Business context and reporting period
Sound Financial Bancorp, Inc., a bank holding company whose business is conducted primarily through Sound Community Bank, filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2015. The bank focuses on retail and commercial deposits, real estate and other lending, and residential mortgage originations, with many mortgage loans sold while servicing is retained. Dollar amounts below are in millions unless otherwise stated.
Financial performance and condition
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Interest income | $5.410 | $5.240 | $10.787 | $10.443 |
| Net interest income | $4.730 | $4.644 | $9.418 | $9.237 |
| Noninterest income | $1.706 | $1.120 | $2.877 | $1.905 |
| Noninterest expense | $4.400 | $3.775 | $8.424 | $7.507 |
| Net income | $1.247 | $1.216 | $2.455 | $2.203 |
| Diluted EPS | $0.48 | $0.47 | $0.94 | $0.85 |
| Net interest margin | 4.11% | 4.40% | 4.11% | 4.43% |
Q2 net income rose 2.5%; first-half net income rose 11.4%. First-half improvement reflected higher net interest and noninterest income and a lower loan-loss provision, partly offset by higher operating expense. Noninterest income growth included higher mortgage loan-sale gains and servicing income; mortgage servicing rights (MSR) fair-value changes also contributed.
- Balance sheet at June 30: Assets $503.4, up 1.7% from year-end; net loans $430.0; deposits $418.6; stockholders’ equity $51.8.
- Funding and debt: Deposits increased $10.8, while borrowings fell $4.3 to $26.3. Deposit growth included more demand and savings balances; certificates and money-market accounts declined. Average deposit costs increased year over year.
- Liquidity: Cash and cash equivalents were $34.1; available-for-sale securities were $7.9; loans held for sale were $3.1. Management reported $42.0 of cash and investment securities available for cash needs, plus borrowing facilities. The bank had $83.1 of certificates of deposit maturing within one year.
- Cash flow, first half: Operating activities provided $0.6; investing activities used $0.8; financing activities provided $5.0. Cash increased $4.8 to $34.1. Financing included $10.8 of net deposit growth, partially used to reduce borrowings and fund lending.
- Credit: Allowance for loan losses was $4.6, or 1.05% of gross loans, versus $4.4, or 1.02%, at year-end. First-half provision was $0.3; net charge-offs were $0.115, down from $0.386 in the first half of 2014. Nonperforming assets were $2.6, or 0.52% of assets, compared with $4.2, or 0.84%, at year-end.
- Capital: The bank reported a 12.51% CET1 risk-based ratio, 12.51% Tier 1 risk-based ratio, 13.65% total risk-based ratio and 10.21% leverage ratio, and stated it exceeded applicable well-capitalized requirements.
Material changes, outlook and risks
- Loan balances grew 1.0% from year-end, led by commercial and multifamily real estate and commercial business lending. Commercial and multifamily loans made up 40.4% of the portfolio.
- Net interest margin contracted to 4.11% from 4.40% in Q2 2014 as asset yields declined in the low-rate environment. Higher average loan balances supported interest income, but deposit expense rose.
- Noninterest expense increased 16.6% in Q2 and 12.2% for the first half. Management cited staffing growth, data-processing costs associated with online and mobile banking, and higher regulatory assessments.
- Mortgage originations increased amid lower rates and refinance activity. Loan-sale gains were $0.390 in Q2 and $0.786 in the first half. MSR fair-value gains were $0.347 and $0.169, respectively; these valuations depend on assumptions including prepayment speeds and discount rates.
- Management provided no numerical earnings or growth guidance. It said liquidity was adequate and reported no material change in market risk since the 2014 Form 10-K. Results remain exposed to interest rates, credit losses, real estate values, deposit competition, loan demand and secondary-market conditions, regulatory changes, operating costs, cybersecurity and third-party performance.
- The filing identifies $76.5 of off-balance-sheet loan commitments in its detailed table, while the liquidity discussion refers to outstanding commitments of $64.1; investors should reconcile these figures. The FHLB note reports $103.2 of remaining borrowing availability, while the liquidity discussion states $93.8 of additional FHLB borrowing capacity; the difference is not clearly reconciled in the filing text.
- Management said the allowance is an estimate subject to uncertainty and regulatory review. Specific reserves increased partly after a commercial real estate loan’s valuation method changed to a collateral basis. Securities had $49,000 of unrealized losses, which management attributed to rates and market spreads rather than credit impairment.
- The company repurchased 63,371 shares for $1.261 million at an average $19.84 per share; the 2015 plan was completed in June. A $0.06-per-share dividend was declared July 30, payable August 26. Management considered pending legal proceedings not likely to have a material adverse effect; disclosure controls were reported effective.
Important facts for investors to verify
- Reconcile the $76.5 million commitment total with the $64.1 million amount in the liquidity discussion, and confirm the nature and scope of each measure.
- Reconcile the differing FHLB borrowing-capacity figures ($103.2 million and $93.8 million) and confirm total immediately available contingent liquidity.
- Assess whether earnings growth is sustainable given margin compression and the contribution of loan-sale gains and MSR fair-value changes.
- Monitor credit quality, especially commercial real estate exposures, nonperforming TDRs, specific reserve changes and the adequacy of the allowance.
- Review deposit pricing and maturities, loan growth, capital requirements and sensitivity of MSR values and net interest income to changing rates.