Sound Financial Bancorp, Inc. — Q3 2012 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three and nine months ended September 30, 2012; balance-sheet comparisons are with December 31, 2011. The company conducts substantially all operations through Sound Community Bank, a community bank focused on deposits, lending and residential mortgage originations. On August 22, 2012, it completed its second-step conversion to a publicly owned stock holding company and raised $12.7 million net from a share offering. Prior-period share and per-share data were adjusted for the conversion exchange ratio.
Financial performance and condition
Amounts below are in millions of dollars except per-share data and percentages.
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Interest income | $4.54 | $4.61 | $13.70 | $13.96 |
| Net interest income | $3.95 | $3.93 | $11.92 | $11.85 |
| Provision for loan losses | $1.08 | $1.30 | $3.68 | $3.35 |
| Noninterest income | $1.21 | $0.27 | $3.33 | $1.84 |
| Noninterest expense | $3.19 | $2.67 | $9.02 | $8.74 |
| Net income | $0.61 | $0.18 | $1.75 | $1.13 |
| Diluted earnings per share | $0.23 | $0.07 | $0.67 | $0.43 |
- Net interest margin was 4.91% for Q3 2012 versus 5.22% a year earlier, and 5.12% for the nine-month period versus 5.25%.
- At September 30, total assets were $366.5 million, net loans $304.7 million, deposits $313.0 million, borrowings $8.0 million, and stockholders’ equity $42.3 million. Total assets increased 7.9% and deposits 4.3% from year-end 2011. Equity rose 47.3%, mainly reflecting offering proceeds and retained earnings.
- Loans grew 3.1% from year-end to $311.7 million before deferred fees and loans held for sale. Commercial and multifamily real estate loans rose 13.1%; construction and land loans rose 16.2%. One-to-four-family, home-equity and consumer balances declined.
- Cash and cash equivalents were $15.7 million; available-for-sale securities were $20.9 million. The securities increase largely reflected purchases of agency mortgage-backed securities using offering proceeds. The allowance for loan losses was $4.3 million, or 1.40% of loans, compared with $4.5 million, or 1.47%, at year-end.
- For the first nine months, operating cash flow was $5.0 million, investing cash outflow $30.7 million and financing cash inflow $24.4 million. Cash decreased $1.4 million to $15.7 million. Net loan growth and securities purchases drove investing outflows; deposits and the stock offering supported financing inflows.
Material changes versus comparable periods
- Net income increased $431,000 in Q3 and $621,000 for the nine months year over year. Higher gains on loan sales and lower Q3 loan-loss provision supported quarterly results; lower interest expense and higher noninterest income supported year-to-date results.
- Gain on loan sales rose to $668,000 in Q3 from $126,000, and to $1.23 million for nine months from $263,000, reflecting greater mortgage originations for sale to Fannie Mae and improved sale margins.
- Interest income fell year over year despite higher average loan balances, as loan yields declined amid low rates and competition. Lower deposit costs reduced interest expense, helping sustain net interest income.
- Noninterest expenses increased 19.1% in Q3 and 3.2% year to date. Q3 increases included salaries, loan-processing, marketing and data-processing costs. Year-to-date regulatory assessments and OREO-related losses and expenses declined.
- Nonperforming assets fell to $6.9 million, or 1.88% of assets, from $9.5 million, or 2.78%, at year-end. Nonperforming loans declined to $4.3 million from $6.6 million. Net charge-offs remained elevated at $3.8 million for the nine months, approximately flat year over year.
Outlook, risks and unusual items
- No specific earnings or financial guidance is provided. Management said elevated nonperforming assets and charge-offs could persist until housing, employment and broader economic conditions in its market improve.
- In October 2012, the Bank applied to convert from a federal savings bank to a Washington state-chartered commercial bank. The company expected the change, subject to regulatory approval, to take effect in December 2012; it said the purpose was to reduce examination costs and align oversight with local community banking.
- Management recorded $156,000 of additional noncash, pretax credit impairment on non-agency mortgage-backed securities during the first nine months. Cumulative OTTI on four of five such securities was $412,000. Management said further impairment is possible if underlying market and economic conditions deteriorate; it does not expect market conditions to permit meaningful risk reduction by selling these securities in the next 12 months.
- Two TDRs totaling $314,000 were newly modified in Q3; $1.5 million was modified over nine months. Total TDRs were $7.3 million at quarter-end. Loans modified within the prior 12 months and subsequently in payment default totaled $3.8 million for Q3 (a default is defined as 30 or more days past due).
- Liquidity included $36.5 million in cash and securities available for sale, $2.1 million in loans held for sale, and stated additional borrowing capacity of $51.0 million from the FHLB, $9.8 million from the Federal Reserve discount window and $2.0 million on an unsecured line. Loan commitments, unused lines and letters of credit totaled $57.4 million; certificates due within one year totaled $70.3 million.
- The Bank reported regulatory capital ratios above minimums and was categorized as well-capitalized. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. Routine legal proceedings were not expected by management to have a material adverse effect.
Most important facts for investors to verify
- Whether the projected December 2012 state-charter conversion received approval and its eventual costs or effects.
- Whether the surge in loan-sale gains and mortgage production is sustainable, and how loan yields and net interest margin respond to rates and competition.
- Credit quality trends, especially charge-offs, criticized loans, TDR payment defaults and the $3.3 million of loans with identified potential credit problems.
- Whether additional OTTI is required for non-agency securities and how the portfolio’s valuation assumptions and liquidity evolve.
- Funding and liquidity against $57.4 million in commitments and $70.3 million of certificates maturing within one year, including reliance on public-fund deposits and borrowing facilities.