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 June 30, 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 June 30, 1999.
Common stock, $5 par value--4,192,185
INDEX
ATLANTIC FINANCIAL CORP. Page No.
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets--
June 30, 1999 and December 31, 1998 3
Consolidated Statements of Income--
Six months ended June 30, 1999 and 1998
Three months ended June 30, 1999 and 1998 4
Consolidated Statements of Stockholders' Equity--
Six months ended June 30, 1999 and 1998 5
Consolidated Statements of Cash Flows--
Six months ended June 30, 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 - 18
Part II. Other Information: 19
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
Part I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
ATLANTIC FINANCIAL CORP.
CONSOLIDATED BALANCE SHEETS
(In Thousands of Dollars)
(Unaudited) (Audited)
June 30, December 31,
ASSETS: 1999 1998
---------------- ---------------------
Cash and due from banks $ 14 264 $ 11 782
Securities available for sale (at market value) 88 854 80 281
Securities held to maturity (market value of
$10,768 and $14,173, respectively) 10 811 13 926
Federal funds sold 22 152 29 524
Loans, net 220 598 207 733
Premises and equipment 10 710 10 703
Other real estate owned 169 212
Other assets 6 782 6 142
---------- ----------
TOTAL ASSETS $ 374 340 $ 360 303
========== ==========
LIABILITIES:
Deposits
Non-interest bearing $ 51 014 $ 49 291
Interest-bearing 275 232 263 019
---------- ----------
TOTAL DEPOSITS 326 246 312 310
Short-term debt 1 139 1 589
Other liabilities 3 985 3 275
---------- ----------
TOTAL LIABILITIES 331 370 317 174
---------- ----------
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 4,192,185 and 4,168,941
shares, respectively 20 965 20 851
Surplus -- --
Undivided profits 22 227 21 048
Accumulated other comprehensive
income, net (222) 1 230
---------- ----------
TOTAL STOCKHOLDERS' EQUITY 42 970 43 129
---------- ----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 374 340 $ 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)
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
---- ---- ---- ----
>
INTEREST INCOME:
Loans and Fees $ 5 244 $ 4 926 $ 10 323 $ 9 580
Federal Funds Sold 290 220 590 496
Investment Securities 1 478 1 374 2 854 2 656
--------- --------- -------- --------
Total Interest Income 7 012 6 520 13 767 12 732
INTEREST EXPENSE:
Interest on deposits 3 020 2 797 5 977 5 479
Interest on federal funds purchased
and other borrowings 26 7 42 15
--------- --------- -------- --------
Total Interest Expense 3 046 2 804 6 019 5 494
--------- --------- -------- --------
Net Interest Income 3 966 3 716 7 748 7 238
PROVISION FOR LOAN
AND LEASE LOSSES 137 176 209 286
--------- --------- -------- --------
Net Interest Income After
Provision for Loan
and Lease Losses 3 829 3 540 7 539 6 952
OTHER INCOME:
Service Charges & Fees 515 546 1 061 1 001
Securities Gains (Losses) 1 -- 1 1
--------- --------- -------- --------
Total Other Income 516 546 1 062 1 002
OTHER EXPENSES:
Salaries & Employee Benefits 1 606 1 370 3 136 2 666
Occupancy Expenses 238 202 469 378
Furniture & Equipment Expenses 439 322 830 566
Other Operating Expenses 766 704 1 516 1 378
--------- --------- -------- --------
Total Other Expenses 3 049 2 598 5 951 4 988
--------- --------- -------- --------
Income Before Income Taxes 1 296 1 488 2 650 2 966
Applicable Income Taxes 335 448 691 892
--------- --------- -------- --------
Net Income $ 961 $ 1 040 $ 1 959 $ 2 074
========= ========= ======== ========
Earnings Per Share, Basic .23 .25 .47 .50
========= ========= ======== ========
Earnings Per Share, Assuming
Dilution .23 .24 .46 .48
========= ========= ======== ========
Notes to financial statements are an integral part of these statements.
4
ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the six months ended June 30, 1999
(In Thousands of Dollars)
(Unaudited)
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 - - - - - - 1 959 - - $1 959 1 959
Other comprehensive income:
Unrealized holding gains (losses) on
securities available for sale arising
during the period net of tax of $(748) (1 452) - -
-------
Other comprehensive income, net of tax - - - - - - - - (1 452) (1 452) (1 452)
-------
Total comprehensive income - - - - - - - - - - $507 - -
=======
Acquisition of common stock (11) (26) (37)
Exercise of stock options 127 (2) - - - - - - 125
Cash dividends - - - - - - (754) - - (764)
------- --- ------ ------- ---- -------
Balance, June 30, 1999 $20 961 $4 $ - - $22 227 $222 $42 970
======= == ====== ======= ==== =======
Notes to financial statements are an integral part of these statements.
5
ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands of Dollars)
(Unaudited)
Six Months Ended
June 30,
1999 1998
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 1 959 $ 2 074
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 337 347
Deferred tax 320 --
Provision for loan losses 209 286
Amortization of premiums, net 47 54
(Gain) on sale of securities available for sale (1) (1)
(Gain) on sale of other real estate owned (14) --
(Gain) on sale of premises and equipment (1) (3)
Changes in assets and liabilities:
(Increase) decrease in accrued interest receivable 36 (144)
(Increase) decrease in other assets 7 (1 112)
Increase in accrued interest payable 27 215
Increase (decrease) in other liabilities 334 (171)
------------ ----------
Net Cash Provided by Operating Activities $ 3 260 $ 1 545
------------ ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase) in loans (13 073) (14 553)
Purchase of securities available for sale (23 779) (16 089)
Proceeds from sales of securities available for sale 1 619 200
Proceeds from calls and maturities of securities available for sale 10 376 8 686
Purchase of securities held to maturity - - (5 682)
Proceeds from calls and maturities of securities held to maturity 3 114 4 526
Proceeds from sale of other real estate 79 --
Purchase of premises and equipment (323) (2 465)
Proceeds from sales of premises and equipment 1 3
------------ ----------
Net Cash (Used In) Investing Activities ($ 21 986) ($ 25 374)
------------ ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in deposits $ 13 936 $ 18 771
Acquisition of common stock (36) --
Issuance of common stock 127 250
Proceeds from long-term debt 1 550 --
Net increase (decrease) in short-term borrowings (439) 600
Cash dividends paid (1 302) (858)
------------ ----------
Net Cash Provided by Financing Activities $ 13 836 $ 18 763
------------ ----------
Net Increase In Cash and Cash Equivalents (4 890) (5 066)
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 41 306 32 550
------------ ----------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 36 416 $ 27 484
============ ==========
Notes to financial statements are an integral part of these statements.
6
ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 June
30, 1999 and December 31, 1998, and the results of operations and cash
flows for the six months ended June 30, 1999 and 1998.
The results of operations for the six months ended June 30, 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:
June 30, 1999
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---- ----- ------ -----
(In Thousands of Dollars)
US Treasury Securities $ 867 $ 1 $ 3 $ 865
US Government Agencies & Corporations 30 456 66 750 29 772
Obligations of States & Political Subdivisions 30 339 275 378 30 236
Mortgage-backed Securities 19 746 15 455 19 306
Corporate Debt Obligations 4 199 5 74 4 131
Restricted Stock 647 -- -- 647
Other Securities 2 934 1 031 67 3 897
-------- --------- -------- --------
$ 89 188 $ 1 393 $ 1 727 $ 88 854
======== ========= ======== ========
Amortized cost and carrying amount (estimated fair value) of securities held
to maturity are summarized as follows:
June 30, 1999
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---- ----- ------ -----
(In Thousands of Dollars)
US Government Agencies & Corporations $ 2 743 $ 3 $ 62 $ 2 684
Obligations of States & Political Subdivisions 5 861 58 20 5 899
Mortgage-backed Securities 2 207 -- 22 2 185
-------- ------ ------- -------
$ 10 811 $ 61 $ 104 $10 768
======== ====== ======= =======
7
ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
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
======== ====== ======= ========
Six Months Ended
June 30,
1999 1998
(In Thousands of Dollars)
Gross proceeds from sales of securities 1 619 391
======== =========
Gross Gains on Sale of Securities 3 1
Gross Losses on Sale of Securities 3 --
-------- ---------
Net Securities Gains (Losses) -- 1
======== =========
8
ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
3. Loans
Major classifications of loans are as follows:
June 30, December 31,
1999 1998
---- ----
(In Thousands of Dollars)
Commercial $ 30 734 $ 30 105
Agriculture 6 691 6 068
Real estate mortgage:
Construction 15 923 13 935
Residential (1-4 family) 57 238 52 632
Home Equity Lines 15 910 15 939
Commercial 52 675 48 788
Agricultural 4 956 3 044
Loans to individuals for household,
family and other consumer expenditures 39 233 39 564
All Other Loans 437 672
--------- --------
223 797 210 747
Less Unearned Income (583) (590)
Less Allowance for Loan Losses (2 616) 2 424)
$220 598 $207 733
========= ========
The following schedule summarizes the changes in the allowance for loan and
lease losses:
Six Months Six Months
Ended Ended December 31,
June 30, 1999 June 30, 1998 1998
------------- ------------- ----
(In Thousands of Dollars
Balance, Beginning $ 2 424 $ 2 430 $ 2 430
Provision Charged Against Income 209 286 477
Recoveries 181 51 110
Loans Charged Off 198 198 (593)
---------- ---------- ---------
Balance, Ending $ 2 616 $ 2 569 $ 2 424
======== ======== =========
Nonperforming assets consist of the following:
June 30, December 31,
1999 1998
------------------ ----------------
(In Thousands of Dollars)
Nonaccrual Loans $ 467 $ 681
Restructured Loans -- --
----------- ----------
Nonperforming Loans 467 681
Foreclosed Properties 169 212
--------- --------
Nonperforming Assets $ 636 $ 893
======== =======
Total loans past due 90 days or more and still accruing were $570 on June 30,
1999 and $559 on December 31, 1998.
9
ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
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.
June 30, 1999 June 30, 1998
------------- -------------
Per Share Per Share
Shares Amount Shares Amount
------ ------ ------ ------
Basic Earnings Per Share 4 185 685 $ .47 4 159 117 $ .50
Effect of dilutive securities:
Nonemployee directors' stock options 20 796 45 085
Employee incentive stock options 59 500 70 714
--------- ---------
Diluted Earnings Per Share 4 265 981 $ .46 4 274 916 $ .48
========= ======= ========= =======
5. Capital Requirements
A comparison of the Company's capital as of June 30, 1999 with the
minimum requirements is presented below:
Minimum
Actual Requirements
------ ------------
Tier I Risk-based Capital 16.99% 4.00 %
Total Risk-based Capital 18.03% 8.00 %
Leverage Ratio 11.62% 4.00 %
10
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
Forward-Looking Statements
Certain information contained in this discussion may include "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
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, 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.
General
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.
The Company is the parent bank holding company for Peninsula Trust Bank,
Incorporated (PTB), The Bank of Franklin (BOF) and The Bank of Sussex and Surry
(BSS) (the "Banks"). PTB, BOF and BSS are Virginia chartered banks that offer a
full range of banking services, principally to individuals and small to medium
size businesses in their respective market areas.
Results of Operations
The Company experienced flat balance sheet expansion during the second quarter
1999, with total assets increasing $3.7 million, or .99%, over March 31, 1999
and $14.0 million, or 3.90%, over December 31, 1998. Growth was funded primarily
with new interest bearing deposits, which reflected a $2.3 million, or .84%,
increase during the second quarter 1999 and a $12.2 million, or 4.64%, increase
during the first six months of 1999.
Deposits represent 98.5% of total liabilities of the Company, including
non-interest-bearing checking accounts that represent 15.6% of total deposits on
June 30, 1999.
Loan demand was moderate during the second quarter, evidenced by net loans
increasing $7.8 million, or 3.65%, over March 31, 1999 and $12.9 million, or
6.19%, 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.
The Company maintained its practice during the second quarter of selling Federal
funds, having sold continuously on a daily basis in amounts averaging $24.0
million, 6.52% of average total assets. The quarter-end balance of $22.2 million
represented a $6.1 million (or 21.56%) decrease from March 31, 1999 and a $7.4
million (or 24.97%) decrease from December 31, 1998. The Company purposely
reduced the level of these overnight investments in an effort to enhance
interest earnings. The majority of the decrease was employed in the purchase of
investment securities (bonds). Yields in the bond market have been rising during
recent months and reached levels not seen within the previous twelve
11
months. Management has attempted to capitalize on higher yields, with greater
call protection (early redemption privileges of the issuer), without unduly
compromising balance liquidity. Liquidity planning, however, will be receiving a
different level of scrutiny for the balance of the year for Year 2000 (Y2K)
purposes, discussed further below.
The level of the investment account increased approximately $3.5 million (3.66%)
during the second quarter 1999 and $19.4 million (24.2%) for the first half of
1999, ending the period at $99.7 million or 26.62% of total assets. The
portfolio is comprised of 1% US Treasuries, 54% US Government Agencies and
Mortgage-backed Securities, 36% State, County and Municipal governments, and 9%
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 held to maturity (HTM) when management has both the intent
and the ability at the time of purchase to hold the securities until maturity.
HTM securities are carried at cost adjusted for amortization of premiums and
accretion of discounts. Securities that are held for indefinite periods of time
are classified as securities available for sale (AFS) and are marked to their
respective market values at each financial reporting date, or at each month-end.
AFS securities include securities that may be sold in response to changes in
interest rates, changes in the security's prepayment risk, increases in loan
demand, general liquidity needs and other similar factors. The increased
volatility of interest rates during the most recent quarter has caused a
significant negative swing in the net unrealized loss in market value of the AFS
segment of the portfolio. Although these securities are identified as AFS,
management has never exercised a practice of selling securities prior to
maturity, nor is there an identifiable liquidity need which would require such
practices in the immediate future.
The Company uses earnings simulations, duration, and gap analysis to analyze and
project future interest rate risk. The investment portfolio, specifically, is
analyzed as to interest rate risk as well as call and extension risk. These
three elements combined will have a direct bearing on long term portfolio
profitability, both in terms of price change and, importantly, future yield. The
amount of interest rate risk and call and extension risk contained in the
portfolio will either stabilize or destabilize future Company earnings if
overall interest rates change. The best mathematical measurements of interest
rate risk and call and extension risk are effective modified duration (EMD) and
convexity, especially in today's environment with so many bonds containing
direct or indirect call options. 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.
Since many types of bonds are callable or can vary in average life as rates
change, the Company considers what effect this could have on market value, and
thus, potential earnings. Duration and Modified Duration are used without
negative convexity and, therefore, are not as accurate predictors of price
change when dealing with bonds that can have variable principal payouts
("callables", "mortgages"). Negative convexity is used in conjunction with EMD
and is useful when there is a chance of more than one average life or workout
date (maturity/call date). It reflects the fact that with these type bonds,
market prices will almost always decrease in value more than they increase given
the same rate shift up and down. EMD and convexity, when used together, provide
a close approximation of market price changes per 1% moves in interest rates.
Negative convexity usually works against the bondholder in both higher and lower
rate scenarios. Future investment strategies will attempt to position the
Company where it is less exposed to either extreme call risk or extreme
extension risk, and, thus reduce overall volatility of investment portfolio
performance in terms of earnings and market value.
Allowance for Loan Losses / Provision for Loan Loss Expense
Asset quality is sound with problem credits considered to be at satisfactory and
manageable levels. Total loans past due 30 days or more equaled $5.1 million
(2.29% of total outstandings). Included in the 30 day total is $570,000, which
are 90 days or more past due and still accruing interest. Non-accrual
12
loans totaled $470,000 at June 30, 1999, which represented 0.21% of total
outstanding loans and 17.97% of the loan loss reserve. Foreclosed properties
totaled $169,000 at June 30, 1999, with potential losses expected to be minimal.
The Allowance for Loan and Lease Losses (ALLL) equaled $2.62 million at June 30,
1999, comfortably above the Company's overall target of 1.10% of total
outstanding loans. Gross charge-offs for the quarter were $198,000, while total
recoveries were $181,000. The provision for loan losses expense was $137,000 in
the second quarter 1999 and $209,000 in the first half of 1999.
The provision reflects management's assessment of the adequacy of the ALLL to
absorb losses inherent in the loan portfolio due to deterioration of borrowers'
financial condition or changes in overall risk profile. Overall risk profile
considers several factors, as appropriate, such as historical credit loss
experience, current economic conditions, the composition of the total loan
portfolio, and assessments of individual credits within specific loan types.
The Company uses a documented system for internal loan classifications to
identify ongoing credit risk imbedded within the loan portfolio. Credit reviews
are based primarily on analysis of borrowers' cash flows, with pledged
collateral values and values of non-pledged borrower assets considered only as a
secondary source of repayment. Management's overall credit review process
assesses Year 2000 compliance / preparedness by borrowers. 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.
Earnings
Net income for the second quarter 1999 decreased to $961,000, compared to
$1,040,000 for the second quarter 1998 and $998,000 for the first quarter 1999.
Net interest income for the second quarter 1999 (tax equivalent interest income
less interest expense) totaled $3.97 million, a 6.7% increase over the second
quarter 1998. The Company continues to try to attract non-interest-bearing
deposits to mitigate negative pressure on the interest rate spread between
interest-earning assets and interest-bearing deposit liabilities. Until the
action of July 1, 1999, by the Federal Reserve System to raise short-term
interest rates, the general interest rate environment had been one of declining
rates. During this period, including the second quarter of 1998 through the
second quarter of 1999, average interest-sensitive asset yields have fallen
faster than average interest-sensitive deposit costs. As a result, the 7.5%
increase in interest income for the second quarter 1999 compared to second
quarter 1998 was offset by an 8.6% 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
net interest spreads. Non-bank investment alternatives persist in tempting and
even luring consumers away from traditional bank deposits, as consumers express
their reluctance to accept the full effect of the decline in interest rates.
Therefore, the Company cannot always reduce the cost of funds in a one-to-one
relationship with reductions of yields on earning assets during falling rate
cycles.
Non-interest expense for the second quarter totaled $3.0 million, compared to
$2.6 for the second quarter 1998. The primary contributors to the increase were
salary and fixed asset depreciation expenses, which were associated with the
opening, during the second half of 1998, of two branch offices by the Company's
lead subsidiary Peninsula Trust Bank (PTB). PTB practices extended office hours
and extensive computer automation in its branch network. Thus, each new office
produces significant overhead expense even during the start-up phase.
Historically, this has dampened earnings as PTB has opened new offices, even
when opening only one office. The impact of two new offices, within ninety days
of each other (July and October, 1998), has placed a more challenging burden on
operating earnings. Additionally, the merger related integration of BOF and BSS
into the Company's central data processing center involved substantial
investment in capitalized fixed assets and upgraded computer equipment during
the third and fourth quarters of 1998. This resulted in increased depreciation
expense
13
beginning in 1999. Thus, quarter over quarter comparisons of the second quarters
of 1999 and 1998, reflect the full impact by second quarter 1999 of these
improvements in technology.
Capital and Liquidity
Equity capital (net of accumulated other comprehensive income) at June 30, 1999
totaled $42.97 million, representing 11.48% of total assets. Cash stockholders'
equity (Total Stockholders' Equity, before adjustments for unrealized gains or
losses on AFS securities as described above) totaled $43.19 million for the same
period, or 11.54% of total assets, compared to $41.9 million, 11.63% of total
assets, on December 31, 1998. This amount of capital is more than adequate to
support current operations, as well as future growth of the balance to levels
approximating $475 million in total assets. The Company continues to attempt to
expand the balance at a pace greater than the rate of internal capital
generation, in an effort to improve return on equity and earnings per share.
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 that include commitments through various lines of credit for
short-term borrowing needs. Federal funds sold equaled 18.7% of total demand
deposits at June 30, 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 in the "Year 2000 Issue", 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
analytical 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. No definite date has
been established for opening an office on this site. The Company also continues
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. The Company has identified non-interest income as a critical component
of its strategic planning and is, therefore, exploring various avenues to
enhance this key element of future earnings.
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
14
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 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
15
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 has completed the majority of its Y2K preparations as of June 30,
1999. Cash expenditures have not had a material effect on the Company's
consolidated financial statements. The Company has formalized for all of its
subsidiaries a corporate contingency strategy, discussed below. A formal
liquidity plan has also been developed to address potentially unusual shifts in
customer habits related to credit line utilization, deposit activity, and cash
requirements. 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
- --------------------------------------------------------------------------------------------------------------
16
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 an omnibus 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's contingency strategy addresses risks associated with Y2K issues.
These issues 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 has been expanded and enhanced to incorporate
the elements of the Y2K challenge. The Company substantially completed and
implemented its business resumption contingency plan by June 30, 1999. The plan
identifies core business processes and details each step in these processes for
identification of alternate methods and means of completing such steps in the
event of failure of current systems. Potential system failures are being studied
for the varying effects of partial system failures compared to full system
failures. Business impact analysis is being performed 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. Each 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, and 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.
The Company has adopted a formal Event Plan Handbook for guiding personnel
through the periods prior to, during, and after the century date change. The
handbook covers, but is not limited to, such critical issues as vacation
policies, internal and external communication trees, rapid response teams,
recovery response teams, media relations, facilities management, and physical
security.
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.
17
The Company previously had 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 loans 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 expects 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.
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.
18
PART II. OTHER INFORMATION
Item 1. Legal Proceedings - None
Item 2. Changes in Securities - None
Item 3. Defaults Upon Senior Securities - None
Item 4. Submission of Matters to a Vote of Security Holders
On April 27, 1999, the Annual Meeting of Shareholders was held to
elect directors for a term of three years each and to ratify the appointment by
the Board of Directors of the firm of Yount, Hyde & Barbour, P.C. as the
Company's independent auditors for the year ending December 31, 1999. The
results of the votes on these matters are as follows:
(1) Election of Directors
Broker
For Against Withheld Non-Votes
Charles F. Dawson 3,382,124 0 29,161 0
William J. Farinholt 3,382,330 0 28,955 0
Harvey G. Pope 3,382,130 0 29,155 0
J. Russell West 3,382,130 0 29,155 0
Thomas Z. Wilke 3,382,227 0 29,058 0
(2) Ratification of Accountants
Broker
For Against Withheld Non-Votes
3,382,926 5,548 22,811 0
Item 5. Other Information - None
Item 6. Exhibits and reports on Form 8-K
a) Exhibits
27 Financial Data Schedule (filed electronically only)
b) Form 8-K - None
19
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: August 13, 1999 BY /s/ W. J. Farinholt
---------------------------------
W. J. Farinholt, President & CEO
Date: August 13, 1999 BY /s/ Kenneth E. Smith
---------------------------------
Kenneth E. Smith, Exec. Vice President
& Chief Financial Officer
20