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VSBN > SEC Filings for VSBN > Form 10-Q on 13-Aug-2013All Recent SEC Filings

Show all filings for VSB BANCORP INC

Form 10-Q for VSB BANCORP INC


13-Aug-2013

Quarterly Report


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

Financial Condition at June 30, 2013

Total assets were $297,322,741 at June 30, 2013, an increase of $27,618,370, or 10.2%, 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 $22,212,321 net increase in investment securities

? a $10,142,290 net increase in cash and cash equivalents, partially offset by

? a $ 4,651,755 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 $268,725,622 at June 30, 2013, an increase of $28,024,416 or 11.6%, 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 $12,595,929 in non-interest demand deposits, $4,893,907 in money market accounts, $4,422,029 in NOW accounts, $3,078,383 in savings accounts, $2,818,268 in time deposits and $215,900 in escrow deposits.

Total stockholders' equity was $27,294,108 at June 30, 2013, a decrease of $459,863, or 1.66%, from December 31, 2012. The decrease reflected: (i) a $219,374 increase in retained earnings due to net income of $432,940 for the six months ended June 30, 2013, partially offset by $213,566 of dividends paid in 2013; (ii) a reduction of $84,539 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 of $816,674.

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, has recently come out of a recession, but the recovery has been slow and uneven. The extent and speed of the recovery is far from clear and the effects of low inflation, moderate job growth, and the Federal Reserve's decision to taper their purchase of mortgage-backed securities have created uncertainty not only on the pace of economic growth but on its sustainability. Some analysts continue to predict a darker road ahead. Substantial stress remains on many financial institutions and financial products due to the artificially maintained low interest rate environment, which directly places negative pressure on interest rate margins. . 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 significant weaknesses in the business economy in our market area. Our customers have been adversely affected by the economic downturn and Superstorm Sandy. 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 June 30, 2013, the percentage had declined to 4.5%. 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 and the uncertain pace of the recovery 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. However, we have a significant level of overnight and short term investments and we receive regular cash flows from the repayment of our securities portfolio, which repayment has averaged in excess of $8 million per quarter for at least the past two years, The availability of these funds should allow us to invest at higher yields as market rates increase, thus blunting the effect of the delay in repricing our loans with interest rate floors.

Transfer of Some Available For Sale Securities to Held to Maturity

During the second quarter of 2013, Senior Management and the Board decided to transfer some securities that we pledge to secure borrowings and deposits (GNMA MBS, GNMA CMOs, and FNMA balloon MBS with final maturities of ten years or less) from available for sale portfolio to the held to maturity portfolio to align those securities with the Bank's ability and intent to hold until maturity. As the securities are backed by GNMA, FNMA or FHLMC, we will recover the recorded investment and thus realize no gains or losses when the issuer pays the amount promised through maturity. Each transfer was done at fair value and any unrealized gain or loss is being amortized or accreted as the security pays down.

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. The inability to realize upon collateral promptly, increases our loss in the event of a default due to the property value deterioration during a lengthy foreclosure.

Effects of Superstorm Sandy

Superstorm 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 Superstorm 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 $275,333 to help defray those costs. In the aftermath of Sandy, we had waived deposit service charges and late fees to those affected customers.

After Superstorm Sandy, we immediately embarked an outreach program to determine the extent that our borrowers were affected by Superstorm Sandy. We contacted 58 customers that we identified as being located in areas affected by the Superstorm 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 Superstorm Sandy. Our operations center was up and running the day Superstorm Sandy left the region and had full access to all of our resources.

We have assessed the short term impact of Superstorm Sandy, including the effects on the allowance for loan losses and the loan portfolio, but the sustainability and the viability of some businesses may take longer to evaluate. We will address any of the associated issues as they arise.

Results of Operations for the Three Months Ended June 30, 2013 and June 30, 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 $223,069 for the three months ended June 30, 2013, compared to net income of $371,857 for the comparable period in 2012. The principal categories which make up the 2013 net income are:

? Interest income of $2,116,230

? Reduced by interest expense of $203,050

? Reduced by a provision for loan losses of $15,000

? Increased by non-interest income of $640,938

? Reduced by non-interest expense of $2,127,877

? Reduced by income tax expense of $188,172

We discuss each of these categories individually and the reasons for the differences between the three months ended June 30, 2013 and 2012 in the following paragraphs.

Interest Income. Interest income was $2,116,230 for the three months ended June 30, 2013, compared to $2,322,033 for the three months ended June 30, 2012, a decrease of $205,803 or 8.9%. The main reason for the decline was a 63 basis point decrease in the yield on investment securities, partially offset by a $7,164,343 increase in average balance on investment securities between the periods, which combined to cause a $143,725 decline in interest income on investment securities.

Interest income on loans decreased by $81,194 as a result of a decrease of $7.1 million in the average balance of loans partially offset by a 6 basis point increase in the average yield, from the three months ended June 30, 2012 to the three months ended June 30, 2013. There was a $1,294,431 decrease in our average non-performing loans, from $6.7 million in the three months ended June 30, 2012 to $5.4 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 June 30, 2013, our average loan yield would have been approximately 41 basis points higher. In contrast, we estimate that the comparable effect in 2012 period would have been approximately a 43 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 63 basis point decrease in the average yield on our investment securities portfolio, from 2.71% to 2.08%, 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 $7.2 million, or 6.1%, between the periods. The investment securities portfolio represented 62.4% of average non-loan interest earning assets in the 2013 period compared to 72.1% in the 2012 period.

Interest income from other interest earning assets (principally overnight investments) increased by $19,116 due to an increase in the yield of 1 basis point from 0.22% for the three months ended June 30, 2012 to 0.23% for the same period ended June 30, 2013. In addition, the average balance of our other interest earning assets increased by $29.6 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 $203,050 for the three months ended June 30, 2013, compared to $192,990 for the three months ended June 30, 2012, an increase of $10,060 or 5.2%. The principal reason for the increase was an increase in the average balance of interest-bearing deposits as we sought to increase our total deposits, partially offset by a decline in average cost of funds as we were able to reprice some deposits downward as market interest rates remained low. The components of this increase included a $13,335 increase in interest on time deposits due to a $8.9 million increase in the average balance between the periods, even as the average cost declined by 1 basis point, and a $9,837 increase in the cost of savings accounts due to 12 basis point increase in the average cost and the $5.3 million increase in the average balance between the periods. The increase in interest expense was partially offset by an $8,640 decrease in the cost of money market accounts, as the average cost declined by 17 basis points and a $4,472 decrease in the cost of NOW accounts, as the average cost declined by 6 basis points. We decided to reprice money market and NOW accounts downward due to a continuation of low market interest rates. As a result, our average cost of funds, excluding the effect of interest-free demand deposits, decreased to 0.52% from 0.49% between the periods.

Net Interest Income Before Provision for Loan Losses. Net interest income before the provision for loan losses was $1,898,180 for the three months ended June 30, 2013, compared to $2,129,043 for the three months ended June 30, 2012, a decrease of $215,863, or 10.1%. 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 June 30, 2013 to the same period ended 2012. The average yield on interest earning assets declined by 74 basis points, while the average cost of funds declined by 3 basis points. The reduction in the yield on assets was principally due to the 63 basis points drop in the yield on investment securities, partially offset by the 6 basis points increase 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 17 basis point decrease in money market accounts and the 6 basis points 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 71 basis points, from 3.17% to 2.46% between the periods. Correspondingly, our net interest margin decreased to 2.66% for the three months ended June 30, 2013 from 3.38% 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 larger average balances of our lowest yielding category, other interest earning assets. 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 $15,000 for the three months ended June 30, 2013 compared to a provision for loan losses of $65,000 for the same period in 2012. The $50,000 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 $1,079,811 in non-performing loans from $6,222,042 at June 30, 2012 to $5,142,231 at June 30, 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 $97,753 of loans for the three months ended June 30, 2013 as compared to charge-offs of $16,675 for the same period in 2012. We also had recoveries (which are added back to the allowance for loan losses) of $17,326 for the three months ended June 30, 2013 as compared to $92,159 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 June 30, 2013 was appropriate to address inherent losses. Overall, our allowance for loan losses decreased from $1,582,397 or 1.84% of total loans, at June 30, 2012 to $1,251,587 or 1.63% of total loans, at June 30, 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 $640,938 for the three months ended June 30, 2013, compared to $628,231 during the same period last year. The $12,707, or 2.0%, increase in non-interest income was a direct result of an increase of $43,659 in other income, primarily due to a reimbursement of $36,394 in expenses from insurance proceeds received in response to Superstorm Sandy, partially offset by a $36,677 decrease in service charges on deposits due to reduced non-sufficient fees. 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 $2,127,877 for the three months ended June 30, 2013, compared to $2,006,779 for the three months ended June 30, 2012, an increase of $121,098 or 6.0%. The principal shifts in the individual categories were:

? a $104,334 increase in other non-interest expenses due to a $62,413 increase in the cost of holding real estate acquired in foreclosure, principally writedowns of REO assets, and foreclosure costs; a $16,080 increases in marketing costs due to a new ad campaign, a $9,812 increase in the costs of operating our ATM's; and increases other normal operating expenses;

? a $62,569 increase in salaries and benefits due to the acceleration of stock benefits due to a retirement and the accrual for termination expenses; partially offset by;

? a $30,734 decrease in occupancy expense due to a reimbursement by our insurance carrier of monies expensed in the remediation and rebuilding of our Dongan Hills branch, which sustained damage during Superstorm Sandy; and

? an $18,978 decrease in legal expense, due primarily to a recovery of two past due loans on which $15,992 in legal fees had been expensed.

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 $188,172 for the three months ended June 30, 2013, compared to income tax expense of $313,638 for the same period ended 2012. The decrease in income tax expense was due to the $274,254 decrease in income before income taxes in the 2013 period. Our effective tax rate for the three months ended June 30, 2013 and 2012 was 45.8%.

Results of Operations for the Six Months Ended June 30, 2013 and June 30, 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 $432,940 for the six months ended June 30, 2013, compared to net income of $653,485 for the comparable period in 2012. The principal categories which make up the 2013 net income are:

? Interest income of $4,185,807

? Reduced by interest expense of $416,064

? Reduced by a provision for loan losses of $135,000

? Increased by non-interest income of $1,251,539

? Reduced by non-interest expense of $4,088,168

? Reduced by income tax expense of $365,174

We discuss each of these categories individually and the reasons for the differences between the six months ended June 30, 2013 and 2012 in the following paragraphs.

Interest Income. Interest income was $4,185,807 for the six months ended June 30, 2013, compared to $4,634,705 for the six months ended June 30, 2012, a decrease of $448,898 or 9.7%. The main reason for the decline was a 67 basis point decrease in the yield on investment securities, partially offset by a $7,389,248 increase in average balance on investment securities between the periods, which combined to cause a $306,384 decline in interest income on investment securities.

Interest income on loans decreased by $178,501 as a result of a decrease of $4.1 million in the average balance of loans and a 4 basis point decrease in the average yield, from the six months ended June 30, 2012 to the six months ended June 30, 2013. There was a $2,786,130 decrease in our average non-performing loans, from $8.5 million in the six months ended June 30, 2012 to $5.7 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 six months ended June 30, 2013, our average loan yield would have been approximately 34 basis points higher. In contrast, we estimate that the comparable effect in 2012 period would have been approximately a 39 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 67 basis point decrease in the average yield on our investment securities portfolio, from 2.80% to 2.13%, 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 $7.4 million, or 6.5%, between the periods. The investment securities portfolio represented 62.3% of average non-loan interest earning assets in the 2013 period compared to 71.7% in the 2012 period.

Interest income from other interest earning assets (principally overnight investments) increased by $35,987 due to an increase in the yield of 1 basis point from 0.22% for the six months ended June 30, 2012 to 0.23% for the same period ended June 30, 2013. In addition, the average balance of our other interest earning assets increased by $28.5 million between the periods because . . .

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