Sound Financial Bancorp, Inc. — 2023 Form 10-K
Reporting period: Fiscal year ended December 31, 2023; comparisons are primarily with fiscal 2022. This is an annual report, not a standalone fourth-quarter earnings report. Sound Financial Bancorp is a bank holding company whose business is conducted mainly through Sound Community Bank, a Washington state-chartered community bank operating in western Washington.
Financial and operating performance
| Metric | 2023 | 2022 | Change / context |
|---|---|---|---|
| Total assets at year-end | $995.2 million | $976.4 million | Up 1.9% |
| Loans held for portfolio, gross | $896.2 million | $867.6 million | Up 3.3% |
| Deposits at year-end | $826.5 million | $808.8 million | Up 2.2% |
| Interest income | $50.6 million | $39.8 million | Up 27.2% |
| Interest expense | $16.8 million | $4.5 million | Up $12.3 million |
| Net interest income | $33.9 million | $35.3 million | Down 4.1% |
| Net interest margin | 3.53% | 3.89% | Down 36 basis points |
| Provision (release) for credit losses | $(0.3) million | $1.2 million | 2023 included a $0.8 million release for unfunded commitments |
| Noninterest income | $5.0 million | $4.6 million | Up 9.3% |
| Noninterest expense | $30.1 million | $27.8 million | Up 8.2% |
| Net income | $7.4 million | $8.8 million | Down 15.5%; diluted EPS was $2.86 versus $3.35 |
| Efficiency ratio | 77.54% | 69.83% | Higher ratio reflects increased expenses and lower overall revenue |
Higher average loan yields and balances lifted interest income, but sharply higher deposit and borrowing costs more than offset the increase. Average loan yield rose to 5.34% from 4.87%; average total deposit cost rose to 1.69% from 0.37%. Average funding cost increased to 1.88% from 0.53%.
Operating cash flow was $6.9 million, compared with $10.1 million in 2022. Investing activities used $26.3 million, principally reflecting net loan growth; financing activities provided $11.3 million. Cash and cash equivalents ended the year at $49.7 million, down from $57.8 million.
Balance sheet, credit quality and capital
- Year-end deposits were $826.5 million. Certificates of deposit rose to $308.0 million from $210.3 million, while noninterest-bearing demand deposits fell to $124.1 million from $170.5 million. Core deposits, as defined by the company, declined to 86.6% of deposits from 92.2%. About $249.5 million of time deposits mature in 2024.
- Estimated uninsured deposits were $140.1 million, or 17.0% of deposits, versus $161.9 million, or 20.0%, a year earlier. The company reported $5.0 million of brokered money-market deposits and no brokered time deposits at year-end.
- Year-end borrowings included $40.0 million of FHLB advances and $11.7 million of subordinated notes, net. FHLB advances peaked at $92.0 million during 2023. Available borrowing capacity was reported as $181.4 million from the FHLB, $18.3 million through the Federal Reserve discount window and $20.0 million through another financial-institution line, subject to collateral and other conditions.
- Nonperforming assets rose to $4.1 million, or 0.42% of assets, from $3.6 million, or 0.37%. Nonaccrual loans were $3.6 million; the largest was a $2.1 million business term loan, which management said was well secured and expected to be repaid in full. There were no loans 90 days or more past due and still accruing.
- The loan allowance for credit losses was $8.8 million, or 0.98% of gross loans, versus $7.6 million, or 0.88%. Net charge-offs were $163,000, compared with net recoveries of $68,000 in 2022. The allowance covered 246% of nonaccrual loans at year-end.
- Commercial and multifamily real estate loans were $315.3 million, or 35.2% of the portfolio; construction and land loans were $126.8 million, or 14.1%. Regulatory concentration measures were 352.9% of CBLR capital for commercial real estate and 106.7% for construction, land development and land loans.
- Stockholders’ equity was $100.7 million, up from $97.7 million. The Bank’s community bank leverage ratio was 10.99%, above the 9% threshold described for well-capitalized status. The company estimated its own ratio at 9.78%.
Material changes, outlook and risks
- Credit-loss accounting: The company adopted CECL on January 1, 2023. The transition increased the loan allowance by $760,000 and the unfunded-commitment allowance by $695,000, reducing opening retained earnings after tax by $1.1 million. The 2023 credit-loss provision is not directly comparable with 2022 under the prior methodology.
- Noninterest items: Noninterest income benefited from $567,000 in BOLI death benefits; total BOLI earnings were $1.2 million versus $219,000. This was partly offset by lower loan-sale gains ($340,000 versus $546,000) and a $219,000 MSR fair-value reduction. Data-processing expense rose 30.6% to $4.4 million, and regulatory assessments rose 52.2% to $688,000.
- Management outlook: The filing gives no numerical earnings or growth guidance. Management expects the high-rate environment to continue pressuring mortgage-sale gains and keeping borrowing costs elevated, which may adversely affect 2024 net interest income and margin. The company’s stated priorities include growing higher-yielding loans and core deposits, managing expenses and problem assets, and expanding digital and business services.
- Interest-rate exposure: The company reported a liability-sensitive position. Its economic value of equity declined 21.59% under an immediate 400-basis-point rate increase and 12.67% under a 400-basis-point decrease. Management considers the modeled risk acceptable but notes that results depend on assumptions about deposit behavior, prepayments and other factors.
- Concentration and funding risks: Lending is concentrated in Washington and includes sizable commercial real estate, construction and land exposures. Deposit competition, migration into higher-cost accounts, uninsured balances and the 2024 certificate maturities could affect funding costs and liquidity. The filing also identifies local economic conditions, inflation, borrower performance, collateral values, cybersecurity and third-party service providers as risks.
- Parent-company liquidity and shareholder returns: The parent company reported only $156,000 of unrestricted cash available for its cash needs at December 31, 2023; its ability to pay dividends and debt service depends substantially on distributions from the Bank, which are subject to restrictions. The company paid $0.74 per share in 2023 and stated it expects regular quarterly dividends to continue, subject to Board discretion and regulatory limits. In January 2024, it authorized a new $1.5 million share repurchase program.
- Other disclosures: A third-party vendor’s use of MOVEit software was associated with a 2023 cybersecurity event. The vendor told the Bank its investigation found customer data was downloaded in connection with a valid file-transfer request; the company reported no indication that customer personal data had been compromised. Management reported no material pending litigation expected to affect results.
The independent auditor issued an unqualified opinion on the financial statements. The auditor identified the allowance for credit losses on loans, including forecasts and qualitative adjustments, as a critical audit matter. Management concluded that disclosure controls and internal control over financial reporting were effective as of year-end; the auditor did not express an opinion on internal control.
Important facts for investors to verify
- Whether deposit retention, 2024 certificate maturities and funding costs materially affect net interest margin and liquidity.
- Performance and collateral coverage of the $2.1 million nonaccrual business loan, and subsequent trends in nonperforming loans, delinquencies and charge-offs.
- Commercial real estate and construction portfolio exposures, including concentration levels, maturities, unfunded commitments and sensitivity to property-market conditions.
- Key assumptions behind the CECL allowance and the effect of changing economic forecasts or portfolio mix on required provisions.
- Parent-company cash, Bank dividend capacity and the sustainability of common dividends and share repurchases.
- Subsequent developments concerning the MOVEit-related vendor event and the security of customer information.