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ACFC > SEC Filings for ACFC > Form 10-Q on 14-Nov-2012All Recent SEC Filings

Show all filings for ATLANTIC COAST FINANCIAL CORP

Form 10-Q for ATLANTIC COAST FINANCIAL CORP


14-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with Item 1. Financial Statements and the notes thereto included elsewhere in this report. The discussion below contains forward-looking statements which are statements that are not historical or current facts. When used in this filing and in future filings by Atlantic Coast Financial Corporation with the Securities and Exchange Commission, in Atlantic Coast Financial Corporation's press releases or other public or shareholder communications, or in oral statements made with the approval of an authorized executive officer, the words or phrases, "anticipate," "would be," "will allow," "intends to," "will likely result," "are expected to," will continue," "is anticipated," "estimated," "projected," or similar expressions are intended to identify, "forward looking statements." Such statements are subject to risks and uncertainties, including but not limited to changes in economic conditions in Atlantic Coast Financial Corporation's market area, changes in policies by regulatory agencies, fluctuations in interest rates, demand for loans in Atlantic Coast Financial Corporation's market area, the availability of liquidity from deposits or borrowings to execute on loan and investing opportunities, changes in the position of banking regulators on the adequacy of the allowance for loan losses, and competition, all or some of which could cause actual results to differ materially from historical earnings and those presently anticipated or projected.

Atlantic Coast Financial Corporation wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made, and advise readers that various factors, including regional and national economic conditions, substantial changes in levels of market interest rates, credit and other risks of lending and investing activities, and competitive and regulatory factors, could affect Atlantic Coast Financial Corporation's financial performance and could cause Atlantic Coast Financial Corporation's actual results for future periods to differ materially from those anticipated or projected.

Atlantic Coast Financial Corporation does not undertake, and specifically disclaims any obligation, to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements.

General Description of Business

The Company's principal business consists of attracting retail deposits from the general public and investing those funds primarily in permanent loans secured by first mortgages on owner-occupied, one- to four-family residences, home equity loans, and, to a lesser extent, automobile and other consumer loans. We also have originated multi-family residential loans and commercial construction and residential construction loans, but will no longer emphasize the origination of such loans. Instead, our new strategy is to increase our small business lending through our Small Business Administration (SBA) lending programs, warehouse lending and to originate commercial business and owner occupied commercial real estate loans to small businesses. Loans are obtained principally through retail staff, brokers and wholesale purchases. The Bank intends to sell loans purchased through warehouse lending and the guaranteed portion of loans originated through small business lending, rather than hold the loans in portfolio. We also invest in investment securities, primarily those issued by U.S. government-sponsored agencies or entities, including Fannie Mae, Freddie Mac and Ginnie Mae.

Revenues are derived principally from interest on loans and other interest-earning assets, such as investment securities. To a lesser extent, revenue is generated from service charges, sales of loans and other income.

The Company offers a variety of deposit accounts having a wide range of interest rates and terms, which generally include savings accounts, money market accounts, demand deposit accounts and time deposit accounts with terms ranging from 90 days to five years. Deposits are primarily solicited in the Bank's market area of southeastern Georgia and the Jacksonville metropolitan area when necessary to fund loan demand.

Recent Events

On August 10, 2012 the Board of Directors of Atlantic Coast Bank agreed to a Consent Order (the Agreement) with the Office of the Comptroller of Currency (OCC). Among other things the Agreement provides that by December 31, 2012 the Bank must achieve and maintain total risk based capital of 13.00% of risk weighted assets and Tier 1 capital of 9.00% of adjusted total assets. As a result of entering into the Agreement to achieve and maintain specific capital levels, the Bank's capital classification under the Prompt Corrective Action (PCA) rules has been lowered to adequately capitalized, notwithstanding actual capital levels that otherwise would be deemed well capitalized under such rules. See Note 12 to the financial statements contained in this report for further description of the provisions contained in the Agreement.

Atlantic Coast Financial Corporation is regulated by the Federal Reserve Bank of Atlanta (Federal Reserve) and remains under the provisions of an Office of Thrift Supervision Supervisory Agreement dated December 10, 2010.

Critical Accounting Policies

Certain accounting policies are important to the portrayal of the Company's financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances, including, but without limitation, changes in interest rates, performance of the economy, financial condition of borrowers and laws and regulations. Management believes that its critical accounting policies include determining the allowance for loan losses, determining fair value of securities available-for-sale, other real estate owned and accounting for deferred income taxes. These accounting policies are discussed in detail in Note 1 of the Notes to the Consolidated Financial Statements included in Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2011 filed with the Securities and Exchange Commission.

Allowance for Loan Losses

An allowance for loan losses (allowance) is maintained to reflect probable incurred losses in the loan portfolio. The allowance is based on ongoing assessments of the estimated losses incurred in the loan portfolio and is established as these losses are recognized through a provision for loan losses charged to earnings. Generally, loan losses are charged against the allowance when management believes the uncollectibity of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Due to declining real estate values in our markets and the weak United States economy in general, it is likely that impairment reserves on non-performing one- to four-family residential and home equity loans, will not be recoverable and represent a confirmed loss. As a consequence the Company recognizes the charge-off of impairment reserves on non-performing one- to four-family residential and home equity loans in the period the loan is classified as such. This process accelerates the recognition of charge-offs but has no impact on the impairment evaluation process.

The reasonableness of the allowance is reviewed and established by management, within the context of applicable accounting and regulatory guidelines, based upon its evaluation of then-existing economic and business conditions affecting the Bank's key lending areas. Senior credit officers monitor the conditions discussed above continuously and reviews are conducted monthly with the Bank's senior management and Board of Directors.

Management's methodology for assessing the reasonableness of the allowance consists of several key elements, which include a general loss component by type of loan and specific allowances for identified problem loans. The allowance also incorporates the results of measuring impaired loans.

The general loss component is calculated by applying loss factors to outstanding loan balances based on the internal risk evaluation of the loans or pools of loans. Changes to the risk evaluations relative to both performing and non-performing loans affect the amount of this component. Loss factors are based on the Bank's recent loss experience, current market conditions that may impact real estate values within the Bank's primary lending areas, and on other significant factors that, in management's judgment, may affect the ability to collect loans in the portfolio as of the evaluation date. Other significant factors that exist as of the balance sheet date that may be considered in determining the adequacy of the allowance include credit quality trends (including trends in non-performing loans expected to result from existing conditions), collateral values, geographic foreclosure rates, new and existing home inventories, loan volumes and concentrations, specific industry conditions within portfolio segments and recent charge-off experience in particular segments of the portfolio. The impact of the general loss component on the allowance began increasing during 2008 and has continued to increase during each year through the third quarter of 2012. The increase reflected the deterioration of market conditions, and the increase in the recent loan loss experience that has resulted from management's proactive approach to charging off losses on impaired one- to four-family and home equity loans in the period the impairment is identified.

Management also evaluates the allowance for loan losses based on a review of certain large balance individual loans. This evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows management expects to receive on impaired loans that may be susceptible to significant change. For all specifically reviewed loans where it is probable that the Bank will be unable to collect all amounts due according to the terms of the loan agreement, impairment is determined by computing a fair value based on either discounted cash flows using the loan's initial interest rate or the fair value of the collateral if the loan is collateral dependent. No specific allowance is recorded unless fair value is less than carrying value. Large groups of smaller balance homogeneous loans, such as individual consumer and residential loans are collectively evaluated for impairment and are excluded from the specific impairment evaluation; for these loans, the allowance for loan losses is calculated in accordance with the general allowance for loan losses policy described above. Accordingly, individual consumer and residential loans are not separately identified for impairment disclosures, unless the loan has been modified as a troubled debt restructuring as discussed below.

Loans for which the terms have been modified as a result of the borrower's financial difficulties are classified as troubled debt restructurings (TDR). TDRs are measured for impairment based upon the present value of estimated future cash flows using the loan's interest rate at inception of the loan or the appraised value of the collateral if the loan is collateral dependent. Impairment of homogenous loans, such as one-to four-family residential loans, that have been modified as TDRs is calculated in the aggregate based on the present value of estimated future cash flows. Loans modified as TDRs with market rates of interest are classified as impaired loans in the year of restructure and until the loan has performed for 12 months in accordance with the modified terms. The assessment of market rates of interest for homogenous TDR loans is done based on the weighted average rates of those loans compared to prevailing interest rates at the time of restructure.

Fair Value of Securities Available-for-Sale

Securities available-for-sale are carried at fair value, with unrealized holding gains and losses reported separately in other comprehensive income, net of tax. The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3).

Management evaluates securities for other-than-temporary impairment (OTTI) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. In determining OTTI, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at the determination date.

When OTTI is determined to have occurred, the amount of the OTTI recognized in earnings depends on whether we intend to sell the security or it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss. If we intend to sell the security or it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss, the OTTI recognized in earnings is equal to the entire difference between its amortized cost basis and its fair value at the balance sheet date. If we do not intend to sell the security and it is not more likely than not that we will be required to sell the security before recovery of its amortized cost basis less any current-period loss, the OTTI is separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized as a charge to earnings. The amount of the OTTI related to other factors is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment. The Company recorded no OTTI for the nine months ended September 30, 2012.

Other Real Estate Owned

Assets acquired through or in lieu of loan foreclosure are initially recorded at fair value, less estimated selling costs, at the date of foreclosure, establishing a new cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Costs relating to improvement of property are capitalized, whereas costs relating to the holding of property are expensed.

Deferred Income Taxes

After converting to a federally chartered savings association, Atlantic Coast Bank became a taxable organization. Income tax expense (benefit) is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary difference between carrying amounts and tax basis of assets and liabilities, computed using enacted tax rates and operating loss carryforwards. The Company's principal deferred tax assets result from the allowance for loan losses and operating loss carryforwards. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. The Internal Revenue Code and applicable regulations are subject to interpretation with respect to the determination of the tax basis of assets and liabilities for credit unions that convert charters and become a taxable organization. Since Atlantic Coast Bank's transition to a federally chartered savings bank, the Company has recorded income tax expense based upon management's interpretation of the applicable tax regulations. Positions taken by the Company in preparing our federal and state tax returns are subject to the review of taxing authorities, and the review by taxing authorities of the positions taken by management could result in a material adjustment to the financial statements.

All available evidence, both positive and negative, is considered when determining whether or not a valuation allowance is necessary to reduce the carrying amount to a balance that is considered more likely than not to be realized. The determination of the realizability of deferred tax assets is highly subjective and dependent upon judgment concerning management's evaluation of such evidence. Positive evidence considered includes the probability of achieving forecasted taxable income and the ability to implement tax planning strategies to accelerate taxable income recognition. Negative evidence includes the Company's cumulative losses. Following the initial establishment of a valuation allowance, if the Company is unable to generate sufficient pre-tax income in future periods or otherwise fails to meet forecasted operating results, an additional valuation allowance may be required. Any valuation allowance is required to be recorded during the period identified. As of September 30, 2012, the Company had a valuation allowance of $28.4 million for the net deferred tax asset.

Comparison of Financial Condition at September 30, 2012 and December 31, 2011

General

Total assets decreased $4.2 million, or 0.5%, to $784.8 million at September 30, 2012 as compared to $789.0 million at December 31, 2011. The primary reason for the decrease in assets was a decrease in loans of $69.1 million, partially offset by an increase in cash and cash equivalents of $22.8 million and an increase in securities available-for-sale of $28.5 million as the Company continued to manage its balance sheet consistent with its capital preservation strategy and to increase the Company's liquidity position. Total deposits decreased $0.5 million, or 0.1%, to $507.9 million at September 30, 2012 from $508.4 million at December 31, 2011. Noninterest-bearing demand and time deposits grew by a total of $12.0 million while interest-bearing demand accounts and savings and money market accounts decreased by a nearly like amount during the nine months ended September 30, 2012. Stockholders' equity decreased by $3.2 million to $43.1 million at September 30, 2012 from $46.3 million at December 31, 2011 due to the net loss of $6.4 million for the nine months ended September 30, 2012, partially offset by an increase in other comprehensive income of $3.1 million for the same time period.

Following is a summarized comparative balance sheet as of September 30, 2012 and December 31, 2011:

                                         September 30,       December 31,          Increase / (Decrease)
                                             2012                2011             Amount              %
                                                               (Dollars in Thousands)
Assets:
Cash and cash equivalents               $        63,840     $       41,017     $      22,823            55.6 %
Securities available-for-sale                   155,368            126,821            28,547            22.5 %
Loans held-for-sale                              74,313             61,619            12,694            20.6 %
Loans                                           452,120            521,233           (69,113 )         -13.3 %
Allowance for loan losses                        12,729             15,526            (2,797 )         -18.0 %
Loans, net                                      439,391            505,707           (66,316 )         -13.1 %
Other Assets                                     51,898             53,803            (1,905 )          -3.5 %
Total assets                            $       784,810     $      788,967     $      (4,157 )          -0.5 %

Liabilities and stockholders' equity:
Deposits:
Noninterest-bearing demand              $        43,305     $       34,586     $       8,719            25.2 %
Interest-bearing demand                          75,603             76,811            (1,208 )          -1.6 %
Savings and money market                        188,057            199,334           (11,277 )          -5.7 %
Time                                            200,941            197,680             3,261             1.6 %
Total deposits                                  507,906            508,411              (505 )          -0.1 %
Securities sold under agreements to
repurchase                                       92,800             92,800                 -               -
Federal Home Loan Bank advances                 135,000            135,000                 -               -
Accrued expenses and other
liabilities                                       6,024              6,462              (438 )          -6.8 %
Total liabilities                               741,730            742,673              (943 )          -0.1 %
Total stockholders' equity                       43,080             46,294            (3,214 )          -6.9 %
Total liabilities and stockholders'
equity                                  $       784,810     $      788,967     $      (4,157 )          -0.5 %

Cash and Cash Equivalents

Cash and cash equivalents increased $22.8 million to $63.8 million at September 30, 2012 from $41.0 million at December 31, 2011. The Bank increased its cash and cash equivalent holdings in order to raise the amount of immediately available liquidity sources in response to reduced contingent sources of liquidity from the Federal Home Loan Bank of Atlanta (FHLB) and the Federal Reserve.

Securities Available-for-Sale

Securities available-for-sale was comprised primarily of debt securities of U.S. Government-sponsored enterprises, and mortgage-backed securities. The investment portfolio increased approximately $28.5 million to $155.4 million at September 30, 2012, from $126.8 million at December 31, 2011. As of September 30, 2012, approximately $118.8 million of securities available-for-sale were pledged as collateral for the securities sold under agreements to repurchase. At September 30, 2012, approximately $154.3 million, or 99.3%, of the debt securities held by the Company were issued by U.S. government-sponsored entities and agencies, primarily Fannie Mae, Freddie Mac and Ginnie Mae, institutions which the government has affirmed its commitment to support.

Loans Held-for-Sale

Loans held-for-sale was comprised primarily of loans secured by one- to four-family residential homes originated internally or purchased from third-party originators and increased $12.7 million, or 20.6% to $74.3 million at September 30, 2012 as compared to $61.6 million at December 31, 2011 primarily due to an increase in loan production from our warehouse lending operations. As of September 30, 2012, the weighted average number of days outstanding of loans held-for-sale was 22 days.

During the nine months ended September 30, 2012, the Company originated a total of $672.9 million of loans held-for-sale, comprised of approximately $27.0 million of one- to four-family residential loans originated internally, and approximately $645.9 million of one- to four-family residential loans purchased from third parties under warehouse loan agreements. Approximately $660.1 million of the one- to four-family residential loans were sold, resulting in a gain of $0.7 million and interest earned of $1.7 million on outstanding balances which was recorded in interest income. The Company intends to continue to focus on opportunities to grow the warehouse line of business in the near future due to its favorable margins and efficient capital usage.

Loans



Below is a comparative composition of net loans as of September 30, 2012 and
December 31, 2011, excluding loans held-for-sale:



                                         September           % of          December 31,         % of
                                          30, 2012        Total Loans          2011          Total Loans
                                                             (Dollars in Thousands)

Real estate loans:
One- to four-family                     $    204,091              45.8 %   $    241,453              46.9 %
Commercial                                    59,963              13.4 %         72,683              14.1 %
Other (land and multi-family)                 20,983               4.7 %         29,134               5.7 %
Total real estate loans                      285,037              63.9 %        343,270              66.7 %
Real estate construction loans:
One- to four-family                              245               0.1 %          2,044               0.4 %
Commercial                                     4,599               1.0 %          4,083               0.8 %
Acquisition and development                        -               0.0 %              -               0.0 %
Total real estate construction loans           4,844               1.1 %          6,127               1.2 %
Other loans:
Home equity                                   66,339              14.9 %         74,199              14.4 %
Consumer                                      63,898              14.3 %         67,850              13.2 %
Commercial                                    25,666               5.8 %         23,181               4.5 %
Total other loans                            155,903              35.0 %        165,230              32.1 %

Total loans                                  445,784             100.0 %        514,627             100.0 %
Allowance for loan losses                    (12,729 )                          (15,526 )
Net deferred loan costs                        6,458                              6,730
Discount on purchased loans                     (122 )                             (124 )
Loans, net                              $    439,391                       $    505,707

Total portfolio loans declined $68.8 million, or approximately 13.4%, to $445.8 million at September 30, 2012 as compared to $514.6 million at December 31, 2011 primarily due to increased payoffs of one- to four-family residential and commercial real estate loans during the nine months ended September 30, 2012 as a result of increased refinancing in the low interest rate environment. In addition, total portfolio loans declined due to transfers to OREO of non-performing loans of $7.8 million during the first nine months of 2012. Portfolio loan originations decreased $4.0 million to $20.6 million for the nine months ended September 30, 2012 from $24.6 million for the same period in 2011.

Small business loan originations, including SBA loans, were $12.1 million during the nine months ended September 30, 2012 of which $3.0 million were reported as loans held for sale. The Company intends to sell the guaranteed portion of SBA loans upon completion of loan funding to increase noninterest income. The gain recorded for SBA loan sales during the nine months ended September 30, 2012 was $0.7 million. The Company plans to continue to expand this business line going forward.

Consistent with its capital preservation and risk management policies, the Company does not intend to grow portfolio originated loans, but rather continue to emphasize the sale of mortgages it originates in the secondary market in the near term. The composition of the Bank's loan portfolio is heavily weighted toward one- to four-family residential loans. As of September 30, 2012, first mortgages (including residential construction loans), second mortgages and home equity loans totaled $270.4 million, or 60.7% of total gross loans.
Approximately $37.0 million, or 55.0% of loans recorded as home equity loans are in a first lien position. Accordingly, $241.1 million, or 89.1% of loans collateralized by one- to four-family residential loans were in a first lien position as of September 30, 2012. The composition of the Bank's loan portfolio by state as of September 30, 2012 was as follows:

. . .

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