-----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, H2/wgSEiokixKpAFm6YjeCwCzf20/G/1KSKFgJqYpiiycKvF5q4x2Y4urVVM/TKJ gkie27lOnlNCPMdcUPDW0g== 0000909654-07-002981.txt : 20071228 0000909654-07-002981.hdr.sgml : 20071228 20071228102919 ACCESSION NUMBER: 0000909654-07-002981 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20070930 FILED AS OF DATE: 20071228 DATE AS OF CHANGE: 20071228 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: 071330490 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 greateratl10kdec-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, 2007 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 21, 2007, there were 3,024,220 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 Proposed Acquisition........................................................................... 3 Market Area and Competition.................................................................... 3 Market Risk.................................................................................... 3 Lending Activities............................................................................. 4 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..................................................................... 23 Item 1A. Risk Factors................................................................................... 24 Item 1B. Unresolved Staff Comments...................................................................... 26 Item 2. Properties..................................................................................... 27 Item 3. Legal Proceedings.............................................................................. 27 Item 4. Submission of Matters to a Vote of Security Holders............................................ 27 PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.............................................................................. 28 Item 6. Selected Financial Data........................................................................ 29 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation........... 31 Item 7A. Quantitative and Qualitative Disclosures About Market Risk..................................... 49 Item 8. Consolidated Financial Statements and Supplementary Data....................................... 50 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure........... 50 Item 9A. Controls and Procedures........................................................................ 50 Item 9B. Other Information.............................................................................. 51 PART III Item 10. Directors and Executive Officers of the Registrant............................................. 51 Item 11. Executive Compensation......................................................................... 53 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. 56 Item 13. Certain Relationships and Related Transactions................................................. 59 Item 14. Principal Accountant Fees and Services......................................................... 59 PART IV Item 15. Exhibits and Financial Statement Schedules..................................................... 59 Signatures ............................................................................................... 60
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 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. PROPOSED ACQUISITION As previously reported in a Form 8-K filed on April 16, 2007, we announced that the company and Summit Financial Group, Inc., entered into a definitive agreement for the company to merge with and into Summit. We also announced that the bank and Bay-Vanguard Federal Savings Bank entered into a definitive agreement for Bay-Vanguard to purchase the bank's branch office in Pasadena, Maryland. The sale of the Pasadena branch office was established as a condition to the completion of the pending merger of the company with and into Summit Financial Group, Inc. Originally the merger was expected to be completed in the fourth calendar quarter of 2007; however, as reported in a Form 8-K filed on December 10, 2007, effective December 6, 2007, the company and Summit amended their agreement to implement the parties' agreement to extend to March 31, 2008, the date on which the agreement may be terminated if the merger is not consummated by that date, subject to regulatory and shareholder approvals. Immediately following the merger, the bank intends to merge with and into Summit Community Bank. Under the agreement to sell its leased branch office located at 8070 Ritchie Highway, Pasadena, Maryland, to Bay-Vanguard, Bay-Vanguard paid the bank an 8.5% premium on the balance of deposits assumed at closing. At August 24, 2007, the closing date of that transaction, the deposits at our Pasadena branch office on which the deposit premium would apply totaled approximately $51.5 million with the bank recognizing a gain of $4.3 million. Bay-Vanguard also purchased the branch office's fixed assets, but did not acquire any loans as part of the transaction. 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 16 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. 3 LENDING ACTIVITIES GENERAL. Net loans receivable at September 30, 2007 were $176.1 million, a decrease of $17.2 million or 8.90% from the $193.3 million held at September 30, 2006. The decrease in loans consisted of real estate loans secured by consumer loans, construction and land loans, first mortgages on residential properties and commercial business loans, offset in part by an increase in commercial real estate loans and multi-family loans. Because the bank's single family and consumer loan portfolios consist primarily of adjustable-rate loans, and with the current yield curve, where short-term rates are only slightly lower than rates for longer terms, customers are able to refinance and extend the terms of their mortgages. Customers are also refinancing away from adjustable-rate loans and into longer term, fixed-rate loans or curtailing outstanding balances. The decrease in construction and land loans was primarily in the single-family residential sector of the market. The company anticipates that lending in that area will continue to decline as a result of the current slow sales pace occurring in the single-family market. The following table shows the bank's loan originations, purchases, sales and principal repayments during the periods indicated:
Year Ended September 30, ----------------------------------------- 2007 2006 2005 --------------------------------------------------------------------------------------------------------- (In Thousands) Total loans at beginning of period (1) $201,971 $224,733 $262,598 Originations of loans for investment: Single-family residential 5,169 12,559 6,624 Multifamily 3,215 625 - Commercial real estate 5,781 9,210 9,977 Construction 6,449 13,089 19,991 Land loans 240 8,494 10,530 Second trust - - - Commercial business 28,967 21,170 21,083 Consumer 29,604 39,048 44,205 --------------------------------------------------------------------------------------------------------- Total originations and purchases for investment 79,425 104,195 112,410 Loans originated for resale by Greater Atlantic Bank - - - Loans originated for resale by Greater Atlantic Mortgage - 91,477 276,038 --------------------------------------------------------------------------------------------------------- Total originations 79,425 195,672 388,448 Repayments (98,921) (117,440) (154,263) Sale of loans originated for resale by Greater Atlantic Mortgage - (100,994) (272,050) --------------------------------------------------------------------------------------------------------- Net activity in loans (19,496) (22,762) (37,865) --------------------------------------------------------------------------------------------------------- Total loans at end of period (1) $182,475 $201,971 $224,733 ========================================================================================================= (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, ---------------------------------------------------------------------------------------- 2007 2006 2005 2004 2003 ----------------- ---------------- ---------------- ----------------- ----------------- Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent ---------------------------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Mortgage loans: Single-family (1) $ 37,972 20.81% $ 43,473 21.52% $ 41,434 19.25% $ 74,620 29.02% $ 95,818 38.20% Multi-family 3,983 2.18 813 0.40 751 0.35 1,074 0.42 1,445 0.58 Construction 9,939 5.45 14,245 7.05 24,273 11.28 16,696 6.49 11,996 4.78 Commercial real estate 34,984 19.17 28,403 14.06 25,531 11.86 23,023 8.95 20,533 8.19 Land 8,097 4.44 13,829 6.86 18,421 8.55 20,668 8.04 17,258 6.88 ----------------- ----------------- ----------------- ---------------- ----------------- Total mortgage loans 94,975 52.05 100,763 49.89 110,410 51.29 136,081 52.92 147,050 58.63 ----------------- ----------------- ----------------- ---------------- ----------------- Commercial business and consumer loans: Commercial business 34,844 19.09 39,794 19.70 35,458 16.47 47,654 18.53 39,043 15.57 Consumer: Home equity 52,262 28.64 61,031 30.22 69,006 32.06 72,814 28.32 63,888 25.47 Automobile 48 .03 81 .04 100 .05 271 0.11 428 0.17 Other 346 .19 302 .15 274 .13 315 0.12 409 0.16 ----------------- ----------------- ----------------- ---------------- ----------------- Total commercial business and consumer loans 87,500 47.95 101,208 50.11 104,838 48.71 121,054 47.08 103,768 41.37 ----------------- ----------------- ----------------- ---------------- ----------------- Total loans 182,475 100.00% 201,971 100.00% 215,248 100.00% 257,135 100.00% 250,818 100.00% ====== ====== ====== ====== ====== Less: Allowance for loan losses (2,305) (1,330) (1,212) (1,600) (1,550) Loans in process (4,947) (8,517) (20,386) (10,453) (8,394) Unearned premium 885 1,183 1,270 1,305 1,379 -------- -------- -------- -------- -------- Loans receivable, net $176,108 $193,307 $194,920 $246,387 $242,253 ======== ======== ======== ======== ======== (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, net of loans-in-process (LIP) at September 30, 2007. 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, 2007 --------------------------------------------------------------- Multi- Commercial One- to Family and Business Four- Commercial and Total Loans, Family Real Estate Consumer (net of LIP) --------------------------------------------------------------------------------------------------------- (In Thousands) Amounts due in: One year or less $ 20,377 $ 11,762 $ 73,608 $105,747 After one year: More than one year to three years 8,185 9,881 3,047 21,113 More than three years to five years 1,103 12,547 3,351 17,001 More than five years to 15 years 5,692 5,526 4,192 15,410 More than 15 years 12,980 1,974 3,303 18,257 --------------------------------------------------------------------------------------------------------- Total amount due $ 48,337 $ 41,690 $ 87,501 $177,528 =========================================================================================================
5 The following table sets forth, at September 30, 2007, the dollar amount of loans contractually due after September 30, 2008, identifying whether such loans have fixed interest rates or adjustable interest rates. The risk of default on ARMs the industry is experiencing should not affect our portfolio because it is a seasoned portfolio. At September 30, 2007, the bank had $13.7 million of construction, acquisition and development, land and commercial business loans that were contractually due after September 30, 2008.
Due After September 30, 2008 ----------------------------------------------- Fixed Adjustable Total ------------------------------------------------------------------------------------------------------------ (In Thousands) Real estate loans: One- to four-family $18,155 $ 9,805 $27,960 Multi-family and commercial 14,944 14,984 29,928 ------------------------------------------------------------------------------------------------------------ Total real estate loans 33,099 24,789 57,888 Commercial business and consumer loans 8,431 5,462 13,893 ------------------------------------------------------------------------------------------------------------ Total loans $41,530 $30,251 $71,781 ============================================================================================================
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, 2007, the bank's one- to four-family mortgage loans totaled $38.0 million, or 20.81% of total loans. Of the one- to four-family mortgage loans outstanding at that date, 47.96% were fixed-rate loans and 52.04% 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, 2007, construction and development loans (including land loans) totaled $18.0 million, or 9.89%, of the bank's total loans, of which, land loans totaled $8.1 million or 4.44% 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, 2007 was $39.0 million, or 21.35% of total loans. The largest multi-family or commercial real estate loan in the bank's portfolio at September 30, 2007, consisted of a $3.9 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 $6.0 million note to another bank. COMMERCIAL BUSINESS LENDING. At September 30, 2007, the bank had $34.8 million in commercial business loans which amounted to 19.09% 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 with some being payable on demand, and all 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. 6 CONSUMER LENDING. Consumer loans at September 30, 2007 amounted to $52.7 million or 28.86% 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, 2007, those loans totaled $52.3 million or 28.64% of the bank's total loans. Other types of consumer loans consisted primarily of secured and unsecured personal loans and loans on new and used automobiles, totaling $394,000, or 0.22% of the bank's total loans and 0.45% of commercial business and consumer loans at September 30, 2007. MORTGAGE BANKING ACTIVITIES The bank's mortgage banking activities primarily consisted of originating mortgage loans secured by single-family properties and were conducted in Greater Atlantic Mortgage Corporation, a subsidiary of the bank. That activity was discontinued effective March 29, 2006, because it was unprofitable, and 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 the mortgage banking subsidiary's originations had been declining, resulting in losses from mortgage banking 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 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 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." 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, 2007, the bank had $4.7 million of loans designated as Substandard which consisted of one residential loan, three commercial business loans, two construction development and one land loan. At that same date, the bank had $675,000 of assets classified as Doubtful, consisting of one commercial business loan and one construction development loan. At September 30, 2007, the bank had no loans classified as Loss and one $887,000 construction loan classified as Special Mention. 7
The following table sets forth delinquencies in the bank's loans as of the dates indicated. At September 30, ---------------------------------------------------------------------------------------------------------- 2007 2006 2005 ---------------------------------- ---------------------------------- ------------------------------------ 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 $ 19 - $ - 2 $ 835 2 $ 168 4 $ 10 Home equity 2 347 - - - - - - - - 2 229 Construction & Land - - 2 1,330 - - 1 31 - - 2 233 Commercial real estate - - - - - - 1 25 - - 1 25 Commercial business - - - - - - 2 216 - - 3 1,105 Consumer - - - - - - 1 3 - - 1 2 ------------------------------------------------------------------------------------------------------------------------------- Total 2 $ 347 4 $1,349 - $ - 7 $ 1,110 2 $ 168 13 $1,604 =============================================================================================================================== NON-PERFORMING ASSETS AND IMPAIRED LOANS. The following table sets forth information regarding non-accrual loans and real estate owned. 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. At September 30, --------------------------------------------- 2007 2006 2005 2004 2003 ----------------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Loans accounted for on a non-accrual basis Mortgage loans: Single-family $ 16 $ - $ 10 $ 563 $ 637 Home equity - - 229 96 - Commercial real estate - 25 25 29 31 Construction and Land 1,330 31 233 31 34 Commercial business - 216 1,105 228 716 Consumer - 3 2 6 - ----------------------------------------------------------------------------------------------------------------- Total non-accrual loans 1,346 275 1,604 953 1,418 Accruing loans which are contractually past due 90 days or more 3 835 - - 28 ----------------------------------------------------------------------------------------------------------------- Total of non-accrual and 90 days past due loans 1,349 1,110 1,604 953 1,446 Foreclosed real estate, net - - 232 - - ----------------------------------------------------------------------------------------------------------------- Total non-performing assets $1,349 $1,110 $1,836 $ 953 $1,446 ================================================================================================================= Non-accrual loans as a percentage of loans held for investment, net 0.76% 0.14% 0.82% 0.39% 0.59% ================================================================================================================= Non-accrual and 90 days or more past due loans as a percentage of loans held for investment, net 0.77% 0.57% 0.82% 0.39% 0.60% ================================================================================================================= Non-accrual and 90 days or more past due loans as a percentage of total assets 0.55% 0.36% 0.47% 0.22% 0.29% ================================================================================================================= Non-performing assets as a percentage of total assets 0.55% 0.36% 0.54% 0.22% 0.29% =================================================================================================================
8 During the year ended September 30, 2007, 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 $110,000. The company considers a loan to be impaired if it is probable that the company 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 alternative, 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. Our total recorded investment in impaired collateral dependent loans at September 30, 2007 was $2.5 million and the related allowance associated with impaired loans was $627,000. There were no impaired loans in the comparable period one year ago. At September 30, 2007, all impaired loans had a related allowance. 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, 2007, the bank's allowance for loan losses amounted to $2.3 million or 1.26% of total loans. The allowance for loan losses to total non-performing loans at September 30, 2007 was 170.87%; as a percentage of total loans, the allowance was increased 60 basis points when compared to September 30, 2006. A $685,000 provision for loan losses was recorded during the year ended September 30, 2007, compared to a provision of $126,000 during the year ended September 30, 2006. The $559,000 increase in the provision for loan losses from the year ago period resulted from the increase in non-performing assets, an increase in the outstanding balance of the bank's commercial real estate loans and an increase of $3.9 million in loans classified as substandard each of which requires an additional allocation of the bank's overall provision. Those were coupled with an increase of $356,000 in loans classified as doubtful. That increase in provision for those loans was offset 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 had 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 evaluating 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. However, because we entered into a definitive agreement for the company to merge with Summit, and based on the due diligence performed by Summit, it was deemed unnecessary to enter into such a contract for the fiscal year ended September 30, 2007. 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, ------------------------------------------------------------ 2007 2006 2005 2004 2003 ----------------------------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Balance at beginning of period $ 1,330 $ 1,212 $ 1,600 $ 1,550 $ 1,699 Provisions 685 126 219 209 855 Charge-offs: Mortgage loans: Single-family 128 - 33 20 162 Commercial real estate - - - - 22 Commercial business 210 78 584 177 828 Consumer 15 2 8 3 8 ----------------------------------------------------------------------------------------------------------------------------- Total charge-offs 353 80 625 200 1,020 Recoveries: Mortgage loans: Single-family 8 2 2 29 6 Commercial real estate - - - - - Commercial business 635 69 15 10 4 Consumer - 1 1 2 6 ----------------------------------------------------------------------------------------------------------------------------- Total recoveries 643 72 18 41 16 Net charge-offs (recoveries) (290) 8 607 159 1,004 ----------------------------------------------------------------------------------------------------------------------------- Balance at end of period $ 2,305 $ 1,330 $ 1,212 $ 1,600 $ 1,550 ============================================================================================================================= Ratio of net charge-offs (recoveries) during the period (0.16)% 0.00% 0.28% 0.06% 0.36% to average loans outstanding during the period ============================================================================================================================= Allowance for loan losses to total non-performing loans at end of period 170.87% 119.82% 75.56% 167.89% 109.31% ============================================================================================================================= Allowance for loan losses to total loans 1.26% 0.66% 0.56% 0.62% 0.62% =============================================================================================================================
10 The following table sets forth the bank's allowance for loan losses in each of the categories listed and the percentage of loans in each category 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, ----------------------------------------------------------------------------------------------------- 2007 2006 2005 2004 2003 -------------------- -------------------- -------------------- ------------------- ------------------ 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 $ 21 20.81% $ 177 21.52% $ 35 19.25% $ 110 29.02% $ 141 38.20% Multi-family 30 2.18 6 0.40 6 0.35 8 0.42 11 0.58 Construction 177 5.45 67 7.05 72 11.28 78 6.49 80 4.78 Commercial real estate 350 19.17 286 14.06 328 11.86 233 8.95 208 8.19 Land 562 4.44 109 6.86 155 8.55 175 8.04 132 6.88 - ------------------------------------------------------------------------------------------------------------------------------------ Total mortgage loans 1,140 52.05 645 49.89 596 51.29 604 52.92 572 58.63 - ------------------------------------------------------------------------------------------------------------------------------------ Commercial and Consumer: Commercial 959 19.09 525 19.70 407 16.47 515 18.53 770 15.57 Consumer: Home equity 131 28.64 152 30.22 195 32.06 213 28.32 159 25.47 Automobile 6 0.22 6 0.19 5 0.18 9 0.23 13 0.33 - ------------------------------------------------------------------------------------------------------------------------------------ Total commercial and consumer loans 1,096 47.95 683 50.11 607 48.71 737 47.08 942 41.37 - ------------------------------------------------------------------------------------------------------------------------------------ Unallocated 69 N/A 2 N/A 9 N/A 259 N/A 36 N/A - ------------------------------------------------------------------------------------------------------------------------------------ Total $2,305 100.00% $1,330 100.00% $1,212 100.00% $1,600 100.00% $1,550 100.00% ====================================================================================================================================
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. The bank does not hold any securities bought and held principally for sale in the near term, which would be, classified as held for trading. At September 30, 2007, the bank had invested $16.5 million in mortgage-backed securities, or 6.71% of total assets, of which $16.3 million were classified as available-for-sale and $207,000 were classified as held-to-maturity. This portfolio is seasoned with no purchases during fiscal year 2007. 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, ------------------------------------------------------------------------------- 2007 2006 2005 -------------------------- ------------------------ --------------------------- Estimated Estimated Estimated Amortized Market Amortized Market Amortized Market Cost Value Cost Value Cost Value --------------------------------------------------------------------------------------------------------------- (In Thousands) Available-for-sale: Corporate debt securities $ 7,300 $ 6,748 $ 7,280 $ 7,142 $ 6,736 $ 6,736 CMOs 7,191 7,087 9,735 9,755 14,446 14,454 U.S. Government SBA's 19,395 18,754 27,629 27,199 30,239 29,781 FHLMC MBS's 2,961 2,920 5,549 5,463 9,044 8,969 FNMA MBS's 8,357 8,141 18,350 17,986 35,548 34,947 GNMA MBS's 5,382 5,260 8,133 7,916 13,097 12,942 --------------------------------------------------------------------------------------------------------------- Total available-for-sale 50,586 48,910 76,676 75,461 109,110 107,829 --------------------------------------------------------------------------------------------------------------- Held-to-maturity: Corporate debt securities - - - 1,000 1,020 U.S. Government SBA's 2,846 2,742 4,461 4,230 6,531 6,213 FHLMC MBS's 104 102 128 125 236 235 FNMA MBS's 103 101 107 105 202 198 --------------------------------------------------------------------------------------------------------------- Total held-to-maturity 3,053 2,945 4,696 4,460 7,969 7,666 --------------------------------------------------------------------------------------------------------------- Total investment securities $53,639 $51,855 $81,372 $79,921 $117,079 $115,495 =============================================================================================================== Investment securities with: Fixed rates $ - $ - $ - $ - $ 1,000 $ 1,020 Adjustable rates 36,732 35,331 49,105 48,326 57,952 57,184 Mortgage-backed securities with: Fixed rates 174 168 243 236 393 376 Adjustable rates 16,733 16,356 32,024 31,359 57,734 56,915 --------------------------------------------------------------------------------------------------------------- Total $53,639 $51,855 $81,372 $79,921 $117,079 $115,495 =============================================================================================================== As of September 30, 2007, the bank held investments in available for sale with unrealized holding losses totaling $1.7 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 $ 2,048 $ 149 $ 4,700 $ 403 $ 6,748 $ 552 CMOs 4,124 108 1,934 28 6,058 136 U.S. Government securities SBA 3,196 38 15,558 603 18,754 641 GNMA - - 5,260 122 5,260 122 U.S. Government agency securities: FHLMC MBS's - - 2,920 41 2,920 41 FNMA MBS's - - 8,141 216 8,141 216 --------------------------------------------------------------------------------------------------------------- Total $ 9,368 $ 295 $ 38,513 $1,413 $ 47,881 $ 1,708 ===============================================================================================================
12 The table below sets forth certain information regarding the carrying value, weighted average yields and contractual maturities of the bank's investment securities and mortgage-backed securities available-for-sale.
At September 30, 2007 ------------------------------------------------------------------------------------------------------- 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 $ - -% $ - -% $ - -% $ 7,087 6.52% $ 7,087 6.52% Corporate debt - - - - 2,760 5.08 3,988 6.83 6,748 6.12 U.S. Government SBA's - - - - 485 7.54 18,269 4.86 18,754 4.92 ------------------------------------------------------------------------------------------------------------------------------ Total - - - - 3,245 5.45 29,344 5.53 32,589 5.52 ------------------------------------------------------------------------------------------------------------------------------ MBS's available for sale: Adjustable-rate securities: FHLMC - - - - - - 2,920 6.95 2,920 6.95 FNMA - - - - - - 7,995 5.77 7,995 5.77 GNMA - - - - - - 5,260 5.57 5,260 5.57 ------------------------------------------------------------------------------------------------------------------------------ Total - - - - - - 16,175 6.01 16,175 6.01 ------------------------------------------------------------------------------------------------------------------------------ MBS'S fixed-rate: FNMA - - 146 7.00 - - - - 146 7.00 ------------------------------------------------------------------------------------------------------------------------------ Total - - 146 7.00 - - - - 146 7.00 ------------------------------------------------------------------------------------------------------------------------------ Total mortgage-backed securities available- for-sale - - 146 7.00 - - 16,175 6.01 16,321 6.02 ------------------------------------------------------------------------------------------------------------------------------ Total investment portfolio $ - -% $146 7.00% $3,245 5.45% $45,519 5.70% $48,910 5.69% ============================================================================================================================== The table below sets forth certain information regarding the carrying value, weighted average yields and contractual maturities of the bank's investment securities and mortgage-backed securities held to maturity. At September 30, 2007 -------------------------------------------------------------------------------------------------------- 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 $ - -% $- -% $380 6.62% $2,466 4.32% $2,846 4.63% Fixed-rate: Corporate debt - - - - - - - - - - - ------------------------------------------------------------------------------------------------------------------------------------ Total investment securities - - - - 380 6.62 2,466 4.32 2,846 4.63 held-to-maturity - ------------------------------------------------------------------------------------------------------------------------------------ MBS's held-to-maturity: Adjustable-rate securities: FHLMC - - - - - - 104 7.23 104 7.23 FNMA - - - - - - 81 7.26 81 7.26 - ------------------------------------------------------------------------------------------------------------------------------------ Total - - - - - - 185 7.24 185 7.24 - ------------------------------------------------------------------------------------------------------------------------------------ Fixed-rate: FNMA - - - - - - 22 6.50 22 6.50 - ------------------------------------------------------------------------------------------------------------------------------------ Total - - - - - - 22 6.50 22 6.50 - ------------------------------------------------------------------------------------------------------------------------------------ Total mortgage-backed securities held-to-maturity - - - - - - 207 7.16 207 7.16 - ------------------------------------------------------------------------------------------------------------------------------------ Total held-to-maturity investments $ - -% $0 -% $380 6.62% $2,673 4.54% $3,053 4.80% ====================================================================================================================================
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, 2007, $107.7 million, or 85.70% 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, ------------------------------------------------------------------------------ 2007 2006 -------------------------------------- --------------------------------------- Percent of Percent of Total Rate Total Rate Balance Deposits Paid Balance Deposits Paid - -------------------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Savings accounts $ 2,468 1.25% 0.97% $ 3,679 1.60% 0.98% Now and money market accounts 60,625 30.62 3.61 73,334 31.86 3.51 Certificates of deposit 125,717 63.49 5.00 127,939 55.58 4.55 Noninterest-bearing deposits: Demand deposits 9,181 4.64 - 25,222 10.96 - - -------------------------------------------------------------------------------------------------------------------- Total deposits $197,991 100.00% 4.29% $230,174 100.00% 3.67% ==================================================================================================================== 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, 2007 ----------------------------- Amount Rate ------------------------------------------------------------------------------------------------ (Dollars in Thousands) Balance maturing: Three months or less $ 52,127 5.04% Three months to one year 55,609 5.04 One year to three years 15,098 4.70 Over three years 2,883 4.97 ------------------------------------------------------------------------------------------------ Total $125,717 5.00% ================================================================================================
14 At September 30, 2007, the bank had $43.1 million in certificate accounts in amounts of $100,000 or more maturing as follows:
Weighed Average Maturity Period Amount Rate ------------------------------------------------------------------------------------------------ Three months or less $20,526 5.13% Over 3 through 6 months 10,372 5.13 Over 6 through 12 months 7,664 5.08 Over 12 months 4,542 4.71 ------------------------------------------------------------------------------------------------ Total $43,104 5.07% ================================================================================================ The following table sets forth the deposit activity of the bank for the periods indicated. At or For the Year Ended September 30, ------------------------------------------- 2007 2006 2005 ------------------------------------------------------------------------------------------------ (In Thousands) Balance at beginning of period $230,174 $237,794 $288,956 Net deposits (withdrawals) before interest credited (41,514) (15,329) (57,499) Interest credited 9,331 7,709 6,337 ------------------------------------------------------------------------------------------------ Net increase (decrease) in deposits (32,183) (7,620) (51,162) ------------------------------------------------------------------------------------------------ Ending balance $197,991 $230,174 $237,794 ================================================================================================ BORROWINGS. At September 30, 2007, borrowings consisted of FHLB advances and reverse repurchase agreements totaling $27.2 million. FHLB advances amounted to $25.0 million at September 30, 2007, a decrease from the $36.0 million outstanding at September 30, 2006, and other borrowings (reverse repurchase agreements) amounted to $2.2 million, a decrease of $16.4 million compared to $18.6 million at September 30, 2006. During the fiscal year ended September 30, 2007, 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, ------------------------------------------ 2007 2006 2005 ----------------------------------------------------------------------------------------------------------------- FHLB Advances: Average balance outstanding $ 33,064 $ 44,894 $ 44,422 Maximum amount outstanding at any month-end during the period 39,000 51,000 49,200 Balance outstanding at end of period 25,000 36,000 38,000 Weighted average interest rate during the period 5.46% 5.05% 4.47% Weighted average interest rate at end of period 5.92% 5.28% 4.85% Reverse repurchase agreements: Average balance outstanding 15,264 31,624 58,837 Maximum amount outstanding at any month-end during the period 10,857 35,641 62,846 Balance outstanding at end of period 2,192 18,574 38,479 Weighted average interest rate during the period 5.61% 4.21% 4.37% Weighted average interest rate at end of period 2.52% 4.65% 3.69%
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 20 to the financial statements. PERSONNEL As of September 30, 2007, we had 54 full-time employees and 9 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, an insured federal savings association, 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, and elsewhere in this document does not purport to be a complete description of such statutes and regulations and their effects on the Bank and the company and is qualified in its entirety by reference to the actual laws and regulations. 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 factors such as 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 effects. 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 regulatory capital requirements or specific restrictions on the payment of dividends or other capital distributions, federal regulations do prescribe such restrictions on subsidiary savings associations. The bank must notify the Office of Thrift Supervision (30) days before declaring any dividend to the company and comply with the additional restrictions described below. 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. On October 4, 2007, Summit filed an application with the Federal Reserve Bank of Richmond to acquire the company and thereby, indirectly, to acquire the bank pursuant to Section 4 of the Bank Holding Company Act and Federal Reserve Regulation Y. The Reserve Bank referred the application to the Board because action under delegated authority was not appropriate. Accordingly, the application is being processed by the Division of Banking Supervision and Regulation of the Board of Governors in Washington, D.C. Summit was notified that, based on the staff's review of the record, additional information was being requested. Subsequently, in order to respond to the request from the Board of Governors and comply with internal application processing guidelines, Summit requested that processing of the application be suspended until such time as the staff of the Board of Governors and Summit consent to the continuation of processing. 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 business 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 associations to meet three minimum capital standards: a 1.5% tangible capital to total assets ratio, a 4% tier 1 capital to total assets 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 associations requires the maintenance of Tier 1 (core) capital and total capital (which is defined as core capital and supplementary capital less certain specified deductions from total capital such as reciprocal holdings of depository institution capital, instruments and equity investments) 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 activities, 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 generally 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 (Tier 2) currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible debt 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. 18 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, 2007, the bank met each of its capital requirements. The following table presents the bank's capital position at September 30, 2007.
Capital Excess -------------------------- Actual Required (Deficiency) Actual Required Capital Capital Amount Percent Percent - --------------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Tangible $18,830 $ 3,684 $15,146 7.67% 1.50% Core (Leverage) 18,830 9,825 9,005 7.67 4.00 Risk-based 20,874 13,630 7,244 12.25 8.00
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 associations with the highest examination rating) is considered to be "undercapitalized." A association 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 association is deemed to have received notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." Compliance with the plan must be guaranteed by any parent holding company in the amount of up to the lesser of 5% of the savings association's total assets when it was deemed to be undercapitalized or the amount necessary to achieve compliance with applicable capital requirements. 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 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. No institution may pay a dividend if in default of its FDIC assessment. 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, credits could be used beginning in 2007 to offset assessments until exhausted. The bank's one-time credit approximated $65,529. 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. 19 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 a predecessor deposit insurance fund. That payment is established quarterly and during fiscal 2007, Financing Corporation payments for savings associations approximated 1.18 basis points of assessable deposits. The Reform Act provided the Federal Deposit Insurance Corporation with authority to adjust the Deposit Insurance Fund ratio to insured deposits within a range of 1.15% and 1.50%, in contrast to the prior statutorily fixed ratio of 1.25%. The ratio, which is viewed by the Federal Deposit Insurance Corporation as the level that the fund should achieve, has been established by the agency at 1.25% for 2008, which was unchanged from 2007. The bank's total assessment paid for this period (including the FICO assessment) was $204,021. The Federal Deposit Insurance Corporation has authority to increase insurance assessments. A significant increase in 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. Generally, subject to certain exceptions, a savings association 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, 2007,the bank's limit on loans to one borrower was $3.2 million, and the bank's largest aggregate outstanding loan to one borrower was $4.0 million. Part of that loan and any other loan in excess of the loans to one borrower limit will be sold in the form of a participation. QTL TEST. Federal law 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 but also defined to include education, credit card and small business loans) 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, 2007, Greater Atlantic maintained 71% of its portfolio assets in qualified thrift investments and, therefore, met the qualified thrift lender test. 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 and Community Reinvestment Act 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 the bank, it is a subsidiary of a holding company. In the event the bank's capital fell below its regulatory requirements or the Office of Thrift Supervision notified it that it was in need of increased 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 Office of Thrift Supervision that it 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). The amount accrued at September 30, 2007, totaled $644,000. 20 ASSESSMENTS. Savings associations 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 association's total assets, including consolidated subsidiaries, its financial condition and complexity of its portfolio. The assessments paid by the bank for the fiscal year ended September 30, 2007, totaled $139,095. TRANSACTIONS WITH RELATED PARTIES. The bank's authority to engage in transactions with "affiliates" (E.G., any company that controls or is under common control with an institution, including the company) 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 association. The aggregate amount of covered transactions with all affiliates is limited to 20% of the savings association's capital and surplus. Certain transactions with affiliates are required to be secured by collateral in an amount and of a type specified 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 associations are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings association 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 a depository institution 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. Loans to executive officers are subject to additional limitations based on the type of loan involved. ENFORCEMENT. The Office of Thrift Supervision has primary enforcement responsibility over savings associations 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. 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 in various areas such as internal controls and information systems, internal audit, loan documentation and credit underwriting, interest rate exposure, asset growth and quality, earnings and compensation, fees and benefits.. 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 The bank is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank provides a central credit facility primarily for member institutions. As a member of the Federal Home Loan Bank, the 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. The bank was in compliance with this requirement with an investment in Federal Home Loan Bank stock at September 30, 2007 of $1.7 million. 21 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 $43.9 million; for a 10% ratio is applied above $43.9 million. The first $9.3 million of otherwise reservable balances (subject to adjustments by the Federal Reserve Board) is 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." 22 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 2007 fiscal year, except for the AMT, they have not recorded 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. 23 ITEM 1A. RISK FACTORS OUR INCREASED EMPHASIS ON COMMERCIAL AND CONSTRUCTION LENDING MAY EXPOSE US TO INCREASED LENDING RISKS. At September 30, 2007, our loan portfolio consisted of $35.0 million, or 19.17% of commercial real estate loans, $18.0 million, or 9.89% of construction and land development loans and $34.8 million, or 19.10% of commercial business 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. 24 A DOWNTURN IN THE WASHINGTON D.C. METROPOLITAN AREA ECONOMY, A DECLINE IN REAL ESTATE VALUES OR DISRUPTIONS IN THE SECONDARY MORTGAGE MARKETS COULD REDUCE OUR EARNINGS AND FINANCIAL CONDITION. Most of our loans are secured by real estate. As a result, a downturn in this market area could cause significant increases in nonperforming loans, which would reduce our profits. Additionally, a decrease in asset quality could require additions to our allowance for loan losses through increased provisions for loan losses, which would also reduce our profits. In prior years, there had been significant increases in real estate values in our market area. As a result of rising home prices, our loans have been well collateralized. However, a decline in real estate values could cause some of our mortgage loans to become inadequately collateralized, which would expose us to a greater risk of loss. The secondary mortgage markets are experiencing disruptions resulting from reduced investor demand for mortgage loans and mortgaged-backed securities and increased investor yield requirements for those loans and securities. These conditions may continue or worsen in the future. As a result, a prolonged period of secondary market illiquidity could have an adverse impact on our future earnings and financial condition. CONSEQUENCES IF MERGER WITH SUMMIT DOESN'T OCCUR. The company entered into an agreement, to merge with and into Summit. In approving the merger agreement, the board of directors consulted with Sandler O'Neill regarding the fairness of the transaction to the company's stockholders from a financial point of view and with the company's legal counsel regarding its legal duties and the terms of the merger agreement and ancillary documents. The understanding of the board of directors of the options available to the company and the assessment of those options with respect to the prospects and estimated results of the implementation by the company of its business plan as an independent entity under various scenarios, and the determination that none of those options or the realization of the business plan under the best case scenarios were likely to create greater present value for the company's stockholders than the value to be paid by Summit. On the other hand, if the merger is not consummated the company's ability to achieve consistent profitability by selling a number of branches to increase capital and reduce overall operating cost would be the next option and, if that option was not successful, the prospects for regulatory action would be the most likely. 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. 25 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 of September 30, 2007, the bank was considered a well capitalized institution. Should the bank be classified as an adequately capitalized institution, the bank could not issue brokered certificates of deposit without the permission of the Office of Thrift Supervision or the Federal Deposit Insurance Corporation. At September 30, 2006, the bank was classified as an adequately capitalized institution and the Office of Thrift Supervision limited the payment of dividends from the bank to the company. Without the payment of a dividend from the bank, the company was unable to make a distribution on the cumulative convertible trust preferred securities. When, on December 13, 2006, the bank was advised by the Office of Thrift Supervision that it would not approve the bank's application to pay a cash dividend to the company, the company exercised its right to defer the scheduled quarterly distributions 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, 2007. 26 ITEM 2. PROPERTIES During fiscal year 2007, we conducted our business from five full-service banking offices and our administrative office. The following table sets forth certain information concerning the bank's offices as of September 30, 2007.
Net Book Value of Property or Leasehold Original Improvements Year Date of at Leased or Leased or Lease September 30, Location Owned Acquired Expiration 2007 ------------------------------------------------------------------------------------------------------------------ (In Thousands) ADMINISTRATIVE OFFICES: 10700 Parkridge Boulevard Reston, Virginia 20191 Leased 1998 01-31-11 $ 65 BRANCH OFFICES: 11834 Rockville Pike Rockville, Maryland 20852 Leased 1998 06-30-09 4 10700 Parkridge Boulevard Reston, Virginia 20191 Leased 2004 01-31-11 303 43086 Peacock Market Plaza South Riding, Virginia 20152 Leased 2000 06-30-15 201 1 South Royal Avenue Front Royal, Virginia 22630 Owned 1977 687 9484 Congress Street New Market, Virginia 22844 Owned 1989 405 LOAN OFFICES: 2200 Defense Highway Crofton, Maryland 21114 Leased 2002 11-30-08 1 12530 Parklawn Drive, Suite 170 Rockville, Maryland 20852 Leased 2005 06-30-10 36 ------------------------------------------------------------------------------------------------------------------ Total $1,702 ==================================================================================================================
The total net book value of the company's furniture, fixtures and equipment at September 30, 2007 was $2.3 million. The properties are considered by management to be in good condition. ITEM 3. LEGAL PROCEEDINGS The company is not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business. Such routine legal proceedings, in the aggregate, are believed by management to be immaterial to the company's financial condition, results of operations or cash flows. 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, 2007, through the solicitation of proxies or otherwise. 27 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES MARKET INFORMATION. The Pink Sheets report trades of the company's stock under the symbol GAFC.PK. At September 30, 2007, there were approximately 278 stockholders of record. The following table sets forth the range of reported high and low bid quotations as reported in the Pink Sheets for the common stock for the periods indicated.
First Second Third Fourth Quarter Ended Quarter Ended Quarter Ended Quarter Ended December 31 March 31 June 30 September 30 --------------------------------------------------------------------------------------------------- Fiscal Year 2007 High 5.10 4.26 5.05 5.35 Low 4.26 2.25 2.25 4.69 Fiscal Year 2006 High 5.41 5.95 5.76 5.35 Low 4.84 4.60 5.00 4.60 ---------------------------------------------------------------------------------------------------
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, 2007. 28 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, 2007 2006 2005 2004 2003 -------------------------------------------------------------------------------------------------------------- (In Thousands, Except Per Share Data) Consolidated Statements of Operations Data: Interest income $18,421 $18,794 $16,958 $18,085 $ 19,361 Interest expense 11,993 11,583 10,013 11,970 12,277 -------------------------------------------------------------------------------------------------------------- Net interest income 6,428 7,211 6,945 6,115 7,084 Provision for loan losses 685 126 219 209 791 -------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 5,743 7,085 6,726 5,906 6,293 Noninterest income 615 917 1,695 547 766 Gain on branch sales 4,255 - 945 - - Noninterest expense 9,626 11,085 9,889 10,370 10,014 -------------------------------------------------------------------------------------------------------------- Income (loss) from continuing operations before taxes 987 (3,083) (523) (3,917) (2,955) Provision for income taxes 36 - - - - -------------------------------------------------------------------------------------------------------------- Income (loss) from continuing operations 951 (3,083) (523) (3,917) (2,955) Discontinued operations: (Loss) income from operations - (2,488) (1,107) 428 4,898 -------------------------------------------------------------------------------------------------------------- Net income (loss) $ 951 $(5,571) $(1,630) $(3,489) $ 1,943 ============================================================================================================== Per Share Data: Net income (loss): Basic $ 0.31 $ (1.84) $ (0.54) $ (1.16) $ 0.65 Diluted $ 0.31 $ (1.84) $ (0.54) $ (1.16) $ 0.44 Book value 3.17 2.93 4.76 5.29 6.79 Tangible book value 3.29 2.96 4.80 5.22 6.38 Weighted average shares outstanding: Basic 3,023,407 3,020,934 3,015,509 3,012,434 3,012,434 Diluted 4,395,008 3,020,934 3,015,509 3,012,434 4,413,462 Shares outstanding 3,024,220 3,020,934 3,020,934 3,012,434 3,012,434 Consolidated Statements of Financial Condition Data: Total assets $245,994 $305,219 $339,542 $433,174 $498,456 Total loans receivable, net 176,108 193,307 194,920 246,387 242,253 Allowance for loan losses 2,305 1,330 1,212 1,600 1,550 Mortgage-loans held for sale - - 9,517 5,528 6,554 Investment securities (1) 35,435 48,557 58,502 60,285 138,049 Mortgage-backed securities 16,528 31,600 57,296 92,722 86,735 Total deposits 197,991 230,174 237,794 288,956 297,876 FHLB advances 25,000 36,000 38,000 51,200 86,800 Other borrowings 2,192 18,574 38,479 64,865 77,835 Guaranteed convertible preferred securities of subsidiary trust 9,374 9,388 9,378 9,369 9,359 Total stockholders' equity 9,571 8,850 14,375 15,944 20,442 Tangible capital 9,939 8,943 14,514 15,379 19,228
29
SELECTED FINANCIAL DATA - (CONTINUED) --------------------------------------------------------------------------------------------------------------- At or For the Years Ended September 30, 2007 2006 2005 2004 2003 --------------------------------------------------------------------------------------------------------------- (In Thousands, Except Per Share Data) Average Consolidated Statements of Financial Condition Data Total assets $284,136 $315,133 $370,729 $504,039 $477,882 Investment securities(1) 64,011 66,789 70,633 123,198 161,161 Mortgage-backed securities(1) 23,848 43,979 77,424 111,016 51,046 Total loans 184,570 193,688 210,152 253,772 251,386 Allowance for loan losses 1,559 1,264 1,609 1,498 1,696 Total deposits 214,118 210,311 245,518 275,636 279,469 Total stockholders' equity 7,871 12,164 13,830 15,236 15,132 Performance Ratios (2) Return on average assets 0.33% (1.77)% (0.44)% (0.69)% 0.41% Return on average equity 12.08 (45.80) (11.79) (22.90) 12.83 Equity to assets 3.89 2.90 4.23 3.68 4.10 Net interest margin 2.36 2.37 1.94 1.68 1.53 Efficiency ratio(3) 85.20 136.38 103.17 155.66 127.58 Asset Quality Data: Non-performing assets to total assets, at period end 0.55 0.36 0.54 0.22 0.28 Non-performing loans to total loans, at period end 0.74 0.55 0.75 0.37 0.57 Net charge-offs (recoveries) to average total loans (0.16) 0.00 0.28 0.06 0.36 Allowance for loan losses to: Total loans 1.26% 0.66% 0.56% 0.62% 0.62% Non-performing loans 170.87 119.82 75.56 167.89 109.31 Non-performing loans $ 1,349 $ 1,110 $ 1,604 $ 953 $ 1,418 Non-performing assets 1,349 1,110 1,836 953 1,446 Allowance for loan losses 2,305 1,330 1,212 1,600 1,550 Capital Ratios of the Bank: Leverage ratio 7.67% 5.51% 6.66% 5.59% 5.68% Tier 1 risk-based capital ratio 11.00 8.59 10.25 9.81 12.08 Total risk-based capital ratio 12.25 9.11 10.75 10.42 12.70
(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 30 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. PROPOSED ACQUISITION As previously reported in a Form 8-K filed on April 16, 2007, we announced that the company and Summit Financial Group, Inc., entered into a definitive agreement for the company to merge with and into Summit. We also announced that the bank and Bay-Vanguard Federal Savings Bank entered into a definitive agreement for Bay-Vanguard to purchase the bank's branch office in Pasadena, Maryland. The sale of the Pasadena branch office was established as a condition to the completion of the pending merger of the company with and into Summit Financial Group, Inc. Originally the merger was expected to be completed in the fourth calendar quarter of 2007; however, as reported in a Form 8-K filed on December 10, 2007, effective December 6, 2007, the company and Summit amended their agreement to implement the parties' agreement to extend to March 31, 2008, the date on which the agreement may be terminated if the merger is not consummated by that date, subject to regulatory and shareholder approvals. Immediately following the merger, the bank intends to merge with and into Summit Community Bank. GENERAL The profitability of the company depends primarily on its net-interest income and non-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. Non-interest income consists primarily of gain on sales of loans, derivatives and available-for-sale investments and fees from service charges on deposits and loans. The level of its operating expenses also affects the company's profitability. Operating expenses consist primarily of salaries and employee benefits, occupancy-related expenses, equipment and technology-related expenses and other general operating expenses. 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. 31 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 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, 2007, the company had deferred tax assets of $2.1 million, which is net of a valuation allowance of $3.5 million. RECENT ACCOUNTING STANDARDS In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements". This statement clarifies the definition of fair value, establishes a framework for measuring fair value and expands the disclosures on fair value measurements. For financial assets and liabilities, SFAS No. 157 is effective for fiscal years beginning after November 15, 2008. We do not believe the adoption of SFAS 157 will have a material impact on the consolidated financial statements. In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" (SFAS 159).This statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective of this Statement is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The fair value option established by this Statement permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The fair value option may be applied instrument by instrument and is irrevocable. SFAS 159 is effective as of the beginning of an entity's first fiscal year that begins after November 15, 2007. The company is in the process of evaluating the impact SFAS 159 may have on its consolidated financial statements. In December 2007, the FASB issued SFAS No. 141 (R), "Business Combinations", to create greater consistency in the accounting and financial reporting of business combinations. SFAS 141 (R) requires a company to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquired entity to be measured at their fair values as of the acquisition date. SFAS 141 (R) also requires companies to recognize and measure goodwill acquired in a business combination or a gain from a bargain purchase and how to evaluate the nature and financial effects of the business combination. SFAS No. 141(R) applies to fiscal years beginning after December 15, 2008 and is adopted prospectively. Earlier adoption is prohibited. We have not determined the effect, if any, the adoption of this statement will have on our results of operations or financial position. In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements -- an amendment of ARB No. 51", to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 requires company to clearly identify and present ownership interests in subsidiaries held by parties other than the company in the consolidated financial statements within the equity section but separate from the company's equity. It also requires the amount of consolidated net income attributable to the parent and to the noncontrolling interest be clearly identified and presented on the face of the consolidated statement of income; changes in ownership interest be accounted for similarly, as equity transactions; and when a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary and the gain or loss on the deconsolidation of the subsidiary be measured at fair value. SFAS No. 160 applies to fiscal years beginning after December 15, 2008. Earlier adoption is prohibited. We have not determined the effect, if any, the adoption of this statement will have on our results of operations or financial position. 32 DISCONTINUED MORTGAGE BANKING OPERATIONS On March 29, 2006, we began the process of discontinuing the operations of the bank's subsidiary, Greater Atlantic Mortgage Corporation. It was determined that, because it was unprofitable, this business no longer fit our strategy. Due to the unprofitable operations of Greater Atlantic Mortgage Corporation, 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 related to Greater Atlantic Mortgage Corporation of $996,000 was recorded and also included in discontinued operations in the consolidated statements of operations for fiscal 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 Greater Atlantic Mortgage Corporation business. The table below summarizes Greater Atlantic Mortgage Corporation results which were treated as discontinued operations for the periods indicated.
Year Ended September 30, ------------------------------------ 2006 2005 - --------------------------------------------------------------------------------------- (Dollars in Thousands, Except Per Share Data Interest income $ 280 $ 478 Interest expense 256 347 - --------------------------------------------------------------------------------------- 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)
FINANCIAL CONDITION 2007 COMPARED TO 2006 At September 30, 2007 the company's total assets were $246.0 million, compared to the $305.2 million held at September 30, 2006, representing a decrease of 19.40%. The decrease resulted primarily from a decrease in investment securities, loans receivable and interest bearing deposits. The decline in the bank's overall asset size is reflected in the consolidated statements of financial condition and statements of operations as we continued to manage the bank's assets and liabilities to maintain the bank in a well capitalized position. Net loans receivable at September 30, 2007 were $176.1 million, a decrease of $17.2 million or 8.90% from the $193.3 million held at September 30, 2006. The decrease in loans consisted primarily of a $5.5 million decline in the bank's single-family loan portfolio, coupled with a decrease of $8.8 million in the Bank's consumer loan portfolio. Because the Bank's single family and consumer loan portfolios consist primarily of adjustable-rate loans, and with the yield curve that existed throughout our fiscal 2007 period, reflecting short-term rates only slightly lower than rates for longer terms, customers were able to extend the terms of their mortgages. Customers were also refinancing away from adjustable-rate loans and into longer term, fixed-rate loans or curtailing outstanding balances. Multifamily loans outstanding increased by $3.2 million and commercial real estate loans increased by $6.6 million during the period. Those increases were offset in part by decreases of $10.0 million in construction and land loans and $5.0 million in commercial business loans. The decrease in construction and land loans was primarily in the single family residential sector of the market. The company anticipates that lending in that area will continue to decline as a result of the current slow sales pace occurring in the single-family market. At September 30, 2007, investment securities were $52.0 million, a decrease of $28.2 million or 35.17% from the $80.2 million held at September 30, 2006. The cash proceeds from the sale or payoff of investment securities were used to reduce higher cost wholesale funding, including borrowings, brokered deposits and wholesale deposits, and to retain cash for the sale of our Pasadena branch office which occurred on August 24, 2007. 33 Deposits at September 30, 2007 were $198.0 million, a decrease of $32.2 million from the $230.2 million held at September 30, 2006. Total deposits decreased primarily due the sale of our Pasadena branch office and our reduced reliance on brokered deposits and wholesale deposits, both of which have a higher cost. The combination of the branch sale and the elimination of brokered deposits and wholesale deposits contributed to a $75.6 million decrease in deposits since September 30, 2006 while total retail deposits increased $40.4 million. The increase in retail deposits is primarily in certificates of deposits and money fund accounts which have been obtained through the bank's marketing efforts and are at a lower cost than brokered and wholesale deposits. On February 22, 2006, the company announced that it had engaged Sandler O'Neill & Partners, L.P. to advise on the financial aspects of the company's review of its strategic options and assist the company in evaluating the financial aspects of all strategic alternatives available. As previously reported in a Form 8-K filed on April 16, 2007, we announced that the company and Summit Financial Group, Inc., entered into a definitive agreement for the company to merge with and into Summit. We also announced that the bank and Bay-Vanguard Federal Savings Bank entered into a definitive agreement for Bay-Vanguard to purchase the bank's branch office in Pasadena, Maryland. The sale of the Pasadena branch office was established as a condition to the completion of the pending merger of the company with and into Summit Financial Group, Inc. Originally the merger was expected to be completed in the fourth calendar quarter of 2007; however, as reported in a Form 8-K filed on December 10, 2007, effective December 6, 2007, the company and Summit amended their agreement to implement the parties' agreement to extend to March 31, 2008, the date on which the agreement may be terminated if the merger is not consummated by that date, subject to regulatory and shareholder approvals. Immediately following the merger, the bank intends to merge with and into Summit Community Bank. Under the agreement to sell its leased branch office located at 8070 Ritchie Highway, Pasadena, Maryland, to Bay-Vanguard, Bay-Vanguard paid the bank an 8.5% premium on the balance of deposits assumed at closing. At August 24, 2007, the closing date of that transaction, the deposits at our Pasadena branch office on which the deposit premium would apply totaled approximately $51.5 million with the bank recognizing a gain of $4.3 million. Bay-Vanguard also purchased the branch office's fixed assets, but did not acquire any loans as part of the transaction. 34 RESULTS OF OPERATIONS 2007 COMPARED TO 2006 NET INCOME. For the fiscal year ended September 30, 2007, the company had a net income from continuing operations of $951,000 or $0.31 per diluted share compared to a loss from continuing operations of $3.1 million or $1.02 per diluted share for fiscal year 2006. The $4.0 million improvement in earnings over the comparable period one-year ago was primarily the result of an increase in non-interest income and a decrease in non-interest expense. That increase in non-interest income and decrease in non-interest expense were partially offset by a decrease in net interest income and increases in the provision for loan losses and the provision for income taxes. The ongoing net losses from continuing operations remain a consistent problem for management because the loan production needed to maintain the retail branch network has not been attained. Due to the gain arising from the sale of the bank's Pasadena branch office in August of this year, the bank is currently managing its assets and liabilities to maintain a well capitalized status. Because of the bank's loans to one borrower limit it cannot aggressively expand its commercial loan portfolio and maintain a consistent level of outstanding loans to larger customers. Those factors have caused earning assets to decline, impacting earnings. Further, margin pressure from the yield curve, which had been inverted since the spring of 2006 and remains inverted from three months to three years and only recently moved to a positive pattern from three to ten years, presents a very challenging environment in which to seek to increase our net interest margin. Accordingly, during 2007, the company entered into an agreement to merge with and into Summit. In approving the merger agreement, the board of directors consulted with Sandler O'Neill regarding the fairness of the transaction to the company's stockholders from a financial point of view and with the company's legal counsel regarding its legal duties and the terms of the merger agreement and ancillary documents. The understanding of the board of directors of the options available to the company and the assessment of those options with respect to the prospects and estimated results of the implementation by the company of its business plan as an independent entity under various scenarios, and the determination that none of those options or the realization of the business plan under the best case scenarios were likely to create greater present value for the company's stockholders than the value to be paid by Summit. On the other hand, the board of directors considered the company's ability to achieve consistent profitability by selling a number of branches to increase capital and reduce overall operating cost and the prospects for regulatory action if it failed to do so. 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 ------------------------------- ------------------------------- 2007 2006 Amount % - ------------------------------------------------------------------------------------------------------------ (Dollars in thousands) Interest income: Loans $ 14,173 $ 13,866 $ 307 2.21% Investments 4,248 4,928 (680) (13.80) - ------------------------------------------------------------------------------------------------------------ Total 18,421 18,794 (373) (1.98) - ------------------------------------------------------------------------------------------------------------ Interest expense: Deposits 9,331 7,709 1,622 21.04 Borrowings 2,662 3,874 (1,212) (31.29) - ------------------------------------------------------------------------------------------------------------ Total 11,993 11,583 410 3.54 - ------------------------------------------------------------------------------------------------------------ Net interest income $ 6,428 $ 7,211 $ (783) (10.86)% ============================================================================================================
35 The decrease in net interest income for fiscal year 2007, from the comparable period one year ago, resulted primarily from a $32.0 million decrease in the bank's interest-earning assets coupled with average interest-earning assets declining by $7.6 million more than the decline in average interest-bearing liabilities. That decrease was coupled with a 1 basis point decrease in net interest margin (net interest income divided by average interest-earning assets) from 2.37% for fiscal year 2006 to 2.36% for fiscal year 2007. The decrease in net interest margin was offset by the average yield on interest-earning assets increasing by 6 basis point more than the increase in the average cost on interest-bearing liabilities. The interest rate environment has been a difficult one for most financial institutions. With short-term rates close to or at times even higher than long-term rates, the prospects of expanding interest rate spread and net interest margin has been difficult. We expect the interest rate environment to remain challenging and we believe it will continue to have an impact on our net interest margin and net interest rate spread. We also believe, however, that our strategy of changing the balance sheet from one that was wholesale oriented, as reflected in the bank's former reliance on brokered and internet deposits, to one which is more retail oriented, will benefit us over time. We believe that change will position us to realize a benefit when the interest rate environment improves. If market interest rates were to rise, given our asset sensitivity position, we would also expect our net interest margin to improve. However, in a declining rate environment our interest rate spread and our net interest income would decline. The bank continues to monitor the markets and its interest rate position to alleviate any material changes in net interest margin. INTEREST INCOME. Interest income for the fiscal year ended September 30, 2007 decreased $373,000 compared to fiscal year 2006, primarily as a result of a $32.0 million decrease in the average balances of outstanding loans and investment securities. The decreases in those balances were partially offset by an increase of 59 basis points in the average yield earned on interest earning assets. INTEREST EXPENSE. The $410,000 increase in interest expense for fiscal year 2007 compared to the 2006 period was principally the result of an 53 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 $24.4 million decrease in average deposits and borrowings. The increase in interest expense on deposits was primarily due to a 69 basis point increase in rates paid on deposits, primarily due to higher rates paid on interest-bearing demand deposits and certificates and elevated pricing on new and renewed time deposits. That increase was coupled with an increase of $3.8 million in average deposits from $210.3 million for fiscal 2006 to $214.1 million for fiscal 2007. The increase in rates was primarily due to market rates requiring higher rates on interest-bearing demand deposits, savings accounts and certificates and increased pricing on new and renewed time deposits. The decrease in interest expense on borrowings for fiscal 2007, when compared to the 2006 period, was principally the result of a $28.2 million decrease in average borrowed funds and was partially offset by a 45 basis point increase in the cost of borrowed funds. Components accountable for the decrease of $1.2 million in interest expense on borrowings were a $1.4 million decrease relating to average volume, offset in part by a $217,000 increase relating to average cost. 36 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, -------------------------------------------------------------------------------------------------- 2007 2006 2005 ------------------------------ ------------------------------- ------------------------------- 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 $ 91,132 $ 6,693 7.34% $ 93,390 $ 6,699 7.17% $ 98,217 $ 6,379 6.49% Consumer loans 55,420 4,353 7.85 65,338 4,701 7.19 71,817 3,748 5.22 Commercial business loans 38,018 3,127 8.23 34,960 2,466 7.05 40,118 2,303 5.74 --------- -------- ------- --------- -------- -------- -------- -------- ------- Total loans 184,570 14,173 7.68 193,688 13,866 7.16 210,152 12,430 5.91 Investment securities 64,011 3,184 4.97 66,789 3,353 5.02 70,633 2,414 3.42 Mortgage-backed securities 23,848 1,064 4.46 43,979 1,575 3.58 77,424 2,114 2.73 --------- -------- ------- --------- -------- -------- -------- -------- ------- Total interest- earning assets 272,429 18,421 6.76 304,456 18,794 6.17 358,209 16,958 4.73 -------- ------- -------- -------- -------- ------- Non-earning assets 11,707 10,677 12,520 --------- --------- --------- Total assets $284,136 $315,133 $370,729 ========= ========= ========= Liabilities and Stockholders' Equity: Interest-bearing liabilities: Savings accounts $ 2,969 27 0.91 $ 5,190 48 0.92 $ 10,202 94 0.92 Now and money market accounts 77,997 2,791 3.58 73,485 2,430 3.31 64,723 1,197 1.85 Certificates of deposit 133,152 6,513 4.89 131,636 5,231 3.97 170,593 5,046 2.96 --------- -------- ------- --------- -------- -------- -------- -------- ------- Total deposits 214,118 9,331 4.36 210,311 7,709 3.67 245,518 6,337 2.58 FHLB advances 33,064 1,806 5.46 44,894 2,266 5.05 44,422 1,985 4.47 Other borrowings 15,264 856 5.61 31,624 1,608 5.08 51,388 1,691 3.29 --------- -------- ------- --------- -------- -------- -------- -------- ------- Total interest- bearing liabilities 262,446 11,993 4.57 286,829 11,583 4.04 341,328 10,013 2.93 -------- ------- -------- -------- -------- ------- Noninterest-bearing liabilities: Noninterest-bearing demand deposits 11,595 14,993 14,138 Other liabilities 2,224 1,147 1,433 --------- --------- --------- Total liabilities 276,265 302,969 356,899 Stockholders' equity 7,871 12,164 13,830 --------- --------- --------- Total liabilities and stockholders' equity $284,136 $315,133 $370,729 ========= ========= ========= Net interest income $6,428 $ 7,211 $ 6,945 ======= ======= ======== Interest rate spread 2.19% 2.13% 1.80% ======= ======= ====== Net interest margin 2.36% 2.37% 1.94% ======= ======= ======
37 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, 2007 Year Ended September 30, 2006 Compared to Year Compared to Year Ended September 30, 2006 Ended September 30, 2005 Change Attributable to Change Attributable to --------------------------------- -------------------------------------- Volume Rate Total Volume Rate Total - ------------------------------------------------------------------------------------------------------------ (In Thousands) Real estate loans $ (162) $ 156 $ (6) $ (314) $ 634 $ 320 Consumer loans (714) 366 (348) (338) 1,291 953 Commercial business loans 216 445 661 (296) 459 163 - ------------------------------------------------------------------------------------------------------------ Total loans (660) 967 307 (948) 2,384 1,436 Investments (139) (30) (169) (131) 1,070 939 Mortgage-backed securities (721) 210 (511) (913) 374 (539) - ------------------------------------------------------------------------------------------------------------ Total interest-earning assets $(1,520) $1,147 $ (373) $(1,992) $3,828 $1,836 ============================================================================================================ Savings accounts $ (21) $ - $ (21) $ (46) $ - $ (46) Now and money market accounts 149 212 361 162 1,071 1,233 Certificates of deposit 60 1,222 1,282 (1,152) 1,337 185 - ------------------------------------------------------------------------------------------------------------ Total deposits 188 1,434 1,622 (1,036) 2,408 1,372 FHLB advances (597) 137 (460) 21 260 281 Other borrowings (832) 80 (752) (650) 567 (83) - ------------------------------------------------------------------------------------------------------------ Total interest-bearing liabilities $(1,241) $1,651 $ 410 $(1,665) $3,235 $1,570 ============================================================================================================ Change in net interest income $ (279) $ (504) $ (783) $ (327) $ 593 $ 266 ============================================================================================================
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 had 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. However, because we entered into a definitive agreement for the company to merge with Summit, and based on the due diligence performed by Summit, it was deemed unnecessary to enter into such a contract for the fiscal year ended September 30, 2007. Non-performing assets were $1.3 million or 0.55% of total assets at September 30, 2007, compared to non-performing assets of $1.1 million or 0.36% of total assets at September 30, 2006. At September 30, 2007, assets of $4.7 million were classified as substandard and $675,000 classified as doubtful. A $685,000 provision for loan losses was recorded during the year ended September 30, 2007, compared to a provision of $126,000 during the year ended September 30, 2006. The increase in the provision for loan losses of $559,000 from the year ago period resulted from the increase in non-performing assets, an increase in the outstanding balance of the bank's commercial real estate loan's which require a larger allocated allowance provision and an increase of $3.9 million in loans classified as substandard which also require an additional allocation of the bank's overall provision coupled with an increase of $356,000 in loans classified as doubtful. That increase in provision for those loans was offset with an overall decline in the size of the bank's loan portfolio. 38 NON-INTEREST INCOME. Non-interest income increased $4.0 million during fiscal 2007, over fiscal 2006. That increase was primarily the result of increases in other operating income and service fees on deposits. Those increases were partially offset by losses on derivatives, real estate owned and service fees on loans. The increase in other operating income reflects the $4.3 gain recognized from the sale of the bank's Pasadena, Maryland branch. As previously reported in a Form 8-K filed on April 16, 2007, and noted previously, on April 12, 2007, the company announced that it and Summit entered into a definitive agreement for the company to merge with and into Summit and that the bank and Bay-Vanguard entered into a definitive agreement for Bay-Vanguard to purchase the bank's branch office in Pasadena, Maryland. The sale of the Pasadena branch office was a condition to the completion of the pending merger of GAFC with and into Summit Financial Group, Inc. The following table presents a comparison of the components of non-interest income.
Years Ended September 30, Difference -------------------------------- ------------------------------------ 2007 2006 Amount % - ------------------------------------------------------------------------------------------------------------------ (Dollars in Thousands) Noninterest income: Service fees on loans $ 169 $ 186 $ (17) (9.14)% Service fees on deposits 444 424 20 4.72 Gain (loss) on derivatives (21) 212 (233) (107.89) Gain on sale of real estate owned - 65 (65) (100.00) Other operating income 23 30 (7) (23.33) Gain on branch sale 4,255 - 4,255 n/a - ------------------------------------------------------------------------------------------------------------------ Total noninterest income $ 4,870 $ 917 $ 3,953 431.08% ================================================================================================================== NON-INTEREST EXPENSE. Noninterest expense for fiscal 2007 amounted to $9.6 million, a decrease of $1.5 million or 13.16% from the $11.1 million incurred in fiscal 2006. The decrease was distributed over various non-interest expense categories with the contributors being compensation, professional services, advertising, deposit insurance premiums, furniture, fixtures and equipment, data processing and other operating expense. The decreases in those categories of expense were offset by an increase of $57,000 in occupancy expense. The decrease in other operating expense is the result of a settlement offer which required a $500,000 payment by the company during fiscal 2006. The following table presents a comparison of the components of noninterest expense. Years Ended September 30, Difference ------------------------------ ------------------------------- 2007 2006 Amount % -------------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Noninterest expense: Compensation and employee benefits $ 4,446 $ 4,718 $ (272) (5.77)% Occupancy 1,394 1,337 57 4.26 Professional services 1,128 1,227 (99) (8.07) Advertising 130 628 (498) (79.30) Deposit insurance premium 69 101 (32) (31.68) Furniture, fixtures and equipment 516 554 (38) (6.86) Data processing 877 919 (42) (4.57) Other operating expense 1,066 1,601 (535) (33.42) -------------------------------------------------------------------------------------------------------------- Total noninterest expense $ 9,626 $ 11,085 $(1,459) (13.16)% ==============================================================================================================
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 recorded a provision for income taxes for fiscal 2007 of $36,000 which was due to the alternative minimum tax. 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 through earnings and branch sales, to assure utilization of a certain portion of the existing net operating losses. 39 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, 2007 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) $ 25,000 $ - $ 25,000 $ - $ - Reverse repurchase agreements 2,192 2,192 - - - Subordinated debt securities (2) 25,982 655 1,310 1,310 22,707 Operating leases 3,779 1,062 1,858 469 390 - ----------------------------------------------------------------------------------------------------------- Total obligations $ 56,953 $ 3,909 $ 28,168 $ 1,779 $ 23,097 =========================================================================================================== (1) The company expects to refinance these short and medium-term obligations under substantially the same terms and conditions. (2) Includes principal and interest due on our junior subordinated debt securities. OTHER COMMERCIAL COMMITMENTS Less Than Two-Three Four-Five After Five Total One Year Years Years Years - ----------------------------------------------------------------------------------------------------------- (In Thousands) Certificates of deposit maturities (1) $ 125,717 $ 111,990 $ 10,922 $ 2,712 $ 93 Loan originations 9,527 9,527 - - - Unfunded lines of credit (2) 111,815 111,815 - - - Standby letter of credit 310 310 - - - - ----------------------------------------------------------------------------------------------------------- Total $ 247,369 $ 233,642 $ 10,922 $ 2,712 $ 93 ===========================================================================================================
(1) The company expects to retain maturing deposits or replace amounts maturing with comparable certificates of deposit based on current market interest rates. (2) Revolving lines of credit secured by one-to-four dwelling units and commercial lines that remain unfunded. The committed amount of these lines total $174.1 million. 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, 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. 40 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. 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, 2007. 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 $ 23,647 $ 3,042 $ 7,709 $ 12,385 $ 7,697 $ 151 $ 54,631 Fixed-rate 700 703 1,881 8,169 5,765 15,708 32,926 Commercial business 22,734 431 1,163 7,526 1,540 1,704 35,098 Consumer 52,362 93 164 427 188 154 53,388 Investment securities 36,444 4,755 - - - - 41,199 Mortgage-backed securities 3,833 12,546 37 48 8 10 16,482 ----------------------------------------------------------------------------------------------------------------------- Total 139,720 21,570 10,954 28,555 15,198 17,727 233,724 ----------------------------------------------------------------------------------------------------------------------- Interest-bearing liabilities: Deposits: Savings accounts 709 505 363 410 223 258 2,468 NOW accounts 2,336 1,802 1,772 1,974 1,040 1,286 10,210 Money market accounts 16,091 10,957 8,496 8,379 3,597 2,907 50,427 Certificates of deposit 52,130 30,140 25,476 15,097 2,803 93 125,739 Borrowings: FHLB advances - - - - 25,000 - 25,000 Other borrowings 2,192 - - - - 9,374 11,566 ----------------------------------------------------------------------------------------------------------------------- Total 73,458 43,404 36,107 25,860 32,663 13,918 $225,410 ----------------------------------------------------------------------------------------------------------------------- GAP $ 66,262 $(21,834) $(25,153) $ 2,695 $(17,465) $ 3,809 $ 8,314 ======================================================================================================================= Cumulative GAP $ 66,262 $ 44,428 $ 19,275 $ 21,970 $ 4,505 $ 8,314 ======================================================================================================================= Ratio of Cumulative GAP to total interest earning assets 28.35% 19.01% 8.25% 9.40% 1.93% 3.56% =======================================================================================================================
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 $19.3 million at September 30, 2007. 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 200 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 200 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 Office of Thrift Supervision Interest Rate Risk Exposure Report to measure value-at-risk. 41 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, 2007: Net Interest Income Sensitivity Analysis --------------------------------------------------------------------- Changes in Rate Basis Point Percent Change by Basis Point Net Interest Change From Base Margin From Base ----------------- ---------------- --------------- ----------------- +200 3.15% 0.14% 4.65% +100 3.08% 0.07% 2.33% +0 3.01% - - -100 2.90% (0.11)% (3.65)% -200 2.75% (0.26)% (8.64)% 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 14 basis points or 4.65% and, if interest rates decrease 200 basis points, net interest margin, as a percent of total assets, would decrease by 26 basis points or 8.64%. 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 those assumptions including how customer preferences or competitor influences might change. Presented below is an analysis of our interest rate risk, as of September 30, 2007, as measured by changes in net portfolio value for parallel shifts of up 200 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) +200 $ (2,054) (8.46)% 8.97% (0.67)% +100 (976) (4.02) 9.33 (0.31) +0 - - 9.64 - -100 282 1.16 9.69 0.06 -200 308 1.27 9.66 0.02
The decline in net portfolio value of $2.0 million or 8.46% 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, 2007 and currently is within the limits established by the board of directors. The foregoing increase in net portfolio value, in the event of a decrease 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 and cap 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. 42 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 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. 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 3,874 3,676 198 5.39 - ------------------------------------------------------------------------------------------------------------ Total 11,583 10,013 1,570 15.68 - ------------------------------------------------------------------------------------------------------------ Net interest income $ 7,211 $ 6,945 $ 266 3.83% ============================================================================================================
Our increase in net interest income for fiscal year 2006, resulted primarily from a 43 basis point increase in net interest margin (net interest income divided by average interest-earning assets) from 1.94% for fiscal year 2005 to 2.37% for fiscal year 2006, offset in part by a $53.8 million decrease in the bank's interest-earning assets. The increase in net interest margin also resulted from the average yield on interest-earning assets increasing by 33 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. 43 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 $1.6 million increase in interest expense for fiscal year 2006 compared to the 2005 period was principally the result of an 111 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 122 basis point increase in the cost of borrowed funds. Components accountable for the increase of $198,000 in interest expense on borrowings were a $629,000 decrease relating to average volume, offset in part by a $827,000 increase relating to average cost. 44 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 2004 -------------------------------------------------------------------------------------------------- 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 1,608 5.08 51,388 1,691 3.29 78,979 1,373 1.74 ---------- -------- ------ --------- -------- ------ --------- -------- ------- Total interest- bearing liabilities 286,829 11,583 4.04 341,328 10,013 2.93 470,770 9,903 2.10 -------- ------ -------- ------ -------- ------- 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 $ 7,211 $ 6,945 $ 8,182 ======== ======== ======== Interest rate spread 2.13% 1.80% 1.61% ====== ====== Net interest margin 2.37% 1.94% 1.68% ======== ====== ======
45 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 --------------------------------- -------------------------------------- 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 (650) 567 (83) (480) 798 318 - ------------------------------------------------------------------------------------------------------------ Total interest-bearing liabilities $(1,665) $3,235 $1,570 $(2,747) $ 2,857 $ 110 ============================================================================================================ Change in net interest income $ (327) $ 593 $ 266 $(1,739) $ 502 $ (1,237) ============================================================================================================
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. 46 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. 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 securities - 539 (539) (100.00) Gain (loss) on derivatives 212 303 (91) (30.03) Gain on sale of real estate owned 65 - 65 n/a Other operating income 30 1,011 (981) (97.03) - ------------------------------------------------------------------------------------------------------------------ Total noninterest income $ 917 $ 2,640 $ (1,723) (65.27)% ================================================================================================================== 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. 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, Greater Atlantic Mortgage Corporation, and Carroll E. Amos, President and Chief Executive Officer of the company and the bank. The increase in other operating expense is the result of a settlement offer which required 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 was executed and as a result, the company established a liability for the settlement and charged $500,000 as other operating expense in fiscal 2006. 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 through earnings and branch sales, to assure utilization of a certain portion of the existing net operating losses. 47 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 regulations of the Office of Thrift Supervision. The bank manages its liquidity position and demands for funding primarily by investing excess funds in short-term investments and utilizing FHLB advances and reverse repurchase agreements in periods when the bank's demands for liquidity exceed funding from deposit inflows. The bank's most liquid assets are cash and cash equivalents, 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, 2007, cash and cash equivalents, interest bearing deposits and securities available-for-sale totaled $56.5 million, or 22.99% 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, 2007, the bank's loan originations and purchases totaled $79.4 million. The bank did not purchase any United States Treasury or agency securities, mortgage-backed and mortgage related securities or other investment securities during the year ended September 30, 2007. All of our investment securities are classified as either available for sale or held to maturity and for the period ended September 30, 2007 were considered temporarily impaired. The market value of our investment portfolio is obtained from various third party brokerage firms and we believe our filing fairly quantifies the value of those securities. The investments are debt securities that pay principal and interest monthly to maturity at such time as principal is repaid. The fluctuation in value of our portfolio is primarily the result of changes in market rates rather than due to the credit quality of the issuer. The Company has the ability and liquidity to hold those securities until such time as the value recovers or the securities mature. The bank has other sources of liquidity if a need for additional funds arises. At September 30, 2007, the bank had $25.0 million in advances outstanding from the FHLB and had an additional overall borrowing capacity from the FHLB of $18.3 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, 2007, 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 $121.3 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, 2007, totaled $107.7 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, 2007, the bank exceeded minimum regulatory capital requirements with a tangible capital level of $18.8 million, or 7.67% of total adjusted assets, which exceeds the required level of $3.7 million, or 1.50%; core capital of $18.8 million, or 7.67% of total adjusted assets, which exceeds the required level of $9.8 million, or 4.00%; and risk-based capital of $20.9 million, or 12.25% of risk-weighted assets, which exceeds the required level of $13.6 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 48 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 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. 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 announced that the first quarter distribution on the 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, would be deferred. The announcement by the Company followed advice received by the bank from the Office of Thrift Supervision that it would not approve the 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). The company retained approximately $1.3 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. 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. 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. 49 ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Please refer to the index on page 61 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. ITEM 9A. CONTROLS AND PROCEDURES An evaluation of the company's disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934 (the "Act")) as of September 30, 2007, was carried out under the supervision and with the participation of the company's Chief Executive Officer, Chief Financial Officer and several other members of the company's senior management. The company's Chief Executive Officer and Chief Financial Officer concluded that the company's disclosure controls and procedures currently in effect are effective in ensuring that the information required to be disclosed by the company in the reports it files or submits under the Act is: (i) accumulated and communicated to the company's management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. In addition, there have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Act) that occurred during the quarter ended September 30, 2007, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. The company does not expect that its disclosure controls and procedures and internal control over financial reporting will prevent all errors and all fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls may be circumvented by the individual acts of some persons, by collusion of two or more people, or by override of the control. The design of any control procedure also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected. Section 404 of the Sarbanes-Oxley Act of 2002 requires that companies evaluate and annually report on their systems of internal control over financial reporting. In addition, our independent accountants must report on management's evaluation for the fiscal year ending September 30, 2010. We are in the process of evaluating, documenting and testing our system of internal control over financial reporting to provide the basis for our report that will, for the first time, be a required part of our annual report on Form 10-K for the fiscal year ending September 30, 2008. Due to the ongoing evaluation and testing of our internal controls, there can be no assurance that if any control deficiencies are identified they will be remediated before the end of the 2008 fiscal year, or that there will not be significant deficiencies or material weaknesses that would be required to be reported. 50 ITEM 9B. OTHER INFORMATION During the quarter ended September 30, 2007, 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 60 Director, President and Chief Executive Officer 1997 2008 Sidney M. Bresler 53 Director 2003 2010 Charles W. Calomiris 50 Director, Chairman of the Board of Directors 2001 2008 Jeffrey W. Ochsman 55 Director 1999 2009 James B. Vito 82 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 59 Senior Vice President and Chief Operating Officer of the Bank and Corporate Secretary of the Company and the Bank Justin R. Golden 57 Senior Vice President, Consumer Lending, of the Bank Gary L. Hobert 58 Senior Vice President, Commercial Business Lending, of the Bank Robert W. Neff 60 Senior Vice President, Commercial Real Estate Lending, of the Bank David E. Ritter 57 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. 51 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. 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. 52 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 2007. 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 year ended September 30, 2007, to the Chief Executive Officer, and for each of the other executive officers of the company who received salary and bonus in excess of $100,000 (collectively, the "Named Executive Officers").
Change in Pension Value and Non- Nonqual- Equity ified Incentive Deferred Plan Compen- Stock Compen- sation All Other Fiscal Salary Bonus Awards sation Earnings Compensation Total Name and Principal Position Year ($) ($) ($) ($) ($) ($) ($) ------------------------------------ ------- --------- ------- --------- ---------- ---------- --------------- ------------- Carroll E. Amos 2007 $182,000 $ - $ - $ - $ - $ - $182,000 President and Chief - Executive Officer - Edward C. Allen 2007 $121,320 $ - $ - $ - $ - $ - $121,320 Senior Vice President, Chief - Operating Officer and Secretary - David E. Ritter 2007 $114,000 $ - $ - $ - $ - $ - $114,000 Senior Vice President and - Chief Financial Officer
53 OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END The following table sets forth certain information concerning option awards held by the named executive officers that were outstanding as of September 30, 2007. There were no other equity awards held by the named executive officers at September 30, 2007. All of the option awards set forth in the table below were immediately exercisable by the recipient upon grant.
Number of Number of Securities Securities Underlying Underlying Unexercised Unexercised Options Options Option Option (#) (#) Exercise Expiration Name and Principal Position Exercisable Unexercisable Price Date - ----------------------------------------------------------------------------------------------------------------- Carroll E. Amos 16,667 - $7.50 10/01/07 President and Chief 16,667 - 8.37 10/29/08 Executive Officer 3,000 - 6.00 12/01/09 8,666 - 4.00 12/14/10 20,000 - 9.00 01/01/12 10,000 - 8.50 10/20/13 Edward C. Allen 2,000 - $6.00 12/01/09 Senior Vice President, Chief Operating 9,000 - 4.00 12/14/10 Officer and Secretary 4,000 - 7.00 01/01/12 3,000 - 8.50 10/20/13 David E. Ritter 3,000 - $6.00 12/01/09 Senior Vice President and 8,000 - 4.00 12/14/10 Chief Financial Officer 4,000 - 7.00 01/01/12 3,000 - 8.50 10/20/13
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 will conduct a performance appraisal of Mr. Amos and may extend the employment agreement for an additional year so that the remaining term shall be three years, unless the board of directors determines that there is no basis upon which to extend the employment agreement, it will be extended for an additional year. 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. 54 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) the 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, or a material reduction in the benefits and perquisites to Mr. Amos from those being provided as of the effective date of the employment agreement ; (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 equal to the greater of (i) the remaining base salary and bonus payments that would have been paid to Mr. Amos during the remaining term of the employment agreement or (ii) thirty-six (36) times the highest monthly base salary received by Mr. Amos during the 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 for any reason other than a change in control, 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 equal to the greater of: (i) the payments due for the remaining term of the employment agreement; 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. 55 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 21, 2007.
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 176,807 shares(1)(2) 5.85% Scarsdale, New York 10583 Common Stock Robert I. Schattner, DDS 121 Congressional Lane 432,328 shares(1)(3) 14.30% Rockville, MD 20852 Common Stock The Ochsman Children Trust 1650 Tysons Boulevard 238,597 shares(1)(4) 7.89% McLean, VA 22102 Common Stock George W. Calomiris 4848 Upton Street, N.W. 199,715 shares(5) 6.40% 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) 6.12% Washington, D.C. 20016
- ---------------------- (1) Does not include warrants exercisable at September 30, 2007 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 warrants exercisable at September 30, 2007 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 warrants exercisable at September 30, 2007 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 warrants exercisable at September 30, 2007 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. 56 INFORMATION WITH RESPECT TO DIRECTORS AND EXECUTIVE OFFICERS The following table sets forth, as of December 21, 2007, 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 21, 2007 by each director and all directors and executive officers as a group as of the December 21, 2007.
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 50 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 60 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 82 1998 2008 79,042(2) 2.61% Partner, James Properties, engaged in the sale and management of property. Jeffrey W. Ochsman is an attorney and 55 1999 2009 500 * partner of the law firm of Friedlander, Misler, Sloan, Kletzkin & Ochsman, PLLC. Sidney M. Bresler is a Director, Chief 53 2003 2010 500 * Executive Officer and Chief Operating Officer of Bresler & Reiner, Inc. engaged in residential land development and construction and rental property ownership and management. 57 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 59 550(4) * Officer and became Chief Operating Officer in 1997. David E. Ritter joined the bank and the company as a 57 300(4) * Senior Vice President and Chief Financial Officer in 1998. All directors and executive officers as a group (seven 301,759 9.98% persons)(3) - ------------------------ (1) Each person effectively exercises sole voting or dispositive power as to shares reported. (2) Does not include warrants exercisable at September 30, 2007 to purchase 9,166 and 2,000 shares, respectively, held by Messrs. Calomiris and Vito under the Greater Atlantic Financial Corp. 1997 Stock Option Plan, or shares of preferred securities presently convertible into 114,841, 34,970, and 6,431 shares of common stock held, respectively, by Messrs. Calomiris, Vito, 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. * 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, 2007. 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 333,516 $6.93 91,000 Equity compensation plans not approved by security holders N/A N/A N/A - --------------------------------- ------------------------------- ------------------------------- ------------------------------ Total 333,516 $6.93 91,000 ================================= =============================== =============================== ==============================
58 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, 2007, one of the bank's directors had loans with the bank which had outstanding balances totaling $73,000. 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 $106,703 and $225,076 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, 2007 and 2006, 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, 2007 or 2006. TAX FEES BDO Seidman billed the company $30,358 and $35,600 for tax services for the fiscal year ended September 30, 2007 and 2006, respectively. Tax fees represented 22.15% of the fees paid to BDO Seidman, LLP in fiscal year 2007 and 13.66% in fiscal year 2006. PART IV ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) 1. FINANCIAL STATEMENTS See Index to Consolidated Financial Statements on page 61 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 59 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: December 28, 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 - ------------------------ Chairman of the Board December 28, 2007 Charles W. Calomiris /s/ Carroll E. Amos Chief Executive Officer, - ------------------- and President and Director December 28, 2007 Carroll E. Amos /s/ Sidney M. Bresler - --------------------- Sidney M. Bresler Director December 28, 2007 /s/ Jeffrey W. Ochsman - ---------------------- Jeffrey W. Ochsman Director December 28, 2007 /s/ James B. Vito - ----------------- James B. Vito Director December 28, 2007 /s/ David E. Ritter Senior Vice President and - ------------------- Chief Financial Officer December 28, 2007 David E. Ritter
60
CONSOLIDATED FINANCIAL STATEMENTS OF GREATER ATLANTIC FINANCIAL CORP. INDEX Page ---- Report of Independent Registered Public Accounting Firm 62 Consolidated Statements of Financial Condition as of September 30, 2007 and 2006 63 Consolidated Statements of Operations for the Years Ended September 30, 2007, 2006 and 2005 64 Consolidated Statements of Comprehensive Income (Loss) for the Years Ended September 30, 2007, 2006 and 2005 65 Consolidated Statements of Stockholders' Equity for the Years Ended September 30, 2007, 2006 and 2005 65 Consolidated Statements of Cash Flows for the Years Ended September 30, 2007, 2006 and 2005 66 Notes to Consolidated Financial Statements 68
61 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, 2007 and 2006, 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, 2007. 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, 2007 and 2006 and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2007 in conformity with accounting principles generally accepted in the United States of America. /s/ BDO Seidman, LLP - -------------------- Richmond, Virginia December 17, 2007 62
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION September 30, --------------------------------- 2007 2006 ---------------------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Assets Cash and cash equivalents $ 3,146 $ 2,516 Interest bearing deposits 4,486 17,288 Investment securities Available-for-sale 48,910 75,461 Held-to-maturity 3,053 4,696 Loans receivable, net 176,108 193,307 Accrued interest and dividends receivable 1,675 2,073 Deferred income taxes 2,096 1,928 Federal Home Loan Bank stock, at cost 1,731 2,388 Premises and equipment, net 2,285 2,764 Goodwill 956 956 Prepaid expenses and other assets 1,548 1,842 ---------------------------------------------------------------------------------------------------------------------- Total Assets $245,994 $305,219 ====================================================================================================================== Liabilities and stockholders' equity Liabilities Deposits $197,991 $230,174 Advance payments from borrowers for taxes and insurance 229 270 Accrued expenses and other liabilities 1,601 1,963 Income taxes payable 36 - Advances from the FHLB and other borrowings 27,192 54,574 Junior subordinated debt securities 9,374 9,388 ---------------------------------------------------------------------------------------------------------------------- Total liabilities 236,423 296,369 ---------------------------------------------------------------------------------------------------------------------- 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; 3,024,220 and 3,020,934 shares outstanding 30 30 Additional paid-in capital 25,273 25,228 Accumulated deficit (14,408) (15,359) Accumulated other comprehensive loss (1,324) (1,049) ---------------------------------------------------------------------------------------------------------------------- Total stockholders' equity 9,571 8,850 ---------------------------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $245,994 $305,219 ====================================================================================================================== See accompanying notes to consolidated financial statements.
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GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Year Ended September 30, ------------------------------------------------- 2007 2006 2005 - -------------------------------------------------------------------------------------------------------------------------- (Dollars in Thousands, Except Per Share Data) Interest income Loans $ 14,173 $ 13,866 $ 12,430 Investments 4,248 4,928 4,528 - -------------------------------------------------------------------------------------------------------------------------- Total interest income 18,421 18,794 16,958 - -------------------------------------------------------------------------------------------------------------------------- Interest expense Deposits 9,331 7,709 6,337 Borrowed money 2,662 3,874 3,676 - -------------------------------------------------------------------------------------------------------------------------- Total interest expense 11,993 11,583 10,013 - -------------------------------------------------------------------------------------------------------------------------- Net interest income 6,428 7,211 6,945 Provision for loan losses 685 126 219 - -------------------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 5,743 7,085 6,726 - -------------------------------------------------------------------------------------------------------------------------- Noninterest income Fees and service charges 613 610 734 Gain (loss) on sale of loans - - 53 Gain (loss)on sale of investment securities - - 539 Gain (loss) on derivatives (21) 212 303 Gain on sale of real estate owned - 65 - Gain on branch sales 4,255 - 945 Other operating income 23 30 66 - -------------------------------------------------------------------------------------------------------------------------- Total noninterest income 4,870 917 2,640 - -------------------------------------------------------------------------------------------------------------------------- Noninterest expense Compensation and employee benefits 4,446 4,718 4,213 Occupancy 1,394 1,337 1,337 Professional services 1,128 1,227 969 Advertising 130 628 301 Deposit insurance premium 69 101 100 Furniture, fixtures and equipment 516 554 641 Data processing 877 919 1,054 Other operating expenses 1,066 1,601 1,274 - -------------------------------------------------------------------------------------------------------------------------- Total noninterest expense 9,626 11,085 9,889 - -------------------------------------------------------------------------------------------------------------------------- Income (loss) from continuing operations before income taxes 987 (3,083) (523) Provision for income taxes 36 - - - -------------------------------------------------------------------------------------------------------------------------- Income (loss) from continuing operations 951 (3,083) (523) Discontinued operations: Income (loss) from operations - (2,488) (1,107) - -------------------------------------------------------------------------------------------------------------------------- Net income (loss) $ 951 $ (5,571) $ (1,630) ========================================================================================================================== Earnings (loss) per common share BASIC: Continuing operations basic $ 0.31 $ (1.02) $ (0.17) Discontinued operations basic - (0.82) (0.37) - -------------------------------------------------------------------------------------------------------------------------- $ 0.31 $ (1.84) $ (0.54) - -------------------------------------------------------------------------------------------------------------------------- DILUTED: - -------------------------------------------------------------------------------------------------------------------------- Continuing operations basic $ 0.31 $ (1.02) $ (0.17) - -------------------------------------------------------------------------------------------------------------------------- Discontinued operations basic - (0.82) (0.37) - -------------------------------------------------------------------------------------------------------------------------- $ 0.31 $ (1.84) $ (0.54) - -------------------------------------------------------------------------------------------------------------------------- Weighted average common shares outstanding Basic 3,023,407 3,020,934 3,015,509 Diluted 4,395,008 3,020,934 3,015,509
See accompanying notes to consolidated financial statements. 64 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
Year Ended September 30, --------------------------------------------- 2007 2006 2005 ----------------------------------------------------------------------------------------------------- (In Thousands) Net income (loss) $951 $ (5,571) $ (1,630) ----------------------------------------------------------------------------------------------------- Other comprehensive (loss) income, net of tax: Unrealized (loss) income on securities (275) 46 (16) ----------------------------------------------------------------------------------------------------- Other comprehensive (loss) income (275) 46 (16) ----------------------------------------------------------------------------------------------------- Comprehensive (loss) income $676 $ (5,525) $ (1,646) ===================================================================================================== 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, 2004 $ - $ 30 $ 25,152 $ (8,158) $ (1,079) $ 15,945 Options exercised - - 76 - - 76 Other comprehensive loss - - - - (16) (16) Net loss for the year - - - (1,630) - (1,630) ----------------------------------------------------------------------------------------------------------------------- Balance at September 30, 2005 - 30 25,228 (9,788) (1,095) 14,375 Other comprehensive income - - - - 46 46 Net loss for the year - - - (5,571) - (5,571) ----------------------------------------------------------------------------------------------------------------------- Balance at September 30, 2006 - 30 25,228 (15,359) (1,049) 8,850 Conversion of trust preferred securities - - 45 - - 45 Other comprehensive loss - - - - (275) (275) Net income for the year - - - 951 - 951 ----------------------------------------------------------------------------------------------------------------------- Balance at September 30, 2007 $ - $ 30 $ 25,273 $(14,408) $ (1,324) $ 9,571 ======================================================================================================================= See accompanying notes to consolidated financial statements
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GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended September 30, ---------------------------------------------------- 2007 2006 2005 --------------------------------------------------------------------------------------------------------------------------------- (In Thousands) Cash flow from operating activities Net income (loss) $ 951 $ (5,571) $ (1,630) Adjustments to reconcile net income (loss) to net cash Provided (used) by operating activities Provision for loan losses 685 126 219 Amortization of deferred loan acquisition costs, net 38 (50) (27) Depreciation and amortization 445 658 930 Gain on branch sale (4,255) - (945) (Gain) loss on disposal of fixed assets - (26) 91 Option compensation - - 42 Realized gain on sale of mortgaged-backed securities - - (539) Loss (gain) on derivatives 21 (212) (303) Amortization of other investment securities premiums 862 753 853 Amortization of mortgage-backed security premiums 397 662 937 Amortization of deferred fees (325) (496) (635) Discount accretion net of premium amortization 287 (277) (361) Amortization of convertible preferred stock costs 9 9 9 Conversion of Trust Preferred Securities (23) - - (Gain) loss on sale of foreclosed real estate - (65) - Gain on sale of loans held for sale - (1,522) (4,720) (Increase) decrease in assets Disbursements for origination of loans - (91,477) (276,038) Proceeds from sales of loans - 102,518 276,770 Accrued interest and dividend receivable 399 (327) 193 Prepaid expenses and other assets 177 1,156 360 Deferred loan fees collected, net of deferred costs incurred 435 431 172 Increase (decrease) in liabilities Accrued expenses and other liabilities (265) 649 (451) Income taxes payable 36 - - --------------------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) operating activities $ (126) $ 6,939 $ (5,073) =================================================================================================================================
(Continued) 66
GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS - (CONTINUED) Year Ended September 30, -------------------------------------- 2007 2006 2005 ----------------------------------------------------------------------------------------------------------------------------- (In Thousands) Cash flow from investing activities Net decrease (increase) in loans $ 16,079 $ 1,879 $ 51,867 Disposal (purchases) of premises and equipment 34 792 2,055 Proceeds from sales of foreclosed real estate - 297 - Purchases of investment securities - (7,707) (21,684) Proceeds from repayments of investment securities 11,528 17,105 21,841 Purchases of mortgage-backed securities - - (24,224) Proceeds from sale of mortgage-backed securities - - 21,921 Proceeds from repayments of mortgage-backed securities 14,963 25,198 37,548 Purchases of FHLB stock (742) (3,015) (5,169) Proceeds from sale of FHLB stock 1,399 3,130 6,751 ----------------------------------------------------------------------------------------------------------------------------- Net cash provided by investing activities 43,261 37,679 90,906 ----------------------------------------------------------------------------------------------------------------------------- Cash flow from financing activities Net (decrease) increase in deposits (27,928) (7,620) (50,217) Net (repayments) advances from FHLB (11,000) (2,000) (13,200) Net borrowings (repayments) on reverse repurchase agreements and other borrowings (16,383) (19,905) (26,386) Increase (decrease) in advance payments by borrowers for taxes and insurance (41) 2 (37) Conversion of trust preferred securities 45 - - Exercise of stock options - - 34 ----------------------------------------------------------------------------------------------------------------------------- Net cash (used in) financing activities (55,307) (29,523) (89,806) ----------------------------------------------------------------------------------------------------------------------------- Increase (decrease) in cash and cash equivalents (12,172) 15,095 (3,973) ----------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents, at beginning of year 19,804 4,709 8,682 ----------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents, at end of year $ 7,632 $ 19,804 $ 4,709 =============================================================================================================================
See accompanying notes to consolidated financial statements. 67 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 is the ownership and management of Greater Atlantic Bank ("GAB" or the "Bank"). 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. PROPOSED ACQUISITION As previously reported in a Form 8-K filed on April 16, 2007, we announced that the company and Summit Financial Group, Inc., entered into a definitive agreement for the company to merge with and into Summit. We also announced that the bank and Bay-Vanguard Federal Savings Bank entered into a definitive agreement for Bay-Vanguard to purchase the bank's branch office in Pasadena, Maryland. The sale of the Pasadena branch office was established as a condition to the completion of the pending merger of the company with and into Summit Financial Group, Inc. Originally the merger was expected to be completed in the fourth calendar quarter of 2007; however, as reported in a Form 8-K filed on December 10, 2007, effective December 6, 2007, the company and Summit amended their agreement to implement the parties' agreement to extend to March 31, 2008, the date on which the agreement may be terminated if the merger is not consummated by that date, subject to regulatory and shareholder approvals. Immediately following the merger, the bank intends to merge with and into Summit Community Bank. Under the agreement to sell its leased branch office located at 8070 Ritchie Highway, Pasadena, Maryland, to Bay-Vanguard, Bay-Vanguard paid the bank an 8.5% premium on the balance of deposits assumed at closing. At August 24, 2007, the closing date of that transaction, the deposits at our Pasadena branch office on which the deposit premium would apply totaled approximately $51.5 million with the bank recognizing a gain of $4.3 million. Bay-Vanguard also purchased the branch office's fixed assets, but did not acquire any loans as part of the transaction. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of GAFC and its wholly owned subsidiaries, the bank 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, 2007 and September 30, 2006, 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 12. 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, 2007. 68 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, 2007. 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 currently includes interest rate caps. 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 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. 69 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 sells loans and participation interests in loans on which it retains servicing. 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, 2007 and September 30, 2006. 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. 70 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 10). 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 disclosed. There were no stock options granted in 2007; however, 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. 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 would have been changed to the pro forma amounts indicated in the following table: 71 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Year Ended September 30, ---------------- 2005 - -------------------------------------------------------------------------------- (In Thousands, Except Per Share Data) Net (loss) income as reported $ (1,630) Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (239) - -------------------------------------------------------------------------------- Pro Forma net income (loss) $ (1,869) ================================================================================ Basic income (loss) per common share: As reported $ (0.54) Pro Forma (0.62) - -------------------------------------------------------------------------------- Diluted income (loss) per common share: As reported $ (0.54) Pro Forma (0.62) - -------------------------------------------------------------------------------- RECLASSIFICATIONS Certain immaterial reclassifications related to interest expense and derivative gains 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. DISCONTINUED OPERATIONS On March 29, 2006, we began the process of discontinuing the operations of the Bank's subsidiary, Greater Atlantic Mortgage Corporation. 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 financial statements, as we completed the closing of the Greater Atlantic Mortgage Corporation business. The table below summarizes Greater Atlantic Mortgage Corporation results which were treated as discontinued operations for the periods indicated.
Year Ended September 30, ------------------------------------ 2006 2005 - --------------------------------------------------------------------------------------- (Dollars in Thousands, Except Per Share Data Interest income $ 280 $ 478 Interest expense 256 347 - --------------------------------------------------------------------------------------- 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)
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GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 3. INVESTMENTS Available-for-Sale, September 30, 2007 - ------------------------------------------------------------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Market Cost Gains Losses Value - ------------------------------------------------------------------------------------------------------------------- (In Thousands) Investment securities SBA notes $ 19,395 $ - $ 641 $ 18,754 CMOs 7,191 32 136 7,087 Corporate debt securities 7,300 - 552 6,748 - ------------------------------------------------------------------------------------------------------------------- 33,886 32 1,329 32,589 - ------------------------------------------------------------------------------------------------------------------- Mortgage-backed securities FNMA notes 8,357 - 216 8,141 GNMA notes 5,382 - 122 5,260 FHLMC notes 2,961 - 41 2,920 - ------------------------------------------------------------------------------------------------------------------- 16,700 - 379 16,321 - ------------------------------------------------------------------------------------------------------------------- $ 50,586 $ 32 $ 1,708 $ 48,910 =================================================================================================================== Held-to-Maturity, September 30, 2007 - -------------------------------------------------------------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Market Cost Gains Losses Value - -------------------------------------------------------------------------------------------------------------------- (In Thousands) Investment securities SBA notes $ 2,846 $ - $ 104 $ 2,742 Corporate debt securities - - - - - -------------------------------------------------------------------------------------------------------------------- 2,846 - 104 2,742 - -------------------------------------------------------------------------------------------------------------------- Mortgage-backed securities FNMA notes 104 - 2 102 FHLMC notes 103 - 2 101 - -------------------------------------------------------------------------------------------------------------------- 207 - 4 203 - -------------------------------------------------------------------------------------------------------------------- $ 3,053 $ - $ 108 $ 2,945 ====================================================================================================================
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GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 notes - - - - - -------------------------------------------------------------------------------------------------------------------- 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 ====================================================================================================================
The weighted average interest rate on investments was 5.47% and 5.03% for the years ended September 30, 2007 and 2006, respectively. TRADING ACTIVITIES There were no net gains (losses) on trading activities included in earnings for the years ended September 30, 2007, 2006 and 2005. 74 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Proceeds from the sale of available for sale securities were zero, zero and $21.9 million for the years ended September 30, 2007, 2006 and 2005, respectively. Gross realized gains were zero, zero and $539,000 for the years ended September 30, 2007, 2006 and 2005, respectively. As of September 30, 2007, the Bank held investments in available for sale securities with unrealized holding losses totaling $1.7 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 $ 2,048 $ 149 $ 4,700 $ 403 $ 6,748 $ 552 CMOs 4,124 108 1,934 28 6,058 136 U.S. Government securities SBA 3,196 38 15,558 603 18,754 641 GNMA - - 5,260 122 5,260 122 U.S. Government agency securities: FHLMC MBS's - - 2,920 41 2,920 41 FNMA MBS's - - 8,141 216 8,141 216 - --------------------------------------------------------------------------------------------------------------- Total $ 9,368 $ 295 $38,513 $1,413 $ 47,881 $ 1,708 =============================================================================================================== As of September 30, 2007, the Bank held investments in held-to-maturity with unrealized holding losses totaling $108,000, consisting of the following: Less than 12 months 12 months or more Total -------------------------- -------------------------- ------------------------- Description of Securities Fair Unrealized Fair Unrealized Fair Unrealized Value Losses Value Losses Value Losses - --------------------------------------------------------------------------------------------------------------- (In Thousands) U.S. Government securities SBA $ - $ - $2,742 $ 104 $ 2,742 $ 104 U.S. Government agency securities: FHLMC MBS's - - 101 2 101 2 FNMA MBS's - - 102 2 102 2 - --------------------------------------------------------------------------------------------------------------- Total $ - $ - $2,945 $ 108 $ 2,945 $ 108 ===============================================================================================================
75 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 2007 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, 2007 The amortized cost and estimated fair value of securities at September 30, 2007 and 2006, by contractual maturity, are as follows:
September 30, 2007 September 30, 2006 --------------------------------------------------------- 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 - - - - After five years through ten years 3,499 3,245 3,891 3,753 After ten years 30,387 29,344 40,704 40,310 Mortgage-backed securities 16,700 16,321 32,032 31,365 ----------------------------------------------------------------------------------------------------------- 50,586 48,910 76,676 75,461 ----------------------------------------------------------------------------------------------------------- Held-to-maturity: One year or less - - - - After one year through five years - - 110 94 After five years through ten years 380 366 553 534 After ten years 2,466 2,376 3,798 3,602 Mortgage-backed securities 207 203 235 230 ----------------------------------------------------------------------------------------------------------- 3,053 2,945 4,696 4,460 ----------------------------------------------------------------------------------------------------------- Total investment securities $53,639 $51,855 $81,372 $79,921 ===========================================================================================================
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. All investment securities currently considered liquid. 76 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. LOANS RECEIVABLE Loans receivable consists of the following: September 30, ----------------------------------- 2007 2006 ---------------------------------------------------------------------------------------------------- (In Thousands) Mortgage loans: Single-family $ 37,972 $ 43,473 Multi-family 3,983 813 Construction 9,939 14,245 Commercial real estate 34,984 28,403 Land loans 8,097 13,829 ---------------------------------------------------------------------------------------------------- Total mortgage loans 94,975 100,763 Commercial loans 34,844 39,794 Consumer loans 52,656 61,414 ---------------------------------------------------------------------------------------------------- Total loans 182,475 201,971 Less: Due borrowers on loans-in process (4,947) (8,517) Deferred loan fees origination costs 832 944 Allowance for loan losses (2,305) (1,330) Unearned (discounts) premium 53 239 ---------------------------------------------------------------------------------------------------- $ 176,108 $ 193,307 ==================================================================================================== The activity in allowance for loan losses is summarized as follows: Year Ended September 30, ---------------------------------------------------- 2007 2006 2005 - -------------------------------------------------------------------------------------------------------------------- (In Thousands) Balance, beginning $ 1,330 $ 1,212 $ 1,600 Provision for loan losses 685 126 219 Charge-offs (353) (80) (625) Recoveries 643 72 18 - -------------------------------------------------------------------------------------------------------------------- Balance, ending $ 2,305 $ 1,330 $ 1,212 ====================================================================================================================
The amount of loans serviced for others totaled $32.0 million and $34.4 million as of September 30, 2007 and September 30, 2006, respectively. The allowance for uncollected interest, established for mortgage loans which are delinquent for a period of 90 days or more, amounted to $110,000, $204,000 and $134,000 as of September 30, 2007, 2006 and 2005, 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 $1.3 million, $274,000 and $1.6 million as of September 30, 2007, 2006, and September 30, 2005, respectively. 77 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. ACCRUED INTEREST AND DIVIDENDS RECEIVABLE Accrued interest and dividends receivable consist of the following: September 30, ------------------------- 2007 2006 -------------------------------------------------------------------------------------------------- (In Thousands) Investments $ 491 $ 751 Loans receivable 1,159 1,282 Accrued dividends on FHLB stock 25 40 -------------------------------------------------------------------------------------------------- $ 1,675 $ 2,073 ================================================================================================== 6. PREMISES AND EQUIPMENT Premises and equipment consists of the following: September 30, ------------------------- 2007 2006 ------------------------------------------------------------------------------------------------- (In Thousands) Furniture, fixtures and equipment $2,283 $2,621 Leasehold improvements 2,804 2,835 Land 377 377 ------------------------------------------------------------------------------------------------- 5,464 5,833 Less: Allowances for depreciation and amortization 3,179 3,069 ------------------------------------------------------------------------------------------------- $2,285 $2,764 =================================================================================================
7. FORECLOSED REAL ESTATE There was no activity in the allowance for losses on foreclosed real estate in fiscal 2007, 2006 or 2005. 78 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. DEPOSITS Deposits are summarized as follows: September 30, 2007 -------------------------------------------------------------------------------------------------------- Ranges of Contractual % Amount Interest Rates of Total -------------------------------------------------------------------------------------------------------- (In Thousands) Savings accounts $ 2,468 0.00 - 1.09% 1.3% NOW/money market accounts 60,625 0.00 - 4.40% 30.6 Certificates of deposit 125,717 0.94 - 9.00% 63.5 Non-interest bearing demand deposits 9,181 0.00% 4.6 -------------------------------------------------------------------------------------------------------- $ 197,991 100.0% ======================================================================================================== 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% ========================================================================================================
79 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Certificates of deposit as of September 30, 2007 mature as follows: Year ending September 30, Amount --------------------------------------------------------------------------------------------- (In Thousands) Thousands 2008 $ 107,736 2009 12,079 2010 3,019 2011 985 2012 and after 1,898 --------------------------------------------------------------------------------------------- $ 125,717 ============================================================================================= Interest expense on deposit accounts consists of the following: Year Ended September 30, -------------------------------------------- 2007 2006 2005 ------------------------------------------------------------------------------------------------------------ (In Thousands) NOW/money market accounts $ 2,791 $ 2,430 $ 1,197 Savings accounts 27 48 94 Certificates of deposit 6,513 5,231 5,046 ------------------------------------------------------------------------------------------------------------ $ 9,331 $ 7,709 $ 6,337 ============================================================================================================
Deposits, including certificates of deposit, with balances in excess of $100,000 totaled $68.0 million and $85.2 million at September 30, 2007, and September 30, 2006, respectively. 80 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 9. ADVANCES FROM FEDERAL HOME LOAN BANK AND OTHER BORROWINGS The Bank has $43.3 million credit availability as of September 30, 2007 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, -------------------------------------------------- 2007 2006 2005 ---------------------------------------------------------------------------------------------------------------------- (Dollars in Thousands) FHLB advances: Average balance outstanding $ 33,064 $ 44,894 $ 44,422 Maximum amount outstanding at any month-end during the period 39,000 51,000 49,200 Balance outstanding at end of period 25,000 36,000 38,000 Weighted average interest rate during the period 5.46% 5.05% 4.47% Weighted average interest rate at end of period 5.92% 5.28% 4.85% Reverse repurchase agreements: Average balance outstanding 15,264 31,624 51,388 Maximum amount outstanding at any month-end during the period 10,857 35,641 62,846 Balance outstanding at end of period 2,192 18,574 38,479 Weighted average interest rate during the period 5.61% 4.21% 4.33% Weighted average interest rate at end of period 2.52% 4.65% 3.69% The Bank has pledged certain investments with carrying values of $24.9 million at September 30, 2007, to collateralize advances from the FHLB. First mortgage loans in the amount of $18.4 million are also available to be pledged as collateral for the advances at September 30, 2007. 10. 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, -------------------------------------------- 2007 2006 2005 ---------------------------------------------------------------------------------------------------------- (In Thousands) Federal tax provision (benefit) $ 335 $(1,894) $ (554) State tax provision (benefit) 39 (223) (65) Changes in provision resulting from: Valuation changes (313) 1,867 613 Other (25) 250 6 ---------------------------------------------------------------------------------------------------------- Income tax provision $ 36 $ - $ - ==========================================================================================================
81
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, -------------------------------- 2007 2006 --------------------------------------------------------------------------------------------- (In Thousands) Deferred tax assets Net operating loss carryforwards $ 4,398 $ 5,039 Unrealized (gains) losses on derivatives 141 178 Allowance for loan losses 876 505 Available for sale securities 648 433 Core deposit intangible - 65 Deferred loan fees 108 125 Other 79 86 --------------------------------------------------------------------------------------------- Total deferred tax assets 6,250 6,431 --------------------------------------------------------------------------------------------- Deferred tax liabilities Tax over book depreciation 410 478 Other 172 140 --------------------------------------------------------------------------------------------- Total deferred tax liabilities 582 618 --------------------------------------------------------------------------------------------- Net deferred tax assets 5,668 5,813 Less: Valuation allowance 3,572 3,885 --------------------------------------------------------------------------------------------- Total $ 2,096 $ 1,928 =============================================================================================
Management has provided a valuation allowance for net deferred tax assets, due to the timing of the generation of future taxable income. The Company believes that it will generate future taxable income through earnings and branch sales to assure utilization of a certain portion of the existing net operating losses. At September 30, 2007, the Company has net operating loss carryforwards for federal income tax purposes of approximately $11.5 million, which expire in the years 2008 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 $114,000. In addition certain additional limitations will exist should the merger with Summit occur. 82 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 11. 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. Those 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. In the event of nonperformance by the other party to financial instrument for commitments to extend credit, for standby letters of credit or for written financial guarantees the Company's exposure to credit loss 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, 2007, the Company had outstanding commitments to originate loans and undisbursed construction mortgages aggregating approximately $9.5 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 $111.8 million and standby letters of credit for approximately $310,000. RENTAL COMMITMENTS The Company has entered into lease agreements for the rental of certain properties expiring on various dates through October 31, 2015. The future minimum rental commitments as of September 30, 2007, for all non-cancelable lease agreements, are as follows: Years ending Rental September 30, Commitments ---------------------------------------------------- (In Thousands) 2008 $ 1,062 2009 1,003 2010 855 2011 344 2012 125 Thereafter 390 ---------------------------------------------------- Total $ 3,779 ==================================================== Net rent expense for the years ended September 30, 2007, 2006 and 2005 was $1.1 million, $1.1 million and $1.0 million, respectively. 83 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 12. 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, 2007, 2006 or 2005. 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, 2007 the Bank was classified as a well capitalized financial institution and was classified as an adequately capitalized financial institution at September 30, 2006. 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, 2007 and September 30, 2006:
- ------------------------------------------------------------------------------------------------------------- Required Required Actual Actual At September 30, 2007 Balance Percent Balance Percent Surplus - ------------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Tangible $ 3,684 1.50% $ 18,830 7.67% $ 15,146 Core $ 9,825 4.00% $ 18,830 7.67% $ 9,005 Risk-based $ 13,630 8.00% $ 20,874 12.25% $ 7,244 ============================================================================================================= - ------------------------------------------------------------------------------------------------------------- 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 =============================================================================================================
84 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 (unaudited).
September 30, ------------------------------ 2007 2006 -------------------------------------------------------------------------------------------------- (In Thousands) GAAP capital $ 11,661 $ 10,161 Guaranteed convertible preferred securities 8,000 8,000 Unrealized losses on available for sale securities 1,324 1,049 Excluded deferred tax asset (1,199) (1,516) Goodwill (956) (956) -------------------------------------------------------------------------------------------------- Tangible capital 18,830 16,738 Adjustments - - -------------------------------------------------------------------------------------------------- Core capital 18,830 16,738 Allowance for general loss reserves 2,132 1,011 Adjustments to arrive at Risk-Weighted Assets (88) (113) -------------------------------------------------------------------------------------------------- Risk-based capital $ 20,874 $ 17,636 ==================================================================================================
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. 13. 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, 2007, 88,016 warrants were outstanding. 85 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, 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 Options expired (7,500) $ 6.75 ------------------------------------------------------------------------------------------------------------ Balance outstanding and exercisable at September 30, 2007 245,500 $ 6.72 ============================================================================================================ Fair value of options issued in 2006 was $22,000 net of related tax effects. A summary of the stock options outstanding and exercisable as of September 30, 2007 is as follows: ------------------------------------------------------------ ----------------------------- Options Outstanding Options Exercisable ------------------------------------------------------------ ----------------------------- Weighted Weighted Average Average Exercise Number Remaining Life Exercise Number Prices Outstanding (years) Price Exercisable ----------------------------------------------------------- ------------------------------ $7.50 16,667 0.2 $7.50 16,667 $8.38 16,667 1.2 $8.38 16,667 $6.00 13,000 2.2 $6.00 13,000 $4.00 41,666 3.2 $4.00 41,666 $5.31 10,000 3.2 $5.31 10,000 $7.00 17,000 4.3 $7.00 17,000 $9.00 20,000 4.3 $9.00 20,000 $8.50 30,000 6.1 $8.50 30,000 $6.75 68,500 7.1 $6.75 68,500 $6.00 12,000 8.5 $6.00 12,000 ------------------------------------------------------------ ------------------------------
86 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 14. 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, 2007, 2006 and 2005:
For the Year Ended September 30, ----------------------------------------------------------------------------------------------- 2007 2006 2005 ----------------------------- ----------------------------- ----------------------------- Income Shares Per Income Shares Per Income Shares Per Share (loss) Share (loss) Share Amount Amount Amount - ------------------------------------------------------------------------------------------------------------------------------- (Dollars in Thousands, Except Per Share Data) Basic earnings per share $ 951 3,023,407 $0.31 $(5,571) 3,020,934 $(1.84) $(1,630) 3,015,509 $(0.54) Effect of conversion of preferred securities 405 1,368,143 - - - - - - - Effect of dilutive stock options - 3,458 - - - - - - - - ------------------------------------------------------------------------------------------------------------------------------- Diluted $1,356 4,395,008 $0.31 $(5,571) 3,020,934 $(1.84) $(1,630) 3,015,509 $(0.54) ===============================================================================================================================
The effect of the conversion of preferred securities and stock options of 1,381,079 and 1,386,030 were excluded in 2006 and 2005, respectively, as they would have been anti-dilutive. 15. 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 $181,000 and $263,000 as of September 30, 2007 and September 30, 2006, respectively. 87 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 16. 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, ----------------------------------------------------------- 2007 2006 ----------------------------- ---------------------------- Carrying Estimated Carrying Estimated value fair value value fair value ---------------------------------------------------------------------------------------------------------- (In Thousands) Assets: Cash and interest bearing deposits $ 7,632 $ 7,632 $ 19,804 $ 19,804 Investment securities 51,963 51,855 80,157 79,921 Loans receivable 176,108 176,833 193,307 193,049 ---------------------------------------------------------------------------------------------------------- Liabilities: Deposits 197,991 198,368 230,174 229,818 Borrowings 27,192 27,980 54,574 55,333 ---------------------------------------------------------------------------------------------------------- Off-balance sheet instruments: Commitments to extend credit - 31 - 10 ----------------------------------------------------------------------------------------------------------
17. 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, 2007, 2006 and 2005. 88 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
18. SUPPLEMENTAL CASH FLOW INFORMATION Year Ended September 30, ---------------------------------------- 2007 2006 2005 ----------------------------------------------------------------------------------------------------------- (In Thousands) Cash paid during period for interest on deposits and borrowings $ 3,318 $ 5,331 $ 5,861 ===========================================================================================================
19. SEGMENT REPORTING AND DISCONTINUED OPERATIONS 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. 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 related to GAMC of $996,000 was recorded and also included in discontinued operations in the consolidated statements of operations for fiscal 2006. 20. 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, 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 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. 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 announced that the first quarter distribution on the 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, would be deferred. The announcement by the Company followed advice received by the bank from the Office of Thrift Supervision that it would not approve the 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). At September 30, 2007, the quarterly distribution amount that is unpaid and accrued totals $644,000. The company retained approximately $1.3 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. 89 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 21. 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 $20 million in notional principal with terms between eight and ten years that limit the float between a floor of 2.00%, and capped between 6.50% - 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 $21,000 in fiscal 2007, a gain of $212,000 in fiscal 2006 and a gain of $303,000 in fiscal 2005 related to its derivatives. 22. RECENT ACCOUNTING STANDARDS In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements". This statement clarifies the definition of fair value, establishes a framework for measuring fair value and expands the disclosures on fair value measurements. For financial assets and liabilities, SFAS No. 157 is effective for fiscal years beginning after November 15, 2008. We do not believe the adoption of SFAS 157 will have a material impact on the consolidated financial statements. In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" (SFAS 159).This statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective of this Statement is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The fair value option established by this Statement permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The fair value option may be applied instrument by instrument and is irrevocable. SFAS 159 is effective as of the beginning of an entity's first fiscal year that begins after November 15, 2007. The Company is in the process of evaluating the impact SFAS 159 may have on its consolidated financial statements. In December 2007, the FASB issued SFAS No. 141 (R), "Business Combinations", to create greater consistency in the accounting and financial reporting of business combinations. SFAS 141 (R) requires a company to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquired entity to be measured at their fair values as of the acquisition date. SFAS 141 (R) also requires companies to recognize and measure goodwill acquired in a business combination or a gain from a bargain purchase and how to evaluate the nature and financial effects of the business combination. SFAS No. 141(R) applies to fiscal years beginning after December 15, 2008 and is adopted prospectively. Earlier adoption is prohibited. We have not determined the effect, if any, the adoption of this statement will have on our results of operations or financial position. 90 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements -- an amendment of ARB No. 51", to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 requires company to clearly identify and present ownership interests in subsidiaries held by parties other than the company in the consolidated financial statements within the equity section but separate from the company's equity. It also requires the amount of consolidated net income attributable to the parent and to the noncontrolling interest be clearly identified and presented on the face of the consolidated statement of income; changes in ownership interest be accounted for similarly, as equity transactions; and when a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary and the gain or loss on the deconsolidation of the subsidiary be measured at fair value. SFAS No. 160 applies to fiscal years beginning after December 15, 2008. Earlier adoption is prohibited. We have not determined the effect, if any, the adoption of this statement will have on our results of operations or financial position.
23. PARENT COMPANY - ONLY FINANCIAL STATEMENTS Parent Company - Only Condensed Statements of Financial Condition September 30, ----------------------------------- 2007 2006 ------------------------------------------------------------------------------------------ (In Thousands) Assets Cash and cash equivalents $ 13 $ 60 Loans receivable - - Investment in subsidiary 21,167 19,423 Prepaid expenses and other assets 316 309 ------------------------------------------------------------------------------------------ Total assets $ 21,496 $ 19,792 ========================================================================================== Liabilities and stockholders' equity Accrued interest payable on subordinated debt $ 644 $ - Other liabilities 117 8 ------------------------------------------------------------------------------------------ Total liabilities 761 8 ------------------------------------------------------------------------------------------ Subordinated debt 9,905 9,928 ------------------------------------------------------------------------------------------ Stockholders' equity Common stock 30 30 Additional paid-in capital 25,208 25,185 Accumulated deficit (14,408) (15,359) ------------------------------------------------------------------------------------------ Total stockholders' equity 10,830 9,856 ------------------------------------------------------------------------------------------ Total liabilities and stockholders' equity $ 21,496 $ 19,792 ==========================================================================================
91 Greater Atlantic Financial Corp. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Parent Company - Only Condensed Statements of Operations Year Ended September 30, -------------------------------------------- 2007 2006 2005 ------------------------------------------------------------------------------------------------------------ (In Thousands) Interest income $ 1 $ 1 $ - Other income - - - ------------------------------------------------------------------------------------------------------------ Total interest income 1 1 - ------------------------------------------------------------------------------------------------------------ Interest expense 644 645 645 ------------------------------------------------------------------------------------------------------------ Total interest expense 644 645 645 ------------------------------------------------------------------------------------------------------------ Net interest income (expense) (643) (644) (645) ------------------------------------------------------------------------------------------------------------ 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 169 149 142 ------------------------------------------------------------------------------------------------------------ Total noninterest expense 169 149 142 ------------------------------------------------------------------------------------------------------------ Loss before income from subsidiaries (793) (774) (768) ------------------------------------------------------------------------------------------------------------ Equity in income (loss) from subsidiaries 1,744 (4,797) (862) ------------------------------------------------------------------------------------------------------------ Net income (loss) $ 951 $ (5,571) $ (1,630) ============================================================================================================ Parent Company - Only Condensed Statements of Cash Flows Year Ended September 30, ------------------------------------------- 2007 2006 2005 ------------------------------------------------------------------------------------------------------------ (In Thousands) Cash flows from operating activities: Net income (loss) $ 951 $ (5,571) $ (1,630) Adjustments to reconcile net loss to net cash (used in) provided by operating activities (Income) loss from subsidiaries (1,744) 4,797 862 (Increase) decrease in assets (7) (5) (1) Increase (decrease) in other liabilities 753 18 (12) ------------------------------------------------------------------------------------------------------------ Net cash used in operating activities (47) (761) (781) ------------------------------------------------------------------------------------------------------------ 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 Stock options exercised - - 33 ------------------------------------------------------------------------------------------------------------ Net cash provided by financing activities - 755 833 ------------------------------------------------------------------------------------------------------------ Net (decrease) increase in cash and cash equivalents (47) (6) 52 Cash and cash equivalents at beginning of year 60 66 14 ------------------------------------------------------------------------------------------------------------ Cash and cash equivalents at end of year $ 13 $ 60 $ 66 ============================================================================================================
92 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 24. 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 Forms 10-Q, for the fiscal years ended September 30, 2007 and 2006.
For Fiscal Year 2007 ------------------------------------------------------------------------ For the Year Ended September 30, Fourth Third Second First 2007 Quarter Quarter Quarter Quarter ------------------------------------------------------------------------------------------------------------ Interest income $18,421 $4,338 $4,684 $4,594 $4,805 Interest expense 11,993 3,017 3,076 2,899 3,001 ------------------------------------------------------------------------------------------------------------ Net interest income 6,428 1,321 1,608 1,695 1,804 Provision (recapture) for loan 685 396 (4) 145 148 losses ------------------------------------------------------------------------------------------------------------ Net interest income, after 5,743 925 1,612 1,550 1,656 provision for loan losses Noninterest income 4,870 4,398 (1) 186 148 138 Noninterest expense 9,626 2,112 2,306 2,522 2,686 ------------------------------------------------------------------------------------------------------------ Income (loss) before income taxes 987 3,211 (508) (824) (892) Provision for income taxes 36 36 - - ------------------------------------------------------------------------------------------------------------ Net income (loss) $ 951 $3,175 $ (508) $ (824) $ (892) ============================================================================================================ BASIC AND DILUTED EARNINGS (LOSS) PER COMMON SHARE: Basic $ 0.31 $ 1.05 $(0.17) $(0.27) $(0.30) Diluted $ 0.31 $ 0.74 $(0.17) $(0.27) $(0.30) ------------------------------------------------------------------------------------------------------------
(1) Includes effect of gain on sale of Pasadena branch of $4.3 million 93 GREATER ATLANTIC FINANCIAL CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For Fiscal Year 2006 ------------------------------------------------------------------------------ For the Year Ended September Fourth Third Second First 30, 2006 Quarter Quarter Quarter Quarter ------------------------------------------------------------------------------------------------------------------------ Interest income $ 18,794 $ 4,851 $ 4,753 $ 4,600 $ 4,590 Interest expense 11,583 3,021 2,941 2,839 2,782 ------------------------------------------------------------------------------------------------------------------------ Net interest income 7,211 1,830 1,812 1,761 1,808 Provision for loan losses 126 39 13 3 71 ------------------------------------------------------------------------------------------------------------------------ Net interest income, after provision 7,085 1,791 1,799 1,758 1,737 for loan losses Noninterest income 917 (63) 307 330 343 Noninterest expense 11,085 3,217 2,722 2,626 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) ========================================================================================================================
94 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: December 28, 2007 95 EX-23.1 2 grtatl10kdec07ex23-1.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 December 17, 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, 2007. /s/ BDO Seidman, LLP Richmond, Virginia December 28, 2007 EX-31.1 3 grtatl10kdec07ex31-1.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: December 28, 2007 /s/ Carroll E. Amos ------------------- Carroll E. Amos Chief Executive Officer EX-31.2 4 grtatl10kdec07ex31-2.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: December 28, 2007 /s/ David E. Ritter ------------------- David E. Ritter Chief Financial Officer EX-32.1 5 grtatl10kdec07ex32-1.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, 2007 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 December 28, 2007 EX-32.2 6 grtatl10kdec07ex32-2.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, 2007 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 December 28, 2007 -----END PRIVACY-ENHANCED MESSAGE-----