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EX-32 - EXHIBIT 32 - Atlantic Coast Financial CORPv465673_ex32.htm
EX-31.2 - EXHIBIT 31.2 - Atlantic Coast Financial CORPv465673_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - Atlantic Coast Financial CORPv465673_ex31-1.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2017

 

Commission file number: 001-35072

 

(Exact name of registrant as specified in its charter)

 

Maryland 65-1310069
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer Identification No.)

 

4655 Salisbury Road, Suite 110

Jacksonville, Florida 32256

(Address of principal executive offices, zip code)

 

(800) 342-2824

(Registrant's telephone number, including area 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 has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

YES x NO ¨.

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and emerging growth company in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer ¨          Accelerated Filer x          Non-Accelerated Filer ¨

Smaller Reporting Company ¨          Emerging Growth Company ¨

 

If an merging growth company, indicate by check mark if the registrarnt has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

YES ¨ NO x.

 

The number of shares outstanding of the registrant’s common stock as of May 1, 2017 was 15,553,709 shares.

 

 

 

 

ATLANTIC COAST FINANCIAL CORPORATION

 

Form 10-Q Quarterly Report

 

Table of Contents

 

    Page
 
PART I. FINANCIAL INFORMATION
     
Item 1. Financial Statements 3
  Condensed Consolidated Balance Sheets (unaudited) 3
  Condensed Consolidated Statements of Operations (unaudited) 4
  Condensed Consolidated Statements of Comprehensive Income (unaudited) 5
  Condensed Consolidated Statements of Stockholders’ Equity (unaudited) 6
  Condensed Consolidated Statements of Cash Flows (unaudited) 7
  Notes to Condensed Consolidated Financial Statements (unaudited) 8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 36
  General Description of Business 37
  Recent Events 37
  Critical Accounting Policies 37
  Comparison of Financial Condition 38
  Comparison of Results of Operations 46
  Liquidity 51
Item 3. Quantitative and Qualitative Disclosures About Market Risk 52
Item 4. Controls and Procedures 54
     
PART II. OTHER INFORMATION
     
Item 1. Legal Proceedings 55
Item 1A. Risk Factors 55
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 55
Item 3. Defaults Upon Senior Securities 55
Item 4. Mine Safety Disclosures 55
Item 5. Other Information 55
Item 6. Exhibits 55
     
Signature Page 56
Index to Exhibits 57

 

 

 

 

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in Thousands, Except Share Information)

(unaudited)

 

   March 31, 2017   December 31, 2016 
         
ASSETS          
Cash and due from financial institutions  $4,041   $3,744 
Short-term interest-earning deposits   23,713    56,149 
Total cash and cash equivalents   27,754    59,893 
Securities available-for-sale   101,069    65,293 
Portfolio loans, net of allowance of $8,272 in 2017 and $8,162 in 2016   681,576    639,245 
Other loans:          
Held-for-sale   2,126    7,147 
Warehouse loans held-for-investment   58,118    80,577 
Total other loans   60,244    87,724 
Federal Home Loan Bank stock, at cost   6,941    8,792 
Land, premises and equipment, net   14,734    14,945 
Bank owned life insurance   17,652    17,535 
Other real estate owned   2,806    2,886 
Accrued interest receivable   1,741    1,979 
Deferred tax assets, net   6,409    6,752 
Other assets   2,561    2,415 
Total assets  $923,487   $907,459 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY          
Liabilities:          
Deposits:          
Noninterest-bearing demand  $67,926   $59,696 
Interest-bearing demand   127,297    106,004 
Savings and money market   249,279    224,987 
Time   241,336    237,726 
Total deposits   685,838    628,413 
Federal Home Loan Bank advances   144,092    188,758 
Accrued expenses and other liabilities   4,692    3,270 
Total liabilities   834,622    820,441 
           
Commitments and contingent liabilities          
           
Stockholders’ equity:          
Preferred stock: $0.01 par value; 25,000,000 shares authorized; none issued and outstanding at March 31, 2017 and December 31, 2016        
Common stock: $0.01 par value; 100,000,000 shares authorized; 15,553,709 issued and outstanding at March 31, 2017 and 15,509,061 issued and outstanding at December 31, 2016   156    155 
Additional paid-in capital   100,341    100,361 
Common stock held by:          
Employee stock ownership plan shares of 65,870 at March 31, 2017 and 67,067 at December 31, 2016   (1,431)   (1,457)
Benefit plans   (94)   (99)
Retained deficit   (8,839)   (10,316)
Accumulated other comprehensive loss   (1,268)   (1,626)
Total stockholders’ equity   88,865    87,018 
Total liabilities and stockholders’ equity  $923,487   $907,459 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

3

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in Thousands, Except Share Information)

(unaudited)

 

   Three Months Ended
March 31,
 
   2017   2016 
Interest and dividend income:          
Loans, including fees  $7,469   $7,500 
Securities and interest-earning deposits in other financial institutions   419    696 
Total interest and dividend income   7,888    8,196 
Interest expense:          
Deposits   1,088    797 
Securities sold under agreements to repurchase       1 
Federal Home Loan Bank advances   428    1,308 
Total interest expense   1,516    2,106 
Net interest income   6,372    6,090 
Provision for portfolio loan losses   100    150 
Net interest income after provision for portfolio loan losses   6,272    5,940 
           
Noninterest income:          
Service charges and fees   434    633 
Gain on sale of securities available-for-sale       828 
Gain on sale of loans held-for-sale   1,542    414 
Bank owned life insurance earnings   117    117 
Interchange fees   329    358 
Other   139    211 
Total noninterest income   2,561    2,561 
           
Noninterest expense:          
Compensation and benefits   3,487    3,458 
Occupancy and equipment   555    602 
Federal Deposit Insurance Corporation insurance premiums   135    172 
Foreclosed assets, net   80     
Data processing   611    456 
Outside professional services   537    471 
Collection expense and repossessed asset losses   139    145 
Other   1,006    774 
Total noninterest expense   6,550    6,078 
           
Income before income tax expense   2,283    2,423 
Income tax expense   806    899 
Net income  $1,477   $1,524 
           
Earnings per common share:          
Basic  $0.10   $0.10 
Diluted  $0.10   $0.10 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

4

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in Thousands)

(unaudited)

 

   Three Months Ended
March 31,
 
   2017   2016 
         
Net income  $1,477   $1,524 
           
Other comprehensive income:          
Change in securities available-for-sale:          
Unrealized holding gains arising during the period   801    2,092 
Less reclassification adjustments for gains recognized in income       (828)
Net unrealized gains   801    1,264 
Income tax effect   (443)   (727)
Net of tax effect   358    537 
           
Total other comprehensive income   358    537 
           
Comprehensive income  $1,835   $2,061 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

5

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Dollars in Thousands, Except Share Information)

(unaudited)

 

   Common
Shares
   Common
Stock
   Additional
Paid-In
Capital
   Employee
Stock
Ownership
Plan Shares
   Benefit
Plans
   Retained
Deficit
   Accumulated
Other
Comprehensive
Loss
   Total
Stockholders’
Equity
 
                                 
For the three months ended March 31, 2017:                                        
                                         
Balance at December 31, 2016   15,509,061   $155   $100,361   $(1,457)  $(99)  $(10,316)  $(1,626)  $87,018 
Employee stock ownership plan shares earned, 1,197 shares           (17)   26                9 
Restricted stock awards   44,648    1                        1 
Distribution from Rabbi Trust           (3)       5            2 
Net income                       1,477        1,477 
Other comprehensive income                           358    358 
Balance at March 31, 2017   15,553,709   $156   $100,341   $(1,431)  $(94)  $(8,839)  $(1,268)  $88,865 
                                         
For the three months ended March 31, 2016:                                        
                                         
Balance at December 31, 2015   15,509,061   $155   $100,458   $(1,561)  $(248)  $(16,734)  $(1,332)  $80,738 
Employee stock ownership plan shares earned, 1,197 shares           (19)   26                7 
Distribution from Rabbi Trust           (21)       47            26 
Net income                       1,524        1,524 
Other comprehensive income                           537    537 
Balance at March 31, 2016   15,509,061   $155   $100,418   $(1,535)  $(201)  $(15,210)  $(795)  $82,832 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

6

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in Thousands)

(unaudited)

 

   Three Months Ended March 31, 
   2017   2016 
Cash flows from operating activities:          
Net income  $1,477   $1,524 
Adjustments to reconcile net income to net cash from operating activities:          
Provision for portfolio loan losses   100    150 
Gain on sale of loans held-for-sale   (1,542)   (414)
Originations of loans held-for-sale   (16,068)   (11,689)
Proceeds from sales of loans held-for-sale   22,242    12,747 
Loss on foreclosed assets, net   80     
Gain on sale of securities available-for-sale       (828)
Employee stock ownership plan compensation expense   9    7 
Restricted stock awards   1     
Amortization of prepayment penalties resulting from repayment of Federal Home Loan Bank advances       744 
Amortization of premiums and deferred fees, net of accretion of discounts on investment securities and loans   (15)   4 
Depreciation expense   291    240 
Deferred tax benefit   129     
Net change in cash surrender value of bank owned life insurance   (117)   (117)
Net change in accrued interest receivable   238    50 
Net change in other assets   (166)   95 
Net change in accrued expenses and other liabilities   1,422    279 
Net cash provided by operating activities   8,081    2,792 
           
Cash flows from investing activities:          
Proceeds from maturities and payments of investment securities   21,276    3,330 
Proceeds from sales of securities available-for-sale       41,852 
Purchase of securities available-for-sale   (56,529)   (5,000)
Funding of warehouse loans held-for-investment   (257,641)   (294,435)
Proceeds from repayments of warehouse loans held-for-investment   280,100    263,279 
Purchase of portfolio loans   (15,872)   (7,130)
Net change in portfolio loans   (26,086)   (29,660)
Purchase of premises and equipment   (80)   (169)
Proceeds from disposal of premises and equipment       62 
Proceeds from sale of other real estate owned       84 
Purchase of Federal Home Loan Bank stock   (3,631)   (3,951)
Redemption of Federal Home Loan Bank stock   5,482    1,785 
Net cash used in investing activities   (52,981)   (29,953)
           
Cash flows from financing activities:          
Net change in deposits   57,425    (5,195)
Repayment of securities sold under agreements to repurchase       (9,991)
Proceeds from Federal Home Loan Bank advances   85,000    110,500 
Repayment of Federal Home Loan Bank advances   (129,666)   (62,667)
Shares purchased for and distributions from Rabbi Trust   2    26 
Net cash provided by financing activities   12,761    32,673 
           
Net increase (decrease) in cash and cash equivalents   (32,139)   5,512 
Cash and cash equivalents, beginning of period   59,893    23,581 
Cash and cash equivalents, end of period  $27,754   $29,093 
           
Supplemental disclosures of cash flow information:          
Interest paid  $1,516   $2,083 
Income taxes paid        
           
Supplemental disclosures of non-cash information:          
Loans transferred to other real estate  $   $59 
Loans transferred to portfolio   409     
Income tax expense from unrealized holding gains and losses on securities available-for-sale arising during the period   214    320 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

7

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2017

(unaudited)

 

NOTE 1. BASIS OF PRESENTATION

 

The accompanying unaudited condensed consolidated financial statements (the Financial Statements) and these notes to the Financial Statements (these Notes) include Atlantic Coast Financial Corporation (the Company) and its wholly owned subsidiary, Atlantic Coast Bank (the Bank). All significant inter-company balances and transactions have been eliminated in consolidation. The principal activity of the Company is the ownership of the Bank’s common stock, and as such, the terms “Company” and “Bank” are used interchangeably throughout the Financial Statements and these Notes in this Quarterly Report on Form 10-Q (this Report) and, unless context indicates otherwise, refer to the activities of the Company and the Bank.

 

The accompanying condensed consolidated balance sheet as of December 31, 2016, which was derived from the Company’s audited consolidated financial statements, and the unaudited condensed consolidated financial statements as of March 31, 2017, and for the three months ended March 31, 2017 and 2016, have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) for interim financial information of smaller reporting companies and with the instructions for Form 10-Q and Article 8 and Article 9 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for a complete financial statement presentation. In the opinion of management, all adjustments (all of which are normal and recurring in nature) considered necessary (i) for a fair presentation and (ii) to make such statements not misleading, have been included.

 

Operating results for the three months ended March 31, 2017, are not necessarily indicative of the results that may be expected for the year ending December 31, 2017. The audited consolidated financial statements presented in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 (the 2016 10-K), should be read in conjunction with these Financial Statements.

 

Certain items in the prior period financial statements have been reclassified to conform to the current period presentation. The reclassifications had no effect on net income, the balance of retained deficit or stockholders’ equity as previously reported.

 

The preparation of the Financial Statements in conformity with U.S. GAAP requires management to make estimates and assumptions based on experience and available information that affect the amounts reported in the Financial Statements and these Notes, and actual results could differ materially from these estimates. Estimates associated with the allowance for portfolio loan losses (the allowance), measuring for impairment of troubled debt restructurings (TDR), the fair values of securities, other financial instruments and other real estate owned (OREO) and the realization of deferred tax assets are particularly susceptible to material change in the near term.

 

Accumulated other comprehensive income consists solely of the effects of unrealized gains and losses on securities available-for-sale, net of income taxes, which include a disproportionate tax effect of $0.7 million at both March 31, 2017 and December 31, 2016. This disproportionate tax effect is a result of the reversal of the deferred tax valuation allowance in 2015.

 

NOTE 2. IMPACT OF CERTAIN ACCOUNTING PRONOUNCEMENTS

 

Recently Issued Standards Adopted

 

In March 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2017-08, Premium Amortization on Purchased Callable Debt Securities (ASU 2017-08). ASU 2017-08 requires premiums on purchased callable debt securities to be amortized to the earliest call date. The guidance in this standard is effective for interim and annual periods beginning after December 15, 2018, and early adoption was permitted. The Company adopted ASU 2017-08 for the first quarter of 2017, with no material impact on the Financial Statements.

 

8

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2017

(unaudited)

 

NOTE 2. IMPACT OF CERTAIN ACCOUNTING PRONOUNCEMENTS (continued)

 

Recently Issued Standards Adopted (continued)

 

In January 2017, the FASB issued ASU 2017-03, Amendments to SEC Paragraphs Pursuant to Staff Announcements at the September 22, 2016 and November 17, 2016 EITF Meetings (ASU 2017-03). ASU 2017-03 provides amendments which includes the text of SEC Staff Announcement: Disclosure of the Impact That Recently Issued Accounting Standards Will Have on the Financial Statements of a Registrant When Such Standards Are Adopted in a Future Period (Staff Accounting Bulletin Topic 11.M). The guidance requires additional disclosures related to the effect that recently issued accounting standards will have on the Company’s financial statements, when adopted in a future period. In cases where a the effect of adoption cannot be reasonably estimated, then additional qualitative disclosures should be considered to assist the reader in assessing the significance of the standard's impact on the Company’s financial statements. The Company has enhanced its disclosures regarding the impact of recently issued accounting standards to be adopted in a future period.

 

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting (ASU 2016-09). ASU 2016-09 reduces complexity in accounting standards related to the accounting for employee share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The guidance in this standard is effective for interim and annual periods beginning after December 15, 2016, and early adoption was permitted. The Company adopted ASU 2016-09 for the first quarter of 2017, with no material impact on the Financial Statements. Additionally, the Company retained its existing accounting policy election to estimate award forfeitures.

 

Recently Issued Standards Not Yet Adopted

 

In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments (ASU 2016-15). The guidance will reduce the diversity in how certain cash receipts and cash payments are presented in the statement of cash flows. ASU 2016-15 provides guidance as to the presentation on the statement of cash flows for eight specific cash flow issues. The guidance in this standard is effective for annual periods beginning after December 15, 2018, and interim periods within those annual periods beginning after December 15, 2019, and early adoption is permitted. The Company is in the process of evaluating the impact of adopting this standard on its financial statements; however, adoption is not expected to materially impact the financial statements.

 

In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments (ASU 2016-13). ASU 2016-13 significantly changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The guidance will replace the current “incurred loss” model with an “expected loss” model for instruments measured at amortized cost. Additionally, the guidance will require allowances for investment securities classified as available-for-sale, rather than reduce the carrying amount under the other-than-temporary impairment (OTTI) model. It also simplifies the accounting model for purchased credit-impaired investment securities and loans. The guidance in this standard is effective for interim and annual periods beginning after December 15, 2019, with early adoption permitted for interim and annual periods beginning after December 15, 2018. The Company is in the process of evaluating the impact of adopting this standard on its financial statements; however, adoption will result in a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective.

 

9

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2017

(unaudited)

 

NOTE 2. IMPACT OF CERTAIN ACCOUNTING PRONOUNCEMENTS (continued)

 

Recently Issued Standards Not Yet Adopted (continued)

 

In February 2016, the FASB issued ASU 2016-02, Leases (ASU 2016-02). ASU 2016-02 requires lessees to present right-of-use assets and lease liabilities on the balance sheet, as well as to disclose key information regarding leasing arrangements. The guidance in this standard is effective for interim and annual periods beginning after December 15, 2018. The Company is in the process of evaluating the impact of adopting this standard on its financial statements; however, adoption will result in new assets and liabilities being recorded on the balance sheet as of the beginning of the first reporting period in which the guidance is effective.

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (ASU 2014-09). ASU 2014-09 is a comprehensive new revenue recognition model requiring a company to recognize revenue to depict the transfer of goods or services to a customer at an amount reflecting the consideration it expects to receive in exchange for those goods or services. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers – Deferral of Effective Date, which deferred the effective date of ASU 2014-09. As a result, the guidance in this standard may be applied using either a full retrospective or a modified retrospective approach and is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, and early adoption is not permitted. The Company is in the process of evaluating the impact of adopting this standard on its financial statements, as well as evaluating which transition method it will apply upon adoption; however, adoption is not expected to materially impact the financial statements.

 

NOTE 3. TRANSACTIONS WITH RELATED PARTIES

 

Transactions between Atlantic Coast Bank and Customers Bank

 

Jay S. Sidhu and Bhanu Choudhrie are directors of the Company and Customers Bancorp, Inc., the parent company of Customers Bank. Mr. Sidhu is also Chairman and Chief Executive Officer of Customers Bancorp, Inc. and Customers Bank.

 

On August 26, 2016, the Bank entered into three amended $15.0 million participation agreements (each was previously $10.0 million) related to warehouse lines of credit secured by one- to four-family residential loans originated by third party originators under purchase and assumption agreements (warehouse loans held-for-investment) with Customers Bank (collectively, the Customers Participation Agreements), which were originally entered into on March 27, 2015 and first amended on March 23, 2016. Under the Customers Participation Agreements, the Bank has an interest in existing lines of credit related to warehouse loans held-for-investment currently serviced by Customers Bank.

 

The Bank receives the full amount of interest earned on the warehouse loans held-for-investment. Customers Bank receives the fees paid for each individual funding request. Customers Bank services the warehouse loans held-for-investment funding requests, manages the collateral receipt and shipment, receives and posts pay downs, and remits principal and interest to the Bank. Under the Customers Participation Agreements, Customers Bank is required to administer the participating lines of credit using the same standards the Bank would use to administer its own accounts. Additionally, the Bank has access to each funding request and all daily activity reporting to monitor its exposure.

 

The Customers Participation Agreements were entered into in the ordinary course of the Bank’s business, were made on substantially the same terms as those prevailing at the time for comparable agreements with non-affiliated business partners and did not involve more than normal risk or present other unfavorable features. The outstanding balance in warehouse loans held-for-investment related to the Customers Participation Agreements was $20.0 million and $25.0 million as of March 31, 2017 and December 31, 2016, respectively. During the three months ended March 31, 2017 and 2016, the Bank earned $39,000 and $3,000, respectively, of interest income related to the Customers Participation Agreements.

 

10

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2017

(unaudited)

 

NOTE 4. FAIR VALUE

 

Asset and liability fair value measurements (in this Note and Note 5. Fair Value of Financial Instruments of these Notes) have been categorized based upon the fair value hierarchy described below:

 

·Level 1 – Valuation is based upon quoted market prices for identical instruments in active markets.

 

·Level 2 – Valuation is based upon observable inputs other than quoted market prices included within Level 1, including quoted market prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

 

·Level 3 – Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect estimates or assumptions that market participants would use in pricing the assets or liabilities. Valuation techniques include use of option pricing models, discounted cash flow models, and similar techniques.

 

Assets measured at fair value on a recurring basis as of March 31, 2017 and December 31, 2016, are summarized below:

 

       Fair Value Hierarchy 
   Total   Level 1   Level 2   Level 3 
   (Dollars in Thousands) 
March 31, 2017                    
Assets:                    
U.S. government-sponsored enterprises  $54,992   $   $54,992   $ 
State and municipal   5,535        5,535     
Mortgage-backed securities – residential   26,645        26,645     
Collateralized mortgage obligations – U.S. government   2,868        2,868     
Corporate debt   11,029        11,029     
Total  $101,069   $   $101,069   $ 
                     
December 31, 2016                    
Assets:                    
U.S. government-sponsored enterprises  $19,997   $   $19,997   $ 
State and municipal   4,991        4,991     
Mortgage-backed securities – residential   27,328        27,328     
Collateralized mortgage obligations – U.S. government   3,059        3,059     
Corporate debt   9,918        9,918     
Total  $65,293   $   $65,293   $ 

 

The fair values of securities available-for-sale are determined by quoted market prices, if available (Level 1). For securities available-for-sale where quoted market prices are not available, fair values are calculated based on quoted market prices of similar securities (Level 2). For securities available-for-sale where quoted market prices or quoted market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3).

 

There were no Level 3 investments measured on a recurring basis as of March 31, 2017 and December 31, 2016, and there were no transfers into or out of Level 3 investments during the three months ended March 31, 2017 and the year ended December 31, 2016. Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. During times when trading is less liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.

 

There were no liabilities measured at fair value on a recurring basis as of March 31, 2017 and December 31, 2016.

 

11

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2017

(unaudited)

 

NOTE 4. FAIR VALUE (continued)

 

Assets measured at fair value on a nonrecurring basis as of March 31, 2017 and December 31, 2016, are summarized below:

 

       Fair Value Hierarchy 
   Total   Level 1   Level 2   Level 3 
   (Dollars in Thousands) 
March 31, 2017                    
Assets:                    
Other real estate owned  $2,806   $   $   $2,806 
Impaired loans – collateral dependent (reported on the consolidated balance sheets in portfolio loans, net)   8,099            8,099 
                     
December 31, 2016                    
Assets:                    
Other real estate owned  $2,886   $   $   $2,886 
Impaired loans – collateral dependent (reported on the consolidated balance sheets in portfolio loans, net)   7,978            7,978 

 

Quantitative information about Level 3 fair value measurements as of March 31, 2017 and December 31, 2016, is as follows:

 

   Fair Value
Estimate
   Valuation
Techniques
  Unobservable Inputs  Range (Weighted
Average) (1)
   (Dollars in Thousands)
              
March 31, 2017              
Assets:              
Other real estate owned  $2,806   Broker price opinions, appraisal of collateral (2), (3)  Appraisal adjustments (4)  0.0% to 64.4%
(5.3%)
           Liquidation expenses  10.0% (10.0%)
               
Impaired loans – collateral dependent (reported on the consolidated balance sheets in portfolio loans, net)   8,099   Appraisal of collateral (2)  Appraisal adjustments (4)  0.0 to 83.0%
(23.4%)
           Liquidation expenses  0.0% to 10.0%
(9.6%)
               
December 31, 2016              
Assets:              
Other real estate owned  $2,886   Broker price opinions, appraisal of collateral (2), (3)  Appraisal adjustments (4)  0.0% to 64.0%
(8.5%)
           Liquidation expenses  10.0% (10.0%)
               
Impaired loans – collateral dependent (reported on the consolidated balance sheets in portfolio loans, net)   7,978   Appraisal of collateral (2)  Appraisal adjustments (4)  0.0% to 83.0%
(24.4%)
           Liquidation expenses  0.0% to 10.0%
(9.9%)

 

 
(1)The range and weighted average of other appraisal adjustments and liquidation expenses are presented as a percent of the appraised value.
(2)Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various Level 3 inputs which are not identifiable.
(3)Includes qualitative adjustments by management and estimated liquidation expenses.
(4)Appraisals may be adjusted by management for qualitative factors such as economic conditions.

 

12

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2017

(unaudited)

 

NOTE 4. FAIR VALUE (continued)

 

The fair value of OREO is determined using inputs which include current and prior appraisals and estimated costs to sell (Level 3). Costs relating to improvement of property may be capitalized, whereas costs relating to the holding of property are expensed. Write-downs on OREO for the three months ended March 31, 2017 were $80,000, while there were no write-downs on OREO for the three months ended March 31, 2016. The fair values of impaired loans that are collateral-dependent are based on a valuation model which incorporates the most current real estate appraisals available, as well as assumptions used to estimate the fair value of all non-real estate collateral as defined in the Bank’s internal loan policy (Level 3).

 

There are no liabilities measured at fair value on a nonrecurring basis as of March 31, 2017 and December 31, 2016.

 

NOTE 5. FAIR VALUE OF FINANCIAL INSTRUMENTS

 

Carrying amount and estimated fair value of financial instruments, not previously presented, as of March 31, 2017 and December 31, 2016, were as follows:

 

           Fair Value Hierarchy 
   Carrying
Amount
   Estimated
Fair Value
   Level 1   Level 2   Level 3 
   (Dollars in Thousands) 
March 31, 2017                    
Assets:                         
Cash and due from financial institutions  $4,041   $4,041   $4,041   $   $ 
Short-term interest-earning deposits   23,713    23,713    23,713         
Portfolio loans, net   681,576    680,842        672,743    8,099 
Loans held-for-sale   2,126    2,263        2,263     
Warehouse loans held-for-investment   58,118    58,118        58,118     
Federal Home Loan Bank stock, at cost   6,941    6,941            6,941 
Bank owned life insurance   17,652    17,661        17,661     
Accrued interest receivable   1,741    1,741        1,741     
Liabilities:                         
Deposits   685,838    686,246        686,246     
Federal Home Loan Bank advances   144,092    144,957        144,957     
Accrued interest payable (reported on consolidated balance sheets in accrued expenses and other liabilities)   122    122        122     
                          
December 31, 2016                         
Assets:                         
Cash and due from financial institutions  $3,744   $3,744   $3,744   $   $ 
Short-term interest-earning deposits   56,149    56,149    56,149         
Portfolio loans, net   639,245    652,133        644,155    7,978 
Loans held-for-sale   7,147    7,281        7,281     
Warehouse loans held-for-investment   80,577    80,577        80,577     
Federal Home Loan Bank stock, at cost   8,792    8,792            8,792 
Bank owned life insurance   17,535    17,546        17,546     
Accrued interest receivable   1,979    1,979        1,979     
Liabilities:                         
Deposits   628,413    628,714        628,714     
Federal Home Loan Bank advances   188,758    189,842        189,842     
Accrued interest payable (reported on consolidated balance sheets in accrued expenses and other liabilities)   121    121        121     

 

13

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2017

(unaudited)

 

NOTE 5. FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)

 

Carrying amount is the estimated fair value for cash and cash equivalents, accrued interest, demand and savings deposits and variable rate loans or deposits that re-price frequently and fully. Fair value of securities held-to-maturity is based on market prices of similar securities. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent re-pricing or re-pricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life without considering the need for adjustments for market illiquidity or credit risk. Fair value of loans held-for-sale is based on quoted market prices, where available, or is determined based on discounted cash flows using current market rates applied to the estimated life and credit risk. Carrying amount is the estimated fair value for warehouse loans held-for-investment, due to the rapid repayment of the loans (generally less than 30 days). Fair value of bank owned life insurance is based on the insurance contract cash surrender value or quoted market prices of the underlying securities or similar securities. Fair value of the Federal Home Loan Bank (FHLB) advances and securities sold under agreements to repurchase (repurchase agreements) is based on current rates for similar financing. It was not practicable to determine the fair value of the FHLB stock due to restrictions placed on its transferability. The estimated fair value of other financial instruments and off-balance-sheet commitments approximate cost and are not considered significant to this presentation.

 

The Bank is a member of the FHLB and as such, is required to maintain a minimum investment in stock of the FHLB that varies with the level of advances outstanding with the FHLB. The stock is bought from and sold to the FHLB based upon its $100.00 par value. The stock does not have a readily determinable fair value and, as such, is classified as restricted stock, carried at cost and evaluated for impairment. Accordingly, the stock’s value is determined by the ultimate recoverability of the par value rather than by recognizing temporary declines. The determination of whether the par value will ultimately be recovered is influenced by criteria such as the following: (a) the significance of the decline in net assets of the FHLB as compared to the capital stock amount and the length of time that such a situation has persisted, (b) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance, (c) the impact of legislative and regulatory changes on the customer base of the FHLB and (d) the liquidity position of the FHLB. The Company did not consider the FHLB stock to be impaired as of March 31, 2017 and December 31, 2016.

 

14

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2017

(unaudited)

 

NOTE 6. INVESTMENT SECURITIES

 

The following table summarizes the amortized cost and fair value of the investment securities and the corresponding amounts of unrealized gains and losses therein as of March 31, 2017 and December 31, 2016:

 

   Amortized
Cost
   Unrealized
Gains
   Unrealized
Losses
   Fair
Value
   Carrying
Amount
 
   (Dollars in Thousands) 
                     
March 31, 2017                         
U.S. government–sponsored enterprises  $54,996   $   $(4)  $54,992   $54,992 
State and municipal   5,518    24    (7)   5,535    5,535 
Mortgage-backed securities – residential   27,396        (751)   26,645    26,645 
Collateralized mortgage obligations – U.S. government   2,950        (82)   2,868    2,868 
Corporate debt   11,034    252    (257)   11,029    11,029 
Total investment securities  $101,894   $276   $(1,101)  $101,069   $101,069 
                          
December 31, 2016                         
U.S. Government–sponsored enterprises  $19,999   $   $(2)  $19,997   $19,997 
State and municipal   5,024    2    (35)   4,991    4,991 
Mortgage-backed securities – residential   28,515        (1,187)   27,328    27,328 
Collateralized mortgage obligations – U.S. Government   3,152        (93)   3,059    3,059 
Corporate debt   10,000    226    (308)   9,918    9,918 
Total investment securities  $66,690   $228   $(1,625)  $65,293   $65,293 

 

The amortized cost and fair value of investment securities, segregated by contractual maturity as of March 31, 2017, are shown below:

 

   Amortized Cost   Fair Value 
   (Dollars in Thousands) 
Due in one year or less  $   $ 
Due in more than one to five years   411    409 
Due in more than five to ten years (1)   13,826    13,836 
Due after ten years   2,315    2,319 
U.S. Government-sponsored enterprises   54,996    54,992 
Mortgage-backed securities – residential   27,396    26,645 
Collateralized mortgage obligations – U.S. government   2,950    2,868 
   $101,894   $101,069 

 

 
(1)Includes $5.0 million (amortized cost) of corporate debt, consisting of one instrument with a scheduled maturity date of March 2026, however, the corporate debt instrument includes a special feature which makes it callable starting in March 2021.

 

Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Investment securities not due at a single maturity date, including mortgage-backed securities and collateralized mortgage obligations, are shown separately.

 

15

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2017

(unaudited)

 

NOTE 6. INVESTMENT SECURITIES (continued)

 

The following table summarizes the investment securities with unrealized losses as of March 31, 2017 and December 31, 2016, aggregated by investment category and length of time in a continuous unrealized loss position:

 

   Less Than 12 Months   12 Months or More   Total 
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
 
   (Dollars in Thousands) 
March 31, 2017                              
U.S. Government–sponsored enterprises  $54,992   $(4)  $   $   $54,992   $(4)
State and municipal   2,065    (7)           2,065    (7)
Mortgage-backed securities – residential   26,611    (751)           26,611    (751)
Collateralized mortgage obligations – U.S. Government           2,868    (82)   2,868    (82)
Corporate debt   5,778    (257)           5,778    (257)
   $89,446   $(1,019)  $2,868   $(82)  $92,314   $(1,101)
                               
December 31, 2016                              
U.S. Government–sponsored enterprises  $19,997   $(2)  $   $   $19,997   $(2)
State and municipal   3,921    (36)           3,921    (36)
Mortgage-backed securities – residential   27,291    (1,187)           27,291    (1,187)
Collateralized mortgage obligations – U.S. Government           3,059    (92)   3,059    (92)
Corporate debt   4,692    (308)           4,692    (308)
   $55,901   $(1,533)  $3,059   $(92)  $58,960   $(1,625)

 

Other-Than-Temporary Impairment

 

Management evaluates investment securities for OTTI on at least a quarterly basis and more frequently when economic or market conditions warrant such an evaluation. As of March 31, 2017, the Company’s security portfolio consisted of 25 investment securities (all classified as available-for-sale), 18 of which were in an unrealized loss position. The unrealized losses were primarily related to debt securities whose underlying collateral is residential mortgages and all of these debt securities were issued by government sponsored organizations, as discussed below.

 

As of March 31, 2017, $84.5 million, or approximately 83.6% of the debt securities held by the Company, including 12 of the Company’s debt securities in an unrealized loss position, were issued by U.S. government-sponsored entities and agencies, primarily Fannie Mae and Freddie Mac, which are institutions the U.S. government has affirmed its commitment to support.

 

16

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2017

(unaudited)

 

NOTE 6. INVESTMENT SECURITIES (continued)

 

Other-Than-Temporary Impairment (continued)

 

The decline in fair value of the Company’s debt securities in an unrealized loss position was attributable to changes in interest rates and not credit quality. It is not more likely than not the Company will be required to sell these securities before their anticipated recovery; however, from time to time the Company makes decisions to sell securities available-for-sale as part of its balance sheet and risk management strategies. Therefore, the Company does not consider these debt securities to be other-than-temporarily impaired as of March 31, 2017.

 

The Company did not hold any non-agency collateralized mortgage-backed securities or collateralized mortgage obligations as of March 31, 2017 and December 31, 2016, and did not record OTTI related to such securities during the three months ended March 31, 2017 and 2016.

 

The 10-year treasury rate as of March 31, 2017 and December 31, 2016, was 2.40% and 2.45%, respectively.

 

Proceeds from Investment Securities

 

Proceeds from sales, payments, maturities, and calls of securities available-for-sale were $21.3 million and $45.2 million for the three months ended March 31, 2017 and 2016, respectively.

 

No gross gains or losses were realized during the three months ended March 31, 2017. Gross gains of $1.0 million were realized during the three months ended March 31, 2016. Gross losses of $0.2 million were realized during the three months ended March 31, 2016. The gross gain on sale of securities available-for-sale for the three months ended March 31, 2016, includes $0.8 million of accumulated other comprehensive income reclassifications from unrealized holding gains.

 

On February 18, 2016, the Company sold $15.8 million of investment securities previously classified as held-to-maturity, representing the Company’s entire balance of such investment securities on that date. As a result, the investment securities were reclassified to available-for-sale as of December 31, 2015. The Company has not classified any investment securities purchased, since this transaction, as held-to-maturity. Therefore, there were no proceeds from payments, maturities, and calls of securities held-to-maturity for the three months ended March 31, 2017 and 2016.

 

Gains and losses on sales of investment securities are recorded on the trade date and are determined using the specific identification method. There were no unsettled investment securities transactions at March 31, 2017 and December 31, 2016.

 

17

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2017

(unaudited)

 

NOTE 7. PORTFOLIO LOANS

 

Following is a comparative composition of net portfolio loans as of March 31, 2017 and December 31, 2016:

 

   March 31,
2017
   % of
Total Loans
   December 31,
2016
   % of
Total Loans
 
   (Dollars in Thousands) 
Real estate loans:                    
One- to four-family  $290,609    42.6%  $276,193    43.1%
Multi-family   77,512    11.4%   70,452    11.0%
Commercial   132,598    19.4%   104,143    16.3%
Land   17,561    2.6%   17,218    2.7%
Total real estate loans   518,280    76.0%   468,006    73.1%
                     
Real estate construction loans:                    
One- to four-family   22,859    3.3%   22,687    3.5%
Commercial   10,215    1.5%   14,432    2.3%
Acquisition and development        %        %
Total real estate construction loans   33,074    4.8%   37,119    5.8%
                     
Other portfolio loans:                    
Home equity   37,317    5.5%   37,748    5.9%
Consumer   38,196    5.6%   39,232    6.1%
Commercial   55,562    8.1%   57,947    9.1%
Total other portfolio loans   131,075    19.2%   134,927    21.1%
                     
Total portfolio loans   682,429    100.0%   640,052    100.0%
                     
Allowance for portfolio loan losses   (8,272)        (8,162)     
Net deferred portfolio loan costs   5,687         5,685      
Premiums and discounts on purchased loans, net   1,732         1,670      
                     
Portfolio loans, net  $681,576        $639,245      

 

18

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2017

(unaudited)

 

NOTE 7. PORTFOLIO LOANS (continued)

 

The following table presents the contractual aging of the recorded investment in past due loans by class of portfolio loans as of March 31, 2017 and December 31, 2016:

 

   Current   30 – 59 Days
Past Due
   60 – 89 Days
Past Due
   > 90 Days
Past Due
   Total
Past Due
   Total 
   (Dollars in Thousands) 
                         
March 31, 2017                              
Real estate loans:                              
One- to four-family  $288,850   $635   $281   $843   $1,759   $290,609 
Multi-family   77,493    19            19    77,512 
Commercial   132,329            269    269    132,598 
Land   12,014        37    5,510    5,547    17,561 
Total real estate loans   510,686    654    318    6,622    7,594    518,280 
                               
Real estate construction loans:                              
One- to four-family   22,859                    22,859 
Commercial   10,215                    10,215 
Acquisition and development                        
Total real estate construction loans   33,074                    33,074 
                               
Other portfolio loans:                              
Home equity   36,610    501    30    176    707    37,317 
Consumer   37,591    393    186    26    605    38,196 
Commercial   54,649    156        757    913    55,562 
Total other portfolio loans   128,850    1,050    216    959    2,225    131,075 
                               
Total portfolio loans  $672,610   $1,704   $534   $7,581   $9,819   $682,429 
                               
December 31, 2016                              
Real estate loans:                              
One- to four-family  $273,564   $1,320   $390   $919   $2,629   $276,193 
Multi-family   70,452                    70,452 
Commercial   101,867            2,276    2,276    104,143 
Land   11,670            5,548    5,548    17,218 
Total real estate loans   457,553    1,320    390    8,743    10,453    468,006 
                               
Real estate construction loans:                              
One- to four-family   22,687                    22,687 
Commercial   14,432                    14,432 
Acquisition and development                        
Total real estate construction loans   37,119                    37,119 
                               
Other portfolio loans:                              
Home equity   37,037    201    510        711    37,748 
Consumer   38,412    506    165    149    820    39,232 
Commercial   57,124    321        502    823    57,947 
Total other portfolio loans   132,573    1,028    675    651    2,354    134,927 
                               
Total portfolio loans  $627,245   $2,348   $1,065   $9,394   $12,807   $640,052 

 

19

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2017

(unaudited)

 

NOTE 7. PORTFOLIO LOANS (continued)

 

The decrease in commercial real estate loans greater than 90 days past due is primarily related to one loan, which was current as of March 31, 2017. However, due to other circumstances surrounding this loan, the loan remained classified as a nonperforming portfolio loan as of March 31, 2017.

 

Nonperforming portfolio loans, including nonaccrual portfolio loans, as of March 31, 2017 and December 31, 2016 were $9.8 million and $10.1 million, respectively. There were no portfolio loans over 90 days past-due and still accruing interest as of March 31, 2017 and December 31, 2016. Nonperforming portfolio loans include both smaller balance homogeneous loans that are collectively evaluated for impairment and larger individually evaluated loans classified as impaired loans that are not accruing interest.

 

The following table presents performing and nonperforming portfolio loans by class of loans as of March 31, 2017 and December 31, 2016:

 

   Performing   Nonperforming   Total 
   (Dollars in Thousands) 
             
March 31, 2017               
Real estate loans:               
One- to four-family  $289,812   $797   $290,609 
Multi-family   77,512        77,512 
Commercial   130,339    2,259    132,598 
Land   12,051    5,510    17,561 
Total real estate loans   509,714    8,566    518,280 
                
Real estate construction loans:               
One- to four-family   22,859        22,859 
Commercial   10,215        10,215 
Acquisition and development            
Total real estate construction loans   33,074        33,074 
                
Other portfolio loans:               
Home equity   37,075    242    37,317 
Consumer   37,991    205    38,196 
Commercial   54,805    757    55,562 
Total other portfolio loans   129,871    1,204    131,075 
                
Total portfolio loans  $672,659   $9,770   $682,429 
                
December 31, 2016               
Real estate loans:               
One- to four-family  $274,660   $1,533   $276,193 
Multi-family   70,452        70,452 
Commercial   101,867    2,276    104,143 
Land   11,670    5,548    17,218 
Total real estate loans   458,649    9,357    468,006 
                
Real estate construction loans:               
One- to four-family   22,687        22,687 
Commercial   14,432        14,432 
Acquisition and development            
Total real estate construction loans   37,119        37,119 
                
Other portfolio loans:               
Home equity   37,690    58    37,748 
Consumer   38,995    237    39,232 
Commercial   57,445    502    57,947 
Total other portfolio loans   134,130    797    134,927 
                
Total portfolio loans  $629,898   $10,154   $640,052 

 

20

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2017

(unaudited)

 

NOTE 7. PORTFOLIO LOANS (continued)

 

The Company utilizes an internal asset classification system for multi-family, commercial and land portfolio loans as a means of reporting problem and potential problem loans. Under the risk rating system, the Company classifies problem and potential problem loans as “Special Mention”, “Substandard” or “Doubtful”, which correspond to risk ratings five, six and seven, respectively. Portfolio loans that do not currently expose the Company to sufficient risk to warrant classification in one of the aforementioned categories, but possess weaknesses that deserve management’s close attention are deemed to be Special Mention, or risk rated five. Substandard portfolio loans, or risk rated six, include those characterized by the distinct possibility the Company may sustain some loss if the deficiencies are not corrected. Portfolio loans classified as Doubtful, or risk rated seven, have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Generally, the Company reviews all revolving credit relationships, regardless of amount, and any other loan relationship in excess of $500,000 on an annual basis. However, risk ratings are updated any time the facts and circumstances warrant.

 

The Company evaluates residential and consumer portfolio loans based on whether the loans are performing or nonperforming, as well as other factors. Residential loans are charged down by the expected loss amount at the time they become nonperforming, which is generally 90 days past due. Consumer loans, including automobile, manufactured housing, unsecured, and other secured loans are charged-off, net of expected recovery, when the loan becomes significantly past due over a range of up to 180 days, depending on the type of loan.

 

The following table presents the risk category of multi-family, commercial and land portfolio loans evaluated by internal asset classification as of March 31, 2017 and December 31, 2016:

 

   Pass   Special
Mention
   Substandard   Doubtful   Total 
   (Dollars in Thousands) 
                     
March 31, 2017                         
Real estate loans:                         
Multi-family  $77,493   $   $19   $   $77,512 
Commercial   128,910    1,349    2,339        132,598 
Land   12,051        5,510        17,561 
Total real estate loans   218,454    1,349    7,868        227,671 
                          
Real estate construction loans:                         
Commercial   10,215                10,215 
Total real estate construction loans   10,215                10,215 
                          
Other portfolio loans:                         
Commercial   54,091    467    1,004        55,562 
Total other portfolio loans   54,091    467    1,004        55,562 
                          
Total risk graded portfolio loans  $282,760   $1,816   $8,872   $   $293,448 
                          
December 31, 2016                         
Real estate loans:                         
Multi-family  $70,419   $   $33   $   $70,452 
Commercial   100,423    1,362    2,358        104,143 
Land   11,708        5,510        17,218 
Total real estate loans   182,550    1,362    7,901        191,813 
                          
Real estate construction loans:                         
Commercial   14,432                14,432 
Total real estate construction loans   14,432                14,432 
                          
Other portfolio loans:                         
Commercial   56,640    301    1,006        57,947 
Total other portfolio loans   56,640    301    1,006        57,947 
                          
Total risk graded portfolio loans  $253,622   $1,663   $8,907   $   $264,192 

 

21

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2017

(unaudited)

 

NOTE 7. PORTFOLIO LOANS (continued)

 

When establishing the allowance, management categorizes loans into risk categories generally based on the nature of the collateral and basis of repayment. These risk categories and the relevant risk characteristics are as follows:

 

Real Estate Loans

 

·One- to four-family residential loans have historically had less credit risk than other loan types as they tend to be smaller balance loans without concentrations to a single borrower or group of borrowers. Repayment depends on the individual borrower’s capacity. If the real estate market deteriorates and the value of residential real estate declines, there is a potential risk of loss if actions such as foreclosure or short sale become necessary to collect the loan and private mortgage insurance was not purchased. In addition, depending on the state in which the collateral is located, the risk of loss may increase, due to the time required to complete the foreclosure process on a property.

 

·Multi-family residential real estate loans generally involve a greater degree of credit risk than residential real estate loans, but are normally smaller individual loan balances than commercial real estate loans. Multi-family residential real estate loans involve a greater degree of credit risk as compared to residential real estate loans due to the reliance on the successful operation of the project. These loans are also more sensitive to adverse economic conditions.

 

·Commercial real estate loans generally have greater credit risk as compared to one- to four-family residential real estate loans, as they usually involve larger loan balances secured by non-homogeneous or specific use properties. Repayment of these loans typically relies on the continued successful operation of a business or the generation of lease income by the property and is therefore more sensitive to adverse conditions in the economy and real estate market.

 

·Land loans generally involve a greater degree of credit risk as compared to residential real estate loans due to the lack of cash flow and reliance on the borrower’s financial capacity. These loans are also more sensitive to adverse economic conditions.

 

Real Estate Construction Loans

 

·Real estate construction loans, including one- to four-family, commercial and acquisition and development loans, generally have greater credit risk than traditional one- to four-family residential and commercial real estate loans. The repayment of these loans can be dependent on the sale of the property to third parties or the successful completion of the improvements by the builder for the end user. In the event a loan is made on property that is not yet approved for the planned development, there is risk that approvals will not be granted or will be delayed. Construction loans also run the risk that improvements will not be completed on time or in accordance with specifications and projected costs. Construction loans include Small Business Administration (SBA) and U.S. Department of Agriculture (USDA) construction loans, which generally have less credit risk than traditional construction loans due to a portion of the balance being guaranteed upon completion of the construction.

 

Other Portfolio Loans

 

·Home equity loans and home equity lines of credit are similar to one- to four-family residential loans and generally carry less risk than other loan types as they tend to be smaller balance loans without concentrations to a single borrower or group of borrowers. However, similar to one- to four-family residential loans, there is a potential risk of loss if the real estate market deteriorates and the value of residential real estate declines.

 

22

 

  

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2017

(unaudited)

NOTE 7. PORTFOLIO LOANS (continued)

 

Other Portfolio Loans (continued)

 

·Consumer loans often are secured by depreciating collateral, including automobiles and mobile homes, or are unsecured and may carry more risk than real estate secured loans. Consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness, or personal bankruptcy.

 

·Commercial loans are secured by business assets or may be unsecured, and repayment is directly dependent on the continued successful operation of the borrower’s business and ability to convert the assets to operating revenue. These possess greater risk than most other types of loans should the repayment capacity of the borrower not be adequate.

 

Activity in the allowance for the three months ended March 31, 2017 and 2016 was as follows:

 

   Beginning
Balance
   Charge-Offs   Recoveries   Provisions   Ending Balance 
   (Dollars in Thousands) 
                     
March 31, 2017                         
Real estate loans:                         
One- to four-family  $3,090   $(35)  $56   $(200)  $2,911 
Multi-family   268            27    295 
Commercial   2,209            342    2,551 
Land   207            (10)   197 
Total real estate loans   5,774    (35)   56    159    5,954 
                          
Real estate construction loans:                         
One- to four-family   159            1    160 
Commercial   120            (27)   93 
Acquisition and development                    
Total real estate construction loans   279            (26)   253 
                          
Other portfolio loans:                         
Home equity   560        5    9    574 
Consumer   457    (77)   61    (55)   386 
Commercial   880            179    1,059 
Total other portfolio loans   1,897    (77)   66    133    2,019 
                          
Unallocated   212            (166)   46 
                          
Total  $8,162   $(112)  $122   $100   $8,272 
                          
March 31, 2016                         
Real estate loans:                         
One- to four-family  $3,142   $(12)  $8   $(131)  $3,007 
Multi-family   217            (1)   216 
Commercial   1,337            236    1,573 
Land   260        11    (61)   210 
Total real estate loans   4,956    (12)   19    43    5,006 
                          
Real estate construction loans:                         
One- to four-family   144            36    180 
Commercial   116            42    158 
Acquisition and development                    
Total real estate construction loans   260            78    338 
                          
Other portfolio loans:                         
Home equity   972    (24)   5    (135)   818 
Consumer   871    (204)   95    68    830 
Commercial   556            25    581 
Total other portfolio loans   2,399    (228)   100    (42)   2,229 
                          
Unallocated   130            71    201 
                          
Total  $7,745   $(240)  $119   $150   $7,774 

 

23

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2017

(unaudited)

 

NOTE 7. PORTFOLIO LOANS (continued)

 

The following table presents ending balances for the allowance and portfolio loans based on the impairment method as of March 31, 2017:

 

   Individually
Evaluated for
Impairment
   Collectively
Evaluated for
Impairment
   Total Ending
Balance
 
   (Dollars in Thousands) 
             
Allowance for portfolio loan losses:               
Real estate loans:               
One- to four-family  $   $2,911   $2,911 
Multi-family       295    295 
Commercial   194    2,357    2,551 
Land       197    197 
Total real estate loans   194    5,760    5,954 
                
Real estate construction loans:               
One- to four-family       160    160 
Commercial       93    93 
Acquisition and development            
Total real estate construction loans       253    253 
                
Other portfolio loans:               
Home equity       574    574 
Consumer       386    386 
Commercial   531    528    1,059 
Total other portfolio loans   531    1,488    2,019 
                
Unallocated       46    46 
                
Total ending allowance for portfolio loan losses balance  $725   $7,547   $8,272 
                
Portfolio loans:               
Real estate loans:               
One- to four-family  $   $290,609   $290,609 
Multi-family   19    77,493    77,512 
Commercial   3,433    129,165    132,598 
Land   5,510    12,051    17,561 
Total real estate loans   8,962    509,318    518,280 
                
Real estate construction loans:               
One- to four-family       22,859    22,859 
Commercial       10,215    10,215 
Acquisition and development            
Total real estate construction loans       33,074    33,074 
                
Other portfolio loans:               
Home equity       37,317    37,317 
Consumer       38,196    38,196 
Commercial   1,040    54,522    55,562 
Total other portfolio loans   1,040    130,035    131,075 
                
Total ending portfolio loans balance  $10,002   $672,427   $682,429 

 

24

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2017

(unaudited)

 

NOTE 7. PORTFOLIO LOANS (continued)

 

The following table presents ending balances for the allowance and portfolio loans based on the impairment method as of December 31, 2016:

 

   Individually
Evaluated for
Impairment
   Collectively
Evaluated for
Impairment
   Total Ending
Balance
 
   (Dollars in Thousands) 
             
Allowance for portfolio loan losses:               
Real estate loans:               
One- to four-family  $   $3,090   $3,090 
Multi-family       268    268 
Commercial   201    2,008    2,209 
Land       207    207 
Total real estate loans   201    5,573    5,774 
                
Real estate construction loans:               
One- to four-family       159    159 
Commercial       120    120 
Acquisition and development            
Total real estate construction loans       279    279 
                
Other portfolio loans:               
Home equity       560    560 
Consumer       457    457 
Commercial   279    601    880 
Total other portfolio loans   279    1,618    1,897 
                
Unallocated       212    212 
                
Total ending allowance for portfolio loan losses balance  $480   $7,682   $8,162 
                
Portfolio loans:               
Real estate loans:               
One- to four-family  $   $276,193   $276,193 
Multi-family   33    70,419    70,452 
Commercial   2,763    101,380    104,143 
Land   5,510    11,708    17,218 
Total real estate loans   8,306    459,700    468,006 
                
Real estate construction loans:               
One- to four-family       22,687    22,687 
Commercial       14,432    14,432 
Acquisition and development            
Total real estate construction loans       37,119    37,119 
                
Other portfolio loans:               
Home equity       37,748    37,748 
Consumer       39,232    39,232 
Commercial   519    57,428    57,947 
Total other portfolio loans   519    134,408    134,927 
                
Total ending portfolio loans balance  $8,825   $631,227   $640,052 

 

25

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2017

(unaudited)

 

NOTE 7. PORTFOLIO LOANS (continued)

 

Portfolio loans for which concessions have been granted as a result of the borrower’s financial difficulties are considered a TDR. These concessions, which in general are applied to all categories of portfolio loans, may include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, or a combination of these or other actions intended to maximize collection. The resulting TDR impairment is included in specific reserves.

 

For homogeneous loan categories, such as one- to four-family residential loans and home equity loans, the amount of impairment resulting from the modification of the loan terms is calculated in aggregate by category of portfolio loan. The resulting impairment is included in specific reserves. If an individual homogeneous loan defaults under terms of the TDR and becomes nonperforming, the Bank follows its usual practice of charging the loan down to its estimated fair value and the charge-off is considered as a factor in determining the amount of the general component of the allowance. For larger non-homogeneous loans, each loan that is modified is evaluated individually for impairment based on either discounted cash flow or, for collateral-dependent loans, the appraised value of the collateral less selling costs. If the loan is not collateral-dependent, the amount of the impairment, if any, is recorded as a specific reserve in the allowance. If the loan is collateral-dependent, the amount of the impairment is charged off. There was an allocated allowance for loans, including TDRs, individually evaluated for impairment of approximately $0.7 million and $0.5 million at March 31, 2017 and December 31, 2016, respectively.

 

Portfolio loans modified as TDRs with market rates of interest are classified as impaired portfolio loans. Once the TDR has performed for 12 months in accordance with the modified terms it is classified as a performing impaired loan. TDRs which do not perform in accordance with modified terms are reported as nonperforming portfolio loans. The policy for returning a nonperforming loan to accrual status is the same for any loan irrespective of whether the loan has been modified. As such, loans which are nonperforming prior to modification continue to be accounted for as nonperforming loans (and are reported as impaired nonperforming loans) until they have demonstrated the ability to maintain sustained performance over a period of time, but no less than six months. Following this period such a modified loan is returned to accrual status and is classified as impaired and reported as a performing TDR. TDRs classified as impaired loans as of March 31, 2017 and December 31, 2016 were as follows:

 

   March 31, 2017   December 31, 2016 
   (Dollars in Thousands) 
Real estate loans:          
One- to four-family  $17,223   $20,060 
Multi-family        
Commercial   3,164    2,488 
Land   6,264    6,311 
Total real estate loans   26,651    28,859 
           
Real estate construction loans:          
One- to four-family        
Commercial        
Acquisition and development        
Total real estate construction loans        
           
Other portfolio loans:          
Home equity   4,106    4,230 
Consumer   1,320    1,573 
Commercial   402    181 
Total other portfolio loans   5,828    5,984 
           
Total TDRs classified as impaired loans  $32,479   $34,843 

 

26

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2017

(unaudited)

 

NOTE 7. PORTFOLIO LOANS (continued)

 

The TDR balances included performing TDRs of $18.9 million and $20.3 million as of March 31, 2017 and December 31, 2016, respectively. There were no commitments to lend additional amounts on TDRs as of March 31, 2017 and December 31, 2016.

 

The Bank is proactive in modifying residential, home equity and consumer loans in early stage delinquency because management believes modifying the loan prior to it becoming nonperforming results in the least cost to the Bank. The Bank also modifies commercial real estate and other large commercial loans as TDRs rather than pursuing other means of collection when it believes the borrower is committed to the successful repayment of the loan and the business operations are likely to support the modified loan terms.

 

The following table presents information on TDRs during the three months ended March 31, 2017 and 2016:

 

   Number of
Contracts
   Pre-Modification
Outstanding Recorded
Investments
   Post-Modification
Outstanding Recorded
Investments
 
   (Dollars in Thousands) 
March 31, 2017               
Troubled debt restructuring:               
Real estate loans:               
One- to four-family   1   $55   $55 
Commercial   1    693    693 
Total real estate loans   2    748    748 
                
Other portfolio loans:               
Home equity   3    271    271 
Consumer   3    55    55 
Total other portfolio loans   6    326    326 
                
Total troubled debt restructurings   8   $1,074   $1,074 
                
March 31, 2016               
Troubled debt restructuring:               
Real estate loans:               
One- to four-family   12    1,505    1,505 
Total real estate loans   12    1,505    1,505 
                
Other portfolio loans:               
Home equity   7    385    385 
Consumer   1    120    120 
Total other portfolio loans   8    505    505 
                
Total troubled debt restructurings   20   $2,010   $2,010 

 

All of the Company’s portfolio loans that were restructured as TDRs during the three months ended March 31, 2017 and 2016, resulted in modifications to either rate, term, amortization or balance. Such modifications are only granted to borrowers who have demonstrated the capacity to repay under the modified terms.

 

There were two subsequent defaults on portfolio loans that were restructured as TDRs during the three months ended March 31, 2017. The subsequent defaults included a one- to four-family residential loan with a recorded investment of $38,000, and a home equity loan with a recorded investment of $8,000

 

There were no subsequent defaults on portfolio loans that were restructured as TDRs during the three months ended March 31, 2016.

 

27

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2017

(unaudited)

 

NOTE 7. PORTFOLIO LOANS (continued)

 

The following table presents information about impaired portfolio loans as of March 31, 2017:

 

   Recorded
Investment
   Unpaid
Principal Balance
   Related
Allowance
 
   (Dollars in Thousands) 
             
With no related allowance recorded:               
Real estate loans:               
One- to four-family  $   $   $ 
Multi-family   19    19     
Commercial   749    749     
Land   5,510    5,510     
Total real estate loans   6,278    6,278     
                
Real estate construction loans:               
One- to four-family            
Commercial            
Acquisition and development            
Total real estate construction loans            
                
Other portfolio loans:               
Home equity            
Consumer            
Commercial   133    133     
Total other portfolio loans   133    133     
                
Total with no related allowance recorded  $6,411   $6,411   $ 
                
With an allowance recorded:               
Real estate loans:               
One- to four-family  $18,196   $18,735   $1,311 
Multi-family            
Commercial   2,684    2,684    194 
Land   754    804    101 
Total real estate loans   21,634    22,223    1,606 
                
Real estate construction loans:               
One- to four-family            
Commercial            
Acquisition and development            
Total real estate construction loans            
                
Other portfolio loans:               
Home equity   4,135    4,292    491 
Consumer   1,463    1,563    203 
Commercial   1,026    1,145    531 
Total other portfolio loans   6,624    7,000    1,225 
                
Total with an allowance recorded  $28,258   $29,223   $2,831 

 

28

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2017

(unaudited)

 

NOTE 7. PORTFOLIO LOANS (continued)

 

The following table presents information about impaired portfolio loans as of December 31, 2016:

 

   Recorded
Investment
   Unpaid
Principal Balance
   Related
Allowance
 
   (Dollars in Thousands) 
             
With no related allowance recorded:               
Real estate loans:               
One- to four-family  $   $   $ 
Multi-family   33    33     
Commercial   589    589     
Land   5,510    5,510     
Total real estate loans   6,132    6,132     
                
Real estate construction loans:               
One- to four-family            
Commercial            
Acquisition and development            
Total real estate construction loans            
                
Other portfolio loans:               
Home equity            
Consumer            
Commercial   61    61     
Total other portfolio loans   61    61     
                
Total with no related allowance recorded  $6,193   $6,193   $ 
                
With an allowance recorded:               
Real estate loans:               
One- to four-family  $21,335   $21,869   $1,514 
Multi-family            
Commercial   2,174    2,174    201 
Land   801    851    108 
Total real estate loans   24,310    24,894    1,823 
                
Real estate construction loans:               
One- to four-family            
Commercial            
Acquisition and development            
Total real estate construction loans            
                
Other portfolio loans:               
Home equity   4,231    4,388    408 
Consumer   1,728    1,832    201 
Commercial   840    840    279 
Total other portfolio loans   6,799    7,060    888 
                
Total with an allowance recorded  $31,109   $31,954   $2,711 

 

29

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2017

(unaudited)

 

NOTE 7. PORTFOLIO LOANS (continued)

 

The following table presents interest income on impaired portfolio loans by class of portfolio loans for the three months ended March 31, 2017 and 2016:

 

   Average Balance   Interest Income
Recognized
   Cash Basis Interest
Income
Recognized
 
   (Dollars in Thousands) 
             
March 31, 2017               
Real estate loans:               
One- to four-family  $19,766   $187   $ 
Multi-family   26          
Commercial   3,098    24    26 
Land   6,288    8     
Total real estate loans   29,178    219    26 
                
Real estate construction loans:               
One- to four-family            
Commercial            
Acquisition and development            
Total real estate construction loans            
                
Other portfolio loans:               
Home equity   4,183    50     
Consumer   1,596    23     
Commercial   1,030    9     
Total other portfolio loans   6,809    82     
                
Total  $35,987   $301   $26 
                
March 31, 2016               
Real estate loans:               
One- to four-family  $21,890   $236   $ 
Multi-family   97    1     
Commercial   2,748    26     
Land   6,724    55     
Total real estate loans   31,459    318     
                
Real estate construction loans:               
One- to four-family            
Commercial            
Acquisition and development            
Total real estate construction loans            
                
Other portfolio loans:               
Home equity   4,871    57     
Consumer   1,986    27     
Commercial   728    5     
Total other portfolio loans   7,585    89     
                
Total  $39,044   $407   $ 

 

30

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2017

(unaudited)

  

NOTE 7. PORTFOLIO LOANS (continued)

 

The Company had $1.0 million and $1.6 million of one- to four-family residential and home equity loans in process of foreclosure as of March 31, 2017 and December 31, 2016, respectively.

 

The Company has originated portfolio loans with the Company’s directors and executive officers and their associates. These loans totaled $1.8 million and $1.9 million as of March 31, 2017 and December 31, 2016, respectively. The activity on these loans during the three months ended March 31, 2017 and the year ended December 31, 2016, was as follows:

 

   March 31, 2017   December 31, 2016 
   (Dollars in Thousands) 
         
Beginning balance  $1,856   $1,919 
New portfolio loans and advances on existing loans        
Effect of changes in related parties        
Repayments   (14)   (63)
Ending balance  $1,842   $1,856 

 

NOTE 8. OTHER LOANS

 

The Company’s other loans are comprised of loans secured by one- to four-family residential homes originated internally and held-for-sale (mortgage loans held-for-sale), small business loans originated internally and held-for-sale (SBA/USDA loans held-for-sale), and warehouse loans held-for-investment. The Company originates mortgage loans held-for-sale with the intent to sell the loans and the servicing rights to investors. The Company originates SBA/USDA loans held-for-sale with the intent to sell the guaranteed portion of the loans to investors, while maintaining the servicing rights. The Company originates warehouse loans held-for-investment and permits third-party originators to sell the loans and servicing rights to investors in order to repay the warehouse balance outstanding.

 

The Company internally originated approximately $9.0 million and $11.1 million of mortgage loans held-for-sale during the three months ended March 31, 2017 and 2016, respectively. The gain recorded on sale of mortgage loans held-for-sale during the three months ended March 31, 2017 and 2016 was $0.8 million and $0.2 million, respectively.

 

During the three months ended March 31, 2017 and 2016, the Company internally originated approximately $7.0 million and $0.6 million, respectively, of SBA/USDA loans held-for-sale. The gain recorded on sales of SBA/USDA loans held-for-sale was $0.7 million and $0.2 million during the three months ended March 31, 2017 and 2016, respectively.

 

During the three months ended March 31, 2017 and 2016, the Company originated approximately $257.6 million and $294.4 million, respectively, of warehouse loans held-for-investment through third parties. Loan sales under the warehouse loans held-for-investment lending program, which are done at par, earned interest on outstanding balances of $0.4 million for each of the three months ended March 31, 2017 and 2016, respectively. The weighted average number of days outstanding of warehouse loans held-for-investment was approximately 10 days and 13 days for the three months ended March 31, 2017 and 2016, respectively.

 

31

 

  

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2017

(unaudited)

 

NOTE 8. OTHER LOANS (continued)

 

As of March 31, 2017 and December 31, 2016, the balance in warehouse loans held-for-investment did not include any past due, nonperforming, classified, restructured, or impaired loans. Warehouse loans held-for-investment possess less risk than other types of loans as they are secured by one- to four-family residential loans which tend to be smaller balance loans without concentrations to a single borrower or group of borrowers. Due to the generally short duration of time warehouse loans held-for-investment are outstanding, the collateral arrangements related to warehouse loans held-for-investment and other factors, management has determined that no allowance for loan losses is necessary.

 

NOTE 9. FEDERAL HOME LOAN BANK ADVANCES

 

As of March 31, 2017 and December 31, 2016, advances from the FHLB were as follows:

 

   March 31, 2017   December 31, 2016 
   (Dollars in Thousands) 
Maturity on January 30, 2017, fixed rate at 0.61%  $   $50,000 
Maturity on April 5, 2017, fixed rate 0.91%   25,000     
Maturity on April 6, 2017, fixed rate 0.93%   10,000     
Maturity on June 20, 2017, fixed rate 0.73%   417    833 
Maturity on June 20, 2017, fixed rate 0.91%   10,000    10,000 
Maturity on June 19, 2018, fixed rate at 1.31%   10,425    10,425 
Maturity on June 20, 2019, fixed rate at 1.27%   2,250    2,500 
Maturity on June 8, 2021, fixed rate at 2.59%   20,000    20,000 
Maturity on June 8, 2021, fixed rate at 2.58%   15,000    15,000 
Maturity on June 8, 2021, fixed rate at 2.58%   15,000    15,000 
Daily rate credit, no maturity date, adjustable rate at 1.07% as of March 31, 2017 and at 0.80% as of December 31, 2016   36,000    65,000 
Total  $144,092   $188,758 

 

The FHLB advances had a weighted-average maturity of 19 months and a weighted-average rate of 1.57% at March 31, 2017. The Company had $368.5 million in portfolio loans posted as collateral for these advances as of March 31, 2017.

 

The Bank’s remaining borrowing capacity with the FHLB was $128.3 million at March 31, 2017. The FHLB requires that the Bank collateralize the excess of the fair value of the FHLB advances over the book value with cash and investment securities. In the event the Bank prepays advances prior to maturity, it must do so at the fair value of such FHLB advances. As of March 31, 2017, fair value exceeded the book value of the individual advances by $0.9 million, which was collateralized by portfolio loans (included in the $368.5 million discussed above). The Bank has the ability to supplement its loan collateral with investment securities as needed to secure the FHLB borrowings or prepay advances to reduce the amount of collateral required to secure the debt. Unpledged investment securities available for collateral amounted to $97.1 million as of March 31, 2017.

 

NOTE 10. INCOME TAXES

 

Income tax expense for the three months ending March 31, 2017 and 2016 was as follows:

 

   Three months ending March 31, 
   2017   2016 
   (Dollars in Thousands) 
Income before income tax expense  $2,283   $2,423 
Effective tax rate   35.30%   37.09%
Income tax expense  $806   $899 

 

32

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2017

(unaudited)

 

NOTE 10. INCOME TAXES (continued)

 

The Company considers at each reporting period all available evidence, both positive and negative, to determine whether, based on the weight of that evidence, a valuation allowance is needed to reduce its deferred tax assets to an amount that is more likely than not to be realized. A determination of the need for a valuation allowance for the deferred tax assets is dependent upon management’s evaluation of both positive and negative evidence.

 

As of March 31, 2017, the Company evaluated the expected realization of its federal and state deferred tax assets. Based on this evaluation it was concluded that no valuation allowance was required for the federal and state deferred tax assets, with the exception of the remaining deferred tax asset related to a capital loss carryover, which resulted in a valuation allowance of $27,000 as of March 31, 2017. The Company’s valuation allowance against its deferred tax assets was $27,000 as of December 31, 2016, representing the same remaining deferred tax asset related to a capital loss carryover.

 

During the three months ended March 31, 2017, the Company used $81,000 of federal net operating loss carryover and $67,000 of state net operating loss carryovers. During the three months ended March 31, 2016, the Company used $1.8 million of federal net operating loss carryover and $1.6 million of state net operating loss carryover.

 

Under the rules of Internal Revenue Code section 382 (IRC § 382), a change in the ownership of the Company occurred during the first quarter of 2013. During the second quarter of 2013, the Company became aware of the change in ownership based on applicable filings made by stockholders with the Securities and Exchange Commission (the SEC). In accordance with IRC § 382, the Company determined the gross amount of net operating loss carryover that it could utilize was limited to approximately $325,000 per year, excluding any net operating loss carryover that may be generated in the future.

 

The Company has a federal net operating loss carryover of $5.3 million which will expire between 2027 and 2033. There is no valuation allowance on this carryover. The Company has a state net operating loss carryover of $5.9 million which will expire between 2017 and 2033. There is no valuation allowance on this carryover.

 

NOTE 11. EARNINGS PER COMMON SHARE

 

Basic earnings per common share is computed by dividing net income by the weighted average number of common shares and common stock equivalents outstanding for the period. The basic weighted average common shares and common stock equivalents are computed using the treasury stock method. The basic weighted average common shares and common stock equivalents outstanding for the period is adjusted for average unallocated employee stock ownership plan shares, average director’s deferred compensation shares and average unearned restricted stock awards. Diluted earnings per common share is computed by dividing net income by the weighted average number of common shares and common stock equivalents outstanding for the period increased for the dilutive effect of unvested stock options and stock awards. The dilutive effect of the unvested stock options and stock awards is calculated under the treasury stock method utilizing the average market value of the Company’s stock for the period.

 

33

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2017

(unaudited)

 

NOTE 11. EARNINGS PER COMMON SHARE (continued)

 

The following table summarizes the basic and diluted earnings per common share computation for the three months ended March 31, 2017 and 2016:

 

   Three months ending March 31, 
   2017   2016 
  

(Dollars in Thousands,

Except Per Share Information)

 
Basic:          
Net income  $1,477   $1,524 
Weighted average common shares outstanding   15,531,239    15,508,969 
Less: average unallocated employee stock ownership plan shares   (67,067)   (71,857)
Less: average director’s deferred compensation shares   (22,530)   (22,594)
Less: average unvested restricted stock awards   (22,324)    
Weighted average common shares outstanding, as adjusted   15,419,318    15,414,518 
Basic earnings per common share  $0.10   $0.10 
           
Diluted:          
Net income  $1,477   $1,524 
Weighted average common shares outstanding, as adjusted (from above)   15,419,318    15,414,518 
Add: dilutive effects of assumed exercise of stock options and stock awards        
Weighted average dilutive shares outstanding   15,419,318    15,414,518 
Diluted earnings per common share  $0.10   $0.10 

 

During the three months ended March 31, 2017 and 2016, all of the Company’s stock options and stock awards were antidilutive and, therefore, were excluded from the calculation of diluted earnings per common share.

 

NOTE 12. STOCK-BASED COMPENSATION

 

2016 Omnibus Incentive Plan

 

The Company’s Board of Directors awarded 44,648 shares of restricted stock, with a grant date fair value of $7.78, under the 2016 Omnibus Incentive Plan (the 2016 Incentive Plan) on February 15, 2017. A summary of the status of the shares as of and for the three months ended March 31, 2017 is presented below:

 

   Shares   Weighted-Average
Grant-Date Fair Value Per Share
 
Non-vested as of January 1, 2017      $ 
Granted   44,648    7.78 
Vested        
Forfeited        
Non-vested as of March 31, 2017   44,648    7.78 

 

There was $334,000 of unrecognized compensation expense related to non-vested shares awarded under the 2016 Incentive Plan at March 31, 2017. The expense is expected to be recognized over a weighted-average period of 4.3 years.

 

34

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

March 31, 2017

(unaudited)

 

NOTE 13. REGULATORY SUPERVISION

 

The Bank’s actual and required capital levels and ratios as of March 31, 2017 and December 31, 2016 were as follows:

 

   Actual   Required to be Well-
Capitalized Under Prompt
Corrective Action
 
   Amount   Ratio   Amount   Ratio 
   (Dollars in Thousands) 
March 31, 2017                    
Total capital (to risk weighted assets)  $94,718    13.76%  $68,844    10.00%
Common equity tier 1 capital (to risk weighted assets)   86,446    12.56%   44,748    6.50%
Tier 1 capital (to risk weighted assets)   86,446    12.56%   55,075    8.00%
Tier 1 capital (to adjusted total assets)   86,446    10.32%   41,885    5.00%
                     
December 31, 2016                    
Total capital (to risk weighted assets)  $92,822    14.83%  $62,580    10.00%
Common equity tier 1 capital (to risk weighted assets)   84,984    13.58%   40,677    6.50%
Tier 1 capital (to risk weighted assets)   84,984    13.58%   50,064    8.00%
Tier 1 capital (to adjusted total assets)   84,984    9.44%   45,020    5.00%

 

The Bank’s capital classification under Prompt Corrective Action (PCA) defined levels as of March 31, 2017 was well-capitalized.

 

Beginning on January 1, 2016, as a result of the commencement of the phase-in of amended regulatory risk-based capital rules, the Company must maintain a capital conservation buffer to avoid restrictions on capital distributions or discretionary bonus payments. The capital conservation buffer must consist solely of common equity tier 1 capital, but it applies to all three risk-weighted measurements (total risk based capital to risk-weighted assets ratio, common equity tier 1 capital to risk-weighted assets ratio, tier 1 capital to risk-weighted assets ratio) in addition to the minimum risk-weighted capital requirements. The capital conservation buffer required for 2016 was common equity equal to 0.625% of risk-weighted assets, the buffer required for 2017 is common equity equal to 1.25% of risk-weighted assets, and will increase by 0.625% per year until reaching 2.5% beginning January 1, 2019.

 

35

 

  

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

 

This Management’s Discussion and Analysis (this MD&A) is provided as a supplement to, should be read in conjunction with, and is qualified in its entirety by reference to, the unaudited Condensed Consolidated Financial Statements and accompanying Notes to the unaudited Condensed Consolidated Financial Statements of Atlantic Coast Financial Corporation (the Company) appearing elsewhere in this Quarterly Report on Form 10-Q (this Report). In addition, reference should be made to our audited Consolidated Financial Statements and accompanying Notes to Consolidated Financial Statements and Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2016, filed with the Securities and Exchange Commission on March 14, 2017 (the 2016 10-K).

 

Cautionary Note Regarding Forward-Looking Statements

 

This Report contains forward-looking statements concerning the Company and its wholly owned subsidiary, Atlantic Coast Bank (the Bank), that involve risks and uncertainties, as well as assumptions that, if they do not materialize or prove to be correct, could cause our results to differ materially from those expressed in or implied by such forward-looking statements. All statements other than statements of historical fact are statements that could be deemed forward-looking statements, including, but not limited to, statements concerning: our plans, strategies and objectives for future operations; new loans and other products, services or developments; future economic conditions, performance or outlook; the outcome of contingencies; the continued suspension of dividends or share repurchases; potential acquisitions or divestitures; expected cash flows or capital expenditures; our beliefs or expectations; activities, events or developments that we intend, expect, project, believe or anticipate will or may occur in the future; and assumptions underlying any of the foregoing. Forward-looking statements may be identified by their use of forward-looking terminology, such as “believes,” “expects,” “may,” “should,” “would,” “will,” “intends,” “plans,” “estimates,” “anticipates,” “projects” and similar words or expressions. You should not place undue reliance on these forward-looking statements, which reflect management’s opinions only as of the date of the filing of this Report and are not guarantees of future performance or actual results. Forward-looking statements are made in reliance on the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended (the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). The following are some of the factors we believe could cause our actual results to differ materially from our historical results or our current expectations or projections:

 

·our ability to respond to changes in the legislative or regulatory environment and governmental initiatives affecting the banking and financial services industry and to comply with and remain abreast of recently enacted, modified or proposed federal, state and local laws, regulations and rules;

 

·local, regional, national and international economic conditions and the impact they may have on us and our customers, and our assessment of that impact on our estimates, including, but not limited to, the allowance for portfolio loan losses;

 

·changes in the financial performance or condition of our borrowers and the ability of our borrowers to perform under the terms of their loans and other credit agreements, and the impact of such changes on our levels of nonperforming assets;

 

·changes in sources and uses of funds, including loans, deposits and borrowings, and our ability to retain and grow core deposits and maintain unsecured federal funds lines and secured lines of credit with correspondent banks;

 

·changes in interest rates, composition and costs of deposits, loan demand, and the values and liquidity of loan collateral, securities, and interest sensitive assets and liabilities;

 

·the concentration of our loan portfolio in real estate based loans and the geographic concentration of those loans secured by one- to four-family residential real estate;

 

·the potential threat of cyber-attacks on our network and the information stored on our servers, and our ability to implement information technology software and security measures to effectively neutralize cyber-security threats; and

 

·our ability to successfully implement changes in accounting policies, rules and practices.

 

36

 

  

Additional details and discussions concerning some of the factors that could affect our forward-looking statements or future results are set forth in the 2016 10-K under Item 1A. “Risk Factors” and in Part II. Item 1A. “Risk Factors” in this Report, which lists of factors, together with the foregoing list of factors, are not exhaustive. Additional risks and uncertainties not known to us or that we currently believe not to be material also may adversely impact our business, financial condition, results of operations and cash flows. Should any risks or uncertainties develop into actual events, these developments could have a material adverse effect on our business, financial condition, results of operations and cash flows. The forward-looking statements contained in this Report are made as of the date hereof and we disclaim any intention or obligation, other than imposed by law, to update or revise any forward-looking statements or to update the reasons actual results could differ materially from those projected in the forward-looking statements, whether as a result of new information, future events or developments or otherwise.

 

General Description of Business

 

The Company and the Bank have traditionally focused on attracting deposits and investing those funds primarily in loans, including commercial real estate loans, consumer loans, first mortgages on owner-occupied, one- to four-family residences and home equity loans. Additionally, the Bank invests funds in multi-family residential loans, commercial business loans, and commercial and residential construction loans. The Bank also invests funds 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 Bank offers a variety of deposit accounts having a wide range of interest rates and terms, which generally include noninterest-bearing and interest-bearing demand, savings and money market, and time deposit accounts with terms ranging from three months to five years. Deposits are primarily solicited in the Bank’s market areas of the Northeast Florida and Southeast Georgia to fund loan demand and other liquidity needs; however, the Bank also solicits deposits in Central Florida.

 

Recent Events

 

Conversion to Florida State-chartered Commercial Bank

 

On December 27, 2016, the Bank consummated the conversion of its charter from that of a federally-chartered savings bank to that of a Florida state-chartered commercial bank supervised by the Florida Office of Financial Regulation (the OFR) and the Federal Deposit Insurance Corporation (the FDIC). The conversion is not expected to affect the Bank’s customers in any way. Bank depositors will continue to have the protection of Federal Deposit Insurance provided by the FDIC.

 

Critical Accounting Policies

 

Certain accounting policies are important to the presentation of the Company’s financial condition, because 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, 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: (i) determining the allowance for portfolio loan losses (the allowance) and the provision for portfolio loan losses (provision expense); (ii) measuring for impairment in troubled debt restructurings (TDR); (iii) determining the fair value of investment securities; (iv) determining the fair value of other real estate owned (OREO); and (v) accounting for deferred income taxes.

 

There have been no material updates to these accounting policies or estimates affected by these accounting policies during the first three months of 2017. For additional discussion of our critical accounting policies and estimates, see the Critical Accounting Policies discussion in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in the 2016 10-K.

 

37

 

 

Comparison of Financial Condition at March 31, 2017 and December 31, 2016

 

General

 

Total assets increased $16.0 million, or 1.8%, to $923.5 million at March 31, 2017, as compared to $907.5 million at December 31, 2016. The increase in assets was funded primarily by increases in non-maturing deposits of $53.8 million, time deposits of $3.6 million, and stockholders’ equity of $1.9 million, as discussed below, partially offset by a reduction of $44.6 million in Federal Home Loan Bank (FHLB) advances. Net portfolio loans increased $42.3 million and investment securities increased $35.8 million, while cash and cash equivalents decreased $32.1 million and other loans decreased $27.5 million. Total deposits increased $57.4 million, or 9.1%, to $685.8 million at March 31, 2017, from $628.4 million at December 31, 2016. Noninterest-bearing demand accounts increased $8.2 million, interest-bearing demand accounts increased by $21.3 million, savings and money market accounts increased $24.3 million, and time deposits increased by $3.6 million during the three months ended March 31, 2017. Total borrowings decreased by $44.6 million to $144.1 million at March 31, 2017, from $188.7 million at December 31, 2016, due to the aforementioned decrease in FHLB advances during the first quarter of 2017, as the Company continues to focus on core deposit growth. Stockholders’ equity increased by $1.9 million to $88.9 million at March 31, 2017, from $87.0 million at December 31, 2016, primarily due to net income of $1.5 million and other comprehensive income of $0.4 million for the three months ended March 31, 2017.

 

Following are the summarized comparative balance sheets as of March 31, 2017 and December 31, 2016:

 

   March 31,   December 31,   Increase / (Decrease) 
   2017   2016   Amount   % 
   (Dollars in Thousands) 
                 
Assets:                    
Cash and cash equivalents  $27,754   $59,893   $(32,139)   (53.7)%
Investment securities   101,069    65,293    35,776    54.8%
Portfolio loans   689,848    647,407    42,441    6.6%
Allowance for portfolio loan losses   8,272    8,162    110    1.3%
Portfolio loans, net   681,576    639,245    42,331    6.6%
Other loans (held-for-sale and warehouse loans held-for-investment)   60,244    87,724    (27,480)   (31.3)%
Other assets   52,844    55,304    (2,460)   (4.4)%
Total assets  $923,487   $907,459   $16,028    1.8%
                     
Liabilities and stockholders’ equity:                    
Deposits:                    
Noninterest-bearing demand  $67,926   $59,696   $8,230    13.8%
Interest-bearing demand   127,297    106,004    21,293    20.1%
Savings and money market   249,279    224,987    24,292    10.8%
Time   241,336    237,726    3,610    1.5%
Total deposits   685,838    628,413    57,425    9.1%
Federal Home Loan Bank advances   144,092    188,758    (44,666)   (23.7)%
Accrued expenses and other liabilities   4,692    3,270    1,422    43.5%
Total liabilities   834,622    820,441    14,181    1.7%
Total stockholders’ equity   88,865    87,018    1,847    2.1%
Total liabilities and stockholders’ equity  $923,487   $907,459   $16,028    1.8%

 

Cash and Cash Equivalents

 

Cash and cash equivalents decreased $32.1 million to $27.8 million at March 31, 2017 from $59.9 million at December 31, 2016. The Bank has increased contingent liquidity capacity and sources to meet potential funding requirements, including availability from the FHLB, the Federal Reserve Bank of Atlanta and other private institutional sources to fund the origination of loans, fund other interest-earning assets, and pay-off liabilities.

 

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Investment Securities

 

Investment securities are comprised primarily of debt securities of U.S. government-sponsored enterprises and mortgage-backed securities. The investment portfolio increased $35.8 million to $101.1 million at March 31, 2017, from $65.3 million at December 31, 2016, primarily due to the purchase of $55.0 million of short-term U.S. Treasury Bills during the first quarter of 2017, partially offset by the maturity of $20.0 million of short-term U.S. Treasury Bills that where purchased in 2016.

 

All of the $101.1 million and $65.3 million as of March 31, 2017 and December 31, 2016, respectively, of investment securities were classified as available-for-sale.

 

As of March 31, 2017, $84.5 million, or 83.6%, of the debt securities held by the Company were issued by U.S. government-sponsored entities and agencies, primarily Fannie Mae and Freddie Mac, which are institutions the U.S. government has affirmed its commitment to support.

 

As of March 31, 2017, no investment securities were pledged as collateral for the FHLB advances or any other borrowings.

 

Portfolio Loans

 

Below is a comparative composition of net portfolio loans as of March 31, 2017 and December 31, 2016, excluding loans held-for-sale and warehouse lines of credit secured by one- to four-family residential loans originated by third party originators under purchase and assumption agreements (warehouse loans held-for-investment):

 

   March 31,
2017
   % of Total
Portfolio Loans
   December 31,
2016
   % of Total
Portfolio Loans
 
   (Dollars in Thousands) 
Real estate loans:                    
One- to four-family  $290,609    42.6%  $276,193    43.1%
Multi-family   77,512    11.4%   70,452    11.0%
Commercial   132,598    19.4%   104,143    16.3%
Land   17,561    2.6%   17,218    2.7%
Total real estate loans   518,280    5.9%   468,006    73.1%
Real estate construction loans:                    
One- to four-family   22,859    3.3%   22,687    3.5%
Commercial   10,215    1.5%   14,432    2.3%
Acquisition and development       %       %
Total real estate construction loans   33,074    4.8%   37,119    5.8%
Other portfolio loans:                    
Home equity   37,317    5.5%   37,748    5.9%
Consumer   38,196    5.6%   39,232    6.1%
Commercial   55,562    8.1%   57,947    9.1%
Total other portfolio loans   131,075    19.2%   134,927    21.1%
                     
Total portfolio loans   682,429    100.0%   640,052    100.0%
Allowance for portfolio loan losses   (8,272)        (8,162)     
Net deferred portfolio loan costs   5,687         5,685      
Premiums and discounts on purchased loans, net   1,732         1,670      
Portfolio loans, net  $681,576        $639,245      

 

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Total portfolio loans increased $42.3 million, or 6.6%, to $682.4 million at March 31, 2017, as compared to $640.1 million at December 31, 2016, primarily due to originations of $31.2 million of commercial real estate loans and $7.5 million of multi-family loans, as well as the purchase of $15.9 million of one- to four-family residential mortgages, partially offset by principal amortization and increased prepayments of one- to four-family residential mortgages and home equity loans during the three months ended March 31, 2017. The increase in prepayments on one- to four-family residential mortgages is consistent with the current low interest rate environment.

 

Total portfolio loans growth was also partially offset by gross loan charge-offs of $0.1 million during the first quarter of 2017; however, the Company did not have any transfers to OREO of nonperforming loans during the first quarter of 2017.

 

All portfolio loans originated to small businesses, including Small Business Administration (SBA) and U.S. Department of Agriculture (USDA) loans originated internally and held-for-sale (SBA/USDA loans held-for-sale), are included in the commercial category of either the Company’s real estate loans, real estate construction loans or other portfolio loans. The Company sells the guaranteed portion of SBA/USDA loans held-for-sale upon completion of loan funding and approval by the SBA or USDA, as applicable. The unguaranteed portion of SBA/USDA loans held-for-sale, which remains in the commercial category of the Company’s real estate construction loans or other portfolio loans, was $17.4 million and $10.7 million at March 31, 2017 and December 31, 2016, respectively. The Company plans to expand the SBA/USDA loans held-for-sale business line going forward.

 

Growth in mortgage origination, the SBA/USDA portfolio and other commercial business loan production is expected to exceed principal amortization and loan pay-offs in the near future, but we can give no assurances regarding such growth.

 

The composition of the Bank’s portfolio loans is weighted toward one- to four-family residential mortgage loans. As of March 31, 2017, first mortgages (including residential construction loans) and home equity loans totaled $350.8 million, or 51.4% of total portfolio loans. Approximately $22.4 million, or 60.1%, of loans recorded as home equity loans and $335.9 million, or 95.8%, of loans collateralized by one- to four-family residential properties were in a first lien position as of March 31, 2017.

 

The composition of first mortgages and home equity loans by state as of March 31, 2017 was as follows:

 

   Florida   Georgia   Other
States
   Total 
   (Dollars in Thousands) 
One- to four-family residential mortgages  $217,983   $48,409   $24,217   $290,609 
Home equity and lines of credit   20,161    16,464    692    37,317 
One- to four-family construction loans   21,919    940        22,859 
   $260,063   $65,813   $24,909   $350,785 

 

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Allowance for Portfolio Loan Losses

 

The allowance was $8.3 million, or 1.2% of total portfolio loans, at March 31, 2017, compared to $8.2 million, or 1.3% of total portfolio loans, at December 31, 2016.

 

The activity in the allowance for the three months ended March 31, 2017 and 2016 was as follows:

 

   March 31, 2017   March 31, 2016 
   (Dollars in Thousands) 
         
Balance at beginning of year  $8,162   $7,745 
           
Charge-offs:          
Real estate loans:          
One- to four-family   (35)   (12)
Multi-family        
Commercial        
Land        
Real estate construction loans:          
One- to four-family        
Commercial        
Acquisition and development        
Other portfolio loans:          
Home equity       (24)
Consumer   (77)   (204)
Commercial        
Total charge-offs   (112)   (240)
           
Recoveries:          
Real estate loans:          
One- to four-family   56    8 
Multi-family        
Commercial        
Land       11 
Real estate construction loans:          
One- to four-family        
Commercial        
Acquisition and development        
Other portfolio loans:          
Home equity   5    5 
Consumer   61    95 
Commercial        
Total recoveries   122    119 
           
Net recoveries (charge-offs)   10    (121)
Provision for portfolio loan losses   100    150 
Balance at end of period  $8,272   $7,774 
           
Net recoveries (charge-offs) to average outstanding portfolio loans   %   0.08%

 

Net recoveries during the three months ended March 31, 2017 compared to net charge-offs in the same period in 2016, were primarily the result of a $45,000 decrease in net charge-offs in consumer auto loans, a $47,000 decrease in net charge-offs in unsecured consumer loans, and a $48,000 increase in gross recoveries in one- to four-family residential and home equity loans.

 

41

 

 

Below is a comparative composition of nonperforming assets as of March 31, 2017 and December 31, 2016:

 

   March 31, 2017   December 31, 2016 
   (Dollars in Thousands) 
Nonperforming assets:          
Real estate loans:          
One- to four-family  $797   $1,533 
Multi-family        
Commercial   2,259    2,276 
Land   5,510    5,548 
Real estate construction loans:          
One- to four-family        
Commercial        
Acquisition and development        
Other portfolio loans:          
Home equity   242    58 
Consumer   205    237 
Commercial   757    502 
Total nonperforming loans   9,770    10,154 
Other real estate owned   2,806    2,886 
Total nonperforming assets  $12,576   $13,040 
           
Nonperforming loans to total portfolio loans   1.4%   1.6%
Nonperforming assets to total assets   1.4%   1.4%

 

Nonperforming loans were $9.8 million, or 1.4% of total portfolio loans, at March 31, 2017, as compared to $10.1 million, or 1.6% of total portfolio loans, at December 31, 2016. The decrease in nonperforming loans was primarily due to nonperforming one- to four-family residential mortgages being reclassified to performing, as well as principal reductions and loan pay-offs of other existing nonperforming loans, partially offset by certain home equity loans and small business loans (included in commercial other portfolio loans) being classified as nonperforming.

 

During the past few years, and continuing into the first three months of 2017, the market for disposing of nonperforming assets has become more active. These types of transactions may result in additional losses over the amounts provided for in the allowance; however, the Company continues to monitor and attempt to reduce nonperforming assets through the least costly means possible. The allowance is determined by the information available at the time such determination is made and reflects management’s estimate of loss.

 

As of March 31, 2017 and December 31, 2016, all nonperforming loans were classified as nonaccrual and there were no loans 90 days past due and accruing interest.

 

OREO was $2.8 million at March 31, 2017, down $0.1 million from $2.9 million at December 31, 2016, as the Company had writedowns of OREO of $0.1 million. The OREO balances at both March 31, 2017 and December 31, 2016 included a commercial real estate property, representing the majority of each balance. As of March 31, 2017 and December 31, 2016, the carrying value of such commercial real estate property was $2.4 million and $2.5 million, respectively.

 

The Company recorded writedowns on foreclosed assets of $0.1 million for the three months ended March 31, 2017, while the Company did not record any losses on foreclosed assets for the three months ended March 31, 2016.

 

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Impaired Loans

 

The following table shows impaired loans segregated by performing and nonperforming status and the associated allowance as of March 31, 2017 and December 31, 2016:

 

   March 31, 2017   December 31, 2016 
   Balance   Allowance   Balance   Allowance 
   (Dollars in Thousands) 
                     
Performing  $101   $   $611   $218 
Nonperforming (1)   9,770    719    10,154    260 
Troubled debt restructuring by category:                    
Performing troubled debt restructurings – commercial   1,494    6    308    2 
Performing troubled debt restructurings – residential   23,304    2,106    26,229    2,231 
Total impaired loans  $34,669   $2,831   $37,302   $2,711 

 

 

(1)Balances include nonperforming TDRs of $7.7 million as of March 31, 2017 and nonperforming TDRs of $8.2 million as of December 31, 2016. There were $0.2 million of specific reserves for these nonperforming TDRs as of both March 31, 2017 and December 31, 2016.

 

Impaired loans include large, non-homogeneous loans where it is probable that the Bank will not receive all principal and interest when contractually due. Impaired loans also include TDRs, which totaled $32.5 million as of December 31, 2016, as compared to $34.8 million at December 31, 2016. 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 nonperforming TDR in the year of restructure and until the loan has performed for 12 months in accordance with the modified terms. At March 31, 2017, approximately $18.9 million of restructured loans, previously disclosed as being impaired and nonperforming TDRs, have demonstrated 12 months of performance under restructured terms and are reported as performing TDRs in this Report. The Company’s performing TDRs are still considered impaired.

 

Other Loans

 

Other loans was comprised of loans secured by one- to four-family residential homes originated internally (mortgage loans held-for-sale), SBA/USDA loans held-for-sale and warehouse loans held-for-investment.

 

The following table shows other loans, segregated by held-for-sale and warehouse loans held-for-investment, as of March 31, 2017 and December 31, 2016:

 

   March 31, 2017   December 31, 2016 
   (Dollars in Thousands) 
Other loans:          
Held-for-sale  $2,126   $7,147 
Warehouse loans held-for-investment   58,118    80,577 
Total other loans  $60,244   $87,724 

 

Other loans decreased $27.5 million, or 31.3%, to $60.2 million at March 31, 2017, as compared to $87.7 million at December 31, 2016, primarily due to a decrease in both originations of mortgage loans held-for-sale and warehouse loans held-for-investment. The decrease in mortgage loans held-for-sale and warehouse loans held-for-investment was primarily due to the generally slowing pace of mortgage refinancing nationwide, as well as the seasonality of mortgage lending, which tends to negatively affect the first quarter of each year. The aforementioned impact on mortgage loans held-for-sale was partially offset by our overall balance sheet strategy, which continues to emphasize originating certain loans, such as mortgages, to be sold, rather than to be held in our portfolio.

 

43

 

  

The Company internally originated $9.0 million and sold $10.6 million of mortgage loans held-for-sale during the three months ended March 31, 2017. The Company internally originated $11.1 million and sold $10.5 million of mortgage loans held-for-sale during the three months ended March 31, 2016. The gain recorded on sales of mortgage loans held-for-sale during the first quarter of 2017 and 2016 was $0.8 million and $0.2 million, respectively. During the three months ended March 31, 2017, the Company internally originated $7.0 million and sold $7.3 million of SBA/USDA loans held-for-sale, compared to originations of $0.6 million and sold of $1.8 million during the three months ended March 31, 2016. The gain recorded on sales and servicing of SBA/USDA loans held-for-sale during the first quarter of 2017 and 2016 was $0.7 million and $0.2 million, respectively. The Bank plans to expand its held-for-sale business lines going forward.

 

Loans originated and sold under the Company’s warehouse loans held-for-investment lending program were $257.6 million and $280.1 million, respectively, for the three months ended March 31, 2017, as compared to originations and sales of $294.4 million and $263.3 million, respectively, for the three months ended March 31, 2016. Loan sales under the warehouse loans held-for-investment lending program, which are done at par, earned interest on outstanding balances of $0.4 million for each of the first quarters of 2017 and 2016. For the three months ended March 31, 2017, the weighted average number of days outstanding of warehouse loans held-for-investment was 10 days. Despite the decrease in production through the first quarter of 2017, and due to the favorable interest rate environment, we expect that production of warehouse loans held-for-investment will continue to be a strategic focus of the Bank.

 

Deferred Income Taxes

 

As of March 31, 2017 and December 31, 2016, the Company evaluated the expected realization of its federal and state deferred tax assets. Based on this evaluation it was concluded that no valuation allowance was required for the federal and state deferred tax assets, with the exception of the remaining deferred tax asset related to a capital loss carryover, which resulted in a valuation allowance of $27,000 as of both March 31, 2017 and December 31, 2016.

 

The future realization of the Company’s net operating loss carryovers is currently limited to $325,000 per year.

 

Deposits

 

Total deposits were $685.8 million at March 31, 2017, an increase of $57.4 million from $628.4 million at December 31, 2016. The increase was comprised of an increase of $53.8 million in non-maturing deposits and an increase of $3.6 million in time deposits.

 

Non-maturing deposits increased to $444.5 million at March 31, 2017, due to an $8.2 million increase in noninterest-bearing demand deposits, a $21.3 million increase in interest-bearing demand deposits and a $24.3 million increase in savings and money market deposits. The increase in non-maturing deposits was due to our continued strategy to grow core deposits, which includes a focus on the development of commercial relationships. Time deposits increased to $241.3 million as of March 31, 2017, due to an increase of $3.1 million in deposits related to a retail certificates of deposit promotion, an increase of $0.7 million in non-brokered Internet certificates of deposit and an increase of $0.4 million in brokered deposits, partially offset by a decrease of $0.6 million in our standard certificates of deposit.

 

Management believes near term deposit growth will be moderate with an emphasis on core deposit growth. The Bank expects to continue to supplement its core deposit growth, if needed, with strategic retail certificates of deposit promotions, certificates of deposit sourced through a well-known national non-broker Internet deposit program, which has been successfully utilized in the past, brokered deposits or the creation of new business deposit products. Significant changes in the short-term interest rate environment could affect the availability of deposits in the markets we serve and, therefore, may cause the Bank to change its strategy.

 

44

 

  

Federal Home Loan Bank Advances

 

As of March 31, 2017 and December 31, 2016, advances from the FHLB were as follows:

 

   March 31, 2017   December 31, 2016 
   (Dollars in Thousands) 
Maturity on January 30, 2017, fixed rate at 0.61%  $   $50,000 
Maturity on April 5, 2017, fixed rate 0.91%   25,000     
Maturity on April 6, 2017, fixed rate 0.93%   10,000     
Maturity on June 20, 2017, fixed rate 0.73%   417    833 
Maturity on June 20, 2017, fixed rate 0.91%   10,000    10,000 
Maturity on June 19, 2018, fixed rate at 1.31%   10,425    10,425 
Maturity on June 20, 2019, fixed rate at 1.27%   2,250    2,500 
Maturity on June 8, 2021, fixed rate at 2.59%   20,000    20,000 
Maturity on June 8, 2021, fixed rate at 2.58%   15,000    15,000 
Maturity on June 8, 2021, fixed rate at 2.58%   15,000    15,000 
Daily rate credit, no maturity date, adjustable rate at 1.07% as of March 31, 2017 and at 0.80% as of December 31, 2016   36,000    65,000 
Total  $144,092   $188,758 

 

The FHLB advances had a weighted-average maturity of 19 months and a weighted-average rate of 1.57% at March 31, 2017. The Company had $368.5 million in portfolio loans posted as collateral for these advances as of March 31, 2017.

 

The Bank’s remaining borrowing capacity with the FHLB was $128.3 million at March 31, 2017. The FHLB requires that the Bank collateralize the excess of the fair value of the FHLB advances over the book value with cash and investment securities. In the event the Bank prepays advances prior to maturity, it must do so at the fair value of such FHLB advances. As of March 31, 2017, fair value exceeded the book value of the individual advances by $0.9 million, which was collateralized by portfolio loans (included in the $368.5 million discussed above). The Bank has the ability to supplement its loan collateral with investment securities as needed to secure the FHLB borrowings or prepay advances to reduce the amount of collateral required to secure the debt. Unpledged investment securities available for collateral amounted to $97.1 million as of March 31, 2017.

 

See “Liquidity” discussion below in this MD&A for further information regarding the Company’s FHLB advances, as well as information regarding the Company’s other liquidity sources.

 

Stockholders’ Equity

 

Stockholders’ equity increased by $1.9 million to $88.9 million at March 31, 2017, from $87.0 million at December 31, 2016, primarily due to net income of $1.5 million and other comprehensive income of $0.4 million for the three months ended March 31, 2017. The other comprehensive income during the first quarter of 2017, which reduced the Company’s accumulated other comprehensive loss as of March 31, 2017, was primarily due to a positive change in the fair value of investment securities as interest rates decreased during the first three months of 2017.

 

45

 

  

The Company’s equity to assets ratio remained at 9.6% at March 31, 2017, compared with 9.6% at December 31, 2016. As of March 31, 2017, the Bank’s total risk based capital to risk-weighted assets ratio was 13.76%, common equity tier 1 capital to risk-weighted assets ratio was 12.56%, tier 1 capital to risk-weighted assets ratio was 12.56% and tier 1 capital to adjusted assets ratio was 10.32%. These ratios as of December 31, 2016 were 14.83%, 13.58%, 13.58% and 9.44%, respectively. The decrease in risk-weighted capital ratios as of March 31, 2017, compared with those as of December 31, 2016, was primarily due to an increase in risk-weighted assets, due to growth in portfolio loans and a decrease in cash and cash equivalents, as well as an increase in the risk weighting of certain portfolio loan categories, partially offset by an increase in investment securities and an increase in capital. The Bank’s capital classification under PCA defined levels as of March 31, 2017 was well-capitalized.

 

The Company continues to monitor strategies to preserve capital including the continued suspension of cash dividends and its stock repurchase program. Resumption of these programs is not expected to occur in the near term.

 

Comparison of Results of Operations for the Three Months Ended March 31, 2017 and 2016

 

General

 

Net income for each of the three months ended March 31, 2017 and 2016 was $1.5 million. The Company’s return on average total assets ratio and return on average stockholders’ equity ratio (both annualized) were 0.70% and 6.70%, respectively, for the three months ended March 31, 2017, compared with 0.71% and 7.38%, respectively, for the three months ended March 31, 2016. Net income for the three months ended March 31, 2017, was virtually the same as compared to net income in the same period in 2016, primarily due to an increase in net interest income of $0.3 million, a decrease in provision expense of $0.1 million, and a decrease in income tax expense of $0.1 million, partially offset by an increase in noninterest expense of $0.5 million. Noninterest income was approximately unchanged in the three months ended March 31, 2017, as compared to the three months ended March 31, 2016.

 

Net interest income increased during the three months ended March 31, 2017, as compared to the three months ended March 31, 2016, primarily due to the impact of increased portfolio loans and other loans outstanding, higher interest rates on investment securities, and decreased interest expense for FHLB advances, partially offset by lower interest rates on portfolio loans, the impact of lower balances in investment securities and increased interest expense on deposits. Noninterest income was approximately unchanged during the three months ended March 31, 2017, as compared to the three months ended March 31, 2016, primarily due to higher gains on the sale of loans held-for-sale, offset by lower gains on the sale of investment securities, a decrease in service charges and fees, a decrease in interchange fees, and a decrease in other miscellaneous operating income. Noninterest expense increased during the three months ended March 31, 2017, as compared to the three months ended March 31, 2016, primarily due to increased foreclosed asset and data processing expenses, as well as increased interchange expense and other miscellaneous operating expenses.

 

46

 

 

Average Balances, Net Interest Income, Yields Earned and Rates Paid

 

The following table sets forth certain information for the three months ended March 31, 2017 and 2016. The average yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods presented.

 

   Three Months Ended March 31, 
   2017   2016 
   Average
Balance
   Interest   Average
Yield / Cost
   Average
Balance
   Interest   Average
Yield / Cost
 
   (Dollars in Thousands)   (Dollars in Thousands) 
                         
Interest-earning assets:                              
Loans (1)  $701,142   $7,469    4.26%  $672,292   $7,500    4.46%
Investment securities (2)   46,516    282    2.42%   103,288    526    2.04%
Other interest-earning assets (3)   48,951    137    1.12%   37,885    170    1.79%
Total interest-earning assets   796,609    7,888    3.96%   813,465    8,196    4.04%
Noninterest-earning assets   43,116              46,779           
Total assets  $839,725             $860,244           
                               
Interest-bearing liabilities:                              
Interest-bearing demand accounts  $115,754   $134    0.46%  $104,450   $114    0.43%
Savings deposits   58,551    17    0.12%   59,767    14    0.10%
Money market accounts   176,631    342    0.77%   111,576    155    0.56%
Time deposits   237,337    595    1.00%   228,309    514    0.90%
Securities sold under agreements to repurchase           %   329    1    1.55%
Federal Home Loan Bank advances   96,769    428    1.77%   220,218    1,308    2.38%
Other borrowings (4)   1        1.25%           %
Total interest-bearing liabilities   685,043    1,516    0.88%   724,649    2,106    1.16%
Noninterest-bearing liabilities   66,489              52,997           
Total liabilities   751,532              777,646           
Total stockholders’ equity   88,193              82,598           
Total liabilities and stockholders’ equity  $839,725             $860,244           
                               
Net interest income       $6,372             $6,090      
Net interest spread             3.08%             2.88%
Net interest-earning assets  $111,566             $88,816           
Net interest margin (5)             3.20%             2.99%
Average interest-earning assets to average interest-bearing liabilities        116.29%             112.26%     

 

 

(1)Includes portfolio loans and other loans. Calculated net of deferred loan fees. Nonaccrual loans included as loans carrying a zero yield.
(2)Calculated based on carrying value. State and municipal investment securities yields have not been adjusted to full tax equivalents, as the numbers would not change materially from those presented in the table.
(3)Includes FHLB stock at cost and term deposits with other financial institutions.
(4)Interest expense on other borrowings during the three months ended March 31, 2017, was less than $100.
(5)Net interest income divided by average interest-earning assets.

 

47

 

 

Rate/Volume Analysis

 

The following table presents the dollar amount of changes in interest income for major components of interest-earning assets and in interest expense for major components of interest-bearing liabilities for the three months ended March 31, 2017, as compared to the three months ended March 31, 2016. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in volume multiplied by the old interest rate; (2) changes in interest rate multiplied by the old volume; and (3) changes not solely attributable to interest rate or volume, which have been allocated proportionately to the change due to volume and the change due to interest rate.

 

   Increase / (Decrease)     
   Due to
Volume
   Due to
Rate
   Total
Increase / (Decrease)
 
   (Dollars in Thousands) 
Interest-earning assets:               
Loans (1)  $315   $(346)  $(31)
Investment securities   (330)   86    (244)
Other interest-earning assets   41    (74)   (33)
Total interest-earning assets   26    (334)   (308)
                
Interest-bearing liabilities:               
Interest-bearing demand accounts   13    7    20 
Savings deposits       3    3 
Money market accounts   112    75    187 
Time deposits   21    60    81 
Securities sold under agreements to repurchase   (1)       (1)
Federal Home Loan Bank advances   (605)   (275)   (880)
Other borrowings            
Total interest-bearing liabilities   (460)   (130)   (590)
                
Net interest income  $486   $(204)  $282 

 

 

(1)Includes portfolio loans and other loans. Calculated net of deferred loan fees. Nonaccrual loans included as loans carrying a zero yield.

 

Loan growth and the decrease in wholesale borrowings, partially offset by the decrease in investment securities, have been the primary contributors to the increase in net interest income in the first quarter of 2017. Decreased loan yields, partially offset by lower borrowing costs resulted in the unfavorable variance due to rate. In general, the prolonged low interest rate environment has resulted in net interest margin compression broadly for the banking industry, including the Company.

 

Interest Income

 

Total interest income decreased $0.3 million to $7.9 million for the three months ended March 31, 2017, as compared to $8.2 million for the three months ended March 31, 2016, due to the decrease in interest rates on portfolio loans and lower balances in investment securities, partially offset by higher balances in portfolio loans and other loans outstanding and higher interest rates on investment securities. Interest income on loans was $7.5 million for each of the three months ended March 31, 2017 and 2016. This was due to an increase in the average balance of loans, which increased $28.8 million to $701.1 million for the three months ended March 31, 2017 from $672.3 million for the three months ended March 31, 2016, offset by a decrease in average yield on loans of 20 basis points to 4.26% for the three months ended March 31, 2017. This decrease in average yield on loans is due to a strategic shift to more adjustable rate loans, in order to take advantage of, as well as limit the negative impact of, a potential rising rate environment.

 

48

 

  

The average balance of loans increased due to an increase in the average balance of portfolio loans and loans held-for-sale, partially offset by a decrease in the average balance of warehouse loans held-for-investment. Despite the increase in originations and purchases of portfolio loans during the three months ended March 31, 2017, as compared to the three months ended March 31, 2016, interest income decreased slightly, due to the decrease in interest rates on such loans. Additionally, fee income was approximately the same during the first quarter of 2017, as compared to the first quarter of 2016. Originations of loans held-for-sale increased during the three months ended March 31, 2017, as compared to the three months ended March 31, 2016, resulting in an increase in interest income from such loans. Originations of warehouse loans held-for-investment and the weighted average number of days outstanding for warehouse loans held-for-investment both decreased during the three months ended March 31, 2017, as compared to the three months ended March 31, 2016, resulting in a slight decrease in interest income and fee income. The decrease in originations of warehouse loans held-for-investment is due to a decrease in home purchase and refinance volume, which resulted in decreased volume with our counterparties.

 

Interest income earned on investment securities decreased $0.2 million to $0.3 million for the three months ended March 31, 2017 from $0.5 million for the three months ended March 31, 2016. This decrease was primarily due to a decrease in the average balance of investment securities of $56.8 million to $46.5 million during the three months ended March 31, 2017, partially offset by higher interest rates on investment securities during the same period.

 

Interest Expense

 

Interest expense declined by $0.6 million to $1.5 million for three months ended March 31, 2017 from $2.1 million for the three months ended March 31, 2016, due to the decrease in interest expense on FHLB advances, partially offset by increased interest expenses on deposits. The increase in interest expense on deposits in the first quarter of 2017, as compared to the first quarter of 2016, was primarily due to higher average rates paid on deposits and an increase in the average balance in such deposits. The average cost of deposits, including noninterest-bearing deposits, increased 9 basis points to 0.67% for the three months ended March 31, 2017, as compared to 0.58% for the three months ended March 31, 2016. The decrease in interest expense on FHLB advances for the three months ended March 31, 2017, as compared to the three months ended March 31, 2016, was due to a decrease in the average balance of FHLB advances, as well as lower average rates paid on such advances, resulting from the Bank’s aggressive strategies to manage interest rates.

 

The Bank’s overall cost of funds, including noninterest-bearing deposits, was 0.80% for the three months ended March 31, 2017, down from 1.08% for the three months ended March 31, 2016, primarily due to the lower average balances and interest rates related to FHLB advances and increased noninterest-bearing deposits, partially offset by an increase in the average rates paid on deposits and the average balance in such deposits.

 

Net Interest Income

 

Net interest income increased $0.3 million to $6.4 million for the three months ended March 31, 2017, from $6.1 million for the three months ended March 31, 2016, due to the increase in portfolio loans and other loans outstanding, higher interest rates on investment securities, and decreased interest expense for FHLB advances, partially offset by lower interest rates on portfolio loans, the impact of lower balances in investment securities and an increase in interest expense on deposits.

 

Our net interest rate spread, which is the difference between the interest rate earned on interest-earning assets and the interest rate paid on interest-bearing liabilities, increased 20 basis points to 3.08% for the three months ended March 31, 2017, as compared to 2.88% for the three months ended March 31, 2016. Our net interest margin, which is net interest income expressed as a percentage of our average interest-earning assets, increased 21 basis point to 3.20% for the three months ended March 31, 2017, as compared to 2.99% for the three months ended March 31, 2016. The increase in the net interest rate spread and net interest margin primarily reflected the positive impact on interest income from increasing balances in portfolio loans and other loans, the positive impact on interest income from higher interest rates on investment securities, and the positive impact on interest expense from declining high fixed-interest rate debt balances, partially offset by the negative impact on interest income from declining interest rates on portfolio loans, the negative impact on interest income from lower balances in investment securities, and the negative impact on interest expense from higher average rates paid on deposits and an increase in the average balance in such deposits.

 

49

 

 

Provision for Portfolio Loan Losses

 

Provision expense was $0.1 million and $0.2 million during the three months ended March 31, 2017 and 2016, respectively. The low level of provision expense during each of the three months ended March 31, 2017 and 2016, primarily reflected solid economic conditions in the Company’s markets, which have led to lower levels of charge-offs in recent years. The Company had a minimal amount of net recoveries during the three months ended March 31, 2017, while net charge-offs were $0.1 million for the three months ended March 31, 2016, representing 0.08% of average portfolio loans.

 

Noninterest Income

 

The components of noninterest income for the three months ended March 31, 2017 and 2016 were as follows:

 

           Increase / (Decrease) 
   2017   2016   Amount   Percentage 
   (Dollars in Thousands) 
Service charges and fees  $434   $633   $(199)   (31.4)%
Gain on sale of securities available-for-sale       828    (828)   (100.0)%
Gain on sale of loans held-for-sale   1,542    414    1,128    272.5%
Bank owned life insurance earnings   117    117        %
Interchange fees   329    358    (29)   (8.1)%
Other   139    211    (72)   (34.1)%
   $2,561   $2,561   $    %

 

Noninterest income was $2.6 million for both of the three months ended March 31, 2017 and 2016. Noninterest income was unchanged during the first quarter of 2017, as compared with the first quarter of 2016, primarily due to higher gains on the sale of loans held-for-sale, offset by lower gains on the sale of investment securities, a decrease in service charges and fees, a decrease in interchange fees, and a decrease in other miscellaneous operating income.

 

For the three months ended March 31, 2017, gains on sales of mortgage loans held-for-sale was $864,000 (including a gain of $585,000 on the sale of a group of TDRs that were transferred into held-for-sale during 2016), deferred fees on mortgage loans held-for-sale was $68,000, gains on sales of SBA/USDA loans held-for-sale was $434,000 and net gains recognized for the servicing of SBA/USDA loans held-for-sale was $311,000. By comparison, for the three months ended March 31, 2016, gains on sales of mortgage loans held-for-sale was $266,000, deferred fees on mortgage loans held-for-sale was $77,000, gains on sales of SBA/USDA loans held-for-sale was $160,000 and net gains recognized for the servicing of SBA/USDA loans held-for-sale was $64,000.

 

The Company expects gains on sales of loans held-for-sale to contribute significantly towards our noninterest income in the future, as the Company continues to emphasize the business activity of internally originating mortgage loans to be sold and participation in government programs relating to commercial business loans originated to be sold.

 

50

 

  

Noninterest Expense

 

The components of noninterest expense for the three months ended March 31, 2017 and 2016 were as follows:

 

           Increase / (Decrease) 
   2017   2016   Amount   Percentage 
   (Dollars in Thousands) 
Compensation and benefits  $3,487   $3,458   $29    0.8%
Occupancy and equipment   555    602    (47)   (7.8)%
Federal Deposit Insurance Corporation insurance premiums   135    172    (37)   (21.5)%
Foreclosed assets, net   80        80    n/a 
Data processing   611    456    155    34.0%
Outside professional services   537    471    66    14.0%
Collection expense and repossessed asset losses   139    145    (6)   (4.1)%
Other   1,006    774    232    30.0%
   $6,550   $6,078   $472    7.8%

 

Noninterest expense increased $0.5 million to $6.6 million for the three months ended March 31, 2017, from $6.1 million for the three months ended March 31, 2016. The increase in noninterest expense during the first quarter of 2017, as compared with the first quarter of 2016, primarily due to increased foreclosed asset and data processing expenses, as well as increased interchange expense and other miscellaneous operating expenses.

 

With the Company’s strengthened capital and asset quality positions, management expects to maintain its lower levels of risk-related operating expenses, including regulatory assessments, FDIC insurance costs and director & officer insurance costs, as well as to continue operating with lower levels of foreclosed asset and collection expenses.

 

Income Tax

 

The Company recorded $0.8 million and $0.9 million in income tax expense for the three months ended March 31, 2017 and 2016, respectively. The Company’s effective tax rate was 35.3% and 37.1% for the first quarter of 2017 and 2016, respectively. This decrease was primarily due to the expiration of temporary differences during 2016, which led to an elevated effective tax rate in the first quarter of 2016. The future realization of the Company’s net operating loss carryovers is currently limited to $325,000 per year. Income taxes are discussed in further detail in Note 11. Income Taxes of the Notes contained in this Report.

 

Liquidity

 

The Company maintains a liquidity position it believes will adequately provide funding for loan demand and deposit run-off that may occur in the normal course of business. The Company relies on a number of different sources of funds in order to meet its liquidity demands. The Company’s primary sources of funds are increases in deposit accounts and cash flows from loan payments, sales of residential and SBA/USDA loans in the secondary market, sales of investment securities, and borrowings. The scheduled amortization of loans and investment securities, as well as proceeds from borrowings, are generally predictable sources of funds. In addition, warehouse loans held-for-investment repay rapidly, with an average duration of approximately 10 days during the three months ended March 31, 2017 and with repayments generally funding advances. Other funding sources, however, such as inflows from new deposits, mortgage and investment securities prepayments and mortgage loan sales are less predictable and greatly influenced by market interest rates, economic conditions and competition.

 

We expect the Company’s primary sources of funds to continue to be sufficient to meet demands, although we can give no assurances, and the Bank has contingent liquidity capacity available to meet potential funding requirements, including availability from the FHLB, the Federal Reserve Bank of Atlanta and other institutional sources as discussed below. Management increased, and plans to continue to increase, the Bank’s higher interest-earning assets, using cash and cash equivalents as the funding source, due to the low interest rate environment on alternative investment options. Management expects that cash and cash equivalents will continue to be at a lower level throughout the remainder of 2017.

 

As of March 31, 2017, the Company had additional borrowing capacity of $128.3 million with the FHLB. The Company’s borrowing capacity with the Federal Reserve Bank of Atlanta, as of March 31, 2017, included the ability to borrow up to approximately $26.0 million under the Primary Credit program, based solely on the current amount of loans the Company has designated for pledging with the Federal Reserve Bank of Atlanta, and $10.0 million of daylight overdraft capacity. Additionally, as of March 31, 2017, the Company had liquidity sources through a $10.0 million line of credit for repurchase and reverse repurchase transactions, as well as one $17.0 million, one $10.0 million, and four $5.0 million lines of credit, all with private financial institutions. As of March 31, 2017, the Bank had no outstanding borrowings against the Primary Credit program, the daylight overdraft capacity or any of the aforementioned lines of credit with private financial institutions. Unpledged investment securities were approximately $97.1 million as of March 31, 2017.

 

51

 

  

The Company utilizes brokered deposits to meet funding needs at interest rates typically equal to or less than the Bank’s local market rates. As of March 31, 2017, the Bank had brokered deposits of $101.1 million, and expects it will continue to utilize such deposits, as necessary, to supplement retail deposit production. Additionally, the Company utilizes a non-brokered Internet certificate of deposit listing service to meet funding needs at interest rates typically equal to or less than the Bank’s local market rates. As of March 31, 2017, the Bank had deposits from this service of $9.9 million, and expects it will continue to utilize the program, as necessary, to supplement retail deposit production.

 

Threats to our liquidity position and capital levels include rapid declines in deposit balances due to market volatility caused by major changes in interest rates or negative public perception about the Bank or the financial services industry in general. In addition, the amount of investment securities that would otherwise be available to meet liquidity needs is limited due to the collateral requirements of our long-term debt. Specifically, the Bank’s repurchase agreements, which did not have an outstanding balance at March 31, 2017, have collateral requirements in excess of the debt. Additionally, the collateral requirements of the FHLB debt are supplemented with investment securities collateral and the Bank is required to collateralize any prepayment penalty amount using investment securities.

 

For the first three months of 2017, cash and cash equivalents decreased $32.1 million to $27.8 million as of March 31, 2017, as compared to $59.9 million as of December 31, 2016, due to the continued deployment of funds, as the Bank remains focused on its strategy to increase portfolio loans and other higher yielding assets. For the first three months of 2017, cash used in investing activities of $53.0 million exceeded cash provided by financing activities of $12.8 million and operating activities of $8.1 million. Primary sources of cash flows included proceeds from repayment of warehouse loans held-for-investment of $280.1 million, proceeds from FHLB advances of $85.0 million, net increases in deposits of $57.4 million, proceeds from sales of loans held-for-sale of $22.2 million, proceeds from the maturities and payments of investment securities of $21.3 million and proceeds from the redemption of FHLB stock of $5.3 million. Primary uses of cash flows included funding of warehouse loans held-for-investment of $257.6 million, the repayment of FHLB advances of $130.0 million, the purchase of investment securities of $56.5 million, net increases in portfolio loans of $26.1 million (excluding the purchase of such loans), originations of loans held-for-sale of $16.1 million and the purchase of portfolio loans of $15.9 million.

 

For the first three months of 2016, cash provided by financing activities of $32.7 million and operating activities of $2.8 million exceeded cash used in investing activities of $30.0 million. Primary sources of cash flows included proceeds from repayment of warehouse loans held-for-investment of $263.3 million, proceeds from FHLB advances of $110.5 million, proceeds from the sale of investment securities of $41.9 million and proceeds from sales of loans held-for-sale of $12.7 million. Primary uses of cash flows included funding of warehouse loans held-for-investment of $294.4 million, the repayment of FHLB advances of $62.7 million, net increases in portfolio loans of $29.7 million (excluding the purchase of such loans), originations of loans held-for-sale of $11.7 million, the repayment of repurchase agreements of $10.0 million, the purchase of portfolio loans of $7.1 million and net decreases in deposits of $5.2 million.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The Bank is subject to interest rate risk to the extent that its interest-bearing liabilities, primarily deposits, re-price more rapidly or at different rates than its interest-earning assets. In order to address the potential for adverse effects of material prolonged increases or decreases in interest rates on our results of operations, management has adopted an asset and liability management policy. The Board of Directors sets the asset and liability policy for the Company, which is implemented by the Bank’s Asset Liability Committee (ALCO). The purpose of the ALCO is to communicate, coordinate and control asset and liability management consistent with our business plan and board-approved policies. The ALCO establishes and monitors the volume and mix of assets and funding sources taking into account the Company’s relative costs and spreads, interest rate sensitivity and liquidity needs. The objectives are to manage assets and funding sources to produce results that are consistent with liquidity, capital adequacy, growth, risk, and profitability goals.

 

52

 

  

The ALCO meets quarterly to review, among other things, economic conditions and interest rate outlook, current and projected liquidity needs and capital position, anticipated changes in the volume and mix of assets and liabilities and interest rate exposure limits versus current projections pursuant to income simulations. The ALCO recommends appropriate strategy changes based on these quarterly reviews. The ALCO is also responsible for reviewing and reporting the effects of the asset and liability policy implementation and strategies to the Board of Directors at least quarterly. A key element of our asset and liability management plan is to protect net earnings by managing the maturity or re-pricing mismatch between our interest-earning assets and interest rate-sensitive interest-bearing liabilities. Historically, the Company has sought to reduce exposure to its earnings through the use of adjustable rate assets, the sale of certain fixed rate loans in the secondary market, and by extending funding maturities through the use of the FHLB advances and repurchase agreements.

 

In part, the Bank measures its exposure to interest rate risk using an analytical model referred to as Net Portfolio Value (NPV) that estimates the value of the net cash flows of interest-earning assets and interest-bearing liabilities under different interest rate scenarios. The Bank also measures interest rate risk by estimating the impact of interest rate changes on its “net interest income” which is defined as the difference between the interest income we earn on our interest-earning assets, such as loans and securities, and the interest we pay on our interest-bearing liabilities, such as deposits and borrowings. In our model, we estimate what our net interest income would be for a rolling forward 12- and 24-month period using historical data for assumptions such as loan prepayment rates and deposit decay rates, the current term structure for interest rates, and current deposit and loan offering rates. We then calculate what the net interest income would be for the same period in the event of an instantaneous 100, 200 and 300 basis point increase or a 100 basis point decrease in market interest rates. Given the current relatively low level of market interest rates, the Bank does not consider interest rate decreases of greater than 100 basis points in either of the two models used to measure interest rate risk.

 

The Bank’s estimated exposure to interest rate risk as of March 31, 2017 and December 31, 2016 is as follows:

 

               Net Present Value as a
Percentage of Present Value
of Assets (3)
   Net Interest Income 
       Estimated Increase /
(Decrease) in Net
Present Value
               Estimated Increase /
(Decrease) in Net
Interest Income
 
Change in
Interest
Rates –
Basis
Points (1)
  Estimated
Net Present
Value (2)
   Amount   Percent   Estimated
Net
Present
Value
Ratio (4)
   Estimated
Increase /
(Decrease)
– Basis
Points
   Estimated
Net Interest
Income
   Amount   Percent 
(Dollars in Thousands)
As of March 31, 2017:                            
+300  $108,166   $  (13,559)   (11.1)%   12.53%   (60)  $25,420   $(1,283)   (4.8)%
+200   114,231    (7,494)   (6.2)%   12.91%   (22)   25,884    (819)   (3.1)%
+100   119,092    (2,633)   (2.2)%   13.14%   1    26,320    (383)   (1.4)%
      0   121,725            13.13%       26,703         
-100   118,822    (2,903)   (2.4)%   12.56%   (57)   26,710    7    0.0%
                                         
As of December 31, 2016:                                    
+300  $87,247   $(24,235)   (21.7)%   10.36%   (192)  $24,754   $(1,454)   (5.5)%
+200   97,614    (13,868)   (12.4)%   11.28%   (100)   25,271    (937)   (3.6)%
+100   105,848    (5,634)   (5.1)%   11.92%   (36)   25,768    (440)   (1.7)%
      0   111,482            12.28%       26,208         
-100   108,611    (2,871)   (2.6)%   11.75%   (53)   26,435    227    0.9%

 

 

(1)Assumes an instantaneous uniform change in interest rates at all maturities.
(2)NPV is the discounted present value of expected cash flows from assets, liabilities and off-balance sheet contracts. Discount rates are unique to each class of asset and liability and are principally estimated as spreads over wholesale rates.
(3)Present Value of Assets (PVA) represents the discounted present value of incoming cash flows on interest-earning assets.
(4)NPV Ratio represents NPV divided by PVA.

 

53

 

  

The Company’s liabilities re-price faster than its assets, therefore, as interest rates rise, net interest income would decrease at a greater rate than if interest rates decline. Additionally, in an upward rate environment, net present value of the Company’s cash flows would decline, and the level of such decline would tend to exceed the level of decline in a downward rate environment. This tendency is due to several factors including, but not limited to, the percentage of fixed rate residential and commercial loans, the retail and wholesale funding mix, and extension risk in the assets. Overall, the Company’s sensitivity remains moderately liability sensitive with modest margin compression expected in a rising interest rate environment.

 

Certain shortcomings are inherent in the methodologies used in determining interest rate risk through changes in net portfolio value and net interest income. Modeling changes require making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the net portfolio value and net interest income information presented above assume that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assume that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or re-pricing of specific assets and liabilities. Accordingly, although interest rate-risk calculations provide an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results.

 

ITEM 4. CONTROLS AND PROCEDURES

 

(a) Evaluation of disclosure controls and procedures. The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. The Company’s disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the Company’s reports filed or submitted under the Exchange Act is accumulated and communicated to management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can provide only reasonable assurance of achieving their control objectives, and management necessarily is required to use its judgment in evaluating the cost-benefit relationship of possible controls and procedures. As required by Rule 13a-15 under the Exchange Act, as of the end of the quarter ended March 31, 2017, the Company carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures. This evaluation was carried out under the supervision and with the participation of management, including the Company’s Chief Executive Officer and Chief Financial Officer. Based upon this work and other evaluation procedures, management, including the Company’s Chief Executive Officer and Chief Financial Officer, has concluded that as of the end of the quarter ended March 31, 2017, the Company’s disclosure controls and procedures were effective.

 

(b) Changes in internal control over financial reporting. There were no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) and Rule 15d-15(f) under the Exchange Act) that occurred during the quarter ended March 31, 2017, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

54

 

  

PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

From time to time, each of the Company and the Bank are subject to legal proceedings incidental to the conduct of its business. Neither the Company nor the Bank is presently a party to any legal proceeding the resolution of which we believe would have a material adverse effect on our consolidated financial condition, operating results or cash flows.

 

ITEM 1A. RISK FACTORS

 

In addition to the other information set forth in this Report, you should carefully consider the factors discussed in Risk Factors included within the 2016 10-K. The Company does not believe there have been any material changes in the Company’s risk factors from those disclosed in the 2016 10-K. The risks described in the 2016 10-K are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition, operating results and cash flows. See the cautionary note regarding forward-looking statements at Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations in this Report, for further information.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

None.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

ITEM 5. OTHER INFORMATION

 

None.

 

ITEM 6. EXHIBITS

 

The exhibits listed in the accompanying Index to Exhibits are filed, furnished herewith, or incorporated by reference as part of this Report.

 

55

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

  ATLANTIC COAST FINANCIAL CORPORATION
       
Date: May 10, 2017   By: /s/ John K. Stephens, Jr._
       
    John K. Stephens, Jr.
    President and Chief Executive Officer
    (Principal Executive Officer)
       
Date: May 10, 2017   By: /s/ Tracy L. Keegan _
       
    Tracy L. Keegan
    Executive Vice President and Chief Financial Officer
    (Principal Financial and Accounting Officer)

 

56

 

  

INDEX TO EXHIBITS

 

      Incorporation by Reference      
Exhibit
Number
  Exhibit Description  Form  Filing
Date
  Exhibit
Number
  SEC File No.  Filed
Herewith
                   
3.1  Amended and Restated Articles of Incorporation of Atlantic Coast Financial Corporation  S-1  6/18/10  3.1  333-167632   
                   
3.2  Bylaws of Atlantic Coast Financial Corporation  S-1  6/18/10  3.2  333-167632   
                   
31.1  Section 302 Certification of Chief Executive Officer  __  __  __  __  X
                   
31.2  Section 302 Certification of Chief Financial Officer  __  __  __  __  X
                   
32*  Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002  __  __  __  __  X
                   
101.INS**  XBRL Instance Document  __  __  __  __  X
                   
101.SCH**  XBRL Taxonomy Extension Schema Document  __  __  __  __  X
                   
101.CAL**  XBRL Taxonomy Calculation Linkbase Document  __  __  __  __  X
                   
101.DEF**  XBRL Taxonomy Extension Definition Linkbase Document  __  __  __  __  X
                   
101.LAB**  XBRL Taxonomy Label Linkbase Document  __  __  __  __  X
                   
101.PRE**  XBRL Taxonomy Presentation Linkbase Document  __  __  __  __  X

 

*Furnished herewith. This certification attached as Exhibit 32 that accompanies this Report is not deemed filed with the SEC and is not to be incorporated by reference into any filing of Atlantic Coast Financial Corporation under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Report, irrespective of any general incorporation language contained in such filing.
**These documents formatted in XBRL (Extensible Business Reporting Language) have been attached as Exhibit 101 to this Report.

 

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