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SFBC > SEC Filings for SFBC > Form 10-Q on 13-Nov-2013All Recent SEC Filings

Show all filings for SOUND FINANCIAL BANCORP, INC.

Form 10-Q for SOUND FINANCIAL BANCORP, INC.


13-Nov-2013

Quarterly Report


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

MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Special Note Regarding Forward-Looking Statements

Certain matters discussed in this Form 10-Q constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our financial condition, results of operations, plans, objectives, future performance or business. Forward-looking statements are not statements of historical fact, are based on certain assumptions and are generally identified by use of the words "believes," "expects," "anticipates," "estimates," "forecasts," "intends," "plans," "targets," "potentially," "probably," "projects," "outlook" or similar expressions or future or conditional verbs such as "may," "will," "should," "would" and "could." Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about, among other things, expectations of the business environment in which we operate, projections of future performance or financial items, perceived opportunities in the market, potential future credit experience, and statements regarding our mission and vision. These forward-looking statements are based upon current management expectations and may, therefore, involve risks and uncertainties. Our actual results, performance, or achievements may differ materially from those suggested, expressed, or implied by forward-looking statements as a result of a wide variety or range of factors including, but not limited to:

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

fluctuations in interest rates;

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

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

our ability to access cost-effective funding;

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

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

our ability to attract and retain deposits;

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

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

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

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

increases in premiums for deposit insurance;

our ability to control operating costs and expenses;

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

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

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

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

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

costs and effects of litigation, including settlements and judgments;

our ability to implement our business strategies;

increased competitive pressures among financial services companies;

changes in consumer spending, borrowing and savings habits;

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

our ability to pay dividends on our common stock;

adverse changes in the securities markets;

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

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

other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and the other risks described from time to time in this Form 10-Q and our other filings with the U.S. Securities and Exchange Commission (the "SEC") .

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

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

References in this document to Sound Financial Bancorp or the ("Company") refer to Sound Financial Bancorp, Inc. and its predecessor, Sound Financial, Inc., a federal corporation, and references to the "Bank" refer to Sound Community Bank. References to "we," "us," and "our" means Sound Financial Bancorp and its wholly-owned subsidiary, Sound Community Bank, unless the context otherwise requires.


General

Sound Financial Bancorp, a Maryland corporation, is a full stock holding company for its wholly owned subsidiary, Sound Community Bank (the "Bank"). On August 22, 2012, Sound Financial Bancorp completed a public offering and share exchange as part of the Bank's conversion from the mutual holding company structure and the elimination of Sound Financial, Inc. and Sound Community MHC (the "Conversion"). Please see Note 3 Conversion and Stock Issuance of the Notes to Consolidated Financial Statements under Item 1 of this report for more information. All share and per share information in this report for periods prior to the Conversion has been adjusted to reflect the 0.87423:1 exchange ratio on publicly traded shares.

Substantially all of Sound Financial Bancorp's business is conducted through Sound Community Bank, which until December 28, 2012, was a federal savings bank subject to extensive regulation by the Office of the Comptroller of the Currency. During October 2012, the Bank filed an application to convert from a federally chartered savings bank to a Washington state-chartered commercial bank. The charter change was completed on December 28, 2012. As a Washington commercial bank, the Bank's regulators are the Washington State Department of Financial Institutions ("WDFI") and the FDIC. The Board of Governors of the Federal Reserve System ("Federal Reserve") remains the primary federal regulator for the Company. The charter change primarily was undertaken to reduce regulatory examination costs and to move oversight of the Bank to the WDFI, which is focused on local community banks and financial institutions.

Sound Community Bank's deposits are insured up to applicable limits by the FDIC. At September 30, 2013, Sound Financial Bancorp had total consolidated assets of $431.7 million, net loans of $375.7 million, deposits of $341.3 million and stockholders' equity of $45.9 million. The shares of Sound Financial Bancorp are traded on The NASDAQ Capital Market under the symbol "SFBC." Our executive offices are located at 2005 5th Avenue, Suite 200, Seattle, Washington, 98121.

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

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

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

Critical Accounting Policies

Certain of our accounting policies are important to an understanding of our financial condition, since they require management to make difficult, complex or subjective judgments, 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 that could affect these judgments include, but are not limited to, changes in interest rates, changes in the performance of the economy and changes in the financial condition of borrowers. Management believes that its critical accounting policies include determining the allowance for loan losses, accounting for other-than-temporary impairment of securities, accounting for mortgage servicing rights, accounting for other real estate owned and accounting for deferred income taxes. Our methodologies for analyzing the allowance for loan losses, mortgage servicing rights, other real estate owned and deferred tax asset accounts are described in our 2012 Form 10-K. There have been no significant changes in the Company's application of accounting policies since December 31, 2012.


Comparison of Financial Condition at September 30, 2013 and December 31, 2012

General. Total assets increased by $50.7 million, or 13.3% to $431.7 million at September 30, 2013 from $381.0 million at December 31, 2012. This increase was primarily the result of a $53.2 million, or 16.5% increase in our net loan portfolio and a $3.7 million, or 51.7%, increase in the cash surrender value of BOLI partially offset by a $6.3 million, or 27.3%, decrease in available for sale securities and a $1.5 million, or 60.8%, decrease in OREO and other repossessed assets. Asset growth was funded by a $29.3 million increase in deposits, an $18.5 million increase in FHLB advances and a $2.5 million increase in shareholders' equity, primarily as a result of net income.

Cash and Securities. Cash, cash equivalents and our available-for-sale securities in the aggregate decreased by $5.0 million, or 17.6%, to $30.6 million at September 30, 2013. Cash and cash equivalents increased by $1.2 million, or 9.7%, to $14.0 million at September 30, 2013. Available-for-sale securities, which consist primarily of agency mortgage-backed securities, decreased by $6.3 million, or 27.3%, from $22.9 million at December 31, 2012 to $16.6 million at September 30, 2013 as a result of normal pay-downs and maturities, with the net proceeds being reinvested into loans.

At September 30, 2013, our available-for-sale securities portfolio consisted of $2.8 million of non-agency mortgage-backed securities. These securities present a higher credit risk than agency mortgage-backed securities or municipal bonds, of which we had $12.4 million and $1.9 million, respectively, at September 30, 2013. In order to monitor the increased risk, management receives and reviews a credit surveillance report from a third party quarterly, which evaluates these securities based on a number of factors, including its credit scores, loan-to-value ratios, geographic locations, delinquencies and loss histories of the underlying mortgage loans. This analysis is prepared in order to project future losses based on various home price depreciation scenarios over a three-year horizon. Based on these reports, management ascertains the appropriate value for these securities and, during the nine months ended September 30, 2013, recorded an other-than-temporary impairment charge of $30,000 on one of these non-agency securities. Please see Note 4 - Investments in the Notes to Consolidated Financial Statements under Item 1 of this report. The current market environment significantly limits our ability to mitigate our exposure to value changes in these more risky securities by selling them, and we do not anticipate these conditions to change significantly throughout the year. Accordingly, if the market and economic environment impacting the loans supporting these securities continues to deteriorate, we could determine that an other-than-temporary impairment must be recorded on these securities, as well as on any other securities in our portfolio. As a result, our future earnings, equity, regulatory capital and ongoing operations could be materially adversely affected.

Loans. Our total loan portfolio, including loans held for sale, increased $53.4 million, or 16.2%, from $329.3 million at December 31, 2012 to $382.7 million at September 30, 2013. Loans held for sale decreased $61,000 from $1.7 million at December 31, 2012 to $1.7 million at September 30, 2013.

The following table reflects the changes in the types of loans in our portfolio at September 30, 2013, as compared to December 31, 2012 (dollars in thousands):

                             September      December       Amount      Percent
                              30, 2013      31, 2012       Change       Change
One-to-four-family           $  116,616     $  95,784     $ 20,832         21.7 %
Home equity                      35,317        35,364          (47 )       (0.1 )
Commercial and multifamily      148,745       133,620       15,125         11.3
Construction and land            43,780        25,458       18,322         72.0
Manufactured homes               13,983        16,232       (2,249 )      (13.9 )
Other consumer                    9,393         8,650          743          8.6
Commercial business              14,842        14,193          649          4.6
Total loans                  $  382,676     $ 329,301     $ 53,375         16.2 %

The most significant change in our loan portfolio was a result of increases in one- to four- family mortgage loans which was primarily a result of increases in higher yielding jumbo mortgage and other portfolio one-to four- family mortgage loans. Construction and land loans increased primarily a result of increased demand for new homes, reflecting the improvement in the housing market in the communities we serve. We work with a small number of well-established single family home builders in our market areas. Management monitors our exposure on construction loans closely and a third party evaluates each project's percentage of completion before any draw is allowed. Commercial and multifamily loans increased primarily as a result of continued efforts to expand and diversify our lending portfolio. Manufactured homes decreased as a result of a lack of demand for these types of loans by well-qualified borrowers. The loan portfolio remains well-diversified with commercial and multifamily real estate loans accounting for 38.9% of the portfolio, of which 27.9% were owner-occupied. Residential real estate loans accounted for 30.5% of the portfolio. Home equity, manufactured and other consumer loans accounted for 15.3% of the portfolio. Construction and land accounted for11.4% of the portfolio and commercial business loans accounted for the remaining 3.9% of total loans at September 30, 2013.

Mortgage Servicing Rights. At September 30, 2013, we had $2.8 million in mortgage servicing rights recorded at fair value compared to $2.3 million at December 31, 2012. The increase was the result of a 18 basis point increase in the estimated market value of the portfolio during the nine month period from 63 basis points at December 31, 2012 to 81 basis points at September 30, 2013 primarily as a result of the increase in long-term mortgage rates slowing prepayment speeds. We record mortgage servicing rights on loans sold to Fannie Mae with servicing retained and upon acquisition of a servicing portfolio. We stratify our capitalized mortgage servicing rights based on the type, term and interest rates of the underlying loans. Mortgage servicing rights are carried at fair value. If the fair value of our mortgage servicing rights fluctuates significantly, our financial results could be materially impacted.

Nonperforming Assets. At September 30, 2013, our nonperforming assets totaled $2.9 million, or 0.67% of total assets, compared to $6.4 million, or 1.68% of total assets at December 31, 2012.

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

                                                               Nonperforming Assets
                                                  At               At
                                             September 30,      December        Amount        Percent
                                                 2013           31, 2012        Change        Change
Nonaccrual loans                            $        1,161     $     3,003     $  (1,842 )       (61.3 )%
Accruing loans 90 days or more delinquent                -              81           (81 )      (100.0 )
Nonperforming restructured loans                       761             828           (67 )        (8.1 )
OREO and repossessed assets                            981           2,503        (1,522 )       (60.8 )
Total nonperforming assets                  $        2,903     $     6,415     $  (3,512 )       (54.7 )%

Nonperforming loans to total loans decreased to 0.50% of total gross loans at September 30, 2013 from 1.19% at December 31, 2012. This decrease reflects a $2.0 million decrease in nonperforming loans during the nine month period ended September 30, 2013. Our largest nonperforming loans at September 30, 2013 consisted of a $248,000 home equity loan secured by property located in Clallam County, Washington, a $238,000 commercial real estate loan secured by property located in Clallam County, Washington and a $230,000 commercial real estate loan secured by property located in Pierce County, Washington.

OREO and repossessed assets decreased during the nine months ended September 30, 2013 primarily due to improving economic conditions in our market and our continued focus on credit administration. During the nine months ended September 30, 2013, we repossessed 11 personal residences, one commercial land development and eight manufactured homes. We sold 13 personal residences, two commercial land developments and 10 manufactured homes at an aggregate loss of $855,000. Our largest OREO at September 30, 2013, consisted of a one- to four- family home with a recorded value of $180,000 located in Mason County, Washington. Our next largest OREO properties were a $179,000 one- to four- family home located in Columbia County, Washington and a $131,000 one- to four- family home located in Snohomish County, Washington.

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

Our allowance for loan losses at September 30, 2013 was $4.1 million, or 1.08% of total loans receivable, compared to $4.2 million, or 1.30% of total loans receivable at December 31, 2012. The $133,000, or 3.1% decrease in the allowance for loan losses reflects the $1.1 million provision for loan losses established during the nine months ended September 30, 2013 as a result of decreasing loan charge-offs and nonperforming loans during this period.


The following table reflects the adjustments in our allowance during the periods indicated (dollars in thousands):

                                                                  Nine Months Ended September 30,
                                                                    2013                  2012
Balance at beginning of period                                 $         4,248       $         4,455
Charge-offs                                                             (1,357 )              (4,048 )
Recoveries:                                                                 74                   251
Net charge-offs                                                         (1,283 )              (3,797 )
Provisions charged to operations                                         1,150                 3,675
Balance at end of period                                       $         4,115       $         4,333

Ratio of net charge-offs during the period to average loans
outstanding during the period                                             0.52 %                1.67 %
Allowance as a percentage of nonperforming loans                        206.58 %               99.75 %
Allowance as a percentage of total loans (end of period)                  1.08 %                1.40 %

Specific loan loss reserves decreased $787,000 at September 30, 2013 compared to September 30, 2012 while general loan loss reserves increased $567,000 at September 30, 2013, compared to September 30, 2012. Net charge-offs for the nine months ended September 30, 2013 were $1.3 million, or 0.52% of average loans on an annualized basis, compared to $3.8 million, or 1.67% of average loans for the same period in 2012. The decrease in net charge-offs was primarily due to improving economic conditions in our market area and continued efforts in credit administration and collections. As of September 30, 2013, the allowance for loan losses as a percentage of total loans receivable and nonperforming loans was 1.08% and 206.58%, respectively, compared to 1.45% and 99.75%, respectively, at December 31, 2012. The allowance for loan losses as a percentage of total loans receivable decreased primarily as a result improved credit metrics related to both specific and general reserves. This includes a decrease in expected losses on loans individually evaluated for impairment as a percentage of these loans and a decrease in expected losses on loans collectively evaluated for impairment. The decrease in loans individually evaluated is due to lower past due and impaired loans as a percentage of the overall loan portfolio and improving values for real estate in the markets where we lend. The decrease in loans collectively evaluated is due to a lower historical charge-off ratio as of September 30, 2013 compared to December 31, 2012. The allowance for loan losses as a percentage of nonperforming loans increased due to the decrease in nonperforming loans from $3.0 million as of December 31, 2012 to $1.2 million as of September 30, 2013.

Deposits. Total deposits increased by $29.3 million, or 9.4%, to $341.3 million at September 30, 2013 from $312.1 million at December 31, 2012, primarily as a result of a $27.6 million increase in demand accounts and a $21.4 million, or 15.8%, increase in certificate of deposit accounts. This increase was partially offset by an $18.5 million, or 21.4%, decrease in money market accounts, a $746,000, or 2.7%, decrease in savings accounts and a $443,000, or 11.6% decrease in escrow accounts. The increases were primarily a result of various marketing efforts during the period as we continued our emphasis on attracting relatively low-cost core deposit accounts. The decrease in money market and saving accounts was primarily of result of customers placing these funds in higher yielding certificate or interest-bearing demand accounts or other higher yielding investments, while the decrease in escrow accounts was due to the timing of tax and insurance payments.

A summary of deposit accounts with the corresponding weighted average cost of funds is presented below:

                                                  As of September 30, 2013                   As of December 31, 2012
                                               Amount             Wtd. Avg. Rate          Amount            Wtd. Avg. Rate
Noninterest-bearing demand                 $        31,211                   0.00 %   $       31,427                   0.00 %
Interest-bearing demand                             56,320                   0.30             28,540                   0.10
Savings                                             26,428                   0.13             27,174                   0.08
Money market                                        67,677                   0.30             86,149                   0.32
Certificates                                       156,342                   1.15            134,986                   1.33
Escrow                                               3,364                   0.00              3,807                   0.00
   Total deposits                          $       341,342                   0.63 %   $      312,083                   0.69 %

Borrowings. FHLB advances increased $18.5 million, or 84.7%, to $40.4 million at September 30, 2013, with a weighted-average cost of 0.60%, from $21.9 million at December 31, 2012, with a weighted-average cost of 1.12%. We rely on FHLB advances to fund interest-earning assets when deposits alone cannot fully fund interest-earning asset growth. This reliance on borrowings, rather than deposits, may increase our overall cost of funds.

Stockholders' Equity. Total stockholders' equity increased $2.5 million, or 5.7%, to $45.9 million at September 30, 2013. This increase primarily reflects $2.9 million in net income.

Comparison of Results of Operation for the Three and Nine Months Ended September 30, 2013 and 2012

. . .

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