Sound Financial Bancorp, Inc. — Q2 2014 Form 10-Q
Business and period. The company is a bank holding company for Sound Community Bank, operating primarily in Washington. This unaudited report covers the quarter and six months ended June 30, 2014; balance-sheet comparisons are with December 31, 2013. Amounts below are in U.S. dollars.
Financial performance and position
- Quarterly earnings: Net income was $1.216 million, up from $1.142 million in Q2 2013; diluted EPS was $0.47 versus $0.43. For the first six months, net income was $2.203 million versus $1.939 million, and diluted EPS was $0.85 versus $0.74.
- Interest income and margin: Q2 net interest income increased 7.0% to $4.644 million; first-half net interest income increased 9.8% to $9.237 million. Net interest margin was 4.40% for Q2 (4.68% in Q2 2013) and 4.43% for the first half (4.46% in 2013). Loan yields fell year over year, while higher average loan balances supported interest income growth.
- Other income and expenses: Noninterest income declined 17.5% to $1.120 million for Q2 and 30.1% to $1.905 million for the first half, chiefly reflecting lower loan-sale gains and mortgage-servicing income. Noninterest expense rose 5.8% to $3.775 million in Q2, but decreased 1.0% to $7.507 million for the first half. First-half salaries and benefits increased 18.7% to $4.025 million.
- Credit costs: Loan-loss provision was $200,000 for Q2 and $400,000 for the first half, down from $450,000 and $700,000, respectively, in 2013. Net charge-offs for the first half were $386,000, or 0.19% of average loans on an annualized basis, versus $819,000, or 0.48%, in 2013.
- Assets, loans and deposits: Total assets increased 5.9% from year-end to $468.9 million. Net loans were $399.7 million, up 3.4%; total deposits increased 7.3% to $373.9 million. Commercial business loans grew 63.5% to $22.3 million, consistent with the company’s strategy to expand non-real-estate-secured lending.
- Liquidity and funding: Cash and cash equivalents were $28.9 million, up from $15.3 million at year-end; available-for-sale securities were $14.1 million. Borrowings were $39.9 million, down from $43.2 million. The company reported $60.1 million of remaining FHLB borrowing capacity, plus access to Federal Reserve and Fed Funds facilities. Deposits cost 0.61% at June 30, compared with 0.64% at year-end.
- Cash flow: First-half operating activities provided $3.4 million; investing activities used $11.0 million, principally reflecting net loan growth; financing activities provided $21.1 million, primarily from deposit growth. Cash increased $13.5 million during the period.
- Capital and equity: Stockholders’ equity was $48.2 million, up 3.6% from year-end. Sound Community Bank was classified as well-capitalized: Tier 1 leverage ratio 10.37%, Tier 1 risk-based ratio 12.99%, and total risk-based capital ratio 14.17%.
Material changes and credit quality
- Total nonperforming assets declined to $2.461 million, or 0.52% of assets, from $3.099 million, or 0.70%, at year-end, mainly as OREO fell. Nonperforming loans were $2.142 million, up from $1.921 million at year-end; nonperforming loans were 0.53% of total loans.
- The allowance for loan losses was $4.191 million, or 1.04% of loans, versus $4.177 million, or 1.07%, at year-end. The allowance covered 195.66% of nonperforming loans. TDRs totaled $6.2 million, compared with $6.4 million at year-end; one new TDR of $176,000 was recorded in the first half, with none in Q2.
- Mortgage originations for sale declined substantially: the company attributed lower loan-sale gains to reduced volumes and premiums, and cited higher mortgage rates. Mortgage servicing rights remained near $3.0 million and are valued using assumptions including prepayment speeds and discount rates.
Outlook, risks and notable items
- The filing provides no formal earnings or financial guidance. Management cited expectations of reimbursement from Fannie Mae for some servicing expenses in Q3 2014.
- In May 2014, the Bank agreed to acquire three Columbia State Bank branches, approximately $25 million of deposits and approximately $1 million of loans, paying a 2.35% deposit premium. Regulatory approval had been received; closing was scheduled for August 22, 2014, after quarter-end. Planned branch consolidations were expected in Q3 and Q4 2014.
- Key stated risks include credit losses and allowance-estimate uncertainty, interest-rate and securities valuation changes, funding and deposit competition, real-estate conditions, and successful integration of the branch acquisition. The company reported no material change in market risk since its 2013 Form 10-K and said disclosure controls were effective.
- Management recorded no Q2 or first-half OTTI charge on securities, but noted that deterioration in the market or underlying loans could require future impairment. Unrealized losses on securities were attributed primarily to interest rates, market spreads or illiquidity.
- A quarterly dividend of $0.05 per share was declared July 28, 2014, payable August 27 to shareholders of record August 13. Management said ordinary legal proceedings were not expected to have a material adverse effect.
Investor verification priorities
- Confirm the Columbia branch transaction closed as scheduled and assess deposit retention, integration costs and the effects of the 2.35% premium.
- Track nonperforming loans, TDR performance, charge-offs and allowance adequacy, particularly as loan balances and commercial business lending grow.
- Monitor net interest margin and funding costs as asset yields decline and deposits and loans expand.
- Review non-agency mortgage-backed securities and mortgage-servicing-rights valuation assumptions for sensitivity to credit, market liquidity, interest rates and prepayments.
- Check whether anticipated Fannie Mae expense reimbursements were received and whether the declared dividend was paid.