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VSBN > SEC Filings for VSBN > Form 10-Q on 14-May-2013All Recent SEC Filings

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Form 10-Q for VSB BANCORP INC


14-May-2013

Quarterly Report


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

Financial Condition at March 31, 2013

Total assets were $276,676,726 at March 31, 2013, an increase of $6,972,355, or 2.6%, from December 31, 2012. The increase resulted from the investment of funds available to us as the result of retained earnings and an increase in deposits. The deposit increase was caused generally by our efforts to grow our franchise and specifically by the deposit increases at our branch offices. We invested these funds primarily in the purchase of new investment securities. The principal changes resulting in the net increase in assets can be summarized as follows:

? a $14,922,458 net increase in investment securities available for sale partially offset by

? a $ 6,044,327 net decrease in cash and cash equivalents and

? a $ 2,174,342 net decrease in loans receivable, net.

In addition to these changes in major asset categories, we also experienced changes in other asset categories due to normal fluctuations in operations.

Our deposits (including escrow deposits) were $247,954,853 at March 31, 2013, an increase of $7,253,647 or 3.0%, from December 31, 2012 as a result of our active solicitation of retail deposits to increase funds for investment. The aggregate increase in deposits resulted from increases of $4,464,946 in non-interest demand deposits, $1,870,882 in time deposits, $1,687,301 in savings accounts, $151,841 in escrow deposits and $68,264 in money market accounts, partially offset by a decrease of $989,587 in NOW accounts.

Total stockholders' equity was $27,729,351 at March 31, 2013, a decrease of $24,620, or 0.09%, from December 31, 2012. The decrease reflected: (i) a $103,088 increase in retained earnings due to net income of $209,871 for the three months ended March 31, 2013, partially offset by $106,783 of dividends paid in 2013; (ii) a reduction of $42,270 in Unearned ESOP shares reflecting the gradual payment of the loan we made to fund the ESOP's purchase of our stock and
(iii) a decrease in the net unrealized gain on securities available for sale of $184,611.

The unrealized gain on securities available for sale is excluded from the calculation of regulatory capital. Management does not anticipate selling securities in this portfolio, but changes in market interest rates or in the demand for funds may change management's plans with respect to the securities portfolio. If there is a material increase in interest rates, the market value of the available for sale portfolio may decline. Management believes that the principal and interest payments on this portfolio, combined with the existing liquidity, will be sufficient to fund loan growth and potential deposit outflow.

The Current Economic Turmoil

The economy in the United States, including the economy in Staten Island, was and may still be in a recession. Although some analysts report that the economy is recovering, the extent and speed of the recovery is far from clear and some analysts predict a darker road ahead. There is substantial stress on many financial institutions and financial products. The federal government has intervened by making hundreds of billions of dollars in capital contributions to the banking industry. We draw a substantial portion of our customer base from local businesses, especially those in the building trades and related industries, and we believe that there continue to be substantial weaknesses in the business economy in our market area. Our customers have been adversely affected by the economic downturn, and if adverse conditions in the local economy continue, it will become more difficult for us to conduct prudent and profitable business in our community.

Making permanent residential mortgage loans is not a material part of our business, and our investments in mortgage-backed securities and collateralized mortgage obligations have been made with a view towards avoiding the types of securities that are backed by low quality mortgage-related assets. However, one of the primary focuses of our local business is receiving deposits from, and making loans to, businesses involved in the construction and building trades industry on Staten Island. Construction loans represented a significant component of our loan portfolio, reaching 39.8% of total loans at year end 2005. As we monitored the economy and the strength of the local construction industry, we elected to reduce our portfolio of construction loans. By March 31, 2013, the percentage had declined to 3.4%. However, developers and builders provide not only a source of loans, but they also provide us with deposits and other business. The weakness in the economy has had an adverse effect on some of our customers and potential customers, making it more difficult for us to find satisfactory loan opportunities. This compelled us to invest in lower yielding securities instead of higher-yielding loans. This has and may continue to reduce our net income.

Possible Adverse Effects on Our Net Income Due to Fluctuations in Market Rates

Our principal source of income is the difference between the interest income we earn on interest-earning assets, such as loans and securities, and our cost of funds, principally interest paid on deposits. These rates of interest change from time to time, depending upon a number of factors, including general market interest rates. However, the frequency of the changes varies among different types of assets and liabilities. For example, for a five-year loan with an interest rate based upon the prime rate, the interest rate may change every time the prime rate changes. In contrast, the rate of interest we pay on a five-year certificate of deposit adjusts only every five years, based upon changes in market interest rates.

In general, the interest rates we pay on deposits adjust more slowly than the interest rates we earn on loans because our loan portfolio consists primarily of loans with interest rates that fluctuate based upon the prime rate. In contrast, although many of our deposit categories have interest rates that could adjust immediately, such as interest checking accounts and savings accounts, changes in the interest rates on those accounts are at our discretion. Thus, the rates on those accounts, as well as the rates we pay on certificates of deposit, tend to adjust more slowly. As a result, the declines in market interest rates that occurred through the end of 2008 initially had an adverse effect on our net income because the yields we earn on our loans declined more rapidly than our cost of funds. However, many of our prime-based loans have minimum interest rates, or floors, below which the interest rate does not decline despite further decreases in the prime rate. As our loans reached their interest rate floors, our loan yields stabilized while our deposit costs continued to decline. This had a positive effect on our net interest income.

When market interest rates begin increasing, which we expect will occur at some point in the future, we anticipate an initial adverse effect on our net income. We anticipate that this will occur because our deposit rates should begin to rise, while loan yields remain relatively steady until the prime rate increases sufficiently that our loans begin to reprice above their interest rate floors. For most of our prime-rate based loans, this will not occur until the prime rate increases above 6%. Once our loan rates exceed the interest rate floors, increases in market interest rates should increase our net interest income because our cost of deposits should probably increase more slowly than the yields on our loans. However, customer preferences and competitive pressures may negate this positive effect because customers may choose to move funds into higher-earning deposit types as higher interest rates make them more attractive, or competitors offer premium rates to attract deposits. We also have a substantial portfolio of investment securities with fixed rates of interest, most of which are mortgage-backed securities with an estimated average life of not more than 7 years.

Delays in Foreclosure Proceedings

The length of time it takes to prosecute a foreclosure action and be able to sell real estate collateral in New York has substantially lengthened. It is not unusual for it to take more than two years from the date a foreclosure action is commenced until the property is sold even in uncontested cases, and some uncontested cases can take longer. This problem, if it continues or gets worse, could have a substantial adverse effect on the value of our collateral for loans in default. Especially in the case of construction loans, where property value deterioration during a lengthy foreclosure is more likely, the inability to realize upon collateral increases our loss in the event of a default.

Effects of Hurricane Sandy

Hurricane Sandy has had a devastating effect on the homes and businesses of New York City, especially Staten Island. We opened four of five locations (all located in Richmond County) the day after the Hurricane and they are in full operation. We re-opened the fifth location in February 2013 and all retail banking services are fully operational. While Hurricane Sandy did not have a significant effect on our operations, we incurred expenses of approximately $300,000 to remediate and reconstruct one of our branches that suffered sewer backup, water and wind driven rain damage. We have received insurance proceeds of $224,133 to help defray those costs. In the aftermath of Sandy, we had waived deposit service charges and late fees to those affected customers.

After Hurricane Sandy, we immediately embarked an outreach program to determine the extent that our borrowers were affected by Hurricane Sandy. We contacted 58 customers that we identified as being located in areas affected by the hurricane who sustained some of, or a combination of, the following issues: substantial water and sewage damage to the business' physical plant, machinery and equipment; extended power loss causing business interruptions; displaced tenants due to the flood and sewage backup; employees unable to report to work due to the loss/damage of their personal homes or cars and the loss of mass transit. We individually assessed their condition and access to resources. The majority of our customers were able to restart their business with little assistance from us.

As we are primarily a commercial lender, we did not have residential loans that were negatively affected. We received 12 requests for either one or two month payment deferrals on commercial loans, which we granted. All twelve resumed their payments.

We operate primarily in Richmond County (Staten Island) and that is where we had the highest impact. We had one loan in Kings County that was affected but has since been current on payments. We had sufficient liquidity and resources to handle the effects of Hurricane Sandy. Our operations center was up and running the day Hurricane Sandy left the region and had full access to all of our resources.

We are still assessing the full impact of Hurricane Sandy, including the effects on the allowance for loan losses and the loan portfolio, and we will address any of the associated issues as they arise.

Results of Operations for the Three Months Ended March 31, 2013 and March 31, 2012

Our results of operations depend primarily on net interest income, which is the difference between the income we earn on our loan and investment portfolios and our cost of funds, consisting primarily of interest we pay on customer deposits. Our operating expenses principally consist of employee compensation and benefits, occupancy expenses, professional fees, advertising and marketing expenses and other general and administrative expenses. Our results of operations are significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government policies and actions of regulatory authorities.

General. We had net income of $209,871 for the three months ended March 31, 2013, compared to net income of $281,628 for the comparable period in 2012. The principal categories which make up the 2013 net income are:

? Interest income of $2,069,577

? Reduced by interest expense of $213,014

? Reduced by a provision for loan losses of $120,000

? Increased by non-interest income of $610,601

? Reduced by non-interest expense of $1,960,291

? Reduced by income tax expense of $177,002

We discuss each of these categories individually and the reasons for the differences between the three months ended March 31, 2013 and 2012 in the following paragraphs.

Interest Income. Interest income was $2,069,577 for the three months ended March 31, 2013, compared to $2,312,672 for the three months ended March 31, 2012, a decrease of $243,095 or 10.5%. The main reason for the decline was a 73 basis point decrease in the yield on investment securities, partially offset by a $7,634,178 increase in average balance on investment securities between the periods, which combined to cause a $162,659 decline in interest income on investment securities.

Interest income on loans decreased by $97,307 as a result of a decrease of $1.1 million in the average balance of loans and a 13 basis point decrease in the average yield, from the three months ended March 31, 2012 to the three months ended March 31, 2013. There was a $4,274,693 decrease in our average non-performing loans, from $10.3 million in the three months ended March 31, 2012 to $6.0 million in the same period ended 2013. During the period in which interest is not being paid, non-performing loans continue to be included in the calculation of average loan yield, but with an effective yield of zero. We estimate that if all non-performing loans were performing according to their contractual terms during the three months ended March 31, 2013, our average loan yield would have been approximately 14 basis points higher. In contrast, we estimate that the comparable effect in 2012 period would have been approximately a 33 basis point increase in average loan yield. Substantially all of the non-accrual loans are secured by mortgages on real estate.

Interest rate floors on most of our loans have helped to stabilize interest income from the loan portfolio, but these floors will have the effect of limiting increases in our income until the prime rate rises above 6%.

We experienced a 73 basis point decrease in the average yield on our investment securities portfolio, from 2.90% to 2.17%, due to the purchase of new investment securities at lower market rates than the rates we had been earning on the investment securities previously purchased that were gradually being repaid. The average balance of our investment portfolio increased by $7.6 million, or 6.9%, between the periods. The investment securities portfolio represented 62.1% of average non-loan interest earning assets in the 2013 period compared to 71.3% in the 2012 period.

Interest income from other interest earning assets (principally overnight investments) increased by $16,871 due to an increase in the yield of 1 basis point from 0.22% for the three months ended March 31, 2012 to 0.23% for the same period ended March 31, 2013. In addition, the average balance of our other interest earning assets increased by $27.5 million between the periods because we elected to invest most of the available funds in overnight investments rather than tie them up in longer term investment securities which were available only at relatively low yields.

Interest Expense. Interest expense was $213,014 for the three months ended March 31, 2013, compared to $214,491 for the three months ended March 31, 2012, a decrease of $1,477 or 0.7%. The decrease was the result of a reduction in the rates we paid on deposits between the periods, principally a 16 basis point decrease in money market account rates and a 10 basis point decrease in the cost of Now account deposits, due to the continuing low market interest rates, partially offset by a 12 basis point increase in the cost of savings accounts. As a result, our average cost of funds, excluding the effect of interest-free demand deposits, decreased to 0.53% from 0.61% between the periods.

Net Interest Income Before Provision for Loan Losses. Net interest income before the provision for loan losses was $1,856,563 for the three months ended March 31, 2013, compared to $2,098,181 for the three months ended March 31, 2012, a decrease of $241,618, or 11.5%. The decrease was because the reduction in our interest income was greater than the reduction in our cost of funds when comparing the three months ended March 31, 2013 to the same period ended 2012. The average yield on interest earning assets declined by 75 basis points, while the average cost of funds declined by 8 basis points. The reduction in the yield on assets was principally due to the 73 basis point drop in the yield on investment securities, the 13 basis point drop in the yield on loans and the increase in low yielding overnight investments as a percentage of total interest-earning assets. The decline in the cost of funds was driven principally by the 16 basis point decrease in money market accounts and the 10 basis point decrease in the cost of NOW accounts , partially offset by a 12 basis point increase in cost of savings accounts. Overall, our interest rate spread declined 67 basis points, from 3.20% to 2.53% between the periods. Correspondingly, our net interest margin decreased to 2.74% for the three months ended March 31, 2013 from 3.45% in the same period of 2012. The margin is higher than the spread because it takes into account the effect of interest free demand deposits and capital.

The spread and margin both decreased because of the combined effect of the decline in earnings we were able to obtain on our investments securities and the adverse effect of the decrease in interest received on problem loans. These declines could not be offset by corresponding declines in the cost of deposits because the rates we paid on deposits were already low due to low markets rates so that we could not reduce them as much as the decline in the earnings on investment securities. In addition, we continued to incur interest expense on deposits that funded the non-performing loans that did not earn interest and on other interest earning assets, our lowest yielding asset class.

Provision for Loan Losses. The provision for loan losses in any period depends upon the amount necessary to bring the allowance for loan losses to the level management believes is appropriate, after taking into account charge offs and recoveries. We took a provision for loan losses of $120,000 for the three months ended March 31, 2013 compared to a provision for loan losses of $175,000 for the same period in 2012. The $55,000 decrease in the provision was a result of a lower level of non-performing loans and total loans, despite a higher level of charge-offs..

We experienced a decrease of $1,430,136 in non-performing loans from $7,161,236 at March 31, 2012 to $5,731,100 at March 31, 2013. Most of those loans are secured by real estate. We individually evaluated the non-performing mortgage loans based primarily upon updated appraisals as part of our analysis of the appropriate level of our allowance for loan and lease losses. We charged-off $582,648 of loans for the three months ended March 31, 2013 as compared to charge-offs of $100,757 for the same period in 2012. We also had recoveries (which are added back to the allowance for loan losses) of $26,141 for the three months ended March 31, 2013 as compared to $24,650 in the same period of 2012.

After considering other matters that increased or decreased the allowance, we determined that the level of our allowance at March 31, 2013 was appropriate to address inherent losses. Overall, our allowance for loan losses decreased from $1,441,913 or 1.74% of total loans, at March 31, 2012 to $1,317,014 or 1.65% of total loans, at March 31, 2013. There can be no assurance that a higher level, or a higher provision for loan losses, will not be necessary in the future.

Non-interest Income. Non-interest income was $610,601 for the three months ended March 31, 2013, compared to $620,725 during the same period last year. The $10,124, or 1.6%, decrease in non-interest income was a direct result of a $43,967 decrease in service charges on deposits, partially offset by an increase of $23,469 in other income primarily due to a $17,571 gain on the sale of a fixed asset. Service charges on deposits consist mainly of insufficient fund fees, which are inherently volatile, and are based upon the number of items being presented for payment against insufficient funds.

Non-interest Expense. Non-interest expense was $1,960,291 for the three months ended March 31, 2013, compared to $2,024,745 for the three months ended March 31, 2012, a decrease of $64,454 or 3.2%. The principal shifts in the individual categories were:

? a $43,402 decrease in occupancy expense due to a reimbursement by our insurance carrier on monies expensed in the remediation and rebuilding of our Dongan Hills branch, which sustained damage during Hurricane Sandy;

? a $38,920 decrease in salaries and benefits due to reduced level of staffing;

? a $17,846 decrease in legal expense due to a lower level of collections;

? a $16,775 decrease in director's fee due to decreased frequency of meetings; partially offset by

? a $28,930 increase in other non-interest expenses due to a $10,269 increase in the cost of holding real estate, a $9,000 increase in the costs of regulatory filings and a $7,055 increase in the costs of operating our ATM's; and

? a $22,287 increase in computer expenses due to a recent rise in software contract expense.

In addition to these changes, we also experienced changes in the various other non-interest expenses categories due to normal fluctuations in operations.

Income Tax Expense. Income tax expense was $177,002 for the three months ended March 31, 2013, compared to income tax expense of $237,533 for the same period ended 2012. The decrease in income tax expense was due to the $132,288 decrease in income before income taxes in the 2013 period. Our effective tax rate for the three months ended March 31, 2013 and 2012 was 45.8%.

                               VSB Bancorp, Inc.

                      Consolidated Average Balance Sheets

                                  (unaudited)



                                                 Three                                          Three
                                              Months Ended                                   Months Ended
                                             March 31, 2013                                 March 31, 2012
                                  Average                         Yield/         Average                         Yield/
                                  Balance         Interest         Cost          Balance         Interest         Cost

Assets:
Interest-earning assets:
Loans receivable               $  81,316,512     $ 1,399,141         6.84 %   $  82,459,455     $ 1,496,448         6.97 %
Investment securities, afs       117,609,978         629,911         2.17       109,975,800         792,570         2.90
Other interest-earning
assets                            71,730,979          40,525         0.23        44,215,778          23,654         0.22
Total interest-earning
assets                           270,657,469       2,069,577         3.06       236,651,033       2,312,672         3.81

Non-interest earning assets        6,594,799                                      7,220,609
Total assets                   $ 277,252,268                                  $ 243,871,642

Liabilities and equity:
Interest-bearing
liabilities:
Savings accounts               $  21,951,820          18,504         0.34     $  17,400,080           9,608         0.22
Time accounts                     75,894,643         128,591         0.69        65,622,245         125,955         0.77
Money market accounts             32,260,499          50,596         0.64        28,608,240          56,712         0.80
Now accounts                      32,327,912          15,323         0.19        30,432,546          22,216         0.29
Total interest-bearing
liabilities                      162,434,874         213,014         0.53       142,063,111         214,491         0.61
Checking accounts                 85,981,493                                     73,057,277
Escrow deposits                      217,956                                        305,576
Total deposits                   248,634,323                                    215,425,964
Other liabilities                    813,579                                      1,244,726
Total liabilities                249,447,902                                    216,670,690
Equity                            27,804,366                                     27,200,952
Total liabilities and equity   $ 277,252,268                                  $ 243,871,642

Net interest income/net
interest rate spread                             $ 1,856,563         2.53 %                     $ 2,098,181         3.20 %

Net interest earning
assets/net interest margin     $ 108,222,595                         2.74 %   $  94,587,922                         3.45 %

Ratio of interest-earning
assets to interest-bearing
liabilities                             1.67 x                                         1.67 x


Return on Average Assets (1)            0.29 %                                         0.40 %
Return on Average Equity (1)            2.84 %                                         3.62 %
Tangible Equity to Total
Assets                                 10.02 %                                        10.84 %


 (1) Ratios have been annualized.

Liquidity and Capital Resources

Our primary sources of funds are increases in deposits, proceeds from the repayment of investment securities, and the repayment of loans. We use these funds to purchase new investment securities and to fund new and renewing loans in our loan portfolio. Remaining funds are invested in short-term liquid assets such as overnight federal funds loans and bank deposits.

During the three months ended March 31, 2013, we had a net increase in total deposits of $7,253,647 due to increases of $4,464,946 in non-interest demand deposits, $1,870,882 in time deposits, $1,687,301 in savings accounts, $151,841 in escrow deposits and $68,264 in money market accounts, partially offset by a decrease of $989,587 in NOW accounts. These are all what are commonly known as "retail" deposits that we obtain through the efforts of our branch network rather than "wholesale" deposits that some banks obtain from deposit brokers. We also received proceeds from repayment of investment securities of $9,105,243. We used $24,496,847 of available funds to purchase new investment securities and we had a net loan decrease of $2,073,064. These changes resulted in an overall decrease in cash and cash equivalents of $6,044,327. Total cash and cash equivalents at March 31, 2013 were $71,684,099.

In contrast, during the three months ended March 31, 2012, we had a net increase in total deposits of $8,579,358 due to increases of $3,981,987 in non-interest demand deposits, $3,686,645 in money market accounts, $1,305,208 in NOW accounts, $274,122 in savings accounts and $126,894 in escrow deposits, partially offset by a decrease of $795,498 in time deposits. We also received proceeds from repayment of investment securities of $9,100,838. We used $18,755,966 of available funds to purchase new investment securities and we had a net loan increase of $910,888. These changes resulted in an overall decrease in cash and cash equivalents of $1,735,480. Total cash and cash equivalents at March 31, 2012 were $46,372,193.

At March 31, 2013, cash and cash equivalents represented 25.9% of total assets. Our cash and cash equivalents decreased as we deployed more funds into investment securities which will enable us to generate higher interest income. We maintain a higher level of cash and cash equivalents to help buffer the adverse effects of potential, future rising interest rates. We anticipate, based upon historical experience that these funds, combined with cash inflows we anticipate from payments on our loan and investment securities portfolios, will be sufficient to fund loan growth and unanticipated deposit outflows. Depending upon competitive pressures, we may need to implement interest-paying business checking in order to maintain demand deposits at historical levels or to increase such deposits.

As a secondary source of liquidity, at March 31, 2013 we had $121.7 million of . . .

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