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, 2008
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________ to ______________.
Commission file number: 0-26467
GREATER ATLANTIC FINANCIAL CORP.
--------------------------------
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 54-1873112
- ------------------------------------- ----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10700 Parkridge Boulevard, Suite P50, Reston, Virginia 20191
------------------------------------------------------ -----------
(Address of Principal Executive Offices) (Zip Code)
703-391-1300
(Registrant's Telephone Number, Including Area Code)
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 a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
the definitions of "large accelerated filer," "accelerated filer" and "smaller
reporting company," in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [__] Accelerated filer [__] Non- accelerated filer [__]
Smaller Reporting Company [ 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 registrant's outstanding Common Stock held by
non-affiliates on March 31, 2008, based upon the closing sale price on that date
of $4.73, as quoted on the Pink Sheets, was $14,304,561.
As of December 21, 2008, 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
----
Item 1. Business....................................................................................... 3
Description of Business........................................................................ 3
Proposed Acquisition........................................................................... 3
Market Area and Competition.................................................................... 3
Market Risk.................................................................................... 3
Lending Activities............................................................................. 5
Asset Quality.................................................................................. 8
Allowance for Loan Losses...................................................................... 10
Investment Activities.......................................................................... 12
Sources of Funds............................................................................... 16
Subsidiary Activities.......................................................................... 18
Personnel...................................................................................... 18
Regulation and Supervision..................................................................... 19
Federal and State Taxation..................................................................... 25
Item 1A. Risk Factors................................................................................... 26
Item 1B. Unresolved Staff Comments...................................................................... 29
Item 2. Properties..................................................................................... 29
Item 3. Legal Proceedings.............................................................................. 29
Item 4. Submission of Matters to a Vote of Security Holders............................................ 29
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities.............................................................................. 30
Item 6. Selected Financial Data........................................................................ 31
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation........... 33
Item 7A. Quantitative and Qualitative Disclosures About Market Risk..................................... 55
Item 8. Consolidated Financial Statements and Supplementary Data....................................... 56
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure........... 56
Item 9A. Controls and Procedures........................................................................ 56
Item 9B. Other Information.............................................................................. 57
PART III
Item 10. Directors and Executive Officers of the Registrant............................................. 57
Item 11. Executive Compensation......................................................................... 59
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. 62
Item 13. Certain Relationships and Related Transactions................................................. 65
Item 14. Principal Accountant Fees and Services......................................................... 65
PART IV
Item 15. Exhibits and Financial Statement Schedules..................................................... 65
Signatures ............................................................................................... 66
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 (the "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. ("Summit") 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 then pending merger of the company with and
into Summit and closed on August 24, 2007.
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 might be terminated if the merger was not
consummated by that date. In a Form 8-K filed on March 26, 2008 we announced
that our shareholders had approved the terms and conditions of the proposed
merger of the company with and into Summit, and on April 9, 2008, the company
announced that it had received written notice from Summit that Summit had
exercised its right to terminate the agreement for the company to merge with and
into Summit.
On June 9, 2008 the company entered into a new definitive agreement for
Greater Atlantic Financial Corp. ("GAFC") to merge with and into Summit. That
new agreement to merge with Summit was approved by the shareholders of the
company on September 4, 2008. Processing of the Summit application to acquire
the company and the bank continued under the new definitive merger agreement
until that new definitive agreement was terminated by mutual consent of the
parties on December 15, 2008.
CEASE AND DESIST ORDER
As previously reported in a Form 8-K filed on April 29, 2008, the bank
consented to the issuance of a Cease and Desist Order (the "Cease and Desist
Order") issued by the Office of Thrift Supervision (the "OTS") effective April
25, 2008. The Cease and Desist Order requires the bank to, among other things,
report, within prescribed time periods to the OTS Regional Director for the
Southeast Region (the "Regional Director") on the status of the ongoing
negotiations with Summit; have, at June 30, 2008 (which was extended to December
31, 2008) and maintain a Tier One (Core) Capital Ratio of at least 6% and a
total risk based capital ratio of at least 12%; develop a comprehensive long
term operating strategy to be implemented if the proposed merger with Summit is
not consummated; incorporate the long term operating strategy into a three-year
business plan containing at a minimum the requirements set forth in the Cease
and Desist Order; cease, effective immediately, making commercial real estate
loans, commercial loans and loans on raw land without the prior written approval
of the Regional Director, except for such loans as to which the bank has a
legally binding written commitment to lend as of the effective date of the Cease
and Desist Order; cease, effective immediately, accepting brokered deposits; and
prohibits the payment of dividends or other capital distributions.
In addition, the Cease and Desist Order requires the bank's board of
directors to take action with respect to credit administration, classified
assets and accounting system controls and to establish a regulatory compliance
committee of three or more non-employee directors to monitor and coordinate
compliance with the provisions of the Cease and Desist Order and provide the
board of directors with progress reports on compliance, which reports are to be
transmitted by the board of directors of the bank to the Regional Director. At
September 30 and December 31, 2008, the bank was in compliance with all the
requirements of the Cease and Desist Order except for the 6% and 12% capital
requirements; however, the limitations in the Cease and Desist Order restricting
the bank's lending in the commercial, commercial real estate and construction
areas adversely affect the ability of the bank to return to profitability.
A description and copies of the Cease and Desist Order and the
Stipulation and Consent to Issuance of the Cease and Desist Order were attached
as exhibits to a report on Form 8-K filed on April 29, 2008, with the Securities
and Exchange Commission.
3
GOING CONCERN
Notwithstanding the circumstances described above, the company
continues actively to market itself, seeking either to be acquired or to obtain
a capital infusion in order to meet the conditions of the Cease and Desist
Order. We cannot assure you that our efforts will be successful and, as a result
of the circumstances described here and in the Risk Factors section, there is
substantial doubt concerning the ability of the company and the bank to continue
as going concerns for a reasonable period of time. Without a waiver by the OTS
or amendment or modification of the Cease and Desist Order, the bank could be
subject to further regulatory enforcement action, including, without limitation,
the issuance of additional cease and desist orders (which may, among other
things, further restrict the bank's business activities), or the placing of the
bank in conservatorship or receivership, any of which would impact the ability
of the bank and the company continuing as going concerns.
RECENT LEGISLATION
On October 3, 2008, the President signed into law the Emergency
Economic Stabilization Act of 2008 or ("EESA"), which, among other measures,
authorized the Secretary of the Treasury to establish the Troubled Asset Relief
Program ("TARP"). EESA gives broad authority to Secretary of the Treasury to
purchase, manage, modify, sell and insure the troubled mortgage related assets
that triggered the current economic crisis as well as other "troubled assets."
Pursuant to the TARP, the U.S. Treasury has the authority to, among
other things, purchase up to $700 billion (of which $350 billion is currently
available) of mortgages, mortgage-backed securities and certain other financial
instruments from financial institutions for the purpose of stabilizing and
providing liquidity to the U.S. financial markets. Shortly following the
enactment of EESA, the Treasury announced the creation of specific TARP programs
to purchase mortgage-backed securities and whole mortgage loans. In addition,
under TARP, the Treasury allocated $250 million of the $350 million and created
a capital purchase program, pursuant to which it provides access to capital that
will serve as Tier I capital to financial institutions through a standardized
program to acquire preferred stock (accompanied by warrants) from eligible
financial institutions. At the time the capital purchase program was announced,
the company was not deemed eligible to participate.
There can be no assurance as to the actual impact that EESA and such
related measures undertaken to alleviate the credit crisis will have generally
on the financial markets, including the extreme levels of volatility and limited
credit availability currently being experienced. The failure of such measures to
help stabilize the financial markets and a continuation or worsening of current
financial market conditions could materially and adversely affect our business,
financial condition, results of operations, access to credit or the trading
price of our common stock.
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 15 of Notes to Consolidated Financial Statements.
4
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. Our net interest margin, the
difference between interest paid on deposits and the interest charged for loans,
has declined and is a key indicator of profitability, particularly for small
banks, such as ours, which generate less fee income than larger banks. With the
state of the current economy coupled with the Federal Reserve lowering its
benchmark discount rate several times this year, our prime lending rate has been
lowered not only on loans tied to prime but also on our investment securities
tied to prime. Normally that would typically also lower rates paid for deposits,
however the intense competition for deposits has made it difficult to reduce our
deposit rates, squeezing net interest margin.
LENDING ACTIVITIES
GENERAL. Net loans receivable at September 30, 2008 were $149.6
million, a decrease of $26.5 million or 15.04% from the $176.1 million held at
September 30, 2007. 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. As noted above, the Cease
and Desist Order requires the bank to obtain the prior approval of the Regional
Director prior to making commercial real estate loans, commercial loans and
loans on raw land. Notwithstanding the Cease and Desist Order, the company
anticipates that demand for land loans for the single-family residential sector
of the market 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,
---------------------------------------------------------------------------------------------
2008 2007
---------------------------------------------------------------------------------------------
(In Thousands)
Total loans at beginning of period $182,475 $201,971
Originations of loans for investment:
Single-family residential 4,602 5,169
Multifamily - 3,215
Commercial real estate 7,522 5,781
Construction 2,360 6,449
Land loans - 240
Commercial business 26,303 28,967
Consumer 25,520 29,604
---------------------------------------------------------------------------------------------
Total originations and purchases for investment 66,307 79,425
Loans originated for resale by Greater Atlantic Bank - -
Loans originated for resale by Greater Atlantic Mortgage - -
---------------------------------------------------------------------------------------------
Total originations 66,307 79,425
Repayments (97,041) (98,921)
Sale of loans originated for resale by Greater Atlantic Mortgage - -
---------------------------------------------------------------------------------------------
Net activity in loans (30,734) (19,496)
---------------------------------------------------------------------------------------------
Total loans at end of period $151,741 $182,475
=============================================================================================
5
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,
----------------- -----------------
2008 2007
----------------- -----------------
Amount Percent Amount Percent
- ------------------------------------------------------------------------------------------
(Dollars in Thousands)
Mortgage loans:
Single-family $ 35,108 23.14% $ 37,972 20.81%
Multi-family 4,932 3.25 3,983 2.18
Construction 3,710 2.44 9,939 5.45
Commercial real estate 37,678 24.83 34,984 19.17
Land 4,668 3.08 8,097 4.44
------------------ ------------------
Total mortgage loans 86,096 56.74 94,975 52.05
------------------ ------------------
Commercial business and consumer loans:
Commercial business 13,555 8.93 34,844 19.09
Consumer:
Home equity 51,857 34.17 52,262 28.64
Automobile 13 .01 48 .03
Other 220 .14 346 .19
------------------ ------------------
Total commercial business and
consumer loans 65,645 43.26 87,500 47.95
------------------ ------------------
Total loans 151,741 100.00% 182,475 100.00%
======= =========
Less:
Allowance for loan losses (2,567) (2,305)
Loans in process (349) (4,947)
Unearned premium 790 885
----------- ---------
Loans receivable, net $ 149,615 $176,108
=========== =========
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, 2008. 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, 2008
---------------------------------------------------------------
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 $ 14,396 $ 15,140 $ 60,089 $ 89,625
After one year:
More than one year to three years 6,089 10,639 2,068 18,796
More than three years to five years 1,196 13,223 723 15,142
More than five years to 15 years 6,524 2,999 2,733 12,256
More than 15 years 13,594 1,947 32 15,573
---------------------------------------------------------------------------------------------------------
Total amount due $ 41,799 $ 43,948 $ 65,645 $151,392
=========================================================================================================
6
The following table sets forth, at September 30, 2008, the dollar
amount of loans contractually due after September 30, 2009, 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, 2008, the bank had $4.4
million of construction, acquisition and development, land and commercial
business loans that were contractually due after September 30, 2009.
Due After September 30, 2009
-----------------------------------------------
Fixed Adjustable Total
------------------------------------------------------------------------------------------------------------
(In Thousands)
Real estate loans:
One- to four-family $19,596 $ 7,807 $27,403
Multi-family and commercial 15,583 13,225 28,808
------------------------------------------------------------------------------------------------------------
Total real estate loans 35,179 21,032 56,211
Commercial business and consumer loans 3,870 1,686 5,556
------------------------------------------------------------------------------------------------------------
Total loans $39,049 $22,718 $61,767
============================================================================================================
ONE- TO FOUR-FAMILY MORTGAGE LENDING. The bank currently offers both
fixed-rate and adjustable-rate mortgage ("ARM") loans with maturities of up to
40 years secured by single-family residences, which term includes real property
containing from one to four residences. At September 30, 2008, the bank's one-
to four-family mortgage loans totaled $37.0 million, or 24.72% of total loans.
Of the one- to four-family mortgage loans outstanding at that date, 53.94% were
fixed-rate loans and 46.06% 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. Under the Cease and
Desist Order, the bank must obtain the prior approval of the Regional Director
of the OTS before making any construction and development loans. At September
30, 2008, construction and development loans (including land loans) totaled $8.4
million, or 5.52%, of the bank's total loans, of which, land loans totaled $4.7
million or 3.08% 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. While the bank has made construction loans outside its primary market
area, all the bank's land loans are secured by property within that 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. Under the Cease and Desist Order, the bank must obtain the prior
approval of the Regional Director of the OTS before making any commercial real
estate loans. 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, 2008 was $42.6 million,
or 28.08% of total loans. The largest multi-family or commercial real estate
loan in the bank's portfolio at September 30, 2008, 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, 2008, the bank had $13.6
million in commercial business loans which amounted to 8.93% of total loans.
Under the Cease and Desist Order, the bank must obtain the prior approval of the
Regional Director of the OTS before making any commercial business 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.
7
CONSUMER LENDING. Consumer loans at September 30, 2008 amounted to
$52.1 million or 34.32% 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, 2008, those loans totaled $51.9
million or 34.17% 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 $233,000, or 0.15% of the bank's total loans and
0.35% of commercial business and consumer loans at September 30, 2008.
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, 2008, the bank had $1.9 million of
loans designated as Substandard which consisted of three residential loans, one
commercial business loan, three commercial real estate loans and one land loan.
At that same date, the bank had $1.6 million of assets classified as Doubtful,
consisting of one commercial business loan, one construction development loan
and one land loan. At September 30, 2008, the bank had no loans classified as
Loss and $3.9 million in loans classified as Special Mention, consisting of one
commercial real estate loan and two land loans. Of the $3.2 million in charge
offs during fiscal 2008, $1.9 resulted from commercial business loans, $975,000
from construction and loans, $308,000 from multi-family, $7,000 from consumer
and $3,000 from residential.
8
The following table sets forth delinquencies in the bank's loans as of
the dates indicated.
----------------------------------------------------------------------
At September 30,
----------------------------------------------------------------------
2008 2007
---------------------------------- -----------------------------------
60 - 89 Days 90 Days or More 60 - 89 Days 90 Days or More
---------------------------------- -----------------------------------
Number Principal Number Principal Number Principal Number Principal
of Balance of Balance of Balance of Balance
Loans of Loans Loans of Loans Loans of Loans Loans of Loans
- ----------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Mortgage loans:
Single-family 2 $ 676 3 $ 526 - $ - 2 $ 19
Home equity - - - - 2 347 - -
Construction & Land - - 1 25 - - 2 1,330
Commercial real estate - - 3 425 - - - -
Commercial business - - 1 950 - - - -
Consumer - - - - - - - -
- ----------------------------------------------------------------------------------------------------
Total 2 $ 676 8 $ 1,926 2 $ 347 4 $ 1,349
====================================================================================================
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,
- -------------------------------------------------------------------------------------------------
2008 2007
- -------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Loans accounted for on a non-accrual basis
Mortgage loans:
Single-family $ 526 $ 16
Home equity - -
Commercial real estate 425 -
Construction and Land 25 1,330
Commercial business 950 -
Consumer - -
- -------------------------------------------------------------------------------------------------
Total non-accrual loans 1,926 1,346
Accruing loans which are contractually past due 90 days or more - 3
- -------------------------------------------------------------------------------------------------
Total of non-accrual and 90 days past due loans 1,926 1,349
Foreclosed real estate, net 1,043 -
- -------------------------------------------------------------------------------------------------
Total non-performing assets $2,969 $1,349
=================================================================================================
Non-accrual loans as a percentage of loans 1.29% 0.76%
held for investment, net
=================================================================================================
Non-accrual and 90 days or more past due loans 1.29% 0.77%
as a percentage of loans held for investment, net
=================================================================================================
Non-accrual and 90 days or more past due loans 0.95% 0.55%
as a percentage of total assets
=================================================================================================
Non-performing assets as a percentage of total assets 1.47% 0.55%
=================================================================================================
9
During the year ended September 30, 2008, 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
$473,000. The amount collected during fiscal 2008 on those loans amounted to
$74,000.
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, 2008 was $2.9 million and the related allowance associated with
impaired loans was $1.9 million, compared to $2.5 million of impaired
collateral-dependent loans at September 30, 2007 and a $627,000 allowance
associated with those loans. At September 30, 2008, 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 is based on two basic
principles of accounting: (1) SFAS No. 5, ACCOUNTING FOR CONTINGENCIES, which
requires that losses be accrued when they are probable of occurring and
estimable, and (2) SFAS No.114, ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A
LOAN, which requires that losses be accrued based on the differences between the
value of collateral, the present value of future cash flows or values that are
observable in the secondary market and the loan balance.
Our allowance for loan losses has two basic components: the specific
allowance for impaired credits and the general allowance based on relevant risk
factors. Each of those components is determined based upon estimates that can
and do change when the actual events occur. The specific allowance is used to
allocate an allowance for individual loans identified as impaired. For those
loans, we analyze the fair value of the collateral underlying the loan and
consider the estimated costs to sell the collateral on a discounted basis. If
the net collateral value is less than the loan balance (including accrued
interest and any unamortized premium or discount associated with the loan), we
recognize impairment and establish a specific reserve for the impaired loan.
Large groups of smaller balance and homogeneous loans are collectively evaluated
for impairment. Accordingly, the Company does not separately identify individual
consumer and residential loans for impairment testing unless such loans become
90 days or more past due.
The general allowance is determined by aggregating un-criticized loans,
those loans not classified under our internal asset classification system, and
loans identified for impairment testing for which no impairment was identified,
into one of six categories: single family residential mortgages; home equity
lines of credit; construction and land; commercial real estate; commercial and
industrial; and other consumer loans. We then apply allowance factors which, in
the judgment of management, represent the expected losses over the life of the
loans. In determining those factors, we consider the following: delinquencies
and overall risk ratings, historical loss experience, trends in volume and terms
of loans, effects of changes in lending policy, the experience and depth of the
borrowers' management, current economic conditions affecting the borrowers'
ability to repay, quality of the loan review system and the effect of external
factors (e.g., competition and regulatory requirements). The general allowance
also includes those loans that have been classified under our internal asset
classification system. We typically apply a 5% loss factor to loans classified
as special mention, a 10% loss factor to loans classified as substandard and a
50% loss factor to loans classified as doubtful, where the loan has not been
determined to be impaired. Loans classified as loss are fully reserved or
charged off.
As of September 30, 2008, the bank's allowance for loan losses amounted
to $2.6 million or 1.69% of total loans. The allowance for loan losses was
133.28% to total non-performing loans at September 30, 2008; as a percentage of
total loans, the allowance was increased by 43 basis points when compared to the
allowance at September 30, 2007. A $3.4 million provision for loan losses was
recorded during the year ended September 30, 2008, compared to a provision of
$685,000 during the year ended September 30, 2007. The $2.7 million increase in
the provision for loan losses from the year ago period resulted primarily from
the provision necessary for loan losses resulting from the deterioration in the
asset quality during the current period and the provision for the $1.6 million
of loans receivable determined to be impaired and classified as doubtful. The
three major categories of loans that required us to increase our provision were
commercial business, construction and land loans and multi-family loans.
10
On an annual basis, or more often as deemed necessary, the bank has
contracted with an independent third party to review its loan portfolio. Because
of the due diligence review of the loan portfolio by Summit, that third party
review was omitted in 2007 but was reinstituted in 2008. The focus of that
review is to identify the extent of potential and actual risk in the bank's
commercial loan portfolio and in our underwriting and processing practices.
Observations made regarding the bank's portfolio risk are based upon review
evaluations, portfolio profiles and discussions with the operational staff,
including the line lenders and senior management. 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. In the most recent examination made in June, 2008, the OTS did not
indicate the need to increase the allowance for loan losses.
Management believes that the allowance for loan losses is adequate at
September 30, 2008. However, there can be no assurance that additional
provisions for loan losses will not be required in the future, due to possible
changes in the economic assumptions underlying management's estimates and
judgments, adverse developments in the economy, actual loss experience or
changes in the circumstances of particular borrowers. Recently, the housing and
the residential mortgage markets have experienced a variety of difficulties and
changed economic conditions. If market conditions continue to deteriorate, they
may lead to additional valuation adjustments to our loan portfolio as we
continue to reassess the market value of our loan portfolio and the severity of
the loss on loans in default. In addition, the homebuilding industry has
experienced a significant and sustained decline in the demand for new homes and
an oversupply of new and existing homes available for sale in various markets.
We do not anticipate that the housing market will improve in the near-term;
accordingly, additional downgrades, provisions for loan losses and charge-offs
relating to the loan portfolio may occur.
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,
- -----------------------------------------------------------------------------------------------------
2008 2007
- -----------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Balance at beginning of period $ 2,305 $ 1,330
Provisions 3,397 685
Charge-offs:
Mortgage loans:
Single-family 4 128
Multi-family 308 -
Construction 400 -
Land 575 -
Commercial business 1,866 210
Consumer 7 15
- -----------------------------------------------------------------------------------------------------
Total charge-offs 3,160 353
Recoveries:
Mortgage loans:
Single-family - 8
Commercial real estate - -
Commercial business 25 635
Consumer - -
- -----------------------------------------------------------------------------------------------------
Total recoveries 25 643
Net charge-offs (recoveries) 3,135 (290)
- -----------------------------------------------------------------------------------------------------
Balance at end of period $ 2,567 $ 2,305
=====================================================================================================
Ratio of net charge-offs (recoveries) during the period 1.93% (0.16)%
to average loans outstanding during the period
=====================================================================================================
Allowance for loan losses to total non-performing
loans at end of period 133.28% 170.87%
=====================================================================================================
Allowance for loan losses to total loans 1.69% 1.26%
=====================================================================================================
11
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,
------------------------------------
2008 2007
------------------------------------
Percent of Percent of
Loans in Loans in
Each Each
Category Category
to Total to Total
Amount Loans Amount Loans
- ----------------------------------------------------------------------------------------
(Dollars in Thousands)
Mortgage loans:
Single-family $ 143 23.14% $ 21 20.81%
Multi-family 25 3.25 30 2.18
Construction 738 2.44 177 5.45
Commercial real estate 307 24.83 350 19.17
Land 834 3.08 562 4.44
- ----------------------------------------------------------------------------------------
Total mortgage loans 2,047 56.74 1,140 52.05
- ----------------------------------------------------------------------------------------
Commercial and Consumer:
Commercial 386 8.93 959 19.09
Consumer:
Home equity 130 34.18 131 28.64
Automobile 4 0.15 6 0.22
- ----------------------------------------------------------------------------------------
Total commercial and
consumer loans 520 43.26 1,096 47.95
- ----------------------------------------------------------------------------------------
Unallocated - N/A 69 N/A
- ----------------------------------------------------------------------------------------
Total $2,567 100.00% $2,305 100.00%
========================================================================================
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.
12
As of September 30, 2008, we held $40.7 million in securities
classified as available for sale ("AFS") and $2.2 million in securities
classified as held to maturity. Our total holding of securities declined $10.7
million due to normal principal payments on mortgage-backed securities,
collateralized mortgage obligations ("CMO's"), Small Business Administration
("SBA") securities and scheduled maturities of other securities. The current
portfolio is seasoned with no purchases made during fiscal year 2008. At
September 30, 2008, our net unrealized loss on securities classified as AFS
totaled $3.6 million compared to a net unrealized loss of $1.7 million at
September 30, 2007. The decline in value resulted primarily from declines in the
values of pooled trust preferred securities and certain adjustable rate
corporate debt securities, which have an amortized cost of $7.3 million and a
related unrealized loss of $2.0 million as of September 30, 2008.
Our investment portfolio consists primarily (78 per cent) of securities
backed or guaranteed by the United States Government through the SBA, Federal
National Mortgage Association ("FNMA"), Federal Home Loan Mortgage Corporation
("FHLMC") and Government National Mortgage Association. For all non-government
or non-agency securities, we complete reviews at least quarterly. In all periods
presented the Company did not hold any FNMA or FHLMC preferred stock or auction
rate securities.
The estimated market value is based upon quoted prices for identical
instruments traded in active markets and upon quoted prices for similar
instruments or assets in active markets, quoted prices for identical or similar
instruments or assets in markets that are not active, and model-based valuation
techniques for which all significant assumptions are observable in the market.
Changes in current market conditions, such as interest rates and the
economic uncertainties in the mortgage, housing, and banking industries, have
severely impacted the securities market. The secondary market for various types
of securities has been limited and has negatively impacted securities values.
Quarterly, we review each security in our investment portfolio to determine the
nature of any change in value and whether any impairment should be classified as
other-than-temporary-impairment.
The initial indication of other-than-temporary impairment for debt
securities is a decline in the market value below the amount recorded for the
investment, and the severity and duration of the decline. In determining whether
an impairment is other-than temporary, we consider the length of time and the
extent to which the market value has been below cost, recent events specific to
the issuer, including investment downgrades by rating agencies and economic
conditions of its industry, and our ability and intent to hold the investment
for a period of time sufficient to allow for anticipated recovery.
For marketable corporate debt securities, we also consider the issuer's
financial condition, capital strength, and near term prospects, as well as the
current ability of the issuer to make future payments in a timely manner, and
any change in the rating agencies' rating at the evaluation date from that made
on the acquisition date and any likely imminent action. Once a decline in value
is determined to be other than temporary, the value of the security is reduced
and a corresponding charge to earnings is recognized. To assist in analyzing for
other-than-temporary impairment, we use an independent pricing service that
reviews our investment in non-government or agency asset-backed or corporate
debt securities.
With respect to the company's $5.3 million investment in corporate debt
securities, although the market value has been less than cost for more than 12
months and there has been a decline in price, that decline has occurred
primarily over the past year due to changes in the market which has limited the
demand for these securities and reduced their liquidity. The corporate debt
securities we hold have not experienced a credit default event as of September
30, 2008, are currently rated investment grade and continue to make the required
interest payments on a timely basis.
The company's $1.7 million investment in pooled trust preferred
securities is primarily in issues of other banks, bank holding companies and
insurance companies which we currently hold in our portfolio in the form of
asset-backed securities. The decline in value of those securities has occurred
primarily over the past year due to changes in the market which has limited the
demand for those securities and reduced their liquidity. While some of those
issuers have reported weaker financial performance since our acquisition of
those securities, in management's opinion they continue to possess more than
acceptable credit risk. The securities are currently rated investment grade and
continue to make required interest payments on a timely basis. Our review of the
tranche in which the company is invested indicate that we have sufficient
collateral support before causing a loss of principal or a break in yield. We
monitor the actual default rates and interest deferrals for expected losses and
contractual shortfalls of interest or principal, which could warrant further
recognition of impairment, and determined that the company's investment in
pooled trust preferred securities were temporarily impaired as of September 30,
2008.
13
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,
-----------------------------------------------------
2008 2007
-------------------------- --------------------------
Estimated Estimated
Amortized Market Amortized Market
Cost Value Cost Value
- ------------------------------------------------------------------------------------------------
(In Thousands)
Available-for-sale:
Corporate debt securities $ 7,318 $ 5,328 $ 7,300 $ 6,748
CMOs 6,763 5,931 7,191 7,087
U.S. Government SBA's 15,474 15,111 19,395 18,754
FHLMC MBS's 2,270 2,216 2,961 2,920
FNMA MBS's 5,673 5,425 8,357 8,141
GNMA MBS's 3,187 3,117 5,382 5,260
- ------------------------------------------------------------------------------------------------
Total available-for-sale 40,685 37,128 50,586 48,910
- ------------------------------------------------------------------------------------------------
Held-to-maturity:
U.S. Government SBA's 2,096 1,990 2,846 2,742
FHLMC MBS's 74 72 104 102
FNMA MBS's 59 58 103 101
- ------------------------------------------------------------------------------------------------
Total held-to-maturity 2,229 2,120 3,053 2,945
- ------------------------------------------------------------------------------------------------
Total investment securities $42,914 $39,248 $53,639 $51,855
================================================================================================
Investment securities with:
Fixed rates $ - $ - $ - $ -
Adjustable rates 31,651 28,360 36,732 35,331
Mortgage-backed securities with:
Fixed rates 125 119 174 168
Adjustable rates 11,138 10,769 16,733 16,356
- ------------------------------------------------------------------------------------------------
Total $42,914 $39,248 $53,639 $51,855
================================================================================================
As of September 30, 2008, the bank held investments in available for
sale with unrealized holding losses totaling $3.6 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 $ - $ - $ 5,328 $ 1,990 $ 5,328 $ 1,990
CMOs 968 30 4,963 802 5,931 832
U.S. Government securities
SBA - - 15,111 363 15,111 363
GNMA - - 3,117 70 3,117 70
U.S. Government agency securities:
FHLMC MBS's - - 2,216 54 2,216 54
FNMA MBS's - - 5,425 248 5,425 248
---------------------------------------------------------------------------------------------------------------
Total $ 968 $ 30 $ 36,160 $ 3,527 $ 37,128 $ 3,557
===============================================================================================================
14
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, 2008
----------------------------------------------------------------------------------------------------
More than One More than Five
One Year or Less Year to Five 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 $ - -% $ - -% $ - -% $ 5,931 4.24% $ 5,931 4.24%
Corporate debt - - - - 2,700 7.91 2,628 4.28 5,328 5.76
U.S. Government SBA's - - - - 1,214 3.78 13,897 4.30 15,111 4.26
------------------------------------------------------------------------------------------------------------------------
Total - - - - 3,914 6.75 22,456 4.28 26,370 4.65
------------------------------------------------------------------------------------------------------------------------
MBS's available for sale:
Adjustable-rate securities:
FHLMC - - - - - - 2,216 5.41 2,216 5.41
FNMA - - - - - - 5,327 5.10 5,327 5.10
GNMA - - - - - - 3,117 5.35 3,117 5.35
------------------------------------------------------------------------------------------------------------------------
Total - - - - - - 10,660 5.24 10,660 5.24
------------------------------------------------------------------------------------------------------------------------
MBS'S fixed-rate:
FNMA - - 98 5.82 - - - - 98 5.82
------------------------------------------------------------------------------------------------------------------------
Total - - 98 5.82 - - - - 98 5.82
------------------------------------------------------------------------------------------------------------------------
Total mortgage-backed
securities
available-for-sale - - 98 5.82 - - 10,660 5.24 10,758 5.24
------------------------------------------------------------------------------------------------------------------------
Total investment portfolio $ - -% $98 5.82% $3,914 6.75% $33,116 4.58% $37,128 4.81%
========================================================================================================================
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, 2008
----------------------------------------------------------------------------------------------------
More than One More than Five
One Year or Less Year to Five 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 $ - -% $- -% $445 3.51% $1,651 0.22% $2,096 0.92%
Fixed-rate:
Corporate debt - - - - - - - - - -
- --------------------------------------------------------------------------------------------------------------------------
Total investment securities - - - - 445 3.51 1,651 0.22 2,096 0.92
held-to-maturity
- --------------------------------------------------------------------------------------------------------------------------
MBS's held-to-maturity:
Adjustable-rate securities:
FHLMC - - - - - - 74 5.49 74 5.49
FNMA - - - - - - 37 5.12 37 5.12
- --------------------------------------------------------------------------------------------------------------------------
Total - - - - - - 111 5.36 111 5.36
- --------------------------------------------------------------------------------------------------------------------------
Fixed-rate:
FNMA - - - - - - 22 6.50 22 6.50
- --------------------------------------------------------------------------------------------------------------------------
Total - - - - - - 22 6.50 22 6.50
- --------------------------------------------------------------------------------------------------------------------------
Total mortgage-backed
securities held-to-maturity - - - - - - 133 5.55 133 5.55
- --------------------------------------------------------------------------------------------------------------------------
Total held-to-maturity
investments $ - -% $0 -% $445 3.51% $1,784 0.65% $2,229 1.22%
==========================================================================================================================
15
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,
among other factors, the minimum balance required, the time periods that the
funds must remain on deposit and the interest rate. 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, 2008, $85.3 million, or 86.79% 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,
------------------------------------------------------------------------------
2008 2007
-------------------------------------- ---------------------------------------
Percent of Percent of
Total Rate Total Rate
Balance Deposits Paid Balance Deposits Paid
- --------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Savings accounts $ 1,988 1.20% 0.97% $ 2,468 1.25% 0.97%
Now and money market accounts 55,898 33.82 2.54 60,625 30.62 3.61
Certificates of deposit 98,305 59.48 3.69 125,717 63.49 5.00
Noninterest-bearing deposits:
Demand deposits 9,088 5.50 - 9,181 4.64 -
- --------------------------------------------------------------------------------------------------------------------
Total deposits $165,279 100.00% 3.05% $197,991 100.00% 4.29%
====================================================================================================================
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, 2008
-----------------------------
Amount Rate
------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Balance maturing:
Three months or less $ 52,006 3.68%
Three months to one year 33,310 3.55
One year to three years 9,898 3.95
Over three years 3,091 4.55
------------------------------------------------------------------------------------------------
Total $ 98,305 3.69%
================================================================================================
16
At September 30, 2008, the bank had $32.2 million in certificate
accounts in amounts of $100,000 or more maturing as follows:
Weighed
Average
Maturity Period Amount Rate
- ------------------------------------------------------------------------------------------------
Three months or less $19,632 3.59%
Over 3 through 6 months 5,139 3.57
Over 6 through 12 months 4,134 3.65
Over 12 months 3,293 4.09
- ------------------------------------------------------------------------------------------------
Total $32,198 3.65%
================================================================================================
The following table sets forth the deposit activity of the bank for the
periods indicated.
At or For the Year Ended
September 30,
- ------------------------------------------------------------------------------------------------
2008 2007
- ------------------------------------------------------------------------------------------------
(In Thousands)
Balance at beginning of period $197,991 $230,174
Net deposits (withdrawals) before interest credited (39,556) (41,514)
Interest credited 6,844 9,331
- ------------------------------------------------------------------------------------------------
Net increase (decrease) in deposits (32,712) (32,183)
- ------------------------------------------------------------------------------------------------
Ending balance $165,279 $197,991
================================================================================================
BORROWINGS. At September 30, 2008, borrowings consisted of FHLB
advances and reverse repurchase agreements totaling $28.9 million. FHLB advances
amounted to $27.0 million at September 30, 2008, an increase from the $25.0
million outstanding at September 30, 2007, and other borrowings (reverse
repurchase agreements) amounted to $1.9 million, a decrease of $283,000 compared
to $2.2 million at September 30, 2007. During the fiscal year ended September
30, 2008, 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,
- -----------------------------------------------------------------------------------------------------
2008 2007
- -----------------------------------------------------------------------------------------------------
FHLB Advances:
Average balance outstanding $ 25,365 $ 33,064
Maximum amount outstanding at any month-end during the period 27,000 39,000
Balance outstanding at end of period 27,000 25,000
Weighted average interest rate during the period 6.00% 5.46%
Weighted average interest rate at end of period 5.72% 5.92%
Reverse repurchase agreements:
Average balance outstanding 11,607 15,264
Maximum amount outstanding at any month-end during the period 2,573 10,857
Balance outstanding at end of period 1,909 2,192
Weighted average interest rate during the period 5.87% 5.61%
Weighted average interest rate at end of period 1.82% 2.52%
17
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 19 to the financial statements.
PERSONNEL
As of September 30, 2008, we had 47 full-time employees and 5 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.
18
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 Deposit 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 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.
19
Savings and loan holding companies are not generally 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, which must notify the
Office of Thrift Supervision (30) days before declaring any dividend to the
parent holding 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.
Under the Cease and Desist Order issued by the Office of Thrift
Supervision effective April 25, 2008, the bank is prohibited from paying
dividends or making any other capital distributions to the company without the
prior written approval of the Regional Director of the Office of Thrift
Supervision and any written request for such approval must be submitted to the
Regional Director at least forty-five days prior to the anticipated date of
payment or distribution.
PROPOSED ACQUISITION OF THE COMPANY. Pursuant to the merger agreement
entered into between Summit and the company on April 12, 2007, 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, and the application was 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. On April 4, 2008, the
company received written notice from Summit that Summit had exercised its right
to terminate the merger agreement entered into on April 12, 2007. On April 9,
2008, the company announced that it had entered into negotiations with Summit
towards entering into a new definitive merger agreement. That new definitive
merger agreement was entered into on June 9, 2008. Processing of the Summit
application to acquire the company and the bank continued at the Federal Reserve
under the new definitive merger agreement until that agreement was terminated by
mutual consent of the parties on December 15, 2008. (For a further discussion,
please see BUSINESS -Proposed Acquisition.)
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.
20
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. The following table presents the bank's
capital position at September 30, 2008.
Capital
Excess ----------------------------
Actual Required (Deficiency) Actual Required
Capital Capital Amount Percent Percent
---------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Tangible $10,859 $3,093 $7,766 5.27% 1.50%
Core (Leverage) 10,859 8,247 2,612 5.27 4.00
Risk-based 11,733 11,185 548 8.39 8.00
Under the Cease and Desist Order issued by the Office of Thrift
Supervision effective April 25, 2008, the bank was required to have a Tier 1
(Core) Capital Ratio of at least 6% and a total Risk-based capital ratio of at
least 12% at June 30, 2008 and at all times thereafter. The Cease and Desist
Order was modified to extend that capital level deadline first to September 30,
2008, and subsequently to December 31, 2008. As shown in the foregoing chart,
the bank did not meet the capital requirements of the Cease and Desist Order at
September 30, 2008.
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.
Under the Federal Deposit Insurance Corporation's risk-based assessment system,
insured institutions are assigned to one of four risk categories based on
supervisory evaluations, regulatory capital levels and certain other factors,
with less risky institutions paying lower assessments. An institution's
assessment rate depends upon the category to which it is assigned. For 2008,
assessments ranged from five to forty-three basis points of assessable deposits.
Due to losses incurred by the Deposit Insurance Fund in 2008 from failed
institutions, and anticipated future losses, the Federal Deposit Insurance
Corporation has adopted an across the board seven basis point increase in the
assessment range for the first quarter of 2009. The Federal Deposit Insurance
Corporation has proposed further refinements to its risk-based assessment that
would be effective April 1, 2009 and would effectively make the range eight to
771/2 basis points. The Federal Deposit Insurance Corporation may adjust the
scale uniformly from one quarter to the next, except that no adjustment can
exceed three basis points from the base scale without notice and comment
rulemaking. No institution may pay a dividend if in default of the federal
deposit insurance assessment.
21
Due to the recent difficult economic conditions, deposit insurance per
account owner has been raised to $250,000 for all types of accounts until
January 1, 2010. In addition, the FDIC adopted an optional Temporary Liquidity
Guarantee Program by which, for a fee, noninterest bearing transaction accounts
would receive unlimited insurance coverage until December 31, 2009 and, for a
fee, certain senior unsecured debt issued by institutions and their holding
companies between October 13, 2008 and June 30, 2009 would be guaranteed by the
FDIC through June 30, 2012. The bank made the business decision to participate
in the unlimited noninterest bearing transaction account coverage and the bank
and the company elected to participate in the unsecured debt guarantee program,
but do not expect to issue any guaranteed debt under the program.
Federal law also provides 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.
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 2008, Financing Corporation payments
for savings associations approximated 1.12 basis points of assessable deposits.
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, 2008, the bank's limit on loans
to one borrower was $1.9 million, and the bank's largest aggregate outstanding
loan to one borrower was $3.9 million, which, when made was within the bank's
loan to one borrower limitation. The portion of any loan that would exceed the
bank's loan to one borrower limitation is sold prior to the bank's investment in
that loan.
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, 2008, Greater Atlantic maintained 76% 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.
22
As noted above, the bank is prohibited under the Cease and Desist
Order from paying dividends or making any other capital distributions to the
company without the prior written approval of the Regional Director of the
Office of Thrift Supervision. On December 13, 2006, prior to the issuance of the
Cease and Desist Order, 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 for the quarterly distributions on the cumulative
convertible trust preferred securities totaled $1.3 million at September 30,
2008.
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, 2008, totaled $141,304.
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. The aggregate balance
of loans to executive officers is $131,000 as of September 30, 2008.
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 proceedings. 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, and authority
to take such action itself under certain circumstances. Federal law also
establishes criminal penalties for certain violations. As previously noted, the
bank is subject to a Cease and Desist Order issued by the Office of Thrift
Supervision effective April 25, 2008.
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.
23
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 Banks
provide a central credit facility primarily for member institutions. As a member
of the Federal Home Loan Bank of Atlanta, the bank is required to acquire and
hold shares of capital stock in that Federal Home Loan Bank in the amount of
$1.6 million. The bank was in compliance with that requirement with an
investment in Federal Home Loan Bank stock at September 30, 2008 of $1.6
million.
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 the interest rate on
future Federal Home Loan Bank advances increased, the bank'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."
24
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 2008 fiscal year, except for the AMT recorded for the 2007 fiscal
year and the reduction in its net deferred asset by $1.7 million for the current
fiscal year, 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.
NET OPERATING LOSS CARRYBACK AND CARRYFOWARD RULES. The Net Operating
Losses ("NOL's") allow a company to apply losses to reduce tax liability. The
company may offset the current year's NOL's, or carryback against profits in the
two immediately preceding years, with the earliest year first. After the
carryback, it may carryforward NOL's up to 20 years. By then it will presumably
have regained financial health.
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.
25
ITEM 1A. RISK FACTORS
IF WE DO NOT RAISE ADDITIONAL CAPITAL, WE WILL NOT BE IN COMPLIANCE WITH THE
CAPITAL REQUIREMENTS OF THE BANK'S CEASE AND DESIST ORDER, WHICH COULD HAVE A
MATERIAL ADVERSE EFFECT UPON US.
The Cease and Desist Order, as amended, requires the bank to have and
maintain a minimum Tier I Core Capital ratio of 6% and a minimum Total
Risk-Based Capital ratio of 12% at December 31, 2008, to date, in the current
economic environment, the bank has not been able to raise sufficient additional
capital to ensure compliance with the capital requirements of the Cease and
Desist Order. Without a waiver by the Office of Thrift Supervision or amendment
or modification of the Cease and Desist Order, the bank could be subject to
further regulatory enforcement action, including, without limitation, the
issuance of additional cease and desist orders (which may, among other things,
further restrict the bank's business activities, or place the bank in
conservatorship or receivership). If the bank is placed in conservatorship or
receivership, it is highly likely that such action would lead to a complete loss
of all value of the company's ownership interest in the bank. In addition,
further restrictions could be placed on the bank if it were determined that the
bank was undercapitalized, significantly undercapitalized, or critically
undercapitalized, with increasingly greater restrictions being imposed as any
level of undercapitalization increased.
Notwithstanding the forgoing, the company continues actively to market
itself, seeking either to be acquired or to obtain a capital infusion in order
to meet the conditions of the Cease and Desist Order. We cannot assure you that
our efforts will be successful and, as a result of the circumstances described
above and in the other Risk Factors herein, there is substantial doubt
concerning the ability of the company and the bank to continue as going concerns
for a reasonable period of time.
DIFFICULT MARKET CONDITIONS HAVE ADVERSELY AFFECTED OUR INDUSTRY.
The bank is particularly exposed to downturns in the U.S. housing
market. Dramatic declines in the housing market over the past year, with falling
home prices and increasing foreclosures, rising unemployment and
under-employment, have negatively impacted the credit performance of mortgage
loans and resulted in significant write-downs of asset values by financial
institutions. With concern about the stability of the financial markets
generally, many lenders and institutional investors have reduced or ceased
providing funding to borrowers, including to other financial institutions. This
market turmoil and tightening of credit have led to an increased level of
commercial and consumer delinquencies, lack of consumer confidence, increased
market volatility and widespread reduction of business activity. We do not
expect that the difficult conditions in the financial markets are likely to
improve in the near future. A worsening of these conditions would likely worsen
the adverse effects of these difficult market conditions on us and others in the
financial institutions industry.
CURRENT LEVELS OF MARKET VOLATILITY ARE UNPRECEDENTED.
The capital and credit markets have been experiencing volatility and
disruption for more than a year. The volatility and disruption has reached
unprecedented levels. In some cases, the markets have produced downward pressure
on stock prices and credit availability for certain issuers without regard to
those issuers' underlying financial strength. If current levels of market
disruption and volatility continue or deteriorate, there can be no assurance
that we will not experience an adverse effect, which may be material, on our
ability to access capital and on our business, financial condition and results
of operations.
OUR INCREASED EMPHASIS ON COMMERCIAL AND CONSTRUCTION LENDING MAY EXPOSE US TO
INCREASED LENDING RISKS.
At September 30, 2008, our loan portfolio consisted of $37.7 million,
or 24.83% of commercial real estate loans, $8.4 million, or 5.52% of
construction and land development loans and $13.6 million, or 8.93% 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. Under the Cease and Desist Order, the
bank can only make commercial real estate loans, commercial loans, construction
loans and land development loans with the prior approval of the Regional
Director of the Office of Thrift Supervision.
26
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.
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.
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.
27
THERE CAN BE NO ASSURANCE THAT RECENTLY ENACTED LEGISLATION AND OTHER MEASURES
UNDERTAKEN BY THE TREASURY, THE FEDERAL RESERVE AND OTHER GOVERNMENTAL AGENCIES
WILL HELP STABILIZE THE U.S. FINANCIAL SYSTEM, IMPROVE THE HOUSING MARKET OR BE
OF SPECIFIC BENEFIT TO THE BANK.
On October 3, 2008, President Bush signed into law the Emergency
Economic Stabilization Act of 2008 or ("EESA"), which, among other measures,
authorized the Treasury Secretary to establish the Troubled Asset Relief Program
("TARP"). EESA gives broad authority to Treasury to purchase, manage, modify,
sell and insure the troubled mortgage related assets that triggered the current
economic crisis as well as other "troubled assets."
Pursuant to the TARP, the U.S. Treasury has the authority to, among
other things, purchase up to $700 billion (of which $250 billion is currently
available) of mortgages, mortgage-backed securities and certain other financial
instruments from financial institutions for the purpose of stabilizing and
providing liquidity to the U.S. financial markets. Shortly following the
enactment of EESA, the Treasury announced the creation of specific TARP programs
to purchase mortgage-backed securities and whole mortgage loans. In addition,
under TARP, the Treasury created a capital purchase program, pursuant to which
it provides access to capital that will serve as Tier I capital to financial
institutions through a standardized program to acquire preferred stock
(accompanied by warrants) from eligible financial institutions. At the time the
capital purchase program was announced, the company was not deemed eligible to
participate.
There can be no assurance as to the actual impact that EESA and such
related measures undertaken to alleviate the credit crisis will have generally
on the financial markets, including the extreme levels of volatility and limited
credit availability currently being experienced. The failure of such measures to
help stabilize the financial markets and a continuation or worsening of current
financial market conditions could materially and adversely affect our business,
financial condition, results of operations, access to credit or the trading
price of our common stock. Finally, there can be no assurance regarding the
specific impact that such measures may have on the bank, or whether or to what
extent the bank will be able to benefit from such programs.
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.
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. 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 and all subsequent quarterly distributions on the
cumulative convertible trust preferred securities for an indefinite period
(which can be no longer than 20 consecutive quarterly periods).
28
ITEM 1B. UNRESOLVED STAFF COMMENTS
The company has no unresolved staff comments for the period ended
September 30, 2008.
ITEM 2. PROPERTIES
During fiscal year 2008, 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,
2008.
Net Book Value
of Property or
Leasehold
Original Improvements
Year Date of at
Leased or Leased or Lease September 30,
Location Owned Acquired Expiration 2008
------------------------------------------------------------------------------------------------------------------
(In Thousands)
ADMINISTRATIVE OFFICES:
10700 Parkridge Boulevard
Reston, Virginia 20191 Leased 1998 01-31-11 $ 45
BRANCH OFFICES:
11834 Rockville Pike
Rockville, Maryland 20852 Leased 1998 06-30-09 -
10700 Parkridge Boulevard
Reston, Virginia 20191 Leased 2004 01-31-11 212
43086 Peacock Market Plaza
South Riding, Virginia 20152 Leased 2000 06-30-15 179
1 South Royal Avenue
Front Royal, Virginia 22630 Owned 1977 662
9484 Congress Street
New Market, Virginia 22844 Owned 1989 385
LOAN OFFICES:
2200 Defense Highway
Crofton, Maryland 21114 Leased 2002 11-30-08 -
12530 Parklawn Drive, Suite 170
Rockville, Maryland 20852 Leased 2005 06-30-10 24
------------------------------------------------------------------------------------------------------------------
Total $1,507
==================================================================================================================
The total net book value of the company's furniture, fixtures and
equipment at September 30, 2008 was $411,000. 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
One matter was submitted for a vote of the stockholders during the
fourth quarter of the fiscal year ended September 30, 2008, through the
solicitation of proxies. That was a special meeting of shareholders held on
September 4, 2008 to consider the proposed merger of the company with Summit. At
that meeting the shareholders cast 2,224,584 votes (73.56%) in favor of the
merger and 107,511 votes (3.55%) against the merger. Abstentions amounted to 800
(0.03%).
29
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, 2008, there were approximately
240 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 2008
High 5.30 4.50 4.41 2.31
Low 3.00 2.75 0.01 1.50
Fiscal Year 2007
High 5.10 4.26 5.05 5.35
Low 4.26 2.25 2.25 4.69
--------------------------------------------------------------------------------------------------
These market quotations reflect inter-dealer prices, without retail
mark-up, mark-down, or commission and may not necessarily represent actual
transactions. The closing stock price at September 30, 2008 was $2.25 and as of
December 23, 2008 the stock traded at $0.06.
The company has not sold any unregistered securities and did not
repurchase any of its equity securities in the fiscal year ended September 30,
2008.
30
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, 2008 2007
- -------------------------------------------------------------------------------------------
(In Thousands, Except Per Share Data)
Consolidated Statements of Operations Data:
Interest income $ 12,899 $ 18,421
Interest expense 9,046 11,993
- -------------------------------------------------------------------------------------------
Net interest income 3,853 6,428
Provision for loan losses 3,397 685
- -------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 456 5,743
Noninterest income 546 615
Gain on branch sales - 4,255
Noninterest expense 10,203 9,626
- -------------------------------------------------------------------------------------------
Income (loss) before taxes (9,201) 987
Provision for income taxes 1,709 36
- -------------------------------------------------------------------------------------------
Net income (loss) $ (10,910) $ 951
===========================================================================================
Per Share Data:
Net income (loss):
Basic $ (3.61) $ 0.31
Diluted $ (3.61) $ 0.31
Book value (1.19) 3.17
Tangible book value (0.01) 3.29
Weighted average shares outstanding:
Basic 3,024,220 3,023,407
Diluted 4,392,363 4,395,008
Shares outstanding 3,024,220 3,024,220
Consolidated Statements of Financial Condition Data:
Total assets $ 202,407 $ 245,994
Total loans receivable, net 149,615 176,108
Allowance for loan losses 2,567 2,305
Mortgage-loans held for sale - -
Investment securities (1) 28,466 35,435
Mortgage-backed securities 10,891 16,528
Total deposits 165,279 197,991
FHLB advances 27,000 25,000
Other borrowings 1,909 2,192
Guaranteed convertible preferred securities of subsidiary trust 9,384 9,374
Total stockholders' equity (3,594) 9,571
Tangible capital (15) 9,939
31
SELECTED FINANCIAL DATA - (CONTINUED)
- ---------------------------------------------------------------------------------------------
At or For the Years Ended September 30, 2008 2007
- ---------------------------------------------------------------------------------------------
(In Thousands, Except Per Share Data)
Average Consolidated Statements of Financial Condition Data
Total assets $ 228,930 $ 284,136
Investment securities(1) 42,186 64,011
Mortgage-backed securities(1) 13,602 23,848
Total loans 162,055 184,570
Allowance for loan losses 2,437 1,559
Total deposits 175,706 214,118
Total stockholders' equity 5,538 7,871
Performance Ratios (2)
Return on average assets (4.77)% 0.33%
Return on average equity (197.00) 12.08
Equity to assets (1.78) 3.89
Net interest margin 1.77 2.36
Efficiency ratio(3) 231.94 85.20
Asset Quality Data:
Non-performing assets to total assets, at period end 1.47 0.55
Non-performing loans to total loans, at period end 1.27 0.74
Net charge-offs (recoveries) to average total loans 1.93 (0.16)
Allowance for loan losses to:
Total loans 1.69% 1.26%
Non-performing loans 133.28 170.87
Non-performing loans $ 1,926 $ 1,349
Non-performing assets 2,969 1,349
Allowance for loan losses 2,567 2,305
Capital Ratios of the Bank:
Leverage ratio 5.27% 7.67%
Tier 1 risk-based capital ratio 7.71 11.00
Total risk-based capital ratio 8.39 12.25
(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
32
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 AND MUTUAL TERMINATION OF MERGER AGREEMENT
As previously reported in a Form 8-K filed on April 16, 2007, we
announced that the company and Summit 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 then pending merger of the company with and into Summit and
closed on August 24, 2007.
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 might be terminated if the merger was not
consummated by that date. In a Form 8-K filed on March 26, 2008 we announced
that our shareholders had approved the terms and conditions of the proposed
merger of the company with and into Summit, and on April 9, 2008, the company
announced that it had received written notice from Summit that Summit had
exercised its right to terminate the agreement for the company to merge with and
into Summit.
On June 9, 2008 the company entered into a new definitive agreement for
GAFC to merge with and into Summit. That new agreement to merge with Summit was
approved by the shareholders of the company on September 4, 2008. Processing of
the Summit application to acquire the company and the bank continued under the
new definitive merger agreement until that new definitive agreement was
terminated by mutual consent of the parties on December 15, 2008.
CEASE AND DESIST ORDER
As previously reported in a Form 8-K filed on April 29, 2008, the bank
consented to the issuance of the Cease and Desist Order issued by the OTS
effective April 25, 2008. The Cease and Desist Order requires the bank to, among
other things, report, within prescribed time periods to the OTS Regional
Director on the status of the ongoing negotiations with Summit; have, at June
30, 2008 (which was extended to December 31, 2008) and maintain a Tier One
(Core) Capital Ratio of at least 6% and a total risk based capital ratio of at
least 12%; develop a comprehensive long term operating strategy to be
implemented if the proposed merger with Summit is not consummated; incorporate
the long term operating strategy into a three-year business plan containing at a
minimum the requirements set forth in the Cease and Desist Order; cease,
effective immediately, making commercial real estate loans, commercial loans and
loans on raw land without the prior written approval of the Regional Director,
except for such loans as to which the bank has a legally binding written
commitment to lend as of the effective date of the Cease and Desist Order;
cease, effective immediately, accepting brokered deposits; and prohibits the
payment of dividends or other capital distributions.
33
In addition, the Cease and Desist Order requires the bank's board of
directors to take action with respect to credit administration, classified
assets and accounting system controls and to establish a regulatory compliance
committee of three or more non-employee directors to monitor and coordinate
compliance with the provisions of the Cease and Desist Order and provide the
board of directors with progress reports on compliance, which reports are to be
transmitted by the board of directors of the bank to the Regional Director. At
September 30 and December 31, 2008, the bank was in compliance with all the
requirements of the Cease and Desist Order except for the 6% and 12% capital
requirements; however, the limitations in the Cease and Desist Order restricting
the bank's lending in the commercial, commercial real estate and construction
areas adversely affects the ability of the bank to return to profitability.
A description and copies of the Cease and Desist Order and the
Stipulation and Consent to Issuance of the Order were attached as exhibits to a
report on Form 8-K filed on April 29, 2008, with the Securities and Exchange
Commission.
GOING CONCERN
Notwithstanding the circumstances described above, the company
continues actively to market itself, seeking either to be acquired or to obtain
a capital infusion in order to meet the conditions of the Cease and Desist
Order. We cannot assure you that our efforts will be successful and, as a result
of the circumstances described here and in the Risk Factors section, there is
substantial doubt concerning the ability of the company and the bank to continue
as going concerns for a reasonable period of time. Without a waiver by the OTS
or amendment or modification of the Cease and Desist Order, the bank could be
subject to further regulatory enforcement action, including, without limitation,
the issuance of additional cease and desist orders (which may, among other
things, further restrict the bank's business activities), or the placing of the
bank in conservatorship or receivership, any of which would mitigate against the
bank and the company continuing as going concerns.
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.
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,
2008, the company has provided a 100% valuation allowance on deferred tax
assets.
34
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, 2007. In October 2008,
the FASB amended SFAS 157 by issuing ESP FAS 157-3, Determining the Fair Value
of a Financial Asset When the Market for That Asset is Not Active. FSP FAS 157-3
clarifies the application of SFAS 157 in a market that is not active and
provides an example to illustrate key considerations in determining the fair
value of a financial asset when the market for that financial assets is not
active. 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.
In March 2008, the FASB issued SFAS No. 161, Disclosures about
Derivative Instruments and Hedging Activities - an amendment of FASB statement
No. 133". SFAS 161 requires enhanced disclosures about how and why an entity
uses derivative instruments, how derivative instruments and related items are
accounted for under Statement 133 and how derivative instruments and related
hedged items affect an entity's financial position, financial performance and
cash flows. The new standard is effective for the Company on January 1, 2009.
The adoption of this standard is not expected to have any impact on the
Company's consolidated financial position or results of operations.
35
FINANCIAL CONDITION
2008 COMPARED TO 2007
At September 30, 2008 the company's total assets were $202.4 million,
compared to the $246.0 million held at September 30, 2007, representing a
decrease of 17.72%. The decrease resulted primarily from a decrease in
investment securities, loans receivable, interest-bearing deposits, deferred
income taxes and goodwill. 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's capital at the level required to effect the sale of the
bank. As previously noted, the Cease and Desist Order requires the bank to
achieve and maintain capital levels that exceed the "well capitalized"
requirement.
Net loans receivable at September 30, 2008 were $149.6 million, a
decrease of $26.5 million or 15.04% from the $176.1 million held at September
30, 2007. The decrease in loans consisted primarily of a $21.3 million in
commercial business loans and a $5.1 million decline in construction and land
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 and in the event the recession deepens. In
addition, the bank is under the Cease and Desist Order that requires the bank to
cease making commercial real estate loans, commercial loans and loans on raw
land without the prior written approval of the Regional Director. The company
also sustained a $2.9 million decline in the bank's single-family loan
portfolio, coupled with a decrease of $566,000 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 2008 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 $949,000 and commercial real estate
loans increased by $2.7 million during the period.
At September 30, 2008, investment securities were $39.4 million, a
decrease of $12.6 million or 24.26% from the $52.0 million held at September 30,
2007. The cash proceeds from the sale or payoff of investment securities were
used to reduce higher cost wholesale funding, including borrowings and wholesale
deposits, and to retain cash for liquidity purposes.
Deposits at September 30, 2008 were $165.3 million, a decrease of $32.7
million from the $198.0 million held at September 30, 2007. Total deposits
decreased due in part to our reduced reliance on wholesale deposits, which have
a higher cost than those originated through the branch network. The reduced
reliance on wholesale deposits contributed to a $7.3 million decrease in
deposits since September 30, 2007 while total retail deposits decreased $25.4
million. The decrease in retail deposits is primarily in certificates of
deposits and money fund accounts which are rate sensitive deposits and in the
past have been obtained through the bank's marketing efforts. However, due to
the cost of these funds, and the need for the bank to reduce its overall cost of
funds, we have lowered our rate for these funds resulting in a decline of $23.3
million. Because of the intense competition for these types of deposits we will
be revisiting increasing our rates for these types of deposits which in turn
will squeeze our net interest margin.
36
RESULTS OF OPERATIONS
2008 COMPARED TO 2007
NET INCOME. For the fiscal year ended September 30, 2008, the company
had a net loss of $10.9 million or $3.61 per diluted share, compared to a net
income of $951,000 or $0.31 per diluted share for fiscal year 2007. The $11.9
million increase in the net loss over the comparable period one-year ago was
primarily the result of an increase in the provision for loan losses and
decreases in net interest income and non-interest income and an increase in
non-interest expense. The ongoing net losses from operations remain a consistent
problem for management because the loan production needed to maintain the retail
branch network has not been attained, and the limitations in the Cease and
Desist Order restricting the bank's lending in the commercial, commercial real
estate and construction areas adversely affect the ability of the bank to
return to profitability. Further, the bank has been managing its assets and
liabilities to maintain the capitalized status required to effect the sale of
the bank, and the OTS has recognized that approach by modifying the Cease and
Desist Order to extend compliance with the 6% and 12% capital requirements to
December 31, 2008. Processing of the Summit application to acquire the company
and the bank continued under the new definitive merger agreement until that
agreement was terminated by mutual consent of the parties on December 15, 2008.
Because of the bank's loans to one borrower limit, and the issuance of the Cease
and Desist Order by the Office of Thrift Supervision, the bank is unable to
expand its commercial loan portfolio and maintain a consistent level of
outstanding loans to larger customers. Those factors have caused and will
continue to cause earning assets to decline, adversely impacting earnings.
Further, margin pressure from the yield curve also presents a challenging
environment which limits the bank's ability to increase our net interest margin.
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 in
combination with the yields earned on the interest-earning assets and the rates
paid on the interest-bearing liabilities. 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
------------------------------- -------------------------------
2008 2007 Amount %
- ------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Interest income:
Loans $ 10,388 $ 14,173 $ (3,785) (26.71)%
Investments 2,511 4,248 (1,737) (40.89)
- ------------------------------------------------------------------------------------------------------------
Total 12,899 18,421 (5,522) (29.98)
- ------------------------------------------------------------------------------------------------------------
Interest expense:
Deposits 6,844 9,331 (2,487) (26.65)
Borrowings 2,202 2,662 (460) (17.28)
- ------------------------------------------------------------------------------------------------------------
Total 9,046 11,993 (2,947) (24.57)
- ------------------------------------------------------------------------------------------------------------
Net interest income $ 3,853 $ 6,428 $ (2,575) (40.06)%
============================================================================================================
37
The decrease in net interest income for fiscal year 2008, from the
comparable period one year ago, resulted primarily from a $54.6 million decrease
in the bank's interest-earning assets coupled with average interest-earning
assets declining by $4.8 million more than the decline in average
interest-bearing liabilities. That decrease was coupled with a 59 basis point
decrease in net interest margin (net interest income divided by average
interest-earning assets) from 2.36% for fiscal year 2007 to 1.77% for fiscal
year 2008. The decrease in net interest margin was also affected by the average
yield on interest-earning assets decreasing by 84 basis points while the average
cost of interest-bearing liabilities only decreased by 32 basis points.
The interest rate environment has been a difficult one for most
financial institutions. With the Federal Reserve lowering its benchmark discount
rate several times this year and with long-term rates close to or at all time
lows, the prospects of expanding interest rate spread and net interest margin
has been difficult. With the reduction in the rates on loans we would typically
lower the rates we pay for deposits, but intense competition for deposits has
made the bank reluctant to drop its rates, squeezing net interest margin. 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.
INTEREST INCOME. Interest income for the fiscal year ended September
30, 2008 decreased $5.5 million compared to fiscal year 2007, primarily as a
result of a $54.6 million decrease in the average balances of outstanding loans
and investment securities. The decreases in those balances were coupled with a
decrease of 84 basis points in the average yield earned on interest earning
assets.
INTEREST EXPENSE. The $2.9 million decrease in interest expense for
fiscal year 2008 compared to fiscal year 2007 was principally the result of a
$49.8million year to year decrease in the average amount of deposits and
borrowings, primarily due to a decrease of $38.4 million in average deposits.
The decrease in the average interest-bearing liabilities was coupled with a 32
basis point decrease in the cost of funds on average deposits and borrowings.
The decrease in interest expense on deposits was primarily due to the decrease
in wholesale and retail certificates of deposit. That decline was coupled with a
46 basis point decrease in rates paid on deposits, primarily due to lower
pricing on new and renewed time deposits.
The decrease in interest expense on borrowings for fiscal 2008, when
compared to the 2007 period, was principally the result of a $11.4 million
decrease in average borrowings and was partially offset by a 45 basis point
increase in the cost of borrowed funds. Components accountable for the decrease
of $460,000 in interest expense on borrowings were a $626,000 decrease relating
to average volume, offset in part by a $166,000 increase relating to average
cost.
38
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,
----------------------------------------------------------------
2008 2007
----------------------------------------------------------------
Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
---------- --------- --------- ------------ --------- ---------
(Dollars in Thousands)
Interest-earning assets:
Real estate loans $ 85,031 $ 5,702 6.71% $ 91,132 $ 6,693 7.34%
Consumer loans 51,146 2,885 5.64 55,420 4,353 7.85
Commercial business loans 25,878 1,801 6.96 38,018 3,127 8.23
--------- -------- ------ --------- -------- -------
Total loans 162,055 10,388 6.41 184,570 14,173 7.68
Investment securities 42,186 1,815 4.30 64,011 3,184 4.97
Mortgage-backed securities 13,602 696 5.12 23,848 1,064 4.46
--------- -------- ------ --------- -------- -------
Total interest-earning assets 217,843 12,899 5.92 272,429 18,421 6.76
-------- ------ -------- -------
Non-earning assets 11,087 11,707
--------- ---------
Total assets $228,930 $284,136
========= =========
Liabilities and Stockholders' Equity:
Interest-bearing liabilities:
Savings accounts $ 1,940 18 0.93 $ 2,969 27 0.91
Now and money market accounts 56,268 1,586 2.82 77,997 2,791 3.58
Certificates of deposit 117,498 5,240 4.46 133,152 6,513 4.89
--------- -------- ------ --------- -------- -------
Total deposits 175,706 6,844 3.90 214,118 9,331 4.36
FHLB advances 25,365 1,521 6.00 33,064 1,806 5.46
Other borrowings 11,607 681 5.87 15,264 856 5.61
--------- -------- ------ --------- -------- -------
Total interest-bearing liabilities 212,678 9,046 4.25 262,446 11,993 4.57
-------- ------ -------- -------
Noninterest-bearing
liabilities:
Noninterest-bearing
demand deposits 8,728 11,595
Other liabilities 1,986 2,224
--------- ---------
Total liabilities 223,392 276,265
Stockholders' equity 5,538 7,871
--------- ---------
Total liabilities and
stockholders' equity $228,930 $284,136
========= =========
Net interest income $3,853 $6,428
======= =======
Interest rate spread 1.67% 2.19%
======= ======
Net interest margin 1.77% 2.36%
======= ======
39
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, 2008
Compared to Year
Ended September 30, 2007
Change Attributable to
-------------------------------------------
Volume Rate Total
- ----------------------------------------------------------------------------------------
(In Thousands)
Real estate loans $ (448) $ (543) $ (991)
Consumer loans (336) (1,132) (1,468)
Commercial business loans (999) (327) (1,326)
- ----------------------------------------------------------------------------------------
Total loans (1,783) (2,002) (3,785)
Investments (1,086) (283) (1,369)
Mortgage-backed securities (457) 89 (368)
- ----------------------------------------------------------------------------------------
Total interest-earning assets $ (3,326) $(2,196) $ (5,522)
========================================================================================
Savings accounts $ (9) $ - $ (9)
Now and money market accounts (778) (427) (1,205)
Certificates of deposit (766) (507) (1,273)
- ----------------------------------------------------------------------------------------
Total deposits (1,553) (934) (2,487)
FHLB advances (421) 136 (285)
Other borrowings (205) 30 (175)
- ----------------------------------------------------------------------------------------
Total interest-bearing liabilities $ (2,178) $ (769) $ (2,947)
========================================================================================
Change in net interest income $ (1,148) $(1,427) $ (2,575)
========================================================================================
PROVISION 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 is
based on two basic principles of accounting: (1) SFAS No. 5, ACCOUNTING FOR
CONTINGENCIES, which requires that losses be accrued when they are probable of
occurring and estimable, and (2) SFAS No.114, ACCOUNTING BY CREDITORS FOR
IMPAIRMENT OF A LOAN, which requires that losses be accrued based on the
differences between the value of collateral, the present value of future cash
flows or values that are observable in the secondary market and the loan
balance.
Our allowance for loan losses has two basic components: the specific
allowance for impaired credits and the general allowance based on relevant risk
factors. Each of those components is determined based upon estimates that can
and do change when the actual events occur. The specific allowance is used to
allocate an allowance for individual loans identified as impaired. For those
loans, we analyze the fair value of the collateral underlying the loan and
consider the estimated costs to sell the collateral on a discounted basis. If
the net collateral value is less than the loan balance (including accrued
interest and any unamortized premium or discount associated with the loan), we
recognize impairment and establish a specific reserve for the impaired loan.
Large groups of smaller balance and homogeneous loans are collectively evaluated
for impairment. Accordingly, the Company does not separately identify individual
consumer and residential loans for impairment testing unless such loans become
90 days or more past due.
40
The general allowance is determined by aggregating un-criticized loans,
those loans not classified under our internal asset classification system, and
loans identified for impairment testing for which no impairment was identified
into one of six categories: single family residential mortgages; home equity
lines of credit; construction and land; commercial real estate; commercial and
industrial; and other consumer loans. We then apply allowance factors which, in
the judgment of management, represent the expected losses over the life of the
loans. In determining those factors, we consider the following: delinquencies
and overall risk ratings, historical loss experience, trends in volume and terms
of loans, effects of changes in lending policy, the experience, and depth of the
borrowers' management, current economic conditions affecting the borrowers'
ability to repay, quality of loan review system and the effect of external
factors (e.g., competition and regulatory requirements). The general allowance
also includes those loans that have been classified under our internal asset
classification system. We typically apply a 5% loss factor to loans classified
as special mention, a 10% loss factor to loans classified as substandard and a
50% loss factor to loans classified as doubtful, where the loan has not been
determined to be impaired. Loans classified as loss loans are fully reserved or
charged off. On an annual basis, or more often if deemed necessary, the bank has
contracted with an independent outside third party to review its loan portfolio.
The focus of that review is to identify the extent of potential and actual risk
in the bank's commercial loan portfolio and in our underwriting and processing
practices. Observations made regarding the bank's portfolio risk are based upon
review evaluations, portfolio profiles and discussions with the operational
staff, including the line lenders and senior management. 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. In the most recent examination made in June 2008 the OTS did not
indicate the need to increase the allowance for loan losses.
Non-performing assets were $3.0 million or 1.47% of total assets at
September 30, 2008, compared to non-performing assets of $1.3 million or 0.55%
of total assets at September 30, 2007. At September 30, 2008, assets of $1.9
million were classified as substandard and $1.1 million was real estate owned. A
$3.4 million provision for loan losses was recorded during the year ended
September 30, 2008, compared to a provision of $685,000 during the year ended
September 30, 2007. The $2.7 million increase in the provision for loan losses
of from the year ago period was required as a result of the deterioration in
asset quality during the current period coupled with a provision of $1.6 million
for loans determined to be impaired and classified as doubtful. Coupled with the
increase in non-performing assets, the bank increased the outstanding balance
of commercial real estate loans which require a larger allocated allowance
provision. That increase in provision for those loans was offset with an overall
decline in the size of the bank's loan portfolio.
NON-INTEREST INCOME. Non-interest income decreased $4.3 million during
fiscal 2008, over fiscal 2007. That decrease primarily reflected the decrease of
$4.3 million in gain recognized from the sale of the bank's Pasadena, Maryland,
branch in August of 2007, with no comparable action in the current year, and was
coupled with decreases in service fees on loans and deposits. Those decreases
were partially offset by a decline in losses on derivatives, and an increase in
other operating income. The sale of the Pasadena branch office was established
as a condition to the completion of the then pending merger of the company with
and into Summit and closed on August 24, 2007.
The following table presents a comparison of the components of
non-interest income.
Years Ended September 30, Difference
-------------------------------- ------------------------------------
2008 2007 Amount %
- ------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Noninterest income:
Service fees on loans $ 133 $ 169 $ (36) (21.30)%
Service fees on deposits 397 444 (47) (10.59)
Gain (loss) on derivatives (14) (21) 7 33.33
Other operating income 30 23 7 30.43
Gain on branch sale - 4,255 (4,255) (100.00)
- ------------------------------------------------------------------------------------------------------------------
Total noninterest income $ 546 $ 4,870 $ (4,324) (88.79)%
==================================================================================================================
41
NON-INTEREST EXPENSE. Noninterest expense for fiscal 2008 amounted to
$10.2 million, an increase of $577,000 or 5.99% from the $9.6 million incurred
in fiscal 2007. The increase was distributed over various non-interest expense
categories with the contributors being professional services, deposit insurance
premiums, other real estate owned expense and other operating expense. The
increase in professional services resulted primarily from fees related to the
proposed merger. The increase in deposit insurance premiums resulted from a
special credit received in the year-ago period, which was not repeated in the
current period, and higher premium rates in the current period. The increase in
other operating expense resulted from goodwill impairment charge. Goodwill is
subject to at least an annual assessment for impairment by applying a fair value
based test. If the fair value equals or exceeds the book value, no write-down of
recorded goodwill is necessary. If the fair value is less than the book value,
an expense may be required to write down the goodwill to the proper carrying
value. Based on the results of these tests, the bank concluded that the entire
amount of goodwill had been impaired and an expense of $956,000 was recognized
in other operating expense during 2008. There was no comparable charge during
the prior fiscal year. Those increases in expense were offset by decreases
totaling $1.2 million in compensation, occupancy expense, advertising, furniture
fixtures and equipment and data processing.
The following table presents a comparison of the components of
noninterest expense.
Years Ended September 30, Difference
------------------------------ -------------------------------
2008 2007 Amount %
--------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Noninterest expense:
Compensation and employee benefits $ 3,514 $ 4,446 $ (932) (20.96)%
Occupancy 1,315 1,394 (79) (5.67)
Professional services 1,665 1,128 537 47.61
Advertising 35 130 (95) (73.08)
Deposit insurance premium 530 69 461 668.12
Furniture, fixtures and equipment 426 516 (90) (17.44)
Data processing 827 877 (50) (5.70)
Other real estate owned expense 25 - 25 n/a
Goodwill impairment 956 - 956 n/a
Other operating expense 909 1,066 (157) (14.73)
--------------------------------------------------------------------------------------------------------------
Total noninterest expense $ 10,202 $ 9,626 $ 576 5.65%
==============================================================================================================
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 current income taxes for
the fiscal year ended September 30, 2008 due to our operating losses. That is
compared to a provision of $36,000 made for fiscal 2007 which was due to the
alternative minimum tax. However, the bank reduced its net deferred tax asset by
$1.7 million for the fiscal year ended September 30, 2008, as a result of
increasing the allowance on the deferred tax asset during the period. In
addition the Office of Thrift Supervision issued a Cease and Desist Order
mandating a 6% core capital ratio and a 12% total risk-based capital ratio. With
the reduction in the bank's capital level, and higher capital requirements, the
bank has had to lower its earning asset growth. That in turn, negatively impacts
expected future earnings and required the reduction in the carrying value of its
deferred tax asset.
42
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, 2008, 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) $ 27,000 $ 2,000 $ 25,000 $ - $ -
Reverse repurchase agreements 1,909 1,909 - - -
Subordinated debt securities (2) 25,982 655 1,310 1,310 22,707
Operating leases 2,942 1,086 1,338 252 266
- -----------------------------------------------------------------------------------------------------------
Total obligations $ 57,833 $ 5,650 $ 27,648 $ 1,562 $ 22,973
===========================================================================================================
(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) $ 98,305 $ 85,316 $ 9,898 $ 2,998 $ 93
Loan originations 1,963 1,963 - - -
Unfunded lines of credit (2) 96,262 96,262 - - -
Standby letter of credit 118 118 - - -
- -----------------------------------------------------------------------------------------------------------
Total $196,648 $183,659 $ 9,898 $ 2,998 $ 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 $95.4 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.
43
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, 2008. 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 One 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 $ 13,501 $ 3,641 $ 7,103 $ 12,165 $ 4,862 $ 285 $ 41,557
Fixed-rate 1,139 2,868 4,542 8,391 10,595 14,228 41,763
Commercial business 8,361 198 410 1,833 743 893 12,438
Consumer 51,158 81 146 374 163 168 52,090
Investment securities 27,869 37 72 213 3,217 933 32,341
Mortgage-backed securities 3,434 3,377 4,118 36 6 12 10,983
-----------------------------------------------------------------------------------------------------------------------
Total 105,462 10,202 16,391 23,012 19,586 16,519 191,172
-----------------------------------------------------------------------------------------------------------------------
Interest-bearing liabilities:
Deposits:
Savings accounts 1,988 - - - - - 1,988
NOW accounts 8,816 - - - - - 8,816
Money market accounts 47,082 - - - - - 47,082
Certificates of deposit 52,006 22,902 10,407 9,898 2,998 93 98,304
Borrowings:
FHLB advances 2,000 - - 25,000 - - 27,000
Other borrowings 1,909 - - - - 9,383 11,292
-----------------------------------------------------------------------------------------------------------------------
Total 113,801 22,902 10,407 34,898 2,998 9,476 $194,482
-----------------------------------------------------------------------------------------------------------------------
GAP $ (8,339) $(12,700) $5,984 $(11,886) $ 16,588 $ 7,043 $ (3,310)
=======================================================================================================================
Cumulative GAP $ (8,339) $(21,039) $(15,055) $(26,941) $(10,353) $(3,310)
===========================================================================================================
Ratio of Cumulative GAP
to total interest earning assets (4.36)% (11.01)% (7.88)% (14.09)% (5.42)% (1.73)%
===========================================================================================================
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 liability sensitive in the
amount of $15.1 million at September 30, 2008.
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 200 or down 100 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
100 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.
44
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, 2008:
Net Interest Income Sensitivity Analysis
---------------------------------------------------------------------
Basis Point Percent
Changes in Rate Net Interest Change Change From
by Basis Point Margin From Base Base
----------------- ---------------- --------------- -----------------
+200 2.91% (0.06)% (1.97)%
+100 2.97% 0.00% (0.01)%
+0 2.97% - -
-100 2.88% (0.09)% (3.07)%
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 decrease by 6 basis points or 1.97% and, if
interest rates decrease 100 basis points, net interest margin, as a percent of
total assets, would decrease by 9 basis points or 3.07%.
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, 2008, as measured by changes in net portfolio value for parallel
shifts of up 200 and down 100 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 $ (1,598) (10.35)% 6.61% (0.66)%
+100 (718) (4.65) 6.98 (0.29)
+0 - - 7.27 -
-100 142 0.92 7.31 0.04
The decline in net portfolio value of $1.6 million or 10.35% 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,
2008 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 100 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.
45
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.
46
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.
47
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)%
============================================================================================================
48
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.
49
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
----------------------------------------------------------------
Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/
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%
Consumer loans 55,420 4,353 7.85 65,338 4,701 7.19
Commercial business loans 38,018 3,127 8.23 34,960 2,466 7.05
--------- -------- ------ --------- -------- -------
Total loans 184,570 14,173 7.68 193,688 13,866 7.16
Investment securities 64,011 3,184 4.97 66,789 3,353 5.02
Mortgage-backed
securities 23,848 1,064 4.46 43,979 1,575 3.58
--------- -------- ------ --------- -------- -------
Total interest-earning
assets 272,429 18,421 6.76 304,456 18,794 6.17
-------- ------ -------- --------
Non-earning assets 11,707 10,677
--------- ---------
Total assets $284,136 $315,133
========= =========
Liabilities and Stockholders'
Equity:
Interest-bearing liabilities:
Savings accounts $ 2,969 27 0.91 $ 5,190 48 0.92
Now and money market
accounts 77,997 2,791 3.58 73,485 2,430 3.31
Certificates of deposit 133,152 6,513 4.89 131,636 5,231 3.97
--------- -------- ------ --------- -------- -------
Total deposits 214,118 9,331 4.36 210,311 7,709 3.67
FHLB advances 33,064 1,806 5.46 44,894 2,266 5.05
Other borrowings 15,264 856 5.61 31,624 1,608 5.08
--------- -------- ------ --------- -------- -------
Total interest-bearing
liabilities 262,446 11,993 4.57 286,829 11,583 4.04
-------- ------ -------- --------
Noninterest-bearing
liabilities:
Noninterest-bearing
demand deposits 11,595 14,993
Other liabilities 2,224 1,147
--------- ---------
Total liabilities 276,265 302,969
Stockholders' equity 7,871 12,164
--------- ---------
Total liabilities and
stockholders' equity $284,136 $315,133
========= =========
Net interest income $ 6,428 $ 7,211
======== ========
Interest rate spread 2.19% 2.13%
======== ========
Net interest margin 2.36% 2.37%
======== ========
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
Compared to Year
Ended September 30, 2006
Change Attributable to
------------------------------------
Volume Rate Total
- ------------------------------------------------------------------------
(In Thousands)
Real estate loans $ (162) $ 156 $ (6)
Consumer loans (714) 366 (348)
Commercial business loans 216 445 661
- ------------------------------------------------------------------------
Total loans (660) 967 307
Investments (139) (30) (169)
Mortgage-backed securities (721) 210 (511)
- ------------------------------------------------------------------------
Total interest-earning assets $(1,520) $1,147 $ (373)
========================================================================
Savings accounts $ (21) $ - $ (21)
Now and money market accounts 149 212 361
Certificates of deposit 60 1,222 1,282
- ------------------------------------------------------------------------
Total deposits 188 1,434 1,622
FHLB advances (597) 137 (460)
Other borrowings (832) 80 (752)
- ------------------------------------------------------------------------
Total interest-bearing liabilities $(1,241) $1,651 $ 410
========================================================================
Change in net interest income $ (279) $(504) $ (783)
========================================================================
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. 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.
51
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.
52
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, 2008, cash and cash
equivalents, interest bearing deposits and securities available-for-sale totaled
$43.7 million, or 21.61% 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. The limitations
in the Cease and Desist Order restricting the bank's lending in the commercial,
commercial real estate and construction areas adversely affect the ability of
the bank to lend in those areas. During the year ended September 30, 2008, the
bank's loan originations and purchases totaled $66.3 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, 2008. All of our investment securities are classified as either
available for sale or held to maturity and for the period ended September 30,
2008 and those where fair value is less than cost were considered temporarily
impaired. The market value of our investment portfolio is obtained from various
third party brokerage firms and we believe 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, 2008, the bank had $27.0 million in advances
outstanding from the FHLB and had an additional overall borrowing capacity from
the FHLB of $11.0 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. All advances to the bank from the FHLB of
Atlanta require the approval of the FHLB's executive committee.
At September 30, 2008, 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 $98.3 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,
2008, totaled $85.3 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.
53
CAPITAL RESOURCES. At September 30, 2008, the bank exceeded minimum
regulatory capital requirements with a tangible capital level of $10.9 million,
or 5.27% of total adjusted assets, which exceeds the required level of $3.1
million, or 1.50%; core capital of $10.9 million, or 5.27% of total adjusted
assets, which exceeds the required level of $8.2 million, or 4.00%; and
risk-based capital of $11.7 million, or 8.39% of risk-weighted assets, which
exceeds the required level of $11.2 million, or 8.00%. However, under the Cease
and Desist Order, as amended, requires the bank to have and maintain a minimum
Tier I Core Capital ratio of 6% and a minimum Total Risk-Based Capital ratio of
12% at December 31, 2008. In the current economic environment, the bank has not
been able to raise sufficient additional capital to comply with the capital
requirements of the Cease and Desist Order. Without a waiver by the Office of
Thrift Supervision or amendment or modification of the Cease and Desist Order,
the bank could be subject to further regulatory enforcement action, including,
without limitation, the issuance of additional cease and desist orders (which
may, among other things, further restrict the bank's business activities, or
place the bank in conservatorship or receivership). If the bank is placed in
conservatorship or receivership, it is highly likely that such action would lead
to a complete loss of all value of the company's ownership interest in the bank.
In addition, further restrictions could be placed on the bank if it were
determined that the bank was undercapitalized, significantly undercapitalized,
or critically undercapitalized, with increasingly greater restrictions being
imposed as any level of undercapitalization increased.
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).
Additionally, the bank is prohibited under the Cease and Desist Order from
paying dividends or making any other capital distributions to the company
without the prior written approval of the Regional Director of the Office of
Thrift Supervision.
54
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.
55
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.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Please refer to the index on page 67 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, 2008, 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, 2008, 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.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of the company is responsible for establishing and
maintaining adequate internal control over financial reporting. This internal
control system has been designed to provide reasonable assurance to the
company's management and board of directors regarding the preparation and fair
presentation of the company's published financial statements.
All internal control systems, no matter how well designed, have
inherent limitations. Therefore, even those systems determined to be effective
can provide only reasonable assurance with respect to financial statement
preparation and presentation.
56
The management of the company has assessed the effectiveness of the
Company's internal control over financial reporting as of September 30, 2008. To
make the assessment, we used the criteria for effective internal control over
financial reporting described in Internal Control - Integrated Framework, issued
by the Committee of Sponsoring Organizations of the Treadway Commission. Based
on our assessment, we believe that, as of September 30, 2008, the company's
internal control over financial reporting was effective based on those criteria.
This annual report does not include the attestation report of the
company's registered public accounting firm regarding internal control over
financial reporting. Management's report was not subject to attestation by the
company's registered public accounting firm pursuant to temporary rules of the
Securities and Exchange Commission that permit the company to provide only
management's report in this annual report.
There were no changes in the company's internal control over financial
reporting during the quarter ended September 30, 2008 that has materially
affected, or is reasonably likely to materially affect, the company's internal
control over financial reporting.
ITEM 9B. OTHER INFORMATION
During the quarter ended September 30, 2008, the company filed Current
Reports on Form 8-K for all information required to be disclosed in reports 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 61 Director, President and Chief Executive Officer 1997 2008
Sidney M. Bresler 54 Director 2003 2010
Charles W. Calomiris 51 Director, Chairman of the Board of Directors 2001 2008
Jeffrey W. Ochsman 56 Director 1999 2009
James B. Vito 83 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 60 Senior Vice President and Chief Operating Officer of the Bank and Corporate
Secretary of the Company and the Bank
Justin R. Golden 58 Senior Vice President, Consumer Lending, of the Bank
Gary L. Hobert 59 Senior Vice President, Commercial Business Lending, of the Bank
Robert W. Neff 61 Senior Vice President, Commercial Real Estate Lending, of the Bank
David E. Ritter 58 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
office until his successor is elected and qualified or until removed or
replaced. Officers are subject to re-election by the board of directors
annually.
57
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 Savings
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.
58
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 2008.
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, 2008, to the Chief Executive Officer, and for each of the other
executive officers of the company who received salary and bonus in excess of
$100,000 (collectively, the "Named Executive Officers").
Change in
Pension
Value and
Non- Nonquali-
Equity ified
Incentive Deferred
Plan Compen-
Stock Compen- sation All Other
Fiscal Salary Bonus Awards sation Earnings Compensation Total
Name and Principal Position Year ($) ($) ($) ($) ($) ($) ($)
------------------------------------ ------- --------- ------- --------- ---------- ---------- --------------- -------------
Carroll E. Amos 2008 $182,000 $ - $ - $ - $ - $ - $182,000
President and Chief
Executive Officer
Edward C. Allen 2008 $121,320 $ - $ - $ - $ - $ - $121,320
Senior Vice President, Chief -
Operating Officer and Secretary
David E. Ritter 2008 $114,000 $ - $ - $ - $ - $ - $114,000
Senior Vice President and
Chief Financial Officer
59
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, 2008. There were no other equity awards held by the named
executive officers at September 30, 2008. 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 3,000 - $6.00 12/01/09
President and Chief 8,666 - 4.00 12/14/10
Executive Officer 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.
60
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.
61
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 22, 2008.
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
Scarsdale, New York 10583 176,807 shares(1)(2) 5.85%
Common Stock Robert I. Schattner, DDS
121 Congressional Lane
Rockville, MD 20852 432,328 shares(1)(3) 14.30%
Common Stock The Ochsman Children Trust
1650 Tysons Boulevard
McLean, VA 22102 238,597 shares(1)(4) 7.89%
Common Stock George W. Calomiris
4848 Upton Street, N.W. 190,548 shares(5) 6.13%
Washington, DC 20016
Common Stock Jenifer Calomiris
4919 Upton Street, N.W. 181,271 shares(6) 5.84%
Washington, D.C. 20016
Common Stock Katherine Calomiris Tompros
5100 Van Ness Street, N.W. 181,471 shares(7) 5.85%
Washington, D.C. 20016
- -------------------
(1) Does not include 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 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 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 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.
62
INFORMATION WITH RESPECT TO DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth, as of December 22, 2008, 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 22, 2008 by
each director and all directors and executive officers as a group as of December
22, 2008.
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 51 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 61 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 83 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 56 1999 2009 500 *
partner of the law firm of Friedlander,
Misler, Sloan, Kletzkin & Ochsman, PLLC.
Sidney M. Bresler is a Director, Chief 54 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.
63
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 60 550(4) *
Officer and became Chief Operating Officer in 1997.
David E. Ritter joined the bank and the company as a 58 300(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 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 41,666 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, 2008.
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 192,666 $6.56 143,834
Equity compensation plans not
approved by security holders N/A N/A N/A
- -----------------------------------------------------------------------------------------------------------------------------
Total 192,666 $6.56 143,834
=============================================================================================================================
64
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, 2008,
one of the bank's directors had loans with the bank which had outstanding
balances totaling $102,000. 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 $228,808 and
$106,703 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, 2008 and 2007, 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, 2008 or 2007.
TAX FEES
BDO Seidman billed the company $37,345 and $30,358 for tax services for
the fiscal year ended September 30, 2008 and 2007, respectively. Tax fees
represented 14.03% of the fees paid to BDO Seidman, LLP in fiscal year 2008 and
22.15% in fiscal year 2007.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) 1. FINANCIAL STATEMENTS
See Index to Consolidated Financial Statements on page 67
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
65
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: January 12, 2009
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
------------------------
Charles W. Calomiris Chairman of the Board January 12, 2009
/s/ Carroll E. Amos
------------------- Chief Executive Officer,
Carroll E. Amos and President and Director January 12, 2009
/s/ Sidney M. Bresler
---------------------
Sidney M. Bresler Director January 12, 2009
/s/ Jeffrey W. Ochsman
----------------------
Jeffrey W. Ochsman Director January 12, 2009
/s/ James B. Vito
-----------------
James B. Vito Director January 12, 2009
/s/ David E. Ritter
------------------- Senior Vice President and
David E. Ritter Chief Financial Officer January 12, 2009
66
CONSOLIDATED FINANCIAL STATEMENTS OF
GREATER ATLANTIC FINANCIAL CORP.
INDEX
Page
----
Report of Independent Registered Public Accounting Firm 68
Consolidated Statements of Financial Condition as of September 30, 2008 and 2007 69
Consolidated Statements of Operations for the Years Ended September 30, 2008and 2007 70
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended
September 30, 2008 and 2007 71
Consolidated Statements of Stockholders' Equity for the Years Ended September 30, 2008 and 2007 71
Consolidated Statements of Cash Flows for the Years Ended September 30, 2008 and 2007 72
Notes to Consolidated Financial Statements 74
67
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, 2008
and 2007 and the related consolidated statements of operations, stockholders'
equity (deficit), comprehensive income (loss) and cash flows for each of the two
years in the period ended September 30, 2008. 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 our 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. An audit includes 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 as of September 30, 2008 and 2007, and the
results of their operations and cash flows for each of the two years in the
period ended September 30, 2008, in conformity with accounting principles
generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming
the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company's bank subsidiary (the "bank")
currently does not meet capital requirements required by a Cease and Desist
Order issued by the Office of Thrift Supervision ("OTS") and has not been able
to raise additional capital to meet those requirements. In addition, the Company
does not expect to regain profitability in the foreseeable future due to
restrictions on the Company's lending activities placed by the Cease and Desist
Order. Without a waiver by the OTS or amendment or modification of the Cease and
Desist Order, the bank could be subject to further regulatory enforcement
action, including, without limitation, the issuance of additional cease and
desist orders on the bank's lending activities or placing of the bank in
conservatorship or receivership. Together, these matters raise substantial doubt
as to the Company's ability to continue as a going concern. Management's plan in
regard to these matters is also described in Note 1. The consolidated financial
statements do not include any adjustments that might result from the outcome of
these uncertainties.
/s/ BDO Seidman, LLP
Richmond, Virginia
January 12, 2009
68
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September 30,
---------------------------------
2008 2007
----------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Assets
Cash and cash equivalents $ 6,175 $ 3,146
Interest bearing deposits 440 4,486
Investment securities
Available-for-sale 37,128 48,910
Held-to-maturity 2,229 3,053
Loans receivable, net 149,615 176,108
Accrued interest and dividends receivable 1,237 1,675
Deferred income taxes - 2,096
Federal Home Loan Bank stock, at cost 1,640 1,731
Other real estate owned 1,043 -
Premises and equipment, net 1,918 2,285
Goodwill - 956
Prepaid expenses and other assets 982 1,548
----------------------------------------------------------------------------------------------------------------------
Total Assets $202,407 $245,994
======================================================================================================================
Liabilities and stockholders' equity (capital deficit)
Liabilities
Deposits $165,279 $197,991
Advance payments from borrowers for taxes and insurance 175 229
Accrued expenses and other liabilities 2,254 1,601
Income taxes payable - 36
Advances from the FHLB and other borrowings 28,909 27,192
Junior subordinated debt securities 9,384 9,374
----------------------------------------------------------------------------------------------------------------------
Total liabilities 206,001 236,423
----------------------------------------------------------------------------------------------------------------------
Commitments and contingencies
----------------------------------------------------------------------------------------------------------------------
Stockholders' Equity (Capital Deficit)
Preferred stock $.01 par value - 2,500,000 shares authorized, none outstanding - -
Common stock, $.01 par value - 10,000,000
shares authorized; 3,024,220 shares outstanding 30 30
Additional paid-in capital 25,273 25,273
Accumulated deficit (25,318) (14,408)
Accumulated other comprehensive loss (3,579) (1,324)
----------------------------------------------------------------------------------------------------------------------
Total stockholders' equity (capital deficit) (3,594) 9,571
----------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity (capital deficit) $202,407 $245,994
======================================================================================================================
See accompanying notes to consolidated financial statements.
69
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
--------------------------------
Year Ended September 30,
- ---------------------------------------------------------------------------------------------------------
2008 2007
- ---------------------------------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Data)
Interest income
Loans $ 10,388 $ 14,173
Investments 2,511 4,248
- ---------------------------------------------------------------------------------------------------------
Total interest income 12,899 18,421
- ---------------------------------------------------------------------------------------------------------
Interest expense
Deposits 6,844 9,331
Borrowed money 2,202 2,662
- ---------------------------------------------------------------------------------------------------------
Total interest expense 9,046 11,993
- ---------------------------------------------------------------------------------------------------------
Net interest income 3,853 6,428
Provision for loan losses 3,397 685
- ---------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 456 5,743
- ---------------------------------------------------------------------------------------------------------
Noninterest income
Fees and service charges 530 613
Gain (loss) on derivatives (14) (21)
Gain on branch sales - 4,255
Other operating income 30 23
- ---------------------------------------------------------------------------------------------------------
Total noninterest income 546 4,870
- ---------------------------------------------------------------------------------------------------------
Noninterest expense
Compensation and employee benefits 3,514 4,446
Occupancy 1,315 1,394
Professional services 1,665 1,128
Advertising 35 130
Deposit insurance premium 530 69
Furniture, fixtures and equipment 426 516
Data processing 827 877
Other real estate owned expense 25 -
Goodwill impairment 956 -
Other operating expenses 909 1,066
- ----------------------------------------------------------------------------------------------------------
Total noninterest expense 10,202 9,626
- ----------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (9,200) 987
Provision for income taxes 1,710 36
- ----------------------------------------------------------------------------------------------------------
Net income (loss) $ (10,910) $ 951
==========================================================================================================
Earnings (loss) per common share
Basic $ (3.61) $ 0.31
Diluted $ (3.61) $ 0.31
- ----------------------------------------------------------------------------------------------------------
Weighted average common shares outstanding
Basic 3,024,220 3,023,407
Diluted 3,024,220 4,395,008
See accompanying notes to consolidated financial statements.
70
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
------------------------------
Year Ended September 30,
- --------------------------------------------------------------------------------
2008 2007
- --------------------------------------------------------------------------------
(In Thousands)
Net (loss) income $ (10,910) $ 951
- ------------------------------------------------- --------------- --------------
Other comprehensive (loss) income, net of tax:
Unrealized (loss) on securities (2,255) (275)
- --------------------------------------------------------------------------------
Other comprehensive (loss) (2,255) (275)
- --------------------------------------------------------------------------------
Comprehensive (loss) income $ (13,165) $ 676
================================================================================
See accompanying notes to consolidated financial statements.
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CAPITAL DEFICIT)
- -----------------------------------------------------------------------------------------------------------------------
Accumulated
Additional Accumulated Other Total
Preferred Common Paid-in Earnings Comprehensive Stockholders' Equity
Stock Stock Capital (Deficit) Income (Loss) (Capital Deficit)
- -----------------------------------------------------------------------------------------------------------------------
(In Thousands)
- -----------------------------------------------------------------------------------------------------------------------
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
Other comprehensive loss - - - - (2,255) (2,255)
Net loss for the year - - - (10,910) - (10,910)
- -----------------------------------------------------------------------------------------------------------------------
Balance at September 30, 2008 $ - $ 30 $ 25,273 $ (25,318) $ (3,579) $ (3,594)
=======================================================================================================================
See accompanying notes to consolidated financial statements
71
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
-----------------------------------
Year Ended September 30,
- -----------------------------------------------------------------------------------------------------------------
2008 2007
- -----------------------------------------------------------------------------------------------------------------
(In Thousands)
Cash flow from operating activities
Net income (loss) $(10,910) $ 951
Adjustments to reconcile net income (loss) to net cash
Provided (used) by operating activities
Provision for loan losses 3,397 685
Amortization of deferred loan acquisition costs, net 5 38
Depreciation and amortization 371 445
Gain on branch sale - (4,255)
Loss (gain) on derivatives 14 21
Amortization of other investment securities premiums 370 862
Amortization of mortgage-backed security premiums 145 397
Amortization of deferred fees (255) (325)
Discount accretion net of premium amortization 237 287
Amortization of convertible preferred stock costs 10 9
Conversion of Trust Preferred Securities - (23)
Impairment of goodwill 956 -
Increase in valuation allowance in net deferred tax asset 1,710 -
(Increase) decrease in assets
Accrued interest and dividend receivable 438 399
Prepaid expenses and other assets 468 177
Deferred loan fees collected, net of deferred costs incurred 320 435
Increase (decrease) in liabilities
Accrued expenses and other liabilities 740 (265)
Income taxes payable (36) 36
- -----------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities $ (2,020) $ (126)
=================================================================================================================
(Continued)
72
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - (CONTINUED)
-----------------------------
Year Ended September 30,
- ---------------------------------------------------------------------------------------------------------------------
2008 2007
- ---------------------------------------------------------------------------------------------------------------------
(In Thousands)
Cash flow from investing activities
Loan repayments $ 80,902 $ 91,411
Loan disbursements net of participations sold (59,156) (75,332)
Disposal (purchases) of premises and equipment (4) 34
Proceeds from repayments of investment securities 4,720 11,528
Proceeds from repayments of mortgage-backed securities 5,499 14,963
Purchases of FHLB stock - (742)
Proceeds from sale of FHLB stock 91 1,399
- ---------------------------------------------------------------------------------------------------------------------
Net cash provided by investing activities 32,052 43,261
- ---------------------------------------------------------------------------------------------------------------------
Cash flow from financing activities
Net (decrease) increase in deposits (32,712) (27,928)
Net borrowings (repayments) advances from FHLB 2,000 (11,000)
Net borrowings (repayments) on reverse repurchase agreements and other borrowings (283) (16,383)
Increase (decrease) in advance payments by borrowers for taxes and insurance (54) (41)
Conversion of trust preferred securities - 45
- ---------------------------------------------------------------------------------------------------------------------
Net cash (used in) financing activities (31,049) (55,307)
- ---------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents (1,017) (12,172)
- ---------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, at beginning of year 7,632 19,804
- ---------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, at end of year $ 6,615 $ 7,632
=====================================================================================================================
See accompanying notes to consolidated financial statements.
73
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. ("Summit") 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 then pending merger of the company with and
into Summit and closed on August 24, 2007.
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 might be terminated if the merger was not
consummated by that date. In a Form 8-K filed on March 26, 2008 we announced
that our shareholders had approved the terms and conditions of the proposed
merger of the company with and into Summit, and on April 9, 2008, the company
announced that it had received written notice from Summit that Summit had
exercised its right to terminate the agreement for the company to merge with and
into Summit.
On June 9, 2008 the company entered into a new definitive agreement for
GAFC to merge with and into Summit. That new agreement to merge with Summit was
approved by the shareholders of the company on September 4, 2008. Processing of
the Summit application to acquire the company and the bank continued under the
new definitive merger agreement until that new definitive agreement was
terminated by mutual consent of the parties on December 15, 2008.
CEASE AND DESIST ORDER
As previously reported in a Form 8-K filed on April 29, 2008, the bank
consented to the issuance of a Cease and Desist Order (the "Cease and Desist
Order") issued by the Office of Thrift Supervision (the "OTS") effective April
25, 2008. The Cease and Desist Order requires the bank to, among other things,
report, within prescribed time periods to the OTS Regional Director for the
Southeast Region (the "Regional Director") on the status of the ongoing
negotiations with Summit; have, at June 30, 2008 (which was extended to December
31, 2008) and maintain a Tier One (Core) Capital Ratio of at least 6% and a
total risk based capital ratio of at least 12%; develop a comprehensive long
term operating strategy to be implemented if the proposed merger with Summit is
not consummated; incorporate the long term operating strategy into a three-year
business plan containing at a minimum the requirements set forth in the Cease
and Desist Order; cease, effective immediately, making commercial real estate
loans, commercial loans and loans on raw land without the prior written approval
of the Regional Director, except for such loans as to which the bank has a
legally binding written commitment to lend as of the effective date of the Cease
and Desist Order; cease, effective immediately, accepting brokered deposits; and
prohibits the payment of dividends or other capital distributions.
In addition, the Cease and Desist Order requires the bank's board of
directors to take action with respect to credit administration, classified
assets and accounting system controls and to establish a regulatory compliance
committee of three or more non-employee directors to monitor and coordinate
compliance with the provisions of the Cease and Desist Order and provide the
board of directors with progress reports on compliance, which reports are to be
transmitted by the board of directors of the bank to the Regional Director. At
September 30 and December 31, 2008, the bank was in compliance with all the
requirements of the Cease and Desist Order except for the 6% and 12% capital
requirements; however, the limitations in the Cease and Desist Order restricting
the bank's lending in the commercial, commercial real estate and construction
areas adversely affects the ability of the bank to return to profitability.
A description and copies of the Cease and Desist Order and the
Stipulation and Consent to Issuance of the Order were attached as exhibits to a
report on Form 8-K filed on April 29, 2008, with the Securities and Exchange
Commission.
74
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
GOING CONCERN
Notwithstanding the circumstances described above, the company
continues actively to market itself, seeking either to be acquired or to obtain
a capital infusion in order to meet the conditions of the Cease and Desist
Order. We cannot assure you that our efforts will be successful and, as a result
of the circumstances described here and in the Risk Factors section, there is
substantial doubt concerning the ability of the company and the bank to continue
as going concerns for a reasonable period of time. Without a waiver by the OTS
or amendment or modification of the Cease and Desist Order, the bank could be
subject to further regulatory enforcement action, including, without limitation,
the issuance of additional cease and desist orders (which may, among other
things, further restrict the bank's business activities), or the placing of the
bank in conservatorship or receivership, any of which would mitigate against the
bank and the company continuing as going concerns.
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, 2008 and
September 30, 2007, 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 11.
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. When
underwriting a home equity loan, all loans secured by a property are taken into
account. The maximum amount the bank will lend is 80% of all combined loans to
the property's appraised value when that value is less than $750,000 and only
65% of appraised value when more than $750,000. The loan-to-value ratio is
calculated using the full credit line. For these reasons, the risk involved with
our home equity loans is similar to the risk involved with our residential real
estate loans. 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, 2008.
75
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, 2008.
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.
76
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, 2008 and September 30, 2007. 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.
77
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 9).
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.
Visa required the bank to provide collateral in the amount of $100,000
to secure the bank's membership obligations and reimbursement of Visa's expenses
incurred in connection with any failure by the bank to meet such obligations.
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 information
disclosed. There were no stock options granted in 2008 or 2007.
GOODWILL
Goodwill is subject to at least an annual assessment for impairment by
applying a fair value based test. If the fair value equals or exceeds the book
value, no write-down of recorded goodwill is necessary. If the fair value is
less than the book value, an expense may be required to write down the goodwill
to the proper carrying value. Based on the results of these tests, the bank
concluded that the entire amount of goodwill had been impaired and an expense of
$956,000 was recognized in other operating expense during 2008.
78
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. INVESTMENTS
Available-for-Sale, September 30, 2008
- -------------------------------------------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
- -------------------------------------------------------------------------------------------------------------------
(In Thousands)
Investment securities
SBA notes $ 15,474 $ - $ 363 $ 15,111
CMOs 6,763 - 832 5,931
Corporate debt securities 7,318 - 1,990 5,328
- -------------------------------------------------------------------------------------------------------------------
29,555 - 3,185 26,370
- -------------------------------------------------------------------------------------------------------------------
Mortgage-backed securities
FNMA notes 5,673 - 248 5,425
GNMA notes 3,187 - 70 3,117
FHLMC notes 2,270 - 54 2,216
- -------------------------------------------------------------------------------------------------------------------
11,130 - 372 10,758
- -------------------------------------------------------------------------------------------------------------------
$ 40,685 $ - $ 3,557 $ 37,128
===================================================================================================================
Held-to-Maturity, September 30, 2008
- --------------------------------------------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
- --------------------------------------------------------------------------------------------------------------------
(In Thousands)
Investment securities
SBA notes $ 2,096 $ - $ 106 $ 1,990
Corporate debt securities - - - -
- --------------------------------------------------------------------------------------------------------------------
2,096 - 106 1,990
- --------------------------------------------------------------------------------------------------------------------
Mortgage-backed securities
FNMA notes 59 - 1 58
FHLMC notes 74 - 2 72
- --------------------------------------------------------------------------------------------------------------------
133 - 3 130
- --------------------------------------------------------------------------------------------------------------------
$ 2,229 $ - $ 109 $ 2,120
====================================================================================================================
79
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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
====================================================================================================================
The weighted average interest rate on investments was 4.63% and 5.47%
for the years ended September 30, 2008 and 2007, respectively.
TRADING ACTIVITIES
There were no net gains (losses) on trading activities included in
earnings for the years ended September 30, 2008 and 2007.
80
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Proceeds from the sale of available for sale securities were zero for
the years ended September 30, 2008 and 2007, respectively. Gross realized gains
were zero for the years ended September 30, 2008 and 2007, respectively.
As of September 30, 2008, the bank held investments in available for
sale securities with unrealized holding losses totaling $3.6 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 $ - $ - $ 5,328 $ 1,990 $ 5,328 $ 1,990
CMOs 968 30 4,963 802 5,931 832
U.S. Government securities
SBA - - 15,111 363 15,111 363
GNMA - - 3,117 70 3,117 70
U.S. Government agency securities:
FHLMC MBS's - - 2,216 54 2,216 54
FNMA MBS's - - 5,425 248 5,425 248
- ---------------------------------------------------------------------------------------------------------------
Total $ 968 $ 30 $36,160 $ 3,527 $ 37,128 $ 3,557
===============================================================================================================
During fiscal year September 30, 2008, changes in current market
conditions, such as interest rates and the economic uncertainties in the
mortgage, housing, and banking industries, have severely impacted the securities
market. The secondary market for various types of securities has been limited
and has negatively impacted securities values. Quarterly, we review each
security in our investment portfolio to determine the nature of any change in
value and whether any impairment should be classified as
other-than-temporary-impairment.
The initial indication of other-than-temporary impairment for debt
securities is a decline in the market value below the amount recorded for the
investment, and the severity and duration of the decline. In determining whether
an impairment is other-than temporary, we consider the length of time and the
extent to which the market value has been below cost, recent events specific to
the issuer, including investment downgrades by rating agencies and economic
conditions of its industry, and our ability and intent to hold the investment
for a period of time sufficient to allow for any anticipated recovery.
For marketable corporate debt securities, we also consider the issuer's
financial condition, capital strength, and near term prospects, as well as the
current ability of the issuer to make future payments in a timely manner, and
any change in the rating agencies' rating at the evaluation date from that made
on the acquisition date and any likely imminent action. Once a decline in value
is determined to be other than temporary, the value of the security is reduced
and a corresponding charge to earnings is recognized. To assist in analyzing for
other-than-temporary impairment, we use an independent pricing service that
reviews our investment in non-government or agency asset-backed or corporate
debt securities.
With respect to the company's $5.3 million investment in corporate debt
securities, although the market value has been less than cost for more than 12
months and there has been a decline in price, that decline has occurred
primarily over the past year due to changes in the market which has limited the
demand for these securities and reduced their liquidity. As of September 30,
2008, the corporate debt securities we hold have not experienced a credit
default event, are rated investment grade and continue to make the required
interest payments on a timely basis.
The company's $1.7 million investment in pooled trust preferred
securities is primarily in issues of other banks, bank holding companies and
insurance companies which we currently hold in our portfolio in the form of
asset-backed securities. The decline in value of those securities has occurred
primarily over the past year due to changes in the market which has limited the
demand for those securities and reduced their liquidity. While some of those
issuers have reported weaker financial performance since our acquisition of
those securities, in management's opinion they continue to possess more than
acceptable credit risk. The securities are currently rated investment grade and
continue to make required interest payments on a timely basis. Our review of the
tranche in which the company is invested further indicated that we had
sufficient collateral support before causing a loss of principal or a break in
yield. We monitor the actual default rates and interest deferrals for expected
losses and contractual shortfalls of interest or principal, which could warrant
further recognition of impairment, and determined that the company's investment
in pooled trust preferred securities were temporarily impaired as of September
30, 2008.
81
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of September 30, 2008, the bank held investments in held-to-maturity
with unrealized holding losses totaling $109,000, 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 $ - $ - $ 1,990 $ 106 $ 1,990 $ 106
U.S. Government agency securities:
FHLMC MBS's - - 72 2 72 2
FNMA MBS's - - 58 1 58 1
- ---------------------------------------------------------------------------------------------------------------
Total $ - $ - $ 2,120 $ 109 $ 2,120 $ 109
===============================================================================================================
The amortized cost and estimated fair value of securities at September
30, 2008 and 2007, by contractual maturity, are as follows:
September 30, 2008 September 30, 2007
---------------------------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
- -------------------------------------------------------------------------------------------------------------
(In Thousands)
Available-for-sale:
One year or less $ - $ - $ - $ -
After one year through five years - - - -
After five years through ten years 4,250 3,914 3,499 3,245
After ten years 25,305 22,456 30,387 29,344
Mortgage-backed securities 11,130 10,758 16,700 16,321
- -------------------------------------------------------------------------------------------------------------
40,685 37,128 50,586 48,910
- -------------------------------------------------------------------------------------------------------------
Held-to-maturity:
One year or less - - - -
After one year through five years - - - -
After five years through ten years 445 422 380 366
After ten years 1,651 1,568 2,466 2,376
Mortgage-backed securities 133 130 207 203
- -------------------------------------------------------------------------------------------------------------
2,229 2,120 3,053 2,945
- -------------------------------------------------------------------------------------------------------------
Total investment securities $42,914 $39,248 $53,639 $51,855
=============================================================================================================
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.
82
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. LOANS RECEIVABLE
Loans receivable consists of the following:
September 30,
-----------------------------------
2008 2007
- ----------------------------------------------------------------------------------------------------
(In Thousands)
Mortgage loans:
Single-family $ 35,108 $ 37,972
Multi-family 4,932 3,983
Construction 3,710 9,939
Commercial real estate 37,678 34,984
Land loans 4,668 8,097
- ----------------------------------------------------------------------------------------------------
Total mortgage loans 86,096 94,975
Commercial loans 13,555 34,844
Consumer loans 52,090 52,656
- ----------------------------------------------------------------------------------------------------
Total loans 151,741 182,475
Less:
Due borrowers on loans-in process (349) (4,947)
Deferred loan fees origination costs 744 832
Allowance for loan losses (2,567) (2,305)
Unearned (discounts) premium 46 53
- ----------------------------------------------------------------------------------------------------
$ 149,615 $ 176,108
====================================================================================================
The activity in allowance for loan losses is summarized as follows:
-----------------------------------
Year Ended September 30,
- ---------------------------------------------------------------------------------------------------
2008 2007
- ---------------------------------------------------------------------------------------------------
(In Thousands)
Balance, beginning $ 2,305 $ 1,330
Provision for loan losses 3,397 685
Charge-offs (3,160) (353)
Recoveries 25 643
- ---------------------------------------------------------------------------------------------------
Balance, ending $ 2,567 $ 2,305
===================================================================================================
The amount of loans serviced for others totaled $27.4 million and $32.0
million as of September 30, 2008 and September 30, 2007, respectively.
The allowance for uncollected interest, established for mortgage loans
which are delinquent for a period of 90 days or more, amounted to $70,000 and
$110,000 as of September 30, 2008 and 2007, 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 $1.9 million and $1.3
million as of September 30, 2008 and 2007, respectively.
As described in Note 1, the Cease and Desist Order requires the bank to
obtain the prior approval of the Regional Director prior to making commercial
real estate loans, commercial loans and loans on raw land. Notwithstanding the
Cease and Desist Order, the company anticipates that demand for land loans for
the single-family residential sector of the market will continue to decline as a
result of the current slow sales pace occurring in the single-family market.
83
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. ACCRUED INTEREST AND DIVIDENDS RECEIVABLE
Accrued interest and dividends receivable consist of the following:
September 30,
-----------------------
2008 2007
- -------------------------------------------------------------------------------------------------
(In Thousands)
Investments $ 257 $ 491
Loans receivable 968 1,159
Accrued dividends on FHLB stock 12 25
- -------------------------------------------------------------------------------------------------
$ 1,237 $ 1,675
=================================================================================================
5. PREMISES AND EQUIPMENT
Premises and equipment consists of the following:
September 30,
--------------------------
2008 2007
- -------------------------------------------------------------------------------------------------
In Thousands)
Furniture, fixtures and equipment $ 2,249 $ 2,283
Leasehold improvements 2,807 2,804
Land 377 377
- -------------------------------------------------------------------------------------------------
5,433 5,464
Less: Allowances for depreciation and amortization 3,515 3,179
- -------------------------------------------------------------------------------------------------
$ 1,918 $ 2,285
=================================================================================================
6. FORECLOSED REAL ESTATE
The $1.0 million in real estate owned at September 30, 2008, represents
$191,000 of a one-to-four family property and $852,000 represents a loan secured
by an apartment building, containing an aggregate total of 40 units.
84
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. DEPOSITS
Deposits are summarized as follows:
September 30, 2008
- --------------------------------------------------------------------------------------------------------
Ranges of
Contractual %
Amount Interest Rates of Total
- --------------------------------------------------------------------------------------------------------
(In Thousands)
Savings accounts $ 1,988 0.00 - 1.09% 1.2%
NOW/money market accounts 55,898 0.00 - 2.96% 33.8
Certificates of deposit 98,305 0.94 - 9.00% 59.5
Non-interest bearing demand deposits 9,088 0.00% 5.5
- --------------------------------------------------------------------------------------------------------
$ 165,279 100.0%
========================================================================================================
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%
========================================================================================================
85
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Certificates of deposit as of September 30, 2008 mature as follows:
Year ending September 30, Amount
---------------------------------------------------------------------------------------------
(In Thousands)
Thousands
2009 $ 85,316
2010 8,387
2011 1,511
2012 1,991
2013 and after 1,100
---------------------------------------------------------------------------------------------
$ 98,305
=============================================================================================
Interest expense on deposit accounts consists of the following:
----------------------------
Year Ended September 30,
--------------------------------------------------------------------------------------------
2008 2007
--------------------------------------------------------------------------------------------
(In Thousands)
NOW/money market accounts $ 1,586 $ 2,791
Savings accounts 18 27
Certificates of deposit 5,240 6,513
--------------------------------------------------------------------------------------------
$ 6,844 $ 9,331
============================================================================================
Deposits, including certificates of deposit, with balances in excess of
$100,000 totaled $52.7 million and $68.0 million at September 30, 2008, and
September 30, 2007, respectively.
86
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. ADVANCES FROM FEDERAL HOME LOAN BANK AND OTHER BORROWINGS
The bank has $40.8 million credit availability as of September 30, 2008
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 bank has pledged certain investments with carrying values of $23.8
million at September 30, 2008, to collateralize advances from the FHLB.
First mortgage loans in the amount of $17.1 million are also available
to be used as collateral for the advances at September 30, 2008.
The following table sets forth information regarding the bank's
borrowed funds:
-------------------------------------------
At of For the Year Ended September 30,
---------------------------------------------------------------------------------------------------------------
2008 2007
---------------------------------------------------------------------------------------------------------------
(Dollars in Thousands) FHLB advances:
Average balance outstanding $ 25,365 $ 33,064
Maximum amount outstanding at any month-end during the period 27,000 39,000
Balance outstanding at end of period 27,000 25,000
Weighted average interest rate during the period 6.00% 5.46%
Weighted average interest rate at end of period 5.72% 5.92%
Other borrowings:
Average balance outstanding 11,607 15,264
Maximum amount outstanding at any month-end during the period 2,573 10,857
Balance outstanding at end of period 1,909 2,192
Weighted average interest rate during the period 5.87% 5.61%
Weighted average interest rate at end of period 1.82% 2.52%
9. 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,
------------------------------------------------------------------------------------------
2008 2007
------------------------------------------------------------------------------------------
(In Thousands)
Federal tax provision (benefit) $ (2,914) $ 335
State tax provision (benefit) (644) 39
Changes in provision resulting from:
Valuation changes 5,268 (313)
Other - (25)
------------------------------------------------------------------------------------------
Income tax provision $ 1,710 $ 36
==========================================================================================
87
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,
--------------------------------
2008 2007
---------------------------------------------------------------------------------------------
(In Thousands)
Deferred tax assets
Net operating loss carryforwards $ 7,751 $ 4,398
Unrealized (gains) losses on derivatives 111 141
Allowance for loan losses 992 876
Available for sale securities 1,382 648
Core deposit intangible - -
Deferred loan fees 62 108
Other 39 79
---------------------------------------------------------------------------------------------
Total deferred tax assets 10,337 6,250
---------------------------------------------------------------------------------------------
Deferred tax liabilities
Tax over book depreciation 329 410
Other (162) 172
---------------------------------------------------------------------------------------------
Total deferred tax liabilities 167 582
---------------------------------------------------------------------------------------------
Net deferred tax assets 10,170 5,668
Less: Valuation allowance 10,170 3,572
---------------------------------------------------------------------------------------------
Total $ - $ 2,096
=============================================================================================
Management has provided a valuation allowance for all of its net
deferred tax assets.
At September 30, 2008, the company has net operating loss carryforwards
for federal income tax purposes of approximately $20.0 million, which expire in
the years 2009 to 2027.
88
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. 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, 2008, the company had outstanding commitments to
originate loans and undisbursed construction mortgages aggregating approximately
$2.0 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 $96.3 million
and standby letters of credit for approximately $118,000.
RENTAL COMMITMENTS
The company has entered into lease agreements for the rental of certain
properties expiring on various dates through June 30, 2015. The future minimum
rental commitments as of September 30, 2008, for all non-cancelable lease
agreements, are as follows:
Years ending Rental
September 30, Commitments
- -------------------------------------------------------
(In Thousands)
2009 $ 1,085
2010 959
2011 379
2012 125
2013 127
Thereafter 267
- -------------------------------------------------------
Total $ 2,942
=======================================================
Net rent expense for the years ended September 30, 2008 and 2007 was
$1.1 million and $1.1 million, respectively.
89
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. 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, 2008 or 2007.
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, 2008 and 2007 the bank was
classified as a adequately capitalized financial institution.
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,
2008 and September 30, 2007:
- -------------------------------------------------------------------------------------------------------------
Required Required Actual Actual
At September 30, 2008 Balance Percent Balance Percent Surplus
- -------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Tangible $ 3,093 1.50% $ 10,859 5.27% $ 7,766
Core $ 8,247 4.00% $ 10,859 5.27% $ 2,612
Risk-based $ 11,185 8.00% $ 11,733 8.39% $ 548
=============================================================================================================
- -------------------------------------------------------------------------------------------------------------
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
=============================================================================================================
Under the Cease and Desist Order issued by the Office of Thrift
Supervision effective April 25, 2008, the bank was required to have a Tier 1
(Core) Capital Ratio of at least 6% and a total Risk-based capital ratio of at
least 12% at June 30, 2008 and at all times thereafter. The Cease and Desist
Order was modified to extend that capital level deadline first to September 30,
2008, and subsequently to December 31, 2008. As shown in the foregoing chart,
the bank did not meet the capital requirements of the Cease and Desist Order at
September 30, 2008.
Notwithstanding the circumstances described above, the company
continues actively to market itself, seeking either to be acquired or to obtain
a capital infusion in order to meet the conditions of the Cease and Desist
Order. We cannot assure you that our efforts will be successful and, as a result
of the circumstances described here and in the Risk Factors section, there is
substantial doubt concerning the ability of the company and the bank to continue
as going concerns for a reasonable period of time.
90
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,
------------------------------
2008 2007
--------------------------------------------------------------------------------------------------
(In Thousands)
GAAP capital $ (720) $ 11,661
Guaranteed convertible preferred securities 8,000 8,000
Unrealized losses on available for sale securities 3,579 1,324
Excluded deferred tax asset - (1,199)
Goodwill - (956)
--------------------------------------------------------------------------------------------------
Tangible capital 10,859 18,830
Adjustments - -
--------------------------------------------------------------------------------------------------
Core capital 10,859 18,830
Allowance for general loss reserves 958 2,132
Adjustments to arrive at Risk-Weighted Assets (84) (88)
--------------------------------------------------------------------------------------------------
Risk-based capital $ 11,733 $ 20,874
==================================================================================================
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.
12. 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, 2008, there
are no warrants outstanding.
91
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, 2006 253,000 $ 6.72
Options expired (7,500) $ 6.75
- ------------------------------------------------------------------------------------------------------------
Balance outstanding and exercisable at September 30, 2007 245,500 $ 6.72
Options expired (52,834) $ 7.33
- ------------------------------------------------------------------------------------------------------------
Balance outstanding and exercisable at September 30, 2008 192,666 $ 6.56
============================================================================================================
A summary of the stock options outstanding and exercisable as of
September 30, 2008 is as follows:
----------------------------------
Options Outstanding Options Exercisable
- ------------------------------------------------------------ ----------------------------------
Weighted Weighted
Average Average
Exercise Number Remaining Life Exercise Number
Prices Outstanding (years) Price Exercisable
- ---------------------------------------------------------- ----------------------------------
$6.00 13,000 1.2 $6.00 13,000
$4.00 41,666 2.2 $4.00 41,666
$5.31 10,000 2.2 $5.31 10,000
$7.00 17,000 3.3 $7.00 17,000
$9.00 20,000 3.3 $9.00 20,000
$8.50 30,000 5.1 $8.50 30,000
$6.75 61,000 6.1 $6.75 61,000
- --------------------------------------------------------------------------------------------------
92
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. 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, 2008 and
2007:
---------------------------------------------------------------
For the Year Ended September 30,
---------------------------------------------------------------
2008 2007
------------------------------ ------------------------------
Per Per
Income Share Share
(loss) Shares Amount Income Shares Amount
- -------------------------------------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Data)
Basic earnings per share $(10,910) 3,024,220 $(3.61) $ 951 3,023,407 $ 0.31
Effect of conversion of preferred securities - - - 405 1,368,143 -
Effect of dilutive stock options - - - - 3,458 -
- -------------------------------------------------------------------------------------------------------------
Diluted $(10,910) 3,024,220 $(3.61) $1,356 4,395,008 $ 0.31
=============================================================================================================
The effect of the conversion of preferred securities and stock options of
1,368,143 were excluded in 2008, as they would have been anti-dilutive.
14. 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 $131,000 and $181,000 as of September 30, 2008 and
September 30, 2007, respectively.
93
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. 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 for identical instruments traded in active markets and upon quoted prices
for similar instruments or assets in active markets, quoted prices for identical
or similar instruments or assets in markets that are not active, and model-based
valuation techniques for which all significant assumptions are observable in the
market.
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:
As of September 30,
-----------------------------------------------------------
2008 2007
----------------------------- ----------------------------
Carrying Estimated Carrying Estimated
value fair value value fair value
----------------------------------------------------------------------------------------------------------
(In Thousands)
Assets:
Cash and interest bearing deposits $ 6,615 $ 6,615 $ 7,632 $ 7,632
Investment securities 39,357 39,248 51,963 51,855
Loans receivable 149,615 151,403 176,108 176,833
----------------------------------------------------------------------------------------------------------
Liabilities:
Deposits 165,279 165,941 197,991 198,368
Borrowings 28,909 29,845 27,192 27,980
----------------------------------------------------------------------------------------------------------
Off-balance sheet instruments:
Commitments to extend credit - 21 - 31
----------------------------------------------------------------------------------------------------------
16. 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, 2008 and 2007.
94
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
17. SUPPLEMENTAL CASH FLOW INFORMATION
-------------------------------
Year Ended September 30,
--------------------------------------------------------------------------------------------------
2008 2007
--------------------------------------------------------------------------------------------------
(In Thousands)
--------------------------------------------------------------------------------------------------
Transfer of loans to real estate owned $ 1,043
Cash paid during period for interest on deposits and borrowings 2,315 3,318
==================================================================================================
18. SEGMENT REPORTING
We have two subsidiaries, the bank and Greater Atlantic Capital Trust
I. 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. 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 19 to the financial statements.
19. 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, 2008, the
quarterly distribution amount that is unpaid and accrued totals $1.3 million.
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.
95
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
20. 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 $14,000 in fiscal 2008
and a loss of $21,000 in fiscal 2007 related to derivatives.
21. 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, 2007. In October 2008,
the FASB amended SFAS 157 by issuing FSP FAS 157-3, Determining the Fair Value
of a Financial Asset When the Market for That Asset Is Not Active. FSP FAS 157-3
clarifies the application of SFAS 157 in a market that is not active and
provides an example to illustrate key considerations in determining the fair
value of a financial asset when the market for that financial asset is not
active. 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.
96
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.
In March 2008, the FASB issued SFAS No. 161, Disclosures about
Derivative Instruments and Hedging Activities - an amendment of FASB statement
No. 133". SFAS 161 requires enhanced disclosures about how and why an entity
uses derivative instruments, how derivative instruments and related items are
accounted for under Statement 133 and how derivative instruments and related
hedged items affect an entity's financial position, financial performance and
cash flows. The new standard is effective for the company on January 1, 2009.
The adoption of this standard is not expected to have any impact on the
company's consolidated financial position or results of operations.
22. PARENT COMPANY - ONLY FINANCIAL STATEMENTS
Parent Company - Only Condensed Statements of Financial Condition
September 30,
-----------------------------------
2008 2007
------------------------------------------------------------------------------------------
(In Thousands)
Assets
Cash and cash equivalents $ - $ 13
Loans receivable - -
Investment in subsidiary 11,032 21,167
Prepaid expenses and other assets 328 316
------------------------------------------------------------------------------------------
Total assets $ 11,360 $ 21,496
==========================================================================================
Liabilities and stockholders' equity
Accrued interest payable on subordinated debt $ 1,288 $ 644
Other liabilities 247 117
------------------------------------------------------------------------------------------
Total liabilities 1,535 761
------------------------------------------------------------------------------------------
Subordinated debt 9,905 9,905
------------------------------------------------------------------------------------------
Stockholders' equity (capital deficit)
Common stock 30 30
Additional paid-in capital 25,208 25,208
Accumulated deficit (25,318) (14,408)
------------------------------------------------------------------------------------------
Total stockholders' equity (capital deficit) (80) 10,830
------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity
(capital deficit) $ 11,360 $ 21,496
==========================================================================================
97
Greater Atlantic Financial Corp. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Parent Company - Only Condensed Statements of Operations
--------------------------------
Year Ended September 30,
---------------------------------------------------------------------------------------------
2008 2007
---------------------------------------------------------------------------------------------
(In Thousands)
Interest income $ - $ 1
Other income - -
---------------------------------------------------------------------------------------------
Total interest income - 1
---------------------------------------------------------------------------------------------
Interest expense 644 644
---------------------------------------------------------------------------------------------
Total interest expense 644 644
---------------------------------------------------------------------------------------------
Net interest income (expense) (644) (643)
---------------------------------------------------------------------------------------------
Noninterest income
Gain (loss) on sale of investment securities - -
Other operating income 19 19
---------------------------------------------------------------------------------------------
Total noninterest income 19 19
---------------------------------------------------------------------------------------------
Noninterest expense
Other operating expense 150 169
---------------------------------------------------------------------------------------------
Total noninterest expense 150 169
---------------------------------------------------------------------------------------------
Loss before income from subsidiaries (775) (793)
---------------------------------------------------------------------------------------------
Equity in income (loss) from subsidiaries (10,135) 1,744
---------------------------------------------------------------------------------------------
Net income (loss) $ (10,910) $ 951
=============================================================================================
Parent Company - Only Condensed Statements of Cash Flows
--------------------------------
Year Ended September 30,
----------------------------------------------------------------------------------------------
2008 2007
----------------------------------------------------------------------------------------------
(In Thousands)
Cash flows from operating activities:
Net income (loss) $ (10,910) $ 951
Adjustments to reconcile net loss to net cash (used in)
provided by operating activities
(Income) loss from subsidiaries 10,135 (1,744)
(Increase) decrease in assets (12) (7)
Increase (decrease) in other liabilities 774 753
----------------------------------------------------------------------------------------------
Net cash used in operating activities (13) (47)
----------------------------------------------------------------------------------------------
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 - -
Stock options exercised - -
----------------------------------------------------------------------------------------------
Net cash provided by financing activities - -
----------------------------------------------------------------------------------------------
Net (decrease) increase in cash and cash equivalents (13) (47)
Cash and cash equivalents at beginning of year 13 60
----------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ - $ 13
==============================================================================================
98
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
23. 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, 2008 and 2007.
For Fiscal Year 2008
---------------------------------------------------------------------------
For the Year
Ended
September 30, Fourth Third Second First
2008 Quarter Quarter Quarter Quarter
------------------------------------------------------------------------------------------------------------------
Interest income $ 12,899 $ 2,769 $ 2,828 $ 3,424 $ 3,878
Interest expense 9,046 1,901 2,142 2,403 2,600
------------------------------------------------------------------------------------------------------------------
Net interest income 3,853 868 686 1,021 1,278
Provision for loan losses 3,397 285 322 2,688 102
------------------------------------------------------------------------------------------------------------------
Net interest income, after provision 456 583 364 (1,667) 1,176
for loan losses
Noninterest income 546 124 158 127 137
Goodwill impairment 956 956 - - -
Noninterest expense 9,246 2,357 2,150 2,582 2,157
------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (9,200) (2,606) (1,628) (4,122) (844)
Provision (benefit) for income taxes 1,710 829 (4) 885 -
------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (10,910) $ (3,435) $ (1,624) $ (5,007) $ (844)
==================================================================================================================
BASIC AND DILUTED EARNINGS (LOSS)
PER COMMON SHARE:
Basic $ (3.61) $ (1.13) $ (0.54) $ (1.66) $ (0.28)
Diluted $ (3.61) $ (1.13) $ (0.54) $ (1.66) $ (0.28)
------------------------------------------------------------------------------------------------------------------
99
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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
100