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ACFC > SEC Filings for ACFC > Form 10-Q on 13-Aug-2013All Recent SEC Filings

Show all filings for ATLANTIC COAST FINANCIAL CORP

Form 10-Q for ATLANTIC COAST FINANCIAL CORP


13-Aug-2013

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 in this report and the Company's Annual Report on Form 10-K for the period ended December 31, 2012, as filed with the Securities and Exchange Commission on April 1, 2013. The discussion below contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Statements in this filing that are not strictly historical are forward-looking and are based upon current expectations that may differ materially from actual results. These forward-looking statements, identified by words such as "expects," "anticipates," "believes," "estimates," "targets," "intends," "plans," "goal" and other similar expressions or future or conditional verbs such as "will," "may," "might," "should," "would" and "could," involve risks and uncertainties that could cause actual results to differ materially from those anticipated by the statements made herein. These risks and uncertainties involve general economic trends and changes in interest rates, increased competition, changes in consumer demand for financial services, the possibility of unforeseen events affecting the industry generally, the uncertainties associated with newly developed or acquired operations, market disruptions and other effects of terrorist activities.

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 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 undertakes no obligation, and specifically disclaims any obligation, to publicly release revisions to these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unforeseen events, except as required to be reported under the rules and regulations of the Securities and Exchange Commission.

General Description of Business

The principal business of Atlantic Coast Financial Corporation (the Company) and Atlantic Coast Bank (the Bank) consists of attracting retail deposits from the general public and investing those funds primarily in loans secured by one- to four-family residences originated under purchase and assumption agreements by third party originators (warehouse loans), and, to a lesser extent, first mortgages on owner occupied, one- to four-family residences, home equity loans and automobile and other consumer loans originated for retention in our loan portfolio. In addition we have been increasing our focus on small business lending through our Small Business Administration (SBA) lending programs, as well as commercial business and owner occupied commercial real estate loans to small businesses. Loans are obtained principally through retail staff and, brokers. The Company sells the guaranteed portion of loans originated through SBA lending, rather than hold the loans in portfolio. We also originate multi-family residential loans and commercial construction and residential construction loans, but no longer emphasize the origination of such loans unless they are connected with SBA lending. 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, gains on the sale 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. In accordance with the Consent Order (the Order) entered into with the Office of the Comptroller of the Currency (the OCC) on August 10, 2012, interest rates paid on deposit are limited and subject to national rates published weekly by the Federal Deposit Insurance Corporation. Deposits are primarily solicited in the Bank's market area of the Jacksonville metropolitan area and southeastern Georgia when necessary to fund loan demand, or other liquidity needs.

Recent Events

Merger Agreement with Bond Street Holdings, Inc.

On February 25, 2013, the Company and the Bank entered into an Agreement and Plan of Merger (the Merger Agreement) with Bond Street Holdings, Inc. (Bond Street) and its bank subsidiary, Florida Community Bank, N.A. (Florida Community Bank). Pursuant to the Merger Agreement, the Company was to be merged with and into Bond Street (the Merger) and the Bank was then to merge with and into Florida Community Bank.

On April 22, 2013, the Company and the Bank entered into Amendment Number 1 to the Merger Agreement (the Amended Merger Agreement) with Bond Street and Florida Community Bank. Under the terms of the Amended Merger Agreement, each share of the Company's common stock issued and outstanding immediately prior to the completion of the merger would have been converted into the right to receive $5.00 in cash at closing.

On June 11, 2013, the proposed merger was rejected by the stockholders of the Company. On June 24, 2013, the Company provided notice to Bond Street that it was terminating the Merger Agreement pursuant to provisions of the Merger Agreement that permitted either the Company or Bond Street to terminate the Merger Agreement if stockholders of the Company did not approve the Merger Agreement by June 21, 2013.

Deferred Tax Asset

Under the rules of Internal Revenue Code 382 (IRC 382), a change in the ownership of the Company occurred during the first quarter of 2013. The Company became aware of the change in ownership during the second quarter of 2013 based on applicable filings made by stockholders with the Securities and Exchange Commission. In accordance with IRC 382, the gross amount of net operating loss carryovers the Company can use is limited to $325,000 per year. The effects of the limitation on the existing deferred tax asset are currently being analyzed. The deferred tax asset is discussed in detail in Note 14 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, 2012 filed with the Securities and Exchange Commission on April 1, 2013.

Critical Accounting Policies

Certain accounting policies are important to the presentation 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, 2012 filed with the Securities and Exchange Commission on April 1, 2013.

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 the decline in real estate values in our markets since 2008 and the weak United States economy in general, we believe it is likely that collateral for non-performing one- to four-family residential and home equity loans, will not be sufficient to fully repay such loans. Therefore the Company charges one- to four-family residential and home equity loans down by the expected loss amount at the time they become non-performing, which is generally 90 days past due. This process accelerates the recognition of charge-offs on one- to four-family residential and home equity loans 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 for unimpaired loans by type of loan and specific allowances for identified impaired loans.

The general loss component is calculated by applying loss factors, adjusted for other qualitative factors to outstanding unimpaired loan balances. Loss factors are based on the Bank's recent loss experience. Qualitative factors consider 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 qualitative factors that exist as of the balance sheet date that are considered in determining the adequacy of the allowance include the following: (1) Current delinquency levels and trends; (2) Non-performing asset levels and trends and related charge-off history; (3) Economic trends - local and national; (4) Changes in loan policy; (5) Expertise of management and staff of the Bank; (6) Volumes and terms of loans; and (7) Concentrations of credit.

The impact of the general loss component on the allowance began increasing during 2008 and has remained at an elevated level through the end of the second quarter of 2013. The increase reflected the deterioration of market conditions since 2008, 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 and risks. 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 homogeneous 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.

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 (loss), 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 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 (loss), 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 six months ended June 30, 2013 and 2012.

Other Real Estate Owned

Assets acquired through or in lieu of loan foreclosure are initially recorded at fair value based on an independent appraisal, less estimated selling costs, at the date of foreclosure, establishing a new cost basis. If fair value declines subsequent to foreclosure, the asset value is written down 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, the Bank became a taxable organization. Income tax expense, or 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 carry forwards. 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 the 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 June 30, 2013, the Company had a valuation allowance of $30.0 million for the net deferred tax asset.

The future realization of the Company's net operating loss carryovers is limited to approximately $325,000 per year, and the effects of the limitation on the existing deferred tax asset are currently being analyzed. See Recent Events:
Deferred Tax Asset for additional information.

Comparison of Financial Condition at June 30, 2013 and December 31, 2012

General

Total assets decreased $30.4 million, or 3.9%, to $742.2 million at June 30, 2013 as compared to $772.6 million at December 31, 2012. The decrease in assets was primarily due to a decrease in net portfolio loans of $34.9 million, and lower held-for-sale and warehouse loans which decreased $9.7 million, partially offset by an increase in cash and cash equivalents of $10.1 million. The Company continued to manage its balance sheet consistent with its capital preservation strategy as well as to strengthen the Company's balance sheet liquidity. Total deposits increased $2.3 million, or 0.5%, to $502.1 million at June 30, 2013 from $499.8 million at December 31, 2012. Time deposits grew by a total of $7.5 million and noninterest-bearing demand accounts increased $1.9 million, while savings and money market accounts decreased by $6.9 million and interest-bearing demand accounts decreased $0.2 million during the six months ended June 30, 2013. Total borrowings decreased by $25.0 million to $202.8 million at June 30, 2013 from $227.8 million at December 31, 2012 due to the repayment of $25.0 million of Federal Home Loan Bank (FHLB) advances. Stockholders' equity decreased by $9.1 million to $31.2 million at June 30, 2013 from $40.3 million at December 31, 2012 due to the net loss of $3.6 million and a decrease in other comprehensive income (loss) of $5.5 million, related to a negative change in the fair value of securities available-for-sale because of an increase in interest rates during the six months ended June 30, 2013.

Following is a summarized comparative balance sheet as of June 30, 2013 and December 31, 2012:

                                         June 30,       December 31,          Increase / (Decrease)
                                           2013             2012             Amount              %
                                                            (Dollars in Thousands)
Assets:
Cash and cash equivalents               $   77,959     $       67,828     $      10,131            14.9 %
Securities available-for-sale              160,856            159,745             1,111             0.7 %
Portfolio loans                            396,314            432,090           (35,776 )          -8.3 %
Allowance for loan losses                   10,029             10,889              (860 )          -7.9 %
Portfolio loans, net                       386,285            421,201           (34,916 )          -8.3 %
Other loans (held-for-sale and
warehouse)                                  62,870             72,568            (9,698 )         -13.4 %
Other Assets                                54,224             51,277             2,947             5.7 %
Total assets                            $  742,194     $      772,619     $     (30,425 )          -3.9 %

Liabilities and stockholders' equity:
Deposits:
Noninterest-bearing demand              $   43,889     $       41,904     $       1,985             4.7 %
Interest-bearing demand                     73,240             73,490              (250 )          -0.3 %
Savings and money market                   174,777            181,708            (6,931 )          -3.8 %
Time                                       210,238            202,658             7,580             3.7 %
Total deposits                             502,144            499,760             2,384             0.5 %
Securities sold under agreements to
repurchase                                  92,800             92,800                 -               -
Federal Home Loan Bank advances            110,000            135,000           (25,000 )         -18.5 %
Accrued expenses and other
liabilities                                  6,085              4,799             1,286            26.8 %
Total liabilities                          711,029            732,359           (21,330 )          -2.9 %
Total stockholders' equity                  31,165             40,260            (9,095 )         -22.6 %
Total liabilities and stockholders'
equity                                  $  742,194     $      772,619     $     (30,425 )          -3.9 %

Cash and Cash Equivalents

Cash and cash equivalents increased $10.1 million to $77.9 million at June 30, 2013 from $67.8 million at December 31, 2012. The Bank's cash and cash equivalent balances are maintained at elevated amounts in response to reduced contingent sources of liquidity from the FHLB and the FRB and to ensure sufficient immediately available liquidity.

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 $1.1 million to $160.8 million at June 30, 2013, from $159.7 million at December 31, 2012. As of June 30, 2013, approximately $120.0 million of securities available-for-sale were pledged as collateral for the securities sold under agreements to repurchase and $24.9 million were pledged to the FHLB as collateral for advances and estimated prepayment fees. At June 30, 2013, $159.9 million, or 99.4%, 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. In the near term, the Company intends to moderately increase its investment in securities available-for-sale in order to meet increasing collateral requirements for its debt.

Portfolio Loans



Below is a comparative composition of net portfolio loans as of June 30, 2013
and December 31, 2012, excluding loans held-for-sale and warehouse loans:



                                                        % of Total                          % of Total
                                         June 30,       Portfolio        December 31,       Portfolio
                                           2013           Loans              2012             Loans
                                                            (Dollars in Thousands)
Real estate loans:
One- to four-family                     $  174,177             44.6 %   $      193,057             45.3 %
Commercial                                  49,145             12.6 %           58,193             13.7 %
Other (land and multi-family)               18,513              4.7 %           19,908              4.7 %
Total real estate loans                    241,835             61.9 %          271,158             63.7 %
Real estate construction loans:
One- to four-family                              -              0.0 %                -              0.0 %
Commercial                                   8,114              2.1 %            5,049              1.2 %
Acquisition and development                      -              0.0 %                -              0.0 %
Total real estate construction loans         8,114              2.1 %            5,049              1.2 %
Other loans:
Home equity                                 57,950             14.9 %           63,867             15.0 %
Consumer                                    57,556             14.7 %           61,558             14.4 %
Commercial                                  25,097              6.4 %           24,308              5.7 %
Total other loans                          140,603             36.0 %          149,733             35.1 %

Total loans                                390,552            100.0 %          425,940            100.0 %
Allowance for loan losses                  (10,029 )                           (10,889 )
Net deferred loan costs                      5,762                               6,150
Loans, net                              $  386,285                      $      421,201

Total gross portfolio loans declined $35.4 million, or 3.3%, to $390.5 million at June 30, 2013 as compared to $425.9 million at December 31, 2012 primarily due to principal amortization and increased prepayments of one- to four-family residential and home equity loans during the six months ended June 30, 2013 consistent with the low interest rate environment for one- to four-family mortgages. Total portfolio loans also declined due to gross loan charge-offs of $2.3 million and transfers to other real estate owned (OREO) of non-performing loans of $9.2 million during the first six months of 2013.

Small business loan originations, including SBA portfolio loans and small business loans originated internally and held-for-sale (SBA loans held-for-sale), were $6.1 million during the six months ended June 30, 2013. The Company sells the guaranteed portion of SBA loans upon completion of loan funding and approval by the SBA. The unguaranteed portion of SBA loans at June 30, 2013 and December 31, 2012 was $4.3 million and $3.3 million, respectively. The Company plans to continue to expand this business line going forward.

Until there is greater certainty about the economic recovery in our market area and the Bank increases its capital levels, management believes portfolio loan balances will likely continue to decline. Principal amortization and loan payoffs are expected to exceed growth in the SBA portfolio and other small . . .

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