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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[ X ] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED March 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____________ TO ______________.
COMMISSION FILE NUMBER: 0-26467
GREATER ATLANTIC FINANCIAL CORP.
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(Exact Name of Registrant as Specified in its Charter)
DELAWARE 54-1873112
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10700 PARKRIDGE BOULEVARD, SUITE P50 703-391-1300
RESTON, VIRGINIA 20191 (Registrant's Telephone Number,
---------------------- -------------------------------
(Address of Principal Executive Offices) Including Area Code
- ----------------------------------------
(Zip Code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 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 ___
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12B-2 of the Exchange Act): Yes ___ No /X/
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date:
At May 7, 2004, there were 3,012,434 shares of the registrant's Common
Stock, par value $0.01 per share outstanding
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GREATER ATLANTIC FINANCIAL CORP.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2004
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE NO.
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Item 1. Financial Statements
Consolidated Statements of Financial Condition
March 31, 2004 (unaudited) and September 30, 2003 (audited)..............................................3
Consolidated Statements of Operations (unaudited)
Three and six months ended March 31, 2004 and March 31, 2003.............................................4
Consolidated Statements of Comprehensive Income (Loss) (unaudited)
Six months ended March 31, 2004 and March 31, 2003 ......................................................5
Consolidated Statements of Changes in Stockholders' Equity (unaudited)
Six months ended March 31, 2004 and March 31, 2003.......................................................5
Consolidated Statements of Cash Flows (unaudited)
Six months ended March 31, 2004 and March 31, 2003.......................................................6
Notes to Consolidated Financial Statements...............................................................8
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................14
Item 3. Quantitative and Qualitative Disclosures about Market Risk...........................................26
Item 4. Controls and Procedures..............................................................................27
PART II. OTHER INFORMATION
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Item 1. Legal Proceedings....................................................................................27
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchase of Equity Securities......................27
Item 3. Defaults Upon Senior Securities......................................................................27
Item 4. Submission of Matters to a Vote of Security Holders..................................................28
Item 5. Other Information....................................................................................28
Item 6. Exhibits and Reports on Form 8-K.....................................................................28
SIGNATURES....................................................................................................29
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GREATER ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
March 31, September 30,
2004 2003
--------------- ---------------
(Unaudited)
(dollars in thousands)
Assets
Cash and cash equivalents $ 2,485 $ 2,029
Interest bearing deposits 6,648 4,114
Investment securities
Available-for-sale 215,922 211,408
Held-to-maturity 11,892 13,376
Trading 7,445 -
Loans held for sale 12,517 6,554
Loans receivable, net 259,200 242,253
Accrued interest and dividends receivable 2,313 2,299
Deferred income taxes 1,520 1,520
Federal Home Loan Bank stock, at cost 6,025 4,340
Premises and equipment, net 8,370 7,948
Goodwill 1,284 1,284
Prepaid expenses and other assets 2,408 2,229
--------------- ---------------
Total assets $538,029 $499,354
=============== ===============
Liabilities and stockholders' equity
Liabilities
Deposits $291,812 $297,876
Advance payments from borrowers for taxes and insurance 376 225
Accrued expenses and other liabilities 3,245 5,919
Advances from the FHLB and other borrowings 214,230 164,635
Guaranteed convertible preferred securities of subsidiary trust 9,364 9,359
--------------- ---------------
Total liabilities 519,027 478,014
--------------- ---------------
Commitments and contingencies
Stockholders' Equity
Preferred stock $.01 par value - 2,500,000 shares authorized,
none outstanding - -
Common stock, $.01 par value - 10,000,000
shares authorized; 3,012,434 shares outstanding 30 30
Additional paid-in capital 25,152 25,152
Accumulated deficit (5,332) (3,771)
Accumulated other comprehensive loss (848) (71)
--------------- ---------------
Total stockholders' equity 19,002 21,340
--------------- ---------------
Total liabilities and stockholders' equity $538,029 $499,354
=============== ===============
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GREATER ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended Six Months Ended
March 31, March 31,
------------------------------ ---------------------------
2004 2003 2004 2003
------------- ------------- ------------- ------------
Interest income
Loans $ 3,375 $ 3,511 $ 6,517 $ 7,400
Investments 1,614 1,642 3,010 3,546
------------- ------------- ------------- ------------
Total interest income 4,989 5,153 9,527 10,946
------------- ------------- ------------- ------------
Interest expense
Deposits 1,377 1,683 2,845 3,583
Borrowed money 1,720 1,516 3,380 3,141
------------- ------------- ------------- ------------
Total interest expense 3,097 3,199 6,225 6,724
------------- ------------- ------------- ------------
Net interest income 1,892 1,954 3,302 4,222
Provision for loan losses 2 66 81 713
------------- ------------- ------------- ------------
Net interest income after provision for loan losses 1,890 1,888 3,221 3,509
------------- ------------- ------------- ------------
Noninterest income
Fees and service charges 247 354 481 785
Gain on sale of loans 2,307 3,150 4,264 7,260
Gain on sale of investment securities (156) (16) 156 (16)
Loss on derivatives (830) (208) (441) (352)
Other operating income 5 10 10 14
------------- ------------- ------------- ------------
Total noninterest income 1,573 3,290 4,470 7,691
------------- ------------- ------------- ------------
Noninterest expense
Compensation and employee benefits 2,181 2,916 4,174 6,141
Occupancy 510 498 1,010 973
Professional services 259 250 547 476
Advertising 525 198 946 381
Deposit insurance premium 11 12 22 23
Furniture, fixtures and equipment 257 269 515 537
Data processing 353 309 703 625
Other real estate owned expenses - 2 - 2
Other operating expenses 636 720 1,335 1,478
------------- ------------- ------------- ------------
Total noninterest expense 4,732 5,174 9,252 10,636
------------- ------------- ------------- ------------
(Loss) income before income tax provision (1,269) 4 (1,561) 564
------------- ------------- ------------- ------------
Income tax provision - - -
------------- ------------- ------------- ------------
Net (loss) income $ (1,269) $ 4 $ (1,561) $ 564
============= ============= ============= ============
(Loss) earnings per common share
Basic $(0.42) $ 0.00 $(0.52) $ 0.19
Diluted $(0.42) $ 0.00 $(0.52) $ 0.17
Weighted average common shares outstanding
Basic 3,012,434 3,012,434 3,012,434 3,012,434
Diluted 3,012,434 4,415,821 3,012,434 4,412,120
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GREATER ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
- --------------------------------------------------------------------------------
Six months ended March 31, 2004 2003
- --------------------------------------------------------------------------------
(in thousands)
Net (loss) earnings $ (1,561) $ 564
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Other comprehensive loss, net of tax
Unrealized loss on securities (777) (203)
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Other comprehensive loss (777) (203)
- --------------------------------------------------------------------------------
Comprehensive (loss) income $ (2,338) $ 361
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GREATER ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED)
- ------------------------------------------------------------------------------------------------------------------------------
Accumulated
Additional Accumulated Other Total
Preferred Common Paid-in Earnings Comprehensive Stockholders'
Stock Stock Capital (Deficit) Income (Loss) Equity
- ------------------------------------------------------------------------------------------------------------------------------
(in thousands)
Balance at September 30, 2002 $- $ 30 $ 25,152 $ (6,032) $ (87) $ 19,063
Other comprehensive loss - - - - (203) (203)
Net earnings for the period - - - 564 - 564
- ------------------------------------------------------------------------------------------------------------------------------
Balance at March 31, 2003 $- $ 30 $ 25,152 $ (5,468) $ (290) $ 19,424
==============================================================================================================================
Balance at September 30, 2003 $- $ 30 $ 25,152 $ (3,771) $ (71) $ 21,340
Other comprehensive loss - - - - (777) (777)
Net loss for the period - - - (1,561) - (1,561)
- ------------------------------------------------------------------------------------------------------------------------------
Balance at March 31, 2004 $- $ 30 $ 25,152 $ (5,332) $ (848) $ 19,002
==============================================================================================================================
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GREATER ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
- --------------------------------------------------------------------------------------------------------------
Six months ended March 31, 2004 2003
- --------------------------------------------------------------------------------------------------------------
(in thousands)
Cash flow from operating activities
Net (loss) income $ (1,561) $ 564
Adjustments to reconcile net income to net cash
provided by operating activities
Provision for loan loss 81 713
Amortization of deposit acquisition adjustment - 23
Amortization of loan acquisition adjustment (14) (14)
Depreciation and amortization 443 443
Proceeds from sale of trading securities 300 292
Net loss on trading securities (300) -
Realized gain on sale of investments 143 16
Loss on derivatives 441 352
Amortization of investment security premiums 774 993
Amortization of mortgage-backed securities premiums 655 -
Amortization of deferred fees (201) (179)
Discount accretion net of premium amortization (208) 272
Amortization of convertible preferred stock costs - -
Amortization of convertible preferred stock costs 5 -
Gain on sale of loans held for sale (4,264) (7,260)
(Increase) decrease in assets
Disbursements for origination of loans (210,203) (314,389)
Proceeds from sales of loans 207,678 325,352
Accrued interest and dividend receivable (14) 407
Prepaid expenses and other assets (231) 18
Deferred loan fees collected, net of deferred costs incurred 305 (20)
Increase (decrease) in liabilities
Accrued expenses and other liabilities (2,279) 179
Income taxes payable - -
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Net cash (used in) provided by operating activities (8,450) 7,762
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GREATER ATLANTIC FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) - (CONTINUED)
- --------------------------------------------------------------------------------------------------------------
Six months ended March 31, 2004 2003
- --------------------------------------------------------------------------------------------------------------
(in thousands)
Cash flow from investing activities
Net increase in loans $ (16,910) $ (8,423)
Purchases of premises and equipment (865) (320)
Purchases of investment securities (16,619) (22,619)
Proceeds from sale of investment securities 24,400 -
Proceeds from repayments of investment securities 18,010 20,311
Purchases of mortgage-backed securities (63,056) -
Proceeds from repayments of mortgage-backed securities 24,483 12,388
Purchases of FHLB stock (9,190) (4,133)
Proceeds from sale of FHLB stock 7,505 4,605
- --------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by investing activities (32,242) 1,809
- --------------------------------------------------------------------------------------------------------------
Cash flow from financing activities
Net (decrease) increase in deposits (6,064) 5,297
Net advances from FHLB 33,700 1,850
Net borrowings on reverse repurchase agreements 15,895 (19,979)
(Decrease) increase in advance payments by borrowers for taxes and 151 45
insurance
Issuance of convertible preferred securities - (1)
- --------------------------------------------------------------------------------------------------------------
Net cash provided (used in) by financing activities 43,682 (12,788)
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Increase (decrease) in cash and cash equivalents 2,990 (3,217)
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Cash and cash equivalents, at beginning of period 6,143 9,358
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Cash and cash equivalents, at end of period $ 9,133 $ 6,141
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GREATER ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INFORMATION AS OF MARCH 31, 2004 AND FOR THE SIX MONTHS THEN ENDED IS UNAUDITED
(1) BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements, which include
the accounts of Greater Atlantic Financial Corp. ("the company") and its wholly
owned subsidiary, Greater Atlantic Bank ("the bank") and its wholly owned
subsidiary, Greater Atlantic Mortgage Corp. ("GAMC"), have been prepared in
accordance with the instructions for Form 10-Q and do not include all of the
disclosures required by generally accepted accounting principles. All
adjustments which, in the opinion of management, are necessary to a fair
presentation of the results for the interim periods presented (consisting of
normal recurring adjustments) have been made. The results of operations for the
six months ended March 31, 2004 are not necessarily indicative of the results of
operations that may be expected for the year ending September 30, 2004 or any
future periods.
(2) LOAN IMPAIRMENT AND LOAN LOSSES
In accordance with guidance in the Statements of Financial Accounting
Standards Nos. 114 and 118, the company prepares a quarterly review to determine
the adequacy of the allowance for loan losses and to identify and value impaired
loans. The company at or during the six months ended March 31, 2004 and 2003
identified impaired loans. An analysis of the change in the allowance for loan
losses follows:
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At or for the Six Months Ended March 31, 2004 2003
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(dollars in thousands)
Balance at beginning of period $1,550 $1,699
Provisions 81 713
Total charge-offs (173) (730)
Total recoveries 18 15
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Net charge-offs (155) (715)
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Balance at end of period $1,476 $1,697
==========================================================================================
Ratio of net charge-offs during the period
to average loans outstanding during the period 0.06% 0.25%
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Allowance for loan losses to total non-performing
loans at end of period 157.52% 108.30%
==========================================================================================
Allowance for loan losses to total loans 0.55% 0.64%
==========================================================================================
(3) REGULATORY MATTERS
The bank qualifies as a Tier 1 institution and may make capital
distributions during a calendar year up to 100% of its net income to date plus
the amount that would reduce by one-half its surplus capital ratio at the
beginning of the calendar year. Any distributions in excess of that amount
require prior notice to the OTS with the opportunity for the OTS to object to
the distribution. A Tier 1 institution is defined as an institution that has, on
a pro forma basis after the proposed distribution, capital equal to or greater
than the OTS fully phased-in capital requirement and has not been deemed by the
OTS to be "in need of more than normal supervision." The bank is currently
classified as a Tier 1 institution for these purposes. The capital distribution
regulation requires that the institution provide the applicable OTS District
Director with a 30-day advance written notice of all proposed capital
distributions whether or not advance approval is required. The bank did not pay
any dividends during the year ended September 30, 2003 or the period ended March
31, 2004.
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GREATER ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
INFORMATION AS OF MARCH 31, 2004 AND FOR THE SIX MONTHS THEN ENDED IS UNAUDITED
The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA)
created five categories of financial institutions based on the adequacy of their
regulatory capital levels: well capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized and critically
undercapitalized. Under FDICIA, a well-capitalized financial institution is one
with Tier 1 leverage capital of 5%, Tier 1 risk-based capital of 6% and total
risk-based capital of 10%. At March 31, 2004, the bank was classified as a
well-capitalized financial institution. The following presents the bank's
capital position:
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Required Required Actual Actual
At March 31, 2004 Balance Percent Balance Percent Surplus
- ---------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Leverage $26,819 5.00% $27,828 5.19% $ 1,009
Tier 1 Risk-based $16,102 6.00% $27,828 10.37% $11,726
Total Risk-based $26,836 10.00% $29,191 10.88% $ 2,355
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(4) STOCK OPTIONS
Effective November 14, 1998, the Company established the 1997 Stock Option
and Warrant Plan (the "Plan"). The Plan reserves options for 76,667 shares to
employees and warrants for 94,685 shares to stockholders. The Plan was amended
effective March 14, 2000, to increase the number of options available for grant
from 76,667 to 225,000 shares to employees and amended again effective March 15,
2002, to increase the number of options available for grant from 225,000 to
350,000 shares to employees and to limit its application to officers and
employees. The stock options and warrants vest immediately upon issuance and
carry a maximum term of 10 years. The exercise price for the stock options and
warrants is the fair market value at grant date. As of March 31, 2004, 94,685
warrants were issued.
The following summary represents the activity under the Plan:
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Number Exercise Expiration
of Shares Price Date
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Balance outstanding at September 30, 2001 139,000
Options granted 10,000 $ 5.31 12-14-2010
Options granted 26,000 $ 7.00 1-1-2012
Options granted 20,000 $ 9.00 1-1-2012
Options exercised (5,000) $ 4.00
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Balance outstanding and exercisable at September 30, 2002 190,000
Options granted -
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Balance outstanding and exercisable at September 30, 2003 190,000
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Options granted 36,000 $ 8.50 10-20-2013
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Balance outstanding and exercisable at March 31, 2004 226,000
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====================================================================================================================
The Company has adopted the disclosure only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"), but it continues to measure compensation cost for
the stock options using the intrinsic value method prescribed by APB Opinion No.
25. As allowable under SFAS 123, the Company used the Black-Scholes method to
measure the compensation cost of stock options granted in the first quarter of
fiscal 2004 with the following assumptions: risk free interest rate of 2.37%, a
dividend payout rate of zero, and an expected option life of seven years. The
volatility is 45%. Using those assumptions, the average weighted fair value of
the stock options granted during fiscal 2004 was $3.59.
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GREATER ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
INFORMATION AS OF MARCH 31, 2004 AND FOR THE SIX MONTHS THEN ENDED IS UNAUDITED
Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
If the Company had elected to recognize compensation cost based on the
value at the grant dates with the method prescribed by SFAS 123, net income
(loss) would have been changed to the pro forma amounts indicated below:
- ------------------------------------------------------------------------------------------------------
Six months ended March 31, 2004 2003
- ------------------------------------------------------------------------------------------------------
(in thousands except per
share data)
Net earnings (loss) $(1,561) $ 564
Deduct: Total stock-based employee compensation expense (129) -
- ------------------------------------------------------------------------------------------------------
Pro forma net earnings (loss) attributable to common stockholders (1,690) 564
======================================================================================================
Earnings (loss) per common share
Basic $ (0.52) $ 0.19
Diluted $ (0.52) $ 0.17
Earnings (loss) per common share, pro forma
Basic $ (0.60) $ 0.19
Diluted $ (0.60) $ 0.17
(5) EARNINGS PER SHARE
Earnings per share is based on the weighted average number of shares of
common stock and dilutive common stock equivalents outstanding. Basic earnings
per share includes no dilution and is computed by dividing income available to
common shareholders by the weighted average number of common shares outstanding
for the period. Diluted earnings per share reflects the potential dilution of
securities that could share in the earnings of an entity. The following table
presents a reconciliation between the weighted average shares outstanding for
basic and diluted earnings per share for the six months ended March 31, 2003.
The effect of the conversion of preferred securities and the impact of stock
options were antidilutive for the period ended March 31, 2004.
For the Six Months
Ended March 31,
------------------------
(dollars in thousands except per share amounts) 2003
----------------------------------------------- ------------------------
Net earnings $564
Effect of conversion of preferred securities 200
Diluted earnings per share 764
Weighted average common shares outstanding 3,012,434
Effect of conversion of preferred securities 1,371,429
Common stock equivalents due to dilutive effect of stock options 28,257
Total weighted average common shares and common share equivalents 4,412,120
outstanding
Basic earnings per common share $0.19
Diluted earnings per common share $0.17
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GREATER ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
INFORMATION AS OF MARCH 31, 2004 AND FOR THE SIX MONTHS THEN ENDED IS UNAUDITED
(6) SEGMENT REPORTING
The company has two reportable segments, banking and mortgage banking. The
bank operates retail deposit branches in the greater Washington, D.C./Baltimore
metropolitan area. The banking segment provides retail consumers and small
businesses with deposit products such as demand, transaction, savings accounts
and certificates of deposit and lending products, such as residential and
commercial real estate, construction and development, consumer and commercial
business loans. Further, the banking segment invests in residential real estate
loans purchased from GAMC and others, and also invests in mortgage-backed and
other securities. The mortgage banking segment activities, which are conducted
principally through GAMC, include the origination of residential real estate
loans either for the bank's portfolio or for sale into the secondary market with
servicing released.
The company evaluates performance based on net interest income, noninterest
income, and noninterest expense. The total of these three items is the
reportable segment's net contribution. The company's reportable segments are
strategic business units that offer different services in different geographic
areas. They are managed separately because each segment appeals to different
markets and, accordingly, requires different technology and marketing
strategies.
Since the company derives a significant portion of its banking revenue from
interest income as offset by interest expense, the segments are reported below
using net interest income. Because the company also evaluates performance based
on noninterest income and noninterest expense, these measures of segment profit
and loss are also presented.
- --------------------------------------------------------------------------------------------------------------------
Total Total
Mortgage Reportable Intersegment Operating
For the Six Months Ended March 31, Banking Banking Segments Eliminations Earnings
- --------------------------------------------------------------------------------------------------------------------
Net interest income: (1)
2004 $ 2,937 $ 284 $ 3,221 $ - $ 3,221
2003 3,196 313 3,509 - 3,509
Noninterest income (expense):
2004 $ 85 $ 4,392 $ 4,477 $ (7) $ 4,470
2003 150 7,561 7,711 (20) 7,691
Noninterest expense:
2004 $ 5,019 $ 4,240 $ 9,259 $ 7 $ 9,252
2003 4,827 5,829 10,656 20 10,636
Net income (loss):
2004 $ (1,996) $ 435 $ (1,561) $ - $ (1,561)
2003 (1,480) 2,044 564 - 564
Segment assets:
2004 $532,400 $ 14,541 $546,941 $ (8,912) $538,029
2003 486,372 12,742 499,114 (8,509) 490,605
(1) Segment net interest income reflects income after provisions for loan losses.
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GREATER ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
INFORMATION AS OF MARCH 31, 2004 AND FOR THE SIX MONTHS THEN ENDED IS UNAUDITED
(7) RECENT ACCOUNTING STANDARDS
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES, which was
replaced by FASB Interpretation No. 46R ("FIN 46R") in December 2003. FIN 46R
became effective in the first quarter of 2004 and defined a variable interest
entity ("VIE") as a corporation, partnership, trust, or any other legal
structure used for the business purpose that either does not have equity
investors with voting rights or has equity investors that do not provide
sufficient financial resources for the entity to support its activities. This
interpretation requires a VIE to be consolidated or deconsolidated by a company
generally based on the risk of loss or return. Most of the original provisions
of Interpretation No. 46 were delayed until March 31, 2004 through the issuance
of FIN 46R. The Company has a VIE in the form of a trust set up to issue trust
preferred securities and accordingly, the implementation of FIN 46R required the
deconsolidation of the Trust. The Company's adoption of FIN 46R did not have a
material impact on the Company's financial position and results of operations.
The restatement of prior years financial statements was not required by FIN 46R
and the Company did not restate the prior year's financial statements.
(8) GUARANTEED CONVERTIBLE PREFERRED SECURITIES OF SUBSIDIARY TRUST
On March 20, 2002, Greater Atlantic Capital Trust I (the, "Trust"), a
Delaware statutory business trust and a wholly owned Trust subsidiary of the
company issued $9.6 million aggregate liquidation amount (963,038 shares) of
6.50% cumulative preferred securities maturing on December 31, 2031, with an
option to call on or after December 31, 2003. Conversion of the preferred
securities into the company's common stock may occur at any time on or after 60
days after the closing of the offering. The company may redeem the preferred
securities, in whole or in part, at any time on or after December 31, 2003.
Distributions on the preferred securities are payable quarterly on March 31,
June 30, September 30 and December 31 of each year beginning on June 30, 2002.
The Trust also issued 29,762 common securities to the company for $297,620. The
company purchased all the shares of the common stock. The proceeds from the sale
of the preferred securities and the proceeds from the sale of the trust's common
securities were utilized to purchase from the company junior subordinated debt
securities of $9,928,000 bearing interest of 6.50% and maturing December 31,
2031. All intercompany interest and equity were eliminated in consolidation.
The Trust was formed for the sole purpose of investing the proceeds from
the sale of the convertible preferred securities in the corresponding
convertible debentures. The Company has fully and unconditionally guaranteed the
preferred securities along with all obligations of the trust related thereto.
The sale of the preferred securities yielded $9.2 million after deducting
offering expenses. The company currently retains approximately $1.5 million of
the proceeds for general corporate purposes, investing the retained funds in
short-term investments. The remaining $8.0 million of the proceeds was invested
in Greater Atlantic Bank to increase its capital position. Initially, these
funds were invested in investment securities. Subsequently, such proceeds were
used to fund new loans.
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GREATER ATLANTIC FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
INFORMATION AS OF MARCH 31, 2004 AND FOR THE SIX MONTHS THEN ENDED IS UNAUDITED
(9) INTEREST RATE EXCHANGE AGREEMENTS
In fiscal 2002, the bank began to utilize derivative financial instruments
to hedge its interest rate risk. The bank does not hold or issue derivative
financial instruments for trading purposes. Beginning in 2002, the bank adopted
statement of Financial Accounting Standard No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133") which requires that an entity
recognize all derivatives as either assets or liabilities and measure those
instruments at fair value. The bank bases the estimated fair values of these
agreements on the cost of interest-rate exchange agreements with similar terms
at available market prices, excluding accrued interest receivable and payable.
However, active markets do not exist for many types of financial instruments.
Consequently, fair values for these instruments must be estimated using
techniques such as discounted cash flow analysis and comparisons to similar
instruments. Estimates developed using these methods are highly subjective and
require judgments regarding significant matters such as the amount and timing of
future cash flows and the selection of discount rates that appropriately reflect
market and credit risks. Changes in these judgments often have a material effect
on the fair value estimates. Since those estimates are made as of a specific
time, they are susceptible to material near term changes.
The bank entered into various interest-rate swaps that total $72 million in
notional principal. The swaps pay a fixed rate with the bank receiving payments
based upon one-to three-month floating rate LIBOR. The capped range is between
1.31% - 4.53%, and expires between 2 and 7 years. The bank also entered into
various interest rate caps that total $30 million in notional principal with
terms between four and ten years that limit the float between a floor of 2.00%,
and capped between 5.00% - 8.00%. The bank accounts for these derivatives, under
the guidelines of SFAS 133.
Realized and unrealized gains and losses on these derivatives which meet
hedge accounting requirements are deferred and recognized when the hedge
transaction occurs. In the event hedge accounting requirements are not met gains
and losses on such instruments are included currently in the statement of
operations. During the six months ended March 31, 2004 and 2003 the instruments
did not meet hedge accounting requirements. The statement of operations includes
net losses of $441,000 and $352,000 for the six months ended March 31, 2004 and
2003, respectively.
13
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with
the Consolidated Financial Statements and Notes presented elsewhere in this
report.
This report contains forward-looking statements. When used in this 10-Q
report and in future filings by the company with the Securities and Exchange
Commission (the "SEC"), in the company's press releases or other public or
shareholder communications, and in oral statements made with the approval of an
authorized executive officer, the words or phrases "will likely result," "are
expected to," "will continue," "is anticipated," "estimate," "project" or
similar expressions are intended to identify "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements are subject to certain risks and uncertainties, including, among
other things, changes in economic conditions in the company's market area,
changes in policies by regulatory agencies, fluctuations in interest rates,
demand for loans in the company's market area and competition that could cause
actual results to differ materially from historical earnings and those presently
anticipated or projected. The company wishes to advise readers that the factors
listed above could affect the company's financial performance and could cause
the company's actual results for future periods to differ materially from any
opinions or statements expressed with respect to future periods in any current
statements.
The company does not undertake and specifically declines any obligation to
publicly release the result of any revisions which may be made to any
forward-looking statements to reflect events or circumstances after the date of
such statements or to reflect the occurrence of anticipated or unanticipated
events.
GENERAL
We are a savings and loan holding company, which was organized in June
1997. We conduct substantially all of our business through our wholly owned
subsidiary, Greater Atlantic Bank, a federally chartered savings bank, and its
wholly owned subsidiary, Greater Atlantic Mortgage Corp. Greater Atlantic Bank
is a member of the Federal Home Loan Bank system and it's deposits are insured
up to applicable limits by the Savings Association Insurance Fund of the Federal
Deposit Insurance Corporation. We offer traditional banking services to
customers through nine Greater Atlantic Bank branches located throughout the
greater Washington, D.C./Baltimore metropolitan area. We also originate mortgage
loans for sale in the secondary market through Greater Atlantic Mortgage Corp.
The profitability of the company, and more specifically, the profitability
of its primary subsidiary Greater Atlantic Bank, depends primarily on its
non-interest income and net interest income. Net interest income is the
difference between the interest income it earns on its loans and investment
portfolio, and the interest it pays on interest-bearing liabilities, which
consists mainly of interest paid on deposits and borrowings. Non-interest income
consists primarily of gains on sales of loans and available-for-sale
investments, service charge fees and commissions earned by non-bank subsidiaries
The level of its operating expenses also affects the company's
profitability. Operating expenses consist primarily of salaries and employee
benefits, occupancy-related expenses, equipment and technology-related expenses
and other general operating expenses.
14
15
At March 31, 2004 the company's total assets were $538.0 million, compared
to the $499.4 million held at September 30, 2003, representing an increase of
7.74%. Both the bank's overall asset size and customer base increased during the
period and that growth is reflected in the consolidated statements of financial
condition and statements of operations. Net loans receivable at March 31, 2004
were $259.2 million, an increase of $16.9 million or 7.00% from the $242.3
million held at September 30, 2003. The increase in loans consisted primarily of
commercial real estate loans and commercial lines of credit secured by mortgages
on residential real estate. At March 31, 2004, investment securities were $235.2
million, an increase of $10.4 million or 4.65% from the $224.8 million held at
September 30, 2003. Deposits at March 31, 2004 were $291.8 million, a decrease
of $6.1 million, which resulted primarily from a decrease in certificates of
deposit of $14.8 million, offset by increases in savings and transaction
accounts of $8.7 million. With the current interest rate environment and
marketing efforts by the bank, we anticipate this trend will continue.
CRITICAL ACCOUNTING POLICIES, ESTIMATES AND JUDGMENTS
The company's financial statements are prepared in accordance with
accounting principles generally accepted in the United States. The preparation
of these financial statements requires management to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenue and
expenses as well as the disclosure of contingent liabilities. Management
continually evaluates its estimates and judgments including those related to the
allowance for loan losses and income taxes. Management bases its estimates and
judgments on historical experience and other factors that are believed to be
reasonable under the circumstances. Actual results may differ from those
estimates under different assumptions or conditions. The company believes that,
of its significant accounting policies, the most critical accounting policies we
apply are those related to the valuation of the loan portfolio.
A variety of factors impact the carrying value of the loan portfolio
including the calculation of the allowance for loan losses, valuation of
underlying collateral, the timing of loan charge-offs and the amount and
amortization of loan fees and deferred origination costs. The allowance for loan
losses is the most difficult and subjective judgment. The allowance is
established and maintained at a level that we believe is adequate to cover
losses resulting from the inability of borrowers to make required payments on
loans. Estimates for loan losses are arrived at by analyzing risks associated
with specific loans and the loan portfolio, current trends in delinquencies and
charge-offs, the views of our regulators, changes in the size and composition of
the loan portfolio and peer comparisons. The analysis also requires
consideration of the economic climate and direction, change in the interest rate
environment, which may impact a borrower's ability to pay, legislation impacting
the banking industry and economic conditions specific to our service area.
Because the calculation of the allowance for loan losses relies on estimates and
judgments relating to inherently uncertain events, results may differ from our
estimates.
15
16
COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED
MARCH 31, 2004 AND MARCH 31, 2003
NET INCOME. For the three months ended March 31, 2004, the company had a
net loss of $1.3 million or $0.42 per diluted share compared to earnings of
$4,000 or $0.00 per diluted share for the three months ended March 31, 2003. The
$1.3 million decline in earnings over the comparable period one-year ago
resulted from a decrease of $1.7 million in non-interest income and was coupled
with a decrease of $62,000 in net interest income. Those declines in income were
offset by decreases in non-interest expense and in provision for loan losses
totaling $506,000. The decreased provision was due primarily to a decrease in
the required provision related to an impaired commercial business loan.
NET INTEREST INCOME. An important source of our earnings is net interest
income, which is the difference between income earned on interest-earning
assets, such as loans, investment securities and mortgage-backed securities, and
interest paid on interest-bearing liabilities such as deposits and borrowings.
The level of net interest income is determined primarily by the relative average
balances of interest-earning assets and interest-bearing liabilities in
combination with the yields earned and rates paid upon them. The correlation
between the re-pricing of interest rates on assets and on liabilities also
influences net interest income.
The following table presents a comparison of the components of interest
income and expense and net interest income.
Difference
- ---------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31, 2004 2003 Amount %
- ---------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Interest income:
Loans $ 3,375 $ 3,511 $ (136) (3.87)%
Investments 1,614 1,642 (28) (1.71)
- ---------------------------------------------------------------------------------------------------------------------
Total 4,989 5,153 (164) (3.18)
- ---------------------------------------------------------------------------------------------------------------------
Interest expense:
Deposits 1,377 1,683 (306) (18.18)
Borrowings 1,720 1,516 204 13.46
- ---------------------------------------------------------------------------------------------------------------------
Total 3,097 3,199 (102) (3.19)
- ---------------------------------------------------------------------------------------------------------------------
Net interest income $ 1,892 $ 1,954 $ (62) (3.17)%
=====================================================================================================================
The decline in net interest income during the quarter ended March 31, 2004,
resulted primarily from a 17 basis point decrease in net interest margin (net
interest income divided by average interest-earning assets) from 1.64% for the
quarter ended March 31, 2003 to 1.47% for the quarter ended March 31, 2004,
offset in part by a $36.9 million increase in the bank's interest-earning
assets. Contributing to the decline in the net interest margin was a $539,000
charge resulting from payments made on certain interest rate swap and cap
agreements compared to a charge of $455,000 in the comparable period one year
ago. That decrease in net interest margin also resulted from the average yield
on interest earning assets declining 12 basis points more than the decline in
the average cost on interest bearing liabilities and was coupled with the
increase in the bank's average interest bearing liabilities exceeding the
increase in average interest earning assets by $3.1 million.
INTEREST INCOME. Interest income for the three months ended March 31, 2004
decreased $164,000 compared to the three months ended March 31, 2003, primarily
as a result of a decrease of 43 basis points in the average yield earned on
interest earning assets. That decrease was partially offset by an increase in
the average outstanding balances of loans and investment securities.
16
17
INTEREST EXPENSE. The $102,000 decrease in interest expense for the three
months ended March 31, 2004 compared to the 2003 period was principally the
result of a 31 basis point decrease in the cost of funds on average deposits and
borrowed funds. The decrease in the cost of those funds was partially offset by
a $39.9 million increase in average deposits and borrowed funds. The decrease in
interest expense on deposits was primarily due to a 36 basis point decrease in
rates paid on certificates of deposit, savings and NOW and money market
accounts. That decrease was coupled with a decrease of $11.6 million, in
certificates, savings and NOW and money market accounts from $276.1 million for
the three months ended March 31, 2003 to $264.5 million for the three months
ended March 31, 2004. The decrease in rates was primarily due to lower rates
paid on interest-bearing demand deposits and savings accounts and lower pricing
on new and renewed time deposits. The decrease in rates resulted from the
Federal Reserve lowering its benchmark interest rate (overnight bank lending
rate) thirteen times since January 3, 2001 by a total of 5.50% to a low of
1.00%.
The increase in interest expense on borrowings for the three months ended
March 31, 2004 compared to the 2003 period was principally the result of a $51.5
million increase in average borrowed funds and was partially offset by a 41
basis point decrease in the cost of borrowed funds. Components accountable for
the increase of $204,000 in interest expense were a $374,000 increase relating
to average volume, offset by a $170,000 decrease relating to average cost
17
18
COMPARATIVE AVERAGE BALANCES AND INTEREST INCOME ANALYSIS. The following
table presents the total dollar amount of interest income from average
interest-earning assets and the resultant yields, as well as the interest
expense on average interest-bearing liabilities, expressed both in dollars and
annualized rates. No tax-equivalent adjustments were made and all average
balances are average daily balances. Non-accruing loans have been included in
the tables as loans carrying a zero yield.
FOR THE THREE MONTHS ENDED MARCH 31,
------------------------------------------- --------------------------------------
2004 2003
------------------------------------------- --------------------------------------
INTEREST INTEREST AVERAGE
AVERAGE INCOME/ AVERAGE YIELD/ AVERAGE INCOME/ YIELD/
BALANCE EXPENSE RATE BALANCE EXPENSE RATE
------------------------------------------- --------------------------------------
ASSETS: (DOLLARS IN THOUSANDS)
Interest-earning assets:
Real estate loans $ 159,264 $ 2,171 5.45% $ 177,827 $ 2,522 5.67%
Consumer loans 66,180 631 3.81 63,269 616 3.89
Commercial business loans 44,572 573 5.14 31,459 373 4.74
----------- -------- ----------- ------------ --------- --------
Total loans 270,016 3,375 5.00 272,555 3,511 5.15
Investment securities 123,465 789 2.56 160,714 1,233 3.07
Mortgage-backed securities 120,126 825 2.75 43,474 409 3.76
----------- -------- ----------- ------------ --------- --------
Total interest-earning assets 513,607 4,989 3.89 476,743 5,153 4.32
-------- ----------- --------- --------
Non-earning assets 18,298 16,159
----------- ------------
Total assets $ 531,905 $ 492,902
=========== ============
LIABILITIES AND STOCKHOLDERS'
EQUITY:
Interest-bearing liabilities:
Savings accounts $ 10,867 26 0.96 $ 8,977 31 1.38
Now and money market accounts 78,320 211 1.08 78,333 272 1.39
Certificates of deposit 175,275 1,140 2.60 188,748 1,380 2.92
----------- -------- ----------- ------------ --------- --------
Total deposits 264,462 1,377 2.08 276,058 1,683 2.44
FHLB advances 137,810 751 2.18 95,227 623 2.62
Other borrowings 92,754 969 4.18 83,812 893 4.26
----------- -------- ----------- ------------ --------- --------
Total interest-bearing 495,026 3,097 2.50 455,097 3,199 2.81
liabilities -------- ----------- --------- --------
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits 13,575 14,583
Other liabilities 3,223 3,822
----------- ------------
Total liabilities 511,824 473,502
Stockholders' equity 20,081 19,400
----------- ------------
Total liabilities and
stockholders' Equity $ 531,905 $ 492,902
=========== ============
Net interest income $ 1,892 $ 1,954
======== =========
Interest rate spread 1.39% 1.51%
=========== ========
Net interest margin 1.47% 1.64%
=========== ========
18
19
RATE/VOLUME ANALYSIS. The following table presents certain information
regarding changes in interest income and interest expense attributable to
changes in interest rates and changes in volume of interest-earning assets and
interest-bearing liabilities for the periods indicated. The change in interest
attributable to both rate and volume has been allocated to the changes in rate
and volume on a pro rata basis.
THREE MONTHS ENDED
MARCH 31, 2004 COMPARED TO
MARCH 31, 2003
----------------------------------------------
CHANGE ATTRIBUTABLE TO
----------------------------------------------
VOLUME RATE TOTAL
----------------------------------------------
(IN THOUSANDS)
Real estate loans $ (263) $ (88) $ (351)
Consumer loans 28 (13) 15
Commercial business loans 155 45 200
-------- ---------- -----------
Total loans (80) (56) (136)
Investments (286) (158) (444)
Mortgage-backed securities 721 (305) 416
-------- ---------- -----------
Total interest-earning assets $ 355 $ (519) $ (164)
======== ========== ===========
Savings accounts $ 7 $ (12) $ (5)
Now and money market accounts - (61) (61)
Certificates of deposit (99) (141) (240)
-------- ---------- -----------
Total deposits (92) (214) (306)
FHLB advances 279 (151) 128
Other borrowings 95 (19) 76
-------- ---------- -----------
Total interest-bearing liabilities 282 (384) (102)
======== ========== ===========
Change in net interest income $ 73 $ (135) $ (62)
======== ========== ===========
PROVISION FOR LOAN LOSSES. The allowance for loan losses, which is
established through provisions for losses charged to expense, is increased by
recoveries on loans previously charged off and is reduced by charge-offs on
loans. Determining the proper reserve level or allowance involves management's
judgment based upon a review of factors, including the company's internal review
process, which segments the loan portfolio into groups based on loan type.
Management then looks at its classified assets, which are loans 30 days or more
delinquent, and classifies those loans as special mention, substandard or
doubtful, based on the performance of the loans. Those classified loans are then
individually evaluated for impairment. Since the historical three-year loss
experience for the bank is new, those loans that are not classified are not
individually evaluated. Those loans are then segmented by type and assigned a
reserve percentage that reflects the industry loss experience. The loans
individually evaluated for impairment are measured by either the present value
of expected future cash flows, the loans observable market price, or the fair
value of the collateral. Although management utilizes its best judgment in
providing for probable losses, there can be no assurance that the bank will not
have to increase its provisions for loan losses in the future. An increase in
provision may result from an adverse market for real estate and economic
conditions generally in the company's primary market area, future increases in
non-performing assets or for other reasons which would adversely affect the
company's results of operations.
Non-performing assets were $937,000 or 0.17% of total assets at March 31,
2004, with $716,000 classified as substandard, $221,000 classified as doubtful
and none classified as real estate owned compared to $1.7 million or 0.35% at
March 31, 2003. Non-performing assets decreased $758,000 from the comparable
period one year ago, coupled with a decrease of $64,000 in the provision for
loan losses. The decrease in non-performing assets from the year ago period was
due to the reduction of the outstanding balance of one of the bank's commercial
business loans. The decrease in provision was due primarily to a reduction in
the required provision for that loan since the bank is in the process of
liquidating that loan from the cash flow of the collateral securing the loan.
19
20
NON-INTEREST INCOME. Non-interest income decreased $1.7 million during the
three months ended March 31, 2004, over the comparable period one year ago. That
decrease was primarily the result of a decrease of $1.5 million in gain on sale
of loans and loss on derivatives and was coupled with decreases of $109,000 and
$140,000 in service fees on loans and loss on sale of investments, respectively.
The level of gain on sale of loans during the three months ended March 31, 2004
resulted from lower than anticipated loan origination and sales volumes at the
bank's mortgage banking subsidiary with margins also being less than those in
the year-ago period. The following table presents a comparison of the components
of non-interest income.
Difference
- -------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31, 2004 2003 Amount %
- -------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Non-interest income:
Gain on sale of loans $ 2,307 $ 3,150 $ (843) (26.76)%
Service fees on loans 54 163 (109) (66.87)
Service fees on deposits 193 191 2 1.05
Loss on sale of investment securities (156) (16) (140) (875.00)
Loss on derivatives (830) (208) (622) (299.04)
Other operating income 5 10 (5) (50.00)
- -------------------------------------------------------------------------------------------------------------------
Total non-interest income $ 1,573 $ 3,290 $ (1,717) (52.19)%
===================================================================================================================
NON-INTEREST EXPENSE. Non-interest expense decreased $442,000 from $5.2
million for the three months ended March 31, 2003 to $4.7 million for the
comparable period in the current year. The decrease was primarily attributable
to a $478,000 decrease in the mortgage company's non-interest expense from the
comparable period one year ago as a result of decreased loan origination and
sales. The increase in the bank's non-interest expense was a modest $36,000
distributed over various non-interest expense categories. The decrease at the
mortgage company level was primarily in compensation, and other operating
expenses, and was offset by increases in professional services, advertising,
occupancy, data processing and furniture fixtures and equipment. Mortgage
related expenses should continue to decline because of the lag in timing of such
expenses compared to the decline in origination and sales volumes. The following
table presents a comparison of the components of non-interest expense.
Difference
- --------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31, 2004 2003 Amount %
- --------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Non-interest expense:
Compensation and employee benefits $ 2,181 $ 2,916 $ (735) (25.21)%
Occupancy 510 498 12 2.41
Professional services 259 250 9 3.60
Advertising 525 198 327 165.15
Deposit insurance premium 11 12 (1) (8.33)
Furniture, fixtures and equipment 257 269 (12) (4.46)
Data processing 353 309 44 14.24
Other operating expense 636 722 (86) (11.91)
---------------------------------------------------------------------------------------------------------------
Total non-interest expense $ 4,732 $ 5,174 $ (442) (8.54)%
===============================================================================================================
INCOME TAXES. The company files a consolidated federal income tax return
with its subsidiaries and computes its income tax provision or benefit on a
consolidated basis. Based on recent tax legislation, the company expects to
offset all taxable income in fiscal 2004 with existing net operating losses
carried forward from prior years. The company believes that it will continue to
generate taxable income for the foreseeable future which will assure the use of
existing net operating losses.
20
21
Contractual Commitments and Obligations
- ----------------------------------------------------------------------------------------------------------------
Less Than One Two - Three Four - Five After Five
Total Year Years Years Years
- ----------------------------------------------------------------------------------------------------------------
(in thousands)
FHLB Advances (1) $ 120,500 $ 95,500 $ - $ - $ 25,000
Reverse repurchase agreements 93,730 93,730 - - -
Operating leases 9,199 1,295 2,703 2,300 2,901
- ----------------------------------------------------------------------------------------------------------------
Total obligations $ 223,429 $ 190,525 $ 2,703 $ 2,300 $ 27,901
================================================================================================================
(1) The company expects to refinance these short and medium-term obligations
under substantially the same terms and conditions.
Other Commercial Commitments
- ----------------------------------------------------------------------------------------------------------------
Less Than One Two - Three Four - Five After Five
Total Year Years Years Years
- ----------------------------------------------------------------------------------------------------------------
(in thousands)
Certificate of deposit maturities (1) $ 183,140 $ 120,621 $ 42,684 $ 19,742 $ 93
Loan originations 129,958 129,958 - - -
Unfunded lines of credit 100,802 100,802 - - -
Standby letters of credit 309 309 - - -
- ----------------------------------------------------------------------------------------------------------------
Total $ 414,209 $ 351,690 $ 42,684 $ 19,742 $ 93
================================================================================================================
(1) The company expects to retain maturing deposits or replace amounts maturing with comparable
certificates of deposits based on current market interest rates.
COMPARISON OF RESULTS OF OPERATIONS FOR THE SIX MONTHS
ENDED MARCH 31, 2004 AND MARCH 31, 2003
NET INCOME. For the six months ended March 31, 2004, the company had a net
loss of $1.6 million or $0.52 per diluted share compared to earnings of $564,000
or $0.17 per diluted share for the six months ended March 31, 2003. The $2.1
million decline in earnings over the comparable period one-year ago resulted
from a decrease of $3.2 million in non-interest income and was coupled with a
decrease of $920,000 in net interest income. Those declines in income were
offset in part by decreases in non-interest expense and in provision for loan
losses totaling $2.0 million. The decreased provision was due primarily to a
decrease in the required provision related to an impaired commercial business
loan
NET INTEREST INCOME. An important source of our earnings is net interest
income, which is the difference between income earned on interest-earning
assets, such as loans, investment securities and mortgage-backed securities, and
interest paid on interest-bearing liabilities such as deposits and borrowings.
The level of net interest income is determined primarily by the relative average
balances of interest-earning assets and interest-bearing liabilities in
combination with the yields earned and rates paid upon them. The correlation
between the re-pricing of interest rates on assets and on liabilities also
influences net interest income.
21
22
The following table presents a comparison of the components of interest
income and expense and net interest income.
Difference
- ---------------------------------------------------------------------------------------------------
Six Months Ended March 31, 2004 2003 Amount %
- ---------------------------------------------------------------------------------------------------
(dollars in thousands)
Interest income:
Loans $ 6,517 $ 7,400 $ (883) (11.93)%
Investments 3,010 3,546 (536) (15.12)
- ---------------------------------------------------------------------------------------------------
Total 9,527 10,946 (1,419) (12.96)
- ---------------------------------------------------------------------------------------------------
Interest expense:
Deposits 2,845 3,583 (738) (20.60)
Borrowings 3,380 3,141 239 7.61
- ---------------------------------------------------------------------------------------------------
Total 6,225 6,724 (499) (7.42)
- ---------------------------------------------------------------------------------------------------
Net interest income $ 3,302 $ 4,222 $ (920) (21.79)%
===================================================================================================
The decline in net interest income during the six months ended March 31,
2004, resulted primarily from a 43 basis point decrease in net interest margin
(net interest income divided by average interest-earning assets) from 1.72% for
the six months ended March 31, 2003 to 1.29% for the six months ended March 31,
2004, offset in part by a $19.0 million increase in the bank's interest-earning
assets. Contributing to the decline in the net interest margin was a $1.1
million charge resulting from payments made on certain interest rate swap and
cap agreements compared to an $836,000 charge in the comparable period one year
ago. The decrease in net interest margin also resulted from the average yield on
interest earning assets declining 37 basis points more than the average cost on
interest bearing liabilities and was coupled with the increase in the bank's
average interest bearing liabilities exceeding the increase in average interest
earning assets by $7.0 million.
INTEREST INCOME. Interest income for the six months ended March 31, 2004
decreased $1.4 million compared to the six months ended March 31, 2003,
primarily as a result of a decrease of 72 basis points in the average yield
earned on interest earning assets. That decrease was partially offset by an
increase in the average outstanding balances of loans and investment securities.
INTEREST EXPENSE. The $499,000 decrease in interest expense for the six
months ended March 31, 2004 compared to the 2003 period was principally the
result of a 35 basis point decrease in the cost of funds on average deposits and
borrowed funds. The decrease in the cost of those funds was partially offset by
a $26.0 million increase in average deposits and borrowed funds. The decrease in
interest expense on deposits was primarily due to a 50 basis point decrease in
rates paid on certificates of deposit, savings and NOW and money market
accounts. That decrease was coupled with a decrease of $4.6 million, in
certificates, savings and NOW and money market accounts from $277.7 million for
the six months ended March 31, 2003 to $273.1 million for the six months ended
March 31, 2004.
The increase in interest expense on borrowings for the six months ended
March 31, 2004 compared to the 2003 period was principally the result of a $30.7
million increase in average borrowed funds and was partially offset by a 25
basis point decrease in the cost of borrowed funds. Components accountable for
the increase of $239,000 in interest expense were a $423,000 increase relating
to average volume, offset by an $184,000 decrease relating to average cost. The
decrease in rates was primarily due to lower rates paid on interest-bearing
demand deposits and savings accounts and lower pricing on new and renewed time
deposits.
22
23
COMPARATIVE AVERAGE BALANCES AND INTEREST INCOME ANALYSIS. The following
table presents the total dollar amount of interest income from average
interest-earning assets and the resultant yields, as well as the interest
expense on average interest-bearing liabilities, expressed both in dollars and
annualized rates. No tax-equivalent adjustments were made and all average
balances are average daily balances. Non-accruing loans have been included in
the tables as loans carrying a zero yield.
FOR THE SIX MONTHS ENDED MARCH 31,
------------------------------------------------------------------------
2004 2003
----------------------------------- -----------------------------------
INTEREST INTEREST AVERAGE
AVERAGE INCOME/ AVERAGE AVERAGE INCOME/ YIELD/
BALANCE EXPENSE YIELD/RATE BALANCE EXPENSE RATE
----------------------------------- -----------------------------------
ASSETS: (DOLLARS IN THOUSANDS)
Interest-earning assets:
Real estate loans $154,933 $4,207 5.43% $189,694 $5,340 5.63%
Consumer loans 66,001 1,253 3.80 62,079 1,277 4.11
Commercial business loans 42,239 1,057 5.00 31,907 783 4.91
---------- --------- ------- ---------- --------- --------
Total loans 263,173 6,517 4.95 283,680 7,400 5.22
Investment securities 133,485 1,688 2.53 161,417 2,584 3.20
Mortgage-backed securities 114,050 1,322 2.32 46,599 962 4.13
---------- --------- ------- ---------- --------- --------
Total interest-earning assets 510,708 9,527 3.73 491,696 10,946 4.45
--------- ------- --------- --------
Non-earning assets 17,750 16,353
---------- ----------
Total assets $528,458 $508,049
========== ==========
LIABILITIES AND STOCKHOLDERS'
EQUITY:
Interest-bearing liabilities:
Savings accounts $ 10,915 51 0.93 $ 8,663 64 1.48
Now and money market accounts 77,697 419 1.08 76,609 594 1.55
Certificates of deposit 184,479 2,375 2.57 192,466 2,925 3.04
---------- --------- ------- ---------- --------- --------
Total deposits 273,091 2,845 2.08 277,738 3,583 2.58
FHLB advances 127,030 1,431 2.25 97,573 1,318 2.70
Other borrowings 90,603 1,949 4.30 89,383 1,823 4.08
---------- --------- ------ ---------- --------- --------
Total interest-bearing liabilities 490,724 6,225 2.54 464,694 6,724 2.89
--------- ------- --------- --------
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits 13,128 19,500
Other liabilities 4,106 4,586
---------- ----------
Total liabilities 507,958 488,780
Stockholders' equity 20,500 19,269
---------- ----------
Total liabilities and stockholders'
equity $528,458 $508,049
========== ==========
Net interest income $3,302 $4,222
========= ==========
Interest rate spread 1.19% 1.56%
======= ========
Net interest margin 1.29% 1.72%
======= ========
23
24
RATE/VOLUME ANALYSIS. The following table presents certain information
regarding changes in interest income and interest expense attributable to
changes in interest rates and changes in volume of interest-earning assets and
interest-bearing liabilities for the periods indicated. The change in interest
attributable to both rate and volume has been allocated to the changes in rate
and volume on a pro rata basis.
SIX MONTHS ENDED
MARCH 31, 2004 COMPARED TO
MARCH 31, 2003
-------------------------------------------------
CHANGE ATTRIBUTABLE TO
-------------------------------------------------
VOLUME RATE TOTAL
-------------------------------------------------
(IN THOUSANDS)
Real estate loans $ (979) $ (154) $ (1,133)
Consumer loans 81 (105) (24)
Commercial business loans 254 20 274
--------- ----------- ------------
Total loans (644) (239) (883)
Investments (447) (449) (896)
Mortgage-backed securities 1,392 (1,032) 360
--------- ----------- ------------
Total interest-earning assets $ 301 $ (1,720) $ (1,419)
========= =========== ============
Savings accounts $ 17 $ (30) $ (13)
Now and money market accounts 8 (183) (175)
Certificates of deposit (121) (429) (550)
--------- ----------- ------------
Total deposits (96) (642) (738)
FHLB advances 398 (285) 113
Other borrowings 25 101 126
--------- ----------- ------------
Total interest-bearing liabilities 327 (826) (499)
========= =========== ============
Change in net interest income $ (26) $ (894) $ (920)
========= =========== ============
PROVISION FOR LOAN LOSSES. Non-performing assets were $937,000 or 0.17% of
total assets at March 31, 2004, compared to $1.7 million or 0.35% at March 31,
2003, with $716,000 classified as substandard, $221,000 classified as doubtful
and none classified as real estate owned. Non-performing assets decreased
$758,000 from the comparable period one year ago, coupled with a decrease of
$632,000 in the provision for loan losses. The decrease in non-performing assets
from the year ago period was due to the reduction of the outstanding balance of
one of the bank's commercial business loans. The decrease in provision was due
primarily to a reduction in the required provision for that loan since the bank
is in the process of liquidating that loan from the cash flow of the collateral
securing the loan.
NON-INTEREST INCOME. Non-interest income decreased $3.2 million during the
six months ended March 31, 2004, over the comparable period one year ago. That
decrease was primarily the result of a decrease in gain on sale of loans and was
coupled with decreases of $287,000, $89,000 and $17,000 in service fees on
loans, losses on derivatives and service fees on deposits, respectively. Those
decreases were offset in part by an increase in gain on sale of investment
securities. The level of gain on sale of loans during the six months ended March
31, 2004 resulted from lower than anticipated loan origination and sales volumes
at the bank's mortgage banking subsidiary with margins also being less than
those in the year-ago period. The following table presents a comparison of the
components of non-interest income.
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The following table presents a comparison of the components of non-interest
income.
Difference
- -------------------------------------------------------------------------------------------
Six Months Ended March 31, 2004 2003 Amount %
- -------------------------------------------------------------------------------------------
(dollars in thousands)
Non-interest income:
Gain on sale of loans $ 4,264 $ 7,260 $ (2,996) (41.27)%
Service fees on loans 113 400 (287) (71.75)
Service fees on deposits 368 385 (17) (4.42)
Gain on sale of investment securities 156 (16) 172 1,075.00
Loss on derivatives (441) (352) (89) (25.28)
Other operating income 10 14 (4) (28.57)
- -------------------------------------------------------------------------------------------
Total non-interest income $ 4,470 $ 7,691 $ (3,221) (41.88)%
===========================================================================================
NON-INTEREST EXPENSE. Non-interest expense decreased $1.4 million from
$10.6 million for the six months ended March 31, 2004 to $9.3 million for the
comparable period in the current year. The decrease was primarily attributable
to a $1.6 million decrease in the mortgage company's non-interest expense from
the comparable period one year ago as a result of decreased loan origination and
sales. The increase in the bank's non-interest expense was a modest $187,000
distributed over various non-interest expense categories. The decrease at the
mortgage company level was primarily in compensation, and other operating
expenses, and was offset by increases in professional services, advertising,
occupancy, data processing and furniture fixtures and equipment. Mortgage
related expenses should continue to decline because of the lag in timing of such
expenses compared to the decline in origination and sales volumes. The following
table presents a comparison of the components of non-interest expense.
The following table presents a comparison of the components of non-interest
expense.
Difference
- -------------------------------------------------------------------------------------------
Six Months Ended March 31, 2004 2003 Amount %
- -------------------------------------------------------------------------------------------
(dollars in thousands)
Noninterest expense:
Compensation and employee benefits $ 4,174 $ 6,141 $ (1,967) (32.03)%
Occupancy 1,010 973 37 3.80
Professional services 547 476 71 14.92
Advertising 946 381 565 148.29
Deposit insurance premium 22 23 (1) (4.35)
Furniture, fixtures and equipment 515 537 (22) (4.10)
Data processing 703 625 78 12.48
Other operating expense 1,335 1,480 (145) (9.80)
- -------------------------------------------------------------------------------------------
Total noninterest expense $ 9,252 $ 10,636 $ (1,384) (13.01)%
===========================================================================================
INCOME TAXES. The company files a consolidated federal income tax return
with its subsidiaries and computes its income tax provision or benefit on a
consolidated basis. Based on recent tax legislation, the company expects to
offset all taxable income in fiscal 2004 with existing net operating losses
carried forward from prior years. The company believes that it will continue to
generate taxable income for the foreseeable future which will assure the use of
existing net operating losses.
LIQUIDITY AND CAPITAL RESOURCES. The bank's primary sources of funds are
deposits, principal and interest payments on loans, mortgage-backed and
investment securities and borrowings. While maturities and scheduled
amortization of loans are predictable sources of funds, deposit flows and
mortgage prepayments are greatly influenced by general interest rates, economic
conditions and competition. The bank has continued to maintain the levels of
liquid assets as previously required by OTS regulations. The bank manages its
liquidity position and demands for funding primarily by investing excess funds
in short-term investments and utilizing FHLB advances and reverse repurchase
agreements in periods when the bank's demands for liquidity exceed funding from
deposit inflows.
The bank's most liquid assets are cash and cash equivalents and securities
available-for-sale. The levels of those assets are dependent on the bank's
operating, financing, lending and investing activities during any given period.
At March 31, 2004, cash and cash equivalents, interest bearing deposits and
securities available-for-sale totaled $232.5 million or 43.21% of total assets.
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The primary investing activities of the bank are the origination of
residential one- to four-family loans, commercial real estate loans, real estate
construction and development loans, commercial borrowing and consumer loans and
the purchase of United States Treasury and agency securities, mortgage-backed
and mortgage-related securities and other investment securities. During the six
months ended March 31, 2004, the bank's loan purchases and originations totaled
$76.6 million. Purchases of United States Treasury and agency securities,
mortgage-backed and mortgage related securities and other investment securities
totaled $79.7 million for the six months ended March 31, 2004.
The bank has other sources of liquidity if a need for additional funds
arises. At March 31, 2004, the bank had $120.5 million in advances outstanding
from the FHLB and had an additional overall borrowing capacity from the FHLB of
$94.7 million. Depending on market conditions, the pricing of deposit products
and FHLB advances, the bank may continue to rely on FHLB borrowings to fund
asset growth.
At March 31, 2004, the bank had commitments to fund loans and unused
outstanding lines of credit, unused standby letters of credit and undisbursed
proceeds of construction mortgages totaling $231.1 million. The bank anticipates
that it will have sufficient funds available to meet its current loan
origination commitments. Certificate accounts, including IRA and Keogh accounts,
which are scheduled to mature in less than one year from March 31, 2004, totaled
$48.2 million. Based upon experience, management believes the majority of
maturing certificates of deposit will remain with the bank. In addition,
management of the bank believes that it can adjust the rates offered on
certificates of deposit to retain deposits in changing interest rate
environments. In the event that a significant portion of these deposits are not
retained by the bank, the bank would be able to utilize FHLB advances and
reverse repurchase agreements to fund deposit withdrawals, which would result in
an increase in interest expense to the extent that the average rate paid on such
borrowings exceeds the average rate paid on deposits of similar duration.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and
rates. The company's market risk arises primarily from interest rate risk
inherent in its lending and deposit taking activities. The company has little or
no risk related to trading accounts, commodities or foreign exchange. In
general, market risk reflects the sensitivity of income to variations in
interest rates and other relevant market rates or prices. The company's market
rate sensitive instruments include interest-earning assets and interest-bearing
liabilities. The company enters into market rate sensitive instruments in
connection with its various business operations, particularly its mortgage
banking activities. Loans originated, and the related commitments to originate
loans that will be sold, represent market risk that is realized in a short
period of time, generally two or three months.
The company's primary source of market risk exposure arises from changes in
United States interest rates and the effects thereof on mortgage prepayment and
closing behavior, as well as depositors' choices ("interest rate risk"). Changes
in those interest rates will result in changes in the company's earnings and the
market value of its assets and liabilities. We expect to continue to realize
income from the differential or "spread" between the interest earned on loans,
securities and other interest-earning assets, and the interest paid on deposits,
borrowings and other interest-bearing liabilities. That spread is affected by
the difference between the maturities and re-pricing characteristics of
interest-earnings assets and interest-bearing liabilities. Loan volume and
yields are affected by market interest rates on loans, and rising interest rates
generally are associated with fewer loan originations. Management expects that a
substantial portion of our assets will continue to be indexed to changes in
market interest rates and we intend to attract a greater proportion of
short-term liabilities, which will help us address our interest rate risk. The
lag in implementation of re-pricing terms on our adjustable-rate assets may
result in a decline in net interest income in a rising interest rate
environment. There can be no assurance that our interest rate risk will be
minimized or eliminated. Further, an increase in the general level of interest
rates may adversely affect the ability of certain borrowers to pay the interest
on and principal of their obligations. Accordingly, changes in levels of market
interest rates, (primarily increases in market interest rates), could materially
adversely affect our interest rate spread, asset quality, loan origination
volume and overall financial condition and results of operations.
To mitigate the impact of changes in market interest rates on our
interest-earning assets and interest-bearing liabilities, we actively manage the
amounts and maturities of these assets and liabilities. A key component of this
strategy is the origination and retention of short-term and adjustable-rate
assets and the origination and sale of fixed-rate loans. We retain short-term
and adjustable-rate assets because they have re-pricing characteristics that
more closely match the re-pricing characteristics of our liabilities.
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To further mitigate the risk of timing differences in the re-pricing of
assets and liabilities, our interest-earning assets are matched with
interest-bearing liabilities that have similar re-pricing characteristics. For
example, the interest rate risk of holding fixed-rate loans is managed with
long-term deposits and borrowings, and the risk of holding ARMs is managed with
short-term deposits and borrowings. Periodically, mismatches are identified and
managed by adjusting the re-pricing characteristics of our interest-bearing
liabilities with derivatives, such as interest rate caps and interest rate
swaps.
Through the use of these derivative instruments, management attempts to
reduce or offset increases in interest expense related to deposits and
borrowings. We use interest rate caps and pay-fixed interest rate swaps to
protect against rising interest rates.
The interest rate caps and pay-fixed interest rate swaps are designed to
provide an additional layer of protection should interest rates on deposits and
borrowings rise, by effectively lengthening the re-pricing period. At March 31,
2004, we held an aggregate notional value of $102 million of caps and pay-fixed
interest rate swaps. None of the interest rate caps had strike rates that were
in effect at March 31, 2004, as current LIBOR rates were below the strike rates.
We are also striving to increase the proportion of transaction deposits to
total deposits to diminish our exposure to adverse changes in interest rates. In
particular, non-interest-bearing checking accounts and custodial accounts are
less sensitive to interest rate fluctuations and provide a growing source of
non-interest income through depositor and other retail banking fees.
ITEM 4. CONTROLS AND PROCEDURES
(a). Evaluation of disclosure controls and procedures. As described in Note
------------------------------------------------
24 to our annual consolidated financial statements, we have restated our
financial statements to reflect adjustments resulting from the revision of our
accounting treatment of certain derivative instruments. In light of this
restatement, we conducted a new evaluation of the effectiveness of our
disclosure controls and procedures as of the date of this amended report. Based
on this evaluation, our principal executive officer and principal financial
officer conclude that our disclosure controls and procedures were adequate.
(b). Changes in internal control. The company made no significant changes
---------------------------
in its internal controls or in other factors that could significantly affect
these controls subsequent to the date of the evaluation of those controls by the
Chief Executive and Chief Financial officers.
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
Not applicable.
ITEM 2. Changes in Securities and Use of Proceeds
Not applicable.
ITEM 3. Defaults Upon Senior Securities
Not applicable.
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ITEM 4. Submission of Matters to a Vote of Security Holders
(a) Greater Atlantic Financial Corp. annual Stockholder's Meeting
was held on February 2, 2004.
(b) Omitted per instructions
(c) A brief description of each matter voted upon at the Annual
Stockholder's Meeting held on February 2, 2004 and number of
votes cast for, against or withheld
1. Election of Directors.
Votes For Votes Against Votes Withheld
--------- ------------- --------------
Jeffrey M. Gitelman 2,845,863 0 9,900
Sidney M. Bresler 2,621,019 0 19,900
In addition to Jeffrey M. Gitelman and Sidney M. Bresler the terms of
office of Directors Paul Cinquegrana, Jeffrey W. Ochsman, Charles W.
Calomiris, Carroll E. Amos and James B. Vito continued after the
meeting.
2. Election of BDO Seidman, LLP as Independent Auditor.
Votes For Votes Against Votes Withheld
--------- ------------- --------------
2,851,563 1,700 2,500
Not applicable
ITEM 5. Other Information
Not applicable.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits
11.0 Statement Regarding Computation of Per Share Earnings
31.1 Certification of Chief Executive Officer pursuant to Section 302 of
Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section 302 of
Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer pursuant to Section 906 of
Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to Section 906 of
Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
On January 30, 2004 the Company filed a Form 8-K to disclose that the
Company issued a press release to announce the company's first quarter
earnings.
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GREATER ATLANTIC FINANCIAL CORP.
SIGNATURES
Pursuant to the requirement of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
GREATER ATLANTIC FINANCIAL CORP.
--------------------------------
(Registrant)
By: /s/ Carroll E. Amos
-----------------------
Carroll E. Amos
President and Chief Executive Officer
By: /s/ David E. Ritter
-----------------------
David E. Ritter
Senior Vice President and Chief Financial Officer
Date: May 27, 2004
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