| Risk Factors Our business, and an investment in our common stock, involves risks |
| Summarized below are the risk factors which we believe are material to our business and could negatively affect our operating results, financial condition and the trading value of our common stock |
| Other risks factors, not currently known to us, or that we currently deem to be immaterial or unlikely, also could adversely affect our business |
| In assessing the following risk factors, you should also refer to the other information contained in this Annual Report on Form 10-K and our other filings with the Securities and Exchange Commission |
| Risks relating to our business Our loan portfolio possesses increased risk due to our substantial number of multi-family, commercial real estate, commercial business and consumer loans, which could increase the level of our provision for loan losses |
| Our outstanding commercial real estate, commercial business, construction, multi-family, and automobile and other consumer loans accounted for approximately 28dtta4prca of our total loan portfolio as of December 31, 2005 |
| Generally, we consider these types of loans to involve a higher degree of risk compared to first mortgage loans on one- to four-family, owner occupied residential properties |
| These loans have higher risks than loans secured by residential real estate for the following reasons: • Commercial Real Estate and Commercial Business Loans |
| Repayment is dependent on income being generated by the rental property or business in amounts sufficient to cover operating expenses and debt service |
| • Commercial and Multi-Family Construction Loans |
| Repayment is dependent upon the completion of the project and income being generated by the rental property or business in amounts sufficient to cover operating expenses and debt service |
| • Single Family Construction Loans |
| Repayment is dependent upon the successful completion of the project and the ability of the contractor or builder to repay the loan from the sale of the property or obtaining permanent financing |
| • Multi-Family Real Estate Loans |
| Repayment is dependent on income being generated by the rental property in amounts sufficient to cover operating expenses and debt service |
| • Consumer Loans |
| Consumer loans (such as automobile loans) are collateralized, if at all, with assets that may not provide an adequate source of repayment of the loan due to depreciation, damage or loss |
| We plan to continue to increase our emphasis on construction, commercial and commercial real estate loans |
| As such, we may determine it necessary to increase the level of our provision for loan losses |
| Increased provisions for loan losses would negatively affect our results of operation |
| For further information concerning these risks, see Item 1 |
| Business –“Lending Activities” and “- Asset Quality |
| ” 35 _________________________________________________________________ [90]Table of Contents Our loan portfolio possesses increased risk due to its rapid expansion and the unseasoned nature of the portfolio |
| Since December 31, 2001 to December 31, 2005, the balance of our gross loan portfolio has grown from dlra337dtta1 million to dlra581dtta2 million, an increase of 72dtta4prca with approximately 32dtta0prca of that growth occurring in the last two years |
| Much of this growth is in one- to four-family residential properties generally located throughout southeastern Georgia and northeastern Florida |
| As a result of this rapid expansion, a significant portion of our portfolio is unseasoned, with the risk that these loans may not have had sufficient time to perform to properly indicate the potential magnitude of losses |
| During this time frame, we have also experienced a historically low interest rate environment |
| Our unseasoned adjustable rate loans have not, therefore, been subject to an interest rate environment that causes them to adjust to the maximum level and may involve repayment risks resulting from potentially increasing payment obligations by the borrower as a result of repricing |
| At December 31, 2005, we had dlra344dtta0 million in adjustable rate loans which make up 59dtta2prca of our loan portfolio |
| Our geographic concentration in loans secured by one- to four- family residential real estate may increase our credit losses, which could increase the level of our provision for loan losses |
| As of December 31, 2005 approximately 73dtta6prca of our total loan portfolio was secured by first or second liens on one- to four-family residential property, primarily in southeastern Georgia and northeastern Florida |
| A major downturn in the local or national economy, or a sudden change in interest rates could adversely affect our loan customers’ ability to repay their loans |
| In the event we are required to foreclose on a property securing one of our mortgage loans or otherwise pursue our remedies in order to protect our investment, there can be no assurance that we will recover funds in an amount equal to any remaining loan balance as a result of prevailing economic conditions, real estate values and other factors associated with the ownership of real property |
| As a result, the market value of the real estate or other collateral underlying our loans may not, at any given time, be sufficient to satisfy the outstanding principal amount of the loans |
| Consequently we would sustain loan losses and potentially incur a higher provision for loan loss expense |
| If our allowance for loan losses is not sufficient to cover actual losses, our income may be negatively affected |
| In the event our loan customers do not repay their loans according to their terms and the collateral security for the payments of these loans is insufficient to pay any remaining loan balance, we may experience significant loan losses |
| Such credit risk is inherent in the lending business, and our failure to adequately assess such credit risk could have a material adverse affect on our financial condition and results of operations |
| We make various assumptions and judgments about the collectibility of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans |
| In determining the amount of the allowance for loans losses, we review our loans and our loss and delinquency experience, and we evaluate economic conditions as well |
| If our assumptions are incorrect, our allowance for loan losses may be insufficient to cover probable incurred losses in our loan portfolio, resulting in additions to our allowance |
| The allowance for loan losses is also periodically reviewed by our regulator, the Office of Thrift Supervision, who may disagree with our allowance and require us to increase the amount |
| The additions to our allowance for loans losses would be made through increased provisions for loan losses and would negatively affect our results of operation |
| 36 _________________________________________________________________ [91]Table of Contents We are dependent on our management team to implement our business strategy and successful operations |
| We are dependent upon the services of our senior management team |
| Our operations and strategy are directed by our senior management team a third of whom, have joined our Company since October 2004 |
| Only our president and chief executive officer, who has served in such position since 1983, has an employment contract |
| There is not, however, a non-compete provision in the contract in the event his employment is terminated |
| Any loss of the services of our president and chief executive officer or other members of our management team could have a material adverse effect on our results of operations, our ability to implement our business strategy and our ability to compete in our market |
| To be profitable, we have to earn more money in interest that we receive on loans and our investments than we pay in interest to our depositors and lenders |
| The Federal Reserve Board increased the Federal Discount rate eight times during 2005, from 3dtta25prca to 5dtta25prca |
| The Federal Discount rate has a direct correlation to general rates of interest, including our interest-bearing deposits |
| As explained in more detail in Item 7A of this Annual Report on Form 10-K, “Quantitative and Qualitative Disclosures About Market Risk,” our mix of asset and liabilities are considered to be liability sensitive to interest rate changes |
| Accordingly if interest rates continue to rise, our net interest income could be reduced because interest paid on interest-bearing liabilities, including deposits and borrowings, increases more quickly than interest received on interest-earning assets, including loans and mortgage-backed and related securities |
| In addition, rising interest rates may negatively affect our income because they may reduce the demand for loans and the value of our mortgage-related and investment securities |
| On the other hand, if interest rates decrease, our net interest income could increase |
| However, in a declining rate environment, we may also be susceptible to the payoff or refinance of high rate mortgage loans that could reduce our net interest income |
| For a further discussion of how changes in interest rates could impact us, see Item 7 in this Annual Report on Form 10-K, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” |
| Strong competition in our primary market area may reduce our ability to attract and retain deposits and obtain loans |
| We operate in a very competitive market for the attraction of deposits, which is our primary source of funds, and the ability to obtain loans through origination or purchase |
| Historically, our most direct competition for deposits has come from credit unions, community banks, large commercial banks and thrift institutions in our primary market areas |
| Particularly in times of extremely low or extremely high interest rates, we have faced additional significant competition for investors’ funds from short-term money market securities and other corporate and government securities |
| During periods of regularly increasing interest rates, such as 2005 (see comment above about Federal Reserve Board interest rate increases), competition for interest bearing deposits increases as customers, particularly time deposit customers, tend to move their accounts between competing businesses to obtain the highest rates in the market |
| Our competition for loans comes principally from mortgage bankers, commercial banks, other thrift institutions, insurance companies and credit unions |
| Such competition for deposits and the origination and purchase of loans may limit our future growth and earnings prospects |
| 37 _________________________________________________________________ [92]Table of Contents If economic conditions deteriorate, our results of operations and financial condition could be adversely impacted as borrowers’ ability to repay loans declines and the value of the collateral securing our loans decreases |
| Our financial results may be adversely affected by changes in prevailing economic conditions, including decreases in real estate values, changes in interest rates which may cause a decrease in interest rate spreads, adverse employment conditions, the monetary and fiscal policies of the federal and the Georgia and Florida state governments and other significant external events |
| We hold approximately 25dtta0prca of the deposits in Ware County, the county in which Waycross, Georgia is located |
| We have less than 1dtta0prca of the deposits in the Jacksonville, Florida, metropolitan area |
| Our share of the loan market in Ware County is approximately 25dtta0prca and approximately 1dtta5prca in the Jacksonville, metropolitan area |
| As a result of the concentration in Ware County, we could be more susceptible to adverse market conditions in that market |
| Because we have a significant amount of real estate loans, decreases in real estate values could adversely affect the value of property used as collateral |
| Adverse changes in the economy may also have a negative effect on the ability of our borrowers to make timely repayments of their loans, which would have an adverse impact on our earnings |
| We operate in a highly regulated environment and we may be adversely affected by changes in laws and regulations |
| Atlantic Coast Federal is subject to extensive regulation, supervision and examination by the Office of Thrift Supervision, its chartering authority, and by the Federal Deposit Insurance Corporation, which insures Atlantic Coast Federal’s deposits |
| As a savings and loan holding company, we are subject to regulation and supervision by the Office of Thrift Supervision |
| Such regulation and supervision govern the activities in which financial institutions and their holding companies may engage and are intended primarily for the protection of the federal deposit insurance fund and depositors |
| These regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operations of financial institutions, the classification of assets by financial institutions and the adequacy of financial institutions’ allowance for loan losses |
| Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, or legislation, could have a material impact on Atlantic Coast Federal and Atlantic Coast Federal Corporation |
| Our operations are also subject to extensive regulation by other federal, state and local governmental authorities, and are subject to various laws and judicial and administrative decisions that impose requirements and restrictions on our operations |
| These laws, rules and regulations are frequently changed by legislative and regulatory authorities |
| There can be no assurance that changes to existing laws, rules and regulations, or any other new laws, rules or regulations, will not be adopted in the future, which could make compliance more difficult or expensive or otherwise adversely affect our business, financial condition or prospects |
| 38 _________________________________________________________________ [93]Table of Contents Risks relating to an investment in our common stock Our stock price may be volatile due to limited trading volume |
| Our common stock is traded on the NASDAQ National Market System |
| However, the average daily trading volume in our common stock is relatively small, less than approximately 20cmam000 shares per day in 2005, and sometimes significantly less than that |
| As a result, trades involving a relatively small number of shares may have a significant effect on the market price of our common stock, and it may be difficult for investors to acquire or dispose of large blocks of stock without significantly affecting the market price |
| Public stockholders own a minority of Atlantic Coast Federal Corporation’s common stock and will not be able to exercise voting control over most matters put to a vote of stockholders |
| Our holding company, Atlantic Coast Federal, MHC owns approximately 61dtta7prca of our common stock |
| Our directors and executive officers own or control approximately 4dtta1prca of our common stock |
| The same directors and executive officers that manage Atlantic Coast Federal Corporation, also manage Atlantic Coast Federal, MHC Public stockholders who are not associated with the MHC or Atlantic Coast Federal Corporation own approximately 34dtta2prca of our common stock |
| The Board of Directors of Atlantic Coast Federal, MHC will be able to exercise voting control over most matters put to a vote of stockholders because it owns a majority of Atlantic Coast Federal Corporation’s common stock |
| For example, Atlantic Coast Federal, MHC may exercise its voting control to prevent a sale or merger transaction in which stockholders could receive a premium for their shares or to approve employee benefit plans |
| Stock issued pursuant to the exercise of stock options awarded to directors and management will dilute public stockholder ownership |
| Directors and management currently hold options to purchase approximately 534cmam000 shares of common stock, or 3dtta8prca of total common stock outstanding |
| There are an additional 178cmam000 shares available for future awards of options under our current stock option plan, or 1dtta3prca of our common stock outstanding |
| Stock options are paid for by the recipient in an amount equal to the fair market value of the stock on the date of grant |
| The payments are not made until the option is actually exercised by the recipient |
| The issuance of common stock pursuant to the exercise of total stock options under our stock option plan will result in the dilution of existing stockholders voting interests by 5dtta1prca unless we repurchase additional shares to cover such exercise |
| Our ability to pay dividends is limited |
| Our ability to pay dividends is limited by regulatory requirements and the need to maintain sufficient consolidated capital to meet the capital needs of our business, including capital needs related to future growth |
| Our primary source of income is the payment of dividends from Atlantic Coast Federal to us |
| Atlantic Coast Federal, in turn, is subject to regulatory requirements potentially limiting its ability to pay such dividends to us and by the need to maintain sufficient capital for its operations and obligations |
| Thus, there can be no assurance that we will continue to pay dividends to our common stockholders, no assurance as to the amount or timing of any such dividends, and no assurance that such dividends, if and when paid, will be maintained, at the same level or at all, in future periods |
| 39 _________________________________________________________________ [94]Table of Contents Atlantic Coast Federal MHC may never convert from a mutual stock to a capital stock form which could adversely affect the market value of our common stock |
| We believe that the current market price of our common stock is partly based on anticipation by investors that our parent company, Atlantic Coast Federal, MHC will convert from mutual form to capital stock form in the future |
| This conversion, which is commonly known as a “second-step conversion,” would permit members of Atlantic Coast Federal, MHC to purchase shares of our common stock of our successor, and allow our stockholders, other than Atlantic Coast Federal, MHC, to exchange their shares for a number of shares in the new stock company based upon an exchange ratio that ensures that such stockholders own the same percentage in the new company that they owned in Atlantic Coast Federal Corporation immediately prior to the conversion |
| We have no current plans to undertake a “second-step conversion |
| ” The market value of our stock could be adversely affected if investors sell our common stock because they no longer anticipate that a “second-step conversion” is imminent in the near term |