Sound Financial Bancorp, Inc. — Q2 2020 Form 10-Q
Business context and reporting period. Sound Financial Bancorp is a bank holding company operating primarily through Sound Community Bank in Washington. This unaudited filing covers the quarter and six months ended June 30, 2020; balance-sheet comparisons are to December 31, 2019. Amounts below are in millions unless stated otherwise.
Key financial metrics
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Interest income | $8.71 | $8.34 | $17.35 | $17.16 |
| Net interest income | $6.90 | $6.46 | $13.62 | $13.50 |
| Provision (recapture) for loan losses | $0.40 | $(0.20) | $0.65 | $(0.40) |
| Noninterest income | $1.58 | $0.86 | $2.29 | $1.82 |
| Noninterest expense | $5.41 | $5.23 | $11.35 | $11.63 |
| Net income | $2.13 | $1.82 | $3.11 | $3.26 |
| Diluted EPS | $0.82 | $0.71 | $1.20 | $1.27 |
| Net interest margin | 3.69% | 4.03% | 3.81% | 4.13% |
- Balance sheet at June 30: assets $871.7, net portfolio loans $684.7, deposits $694.3, borrowings $79.8, and stockholders’ equity $80.2. Assets rose 21.1% from year-end 2019; net portfolio loans rose 11.5% and deposits rose 12.6%.
- Credit: allowance for loan losses was $6.0, or 0.87% of total loans (0.97% excluding PPP loans). Nonperforming assets were $4.1, or 0.47% of assets; nonaccrual loans were $3.5. Six-month net charge-offs were $0.26.
- Cash flow, six months: operating activities used $2.5; investing activities used $71.7; financing activities provided $149.0. Cash and cash equivalents increased $74.8 to $130.5.
- Liquidity and capital: management reported $140.7 of cash and available-for-sale securities, $7.4 of loans held for sale, $218.7 of remaining FHLB borrowing capacity, $33.4 of Federal Reserve discount-window capacity, and $20.0 of other credit lines. The Bank’s Community Bank Leverage Ratio was 10.17%, above the applicable 8% threshold.
Material changes versus the prior comparable period
- Q2 net income increased 17.1% year over year, mainly reflecting higher net interest income and a $1.06 increase in gains on loan sales, partly offset by a $0.40 provision for credit losses versus a $0.20 recapture a year earlier.
- Six-month net income declined $0.15 year over year, primarily because the company recorded a $0.65 provision instead of a $0.40 recapture. Higher noninterest income and lower expenses partially offset the effect.
- Net interest margin contracted in both the quarter and six-month period as asset yields fell faster than funding costs. Lower market rates and PPP loans contributed; PPP loans averaged a 2.83% yield in Q2, including recognized deferred fees.
- Loan-sale gains rose sharply with mortgage refinance activity: Q2 gains were $1.26 versus $0.20 a year earlier; loans sold were $57.3 versus $9.4. Six-month gains were $1.58 versus $0.70.
- Commercial business loans increased $70.8 from year-end, largely from PPP originations. Deposits increased $77.6, including growth in noninterest-bearing demand deposits of $45.2.
Outlook, management commentary, risks, and unusual items
- COVID-19 and PPP: At quarter-end the Bank had funded 782 PPP loans totaling $73.1, fully guaranteed by the SBA; related SBA processing fees totaled $2.7. The Bank had also approved 122 pandemic-related payment modifications totaling approximately $51.3, or 7.4% of loans. Management said modified loans would be monitored and reassessed, and warned that credit losses could rise as the economic effects develop.
- Credit outlook: Management’s allowance estimate incorporates potential pandemic effects, but actual losses may exceed estimates. Management cautioned that further economic deterioration could materially increase the allowance and adversely affect earnings and capital.
- Liquidity and funding: Borrowings increased $72.3 from year-end, entirely due to the Federal Reserve’s PPP Liquidity Facility. The Bank had $136.5 of outstanding loan commitments, including $37.2 of undisbursed construction and land commitments; certificates of deposit of $158.2 were scheduled to mature within one year.
- Litigation: Sound Community Bank and ten other institutions were sued in June 2020 by an alleged PPP agent seeking fees and damages, including treble damages, on behalf of a putative class. The Bank moved to dismiss; management said the outcome and impact could not be predicted.
- Other items: The Seattle 5th and Virginia branch closed in May, with customer relationships transferred to a nearby branch. A quarterly dividend of $0.15 per share was declared July 24, payable August 19, 2020. No formal earnings or financial guidance is provided in the filing.
- Additional risks: The filing cites pandemic-related borrower stress, lower rates and margin pressure, deposit and loan-demand uncertainty, operational and cybersecurity risks from remote work, third-party service-provider dependence, and evolving PPP forgiveness rules. The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether PPP borrowers obtain forgiveness as expected, and the timing and effect of SBA reimbursements, fee recognition, and PPPLF repayment.
- Whether pandemic-related deferrals resume payment or lead to increased delinquencies, criticized loans, charge-offs, and allowance needs; review exposure by loan type and borrower concentration.
- Whether deposit growth and available borrowing capacity remain sufficient as loan commitments are funded and certificates mature.
- Whether lower interest rates, PPP loan mix, mortgage refinancing, and mortgage-servicing-rights valuation continue to affect margins and earnings volatility.
- The outcome and potential financial or reputational consequences of the PPP agent-fee litigation; the filing does not provide a clear estimate of exposure.