Sound Financial Bancorp, Inc. — Q2 2018 Form 10-Q
Business context and reporting period
The company is a bank holding company whose business is conducted primarily through Sound Community Bank, a Washington-chartered commercial bank. It gathers retail and commercial deposits and lends principally in residential, commercial and multifamily real estate, construction, consumer, and commercial business markets. The filing covers the quarter and six months ended June 30, 2018; financial statements are unaudited.
Financial performance and position
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net interest income | $6.94 million | $5.75 million | $13.41 million | $11.55 million |
| Provision for loan losses | $150,000 | None | $250,000 | None |
| Noninterest income | $1.09 million | $983,000 | $2.18 million | $1.98 million |
| Noninterest expense | $5.40 million | $4.80 million | $10.84 million | $9.42 million |
| Net income | $1.97 million | $1.30 million | $3.57 million | $2.72 million |
| Diluted earnings per share | $0.77 | $0.50 | $1.39 | $1.04 |
- Profitability: Net income rose about 51% year over year in Q2 and 31% for the first half. Net interest margin was 4.36% for Q2 and 4.31% for the first half, compared with 4.27% and 4.25%, respectively, a year earlier. The efficiency ratio was 67.3% for Q2 and 69.5% for the first half.
- Revenue and costs: Management attributed higher interest income and net interest income mainly to loan growth and higher yields. Deposit and borrowing costs also rose. First-half noninterest expense increased 15%, primarily on higher salaries and benefits, operations, and occupancy costs.
- Balance sheet at June 30: Total assets were $686.2 million, up 6.4% from year-end 2017; net loans were $585.3 million, up 7.7%; deposits were $539.4 million, up 4.9%; and stockholders’ equity was $68.5 million. Commercial and multifamily loans grew 12.1% to $236.9 million, the largest loan-category increase; home equity loans declined 8.5%.
- Credit: The allowance for loan losses was $5.5 million, or 0.93% of gross loans, versus $5.2 million and 0.96% at year-end. Nonperforming assets were $2.64 million, or 0.39% of assets, compared with $2.89 million at year-end. Nonperforming loans were $2.03 million, or 0.34% of loans; the allowance equaled 270.6% of nonperforming loans.
- Cash flow and liquidity: First-half operating cash flow was $5.5 million; investing activities used $42.7 million, principally to fund loan growth; financing activities provided $36.0 million, including $25.0 million of deposit growth and $12.0 million of net borrowing growth. Cash and cash equivalents were $59.4 million at quarter-end.
- Debt and funding: Borrowings were $71.0 million, up from $59.0 million at year-end; the weighted-average borrowing rate was 1.88%, versus 1.63%. The Bank reported $145.1 million of remaining FHLB borrowing capacity, $54.6 million of Federal Reserve discount-window capacity, and $21.0 million in other financial institution credit lines.
- Capital and shareholder returns: The Bank was reported as well-capitalized. Its CET1 risk-based capital ratio was 11.34%, above the 6.5% well-capitalized threshold. First-half common dividends were $656,000 ($0.26 per share); a subsequent quarterly dividend of $0.14 per share was declared July 26, 2018.
Material changes, outlook, and risks
- Management cited loan growth and higher asset yields as principal drivers of improved net interest income. Rising rates and higher average balances increased deposit and borrowing expense, with the cost of interest-bearing liabilities reaching 0.96% in Q2 versus 0.71% a year earlier.
- The federal corporate tax rate reduction under the Tax Cuts and Jobs Act lowered the effective tax rate to 20.7% in Q2 and 20.8% for the first half, versus 32.8% and 34.0% in the comparable 2017 periods.
- Expenses increased partly because of added staffing following the University Place branch opening in 2017, higher quarterly incentive bonuses, operations costs, and a change to straight-line recognition of lease rental expense. The filing gives no earnings or revenue guidance.
- Management stated that the expected-credit-loss standard (CECL), effective for the company after 2019 under the disclosed schedule, is expected to increase the allowance and accelerate loss recognition; the amount of any increase had not been quantified. The company also expected higher assets and liabilities when it adopts the lease standard.
- Principal disclosed risks include loan and real-estate credit conditions, interest-rate changes, access to cost-effective funding and deposit retention, liquidity and loan demand, regulatory examinations, operating-cost control, competition, cybersecurity and third-party performance. Outstanding loan commitments, including unused lines and letters of credit, totaled $72.4 million; certificates of deposit maturing within one year totaled $103.5 million. Management believed most maturing deposits would remain, based on competitive pricing.
- Management reported disclosure controls and procedures were effective at June 30, 2018, and no material change in internal control over financial reporting during the quarter. It stated that ordinary-course legal proceedings were not expected to have a material adverse effect.
Important facts for investors to verify
- Whether loan growth—particularly in commercial and multifamily real estate—continues without deterioration in underwriting quality, delinquencies, or collateral values.
- Whether the allowance remains adequate as the portfolio expands and as CECL adoption approaches; review the impaired, criticized, and nonperforming loan details.
- Whether deposit growth can fund lending at acceptable cost, given rising deposit and borrowing rates and $103.5 million of certificates maturing within a year.
- Whether higher noninterest expenses persist and how they affect efficiency and earnings as the company continues to grow.
- How the company’s liquidity, available borrowing capacity, and capital ratios evolve alongside loan commitments and funding needs.