-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Kog+vKAPj/SQ2Tu5mNKuVWvRGqCSvIe8CJlxkmDwKQk8Xe+7ayHctSHcWG6Mse0C UJ6kNxQ288PrWr1uPXv1IQ== 0000909654-07-000195.txt : 20070202 0000909654-07-000195.hdr.sgml : 20070202 20070202151246 ACCESSION NUMBER: 0000909654-07-000195 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20060930 FILED AS OF DATE: 20070202 DATE AS OF CHANGE: 20070202 FILER: COMPANY DATA: COMPANY CONFORMED NAME: GREATER ATLANTIC FINANCIAL CORP CENTRAL INDEX KEY: 0001082735 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTIONS, NOT FEDERALLY CHARTERED [6036] IRS NUMBER: 541873112 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-26467 FILM NUMBER: 07576198 BUSINESS ADDRESS: STREET 1: BOX 10700 PARKRIDGE BLVD CITY: RESTON STATE: VA ZIP: 20191 BUSINESS PHONE: 7033911300 MAIL ADDRESS: STREET 1: BOX 10700 PARKRIDGE BLVD CITY: RESTON STATE: VA ZIP: 20191 10-K 1 greateratl10kfeb1-07.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended September 30, 2006 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____________ to ______________. Commission file number: 0-26467 GREATER ATLANTIC FINANCIAL CORP. -------------------------------- (Exact Name of Registrant as Specified in its Charter) DELAWARE 54-1873112 -------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 10700 Parkridge Boulevard, Suite P50, Reston, Virginia 20191 ------------------------------------------------------ ----- (Address of Principal Executive Offices) (Zip Code) 703-391-1300 ------------ (Registrant's Telephone Number, Including Area Code) Securities registered pursuant to Section 12 (b) of the Act: None Securities registered pursuant to Section 12 (g) of the Act: Common Stock, par value $.01 per share (Title of class) Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No [ X ]. Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 of Section 15(d) of the Act. Yes [ ] No [ X ]. Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ] Indicate by check mark whether disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (ss.299.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act. Yes [ ]. No [ X ]. Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [ X ] The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant computed by reference to the price at which the common equity was sold, or the average bid and asked prices of such stock, as of the last business day of the registrant's most recently completed second fiscal quarter was $15.7 million. As of December 31, 2006, there were 3,023,506 shares of the registrant's Common Stock, par value $0.01 per share, outstanding. DOCUMENTS INCORPORATED BY REFERENCE None
INDEX PART I Page ---- Item 1. Business....................................................................................... 3 Description of Business........................................................................ 3 Market Area and Competition.................................................................... 3 Market Risk.................................................................................... 3 Lending Activities............................................................................. 3 Mortgage Banking Activities.................................................................... 7 Asset Quality.................................................................................. 7 Allowance for Loan Losses...................................................................... 9 Investment Activities.......................................................................... 11 Sources of Funds............................................................................... 14 Subsidiary Activities.......................................................................... 16 Personnel...................................................................................... 16 Regulation and Supervision..................................................................... 17 Federal and State Taxation..................................................................... 22 Item 1A. Risk Factors................................................................................... 23 Item 1B. Unresolved Staff Comments...................................................................... 24 Item 2. Properties..................................................................................... 25 Item 3. Legal Proceedings.............................................................................. 26 Item 4. Submission of Matters to a Vote of Security Holders............................................ 26 PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.............................................................................. 27 Item 6. Selected Financial Data........................................................................ 28 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation........... 30 Item 7A. Quantitative and Qualitative Disclosures About Market Risk..................................... 47 Item 8. Consolidated Financial Statements and Supplementary Data....................................... 47 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure........... 47 Item 9A. Controls and Procedures........................................................................ 48 Item 9B. Other Information.............................................................................. 49 PART III Item 10. Directors and Executive Officers of the Registrant............................................. 49 Item 11. Executive Compensation......................................................................... 51 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. 54 Item 13. Certain Relationships and Related Transactions................................................. 57 Item 14. Principal Accountant Fees and Services......................................................... 57 PART IV Item 15. Exhibits and Financial Statement Schedules..................................................... 57 Signatures ............................................................................................... 58
2 PART I ITEM 1. BUSINESS DESCRIPTION OF BUSINESS We are a savings and loan holding company which was organized in June 1997. We conduct substantially all of our business through our wholly-owned subsidiary, Greater Atlantic Bank, a federally-chartered savings bank. We offer traditional banking services to customers through our bank branches located throughout the greater Washington, DC/Baltimore metropolitan area. We established the Greater Atlantic Capital Trust I ("Trust") in January 2002 to issue certain convertible preferred securities which we completed in March 2002. MARKET AREA AND COMPETITION We operate in a competitive environment, competing for deposits and loans with other thrifts, commercial banks and other financial entities. Numerous mergers and consolidations involving banks in the market in which we operate have occurred resulting in an intensification of competition in the banking industry in our geographic market. Many of the financial intermediaries operating in our market area offer certain services, such as trust, investment and international banking services, which we do not offer. In addition, banks with a larger capitalization than ours, and financial intermediaries not subject to bank regulatory restrictions, have larger lending limits and are thereby able to serve the needs of larger customers. MARKET RISK Market risk is the risk of loss from adverse changes in market prices and rates. Our market risk arises primarily from interest-rate risk inherent in our lending and deposit taking activities. To that end, management actively monitors and manages interest-rate risk exposure. The measurement of market risk associated with financial instruments is meaningful only when all related and offsetting on- and off-balance-sheet transactions are aggregated, and the resulting net positions are identified. Disclosures about the fair value of financial instruments, which reflect changes in market prices and rates, can be found in Note 18 of Notes to Consolidated Financial Statements. Our primary objective in managing interest-rate risk is to minimize the adverse impact of changes in interest rates on our net interest income and capital, while adjusting our asset-liability structure to obtain the maximum yield-cost spread on that structure. We rely primarily on our asset-liability structure to control interest-rate risk. However, a sudden and substantial increase in interest rates may adversely impact our earnings, to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent, or on the same basis. LENDING ACTIVITIES GENERAL. Net loans receivable at September 30, 2006 were $193.3 million, a decrease of $1.6 million or 0.83% from the $194.9 million held at September 30, 2005. The decrease in loans consisted of real estate loans secured by consumer, and land loans, offset by an increase in first mortgages on residential properties, commercial real estate loans, construction loans and commercial business loans. No loans were held for sale at September 30, 2006 compared to $9.5 million held for sale at September 30, 2005. That decrease resulted from discontinuing the operations of Greater Atlantic Mortgage Corporation as the type of business conducted by that mortgage corporation no longer fit the strategy of the bank. 3
The following table shows the bank's loan originations, purchases, sales and principal repayments during the periods indicated: Year Ended September 30, ----------------------------------------- 2006 2005 2004 - --------------------------------------------------------------------------------------------------------- (In Thousands) Total loans at beginning of period (1) $224,733 $262,598 $257,247 Originations of loans for investment: Single-family residential 12,559 6,624 16,202 Multifamily 625 - 145 Commercial real estate 9,210 9,977 11,265 Construction 13,089 19,991 17,405 Land loans 8,494 10,530 11,543 Second trust - - - Commercial business 21,170 21,083 38,345 Consumer 39,048 44,205 50,937 - --------------------------------------------------------------------------------------------------------- Total originations and purchases for investment 104,195 112,410 145,842 Loans originated for resale by Greater Atlantic Bank - - - Loans originated for resale by Greater Atlantic Mortgage 91,477 276,038 402,988 - --------------------------------------------------------------------------------------------------------- Total originations 195,672 388,448 548,830 Repayments (117,440) (154,263) (139,466) Sale of loans originated for resale by Greater Atlantic Mortgage (100,994) (272,050) (404,013) - --------------------------------------------------------------------------------------------------------- Net activity in loans (22,762) (37,865) 5,351 - --------------------------------------------------------------------------------------------------------- Total loans at end of period (1) $201,971 $224,733 $262,598 =========================================================================================================
(1) Includes loans held for sale of $9.5 million at September 30, 2005. 4
LOAN PORTFOLIO. The following table sets forth the composition of the bank's loan portfolio in dollar amounts and as a percentage of the portfolio at the dates indicated. At September 30, ----------------------------------------------------------------------------------------- 2006 2005 2004 2003 2002 ---------------- --------------- --------------- --------------- ----------------- Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent ----------------------------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Mortgage loans: Single-family (1) $ 43,473 21.52% $ 41,434 19.25% $ 74,620 29.02% $ 95,818 38.20% $122,143 47.11% Multi-family 813 0.40 751 0.35 1,074 0.42 1,445 0.58 536 0.21 Construction 14,245 7.05 24,273 11.28 16,696 6.49 11,996 4.78 18,993 7.32 Commercial real estate 28,403 14.06 25,531 11.86 23,023 8.95 20,533 8.19 18,932 7.30 Land 13,829 6.86 18,421 8.55 20,668 8.04 17,258 6.88 9,947 3.84 ----------------- ---------------- ---------------- ---------------- ---------------- Total mortgage loans 100,763 49.89 110,410 51.29 136,081 52.92 147,050 58.63 170,551 65.78 ----------------- ---------------- ---------------- ---------------- ---------------- Commercial business and consumer loans: Commercial business 39,794 19.70 35,458 16.47 47,654 18.53 39,043 15.57 28,880 11.14 Consumer: Home equity 61,031 30.22 69,006 32.06 72,814 28.32 63,888 25.47 58,531 22.58 Automobile 81 .04 100 .05 271 0.11 428 0.17 771 0.30 Other 302 .15 274 .13 315 0.12 409 0.16 533 0.20 ----------------- ---------------- ---------------- ---------------- ---------------- Total commercial business and consumer loans 101,208 50.11 104,838 48.71 121,054 47.08 103,768 41.37 88,715 34.22 ----------------- ---------------- ---------------- ---------------- ---------------- Total loans 201,971 100.00% 215,248 100.00% 257,135 100.00% 250,818 100.00% 259,266 100.00% ====== ====== ====== ====== ====== Less: Allowance for loan losses (1,330) (1,212) (1,600) (1,550) (1,699) Loans in process (8,517) (20,386) (10,453) (8,394) (11,103) Unearned premium 1,183 1,270 1,305 1,379 1,617 -------- -------- -------- -------- -------- Loans receivable, net $193,307 $194,920 $246,387 $242,253 $248,081 ======== ======== ======== ======== ========
(1) Includes loans secured by second trusts on single-family residential property. LOAN MATURITY. The following table shows the remaining contractual maturity of the bank's total loans at September 30, 2006. Loans that have adjustable rates are shown as amortizing when the interest rates are next subject to change. The table does not include the effect of future principal prepayments.
At September 30, 2006 --------------------------------------------------------------- Multi- Commercial One- to Family and Business Four- Commercial and Total Family Real Estate Consumer Loans --------------------------------------------------------------------------------------------------------- (In Thousands) Amounts due in: One year or less $ 25,554 $ 7,834 $ 82,533 $115,921 After one year: More than one year to three years 12,182 6,197 4,407 22,786 More than three years to five years 2,321 11,640 3,966 17,927 More than five years to 15 years 5,135 7,634 4,898 17,667 More than 15 years 11,751 1,998 5,404 19,153 --------------------------------------------------------------------------------------------------------- Total amount due $ 56,943 $ 35,303 $ 101,208 $193,454 =========================================================================================================
5 The following table sets forth, at September 30, 2006, the dollar amount of loans contractually due after September 30, 2007, identifying whether such loans have fixed interest rates or adjustable interest rates. At September 30, 2006, the bank had $20.3 million of construction, acquisition and development, land and commercial business loans that were contractually due after September 30, 2007
Due After September 30, 2007 ----------------------------------------------- Fixed Adjustable Total ------------------------------------------------------------------------------------------------------------ (In Thousands) Real estate loans: One- to four-family $16,964 $14,425 $31,389 Multi-family and commercial 16,528 10,941 27,469 ------------------------------------------------------------------------------------------------------------ Total real estate loans 33,492 25,366 58,858 Commercial business and consumer loans 7,923 10,752 18,675 ------------------------------------------------------------------------------------------------------------ Total loans $41,415 $36,118 $77,533 ============================================================================================================
ONE- TO FOUR-FAMILY MORTGAGE LENDING. The bank currently offers both fixed-rate and adjustable-rate mortgage ("ARM") loans with maturities of up to 30 years secured by single-family residences, which term includes real property containing from one to four residences. At September 30, 2006, the bank's one- to four-family mortgage loans totaled $43.5 million, or 21.52% of total loans. Of the one- to four-family mortgage loans outstanding at that date, 39.19% were fixed-rate loans and 60.81% were ARM loans. CONSTRUCTION AND DEVELOPMENT LENDING. The bank originates construction and development loans primarily to finance the construction of one- to four-family, owner-occupied residential real estate properties located in the bank's primary market area. The bank also originates land loans to local contractors and developers for the purpose of making improvements thereon, including small residential subdivisions in the bank's primary market area or for the purpose of holding or developing land for sale. At September 30, 2006, construction and development loans (including land loans) totaled $28.1 million, or 13.91%, of the bank's total loans, of which, land loans totaled $13.8 million or 6.86% of total loans. Such loans are secured by a lien on the property, are limited to 75% of the lower of the acquisition price or the appraised value of the land and have a term of up to three years with a floating interest rate generally based on the prime rate as reported in THE WALL STREET JOURNAL. All the bank's land loans are secured by property in its primary market area. MULTI-FAMILY AND COMMERCIAL REAL ESTATE LENDING. The bank originates multi-family and commercial real estate loans that are generally secured by five or more unit apartment buildings and properties used for business purposes such as small office buildings or retail facilities located primarily in the bank's market area. The bank's multi-family and commercial real estate underwriting policies provide that such real estate loans may be made in amounts of up to 75-80% of the appraised value of the property. The bank's multi-family and commercial real estate loan portfolio at September 30, 2006 was $29.2 million, or 14.46% of total loans. The largest multi-family or commercial real estate loan in the bank's portfolio at September 30, 2006, consisted of a $4.0 million commercial real estate loan secured by real property in Alabama. The property is a skilled nursing facility on which the bank has participated $2.1 million of the $6.1 million note to another bank. COMMERCIAL BUSINESS LENDING. At September 30, 2006, the bank had $39.8 million in commercial business loans which amounted to 19.70% of total loans. The bank makes commercial business loans primarily in its market area to a variety of professionals, sole proprietorships and small businesses. The bank offers a variety of commercial lending products, including term loans for fixed assets and working capital, revolving lines of credit and letters of credit. Term loans are generally offered with initial fixed rates of interest for the first five years and with terms of up to 7 years. Business lines of credit have adjustable rates of interest and are payable on demand, subject to annual review and renewal. Business loans with variable rates of interest adjust on a monthly basis and are generally indexed to the prime rate as published in THE WALL STREET JOURNAL. CONSUMER LENDING. Consumer loans at September 30, 2006 amounted to $61.4 million or 30.41% of the bank's total loans, and consisted primarily of home equity loans, home equity lines of credit, and, to a significantly lesser extent, secured and unsecured personal loans and loans on new and used automobiles. These loans are generally made to residents of the bank's primary market area and generally are secured by real estate, deposit accounts and automobiles. These loans are typically shorter term and generally have higher interest rates than one- to four-family mortgage loans. The bank offers home equity loans and home equity lines of credit (collectively, "home equity loans"). Most of the bank's home equity loans are secured by second mortgages on one- to four-family residences located in the bank's primary market area. At September 30, 2006, these loans totaled $61.0 million or 30.22% of the bank's total loans and 60.30% of commercial business and consumer loans. Other types of consumer loans, primarily consisting of secured and unsecured personal loans and new and used automobile loans, totaled $383,000, or 0.19% of the bank's total loans and 0.38% of commercial business and consumer loans at September 30, 2006. 6 MORTGAGE BANKING ACTIVITIES The bank's mortgage banking activities primarily consist of originating mortgage loans secured by single-family properties. However, the mortgage-banking activities conducted in Greater Atlantic Mortgage Corporation ("GAMC") were discontinued effective March 29, 2006 as it was determined that, because it was unprofitable, this business no longer fit our strategy. Mortgage banking involves the origination and sale of mortgage loans for the purpose of generating gains on sale of loans and fee income on the origination of loans, in addition to loan interest income. In recent years, the volume of GAMC's originations had been declining, resulting in losses from mortgage banking operations, which, pursuant to an agreement, the manager had agreed to fund. In the third quarter of 2006, we applied discontinued operations accounting for GAMC as we completed closing those operations during the quarter. This business no longer fit our strategy because it was unprofitable. Accordingly, the income statements for all periods have been adjusted. The reclassifications primarily resulted in a reduction to previously reported levels of net interest income, a reduction in noninterest income and a reduction in noninterest expense. In 2004, the bank entered into a management agreement with the manager of GAMC, its mortgage-banking subsidiary. Under the management agreement the manager was to reimburse operating losses equal to approximately 100% of any operating loss in return for an increase in his share of net earnings from 40% to 80%. Reflected in the loss from discontinued operations for 2005 is a reimbursement of $1.8 million of losses of GAMC provided by the manager of GAMC. During the three months ended September 30, 2005, the manager was no longer able to reimburse GAMC for the losses incurred and as a result $993,000 of losses was recognized during the quarter. The management contract was subsequently terminated in the first quarter of fiscal 2006. Due to the unprofitable operations of GAMC, the company recognized an additional loss of $1.5 million for the nine months ended June 30, 2006. In addition to the loss from operations, a non-recurring pre-tax impairment charge on long-lived assets of $996,000 was recorded for the nine months ended June 30, 2006 and included in discontinued operations in the consolidated statements of operations. ASSET QUALITY DELINQUENT LOANS AND CLASSIFIED ASSETS. Reports listing all delinquent accounts are generated and reviewed monthly by management and the board of directors and all loans or lending relationships delinquent 30 days or more and all real estate owned ("REO") are reviewed monthly by the board of directors. The procedures taken by the bank with respect to delinquencies vary depending on the nature of the loan, the length and cause of delinquency and whether the borrower has previously been delinquent. Federal regulations and the bank's Asset Classification Policy require that the bank utilize an internal asset classification system as a means of reporting problem and potential problem assets. The bank has incorporated the internal asset classifications of the Office of Thrift Supervision (the "OTS") as a part of its credit monitoring system. The bank currently classifies problem and potential problem assets as "Substandard," "Doubtful" or "Loss" assets. 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" that 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 "uncollectible" and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets which do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are required to be designated "Special Mention." 7 The bank's management reviews and classifies the bank's assets on a regular basis and the board of directors reviews management's reports on a monthly basis. The bank classifies assets in accordance with the management guidelines described above. At September 30, 2006, the bank had $791,000 of loans designated as Substandard which consisted of two residential loans, one commercial business loan, one commercial real estate loan, one consumer loan, and one land loan. At that same date, the bank had $319,000 of assets classified as Doubtful, consisting of one commercial business loan and one residential real estate loan. At September 30, 2006, the bank had no loans classified as Loss. As of September 30, 2006, the bank had no loans designated as Special Mention. The following table sets forth delinquencies in the bank's loans as of the dates indicated.
At September 30, ---------------------------------------------------------------------------------------------------------- 2006 2005 2004 ---------------------------------- ---------------------------------- ------------------------------------ 60 - 89 Days 90 Days or More 60 - 89 Days 90 Days or More 60 - 89 Days 90 Days or More ---------------- ---------------- ----------------- ------------------ ---------------- ----------------- Number Principal Number Principal Number Principal Number Principal Number Principal Number Principal of Balance of Balance of Balance of Balance of Balance of Balance Loans of Loans Loans of Loans Loans of Loans Loans of Loans Loans of Loans Loans of Loans --------------------------------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Mortgage loans: Single-family - $ - 2 $ 835 2 $ 168 4 $ 10 - $ - 6 $ 563 Home equity - - - - - - 2 229 1 275 1 96 Construction & Land - - 1 31 - - 2 233 1 118 1 31 Commercial real estate - - 1 25 - - 1 25 - - 1 29 Commercial business - - 2 216 - - 3 1,105 1 28 1 228 Consumer - - 1 3 - - 1 2 - - 1 6 ------------------------------------------------------------------------------------------------------------------------------- Total - $ - 7 $1,110 2 $ 168 13 $1,604 3 $421 11 $ 953 ===============================================================================================================================
NON-PERFORMING ASSETS AND IMPAIRED LOANS. The following table sets forth information regarding non-accrual loans and REO. The bank's policy is to cease accruing interest on mortgage loans 90 days or more past due, to cease accruing interest on consumer loans 60 days or more past due (unless the loan principal and interest are determined by management to be fully secured and in the process of collection), and to charge off any accrued and unpaid interest. 8
At September 30, --------------------------------------------- 2006 2005 2004 2003 2002 ----------------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Loans accounted for on a non-accrual basis Mortgage loans: Single-family $ - $ 10 $ 563 $ 637 $ 388 Home equity - 229 96 - - Commercial real estate 25 25 29 31 21 Construction and Land 31 233 31 34 - Commercial business 216 1,105 228 716 45 Consumer 3 2 6 - - ----------------------------------------------------------------------------------------------------------------- Total non-accrual loans 275 1,604 953 1,418 454 Accruing loans which are contractually past due 90 days or more 835 - - 28 343 ----------------------------------------------------------------------------------------------------------------- Total of non-accrual and 90 days past due loans 1,110 1,604 953 1,446 797 Foreclosed real estate, net - 232 - - - ----------------------------------------------------------------------------------------------------------------- Total non-performing assets $ 1,110 $ 1,836 $ 953 $1,446 $ 797 ================================================================================================================= Non-accrual loans as a percentage of loans 0.14% 0.82% 0.39% 0.59% 0.18% held for investment, net ================================================================================================================= Non-accrual and 90 days or more past due loans 0.57% 0.82% 0.39% 0.60% 0.32% as a percentage of loans held for investment, net ================================================================================================================= Non-accrual and 90 days or more past due loans 0.36% 0.47% 0.22% 0.29% 0.16% as a percentage of total assets ================================================================================================================= Non-performing assets as a percentage of total assets 0.36% 0.54% 0.22% 0.29% 0.16% =================================================================================================================
During the year ended September 30, 2006, the amount of additional interest income that would have been recognized on non-accrual loans if such loans had continued to perform in accordance with their contractual terms was $204,000. ALLOWANCE FOR LOAN LOSSES The allowance for loan losses is established through a provision for loan losses based on management's evaluation of the risks inherent in its loan portfolio and the general economy. The allowance for loan losses is maintained at an amount management considers adequate to cover estimated losses in loans receivable which are deemed probable and estimable based on information currently known to management. The allowance is based upon a number of factors, including current economic conditions, actual loss experience and industry trends. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the bank's allowance for loan losses. Such agencies may require the bank to make additional provisions for estimated loan losses based upon their judgment about information available to them at the time of their examination. There can be no assurance that the bank will not sustain credit losses in future periods, which could be substantial in relation to the size of the allowance. As of September 30, 2006, the bank's allowance for loan losses amounted to $1.3 million or 0.66% of total loans. While the allowance for loan losses to total non-performing loans at September 30, 2006 is 119.82%, the allowance as a percentage of total loans increased 10 basis points when compared to September 30, 2005. A $126,000 provision for loan losses was recorded during the year ended September 30, 2006, compared to a provision of $219,000 during the year ended September 30, 2005. The decrease in the provision for loan losses of $93,000 from the year ago period resulted from the decline in non-performing assets and the outstanding balance of the bank's land loans, commercial business loans, home equity loans and real estate owned. The decrease in provision was due primarily to the decreases in the required provisions for those loans coupled with an overall decline in the size of the bank's loan portfolio. On an annual basis, or more often if deemed necessary, the bank has contracted with an independent outside third party to have its loan portfolio reviewed. The focus of their review is to identify the extent of potential and actual risk in the bank's commercial loan portfolio, in addition to the underwriting and processing practices. Observations made regarding the bank's portfolio risk are based upon review evaluations, portfolio profiles and discussion with the operational staff, including the line lenders and senior management. 9 The following table sets forth activity in the bank's allowance for loan losses for the periods indicated. Where specific loan loss reserves have been established, any differences between the loss allowances and the amount of loss realized has been charged or credited to current operations.
Year Ended September 30, ------------------------------------------------------------ 2006 2005 2004 2003 2002 ----------------------------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Balance at beginning of period $ 1,212 $ 1,600 $ 1,550 $ 1,699 $ 810 Provisions 126 219 209 855 968 Charge-offs: Mortgage loans: Single-family - 33 20 162 64 Commercial real estate - - - 22 - Commercial business 78 584 177 828 7 Consumer 2 8 3 8 27 ----------------------------------------------------------------------------------------------------------------------------- Total charge-offs 80 625 200 1,020 98 Recoveries: Mortgage loans: Single-family 2 2 29 6 12 Commercial real estate - - - - - Commercial business 69 15 10 4 - Consumer 1 1 2 6 7 ----------------------------------------------------------------------------------------------------------------------------- Total recoveries 72 18 41 16 19 Net charge-offs 8 607 159 1,004 79 ----------------------------------------------------------------------------------------------------------------------------- Balance at end of period $ 1,330 $ 1,212 $ 1,600 $ 1,550 $ 1,699 ============================================================================================================================= Ratio of net charge-offs during the period 0.00% 0.28% 0.06% 0.36% 0.03% to average loans outstanding during the period ============================================================================================================================= Allowance for loan losses to total non-performing loans at end of period 119.82% 75.56% 167.89% 109.31% 374.23% ============================================================================================================================= Allowance for loan losses to total loans 0.66% 0.56% 0.62% 0.62% 0.66% =============================================================================================================================
10 The following table sets forth the bank's allowance for loan losses in each of the categories listed and the percentage of such amounts to the total allowance and the percentage of such amounts to total loans. Management believes that the allowance can be allocated by category only on an approximate basis. The allocation of the allowance to each category is not necessarily indicative of future losses and does not restrict the use of the allowance to absorb losses in any other categories.
At September 30, ----------------------------------------------------------------------------------------------------- 2006 2005 2004 2003 2002 --------------------- -------------------- -------------------- ------------------- ----------------- Percent of Percent of Percent of Percent of Percent of Loans in Loans in Loans in Loans in Loans in Each Each Each Each Each Category Category Category Category Category to Total to Total to Total to Total to Total Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans - ------------------------------------------------------------------------------------------------------------------------------------ (Dollars in Thousands) Mortgage loans: Single-family $ 177 13.31% $ 35 19.25% $ 110 29.02% $ 141 38.20% $ 148 47.11% Multi-family 6 0.45 6 0.35 8 0.42 11 0.58 4 0.21 Construction 67 5.04 72 11.28 78 6.49 80 4.78 80 7.32 Commercial real estate 286 21.50 328 11.86 233 8.95 208 8.19 219 7.30 Land 109 8.20 155 8.55 175 8.04 132 6.88 72 3.84 - ------------------------------------------------------------------------------------------------------------------------------------ Total mortgage loans 645 48.50 596 51.29 604 52.92 572 58.63 523 65.78 - ------------------------------------------------------------------------------------------------------------------------------------ Commercial and Consumer: Commercial 525 39.47 407 16.47 515 18.53 770 15.57 1,005 11.14 Consumer: Home equity 152 11.43 195 32.06 213 28.32 159 25.47 151 22.58 Automobile 6 0.45 5 0.18 9 0.23 13 0.33 20 0.50 - ------------------------------------------------------------------------------------------------------------------------------------ Total commercial and consumer 683 51.35 607 48.71 737 47.08 942 41.37 1,176 34.22 - ------------------------------------------------------------------------------------------------------------------------------------ Unallocated 2 0.15 9 N/A 259 N/A 36 N/A - N/A - ------------------------------------------------------------------------------------------------------------------------------------ Total $1,330 100.00% $1,212 100.00% $1,600 100.00% $1,550 100.00% $1,699 100.00% ====================================================================================================================================
INVESTMENT ACTIVITIES The investment policy of the bank, as approved by the board of directors, requires management to maintain adequate liquidity and generate a favorable return on investments, to complement the bank's lending activities without incurring undue interest rate and credit risk. The bank primarily utilizes investments in securities for liquidity management, as a source of income and as a method of deploying excess funds not utilized for investment in loans. Securities bought and held principally for sale in the near term, generally within 90 days, are classified as trading. At September 30, 2006, the bank had invested $31.6 million in mortgage-backed securities, or 10.35% of total assets, of which $31.4 million were classified as available-for-sale and $235,000 were classified as held-to-maturity. Investments in mortgage-backed securities involve a risk that actual prepayments will be greater than estimated prepayments over the life of the security, which may require adjustments to the amortization of any premium or accretion of any discount relating to such instruments thereby changing the net yield on such securities. There is also reinvestment risk associated with the cash flows from such securities or in the event such securities are redeemed by the issuer. In addition, the market value of such securities may be adversely affected by changes in interest rates. 11 The following table sets forth information regarding the amortized cost and estimated market value of the bank's investment portfolio at the dates indicated.
At September 30, ------------------------------------------------------------------------------- 2006 2005 2004 -------------------------- ------------------------- -------------------------- Estimated Estimated Estimated Amortized Market Amortized Market Amortized Market Cost Value Cost Value Cost Value --------------------------------------------------------------------------------------------------------------- (In Thousands) Available-for-sale: Corporate debt securities $ 7,280 $ 7,142 $ 6,736 $ 6,736 $ 3,923 $ 3,928 CMOs 9,735 9,755 14,446 14,454 9,812 9,823 U.S. Government SBA's 27,629 27,199 30,239 29,781 36,919 36,721 FHLMC MBS's 5,549 5,463 9,044 8,969 14,146 14,085 FNMA MBS's 18,350 17,986 35,548 34,947 61,195 60,302 GNMA MBS's 8,133 7,916 13,097 12,942 17,946 17,853 --------------------------------------------------------------------------------------------------------------- Total available-for-sale 76,676 75,461 109,110 107,829 143,941 142,712 --------------------------------------------------------------------------------------------------------------- Held-to-maturity: Corporate debt securities - - 1,000 1,020 1,003 1,065 U.S. Government SBA's 4,461 4,230 6,531 6,213 8,810 8,427 FHLMC MBS's 128 125 236 235 245 247 FNMA MBS's 107 105 202 198 237 235 --------------------------------------------------------------------------------------------------------------- Total held-to-maturity 4,696 4,460 7,969 7,666 10,295 9,974 --------------------------------------------------------------------------------------------------------------- Total investment securities $ 81,372 $ 79,921 $117,079 $115,495 $154,236 $152,686 =============================================================================================================== Investment securities with: Fixed rates $ - $ - $ 1,000 $ 1,020 $ 1,003 $ 1,065 Adjustable rates 49,105 48,326 57,952 57,184 59,464 58,899 Mortgage-backed securities with: Fixed rates 243 236 393 376 551 541 Adjustable rates 32,024 31,359 57,734 56,915 93,218 92,181 --------------------------------------------------------------------------------------------------------------- Total $ 81,372 $ 79,921 $117,079 $115,495 $154,236 $152,686 ===============================================================================================================
As of September 30, 2006, the bank held investments in available for sale with unrealized holding losses totaling $1.4 million. All losses are considered temporary and consisted of the following:
Less than 12 months 12 months or more Total -------------------------- -------------------------- ------------------------ Fair Unrealized Fair Unrealized Fair Unrealized Description of Securities Value Losses Value Losses Value Losses --------------------------------------------------------------------------------------------------------------- (In Thousands) Corporate debt securities $ 4,921 $ 174 $ - $ - $ 4,921 $ 174 CMOs 3,279 28 - - 3,279 28 U.S. Government securities SBA 22,375 536 - - 22,375 536 GNMA 7,916 217 - - 7,916 217 U.S. Government agency securities: FHLMC MBS's 5,463 86 - - 5,463 86 FNMA MBS's 17,773 357 213 7 17,986 364 --------------------------------------------------------------------------------------------------------------- Total $ 61,727 $ 1,398 $ 213 $ 7 $ 61,940 $ 1,405 ===============================================================================================================
12 The table below sets forth certain information regarding the carrying value, weighted average yields and contractual maturities of the bank's investment securities available-for-sale and mortgage-backed securities available-for-sale.
At September 30, 2006 ------------------------------------------------------------------------------------------------------- More than One More than Five One Year or Less Year to Five Years Years to Ten Years More than Ten Years Total ------------------ -------------------- -------------------- --------------------- ------------------ Weighted Weighted Weighted Weighted Weighted Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average Value Yield Value Yield Value Yield Value Yield Value Yield ------------------------------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Investment securities available-for-sale: Adjustable-rate securities: CMO's $ - -% $ - -% $ - -% $ 9,755 5.78% $ 9,755 5.78% Corporate debt - - - - 2,880 6.46 4,262 7.04 7,142 6.81 U.S. Government SBA's 32 3.02 - - 873 6.90 26,294 5.95 27,199 5.97 ------------------------------------------------------------------------------------------------------------------------------ Total 32 3.02 - - 3,753 6.56 40,311 6.02 44,096 6.06 ------------------------------------------------------------------------------------------------------------------------------ MBS's available for sale: Adjustable-rate securities: FHLMC - - - - - - 5,463 3.82 5,463 3.82 FNMA - - - - - - 17,773 3.48 17,773 3.48 GNMA 34 4.66 - - - - 7,882 3.62 7,916 3.62 ------------------------------------------------------------------------------------------------------------------------------ Total 34 4.66 - - - - 31,118 3.58 31,152 3.58 ------------------------------------------------------------------------------------------------------------------------------ MBS'S fixed-rate: FNMA - - 159 6.67 54 7.28 - - 213 6.89 ------------------------------------------------------------------------------------------------------------------------------ Total - - 159 6.67 54 7.28 - - 213 6.89 ------------------------------------------------------------------------------------------------------------------------------ Total mortgage-backed securities available- for-sale 34 4.66 159 6.67 54 7.28 31,118 3.58 31,365 3.60 ------------------------------------------------------------------------------------------------------------------------------ Total investment portfolio $ 66 3.86% $159 6.67% $3,807 6.57% $ 71,429 4.96% $75,461 5.04% ==============================================================================================================================
The table below sets forth certain information regarding the carrying value, weighted average yields and contractual maturities of the bank's investment securities held-to-maturity and mortgage-backed securities held to maturity.
At September 30, 2006 ------------------------------------------------------------------------------------------------------- More than One More than Five One Year or Less Year to Five Years Years to Ten Years More than Ten Years Total ------------------ -------------------- -------------------- --------------------- ------------------ Weighted Weighted Weighted Weighted Weighted Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average Value Yield Value Yield Value Yield Value Yield Value Yield - ----------------------------------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Investment securities held-to-maturity: Adjustable-rate securities: U.S. Government SBA's $ - -% $110 4.87% $553 5.21% $3,798 4.80% $4,461 4.86% Fixed-rate: Corporate debt - - - - - - - - - - - ----------------------------------------------------------------------------------------------------------------------------------- Total investment securities - - 110 4.87 553 5.21 3,798 4.80 4,461 4.86 held-to-maturity - ----------------------------------------------------------------------------------------------------------------------------------- MBS's held-to-maturity: Adjustable-rate securities: FHLMC - - - - - - 128 3.00 128 3.00 FNMA - - - - - - 84 6.92 84 6.92 - ----------------------------------------------------------------------------------------------------------------------------------- Total - - - - - - 212 4.56 212 4.56 - ----------------------------------------------------------------------------------------------------------------------------------- Fixed-rate: FNMA - - - - - - 23 6.50 23 6.50 - ----------------------------------------------------------------------------------------------------------------------------------- Total - - - - - - 23 6.50 23 6.50 - ----------------------------------------------------------------------------------------------------------------------------------- Total mortgage-backed securities held-to-maturity - - - - - - 235 4.75 235 4.75 - ----------------------------------------------------------------------------------------------------------------------------------- Total held-to-maturity investments $ - -% $110 4.87% $553 5.21% $4,033 4.80% $4,696 4.85% ===================================================================================================================================
13 SOURCES OF FUNDS GENERAL. Deposits, loan repayments and prepayments, cash flows generated from operations, Federal Home Loan Bank ("FHLB") advances and reverse repurchase agreements are the primary sources of the bank's funds for use in lending, investing and for other general purposes. DEPOSITS. Deposits are attracted from within the bank's market area by offering a broad selection of deposit instruments, including checking, savings, money market and time deposits. Deposit account terms vary, differentiated by the minimum balance required, the time periods that the funds must remain on deposit and the interest rate, among other factors. In determining the terms of its deposit accounts, the bank considers current interest rates, profitability to the bank, interest rate risk characteristics, competition and its customer preferences and concerns. The bank may pay above-market interest rates to attract or retain deposits when less expensive sources of funds are not available. The bank reviews its deposit composition and pricing weekly. At September 30, 2006, $102.3 million, or 79.93% of the bank's certificate of deposit accounts were to mature within one year. The following table sets forth the distribution and the rates paid on each category of the bank's deposits.
At September 30, ------------------------------------------------------------------------------ 2006 2005 -------------------------------------- --------------------------------------- Percent of Percent of Total Rate Total Rate Balance Deposits Paid Balance Deposits Paid - -------------------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Savings accounts $ 3,679 1.60% 0.98% $ 8,078 3.40% 0.99% Now and money market accounts 73,334 31.86 3.51 66,638 28.02 2.75 Certificates of deposit 127,939 55.58 4.55 145,912 61.36 3.32 Noninterest-bearing deposits: Demand deposits 25,222 10.96 - 17,166 7.22 - - -------------------------------------------------------------------------------------------------------------------- Total deposits $230,174 100.00% 3.67% $237,794 100.00% 2.84% ====================================================================================================================
The following table presents information concerning the amounts, the rates and the periods to maturity of the bank's certificate accounts outstanding.
At September 30, 2006 ----------------------------- Amount Rate ------------------------------------------------------------------------------------------------ (Dollars in Thousands) Balance maturing: Three months or less $ 47,401 4.54% Three months to one year 54,856 4.66 One year to three years 21,264 4.31 Over three years 4,418 4.48 ------------------------------------------------------------------------------------------------ Total $127,939 4.55% ================================================================================================
14 At September 30, 2006, the bank had $46.9 million in certificate accounts in amounts of $100,000 or more maturing as follows:
Maturity Period Weighed Average Amount Rate ------------------------------------------------------------------------------------------------ Three months or less $25,992 4.74% Over 3 through 6 months 5,577 4.70 Over 6 through 12 months 10,021 5.01 Over 12 months 5,315 4.41 ------------------------------------------------------------------------------------------------ Total $46,905 4.75% ================================================================================================
The following table sets forth the deposit activity of the bank for the periods indicated.
At or For the Year Ended September 30, ------------------------------------------- 2006 2005 2004 ------------------------------------------------------------------------------------------------ (In Thousands) Balance at beginning of period $237,794 $288,956 $297,876 Net deposits (withdrawals) before interest credited (15,329) (57,499) (14,671) Interest credited 7,709 6,337 5,751 ------------------------------------------------------------------------------------------------ Net increase (decrease) in deposits (7,620) (51,162) (8,920) ------------------------------------------------------------------------------------------------ Ending balance $230,174 $237,794 $288,956 ================================================================================================
BORROWINGS. At September 30, 2006, borrowings consisted of FHLB advances and reverse repurchase agreements totaling $54.6 million. FHLB advances amounted to $36.0 million at September 30, 2006, a decrease from the $38.0 million outstanding at September 30, 2005, and other borrowings (reverse repurchase agreements) amounted to $18.6 million, a decrease of $19.9 million compared to $38.5 million at September 30, 2005. During the fiscal year ended September 30, 2006, all reverse repurchase agreements represented agreements to repurchase the same securities. The following table sets forth information regarding the bank's borrowed funds:
At or For the Year Ended September 30, ------------------------------------------ 2006 2005 2004 ----------------------------------------------------------------------------------------------------------------- FHLB Advances: Average balance outstanding $ 44,894 $ 44,422 $ 116,155 Maximum amount outstanding at any month-end during the period 51,000 49,200 142,250 Balance outstanding at end of period 36,000 38,000 51,200 Weighted average interest rate during the period 5.05% 4.47% 2.39% Weighted average interest rate at end of period 5.28% 4.85% 3.93% Reverse repurchase agreements: Average balance outstanding 31,624 58,837 89,734 Maximum amount outstanding at any month-end during the period 35,641 62,846 93,730 Balance outstanding at end of period 18,574 38,479 64,865 Weighted average interest rate during the period 4.21% 4.37% 4.26% Weighted average interest rate at end of period 4.65% 3.69% 1.98%
15 SUBSIDIARY ACTIVITIES We have two subsidiaries, the bank and Greater Atlantic Capital Trust I. We established the Trust in January 2002 to issue certain convertible preferred securities which we completed in March 2002. See discussion of the Trust in Note 22 to the financial statements. PERSONNEL As of September 30, 2006, we had 62 full-time employees and 14 part-time employees. The employees are not represented by a collective bargaining unit and the company considers its relationship with its employees to be good. 16 REGULATION AND SUPERVISION GENERAL As a savings and loan holding company, the company is required by federal law to report to, and otherwise comply with the rules and regulations of, the Office of Thrift Supervision. The bank is subject to extensive regulation, examination and supervision by the Office of Thrift Supervision, as its primary federal regulator, and the Federal Deposit Insurance Corporation, as the deposit insurer. The bank is a member of the Federal Home Loan Bank System and, with respect to deposit insurance, of the Savings Association Insurance Fund managed by the Federal Deposit Insurance Corporation. The bank must file reports with the Office of Thrift Supervision and the Federal Deposit Insurance Corporation concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other savings institutions. The Office of Thrift Supervision and/or the Federal Deposit Insurance Corporation conduct periodic examinations to test the bank's safety and soundness and compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulatory requirements and policies, whether by the Office of Thrift Supervision, the Federal Deposit Insurance Corporation or Congress, could have a material adverse impact on the company, the bank and their operations. Certain regulatory requirements applicable to the bank and to the company are referred to below or elsewhere herein. The description of statutory provisions and regulations applicable to savings institutions and their holding companies set forth below does not purport to be a complete description of such statutes and regulations and their effects on the Bank and the company. HOLDING COMPANY REGULATION The company is a nondiversified unitary savings and loan holding company within the meaning of federal law. Under prior law, a unitary savings and loan holding company, such as the company, was not generally restricted as to the types of business activities in which it may engage, provided that the bank continued to be a qualified thrift lender. See "FEDERAL SAVINGS INSTITUTION REGULATION - QTL TEST." The Gramm-Leach-Bliley Act of 1999 provides that no company may acquire control of a savings institution after May 4, 1999 unless it engages only in the financial activities permitted for financial holding companies under the law or for multiple savings and loan holding companies as described below. Further, the Gramm-Leach-Bliley Act specifies that existing savings and loan holding companies may only engage in such activities. The Gramm-Leach-Bliley Act, however, grandfathered the unrestricted authority for activities with respect to unitary savings and loan holding companies existing prior to May 4, 1999, so long as the holding company's savings institution subsidiary continues to comply with the QTL Test. The company does not qualify for the grandfathering. Upon any non-supervisory acquisition by the company of another savings institution or savings bank that meets the qualified thrift lender test and is deemed to be a savings institution by the Office of Thrift Supervision, the company would become a multiple savings and loan holding company (if the acquired institution is held as a separate subsidiary) and would generally be limited to activities permissible for bank holding companies under Section 4(c)(8) of the Bank Holding Company Act, subject to the prior approval of the Office of Thrift Supervision, and certain activities authorized by Office of Thrift Supervision regulation. However, the OTS has issued an interpretation concluding that multiple savings and loan holding companies may also engage in activities permitted for financial holding companies. A savings and loan holding company is prohibited from, directly or indirectly, acquiring more than 5% of the voting stock of another savings institution or savings and loan holding company, without prior written approval of the Office of Thrift Supervision and from acquiring or retaining control of a depository institution that is not insured by the Federal Deposit Insurance Corporation. In evaluating applications by holding companies to acquire savings institutions, the Office of Thrift Supervision considers the financial and managerial resources and future prospects of the company and institution involved, the effect of the acquisition on the risk to the deposit insurance funds, the convenience and needs of the community and competitive factors. The Office of Thrift Supervision may not approve any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions: (i) the approval of interstate supervisory acquisitions by savings and loan holding companies and (ii) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions. 17 Although savings and loan holding companies are not currently subject to specific capital requirements or specific restrictions on the payment of dividends or other capital distributions, federal regulations do prescribe such restrictions on subsidiary savings institutions as described below. The bank must notify the Office of Thrift Supervision (30) days before declaring any dividend to the company. In addition, the financial impact of a holding company on its subsidiary institution is a matter that is evaluated by the Office of Thrift Supervision and the agency has authority to order cessation of activities or divestiture of subsidiaries deemed to pose a threat to the safety and soundness of the institution. ACQUISITION OF THE COMPANY. Under the Federal Change in Bank Control Act, a notice must be submitted to the Office of Thrift Supervision if any person (including a company), or group acting in concert, seeks to acquire "control" of a savings and loan holding company. Under certain circumstances, a change of control may occur, and prior notice is required, upon the acquisition of 10% or more of the company's outstanding voting stock, unless the Office of Thrift Supervision has found that the acquisition will not result in a change of control of the company. Under the Change in Bank Control Act, the Office of Thrift Supervision has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the anti-trust effects of the acquisition. Any company that acquires control would then be subject to regulation as a savings and loan holding company. FEDERAL SAVINGS INSTITUTION REGULATION BUSINESS ACTIVITIES. The activities of federal savings banks are governed by federal law and regulations. These laws and regulations delineate the nature and extent of the activities in which federal savings banks may engage. In particular, certain lending authority for federal savings banks, E.G., commercial, non-residential real property loans and consumer loans, is limited to a specified percentage of the institution's capital or assets. CAPITAL REQUIREMENTS. The Office of Thrift Supervision capital regulations require savings institutions to meet three minimum capital standards: a 1.5% tangible capital to total assets ratio, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS examination rating system) and an 8% risk-based capital ratio. In addition, the prompt corrective action standards discussed below also establish, in effect, a minimum 2% tangible capital standard, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS system) and, together with the risk-based capital standard itself, a 4% Tier 1 risk-based capital standard. The Office of Thrift Supervision regulations also require that, in meeting the tangible, leverage and risk-based capital standards, institutions must generally deduct investments in and loans to subsidiaries engaged in activities as principal that are not permissible for a national bank. The risk-based capital standard for savings institutions requires the maintenance of Tier 1 (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, recourse obligations, residual interests and direct credit substitutes, are multiplied by a risk-weight factor of 0% to 100%, assigned by the Office of Thrift Supervision capital regulation based on the risks believed inherent in the type of asset. Core (Tier 1) capital is defined as common stockholders' equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus, and minority interests in equity accounts of consolidated subsidiaries less intangibles other than certain mortgage servicing rights and credit card relationships. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and up to 45% of unrealized gains on available-for-sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital. The Office of Thrift Supervision also has authority to establish individual minimum capital requirements in appropriate cases upon a determination that an institution's capital level is or may become inadequate in light of the particular circumstances. At September 30, 2006, the bank met each of its capital requirements. The following table presents the bank's capital position at September 30, 2006.
Capital Excess ---------------------------- Actual Required (Deficiency) Actual Required Capital Capital Amount Percent Percent --------------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Tangible $16,738 $ 4,560 $12,178 5.51% 1.50% Core (Leverage) 16,738 12,159 4,579 5.51 4.00 Risk-based 17,636 15,487 2,149 9.11 8.00
18 PROMPT CORRECTIVE REGULATORY ACTION. The Office of Thrift Supervision is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution's degree of undercapitalization. Generally, a savings institution that has a ratio of total capital to risk weighted assets of less than 8%, a ratio of Tier 1 (core) capital to risk-weighted assets of less than 4% or a ratio of core capital to total assets of less than 4% (3% or less for institutions with the highest examination rating) is considered to be "undercapitalized." A savings institution that has a total risk-based capital ratio less than 6%, a Tier 1 capital ratio of less than 3% or a leverage ratio that is less than 3% is considered to be "significantly undercapitalized" and a savings institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be "critically undercapitalized." Subject to a narrow exception, the Office of Thrift Supervision is required to appoint a receiver or conservator within specified time frames for an institution that is "critically undercapitalized." The regulation also provides that a capital restoration plan must be filed with the Office of Thrift Supervision within 45 days of the date a savings institution receives notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." Compliance with the plan must be guaranteed by any parent holding company. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The Office of Thrift Supervision could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. Significantly and critically undercapitalized institutions are subject to additional mandatory and discretionary measures. INSURANCE OF DEPOSIT ACCOUNTS. The bank's deposits are insured up to applicable limits by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation. The Deposit Insurance Fund is the successor to the Bank Insurance Fund and the Savings Association Insurance Fund, which were merged in 2006. The Federal Deposit Insurance Corporation recently amended its risk-based assessment system for 2007 to implement authority granted by the Federal Deposit Insurance Reform Act of 2005 ("Reform Act"). Under the revised system, insured institutions are assigned to one of four 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. Risk category I, which contains the least risky depository institutions, is expected to include more than 90% of all institutions. Unlike the other categories, Risk Category I contains further risk differentiation based on the Federal Deposit Insurance Corporation's analysis of financial ratios, examination component ratings and other information. Assessment rates are determined by the Federal Deposit Insurance Corporation and currently range from five to seven basis points for the healthiest institutions (Risk Category I) to 43 basis points of assessable deposits for the riskiest (Risk Category IV). The Federal Deposit Insurance Corporation may adjust rates uniformly from one quarter to the next, except that no single adjustment can exceed three basis points. The Reform Act also provided for a one-time credit for eligible institutions based on their assessment base as of December 31, 1996. Subject to certain limitations with respect to institutions that are exhibiting weaknesses, credits can be used to offset assessments until exhausted. The bank's one-time credit is expected to approximate $103,000. The Reform Act also provided for the possibility that the Federal Deposit Insurance Corporation may pay dividends to insured institutions once the Deposit Insurance fund reserve ratio equals or exceeds 1.35% of estimated insured deposits. In addition to the assessment for deposit insurance, institutions are required to make payments on bonds issued in the late 1980s by the Financing Corporation to recapitalize the predecessor to the Savings Association Insurance Fund. During fiscal 2006, Financing Corporation payments for Savings Association Insurance Fund members approximated 1.28 basis points of assessable deposits. The bank's total assessment paid for this period (including the FICO assessment) was $105,044. The Federal Deposit Insurance Corporation has authority to increase insurance assessments. A significant increase in Savings Association Insurance Fund insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the bank. Management cannot predict what insurance assessment rates will be in the future. Insurance of deposits may be terminated by the Federal Deposit Insurance Corporation upon a finding that the 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 Federal Deposit Insurance Corporation or the Office of Thrift Supervision. The management of the bank does not know of any practice, condition or violation that might lead to termination of deposit insurance. LOANS TO ONE BORROWER. Federal law provides that savings institutions are generally subject to the limits on loans to one borrower applicable to national banks. A savings institution may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if secured by specified readily marketable collateral. At September 30, 2006, Greater Atlantic's limit on loans to one borrower was $2.7 million, and Greater Atlantic's largest aggregate outstanding loan to one borrower was $4.0 million. This loan and any other loan in excess of the loans to one borrower limit will be sold in the form of a participation. 19 QTL TEST. The Home Owners' Loan Act requires savings institutions to meet a qualified thrift lender test. Under the test, a savings association is required to either qualify as a "domestic building and loan association" under the Internal Revenue Code or maintain at least 65% of its "portfolio assets" (total assets less: (i) specified liquid assets up to 20% of total assets; (ii) intangibles, including goodwill; and (iii) the value of property used to conduct business) in certain "qualified thrift investments" (primarily residential mortgages and related investments, including certain mortgage-backed securities) in at least 9 months out of each 12 month period. A savings institution that fails the qualified thrift lender test is subject to certain operating restrictions and may be required to convert to a bank charter. As of September 30, 2006, Greater Atlantic maintained 74% of its portfolio assets in qualified thrift investments and, therefore, met the qualified thrift lender test. Recent legislation has expanded the extent to which education loans, credit card loans and small business loans may be considered "qualified thrift investments." LIMITATION ON CAPITAL DISTRIBUTIONS. Office of Thrift Supervision regulations impose limitations upon all capital distributions by a savings institution, including cash dividends, payments to repurchase its shares and payments to stockholders of another institution in a cash-out merger. An application to and the prior approval of the Office of Thrift Supervision is required prior to any capital distribution if the institution does not meet the criteria for "expedited treatment" of applications under Office of Thrift Supervision regulations (I.E., generally, examination ratings in the two top categories), the total capital distributions for the calendar year exceed net income for that year plus the amount of retained net income for the preceding two years, the institution would be undercapitalized following the distribution or the distribution would otherwise be contrary to a statute, regulation or agreement with Office of Thrift Supervision. If an application is not required, the institution must still provide prior notice to Office of Thrift Supervision of the capital distribution if, like Greater Atlantic, it is a subsidiary of a holding company. In the event Greater Atlantic's capital fell below its regulatory requirements or the Office of Thrift Supervision notified it that it was in need of more than normal supervision, Greater Atlantic's ability to make capital distributions could be restricted. In addition, the Office of Thrift Supervision could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the Office of Thrift Supervision determines that such distribution would constitute an unsafe or unsound practice. On December 13, 2006, the bank was advised by the OTS that the OTS would not approve the bank's application to pay a cash dividend to the company, and the company exercised its right to defer the next scheduled quarterly distribution on the cumulative convertible trust preferred securities for an indefinite period (which can be no longer than 20 consecutive quarterly periods). ASSESSMENTS. Savings institutions are required to pay assessments to the Office of Thrift Supervision to fund the agency's operations. The general assessments, paid on a semi-annual basis, are computed based upon the savings institution's total assets, including consolidated subsidiaries, as reported in Greater Atlantic's latest quarterly thrift financial report. The assessments paid by Greater Atlantic for the fiscal year ended September 30, 2006, totaled $125,783. TRANSACTIONS WITH RELATED PARTIES. Greater Atlantic's authority to engage in transactions with "affiliates" (E.G., any company that controls or is under common control with an institution, including Greater Atlantic Financial and its non-savings institution subsidiaries) is limited by federal law. The aggregate amount of covered transactions with any individual affiliate is limited to 10% of the capital and surplus of the savings institution. The aggregate amount of covered transactions with all affiliates is limited to 20% of the savings institution's capital and surplus. Certain transactions with affiliates are required to be secured by collateral in an amount and of a type described in federal law. The purchase of low quality assets from affiliates is generally prohibited. The transactions with affiliates must be on terms and under circumstances, that are at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies. In addition, savings institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings institution may purchase the securities of any affiliate other than a subsidiary. The Sarbanes-Oxley Act of 2002 generally prohibits loans by the company to its executive officers and directors. However, that law contains a specific exception for loans by the bank to its executive officers and directors in compliance with federal banking laws. Under such laws, the bank's authority to extend credit to executive officers, directors and 10% shareholders ("insiders"), as well as entities such persons control, is limited. The law limits both the individual and aggregate amount of loans the bank may make to insiders based, in part, on the bank's capital position and requires certain board approval procedures to be followed. Such loans are required to be made on terms substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of repayment. There is an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees. 20 ENFORCEMENT. The Office of Thrift Supervision has primary enforcement responsibility over savings institutions and has the authority to bring actions against the institution and all institution-affiliated parties, including stockholders, and any 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 may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors to institution of receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and can amount to $25,000 per day, or even $1.0 million per day in especially egregious cases. The Federal Deposit Insurance Corporation has the authority to recommend to the Director of the Office of Thrift Supervision that enforcement action be taken with respect to a particular savings institution. If the Director does not take action, the Federal Deposit Insurance Corporation has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations. STANDARDS FOR SAFETY AND SOUNDNESS. The federal banking agencies have adopted Interagency Guidelines prescribing Standards for Safety and Soundness. 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. If the Office of Thrift Supervision determines that a savings institution fails to meet any standard prescribed by the guidelines, the Office of Thrift Supervision may require the institution to submit an acceptable plan to achieve compliance with the standard. FEDERAL HOME LOAN BANK SYSTEM Greater Atlantic is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank provides a central credit facility primarily for member institutions. Greater Atlantic, as a member of the Federal Home Loan Bank, is required to acquire and hold shares of capital stock in that Federal Home Loan Bank in an amount at least equal to 1.0% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year, or 1/20 of its advances (borrowings) from the Federal Home Loan Bank, whichever is greater. Greater Atlantic was in compliance with this requirement with an investment in Federal Home Loan Bank stock at September 30, 2006 of $2.4 million. The Federal Home Loan Banks are required to provide funds used for the resolution of insolvent thrifts in the late 1980s and to contribute funds for affordable housing programs. Those requirements could reduce the amount of dividends that the Federal Home Loan Banks pay to their members and could also result in the Federal Home Loan Banks imposing a higher rate of interest on advances to their members. If dividends were reduced, or interest on future Federal Home Loan Bank advances increased, Greater Atlantic's net interest income would likely also be reduced. FEDERAL RESERVE SYSTEM The Federal Reserve Board regulations require savings institutions to maintain non-interest earning reserves against their transaction accounts (primarily NOW and regular checking accounts). The regulations generally provide that reserves be maintained against aggregate transaction accounts as follows: a 3% reserve ratio is assessed on net transaction accounts up to $48.3 million; for $48.3 million the required reserve is $1.2 million, and, for amounts in excess of $48.3 million the required ratio is 10%. The first $7.8 million of otherwise reservable balances (subject to adjustments by the Federal Reserve Board) are exempted from the reserve requirements. The amounts are adjusted annually. The bank complies with the foregoing requirements. COMMUNITY REINVESTMENT ACT Under the Community Reinvestment Act, as implemented by Office of Thrift Supervision regulations, a savings association has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The Community Reinvestment Act does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the Community Reinvestment Act. The Community Reinvestment Act requires the Office of Thrift Supervision, in connection with its examination of an institution, to assess the institution's record of meeting the credit needs of its community and to take such record into account in its evaluation of applications by such institution. The Community Reinvestment Act requires public disclosure of an institution's Community Reinvestment Act rating. Greater Atlantic's latest Community Reinvestment Act rating, received from the Office of Thrift Supervision was "Satisfactory." 21 FEDERAL AND STATE TAXATION GENERAL. The company and the bank report their income on a fiscal year basis using the accrual method of accounting and are subject to federal income taxation in the same manner as other corporations with some exceptions. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the bank or the company. The bank has not been audited by the IRS or the Virginia Department of Taxation ("DOT") in the past five years. DISTRIBUTIONS. To the extent that the bank makes "non-dividend distributions" to the company that are considered as made (i) from the reserve for losses on qualifying real property loans, to the extent the reserve for such losses exceeds the amount that would have been allowed under the experience method, or (ii) from the supplemental reserve for losses on loans ("Excess Distributions"), then an amount based on the amount distributed will be included in the bank's taxable income. Non-dividend distributions include distributions in excess of the bank's current and accumulated earnings and profits, distributions in redemption of stock and distributions in partial or complete liquidation. However, dividends paid out of the bank's current or accumulated earnings and profits, as calculated for federal income tax purposes, will not be considered to result in a distribution from the bank's bad debt reserve. Thus, any dividends to the company that would reduce amounts appropriated to the bank's bad debt reserve and deducted for federal income tax purposes would create a tax liability for the bank. The amount of additional taxable income created by an Excess Distribution is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, if, after the Conversion, the bank makes a "non-dividend distribution," then approximately one and one-half times the amount so used would be includable in gross income for federal income tax purposes, presumably taxed at a 34% corporate income tax rate (exclusive of state and local taxes). See "Regulation" and "Dividend Policy" for limits on the payment of dividends of the bank. The bank does not intend to pay dividends that would result in a recapture of any portion of its bad debt reserve. CORPORATE ALTERNATIVE MINIMUM TAX ("AMT"). The Code imposes a tax on alternative minimum taxable income ("AMTI") at a rate of 20%. Only 90% of AMTI could be offset by net operating loss carryovers. AMTI is increased by an amount equal to 75% of the amount by which the bank's adjusted current earnings exceeds its AMTI (determined without regard to this preference and prior to reduction for net operating losses). Since the company and the bank have net operating losses for the 2006 fiscal year, they do not record a provision for income taxes. DIVIDENDS RECEIVED DEDUCTION AND OTHER MATTERS. The company may exclude from its income 100% of dividends received from the bank as a member of the same affiliated group of corporations. The corporate dividends received deduction is generally 70% in the case of dividends received from unaffiliated corporations with which the company and the bank will not file a consolidated tax return, except that if the company or the bank owns more than 20% of the stock of a corporation distributing a dividend then 80% of any dividends received may be deducted. STATE AND LOCAL TAXATION COMMONWEALTH OF VIRGINIA. The Commonwealth of Virginia imposes a tax at the rate of 6.0% on the "Virginia taxable income" of the company. Virginia taxable income is equal to federal taxable income with certain adjustments. Significant modifications include the subtraction from federal taxable income of interest or dividends on obligations or securities of the United States that are exempt from state income taxes. DELAWARE TAXATION. As a Delaware company not earning income in Delaware, the company is exempt from Delaware corporate income tax but is required to file an annual report with and pay an annual franchise tax to the State of Delaware. However, to the extent that the company conducts business outside of Delaware, the company may be considered doing business and subject to additional taxing jurisdictions outside of Delaware. 22 ITEM 1A. RISK FACTORS OUR INCREASED EMPHASIS ON COMMERCIAL AND CONSTRUCTION LENDING MAY EXPOSE US TO INCREASED LENDING RISKS. At September 30, 2006, our loan portfolio consisted of $28.4 million, or 14.06% of commercial real estate loans, $28.1 million, or 13.91% of construction and land development loans and $39.8 million, or 19.70% of commercial business loans. We intend to increase our emphasis on these types of loans. These types of loans generally expose a lender to greater risk of non-payment and loss than one-to-four-family residential mortgage loans because repayment of the loans often depends on the successful operation of the property, the income stream of the borrowers and, for construction loans, the accuracy of the estimate of the property's value at completion of construction and the estimated cost of construction. Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one- to four-family residential mortgage loans. Commercial business loans expose us to additional risks since they typically are made on the basis of the borrower's ability to make repayments from the cash flow of the borrower's business and are secured by non-real estate collateral that may depreciate over time. In addition, since such loans generally entail greater risk than one- to four-family residential mortgage loans, we may need to increase our allowance for loan losses in the future to account for the likely increase in probable incurred credit losses associated with the growth of such loans. Also, many of our commercial and construction borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a one- to four-family residential mortgage loan. STRONG COMPETITION WITHIN OUR MARKET AREA COULD HURT OUR ABILITY TO COMPETE AND COULD SLOW OUR GROWTH. We face intense competition both in making loans and attracting deposits. This competition has made it more difficult for us to make new loans and has occasionally forced us to offer higher deposit rates. Price competition for loans and deposits might result in us earning less on our loans and paying more on our deposits, which reduces net interest income. Some of the institutions with which we compete have substantially greater resources and lending limits than we have and may offer services that we do not provide. We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Our profitability depends upon our continued ability to compete successfully in our market area. AN INCREASE IN LOAN PREPAYMENTS AND ON PREPAYMENT OF LOANS UNDERLYING MORTGAGE-BACKED SECURITIES AND SMALL BUSINESS ADMINISTRATION CERTIFICATES MAY ADVERSELY AFFECT OUR PROFITABILITY. Prepayment rates are affected by consumer behavior, conditions in the housing and financial markets, general economic conditions and the relative interest rates on fixed-rate and adjustable-rate mortgage loans. Although changes in prepayment rates are, therefore, difficult for us to predict, prepayment rates tend to increase when market interest rates decline relative to the rates on the prepaid instruments. We recognize our deferred loan origination costs and premiums paid on originating these loans by adjusting our interest income over the contractual life of the individual loans. As prepayments occur, the rate at which net deferred loan origination costs and premiums are expensed accelerates. The effect of the acceleration of deferred costs and premium amortization may be mitigated by prepayment penalties paid by the borrower when the loan is paid in full within a certain period of time, which varies between loans. If prepayment occurs after the period of time when the loan is subject to a prepayment penalty, the effect of the acceleration of premium and deferred cost amortization is no longer mitigated. We recognize premiums we pay on mortgage-backed securities and Small Business Administration Certificates as an adjustment to interest income over the life of the security based on the rate of repayment of the securities. Acceleration of prepayment on the loans underlying a mortgage-backed security or Small Business Administration Certificate shortens the life of the security, increases the rate at which premiums are expensed and further reduces interest income. We may not be able to reinvest loan and security prepayments at rates comparable to the prepaid instruments particularly in periods of declining interest rates. 23 WE OPERATE IN A HIGHLY REGULATED ENVIRONMENT AND WE MAY BE ADVERSELY AFFECTED BY CHANGES IN LAWS AND REGULATIONS. The bank is subject to extensive regulation, supervision and examination by the Office of Thrift Supervision and by the Federal Deposit Insurance Corporation, as insurer of its deposits. Such regulation and supervision govern the activities in which the bank and the company may engage, and are intended primarily for the protection of the insurance fund and for the depositors and borrowers of the bank. The regulation and supervision by the Office of Thrift Supervision and the Federal Deposit Insurance Corporation are not intended to protect the interests of investors in the common stock of the company. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets and determination of the level of our allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on our operations. A BREACH OF INFORMATION SECURITY COULD NEGATIVELY AFFECT OUR EARNINGS. Increasingly, we depend upon data processing, communication and information exchange on a variety of computing platforms and networks and over the Internet. We cannot be certain all our systems are entirely free from vulnerability to attack, despite safeguards we have instituted. In addition, we rely on the services of a variety of vendors to meet data processing and communication needs. If information security is breached, information can be lost or misappropriated, resulting in financial loss or costs to us or damages to others. These costs or losses could materially exceed the amount of insurance coverage, if any, which would adversely affect our earnings. WE ARE SUBJECT TO HEIGHTENED REGULATORY SCRUTINY WITH RESPECT TO BANK SECRECY AND ANTI-MONEY LAUNDERING STATUTES AND REGULATIONS. Recently, regulators have intensified their focus on the USA PATRIOT Act's anti-money laundering and Bank Secrecy Act compliance requirements. There is also increased scrutiny of our compliance with the rules enforced by the Office of Foreign Assets Control. In order to comply with regulations, guidelines and examination procedures in this area, we have been required to adopt new policies and procedures and to install new systems. We cannot be certain that the policies, procedures and systems we have in place are flawless. Therefore, there is no assurance that in every instance we are in full compliance with these requirements. FAILURE TO PAY INTEREST ON OUR DEBT MAY ADVERSELY IMPACT US. Deferral of interest payments where allowed on our convertible preferred securities may affect our ability to issue additional debt. FAILURE TO REMAIN A WELL CAPITALIZED INSTITUTION. As a result of recording losses of $5.6 million during the year ended September 30, 2006, the bank ceased to be considered a well capitalized institution and is now considered to be an adequately capitalized institution. As an adequately capitalized institution, the bank cannot issue brokered certificates of deposit without OTS or FDIC permission, and the OTS can limit the payment of dividends from the bank to the company. Without the payment of a dividend from the bank, the company is unable to make a distribution on the cumulative convertible trust preferred securities. On December 13, 2006, the bank was advised by the OTS that the OTS would not approve the bank's application to pay a cash dividend to the company, and the company exercised its right to defer the next scheduled quarterly distribution on the cumulative convertible trust preferred securities. ITEM 1B. UNRESOLVED STAFF COMMENTS The company has no unresolved staff comments for the period ended September 30, 2006. 24 ITEM 2. PROPERTIES During fiscal year 2006, we conducted our business from six full-service banking offices and our administrative office. The following table sets forth certain information concerning the bank's offices as of September 30, 2006.
Net Book Value of Property or Leasehold Original Improvements Year Date of at Leased or Leased or Lease September 30, Location Owned Acquired Expiration 2006 ------------------------------------------------------------------------------------------------------------------ (In Thousands) ADMINISTRATIVE OFFICES: 10700 Parkridge Boulevard Reston, Virginia 20191 Leased 1998 01-31-11 $ 101 BRANCH OFFICES: 11834 Rockville Pike Rockville, Maryland 20852 Leased 1998 06-30-09 8 8070 Ritchie Highway Pasadena, Maryland 21122 Leased 1998 08-31-08 23 10700 Parkridge Boulevard Reston, Virginia 20191 Leased 2004 01-31-11 394 43086 Peacock Market Plaza South Riding, Virginia 20152 Leased 2000 06-30-15 225 1 South Royal Avenue Front Royal, Virginia 22630 Owned 1977 700 9484 Congress Street New Market, Virginia 22844 Owned 1989 421 LOAN OFFICES: 2200 Defense Highway Crofton, Maryland 21114 Leased 2002 11-30-08 2 12530 Parklawn Drive, Suite 170 Rockville, Maryland 20852 Leased 2005 06-30-10 48 ------------------------------------------------------------------------------------------------------------------ Total $1,922 ==================================================================================================================
The total net book value of the company's furniture, fixtures and equipment at September 30, 2006 was $2.8 million. The properties are considered by management to be in good condition. 25 ITEM 3. LEGAL PROCEEDINGS As previously reported in a Form 8-K filed on September 8, 2006, the company announced that a Demand for Arbitration Before the American Arbitration Association was filed against the company, the bank, GAMC, and Carroll E. Amos, President and Chief Executive Officer of the company and the bank. The Demand for Arbitration was filed by Stamm Mortgage Management, Inc. ("Stamm Mortgage") and T. Mark Stamm, President of Stamm Mortgage in connection with the Management Agreement among Stamm Mortgage, the bank, and GAMC that governed the management of GAMC by Stamm Mortgage before the bank terminated the operations of GAMC earlier this year, and certain aspects of the company's public disclosures of that event. The Demand for Arbitration alleges three counts: rescission, breach of contract, and defamation. As against the Bank and GAMC, Stamm Mortgage alleges that the Management Agreement is unenforceable and should be rescinded, requiring the Bank and GAMC, jointly and severally, to return $1.77 million that Stamm Mortgage paid to the Bank and GAMC under the Management Agreement. As an alternative to rescission, Stamm Mortgage alleges that the Bank and GAMC breached the Management Agreement by terminating it contrary to its terms, resulting in $9.6 million in lost profits to Stamm Mortgage. Stamm Mortgage and Mr. Stamm both allege that the company, the bank, GAMC, and Mr. Amos, acting in his official capacity, defamed Stamm Mortgage and Mr. Stamm through certain public statements made in press releases and in public securities filings by the company and seek $1.0 million in compensatory damages and $350,000 in punitive damages. On December 29, 2006, counsel for the company, the bank, GAMC and Mr. Amos filed an Answering Statement and Counterclaim in Arbitration. In, January 2007, the parties entered into negotiations looking toward a mutually acceptable and amicable resolution of their claims. In the event that the claims cannot be resolved through negotiations, the company intends to defend its position vigorously. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of the stockholders during the fourth quarter of the fiscal year ended September 30, 2006, through the solicitation of proxies or otherwise. 26 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES MARKET INFORMATION. The company's stock trades on the NASDAQ Stock Market (ticker symbol GAFC). At September 30, 2006, there were approximately 373 stockholders of record. The following table sets forth market price information, based on closing prices, as reported by the NASDAQ for the common stock high and low closing prices for the periods indicated.
First Quarter Second Fourth Quarter Ended Quarter Ended Third Quarter Ended December 31 March 31 Ended June 30 September 30 ------------------------------------------------------------------------------------------------- Fiscal Year 2006 High 5.45 6.05 5.90 5.36 Low 4.84 4.60 5.04 4.75 Fiscal Year 2005 High 7.08 6.46 6.20 5.62 Low 6.01 5.77 5.03 5.10 -------------------------------------------------------------------------------------------------
These market quotations reflect inter-dealer prices, without retail mark-up, mark-down, or commission and may not necessarily represent actual transactions. The company has not sold any unregistered securities and did not repurchase any of its equity securities in the fiscal year ended September 30, 2006. 27 ITEM 6. SELECTED FINANCIAL DATA The following Selected Consolidated Financial Data should be read in conjunction with our Consolidated Financial Statements and the notes thereto, the information contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other financial information included elsewhere in this Annual Report.
--------------------------------------------------------------------------------------------------------------------- At or For the Years Ended September 30, 2006 2005 2004 2003 2002 (Restated)(4)(Restated)(4)(Restated)(4) (Restated)(4) --------------------------------------------------------------------------------------------------------------------- (In Thousands, Except Per Share Data) Consolidated Statements of Operations Data: Interest income $ 18,794 $ 16,958 $ 18,085 $ 19,361 $ 20,538 Interest expense 11,305 10,546 11,970 12,277 12,933 --------------------------------------------------------------------------------------------------------------------- Net interest income 7,489 6,412 6,115 7,084 7,605 Provision for loan losses 126 219 209 791 832 --------------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 7,363 6,193 5,906 6,293 6,773 Noninterest income (loss) 639 3,173 547 766 (2,589) Noninterest expense 11,085 9,889 10,370 10,014 8,985 --------------------------------------------------------------------------------------------------------------------- (Loss) income from continuing operations before taxes (3,083) (523) (3,917) (2,955) (4,800) Provision for income taxes - - - - - --------------------------------------------------------------------------------------------------------------------- (Loss) income from continuing operations (3,083) (523) (3,917) (2,955) (4,800) Discontinued operations: (Loss) income from operations (2,488) (1,107) 428 4,898 1,968 --------------------------------------------------------------------------------------------------------------------- Net (loss) income $ (5,571) $ (1,630) $ (3,489) $ 1,943 $ (2,832) ===================================================================================================================== Per Share Data: Net income (loss): Basic $ (1.84) $ (0.54) $ (1.16) $ 0.65 $ (0.94) Diluted $ (1.84) $ (0.54) $ (1.16) $ 0.44 $ (0.94) Book value 2.93 4.76 5.29 6.79 6.14 Tangible book value 2.96 4.80 5.22 6.38 5.74 Weighted average shares outstanding: Basic 3,020,934 3,015,509 3,012,434 3,012,434 3,010,420 Diluted 3,020,934 3,015,509 3,012,434 4,413,462 3,010,420 Shares outstanding 3,020,934 3,020,934 3,012,434 3,012,434 3,012,434 Consolidated Statements of Financial Condition Data: Total assets $ 305,219 $ 339,542 $ 433,174 $ 498,456 $ 502,098 Total loans receivable, net 193,307 194,920 246,387 242,253 248,081 Allowance for loan losses 1,330 1,212 1,600 1,550 1,699 Mortgage-loans held for sale - 9,517 5,528 6,554 14,553 Investment securities (1) 48,557 58,502 60,285 138,049 157,247 Mortgage-backed securities 31,600 57,296 92,722 86,735 52,112 Total deposits 230,174 237,794 288,956 297,876 281,877 FHLB advances 36,000 38,000 51,200 86,800 96,500 Other borrowings 18,574 38,479 64,865 77,835 91,010 Guaranteed convertible preferred securities of subsidiary trust 9,388 9,378 9,369 9,359 9,346 Total stockholders' equity 8,850 14,375 15,944 20,442 18,483 Tangible capital 8,943 14,514 15,379 19,228 17,286 28 SELECTED FINANCIAL DATA - (CONTINUED) --------------------------------------------------------------------------------------------------------------------- At or For the Years Ended September 30, 2006 2005 2004 2003 2002 (Restated)(4)(Restated)(4)(Restated)(4) (Restated)(4) --------------------------------------------------------------------------------------------------------------------- (In Thousands, Except Per Share Data) Average Consolidated Statements of Financial Condition Data Total assets $ 315,133 $ 370,729 $ 504,039 $ 477,882 $ 422,825 Investment securities(1) 66,789 70,633 123,198 161,161 155,350 Mortgage-backed securities(1) 43,979 77,424 111,016 51,046 39,320 Total loans 193,688 210,152 253,772 251,386 214,501 Allowance for loan losses 1,264 1,609 1,498 1,696 1,148 Total deposits 210,311 245,518 275,636 279,469 243,120 Total stockholders' equity 12,164 13,830 15,236 15,132 18,140 Performance Ratios (2) Return on average assets (1.77)% (0.44)% (0.69)% 0.41% (0.67)% Return on average equity (45.80) (11.79) (22.90) 12.83 (15.61) Equity to assets 2.90 4.23 3.68 4.10 3.68 Net interest margin 2.46 1.79 1.25 1.53 1.86 Efficiency ratio(3) 136.38 103.17 155.66 127.58 179.13 Asset Quality Data: Non-performing assets to total assets, at period end 0.36 0.54 0.22 0.28 0.09 Non-performing loans to total loans, at period end 0.55 0.75 0.37 0.57 0.18 Net charge-offs to average total loans 0.00 0.28 0.06 0.36 0.03 Allowance for loan losses to: Total loans 0.66% 0.56% 0.62% 0.62% 0.66% Non-performing loans 119.82 75.56 167.89 109.31 374.23 Non-performing loans $ 1,110 $ 1,604 $ 953 $ 1,418 $ 454 Non-performing assets 1,110 1,836 953 1,446 797 Allowance for loan losses 1,330 1,212 1,600 1,550 1,699 Capital Ratios of the Bank: Leverage ratio 5.51% 6.66% 5.59% 5.68% 4.90% Tier 1 risk-based capital ratio 8.59 10.25 9.81 12.08 10.97 Total risk-based capital ratio 9.11 10.75 10.42 12.70 11.73
(1) Consists of securities classified as available-for-sale, held-to-maturity and for trading. (2) Ratios are presented on an annualized basis where appropriate. (3) Efficiency ratio consists of noninterest expense divided by net interest income and noninterest income. (4) The Consolidated Financial Statements and data for 2005, 2004, 2003 and 2002 have been restated to reflect adjustments that are described in Notes 2 and 3 to the Consolidated Financial Statements. 29 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION FORWARD-LOOKING STATEMENTS When used in this Annual Report on Form 10-K and in future filings by the company with the Securities and Exchange Commission (the "SEC"), in the company's press releases or other public or shareholder communications, and in oral statements made with the approval of an authorized executive officer, the words or phrases "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project" or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties, including, among other things, changes in economic conditions in the company's market area, changes in policies by regulatory agencies, fluctuations in interest rates, demand for loans in the company's market area and competition, that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. The company wishes to advise readers that the factors listed above could affect the company's financial performance and could cause the company's actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements. The company does not undertake and specifically declines any obligation to publicly release the results of any revisions, which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. GENERAL The profitability of the company and, more specifically, the profitability of its primary subsidiary, the bank, depends primarily on its net interest income. Net interest income is the difference between the interest income it earns on its loans and investment portfolio, and the interest it pays on interest-bearing liabilities, which consist mainly of interest paid on deposits and borrowings. The level of our non-interest income and operating expenses also affects our profitability. Non-interest income consists primarily of gains on sales of loans and available-for-sale investments, service charge fees and commissions earned by non-bank subsidiaries. Operating expenses consist primarily of salaries and employee benefits, occupancy-related expenses, equipment and technology-related expenses and other general operating expenses. The operations of the bank, and banking institutions in general, are significantly influenced by general economic conditions and related monetary and fiscal policies of regulatory agencies. Deposit flows and the cost of deposits and borrowings are influenced by interest rates on competing investments and general market rates of interest. Lending activities are affected by the demand for financing real estate and other types of loans, which in turn are affected by the interest rates at which such financing may be offered and other factors affecting loan demand and the availability of funds. During 2006, the company restated its historical financial statements to reflect the accounting treatment for losses discovered in its subsidiary's, (GAMC's) unreconciled inter-company account (See Note 2 to the consolidated financial statements). The losses were discovered as the bank discontinued the operations of the subsidiary. The loss in any given year did not reach a material amount such as to require restatement. However, the bank determined to provide the restatements because the cumulative amount of the losses aggregated $1.4 million. The revisions had no impact on the cash flows of the bank. As previously reported in a Form 8-K filed on September 8, 2006, the company announced that a Demand for Arbitration Before the American Arbitration Association was filed against the company, the bank, GAMC, and Carroll E. Amos, President and Chief Executive Officer of the company and the bank. (See Item 3. Legal Proceedings of this Form 10-K.) During the course of the negotiations, the company proposed a settlement offer which would require a contribution of $500,000 by the company toward the settlement. That offer was accepted conditioned on the execution of a mutual release by the parties. That mutual release is currently the subject of negotiation. As a result, the company has established a liability for the probable settlement and charged $500,000 as other operating expense. Should the settlement not occur the company intends to defend its position vigorously. 30 CRITICAL ACCOUNTING POLICIES, ESTIMATES AND JUDGMENTS The company's financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses as well as the disclosure of contingent liabilities. Management continually evaluates its estimates and judgments including those related to the allowance for loan losses and income taxes. Management bases its estimates and judgments on historical experience and other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. The company believes that of its significant accounting policies, the following may involve a higher degree of judgment or complexity. ALLOWANCE FOR LOAN LOSSES The company maintains an allowance for loan losses based on management's evaluation of the risks inherent in its loan portfolio and the general economy. Management classifies loans as substandard, doubtful or loss as required by federal regulations. Management provides a 100% reserve for all assets classified as loss. Further, management bases its estimates of the allowance on current economic conditions, actual loss experience and industry trends. Also, the company discontinues recognizing interest income on loans with principal and/or interest past due 90 days. INCOME TAXES The provision (or benefit) for income taxes is based on taxable income, tax credits and available net operating losses. The company records deferred tax assets and liabilities using enacted tax rates for the effect of temporary differences between the book and tax bases of assets and liabilities. If enacted tax rates change, the company would adjust the deferred tax assets and liabilities, through the provision for income taxes in the period of change, to reflect the enacted tax rate expected to be in effect when the deferred tax items reverse. The company records a valuation allowance on deferred tax assets to reflect the expected future tax benefits expected to be realized. In determining the appropriate valuation allowance, the company considers the expected level of future taxable income and available tax planning strategies. At September 30, 2006, the company had deferred tax assets of $1.9 million, which is net of a valuation allowance of $3.5 million. RECENT ACCOUNTING STANDARDS The Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 123 (Revised 2004) ("SFAS No. 123R"), "Share-Based Payment," in December 2004. SFAS No. 123R is a revision of FASB Statement 123, "Accounting for Stock-Based Compensation" and supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees," and its related implementation guidance. The Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS No. 123R requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide service in exchange for the award. This statement is effective as of the beginning of the first annual reporting period that begins after June 15, 2005 and the company adopted the standard in the first quarter of fiscal 2006. The adoption of this statement did not have a material impact on its consolidated financial position or results of operations. In May 2005, the FASB issued SFAS 154, "Accounting Changes and Error Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3." SFAS 154 generally requires retrospective application to prior periods' financial statements of all voluntary changes in accounting principle and changes required when a new pronouncement does not include specific transition provisions. This standard was effective for the company beginning October 1, 2006. In July 2006, the FASB issued Interpretation (FIN) No. 48, "Accounting for Uncertainty in Income Taxes" - an Interpretation of SFAS No. 109, "Accounting for Income Taxes." FIN 48 defines the threshold for recognizing the benefits of tax return positions in the financial statements as "more-likely-than-not" to be sustained by a taxing authority. The term "more-likely-than-not" means a likelihood of more than 50 percent. FIN 48 is effective as of Jan. 1, 2007, with early application permitted. Any impact from the adoption of FIN 48 will be recorded directly to the beginning balance of retained earnings and reported as a change in accounting principle. We are currently evaluating the impact of this Interpretation, but do not expect it to be material. On October 1, 2006, we adopted SFAS 156, "Accounting for Servicing of Financial Assets - an amendment of FASB Statement No.140." SFAS 156 was issued in March 2006 and requires all newly recognized servicing rights and obligations to be initially measured at fair value. For each class of separately recognized servicing rights and obligations retained, we have elected to continue to account for each under the amortization method which requires us to amortize servicing assets or liabilities in proportion to and over the periods of estimated net servicing income or net servicing loss. 31 In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108 (SAB 108). Due to diversity in practice among registrants, SAB 108 expresses the SEC staff views regarding the process by which misstatements in financials statements are evaluated for purposes of determining whether financial statement restatement is necessary. SAB 108 is effective for fiscal years ending after November 15, 2006, and early application is encouraged. The company does not believe SAB 108 will have a material impact on its consolidated financials statements. In September 2006, the Financial Accounting Standards Board released Statement No. 157, "Fair Value Measurements" which defines fair value, establishes a framework for measuring fair value in GAAP, and enhances disclosures about fair value measurements. This Statement applies when other accounting pronouncements require fair value measurements; it does not require new fair value measurements. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those years. While we are currently evaluating the effect of the guidance contained in this Statement, we do not expect the implementation to have a material impact on our consolidated financial statements. DISCONTINUED MORTGAGE BANKING OPERATIONS On March 29, 2006, we began the process of discontinuing the operations of the bank's subsidiary, GAMC. It was determined that, because it was unprofitable, this business no longer fit our strategy. Due to the unprofitable operations of GAMC, the company recognized an additional loss of $1.5 million during fiscal 2006. In addition to the loss from operations, a non-recurring pre-tax impairment charge on long-lived assets of $996,000 was recorded and included in discontinued operations in the consolidated statements of operations. That charge requires a write down of long-lived assets by recording an impairment charge due to the discontinuance of operations effective March 29, 2006. As a result of the above action, we applied discontinued operations accounting in the third quarter of 2006, as we completed the closing of the GAMC business. Accordingly, the income statements for all periods have been adjusted. The reclassification of GAMC's results to discontinued operations primarily resulted in a reduction to previously reported levels of net interest income, a reduction in noninterest income and a reduction in noninterest expense. The table below summarizes GAMC's results which were treated as discontinued operations for the periods indicated.
Year Ended September 30, ------------------------------------ 2006 2005 (Restated) - --------------------------------------------------------------------------------------- (Dollars in Thousands, Except Per Share Data Interest income $ 280 $ 478 Interest expense 257 347 - --------------------------------------------------------------------------------------- Net interest income 24 131 Noninterest income 2,149 5,072 Noninterest expense 4,661 6,310 Provision for income taxes - - - --------------------------------------------------------------------------------------- Net income (loss) $ (2,488) $ (1,107) ======================================================================================= Earnings per share - basic $ (0.82) $ (0.37) Earnings per share - diluted (0.82) (0.37)
32 FINANCIAL CONDITION 2006 COMPARED TO 2005 At September 30, 2006, the company had total assets of $305.2 million, a decrease of $34.3 million or 10.11% from the $339.5 million recorded at the close of the comparable period one-year ago. Investments and mortgage-backed securities at September 30, 2006, amounted to $80.2 million a decrease of $35.6 million or 30.78% from the $115.8 million held at September 30, 2005, as a result of prepayments of $42.0 million offset in part by purchases of $7.7 million. Loans receivable and loans held for sale at September 30, 2006, amounted to $193.3 million, a decrease of 5.44% from the $204.4 million held at September 30, 2005, primarily as a result a $9.5 million decrease in loans held for sale, coupled with a $12.6 million decline in land and consumer loans outstanding. Those declines were due primarily to discontinuing the operations of the bank's subsidiary, GAMC as it was determined that, because it was unprofitable, this business no longer fit our strategy and was coupled with payoffs and lower than anticipated loan originations. Deposits amounted to $230.2 million at September 30, 2006, a decrease of $7.6 million from the $237.8 million held one year ago. That decline was primarily the result of decreases in our checking, savings and certificates of deposit accounts, and was offset by increases in non-interest checking and our money funds accounts. RESULTS OF OPERATIONS 2006 COMPARED TO 2005 During 2006, the company restated its historical financial statements to revise the accounting treatment for losses discovered in its subsidiary, GAMC's unreconciled inter-company account. The losses were discovered as the bank discontinued the operations of the subsidiary. The loss in any given year did not reach a material amount such as to require restatement. However, the bank determined to provide the restatements because of the cumulative amount of the losses aggregated $1.4 million. The revisions had no impact on the cash flows of the bank. The table below includes the effect of the restatement and the presentation of GAMC as discontinued operations.
As originally Discontinued reported Restatement operations As restated --------------- -------------- --------------- ------------- Year ended September 30, 2005 Interest income $ 17,436 $ - $ 478 $ 16,958 Interest expense 10,893 - 347 10,546 Net interest income 6,543 - 131 6,412 Noninterest income 8,317 (72) 5,072 3,173 Noninterest expense 16,199 - 6,310 9,889 Discontinued operations - - (1,107) (1,107) Net income (loss) (1,558) (72) - (1,630) Earnings per share - continuing (0.52) (0.02) 0.37 (0.17) Earnings per share - discontinued (0.00) (0.00) (0.37) (0.37) Year ended September 30, 2004 Interest income $ 18,962 $ - $ 877 $ 18,085 Interest expense 12,355 - 385 11,970 Net interest income 6,607 - 492 6,115 Noninterest income 9,929 (297) 9,085 547 Noninterest expense 19,430 - 9,060 10,370 Discontinued operations - - 428 428 Net income (loss) (3,192) (297) - (3,489) Earnings per share - continuing (1.06) (0.10) (0.14) (1.30) Earnings per share - discontinued (0.00) 0.00 0.14 0.14
NET INCOME. For the fiscal year ended September 30, 2006, the company had a net loss from continuing operations of $3.1 million or $1.02 per diluted share compared to a loss from continuing operations of $523,000 or $0.17 per diluted share for fiscal year 2005. The $2.6 million decline in earnings over the comparable period one-year ago was primarily the result of an increase in non-interest expense and a decrease in non-interest income. That increase in non-interest expense and decrease in non-interest income were partially offset by an increase in net interest income and a decrease in the provision for loan losses. 33 NET INTEREST INCOME. An important source of our earnings is net interest income, which is the difference between income earned on interest-earning assets, such as loans, investment securities and mortgage-backed securities, and interest paid on interest-bearing liabilities such as deposits and borrowings. The level of net interest income is determined primarily by the relative average balances of interest-earning assets and interest-bearing liabilities in combination with the yields earned and rates paid upon them. The correlation between the repricing of interest rates on assets and on liabilities also influences net interest income. The following table presents a comparison of the components of interest income and expense and net interest income.
Years ended September 30, Difference ------------------------------- ------------------------------- 2006 2005 Amount % - ------------------------------------------------------------------------------------------------------------ (Dollars in thousands) Interest income: Loans $ 13,866 $ 12,430 $ 1,436 11.55% Investments 4,928 4,528 400 8.83 - ------------------------------------------------------------------------------------------------------------ Total 18,794 16,958 1,836 10.83 - ------------------------------------------------------------------------------------------------------------ Interest expense: Deposits 7,709 6,337 1,372 21.65 Borrowings 3,596 4,209 (613) (14.56) - ------------------------------------------------------------------------------------------------------------ Total 11,305 10,546 759 7.20 - ------------------------------------------------------------------------------------------------------------ Net interest income $ 7,489 $ 6,412 $ 1,077 16.80% ============================================================================================================
Our increase in net interest income for fiscal year 2006, resulted primarily from a 67 basis point increase in net interest margin (net interest income divided by average interest-earning assets) from 1.79% for fiscal year 2005 to 2.46% for fiscal year 2006, offset in part by a $53.8 million decrease in the bank's interest-earning assets. Contributing to the increase in the net interest margin was a $278,000 reduction in interest expense resulting from payments made on certain interest rate swap and cap agreements compared to a charge of $533,000 in the comparable period one year ago. The increase in net interest margin also resulted from the average yield on interest-earning assets increasing by 59 basis points more than the increase in the average cost on interest-bearing liabilities and was coupled with average interest earning assets decreasing by $746,000 less than the decline in average interest-bearing liabilities. INTEREST INCOME. Interest income for the fiscal year ended September 30, 2006 increased $1.8 million compared to fiscal year 2005, primarily as a result of a 144 basis point increase in the average yield earned on interest earning assets. That increase was partially offset by a decrease of $53.8 million in the average outstanding balances of loans and securities. INTEREST EXPENSE. The $759,000 increase in interest expense for fiscal year 2006 compared to the 2005 period was principally the result of an 85 basis point increase in the cost of funds on average deposits and borrowings. That increase in the cost of funds was partially offset by a $54.5 million decrease in average deposits and borrowings. The increase in interest expense on deposits was primarily due to a 109 basis point increase in rates paid on deposits, primarily due to higher rates paid on interest-bearing demand deposits, savings accounts and certificates and elevated pricing on new and renewed time deposits. That increase was partially offset by a decrease of $35.2 million in average deposits from $245.5 million for fiscal 2005 to $210.3 million for fiscal 2006. The increase in rates was primarily due to market rates moving rates higher on interest-bearing demand deposits, savings accounts and certificates and the pricing on new and renewed time deposits. The decrease in interest expense on borrowings for fiscal 2006, when compared to the 2005 period, was principally the result of a $19.3 million decrease in average borrowed funds and was partially offset by a 31 basis point increase in the cost of borrowed funds. Components accountable for the decrease of $613,000 in interest expense on borrowings were a $834,000 decrease relating to average volume, offset in part by a $221,000 increase relating to average cost. 34 COMPARATIVE AVERAGE BALANCES AND INTEREST INCOME ANALYSIS. The following table presents the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and annualized rates. No tax-equivalent adjustments were made and all average balances are average daily balances. Non-accruing loans have been included in the tables as loans carrying a zero yield.
Year Ended September 30, -------------------------------------------------------------------------------------------------- 2006 2005 restated 2004 restated -------------------------------------------------------------------------------------------------- Interest Average Interest Average Interest Average Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/ Balance Expense Rate Balance Expense Rate Balance Expense Rate --------- -------- ------- ------- -------- -------- -------- -------- ------- (Dollars in Thousands) Interest-earning assets: Real estate loans $ 93,390 $ 6,699 7.17% $ 98,217 $ 6,379 6.49% $138,655 $ 7,705 5.56% Consumer loans 65,338 4,701 7.19 71,817 3,748 5.22 68,268 2,566 3.76 Commercial business loans 34,960 2,466 7.05 40,118 2,303 5.74 46,849 2,358 5.03 --------- -------- ------ --------- -------- ------ --------- -------- ------ Total loans 193,688 13,866 7.16 210,152 12,430 5.91 253,772 12,629 4.98 Investment securities 66,789 3,353 5.02 70,633 2,414 3.42 123,198 3,077 2.50 Mortgage-backed securities 43,979 1,575 3.58 77,424 2,114 2.73 111,016 2,379 2.14 --------- -------- ------ --------- -------- ------ --------- -------- ------ Total interest- earning assets 304,456 18,794 6.17 358,209 16,958 4.73 487,986 18,085 3.71 -------- ------ -------- ------ --------- Non-earning assets 10,677 12,520 16,053 --------- --------- --------- Total assets $315,133 $370,729 $504,039 ========= ========= ========= Liabilities and Stockholders' Equity: Interest-bearing liabilities: Savings accounts $ 5,190 48 0.92 $ 10,202 94 0.92 $ 11,978 113 0.94 Now and money market accounts 73,485 2,430 3.31 64,723 1,197 1.85 77,981 852 1.09 Certificates of deposit 131,636 5,231 3.97 170,593 5,046 2.96 185,677 4,786 2.58 --------- -------- ------ --------- -------- ------ --------- -------- ------ Total deposits 210,311 7,709 3.67 245,518 6,337 2.58 275,636 5,751 2.09 FHLB advances 44,894 2,266 5.05 44,422 1,985 4.47 116,155 2,779 2.39 Other borrowings 31,624 1,330 4.21 51,388 2,224 4.33 78,979 3,440 4.36 --------- -------- ------ --------- -------- ------ --------- -------- ------ Total interest- bearing liabilities 286,829 11,305 3.94 341,328 10,546 3.09 470,770 11,970 2.54 -------- ------ -------- ------ -------- ------ Noninterest-bearing liabilities: Noninterest-bearing demand deposits 14,993 14,138 15,243 Other liabilities 1,147 1,433 2,790 --------- --------- --------- Total liabilities 302,969 356,899 488,803 Stockholders' equity 12,164 13,830 15,236 --------- --------- --------- Total liabilities and stockholders' equity $315,133 $370,729 $504,039 ========= ========= ========= Net interest income $ 7,489 $ 6,412 $ 6,115 ======== ======== ======== Interest rate spread 2.23% 1.64% 1.17% ======= ====== ====== Net interest margin 2.46% 1.79% 1.25% ======= ====== ======
35 RATE/VOLUME ANALYSIS. The following table presents certain information regarding changes in interest income and interest expense attributable to changes in interest rates and changes in volume of interest-earning assets and interest-bearing liabilities for the periods indicated. The change in interest attributable to both rate and volume has been allocated to the changes in rate and volume on a pro rata basis.
Year Ended September 30, 2006 Year Ended September 30, 2005 Compared to Year Compared to Year Ended September 30, 2005 Ended September 30, 2004 Change Attributable to Change Attributable to (restated) ----------------------------------------------------------------------- Volume Rate Total Volume Rate Total - ----------------------------------------------------------------------------------------------------------- (In Thousands) Real estate loans $ (314) $ 634 $ 320 $ (2,247) $ 921 $ (1,326) Consumer loans (338) 1,291 953 133 1,049 1,182 Commercial business loans (296) 459 163 (339) 284 (55) - ------------------------------------------------------------------------------------------------------------ Total loans (948) 2,384 1,436 (2,453) 2,254 (199) Investments (131) 1,070 939 (1,313) 650 (663) Mortgage-backed securities (913) 374 (539) (720) 455 (265) - ------------------------------------------------------------------------------------------------------------ Total interest-earning assets $(1,992) $ 3,828 $ 1,836 $ (4,486) $ 3,359 $ (1,127) ============================================================================================================ Savings accounts $ (46) $ - $ (46) $ (17) $ (2) $ (19) Now and money market accounts 162 1,071 1,233 (145) 490 345 Certificates of deposit (1,152) 1,337 185 (389) 649 260 - ------------------------------------------------------------------------------------------------------------ Total deposits (1,036) 2,408 1,372 (551) 1,137 586 FHLB advances 21 260 281 (1,716) 922 (794) Other borrowings (855) (39) (894) (1,202) (14) (1,216) - ------------------------------------------------------------------------------------------------------------ Total interest-bearing liabilities $(1,870) $ 2,629 $ 759 $ (3,469) $ 2,045 $ (1,424) ============================================================================================================ Change in net interest income $ (122) $ 1,199 $ 1,077 $ (1,017) $ 1,314 $ 297 ============================================================================================================
PROVISION FOR LOAN LOSSES. The allowance for loan losses, which is established through provisions for losses charged to expense, is increased by recoveries on loans previously charged off and is reduced by charge-offs on loans. Determining the proper reserve level or allowance involves management's judgment based upon a review of factors, including the company's internal review process, which segments the loan portfolio into groups based on loan type. Management then looks at its classified assets, which are loans 30 days or more delinquent, and classifies those loans as special mention, substandard or doubtful, based on the performance of the loans. Those classified loans are then individually evaluated for impairment. Those loans that are not individually evaluated are then segmented by type and assigned a reserve percentage that reflects the industry loss experience. The loans individually evaluated for impairment are measured by either the present value of expected future cash flows, the loans observable market price, or the fair value of the collateral. Although management utilizes its best judgment in providing for probable losses, there can be no assurance that the bank will not have to increase its provisions for loan losses in the future. An increase in provision may result from an adverse market for real estate and economic conditions generally in the company's primary market area, future increases in non-performing assets or for other reasons which would adversely affect the company's results of operations. On an annual basis, or more often if deemed necessary, the bank has contracted with an independent outside third party to have its loan portfolio reviewed. The focus of their review is to identify the extent of potential and actual risk in the bank's commercial loan portfolio, in addition to the underwriting and processing practices. Observations made regarding the bank's portfolio risk are based upon review evaluations, portfolio profiles and discussion with the operational staff, including the line lenders and senior management. Non-performing assets were $1.1 million or 0.36% of total assets at September 30, 2006, compared to non-performing assets of $1.8 million or 0.54% of total assets at September 30, 2005. At September 30, 2006, assets of $791,000 were classified as substandard and $319,000 classified as doubtful. The decrease in the provision for loan losses of $93,000 resulted from declines in non-performing assets and the outstanding balance of the bank's land loans, commercial business loans, home equity loans and real estate owned. The decrease in provision was due primarily to the decreases in the required provisions for those loans coupled with an overall decline in the size of the bank's loan portfolio. NON-INTEREST INCOME. Non-interest income decreased $2.5 million during fiscal 2006, over fiscal 2005. That decrease was primarily the result of decreases in gain on sale of loans, gains on derivatives, gain on sale of investment securities and declines in other operating income and service fees on deposits. Those decreases in income were partially offset by an increase of $65,000 in gain on sale of real estate owned. The decrease in other operating income reflects the $946,000 gain recognized one year ago from the sale of the bank's Washington, D.C., Winchester and Sterling, Virginia, branches. 36 The following table presents a comparison of the components of non-interest income.
Years Ended September 30, Difference -------------------------------- ------------------------------------ 2006 2005 Amount % - ------------------------------------------------------------------------------------------------------------------ (Dollars in Thousands) Noninterest income: Gain on sale of loans $ - $ 53 $ (53) (100.00)% Service fees on loans 186 182 4 2.20 Service fees on deposits 424 552 (128) (23.19) Gain (loss) on sale of investment - 539 (539) (100.00) securities Gain (loss) on derivatives (66) 836 (902) (107.89) Gain on sale of real estate owned 65 - 65 n/a Other operating income 30 1,011 (981) (97.03) - ------------------------------------------------------------------------------------------------------------------ Total noninterest income $ 639 $ 3,173 $ (2,534) (79.86)% ==================================================================================================================
NON-INTEREST EXPENSE. Noninterest expense for fiscal 2006 amounted to $11.1 million, an increase of $1.2 million or 12.09% from the $9.9 million incurred in fiscal 2005. The increase in non-interest expense was distributed over various non-interest expense categories with the major contributors being compensation, professional services, advertising and other operating and was offset in part by decreases in, furniture fixtures and equipment and data processing. The increase in other operating expense is the result of a proposed settlement offer which would require a contribution of $500,000 by the company toward the settlement. That offer was accepted conditioned on the execution of a mutual release by the parties. That mutual release is currently the subject of negotiation. The following table presents a comparison of the components of noninterest expense.
Years Ended September 30, Difference ------------------------------ ------------------------------ 2006 2005 Amount % -------------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Noninterest expense: Compensation and employee benefits $ 4,718 $ 4,213 $ 505 11.99% Occupancy 1,337 1,337 - - Professional services 1,227 969 258 26.63 Advertising 628 301 327 108.64 Deposit insurance premium 101 100 1 1.00 Furniture, fixtures and equipment 554 641 (87) (13.57) Data processing 919 1,054 (135) (12.81) Other operating expense 1,601 1,274 327 25.67 -------------------------------------------------------------------------------------------------------------- Total noninterest expense $ 11,085 $ 9,889 $ 1,196 12.09% ==============================================================================================================
INCOME TAXES. The company files a consolidated federal income tax return with its subsidiaries and computes its income tax provision or benefit on a consolidated basis. We did not record a provision for income taxes for fiscal 2006 and 2005 due to our operating losses. The company believes that it will generate future taxable income to assure utilization of a certain portion of the existing net operating losses. 37 CONTRACTUAL COMMITMENTS AND OBLIGATIONS The following summarizes the company's contractual cash obligations and commercial commitments, including maturing certificates of deposit, as of September 30, 2006 and the effect such obligations may have on liquidity and cash flow in future periods.
Less Than Two-Three Four-Five After Five Total One Year Years Years Years - ----------------------------------------------------------------------------------------------------------- (In Thousands) FHLB Advances (1) $ 36,000 $ 6,000 $ - $ 30,000 $ - Reverse repurchase agreements 18,574 18,574 - - - Operating leases 4,865 1,089 2,108 1,175 493 - ----------------------------------------------------------------------------------------------------------- Total obligations $ 59,439 $ 25,663 $ 2,108 $ 31,175 $ 493 ===========================================================================================================
(1) The company expects to refinance these short and medium-term obligations under substantially the same terms and conditions.
OTHER COMMERCIAL COMMITMENTS Less Than Two-Three Four-Five After Five Total One Year Years Years Years - ----------------------------------------------------------------------------------------------------------- (In Thousands) Certificates of deposit maturities (1) $ 127,939 $ 102,257 $ 21,264 $ 4,325 $ 93 Loan originations 13,868 13,868 - - - Unfunded lines of credit 113,117 113,117 - - - Standby letter of credit 55 55 - - - - ----------------------------------------------------------------------------------------------------------- Total $ 254,979 $ 229,297 $ 21,264 $ 4,325 $ 93 ===========================================================================================================
(1) The company expects to retain maturing deposits or replace amounts maturing with comparable certificates of deposit based on current market interest rates. ASSET-LIABILITY MANAGEMENT The primary objective of asset/liability management is to ensure the steady growth of the company's primary earnings component, net interest income, and the maintenance of reasonable levels of capital independent of fluctuating interest rates. Interest rate risk can be defined as the vulnerability of an institution's financial condition and/or results of operations to movements in interest rates. Interest rate risk, or sensitivity, arises when the maturity or repricing characteristics of assets differ significantly from the maturity or repricing characteristics of liabilities. Management endeavors to structure the balance sheet so that repricing opportunities exist for both assets and liabilities in roughly equivalent amounts at approximately the same time intervals to maintain interest rate risk at an acceptable level. Management oversees the asset/liability management function and meets periodically to monitor and manage the structure of the balance sheet, control interest rate exposure, and evaluate pricing strategies for the company. The asset mix of the balance sheet is continually evaluated in terms of several variables: yield, credit quality, and appropriate funding sources and liquidity. Management of the liability mix of the balance sheet focuses on expanding the company's various funding sources. At times, depending on the general level of interest rates, the relationship between long- and short-term interest rates, market conditions and competitive factors, the bank may determine to increase our interest rate risk position in order to increase our net interest margin. The bank manages its exposure to interest rates by structuring the balance sheet in the ordinary course of business. The bank currently emphasizes adjustable rate loans and/or loans that mature in a relatively short period when compared to single-family residential loans. In addition, to the extent possible, the bank attempts to attract longer-term deposits. While the bank has entered into interest rate swaps and caps to assist in managing interest rate risk, it has not entered into instruments such as leveraged derivatives, structured notes, financial options, financial futures contracts or forward delivery contracts to manage interest rate risk. One of the ways the bank monitors interest rate risk is through an analysis of the relationship between interest-earning assets and interest-bearing liabilities to measure the impact that future changes in interest rates will have on net interest income. An interest rate sensitive asset or liability is one that, within a defined time period, either matures or experiences an interest rate change in line with general market interest rates. The management of interest rate risk is performed by analyzing the maturity and repricing relationships between interest-earning assets and interest-bearing liabilities at specific points in time ("GAP") and by analyzing the effects of interest rate changes on net interest income over specific periods of time by projecting the performance of the mix of assets and liabilities in varied interest rate environments. 38 The table below illustrates the maturities or repricing of the company's assets and liabilities, including noninterest-bearing sources of funds to specific periods, at September 30, 2006. Estimates and assumptions concerning allocating prepayment rates of major asset categories are based on information obtained from Farin and Associates on projected prepayment levels on mortgage-backed and related securities and decay rates on savings, NOW and money market accounts. The bank believes that such information is consistent with our current experience.
----------------------------------------------------------------------------------------------------------------------- Three 91 Days 181 Days One Year Years to Five 90 Days to 180 to Dne to Three Five Years or Maturing or Repricing Periods or Less Days Year Years Years More Total ----------------------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Interest-earning assets Loans: Adjustable and balloon $ 23,750 $ 7,801 $ 8,688 $ 10,535 $ 6,088 $ 13 $ 56,875 Fixed-rate 1,916 627 2,508 5,703 5,805 16,981 33,540 Commercial business 31,109 1,093 892 3,929 2,062 1,473 40,558 Consumer 61,896 84 151 402 184 153 62,870 Investment securities 58,496 160 288 817 460 5,966 66,187 Mortgage-backed securities 8,838 7,643 13,331 1,610 11 11 31,444 ----------------------------------------------------------------------------------------------------------------------- Total 186,005 17,408 25,858 22,996 14,610 24,597 291,474 ----------------------------------------------------------------------------------------------------------------------- Interest-bearing liabilities: Deposits: Savings accounts 1,056 753 541 611 332 386 3,679 NOW accounts 3,335 2,572 2,530 2,817 861 2,463 14,578 Money market accounts 18,747 12,765 9,898 9,762 4,192 3,386 58,750 Certificates of deposit 47,412 19,711 35,146 21,264 4,324 93 127,950 Borrowings: FHLB advances 5,000 - 6,000 - 25,000 - 36,000 Other borrowings 18,574 - - - - 9,388 27,962 ----------------------------------------------------------------------------------------------------------------------- Total 94,124 35,801 54,115 34,454 34,709 15,716 $268,919 ----------------------------------------------------------------------------------------------------------------------- GAP $ 91,881 $(18,393) $(28,257) $(11,458) $(20,099) $ 8,881 $ 22,555 ======================================================================================================================= Cumulative GAP $ 91,881 $ 73,488 $ 45,231 $ 33,773 $ 13,674 $ 22,555 ========================================================================================================= Ratio of Cumulative GAP to total interest earning assets 31.52% 25.21% 15.52% 11.59% 4.69% 7.74% =========================================================================================================
As indicated in the interest rate sensitivity table, the 181 day to one year cumulative gap, representing the total net assets and liabilities that are projected to re-price over the next year, was asset sensitive in the amount of $45.2 million at September 30, 2006. While the GAP position is a useful tool in measuring interest rate risk and contributes toward effective asset and liability management, it is difficult to predict the effect of changing interest rates solely on the GAP measure without accounting for alterations in the maturity or repricing characteristics of the balance sheet that occur during changes in market interest rates. The GAP position reflects only the prepayment assumptions pertaining to the current rate environment, and assets tend to prepay more rapidly during periods of declining interest rates than they do during periods of rising interest rates. Management uses two other analyses to manage interest rate risk: (1) an earnings-at-risk analysis to develop an estimate of the direction and magnitude of the change in net interest income if rates move up or down 300 basis points; and (2) a value-at-risk analysis to estimate the direction and magnitude of the change in net portfolio value if rates move up 300 basis points or down 200 basis points. Currently the bank uses a sensitivity of net interest income analysis prepared by Farin and Associates to measure earnings-at-risk and the OTS Interest Rate Risk Exposure Report to measure value-at-risk. 39 The following table sets forth the earnings at risk analysis that measures the sensitivity of net interest income to changes in interest rates at September 30, 2006:
Net Interest Income Sensitivity Analysis --------------------------------------------------------------------- Changes in Rate Basis Point Percent by Basis Net Interest Change Change From Point Margin From Base Base ----------------- --------------- --------------- ----------------- +300 3.28% 0.03% 0.92% +200 3.27% 0.02% 0.62% +100 3.27% 0.02% 0.62% +0 3.25% - - -100 3.12% (0.13)% (4.00)% -200 2.96% (0.29)% (8.92)% -300 2.78% (0.47)% (14.46)%
In a declining rate scenario the bank is not within the limits established by the board of directors. Management will monitor the situation over the next several quarters to determine if a change should be made in our position. The above table indicates that, based on an immediate and sustained 200 basis point increase in market interest rates, net interest margin, as measured as a percent of total assets, would increase by 2 basis points or 0.62% and, if interest rates decrease 200 basis points, net interest margin, as a percent of total assets, would decrease by 29 basis points or 8.92%. The net interest income sensitivity analysis does not represent a forecast and should not be relied upon as being indicative of expected operating results. The estimates used are based upon assumptions as to the nature and timing of interest rate levels including the shape of the yield curve. Those estimates have been developed based upon current economic conditions; the company cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change. Presented below, as of September 30, 2006, is an analysis of our interest rate risk as measured by changes in net portfolio value for parallel shifts of up 300 and down 200 basis points in market interest rates:
Net Portfolio Value as a Percent of Net Portfolio Value the Present Value of Assets ---------------------------------- -------------------------------------- Changes in Rates Dollar Percent Net Portfolio Change in (bp) Change Change Value Ratio NPV Ratio - ---------------------------------------------------------------------------------------------- (Dollars in thousands) +300 $ (1,952) (7.67)% 7.46% (0.72)% +200 (908) (3.57) 7.81 (0.37) +100 (355) (1.40) 8.02 (0.16) +0 - - 8.18 - -100 (490) (1.93) 8.07 (0.11) -200 (1,235) (4.85) 7.89 (0.29)
The decline in net portfolio value of $908,000 or 3.50% in the event of a 200 basis point increase in rates is a result of the current amount of adjustable rate loans and investments held by the bank as of September 30, 2006. The foregoing decrease in net portfolio value, in the event of an increase in interest rates of 200 basis points, currently exceeds the company's internal board guidelines. In addition to the strategies set forth above, in 2002, the bank began using derivative financial instruments, such as interest rate swaps, to help manage interest rate risk. The bank does not use derivative financial instruments for trading or speculative purposes. All derivative financial instruments are used in accordance with board-approved risk management policies. The bank enters into interest rate swap agreements principally to manage its exposure to the impact of rising short-term interest rates on its earnings and cash flows. Since short-term interest rates have stabilized the bank has unwound its interest rate swaps during fiscal 2006. 40 FINANCIAL CONDITION 2005 COMPARED TO 2004 At September 30, 2005, the company had total assets of $339.5 million, a decrease of $93.6 million or 21.62% from the $433.2 million recorded at the close of the comparable period one-year ago. Investments and mortgage-backed securities at September 30, 2005, amounted to $115.8 million a decrease of $37.2 million or 24.32% from the $153.0 million held at September 30, 2004, as a result of prepayments of $59.9 million offset in part by purchases of $21.6 million. Loans receivable and loans held for sale at September 30, 2005, amounted to $204.4 million, a decrease of 18.85% from the $251.9 million held at September 30, 2004, primarily as a result of a $29.2 million decrease in the bank's single family loan portfolio, coupled with a $16.2 million decline in commercial and consumer loans outstanding. Those declines were due primarily to payoffs and lower than anticipated loan originations. Deposits amounted to $237.8 million at September 30, 2005, a decrease of $51.2 million from the $289.0 million held one year ago, and was primarily the result of the sale of three branches located in Washington, D.C., Winchester and Sterling, Virginia. Those sales accounted for approximately $41.1 million of the decline in deposits and was coupled with the $11.0 million decline in certificates of deposits of $100,000 or more, continuing the bank's approach to rely less and less on those types of deposit. RESULTS OF OPERATIONS 2005 COMPARED TO 2004 DISCONTINUED MORTGAGE BANKING OPERATIONS In 2004, the bank entered into a management agreement with the manager of GAMC, its mortgage-banking subsidiary. Under the management agreement the manager was to reimburse operating expenses equal to approximately 100% of any operating loss in return for an increase in the manager's share of net earnings from 40% to 80%. Reflected in the discontinued mortgage banking operations for 2005 is a reduction in expense of $1.8 million provided by the manager of the mortgage company. Under the management agreement, if GAMC sustained losses in excess of the amount in the escrow, and the manager did not restore those losses within 15 days of demand, GAMC's recourse was to terminate the agreement. At June 30, 2005, the escrow had been depleted, the manager contributed an additional $108,000 to GAMC to make up the deficiency and the agreement was continued for three months. During the three months ended September 30, 2005, the losses at GAMC continued and reached approximately $993,000. Because the escrow account was depleted and the manager had not posted sufficient collateral to securitize the account receivable due from the manager, the bank's earnings were reduced by the $993,000 loss. As disclosed earlier, we applied discontinued operations accounting in the third quarter of 2006, as we completed the closing of the GAMC business. Accordingly, the income statements for all periods have been adjusted. The reclassification of GAMC's results to discontinued operations primarily resulted in a reduction to previously reported levels of net interest income, a reduction in noninterest income and a reduction in noninterest expense. The table below summarizes GAMC's results which were treated as discontinued operations for the periods indicated.
Year Ended September 30, ------------------------------------ 2005(Restated) 2004 (Restated) - --------------------------------------------------------------------------------------- (Dollars in Thousands, Except Per Share Data Interest income $ 478 $ 877 Interest expense 347 385 - --------------------------------------------------------------------------------------- Net interest income 131 492 Noninterest income 5,072 9,085 Noninterest expense 6,310 9,060 Provision for income taxes - 89 - --------------------------------------------------------------------------------------- Net income (loss) $(1,107) $ 428 ======================================================================================= Earnings per share - basic $ (0.37) $ 0.14 Earnings per share - diluted (0.37) 0.14
41 NET INCOME. For the fiscal year ended September 30, 2005, the company had a net loss from continuing operations of $523,000 or $0.17 per diluted share compared to a loss from continuing operations of $3.9 million or $1.30 per diluted share for fiscal year 2004. The $3.4 million improvement in earnings over the comparable period one-year ago resulted from an increase in non-interest income of $2.6 million, a decrease of $481,000 in non-interest expense and was coupled with an increase in net interest income of $297,000. Those improvements in expenses and net interest income were offset in part by an increase in the provision for loan losses of $10,000. The increase in the provision for loan losses was due primarily to an increase in the required allowance for non-performing loans, notwithstanding a reduction in the required allowance for loans based on the structure of the bank's overall loan portfolio. NET INTEREST INCOME. An important source of our earnings is net interest income, which is the difference between income earned on interest-earning assets, such as loans, investment securities and mortgage-backed securities, and interest paid on interest-bearing liabilities such as deposits and borrowings. The level of net interest income is determined primarily by the relative average balances of interest-earning assets and interest-bearing liabilities in combination with the yields earned and rates paid upon them. The correlation between the repricing of interest rates on assets and on liabilities also influences net interest income. The following table presents a comparison of the components of interest income and expense and net interest income.
Years ended September 30, Difference ------------------------------- ------------------------------- 2005 2004 Amount % - ------------------------------------------------------------------------------------------------------------ (Dollars in thousands) Interest income: Loans $ 12,430 $ 12,629 $ (199) (1.58)% Investments 4,528 5,456 (928) (17.01) - ------------------------------------------------------------------------------------------------------------ Total 16,958 18,085 (1,127) (6.23) - ------------------------------------------------------------------------------------------------------------ Interest expense: Deposits 6,337 5,751 586 10.19 Borrowings 4,209 6,219 (2,010) (32.32) - ------------------------------------------------------------------------------------------------------------ Total 10,546 11,970 (1,424) (11.90) - ------------------------------------------------------------------------------------------------------------ Net interest income $ 6,412 $ 6,115 $ 297 4.86% ============================================================================================================
Our increase in net interest income for fiscal year 2005, resulted primarily from a 54 basis point increase in net interest margin (net interest income divided by average interest-earning assets) from 1.25% for fiscal year 2004 to 1.79% for fiscal year 2005, offset in part by a $129.8 million decrease in the bank's interest-earning assets. Contributing to the increase in the net interest margin was a $1.5 million reduction in interest expense resulting from payments made on certain interest rate swap and cap agreements compared to a charge of $2.1 million in the comparable period one year ago. The improvement in net interest margin also resulted from increasing the average yield on interest-earning assets by 47 basis points more than the increase in the average cost on average interest-bearing liabilities, but that increase was partially offset by a decrease in the amount the bank's average interest-earning assets exceeded the decrease in average interest-bearing liabilities by $335,000. INTEREST INCOME. Interest income for the fiscal year ended September 30, 2005 decreased $1.1 million compared to fiscal year 2004, primarily as a result of a decrease in the average outstanding balances of loans and investment securities. That decrease was partially offset by a 102 basis point increase of in the average yield earned on interest earning assets. INTEREST EXPENSE. The $1.4 million decrease in interest expense for fiscal year 2005 compared to the 2004 period was principally the result of a $129.4 million decrease in average deposits and borrowed funds. The decrease was partially offset by a 55 basis point increase in the cost of funds on average deposits and borrowed funds. The increase in interest expense on deposits was primarily due to a 49 basis point increase in rates paid on certificates of deposit, savings and NOW and money market accounts. That increase was partially offset by a decrease of $30.1 million, in certificates, savings and NOW and money market accounts from $275.6 million for fiscal 2004 to $245.5 million for fiscal 2005. The increase in rates was primarily due to market rates moving rates higher on interest-bearing demand deposits, savings accounts and certificates and the pricing on new and renewed time deposits. 42 COMPARATIVE AVERAGE BALANCES AND INTEREST INCOME ANALYSIS. The following table presents the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and annualized rates. No tax-equivalent adjustments were made and all average balances are average daily balances. Non-accruing loans have been included in the tables as loans carrying a zero yield.
Year Ended September 30, ----------------------------------------------------------------------------------------------- 2005 restated 2004 restated 2003 restated ----------------------------------------------------------------------------------------------- Interest Average Interest Average Interest Average Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/ Balance Expense Rate Balance Expense Rate Balance Expense Rate --------- --------- ------- --------- -------- ------ --------- --------- ------- (Dollars in Thousands) Interest-earning assets: Real estate loans $ 98,217 $ 6,379 6.49% $138,655 $ 7,705 5.56% $155,082 $ 8,568 5.52% Consumer loans 71,817 3,748 5.22 68,268 2,566 3.76 63,548 2,539 4.00 Commercial business loans 40,118 2,303 5.74 46,849 2,358 5.03 32,756 1,636 4.99 --------- --------- ------- --------- -------- ------ --------- --------- ------ Total loans 210,152 12,430 5.91 253,772 12,629 4.98 251,386 12,743 5.07 Investment securities 70,633 2,414 3.42 123,198 3,077 2.50 161,161 4,899 3.04 Mortgage-backed securities 77,424 2,114 2.73 111,016 2,379 2.14 51,046 1,719 3.37 --------- --------- ------- --------- -------- ------ --------- --------- ------ Total interest- earning assets 358,209 16,958 4.73 487,986 18,085 3.71 463,593 19,361 4.18 --------- ------- -------- ------ --------- ------ Non-earning assets 12,520 16,053 14,289 --------- --------- --------- Total assets $370,729 $504,039 $477,882 ========= ========= ========= Liabilities and Stockholders' Equity: Interest-bearing liabilities: Savings accounts $ 10,202 94 0.92 $ 11,978 113 0.94 $ 9,686 122 1.26 Now and money market accounts 64,723 1,197 1.85 77,981 852 1.09 76,744 1,050 1.37 Certificates of deposit 170,593 5,046 2.96 185,677 4,786 2.58 193,039 5,501 2.85 --------- --------- ------- --------- -------- ------ --------- --------- ------ Total deposits 245,518 6,337 2.58 275,636 5,751 2.09 279,469 6,673 2.39 FHLB advances 44,422 1,985 4.47 116,155 2,779 2.39 102,868 2,657 2.58 Other borrowings 51,388 2,224 4.33 78,979 3,440 4.36 60,037 2,947 4.91 --------- --------- ------- --------- -------- ------ --------- --------- ------ Total interest- bearing liabilities 341,328 10,546 3.09 470,770 11,970 2.54 442,374 12,277 2.78 --------- ------- -------- ------ --------- ------- Noninterest-bearing liabilities: Noninterest-bearing demand deposits 14,138 15,243 17,130 Other liabilities 1,433 2,790 3,246 --------- --------- --------- Total liabilities 356,899 488,803 462,750 Stockholders' equity 13,830 15,236 15,132 --------- --------- --------- Total liabilities and stockholders' equity $370,729 $504,039 $477,882 ========= ========= ========= Net interest income $ 6,412 $ 6,115 $ 7,084 ========= ======== ======== Interest rate spread 1.64% 1.17% 1.40% ====== ======= ======= Net interest margin 1.79% 1.25% 1.53% ====== ======= =======
43 RATE/VOLUME ANALYSIS. The following table presents certain information regarding changes in interest income and interest expense attributable to changes in interest rates and changes in volume of interest-earning assets and interest-bearing liabilities for the periods indicated. The change in interest attributable to both rate and volume has been allocated to the changes in rate and volume on a pro rata basis.
Year Ended September 30, 2005 Year Ended September 30, 2004 Compared to Year Compared to Year Ended September 30, 2004 Ended September 30, 2003 Change Attributable to (restated) Change Attributable to (restated) -------------------------------------------------------------------------- Volume Rate Total Volume Rate Total - -------------------------------------------------------------------------------------------------------------- (In Thousands) Real estate loans $ (2,247) $ 921 $ (1,326) $ (908) $ 45 $ (863) Consumer loans 133 1,049 1,182 189 (162) 27 Commercial business loans (339) 284 (55) 704 18 722 - ------------------------------------------------------------------------------------------------------------ Total loans (2,453) 2,254 (199) (15) (99) (114) Investments (1,313) 650 (663) (1,154) (668) (1,822) Mortgage-backed securities (720) 455 (265) 2,020 (1,360) 660 - ------------------------------------------------------------------------------------------------------------ Total interest-earning assets $ (4,486) $ 3,359 $ (1,127) $ 851 $(2,127) $ (1,276) ============================================================================================================ Savings accounts $ (17) $ (2) $ (19) $ 29 $ (38) $ (9) Now and money market accounts (145) 490 345 17 (215) (198) Certificates of deposit (389) 649 260 (210) (505) (715) - ------------------------------------------------------------------------------------------------------------ Total deposits (551) 1,137 586 (164) (758) (922) FHLB advances (1,716) 922 (794) 343 (221) 122 Other borrowings (1,202) (14) (1,216) 930 (437) 493 - ------------------------------------------------------------------------------------------------------------ Total interest-bearing liabilities $ (3,469) $ 2,045 $ (1,424) $ 1,109 $(1,416) $ (307) ============================================================================================================ Change in net interest income $ (1,017) $ 1,314 $ 297 $ (258) $ (711) $ (969) ============================================================================================================
PROVISION FOR LOAN LOSSES. The allowance for loan losses, which is established through provisions for losses charged to expense, is increased by recoveries on loans previously charged off and is reduced by charge-offs on loans. Determining the proper reserve level or allowance involves management's judgment based upon a review of factors, including the company's internal review process, which segments the loan portfolio into groups based on loan type. Management then looks at its classified assets, which are loans 30 days or more delinquent, and classifies those loans as special mention, substandard or doubtful, based on the performance of the loans. Those classified loans are then individually evaluated for impairment. Since the historical three-year loss experience for the bank is new, those loans that are not classified are not individually evaluated. Those loans that are not individually evaluated are then segmented by type and assigned a reserve percentage that reflects the industry loss experience. The loans individually evaluated for impairment are measured by either the present value of expected future cash flows, the loans observable market price, or the fair value of the collateral. Although management utilizes its best judgment in providing for probable losses, there can be no assurance that the bank will not have to increase its provisions for loan losses in the future. An increase in provision may result from an adverse market for real estate and economic conditions generally in the company's primary market area, future increases in non-performing assets or for other reasons which would adversely affect the company's results of operations. Non-performing assets were $1.8 million or 0.54% of total assets at September 30, 2005, compared to non-performing assets of $953,000 or 0.22%of total assets at September 30, 2004. At September 30, 2005, assets of $1.6 million were classified as substandard, $27,000 classified as doubtful and $232,000 classified as real estate owned. The increase in non-performing assets from the comparable period one-year ago was due primarily to a $1.0 million home loan that became non-performing. As a result, the bank provided an increase of $46,000 in the required allowance for the bank's non-performing loans. Notwithstanding a reduction in the required allowance, based on the structure of the bank's overall loan portfolio, the provision for loan losses was increased due primarily to an increase in the required allowance for non-performing loans. NON-INTEREST INCOME. Non-interest income increased $2.6 million during fiscal 2005 over fiscal 2004. That increase was primarily the result of increases of $1.1 million in gains on derivatives, $980,000 in other operating income and $597,000 in gains on sale of investments and an increase of $68,000 in service fee income on loans. That increase was partially offset by a decrease of $203,000 in service fee income on deposits. The increase in other operating income reflects the gain of $945,000 recognized from the sale of the bank's Washington D.C., Winchester and Sterling, Virginia, branches. 44 The following table presents a comparison of the components of non-interest income.
Years Ended September 30, Difference -------------------------------- ------------------------------------ 2005 2004 Amount % - ------------------------------------------------------------------------------------------------------------------ (Dollars in Thousands) Noninterest income: Gain on sale of loans $ 53 $ (68) $ 121 177.94% Service fees on loans 182 114 68 59.65 Service fees on deposits 552 755 (203) (26.89) Gain (loss) on sale of investment 539 (58) 597 1,029.31 securities Gain (loss) on derivatives 836 (227) 1,063 468.28 Other operating income 1,011 31 980 3,161.29 - ------------------------------------------------------------------------------------------------------------------ Total noninterest income $ 3,173 $ 547 $ 2,626 480.07% ==================================================================================================================
NON-INTEREST EXPENSE. Noninterest expense for fiscal 2005 amounted to $9.9 million, a decrease of $481,000 or 4.64% from the $10.4 million incurred in fiscal 2004. The decrease was primarily attributable to a decrease in compensation, occupancy, furniture fixtures and equipment and data processing. Those decreases were offset by increases in professional services, advertising, deposit insurance premium and other operating expenses The following table presents a comparison of the components of noninterest expense.
Years Ended September 30, Difference ------------------------------ ------------------------------- 2005 2004 Amount % -------------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Noninterest expense: Compensation and employee benefits $ 4,213 $ 4,306 $ (93) (2.16)% Occupancy 1,337 1,759 (422) (23.99) Professional services 969 717 252 35.15 Advertising 301 244 57 23.36 Deposit insurance premium 100 44 56 127.27 Furniture, fixtures and equipment 641 818 (177) (21.64) Data processing 1,054 1,306 (252) (19.30) Other operating expense 1,274 1,176 98 8.33 -------------------------------------------------------------------------------------------------------------- Total noninterest expense $ 9,889 $ 10,370 $ (481) (4.64)% ==============================================================================================================
INCOME TAXES. The company files a consolidated federal income tax return with its subsidiaries and computes its income tax provision or benefit on a consolidated basis. The company believes that it will generate future taxable income to assure utilization of a portion of the existing net operating losses. Management has provided a valuation allowance for net deferred tax assets of $3.0 million, due to the timing of the generation of future taxable income. At September 30, 2005, the company had net operating loss carryforwards totaling approximately $6.1 million, which expire in years 2006 to 2022. As a result of the change in ownership of the bank, approximately $1.5 million of the total net operating loss carryforwards is subject to an annual usage limitation of approximately $114,000. 45 LIQUIDITY AND CAPITAL RESOURCES LIQUIDITY. The bank's primary sources of funds are deposits, principal and interest payments on loans, mortgage-backed and investment securities and borrowings. While maturities and scheduled amortization of loans are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. The bank has continued to maintain the levels of liquid assets as previously required by OTS regulations. The bank manages its liquidity position and demands for funding primarily by investing excess funds in short-term investments and utilizing FHLB advance and reverse repurchase agreements in periods when the bank's demands for liquidity exceed funding from deposit inflows. The bank's most liquid assets are cash and cash equivalents, interest bearing deposits and securities available-for-sale. The levels of those assets are dependent on the bank's operating, financing, lending and investing activities during any given period. At September 30, 2006, cash and cash equivalents, interest bearing deposits and securities available-for-sale totaled $95.3 million, or 31.21% of total assets. The primary investing activities of the bank are the origination of residential one- to four-family loans, commercial real estate loans, real estate construction and development loans, commercial business and consumer loans and the purchase of United States Treasury and agency securities, mortgage-backed and mortgage-related securities and other investment securities. During the year ended September 30, 2006, the bank's loan originations and purchases totaled $104.2 million. Purchases of United States Treasury and agency securities, mortgage-backed and mortgage related securities and other investment securities totaled $7.7 million for the year ended September 30, 2006. The bank has other sources of liquidity if a need for additional funds arises. At September 30, 2006, the bank had $36.0 million in advances outstanding from the FHLB and had an additional overall borrowing capacity from the FHLB of $20.2 million at that date. Depending on market conditions, the pricing of deposit products and FHLB advances, the bank may continue to rely on FHLB borrowings to fund asset growth. At September 30, 2006, the bank had commitments to fund loans and unused outstanding lines of credit, unused standby letters of credit and undisbursed proceeds of construction mortgages totaling $127.0 million. The bank anticipates that it will have sufficient funds available to meet its current loan origination commitments. Certificate accounts, including IRA and Keogh accounts, which are scheduled to mature in less than one year from September 30, 2006, totaled $102.3 million. Based upon experience, management believes the majority of maturing certificates of deposit will remain with the bank. In addition, management of the bank believes that it can adjust the rates offered on certificates of deposit to retain deposits in changing interest rate environments. In the event that a significant portion of these deposits are not retained by the bank, the bank would be able to utilize FHLB advances and reverse repurchase agreements to fund deposit withdrawals, which would result in an increase in interest expense to the extent that the average rate paid on such borrowings exceeds the average rate paid on deposits of similar duration. CAPITAL RESOURCES. At September 30, 2006, the bank exceeded minimum regulatory capital requirements with a tangible capital level of $16.7 million, or 5.51% of total adjusted assets, which exceeds the required level of $4.6 million, or 1.50%; core capital of $16.7 million, or 5.51% of total adjusted assets, which exceeds the required level of $12.2 million, or 4.00%; and risk-based capital of $17.6 million, or 9.11% of risk-weighted assets, which exceeds the required level of $15.5 million, or 8.00%. On March 20, 2002, Greater Atlantic Capital Trust I (the, "Trust"), a Delaware statutory business trust and a wholly owned Trust subsidiary of the company, issued $9.6 million aggregate liquidation amount (963,038 shares) of 6.50% cumulative preferred securities maturing on December 31, 2031, retaining an option to call the securities on or after December 31, 2003. Conversion of the preferred securities into the company's common stock may occur at any time on or after 60 days after the closing of the offering. The company may redeem the preferred securities, in whole or in part, at any time on or after December 31, 2003. Distributions on the preferred securities are payable quarterly on March 31, June 30, September 30 and December 31 of each year beginning on June 30, 2002. The Trust also issued 29,762 common securities to the company for $297,620. The proceeds from the sale of the preferred securities and the proceeds from the sale of the trust's common securities were utilized to purchase from the company junior subordinated debt securities of $9,928,000 bearing interest of 6.50% and maturing December 31, 2031. The Trust was formed for the sole purpose of investing the proceeds from the sale of the convertible preferred securities in the corresponding convertible debentures. The company has fully and unconditionally guaranteed the preferred securities along with all obligations of the trust related thereto. The sale of the preferred securities yielded $9.2 million after deducting offering expenses. The company retained approximately $1.5 million of the proceeds for general corporate purposes, investing the retained funds in short-term investments. The remaining $8.0 million of the proceeds was invested in the bank to increase its capital position. 46 On December 19, 2006, the Company issued a news release announcing that the first quarter distribution of Greater Atlantic Capital Trust I 6.50% Cumulative Convertible Trust Preferred Securities scheduled for December 31, 2006, as well as future distributions on the Trust Preferred Securities, will be deferred. The announcement by the Company follows advice received by Greater Atlantic Bank from the Office of Thrift Supervision that it would not approve Greater Atlantic Bank's application to pay a cash dividend to the Company. Accordingly, the Company exercised its right to defer the payment of interest on its 6.50% Convertible Junior Subordinated Debentures Due 2031 related to the Trust Preferred Securities, for an indefinite period (which can be no longer than 20 consecutive quarterly periods). ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk is the risk of loss from adverse changes in market prices and rates. The company's market risk arises primarily from interest rate risk inherent in its lending and deposit taking activities. The company has little or no risk related to trading accounts, commodities or foreign exchange. CHANGES IN LEVELS OF INTEREST RATES MAY ADVERSELY AFFECT US. In general, market risk is the sensitivity of income to variations in interest rates and other relevant market rates or prices. The company's market rate sensitive instruments include interest-earning assets and interest-bearing liabilities. The company enters into market rate sensitive instruments in connection with its various business operations, particularly its mortgage banking activities. Loans originated, and the related commitments to originate loans that will be sold, represent market risk that is realized in a short period of time, generally two or three months. The company's primary source of market risk exposure arises from changes in United States interest rates and the effects thereof on mortgage prepayment and closing behavior, as well as depositors' choices ("interest rate risk"). Changes in these interest rates will result in changes in the company's earnings and the market value of its assets and liabilities. We expect to continue to realize income from the differential or "spread" between the interest earned on loans, securities and other interest-earning assets, and the interest paid on deposits, borrowings and other interest-bearing liabilities. That spread is affected by the difference between the maturities and re-pricing characteristics of interest-earnings assets and interest-bearing liabilities. Loan volume and yields are affected by market interest rates on loans, and rising interest rates generally are associated with fewer loan originations. Management expects that a substantial portion of our assets will continue to be indexed to changes in market interest rates and we intend to attract a greater proportion of short-term liabilities, which will help address our interest rate risk. The lag in implementation of re-pricing terms on our adjustable-rate assets may result in a decline in net interest income in a rising interest rate environment. There can be no assurance that our interest rate risk will be minimized or eliminated. Further, an increase in the general level of interest rates may adversely affect the ability of certain borrowers to pay the interest on and principal of their obligations. Accordingly, changes in levels of market interest rates, (primarily increases in market interest rates), could materially adversely affect our interest rate spread, asset quality, loan origination volume and overall financial condition and results of operations. To mitigate the impact of changes in market interest rates on our interest-earning assets and interest-bearing liabilities, we actively manage the amounts and maturities of these assets and liabilities. A key component of this strategy is the origination and retention of short-term and adjustable-rate assets and the origination and sale of fixed-rate loans. We retain short-term and adjustable-rate assets because they have re-pricing characteristics that more closely match the re-pricing characteristics of our liabilities. To further mitigate the risk of timing differences in the re-pricing of assets and liabilities, our interest-earning assets are matched with interest-bearing liabilities that have similar re-pricing characteristics. For example, the interest rate risk of holding fixed-rate loans is managed with long-term deposits and borrowings, and the risk of holding ARMs is managed with short-term deposits and borrowings. Periodically, mismatches are identified and managed by adjusting the re-pricing characteristics of our interest-bearing liabilities with derivatives, such as interest rate caps and interest rate swaps. ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Please refer to the index on page 59 for the Consolidated Financial Statements of Greater Atlantic Financial Corp. and subsidiaries, together with the report thereon by BDO Seidman, LLP. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There have been no disagreements with the Registrant's accountants on any matters of accounting principles or practices or financial statement disclosures. 47 ITEM 9A. CONTROLS AND PROCEDURES Pursuant to an investigation being conducted under the supervision of the company's Audit Committee, management discovered a $2.1 million difference in an inter-company account between the company and its subsidiary, GAMC. The company discovered the un-reconciled inter-company account at GAMC during its review of the closing entries to the accounts of GAMC in connection with the preparation of the company's consolidated financial statements for the quarterly period ended June 30, 2006. The investigation resulted in a determination that the warehouse payable account maintained at GAMC had not been properly reconciled. The extensive investigation revealed numerous errors in the reconciliation of the warehouse payable account of GAMC over a period of five (5) years. As a result of the investigation, the company determined that it has sustained losses aggregating approximately $1.4 million. To date, the company has identified claims of $738,000, primarily for duplicate checks issued and paid on the same loan. Of that sum, $422,000 has been collected and the company believes that the balance is recoverable. The investigation regarding this matter is ongoing and the company has retained legal and accounting personnel to assist in the company's investigation. Costs associated with engaging personnel to provide those professional services are being treated as period costs. The company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed by the company in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and regulations and that such information is accumulated and communicated to the company's management, including the company's Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that the company's disclosure controls and procedures will detect or uncover every situation involving the failure of persons within the company or its subsidiary to disclose material information otherwise required to be set forth in the company's periodic reports. The company, under the supervision and with the participation of the company's management, including the company's Chief Executive Officer and the Chief Financial Officer, has evaluated the effectiveness of the company's disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that the company's disclosure controls and procedures were not effective as of June 30, 2006 due to the override of certain internal control procedures relating to preparation and review of certain reconciliations. The override of those internal control procedures enabled the differences in the reconciliations performed at GAMC to go un-detected over a long period of time. While the bank had outsourced its internal audit function to an independent CPA firm, neither their review of the reconciliations or that of the company's then controller uncovered any errors that were brought to the attention of senior management. The person responsible for the reconciliations at GAMC is no longer employed by GAMC, and the then controller of the bank, who was responsible for review of the reconciliations at GAMC, is no longer employed by the bank. While the problem was isolated to one unique account with a subsidiary that is no longer in business, and was the responsibility of individuals who are no longer employed by subsidiaries of the company, the company has enhanced controls in similar situations going forward by: o Strengthening the procedures for reconciling the intercompany accounts. Those procedures include having an outside party perform reconciliations semi-annually instead of merely reviewing reconciliations performed by parties with account responsibility; and o The company has strengthened the accounting staff at the controller position. In connection with this Form 10-K, the company's management, with the participation of its Chief Executive Officer and Chief Financial Officer, evaluated the company's disclosure controls and procedures as currently in effect, including the changes discussed above, and such officers have concluded that, as of this date, the company's disclosure controls and procedures are effective. Management of the company is also responsible for establishing and maintaining adequate internal control over financial reporting and control of the company's assets to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Other than those described above, there were no significant changes in the company's internal control over financial reporting during the company's quarter ended September 30, 2006 that have materially affected, or are reasonably likely to materially affect, the company's internal control over financial reporting. 48 ITEM 9B. OTHER INFORMATION During the quarter ended September 30, 2006, the company filed a Current Report on Form 8-K for all information required to be disclosed in a report on Form 8-K. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY. DIRECTORS The following table sets forth information regarding the board of directors of the company. Each of the directors of the company is also a director of the bank.
Director Term Name Age Position(s) Held With the Company Since Expires ------------------------------ -------- -------------------------------------------------- ---------- --------- Carroll E. Amos 59 Director, President and Chief Executive Officer 1997 2008 Sidney M. Bresler 52 Director 2003 2007 Charles W. Calomiris 49 Director, Chairman of the Board of Directors 2001 2008 Paul J. Cinquegrana 65 Director 1997 2009 Jeffrey M. Gitelman 62 Director 1997 2007 Jeffrey W. Ochsman 54 Director 1999 2009 James B. Vito 81 Director 1998 2008
EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS The following table sets forth information regarding the executive officers of the company and the bank who are not also directors.
Name Age Position(s) Held With the Company ----------------------------- ------- ---------------------------------------------------------------------------------- Edward C. Allen 58 Senior Vice President and Chief Operating Officer of the Bank and Corporate Secretary of the Company and the Bank Justin R. Golden 56 Senior Vice President, Consumer Lending, of the Bank Gary L. Hobert 57 Senior Vice President, Commercial Business Lending, of the Bank Robert W. Neff 59 Senior Vice President, Commercial Real Estate Lending, of the Bank David E. Ritter 56 Senior Vice President and Chief Financial Officer of the Company and the Bank
Each of the executive officers of the company and the bank holds his or her office until his or her successor is elected and qualified or until removed or replaced. Officers are subject to re-election by the board of directors annually. 49 BIOGRAPHICAL INFORMATION DIRECTORS Charles W. Calomiris, Chairman of the Board of Directors of the company and the bank. Mr. Calomiris is currently the Henry Kaufman Professor of Finance and Economics at the Columbia University Graduate School of Business and a professor at the School of International and Public Affairs at Columbia. During the last five years he has served as a consultant to the Federal Reserve Board as well as to Federal Reserve Banks and the World Bank, to the governments of states and foreign countries and to major U. S. corporations. Carroll E. Amos is President and Chief Executive Officer of the company and of the bank. He is a private investor who until 1996 served as President and Chief Executive Officer of 1st Washington Bancorp and Washington Federal Saving Bank. Sidney M. Bresler is Chief Executive Officer of Bresler & Reiner Inc., engaged in residential land development and construction and rental property ownership and management. Paul J. Cinquegrana is a Principal of Washington Securities Corporation, a stock and bond brokerage firm. Jeffrey M. Gitelman, D.D.S., is an Oral Surgeon and the owner of Jeffrey M. Gitelman D.D.S., P.C. Jeffrey W. Ochsman is a partner in the law firm of Friedlander, Misler, Sloan, Kletzkin & Ochsman, PLLC, Washington, D.C. James B. Vito is a managing general partner of James Properties, engaged in the sale and management of property. EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS Edward C. Allen joined the bank as a Senior Vice President and Chief Financial Officer in mid 1996 and became Chief Operating Officer in 1997. Prior to joining the bank, Mr. Allen was the Chief Financial Officer of Servus Financial Corp. from 1994 to 1996 and Senior Vice President of NVR Savings Bank from 1992 to 1994. Justin R. Golden joined the bank as Senior Vice President of the Consumer Lending Department in 1998. From 1984 until 1997 he served in various capacities at Citizens Bank, most recently having responsibility for reorganizing and operating that bank's home equity lending function. Gary L. Hobert joined the bank as Senior Vice President of the Commercial Business Lending Department in 2001. From 2000 until joining the bank, Mr. Hobert was the Senior Vice President of Adams National Bank. From 1998 until 2000 he served as Executive Vice President and Senior Loan Officer for Grandbank. Robert W. Neff joined the bank in 1997 as Senior Vice President, Commercial Real Estate Lending. Prior to joining the bank, Mr. Neff served as a Consultant on commercial real estate loan brokerage with the First Financial Group of Washington after serving from 1984 until 1996 as an Executive Vice President for Commercial Real Estate Lending at Washington Federal Savings Bank. David E. Ritter joined the bank and the company as a Senior Vice President and Chief Financial Officer in 1998. From 1996 to 1997, Mr. Ritter was a Senior Financial Consultant with Peterson Consulting. From 1988 until 1996, he was the Executive Vice President and Chief Financial Officer of Washington Federal Savings Bank. 50 COMPLIANCE WITH SECTION 16 (A) OF THE EXCHANGE ACT Section 16(a) of the Securities and Exchange Act requires the company's executive officers and directors, and persons who own more than ten percent of a registered class of the company's equity securities, to file reports of ownership and changes in ownership with the Securities and Exchange Commission and the National Association of Securities Dealers, Inc., and to furnish the company with copies of all Section 16(a) forms they file. Based solely on its review of the copies of such forms received by it, or written representations from certain reporting persons that no Forms 5 were required for those persons, the company believes that all filing requirements applicable to its executive officers and directors were met during fiscal 2006. CODE OF ETHICS AND BUSINESS CONDUCT The company has adopted a Code of Ethics and Business Conduct applicable to all employees, officers and directors of the company and its subsidiaries. A copy of the Code of Ethics and Business Conduct will be furnished without charge to stockholders of record upon written request to Greater Atlantic Financial Corp., Mr. Edward C. Allen, Corporate Secretary, 10700 Parkridge Boulevard, Suite P50, Reston, Virginia 20191. AUDIT COMMITTEE FINANCIAL EXPERT No current member of the Audit Committee qualifies as an "audit committee financial expert" as defined in the rules of the Securities and Exchange Commission. The company is currently seeking an additional director who will qualify as an "audit committee financial expert," but has not found a qualified candidate who is willing to serve in that capacity. ITEM 11. EXECUTIVE COMPENSATION SUMMARY COMPENSATION TABLE. The following table sets forth the cash compensation paid by the company for services rendered in all capacities during the fiscal years ended September 30, 2006, 2005 and 2004, to the Chief Executive Officer, and for each of the other executive officers of the company who received salary and bonus in excess of $100,000 (collectively, the "Named Executive Officers").
Long-Term Annual Compensation Awards Compensation Issued --------------- ---------------------- Restricted Securities Fiscal Stock Underlying All Other Name and Principal Position Year Salary Bonus Compensation Other Awards Options Compensation --------------------------- ------ -------- ----- ------------ ----- ------ ------- ------------ Carroll E. Amos, 2006 $182,000 $ - $182,000 $ - - - - President and Chief 2005 $182,000 $ - $182,000 $ - - - - Executive Officer 2004 $182,000 $ - $182,000 $ - - 10,000 - Edward C. Allen 2006 $115,000 $ - $115,000 $ - - - - Senior Vice President, Chief 2005 $103,800 $ - $103,800 $ - - - - Operating Officer and 2004 $100,300 $ - $100,300 $ - - 3,000 - Secretary David E. Ritter 2006 $108,000 $ - $108,000 $ - - - - Senior Vice President and Chief Financial Officer
For 2006, 2005 and 2004, there were no (a) perquisites over the lesser of $50,000 or 10% of the Chief Executive Officer's total salary and bonus for the year; (b) payments of above-market preferential earnings on deferred compensation; (c) payments of earnings with respect to long-term incentive plans prior to settlement or maturation; (d) tax payment reimbursements; or (e) preferential discounts on stock. 51 EMPLOYMENT AGREEMENT. The company has entered into an employment agreement with Mr. Carroll E. Amos. The Employment Agreement is intended to ensure that the bank and the company will be able to maintain a stable and competent management base. The continued success of the bank and the company depends to a significant degree on the skills and competence of its executive officers, particularly the Chief Executive Officer. The Employment Agreement provides for a three-year term for Mr. Amos and provides that commencing on the first anniversary date and continuing each anniversary date thereafter the board of directors may extend the Employment Agreement for an additional year so that the remaining term shall be three years, unless written notice of non-renewal is given by the board of directors after conducting a performance evaluation of Mr. Amos. The Employment Agreement provides that Mr. Amos's base salary will be reviewed annually. The base salary provided for in the Employment Agreement for Mr. Amos was increased to $165,400 at the fourth anniversary date and to $182,000 on January 1, 2003. In addition to the base salary, the Employment Agreement provides for, among other things, participation in various employee benefit plans and stock-based compensation programs, as well as furnishing fringe benefits available to similarly situated executive personnel. The Employment Agreement provides for termination by the bank for cause (as defined in the Employment Agreement) at any time. In the event the bank chooses to terminate Mr. Amos's employment for reasons other than for cause or, in the event of Mr. Amos's resignation from the bank upon: (i) failure to re-elect Mr. Amos to his current office; (ii) a material change in Mr. Amos's functions, duties or responsibilities; (iii) a relocation of Mr. Amos's principal place of employment by more than 30 miles; (iv) liquidation or dissolution of the bank or the company; or (v) a breach of the Employment Agreement by the bank, Mr. Amos or, in the event of death, Mr. Amos's beneficiary would be entitled to receive an amount generally equal to the remaining base salary and bonus payments that would have been paid to Mr. Amos during the remaining term of the Employment Agreement. The bank would also continue and pay for Mr. Amos's life, health and disability coverage for the remaining term of the Employment Agreement. Upon any termination of Mr. Amos's employment, Mr. Amos is subject to a covenant not to compete with the bank for one year. Under the Employment Agreement, if involuntary termination or voluntary termination follows a change in control of the bank or the company, Mr. Amos or, in the event of his death, his beneficiary, would receive a severance payment generally equal to the greater of: (i) the payments due for the remaining terms of the agreement, including the value of stock-based incentives previously awarded to Mr. Amos; or (ii) two times the average of the three preceding taxable years' annual compensation. The bank would also continue Mr. Amos's life, health, and disability coverage for thirty-six months. In the event of a change in control of the bank, the total amount of payment due under the Employment Agreement, based solely on the base salary paid to Mr. Amos, and excluding any benefits under any employee benefit plan which may otherwise become payable, would equal approximately $364,000. All reasonable costs and legal fees paid or incurred by Mr. Amos pursuant to any dispute or question of interpretation relating to the Employment Agreement is to be paid by the bank, if he is successful on the merits pursuant to a legal judgment, arbitration or settlement. The Employment Agreement also provides that the bank will indemnify Mr. Amos to the fullest extent allowable under federal law. DIRECTORS' COMPENSATION FEES. Since the formation of the company, the executive officers, directors and other personnel have been compensated for services by the bank and have not received additional remuneration from the company. Beginning on October 1, 1998, the Chairman was made a salaried officer of the bank and the company and in those capacities received compensation at the rate of $3,000 per month. Since January 1, 2003, each outside directors of the bank has received $750 for each Board meeting and $350 for each committee meeting attended. 52 STOCK OPTION AND WARRANT PLANS Under the Greater Atlantic Financial Corp. 1997 Stock Option and Warrant Plan (the "Option Plan"), which was ratified by shareholders in 1997 and amended in 2000 and 2002, options are granted to employees at the discretion of a committee comprised of disinterested directors who administer the plan. There were no options granted to the Chief Executive Officer in fiscal year 2006. The following table provides information regarding Messrs. Amos, Allen and Ritter's unexercised stock options as of September 30, 2006. Messrs. Amos, Allen and Ritter did not exercise any stock options and were not granted any stock options during the fiscal year ended September 30, 2006.
Fiscal Year-End Options/SAR Values -------------------------------------------------------------- Number of Securities Underlying Unexercised Options at Fiscal Year Value of Unexercised Shares Value End (#) In-the-Money Options at Fiscal Acquired on Realized Exercisable/ Year End ($) Name Exercise (#) ($) Unexercisable Exercisable/Unexercisable -------------------- ---------------- ------------ --------------------------- ---------------------------------- Carroll E. Amos 0 0 75,000 / 0 $8,059 Edward C. Allen 0 0 18,000 / 0 $8,370 David E. Ritter 0 0 18,000 / 0 $7,440
(1) Value of unexercised in-the-money stock options equals the market value of shares covered by in-the-money options on September 29, 2006 (the last trading day in 2006) less the option exercise price. Options are in-the-money if the market value of shares covered by the options is greater than the exercise price. 53 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS Persons and groups owning in excess of five percent of the company's Common Stock are required to file certain reports regarding such ownership with the company and with the Securities and Exchange Commission ("SEC"), in accordance with the Securities Exchange Act of 1934 (the "Exchange Act"). The following table sets forth information regarding persons known to be beneficial owners of more than five percent of the company's outstanding Common Stock as of December 31, 2006.
Amount and Nature of Name and Address Beneficial Percent Title of Class of Beneficial Owner Ownership of Class - ------------------------------------------------------------------------------------------------------------ Common Stock Charles W. Calomiris 251 Fox Meadow Road Scarsdale, New York 10583 176,807 shares(1)(2) 5.85% Common Stock Robert I. Schattner, DDS 121 Congressional Lane Rockville, MD 20852 432,328 shares(1)(3) 14.21% Common Stock The Ochsman Children Trust 1650 Tysons Boulevard McLean, VA 22102 238,597 shares(1)(4) 7.90% Common Stock George W. Calomiris 4848 Upton Street, N.W. 199,715 shares(5) 6.41% Washington, DC 20016 Common Stock Jenifer Calomiris 4919 Upton Street, N.W. 190,438 shares(6) 6.12% Washington, D.C. 20016 Common Stock Katherine Calomiris Tompros 5100 Van Ness Street, N.W. 190,638 shares(7) 6.13% Washington, D.C. 20016
- ---------------------- (1) Does not include presently exercisable warrants to purchase 9,166, 20,000 and 13,334 shares held, respectively, by Charles W. Calomiris, Dr. Schattner, and The Ochsman Children Trust under the Greater Atlantic Financial Corp. 1997 Stock Option Plan, or shares of preferred securities presently convertible into 114,841, 330,099 and 69,545 shares of common stock held, respectively, by Charles W. Calomiris Dr. Schattner and the Ochsman Children Trust. (2) The information furnished is derived from a Schedule 13D filed by Charles W. Calomiris on July 25, 2003, and a Form 4 filed on July 24, 2003. (3) The information furnished is derived from a Schedule 13D and a Form 4 filed by Robert I Schattner filed on September 6, 2005. (4) The information furnished is derived from a Schedule 13D filed by The Ochsman Children Trust on April 9, 2002. (5) Includes presently exercisable warrants to purchase 9,167 shares and shares of preferred securities presently convertible into 85,754 shares of common stock held by George W. Calomiris. The information furnished is derived from a Schedule 13D filed by George Calomiris on December 7, 2004. (6) Includes presently exercisable warrants to purchase 9,167 shares and shares of preferred securities presently convertible into 79,747 shares of common stock held by Jenifer Calomiris. The information furnished is derived from a Schedule 13D filed by Jenifer Calomiris on March 21, 2003. (7) Includes presently exercisable warrants to purchase 9,167 shares and shares of preferred securities presently convertible into 79,747 shares of common stock held by Katherine Calomiris Tompros. The information furnished is derived from a Schedule 13D filed by Katherine Calomiris Tompros on March 21, 2003. 54 INFORMATION WITH RESPECT TO DIRECTORS AND EXECUTIVE OFFICERS The following table sets forth, as of December 31, 2006, the names of the directors, and executive officers of the company as well as their ages; a brief description of their recent business experience, including present occupations and employment; certain directorships held by each; the year in which each became a director of the company and the year in which his term as director of the company expires. This table also sets forth the amount of Common Stock and the percent thereof beneficially owned as of the December 31, 2006 by each director and all directors and executive officers as a group as of the December 31, 2006.
Expiration Shares of Name and Principal of Common Stock Ownership as of Occupation at Present Director Term as Beneficial Percent of and for Past Five Years Age Since (1) Director Owned(1) Class - ----------------------------------------------- ------- ------------ ------------ ----------------- -------------------- Charles W. Calomiris, Chairman of the 49 2001 2008 176,807(2)(3) 5.85% Board of the Company, is the Henry Kaufman Professor of Finance and Economics at the Columbia University Graduate School of Business. Carroll E. Amos, President and Chief 59 1997 2008 44,060(4) 1.46% Executive Officer of the company, is a private investor who until 1996 served as President and Chief Executive Officer of 1st Washington Bancorp and Washington Federal Savings Bank. James B. Vito is Managing General 81 1998 2008 79,042(2) 2.62% Partner, James Properties, engaged in the sale and management of property. Paul J. Cinquegrana is a Principal of 65 1997 2006 52,134(2) 1.73% Washington Securities Corporation, stock and bond brokerage firm. Jeffrey W. Ochsman is an attorney and 54 1999 2006 500 * partner of the law firm of Friedlander, Misler, Sloan, Kletzkin & Ochsman, PLLC. Jeffrey M. Gitelman, D.D.S., is an Oral 62 1997 2007 84,913(2) 2.81% Surgeon and the owner of Jeffrey M. Gitelman - D.D.S., P.C. Sidney M. Bresler is a Director, Chief 52 2003 2007 500 * Executive Officer and Chief Operating Officer of Bresler & Reiner, Inc. engaged in residential land development and construction and rental property ownership and management.
55
Shares of Name and Principal Common Stock Occupation at Present Beneficially Ownership as A and for Past Five Years Age Owned(1) Percent of Class --------------------------------------------------------- ------- ---------------------- -------------------- EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS Edward C. Allen joined the bank as Chief Financial 58 550(4) * Officer and became Chief Operating Officer in 1997. David E. Ritter joined the bank and the company as a 56 300(4) * Senior Vice President and Chief Financial Officer in 1998. All directors and executive officers as a group (eight 438,806 14.53% persons)(3)
(1) Each person effectively exercises sole voting or dispositive power as to shares reported. (2) Does not include presently exercisable warrants to purchase 9,166, 3,334, 3,334, and 2,000 shares, respectively, held by Messrs. Calomiris, Gitelman, Cinquegrana, and Vito under the Greater Atlantic Financial Corp. 1997 Stock Option Plan, or shares of preferred securities presently convertible into 114,841, 34,970, 37,797, 17,387, and 6,431 shares of common stock held, respectively, by Messrs. Calomiris, Vito, Cinquegrana, Gitelman and Amos. (3) Includes 128,727 shares held directly, 10,000 shares held by his spouse and 38,080 shares held as custodian for minor children. (4) Does not include presently exercisable options to purchase 75,000 shares granted to Mr. Amos or 18,000 granted to Mr. Allen and Mr. Ritter under the Greater Atlantic Financial Corp. 1997 Stock Option and Warrant Plan. o Does not exceed 1.0% of the company's Common Stock. The following table summarizes share and exercise price information about the company's equity compensation plans as of September 30, 2006.
Number of securities remaining available for Number of securities to be future issuance under equity issued upon exercise of Weighted-average exercise compensation plans outstanding options, warrants price of outstanding options, (excluding securities Plan category and rights warrants and rights reflected in column (a)) - ----------------------------------------------------------------------------------------------------------------------------- Equity compensation plans approved by security holders: 1997 Stock Option and Warrant Plan 431,171 $6.94 83,500 Equity compensation plans not approved by security holders N/A N/A N/A - ----------------------------------------------------------------------------------------------------------------------------- Total 431,171 $6.94 83,500 =============================================================================================================================
56 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Federal regulations require that all loans or extensions of credit to executive officers and directors must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with the general public and must not involve more than the normal risk of repayment or present other unfavorable features. In addition, loans made to a director or executive officer in excess of the greater of $25,000 or 5% of the bank's capital and surplus (up to a maximum of $500,000) must be approved in advance by a majority of the disinterested members of the board of directors. The bank currently makes loans to its executive officers and directors on the same terms and conditions offered to the general public. The bank's policy provides that all loans made by the bank to its executive officers and directors be made in the ordinary course of business, on substantially the same terms, including collateral, as those prevailing at the time for comparable transactions with other persons and may not involve more than the normal risk of collectibility or present other unfavorable features. As of September 30, 2006, one of the bank's directors had loans with the bank which had outstanding balances totaling $164,000. Such loans were made by the bank in the ordinary course of business, with no favorable terms and do not involve more than the normal risk of collectibility or present unfavorable features. The company's policy is that all transactions between the company and its executive officers, directors, holders of 10% or more of the shares of any class of its common stock and affiliates thereof, will contain terms no less favorable to the company than could have been obtained by it in arm's length negotiations with unaffiliated persons and will be approved by a majority of independent outside directors of the company not having any interest in the transaction. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES AUDIT FEES BDO Seidman, LLP billed the company aggregate fees of $249,000 and $185,705 for professional services rendered for the audit of the company's annual consolidated financial statements and for the reviews of the condensed consolidated financial statements included in the company's Forms 10-Q for the fiscal year ended September 30, 2006 and 2005, respectively. Before the company or any subsidiary engages an accountant, the company's audit committee approves the engagement. AUDIT-RELATED FEES BDO Seidman, LLP did not provide any such services to the company for the fiscal year ended September 30, 2006 or 2005. TAX FEES BDO Seidman billed the company $35,600 and $19,850 for tax services for the fiscal year ended September 30, 2006 and 2005, respectively. Tax fees represented 14.30% of the fees paid to BDO Seidman, LLP in fiscal year 2006 and 9.66% in fiscal year 2005. PART IV ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) 1. FINANCIAL STATEMENTS See Index to Consolidated Financial Statements on page 59 2. FINANCIAL STATEMENT SCHEDULES All schedules are omitted because they are not required or applicable, or the required information is shown in the consolidated financial statements or the notes thereto.
(b) EXHIBITS 23.1 Consent of BDO Seidman, LLP 31.1 Certification of Chief Executive Officer 31.2 Certification of Chief Financial Officer 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350 32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350
57 Pursuant to the requirements of 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. GREATER ATLANTIC FINANCIAL CORP. By: /s/ Carroll E. Amos ------------------------------- Carroll E. Amos Chief Executive Officer, President and Director Dated: February 1, 2007 Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed by the following persons of the registrant and in the capacities and on the dates indicated.
Name Title Date ---- ----- ---- /s/ Charles W. Calomiris ------------------------ Charles W. Calomiris Chairman of the Board February 1, 2007 /s/ Carroll E. Amos Chief Executive Officer, ------------------- and President and Director February 1, 2007 Carroll E. Amos /s/ Sidney M. Bresler --------------------- Sidney M. Bresler Director February 1, 2007 /s/ Paul J. Cinquegrana ----------------------- Paul J. Cinquegrana Director February 1, 2007 /s/ Jeffrey M. Gitelman ----------------------- Jeffrey M. Gitelman Director February 1, 2007 /s/ Jeffrey W. Ochsman ---------------------- Jeffrey W. Ochsman Director February 1, 2007 /s/ James B. Vito ----------------- James B. Vito Director February 1, 2007 /s/ David E. Ritter Senior Vice President and ------------------- Chief Financial Officer February 1, 2007 David E. Ritter
58
CONSOLIDATED FINANCIAL STATEMENTS OF GREATER ATLANTIC FINANCIAL CORP. INDEX Page ---- Report of Independent Registered Public Accounting Firm 60 Consolidated Statements of Financial Condition as of September 30, 2006 and 2005 (restated) 61 Consolidated Statements of Operations for the Years Ended September 30, 2006, 2005 (restated) and 2004 (restated) 62 Consolidated Statements of Comprehensive Income (Loss) for the Years Ended September 30, 2006, 2005 (restated) and 2004 (restated) 63 Consolidated Statements of Stockholders' Equity for the Years Ended September 30, 2006, 2005 (restated) and 2004 (restated) 63 Consolidated Statements of Cash Flows for the Years Ended September 30, 2006, 2005 (restated) and 2004 (restated) 64 Notes to Consolidated Financial Statements 66
59 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and Stockholders Greater Atlantic Financial Corp. Reston, Virginia We have audited the accompanying consolidated statements of financial condition of Greater Atlantic Financial Corp. and Subsidiaries as of September 30, 2006 and 2005 (restated), and the related consolidated statements of operations, comprehensive income (loss), stockholders' equity, and cash flows for each of the three years in the period ended September 30, 2006 (2005 and 2004 restated). 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 audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits 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 audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Greater Atlantic Financial Corp. and Subsidiaries at September 30, 2006 and 2005 (restated) and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2006 (2005 and 2004 restated) in conformity with accounting principles generally accepted in the United States of America. As described in Note 2, the Company restated its consolidated Statement of Financial Condition as of September 30, 2005 and the related consolidated statements of operations, comprehensive income (loss), stockholders' equity and cash flows for each of the two years in the period ended September 30, 2005. /s/ BDO Seidman, LLP - -------------------- Richmond, Virginia January 30, 2007 60
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION September 30, --------------------------------- 2006 2005 - ---------------------------------------------------------------------------------------------------------------------- (Restated) (Dollars in Thousands) Assets Cash and cash equivalents $ 2,516 $ 2,291 Interest bearing deposits 17,288 2,418 Investment securities Available-for-sale 75,461 107,829 Held-to-maturity 4,696 7,969 Loans held for sale - 9,517 Loans receivable, net 193,307 194,920 Accrued interest and dividends receivable 2,073 1,746 Deferred income taxes 1,928 1,974 Federal Home Loan Bank stock, at cost 2,388 2,503 Other real estate owned - 232 Premises and equipment, net 2,764 4,198 Goodwill 956 956 Prepaid expenses and other assets 1,842 2,989 - ---------------------------------------------------------------------------------------------------------------------- Total Assets $ 305,219 $ 339,542 ====================================================================================================================== Liabilities and stockholders' equity Liabilities Deposits $ 230,174 $ 237,794 Advance payments from borrowers for taxes and insurance 270 268 Accrued expenses and other liabilities 1,963 1,248 Advances from the FHLB and other borrowings 54,574 76,479 Junior subordinated debt securities 9,388 9,378 - ---------------------------------------------------------------------------------------------------------------------- Total liabilities 296,369 325,167 - ---------------------------------------------------------------------------------------------------------------------- Commitments and contingencies - ---------------------------------------------------------------------------------------------------------------------- Stockholders' Equity Preferred stock $.01 par value - 2,500,000 shares authorized, none outstanding - - Common stock, $.01 par value - 10,000,000 shares authorized; 3,020,934 shares outstanding 30 30 Additional paid-in capital 25,228 25,228 Accumulated deficit (15,359) (9,788) Accumulated other comprehensive loss (1,049) (1,095) - ---------------------------------------------------------------------------------------------------------------------- Total stockholders' equity 8,850 14,375 - ---------------------------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $ 305,219 $ 339,542 ======================================================================================================================
See accompanying notes to consolidated financial statements. 61
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Year Ended September 30, ------------------------------------------------- 2006 2005 2004 - -------------------------------------------------------------------------------------------------------------------------- (Restated) (Restated) (Dollars in Thousands, Except Per Share Data) Interest income Loans $ 13,866 $ 12,430 $ 12,629 Investments 4,928 4,528 5,456 - -------------------------------------------------------------------------------------------------------------------------- Total interest income 18,794 16,958 18,085 - -------------------------------------------------------------------------------------------------------------------------- Interest expense Deposits 7,709 6,337 5,751 Borrowed money 3,596 4,209 6,219 - -------------------------------------------------------------------------------------------------------------------------- Total interest expense 11,305 10,546 11,970 - -------------------------------------------------------------------------------------------------------------------------- Net interest income 7,489 6,412 6,115 Provision for loan losses 126 219 209 - -------------------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 7,363 6,193 5,906 - -------------------------------------------------------------------------------------------------------------------------- Noninterest income Fees and service charges 610 734 869 Gain (loss) on sale of loans - 53 (68) Gain (loss)on sale of investment securities - 539 (58) Gain (loss) on derivatives (66) 836 (227) Gain on sale of real estate owned 65 - - Other operating income 30 1,011 31 - -------------------------------------------------------------------------------------------------------------------------- Total noninterest income 639 3,173 547 - -------------------------------------------------------------------------------------------------------------------------- Noninterest expense Compensation and employee benefits 4,718 4,213 4,306 Occupancy 1,337 1,337 1,759 Professional services 1,227 969 717 Advertising 628 301 244 Deposit insurance premium 101 100 44 Furniture, fixtures and equipment 554 641 818 Data processing 919 1,054 1,306 Other operating expenses 1,601 1,274 1,176 - -------------------------------------------------------------------------------------------------------------------------- Total noninterest expense 11,085 9,889 10,370 - -------------------------------------------------------------------------------------------------------------------------- Income (loss) from continuing operations before income taxes (3,083) (523) (3,917) Provision for income taxes - - - - -------------------------------------------------------------------------------------------------------------------------- Income (loss) from continuing operations (3,083) (523) (3,917) Discontinued operations: Income (loss) from operations (2,488) (1,107) 428 - -------------------------------------------------------------------------------------------------------------------------- Net income (loss) $ (5,571) $ (1,630) $ (3,489) ========================================================================================================================== Earnings (loss) per common share BASIC AND DILUTED: Continuing operations $ (1.02) $ (0.17) $ (1.30) Discontinued operations (0.82) (0.37) 0.14 - -------------------------------------------------------------------------------------------------------------------------- $ (1.84) $ (0.54) $ (1.16) - -------------------------------------------------------------------------------------------------------------------------- Weighted average common shares outstanding Basic and diluted 3,020,934 3,015,509 3,012,434
See accompanying notes to consolidated financial statements. 62
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) Year Ended September 30, --------------------------------------------- 2006 2005 2004 ----------------------------------------------------------------------------------------------------- (In Thousands) (Restated) (Restated) Net (loss) income $ (5,571) $ (1,630) $ (3,489) ----------------------------------------------------------------------------------------------------- Other comprehensive (loss) income, net of tax: Unrealized (loss) income on securities 46 (16) (1,008) ----------------------------------------------------------------------------------------------------- Other comprehensive (loss) income 46 (16) (1,008) ----------------------------------------------------------------------------------------------------- Comprehensive (loss) income $ (5,525) $ (1,646) $ (4,497) =====================================================================================================
See accompanying notes to consolidated financial statements
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY ----------------------------------------------------------------------------------------------------------------------- Accumulated Additional Accumulated Other Total Preferred Common Paid-in Earnings Comprehensive Stockholders' Stock Stock Capital (Deficit) Income (Loss) Equity ----------------------------------------------------------------------------------------------------------------------- (In Thousands) Balance at September 30, 2003 (as restated) $ - $ 30 $ 25,152 $ (4,669) $ (71) $ 20,442 Other comprehensive loss - - - - (1,008) (1,008) Net loss for the period - - - (3,489) - (3,489) ----------------------------------------------------------------------------------------------------------------------- Balance at September 30, 2004 (as restated) - 30 25,152 (8,158) (1,079) 15,945 Options exercised - - 76 - - 76 Other comprehensive loss - - - - (16) (16) Net loss for the period - - - (1,630) - (1,630) ----------------------------------------------------------------------------------------------------------------------- Balance at September 30, 2005 (as restated) - 30 25,228 (9,788) (1,095) 14,375 Other comprehensive income - - - - 46 46 Net loss for the period - - - (5,571) - (5,571) ----------------------------------------------------------------------------------------------------------------------- Balance at September 30, 2006 $ - $ 30 $ 25,228 $(15,359) $(1,049) $ 8,850 =======================================================================================================================
See accompanying notes to consolidated financial statements 63
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended September 30, ---------------------------------------------------- 2006 2005 2004 (Restated) (Restated) --------------------------------------------------------------------------------------------------------------------------------- (In Thousands) Cash flow from operating activities Net income (loss) $ (5,571) $ (1,630) $ (3,489) Adjustments to reconcile net income (loss) to net cash Provided (used) by operating activities Provision for loan losses 126 219 209 Amortization of loan acquisition adjustment (50) (27) (27) Depreciation and amortization 658 930 986 (Gain) loss on disposal of fixed assets (26) 91 - Option compensation - 42 - Realized loss (gain) on trading securities - - 135 Realized gain on sale of investment securities - - (77) Realized gain on sale of mortgaged-backed securities - (539) - Loss (gain) on derivatives 66 (836) 227 Amortization of investment security premiums 753 853 1,573 Amortization of mortgage-backed security premiums 662 937 1,453 Amortization of deferred fees (496) (635) (563) Discount accretion net of premium amortization (277) (361) 628 Amortization of convertible preferred stock costs 9 9 9 (Gain) loss on sale of foreclosed real estate (65) - - Gain on sale of loans held for sale (1,522) (4,720) (9,191) (Increase) decrease in assets Disbursements for origination of loans (91,477) (276,038) (402,988) Proceeds from sales of loans 102,518 276,770 413,204 Accrued interest and dividend receivable (327) 193 359 Prepaid expenses and other assets 1,156 360 (261) Deferred loan fees collected, net of deferred costs incurred 431 172 436 Increase (decrease) in liabilities Accrued expenses and other liabilities 649 (451) (3,382) --------------------------------------------------------------------------------------------------------------------------------- Net cash provided by (used) in operating activities $ 7,217 $ (4,661) $ (759) =================================================================================================================================
(Continued) 64
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS - (CONTINUED) Year Ended September 30, -------------------------------------- 2006 2005 2004 (Restated) (Restated) ------------------------------------------------------------------------------------------------------------------------- (In Thousands) Cash flow from investing activities Net decrease (increase) in loans $ 1,879 $ 51,867 $ (4,817) Disposal (purchases) of premises and equipment 792 2,055 (312) Proceeds from sales of foreclosed real estate 297 - - Purchases of investment securities (7,707) (21,684) (25,748) Proceeds from sale of investment securities - - 67,843 Proceeds from repayments of investment securities 16,827 22,374 33,235 Purchases of mortgage-backed securities - (24,224) (63,056) Proceeds from sale of mortgage-backed securities - 21,921 - Proceeds from repayments of mortgage-backed securities 25,198 37,548 54,932 Purchases of FHLB stock (3,015) (5,169) (15,875) Proceeds from sale of FHLB stock 3,130 6,751 16,130 ------------------------------------------------------------------------------------------------------------------------- Net cash provided by (used) in investing activities 37,401 91,439 62,332 ------------------------------------------------------------------------------------------------------------------------- Cash flow from financing activities Net (decrease) increase in deposits (7,620) (51,162) (8,920) Net (repayments) advances from FHLB (2,000) (13,200) (35,600) Net borrowings (repayments) on reverse repurchase agreements and other borrowings (19,905) (26,386) (12,971) Increase (decrease) in advance payments by borrowers for taxes and insurance 2 (37) 81 Exercise of stock options - 34 - ------------------------------------------------------------------------------------------------------------------------- Net cash (used) in provided by financing activities (29,523) (90,751) (57,410) ------------------------------------------------------------------------------------------------------------------------- Increase (decrease) in cash and cash equivalents 15,095 (3,973) 4,163 ------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents, at beginning of year 4,709 8,682 4,519 ------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents, at end of year $ 19,804 $ 4,709 $ 8,682 =========================================================================================================================
See accompanying notes to consolidated financial statements. 65 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS Greater Atlantic Financial Corp. (GAFC or the "Company") is a bank holding company whose principal activity was the ownership and management of Greater Atlantic Bank (GAB or "the Bank"), and its wholly owned subsidiary, Greater Atlantic Mortgage Corporation (GAMC). However, the mortgage-banking activities conducted in GAMC were discontinued effective March 29, 2006 as it was determined that, because it was unprofitable, this business no longer fit our strategy. The Bank originates commercial, mortgage and consumer loans and receives deposits from customers located primarily in Virginia, Washington, D.C. and Maryland. The Bank operates under a federal bank charter and provides full banking services. GAMC was incorporated as a separate entity on June 11, 1998 and began independent operations on September 1, 1998. GAMC was involved primarily in the origination and sale of single-family mortgage loans and, to a lesser extent, multi-family residential and second mortgage loans. The Company closed GAMC during the fiscal year ended September 30, 2006, (see Note 3). GAMC also originated loans for the Bank's portfolio. In January 2002, GAFC established Greater Atlantic Capital Trust I to issue certain convertible preferred securities (see Note 22). PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of GAFC and its wholly owned subsidiaries, GAB and GAMC and Greater Atlantic Capital Trust I. All significant intercompany accounts and transactions have been eliminated in consolidation. RISK AND UNCERTAINTIES In its normal course of business, the Company encounters two significant types of risk: economic and regulatory. There are three main components of economic risk: interest rate risk, credit risk and market risk. The Company is subject to interest rate risk to the degree that its interest-bearing liabilities mature or reprice more rapidly, or on a different basis, than its interest-earning assets. Credit risk is the risk of default on the Company's loan portfolio that results from the borrowers' inability or unwillingness to make contractually required payments. Market risk reflects changes in the value of collateral underlying loans receivable and the valuation of real estate held by the Company. The determination of the allowance for loan losses and the valuation of real estate are based on estimates that are particularly susceptible to significant changes in the economic environment and market conditions. Management believes that, as of September 30, 2006 and September 30, 2005, the allowance for loan losses and valuation of real estate are adequate based on information currently available. A worsening or protracted economic decline would increase the likelihood of losses due to credit and market risks and could create the need for substantial additional loan loss reserves. See discussion of regulatory matters in Note 14. CONCENTRATION OF CREDIT RISK The Company's primary business activity is with customers located in Maryland, Virginia and the District of Columbia. The Company primarily originates residential loans to customers throughout these areas, most of whom are residents local to the Company's business locations. The Company has a diversified loan portfolio consisting of residential, commercial and consumer loans. Commercial and consumer loans generally provide for higher interest rates and shorter terms, however such loans have a higher degree of credit risk. Management monitors all loans, including, when possible, making inspections of the properties, maintaining current operating statements, and performing net realizable value calculations with allowances for losses established as necessary to properly reflect the value of the properties. Management believes the current loss allowances are sufficient to cover the credit risk estimated to exist at September 30, 2006. 66 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS INVESTMENT SECURITIES Investment securities, which the Company has the intent and ability to hold to maturity, are carried at amortized cost. The amortization of premiums and accretion of discounts are recorded on the level yield (interest) method, over the period from the date of purchase to maturity. When sales do occur, gains and losses are recognized at the time of sale and the determination of cost of securities sold is based upon the specific identification method. Investment securities which the Company intends to hold for indefinite periods of time, use for asset/liability management or that are to be sold in response to changes in interest rates, prepayment risk, the need to increase regulatory capital or other similar factors are classified as available-for-sale and carried at fair value with unrealized gains and losses excluded from earnings and reported in a separate component of stockholders' equity. If a sale does occur, gains and losses are recognized as a component of earnings at the time of the sale. The amortization of premiums and accretion of discounts are recorded on the level yield (interest) method. Investment securities that are bought and held principally for the purpose of selling them in the near term would be classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings. LOANS AND ALLOWANCE FOR LOAN LOSSES Loans receivable are stated at unpaid principal balances, net of unearned discounts resulting from add-on interest, participation or whole-loan interests owned by others, undisbursed loans in process, deferred loan fees, and allowances for loan losses. Loans are placed on non-accrual status when the principal or interest is past due more than 90 days or when, in management's opinion, collection of principal and interest is not likely to be made in accordance with a loan's contractual terms unless the loan principal and interest are determined by management to be fully secured and in the process of collection. The allowance for loan losses provides for the risk of losses inherent in the lending process. The allowance for loan losses is based on periodic reviews and analyses of the loan portfolio which include consideration of such factors as the risk rating of individual credits, the size and diversity of the portfolio, economic conditions, prior loss experience and results of periodic credit reviews of the portfolio. The allowance for loan losses is increased by provisions for loan losses charged against income and reduced by charge-offs, net of recoveries. In management's judgment, the allowance for loan losses is considered adequate to absorb losses inherent in the loan portfolio at September 30, 2006. The Company considers a loan to be impaired if it is probable that they will be unable to collect all amounts due (both principal and interest) according to the contractual terms of the loan agreement. When a loan is deemed impaired, the Company computes the present value of the loan's future cash flows, discounted at the effective interest rate. As an expedient, creditors may account for impaired loans at the fair value of the collateral or at the observable market price of the loan if one exists. If the present value is less than the carrying value of the loan, a valuation allowance is recorded. For collateral dependent loans, the Company uses the fair value of the collateral, less estimated costs to sell on a discounted basis, to measure impairment. Mortgage loans originated and intended for sale are carried at the lower of cost or estimated market value in the aggregate. Net unrealized losses are recognized in a valuation allowance by charges to income. DERIVATIVE FINANCIAL INSTRUMENTS The Company uses derivative financial instruments to mitigate market risk from changes in interest rates. Our derivative financial instruments are contracted in the over-the-counter market and include interest rate swaps. Derivative financial instruments are accounted for in accordance with Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133), which requires that all derivative instruments be recorded on the balance sheet at fair value. Changes in the fair value of derivatives are recorded each period either in current results of operations or other comprehensive income (loss). For a derivative designated as part of a hedge transaction, where it is recorded is dependent on whether it is a fair value hedge or a cash flow hedge. For a derivative designated as a fair value hedge, the gain or loss of the derivative in the period of change and the offsetting loss or gain of the hedged item attributed to the hedged risk are recognized in results of operations. For a derivative designated as a cash flow hedge, the effective portion of the derivative's gain or loss is initially reported as a component of other comprehensive income (loss) and subsequently reclassified into results of operations when the hedged exposure affects results of operations. The ineffective portion of the gain or loss of a cash flow hedge is recognized currently in results of operations. For a derivative not designated as a hedging instrument, the gain or loss is recognized currently in results of operations. The Bank seeks to control or limit the interest rate risk caused by mortgage banking activities. The method used to help reduce interest rate risk from its mortgage banking activities are forward loan sale agreements. At various times, depending on loan origination volume and management's assessment of projected loan fallout, the Bank may reduce or increase its derivative positions. 67 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MORTGAGE LOAN INCOME, DISCOUNTS AND PREMIUMS Interest income on loans is recorded on the accrual method. Discounts and premiums relating to mortgage loans purchased are deferred and amortized against or accreted into income over the estimated lives of the loans using the level yield (interest) method. Accrual of interest is discontinued and an allowance for uncollected interest is established and charged to interest income for the full amount of accrued interest receivable on loans, which are delinquent for a period of 90 days or more. LOAN ORIGINATION AND COMMITMENT FEES Loan origination and commitment fees and certain incremental direct loan origination costs are being deferred with the net amount being amortized as an adjustment of the related loan's yield. The Company is amortizing those amounts over the contractual life of the related loans as adjusted for anticipated prepayments using current and past payment trends. MORTGAGE LOAN SALES AND SERVICING The Company originates and sells loans and participating interest in loans generally without retaining servicing rights. Loans are sold to provide the Company with additional funds and to generate gains from mortgage banking operations. Loans originated for sale are carried at the lower of cost or market. When a loan and the related servicing are sold the Company recognizes any gain or loss at the time of sale. When servicing is retained on a loan that is sold, the Company recognizes a gain or loss based on the present value of the difference between the average constant rate of interest it receives, adjusted for a normal servicing fee, and the yield it must pay to the purchaser of the loan over the estimated remaining life of the loan. Any resulting net premium is deferred and amortized over the estimated life of the loan using a method approximating the level yield (interest) method. There were no loans sold with servicing rights retained during the years ended September 30, 2006 and September 30, 2005. The Company also sells participation interests in loans that it services. PREMISES AND EQUIPMENT Premises and equipment are recorded at cost. Depreciation is computed on the straight-line method over useful lives ranging from five to ten years. Leasehold improvements are capitalized and amortized using the straight-line method over the life of the related lease. FORECLOSED REAL ESTATE Real estate acquired through foreclosure is recorded at the lower of cost or fair value less estimated selling costs. Subsequent to the date of foreclosure, valuation adjustments are made, if required, to the lower of cost or fair value less estimated selling costs. Costs related to holding the real estate, net of related income, are reflected in operations when incurred. Recognition of gains on sale of real estate is dependent upon the transaction meeting certain criteria relating to the nature of the property sold and the terms of the sale. GUARANTEED CONVERTIBLE PREFERRED SECURITIES On July 1, 2003, the Company adopted Statement of Financial Accounting Standards No. 150, "Accounting for Mandatorily Redeemable Securities" ("SFAS 150"). SFAS 150 requires that the Company classify redeemable securities with a mandatory redemption date as liabilities in its balance sheet and classify distributions related to such securities as interest expense. Also, SFAS 150 requires that the redeemable securities be reflected at fair market value when reclassified as a liability. Accordingly, the guaranteed convertible preferred securities are presented as a liability in the Statements of Financial Condition. The Company has consistently accounted for distributions related to these securities as interest expense, and since the Company sold the securities in a public offering, there was no fair market value adjustment necessary. 68 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS INCOME TAXES Income taxes are calculated using the liability method specified by Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes". The net deferred tax asset is reduced, if necessary, by a valuation allowance for the amount of any tax benefits that, based on available evidence, are not expected to be realized (See Note 12). CASH AND CASH EQUIVALENTS The Company considers cash and interest bearing deposits in other banks as cash and cash equivalents for purposes of preparing the statement of cash flows. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. COMPREHENSIVE INCOME Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"), establishes standards for the reporting and display of comprehensive income, its components and accumulated balances. Comprehensive income is defined to include all changes in equity except those resulting from investments by owners and distributions to owners. Among other disclosures, SFAS 130 requires that all items that are required to be recognized under current accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. Presently, the Company's comprehensive income and loss is from unrealized gains and losses on certain investment securities. STOCK-BASED COMPENSATION The Company has adopted the provisions of Statement of Financial Accounting Standards No. 123R, "Accounting for Stock-Based Compensation" ("SFAS 123R"), to measure compensation cost for stock options effective after October 1, 2005. Prior to its adoption, the Company accounted for its options under APB 25 "Accounting for Stock Issued to Employees" with pro forma disclosure. As allowable under SFAS 123R, the Company used the Black-Scholes method to measure the compensation cost of stock options granted in 2006 with the following assumptions: risk-free interest rate of 4.88%, a dividend payout rate of zero, and an expected option life of nine years. The volatility is 32%. Using these assumptions, the fair value of stock options granted during fiscal 2006 was $2.92. In 2005 the Company used the following assumptions: risk-free interest rate of 4.23%, a dividend payout rate of zero, and an expected option life of nine years. The volatility is 47%. Using these assumptions, the fair value of stock options granted during fiscal 2005 was $3.70. In 2004 the Company used the following assumptions: risk-free interest rate of 4.41%, a dividend payout rate of zero, and an expected option life of ten years. The volatility is 66%. Using these assumptions, the fair value of stock options granted during fiscal 2004 was $5.75. There were 12,000 options granted during fiscal 2006 with an estimated fair value of $22,000. If the Company had elected to recognize compensation cost based on the value at the grant dates with the method prescribed by SFAS 123, net income (loss) and earnings (loss) per share for 2005 and 2004 would have been changed to the pro forma amounts indicated in the following table: 69
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Year Ended September 30, ----------------------------- 2005 2004 - --------------------------------------------------------------------------------------------- (In Thousands, Except Per Share Data) (Restated) (Restated) Net (loss) income as reported $ (1,630) $ (3,489) Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (239) (128) - --------------------------------------------------------------------------------------------- Pro Forma net income (loss) $ (1,869) $ (3,617) ============================================================================================= Basic income (loss) per common share: As reported $ (0.54) $ (1.16) Pro Forma (0.62) (1.20) - --------------------------------------------------------------------------------------------- Diluted income (loss) per common share: As reported $ (0.54) $ (1.16) Pro Forma (0.62) (1.20) - ---------------------------------------------------------------------------------------------
RECLASSIFICATIONS In addition to reclassifications related to discontinued operations (see Note 3), other reclassifications have been made to prior periods to place them on a basis comparable with the current period presentation. These reclassifications have no effect on the results of operations previously reported. 2. RESTATEMENTS During 2006, the Company restated its historical financial statements to reflect the accounting treatment for losses discovered in its subsidiary, GAMC's unreconciled inter-company account. The losses were discovered as the Bank discontinued the operations of the subsidiary. The loss in any given year did not reach a material amount such as to require restatement. However, the Bank determined to provide the restatements because of the cumulative amount of the losses aggregated $1.4 million. The revisions had no impact on the cash flows of the Bank. The table below includes the effect of the restatement and the presentation of GAMC as discontinued operations. 70 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As originally Discontinued reported Restatement operations As restated --------------- -------------- --------------- ------------- Year ended September 30, 2005 Interest income $ 17,436 $ - $ 478 $ 16,958 Interest expense 10,893 - 347 10,546 Net interest income 6,543 - 131 6,412 Noninterest income 8,317 (72) 5,072 3,173 Noninterest expense 16,199 - 6,310 9,889 Discontinued operations - - (1,107) (1,107) Net income (loss) (1,558) (72) - (1,630) Earnings per share - continuing (0.52) (0.02) 0.37 (0.17) Earnings per share - discontinued (0.00) (0.00) (0.37) (0.37) Year ended September 30, 2004 Interest income $ 18,962 $ - $ 877 $ 18,085 Interest expense 12,355 - 385 11,970 Net interest income 6,607 - 492 6,115 Noninterest income 9,929 (297) 9,085 547 Noninterest expense 19,430 - 9,060 10,370 Discontinued operations - - 428 428 Net income (loss) (3,192) (297) - (3,489) Earnings per share - continuing (1.06) (0.10) (0.14) (1.30) Earnings per share - discontinued (0.00) 0.00 0.14 0.14
The $72,000 and $297,000 adjustments to noninterest income relate to gains on sale of loans. In addition, the September 30, 2003 retained earnings balance was reduced by $898,000 to reflect the cumulative effect of the restatement of all prior periods. 3. DISCONTINUED OPERATIONS On March 29, 2006, we began the process of discontinuing the operations of the Bank's subsidiary, GAMC. It was determined that, because it was unprofitable, this business no longer fit our strategy. As a result of the above action, we applied discontinued operations accounting in the third quarter of 2006, as we completed the closing of the GAMC business. Accordingly, the income statements for all periods have been adjusted. The reclassification of GAMC's results to discontinued operations primarily resulted in a reduction to previously reported levels of net interest income, a reduction in noninterest income and a reduction in noninterest expense. The table below summarizes GAMC's results which were treated as discontinued operations for the periods indicated.
Year Ended September 30, ------------------------------------ 2005 2004 - --------------------------------------------------------------------------------------- (Dollars in Thousands, Except Per Share Data Interest income $ 478 $ 877 Interest expense 347 385 - --------------------------------------------------------------------------------------- Net interest income 131 492 Noninterest income 5,072 9,085 Noninterest expense 6,310 9,060 Provision for income taxes - 89 - --------------------------------------------------------------------------------------- Net income (loss) $(1,107) $ 428 ======================================================================================= Earnings per share - basic $ (0.37) $ 0.14 Earnings per share - diluted (0.37) 0.14
71
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 4. INVESTMENTS Available-for-Sale, September 30, 2006 - ------------------------------------------------------------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Market Cost Gains Losses Value - ------------------------------------------------------------------------------------------------------------------- (In Thousands) Investment securities SBA notes $ 27,629 $ 106 $ 536 $ 27,199 CMOs 9,735 48 28 9,755 Corporate debt securities 7,280 36 174 7,142 - ------------------------------------------------------------------------------------------------------------------- 44,644 190 738 44,096 - ------------------------------------------------------------------------------------------------------------------- Mortgage-backed securities FNMA notes 18,350 - 364 17,986 GNMA notes 8,133 - 217 7,916 FHLMC notes 5,549 - 86 5,463 - ------------------------------------------------------------------------------------------------------------------- 32,032 - 667 31,365 - ------------------------------------------------------------------------------------------------------------------- $ 76,676 $ 190 $ 1,405 $ 75,461 =================================================================================================================== Held-to-Maturity, September 30, 2006 - -------------------------------------------------------------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Market Cost Gains Losses Value - -------------------------------------------------------------------------------------------------------------------- (In Thousands) Investment securities SBA notes $ 4,461 $ - $ 231 $ 4,230 Corporate debt securities - - - - - -------------------------------------------------------------------------------------------------------------------- 4,461 - 231 4,230 - -------------------------------------------------------------------------------------------------------------------- Mortgage-backed securities FNMA notes 107 - 2 105 FHLMC notes 128 - 3 125 - -------------------------------------------------------------------------------------------------------------------- 235 - 5 230 - -------------------------------------------------------------------------------------------------------------------- $ 4,696 $ - $ 236 $ 4,460 ====================================================================================================================
72
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Available-for-sale, September 30, 2005 - -------------------------------------------------------------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Market Cost Gains Losses Value - -------------------------------------------------------------------------------------------------------------------- (In Thousands) Investment securities SBA notes $ 30,239 $ 112 $ 570 $ 29,781 CMOs 14,446 33 25 14,454 Corporate debt securities 6,736 39 39 6,736 - -------------------------------------------------------------------------------------------------------------------- 51,421 184 634 50,971 - -------------------------------------------------------------------------------------------------------------------- Mortgage-backed securities FNMA notes 35,548 29 630 34,947 GNMA notes 13,097 - 155 12,942 FHLMC notes 9,044 10 85 8,969 - -------------------------------------------------------------------------------------------------------------------- 57,689 39 870 56,858 - -------------------------------------------------------------------------------------------------------------------- $ 109,110 $ 223 $ 1,504 $ 107,829 ==================================================================================================================== Held-to-maturity, September 30, 2005 - -------------------------------------------------------------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Market Cost Gains Losses Value - -------------------------------------------------------------------------------------------------------------------- (In Thousands) Investment securities SBA notes $ 6,531 $ 1 $ 319 $ 6,213 Corporate notes 1,000 20 - 1,020 - -------------------------------------------------------------------------------------------------------------------- 7,531 21 319 7,233 - -------------------------------------------------------------------------------------------------------------------- Mortgage-backed securities FNMA notes 202 - 4 198 FHLMC notes 236 - 1 235 - -------------------------------------------------------------------------------------------------------------------- 438 - 5 433 - -------------------------------------------------------------------------------------------------------------------- $ 7,969 $ 21 $ 324 $ 7,666 ====================================================================================================================
The weighted average interest rate on investments was 5.03% and 3.38% for the years ended September 30, 2006 and 2005, respectively. TRADING ACTIVITIES
The net gains (losses) on trading activities included in earnings are as follows: Year Ended September 30, ----------------------------------- 2006 2005 2004 - ------------------------------------------------------------------------------------------------------ (In Thousands) FHLB notes $ - $ - $ - Mortgage-backed securities - - (135) - ------------------------------------------------------------------------------------------------------ $ - $ - $ (135) ======================================================================================================
73 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Proceeds from the sale of available for sale securities were zero, $21.9 million and $67.8 million for the years ended September 30, 2006, 2005 and 2004, respectively. Gross realized gains were zero, $539,000 and $77,000 for the years ended September 30, 2006, 2005 and 2004, respectively. As of September 30, 2006, the Bank held investments in available for sale with unrealized holding losses totaling $1.4 million, consisting of the following:
Less than 12 months 12 months or more Total -------------------------- -------------------------- ------------------------- Fair Unrealized Fair Unrealized Fair Unrealized Description of Securities Value Losses Value Losses Value Losses - --------------------------------------------------------------------------------------------------------------- (In Thousands) Corporate debt securities $ 4,921 $ 174 $ - $ - $ 4,921 $ 174 CMOs 3,279 28 - - 3,279 28 U.S. Government securities SBA 22,375 536 - - 22,375 536 GNMA 7,916 217 - - 7,916 217 U.S. Government agency securities: FHLMC MBS's 5,463 86 - - 5,463 86 FNMA MBS's 17,773 357 213 7 17,986 364 - --------------------------------------------------------------------------------------------------------------- Total $ 61,727 $ 1,398 $ 213 $ 7 $ 61,940 $ 1,405 ===============================================================================================================
As of September 30, 2006, the Bank held investments in held-to-maturity with unrealized holding losses totaling $236,000, consisting of the following:
Less than 12 months 12 months or more Total -------------------------- -------------------------- ------------------------- Fair Unrealized Fair Unrealized Fair Unrealized Description of Securities Value Losses Value Losses Value Losses - --------------------------------------------------------------------------------------------------------------- (In Thousands) U.S. Government securities SBA $ 4,230 $ 231 $ - $ - $ 4,230 $ 231 U.S. Government agency securities: FHLMC MBS's 125 3 - - 125 3 FNMA MBS's 82 2 23 - 105 2 - --------------------------------------------------------------------------------------------------------------- Total $ 4,437 $ 236 $ 23 $ - $ 4,460 $ 236 ===============================================================================================================
74 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Such unrealized holding losses are the result of an increase in market interest rates during fiscal 2006 and are not the result of credit or principal risk. Based on the nature of the investments and other considerations discussed above, management concluded that such unrealized losses were not other than temporary as of September 30, 2006 The amortized cost and estimated fair value of securities at September 30, 2006 and 2005, by contractual maturity, are as follows:
September 30, 2006 September 30, 2005 --------------------------------------------------------- Amortized Fair Amortized Fair Cost Value Cost Value - ----------------------------------------------------------------------------------------------------------- (In Thousands) Available-for-sale: One year or less $ 49 $ 33 $ - $ - After one year through five years - - 185 169 After five years through ten years 3,891 3,753 4,070 4,041 After ten years 40,704 40,310 47,166 46,761 Mortgage-backed securities 32,032 31,365 57,689 56,858 - ----------------------------------------------------------------------------------------------------------- 76,676 75,461 109,110 107,829 - ----------------------------------------------------------------------------------------------------------- Held-to-maturity: One year or less - - 1,000 1,020 After one year through five years 110 94 408 373 After five years through ten years 553 534 253 231 After ten years 3,798 3,602 5,870 5,609 Mortgage-backed securities 235 230 438 433 - ----------------------------------------------------------------------------------------------------------- 4,696 4,460 7,969 7,666 - ----------------------------------------------------------------------------------------------------------- Total investment securities $81,372 $79,921 $117,079 $115,495 ===========================================================================================================
Actual maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. 75 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5. LOANS RECEIVABLE Loans receivable consists of the following:
September 30, ----------------------------------- 2006 2005 - ---------------------------------------------------------------------------------------------------- (In Thousands) Mortgage loans: Single-family $ 43,473 $ 50,919 Multi-family 813 751 Construction 14,245 24,273 Commercial real estate 28,403 25,530 Land loans 13,829 18,421 - ---------------------------------------------------------------------------------------------------- Total mortgage loans 100,763 119,894 Commercial loans 39,794 35,458 Consumer loans 61,414 69,381 - ---------------------------------------------------------------------------------------------------- Total loans 201,971 224,733 Less: Due borrowers on loans-in process (8,517) (20,386) Deferred loan fees origination costs 944 873 Allowance for loan losses (1,330) (1,212) Unearned (discounts) premium 239 429 - ---------------------------------------------------------------------------------------------------- $ 193,307 $ 204,437 ==================================================================================================== Loans held for sale $ - $ 9,517 Loans receivable, net 193,307 194,920 - ---------------------------------------------------------------------------------------------------- $ 193,307 $ 204,437 ====================================================================================================
Loans held for sale are all single-family mortgage loans. The activity in allowance for loan losses is summarized as follows:
Year Ended September 30, ---------------------------------------------------- 2006 2005 2004 - -------------------------------------------------------------------------------------------------------------------- (In Thousands) Balance, beginning $ 1,212 $ 1,600 $ 1,550 Provision for loan losses 126 219 209 Charge-offs (80) (625) (200) Recoveries 72 18 41 - -------------------------------------------------------------------------------------------------------------------- Balance, ending $ 1,330 $ 1,212 $ 1,600 ====================================================================================================================
The amount of loans serviced for others totaled $34.4 million and $40.0 million as of September 30, 2006 and September 30, 2005, respectively. The allowance for uncollected interest, established for mortgage loans which are delinquent for a period of 90 days or more, amounted to $204,000, $134,000 and $108,000 as of September 30, 2006, 2005 and September 30, 2004, respectively. This is the entire amount of interest income that would have been recorded in these periods under the contractual terms of such loans. Principal balances of non-performing loans related to reserves for uncollected interest totaled $274,000, $1.6 million and $953,000 as of September 30, 2006, 2005, and September 30, 2004, respectively. 76 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6. ACCRUED INTEREST AND DIVIDENDS RECEIVABLE Accrued interest and dividends receivable consist of the following:
September 30, ------------------------- 2006 2005 -------------------------------------------------------------------------------------------------- (In Thousands) Investments $ 751 $ 718 Loans receivable 1,282 1,005 Accrued dividends on FHLB stock 40 23 -------------------------------------------------------------------------------------------------- $ 2,073 $ 1,746 ==================================================================================================
7. PREMISES AND EQUIPMENT Premises and equipment consists of the following:
September 30, ------------------------- 2006 2005 ------------------------------------------------------------------------------------------------- (In Thousands) Furniture, fixtures and equipment $ 2,621 $ 5,228 Leasehold improvements 2,835 2,836 Land 377 377 ------------------------------------------------------------------------------------------------- 5,833 8,441 Less: Allowances for depreciation and amortization 3,069 4,243 ------------------------------------------------------------------------------------------------- $ 2,764 $ 4,198 =================================================================================================
8. FORECLOSED REAL ESTATE Foreclosed real estate is summarized as follows.
September 30, ------------------------------- 2006 2005 - ------------------------------------------------------------------------------------------------ (In Thousands) Real estate acquired through settlement of loans $ - $ 232 ================================================================================================
There was no activity in the allowance for losses on foreclosed real estate in fiscal 2006, 2005 or 2004. 77 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 9. DEPOSITS Deposits are summarized as follows:
September 30, 2006 -------------------------------------------------------------------------------------------------------- Ranges of Contractual % Amount Interest Rates of Total -------------------------------------------------------------------------------------------------------- (In Thousands) Savings accounts $ 3,679 0.00 - 1.09% 1.6% NOW/money market accounts 73,334 0.00 - 4.40% 31.9 Certificates of deposit 127,939 0.94 - 9.00% 55.6 Non-interest bearing demand deposits 25,222 0.00% 10.9 -------------------------------------------------------------------------------------------------------- $ 230,174 100.0% ======================================================================================================== September 30, 2005 -------------------------------------------------------------------------------------------------------- Ranges of Contractual % Amount Interest Rates of Total -------------------------------------------------------------------------------------------------------- (In Thousands) Savings accounts $ 8,078 0.00 - 1.09% 3.4% NOW/money market accounts 66,638 0.00 - 3.54% 28.0 Certificates of deposit 145,912 0.99 - 9.00% 61.4 Non-interest bearing demand deposits 17,166 0.00% 7.2 -------------------------------------------------------------------------------------------------------- $ 237,794 100.0% ========================================================================================================
78 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Certificates of deposit as of September 30, 2006 mature as follows: Year ending September 30, Amount --------------------------------------------------------------------------------------------- (In Thousands) Thousands 2007 $ 102,257 2008 16,930 2009 4,334 2010 3,451 2011 and after 967 --------------------------------------------------------------------------------------------- $ 127,939 =============================================================================================
Interest expense on deposit accounts consists of the following:
Year Ended September 30, -------------------------------------------- 2006 2005 2004 ------------------------------------------------------------------------------------------------------------ (In Thousands) NOW/money market accounts $ 2,430 $ 1,197 $ 852 Savings accounts 48 94 113 Certificates of deposit 5,231 5,046 4,786 ------------------------------------------------------------------------------------------------------------ $ 7,709 $ 6,337 $ 5,751 ============================================================================================================
Deposits, including certificates of deposit, with balances in excess of $100,000 totaled $85.2 million and $83.7 million at September 30, 2006, and September 30, 2005, respectively. 10. DEFERRED COMPENSATION PLAN On October 30, 1997, the Company adopted a deferred compensation plan. Under the deferred compensation plan, an employee may elect to participate by directing that all or part of his or her compensation be credited to a deferral account. The election must be made prior to the beginning of the calendar year. The deferral account bears interest at 6% per year. The amounts credited to the deferral account are payable in preferred stock or cash at the election of the board of directors on the date the Company announces a change in control or the date three years from the date the participant elects to participate in the deferred compensation plan. The liability associated with the plan was zero at September 30, 2006 and 2005, respectively. 79 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 11. ADVANCES FROM FEDERAL HOME LOAN BANK AND OTHER BORROWINGS The Bank has $56.2 million credit availability as of September 30, 2006 from the Federal Home Loan Bank of Atlanta (FHLB). Any advances in excess of $10 million are required to be collateralized with eligible securities. The credit availability is at the discretion of the FHLB. The following table sets forth information regarding the Bank's borrowed funds:
At or For the Year Ended September 30, -------------------------------------------------- 2006 2005 2004 ---------------------------------------------------------------------------------------------------------------------- (Dollars in Thousands) FHLB advances: Average balance outstanding $ 44,894 $ 44,422 $ 116,155 Maximum amount outstanding at any month-end during the period 51,000 49,200 142,250 Balance outstanding at end of period 36,000 38,000 51,200 Weighted average interest rate during the period 5.05% 4.47% 2.39% Weighted average interest rate at end of period 5.28% 4.85% 3.93% Reverse repurchase agreements: Average balance outstanding 31,624 51,388 78,979 Maximum amount outstanding at any month-end during the period 35,641 62,846 93,730 Balance outstanding at end of period 18,574 38,479 64,865 Weighted average interest rate during the period 4.21% 4.33% 4.36% Weighted average interest rate at end of period 4.65% 3.69% 1.98%
The Bank has pledged certain investments with carrying values of $25.6 million at September 30, 2006, to collateralize advances from the FHLB. First mortgage loans in the amount of $30.8 million are also available to be pledged as collateral for the advances at September 30, 2006. 12. INCOME TAXES The provision (benefit) for income taxes differs from the amount of income tax determined by applying the applicable U.S. statutory federal income tax rate to pre-tax income (loss) as a result of the following differences:
Year Ended September 30, -------------------------------------------- 2006 2005 2004 (Restated) (Restated) ---------------------------------------------------------------------------------------------------------- (In Thousands) Federal tax provision (benefit) $ (1,894) $ (554) $ (1,186) State tax provision (benefit) (223) (65) (139) (Increase) decrease in provision resulting from: Valuation changes 1,867 613 1,319 Other 250 6 6 ---------------------------------------------------------------------------------------------------------- Income tax provision $ - $ - $ - ==========================================================================================================
80 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Significant components of the Company's deferred tax assets and liabilities are as follows:
September 30, -------------------------------- 2006 2005 (Restated) - --------------------------------------------------------------------------------------------- (In Thousands) Deferred tax assets Net operating loss carryforwards $ 4,658 $ 2,654 Unrealized (gains) losses on derivatives 178 (76) Allowance for loan losses 505 461 Available for sale securities 433 515 Core deposit intangible 65 65 Deferred loan fees 125 177 Other 86 458 - --------------------------------------------------------------------------------------------- Total deferred tax assets 6,050 4,254 - --------------------------------------------------------------------------------------------- Deferred tax liabilities Tax over book depreciation 478 535 Other 140 108 - --------------------------------------------------------------------------------------------- Total deferred tax liabilities 618 643 - --------------------------------------------------------------------------------------------- Net deferred tax assets 5,432 3,611 Less: Valuation allowance 3,504 1,637 - --------------------------------------------------------------------------------------------- Total $ 1,928 $ 1,974 =============================================================================================
Management has provided a valuation allowance for net deferred tax assets, due to the timing of the generation of future taxable income. At September 30, 2006, the Company has net operating loss carryforwards for federal income tax purposes of approximately $12.1 million, which expire in the years 2007 to 2026. As a result of the change in ownership of the Bank, approximately $1.5 million of the total net operating loss carryforwards are subject to an annual usage limitation of approximately $114,000. 81 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 13. COMMITMENTS AND CONTINGENCIES The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, standby letters of credit, and financial guarantees. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and financial guarantees written is represented by the contractual notional amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. At September 30, 2006, the Company had outstanding commitments to originate and purchase loans and undisbursed construction mortgages aggregating approximately $13.9 million. Fixed rate commitments are at market rates as of the commitment dates and generally expire within 60 days. In addition, the Company was contingently liable under unused lines of credit for approximately $113.1 million and standby letters of credit for approximately $55,000. The Company announced in September 2006 that a Demand for Arbitration before the American Arbitration Association was filed by the former manager of GAMC (Stamm Mortgage). The Demand for Arbitration alleges three counts: rescission, breach of contract, and defamation. As against the Bank and GAMC, Stamm Mortgage alleges that the Management Agreement is unenforceable and should be rescinded, requiring the Bank and GAMC, jointly and severally, to return $1.77 million that Stamm Mortgage paid to the Bank and GAMC under the Management Agreement. As an alternative to rescission, Stamm Mortgage alleges that the Bank and GAMC breached the Management Agreement by terminating it contrary to its terms, resulting in $9.6 million in lost profits to Stamm Mortgage. Stamm Mortgage and Mr. Stamm both allege that the company, the bank, GAMC, and Mr. Amos, acting in his official capacity, defamed Stamm Mortgage and Mr. Stamm through certain public statements made in press releases and in public securities filings by the company and seek $1.0 million in compensatory damages and $350,000 in punitive damages. On December 29, 2006, counsel for the company, the bank, GAMC and Mr. Amos filed an Answering Statement and Counterclaim in Arbitration. In, January 2007, the parties entered into negotiations looking toward a mutually acceptable and amicable resolution of their claims. During the course of these negotiations, the Company proposed a settlement offer which would require a contribution of $500,000 by the Company towards the settlement, and has been accrued by the Company as of September 30, 2006. In the event that the claims cannot be resolved through negotiations, the company intends to defend its position vigorously. RENTAL COMMITMENTS The Company has entered into lease agreements for the rental of certain properties expiring on various dates through June 30, 2015. The future minimum rental commitments as of September 30, 2006, for all non-cancelable lease agreements, are as follows: Years ending Rental September 30, Commitments ------------------------------------------------------- (In Thousands) 2007 $ 1,089 2008 1,116 2009 992 2010 836 2011 339 Thereafter 493 ------------------------------------------------------- Total $ 4,865 ======================================================= Net rent expense for the years ended September 30, 2006, 2005 and 2004 was $1.1 million, $1.0 million and $1.3 million, respectively. 82 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 14. REGULATORY MATTERS Generally, annual dividends by the Bank to the Company as its sole shareholder are limited to the amount of current year net income, plus the total net income for the preceding two years, adjusted for any prior year distributions. Under certain circumstances, regulatory approval would be required before making a capital distribution. The Bank did not pay any cash dividends during the years ended September 30, 2006, 2005 or 2004. The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) created five categories of financial institutions based on the adequacy of their regulatory capital level: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. Under FDICIA, a well-capitalized financial institution is one with Tier 1 leverage capital of 5%, Tier 1 risk-based capital of 6% and total risk-based capital of 10%. At September 30, 2006 the Bank was classified as an adequately capitalized financial institution and was classified as a well capitalized financial institution at September 30, 2005. As part of FDICIA, the minimum capital requirements that the Bank is subject to are as follows: 1) tangible capital equal to at least 1.5% of adjusted total assets, 2) core capital equal to at least 4% of adjusted total assets and 3) total risk-based capital equal to at least 8% of risk-based assets. The following presents the Bank's capital position at September 30, 2006 and September 30, 2005:
- ------------------------------------------------------------------------------------------------------------- Required Required Actual Actual At September 30, 2006 Balance Percent Balance Percent Surplus - ------------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Tangible $ 4,560 1.50% $ 16,738 5.51% $ 12,178 Core $ 12,159 4.00% $ 16,738 5.51% $ 4,579 Risk-based $ 15,487 8.00% $ 17,636 9.11% $ 2,149 ============================================================================================================= - ------------------------------------------------------------------------------------------------------------- Required Required Actual Actual At September 30, 2005 (Restated) Balance Percent Balance Percent Surplus - ------------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Tangible $ 5,080 1.50% $ 22,546 6.66% $ 17,466 Core $ 13,547 4.00% $ 22,546 6.66% $ 8,999 Risk-based $ 17,600 8.00% $ 23,645 10.75% $ 6,045 =============================================================================================================
83 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following is a reconciliation of the Bank's net worth as reported to the OTS on GAAP capital as presented in the accompanying financial statements.
September 30, ------------------------------ 2006 2005 (Restated) - -------------------------------------------------------------------------------------------------- (In Thousands) GAAP capital $ 10,161 $ 15,658 Guaranteed convertible preferred securities 8,000 8,000 Unrealized losses on available for sale securities 1,049 1,095 Excluded deferred tax asset (1,516) (1,250) Goodwill (956) (956) - -------------------------------------------------------------------------------------------------- Tangible capital 16,738 22,546 Adjustments - - - -------------------------------------------------------------------------------------------------- Core capital 16,738 22,546 Allowance for general loss reserves 1,011 1,212 Adjustments to arrive at Risk-Weighted Assets (113) (113) - -------------------------------------------------------------------------------------------------- Risk-based capital $ 17,636 $ 23,645 ==================================================================================================
Failure to meet any of the three capital requirements causes savings institutions to be subject to certain regulatory restrictions and limitations including a limit on asset growth, and the requirement to obtain regulatory approval before certain transactions or activities are entered into. 15. STOCKHOLDERS' EQUITY Effective November 14, 1998, the Company established the 1997 Stock Option and Warrant Plan (the "Plan"). The Plan reserves options for 76,667 shares to employees and warrants for 94,685 shares to stockholders. The Plan was amended effective March 14, 2000, to increase the number of options available for grant from 76,667 to 225,000 shares to employees and amended again effective March 15, 2002, to increase the number of options available for grant from 225,000 to 350,000 shares to employees and to limit its application to officers and employees. The stock options and warrants vest immediately upon issuance and carry a maximum term of 10 years. The exercise price for the stock options and warrants is the fair market value at grant date. As of September 30, 2006, 94,671 warrants were outstanding. 84 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following summary represents the activity under the Plan: ------------------------------------------------------------------------------------------------------------ Number Exercise Expiration of Shares Price Date ------------------------------------------------------------------------------------------------------------ Balance outstanding and exercisable at September 30, 2003 190,000 Options granted 36,000 $ 8.50 10-20-13 ------------------------------------------------------------------------------------------------------------ Balance outstanding and exercisable at September 30, 2004 226,000 Options granted 104,000 $ 6.75 10-6-14 Options exercised (8,500) $ 4.00 Options expired (55,500) $ 6.52 ------------------------------------------------------------------------------------------------------------ Balance outstanding and exercisable at September 30, 2005 266,000 $ 6.91 Options granted 12,000 $ 6.00 3-31-2016 Options expired (25,000) $ 8.37 ------------------------------------------------------------------------------------------------------------ Balance outstanding and exercisable at September 30, 2006 253,000 $ 6.72 ============================================================================================================
A summary of the stock options outstanding and exercisable as of September 30, 2006 is as follows: - ----------------------------------------------------------- ------------------------------------------------------ Options Outstanding Options Exercisable - ----------------------------------------------------------- ------------------------------------------------------ Weighted Weighted Weighted Average Average Average Exercise Number Remaining Life Exercise Number Exercise Prices Outstanding (years) Price Exercisable Price - ----------------------------------------------------------- ------------------------------------------------------ $7.50 16,667 1.2 $7.50 16,667 $7.50 $8.38 16,667 2.2 $8.38 16,667 $8.38 $6.00 13,000 3.2 $6.00 13,000 $6.00 $4.00 41,666 4.2 $4.00 41,666 $4.00 $5.31 10,000 4.2 $5.31 10,000 $5.31 $7.00 17,000 5.3 $7.00 17,000 $7.00 $9.00 20,000 5.3 $9.00 20,000 $9.00 $8.50 30,000 7.1 $8.50 30,000 $8.50 $6.75 76,000 8.1 $6.75 76,000 $6.75 $6.00 12,000 9.5 $6.00 12,000 $6.00 - ----------------------------------------------------------- ------------------------------------------------------
85 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 16. EARNINGS (LOSS) PER SHARE OF COMMON STOCK The Company reports earning per share in accordance with Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"). SFAS 128 requires two presentations of earning per share - "basic" and "diluted." Basic earnings per share are computed by dividing income available to common stockholders (the numerator) for the period by the weighted average number of shares of common stock outstanding during the year (the denominator). The computation of diluted earnings per share is similar to basic earnings per share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potentially dilutive common shares had been issued. The following table presents a reconciliation between the basic and diluted earnings (loss) per share for the year ended September 30, 2006, 2005 and 2004:
For the Year Ended September 30, ----------------------------------------------------------------------------------------------- 2006 2005 (Restated) 2004 (Restated) ----------------------------- ----------------------------- ----------------------------- Income Shares Per Income Shares Per Income Shares Per Share Share Share Amount Amount Amount - ------------------------------------------------------------------------------------------------------------------------------- (Dollars in Thousands, Except Per Share Data) Basic earnings per share $(5,571) 3,020,934 $(1.84) $(1,630) 3,015,509 $(0.54) $(3,489) 3,012,434 $(1.16) Effect of conversion of preferred securities - - - - - - - - - Effect of dilutive stock options - - - - - - - - - - ------------------------------------------------------------------------------------------------------------------------------- Diluted $(5,571) 3,020,934 $(1.84) $(1,630) 3,015,509 $(0.54) $(3,489) 3,012,434 $(1.16) ===============================================================================================================================
The effect of the conversion of preferred securities and stock options were excluded in 2006, 2005 and 2004, as they would have been anti-dilutive. 17. RELATED PARTY TRANSACTIONS The Bank offers loans to its officers, directors, employees and related parties of such persons. These loans are made in the ordinary course of business and, in the opinion of management, do not involve more than the normal risk of collectibility, or present other unfavorable features. Such loans are made on the same terms as those prevailing at the time for comparable transactions with non-affiliated persons. The aggregate balance of loans to directors, officers and other related parties is $263,000 and $204,000 as of September 30, 2006 and September 30, 2005, respectively. 86 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 18. MARKET VALUE DISCLOSURE OF FINANCIAL INSTRUMENTS The fair value information for financial instruments, which is provided below, is based on the requirements of Financial Accounting Standard Board Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments," and does not represent the aggregate net fair value of the Bank. Much of the information used to determine fair value is subjective and judgmental in nature; therefore, fair value estimates, especially for less marketable securities, may vary. The amounts actually realized or paid upon settlement or maturity could be significantly different. The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is reasonable to estimate that value: A. Cash and interest bearing deposits - Fair value is estimated to be carrying value. B. Investment securities - Fair value is estimated using quoted market prices or market estimates. C. Loans receivable - Fair value is estimated by discounting future cash flows using the current rate for similar loans. D. Deposits - For passbook savings, checking and money market accounts, fair value is estimated at carrying value. For fixed maturity certificates of deposit, fair value is estimated by discounting future cash flows at the currently offered rates for deposits of similar remaining maturities. E. Advances from the FHLB of Atlanta and reverse repurchase agreements - - Fair value is estimated by discounting future cash flows at the currently offered rates for advances of similar remaining maturities. F. Off-balance sheet instruments - The fair value of commitments is determined by discounting future cash flows using the current rate for similar loans. Commitments to extend credit for other types of loans and standby letters of credit were determined by discounting future cash flows using current rates. The carrying value and estimated fair value of financial instruments is summarized as follows:
For the Year Ended September 30, ----------------------------------------------------------- 2006 2005 ----------------------------- ---------------------------- Carrying Estimated Carrying Estimated value fair value value fair value ---------------------------------------------------------------------------------------------------------- (In Thousands) Assets: Cash and interest bearing deposits $ 19,804 $ 19,804 $ 4,709 $ 4,709 Investment securities 80,157 79,921 115,798 115,495 Loans receivable 193,307 193,049 204,437 204,806 ---------------------------------------------------------------------------------------------------------- Liabilities: Deposits 230,174 229,818 237,794 236,968 Borrowings 54,574 55,333 76,479 77,689 ---------------------------------------------------------------------------------------------------------- Off-balance sheet instruments: Commitments to extend credit - 10 - 1,362 ----------------------------------------------------------------------------------------------------------
19. EMPLOYEE BENEFIT PLANS The Company operates a 401(k) Retirement Plan covering all full-time employees meeting the minimum age and service requirements. Contributions to the Retirement Plan are at the discretion of the Company. The Company made no contributions for the years ended September 30, 2006 and 2005. 87 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 20. SUPPLEMENTAL CASH FLOW INFORMATION
Year Ended September 30, ---------------------------------------- 2006 2005 2004 ----------------------------------------------------------------------------------------------------------- (In Thousands) Cash paid during period for interest on deposits and borrowings $5,331 $5,861 $7,777 ===========================================================================================================
21. SEGMENT REPORTING The Company had two reportable segments, banking and mortgage banking. However, the mortgage-banking activities conducted in GAMC, to which the mortgage-banking segment applied, were discontinued effective March 29, 2006. The Bank operates retail deposit branches in the greater Washington, D.C./Baltimore metropolitan area. The banking segment provides retail consumers and small businesses with deposit products such as demand, transaction, and savings accounts and certificates of deposit and lending products, such as residential and commercial real estate, construction and development, consumer and commercial business loans. Further, the banking segment invests in residential real estate loans purchased from GAMC and others, and also invests in mortgage-backed and other securities. The mortgage banking activities, which were conducted principally through GAMC, included the origination of residential real estate loans either for sale into the secondary market, with servicing released or for the Bank's portfolio. On March 29, 2006, we began the process of discontinuing the operations of the Bank's subsidiary, GAMC. It was determined that, because it was unprofitable, this business no longer fit our strategy. In the third quarter of 2006, we applied discontinued operations accounting for GAMC. Accordingly, the income statements for all periods have been restated. The restatements primarily resulted in a reduction to previously reported levels of net interest income, a reduction in noninterest income and a reduction in noninterest expense. Due to the unprofitable operations of GAMC, the Company recognized an additional loss of $1.5 million for the year ended September 30, 2006. In addition to the loss from operations, a non-recurring pre-tax impairment charge for long-lived assets of $996,000 was recorded and included in discontinued operations in the consolidated statements of operations. 22. JUNIOR SUBORDINATED DEBT SECURITIES On March 20, 2002, Greater Atlantic Capital Trust I (the, "Trust"), a Delaware statutory business trust and a wholly owned Trust subsidiary of the Company issued $9.6 million aggregate liquidation amount (963,038 shares) of 6.50% cumulative preferred securities maturing on December 31, 2031, with an option to call on or after December 31, 2003. Conversion of the preferred securities into the Company's common stock may occur at any time on or after 60 days after the closing of the offering. The Company may redeem the preferred securities, in whole or in part, at any time on or after December 31, 2003. Distributions on the preferred securities are payable quarterly on March 31, June 30, September 30 and December 31 of each year beginning on June 30, 2002. The Trust also issued 29,762 common securities to the Company for $297,620. The Company purchased all the shares of the common stock. The proceeds from the sale of the preferred securities and the proceeds from the sale of the trust's common securities were utilized to purchase from the Company junior subordinated debt securities of $9,928,000 bearing interest of 6.50% and maturing December 31, 2031. All intercompany interest and equity were eliminated in consolidation. The Trust was formed for the sole purpose of investing the proceeds from the sale of the convertible preferred securities in the corresponding convertible debentures. The Company has fully and unconditionally guaranteed the preferred securities along with all obligations of the trust related thereto. The sale of the preferred securities yielded $9.3 million after deducting offering expenses. The Company currently retained approximately $1.3 million of the proceeds for general corporate purposes. The remaining $8.0 million of the proceeds was invested in Greater Atlantic Bank to increase its capital position. 88 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS To comply with FIN46, the trust preferred subsidiary was deconsolidated in 2004, and the related securities have been presented as obligations of the Company and titled "Junior Subordinated Debt Securities" in the financial statements. On December 19, 2006, the Company issued a news release announcing that the first quarter distribution of Greater Atlantic Capital Trust I 6.50% Cumulative Convertible Trust Preferred Securities scheduled for December 31, 2006, as well as future distributions on the Trust Preferred Securities, will be deferred. The announcement by the Company follows advice received by Greater Atlantic Bank from the Office of Thrift Supervision that it would not approve Greater Atlantic Bank's application to pay a cash dividend to the Company. Accordingly, the Company exercised its right to defer the payment of interest on its 6.50% Convertible Junior Subordinated Debentures Due 2031 related to the Trust Preferred Securities, for an indefinite period (which can be no longer than 20 consecutive quarterly periods). 23. DERIVATIVE FINANCIAL INSTRUMENTS Beginning in fiscal 2002, the Bank utilized derivative financial instruments to hedge its interest rate risk. Beginning in 2002, the Bank adopted statement of Financial Accounting Standard No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133") which requires that an entity recognize all derivatives as either assets or liabilities and measure those instruments at fair value. The Bank bases the estimated fair values of these agreements on the cost of interest-rate exchange agreements with similar terms at available market prices, excluding accrued interest receivable and payable. However, active markets do not exist for many types of financial instruments. Consequently, fair values for these instruments must be estimated using techniques such as discounted cash flow analysis and comparisons to similar instruments. Estimates developed using these methods are highly subjective and require judgments regarding significant matters such as the amount and timing of future cash flows and the selection of discount rates that appropriately reflect market and credit risks. Changes in these judgments often have a material effect on the fair value estimates. Since those estimates are made as of a specific time, they are susceptible to material near term changes. The Bank entered into various interest-rate swaps during fiscal year 2003 and 2002 that were sold during the fourth quarter of fiscal 2006 and totaled at that time $21 million in notional principal. The swaps paid a fixed rate with the Bank receiving payments based upon one-to three-month floating rate LIBOR. The capped range was between 1.67% - 3.01%, and expired between 1 and 5 years. The Bank also entered into various interest rate caps during fiscal year 2003 and 2002 that total $25 million in notional principal with terms between five and ten years that limit the float between a floor of 2.00%, and capped between 5.00% - 8.00%. The Bank accounts for these derivatives, under the guidelines of SFAS 133. The Company's derivatives do not meet hedge accounting requirements under SFAS 133, and therefore, the Company carries the derivatives at their fair value on the balance sheet, recognizing changes in their fair value in current-period earnings. The Company recognized a loss of $66,000 in fiscal 2006, a gain of $836,000 in fiscal 2005 and a loss of $227,000 in fiscal 2004 related to its derivatives. 24. RECENT ACCOUNTING STANDARDS The Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 123 (Revised 2004) ("SFAS No. 123R"), "Share-Based Payment," in December 2004. SFAS No. 123R is a revision of FASB Statement 123, "Accounting for Stock-Based Compensation" and supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees," and its related implementation guidance. The Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS No. 123R requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide service in exchange for the award. This statement is effective as of the beginning of the first annual reporting period that begins after June 15, 2005 and the Company adopted the standard in the first quarter of fiscal 2006. The adoption of this statement did not have a material impact on its consolidated financial position or results of operations. In May 2005, the FASB issued SFAS 154, "Accounting Changes and Error Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3." SFAS 154 generally requires retrospective application to prior periods' financial statements of all voluntary changes in accounting principle and changes required when a new pronouncement does not include specific transition provisions. This standard was effective for the Company beginning October 1, 2006. 89 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In July 2006, the FASB issued Interpretation (FIN) No. 48, "Accounting for Uncertainty in Income Taxes" - an Interpretation of SFAS No. 109, "Accounting for Income Taxes." FIN 48 defines the threshold for recognizing the benefits of tax return positions in the financial statements as "more-likely-than-not" to be sustained by a taxing authority. The term "more-likely-than-not" means a likelihood of more than 50 percent. FIN 48 is effective as of Jan. 1, 2007, with early application permitted. Any impact from the adoption of FIN 48 will be recorded directly to the beginning balance of retained earnings and reported as a change in accounting principle. We are currently evaluating the impact of this Interpretation, but do not expect it to be material. On October 1, 2006, we adopted SFAS 156, "Accounting for Servicing of Financial Assets - an amendment of FASB Statement No.140." SFAS 156 was issued in March 2006 and requires all newly recognized servicing rights and obligations to be initially measured at fair value. For each class of separately recognized servicing rights and obligations retained, we have elected to continue to account for each under the amortization method which requires us to amortize servicing assets or liabilities in proportion to and over the periods of estimated net servicing income or net servicing loss. In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108 (SAB 108). Due to diversity in practice among registrants, SAB 108 expresses the SEC staff views regarding the process by which misstatements in financials statements are evaluated for purposes of determining whether financial statement restatement is necessary. SAB 108 is effective for fiscal years ending after November 15, 2006, and early application is encouraged. The company does not believe SAB 108 will have a material impact on its consolidated financials statements. In September 2006, the Financial Accounting Standards Board released Statement No. 157, "Fair Value Measurements" which defines fair value, establishes a framework for measuring fair value in GAAP, and enhances disclosures about fair value measurements. This Statement applies when other accounting pronouncements require fair value measurements; it does not require new fair value measurements. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those years. While we are currently evaluating the effect of the guidance contained in this Statement, we do not expect the implementation to have a material impact on our consolidated financial statements. 25. PARENT COMPANY - ONLY FINANCIAL STATEMENTS Parent Company - Only Condensed Statements of Financial Condition
September 30, ----------------------------------- 2006 2005 (Restated) ------------------------------------------------------------------------------------------ (In Thousands) Assets Cash and cash equivalents $ 60 $ 66 Loans receivable - - Investment in subsidiary 19,423 24,976 Prepaid expenses and other assets 309 304 ------------------------------------------------------------------------------------------ Total assets $ 19,792 $ 25,346 ========================================================================================== Liabilities and stockholders' equity Accrued interest payable on subordinated debt $ - $ - Other liabilities 8 (9) ------------------------------------------------------------------------------------------ Total liabilities 8 (9) ------------------------------------------------------------------------------------------ Subordinated debt 9,928 9,928 ------------------------------------------------------------------------------------------ Stockholders' equity Common stock 30 30 Additional paid-in capital 25,185 25,185 Accumulated deficit (15,359) (9,788) ------------------------------------------------------------------------------------------ Total stockholders' equity 9,856 15,427 ------------------------------------------------------------------------------------------ Total liabilities and stockholders' equity $ 19,792 $ 25,346 ==========================================================================================
90 Greater Atlantic Financial Corp. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Parent Company - Only Condensed Statements of Operations
Year Ended September 30, -------------------------------------------- 2006 2005 2004 (Restated) (Restated) ------------------------------------------------------------------------------------------------------------ (In Thousands) Interest income $ 1 $ - $ 2 Other income - - - ------------------------------------------------------------------------------------------------------------ Total interest income 1 - 2 ------------------------------------------------------------------------------------------------------------ Interest expense 645 645 645 ------------------------------------------------------------------------------------------------------------ Total interest expense 645 645 645 ------------------------------------------------------------------------------------------------------------ Net interest income (expense) (644) (645) (643) ------------------------------------------------------------------------------------------------------------ Noninterest income Gain (loss) on sale of investment securities - - - Other operating income 19 19 19 ------------------------------------------------------------------------------------------------------------ Total noninterest income 19 19 19 ------------------------------------------------------------------------------------------------------------ Noninterest expense Other operating expense 149 142 135 ------------------------------------------------------------------------------------------------------------ Total noninterest expense 149 142 135 ------------------------------------------------------------------------------------------------------------ Loss before income from subsidiaries (774) (768) (759) ------------------------------------------------------------------------------------------------------------ Equity (loss) income from subsidiaries (4,797) (862) (2,730) ------------------------------------------------------------------------------------------------------------ Net (loss) income $ (5,571) $ (1,630) $ (3,489) ============================================================================================================ Parent Company - Only Condensed Statements of Cash Flows Year Ended September 30, ------------------------------------------- 2006 2005 2004 (Restated) (Restated) ------------------------------------------------------------------------------------------------------------ (In Thousands) Cash flows from operating activities: Net income (loss) $ (5,571) $ (1,630) $ (3,489) Adjustments to reconcile net loss to net cash (used in) provided by operating activities (Income) loss from subsidiaries 4,797 862 2,730 (Increase) decrease in assets (5) (1) (283) Decrease in other liabilities 18 (12) (9) ------------------------------------------------------------------------------------------------------------ Net cash used in operating activities (761) (781) (1,051) ------------------------------------------------------------------------------------------------------------ Cash flows from investing activities: Loan originations in excess of repayments - - - Investment in subsidiary - - - ------------------------------------------------------------------------------------------------------------ Net cash provided by investing activities - - - ------------------------------------------------------------------------------------------------------------ Cash flows from financing activities: Cash dividend from subsidiary 755 800 500 Stock options exercised - 33 - ------------------------------------------------------------------------------------------------------------ Net cash provided by financing activities 755 833 500 ------------------------------------------------------------------------------------------------------------ Net (decrease) increase in cash and cash equivalents (6) 52 (551) Cash and cash equivalents at beginning of year 66 14 565 ------------------------------------------------------------------------------------------------------------ Cash and cash equivalents at end of year $ 60 $ 66 $ 14 ============================================================================================================
91 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 26. QUARTERLY RESULTS OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE INFORMATION) (UNAUDITED) The following tables set forth the quarterly financial data, which was derived from the consolidated financial statements presented in Form 10-Qs, for the fiscal years ended September 30, 2006 and 2005.
For Fiscal Year 2006 ------------------------------------------------------------------------------ For the Year Second First Ended September Fourth Third Quarter Quarter 30, 2006 Quarter Quarter (Restated) (Restated) ------------------------------------------------------------------------------------------------------------------------ Interest income $ 18,794 $ 4,851 $ 4,753 $ 4,600 $ 4,590 Interest expense 11,305 2,955 2,837 2,772 2,741 ------------------------------------------------------------------------------------------------------------------------ Net interest income 7,489 1,896 1,916 1,828 1,849 Provision for loan losses 126 39 13 3 71 ------------------------------------------------------------------------------------------------------------------------ Net interest income, after provision 7,363 1,857 1,903 1,825 1,778 for loan losses Noninterest income 639 (130) 203 264 302 Noninterest expense 11,085 3,216 2,722 2,627 2,520 ------------------------------------------------------------------------------------------------------------------------ Income (loss) before income taxes (3,083) (1,489) (616) (538) (440) Provision for income taxes - - - - - ------------------------------------------------------------------------------------------------------------------------ Net income (loss) from continuing (3,083) (1,489) (616) (538) (440) operations Income (loss) from discontinued operations (2,488) 11 (19) (698) (1,782) ------------------------------------------------------------------------------------------------------------------------ Net income (loss) $ (5,571) $ (1,478) $ (635) $ (1,236) $ (2,222) ======================================================================================================================== BASIC AND DILUTED EARNINGS (LOSS) PER COMMON SHARE: Continuing operations $ (1.02) $ (0.49) $ (0.20) $ (0.18) $ (0.15) Discontinued operations (0.82) 0.01 (0.01) (0.23) (0.59) ------------------------------------------------------------------------------------------------------------------------ Net income (loss) $ (1.84) $ (0.48) $ (0.21) $ (0.41) $ (0.74) ========================================================================================================================
92
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For Fiscal Year 2005 (Restated) ------------------------------------------------------------------------------ For the Year Ended September Fourth Third Second First 30, 2005 Quarter Quarter Quarter Quarter ------------------------------------------------------------------------------------------------------------------------ Interest income $ 16,958 $ 4,378 $ 4,512 $ 4,141 $ 4,405 Interest expense 10,546 2,742 2,660 2,674 2,817 ------------------------------------------------------------------------------------------------------------------------ Net interest income 6,412 1,608 1,822 1,443 1,539 Provision for loan losses 219 71 145 1 2 ------------------------------------------------------------------------------------------------------------------------ Net interest income, after provision 6,193 1,537 1,677 1,442 1,537 for loan losses Noninterest income 3,173 455 139 1,131 1,448 Noninterest expense 9,889 2,478 2,433 2,478 2,500 ------------------------------------------------------------------------------------------------------------------------ Income (loss) before income taxes (523) (486) (617) 95 485 Provision for income taxes - - - - - ------------------------------------------------------------------------------------------------------------------------ Net income (loss) from continuing (523) (486) (617) 95 485 operations Income (loss) from discontinued operations (1,107) (1,035) (32) (15) (25) ------------------------------------------------------------------------------------------------------------------------ Net income (loss) $ (1,630) $ (1,521) $ (649) $ 80 $ 460 ======================================================================================================================== BASIC AND DILUTED EARNINGS (LOSS) PER COMMON SHARE: Continuing operations $ (0.17) $ (0.16) $ (0.21) $ 0.04 $ 0.16 Discontinued operations (0.37) (0.34) (0.01) (0.01) (0.01) ------------------------------------------------------------------------------------------------------------------------ Net income (loss) $ (0.54) $ (0.50) $ (0.22) $ 0.03 $ 0.15 ========================================================================================================================
93 Pursuant to the requirements of Section 13 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. GREATER ATLANTIC FINANCIAL CORP. By: /s/ Carroll E. Amos ------------------- Carroll E. Amos Chief Executive Officer, President and Director Dated: February 1, 2007 94 EX-23.1 2 greateratl10kfeb107ex23-1.txt Exhibit 23.1 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors Greater Atlantic Financial Corp. We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (333-76169 and 333-92342) of our report dated January 30, 2007, relating to the consolidated financial statements of Greater Atlantic Financial Corp. appearing in the Company's Annual Report on Form 10-K for the year ended September 30, 2006. /s/ BDO Seidman, LLP Richmond, Virginia January 30, 2007 EX-31.1 3 grtatl10kfeb107ex31-1.txt Exhibit 31.1 CERTIFICATION I, Carroll E. Amos, Chief Executive Officer of Greater Atlantic Financial Corp., certify that: 1. I have reviewed this annual report on Form 10-K of Greater Atlantic Financial Corp.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15 (e) and 15d-15 (e) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this based on such; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.; Date: February 1, 2007 /s/ Carroll E. Amos ------------------- Carroll E. Amos Chief Executive Officer EX-31.2 4 grtatl10kfeb107ex31-2.txt Exhibit 31.2 CERTIFICATION I, David E. Ritter, Chief Financial Officer of Greater Atlantic Financial Corp., certify that: 1. I have reviewed this annual report on Form 10-K of Greater Atlantic Financial Corp.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15 (e) and 15d-15 (e) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this based on such; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: February 1, 2007 /s/ David E. Ritter ------------------- David E. Ritter Chief Financial Officer EX-32.1 5 grtatl10kfeb107ex32-1.txt Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Report of Greater Atlantic Financial Corp. (the "Company") on Form 10-K for the year ended September 30, 2006 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Carroll E. Amos, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C.ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that: (A) The Report fully complies with the requirements of Section 13(a) - 15(e) or 15(d) -15(e) of the Securities Exchange Act of 1934; and (B) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of and for the period covered by the Report. /s/ Carroll E. Amos ------------------- Carroll E. Amos Chief Executive Officer February 1, 2007 EX-32.2 6 grtatl10kfeb107ex32-2.txt Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Report of Greater Atlantic Financial Corp. (the "Company") on Form 10-K for the year ended September 30, 2006 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, David E. Ritter, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C.ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that: (A) The Report fully complies with the requirements of Section 13(a) -15(e) or 15(d) -15(e) of the Securities Exchange Act of 1934; and (B) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of and for the period covered by the Report. /s/ David E. Ritter - ------------------- David E. Ritter Chief Financial Officer February 1, 2007 -----END PRIVACY-ENHANCED MESSAGE-----