Sound Financial Bancorp, Inc. — 2020 Form 10-K
Reporting period: Fiscal year ended December 31, 2020. This is an annual report, not a standalone fourth-quarter report. The company is a bank holding company whose principal business is conducted through Sound Community Bank in Washington.
Financial performance and condition
| Metric | 2020 | 2019 |
|---|---|---|
| Total assets at year-end | $861.4 million | $719.9 million |
| Net interest income | $27.5 million | $27.0 million |
| Net income | $8.9 million | $6.7 million |
| Diluted earnings per share | $3.42 | $2.57 |
| Net interest margin | 3.57% | 4.06% |
| Return on assets | 1.10% | 0.95% |
| Return on equity | 10.94% | 8.90% |
- Revenue and margins: Net interest income rose 1.9%, while net interest margin declined 49 basis points. Total noninterest income increased to $7.4 million from $4.0 million, principally because net gains on loan sales rose to $6.0 million from $1.4 million. Noninterest expense was nearly flat at $22.7 million. The efficiency ratio improved to 64.90% from 73.52%.
- Credit costs: The company recorded a $925,000 loan-loss provision, versus a $125,000 reserve recapture in 2019. Net charge-offs were $565,000, including a $514,000 loss on a commercial borrower’s specialized tour vehicles. The allowance was $6.0 million, or 0.98% of loans.
- Loans and credit quality: Portfolio loans, net, were $607.4 million, down 1.1%; loans held for sale increased to $11.6 million. Nonperforming assets declined to $3.5 million, or 0.40% of assets, from $5.2 million, or 0.73%. Nonaccrual loans were $2.9 million, and there were no loans over 90 days past due and still accruing.
- Deposits and liquidity: Deposits grew 21.3% to $748.0 million; non-maturity deposits were 68.5% of deposits. Year-end cash and cash equivalents were $193.8 million, and cash plus available-for-sale securities totaled $204.0 million. The bank had no year-end FHLB advances or Federal Reserve borrowings; reported available FHLB borrowing capacity was $213.7 million, subject to collateral requirements.
- Debt and capital: The company issued $12.0 million of subordinated notes in 2020, with $11.6 million net carrying value at year-end. The notes bear 5.25% through October 2025, then float at a stated spread over a reference rate through their 2030 maturity. Stockholders’ equity was $85.5 million. The bank’s Community Bank Leverage Ratio was 10.4% and it was considered well-capitalized.
- Cash flow: Operating activities used $484,000; investing activities provided $4.5 million; financing activities provided $134.0 million. Cash and cash equivalents increased $138.1 million to $193.8 million, mainly reflecting deposit growth and financing proceeds.
Material changes versus 2019
- Net income increased 33.8%, driven mainly by higher loan-sale gains and modestly higher net interest income, partly offset by higher provision expense and taxes.
- Mortgage refinancing activity drove one-to-four-family originations to $321.3 million from $129.0 million, and loan sales to $258.2 million from $78.9 million. The larger sale volume boosted gains but also increased exposure to mortgage servicing valuation changes.
- PPP lending contributed $43.3 million of loans outstanding at year-end. The bank originated 909 PPP loans totaling $74.8 million; $31.5 million had been forgiven by year-end. It recognized $467,000 of PPP fee income in interest income during 2020.
- Commercial business loans increased 65.0% to $64.2 million, largely due to PPP. Deposits increased $131.3 million, while FHLB advances fell from $7.5 million to zero at year-end.
- Mortgage servicing rights were valued at $3.8 million, up from $3.2 million, but the 2020 fair-value adjustment was a $1.9 million loss, compared with a $760,000 loss in 2019.
Outlook, risks, contingencies, and unusual items
- The filing provides no specific numerical earnings or revenue guidance. Management describes continued attention to asset quality, core-deposit growth, higher-yielding lending, expense management, customer service, and selective expansion.
- Management expected pandemic effects to continue to create uncertainty, including potential pressure on net interest income and margin, credit quality, loan demand, operations, and asset values. In 2020, COVID-related payment relief covered 49 commercial loans totaling $37.2 million and 84 residential loans totaling $19.0 million. At year-end, $8.1 million of commercial and $4.4 million of residential loans remained under relief. Qualifying modifications were not classified as TDRs under applicable temporary guidance.
- Credit risks include the bank’s Washington geographic concentration and its commercial real estate, construction and land, consumer, and commercial business exposures. At year-end, 13 additional loans totaling $15.1 million were identified as loans of concern; the two largest had received COVID-related modifications and returned to contractual payments, while another borrower renewed its loan to mature in 2021.
- Interest-rate and funding risks include margin sensitivity, mortgage prepayments, deposit competition, and LIBOR transition exposure. The company also identifies cybersecurity, third-party service-provider, regulatory, and valuation risks, including sensitivity of mortgage servicing rights to prepayment assumptions.
- Year-end off-balance-sheet loan commitments totaled $56.5 million, including $19.0 million of unfunded construction commitments and $34.1 million of unused lines of credit. Loan-servicing representations could require repurchase or indemnification if loan-sale defects are identified; no loans were repurchased in 2020 or 2019.
- The board authorized up to $2.0 million of share repurchases; $73,000 was repurchased during 2020, leaving approximately $1.9 million available. A January 2021 dividend of $0.17 per share plus a special $0.10 per share was declared after year-end.
- The independent auditor issued an unqualified opinion on the financial statements. The allowance for loan losses was identified as a critical audit matter. Management reported effective disclosure controls and internal control over financial reporting; the auditor was not engaged to express an opinion on internal control.
Important facts for investors to verify
- Whether the remaining COVID-modified loans and the $15.1 million of loans of concern perform as scheduled, and whether further provisioning or charge-offs are needed.
- How PPP forgiveness, renewed PPP originations, and fee recognition affect loan balances, interest income, and credit exposure.
- Whether mortgage-sale gains and elevated origination activity are sustainable, and how refinancing and prepayment trends affect servicing-rights valuations and recurring income.
- Whether deposit growth persists and whether reported borrowing capacity remains available on acceptable terms as liquidity needs and loan commitments change.
- How the 2021–22 Community Bank Leverage Ratio thresholds, LIBOR transition, and eventual CECL adoption affect capital, earnings, and lending capacity.