Sound Financial Bancorp, Inc. — Q2 2016 Form 10-Q
Business context and reporting period. The company is a bank holding company whose principal operations are conducted through Sound Community Bank, a Washington state-chartered bank. It gathers retail and commercial deposits and lends primarily in residential and commercial real estate, consumer, construction and commercial business markets. This unaudited report covers the quarter and six months ended June 30, 2016; balance-sheet comparisons are with December 31, 2015. Dollar amounts below are in millions unless stated otherwise.
Financial performance and position
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Interest income | $6.14 | $5.41 | $12.18 | $10.79 |
| Net interest income | $5.43 | $4.73 | $10.76 | $9.42 |
| Provision for loan losses | $0.10 | $0.20 | $0.25 | $0.30 |
| Noninterest income | $1.21 | $1.71 | $2.19 | $2.88 |
| Noninterest expense | $4.66 | $4.40 | $9.12 | $8.42 |
| Net income | $1.25 | $1.25 | $2.36 | $2.46 |
| Diluted EPS | $0.49 | $0.48 | $0.92 | $0.94 |
| Net interest margin | 4.26% | 4.11% | 4.26% | 4.11% |
| Efficiency ratio | 69.51% | 68.21% | 69.88% | 67.36% |
At June 30, total assets were $541.8; net loans $459.8; deposits $443.9; borrowings $35.6; and stockholders’ equity $56.8. Since year-end 2015, gross loans grew 1.1% to $466.4, deposits increased 0.9%, borrowings declined 11.9%, and equity rose 4.2%. Cash and cash equivalents were $45.2, down from $48.3.
For the first six months, operating cash flow was $4.2, investing cash flow was negative $5.9, and financing cash flow was negative $1.4. Cash declined $3.1 to $45.2. The bank reported $52.6 of cash and securities available for sale and loans held for sale, plus additional borrowing capacity of $101.5 from the FHLB, $27.4 at the Federal Reserve, and $11.0 through two Fed funds lines. Loan commitments, unused lines and letters of credit totaled $66.7; certificates of deposit maturing within one year totaled $95.8.
The bank’s regulatory capital ratios were 10.14% Tier 1 leverage, 12.80% CET1 and Tier 1 risk-based, and 13.95% total risk-based capital. The filing states the bank exceeded applicable well-capitalized requirements.
Material changes versus comparable periods
- Q2 net income was nearly flat year over year; six-month net income fell $0.10, or about 3.9%. Higher net interest income and a lower loan-loss provision were offset by lower noninterest income and higher expenses.
- Net interest income rose 14.9% in Q2 and 14.2% for the first half, reflecting higher average earning-asset balances and loan yields. Net interest margin increased 15 basis points to 4.26%.
- Noninterest income fell 29.1% in Q2 and 24.0% year to date. The principal driver was the swing in mortgage servicing rights fair-value adjustments: negative $0.08 in Q2 2016 versus positive $0.35 in Q2 2015, and negative $0.19 for the first half versus positive $0.17.
- Noninterest expense increased 5.8% in Q2 and 8.2% year to date, primarily from higher salaries and benefits and operating costs. The efficiency ratio worsened.
- Nonperforming assets increased to $5.26, or 0.97% of assets, from $2.90, or 0.54%, at year-end. Nonperforming loans were $4.48, up from $2.13; the increase primarily reflects a $2.3 multifamily loan moved to nonaccrual status because of uncertainty about full collection, although the loan was currently performing.
Outlook, commentary, risks and unusual items
- The filing provides no quantitative earnings or balance-sheet guidance. Management says it believes liquidity is adequate and expects a majority of near-term maturing certificates of deposit to remain with the bank.
- The allowance for loan losses was $4.84, or 1.04% of loans, compared with $4.64, or 1.01%, at year-end. Allowance coverage of nonperforming loans fell to 107.94% from 217.65%, principally because of the newly nonaccrual multifamily loan. Management reported a specific reserve of approximately $0.39 on that credit. Six-month net charge-offs were $0.05.
- Key risks identified include changing economic conditions and interest rates; loan and real-estate credit risk; the adequacy of loss reserves; deposit retention and cost-effective funding; mortgage loan sale and servicing conditions; regulatory and capital requirements; fair-value estimates for servicing rights; competition; and operational, cyber, litigation and third-party-provider risks. Management notes that mortgage servicing rights fair value is sensitive to interest rates and prepayment assumptions.
- At June 30, unused lending commitments and related off-balance-sheet exposures totaled $66.7. The bank had $35.6 of FHLB borrowings outstanding and substantial collateralized borrowing capacity. Management reported no off-balance-sheet transactions expected to have a material effect on financial condition, results or cash flows.
- Subsequent to quarter-end, the board declared a $0.075-per-share quarterly dividend and authorized repurchases of up to 50,000 shares, approximately 2% of outstanding shares, over 12 months, subject to market conditions and other factors.
- Management said legal proceedings in the ordinary course were not expected to have a material adverse effect. Disclosure controls were concluded to be effective, and no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- Developments, collateral values and expected recoveries on the $2.3 multifamily nonaccrual loan; its reserve and the trend in total nonperforming assets.
- Whether deposit growth and the reported borrowing capacity remain available at acceptable cost, particularly as $95.8 of certificates mature within one year.
- Mortgage servicing rights valuation assumptions, refinancing/prepayment trends and related fair-value effects on earnings.
- Whether rising salary and operating expenses, together with lower loan-sale gains and fee income, continue to pressure earnings and the efficiency ratio.
- The ability to meet the $66.7 of commitments while maintaining capital, liquidity and the declared dividend; monitor execution of the authorized share-repurchase program.