Sound Financial Bancorp, Inc. — Q2 2019 Form 10-Q
Business and period: Bank holding company for Sound Community Bank, operating primarily in Washington, with consumer and commercial banking, mortgage lending and servicing, and insurance activities. This unaudited report covers the quarter and six months ended June 30, 2019; balance-sheet comparisons are with December 31, 2018. Amounts are in millions unless stated otherwise.
Key financial results
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net interest income | $6.36 | $6.89 | $13.35 | $13.32 |
| Net income | $1.82 | $1.97 | $3.26 | $3.57 |
| Diluted EPS | $0.71 | $0.77 | $1.27 | $1.39 |
| Net interest margin | 3.97% | 4.34% | 4.08% | 4.32% |
| Efficiency ratio | 71.50% | 67.3% | 75.9% | 69.5% |
Q2 interest income was $8.24 million and interest expense $1.88 million. Six-month interest income was $17.01 million and interest expense $3.66 million. Noninterest income was $0.96 million for Q2 and $1.97 million year to date; noninterest expense was $5.23 million and $11.63 million, respectively. Effective tax rates were 20.5% for Q2 and 20.2% year to date.
Financial position, liquidity and capital
- Assets were $686.0 million, down 4.3% from year-end. Cash and cash equivalents rose to $80.4 million from $61.8 million.
- Net portfolio loans were $560.0 million, down 8.8%; loan payoffs exceeded originations, and the company sold $16.2 million of one-to-four-family loans in Q1.
- Deposits increased 4.7% to $579.5 million. Time deposits rose $39.2 million to $231.1 million; the reported total deposit cost increased to 1.09% from 0.71% at year-end.
- Borrowings fell to $16.3 million from $84.0 million. Stockholders’ equity increased to $74.6 million from $71.6 million.
- Six-month cash flows: $4.3 million provided by operations, $54.0 million provided by investing (primarily the net decrease in loans), and $39.7 million used in financing, mainly from repayment of borrowings. Cash increased $18.6 million.
- Management reported $85.4 million of cash and available-for-sale securities, $205.1 million of additional FHLB capacity, $40.5 million of Federal Reserve discount-window capacity and $20.0 million of unused lines with other financial institutions. Loan commitments totaled $99.8 million, including $51.0 million of undisbursed construction and land loans.
- The Bank exceeded regulatory minimums and was considered well-capitalized. Its June 30 CET1 ratio was 12.21%; total risk-based capital ratio was 13.21%.
Changes, credit quality and notable items
- Q2 net income declined 7.6% year over year; six-month net income declined $0.31 million. Higher deposit and borrowing costs weighed on earnings: Q2 net interest income fell 7.7%, while the six-month figure was nearly flat. Management attributed margin compression to funding costs rising faster than asset yields.
- The allowance for loan losses decreased to $5.37 million after a $0.20 million Q2 and $0.40 million six-month recapture, primarily attributed to the smaller loan portfolio. Allowance coverage was 0.95% of loans and 176.88% of nonperforming loans.
- Nonperforming assets increased to $4.11 million, or 0.60% of assets, from $3.24 million, or 0.45%, at year-end. Nonperforming loans were $3.04 million; OREO and repossessed assets increased to $1.07 million. Six loans totaling $297,000 were reported as TDRs that defaulted within 12 months of modification; no loans were modified as TDRs during the first half.
- Noninterest income fell 15.8% in Q2 and 13.5% for the first half. The six-month decline included a $0.49 million negative fair-value adjustment to mortgage servicing rights, compared with $0.12 million in the prior-year period. The MSR asset was $3.21 million at June 30.
- Operating lease accounting was adopted January 1, 2019, adding $7.88 million of right-of-use assets and $8.23 million of lease liabilities to the June 30 balance sheet.
- After quarter-end, the board declared a $0.14-per-share dividend and authorized a stock repurchase program of up to $1.75 million, with purchases permitted through February 5, 2020. The filing states no shares had been repurchased under the program as of June 30.
Outlook, risks and contingencies
The filing provides no specific earnings or revenue guidance. Management said it expected most certificates of deposit maturing within one year to remain at the Bank, based on competitive pricing. The company was evaluating adoption of the expected-credit-loss standard (CECL), effective for it in 2020; it expected earlier loss recognition and a higher allowance, but had not quantified the effect.
Identified risks include loan demand and real-estate conditions, borrower credit performance, deposit retention and funding costs, interest-rate movements, loan-sale market conditions, regulatory examinations and capital requirements, fair-value estimates for mortgage servicing rights, competition, cyber and third-party service-provider risks, and legal and economic changes. Management stated that ordinary-course legal proceedings were not expected to have a material adverse effect. Disclosure controls were assessed as effective, and no material change in internal control over financial reporting was reported.
Investor verification points
- Track deposit pricing and funding costs against loan yields and net interest margin.
- Assess whether the loan contraction continues, including the impact of the Q1 loan sale, and monitor concentration in commercial real estate and construction lending.
- Review trends in nonperforming assets, TDR defaults, OREO and the adequacy of the allowance, including the eventual CECL transition adjustment.
- Monitor mortgage servicing rights valuation assumptions and related fair-value changes.
- Confirm liquidity and capital remain adequate as commitments are funded and deposits mature; evaluate execution of the announced dividend and repurchase authorization.