Business context and reporting period
Sound Financial Bancorp, Inc. is the holding company for Sound Community Bank and an insurance agency. Its banking business primarily gathers deposits and makes residential, commercial real estate, construction, consumer and commercial business loans. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2023; comparisons are to the corresponding 2022 periods unless stated otherwise. Amounts below are in U.S. dollars.
Financial performance and position
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Net interest income | $8.2 million | $9.6 million | $26.3 million | $25.6 million |
| Net income | $1.2 million | $2.5 million | $6.2 million | $5.9 million |
| Diluted earnings per share | $0.45 | $0.97 | $2.39 | $2.23 |
| Net interest margin | 3.38% | 4.13% | 3.70% | 3.83% |
| Net interest expense / income tax provision | Credit-loss provision: $75,000 | $346,000 | Credit-loss release: $246,000 | Provision: $1.1 million |
Quarterly interest income rose 17.7% to $12.7 million, but interest expense increased 283.2% to $4.5 million, principally as deposit and borrowing costs rose. Quarterly noninterest expense increased 9.1% to $7.7 million, including higher technology-related data-processing costs. The efficiency ratio rose to 83.36% from 66.51%. For the nine-month period, net income increased 5.9%, supported by higher net interest income, lower credit-loss expense and greater noninterest income.
At September 30, 2023, total assets were $1.03 billion, up 5.5% from year-end 2022. Net loans held for portfolio were $867.0 million, up 1.0%; deposits were $860.9 million, up 6.4%; and stockholders’ equity was $100.2 million, up 2.6%. Cash and cash equivalents were $101.9 million, compared with $57.8 million at December 31, 2022. The nine-month cash flow statement reports $4.8 million cash provided by operating activities, $7.2 million used in investing activities, and $46.5 million provided by financing activities.
Deposit pricing is a key pressure: the average cost of total deposits for Q3 was 1.85%, compared with 0.36% a year earlier; the period-end weighted-average deposit rate was 1.45%, versus 0.37% at year-end 2022. Noninterest-bearing deposits were 17.9% of deposits, down from 21.4%. Period-end borrowings included $40.0 million of FHLB advances and $11.7 million of subordinated notes. The company reported $112.0 million in cash and available-for-sale securities, $178.5 million of remaining FHLB borrowing capacity (subject to eligible collateral), $17.5 million available through the Federal Reserve, and a $20.0 million unused unsecured credit line. The Bank’s Community Bank Leverage Ratio was 11.23%; the company’s was 10.05%, above the stated 9% minimum.
Material changes and notable items
- Quarterly net income fell 54.1%, mainly because higher funding costs reduced net interest income by $1.4 million and noninterest expense rose by $645,000. Year-to-date net income increased 5.9%.
- Deposit growth included a $32.6 million related-party depositor relationship in Q3. The filing reports $148.6 million of estimated uninsured deposits, or 17.3% of total deposits, at quarter-end.
- Nonaccrual loans declined to $1.8 million from $3.0 million at year-end 2022; nonperforming assets declined to $2.3 million from $3.6 million. The allowance for credit losses on loans was $8.4 million, 0.96% of total loans; the combined allowance for loans and unfunded commitments was $9.0 million.
- The company adopted CECL on January 1, 2023. The transition increased the loan allowance by $760,000 and the reserve for unfunded commitments by $695,000, and reduced opening retained earnings by approximately $1.1 million after tax. The new methodology means prior-period credit-loss measures are not directly comparable.
- Nine-month noninterest income included $567,000 of BOLI death-benefit gains. Mortgage servicing rights had a $123,000 fair-value reduction for the nine months, versus a $334,000 increase in 2022.
- Cash dividends paid in the first nine months were $0.55 per share. A $0.19 quarterly dividend was declared after quarter-end, payable November 22, 2023. The company repurchased 6,169 shares in Q3 for an average $36.93 per share; approximately $746,000 remained under the repurchase authorization at September 30.
Outlook, commentary and risks
The filing provides no specific earnings, margin or loan-growth guidance. Management said it expected to use borrowing facilities from time to time, subject to market conditions, for originations, withdrawals and other funding needs; it reported no known event expected to materially impair liquidity, capital resources or operations. The Board retains discretion over future dividends.
Management identifies uncertainty around interest rates, inflation, recession or slower growth, deposit retention and funding costs, uninsured deposit outflows, real-estate values, borrower performance and allowance adequacy. Other disclosed risks include regulatory actions, competition, technology and cybersecurity, third-party providers, and fair-value estimates. Credit-loss estimates rely on economic forecasts and management judgments; regulators may require reserve adjustments. Securities had substantial interest-rate-related unrealized losses, which the company said were not credit-related; management stated it did not intend, and was not likely to be required, to sell them before recovery of amortized cost. The filing reports no material change in previously disclosed risk factors, no material adverse effect expected from pending legal proceedings, and effective disclosure controls as of September 30, 2023.
Important facts for investors to verify
- Whether deposit pricing and mix continue to pressure net interest margin and earnings, particularly as certificates mature and reprice.
- The stability and concentration of deposit funding, including the $32.6 million related-party relationship and the level of uninsured deposits.
- Credit quality trends in commercial real estate, construction and land, and consumer portfolios, and whether CECL assumptions and reserves remain adequate.
- Availability of collateral and borrowing capacity under liquidity facilities, and the effect of any required borrowing or deposit outflows.
- The duration and potential recovery of unrealized securities losses, and the sensitivity of mortgage servicing rights to prepayment and discount-rate assumptions.
- Whether technology spending and other operating costs produce expected benefits, and whether dividends and repurchases remain consistent with capital and funding needs.