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

Show all filings for SOUTHERN CONNECTICUT BANCORP INC | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for SOUTHERN CONNECTICUT BANCORP INC


14-Nov-2012

Quarterly Report


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

The following discussion and analysis is intended to assist you in understanding the financial condition and results of operations of the Company. This discussion should be read in conjunction with the accompanying unaudited financial statements as of and for the three and nine months ended September 30, 2012 and 2011 together with the audited financial statements as of and for the year ended December 31, 2011, included in the Company's Form 10-K filed with the Securities and Exchange Commission on March 30, 2012.

Summary

As of September 30, 2012, the Company had $122.7 million of total assets, $106.3 million of gross loans receivable, and $109.1 million of total deposits. Total equity capital at September 30, 2012 was $11.8 million, and the Company's Tier I Leverage Capital Ratio was 9.49%.

The Company had net income for the quarter ended September 30, 2012 of $163,000 (or basic and diluted income per share of $0.06) as compared to a net loss of $251,000 (or basic and diluted loss per share of $0.09) for the third quarter of 2011. The improvement in the Company's net income was largely attributable to a decrease in the provision for loan losses to $30,000 for the three months ended September 30, 2012 compared to a provision for loan losses of $373,000 for the same period in 2011. The decrease in the provision for loan losses was primarily related to a decrease in net charge-offs during the third quarter of 2012 compared to the third quarter of 2011.

In addition to the impact of the decrease in the provision for loan losses, the Company's operating results for the third quarter of 2012, when compared to the same period of 2011, were influenced by the following factors:

Net interest income decreased by $32,000 due to the combined effects of decreases in loan volume and lower yields on interest earning assets (primarily attributable to a decline in yields in the loan portfolio), which were partially offset by decreases in deposit liability volumes and lower rates paid on interest bearing liabilities (as management determined to reduce deposits by offering lower rates on deposits, which could lead to an improvement in the Company's regulatory capital ratios);
Noninterest income increased by $31,000 because of increases in loan prepayment fees recognized during the three months ended September 30, 2012 with no similar income recognized in the same period of 2011, which were partially offset by a decrease in service charges and fees resulting from changes in the business practices of customers of the Bank; and
Noninterest expenses decreased by $72,000 during the third quarter of 2012 compared to the same period in 2011 primarily due to a loss on the sale of other real estate owned during the third quarter of 2011 with no such loss during the corresponding period in 2012, as well as decreases in directors' fees, data processing fees and the cost of FDIC insurance, which were partially offset by increases in salaries and benefits expense and insurance expense. The decrease in directors' fees was attributable to reductions in director fees that were approved by the Company's compensation committee effective January 1, 2012. The decrease in data processing fees resulted from benefits the Company continued to realize during the third quarter of 2012 related to the renewal of certain data processing service contracts on more favorable terms during the fourth quarter of 2011. The cost of FDIC insurance was lower during the third quarter of 2012 compared to 2011 primarily due to a decline in deposit balances subject to the FDIC deposit insurance assessment. These favorable changes were partially offset by an increase in salaries and benefits expense during the third quarter of 2012, when compared to the third quarter of 2011, which was primarily due to salary and benefits expenses attributable to the hiring of a Chief Executive Officer in October 2011 to fill an open position at the Bank that existed during the third quarter of 2011. In addition, insurance expense increased due to increased costs in 2012 associated with insurance policies that the Company had entered into during a more favorable environment in July 2008.

The Company had net income for the nine months ended September 30, 2012 of $64,000 (or basic and diluted income per share of $0.02) as compared to a net loss of $711,000 (or basic and diluted loss per share of $0.26) for the nine months ended September 30, 2011. The improvement in the Company's earnings was largely attributable to a decrease in the provision for loan losses to $240,000 for the nine months ended September 30, 2012 compared to a provision for loan losses of $1,039,000 for the same period in 2011. The decrease in the provision for loan losses during the nine months ended September 30, 2012 compared to the same period in 2011 was primarily related to the 2011 provision being negatively affected by one commercial loan secured by real estate that was severely impacted by prevailing economic conditions in 2011.

In addition to the impact of the decrease in the provision for loan losses, the Company's operating results for the nine months ended September 30, 2012, when compared to the same period of 2011, were influenced by the following factors:

Net interest income decreased by $97,000 due to the combined effects of decreases in loan volume and lower yields on interest earning assets (primarily attributable to a decline in yields in the loan portfolio), which were partially offset by decreases in deposit liability volumes (as management determined to reduce deposits by offering lower rates on deposits, which could lead to an improvement in the Company's regulatory capital ratios);
Noninterest income increased by $79,000 because of loan prepayment fees received during the nine months ended September 30, 2012 with no similar income recognized in the same period of 2011, as well as an increase in other noninterest income, which was partially offset by a decrease in service charges and fees resulting from changes in the business practices of customers of the Bank; and
Noninterest expenses increased by $6,000 during the first nine months of 2012 compared to the same period in 2011 primarily due to increases in salaries and benefits expense, professional services fees and insurance expense, which were partially offset by a loss on the sale of other real estate owned during the nine months ended September 30, 2011 with no such loss during the corresponding period in 2012, as well as decreases in directors' fees, data processing fees and the cost of FDIC insurance. The increase in salaries and benefits expense during the first nine months of 2012 when compared to the same period in 2011 was primarily attributable to restricted stock compensation expense recorded by the Company based upon the vesting schedule for restricted stock granted to the Chief Executive Officer under his employment agreement and restricted stock agreement executed on February 28, 2012 and to salary and benefits associated with the hiring of a Chief Executive Officer in October 2011 to fill an open position at the Bank that existed during the corresponding period of 2011.The increase in professional services fees was due to increased costs for loan review, internal audit and consulting services performed during the nine months ended September 30, 2012, compared to the same period in 2011. Insurance expense increased due to increased costs in 2012 associated with insurance policies that the Company had entered into during a more favorable environment in July 2008. The decrease in directors' fees was attributable to reductions in director fees that were approved by the Company's compensation committee effective January 1, 2012. The decrease in data processing fees resulted from benefits the Company continued to realize during the nine months ended September 30, 2012 related to the renewal of certain data processing service contracts on more favorable terms during the fourth quarter of 2011. The cost of FDIC insurance was lower during the nine months ended September 30, 2012 compared to the same period in 2011 primarily due to a decline in deposit balances subject to the FDIC deposit insurance assessment. In addition the Company realized a loss on the sale of other real estate owned during the nine months ended September 30, 2011 with no similar loss in the same period of 2012.

Critical Accounting Policy

In the ordinary course of business, the Company has made a number of estimates and assumptions relating to reporting the results of operations and financial condition in preparing its financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ significantly from those estimates under different assumptions and conditions. The Company believes the following discussion addresses the Company's only critical accounting policy, which is the policy that is most important to the portrayal of the Company's financial condition and results of operations, and requires management's most difficult, subjective and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The Company has reviewed this critical accounting policy and estimate with its audit committee. Refer to the discussion below under "Allowance for Loan Losses" and Note 1 to the audited financial statements as of and for the year ended December 31, 2011 included in the Company's Form 10-K filed with the Securities and Exchange Commission on March 30, 2012.

Allowance for Loan Losses

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management's periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of allocated and general components. The allocated component relates to loans that are considered impaired. For such impaired loans, an allowance is established when the discounted cash flows (or observable market price or collateral value if the loan is collateral dependent) of the impaired loan is lower than the carrying value of that loan. The general component covers all other loans, segregated generally by loan type (and further segregated by risk rating), and is based on historical loss experience with adjustments for qualitative factors which are made after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss data.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors

considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and real estate loans by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the fair value of the collateral if the loan is collateral dependent.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer loans for impairment disclosures, unless such loans are the subject of a restructuring agreement due to financial difficulties of the borrower.

Impaired loans also include loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection.

A modified loan is considered a troubled debt restructuring ("TDR") when two conditions are met: (1) the borrower is experiencing documented financial difficulty and (2) concessions are made by the Company that would not otherwise be considered for a borrower with similar credit characteristics. The most common types of modifications include interest rate reductions and/or maturity extensions. Modified terms are dependent upon the financial position and needs of the individual borrower, as the Bank does not employ modification programs for temporary or trial periods. All modifications are permanent. The modified loan does not revert back to its original terms, even if the modified loan agreement is violated. The Company's workout committee continues to monitor the modified loan and if a re-default occurs, the loan is classified as a re-defaulted TDR and collection is pursued through liquidation of collateral, from guarantors, if any, or through other legal action.

Most TDRs are placed on nonaccrual status at the time of restructuring, and continue on nonaccrual status until they have performed under the revised terms of the modified loan agreement for a minimum of nine months. In certain instances, for TDRs that are on accrual status at the time the loans are restructured, the Bank may continue to classify the loans as accruing loans based upon the terms and conditions of the restructuring.

Impairment analysis is performed on a loan by loan basis for all modified commercial loans, residential mortgages and consumer loans that are deemed to be TDRs, and related charge-offs are recorded or specific reserves are established as appropriate. Commercial loans include loans categorized as commercial loans secured by real estate, commercial loans, and construction and land loans. Impairment is measured by the present value of expected future cash flows discounted at the loan's effective interest rate. The original contractual interest rate for the loan is used as the discount rate for fixed rate loan modifications. The current rate is used as the discount rate when the loan's interest rate floats with a specified index. A change in terms or payments would be included in the impairment calculation.

The allowances established for losses on specific loans are based on a regular analysis and evaluation of problem loans. Loans are classified based on an internal credit risk grading process that evaluates, among other things: (i) the borrower's ability to repay; (ii) the underlying collateral, if any; and
(iii) the economic environment and industry in which the borrower operates. This analysis is performed by the credit department, in consultation with the loan officers, for all commercial loans. Specific valuation allowances are determined by analyzing the borrower's ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower's industry, among other things.

General valuation allowances are calculated based on the historical loss experience of specific types of loans. A historical valuation allowance is established for each pool of similar loans based upon the product of the historical loss ratio and the total dollar amount of the loans in the pool. The Company's pools of similar loans include analogous risk-graded groups of commercial and industrial loans, commercial real estate loans, consumer real estate loans and consumer and other loans.

Due to the relatively small asset size and loans outstanding of the Company, the Company uses readily available data from the FDIC regarding the loss experience of national banks with assets between $100 million and $300 million and combines this data with the Company's actual loss experience to develop average loss factors by weighting the national banks' loss experience and the Company's loss experience. As both the Company's asset size and outstanding loan balance increased significantly during 2010, beginning with the quarter ended March 31, 2011, the Company determined to place greater emphasis on the Company's loss experience and to utilize the average loss experience for the prior four years instead of the prior three years used in the Company's calculations through December 31, 2010. The Company increased the weighting of its loss experience from 25% to 50%. The Company intends to weight the Company's loss experience more heavily in determining the allowance for loan loss provision as the size of the Company's loan portfolio becomes more significant. The historical loss period was extended by an additional year from the loss period utilized through December 31, 2010, which is considered more representative of average annual losses inherent in the loan portfolio.

General valuation allowances are based on general economic conditions and other qualitative risk factors, both internal and external, to the Company. In general, such valuation allowances are determined by evaluating, among other things: (i) the experience, ability and effectiveness of the Bank's lending management and staff; (ii) the effectiveness of the Company's loan policies, procedures and internal controls; (iii) changes in asset quality; (iv) changes in loan portfolio volume; (v) the composition and concentrations of credit; and
(vi) the impact of national and local economic trends and conditions. Management evaluates the degree of risk that each one of these components has on the quality of the loan portfolio on a quarterly basis. Each component is determined to have either a high, moderate or low degree of risk. The results are then entered into a general allocation matrix to determine an appropriate general valuation allowance.

Based upon this evaluation, management believes the allowance for loan losses of $2,228,000 or 2.10% of gross loans outstanding at September 30, 2012 is adequate, under prevailing economic conditions, to absorb losses on existing loans. At December 31, 2011, the allowance for loan losses was $2,300,000 or 2.02% of gross loans outstanding. The decrease in the allowance was attributable to a $72,000 decrease in the general component of the allowance. The decrease in the general component of the reserve was primarily due to a decline in loan volume during the nine months ended September 30, 2012. In addition, the Company had $420,000 in charge-offs during the nine months ended September 30, 2012, of which $387,000 was for loans that were not impaired at December 31, 2011 and $33,000 was related to a decline in collateral for a loan impaired at December 31, 2011. The charge-offs during the first nine months of 2012 primarily relate to three commercial and industrial loans and one residential loan. The Company's net loan charge-offs were adequately provided for during the nine months ended September 30, 2012.

The accrual of interest on loans is discontinued at the time loans are 90 days past due unless the loan is well-secured and in process of collection. Consumer installment loans are typically charged off no later than 180 days past due. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not collected for loans that are placed on nonaccrual status or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis method until qualifying for return to accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Management considers all nonaccrual loans and troubled-debt restructured loans to be impaired. In most cases, loan payments that are past due less than 90 days and the related loans are not considered to be impaired.

Allowance for Loan Losses and Nonaccrual, Past Due and Restructured Loans



The changes in the allowance for loan losses for the nine months ended September
30, 2012 and 2011 are as follows:



                                                 2012              2011
Balance at beginning of year                  $ 2,299,625      $  2,786,641
Provision for loan losses                         240,254         1,039,212
Recoveries of loans previously charged-off:
Commercial                                         79,517             4,104
Commercial loans secured by real estate            29,114
Consumer                                                -             2,301
Total recoveries                                  108,631             6,405
Loans charged-off:
Commercial                                       (384,027 )        (138,778 )
Commercial loans secured by real estate                 -        (1,344,057 )
Residential mortgages                             (33,192 )         (40,910 )
Consumer                                           (2,959 )          (9,675 )
    Total charge-offs                            (420,178 )      (1,533,420 )
Balance at end of period                      $ 2,228,332      $  2,298,838

Net charge-offs to average loans                    (0.28 )%          (1.24 %)

Non-Performing Assets and Potential Problem Loans



The following table represents non-performing assets and potential problem loans
at September 30, 2012 and December 31, 2011:



Nonaccrual loans:                                        2012                2011
Commercial loans secured by real estate             $      553,159      $      787,311
Commercial                                               1,814,010           1,707,720
Construction and land                                    1,387,660           1,420,156
Residential mortgages                                      653,482             554,678
Consumer                                                         -               1,460
Total non-accrual loans                                  4,408,311           4,471,325

Troubled debt restructured (TDR) loans:
Nonaccrual TDR loans not included in Total
nonaccrual loans above:
Commercial loans secured by real estate                    255,383           1,314,030
Commercial                                                 252,233           1,899,342
Accruing TDR impaired loans:
Commercial loans secured by real estate                  1,044,481
Commercial                                               1,652,422                   -
Foreclosed assets:
Commercial                                                 474,948             374,211
Residential                                                156,838                   -
Total non-performing assets                         $    8,244,616      $    8,058,908

Ratio of non-performing assets to:
Total loans and foreclosed assets                             7.73 %              7.05 %
Total assets                                                  6.72 %              5.52 %
Accruing past due loans:
30 to 89 days past due                              $    3,010,371      $    1,392,936
90 or more days past due                                        20                   -
Total accruing past due loans                       $    3,010,391      $    1,392,936

Ratio of accruing past due loans to gross loans
net of unearned income:
30 to 89 days past due                                        2.83 %              1.22 %

Recent Accounting Changes

In April 2011, the FASB amended its guidance relating to repurchase agreements. The amendments change the effective control assessment by removing the criterion that required the transferor to have the ability to repurchase or redeem financial assets on substantially the agreed terms, even in the event of default by the transferee. Instead, the amendments focus the assessment of effective control on the transferor's rights and obligations with respect to the transferred financial assets and not whether the transferor has the practical ability to perform in accordance with those rights or obligations. The amended guidance became effective for the Company as it relates to transactions or modifications of existing transactions that occur in interim and annual periods beginning with the quarter ended March 31, 2012.These amendments did not have an impact on the Company's consolidated financial statements.

In May 2011, the FASB issued Accounting Standards Update (ASU) 2011-04, Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRs, (ASU 2011-04). ASU 2011-04 converges the fair value measurement guidance in U.S. GAAP and International Financial Reporting Standards (IFRSs). Some of the amendments clarify the application of existing fair value measurement requirements, while other amendments change a particular principle in existing guidance. In addition, ASU 2011-04 requires additional fair value disclosures. The amendments are to be applied prospectively and are effective for interim and annual periods beginning after December 15, 2011. The Company adopted the methodologies prescribed by this ASU during the quarter ended March 31, 2012. Adoption of this guidance did not have a material effect on the Company's financial statements.

In June 2011, the FASB issued new accounting guidance related to the presentation of comprehensive income that eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders' equity. The amendments require that all non-owner changes in stockholders' equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The amendments do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company adopted this guidance during the quarter ended March 31, 2012. The adoption of this guidance did not impact the Company's financial position, results of operations or cash flows and only impacted the presentation of other comprehensive income in the financial statements.

Comparison of Financial Condition as of September 30, 2012 versus December 31, 2011

General

The Company's total assets were $122.7 million at September 30, 2012, a decrease of $23.3 million over total assets of $146.0 million at December 31, 2011. The Bank's net loans receivable decreased to $104.1 million at September 30, 2012 from $111.6 million at December 31, 2011, and cash and cash equivalents, including short term investments, decreased to $10.1 million as of September 30, 2012 from $24.9 million as of December 31, 2011. Total deposits decreased to $109.1 million as of September 30, 2012 from $132.6 million as of December 31, 2011. The decreases in net loans receivable and cash and cash equivalents corresponded with the decrease in deposit liabilities during the nine months ended September 30, 2012.

Short-term investments

Short-term investments, consisting of money market investments, decreased to $3.6 million at September 30, 2012 compared to $6.8 million at December 31, 2011.

Investments

Available for sale securities, which consisted of U.S. Treasury Bills, decreased $900,000 to $2.9 million at September 30, 2012 from $3.8 million at December 31, 2011. The Company uses the U.S. Treasury Bills included in its available for sale securities portfolio to meet pledge requirements for public deposits and . . .

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