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ACFC > SEC Filings for ACFC > Form 10-Q on 8-Nov-2013All Recent SEC Filings

Show all filings for ATLANTIC COAST FINANCIAL CORP | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for ATLANTIC COAST FINANCIAL CORP


8-Nov-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 Securities Act of 1933, as amended, the Securities Exchange Act of 1934, as amended, and 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 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 demand for financial services, the state of the banking industry generally, the uncertainties associated with newly developed or acquired operations, and market disruptions.

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 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 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. The Company also originates multi-family residential loans and commercial construction and residential construction loans, but no longer emphasizes the origination of such loans unless they are connected with SBA lending. The Company also invests 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 (FDIC). 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

Changes in the Company's Executive Management Team and Board of Directors On September 10, 2013, the Company announced its decision to name John K. Stephens, Jr. as President and Chief Executive Officer, and a director of the Company and the Bank. On September 13, 2013, Thomas B. Wagers, Sr. informed the Company that he was resigning from his positions as Interim President, Chief Executive Officer and Chief Financial Officer of the Company and the Bank, effective October 21, 2013. On September 23, 2013, the Board of Directors appointed James D. Hogan as the Company's interim Chief Financial Officer, and as a director of the Company and the Bank. Mr. Hogan's appointment is contingent upon receipt of regulatory non-objection from the OCC and the Federal Reserve Bank of Atlanta (the FRB). Effective October 21, 2013, Marshall D. Stone, who has served as the Controller of the Company and the Bank since 2003, became our Interim Principal Accounting Officer.

Additionally, three members of the Board of Directors announced their decisions not to stand for re-election, and the Company's stockholders elected the three new director nominees at the Company's annual meeting on August 16, 2013.

Strategic Alternatives and Capital

In November 2011, the Company's Board of Directors began a review of the strategic alternatives. Following the June 2013 rejection by stockholders of the proposed merger of the Company with Bond Street Holdings, Inc., the Company's newly restructured Board of Directors began evaluating alternatives to raise capital. As a result of that, the Company is planning to pursue an equity capital raise through a public offering or private placement.

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, including recent short sales and sales of non-performing loans. 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 considering the impact of recent short sales and sales of non-performing loans.

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 third 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. The determination of the fair value of collateral considers recent trends in valuation as indicated by short sales and sales of non-performing loans of the applicable loan category. 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.

Troubled Debt Restructurings

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.

A portfolio loan that is modified as a TDR with a market rate of interest is classified as an impaired loan and reported as a TDR in the year of restructure and until the loan has performed for twelve months in accordance with the modified terms. The policy for returning a non-performing loan to accrual status is the same for any loan irrespective of whether the loan has been modified. As such, loans which are non-performing prior to modification continue to be accounted for as non-performing loans until they have demonstrated the ability to maintain sustained performance over a period of time, but no less than six months, and are reported as impaired non-performing loans.

Fair Value of Investment Securities

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. Securities held-to-maturity are carried at amortized cost. 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 investment 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 nine months ended September 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 holding of the 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 carryovers. The Company's principal deferred tax assets result from the allowance for loan losses and operating loss carryovers. 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 September 30, 2013, the Company had a valuation allowance of $30.3 million for the net 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 carryover 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.

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

General

Total assets decreased $58.5 million, or 7.6%, to $714.1 million at September 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 $41.1 million, and lower held-for-sale and warehouse loans which decreased $50.3 million, partially offset by an increase in cash and cash equivalents of $14.8 million and an increase in investment securities of $17.8 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 decreased $23.7 million, or 4.7%, to $476.1 million at September 30, 2013 from $499.8 million at December 31, 2012. Noninterest-bearing demand accounts decreased $2.8 million, interest-bearing demand accounts decreased $4.2 million, savings and money market accounts decreased by $10.8 million, and time deposits decreased by a total of $5.9 million during the nine months ended September 30, 2013. Total borrowings decreased by $25.0 million to $202.8 million at September 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 $10.4 million to $29.9 million at September 30, 2013 from $40.3 million at December 31, 2012 due to the net loss of $4.5 million and a decrease in accumulated other comprehensive income (loss) of $5.9 million, related to a negative change in the fair value of securities available-for-sale because of an increase in interest rates during the nine months ended September 30, 2013.

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

                                            September 30,     December 31,       Increase / (Decrease)
                                                2013              2012            Amount            %
                                                               (Dollars in Thousands)
Assets:
Cash and cash equivalents                  $        82,584   $       67,828   $        14,756        21.8 %
Investment securities
(available-for-sale and
held-to-maturity)                                  177,568          159,745            17,823        11.2 %
Portfolio loans                                    389,590          432,090          (42,500)        -9.8 %
Allowance for loan losses                            9,522           10,889           (1,367)       -12.6 %
Portfolio loans, net                               380,068          421,201          (41,133)        -9.8 %
Other loans (held-for-sale and
warehouse)                                          22,248           72,568          (50,320)       -69.3 %
Other Assets                                        51,646           51,277               369         0.7 %
Total assets                               $       714,114   $      772,619   $      (58,505)        -7.6 %

Liabilities and stockholders' equity:
Deposits:
Noninterest-bearing demand                 $        39,107   $       41,904   $       (2,797)        -6.7 %
Interest-bearing demand                             69,222           73,490           (4,268)        -5.8 %
Savings and money market                           170,946          181,708          (10,762)        -5.9 %
Time                                               196,768          202,658           (5,890)        -2.9 %
Total deposits                                     476,043          499,760          (23,717)        -4.7 %
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               5,396            4,799               597        12.4 %
Total liabilities                                  684,239          732,359          (48,120)        -6.6 %
Total stockholders' equity                          29,875           40,260          (10,385)       -25.8 %
Total liabilities and stockholders'
equity                                     $       714,114   $      772,619   $      (58,505)        -7.6 %

Cash and Cash Equivalents

Cash and cash equivalents increased $14.8 million to $82.6 million at September 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.

Investment Securities

Investment securities, both available-for-sale and held-to-maturity, are comprised primarily of debt securities of U.S. Government-sponsored enterprises, and mortgage-backed securities. The investment portfolio increased $17.9 million to $177.6 million at September 30, 2013, from $159.7 million at December 31, 2012. As of September 30, 2013, $158.1 million of investment securities were classified as available-for-sale, while $19.5 million of investment securities were classified as held-to-maturity. As of December 31, 2012, $159.7 million of investment securities were classified as available-for-sale, while no investment securities were classified as held-to-maturity.

As of September 30, 2013, approximately $117.7 million of investment securities were pledged as collateral for the securities sold under agreements to repurchase and $24.0 million were pledged to the FHLB as collateral for advances and estimated prepayment fees. At September 30, 2013, $176.6 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 September 30,
2013 and December 31, 2012, excluding loans held-for-sale and warehouse loans:

                                                             % of Total                     % of Total
                                            September 30,    Portfolio      December 31,    Portfolio
                                                2013           Loans            2012          Loans
                                                             (Dollars in Thousands)
Real estate loans:
One- to four-family                        $       171,889         44.8 %  $      193,057         45.3 %
Commercial                                          50,867         13.2 %          58,193         13.7 %
Other (land and multi-family)                       17,108          4.5 %          19,908          4.7 %
Total real estate loans                            239,864         62.5 %         271,158         63.7 %
Real estate construction loans:
One- to four-family                                      -          0.0 %               -          0.0 %
Commercial                                           6,219          1.6 %           5,049          1.2 %
Acquisition and development                              -          0.0 %               -          0.0 %
Total real estate construction loans                 6,219          1.6 %           5,049          1.2 %
Other loans:
Home equity                                         55,241         14.4 %          63,867         15.0 %
Consumer                                            56,004         14.6 %          61,558         14.4 %
Commercial                                          26,601          6.9 %          24,308          5.7 %
Total other loans                                  137,846         35.9 %         149,733         35.1 %

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