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SFBC > SEC Filings for SFBC > Form 10-Q on 14-May-2014All Recent SEC Filings

Show all filings for SOUND FINANCIAL BANCORP, INC.



Quarterly Report

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



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 Board of Governors of the Federal Reserve System ("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-K 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.


Sound Financial Bancorp, a Maryland corporation, is a stock holding company for its wholly owned subsidiary, Sound Community Bank (the "Bank"). Substantially all of Sound Financial Bancorp's business is conducted through Sound Community Bank, a Washington state-chartered commercial bank. 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") is the primary federal regulator for the Company.

Sound Community Bank's deposits are insured up to applicable limits by the FDIC. At March 31, 2014, Sound Financial Bancorp had total consolidated assets of $445.6 million, net loans of $390.7 million, deposits of $363.3 million and stockholders' equity of $46.8 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, some 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 to our borrowers.

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 2013 Form 10-K. There have been no significant changes in the Company's application of accounting policies since December 31, 2013.

Comparison of Financial Condition at March 31, 2014 and December 31, 2013

General. Total assets increased by $3.0 million, or 0.7% to $445.6 million at March 31, 2014 from $442.6 million at December 31, 2013. This increase was primarily the result of a $4.0 million, or 1.0%, increase in our net loan portfolio, partially offset by a $1.4 million, or 4.6%, decrease in cash, cash equivalents and available for sale securities and an $825,000 decrease in OREO and other repossessed assets. A $15.0 million increase in deposits was used to primarily to pay down outstanding borrowings and fund the increase in loans.

Cash and Securities. Cash, cash equivalents and our available-for-sale securities in the aggregate decreased by $1.4 million, or 4.6%, to $29.3 million at March 31, 2014. Cash and cash equivalents decreased by $720,000, or 4.7%, to $14.6 million at March 31, 2014. Available-for-sale securities, which consist primarily of agency mortgage-backed securities, decreased by $691,000, or 4.5%, from $15.4 million at December 31, 2013 to $14.7 million at March 31, 2014 as a result of normal pay-downs and maturities, with the net proceeds being reinvested into loans.

At March 31, 2014, our available-for-sale securities portfolio consisted of $2.4 million of non-agency mortgage-backed securities. These securities present a higher credit risk than agency mortgage-backed securities and municipal bonds, of which we had $10.3 million and $2.0 million, respectively, at March 31, 2014. In order to monitor the increased risk, management receives and reviews a credit surveillance report from a third party semiannually, 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 three months ended March 31, 2014, recorded no other-than-temporary impairment charges on these non-agency securities. Please see Note 3 - 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, excluding loans held for sale, increased $4.0 million, or 1.0%, from $392.2 million at December 31, 2013 to $396.1 million at March 31, 2014. Loans held for sale increased $1.3 million from $130,000 at December 31, 2013 to $1.4 million at March 31, 2014.

The following table reflects the changes in the types of loans in our portfolio at March 31, 2014, as compared to December 31, 2013 (dollars in thousands):

                                           March 31,       December
                                              2014         31, 2013        Amount Change       Percent Change
One-to-four-family                         $  120,142     $   117,739     $         2,403                  2.0 %
Home equity                                    34,782          35,155                (373 )               (1.1 )
Commercial and multifamily                    155,040         157,516              (2,476 )               (1.6 )
Construction and land                          42,951          44,300              (1,349 )               (3.0 )
Manufactured homes                             13,030          13,496                (466 )               (3.5 )
Other consumer                                  9,927          10,284                (357 )               (3.5 )
Commercial business                            20,266          13,668               6,598                 48.3
Total loans                                $  396,138     $   392,158     $         3,980                  1.0 %

The most significant change in our loan portfolio was an increase in our commercial business loans. These types of loans increased as a result of our strategy of further diversifying our loan portfolio by attracting these non-real estate types of loans. At March 31, 2014, our loan portfolio remained well-diversified with commercial and multifamily real estate loans accounting for 39.1% of the portfolio, of which 29.4% were owner-occupied. Residential real estate loans accounted for 30.3% of the portfolio. Home equity, manufactured and other consumer loans accounted for 14.6% of the portfolio. Construction and land accounted for 10.8% of the portfolio and commercial business loans accounted for the remaining 5.1% of total loans.

Mortgage Servicing Rights. At March 31, 2014, we had $2.9 million in mortgage servicing rights recorded at fair value compared to $3.0 million at December 31, 2013. The decrease was the result of lower average balances of serviced loans as a result of reduced refinancing activity and lower purchase activity due to seasonality in the home buying market. 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 March 31, 2014, nonperforming assets totaled $2.2 million, or 0.50% of total assets, compared to $3.1 million, or 0.70% of total assets at December 31, 2013.

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

                                                                    Nonperforming Assets
                                             At March       At December
                                             31, 2014         31, 2013        Amount Change      Percent Change
Nonaccrual loans                            $       758     $        558     $           200                35.8 %
Accruing loans 90 days or more delinquent             -              321                (321 )            (100.0 )
Nonperforming restructured loans                  1,103            1,042                  61                 5.9
OREO and repossessed assets                         353            1,178                (825 )             (70.0 )
Total nonperforming assets                  $     2,214     $      3,099     $          (885 )             (28.6 )%

Nonperforming loans to total loans decreased to 0.50% of total gross loans at March 31, 2014 from 0.70% at December 31, 2013. This reflects a $60,000 decrease in nonperforming loans during the three months ended March 31, 2014. Our largest nonperforming loans at March 31, 2014 consisted of three commercial real estate loans secured by property located in Clallam County, Washington and totaled $780,000 in the aggregate.

OREO and repossessed assets decreased during the three months ended March 31, 2014, primarily due to improving economic conditions in our market and our continued focus on credit administration. During the three months ended March 31, 2014, we repossessed one personal residence and three manufactured homes. We sold eig ht personal residences and one manufactured home at an aggregate loss of $25,000. Our largest OREO at March 31, 2014, consisted of a one- to four- family home with a recorded value of $127,000 located in Clallam County, Washington. Our next largest OREO properties were a $54,000 manufactured home located in Clallam County, Washington and a $50,000 one- to four- family home located in Pierce 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 March 31, 2014 was $4.2 million, or 1.06% of total loans receivable compared to $4.2 million, or 1.07% of total loans receivable at December 31, 2013. The allowance for loan losses reflects the $200,000 provision for loan losses established during the three months ended March 31, 2014.

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

                                                                  Three Months Ended March 31,
                                                                    2014                 2013
Balance at beginning of period                                 $        4,177       $        4,248
Charge-offs                                                              (236 )               (494 )
Recoveries:                                                                35                   42
Net charge-offs                                                          (201 )               (452 )
Provisions charged to operations                                          200                  250
Balance at end of period                                       $        4,176       $        4,046

Ratio of net charge-offs during the period to average loans
outstanding during the period                                            0.20 %               0.54 %
Allowance as a percentage of nonperforming loans                       224.40 %             176.30 %
Allowance as a percentage of total loans (end of period)                 1.06 %               1.19 %

Specific loan loss reserves decreased $62,000 at March 31, 2014 compared to December 31, 2013, while general loan loss reserves increased $61,000 at March 31, 2014, compared to December 31, 2013. Net charge-offs for the three months ended March 31, 2014 were $201,000, or 0.20% of average loans on an annualized basis, compared to $452,000, or 0.54% of average loans for the same period in 2013. 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 March 31, 2014, the allowance for loan losses as a percentage of total loans receivable and nonperforming loans was 1.06% and 224.40%, respectively, compared to 1.07% and 217.44%, respectively, at December 31, 2013. 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 increase in loans collectively evaluated is

due to an increase in loans receivable and an evaluation by management of a longer look-back period in calculating the historical loss ratios. Management will continue to evaluate the appropriate loss periods given changes in the economic environment and nature of the risks within the loan portfolio. The allowance for loan losses as a percentage of nonperforming loans increased due to a $60,000 decrease in nonperforming loans from $1.92 million as of December 31, 2013 to $1.86 million as of March 31, 2014.

Deposits. Total deposits increased by $15.0 million, or 4.3%, to $363.3 million at March 31, 2014 from $348.3 million at December 31, 2013, primarily as a result of a $10.1 million increase in interest-bearing demand accounts and a $6.8 million, or 4.3%, increase in certificate of deposit accounts. This increase was partially offset by a $5.3 million, or 9.0%, decrease in money market accounts. The increases were primarily a result of retail and marketing efforts during the period as we continued our emphasis on attracting relatively low-cost core deposit accounts. The decrease in money market was primarily of result of customers placing these funds in higher yielding certificate or interest-bearing demand accounts.

A summary of deposit accounts with the corresponding weighted average cost of funds is presented below (dollars in thousands):

                                                  As of March 31, 2014                    As of December 31, 2013
                                              Amount           Wtd. Avg. Rate          Amount            Wtd. Avg. Rate
Noninterest-bearing demand                 $      33,931                  0.00 %   $       31,877                   0.00 %
Interest-bearing demand                           80,729                  0.45             70,639                   0.37
Savings                                           27,111                  0.15             26,509                   0.14
Money market                                      53,779                  0.27             59,069                   0.30
Certificates                                     164,321                  1.06            157,528                   1.13
Escrow                                             3,476                  0.00              2,717                   0.00
Total deposits                             $     363,347                  0.63 %   $      348,339                   0.64 %

Borrowings. FHLB advances decreased $15.2 million, or 35.1%, to $28.1 million at March 31, 2014, with a weighted-average cost of 0.53%, from $43.2 million at December 31, 2013, with a weighted-average cost of 0.53%. 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 $286,000, or 0.7%, to $46.8 million at March 31, 2014. This increase reflects $987,000 in net income and other comprehensive income of $131,000 which was partially offset by $904,000 in stock repurchases and dividends of $125,000.

Comparison of Results of Operation for the Three Months Ended March 31, 2014 and 2013

General. Net income increased $190,000 to $987,000, or $0.38 per diluted common share, for the three months ended March 31, 2014, compared to $797,000, or $0.30 per diluted common share, for the three months ended March 31, 2013. The primary reasons for the improvement in comparative periods were an increase in net interest income and decreases in noninterest expense and provision for loan losses, which were partially offset by lower gain on sale of loans and lower mortgage servicing income.

Interest Income. Interest income increased by $566,000, or 12.2%, to $5.2 million for the three months ended March 31, 2014, from $4.6 million for the three months ended March 31, 2013. The increase in interest income primarily reflected the increase in the average balance of interest-earning assets. In particular, our average balance of loans receivable outpaced the decline in the weighted average yield on our interest-earning assets during the three months ended March 31, 2014 as compared to the same period last year.

Our weighted average yield on interest-earning assets was 4.99% for the three months ended March 31, 2014, compared to 5.19% for the three months ended March 31, 2013. The weighted average yield on loans decreased to 5.24% for the three months ended March 31, 2014, from 5.37% for the three months ended March 31, 2013. The average balance of gross loans receivable increased $58.9 million, or 17.6% for the three months ended March 31, 2014 as compared to the same period last year. The weighted average yield on available-for-sale securities (including OTTI) was 0.91% for the three months ended March 31, 2014, compared to 2.12% for the three months ended March 31, 2013, reflecting higher average balances of agency mortgage-backed securities and municipal bonds, which generate a lower yield than non-agency mortgage-backed securities. The average . . .

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