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SSNF > SEC Filings for SSNF > Form 10-K on 25-Mar-2013All Recent SEC Filings

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Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation



This discussion and analysis reviews our consolidated financial statements and other relevant statistical data and is intended to enhance your understanding of our financial conditions and results of operations. The information in this section has been derived from the consolidated financial statements and footnotes thereto, which appear in Part I, Item 8 of this report. You should read the information in this section in conjunction with the business and financial information regarding the Company as provided in this report.


Sunshine Financial is the holding company for its wholly owned subsidiary, Sunshine Savings Bank. Sunshine Savings Bank was originally chartered as a credit union in 1952 as Sunshine State Credit Union to serve state government employees in the metropolitan Tallahassee area. On July 1, 2007, we converted from a state-chartered credit union known as Sunshine State Credit Union to a federal mutual savings bank known as Sunshine Savings Bank, and in 2009 reorganized into the non-stock mutual holding company structure. On April 5, 2011, Sunshine Financial completed a public offering as part of the Sunshine Saving Bank's conversion and reorganization from a non-stock mutual holding company to a fully public stock holding company structure. Please see Note 18 of the Notes to Consolidated Financial Statements under Item 8 of this report for more information.

Our principal business consists of attracting retail deposits from the general public and investing those funds in loans secured by first and second mortgages on one- to four-family residences, home equity loans and lines of credit, lot loans, and direct automobile, credit card and other consumer loans.

We offer a variety of deposit accounts, which are our primary source of funding for our lending activities. We have adopted a plan of conversion and reorganization, primarily to increase our capital to grow our loan portfolio and to continue to build our franchise.

Our operations are significantly affected by prevailing economic conditions as well as government policies and regulations concerning, among other things, monetary and fiscal affairs, housing and financial institutions. Deposit flows are influenced by a number of factors, including interest rates paid on competing time deposits, other investments, account maturities, and the overall level of personal income and savings. Lending activities are influenced by the demand for funds, the number and quality of lenders, and regional economic cycles. Sources of funds for our lending activities include primarily deposits, borrowings, payments on loans and income provided from operations.

Our primary source of pre-tax income is net interest income. Net interest income is the difference between interest income, which is the income that we earn on our loans and investments, and interest expense, which is the interest that we pay on our deposits and borrowings. Changes in levels of interest rates affect our net interest income. A secondary source of income is noninterest income, which includes revenue we receive from providing products and services. Our noninterest expense has typically exceeded our net interest income and we have relied primarily upon noninterest income to supplement our net interest income and to achieve earnings.

Our operating expenses consist primarily of salaries and employee benefits, general and administrative, occupancy and equipment, data processing services, professional services and marketing expenses. Salaries and benefits consist primarily of the salaries and wages paid to our employees, payroll taxes, expenses for retirement and other employee benefits. Occupancy and equipment expenses, which

are the fixed and variable costs of building and equipment, consist primarily of lease payments, taxes, depreciation charges, maintenance and costs of utilities.

Over the last year, our net interest margin has decreased as a result of the decrease in our yield on earning assets. While our average yield on interest-earning assets decreased 41 basis points to 4.50% for the year ended December 31, 2012 compared to 4.91% for the year ended December 31, 2011, our average funding costs decreased from 0.90% during the year ended December 31, 2011 to 0.57% for the year ended December 31, 2012. Our net interest rate spread decreased to 3.93% for the year ended December 31, 2012 compared to 4.01% for the year ended December 31, 2011.

Business and Operating Strategy and Goals

Our primary objective is to continue to grow Sunshine Savings Bank as a well-capitalized, profitable, independent, community-oriented financial institution serving customers in our market area. Our strategy is simply to provide innovative products and superior service to customers in our market area, which we serve through our four convenient banking centers located in Tallahassee, Florida. We support these banking centers with 24/7 access to on-line banking and participation in a world wide ATM network. Our recently completed stock offering was a critical component of our business strategy because of the significant increase it provided to our capital base. To accomplish our objectives, we also need to continually motivate our employees and provide them with the tools necessary to compete effectively with other financial institutions operating in our market area.

Maintaining and improving our asset quality. Our goal is to maintain and improve upon our level of nonperforming assets by managing credit risk. We are focused on actively monitoring and managing all segments of our loan portfolio in order to proactively identify and mitigate risk. We will continue to devote significant efforts and resources to reducing problem assets to levels consistent with our historical experience. As a result of our efforts, nonperforming assets recently decreased to $4.3 million at December 31, 2012 compared to $5.4 million at December 31, 2011, and our nonperforming loans decreased to $2.3 million at December 31, 2012 compared to $4.6 million a year ago. Our percentage of nonperforming assets to total assets was 2.89% and 3.70% at December 31, 2012 and 2011, respectively.

Leveraging our capital to improve our overall efficiency and profitability. We may improve our overall efficiency and profitability by leveraging our increased capital base resulting from our recent stock offering. We also may utilize our borrowing capacity at the FHLB of Atlanta to purchase investment grade securities to leverage our balance sheet and increase our net interest income and liquidity. We also will continue to emphasize lower cost deposits.

Improving our earnings through product selection, pricing and lower cost of funds. Through product selection and pricing and lower cost funds, we will seek to optimize our interest rate margin while managing our interest rate risk. We will continue to expand our business by cross-selling our loan and deposit products and services to our customers and emphasizing our traditional strengths, which include residential mortgages, consumer loans and deposit products and services. In addition, from time to time, consistent with our asset/liability objectives, we may sell a portion of our residential mortgage loan originations to Freddie Mac or private investors. This will allow us to maintain our customer relationships and generate servicing income, while also having the funds from any such loan sales available to make additional loans.

Growing our franchise within the Tallahassee metropolitan area. We operate with a service-oriented approach to banking by meeting our customers' needs and emphasizing the delivery of a consistent and high-quality level of professional service. The net proceeds of our recently completed stock offering will allow us to invest in more loans, when appropriate, and provide a menu of services consistent with the needs of the customers in our market area. Our attention to client service and

competitive rates allows us to attract and retain deposit and loan customers. During 2012, we contracted with DealerTrack and local new automobile dealerships to originate car loans. The DealerTrack program allows us to control the terms of the financing to our current lending guidelines and gives us the final decision on the loan.

Emphasizing lower cost core deposits to manage the funding costs of our loan growth. We offer personal checking, savings and money-market accounts, which generally are lower-cost sources of funds than certificates of deposits and are less sensitive to withdrawal when interest rates fluctuate. To build our core deposit base, we are pursuing a number of strategies that include sales promotions on savings and checking accounts to encourage the growth of these types of deposits.

Continuing to originate residential and increasing owner-occupied commercial real estate loans. Our primary lending focus has been, and will continue to be, on originating one- to four-family, owner-occupied mortgage loans and, to a lesser extent, automobile, credit card and other consumer loans. Although our loan originations have declined during recent periods as we focused on our asset quality and experienced lower demand for residential and consumer loans reflecting both the weak housing market and overall weak economic conditions, we intend to continue to emphasize these lending activities without reducing our credit underwriting standards. We believe the continuing changes in the secondary market as a result of the uncertainty that is surrounding Fannie Mae and Freddie Mac will result in increased opportunities in the coming years to originate high quality residential loans with more attractive pricing for our loan portfolio. With our long experience and expertise in residential lending we believe we can be effective in capturing the opportunities of these market changes in residential lending. In addition, we began originating owner occupied commercial real estate loans in the second quarter of 2012. Although our focus is on owner occupied commercial real estate loans, we will originate nonowner occupied commercial loans. Commercial real estate lending diversifies our loan portfolio and gives us the opportunity to earn more income because these loans have higher interest rates than residential mortgages in order to compensate for the increased credit risk. At December 31, 2012, commercial real estate loans represented 8.0% of our loan portfolio compared to none a year ago.

Controlling our operating expense while continuing to provide excellent customer service. Our infrastructure, personnel and fixed operating base can support a substantially larger asset base. As a result we believe we can cost-effectively grow as we continue to meet the financial needs of the communities in which we operate. We believe that we can be more effective in servicing our customers than many of our non-local competitors because our employees and senior management are able to respond promptly to customer needs and inquiries. Our ability to provide these services is enhanced by the experience of our executive officers, who have an average of over 27 years' experience in the financial services industry.

Critical Accounting Policies

Certain of our accounting policies are important to the portrayal of our financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Facts and circumstances which 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 deferred income taxes as well as the valuation of foreclosed assets. Our accounting policies are discussed in detail in Note 1 of the Notes to Consolidated Financial Statements included under Part I, Item 8 of this report.

Allowance for Loan Loss. We believe that the accounting estimate related to the allowance for loan losses is a critical accounting estimate because it is highly susceptible to change from period to period, requiring management to make assumptions about losses on loans. The impact of a sudden large loss could deplete the allowance and require increased provisions to replenish the allowance, which would negatively affect earnings.

The allowance for loan losses is the amount estimated by management as necessary to cover losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which is charged to income. Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. 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 specific and general components. The specific component relates to loans that are classified as impaired. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers all other loans and is based on historical industry loss experience adjusted for qualitative factors.

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. 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 residential mortgage loans by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral if the loan is collateral-dependent.

Deferred Tax Assets. Income taxes are reflected in our financial statements to show the tax effects of the operations and transactions reported in the financial statements and consist of taxes currently payable plus deferred taxes. SFAS No. 109, "Accounting for Income Taxes," requires the asset and liability approach for financial accounting and reporting for deferred income taxes. Deferred tax assets and liabilities result from differences between the financial statement carrying amounts and the tax bases of assets and liabilities. They are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled and are determined using the assets and liability method of accounting. The deferred income provision represents the difference between net deferred tax asset/liability at the beginning and end of the reported period. In formulating our deferred tax asset, we are required to estimate our income and taxes in the jurisdiction in which we operate. This process involves estimating our actual current tax exposure for the reported period together with assessing temporary differences resulting from differing treatment of items, such as depreciation and the provision for loan losses, for tax and financial reporting purposes. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. The realization of deferred tax assets is dependent on results of future operations. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.

Foreclosed Assets. Real estate acquired through foreclosure is carried at fair value less estimated selling costs. Costs associated with foreclosed assets for maintenance, repair, property tax, etc., are expensed during the period incurred. Foreclosed assets is reviewed monthly for potential impairment. When impairment is indicated the impairment is charged against current period operating results and netted against the carrying value of the property. At disposition any residual difference is either charged to current period earnings as a loss on sale or reflected as income in a gain on sale.

Comparison of Financial Condition at December 31, 2012 and December 31, 2011General. Total assets increased $1.6 million, or 1.2%, to $147.4 million at December 31, 2012 from $145.8 million at December 31, 2011. The increase in total assets was due primarily to increases in securities held to maturity and interest-bearing deposits with banks, partially offset by decreases in loans receivable. Securities held to maturity increased $5.6 million and interest-bearing deposits with banks increased $2.4 million, while loans receivable decreased $6.7 million since December 31, 2011.

Loans. Our loan portfolio decreased $6.7 million, or 6.5% to $95.3 million at December 31, 2012 from $102.0 million at December 31, 2011. One- to four-family real estate mortgage loans decreased $10.1 million, lot loans decreased $1.1 million while commercial real estate loans increased $7.8 million and construction single family loans increased $1.0 million. Consumer loans decreased $3.0 million primarily due to decreases in home equity loans. The decrease in loans receivable was due primarily to loan repayments exceeding loan originations. The decrease in loan originations was primarily attributable to the weakness in the housing market and the economy. We originate and sell one- to four-family real estate mortgage loans to Freddie Mac to generate additional income. For the year ended December 31, 2012, we originated $15.0 million of one- to four-family mortgage loans for sale, of which $14.7 million were sold to Freddie Mac at a gain on sale of $350,000.

Allowance for Loan Losses. Our allowance for loan losses at December 31, 2012 was $1.5 million, or 1.56% of net loans receivable, compared to $1.3 million, or 1.30% of net loans receivable, at December 31, 2011. Nonperforming loans decreased to $2.3 million at December 31, 2012 from $4.6 million at December 31, 2011. Nonperforming loans to total loans decreased to 2.35% at December 31, 2012 from 4.55% at December 31, 2011, primarily due to our collection efforts to work with our borrowers when possible to bring their loan payments current and when this option was not feasible, to proceed with foreclosure proceedings, as well as charge offs on impaired loans. Loans on nonaccrual which were less than ninety days past due totaled $323,000 at December 31, 2012 compared to $242,000 at December 31, 2011.

Deposits. Total deposits increased $2.2 million, or 1.9%, to $121.7 million at December 31, 2012 from $119.4 million at December 31, 2011. This increase was due primarily to an increase in money-market deposit accounts, noninterest-bearing deposit accounts and savings accounts, partially offset by a decrease in time deposits as some bank customers chose to move maturing time deposits into money-market deposit accounts due to relatively comparable interest rates, the immediate availability of funds and the anticipation of higher time deposit rates in the future. These decreases also reflect our strategy to compete less aggressively on time deposit interest rates to reduce our cost of funds.

Equity. Total equity decreased $450,000 to $24.9 million at December 31, 2012, from $25.4 million at December 31, 2011. This decrease was due to the net loss for the year ended December 31, 2012.

Average Balances, Interest and Average Yields/Cost

The following table presents for the periods indicated the total dollar amount
of interest income from average interest-earning assets and the resultant
yields, as well as the interest expense on average interest-bearing liabilities,
expressed both in dollars and rates. Income and yields on tax-exempt obligations
have not been computed on a tax equivalent basis. All average balances are daily
average balances. Nonaccruing loans have been included in the table as loans
carrying a zero yield for the period they have been on non-accrual.

                                                           Year Ended December 31,
                                            2012                                            2011
                            Average         Interest                        Average         Interest
                          Outstanding       Earned/         Yield/        Outstanding       Earned/         Yield/
                            Balance           Paid           Rate           Balance           Paid           Rate
                                                           (Dollars in thousands)
Loans receivable(1)      $      97,181     $    5,614           5.78 %   $     110,843     $    6,561           5.92 %
Investments                     11,528            263           2.28             8,148            257           3.16
FHLB stock                         232              4           1.69               276              2           0.72
Other interest-earning
assets                          23,217             59           0.25            20,383             38           0.18

Total interest-earning
assets(1)                      132,158          5,940           4.50           139,650          6,858           4.91

Money market and
savings                         63,778            317           0.50            59,814            433           0.72
Time deposits                   33,935            236           0.69            45,190            515           1.14

Total interest-bearing
liabilities                     97,713            553           0.57           105,004            948           0.90

Net interest income                        $    5,387                                      $    5,910
Interest rate spread                                            3.93 %                                          4.01 %
Net earning assets       $      34,445                                   $      34,646
Net interest
margin(2)                                                       4.08 %                                          4.23 %
Ratio of average
assets to average
liabilities                       1.35 x                                          1.33 x


(1) Calculated net of deferred loan fees, loan discounts, loans in process and loss reserves.
(2) Net interest margin represents net interest income as a percentage of average interest-bearing assets.

Rate/Volume Analysis

The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between the changes related to outstanding balances and that due to the changes in interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate multiplied by old volume). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate.

                                                   Year Ended December 31,
                                                        2012 vs. 2011

                                                   Increase               Total
                                              (decrease) due to         increase
                                             Volume          Rate      (decrease)

       Interest earning assets:
       Loans receivable                     $    (809 )     $ (137 )   $      (946 )
       Investments                                107         (101 )             6
       FHLB stock                                   -            2               2
       Other interest-earning assets                6           15              21

       Total interest-earning assets             (696 )       (221 )          (917 )

       Interest-bearing liabilities:
       Money market and savings                    29         (145 )          (116 )
       Time deposits                             (128 )       (151 )          (279 )

       Total interest-bearing liabilities         (99 )       (296 )          (395 )

       Net interest income                  $    (597 )     $   75     $      (522 )

Comparison of Results of Operation for the Year Ended December 31, 2012 and 2011

General. For the year ended December 31, 2012 we recorded a net loss of $528,000 or ($0.43) per basic and diluted share compared to a net loss of $226,000 or ($0.18) per basic and diluted share for the year ended December 31, 2011, resulting in an annualized loss on average assets of 0.37% for the year ended December 31, 2012 compared to an annualized loss on average assets of 0.15% for last year. The increase in net loss was due primarily to an 8.9% decrease in our net interest income, a 4.3% decrease in provision for loan loss, a 2.6% increase in noninterest expense, offset by a 10.9% increase in noninterest income.

Net Interest Income. Net interest income decreased $523,000, or 8.9%, to $5.4 million for the year ended December 31, 2012 from $5.9 million for the same period in 2011, primarily due to the decline in the average balance and yield of our loan portfolio, partially offset by our lower cost of deposits. Our interest-rate-spread decreased to 3.93% for the year ended December 31, 2012 from 4.01% for the same period in 2011, while our net interest margin decreased to 4.08% at December 31, 2012 from 4.23% at December 31, 2011. The ratio of average interest-earning assets to average interest-bearing liabilities for the year ended December 31, 2012 increased to 1.35x, from 1.33x for the year ended December 31, 2011.

Interest Income. Interest income for the year ended December 31, 2012 decreased $918,000, or 13.4%, to $5.9 million from $6.9 million for the same period ended December 31, 2011. The decrease in interest income for the year ended December 31, 2012 was primarily due to lower average balances of

loans receivable and a 14 basis point decline in the yield earned on loans. Average interest-earning loans receivable decreased to $97.2 million during the year ended December 31, 2012 compared to $110.8 million for the year ended December 31, 2011.

Interest Expense. Interest expense for the year ended December 31, 2012 was $553,000 compared to $948,000 for the same period in 2011, a decrease of $395,000 or 41.7%. The decrease was primarily the result of decreases in both the average balance of and the average rate paid on time deposits. The average balance of time deposits decreased to $33.9 million for the year ended December 31, 2012 from $45.2 million for the same period in 2011 and the average rate paid on certificates of deposit decreased to 0.69% from 1.14%. The total cost of funds for the year ended December 31, 2012 decreased to 0.57% from 0.90% for the year ended December 31, 2011.

Provision for Loan Losses. We establish an allowance for loan losses by charging amounts to the loan provision at a level required to reflect estimated credit . . .

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