Sound Financial Bancorp, Inc. — Q3 2020 Form 10-Q
Business context and reporting period. The company is a bank holding company whose primary business is conducted through Sound Community Bank in Washington. This unaudited quarterly report covers the three and nine months ended September 30, 2020; balance-sheet comparisons are with December 31, 2019. Amounts below are in millions unless otherwise noted.
Key financial metrics
| Metric | Q3 / September 30, 2020 | Comparable period / prior date |
|---|---|---|
| Net income | Q3: $2.34; nine months: $5.44 | Q3 2019: $1.55; nine months 2019: $4.81 |
| Diluted earnings per share | Q3: $0.90; nine months: $2.09 | Q3 2019: $0.60; nine months 2019: $1.87 |
| Net interest income | Q3: $6.66; nine months: $20.29 | Q3 2019: $6.65; nine months 2019: $20.14 |
| Net interest margin | Q3: 3.26%; nine months: 3.61% | Q3 2019: 4.03%; nine months 2019: 4.10% |
| Total assets | $867.4 | $719.9 at December 31, 2019 |
| Loans held for portfolio, net | $683.4 | $614.2 at December 31, 2019 |
| Deposits | $748.9 | $616.7 at December 31, 2019 |
| Cash and cash equivalents | $115.8 | $55.8 at December 31, 2019 |
| Allowance for loan losses | $6.0; 0.87% of total loans | $5.6; 0.91% at December 31, 2019 |
| Nonperforming assets | $3.9; 0.45% of assets | $5.2; 0.73% at December 31, 2019 |
| Borrowings and subordinated debt | $19.2 total, including $7.5 FHLB advances and $11.7 net subordinated debt | $7.5 at December 31, 2019 |
| Stockholders’ equity | $82.3 | $77.7 at December 31, 2019 |
For the nine months, operating cash flow was negative $9.6, investing cash flow negative $73.0, and financing cash flow positive $142.6. Cash increased $60.0 to $115.8, primarily reflecting deposit growth and subordinated-note proceeds. The bank reported a 10.42% Community Bank Leverage Ratio, above the temporary 8.0% 2020 threshold described in the filing.
Material changes versus prior periods
- Net income rose 50.8% in Q3 and 13.2% for the first nine months year over year. Higher gains on loan sales drove much of the increase: nine-month gains were $3.40 versus $1.00 in 2019.
- Net interest margin narrowed year over year, which management attributed to low market rates, lower-yielding PPP loans, growth in low-yielding interest-bearing deposits, and slower repricing of deposit costs.
- Portfolio loans increased $69.2 from year-end, substantially reflecting $74.8 of PPP loans. Commercial business loans grew $72.1; residential and home-equity balances declined.
- Deposits increased $132.1, including a $55.0 increase in noninterest-bearing demand deposits. Management cited PPP-related balances and reduced customer withdrawals.
- The allowance rose $0.35 from year-end. Nine-month net charge-offs were $0.58, versus $0.006 in 2019; nonaccrual loans nevertheless declined to $3.32 from $4.66.
- Loan-sale activity increased with mortgage refinancing: loans sold were $89.5 in Q3 versus $16.6, and $176.0 for nine months versus $54.5.
Outlook, risks, contingencies and unusual items
- COVID-19 and credit. At quarter-end, $34.3 of loans remained under COVID-related payment relief, equal to 4.98% of total loans. These qualifying short-term modifications were not treated as troubled debt restructurings. Management warned that uncertainty could lead to higher delinquencies, criticized loans, charge-offs and provisions.
- PPP. The bank originated 909 PPP loans totaling $74.8, guaranteed by the SBA, and reported $2.9 of SBA processing fees. Forgiveness timing and final procedures remain uncertain; the filing also identifies servicing, compliance and litigation risks.
- Liquidity and commitments. The bank reported $129.1 of cash and available-for-sale securities, $16.1 of loans held for sale, $198.6 of remaining FHLB borrowing capacity, $29.4 of Federal Reserve capacity and $20.0 of other credit facilities. Off-balance-sheet loan commitments totaled $144.6; certificates of deposit maturing within one year totaled $186.6.
- Debt issuance and capital returns. In September, the company issued $12.0 principal amount of 5.25% fixed-to-floating subordinated notes due 2030, receiving approximately $11.7 net. Subsequent to quarter-end, the board declared a $0.15 per-share dividend and authorized up to $2.0 of share repurchases over six months.
- Mortgage servicing rights. A $1.42 nine-month negative fair-value adjustment reduced noninterest income. Management notes that changes in prepayment and discount-rate assumptions can materially affect valuation.
- Contingency. Sound Community Bank is a defendant in a lawsuit brought by a PPP loan agent seeking fees and damages, including treble damages. The bank moved to dismiss; the outcome and potential impact were not predictable as of the filing.
- Guidance. The filing provides no specific earnings or financial guidance. Management expects low interest rates and pandemic effects to pressure net interest income and margin in the near term, potentially longer.
Important facts for investors to verify
- Whether borrowers receiving COVID-related relief resume payments, and whether the $34.3 still under relief requires additional risk-rating changes or reserves.
- PPP forgiveness progress, fee recognition, and any outcomes or exposure from the agent-fee lawsuit.
- Credit performance and allowance adequacy as pandemic-related economic effects evolve, especially given increased net charge-offs and the concentration of loan growth in PPP lending.
- Whether loan-sale gains and refinancing volumes persist, and how margin responds to rate and deposit-cost changes.
- Execution and funding implications of the subordinated debt, announced dividend and authorized repurchase program; the filing does not quantify future repurchases.