Atlantic Coast Financial CORP - FORM 10-Q

Attached files

file	filename
EX-31.1 - EXHIBIT 31.1 - Atlantic Coast Financial CORP	v416874_ex31-1.htm
EX-32 - EXHIBIT 32 - Atlantic Coast Financial CORP	v416874_ex32.htm
EX-31.2 - EXHIBIT 31.2 - Atlantic Coast Financial CORP	v416874_ex31-2.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2015

Commission file number: 001-35072

ATLANTIC COAST FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

Maryland	65-1310069
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
4655 Salisbury Road, Suite 110 Jacksonville, Florida	32256
(Address of principal executive offices)	(Zip Code)

(800) 342-2824

(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES x NO ¨.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

YES x NO ¨.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer ¨

Accelerated Filer ¨

Non-Accelerated Filer ¨

Smaller Reporting Company 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 number of shares outstanding of the registrant’s common stock as of August 3, 2015 was 15,509,061 shares.

ATLANTIC COAST FINANCIAL CORPORATION

Form 10-Q Quarterly Report

Table of Contents

		Page

	PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements	3
	Condensed Consolidated Balance Sheets	3
	Condensed Consolidated Statements of Operations	4
	Condensed Consolidated Statements of Comprehensive Income	5
	Condensed Consolidated Statements of Stockholders’ Equity	6
	Condensed Consolidated Statements of Cash Flows	7
	Notes to Condensed Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	38
	General Description of Business	39
	Recent Events	39
	Critical Accounting Policies	40
	Comparison of Financial Condition	40
	Comparison of Results of Operations	49
	Liquidity	59
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	60
Item 4.	Controls and Procedures	60

	PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	61
Item 1A.	Risk Factors	61
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	61
Item 3.	Defaults Upon Senior Securities	61
Item 4.	Mine Safety Disclosures	61
Item 5.	Other Information	61
Item 6.	Exhibits	61

Signature Page		62
Index to Exhibits		63

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in Thousands, Except Share Information)

(unaudited)

	June 30, 2015			December 31, 2014

ASSETS
Cash and due from financial institutions	$	17,379		$	2,974
Short-term interest-earning deposits		21,166			19,424
Total cash and cash equivalents		38,545			22,398
Investment securities:
Securities available-for-sale		110,285			118,699
Securities held-to-maturity		17,054			17,919
Total investment securities		127,339			136,618
Portfolio loans, net of allowance of $7,400 in 2015 and $7,107 in 2014		475,455			446,870
Other loans:
Held-for-sale		12,685			7,219
Warehouse loans held-for-investment		95,205			33,972
Total other loans		107,890			41,191
Federal Home Loan Bank stock, at cost		9,999			6,257
Land, premises and equipment, net		14,746			14,505
Bank owned life insurance		16,827			16,590
Other real estate owned		3,886			3,908
Accrued interest receivable		1,959			1,924
Deferred tax assets, net		10,539			–
Other assets		3,242			16,237
Total assets	$	810,427		$	706,498

LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits:
Noninterest-bearing demand	$	47,907		$	41,283
Interest-bearing demand		64,027			65,718
Savings and money market		178,300			171,657
Time		210,861			162,122
Total deposits		501,095			440,780
Securities sold under agreements to repurchase		10,000			66,300
Federal Home Loan Bank advances		217,371			123,667
Accrued expenses and other liabilities		3,881			3,415
Total liabilities		732,347			634,162

Commitments and contingent liabilities

Preferred stock: $0.01 par value; 25,000,000 shares authorized; none issued and outstanding at June 30, 2015 and December 31, 2014		–			–
Common stock: $0.01 par value; 100,000,000 shares authorized; 15,509,061 issued and outstanding at June 30, 2015 and December 31, 2014		155			155
Additional paid-in capital		100,556			100,604
Common stock held by:
Employee stock ownership plan shares of 74,252 at June 30, 2015 and 76,647 at December 31, 2014		(1,613	)		(1,665	)
Benefit plans		(288	)		(297	)
Retained deficit		(18,431	)		(24,452	)
Accumulated other comprehensive income (loss)		(2,299	)		(2,009	)
Total stockholders’ equity		78,080			72,336
Total liabilities and stockholders’ equity	$	810,427		$	706,498

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

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in Thousands, Except Share Information)

(unaudited)

	Three Months Ended June 30,					Six Months Ended June 30,
	2015			2014		2015			2014

Interest and dividend income:
Loans, including fees	$	6,647		$	5,901	$	12,762		$	11,780
Securities and interest-earning deposits in other financial institutions		775			1,030		1,531			2,076
Total interest and dividend income		7,422			6,931		14,293			13,856
Interest expense:
Deposits		578			629		1,128			1,291
Securities sold under agreements to repurchase		722			827		1,540			1,802
Federal Home Loan Bank advances		1,137			1,148		2,220			2,279
Total interest expense		2,437			2,604		4,888			5,372
Net interest income		4,985			4,327		9,405			8,484
Provision for portfolio loan losses		190			350		387			800
Net interest income after provision for portfolio loan losses		4,795			3,977		9,018			7,684

Noninterest income:
Service charges and fees		660			680		1,296			1,317
Gain on sale of loans held-for-sale		350			269		849			493
Gain (loss) on sale of securities available-for-sale		–			7		(9	)		7
Bank owned life insurance earnings		119			119		237			209
Interchange fees		408			388		803			761
Other		139			118		262			254
Total noninterest income		1,676			1,581		3,438			3,041

Noninterest expense:
Compensation and benefits		3,133			2,633		6,049			4,920
Occupancy and equipment		538			492		1,052			983
Federal Deposit Insurance Corporation insurance premiums		154			358		349			742
Foreclosed assets, net		102			13		102			19
Data processing		472			365		867			658
Outside professional services		554			405		1,086			788
Collection expense and repossessed asset losses		105			130		224			294
Securities sold under agreements to repurchase and Federal Home Loan Bank advances prepayment penalties		5,188			–		5,188			–
Other		1,040			892		1,910			1,797
Total noninterest expense		11,286			5,288		16,827			10,201

Income (loss) before income tax expense		(4,815	)		270		(4,371	)		524
Income tax expense (benefit)		(10,440	)		45		(10,392	)		93
Net income	$	5,625		$	225	$	6,021		$	431

Earnings per common share:
Basic	$	0.36		$	0.02	$	0.39		$	0.03
Diluted	$	0.36		$	0.02	$	0.39		$	0.03

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

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in Thousands)

(unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2015			2014			2015			2014

Net income	$	5,625		$	225		$	6,021		$	431

Other comprehensive income (loss):
Change in securities available-for-sale:
Unrealized holding gains (losses) arising during the period		(1,367	)		1,997			(473	)		4,507
Reclassification adjustments for losses (gains) recognized in income		–			(7	)		9			(7	)
Net unrealized gains (losses)		(1,367	)		1,990			(464	)		4,500
Income tax effect		174			–			174			–
Net of tax effect		(1,193	)		1,990			(290	)		4,500

Total other comprehensive income (loss)		(1,193	)		1,990			(290	)		4,500

Comprehensive income	$	4,432		$	2,215		$	5,731		$	4,931

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

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Dollars in Thousands, Except Share Information)

(unaudited)

	Common Stock		Additional Paid-In Capital			Employee Stock Ownership Plan Shares			Benefit Plans			Retained Deficit			Accumulated Other Comprehensive Income (Loss)			Total Stockholders’ Equity

For the six months ended June 30, 2015:

Balance at December 31, 2014	$	155	$	100,604		$	(1,665	)	$	(297	)	$	(24,452	)	$	(2,009	)	$	72,336
Employee stock ownership plan shares earned, 2,395 shares		–		(42	)		52			–			–			–			10
Management restricted stock expense		–		2			–			–			–			–			2
Stock options expense		–		11			–			–			–			–			11
Distribution from Rabbi Trust		–		(19	)		–			9			–			–			(10	)
Net income		–		–			–			–			6,021			–			6,021
Other comprehensive loss		–		–			–			–			–			(290	)		(290	)
Balance at June 30, 2015	$	155	$	100,556		$	(1,613	)	$	(288	)	$	(18,431	)	$	(2,299	)	$	78,080

For the six months ended June 30, 2014:

Balance at December 31, 2013	$	155	$	100,794		$	(1,769	)	$	(317	)	$	(25,779	)	$	(7,559	)	$	65,525
Additional cost associated with the issuance of common stock in a public offering in 2013		–		(112	)		–			–			–			–			(112	)
Employee stock ownership plan shares earned, 2,395 shares		–		(42	)		52			–			–			–			10
Management restricted stock expense		–		2			–			–			–			–			2
Stock options expense		–		11			–			–			–			–			11
Distribution from Rabbi Trust		–		(10	)		–			10			–			–			–
Net income		–		–			–			–			431			–			431
Other comprehensive income		–		–			–			–			–			4,500			4,500
Balance at June 30, 2014	$	155	$	100,643		$	(1,717	)	$	(307	)	$	(25,348	)	$	(3,059	)	$	70,367

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

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in Thousands)

(unaudited)

	Six Months Ended June 30,
	2015			2014

Cash flows from operating activities:
Net income	$	6,021		$	431
Adjustments to reconcile net income to net cash from operating activities:
Provision for portfolio loan losses		387			800
Gain on sale of loans held-for-sale		(849	)		(493	)
Originations of loans held-for-sale		(5,913	)		(6,300	)
Proceeds from sales of loans held-for-sale		7,662			5,012
Foreclosed assets, net		102			19
(Gain) loss on sale of securities available-for-sale		9			(7	)
Employee stock ownership plan compensation expense		10			10
Share-based compensation expense		13			13
Amortization of premiums and deferred fees, net of accretion of discounts on investment securities and loans		(190	)		(830	)
Depreciation expense		402			295
Deferred tax benefit		(10,539	)		–
Net change in cash surrender value of bank owned life insurance		(237	)		(210	)
Net change in accrued interest receivable		(35	)		(125	)
Net change in other assets		(957	)		818
Net change in accrued expenses and other liabilities		466			(735	)
Net cash used in operating activities		(3,648	)		(1,302	)

Cash flows from investing activities:
Proceeds from maturities and payments of investment securities		8,484			10,700
Proceeds from sales of securities available-for-sale		14,126			6,266
Purchase of securities available-for-sale		–			(32,297	)
Funding of warehouse loans held-for-investment		(560,980	)		(179,407	)
Proceeds from repayments of warehouse loans held-for-investment		499,747			177,624
Purchase of portfolio loans		(12,503	)		(32,515	)
Net change in portfolio loans		(22,663	)		(2,245	)
Expenditures on premises and equipment		(643	)		(334	)
Proceeds from sale of other real estate owned		260			199
Purchase of Federal Home Loan Bank stock		(6,059	)		(675	)
Redemption of Federal Home Loan Bank stock		2,317			267
Net cash used in investing activities		(77,914	)		(52,417	)

Cash flows from financing activities:
Net change in deposits		60,315			(16,152	)
Proceeds from securities sold under agreements to repurchase		10,000			–
Repayment of securities sold under agreements to repurchase		(66,300	)		(26,500	)
Proceeds from Federal Home Loan Bank advances		324,925			15,000
Repayment of Federal Home Loan Bank advances		(228,333	)		–
Prepayment penalties resulting from repayment of Federal Home Loan Bank advances		(2,888	)		–
Additional cost associated with the issuance of common stock in a public offering in 2013		–			(112	)
Shares purchased for and distributions from Rabbi Trust		(10	)		–
Net cash provided by (used in) financing activities		97,709			(27,764	)

Net decrease in cash and cash equivalents		16,147			(81,483	)
Cash and cash equivalents, beginning of period		22,398			114,194
Cash and cash equivalents, end of period	$	38,545		$	32,711

Supplemental disclosures of cash flow information:
Interest paid	$	5,639		$	5,601
Income taxes paid		–			394

Supplemental disclosures of non-cash information:
Loans transferred to other real estate	$	340		$	411
Loans transferred to held-for-sale		6,366			1,552
Income tax benefit from unrealized holding gains and losses on securities available-for-sale arising during the period		174			–

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

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2015

(unaudited)

NOTE 1. BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements (the Financial Statements) and these notes to unaudited condensed consolidated financial statements (these Notes) include Atlantic Coast Financial Corporation (the Company) and its wholly owned subsidiary, Atlantic Coast Bank (the Bank). All significant inter-company balances and transactions have been eliminated in consolidation. The principal activity of the Company is the ownership of the Bank’s common stock, and as such, the terms “Company” and “Bank” are used interchangeably throughout this Quarterly Report on Form 10-Q (this Report).

The accompanying condensed consolidated balance sheet as of December 31, 2014, which was derived from our audited consolidated financial statements, and the unaudited condensed consolidated financial statements as of June 30, 2015 and for the three and six months ended June 30, 2015 and 2014, have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for a complete financial statement presentation. In the opinion of management, all adjustments (all of which are normal and recurring in nature) considered necessary (i) for a fair presentation and (ii) to make such statements not misleading, have been included.

Operating results for the three and six months ended June 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015. The audited consolidated financial statements presented in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014 (the 2014 10-K) should be read in conjunction with these Financial Statements.

Certain items in the prior period financial statements have been reclassified to conform to the current period presentation. The reclassifications had no effect on net income, the balance of retained deficit, or stockholders’ equity as previously reported.

The preparation of unaudited condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions based on experience and available information that affect the amounts reported in the Financial Statements and these Notes, and actual results could differ materially from these estimates. Estimates associated with the allowance for portfolio loan losses (the allowance), measuring for impairment of troubled debt restructurings (TDR), the fair values of securities, other financial instruments and other real estate owned (OREO), and the realization of deferred tax assets are particularly susceptible to material change in the near term.

NOTE 2. IMPACT OF CERTAIN ACCOUNTING PRONOUNCEMENTS

In April 2015, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2015-03, Simplifying the Presentation of Debt Issuance Costs (ASU 2015-03). ASU 2015-03 changes the financial statement presentation of debt issuance costs to be a direct reduction to long-term debt, rather than presented as a long-term asset. The amortization of debt issuance costs will continue to be included in interest expense. The guidance in this standard is effective for interim and annual periods beginning after December 15, 2015, and early adoption is permitted, with retrospective disclosure necessary for all comparative periods presented. The Company adopted ASU 2015-03 for the second quarter of 2015, with no material impact on the Financial Statements.

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 2. IMPACT OF CERTAIN ACCOUNTING PRONOUNCEMENTS (continued)

In August 2014, the FASB issued ASU 2014-14, Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure (ASU 2014-14). ASU 2014-14 requires that a government-guaranteed mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure if certain conditions are met. The guidance in this standard may be applied using either a prospective or a modified retrospective approach and is effective for fiscal years, and interim periods within those years, beginning after December 15, 2014. However, a reporting entity must apply the same method of transition as elected under ASU 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (ASU 2014-04). Early adoption of ASU 2014-14, including adoption in an interim period, is permitted if the entity already has adopted ASU 2014-04. The Company adopted ASU 2014-14 for the first quarter of 2015, with no material impact on the Financial Statements.

In June 2014, the FASB issued ASU 2014-11, Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures (ASU 2014-11). ASU 2014-11 requires that repurchase-to-maturity transactions be accounted for as secured borrowings and requires separate secured borrowing accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty. Additionally, ASU 2014-11 requires disclosure of information about transfers accounted for as sales in transactions that are economically similar to repurchase agreements and disclosure of the types of collateral pledged in such transactions. The guidance in this standard is effective for interim and annual periods beginning after December 15, 2014, with retrospective disclosure necessary for all comparative periods presented. The adoption of this standard for the first quarter of 2015 did not result in additional disclosures, nor did it have any material impact on the Financial Statements.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (ASU 2014-09). ASU 2014-09 is a comprehensive new revenue recognition model requiring a company to recognize revenue to depict the transfer of goods or services to a customer at an amount reflecting the consideration it expects to receive in exchange for those goods or services. The guidance in this standard may be applied using either a full retrospective or a modified retrospective approach and is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, and early adoption is not permitted. The Company is in the process of evaluating the impact of adopting this standard on the Financial Statements, as well as evaluating which transition method will be applied upon adoption.

In January 2014, the FASB issued ASU 2014-04, which will eliminate diversity in practice regarding the timing of derecognition for residential mortgage loans when an in-substance repossession or foreclosure has occurred. Additionally, ASU 2014-04 requires both interim and annual disclosure of properties that are in the process of foreclosure. The guidance in this standard is effective for interim and annual periods beginning after December 15, 2014, with retrospective disclosure necessary for all comparative periods presented. The adoption of this standard for the first quarter of 2015 resulted in additional disclosures, but did not have any material impact on the Financial Statements.

NOTE 3. TRANSACTIONS WITH RELATED PARTIES

Transactions between Atlantic Coast Bank and Customers Bank

Jay S. Sidhu and Bhanu Choudhrie are directors of the Company and Customers Bancorp, Inc., the parent company of Customers Bank. Mr. Sidhu is also Chairman and Chief Executive Officer of Customers Bancorp, Inc. and Customers Bank.

On March 27, 2015, the Bank entered into three $10.0 million participation agreements related to warehouse lines of credit secured by one- to four-family residential loans originated by third party originators under purchase and assumption agreements (warehouse loans held-for-investment) with Customers Bank (collectively, the Customers Participation Agreements). Under the Customers Participation Agreements, the Bank has an interest in existing lines of credit related to warehouse loans held-for-investment currently serviced by Customers Bank.

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 3. TRANSACTIONS WITH RELATED PARTIES (continued)

Transactions between Atlantic Coast Bank and Customers Bank (continued)

The Bank receives the full amount of interest earned on the warehouse loans held-for-investment. Customers Bank receives the fees paid for each individual funding request. Customers Bank services the warehouse loans held-for-investment funding requests, manages the collateral receipt and shipment, receives and posts pay downs, and remits principal and interest to the Bank. Under the Customers Participation Agreements, Customers Bank is required to administer the participated lines of credit using the same standards the Bank would use to administer its own accounts. Additionally, the Bank has access to each funding request and all daily activity reporting to monitor its exposure.

The Customers Participation Agreements were entered into in the ordinary course of the Bank’s business, made on substantially the same terms as those prevailing at the time for comparable agreements with non-affiliated business partners, and did not involve more than a normal risk or present other unfavorable features. As of June 30, 2015, the outstanding balance in warehouse loans held-for-investment related to the Customers Participation Agreements was $28.2 million.

On March 26, 2014, the Bank purchased $16.2 million of one- to four-family mortgages, comprised entirely of loans within our markets, from Customers Bank for $16.5 million, at a premium of 1.75%. This loan purchase transaction was in the ordinary course of the Bank’s business, made on substantially the same terms as those prevailing at the time for comparable transactions with non-affiliated business partners, and did not involve more than a normal risk or present other unfavorable features.

NOTE 4. FAIR VALUE

Asset and liability fair value measurements (in this Note and Note 5. Fair Value of Financial Instruments of these Notes) have been categorized based upon the fair value hierarchy described below:

Level 1 – Valuation is based upon quoted market prices for identical instruments in active markets.

Level 2 – Valuation is based upon quoted market prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3 – Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect estimates or assumptions that market participants would use in pricing the assets or liabilities. Valuation techniques include use of option pricing models, discounted cash flow models, and similar techniques.

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 4. FAIR VALUE (continued)

Assets and liabilities measured at fair value on a recurring basis as of June 30, 2015 and December 31, 2014 are summarized below:

			Fair Value Hierarchy
	Total		Level 1		Level 2		Level 3
	(Dollars in Thousands)
June 30, 2015
Assets:
Securities available-for-sale:
U.S. Government-sponsored enterprises	$	4,788	$	–	$	4,788	$	–
State and municipal		5,038		–		5,038		–
Mortgage-backed securities – residential		91,056		–		91,056		–
Collateralized mortgage obligations – U.S. Government		9,403		–		9,403		–
Total	$	110,285	$	–	$	110,285	$	–

December 31, 2014
Assets:
Securities available-for-sale:
U.S. Government-sponsored enterprises	$	4,738	$	–	$	4,738	$	–
State and municipal		5,083		–		5,083		–
Mortgage-backed securities – residential		98,514		–		98,514		–
Collateralized mortgage obligations – U.S. Government		10,364		–		10,364		–
Total	$	118,699	$	–	$	118,699	$	–

The fair values of securities available-for-sale are determined by quoted market prices, if available (Level 1). For securities available-for-sale where quoted market prices are not available, fair values are calculated based on quoted market prices of similar securities (Level 2). For securities available-for-sale where quoted market prices or quoted market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. During times when trading is less liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.

Assets and liabilities measured at fair value on a nonrecurring basis as of June 30, 2015 and December 31, 2014 are summarized below:

Fair Value Hierarchy

Total

Level 1

Level 2

Level 3

(Dollars in Thousands)

June 30, 2015

Assets:

Other real estate owned

3,886

–

3,886

December 31, 2014

Assets:

Other real estate owned

3,908

–

3,908

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 4. FAIR VALUE (continued)

Quantitative information about Level 3 fair value measurements as of June 30, 2015 and December 31, 2014 is summarized below:

	Fair Value Estimate		Valuation Techniques	Unobservable Input	Range (Weighted Average) (1)
	(Dollars in Thousands)

June 30, 2015
Assets:
Other real estate owned	$	3,886	Broker price opinions, appraisal of collateral (2), (3)	Appraisal adjustments (4) Liquidation expenses	0.0% to 30.7% (6.6%) 10.0% (10.0%)

December 31, 2014
Assets:
Other real estate owned	$	3,908	Broker price opinions, appraisal of collateral (2), (3)	Appraisal adjustments (4) Liquidation expenses	0.0% to 38.8% (4.4%) 10.0% (10.0%)

(1)

The range and weighted average of other appraisal adjustments and liquidation expenses are presented as a percent of the appraised value.

(2)

Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various level 3 inputs which are not identifiable.

(3)

Includes qualitative adjustments by management and estimated liquidation expenses.

(4)

Appraisals may be adjusted by management for qualitative factors such as economic conditions.

The fair value of OREO is determined using inputs which include current and prior appraisals and estimated costs to sell (Level 3). Assets acquired through or in lieu of loan foreclosure are initially recorded at fair value based on appraisals, as adjusted, less estimated selling costs at the date of foreclosure, establishing a new cost basis. At the initial time of transfer to OREO, an impairment loss is recognized through the allowance in cases where the carrying amount exceeds the new cost basis. Subsequent declines in fair value are recorded directly as an adjustment to current earnings through noninterest expense. Costs relating to improvement of property may be capitalized, whereas costs relating to the holding of property are expensed. Write-downs on OREO for the three and six months ended June 30, 2015 were $80,000. There were no write-downs on OREO for the three months ended June 30, 2014. Write-downs on OREO for the six months ended June 30, 2014 were $13,000.

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 5. FAIR VALUE OF FINANCIAL INSTRUMENTS

Carrying amount and estimated fair value of financial instruments, not previously presented, as of June 30, 2015 and December 31, 2014 were as follows:

					Fair Value Hierarchy
	Carrying Amount		Estimated Fair Value		Level 1		Level 2		Level 3
	(Dollars in Thousands)
June 30, 2015
Assets:
Cash and due from financial institutions	$	17,379	$	17,379	$	17,379	$	–	$	–
Short-term interest-earning deposits		21,166		21,166		21,166		–		–
Securities held-to-maturity		17,054		17,015		–		17,015		–
Portfolio loans, net		475,455		503,627		–		503,627		–
Loans held-for-sale		12,685		14,171		–		14,171		–
Warehouse loans held-for-investment		95,205		95,205		–		95,205		–
Federal Home Loan Bank stock, at cost		9,999		9,999		–		–		9,999
Accrued interest receivable		1,959		1,959		–		1,959		–
Liabilities:
Deposits		501,095		506,670		–		506,670		–
Securities sold under agreements to repurchase		10,000		10,000		–		10,000		–
Federal Home Loan Bank advances		217,371		220,968		–		220,968		–
Accrued interest payable (reported on consolidated balance sheets in accrued expenses and other liabilities)		55		55		–		55		–

December 31, 2014
Assets:
Cash and due from financial institutions	$	2,974	$	2,974	$	2,974	$	–	$	–
Short-term interest-earning deposits		19,424		19,424		19,424		–		–
Securities held-to-maturity		17,919		17,886		–		17,886		–
Portfolio loans, net		446,870		480,839		–		480,839		–
Loans held-for-sale		7,219		7,848		–		7,848		–
Warehouse loans held-for-investment		33,972		33,972		–		33,972		–
Federal Home Loan Bank stock, at cost		6,257		6,257		–		–		6,257
Accrued interest receivable		1,924		1,924		–		1,924		–
Liabilities:
Deposits		440,780		441,004		–		441,004		–
Securities sold under agreements to repurchase		66,300		72,533		–		72,533		–
Federal Home Loan Bank advances		123,667		131,005		–		131,005		–
Accrued interest payable (reported on consolidated balance sheets in accrued expenses and other liabilities)		806		806		–		806		–

Carrying amount is the estimated fair value for cash and cash equivalents, accrued interest, demand and savings deposits and variable rate loans or deposits that re-price frequently and fully. Fair value of securities held-to-maturity is based on market prices of similar securities. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent re-pricing or re-pricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life without considering the need for adjustments for market illiquidity or credit risk. Fair value of loans held-for-sale is based on quoted market prices, where available, or is determined based on discounted cash flows using current market rates applied to the estimated life and credit risk. Carrying amount is the estimated fair value for warehouse loans held-for-investment, due to the rapid repayment of the loans (generally less than 30 days). Fair value of the Federal Home Loan Bank (FHLB) advances and securities sold under agreements to repurchase (repurchase agreements) is based on current rates for similar financing. It was not practicable to determine the fair value of the FHLB stock due to restrictions placed on its transferability. The estimated fair value of other financial instruments and off-balance-sheet commitments approximate cost and are not considered significant to this presentation.

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 5. FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)

The Bank is a member of the FHLB and as such, is required to maintain a minimum investment in stock of the FHLB that varies with the level of advances outstanding with the FHLB. The stock is bought from and sold to the FHLB based upon its $100.00 par value. The stock does not have a readily determinable fair value and, as such, is classified as restricted stock, carried at cost and evaluated for impairment. Accordingly, the stock’s value is determined by the ultimate recoverability of the par value rather than by recognizing temporary declines. The determination of whether the par value will ultimately be recovered is influenced by criteria such as the following: (a) the significance of the decline in net assets of the FHLB as compared to the capital stock amount and the length of time that such a situation has persisted, (b) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance, (c) the impact of legislative and regulatory changes on the customer base of the FHLB and (d) the liquidity position of the FHLB. The Company did not consider the FHLB stock to be impaired as of June 30, 2015.

NOTE 6. INVESTMENT SECURITIES

The following table summarizes the amortized cost and fair value of the investment securities and the corresponding amounts of unrealized gains and losses therein as of June 30, 2015 and December 31, 2014:

	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value		Carrying Amount
	(Dollars in Thousands)

June 30, 2015
Securities available-for-sale:
U.S. Government – sponsored enterprises	$	5,000	$	–	$	(212	)	$	4,788	$	4,788
State and municipal		5,061		2		(25	)		5,038		5,038
Mortgage-backed securities – residential		93,010		–		(1,954	)		91,056		91,056
Collateralized mortgage obligations – U.S. Government		9,687		–		(284	)		9,403		9,403
Total securities available-for-sale		112,758		2		(2,475	)		110,285		110,285
Securities held-to-maturity (1):
Mortgage-backed securities – residential		17,054		–		(39	)		17,015		17,054
Total securities held-to-maturity		17,054		–		(39	)		17,015		17,054
Total investment securities	$	129,812	$	2	$	(2,514	)	$	127,300	$	127,339

December 31, 2014
Securities available-for-sale:
U.S. Government – sponsored enterprises	$	5,000	$	–	$	(262	)	$	4,738	$	4,738
State and municipal		5,071		20		(8	)		5,083		5,083
Mortgage-backed securities – residential		99,861		28		(1,375	)		98,514		98,514
Collateralized mortgage obligations – U.S. Government		10,776		–		(412	)		10,364		10,364
Total securities available-for-sale		120,708		48		(2,057	)		118,699		118,699
Securities held-to-maturity (1):
Mortgage-backed securities – residential		17,919		–		(33	)		17,886		17,919
Total securities held-to-maturity		17,919		–		(33	)		17,886		17,919
Total investment securities	$	138,627	$	48	$	(2,090	)	$	136,585	$	136,618

(1)

Investment securities held-to-maturity are carried at amortized cost.

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 6. INVESTMENT SECURITIES (continued)

The amortized cost and fair value of investment securities, both available-for-sale and held-to-maturity, segregated by contractual maturity as of June 30, 2015, are shown below:

	Amortized Cost		Fair Value
	(Dollars in Thousands)
Due in one year or less	$	–	$	–
Due from more than one to five years		–		–
Due from more than five to ten years		3,236		3,230
Due after ten years		1,825		1,808
U.S. Government-sponsored enterprises		5,000		4,788
Mortgage-backed securities – residential (1)		110,064		108,071
Collateralized mortgage obligations – U.S. Government		9,687		9,403
	$	129,812	$	127,300

(1)

Investment securities held-to-maturity, included in Mortgage-backed securities – residential, are carried at amortized cost.

Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Investment securities not due at a single maturity date, including mortgage-backed securities and collateralized mortgage obligations, are shown separately.

The following table summarizes the investment securities, both available-for-sale and held-to-maturity with unrealized losses as of June 30, 2015 and December 31, 2014, aggregated by investment category and length of time in a continuous unrealized loss position:

	Less Than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
	(Dollars in Thousands)
June 30, 2015
U.S. Government-sponsored enterprises	$	–	$	–		$	4,788	$	(212	)	$	4,788	$	(212	)
State and municipal		3,598		(25	)		–		–			3,598		(25	)
Mortgage-backed securities – residential (1)		32,370		(185	)		75,676		(1,808	)		108,046		(1,993	)
Collateralized mortgage obligations – U.S. Government		–		–			9,402		(284	)		9,402		(284	)
	$	35,968	$	(210	)	$	89,866	$	(2,304	)	$	125,834	$	(2,514	)

December 31, 2014
U.S. Government – sponsored enterprises	$	–	$	–		$	4,738	$	(262	)	$	4,738	$	(262	)
State and municipal		1,836		(8	)		–		-			1,836		(8	)
Mortgage-backed securities – residential (1)		14,230		(172	)		93,779		(1,236	)		108,009		(1,408	)
Collateralized mortgage obligations – U.S. Government		–		–			10,364		(412	)		10,364		(412	)
	$	16,066	$	(180	)	$	108,881	$	(1,910	)	$	124,947	$	(2,090	)

(1)

Investment securities held-to-maturity, included in Mortgage-backed securities – residential, are carried at amortized cost.

The increase in unrealized losses as of June 30, 2015 is due to a decrease in interest rates, which started in 2014 and continued through the end of the second quarter of 2015. The 10-year treasury rate as of June 30, 2015 and December 31, 2014 was 2.35% and 2.17%, respectively.

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 6. INVESTMENT SECURITIES (continued)

Other-Than-Temporary Impairment

Management evaluates investment securities for other-than-temporary impairment (OTTI) on at least a quarterly basis and more frequently when economic or market conditions warrant such an evaluation. As of June 30, 2015, the Company’s security portfolio consisted of 32 securities available-for-sale, 30 of which were in an unrealized loss position, and two securities held-to-maturity, both of which were in an unrealized loss position. Nearly all unrealized losses were related to debt securities whose underlying collateral is residential mortgages. However, all of these debt securities were issued by government sponsored organizations, as discussed below.

As of June 30, 2015, $122.3 million, or approximately 96.0% of the debt securities held by the Company, were issued by U.S. government-sponsored entities and agencies, primarily Fannie Mae, Freddie Mac and Ginnie Mae, institutions which the government has affirmed its commitment to support. The decline in fair value was attributable to changes in interest rates and not credit quality. The Company currently does not have the intent to sell these securities and it is not more likely than not it will be required to sell the securities before their anticipated recovery. Therefore, the Company does not consider these debt securities to be other-than-temporarily impaired as of June 30, 2015. During the three and six months ended June 30, 2015 and 2014, the Company did not record OTTI related to non-agency collateralized mortgage-backed securities or collateralized mortgage obligations

Proceeds from Investment Securities

Proceeds from sales, payments, maturities, and calls of securities available-for-sale were $4.1 million and $7.6 million for the three and six months ended June 30, 2015, respectively. Proceeds from sales, payments, maturities, and calls of securities available-for-sale were $11.7 million and $16.4 million for the three and six months ended June 30, 2014, respectively.

No gross gains were realized during the three and six months ended June 30, 2015. No gross losses were realized during the three months ended June 30, 2015. Gross losses of $9,000 were realized during the six months ended June 30, 2015. The net loss on sale of securities available-for-sale for the six months ended June 30, 2015, includes $9,000 of accumulated other comprehensive loss reclassifications from unrealized holding gains. Gross gains of $25,000 were realized during both the three and six months ended June 30, 2014. Gross losses of $18,000 were realized during both the three and six months ended June 30, 2014. The net gain on sale of securities available-for-sale for the three and six months ended June 30, 2014, includes $7,000 of accumulated other comprehensive income reclassifications from unrealized holding gains.

Gains and losses on sales of investment securities are recorded on the trade date and are determined using the specific identification method. There were no unsettled investment securities transactions at June 30, 2015, and $14.1 million in unsettled investment securities transactions at December 31, 2014.

Proceeds from payments, maturities, and calls of securities held-to-maturity were $0.5 million and $0.9 million for the three and six months ended June 30, 2015, respectively. Proceeds from payments, maturities, and calls of securities held-to-maturity were $0.3 million and $0.6 million for the three and six months ended June 30, 2014, respectively. The Company did not sell investment securities classified as held-to-maturity during the three and six months ended June 30, 2015 and 2014, and currently intends to hold such securities until maturity.

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 7. PORTFOLIO LOANS

Following is a comparative composition of net portfolio loans as of June 30, 2015 and December 31, 2014:

	June 30, 2015			% of Total Loans			December 31, 2014			% of Total Loans
	(Dollars in Thousands)

Real estate loans:
One- to four-family	$	248,027			52.1	%	$	237,151			53.0	%
Commercial		59,935			12.6	%		50,322			11.3	%
Other (land and multi-family)		16,524			3.5	%		14,680			3.3	%
Total real estate loans		324,486			68.2	%		302,153			67.6	%

Real estate construction loans:
One- to four-family		9,098			1.9	%		2,580			0.6	%
Commercial		6,807			1.4	%		2,939			0.6	%
Acquisition and development		–			–			–			–
Total real estate construction loans		15,905			3.3	%		5,519			1.2	%

Other portfolio loans:
Home equity		43,721			9.2	%		46,343			10.4	%
Consumer		47,495			10.0	%		49,854			11.2	%
Commercial		44,254			9.3	%		43,119			9.6	%
Total other portfolio loans		135,470			28.5	%		139,316			31.2	%

Total portfolio loans		475,861			100.0	%		446,988			100.0	%

Allowance for portfolio loan losses		(7,400	)					(7,107	)
Net deferred portfolio loan costs		5,216						5,122
Premiums and discounts on purchased loans, net		1,778						1,867

Portfolio loans, net	$	475,455					$	446,870

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 7. PORTFOLIO LOANS (continued)

The following table presents the contractual aging of the recorded investment in past due loans by class of portfolio loans as of June 30, 2015 and December 31, 2014:

	Current		30 – 59 Days Past Due		60 – 89 Days Past Due		> 90 Days Past Due		Total Past Due		Total
	(Dollars in Thousands)

June 30, 2015
Real estate loans:
One- to four-family	$	243,593	$	1,693	$	439	$	2,302	$	4,434	$	248,027
Commercial		59,236		198		–		501		699		59,935
Other (land and multi-family)		16,304		171		–		49		220		16,524
Total real estate loans		319,133		2,062		439		2,852		5,353		324,486

Real estate construction loans:
One- to four-family		9,098		–		–		–		–		9,098
Commercial		6,807		–		–		–		–		6,807
Acquisition and development		–		–		–		–		–		–
Total real estate construction loans		15,905		–		–		–		–		15,905

Other portfolio loans:
Home equity		42,799		599		76		247		922		43,721
Consumer		46,945		290		40		220		550		47,495
Commercial		43,813		–		–		441		441		44,254
Total other portfolio loans		133,557		889		116		908		1,913		135,470

Total portfolio loans	$	468,595	$	2,951	$	555	$	3,760	$	7,266	$	475,861

December 31, 2014
Real estate loans:
One- to four-family	$	233,654	$	923	$	338	$	2,236	$	3,497	$	237,151
Commercial		49,478		343		–		501		844		50,322
Other (land and multi-family)		14,569		–		111		–		111		14,680
Total real estate loans		297,701		1,266		449		2,737		4,452		302,153

Real estate construction loans:
One- to four-family		2,580		–		–		–		–		2,580
Commercial		2,939		–		–		–		–		2,939
Acquisition and development		–		–		–		–		–		–
Total real estate construction loans		5,519		–		–		–		–		5,519

Other portfolio loans:
Home equity		45,363		650		118		212		980		46,343
Consumer		49,255		363		51		185		599		49,854
Commercial		42,797		–		–		322		322		43,119
Total other portfolio loans		137,415		1,013		169		719		1,901		139,316

Total portfolio loans	$	440,635	$	2,279	$	618	$	3,456	$	6,353	$	446,988

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 7. PORTFOLIO LOANS (continued)

Nonperforming portfolio loans, including nonaccrual portfolio loans, as of June 30, 2015 and December 31, 2014 were $3.9 million and $4.5 million, respectively. There were no portfolio loans over 90 days past-due and still accruing interest as of June 30, 2015 and December 31, 2014. Nonperforming portfolio loans include both smaller balance homogeneous loans that are collectively evaluated for impairment and larger individually evaluated loans classified as impaired loans.

The following table presents performing and nonperforming portfolio loans by class of loans as of June 30, 2015 and December 31, 2014:

	Performing		Nonperforming		Total
	(Dollars in Thousands)

June 30, 2015
Real estate loans:
One- to four-family	$	245,601	$	2,426	$	248,027
Commercial		59,434		501		59,935
Other (land and multi-family)		16,475		49		16,524
Total real estate loans		321,510		2,976		324,486

Real estate construction loans:
One- to four-family		9,098		–		9,098
Commercial		6,807		–		6,807
Acquisition and development		–		–		–
Total real estate construction loans		15,905		–		15,905

Other portfolio loans:
Home equity		43,413		308		43,721
Consumer		47,161		334		47,495
Commercial		43,932		322		44,254
Total other portfolio loans		134,506		964		135,470

Total portfolio loans	$	471,921	$	3,940	$	475,861

December 31, 2014
Real estate loans:
One- to four-family	$	234,301	$	2,850	$	237,151
Commercial		49,821		501		50,322
Other (land and multi-family)		14,569		111		14,680
Total real estate loans		298,691		3,462		302,153

Real estate construction loans:
One- to four-family		2,580		–		2,580
Commercial		2,939		–		2,939
Acquisition and development		–		–		–
Total real estate construction loans		5,519		–		5,519

Other portfolio loans:
Home equity		46,131		212		46,343
Consumer		49,315		539		49,854
Commercial		42,797		322		43,119
Total other portfolio loans		138,243		1,073		139,316

Total portfolio loans	$	442,453	$	4,535	$	446,988

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 7. PORTFOLIO LOANS (continued)

The Company utilizes an internal asset classification system for portfolio loans other than consumer and residential loans as a means of reporting problem and potential problem loans. Under the risk rating system, the Company classifies problem and potential problem loans as “Special Mention”, “Substandard” or “Doubtful”, which correspond to risk ratings five, six and seven, respectively. Portfolio loans that do not currently expose the Company to sufficient risk to warrant classification in one of the aforementioned categories, but possess weaknesses that deserve management’s close attention are deemed to be Special Mention, or risk rated five. Substandard portfolio loans, or risk rated six, include those characterized by the distinct possibility the Company may sustain some loss if the deficiencies are not corrected. Portfolio loans classified as Doubtful, or risk rated seven, have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Risk ratings are updated any time the facts and circumstances warrant.

The Company evaluates consumer and residential loans based on whether the loans are performing or nonperforming as well as other factors. One- to four-family residential loan balances are charged down by the expected loss amount at the time they become nonperforming, which is generally 90 days past due. Consumer loans including automobile, manufactured housing, unsecured, and other secured loans are charged-off, net of expected recovery, when the loan becomes significantly past due over a range of up to 180 days, depending on the type of loan.

The following table presents the risk category of commercial and other real estate portfolio loans evaluated by internal asset classification as of June 30, 2015 and December 31, 2014:

	Pass		Special Mention		Substandard		Doubtful		Total
	(Dollars in Thousands)

June 30, 2015
Real estate loans:
Commercial	$	56,445	$	2,642	$	848	$	–	$	59,935
Other (land and multi-family)		10,266		129		6,129		–		16,524
Total real estate loans		66,711		2,771		6,977		–		76,459

Real estate construction loans:
Commercial		6,807		–		–		–		6,807
Total real estate construction loans		6,807		–		–		–		6,807

Other portfolio loans:
Commercial		41,688		2,244		322		–		44,254
Total other portfolio loans		41,688		2,244		322		–		44,254

Total portfolio loans	$	115,206	$	5,015	$	7,299	$	–	$	127,520

December 31, 2014
Real estate loans:
Commercial	$	46,749	$	2,084	$	1,489	$	–	$	50,322
Other (land and multi-family)		8,613		–		6,067		–		14,680
Total real estate loans		55,362		2,084		7,556		–		65,002

Real estate construction loans:
Commercial		2,939		–		–		–		2,939
Total real estate construction loans		2,939		–		–		–		2,939

Other portfolio loans:
Commercial		40,439		1,985		695		–		43,119

Total other portfolio loans		40,439		1,985		695		–		43,119

Total portfolio loans	$	98,740	$	4,069	$	8,251	$	–	$	111,060

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 7. PORTFOLIO LOANS (continued)

When establishing the allowance, management categorizes loans into risk categories generally based on the nature of the collateral and the basis of repayment. These risk categories and the relevant risk characteristics are as follows:

Real Estate Loans

One- to four-family residential loans have historically had less risk than other loan types as they tend to be smaller balance loans without concentrations to a single borrower or group of borrowers. Repayment depends on the individual borrower’s capacity. If the real estate market deteriorates and the value of residential real estate declines, there is a potential risk of loss if actions such as foreclosure or short sale become necessary to collect the loan and private mortgage insurance was not purchased. In addition, depending on the state in which the collateral is located, the risk of loss may increase, due to the time required to complete the foreclosure process on a property.

Commercial real estate loans generally have greater credit risks compared to one- to four-family residential real estate loans, as they usually involve larger loan balances secured by non-homogeneous or specific use properties. Repayment of these loans typically relies on the successful operation of a business or the generation of lease income by the property and is therefore more sensitive to adverse conditions in the economy and real estate market.

Other real estate loans include loans secured by multi-family residential real estate and land. Generally these loans involve a greater degree of credit risk than residential real estate loans, but are normally smaller individual loan balances than commercial real estate loans. Land loans involve a greater degree of credit risk as compared to residential real estate loans due to the lack of cash flow and reliance on the borrower’s financial capacity. Multi-family residential real estate loans involve a greater degree of credit risk as compared to residential real estate loans due to the reliance on the successful operation of the project. Both loan types are also more sensitive to adverse economic conditions.

Real Estate Construction Loans

Real estate construction loans, including one- to four-family, commercial and acquisition and development loans, generally have greater credit risk than traditional one- to four-family residential and commercial real estate loans. The repayment of these loans can be dependent on the sale of the property to third parties or the successful completion of the improvements by the builder for the end user. In the event a loan is made on property that is not yet approved for the planned development, there is risk that approvals will not be granted or will be delayed. Construction loans also run the risk that improvements will not be completed on time or in accordance with specifications and projected costs. Construction loans include Small Business Administration (SBA) construction loans, which generally have less credit risk than traditional construction loans due to a portion of the balance being guaranteed upon completion of the construction.

Other Loans

Home equity loans and home equity lines of credit are similar to one- to four-family residential loans and generally carry less risk than other loan types as they tend to be smaller balance loans without concentrations to a single borrower or group of borrowers. However, similar to one- to four-family residential loans, there is a potential risk of loss if the real estate market deteriorates and the value of residential real estate declines.

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 7. PORTFOLIO LOANS (continued)

Consumer loans often are secured by depreciating collateral, including automobiles and mobile homes, or are unsecured and may carry more risk than real estate secured loans. Consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness, or personal bankruptcy.

Commercial loans are secured by business assets or may be unsecured, and repayment is directly dependent on the successful operation of the borrower’s business and ability to convert the assets to operating revenue. These possess greater risk than most other types of loans should the repayment capacity of the borrower not be adequate.

Activity in the allowance for the three months ended June 30, 2015 and 2014 was as follows:

	Beginning Balance		Charge-Offs			Recoveries		Provisions			Ending Balance
	(Dollars in Thousands)

June 30, 2015
Real estate loans:
One- to four-family	$	3,194	$	(31	)	$	141	$	(8	)	$	3,296
Commercial		1,060		–			–		199			1,259
Other (land and multi-family)		225		(2	)		37		(81	)		179
Total real estate loans		4,479		(33	)		178		110			4,734

Real estate construction loans:
One- to four-family		41		–			–		17			58
Commercial		39		–			–		14			53
Acquisition and development		–		–			–		–			–
Total real estate construction loans		80		–			–		31			111

Other portfolio loans:
Home equity		939		–			14		38			991
Consumer		850		(196	)		97		69			820
Commercial		629		–			–		(50	)		579
Total other portfolio loans		2,418		(196	)		111		57			2,390

Unallocated		173		–			–		(8	)		165

Total	$	7,150	$	(229	)	$	289	$	190		$	7,400

June 30, 2014
Real estate loans:
One- to four-family	$	3,301	$	(93	)	$	15	$	101		$	3,324
Commercial		965		(5	)		9		(94	)		875
Other (land and multi-family)		315		–			9		54			378
Total real estate loans		4,581		(98	)		33		61			4,577

Real estate construction loans:
One- to four-family		–		–			–		–			–
Commercial		22		–			–		11			33
Acquisition and development		–		–			–		–			–
Total real estate construction loans		22		–			–		11			33

Other portfolio loans:
Home equity		913		(135	)		50		276			1,104
Consumer		1,037		(115	)		69		(213	)		778
Commercial		301		(119	)		–		220			402
Total other portfolio loans		2,251		(369	)		119		283			2,284

Unallocated		96		–			–		(5	)		91

Total	$	6,950	$	(467	)	$	152	$	350		$	6,985

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 7. PORTFOLIO LOANS (continued)

Activity in the allowance for the six months ended June 30, 2015 and 2014 was as follows:

	Beginning Balance		Charge-Offs			Recoveries		Provisions			Ending Balance
	(Dollars in Thousands)

June 30, 2015
Real estate loans:
One- to four-family	$	3,206	$	(167	)	$	222	$	35		$	3,296
Commercial		1,023		–			51		185			1,259
Other (land and multi-family)		225		(28	)		45		(63	)		179
Total real estate loans		4,454		(195	)		318		157			4,734

Real estate construction loans:
One- to four-family		16		–			–		42			58
Commercial		19		–			–		34			53
Acquisition and development		–		–			–		–			–
Total real estate construction loans		35		–			–		76			111

Other portfolio loans:
Home equity		992		(68	)		23		44			991
Consumer		844		(327	)		155		148			820
Commercial		663		–			–		(84	)		579
Total other portfolio loans		2,499		(395	)		178		108			2,390

Unallocated		119		–			–		46			165

Total	$	7,107	$	(590	)	$	496	$	387		$	7,400

June 30, 2014
Real estate loans:
One- to four-family	$	3,188	$	(396	)	$	103	$	429		$	3,324
Commercial		827		(5	)		10		43			875
Other (land and multi-family)		282		(8	)		16		88			378
Total real estate loans		4,297		(409	)		129		560			4,577

Real estate construction loans:
One- to four-family		–		–			–		–			–
Commercial		125		–			–		(92	)		33
Acquisition and development		–		–			–		–			–
Total real estate construction loans		125		–			–		(92	)		33

Other portfolio loans:
Home equity		1,046		(274	)		78		254			1,104
Consumer		1,223		(361	)		195		(279	)		778
Commercial		214		(119	)		–		307			402
Total other portfolio loans		2,483		(754	)		273		282			2,284

Unallocated		41		–			–		50			91

Total	$	6,946	$	(1,163	)	$	402	$	800		$	6,985

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 7. PORTFOLIO LOANS (continued)

The following table presents ending balances for the allowance and portfolio loans based on the impairment method as of June 30, 2015:

	Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Total Ending Balance
	(Dollars in Thousands)

Allowance for portfolio loan losses:
Real estate loans:
One- to four-family	$	1,324	$	1,972	$	3,296
Commercial		292		967		1,259
Other (land and multi-family)		91		88		179
Total real estate loans		1,707		3,027		4,734

Real estate construction loans:
One- to four-family		–		58		58
Commercial		–		53		53
Acquisition and development		–		–		–
Total real estate construction loans		–		111		111

Other portfolio loans:
Home equity		520		471		991
Consumer		240		580		820
Commercial		51		528		579
Total other portfolio loans		811		1,579		2,390

Unallocated		–		165		165

Total ending allowance for portfolio loan losses balance	$	2,518	$	4,882	$	7,400

Portfolio loans:
Real estate loans:
One- to four-family	$	19,798	$	228,229	$	248,027
Commercial		3,168		56,767		59,935
Other (land and multi-family)		7,225		9,299		16,524
Total real estate loans		30,191		294,295		324,486

Real estate construction loans:
One- to four-family		–		9,098		9,098
Commercial		–		6,807		6,807
Acquisition and development		–		–		–
Total real estate construction loans		–		15,905		15,905

Other portfolio loans:
Home equity		3,834		39,887		43,721
Consumer		1,575		45,920		47,495
Commercial		656		43,598		44,254
Total other portfolio loans		6,065		129,405		135,470

Total ending portfolio loans balance	$	36,256	$	439,605	$	475,861

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 7. PORTFOLIO LOANS (continued)

The following table presents ending balances for the allowance and portfolio loans based on the impairment method as of December 31, 2014:

	Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Total Ending Balance
	(Dollars in Thousands)

Allowance for portfolio loan losses:
Real estate loans:
One- to four-family	$	1,374	$	1,832	$	3,206
Commercial		311		712		1,023
Other (land and multi-family)		91		134		225
Total real estate loans		1,776		2,678		4,454

Real estate construction loans:
One- to four-family		–		16		16
Commercial		–		19		19
Acquisition and development		–		–		–
Total real estate construction loans		–		35		35

Other portfolio loans:
Home equity		490		502		992
Consumer		217		627		844
Commercial		57		606		663
Total other portfolio loans		764		1,735		2,499

Unallocated		–		119		119

Total ending allowance for portfolio loan losses balance	$	2,540	$	4,567	$	7,107

Portfolio loans:
Real estate loans:
One- to four-family	$	18,885	$	218,266	$	237,151
Commercial		3,884		46,438		50,322
Other (land and multi-family)		7,131		7,549		14,680
Total real estate loans		29,900		272,253		302,153

Real estate construction loans:
One- to four-family		–		2,580		2,580
Commercial		–		2,939		2,939
Acquisition and development		–		–		–
Total real estate construction loans		–		5,519		5,519

Other portfolio loans:
Home equity		3,860		42,483		46,343
Consumer		1,489		48,365		49,854
Commercial		809		42,310		43,119
Total other portfolio loans		6,158		133,158		139,316

Total ending portfolio loans balance	$	36,058	$	410,930	$	446,988

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 7. PORTFOLIO LOANS (continued)

Portfolio loans for which concessions have been granted as a result of the borrower’s financial difficulties are considered a TDR. These concessions, which in general are applied to all categories of portfolio loans, may include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, or a combination of these or other actions intended to maximize collection. The resulting TDR impairment is included in specific reserves.

For homogeneous loan categories, such as one- to four-family residential loans and home equity loans, the amount of impairment resulting from the modification of the loan terms is calculated in aggregate by category of portfolio loan. The resulting impairment is included in specific reserves. If an individual homogeneous loan defaults under terms of the TDR and becomes nonperforming, the Bank follows its usual practice of charging the loan down to its estimated fair value and the charge-off is considered as a factor in determining the amount of the general component of the allowance.

For larger non-homogeneous loans, each loan that is modified is evaluated individually for impairment based on either discounted cash flow or, for collateral-dependent loans, the appraised value of the collateral less selling costs. If the loan is not collateral-dependent, the amount of the impairment, if any, is recorded as a specific reserve in the allowance. If the loan is collateral-dependent, the amount of the impairment is charged off. There was an allocated allowance for loans individually evaluated for impairment of approximately $0.3 million and $0.4 million at June 30, 2015 and December 31, 2014, respectively.

Portfolio loans modified as TDRs with market rates of interest are classified as impaired portfolio loans. Once the TDR loan has performed for 12 months in accordance with the modified terms it is classified as a performing impaired loan. TDRs which do not perform in accordance with modified terms are reported as nonperforming portfolio loans. The policy for returning a nonperforming loan to accrual status is the same for any loan irrespective of whether the loan has been modified. As such, loans which are nonperforming prior to modification continue to be accounted for as nonperforming loans until they have demonstrated the ability to maintain sustained performance over a period of time, but no less than six months, and are reported as impaired nonperforming loans. Following this period such a modified loan is returned to accrual status and is classified as impaired and reported as a performing TDR. TDRs classified as impaired loans as of June 30, 2015 and December 31, 2014 were as follows:

	June 30, 2015		December 31, 2014
	(Dollars in Thousands)

Real estate loans:
One- to four-family	$	19,548	$	18,885
Commercial		2,667		3,248
Other (land and multi-family)		7,072		6,947
Total real estate loans		29,287		29,080

Real estate construction loans:
One- to four-family		–		–
Commercial		–		–
Acquisition and development		–		–
Total real estate construction loans		–		–

Other portfolio loans:
Home equity		3,812		3,816
Consumer		1,524		1,379
Commercial		333		606
Total other portfolio loans		5,669		5,801

Total TDRs classified as impaired loans	$	34,956	$	34,881

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 7. PORTFOLIO LOANS (continued)

The TDR balances included performing TDRs of $28.9 million and $21.0 million as of June 30, 2015 and December 31, 2014, respectively. There were no commitments to lend additional amounts on TDRs as of June 30, 2015 and December 31, 2014.

The Bank is proactive in modifying residential, home equity and consumer loans in early stage delinquency because management believes modifying the loan prior to it becoming nonperforming results in the least cost to the Bank. The Bank also modifies commercial real estate and other large commercial loans as TDRs rather than pursuing other means of collection when it believes the borrower is committed to the successful repayment of the loan and the business operations are likely to support the modified loan terms.

The following table presents information on TDRs during the six months ended June 30, 2015 and 2014:

	Number of Contracts		Pre-Modification Outstanding Recorded Investments		Post-Modification Outstanding Recorded Investments
	(Dollars in Thousands)

June 30, 2015
Troubled debt restructuring:
Real estate loans:
One- to four-family		9	$	1,091	$	1,091
Other (land and multi-family)		4		693		693
Total real estate loans		13		1,784		1,784

Other portfolio loans:
Home equity		6		525		525
Consumer		8		129		129
Total other portfolio loans		14		654		654

Total troubled debt restructurings		27	$	2,438	$	2,438

June 30, 2014
Troubled debt restructuring:
Real estate loans:
One- to four-family		22	$	5,740	$	5,740
Other (land and multi-family)		1		274		274
Total real estate loans		23		6,014		6,014

Other portfolio loans:
Home equity		7		833		833
Consumer		1		160		160
Total other portfolio loans		8		993		993

Total troubled debt restructurings		31	$	7,007	$	7,007

There were no subsequent defaults on portfolio loans that were restructured as TDRs during the six months ended June 30, 2015.

There were six subsequent defaults on portfolio loans that were restructured as troubled debt restructurings during the six months ended June 30, 2014. The subsequent defaults included five one- to four-family residential loans with a combined recorded investment of $0.5 million, and one commercial real estate loan with a recorded investment of $0.6 million

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 7. PORTFOLIO LOANS (continued)

The following table presents information about impaired portfolio loans as of June 30, 2015:

Recorded
Investment

Unpaid
Principal Balance

Related
Allowance

(Dollars in Thousands)

With no related allowance recorded:

Real estate loans:

One- to four-family

–

Commercial

527

–

Other (land and multi-family)

6,129

–

Total real estate loans

6,656

–

Real estate construction loans:

One- to four-family

–

Commercial

–

Acquisition and development

–

Total real estate construction loans

–

Other portfolio loans:

Home equity

–

Consumer

–

Commercial

413

532

–

Total other portfolio loans

413

532

–

Total with no related allowance recorded

7,069

7,188

–

With an allowance recorded:

Real estate loans:

One- to four-family

19,798

20,103

1,324

Commercial

2,641

292

Other (land and multi-family)

1,096

1,147

Total real estate loans

23,535

23,891

1,707

Real estate construction loans:

One- to four-family

–

Commercial

–

Acquisition and development

–

Total real estate construction loans

–

Other portfolio loans:

Home equity

3,834

3,991

520

Consumer

1,575

240

Commercial

243

Total other portfolio loans

5,652

5,809

811

Total with an allowance recorded

29,187

29,700

2,518

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 7. PORTFOLIO LOANS (continued)

The following table presents information about impaired portfolio loans as of December 31, 2014:

Recorded
Investment

Unpaid
Principal Balance

Related
Allowance

(Dollars in Thousands)

With no related allowance recorded:

Real estate loans:

One- to four-family

–

Commercial

1,182

–

Other (land and multi-family)

5,694

–

Total real estate loans

6,876

–

Real estate construction loans:

One- to four-family

–

Commercial

–

Acquisition and development

–

Total real estate construction loans

–

Other portfolio loans:

Home equity

–

Consumer

–

Commercial

371

–

Total other portfolio loans

371

–

Total with no related allowance recorded

7,247

–

With an allowance recorded:

Real estate loans:

One- to four-family

18,885

18,984

1,374

Commercial

2,702

311

Other (land and multi-family)

1,437

1,488

Total real estate loans

23,024

23,174

1,776

Real estate construction loans:

One- to four-family

–

Commercial

–

Acquisition and development

–

Total real estate construction loans

–

Other portfolio loans:

Home equity

3,860

4,063

490

Consumer

1,489

217

Commercial

438

Total other portfolio loans

5,787

5,990

764

Total with an allowance recorded

28,811

29,164

2,540

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 7. PORTFOLIO LOANS (continued)

The following table presents interest income on impaired portfolio loans by class of portfolio loans for the three months ended June 30, 2015 and 2014:

Average Balance

Interest Income
Recognized

Cash Basis
Interest Income
Recognized

(Dollars in Thousands)

June 30, 2015

Real estate loans:

One- to four-family

19,730

223

–

Commercial

3,507

–

Other (land and multi-family)

7,193

–

Total real estate loans

30,430

331

–

Real estate construction loans:

One- to four-family

–

Commercial

–

Acquisition and development

–

Total real estate construction loans

–

Other portfolio loans:

Home equity

3,723

–

Consumer

1,528

–

Commercial

684

–

Total other portfolio loans

5,935

–

Total

36,365

409

–

June 30, 2014

Real estate loans:

One- to four-family

17,269

235

–

Commercial

6,705

103

–

Other (land and multi-family)

7,214

–

Total real estate loans

31,188

411

–

Real estate construction loans:

One- to four-family

–

Commercial

–

Acquisition and development

–

Total real estate construction loans

–

Other portfolio loans:

Home equity

3,787

–

Consumer

776

–

Commercial

563

–

Total other portfolio loans

5,126

–

Total

36,314

490

–

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 7. PORTFOLIO LOANS (continued)

The following table presents interest income on impaired portfolio loans by class of portfolio loans for the six months ended June 30, 2015 and 2014:

Average Balance

Interest Income
Recognized

Cash Basis
Interest Income
Recognized

(Dollars in Thousands)

June 30, 2015

Real estate loans:

One- to four-family

19,342

458

–

Commercial

3,527

–

Other (land and multi-family)

7,179

138

–

Total real estate loans

30,048

665

–

Real estate construction loans:

One- to four-family

–

Commercial

–

Acquisition and development

–

Total real estate construction loans

–

Other portfolio loans:

Home equity

3,847

–

Consumer

1,532

–

Commercial

733

–

Total other portfolio loans

6,112

151

–

Total

36,160

816

–

June 30, 2014

Real estate loans:

One- to four-family

16,927

421

–

Commercial

6,724

183

–

Other (land and multi-family)

7,231

141

–

Total real estate loans

30,882

745

–

Real estate construction loans:

One- to four-family

–

Commercial

–

Acquisition and development

–

Total real estate construction loans

–

Other portfolio loans:

Home equity

3,799

–

Consumer

788

–

Commercial

584

–

Total other portfolio loans

5,171

150

–

Total

36,053

895

–

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 7. PORTFOLIO LOANS (continued)

The Company had $2.8 million and $4.2 million of one- to four-family residential and home equity loans in process of foreclosure as of June 30, 2015 and December 31, 2014, respectively.

The Company has originated portfolio loans with the Company’s directors and executive officers and their associates. These loans totaled $1.9 million and $0.2 million as of June 30, 2015 and December 31, 2014, respectively. The activity on these loans during the six months ended June 30, 2015 and the year ended December 31, 2014 was as follows:

	June 30, 2015			December 31, 2014
	(Dollars in Thousands)

Beginning balance	$	169		$	137
New portfolio loans and advances on existing loans		1,776			–
Effect of changes in related parties		–			37
Repayments		(3	)		(5	)
Ending balance	$	1,942		$	169

NOTE 8. OTHER LOANS

The Company’s other loans are comprised of loans secured by one- to four-family residential homes originated internally and held-for-sale (mortgage loans held-for-sale), small business loans originated internally and held-for-sale (SBA loans held-for-sale), and warehouse loans held-for-investment. The Company originates mortgage loans held-for-sale with the intent to sell the loans and the servicing rights to investors. The Company originates SBA loans held-for-sale with the intent to sell the guaranteed portion of the loans to investors, while maintaining the servicing rights. The Company originates warehouse loans held-for-investment and permits the third-party originator to sell the loans and servicing rights to investors in order to repay the warehouse balance outstanding.

During the three and six months ended June 30, 2015, the Company internally originated approximately $1.8 million and $3.5 million of mortgage loans held-for-sale, respectively. During the three and six months ended June 30, 2014, the Company internally originated approximately $0.9 million and $1.1 million of mortgage loans held-for-sale, respectively. The gain recorded on sale of mortgage loans held-for-sale during the three and six months ended June 30, 2015 was $188,000 and $317,000, respectively. The gain recorded on sale of mortgage loans held-for-sale during the three and six months ended June 30, 2014 was $12,000 and $21,000, respectively.

During the three and six months ended June 30, 2015, the Company internally originated approximately $1.1 million and $2.4 million, respectively, of SBA loans held-for-sale. During the three and six months ended June 30, 2014, the Company internally originated approximately $4.2 million and $5.2 million, respectively, of SBA loans held-for-sale. The gain recorded on sales of SBA loans held-for-sale was $0.2 million and $0.5 million during the three and six months ended June 30, 2015, respectively. Additionally, the Company recognized gains (losses) on the servicing of these loans of $(15,000) and $76,000 during the three and six months ended June 30, 2015, respectively. The gain recorded on sales of SBA loans held-for-sale was $0.2 million and $0.4 million during the three and six months ended June 30, 2014, respectively. Additionally, the Company recognized gains on the servicing of these loans of $26,000 and $47,000 during the three and six months ended June 30, 2014, respectively.

During the three and six months ended June 30, 2015, the Company originated approximately $346.1 million and $561.0 million, respectively, of warehouse loans held-for-investment through third parties. During the three and six months ended June 30, 2014, the Company originated approximately $94.5 million and $179.4 million, respectively, of warehouse loans held-for-investment through third parties. The weighted average number of days outstanding of warehouse loans held-for-investment was approximately 19 days for both the three and six months ended June 30, 2015 and 2014, respectively.

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 8. OTHER LOANS (continued)

As of June 30, 2015 and December 31, 2014, the balance in warehouse loans held-for-investment did not include any past due, nonperforming, classified, restructured, or impaired loans. Warehouse loans held-for-investment possess less risk than other types of loans as they are secured by one- to four-family residential loans which tend to be smaller balance loans without concentrations to a single borrower or group of borrowers. Due to the generally short duration of time warehouse loans held-for-investment are outstanding, the collateral arrangements related to warehouse loans held-for-investment, and other factors, management has determined that no allowance for loan losses is necessary.

NOTE 9. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE

The Company had repurchase agreements with a carrying amount of $10.0 million and $66.3 million as of June 30, 2015 and December 31, 2014, respectively. On June 22, 2015, the Company prepaid $66.3 million of repurchase agreements, representing the entire outstanding balance of repurchase agreements as of such date. Under the terms of the repurchase agreements, any prepayment prior to maturity would result in a prepayment penalty equal to the amount fair value exceeded the book value. As such, the Company paid $5.2 million in prepayment penalties. On June 26, 2015, the Company entered into a $10.0 million short-term variable rate repurchase agreement. Under the terms of the new repurchase agreement, the instrument does not have a stated maturity date and continues until terminated by either the Company or the counterparty. Additionally, the collateral required to be pledged by the Company is subject to an adjustment determined by the counterparty and must be pledged in amounts equal to the debt plus the adjustment. As a result, the Company had $11.2 million in investment securities posted as collateral for the instrument as of June 30, 2015.

Information concerning repurchase agreements as of and for the three months ending June 30, 2015, and as of and for the year ended December 31, 2014 is summarized as follows:

	June 30, 2015			December 31, 2014
	(Dollars in Thousands)

Average daily balance	$	63,370		$	69,075
Weighted average coupon interest rate during the period		4.94	%		4.96	%
Maximum month-end balance during the period	$	66,300		$	78,300
Weighted average coupon interest rate at end of period		0.80	%		4.94	%
Weighted average maturity (months)		–			30

The repurchase agreements as of June 30, 2015 mature as follows:

	Amount Maturing
	(Dollars in Thousands)

2015 (1) (2)	$	10,000
2016		–
2017		–
2018		–
2019		–
Thereafter		–
Total	$	10,000

(1)

Remaining maturities between July 1, 2015 and December 31, 2015.

(2)

Includes the repurchase agreement entered into on June 26, 2015. This repurchase agreement does not have a maturity date, but is considered short-term in nature.

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 10. FEDERAL HOME LOAN BANK ADVANCES

As of June 30, 2015 and December 31, 2014, advances from the FHLB were as follows:

	June 30, 2015			December 31, 2014
	(Dollars in Thousands)

Maturity on January 23, 2015, fixed rate at 0.24%	$	–		$	5,000
Maturity on August 10, 2015, fixed rate at 0.21%		20,000			–
Maturity on September 10, 2015, fixed rate at 0.24%		10,000			–
Maturity on June 22, 2016, fixed rate at 0.54%		47,500			–
Maturity on August 26, 2016, fixed rate 2.32% (1)		–			10,000
Maturity on September 28, 2016, fixed rate 4.15%		–			10,000
Maturity on December 8, 2016, fixed rate at 4.26%		–			10,000
Maturity on May 30, 2017, fixed rate at 4.33%		–			10,000
Maturity on June 20, 2017, fixed rate 0.91%		10,000			–
Maturity on June 20, 2017, fixed rate 0.73%		3,333			4,167
Maturity on August 1, 2017, fixed rate at 4.39%		–			20,000
Maturity on August 22, 2017, fixed rate at 3.74%		–			5,000
Maturity on August 28, 2017, fixed rate at 2.87% (1)		–			10,000
Maturity on December 21, 2017, fixed rate at 3.77%		–			15,000
Maturity on December 29, 2017, fixed rate at 3.89%		–			15,000
Maturity on March 26, 2018, fixed rate 4.11%		–			5,000
Maturity on June 19, 2018, fixed rate at 1.31%		10,425			–
Maturity on June 20, 2018, fixed rate at 0.50%		55,000			–
Maturity on June 20, 2019, fixed rate at 1.27%		4,000			4,500
Maturity on December 23, 2019, fixed rate 2.08% (2)		20,000			–
Maturity on June 23, 2020, fixed rate at 1.81% (2)		15,000			–
Maturity on June 23, 2020, fixed rate at 1.89% (2)		15,000			–
Daily rate credit, no maturity date, fixed rate at 0.36%		10,000			–
Prepayment penalties to be amortized from July 2015 to June 2016		(2,887	)		–
Total	$	217,371		$	123,667

(1)

As a result of the prepayment and restructure of two $10.0 million advances, on August 26, 2014, $0.8 million of deferred prepayment penalties were factored into the new interest rate of the two $10.0 million advances granted on August 26, 2014.

(2)

As a result of the prepayment and restructure of three advances, totaling $50.0 million, on June 22, 2015, $3.5 million of deferred prepayment penalties were factored into the new interest rate of three advances, totaling $50.0 million, granted on June 22, 2015.

The FHLB advances had a weighted-average maturity of 23 months and a weighted-average rate of 0.86% at June 30, 2015. The Company had $255.0 million in portfolio loans and $23.8 million in investment securities posted as collateral for these advances as of June 30, 2015.

During the six months ended June 30, 2015, the Company paid off $228.3 million of the FHLB borrowings, including $112.0 million that had been borrowed during 2015.

The Bank’s remaining borrowing capacity with the FHLB is $3.4 million at June 30, 2015. The FHLB requires that the Bank collateralize the excess of the fair value of the FHLB advances over the book value with cash and securities. As of June 30, 2015, fair value exceeded the book value of the individual advances by $3.6 million, which was partially collateralized by portfolio loans (included in the $255.0 million and $23.8 million discussed above). The Bank intends to supplement its loan collateral with investment securities as needed to secure the FHLB borrowings or prepay advances to reduce the amount of collateral required to secure the debt. Unpledged securities available for collateral amounted to $88.0 million as of June 30, 2015. In the event the Bank prepays additional advances prior to maturity, it must do so at the fair value of such FHLB advances.

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 11. INCOME TAXES

Income tax expense (benefit) for the six months ending June 30, 2015 and 2014 was as follows:

	Six months ending June 30,
	2015			2014
	(Dollars in Thousands)

Income (loss) before income tax expense	$	(4,371	)	$	524
Effective tax rate		39.6	%		17.8	%
Income tax expense (benefit)		(1,731	)		93
Change in valuation allowance – federal		(7,772	)		–
Change in valuation allowance – state		(889	)		–
Income tax expense (benefit)	$	(10,392	)	$	93

During the six months ended June 30, 2015 and 2014, the Company did not use any federal net operating loss carryover or state net operating loss carryover.

The Company considers at each reporting period all available evidence, both positive and negative, to determine whether, based on the weight of that evidence, a valuation allowance is needed to reduce its deferred tax assets to an amount that is more likely than not to be realized. A determination of the need for a valuation allowance for the deferred tax assets is dependent upon management’s evaluation of both positive and negative evidence.

Despite the Company being in a three-year cumulative loss position as of June 30, 2015, based on the assessment during the second quarter of 2015 of this fact and all the other positive and negative evidence bearing on the likelihood of realization of the Company’s deferred tax assets, management has concluded that it is more likely than not that $8.5 million of the deferred tax assets, primarily comprised of future tax benefits associated with the allowance for portfolio loan losses, net operating loss carryover, and net unrealized loss on securities available-for-sale, will be realized based upon future taxable income. Therefore, $8.5 million of the valuation allowance was reversed during June 2015, while $0.3 million of the valuation allowance remained as of June 30, 2015.

The positive evidence considered by management in arriving at the conclusion to remove the valuation allowance included five consecutive profitable quarters beginning with the first quarter of 2014, strong growth in core earnings, assessments of the current and future economic and business conditions, which demonstrates demand for the Company’s products and services, the significant improvement in credit measures, which impacts the sustainability of profitability and management’s ability to forecast future credit losses, the probability of achieving forecasted future taxable income, and the termination of a Consent Order with one of the Bank’s regulatory agencies. The negative evidence considered by management includes the aforementioned cumulative loss position, expiring tax credit carryovers, and the continuation of a Supervisory Agreement with one of the Company’s regulatory agencies, which was terminated subsequent to the reversal of the valuation allowance (see Note 13. Regulatory Supervision of these Notes). Now that the valuation allowance has been substantially reduced, future tax benefits will be recognized as a reduction to income tax expense which will have a positive non-cash impact on our net income and stockholders’ equity.

As of December 31, 2014, the Company evaluated the expected realization of its federal and state deferred tax assets which, prior to a valuation allowance, totaled $8.9 million. Based on this evaluation it was concluded that a valuation allowance was required for the federal and state deferred tax assets.

Under the rules of Internal Revenue Code section 382 (IRC § 382), a change in the ownership of the Company occurred during the first quarter of 2013. During the second quarter of 2013, the Company became aware of the change in ownership based on applicable filings made by stockholders with the Securities and Exchange Commission (the SEC). In accordance with IRC § 382, the Company determined the gross amount of net operating loss carryover that it could utilize was limited to approximately $325,000 per year.

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 11. INCOME TAXES (continued)

The Company also determined it was in a net unrealized built-in loss position (NUBIL) at the time of the ownership change. Due to the Company’s NUBIL position, recognition of certain OREO losses during the next three years will have an adverse effect on the utilization of the existing net operating losses, as the recognized losses will be applied to the annual limitation before the net operating losses are applied. As a result of the limitation, the Company wrote off approximately $14.7 million of federal net operating loss carryover and $12.8 million of state net operating loss carryover during 2014, all of which had been previously reserved for with a valuation allowance.

NOTE 12. EARNINGS PER COMMON SHARE

Basic earnings per common share is computed by dividing net income by the weighted average number of common shares and common stock equivalents outstanding for the period. The basic weighted average common shares and common stock equivalents are computed using the treasury stock method. The basic weighted average common shares and common stock equivalents outstanding for the period is adjusted for average unallocated employee stock ownership plan shares, average director’s deferred compensation shares and average unearned restricted stock awards. Diluted earnings per common share is computed by dividing net income by the weighted average number of common shares and common stock equivalents outstanding for the period increased for the dilutive effect of unvested stock options and stock awards. The dilutive effect of the unvested stock options and stock awards is calculated under the treasury stock method utilizing the average market value of the Company’s stock for the period.

The following table summarizes the basic and diluted earnings per common share computation for the three and six months ended June 30, 2015 and 2014:

	Three months ending June 30,						Six months ending June 30,
	2015			2014			2015			2014
	(Dollars in Thousands, Except Share Information)

Basic:
Net income	$	5,625		$	225		$	6,021		$	431
Weighted average common shares outstanding		15,508,969			15,508,969			15,508,969			15,508,969
Less: average unallocated employee stock ownership plan shares		(76,647	)		(81,437	)		(76,647	)		(81,437	)
Less: average director’s deferred compensation shares		(33,958	)		(35,424	)		(34,150	)		(35,593	)
Less: average unvested restricted stock awards		(268	)		(542	)		(271	)		(545	)
Weighted average common shares outstanding, as adjusted		15,398,096			15,391,566			15,397,901			15,391,394
Basic earnings per common share	$	0.36		$	0.02		$	0.39		$	0.03

Diluted:
Net income	$	5,625		$	225		$	6,021		$	431
Weighted average common shares outstanding, as adjusted (from above)		15,398,096			15,391,566			15,397,901			15,391,394
Add: dilutive effects of assumed exercise of stock options		–			–			–			–
Add: dilutive effects of full vesting of stock awards		–			–			–			–
Weighted average dilutive shares outstanding		15,398,096			15,391,566			15,397,901			15,391,394
Diluted earnings per common share	$	0.36		$	0.02		$	0.39		$	0.03

During the three and six months ended June 30, 2015 and 2014, all of the Company’s stock options and stock awards were antidilutive and, therefore, were excluded from the calculation of diluted earnings per common share.

ATLANTIC COAST FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

June 30, 2015

(unaudited)

NOTE 13. REGULATORY SUPERVISION

On March 26, 2015, the Office of the Comptroller of the Currency (the OCC), the Bank’s primary regulator, terminated the Consent Order, dated August 10, 2012 (the Order), between the OCC and the Bank, which had restricted the activities of the Bank in various ways as previously reported. Additionally, the OCC has reclassified the Bank as a well-capitalized institution.

The Bank’s actual and required capital levels and ratios as of June 30, 2015 and December 31, 2014 were as follows:

	Actual					Required to be Well- Capitalized Under Prompt Corrective Action
	Amount		Ratio			Amount		Ratio
	(Dollars in Millions)

June 30, 2015
Total capital (to risk weighted assets)	$	81.0		14.72	%	$	55.0		10.00	%
Common equity tier 1 capital (to risk weighted assets)		74.1		13.48	%		35.7		6.50	%
Tier 1 capital (to risk weighted assets)		74.1		13.48	%		44.0		8.00	%
Tier 1 capital (to adjusted total assets)		74.1		9.69	%		38.3		5.00	%

December 31, 2014
Total capital (to risk weighted assets)	$	79.2		17.64	%	$	44.9		10.00	%
Tier 1 capital (to risk weighted assets)		73.5		16.38	%		26.9		6.00	%
Tier 1 capital (to adjusted total assets)		73.5		10.35	%		35.5		5.00	%

The Bank’s capital classification under PCA defined levels as of June 30, 2015 was well-capitalized.

As of June 30, 2015, the Company remained subject to a Supervisory Agreement initiated on December 10, 2010 (the Supervisory Agreement) with the Board of Governors of the Federal Reserve System (the FRB), which provided, among other things, that: (1) the Company must comply with regulatory prior notification requirements with respect to changes in directors and senior executive officers; (2) the Company cannot declare or pay dividends or make any other capital distributions without prior written FRB approval; (3) the Company will not be permitted to enter into, renew, extend or revise any contractual arrangement relating to compensation or benefits for any senior executive officers or directors, unless it provides 30 days prior written notice of the proposed transaction to the FRB; (4) the Company may not make any golden parachute payment or prohibited indemnification payment without FRB prior written approval; and (5) the Company may not incur, issue, renew or rollover any debt or debt securities, increase any current lines of credit, guarantee the debt of any entity, or otherwise incur any additional debt without the prior written non-objection of the FRB.

On July 17, 2015, the Company received written notice of termination of the Supervisory Agreement. The notice of termination, dated July 15, 2015, was received from the Federal Reserve Bank of Atlanta on behalf of the FRB and also stated the Company is no longer considered to be in “troubled condition” for savings and loan holding company regulatory purposes.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Management’s Discussion and Analysis (this MD&A) is provided as a supplement to, should be read in conjunction with, and is qualified in its entirety by reference to, the unaudited Condensed Consolidated Financial Statements and accompanying Notes to the unaudited Condensed Consolidated Financial Statements of Atlantic Coast Financial Corporation (the Company) appearing elsewhere in this Quarterly Report on Form 10-Q (this Report). In addition, reference should be made to our audited Consolidated Financial Statements and accompanying Notes to Consolidated Financial Statements and Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2014 filed with the Securities and Exchange Commission on March 20, 2015 (the 2014 10-K).

Cautionary Note Regarding Forward-Looking Statements

This Report contains forward-looking statements concerning the Company and its wholly owned subsidiary, Atlantic Coast Bank (the Bank), that involve risks and uncertainties, as well as assumptions that, if they do not materialize or prove to be correct, could cause our results to differ materially from those expressed in or implied by such forward-looking statements. All statements other than statements of historical fact are statements that could be deemed forward-looking statements, including, but not limited to, statements concerning: our plans, strategies and objectives for future operations; new loans and other products, services or developments; future economic conditions, performance or outlook; the outcome of contingencies; the continued suspension of dividends or share repurchases; potential acquisitions or divestitures; expected cash flows or capital expenditures; our beliefs or expectations; activities, events or developments that we intend, expect, project, believe or anticipate will or may occur in the future; and assumptions underlying any of the foregoing. Forward-looking statements may be identified by their use of forward-looking terminology, such as “believes,” “expects,” “may,” “should,” “would,” “will,” “intends,” “plans,” “estimates,” “anticipates,” “projects” and similar words or expressions. You should not place undue reliance on these forward-looking statements, which reflect management’s opinions only as of the date of the filing of this Report and are not guarantees of future performance or actual results. Forward-looking statements are made in reliance on the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended (the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). The following are some of the factors we believe could cause our actual results to differ materially from our historical results or our current expectations or projections:

our ability to respond to changes in the legislative or regulatory environment and governmental initiatives affecting the banking and financial services industry and to comply with and remain abreast of recently enacted, modified or proposed federal, state and local laws, regulations and rules;

local, regional, national and international economic conditions and the impact they may have on us and our customers, and our assessment of that impact on our estimates, including, but not limited to, the allowance for portfolio loan losses;

changes in the financial performance or condition of our borrowers and the ability of our borrowers to perform under the terms of their loans and other credit agreements, and the impact of such changes on our levels of nonperforming assets;

changes in sources and uses of funds, including loans, deposits and borrowings, and our ability to retain and grow core deposits and maintain unsecured federal funds lines and secured lines of credit with correspondent banks;

changes in interest rates on levels, composition and costs of deposits, loan demand, and the values and liquidity of loan collateral, securities, and interest sensitive assets and liabilities;

the concentration of our loan portfolio in real estate based loans and the geographic concentration of those loans secured by one- to four-family residential real estate despite weakness in the real estate market; and

our ability to successfully implement changes in accounting policies, rules and practices.

Additional details and discussions concerning some of the factors that could affect our forward-looking statements or future results are set forth in the 2014 10-K under Item 1A. “Risk Factors” and in Part II. Item 1A. “Risk Factors” in this Report, which lists of factors, together with the foregoing list of factors, are not exhaustive. Additional risks and uncertainties not known to us or that we currently believe not to be material also may adversely impact our business, financial condition, results of operations and cash flows. Should any risks or uncertainties develop into actual events, these developments could have a material adverse effect on our business, financial condition, results of operations and cash flows. The forward-looking statements contained in this Report are made as of the date hereof and we disclaim any intention or obligation, other than imposed by law, to update or revise any forward-looking statements or to update the reasons actual results could differ materially from those projected in the forward-looking statements, whether as a result of new information, future events or developments or otherwise.

General Description of Business

The Company and the Bank have traditionally focused on attracting retail deposits from the general public and investing those funds primarily in first mortgages on owner-occupied, one- to four-family residences, and home equity loans for retention in our loan portfolio, loans secured by one- to four-family residences originated by third party originators under purchase and assumption agreements (warehouse loans held-for-investment), and, to a lesser extent, automobile and other consumer loans originated for retention in our loan portfolio. In addition, we increasingly focus on small business lending through our Small Business Administration (SBA) lending programs, as well as commercial business and owner-occupied commercial real estate loans to small businesses. Loans are obtained principally through retail staff and brokers. The Bank sells the guaranteed portion of loans originated through SBA lending rather than hold such guaranteed portion of the loans in its portfolio. The Bank also originates multi-family residential loans and commercial construction and residential construction loans. The Bank also invests in investment securities, primarily those issued by U.S. government-sponsored agencies or entities, including Fannie Mae, Freddie Mac and Ginnie Mae.

Revenues are derived principally from interest on loans and other interest-earning assets, such as investment securities. To a lesser extent, revenue is generated from service charges, gains on the sale of loans and other income.

The Bank offers a variety of deposit accounts having a wide range of interest rates and terms, which generally include savings accounts, money market accounts, demand deposit accounts and time deposit accounts with terms ranging from 90 days to five years. Deposits are primarily solicited in the Bank’s market areas of the Jacksonville, Florida metropolitan area and Southeast Georgia to fund loan demand and other liquidity needs.

Recent Events

Termination of the Regulatory Restrictions for the Company and the Bank

On July 17, 2015, the Company received written notice of termination of the Supervisory Agreement initiated on December 10, 2010 (the Supervisory Agreement), between the Board of Governors of the Federal Reserve System (the FRB) and the Company. Prior to the termination, the Supervisory Agreement had restricted the activities of the Company in various ways as previously reported. The notice of termination, dated July 15, 2015, was received from the Federal Reserve Bank of Atlanta on behalf of the FRB and also stated the Company is no longer considered to be in “troubled condition” for savings and loan holding company regulatory purposes.

Executive Management Team and Board of Directors

On January 28, 2015, James D. Hogan was appointed to serve as interim Chief Financial Officer of the Company and the Bank, contingent upon receipt of regulatory non-objection from the OCC and the the FRB. On March 25, 2015, Tracy L. Keegan was appointed as Executive Vice President and Chief Financial Officer of the Company and the Bank, contingent upon receipt of regulatory non-objection from the OCC and the FRB. On March 30, 2015, the Bank appointed Ms. Keegan as Executive Vice President and Chief Financial Officer of the Bank, effective immediately, given that the termination of the Order, on March 26, 2015, alleviated the requirement of Ms. Keegan’s appointment at the Bank being subject to OCC non-objection.

On March 31, 2015, the FRB notified the Company that it did not have any objection to the appointment of Mr. Hogan as interim Chief Financial Officer of the Company. Mr. Hogan began his service as interim Chief Financial Officer of the Company effective March 31, 2015. On May 15, 2015, the FRB notified the Company that the FRB did not have any objection to the appointment of Ms. Keegan as Chief Financial Officer of the Company. On May 18, 2015, Ms. Keegan began her service as Executive Vice President and Chief Financial Officer of the Company, and Mr. Hogan’s ended his service as interim Chief Financial Officer of the Company. As Chief Financial Officer, Ms. Keegan also replaced Mr. Hogan as the Company’s principal accounting officer. Additionally, Mr. Hogan informed the Boards of Directors of the Company and the Bank that he was also retiring as Chief Risk Officer of the Company and the Bank, effective immediately. Mr. Hogan continues to serve as a member of the Boards of Directors of the Company and the Bank.

On February 11, 2015, H. Dennis Woods, a director of the Company and the Bank, informed the Board of Directors that he was retiring and would not stand for re-election at the next Annual Meeting of Stockholders, which was held on May 18, 2015 (the Annual Meeting). After Mr. Woods’ announcement of his retirement, the Company’s Board of Directors voted to reduce the number of seats on the Board of Directors from nine to eight effective as of the date of the Annual Meeting and contemporaneous with Mr. Woods’ retirement from the Company’s Board of Directors.

Critical Accounting Policies

Certain accounting policies are important to the presentation of the Company’s financial condition because they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances, including, without limitation, changes in interest rates, performance of the economy, financial condition of borrowers, and laws and regulations. Management believes that its critical accounting policies include: (i) determining the allowance for portfolio loan losses (the allowance) and the provision for portfolio loan losses (provision expense); (ii) measuring for impairment in troubled debt restructurings (TDR); (iii) determining the fair value of investment securities; (iv) determining the fair value of other real estate owned (OREO); and (v) accounting for deferred income taxes.

There have been no material updates to these accounting policies during the first six months of 2015, other than the update regarding the Company’s deferred tax assets and associated valuation allowance, which is discussed below. For additional discussion of our critical accounting policies and estimates, see the Critical Accounting Policies discussion in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in the 2014 10-K.

Deferred Income Taxes

Based on the Company’s assessment during the second quarter of 2015 of all the positive and negative evidence bearing on the likelihood of realization of the Company’s deferred tax assets, management has concluded that it is more likely than not that $8.5 million of the deferred tax assets, will be realized based upon future taxable income. Therefore, $8.5 million of the valuation allowance was reversed during June 2015.

Comparison of Financial Condition at June 30, 2015 and December 31, 2014

General

Total assets increased $103.9 million, or 14.7%, to $810.4 million at June 30, 2015 as compared to $706.5 million at December 31, 2014. The primary reasons for the increase in assets were due to increases in Federal Home Loan Bank (FHLB) advances of $93.7 million, time deposits of $48.7 million, non-maturing deposits of $11.6 million, and stockholders’ equity of $5.7 million, as discussed below, partially offset by the reduction of $56.3 million in securities sold under agreements to repurchase (repurchase agreements). Other loans increased $66.7 million, net portfolio loans increased $28.6 million, and cash and cash equivalents increased $16.1 million, while investment securities decreased $9.3 million. Total deposits increased $60.3 million, or 13.7%, to $501.1 million at June 30, 2015 from $440.8 million at December 31, 2014. Noninterest-bearing demand accounts increased $6.6 million, savings and money market accounts increased by $6.7 million, and time deposits increased by $48.7 million, while interest-bearing demand accounts decreased $1.7 million during the six months ended June 30, 2015. Total borrowings increased by $37.4 million to $227.4 million at June 30, 2015 from $190.0 million at December 31, 2014 due to the aforementioned increase in FHLB advances in the first half of 2015, partially offset by the aforementioned reduction in repurchase agreements in the first half of 2015. Stockholders’ equity increased by $5.7 million to $78.0 million at June 30, 2015 from $72.3 million at December 31, 2014, due to net income of $6.0 million, partially offset by other comprehensive loss of $0.3 million for the six months ended June 30, 2015.

Following are the summarized comparative balance sheets as of June 30, 2015 and December 31, 2014:

	June 30,		December 31,		Increase / (Decrease)
	2015		2014		Amount			%
	(Dollars in Thousands)
Assets:
Cash and cash equivalents	$	38,545	$	22,398	$	16,147			72.1	%
Investment securities (available-for-sale and held-to-maturity)		127,339		136,618		(9,279	)		(6.8	)%
Portfolio loans		482,855		453,977		28,878			6.4	%
Allowance for portfolio loan losses		7,400		7,107		293			4.1	%
Portfolio loans, net		475,455		446,870		28,585			6.4	%
Other loans (held-for-sale and warehouse loans held-for-investment)		107,890		41,191		66,699			161.9	%
Other Assets		61,198		59,421		1,777			3.0	%
Total assets	$	810,427	$	706,498	$	103,929			14.7	%

Liabilities and stockholders’ equity:
Deposits:
Noninterest-bearing demand	$	47,907	$	41,283	$	6,624			16.0	%
Interest-bearing demand		64,027		65,718		(1,691	)		(2.6	)%
Savings and money market		178,300		171,657		6,643			3.9	%
Time		210,861		162,122		48,739			30.1	%
Total deposits		501,095		440,780		60,315			13.7	%
Securities sold under agreements to repurchase		10,000		66,300		(56,300	)		(84.9	)%
Federal Home Loan Bank advances		217,371		123,667		93,704			75.8	%
Accrued expenses and other liabilities		3,881		3,415		466			13.6	%
Total liabilities		732,347		634,162		98,185			15.5	%
Total stockholders’ equity		78,080		72,336		5,744			7.9	%
Total liabilities and stockholders’ equity	$	810,427	$	706,498	$	103,929			14.7	%

Cash and Cash Equivalents

Cash and cash equivalents increased $16.1 million to $38.5 million at June 30, 2015 from $22.4 million at December 31, 2014. During 2014, the Bank added contingent liquidity capacity and sources available to meet potential funding requirements, including increased availability from the FHLB, and new availability from the Federal Reserve Bank of Atlanta and other institutional sources. The contingent liquidity has remained available throughout the first half of 2015 and, as a result, cash and cash equivalents continue to be utilized to fund the origination of loans and pay off liabilities.

Investment Securities

Investment securities, both available-for-sale and held-to-maturity, are comprised primarily of debt securities of U.S. Government-sponsored enterprises and mortgage-backed securities. The investment portfolio decreased $9.3 million to $127.3 million at June 30, 2015, from $136.6 million at December 31, 2014. As of June 30, 2015, $110.3 million of investment securities were classified as available-for-sale, while $17.0 million of investment securities were classified as held-to-maturity. As of December 31, 2014, $118.7 million of investment securities were classified as available-for-sale, while $17.9 million of investment securities were classified as held-to-maturity.

As of June 30, 2015, approximately $11.2 million and $23.8 million of investment securities were pledged as collateral for the repurchase agreements and FHLB advances, respectively. At June 30, 2015, $122.3 million, or 96.0%, of the debt securities held by the Company were issued by U.S. government-sponsored entities and agencies, primarily Fannie Mae, Freddie Mac and Ginnie Mae, institutions which the government has affirmed its commitment to support.

Portfolio Loans

Below is a comparative composition of net portfolio loans as of June 30, 2015 and December 31, 2014, excluding loans held-for-sale and warehouse loans held-for-investment:

	June 30, 2015			% of Total Portfolio Loans			December 31, 2014			% of Total Portfolio Loans
	(Dollars in Thousands)

Real estate loans:
One- to four-family	$	248,027			52.1	%	$	237,151			53.0	%
Commercial		59,935			12.6	%		50,322			11.3	%
Other (land and multi-family)		16,524			3.5	%		14,680			3.3	%
Total real estate loans		324,486			68.2	%		302,153			67.6	%
Real estate construction loans:
One- to four-family		9,098			1.9	%		2,580			0.6	%
Commercial		6,807			1.4	%		2,939			0.6	%
Acquisition and development		–			–			–			–
Total real estate construction loans		15,905			3.3	%		5,519			1.2	%
Other portfolio loans:
Home equity		43,721			9.2	%		46,343			10.4	%
Consumer		47,495			10.0	%		49,854			11.2	%
Commercial		44,254			9.3	%		43,119			9.6	%
Total other portfolio loans		135,470			28.5	%		139,316			31.2	%

Total portfolio loans		475,861			100.0	%		446,988			100.0	%
Allowance for portfolio loan losses		(7,400	)					(7,107	)
Net deferred portfolio loan costs		5,216						5,122
Premiums and discounts on purchased loans, net		1,778						1,867
Portfolio loans, net	$	475,455					$	446,870

Total gross portfolio loans increased $28.9 million, or 6.5%, to $475.9 million at June 30, 2015 as compared to $447.0 million at December 31, 2014, primarily due to originations of $35.2 million and the purchase of $12.5 million of one- to four-family residential mortgages, partially offset by transfers to held-for-sale of one- to four-family residential mortgages, and principal amortization and increased prepayments of one- to four-family residential mortgages and home equity loans during the six months ended June 30, 2015. The increase in prepayments on one- to four-family residential mortgages is consistent with the current low interest rate environment. Total portfolio loans growth was also partially offset by gross loan charge-offs of $0.6 million and transfers to OREO of nonperforming loans of $0.3 million during the first six months of 2015.

Small business loans originated internally and held-for-sale (SBA loans held-for-sale), SBA portfolio loans, and other portfolio loans to small businesses are included in the commercial category of other portfolio loans. The Company sells the guaranteed portion of SBA loans held-for-sale upon completion of loan funding and approval by the SBA. The unguaranteed portion of SBA loans held-for-sale, which remains in the Company’s portfolio in commercial other loans, at June 30, 2015 and December 31, 2014, was $7.6 million and $7.8 million, respectively. The Company plans to expand this business line going forward.

Growth in mortgage origination, the SBA portfolio, and other commercial business loan production is expected to exceed principal amortization and loan payoffs in the near future, but we can give no assurances.

The composition of the Bank’s portfolio loans is weighted toward one- to four-family residential mortgage loans. As of June 30, 2015, first mortgages (including residential construction loans) and home equity loans totaled $300.8 million, or 63.2% of total gross portfolio loans. Approximately $25.2 million, or 57.7% of loans recorded as home equity loans are in a first lien position. Accordingly, $282.4 million, or 93.9% of loans collateralized by one- to four-family residential properties were in a first lien position as of June 30, 2015.

The composition of first mortgages and home equity loans by state as of June 30, 2015 was as follows:

	Florida		Georgia		Other States		Total
	(Dollars in Thousands)
One- to four-family residential mortgages	$	156,452	$	50,557	$	41,018	$	248,027
Home equity and lines of credit		20,731		22,469		521		43,721
One- to four-family construction loans		8,293		805		–		9,098
	$	185,476	$	73,831	$	41,539	$	300,846

Allowance for Portfolio Loan Losses

The allowance was $7.4 million, or 1.5% of total portfolio loans, at June 30, 2015, compared to $7.1 million, or 1.6% of total portfolio loans, at December 31, 2014.

The activity in the allowance for loan losses for the six months ended June 30, 2015 and 2014 was as follows:

	2015			2014
	(Dollars in Thousands)

Balance at beginning of period	$	7,107		$	6,946

Charge-offs:
Real estate loans:
One- to four-family		(167	)		(396	)
Commercial		–			(5	)
Other (land and multi-family)		(28	)		(8	)
Real estate construction loans:
One- to four-family		–			–
Commercial		–			–
Acquisition and development		–			–
Other portfolio loans:
Home equity		(68	)		(274	)
Consumer		(327	)		(361	)
Commercial		–			(119	)
Total charge-offs		(590	)		(1,163	)

Recoveries:
Real estate loans:
One- to four-family		222			103
Commercial		51			10
Other (land and multi-family)		45			16
Real estate construction loans:
One- to four-family		–			–
Commercial		–			–
Acquisition and development		–			–
Other portfolio loans:
Home equity		23			78
Consumer		155			195
Commercial		–			–
Total recoveries		496			402
Net charge-offs		(94	)		(761	)
Provision for portfolio loan losses		387			800
Balance at end of period	$	7,400		$	6,985
Net charge-offs to average outstanding portfolio loans		0.05	%		0.39	%

Net charge-offs during the first six months of 2015 decreased compared to the same period in 2014, primarily due to $0.4 million less in charge-offs related to one- to four-family residential loans and home equity loans, $0.1 million less in charge-offs related to collateral-dependent commercial real estate property, and a $0.1 million increase in recoveries related to one- to four-family residential loans and home equity loans.

It is the Company’s policy to charge-off one- to four-family first mortgages and home equity loans to the estimated fair value of the collateral at the time the loan becomes nonperforming. During the six months ended June 30, 2015, charge-offs did not include any partial charge-offs of one- to four-family first mortgages and home equity loans identified as nonperforming, which is a decrease of $0.3 million compared to $0.3 million in partial charge-offs for the six months ended June 30, 2014. The decrease in partial charge-offs is attributable to decreased losses on both first mortgages and home equity loans.

Below is a comparative composition of nonperforming assets as of June 30, 2015 and December 31, 2014:

	June 30, 2015			December 31, 2014
	(Dollars in Thousands)

Nonperforming assets:
Real estate loans:
One- to four-family	$	2,426		$	2,850
Commercial		501			501
Other (land and multi-family)		49			111
Real estate construction loans:
One- to four-family		–			–
Commercial		–			–
Acquisition and development		–			–
Other portfolio loans:
Home equity		308			212
Consumer		334			539
Commercial		322			322
Total nonperforming loans		3,940			4,535
Other real estate owned		3,886			3,908
Total nonperforming assets	$	7,826		$	8,443

Nonperforming loans to total portfolio loans		0.8	%		1.0	%
Nonperforming assets to total assets		1.0	%		1.2	%

Nonperforming loans were $3.9 million, or 0.8% of total portfolio loans, at June 30, 2015 as compared to $4.5 million, or 1.0% of total portfolio loans, at December 31, 2014. The decrease in nonperforming loans was primarily due to the transfer of $0.3 million in nonperforming loans to OREO and charge-offs related to nonperforming loans, partially offset by a commercial land loan that became nonperforming.

During the past few years, and continuing in 2015, the market for disposing of nonperforming assets has become more active. These types of transactions may result in additional losses over the amounts provided for in the allowance; however, the Company continues to monitor and attempt to reduce nonperforming assets through the least costly means possible. The allowance is determined by the information available at the time such determination is made and reflects management’s estimate of loss.

As of June 30, 2015, total nonperforming one- to four-family residential and home equity loans of $2.7 million was derived from $3.6 million in contractual balances that had been written-down to the estimated fair value of their collateral, less estimated selling costs, at the date the applicable loan was classified as nonperforming. Further declines in the fair value of the collateral, or a decision to sell such loans as distressed assets, could result in additional losses. As of June 30, 2015 and December 31, 2014, all nonperforming loans were classified as nonaccrual and there were no loans 90 days past due and accruing interest.

OREO was $3.9 million at both June 30, 2015 and December 31, 2014 as the Company had transfers from nonperforming loans into OREO of $0.3 million, which was offset by sales of OREO of $0.2 million and writedowns of OREO of $0.1 million. Historically, the Company has not incurred additional material losses after nonperforming loans are moved to OREO, or as a result of the sale of OREO. The Company recorded losses on foreclosed assets of $102,000 and $19,000 for the six months ended June 30, 2015 and 2014, respectively.

Impaired Loans

The following table shows impaired loans segregated by performing and nonperforming status and the associated specific reserve as of June 30, 2015 and December 31, 2014:

	June 30, 2015				December 31, 2014
	Balance		Specific Reserve		Balance		Specific Reserve
	(Dollars in Thousands)

Performing	$	490	$	–	$	185	$	–
Nonperforming (1)		1,408		89		1,576		89
Troubled debt restructuring by category:
Performing troubled debt restructurings – commercial		8,639		254		9,871		287
Performing troubled debt restructurings – residential		25,719		2,175		24,426		2,164
Total impaired loans	$	36,256	$	2,518	$	36,058	$	2,540

(1)

Balances include nonperforming TDR loans of $0.6 million as of June 30, 2015 and nonperforming TDR loans of $0.9 million as of December 31, 2014. There were no specific reserves for these TDR loans as of June 30, 2015 and December 31, 2014.

Impaired loans include large, non-homogeneous loans where it is probable that the Bank will not receive all principal and interest when contractually due. Impaired loans also include TDRs, which totaled $34.9 million as of June 30, 2015 as compared to $34.8 million at December 31, 2014. A portfolio loan that is modified as a TDR with a market rate of interest is classified as an impaired loan and reported as a nonperforming TDR in the year of restructure and until the loan has performed for 12 months in accordance with the modified terms. At June 30, 2015, approximately $28.9 million of restructured loans, previously disclosed as being impaired and nonperforming TDRs, have demonstrated 12 months of performance under restructured terms and are reported as performing TDRs in this Report. The Company’s performing TDRs are still considered impaired.

Other Loans

Other loans was comprised of loans secured by one- to four-family residential homes originated internally (mortgage loans held-for-sale), SBA loans held-for-sale, and warehouse loans held-for-investment. The following table shows other loans, segregated by held-for-sale and warehouse loans held-for-investment, as of June 30, 2015 and December 31, 2014:

	June 30, 2015		December 31, 2014
	(Dollars in Thousands)
Other loans:
Held-for-sale	$	12,685	$	7,219
Warehouse loans held-for-investment		95,205		33,972
Total other loans	$	107,890	$	41,191

Other loans increased $66.7 million, or 161.9%, to $107.9 million at June 30, 2015 as compared to $41.2 million at December 31, 2014 due to an increase in originations of warehouse loans held-for-investment. The increase in warehouse loans held-for-investment was primarily due to three loan participation agreements that the Company entered into with Customers Bank at the end of the first quarter of 2015, and other relationships with new counterparties.

The Company internally originated $3.5 million and sold $2.5 million of mortgage loans held-for-sale during the six months ended June 30, 2015. The gain recorded on sales of mortgage loans held-for-sale during the six months ended June 30, 2015 was $317,000. Comparatively, the Company internally originated $1.1 million and sold $0.7 million of mortgage loans held-for-sale during the six months ended June 30, 2014. The gain recorded on sales of mortgage loans held-for-sale during the six months ended June 30, 2014 was $21,000. The Company internally originated $2.4 million and sold $4.4 million of SBA loans held-for-sale during the six months ended June 30, 2015, compared to originations of $5.2 million and sales of $4.3 million during the six months ended June 30, 2014. The gain recorded on sales and servicing of SBA loans held-for-sale was $0.5 million during both the six months ended June 30, 2015 and 2014. The Bank plans to expand its mortgage loans held-for-sale and SBA loans held-for-sale business lines going forward.

Loans originated and sold under the Company’s warehouse loans held-for-investment lending program were $561.0 million and $499.7 million, respectively, for the six months ended June 30, 2015 as compared to originations and sales of $179.4 million and $177.6 million, respectively, for the six months ended June 30, 2014. Loan sales under the warehouse loans held-for-investment lending program, which are done at par, earned interest on outstanding balances for the six months ended June 30, 2015 and 2014, of $0.9 million and $0.4 million, respectively. For the six months ended June 30, 2015, the weighted average number of days outstanding of warehouse loans held-for-investment was approximately 19 days. Due to the favorable interest rate environment, we expect that production of warehouse loans held-for-investment will continue to be a strategic focus of the Bank.

Deferred Income Taxes

Despite the Company being in a three-year cumulative loss position as of June 30, 2015, based on the assessment during the second quarter of 2015 of this fact and all the other positive and negative evidence bearing on the likelihood of realization of the Company’s deferred tax assets, management has concluded that it is more likely than not that $8.5 million of the deferred tax assets, primarily comprised of future tax benefits associated with the allowance for portfolio loan losses, net operating loss carryover, and net unrealized loss on securities available-for-sale, will be realized based upon future taxable income. Therefore, $8.5 million of the valuation allowance was reversed during June 2015. As such, the Company expects to record tax benefits in future periods that will likely reduce net income before income tax expense in such future periods. The future realization of the Company’s net operating loss carryovers is limited to $325,000 per year.

As of December 31, 2014, the Company concluded that, while improved operating results were expected as the economy continued to improve and the Bank’s nonperforming assets remained at low levels, a more likely than not conclusion that the realization of the Company’s deferred tax asset could not be supported due to the variability of the Company’s credit-related costs and the impact of the Company’s high debt costs on its profitability. Consequently, the Company had recorded a valuation allowance of $8.9 million for the entire amount of the net federal and state deferred tax assets as of December 31, 2014.

Deposits

Total deposits were $501.1 million at June 30, 2015, an increase of $60.3 million from $440.8 million at December 31, 2014. Non-maturing deposits increased by $11.6 million during the first six months of 2015, while time deposits increased by $48.7 million during the same time period. Non-maturing deposits increased to $290.2 million at June 30, 2015 due to a $6.6 million increase in noninterest-bearing demand deposits and a $6.7 million increase in savings and money market deposits, partially offset by a $1.7 million decrease in interest-bearing demand deposits.

The increase in non-maturing deposits was due to our continued development of commercial relationships. Time deposits increased to $210.9 million as of June 30, 2015 due to an increase of $46.2 million in brokered deposits, an increase of $16.4 million in deposits related to a retail certificates of deposit promotion, an increase of $4.4 million in non-brokered Internet certificates of deposit, partially offset by a decrease of $18.3 million in our standard certificates of deposit.

As a part of its capital preservation strategy, the Bank strategically lowered rates on time deposits beginning in the second half of 2009 in order to reduce those deposits consistent with loan balance decreases. As a result of the successful capital raise in December 2013, the Bank actively sought to grow deposits to help meet liquidity needs throughout 2014 and during the first six months of 2015. Management believes near term deposit growth will be moderate with an emphasis on core deposit growth. The Bank expects to supplement its core deposit growth, if needed, with strategic retail certificates of deposit promotions, certificates of deposit sourced through a well-known national non-broker Internet deposit program, which has been successfully utilized in the past, brokered deposits, or the creation of new business deposit products. Significant changes in the short-term interest rate environment could affect the availability of deposits in our local market and, therefore, may cause the Bank to change its strategy.

Securities Sold Under Agreements to Repurchase

Information concerning repurchase agreements as of and for the three months ending June 30, 2014, and as of and for the year ended December 31, 2014 is summarized as follows:

	June 30, 2015			December 31, 2014
	(Dollars in Thousands)

Average daily balance	$	63,370		$	69,075
Weighted average coupon interest rate during the period		4.94	%		4.96	%
Maximum month-end balance during the period	$	66,300		$	78,300
Weighted average coupon interest rate at end of period		0.80	%		4.94	%
Weighted average maturity (months)		–			30

Federal Home Loan Bank Advances

As of June 30, 2015 and December 31, 2014, advances from the FHLB were as follows:

	June 30, 2015			December 31, 2014
	(Dollars in Thousands)

Maturity on January 23, 2015, fixed rate at 0.24%	$	–		$	5,000
Maturity on August 10, 2015, fixed rate at 0.21%		20,000			–
Maturity on September 10, 2015, fixed rate at 0.24%		10,000			–
Maturity on June 22, 2016, fixed rate at 0.54%		47,500			–
Maturity on August 26, 2016, fixed rate 2.32% (1)		–			10,000
Maturity on September 28, 2016, fixed rate 4.15%		–			10,000
Maturity on December 8, 2016, fixed rate at 4.26%		–			10,000
Maturity on May 30, 2017, fixed rate at 4.33%		–			10,000
Maturity on June 20, 2017, fixed rate 0.91%		10,000			–
Maturity on June 20, 2017, fixed rate 0.73%		3,333			4,167
Maturity on August 1, 2017, fixed rate at 4.39%		–			20,000
Maturity on August 22, 2017, fixed rate at 3.74%		–			5,000
Maturity on August 28, 2017, fixed rate at 2.87% (1)		–			10,000
Maturity on December 21, 2017, fixed rate at 3.77%		–			15,000
Maturity on December 29, 2017, fixed rate at 3.89%		–			15,000
Maturity on March 26, 2018, fixed rate 4.11%		–			5,000
Maturity on June 19, 2018, fixed rate at 1.31%		10,425			–
Maturity on June 20, 2018, fixed rate at 0.50%		55,000			–
Maturity on June 20, 2019, fixed rate at 1.27%		4,000			4,500
Maturity on December 23, 2019, fixed rate 2.08% (2)		20,000			–
Maturity on June 23, 2020, fixed rate at 1.81% (2)		15,000			–
Maturity on June 23, 2020, fixed rate at 1.89% (2)		15,000			–
Daily rate credit, no maturity date, fixed rate at 0.36%		10,000			–
Prepayment penalties to be amortized ratably from July 2015 to June 2016		(2,887	)		–
Total	$	217,371		$	123,667

(1)

(2)

During the six months ended June 30, 2015, the Company paid off $228.3 million of the FHLB borrowings, including $112.0 million that had been borrowed during 2015.

Stockholders’ Equity

Stockholders’ equity increased by $5.7 million to $78.0 million at June 30, 2015 from $72.3 million at December 31, 2014, due to net income of $6.0 million, partially offset by other comprehensive loss of $0.3 million for the six months ended June 30, 2015. The increase in accumulated other comprehensive loss was due to a negative change in the fair value of securities available-for-sale because of an increase in interest rates during the first six months of 2015. The Company continues to monitor strategies to preserve capital including the suspension of cash dividends and its stock repurchase program. Resumption of these programs is not expected to occur in the near term.

The Company’s equity to assets ratio decreased to 9.6% at June 30, 2015, from 10.2% at December 31, 2014. As of June 30, 2015, the Bank’s Tier 1 capital to adjusted assets ratio was 9.69%, total risk based capital to risk-weighted assets ratio was 14.74% and Tier 1 capital to risk-weighted assets ratio was 13.48%. These ratios as of December 31, 2014 were 10.35%, 17.64%, and 16.38%, respectively.

The decrease in capital ratios as of June 30, 2015, compared with those as of December 31, 2014, was primarily due to an increase in assets, which resulted in an increase in risk-weighted assets and adjusted total assets, partially offset by an increase in capital. Additionally, risk-weighted assets increased as the Bank continued to shift its asset base to higher interest-earning loans with higher risk weighting. The Bank is currently deemed well capitalized.

Comparison of Results of Operations for the Three Months Ended June 30, 2015 and 2014

General

Net income for the three months ended June 30, 2015 was $5.6 million, as compared to net income of $0.2 million for the three months ended June 30, 2014. The net income for the three months ended June 30, 2015 increased $5.4 million as compared to the net income in the same period in 2014, primarily due to the reversal of $8.5 million of the Company’s valuation allowance against its deferred tax assets, as well as an increase in net interest income of $0.7 million, a reduction in the provision expense of $0.1 million and an increase in noninterest income of $0.1 million, partially offset by an increase in noninterest expense of $6.0 million. Net interest income increased during the second quarter of 2015 as compared to the same period in 2014 due to the impact of increased portfolio loans and other loans outstanding and decreased interest expense for deposits, repurchase agreements and FHLB advances, partially offset by lower interest rates on portfolio loans and the impact of lower balances in investment securities with lower interest rates on those funds invested in such investment securities. Noninterest income increased during the second quarter of 2015 as compared to the same period in 2014 primarily due to higher gains on sales of loans held-for-sale. Noninterest expense increased during the three months ended June 30, 2015 as compared to the three months ended June 30, 2014, primarily due to prepayment penalties associated with the prepayment and restructure of wholesale debt, as well as an increase in compensation and benefits, data processing and outside professional services expense, partially offset by lower Federal Deposit Insurance Corporation (FDIC) insurance costs.

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

The following table sets forth certain information for the three months ended June 30, 2015 and 2014. The average yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods presented.

	Three Months Ended June 30,
	2015								2014
	Average Balance		Interest			Average Yield / Cost			Average Balance		Interest			Average Yield / Cost
	(Dollars in Thousands)								(Dollars in Thousands)
Interest-earning assets:
Loans (1)	$	545,734	$	6,647			4.87	%	$	426,598	$	5,901			5.53	%
Investment securities (2)		131,549		692			2.10	%		179,028		885			1.98	%
Other interest-earning assets (3)		32,158		83			1.04	%		62,473		145			0.93	%
Total interest-earning assets		709,441		7,422			4.20	%		668,099		6,931			4.16	%
Noninterest-earning assets		56,875								38,327
Total assets	$	766,316							$	706,426

Interest-bearing liabilities:
Interest-bearing demand accounts	$	64,947	$	26			0.16	%	$	70,292		45			0.25	%
Savings deposits		63,318		23			0.15	%		68,937		45			0.26	%
Money market accounts		113,289		152			0.53	%		101,489		119			0.47	%
Time deposits		180,699		377			0.82	%		171,426		420			0.98	%
Securities sold under agreements to repurchase		58,259		722			4.96	%		66,300		827			4.99	%
Federal Home Loan Bank advances		159,448		1,137			2.85	%		111,868		1,148			4.10	%
Total interest-bearing liabilities		639,960		2,437			1.52	%		590,312		2,604			1.76	%
Noninterest-bearing liabilities		51,562								46,168
Total liabilities		691,522								636,480
Total stockholders’ equity		74,794								69,946
Total liabilities and stockholders’ equity	$	766,316							$	706,426

Net interest income			$	4,985							$	4,327
Net interest spread							2.68	%							2.40	%
Net interest-earning assets	$	69,481							$	77,787
Net interest margin (4)							2.81	%							2.59	%
Average interest-earning assets to average interest-bearing liabilities				110.86	%							113.18	%

(1)

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

(2)

Calculated based on carrying value. State and municipal investment securities yields have not been adjusted to full tax equivalents, as the numbers would not change materially from those presented in the table.

(3)

Includes FHLB stock at cost and term deposits with other financial institutions.

(4)

Net interest income divided by average interest-earning assets.

Rate/Volume Analysis

The following table presents the dollar amount of changes in interest income for major components of interest-earning assets and in interest expense for major components of interest-bearing liabilities for the three months ended June 30, 2015 as compared to the three months ended June 30, 2014. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in volume multiplied by the old interest rate; (2) changes in interest rate multiplied by the old volume; and (3) changes not solely attributable to interest rate or volume, which have been allocated proportionately to the change due to volume and the change due to interest rate.

	Increase / (Decrease)
	Due to Volume			Due to Rate			Total Increase / (Decrease)
	(Dollars in Thousands)

Interest-earning assets:
Loans (1)	$	1,510		$	(764	)	$	746
Investment securities		(247	)		54			(193	)
Other interest-earning assets		(77	)		15			(62	)
Total interest-earning assets		1,186			(695	)		491

Interest-bearing liabilities:
Interest-bearing demand accounts		(3	)		(16	)		(19	)
Savings deposits		(3	)		(19	)		(22	)
Money market accounts		15			17			32
Time deposits		22			(65	)		(43	)
Securities sold under agreements to repurchase		(100	)		(5	)		(105	)
Federal Home Loan Bank advances		401			(412	)		(11	)
Total interest-bearing liabilities		332			(500	)		(168	)

Net interest income	$	854		$	(195	)	$	659

(1)

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

Interest Income

Total interest income increased $0.5 million to $7.4 million for the three months ended June 30, 2015 as compared with $6.9 million for the three months ended June 30, 2014 due to the impact of higher balances in portfolio loans and other loans outstanding and higher interest rates on funds invested in investment securities, partially offset by the decrease in interest rates on portfolio loans and lower balances in investment securities. Interest income on loans increased to $6.6 million for the three months ended June 30, 2015 from $5.9 million for the three months ended June 30, 2014. This increase was due to an increase in the average balance of loans, which increased $119.1 million to $545.7 million for the three months ended June 30, 2015 from $426.6 million for the three months ended June 30, 2014, partially offset by a decrease in average yield on loans of 66 basis points to 4.87% for the three months ended June 30, 2015.

The average balance of loans increased due to an increase in portfolio loans and other loans outstanding. Originations of portfolio loans increased during the three months ended June 30, 2015, resulting in increased interest income on portfolio loans outstanding and additional fee income. Originations of warehouse loans held-for-investment increased, while the weighted average number of days outstanding for warehouse loans held-for-investment held steady during the three months ended June 30, 2015, resulting in increased interest income and additional fee income. The increase in originations of warehouse loans held-for-investment is the result of an increase in home purchase and refinance volume, and three loan participation agreements that the Company entered into with Customers Bank at the end of the first quarter of 2015, and other relationships with new counterparties.

Interest income earned on investment securities decreased $0.2 million to $0.7 million for the three months ended June 30, 2015 from $0.9 million for the three months ended June 30, 2014. This decrease was primarily due to a decrease in the average balance of investment securities of $47.5 million to $131.5 million, partially offset by the impact of higher yields on investment securities for the three months ended June 30, 2015.

Interest Expense

Interest expense declined by $0.2 million to $2.4 million for the three months ended June 30, 2015 from $2.6 million for the three months ended June 30, 2014, primarily due to the decrease in interest expense on deposits, repurchase agreements and FHLB advances. The decrease in interest expense on deposits for the three months ended June 30, 2015, as compared to the three months ended June 30, 2014, was primarily due to lower average rates paid on interest-bearing deposits. The average cost of deposits, including noninterest-bearing deposits, decreased 6 basis points to 0.49% for the three months ended June 30, 2015 as compared to 0.55% for the three months ended June 30, 2014.

The Bank’s overall cost of funds, including noninterest-bearing deposits, was 1.40% for the three months ended June 30, 2015, down from 1.64% for the three months ended June 30, 2014, due to the lower cost of deposits, repurchase agreements and FHLB advances. The Bank’s cost of funds remained elevated relative to the current interest rate environment due to the structured rates associated with the repurchase agreements and FHLB advances which were at interest rates significantly above market rates. However, the Company's successful efforts during June 2015 to lower the effective interest rate on its wholesale debt are expected to reduce interest expense going forward by approximately $2.2 million over the next 12 months and approximately $5.0 million annually thereafter.

Net Interest Income

Net interest income increased $0.7 million to $5.0 million for the three months ended June 30, 2015 from $4.3 million for the three months ended June 30, 2014, due to the increase in portfolio loans and other loans outstanding, and decreased interest expense for deposits, repurchase agreements and FHLB advances, partially offset by lower interest rates on portfolio loans and the impact of lower balances in investment securities interest rates on funds invested in investment securities.

Our net interest rate spread, which is the difference between the interest rate earned on interest-earning assets and the interest rate paid on interest-bearing liabilities, increased 28 basis points to 2.68% for the three months ended June 30, 2015 as compared to 2.40% for the three months ended June 30, 2014. Our net interest margin, which is net interest income expressed as a percentage of our average interest-earning assets, increased 22 basis point to 2.81% for the three months ended June 30, 2015 as compared to 2.59% for the three months ended June 30, 2014. The increase in the net interest rate spread primarily reflected the positive impact on interest income from increasing balances in portfolio loans and other loans and the positive impact on interest expense from declining high fixed-interest rate debt balances, partially offset by the negative impact on interest income from declining interest rates on portfolio loans, as well as the negative impact on interest income from lower balances in investment securities with lower interest rates on those investment securities.

Provision for Portfolio Loan Losses

Provision expense was $0.2 million and $0.3 million during the three months ended June 30, 2015 and 2014, respectively. The decline in the provision expense during the second quarter of 2015 compared with the same period in 2014 reflected improving economic conditions in the Company’s markets, which have led to a decline in net charge-offs over the past 12 months, partially offset by loan growth.

The Company had net recoveries of $0.1 million for the three months ended June 30, 2015 as compared to net charge-offs of $0.3 million for the three months ended June 30, 2014. The change to net recoveries in the second quarter of 2015 from net charge-offs in the same period in 2014 was primarily due to a decrease in charge-offs in one- to four-family residential loans, home equity loans and collateral-dependent commercial real estate property, which was partially offset by an increase in charge-offs related to manufactured home loans.

Typically, the Company’s policy to charge-down one- to four-family first mortgages and home equity loans to the estimated fair value of the collateral at the time the loan becomes nonperforming will impact net charge-offs. However, net charge-offs did not include any partial charge-offs in either the second quarter of 2015 or 2014 due to improving economic conditions in the Company’s markets.

Noninterest Income

The components of noninterest income for the three months ended June 30, 2015 and 2014 were as follows:

					Increase / (Decrease)
	2015		2014		Amount			Percentage
	(Dollars in Thousands)
Service charges and fees	$	660	$	680	$	(20	)		(2.9	)%
Gain on sale of loans held-for-sale		350		269		81			30.1	%
Gain on sale of securities available-for-sale		–		7		(7	)		(100.0	)%
Bank owned life insurance earnings		119		119		-			0.0	%
Interchange fees		408		388		20			5.2	%
Other		139		118		21			17.8	%
	$	1,676	$	1,581	$	95			6.0	%

Noninterest income for the three months ended June 30, 2015 increased $0.1 million to $1.7 million as compared to $1.6 million in the second quarter of 2014. The increase in noninterest income was primarily due to an increase in gains on the sale of loans held-for-sale.

For the three months ended June 30, 2015, gains on sales of mortgage loans held-for-sale was $211,000, deferred fees on mortgage loans held-for-sale was $23,000, gains on sales of SBA loans held-for-sale was $177,000, and net losses recognized for the servicing of SBA loans held-for-sale was $15,000. By comparison, for the three months ended June 30, 2014, gains on sales of mortgage loans held-for-sale was $12,000, there were no deferred fees on mortgage loans held-for-sale, gains on sales of SBA loans held-for-sale was $237,000, and net gains recognized for the servicing of SBA loans held-for-sale was $26,000.

The Company expects gains on sales of SBA loans held-for-sale to represent the majority of gains on loan sales in the future as the Company emphasizes SBA lending. Management expects growth in the business activity of internally originated mortgage loans held-for-sale to be moderate in the near term, due to the Company’s emphasis on originating one- to four-family residential loans to grow its portfolio loans.

Noninterest Expense

The components of noninterest expense for the three months ended June 30, 2015 and 2014 were as follows:

					Increase / (Decrease)
	2015		2014		Amount			Percentage
	(Dollars in Thousands)
Compensation and benefits	$	3,133	$	2,633	$	500			19.0	%
Occupancy and equipment		538		492		46			9.3	%
Federal Deposit Insurance Corporation insurance premiums		154		358		(204	)		(57.0	)%
Foreclosed assets, net		102		13		89			684.6	%
Data processing		472		365		107			29.3	%
Outside professional services		554		405		149			36.8	%
Collection expense and repossessed asset losses		105		130		(25	)		(19.2	)%
Securities sold under agreements to repurchase and Federal Home Loan Bank advances prepayment penalties		5,188		-		5,188			n/a
Other		1,040		892		148			16.6	%
	$	11,286	$	5,288	$	5,998			113.4	%

Noninterest expense increased $6.0 million to $11.3 million for the three months ended June 30, 2015 from $5.3 million for the three months ended June 30, 2014. The increase in noninterest expense for the second quarter of 2015 as compared with the first quarter of 2014, primarily reflected the penalties associated with the prepayment of some of the Company's high-cost wholesale debt during the second quarter of 2015, as well as an increase in compensation and benefits, data processing and outside professional services expense, partially offset by lower FDIC insurance costs.

With the Company’s strengthened capital position, management expects to further reduce its risk-related operating expenses, including OCC assessments, FDIC insurance costs, accounting costs and director & officer insurance costs, as well as to continue operating with lower levels of foreclosed asset and collection expenses.

Income Tax

The Company recorded $10.4 million in income tax benefit and $45,000 in income tax expense for the three months ended June 30, 2015 and 2014, respectively. The future realization of the Company’s net operating loss carryovers is limited to $325,000 per year. Income taxes are discussed in further detail in Note 11. Income Taxes of the Notes contained in this Report.

Comparison of Results of Operations for the Six Months Ended June 30, 2015 and 2014

General

Net income for the six months ended June 30, 2015 was $6.0 million, as compared to net income of $0.4 million for the six months ended June 30, 2014. The net income for the six months ended June 30, 2015 increased $5.6 million as compared to the net income in the same period in 2014 due primarily to the reversal of $8.5 million of the Company’s valuation allowance against its deferred tax assets, as well as an increase in net interest income of $0.9 million, a reduction in the provision expense of $0.4 million, and an increase in noninterest income of $0.4 million, partially offset by an increase in noninterest expense of $6.6 million. Net interest income increased during the first six months of 2015 as compared to the same period in 2014 due to the impact of increased portfolio loans and other loans outstanding, and decreased interest expense for deposits, repurchase agreements and FHLB advances, partially offset by lower interest rates on portfolio loans and the impact of lower balances in investment securities. Noninterest income increased during the first six months of 2015 as compared to the same period in 2014 primarily due to higher gains on sales of loans held-for-sale. Noninterest expense increased during the six months ended June 30, 2015 as compared to the six months ended June 30, 2014, primarily due to prepayment penalties associated with the prepayment and restructure of wholesale debt, as well as an increase in compensation and benefits, data processing and outside professional services expense, partially offset by lower FDIC insurance costs.

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

The following table sets forth certain information for the six months ended June 30, 2015 and 2014. The average yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods presented.

	Six Months Ended June 30,
	2015								2014
	Average Balance		Interest			Average Yield / Cost			Average Balance		Interest			Average Yield / Cost
	(Dollars in Thousands)								(Dollars in Thousands)
Interest-earning assets:
Loans (1)	$	520,482	$	12,762			4.90	%	$	415,172	$	11,780			5.53	%
Investment securities (2)		134,150		1,360			2.03	%		178,733		1,818			1.98	%
Other interest-earning assets (3)		38,053		171			0.90	%		81,815		258			0.93	%
Total interest-earning assets		692,685		14,293			4.12	%		675,720		13,856			4.16	%
Noninterest-earning assets		45,683								37,615
Total assets	$	738,368							$	713,335

Interest-bearing liabilities:
Interest-bearing demand accounts	$	65,170	$	53			0.16	%	$	69,763		91			0.25	%
Savings deposits		63,160		46			0.15	%		68,361		91			0.26	%
Money market accounts		112,085		294			0.52	%		102,313		238			0.47	%
Time deposits		170,464		735			0.86	%		175,947		871			0.99	%
Securities sold under agreements to repurchase		62,257		1,540			4.95	%		71,963		1,802			5.01	%
Federal Home Loan Bank advances		140,766		2,220			3.15	%		110,939		2,279			4.11	%
Total interest-bearing liabilities		613,902		4,888			1.60	%		599,286		5,372			1.80	%
Noninterest-bearing liabilities		50,052								45,208
Total liabilities		663,954								644,494
Total stockholders’ equity		74,414								68,841
Total liabilities and stockholders’ equity	$	738,368							$	713,335

Net interest income			$	9,405							$	8,484
Net interest spread							2.52	%							2.30	%
Net interest-earning assets	$	78,783							$	76,434
Net interest margin (4)							2.72	%							2.51	%
Average interest-earning assets to average interest-bearing liabilities				112.83	%							112.75	%

(1)

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

(2)

(3)

Includes FHLB stock at cost and term deposits with other financial institutions.

(4)

Net interest income divided by average interest-earning assets.

Rate/Volume Analysis

The following table presents the dollar amount of changes in interest income for major components of interest-earning assets and in interest expense for major components of interest-bearing liabilities for the six months ended June 30, 2015 as compared to the six months ended June 30, 2014. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in volume multiplied by the old interest rate; (2) changes in interest rate multiplied by the old volume; and (3) changes not solely attributable to interest rate or volume, which have been allocated proportionately to the change due to volume and the change due to interest rate.

	Increase / (Decrease)
	Due to Volume			Due to Rate			Total Increase / (Decrease)
	(Dollars in Thousands)

Interest-earning assets:
Loans (1)	$	2,724		$	(1,742	)	$	982
Investment securities		(452	)		(6	)		(458	)
Other interest-earning assets		(171	)		84			(87	)
Total interest-earning assets		2,101			(1,664	)		437

Interest-bearing liabilities:
Interest-bearing demand accounts		(6	)		(32	)		(38	)
Savings deposits		(6	)		(39	)		(45	)
Money market accounts		24			32			56
Time deposits		(26	)		(110	)		(136	)
Securities sold under agreements to repurchase		(240	)		(22	)		(262	)
Federal Home Loan Bank advances		536			(595	)		(59	)
Total interest-bearing liabilities		282			(766	)		(484	)

Net interest income	$	1,819		$	(898	)	$	921

(1)

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

Interest Income

Total interest income increased $0.4 million to $14.3 million for the six months ended June 30, 2015 as compared to $13.9 million for the six months ended June 30, 2014 due to the impact of higher balances in portfolio loans and other loans outstanding, partially offset by the decrease in interest rates on portfolio loans and lower balances in investment securities. Interest income on loans increased to $12.8 million for the six months ended June 30, 2015 from $11.8 million for the six months ended June 30, 2014. This increase was due to an increase in the average balance of loans, which increased $105.3 million to $520.5 million for the six months ended June 30, 2015 from $415.2 million for the six months ended June 30, 2014, partially offset by a decrease in average yield on loans of 77 basis points to 4.90% for the six months ended June 30, 2015.

The average balance of loans increased due to an increase in portfolio loans and other loans outstanding. Originations of portfolio loans increased during the six months ended June 30, 2015, resulting in increased interest income on portfolio loans outstanding and additional fee income. Originations of warehouse loans held-for-investment increased, while the weighted average number of days outstanding for warehouse loans held-for-investment held steady during the six months ended June 30, 2015, resulting in increased interest income and additional fee income. The increase in originations of warehouse loans held-for-investment is the result of an increase in home purchase and refinance volume, three loan participation agreements that the Company entered into with Customers Bank at the end of the first quarter of 2015, and other relationships with new counterparties.

Interest income earned on investment securities decreased $0.4 million to $1.4 million for the six months ended June 30, 2015 from $1.8 million for the six months ended June 30, 2014. This decrease was primarily due to a decrease in the average balance of investment securities of $44.6 million to $134.1 million during the six months ended June 30, 2015.

Interest Expense

Interest expense declined by $0.5 million to $4.9 million for the six months ended June 30, 2015 from $5.4 million for the six months ended June 30, 2014, due to the decrease in interest expense on deposits, repurchase agreements, and FHLB advances. The decrease in interest expense on deposits for the six months ended June 30, 2015 as compared to the six months ended June 30, 2014, was primarily due to lower average rates paid on interest-bearing deposits. The average cost of deposits, including noninterest-bearing deposits, decreased 8 basis points to 0.49% for the six months ended June 30, 2015 as compared to 0.57% for the six months ended June 30, 2014.

The Bank’s overall cost of funds, including noninterest-bearing deposits, was 1.48% for the six months ended June 30, 2015 down from 1.68% for the six months ended June 30, 2014, due to the lower cost of deposits, repurchase agreements, and FHLB advances. The Bank’s cost of funds remained elevated relative to the current interest rate environment due to the structured rates associated with the repurchase agreements and FHLB advances which were at interest rates significantly above market rates. However, the Company's successful efforts during June 2015 to lower the effective interest rate on its wholesale debt are expected to reduce interest expense going forward by approximately $2.2 million over the next 12 months and approximately $5.0 million annually thereafter.

Net Interest Income

Net interest income increased $0.9 million to $9.4 million for the six months ended June 30, 2015 from $8.5 million for the six months ended June 30, 2014, due to the increase in portfolio loans and other loans outstanding, and decreased interest expense for deposits, repurchase agreements and FHLB advances, partially offset by lower interest rates on portfolio loans and the impact of lower balances in investment securities.

Our net interest rate spread, which is the difference between the interest rate earned on interest-earning assets and the interest rate paid on interest-bearing liabilities, increased 22 basis points to 2.52% for the six months ended June 30, 2015 as compared to 2.30% for the six months ended June 30, 2014. Our net interest margin, which is net interest income expressed as a percentage of our average interest-earning assets, increased 21 basis point to 2.72% for the six months ended June 30, 2015 as compared to 2.51% for the six months ended June 30, 2014. The increase in the net interest rate spread primarily reflected the positive impact on interest income from increasing balances in portfolio loans and other loans and the positive impact on interest expense from declining high fixed-interest rate debt balances, partially offset by the negative impact on interest income from declining interest rates on portfolio loans, as well as the negative impact on interest income from lower balances in investment securities with lower interest rates on those investment securities.

Provision for Portfolio Loan Losses

Provision expense was $0.4 million and $0.8 million during the six months ended June 30, 2015 and 2014, respectively. The decline in the provision expense during the first six months of 2015 compared with the same period in 2014 reflected improving economic conditions in the Company’s markets, which have led to a decline in net charge-offs over the past 12 months, partially offset by loan growth.

The Company had net charge-offs of $0.1 million for the six months ended June 30, 2015 as compared to $0.8 million for the six months ended June 30, 2014. The decrease in net charge-offs in the first six months of 2015 compared with the same period in 2014 was primarily due to a decrease in charge-offs in one- to four-family residential loans, home equity loans and collateral-dependent commercial real estate property.

Consistent with the Company’s policy to charge-down one- to four-family first mortgages and home equity loans to the estimated fair value of the collateral at the time the loan becomes nonperforming, net charge-offs in the first six months of 2014 included $0.3 million of partial charge-offs. However, net charge-offs did not include any partial charge-offs in the first six months of 2015 due to improving economic conditions in the Company’s markets.

Noninterest Income

The components of noninterest income for the six months ended June 30, 2015 and 2014 were as follows:

						Increase / (Decrease)
	2015			2014		Amount			Percentage
	(Dollars in Thousands)
Service charges and fees	$	1,296		$	1,317	$	(21	)		(1.6	)%
Gain on sale of loans held-for-sale		849			493		356			72.2	%
Gain on sale of securities available-for-sale		(9	)		7		(16	)		(228.6	)%
Bank owned life insurance earnings		237			209		28			13.4	%
Interchange fees		803			761		42			5.5	%
Other		262			254		8			3.1	%
	$	3,438		$	3,041	$	397			13.1	%

Noninterest income for the six months ended June 30, 2015 increased $0.4 million to $3.4 million as compared to $3.0 million in the first six months of 2014. The increase in noninterest income was primarily due to an increase in gains on the sale of loans held-for-sale.

For the six months ended June 30, 2015, gains on sales of mortgage loans held-for-sale was $353,000, deferred fees on mortgage loans held-for-sale was $36,000, gains on sales of SBA loans held-for-sale was $456,000, and net gains recognized for the servicing of SBA loans held-for-sale was $76,000. By comparison, for the six months ended June 30, 2014, gains on sales of mortgage loans held-for-sale was $16,000, deferred fees on mortgage loans held-for-sale was $5,000, gains on sales of SBA loans held-for-sale was $429,000, and net gains recognized for the servicing of SBA loans held-for-sale was $47,000.

Noninterest Expense

The components of noninterest expense for the six months ended June 30, 2015 and 2014 were as follows:

					Increase / (Decrease)
	2015		2014		Amount			Percentage
	(Dollars in Thousands)
Compensation and benefits	$	6,049	$	4,920	$	1,129			22.9	%
Occupancy and equipment		1,052		983		69			7.0	%
Federal Deposit Insurance Corporation insurance premiums		349		742		(393	)		(53.0	)%
Foreclosed assets, net		102		19		83			436.8	%
Data processing		867		658		209			31.8	%
Outside professional services		1,086		788		298			37.8	%
Collection expense and repossessed asset losses		224		294		(70	)		(23.8	)%
Securities sold under agreements to repurchase and Federal Home Loan Bank advances prepayment penalties		5,188		-		5,188			n/a
Other		1,910		1,797		113			6.3	%
	$	16,827	$	10,201	$	6,626			65.0	%

Noninterest expense increased $6.6 million to $16.8 million for the six months ended June 30, 2015 from $10.2 million for the six months ended June 30, 2014. The increase in noninterest expense for the first six months of 2015 as compared with the first quarter of 2014 primarily reflected the penalties associated with the prepayment of some of the Company's high-cost wholesale debt during the second quarter of 2015, as well as an increase in compensation and benefits, data processing and outside professional services expense, partially offset by lower FDIC insurance costs.

Income Tax

The Company recorded $10.4 million in income tax benefit and $45,000 in income tax expense for the six months ended June 30, 2015 and 2014, respectively. The future realization of the Company’s net operating loss carryovers is limited to $325,000 per year. Income taxes are discussed in further detail in Note 11. Income Taxes of the Notes contained in this Report.

Liquidity

The Company maintains a liquidity position it believes will adequately provide funding for loan demand and deposit run-off that may occur in the normal course of business. The Company relies on a number of different sources of funds in order to meet its liquidity demands. The Company’s primary sources of funds are increases in deposit accounts and cash flows from loan payments, sales of residential and SBA loans in the secondary market, sales of investment securities, and borrowings. The scheduled amortization of loans and investment securities, as well as proceeds from borrowings, are generally predictable sources of funds. In addition, warehouse loans held-for-investment repay rapidly, with an average duration of approximately 19 days during the first six months of 2015, and with repayments generally funding advances. Other funding sources, however, such as inflows from new deposits, mortgage and investment securities prepayments and mortgage loan sales are greatly influenced by market interest rates, economic conditions, and competition.

We expect the Company’s primary sources of funds to continue to be sufficient to meet demands, although we can give no assurances, and the Bank has contingent liquidity capacity available to meet potential funding requirements, including availability from the FHLB, the Federal Reserve Bank of Atlanta, and other institutional sources. Management aggressively increased, and plans to continue to increase, the Bank’s higher interest-earning assets, using cash and cash equivalents as the funding source. Consequently, the Bank’s cash and cash equivalents on hand have decreased. The average balance of cash and cash equivalents decreased to $44.3 million during the six months ended June 30, 2015 from $80.8 million during the six months ended June 30, 2014, and consistent with this strategy, management expects that cash and cash equivalents will continue to be at a lower level throughout the remainder of 2015. As of June 30, 2015 and December 31, 2014, the Company had additional borrowing capacity of $3.4 million and $11.5 million, respectively, with the FHLB. The Company’s borrowing capacity with the Federal Reserve Bank of Atlanta, as of June 30, 2015, included the ability to borrow up to approximately $32.5 million under the Primary Credit program, based solely on the current amount of loans the Company has designated for pledging with the Federal Reserve Bank of Atlanta, and $10.0 million of daylight overdraft capacity. Additionally, as of June 30, 2015, the Company had liquidity sources through two $5.0 million lines of credit, both with private financial institutions. As of June 30, 2015, the Bank has not borrowed against any of these contingent liquidity sources. As of June 30, 2015, a $10.0 million line of credit for repurchase and reverse repurchase transactions had been utilized by the Company; however, the borrowing was short-term in nature and the balance was fully repaid early in July 2015. Unpledged investment securities were approximately $88.0 million and $29.3 million as of June 30, 2015 and December 31, 2014, respectively. The Company also utilizes a non-brokered Internet certificate of deposit listing service to meet funding needs at interest rates equal to or less than the Bank’s local market rates. During the first six months of 2015, the Bank had deposits from this service of $19.8 million, and expects it will continue to utilize the program, as necessary, to supplement retail deposit production.

Threats to our liquidity position include rapid declines in deposit balances due to market volatility caused by major changes in interest rates or negative public perception about the Bank or the financial services industry in general. In addition, the amount of investment securities that would otherwise be available to meet liquidity needs is limited due to the collateral requirements of our long term debt. Specifically, the Bank’s repurchase agreements, which total $10.0 million at June 30, 2015, have collateral requirements in excess of the debt. Additionally, the collateral requirements of the FHLB debt are supplemented with investment securities collateral and the Bank is required to collateralize the prepayment penalty amount using investment securities.

For the first six months of 2015, cash and cash equivalents increased $16.1 million to $38.5 million as of June 30, 2015 as compared to $22.4 million as of December 31, 2014, due to borrowings at the end of the second quarter of 2015 which resulted in an increase in cash and cash equivalents. The borrowings were in anticipation of further growth in loans, as the Bank remains focused on its strategy to increase portfolio loans and other higher yielding assets. For the first six months of 2015, cash from financing activities of $97.7 million exceeded cash used in operating activities of $3.7 million and investing activities of $77.9 million. Primary sources of cash flows were from repayment of warehouse loans held-for-investment of $499.7 million, proceeds from FHLB advances of $324.9 million, net increases in deposits of $60.3 million, and proceeds from sale of investment securities of $14.1 million. Primary uses of cash flows included funding of warehouse loans held-for-investment of $561.0 million, the repayment of FHLB advances of $228.3 million, the repayment of repurchase agreements of $66.3 million, and net increases in portfolio loans of $22.7 million (excluding the purchase of such loans).

During the first six months of 2014, cash and cash equivalents decreased $81.5 million to $32.7 million as of June 30, 2014 as compared to $114.2 million as of December 31, 2013, as part of the Bank’s strategy to increase portfolio loans and other higher yielding assets which resulted in a reduction of cash and cash equivalents. Cash of $1.3 million, $52.4 million, and $27.8 million was used in operating activities, investing activities, and financing activities, respectively. Primary sources of cash were from repayment of warehouse loans held-for-investment of $177.6 million, proceeds from FHLB advances of $15.0 million, and proceeds from maturities and payments of investment securities of $10.7 million. Primary uses of cash included funding of warehouse loans held-for-investment of $179.4 million, the purchase of portfolio loans of $32.5 million, the purchase of securities available-for-sale of $32.3 million, the repayment of repurchase agreements of $26.5 million, and net decreases in deposits of $16.2 million.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

This item is not applicable because the Company is a smaller reporting company.

ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures. The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. The Company’s disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the Company’s reports filed or submitted under the Exchange Act is accumulated and communicated to management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can provide only reasonable assurance of achieving their control objectives, and management necessarily is required to use its judgment in evaluating the cost-benefit relationship of possible controls and procedures. As required by Rule 13a-15 under the Exchange Act, as of the end of the quarter ended June 30, 2015, the Company carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures. This evaluation was carried out under the supervision and with the participation of management, including the Company’s Chief Executive Officer and our Chief Financial Officer. Based upon this work and other evaluation procedures, management, including the Company’s Chief Executive Officer and our Chief Financial Officer, has concluded that as of the end of the quarter ended June 30, 2015 our disclosure controls and procedures were effective.

(b) Changes in internal control over financial reporting. There were no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) and Rule 15d-15(f) under the Exchange Act) that occurred during the quarter ended June 30, 2015, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

From time to time, each of the Company and the Bank are subject to legal proceedings incidental to the conduct of its business. Neither the Company nor the Bank is presently a party to any legal proceeding the resolution of which we believe would have a material adverse effect on our consolidated financial condition, operating results or cash flows.

On July 15, 2015, the FRB terminated the Agreement, as further discussed in Note 13. Regulatory Supervision of the Notes contained in this Report.

On March 26, 2015, the OCC terminated the Order, as further discussed in Note 13. Regulatory Supervision of the Notes contained in this Report.

ITEM 1A. RISK FACTORS

In addition to the other information set forth in this Report, you should carefully consider the factors discussed in Risk Factors included within the 2014 10-K. The Company does not believe there have been any material changes in the Company’s risk factors from those disclosed in the 2014 10-K. The risks described in the 2014 10-K are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition, operating results and cash flows. See the cautionary note regarding forward-looking statements at Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations in this Report, for further information.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

The exhibits listed in the accompanying Index to Exhibits are filed, furnished herewith, or incorporated by reference as part of this Report.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

ATLANTIC COAST FINANCIAL CORPORATION

Date: August 13, 2015	By:	/s/ John K. Stephens, Jr._

	John K. Stephens, Jr.
	President and Chief Executive Officer
	(Principal Executive Officer and duly authorized officer)

Date: August 13, 2015	By:	/s/ Tracy L. Keegan_

	Tracy L. Keegan
	Executive Vice President and Chief Financial Officer
	(Principal Financial and Accounting Officer and duly authorized officer)

INDEX TO EXHIBITS

Incorporation by Reference

Exhibit
Number

Exhibit Description

Form

Filing
Date

Exhibit
Number

SEC File No.

Filed
Herewith

3.1

Amended and Restated Articles of Incorporation of Atlantic Coast Financial Corporation

S-1

6/18/10

3.1

333-167632

3.2

Bylaws of Atlantic Coast Financial Corporation

S-1

6/18/10

3.2

333-167632

31.1

Certification of Chief Executive Officer of Atlantic Coast Financial Corporation pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2

Certification of Chief Financial Officer of Atlantic Coast Financial Corporation pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32*

Certification of Chief Executive Officer and Chief Financial Officer of Atlantic Coast Financial Corporation pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101.INS**

XBRL Instance Document

101.SCH**

XBRL Taxonomy Extension Schema Document

101.CAL**

XBRL Taxonomy Calculation Linkbase Document

101.DEF**

XBRL Taxonomy Extension Definition Linkbase Document

101.LAB**

XBRL Taxonomy Label Linkbase Document

101.PRE**

XBRL Taxonomy Presentation Linkbase Document

Furnished herewith. This certification attached as Exhibit 32 that accompanies this Report is not deemed filed with the SEC and is not to be incorporated by reference into any filing of Atlantic Coast Financial Corporation under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Report, irrespective of any general incorporation language contained in such filing.

These documents formatted in XBRL (Extensible Business Reporting Language) have been attached as Exhibit 101 to this Report.

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