ITEM 1. BUSINESS
General
Atlantic Coast Financial Corporation
Atlantic Coast Financial Corporation (the Company), a bank holding company headquartered in Jacksonville, Florida, is a Maryland corporation incorporated in 2007. Through our principal wholly owned subsidiary, Atlantic Coast Bank (the Bank), we serve the Northeast Florida, Central Florida and Southeast Georgia markets.
The Company does not maintain offices separate from those of the Bank or utilize personnel other than certain of the Bank’s officers. Any officer that serves as a director of the Company is not separately compensated for his or her service as a director.
Atlantic Coast Bank
The Bank was established in 1939 as a credit union to serve the employees of the Atlantic Coast Line Railroad. On November 1, 2000, after receiving the necessary regulatory and membership approvals, Atlantic Coast Federal Credit Union converted to a federal mutual savings bank (and subsequently a federally-chartered savings bank) known as Atlantic Coast Bank. The conversion allowed the Bank to diversify its customer base by marketing products and services to individuals and businesses in its market areas and make loans to customers who did not have a deposit relationship with the 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 Bank has 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.
The Bank is headquartered at 4655 Salisbury Road, Suite 110, Jacksonville, Florida, 32256 and its telephone number is (800) 342-2824. Its website is www.AtlanticCoastBank.net. The Bank’s website is not incorporated into this Report.
Recent Events
Agreement and Plan of Merger with Ameris Bancorp
On November 16, 2017, the Company entered into an Agreement and Plan of Merger (the Merger Agreement) with Ameris Bancorp, a Georgia corporation (Ameris). Pursuant to the Merger Agreement, the Company will merge into Ameris, with Ameris as the surviving entity (the Ameris Merger). The Merger Agreement provides that, immediately following the Ameris Merger, the Bank will be merged into Ameris Bank, a Georgia bank wholly owned by Ameris, with Ameris Bank as the surviving entity (the Bank Merger).
Under the terms and subject to the conditions of the Merger Agreement, the Company’s stockholders will have the right to receive $1.39 in cash and 0.17 shares of Ameris common stock for each share of the common stock of the Company they hold. The Merger Agreement provides that immediately prior to the closing of the Ameris Merger, the Company’s outstanding restricted stock awards will fully vest and be converted into the right to receive the same merger consideration per share as other outstanding shares of the Company’s common stock.
The Merger Agreement has been unanimously approved by the boards of directors of the Company and Ameris. The closing of the Ameris Merger is subject to the required approval of the Company’s stockholders, requisite regulatory approvals and other customary closing conditions. The Ameris Merger is expected to close during the second quarter of 2018.
Market Areas
The Bank’s primary deposit customers reside in Northeast Florida, Central Florida and Southeast Georgia markets with our lending areas primarily covering those same markets. The Bank operates seven branches and has its home and executive offices (which includes a stand-alone ATM) in greater Jacksonville, Florida, and three branches in Southeast Georgia. The Florida branches include Jacksonville Beach, Neptune Beach, the Southside of Jacksonville, Arlington, Julington Creek, the Westside of Jacksonville, and Orange Park. The Georgia branches include Waycross (two locations, one of which has a drive-up facility in addition to the branch) and Douglas. In addition to its branches, the Bank has mortgage lending offices in Clearwater, Florida, and in Saint Simons Island, Georgia, a general lending office in Savannah, Georgia, as well as a combined mortgage lending and commercial banking office in Lake Mary (Orlando), Florida. The office in Lake Mary includes a small business lending group, which primarily funds small business loans in Florida, Georgia, North Carolina and South Carolina.
Although the majority of the Bank’s operations are in its primary market areas of Northeast Florida, Central Florida and Southeast Georgia, the Bank will also originate and purchase portfolio loans collateralized by property outside these areas.
Florida Market Area
The city of Jacksonville, Florida ranks as the 12th largest city in the United States in terms of population, with an estimated 926,000 residents, based on 2016 estimates. When including the three beach cities east of Jacksonville, along with surrounding counties, the Jacksonville metropolitan area has an estimated 1,500,000 residents, based on 2016 estimates. The Jacksonville metropolitan area, with deposits of approximately $59 billion as of June 30, 2017, is the third largest market in Florida by deposits. Jacksonville has an estimated median household income of $59,300, and the unemployment rate was 3.4% at December 31, 2017. There are a number of large companies with corporate or regional headquarters located in the Jacksonville metropolitan area, including four Fortune 1000 companies whose corporate headquarters are located in or near the city.
The city of Orlando, Florida ranks as the 73rd largest city in the United States in terms of population, with an estimated 277,000 residents, based on 2016 estimates. When including the surrounding counties, the Orlando metropolitan area has an estimated 2,500,000 residents, based on 2016 estimates. The Orlando metropolitan area, with deposits of approximately $48 billion as of June 30, 2017, is the fourth largest market in Florida by deposits. Orlando has an estimated median household income of $56,000, and the unemployment rate was 3.3% at December 31, 2017. There are a number of large companies with corporate or regional headquarters located in the Orlando metropolitan area, including one Fortune 1000 company whose corporate headquarters is located in or near the city.
The city of Tampa, Florida ranks as the 52nd largest city in the United States in terms of population, with an estimated 377,000 residents, based on 2016 estimates. When including the surrounding counties, the Tampa metropolitan area (which includes Clearwater) has an estimated 3,050,000 residents, based on 2016 estimates. The Tampa metropolitan area, with deposits of approximately $82 billion as of June 30, 2017, is the second largest market in Florida by deposits. Tampa has an estimated median household income of $53,000, and the unemployment rate was 3.4% at December 31, 2017. There are a number of large companies with corporate or regional headquarters located in the Tampa metropolitan area, including seven Fortune 1000 companies whose corporate headquarters are located in or near the city.
Georgia Market Area
The Bank was established in Waycross, Georgia, the county seat of Ware County, and began as a credit union for the Atlantic Coast Line Railroad and then the Seaboard System Railroad, which is now a part of CSX Transportation. Waycross has an estimated population of 14,000, based on 2016 estimates, with an estimated median household income of $25,000. The unemployment rate in Waycross was 4.4% at December 31, 2017. One of the largest employers in Waycross is the Satilla Regional Medical Center, with over 1,300 employees. Waycross began as a crossroads for southeastern travel and became a hub for rail traffic in the mid-1800s. Today, it is home to the largest CSX Transportation rail yard on the East Coast, with over 1,200 employees.
Douglas, Georgia, which is in Coffee County, has a population of 12,000, based on 2016 estimates, with an estimated median household income of $31,000. The unemployment rate for Douglas was 5.0% at December 31, 2017. Wal-Mart is the biggest employer in the area, with a retail store and a distribution center, which employs over 900 people. The largest public employer is the Board of Education, with 1,200 employees. Agriculture plays a major role in the area with products that include peanuts, corn, tobacco and cotton. Poultry is also a major part of the economy with a processing plant, operated by Pilgrim’s Pride Corporation, in the area.
Savannah, Georgia, which is in Chatham County, has an estimated population of 147,000, based on 2016 estimates, with an estimated median household income of $36,000. The unemployment rate for the Savannah area was 4.0% at December 31, 2017. The Port of Savannah boasts the largest concentration of import distribution centers on the East Coast and has the largest single container terminal in North America. The terminal is the fourth largest container port in the United States (based on standard units for carrying and handling capacity), with two railroads on the terminal: CSX Transportation and Norfolk Southern Railway.
Competition
The Bank is competitive in attracting deposits and originating real estate and other loans, but faces strong competition in both areas. Historically, most of the Bank’s direct competition for deposits has come from credit unions, community banks, large commercial banks, and thrift institutions within our primary market areas. There are more than 1,700 branches operating in the Bank’s markets, the majority of which are in the Jacksonville, Orlando and Tampa markets.
In recent years, competition also has come from institutions that largely deliver their services over the Internet. Internet banking has the competitive advantage of lower infrastructure costs. Particularly during times of extremely low or extremely high interest rates, the Bank has faced significant competition for customers’ funds from short-term money market securities and other corporate and government securities. During periods of increasing volatility in interest rates, competition for interest-bearing deposits increases as customers, particularly time-deposit customers, tend to move their accounts between competing businesses to obtain the highest rates in the market. The Bank competes for these deposits by offering convenient locations, superior service, competitive rates and attractive deposit products. An arrangement that gives all of our customers access to over 900 ATMs, at no charge, has proven to be a positive competitive advantage for the Bank. Additionally, the Bank’s “High Tide” deposit account is also a competitive advantage for the Bank, as it provides customers the ability to obtain refunds for ATM surcharges.
As of June 30, 2017 (the most recent date for which market share peer data is available), the Bank was ranked number 13 in Jacksonville deposit market share, holding $372 million, or less than 1% of total deposits in the area. As of June 30, 2017, the Bank had $20 million in deposits in Orlando and $2 million in Tampa. In Waycross, the Bank was ranked number two with 22% of the deposit market share, holding $199 million as of June 30, 2017. The Bank holds approximately 5% of total deposit market share in Douglas, with $38 million as of June 30, 2017.
Competition within our geographic markets also affects the Bank’s ability to obtain loans through origination or purchase and to originate loans at rates that provide an attractive yield. Competition for loans comes principally from mortgage bankers, commercial banks, national homebuilders, and credit unions. Internet-based lenders also have become a greater competitive factor in recent years. Such competition for the origination and purchase of loans may limit the Bank’s future growth and earnings potential. However, the Bank’s website should help the Bank’s competitiveness in the electronic banking arena.
Lending Activities
General
Historically, the Bank has originated portfolio one- to four-family residential first and second mortgage loans, home-equity loans, and commercial real estate loans and, to a lesser extent, commercial and residential construction loans, multi-family real estate loans, commercial business loans, and automobile and other consumer loans. We have not originated any land loans since 2008 except for those associated with the development of property for a residential or commercial end user. We have not and currently do not originate or purchase non-QM loans (i.e., loans that do not comply with “Qualified Mortgage” rules), or offer “teaser” rate loans (i.e., loans with low, temporary introductory rates). Our current strategy has been to expand commercial real estate, one- to four-family mortgage and warehouse lending.
The Bank originates commercial real estate loans and commercial and industrial loans with small to mid-size businesses for the purposes of purchasing real estate and inventory, financing equipment, and providing working capital.
The Bank also originates 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). Warehouse lending uses mortgage bankers to originate one- to four-family residential mortgage loans for sale in the secondary market. The third-party originator sells the loans and servicing rights to investors in order to repay the outstanding balance on warehouse loans held-for-investment. The Bank earns interest until the loan is sold and typically earns fee income as well. Loans originated within the warehouse lending program generally have commitments to purchase from investors, are sold with no recourse, and are sold with servicing released to the investor. The weighted average number of days outstanding of warehouse loans held-for-investment was 10 days during 2017.
The Bank originates commercial loans through the Small Business Administration’s (SBA) 7(a) and 504 Programs, and the U.S. Department of Agriculture’s (USDA) Business & Industry (B&I) Program. The SBA 7(a) loans are guaranteed by the SBA up to 75% of the loan amount up to a maximum guaranty cap of $3,750,000. The Bank typically, but not always, sells the guaranteed portion of the SBA 7(a) loans into the secondary market at a premium. The Bank earns a 1% servicing fee on the amount sold. These loans are non-recourse, other than for proof of fraud or misrepresentation on the part of the lender. The Bank generally retains the unguaranteed portion of SBA 7(a) loans. In the 504 program, the Bank and the SBA are in different lien positions. The typical structure of an SBA 504 loan is that the Bank is in a first lien position at a 50% loan-to-value (LTV), and the SBA is in a second lien position at a 40% LTV. The remaining 10% is an equity investment from the borrower. USDA B&I loans are guaranteed on a scaled basis from 60% to 80% based on the size of the originated loan. The Bank typically, but not always, sells the guaranteed portion of the B&I loans on the secondary market at a premium. The Bank retains servicing for the B&I loan, but only earns a servicing fee on the portion that is sold. The servicing fees are determined by the secondary market, and range from 0.25% to 1%. These loans are non-recourse, other than for proof of fraud or misrepresentation on the part of the lender. The Bank generally retains the unguaranteed portion of the USDA B&I loans.
At December 31, 2017, the net loan portfolio totaled $757.5 million, which constituted 77.0% of total assets. Loans carry either a fixed or adjustable rate of interest. Mortgage loans have a longer-term amortization, with maturities generally up to 30 years, with principal and interest due each month. Commercial real estate loans, commercial and industrial loans, commercial construction loans, and multi-family real estate loans generally have larger balances and involve a greater degree of credit risk than one- to four-family residential mortgage loans.
Consumer loans are generally shorter in term and amortize monthly or have interest payable monthly. Warehouse loans held-for-investment are underwritten and funded on an individual loan basis. A percentage of loans are randomly selected for advanced quality control or a third-party fraud-risk analysis report in addition to the standard underwriting process. SBA loans are underwritten in accordance with SBA guidelines and the Bank’s commercial credit policy.
At December 31, 2017, the maximum amount we could have loaned to any one borrower and related entities under applicable regulations was approximately $13.7 million, a 15% limit for unsecured loans, and $22.9 million, a 25% limit for amply and entirely secured loans. At December 31, 2017, there were no portfolio loans or group of portfolio loans to related borrowers with outstanding balances in excess of either of these amounts.
The following table presents the composition of the Bank’s net portfolio loans, and other loans (held-for-sale and warehouse), in dollar amounts and in percentages at the dates indicated:
Portfolio Loans Maturities and Yields
The following table summarizes the contractual maturities of our portfolio loans at December 31, 2017:
(1)Demand loans, loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less.
(2)Construction loans include notes that cover both the construction period and the end permanent financing.
The following table sets forth the scheduled repayments of fixed- and adjustable-rate portfolio loans at December 31, 2017 that are contractually due after December 31, 2018:
One- to Four-Family Real Estate Portfolio Lending
As of December 31, 2017, one- to four-family residential mortgage loans totaled $286.7 million, or 37.8% of gross portfolio loans. Generally, one- to four-family residential loans are underwritten based on the applicant’s employment, income, credit history and the appraised value of the subject property. The Bank underwrites all loans on a fully indexed, fully amortizing basis. The Bank will generally lend up to 80% of the lesser of the appraised value or purchase price for one- to four-family residential loans. Should a loan be granted with a loan-to-value ratio in excess of 80%, private mortgage insurance would be required to reduce overall exposure to below 80%. Such collateral requirements are intended to protect the Bank from loss in the event of foreclosure.
Properties securing one- to four-family residential mortgage loans are appraised by independent fee appraisers. Borrowers are required to obtain title and hazard insurance, and flood insurance, if necessary, in an amount not less than the value of the property improvements. Management’s pricing strategy for one- to four-family mortgage loans includes setting interest rates that are competitive with other local financial institutions and consistent with the Bank’s internal needs. Adjustable-rate mortgage (ARM) loans are tied to a variety of indices, including rates based on U.S. Treasury securities. The majority of ARM loans carry an initial fixed rate of interest for between three and seven years, which then converts to an interest rate that is adjusted based upon the applicable index and in accordance with the promissory note. As of December 31, 2017, the total amount of one- to four-family residential mortgage loans allowing for interest only payments totaled $1.4 million, or 0.5% of the total one- to four-family mortgage loan portfolio, and 0.2% of the total portfolio loans. We do not currently originate or purchase interest-only one- to four-family residential mortgage loans and discontinued such activity in December 2007.
The Bank’s home mortgages are structured with five to 30-year maturities and with amortizations up to 30 years. The majority of the one- to four-family mortgage loans originated are secured by properties located in Northeast Florida, Central Florida and Southeast Georgia. During 2008 and continuing through and including 2017, the Bank implemented stricter underwriting guidelines related to the origination of one- to four-family residential mortgage loans secured by investment property.
All residential real estate loans contain a “due on sale” clause allowing the Bank to declare the unpaid principal balance due and payable upon the sale of the underlying property that serves as collateral for the loan, subject to certain laws. Loans originated or purchased are generally underwritten and documented pursuant to Freddie Mac or Fannie Mae guidelines.
The Bank also originates investor loans for one- to four-family properties, and the majority of our lending activity has focused on owner-occupied property. We have not in the past, nor do we currently, originate sub-prime loans, option-ARM loans, or other similar loans. We do not currently originate non-QM loans for the Bank’s loan portfolio.
Multi-Family Loans
As of December 31, 2017, multi-family residential loans totaled $65.4 million, or 8.6% of gross portfolio loans. The majority of the loans are to borrowers who are experienced, in-market real estate investors, and are secured by properties located in New York, New York and Philadelphia, Pennsylvania. The majority of the loans were purchased in two separate transactions during 2015; however, the Bank also began originating multi-family residential loans in 2017. The underwriting for multi-family residential loans is based on the cash flow of the property and includes underwriting stresses for interest rate increases and a rise in cap rates. Multi-family residential loans are generally originated with adjustable interest rates based on the prime rate, U.S. Treasury securities, or regional Federal Home Loan Bank (FHLB) indices. Loan-to-value ratios on multi-family residential loans do not exceed 75% of the appraised value of the property securing the loan. These loans require monthly payments, amortize up to 30 years, and generally have maturities of up to 10 years and may carry pre-payment penalties.
The net operating income must be sufficient to cover the payments related to the outstanding debt. Assignments of rents and leases are required in order for us to be assured the cash flow from the project will be used to repay the debt. Appraisals on properties securing multi-family residential loans are performed by independent, state-licensed fee appraisers. Payments on loans secured by multi-family real estate properties are often dependent on the successful operation or management of the properties and, as such, repayment of these loans may be subject to adverse conditions in the real estate market or the economy. If the cash flow from the project is reduced, or if leases are not obtained or renewed, the borrower’s ability to repay the loan may be impaired.
Commercial Real Estate Lending
The Bank offers commercial real estate loans for both permanent financing and construction/mini-perm financing. Our current strategy has been to focus primarily on permanent financing for owner occupied businesses and income producing properties. These loans are typically secured by single tenant or small retail establishments, office buildings, or other income producing properties located in the Bank’s primary market areas. As of December 31, 2017, permanent commercial real estate loans totaled $220.3 million, or 29.0% of gross portfolio loans.
The Bank originates both fixed-rate and adjustable-rate commercial real estate loans. The interest rate on adjustable-rate loans is tied to a variety of indices, including rates based on the prime rate, LIBOR, and U.S. Treasury securities. The majority of the Bank’s adjustable-rate loans carry an initial fixed-rate of interest, for either five, seven or ten years, and then convert to an interest rate that is adjusted based upon the current index rate for another period up to ten years. Loan-to-value ratios on commercial real estate loans generally do not exceed 80% of the appraised value of the property securing the loan. These loans require monthly payments, amortize up to 25 years, and generally have maturities of up to 10 years and may carry pre-payment penalties.
Loans secured by commercial real estate are underwritten based on the cash flow of the borrower or income producing potential of the property and the financial strength of the borrower and guarantors. Loan guarantees are generally obtained from financially capable parties based on a review of personal financial statements. The Bank generally requires commercial real estate borrowers with aggregate balances in excess of $500,000 to submit financial statements, including rent rolls if applicable, annually. The net operating income, which is the income derived from the operation of the property less all operating expenses, must be sufficient to cover the payments related to the outstanding debt. The Bank generally requires an income-to-debt service ratio of 1.25 times debt. Additionally, the Bank considers interest and cap rate stresses to account for the potential of rising interest rates and the effect on the borrower’s ability to repay and valuation of the collateral. Assignments of rents and leases are required in order for us to be assured the cash flow from the project will be used to repay the debt. Appraisals on properties securing commercial real estate loans are performed by independent, state-licensed fee appraisers. The majority of the properties securing commercial real estate loans are located in the Bank’s market areas.
Loans secured by commercial real estate properties are generally larger and involve a greater degree of credit risk than one- to four-family residential mortgage loans. Because payments on loans secured by commercial real estate properties are often dependent on the successful operation and management of the owner’s business or successful management of the property, repayment of such loans may be subject to adverse conditions in the real estate market or the economy. If the cash flow from the project or business is reduced, or if leases are not obtained or renewed, the borrower’s ability to repay the loan may be impaired.
Land Loans
As of December 31, 2017, land loans totaled $13.8 million, or 1.8% of gross portfolio loans. In an effort to prevent potential exposure to additional credit risk, the Bank no longer originates new land loans unless the borrower is acquiring the land as part of the development of a property for individual residential or commercial use. Generally, these loans carry a higher rate of interest than permanent residential loans. The Bank generally assesses the borrower’s ability to repay, credit history, appraised value of the subject property, and the intended end use of the property to underwrite land loans.
Loans secured by land generally involve a greater degree of credit risk than one- to four-family residential mortgage loans and commercial real estate loans.
Real Estate Construction Lending
As of December 31, 2017, real estate construction loans totaled $25.9 million, or 3.4% of gross portfolio loans. The real estate construction portfolio consists of both residential and commercial construction loans. As of December 31, 2017, the Bank had residential construction loans totaling $8.6 million, or 1.1% of gross portfolio loans, and commercial construction loans totaling $17.3 million, or 2.3% of gross portfolio loans.
Residential construction loans are generally made to individual borrowers for the construction of a personal residence. Generally, construction loans are limited to a loan to value ratio not to exceed 80% based on the lesser of construction costs or the appraised value of the property upon completion. The Bank originates only residential construction loans to individual borrowers whose intent is to occupy the house upon completion.
Commercial construction loans are generally made for the construction of commercial, owner-occupied properties and investment income producing properties with tenant leases in place at closing with rents commencing upon completion of construction. These loans are limited to a loan to value not to exceed 80% based on the lesser of construction costs or the appraised value of the property upon completion, and are underwritten based on the owner’s anticipated cash flow or the lease income from tenants.
Home-Equity Lending
The Bank generally originates fixed-term, fully amortizing home equity loans and home equity lines of credit. At December 31, 2017, the home equity portfolio totaled $34.5 million, or 4.5%, of gross portfolio loans. Due to the decline of both real estate values in our market areas and the increased risk inherent with second lien real estate financing, the Bank ceased originating home equity lines of credit in January 2009, but began originating home equity lines of credit again in 2014 under stricter credit criteria. The Bank generally underwrites one- to four-family home equity loans and lines of credit based on the applicant’s employment and credit history and the appraised value of the subject property. Presently, the Bank will lend up to 80% of the appraised value less any prior liens. In limited circumstances, the Bank may lend up to 90% of the appraised value less any prior liens. This ratio may be reduced in accordance with internal guidelines given the risk and credit profile of the borrower. Properties securing one- to four-family mortgage loans are generally appraised by independent fee appraisers. The Bank requires a title search and hazard insurance, and flood insurance, if necessary, in an amount not less than the value of the property improvements. Currently, home equity loans are retained in our loan portfolio.
The Bank’s home equity lines of credit carry an adjustable interest rate based upon the prime rate of interest and generally have an interest rate floor. As of December 31, 2017, interest only lines of credit totaled $9.9 million, or 28.8% of the total home equity loan portfolio, and 3.1% of total loans collateralized by one- to four-family residential property. All home equity lines of credit have a maximum draw period of 10 years with a repayment period of up to 20 years following such draw period depending on the outstanding balance.
Consumer Loans
The Bank currently offers a variety of consumer loans, primarily manufactured home loans, automobile loans and unsecured loans. At December 31, 2017, consumer loans totaled $34.7 million, or 4.6% of gross portfolio loans.
The most significant component of the Bank’s consumer loan portfolio consists of manufactured home loans originated primarily through an on-site financing broker after being underwritten by the Bank. Loans secured by manufactured homes totaled $21.0 million, or 2.8% of gross portfolio loans as of December 31, 2017. Manufactured home loans have a fixed rate of interest and may carry terms up to 25 years. Down payments are required, and the amounts are based on several factors, including the borrower’s credit history. The Bank has not originated manufactured home loans since early in 2011, and does not intend to originate such loans in the future.
Another significant component of our consumer loan portfolio consists of automobile loans. The loans are originated primarily through our branch network and are underwritten by Atlantic Coast Bank. Loans secured by automobiles totaled $5.3 million, or 0.7% of gross portfolio loans as of December 31, 2017. Automobile loans have a fixed rate of interest and may carry terms up to six years. Down payments are required, and the amounts are based on several factors, including the borrower’s credit history.
Consumer loans, except for those secured by manufactured homes, have shorter terms to maturity and are principally fixed rate, thereby reducing exposure to changes in interest rates, and carry higher rates of interest than one- to four-family residential mortgage loans. Consumer loans have an inherently greater risk of loss because they are predominantly secured by rapidly depreciable assets, such as automobiles or manufactured homes. In these cases, repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance. As a result, 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 Business Lending
The Bank also offers commercial business loans that may be secured by assets other than real estate. At December 31, 2017, commercial business loans totaled $78.5 million, or 10.3% of gross portfolio loans. The purpose of these loans is to provide working capital, inventory financing, or equipment financing. Generally, working capital and inventory loans carry a floating rate of interest based on the prime rate plus a margin and mature annually. Loans to finance equipment generally carry a fixed rate of interest and terms of up to seven years. The collateral securing these types of loans is other business assets such as inventory, accounts receivable, and equipment. Once a loan is in the portfolio, the credit department monitors based on loan size, payment status, and borrower risk rating. Relationships with aggregate exposure of $500,000 or greater and lines of credit (regardless of amount) are required to submit financial statements annually. The Bank reviews the performance of these companies and affirms or changes their risk rating accordingly. Loans with borrowers whose risk ratings are classified as monitor or special mention are reviewed and documented quarterly and those rated substandard are reviewed monthly. Loans that become past due 30 days or more are monitored daily and borrower risk ratings are adjusted accordingly. Commercial business loans generally have higher interest rates than other loans in our portfolio because they have a higher risk of default since their repayment generally depends on the successful operation of the borrower’s business and the sufficiency of any collateral. In addition, the Bank originates commercial loans through the 7(a) Program and the 504 Program of the SBA, as well as the B&I Program of the USDA.
Loan Originations, Purchases, and Sales
The Bank originates portfolio loans through its branch network, its lending offices, and its call center. Referrals from current customers, advertisements, real estate brokers, mortgage loan brokers and builders are also important sources of loan originations. While the Bank originates both adjustable-rate loans and fixed-rate loans, origination volume is dependent upon customer loan demand within the Bank’s market areas. Demand is affected by local competition, the real estate market and the interest rate environment.
The Bank shut down its internal mortgage origination division in 2012, and moved to a referral model to originate mortgages. However, with the success of the Company’s capital raise in December 2013, the Bank reentered the business of originating one- to four-family residential loans for investment and sale, and intends to continue originating such loans in the future. Additionally, the Company has two mortgage loan production offices, with one in Florida and one in Georgia.
Prior to 2008, the Bank occasionally purchased pools of residential loans originated by other banks when organic growth was not sufficient. These loan purchases were made based on the Bank’s underwriting standards, such as loan-to-value ratios and borrower credit scores. The Bank ceased purchasing pools of loans between 2008 and 2012. However, during 2013, the Bank reentered the business of purchasing pools of residential loans originated by other banks, and intends to continue purchasing such loans to supplement organic growth. The Bank had limited purchase activity during the year ended December 31, 2017. The Bank may purchase pooled loans secured by properties located in areas other than the Bank’s market areas.
Similarly, prior to 2008, the Bank also participated in commercial real estate loans originated by other banks. These participation loans were subject to the Bank’s usual underwriting standards as described above applicable to this type of loan. The Bank had not participated in a commercial real estate loan originated by another bank from mid-2007 through 2015. However, during 2016, the Bank reentered the business of participating in commercial real estate loans originated by other banks, and intends to continue participating in such loans in the future.
From time-to-time, the Bank may sell performing residential loans from our portfolio to enhance liquidity or to appropriately manage interest rate risk. The Bank has also utilized the services of a national loan sale advisor to sell nonperforming residential mortgage loans in the past.
Loans Held-for-Sale
Beginning in 2008 and continuing into 2012, the Bank regularly sold originated, conforming one- to four-family residential loans, both fixed rate and adjustable rate, including the related servicing, to other financial institutions in the secondary market for favorable fees. The Bank had not originated residential loans to be held-for-sale from mid-2012 through 2013, but began originating such loans again early in 2014.
Beginning in 2010, the Bank began to sell the guaranteed portion of the internally originated SBA 7(a) loans to investors, while maintaining the servicing rights. Additionally, beginning in 2016, the Bank began to sell the guaranteed portion of the internally originated USDA B&I loans to investors, while maintaining the servicing rights. The Bank intends to continue originating such loans for the foreseeable future.
Warehouse Loans Held-for-Investment
Beginning in 2010, the Bank began to originate warehouse loans held-for-investment and permit third-party originators to sell the loans and servicing rights to investors in order to repay the warehouse balance outstanding. The Bank intends to continue originating such loans for the foreseeable future.
Loan Approval Procedures and Authority
Lending authority per credit officer ranges from $100,000 to $1.0 million based on the individual credit officer’s lending and loan underwriting experience. Loans which exceed an individual credit officer’s lending authority may be approved using the combined authority of another credit officer on loan amounts up to and including $1.0 million. Loans exceeding $1.0 million must be approved by our management loan committee.
Nonperforming and Problem Assets
General
When a borrower fails to make a timely payment on a loan, contact is made initially in the form of a reminder letter sent at either 10 or 15 days after the payment due date depending on the terms of the loan agreement. If a response is not received within a reasonable period of time, contact by telephone is made in an attempt to determine the reason for the delinquency and to request payment of the delinquent amount in full or to establish an acceptable repayment plan to bring the loan current.
Modifications are considered at the request of the borrower or upon the Bank’s determination that a modification of terms may be beneficial to the Bank. Generally, the borrower and any guarantors must provide current financial information and communicate to the Bank the underlying cause of their financial hardship and expectations for the near future. The Bank must then verify the hardship and structure a modification that addresses the situation accordingly.
If the borrower is unable to make or keep payment arrangements, additional collection action is taken in the form of repossession of collateral for secured, non-real estate loans and small claims or legal action for unsecured loans. If the loan is secured by real estate, a letter of intent to foreclose is sent to the borrower when an agreement for an acceptable repayment plan cannot be established or agreed upon. The letter of intent to foreclose allows the borrower up to 30 days to bring the account current. Once the loan becomes delinquent and an acceptable repayment plan has not been established, a foreclosure action is initiated on the loan.
Delinquent Loans
Total portfolio loans past due 60 days or more totaled $8.1 million, or 1.1% of total portfolio loans at December 31, 2017. Real estate loans 60 days or more past due totaled $7.0 million, or 0.9% of total loans at December 31, 2017. There were no construction loans 60 days or more past due at December 31, 2017. Other portfolio loans (consisting of home equity, consumer, and commercial non-real estate) 60 days or more past due totaled $1.1 million, or 0.1% of total loans at December 31, 2017.
Nonperforming Assets
Nonperforming assets consist of nonperforming portfolio loans, accruing portfolio loans past due 90 days or more, and foreclosed assets. Loans to a customer whose financial condition has deteriorated are considered for nonperforming status whether or not the loan is 90 days and over past due. Generally, all loans past due 90 days or more are classified as nonperforming. For portfolio loans classified as nonperforming, interest income is not recognized until actually collected. At the time the loan is placed on nonperforming status, interest previously accrued, but not collected, is reversed and charged against current income.
The following table sets forth the amounts and categories of the Bank’s nonperforming assets:
At December 31, 2017, the Bank had $7.8 million in nonperforming portfolio loans, or 1.0% of total portfolio loans. Our largest nonperforming portfolio loan at December 31, 2017 was a $5.5 million nonperforming land loan.
Real estate acquired as a result of foreclosure is classified as other real estate owned (OREO). At the time of foreclosure or repossession, the property is recorded at estimated fair value less selling costs, with any write-down charged against the allowance for portfolio loan losses. As of December 31, 2017, the Bank had OREO of $1.7 million.
Portfolio loans for which terms have been modified as a result of the borrower's financial difficulties are considered troubled debt restructurings (TDR). Portfolio loans modified as TDRs with market rates of interest are classified as impaired portfolio loans. Once the TDR loan 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, and as of December 31, 2017, such portfolio loans totaled $5.9 million and included the previously mentioned land loan.
Classified Assets
Banking regulations provide for the classification of portfolio loans and other assets, such as OREO, debt and equity securities considered by the Bank and regulators to be of lesser quality, as “substandard,” “doubtful” or “loss.” An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” the insured institution will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of 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.” Assets classified as “loss” are those considered not collectable and of such little value that their continuance as assets without the establishment of a full specific loss reserve is not warranted. Those assets classified as “loss” are generally charged-off.
When an insured institution classifies problem assets as either substandard or doubtful, it may establish general allowances for portfolio loan losses in an amount deemed prudent by management and reviewed by its board of directors. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies problem assets as “loss,” it is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge off such amount. The Bank’s determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the OFR and the FDIC, which may order the establishment of additional general or specific loss allowances.
In connection with the filing of the Bank’s regulatory reports with the OFR and in accordance with its classification of assets policy, management regularly reviews the problem assets in the portfolio to determine whether any assets require classification in accordance with applicable regulations. The total amount of classified assets (consisting primarily of portfolio loans secured by real estate and OREO) represented 13.7% of the Bank‘s equity capital and 1.3% of the Bank’s total assets at December 31, 2017.
There were no portfolio loans classified doubtful or loss at December 31, 2017. Assets classified substandard were $12.4 million at December 31, 2017. The Bank also designates certain portfolio loans as special mention when it is determined a loan relationship should be monitored more closely. Portfolio loans are classified as special mention for a variety of reasons including changes in recent borrower financial condition, changes in borrower operations, changes in value of available collateral, concerns regarding changes in economic conditions in a borrower’s industry, and other matters. A portfolio loan classified as special mention in many instances may be performing in accordance with the loan terms. Special mention portfolio loans were $1.2 million at December 31, 2017. As of December 31, 2017, $7.7 million of classified portfolio loans were on nonperforming status.
Allowance for Portfolio Loan Losses
An allowance for portfolio loan losses (the allowance) is maintained to reflect probable incurred losses in the loan portfolio. The allowance is based on ongoing assessments of the estimated losses incurred in the loan portfolio and is established as these losses are recognized through a provision for portfolio loan losses (provision expense) charged to earnings. Generally, portfolio loan losses are charged against the allowance when management believes the loan balance is not fully collectible. Subsequent recoveries, if any, are credited to the allowance.
At December 31, 2017, the allowance was $8.6 million, or 1.1% of total portfolio loans and 110.4% of total nonperforming portfolio loans. The following table sets forth activity in the Bank’s allowance for the years indicated:
(1)Total portfolio loans are net of deferred fees and costs and purchase premiums or discounts.
(2)Net charge-offs were $0.3 million, $0.2 million, and $0.2 million in 2017, 2016 and 2015, respectively; however, the ratio appears as zero due to rounding.
The following table summarizes the allocation of the allowance by portfolio loan category at the dates indicated:
The reasonableness of the allowance is established and reviewed by management, within the context of applicable accounting and regulatory guidelines, based upon its evaluation of then-existing economic and business conditions affecting the Bank’s key lending areas. Senior credit officers monitor those conditions continuously and reviews are conducted quarterly with the Bank’s senior management and Board of Directors. Management’s methodology for assessing the reasonableness of the allowance consists of several key elements, which include a general loss component by type of portfolio loan and specific allowances for identified problem portfolio loans. The allowance also incorporates the results of measuring impaired portfolio loans. Furthermore, the allowance allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories.
Investment Activities
General
The Bank maintains an amount of liquid assets, such as cash and short-term securities, for the purposes of meeting operational needs. The Bank is permitted to make certain other securities investments. Cash flow projections are regularly reviewed and updated to assure that adequate liquidity is provided.
The Bank is authorized to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various federal agencies and government sponsored enterprises, certain certificates of deposit of insured banks and savings institutions, certain bankers’ acceptances, repurchase agreements and federal funds. Subject to various restrictions, Florida-state chartered banks may also invest their assets in investment grade commercial paper and corporate debt securities and mutual funds.
The Bank’s Board of Directors has adopted an investment policy which governs the nature and extent of investment activities, and the responsibilities of management and the Board of Directors. Investment activities are directed by the Chief Financial Officer in coordination with the Bank’s Asset and Liability Committee (ALCO). Various factors are considered when making decisions, including the marketability, maturity and tax consequences of the proposed investment. The maturity structure of investments will be affected by various market conditions, including the current and anticipated short and long term interest rates, the level of interest rates, the trend of new deposit inflows, and the anticipated demand for funds through deposit withdrawals and loan originations and purchases.
The structure of the investment portfolio is intended to provide liquidity when loan demand is high, assist in maintaining earnings when loan demand is low and maximize earnings while managing risk, including credit risk, reinvestment risk, liquidity risk and interest rate risk.
Investment Securities
The Bank invests in investment securities, such as U.S. government sponsored enterprises and state and municipal obligations, as part of its asset liability management strategy.
Accounting principles generally accepted in the United States of America (U.S. GAAP) require that investments be categorized as “held-to-maturity,” “trading securities” or “available-for-sale,” based on management’s intent as to the ultimate disposition of each security. Securities are classified as held-to-maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity. Securities are classified as available-for-sale when they might be sold before maturity.
At December 31, 2017, $37.7 million of investment securities, representing the entire balance in investment securities, were classified as available-for-sale. The Bank held no non-agency collateralized mortgage-backed securities or non-agency collateralized mortgage obligations, as of December 31, 2017.
Management evaluates investment securities for other-than-temporary impairment (OTTI) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. In determining OTTI, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at the determination date.
When OTTI is determined to have occurred, the amount of the OTTI recognized in earnings depends on whether we intend to sell the security or it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss. If we intend to sell the security or it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss, the OTTI recognized in earnings is equal to the entire difference between its amortized cost basis and its fair value at the balance sheet date. If we do not intend to sell the security and it is not more likely than not that we will be required to sell the security before recovery of its amortized cost basis less any current-period loss, the OTTI is separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized as a charge to earnings. The amount of the OTTI related to other factors is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.
The following table sets forth the composition of the Company’s investment securities portfolio, excluding FHLB stock, at the dates indicated:
Portfolio Maturities and Yields
The composition and scheduled maturities of the investment securities portfolio at December 31, 2017, are summarized in the following table:
Maturities are based on the final contractual payment dates, and do not reflect the impact of prepayments or early redemptions that may occur. State and municipal investment securities yields have not been adjusted to a tax equivalent basis.
Sources of Funds
General
The Bank’s sources of funds are deposits, payment of principal and interest on loans, interest earned on or maturation of investment securities, borrowings, and funds provided from operations.
Deposits
The Bank offers a variety of deposit accounts to consumers and businesses with a wide range of interest rates and terms. Deposits consist of noninterest-bearing and interest-bearing demand, savings and money market, and time deposit accounts. The Bank relies primarily on competitive pricing policies, customer service and marketing to attract and retain these deposits. Additionally, the Bank has purchased time deposit accounts from brokers at costs and terms which are comparable or better to time deposits originated in the Bank’s branch offices. The Bank had $74.9 million in brokered deposits at December 31, 2017, of which approximately $38.7 million is included in money market accounts and approximately $36.0 million is included in time deposits.
The variety of deposit accounts offered has allowed the Bank to be competitive in obtaining funds and to respond with flexibility to changes in consumer demand. Pricing of deposits are managed to be consistent with overall asset and liability management, liquidity and growth objectives. Management considers numerous factors including: (1) the need for funds based on loan demand, current maturities of deposits, and other cash flow needs; (2) rates offered by market area competitors for similar deposit products; (3) current cost of funds and yields on assets; and (4) the alternative cost of funds on a wholesale basis, in particular the cost of advances from the FHLB and short-term borrowings from securities sold under agreements to repurchase (repurchase agreements). Interest rates are reviewed regularly by senior management as a part of its asset and liability management. Based on historical experience, management believes the Bank’s deposits are a relatively stable source of funds.
The following table sets forth the distribution of total deposit accounts, by account type, and weighted average annual interest rate payable for each account type, at the dates indicated:
As of December 31, 2017, the aggregate amount of outstanding retail time deposits in amounts equal to or greater than $100,000 were approximately $150.6 million. The following table sets forth the maturity of those deposits in excess of $100,000 as of December 31, 2017:
Securities Sold Under Agreements to Repurchase
Information concerning repurchase agreements as of and for the years indicated is summarized as follows:
Federal Home Loan Bank Advances
Although deposits are the primary source of funds, the Bank may utilize borrowings when it is a less costly source of funds, and can be invested at a positive interest rate spread, when additional capacity is required to fund loan demand or when the borrowings meet asset and liability management goals. Borrowings have historically consisted primarily of advances from the FHLB; however, the Bank also has the ability to borrow from the Federal Reserve Bank of Atlanta under the Primary Credit program and daylight overdraft capacity.
FHLB advances may be obtained upon the security of mortgage loans and mortgage-backed securities. These advances may be obtained pursuant to several different credit programs, each of which has its own interest rate, range of maturities, and call features.
The Bank’s remaining borrowing capacity with the FHLB was $63.3 million at December 31, 2017. The FHLB requires that the Bank collateralize the excess of the fair value of the FHLB advances over the book value with cash and investment securities. In the event the Bank prepays advances prior to maturity, it must do so at the fair value of such FHLB advances. As of December 31, 2017, fair value exceeded the book value of the individual advances by $0.4 million, which was collateralized by portfolio loans. 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 $34.1 million as of December 31, 2017.
The following table sets forth information as to FHLB advances, for the years indicated:
Subsidiary and Other Activities
At December 31, 2017, the Company did not have any subsidiaries other than the Bank, and the Bank did not have any subsidiaries other than Atlantic Coast Financial Investments, Inc.
Employees
At December 31, 2017, the Company had a total of 165 employees, including 2 part-time employees. The Company’s employees are not represented by any collective bargaining group.
Supervision and Regulation
General
The U.S. banking industry is highly regulated under federal and state law. These regulations affect the operations of the Company and its subsidiaries, including the Bank. Investors should understand that the primary objectives of the U.S. bank regulatory regime are the protection of depositors and consumers and maintaining the stability of the U.S. financial system, and not the protection of stockholders.
As a bank holding company, the Company is subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the FRB). The Company is also subject to the rules and regulations of the Securities and Exchange Commission (the SEC) under the federal securities laws.
As of December 27, 2016, the Bank is a Florida state-chartered commercial bank, subject to supervision and regulation by the FDIC and the OFR. Prior to December 27, 2016, the Bank was a federally-chartered federal savings bank, subject to the supervision and regulation by the Office of Comptroller Currency (the OCC). Some of the Bank’s retail operations are also subject to supervision and regulation by the Consumer Financial Protection Bureau (the CFPB).
The aforementioned regulation and supervision establishes a comprehensive framework of activities in which an institution may engage and is intended primarily for the protection of the FDIC’s deposit insurance fund and depositors. Under this system of federal and state regulation, financial institutions are periodically examined to ensure that they satisfy applicable standards with respect to their capital adequacy, assets, management, earnings, liquidity and sensitivity to market interest rates. Following completion of its examination, the applicable federal agency critiques the institution’s operations and assigns its rating (known as an institution’s CAMELS rating). Under federal law, an institution may not disclose its CAMELS rating to the public.
Set forth below is a brief description of the bank regulatory framework that is or will be applicable to the Company and the Bank. This description is not intended to describe all laws and regulations applicable to the Company. Banking statutes, regulations and policies are continually under review by Congress and state legislatures and federal and state regulatory agencies, including changes in how they are interpreted or implemented, could have a material adverse impact on the Company or its subsidiaries (including the Bank) and their respective operations. In addition to laws and regulations, state and federal bank regulatory agencies (including the FRB, the FDIC, the OCC and the OFR) may issue policy statements, interpretive letters and similar written guidance applicable to the Company and its subsidiaries (including the Bank). These issuances also may affect the conduct of the Company’s business or impose additional regulatory obligations. The brief description below is qualified in its entirety by reference to the full text of the statutes, regulations, policies, interpretive letters and other written guidance that are described.
Dodd-Frank Wall Street Reform and Consumer Protection Act
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) has had and will continue to have a broad impact on the financial services industry, imposing significant regulatory and compliance changes, including a fundamental restructuring of the supervisory regime applicable to federal savings banks and bank holding companies, the imposition of increased capital, leverage and liquidity requirements, and numerous other provisions designed to improve supervision and oversight of, and strengthen safety and soundness within, the financial services sector. Additionally, the Dodd-Frank Act established a new framework of authority to conduct systemic risk oversight within the financial system distributed among new and existing federal regulatory agencies, including the Financial Stability Oversight Council, or Oversight Council, the FRB and the FDIC.
Many of the requirements called for in the Dodd-Frank Act remain subject to final rulemaking or phase-in over time. Given the uncertainty associated with the implementation of the Dodd-Frank Act, the full extent of the impact such requirements will have on our operations continues to be unclear. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain business practices, impose upon us more stringent capital, liquidity and leverage requirements or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make any changes necessary to comply with new statutory and regulatory requirements. Failure to comply with the new requirements may negatively impact our results of operations and financial condition. While we cannot predict what effect any presently contemplated or future changes in the laws or regulations or their interpretations would have on us, these changes could be materially adverse to our investors.
The following items provide a brief description of the relevant provisions of the Dodd-Frank Act and their potential impact on the Company’s operations and activities, both currently and prospectively.
Creation of New Governmental Agencies. The Dodd-Frank Act creates various new governmental agencies such as the Financial Stability Oversight Council and the CFPB. The CFPB has a broad mandate to issue regulations, examine compliance and take enforcement action under the federal consumer financial laws, including with respect to the Company. In addition, the Dodd-Frank Act permits states to adopt consumer protection laws and regulations that are stricter than those regulations promulgated by the CFPB, and state attorneys general are permitted to enforce consumer protection rules adopted by the CFPB against certain institutions.
Mortgage Loan Origination and Risk Retention. The Dodd-Frank Act contains additional regulatory requirements that may affect our mortgage origination and servicing operations, result in increased compliance costs and may impact revenue. For example, in addition to numerous new disclosure requirements, the Dodd-Frank Act imposes new standards for mortgage loan originations on all lenders, including state-chartered banks. Most significantly, the new standards prohibit the Bank from originating a residential mortgage loan without verifying a borrower's ability to repay, limit the total points and fees that the Bank and/or a broker may charge on conforming and jumbo loans to 3% of the total loan amount and prohibit certain prepayment penalty practices. Also, the Dodd-Frank Act, in conjunction with the FRB's final rule on loan originator prohibits certain compensation payments to loan originators and the steering of consumers to loans not in their interest because the loans will result in greater compensation for a loan originator. These standards will result in a myriad of new system, pricing and compensation controls in order to ensure compliance and to decrease repurchase requests and foreclosure defenses. In addition, the Dodd-Frank Act generally requires lenders or securitizers to retain an economic interest in the credit risk relating to loans the lender sells and other asset-backed securities that the securitizer issues if the loans have not complied with the ability to repay standards. The risk retention requirement generally will be 5%, but could be increased or decreased by regulation.
FDIC Insurance Assessments. The Dodd-Frank Act also broadened the base for FDIC insurance assessments. Assessments are now based on the average consolidated total assets less tangible equity capital of a financial institution. The Dodd-Frank Act also permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor.
Corporate Governance and Executive Compensation. The Dodd-Frank Act requires companies to give stockholders a non-binding vote on executive compensation and change-in-control payments. The legislation also directs the FRB to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded or not.
Delayed, Phased-in Implementation. As noted above, many of the provisions of the Dodd-Frank Act involve delayed effective dates and/or require implementing regulations. Accordingly, it will be some time before management can assess the full impact on operations. However, the Dodd-Frank Act has already resulted in an increased regulatory burden and compliance, operating and interest expense for the Company and its subsidiaries (including the Bank).
Federal Banking Regulation
Business Activities. A Florida state-chartered commercial bank derives its lending and investment powers from the laws and the regulations enforced and administered by the FDIC and the OFR. Under these laws and regulations, the Bank may invest in mortgage loans secured by residential and nonresidential real estate, commercial business loans and consumer loans, certain types of debt securities and certain other assets, subject to applicable limits. The Bank also may establish subsidiaries that may engage in activities not otherwise permissible for the Bank, including real estate investment and securities and insurance brokerage.
Capital Requirements. In accordance with Dodd-Frank, the FRB and the FDIC adopted new capital requirements for depository institutions, which would be phased in from 2015 to 2019, and would refine the definition of what constitutes “capital” for purposes of calculating those ratios. The new minimum capital level requirements applicable to the Company and the are: (i) a common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 4% for all institutions.
The rules also establish a “capital conservation buffer” above the regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital. The capital conservation buffer will be phased-in over four years beginning on January 1, 2016, as follows: the maximum buffer will be 0.625% of risk-weighted assets for 2016, 1.25% for 2017, 1.875% for 2018, and 2.5% for 2019 and thereafter. This will result in the following minimum ratios beginning in 2019: (i) a common equity Tier 1 capital ratio of 7.0%; (ii) a Tier 1 capital ratio of 8.5%; and (iii) a total capital ratio of 10.5%.
An institution is also subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.
Basel III provided discretion for regulators to impose an additional buffer, the “countercyclical buffer,” of up to 2.5% of common equity Tier 1 capital to take into account the macro-financial environment and periods of excessive credit growth. However, the final amended rules permit the countercyclical buffer to be applied only to “advanced approach banks” (i.e., banks with $250 billion or more in total assets or $10 billion or more in total foreign exposures), which currently excludes the Company and the Bank. The rules also implement revisions and clarifications consistent with Basel III regarding the various components of Tier 1 capital, including common equity, unrealized gains and losses, as well as certain instruments that no longer qualify as Tier 1 capital, some of which will be phased out over time. However, the final amended rules provide that small depository institution holding companies with less than $15 billion in total assets as of December 31, 2009 (which includes the Company) will be able to permanently include non-qualifying instruments that were issued and included in Tier 1 or Tier 2 capital prior to May 19, 2010 in additional Tier 1 or Tier 2 capital until they redeem such instruments or until the instruments mature.
In addition, smaller banking institutions (less than $250 billion in consolidated assets) were permitted to make a one-time election to opt-out of including most elements of accumulated other comprehensive income in regulatory capital. Importantly, the opt-out excluded from regulatory capital not only unrealized gains and losses on available-for-sale debt securities, but also accumulated net gains and losses on cash-flow hedges and amounts attributable to defined benefit postretirement plans. The Bank elected to opt-out on its March 31, 2015 Call Report.
The rules also contain revisions to the Prompt Corrective Action (PCA) framework, which is designed to place restrictions on insured depository institutions, including the Bank, if their capital levels begin to show signs of weakness. These revisions took effect January 1, 2015. Under the PCA requirements, which are designed to complement the capital conservation buffer, insured depository institutions are required to meet the following increased capital level requirements in order to qualify as “well-capitalized:”(i) a common equity Tier 1 capital ratio of 6.5%; (ii) a Tier 1 capital ratio of 8% (increased from 6%); (iii) a total capital ratio of 10% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 5% (increased from 4%).
The rules set forth certain changes for the calculation of risk-weighted assets, which were effective for us beginning January 1, 2015. The standardized approach final rule utilizes an increased number of credit risk exposure categories and risk weights, and also addresses: (i) an alternative standard of creditworthiness consistent with Section 939A of the Dodd-Frank Act; (ii) revisions to recognition of credit risk mitigation; (iii) rules for risk weighting of equity exposures and past due loans; (iv) revised capital treatment for derivatives and repo-style transactions; and (v) disclosure requirements for top-tier banking organizations with $50 billion or more in total assets that are not subject to the “advance approach rules” that apply to banks with greater than $250 billion in consolidated assets.
As of December 31, 2017, the Bank met the PCA requirements in order to qualify as “well-capitalized.”
Loans-to-One Borrower. Generally, a state-chartered bank may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of unimpaired capital and surplus. An additional amount may be loaned, equal to 10% of unimpaired capital and surplus, if the loan is secured by readily marketable collateral, which generally does not include real estate. As of December 31, 2017, the Bank was in compliance with the loans-to-one borrower limitations.
Capital Distributions. The laws and regulations enforced and administered by the FDIC and the OFR govern capital distributions by a Florida state-chartered commercial bank, which include cash dividends, stock repurchases and other transactions charged to the capital account.
A depository institution must file an application for approval of a capital distribution with the FDIC if:
·the depository institution’s eligible retained income (i.e., net income for the four calendar quarters preceding the current calendar quarter, based on the FDIC-supervised institution's quarterly call reports, net of any distributions and associated tax effects not already reflected in net income) is negative; and (b) the depository institution’s capital conservation buffer ratio is less than 2.5 percent as of the end of the previous calendar quarter;
·the depository institution would not be at least adequately capitalized following the distribution;
·the distribution would violate any applicable statute, regulation, agreement or FDIC-imposed condition; or
·the depository institution is not eligible for expedited treatment of its filings.
Additionally, a Florida state-chartered commercial bank must obtain approval of the OFR to declare a dividend from retained net profits which accrued prior to the preceding two years, but each bank or trust company shall, before the declaration of a dividend on its common stock, carry 20 percent of its net profits for such preceding period as is covered by the dividend to its surplus fund, until the same shall at least equal the amount of its common and preferred stock then issued and outstanding. No Florida state-chartered commercial bank shall declare any dividend at any time at which its net income from the current year combined with the retained net income from the preceding two years is a loss or which would cause the capital accounts of the bank or trust company to fall below the minimum amount required by law, regulation, order, or any written agreement with the office or a state or federal regulatory agency.
The FDIC or FRB may disapprove a notice or application if:
·the depository institution would be undercapitalized following the distribution;
·the proposed capital distribution raises safety and soundness concerns; or
·the capital distribution would violate a prohibition contained in any statute, regulation or agreement.
In addition, the Federal Deposit Insurance Act provides that an insured depository institution may not make any capital distribution, if after making such distribution the institution would be undercapitalized.
Liquidity. A depository institution is required to maintain a sufficient amount of liquid assets to ensure its safe and sound operation.
Community Reinvestment Act and Fair Lending Laws. All depository institutions have a responsibility under the Community Reinvestment Act and related regulations of the FDIC to help meet the credit needs of their communities, including low- and moderate-income neighborhoods. In connection with its examination of a depository institution, the FDIC is required to assess the association’s record of compliance with the Community Reinvestment Act. In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. Failure to comply with the Community Reinvestment Act could, at a minimum, result in denial of certain corporate applications such as branches or mergers, or in restrictions on its activities. The failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions by the FDIC, as well as other federal regulatory agencies and the Department of Justice. The Bank received a “satisfactory” Community Reinvestment Act rating in its most recent federal examination.
Transactions with Related Parties. A depository institution’s authority to engage in transactions with its affiliates is limited by FDIC regulations and by Sections 23A and 23B of the Federal Reserve Act and its implementing regulation, Regulation W. An affiliate is a company that controls, is controlled by, or is under common control with an insured depository institution such as the Bank. The Company is an affiliate of the Bank. In general, loan transactions between an insured depository institution and its affiliate are subject to certain quantitative and collateral requirements. In this regard, transactions between an insured depository institution and its affiliate are limited to 10% of the institution’s unimpaired capital and unimpaired surplus for transactions with any one affiliate and 20% of unimpaired capital and unimpaired surplus for transactions in the aggregate with all affiliates. Collateral in specified amounts ranging from 100% to 130% of the amount of the transaction must usually be provided by affiliates in order to receive loans from the institution. In addition, FDIC regulations prohibit a depository institution from lending to any of its affiliates that are engaged in activities that are not permissible for bank holding companies and from purchasing the securities of any affiliate, other than a subsidiary. Finally, transactions with affiliates must be consistent with safe and sound banking practices, not involve low-quality assets and be on terms that are as favorable to the institution as comparable transactions with non-affiliates. The FDIC requires depository institutions to maintain detailed records of all transactions with affiliates.
The Bank’s authority to extend credit to its directors, executive officers and 10% stockholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O promulgated by the FRB. Among other things, these provisions require that extensions of credit to insiders (i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features, and (ii) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of the Bank’s capital. In addition, extensions of credit in excess of certain limits must be approved by the Bank’s Board of Directors. The Bank is in compliance with Regulation O.
A Florida state-chartered commercial bank is also subject to other limitations under Fla. Stat. § 655.0386 that limit “financial institution-affiliated parties” (including directors, officers, employees, or controlling stockholders) from engaging or participating, directly or indirectly, in any business or transaction conducted on behalf of or involving the Florida state-chartered commercial bank, subsidiary, or service corporation which would result in a conflict of the party’s own personal interests with those of the Florida state-chartered commercial bank, subsidiary, or service corporation with which he or she is affiliated.
Enforcement. The FDIC and the OFR have primary enforcement responsibility over Florida state-chartered commercial banks, including the Bank, and have the authority to bring enforcement actions against all “institution-affiliated parties,” including stockholders, attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action by the FDIC or the OFR may range from the issuance of a capital directive or cease and desist order, to removal of officers and/or directors of the institution and the appointment of a receiver or conservator. Civil money penalties cover a wide range of violations and actions, and range up to $25,000 per day, unless a finding of reckless disregard is made, in which case penalties may be as high as $1 million per day. The FDIC also has the authority to terminate deposit insurance with respect to a particular depository institution.
Standards for Safety and Soundness. Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions. These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation, and other operational and managerial standards as the agency deems appropriate. The federal banking agencies adopted Interagency Guidelines Prescribing Standards for Safety and Soundness to implement the safety and soundness standards required under federal law. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. The guidelines address internal controls and information systems, internal audit systems, credit underwriting, loan documentation, interest rate risk exposure, asset growth, compensation, fees and benefits. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard. If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to submit a compliance plan.
Prompt Corrective Action Regulation. Under the PCA rules, the FDIC is required and authorized to take supervisory actions against undercapitalized depository institutions. For this purpose, a depository institution is placed in one of the following five categories based on the depository institution’s capital:
·well-capitalized (total risk-based capital ratio of 10% or greater, tier 1 risk-based capital ratio of 8% or greater, common equity tier 1 capital ratio of 6.5% or greater and leverage ratio of 5% or greater);
·adequately capitalized (total risk-based capital ratio of 8% or greater, tier 1 risk-based capital ratio of 6% or greater, common equity tier 1 capital ratio of 4.5% or greater and leverage ratio of 4% or greater);
·undercapitalized (total risk-based capital ratio less than 8%, tier 1 risk-based capital ratio less than 6%, common equity tier 1 capital ratio less than 4.5% or leverage ratio less than 4%);
·significantly undercapitalized (total risk-based capital ratio less than 6%, tier 1 risk-based capital ratio less than 4%, common equity tier 1 capital ratio less than 3% or leverage ratio less than 3%); or
·critically undercapitalized (ratio of tangible equity to total assets equal to or less than 2%).
Generally, the FDIC is required to appoint a receiver or conservator for a depository institution that is “critically undercapitalized” within specific time frames. The regulations also provide that a capital restoration plan must be filed with the FDIC within 45 days of the date a depository institution receives notice that it is “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” The criteria for an acceptable capital restoration plan include, among other things, the establishment of the methodology and assumptions for attaining adequately capitalized status on an annual basis, procedures for ensuring compliance with restrictions imposed by applicable federal regulations, the identification of the types and levels of activities the depository institution will engage in while the capital restoration plan is in effect, and assurances that the capital restoration plan will not appreciably increase the current risk profile of the depository institution. Any holding company for the depository institution required to submit a capital restoration plan must guarantee the lesser of: an amount equal to 5% of a depository institution’s assets at the time it was notified or deemed to be undercapitalized by the FDIC, or the amount necessary to restore the depository institution to adequately capitalized status. This guarantee remains in place until the FDIC notifies the depository institution that it has maintained adequately capitalized status for each of four consecutive calendar quarters, and the FDIC has the authority to require payment and collect payment under the guarantee. Failure by a holding company to provide the required guarantee will result in certain operating restrictions on the depository institution, such as restrictions on the ability to declare and pay dividends, pay executive compensation and management fees, and increase assets or expand operations. The FDIC may also take any one of a number of discretionary supervisory actions against undercapitalized depository institutions, including the issuance of a capital directive and the replacement of senior executive officers and directors.
Insurance of Deposit Accounts. The Bank is a member of the Deposit Insurance Fund, which is administered by the FDIC. Deposit accounts in the Bank are insured up to $250,000 by the FDIC. The FDIC imposes an assessment for deposit insurance on all depository institutions. Under the FDIC’s risk-based assessment system, insured institutions are assigned to risk categories based on supervisory evaluations, regulatory capital levels and certain other factors. An institution’s assessment rate depends upon the category to which it is assigned and certain adjustments specified by FDIC regulations, with institutions deemed less risky paying lower rates. Assessment rates (inclusive of possible adjustments) currently range from 2 ½ to 45 basis points of each institution’s total assets less tangible capital. The FDIC may increase or decrease the scale uniformly, except that no adjustment can deviate more than two basis points from the base scale without notice and comment rulemaking.
The Dodd-Frank Act increased the minimum target Deposit Insurance Fund ratio from 1.15% of estimated insured deposits to 1.35% of estimated insured deposits. The FDIC must seek to achieve the 1.35% ratio by September 30, 2020. Insured institutions with assets of $10 billion or more are supposed to fund the increase. The Dodd-Frank Act eliminated the 1.5% maximum fund ratio, instead leaving it to the discretion of the FDIC and the FDIC has exercised that discretion by establishing a long term fund ratio of 2%.
The FDIC has authority to increase insurance assessments. Any significant increases would have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what assessment rates will be in the future. Insurance of deposits may be terminated by the FDIC upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. We do not currently know of any practice, condition or violation that may lead to termination of our deposit insurance.
In addition to the FDIC assessments, the Financing Corporation (FICO) is authorized to impose and collect, with the approval of the FDIC, assessments for anticipated payments, issuance costs and custodial fees on bonds issued by the FICO in the 1980s to recapitalize the former Federal Savings and Loan Insurance Corporation. The bonds issued by the FICO are due to mature in 2017 through 2019. For the quarter ended December 31, 2017, the annualized FICO assessment was equal to 12 basis points for each $100 in domestic deposits maintained at an institution.
Prohibitions Against Tying Arrangements. Depository institutions banks are prohibited, subject to some exceptions, from extending credit to or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or its affiliates or not obtain services of a competitor of the institution.
Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank System provides a central credit facility primarily for member institutions as well as other entities involved in home mortgage lending. As a member of the Federal Home Loan Bank of Atlanta, the Bank is required to acquire and hold shares of capital stock in the Federal Home Loan Bank. As of December 31, 2017, the Bank was in compliance with this requirement.
Federal Reserve System
FRB regulations require depository institutions to maintain noninterest-earning reserves against their transaction accounts, such as negotiable order of withdrawal and regular checking accounts. At December 31, 2017, the Bank was in compliance with these reserve requirements.
Other Laws/Regulations
The Bank’s operations are also subject to federal or state laws and regulations applicable to financial institutions which relate to credit transactions, products and services offered to consumers, anti-money laundering, anti-terrorism financing and financial privacy. These laws, include, without limitation, the following:
·State usury laws and federal laws concerning interest rates and other charges collected or contracted for by the Bank;
·Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
·Home Mortgage Disclosure Act, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
·Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
·Fair Credit Reporting Act, governing the use and provision of information to credit reporting agencies;
·Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;
·Truth in Savings Act;
·Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;
·Electronic Funds Transfer Act and Regulation E promulgated thereunder, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services;
·Check Clearing for the 21st Century Act (also known as “Check 21”), which gives “substitute checks,” such as digital check images and copies made from that image, the same legal standing as the original paper check;
·The Financial Recordkeeping and Reporting of Currency and Foreign Transactions Act of 1970, as amended (commonly known as the “Bank Secrecy Act”), which, among other things, requires U.S. financial institutions to maintain appropriate records, file certain reports involving currency transactions and a financial institution’s customer relationships and to implement anti-money laundering programs;
·The economic or financial sanctions, requirements or trade embargoes imposed, administered or enforced from time to time by the U.S. Department of the Treasury’s Office of Foreign Assets Control, which require all U.S. persons, including U.S. banks, bank holding companies, and nonbank subsidiaries to comply with these sanctions, and require banks to block accounts and other property of, or reject unlicensed trade and financial transactions with specified countries, entities, and individuals;
·The USA PATRIOT Act, which requires depository institutions to, among other things, establish broadened anti-money laundering compliance programs, and due diligence policies and controls to ensure the detection and reporting of money laundering. Such required compliance programs are intended to supplement existing compliance requirements that also apply to financial institutions under the Bank Secrecy Act and the sanctions programs enforced and administered by the U.S. Department of the Treasury’s Office of Foreign Assets Control;
·The Gramm-Leach-Bliley Act, which, among other things, places limitations on the sharing of consumer financial information by financial institutions with unaffiliated third parties. Specifically, the Gramm-Leach-Bliley Act requires all financial institutions offering financial products or services to retail customers to provide such customers with the financial institution’s privacy policy and provide such customers the opportunity to “opt-out” of the sharing of certain personal financial information with unaffiliated third parties; and
·Rules and regulations of the various state and federal agencies charged with the responsibility of implementing such state or federal laws.
Holding Company Regulation
General. Atlantic Coast Financial Corporation is a bank holding company, subject to regulation and supervision by the FRB. The FRB has enforcement authority over Atlantic Coast Financial Corporation and its non-banking institution subsidiaries. Among other things, this authority permits the FRB to restrict or prohibit activities that are determined to be a risk to the Bank.
Atlantic Coast Financial Corporation’s activities are limited to those activities permissible for financial holding companies (if elected) or for bank holding companies. A financial holding company may engage in activities that are financial in nature, including underwriting equity securities and insurance, incidental to financial activities or complementary to a financial activity. A bank holding company must elect such status in order to engage in activities permissible for a financial holding company and conduct the activities in accordance with the requirements that would apply to a financial holding company’s conduct of the activity. A bank holding company is generally limited to activities permissible for bank holding companies under Section 4(c)(8) of the Bank Holding Company Act (BHCA), subject to the prior approval of the FRB, and certain additional activities authorized by FRB regulations.
Federal law prohibits a bank holding company, directly or indirectly, or through one or more subsidiaries, from acquiring control of another depository institution or holding company thereof, without prior written approval of the FRB. It also prohibits the acquisition or retention of, with specified exceptions, more than 5% of the equity securities of a company engaged in activities that are not closely related to banking or financial in nature or acquiring or retaining control of an institution that is not federally insured. In evaluating applications by holding companies to acquire depository institutions, the FRB must consider the financial and managerial resources and future prospects of the depository institution involved, the effect of the acquisition on the risk to the insurance fund, and the convenience and needs of the community and competitive factors.
Capital. The Dodd-Frank Act required the FRB to promulgate consolidated capital requirements for depository institution holding companies that are no less stringent, both quantitatively and in terms of components of capital, than those applicable to depository institutions themselves. Instruments such as cumulative preferred stock and trust preferred securities will no longer be includable as Tier 1 capital as is currently the case with bank holding companies. Instruments issued by May 19, 2010 will be grandfathered for companies with consolidated assets of $15 billion or less. The Company had no cumulative preferred stock or trust preferred securities outstanding as of December 31, 2017.
Source of Strength. The Dodd-Frank Act also extended the “source of strength” doctrine to bank holding companies, savings and loan holding companies, and other companies that control insured depository institutions and requires the regulatory agencies to issue regulations requiring that these companies serve as a source of strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of financial stress. FRB policies also provide that holding companies should pay dividends only out of current earnings and only if the prospective rate of earnings retention by the holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition.
Dividends. The Company is a legal entity separate and distinct from its subsidiaries. The majority of the Company’s revenue is from dividends paid to the Company by the Bank. The Bank is subject to laws and regulations that limit the amount of dividends it can pay. In addition, the Company and the Bank are subject to various regulatory restrictions relating to the payment of dividends, including requirements to maintain capital at or above regulatory minimums, and to remain “well-capitalized” under the prompt corrective action regulations summarized above. Federal banking regulators have indicated that banking organizations should generally pay dividends only if (1) the organization’s net income available to common stockholders over the past year has been sufficient to fully fund the dividends and (2) the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality and overall financial condition. Florida law states that, subject to certain capital requirements, the board of directors of a bank chartered under the laws of Florida may quarterly, semiannually, or annually declare a dividend of so much of the aggregate of the net profits of that period combined with its retained net profits of the preceding two years as they shall judge expedient, and, with the approval of the OFR, declare a dividend from retained net profits which accrued prior to the preceding two years.
Federal Securities Laws
Atlantic Coast Financial Corporation common stock is registered with the SEC. Atlantic Coast Financial Corporation is subject to the information, proxy solicitation, insider trading restrictions and other requirements under the Securities Exchange Act of 1934.
The registration under the Securities Act of 1933 of shares of common stock issued in Atlantic Coast Financial Corporation’s public offering does not cover the resale of those shares. Shares of common stock purchased by persons who are not affiliates of Atlantic Coast Financial Corporation may be resold without registration. Shares purchased by an affiliate of Atlantic Coast Financial Corporation are subject to the resale restrictions of Rule 144 under the Securities Act of 1933 or the requirements of other available exemptions from registration for resales of restricted securities. If Atlantic Coast Financial Corporation meets the current public information requirements of Rule 144 under the Securities Act of 1933, each affiliate of Atlantic Coast Financial Corporation that complies with the other conditions of Rule 144, including those that require the affiliate’s sale to be aggregated with those of other persons, would be able to sell in the public market, without registration, a number of shares not to exceed, in any three-month period, the greater of 1% of the outstanding shares of Atlantic Coast Financial Corporation, or the average weekly volume of trading in the shares during the preceding four calendar weeks. In the future, Atlantic Coast Financial Corporation may permit affiliates to have their shares registered for sale under the Securities Act of 1933.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 addresses, among other issues, corporate governance, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information. As directed by the Sarbanes-Oxley Act, the Company’s Chief Executive Officer and Chief Financial Officer will be required to certify that the Company’s quarterly and annual reports do not contain any untrue statement of a material fact. The rules adopted by the SEC under the Sarbanes-Oxley Act have several requirements, including having these officers certify that: they are responsible for establishing, maintaining and regularly evaluating the effectiveness of internal control over financial reporting; they have made certain disclosures to the Company’s auditors and the audit committee of the Board of Directors about internal control over financial reporting; and they have included information in the Company’s quarterly and annual reports about their evaluation and whether there have been changes in internal control over financial reporting or in other factors that could materially affect internal control over financial reporting. The Company has existing policies, procedures and systems designed to comply with these regulations, and it continues to enhance and document such policies, procedures and systems to ensure continued compliance with these regulations.
Change in Control Regulations
Under the Change in Bank Control Act, no person may acquire control of a bank holding company such as the Company unless the FRB has been given 60 days’ prior written notice and has not issued a notice disapproving the proposed acquisition, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the competitive effects of the acquisition. Control, as defined under federal law, means ownership, control of or holding irrevocable proxies representing more than 25% of any class of voting stock, control in any manner of the election of a majority of the institution’s directors, or a determination by the regulator that the acquirer has the power, directly or indirectly, to exercise a controlling influence over the management or policies of the institution. Acquisition of more than 10% of any class of a bank holding company’s voting stock constitutes a rebuttable determination of control under the regulations under certain circumstances including where, as will be the case with the Company, the issuer has registered securities under Section 12 of the Securities Exchange Act of 1934.
In addition, federal regulations provide that no company may acquire control of a bank holding company without the prior approval of the FRB. Any company that acquires such control becomes a “bank holding company” subject to registration, examination and regulation by the FRB.
Federal Taxation
General
The Company and the Bank are subject to federal income taxation in the same general manner as other corporations, with some exceptions discussed below. The following discussion of federal taxation is intended only to summarize certain pertinent federal income tax matters and is not a comprehensive description of the tax rules applicable to the Company or the Bank.
The Tax Cuts and Jobs Act (Tax Reform) was enacted on December 22, 2017. The Tax Reform reduced the corporate income tax rate to 21% effective January 1, 2018 and changed certain other provisions. Accounting guidance required the Company to remeasure its deferred tax assets and deferred tax liabilities using the new enacted tax rate. The Company has recorded additional expense of $1.6 million to reflect changes that resulted from the enactment of the Tax Reform.
Method of Accounting
For federal income tax purposes, the Company currently reports its income and expenses on the accrual method of accounting and uses a tax year ending December 31 for filing its federal and state income tax returns.
Alternative Minimum Tax
The Company and the Bank have been subject to the alternative minimum tax (AMT) in prior years and have $0.5 million available as credits to offset future tax liability; however, the utilization of the AMT credit carryforward is subject to annual limitation under Internal Revenue Code § 382 (IRC § 382).
Net Operating Loss Carryovers
Generally, a financial institution may carry back net operating losses to the preceding two taxable years and forward to the succeeding 20 taxable years. At December 31, 2017, the Company and the Bank have $5.0 million in net operating loss carryovers for federal income tax purposes which begin to expire in 2027. The utilization of these net operating loss carryovers will be restricted due to Internal Revenue Service (IRS) limitations. See Note 14. Income Taxes of the Notes contained in this Report for additional information.
Internal Revenue Code § 382
Under the rules of IRC § 382, a change in the ownership of a company limits the gross amount of net operating loss carryover a company can use per year (the annual limitation). After a change in ownership occurs, recognition of certain losses during years one to five will have an adverse effect on the utilization of the annual limitation on net operating losses. Those recognized losses will be applied to the annual limitation before the net operating losses are applied. The annual limitation is discussed in detail in Note 14. Income Taxes of the Notes contained in this Report.
Corporate Dividends-Received Deduction
The Company may exclude from its federal taxable income 100% of dividends received from the Bank as a wholly owned subsidiary pursuant to Internal Revenue Code § 243.
State Taxation
Net Operating Loss Carryovers
Net operating losses in Florida may only be carried forward for 20 taxable years; however, a corporation may carry back Georgia net operating losses to the preceding two taxable years and forward to the succeeding 20 taxable years. Through December 31, 2017, the Company and the Bank had a Florida and Georgia net operating loss carryover of $5.6 million, which begins to expire in 2018. The utilization of these net operating loss carryovers will be restricted due to IRS limitations. See Note 14. Income Taxes of the Notes contained in this Report for additional information.
Income Taxation
The Company and the Bank are subject to Florida corporate income tax, which is assessed at the rate of 5.5%. The Company and the Bank are subject to Georgia corporate income tax, which is assessed at the rate of 6.0%. For both states, taxable income generally means federal taxable income subject to certain modifications provided for in the applicable state statutes. The Company and the Bank are not currently under audit with respect to their state income tax returns, and their state income tax returns have not been audited for the past five years. As a Maryland corporation, the Company is required to file annual returns and pay annual fees to the State of Maryland.
Available Information
The Company makes available financial information, news releases and other information on the Company’s website at www.atlanticcoastbank.net. The Company’s website is not incorporated into this Report. There is a link to obtain all filings made by the Company with the SEC, including the Company’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act. The reports or amendments are available free of charge as soon as reasonably practicable after the Company files such reports and amendments with, or furnishes them to, the SEC. Stockholders of record may also contact the Company’s Investor Relations Department, 4655 Salisbury Road, Suite 110, Jacksonville, Florida 32256 or call (904) 559-8599 to obtain copies of these reports and amendments without charge.
ITEM 1A.
ITEM 1A. RISK FACTORS
Our business, and an investment in our common stock, involves risks. The risk factors which management believes are material to our business and could negatively affect our results of operations, our financial condition and the trading value of our common stock are summarized below. Other risk factors not currently known to management, or risk factors that are currently deemed to be immaterial or unlikely, could also adversely affect our business. In assessing the following risk factors, investors should also refer to the other information contained in this Report and the Company’s other filings with the SEC.
Risks Relating to our Merger with Ameris
Because the market price of Ameris common stock may fluctuate, our shareholders cannot be sure of the market value of the merger consideration they will receive until the closing.
Upon completion of the Ameris Merger, each share of Company common stock outstanding immediately prior to the effective time of the merger will be converted into the right to receive (i) 0.17 shares of Ameris common stock and (ii) a cash amount equal to $1.39 ((i) and (ii) together, the merger consideration). The market value of the stock portion of the merger consideration will fluctuate from the closing price of Ameris common stock on the date Ameris and we announced the merger, the date of our special meeting relating to the merger, and the date the merger is completed and thereafter. There will be no adjustment to the merger consideration for changes in the market price of either shares of Ameris common stock or shares of Company common stock; provided that if (i) the average closing price of Ameris common stock over a specified period prior to completion of the merger decreases below certain specified thresholds and (ii) we elect to terminate the merger agreement due to such decrease, then Ameris may elect to increase the merger consideration as outlined in the merger agreement. Stock price changes may result from a variety of factors that are beyond the control of Ameris, including, but not limited to, general market and economic conditions, changes in Ameris’ business, operations and prospects, and regulatory considerations. We make no assurances as to whether or when the merger will be completed. Therefore, at the time of our special meeting, shareholders will not know the precise market value of the aggregate merger consideration shareholders will be entitled to receive at the effective time of the merger. You should obtain current market quotations for shares of Ameris and Company common stock before you vote.
The Ameris Merger will not be completed unless important conditions are satisfied or waived, including approval by our shareholders.
Specified conditions set forth in the Merger Agreement must be satisfied or waived to complete the merger. If the conditions are not satisfied or waived, to the extent permitted by law, the merger will not occur or will be delayed and each of Ameris and the Company may lose some or all of the intended benefits of the merger.
The termination fees and the restrictions on third party proposals set forth in the Merger Agreement may discourage others from trying to acquire the Company.
Until the completion of the Ameris Merger, with some exceptions, we are prohibited from participating in any discussion of or otherwise considering any inquiries or proposals that may lead to a proposal to acquire the Company, such as a merger or other business combination transaction, with any person other than Ameris. In addition, we have agreed to pay to Ameris in certain circumstances a termination fee equal to $5.75 million. These provisions could discourage a potential competing acquiror from trying to acquire us even though this third party might be willing to offer greater value to our shareholders than Ameris has offered in the merger. Similarly, such a competing acquiror might propose a price lower than it might otherwise have been willing to offer because of the potential added expense of the termination fee that may become payable to Ameris in certain circumstances under the Merger Agreement. The payment of any termination fee could also have a material adverse effect on our financial condition.
The Ameris Merger is subject to the receipt of consents and approvals from regulatory authorities that may impose conditions that could have an adverse effect on Ameris.
Before the Ameris Merger can be completed, various approvals or consents must be obtained from bank regulatory authorities. These authorities may impose conditions on the completion of the or require changes to its terms. Such conditions or changes and the process of obtaining regulatory approvals or waivers could have the effect of delaying completion of the merger. The regulatory approvals or waivers may not be received at all, may not be received in a timely fashion or may contain conditions on the completion of the merger that are that are burdensome, not anticipated or cannot be met. If the completion of the merger is delayed, including by a delay in receipt of necessary governmental approvals or waivers, the business, financial condition and results of operations of each company may also be materially adversely affected.
We will be subject to business uncertainties and contractual restrictions while the Ameris Merger is pending.
Uncertainty about the effect of the Ameris Merger on employees, customers, suppliers and vendors may have an adverse effect on our business, financial condition and results of operations, which could negatively affect our and Ameris combined business operations. These uncertainties may impair our ability to attract, retain and motivate key personnel, depositors and borrowers pending the consummation of the merger, as such personnel, depositors and borrowers may experience uncertainty about their future roles following the consummation of the merger. Additionally, these uncertainties could cause customers (including depositors and borrowers), suppliers, vendors and others who deal with us to seek to change existing business relationships with us or fail to extend an existing relationship with us. In addition, competitors may target each party’s existing customers by highlighting potential uncertainties and integration difficulties that may result from the merger.
The pursuit of the merger and the preparation for the integration of our operations into Ameris’ may place a burden on each company’s management and internal resources. Any significant diversion of management attention away from ongoing business concerns and any difficulties encountered in the transition and integration process could have a material adverse effect on each company’s business, financial condition and results of operations. Our retention of certain employees also may be challenging while the merger is pending, as certain employees may experience uncertainty about their future roles with Ameris after the merger. If key employees depart because of issues relating to the uncertainty and difficulty of integration or a desire not to remain with us, our business could be harmed.
In addition, in the merger agreement requires us to operate our business in the ordinary course prior to closing and we are restricted from taking certain actions without Ameris’ consent while the merger is pending. These restrictions may, among other matters, prevent us from pursuing otherwise attractive business opportunities, selling assets, incurring indebtedness, engaging in significant capital expenditures in excess of certain limits set forth in the merger agreement, entering into other transactions or making other changes to our business prior to consummation of the merger or termination of the merger agreement. These restrictions could have a material adverse effect on our business, financial condition and results of operations.
Failure of the Ameris Merger to be consummated, the termination of the Merger Agreement or a significant delay in the consummation of the merger could negatively impact the Company.
If the Ameris Merger is not consummated, our ongoing business, financial condition and results of operations may be materially adversely affected and the market price of our or Ameris’ common stock may decline significantly, particularly to the extent that the current market prices reflect a market assumption that the merger will be consummated. If the consummation of the merger is delayed, the business, financial condition and results of operations of each company may be materially adversely affected. If the merger agreement is terminated and our board of directors seeks another merger or business combination, our shareholders cannot be certain that we will be able to find a party willing to engage in a transaction on more attractive terms than the merger.
Additionally, the Ameris/Company Joint Proxy Statement/Prospectus filed on Form S-4, filed on February 14, 2018, includes “Risk Factors” related to the merger and an investment in Ameris’ common stock.
Risks Relating to Our Business and Operations
Repayment risk associated with our adjustable rate loans may increase as interest rates rise.
Given the historically low interest rate environment in recent years, our adjustable rate loans have not been subject to an interest rate environment that causes them to adjust to the maximum level. As interest rates rise, such loans may involve repayment risks resulting from potentially increasing payment obligations by borrowers due to re-pricing. At December 31, 2017, there were approximately $354.7 million in adjustable rate loans, which made up 46.3% of our loan portfolio.
Interest rate volatility could significantly reduce our profitability, business, financial condition, results of operations and liquidity.
Our earnings largely depend on the relationship between the yield on our earning assets, primarily loans and investment securities, and the cost of funds, primarily deposits and borrowings. This relationship, commonly known as the net interest margin, is susceptible to significant fluctuation and is affected by economic and competitive factors that influence the yields and rates for, and the volume and mix of, our interest-earning assets and interest-bearing liabilities.
Interest rate risk can be defined as an exposure to movement in interest rates that could have an adverse impact on our net interest income. Interest rate risk arises from the imbalance in the re-pricing, maturity and/or cash flow characteristics of assets and liabilities. We are subject to interest rate risk to the degree that our interest-bearing liabilities re-price or mature more slowly or more rapidly or on a different basis than our interest earning assets. Significant fluctuations in interest rates could have a material adverse impact on our business, financial condition, results of operations or liquidity.
Our interest rate risk measurement and management techniques incorporate the re-pricing and cash flow attributes of our balance sheet and off-balance sheet instruments as they relate to current and potential changes in interest rates. The level of interest rate risk, measured in terms of the potential future effect on net interest income, is determined through the use of modeling and other techniques under multiple interest rate scenarios. Management’s objectives are to measure, monitor and develop strategies in response to the interest rate risk profile inherent in our balance sheet.
Future changes in interest rates could impact our financial condition and results of operations.
The FRB maintained the federal funds rate at the historically low rate of 0.25% during 2014 and through mid-December 2015. The rate was raised to a target rate of 0.50% in December 2015, 0.75% in December 2016, and then 1.00%, 1.25%, and 1.50% in March, June, and December 2017, respectively. It is currently unclear what the FRB intends to do in 2018. The federal funds rate has a direct correlation to general rates of interest, including our interest-bearing deposits. Our mix of asset and liabilities are considered to be sensitive to interest rate changes. Generally, customers may prepay the principal amount of their outstanding loans at any time. The speeds at which such prepayments occur, as well as the amount of such prepayments, are within our customers’ discretion. If customers prepay the principal amount of their loans, and we are unable to lend those funds to other borrowers or invest the funds at the same or higher interest rates, our interest income will be reduced. A similar prepayment risk exists for our investment portfolio which is primarily made up of mortgage-related securities, with the added impact of accelerated recognition of premiums paid to acquire the investment security. A significant reduction in interest income could have a negative impact on our results of operations and financial condition. On the other hand, if interest rates rise, net interest income might be reduced because interest paid on interest-bearing liabilities, including deposits, increases more quickly than interest received on interest-earning assets, including loans and mortgage-backed and related securities. In addition, rising interest rates may negatively affect our financial condition and results of operations because higher rates may reduce the demand for loans and the value of mortgage-related investment securities.
A significant portion of our loan portfolio is secured by real estate, and events that negatively impact the real estate market, including the secondary market for residential mortgage loans, could hurt our business.
As of December 31, 2017, approximately 91.3% of our portfolio loans had real estate as a primary or secondary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. Real estate values and the real estate markets are generally affected by a variety of factors including, but not limited to, changes in economic conditions, fluctuations in interest rates, the availability of credit, changes in tax laws and other statutes, regulations, and policies, and acts of nature. Weakening of the real estate market could result in an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing those loans, which in turn could adversely affect our profitability and asset quality. If we were required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected.
Additionally, weakness in the secondary market for residential lending could have an adverse impact on our profitability. Significant disruptions in the secondary market for residential mortgage loans may limit the market for and liquidity of mortgage loans other than conforming Fannie Mae and Freddie Mac loans. The effects of potential market challenges and uncertainty, including uncertainty with respect to U.S. monetary policy, could result in price reductions in single family home values, adversely affecting the value of collateral securing mortgage loans held, any future mortgage loan originations and gains on sale of mortgage loans. Declines in real estate values and home sales volumes and financial stress on borrowers as a result of job losses or other factors could have further adverse effects on borrowers that result in higher delinquencies and charge-offs in future periods, which could adversely affect our financial condition and results of operations.
Our loan portfolio possesses increased risk due to our number of commercial real estate, commercial business, construction and multi-family loans and consumer loans, which could increase our level of provision expense.
Our outstanding commercial real estate, commercial business, construction and multi-family real estate loans and our manufactured home, automobile and other consumer loans, in aggregate, accounted for approximately 55.9% of our total loan portfolio as of December 31, 2017. Generally, management considers these types of loans to involve a higher degree of risk compared to first mortgage loans on one- to four-family, owner occupied residential properties.
Historically, these loans have had higher risks than loans secured by residential real estate for the following reasons:
·Commercial Real Estate and Commercial Business Loans. Repayment is dependent on income being generated by the rental property or business in amounts sufficient to cover operating expenses and debt service;
·Multi-Family Real Estate Loans. Repayment is dependent on income being generated by the rental property in amounts sufficient to cover operating expenses and debt service;
·Single Family Construction Loans. Repayment is dependent upon the successful completion of the project and the ability of the contractor or builder to repay the loan from the sale of the property or obtaining permanent financing;
·Commercial and Multi-Family Construction Loans. Repayment is dependent upon the completion of the project and income being generated by the rental property or business in amounts sufficient to cover operating expenses and debt service. The collateral cannot be liquidated as easily as residential real estate and may involve expensive workout techniques. It may also involve large balances of loans to single borrowers or related groups of borrowers. Commercial business loans may be collateralized by equipment, inventory, accounts receivable, etc. which are difficult to liquidate in an event of default; and
·Consumer Loans. Consumer loans (such as automobile and manufactured home loans) are collateralized, if at all, with assets that may not provide an adequate source of repayment of the loan due to depreciation, damage or loss.
If these non-residential loans become nonperforming, we may have to increase our provision expense which would negatively affect our results of operations.
Our current asset mix and our current investments may not be indicative of our future asset mix and investments, which may make it difficult to predict our future financial and operating performance.
Certain factors make it difficult to predict our future financial and operating performance including, among others: (i) our current asset mix may not be representative of our anticipated future asset mix and may change as we continue to execute on our plans for organic loan origination and banking activities and potentially grow through future acquisitions; (ii) our significant liquid securities portfolio may not necessarily be representative of our future liquid securities position; and (iii) our cost structure and capital expenditure requirements during the periods for which financial information is available may not be reflective of our anticipated cost structure and capital spending as we continue to realize efficiencies in our business, integrate future acquisitions and continue to grow our organic banking platform.
If economic conditions deteriorate or the economic recovery from such deterioration remains slow over an extended period of time in our primary market areas of Northeast Florida, Central Florida and Southeast Georgia, our results of operation and financial condition could be adversely impacted as borrowers’ ability to repay loans declines and the value of the collateral securing the loans decreases. This geographic concentration in loans secured by one- to four-family residential real estate may increase credit losses, which could increase the level of provision expense.
Our financial results and financial condition may be adversely affected by changes in prevailing economic conditions, including decreases in real estate values, changes in interest rates, which may cause a decrease in interest rate spreads, adverse employment conditions, the monetary and fiscal policies of the federal and the Florida and Georgia state governments and other significant external events. Our market share of loans in Ware County, Georgia is significantly greater than our share of the loan market in the Jacksonville, Orlando or Tampa, Florida metropolitan areas. As a result of the concentration in Ware County, we may be more susceptible to adverse market conditions in that market. Due to the significant portion of real estate loans in the loan portfolio, decreases in real estate values could adversely affect the value of property used as collateral.
Adverse changes in the economy may also have a negative effect on the ability of borrowers to make timely repayments of their loans, which would have an adverse impact on our earnings.
Our loan portfolio possesses increased risk due to portfolio lending during a period of rising real estate values, high sales volume activity and historically low interest rate environment. The resulting high loan-to-value ratios on a portion of our residential mortgage loan portfolio expose us to greater risk of loss.
Much of our portfolio lending is in one- to four-family residential properties generally located throughout Northeast Florida, Central Florida and Southeast Georgia. Because many of our portfolio loans were originated during a period of rising real estate values and historically low interest rates, based on the Company’s most recent analysis, approximately 2.5% of the residential loan portfolio collateral is deficient due to a decline in real estate values since origination.
Many of our residential mortgage loans are secured by liens on real property, and we believe some of our borrowers may have reduced equity. Residential loans with high loan-to-value ratios will be more sensitive to declining property values than those with lower combined loan-to-value ratios and, therefore, may experience a higher incidence of default and severity of losses. In addition, if the borrowers sell their homes, such borrowers may be unable to repay their loans in full from the sale. As a result, these loans may experience higher rates of delinquencies, defaults and losses.
If our nonperforming assets increase, our earnings may be reduced.
Our nonperforming assets may increase in future periods. Our nonperforming assets adversely affect our net income in various ways. We do not record interest income on nonperforming loans or real estate owned. We must establish the allowance for losses inherent in the loan portfolio that are both probable and reasonably estimable through the current period provision expenses, which are recorded as a charge to income. From time to time, we also write down the value of properties in our OREO portfolio to reflect changing market values. Additionally, there are substantial collections costs, such as legal fees associated with the resolution of problem assets, as well as carrying costs, such as taxes, insurance and maintenance related to OREO. Further, the resolution of nonperforming assets requires the active involvement of management, which can distract management from our overall supervision of operations and other income-producing activities.
Legislative action regarding foreclosures or bankruptcy laws may negatively impact our business, financial condition, liquidity and results of operations.
Certain laws adopted following the financial crisis delay the initiation or completion of foreclosure proceedings on specified types of residential mortgage loans (some for a limited period of time), or otherwise limit the ability of residential loan servicers to take actions that may be essential to preserve the value of the mortgage loans. Any such limitations are likely to cause delayed or reduced collections from mortgagors and generally increased servicing costs. Any restriction on our ability to foreclose on a loan, any requirement that we forego a portion of the amount otherwise due on a loan or any requirement that we modify any original loan terms will in some instances require us to advance principal, interest, tax and insurance payments, which is likely to negatively impact our business, financial condition, liquidity and results of operations.
We continue to hold and acquire OREO which may lead to increased operating expenses and vulnerability to declines in real property values.
We foreclose on and take title to the real estate serving as collateral for some of our loans as part of our business. Real estate owned by us and not used in the ordinary course of operations is referred to as OREO. In the past, increased OREO balances have led to greater expenses as we incur costs to manage and dispose of the properties. Our earnings could be negatively affected by various expenses associated with OREO, including personnel costs, insurance and taxes, completion and repair costs, valuation adjustments and other expenses associated with property ownership, as well as by the funding costs associated with assets that are tied up in OREO. Any decrease in real estate market prices could lead to additional OREO write-downs, with a corresponding expense in our statement of operations. We evaluate OREO properties periodically and write down the carrying value of the properties if the results of our evaluation require it. The potential expenses associated with OREO and any further write-downs on such properties could have a material adverse effect on our financial condition and results of operations.
We may be exposed to environmental liabilities with respect to properties that we take title to upon foreclosure that could increase our costs of doing business and harm our results of operations.
In the course of our activities, we may foreclose and take title to residential and commercial properties and become subject to environmental liabilities with respect to those properties. The laws and regulations related to environmental contamination often impose liability without regard to responsibility for the contamination. We may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. Moreover, as the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based upon damages and costs resulting from environmental contamination emanating from the property. If we ever become subject to significant environmental liabilities, our business, financial condition, liquidity and results of operations would be significantly harmed.
Hurricanes or other adverse weather events could negatively affect our local markets or disrupt our operations, which would have an adverse effect on our business and results of operations.
Our market areas in Florida and Georgia are susceptible to hurricanes, tropical storms and related flooding and wind damage. Such weather events can disrupt operations, result in damage to properties and negatively affect the local economies in the markets where we operate. We cannot predict whether or to what extent damage that may be caused by such future weather events will affect our operations or the economies in our current or future market areas, but such weather events could result in a decline in loan originations, a decline in the value or destruction of properties securing our loans and an increase in the delinquencies, foreclosures or loan losses. Our business and results of operations may be adversely affected by these and other negative effects of future hurricanes, tropical storms, related flooding and wind damage and other similar weather events. As a result of the potential for such weather events, many of our customers have incurred significantly higher property and casualty insurance premiums on their properties located in our markets, which may adversely affect real estate sales and values in our markets.
If the allowance for portfolio loan losses is not sufficient to cover actual portfolio loan losses, results of operations and financial condition will be negatively affected.
In the event loan customers do not repay their loans according to their terms and the collateral security for the payments of these loans is insufficient to satisfy any remaining loan balance, we may experience significant loan losses. Such credit risk is inherent in the lending business, and failure to adequately assess such credit risk could have a material adverse effect on our financial condition and results of operations. Management makes various assumptions and judgments about the collectability of the loan portfolio, including the creditworthiness of the borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of the loans. In determining the amount of the allowance, management reviews the loan portfolio and our historical loss and delinquency experience, as well as overall economic conditions. For larger balance non-homogeneous real estate loans, the estimate of impairment is based on the underlying collateral if collateral-dependent, and if such loans are not collateral-dependent, the estimate of impairment is based on a cash flow analysis. If management’s assumptions are incorrect, the allowance may be insufficient to cover probable incurred losses in the loan portfolio, resulting in additions to the allowance for portfolio loan losses. The allowance for portfolio loan losses is also periodically reviewed by the OFR and the FDIC, who may require us to increase the amount. Additions to the allowance for portfolio loan losses would be made through increased provision expense and would negatively affect our net income and results of operations.
Operating expenses are high as a percentage of our net interest income and noninterest income, making it more difficult to maintain profitability.
Noninterest expense, which consists primarily of the costs associated with operating our business, represents a high percentage of the income we generate. The cost of generating our income is measured by our efficiency ratio, which represents noninterest expense divided by the sum of our net interest income and our noninterest income. If we are able to lower our efficiency ratio, our ability to generate income from our operations will be more effective. For the years ended December 31, 2017, 2016, and 2015, our efficiency ratios were 75.2%, 70.1%, and 103.5%, respectively. Generally, this means we spent approximately $0.75, $0.70, and $1.04 during those periods to generate $1.00 of income.
If we are unable to generate noninterest income from sales of loans originated for sale, it could have an adverse effect on our business because service charges and deposit fees are expected to continue to be under pressure.
For the year ended December 31, 2017, our service charges and deposit fees were 25.4% of total noninterest income, while gains from the sale of mortgage loans and the sale of commercial loans originated for sale under government programs was 32.4% of total noninterest income. Gains earned from the sale of mortgage loans originated for sale and from the sale of commercial loans originated for sale under government programs are expected to be an increasingly larger part of our noninterest income under our business strategy. If our plans to increase our mortgage banking business and SBA/USDA lending are not successful, resulting in less loan originations or smaller levels of gains, our operating results could be materially affected.
We may not be able to realize our deferred tax asset.
We recognize deferred tax assets and liabilities based on differences between the financial statement carrying amounts and the tax bases of assets and liabilities. The realization of the deferred tax asset is dependent upon generating taxable income, and future tax benefits will be recognized as a reduction to income tax expense which will have a positive non-cash impact on our net income and stockholders’ equity.
We could be subject to changes in tax laws, regulations and interpretations or challenges to our income tax provision.
We compute our income tax provision based on enacted tax rates in the jurisdictions in which we operate. Any change in enacted tax laws, rules or regulatory or judicial interpretations, any adverse outcome in connection with tax audits in any jurisdiction or any change in the pronouncements relating to accounting for income taxes could adversely affect our effective tax rate, tax payments and results of operations. In addition, changes in enacted tax laws, such as adoption of a lower income tax rate in any of the jurisdictions in which we operate, could impact our ability to obtain the future tax benefits represented by our deferred tax assets.
Strong competition in our primary market areas may reduce our ability to attract and retain deposits and also increase our cost of funds.
The Bank operates in very competitive markets for the attraction of deposits, the primary source of our funding. Historically, our most direct competition for deposits has come from credit unions, community banks, large commercial banks and thrift institutions within our primary market areas. In recent years, competition has also come from institutions that largely deliver their services over the internet. Such competitors have the competitive advantage of lower infrastructure costs and substantially greater resources and lending limits and may offer services we do not provide. Particularly during times of extremely low or extremely high interest rates, we have faced significant competition for investors’ funds from short-term money market securities and other corporate and government securities. During periods of regularly increasing interest rates, competition for interest-bearing deposits increases as customers, particularly time deposit customers, tend to move their accounts between competing businesses to obtain the highest rates in the market. As a result, we incur a higher cost of funds in an effort to attract and retain customer deposits. We strive to grow our lower cost deposits, such as noninterest-bearing checking accounts, in order to reduce our cost of funds.
Wholesale funding sources may be unavailable to replace deposits at maturity and support our liquidity needs or growth, which could materially adversely impact our operating margins and profitability.
The Bank must maintain sufficient funds to respond to the needs of depositors and borrowers. As part of our liquidity management, we use a number of wholesale funding sources in addition to non-maturity deposit growth and repayments and maturities of loans and investments.
Our financial flexibility will be severely constrained if we are unable to maintain our access to wholesale funding or if adequate financing is not available to accommodate future growth at acceptable interest rates. If we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs. In this case, our operating margins and profitability would be adversely affected.
Our deposit insurance premiums could be substantially higher in the future, which could have a material adverse effect on our profitability or ability to pursue certain business opportunities.
The FDIC insures deposits at FDIC-insured depository institutions, such as Atlantic Coast Bank, up to $250,000 per account. The amount of a particular institution’s deposit insurance assessment is based on that institution’s risk classification under an FDIC risk-based assessment system. An institution’s risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to its regulators. We are generally unable to control the amount of premiums that we are required to pay for FDIC insurance. If our financial condition deteriorates or if the Bank's regulators otherwise have supervisory concerns, then our assessments could rise. Any future additional assessments, increases or required prepayments in FDIC insurance premiums could reduce our profitability, may limit our ability to pursue certain business opportunities, or otherwise negatively impact our operations.
New mortgage lending rules may constrain Atlantic Coast Bank’s residential mortgage lending business.
Over the course of the last few years, the CFPB has issued several rules on mortgage lending, notably a rule requiring all home mortgage lenders to determine a borrower’s ability to repay the loan. Loans with certain terms and conditions and that otherwise meet the definition of a “qualified mortgage” may be protected from liability. In either case, the Bank may find it necessary to tighten its mortgage loan underwriting standards, which may constrain our ability to make loans consistent with our business strategies.
Financial reform legislation may continue to result in new laws and regulations that are expected to increase our costs of operations and compliance.
The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations, and consequently many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years.
We expect that our operating and compliance costs, and possibly our interest expense, could increase as a result of the Dodd-Frank Act and the implementing rules and regulations. The need to comply with additional rules and regulations, as well as state laws and regulations, will also divert management’s time from managing our operations. Higher capital levels would reduce our ability to grow and increase our interest-earning assets which would adversely affect our return on stockholders’ equity.
We are also subject to fair lending laws and regulations, such as the Equal Credit Opportunity Act and the Fair Housing Act. Both federal/state agencies and individuals can challenge an institution's performance under these laws. This can impact our ratings under the Community Reinvestment Act and result in sanctions, including damages and civil money penalties, injunctive relief, etc., which could negatively impact business and operations.
The short-term and long-term impact of the changing regulatory capital requirements and anticipated new capital rules are uncertain and could materially adversely impact our business and ability to pay dividends or buyback our shares in the future.
On July 2, 2013, the federal banking agencies issued final capital rules that substantially amend the regulatory risk-based capital rules applicable to us. The rules implement the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act. The rules phase in over time beginning in 2015 and will become fully effective in 2019. The rules apply both to our Company, which currently is not subject to formal capital rules, and Atlantic Coast Bank. The final rules resulted in higher regulatory capital standards, which may result in lower returns on equity, require the raising of additional capital, or result in regulatory actions if we were to be unable to comply with such requirements. As of December 31, 2017, the Bank would have been in compliance with the minimum capital requirements set forth in Basel III.
Additionally, in any economic or regulatory environment, bank regulators may impose capital requirements that are more stringent than those required by applicable existing regulations. The application of more stringent capital requirements for Atlantic Coast Bank could, also limit our ability to make distributions, including paying dividends or buying back our shares.
The federal banking agencies are likely to issue new liquidity standards that could result in our having to lengthen the term of our funding, restructure our business models, and increase our holdings of liquid assets.
As part of the Basel III capital process, the Basel Committee on Banking Supervision has finalized a new Liquidity Coverage Ratio, which requires a banking organization to hold sufficient “high quality liquid assets” to meet liquidity needs for a 30 calendar day liquidity stress scenario, and a Net Stable Funding Ratio, which imposes a similar requirement over a one-year period. The U.S. banking regulators have said that they intend to adopt such liquidity standards, although they have not yet proposed a rule. New rules could restrict our operations and adversely affect our results and financial condition, by requiring us to lengthen the term of our funding, restructure our business models, and increase our holdings of liquid assets.
Florida financial institutions face a higher risk of noncompliance and enforcement actions with the Bank Secrecy Act and other Anti-Money Laundering statutes and regulations.
Banking regulators intensely focus on Anti-Money Laundering and Bank Secrecy Act compliance requirements, particularly the Anti-Money Laundering provisions of the USA PATRIOT Act. There is also scrutiny of compliance with the rules enforced by the Office of Foreign Assets Control. Banking regulators and examiners are aggressive in their supervision and examination of financial institutions located in the State of Florida with respect to institutions’ Bank Secrecy Act and Anti-Money Laundering compliance. Consequently, a number of formal enforcement actions have been issued against Florida financial institutions.
In order to comply with regulations, guidelines, and examination procedures in this area, the Bank has been required to adopt new policies and procedures and to install new systems. If the Bank has policies, procedures, and systems that are deemed deficient, then the Bank would be subject to liability, including fines and regulatory actions such as restrictions on its ability to pay dividends and the necessity to obtain regulatory approvals to proceed with certain aspects of its business plan including its acquisition plans.
We may be unable to successfully implement our business strategy and as a result, our financial condition and results of operations may be negatively affected.
Our future success will depend on management’s ability to successfully implement its business strategy, which includes managing nonperforming assets and operating expenses, continuing to grow our mortgage banking, our commercial and industrial lending, warehouse lending, and small business lending businesses, as well as our banking services to small businesses. While we believe we have the management resources and internal systems in place to successfully implement our strategy, it will take time to fully implement our strategy. We expect that it may take a significant period of time before we can achieve the intended results of our business strategy. During the period we are implementing our plan, our results of operations may be negatively impacted. In addition, even if our strategy is successfully implemented, it may not produce positive results.
Additionally, future success in the expansion of mortgage banking, commercial and industrial lending, warehouse lending, and small business lending businesses will depend on management’s ability to attract and retain highly skilled and motivated loan originators. The Bank competes against many institutions with greater financial resources to attract these qualified individuals. Failure to recruit and retain adequate talent could reduce our ability to compete successfully and adversely affect our business and profitability.
Our internal controls may be ineffective.
Management regularly reviews and updates our internal controls over financial reporting, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, can provide only reasonable, not absolute, assurances that the objectives of the controls are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our financial condition and results of operations.
Our enterprise risk management framework may not be effective in mitigating the risks to which we are subject, or in reducing the potential for losses in connection with such risks.
Our enterprise risk management framework is designed to minimize or mitigate the risks to which we are subject, as well as any losses stemming from such risks. Although we seek to identify, measure, monitor, report, and control our exposure to such risks, and employ a broad and diversified set of risk monitoring and mitigation techniques in the process, those techniques are inherently limited in their ability to anticipate the existence or development of risks that are currently unknown and unanticipated. The ineffectiveness of our enterprise risk management framework in mitigating the impact of known risks or the emergence of previously unknown or unanticipated risks may result in our incurring losses in the future that could adversely impact our financial condition and results of operations.
Failure to keep pace with technological changes, invest in technological improvements, and manage our information systems and related risks could have an adverse effect on our financial condition and results of operations.
The financial services industry continues to undergo rapid technological changes with frequent introductions of new technology-driven products and services. In addition to serving clients better, the effective use of technology may increase efficiency and may enable financial institutions to reduce costs. Our future success will depend, in part, upon our ability to use technology to provide products and services that provide convenience to customers and to create additional efficiencies in operations. We may need to make significant additional capital investments in technology in the future, and we may not be able to effectively implement new technology-driven products and services. Many competitors have substantially greater resources to invest in technological improvements.
We rely on our information technology and telecommunications systems and third-party service providers. Failures or interruptions affecting information technology and telecommunications systems maintained by us or our service providers could have an adverse effect on our financial condition and results of operations.
Third parties provide key components of our business infrastructure, such as banking services, processing, and internet connections and network access. Any disruption in such services provided by these third parties or any failure of these third parties to handle currently or higher volumes of use could adversely affect our ability to deliver products and services to clients and otherwise to conduct business. Technological or financial difficulties of a third party service provider could adversely affect our business to the extent those difficulties result in the interruption or discontinuation of services provided by that party. Further, in some instances we may be responsible for the failure of such third parties to comply with government regulations. We may not be insured against all types of losses as a result of third party failures and our insurance coverage may not be inadequate to cover all losses resulting from system failures or other disruptions. Failures in our business infrastructure could interrupt the operations or increase the cost of doing business.
Our business is subject to cybersecurity risks associated with our on-line banking services and our reliance on electronic data transfer. Failure to detect or prevent a breach of our technological infrastructure or information security systems, or those of our third party vendors and other service providers, including as a result of a cyberattack, “hacking” or identity theft, could disrupt our business, result in a disclosure or misuse of confidential or propriety information, damage our reputation, increase our costs, or have an adverse effect on our financial condition and results of operations.
We depend on our ability to process, record and monitor a large number of client transactions on a continuous basis. As client, public and regulatory expectations regarding operational and information security have increased, our operational systems and infrastructure must continue to be safeguarded and monitored for potential failures, disruptions and breakdowns. Our business, financial, accounting, data processing, or other operating systems and facilities may stop operating properly or become disabled or damaged as a result of a number of factors including events that are wholly or partially beyond our control. Although we have business continuity plans and other safeguards in place, our business operations may be adversely affected by significant and widespread disruption to our physical infrastructure or operating systems that support our businesses and clients.
Information security risks for financial institutions have generally increased in recent years in part because of the proliferation of new technologies, the use of the internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of hackers, terrorists, activists, and other external parties. As noted, above, our operations rely on the secure processing, transmission, and storage of confidential information in our computer systems and networks. Our banking and other businesses rely on our digital technologies, computer and e-mail systems, software and networks to conduct our operations. In addition, to access our products and services, our clients may use personal smartphones, tablets, personal computers, and other mobile devices that are beyond our control systems. Although we have information security procedures and controls in places, our technologies, systems, networks and our client’s devices may become the target of cyber-attacks or information security breaches that could result in the misappropriation of clients’ funds, the unauthorized release, gathering, monitoring, misuse, loss or destruction of our or our client’s confidential, proprietary and other information, or otherwise disrupt our or our clients’ or other third parties’ business operations. Therefore, a successful breach could result in significant financial loss to the Company, as well as damage our reputation in the markets we serve, the banking industry in general, and among our counterparties.
We may be subject to losses due to the errors or fraudulent behavior of employees or third parties.
We are exposed to many types of operational risk, including the risk of fraud by employees and outsiders, clerical recordkeeping errors and transactional errors. Our business is dependent on our employees as well as third-party service providers to process a large number of increasingly complex transactions. We could be materially adversely affected if any of our employees cause a significant operational breakdown or failure, either as a result of human error or where an individual purposefully sabotages or fraudulently manipulates our operations or systems or if one of our third-party service providers experiences an operational breakdown or failure. When we originate loans, we rely upon information supplied by loan applicants and third parties, including the information contained in the loan application, property appraisal and title information, if applicable, and employment and income documentation provided by third parties. If any of this information is misrepresented and such misrepresentation is not detected prior to loan funding, we generally bear the risk of loss associated with the misrepresentation. Any of these occurrences could result in a diminished ability of us to operate our business, potential liability to customers, reputational damage and regulatory intervention, which could negatively impact our business, financial condition and results of operations.
We operate in a highly regulated environment and the laws and regulations that govern our operations, corporate governance, executive compensation and accounting principles, or changes in them, or our failure to comply with them, may adversely affect us.
The Bank is currently subject to extensive laws and regulations, as well as supervision and examination by the FDIC (which insures the Bank’s deposits) and the OFR. As a bank holding company, we are also currently subject to regulation and supervision by the FRB. These regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities. Intended to protect clients, depositors, the deposit insurance fund, and the overall financial system, these laws and regulations, among other matters, prescribe minimum capital requirements, impose limitations or restrictions on the business activities in which we can engage, limit the dividend or distributions that the Bank can pay to the Company, restrict the ability of institutions to guarantee our debt, impose certain specific accounting requirements on us that may be more restrictive and may result in greater or earlier charges to earnings or reductions in our capital than U.S. GAAP, among other things.
Our operations are also subject to extensive regulation by other federal, state and local governmental authorities, and are subject to various laws and judicial and administrative decisions that impose requirements and restrictions on our operations. These laws, rules and regulations are frequently changed by legislative and regulatory authorities. In the future, changes to existing laws, rules and regulations, or any other new laws, rules or regulations could make compliance more difficult or expensive or otherwise adversely affect our business, financial condition or prospects.
Compliance with laws and regulations can be difficult and costly, and changes to laws and regulations often impose additional compliance costs. We are currently facing increased regulation and supervision of our industry as a result of the financial crisis in the banking and financial markets, and, to the extent that we participate in any programs established or to be established by the U.S. Treasury or by the federal bank regulatory agencies, there will be additional and changing requirements and conditions imposed on us. Such additional regulation and supervision may increase our costs and limit our ability to pursue business opportunities. Further, our failure to comply with these laws and regulations, even if the failure is inadvertent or reflects a difference in interpretation, could subject us to restrictions on our business activities, fines and other penalties, any of which could adversely affect our results of operations, capital base and the price of our securities.
We rely on our management team for the successful implementation of our business strategy.
Turnover of key management and directors, or the loss of other senior managers could have a disproportionate impact on the Company and may have a material adverse effect on our ability to implement our business plan. As we are a relatively small bank with a relatively small management team, certain members of our senior management team have more responsibility than his or her counterpart typically would have at a larger institution with more employees, and we have fewer management-level personnel who are in a position to assume the responsibilities of our executive management team.
Risks Relating to Ownership of Our Common Stock
Our stock price may be volatile due to limited trading volume.
Our common stock is traded on the NASDAQ Global Market. However, the average daily trading volume in our common stock is relatively small, approximately 52,000 shares per day in 2017, and sometimes significantly less than that. As a result, trades involving a relatively small number of shares may have a significant effect on the market price of the common stock, and it may be difficult for investors to acquire or dispose of large blocks of stock without significantly affecting the market price. If our Market Value of Publicly Held Shares (as defined under NASDAQ rules) falls below $5.0 million or the price per share of the common stock falls below $1.00 for a specified amount of time, under applicable NASDAQ rules, we will generally have 180 calendar days from the date of the receipt of the notification from NASDAQ that we have failed to comply with its applicable listing standards to regain compliance with those standards. If we are unable to regain compliance, we may have to transfer the listing of our common stock to the NASDAQ Capital Market or begin trading on the over-the-counter market, which may adversely affect the trading market for our shares.
Our ability to pay dividends is limited.
We have not paid dividends to our common stockholders since July 2009. Our ability to pay dividends is limited by the Merger Agreement, regulatory requirements and the need to maintain sufficient consolidated capital to meet the capital needs of our business, including capital needs related to future growth. The Company’s primary source of funds available for the payment of dividends is the dividend payments we receive from Atlantic Coast Bank.
A Florida state-chartered commercial bank may not pay cash dividends that would cause the bank’s capital to fall below the minimum amount required by federal or state law. Accordingly, Florida state-chartered commercial banks may only pay dividends out of the total of current net profits plus retained net profits of the preceding two years to the extent it deems expedient, except no bank may pay a dividend at any time such that the total of net income for the current year when combined with retained net income from the preceding two years, produces a loss. We cannot provide assurances that we will be able to pay dividends to common stockholders in the future, and, if we are able to pay dividends, we cannot provide assurances as to the amount or timing of any such dividends. If we are able to pay dividends in the future, we cannot provide assurances that those dividends will be maintained, at the same level or at all, in future periods.
We may need additional financing in the future, and any additional financing may result in substantial dilution to our stockholders.
If the Ameris Merger is not consummated for any reason, we may need to obtain additional financing in the future for a variety of reasons, including meeting our regulatory obligations, conducting our ongoing operations, or funding expansion, as well as to respond to unanticipated situations. We may try to raise additional funds through public or private financings, strategic relationships or other arrangements.
Our ability to obtain additional financing will depend on a number of factors, including market conditions, our operating performance and investor interest. Additional funding may not be available to us on acceptable terms or at all. If we succeed in raising additional funds through the issuance of equity or convertible securities, it could result in substantial dilution to existing stockholders.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
ITEM 2. PROPERTIES
At December 31, 2017, the Company had ten full-service branch offices, one drive-up facility, office space for the home and executive offices (which includes a drive-up ATM) and four lending offices. The Company owns many of these locations; however, the home and executive offices in Jacksonville, Florida, the branch location in Orange Park, Florida, and the four lending offices are all leased.
Management believes the Company’s facilities are suitable for their intended purposes and adequate to support its current and projected business needs. Management continuously reviews the branch and office locations in order to improve the visibility and accessibility of the Bank.
The following table provides a list of the Company’s offices as of December 31, 2017:
(1)This lease term was extended on a month to month basis, subsequent to December 31, 2017.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
Part II.
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Atlantic Coast Financial Corporation’s common stock is traded on the NASDAQ Global Market under the symbol “ACFC.” As of March 1, 2018, there were 15,552,833 shares of common stock issued and outstanding, with approximately 2,000 stockholders, including stockholders of record and beneficial stockholders.
The Company paid quarterly cash dividends from May 2005 until September 2009, at which time the Company suspended its regular quarterly cash dividend. Future cash dividend payments by the Company and the amount thereof will depend on a number of factors, including financial condition, capital requirements, cash flows, results of operations, future business prospects and other factors that the Company’s Board of Directors may deem relevant and will also be substantially dependent on cash dividends the Company receives from its subsidiary, the Bank. The Bank is limited in the amount of cash dividends that may be paid, and such amount is based on the Bank’s net earnings of the current year combined with the Bank’s retained earnings of the preceding two years, as defined by state banking regulations. In addition, bank regulators have the authority to prohibit banks from paying dividends if they deem such payment to be an unsafe or unsound practice.
The following table sets forth the quarterly high and low sales prices and cash dividends declared on the Company’s common stock for the years ended December 31, 2017 and 2016:
The Company did not repurchase any shares of its common stock during the year ended December 31, 2017.
The table below sets forth information, as of December 31, 2017, regarding equity compensation plans categorized by those plans that have been approved by stockholders and those plans that have not been approved by stockholders.
(1)Consists of options to purchase 20,776 shares of common stock under the Atlantic Coast Federal Corporation 2005 Stock Option Plan.
(2)The weighted average exercise price reflects the weighted average exercise price of stock options awarded under the Atlantic Coast Federal Corporation 2005 Stock Option Plan.
(3)In accordance with its provisions, the Atlantic Coast Federal Corporation 2005 Stock Option Plan was terminated on July 27, 2015; therefore, no securities remain available for future issuance under this plan.
(4)The Atlantic Coast Financial Corporation 2016 Omnibus Incentive Plan was approved at the Company’s 2016 Annual Meeting of Stockholders; therefore, 455,352 securities are available for future issuance under this plan.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following is a summary of selected consolidated financial data of the Company at and for the years indicated. The summary should be read in conjunction with the consolidated financial statements and accompanying notes to the consolidated financial statements contained in Item 8. Financial Statements and Supplementary Data herein.
Selected Consolidated Balance Sheet Data
Selected Consolidated Statement of Operations Data
Selected Consolidated Financial Ratios and Other Data
(1)Interest rate spread represents the difference between the weighted-average yield on interest-earning assets and the weighted-average cost of interest-bearing liabilities for the period.
(2)Net interest margin represents net interest income divided by average interest earning assets.
(3)Efficiency ratio represents noninterest expense as a percentage of net interest income plus noninterest income.
ITEM 7.
ITEM 7. 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 Consolidated Financial Statements and accompanying Notes of the Company appearing elsewhere in this Report (the Notes).
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, late in 2015 the Bank also started soliciting deposits in Central Florida.
See Item 1. Business and Item 8. Financial Statements and Supplementary Data in this Report for further information related to financial condition and results of operation.
Business Strategy
Overview
Our primary objective is to operate a community-oriented financial institution, serving customers in our market areas while providing stockholders with a solid long-term return on capital. Accomplishing this objective will require financial strength based on a strong capital position and the implementation of business strategies designed to keep the Company profitable consistent with safety and soundness considerations. The Company’s operating strategies are focused on increasing revenues from traditional small business commercial lending, including SBA and USDA lending activity, mortgage banking through the Bank’s internal mortgage loan origination platform, and warehouse loans held-for-investment origination. In addition, the Company will focus on a conservative credit culture designed to keep nonperforming assets at a low level. Finally, the Company will seek to increase non-maturity deposits through added customer relationships to improve our cost of funds and to help further reduce our cost structure.
Management has pursued, and plans to continue to pursue, various options to aid in the steady improvement of the Company’s financial condition and results of operations. The following are the key elements of our business strategy:
Increasing Revenue By Continuing to Focus on Commercial Lending to Small Businesses, Continuing to Build Our Internal Mortgage Originations, and Growing Our Warehouse Loans Held-For-Investment Operations. In 2014, the Bank began emphasizing increased production in commercial lending to small businesses. As a result, at December 31, 2017, our commercial real estate and commercial business loans totaled $298.7 million, or 39.3% of our loan portfolio. Since the beginning of 2014, the Bank has emphasized the origination of one- to four-family residential mortgage loans in Northeast Florida and Southeast Georgia, and expanded into Central Florida in the beginning of 2015. At December 31, 2017, our one- to four-family residential loan portfolio was $286.7 million, or 37.8% of our loan portfolio. Additionally, during 2012, management shifted our business model to include an emphasis on growth in warehouse loans held-for-investment lending.
·Commercial lending strategy. Management plans to increase commercial business lending and owner-occupied commercial real estate lending with an emphasis on small businesses. The Bank intends to participate in government programs relating to commercial business loans, such as the programs administered by the USDA and the SBA. The Company generally sells the guaranteed portion of SBA and USDA loans to investors at attractive premiums. Our focus on owner-occupied commercial real estate loans will be to professional service businesses. The Bank does not intend to originate or purchase higher risk loans, such as commercial real estate development projects or land acquisition and development loans.
·Internal mortgage originations strategy. Early in 2014, the Bank reentered the business of originating one- to four-family residential loans for investment, and intends to continue originating such loans internally. Additionally, the Bank intends to originate one- to four-family residential loans for sale on the secondary market to supplement noninterest income.
·Warehouse loans held-for-investment lending strategy. In the latter part of 2009, the Bank began a program for warehouse loans held-for-investment lending where we finance lines of credit secured by one- to four-family residential loans originated under purchase and assumption agreements by third-party originators and hold a lien position for a short duration (usually less than 30 days) while earning interest and often a fee until a sale is completed to an investor. During 2012, management started emphasizing growth in this business by expanding relationships with existing counterparties, as well as establishing relationships with new counterparties. The Bank expects to continue modestly expanding this aspect of mortgage banking in the future.
Continuing Our Proactive Approach to Keeping Nonperforming Assets at a Low Level Through Aggressive Resolution and Disposition Initiatives. As a result of management’s proactive strategy, our nonperforming assets were $9.5 million at December 31, 2017. Management plans to continue to use a proactive strategy to keep nonperforming assets at a low level through loan workout programs with borrowers and enhanced collection practices.
·A conservative charge-off policy. Management utilizes a conservative charge-off strategy for one- to four-family residential mortgage loans and home equity loans by taking partial or full charge-offs in the period that such loans became nonaccruing, generally when loans are 90 days or more past due.
·Loan workout programs with borrowers. The Bank is committed to working with responsible borrowers to renegotiate loan terms. The Bank had $30.9 million in TDRs (including $15.7 million of TDRs performing for more than 12 months under the modified terms) at December 31, 2017. TDRs avoid the expense of foreclosure proceedings and holding and disposition expenses of selling foreclosed property and provide us increased interest income.
·Nonperforming asset sales. As a part of the Bank’s workout program, the Bank continues to accept short sales of residential property by borrowers where such properties are sold at a loss and the proceeds of such sales are paid to us when this action represents the least costly resolution for the Company. Also, when necessary, in order to reduce the expenses of the foreclosure process, including the sale of foreclosed property, the Bank may sell certain nonperforming loans through national loan sales of distressed assets, which may mitigate future losses. During 2017, the Bank did not sell any nonperforming assets through bulk distressed asset sales and does not intend to use bulk distressed asset sales in the near future.
·Credit risk management. The Bank is committed to enhancing credit administration by improving internal risk management processes. In 2010, an independent risk committee of the Bank’s Board of Directors was established to evaluate and monitor system, market and credit risk. In 2012, the Bank established a broad problem asset resolution program and developed enhanced asset workout plans for each criticized asset.
Strengthening Our Retail Franchise By Growing Noninterest-bearing Deposits and Reducing Our Overall Cost of Deposits. We believe a successful retail franchise results from a strong core customer base that focuses on noninterest-bearing deposits within an overall deposit strategy that offers interest rates that are competitive to its markets, but in line with the overall interest rate environment. Therefore, we remain committed to generating lower-cost and more stable noninterest-bearing deposits and offering our customers other deposit products with interest rates that are fair and meet their financial needs. The Bank complements its attractive deposit products with excellent customer service and a comprehensive marketing program. The Bank will continue to build a core customer base by offering noninterest-bearing and other non-maturity deposits to individuals, businesses and municipalities located in our market areas. Our noninterest-bearing deposits were $63.9 million at December 31, 2017. The average cost of deposits (interest expense on deposits as compared to total average deposits) for the full year of 2017 was 0.77%. In addition to improving our interest rate spread, noninterest-bearing deposits also contribute noninterest income from account related services.
Reducing Our Expense Base. In order to improve the Company’s profitability, we continue to emphasize expense reduction initiatives in order to reduce operating costs that do not add value to our other business strategies. We intend to continue this focus in order to eliminate non-value added expenses and activities.
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 and provision expense; (ii) measuring for impairment in TDRs; (iii) determining the fair value of investment securities; (iv) determining the fair value of OREO; and (v) accounting for deferred income taxes.
Allowance for Portfolio Loan Losses
An allowance is maintained to reflect probable incurred losses in the loan portfolio. The allowance is based on ongoing assessments of the estimated losses incurred in the loan portfolio and is established as these losses are recognized through provision expense charged to earnings. Generally, portfolio loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The reasonableness of the allowance is reviewed and established by management, within the context of applicable accounting and regulatory guidelines, based upon its evaluation of then-existing economic and business conditions affecting the Bank’s key lending areas. Senior credit officers monitor those conditions continuously and reviews are conducted quarterly with the Bank’s senior management and Board of Directors.
The allowance was $8.6 million, or 1.1%, and $8.2 million, or 1.3%, of total portfolio loans outstanding at December 31, 2017 and 2016, respectively. The provision expense for each quarter of 2017, 2016 and 2015, and the total for the respective years is as follows:
(1)May not foot due to rounding.
The amount of the allowance and related provision expense can vary over long-term and short-term periods. Changes in economic conditions, the composition of the loan portfolio, and individual borrower conditions can dramatically impact the required level of allowance, particularly for larger individually evaluated loan relationships, in relatively short periods of time. The allowance allocated to individually evaluated loan relationships was $0.5 million at both December 31, 2017 and 2016, respectively. Given the constantly shifting real estate market coupled with changes in borrowers’ financial condition, changes in collateral values, and the overall economic uncertainty that continues to persist, management believes there could be significant changes in individual specific loss allocations in future periods as these factors are difficult to predict and can vary widely as more information becomes available or as projected events change.
The allowance is discussed in further detail in Note 1. Summary of Significant Accounting Policies of the Notes contained in this Report.
Troubled Debt Restructurings
Portfolio loans for which concessions have been granted as a result of the borrower’s financial difficulties are classified as a TDR and, consequently, an impaired loan. TDRs are measured for impairment based upon the present value of estimated future cash flows using the loan’s interest rate at inception of the loan or the appraised value of the collateral if the loan is collateral dependent. Impairment of homogeneous portfolio loans, such as one- to four-family residential loans, that have been modified as TDRs is calculated in the aggregate based on the present value of estimated future cash flows. Portfolio loans modified as TDRs with market rates of interest are classified as impaired portfolio loans. Once the TDR loan has performed for twelve 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.
Fair Value of Investment Securities
Investment securities available-for-sale are carried at fair value, with unrealized holding gains and losses reported separately in other comprehensive income (loss), net of tax. Investment securities held-to-maturity are carried at amortized cost. The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or model-based techniques that use significant assumptions not observable in the market (Level 3).
Management evaluates investment securities for OTTI at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. The assessment of whether other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at the determination date. The Company recorded no OTTI for the years ended December 31, 2017, 2016 and 2015.
The fair value of investment securities is discussed in further detail in Note 1. Summary of Significant Accounting Policies and Note 4. Fair Values of the Notes contained in this Report.
Fair Value of Other Real Estate Owned and Foreclosed Assets
Assets acquired by the Bank through or in lieu of loan foreclosure are initially recorded at fair value based on an independent appraisal, less estimated selling costs, at the date of foreclosure, establishing a new cost basis. If fair value declines subsequent to foreclosure, the asset value is written down through expense. Costs relating to improvement of property are capitalized, whereas costs relating to holding of the property are expensed.
Deferred Income Taxes
After previously converting to a federally-chartered savings bank, the Bank became a taxable organization and, after the Bank’s recent charter conversion, remains a taxable organization as a Florida state-chartered commercial bank. Income tax expense, or benefit, is the total of the current year income tax due, or refundable, and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary difference between carrying amounts and tax basis of assets and liabilities, computed using enacted tax rates and operating loss carryovers. The Company’s principal deferred tax assets result from the allowance for portfolio loan losses and operating loss carryovers. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. The Internal Revenue Code and applicable regulations are subject to interpretation with respect to the determination of the tax basis of assets and liabilities for credit unions that convert charters and become a taxable organization. Since the Bank’s transition to a taxable organization, the Company has recorded income tax expense based upon management’s interpretation of the applicable tax regulations. Positions taken by the Company in preparing our federal and state tax returns are subject to the review of taxing authorities, and the review by taxing authorities of the positions taken by management could result in a material adjustment to the financial statements.
All available evidence, both positive and negative, is considered when determining whether or not a valuation allowance is necessary to reduce the carrying amount to a balance that is considered more likely than not to be realized. The determination of the realizability of deferred tax assets is highly subjective and dependent upon judgment concerning management’s evaluation of such evidence.
Under the rules of IRC § 382, a change in the ownership of the Company occurred during the first quarter of 2013. During the second quarter of 2013, the Company became aware of the change in ownership based on applicable filings made by stockholders with the SEC. In accordance with IRC § 382, the Company determined the gross amount of net operating loss carryover that it could utilize was limited to approximately $325,000 per year.
The deferred tax asset is discussed in further detail in Deferred Income Taxes on page 66 and in Note 14. Income Taxes of the Notes contained in this Report.
Comparison of Financial Condition at December 31, 2017 and 2016
General
Total assets increased $75.8 million, or 8.4%, to $983.3 million at Deecmber 31, 2017, as compared to $907.5 million at December 31, 2016. The increase in assets was funded primarily by increases in non-maturing deposits of $65.2 million, an increase of $24.8 million in Federal Home Loan Bank (FHLB) advances and stockholders’ equity of $3.7 million, as discussed below, partially offset by a decrease in time deposits of $17.8 million. Net portfolio loans increased $118.3 million, while cash and cash equivalents decreased $9.5 million, investment securities decreased $27.6 million and other loans decreased $2.4 million. Total deposits increased $47.4 million, or 7.5%, to $675.8 million at December 31, 2017, from $628.4 million at December 31, 2016. Noninterest-bearing demand accounts increased $4.2 million and savings and money market accounts increased $69.7 million, while interest-bearing demand accounts decreased by $8.7 million and time deposits decreased by $17.8 million during the year ended December 31, 2017. Total borrowings increased by $24.8 million to $213.5 million at December 31, 2017, from $188.7 million at December 31, 2016, due to the aforementioned increase in FHLB advances during 2017, as the Company supplemented its core deposit growth in order to meet its loan funding demand. Stockholders’ equity increased by $3.7 million to $90.7 million at December 31, 2017, from $87.0 million at December 31, 2016, primarily due to net income of $3.2 million and other comprehensive income of $0.3 million for the year ended December 31, 2017.
Following are the summarized comparative balance sheets as of December 31, 2017 and 2016:
Cash and Cash Equivalents
Cash and cash equivalents decreased $9.5 million to $50.4 million at December 31, 2017 from $59.9 million at December 31, 2016. The Bank has increased contingent liquidity capacity and sources to meet potential funding requirements, including availability from the FHLB, the Federal Reserve Bank of Atlanta and other private institutional sources to fund the origination of loans, fund other interest-earning assets, and pay-off liabilities.
Investment Securities
Investment securities are comprised primarily of debt securities of U.S. government-sponsored enterprises and mortgage-backed securities. The investment portfolio decreased $27.6 million to $37.7 million at December 31, 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 2017, partially offset by the purchase of $57.0 million of short-term U.S. Treasury Bills during 2017.
All of the $37.7 million and $65.3 million as of December 31, 2017 and 2016, respectively, of investment securities were classified as available-for-sale.
As of December 31, 2017, $25.8 million, or 68.5%, 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 December 31, 2017, no investment securities were pledged as collateral for the FHLB advances or any other borrowings. As of December 31, 2017, $3.2 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 December 31, 2017 and 2016, excluding loans held-for-sale and warehouse loans held-for-investment:
Total portfolio loans increased $119.6 million, or 18.7%, to $759.7 million at December 31, 2017, as compared to $640.1 million at December 31, 2016, primarily due to originations of $106.0 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 year ended December 31, 2017. The increase in prepayments on one- to four-family residential mortgages is consistent with the current low interest rate environment.
Total portfolio loans growth was also partially offset by gross loan charge-offs of $0.8 million and transfers to OREO of nonperforming loans of $1.6 million during 2017.
All portfolio loans originated to small businesses, including SBA and 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 $18.3 million and $10.7 million at December 31, 2017 and 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 December 31, 2017, first mortgages (including residential construction loans) and home equity loans totaled $329.7 million, or 43.4% of total portfolio loans. Approximately $22.2 million, or 64.4%, of loans recorded as home equity loans and $317.5 million, or 96.3%, of loans collateralized by one- to four-family residential properties were in a first lien position as of December 31, 2017.
The composition of first mortgages and home equity loans by state as of December 31, 2017 was as follows:
Allowance for Portfolio Loan Losses
The allowance was $8.6 million, or 1.1% of total portfolio loans, at December 31, 2017, compared to $8.2 million, or 1.3% of total portfolio loans, at December 31, 2016.
The activity in the allowance for the year ended December 31, 2017 and 2016 was as follows:
Net charge-offs were virtually flat during the year ended December 31, 2017 compared with those in 2016, remaining very low at 0.04% of average portfolio loans in 2017 compared to 0.03% in 2016.
Below is a comparative composition of nonperforming assets as of December 31, 2017 and 2016:
Nonperforming loans were $7.8 million, or 1.0% of total portfolio loans, at December 31, 2017, as compared to $10.1 million, or 1.6% of total portfolio loans, at December 31, 2016. The decrease in nonperforming loans was primarily due to nonperforming one- to four-family residential mortgages being reclassified to performing, as well as principal reductions and loan pay-offs of other existing nonperforming loans, partially offset by certain home equity loans and small business loans (included in commercial other portfolio loans) being classified as nonperforming.
During the past few years, and continuing into 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 December 31, 2017 and 2016, all nonperforming loans were classified as nonaccrual and there were no loans 90 days past due and accruing interest.
OREO was $1.7 million at December 31, 2017, down $1.2 million from $2.9 million at December 31, 2016, primarily due to the disposal of a $2.6 million foreclosed propertyin the second quarter of 2017, which resulted in a $0.2 million loss, and write-downs of OREO of $0.1 million, partially offset by the foreclosure of a $1.6 million property in the fourth quarter of 2017, which was expected to occur and had been fully reserved for prior to the foreclosure.
Impaired Loans
The following table shows impaired loans segregated by performing and nonperforming status and the associated allowance as of December 31, 2017 and December 31, 2016:
(1)Balances include nonperforming TDR loans of $5.9 million as of December 31, 2017 and nonperforming TDR loans of $8.2 million as of December 31, 2016. There were no specific reserves for these nonperforming TDRs as of December 31, 2017, while there were $0.2 million of specific reserves for these nonperforming TDRs as of 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 $30.9 million as of December 31, 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 December 31, 2017, approximately $15.7 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 December 31, 2017 and 2016:
Other loans decreased $2.4 million, or 2.8%, to $85.3 million at December 31, 2017, as compared to $87.7 million at December 31, 2016, due to a decrease in originations of mortgage loans held-for-sale, offset by a slight increase in warehouse loans held-for-investment. The decrease in mortgage loans held-for-sale and the slight increase in 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 $37.8 million and sold $51.3 million of mortgage loans held-for-sale during the year ended December 31, 2017. The Company internally originated $72.3 million and sold $69.7 million of mortgage loans held-for-sale during the year ended December 31, 2016. The gain recorded on sales of mortgage loans held-for-sale during 2017 and 2016 was $1.5 million (including a gain on the sale of a group of TDRs that were transferred into held-for-sale) and $1.0 million, respectively. During the year ended December 31, 2017, the Company internally originated $10.4 million and sold $8.7 million of SBA/USDA loans held-for-sale, compared to originations of $13.6 million and sold of $15.8 million during the year ended December 31, 2016. The gain recorded on sales and servicing of SBA/USDA loans held-for-sale during 2017 and 2016 was $0.7 million and $1.0 million, respectively. The Bank plans to expand its held-for-sale business lines going forward.
Loans originated and sold under the Company’s warehouse loans held-for-investment lending program were $1.1 billion and $1.1 billion, respectively, for the year ended December 31, 2017, as compared to originations and sales of $1.8 billion and $1.8 billion, respectively, for the year ended December 31, 2016. Loan sales under the warehouse loans held-for-investment lending program, which are done at par, earned interest on outstanding balances for 2017 and 2016 of $1.7 million and $2.7 million, respectively. For the year ended December 31, 2017, the weighted average number of days outstanding of warehouse loans held-for-investment was 10 days. 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
Tax Reform was enacted on December 22, 2017. The Tax Reform reduced the corporate income tax rate to 21% effective January 1, 2018 and changed certain other provisions. Accounting guidance required the Company to remeasure its deferred tax assets and deferred tax liabilities on the date of enactment using the new enacted tax rate. The Company has recorded additional expense of $1.6 million to reflect changes that resulted from the enactment of the Tax Reform because of its net deferred tax asset position. As of both December 31, 2017 and 2016, the Company evaluated the expected realization of its federal and state deferred tax assets. Based on these evaluations, 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 $102,000 and $27,000 as of December 31, 2017 and 2016, respectively.
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 $675.8 million at December 31, 2017, an increase of $47.4 million from $628.4 million at December 31, 2016. The increase was comprised of an increase of $65.2 million in non-maturing deposits, partially offset by a decrease of $17.8 million in time deposits.
Non-maturing deposits increased to $455.9 million at December 31, 2017, due to a $4.2 million increase in noninterest-bearing demand deposits and a $69.7 million increase in savings and money market deposits, partially offset by a $8.7 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 $219.9 million as of December 31, 2017, due to a decrease of $34.5 million in brokered deposits, a decrease of $3.2 million in non-brokered Internet certificates of deposit and a decrease of $8.7 million in our standard certificates of deposit, partially offset by an increase of $28.6 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.
Securities Sold Under Agreements to Repurchase
The Company had no outstanding balance on repurchase agreements as of December 31, 2017 and 2016. Information concerning repurchase agreements as of and for the years ended December 31, 2017, 2016 and 2015, is summarized as follows:
The Company had no investment securities posted as collateral under the repurchase agreement as of December 31, 2017 and 2016.
Federal Home Loan Bank Advances
As of December 31, 2017 and 2016, advances from the FHLB were as follows:
The FHLB advances had a weighted-average maturity of 10 months and a weighted-average rate of 1.77% at December 31, 2017. The Company had $405.6 million in portfolio loans posted as collateral for these advances as of December 31, 2017.
The Bank’s remaining borrowing capacity with the FHLB was $63.3 million at December 31, 2017. The FHLB requires that the Bank collateralize the excess of the fair value of the FHLB advances over the book value with cash and investment securities. In the event the Bank prepays advances prior to maturity, it must do so at the fair value of such FHLB advances. As of December 31, 2017, fair value exceeded the book value of the individual advances by $0.4 million, which was collateralized by portfolio loans (included in the $405.6 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 $34.1 million as of December 31, 2017.
See “Liquidity” discussion below in this MD&A for further information regarding the Company’s FHLB advances, as well as information regarding the Company’s other liquidity sources.
Stockholders’ Equity
Stockholders’ equity increased by $3.7 million to $90.7 million at December 31, 2017, from $87.0 million at December 31, 2016, primarily due to net income of $3.2 million and other comprehensive income of $0.3 million for the year ended December 31, 2017. The other comprehensive income during 2017, which reduced the Company’s accumulated other comprehensive loss as of December 31, 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 2017.
The Company’s equity to assets ratio decreased to 9.2% at December 31, 2017, compared with 9.6% at December 31, 2016. As of December 31, 2017, the Bank’s total risk based capital to risk-weighted assets ratio was 12.53%, common equity tier 1 capital to risk-weighted assets ratio was 11.43%, tier 1 capital to risk-weighted assets ratio was 11.43% and tier 1 capital to adjusted assets ratio was 9.67%. 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 at December 31, 2017, compared with December 31, 2016, reflected 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 equity due to accumulated earnings. The charge to remeasure net deferred tax assets, together with merger related expenses, reduced the Company’s Tier 1 (core) capital ratio as of December 31, 2017, by approximately 20 basis points. The Bank’s capital classification under PCA defined levels as of December 31, 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 Years Ended December 31, 2017 and 2016
General
Net income for the year ended December 31, 2017, was $3.2 million, as compared to net income of $6.4 million for the year ended December 31, 2016. The Company’s return on average total assets ratio and return on average stockholders’ equity ratio (both annualized) were 0.36% and 3.50%, respectively, for the year ended December 31, 2017, compared with 0.72% and 7.54%, respectively, for the year ended December 31, 2016. Net income for the year ended December 31, 2017, decreased $3.2 million as compared to net income in 2016, primarily due to a decrease in noninterest income of $2.2 million, an increase in noninterest expense of $0.5 million and an increase in income tax expense of $0.9 million, partially offset by an increase in net interest income of $0.5 million.
Net interest income increased during the year ended December 31, 2017, as compared to the year ended December 31, 2016, primarily due to the impact of increased portfolio loans and other loans outstanding, higher interest rates on investment securities, and decreased interest expense for FHLB advances, partially offset by lower interest rates on portfolio loans, the impact of lower balances in investment securities and increased interest expense on deposits. Noninterest income decreased during the year ended December 31, 2017, as compared to the year ended December 31, 2016, primarily due to lower gains on the sale of investment securities, lower gains on the sale of portfolio loans, reduced service charges and fees, and a decrease in miscellaneous operating income related to an escrow account that was forfeited in 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 year ended December 31, 2017, as compared to the year ended December 31, 2016, primarily due to an increase in compensation and benefits, increased data processing expenses associated with efforts to improve the Company’s IT infrastructure, an increase in occupancy and equipment expense, and the aforementioned merger-related costs, partially offset by the positive impact of an adjustment to the rate of accrual for FDIC insurance premiums, reducing the amount accrued for the full year, and a decrease in collection expense.
Average Balances, Net Interest Income, Yields Earned and Rates Paid
The following table sets forth certain information for the years ended December 31, 2017 and 2016. The average yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the years presented.
(1)Includes portfolio loans and other loans. Calculated net of deferred loan fees. Nonaccrual loans included as loans carrying a zero yield.
(2)Calculated based on carrying value. State and municipal investment securities yields have not been adjusted to full tax equivalents, as the numbers would not change materially from those presented in the table.
(3)Includes FHLB stock at cost and term deposits with other financial institutions.
(4)Interest expense on other borrowings during the year ended December 31, 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 year ended December 31, 2017 as compared to the year ended December 31, 2016. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in volume multiplied by the old interest rate; (2) changes in interest rate multiplied by the old volume; and (3) changes not solely attributable to interest rate or volume, which have been allocated proportionately to the change due to volume and the change due to interest rate.
(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 2017. Decreased loan yields and increased deposit costs, and increased borrowing rates 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 $0.5 million to $34.4 million for the year ended December 31, 2017, as compared to $33.9 million for the year ended December 31, 2016, due to higher balances in portfolio loans and higher interest rates on investment securities, partially offset by the decrease in loan yields on portfolio loans and lower balances in investment securities. Interest income on loans increased to $32.8 million for the year ended December 31, 2017 from $31.7 million for the year ended December 31, 2016. This increase was due to an increase in the average balance of loans, which increased $33.0 million to $758.6 million for the year ended December 31, 2017 from $725.6 million for the year ended December 31, 2016, partially offset by a decrease in average yield on loans of 4 basis points to 4.33% for the year ended December 31, 2017.
Interest income earned on investment securities decreased $0.6 million to $1.0 million for the year ended December 31, 2017 from $1.6 million for the year ended December 31, 2016. This decrease was primarily due to a decrease in the average balance of investment securities of $31.8 million to $43.6 million during the year ended December 31, 2017, partially offset by higher interest rates on investment securities during the same period.
Interest Expense
Interest expense was flat at $7.4 million for year ended December 31, 2017, from $7.4 million for the year ended December 31, 2016, due to the decrease in interest expense on FHLB advances, offset by increased interest expenses on deposits. The increase in interest expense on deposits in 2017, as compared to 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 15 basis points to 0.77% for the year ended December 31, 2017, as compared to 0.62% for the year ended December 31, 2016. The decrease in interest expense on FHLB advances for the year ended December 31, 2017, as compared to the year ended December 31, 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 0.93% for the year ended December 31, 2017, slightly up from 0.92% for the year ended December 31, 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 an increase in interest rates related to FHLB advances, offset by the lower average balances related to FHLB advances and increased noninterest-bearing deposits.
Net Interest Income
Net interest income increased $0.5 million to $27.0 million for the year ended December 31, 2017, from $26.5 million for the year ended December 31, 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 5 basis points to 3.06% for the year ended December 31, 2017, as compared to 3.01% for the year ended December 31, 2016. Our net interest margin, which is net interest income expressed as a percentage of our average interest-earning assets, increased 8 basis point to 3.20% for the year ended December 31, 2017, as compared to 3.12% for the year ended December 31, 2016. The increase in the net interest rate spread and net interest margin primarily reflected the positive impact on interest income from increasing balances in portfolio loans and other loans, the positive impact on interest income from higher interest rates on investment securities, and the positive impact on interest expense from declining high fixed-interest rate debt balances, partially offset by the negative impact on interest income from declining interest rates on portfolio loans, the negative impact on interest income from lower balances in investment securities, and the negative impact on interest expense from higher average rates paid on deposits and an increase in the average balance in such deposits.
Provision for Portfolio Loan Losses
Provision expense was $0.7 million and $0.6 million during the years ended December 31, 2017 and 2016, respectively. The low level of provision expense during each of the years ended December 31, 2017 and 2016, primarily reflected solid economic conditions in the Company’s markets, which have led to lower levels of charge-offs in recent years. The Company had net charge-offs of $0.3 million and $0.2 million during the years ended December 31, 2017 and 2016, respectively, representing 0.04% of average portfolio loans in 2017 and 0.03% of average portfolio loans in 2016.
Noninterest Income
The components of noninterest income for the years ended December 31, 2017 and 2016 were as follows:
Noninterest income for the year ended December 31, 2017 decreased $2.2 million to $7.0 million, as compared to $9.2 million for the year ended December 31, 2016. The decrease in noninterest income for the year ended December 31, 2017, compared with that of the year ended December 31, 2016, primarily reflected lower gains on the sale of investment securities, lower gains on the sale of portfolio loans, reduced service charges and fees, and a decrease in miscellaneous operating income related to an escrow account that was forfeited in 2016 in connection with an OREO sale, partially offset by higher gains on the sale of loans held-for-sale.
For the year ended December 31, 2017, gains on sales of mortgage loans held-for-sale were $1.8 million (including a gain of $0.6 million on the sale of a group of TDRs that were transferred into held-for-sale), deferred fees on mortgage loans held-for-sale were $0.3 million, gains on sales of SBA/USDA loans held-for-sale were $0.5 million and net gains recognized for the servicing of SBA/USDA loans held-for-sale were $0.2 million. By comparison, for the year ended December 31, 2016, gains on sales of mortgage loans held-for-sale was $1.6 million, deferred fees on mortgage loans held-for-sale was $0.6 million, gains on sales of SBA/USDA loans held-for-sale was $0.8 million and net gains recognized for the servicing of SBA/USDA loans held-for-sale was $0.2 million.
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 years ended December 31, 2017 and 2016 were as follows:
Noninterest expense increased $0.5 million to $25.6 million for the year ended December 31, 2017, from $25.1 million for the year ended December 31, 2016. The increase in noninterest expense during the year ended December 31, 2017, compared with that of the year ended December 31, 2016, primarily reflected an increase in compensation and benefits, increased data processing expenses associated with efforts to improve the Company’s IT infrastructure, an increase in occupancy and equipment expense, and the aforementioned merger-related costs, partially offset by the positive impact of an adjustment to the rate of accrual for FDIC insurance premiums, reducing the amount accrued for the full year, and a decrease in collection expense.
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 $4.6 million and $3.6 million in income tax expense for the years ended December 31, 2017 and 2016, respectively. The Company’s effective tax rate was 59.0% and 36.1% for the years ended December 31, 2017 and 2016, respectively. In the fourth quarter of 2017, the Company recorded $1.6 million in income tax expense to remeasure its net deferred tax assets upon the enactment of lower corporate tax rates with the Tax Reform. Effective tax rates commencing January 1, 2018, are expected to decrease with the 14% reduction in the maximum corporate tax rate. The future realization of the Company’s net operating loss carryovers is limited to $325,000 per year. Income taxes are discussed in further detail in Deferred Income Taxes on page 66 and in Note 14. Income Taxes of the Notes contained in this Report.
Comparison of Results of Operations for the Years Ended December 31, 2016 and 2015
General
Net income for the year ended December 31, 2016, was $6.4 million, as compared to net income of $7.7 million for the year ended December 31, 2015. The Company’s return on average total assets ratio and return on average stockholders’ equity ratio (both annualized) were 0.72% and 7.54%, respectively, for the year ended December 31, 2016, compared with 1.00% and 9.94%, respectively, for the year ended December 31, 2015. Net income for the year ended December 31, 2016, decreased $1.3 million as compared to net income in 2015, primarily due to the reversal of $8.5 million of the Company’s valuation allowance against its deferred tax assets in the second quarter of 2015, partially offset by $5.2 million of penalties associated with the early prepayment of some of the Company's wholesale debt, also in the second quarter of 2015. Net income also benefited from an increase in net interest income of $5.4 million and an increase in noninterest income of $2.4 million.
Net interest income increased during the year ended December 31, 2016, as compared to the year ended December 31, 2015, primarily due to the impact of increased portfolio loans and other loans outstanding and decreased interest expense for repurchase agreements and 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 increased during the year ended December 31, 2016, as compared to the year ended December 31, 2015, primarily due to higher gains on the sale of investment securities, higher gains on the sale of both loans held-for-sale and portfolio loans, as well as the gain from the extinguishment of FHLB advances, the gain on the sale of the Garden City branch and the income from a forfeited escrow account related to an OREO sale in 2015 (which are all included in Other noninterest income), partially offset by a decrease in service charges and fees, and a decrease in interchange fees. Noninterest expense decreased during the year ended December 31, 2016, as compared to the year ended December 31, 2015, primarily due to penalties associated with the prepayment of some of the Company's high-cost wholesale debt during the second quarter of 2015, partially offset by increased incentive compensation costs associated with the Company's continuing growth strategies.
Average Balances, Net Interest Income, Yields Earned and Rates Paid
The following table sets forth certain information for the years ended December 31, 2016 and 2015. The average yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the years presented.
(1)Includes portfolio loans and other loans. Calculated net of deferred loan fees. Nonaccrual loans included as loans carrying a zero yield.
(2)Calculated based on carrying value. State and municipal investment securities yields have not been adjusted to full tax equivalents, as the numbers would not change materially from those presented in the table.
(3)Includes FHLB stock at cost and term deposits with other financial institutions.
(4)Interest expense on other borrowings during the year ended December 31, 2015, 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 year ended December 31, 2016 as compared to the year ended December 31, 2015. 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.
(1)Includes portfolio loans and other loans. Calculated net of deferred loan fees. Nonaccrual loans included as loans carrying a zero yield.
Loan growth has been the primary contributor to the increase in net interest income in 2016. Decreased loan yields, partially offset by lower borrowing costs resulted in the unfavorable variance due to rate. In general, the prolonged low interest rate environment has resulted in net interest margin compression broadly for the banking industry, including the Company.
Interest Income
Total interest income increased $4.1 million to $33.9 million for the year ended December 31, 2016, as compared to $29.8 million for the year ended December 31, 2015, due to higher balances in portfolio loans and other loans outstanding, partially offset by the decrease in interest rates on portfolio loans and lower balances in investment securities. Interest income on loans increased to $31.7 million for the year ended December 31, 2016 from $26.7 million for the year ended December 31, 2015. This increase was due to an increase in the average balance of loans, which increased $172.2 million to $725.6 million for the year ended December 31, 2016 from $553.4 million for the year ended December 31, 2015, partially offset by a decrease in average yield on loans of 46 basis points to 4.37% for the year ended December 31, 2016.
The average balance of loans increased due to an increase in portfolio loans and other loans outstanding. Originations of portfolio loans increased during the year ended December 31, 2016, resulting in increased interest income on portfolio loans outstanding and additional fee income. Originations of warehouse loans held-for-investment increased during the year ended December 31, 2016, partially offset by a decrease in the weighted average number of days outstanding for warehouse loans held-for-investment during 2016, resulting in increased interest income and additional fee income. The increase in originations of warehouse loans held-for-investment is the result of an increase in home purchase and refinance volume, and increased volume related to our expanded relationships with current counterparties, as well as relationships with new counterparties.
Interest income earned on investment securities decreased $1.1 million to $1.6 million for the year ended December 31, 2016 from $2.7 million for the year ended December 31, 2015. This decrease was primarily due to a decrease in the average balance of investment securities of $53.9 million to $75.4 million during the year ended December 31, 2016.
Interest Expense
Interest expense declined by $1.3 million to $7.4 million for year ended December 31, 2016 from $8.7 million for the year ended December 31, 2015, due to the decrease in interest expense on repurchase agreements and FHLB advances, partially offset by increased interest expenses on deposits. The increase in interest expense on deposits in 2016, as compared to 2015, 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 11 basis points to 0.62% for the year ended December 31, 2016, as compared to 0.51% for the year ended December 31, 2015. The decrease in interest expense on repurchase agreements in 2016, as compared to 2015, was primarily due to the repayment of outstanding repurchase agreement balances in the second quarter of 2015 and during the year ended December 31, 2016. The decrease in interest expense on FHLB advances for the year ended December 31, 2016, as compared to the year ended December 31, 2015, was primarily due to lower average rates paid on FHLB advances resulting from the Bank’s aggressive strategies to manage interest rates, which were partially offset by an increase in the average balance of such advances.
The Bank’s overall cost of funds, including noninterest-bearing deposits, was 0.92% for the year ended December 31, 2016, down from 1.26% for the year ended December 31, 2015, primarily due to the lower average balances and interest rates related to repurchase agreements, as well as lower interest rates on FHLB advances and increased noninterest-bearing deposits, partially offset by higher average balances in FHLB advances and an increase in the average rates paid on deposits and the average balance in such deposits. The restructuring and refinancing transaction in the first nine months of 2015 substantially reduced the weighted average interest rate, and related interest expense, on borrowings for the year ended December 31, 2016 as compared to the year ended December 31, 2015.
Net Interest Income
Net interest income increased $5.4 million to $26.5 million for the year ended December 31, 2016, from $21.1 million for the year ended December 31, 2015, due to the increase in portfolio loans and other loans outstanding and decreased interest expense for repurchase agreements and FHLB advances, partially offset by lower interest rates on portfolio loans, the impact of lower balances in investment securities and an increase in interest expense on deposits.
Our net interest rate spread, which is the difference between the interest rate earned on interest-earning assets and the interest rate paid on interest-bearing liabilities, increased 20 basis points to 3.01% for the year ended December 31, 2016, as compared to 2.81% for the year ended December 31, 2015. Our net interest margin, which is net interest income expressed as a percentage of our average interest-earning assets, increased 17 basis point to 3.12% for the year ended December 31, 2016, as compared to 2.95% for the year ended December 31, 2015. 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 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, as well as the negative impact on interest income from lower balances in investment securities.
Provision for Portfolio Loan Losses
Provision expense was $0.6 million and $0.8 million during the years ended December 31, 2016 and 2015, respectively. The low level of provision expense during each of the years ended December 31, 2016 and 2015, 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 for each of the years ended December 31, 2016 and 2015, representing 0.03% and 0.04% of average portfolio loans, respectively.
Noninterest Income
The components of noninterest income for the years ended December 31, 2016 and 2015 were as follows:
Noninterest income for the year ended December 31, 2016 increased $2.4 million to $9.2 million as compared to $6.8 million for the year ended December 31, 2015. The increase in noninterest income during 2016, as compared with 2015, was primarily due to higher gains on the sale of investment securities, higher gains on the sale of both loans held-for-sale and portfolio loans, as well as the gain from the extinguishment of FHLB advances, the gain on the sale of the Garden City branch and the income from a forfeited escrow account related to an OREO sale in 2015 (which are all included in Other in the table above).
For the year ended December 31, 2016, gains on sales of mortgage loans held-for-sale was $1.6 million, deferred fees on mortgage loans held-for-sale was $0.6 million, gains on sales of SBA/USDA loans held-for-sale was $0.8 million and net gains recognized for the servicing of SBA/USDA loans held-for-sale was $0.2 million. By comparison, for the year ended December 31, 2015, gains on sales of mortgage loans held-for-sale was $0.9 million, deferred fees on mortgage loans held-for-sale was $0.1 million, gains on sales of SBA/USDA loans held-for-sale was $0.6 million and net gains recognized for the servicing of SBA/USDA loans held-for-sale was $0.1 million.
The Company expected gains on sales of loans held-for-sale to contribute significantly towards noninterest income in the future, as the Company continued 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 years ended December 31, 2016 and 2015 were as follows:
Noninterest expense decreased $3.9 million to $25.1 million for the year ended December 31, 2016 from $29.0 million for the year ended December 31, 2015. The decrease in noninterest expense during 2016, as compared with 2015, primarily reflected the penalties associated with the prepayment of some of the Company's high-cost wholesale debt during the second quarter of 2015, partially offset by an increase in incentive compensation costs and occupancy costs, both associated with the Company’s continuing growth strategies and increased technology costs, resulting from an increase in data processing costs associated with loan and deposit growth.
With the Company’s strengthened capital and asset quality positions, management expected to maintain its lower levels of risk-related operating expenses, including regulatory assessments, FDIC insurance costs, accounting 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 $3.6 million in income tax expense for the year ended December 31, 2016 and recorded $9.5 million in income tax benefit for the year ended December 31, 2015. The Company’s effective tax rate was 36.1% for the year ended December 31, 2016. The $9.5 million income tax benefit for the year ended December 31, 2015, substantially reflected the reversal of a deferred tax asset valuation allowance. The future realization of the Company’s net operating loss carryovers is limited to $325,000 per year. Income taxes are discussed in further detail in Deferred Income Taxes on page 66 and in Note 14. Income Taxes of the Notes contained in this Report.
Selected Quarterly Financial Data
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 year ended December 31, 2017 and with repayments generally funding advances. Other funding sources, however, such as inflows from new deposits, mortgage and investment securities prepayments and mortgage loan sales are less predictable and greatly influenced by market interest rates, economic conditions and competition.
We expect the Company’s primary sources of funds to continue to be sufficient to meet demands, although we can give no assurances. 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 2018.
As of December 31, 2017, the Bank had additional borrowing capacity of $63.3 million with the FHLB. The Bank’s borrowing capacity with the Federal Reserve Bank of Atlanta, as of December 31, 2017, included the ability to borrow up to approximately $23.8 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 December 31, 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 December 31, 2017, the Bank had no outstanding borrowings against the Primary Credit program, the daylight overdraft capacity or any of the aforementioned lines of credit with private financial institutions. Unpledged investment securities were approximately $34.1 million as of December 31, 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 December 31, 2017, the Bank had brokered deposits of $74.9 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 December 31, 2017, the Bank had deposits from this service of $5.9 million, and expects it will continue to utilize the program, as necessary, to supplement retail deposit production.
Threats to our liquidity position and capital levels include rapid declines in deposit balances due to market volatility caused by major changes in interest rates or negative public perception about the Bank or the financial services industry in general. In addition, the amount of investment securities that would otherwise be available to meet liquidity needs is limited due to the collateral requirements of our long-term debt. Specifically, the Bank’s repurchase agreements, which did not have an outstanding balance at December 31, 2017, have collateral requirements in excess of the debt. Additionally, the collateral requirements of the FHLB debt are supplemented with investment securities collateral and the Bank is required to collateralize any prepayment penalty amount using investment securities.
During 2017, cash and cash equivalents decreased $9.5 million to $50.4 million as of December 31, 2017, as compared to $59.9 million as of December 31, 2016, due to the continued deployment of funds, as the Bank remains focused on its strategy to increase portfolio loans and other higher yielding assets. For 2017, cash used in investing activities of $104.4 million exceeded cash provided by financing activities of $72.2 million and cash provided by operating activities of $22.7 million. Primary sources of cash flows included proceeds from repayment of warehouse loans held-for-investment of $1.1 billion, proceeds from FHLB advances of $737.2 million, proceeds from the maturities and payments of investment securities of $79.9 million, proceeds from sales of loans held-for-sale of $65.0 million, net increases in deposits of $47.4 million and proceeds from the redemption of FHLB stock of $24.1 million. Primary uses of cash flows included funding of warehouse loans held-for-investment of $1.1 billion, the repayment of FHLB advances of $712.4 million, net increases in portfolio loans of $121.7 million (excluding the purchase of such loans), the purchase of investment securities of $57.1 million, originations of loans held-for-sale of $48.2 million, the purchase of FHLB stock of $25.2 million and the purchase of portfolio loans of $18.3 million.
During 2016, cash and cash equivalents increased $36.3 million to $59.9 million as of December 31, 2016, as compared to $23.6 million as of December 31, 2015. For 2016, cash provided by financing activities of $55.9 million and cash provided by operating activities of $13.0 million exceeded cash used in investing activities of $32.6 million. Primary sources of cash flows included proceeds from repayment of warehouse loans held-for-investment of $1.8 billion, proceeds from FHLB advances of $1.5 billion, proceeds from sales of loans held-for-sale of $89.1 million, net increases in deposits of $86.0 million, proceeds from the sale of investment securities of $74.0 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 $1.8 billion, the repayment of FHLB advances of $1.5 billion, originations of loans held-for-sale of $85.9 million and net increases in portfolio loans of $62.9 million (excluding the purchase of such loans).
During 2015, cash and cash equivalents increased $1.2 million to $23.6 million as of December 31, 2015, as compared to $22.4 million as of December 31, 2014. For 2015, cash provided by financing activities of $142.6 million and cash provided by operating activities of $2.6 million exceeded cash used in investing activities of $144.0 million. Primary sources of cash flows included proceeds from repayment of warehouse loans held-for-investment of $1.1 billion, proceeds from FHLB advances of $488.9 million, net increases in deposits of $115.0 million, proceeds from sales of loans held-for-sale of $46.0 million, proceeds from repurchase agreements of $20.0 million, proceeds from the redemption of FHLB stock of $18.3 million and proceeds from maturities and payments of investment securities of $17.0 million. Primary uses of cash flows included funding of warehouse loans held-for-investment of $1.1 billion, the repayment of FHLB advances of $403.7 million, the purchase of portfolio loans of $101.4 million, the repayment of repurchase agreements of $76.3 million, net increases in portfolio loans of $59.3 million (excluding the purchase of such loans), originations of loans held-for-sale of $39.2 million and the purchase of FHLB stock of $21.6 million.
Capital Resources
At December 31, 2017, stockholders’ equity totaled $90.7 million. During 2017 the Company’s Board of Directors declared no dividends. Future cash dividend payments by the Company and the amount thereof will depend on a number of factors, including financial condition, capital requirements, cash flows, results of operations, future business prospects and other factors that the Company’s Board of Directors may deem relevant and will also be substantially dependent on cash dividends the Company receives from its subsidiary, the Bank. As of December 31, 2017, the Company held no treasury stock. The Company suspended its share repurchase program in March 2009. Initiation of future share repurchase programs is dependent on liquidity, opportunities for alternative investments, and capital requirements.
The Bank’s actual and required capital levels and ratios as of December 31, 2017 were as follows:
The Bank’s capital classification under PCA defined levels as of December 31, 2017 was well-capitalized.
Inflation
The effects of price changes and inflation can vary substantially for most financial institutions. While management believes that inflation affects the growth of total assets and our profitability, management also believes that it is difficult to assess the overall impact. Management believes this to be the case due to the fact that, generally, neither the timing nor the magnitude of inflationary changes in the consumer price index (CPI) coincides with changes in interest rates. The price of one or more components of the CPI may fluctuate considerably and thereby influence the overall CPI without having a corresponding effect on interest rates or on the cost of those goods and services normally purchased by us. In years of high inflation and high interest rates, intermediate and long-term interest rates tend to increase, thereby adversely impacting the market values of investment securities, mortgage loans and other long-term fixed rate loans. In addition, higher short-term interest rates caused by inflation tend to increase the cost of funds. In years of low inflation and low interest rates, the opposite may occur.
Off-Balance Sheet Arrangements
Neither the Company nor the Bank is currently participating in any material transaction that generates relationships with unconsolidated entities or financial partnerships, including variable interest entities, and neither the Company nor the Bank has any material retained or contingent interest in such entities or assets. As of December 31, 2017, we did not have material financial guarantee contracts that are reasonably likely to adversely affect our results of operations, financial condition, or cash flows. However, as a financial services provider, we routinely are a party to various financial instruments with off-balance sheet risks, such as commitments to extend credit and unused lines of credit. While these contractual obligations are not “off-balance sheet arrangements,” as defined in SEC rules, and although they represent our potential future cash requirements, a significant portion of those commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans we make. In addition, we enter into commitments to sell mortgage loans. For additional information regarding commitments to extend credit and unused lines of credit, see Note 13. Commitments and Contingencies of the Notes contained in this Report.
Future Accounting Pronouncements
See Note 2. Impact of Certain Accounting Pronouncements of the Notes contained in this Report for a discussion of recently issued or proposed accounting pronouncements.
ITEM 7A.
ITEM 7A. 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 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 December 31, 2017 and 2016 is as follows:
(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 December 31, 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 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of Atlantic Coast Financial Corporation (the Company) is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended. The Company’s internal control over financial reporting is designed to provide reasonable assurance, based on an appropriate cost-benefit analysis, regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management, with the participation of our Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2017. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework (2013). Based on management’s assessment and those criteria, management concluded that the Company maintained effective internal control over financial reporting as of December 31, 2017.
The Company’s independent registered certified public accounting firm, Dixon Hughes Goodman LLP, has issued a report on the effectiveness of the Company’s internal control over financial reporting. This report appears on page 85 of this Annual Report on Form 10-K.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and the Board of Directors of
Atlantic Coast Financial Corporation
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Atlantic Coast Financial Corporation and subsidiary (the Company) as of December 31, 2017 and 2016, the related consolidated statements of operations, comprehensive income, stockholders' equity, and cash flows, for the years then ended, and the related notes (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 16, 2018 expressed an unqualified opinion thereon.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
We have served as the Company's auditor since 2016.
Atlanta, Georgia
March 16, 2018
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and the Board of Directors of
Atlantic Coast Financial Corporation
Opinion on Internal Control Over Financial Reporting
We have audited Atlantic Coast Financial Corporation and subsidiary’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, Atlantic Coast Financial Corporation and subsidiary (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31 2017, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements of Atlantic Coast Financial Corporation and subsidiary as of December 31, 2017 and 2016 and for the years then ended, and our report dated March 16, 2018, expressed an unqualified opinion on those consolidated financial statements.
Basis for Opinion
The Company's management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report on Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Atlanta, Georgia
March 16, 2018
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Atlantic Coast Financial Corporation
We have audited the accompanying consolidated statements of operations, comprehensive income, stockholders' equity, and cash flows for the year ended December 31, 2015. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Atlantic Coast Financial Corporation and its subsidiary for the year ended December 31, 2015, in conformity with U.S. generally accepted accounting principles.
Miami, Florida
March 16, 2016
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 2017 and 2016
(Dollars in Thousands, Except Share Information)
The accompanying notes are an integral part of these consolidated financial statements.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2017, 2016 and 2015
(Dollars in Thousands, Except Share Information)
The accompanying notes are an integral part of these consolidated financial statements.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years Ended December 31, 2017, 2016 and 2015
(Dollars in Thousands)
The accompanying notes are an integral part of these consolidated financial statements.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
Years Ended December 31, 2017, 2016 and 2015
(Dollars in Thousands, Except Share Information)
The accompanying notes are an integral part of these consolidated financial statements.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2017, 2016 and 2015
(Dollars in Thousands)
The accompanying notes are an integral part of these consolidated financial statements.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2017, 2016 and 2015
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Financial Statement Presentation
The accompanying consolidated financial statements (the Financial Statements) and these notes to consolidated financial statements (these Notes) include Atlantic Coast Financial Corporation (the Company), a Maryland corporation, and its wholly owned subsidiary, Atlantic Coast Bank (the Bank). The Company is 100% owned by public stockholders and the Bank is 100% owned by the Company. The principal activity of the Company is the ownership of the Bank’s common stock, as such, the terms “Company” and “Bank” are used interchangeably throughout these Notes.
All significant inter-company balances and transactions have been eliminated in consolidation. The consolidated balance sheets as of December 31, 2017 and 2016, and the consolidated financial statements for the years ended December 31, 2017, 2016 and 2015 have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). 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.
Nature of Operations
The Bank provides a broad range of banking services to individual and business customers primarily in Northeast Florida, Central Florida and Southeast Georgia. The Bank’s primary deposit products are noninterest-bearing and interest-bearing demand, savings and money market, and time deposit accounts, and its primary lending products are commercial real estate loans, consumer loans, residential mortgages and home equity loans. Substantially all loans are secured by specific items of collateral, including business assets, consumer assets, and commercial and residential real estate. There are no significant concentrations of loans to any one industry or customer. However, any customers' ability to repay their loans is dependent on the real estate and general economic conditions in the area.
Operating Segments
The chief decision-makers monitor operating results and make resource allocation decisions on a company-wide basis. Accordingly, the Company does not have multiple operating segments.
Reclassifications
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, retained deficit or stockholders’ equity as previously reported.
Use of Estimates
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.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Fair Value of Financial Instruments
Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 5. Fair Value of Financial Instruments of these Notes. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents is defined to include cash on hand, deposits with other financial institutions with maturities less than 90 days and short-term interest-earning deposits in investment companies. The Company reports net cash flows for customer loan transactions and deposit transactions.
Restrictions on Cash
The Bank was not required to maintain cash on hand or on deposit with the Federal Reserve Bank of Atlanta as of December 31, 2017 and 2016 to meet regulatory reserve and clearing requirements. There were no restrictions on cash as of December 31, 2017 and 2016.
Investment Securities
Investment securities are classified as available-for-sale when they might be sold before maturity and are carried at fair value, with unrealized holding gains and losses reported separately in other comprehensive income, net of tax. Investment securities are classified as held-to-maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity.
The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted market prices are not available, fair values are calculated based on quoted market prices of similar securities (Level 2). For securities 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).
Interest income from investment securities includes amortization of purchase premium or discount. Premiums and discounts on investment securities are amortized on the level-yield method without anticipating prepayments. Gains and losses on sales of investment securities are recorded on the trade date and are determined using the specific identification method.
Management evaluates investment securities for other-than-temporary impairment (OTTI) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. In determining OTTI, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at the determination date.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Investment Securities (continued)
When OTTI is determined to have occurred, the amount of the OTTI recognized in earnings depends on whether the Company intends to sell the security or it is more likely than not that it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss. If the Company intends to sell the security or it is more likely than not that it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss, the OTTI recognized in earnings is equal to the entire difference between its amortized cost basis and its fair value at the balance sheet date. If the Company does not intend to sell the security and it is not more likely than not that we will be required to sell the security before recovery of its amortized cost basis less any current-period loss, the OTTI is separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized as a charge to earnings. The amount of the OTTI related to other factors is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment. The Company recorded no OTTI for the years ended December 31, 2017, 2016 and 2015.
Portfolio Loans
Portfolio loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay off are reported at the principal balance outstanding, net of unearned loan fees and costs, premiums on loans purchased, and an allowance for portfolio loan losses. The Bank may also purchase portfolio loans that conform to our underwriting standards, principally one- to four-family residential mortgages, in the form of whole loans for interest rate risk management and portfolio diversification and to supplement our organic growth.
Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method over the estimated life of the portfolio loan. Interest income includes amortization of purchase premiums or discounts on portfolio loans purchased. Premiums and discounts are amortized on the level yield-method over the estimated life of the portfolio loan.
Accrual of interest income on all portfolio loans is discontinued, and the loan is placed on nonperforming status at the time any such portfolio loan is 90 days delinquent unless the credit is well secured and in process of collection. Past due status is based on the contractual terms of the portfolio loan. In all cases, portfolio loans are placed on nonperforming status or charged-off at an earlier date if collection of principal or interest is considered doubtful.
Portfolio loans for which terms have been modified to grant a concession to the borrower as a result of the borrower's financial difficulties are considered TDRs. 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. TDRs are measured for impairment based upon the present value of estimated future cash flows using the loan’s existing rate at inception of the loan or the appraised value of the collateral if the loan is collateral-dependent. Impairment of homogeneous loans, such as one- to four-family residential loans, that have been modified as TDRs is calculated in the aggregate based on the present value of estimated future cash flows. Portfolio loans modified as TDRs with market rates of interest are classified as impaired portfolio loans. Once the TDR loan has performed for 12 months in accordance with the modified terms it is classified as a performing impaired loan.
All interest accrued but not received on portfolio loans placed on nonperforming status is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Portfolio loans are returned to accrual status when all the principal or interest amounts contractually due are brought current and future payments are reasonably assured.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Allowance for Portfolio Loan Losses
An allowance is maintained to reflect probable incurred losses in the loan portfolio. The allowance is based on ongoing assessments of the estimated losses incurred in the loan portfolio and is established as these losses are recognized through a provision for portfolio loan losses (provision expense) charged to earnings. Generally, portfolio loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
Although the real estate values in our markets have recovered, as well as the general improvement in the U.S. economy, we believe it is still possible that collateral for certain nonperforming one- to four-family residential and home equity loans, will not be sufficient to fully repay such loans. Therefore, the Company charges one- to four-family residential and home equity loans down by the expected loss amount at the time they become nonperforming, which is generally 90 days past due. This process accelerates the recognition of charge-offs on one- to four-family residential and home equity loans, but has no impact on the impairment evaluation process.
The reasonableness of the allowance is reviewed and established by management, within the context of applicable accounting and regulatory guidelines, based upon its evaluation of then-existing economic and business conditions affecting the Bank’s key lending areas. Senior credit officers monitor those conditions continuously and reviews are conducted quarterly with the Bank’s senior management and the Board of Directors.
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.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Allowance for Portfolio Loan Losses (continued)
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. Such loans may be of increased risk if the lien position on the collateral is secondary.
·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.
Management’s methodology for assessing the reasonableness of the allowance consists of several key elements, which include a general loss component by type of portfolio loan and specific allowances for identified problem portfolio loans. The allowance also incorporates the results of measuring impaired portfolio loans.
The general loss component of the allowance is calculated by applying loss factors, adjusted for other qualitative factors to outstanding unimpaired loan balances. Loss factors are based on the Bank’s recent loss experience, including recent short sales and sales of nonperforming loans. The Company uses a 3-year historical loss lookback period in its allowance model, adjusted for qualitative factors. Qualitative factors consider current market conditions that may impact real estate values within the Bank’s primary lending areas, and other significant factors that, in management’s judgment, may affect the ability to collect loans in the portfolio as of the evaluation date. Other significant qualitative factors that exist as of the balance sheet date that are considered in determining the adequacy of the allowance include the following: (1) current delinquency levels and trends; (2) nonperforming asset levels, trends, and related charge-off history; (3) economic trends - local and national; (4) changes in loan policy; (5) expertise of management and staff of the Bank; (6) volumes and terms of loans; and (7) concentrations of credit considering the impact of recent short sales and sales of nonperforming loans.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Allowance for Portfolio Loan Losses (continued)
The specific loss component of the allowance generally relates to portfolio loans that have been classified as doubtful, substandard, or special mention according to the Company’s internal asset risk classification system. Substandard portfolio loans include those characterized by the distinct possibility that the Company may sustain some loss if the deficiencies are not corrected. Portfolio loans classified as doubtful have all the weaknesses inherent in loans classified as 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. 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. Risk ratings are updated any time the facts and circumstances warrant.
For portfolio loans that are also identified as impaired, an allowance is established when the discounted cash flows, collateral value, or observable market price of the impaired loan is lower than the carrying value. A portfolio loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest according to the contractual terms of the loan agreement. Factors used by management to determine impairment include payment status, collateral value and the probability of collecting scheduled principal or interest payments when due. Portfolio loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan, the borrower, and the amount of the shortfall in relation to the principal or interest owed. TDRs with a borrower for whom the Bank has granted a concession to the borrower because of the borrower’s financial difficulties are considered impaired portfolio loans. Impairment is measured on a loan-by-loan basis for non-homogeneous portfolio loans, such as commercial real estate, commercial real estate construction, and commercial business loans, by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.
Management also evaluates the allowance based on a review of certain large balance individual loans. This evaluation is inherently subjective as it requires material estimates, including the amounts and timing of future cash flows management expects to receive on impaired loans, which may be susceptible to significant change and risks. The determination of the fair value of collateral considers recent trends in valuation as indicated by short sales and sales of nonperforming portfolio loans of the applicable loan category. No specific allowance is recorded unless fair value is less than carrying value.
Large groups of smaller balance, homogeneous portfolio loans, such as individual consumer and residential loans, are collectively evaluated for impairment and are excluded from the specific impairment evaluation. For these portfolio loans, the allowance is calculated in accordance with the general loss policy described above. Accordingly, individual consumer and residential loans are not separately identified for impairment disclosures, unless the loan has been modified as a TDR as discussed below.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Allowance for Portfolio Loan Losses (continued)
Portfolio loans are charged off against the allowance account when the following conditions are present:
Real Estate Loans
·One- to four-family residential loans are charged down by the expected loss amount at the time they become nonperforming, which is generally 90 days past due. Impairment allowances on nonperforming collateral-dependent loans, particularly one- to four-family residential loans, may not be recoverable and represent a potential loss, depending on real estate values in our markets and the U.S. economy in general. Therefore, this process accelerates the recognition of charge-offs, but has no impact on the impairment evaluation procedures. Additional losses, if any, are charged off against the allowance once a property is foreclosed or a short sale occurs.
·Multi-family residential real estate loans, commercial real estate loans, and land loans typically have specific reserves established once a loan is classified as substandard or impaired unless the collateral is adequate to cover the balance of the loan plus selling costs. Generally, the specific reserve on a loan will be charged off once the property has been foreclosed and title to the property transferred to the Bank.
Real Estate Construction Loans
·Real estate construction loans include one- to four-family, commercial and acquisition and development loans. These loans typically have specific reserves established once a loan is classified as substandard or impaired unless the collateral is adequate to cover the balance of the loan plus selling costs. Generally, the specific reserve on a loan will be charged off once the property has been foreclosed and title to the property transferred to the Bank.
Other Portfolio Loans
·First lien position home equity loans are charged down by the expected loss amount at the time they become nonperforming, which is generally 90 days past due. In the case of second lien position loans, the entire loan balance is charged off at 90 days past due. Impairment allowances on nonperforming collateral-dependent loans, particularly one- to four-family residential loans, may not be recoverable and represent a potential loss, depending on real estate values in our markets and the U.S. economy in general. Therefore, this process accelerates the recognition of charge-offs, but has no impact on the impairment evaluation procedures. Additional losses, if any, are charged off against the allowance once a property is foreclosed or a short sale occurs.
·Consumer loans, including auto, 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. Loans with non-real estate collateral are written down to the value of the collateral, less cost to sell, when repossession of collateral has occurred.
·Commercial loans secured by business assets, including inventory and receivables, will typically have specific reserves established once a loan is classified as substandard or impaired. The specific reserve will be charged off once the outcomes of attempts to legally collect the collateral are known and have been exhausted.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Other Loans (Loans Held-for-Sale and Warehouse Loans Held-for-Investment)
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 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).
The Company originates mortgage loans held-for-sale with the intent to sell the loans and the servicing rights to investors. Mortgage loans held-for-sale are carried at the lower of cost or market in the aggregate with adjustments for unrealized losses recorded in a valuation account by a charge against current earnings. Sales in the secondary market are recognized when full acceptance has been received.
The Company originates SBA/USDA loans held-for-sale through the 7(a) Program of the SBA, the 504 Program of the SBA and the B&I Program of the USDA. SBA/USDA loans held-for-sale are carried at the lower of cost or market in the aggregate with adjustments for unrealized losses recorded in a valuation account by a charge against current earnings.
The SBA 7(a) loans are guaranteed by the SBA up to 75% of the loan amount up to a maximum guaranty cap of $3,750,000. The Bank typically, but not always, sells the guaranteed portion of the SBA 7(a) loans into the secondary market at a premium. The Bank earns a 1% servicing fee on the amount sold. These loans are non-recourse, other than for proof of fraud or misrepresentation on the part of the lender. The Bank generally retains the unguaranteed portion of SBA 7(a) loans. In the 504 program, the Bank and the SBA are in different lien positions. The typical structure of an SBA 504 loan is that the Bank is in a first lien position at a 50% loan-to-value (LTV), and the SBA is in a second lien position at a 40% LTV. The remaining 10% is an equity investment from the borrower. USDA Business & Industry (B&I) loans are guaranteed on a scaled basis from 60% to 80% based on the size of the originated loan. The Bank typically, but not always, sells the guaranteed portion of the B&I loans on the secondary market at a premium. The Bank retains servicing for the B&I loan, but only earns a servicing fee on the portion that is sold. The servicing fees are determined by the secondary market, and range from 0.25% to 1%. These loans are non-recourse, other than for proof of fraud or misrepresentation on the part of the lender. The Bank generally retains the unguaranteed portion of the USDA B&I loans.
Servicing assets are initially recognized at fair value. For subsequent measurement of servicing rights, the Company elected the amortization method. Under the amortization method, servicing assets are amortized in proportion to, and over the period of, estimated servicing income, and assessed for impairment based on fair value at each reporting period.
The Company originates warehouse loans held-for-investment and permits the third-party originator to sell the loans and servicing rights to investors in order to repay the warehouse balance outstanding. 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. Additionally, due to the generally short duration of time the Company holds these loans, the collateral arrangements related to the loans, and other factors, management has determined that no allowance for loan losses is necessary.
Loan Commitments and Related Financial Instruments
Financial instruments include off-balance sheet credit instruments, including commitments to make loans and unused lines of credit, issued to meet customers' financing needs. The face amount for these items represents the exposure to loss, before considering collateral or ability to repay. Such financial instruments are recorded when they are funded.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Concentration of Credit Risk
A majority of the Company’s business activity is with customers located in Northeast Florida, Central Florida and Southeast Georgia. Additionally, an estimated 76% of the Company’s portfolio loans were originated in Northeast Florida, Central Florida and Southeast Georgia. Therefore, the Company’s exposure to credit risk is significantly affected by changes in the economy and real estate markets in Northeast Florida, Central Florida and Southeast Georgia.
The Company’s exposure to credit risk is also affected by changes in the economy and real estate markets in New York, as an estimated 8% of the Company’s portfolio loans were originated with borrowers in New York.
Federal Home Loan Bank Stock
The Bank is a member of the Federal Home Loan Bank (the FHLB) of Atlanta. Members are required to own a certain amount of FHLB stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock has no quoted market value, is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of cost. Both cash and stock dividends issued by the FHLB are reported as income.
Land, Premises, and Equipment
Land is carried at cost. Buildings and furniture, fixtures and equipment are carried at cost, less accumulated depreciation and amortization. Premises and equipment are depreciated using the straight-line and accelerated methods over the estimated useful lives of the assets. Buildings and related components have useful lives ranging from 15 to 39 years. Furniture, fixtures, and equipment have useful lives ranging from 1 to 15 years. Interest expense associated with the construction of new facilities is capitalized at the weighted average cost of funds.
Bank Owned Life Insurance
The Bank has purchased life insurance policies on certain employees. Bank owned life insurance (BOLI) is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement. The Bank is subject to a policy that restricts financial institutions from investing more than 25% of total capital in BOLI without first obtaining approval from its Board of Directors. The Bank was in compliance with this policy as of December 31, 2017.
Other Real Estate Owned and Foreclosed Assets
Assets acquired through or in lieu of loan foreclosure are initially recorded at fair value, at the date of foreclosure, based on an independent appraisal, less estimated selling costs establishing a new cost basis. If fair value declines subsequent to foreclosure, the asset value is written down through expense. Costs relating to improvement of property are capitalized, whereas costs relating to holding of the property are expensed.
Long-Term Assets
Premises and equipment, non-maturity deposits and other intangible assets, and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales, when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Loss Contingencies
Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and amount or range of loss can be reasonably estimated. Management does not believe there are currently any such matters that will have a material effect on the Financial Statements.
Income Taxes
Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. The Company files consolidated income tax returns and allocates tax liabilities and benefits among subsidiaries pursuant to a tax sharing agreement. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. In December 2017, a law was enacted which changed the corporate federal income tax rate from 34% to 21%, beginning January 1, 2018. Accordingly, the Company’s deferred tax assets and liabilities were revalued at December 31, 2017 using the 21% corporate federal income tax rate resulting in a $1.6 million increase in tax expense in 2017.
A tax position is recognized as a benefit only if it is more likely than not that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely to be realized on examination. For tax positions not meeting the "more likely than not" test, no tax benefit is recorded.
The Company recognizes interest expense and penalties related to income tax matters, if any, in income tax expense. Income tax returns for 2014, 2015, and 2016 are still open to examination by the Internal Revenue Service.
Earnings Per Common Share
Basic earnings per common share is computed by dividing net income by the basic 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 are adjusted for average unallocated employee stock ownership plan (ESOP) 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 CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Dividends
Banking regulations require the Company and the Bank to maintain certain capital levels and may limit the dividends paid by the Bank to the Company or by the Company to stockholders.
Comprehensive Income
Comprehensive income consists of net income and other comprehensive income (or loss). Other comprehensive income (or loss) includes the net change in unrealized appreciation and depreciation on investment securities available-for-sale, net of taxes, which are recognized as separate components of equity, and the amount of the total OTTI related to factors other than credit loss, net of taxes, which are recognized as separate components of equity.
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 December 31, 2017 and 2016. This disproportionate tax effect, for both years, is a result of the reversal of the deferred tax valuation allowance in June 2015.
Benefit Plans
Profit-sharing and 401(k) plan expense is the amount contributed by the Company as determined by the Board of Directors. Deferred compensation plan expense is allocated over years of service.
Rabbi Trusts
Vested but unpaid benefits for the executive deferred compensation plan, director retirement plan and the supplemental executive retirement plan for certain executives are funded with the Company’s own common stock held in rabbi trusts. Unpaid benefits are recorded as contra accounts to stockholders’ equity at cost and are reduced as benefits are paid out by the trustee over the terms defined by the plans.
Employee Stock Ownership Plan
Since the Company sponsors ESOP with an employer loan, neither the ESOP's loan payable or the Company's loan receivable are reported in the Company's consolidated balance sheet. Likewise, the Company does not recognize interest income or interest cost on the loan. Unallocated shares held by the ESOP are recorded as unearned ESOP shares in the consolidated statement of changes in stockholders' equity. As shares are committed to be released for allocation, the Company recognizes compensation expense equal to the average market price of the shares for the period. Dividends on allocated ESOP shares reduce retained earnings. Dividends on unearned ESOP shares are used to reduce the ESOP loan balance at the Company.
Stock-Based Compensation
The Company records compensation cost for restricted stock or stock options awarded to employees in return for employee service. The cost is measured at the grant-date fair value of the award and recognized as compensation expense over the employee service period, which is normally the vesting period. A Black-Scholes model is utilized to estimate the fair value of stock options, while the market price of the Company’s common stock at the date of grant is used for restricted stock awards.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 2. IMPACT OF CERTAIN ACCOUNTING PRONOUNCEMENTS
Recently Issued Standards Adopted
In February 2018, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (ASU 2018-02). The guidance permits entities to reclassify stranded tax effects in accumulated other comprehensive income to retained earnings as a result of the Tax Cuts and Jobs Act enacted on December 22, 2017. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2018, with early adoption permitted. The Company adopted ASU 2018-02 for the fourth quarter of 2017, resulting in a $111,000 increase to retained earnings and an offsetting decrease of $111,000 to accumulated other comprehensive income.
In May 2017, the FASB issued 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.
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.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 2. IMPACT OF CERTAIN ACCOUNTING PRONOUNCEMENTS (continued)
Recently Issued Standards Not Yet Adopted (continued)
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.
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 January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities (ASU 2016-01). The amendments in ASU 2016-1: (a) require equity investments (except for those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; (b) simplify the impairment assessment of equity securities without readily determinable fair values by requiring a qualitative assessment to identify impairment; (c) eliminate the requirement for public business entities to disclose the method and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (d) require public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (e) require an entity to present separately in other comprehensive income, the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; (f) require separate presentation of financial assets and financial liabilities by measurement category and form of financial assets on the balance sheet or the notes to the financial statements; and (g) clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. The guidance in this standard is effective for interim and annual periods beginning after December 15, 2017. The Company has evaluated the impact of adopting this standard on its financial statements, and has determined the adoption will not materially impact the financial statements.
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 has evaluated the impact of adopting this standard on its financial statements, and has determined the adoption will not 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 $42.7 million and $25.0 million as of December 31, 2017 and 2016. During the years ended December 31, 2017, 2016 and 2015, the Bank earned $230,000, $573,000 and $226,000, respectively, of interest income related to the Customers Participation Agreements.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
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.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 4. FAIR VALUE (continued)
Assets measured at fair value on a recurring basis as of December 31, 2017 and 2016 are summarized below:
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 December 31, 2017 and 2016, and there were no transfers into or out of Level 3 investments during the years ended December 31, 2017, 2016 and 2015. 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 December 31, 2017 and 2016.
Assets measured at fair value on a nonrecurring basis as of December 31, 2017 and 2016 are summarized below:
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 4. FAIR VALUE (continued)
Quantitative information about Level 3 fair value measurements as of December 31, 2017 and 2016 as follows:
(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.
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 years ended December 31, 2017, 2016 and 2015 were $84,000, $39,000 and $605,000, respectively. 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 December 31, 2017 and 2016.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 5. FAIR VALUE OF FINANCIAL INSTRUMENTS
Carrying amount and estimated fair value of financial instruments, not previously presented, as of December 31, 2017 and 2016 were as follows:
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 BOLI is based on the insurance contract cash surrender value or quoted market prices of the underlying securities or similar securities. Fair value of the 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.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 5. FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)
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 December 31, 2017 and 2016.
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 December 31, 2017 and 2016:
The amortized cost and fair value of investment securities, segregated by contractual maturity as of December 31, 2017, are shown below:
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 6. INVESTMENT SECURITIES (continued)
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.
The following table summarizes the investment securities with unrealized losses as of December 31, 2017 and 2016, aggregated by investment category and length of time in a continuous unrealized loss position:
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 December 31, 2017, the Company’s security portfolio consisted of 23 investment securities (all classified as available-for-sale), 14 of which were in an unrealized loss position. All unrealized losses were 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 December 31, 2017, $25.8 million, or approximately 68.5% 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 CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
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 December 31, 2017.
The Company did not hold any non-agency collateralized mortgage-backed securities or collateralized mortgage obligations as of December 31, 2017 and 2016, and did not record OTTI related to such securities during the years ended December 31, 2017, 2016 and 2015.
Proceeds from Investment Securities
Proceeds from sales, payments, maturities, and calls of securities available-for-sale were $85.4 million, $85.7 million and $15.1 million for the years ended December 31, 2017, 2016 and 2015, respectively.
Gross gains of $0.4 million were realized during the year ended December 31, 2017, while no gross losses were realized during the year ended December 31, 2017. The net gain on sale of securities available-for-sale for the year ended December 31, 2017, includes $0.4 million of accumulated other comprehensive income reclassifications from unrealized holding gains. Gross gains of $1.5 million were realized during the year ended December 31, 2016. Gross losses of $0.2 million were realized during the year ended December 31, 2016. The net gain on sale of securities available-for-sale for the year ended December 31, 2016, includes $1.3 million of accumulated other comprehensive income reclassifications from unrealized holding gains. No gross gains were realized during the year ended December 31, 2015. Gross losses of $9,000 were realized during the year ended December 31, 2015. The net loss on sale of securities available-for-sale for the year ended December 31, 2015, includes $9,000 of accumulated other comprehensive loss reclassifications from unrealized holding gains.
On February 18, 2016, the Company sold $15.8 million of investment securities previously classified as held-to-maturity, which were reclassified to available-for-sale as of December 31, 2015. Therefore, there were no proceeds from payments, maturities, and calls of securities held-to-maturity for the years ended December 31, 2017 and 2016. Proceeds from payments, maturities, and calls of securities held-to-maturity were $1.9 million for the year ended December 31, 2015. The Company did not sell any investment securities classified as held-to-maturity during the years ended December 31, 2015.
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 December 31, 2017 and 2016.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 7. PORTFOLIO LOANS
The following is a comparative composition of net portfolio loans as of December 31, 2017 and 2016:
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
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 December 31, 2017 and 2016:
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 7. PORTFOLIO LOANS (continued)
Nonperforming portfolio loans, including nonaccrual portfolio loans, as of December 31, 2017 and 2016 were $7.8 million and $10.1 million, respectively. There were no portfolio loans over 90 days past-due and still accruing interest as of December 31, 2017 and 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 December 31, 2017 and 2016:
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
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 December 31, 2017 and 2016:
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 7. PORTFOLIO LOANS (continued)
When establishing the allowance, management categorizes loans into risk categories generally based on the nature of the collateral and the basis of repayment. Activity in the allowance for the years ended December 31, 2017, 2016 and 2015 was as follows:
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
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, 2017:
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
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:
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
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 $0.5 million at both December 31, 2017 and 2016.
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 December 31, 2017 and 2016 were as follows:
The TDR balances included performing TDRs of $15.7 million and $20.3 million as of December 31, 2017 and 2016, respectively. There were no commitments to lend additional amounts on TDRs as of December 31, 2017 and 2016.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 7. PORTFOLIO LOANS (continued)
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 years ended December 31, 2017, 2016 and 2015:
All of the Company’s portfolio loans that were restructured as TDRs during the years ended December 31, 2017, 2016 and 2015, resulted in modifications to either rate, term, amortization or balance. Such modifications are only granted to borrowers who have demonstrated the capacity to repay under the modified terms.
There was one subsequent default on portfolio loans that were restructured as TDRs during the year ended December 31, 2017. The subsequent default was a home equity loan with a recorded investment of $8,000.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 7. PORTFOLIO LOANS (continued)
There were six subsequent defaults on portfolio loans that were restructured as TDRs during the year ended December 31, 2016. The subsequent defaults included two one- to four-family residential loans with a combined recorded investment of $0.4 million, one commercial real estate loan with a recorded investment of $2.0 million, one land loan with a recorded investment of $5.5 million, and two home equity loans with a combined recorded investment of $30,000.
There was one subsequent default on portfolio loans that were restructured as TDRs during the year ended December 31, 2015. This subsequent default was a consumer loan with a recorded investment of $4,000.
The following table presents information about impaired portfolio loans as of December 31, 2017:
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 7. PORTFOLIO LOANS (continued)
The following table presents information about impaired portfolio loans as of December 31, 2016:
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 7. PORTFOLIO LOANS (continued)
The following table presents interest income on impaired portfolio loans by class of portfolio loans for the years ended December 31, 2017, 2016 and 2015:
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 7. PORTFOLIO LOANS (continued)
The Company had $0.5 million and $1.6 million of one- to four-family residential and home equity loans in process of foreclosure as of December 31, 2017 and 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 December 31, 2017 and 2016. The activity on these loans during the years ended December 31, 2017, 2016 and 2015, was as follows:
NOTE 8. OTHER LOANS
The Company’s other loans are comprised of mortgage loans 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 $37.8 million, $72.3 million and $35.3 million of mortgage loans held-for-sale during the years ended December 31, 2017, 2016 and 2015, respectively. The gain recorded on sale of mortgage loans held-for-sale during the years ended December 31, 2017, 2016 and 2015 was $1.5 million, $1.0 million and $0.8 million, respectively.
During the years ended December 31, 2017, 2016 and 2015, the Company internally originated approximately $10.4 million, $13.6 million and $3.9 million, respectively, of SBA/USDA loans held-for-sale. The gain recorded on sales of SBA/USDA loans held-for-sale was $0.7 million, $1.0 million and $0.7 million during the years ended December 31, 2017, 2016 and 2015, respectively.
During the years ended December 31, 2017, 2016 and 2015, the Company originated approximately $1.1 billion, $1.8 billion and $1.1 billion, 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 $1.7 million, $2.7 million and $1.9 million for the years ended December 31, 2017, 2016 and 2015, respectively. The weighted average number of days outstanding of warehouse loans held-for-investment was approximately 10 days, 12 days and 17 days for the years ended December 31, 2017, 2016 and 2015, respectively.
As of December 31, 2017 and 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.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 9. LAND, PREMISES, AND EQUIPMENT, NET
Land, premises, and equipment, net at December 31, 2017 and 2016 are summarized as follows:
Depreciation expense was $1.1 million, $1.1 million and $0.9 million for the years ended December 31, 2017, 2016 and 2015, respectively.
NOTE 10. DEPOSITS
The Company had $455.9 million and $390.7 million in non-maturity deposits at December 31, 2017 and 2016, respectively. Time deposits were $219.9 million and $237.7 million at December 31, 2017 and 2016, respectively. Scheduled maturities of time deposits at December 31, 2017 were as follows:
Time deposits in amounts equal to or greater than $250,000 were approximately $76.0 million and $30.1 million at December 31, 2017 and 2016, respectively. Deposit amounts in excess of $250,000 are generally not insured by the Federal Deposit Insurance Corporation (FDIC).
As of December 31, 2017, the Company did not have any deposit relationships in excess of 5% of total deposits. Brokered deposits, which are reported on the consolidated balance sheets in either money market accounts or time deposits, were $74.9 million, or 11.1% of total deposits, at December 31, 2017. As of December 31, 2016, the Company had deposit relationships in excess of 5% of total deposits with one customer, which totaled $40.0 million, or 6.4% of total deposits. Additionally, brokered deposits were $84.0 million, or 13.4% of total deposits, at December 31, 2016. Brokered deposits typically consist of smaller individual balances that have liquidity characteristics and yields consistent with time deposits in amounts equal to or greater than $250,000. Management does not view these concentrations as a liquidity risk.
Deposits from directors, executive officers and their associates were approximately $0.3 million and $0.2 million at December 31, 2017 and 2016, respectively.
Interest expense on customer deposit accounts for the years ending December 31, 2017, 2016 and 2015 is summarized as follows:
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 11. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
The Company had no outstanding balance on repurchase agreements as of December 31, 2017 and 2016. Information concerning repurchase agreements as of and for the years ended December 31, 2017, 2016 and 2015, is summarized as follows:
The Company had no investment securities posted as collateral under the repurchase agreement as of December 31, 2017 and 2016.
NOTE 12. FEDERAL HOME LOAN BANK ADVANCES
As of December 31, 2017 and 2016, advances from the FHLB were as follows:
The FHLB advances had a weighted-average maturity of 10 months and a weighted-average rate of 1.77% at December 31, 2017. The Company had $405.6 million in portfolio loans posted as collateral for these advances as of December 31, 2017.
The Bank’s remaining borrowing capacity with the FHLB was $63.3 million at December 31, 2017. The FHLB requires that the Bank collateralize the excess of the fair value of the FHLB advances over the book value with cash and investment securities. In the event the Bank prepays advances prior to maturity, it must do so at the fair value of such FHLB advances. As of December 31, 2017, fair value exceeded the book value of the individual advances by $0.4 million, which was collateralized by portfolio loans (included in the $405.6 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 $34.1 million as of December 31, 2017.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 13. COMMITMENTS AND CONTINGENCIES
In the ordinary course of business, the Company has various outstanding commitments and contingent liabilities that are not reflected in the Financial Statements and these Notes. The principal commitments as of December 31, 2017 and 2016 are as follows:
As of December 31, 2017, the undisbursed portion of loans closed was primarily unfunded SBA loans with variable rates ranging from 4.95% to 7.00%, and the unused lines of credit and commitments to fund loans were made up of both fixed rate and variable rate commitments. The fixed rate commitments totaled $33.9 million and had interest rates that ranged from 2.45% to 18.00% and the variable rate commitments totaled $175.4 million and had interest rates that ranged from 2.81% to 9.25%. As of December 31, 2016, the undisbursed portion of loans closed was primarily unfunded SBA loans with variable rates ranging from 4.25% to 6.25%, and the unused lines of credit and commitments to fund loans were made up of both fixed rate and variable rate commitments. The fixed rate commitments totaled $23.5 million and had interest rates that ranged from 2.45% to 18.00% and the variable rate commitments totaled $86.9 million and had interest rates that ranged from 2.01% to 8.50%. As of December 31, 2017 and 2016, the Company had fully secured outstanding standby letters of credit commitments totaling $122,000 and $623,000, respectively.
Since certain commitments to make loans, provide lines of credit, and fund loans in process may expire without being used by the customer, the amount does not necessarily represent future cash commitments. In addition, commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. The exposure to credit loss in the event of nonperformance by the other party to these financial instruments is represented by the contractual amount of these instruments. The Company follows the same credit policies to make such commitments as is followed for those loans recorded on the consolidated balance sheet.
The Company has employment agreements with three of its officers, which were all effective as of December 31, 2017 and 2016. However, as of December 31, 2017 and 2016, the Company had no balance accrued for any liabilities related to these agreements.
In addition to its borrowing capacity with the FHLB, the Company maintained lines of credit with private financial institutions as of December 31, 2017 and 2016. These lines of credit totaled $62.0 million and $47.0 million as of December 31, 2017 and 2016, respectively, for which no balance was outstanding as of December 31, 2017 or 2016.
The Company has operating leases in place for six business locations. Lease payments in total over the next 5 years are approximately $1.8 million.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 14. INCOME TAXES
Income tax expense for the years ending December 31, 2017, 2016 and 2015 was as follows:
The effective tax rate differs from the statutory federal income tax rate for the years ending December 31, 2017, 2016 and 2015 as follows:
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 14. INCOME TAXES (continued)
Deferred tax assets and liabilities as of December 31, 2017 and 2016 were as follows:
The Tax Cuts and Jobs Act (Tax Reform) was enacted on December 22, 2017. The Tax Reform reduced the corporate income tax rate to 21% effective January 1, 2018 and changed certain other provisions. Accounting guidance required the Company to remeasure its deferred tax assets and deferred tax liabilities using the new enacted tax rate. The Company has recorded additional expense of $1.6 million to reflect changes that resulted from the enactment of the Tax Reform. Notwithstanding the foregoing, we are still analyzing certain aspects of the new law and refining our calculations, which could affect the measurement of these assets and liabilities or give rise to new deferred tax amounts.
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 both December 31, 2017 and 2016, the Company evaluated the expected realization of its federal and state deferred tax assets. Based on these evaluations, 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 $102,000 and $27,000 as of December 31, 2017 and 2016, respectively.
During the years ended December 31, 2017 and 2016, the Company used $0.3 million and $4.1 million of federal net operating loss carryover, while no federal net operating loss carryover was used during the year ended December 31, 2015. During the years ended December 31, 2017, 2016 and 2015, the Company used $0.3 million, $2.6 million and $0.1 million, respectively, of state net operating loss carryover.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 14. INCOME TAXES (continued)
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 year ended December 31, 2017, $0.6 million of state net operating losses were generated.
As of December 31, 2017, the Company has a federal net operating loss carryover of $5.0 million which will expire between 2027 and 2033. There is no valuation allowance on this carryover. As of December 31, 2017, the Company has a state net operating loss carryover of $5.6 million which will expire between 2018 and 2033. There is no valuation allowance on this carryover.
NOTE 15. 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.
The following table summarizes the basic and diluted earnings per common share computation for the years ended December 31, 2017, 2016 and 2015:
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 15. EARNINGS PER COMMON SHARE (continued)
During the years ended December 31, 2017, 2016 and 2015, 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 16. EMPLOYEE BENEFITS
Defined Contribution Plan
Company employees meeting certain age and length of service requirements may participate in a 401(k) plan sponsored by the Company. Plan participants may contribute between 1% and 75% of gross income, subject to an Internal Revenue Service maximum amount, with a Company match equal to 100% of the first 3% of the compensation contributed, plus 50% of the next 2% of the compensation contributed. For the years ended December 31, 2017, 2016 and 2015, the total plan expense was $375,000, $382,000 and $160,000, respectively.
Supplemental Executive Retirement Plans and Director Retirement Plan
Under the terms of the executive and senior officer supplemental executive retirement plans (SERP) and the Director Retirement Plan, each participant will receive a periodic benefit payment beginning on a date defined by each plan. Under the executive SERP, benefit payments begin the first month after the retirement date. Under the Director Retirement Plan, benefit payments began on the first month following 100% vesting. Under the senior officer SERP, benefit payments begin on January 1st of the year following the retirement date. Benefit payments are due over a period of ten (10) to twenty (20) years after retirement and are based on the amount of each participant’s appreciation benefit plus accrued interest on unpaid balances.
Vesting in the appreciation benefit for the executive SERPs and Director Retirement Plan was contingent upon the occurrence of certain events. For the executive SERPs, such events included the successful completion of the second step conversion, two consecutive quarters of positive income before the expense of participant vesting by the Company, the participant's death or disability, a change-of control of the Company, or involuntary termination of employment. For the Director Retirement Plan, such events included the successful completion of the second step conversion. The vested appreciation benefit would have been payable over 15 years for executive SERPs and is payable over 10 years for the Director Retirement Plan. The vested but unpaid appreciation benefits of the executive SERPs and Director Retirement Plan are credited for interest at a rate of 3-month LIBOR plus 275 basis points.
Under the terms of the senior officer SERP, the appreciation benefit was established upon completion of the second step conversion and becomes payable to the participant over 20 years following separation from service due to retirement from the Company, which may be no earlier than age 55. In the event of a death of a participant with 5 or more years of service, a lump sum payment is due to the participant's beneficiary. The participant forfeits their appreciation benefit if the employee leaves the Company prior to retirement. The unpaid appreciation benefit for each participant is credited for interest at a rate of 3-month LIBOR plus 275 basis points.
The executive SERPs and Director Retirement Plan were partially funded through the creation of a rabbi trust (the Trust). The Trust purchased 34,009 shares of Company stock at $10.00 per share during the second step conversion and has recorded the purchase as common stock held by benefits plans in stockholders’ equity. Benefits paid by the Trust may be paid in cash or stock and the assets of the Trust are considered general assets of the Company. Changes in the value of Company stock are recorded as adjustments to the benefits accrued for each participant.
The Company recorded expense of $14,000, $13,000 and $7,000 for SERP and Director Retirement Plans in 2017, 2016 and 2015, respectively, including increases for vesting, increases in the market value of Company stock held in the Trust, and interest on unpaid appreciation benefits, net of the reversal of benefits accrued for SERP participants who severed their employment prior to retirement.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 16. EMPLOYEE BENEFITS (continued)
Below is the amount of accrued liability and unvested appreciation benefit under the SERP and Director Retirement Plan as of December 31, 2017 and 2016:
In October 2015, the Company’s Board of Directors approved the payment and disbursement of vested appreciation benefits to participants under the Director Retirement Plan, which would have normally been paid out and disbursed between April 2012 and October 2015. Such payments and disbursements were temporarily suspended due to the Consent Order (the Order), dated August 10, 2012 and terminated March 26, 2015, between the Bank and the Office of Comptroller Currency (the OCC), among other things. These catch up payments were made in November 2015, totaling $53,000 in cash, and some of the catch up distributions were made in December 2015, totaling 4,688 shares. The remaining catch up distributions were made early in 2016, totaling 3,771 shares.
The Company’s Board of Directors also approved resumption of regularly scheduled payments and disbursements under the Director Retirement Plan. Regular payments and disbursements totaled $16,000 in cash and 205 shares during the year ended December 31, 2017, $16,000 in cash and 175 shares during the year ended December 31, 2016, and $1,000 in cash and 43 shares during the year ended December 31, 2015.
Under the Director Retirement Plan, all cash payments during 2017, 2016, and 2015 were previously accrued for and all share distributions during 2017, 2016, and 2015 were of previously issued and outstanding Company stock.
Deferred Director Fee Plan
A deferred director fee compensation plan covers all non-employee directors. Under the plan, directors may defer director fees. These fees are expensed as earned and the plan accumulates the fees plus earnings. At December 31, 2017 and 2016, the liability for the plan was $99,000 and $118,000, respectively.
NOTE 17. EMPLOYEE STOCK OWNERSHIP PLAN
The Company established the ESOP through the purchase of 465,520 shares of common stock from Atlantic Coast Federal Corporation’s first step conversion in 2004, with proceeds from a ten-year note in the amount of $4.7 million between the ESOP and Atlantic Coast Federal Corporation. Upon completion of the Company’s second step conversion in 2011, all unallocated shares in the plan were exchanged for Atlantic Coast Financial Corporation shares at a rate of 0.1960 shares of Atlantic Coast Financial Corporation for each share of Atlantic Coast Federal Corporation. As part of the conversion, the Company loaned $0.7 million to the trust for the ESOP enabling it to purchase 68,434 shares of common stock in the stock offering for allocation under such plan. The Company’s loan to the ESOP was combined with the remaining debt from the original note, described below, and modified to be payable over 20 years. Further, the ESOP was modified such that unearned shares held by the ESOP will be allocated over the same term as the debt.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 17. EMPLOYEE STOCK OWNERSHIP PLAN (continued)
The Company's Board of Directors determines the amount of contribution to the ESOP annually, but is required to make contributions sufficient to service the ESOP's debt. Shares are released for allocation to employees as the ESOP debt is repaid. Eligible employees receive an allocation of released shares at the end of the calendar year on a relative compensation basis. An employee becomes eligible on January 1st or July 1st immediately following the date they complete one year of service. In the event the Company pays dividends to stockholders, the dividends paid on allocated ESOP shares will be paid to employee accounts, while the dividends paid on unallocated shares held by the ESOP will be applied to the ESOP note payable.
Contributions to the ESOP were $97,000, $97,000 and $94,000 for the years ended December 31, 2017, 2016 and 2015, respectively, and did not include dividends on unearned shares during any of the years.
Compensation expense for shares committed to be released under the ESOP was $39,000, $30,000 and $23,000 for the years ended December 31, 2017, 2016 and 2015, respectively.
Shares held by the ESOP as of December 31, 2017 and 2016 were as follows:
NOTE 18. STOCK-BASED COMPENSATION
Plans Adopted in 2016
2016 Omnibus Incentive Plan
At the 2016 Annual Meeting of Stockholders, the Company’s stockholders approved the 2016 Omnibus Incentive Plan (2016 Incentive Plan). In 2016, the Company also adopted, two incentive compensation plans under the 2016 Incentive Plan. These plans provided for the grants of awards to the Company’s three executive officers, based on the Company’s earnings per share, return on average assets, and the amount of non-performing assets as a percentage of total assets. Under the first plan, the Annual Incentive Plan, awards are made 70% in cash and 30% in restricted stock to vest over a three-year period. Under the second plan, the Long Term Incentive Plan, awards are made in restricted stock, which will cliff vest after five years.
The compensation cost that has been charged against income for 2016 Incentive Plan restricted stock awards was $131,000 during the year ended December 31, 2017. There was no compensation cost that has been charged against income for 2016 Incentive Plan restricted stock awards for the years ended December 31, 2016 and 2015.
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 Incentive Plan on February 15, 2017.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 18. STOCK-BASED COMPENSATION (continued)
A summary of the status of the shares as of and for the year ended December 31, 2017 is presented below:
There was approximately $216,000 of unrecognized compensation expense related to non-vested shares awarded under the 2016 Incentive Plan at December 31, 2017. The expense is expected to be recognized over a weighted-average period of 3.6 years.
Plans Adopted in 2005
The Company established stock-based compensation plans following Atlantic Coast Federal Corporation’s first step conversion in 2004. In 2005, the Company’s stockholders approved the establishment of both the Atlantic Coast Federal Corporation 2005 Recognition and Retention Plan (the Recognition Plan) and the Atlantic Coast Federal Corporation 2005 Stock Option Plan (the Stock Option Plan). Upon completion of the Company’s second step conversion in 2011, all unallocated or unvested shares in the plans were exchanged for Atlantic Coast Financial Corporation shares at a rate of 0.1960 shares of Atlantic Coast Financial Corporation for each share of Atlantic Coast Federal Corporation.
There was no compensation cost that has been charged against income for the Recognition Plan or the Stock Option Plan for the years ended December 31, 2017 and 2016. The compensation cost that has been charged against income for the Recognition Plan was $2,000 during the year ended December 31, 2015. The compensation cost that has been charged against income for the Stock Option Plan for the year ended December 31, 2015 was $12,000.
The Recognition Plan
The Recognition Plan became effective on July 1, 2005 and expired on June 30, 2015. The Recognition Plan permitted the Company’s Board of Directors to award up to 55,888 shares of its common stock to directors and key employees designated by the Board of Directors. Under the terms of the Recognition Plan, awarded shares were restricted as to transferability and could not be sold, assigned, or transferred prior to vesting. Awarded shares vested at a rate of 20% of the initially awarded amount per year, beginning on the first anniversary date of the award, and were contingent upon continuous service by the recipient through the vesting date. An accelerated vesting occurred if there was a change in control of the Company or death or disability of the participant. Any awarded shares which were forfeited were returned to the Company and could have been re-awarded to another recipient.
There were no common stock share awards during the years ended December 31, 2017, 2016 and 2015. There were no non-vested shares outstanding under the Recognition Plan at December 31, 2017 and 2016.
There was no unrecognized compensation expense related to non-vested shares awarded under the Recognition Plan at December 31, 2017.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 18. STOCK-BASED COMPENSATION (continued)
The Stock Option Plan
The Stock Option Plan became effective on July 28, 2005 and expired on July 27, 2015. The Stock Option Plan permitted the Company’s Board of Directors to grant options to purchase up to 139,720 shares of its common stock to the Company’s directors and key employees. Under the terms of the Stock Option Plan, granted stock options have a contractual term of 10 years from the date of grant, with an exercise price equal to the market price of the Company’s common stock on the date of grant. Key employees were eligible to receive incentive stock options or non-qualified stock options, while outside directors were eligible for non-statutory stock options only.
The Stock Option Plan also permitted the Company’s Board of Directors to issue key employees, simultaneous with the issuance of stock options, an equal number of Limited Stock Appreciation Rights (Limited SAR). The Limited SARs were exercisable only upon a change of control and, if exercised, reduced one-for-one the recipient’s related stock option grants. Under the terms of the Stock Option Plan, granted stock options vested at a rate of 20% of the initially granted amount per year, beginning on the first anniversary date of the grant, and were contingent upon continuous service by the recipient through the vesting date. Accelerated vesting occurred if there was a change in control of the Company or death or disability of the participant. There were 97,314 stock options remaining to be awarded as of July 27, 2015, the date the plan was terminated.
There were no incentive stock option awards during the years ended December 31, 2017, 2016 and 2015.
A summary of the option activity under the Stock Option Plan as of December 31, 2017 and 2016, and changes for the year then ended is presented below:
The fair value of each option award was estimated on the date of grant using the Black Scholes option-pricing model based on certain assumptions. Due to the somewhat limited daily trading volume of shares of our Company stock, the volatility of the SNL thrift index was used in lieu of the historical volatility of our Company stock. The risk free rate for periods within the contractual term of the option was based on the U.S. Treasury yield curve in effect at the date of the grant. The expected life of the options was estimated based on historical employee behavior and represents the period of time that options were expected to remain outstanding.
There was no unrecognized compensation cost related to non-vested stock options granted under the Stock Option Plan as of December 31, 2017.
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 19. REGULATORY SUPERVISION
The Bank’s actual and required capital levels and ratios as of December 31, 2017 and 2016 were as follows:
The Bank’s capital classification under Prompt Corrective Action (PCA) defined levels as of December 31, 2017 was well-capitalized.
Beginning on January 1, 2016, as a result of the commencement of the phase-in of amended regulatory risk-based capital rules, the 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 4.53% as of December 31, 2017.
NOTE 20. PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION
Condensed Balance Sheets - December 31, 2017 and 2016
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 20. PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION (continued)
Condensed Statements Of Operations - Years ended December 31, 2017, 2016 and 2015
Condensed Statements Of Cash Flows - Years ended December 31, 2017, 2016 and 2015
NOTE 21. AGREEMENT AND PLAN OF MERGER WITH AMERIS BANCORP
On November 16, 2017, the Company entered into an Agreement and Plan of Merger (the Merger Agreement) with Ameris Bancorp, a Georgia corporation (Ameris). Pursuant to the Merger Agreement, the Company will merge into Ameris, with Ameris as the surviving entity (the Ameris Merger). The Merger Agreement provides that, immediately following the Ameris Merger, the Bank will be merged into Ameris Bank, a Georgia bank wholly owned by Ameris, with Ameris Bank as the surviving entity (the Bank Merger).
ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Years Ended December 31, 2017, 2016 and 2015
NOTE 21. AGREEMENT AND PLAN OF MERGER WITH AMERIS BANCORP (continued)
Under the terms and subject to the conditions of the Merger Agreement, the Company’s stockholders will have the right to receive $1.39 in cash and 0.17 shares of Ameris common stock for each share of the common stock of the Company they hold. The Merger Agreement provides that immediately prior to the closing of the Ameris Merger, the Company’s outstanding restricted stock awards will fully vest and be converted into the right to receive the same merger consideration per share as other outstanding shares of the Company’s common stock.
The Merger Agreement has been unanimously approved by the boards of directors of the Company and Ameris. The closing of the Ameris Merger is subject to the required approval of the Company’s stockholders, requisite regulatory approvals and other customary closing conditions. The Ameris Merger is expected to close during the second quarter of 2018.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A. 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 Securities Exchange Act of 1934, as amended (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 December 31, 2017, the Company carried out an evaluation of the effectiveness of the design and operation of the Company’s 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 December 31, 2017, the Company’s disclosure controls and procedures were effective.
(b) Evaluation of internal control over financial reporting. The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
The Company’s internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2017. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework (2013). Based on that assessment and those criteria, management concluded the Company maintained effective internal control over financial reporting as of December 31, 2017. “Management’s Report on Internal Control Over Financial Reporting” is included within Item 8. Financial Statements and Supplementary Data of this Report. The effectiveness of our internal control over financial reporting was audited by Dixon Hughes Goodman LLP, our independent registered public accounting firm, whose unqualified report is also included within Item 8. Financial Statements and Supplementary Data of this Report.
(c) 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 December 31, 2017, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III.
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Board of Directors
Our Board of Directors currently consists of seven directors. Our Bylaws divide our directors into three classes that are as nearly equal in number as possible. We currently have three classes with one class consisting of three directors and two classes consisting of two directors. Our directors are generally elected at our annual meeting of stockholders for a three-year term expiring at the third succeeding annual meeting of stockholders after their election, or such shorter period as our Board of Directors may determine or if the director is elected to fill a vacancy, and until their respective successors have been duly elected and qualified. The terms of office of our three classes of directors expire on a staggered basis such that the terms of one of the three classes expires at each annual meeting of our stockholders, unless the term of a director in that class ended early due to the earlier death, resignation, retirement, or removal of the director.
Class I Directors - Terms Scheduled to End in 2020
W. Eric Palmer, age 55. Mr. Palmer is a life-long resident of Jacksonville, Florida. He has been employed by the Mayo Clinic for the past 26 years. He currently serves as an Operations Administrator for the Provider Relation Departments. He previously served as the Operations Manager for Primary Care, the Director and Section Head of Patient Financial Services and as Section Manager of Accounts Receivable. Mr. Palmer is active in a number of Jacksonville area civic organizations, which provide an opportunity for the community to learn more about Atlantic Coast Bank and its products and services. Mr. Palmer was associated with Atlantic Coast Federal Credit Union as a member of its Credit Union Service Organization and its Community Advisory Board. In those roles, Mr. Palmer interacted with members and member organizations and helped identify business development opportunities. Originally, Mr. Palmer was nominated as a director in order to use his previous experience and familiarity with the Atlantic Coast Federal Credit Union members to assist management in the transition from a credit union to a publicly traded bank holding company. Mr. Palmer also brings to our Board of Directors and organization knowledge and insight about our Northeast Florida markets through his involvement in Jacksonville civic organizations which is useful to Atlantic Coast Bank’s product design and marketing plans.
Jay S. Sidhu, age 66. Mr. Sidhu, who has been named Vice Chairman of our Board of Directors, is a director and the Chairman and Chief Executive Officer of Customers Bancorp, Inc. (Customers), Wyomissing, Pennsylvania, where he has served since June 2009. Since Mr. Sidhu joined Customers, the company has grown from $250 million in assets to over $9 billion in assets. Mr. Sidhu also serves as Chairman and Chief Executive Officer of Customers’ subsidiary, Customers Bank, and its division, BankMobile. Mr. Sidhu was the Chairman and Chief Executive Officer of Sidhu Advisors, LLC, a private equity and financial services consulting company, from 2006 until 2009. Previously, Mr. Sidhu served as Chairman and Chief Executive Officer of Sovereign Bancorp, Inc. (Sovereign), Philadelphia, Pennsylvania, where he was employed from 1986 until 2006. Under his leadership, Sovereign grew from a small thrift with less than $1 billion in assets to a nearly $90 billion financial institution, ranking as the 17th largest bank in the United States, with a branch network of 800 locations serving customers from Maryland to New Hampshire. Mr. Sidhu has extensive experience in the financial services industry, as well as his capital markets background. Mr. Sidhu brings to our Board of Directors significant experience in public company operations and management, and is expected to contribute meaningfully to the Board of Director's work in evaluating strategic opportunities, and offering guidance with respect to credit management.
John K. Stephens, age 54. Mr. Stephens is a 27-year veteran of the banking and financial services industry. Mr. Stephens joined us as President and Chief Executive Officer in October 2013. Prior to joining us, from May 2011 until September 2013, Mr. Stephens served as President of Orlando, Florida-based Tower Bridge Capital, Inc., a privately held mezzanine debt and strategic advisory firm focused on emerging growth companies. From 2006 to 2011, he served as Chief Lending Officer for the Central and North Florida operations of Fifth Third Bank, N.A., overseeing a loan portfolio of almost $2 billion and was responsible for strategic leadership for all wholesale banking activities in that market area. Mr. Stephens began his career in 1986 with Wachovia Bank, N.A., now Wells Fargo & Company, where he started as a regional banking officer, later became a relationship manager responsible for originating and managing senior debt and ancillary service relationships with corporate clients, and was ultimately selected to start and lead a leveraged finance group. Mr. Stephens brings significant and varied banking experience to our Board of Directors, including work within the Northeast Florida market.
Class II Directors - Terms Scheduled to End in 2018
Bhanu Choudhrie, age 39. Mr. Choudhrie is a private equity investor with investments in the United States, United Kingdom, Europe and Asia. He was elected to our Board of Directors is 2010. He also has served as a Director of Customers Bank since July 2009 and a Director of Customers Bancorp since 2013. Mr. Choudhrie has also been an Executive Director of C&C Alpha Group Limited since November 2006 through February 2014 and then reappointed in August 2014. C&C Alpha Group Limited is a London based family private equity group, which was founded in 2002 and has established office sin several countries. Additionally, he serves as a Director or officer of various investment or operating entities formed and/or doing business in the United States, United Kingdom, Europe and Asia. He also currently serves as a Trustee of Path to Success, a United Kingdom registered charity, and as a Director and President of the Choudhrie Family Foundation, a U.S. foundation. Mr. Choudhrie completed the Harvard Business School Owner/President Management Program. Mr. Choudhrie benefits us with his business and financial services industry experiences as well as his knowledge of global economic trends and conditions that frequently impact U.S. financial institutions.
James D. Hogan, age 73. Mr. Hogan has been a director since December 2013, as well as serving in various executive management roles from 2013 through 2015. Mr. Hogan first joined us as Executive Vice President and interim Chief Financial Officer in December 2013 and served in that role through April 2014. Subsequently, Mr. Hogan served as our Chief Risk Officer from May 2014 to May 2015, while also serving again as interim Chief Financial Officer from March 2015 to May 2015. Prior to joining us, Mr. Hogan served as Executive Vice President and interim Chief Financial Officer of Customers Bancorp and Customers Bank (collectively with Customers Bancorp, Customers), both headquartered in Southeast Pennsylvania, from October 2012 to August 2013. Mr. Hogan also served as Customers’ Executive Vice President and Director of Enterprise Risk Management from June 2010 to October 2012. From 2005 to 2010, Mr. Hogan was retired, but continued to work occasionally, primarily in private consulting. Mr. Hogan was Executive Vice President and Chief Financial Officer of the Philadelphia-based Sovereign Bancorp, Inc. (Sovereign), now Santander Bank, from 2001 to 2005. Prior to Sovereign, he was Executive Vice President and Corporate Controller of Firstar Bancorp (now US Bancorp) from 1987 to 2001, and was the Controller of The Idaho First National Bank (now West One Bank) from 1978 to 1987. Mr. Hogan became a certified public accountant in 1970, keeping an active license through 2005, and began his career as a bank audit specialist with Coopers and Lybrand (now PriceWaterhouseCoopers). Mr. Hogan’s extensive and lengthy experience in the banking industry as a chief financial officer as well as in the risk management and audit related areas provide significant value to the Board of Directors.
Class III Directors - Terms Scheduled to End in 2019
Dave Bhasin, age 67. Mr. Bhasin is Chief Executive Officer of D.B. Concepts, Inc., a privately-held company he started in 2000, which operates franchised restaurants with locations throughout East Pennsylvania. In addition, he is the founder and president of various related private companies that own the restaurants and related real estate. Prior to starting D.B. Concepts, Inc., Mr. Bhasin held various technology and business management positions with Air Products & Chemicals, Inc. Mr. Bhasin’s extensive business background provides valuable business and entrepreneurial insight and perspective to our Board of Directors.
John J. Dolan, age 61. Mr. Dolan has been Chairman of our Board of Directors since 2016. He has been the Managing Member of Dolan Finance, LLC, since February 2015, which serves as general partner for Dolan Real Estate Finance, LP, which is a private investment fund that deals in financing short-term commercial real estate transactions. He was retired from January 2012 until February 2015. In January 2016, Mr. Dolan began to serve as a Partner in Profit Focus, LLC, a C-Level advisory and coaching firm, providing high level financial and strategic consulting services to enable entities to optimize their financial performance and increase their strategic focus. Mr. Dolan was employed by First Commonwealth Financial Corporation and its predecessor (First Commonwealth) headquartered in Indiana, Pennsylvania, from 1980 until December 2011. Mr. Dolan most recently served as the President and Chief Executive Officer of First Commonwealth after serving First Commonwealth as Chief Financial Officer for 20 years, and was also a director of First Commonwealth from 2007 to December 2011. He helped transform First Commonwealth from a bank with $200 million in assets to a publicly traded bank holding company with $6 billion in assets. Mr. Dolan brings to our Board of Directors extensive experience as the strategic and financial leader of a community bank, including raising capital, the development of executive management, and achieving growth through acquisitions.
Executive Officers Who Are Not Directors
Tracy L. Keegan, age 52. Ms. Keegan has served as Executive Vice President and Chief Financial Officer of Atlantic Coast Financial Corporation since May 2015 and in the same position for Atlantic Coast Bank since March 2015. Prior to joining Atlantic Coast Bank, from June 2014 to February 2015, Ms. Keegan worked for the Seminole Tribe of Florida as a banking expert and consultant. From April 2012 to May 2014, she served as Executive Vice President and as both Chief Financial Officer and Chief Operating Officer for First Southern Bancorp, Inc., Boca Raton, Florida. From June 2011 to March 2012, Ms. Keegan served as Executive Vice President and Chief Financial Officer for Florida Community Bank. From June 2010 to May 2011, Ms. Keegan served as Director of Investor Relations for EverBank Financial Corp (EverBank), during the transition and integration of the subsidiary banks of Bank of Florida Corporation (Bank of Florida), which were acquired by EverBank. Ms. Keegan had served as Executive Vice President and Chief Financial Officer of Bank of Florida since 2006. Ms. Keegan has been a member of the Florida State Board of Accountancy since July 2014 and has 28 years of management experience in banking.
Phillip S. Buddenbohm, age 47. Mr. Buddenbohm has served as Executive Vice President and Chief Credit Officer of Atlantic Coast Financial Corporation since 2013 and of Atlantic Coast Bank since 2007. He previously served as Senior Vice President of Credit Administration from 2005 until 2007. Formerly a Vice President in the Consumer Services Division of National Commerce Financial Corporation in Memphis, Tennessee, Mr. Buddenbohm has 24 years of experience in lending, credit administration and branch services.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our directors, executive officers and beneficial owners of greater than 10% of our common stock to file reports on Forms 3, 4, and 5 with the Securities and Exchange Commission disclosing ownership and changes in ownership of our common stock. Securities and Exchange Commission rules require disclosure in a company’s annual proxy statement or Annual Report on Form 10-K of the failure of an officer, director or 10% beneficial owner of our common stock to file a Form 3, 4, or 5 on a timely basis.
Based solely on a review of Forms 3, 4, and 5 filed during or with respect to 2017, and written representations from the applicable reporting persons, we believe that all of our officers and directors complied with all their applicable filing requirements during the fiscal year ended December 31, 2017, except that on July 10, 2017 and November 27, 2017, Dave Bhasin filed Form 4’s reporting a total of 24 late transactions, related to a deferred compensation plan.
Code of Ethics
Our Board of Directors has adopted a Code of Business Conduct and Ethics that applies to all of our directors, officers and employees, and a Code of Ethics for our Chief Executive Officer and Senior Financial Officers. The codes are intended to promote honest and ethical conduct, full and accurate reporting and compliance with laws. The codes are available on our website at www.atlanticcoastbank.net, by clicking on Investor Relations and then Governance Documents. Amendments to and waivers from the codes that are required to be disclosed to stockholders will be posted on our website.
Audit Committee
Our Audit Committee currently consists of directors Dolan, who serves as Chairman, Choudhrie, and Palmer. Our Audit Committee assists our Board of Directors in fulfilling its oversight responsibility relating to the integrity of our financial statements and the financial reporting processes; the systems of internal control over financial reporting; compliance with legal and regulatory requirements; the performance of our internal audit function; and our relationship with our independent registered public accounting firm. The committee hires, and reviews the reports prepared by, our registered public accounting firm and reviews substantially all of our periodic public financial disclosures. The committee is empowered to investigate any matter, with full access to all of our books, records, facilities and personnel that are necessary, and has the authority to retain at our expense legal, accounting or other advisors, consultants or experts, as it deems appropriate. Our Board of Directors has determined in its business judgment that each member of our Audit Committee is, and in 2017 was, “independent” as defined in the NASDAQ corporate governance listing standards for audit committee members and under the rules of the Securities and Exchange Commission and possesses “financial sophistication,” as defined under the NASDAQ corporate governance listing standards. Our Board of Directors has determined in its business judgment that based on his financial and banking experience, director Dolan qualifies as an “audit committee financial expert” as that term is used in the rules of the Securities and Exchange Commission. Our Board of Directors has adopted a written charter for our Audit Committee, which is available on our website at www.atlanticcoastbank.net, by clicking on Investor Relations and then Governance Documents. Our Audit Committee met eleven times during the fiscal year ended December 31, 2017.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
EXECUTIVE COMPENSATION
Compensation Discussion and Analysis
General
This Compensation Discussion and Analysis provides information regarding the philosophy, objectives, and elements of our compensation program, policies, and practices with respect to the compensation of our executive officers who appear in the “Summary Compensation Table” below (referred to collectively throughout this section as our named executive officers). Our named executive officers for the fiscal year ended December 31, 2017 were:
·John K. Stephens, Jr., our President and Chief Executive Officer
·Tracy L. Keegan, our Executive Vice President, Chief Financial Officer and Corporate Secretary
·Phillip S. Buddenbohm, our Executive Vice President and Chief Credit Officer
Compensation Philosophy and Objectives
The compensation programs and policies of the Company are designed to enhance stockholder value by aligning the financial interests of the named executive officers with those of the stockholders. The Company competes with other financial institutions by seeking to attract and retain a highly qualified and capable management team and by utilizing compensation programs that reward exceptional performance. The Compensation Committee and the Board of Directors believe that its executive management compensation programs should:
·Reflect the qualifications, skills, experience and responsibilities of each officer on the management team;
·Serve to attract and retain the most qualified individuals available to the Company by being competitive with compensation that is paid to persons having similar positions and responsibilities within other financial institutions in the same or other market areas from which we compete for talent; and
·Provide each officer on the management team with appropriate incentive to perform at his or her best, on both a short-term and long-term basis, in a manner that is consistent with the overall strategic goals of the Company and enhances long-term stockholder value.
The compensation of the named executive officer is reviewed and approved annually by the Compensation Committee, with recommendations provided to the Board of Directors. Their review includes base salaries (the “fixed” portion of compensation) and performance-based incentive compensation (the “variable” or incentive portion of compensation).
We believe in providing executives with base salaries that target the 50th percentile of market compensation. We believe in providing the executive the opportunity to earn total compensation (which included performance-based compensation) at the 75th percentile, or higher, should performance warrant.
The key elements of our compensation program for executives include base salary and incentive compensation, which for 2017 originally included annual cash incentive compensation and stock based award compensation. Ultimately, the Compensation Committee determined not to award stock based incentive compensation due to the Company’s pending merger with Ameris Bancorp. As deemed necessary to determine that the key elements of our executive compensation strategy are appropriate for our industry and market, our Compensation Committee may utilize the services of third party compensation consultants to gain perspective on similar executive positons in peer groups of publicly traded financial institutions.
Peer Group
In developing our compensation philosophies and practices in 2017, we, with the assistance of our outside, independent consulting firm, Compensation Advisors, identified a group of 17 other financial institutions with total assets between $500 million and $1.2 billion, with publicly available compensation information. This peer group was composed of:
Community Bankers Trust Corporation - Richmond, Virginia
Avenue Financial Holdings, Inc., - Nashville, Tennessee
First Bancshares, Inc. - Hattiesburg, Mississippi
Southern National Bancorp of Virginia, Inc. - McLean, Virginia
Entegra Financial Corp. - Franklin, North Carolina
Charter Financial Corporation - West Point, Georgia
Porter Bancorp, Inc. - Louisville, Kentucky
Commerce Union Bancshares, Inc. - Brentwood, Tennessee
First Community Corporation - Lexington, South Carolina
Auburn National Bancorporation, Inc. - Auburn, Alabama
Security Federal Corporation - Aiken, South Carolina
ASB Bancorp, Inc. - Asheville, North Carolina
Carolina Bank Holdings, Inc. - Greensboro, North Carolina
Peoples Financial Corporation - Biloxi, Mississippi
United Security Bancshares, Inc. - Thomasville, Alabama
Virginia National Bankshares Corporation - Charlottesville, Virginia
Sunshine Bancorp, Inc. - Plant City, Florida
Base Salaries
In early 2017, the Compensation Committee discussed increasing the salaries of the named executive officers both to reward them for the performance of the Company and to bring them closer to the 50th percentile of our peer group of other financial institutions. The Compensation Committee recommended, and the Board of Directors approved, a 5% increase in each of the named executive officer’s salaries effective February 6, 2017. In December 2017, the Compensation Committee recommended, and the Board of Directors approved, an additional 5% increase in the salaries of the named executive officers to be effective in the final payroll period in 2017. As a result, as of that date, Mr. Stephens’ salary is $443,205, Ms. Keegan’s is $242,550, and Mr. Buddenbohm’s is $209,475.
2017 Incentive Compensation
After consultation with Compensation Advisors, in 2017, the Compensation Committee recommended to the Board of Directors, which adopted, two incentive compensation plans under our 2016 Omnibus Incentive Plan. The Compensation Committee concluded that the Company’s principal strategic objectives should include return to stockholders, continuing improvement in earnings relative to our size, and our loan underwriting and credit administration functions. To measure the Company’s progress in 2017 towards the achievement of those objectives, the Compensation Committee identified certain key performance metrics which would fairly take into account the named executive officers’ contribution thereto. The Compensation Committee identified these metrics to be earnings per share for 2017, return on average assets for 2017, and the amount of non-performing assets as a percentage of total assets at December 31, 2017. We believe these metrics effectively measure and reflect our financial performance and return to stockholders during the year, and serve as an accurate representation of the accomplishments, leadership, and performance of our named executive officers.
One of these plans was titled the Annual Incentive Plan, which provided an opportunity for the named executive officers to receive incentive awards based on the three performance metrics listed above. Mr. Stephens could earn a target award of 40% of his salary, and Ms. Keegan and Mr. Buddenbohm could each earn target awards equal to 25% of their salaries. As a percentage of the target awards, earnings per share was weighted at 60%, with a target of $0.54. Return on average assets was weighted as 20%, with a target of 0.82%. Non-performing assets as a percentage of total assets was also weighted as 20%, with a target of 0.75%. A minimum performance threshold was set at 85% of the targets, with a payout of 50% of the target award. A performance maximum was set at 115% of the targets, with a payout of 150% of the target award. Performance below the thresholds provided for no award for that metric and awards were prorated between the threshold and the maximum. Awards were originally structured to be made 70% in cash and 30% in restricted stock to vest over a three-year period. The cash component of this award was intended to provide an immediate financial benefit to the named executive officers to reward them for their efforts during 2017. The stock component of the award was intended to tie its value to the potential long-term effects of the achievements and progress made in 2016 and 2017. The three-year vesting schedule was also intended to act as a retention tool for the named executive officers.
The second plan was titled the Long Term Incentive Plan, which provided an opportunity for the named executive officers to receive incentive awards based on earnings per share. Under this award, Mr. Stephens could earn an award of 40% of his salary, and Ms. Keegan and Mr. Buddenbohm could each earn an award equal to 25% of her or his respective salary. Awards would only be made if the Company’s average earnings per share for 2016 and 2017 was at least $0.48. Awards were originally structured to be made in restricted stock, which would cliff vest after five years. The all-stock nature of the award and the five-year cliff vesting was intended to serve as a retention tool for the named executive officers and to provide an incentive to them to continue to work in a manner intended to increase long-term stockholder value and return.
Due to the pending merger with Ameris Bancorp, the Board of Directors determined not to make a stock based award and instead pay that award in cash. Furthermore, due to the efforts of the named executive officers in positioning ACFC for the merger, their significant involvement in negotiating the merger and participating in due diligence, and their efforts in working towards consummation of the merger, the Board of Directors instructed ACFC to pay cash bonuses to the named executive officers prior to March 15, 2018. The amounts of such bonuses were $331,957 for Mr. Stephens, $113,535 for Ms. Keegan, and $99,059 for Mr. Buddenbohm.
When combined with the named executive officers’ base salaries, the total compensation paid to our named executive officers was close to the compensation paid by the 50th percentile of our peer group members, but did not reach our goal of being at the 75th percentile upon our named executive officers having met the performance goals the Compensation Committee set for them.
2018 Incentive Compensation
Due to the pending merger with Ameris Bancorp, the Compensation Committee has elected to defer the design of any incentive compensation plans for 2018. If the merger is consummated, the Compensation Committee will not adopt any such plan. If the merger is terminated, the Compensation Committee will work with Compensation Advisors to develop incentive compensation plans for 2018. The Compensation Committee’s goal if it does develop new plans will be to reward the named executive officers for their contributions to our performance in 2018, incent them to manage our Company as an independent institution with a long-term vision, and to tie part of the value of their stock-based compensation to their continued employment with the Company.
Summary Compensation Table
The following table sets forth, for the years ended December 31, 2017, 2016, and 2015, compensation for each of the individuals listed in the table below, who are each referred to as “named executive officers.” ACFC has no executive officers other than the named executive officers.
(1)Certain columns were intentionally omitted from the table because they contained no values.
(2)Represents bonus payments made to Mr. Stephens and Mr. Buddenbohm in 2015 for performance in 2015 and a bonus payment made to Ms. Keegan in 2015 in connection with her becoming employed by the Company.
(3)Represents grants made on February 15, 2017, for performance in 2016.
(4)The amounts in this column reflect the various benefits and payments received by the named executive officers. A break-down of the various elements of compensation in this column is set forth in the table below for the year ended December 31, 2017.
(5)Mr. Stephens also serves as a member of our Board of Directors, but does not receive compensation for his service as a director.
(6)Ms. Keegan began working for Atlantic Coast Financial Corporation on March 23, 2015 in a financial manager role prior to assuming her position as Executive Vice President and Chief Financial Officer on May 18, 2015, after receipt of regulatory non objection on May 15, 2015.
All Other Compensation Table
Grants of Plan Based Awards
The Company made no grants of equity incentive or compensation awards in 2016 or 2018. However, on February 15, 2017, the Company made grants of restricted stock to each of the named executive officers for performance in 2016. Information related to those grants is contained in the following table.
1)Will vest on the earlier of February 15, 2022 or consummation of the merger with Ameris Bancorp.
2)Will vest in three, equal, annual installments beginning on February 15, 2018 or upon consummation of the merger with Ameris Bancorp, if it occurs earlier.
3)Based on the fair market value per share on February 15, 2017, computed in accordance with the 2016 Omnibus Incentive Plan.
Named Executive Officer Agreements
On April 1, 2016, Atlantic Coast Bank entered into Employment Agreements (collectively, the Employment Agreements) with Mr. Stephens, Ms. Keegan, and Mr. Buddenbohm (each, an Executive) on April 1, 2016. Each Employment Agreement is for a term of one year (which may be renewed for successive periods of one year thereafter unless otherwise terminated as set forth in the Employment Agreement), provides for an initial annual base salary ($402,000 for Mr. Stephens, $220,000 for Ms. Keegan, and $190,000 for Mr. Buddenbohm), and entitlement to potential equity and non-equity incentive/bonus awards, reimbursement for business expenses, benefits under Atlantic Coast Bank’s policies, perquisites customarily provided to Atlantic Coast Bank’s executive officers, supplemental life insurance coverage equal to three times the Executive’s base salary, four weeks of vacation pay, and monthly disability benefits to age 65 not to exceed the lesser of: (i) 60% of base salary (with such coverage to increase following any increase in the base salary) or (ii) $25,000.
The Employment Agreements may be terminated by Atlantic Coast Bank without Cause (as defined in the Employment Agreements), by Atlantic Coast Bank for Cause, and by the Executive upon the Executive’s voluntary resignation. If terminated by Atlantic Coast Bank without Cause, the Executive is entitled to a payment in an amount equal to two times the sum of: (i) the then current annual salary, plus (ii) the annual premium for family medical, life and disability insurance coverages. In the event the Executive’s employment is terminated within twelve months following the closing of a Change in Control (as defined in the Employment Agreements) other than for Cause or by the Executive for Good Reason (as defined in the Employment Agreements), then the Executive is entitled to a payment in an amount equal to two times (or three times in the case of Mr. Stephens) the sum of: (i) the then current annual salary, plus (ii) the annual premium for family medical, life and disability insurance coverages, plus (iii) the average cash bonus received by the Executive during the three-year period preceding the closing of such Change in Control. If in one or more of those years, an Executive did not receive a cash bonus, the average would be calculated based on the years in which the Executive did receive a cash bonus. The amounts are payable in a single lump sum. In addition, any unvested restricted stock awards, stock options, and other equity awards will become fully vested as of the date of termination. However, if any portion of the foregoing payments would be subject to the excise tax imposed under Section 4999 of the Internal Revenue Code or would be non-deductible by us or Atlantic Coast Bank pursuant to Section 280G of the Internal Revenue Code, then the payments will be reduced (but not below zero) if and to the extent necessary so that no portion of any payment would be subject to the foregoing excise taxes or non-deductible by us or Atlantic Coast Bank pursuant to Section 280G of the Internal Revenue Code.
The Employment Agreements also include non-competition, non-solicitation, confidentiality, and other restrictive covenants binding on the Executive and provide for Atlantic Coast Bank to withhold compensation if required pursuant to applicable law. Any incentive-based or other compensation paid to the Executive under the Employment Agreement or any other agreement or arrangement with Atlantic Coast Bank that is subject to recovery under any law, regulation or stock exchange listing requirement will be subject to such deduction and clawback as may be required to be made pursuant to such law, regulation or requirement (or any policy adopted by Atlantic Coast Bank).
Potential Payments upon Termination or Change in Control
The following table summarizes the payments that would be made to Mr. Stephens, Ms. Keegan, and Mr. Buddenbohm at December 31, 2017, pursuant to the Employment Agreements, under the circumstances indicated, and subject to the requirements described above.
Notwithstanding the foregoing, assuming the Company’s merger with Ameris Bancorp occurred on January 31, 2018, at the effective time of the merger, the named executive officers would receive the following compensation. The differences between the preceding and following tables are due to agreements reached between the executives and Ameris Bancorp and compensation paid or earned subsequent to December 31, 2017.
Golden Parachute Compensation
1)Represents the value of the accelerated vesting of restricted stock awards, equal to $1.39 in cash and 0.17 shares of Ameris Bancorp common stock per share of Company common stock. For purposes of this table, each share of Ameris Bancorp common stock is valued at $48.18 per share, the average closing market price of Ameris Bancorp common stock over the first five business days following the first public announcement of the merger.
Outstanding Equity Awards at Year End
The Company made no grants of equity incentive or compensation awards in 2016 or 2018. However, on February 15, 2017, the Company made grants of restricted stock to each of the named executive officers for performance in 2016. Information as of December 31, 2017, related to those grants is contained in the following table.
1)Will vest on the earlier of February 15, 2022 or the consummation of the merger with Ameris Bancorp.
2)Will vest in three, equal, annual installments beginning on February 15, 2018 or upon consummation of the merger with Ameris Bancorp, if it occurs earlier.
3)Based on the closing price of $9.43 per share on December 29, 2017.
Compensation Plans
2016 Omnibus Incentive Plan
General. Our Compensation Committee administers the 2016 Omnibus Incentive Plan (the 2016 Incentive Plan). This will continue unless our Compensation Committee or Board of Directors delegates such authority. Our Compensation Committee and any such delegate are referred to as the “Administrator.” The Administrator may designate any of our officers, other employees, individuals engaged to become employed by us, directors, consultants, or advisors.
Types of Awards. Awards may consist of stock options, stock appreciation rights (SARs), performance shares, performance units, shares of common stock, restricted stock, restricted stock units, incentive awards, and dividend equivalent units. Only our employees may receive incentive stock options within the meaning of Section 422 of the Internal Revenue Code.
Shares Reserved under the 2016 Incentive Plan. The 2016 Incentive Plan provides that 500,000 shares of common stock are reserved for issuance under the 2016 Incentive Plan, subject to adjustment, as described below. In general, if it can be determined that shares will not be issued pursuant to an award that had been previously granted, then such shares may again be used for new awards. The 2016 Incentive Plan also includes specific limits as to the size of specific awards that any participant may receive over certain periods of time. Each of these limitations is subject to adjustment as described below.
Stock Options. The Administrator determines the number of shares subject to the stock options granted, whether a stock option is to be an incentive stock option or non-qualified stock option and the grant date for the stock option, which may not be any date prior to the date that the Administrator approves the grant. The Administrator fixes the stock option exercise price, which may never be less than the fair market value of a share of our common stock on the date of grant. The Administrator determines the expiration date of each stock option, except that the expiration date may not be later than 10 years after the date of grant. Stock options are exercisable and vest at such times and are subject to such restrictions and conditions as the Administrator deems necessary or advisable, including with respect to the manner of payment of the exercise price of such stock options.
SARs. A SAR is the right of a participant to receive cash in an amount, and/or common stock with a fair market value, equal to the appreciation of the fair market value of a share of our common stock during a specified period of time. The Administrator determines all terms and conditions of each SAR, including: (1) whether the SAR is granted independent of a stock option or relates to a stock option; (2) the grant date, which may not be a date prior to the date of the grant; (3) the number of shares of our common stock to which the SAR relates; (4) the grant price, which may never be less than the fair market value of our common stock on the date of grant; (5) the terms and conditions of exercise or maturity, including vesting; (6) a term that must end no later than 10 years after the date of grant; and (7) whether the SAR will settle in cash, common stock, or a combination of the two.
Performance and Stock Awards. The Administrator has the authority to grant awards of shares of common stock, restricted stock, restricted stock units, performance shares, or performance units. Restricted stock awards are shares of common stock subject to a risk of forfeiture and/or restrictions on transfer, which may lapse upon the achievement of performance goals established by the Administrator and/or upon completing a period of service. Restricted stock units represent the right to receive cash and/or shares of common stock, the value of which is equal to the fair market value of one share of our common stock. Performance shares are the right to receive shares of common stock to the extent performance goals are achieved or other requirements are met. Performance units represent the right to receive cash and/or shares of common stock valued in relation to a unit that has a dollar value or the value of which is equal to the fair market value of shares of common stock, to the extent performance goals are achieved or other requirements are met.
The Administrator determines all terms and conditions of the performance and stock awards, including: (1) the number of shares of common stock and/or units to which such award relates; (2) whether performance goals must be achieved for the participant to realize any portion of the benefit under the award; (3) the length of the vesting and/or performance period and, if different, the date of payment of the award; (4) with respect to performance units, whether to measure the value of each unit in relation to a dollar value or the fair market value of shares of common stock; and (5) with respect to performance units and restricted stock units, whether the awards will be settled in cash, in shares of common stock (including restricted stock), or in a combination of the two. However, the 2016 Incentive Plan requires a minimum vesting period on certain types of awards: any period of vesting applicable to restricted stock or restricted stock units that are not subject to a performance goal and are granted to a participant other than a non-employee director may not lapse more quickly than ratably over three years from the date of grant.
Performance Goals and Incentive Awards. The Administrator has the authority to grant annual and long-term incentive awards. An incentive award is the right to receive an award, to the extent performance goals are achieved. Performance goals are any goals the Administrator establishes that relate to our performance. The Administrator determines all terms and conditions of an annual or long-term incentive award, the performance period, the potential amount payable, and the timing of payment.
Dividend Equivalent Units. The Administrator has the authority to grant dividend equivalent units in tandem with awards other than stock options or SARs. A dividend equivalent unit is the right to receive a payment (in cash or shares) equal to the cash dividends paid with respect to a share of our common stock.
Other Stock-Based Awards. The Administrator may grant to any participant shares of unrestricted stock as a replacement for other compensation to which such participant is entitled, such as in payment of director fees, in lieu of cash compensation, in exchange for cancellation of a compensation right, or as a bonus.
Minimum Vesting and Performance Periods. Any period of vesting applicable to restricted stock or restricted stock units that are not subject to a performance goal and are granted to a participant other than a non-employee director may not lapse more quickly than ratably over three years from the date of grant. In addition, the performance period for an annual incentive award must relate to a period of at least one year, and the performance period for a long-term incentive award must relate to a period longer than one year. Under certain circumstances, the Administrator may adjust vesting or performance periods for certain types of awards.
Transferability. Awards are not transferable other than by will or the laws of descent and distribution, unless the Administrator allows a participant: (i) to designate in writing a beneficiary to exercise the award or receive payment after the participant’s death, (ii) to transfer an award to a former spouse incident to a divorce, or (iii) provided that the participant receives no consideration in connection therewith, to otherwise transfer an award.
Adjustments. If (1) we are involved in a merger or other similar transaction, (2) we subdivide or combine shares of common stock or declare a dividend payable in shares of common stock, other securities, or other property, (3) we pay a cash dividend that exceeds 10% of the fair market value of a share of common stock or engage in an extraordinary repurchase of shares of common stock, or (4) any other event occurs that in the judgment of the Administrator requires an adjustment to prevent dilution or enlargement of the benefits intended to be made available under the 2016 Incentive Plan, then the Administrator will, in a manner it deems equitable to prevent dilution or enlargement of such benefits, adjust: (A) the number and type of shares subject to the 2016 Incentive Plan; (B) the number and type of shares subject to outstanding awards; (C) the grant, purchase or exercise price with respect to any award; and (D) to the extent such discretion does not cause an award intended to qualify as performance-based compensation under Section 162(m) of the Internal Revenue Code to lose its status as such, the performance goals of an award. In any such case, the Administrator may also provide for a cash payment to the holder of an outstanding award in exchange for the cancellation of all or a portion of the award.
Change of Control. The 2016 Incentive Plan does not provide for automatic vesting of awards solely upon a change of control. However, in the event of a change of control, the Administrator in its discretion may provide for immediate vesting or other adjustments to the awards. Except as otherwise provided in any agreement between participant and us or an affiliate, if the receipt of any payment by a participant under such circumstances described above would result in the payment of any excise tax provided for in Section 280G and Section 4999 of the Internal Revenue Code, then the amounts and benefits to such participant shall be reduced to the extent necessary so as to maximize amounts and the value of benefits to the participant without causing any amount to become nondeductible by us pursuant to Section 280G of the Internal Revenue Code.
Term of Plan. Unless earlier terminated by the Board of Directors or the Administrator, the 2016 Incentive Plan will remain in effect until May 23, 2026.
Termination and Amendment. Board of Directors or the Administrator may amend, alter, suspend, discontinue or terminate the 2016 Incentive Plan at any time, subject to certain limitations as may be required by law or the listing requirements of a stock exchange or market, or that would diminish the restrictions against repricing and backdating of outstanding stock options or SARs.
The Administrator may modify, amend, or cancel any award or waive any restrictions or conditions applicable to any award or the exercise of the award, except a participant must agree to any such change which would materially diminish the rights of the participant. The Administrator does not need such consent for such changes which are pursuant to a change of control , required by law or listing requirements of a stock exchange or market, are intended to preserve favorable accounting or tax treatment, or if such changes will not materially and adversely affect the value of an award.
Recoupment and Disgorgement of Awards. The 2016 Incentive Plan gives the Administrator the authority to terminate or cause a participant to forfeit an award, and require the participant to disgorge to the Company any gains attributable to an award, if the participant engages in certain actions which are harmful to the Company, or if required by law or any listing standards to which we are subject.
Repricing and Backdating Prohibited. In general, the administrator may not: (1) amend the terms of stock options or SARs to reduce the exercise or grant; (2) cancel outstanding stock options or SARs in exchange for stock options or SARs with an exercise or grant price less than the exercise or grant price of the original stock options or SARs; or (3) cancel outstanding stock options or SARs with an exercise or grant price above the current Fair Market Value of a share of our common stock in exchange for cash or other securities. The Administrator may not make a grant of a stock option or SAR with a grant date that is effective before the date the Administrator takes action to approve such award.
Amended and Restated Supplemental Executive Retirement Plan
Atlantic Coast Bank adopted the Atlantic Coast Bank Amended and Restated Supplemental Executive Retirement Plan, which was originally established on November 1, 2004 and was most recently amended and restated on January 1, 2005. Each employee who is selected by the Board of Directors of Atlantic Coast Bank is eligible to participate in this plan. Mr. Buddenbohm, but not Mr. Stephens nor Ms. Keegan, is participating in this plan.
Each participant in the plan is entitled to a supplemental retirement benefit equal to the executive’s “appreciation benefit.” The participant’s “appreciation benefit” is calculated based on the following formula: the “prior benefit” multiplied by the “issue price” multiplied by the “exchange ratio.” The “prior benefit” is the number of shares of our common stock equal to the participant’s accrued benefit under the plan as of December 11, 2009. The fair market value of our common stock as of December 11, 2009 used to determine the “prior benefit” is $1.44. The “issue price” is $10.00, which was the initial offering price of the shares of our common stock in connection with the second-step conversion. The “exchange ratio” is 0.196, which was used to determine the number of shares of our common stock that were exchanged for each share of common stock of Atlantic Coast Federal Corporation as a result of the second-step conversion.
Each participant became 100% vested in the participant’s appreciation benefit as a result of the completion of the second-step conversion. Payment of the participant’s vested appreciation benefit will commence on January 1st of the year following the participant’s separation from service at or after attaining age 65 (the normal retirement age) and will be payable in 20 equal annual installments. If the participant’s separation from service occurs at or after attaining age 55 but before attaining the normal retirement age (the early retirement age), the participant’s appreciation benefit shall be reduced by 5% for each year the participant’s early retirement age is less than the normal retirement age. The reduced appreciation benefit will commence on January 1st of the year following the participant’s separation from service and will be payable in 20 equal annual installments.
Information regarding Mr. Buddenbohm’s participation in this plan is reflected in the following table.
401(k) Plan
On January 1, 2016, Atlantic Coast Bank adopted The Wealthy and Wise 401(k) Plan (the 401(k) Plan), which is a multiple employer plan. The 401(k) Plan is a tax-qualified defined contribution retirement plan for all employees who have satisfied the plan’s eligibility requirements. Employees who have completed three consecutive months of service will begin participation in the 401(k) Plan on the first day of the month coinciding with or following the date the employee has satisfied the eligibility requirements.
A participant may contribute up to 75% of his or her compensation to the 401(k) Plan on a pre-tax basis, subject to the limitations imposed by the Internal Revenue Code. In addition to salary deferral contributions, Atlantic Coast Bank will make matching contributions under the 401(k) Plan equal to the sum of 100% of the amount of the participant's elective deferrals that do not exceed 3% of the participant's compensation, plus 50% of the amount of the participant's elective deferrals that exceed 3% of the participant's compensation, but do not exceed 5% of the participant's compensation. A participant is always 100% vested in his or her salary deferral contributions and, under the 401(k) Plan, all employer contributions are always 100% vested. Generally, a participant (or participant’s beneficiary) will be eligible to receive a distribution from his or her vested account at retirement (age 60), age 59½ (while employed with Atlantic Coast Bank), death, disability, or termination of employment.
Each participant has an individual account under the 401(k) Plan and may direct the investment of his or her account among a variety of investment options or vehicles available.
Employee Stock Ownership Plan
We maintain the Atlantic Coast Financial Corporation Employee Stock Ownership Plan. Our employees who have been credited with at least 1,000 hours of service during a twelve-month period are eligible to participate in the employee stock ownership plan. As part of the initial public offering of Atlantic Coast Federal Corporation, the employee stock ownership plan borrowed funds from Atlantic Coast Federal Corporation to purchase 465,520 shares of common stock, which served as collateral for the loan. Shares purchased by the employee stock ownership plan are held in a suspense account for allocation among the participants’ accounts as the loan is repaid.
Contributions to the employee stock ownership plan and shares released from the unallocated suspense account in an amount proportional to the repayment of the employee stock ownership plan loan will be allocated to each eligible participant’s plan account, based on the ratio of each participant’s compensation to the total compensation of all eligible participants. Vested benefits will be payable generally upon the participants’ termination of employment, and will be paid in the form of common stock, or to the extent participants’ accounts contain cash, benefits will be paid in cash. However, participants have the right to elect to receive their benefits entirely in the form of common stock. We are required to record compensation expense each year in an amount equal to the fair market value of the shares released from the suspense account.
As a result of the second-step conversion, the 139,656 shares of Atlantic Coast Federal Corporation held in the suspense account were converted to 27,372 shares of our common stock, and all shares allocated to participants’ accounts were converted to shares of our common stock pursuant to the 0.1960 exchange ratio. In addition, the employee stock ownership plan purchased 68,434 of shares of our common stock issued in the conversion offering. The employee stock ownership plan funded its stock purchase with a loan from us equal to the aggregate purchase price of the common stock. This loan will be repaid principally through Atlantic Coast Bank’s contribution to the employee stock ownership plan and dividends payable on the common stock held by the employee stock ownership plan over the anticipated 20-year term of the loan, with payment in full by 2031. The interest rate for the employee stock ownership plan loan is an adjustable-rate equal to the prime rate, as published in The Wall Street Journal. The interest rate is currently 4.50% and adjusts annually.
The trustee will hold the shares purchased by the employee stock ownership plan and all remaining unallocated shares that were purchased in connection with the initial public offering (95,806 shares in the aggregate) in an unallocated suspense account, and shares will be released to the participants’ accounts as the new loan is repaid, on a pro-rata basis. The trustee will allocate the shares released among the participants’ accounts on the basis of each participant’s proportional share of eligible plan compensation relative to all participants’ proportional share of eligible plan compensation.
Compensation Committee Report
The Compensation Committee of the Board has reviewed and discussed the Compensation Discussion and Analysis required by Item 402(b) of Regulation S-K with management and, based on such review and discussions, the Compensation Committee recommended to the Board that the Compensation Discussion and Analysis be included in this proxy statement.
This Compensation Committee Report does not constitute soliciting material and this Compensation Committee Report should not be deemed filed or incorporated by reference into any of our other previous or future filings by the Company under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, except to the extent that the Company specifically incorporates this Compensation Committee Report by reference therein.
This report has been provided by the Compensation Committee.
Dave Bhasin, Chairman
Bhanu Choudhrie
W. Eric Palmer
Jacksonville, Florida
February 26, 2018
Compensation Committee Interlocks and Insider Participation
No member of our Compensation Committee in 2016 was an employee or officer of the Company or was formerly an officer of the Company. Director Choudhrie serves on the Board of Directors of Customers, which in 2017 engaged in certain transactions with Atlantic Coast Bank, which are described in more detail below, under “Transactions with Certain Related Persons.”
DIRECTOR COMPENSATION
General
Set forth below is information regarding compensation paid to, or earned, by each of our non-employee directors for the year ended December 31, 2017.
Non-Employee Director Compensation
The following columns were intentionally omitted from the table because they contained no values: (a) all other compensation, (b) option awards, (c) non-equity incentive plan compensation, and (d) non-qualified deferred compensation earnings
1)These amounts represent quarterly grants of 600 shares of restricted stock. The first grant was made on January 27, 2017, at $7.45 per share, the second grant was made on April 28, 2017, at $7.77 per share, the third grant was made on July 26, 2017, at $7.90 per share, and the fourth grant was made on October 27, 2017, at $8.99 per share.
2)Mr. Bhasin elected to defer his cash compensation.
3)As of December 31, 2017, Mr. Palmer had 1,176 outstanding option awards.
4)Mr. Palmer elected to defer $5,400 of his cash compensation.
5)Represents payouts from former retirement plans.
6)As of December 31, 2017, Mr. Sidhu had 20,148 outstanding option awards.
Cash Compensation
Members of the Board of Directors of Atlantic Coast Bank who are also members of the Board of Directors of Atlantic Coast Financial Corporation do not receive separate compensation for their service on the Board of Directors or the committees of Atlantic Coast Bank. Members of our Board of Directors receive a fee of $1,962 per month with the following exceptions: Mr. Dolan, as the Chairman of the Board and Chairman of our Audit Committee, received a fee of $2,375 per month, Mr. Sidhu as Vice Chairman of the Board received a fee of $2,073 per month. Other than as described above, committee members are not separately compensated for their service. Our directors who are also our employees are not compensated for their service as a director.
Director Plans
2016 Incentive Plan
The directors are eligible to participate in our 2016 Incentive Plan. Please see the description of the plans set forth under Executive Compensation - Compensation Plans - 2016 Omnibus Incentive Plan for further details.
Director Stock Purchase Plan
The Atlantic Coast Financial Corporation Director Stock Purchase Plan was adopted on June 1, 2010 and is intended to encourage and facilitate the purchase of shares our common stock by directors. Under the plan, 29,400 shares of our common stock may be issued, with an annual increase of 9,800 shares to be added to the plan on the first day of each calendar year, starting on January 1, 2011 (as adjusted as a result of the second-step conversion). Stock subject to purchase under the plan are shares of our common stock that have been authorized but unissued, or have been previously issued, or both.
The plan is open to all of our directors. Each participant must enter into a stock purchase agreement with us, which will state the number of shares of common stock that are eligible to be purchased by the participant during a specified period of time beginning on the offering date and ending on a purchase date established by our Compensation Committee (the purchase period), provided however that the purchase period does not last longer than 27 months following the offering date. Each agreement also provides the purchase price of the shares of common stock that are eligible to be purchased by the participant. However, the purchase price of a share of common stock will be not less than 85% of its fair market value on the date of the stock purchase agreement.
During the purchase period, the participant designates a fixed dollar amount of his or her director fees to be withheld for the purchase of common stock equal to the purchase price of the shares that are eligible to be purchased by the participant, as adjusted as a result of the second-step conversion. We, or the appropriate participating subsidiary, credits these amounts to a plan account. Accounts are not credited with interest. The amount of deductions remain in effect until changed by the participant and remain in effect for successive purchase periods. Our Compensation Committee determines how often participants may change their deferral elections during a purchase period. A participant’s stock purchases during a calendar year may not exceed the total dollar amount or number of shares specified by our Compensation Committee.
At the end of the purchase period, if the fair market value of a share of common stock is equal to or greater than the purchase price specified in the stock purchase agreement, the shares covered by the agreement are automatically purchased by the participant with the funds held on behalf of the participant in the plan account. However, the participant may elect not to purchase any shares or to purchase fewer than all of the shares covered by the agreement. Any balance in the plan account held on behalf of the participant after purchase of the shares is paid to the participant. If a participant does not purchase any shares, all funds in the plan account held on his or her behalf are paid to the participant. The number of shares the participant purchases on each purchase date is determined by dividing the total amount of payroll deductions withheld from the participant’s compensation since the prior purchase date by the purchase price. As soon as practicable after each purchase date, the custodian causes to be credited to the participant’s account the number of shares of common stock with respect to which the participant exercised his or her purchase rights under the plan.
Termination of a participant’s services for any reason, including disability or death or the failure of the participant to continuously remain our director or a director of one of our subsidiaries will terminate his or her participation in the plan immediately. Fees contributed to the participant’s account shall be returned to him or her or, in the case of death, to the person or persons entitled thereto in accordance with the plan.
Director Retirement Plan
Atlantic Coast Bank has adopted the Atlantic Coast Bank 2005 Amended and Restated Director Retirement Plan, effective June 17, 2010. Each member of the Board of Directors of Atlantic Coast Bank is eligible to participate in the plan. As a result of the completion of the second-step conversion, each participant is entitled to receive his or her “appreciation benefit.” The participant’s “appreciation benefit” will be payable in equal monthly installments of 120 months, commencing on the first day of the month following the completion of the second-step conversion.
The participant’s “appreciation benefit” is calculated based on the following formula: the sum of (i) the lesser of (A) the “prior benefit component” multiplied by the “issue price,” or (B) the director’s accrued benefit under the old agreement as of December 11, 2009 multiplied by 3% per annum, (ii) the “stock award component” multiplied by the “issue price,” and (iii) the “stock ownership component,” multiplied by the “issue price.” The “prior benefit component” is determined by dividing the director’s accrued benefit under the plan as of December 11, 2009 by $1.44, which is the fair market value of our common stock on December 11, 2009. The “stock award component” is equal to 25% of the number of shares of our common stock awarded to the participant under the 2005 Recognition and Retention Plan that were still held by the participant as of December 11, 2009. The “stock ownership component” is equal to 75% of the amount of shares of our common stock that were beneficially owned by the participant as of December 11, 2009. The “issue price” is the average selling price of a share of our common stock over the 30 day period immediately preceding the conversion, minus $1.44. The aggregate value of the “prior benefit component,” the “stock award component,” and the “stock ownership component” will be adjusted in accordance with the exchange ratio. Atlantic Coast Bank will pay interest on the unpaid balance of the participant’s appreciation benefit at the rate of the monthly average of the three-month LIBOR plus 275 basis points per annum until the appreciation benefit is paid in full.
Each participant became 100% vested in his appreciation benefit as a result of the completion of the second-step conversion on February 3, 2011. A portion of the participant’s vested appreciation benefit was used to purchase shares of our common stock that was issued in connection with the second-step conversion. Such purchased common stock is being held in a rabbi trust that was created by Atlantic Coast Bank. As a result, to the extent the participant’s appreciation benefit is invested in our common stock, then the participant’s appreciation benefit attributable to common stock will be distributed in-kind.
Director Deferred Fee Plan
We adopted the Atlantic Coast Financial Corporation Amended and Restated 2005 Director Deferred Fee Plan, effective January 1, 2005. The plan allows for a participant to elect to defer a portion of his or her director fees to the plan. All amounts contributed to the plan are credited to a bookkeeping account established on behalf of each participant. The participant’s account balance is credited with earnings based on the participant’s choice among the investment alternatives made available under the plan. However, participants are not permitted to invest in our common stock through this plan. Each participant has the right to elect for the payment of his or her account balance to commence on either a specified date or within 30 days following his or her separation from service (the commencement date). However, the participant’s account balance may be paid out prior to the commencement date due to the participant’s death or disability, or if we experience a change in control. Generally, the participant’s account balance is payable in a lump sum distribution. However, a participant can elect for his or her account balance to be payable in equal monthly installments over a period not to exceed 10 years.
Director Deferred Compensation Plan for Equity
We adopted the Atlantic Coast Financial Corporation Amended and Restated 2007 Director Deferred Compensation Plan for Equity in order to allow participants to defer receipt of board fees and annual cash incentives to the plan, which is used to purchase “phantom shares” of our common stock. Each phantom share is deemed to be acquired at the prevailing market rate of our common stock, and is credited to a bookkeeping account established on behalf of each participant. The account is maintained in phantom shares for the duration of the participant’s participation in the plan. To the extent dividends are issued on our common stock, dividends are credited to the phantom shares in the same proportion as the actual dividends are credited to our common stock.
Each participant has the right to elect for the payment of his or her account balance to commence on either a specified date or within 30 days following his or her separation from service (the commencement date). However, the participant’s account balance may be paid out prior to the commencement date due to the participant’s death or disability, or if we experience a change in control. Generally, the participant’s account balance will be payable in a lump sum distribution. However, a participant can elect for his or her account balance to be payable in equal monthly installments over a period not to exceed 10 years. All payments made under the plan to the participant will be made in the form of our common stock.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
EQUITY COMPENSATION PLAN INFORMATION
The table below sets forth information, as of December 31, 2017, regarding equity compensation plans categorized by those plans that have been approved by stockholders and those plans that have not been approved by stockholders.
(1)Consists of options to purchase 20,776 shares of common stock under the Atlantic Coast Federal Corporation 2005 Stock Option Plan.
(2)The weighted average exercise price reflects the weighted average exercise price of stock options awarded under the Atlantic Coast Federal Corporation 2005 Stock Option Plan.
(3)In accordance with its provisions, the Atlantic Coast Federal Corporation 2005 Stock Option Plan was terminated on July 27, 2015; therefore, no securities remain available for future issuance under this plan.
(4)The Atlantic Coast Financial Corporation 2016 Omnibus Incentive Plan was approved at the Company’s 2016 Annual Meeting of Stockholders; therefore, 455,352 securities are available for future issuance under this plan.
VOTING SECURITIES AND PRINCIPAL HOLDERS THEREOF
Persons and groups who beneficially own in excess of 5% of our common stock are required to file certain reports with the Securities and Exchange Commission regarding such ownership pursuant to the Securities Exchange Act of 1934, as amended.
The following table sets forth, as of the dates indicated in the footnotes below, the shares of common stock beneficially owned by each person who has reported to the Securities and Exchange Commission beneficial ownership of more than 5% of the outstanding shares of our common stock, based on the reports filed by these persons.
(1)In accordance with Rule 13d-3 under the Securities Exchange Act of 1934, as amended, a person is deemed to be the beneficial owner for purposes of this table, of any shares of common stock if such person has shared voting or investment power with respect to such security, or has a right to acquire beneficial ownership at any time within 60 days from the date as of which beneficial ownership is being determined. As used herein, “voting power” is the power to vote or direct the voting of shares, and “investment power” is the power to dispose or direct the disposition of shares, and includes all shares held directly as well as by spouses and minor children, in trust and other indirect ownership, over which shares the named individuals effectively exercise sole or shared voting or investment power.
(2)Based on a Schedule 13G/A filed with the Securities and Exchange Commission on February 14, 2017 by Financial Opportunity Fund LLC, Bridge Equities III LLC, Bridge Equities VIII LLC, FJ Capital Management LLC, Martin S. Friedman, SunBridge Manager LLC, SunBridge Holdings LLC, and Realty Investment Company Inc. (the FJ Group), each member of the FJ Group shares voting and investment power over all or a portion of the 1,517,200 shares. Mr. Friedman is CEO of FJ Capital Management LLC, and managing member of Financial Opportunity Fund LLC.
(3)Based on a Schedule 13D filed with the Securities and Exchange Commission on April 23, 2014, Bhanu Choudhrie, one of our directors, Emblem Investments LLC, and Emblem Capital Limited had shared voting and investment power over 1,409,077 shares. Mr. Choudhrie is a manager of Emblem Investments LLC and Emblem Capital Limited. Mr. Choudhrie also owns 2,400 shares of restricted stock, for which he has sole voting and investment power.
(4)Based on a Schedule 13G/A filed with the Securities and Exchange Commission on February 13, 2017, by RMB Capital Holdings LLC, RMB Capital Management LLC, Iron Road Capital Partners LLC, RMB Mendon Managers LLC, and Mendon Capital Advisors Corp. (the RMB Group), each member of the RMB Group shares voting and investment power over all or a portion of the 1,374,455 shares.
(5)Based on a Schedule 13G/A filed with the Securities and Exchange Commission on February 14, 2017, TFO USA Limited has sole voting and investment power over all 1,012,238 shares.
(6)Based on a Schedule 13D filed with the Securities and Exchange Commission on August 7, 2015, PL Capital LLC, Financial Edge Fund LP, Financial Edge - Strategic Fund LP, PL Capital - Focused Fund LP, Goodbody/PL Capital LP, Goodbody/PL Capital LLC, PL Capital Advisors LLC, John W. Palmer and Richard J. Lashley have shared voting and investment power over all or a portion of the 1,000,000 shares.
(7)Based on a Schedule 13G filed with the Securities and Exchange Commission on August 31, 2016 by EJF Capital LLC, Emanuel J. Friedman, and EJF Sidecar Fund, Series LLC - Series E (the EJF Group), each member of the EJF Group shares voting and investment power over all of the 904,707 shares. Mr. Friedman is controlling member of EJF Capital LLC, which is the managing member of EJF Sidecar Fund, Series LLC - Series E.
The following table sets forth the beneficial ownership of shares of our common stock of our directors, including the nominees, our Chief Executive Officer and other named executive officers, as of February 28, 2018.
*Less than 1%.
(1)The mailing address for each person listed is 4655 Salisbury Road, Suite 110, Jacksonville, Florida 32256.
(2)Each of our directors and executive officers is also a director and/or executive officer of Atlantic Coast Bank.
(3)See definition of “beneficial ownership” at footnote (1) to the table in “Voting Securities and Principal Holders Thereof.”
(4)Includes 1,746 shares of common stock held in Mr. Sidhu’s 401(k) plan account, 2,400 shares of restricted stock, and 20,148 shares of common stock that can be acquired pursuant to stock options within 60 days of March 31, 2017.
(5)Includes 619 shares of common stock held in Mr. Stephens’ employee stock ownership plan account and 27,267 shares of restricted stock.
(6)Includes 425 shares of common stock held in a director retirement plan account, 1,176 shares of common stock that can be acquired pursuant to stock options exercisable within 60 days of March 31, 2017, 2,400 shares of restricted stock, and 19 shares of common stock held by Mr. Palmer’s children.
(7)Includes 2,400 shares of restricted stock and 1,409,077 shares of common stock held by companies controlled by Mr. Choudhrie, see footnote (3) to the table in “Voting Securities and Principal Holders Thereof” for more information.
(8)Includes 2,400 shares of restricted stock.
(9)Includes 8,526 shares of common stock held in a director deferred compensation plan account and 2,400 shares of restricted stock.
(10)Includes 2,400 shares of restricted stock.
(11)Includes 180 shares of common stock held in Ms. Keegan’s employee stock ownership plan account 9,326 shares of restricted stock.
(12)Includes 8,055 shares of restricted stock, 265 shares of common stock held in Mr. Buddenbohm’s 401(k) plan account and 2,064 shares of common stock held in Mr. Buddenbohm’s employee stock ownership plan account.
No directors or executive officers have pledged any of our common stock.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
We have a policy of granting loans to officers and directors, which fully complies with all applicable federal regulations. Loans to directors and executive officers are made in the ordinary course of business and on substantially the same terms and conditions as those of comparable transactions with unaffiliated third parties prevailing at the time, in accordance with our underwriting guidelines, and do not involve more than the normal risk of collectability or present other unfavorable features. In addition, all loans to directors and executive officers are approved by at least a majority of the independent, disinterested members of our Board of Directors.
All loans Atlantic Coast Bank makes to its directors and executive officers are subject to regulations restricting loans and other transactions with affiliated persons of Atlantic Coast Bank. Loans to all directors and executive officers and their associates totaled approximately $1.8 million at December 31, 2017. All loans to directors and executive officers were performing in accordance with their terms at December 31, 2017.
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, Atlantic Coast Bank entered into three amended $15.0 million participation agreements (each was previously $10.0 million) related to 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, Atlantic Coast 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 Atlantic Coast 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, Atlantic Coast 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 Atlantic Coast 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 balances in warehouse loans held-for-investment related to the Customers Participation Agreements were $42.7 and $25.0 million as of December 31, 2017 and December 31, 2016, respectively. During the years ended December 31, 2017 and 2016, Atlantic Coast Bank earned $230,000 and $573,000, respectively, of interest income related to the Customers Participation Agreements.
Our Board of Directors consists of a majority of “independent directors” within the meaning of the NASDAQ corporate governance listing standards. Our Board of Directors has determined in its business judgment that each of our directors and nominees for director is “independent” within the meaning of the NASDAQ corporate governance listing standards with the exception of James D. Hogan, who is our former Chief Risk Officer and interim Chief Financial Officer, Jay S. Sidhu, who has a loan from Atlantic Coast Bank and is a director and an executive officer of Customers, a counterparty to our related party transactions during 2017 and 2016, and John K. Stephens, Jr., who is our President and Chief Executive Officer. Our Board of Directors has adopted a policy that its independent directors shall meet in executive session periodically, and at least twice per year, which meetings may be held in conjunction with regularly scheduled board meetings. In determining the independence of the non-executive directors, our Board of Directors also reviewed Mr. Choudhrie’s position as a director of Customers, a counterparty to our related party transactions during 2017 and 2016.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Set forth below is certain information concerning aggregate fees billed for professional services rendered by Dixon Hughes Goodman, LLP during the fiscal years ended December 31, 2017 and December 31, 2016.
Audit Fees
Audit Fees for the audit of our consolidated financial statements were $170,000 in both fiscal yearend 2017 and 2016, and included fees related to review of the financial statements included in our quarterly reports on Form 10-Q and review of our Annual Report on Form 10-K. Audit fees also included $60,000 and $65,000 in fiscal years 2017 and 2016 respectively, for the audit of internal controls over financial reporting.
Audit - Related Fees
Audit related fees of $52,300 in 2017 were for annual benefit plan audits of our Employee Stock Ownership Plan and 401(k) Plan and for the HUD-assisted audit that included fees for the annual audit; report on our financial statements, internal control, and compliance and accounting consultations. Audit related fees of $62,600 in 2016 were for annual benefit plan audits of our Employee Stock Ownership Plan and 401(k) Plan and for the HUD-assisted audit that included fees for the annual audit and report on our financial statements, internal control, and compliance.
All Other Fees
We paid no other fees to Dixon Hughes Goodman LLP in 2017, but did pay $400 related to attending our 2016 annual meeting of shareholders.
Audit and Non-Audit Services Pre-Approval Policy
The Audit Committee’s charter provides that the Audit Committee must pre-approve services to be performed by our independent registered public accounting firm. In accordance with that requirement, the Audit Committee pre-approved the engagement of Dixon Hughes Goodman LLP pursuant to which it provided the audit and audit-related services described above for the fiscal year ended December 31, 2017. All of the fees set forth above are pre-approved by the Audit Committee.
PART IV.
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Documents filed as a part of this Report
1.The following consolidated financial statements are set forth under Item 8. Financial Statements and Supplementary Data of this Report:
·Management’s Report on Internal Control Over Financial Reporting
·Reports of Independent Registered Public Accounting Firms
·Consolidated Balance Sheets as of December 31, 2017 and 2016
·Consolidated Statements of Operations for the years ended December 31, 2017, 2016 and 2015
·Consolidated Statements of Comprehensive Income for the years ended December 31, 2017, 2016 and 2015
·Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2017, 2016 and 2015
·Consolidated Statements of Cash Flows for the years ended December 31, 2017, 2016 and 2015
·Notes to Consolidated Financial Statements
2.Financial statement schedules.
All financial statement schedules have been omitted because they were not applicable or because the required information has been included in the consolidated financial statements or notes thereto.
3.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 Section 13 or 15(d) 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
(Registrant)
Date: March 16, 2018 By: /s/ John K. Stephens, Jr.
John K. Stephens, Jr.
President and Chief Executive Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the registrant and in the capacity and on the dates indicated.
By: /s/ John K. Stephens, Jr..
By: /s/ Tracy L. Keegan
John K. Stephens, Jr.
Tracy L. Keegan
President and Chief Executive Officer
Executive Vice President and
(Principal Executive Officer)
Chief Financial Officer
Director
(Principal Financial and Accounting Officer)
Date: March 16, 2018
Date: March 16, 2018
By: /s/ Dave Bhasin
By: /s/ Bhanu Choudhrie
Dave Bhasin
Bhanu Choudhrie
Director
Director
Date: March 16, 2018
Date: March 16, 2018
By: /s/ John J. Dolan
By: /s/ James D. Hogan
John J. Dolan
James D. Hogan
Chairman, Director
Director
Date: March 16, 2018
Date: March 16, 2018
By: /s/ W. Eric Palmer
By: /s/ Jay S. Sidhu
W. Eric Palmer
Jay S. Sidhu
Director
Vice Chairman, Director
Date: March 16, 2018
Date: March 16, 2018
INDEX TO EXHIBITS
*Indicates management contract or compensatory plan or arrangement.
**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.