SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[ x ] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 1999
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ___________________ to ___________________
Commission file number 0-21285
ATLANTIC FINANCIAL CORP.
(Exact Name of Small Business Issuer as Specified in its Charter)
VIRGINIA 54-1809409
- --------------------------------- --------------------------------------
(State or Other Jurisdiction (I.R.S. Employer Identification No.)
of Incorporation or Organization)
737 J. Clyde Morris Boulevard
Newport News, Virginia 23601
-------------------------------------------------------------
(Address of Principal Executive Offices)
(757) 595-7020
-------------------------------------------------------------
(Issuer's Telephone Number, Including Area Code)
- -------------------------------------------------------------------------------
(Former Name, Former Address and Former Fiscal Year,
If Changed Since Last Report)
Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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 ___.
State the number of shares outstanding of each of the issuer's classes of common
equity, as of March 31, 1999.
Common stock, $5 par value--4,189,385
INDEX
ATLANTIC FINANCIAL CORP. Page No.
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets--
March 31, 1999 and December 31, 1998 3
Consolidated Statements of Income--
Three months ended March 31, 1999 and 1998 4
Consolidated Statements of Stockholders' Equity--
Three months ended March 31, 1999 and 1998 5
Consolidated Statements of Cash Flows--
Three months ended March 31, 1999 and 1998 6
Notes to Consolidated Financial Statements 7 - 10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11 - 17
Part II. Other Information: 18
Item 1. Legal Proceedings
Item 2. Changes in Securities
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
2
Item 1. FINANCIAL STATEMENTS
ATLANTIC FINANCIAL CORP.
CONSOLIDATED BALANCE SHEETS
(In Thousands of Dollars)
March 31, December 31,
ASSETS: 1999 1998
---------------- ---------------------
Cash and due from bank $ 16,093 $ 11,782
Securities available for sale (at market value) 84,958 80,281
Securities held to maturity (market value of
$11,393 and $14,173, respectively) 11,188 13,926
Federal funds sold 28,242 29,524
Loans, net 212,828 207,733
Premises and equipment 10,676 10,703
Other real estate owned 212 212
Other assets 6,469 6,142
--------- ---------
TOTAL ASSETS $ 370,666 $ 360,303
========= =========
LIABILITIES:
Deposits
Non-interest bearing $ 49,223 $ 49,291
Interest-bearing 272,951 263,019
--------- ---------
TOTAL DEPOSITS 322,174 312,310
Short-term debt 397 1,589
Other liabilities 4,543 3,275
--------- ---------
TOTAL LIABILITIES 327,114 317,174
--------- ---------
STOCKHOLDERS' EQUITY:
Preferred stock; $1 par value per share;
authorized 1,000,000 shares; no shares
issued and outstanding $ -- $ --
Common stock; $5 par value per share;
authorized 20,000,000 shares; issued and
outstanding 4,189,385 and 4,168,941
shares, respectively 20,951 20,851
Surplus -- --
Undivided profits 21,669 21,048
Accumulated other comprehensive
income, net 932 1,230
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 43,552 43,129
--------- ---------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 370,666 $ 360,303
========== ==========
Notes to financial statements are an integral part of these statements.
3
ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands of Dollars)
Three Months Ended
March 31,
1999 1998
---- ----
INTEREST INCOME:
Loans and Fees $ 5079 $ 4653
Federal Funds Sold 299 276
Investment Securities 1377 1282
--------- --------
Total Interest Income 6755 6211
INTEREST EXPENSE:
Interest on deposits 2957 2683
Interest on federal funds purchased
and other borrowings 16 7
--------- --------
Total Interest Expense 2973 2690
--------- --------
Net Interest Income 3782 3521
PROVISION FOR LOAN
AND LEASE LOSSES 72 110
--------- --------
Net Interest Income After
Provision for Loan
and Lease Losses 3710 3411
OTHER INCOME:
Service Charges & Fees 547 456
Securities Gains (Losses) -- 1
--------- --------
Total Other Income 547 457
OTHER EXPENSES:
Salaries & Employee Benefits 1531 1295
Occupancy Expenses 230 176
Furniture & Equipment Expenses 391 236
Other Operating Expenses 751 683
--------- --------
Total Other Expenses 2903 2390
--------- --------
Income Before Income Taxes 1354 1478
Applicable Income Taxes 356 445
--------- --------
Net Income $ 998 $ 1033
========= ========
Earnings Per Share, Basic .24 .25
========= ========
Earnings Per Share, Assuming
Dilution .23 .24
========= ========
Notes to financial statements are an integral part of these statements.
4
ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the three months ended March 31, 1999
(In Thousands of Dollars)
Accumulated
Other
Common Stock Retained Comprehensive Comprehensive
Stock Options Surplus Earnings Income Income Total
----- ------- ------- -------- ------ ------ -----
Balance, January 1, 1999 $20,845 $6 - - $21,048 $1,230 $43,129
Comprehensive Income:
Net Income - - - - - - 998 - - $998 998
Other comprehensive income:
Unrealized holding gains (losses) on
securities available for sale arising
during the period net of tax of $153
(298) - -
----
Other comprehensive income, net of tax - - - - - - - - (298) (298)
----
Total comprehensive income - - - - - - - - $700 - -
====
Exercise of stock options 102 (2) - - - - - - 100
Cash dividends - - - - - - (377) - - (377)
--- --- --- ----- --- -----
Balance, March 31, 1999 $20,947 $4 $ - - $21,669 $932 $43,552
=============================================== =======
Notes to financial statements are an integral part of these statements.
5
ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands of Dollars)
Three Months Ended
March 31,
1999 1998
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 998 $ 1,033
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 316 171
Provision for loan losses 72 110
Amortization of premiums, net 24 23
(Gain) on sale of securities available for sale - - (1)
(Gain) on sale of premises and equipment - - (3)
Changes in operating assets and liabilities:
(Increase) decrease in accrued interest receivable 110 133
(Increase) decrease in other assets 1 (769)
Increase in accrued interest payable 69 70
Increase (decrease) in other liabilities 249 (53)
----------- -----------
Net Cash Provided by Operating Activities $ 1,839 $ 714
----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase) in loans (5,195) (949)
Purchase of securities available for sale (11,506) (7,387)
Proceeds from sales of securities available for sale 502 200
Proceeds from calls and maturities of securities available for sale 5,469 5,449
Purchase of securities held to maturity - - (6,431)
Proceeds from calls and maturities of securities held to maturity 2,737 2,497
Purchase of premises and equipment (268) (906)
Proceeds from sales of premises and equipment - - 3
----------- ------------
Net Cash (Used In) Investing Activities ($ 8,261) ($ 7,524)
----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in deposits $ 9,864 $ 12,248
Issuance of common stock 100 250
Net increase in short-term borrowings 371 112
Cash dividends paid (884) (311)
----------- ------------
Net Cash Provided by Financing Activities $ 9,451 $ 12,299
----------- ------------
Net Increase In Cash and Cash Equivalents $ 3,029 5,489
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 41,306 32,550
----------- ------------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 44,335 $ 38,039
=========== ============
Notes to financial statements are an integral part of these statements.
6
ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. General
The consolidated statements include the accounts of Atlantic Financial
Corp. and its subsidiaries, Peninsula Trust Bank, Inc. (PTB), The Bank of
Franklin (BOF) and The Bank of Sussex and Surry (BSS). All significant
intercompany balances and transactions have been eliminated. In the
opinion of management, the accompanying unaudited consolidated financial
statements contain all adjustments (consisting of only normal recurring
accruals) necessary to present fairly the financial positions as of March
31, 1999 and December 31, 1998, and the results of operations and cash
flows for the three months ended March 31, 1999 and 1998.
The results of operations for the three months ended March 31, 1999 and
1998 are not necessarily indicative of the results to be expected for the
full year.
2. Investment Securities
Amortized cost and carrying amount (estimated fair value) of securities
available for sale are summarized as follows:
March 31, 1999
--------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---- ----- ------ -----
(In Thousands of Dollars)
US Treasury Securities 872 2 -- 874
US Government Agencies & Corporations 30,293 171 161 30,304
Obligations of States & Political Subdivisions 29,301 573 80 29,793
Mortgage-backed Securities 16,203 49 43 16,208
Corporate Debt Obligations 2,992 -- -- 2,992
Restricted Stock 702 -- -- 702
Other Securities 3,183 919 18 4,085
-------- --------- -------- --------
$ 83,546 $ 1,714 $ 302 $ 84,958
======== ========= ======== ========
Amortized cost and carrying amount (estimated fair value) of securities held
to maturity are summarized as follows:
March 31, 1999
--------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---- ----- ------ -----
(In Thousands of Dollars)
US Government Agencies & Corporations 2,866 25 2 2,890
Obligations of States & Political Subdivisions 6,062 173 11 6,224
Mortgage-backed Securities 2,260 20 -- 2,279
-------- ------- ------- -------
$ 11,188 $ 218 $ 13 $11,393
======== ======= ======= =======
7
ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Securities available for sale at December 31, 1998 consist of the following:
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---- ----- ------ -----
(In Thousands of Dollars)
US Treasury Securities 877 9 -- 886
US Government & Federal Agencies 25,938 321 (82) 26,177
States & Local Governments 28,596 696 (55) 29,237
Mortgage-backed Securities 15,148 97 (37) 15,208
Corporate Debt Obligations 3,091 50 (6) 3,135
Restricted Stocks 698 -- -- 698
Other Securities 4,069 881 (10) 4,940
--------- ------ -------- --------
$ 78,417 $2,054 $ (190) $ 80,281
========= ====== ======== ========
Securities held to maturity at December 31, 1998 consist of the following:
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---- ----- ------ -----
(In Thousands of Dollars)
US Government & Federal Agencies 4,718 41 (4) 4,755
State & Local Governments 6,493 199 (12) 6,680
Mortgage-backed Securities 2,715 23 -- 2,738
-------- ------ ------- --------
$ 13,926 $ 263 $ (16) $ 14,173
======== ====== ======= ========
Three Months Ended
March 31,
1999 1998
---- ----
(In Thousands of Dollars)
Gross proceeds from sales of securities 502 200
======== =========
Gross Gains on Sale of Securities -- 1
Gross Losses on Sale of Securities -- --
-------- ---------
Net Securities Gains (Losses) -- 1
======== =========
8
ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
3. Loans
Major classifications of loans are as follows:
March 31, December 31,
1999 1998
---- ----
(In Thousands of Dollars)
Commercial 33,318 30,105
Agriculture 5,204 6,068
Real estate mortgage:
Construction 13,476 13,935
Residential (1-4 family) 55,099 52,632
Home Equity Lines 15,365 15,939
Commercial 48,650 48,788
Agricultural 4,011 3,044
Loans to individuals for household,
family and other consumer expenditures 39,256 39,564
All Other Loans 1581 672
--------- --------
215,960 210,747
Less Unearned Income (577) (590)
--------- --------
Less Allowance for Loan Losses (2555) 2,424)
--------- --------
$212,828 $207,733
========= ========
The following schedule summarizes the changes in the allowance for loan and
lease losses:
Three Months Three Months
Ending Ending
March 31, March 31, December 31,
1999 1998 1998
---- ---- ----
(In Thousands of Dollars)
Balance, Beginning 2,424 2,430 2,430
Provision Charged Against Income 72 110 477
Recoveries 150 34 110
Loans Charged Off (91) (100) (593)
-------- -------- ---------
Balance, Ending $ 2,555 $ 2,474 $ 2,424
======== ======== =========
Nonperforming assets consist of the following:
March 31, December 31,
1999 1998
---- ----
(In Thousands of Dollars)
Nonaccrual Loans $ 479 $ 681
Restructured Loans -- --
-------- --------
Nonperforming Loans 479 681
Foreclosed Properties 212 212
-------- --------
Nonperforming Assets $ 691 $ 893
======== ========
Total loans past due 90 days or more and still accruing were $1,645 on March 31,
1999 and $559 on December 31, 1998.
9
ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
4. Earnings Per Share
The following shows the weighted average number of shares used in
computing earnings per share and the effect on weighted average number of
shares of diluted potential common stock income available to common
shareholders.
March 31, 1999 March 31, 1998
-------------- --------------
Per Share Per Share
Shares Amount Shares Amount
------ ------ ------ ------
Basic Earnings Per Share 4,181,930 $ .24 4,153,532 $ .25
Effect of dilutive securities:
Nonemployee directors' stock options 24,269 44,351
Employee incentive stock options 59,500 68,226
--------- ---------
Diluted Earnings Per Share 4,265,699 $ .23 4,266,109 $ .24
========= ======= ========= =======
5. Capital Requirements
A comparison of the Company's capital as of March 31, 1999 with the
minimum requirements is presented below:
Minimum
Actual Requirements
------ ------------
Tier I Risk-based Capital 17.26% 4.00 %
Total Risk-based Capital 17.87% 8.00 %
Leverage Ratio 11.75% 4.00 %
10
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
The following presents management's discussion and analysis of the consolidated
financial condition and results of operations of Atlantic Financial Corp. (the
"Company") as of the dates and for the periods indicated. This discussion should
be read in conjunction with the Company's Consolidated Financial Statements and
the Notes thereto, and other financial data appearing elsewhere in this report.
Results of Operations
The Company experienced moderate balance sheet expansion during the first
quarter 1999, with total assets increasing $10.4 million, or 2.9% over December
31, 1998. Growth was funded with new interest bearing deposits, which reflected
a $9.9 million, or 3.8% increase, for the three months ending March 31, 1999.
Loan demand was moderate during the first quarter, evidenced by net loans
increasing $5.1 million, or 2.5%, over December 31, 1998. Competition for loans
intensified primarily relative to pricing as all banks in the Company's trade
area were experiencing similar moderation in overall loan demand. The Company
has been reluctant to match all competitor pricing bids when the credit quality
does not match the pricing structure. Put another way, the risk / rate
relationship continues to represent a major portion of the underwriting
practices of the Company.
Asset quality continues to be sound with problem credits considered to be at
satisfactory and manageable levels. Total loans past due 30 days or more equaled
$7.6 million (3.52% of total outstandings). Included in the 30 day total are
$1.6 million, which are 90 days or more past due and still accruing interest.
Non-accrual loans totaled $479,000 at March 31, 1999, which represented 0.22% of
total outstanding loans and 18.75% of the loan loss reserve. Foreclosed
properties totaled $212,000 at March 31, 1999, with potential losses expected to
be minimal. The provision for loan losses was $72,000 in the first quarter 1999.
Gross charge-offs for the quarter were $91,000, while total recoveries were
$151,000.
The Allowance for Loan and Lease Losses (ALLL) equaled $2.56 million March 31,
1999, comfortably above the Company's overall target of 1.10% of total
outstanding loans. Additionally, the Company has begun a documented system for
internal loan classifications to more accurately identify ongoing credit risk
imbedded within the loan portfolio. Utilizing the results of this system to test
the adequacy of the ALLL also indicates that the ALLL is sufficient to safeguard
the Company in light of known or identified potential loan loss risks.
The Company maintained its practice during the first quarter of selling Federal
funds, having sold continuously on a daily basis in amounts averaging $26.0
million, 7.22% of average total assets. These figures compare to $20.5 million
and 6.50%, respectively, for the first quarter 1998. The quarter-end balance of
$28.2 million represented a $1.3 million (or 4.41%) decrease from December 31,
1998.
The level of the investment account increased approximately $1.9 million (2.06%)
during the first quarter 1999, ending the period at $96.1 million or 25.94% of
total assets. The portfolio was used to absorb some of the rapid deposit growth
which occurred during the first quarter while loan demand, discussed above, was
too soft to fully employ all of the deposit expansion. The portfolio is
comprised of 1% US Treasuries, 54% US Government Agencies and Mortgage-backed
Securities, 37% State, County and Municipal governments, and 8% other debt and
equity securities.
The Financial Accounting Standards Board (FASB) Statement 115 stipulated the way
in which banks must classify and account for their securities portfolio,
beginning with the first quarter of 1994. Securities are classified as
Investment Securities when management has both the intent and the ability at the
time of purchase to hold the securities until maturity. Investment Securities
are carried at cost adjusted for amortization of premiums and accretion of
discounts. Securities which are held for an indefinite period of time are
classified as Securities Available for Sale and are marked to market at each
financial reporting date, or at each month-end. Securities Available for Sale
include securities that may be sold in
11
response to changes in interest rates, changes in the security's prepayment
risk, increases in loan demand, general liquidity needs and other similar
factors.
Management has implemented additional tools for the measurement of three
critical elements in portfolio management: interest rate risk, call and/or
extension risk and maturity distribution. Activities of the Bank's Asset
Liability Committee (ALCO) will include establishing parameters for the
effective modified duration (EMD) for the portfolio in the future. With better
tools to monitor duration, long-term earnings performance of the portfolio is
expected to demonstrate improved stability over varying interest rate cycles.
These parameters will also draw a tighter relationship between EMD and bond
convexity. Convexity measures the percentage amount of portfolio price
appreciation if interest rates fall 1% relative to the percentage of price
depreciation if interest rates rise 1%. The more a bond declines relative to its
depreciation, the higher the negative convexity and, consequently the more
potential call and extension risk that bond is likely to have. Relative to the
current EMD, management is targeting an overall portfolio negative convexity of
not more than .70. Currently, the portfolio's negative convexity is slightly
below this target level.
Deposits represent 98.5% of total liabilities of the Company, including
non-interest bearing checking accounts which represent 15.3% of total deposits
on March 31, 1999.
Earnings
Net income for the first quarter 1999 decreased to $998,000, compared to
$1,033,000 for the first quarter 1998. Flat earnings were expected due to
several growth initiatives occurring in the third and fourth quarters of 1998,
plus several capital investments in the technology area, also in the second half
of 1998. These are discussed further below. The negative impact to earnings is
expected to be temporary.
Net interest income for the first quarter 1999 (tax equivalent interest income
less interest expense) totaled $3.8 million (a 7.41% increase over the first
quarter 1998), while the net interest margin (tax equivalent net interest income
expressed as a percentage of average earning assets) declined from 4.83% in the
first quarter 1998 to 4.76% in the first quarter 1999. The average yield on
interest earning assets declined 15 basis points during a time when the average
rate on interest bearing liabilities declined only 6 basis points. As a result,
the 8.76% increase in interest income for the first quarter 1999 compared to
first quarter 1998 was offset by a 10.55% increase in interest expense for the
same period. The challenge to attract and retain consumer certificates of
deposits in a falling interest rate environment has been the major cause of
compression of the net interest margin. Non-bank investment alternatives for
consumers result in consumers' reluctance to accept the full brunt of the
decline in interest rates. Therefore, the Company cannot always reduce cost of
funds in a one-to-one relationship with yield on earning assets during falling
rate cycles.
Non-interest expense for the first quarter totaled $2.9 million, compared to
$2.4 million in the first quarter 1998. Installation, in March and April of
1998, of new item processing software utilizing image technology resulted in
capitalized expenditures approximating $500,000, resulting in increased
depreciation of more than $10,000 per month. New branch offices opened in the
third and fourth quarters of 1998 also caused increases in depreciation and
other occupancy expenses, as well as personnel expense. The computer conversions
of BOF and BSS to the data processing center of PTB in the third and fourth
quarters of 1998 further contributed to increased depreciation expense through
required upgrades to computer hardware and telecommunications.
12
Capital and Liquidity
Equity capital at March 31, 1999 totaled $43.5 million, representing 11.7% of
total assets. This level is adequate to support both current operations, as well
as asset growth to a level in excess of $450 million.
Liquidity is provided by both excess funds in the form of Federal funds sold and
access to the Federal funds market through the purchase of Federal funds from
correspondent banks. The Company maintains deposit relationships with several
correspondent banks which include commitments through various lines of credit
for short-term borrowing needs. Federal funds sold equaled 24.1% of total demand
deposits at March 31, 1999. The Company, through two of its subsidiary banks, is
a member of the Federal Home Loan Bank of Atlanta. This membership affords the
Company various credit vehicles. The level of balance sheet liquidity and
available credit facilities is considered adequate to meet anticipated deposit
withdrawals and expected loan demand from normal operations. However, as
discussed further below, liquidity planning in anticipation of potential
increased demand for funds in the second half of this year (and more importantly
the fourth quarter) will dictate more sophisticated exercises and possibly
greater levels of liquidity.
Future Plans
The Company continues to explore branch expansion opportunities for its banking
operations; however, it has secured only one site for such growth. That site is
located on U. S. Route 17 in Gloucester Point, Virginia. The Company is also
interviewing prospective candidates to staff a new relationship with UVEST for
the sale of fixed and variable rate annuity products to enhance non-interest
income.
Year 2000 Issue
The Company utilizes and is dependent upon data processing systems and software
to conduct its business. The data processing systems include various software
packages licensed to the Company by outside vendors and a mainframe processing
system, which are run on in-house computer networks. All of these systems are
vulnerable to the Year 2000 (Y2K) issue. The Company's Board of Directors has
addressed the Y2K issue and identified the seriousness of the challenge. The
Directors receive routine reports from management of the Company to enable them
to monitor the Company's progress in its preparation for Y2K readiness. The
Board has passed a resolution authorizing management to commit the full
financial and human resources of the Company to achieve satisfactory Y2K
readiness with a minimum of disruption to ordinary operations. The Company's Y2K
coordinator, who was hired in 1997, commits approximately 75% of her schedule to
the Y2K project. In addition, a Y2K project team was formed and meets regularly
to review and ensure consistent progress in moving toward Y2K readiness.
In 1997, the Company initiated a review and assessment of all hardware and
software to confirm that it will function properly in the year 2000. The Company
inventoried more than 70 applications on which it relies for its routine
operations. The degree of reliance was evaluated, with each application being
identified as either mission critical, mission necessary or mission desirable.
An application was deemed mission critical if it is vital to the successful
continuation of a core business activity. The Federal Financial Institutions
Examination Council (FFIEC) has issued several inter-agency statements providing
guidance and/or requirements of all financial institutions. Included in this
guidance was an emphasis that mission critical applications be identified and
related priorities be set by the end of the third quarter of 1998. Based on this
regulatory guidance, the Company's inventory process identified twelve mission
critical applications, all of which are associated with information technology
(IT). There were no non-IT systems identified as mission critical. Such systems
might include elevators or other equipment with embedded micro-controllers that
may be century date sensitive. The Company currently has only two elevators
throughout its branching network. In each of these locations, all business
activities can be conducted in the event that the elevators are rendered
inoperable. Other non-IT systems include electricity and telephone line
communications. Both of these are necessary for daily operations but are
considered to be beyond the Company's control to facilitate Y2K readiness. The
Company is communicating with the providers of these services to monitor their
progress toward Y2K readiness. The Company possesses and routinely tests a
gasoline-powered generator for temporary electrical power for
13
its primary computer room operations. This form of backup power provides limited
business continuation features to the Company in the area of processing customer
information in its core data processing package. Therefore, the Company believes
that the integrity of critical customer information will be protected.
Based on the assessment described above, the Company's mainframe hardware (an
IBM AS-400) and banking software are currently Y2K compliant. The Company's core
data processing package is currently installed in more than 200 banks across the
country. The vendor of this software, Jack Henry & Associates (JHA) has
completed their testing of the software and distributed the software release to
provide for Y2K compliance. However, JHA is also facilitating a process for
independent user group testing in order for the user banks to test their live
customer data files in a non-production test environment. Members of the Federal
Reserve System, FDIC, and OCC met JHA management to discuss and review the
process of User Group Testing. The regulatory authorities, while unable to issue
an approval of the specific JHA plan, did specify that User Group Testing was an
acceptable method for testing Y2K readiness. The Company was one of the users
selected for the user group testing. This test was conducted in December 1998.
Total cost to the Company including the vendor's certification, third party
certification of the vendor's testing, user group testing and third party
certification of the latter's test was less than $10,000. Considerable planning
went into the writing of test scripts to assess the impact of the century date
change on the processing of transactions that affected date sensitive data
fields as well as interest accruals. These transactions were processed on a
mainframe on which the system date had been advanced to January 01, 2000. Normal
daily processing was conducted throughout the first quarter of 2000. All test
transactions were considered successful as related to Y2K. It is also important
to note that JHA Liberty Banking System received an ITAA*2000 certification from
the Information Technology Association of America indicating it meets the
information technology industry's best software development practices for
addressing the Year 2000 issue.
Two of the affiliate banks, BOF and BSS, were operating non-Y2K ready core data
processing systems prior to the merger of UCB and MACB. These two banks were
converted to the JHA Liberty product discussed above and are processed in the
Company's centralized data center. For these two banks, there was more
substantial expense associated with Y2K readiness preparation. These accumulated
historical costs approximated $100,000, bringing the total for the Company to
approximately $125,000.
For certain other systems, the Company has determined that it will have to
replace or modify certain pieces of hardware and/or software so that the systems
will properly function in the year 2000. The third party vendors of these
systems have been contacted and have indicated that the hardware and/or software
will be Y2K compliant. Modifications and/or replacements depend on the
individual vendor and their respective products. During the first quarter of
1999, the Company installed Y2K updates in each of its ATMs based on each
respective vendor's recommendation.
The Company utilizes an extensive network of personal computers (PCs) in its
daily operations. With the rapid changes in technology in the past 10 years, the
Company adopted a philosophy more than five years ago that acknowledged that the
average useful life of PCs was in the three-to four-year time range. Having
embraced this philosophy previously, replacement of PCs is a part of routine
hardware planning. Currently, approximately 30% of the Company's PCs are viewed
as nearing the end of their useful life even absent any Y2K considerations.
Throughout the first quarter of 1999, the Company has purchased hardware and
software upgrades in its PC workstation and network communications area, with an
approximate capitalized cost of $35,000 and associated increase in depreciation
expense of $1,000 per month for the useful life of the asset. This
renovation/replacement process also has included one-time consultant and
installation costs approximating $5,000. Additional one-time costs may approach
$20,000 during the next two quarters. Management considers that its total
requirement in hardware expenditure associated with Y2K readiness will not have
a significant negative effect on the Company's total earnings performance. It is
anticipated that the total future costs directly associated with the Y2K project
will not exceed $250,000 (approximately 6.25% of projected 1999 net income).
The Company has implemented a process by which all significant loan and deposit
customers have been contacted to determine the extent to which the Company is
vulnerable to those third parties' failure to
remedy their own Y2K issue. Loan officers have received training to include a
Y2K understanding in the credit decision making process. Existing borrowers have
been evaluated to determine the risk that Y2K poses to their respective cash
flow capacities or other related factors that may impact their ability to repay
their loans. The Company is also working with borrowers who have current line of
credit commitments to properly plan for the liquidity requirements of the
Company to fund greater than normal line of credit draw requests. In this same
vein, deposit customers are being evaluated to produce some basis for projecting
possible interruption to daily deposit inflows. While the Company does not
intend to abandon meeting the credit needs of its community, it has adopted a
more conservative position in its lending associated with overall liquidity
planning as well as credit evaluation of borrowing requests. Also in the
interest of liquidity, the Company will be more aggressive in its pricing of
certificates of deposit with maturities that extend beyond the Year 2000. This
position should reduce the possibility of deposit runoff during the fourth
quarter of 1999 and first quarter of the year 2000.
The Company plans to complete the majority of the Y2K project by the second
quarter of 1999. Cash expenditures are not expected to have a large material
effect on the Company's consolidated financial statements. The Company will
evaluate before June 30, 1999, the loss of income that may result from increased
liquidity in the form of above normal levels of cash and increased volumes of
lower yielding overnight Fed funds sold. The following tables present the
Company's overall progress of its mission critical applications.
Year 2000 Plan - Planned Number of Mission Critical Applications In Each Phase
Year 2000 Plan
- --------------------------------------------------------------------------------------------------------------
Phase 12/31/97 3/31/98 6/30/98 9/30/98 12/31/98 3/31/99 6/30/99 9/30/99 12/31/99
- --------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------
Awareness - - - - - - - - -
- --------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------
Assessment 9 6 2 1 - - - - -
- --------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------
Renovation 3 6 7 8 5 - - - -
- --------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------
Validation - - 3 3 7 9 - - -
- --------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------
Implementation - - - - - 3 12 12 12
- --------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------
TOTAL 12 12 12 12 12 12 12 12 12
- --------------------------------------------------------------------------------------------------------------
Year 2000 Plan - Planned Percentage of Completion by Phase
Year 2000 Plan
- --------------------------------------------------------------------------------------------------------------
Phase 12/31/97 3/31/98 6/30/98 9/30/98 12/31/98 3/31/99 6/30/99 9/30/99 12/31/99
- --------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------
Awareness - - - - - - - - -
- --------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------
Assessment 75 50 17 8 - - - - -
- --------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------
Renovation 25 50 58 67 42 75 - - -
- --------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------
Validation - - 25 25 58 25 - - -
- --------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------
Implementation - - - - - - 100 100 100
- --------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------
TOTAL 100 100 100 100 100 100 100 100 100
- --------------------------------------------------------------------------------------------------------------
The Company has an internal Y2K committee comprised of Senior Management, other
officers, and staff under the direction of the Company's Executive Vice
President and Chief Financial Officer. The committee meets monthly and
subsequently reports on its activities to the Board of Directors. The Board
passed a resolution in 1998 committing all of the financial and human resources
necessary to enable the Company to satisfactorily achieve Y2K readiness and to
conduct normal operations beyond the century date change with minimal disruption
to either the quantity or quality of customer service.
The Company is developing contingency plans to address risks associated with Y2K
issues. These plans include remediation contingency plans, Y2K business
resumption contingency plans, and event
management plans. Remediation contingency covers the actions that may be
required if the current approach to remediating a mission critical application
is falling behind schedule or may not be completed when required. The Company
has substantially completed its remediation contingency plans. The Company
already had in place a documented and tested disaster recovery plan. This plan
is being expanded and enhanced to incorporate the elements of the Y2K challenge.
The Company will substantially complete and implement its business resumption
contingency plan by June 30, 1999. The plan, currently being developed, will
identify core business processes and detail each step in these processes for
identification of alternate methods and means of completing such steps in the
event of failure of current systems. Business impact analysis is being
accomplished through the use of risk analysis worksheets to assess among other
things the probability of certain failures, the expected warning time, the
consequences of such failure, and the weight that should be applied to system
component failure in the overall operation of a specific system or department.
An example of a core business process is taking a deposit. Every step of this
process is being flowcharted to establish rudimentary, manual alternatives in
the event of a failure of internal computer systems, loss of electrical power,
or loss of telecommunication lines. Business resumption may also be dependent on
backup or saved information from prior to year-end 1999. Therefore, all computer
processing during December, 1999 will be amended to include changes in backup
save routines, printing hardcopy reports normally only saved to optical disks,
rotation of backup media to name a few. The Company is continuing direct
communication with customers to minimize unwarranted public alarm that could
cause serious problems for financial institutions.
As a part of the Company's normal disaster recovery plan, it has decided to add
generator power for its two remote item capture / check processing centers and
to upgrade its existing generator power for its Glenns, Virginia Operations /
Data Center. The Glenns site will be capable of operating not only data
processing and bookkeeping functions, but also a full service banking branch
office. These efforts will enable the Company to meet customer needs in the case
of a natural disaster with extended electrical power outages. It will also
complement Y2K business resumption plans in the case of a Y2K related
interruption of electricity.
The Company has established a series of trigger dates associated with core
application products that govern primarily the customer loan and deposit data
bases. These applications address production of new and renewal loan and deposit
accounts as well as maintenance of ongoing customer relationships. The trigger
dates started November 30, 1998 and concluded on March 31, 1999. Through the
various testing methods that management has selected to validate the readiness
of these applications, management has determined that all current vendors will
be Y2K ready and that the Company will continue to utilize all existing
applications.
Worst-case analysis
Until the year 2000 event actually occurs, and for a period thereafter, there
can be no assurance that there will be no problems related to the year 2000.
Worst-case scenarios would indicate that if Y2K issues are not adequately
addressed by the Company as well as third parties, the Company could face, among
other things, business disruptions, operational problems, financial losses,
legal liability and similar risks, and the Company's business, results of
operations and financial position could be materially adversely affected. The
Company's credit risks associated with borrowers may increase to the extent
borrowers fail to prepare for Y2K in ways that impact their cash flow and
capacity to repay. As a result there may increases in the Company's problem
loans, non-performing assets, and credit losses in future years. Additionally
the Company may be subject to increased liquidity risks associated with
excessive cash withdrawals and/or abnormally high draws against borrowers' lines
of credit. It is not possible to quantify the potential impact of any such risks
or losses at this time. Temporary closings of individual offices could
materialize, but would do so only under the allowances provided by the banking
regulatory authorities. Bank customers should note that FDIC deposits are
considered safe.
The Company is cognizant of and sensitive to the potential risks associated with
the Year 2000 challenge. However, in its efforts to be prepared, the Company
also sees a social responsibility to calm public anxiety and potential panic
where verifiable preparedness can be identified.
16
Forward Looking Statements
The foregoing year 2000 discussion contains "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements, including, without limitation, anticipated costs, the dates by which
the Company expects to complete remediation and testing of systems and
contingency planning, and the impact of the redeployment of existing staff, are
based on management's best current estimates, which were derived utilizing
numerous assumptions about future events, including the continued availability
of certain resources, representations received from third-party vendors and
other factors.
However, there can be no guarantee that these estimates will be achieved and
actual results could differ materially from those plans. Specific factors that
might cause such material differences include, but are not limited to, the
availability of personnel trained in this area, the ability of third party
vendors to correct their software and hardware, the ability of significant
customers to remedy their Y2K issues, and similar uncertainties.
The foregoing Year 2000 discussion constitutes a Year 2000 Readiness Disclosure
within the meaning of the Year 2000 Readiness and Disclosure Act of 1998.
Other information contained in this report may also include "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. These forward-looking statements are generally identified by phrases
such as "the Company expects," "the Company believes" or words of similar
import. Such forward-looking statements involve known and unknown risks
including, but not limited to, changes in general economic and business
conditions, interest rate fluctuations, competition within and from outside the
banking industry, new products and services in the banking industry, risk
inherent in making loans such as repayment risks and fluctuating collateral
values, problems with technology utilized by the Company (as described above),
changing trends in customer profiles and changes in laws and regulations
applicable to the Company. Although the Company believes that its expectations
with respect to the forward-looking statements are based upon reliable
assumptions within the bounds of its knowledge of its business and operations,
there can be no assurance that actual results, performance or achievements of
the Company will not differ materially from any future results, performance or
achievements expressed or implied by such forward-looking statements.
17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings - None
Item 2. Changes in Securities and Use of Proceeds - None
Item 3. Defaults Upon Senior Securities - None
Item 4. Submission of Matters to a Vote of Security Holders - None
Item 5. Other Information - None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27 Financial Data Schedule (filed electronically only).
(b) Reports on Form 8-K.
On February 16, 1999, the Company filed a Current Report on
Form 8-K/A to amend a Form 8-K dated December 1, 1998, which
announced the consummation of the Company's merger with United
Community Bankshares, Inc. (UCB), to include the financial
statements of UCB and pro forma financial information.
18
SIGNATURES
Pursuant to the requirements 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.
ATLANTIC FINANCIAL CORP.
Date: May 14, 1999 BY /s/ W. J. Farinholt
---------------------------------
W. J. Farinholt, President & CEO
Date: May 14, 1999 BY /s/ Kenneth E. Smith
---------------------------------
Kenneth E. Smith, Exec. Vice President
& Chief Financial Officer
19