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SFBC > SEC Filings for SFBC > Form 10-Q on 14-Nov-2012All Recent SEC Filings

Show all filings for SOUND FINANCIAL BANCORP, INC.



Quarterly Report

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation




On August 22, 2012, Sound Financial Bancorp, Inc. (the "Company") became the holding company for Sound Community Bank (the "Bank") and owner of all of the issued and outstanding shares of the Bank's common stock. The Company is a Maryland chartered stock holding company and is subject to regulation by the Board of Governors of the Federal Reserve System ("Federal Reserve"). See Note 2
- Conversion and Stock Issuance for additional information.

Substantially all of the Company's business is conducted through the Bank, which is a federal savings bank subject to extensive regulation by the Office of the Comptroller of the Currency ("OCC"). The Bank's deposits are insured up to applicable limits by the Federal Deposit Insurance Corporation ("FDIC"). At September 30, 2012, the Company had total consolidated assets of $366.5 million, net loans of $304.7 million, deposits of $313.0 million and stockholders' equity of $42.3 million. Shares of the Company's common stock are traded on the Nasdaq Capital Market under the symbol "SFBC." Our executive offices are located at 2005 5th Avenue - Suite 200, Seattle, Washington, 98121.

During October 2012, the Bank filed an application to convert from a federally chartered savings bank to a Washington state-chartered commercial bank. As a Washington commercial bank, the Bank's regulators will be the Washington State Department of Financial Institutions ("WDFI") and the FDIC. The Federal Reserve will remain as the primary federal regulator for the Company. While the proposed charter conversion requires regulatory approval, the Bank expects the new charter to become effective in December 2012. The change is intended to reduce regulatory examination costs and to move oversight of the Bank to the WDFI, which is focused on local community banks and financial institutions. The charter conversion will not affect our customers in any way, and they will continue to receive the same protection on deposits through the FDIC.

Our principal business consists of attracting retail deposits from the general public and investing those funds, along with borrowed funds, in loans secured by first and second mortgages on one- to four-family residences (including home equity loans and lines of credit), commercial and multifamily, consumer and commercial business loans and, to a lesser extent, construction and land loans. We offer a wide variety of secured and unsecured consumer loan products, including manufactured home loans, automobile loans, boat loans and recreational vehicle loans. As part of our business, we focus on residential mortgage loan originations, many of which we sell to Fannie Mae. We sell these loans with servicing retained to maintain the direct customer relationship and promote our emphasis on strong customer service.

Our operating revenues are derived principally from earnings on interest earning assets, service charges and fees, and gains on the sale of loans. Our primary sources of funds are retail deposits, Federal Home Loan Bank ("FHLB") advances and other borrowings, and payments received on loans and securities. We offer a variety of deposit accounts that provide a range of interest rates and terms based on market conditions, generally including savings, money market, term certificate and demand accounts.

Our noninterest expenses consist primarily of salaries and employee benefits, expenses for occupancy, marketing and computer services and FDIC deposit insurance premiums. Salaries and benefits consist primarily of the salaries and wages paid to our employees, payroll taxes, expenses for retirement and other employee benefits. Occupancy expenses, which are the fixed and variable costs of buildings and equipment, consist primarily of lease payments, property taxes, depreciation charges, maintenance and costs of utilities.

Forward-Looking Statements

When used in this Form 10-Q the words or phrases "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project," "intends" or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about future performance. These forward-looking statements are subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from the results anticipated, including, among other things,

changes in economic conditions, either nationally or in our market area;

fluctuations in interest rates;

the risks of lending and investing activities, including changes in the level and direction of loan delinquencies and charge-offs and changes in estimates of the adequacy of our allowance for loan losses;

the possibility of other-than-temporary impairments of securities held in our securities portfolio;

our ability to access cost-effective funding;

fluctuations in the demand for loans, the volume of unsold homes, land and other properties, and fluctuations in real estate values and both residential and commercial and multifamily real estate market conditions in our market area;

secondary market conditions for loans and our ability to sell loans in the secondary market;

our ability to attract and retain deposits;

our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we may acquire into our operations and our ability to realize related revenue synergies and expected cost savings and other benefits within the anticipated time frames or at all;

legislative or regulatory changes such as the Dodd-Frank Wall Street Reform and Consumer Protection Act and it implementing regulations that adversely affect our business, as well as changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules, including changes related to Basel III;

monetary and fiscal policies of the Federal Reserve and the U.S. Government and other governmental initiatives affecting the financial services industry;

results of examinations of Sound Financial and Sound Community Bank by their regulators, including the possibility that the regulators may, among other things, require us to increase our allowance for loan losses or to write-down assets, change Sound Community Bank's regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings;

increases in premiums for deposit insurance;

our ability to control operating costs and expenses;

the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation;

difficulties in reducing risks associated with the loans on our balance sheet;

staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges;

computer systems on which we depend could fail or experience a security breach;

our ability to retain key members of our senior management team;

costs and effects of litigation, including settlements and judgments;

our ability to implement our business strategies;

increased competitive pressures among financial services companies;

changes in consumer spending, borrowing and savings habits;

the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;

our ability to pay dividends on our common stock;

adverse changes in the securities markets;

the inability of key third-party providers to perform their obligations to us;

statements made with respect to our intentions regarding disclosure and other changes resulting from the Jumpstart Our Business Startups Act of 2012;

changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; and

other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and the other risks described from time to time in our filings with the Securities and Exchange Commission ("SEC").

We wish to advise readers not to place undue reliance on any forward-looking statements and that the factors listed above could materially affect our financial performance and could cause our actual results for future periods to differ materially from any such forward-looking statements expressed with respect to future periods and could negatively affect our stock price performance.

We do not undertake and specifically decline any obligation to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

References in this document to "we," "us," and "our" means Sound Financial Bancorp, Inc. and its wholly-owned subsidiary, Sound Community Bank, unless the context otherwise requires.

Critical Accounting Policies

We consider accounting policies involving significant judgments and assumptions by management that have, or could have, a material impact on the carrying value of certain assets or on income to be critical accounting policies. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Facts and circumstances that could affect these judgments include, but are not limited to, changes in interest rates, changes in the performance of the economy and changes in the financial condition of borrowers. Management believes that its critical accounting policies include determining the allowance for loan losses, accounting for other-than-temporary impairment of securities, accounting for mortgage servicing rights, accounting for other real estate owned, and accounting for deferred income taxes. For additional information on our accounting policies see our Form 10-K Annual Report for the year ended December 31, 2011.

Comparison of Financial Condition at September 30, 2012 and December 31, 2011

General. Total assets increased by $26.8 million, or 7.9%, to $366.5 million at September 30, 2012 from $339.7 million at December 31, 2011. This increase was primarily the result of a $9.0 million, or 3.1% increase in our net loan portfolio, and a $17.9 million, or 598.2% increase in available-for-sale securities. Our total liabilities increased by $13.2 million or 4.2% to $324.2 million at September 30, 2012 from $311.0 million at December 31, 2011 primarily as a result of a $13.0 million, or 4.3% increase in deposits.

Cash and Securities. Cash, cash equivalents and our available-for-sale securities increased $16.5 million, or 82.5%, to $36.5 million at September 30, 2012. Cash and cash equivalents decreased by $1.4 million, or 8.1%, to $15.7 million at September 30, 2012, as excess cash balances were deployed to purchase agency mortgage-backed securities. Available-for-sale securities increased $17.9 million, or 598.2%, to $20.9 million at September 30, 2012. This increase reflects purchases of agency mortgage-backed securities made in the third quarter with the proceeds received from our stock offering completed in August 2012, slightly offset by investment pay-downs and other-than- temporary impairment charges on our non-agency mortgage-backed security portfolio.

At September 30, 2012, included in our available-for-sale securities portfolio, were $2.8 million of non-agency mortgage-backed securities. These securities present a higher credit risk than U.S. agency mortgage-backed securities, of which we had $18.1 million at September 30, 2012. In order to monitor the increased risk, management receives and reviews a quarterly credit surveillance report from a third party, which evaluates non-agency securities based on a number of factors, including credit scores, loan-to-value ratios, geographic locations, delinquencies and loss histories of the underlying mortgage loans. This analysis is prepared in order to project potential future losses based on various home price depreciation scenarios over a three-year horizon. Based on these reports, management ascertains the appropriate value for these securities and, in the nine months ended September 30, 2012, recorded an impairment charge of $156,000 on four of these non-agency securities. The current market environment significantly limits our ability to mitigate our exposure to value changes in these more risky securities by selling them, and we do not anticipate these conditions to change significantly in the next 12 months. Accordingly, if the market and economic environment impacting the loans supporting these securities continues to deteriorate, we could determine that additional impairment must be recorded on these securities, as well as on any other securities in our portfolio. As a result, our future earnings, equity, regulatory capital and ongoing operations could be materially adversely affected.

Loans. Our total loan portfolio (including loans held for sale and excluding deferred fees) increased $9.2 million, or 3.0%, to $311.1 million at September 30, 2012. Loans held for sale increased from $1.8 million at December 31, 2011, to $2.1 million at September 30, 2012. The increase was primarily due to the timing difference between loan fundings and loan sale settlements.

The most significant changes in our loan portfolio during the year to date included an increase of $13.9 million or 13.1% in our commercial and multifamily real estate, a $2.9 million or 16.2% increase in our construction and land loans and a $1.6 million or 12.1% increase in commercial business loans. Manufactured home loans decreased by $1.4 million or 7.8% while other consumer loans decreased $1.8 million or 16.8% between December 31, 2011 and September 30, 2012 primarily as a result of charge-offs, prepayments and lower demand from creditworthy borrowers in the current economic environment.

The following table reflects the changes in the types of loans in our loan portfolio at September 30, 2012 as compared to the end of 2011:

                                            September       December
                                            30, 2012        31, 2011        Amount Change       Percent Change
                                                              (Dollar amounts in thousands)
One-to-four family loans                   $    94,341     $    96,305     $        (1,964 )               (2.0 )%
Home equity                                     35,883          39,656              (3,773 )               (9.5 )
Commercial and multifamily                     119,938         106,016              13,922                 13.1
Construction and land                           20,694          17,805               2,889                 16.2
Manufactured homes                              17,010          18,444              (1,434 )               (7.8 )
Other consumer                                   9,085          10,920              (1,835 )              (16.8 )
Commercial business                             14,761          13,163               1,598                 12.1
Total                                      $   311,712     $   302,309     $         9,403                  3.1 %

Mortgage Servicing Rights. At September 30, 2012, we had $2.3 million in mortgage servicing rights recorded at fair value compared to $2.4 million at December 31, 2011. The decrease during the period was the result of a lower market valuation for our mortgage servicing rights which was offset somewhat by an increase in our originated servicing portfolio as of September 30, 2012 compared to December 31, 2011.

Nonperforming Assets. At September 30, 2012, our nonperforming assets totaled $6.9 million, or 1.88% of total assets, compared to $9.5 million, or 2.78% of total assets at December 31, 2011.

Nonperforming loans to total loans decreased to 1.41% of total loans at September 30, 2012 from 2.20% at December 31, 2011. The decrease reflects a $2.3 million decrease in nonperforming loans in the nine month period although nonperforming loans remain elevated compared to historical levels due to the continuing weak economy in our market area. Our largest nonperforming loans at September 30, 2012 consisted of a $1.1 million commercial real estate loan, a $471,000 commercial land development loan and a $338,000 home equity loan.

OREO and repossessed assets decreased by $273,000 during the first nine months of 2012. We repossessed 17 one- to four- family residences, nine manufactured homes, two boats and one recreational vehicle in the nine months ended September 30, 2012. During the same period, we sold seven one- to four- family residences, two commercial properties, nine manufactured homes and a recreational vehicle at an aggregate loss of $314,000. Our largest OREO at September 30, 2012, consisted of a mobile home park with a recorded value of $1.1 million located in Spanaway, Washington. Our next two largest OREO properties were comprised of a $490,000 one- to four- family property located in Carnation, Washington and a $198,000 one- to four- family property located in Dayton, Washington.

The table below sets forth the amounts and categories of nonperforming assets in our loan portfolio at the dates indicated:

                                                              Nonperforming Assets
                                            September 30,       December        Amount       Percent
                                                 2012           31, 2011        Change       Change
                                                             (Dollars in thousands)
Nonperforming loans(1):
One-to four- family                        $         1,407     $     4,401     $  (2,994 )       (68.0 )%
Home equity                                            790             873           (83 )        (9.5 )
Commercial and multifamily                           1,366           1,219           147          12.1
Construction and land                                  550              80           470         587.5
Manufactured homes                                      19               -            19            NM
Other consumer                                           3              64           (61 )       (95.3 )
Commercial business                                    209               -           209            NM
Total                                      $         4,344     $     6,637     $  (2,293 )       (34.5 )%

OREO and repossessed assets:
One-to four- family                        $         1,360     $       478     $     882         184.5 %
Commercial and multifamily                           1,073           2,225        (1,152 )       (51.8 )
Manufactured homes                                      46             118           (72 )       (61.0 )
Other consumer                                          69               -            69            NM
Total                                      $         2,548     $     2,821     $    (273 )        (9.7 )%

Total nonperforming assets                 $         6,892     $     9,458     $  (2,566 )       (27.1 )%
Nonperforming assets as a percentage of
total assets                                          1.88 %          2.78 %

Performing restructured loans:
One-to four- family                        $         3,017     $     2,508     $     509          20.3 %
Home equity                                            239             812          (573 )       (70.6 )
Commercial and multifamily                             780             785            (5 )        (0.6 )
Construction and land                                  102               -           102            NM
Manufactured homes                                     622               -           622            NM
Other consumer                                          47               4            43        1075.0
Commercial business                                    565              26           539        2073.1
Total                                      $         5,372     $     4,135     $   1,237          29.9 %

(1) Nonperforming loans include $814,000 and $2.8 million in nonperforming TDRs as of September 30, 2012 and December 31, 2011.

In addition to the non-performing assets set forth in the table above, as of September 30, 2012, there were $3.3 million in loans with respect to which known information about possible credit problems of the borrowers have caused management to have doubts as to the abilities of the borrowers to comply with present loan repayment terms. This may result in the future inclusion of such loans in the nonperforming asset categories.

Allowance for Loan Losses. The allowance for loan losses is maintained to cover losses that are probable and can be estimated on the date of the evaluation in accordance with generally accepted accounting principles in the United States. It is our best estimate of probable incurred credit losses in our loan portfolio.

Our allowance for loan losses at September 30, 2012 was $4.3 million, or 1.40% of total loans receivable, compared to $4.5 million, or 1.47% of total loans receivable at December 31, 2011. The $122,000, or 2.7% decrease in the allowance for loan losses reflects the $3.7 million provision for loan losses established during the first nine months of 2012 as a result of an increase in our loan portfolio and net charge-offs of $3.8 million during the period as well as the decline in nonperforming loans.

Specific loan loss reserves increased $274,000, and general loan loss reserves decreased by $396,000 at September 30, 2012 compared to December 31, 2011. Net charge-offs for the nine months ending September 30, 2012 were $3.8 million, or 1.67% of average loans on an annualized basis, compared to $3.8 million, or 1.69% of average loans for the same period in 2011. As of September 30, 2012, the allowance for loan losses as a percentage of loans receivable and nonperforming loans was 1.40% and 99.75%, respectively, compared to 1.47% and 67.12%, respectively, at December 31, 2011. The allowance for loan losses as a percentage of loans receivable decreased slightly due to an increase in loans receivable during the nine month period ended September 30, 2012. The allowance for loan losses as a percentage of nonperforming loans increased during this same period due to an decrease in nonperforming loans.

The following table shows the adjustments in our allowance during the first nine months of 2012 as compared to the same period in 2011:

                                                                   At and for the Nine Month
                                                                         Period Ended
                                                                         September 30,
                                                                   2012                2011
                                                                    (Dollars in thousands)
Balance at beginning of period                                 $       4,455       $       4,436
Charge-offs                                                           (4,048 )            (3,919 )
Recoveries                                                               251                 140
Net charge-offs                                                       (3,797 )            (3,779 )
Provisions charged to operations                                       3,675               3,350
Balance at end of period                                       $       4,333       $       4,007

Ratio of net charge-offs during the period to average loans
outstanding during the period                                           1.67 %              1.69 %

Allowance as a percentage of non-performing loans                      99.75 %              62.1 %

Allowance as a percentage of total loans (end of period)                1.40 %              1.32 %

Deposits. Total deposits increased by $13.0 million, or 4.3%, to $313.0 million at September 30, 2012 from $300.0 million at December 31, 2011. A summary of deposit accounts with the corresponding weighted average cost of funds is presented below:

                             As of September 30, 2012             As of December 31, 2011
                                               Wtd. Avg.                           Wtd. Avg.
                             Amount               Rate            Amount              Rate
                                                (Dollars in thousands)
Checking (noninterest)   $        29,895             0.00 %   $       26,907             0.00 %
NOW (interest)                    25,331             0.08             22,332             0.09
Savings                           25,046             0.06             22,092             0.10
Money Market                      92,885             0.33             95,029             0.58
Certificates                     136,475             1.33            129,968             1.53
Escrow                             3,412             0.00              3,669             0.00
Total                    $       313,044             0.69 %   $      299,997             0.87 %

During the first nine months of 2012, checking and NOW accounts increased $6.0 million, or 12.2% to $55.2 million. These increases were a result of our emphasis on attracting these and other low-cost deposits such as savings accounts, which increased $3.0 million, or 13.4% in the first nine months of 2012. Although certificate balances increased $6.5 million in the first nine months of 2012, this was a result of increases in our public fund certificates. Public fund certificates increased $9.4 million while business and consumer certificates decreased $2.9 million, or 2.7%. This is a result of the low interest rate environment and strategic decision to compete less aggressively on certificate interest rates

Borrowings. FHLB advances decreased $482,000, or 5.7%, to $8.0 million at September 30, 2012, with a weighted-average cost of 2.76%, from $8.5 million at December 31, 2011, with a weighted-average cost of 2.17%. We continue to utilize FHLB advances to fund interest-earning asset growth and/or enhance our interest rate risk management despite our strong deposit growth.

Stockholders' Equity. Total stockholders' equity increased $13.6 million, or 47.3%, to $42.3 million at September 30, 2012, from $28.7 million at December 31, 2011. This primarily reflects an increase in paid-in capital as a result of net proceeds from the Conversion of $12.7 million as well as $1.8 million in net income and a $186,000 decrease in accumulated other comprehensive loss.

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