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 September 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
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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 September 30, 1999.
Common stock, $5 par value--4,190,185
-------------------------------------
INDEX
ATLANTIC FINANCIAL CORP. Page No.
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets--
September 30, 1999 and December 31, 1998 3
Consolidated Statements of Income--
Nine months ended September 30, 1999 and 1998
Three months ended September 30, 1999 and 1998 4
Consolidated Statements of Stockholders' Equity--
Nine months ended September 30, 1999 and 1998 5
Consolidated Statements of Cash Flows--
Nine months ended September 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 - 19
Part II. Other Information: 20
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)
September 30, December 31,
ASSETS: 1999 1998
---------------- -----------------
Cash and due from banks $ 17 376 $ 11 782
Securities available for sale (at market value) 91 465 80 281
Securities held to maturity (market value of
$9,962 and $14,173, respectively) 10 072 13 926
Federal funds sold 3 889 29 524
Loans, net 225 554 207 733
Premises and equipment 10 623 10 703
Other real estate owned 374 212
Other assets 7 233 6 142
---------- ----------
TOTAL ASSETS $ 366 586 $ 360 303
========== ==========
LIABILITIES:
Deposits
Non-interest bearing $ 46 279 $ 49 291
Interest-bearing 272 653 263 019
---------- ----------
TOTAL DEPOSITS 318 932 312 310
Short-term debt 730 1 589
Other liabilities 3 873 3 275
---------- ----------
TOTAL LIABILITIES 323 535 317 174
---------- ----------
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 4,190,185 and 4,168,941
shares, respectively 20 950 20 845
Stock Options 4 6
Surplus -- --
Undivided profits 22 853 21 048
Accumulated other comprehensive
income, net (756) 1 230
---------- ----------
TOTAL STOCKHOLDERS' EQUITY 43 051 43 129
---------- ----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 366 586 $ 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 Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
---- ---- ---- ----
INTEREST INCOME:
Loans and Fees $ 5 375 $ 5 139 $ 15 680 $ 14 722
Federal Funds Sold 191 214 781 711
Investment Securities 1 571 1 359 4 425 4 015
-------- -------- -------- --------
Total Interest Income 7 137 6 712 20 886 19 448
INTEREST EXPENSE:
Interest on deposits 3 043 2 886 9 020 8 366
Interest on federal funds purchased
and other borrowings 29 25 71 39
-------- -------- -------- --------
Total Interest Expense 3 072 2 911 9 091 8 405
-------- -------- -------- --------
Net Interest Income 4 065 3 801 11 795 11 043
PROVISION FOR LOAN
AND LEASE LOSSES 136 89 345 375
-------- -------- -------- --------
Net Interest Income After
Provision for Loan
and Lease Losses 3 929 3 712 11 450 10 668
OTHER INCOME:
Service Charges & Fees 605 513 1 685 1 500
Securities Gains (Losses) -- -- 1 1
-------- -------- -------- --------
Total Other Income 605 513 1 686 1 501
OTHER EXPENSES:
Salaries & Employee Benefits 1 737 1 451 4 873 4 135
Occupancy Expenses 245 261 714 639
Furniture & Equipment Expenses 413 310 1 243 876
Other Operating Expenses 775 891 2 292 2 311
-------- -------- -------- --------
Total Other Expenses 3 170 2 913 9 122 7 961
-------- -------- -------- --------
Income Before Income Taxes 1 364 1 312 4 014 4 208
Applicable Income Taxes 337 368 1 028 1 191
-------- -------- -------- --------
Net Income $ 1 027 $ 944 $ 2 986 $ 3 017
======== ======== ======== ========
Earnings Per Share, Basic .25 .23 .71 .73
======== ======== ======== ========
Earnings Per Share, Assuming
Dilution .24 .22 .70 .71
======== ======== ======== ========
Notes to financial statements are an integral part of these statements.
4
ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the nine months ended September 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 - - - - - - 2 986 - - $ 2 986 2 986
Other comprehensive income:
Unrealized holding gains (losses) on
securities available for sale arising
during the period net of tax of $(1,023) (1 986) - -
-------
Other comprehensive income, net of tax - - - - - - - - (1 986) (1 986) (1 986)
-------
Total comprehensive income - - - - - - - - - - $ 1 000 - -
=======
Acquisition of common stock (22) (50) (72)
Exercise of stock options 127 (2) - - - - - - 125
Cash dividends - - - - - - (1 131) - - (1 131)
------- ------- ------- ------- ------- -------
Balance, September 30, 1999 $20 950 $ 4 $ - - $22 853 $ (756) $43 051
======= ======= ======= ======= ======= =======
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)
Nine Months Ended
September 30,
1999 1998
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 2 986 $ 3 017
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 941 573
Provision for loan losses 345 375
Amortization of premiums, net 76 48
(Gain) on sale of securities available for sale (1) (2)
(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 other assets 225 (1 543)
Increase (decrease) in other liabilities 790 (48)
---------- ----------
Net Cash Provided by Operating Activities $ 5 347 $ 2 417
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase) in loans (18 393) (21 670)
Purchase of securities available for sale (31 722) (23 010)
Proceeds from sales of securities available for sale 1 619 200
Proceeds from calls and maturities of securities available for sale 15 835 13 440
Purchase of securities held to maturity - - (5 682)
Proceeds from calls and maturities of securities held to maturity 3 854 6 480
Proceeds from sale of other real estate 79 --
Purchase of premises and equipment (798) (3 513)
Proceeds from sales of premises and equipment 1 3
---------- ----------
Net Cash (Used In) Investing Activities ($ 29 525) ($ 33 752)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in deposits $ 6 622 $ 21 319
Acquisition of common stock (72) --
Issuance of common stock 125 --
Net increase (decrease) in short-term borrowings (859) 2 392
Cash dividends paid (1 679) (640)
---------- ----------
Net Cash Provided by Financing Activities $ 4 137 $ 23 071
---------- ----------
Net Increase In Cash and Cash Equivalents (20 041) (8 264)
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 41 306 32 550
---------- ----------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 21 265 $ 24 286
========== ==========
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) and United
Community Bank (UCB). 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 September 30, 1999 and
December 31, 1998, and the results of operations and cash flows for the
nine months ended September 30, 1999 and 1998.
The results of operations for the nine months ended September 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:
September 30, 1999
----------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
----------------------------------------------------
(In Thousands of Dollars)
US Treasury Securities 862 1 2 861
US Government Agencies & Corporations 29 953 34 912 29 075
Obligations of States & Political Subdivisions 30 153 210 502 29 861
Mortgage-backed Securities 22 964 6 633 22 337
Corporate Debt Obligations 4 599 2 87 4 514
Restricted Stock 647 -- -- 647
Other Securities 3 432 935 197 4 170
---------- ---------- ---------- ----------
$ 92 610 $ 1 188 $ 2 333 $ 91 465
========== ========== ========== ==========
Amortized cost and carrying amount (estimated fair value) of securities held
to maturity are summarized as follows:
September 30, 1999
----------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
----------------------------------------------------
(In Thousands of Dollars)
US Government Agencies & Corporations 2 592 2 74 2 520
Obligations of States & Political Subdivisions 5 440 36 35 5 441
Mortgage-backed Securities 2 040 -- 39 2 001
---------- ---------- ---------- ----------
$ 10 072 $ 38 $ 148 $ 9 962
========== ========== ========== ==========
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
========== ========== ========== ==========
Nine Months Ended
September 30,
----------------------------
1999 1998
---------- ---------
(In Thousands of Dollars)
Gross proceeds from sales of securities 1 619 1,535
========== =========
Gross Gains on Sale of Securities 3 16
Gross Losses on Sale of Securities 3 14
---------- ---------
Net Securities Gains (Losses) -- 2
========== =========
8
ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
3. Loans
Major classifications of loans are as follows:
September 30, December 31,
1999 1998
--------- --------
(In Thousands of Dollars)
Commercial 29 790 30 105
Agriculture 8 099 6 068
Real estate mortgage:
Construction 15 995 13 935
Residential (1-4 family) 56 403 52 632
Home Equity Lines 16 946 15 939
Commercial 57 316 48 788
Agricultural 5 447 3 044
Loans to individuals for household,
family and other consumer expenditures 38 184 39 564
All other Loans 670 672
--------- ---------
228 850 210 747
Less Unearned Income (585) (590)
Less Allowance for Loan Losses (2 711) (2 424)
$ 225 554 $ 207 733
========= =========
The following schedule summarizes the changes in the allowance for loan and
lease losses:
Nine Months Nine Months
Ending Ending December 31,
Sept 30, 1999 Sept 30, 1998 1998
------------- ------------- ----
(In Thousands of Dollars)
Balance, Beginning 2 424 2 430 2 430
Provision Charged Against Income 345 375 477
Recoveries 215 87 110
Loans Charged Off 273 355 593
---------- ---------- ---------
Balance, Ending $ 2 711 $ 2 537 $ 2 424
========== ========== =========
Nonperforming assets consist of the following:
September 30, December 31,
1999 1998
-------- -------
(In Thousands of Dollars)
Nonaccrual Loans $ 1 004 $ 681
Restructured Loans -- --
-------- -------
Nonperforming Loans 1 004 681
Foreclosed Properties 374 212
-------- -------
Nonperforming Assets $ 1 378 $ 893
======== =======
Total loans past due 90 days or more and still accruing were $449 on September
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.
September 30, 1999 September 30, 1998
------------------ ------------------
Per Share Per Share
Shares Amount Shares Amount
------ ------ ------ ------
Basic Earnings Per Share 4 187 711 $ .71 4 160 979 $ .73
Effect of dilutive securities:
Nonemployee directors' stock options 20 897 45 246
Employee incentive stock options 60 139 71 263
--------- ---------
Diluted Earnings Per Share 4 268 747 $ .70 4 277 488 $ .71
========= ======= ========= =======
5. Capital Requirements
A comparison of the Company's capital as of September 30, 1999 with the
minimum requirements is presented below:
Minimum
Actual Requirements
------ ------------
Tier I Risk-based Capital 16.87% 4.00 %
Total Risk-based Capital 17.94% 8.00 %
Leverage Ratio 12.42% 4.00 %
10
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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) and United Community Bank (UCB), (the "Banks"). PTB and UCB
are Virginia chartered banks that offer a full range of banking services through
fifteen offices, principally to individuals and small to medium size businesses
in their respective market areas. UCB is the successor to The Bank of Franklin
(BOF) and The Bank of Sussex and Surry (BSS). These latter two banks were merged
effective August 26, 1999. The merger is expected to improve operating
efficiencies of the combined entity.
Results of Operations
- ---------------------
During the third quarter, the Company's trade area experienced significant
hurricane activity. In September, Hurricane Floyd caused severe flooding,
particularly in Franklin, VA, where the Company's UCB Main Office was under more
than four feet of water for more than a week. The office will likely be closed
until the end of the year. The Company was covered by a flood insurance policy
including both the building and its contents, plus extra expense coverage.
Restoration efforts are already under way and a second office in Franklin that
was not flooded is servicing the Main Office customers with little
inconvenience.
The Company experienced balance sheet contraction during the third quarter 1999,
with total assets decreasing $7.8 million, or 2.1% below June 30, 1999 and
increasing $6.3 million, or 1.7% over December 31, 1998. Deposits represent
98.6% of total liabilities of the Company, including non-interest-bearing
checking accounts that represent 14.5% of total deposits on September 30, 1999.
Loan demand was moderate during the third quarter, evidenced by net loans
increasing $5.0 million, or 2.3%, over June 30, 1999 and $17.8 million, or 8.6%,
over December 31, 1998. Competition for loans continued from the previous
quarter, relative to pricing, as all banks in the Company's trade area were
experiencing similar moderation in overall loan demand. The Company continues to
be reluctant to match all competitor pricing bids when the credit quality does
not match the pricing structure. While there are many signs of strength in the
overall U.S. economy, there are also many signs of weakness in the local markets
of the Company's trade area. Some local businesses are reducing hours of hourly
11
workers, even though there are only limited actual layoffs. Therefore, the risk
/ rate relationship continues to represent a major portion of the underwriting
practices of the Company.
The Company maintained its practice during the third quarter of selling Federal
funds, having sold continuously on a daily basis in amounts averaging $18.7
million, 5.1% of average total assets. The quarter-end balance of $3.9 million
represented an $18.3 million (or 82.4%) decrease from June 30, 1999 and a $25.6
million (or 86.8%) decrease from December 31, 1998. Earlier this year, the
Company had 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). However, in the current
quarter, the decrease was primarily the result of two different factors. First,
competition for certificates of deposits (CDs) intensified as many larger banks
began offering premium rates as a part of their Year 2000 (Y2K) liquidity
promotions. This occurred at the same time that UCB allowed some of its higher
cost maturing CDs to be redeemed in an effort to reduce cost of funds. Secondly,
the flooding caused by Hurricane Floyd resulted in reduced deposits among UCB's
offices during the latter half of September, 1999. Several businesses in the
flood-affected areas were inoperative for several days during this period,
restricting their normal cash flow.
The level of the investment account increased approximately $1.9 million (1.9%)
during the third quarter 1999 and $7.3 million (7.8%) for the first nine months
of 1999, ending the period at $101.5 million or 27.7% of total assets. Yields in
the bond market have been rising during recent months and reached levels not
seen within the previous twelve months. Management has attempted to capitalize
on higher yields, with greater call protection (early redemption privileges of
the issuer), without unduly compromising balance sheet liquidity. The portfolio
is comprised of 1% US Treasuries, 55% US Government Agencies and Mortgage-backed
Securities, 35% 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. Call risk
occurs when interest rates decline and additional principal dollars must be
reinvested at lower interest rates. Extension risk occurs when interest rates
increase and fewer principal dollars can be reinvested at higher interest rates.
The timing and magnitude of principal return will determine the degree of 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
12
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 $5.9 million
(2.6% of total outstandings). Included in the 30 day total is $449,000, which
are 90 days or more past due and still accruing interest. Non-accrual loans
totaled $1,004,000 at September 30, 1999, which represented 0.4% of total
outstanding loans and 37% of the loan loss reserve. Foreclosed properties
totaled $374,000 at September 30, 1999, with potential losses expected to be
minimal.
The Allowance for Loan and Lease Losses (ALLL) equaled $2.71 million at
September 30, 1999, comfortably above the Company's overall target of 1.1% of
total outstanding loans. Gross charge-offs for the current quarter were $75,000,
while total recoveries were $34,000. The provision for loan losses expense was
$136,000 in the third quarter 1999 and $345,000 in the first nine months 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. 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. Management
has been continuously monitoring credit quality relative to borrowers' readiness
for the upcoming century date change. Although no significant deficiencies have
been identified in any specific credit relationships, the Company has allocated
a portion of the ALLL as "Year 2000" reserves. Even with this allocation, the
ALLL exceeds management's desired level, indicating no need for more than normal
expense provisions during the fourth quarter.
As mentioned above, the flooding associated with Hurricane Floyd has rendered
many businesses to be fully or partially inoperable in part of the Company's
market area. This could have a negative financial impact on some of the
Company's borrowers. Management is carefully monitoring credits in the affected
areas to quickly identify potential deterioration in credit quality. No
substantial loss or deterioration has been reflected thus far. However, as
acknowledged by the State Banking Commission, there may be instances requiring
some level of forbearance with specific borrowers. This practice will not be
done to delay recognition of problem assets, but to assist those borrowers who
can recover from the flood with minor changes to their credit facility.
13
Earnings
- --------
Net income for the third quarter 1999 increased to $1,027,000, compared to
$944,000 for the third quarter 1998 and $961,000 for the second quarter 1999.
After two consecutive quarters of flat or down earnings, the current quarter
earnings per share (EPS) represented an up quarter. The current quarter's $.24
EPS was a $.02 per share increase over third quarter 1998 and $.01 per share
over the second quarter 1999.
Net interest income for the third quarter 1999 (tax equivalent interest income
less interest expense) totaled $4.25 million, a 7.1% increase over the third
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 (Fed) to raise short-term
interest rates, the general interest rate environment had been one of declining
rates. The quarter saw the Fed raise rates a second time August 25, 1999. Each
of the actions taken by the Fed resulted in a 0.25% increase in the Prime
interest rate. The Company's balance sheet was positioned to benefit from these
increases in short-term interest rates. As a result, the 6.3% increase in
interest income for the third quarter 1999 compared to third quarter 1998 more
than offset the 5.5% increase in interest expense for the same period. The
Company's balance sheet asset liability mix should allow for a slower increase
in interest expense compared to interest income in the current rate environment.
Premium rates offered on Y2K deposits, discussed elsewhere, may slightly slow
the improving trend in net interest earnings in the short-term, but general
improvement is still projected. Non-bank investment alternatives persist in
tempting and even luring consumers away from traditional bank deposits, as
consumers express their reluctance to accept relatively low rate deposits, even
with the slight increases of recent months.
Non-interest expense for the third quarter totaled $3.2 million, compared to
$2.9 for the third 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 and computer related integration of
BOF and BSS into the Company's central data processing center in August and
November, 1998, required substantial investment in capitalized fixed assets and
upgraded computer equipment during the third and fourth quarters of 1998. This
resulted in increased depreciation expense beginning in 1999. Thus, quarter over
quarter comparisons of the third quarters of 1999 and 1998, reflect the full
impact by third quarter 1999 of these improvements in technology.
Capital and Liquidity
- ---------------------
Equity capital (net of accumulated other comprehensive income) at September 30,
1999 totaled $43.1 million, representing 11.7% of total assets. Cash
stockholders' equity (Total Stockholders' Equity, before adjustments for
unrealized gains or losses on AFS securities as described above) totaled $43.8
million for the same period, or 11.9% of total assets, compared to $41.9
million, 11.6% 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 $500 million in total assets without
external augmentation of capital funds. The Company continues to attempt to
expand the balance sheet at a pace greater than the rate of internal capital
generation. This creates a leveraging effect on capital that should improve
return on equity and earnings per share, thus, enhancing stockholder value.
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 3.4% of total demand
14
deposits at September 30, 1999. The investment portfolio also provides liquidity
through actual and projected cash flows. The actual cash flows are provided
through known maturities, while projected amounts are from anticipated principal
reductions through early redemption calls and prepayments of mortgage backed
securities. At level rates, cumulative cash flow projection over the next twelve
months approximates $10 million. The Company, through 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 last quarter of this
year will result in higher levels of short-term liquidity. Management has
targeted some short-term deposit products to be offered at premium or bonus
rates to bolster short-term liquidity. The two primary maturities to be used in
the promotion are 182 days and 13 months. These products were created to induce
depositors to take advantage of the premium rate, while not creating an
unnecessarily long-term increase in cost of funds. The increase cost of funds
will be exacerbated by the reduced yield on the employment of these funds to
provide the necessary liquidity, thus, causing pressure on the net interest
margin albeit short-term and by design.
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 recognizes the
importance of growth, but has determined a greater need to absorb and assimilate
some of its recent growth initiatives, discussed above. Immediate future focus
will be on improving the efficiency ratio and earnings performance ratios.
The Company employed an individual in September, 1999 to staff a new
relationship with UVEST for the sale of fixed and variable rate annuity products
to enhance non-interest income, as well as attract potential new bank customers.
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 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.
Internal Systems: Computer Hardware and Software
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
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.
15
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.
As a part of its normal disaster recovery plan (prior to any Y2K plans), the
Company had installed generator power for its primary Bookkeeping, Item
Processing, and Computer Data Processing Operations Center in Glenns, Va.
Subsequently, the Company added generator power for its two remote item capture
/ check processing centers. The Glenns site is capable of operating not only
data processing and bookkeeping functions, but also a full service banking
branch office and the Company's Accounting Department. These efforts will enable
the Company to meet customer needs in the case of a natural disaster with
extended electrical power outages. In fact during the flood of Hurricane Floyd
in September, 1999, the Company operated in a disaster mode that very much
simulated disaster conditions that could be possible from Y2K, such as
combinations power failures, loss of voice phone lines, and data circuit
communication lines. The Company continued banking operations and satisfactory
customer service with limited inconveniences. These disaster recovery and backup
efforts will also complement Y2K business resumption plans in the case of a Y2K
related interruption of electricity.
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 facilitated 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
16
Association of America indicating it meets the information technology industry's
best software development practices for addressing the Year 2000 issue.
UCB had previously been operating a non-Y2K ready core data processing system.
It was converted to the JHA Liberty product discussed above in 1998 and is
processed in the Company's centralized data center.
Certain other systems were determined to require replacement or modification to
properly function in the year 2000. The replacement / modification process has
been coordinated with third party vendors of these systems and is virtually
complete as of the end of the current quarter.
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, all of the Company's PCs are considered Y2K
compliant. Total historical and future costs directly associated with the Y2K
project are expected to approximate $225,000 - $250,000 (approximately 6.25% of
projected 1999 net income).
Customer / Public Relations Issues
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 been pro-actively involved with public information and education
programs to assist customers in satisfying themselves that their banks are safe.
These programs have been coordinated with other banks as well as the Virginia
Association of Community Banks and includes a cable TV advertising program
describing some of the preparations performed by banks as a group. The Company
has also issued substantial amounts of direct correspondence to its customer
base. The Company has developed a cash withdrawal policy for customers to
require customers to acknowledge certain risks (physical and financial) to
reduce unnecessarily chaotic, irrational, or unreasonable practices by
customers. Total estimated costs in the areas should be less than $10,000.
Summary
The Company has completed the majority of its Y2K preparations as of 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.
17
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'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. The Event Plan is "process" driven and includes extensive checklist
verification and validation activities for January 1,
18
2000. These practices are designed to enhance smooth operations for the first
normal business day, Monday, January 3, 2000.
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.
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.
19
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 - 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) Form 8-K - None
20
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: November 15, 1999 BY /s/ W. J. Farinholt
-------------------------------------
W. J. Farinholt, President & CEO
Date: November 15, 1999 BY /s/ Kenneth E. Smith
-------------------------------------
Kenneth E. Smith, Exec. Vice President
& Chief Financial Officer
21