Sound Financial Bancorp, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Interim financial statements are unaudited. Sound Financial Bancorp is the holding company for Sound Community Bank, a Washington-chartered commercial bank focused on deposit gathering, residential and commercial real estate lending, and consumer and business loans.
Financial performance
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Net interest income | $6.19 million, up 14.2% from 2016 | $17.74 million, up 9.7% |
| Provision for loan losses | $250,000; none in Q3 2016 | $250,000, unchanged from 2016 |
| Noninterest income | $826,000, down 46.5% | $2.81 million, down 24.8% |
| Noninterest expense | $4.94 million, up 3.9% | $14.35 million, up 3.5% |
| Net income | $1.22 million, versus $1.45 million | $3.94 million, versus $3.81 million |
| Diluted earnings per share | $0.48, versus $0.57 | $1.54, versus $1.48 |
| Net interest margin | 4.40%, versus 4.19% | 4.34%, versus 4.23% |
| Efficiency ratio | 70.39%, versus 68.19% | 69.87%, versus 69.67% |
Higher average loan balances and yields supported net interest income: Q3 interest income rose 14.9% while interest expense rose 20.5%. Lower service charges, mortgage servicing income, and loan-sale gains weighed on noninterest income. Q3 loan-sale gains were $287,000 versus $477,000 a year earlier; mortgage servicing income was $18,000 versus $239,000. Q3 net income also reflected higher expenses and the loan-loss provision.
Financial position, funding and credit
- At September 30, 2017, total assets were $622.5 million, up 5.8% from December 31, 2016; net loans were $523.2 million, deposits $524.8 million, and stockholders’ equity $63.3 million.
- Gross loans grew 5.6% to $528.2 million. Commercial and multifamily loans increased 11.3% to $201.4 million, and commercial business loans increased 48.7% to $39.2 million; construction and land loans declined 22.6% to $54.9 million.
- Deposits increased 12.2% to $524.8 million. Borrowings fell 48.9% to $28.0 million; their weighted-average cost rose to 1.08% from 0.55% at year-end. Cash and cash equivalents were $60.7 million, and available-for-sale securities were $5.7 million.
- For the first nine months, operating activities provided $5.5 million, investing activities used $15.3 million, and financing activities provided $15.8 million. Cash increased $6.1 million to $60.7 million.
- Net interest margin improved, but funding costs rose: Q3 weighted-average cost of deposits was 0.63%, compared with 0.59% in 2016; cost of interest-bearing liabilities was 0.77%, compared with 0.69%.
- The allowance for loan losses was $5.0 million, or 0.94% of gross loans, versus $4.8 million and 0.96% at year-end. Nonperforming loans were $3.5 million, 0.66% of loans; nonperforming assets were $4.5 million, or 0.73% of assets.
- Bank regulatory capital ratios exceeded well-capitalized thresholds: Tier 1 leverage 10.15%, CET1 11.94%, Tier 1 risk-based 11.94%, and total risk-based capital 12.95%.
Material changes, outlook and risks
- The Q3 earnings decline contrasted with modest nine-month earnings growth. Management attributed the Q3 decline mainly to lower noninterest income and higher noninterest expense and loan-loss provision; YTD growth was primarily supported by higher net interest income.
- The University Place branch acquisition in Q2 contributed $14.5 million of acquired assets and $13.7 million of net cash received. Management said the acquisition added $14.5 million of deposits; deposit growth also reflected organic gathering. The company used deposit growth and acquisition proceeds to reduce FHLB borrowings.
- Occupancy costs increased with the University Place branch, headquarters relocation, and a Sequim loan production office. Management expected occupancy expense to remain higher than in 2016 due to these locations and related costs.
- A Q3 agreement to sell an OREO property below carrying value resulted in a reported $117,000 loss. Noninterest expense included $109,000 of net OREO and repossessed-asset losses for the quarter.
- Liquidity sources included $66.3 million in cash and available-for-sale securities, $161.6 million of remaining FHLB borrowing capacity, $34.8 million of Federal Reserve discount-window capacity, and $21.0 million in other credit facilities. Loan commitments totaled $74.0 million; certificates of deposit maturing within one year totaled $60.6 million.
- No earnings guidance was provided. Management cited risks including economic and interest-rate changes, credit quality and collateral values, funding and deposit competition, loan demand and secondary-market conditions, acquisition integration, regulatory actions, cybersecurity and third-party performance. Management stated there had been no material change in market risk since the 2016 Form 10-K and no known liquidity trend expected to materially affect operations.
- The company was preparing for new accounting standards. Adoption of the expected-credit-loss standard was expected to result in earlier loss recognition and a higher loan-loss allowance, but the amount had not been quantified. Management expected no material financial-statement impact from several other standards discussed in the filing.
- A quarterly dividend of $0.10 per share was declared October 26, payable November 24, 2017. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Investor items to verify
- Whether loan growth, particularly in commercial real estate and commercial business lending, is accompanied by stable underwriting and credit performance.
- How impaired loans, nonperforming TDRs, and the allowance evolve; impaired loans rose to $10.2 million and TDRs totaled $4.0 million.
- Whether deposit costs continue to rise and how that affects net interest margin and earnings.
- Whether lower mortgage originations and loan-sale activity persist, and how servicing income and servicing-rights valuations respond.
- Integration and ongoing costs of the University Place branch and other new locations, along with the company’s capacity to meet $74.0 million of commitments and near-term deposit maturities.
- The eventual quantified impact of the expected-credit-loss accounting standard and any related regulatory or capital effects.