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 September 30, 2017

 

Commission file number: 001-35072

 

 

(Exact name of registrant as specified in its charter)

 

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

 

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 emerging growth company, indicate by check mark if the registrant 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 November 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	38
	General Description of Business	39
	Recent Events	39
	Critical Accounting Policies	39
	Comparison of Financial Condition	40
	Comparison of Results of Operations	48
	Liquidity	58
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	59
Item 4.	Controls and Procedures	61
PART II.  OTHER INFORMATION
Item 1.	Legal Proceedings	62
Item 1A.	Risk Factors	62
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	62
Item 3.	Defaults Upon Senior Securities	62
Item 4.	Mine Safety Disclosures	62
Item 5.	Other Information	62
Item 6.	Exhibits	62
Signature Page		63
Index to Exhibits		64

 

 

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)

 

		September 30, 2017				December 31, 2016
ASSETS
Cash and due from financial institutions		$	4,091			$	3,744
Short-term interest-earning deposits			38,143				56,149
Total cash and cash equivalents			42,234				59,893
Securities available-for-sale			39,113				65,293
Portfolio loans, net of allowance of $8,405 in 2017 and $8,162 in 2016			745,260				639,245
Other loans:
Held-for-sale			5,025				7,147
Warehouse loans held-for-investment			40,262				80,577
Total other loans			45,287				87,724
Federal Home Loan Bank stock, at cost			7,228				8,792
Land, premises and equipment, net			14,360				14,945
Bank owned life insurance			17,887				17,535
Other real estate owned			188				2,886
Accrued interest receivable			2,034				1,979
Deferred tax assets, net			5,836				6,752
Other assets			2,508				2,415
Total assets		$	921,935			$	907,459
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Deposits:
Noninterest-bearing demand		$	70,029			$	59,696
Interest-bearing demand			89,503				106,004
Savings and money market			294,804				224,987
Time			222,080				237,726
Total deposits			676,416				628,413
Federal Home Loan Bank advances			150,842				188,758
Accrued expenses and other liabilities			3,283				3,270
Total liabilities			830,541				820,441
Commitments and contingent liabilities
Stockholders’ equity:
Preferred stock: $0.01 par value; 25,000,000 shares authorized; none issued and outstanding at September 30, 2017 and December 31, 2016			-				-
Common stock: $0.01 par value; 100,000,000 shares authorized; 15,553,709 issued and outstanding at September 30, 2017 and 15,509,061 issued and outstanding at December 31, 2016			156				155
Additional paid-in capital			100,423				100,361
Common stock held by:
Employee stock ownership plan shares of 63,474 at September 30, 2017 and 67,067 at December 31, 2016			(1,379	)			(1,457	)
Benefit plans			(105	)			(99	)
Retained deficit			(6,532	)			(10,316	)
Accumulated other comprehensive loss			(1,169	)			(1,626	)
Total stockholders’ equity			91,394				87,018
Total liabilities and stockholders’ equity		$	921,935			$	907,459

 

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

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in Thousands, Except Share Information)

(unaudited)

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2017				2016				2017				2016
Interest and dividend income:
Loans, including fees		$	8,364			$	7,961			$	23,861			$	23,399
Securities and interest-earning deposits in other financial institutions			347				521				1,159				1,785
Total interest and dividend income			8,711				8,482				25,020				25,184
Interest expense:
Deposits			1,363				962				3,712				2,606
Securities sold under agreements to repurchase			-				-				-				1
Federal Home Loan Bank advances			595				658				1,532				3,220
Other borrowings			-				-				-				1
Total interest expense			1,958				1,620				5,244				5,828
Net interest income			6,753				6,862				19,776				19,356
Provision for portfolio loan losses			167				220				458				569
Net interest income after provision for portfolio loan losses			6,586				6,642				19,318				18,787
Noninterest income:
Service charges and fees			452				592				1,340				1,788
Gain on sale of securities available-for-sale			9				493				409				1,321
Gain on sale of loans held-for-sale			186				235				2,119				1,598
Gain on sale of portfolio loans			-				9				-				227
Bank owned life insurance earnings			117				117				352				349
Interchange fees			315				326				983				1,033
Other			156				425				512				991
Total noninterest income			1,235				2,197				5,715				7,307
Noninterest expense:
Compensation and benefits			3,544				3,562				10,558				10,532
Occupancy and equipment			642				658				1,745				1,863
Federal Deposit Insurance Corporation insurance premiums			34				135				290				473
Foreclosed assets, net			(6	)			-				293				254
Data processing			581				587				1,774				1,556
Outside professional services			458				487				1,557				1,497
Collection expense and repossessed asset losses			82				101				316				363
Other			810				836				2,658				2,536
Total noninterest expense			6,145				6,366				19,191				19,074
Income before income tax expense			1,676				2,473				5,842				7,020
Income tax expense			561				917				2,058				2,604
Net income		$	1,115			$	1,556			$	3,784			$	4,416
Earnings per common share:
Basic		$	0.07			$	0.10			$	0.25			$	0.29
Diluted		$	0.07			$	0.10			$	0.25			$	0.29

 

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

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in Thousands)

(unaudited)

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2017				2016				2017				2016
Net income		$	1,115			$	1,556			$	3,784			$	4,416
Other comprehensive income (loss):
Change in securities available-for-sale:
Unrealized holding gains (losses) arising during the period			(174	)			681				1,368				3,213
Less reclassification adjustments for gains recognized in income			(9	)			(493	)			(409	)			(1,321	)
Net unrealized gains (losses)			(183	)			188				959				1,892
Income tax effect			65				(71	)			(502	)			(962	)
Net of tax effect			(118	)			117				457				930
Total other comprehensive income (loss)			(118	)			117				457				930
Comprehensive income		$	997			$	1,673			$	4,241			$	5,346

 

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

 

 

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 nine months ended September 30, 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, 3,593 shares			-				-				(50	)			78				-				-				-				28
Restricted stock awards			44,648				1				-				-				-				-				-				1
Restricted stock expense			-				-				103				-				-				-				-				103
Distribution from Rabbi Trust			-				-				9				-				(6	)			-				-				3
Net income			-				-				-				-				-				3,784				-				3,784
Other comprehensive income			-				-				-				-				-				-				457				457
Balance at September 30, 2017			15,553,709			$	156			$	100,423			$	(1,379	)		$	(105	)		$	(6,532	)		$	(1,169	)		$	91,394
For the nine months ended September 30, 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, 3,593 shares			-				-				(56	)			78				-				-				-				22
Distribution from Rabbi Trust			-				-				(15	)			-				35				-				-				20
Net income			-				-				-				-				-				4,416				-				4,416
Other comprehensive income			-				-				-				-				-				-				930				930
Balance at September 30, 2016			15,509,061			$	155			$	100,387			$	(1,483	)		$	(213	)		$	(12,318	)		$	(402	)		$	86,126

 

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

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in Thousands)

(unaudited)

 

		Nine Months Ended September 30,
		2017				2016
Cash flows from operating activities:
Net income		$	3,784			$	4,416
Adjustments to reconcile net income to net cash from operating activities:
Provision for portfolio loan losses			458				569
Gain on sale of loans held-for-sale			(2,119	)			(1,598	)
Originations of loans held-for-sale			(41,866	)			(65,720	)
Proceeds from sales of loans held-for-sale			56,941				65,300
Gain on sale of portfolio loans			-				(227	)
Loss on foreclosed assets, net			293				254
Gain on sale of securities available-for-sale			(409	)			(1,321	)
Gain on sale of branch			-				(137	)
Employee stock ownership plan compensation expense			28				22
Restricted stock awards			1				-
Share-based compensation expense			103				-
Amortization of premiums and deferred fees, net of accretion of discounts on investment securities and loans			941				938
Amortization of prepayment penalties resulting from repayment of Federal Home Loan Bank advances			-				1,382
Depreciation expense			834				817
Deferred tax benefit			643				2,111
Net change in cash surrender value of bank owned life insurance			(352	)			(349	)
Net change in accrued interest receivable			(55	)			169
Net change in other assets			(53	)			(6,780	)
Net change in accrued expenses and other liabilities			13				241
Net cash provided by operating activities			19,185				87
Cash flows from investing activities:
Proceeds from maturities and payments of investment securities			78,801				16,294
Proceeds from sales of securities available-for-sale			5,525				66,534
Purchase of securities available-for-sale			(57,149	)			(10,000	)
Funding of warehouse loans held-for-investment			(771,775	)			(1,210,834	)
Proceeds from repayments of warehouse loans held-for-investment			812,090				1,135,292
Purchase of portfolio loans			(18,290	)			(7,130	)
Proceeds from sales of portfolio loans			-				31,265
Net change in portfolio loans			(99,856	)			(67,127	)
Purchase of premises and equipment			(249	)			(694	)
Proceeds from disposal of premises and equipment			-				331
Proceeds from sale of other real estate owned			2,405				492
Purchase of Federal Home Loan Bank stock			(18,228	)			(10,807	)
Redemption of Federal Home Loan Bank stock			19,792				9,782
Net cash paid in sale of branch			-				(13,256	)
Net cash used in investing activities			(46,934	)			(59,858	)
Cash flows from financing activities:
Net change in deposits			48,003				75,068
Repayment of securities sold under agreements to repurchase			-				(9,991	)
Proceeds from Federal Home Loan Bank advances			457,700				943,000
Repayment of Federal Home Loan Bank advances			(495,616	)			(922,000	)
Proceeds from other borrowings			-				5,000
Repayment of other borrowings			-				(5,000	)
Shares purchased for and distributions from Rabbi Trust			3				20
Net cash provided by financing activities			10,090				86,097
Net increase (decrease) in cash and cash equivalents			(17,659	)			26,326
Cash and cash equivalents, beginning of period			59,893				23,581
Cash and cash equivalents, end of period		$	42,234			$	49,907
Supplemental disclosures of cash flow information:
Interest paid		$	5,145			$	5,760
Income taxes paid			1,950				78
Supplemental disclosures of non-cash information:
Loans transferred to other real estate		$	-			$	299
Loans transferred to held-for-sale			11,515				-
Loans transferred to portfolio			641				635
Income tax expense from unrealized holding gains and losses on securities available-for-sale arising during the period			273				556

 

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

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 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 September 30, 2017, and for the three and nine months ended September 30, 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 and nine months ended September 30, 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 September 30, 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 May 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2017-09, Scope Modification Accounting (Stock Compensation) (ASU 2017-09). ASU 2017-09 reduces diversity in practice by clarifying which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. The guidance in this standard is effective for interim and annual periods beginning after December 15, 2017, and early adoption was permitted. The Company adopted ASU 2017-09 for the second quarter of 2017, with no material impact on the Financial Statements.

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 2017

(unaudited)

 

NOTE 2. IMPACT OF CERTAIN ACCOUNTING PRONOUNCEMENTS (continued)

 

Recently Issued Standards Adopted (continued)

 

In March 2017, the FASB issued 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.

 

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 held-to-maturity, 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.

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 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. Additionally, the adoption is expected to increase risk-weighted assets, which will impact certain capital ratios.

 

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 it expects to receive in exchange for 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 because the standard does not apply to financial instruments, which account for the majority of the Company’s revenues.

 

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 $0.4 million and $25.0 million as of September 30, 2017 and December 31, 2016, respectively. During the three and nine months ended September 30, 2017, the Bank earned $62,000 and $169,000, respectively, of interest income related to the Customers Participation Agreements. During the three and nine months ended September 30, 2016, the Bank earned $206,000 and $359,000, respectively, of interest income related to the Customers Participation Agreements.

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 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 September 30, 2017 and December 31, 2016, are summarized below:

 

						Fair Value Hierarchy
		Total				Level 1				Level 2				Level 3
		(Dollars in Thousands)
September 30, 2017
Assets:
State and municipal		$	5,611			$	-			$	5,611			$	-
Mortgage-backed securities – residential			24,761				-				24,761				-
Collateralized mortgage obligations – U.S. government			2,514				-				2,514				-
Corporate debt			6,227				-				6,227				-
Total		$	39,113			$	-			$	39,113			$	-
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 September 30, 2017 and December 31, 2016, and there were no transfers into or out of Level 3 investments during the three and nine months ended September 30, 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 September 30, 2017 and December 31, 2016.

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 2017

(unaudited)

 

NOTE 4. FAIR VALUE (continued)

 

Assets measured at fair value on a nonrecurring basis as of September 30, 2017 and December 31, 2016, are summarized below:

 

						Fair Value Hierarchy
		Total				Level 1				Level 2				Level 3
		(Dollars in Thousands)
September 30, 2017
Assets:
Other real estate owned		$	188			$	-			$	-			$	188
Impaired loans – collateral dependent (reported on the consolidated balance sheets in portfolio loans, net)			8,042				-				-				8,042
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 September 30, 2017 and December 31, 2016, is as follows:

 

		Fair Value Estimate				Valuation Techniques		Unobservable Inputs		Range (Weighted Average) (1)
		(Dollars in Thousands)
September 30, 2017
Assets:
Other real estate owned		$	188			Broker price opinions, appraisal of collateral (2), (3)		Appraisal adjustments (4)		0.0% to 90.0% (40.4%)
								Liquidation expenses		10.0% (10.0%)
Impaired loans – collateral dependent (reported on the consolidated balance sheets in portfolio loans, net)			8,042			Appraisal of collateral (2)		Appraisal adjustments (4)		0.0 to 58.7% (22.8%)
								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.

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 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 and nine months ended September 30, 2017 were $4,000 and $84,000, respectively. There were no write-downs on OREO for each of the three and nine months ended September 30, 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 September 30, 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 September 30, 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)
September 30, 2017
Assets:
Cash and due from financial institutions		$	4,091			$	4,091			$	4,091			$	-			$	-
Short-term interest-earning deposits			38,143				38,143				38,143				-				-
Portfolio loans, net			745,260				741,126				-				733,084				8,042
Loans held-for-sale			5,025				5,247				-				5,247				-
Warehouse loans held-for-investment			40,262				40,262				-				40,262				-
Federal Home Loan Bank stock, at cost			7,228				7,228				-				-				7,228
Bank owned life insurance			17,887				17,898				-				17,898				-
Accrued interest receivable			2,034				2,034				-				2,034				-
Liabilities:
Deposits			676,416				676,960				-				676,960				-
Federal Home Loan Bank advances			150,842				151,648				-				151,648				-
Accrued interest payable (reported on consolidated balance sheets in accrued expenses and other liabilities)			220				220				-				220				-
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				-

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 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 September 30, 2017 and December 31, 2016.

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 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 September 30, 2017 and December 31, 2016:

 

		Amortized Cost				Unrealized Gains				Unrealized Losses				Fair Value				Carrying Amount
		(Dollars in Thousands)
September 30, 2017
State and municipal		$	5,506			$	105			$	-			$	5,611			$	5,611
Mortgage-backed securities – residential			25,154				-				(393	)			24,761				24,761
Collateralized mortgage obligations – U.S. government			2,583				-				(69	)			2,514				2,514
Corporate debt			6,537				6				(316	)			6,227				6,227
Total investment securities		$	39,780			$	111			$	(778	)		$	39,113			$	39,113
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 September 30, 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			406				408
Due in more than five to ten years			10,830				10,602
Due after ten years			807				828
Mortgage-backed securities – residential			25,154				24,761
Collateralized mortgage obligations – U.S. government			2,583				2,514
		$	39,780			$	39,113

 

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.

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 2017

(unaudited)

 

NOTE 6. INVESTMENT SECURITIES (continued)

 

The following table summarizes the investment securities with unrealized losses as of September 30, 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)
September 30, 2017
Mortgage-backed securities – residential		$	24,732			$	(393	)		$	-			$	-			$	24,732			$	(393	)
Collateralized mortgage obligations – U.S. Government			-				-				2,514				(69	)			2,514				(69	)
Corporate debt			4,684				(316	)			-				-				4,684				(316	)
		$	29,416			$	(709	)		$	2,514			$	(69	)		$	31,930			$	(778	)
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 September 30, 2017, the Company’s security portfolio consisted of 23 investment securities (all classified as available-for-sale), 10 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 September 30, 2017, $27.2 million, or approximately 70% of the debt securities held by the Company, including 9 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.

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 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 September 30, 2017.

 

The Company did not hold any non-agency collateralized mortgage-backed securities or collateralized mortgage obligations as of September 30, 2017 and December 31, 2016, and did not record OTTI related to such securities during the three and nine months ended September 30, 2017 and 2016.

 

Proceeds from Investment Securities

 

Proceeds from sales, payments, maturities, and calls of securities available-for-sale were $1.4 million and $84.3 million for the three and nine months ended September 30, 2017, respectively. Proceeds from sales, payments, maturities, and calls of securities available-for-sale were $35.3 million and $83.6 million for the three and nine months ended September 30, 2016, respectively.

 

Gross gains of $9,000 and $0.4 million were realized during the three and nine months ended September 30, 2017, respectively, while no gross losses were realized during the three and nine months ended September 30, 2017. The net gain on sale of securities available-for-sale for the three and nine months ended September 30, 2017, includes $9,000 and $0.4 million, respectively, of accumulated other comprehensive income reclassifications from unrealized holding gains. Gross gains of $0.5 million and $1.5 million were realized during the three and nine months ended September 30, 2016, respectively. No gross losses were realized during the three months ended September 30, 2016, while gross losses of $0.2 million were realized during the nine months ended September 30, 2016. The net gain on sale of securities available-for-sale for the three and nine months ended September 30, 2016, includes $0.5 million and $1.3 million, respectively, 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 each of the three and nine months ended September 30, 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 September 30, 2017 and December 31, 2016.

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 2017

(unaudited)

 

NOTE 7. PORTFOLIO LOANS

 

Following is a comparative composition of net portfolio loans as of September 30, 2017 and December 31, 2016:

 

		September 30, 2017				% of Total Loans				December 31, 2016				% of Total Loans
		(Dollars in Thousands)
Real estate loans:
One- to four-family		$	285,039				38.2	%		$	276,193				43.1	%
Multi-family			82,360				11.0	%			70,452				11.0	%
Commercial			213,980				28.6	%			104,143				16.3	%
Land			14,623				2.0	%			17,218				2.7	%
Total real estate loans			596,002				79.8	%			468,006				73.1	%
Real estate construction loans:
One- to four-family			10,751				1.4	%			22,687				3.5	%
Commercial			11,763				1.6	%			14,432				2.3	%
Acquisition and development			-				-	%			-				-	%
Total real estate construction loans			22,514				3.0	%			37,119				5.8	%
Other portfolio loans:
Home equity			35,038				4.7	%			37,748				5.9	%
Consumer			35,825				4.8	%			39,232				6.1	%
Commercial			57,729				7.7	%			57,947				9.1	%
Total other portfolio loans			128,592				17.2	%			134,927				21.1	%
Total portfolio loans			747,108				100.0	%			640,052				100.0	%
Allowance for portfolio loan losses			(8,405	)							(8,162	)
Net deferred portfolio loan costs			5,575								5,685
Premiums and discounts on purchased loans, net			982								1,670
Portfolio loans, net		$	745,260							$	639,245

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 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 September 30, 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)
September 30, 2017
Real estate loans:
One- to four-family		$	282,763			$	915			$	766			$	595			$	2,276			$	285,039
Multi-family			82,360				-				-				-				-				82,360
Commercial			211,753				-				1,986				241				2,227				213,980
Land			9,113				-				-				5,510				5,510				14,623
Total real estate loans			585,989				915				2,752				6,346				10,013				596,002
Real estate construction loans:
One- to four-family			10,751				-				-				-				-				10,751
Commercial			11,763				-				-				-				-				11,763
Acquisition and development			-				-				-				-				-				-
Total real estate construction loans			22,514				-				-				-				-				22,514
Other portfolio loans:
Home equity			34,391				346				272				29				647				35,038
Consumer			35,336				345				128				16				489				35,825
Commercial			57,098				-				-				631				631				57,729
Total other portfolio loans			126,825				691				400				676				1,767				128,592
Total portfolio loans		$	735,328			$	1,606			$	3,152			$	7,022			$	11,780			$	747,108
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

 

The decrease in commercial real estate loans greater than 90 days past due is primarily related to one loan, which was current as of September 30, 2017. However, due to other circumstances surrounding this loan, the loan remained classified as a nonperforming portfolio loan as of September 30, 2017.

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 2017

(unaudited)

 

NOTE 7. PORTFOLIO LOANS (continued)

 

Nonperforming portfolio loans, including nonaccrual portfolio loans, as of September 30, 2017 and December 31, 2016 were $9.5 million and $10.1 million, respectively. There were no portfolio loans over 90 days past-due and still accruing interest as of September 30, 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 September 30, 2017 and December 31, 2016:

 

		Performing				Nonperforming				Total
		(Dollars in Thousands)
September 30, 2017
Real estate loans:
One- to four-family		$	284,122			$	917			$	285,039
Multi-family			82,360				-				82,360
Commercial			211,753				2,227				213,980
Land			9,113				5,510				14,623
Total real estate loans			587,348				8,654				596,002
Real estate construction loans:
One- to four-family			10,751				-				10,751
Commercial			11,763				-				11,763
Acquisition and development			-				-				-
Total real estate construction loans			22,514				-				22,514
Other portfolio loans:
Home equity			34,904				134				35,038
Consumer			35,710				115				35,825
Commercial			57,098				631				57,729
Total other portfolio loans			127,712				880				128,592
Total portfolio loans		$	737,574			$	9,534			$	747,108
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

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 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 September 30, 2017 and December 31, 2016:

 

		Pass				Special Mention				Substandard				Doubtful				Total
		(Dollars in Thousands)
September 30, 2017
Real estate loans:
Multi-family		$	82,360			$	-			$	-			$	-			$	82,360
Commercial			210,430				-				3,550				-				213,980
Land			9,113				-				5,510				-				14,623
Total real estate loans			301,903				-				9,060				-				310,963
Real estate construction loans:
Commercial			11,763				-				-				-				11,763
Total real estate construction loans			11,763				-				-				-				11,763
Other portfolio loans:
Commercial			56,435				61				1,233				-				57,729
Total other portfolio loans			56,435				61				1,233				-				57,729
Total risk graded portfolio loans		$	370,101			$	61			$	10,293			$	-			$	380,455
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

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 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. 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.

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 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 September 30, 2017 and 2016 was as follows:

 

		Beginning Balance				Charge-Offs				Recoveries				Provisions				Ending Balance
		(Dollars in Thousands)
September 30, 2017
Real estate loans:
One- to four-family		$	2,767			$	(23	)		$	117			$	(81	)		$	2,780
Multi-family			190				-				-				24				214
Commercial			2,723				-				-				304				3,027
Land			205				-				1				(21	)			185
Total real estate loans			5,885				(23	)			118				226				6,206
Real estate construction loans:
One- to four-family			97				-				-				(28	)			69
Commercial			111				-				-				(20	)			91
Acquisition and development			-				-				-				-				-
Total real estate construction loans			208				-				-				(48	)			160
Other portfolio loans:
Home equity			717				(51	)			20				(11	)			675
Consumer			390				(101	)			49				42				380
Commercial			898				-				6				13				917
Total other portfolio loans			2,005				(152	)			75				44				1,972
Unallocated			122				-				-				(55	)			67
Total		$	8,220			$	(175	)		$	193			$	167			$	8,405
September 30, 2016
Real estate loans:
One- to four-family		$	3,215			$	(58	)		$	68			$	(103	)		$	3,122
Multi-family			264				-				-				(2	)			262
Commercial			1,552				(74	)			-				523				2,001
Land			146				-				11				46				203
Total real estate loans			5,177				(132	)			79				464				5,588
Real estate construction loans:
One- to four-family			178				-				-				19				197
Commercial			165				-				-				(36	)			129
Acquisition and development			-				-				-				-				-
Total real estate construction loans			343				-				-				(17	)			326
Other portfolio loans:
Home equity			879				(97	)			6				(145	)			740
Consumer			733				(12	)			56				(46	)			646
Commercial			750				-				-				(78	)			660
Total other portfolio loans			2,362				(109	)			62				(269	)			2,046
Unallocated			148				-				-				42				190
Total		$	8,030			$	(241	)		$	141			$	220			$	8,150

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 2017

(unaudited)

 

NOTE 7. PORTFOLIO LOANS (continued)

 

Activity in the allowance for the nine months ended September 30, 2017 and 2016 was as follows:

 

		Beginning Balance				Charge-Offs				Recoveries				Provisions				Ending Balance
		(Dollars in Thousands)
September 30, 2017
Real estate loans:
One- to four-family		$	3,090			$	(82	)		$	234			$	(462	)		$	2,780
Multi-family			268				-				-				(54	)			214
Commercial			2,209				-				-				818				3,027
Land			207				-				5				(27	)			185
Total real estate loans			5,774				(82	)			239				275				6,206
Real estate construction loans:
One- to four-family			159				-				-				(90	)			69
Commercial			120				-				-				(29	)			91
Acquisition and development			-				-				-				-				-
Total real estate construction loans			279				-				-				(119	)			160
Other portfolio loans:
Home equity			560				(167	)			31				251				675
Consumer			457				(328	)			199				52				380
Commercial			880				(119	)			12				144				917
Total other portfolio loans			1,897				(614	)			242				447				1,972
Unallocated			212				-				-				(145	)			67
Total		$	8,162			$	(696	)		$	481			$	458			$	8,405
September 30, 2016
Real estate loans:
One- to four-family		$	3,142			$	(185	)		$	421			$	(256	)		$	3,122
Multi-family			217				-				-				45				262
Commercial			1,337				(74	)			-				738				2,001
Land			260				-				32				(89	)			203
Total real estate loans			4,956				(259	)			453				438				5,588
Real estate construction loans:
One- to four-family			144				-				-				53				197
Commercial			116				-				-				13				129
Acquisition and development			-				-				-				-				-
Total real estate construction loans			260				-				-				66				326
Other portfolio loans:
Home equity			972				(136	)			17				(113	)			740
Consumer			871				(434	)			207				2				646
Commercial			556				(12	)			-				116				660
Total other portfolio loans			2,399				(582	)			224				5				2,046
Unallocated			130				-				-				60				190
Total		$	7,745			$	(841	)		$	677			$	569			$	8,150

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 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 September 30, 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		$	-			$	2,780			$	2,780
Multi-family			-				214				214
Commercial			190				2,837				3,027
Land			-				185				185
Total real estate loans			190				6,016				6,206
Real estate construction loans:
One- to four-family			-				69				69
Commercial			-				91				91
Acquisition and development			-				-				-
Total real estate construction loans			-				160				160
Other portfolio loans:
Home equity			-				675				675
Consumer			-				380				380
Commercial			443				474				917
Total other portfolio loans			443				1,529				1,972
Unallocated			-				67				67
Total ending allowance for portfolio loan losses balance		$	633			$	7,772			$	8,405
Portfolio loans:
Real estate loans:
One- to four-family		$	-			$	285,039			$	285,039
Multi-family			-				82,360				82,360
Commercial			3,358				210,622				213,980
Land			5,510				9,113				14,623
Total real estate loans			8,868				587,134				596,002
Real estate construction loans:
One- to four-family			-				10,751				10,751
Commercial			-				11,763				11,763
Acquisition and development			-				-				-
Total real estate construction loans			-				22,514				22,514
Other portfolio loans:
Home equity			-				35,038				35,038
Consumer			-				35,825				35,825
Commercial			943				56,786				57,729
Total other portfolio loans			943				127,649				128,592
Total ending portfolio loans balance		$	9,811			$	737,297			$	747,108

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 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

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 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 $0.6 million and $0.5 million at September 30, 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 September 30, 2017 and December 31, 2016 were as follows:

 

		September 30, 2017				December 31, 2016
		(Dollars in Thousands)
Real estate loans:
One- to four-family		$	17,772			$	20,060
Multi-family			-				-
Commercial			3,117				2,488
Land			6,280				6,311
Total real estate loans			27,169				28,859
Real estate construction loans:
One- to four-family			-				-
Commercial			-				-
Acquisition and development			-				-
Total real estate construction loans			-				-
Other portfolio loans:
Home equity			4,075				4,230
Consumer			1,342				1,573
Commercial			403				181
Total other portfolio loans			5,820				5,984
Total TDRs classified as impaired loans		$	32,989			$	34,843

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 2017

(unaudited)

 

NOTE 7. PORTFOLIO LOANS (continued)

 

The TDR balances included performing TDRs of $15.9 million and $20.3 million as of September 30, 2017 and December 31, 2016, respectively. There were no commitments to lend additional amounts on TDRs as of September

30, 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 nine months ended September 30, 2017 and 2016:

 

		Number of Contracts				Pre-Modification Outstanding Recorded Investments				Post-Modification Outstanding Recorded Investments
		(Dollars in Thousands)
September 30, 2017
Troubled debt restructuring:
Real estate loans:
One- to four-family			9			$	1,377			$	1,377
Commercial			1				665				665
Land			2				194				194
Total real estate loans			12				2,236				2,236
Other portfolio loans:
Home equity			8				545				545
Consumer			11				274				274
Commercial			2				294				294
Total other portfolio loans			21				1,113				1,113
Total troubled debt restructurings			33			$	3,349			$	3,349
September 30, 2016
Troubled debt restructuring:
Real estate loans:
One- to four-family			23				3,513				3,307
Land			2				99				99
Total real estate loans			25				3,612				3,406
Other portfolio loans:
Home equity			16				1,157				1,157
Consumer			9				235				235
Total other portfolio loans			25				1,392				1,392
Total troubled debt restructurings			50			$	5,004			$	4,798

 

All of the Company’s portfolio loans that were restructured as TDRs during the nine months ended September 30, 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.

 

During the nine months ended September 30, 2017, there was one subsequent default on portfolio loans that were restructured as TDRs in the previous twelve months. The subsequent default was a home equity loan with a recorded investment of $8,000.

 

During the nine months ended September 30, 2016, there were two subsequent defaults on portfolio loans that were restructured as TDRs in the previous twelve months. The subsequent defaults included one commercial real estate loan with a recorded investment of $2.0 million, and one land loan with a recorded investment of $5.5 million.

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 2017

(unaudited)

 

NOTE 7. PORTFOLIO LOANS (continued)

 

The following table presents information about impaired portfolio loans as of September 30, 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			-				-				-
Commercial			542				542				-
Land			5,510				5,510				-
Total real estate loans			6,052				6,052				-
Real estate construction loans:
One- to four-family			-				-				-
Commercial			-				-				-
Acquisition and development			-				-				-
Total real estate construction loans			-				-				-
Other portfolio loans:
Home equity			-				-				-
Consumer			-				-				-
Commercial			40				40				-
Total other portfolio loans			40				40				-
Total with no related allowance recorded		$	6,092			$	6,092			$	-
With an allowance recorded:
Real estate loans:
One- to four-family		$	18,690			$	19,056			$	1,441
Multi-family			-				-				-
Commercial			2,816				2,816				190
Land			770				820				111
Total real estate loans			22,276				22,692				1,742
Real estate construction loans:
One- to four-family			-				-				-
Commercial			-				-				-
Acquisition and development			-				-				-
Total real estate construction loans			-				-				-
Other portfolio loans:
Home equity			4,208				4,396				512
Consumer			1,457				1,457				176
Commercial			902				902				443
Total other portfolio loans			6,567				6,755				1,131
Total with an allowance recorded		$	28,843			$	29,447			$	2,873

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 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

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 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 September 30, 2017 and 2016:

 

		Average Balance				Interest Income Recognized				Cash Basis Interest Income Recognized
		(Dollars in Thousands)
September 30, 2017
Real estate loans:
One- to four-family		$	18,674			$	206			$	-
Multi-family			-				-				-
Commercial			3,375				19				-
Land			6,285				9				-
Total real estate loans			28,334				234				-
Real estate construction loans:
One- to four-family			-				-				-
Commercial			-				-				-
Acquisition and development			-				-				-
Total real estate construction loans			-				-				-
Other portfolio loans:
Home equity			4,259				49				-
Consumer			1,457				33				-
Commercial			957				7				-
Total other portfolio loans			6,673				89				-
Total		$	35,007			$	323			$	-
September 30, 2016
Real estate loans:
One- to four-family		$	21,084			$	230			$	-
Multi-family			57				-				-
Commercial			2,668				38				-
Land			6,327				10				-
Total real estate loans			30,136				278				-
Real estate construction loans:
One- to four-family			-				-				-
Commercial			-				-				-
Acquisition and development			-				-				-
Total real estate construction loans			-				-				-
Other portfolio loans:
Home equity			4,896				57				-
Consumer			1,870				29				-
Commercial			785				3				-
Total other portfolio loans			7,551				89				-
Total		$	37,687			$	367			$	-

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 2017

(unaudited)

 

NOTE 7. PORTFOLIO LOANS (continued)

 

The following table presents interest income on impaired portfolio loans by class of portfolio loans for the nine months ended September 30, 2017 and 2016:

 

		Average Balance				Interest Income Recognized				Cash Basis Interest Income Recognized
		(Dollars in Thousands)
September 30, 2017
Real estate loans:
One- to four-family		$	20,013			$	593			$	-
Multi-family			17				-				-
Commercial			3,061				67				32
Land			6,296				28				-
Total real estate loans			29,387				688				32
Real estate construction loans:
One- to four-family			-				-				-
Commercial			-				-				-
Acquisition and development			-				-				-
Total real estate construction loans			-				-				-
Other portfolio loans:
Home equity			4,220				148				-
Consumer			1,593				78				-
Commercial			922				24				-
Total other portfolio loans			6,735				250				-
Total		$	36,122			$	938			$	32
September 30, 2016
Real estate loans:
One- to four-family		$	21,424			$	698			$	-
Multi-family			77				2				-
Commercial			2,698				83				-
Land			6,699				76				-
Total real estate loans			30,898				859				-
Real estate construction loans:
One- to four-family			-				-				-
Commercial			-				-				-
Acquisition and development			-				-				-
Total real estate construction loans			-				-				-
Other portfolio loans:
Home equity			4,837				172				-
Consumer			1,833				81				-
Commercial			671				12				-
Total other portfolio loans			7,341				265				-
Total		$	38,239			$	1,124			$	-

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 2017

(unaudited)

 

NOTE 7. PORTFOLIO LOANS (continued)

 

The Company had $0.6 million and $1.6 million of one- to four-family residential and home equity loans in process of foreclosure as of September 30, 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 September 30, 2017 and December 31, 2016, respectively. The activity on these loans during the nine months ended September 30, 2017 and the year ended December 31, 2016, was as follows:

 

		September 30, 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			(44	)			(63	)
Ending balance		$	1,812			$	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 $10.6 million and $32.6 million of mortgage loans held-for-sale during the three and nine months ended September 30, 2017, respectively. The Company internally originated approximately $25.0 million and $61.0 million of mortgage loans held-for-sale during the three and nine months ended September 30, 2016, respectively. The gain recorded on sale of mortgage loans held-for-sale during the three and nine months ended September 30, 2017 was $0.2 million and $1.3 million, respectively. The gain recorded on sale of mortgage loans held-for-sale during the three and nine months ended September 30, 2016 was $0.3 million and $0.8 million, respectively.

 

During the three and nine months ended September 30, 2017, the Company internally originated approximately $0.9 million and $9.3 million, respectively, of SBA/USDA loans held-for-sale. During the three months ended September 30, 2016, the Company did not internally originate a material amount of SBA/USDA loans held-for-sale, while the Company internally originated approximately $4.7 million of SBA/USDA loans held-for-sale during the nine months ended September 30, 2016. The Company did not record a material gain on sales of SBA/USDA loans held-for-sale during the three months ended September 30, 2017, while the gain recorded on sales of SBA/USDA loans held-for-sale was $772,000 during the nine months ended September 30, 2017. The Company did not record a material gain on sales of SBA/USDA loans held-for-sale during the three months ended September 30, 2016, while the gain recorded on sales of SBA/USDA loans held-for-sale was $786,000 during the nine months ended September 30, 2016.

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 2017

(unaudited)

 

NOTE 8. OTHER LOANS (continued)

 

During the three and nine months ended September 30, 2017, the Company originated approximately $214.6 million and $771.8 million, respectively, of warehouse loans held-for-investment through third parties. During the three and nine months ended September 30, 2016, the Company originated approximately $530.2 million and $1,210.8 million, respectively, of warehouse loans held-for-investment through third parties. Loans which were ultimately sold under the warehouse loans held-for-investment lending program, which are done at par, earned interest on outstanding balances of $0.4 million and $1.3 million for the three and nine months ended September 30, 2017, respectively. Such loans also earned interest on outstanding balances of $0.8 million and $1.8 million for the three and nine months ended September 30, 2016, respectively. The weighted average number of days outstanding of warehouse loans held-for-investment was approximately 10 days for each of the three and nine months ended September 30, 2017, respectively, and 12 days and 13 days for the three and nine months ended September 30, 2016, respectively.

 

As of September 30, 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 September 30, 2017 and December 31, 2016, advances from the FHLB were as follows:

 

		September 30, 2017				December 31, 2016
		(Dollars in Thousands)
Maturity on January 30, 2017, fixed rate at 0.61%		$	-			$	50,000
Maturity on June 20, 2017, fixed rate 0.73%			-				833
Maturity on June 20, 2017, fixed rate 0.91%			-				10,000
Maturity on October 16, 2017, fixed rate at 1.16%			8,000				-
Maturity on June 19, 2018, fixed rate at 1.31%			10,425				10,425
Maturity on June 20, 2019, fixed rate at 1.27%			1,750				2,500
Maturity on May 18, 2020, fixed rate at 1.56%			36,667				-
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 1.32% as of September 30, 2017 and at 0.80% as of December 31, 2016			44,000				65,000
Total		$	150,842			$	188,758

 

The FHLB advances had a weighted-average maturity of 23 months and a weighted-average rate of 1.79% at September 30, 2017. The value of portfolio loans posted by the Company as collateral for these advances was $375.3 million as of September 30, 2017.

 

The Bank’s remaining borrowing capacity with the FHLB was $123.2 million at September 30, 2017. The FHLB requires that the Bank collateralize the excess of the fair value of the FHLB advances over the book value with portfolio loans 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 September 30, 2017, fair value exceeded the book value of the individual advances by $0.8 million, which was collateralized by portfolio loans (included in the $375.3 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 $34.7 million as of September 30, 2017.

 

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 2017

(unaudited)

 

NOTE 10. INCOME TAXES

 

Income tax expense for the nine months ending September 30, 2017 and 2016 was as follows:

 

		Nine months ending September 30,
		2017				2016
		(Dollars in Thousands)
Income before income tax expense		$	5,842			$	7,020
Effective tax rate			35.23	%			37.09	%
Income tax expense		$	2,058			$	2,604

 

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 September 30, 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 September 30, 2017.

 

During the nine months ended September 30, 2017, the Company used $244,000 of federal net operating loss carryover and $207,000 of state net operating loss carryovers. During the nine months ended September 30, 2016, the Company used $4.2 million of federal net operating loss carryover and $2.6 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 third 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 federal 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. For federal purposes, only pre-change net operating loss carryforward remains. For state purposes, post-change, non-limited net operating loss carryforward remains. During the nine months ended September 30, 2017, $319,000 of state net operating losses were generated.

 

As of September 30, 2017, the Company has a federal net operating loss carryover of $5.1 million which will expire between 2027 and 2033. There is no valuation allowance on this carryover. As of September 30, 2017, the Company has a state net operating loss carryover of $6.0 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.

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 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 and nine months ended September 30, 2017 and 2016:

 

		Three months ending September 30,								Nine months ending September 30,
		2017				2016				2017				2016
		(Dollars in Thousands, Except Per Share Information)
Basic:
Net income		$	1,115			$	1,556			$	3,784			$	4,416
Weighted average common shares outstanding			15,553,709				15,508,969				15,546,301				15,508,969
Less: average unallocated employee stock ownership plan shares			(67,067	)			(71,857	)			(67,067	)			(71,857	)
Less: average director’s deferred compensation shares			(12,385	)			(17,054	)			(18,048	)			(19,622	)
Less: average unvested restricted stock awards			(44,648	)			-				(37,288	)			-
Weighted average common shares outstanding, as adjusted			15,429,609				15,420,058				15,423,898				15,417,490
Basic earnings per common share		$	0.07			$	0.10			$	0.25			$	0.29
Diluted:
Net income		$	1,115			$	1,556			$	3,784			$	4,416
Weighted average common shares outstanding, as adjusted (from above)			15,429,609				15,420,058				15,423,898				15,417,490
Add: dilutive effects of assumed exercise of stock options and stock awards			-				-				-				-
Weighted average dilutive shares outstanding			15,429,609				15,420,058				15,423,898				15,417,490
Diluted earnings per common share		$	0.07			$	0.10			$	0.25			$	0.29

 

During the three and nine months ended September 30, 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 nine months ended September 30, 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 September 30, 2017			44,648				7.78

 

There was approximately $294,000 of unrecognized compensation expense related to non-vested shares awarded under the 2016 Incentive Plan at September 30, 2017. The expense is expected to be recognized over a weighted-average period of 3.8 years.

 

 

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

September 30, 2017

(unaudited)

 

NOTE 13. REGULATORY SUPERVISION

 

The Bank’s actual and required capital levels and ratios as of September 30, 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)
September 30, 2017
Total capital (to risk weighted assets)		$	97,408				12.99	%		$	75,004				10.00	%
Common equity tier 1 capital (to risk weighted assets)			89,003				11.87	%			48,752				6.50	%
Tier 1 capital (to risk weighted assets)			89,003				11.87	%			60,003				8.00	%
Tier 1 capital (to adjusted total assets)			89,003				10.03	%			44,372				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 September 30, 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 Bank 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. The Bank’s actual capital conservation buffer was 4.99% as of September 30, 2017.

 

 

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.

 

 

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 has not affected, and 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 nine 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.

 

 

Comparison of Financial Condition at September 30, 2017 and December 31, 2016

 

General

 

Total assets increased $14.4 million, or 1.6%, to $921.9 million at September 30, 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 $63.6 million, and stockholders’ equity of $4.4 million, as discussed below, partially offset by a reduction of $37.9 million in Federal Home Loan Bank (FHLB) advances and a decrease in time deposits of $15.6 million. Net portfolio loans increased $106.0 million, while cash and cash equivalents decreased $17.7 million, investment securities decreased $26.2 million and other loans decreased $42.4 million. Total deposits increased $48.0 million, or 7.6%, to $676.4 million at September 30, 2017, from $628.4 million at December 31, 2016. Noninterest-bearing demand accounts increased $10.3 million and savings and money market accounts increased $69.8 million, while interest-bearing demand accounts decreased by $16.5 million and time deposits decreased by $15.6 million during the nine months ended September 30, 2017. Total borrowings decreased by $37.9 million to $150.8 million at September 30, 2017, from $188.7 million at December 31, 2016, due to the aforementioned decrease in FHLB advances during the first nine months of 2017, as the Company continues to focus on core deposit growth. Stockholders’ equity increased by $4.4 million to $91.4 million at September 30, 2017, from $87.0 million at December 31, 2016, primarily due to net income of $3.8 million and other comprehensive income of $0.5 million for the nine months ended September 30, 2017.

 

Following are the summarized comparative balance sheets as of September 30, 2017 and December 31, 2016:

 

		September 30,				December 31,				Increase / (Decrease)
		2017				2016				Amount				%
		(Dollars in Thousands)
Assets:
Cash and cash equivalents		$	42,234			$	59,893			$	(17,659	)			(29.5	)%
Investment securities			39,113				65,293				(26,180	)			(40.1	)%
Portfolio loans			753,665				647,407				106,258				16.4	%
Allowance for portfolio loan losses			8,405				8,162				243				3.0	%
Portfolio loans, net			745,260				639,245				106,015				16.6	%
Other loans (held-for-sale and warehouse loans held-for-investment)			45,287				87,724				(42,437	)			(29.7	)%
Other assets			50,041				55,304				(5,263	)			(50.0	)%
Total assets		$	921,935			$	907,459			$	14,476				1.6	%
Liabilities and stockholders’ equity:
Deposits:
Noninterest-bearing demand		$	70,029			$	59,696			$	10,333				17.3	%
Interest-bearing demand			89,503				106,004				(16,501	)			(15.6	)%
Savings and money market			294,804				224,987				69,817				31.0	%
Time			222,080				237,726				(15,646	)			(6.6	)%
Total deposits			676,416				628,413				48,003				7.6	%
Federal Home Loan Bank advances			150,842				188,758				(37,916	)			(20.1	)%
Accrued expenses and other liabilities			3,283				3,270				13				0.4	%
Total liabilities			830,541				820,441				10,100				1.2	%
Total stockholders’ equity			91,394				87,018				4,376				5.0	%
Total liabilities and stockholders’ equity		$	921,935			$	907,459			$	14,476				1.6	%

 

Cash and Cash Equivalents

 

Cash and cash equivalents decreased $17.7 million to $42.2 million at September 30, 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.

 

 

Investment Securities

 

Investment securities are comprised primarily of debt securities of U.S. government-sponsored enterprises and mortgage-backed securities. The investment portfolio decreased $26.2 million to $39.1 million at September 30, 2017, from $65.3 million at December 31, 2016, primarily due to the maturity of $75.0 million of short-term U.S. Treasury Bills and the sale of $5.0 million of corporate debt during the first nine months of 2017, partially offset by the purchase of $57.0 million of short-term U.S. Treasury Bills during the first nine months of 2017.

 

All of the $39.1 million and $65.3 million as of September 30, 2017 and December 31, 2016, respectively, of investment securities were classified as available-for-sale.

 

As of September 30, 2017, $27.2 million, or 69.7%, 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 September 30, 2017, no investment securities were pledged as collateral for the FHLB advances or any other borrowings. As of September 30, 2017, $3.5 million of investment securities were pledged as collateral for public fund deposits.

 

Portfolio Loans

 

Below is a comparative composition of net portfolio loans as of September 30, 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):

 

		September 30, 2017				% of Total Portfolio Loans				December 31, 2016				% of Total Portfolio Loans
		(Dollars in Thousands)
Real estate loans:
One- to four-family		$	285,039				38.2	%		$	276,193				43.1	%
Multi-family			82,360				11.0	%			70,452				11.0	%
Commercial			213,980				28.6	%			104,143				16.3	%
Land			14,623				2.0	%			17,218				2.7	%
Total real estate loans			596,002				79.8	%			468,006				73.1	%
Real estate construction loans:
One- to four-family			10,751				1.4	%			22,687				3.5	%
Commercial			11,763				1.6	%			14,432				2.3	%
Acquisition and development			-				-	%			-				-	%
Total real estate construction loans			22,514				3.0	%			37,119				5.8	%
Other portfolio loans:
Home equity			35,038				4.7	%			37,748				5.9	%
Consumer			35,825				4.8	%			39,232				6.1	%
Commercial			57,729				7.7	%			57,947				9.1	%
Total other portfolio loans			128,592				17.2	%			134,927				21.1	%
Total portfolio loans			747,108				100.0	%			640,052				100.0	%
Allowance for portfolio loan losses			(8,405	)							(8,162	)
Net deferred portfolio loan costs			5,575								5,685
Premiums and discounts on purchased loans, net			982								1,670
Portfolio loans, net		$	745,260							$	639,245

 

 

Total portfolio loans increased $107.0 million, or 16.7%, to $747.1 million at September 30, 2017, as compared to $640.1 million at December 31, 2016, primarily due to originations of $96.3 million of commercial real estate loans and $20.3 million of multi-family loans, as well as the purchase of $18.3 million of portfolio loans, partially offset by principal amortization and increased prepayments of one- to four-family residential mortgages and home equity loans during the nine months ended September 30, 2017. The increase in prepayments on one- to four-family residential mortgages is consistent with the current low interest rate environment.

 

Total portfolio loan growth was also partially offset by gross loan charge-offs of $0.7 million during the first nine months of 2017; however, the Company did not have any loans transfer to OREO during the first nine months 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 $18.2 million and $10.7 million at September 30, 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 significantly comprised of one- to four-family residential mortgage loans. As of September 30, 2017, first mortgages (including residential construction loans) and home equity loans totaled $330.8 million, or 44.3% of total portfolio loans. Approximately $22.2 million, or 63.4%, of loans recorded as home equity loans and $318.0 million, or 96.1%, of loans collateralized by one- to four-family residential properties were in a first lien position as of September 30, 2017.

 

The composition of first mortgages and home equity loans by state as of September 30, 2017 was as follows:

 

		Florida				Georgia				Other States				Total
		(Dollars in Thousands)
One- to four-family residential mortgages		$	214,731			$	47,423			$	22,885			$	285,039
Home equity and lines of credit			18,763				15,578				697				35,038
One- to four-family construction loans			10,620				131				-				10,751
		$	244,114			$	63,132			$	23,582			$	330,828

 

 

Allowance for Portfolio Loan Losses

 

The allowance was $8.4 million, or 1.1% of total portfolio loans, at September 30, 2017, compared to $8.2 million, or 1.3% of total portfolio loans, at December 31, 2016.

 

The activity in the allowance for the nine months ended September 30, 2017 and 2016 was as follows:

 

		September 30, 2017				September 30, 2016
		(Dollars in Thousands)
Balance at beginning of year		$	8,162			$	7,745
Charge-offs:
Real estate loans:
One- to four-family			(82	)			(185	)
Multi-family			-				-
Commercial			-				(74	)
Land			-				-
Real estate construction loans:
One- to four-family			-				-
Commercial			-				-
Acquisition and development			-				-
Other portfolio loans:
Home equity			(167	)			(136	)
Consumer			(328	)			(434	)
Commercial			(119	)			(12	)
Total charge-offs			(696	)			(841	)
Recoveries:
Real estate loans:
One- to four-family			234				421
Multi-family			-				-
Commercial			-				-
Land			5				32
Real estate construction loans:
One- to four-family			-				-
Commercial			-				-
Acquisition and development			-				-
Other portfolio loans:
Home equity			31				17
Consumer			199				207
Commercial			12				-
Total recoveries			481				677
Net charge-offs			(215	)			(164	)
Provision for portfolio loan losses			458				569
Balance at end of period		$	8,405			$	8,150
Net charge-offs to average outstanding portfolio loans			0.04	%			0.04	%

 

The increase in net charge-offs during the nine months ended September 30, 2017 compared to the same period in 2016, were primarily the result of decreased recoveries related to one- to four-family residential mortgage loans, as well as the charge-off of one commercial loan.

 

 

Below is a comparative composition of nonperforming assets as of September 30, 2017 and December 31, 2016:

 

		September 30, 2017				December 31, 2016
		(Dollars in Thousands)
Nonperforming assets:
Real estate loans:
One- to four-family		$	917			$	1,533
Multi-family			-				-
Commercial			2,227				2,276
Land			5,510				5,548
Real estate construction loans:
One- to four-family			-				-
Commercial			-				-
Acquisition and development			-				-
Other portfolio loans:
Home equity			134				58
Consumer			115				237
Commercial			631				502
Total nonperforming loans			9,534				10,154
Other real estate owned			188				2,886
Total nonperforming assets		$	9,722			$	13,040
Nonperforming loans to total portfolio loans			1.3	%			1.6	%
Nonperforming assets to total assets			1.1	%			1.4	%

 

Nonperforming loans were $9.5 million, or 1.3% of total portfolio loans, at September 30, 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 nine 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 September 30, 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 $0.2 million at September 30, 2017, down $2.7 million from $2.9 million at December 31, 2016, as the Company disposed of a $2.6 million foreclosed property, which resulted in a $0.2 million loss, and had write-downs of OREO of $0.1 million.

 

 

Impaired Loans

 

The following table shows impaired loans segregated by performing and nonperforming status and the associated allowance as of September 30, 2017 and December 31, 2016:

 

		September 30, 2017								December 31, 2016
		Balance				Allowance				Balance				Allowance
		(Dollars in Thousands)
Performing		$	-			$	-			$	611			$	218
Nonperforming (1)			9,534				626				10,154				260
Troubled debt restructuring by category:
Performing troubled debt restructurings – commercial			1,442				7				308				2
Performing troubled debt restructurings – residential			23,959				2,240				26,229				2,231
Total impaired loans		$	34,935			$	2,873			$	37,302			$	2,711

 

(1)

Balances include nonperforming TDRs of $7.5 million as of September 30, 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 September 30, 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 $33.0 million as of September 30, 2017, 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 September 30, 2017, approximately $15.9 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 September 30, 2017 and December 31, 2016:

 

		September 30, 2017				December 31, 2016
		(Dollars in Thousands)
Other loans:
Held-for-sale		$	5,025			$	7,147
Warehouse loans held-for-investment			40,262				80,577
Total other loans		$	45,287			$	87,724

 

Other loans decreased $42.4 million, or 29.7%, to $45.3 million at September 30, 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. The Company’s overall balance sheet strategy continues to emphasize originating certain loans, such as mortgages, to be sold, rather than to be held in our portfolio.

 

 

The Company internally originated $32.6 million and sold $43.8 million of mortgage loans held-for-sale during the nine months ended September 30, 2017. The Company internally originated $61.0 million and sold $53.5 million of mortgage loans held-for-sale during the nine months ended September 30, 2016. The gain recorded on sales of mortgage loans held-for-sale during the first nine months of 2017 and 2016 was $1.3 million (including a gain on the sale of a group of TDRs that were transferred into held-for-sale during 2016) and $0.8 million, respectively. During the nine months ended September 30, 2017, the Company internally originated $9.3 million and sold $8.4 million of SBA/USDA loans held-for-sale, compared to originations of $4.7 million and sold of $7.1 million during the nine months ended September 30, 2016. The gain recorded on sales and servicing of SBA/USDA loans held-for-sale during both the first nine months of 2017 and 2016 was $0.8 million. 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 $771.8 million and $812.1 million, respectively, for the nine months ended September 30, 2017, as compared to originations and sales of $1,210.8 million and $1,135.3 million, respectively, for the nine months ended September 30, 2016. Loan sales under the warehouse loans held-for-investment lending program, which are done at par, earned interest on outstanding balances of $1.3 million and $1.8 million for the nine months ended September 30, 2017 and 2016, respectively. For the nine months ended September 30, 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 nine months 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 September 30, 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 September 30, 2017 and December 31, 2016.

 

The future realization of the Company’s federal net operating loss carryovers is currently limited to $325,000 per year. The Company expects to fully utilize $325,000 of federal net operating loss carryovers in 2017.

 

Deposits

 

Total deposits were $676.4 million at September 30, 2017, an increase of $48.0 million from $628.4 million at December 31, 2016. The increase was comprised of an increase of $63.6 million in non-maturing deposits, partially offset by a decrease of $15.6 million in time deposits.

 

Non-maturing deposits increased to $454.3 million at September 30, 2017, due to an $10.3 million increase in noninterest-bearing demand deposits and a $69.8 million increase in savings and money market deposits, partially offset by a $16.5 million decrease in interest-bearing demand 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 decreased to $222.1 million as of September 30, 2017, due to a decrease of $25.4 million in brokered deposits, a decrease of $4.4 million in non-brokered Internet certificates of deposit and a decrease of $3.3 million in our standard certificates of deposit, partially offset by an increase of $17.5 million in deposits related to a retail certificates of deposit promotion.

 

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.

 

 

Federal Home Loan Bank Advances

 

As of September 30, 2017 and December 31, 2016, advances from the FHLB were as follows:

 

		September 30, 2017				December 31, 2016
		(Dollars in Thousands)
Maturity on January 30, 2017, fixed rate at 0.61%		$	-			$	50,000
Maturity on June 20, 2017, fixed rate 0.73%			-				833
Maturity on June 20, 2017, fixed rate 0.91%			-				10,000
Maturity on October 16, 2017, fixed rate at 1.16%			8,000				-
Maturity on June 19, 2018, fixed rate at 1.31%			10,425				10,425
Maturity on June 20, 2019, fixed rate at 1.27%			1,750				2,500
Maturity on May 18, 2020, fixed rate at 1.56%			36,667				-
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 1.32% as of September 30, 2017 and at 0.80% as of December 31, 2016			44,000				65,000
Total		$	150,842			$	188,758

 

The FHLB advances had a weighted-average maturity of 23 months and a weighted-average rate of 1.79% at September 30, 2017. The value of portfolio loans posted by the Company as collateral for these advances was $375.3 million as of September 30, 2017.

 

The Bank’s remaining borrowing capacity with the FHLB was $123.2 million at September 30, 2017. The FHLB requires that the Bank collateralize the excess of the fair value of the FHLB advances over the book value with portfolio loans 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 September 30, 2017, fair value exceeded the book value of the individual advances by $0.8 million, which was collateralized by portfolio loans (included in the $375.3 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 $34.7 million as of September 30, 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 $4.4 million to $91.4 million at September 30, 2017, from $87.0 million at December 31, 2016, primarily due to net income of $3.8 million and other comprehensive income of $0.5 million for the nine months ended September 30, 2017. The other comprehensive income during the first nine months of 2017, which reduced the Company’s accumulated other comprehensive loss as of September 30, 2017, was primarily due to a positive change in the fair value of investment securities as interest rates affecting the fair value of such investments decreased during the first nine months of 2017.

 

 

The Company’s equity to assets ratio increased to 9.9% at September 30, 2017, compared with 9.6% at December 31, 2016. As of September 30, 2017, the Bank’s total risk based capital to risk-weighted assets ratio was 12.99%, common equity tier 1 capital to risk-weighted assets ratio was 11.87%, tier 1 capital to risk-weighted assets ratio was 11.87% and tier 1 capital to adjusted assets ratio was 10.03%. 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 September 30, 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 and investment securities, as well as an increase in the risk weighting of certain portfolio loan categories, partially offset by an increase in capital. The Bank’s capital classification under PCA defined levels as of September 30, 2017 was well-capitalized.

 

The Company continues to monitor strategies to preserve capital to support our expected growth, 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 September 30, 2017 and 2016

 

General

 

Net income for the three months ended September 30, 2017 and 2016 was $1.1 million and $1.5 million, respectively. The Company’s annualized return on average total assets ratio and return on average stockholders’ equity ratio were 0.50% and 4.89%, respectively, for the three months ended September 30, 2017, compared with 0.68% and 7.19%, respectively, for the three months ended September 30, 2016. Net income for the three months ended September 30, 2017, decreased $0.4 million as compared to net income in the same period in 2016, primarily due to a decrease in noninterest income of $1.0 million and a decrease in net interest income of $0.1 million, partially offset by a decrease in income tax expense of $0.4 million, a decrease in noninterest expense of $0.2 million, and a decrease in provision expense of $0.1 million.

 

Net interest income decreased during the three months ended September 30, 2017, as compared to the three months ended September 30, 2016, primarily due to increased interest expense on deposits, the impact of lower balances in investment securities and interest rates on those investment securities, partially offset by increased portfolio loans and other loans outstanding, higher interest rates on those loans, and decreased interest expense for FHLB advances. Noninterest income decreased during the three months ended September 30, 2017, as compared to the three months ended September 30, 2016, primarily due to lower gains on the sale of investment securities and reduced service charges and fees, as well as a decrease in miscellaneous operating income related to an escrow account that was forfeited during the three months ended September 30, 2016, in connection with an OREO sale. Noninterest expense decreased during the three months ended September 30, 2017, as compared to the three months ended September 30, 2016, primarily due to the positive impact of an adjustment to the rate of accrual for FDIC insurance premiums.

 

 

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

 

The following table sets forth certain information for the three months ended September 30, 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 September 30,
		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)		$	776,391			$	8,364				4.31	%		$	750,222			$	7,961				4.24	%
Investment securities (2)			40,119				206				2.05	%			70,175				372				2.12	%
Other interest-earning assets (3)			33,764				141				1.68	%			40,383				149				1.47	%
Total interest-earning assets			850,274				8,711				4.10	%			860,780				8,482				3.94	%
Noninterest-earning assets			38,967												48,523
Total assets		$	889,241											$	909,303
Interest-bearing liabilities:
Interest-bearing demand accounts		$	101,132			$	102				0.40	%		$	102,012			$	113				0.45	%
Savings deposits			59,351				18				0.12	%			59,028				17				0.11	%
Money market accounts			229,403				553				0.96	%			142,374				243				0.68	%
Time deposits			217,108				690				1.27	%			239,524				589				0.98	%
Federal Home Loan Bank advances			117,812				595				2.02	%			217,941				658				1.21	%
Total interest-bearing liabilities			724,806				1,958				1.08	%			760,879				1,620				0.85	%
Noninterest-bearing liabilities			73,208												61,875
Total liabilities			798,014												822,754
Total stockholders’ equity			91,227												86,549
Total liabilities and stockholders’ equity		$	889,241											$	909,303
Net interest income						$	6,753											$	6,862
Net interest spread											3.02	%											3.09	%
Net interest-earning assets		$	125,468											$	99,901
Net interest margin (4)											3.18	%											3.19	%
Average interest-earning assets to average interest-bearing liabilities							117.31	%											113.13	%

 

(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)

Net interest income divided by average interest-earning assets.

 

 

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 September 30, 2017, as compared to the three months ended September 30, 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)		$	281			$	122			$	403
Investment securities			(155	)			(11	)			(166	)
Other interest-earning assets			(26	)			18				(8	)
Total interest-earning assets			100				129				229
Interest-bearing liabilities:
Interest-bearing demand accounts			(1	)			(10	)			(11	)
Savings deposits			-				1				1
Money market accounts			185				125				310
Time deposits			(59	)			160				101
Securities sold under agreements to repurchase			-				-				-
Federal Home Loan Bank advances			(384	)			321				(63	)
Other borrowings			-				-				-
Total interest-bearing liabilities			(259	)			597				338
Net interest income		$	359			$	(468	)		$	(109	)

 

(1)

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

 

Deposit growth and the associated costs, partially offset by loan growth and the decrease in wholesale borrowings, have been the primary contributors to the decrease in net interest income in the third quarter of 2017. Increased deposit costs, partially offset by increased loan yields and 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 increased $0.2 million to $8.7 million for the three months ended September 30, 2017, as compared to $8.5 million for the three months ended September 30, 2016, due to higher balances in portfolio loans and the increase in loan yields on portfolio loans, partially offset by lower balances in investment securities and lower interest rates on investment securities. Interest income on loans increased to $8.4 million for the three months ended September 30, 2017 from $8.0 million for the three months ended September 30, 2016. This increase was due to an increase in the average balance of loans, which increased $26.2 million to $776.4 million for the three months ended September 30, 2017 from $750.2 million for the three months ended September 30, 2016, and an increase in average yield on loans of 7 basis points to 4.31% for the three months ended September 30, 2017. This increase in average yield on loans is due to rising interest rates, partially offset by 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.

 

Interest income earned on investment securities decreased $0.2 million to $0.2 million for the three months ended September 30, 2017 from $0.4 million for the three months ended September 30, 2016. This decrease was due to a decrease in the average balance of investment securities of $30.1 million to $40.1 million during the three months ended September 30, 2017, as well as lower interest rates on investment securities during the same period.

 

 

Interest Expense

 

Interest expense increased by $0.3 million to $1.9 million for three months ended September 30, 2017 from $1.6 million for the three months ended September 30, 2016, due to increased interest expenses on deposits, partially offset by a decrease in interest expense on FHLB advances. The increase in interest expense on deposits in the third quarter of 2017, as compared to the third 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 16 basis points to 0.80% for the three months ended September 30, 2017, as compared to 0.64% for the three months ended September 30, 2016. The decrease in interest expense on FHLB advances for the three months ended September 30, 2017, as compared to the three months ended September 30, 2016, was due to a decrease in the average balance of FHLB advances, resulting from the Bank’s aggressive strategies to increase funding from core deposits, partially offset by an increase in average rates paid on such advances.

 

The Bank’s overall cost of funds, including noninterest-bearing deposits, was 0.98% for the three months ended September 30, 2017, up from 0.79% for the three months ended September 30, 2016, primarily due to an increase in the average rates paid on interest-bearing deposits and the average balance in such deposits, as well as higher interest rates related to FHLB advances, partially offset by the lower average balances related to FHLB advances and increased noninterest-bearing deposits.

 

Net Interest Income

 

Net interest income decreased $0.1 million to $6.8 million for the three months ended September 30, 2017, from $6.9 million for the three months ended September 30, 2016, due to an increase in interest expense on deposits and the impact of lower balances in investment securities and interest rates on investment securities, partially offset by the increase in portfolio loans, higher interest rates on portfolio loans, and decreased interest expense for FHLB advances.

 

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, decreased 7 basis points to 3.02% for the three months ended September 30, 2017, as compared to 3.09% for the three months ended September 30, 2016. Our net interest margin, which is net interest income expressed as a percentage of our average interest-earning assets, decreased 1 basis point to 3.18% for the three months ended September 30, 2017, as compared to 3.19% for the three months ended September 30, 2016. The decrease in the net interest rate spread and net interest margin primarily reflected the negative impact on interest income from lower balances in investment securities and lower interest rates on 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, partially offset by the positive impact on interest income from increasing balances in portfolio loans and other loans and higher interest rates on portfolio loans, and the positive impact on interest expense from declining high fixed-interest rate debt balances.

 

Provision for Portfolio Loan Losses

 

Provision expense was $0.2 million during each of the three months ended September 30, 2017 and 2016. The low level of provision expense during each of the three months ended September 30, 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 net recoveries during the three months ended September 30, 2017, representing 0.01% of average portfolio loans, while net charge-offs were $0.1 million for the three months ended September 30, 2016, representing 0.06% of average portfolio loans.

 

 

Noninterest Income

 

The components of noninterest income for the three months ended September 30, 2017 and 2016 were as follows:

 

										Increase / (Decrease)
		2017				2016				Amount				Percentage
		(Dollars in Thousands)
Service charges and fees		$	452			$	592			$	(140	)			(23.6	)%
Gain on sale of securities available-for-sale			9				493				(484	)			(98.2	)%
Gain on sale of portfolio loans			-				9				(9	)			(100.0	)%
Gain on sale of loans held-for-sale			186				235				(49	)			(20.9	)%
Bank owned life insurance earnings			117				117				-				-	%
Interchange fees			315				326				(11	)			(3.4	)%
Other			156				425				(269	)			(63.3	)%
		$	1,235			$	2,197			$	(962	)			(43.8	)%

 

Noninterest income for the three months ended September 30, 2017 decreased $1.0 million to $1.2 million, as compared to $2.2 million for the three months ended September 30, 2016. The decrease in noninterest income during the third quarter of 2017, as compared with the same period in 2016, was primarily due to lower gains on the sale of investment securities and reduced service charges and fees, the latter reflecting an improving economic climate and shifting customer demographics and preferences, as well as a decrease in miscellaneous operating income related to an escrow account that was forfeited in the year-earlier period in connection with an OREO sale (included in Other in the table above).

 

For the three months ended September 30, 2017, gains on sales of mortgage loans held-for-sale were $266,000, deferred fees on mortgage loans held-for-sale were $69,000, gains on sales of SBA/USDA loans held-for-sale were $31,000 and net amortization expense recognized for the servicing of SBA/USDA loans held-for-sale were $43,000. By comparison, for the three months ended September 30, 2016, gains on sales of mortgage loans held-for-sale were $626,000, deferred fees on mortgage loans held-for-sale were $343,000, gains on sales of SBA/USDA loans held-for-sale were $8,000 and net amortization expense recognized for the servicing of SBA/USDA loans held-for-sale were $56,000.

 

The Company expects gains on sales of loans held-for-sale to increasingly contribute 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.

 

Noninterest Expense

 

The components of noninterest expense for the three months ended September 30, 2017 and 2016 were as follows:

 

										Increase / (Decrease)
		2017				2016				Amount				Percentage
		(Dollars in Thousands)
Compensation and benefits		$	3,544			$	3,562			$	(18	)			(0.5	)%
Occupancy and equipment			642				658				(16	)			(2.4	)%
Federal Deposit Insurance Corporation insurance premiums			34				135				(101	)			(74.8	)%
Foreclosed assets, net			(6	)			-				(6	)			n/a
Data processing			581				587				(6	)			(1.0	)%
Outside professional services			458				487				(29	)			(6.0	)%
Collection expense and repossessed asset losses			82				101				(19	)			(18.8	)%
Other			810				836				(26	)			(3.1	)%
		$	6,145			$	6,366			$	(221	)			(3.5	)%

 

 

Noninterest expense decreased $0.2 million to $6.2 million for the three months ended September 30, 2017, from $6.4 million for the three months ended September 30, 2016. The decrease in noninterest expense during the third quarter of 2017, as compared with the same period in 2016, primarily reflected the positive impact of an adjustment to the rate of accrual for FDIC insurance premiums.

 

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 $0.5 million and $0.9 million in income tax expense for the three months ended September 30, 2017 and 2016, respectively. The Company’s effective tax rate was 33.5% and 37.1% for the third quarter of 2017 and 2016, respectively. This decrease was primarily due to decreased pretax earnings during the three months ended September 30, 2017, as compared with the same period in 2016, while permanent differences remained stable. The future realization of the Company’s federal 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.

 

Comparison of Results of Operations for the Nine Months Ended September 30, 2017 and 2016

 

General

 

Net income for the nine months ended September 30, 2017 and 2016 was $3.8 million and $4.4 million, respectively. The Company’s annualized return on average total assets ratio and return on average stockholders’ equity ratio were 0.58% and 5.61%, respectively, for the nine months ended September 30, 2017, compared with 0.66% and 6.98% respectively, for the nine months ended September 30, 2016. Net income for the nine months ended September 30, 2017, decreased $0.6 million as compared to net income in the same period in 2016, primarily due to a decrease in noninterest income of $1.6 million and an increase in noninterest expense of $0.1 million, partially offset by a decrease in income tax expense of $0.5 million, an increase in net interest income of $0.4 million, and a decrease in provision expense of $0.1 million.

 

Net interest income increased during the nine months ended September 30, 2017, as compared to the nine months ended September 30, 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 decreased during the nine months ended September 30, 2017, as compared to the nine months ended September 30, 2016, primarily due to lower gains on the sale of investment securities, lower gains on the sale of portfolio loans, and reduced service charges and fees, as well as a decrease in miscellaneous operating income related to an escrow account that was forfeited during the three months ended September 30, 2016, in connection with an OREO sale, partially offset by higher gains on the sale of loans held-for-sale. Noninterest expense increased during the nine months ended September 30, 2017, as compared to the nine months ended September 30, 2016, primarily due to increased data processing expenses associated with ongoing efforts to improve the Company’s IT infrastructure, partially offset by a decrease in occupancy and equipment expense and the positive impact of an adjustment to the rate of accrual for FDIC insurance premiums.

 

 

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

 

The following table sets forth certain information for the nine months ended September 30, 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.

 

		Nine Months Ended September 30,
		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)		$	744,388			$	23,861				4.27	%		$	716,189			$	23,399				4.36	%
Investment securities (2)			45,251				777				2.29	%			84,521				1,315				2.07	%
Other interest-earning assets (3)			37,433				382				1.36	%			36,264				470				1.73	%
Total interest-earning assets			827,072				25,020				4.03	%			836,974				25,184				4.01	%
Noninterest-earning assets			40,898												50,711
Total assets		$	867,970											$	887,685
Interest-bearing liabilities:
Interest-bearing demand accounts		$	113,967			$	397				0.46	%		$	103,177			$	340				0.44	%
Savings deposits			59,362				53				0.12	%			59,070				46				0.10	%
Money market accounts			202,569				1,339				0.88	%			124,710				585				0.63	%
Time deposits			225,161				1,923				1.14	%			230,046				1,635				0.95	%
Securities sold under agreements to repurchase			-				-				-	%			109				1				1.56	%
Federal Home Loan Bank advances			107,011				1,532				1.91	%			229,147				3,220				1.87	%
Other borrowings (4)			-				-				1.27	%			55				1				1.62	%
Total interest-bearing liabilities			708,070				5,244				0.99	%			746,314				5,828				1.04	%
Noninterest-bearing liabilities			70,004												56,959
Total liabilities			778,074												803,273
Total stockholders’ equity			89,896												84,412
Total liabilities and stockholders’ equity		$	867,970											$	887,685
Net interest income						$	19,776											$	19,356
Net interest spread											3.05	%											2.97	%
Net interest-earning assets		$	119,002											$	90,660
Net interest margin (5)											3.19	%											3.08	%
Average interest-earning assets to average interest-bearing liabilities							116.81	%											112.15	%

 

(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)

Average balance and interest expense on other borrowings during the nine months ended September 30, 2017, was less than $500.

(5)

Net interest income divided by average interest-earning assets.

 

 

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 nine months ended September 30, 2017, as compared to the nine months ended September 30, 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)		$	910			$	(448	)		$	462
Investment securities			(663	)			125				(538	)
Other interest-earning assets			15				(103	)			(88	)
Total interest-earning assets			262				(426	)			(164	)
Interest-bearing liabilities:
Interest-bearing demand accounts			37				20				57
Savings deposits			-				7				7
Money market accounts			456				298				754
Time deposits			(35	)			323				288
Securities sold under agreements to repurchase			(1	)			-				(1	)
Federal Home Loan Bank advances			(1,748	)			60				(1,688	)
Other borrowings			(1	)			-				(1	)
Total interest-bearing liabilities			(1,292	)			708				(584	)
Net interest income		$	1,554			$	(1,134	)		$	420

 

(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 nine months of 2017. Decreased loan yields and increased deposit costs, 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 $0.2 million to $25.0 million for the nine months ended September 30, 2017, as compared to $25.2 million for the nine months ended September 30, 2016, due to the decrease in loan yields on portfolio loans and lower balances in investment securities, partially offset by higher balances in portfolio loans and higher interest rates on investment securities. Interest income on loans increased to $23.9 million for the nine months ended September 30, 2017 from $23.4 million for the nine months ended September 30, 2016. This increase was due to an increase in the average balance of loans, which increased $28.2 million to $744.4 million for the nine months ended September 30, 2017 from $716.2 million for the nine months ended September 30, 2016, offset by a decrease in average yield on loans of 9 basis points to 4.27% for the nine months ended September 30, 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.

 

 

Interest income earned on investment securities decreased $0.5 million to $0.8 million for the nine months ended September 30, 2017 from $1.3 million for the nine months ended September 30, 2016. This decrease was primarily due to a decrease in the average balance of investment securities of $39.3 million to $45.2 million during the nine months ended September 30, 2017, partially offset by higher interest rates on investment securities during the same period.

 

Interest Expense

 

Interest expense declined by $0.6 million to $5.2 million for nine months ended September 30, 2017 from $5.8 million for the nine months ended September 30, 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 nine months of 2017, as compared to the first nine months 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 13 basis points to 0.74% for the nine months ended September 30, 2017, as compared to 0.61% for the nine months ended September 30, 2016. The decrease in interest expense on FHLB advances for the nine months ended September 30, 2017, as compared to the nine months ended September 30, 2016, was due to a decrease in the average balance of FHLB advances, resulting from the Bank’s aggressive strategies to increase funding from core deposits, partially offset by an increase in average rates paid on such advances.

 

The Bank’s overall cost of funds, including noninterest-bearing deposits, was 0.90% for the nine months ended September 30, 2017, down from 0.97% for the nine months ended September 30, 2016, primarily due to the lower average balances related to FHLB advances and increased noninterest-bearing deposits, partially offset by an increase in the average rates paid on interest-bearing deposits and the average balance in such deposits, as well as an increase in interest rates related to FHLB advances.

 

Net Interest Income

 

Net interest income increased $0.4 million to $19.8 million for the nine months ended September 30, 2017, from $19.4 million for the nine months ended September 30, 2016, due to the increase in portfolio loans, 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 8 basis points to 3.05% for the nine months ended September 30, 2017, as compared to 2.97% for the nine months ended September 30, 2016. Our net interest margin, which is net interest income expressed as a percentage of our average interest-earning assets, increased 11 basis point to 3.19% for the nine months ended September 30, 2017, as compared to 3.08% for the nine months ended September 30, 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.

 

Provision for Portfolio Loan Losses

 

Provision expense was $0.5 million and $0.6 million during the nine months ended September 30, 2017 and 2016, respectively. The low level of provision expense during each of the nine months ended September 30, 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 net charge-offs of $0.2 million during each of the nine months ended September 30, 2017 and 2016, representing 0.04% of average portfolio loans.

 

 

Noninterest Income

 

The components of noninterest income for the nine months ended September 30, 2017 and 2016 were as follows:

 

										Increase / (Decrease)
		2017				2016				Amount				Percentage
		(Dollars in Thousands)
Service charges and fees		$	1,340			$	1,788			$	(448	)			(25.1	)%
Gain on sale of securities available-for-sale			409				1,321				(912	)			(69.0	)%
Gain on sale of portfolio loans			-				227				(227	)			(100.0	)%
Gain on sale of loans held-for-sale			2,119				1,598				521				32.6	%
Bank owned life insurance earnings			352				349				3				0.9	%
Interchange fees			983				1,033				(50	)			(4.8	)%
Other			512				991				(479	)			(48.3	)%
		$	5,715			$	7,307			$	(1,592	)			(21.8	)%

 

Noninterest income for the nine months ended September 30, 2017 decreased $1.6 million to $5.7 million, as compared to $7.3 million for the nine months ended September 30, 2016. The decrease in noninterest income during the first nine months of 2017, as compared with the same period in 2016, was primarily due to lower gains on the sale of investment securities, lower gains on the sale of portfolio loans, and reduced service charges and fees, the latter reflecting an improving economic climate and shifting customer demographics and preferences, as well as a decrease in miscellaneous operating income related to an escrow account that was forfeited in the year-earlier period in connection with an OREO sale (included in Other in the table above), partially offset by higher gains on the sale of loans held-for-sale.

 

For the nine months ended September 30, 2017, gains on sales of mortgage loans held-for-sale were $1,604,000 (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 were $257,000, gains on sales of SBA/USDA loans held-for-sale were $523,000 and net gains recognized for the servicing of SBA/USDA loans held-for-sale were $248,000. By comparison, for the nine months ended September 30, 2016, gains on sales of mortgage loans held-for-sale were $1,298,000, deferred fees on mortgage loans held-for-sale were $486,000, gains on sales of SBA/USDA loans held-for-sale were $730,000 and net gains recognized for the servicing of SBA/USDA loans held-for-sale were $56,000.

 

The Company expects gains on sales of loans held-for-sale to increasingly contribute 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.

 

Noninterest Expense

 

The components of noninterest expense for the nine months ended September 30, 2017 and 2016 were as follows:

 

										Increase / (Decrease)
		2017				2016				Amount				Percentage
		(Dollars in Thousands)
Compensation and benefits		$	10,558				10,532			$	26				0.2	%
Occupancy and equipment			1,745				1,863				(118	)			(6.3	)%
Federal Deposit Insurance Corporation insurance premiums			290				473				(183	)			(38.7	)%
Foreclosed assets, net			293				254				39				15.4	%
Data processing			1,774				1,556				218				14.0	%
Outside professional services			1,557				1,497				60				4.0	%
Collection expense and repossessed asset losses			316				363				(47	)			(12.9	)%
Other			2,658				2,536				122				4.8	%
		$	19,191			$	19,074			$	117				0.6	%

 

 

Noninterest expense increased $0.1 million to $19.2 million for the nine months ended September 30, 2017, from $19.1 million for the nine months ended September 30, 2016. The increase in noninterest expense during the first nine months of 2017, as compared with the same period in 2016, primarily reflected increased data processing expenses associated with ongoing efforts to improve the Company’s IT infrastructure, partially offset by a decrease in occupancy and equipment expense and the aforementioned adjustment to the rate of accrual for FDIC insurance premiums.

 

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 $2.1 million and $2.6 million in income tax expense for the nine months ended September 30, 2017 and 2016, respectively. The Company’s effective tax rate was 35.2% and 37.1% for the first nine months of 2017 and 2016, respectively. This decrease was primarily due to decreased pretax earnings during the nine months ended September 30, 2017, as compared with the same period in 2016, while permanent differences remained stable. The future realization of the Company’s federal 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 nine months ended September 30, 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. 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 September 30, 2017, the Bank had additional borrowing capacity of $123.2 million with the FHLB. The Bank’s borrowing capacity with the Federal Reserve Bank of Atlanta, as of September 30, 2017, included the ability to borrow up to approximately $25.0 million under the Primary Credit program, based solely on the current amount of loans the Bank has designated for pledging with the Federal Reserve Bank of Atlanta, and $10.0 million of daylight overdraft capacity. Additionally, as of September 30, 2017, the Bank had liquidity sources through a $10.0 million line of credit for repurchase and reverse repurchase transactions, as well as one $20.0 million, one $17.0 million, one $10.0 million, and three $5.0 million lines of credit, all with private financial institutions. As of September 30, 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 $34.7 million as of September 30, 2017.

 

 

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 September 30, 2017, the Bank had brokered deposits of $87.0 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 September 30, 2017, the Bank had deposits from this service of $4.7 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 September 30, 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 nine months of 2017, cash and cash equivalents decreased $17.7 million to $42.2 million as of September 30, 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 nine months of 2017, cash used in investing activities of $46.9 million exceeded cash provided by operating activities of $19.1 million and financing activities of $10.1 million. Primary sources of cash flows included proceeds from repayment of warehouse loans held-for-investment of $812.1 million, proceeds from FHLB advances of $457.7 million, proceeds from the maturities and payments of investment securities of $78.8 million, proceeds from sales of loans held-for-sale of $56.9 million, net increases in deposits of $48.0 million and proceeds from the redemption of FHLB stock of $19.8 million. Primary uses of cash flows included funding of warehouse loans held-for-investment of $771.8 million, the repayment of FHLB advances of $495.6 million, net increases in portfolio loans of $99.9 million (excluding the purchase of such loans), the purchase of investment securities of $57.1 million, originations of loans held-for-sale of $41.9 million, the purchase of portfolio loans of $18.3 million and the purchase of FHLB stock of $18.2 million.

 

For the first nine months of 2016, cash provided by financing activities of $86.1 million and operating activities of $0.1 million exceeded cash used in investing activities of $59.9 million. Primary sources of cash flows included proceeds from repayment of warehouse loans held-for-investment of $1,135.3 million, proceeds from FHLB advances of $943.0 million, net increases in deposits of $75.1 million, proceeds from the sale of investment securities of $66.5 million, proceeds from sales of loans held-for-sale of $65.3 million and proceeds from the sale of portfolio loans of $31.3 million. Primary uses of cash flows included funding of warehouse loans held-for-investment of $1,210.8 million, the repayment of FHLB advances of $922.0 million, net increases in portfolio loans of $67.1 million (excluding the purchase of such loans) and originations of loans held-for-sale of $65.7 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.

 

 

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 September 30, 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 September 30, 2017:
+300		$	105,364			$	(14,225	)			(11.9	)%			12.21	%			(71	)		$	25,212			$	(2,065	)			(7.6	)%
+200			111,628				(7,961	)			(6.7	)%			12.62	%			(18	)			25,956				(1,321	)			(4.8	)%
+100			116,717				(2,872	)			(2.4	)%			12.89	%			(3	)			26,660				(617	)			(2.3	)%
0			119,589				-				-				12.92	%			-				27,277				-				-
-100			112,052				(7,537	)			(6.3	)%			11.88	%			(75	)			26,776				(501	)			(1.8	)%
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.

 

 

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; however, the Company’s sensitivity continues to move towards a more neutral position due to an increase in adjustable rate loans and core deposits, as well as longer initial term on wholesale funding borrowings. The relative improvement in the effects of rate shocks on NPV at September 30, 2017, compared with December 31, 2016, relates to the improved mix of adjustable rate loans and growth in noninterest-bearing demand deposits and capital levels.

 

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 September 30, 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 September 30, 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 September 30, 2017, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 

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.

 

 

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: November 9, 2017	By:	/s/ John K. Stephens, Jr.
	John K. Stephens, Jr.
	President and Chief Executive Officer
	(Principal Executive Officer)

 

Date: November 9, 2017	By:	/s/ Tracy L. Keegan
	Tracy L. Keegan
	Executive Vice President and Chief Financial Officer
	(Principal Financial and Accounting Officer)

 

 

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.