Sound Financial Bancorp, Inc. annual report, FY2018

Sound Financial Bancorp, Inc. — FY 2018 Form 10-K

Reporting period: Fiscal year ended December 31, 2018; filed March 14, 2019. The company is a bank holding company operating primarily through Sound Community Bank in Washington. This is an annual filing; it does not provide a clear standalone fourth-quarter income statement or results.

Financial and operating highlights

Metric	FY 2018 / Dec. 31, 2018	FY 2017 / Dec. 31, 2017
Total assets	$716.7 million	$645.2 million
Loans held for portfolio, net	$613.8 million	$543.4 million
Deposits	$553.6 million	$514.4 million
FHLB borrowings	$84.0 million	$59.0 million
Stockholders’ equity	$71.6 million	$65.2 million
Net interest income	$27.6 million	$24.1 million
Net income	$7.0 million	$5.1 million
Diluted EPS	$2.74	$2.00
Net interest margin	4.25%	4.30%
Return on assets / equity	1.03% / 10.24%	0.87% / 8.13%

• Net interest income rose 14.6%, primarily from loan growth and higher asset yields; interest expense rose 59.1% as deposit and borrowing costs increased. Net interest margin edged down 5 basis points.
• Noninterest income increased 16.8% to $4.5 million, including a one-time $490,000 gain on sale of Visa B shares. Noninterest expense rose 18.6% to $22.8 million; the efficiency ratio increased to 71.12% from 68.89%.
• Net cash from operating activities was $10.3 million; investing activities used $71.5 million, principally for net loan growth; financing activities provided $62.3 million, mainly from deposit growth and increased FHLB advances. Cash and cash equivalents ended at $61.8 million.
• Cash and available-for-sale securities totaled $66.8 million. The Bank reported $156.0 million of remaining FHLB borrowing capacity, subject to collateral requirements, plus $47.3 million of discount-window capacity and $21.0 million of other credit facilities.
• Bank regulatory capital ratios were 9.73% leverage, 11.76% CET1 and Tier 1 risk-based, and 12.80% total risk-based capital. The Bank was classified as well capitalized.

Material changes and asset quality

• Assets grew 11.1% and portfolio loans grew approximately 13% year over year. Commercial and multifamily real estate loans rose 19.6% to $252.6 million; consumer loans rose to $67.6 million, led by floating-home lending. Commercial lending represented 46.8% of the loan portfolio.
• Deposits increased 7.6%; noninterest-bearing demand deposits grew substantially. Core deposits were 90.5% of deposits. Average deposit cost rose to 0.71% from 0.61%.
• FHLB advances increased 42.4%; their year-end weighted-average rate rose to 2.72% from 1.63%. Management said borrowings helped fund loan growth and may raise funding costs.
• Nonperforming loans increased to $2.7 million from $2.3 million; nonperforming assets were $3.2 million, or 0.45% of assets, versus $2.9 million, also 0.45%. The allowance for loan losses was $5.8 million, or 0.93% of gross loans, compared with $5.2 million, or 0.96%.
• Management disclosed $8.5 million across 34 additional loans of concern that could become nonperforming. Classified assets totaled $11.7 million, up from $6.8 million. Net recoveries were $8,000 for 2018.

Outlook, risks and unusual items

• Management described local economic conditions and loan demand as favorable and expects to pursue organic growth, higher-yielding commercial and consumer lending, core deposits, and expansion selectively in Western Washington. The filing provides no quantified earnings or growth guidance.
• Key exposures include concentration in Washington real estate and local economic conditions; commercial, multifamily, construction and land lending; borrower and collateral performance; deposit retention and funding costs; and interest-rate risk. The loan portfolio is increasingly adjustable-rate, but repricing caps and lags can limit protection as funding costs rise.
• The company reported $110.6 million in off-balance-sheet loan commitments, including $60.6 million of unfunded construction commitments. Commitments may expire undrawn. It also disclosed potential repurchase or indemnity obligations on loans serviced for others; maximum amounts cited were $376.5 million, representing unpaid principal balances subject to contractual defects.
• The Tax Cuts and Jobs Act reduced the federal corporate rate to 21% in 2018. The effective tax rate fell to 19.5% from 38.4%; 2017 included a $309,000 deferred-tax revaluation charge.
• CECL was expected to take effect for the company in 2020. Management anticipated earlier loss recognition and a possible increase in the allowance, but had not quantified the impact. The company also expected lease-standard adoption to add right-of-use assets and liabilities of less than 5% of total assets.
• After year-end, the Board declared a $0.14-per-share quarterly dividend and authorized a share repurchase program of up to $1.75 million over six months. FY 2018 dividends were $0.54 per share; future dividends remain subject to capital, regulatory and other constraints.
• The independent auditor gave unqualified opinions on the financial statements and internal control over financial reporting; management also concluded controls were effective. Management said it did not expect pending ordinary-course litigation to have a material adverse effect.

Important facts for investors to verify

1. Whether loan growth—particularly in commercial real estate, multifamily and construction—continues without worsening delinquencies, criticized loans or loss reserves.
2. Deposit pricing, deposit retention and the cost and availability of FHLB and other funding as rates and competition change.
3. The composition and performance of the $8.5 million loan-of-concern pool, classified assets, and nonperforming loans, including restructured credits.
4. The sustainability of earnings excluding the one-time Visa share-sale gain and the benefit from the lower statutory tax rate; also monitor expense growth and margin trends.
5. The eventual CECL allowance and capital impact, as well as actual use of the authorized repurchase program and capacity to sustain dividends.