,087 9,735 9,755 14,446 14,454
U.S. Government SBA's 19,395 18,754 27,629 27,199 30,239 29,781
FHLMC MBS's 2,961 2,920 5,549 5,463 9,044 8,969
FNMA MBS's 8,357 8,141 18,350 17,986 35,548 34,947
GNMA MBS's 5,382 5,260 8,133 7,916 13,097 12,942
---------------------------------------------------------------------------------------------------------------
Total available-for-sale 50,586 48,910 76,676 75,461 109,110 107,829
---------------------------------------------------------------------------------------------------------------
Held-to-maturity:
Corporate debt securities - - - 1,000 1,020
U.S. Government SBA's 2,846 2,742 4,461 4,230 6,531 6,213
FHLMC MBS's 104 102 128 125 236 235
FNMA MBS's 103 101 107 105 202 198
---------------------------------------------------------------------------------------------------------------
Total held-to-maturity 3,053 2,945 4,696 4,460 7,969 7,666
---------------------------------------------------------------------------------------------------------------
Total investment securities $53,639 $51,855 $81,372 $79,921 $117,079 $115,495
===============================================================================================================
Investment securities with:
Fixed rates $ - $ - $ - $ - $ 1,000 $ 1,020
Adjustable rates 36,732 35,331 49,105 48,326 57,952 57,184
Mortgage-backed securities with:
Fixed rates 174 168 243 236 393 376
Adjustable rates 16,733 16,356 32,024 31,359 57,734 56,915
---------------------------------------------------------------------------------------------------------------
Total $53,639 $51,855 $81,372 $79,921 $117,079 $115,495
===============================================================================================================
As of September 30, 2007, the bank held investments in available for sale with unrealized holding losses
totaling $1.7 million. All losses are considered temporary and consisted of the following:
Less than 12 months 12 months or more Total
-------------------------- ------------------------- -------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Description of Securities Value Losses Value Losses Value Losses
---------------------------------------------------------------------------------------------------------------
(In Thousands)
Corporate debt securities $ 2,048 $ 149 $ 4,700 $ 403 $ 6,748 $ 552
CMOs 4,124 108 1,934 28 6,058 136
U.S. Government securities
SBA 3,196 38 15,558 603 18,754 641
GNMA - - 5,260 122 5,260 122
U.S. Government agency securities:
FHLMC MBS's - - 2,920 41 2,920 41
FNMA MBS's - - 8,141 216 8,141 216
---------------------------------------------------------------------------------------------------------------
Total $ 9,368 $ 295 $ 38,513 $1,413 $ 47,881 $ 1,708
===============================================================================================================
12
The table below sets forth certain information regarding the carrying
value, weighted average yields and contractual maturities of the bank's
investment securities and mortgage-backed securities available-for-sale.
At September 30, 2007
-------------------------------------------------------------------------------------------------------
More than One More than Five
One Year or Less Year to Five Years Years to Ten Years More than Ten Years Total
------------------ -------------------- -------------------- --------------------- ------------------
Weighted Weighted Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield Value Yield
-------------------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Investment securities available-for-sale:
Adjustable-rate securities:
CMO's $ - -% $ - -% $ - -% $ 7,087 6.52% $ 7,087 6.52%
Corporate debt - - - - 2,760 5.08 3,988 6.83 6,748 6.12
U.S. Government SBA's - - - - 485 7.54 18,269 4.86 18,754 4.92
------------------------------------------------------------------------------------------------------------------------------
Total - - - - 3,245 5.45 29,344 5.53 32,589 5.52
------------------------------------------------------------------------------------------------------------------------------
MBS's available for sale:
Adjustable-rate securities:
FHLMC - - - - - - 2,920 6.95 2,920 6.95
FNMA - - - - - - 7,995 5.77 7,995 5.77
GNMA - - - - - - 5,260 5.57 5,260 5.57
------------------------------------------------------------------------------------------------------------------------------
Total - - - - - - 16,175 6.01 16,175 6.01
------------------------------------------------------------------------------------------------------------------------------
MBS'S fixed-rate:
FNMA - - 146 7.00 - - - - 146 7.00
------------------------------------------------------------------------------------------------------------------------------
Total - - 146 7.00 - - - - 146 7.00
------------------------------------------------------------------------------------------------------------------------------
Total mortgage-backed
securities available-
for-sale - - 146 7.00 - - 16,175 6.01 16,321 6.02
------------------------------------------------------------------------------------------------------------------------------
Total investment
portfolio $ - -% $146 7.00% $3,245 5.45% $45,519 5.70% $48,910 5.69%
==============================================================================================================================
The table below sets forth certain information regarding the carrying value, weighted average yields and contractual
maturities of the bank's investment securities and mortgage-backed securities held to maturity.
At September 30, 2007
--------------------------------------------------------------------------------------------------------
More than One More than Five
One Year or Less Year to Five Years Years to Ten Years More than Ten Years Total
------------------ -------------------- -------------------- --------------------- -------------------
Weighted Weighted Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield Value Yield
- ------------------------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Investment securities held-to-maturity:
Adjustable-rate securities:
U.S. Government SBA's $ - -% $- -% $380 6.62% $2,466 4.32% $2,846 4.63%
Fixed-rate:
Corporate debt - - - - - - - - - -
- ------------------------------------------------------------------------------------------------------------------------------------
Total investment securities - - - - 380 6.62 2,466 4.32 2,846 4.63
held-to-maturity
- ------------------------------------------------------------------------------------------------------------------------------------
MBS's held-to-maturity:
Adjustable-rate securities:
FHLMC - - - - - - 104 7.23 104 7.23
FNMA - - - - - - 81 7.26 81 7.26
- ------------------------------------------------------------------------------------------------------------------------------------
Total - - - - - - 185 7.24 185 7.24
- ------------------------------------------------------------------------------------------------------------------------------------
Fixed-rate:
FNMA - - - - - - 22 6.50 22 6.50
- ------------------------------------------------------------------------------------------------------------------------------------
Total - - - - - - 22 6.50 22 6.50
- ------------------------------------------------------------------------------------------------------------------------------------
Total mortgage-backed securities
held-to-maturity - - - - - - 207 7.16 207 7.16
- ------------------------------------------------------------------------------------------------------------------------------------
Total held-to-maturity
investments $ - -% $0 -% $380 6.62% $2,673 4.54% $3,053 4.80%
====================================================================================================================================
13
SOURCES OF FUNDS
GENERAL. Deposits, loan repayments and prepayments, cash flows
generated from operations, Federal Home Loan Bank ("FHLB") advances and reverse
repurchase agreements are the primary sources of the bank's funds for use in
lending, investing and for other general purposes.
DEPOSITS. Deposits are attracted from within the bank's market area by
offering a broad selection of deposit instruments, including checking, savings,
money market and time deposits. Deposit account terms vary, differentiated by
the minimum balance required, the time periods that the funds must remain on
deposit and the interest rate, among other factors. In determining the terms of
its deposit accounts, the bank considers current interest rates, profitability
to the bank, interest rate risk characteristics, competition and its customer
preferences and concerns. The bank may pay above-market interest rates to
attract or retain deposits when less expensive sources of funds are not
available. The bank reviews its deposit composition and pricing weekly.
At September 30, 2007, $107.7 million, or 85.70% of the bank's
certificate of deposit accounts were to mature within one year.
The following table sets forth the distribution and the rates paid on
each category of the bank's deposits.
At September 30,
------------------------------------------------------------------------------
2007 2006
-------------------------------------- ---------------------------------------
Percent of Percent of
Total Rate Total Rate
Balance Deposits Paid Balance Deposits Paid
- --------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Savings accounts $ 2,468 1.25% 0.97% $ 3,679 1.60% 0.98%
Now and money market accounts 60,625 30.62 3.61 73,334 31.86 3.51
Certificates of deposit 125,717 63.49 5.00 127,939 55.58 4.55
Noninterest-bearing deposits:
Demand deposits 9,181 4.64 - 25,222 10.96 -
- --------------------------------------------------------------------------------------------------------------------
Total deposits $197,991 100.00% 4.29% $230,174 100.00% 3.67%
====================================================================================================================
The following table presents information concerning the amounts, the rates and the periods to maturity of the
bank's certificate accounts outstanding.
At September 30, 2007
-----------------------------
Amount Rate
------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Balance maturing:
Three months or less $ 52,127 5.04%
Three months to one year 55,609 5.04
One year to three years 15,098 4.70
Over three years 2,883 4.97
------------------------------------------------------------------------------------------------
Total $125,717 5.00%
================================================================================================
14
At September 30, 2007, the bank had $43.1 million in certificate
accounts in amounts of $100,000 or more maturing as follows:
Weighed
Average
Maturity Period Amount Rate
------------------------------------------------------------------------------------------------
Three months or less $20,526 5.13%
Over 3 through 6 months 10,372 5.13
Over 6 through 12 months 7,664 5.08
Over 12 months 4,542 4.71
------------------------------------------------------------------------------------------------
Total $43,104 5.07%
================================================================================================
The following table sets forth the deposit activity of the bank for the periods indicated.
At or For the Year Ended September 30,
-------------------------------------------
2007 2006 2005
------------------------------------------------------------------------------------------------
(In Thousands)
Balance at beginning of period $230,174 $237,794 $288,956
Net deposits (withdrawals) before interest credited (41,514) (15,329) (57,499)
Interest credited 9,331 7,709 6,337
------------------------------------------------------------------------------------------------
Net increase (decrease) in deposits (32,183) (7,620) (51,162)
------------------------------------------------------------------------------------------------
Ending balance $197,991 $230,174 $237,794
================================================================================================
BORROWINGS. At September 30, 2007, borrowings consisted of FHLB
advances and reverse repurchase agreements totaling $27.2 million. FHLB advances
amounted to $25.0 million at September 30, 2007, a decrease from the $36.0
million outstanding at September 30, 2006, and other borrowings (reverse
repurchase agreements) amounted to $2.2 million, a decrease of $16.4 million
compared to $18.6 million at September 30, 2006. During the fiscal year ended
September 30, 2007, all reverse repurchase agreements represented agreements to
repurchase the same securities.
The following table sets forth information regarding the bank's
borrowed funds:
At or For the Year Ended September 30,
------------------------------------------
2007 2006 2005
-----------------------------------------------------------------------------------------------------------------
FHLB Advances:
Average balance outstanding $ 33,064 $ 44,894 $ 44,422
Maximum amount outstanding at any month-end during the period 39,000 51,000 49,200
Balance outstanding at end of period 25,000 36,000 38,000
Weighted average interest rate during the period 5.46% 5.05% 4.47%
Weighted average interest rate at end of period 5.92% 5.28% 4.85%
Reverse repurchase agreements:
Average balance outstanding 15,264 31,624 58,837
Maximum amount outstanding at any month-end during the period 10,857 35,641 62,846
Balance outstanding at end of period 2,192 18,574 38,479
Weighted average interest rate during the period 5.61% 4.21% 4.37%
Weighted average interest rate at end of period 2.52% 4.65% 3.69%
15
SUBSIDIARY ACTIVITIES
We have two subsidiaries, the bank and Greater Atlantic Capital Trust
I. We established the Trust in January 2002 to issue certain convertible
preferred securities which we completed in March 2002. See discussion of the
Trust in Note 20 to the financial statements.
PERSONNEL
As of September 30, 2007, we had 54 full-time employees and 9 part-time
employees. The employees are not represented by a collective bargaining unit and
the company considers its relationship with its employees to be good.
16
REGULATION AND SUPERVISION
GENERAL
As a savings and loan holding company, the company is required by
federal law to report to, and otherwise comply with the rules and regulations
of, the Office of Thrift Supervision. The bank, an insured federal savings
association, is subject to extensive regulation, examination and supervision by
the Office of Thrift Supervision, as its primary federal regulator, and the
Federal Deposit Insurance Corporation, as the deposit insurer. The bank is a
member of the Federal Home Loan Bank System and, with respect to deposit
insurance, of the Savings Association Insurance Fund managed by the Federal
Deposit Insurance Corporation. The bank must file reports with the Office of
Thrift Supervision and the Federal Deposit Insurance Corporation concerning its
activities and financial condition in addition to obtaining regulatory approvals
prior to entering into certain transactions such as mergers with, or
acquisitions of, other savings institutions. The Office of Thrift Supervision
and/or the Federal Deposit Insurance Corporation conduct periodic examinations
to test the bank's safety and soundness and compliance with various regulatory
requirements. This regulation and supervision establishes a comprehensive
framework of activities in which an institution can engage and is intended
primarily for the protection of the insurance fund and depositors. The
regulatory structure also gives the regulatory authorities extensive discretion
in connection with their supervisory and enforcement activities and examination
policies, including policies with respect to the classification of assets and
the establishment of adequate loan loss reserves for regulatory purposes. Any
change in such regulatory requirements and policies, whether by the Office of
Thrift Supervision, the Federal Deposit Insurance Corporation or Congress, could
have a material adverse impact on the company, the bank and their operations.
Certain regulatory requirements applicable to the bank and to the company are
referred to below or elsewhere herein. The description of statutory provisions
and regulations applicable to savings institutions and their holding companies
set forth below, and elsewhere in this document does not purport to be a
complete description of such statutes and regulations and their effects on the
Bank and the company and is qualified in its entirety by reference to the actual
laws and regulations.
HOLDING COMPANY REGULATION
The company is a nondiversified unitary savings and loan holding
company within the meaning of federal law. Under prior law, a unitary savings
and loan holding company, such as the company, was not generally restricted as
to the types of business activities in which it may engage, provided that the
bank continued to be a qualified thrift lender. See "FEDERAL SAVINGS INSTITUTION
REGULATION - QTL TEST." The Gramm-Leach-Bliley Act of 1999 provides that no
company may acquire control of a savings institution after May 4, 1999 unless it
engages only in the financial activities permitted for financial holding
companies under the law or for multiple savings and loan holding companies as
described below. Further, the Gramm-Leach-Bliley Act specifies that existing
savings and loan holding companies may only engage in such activities. The
Gramm-Leach-Bliley Act, however, grandfathered the unrestricted authority for
activities with respect to unitary savings and loan holding companies existing
prior to May 4, 1999, so long as the holding company's savings institution
subsidiary continues to comply with the QTL Test. The company does not qualify
for the grandfathering. Upon any non-supervisory acquisition by the company of
another savings institution or savings bank that meets the qualified thrift
lender test and is deemed to be a savings institution by the Office of Thrift
Supervision, the company would become a multiple savings and loan holding
company (if the acquired institution is held as a separate subsidiary) and would
generally be limited to activities permissible for bank holding companies under
Section 4(c)(8) of the Bank Holding Company Act, subject to the prior approval
of the Office of Thrift Supervision, and certain activities authorized by Office
of Thrift Supervision regulation. However, the OTS has issued an interpretation
concluding that multiple savings and loan holding companies may also engage in
activities permitted for financial holding companies.
A savings and loan holding company is prohibited from, directly or
indirectly, acquiring more than 5% of the voting stock of another savings
institution or savings and loan holding company, without prior written approval
of the Office of Thrift Supervision and from acquiring or retaining control of a
depository institution that is not insured by the Federal Deposit Insurance
Corporation. In evaluating applications by holding companies to acquire savings
institutions, the Office of Thrift Supervision considers factors such as the
financial and managerial resources and future prospects of the company and
institution involved, the effect of the acquisition on the risk to the deposit
insurance funds, the convenience and needs of the community and competitive
effects.
The Office of Thrift Supervision may not approve any acquisition that
would result in a multiple savings and loan holding company controlling savings
institutions in more than one state, subject to two exceptions: (i) the approval
of interstate supervisory acquisitions by savings and loan holding companies and
(ii) the acquisition of a savings institution in another state if the laws of
the state of the target savings institution specifically permit such
acquisitions. The states vary in the extent to which they permit interstate
savings and loan holding company acquisitions.
17
Although savings and loan holding companies are not currently subject
to specific regulatory capital requirements or specific restrictions on the
payment of dividends or other capital distributions, federal regulations do
prescribe such restrictions on subsidiary savings associations. The bank must
notify the Office of Thrift Supervision (30) days before declaring any dividend
to the company and comply with the additional restrictions described below. In
addition, the financial impact of a holding company on its subsidiary
institution is a matter that is evaluated by the Office of Thrift Supervision
and the agency has authority to order cessation of activities or divestiture of
subsidiaries deemed to pose a threat to the safety and soundness of the
institution.
ACQUISITION OF THE COMPANY. On October 4, 2007, Summit filed an
application with the Federal Reserve Bank of Richmond to acquire the company and
thereby, indirectly, to acquire the bank pursuant to Section 4 of the Bank
Holding Company Act and Federal Reserve Regulation Y. The Reserve Bank referred
the application to the Board because action under delegated authority was not
appropriate. Accordingly, the application is being processed by the Division of
Banking Supervision and Regulation of the Board of Governors in Washington, D.C.
Summit was notified that, based on the staff's review of the record, additional
information was being requested. Subsequently, in order to respond to the
request from the Board of Governors and comply with internal application
processing guidelines, Summit requested that processing of the application be
suspended until such time as the staff of the Board of Governors and Summit
consent to the continuation of processing.
FEDERAL SAVINGS INSTITUTION REGULATION
BUSINESS ACTIVITIES. The activities of federal savings banks are
governed by federal law and regulations. These laws and regulations delineate
the nature and extent of the business activities in which federal savings banks
may engage. In particular, certain lending authority for federal savings banks,
E.G., commercial, non-residential real property loans and consumer loans, is
limited to a specified percentage of the institution's capital or assets.
CAPITAL REQUIREMENTS. The Office of Thrift Supervision capital
regulations require savings associations to meet three minimum capital
standards: a 1.5% tangible capital to total assets ratio, a 4% tier 1 capital to
total assets leverage ratio (3% for institutions receiving the highest rating on
the CAMELS examination rating system) and an 8% risk-based capital ratio. In
addition, the prompt corrective action standards discussed below also establish,
in effect, a minimum 2% tangible capital standard, a 4% leverage ratio (3% for
institutions receiving the highest rating on the CAMELS system) and, together
with the risk-based capital standard itself, a 4% Tier 1 risk-based capital
standard. The Office of Thrift Supervision regulations also require that, in
meeting the tangible, leverage and risk-based capital standards, institutions
must generally deduct investments in and loans to subsidiaries engaged in
activities as principal that are not permissible for a national bank.
The risk-based capital standard for savings associations requires the
maintenance of Tier 1 (core) capital and total capital (which is defined as core
capital and supplementary capital less certain specified deductions from total
capital such as reciprocal holdings of depository institution capital,
instruments and equity investments) to risk-weighted assets of at least 4% and
8%, respectively. In determining the amount of risk-weighted assets, all assets,
including certain off-balance sheet activities, recourse obligations, residual
interests and direct credit substitutes, are multiplied by a risk-weight factor
of 0% to 100%, assigned by the Office of Thrift Supervision capital regulation
based on the risks believed inherent in the type of asset. Core (Tier 1) capital
is generally defined as common stockholders' equity (including retained
earnings), certain noncumulative perpetual preferred stock and related surplus,
and minority interests in equity accounts of consolidated subsidiaries less
intangibles other than certain mortgage servicing rights and credit card
relationships. The components of supplementary capital (Tier 2) currently
include cumulative preferred stock, long-term perpetual preferred stock,
mandatory convertible debt securities, subordinated debt and intermediate
preferred stock, the allowance for loan and lease losses limited to a maximum of
1.25% of risk-weighted assets, and up to 45% of unrealized gains on
available-for-sale equity securities with readily determinable fair market
values. Overall, the amount of supplementary capital included as part of total
capital cannot exceed 100% of core capital.
18
The Office of Thrift Supervision also has authority to establish
individual minimum capital requirements in appropriate cases upon a
determination that an institution's capital level is or may become inadequate in
light of the particular circumstances. At September 30, 2007, the bank met each
of its capital requirements.
The following table presents the bank's capital position at September
30, 2007.
Capital
Excess --------------------------
Actual Required (Deficiency) Actual Required
Capital Capital Amount Percent Percent
- ---------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Tangible $18,830 $ 3,684 $15,146 7.67% 1.50%
Core (Leverage) 18,830 9,825 9,005 7.67 4.00
Risk-based 20,874 13,630 7,244 12.25 8.00
PROMPT CORRECTIVE REGULATORY ACTION. The Office of Thrift Supervision
is required to take certain supervisory actions against undercapitalized
institutions, the severity of which depends upon the institution's degree of
undercapitalization. Generally, a savings institution that has a ratio of total
capital to risk weighted assets of less than 8%, a ratio of Tier 1 (core)
capital to risk-weighted assets of less than 4% or a ratio of core capital to
total assets of less than 4% (3% or less for associations with the highest
examination rating) is considered to be "undercapitalized." A association that
has a total risk-based capital ratio less than 6%, a Tier 1 capital ratio of
less than 3% or a leverage ratio that is less than 3% is considered to be
"significantly undercapitalized" and a savings institution that has a tangible
capital to assets ratio equal to or less than 2% is deemed to be "critically
undercapitalized." Subject to a narrow exception, the Office of Thrift
Supervision is required to appoint a receiver or conservator within specified
time frames for an institution that is "critically undercapitalized." The
regulation also provides that a capital restoration plan must be filed with the
Office of Thrift Supervision within 45 days of the date a savings association is
deemed to have received notice that it is "undercapitalized," "significantly
undercapitalized" or "critically undercapitalized." Compliance with the plan
must be guaranteed by any parent holding company in the amount of up to the
lesser of 5% of the savings association's total assets when it was deemed to be
undercapitalized or the amount necessary to achieve compliance with applicable
capital requirements. In addition, numerous mandatory supervisory actions become
immediately applicable to an undercapitalized institution, including, but not
limited to, increased monitoring by regulators and restrictions on growth,
capital distributions and expansion. The Office of Thrift Supervision could also
take any one of a number of discretionary supervisory actions, including the
issuance of a capital directive and the replacement of senior executive officers
and directors. Significantly and critically undercapitalized institutions are
subject to additional mandatory and discretionary measures.
INSURANCE OF DEPOSIT ACCOUNTS. The bank's deposits are insured up to
applicable limits by the Deposit Insurance Fund of the Federal Deposit Insurance
Corporation. The Deposit Insurance Fund is the successor to the Bank Insurance
Fund and the Savings Association Insurance Fund, which were merged in 2006. The
Federal Deposit Insurance Corporation amended its risk-based assessment system
for 2007 to implement authority granted by the Federal Deposit Insurance Reform
Act of 2005 ("Reform Act"). Under the revised system, insured institutions are
assigned to one of four risk categories based on supervisory evaluations,
regulatory capital levels and certain other factors. An institution's assessment
rate depends upon the category to which it is assigned. Risk category I, which
contains the least risky depository institutions, is expected to include more
than 90% of all institutions. Unlike the other categories, Risk Category I
contains further risk differentiation based on the Federal Deposit Insurance
Corporation's analysis of financial ratios, examination component ratings and
other information. Assessment rates are determined by the Federal Deposit
Insurance Corporation and currently range from five to seven basis points for
the healthiest institutions (Risk Category I) to 43 basis points of assessable
deposits for the riskiest (Risk Category IV). The Federal Deposit Insurance
Corporation may adjust rates uniformly from one quarter to the next, except that
no single adjustment can exceed three basis points. No institution may pay a
dividend if in default of its FDIC assessment.
The Reform Act also provided for a one-time credit for eligible
institutions based on their assessment base as of December 31, 1996. Subject to
certain limitations, credits could be used beginning in 2007 to offset
assessments until exhausted. The bank's one-time credit approximated $65,529.
The Reform Act also provided for the possibility that the Federal Deposit
Insurance Corporation may pay dividends to insured institutions once the Deposit
Insurance fund reserve ratio equals or exceeds 1.35% of estimated insured
deposits.
19
In addition to the assessment for deposit insurance, institutions are
required to make payments on bonds issued in the late 1980s by the Financing
Corporation to recapitalize a predecessor deposit insurance fund. That payment
is established quarterly and during fiscal 2007, Financing Corporation payments
for savings associations approximated 1.18 basis points of assessable deposits.
The Reform Act provided the Federal Deposit Insurance Corporation with
authority to adjust the Deposit Insurance Fund ratio to insured deposits within
a range of 1.15% and 1.50%, in contrast to the prior statutorily fixed ratio of
1.25%. The ratio, which is viewed by the Federal Deposit Insurance Corporation
as the level that the fund should achieve, has been established by the agency at
1.25% for 2008, which was unchanged from 2007.
The bank's total assessment paid for this period (including the FICO
assessment) was $204,021. The Federal Deposit Insurance Corporation has
authority to increase insurance assessments. A significant increase in insurance
premiums would likely have an adverse effect on the operating expenses and
results of operations of the bank. Management cannot predict what insurance
assessment rates will be in the future.
Insurance of deposits may be terminated by the Federal Deposit
Insurance Corporation upon a finding that the institution has engaged in unsafe
or unsound practices, is in an unsafe or unsound condition to continue
operations or has violated any applicable law, regulation, rule, order or
condition imposed by the Federal Deposit Insurance Corporation or the Office of
Thrift Supervision. The management of the bank does not know of any practice,
condition or violation that might lead to termination of deposit insurance.
LOANS TO ONE BORROWER. Federal law provides that savings institutions
are generally subject to the limits on loans to one borrower applicable to
national banks. Generally, subject to certain exceptions, a savings association
may not make a loan or extend credit to a single or related group of borrowers
in excess of 15% of its unimpaired capital and surplus. An additional amount may
be lent, equal to 10% of unimpaired capital and surplus, if secured by specified
readily marketable collateral. At September 30, 2007,the bank's limit on loans
to one borrower was $3.2 million, and the bank's largest aggregate outstanding
loan to one borrower was $4.0 million. Part of that loan and any other loan in
excess of the loans to one borrower limit will be sold in the form of a
participation.
QTL TEST. Federal law requires savings institutions to meet a qualified
thrift lender test. Under the test, a savings association is required to either
qualify as a "domestic building and loan association" under the Internal Revenue
Code or maintain at least 65% of its "portfolio assets" (total assets less: (i)
specified liquid assets up to 20% of total assets; (ii) intangibles, including
goodwill; and (iii) the value of property used to conduct business) in certain
"qualified thrift investments" (primarily residential mortgages and related
investments, including certain mortgage-backed securities but also defined to
include education, credit card and small business loans) in at least 9 months
out of each 12 month period.
A savings institution that fails the qualified thrift lender test is
subject to certain operating restrictions and may be required to convert to a
bank charter. As of September 30, 2007, Greater Atlantic maintained 71% of its
portfolio assets in qualified thrift investments and, therefore, met the
qualified thrift lender test.
LIMITATION ON CAPITAL DISTRIBUTIONS. Office of Thrift Supervision
regulations impose limitations upon all capital distributions by a savings
institution, including cash dividends, payments to repurchase its shares and
payments to stockholders of another institution in a cash-out merger. An
application to and the prior approval of the Office of Thrift Supervision is
required prior to any capital distribution if the institution does not meet the
criteria for "expedited treatment" of applications under Office of Thrift
Supervision regulations (I.E., generally, examination and Community Reinvestment
Act ratings in the two top categories), the total capital distributions for the
calendar year exceed net income for that year plus the amount of retained net
income for the preceding two years, the institution would be undercapitalized
following the distribution or the distribution would otherwise be contrary to a
statute, regulation or agreement with Office of Thrift Supervision. If an
application is not required, the institution must still provide prior notice to
Office of Thrift Supervision of the capital distribution if, like the bank, it
is a subsidiary of a holding company. In the event the bank's capital fell below
its regulatory requirements or the Office of Thrift Supervision notified it that
it was in need of increased supervision, Greater Atlantic's ability to make
capital distributions could be restricted. In addition, the Office of Thrift
Supervision could prohibit a proposed capital distribution by any institution,
which would otherwise be permitted by the regulation, if the Office of Thrift
Supervision determines that such distribution would constitute an unsafe or
unsound practice. On December 13, 2006, the bank was advised by the Office of
Thrift Supervision that it 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 for an indefinite period (which can be no longer than 20
consecutive quarterly periods). The amount accrued at September 30, 2007,
totaled $644,000.
20
ASSESSMENTS. Savings associations are required to pay assessments to
the Office of Thrift Supervision to fund the agency's operations. The general
assessments, paid on a semi-annual basis, are computed based upon the savings
association's total assets, including consolidated subsidiaries, its financial
condition and complexity of its portfolio. The assessments paid by the bank for
the fiscal year ended September 30, 2007, totaled $139,095.
TRANSACTIONS WITH RELATED PARTIES. The bank's authority to engage in
transactions with "affiliates" (E.G., any company that controls or is under
common control with an institution, including the company) is limited by federal
law. The aggregate amount of covered transactions with any individual affiliate
is limited to 10% of the capital and surplus of the savings association. The
aggregate amount of covered transactions with all affiliates is limited to 20%
of the savings association's capital and surplus. Certain transactions with
affiliates are required to be secured by collateral in an amount and of a type
specified in federal law. The purchase of low quality assets from affiliates is
generally prohibited. The transactions with affiliates must be on terms and
under circumstances, that are at least as favorable to the institution as those
prevailing at the time for comparable transactions with non-affiliated
companies. In addition, savings associations are prohibited from lending to any
affiliate that is engaged in activities that are not permissible for bank
holding companies and no savings association may purchase the securities of any
affiliate other than a subsidiary.
The Sarbanes-Oxley Act of 2002 generally prohibits loans by the company
to its executive officers and directors. However, that law contains a specific
exception for loans by a depository institution to its executive officers and
directors in compliance with federal banking laws. Under such laws, the bank's
authority to extend credit to executive officers, directors and 10% shareholders
("insiders"), as well as entities such persons control, is limited. The law
limits both the individual and aggregate amount of loans the bank may make to
insiders based, in part, on the bank's capital position and requires certain
board approval procedures to be followed. Such loans are required to be made on
terms substantially the same as those offered to unaffiliated individuals and
not involve more than the normal risk of repayment. There is an exception for
loans made pursuant to a benefit or compensation program that is widely
available to all employees of the institution and does not give preference to
insiders over other employees. Loans to executive officers are subject to
additional limitations based on the type of loan involved.
ENFORCEMENT. The Office of Thrift Supervision has primary enforcement
responsibility over savings associations and has the authority to bring actions
against the institution and all institution-affiliated parties, including
stockholders, and any attorneys, appraisers and accountants who knowingly or
recklessly participate in wrongful action likely to have an adverse effect on an
insured institution. Formal enforcement action may range from the issuance of a
capital directive or cease and desist order to removal of officers and/or
directors to institution of receivership, conservatorship or termination of
deposit insurance. Civil penalties cover a wide range of violations and can
amount to $25,000 per day, or even $1.0 million per day in especially egregious
cases. The Federal Deposit Insurance Corporation has the authority to recommend
to the Director of the Office of Thrift Supervision that enforcement action be
taken with respect to a particular savings institution. The Federal Deposit
Insurance Corporation has authority to take such action under certain
circumstances. Federal law also establishes criminal penalties for certain
violations.
STANDARDS FOR SAFETY AND SOUNDNESS. The federal banking agencies have
adopted Interagency Guidelines prescribing Standards for Safety and Soundness in
various areas such as internal controls and information systems, internal audit,
loan documentation and credit underwriting, interest rate exposure, asset growth
and quality, earnings and compensation, fees and benefits.. The guidelines set
forth the safety and soundness standards that the federal banking agencies use
to identify and address problems at insured depository institutions before
capital becomes impaired. If the Office of Thrift Supervision determines that a
savings institution fails to meet any standard prescribed by the guidelines, the
Office of Thrift Supervision may require the institution to submit an acceptable
plan to achieve compliance with the standard.
FEDERAL HOME LOAN BANK SYSTEM
The bank is a member of the Federal Home Loan Bank System, which
consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank
provides a central credit facility primarily for member institutions. As a
member of the Federal Home Loan Bank, the bank is required to acquire and hold
shares of capital stock in that Federal Home Loan Bank in an amount at least
equal to 1.0% of the aggregate principal amount of its unpaid residential
mortgage loans and similar obligations at the beginning of each year, or 1/20 of
its advances (borrowings) from the Federal Home Loan Bank, whichever is greater.
The bank was in compliance with this requirement with an investment in Federal
Home Loan Bank stock at September 30, 2007 of $1.7 million.
21
The Federal Home Loan Banks are required to provide funds used for the
resolution of insolvent thrifts in the late 1980s and to contribute funds for
affordable housing programs. Those requirements could reduce the amount of
dividends that the Federal Home Loan Banks pay to their members and could also
result in the Federal Home Loan Banks imposing a higher rate of interest on
advances to their members. If dividends were reduced, or interest on future
Federal Home Loan Bank advances increased, Greater Atlantic's net interest
income would likely also be reduced.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board regulations require savings institutions to
maintain non-interest earning reserves against their transaction accounts
(primarily NOW and regular checking accounts). The regulations generally provide
that reserves be maintained against aggregate transaction accounts as follows: a
3% reserve ratio is assessed on net transaction accounts up to $43.9 million;
for a 10% ratio is applied above $43.9 million. The first $9.3 million of
otherwise reservable balances (subject to adjustments by the Federal Reserve
Board) is exempted from the reserve requirements. The amounts are adjusted
annually. The bank complies with the foregoing requirements.
COMMUNITY REINVESTMENT ACT
Under the Community Reinvestment Act, as implemented by Office of
Thrift Supervision regulations, a savings association has a continuing and
affirmative obligation consistent with its safe and sound operation to help meet
the credit needs of its entire community, including low and moderate income
neighborhoods. The Community Reinvestment Act does not establish specific
lending requirements or programs for financial institutions nor does it limit an
institution's discretion to develop the types of products and services that it
believes are best suited to its particular community, consistent with the
Community Reinvestment Act. The Community Reinvestment Act requires the Office
of Thrift Supervision, in connection with its examination of an institution, to
assess the institution's record of meeting the credit needs of its community and
to take such record into account in its evaluation of applications by such
institution. The Community Reinvestment Act requires public disclosure of an
institution's Community Reinvestment Act rating. Greater Atlantic's latest
Community Reinvestment Act rating, received from the Office of Thrift
Supervision was "Satisfactory."
22
FEDERAL AND STATE TAXATION
GENERAL. The company and the bank report their income on a fiscal year
basis using the accrual method of accounting and are subject to federal income
taxation in the same manner as other corporations with some exceptions. The
following discussion of tax matters is intended only as a summary and does not
purport to be a comprehensive description of the tax rules applicable to the
bank or the company. The bank has not been audited by the IRS or the Virginia
Department of Taxation ("DOT") in the past five years.
DISTRIBUTIONS. To the extent that the bank makes "non-dividend
distributions" to the company that are considered as made (i) from the reserve
for losses on qualifying real property loans, to the extent the reserve for such
losses exceeds the amount that would have been allowed under the experience
method, or (ii) from the supplemental reserve for losses on loans ("Excess
Distributions"), then an amount based on the amount distributed will be included
in the bank's taxable income. Non-dividend distributions include distributions
in excess of the bank's current and accumulated earnings and profits,
distributions in redemption of stock and distributions in partial or complete
liquidation. However, dividends paid out of the bank's current or accumulated
earnings and profits, as calculated for federal income tax purposes, will not be
considered to result in a distribution from the bank's bad debt reserve. Thus,
any dividends to the company that would reduce amounts appropriated to the
bank's bad debt reserve and deducted for federal income tax purposes would
create a tax liability for the bank. The amount of additional taxable income
created by an Excess Distribution is an amount that, when reduced by the tax
attributable to the income, is equal to the amount of the distribution. Thus,
if, after the Conversion, the bank makes a "non-dividend distribution," then
approximately one and one-half times the amount so used would be includable in
gross income for federal income tax purposes, presumably taxed at a 34%
corporate income tax rate (exclusive of state and local taxes). See "Regulation"
and "Dividend Policy" for limits on the payment of dividends of the bank. The
bank does not intend to pay dividends that would result in a recapture of any
portion of its bad debt reserve.
CORPORATE ALTERNATIVE MINIMUM TAX ("AMT"). The Code imposes a tax on
alternative minimum taxable income ("AMTI") at a rate of 20%. Only 90% of AMTI
could be offset by net operating loss carryovers. AMTI is increased by an amount
equal to 75% of the amount by which the bank's adjusted current earnings exceeds
its AMTI (determined without regard to this preference and prior to reduction
for net operating losses). Since the company and the bank have net operating
losses for the 2007 fiscal year, except for the AMT, they have not recorded a
provision for income taxes.
DIVIDENDS RECEIVED DEDUCTION AND OTHER MATTERS. The company may exclude
from its income 100% of dividends received from the bank as a member of the same
affiliated group of corporations. The corporate dividends received deduction is
generally 70% in the case of dividends received from unaffiliated corporations
with which the company and the bank will not file a consolidated tax return,
except that if the company or the bank owns more than 20% of the stock of a
corporation distributing a dividend then 80% of any dividends received may be
deducted.
STATE AND LOCAL TAXATION
COMMONWEALTH OF VIRGINIA. The Commonwealth of Virginia imposes a tax at
the rate of 6.0% on the "Virginia taxable income" of the company. Virginia
taxable income is equal to federal taxable income with certain adjustments.
Significant modifications include the subtraction from federal taxable income of
interest or dividends on obligations or securities of the United States that are
exempt from state income taxes.
DELAWARE TAXATION. As a Delaware company not earning income in
Delaware, the company is exempt from Delaware corporate income tax but is
required to file an annual report with and pay an annual franchise tax to the
State of Delaware. However, to the extent that the company conducts business
outside of Delaware, the company may be considered doing business and subject to
additional taxing jurisdictions outside of Delaware.
23
ITEM 1A. RISK FACTORS
OUR INCREASED EMPHASIS ON COMMERCIAL AND CONSTRUCTION LENDING MAY EXPOSE US TO
INCREASED LENDING RISKS.
At September 30, 2007, our loan portfolio consisted of $35.0 million,
or 19.17% of commercial real estate loans, $18.0 million, or 9.89% of
construction and land development loans and $34.8 million, or 19.10% of
commercial business loans. These types of loans generally expose a lender to
greater risk of non-payment and loss than one-to-four-family residential
mortgage loans because repayment of the loans often depends on the successful
operation of the property, the income stream of the borrowers and, for
construction loans, the accuracy of the estimate of the property's value at
completion of construction and the estimated cost of construction. Such loans
typically involve larger loan balances to single borrowers or groups of related
borrowers compared to one- to four-family residential mortgage loans. Commercial
business loans expose us to additional risks since they typically are made on
the basis of the borrower's ability to make repayments from the cash flow of the
borrower's business and are secured by non-real estate collateral that may
depreciate over time. In addition, since such loans generally entail greater
risk than one- to four-family residential mortgage loans, we may need to
increase our allowance for loan losses in the future to account for the likely
increase in probable incurred credit losses associated with the growth of such
loans. Also, many of our commercial and construction borrowers have more than
one loan outstanding with us. Consequently, an adverse development with respect
to one loan or one credit relationship can expose us to a significantly greater
risk of loss compared to an adverse development with respect to a one- to
four-family residential mortgage loan.
STRONG COMPETITION WITHIN OUR MARKET AREA COULD HURT OUR ABILITY TO COMPETE AND
COULD SLOW OUR GROWTH.
We face intense competition both in making loans and attracting
deposits. This competition has made it more difficult for us to make new loans
and has occasionally forced us to offer higher deposit rates. Price competition
for loans and deposits might result in us earning less on our loans and paying
more on our deposits, which reduces net interest income. Some of the
institutions with which we compete have substantially greater resources and
lending limits than we have and may offer services that we do not provide. We
expect competition to increase in the future as a result of legislative,
regulatory and technological changes and the continuing trend of consolidation
in the financial services industry. Our profitability depends upon our continued
ability to compete successfully in our market area.
AN INCREASE IN LOAN PREPAYMENTS AND ON PREPAYMENT OF LOANS UNDERLYING
MORTGAGE-BACKED SECURITIES AND SMALL BUSINESS ADMINISTRATION CERTIFICATES MAY
ADVERSELY AFFECT OUR PROFITABILITY.
Prepayment rates are affected by consumer behavior, conditions in the
housing and financial markets, general economic conditions and the relative
interest rates on fixed-rate and adjustable-rate mortgage loans. Although
changes in prepayment rates are, therefore, difficult for us to predict,
prepayment rates tend to increase when market interest rates decline relative to
the rates on the prepaid instruments.
We recognize our deferred loan origination costs and premiums paid on
originating these loans by adjusting our interest income over the contractual
life of the individual loans. As prepayments occur, the rate at which net
deferred loan origination costs and premiums are expensed accelerates. The
effect of the acceleration of deferred costs and premium amortization may be
mitigated by prepayment penalties paid by the borrower when the loan is paid in
full within a certain period of time, which varies between loans. If prepayment
occurs after the period of time when the loan is subject to a prepayment
penalty, the effect of the acceleration of premium and deferred cost
amortization is no longer mitigated.
We recognize premiums we pay on mortgage-backed securities and Small
Business Administration Certificates as an adjustment 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.
24
A DOWNTURN IN THE WASHINGTON D.C. METROPOLITAN AREA ECONOMY, A DECLINE IN REAL
ESTATE VALUES OR DISRUPTIONS IN THE SECONDARY MORTGAGE MARKETS COULD REDUCE OUR
EARNINGS AND FINANCIAL CONDITION.
Most of our loans are secured by real estate. As a result, a downturn in
this market area could cause significant increases in nonperforming loans, which
would reduce our profits. Additionally, a decrease in asset quality could
require additions to our allowance for loan losses through increased provisions
for loan losses, which would also reduce our profits. In prior years, there had
been significant increases in real estate values in our market area. As a result
of rising home prices, our loans have been well collateralized. However, a
decline in real estate values could cause some of our mortgage loans to become
inadequately collateralized, which would expose us to a greater risk of loss.
The secondary mortgage markets are experiencing disruptions resulting from
reduced investor demand for mortgage loans and mortgaged-backed securities and
increased investor yield requirements for those loans and securities. These
conditions may continue or worsen in the future. As a result, a prolonged period
of secondary market illiquidity could have an adverse impact on our future
earnings and financial condition.
CONSEQUENCES IF MERGER WITH SUMMIT DOESN'T OCCUR.
The company entered into an agreement, to merge with and into Summit.
In approving the merger agreement, the board of directors consulted with Sandler
O'Neill regarding the fairness of the transaction to the company's stockholders
from a financial point of view and with the company's legal counsel regarding
its legal duties and the terms of the merger agreement and ancillary documents.
The understanding of the board of directors of the options available to the
company and the assessment of those options with respect to the prospects and
estimated results of the implementation by the company of its business plan as
an independent entity under various scenarios, and the determination that none
of those options or the realization of the business plan under the best case
scenarios were likely to create greater present value for the company's
stockholders than the value to be paid by Summit. On the other hand, if the
merger is not consummated the company's ability to achieve consistent
profitability by selling a number of branches to increase capital and reduce
overall operating cost would be the next option and, if that option was not
successful, the prospects for regulatory action would be the most likely.
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.
25
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 of September 30, 2007, the bank was considered a well capitalized
institution. Should the bank be classified as an adequately capitalized
institution, the bank could not issue brokered certificates of deposit without
the permission of the Office of Thrift Supervision or the Federal Deposit
Insurance Corporation. At September 30, 2006, the bank was classified as an
adequately capitalized institution and the Office of Thrift Supervision limited
the payment of dividends from the bank to the company. Without the payment of a
dividend from the bank, the company was unable to make a distribution on the
cumulative convertible trust preferred securities. When, on December 13, 2006,
the bank was advised by the Office of Thrift Supervision that it would not
approve the bank's application to pay a cash dividend to the company, the
company exercised its right to defer the scheduled quarterly distributions on
the cumulative convertible trust preferred securities.
ITEM 1B. UNRESOLVED STAFF COMMENTS
The company has no unresolved staff comments for the period ended
September 30, 2007.
26
ITEM 2. PROPERTIES
During fiscal year 2007, we conducted our business from five
full-service banking offices and our administrative office. The following table
sets forth certain information concerning the bank's offices as of September 30,
2007.
Net Book Value
of Property or
Leasehold
Original Improvements
Year Date of at
Leased or Leased or Lease September 30,
Location Owned Acquired Expiration 2007
------------------------------------------------------------------------------------------------------------------
(In Thousands)
ADMINISTRATIVE OFFICES:
10700 Parkridge Boulevard
Reston, Virginia 20191 Leased 1998 01-31-11 $ 65
BRANCH OFFICES:
11834 Rockville Pike
Rockville, Maryland 20852 Leased 1998 06-30-09 4
10700 Parkridge Boulevard
Reston, Virginia 20191 Leased 2004 01-31-11 303
43086 Peacock Market Plaza
South Riding, Virginia 20152 Leased 2000 06-30-15 201
1 South Royal Avenue
Front Royal, Virginia 22630 Owned 1977 687
9484 Congress Street
New Market, Virginia 22844 Owned 1989 405
LOAN OFFICES:
2200 Defense Highway
Crofton, Maryland 21114 Leased 2002 11-30-08 1
12530 Parklawn Drive, Suite 170
Rockville, Maryland 20852 Leased 2005 06-30-10 36
------------------------------------------------------------------------------------------------------------------
Total $1,702
==================================================================================================================
The total net book value of the company's furniture, fixtures and
equipment at September 30, 2007 was $2.3 million. The properties are considered
by management to be in good condition.
ITEM 3. LEGAL PROCEEDINGS
The company is not involved in any pending legal proceedings other than
routine legal proceedings occurring in the ordinary course of business. Such
routine legal proceedings, in the aggregate, are believed by management to be
immaterial to the company's financial condition, results of operations or cash
flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the stockholders during the
fourth quarter of the fiscal year ended September 30, 2007, through the
solicitation of proxies or otherwise.
27
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
MARKET INFORMATION. The Pink Sheets report trades of the company's
stock under the symbol GAFC.PK. At September 30, 2007, there were approximately
278 stockholders of record. The following table sets forth the range of reported
high and low bid quotations as reported in the Pink Sheets for the common stock
for the periods indicated.
First Second Third Fourth
Quarter Ended Quarter Ended Quarter Ended Quarter Ended
December 31 March 31 June 30 September 30
---------------------------------------------------------------------------------------------------
Fiscal Year 2007
High 5.10 4.26 5.05 5.35
Low 4.26 2.25 2.25 4.69
Fiscal Year 2006
High 5.41 5.95 5.76 5.35
Low 4.84 4.60 5.00 4.60
---------------------------------------------------------------------------------------------------
These market quotations reflect inter-dealer prices, without retail
mark-up, mark-down, or commission and may not necessarily represent actual
transactions.
The company has not sold any unregistered securities and did not
repurchase any of its equity securities in the fiscal year ended September 30,
2007.
28
ITEM 6. SELECTED FINANCIAL DATA
The following Selected Consolidated Financial Data should be read in
conjunction with our Consolidated Financial Statements and the notes thereto,
the information contained in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and other financial information included
elsewhere in this Annual Report.
--------------------------------------------------------------------------------------------------------------
At or For the Years Ended September 30, 2007 2006 2005 2004 2003
--------------------------------------------------------------------------------------------------------------
(In Thousands, Except Per Share Data)
Consolidated Statements of Operations Data:
Interest income $18,421 $18,794 $16,958 $18,085 $ 19,361
Interest expense 11,993 11,583 10,013 11,970 12,277
--------------------------------------------------------------------------------------------------------------
Net interest income 6,428 7,211 6,945 6,115 7,084
Provision for loan losses 685 126 219 209 791
--------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan
losses 5,743 7,085 6,726 5,906 6,293
Noninterest income 615 917 1,695 547 766
Gain on branch sales 4,255 - 945 - -
Noninterest expense 9,626 11,085 9,889 10,370 10,014
--------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations before
taxes 987 (3,083) (523) (3,917) (2,955)
Provision for income taxes 36 - - - -
--------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations 951 (3,083) (523) (3,917) (2,955)
Discontinued operations:
(Loss) income from operations - (2,488) (1,107) 428 4,898
--------------------------------------------------------------------------------------------------------------
Net income (loss) $ 951 $(5,571) $(1,630) $(3,489) $ 1,943
==============================================================================================================
Per Share Data:
Net income (loss):
Basic $ 0.31 $ (1.84) $ (0.54) $ (1.16) $ 0.65
Diluted $ 0.31 $ (1.84) $ (0.54) $ (1.16) $ 0.44
Book value 3.17 2.93 4.76 5.29 6.79
Tangible book value 3.29 2.96 4.80 5.22 6.38
Weighted average shares outstanding:
Basic 3,023,407 3,020,934 3,015,509 3,012,434 3,012,434
Diluted 4,395,008 3,020,934 3,015,509 3,012,434 4,413,462
Shares outstanding 3,024,220 3,020,934 3,020,934 3,012,434 3,012,434
Consolidated Statements of Financial Condition Data:
Total assets $245,994 $305,219 $339,542 $433,174 $498,456
Total loans receivable, net 176,108 193,307 194,920 246,387 242,253
Allowance for loan losses 2,305 1,330 1,212 1,600 1,550
Mortgage-loans held for sale - - 9,517 5,528 6,554
Investment securities (1) 35,435 48,557 58,502 60,285 138,049
Mortgage-backed securities 16,528 31,600 57,296 92,722 86,735
Total deposits 197,991 230,174 237,794 288,956 297,876
FHLB advances 25,000 36,000 38,000 51,200 86,800
Other borrowings 2,192 18,574 38,479 64,865 77,835
Guaranteed convertible preferred securities of
subsidiary trust 9,374 9,388 9,378 9,369 9,359
Total stockholders' equity 9,571 8,850 14,375 15,944 20,442
Tangible capital 9,939 8,943 14,514 15,379 19,228
29
SELECTED FINANCIAL DATA - (CONTINUED)
---------------------------------------------------------------------------------------------------------------
At or For the Years Ended September 30, 2007 2006 2005 2004 2003
---------------------------------------------------------------------------------------------------------------
(In Thousands, Except Per Share Data)
Average Consolidated Statements of Financial
Condition Data
Total assets $284,136 $315,133 $370,729 $504,039 $477,882
Investment securities(1) 64,011 66,789 70,633 123,198 161,161
Mortgage-backed securities(1) 23,848 43,979 77,424 111,016 51,046
Total loans 184,570 193,688 210,152 253,772 251,386
Allowance for loan losses 1,559 1,264 1,609 1,498 1,696
Total deposits 214,118 210,311 245,518 275,636 279,469
Total stockholders' equity 7,871 12,164 13,830 15,236 15,132
Performance Ratios (2)
Return on average assets 0.33% (1.77)% (0.44)% (0.69)% 0.41%
Return on average equity 12.08 (45.80) (11.79) (22.90) 12.83
Equity to assets 3.89 2.90 4.23 3.68 4.10
Net interest margin 2.36 2.37 1.94 1.68 1.53
Efficiency ratio(3) 85.20 136.38 103.17 155.66 127.58
Asset Quality Data:
Non-performing assets to total assets, at
period end 0.55 0.36 0.54 0.22 0.28
Non-performing loans to total loans, at period
end 0.74 0.55 0.75 0.37 0.57
Net charge-offs (recoveries) to average total
loans (0.16) 0.00 0.28 0.06 0.36
Allowance for loan losses to:
Total loans 1.26% 0.66% 0.56% 0.62% 0.62%
Non-performing loans 170.87 119.82 75.56 167.89 109.31
Non-performing loans $ 1,349 $ 1,110 $ 1,604 $ 953 $ 1,418
Non-performing assets 1,349 1,110 1,836 953 1,446
Allowance for loan losses 2,305 1,330 1,212 1,600 1,550
Capital Ratios of the Bank:
Leverage ratio 7.67% 5.51% 6.66% 5.59% 5.68%
Tier 1 risk-based capital ratio 11.00 8.59 10.25 9.81 12.08
Total risk-based capital ratio 12.25 9.11 10.75 10.42 12.70
(1) Consists of securities classified as available-for-sale, held-to-maturity
and for trading.
(2) Ratios are presented on an annualized basis where appropriate.
(3) Efficiency ratio consists of noninterest expense divided by net interest
income and noninterest income
30
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
FORWARD-LOOKING STATEMENTS
When used in this Annual Report on Form 10-K 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 results 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.
PROPOSED ACQUISITION
As previously reported in a Form 8-K filed on April 16, 2007, we
announced that the company and Summit Financial Group, Inc., entered into a
definitive agreement for the company to merge with and into Summit. We also
announced that the bank and Bay-Vanguard Federal Savings Bank entered into a
definitive agreement for Bay-Vanguard to purchase the bank's branch office in
Pasadena, Maryland. The sale of the Pasadena branch office was established as a
condition to the completion of the pending merger of the company with and into
Summit Financial Group, Inc.
Originally the merger was expected to be completed in the fourth
calendar quarter of 2007; however, as reported in a Form 8-K filed on December
10, 2007, effective December 6, 2007, the company and Summit amended their
agreement to implement the parties' agreement to extend to March 31, 2008, the
date on which the agreement may be terminated if the merger is not consummated
by that date, subject to regulatory and shareholder approvals. Immediately
following the merger, the bank intends to merge with and into Summit Community
Bank.
GENERAL
The profitability of the company depends primarily on its net-interest
income and non-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.
CRITICAL ACCOUNTING POLICIES, ESTIMATES AND JUDGMENTS
The company's financial statements are prepared in accordance with
accounting principles generally accepted in the United States. The preparation
of these financial statements requires management to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenue and
expenses as well as the disclosure of contingent liabilities. Management
continually evaluates its estimates and judgments including those related to the
allowance for loan losses and income taxes. Management bases its estimates and
judgments on historical experience and other factors that are believed to be
reasonable under the circumstances. Actual results may differ from these
estimates under different assumptions or conditions. The company believes that
of its significant accounting policies, the following may involve a higher
degree of judgment or complexity.
31
ALLOWANCE FOR LOAN LOSSES
The company maintains an allowance for loan losses based on
management's evaluation of the risks inherent in its loan portfolio and the
general economy. Management classifies loans as substandard, doubtful or loss as
required by federal regulations. Management provides a 100% reserve for all
assets classified as loss. Further, management bases its estimates of the
allowance on current economic conditions, actual loss experience and industry
trends. Also, the company discontinues recognizing interest income on loans with
principal and/or interest past due 90 days.
INCOME TAXES
The provision (or benefit) for income taxes is based on taxable income,
tax credits and available net operating losses. The company records deferred tax
assets and liabilities using enacted tax rates for the effect of temporary
differences between the book and tax bases of assets and liabilities. If enacted
tax rates change, the company would adjust the deferred tax assets and
liabilities, through the provision for income taxes in the period of change, to
reflect the enacted tax rate expected to be in effect when the deferred tax
items reverse. The company records a valuation allowance on deferred tax assets
to reflect the future tax benefits expected to be realized. In determining the
appropriate valuation allowance, the company considers the expected level of
future taxable income and available tax planning strategies. At September 30,
2007, the company had deferred tax assets of $2.1 million, which is net of a
valuation allowance of $3.5 million.
RECENT ACCOUNTING STANDARDS
In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements". This statement clarifies the definition of fair value,
establishes a framework for measuring fair value and expands the disclosures on
fair value measurements. For financial assets and liabilities, SFAS No. 157 is
effective for fiscal years beginning after November 15, 2008. We do not believe
the adoption of SFAS 157 will have a material impact on the consolidated
financial statements.
In February 2007, the FASB issued Statement of Financial Accounting
Standards No. 159, "The Fair Value Option for Financial Assets and Financial
Liabilities" (SFAS 159).This statement permits entities to choose to measure
many financial instruments and certain other items at fair value. The objective
of this Statement is to improve financial reporting by providing entities with
the opportunity to mitigate volatility in reported earnings caused by measuring
related assets and liabilities differently without having to apply complex hedge
accounting provisions. The fair value option established by this Statement
permits all entities to choose to measure eligible items at fair value at
specified election dates. A business entity shall report unrealized gains and
losses on items for which the fair value option has been elected in earnings at
each subsequent reporting date. The fair value option may be applied instrument
by instrument and is irrevocable. SFAS 159 is effective as of the beginning of
an entity's first fiscal year that begins after November 15, 2007. The company
is in the process of evaluating the impact SFAS 159 may have on its consolidated
financial statements.
In December 2007, the FASB issued SFAS No. 141 (R), "Business
Combinations", to create greater consistency in the accounting and financial
reporting of business combinations. SFAS 141 (R) requires a company to recognize
the assets acquired, the liabilities assumed, and any noncontrolling interest in
the acquired entity to be measured at their fair values as of the acquisition
date. SFAS 141 (R) also requires companies to recognize and measure goodwill
acquired in a business combination or a gain from a bargain purchase and how to
evaluate the nature and financial effects of the business combination. SFAS No.
141(R) applies to fiscal years beginning after December 15, 2008 and is adopted
prospectively. Earlier adoption is prohibited. We have not determined the
effect, if any, the adoption of this statement will have on our results of
operations or financial position.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling
Interests in Consolidated Financial Statements -- an amendment of ARB No. 51",
to establish accounting and reporting standards for the noncontrolling interest
in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 requires
company to clearly identify and present ownership interests in subsidiaries held
by parties other than the company in the consolidated financial statements
within the equity section but separate from the company's equity. It also
requires the amount of consolidated net income attributable to the parent and to
the noncontrolling interest be clearly identified and presented on the face of
the consolidated statement of income; changes in ownership interest be accounted
for similarly, as equity transactions; and when a subsidiary is deconsolidated,
any retained noncontrolling equity investment in the former subsidiary and the
gain or loss on the deconsolidation of the subsidiary be measured at fair value.
SFAS No. 160 applies to fiscal years beginning after December 15, 2008. Earlier
adoption is prohibited. We have not determined the effect, if any, the adoption
of this statement will have on our results of operations or financial position.
32
DISCONTINUED MORTGAGE BANKING OPERATIONS
On March 29, 2006, we began the process of discontinuing the operations
of the bank's subsidiary, Greater Atlantic Mortgage Corporation. It was
determined that, because it was unprofitable, this business no longer fit our
strategy.
Due to the unprofitable operations of Greater Atlantic Mortgage
Corporation, the company recognized an additional loss of $1.5 million during
fiscal 2006. In addition to the loss from operations, a non-recurring pre-tax
impairment charge on long-lived assets related to Greater Atlantic Mortgage
Corporation of $996,000 was recorded and also included in discontinued
operations in the consolidated statements of operations for fiscal 2006.
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
Greater Atlantic Mortgage Corporation business. The table below summarizes
Greater Atlantic Mortgage Corporation results which were treated as discontinued
operations for the periods indicated.
Year Ended September 30,
------------------------------------
2006 2005
- ---------------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Data
Interest income $ 280 $ 478
Interest expense 256 347
- ---------------------------------------------------------------------------------------
Net interest income 24 131
Noninterest income 2,149 5,072
Noninterest expense 4,661 6,310
Provision for income taxes - -
- ---------------------------------------------------------------------------------------
Net income (loss) $(2,488) $(1,107)
=======================================================================================
Earnings per share - basic $ (0.82) $ (0.37)
Earnings per share - diluted (0.82) (0.37)
FINANCIAL CONDITION
2007 COMPARED TO 2006
At September 30, 2007 the company's total assets were $246.0 million,
compared to the $305.2 million held at September 30, 2006, representing a
decrease of 19.40%. The decrease resulted primarily from a decrease in
investment securities, loans receivable and 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 the bank's assets and liabilities to maintain the bank in a well
capitalized position.
Net loans receivable at September 30, 2007 were $176.1 million, a
decrease of $17.2 million or 8.90% from the $193.3 million held at September 30,
2006. The decrease in loans consisted primarily of a $5.5 million decline in the
bank's single-family loan portfolio, coupled with a decrease of $8.8 million in
the Bank's consumer loan portfolio. Because the Bank's single family and
consumer loan portfolios consist primarily of adjustable-rate loans, and with
the yield curve that existed throughout our fiscal 2007 period, reflecting
short-term rates only slightly lower than rates for longer terms, customers were
able to extend the terms of their mortgages. Customers were 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 $6.6 million during the
period. Those increases were offset in part by decreases of $10.0 million in
construction and land loans and $5.0 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 September 30, 2007, investment securities were $52.0 million, a
decrease of $28.2 million or 35.17% 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, and to retain cash for the sale of our Pasadena
branch office which occurred on August 24, 2007.
33
Deposits at September 30, 2007 were $198.0 million, a decrease of $32.2
million from the $230.2 million held at September 30, 2006. Total deposits
decreased primarily due the sale of our Pasadena branch office and our reduced
reliance on brokered deposits and wholesale deposits, both of which have a
higher cost. The combination of the branch sale and the elimination of brokered
deposits and wholesale deposits contributed to a $75.6 million decrease in
deposits since September 30, 2006 while total retail deposits increased $40.4
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, we
announced that the company and Summit Financial Group, Inc., entered into a
definitive agreement for the company to merge with and into Summit. We also
announced that the bank and Bay-Vanguard Federal Savings Bank entered into a
definitive agreement for Bay-Vanguard to purchase the bank's branch office in
Pasadena, Maryland. The sale of the Pasadena branch office was established as a
condition to the completion of the pending merger of the company with and into
Summit Financial Group, Inc.
Originally the merger was expected to be completed in the fourth
calendar quarter of 2007; however, as reported in a Form 8-K filed on December
10, 2007, effective December 6, 2007, the company and Summit amended their
agreement to implement the parties' agreement to extend to March 31, 2008, the
date on which the agreement may be terminated if the merger is not consummated
by that date, subject to regulatory and shareholder approvals. Immediately
following the merger, the bank intends to merge with and into Summit Community
Bank.
Under the agreement to sell its leased branch office located at 8070
Ritchie Highway, Pasadena, Maryland, to Bay-Vanguard, Bay-Vanguard paid the bank
an 8.5% premium on the balance of deposits assumed at closing. At August 24,
2007, the closing date of that transaction, the deposits at our Pasadena branch
office on which the deposit premium would apply totaled approximately $51.5
million with the bank recognizing a gain of $4.3 million. Bay-Vanguard also
purchased the branch office's fixed assets, but did not acquire any loans as
part of the transaction.
34
RESULTS OF OPERATIONS
2007 COMPARED TO 2006
NET INCOME. For the fiscal year ended September 30, 2007, the company
had a net income from continuing operations of $951,000 or $0.31 per diluted
share compared to a loss from continuing operations of $3.1 million or $1.02 per
diluted share for fiscal year 2006. The $4.0 million improvement in earnings
over the comparable period one-year ago was primarily the result of an increase
in non-interest income and a decrease in non-interest expense. That increase in
non-interest income and decrease in non-interest expense were partially offset
by a decrease in net interest income and increases in the provision for loan
losses and the provision for income taxes. 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 gain arising from the sale of the bank's Pasadena branch
office in August of this year, the bank is currently managing its assets and
liabilities to maintain a well capitalized status. Because of the bank's loans
to one borrower limit it cannot aggressively expand its commercial loan
portfolio and 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, during 2007, the company entered into an agreement to
merge with and into Summit. In approving the merger agreement, the board of
directors consulted with Sandler O'Neill regarding the fairness of the
transaction to the company's stockholders from a financial point of view and
with the company's legal counsel regarding its legal duties and the terms of the
merger agreement and ancillary documents. The understanding of the board of
directors of the options available to the company and the assessment of those
options with respect to the prospects and estimated results of the
implementation by the company of its business plan as an independent entity
under various scenarios, and the determination that none of those options or the
realization of the business plan under the best case scenarios were likely to
create greater present value for the company's stockholders than the value to be
paid by Summit. On the other hand, the board of directors considered the
company's ability to achieve consistent profitability by selling a number of
branches to increase capital and reduce overall operating cost and the prospects
for regulatory action if it failed to do so.
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 repricing 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.
Years ended September 30, Difference
------------------------------- -------------------------------
2007 2006 Amount %
- ------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Interest income:
Loans $ 14,173 $ 13,866 $ 307 2.21%
Investments 4,248 4,928 (680) (13.80)
- ------------------------------------------------------------------------------------------------------------
Total 18,421 18,794 (373) (1.98)
- ------------------------------------------------------------------------------------------------------------
Interest expense:
Deposits 9,331 7,709 1,622 21.04
Borrowings 2,662 3,874 (1,212) (31.29)
- ------------------------------------------------------------------------------------------------------------
Total 11,993 11,583 410 3.54
- ------------------------------------------------------------------------------------------------------------
Net interest income $ 6,428 $ 7,211 $ (783) (10.86)%
============================================================================================================
35
The decrease in net interest income for fiscal year 2007, from the
comparable period one year ago, resulted primarily from a $32.0 million decrease
in the bank's interest-earning assets coupled with average interest-earning
assets declining by $7.6 million more than the decline in average
interest-bearing liabilities. That decrease was coupled with a 1 basis point
decrease in net interest margin (net interest income divided by average
interest-earning assets) from 2.37% for fiscal year 2006 to 2.36% for fiscal
year 2007. The decrease in net interest margin was offset by the average yield
on interest-earning assets increasing by 6 basis point more than the increase in
the average cost on interest-bearing liabilities.
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. 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 bank'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 fiscal year ended September
30, 2007 decreased $373,000 compared to fiscal year 2006, primarily as a result
of a $32.0 million decrease in the average balances of outstanding loans and
investment securities. The decreases in those balances were partially offset by
an increase of 59 basis points in the average yield earned on interest earning
assets.
INTEREST EXPENSE. The $410,000 increase in interest expense for fiscal
year 2007 compared to the 2006 period was principally the result of an 53 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 $24.4 million decrease
in average deposits and borrowings. The increase in interest expense on deposits
was primarily due to a 69 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 $3.8 million in average deposits from
$210.3 million for fiscal 2006 to $214.1 million for fiscal 2007. The increase
in rates was primarily due to market rates requiring higher rates on
interest-bearing demand deposits, savings accounts and certificates and
increased pricing on new and renewed time deposits.
The decrease in interest expense on borrowings for fiscal 2007, when
compared to the 2006 period, was principally the result of a $28.2 million
decrease in average borrowed funds and was partially offset by a 45 basis point
increase in the cost of borrowed funds. Components accountable for the decrease
of $1.2 million in interest expense on borrowings were a $1.4 million decrease
relating to average volume, offset in part by a $217,000 increase relating to
average cost.
36
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.
Year Ended September 30,
--------------------------------------------------------------------------------------------------
2007 2006 2005
------------------------------ ------------------------------- -------------------------------
Interest Average Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate Balance Expense Rate
--------- -------- ------- ------- -------- -------- -------- -------- -------
(Dollars in Thousands)
Interest-earning assets:
Real estate loans $ 91,132 $ 6,693 7.34% $ 93,390 $ 6,699 7.17% $ 98,217 $ 6,379 6.49%
Consumer loans 55,420 4,353 7.85 65,338 4,701 7.19 71,817 3,748 5.22
Commercial business
loans 38,018 3,127 8.23 34,960 2,466 7.05 40,118 2,303 5.74
--------- -------- ------- --------- -------- -------- -------- -------- -------
Total loans 184,570 14,173 7.68 193,688 13,866 7.16 210,152 12,430 5.91
Investment securities 64,011 3,184 4.97 66,789 3,353 5.02 70,633 2,414 3.42
Mortgage-backed
securities 23,848 1,064 4.46 43,979 1,575 3.58 77,424 2,114 2.73
--------- -------- ------- --------- -------- -------- -------- -------- -------
Total interest-
earning assets 272,429 18,421 6.76 304,456 18,794 6.17 358,209 16,958 4.73
-------- ------- -------- -------- -------- -------
Non-earning assets 11,707 10,677 12,520
--------- --------- ---------
Total assets $284,136 $315,133 $370,729
========= ========= =========
Liabilities and
Stockholders' Equity:
Interest-bearing
liabilities:
Savings accounts $ 2,969 27 0.91 $ 5,190 48 0.92 $ 10,202 94 0.92
Now and money
market accounts 77,997 2,791 3.58 73,485 2,430 3.31 64,723 1,197 1.85
Certificates of
deposit 133,152 6,513 4.89 131,636 5,231 3.97 170,593 5,046 2.96
--------- -------- ------- --------- -------- -------- -------- -------- -------
Total deposits 214,118 9,331 4.36 210,311 7,709 3.67 245,518 6,337 2.58
FHLB advances 33,064 1,806 5.46 44,894 2,266 5.05 44,422 1,985 4.47
Other borrowings 15,264 856 5.61 31,624 1,608 5.08 51,388 1,691 3.29
--------- -------- ------- --------- -------- -------- -------- -------- -------
Total interest-
bearing liabilities 262,446 11,993 4.57 286,829 11,583 4.04 341,328 10,013 2.93
-------- ------- -------- -------- -------- -------
Noninterest-bearing
liabilities:
Noninterest-bearing
demand deposits 11,595 14,993 14,138
Other liabilities 2,224 1,147 1,433
--------- --------- ---------
Total liabilities 276,265 302,969 356,899
Stockholders' equity 7,871 12,164 13,830
--------- --------- ---------
Total liabilities
and stockholders'
equity $284,136 $315,133 $370,729
========= ========= =========
Net interest income $6,428 $ 7,211 $ 6,945
======= ======= ========
Interest rate spread 2.19% 2.13% 1.80%
======= ======= ======
Net interest margin 2.36% 2.37% 1.94%
======= ======= ======
37
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.
Year Ended September 30, 2007 Year Ended September 30, 2006
Compared to Year Compared to Year
Ended September 30, 2006 Ended September 30, 2005
Change Attributable to Change Attributable to
--------------------------------- --------------------------------------
Volume Rate Total Volume Rate Total
- ------------------------------------------------------------------------------------------------------------
(In Thousands)
Real estate loans $ (162) $ 156 $ (6) $ (314) $ 634 $ 320
Consumer loans (714) 366 (348) (338) 1,291 953
Commercial business loans 216 445 661 (296) 459 163
- ------------------------------------------------------------------------------------------------------------
Total loans (660) 967 307 (948) 2,384 1,436
Investments (139) (30) (169) (131) 1,070 939
Mortgage-backed securities (721) 210 (511) (913) 374 (539)
- ------------------------------------------------------------------------------------------------------------
Total interest-earning assets $(1,520) $1,147 $ (373) $(1,992) $3,828 $1,836
============================================================================================================
Savings accounts $ (21) $ - $ (21) $ (46) $ - $ (46)
Now and money market accounts 149 212 361 162 1,071 1,233
Certificates of deposit 60 1,222 1,282 (1,152) 1,337 185
- ------------------------------------------------------------------------------------------------------------
Total deposits 188 1,434 1,622 (1,036) 2,408 1,372
FHLB advances (597) 137 (460) 21 260 281
Other borrowings (832) 80 (752) (650) 567 (83)
- ------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities $(1,241) $1,651 $ 410 $(1,665) $3,235 $1,570
============================================================================================================
Change in net interest income $ (279) $ (504) $ (783) $ (327) $ 593 $ 266
============================================================================================================
PROVISION FOR LOAN LOSSES. The allowance for loan losses, which is established
through provisions for losses charged to expense, is increased by recoveries on
loans previously charged off and is reduced by charge-offs on loans. Determining
the proper reserve level or allowance involves management's judgment based upon
a review of factors, including the company's internal review process, which
segments the loan portfolio into groups based on loan type. Management then
looks at its classified assets, which are loans 30 days or more delinquent, and
classifies those loans as special mention, substandard or doubtful, based on the
performance of the loans. Those classified loans are then individually evaluated
for impairment. Those loans that are not individually evaluated are then
segmented by type and assigned a reserve percentage that reflects the industry
loss experience. The loans individually evaluated for impairment are measured by
either, the present value of expected future cash flows, the loans observable
market price, or the fair value of the collateral. Although management utilizes
its best judgment in providing for probable losses, there can be no assurance
that the bank will not have to increase its provisions for loan losses in the
future. An increase in provision may result from an adverse market for real
estate and economic conditions generally in the company's primary market area,
future increases in non-performing assets or for other reasons which would
adversely affect the company's results of operations. On an annual basis, or
more often if deemed necessary, the bank had 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 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. However, because we
entered into a definitive agreement for the company to merge with Summit, and
based on the due diligence performed by Summit, it was deemed unnecessary to
enter into such a contract for the fiscal year ended September 30, 2007.
Non-performing assets were $1.3 million or 0.55% of total assets at
September 30, 2007, compared to non-performing assets of $1.1 million or 0.36%
of total assets at September 30, 2006. At September 30, 2007, assets of $4.7
million were classified as substandard and $675,000 classified as doubtful. A
$685,000 provision for loan losses was recorded during the year ended September
30, 2007, compared to a provision of $126,000 during the year ended September
30, 2006. The increase in the provision for loan losses of $559,000 from the
year ago period resulted from the increase in non-performing assets, an increase
in the outstanding balance of the bank's commercial real estate loan's which
require a larger allocated allowance provision and an increase of $3.9 million
in loans classified as substandard which also require an additional allocation
of the bank's overall provision coupled with an increase of $356,000 in loans
classified as doubtful. That increase in provision for those loans was offset
with an overall decline in the size of the bank's loan portfolio.
38
NON-INTEREST INCOME. Non-interest income increased $4.0 million during
fiscal 2007, over fiscal 2006. That increase was primarily the result of
increases in other operating income and service fees on deposits. Those
increases were partially offset by losses on derivatives, real estate owned and
service fees on loans. The increase in other operating income reflects the $4.3
gain recognized from the sale of the bank's Pasadena, Maryland branch. 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 sale of the
Pasadena branch office was a condition to the completion of the pending merger
of GAFC with and into Summit Financial Group, Inc.
The following table presents a comparison of the components of
non-interest income.
Years Ended September 30, Difference
-------------------------------- ------------------------------------
2007 2006 Amount %
- ------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Noninterest income:
Service fees on loans $ 169 $ 186 $ (17) (9.14)%
Service fees on deposits 444 424 20 4.72
Gain (loss) on derivatives (21) 212 (233) (107.89)
Gain on sale of real estate owned - 65 (65) (100.00)
Other operating income 23 30 (7) (23.33)
Gain on branch sale 4,255 - 4,255 n/a
- ------------------------------------------------------------------------------------------------------------------
Total noninterest income $ 4,870 $ 917 $ 3,953 431.08%
==================================================================================================================
NON-INTEREST EXPENSE. Noninterest expense for fiscal 2007 amounted to
$9.6 million, a decrease of $1.5 million or 13.16% from the $11.1 million
incurred in fiscal 2006. The decrease was distributed over various non-interest
expense categories with the contributors being compensation, professional
services, advertising, deposit insurance premiums, furniture, fixtures and
equipment, data processing and other operating expense. The decreases in those
categories of expense were offset by an increase of $57,000 in occupancy
expense. The decrease in other operating expense is the result of a settlement
offer which required a $500,000 payment by the company during fiscal 2006.
The following table presents a comparison of the components of
noninterest expense.
Years Ended September 30, Difference
------------------------------ -------------------------------
2007 2006 Amount %
--------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Noninterest expense:
Compensation and employee benefits $ 4,446 $ 4,718 $ (272) (5.77)%
Occupancy 1,394 1,337 57 4.26
Professional services 1,128 1,227 (99) (8.07)
Advertising 130 628 (498) (79.30)
Deposit insurance premium 69 101 (32) (31.68)
Furniture, fixtures and equipment 516 554 (38) (6.86)
Data processing 877 919 (42) (4.57)
Other operating expense 1,066 1,601 (535) (33.42)
--------------------------------------------------------------------------------------------------------------
Total noninterest expense $ 9,626 $ 11,085 $(1,459) (13.16)%
==============================================================================================================
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 recorded a provision for income taxes for fiscal 2007
of $36,000 which was due to the alternative minimum tax. We did not record a
provision for income taxes for fiscal 2006 and 2005 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.
39
CONTRACTUAL COMMITMENTS AND OBLIGATIONS
The following summarizes the company's contractual cash obligations and
commercial commitments, including maturing certificates of deposit, as of
September 30, 2007 and the effect such obligations may have on liquidity and
cash flow in future periods.
Less Than Two-Three Four-Five After Five
Total One Year Years Years Years
- -----------------------------------------------------------------------------------------------------------
(In Thousands)
FHLB Advances (1) $ 25,000 $ - $ 25,000 $ - $ -
Reverse repurchase agreements 2,192 2,192 - - -
Subordinated debt securities (2) 25,982 655 1,310 1,310 22,707
Operating leases 3,779 1,062 1,858 469 390
- -----------------------------------------------------------------------------------------------------------
Total obligations $ 56,953 $ 3,909 $ 28,168 $ 1,779 $ 23,097
===========================================================================================================
(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 Two-Three Four-Five After Five
Total One Year Years Years Years
- -----------------------------------------------------------------------------------------------------------
(In Thousands)
Certificates of deposit maturities (1) $ 125,717 $ 111,990 $ 10,922 $ 2,712 $ 93
Loan originations 9,527 9,527 - - -
Unfunded lines of credit (2) 111,815 111,815 - - -
Standby letter of credit 310 310 - - -
- -----------------------------------------------------------------------------------------------------------
Total $ 247,369 $ 233,642 $ 10,922 $ 2,712 $ 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 lines of credit secured by one-to-four dwelling units and
commercial lines that remain unfunded. The committed amount of these lines
total $174.1 million.
ASSET-LIABILITY MANAGEMENT
The primary objective of asset/liability management is to ensure the
steady growth of the company's primary earnings component, net interest income,
and the maintenance of reasonable levels of capital independent of fluctuating
interest rates. Interest rate risk can be defined as the vulnerability of an
institution's financial condition and/or results of operations to movements in
interest rates. Interest rate risk, or sensitivity, arises when the maturity or
repricing characteristics of assets differ significantly from the maturity or
repricing characteristics of liabilities. Management endeavors to structure the
balance sheet so that repricing opportunities exist for both assets and
liabilities in roughly equivalent amounts at approximately the same time
intervals to maintain interest rate risk at an acceptable level.
Management oversees the asset/liability management function and meets
periodically to monitor and manage the structure of the balance sheet, control
interest rate exposure, and evaluate pricing strategies for the company. The
asset mix of the balance sheet is continually evaluated in terms of several
variables: yield, credit quality, appropriate funding sources and liquidity.
Management of the liability mix of the balance sheet focuses on expanding the
company's various funding sources. At times, depending on the general level of
interest rates, the relationship between long- and short-term interest rates,
market conditions and competitive factors, the bank may determine to increase
our interest rate risk position in order to increase our net interest margin.
The bank manages its exposure to interest rates by structuring the
balance sheet in the ordinary course of business. The bank currently emphasizes
adjustable rate loans and/or loans that mature in a relatively short period when
compared to single-family residential loans. In addition, to the extent
possible, the bank attempts to attract longer-term deposits. While the bank has
entered into interest rate swaps and caps to assist in managing interest rate
risk, it has not entered into instruments such as leveraged derivatives,
structured notes, financial options, financial futures contracts or forward
delivery contracts to manage interest rate risk.
40
One of the ways the bank monitors interest rate risk is through an
analysis of the relationship between interest-earning assets and
interest-bearing liabilities to measure the impact that future changes in
interest rates will have on net interest income. An interest rate sensitive
asset or liability is one that, within a defined time period, either matures or
experiences an interest rate change in line with general market interest rates.
The management of interest rate risk is performed by analyzing the maturity and
repricing relationships between interest-earning assets and interest-bearing
liabilities at specific points in time ("GAP") and by analyzing the effects of
interest rate changes on net interest income over specific periods of time by
projecting the performance of the mix of assets and liabilities in varied
interest rate environments.
The table below illustrates the maturities or repricing of the
company's assets and liabilities, including noninterest-bearing sources of
funds, to specific periods, at September 30, 2007. Estimates and assumptions
concerning allocating prepayment rates of major asset categories are based on
information obtained from Farin and Associates on projected prepayment levels on
mortgage-backed and related securities and decay rates on savings, NOW and money
market accounts. The bank believes that such information is consistent with our
current experience.
-----------------------------------------------------------------------------------------------------------------------
Three
91 Days 181 Days One Year Years to Five
90 Days to 180 to Dne to Three Five Years or
Maturing or Repricing Periods or Less Days Year Years Years More Total
-----------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Interest-earning assets
Loans:
Adjustable and balloon $ 23,647 $ 3,042 $ 7,709 $ 12,385 $ 7,697 $ 151 $ 54,631
Fixed-rate 700 703 1,881 8,169 5,765 15,708 32,926
Commercial business 22,734 431 1,163 7,526 1,540 1,704 35,098
Consumer 52,362 93 164 427 188 154 53,388
Investment securities 36,444 4,755 - - - - 41,199
Mortgage-backed securities 3,833 12,546 37 48 8 10 16,482
-----------------------------------------------------------------------------------------------------------------------
Total 139,720 21,570 10,954 28,555 15,198 17,727 233,724
-----------------------------------------------------------------------------------------------------------------------
Interest-bearing liabilities:
Deposits:
Savings accounts 709 505 363 410 223 258 2,468
NOW accounts 2,336 1,802 1,772 1,974 1,040 1,286 10,210
Money market accounts 16,091 10,957 8,496 8,379 3,597 2,907 50,427
Certificates of deposit 52,130 30,140 25,476 15,097 2,803 93 125,739
Borrowings:
FHLB advances - - - - 25,000 - 25,000
Other borrowings 2,192 - - - - 9,374 11,566
-----------------------------------------------------------------------------------------------------------------------
Total 73,458 43,404 36,107 25,860 32,663 13,918 $225,410
-----------------------------------------------------------------------------------------------------------------------
GAP $ 66,262 $(21,834) $(25,153) $ 2,695 $(17,465) $ 3,809 $ 8,314
=======================================================================================================================
Cumulative GAP $ 66,262 $ 44,428 $ 19,275 $ 21,970 $ 4,505 $ 8,314
=======================================================================================================================
Ratio of Cumulative GAP
to total interest earning assets 28.35% 19.01% 8.25% 9.40% 1.93% 3.56%
=======================================================================================================================
As indicated in the interest rate sensitivity table, the 181 day to
one-year cumulative gap, representing the total net assets and liabilities that
are projected to re-price over the next year, was asset sensitive in the amount
of $19.3 million at September 30, 2007.
While the GAP position is a useful tool in measuring interest rate risk
and contributes toward effective asset and liability management, it is difficult
to predict the effect of changing interest rates solely on the GAP measure
without accounting for alterations in the maturity or repricing characteristics
of the balance sheet that occur during changes in market interest rates. The GAP
position reflects only the prepayment assumptions pertaining to the current rate
environment, and assets tend to prepay more rapidly during periods of declining
interest rates than they do during periods of rising interest rates.
Management uses two other analyses to manage interest rate risk: (1) an
earnings-at-risk analysis to develop an estimate of the direction and magnitude
of the change in net interest income if rates move up or down 200 basis points;
and (2) a value-at-risk analysis to estimate the direction and magnitude of the
change in net portfolio value if rates move up 200 basis points or down 200
basis points. Currently the bank uses a sensitivity of net interest income
analysis prepared by Farin and Associates to measure earnings-at-risk and the
Office of Thrift Supervision Interest Rate Risk Exposure Report to measure
value-at-risk.
41
The following table sets forth the earnings at risk analysis that
measures the sensitivity of net interest income to changes in interest rates at
September 30, 2007:
Net Interest Income Sensitivity Analysis
---------------------------------------------------------------------
Changes in Rate Basis Point Percent Change
by Basis Point Net Interest Change From Base
Margin From Base
----------------- ---------------- --------------- -----------------
+200 3.15% 0.14% 4.65%
+100 3.08% 0.07% 2.33%
+0 3.01% - -
-100 2.90% (0.11)% (3.65)%
-200 2.75% (0.26)% (8.64)%
In a declining rate scenario the bank is not within the limits
established by the board of directors. Management will monitor the situation
over the next several quarters to determine if a change should be made in our
position.
The above table indicates that, based on an immediate and sustained 200
basis point increase in market interest rates, net interest margin, as measured
as a percent of total assets, would increase by 14 basis points or 4.65% and, if
interest rates decrease 200 basis points, net interest margin, as a percent of
total assets, would decrease by 26 basis points or 8.64%.
The net interest income sensitivity analysis does not represent a
forecast and should not be relied upon as being indicative of expected operating
results. The estimates used are based upon assumptions as to the nature and
timing of interest rate levels including the shape of the yield curve. Those
estimates have been developed based upon current economic conditions; the
company cannot make any assurances as to the predictive nature of those
assumptions including how customer preferences or competitor influences might
change.
Presented below is an analysis of our interest rate risk, as of
September 30, 2007, as measured by changes in net portfolio value for parallel
shifts of up 200 and down 200 basis points in market interest rates:
Net Portfolio Value as a Percent of
Net Portfolio Value the Present Value of Assets
---------------------------------- --------------------------------------
Changes in Rates Dollar Percent Net Portfolio Change in
(bp) Change Change Value Ratio NPV Ratio
- ----------------------------------------------------------------------------------------------
(Dollars in thousands)
+200 $ (2,054) (8.46)% 8.97% (0.67)%
+100 (976) (4.02) 9.33 (0.31)
+0 - - 9.64 -
-100 282 1.16 9.69 0.06
-200 308 1.27 9.66 0.02
The decline in net portfolio value of $2.0 million or 8.46% in the
event of a 200 basis point increase in rates is a result of the current amount
of adjustable rate loans and investments held by the bank as of September 30,
2007 and currently is within the limits established by the board of directors.
The foregoing increase in net portfolio value, in the event of a decrease in
interest rates of 200 basis points, currently exceeds the company's internal
board guidelines.
In addition to the strategies set forth above, in 2002, the bank began
using derivative financial instruments, such as interest rate swaps, to help
manage interest rate risk. The bank does not use derivative financial
instruments for trading or speculative purposes. All derivative financial
instruments are used in accordance with board-approved risk management policies.
The bank enters into interest rate swap and cap agreements principally
to manage its exposure to the impact of rising short-term interest rates on its
earnings and cash flows. Since short-term interest rates have stabilized, the
bank has unwound its interest rate swaps during fiscal 2006.
42
FINANCIAL CONDITION
2006 COMPARED TO 2005
At September 30, 2006, the company had total assets of $305.2 million,
a decrease of $34.3 million or 10.11% from the $339.5 million recorded at the
close of the comparable period one-year ago. Investments and mortgage-backed
securities at September 30, 2006, amounted to $80.2 million a decrease of $35.6
million or 30.78% from the $115.8 million held at September 30, 2005, as a
result of prepayments of $42.0 million offset in part by purchases of $7.7
million. Loans receivable and loans held for sale at September 30, 2006,
amounted to $193.3 million, a decrease of 5.44% from the $204.4 million held at
September 30, 2005, primarily as a result a $9.5 million decrease in loans held
for sale, coupled with a $12.6 million decline in land and consumer loans
outstanding. Those declines were due primarily to discontinuing the operations
of the bank's subsidiary, GAMC as it was determined that, because it was
unprofitable, this business no longer fit our strategy and was coupled with
payoffs and lower than anticipated loan originations. Deposits amounted to
$230.2 million at September 30, 2006, a decrease of $7.6 million from the $237.8
million held one year ago. That decline was primarily the result of decreases in
our checking, savings and certificates of deposit accounts, and was offset by
increases in non-interest checking and our money funds accounts.
RESULTS OF OPERATIONS
2006 COMPARED TO 2005
NET INCOME. For the fiscal year ended September 30, 2006, the company
had a net loss from continuing operations of $3.1 million or $1.02 per diluted
share compared to a loss from continuing operations of $523,000 or $0.17 per
diluted share for fiscal year 2005. The $2.6 million decline in earnings over
the comparable period one-year ago was primarily the result of an increase in
non-interest expense and a decrease in non-interest income. That increase in
non-interest expense and decrease in non-interest income were partially offset
by an increase in net interest income and a decrease in the provision for loan
losses.
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 repricing 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.
Years ended September 30, Difference
------------------------------- -------------------------------
2006 2005 Amount %
- ------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Interest income:
Loans $ 13,866 $ 12,430 $ 1,436 11.55%
Investments 4,928 4,528 400 8.83
- ------------------------------------------------------------------------------------------------------------
Total 18,794 16,958 1,836 10.83
- ------------------------------------------------------------------------------------------------------------
Interest expense:
Deposits 7,709 6,337 1,372 21.65
Borrowings 3,874 3,676 198 5.39
- ------------------------------------------------------------------------------------------------------------
Total 11,583 10,013 1,570 15.68
- ------------------------------------------------------------------------------------------------------------
Net interest income $ 7,211 $ 6,945 $ 266 3.83%
============================================================================================================
Our increase in net interest income for fiscal year 2006, resulted
primarily from a 43 basis point increase in net interest margin (net interest
income divided by average interest-earning assets) from 1.94% for fiscal year
2005 to 2.37% for fiscal year 2006, offset in part by a $53.8 million decrease
in the bank's interest-earning assets. The increase in net interest margin also
resulted from the average yield on interest-earning assets increasing by 33
basis points more than the increase in the average cost on interest-bearing
liabilities and was coupled with average interest earning assets decreasing by
$746,000 less than the decline in average interest-bearing liabilities.
43
INTEREST INCOME. Interest income for the fiscal year ended September
30, 2006 increased $1.8 million compared to fiscal year 2005, primarily as a
result of a 144 basis point increase in the average yield earned on interest
earning assets. That increase was partially offset by a decrease of $53.8
million in the average outstanding balances of loans and securities.
INTEREST EXPENSE. The $1.6 million increase in interest expense for
fiscal year 2006 compared to the 2005 period was principally the result of an
111 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 $54.5
million decrease in average deposits and borrowings. The increase in interest
expense on deposits was primarily due to a 109 basis point increase in rates
paid on deposits, primarily due to higher rates paid on interest-bearing demand
deposits, savings accounts and certificates and elevated pricing on new and
renewed time deposits. That increase was partially offset by a decrease of $35.2
million in average deposits from $245.5 million for fiscal 2005 to $210.3
million for fiscal 2006. The increase in rates was primarily due to market rates
moving rates higher on interest-bearing demand deposits, savings accounts and
certificates and the pricing on new and renewed time deposits.
The decrease in interest expense on borrowings for fiscal 2006, when
compared to the 2005 period, was principally the result of a $19.3 million
decrease in average borrowed funds and was partially offset by a 122 basis point
increase in the cost of borrowed funds. Components accountable for the increase
of $198,000 in interest expense on borrowings were a $629,000 decrease relating
to average volume, offset in part by a $827,000 increase relating to average
cost.
44
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.
Year Ended September 30,
--------------------------------------------------------------------------------------------------
2006 2005 2004
--------------------------------------------------------------------------------------------------
Interest Average Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate Balance Expense Rate
--------- --------- ------- --------- -------- ------ --------- --------- -------
(Dollars in Thousands)
Interest-earning assets:
Real estate loans $ 93,390 $ 6,699 7.17% $ 98,217 $ 6,379 6.49% $138,655 $ 7,705 5.56%
Consumer loans 65,338 4,701 7.19 71,817 3,748 5.22 68,268 2,566 3.76
Commercial business
loans 34,960 2,466 7.05 40,118 2,303 5.74 46,849 2,358 5.03
---------- -------- ------ --------- -------- ------ --------- -------- -------
Total loans 193,688 13,866 7.16 210,152 12,430 5.91 253,772 12,629 4.98
Investment securities 66,789 3,353 5.02 70,633 2,414 3.42 123,198 3,077 2.50
Mortgage-backed
securities 43,979 1,575 3.58 77,424 2,114 2.73 111,016 2,379 2.14
---------- -------- ------ --------- -------- ------ --------- -------- -------
Total interest-
earning assets 304,456 18,794 6.17 358,209 16,958 4.73 487,986 18,085 3.71
-------- ------ -------- ------ -------- -------
Non-earning assets 10,677 12,520 16,053
---------- ---------- ---------
Total assets $315,133 $370,729 $504,039
========== ========== =========
Liabilities and
Stockholders' Equity:
Interest-bearing
liabilities:
Savings accounts $ 5,190 48 0.92 $ 10,202 94 0.92 $ 11,978 113 0.94
Now and money
market accounts 73,485 2,430 3.31 64,723 1,197 1.85 77,981 852 1.09
Certificates of
deposit 131,636 5,231 3.97 170,593 5,046 2.96 185,677 4,786 2.58
---------- -------- ------ --------- -------- ------ --------- -------- -------
Total deposits 210,311 7,709 3.67 245,518 6,337 2.58 275,636 5,751 2.09
FHLB advances 44,894 2,266 5.05 44,422 1,985 4.47 116,155 2,779 2.39
Other borrowings 31,624 1,608 5.08 51,388 1,691 3.29 78,979 1,373 1.74
---------- -------- ------ --------- -------- ------ --------- -------- -------
Total interest-
bearing liabilities 286,829 11,583 4.04 341,328 10,013 2.93 470,770 9,903 2.10
-------- ------ -------- ------ -------- -------
Noninterest-bearing
liabilities:
Noninterest-bearing
demand deposits 14,993 14,138 15,243
Other liabilities 1,147 1,433 2,790
---------- ---------- ---------
Total liabilities 302,969 356,899 488,803
Stockholders' equity 12,164 13,830 15,236
---------- ---------- ---------
Total liabilities
and stockholders'
equity $315,133 $370,729 $ 504,039
========== ========== =========
Net interest income $ 7,211 $ 6,945 $ 8,182
======== ======== ========
Interest rate spread 2.13% 1.80% 1.61%
====== ======
Net interest margin 2.37% 1.94% 1.68%
======== ====== ======
45
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.
Year Ended September 30, 2006 Year Ended September 30, 2005
Compared to Year Compared to Year
Ended September 30, 2005 Ended September 30, 2004
Change Attributable to Change Attributable to
--------------------------------- --------------------------------------
Volume Rate Total Volume Rate Total
- ------------------------------------------------------------------------------------------------------------
(In Thousands)
Real estate loans $ (314) $ 634 $ 320 $(2,247) $ 921 $ (1,326)
Consumer loans (338) 1,291 953 133 1,049 1,182
Commercial business loans (296) 459 163 (339) 284 (55)
- ------------------------------------------------------------------------------------------------------------
Total loans (948) 2,384 1,436 (2,453) 2,254 (199)
Investments (131) 1,070 939 (1,313) 650 (663)
Mortgage-backed securities (913) 374 (539) (720) 455 (265)
- ------------------------------------------------------------------------------------------------------------
Total interest-earning assets $(1,992) $3,828 $1,836 $(4,486) $ 3,359 $ (1,127)
============================================================================================================
Savings accounts $ (46) $ - $ (46) $ (17) $ (2) $ (19)
Now and money market accounts 162 1,071 1,233 (145) 490 345
Certificates of deposit (1,152) 1,337 185 (389) 649 260
- ------------------------------------------------------------------------------------------------------------
Total deposits (1,036) 2,408 1,372 (551) 1,137 586
FHLB advances 21 260 281 (1,716) 922 (794)
Other borrowings (650) 567 (83) (480) 798 318
- ------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities $(1,665) $3,235 $1,570 $(2,747) $ 2,857 $ 110
============================================================================================================
Change in net interest income $ (327) $ 593 $ 266 $(1,739) $ 502 $ (1,237)
============================================================================================================
PROVISION FOR LOAN LOSSES. The allowance for loan losses, which is
established through provisions for losses charged to expense, is increased by
recoveries on loans previously charged off and is reduced by charge-offs on
loans. Determining the proper reserve level or allowance involves management's
judgment based upon a review of factors, including the company's internal review
process, which segments the loan portfolio into groups based on loan type.
Management then looks at its classified assets, which are loans 30 days or more
delinquent, and classifies those loans as special mention, substandard or
doubtful, based on the performance of the loans. Those classified loans are then
individually evaluated for impairment. Those loans that are not individually
evaluated are then segmented by type and assigned a reserve percentage that
reflects the industry loss experience. The loans individually evaluated for
impairment are measured by either, the present value of expected future cash
flows, the loans observable market price, or the fair value of the collateral.
Although management utilizes its best judgment in providing for probable losses,
there can be no assurance that the bank will not have to increase its provisions
for loan losses in the future. An increase in provision may result from an
adverse market for real estate and economic conditions generally in the
company's primary market area, future increases in non-performing assets or for
other reasons which would adversely affect the company's results of operations.
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 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.
Non-performing assets were $1.1 million or 0.36% of total assets at
September 30, 2006, compared to non-performing assets of $1.8 million or 0.54%
of total assets at September 30, 2005. At September 30, 2006, assets of $791,000
were classified as substandard and $319,000 classified as doubtful. The decrease
in the provision for loan losses of $93,000 resulted from declines in
non-performing assets and the outstanding balance of the bank's land loans,
commercial business loans, home equity loans and real estate owned. The decrease
in provision was due primarily to the decreases in the required provisions for
those loans coupled with an overall decline in the size of the bank's loan
portfolio.
46
NON-INTEREST INCOME. Non-interest income decreased $2.5 million during
fiscal 2006, over fiscal 2005. That decrease was primarily the result of
decreases in gain on sale of loans, gains on derivatives, gain on sale of
investment securities and declines in other operating income and service fees on
deposits. Those decreases in income were partially offset by an increase of
$65,000 in gain on sale of real estate owned. The decrease in other operating
income reflects the $946,000 gain recognized one year ago from the sale of the
bank's Washington, D.C., Winchester and Sterling, Virginia, branches.
The following table presents a comparison of the components of
non-interest income.
Years Ended September 30, Difference
-------------------------------- ------------------------------------
2006 2005 Amount %
- ------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Noninterest income:
Gain on sale of loans $ - $ 53 $ (53) (100.00)%
Service fees on loans 186 182 4 2.20
Service fees on deposits 424 552 (128) (23.19)
Gain (loss) on sale of investment
securities - 539 (539) (100.00)
Gain (loss) on derivatives 212 303 (91) (30.03)
Gain on sale of real estate owned 65 - 65 n/a
Other operating income 30 1,011 (981) (97.03)
- ------------------------------------------------------------------------------------------------------------------
Total noninterest income $ 917 $ 2,640 $ (1,723) (65.27)%
==================================================================================================================
NON-INTEREST EXPENSE. Noninterest expense for fiscal 2006 amounted to
$11.1 million, an increase of $1.2 million or 12.09% from the $9.9 million
incurred in fiscal 2005. The increase in non-interest expense was distributed
over various non-interest expense categories with the major contributors being
compensation, professional services, advertising and other operating and was
offset in part by decreases in, furniture fixtures and equipment and data
processing. As previously reported in a Form 8-K filed on September 8, 2006, the
company announced that a Demand for Arbitration before the American Arbitration
Association was filed against the company, the bank, Greater Atlantic Mortgage
Corporation, and Carroll E. Amos, President and Chief Executive Officer of the
company and the bank. The increase in other operating expense is the result of a
settlement offer which required a contribution of $500,000 by the company toward
the settlement. That offer was accepted conditioned on the execution of a mutual
release by the parties. That mutual release was executed and as a result, the
company established a liability for the settlement and charged $500,000 as other
operating expense in fiscal 2006.
The following table presents a comparison of the components of
noninterest expense.
Years Ended September 30, Difference
------------------------------ ------------------------------
2006 2005 Amount %
--------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Noninterest expense:
Compensation and employee benefits $ 4,718 $ 4,213 $ 505 11.99%
Occupancy 1,337 1,337 - -
Professional services 1,227 969 258 26.63
Advertising 628 301 327 108.64
Deposit insurance premium 101 100 1 1.00
Furniture, fixtures and equipment 554 641 (87) (13.57)
Data processing 919 1,054 (135) (12.81)
Other operating expense 1,601 1,274 327 25.67
--------------------------------------------------------------------------------------------------------------
Total noninterest expense $ 11,085 $ 9,889 $ 1,196 12.09%
==============================================================================================================
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 fiscal
2006 and 2005 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.
47
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY. The bank's primary sources of funds are deposits, principal
and interest payments on loans, mortgage-backed and investment securities and
borrowings. While maturities and scheduled amortization of loans are predictable
sources of funds, deposit flows and mortgage prepayments are greatly influenced
by general interest rates, economic conditions and competition. The bank has
continued to maintain the levels of liquid assets as previously required by
regulations of the Office of Thrift Supervision. 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, interest
bearing deposits 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 September 30, 2007, cash and cash
equivalents, interest bearing deposits and securities available-for-sale totaled
$56.5 million, or 22.99% of total assets.
The primary investing activities of the bank are the origination of
residential one- to four-family loans, commercial real estate loans, real estate
construction and development loans, commercial business and consumer loans and
the purchase of United States Treasury and agency securities, mortgage-backed
and mortgage-related securities and other investment securities. During the year
ended September 30, 2007, the bank's loan originations and purchases totaled
$79.4 million. The bank did not purchase any United States Treasury or agency
securities, mortgage-backed and mortgage related securities or other investment
securities during the year ended September 30, 2007. All of our investment
securities are classified as either available for sale or held to maturity and
for the period ended September 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.
The bank has other sources of liquidity if a need for additional funds
arises. At September 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 $18.3 million at that date. Depending on market conditions, the
pricing of deposit products and FHLB advances, the bank may continue to rely on
FHLB borrowings to fund asset growth.
At September 30, 2007, the bank had commitments to fund loans and
unused outstanding lines of credit, unused standby letters of credit and
undisbursed proceeds of construction mortgages totaling $121.3 million. The bank
anticipates that it will have sufficient funds available to meet its current
loan origination commitments. Certificate accounts, including IRA and Keogh
accounts, which are scheduled to mature in less than one year from September 30,
2007, totaled $107.7 million. Based upon experience, management believes the
majority of maturing certificates of deposit will remain with the bank. In
addition, management of the bank believes that it can adjust the rates offered
on certificates of deposit to retain deposits in changing interest rate
environments. In the event that a significant portion of these deposits are not
retained by the bank, the bank would be able to utilize FHLB advances and
reverse repurchase agreements to fund deposit withdrawals, which would result in
an increase in interest expense to the extent that the average rate paid on such
borrowings exceeds the average rate paid on deposits of similar duration.
CAPITAL RESOURCES. At September 30, 2007, the bank exceeded minimum
regulatory capital requirements with a tangible capital level of $18.8 million,
or 7.67% of total adjusted assets, which exceeds the required level of $3.7
million, or 1.50%; core capital of $18.8 million, or 7.67% of total adjusted
assets, which exceeds the required level of $9.8 million, or 4.00%; and
risk-based capital of $20.9 million, or 12.25% of risk-weighted assets, which
exceeds the required level of $13.6 million, or 8.00%.
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
48
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 announced 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, would be deferred.
The announcement by the Company followed 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.
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.
ITEM 7A. 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.
CHANGES IN LEVELS OF INTEREST RATES MAY ADVERSELY AFFECT US. In
general, market risk is the sensitivity of income to variations in interest
rates and other relevant market rates or prices. The company's market rate
sensitive instruments include interest-earning assets and interest-bearing
liabilities. The company enters into market rate sensitive instruments in
connection with its various business operations. 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 these 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 address our interest rate
risk. The lag in implementation of re-pricing terms on our adjustable-rate
assets may result in a decline in net interest income in a rising interest rate
environment. There can be no assurance that our interest rate risk will be
minimized or eliminated. Further, an increase in the general level of interest
rates may adversely affect the ability of certain borrowers to pay the interest
on and principal of their obligations. Accordingly, changes in levels of market
interest rates, (primarily increases in market interest rates), could materially
adversely affect our interest rate spread, asset quality, loan origination
volume and overall financial condition and results of operations.
To mitigate the impact of changes in market interest rates on our
interest-earning assets and interest-bearing liabilities, we actively manage the
amounts and maturities of these assets and liabilities. A key component of this
strategy is the origination and retention of short-term and adjustable-rate
assets and the origination and sale of fixed-rate loans. We retain short-term
and adjustable-rate assets because they have re-pricing characteristics that
more closely match the re-pricing characteristics of our liabilities.
To further mitigate the risk of timing differences in the re-pricing of
assets and liabilities, our interest-earning assets are matched with
interest-bearing liabilities that have similar re-pricing characteristics. For
example, the interest rate risk of holding fixed-rate loans is managed with
long-term deposits and borrowings, and the risk of holding ARMs is managed with
short-term deposits and borrowings. Periodically, mismatches are identified and
managed by adjusting the re-pricing characteristics of our interest-bearing
liabilities with derivatives, such as interest rate caps and interest rate
swaps.
49
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Please refer to the index on page 61 for the Consolidated Financial
Statements of Greater Atlantic Financial Corp. and subsidiaries, together with
the report thereon by BDO Seidman, LLP.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no disagreements with the Registrant's accountants on
any matters of accounting principles or practices or financial statement
disclosures.
ITEM 9A. CONTROLS AND PROCEDURES
An evaluation of the company's disclosure controls and procedures (as
defined in Rule 13a-15(e) of the Securities Exchange Act of 1934 (the "Act")) as
of September 30, 2007, was carried out under the supervision and with the
participation of the company's Chief Executive Officer, Chief Financial Officer
and several other members of the company's senior management. The company's
Chief Executive Officer and Chief Financial Officer concluded that the company's
disclosure controls and procedures currently in effect are effective in ensuring
that the information required to be disclosed by the company in the reports it
files or submits under the Act is: (i) accumulated and communicated to the
company's management (including the Chief Executive Officer and Chief Financial
Officer) in a timely manner and (ii) recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and forms. In
addition, there have been no changes in our internal control over financial
reporting (as defined in Rule 13a-15(f) of the Act) that occurred during the
quarter ended September 30, 2007, that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
The company does not expect that its disclosure controls and procedures
and internal control over financial reporting will prevent all errors and all
fraud. A control procedure, no matter how well conceived and operated, can
provide only reasonable, not absolute, assurance that the objectives of the
control procedure are met. Because of the inherent limitations in all control
procedures, no evaluation of controls can provide absolute assurance that all
control issues and instances of fraud, if any, within the company have been
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty, and that breakdowns can occur because of simple
error or mistake. Additionally, controls may be circumvented by the individual
acts of some persons, by collusion of two or more people, or by override of the
control. The design of any control procedure also is based in part upon certain
assumptions about the likelihood of future events, and there can be no assurance
that any design will succeed in achieving its stated goals under all potential
future conditions; over time, controls may become inadequate because of changes
in conditions, or the degree of compliance with the policies or procedures may
deteriorate. Because of the inherent limitations in a cost-effective control
procedure, misstatements due to error or fraud may occur and not be detected.
Section 404 of the Sarbanes-Oxley Act of 2002 requires that companies
evaluate and annually report on their systems of internal control over financial
reporting. In addition, our independent accountants must report on management's
evaluation for the fiscal year ending September 30, 2010. We are in the process
of evaluating, documenting and testing our system of internal control over
financial reporting to provide the basis for our report that will, for the first
time, be a required part of our annual report on Form 10-K for the fiscal year
ending September 30, 2008. Due to the ongoing evaluation and testing of our
internal controls, there can be no assurance that if any control deficiencies
are identified they will be remediated before the end of the 2008 fiscal year,
or that there will not be significant deficiencies or material weaknesses that
would be required to be reported.
50
ITEM 9B. OTHER INFORMATION
During the quarter ended September 30, 2007, the company filed a
Current Report on Form 8-K for all information required to be disclosed in a
report on Form 8-K.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY.
DIRECTORS
The following table sets forth information regarding the board of
directors of the company. Each of the directors of the company is also a
director of the bank.
Director Term
Name Age Position(s) Held With the Company Since Expires
------------------------------ -------- -------------------------------------------------- ---------- ---------
Carroll E. Amos 60 Director, President and Chief Executive Officer 1997 2008
Sidney M. Bresler 53 Director 2003 2010
Charles W. Calomiris 50 Director, Chairman of the Board of Directors 2001 2008
Jeffrey W. Ochsman 55 Director 1999 2009
James B. Vito 82 Director 1998 2008
EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS
The following table sets forth information regarding the executive
officers of the company and the bank who are not also directors.
Name Age Position(s) Held With the Company
----------------------------- ------- ----------------------------------------------------------------------------------
Edward C. Allen 59 Senior Vice President and Chief Operating Officer of the Bank and Corporate
Secretary of the Company and the Bank
Justin R. Golden 57 Senior Vice President, Consumer Lending, of the Bank
Gary L. Hobert 58 Senior Vice President, Commercial Business Lending, of the Bank
Robert W. Neff 60 Senior Vice President, Commercial Real Estate Lending, of the Bank
David E. Ritter 57 Senior Vice President and Chief Financial Officer of the Company and the Bank
Each of the executive officers of the company and the bank holds his or
her office until his or her successor is elected and qualified or until removed
or replaced. Officers are subject to re-election by the board of directors
annually.
51
BIOGRAPHICAL INFORMATION
DIRECTORS
Charles W. Calomiris, Chairman of the Board of Directors of the company
and the bank. Mr. Calomiris is currently the Henry Kaufman Professor of Finance
and Economics at the Columbia University Graduate School of Business and a
professor at the School of International and Public Affairs at Columbia. During
the last five years he has served as a consultant to the Federal Reserve Board
as well as to Federal Reserve Banks and the World Bank, to the governments of
states and foreign countries and to major U. S. corporations.
Carroll E. Amos is President and Chief Executive Officer of the company
and of the bank. He is a private investor who until 1996 served as President and
Chief Executive Officer of 1st Washington Bancorp and Washington Federal Saving
Bank.
Sidney M. Bresler is Chief Executive Officer of Bresler & Reiner Inc.,
engaged in residential land development and construction and rental property
ownership and management.
Jeffrey W. Ochsman is a partner in the law firm of Friedlander, Misler,
Sloan, Kletzkin & Ochsman, PLLC, Washington, D.C.
James B. Vito is a managing general partner of James Properties,
engaged in the sale and management of property.
EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS
Edward C. Allen joined the bank as a Senior Vice President and Chief
Financial Officer in mid 1996 and became Chief Operating Officer in 1997. Prior
to joining the bank, Mr. Allen was the Chief Financial Officer of Servus
Financial Corp. from 1994 to 1996 and Senior Vice President of NVR Savings Bank
from 1992 to 1994.
Justin R. Golden joined the bank as Senior Vice President of the
Consumer Lending Department in 1998. From 1984 until 1997 he served in various
capacities at Citizens Bank, most recently having responsibility for
reorganizing and operating that bank's home equity lending function.
Gary L. Hobert joined the bank as Senior Vice President of the
Commercial Business Lending Department in 2001. From 2000 until joining the
bank, Mr. Hobert was the Senior Vice President of Adams National Bank. From 1998
until 2000 he served as Executive Vice President and Senior Loan Officer for
Grandbank.
Robert W. Neff joined the bank in 1997 as Senior Vice President,
Commercial Real Estate Lending. Prior to joining the bank, Mr. Neff served as a
Consultant on commercial real estate loan brokerage with the First Financial
Group of Washington after serving from 1984 until 1996 as an Executive Vice
President for Commercial Real Estate Lending at Washington Federal Savings Bank.
David E. Ritter joined the bank and the company as a Senior Vice
President and Chief Financial Officer in 1998. From 1996 to 1997, Mr. Ritter was
a Senior Financial Consultant with Peterson Consulting. From 1988 until 1996, he
was the Executive Vice President and Chief Financial Officer of Washington
Federal Savings Bank.
52
COMPLIANCE WITH SECTION 16 (A) OF THE EXCHANGE ACT
Section 16(a) of the Securities and Exchange Act requires the company's
executive officers and directors, and persons who own more than ten percent of a
registered class of the company's equity securities, to file reports of
ownership and changes in ownership with the Securities and Exchange Commission
and the National Association of Securities Dealers, Inc., and to furnish the
company with copies of all Section 16(a) forms they file.
Based solely on its review of the copies of such forms received by it,
or written representations from certain reporting persons that no Forms 5 were
required for those persons, the company believes that all filing requirements
applicable to its executive officers and directors were met during fiscal 2007.
CODE OF ETHICS AND BUSINESS CONDUCT
The company has adopted a Code of Ethics and Business Conduct
applicable to all employees, officers and directors of the company and its
subsidiaries. A copy of the Code of Ethics and Business Conduct will be
furnished without charge to stockholders of record upon written request to
Greater Atlantic Financial Corp., Mr. Edward C. Allen, Corporate Secretary,
10700 Parkridge Boulevard, Suite P50, Reston, Virginia 20191.
AUDIT COMMITTEE FINANCIAL EXPERT
No current member of the Audit Committee qualifies as an "audit
committee financial expert" as defined in the rules of the Securities and
Exchange Commission. The company is currently seeking an additional director who
will qualify as an "audit committee financial expert," but has not found a
qualified candidate who is willing to serve in that capacity.
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth the cash compensation paid by the
company for services rendered in all capacities during the fiscal year ended
September 30, 2007, to the Chief Executive Officer, and for each of the other
executive officers of the company who received salary and bonus in excess of
$100,000 (collectively, the "Named Executive Officers").
Change in
Pension
Value and
Non- Nonqual-
Equity ified
Incentive Deferred
Plan Compen-
Stock Compen- sation All Other
Fiscal Salary Bonus Awards sation Earnings Compensation Total
Name and Principal Position Year ($) ($) ($) ($) ($) ($) ($)
------------------------------------ ------- --------- ------- --------- ---------- ---------- --------------- -------------
Carroll E. Amos 2007 $182,000 $ - $ - $ - $ - $ - $182,000
President and Chief -
Executive Officer -
Edward C. Allen 2007 $121,320 $ - $ - $ - $ - $ - $121,320
Senior Vice President, Chief -
Operating Officer and Secretary -
David E. Ritter 2007 $114,000 $ - $ - $ - $ - $ - $114,000
Senior Vice President and -
Chief Financial Officer
53
OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END
The following table sets forth certain information concerning option
awards held by the named executive officers that were outstanding as of
September 30, 2007. There were no other equity awards held by the named
executive officers at September 30, 2007. All of the option awards set forth in
the table below were immediately exercisable by the recipient upon grant.
Number of Number of
Securities Securities
Underlying Underlying
Unexercised Unexercised
Options Options Option Option
(#) (#) Exercise Expiration
Name and Principal Position Exercisable Unexercisable Price Date
- -----------------------------------------------------------------------------------------------------------------
Carroll E. Amos 16,667 - $7.50 10/01/07
President and Chief 16,667 - 8.37 10/29/08
Executive Officer 3,000 - 6.00 12/01/09
8,666 - 4.00 12/14/10
20,000 - 9.00 01/01/12
10,000 - 8.50 10/20/13
Edward C. Allen 2,000 - $6.00 12/01/09
Senior Vice President, Chief Operating 9,000 - 4.00 12/14/10
Officer and Secretary 4,000 - 7.00 01/01/12
3,000 - 8.50 10/20/13
David E. Ritter 3,000 - $6.00 12/01/09
Senior Vice President and 8,000 - 4.00 12/14/10
Chief Financial Officer 4,000 - 7.00 01/01/12
3,000 - 8.50 10/20/13
EMPLOYMENT AGREEMENT. The company has entered into an employment
agreement with Mr. Carroll E. Amos. The employment agreement is intended to
ensure that the bank and the company will be able to maintain a stable and
competent management base. The continued success of the bank and the company
depends to a significant degree on the skills and competence of its executive
officers, particularly the Chief Executive Officer.
The employment agreement provides for a three-year term for Mr. Amos
and provides that commencing on the first anniversary date and continuing each
anniversary date thereafter the board of directors will conduct a performance
appraisal of Mr. Amos and may extend the employment agreement for an additional
year so that the remaining term shall be three years, unless the board of
directors determines that there is no basis upon which to extend the employment
agreement, it will be extended for an additional year. The employment agreement
provides that Mr. Amos's base salary will be reviewed annually. The base salary
provided for in the employment agreement for Mr. Amos was increased to $165,400
at the fourth anniversary date and to $182,000 on January 1, 2003. In addition
to the base salary, the employment agreement provides for, among other things,
participation in various employee benefit plans and stock-based compensation
programs, as well as furnishing fringe benefits available to similarly situated
executive personnel.
54
The employment agreement provides for termination by the bank for cause
(as defined in the employment agreement) at any time. In the event the bank
chooses to terminate Mr. Amos's employment for reasons other than for cause or,
in the event of Mr. Amos's resignation from the bank upon: (i) the failure to
re-elect Mr. Amos to his current office; (ii) a material change in Mr. Amos's
functions, duties or responsibilities; (iii) a relocation of Mr. Amos's
principal place of employment by more than 30 miles, or a material reduction in
the benefits and perquisites to Mr. Amos from those being provided as of the
effective date of the employment agreement ; (iv) liquidation or dissolution of
the bank or the company; or (v) a breach of the employment agreement by the
bank, Mr. Amos or, in the event of death, Mr. Amos's beneficiary, would be
entitled to receive an amount equal to the greater of (i) the remaining base
salary and bonus payments that would have been paid to Mr. Amos during the
remaining term of the employment agreement or (ii) thirty-six (36) times the
highest monthly base salary received by Mr. Amos during the term of the
employment agreement. The bank would also continue and pay for Mr. Amos's life,
health and disability coverage for the remaining term of the employment
agreement. Upon any termination of Mr. Amos's employment for any reason other
than a change in control, Mr. Amos is subject to a covenant not to compete with
the bank for one year.
Under the employment agreement, if involuntary termination or voluntary
termination follows a change in control of the bank or the company, Mr. Amos or,
in the event of his death, his beneficiary, would receive a severance payment
equal to the greater of: (i) the payments due for the remaining term of the
employment agreement; or (ii) two times the average of the three preceding
taxable years' annual compensation. The bank would also continue Mr. Amos's
life, health, and disability coverage for thirty-six months. In the event of a
change in control of the bank, the total amount of payment due under the
employment agreement, based solely on the base salary paid to Mr. Amos, and
excluding any benefits under any employee benefit plan which may otherwise
become payable, would equal approximately $364,000.
All reasonable costs and legal fees paid or incurred by Mr. Amos
pursuant to any dispute or question of interpretation relating to the employment
agreement is to be paid by the bank, if he is successful on the merits pursuant
to a legal judgment, arbitration or settlement. The employment agreement also
provides that the bank will indemnify Mr. Amos to the fullest extent allowable
under federal law.
DIRECTORS' COMPENSATION
FEES. Since the formation of the company, the executive officers,
directors and other personnel have been compensated for services by the bank and
have not received additional remuneration from the company. Beginning on October
1, 1998, the Chairman was made a salaried officer of the bank and the company
and in those capacities received compensation at the rate of $3,000 per month.
Since January 1, 2003, each outside directors of the bank has received $750 for
each Board meeting and $350 for each committee meeting attended.
55
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Persons and groups owning in excess of five percent of the company's
Common Stock are required to file certain reports regarding such ownership with
the company and with the Securities and Exchange Commission ("SEC"), in
accordance with the Securities Exchange Act of 1934 (the "Exchange Act").
The following table sets forth information regarding persons known to
be beneficial owners of more than five percent of the company's outstanding
Common Stock as of December 21, 2007.
Amount and Nature of
Name and Address Beneficial Percent
Title of Class of Beneficial Owner Ownership of Class
- ----------------------------------------------------------------------------------------------------------
Common Stock Charles W. Calomiris
251 Fox Meadow Road 176,807 shares(1)(2) 5.85%
Scarsdale, New York 10583
Common Stock Robert I. Schattner, DDS
121 Congressional Lane 432,328 shares(1)(3) 14.30%
Rockville, MD 20852
Common Stock The Ochsman Children Trust
1650 Tysons Boulevard 238,597 shares(1)(4) 7.89%
McLean, VA 22102
Common Stock George W. Calomiris
4848 Upton Street, N.W. 199,715 shares(5) 6.40%
Washington, DC 20016
Common Stock Jenifer Calomiris
4919 Upton Street, N.W. 190,438 shares(6) 6.12%
Washington, D.C. 20016
Common Stock Katherine Calomiris Tompros
5100 Van Ness Street, N.W. 190,638 shares(7) 6.12%
Washington, D.C. 20016
- ----------------------
(1) Does not include warrants exercisable at September 30, 2007 to purchase
9,166, 20,000 and 13,334 shares held, respectively, by Charles W.
Calomiris, Dr. Schattner, and The Ochsman Children Trust under the
Greater Atlantic Financial Corp. 1997 Stock Option Plan, or shares of
preferred securities presently convertible into 114,841, 330,099 and
69,545 shares of common stock held, respectively, by Charles W. Calomiris
Dr. Schattner and the Ochsman Children Trust.
(2) The information furnished is derived from a Schedule 13D filed by Charles
W. Calomiris on July 25, 2003, and a Form 4 filed on July 24, 2003.
(3) The information furnished is derived from a Schedule 13D and a Form 4
filed by Robert I Schattner filed on September 6, 2005.
(4) The information furnished is derived from a Schedule 13D filed by The
Ochsman Children Trust on April 9, 2002.
(5) Includes warrants exercisable at September 30, 2007 to purchase 9,167
shares and shares of preferred securities presently convertible into
85,754 shares of common stock held by George W. Calomiris. The
information furnished is derived from a Schedule 13D filed by George
Calomiris on December 7, 2004.
(6) Includes warrants exercisable at September 30, 2007 to purchase 9,167
shares and shares of preferred securities presently convertible into
79,747 shares of common stock held by Jenifer Calomiris. The information
furnished is derived from a Schedule 13D filed by Jenifer Calomiris on
March 21, 2003.
(7) Includes warrants exercisable at September 30, 2007 to purchase 9,167
shares and shares of preferred securities presently convertible into
79,747 shares of common stock held by Katherine Calomiris Tompros. The
information furnished is derived from a Schedule 13D filed by Katherine
Calomiris Tompros on March 21, 2003.
56
INFORMATION WITH RESPECT TO DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth, as of December 21, 2007, the names of
the directors, and executive officers of the company as well as their ages; a
brief description of their recent business experience, including present
occupations and employment; certain directorships held by each; the year in
which each became a director of the company and the year in which his term as
director of the company expires. This table also sets forth the amount of Common
Stock and the percent thereof beneficially owned as of the December 21, 2007 by
each director and all directors and executive officers as a group as of the
December 21, 2007.
Expiration Shares of
Name and Principal of Common Stock Ownership as of
Occupation at Present Director Term as Beneficial Percent of
and for Past Five Years Age Since (1) Director Owned(1) Class
- ----------------------------------------------- ------- ------------ ------------ ----------------- --------------------
Charles W. Calomiris, Chairman of the 50 2001 2008 176,807(2)(3) 5.85%
Board of the Company, is the Henry Kaufman
Professor of Finance and Economics at the
Columbia University Graduate School of
Business.
Carroll E. Amos, President and Chief 60 1997 2008 44,060(4) 1.46%
Executive Officer of the company, is a
private investor who until 1996 served as
President and Chief Executive Officer of
1st Washington Bancorp and Washington
Federal Savings Bank.
James B. Vito is Managing General 82 1998 2008 79,042(2) 2.61%
Partner, James Properties, engaged in the
sale and management of property.
Jeffrey W. Ochsman is an attorney and 55 1999 2009 500 *
partner of the law firm of Friedlander,
Misler, Sloan, Kletzkin & Ochsman, PLLC.
Sidney M. Bresler is a Director, Chief 53 2003 2010 500 *
Executive Officer and Chief Operating
Officer of Bresler & Reiner, Inc. engaged
in residential land development and
construction and rental property ownership
and management.
57
Shares of
Name and Principal Common Stock
Occupation at Present Beneficially Ownership as A
and for Past Five Years Age Owned(1) Percent of Class
--------------------------------------------------------- ------- ---------------------- --------------------
EXECUTIVE OFFICERS
WHO ARE NOT DIRECTORS
Edward C. Allen joined the bank as Chief Financial 59 550(4) *
Officer and became Chief Operating Officer in 1997.
David E. Ritter joined the bank and the company as a 57 300(4) *
Senior Vice President and Chief Financial Officer in
1998.
All directors and executive officers as a group (seven 301,759 9.98%
persons)(3)
- ------------------------
(1) Each person effectively exercises sole voting or dispositive power as to
shares reported.
(2) Does not include warrants exercisable at September 30, 2007 to purchase
9,166 and 2,000 shares, respectively, held by Messrs. Calomiris and Vito
under the Greater Atlantic Financial Corp. 1997 Stock Option Plan, or
shares of preferred securities presently convertible into 114,841, 34,970,
and 6,431 shares of common stock held, respectively, by Messrs. Calomiris,
Vito, and Amos.
(3) Includes 128,727 shares held directly, 10,000 shares held by his spouse and
38,080 shares held as custodian for minor children.
(4) Does not include presently exercisable options to purchase 75,000 shares
granted to Mr. Amos or 18,000 granted to Mr. Allen and Mr. Ritter under the
Greater Atlantic Financial Corp. 1997 Stock Option and Warrant Plan.
* Does not exceed 1.0% of the company's Common Stock.
The following table summarizes share and exercise price information
about the company's equity compensation plans as of September 30, 2007.
Number of securities
remaining available for
Number of securities to be future issuance under equity
issued upon exercise of Weighted-average exercise compensation plans
outstanding options, warrants price of outstanding options, (excluding securities
Plan category and rights warrants and rights reflected in column (a))
- --------------------------------- ------------------------------- ------------------------------- ------------------------------
Equity compensation plans
approved by security holders:
1997 Stock Option and
Warrant Plan 333,516 $6.93 91,000
Equity compensation plans
not approved by security
holders N/A N/A N/A
- --------------------------------- ------------------------------- ------------------------------- ------------------------------
Total 333,516 $6.93 91,000
================================= =============================== =============================== ==============================
58
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Federal regulations require that all loans or extensions of credit to
executive officers and directors must be made on substantially the same terms,
including interest rates and collateral, as those prevailing at the time for
comparable transactions with the general public and must not involve more than
the normal risk of repayment or present other unfavorable features. In addition,
loans made to a director or executive officer in excess of the greater of
$25,000 or 5% of the bank's capital and surplus (up to a maximum of $500,000)
must be approved in advance by a majority of the disinterested members of the
board of directors.
The bank currently makes loans to its executive officers and directors
on the same terms and conditions offered to the general public. The bank's
policy provides that all loans made by the bank to its executive officers and
directors be made in the ordinary course of business, on substantially the same
terms, including collateral, as those prevailing at the time for comparable
transactions with other persons and may not involve more than the normal risk of
collectibility or present other unfavorable features. As of September 30, 2007,
one of the bank's directors had loans with the bank which had outstanding
balances totaling $73,000. Such loans were made by the bank in the ordinary
course of business, with no favorable terms and do not involve more than the
normal risk of collectibility or present unfavorable features.
The company's policy is that all transactions between the company and
its executive officers, directors, holders of 10% or more of the shares of any
class of its common stock and affiliates thereof, will contain terms no less
favorable to the company than could have been obtained by it in arm's length
negotiations with unaffiliated persons and will be approved by a majority of
independent outside directors of the company not having any interest in the
transaction.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
AUDIT FEES
BDO Seidman, LLP billed the company aggregate fees of $106,703 and
$225,076 for professional services rendered for the audit of the company's
annual consolidated financial statements and for the reviews of the condensed
consolidated financial statements included in the company's Forms 10-Q for the
fiscal year ended September 30, 2007 and 2006, respectively. Before the company
or any subsidiary engages an accountant, the company's audit committee approves
the engagement.
AUDIT-RELATED FEES
BDO Seidman, LLP did not provide any such services to the company for
the fiscal year ended September 30, 2007 or 2006.
TAX FEES
BDO Seidman billed the company $30,358 and $35,600 for tax services for
the fiscal year ended September 30, 2007 and 2006, respectively. Tax fees
represented 22.15% of the fees paid to BDO Seidman, LLP in fiscal year 2007 and
13.66% in fiscal year 2006.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) 1. FINANCIAL STATEMENTS
See Index to Consolidated Financial Statements on page 61
2. FINANCIAL STATEMENT SCHEDULES
All schedules are omitted because they are not required or applicable,
or the required information is shown in the consolidated financial
statements or the notes thereto.
(b) EXHIBITS
23.1 Consent of BDO Seidman, LLP
31.1 Certification of Chief Executive Officer
31.2 Certification of Chief Financial Officer
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350
59
Pursuant to the requirements of Section 13 or 15(d) of the Securities
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.
By: /s/ Carroll E. Amos
-------------------
Carroll E. Amos
Chief Executive Officer, President and Director
Dated: December 28, 2007
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed by the following persons of the registrant and
in the capacities and on the dates indicated.
Name Title Date
- ---- ----- ----
/s/ Charles W. Calomiris
- ------------------------ Chairman of the Board December 28, 2007
Charles W. Calomiris
/s/ Carroll E. Amos Chief Executive Officer,
- ------------------- and President and Director December 28, 2007
Carroll E. Amos
/s/ Sidney M. Bresler
- ---------------------
Sidney M. Bresler Director December 28, 2007
/s/ Jeffrey W. Ochsman
- ----------------------
Jeffrey W. Ochsman Director December 28, 2007
/s/ James B. Vito
- -----------------
James B. Vito Director December 28, 2007
/s/ David E. Ritter Senior Vice President and
- ------------------- Chief Financial Officer December 28, 2007
David E. Ritter
60
CONSOLIDATED FINANCIAL STATEMENTS OF
GREATER ATLANTIC FINANCIAL CORP.
INDEX
Page
----
Report of Independent Registered Public Accounting Firm 62
Consolidated Statements of Financial Condition as of September 30, 2007 and 2006 63
Consolidated Statements of Operations for the Years Ended September 30, 2007, 2006 and 2005 64
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended
September 30, 2007, 2006 and 2005 65
Consolidated Statements of Stockholders' Equity for the Years Ended September 30, 2007, 2006 and 2005 65
Consolidated Statements of Cash Flows for the Years Ended September 30, 2007, 2006 and 2005 66
Notes to Consolidated Financial Statements 68
61
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Greater Atlantic Financial Corp.
Reston, Virginia
We have audited the accompanying consolidated statements of financial condition
of Greater Atlantic Financial Corp. and Subsidiaries as of September 30, 2007
and 2006, and the related consolidated statements of operations, comprehensive
income (loss), stockholders' equity, and cash flows for each of the three years
in the period ended September 30, 2007. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Greater Atlantic
Financial Corp. and Subsidiaries at September 30, 2007 and 2006 and the results
of their operations and their cash flows for each of the three years in the
period ended September 30, 2007 in conformity with accounting principles
generally accepted in the United States of America.
/s/ BDO Seidman, LLP
- --------------------
Richmond, Virginia
December 17, 2007
62
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September 30,
---------------------------------
2007 2006
----------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Assets
Cash and cash equivalents $ 3,146 $ 2,516
Interest bearing deposits 4,486 17,288
Investment securities
Available-for-sale 48,910 75,461
Held-to-maturity 3,053 4,696
Loans receivable, net 176,108 193,307
Accrued interest and dividends receivable 1,675 2,073
Deferred income taxes 2,096 1,928
Federal Home Loan Bank stock, at cost 1,731 2,388
Premises and equipment, net 2,285 2,764
Goodwill 956 956
Prepaid expenses and other assets 1,548 1,842
----------------------------------------------------------------------------------------------------------------------
Total Assets $245,994 $305,219
======================================================================================================================
Liabilities and stockholders' equity
Liabilities
Deposits $197,991 $230,174
Advance payments from borrowers for taxes and insurance 229 270
Accrued expenses and other liabilities 1,601 1,963
Income taxes payable 36 -
Advances from the FHLB and other borrowings 27,192 54,574
Junior subordinated debt securities 9,374 9,388
----------------------------------------------------------------------------------------------------------------------
Total liabilities 236,423 296,369
----------------------------------------------------------------------------------------------------------------------
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 and 3,020,934 shares outstanding 30 30
Additional paid-in capital 25,273 25,228
Accumulated deficit (14,408) (15,359)
Accumulated other comprehensive loss (1,324) (1,049)
----------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 9,571 8,850
----------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $245,994 $305,219
======================================================================================================================
See accompanying notes to consolidated financial statements.
63
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended September 30,
-------------------------------------------------
2007 2006 2005
- --------------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Data)
Interest income
Loans $ 14,173 $ 13,866 $ 12,430
Investments 4,248 4,928 4,528
- --------------------------------------------------------------------------------------------------------------------------
Total interest income 18,421 18,794 16,958
- --------------------------------------------------------------------------------------------------------------------------
Interest expense
Deposits 9,331 7,709 6,337
Borrowed money 2,662 3,874 3,676
- --------------------------------------------------------------------------------------------------------------------------
Total interest expense 11,993 11,583 10,013
- --------------------------------------------------------------------------------------------------------------------------
Net interest income 6,428 7,211 6,945
Provision for loan losses 685 126 219
- --------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 5,743 7,085 6,726
- --------------------------------------------------------------------------------------------------------------------------
Noninterest income
Fees and service charges 613 610 734
Gain (loss) on sale of loans - - 53
Gain (loss)on sale of investment securities - - 539
Gain (loss) on derivatives (21) 212 303
Gain on sale of real estate owned - 65 -
Gain on branch sales 4,255 - 945
Other operating income 23 30 66
- --------------------------------------------------------------------------------------------------------------------------
Total noninterest income 4,870 917 2,640
- --------------------------------------------------------------------------------------------------------------------------
Noninterest expense
Compensation and employee benefits 4,446 4,718 4,213
Occupancy 1,394 1,337 1,337
Professional services 1,128 1,227 969
Advertising 130 628 301
Deposit insurance premium 69 101 100
Furniture, fixtures and equipment 516 554 641
Data processing 877 919 1,054
Other operating expenses 1,066 1,601 1,274
- --------------------------------------------------------------------------------------------------------------------------
Total noninterest expense 9,626 11,085 9,889
- --------------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations before income taxes 987 (3,083) (523)
Provision for income taxes 36 - -
- --------------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations 951 (3,083) (523)
Discontinued operations:
Income (loss) from operations - (2,488) (1,107)
- --------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 951 $ (5,571) $ (1,630)
==========================================================================================================================
Earnings (loss) per common share BASIC:
Continuing operations basic $ 0.31 $ (1.02) $ (0.17)
Discontinued operations basic - (0.82) (0.37)
- --------------------------------------------------------------------------------------------------------------------------
$ 0.31 $ (1.84) $ (0.54)
- --------------------------------------------------------------------------------------------------------------------------
DILUTED:
- --------------------------------------------------------------------------------------------------------------------------
Continuing operations basic $ 0.31 $ (1.02) $ (0.17)
- --------------------------------------------------------------------------------------------------------------------------
Discontinued operations basic - (0.82) (0.37)
- --------------------------------------------------------------------------------------------------------------------------
$ 0.31 $ (1.84) $ (0.54)
- --------------------------------------------------------------------------------------------------------------------------
Weighted average common shares outstanding
Basic 3,023,407 3,020,934 3,015,509
Diluted 4,395,008 3,020,934 3,015,509
See accompanying notes to consolidated financial statements.
64
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
Year Ended September 30,
---------------------------------------------
2007 2006 2005
-----------------------------------------------------------------------------------------------------
(In Thousands)
Net income (loss) $951 $ (5,571) $ (1,630)
-----------------------------------------------------------------------------------------------------
Other comprehensive (loss) income, net of tax:
Unrealized (loss) income on securities (275) 46 (16)
-----------------------------------------------------------------------------------------------------
Other comprehensive (loss) income (275) 46 (16)
-----------------------------------------------------------------------------------------------------
Comprehensive (loss) income $676 $ (5,525) $ (1,646)
=====================================================================================================
See accompanying notes to consolidated financial statements.
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
-----------------------------------------------------------------------------------------------------------------------
Accumulated
Additional Accumulated Other Total
Preferred Common Paid-in Earnings Comprehensive Stockholders'
Stock Stock Capital (Deficit) Income (Loss) Equity
-----------------------------------------------------------------------------------------------------------------------
(In Thousands)
Balance at September 30, 2004 $ - $ 30 $ 25,152 $ (8,158) $ (1,079) $ 15,945
Options exercised - - 76 - - 76
Other comprehensive loss - - - - (16) (16)
Net loss for the year - - - (1,630) - (1,630)
-----------------------------------------------------------------------------------------------------------------------
Balance at September 30, 2005 - 30 25,228 (9,788) (1,095) 14,375
Other comprehensive income - - - - 46 46
Net loss for the year - - - (5,571) - (5,571)
-----------------------------------------------------------------------------------------------------------------------
Balance at September 30, 2006 - 30 25,228 (15,359) (1,049) 8,850
Conversion of trust preferred
securities - - 45 - - 45
Other comprehensive loss - - - - (275) (275)
Net income for the year - - - 951 - 951
-----------------------------------------------------------------------------------------------------------------------
Balance at September 30, 2007 $ - $ 30 $ 25,273 $(14,408) $ (1,324) $ 9,571
=======================================================================================================================
See accompanying notes to consolidated financial statements
65
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended September 30,
----------------------------------------------------
2007 2006 2005
---------------------------------------------------------------------------------------------------------------------------------
(In Thousands)
Cash flow from operating activities
Net income (loss) $ 951 $ (5,571) $ (1,630)
Adjustments to reconcile net income (loss) to net cash
Provided (used) by operating activities
Provision for loan losses 685 126 219
Amortization of deferred loan acquisition costs, net 38 (50) (27)
Depreciation and amortization 445 658 930
Gain on branch sale (4,255) - (945)
(Gain) loss on disposal of fixed assets - (26) 91
Option compensation - - 42
Realized gain on sale of mortgaged-backed securities - - (539)
Loss (gain) on derivatives 21 (212) (303)
Amortization of other investment securities premiums 862 753 853
Amortization of mortgage-backed security premiums 397 662 937
Amortization of deferred fees (325) (496) (635)
Discount accretion net of premium amortization 287 (277) (361)
Amortization of convertible preferred stock costs 9 9 9
Conversion of Trust Preferred Securities (23) - -
(Gain) loss on sale of foreclosed real estate - (65) -
Gain on sale of loans held for sale - (1,522) (4,720)
(Increase) decrease in assets
Disbursements for origination of loans - (91,477) (276,038)
Proceeds from sales of loans - 102,518 276,770
Accrued interest and dividend receivable 399 (327) 193
Prepaid expenses and other assets 177 1,156 360
Deferred loan fees collected, net of deferred costs incurred 435 431 172
Increase (decrease) in liabilities
Accrued expenses and other liabilities (265) 649 (451)
Income taxes payable 36 - -
---------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities $ (126) $ 6,939 $ (5,073)
=================================================================================================================================
(Continued)
66
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - (CONTINUED)
Year Ended September 30,
--------------------------------------
2007 2006 2005
-----------------------------------------------------------------------------------------------------------------------------
(In Thousands)
Cash flow from investing activities
Net decrease (increase) in loans $ 16,079 $ 1,879 $ 51,867
Disposal (purchases) of premises and equipment 34 792 2,055
Proceeds from sales of foreclosed real estate - 297 -
Purchases of investment securities - (7,707) (21,684)
Proceeds from repayments of investment securities 11,528 17,105 21,841
Purchases of mortgage-backed securities - - (24,224)
Proceeds from sale of mortgage-backed securities - - 21,921
Proceeds from repayments of mortgage-backed securities 14,963 25,198 37,548
Purchases of FHLB stock (742) (3,015) (5,169)
Proceeds from sale of FHLB stock 1,399 3,130 6,751
-----------------------------------------------------------------------------------------------------------------------------
Net cash provided by investing activities 43,261 37,679 90,906
-----------------------------------------------------------------------------------------------------------------------------
Cash flow from financing activities
Net (decrease) increase in deposits (27,928) (7,620) (50,217)
Net (repayments) advances from FHLB (11,000) (2,000) (13,200)
Net borrowings (repayments) on reverse repurchase agreements and other borrowings (16,383) (19,905) (26,386)
Increase (decrease) in advance payments by borrowers for taxes and insurance (41) 2 (37)
Conversion of trust preferred securities 45 - -
Exercise of stock options - - 34
-----------------------------------------------------------------------------------------------------------------------------
Net cash (used in) financing activities (55,307) (29,523) (89,806)
-----------------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents (12,172) 15,095 (3,973)
-----------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, at beginning of year 19,804 4,709 8,682
-----------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, at end of year $ 7,632 $ 19,804 $ 4,709
=============================================================================================================================
See accompanying notes to consolidated financial statements.
67
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
Greater Atlantic Financial Corp. ("GAFC" or the "Company") is a bank
holding company whose principal activity is the ownership and management of
Greater Atlantic Bank ("GAB" or the "Bank"). The Bank originates commercial,
mortgage and consumer loans and receives deposits from customers located
primarily in Virginia, Washington, D.C. and Maryland. The Bank operates under a
federal bank charter and provides full banking services.
PROPOSED ACQUISITION
As previously reported in a Form 8-K filed on April 16, 2007, we
announced that the company and Summit Financial Group, Inc., entered into a
definitive agreement for the company to merge with and into Summit. We also
announced that the bank and Bay-Vanguard Federal Savings Bank entered into a
definitive agreement for Bay-Vanguard to purchase the bank's branch office in
Pasadena, Maryland. The sale of the Pasadena branch office was established as a
condition to the completion of the pending merger of the company with and into
Summit Financial Group, Inc.
Originally the merger was expected to be completed in the fourth
calendar quarter of 2007; however, as reported in a Form 8-K filed on December
10, 2007, effective December 6, 2007, the company and Summit amended their
agreement to implement the parties' agreement to extend to March 31, 2008, the
date on which the agreement may be terminated if the merger is not consummated
by that date, subject to regulatory and shareholder approvals. Immediately
following the merger, the bank intends to merge with and into Summit Community
Bank.
Under the agreement to sell its leased branch office located at 8070
Ritchie Highway, Pasadena, Maryland, to Bay-Vanguard, Bay-Vanguard paid the bank
an 8.5% premium on the balance of deposits assumed at closing. At August 24,
2007, the closing date of that transaction, the deposits at our Pasadena branch
office on which the deposit premium would apply totaled approximately $51.5
million with the bank recognizing a gain of $4.3 million. Bay-Vanguard also
purchased the branch office's fixed assets, but did not acquire any loans as
part of the transaction.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of GAFC and
its wholly owned subsidiaries, the bank and Greater Atlantic Capital Trust I.
All significant intercompany accounts and transactions have been eliminated in
consolidation.
RISK AND UNCERTAINTIES
In its normal course of business, the Company encounters two
significant types of risk: economic and regulatory. There are three main
components of economic risk: interest rate risk, credit risk and market risk.
The Company is subject to interest rate risk to the degree that its
interest-bearing liabilities mature or reprice more rapidly, or on a different
basis, than its interest-earning assets. Credit risk is the risk of default on
the Company's loan portfolio that results from the borrowers' inability or
unwillingness to make contractually required payments. Market risk reflects
changes in the value of collateral underlying loans receivable and the valuation
of real estate held by the Company. The determination of the allowance for loan
losses and the valuation of real estate are based on estimates that are
particularly susceptible to significant changes in the economic environment and
market conditions. Management believes that, as of September 30, 2007 and
September 30, 2006, the allowance for loan losses and valuation of real estate
are adequate based on information currently available. A worsening or protracted
economic decline would increase the likelihood of losses due to credit and
market risks and could create the need for substantial additional loan loss
reserves. See discussion of regulatory matters in Note 12.
CONCENTRATION OF CREDIT RISK
The Company's primary business activity is with customers located in
Maryland, Virginia and the District of Columbia. The Company primarily
originates residential loans to customers throughout these areas, most of whom
are residents local to the Company's business locations. The Company has a
diversified loan portfolio consisting of residential, commercial and consumer
loans. Commercial and consumer loans generally provide for higher interest rates
and shorter terms; however, such loans have a higher degree of credit risk.
Management monitors all loans, including, when possible, making inspections of
the properties, maintaining current operating statements, and performing net
realizable value calculations with allowances for losses established as
necessary to properly reflect the value of the properties. Management believes
the current loss allowances are sufficient to cover the credit risk estimated to
exist at September 30, 2007.
68
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INVESTMENT SECURITIES
Investment securities, which the Company has the intent and ability to
hold to maturity, are carried at amortized cost. The amortization of premiums
and accretion of discounts are recorded on the level yield (interest) method,
over the period from the date of purchase to maturity. When sales do occur,
gains and losses are recognized at the time of sale and the determination of
cost of securities sold is based upon the specific identification method.
Investment securities which the Company intends to hold for indefinite periods
of time, use for asset/liability management or that are to be sold in response
to changes in interest rates, prepayment risk, the need to increase regulatory
capital or other similar factors are classified as available-for-sale and
carried at fair value with unrealized gains and losses excluded from earnings
and reported in a separate component of stockholders' equity. If a sale does
occur, gains and losses are recognized as a component of earnings at the time of
the sale. The amortization of premiums and accretion of discounts are recorded
on the level yield (interest) method.
Investment securities that are bought and held principally for the
purpose of selling them in the near term would be classified as trading
securities and reported at fair value, with unrealized gains and losses included
in earnings.
LOANS AND ALLOWANCE FOR LOAN LOSSES
Loans receivable are stated at unpaid principal balances, net of
unearned discounts resulting from add-on interest, participation or whole-loan
interests owned by others, undisbursed loans in process, deferred loan fees, and
allowances for loan losses.
Loans are placed on non-accrual status when the principal or interest
is past due more than 90 days or when, in management's opinion, collection of
principal and interest is not likely to be made in accordance with a loan's
contractual terms unless the loan principal and interest are determined by
management to be fully secured and in the process of collection.
The allowance for loan losses provides for the risk of losses inherent
in the lending process. The allowance for loan losses is based on periodic
reviews and analyses of the loan portfolio which include consideration of such
factors as the risk rating of individual credits, the size and diversity of the
portfolio, economic conditions, prior loss experience and results of periodic
credit reviews of the portfolio. The allowance for loan losses is increased by
provisions for loan losses charged against income and reduced by charge-offs,
net of recoveries. In management's judgment, the allowance for loan losses is
considered adequate to absorb losses inherent in the loan portfolio at September
30, 2007.
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.
Mortgage loans originated and intended for sale are carried at the
lower of cost or estimated market value in the aggregate. Net unrealized losses
are recognized in a valuation allowance by charges to income.
DERIVATIVE FINANCIAL INSTRUMENTS
The Company uses derivative financial instruments to mitigate market
risk from changes in interest rates. Our derivative financial instruments are
contracted in the over-the-counter market and currently includes interest rate
caps. Derivative financial instruments are accounted for in accordance with
Statement of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities (SFAS 133), which requires that all
derivative instruments be recorded on the balance sheet at fair value. Changes
in the fair value of derivatives are recorded each period either in current
results of operations or other comprehensive income (loss). For a derivative
designated as part of a hedge transaction, where it is recorded is dependent on
whether it is a fair value hedge or a cash flow hedge. For a derivative
designated as a fair value hedge, the gain or loss of the derivative in the
period of change and the offsetting loss or gain of the hedged item attributed
to the hedged risk are recognized in results of operations. For a derivative
designated as a cash flow hedge, the effective portion of the derivative's gain
or loss is initially reported as a component of other comprehensive income
(loss) and subsequently reclassified into results of operations when the hedged
exposure affects results of operations. The ineffective portion of the gain or
loss of a cash flow hedge is recognized currently in results of operations. For
a derivative not designated as a hedging instrument, the gain or loss is
recognized currently in results of operations. The Company's derivatives do not
meet hedge accounting requirements under SFAS 133, and, therefore, the Company
carries the derivatives at their fair value on the balance sheet, recognizing
changes in their fair value in current-period earnings.
69
Greater Atlantic Financial Corp. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MORTGAGE LOAN INCOME, DISCOUNTS AND PREMIUMS
Interest income on loans is recorded on the accrual method. Discounts
and premiums relating to mortgage loans purchased are deferred and amortized
against or accreted into income over the estimated lives of the loans using the
level yield (interest) method. Accrual of interest is discontinued and an
allowance for uncollected interest is established and charged to interest income
for the full amount of accrued interest receivable on loans, which are
delinquent for a period of 90 days or more.
LOAN ORIGINATION AND COMMITMENT FEES
Loan origination and commitment fees and certain incremental direct
loan origination costs are being deferred with the net amount being amortized as
an adjustment of the related loan's yield. The Company is amortizing those
amounts over the contractual life of the related loans as adjusted for
anticipated prepayments using current and past payment trends.
MORTGAGE LOAN SALES AND SERVICING
The Company sells loans and participation interests in loans on which
it retains servicing.
When servicing is retained on a loan that is sold, the Company
recognizes a gain or loss based on the present value of the difference between
the average constant rate of interest it receives, adjusted for a normal
servicing fee, and the yield it must pay to the purchaser of the loan over the
estimated remaining life of the loan. Any resulting net premium is deferred and
amortized over the estimated life of the loan using a method approximating the
level yield (interest) method. There were no loans sold with servicing rights
retained during the years ended September 30, 2007 and September 30, 2006. The
Company also sells participation interests in loans that it services.
PREMISES AND EQUIPMENT
Premises and equipment are recorded at cost. Depreciation is computed
on the straight-line method over useful lives ranging from five to ten years.
Leasehold improvements are capitalized and amortized using the straight-line
method over the life of the related lease.
FORECLOSED REAL ESTATE
Real estate acquired through foreclosure is recorded at the lower of
cost or fair value less estimated selling costs. Subsequent to the date of
foreclosure, valuation adjustments are made, if required, to the lower of cost
or fair value less estimated selling costs. Costs related to holding the real
estate, net of related income, are reflected in operations when incurred.
Recognition of gains on sale of real estate is dependent upon the transaction
meeting certain criteria relating to the nature of the property sold and the
terms of the sale.
GUARANTEED CONVERTIBLE PREFERRED SECURITIES
On July 1, 2003, the Company adopted Statement of Financial Accounting
Standards No. 150, "Accounting for Mandatorily Redeemable Securities" ("SFAS
150"). SFAS 150 requires that the Company classify redeemable securities with a
mandatory redemption date as liabilities in its balance sheet and classify
distributions related to such securities as interest expense. Also, SFAS 150
requires that the redeemable securities be reflected at fair market value when
reclassified as a liability. Accordingly, the guaranteed convertible preferred
securities are presented as a liability in the Statements of Financial
Condition. The Company has consistently accounted for distributions related to
these securities as interest expense, and since the Company sold the securities
in a public offering, there was no fair market value adjustment necessary.
70
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INCOME TAXES
Income taxes are calculated using the liability method specified by
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes". The net deferred tax asset is reduced, if necessary, by a valuation
allowance for the amount of any tax benefits that, based on available evidence,
are not expected to be realized (See Note 10).
CASH AND CASH EQUIVALENTS
The Company considers cash and interest bearing deposits in other banks
as cash and cash equivalents for purposes of preparing the statement of cash
flows.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
COMPREHENSIVE INCOME
Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" ("SFAS 130"), establishes standards for the reporting and
display of comprehensive income, its components and accumulated balances.
Comprehensive income is defined to include all changes in equity except those
resulting from investments by owners and distributions to owners. Among other
disclosures, SFAS 130 requires that all items that are required to be recognized
under current accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements. Presently, the Company's comprehensive income and
loss is from unrealized gains and losses on certain investment securities.
STOCK-BASED COMPENSATION
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. There
were no stock options granted in 2007; however, 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 these assumptions, the fair value of
stock options granted during fiscal 2006 was $2.92. In 2005 the Company used the
following assumptions: risk-free interest rate of 4.23%, a dividend payout rate
of zero, and an expected option life of nine years. The volatility is 47%. Using
these assumptions, the fair value of stock options granted during fiscal 2005
was $3.70. There were 12,000 options granted during fiscal 2006 with an
estimated fair value of $22,000. If the Company had elected to recognize
compensation cost based on the value at the grant dates with the method
prescribed by SFAS 123, net income (loss) and earnings (loss) per share for 2005
would have been changed to the pro forma amounts indicated in the following
table:
71
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Year Ended
September 30,
----------------
2005
- --------------------------------------------------------------------------------
(In Thousands, Except Per Share Data)
Net (loss) income as reported $ (1,630)
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards, net
of related tax effects (239)
- --------------------------------------------------------------------------------
Pro Forma net income (loss) $ (1,869)
================================================================================
Basic income (loss) per common share:
As reported $ (0.54)
Pro Forma (0.62)
- --------------------------------------------------------------------------------
Diluted income (loss) per common share:
As reported $ (0.54)
Pro Forma (0.62)
- --------------------------------------------------------------------------------
RECLASSIFICATIONS
Certain immaterial reclassifications related to interest expense and
derivative gains have been made to prior periods to place them on a basis
comparable with the current period presentation. These reclassifications have no
effect on the results of operations previously reported.
2. DISCONTINUED OPERATIONS
On March 29, 2006, we began the process of discontinuing the operations
of the Bank's subsidiary, Greater Atlantic Mortgage Corporation. It was
determined that, because it was unprofitable, this business no longer fit our
strategy.
As a result of the above action, we applied discontinued operations
accounting in the financial statements, as we completed the closing of the
Greater Atlantic Mortgage Corporation business. The table below summarizes
Greater Atlantic Mortgage Corporation results which were treated as discontinued
operations for the periods indicated.
Year Ended September 30,
------------------------------------
2006 2005
- ---------------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Data
Interest income $ 280 $ 478
Interest expense 256 347
- ---------------------------------------------------------------------------------------
Net interest income 24 131
Noninterest income 2,149 5,072
Noninterest expense 4,661 6,310
Provision for income taxes - -
- ---------------------------------------------------------------------------------------
Net income (loss) $ (2,488) $ (1,107)
=======================================================================================
Earnings per share - basic $ (0.82) $ (0.37)
Earnings per share - diluted (0.82) (0.37)
72
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. INVESTMENTS
Available-for-Sale, September 30, 2007
- -------------------------------------------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
- -------------------------------------------------------------------------------------------------------------------
(In Thousands)
Investment securities
SBA notes $ 19,395 $ - $ 641 $ 18,754
CMOs 7,191 32 136 7,087
Corporate debt securities 7,300 - 552 6,748
- -------------------------------------------------------------------------------------------------------------------
33,886 32 1,329 32,589
- -------------------------------------------------------------------------------------------------------------------
Mortgage-backed securities
FNMA notes 8,357 - 216 8,141
GNMA notes 5,382 - 122 5,260
FHLMC notes 2,961 - 41 2,920
- -------------------------------------------------------------------------------------------------------------------
16,700 - 379 16,321
- -------------------------------------------------------------------------------------------------------------------
$ 50,586 $ 32 $ 1,708 $ 48,910
===================================================================================================================
Held-to-Maturity, September 30, 2007
- --------------------------------------------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
- --------------------------------------------------------------------------------------------------------------------
(In Thousands)
Investment securities
SBA notes $ 2,846 $ - $ 104 $ 2,742
Corporate debt securities - - - -
- --------------------------------------------------------------------------------------------------------------------
2,846 - 104 2,742
- --------------------------------------------------------------------------------------------------------------------
Mortgage-backed securities
FNMA notes 104 - 2 102
FHLMC notes 103 - 2 101
- --------------------------------------------------------------------------------------------------------------------
207 - 4 203
- --------------------------------------------------------------------------------------------------------------------
$ 3,053 $ - $ 108 $ 2,945
====================================================================================================================
73
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Available-for-sale, September 30, 2006
- --------------------------------------------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
- --------------------------------------------------------------------------------------------------------------------
(In Thousands)
Investment securities
SBA notes $ 27,629 $ 106 $ 536 $ 27,199
CMOs 9,735 48 28 9,755
Corporate debt securities 7,280 36 174 7,142
- --------------------------------------------------------------------------------------------------------------------
44,644 190 738 44,096
- --------------------------------------------------------------------------------------------------------------------
Mortgage-backed securities
FNMA notes 18,350 - 364 17,986
GNMA notes 8,133 - 217 7,916
FHLMC notes 5,549 - 86 5,463
- --------------------------------------------------------------------------------------------------------------------
32,032 - 667 31,365
- --------------------------------------------------------------------------------------------------------------------
$ 76,676 $ 190 $ 1,405 $ 75,461
====================================================================================================================
Held-to-maturity, September 30, 2006
- --------------------------------------------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
- --------------------------------------------------------------------------------------------------------------------
(In Thousands)
Investment securities
SBA notes $ 4,461 $ - $ 231 $ 4,230
Corporate notes - - - -
- --------------------------------------------------------------------------------------------------------------------
4,461 - 231 4,230
- --------------------------------------------------------------------------------------------------------------------
Mortgage-backed securities
FNMA notes 107 - 2 105
FHLMC notes 128 - 3 125
- --------------------------------------------------------------------------------------------------------------------
235 - 5 230
- --------------------------------------------------------------------------------------------------------------------
$ 4,696 $ - $ 236 $ 4,460
====================================================================================================================
The weighted average interest rate on investments was 5.47% and 5.03%
for the years ended September 30, 2007 and 2006, respectively.
TRADING ACTIVITIES
There were no net gains (losses) on trading activities included in
earnings for the years ended September 30, 2007, 2006 and 2005.
74
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Proceeds from the sale of available for sale securities were zero, zero
and $21.9 million for the years ended September 30, 2007, 2006 and 2005,
respectively. Gross realized gains were zero, zero and $539,000 for the years
ended September 30, 2007, 2006 and 2005, respectively.
As of September 30, 2007, the Bank held investments in available for
sale securities with unrealized holding losses totaling $1.7 million, consisting
of the following:
Less than 12 months 12 months or more Total
-------------------------- -------------------------- -------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Description of Securities Value Losses Value Losses Value Losses
- ---------------------------------------------------------------------------------------------------------------
(In Thousands)
Corporate debt securities $ 2,048 $ 149 $ 4,700 $ 403 $ 6,748 $ 552
CMOs 4,124 108 1,934 28 6,058 136
U.S. Government securities
SBA 3,196 38 15,558 603 18,754 641
GNMA - - 5,260 122 5,260 122
U.S. Government agency securities:
FHLMC MBS's - - 2,920 41 2,920 41
FNMA MBS's - - 8,141 216 8,141 216
- ---------------------------------------------------------------------------------------------------------------
Total $ 9,368 $ 295 $38,513 $1,413 $ 47,881 $ 1,708
===============================================================================================================
As of September 30, 2007, the Bank held investments in held-to-maturity
with unrealized holding losses totaling $108,000, consisting of the following:
Less than 12 months 12 months or more Total
-------------------------- -------------------------- -------------------------
Description of Securities Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
- ---------------------------------------------------------------------------------------------------------------
(In Thousands)
U.S. Government securities
SBA $ - $ - $2,742 $ 104 $ 2,742 $ 104
U.S. Government agency securities:
FHLMC MBS's - - 101 2 101 2
FNMA MBS's - - 102 2 102 2
- ---------------------------------------------------------------------------------------------------------------
Total $ - $ - $2,945 $ 108 $ 2,945 $ 108
===============================================================================================================
75
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Such unrealized holding losses are the result of an increase in market
interest rates during fiscal 2007 and are not the result of credit or principal
risk. Based on the nature of the investments and other considerations discussed
above, management concluded that such unrealized losses were not other than
temporary as of September 30, 2007
The amortized cost and estimated fair value of securities at September
30, 2007 and 2006, by contractual maturity, are as follows:
September 30, 2007 September 30, 2006
---------------------------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
-----------------------------------------------------------------------------------------------------------
(In Thousands)
Available-for-sale:
One year or less $ - $ - $ 49 $ 33
After one year through five years - - - -
After five years through ten years 3,499 3,245 3,891 3,753
After ten years 30,387 29,344 40,704 40,310
Mortgage-backed securities 16,700 16,321 32,032 31,365
-----------------------------------------------------------------------------------------------------------
50,586 48,910 76,676 75,461
-----------------------------------------------------------------------------------------------------------
Held-to-maturity:
One year or less - - - -
After one year through five years - - 110 94
After five years through ten years 380 366 553 534
After ten years 2,466 2,376 3,798 3,602
Mortgage-backed securities 207 203 235 230
-----------------------------------------------------------------------------------------------------------
3,053 2,945 4,696 4,460
-----------------------------------------------------------------------------------------------------------
Total investment securities $53,639 $51,855 $81,372 $79,921
===========================================================================================================
Actual maturities may differ from contractual maturities because
issuers may have the right to call or prepay obligations with or without call or
prepayment penalties. All investment securities currently considered liquid.
76
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. LOANS RECEIVABLE
Loans receivable consists of the following:
September 30,
-----------------------------------
2007 2006
----------------------------------------------------------------------------------------------------
(In Thousands)
Mortgage loans:
Single-family $ 37,972 $ 43,473
Multi-family 3,983 813
Construction 9,939 14,245
Commercial real estate 34,984 28,403
Land loans 8,097 13,829
----------------------------------------------------------------------------------------------------
Total mortgage loans 94,975 100,763
Commercial loans 34,844 39,794
Consumer loans 52,656 61,414
----------------------------------------------------------------------------------------------------
Total loans 182,475 201,971
Less:
Due borrowers on loans-in process (4,947) (8,517)
Deferred loan fees origination costs 832 944
Allowance for loan losses (2,305) (1,330)
Unearned (discounts) premium 53 239
----------------------------------------------------------------------------------------------------
$ 176,108 $ 193,307
====================================================================================================
The activity in allowance for loan losses is summarized as follows:
Year Ended September 30,
----------------------------------------------------
2007 2006 2005
- --------------------------------------------------------------------------------------------------------------------
(In Thousands)
Balance, beginning $ 1,330 $ 1,212 $ 1,600
Provision for loan losses 685 126 219
Charge-offs (353) (80) (625)
Recoveries 643 72 18
- --------------------------------------------------------------------------------------------------------------------
Balance, ending $ 2,305 $ 1,330 $ 1,212
====================================================================================================================
The amount of loans serviced for others totaled $32.0 million and $34.4
million as of September 30, 2007 and September 30, 2006, respectively.
The allowance for uncollected interest, established for mortgage loans
which are delinquent for a period of 90 days or more, amounted to $110,000,
$204,000 and $134,000 as of September 30, 2007, 2006 and 2005, respectively.
This is the entire amount of interest income that would have been recorded in
these periods under the contractual terms of such loans. Principal balances of
non-performing loans related to reserves for uncollected interest totaled $1.3
million, $274,000 and $1.6 million as of September 30, 2007, 2006, and September
30, 2005, respectively.
77
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. ACCRUED INTEREST AND DIVIDENDS RECEIVABLE
Accrued interest and dividends receivable consist of the following:
September 30,
-------------------------
2007 2006
--------------------------------------------------------------------------------------------------
(In Thousands)
Investments $ 491 $ 751
Loans receivable 1,159 1,282
Accrued dividends on FHLB stock 25 40
--------------------------------------------------------------------------------------------------
$ 1,675 $ 2,073
==================================================================================================
6. PREMISES AND EQUIPMENT
Premises and equipment consists of the following:
September 30,
-------------------------
2007 2006
-------------------------------------------------------------------------------------------------
(In Thousands)
Furniture, fixtures and equipment $2,283 $2,621
Leasehold improvements 2,804 2,835
Land 377 377
-------------------------------------------------------------------------------------------------
5,464 5,833
Less: Allowances for depreciation and amortization 3,179 3,069
-------------------------------------------------------------------------------------------------
$2,285 $2,764
=================================================================================================
7. FORECLOSED REAL ESTATE
There was no activity in the allowance for losses on foreclosed real
estate in fiscal 2007, 2006 or 2005.
78
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. DEPOSITS
Deposits are summarized as follows:
September 30, 2007
--------------------------------------------------------------------------------------------------------
Ranges of
Contractual %
Amount Interest Rates of Total
--------------------------------------------------------------------------------------------------------
(In Thousands)
Savings accounts $ 2,468 0.00 - 1.09% 1.3%
NOW/money market accounts 60,625 0.00 - 4.40% 30.6
Certificates of deposit 125,717 0.94 - 9.00% 63.5
Non-interest bearing demand deposits 9,181 0.00% 4.6
--------------------------------------------------------------------------------------------------------
$ 197,991 100.0%
========================================================================================================
September 30, 2006
--------------------------------------------------------------------------------------------------------
Ranges of
Contractual %
Amount Interest Rates of Total
--------------------------------------------------------------------------------------------------------
(In Thousands)
Savings accounts $ 3,679 0.00 - 1.09% 1.6%
NOW/money market accounts 73,334 0.00 - 4.40% 31.9
Certificates of deposit 127,939 0.94 - 9.00% 55.6
Non-interest bearing demand deposits 25,222 0.00% 10.9
--------------------------------------------------------------------------------------------------------
$ 230,174 100.0%
========================================================================================================
79
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Certificates of deposit as of September 30, 2007 mature as follows:
Year ending September 30, Amount
---------------------------------------------------------------------------------------------
(In Thousands)
Thousands
2008 $ 107,736
2009 12,079
2010 3,019
2011 985
2012 and after 1,898
---------------------------------------------------------------------------------------------
$ 125,717
=============================================================================================
Interest expense on deposit accounts consists of the following:
Year Ended September 30,
--------------------------------------------
2007 2006 2005
------------------------------------------------------------------------------------------------------------
(In Thousands)
NOW/money market accounts $ 2,791 $ 2,430 $ 1,197
Savings accounts 27 48 94
Certificates of deposit 6,513 5,231 5,046
------------------------------------------------------------------------------------------------------------
$ 9,331 $ 7,709 $ 6,337
============================================================================================================
Deposits, including certificates of deposit, with balances in excess of
$100,000 totaled $68.0 million and $85.2 million at September 30, 2007, and
September 30, 2006, respectively.
80
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. ADVANCES FROM FEDERAL HOME LOAN BANK AND OTHER BORROWINGS
The Bank has $43.3 million credit availability as of September 30, 2007
from the Federal Home Loan Bank of Atlanta (FHLB). Any advances in excess of $10
million are required to be collateralized with eligible securities. The credit
availability is at the discretion of the FHLB.
The following table sets forth information regarding the Bank's
borrowed funds:
At or For the Year Ended September 30,
--------------------------------------------------
2007 2006 2005
----------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands) FHLB advances:
Average balance outstanding $ 33,064 $ 44,894 $ 44,422
Maximum amount outstanding at any month-end during the period 39,000 51,000 49,200
Balance outstanding at end of period 25,000 36,000 38,000
Weighted average interest rate during the period 5.46% 5.05% 4.47%
Weighted average interest rate at end of period 5.92% 5.28% 4.85%
Reverse repurchase agreements:
Average balance outstanding 15,264 31,624 51,388
Maximum amount outstanding at any month-end during the period 10,857 35,641 62,846
Balance outstanding at end of period 2,192 18,574 38,479
Weighted average interest rate during the period 5.61% 4.21% 4.33%
Weighted average interest rate at end of period 2.52% 4.65% 3.69%
The Bank has pledged certain investments with carrying values of $24.9
million at September 30, 2007, to collateralize advances from the FHLB.
First mortgage loans in the amount of $18.4 million are also available
to be pledged as collateral for the advances at September 30, 2007.
10. INCOME TAXES
The provision (benefit) for income taxes differs from the amount of
income tax determined by applying the applicable U.S. statutory federal income
tax rate to pre-tax income (loss) as a result of the following differences:
Year Ended September 30,
--------------------------------------------
2007 2006 2005
----------------------------------------------------------------------------------------------------------
(In Thousands)
Federal tax provision (benefit) $ 335 $(1,894) $ (554)
State tax provision (benefit) 39 (223) (65)
Changes in provision resulting from:
Valuation changes (313) 1,867 613
Other (25) 250 6
----------------------------------------------------------------------------------------------------------
Income tax provision $ 36 $ - $ -
==========================================================================================================
81
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Significant components of the Company's deferred tax assets and
liabilities are as follows:
September 30,
--------------------------------
2007 2006
---------------------------------------------------------------------------------------------
(In Thousands)
Deferred tax assets
Net operating loss carryforwards $ 4,398 $ 5,039
Unrealized (gains) losses on derivatives 141 178
Allowance for loan losses 876 505
Available for sale securities 648 433
Core deposit intangible - 65
Deferred loan fees 108 125
Other 79 86
---------------------------------------------------------------------------------------------
Total deferred tax assets 6,250 6,431
---------------------------------------------------------------------------------------------
Deferred tax liabilities
Tax over book depreciation 410 478
Other 172 140
---------------------------------------------------------------------------------------------
Total deferred tax liabilities 582 618
---------------------------------------------------------------------------------------------
Net deferred tax assets 5,668 5,813
Less: Valuation allowance 3,572 3,885
---------------------------------------------------------------------------------------------
Total $ 2,096 $ 1,928
=============================================================================================
Management has provided a valuation allowance for net deferred tax
assets, due to the timing of the generation of future taxable income. 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.
At September 30, 2007, the Company has net operating loss carryforwards
for federal income tax purposes of approximately $11.5 million, which expire in
the years 2008 to 2026. As a result of the change in ownership of the bank,
approximately $1.5 million of the total net operating loss carryforwards are
subject to an annual usage limitation of $114,000. In addition certain
additional limitations will exist should the merger with Summit occur.
82
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. COMMITMENTS AND CONTINGENCIES
The Company is a party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs of its
customers and to reduce its own exposure to fluctuations in interest rates.
Those financial instruments include commitments to extend credit, standby
letters of credit, and financial guarantees. Those instruments involve, to
varying degrees, elements of credit and interest rate risk in excess of the
amount recognized in the balance sheet. The contract or notional amounts of
those instruments reflect the extent of involvement the Company has in
particular classes of financial instruments.
In the event of nonperformance by the other party to financial
instrument for commitments to extend credit, for standby letters of credit or
for written financial guarantees the Company's exposure to credit loss is
represented by the contractual notional amount of those instruments. The Company
uses the same credit policies in making commitments and conditional obligations
as it does for on-balance-sheet instruments.
At September 30, 2007, the Company had outstanding commitments to
originate loans and undisbursed construction mortgages aggregating approximately
$9.5 million. Fixed rate commitments are at market rates as of the commitment
dates and generally expire within 60 days. In addition, the Company was
contingently liable under unused lines of credit for approximately $111.8
million and standby letters of credit for approximately $310,000.
RENTAL COMMITMENTS
The Company has entered into lease agreements for the rental of certain
properties expiring on various dates through October 31, 2015. The future
minimum rental commitments as of September 30, 2007, for all non-cancelable
lease agreements, are as follows:
Years ending Rental
September 30, Commitments
----------------------------------------------------
(In Thousands)
2008 $ 1,062
2009 1,003
2010 855
2011 344
2012 125
Thereafter 390
----------------------------------------------------
Total $ 3,779
====================================================
Net rent expense for the years ended September 30, 2007, 2006 and 2005
was $1.1 million, $1.1 million and $1.0 million, respectively.
83
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. REGULATORY MATTERS
Generally, annual dividends by the Bank to the Company as its sole
shareholder are limited to the amount of current year net income, plus the total
net income for the preceding two years, adjusted for any prior year
distributions. Under certain circumstances, regulatory approval would be
required before making a capital distribution. The Bank did not pay any cash
dividends during the years ended September 30, 2007, 2006 or 2005.
The Federal Deposit Insurance Corporation Improvement Act of 1991
(FDICIA) created five categories of financial institutions based on the adequacy
of their regulatory capital level: well capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized and critically
undercapitalized. Under FDICIA, a well-capitalized financial institution is one
with Tier 1 leverage capital of 5%, Tier 1 risk-based capital of 6% and total
risk-based capital of 10%. At September 30, 2007 the Bank was classified as a
well capitalized financial institution and was classified as an adequately
capitalized financial institution at September 30, 2006.
As part of FDICIA, the minimum capital requirements that the Bank is
subject to are as follows: 1) tangible capital equal to at least 1.5% of
adjusted total assets, 2) core capital equal to at least 4% of adjusted total
assets and 3) total risk-based capital equal to at least 8% of risk-based
assets.
The following presents the Bank's capital position at September 30,
2007 and September 30, 2006:
- -------------------------------------------------------------------------------------------------------------
Required Required Actual Actual
At September 30, 2007 Balance Percent Balance Percent Surplus
- -------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Tangible $ 3,684 1.50% $ 18,830 7.67% $ 15,146
Core $ 9,825 4.00% $ 18,830 7.67% $ 9,005
Risk-based $ 13,630 8.00% $ 20,874 12.25% $ 7,244
=============================================================================================================
- -------------------------------------------------------------------------------------------------------------
Required Required Actual Actual
At September 30, 2006 Balance Percent Balance Percent Surplus
- -------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Tangible $ 4,560 1.50% $ 16,738 5.51% $ 12,178
Core $ 12,159 4.00% $ 16,738 5.51% $ 4,579
Risk-based $ 15,487 8.00% $ 17,636 9.11% $ 2,149
=============================================================================================================
84
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following is a reconciliation of the Bank's net worth as reported
to the OTS on GAAP capital as presented in the accompanying financial statements
(unaudited).
September 30,
------------------------------
2007 2006
--------------------------------------------------------------------------------------------------
(In Thousands)
GAAP capital $ 11,661 $ 10,161
Guaranteed convertible preferred securities 8,000 8,000
Unrealized losses on available for sale securities 1,324 1,049
Excluded deferred tax asset (1,199) (1,516)
Goodwill (956) (956)
--------------------------------------------------------------------------------------------------
Tangible capital 18,830 16,738
Adjustments - -
--------------------------------------------------------------------------------------------------
Core capital 18,830 16,738
Allowance for general loss reserves 2,132 1,011
Adjustments to arrive at Risk-Weighted Assets (88) (113)
--------------------------------------------------------------------------------------------------
Risk-based capital $ 20,874 $ 17,636
==================================================================================================
Failure to meet any of the three capital requirements causes savings
institutions to be subject to certain regulatory restrictions and limitations
including a limit on asset growth, and the requirement to obtain regulatory
approval before certain transactions or activities are entered into.
13. STOCKHOLDERS' EQUITY
Effective November 14, 1998, the Company established the 1997 Stock
Option and Warrant Plan (the "Plan"). The Plan reserves options for 76,667
shares to employees and warrants for 94,685 shares to stockholders. The Plan was
amended effective March 14, 2000, to increase the number of options available
for grant from 76,667 to 225,000 shares to employees and amended again effective
March 15, 2002, to increase the number of options available for grant from
225,000 to 350,000 shares to employees and to limit its application to officers
and employees. The stock options and warrants vest immediately upon issuance and
carry a maximum term of 10 years. The exercise price for the stock options and
warrants is the fair market value at grant date. As of September 30, 2007,
88,016 warrants were outstanding.
85
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following summary represents the activity under the Plan:
------------------------------------------------------------------------------------------------------------
Number Exercise Expiration
of Shares Price Date
------------------------------------------------------------------------------------------------------------
Balance outstanding and exercisable at September 30, 2004 226,000
Options granted 104,000 $ 6.75 10-6-14
Options exercised (8,500) $ 4.00
Options expired (55,500) $ 6.52
------------------------------------------------------------------------------------------------------------
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 expired (7,500) $ 6.75
------------------------------------------------------------------------------------------------------------
Balance outstanding and exercisable at September 30, 2007 245,500 $ 6.72
============================================================================================================
Fair value of options issued in 2006 was $22,000 net of related tax effects.
A summary of the stock options outstanding and exercisable as of September 30, 2007 is as follows:
------------------------------------------------------------ -----------------------------
Options Outstanding Options Exercisable
------------------------------------------------------------ -----------------------------
Weighted Weighted
Average Average
Exercise Number Remaining Life Exercise Number
Prices Outstanding (years) Price Exercisable
----------------------------------------------------------- ------------------------------
$7.50 16,667 0.2 $7.50 16,667
$8.38 16,667 1.2 $8.38 16,667
$6.00 13,000 2.2 $6.00 13,000
$4.00 41,666 3.2 $4.00 41,666
$5.31 10,000 3.2 $5.31 10,000
$7.00 17,000 4.3 $7.00 17,000
$9.00 20,000 4.3 $9.00 20,000
$8.50 30,000 6.1 $8.50 30,000
$6.75 68,500 7.1 $6.75 68,500
$6.00 12,000 8.5 $6.00 12,000
------------------------------------------------------------ ------------------------------
86
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. EARNINGS (LOSS) PER SHARE OF COMMON STOCK
The Company reports earning per share in accordance with Statement of
Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"). SFAS
128 requires two presentations of earning per share - "basic" and "diluted."
Basic earnings per share are computed by dividing income available to common
stockholders (the numerator) for the period by the weighted average number of
shares of common stock outstanding during the year (the denominator). The
computation of diluted earnings per share is similar to basic earnings per
share, except that the denominator is increased to include the number of
additional common shares that would have been outstanding if the potentially
dilutive common shares had been issued.
The following table presents a reconciliation between the basic and
diluted earnings (loss) per share for the year ended September 30, 2007, 2006
and 2005:
For the Year Ended September 30,
-----------------------------------------------------------------------------------------------
2007 2006 2005
----------------------------- ----------------------------- -----------------------------
Income Shares Per Income Shares Per Income Shares Per
Share (loss) Share (loss) Share
Amount Amount Amount
- -------------------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands, Except
Per Share Data)
Basic earnings per share $ 951 3,023,407 $0.31 $(5,571) 3,020,934 $(1.84) $(1,630) 3,015,509 $(0.54)
Effect of conversion of
preferred securities 405 1,368,143 - - - - - - -
Effect of dilutive stock
options - 3,458 - - - - - - -
- -------------------------------------------------------------------------------------------------------------------------------
Diluted $1,356 4,395,008 $0.31 $(5,571) 3,020,934 $(1.84) $(1,630) 3,015,509 $(0.54)
===============================================================================================================================
The effect of the conversion of preferred securities and stock options of
1,381,079 and 1,386,030 were excluded in 2006 and 2005, respectively, as they
would have been anti-dilutive.
15. RELATED PARTY TRANSACTIONS
The Bank offers loans to its officers, directors, employees and related
parties of such persons. These loans are made in the ordinary course of business
and, in the opinion of management, do not involve more than the normal risk of
collectibility, or present other unfavorable features. Such loans are made on
the same terms as those prevailing at the time for comparable transactions with
non-affiliated persons. The aggregate balance of loans to directors, officers
and other related parties is $181,000 and $263,000 as of September 30, 2007 and
September 30, 2006, respectively.
87
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
16. MARKET VALUE DISCLOSURE OF FINANCIAL INSTRUMENTS
The fair value information for financial instruments, which is provided
below, is based on the requirements of Financial Accounting Standard Board
Statement of Financial Accounting Standards No. 107, "Disclosures about Fair
Value of Financial Instruments," and does not represent the aggregate net fair
value of the Bank.
Much of the information used to determine fair value is subjective and
judgmental in nature; therefore, fair value estimates, especially for less
marketable securities, may vary. The amounts actually realized or paid upon
settlement or maturity could be significantly different.
The following methods and assumptions were used to estimate the fair
value of each class of financial instrument for which it is reasonable to
estimate that value:
A. Cash and interest bearing deposits - Fair value is estimated to be
carrying value.
B. Investment securities - Fair value is estimated using quoted market
prices or market estimates.
C. Loans receivable - Fair value is estimated by discounting future
cash flows using the current rate for similar loans.
D. Deposits - For passbook savings, checking and money market accounts,
fair value is estimated at carrying value. For fixed maturity certificates of
deposit, fair value is estimated by discounting future cash flows at the
currently offered rates for deposits of similar remaining maturities.
E. Advances from the FHLB of Atlanta and reverse repurchase agreements
- - Fair value is estimated by discounting future cash flows at the currently
offered rates for advances of similar remaining maturities.
F. Off-balance sheet instruments - The fair value of commitments is
determined by discounting future cash flows using the current rate for similar
loans. Commitments to extend credit for other types of loans and standby letters
of credit were determined by discounting future cash flows using current rates.
The carrying value and estimated fair value of financial instruments is
summarized as follows:
For the Year Ended September 30,
-----------------------------------------------------------
2007 2006
----------------------------- ----------------------------
Carrying Estimated Carrying Estimated
value fair value value fair value
----------------------------------------------------------------------------------------------------------
(In Thousands)
Assets:
Cash and interest bearing deposits $ 7,632 $ 7,632 $ 19,804 $ 19,804
Investment securities 51,963 51,855 80,157 79,921
Loans receivable 176,108 176,833 193,307 193,049
----------------------------------------------------------------------------------------------------------
Liabilities:
Deposits 197,991 198,368 230,174 229,818
Borrowings 27,192 27,980 54,574 55,333
----------------------------------------------------------------------------------------------------------
Off-balance sheet instruments:
Commitments to extend credit - 31 - 10
----------------------------------------------------------------------------------------------------------
17. EMPLOYEE BENEFIT PLANS
The Company operates a 401(k) Retirement Plan covering all full-time
employees meeting the minimum age and service requirements. Contributions to the
Retirement Plan are at the discretion of the Company. The Company made no
contributions for the years ended September 30, 2007, 2006 and 2005.
88
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
18. SUPPLEMENTAL CASH FLOW INFORMATION
Year Ended September 30,
----------------------------------------
2007 2006 2005
-----------------------------------------------------------------------------------------------------------
(In Thousands)
Cash paid during period for interest on deposits and borrowings $ 3,318 $ 5,331 $ 5,861
===========================================================================================================
19. SEGMENT REPORTING AND DISCONTINUED OPERATIONS
The Company had two reportable segments, banking and mortgage banking.
However, 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
residential real estate loans purchased from GAMC and others, and also invests
in mortgage-backed and other securities. The mortgage banking activities, which
were conducted principally through GAMC, included the origination of residential
real estate loans either for sale into the secondary market, with servicing
released or for the Bank's portfolio.
On March 29, 2006, we began the process of discontinuing the operations
of the Bank's subsidiary, GAMC. It was determined that, because it was
unprofitable, this business no longer fit our strategy. In the third quarter of
2006, we applied discontinued operations accounting for GAMC.
Due to the unprofitable operations of GAMC, the Company recognized an
additional loss of $1.5 million for the year ended September 30, 2006. In
addition to the loss from operations, a non-recurring pre-tax impairment charge
for long-lived assets related to GAMC of $996,000 was recorded and also included
in discontinued operations in the consolidated statements of operations for
fiscal 2006.
20. 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 announced 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, would be deferred.
The announcement by the Company followed 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.
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). At September 30, 2007, the
quarterly distribution amount that is unpaid and accrued totals $644,000.
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.
89
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
21. DERIVATIVE FINANCIAL INSTRUMENTS
Beginning in fiscal 2002, the Bank utilized derivative financial
instruments to hedge its interest rate risk. Beginning in 2002, the Bank adopted
statement of Financial Accounting Standard No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133") which requires that an entity
recognize all derivatives as either assets or liabilities and measure those
instruments at fair value. The Bank bases the estimated fair values of these
agreements on the cost of interest-rate exchange agreements with similar terms
at available market prices, excluding accrued interest receivable and payable.
However, active markets do not exist for many types of financial instruments.
Consequently, fair values for these instruments must be estimated using
techniques such as discounted cash flow analysis and comparisons to similar
instruments. Estimates developed using these methods are highly subjective and
require judgments regarding significant matters such as the amount and timing of
future cash flows and the selection of discount rates that appropriately reflect
market and credit risks. Changes in these judgments often have a material effect
on the fair value estimates. Since those estimates are made as of a specific
time, they are susceptible to material near term changes.
The Bank entered into various interest-rate swaps during fiscal year
2003 and 2002 that were sold during the fourth quarter of fiscal 2006 and
totaled at that time $21 million in notional principal. The swaps paid a fixed
rate with the Bank receiving payments based upon one-to three-month floating
rate LIBOR. The capped range was between 1.67% - 3.01%, and expired between 1
and 5 years. The Bank also entered into various interest rate caps during fiscal
year 2003 and 2002 that total $20 million in notional principal with terms
between eight and ten years that limit the float between a floor of 2.00%, and
capped between 6.50% - 8.00%. The Bank accounts for these derivatives, under the
guidelines of SFAS 133.
The Company's derivatives do not meet hedge accounting requirements
under SFAS 133, and therefore, the Company carries the derivatives at their fair
value on the balance sheet, recognizing changes in their fair value in
current-period earnings. The Company recognized a loss of $21,000 in fiscal
2007, a gain of $212,000 in fiscal 2006 and a gain of $303,000 in fiscal 2005
related to its derivatives.
22. RECENT ACCOUNTING STANDARDS
In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements". This statement clarifies the definition of fair value,
establishes a framework for measuring fair value and expands the disclosures on
fair value measurements. For financial assets and liabilities, SFAS No. 157 is
effective for fiscal years beginning after November 15, 2008. We do not believe
the adoption of SFAS 157 will have a material impact on the consolidated
financial statements.
In February 2007, the FASB issued Statement of Financial Accounting
Standards No. 159, "The Fair Value Option for Financial Assets and Financial
Liabilities" (SFAS 159).This statement permits entities to choose to measure
many financial instruments and certain other items at fair value. The objective
of this Statement is to improve financial reporting by providing entities with
the opportunity to mitigate volatility in reported earnings caused by measuring
related assets and liabilities differently without having to apply complex hedge
accounting provisions. The fair value option established by this Statement
permits all entities to choose to measure eligible items at fair value at
specified election dates. A business entity shall report unrealized gains and
losses on items for which the fair value option has been elected in earnings at
each subsequent reporting date. The fair value option may be applied instrument
by instrument and is irrevocable. SFAS 159 is effective as of the beginning of
an entity's first fiscal year that begins after November 15, 2007. The Company
is in the process of evaluating the impact SFAS 159 may have on its consolidated
financial statements.
In December 2007, the FASB issued SFAS No. 141 (R), "Business
Combinations", to create greater consistency in the accounting and financial
reporting of business combinations. SFAS 141 (R) requires a company to recognize
the assets acquired, the liabilities assumed, and any noncontrolling interest in
the acquired entity to be measured at their fair values as of the acquisition
date. SFAS 141 (R) also requires companies to recognize and measure goodwill
acquired in a business combination or a gain from a bargain purchase and how to
evaluate the nature and financial effects of the business combination. SFAS No.
141(R) applies to fiscal years beginning after December 15, 2008 and is adopted
prospectively. Earlier adoption is prohibited. We have not determined the
effect, if any, the adoption of this statement will have on our results of
operations or financial position.
90
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling
Interests in Consolidated Financial Statements -- an amendment of ARB No. 51",
to establish accounting and reporting standards for the noncontrolling interest
in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 requires
company to clearly identify and present ownership interests in subsidiaries held
by parties other than the company in the consolidated financial statements
within the equity section but separate from the company's equity. It also
requires the amount of consolidated net income attributable to the parent and to
the noncontrolling interest be clearly identified and presented on the face of
the consolidated statement of income; changes in ownership interest be accounted
for similarly, as equity transactions; and when a subsidiary is deconsolidated,
any retained noncontrolling equity investment in the former subsidiary and the
gain or loss on the deconsolidation of the subsidiary be measured at fair value.
SFAS No. 160 applies to fiscal years beginning after December 15, 2008. Earlier
adoption is prohibited. We have not determined the effect, if any, the adoption
of this statement will have on our results of operations or financial position.
23. PARENT COMPANY - ONLY FINANCIAL STATEMENTS
Parent Company - Only Condensed Statements of Financial Condition
September 30,
-----------------------------------
2007 2006
------------------------------------------------------------------------------------------
(In Thousands)
Assets
Cash and cash equivalents $ 13 $ 60
Loans receivable - -
Investment in subsidiary 21,167 19,423
Prepaid expenses and other assets 316 309
------------------------------------------------------------------------------------------
Total assets $ 21,496 $ 19,792
==========================================================================================
Liabilities and stockholders' equity
Accrued interest payable on subordinated debt $ 644 $ -
Other liabilities 117 8
------------------------------------------------------------------------------------------
Total liabilities 761 8
------------------------------------------------------------------------------------------
Subordinated debt 9,905 9,928
------------------------------------------------------------------------------------------
Stockholders' equity
Common stock 30 30
Additional paid-in capital 25,208 25,185
Accumulated deficit (14,408) (15,359)
------------------------------------------------------------------------------------------
Total stockholders' equity 10,830 9,856
------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 21,496 $ 19,792
==========================================================================================
91
Greater Atlantic Financial Corp. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Parent Company - Only Condensed Statements of Operations
Year Ended September 30,
--------------------------------------------
2007 2006 2005
------------------------------------------------------------------------------------------------------------
(In Thousands)
Interest income $ 1 $ 1 $ -
Other income - - -
------------------------------------------------------------------------------------------------------------
Total interest income 1 1 -
------------------------------------------------------------------------------------------------------------
Interest expense 644 645 645
------------------------------------------------------------------------------------------------------------
Total interest expense 644 645 645
------------------------------------------------------------------------------------------------------------
Net interest income (expense) (643) (644) (645)
------------------------------------------------------------------------------------------------------------
Noninterest income
Gain (loss) on sale of investment securities - - -
Other operating income 19 19 19
------------------------------------------------------------------------------------------------------------
Total noninterest income 19 19 19
------------------------------------------------------------------------------------------------------------
Noninterest expense
Other operating expense 169 149 142
------------------------------------------------------------------------------------------------------------
Total noninterest expense 169 149 142
------------------------------------------------------------------------------------------------------------
Loss before income from subsidiaries (793) (774) (768)
------------------------------------------------------------------------------------------------------------
Equity in income (loss) from subsidiaries 1,744 (4,797) (862)
------------------------------------------------------------------------------------------------------------
Net income (loss) $ 951 $ (5,571) $ (1,630)
============================================================================================================
Parent Company - Only Condensed Statements of Cash Flows
Year Ended September 30,
-------------------------------------------
2007 2006 2005
------------------------------------------------------------------------------------------------------------
(In Thousands)
Cash flows from operating activities:
Net income (loss) $ 951 $ (5,571) $ (1,630)
Adjustments to reconcile net loss to net cash (used in)
provided by operating activities
(Income) loss from subsidiaries (1,744) 4,797 862
(Increase) decrease in assets (7) (5) (1)
Increase (decrease) in other liabilities 753 18 (12)
------------------------------------------------------------------------------------------------------------
Net cash used in operating activities (47) (761) (781)
------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Loan originations in excess of repayments - - -
Investment in subsidiary - - -
------------------------------------------------------------------------------------------------------------
Net cash provided by investing activities - - -
------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Cash dividend from subsidiary - 755 800
Stock options exercised - - 33
------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities - 755 833
------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and cash equivalents (47) (6) 52
Cash and cash equivalents at beginning of year 60 66 14
------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 13 $ 60 $ 66
============================================================================================================
92
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
24. QUARTERLY RESULTS OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE INFORMATION)
(UNAUDITED)
The following tables set forth the quarterly financial data, which was
derived from the consolidated financial statements presented in Forms 10-Q, for
the fiscal years ended September 30, 2007 and 2006.
For Fiscal
Year 2007
------------------------------------------------------------------------
For the Year
Ended
September 30, Fourth Third Second First
2007 Quarter Quarter Quarter Quarter
------------------------------------------------------------------------------------------------------------
Interest income $18,421 $4,338 $4,684 $4,594 $4,805
Interest expense 11,993 3,017 3,076 2,899 3,001
------------------------------------------------------------------------------------------------------------
Net interest income 6,428 1,321 1,608 1,695 1,804
Provision (recapture) for loan 685 396 (4) 145 148
losses
------------------------------------------------------------------------------------------------------------
Net interest income, after 5,743 925 1,612 1,550 1,656
provision for loan losses
Noninterest income 4,870 4,398 (1) 186 148 138
Noninterest expense 9,626 2,112 2,306 2,522 2,686
------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes 987 3,211 (508) (824) (892)
Provision for income taxes 36 36 - -
------------------------------------------------------------------------------------------------------------
Net income (loss) $ 951 $3,175 $ (508) $ (824) $ (892)
============================================================================================================
BASIC AND DILUTED EARNINGS (LOSS)
PER COMMON SHARE:
Basic $ 0.31 $ 1.05 $(0.17) $(0.27) $(0.30)
Diluted $ 0.31 $ 0.74 $(0.17) $(0.27) $(0.30)
------------------------------------------------------------------------------------------------------------
(1) Includes effect of gain on sale of Pasadena branch of $4.3 million
93
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For Fiscal Year 2006
------------------------------------------------------------------------------
For the Year
Ended September Fourth Third Second First
30, 2006 Quarter Quarter Quarter Quarter
------------------------------------------------------------------------------------------------------------------------
Interest income $ 18,794 $ 4,851 $ 4,753 $ 4,600 $ 4,590
Interest expense 11,583 3,021 2,941 2,839 2,782
------------------------------------------------------------------------------------------------------------------------
Net interest income 7,211 1,830 1,812 1,761 1,808
Provision for loan losses 126 39 13 3 71
------------------------------------------------------------------------------------------------------------------------
Net interest income, after provision 7,085 1,791 1,799 1,758 1,737
for loan losses
Noninterest income 917 (63) 307 330 343
Noninterest expense 11,085 3,217 2,722 2,626 2,520
------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (3,083) (1,489) (616) (538) (440)
Provision for income taxes - - - - -
------------------------------------------------------------------------------------------------------------------------
Net income (loss) from continuing (3,083) (1,489) (616) (538) (440)
operations
Income (loss) from discontinued
operations (2,488) 11 (19) (698) (1,782)
------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (5,571) $ (1,478) $ (635) $ (1,236) $ (2,222)
========================================================================================================================
BASIC AND DILUTED EARNINGS (LOSS) PER
COMMON SHARE:
Continuing operations $ (1.02) $ (0.49) $ (0.20) $ (0.18) $ (0.15)
Discontinued operations (0.82) 0.01 (0.01) (0.23) (0.59)
------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (1.84) $ (0.48) $ (0.21) $ (0.41) $ (0.74)
========================================================================================================================
94
Pursuant to the requirements of Section 13 of the Securities 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.
By: /s/ Carroll E. Amos
-------------------
Carroll E. Amos
Chief Executive Officer, President and Director
Dated: December 28, 2007
95