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Sound Financial Bancorp, Inc. - Quarter Report: 2013 March (Form 10-Q)

sfbc10q033113.htm
 
 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
FORM 10-Q

[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2013
 
OR
[  ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ___________ to ____________  

COMMISSION FILE NUMBER 001-35633

Sound Financial Bancorp, Inc.
 
(Exact Name of Registrant as Specified in its Charter)

Maryland
 
45-5188530
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
     
2005 5th Avenue, Suite 200, Seattle Washington
 
98121
(Address of principal executive offices)
 
(Zip Code)

Registrant’s telephone number, including area code:  (206) 448-0884

None
(Former name, former address and former fiscal year, if changed since last report)

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   YES [X]  NO [   ]

Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   YES [X]   NO [   ]

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting Company.  See definition of “large accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Act.

Large accelerated filer [  ]
Accelerated filer [  ]
Non-accelerated filer [  ]
Smaller reporting Company [X]
   
(Do not check if smaller reporting company)
 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  YES [   ]    NO [X]


Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of the latest practicable date.

As of May 15, 2013, there were 2,587,544 shares of the registrant’s common stock outstanding.


 
 

 

SOUND FINANCIAL BANCORP, INC.
FORM 10-Q
TABLE OF CONTENTS

 
Page Number
PART I    FINANCIAL INFORMATION
 
 
Item 1.      Financial Statements 
 
 
Condensed Consolidated Balance Sheets as of March 31, 2013 (unaudited) and December 31, 2012 (unaudited)
 
3
Condensed Consolidated Statements of Income for the Three Months Ended March 31, 2013 and 2012 (unaudited)
 
4
Condensed Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2013 and 2012 (unaudited)
 
5
Condensed Consolidated Statement of Stockholders’ Equity for the Three Months Ended March 31, 2013 and 2012 (unaudited)
 
6
Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2013 and 2012 (unaudited)
 
7
Selected Notes to Condensed Consolidated Financial Statements
 
8
Item 2.      Management's Discussion and Analysis of Financial Condition and Results of Operations
 
29
Item 3.      Quantitative and Qualitative Disclosures About Market Risk
 
39
Item 4.      Controls and Procedures
 
39
PART II   OTHER INFORMATION
 
 
Item 1.       Legal Proceedings
 
40
Item 1A     Risk Factors
 
40
Item 2.        Unregistered Sales of Equity Securities and Use of Proceeds
 
40
Item 3.        Defaults Upon Senior Securities
 
40
Item 4.        Mine Safety Disclosures
 
40
Item 5.        Other Information
 
40
Item 6.        Exhibits
 
41
SIGNATURES
 
 
EXHIBITS
 


 
 

 


SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Condensed Consolidated Balance Sheets (Unaudited)
(In thousands, except share amounts)

  ASSETS  
March 31, 2013
   
December 31, 2012
 
Cash and cash equivalents
  $ 8,795     $ 12,727  
Available-for-sale securities, at fair value
    19,713       22,900  
Federal Home Loan Bank (FHLB) stock, at cost
    2,379       2,401  
Loans held for sale
    2,083       1,725  
Loans
    338,866       326,744  
Less allowance for loan losses
    (4,046 )     (4,248 )
Total Loans, net
    334,820       322,496  
                 
Accrued interest receivable
    1,303       1,280  
Bank-owned life insurance, net
    10,798       7,220  
Other real estate owned (“OREO”) and repossessed assets, net
    2,453       2,503  
Mortgage servicing rights, at fair value
    2,396       2,306  
Premises and equipment, net
    2,280       2,256  
Other assets
    3,636       3,230  
Total assets
  $ 390,656     $ 381,044  
                 
LIABILITIES
               
Deposits
               
Interest-bearing
    281,698       276,849  
Noninterest-bearing demand
    35,029       35,234  
Total deposits
    316,727       312,083  
                 
Borrowings
    25,703       21,864  
Accrued interest payable
    78       83  
Other liabilities
    3,223       3,226  
Advance payments from borrowers for taxes and insurance
    585       331  
Total liabilities
    346,316       337,587  
                 
COMMITMENTS AND CONTINGENCIES (NOTE 8)
               
                 
STOCKHOLDERS' EQUITY
               
Preferred stock, $0.01 par value, 1,000,000 shares authorized, none issued or outstanding
    -       -  
Common stock, $0.01 par value, 40,000,000 shares authorized, 2,587,544 shares issued and outstanding as of March 31, 2013 and December 31, 2012
    26       26  
Additional paid-in capital
    24,832       24,789  
Unearned shares - Employee Stock Ownership Plan (“ESOP”)
    (1,598 )     (1,598 )
Retained earnings
    21,533       20,736  
Accumulated other comprehensive loss, net of tax
    (452 )     (496 )
Total stockholders’ equity
    44,341       43,457  
Total liabilities and stockholders’ equity
  $ 390,657     $ 381,044  

See notes to condensed consolidated financial statements

 
 

 
 
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Income (unaudited)
(In thousands, except share and per share amounts)

   
Three Months Ended March 31,
 
  INTEREST INCOME  
2013
   
2012
 
Loans, including fees
  $ 4,504     $ 4,508  
Interest and dividends on investments, cash and cash equivalents
    132       55  
Total interest income
    4,636       4,563  
                 
INTEREST EXPENSE
               
Deposits
    501       546  
Borrowings
    68       55  
Total interest expense
    569       601  
                 
NET INTEREST INCOME
    4,067       3,962  
PROVISION FOR LOAN LOSSES
    250       1,500  
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
    3,817       2,462  
                 
NONINTEREST INCOME
               
Service charges and fee income
    598       550  
Earnings on cash surrender value of bank-owned life insurance
    78       66  
Mortgage servicing income
    127       177  
Fair value adjustment on mortgage servicing rights
    135       384  
Other-than-temporary impairment losses on securities
    (19 )     (91 )
Net gain on sale of loans
    447       251  
Total noninterest income
    1,366       1,337  
                 
NONINTEREST EXPENSE
               
Salaries and benefits
    1,687       1,283  
Operations
    967       582  
Regulatory assessments
    100       122  
Occupancy
    299       310  
Data processing
    288       242  
Net loss on OREO and repossessed assets
    675       469  
Total noninterest expense
    4,016       3,008  
                 
INCOME BEFORE PROVISION FOR INCOME TAXES
    1,167       791  
PROVISION FOR INCOME TAXES
    370       245  
NET INCOME
  $ 797     $ 546  
                 
Earnings per common share
               
Basic
  $ 0.31     $ 0.21  
Diluted
  $ 0.30     $ 0.21  
Weighted average shares outstanding
               
Basic
    2,587,544       2,581,631  
Diluted
    2,645,109       2,603,585  

See notes to condensed consolidated financial statements


 
 

 


SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Comprehensive Income (unaudited)
(In thousands)

   
Three Months Ended March 31,
 
   
2013
   
2012
 
Net Income
  $ 797     $ 546  
                 
Other comprehensive income
               
                 
Unrealized gain on securities
               
Unrealized holding gain, net of
               
taxes of $16 and $59, respectively
    31       114  
Reclassification adjustments for other-than-temporary
               
impairment on securities, net of taxes of $6 and $31, respectively
    13       60  
                 
Other comprehensive income, net of tax
    44       174  
                 
Comprehensive income
  $ 841     $ 720  

See notes to condensed consolidated financial statements

 
 

 

SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Stockholders’ Equity
For the Three Months Ended March 31, 2013 and 2012 (unaudited)
(In thousands, except number of shares)
 
   
Shares
   
Common Stock
   
Additional Paid-in Capital
   
Unearned ESOP Shares
   
Retained Earnings
   
Accumulated Other Comprehensive Loss, net of tax
   
Total Stockholders’ Equity
 
Balances at December 31, 2012
    2,587,544     $ 26     $ 24,789     $ (1,598 )   $ 20,736     $ (496 )   $ 43,457  
                                                         
Net income
                                    797               797  
                                                         
Other comprehensive income, net of tax
                                            44       44  
                                                         
Share-based compensation
                    43                               43  
                                                         
Balances at March 31, 2013
    2,587,544     $ 26     $ 24,832     $ (1,598 )   $ 21,533     $ (452 )   $ 44,341  


   
Shares
   
Common Stock
   
Additional Paid-in Capital
   
Unearned ESOP Shares
   
Retained Earnings
   
Accumulated Other Comprehensive Loss, net of tax
   
Total Stockholders’ Equity
 
Balances at December 31, 2011
    2,949,045     $ 30     $ 11,939     $ (693 )   $ 18,096     $ (659 )   $ 28,713  
                                                         
Net income
                                    546               546  
                                                         
Other comprehensive income, net of tax
                                            174       174  
                                                         
Restricted stock awards
    11,000                                               -  
                                                         
Share-based compensation
                    33                               33  
                                                         
Balances at March 31, 2012
    2,960,045     $ 30     $ 11,972     $ (693 )   $ 18,642     $ (485 )   $ 29,466  

See notes to condensed consolidated financial statements

 
 

 

 SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Cash Flows (unaudited)
(In thousands)
 
   
Three Months Ended March 31,
 
  CASH FLOWS FROM OPERATING ACTIVITIES  
2013
   
2012
 
Net income
  $ 797     $ 546  
Adjustments to reconcile net income to net cash from operating activities
               
Accretion of net premium on investments
    138       -  
Other-than-temporary impairment losses on securities
    19       91  
Provision for loan losses
    250       1,500  
Depreciation and amortization
    109       90  
Compensation expense related to stock options and restricted stock
    43       33  
Fair value adjustment on mortgage servicing rights
    (135 )     (384 )
Additions to mortgage servicing rights
    (217 )     (185 )
Amortization of mortgage servicing rights
    262       215  
Increase in cash surrender value of bank-owned life insurance
    (78 )     (66 )
Gain on sale of loans
    (447 )     (251 )
Proceeds from sale of loans
    25,876       21,132  
Originations of loans held for sale
    (25,787 )     (20,213 )
Loss on sale of other real estate owned and repossessed assets
    584       255  
Change in operating assets and liabilities
               
Accrued interest receivable
    (23 )     81  
Other assets
    (431 )     (1,034 )
Accrued interest payable
    (5 )     (2 )
Other liabilities
    (3 )     299  
Net cash from operating activities
    952       2,107  
CASH FLOWS FROM INVESTING ACTIVITIES
               
Proceeds from principal payments, maturities and sales of available for sale securities
    3,098       130  
FHLB stock redeemed
    22       -  
Net increase in loans
    (13,385 )     (2,735 )
Improvements to OREO and other repossessed assets
    (33 )     (206 )
Proceeds from sale of OREO and other repossessed assets
    310       1,190  
Purchases of premises and equipment, net
    (133 )     (15 )
Purchases of bank-owned life insurance
    (3,500 )     -  
Net cash used by investing activities
    (13,621 )     (1,636 )
CASH FLOWS FROM FINANCING ACTIVITIES
               
Net increase in deposits
    4,644       7,779  
Proceeds from borrowings
    68,000       -  
Repayment of borrowings
    (64,161 )     (160 )
Net change in advances from borrowers for taxes and insurance
    254       288  
Net cash from financing activities
    8,737       7,907  
(DECREASE) INCREASE CASH AND CASH EQUIVALENTS
    (3,932 )     8,378  
CASH AND CASH EQUIVALENTS, beginning of period
    12,727       17,031  
CASH AND CASH EQUIVALENTS, end of period
  $ 8,795     $ 25,409  
                 
SUPPLEMENTAL CASH FLOW INFORMATION
               
Cash paid for income taxes
  $ -     $ -  
Interest paid on deposits and borrowings
  $ 574     $ 603  
Noncash net transfer from loans to other real estate owned and repossessed assets
  $ 811     $ 483  
 
See notes to condensed consolidated financial statements

 
 

 

SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)


Note 1 – Basis of Presentation

The accompanying financial information is unaudited and has been prepared from the consolidated financial statements of Sound Financial Bancorp, Inc. (“we,” “us,” “our,” “Sound Financial Bancorp,” or the “Company”) and its wholly owned subsidiary, Sound Community Bank (the “Bank”).  These unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission (“SEC”).  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the financial position and results of operations for the periods presented have been included.  Certain information and disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the rules and regulations of the SEC.  These unaudited financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2012, as filed with the SEC on March 31, 2013 (“2012 Form 10-K”).  The results for the interim periods are not necessarily indicative of results for a full year.  For further information, refer to the consolidated financial statements and footnotes for the year ended December 31, 2012, included in the 2012 Form 10-K.

Certain amounts in the prior quarters’ financial statements have been reclassified to conform to the current presentation.  These classifications do not have an impact on previously reported net income, retained earnings or earnings per share.

On August 22, 2012, the Company completed its conversion from the mutual holding company structure and related public stock offering, so that it is now a stock holding company that is wholly owned by public shareholders.  Please see Note 2 – Conversion and Stock Issuance for more information.

Note 2 – Conversion and Stock Issuance

The Company, a Maryland corporation, was organized by Sound Community MHC, Sound Financial, Inc. and Sound Community Bank to facilitate the “second-step” conversion of Sound Community Bank from the mutual holding company structure to the stock holding company structure (the “Conversion”).  Upon consummation of the Conversion, which occurred on August 22, 2012, the Company became the holding company for Sound Community Bank and now owns all of the issued and outstanding shares of Sound Community Bank’s common stock.

In connection with the Conversion, the Company sold a total of 1,417,500 shares of common stock in offering to certain depositors of Sound Community Bank and others, including 113,400 shares to the Sound Community Bank employee stock ownership plan (“ESOP”).  All shares were sold at a purchase price of $10.00 per share.  Proceeds from the offering, net of $1.5 million in expenses, totaled $12.7 million.  The Company used $1.1 million of the proceeds to fund the ESOP and made a $7.5 million capital contribution to the Bank.  In addition, concurrent with the offering, shares of Sound Financial, Inc. common stock owned by public stockholders were exchanged for 0.87423 shares of the Company’s common stock, with cash being paid in lieu of issuing any fractional shares.  As a result of the offering, exchange and cash in lieu of fractional shares, the Company had 2,587,544 shares outstanding as of March 31, 2013.

All share and per share information in this report for periods prior to the Conversion has been revised to reflect the 0.87423 Conversion exchange ratio.


Note 3 – Accounting Pronouncements Recently Issued or Adopted

In December 2011, the Financial Accounting Standards Board (the "FASB") issued ASU No. 2011-11, Disclosures about Offsetting Assets and Liabilities.  This update requires an entity to offset, and present as a single net amount, a recognized eligible asset and a recognized eligible liability when it has an unconditional and legally enforceable right of setoff and intends either to settle the asset and liability on a net basis or to realize the asset and settle the liability simultaneously.  This update further requires an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position.  The amendments are effective for annual and interim reporting periods beginning on or after January 1, 2013.  The adoption of this update did not have a material impact on the Company’s consolidated financial statements. 

 
 

 

SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)

 
In July 2012, the FASB issued ASU No. 2012-02, Testing Indefinite-Lived Intangible Assets for Impairment.  Under this update, a company testing indefinite-lived intangibles for impairment now has the option to assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired.  If, after assessing the totality of events and circumstances, an entity concludes that it is not more likely than not that the indefinite-lived intangible asset is impaired, then the entity is not required to take further action.  However, if an entity concludes otherwise, then it is required to determine the fair value of the indefinite-lived intangible asset and perform the quantitative impairment test by comparing the fair value with the carrying amount in accordance with current guidance.  An entity also has the option to bypass the qualitative assessment for any indefinite-lived intangible asset in any period and proceed directly to performing the quantitative impairment test.  An entity will be able to resume performing the qualitative assessment in any subsequent period.  The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after September 15, 2012.   The adoption of this update did not have a material impact on the Company’s consolidated financial statements. 
 
In October 2012, the FASB issued ASU No. 2012-06, Subsequent Accounting for an Indemnification Asset Recognized at the Acquisition Date as a Result of a Government-Assisted Acquisition of a Financial Institution.   This update clarifies that when an entity recognizes an indemnification asset as a result of a government-assisted acquisition of a financial institution and subsequently, a change in the cash flows expected to be collected on the indemnification asset occurs, as a result of a change in cash flows expected to be collected on the assets subject to indemnification, the reporting entity should subsequently account for the change in the measurement of the indemnification asset on the same basis as the change in the assets subject to indemnification.  Any amortization of changes in value should be limited to the contractual term of the indemnification agreement.  The amendments are effective for annual and interim reporting periods beginning on or after December 15, 2012. The adoption of this update did not have a material impact on the Company’s consolidated financial statements.

In January 2013, the FASB issued ASU No. 2013-01, Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities. This update clarifies that ASU No. 2011-11 applies only to derivatives, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset or subject to an enforceable master netting arrangement or similar agreement.  Entities with other types of financial assets and financial liabilities subject to a master netting arrangement or similar agreement are no longer subject to the disclosure requirements in ASU No. 2011-11.  The amendments are effective for annual and interim reporting periods beginning on or after January 1, 2013.  The adoption of ASU No. 2013-01 did not have a material impact on the Company's consolidated financial statements. 

In February 2013, the FASB issued ASU No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.  This update requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component and to present either on the face of the statement where net income is presented, or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income, but only if the amount reclassified is required to be reclassified to net income in its entirety in the same reporting period. The amendments are effective for annual and interim reporting periods beginning on or after December 15, 2012.  The adoption of this update did not have a material impact on the Company's consolidated financial statements.

 
 

 

SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)
 
Note 4 – Investments
 
The amortized cost and fair value of our available-for-sale securities (“AFS”) and the corresponding amounts of gross unrealized gains and losses at the dates indicated were as follows:
 
   
Amortized
Cost
   
Gross Unrealized
   
Estimated FairValue
 
 
Gains
   
Losses 1 Year
Or Less
   
Losses Greater
Than 1 Year
 
March 31, 2013
 
(In thousands)
 
Agency mortgage-backed securities
  $ 17,276     $ 5     $ (265 )   $ -     $ 17,016  
Non-agency mortgage-backed securities
    3,121       53       -     $ (477 )     2,697  
Total
  $ 20,397     $ 58     $ (265 )   $ (477 )   $ 19,713  
                                         
December 31, 2012
     
Agency mortgage-backed securities
  $ 20,378     $ 27     $ (278 )   $ -     $ 20,127  
Non-agency mortgage-backed securities
    3,273       19       -       (519 )     2,773  
Total
  $ 23,651     $ 46     $ (278 )   $ (519 )   $ 22,900  

The amortized cost and fair value of mortgage-backed securities by contractual maturity, at March 31, 2013, are shown below.  Expected maturities of mortgage-backed securities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

   
At March 31, 2013
 
   
Amortized Cost
   
Fair Value
 
   
(In thousands)
 
Due after ten years
  $ 20,397     $ 19,713  

Securities with an amortized cost of $8.1 million and fair value of $8.0 million at March 31, 2013 were pledged to secure Washington State Public Funds.  Additionally, the Company has letters of credit with a notional amount of $24.5 million to secure public deposits.

There were no sales of available for sale securities during the three months ended March 31, 2013 and 2012.

 
 

 
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)
 
 

The following table summarizes at the dates indicated the aggregate fair value and gross unrealized loss by length of time of those investments that have been continuously in an unrealized loss position:
 
   
March 31, 2013
 
   
Less Than 12 Months
   
12 Months or Longer
   
Total
 
   
Fair
Value
   
Unrealized Loss
   
Fair
Value
   
Unrealized Loss
   
Fair
Value
   
Unrealized Loss
 
March 31, 2013
 
(In thousands)
 
Agency mortgage-backed securities
  $ 16,962     $ (265 )   $ -     $ -     $ 16,962     $ (265 )
Non-agency mortgage-backed securities
    -       -       1,503       (477 )     1,503       (477 )
   Total
  $ 16,962     $ (265 )   $ 1,503     $ (477 )   $ 18,465     $ (742 )
                                                 
   
December 31, 2012
 
   
Less Than 12 Months
   
12 Months or Longer
   
Total
 
   
Fair
Value
 
Unrealized Loss
   
Fair
Value
   
Unrealized Loss
   
Fair
Value
   
Unrealized Loss
 
December 31, 2012
 
(In thousands)
 
Agency mortgage-backed securities
  $ 17,685     $ (278 )   $ -     $ -     $ 17,685     $ (278 )
Non-agency mortgage-backed securities
    -       -       2,137       (519 )     2,137       (519 )
   Total
  $ 17,685     $ (278 )   $ 2,137     $ (519 )   $ 19,822     $ (797 )

 
The following table presents the cumulative roll forward of credit losses recognized in earnings during the three months ended March 31, 2013 and 2012 relating to the Company’s non-U.S. agency mortgage backed securities:
 
   
Three Months Ended March 31,
 
   
2013
   
2012
 
   
(In thousands)
 
Estimated credit losses, beginning balance
  $ 420     $ 256  
Additions for credit losses not previously recognized
    19       91  
Reduction for increases in cash flows
    -       -  
Reduction for realized losses
    -       -  
Estimated credit losses, ending balance
  $ 439     $ 347  
 
As of March 31, 2013, our securities portfolio consisted of 17 U.S. agency and five non-U.S. agency mortgage backed securities with a fair value of $19.7 million.  Three of the five non-U.S. agency securities and 15 of the 17 U.S. agency securities were in an unrealized loss position.  The unrealized losses were caused by changes in interest rates and
market illiquidity causing a decline in the fair value subsequent to the purchase.  The contractual terms of these investments do not permit the issuer to settle the securities at a price less than par.  While management does not intend to sell the non-agency mortgage backed securities, and it is unlikely that the Company will be required to sell these securities before recovery of its amortized cost basis, management’s impairment evaluation indicates that certain securities possess qualitative and quantitative factors that suggest an other-than-temporary impairment (“OTTI”).  These factors include, but are not limited to: the length of time and extent of the fair value declines, ratings agency down grades, the potential for an increased level of actual defaults, and the extension in duration of the securities.  In addition to the qualitative factors, management’s evaluation includes an assessment of quantitative evidence that involves the use of cash flow modeling and present value calculations as determined by considering the applicable OTTI accounting guidance.  The Company compares the present value of the current estimated cash flows to the present value of the previously estimated cash flows.  Accordingly, if the present value of the current estimated cash flows is less than the present value of the previous period’s present value, an adverse change is considered to exist and the security is considered OTTI.  The associated “credit loss” is the amount by which the security’s amortized cost exceeds the present value of the current estimated cash flows.  Based upon the results of the cash flow modeling, four securities reflected OTTI of $19,000 during the three months ended March 31, 2013.  Estimating the expected cash flows and determining the present values of the cash flows involves the use of a variety of assumptions and complex modeling.  In developing its assumptions, the Company considers all available information relevant to the collectability of the applicable security, including information about past events, current conditions, and reasonable and supportable forecasts.  Furthermore, the Company asserts that the cash flows used in the determination of OTTI are its “best estimate” of cash flows.

 
 

 


SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)


Note 5 – Loans

The composition of the loan portfolio at the dates indicated, including loans held for sale, was as follows:
 
   
At March 31, 2013
   
At December 31, 2012
 
Real estate loans:
 
(In thousands)
 
One- to four- family
  $ 98,993     $ 95,784  
Home equity
    35,339       35,364  
Commercial and multifamily
    133,178       133,620  
Construction and land
    34,513       25,458  
Total real estate loans
    302,023       290,226  
                 
Consumer loans:
               
Manufactured homes
    15,576       16,232  
Other consumer
    8,779       8,650  
Total consumer loans
    24,355       24,882  
                 
Commercial business loans
    14,571       14,193  
                 
Total loans
    340,949       329,301  
Deferred fees
    (957 )     (832 )
Loans held for sale
    (2,083 )     (1,725 )
Total loans, gross
    338,866       326,744  
Allowance for loan losses
    (4,046 )     (4,248 )
Total loans, net
  $ 334,820     $ 322,496  

 
 

 
 
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)


The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of March 31, 2013:

   
One-to-
four family
   
Home
 equity
   
Commercial
and multifamily
   
Construction
and land
   
Manufactured
homes
   
Other
 consumer
   
Commercial
business
   
Unallocated
   
Total
 
Allowance for loan losses:  
(In thousands)
 
Individually evaluated for impairment
  $ 336     $ 334     $ 69     $ 25     $ 107     $ 27     $ 108     $ -     $ 1,006  
Collectively evaluated for impairment
    963       669       458       262       110       151       92       335       3,040  
Ending balance
  $ 1,299     $ 1,003     $ 527     $ 287     $ 217     $ 178     $ 200     $ 335     $ 4,046  
   
Loans receivable
 
Individually evaluated for impairment
  $ 6,305     $ 1,748     $ 1,015     $ 99     $ 623     $ 52     $ 1,027     $ -     $ 10,869  
Collectively evaluated for impairment
    92,688       33,591       132,163       34,414       14,953       8,727       13,544       -       330,080  
Ending balance
  $ 98,993     $ 35,339     $ 133,178     $ 34,513     $ 15,576     $ 8,779     $ 14,571     $ -     $ 340,949  

 
The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of December 31, 2012:
 
   
One-to-
four family
   
Home
 equity
   
Commercial
and multifamily
   
Construction
and land
   
Manufactured
 homes
   
Other
consumer
   
Commercial
 business
   
Unallocated
   
Total
 
Allowance for loan losses:  
(In thousands)
 
Individually evaluated for impairment
  $ 392     $ 247     $ 70     $ 25     $ 117     $ 22     $ 145     $ -     $ 1,018  
Collectively evaluated for impairment
    1,025       750       422       192       143       124       73       501       3,230  
Ending balance
  $ 1,417     $ 997     $ 492     $ 217     $ 260     $ 146     $ 218     $ 501     $ 4,248  
   
Loans receivable:
 
Individually evaluated for impairment
  $ 6,016     $ 1,731     $ 2,127     $ 571     $ 654     $ 55     $ 839     $ -     $ 11,993  
Collectively evaluated for impairment
    89,768       33,633       131,493       24,887       15,578       8,595       13,354       -       317,308  
Ending balance
  $ 95,784     $ 35,364     $ 133,620     $ 25,458     $ 16,232     $ 8,650     $ 14,193     $ -     $ 329,301  


 
 

 
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)


The following table summarizes the activity in loan losses for the three months ended March 31, 2013:
 
   
Beginning
Allowance
   
Charge-offs
   
Recoveries
   
Provision
   
Ending
Allowance
 
   
(In thousands)
 
One-to-four family
  $ 1,417     $ (69 )   $ -     $ (49 )   $ 1,299  
Home equity
    997       (147 )     2       151       1,003  
Commercial and multifamily
    492       (192 )     32       195       527  
Construction and land
    217       (7 )     -       77       287  
Manufactured homes
    260       (24 )     -       (19 )     217  
Other consumer
    146       (11 )     8       35       178  
Commercial business
    218       (44 )     -       26       200  
Unallocated
    501       -       -       (166 )     335  
  Total   $ 4,248     $ (494 )   $ 42     $ 250     $ 4,046  

The following table summarizes the activity in loan losses for the three months ended March 31, 2012:
 

 
   
Beginning
Allowance
   
Charge-offs
   
Recoveries
   
Provision
   
Ending
Allowance
 
   
(In thousands)
 
One-to-four family
  $ 1,117     $ (750 )   $ -     $ 1,215     $ 1,582  
Home equity
    1,426       (714 )     2       697       1,410  
Commercial and multifamily
    969       -       -       (461 )     508  
Construction and land
    105       (37 )     -       (2 )     66  
Manufactured homes
    290       (28 )     1       114       377  
Other consumer
    213       (78 )     7       2       142  
Commercial business
    254       (6 )     -       (14 )     234  
Unallocated
    81       -       -       (50 )     31  
  Total   $ 4,455     $ (1,613 )   $ 10     $ 1,500     $ 4,350  

Credit Quality Indicators.  Federal regulations provide for the classification of lower quality loans and other assets, such as debt and equity securities, as substandard, doubtful or loss.  An asset is considered substandard if it is inadequately protected by the current net worth and payment capacity of the borrower or of any collateral pledged.  Substandard assets include those characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected.  Assets classified as doubtful have all the weaknesses of currently existing facts, conditions and values.  Assets classified as loss are those considered uncollectible and of such little value that their continuance as assets without establishment of a specific loss reserve is not warranted.
 
When we classify problem loans as either substandard or doubtful, we may establish a specific allowance in an amount we deem prudent to address the risk specifically (if the loan is impaired) or we may allow the loss to be addressed in the general allowance (if the loan is not impaired).  General allowances represent loss reserves which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been specifically allocated to particular problem loans.  When the Company classifies problem loans as a loss, we charge off such assets in the period in which they are deemed uncollectible.  Assets that do not currently expose us to sufficient risk to warrant classification as substandard or doubtful but possess identified weaknesses are classified as either watch or special mention assets.  Our determination as to the classification of our assets and the amount of our valuation allowances is subject to review by the FDIC, which can order the establishment of additional loss allowances.  Pass rated loans are loans that are not otherwise classified or criticized.
 

 
 

 


SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)

 

The following table represents the internally assigned grades as of March 31, 2013 by type of loan:
 
   
One-to-
four family
   
Home
equity
   
Commercial
and multifamily
   
Construction
and land
   
Manufactured
homes
   
Other
 consumer
   
Commercial
business
   
Total
 
Grade:
 
(In thousands)
 
Pass
  $ 87,345     $ 31,079     $ 131,399     $ 34,168     $ 14,260     $ 8,283     $ 12,644     $ 319,178  
Watch
    8,622       2,927       945       345       1,288       469       1,154       15,750  
Special Mention
    437       494       592       -       -       -       27       1,550  
Substandard
    2,589       839       242       -       28       27       746       4,471  
Doubtful
    -       -       -       -       -       -       -       -  
Loss
    -       -       -       -       -       -       -       -  
Total
  $ 98,993     $ 35,339     $ 133,178     $ 34,513     $ 15,576     $ 8,779     $ 14,571     $ 340,949  

 

 
The following table represents the internally assigned grades as of December 31, 2012 by type of loan:
 

 
   
One-to-
 four family
   
Home
equity
   
Commercial
and multifamily
   
Construction
and land
   
Manufactured
 homes
   
Other
consumer
   
Commercial
business
   
Total
 
Grade:
 
(In thousands)
 
Pass
  $ 84,685     $ 30,927     $ 130,721     $ 24,641     $ 14,898     $ 8,102     $ 12,290     $ 306,264  
Watch
    8,279       3,064       954       347       1,312       520       1,087       15,563  
Special Mention
    490       499       595       -       -       -       -       1,584  
Substandard
    2,329       874       1,350       471       23       28       815       5,890  
Doubtful
    -       -       -       -       -       -       -       -  
Loss
    -       -       -       -       -       -       -       -  
Total
  $ 95,784     $ 35,364     $ 133,620     $ 25,458     $ 16,232     $ 8,650     $ 14,193     $ 329,301  

 
Nonaccrual and Past Due Loans.  Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due.  Loans are automatically placed on nonaccrual once the loan is three months past due or sooner if, in management’s opinion, the borrower may be unable to meet payment of obligations as they become due, as well as when required by regulatory provisions.
 
The following table presents the recorded investment in nonaccrual loans as of March 31, 2013 and December 31, 2012, by type of loan:
 
   
March 31, 2013
   
December 31, 2012
 
   
(In thousands)
 
One- to four- family
  $ 1,234     $ 1,013  
Home equity
    306       332  
Commercial and multifamily
    -       1,106  
Construction and land
    -       471  
Other consumer
    3       1  
Commercial business
    12       80  
Total
  $ 1,555     $ 3,003  

 

 
 

 

SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)

 
 
The following table represents the aging of the recorded investment in past due loans as of March 31, 2013 by type of loan:
 
   
30-59 Days
Past Due
   
60-89 Days
Past Due
   
Greater Than 90
Days Past Due
   
Recorded Investment > 90 Days
 and Accruing
   
Total Past Due
   
Current
   
Total Loans
 
   
(In thousands)
 
One-to-four family
  $ 2,450     $ -     $ 1,128     $ -     $ 3,578     $ 95,415     $ 98,993  
Home equity
    759       305       306       -       1,370       33,969       35,339  
Commercial and multifamily
    -       -       -       -       -       133,178       133,178  
Construction and land
    134       -       -       -       134       34,379       34,513  
Manufactured homes
    152       21       -       -       173       15,403       15,576  
Other consumer
    27       17       3       -       47       8,732       8,779  
Commercial business
    368       -       12       -       380       14,191       14,571  
Total
  $ 3,890     $ 343     $ 1,449     $ -     $ 5,682     $ 335,267     $ 340,949  

 
The following table represents the aging of the recorded investment in past due loans as of December 31, 2012 by type of loan:
 

 
   
30-59 Days
Past Due
   
60-89 Days
Past Due
   
Greater Than 90 Days Past Due
   
Recorded Investment > 90 Days and Accruing
   
Total Past Due
   
Current
   
Total Loans
 
   
(In thousands)
 
One-to-four family
  $ 2,238     $ 572     $ 836     $ 81     $ 3,727     $ 92,057     $ 95,784  
Home equity
    886       364       332       -       1,582       33,782       35,364  
Commercial and multifamily
    -       -       -       -       -       133,620       133,620  
Construction and land
    243       -       471       -       714       24,744       25,458  
Manufactured homes
    326       2       -       -       328       15,904       16,232  
Other consumer
    65       2       1       -       68       8,582       8,650  
Commercial business
    63       -       80       -       143       14,050       14,193  
Total
  $ 3,821     $ 940     $ 1,720     $ 81     $ 6,562     $ 322,739     $ 329,301  

 
Nonperforming Loans.  Loans are considered nonperforming when they are placed on nonaccrual and/or when they are considered to be nonperforming troubled debt restructurings (“TDRs”).  A TDR is a loan to a borrower that is experiencing financial difficulty that has been modified from its original terms and conditions in such a way that the Company is granting the borrower a concession of some kind.  Nonperforming TDRs include TDRs that do not have sufficient payment history (typically six months) to be considered performing or performing TDRs that have become 31 or more days past due.
 

 
The following table represents the credit risk profile based on payment activity as of March 31, 2013 by type of loan:
 

 
   
One-to-
four family
   
Home
equity
   
Commercial
 and multifamily
   
Construction
and land
   
Manufactured
homes
   
Other
consumer
   
Commercial
business
   
Total
 
(In thousands)
 
Performing
  $ 97,710     $ 34,697     $ 132,938     $ 34,513     $ 15,576     $ 8,776     $ 14,444     $ 338,654  
Nonperforming
    1,283       642       240       -       -       3       127       2,295  
Total
  $ 98,993     $ 35,339     $ 133,178     $ 34,513     $ 15,576     $ 8,779     $ 14,571     $ 340,949  

 
The following table represents the credit risk profile based on payment activity as of December 31, 2012 by type of loan:
 

 
   
One-to- four family
   
Home equity
   
Commercial
and multifamily
   
Construction
and land
   
Manufactured
homes
   
Other
consumer
   
Commercial
business
   
Total
 
(In thousands)
 
Performing
  $ 94,641     $ 34,647     $ 132,273     $ 24,987     $ 16,203     $ 8,642     $ 13,996     $ 325,389  
Nonperforming
    1,143       717       1,347       471       29       8       197       3,912  
Total
  $ 95,784     $ 35,364     $ 133,620     $ 25,458     $ 16,232     $ 8,650     $ 14,193     $ 329,301  

 
 

 
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)


 
Impaired Loans.  A loan is considered impaired when we have determined that we may be unable to collect payments of principal or interest when due under the terms of the loan.  In the process of identifying loans as impaired, we take into consideration factors which include payment history and status, collateral value, financial condition of the borrower, and the probability of collecting scheduled payments in the future.  Minor payment delays and insignificant payment shortfalls typically do not result in a loan being classified as impaired.  The significance of payment delays and shortfalls is considered on a case by case basis, after taking into consideration the totality of circumstances surrounding the loans and the borrowers, including payment history and amounts of any payment shortfall, length and reason for delay, and likelihood of return to stable performance.  Impairment is measured on a loan by loan basis for all loans in the portfolio.
 
The following table presents loans individually evaluated for impairment as of March 31, 2013 by type of loan:
 
   
Recorded Investment
   
Unpaid Principal Balance
   
Related Allowance
 
With no related allowance recorded:
 
(In thousands)
 
One-to-four family
  $ 2,160     $ 2,478     $ -  
Home equity
    799       899       -  
Commercial and multifamily
    772       772       -  
Construction and land
    23       23       -  
Manufactured homes
    100       100       -  
Other consumer
    7       49       -  
Commercial business
    654       654       -  
Total
  $ 4,515     $ 4,975     $ -  
                         
With an allowance recorded:
                       
One-to-four family
  $ 4,145     $ 4,351     $ 336  
Home equity
    949       1,014       334  
Commercial and multifamily
    243       242       69  
Construction and land
    76       76       25  
Manufactured homes
    523       523       107  
Other consumer
    44       44       27  
Commercial business
    373       373       108  
Total
  $ 6,353     $ 6,623     $ 1,006  
                         
Totals:
                       
One-to-four family
  $ 6,305     $ 6,829     $ 336  
Home equity
    1,748       1,912       334  
Commercial and multifamily
    1,015       1,015       69  
Construction and land
    99       99       25  
Manufactured homes
    623       623       107  
Other consumer
    51       93       27  
Commercial business
    1,027       1,027       108  
Total
  $ 10,868     $ 11,598     $ 1,006  

 

 
 

 
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)

 
 
The following table presents loans individually evaluated for impairment as of December 31, 2012 by type of loan:
 
   
Recorded Investment
   
Unpaid Principal Balance
   
Related Allowance
 
With no related allowance recorded:
 
(In thousands)
 
One-to-four family
  $ 2,521     $ 2,826     $ -  
Home equity
    949       1,132       -  
Commercial and multifamily
    1,883       1,883       -  
Construction and land
    495       608       -  
Manufactured homes
    67       67       -  
Other consumer
    9       49       -  
Commercial business
    682       682       -  
Total
  $ 6,606     $ 7,247     $ -  
                         
With an allowance recorded:
                       
One-to-four family
  $ 3,495     $ 3,651     $ 392  
Home equity
    782       782       247  
Commercial and multifamily
    244       244       70  
Construction and land
    76       76       25  
Manufactured homes
    587       587       117  
Other consumer
    46       46       22  
Commercial business
    157       196       145  
Total
  $ 5,387     $ 5,582     $ 1,018  
                         
Totals:
                       
One-to-four family
  $ 6,016     $ 6,477     $ 392  
Home equity
    1,731       1,914       247  
Commercial and multifamily
    2,127       2,127       70  
Construction and land
    571       684       25  
Manufactured homes
    654       654       117  
Other consumer
    55       95       22  
Commercial business
    839       878       145  
Total
  $ 11,993     $ 12,829     $ 1,018  


 
 

 

SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)


The following table presents loans individually evaluated for impairment as of March 31, 2013 and 2012 by type of loan:

   
Three Months Ended
 
   
March 31, 2013
   
March 31, 2012
 
   
Average Recorded Investment
   
Interest Income Recognized
   
Average Recorded Investment
   
Interest Income Recognized
 
With no related allowance recorded:
 
(In thousands)
 
One-to-four family
  $ 2,341     $ 10     $ 1,731     $ 10  
Home equity
    874       3       542       3  
Commercial and multifamily
    1,328       2       453       2  
Construction and land
    259       -       -       -  
Manufactured homes
    84       1       46       1  
Other consumer
    8       -       55       -  
Commercial business
    668       33       147       33  
Total
  $ 5,562     $ 49     $ 2,972     $ 49  
                                 
With an allowance recorded:
                               
One-to-four family
  $ 3,820     $ 30     $ 4,135     $ 30  
Home equity
    866       6       1,069       6  
Commercial and multifamily
    243       1       3,074       1  
Construction and land
    76       -       -       -  
Manufactured homes
    555       3       72       3  
Other consumer
    45       -       35       -  
Commercial business
    265       4       131       4  
Total
  $ 5,870     $ 44     $ 8,516     $ 44  
                                 
Totals:
                               
One-to-four family
  $ 6,161     $ 40     $ 5,866     $ 40  
Home equity
    1,740       9       1,611       9  
Commercial and multifamily
    1,571       3       3,527       3  
Construction and land
    335       -       -       -  
Manufactured homes
    639       4       118       4  
Other consumer
    53       -       90       -  
Commercial business
    933       37       278       37  
Total
  $ 11,432     $ 93     $ 11,489     $ 93  


Forgone interest on nonaccrual loans was $87,000 and $78,000 at March 31, 2013 and 2012, respectively.  There were no commitments to lend additional funds to borrowers whose loans were classified as nonaccrual, TDR or impaired at March 31, 2013 or December 31, 2012.

Troubled debt restructurings.  Loans classified as TDRs totaled $6.9 million and $7.7 million at March 31, 2013 and December 31, 2012, respectively, and are included in impaired loans.  The Company has granted in its TDRs a variety of concessions to borrowers in the form of loan modifications.  The modifications granted can generally be described in the following categories:

Rate Modification: A modification in which the interest rate is changed.

Term Modification: A modification in which the maturity date, timing of payments, or frequency of payments is changed.

Payment Modification: A modification in which the dollar amount of the payment is changed.  Interest only modifications in which a loan in converted to interest only payments for a period of time are included in this category.

Combination Modification:  Any other type of modification, including the use of multiple categories above.


 
 

 

SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)
 


The following table presents new TDRs by type of modification that occurred during the three months ended March 31, 2013:

   
Three months ended March 31, 2013
 
   
Number of Contracts
   
Rate Modifications
   
Term Modifications
   
Payment Modifications
   
Combination Modifications
   
Total Modifications
 
         
(In thousands)
 
One- to- four family
    3     $ -     $ -     $ -     $ 878     $ 878  
Total
    3     $ -     $ -     $ -     $ 878     $ 878  

The following table presents new TDRs by type of modification that occurred during the three months ended March 31, 2012:

   
Three months ended March 31, 2012
 
   
Number of Contracts
   
Rate Modifications
   
Term Modifications
   
Payment Modifications
   
Combination Modifications
   
Total Modifications
 
         
(In thousands)
 
One- to- four family
    2     $ -     $ -     $ -     $ 88     $ 88  
Home equity
    1       -       -       -       49       49  
Commercial and multifamily
    1       -       -       -       243       243  
Other consumer
    1       -       -       -       12       12  
Commercial business
    2       121       -       -       160       281  
Total
    7     $ 121     $ -     $ -     $ 552     $ 673  

There were no post-modification changes for the recorded investment in loans that were recorded as a result of the TDRs for the three months ended March 31, 2013 and 2012, respectively.

The following table represents financing receivables modified as TDRs for which there was a payment default within the first twelve months of restructuring for the dates indicated below:

   
Quarter ended March 31,
 
   
2013
   
2012
 
   
(In thousands)
 
One- to four- family
  $ 202     $ 2,749  
Home equity
    115       767  
Manufactured homes
    -       574  
Other consumer
    -       42  
Commercial business
    540       540  
Total
  $ 857     $ 4,672  

For the preceding table, a loan is considered in default when a payment is 31 days past due. No TDRs modified within the previous 12 months were three months past due as of March 31, 2013. A single one- to four- family first mortgage was three months past due as of March 30, 2012 and was on nonaccrual status.

The Company had no commitments to extend additional credit to borrowers owing receivables whose terms have been modified in troubled debt restructurings.  All TDRs are also classified as impaired loans and are included in the loans individually evaluated for impairment in the calculation of the allowance for loan losses.


 
 

 

SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)
 
 
Note 6 – Fair Value Measurements
 
The following table presents information about the level in the fair value hierarchy for the Company’s financial assets and liabilities that are measured at fair value as of March 31, 2013:

   
Fair Value at March 31, 2013
 
Description
 
Total
   
Level 1
   
Level 2
   
Level 3
 
Financial assets:
 
(In thousands)
 
Cash and cash equivalents
  $ 8,795     $ 8,795     $ -     $ -  
Available for sale securities
    19,713       -       17,016       2,697  
FHLB Stock
    2,379       -       -       2,379  
Loans held for sale
    2,083       -       2,083       -  
Loans, net
    341,695       -       -       341,695  
Accrued interest receivable
    1,303       1,303       -       -  
Bank owned life insurance, net
    10,798       -       10,798       -  
Mortgage servicing rights
    2,396       -       -       2,396  
                                 
Financial liabilities:
                               
Non-maturity deposits
    171,851       -       171,851       -  
Time deposits
    146,266       -       146,266       -  
Borrowings
    25,567       -       25,567       -  
Accrued interest payable
    78       -       78       -  
Advance payments from borrowers for taxes and insurance
    585       -       585       -  

The following table presents information about the level in the fair value hierarchy for the Company’s financial assets and liabilities that are not measured at fair value as of December 31, 2012:

   
Fair Value at December 31, 2012
 
Description
 
Total
   
Level 1
   
Level 2
   
Level 3
 
Financial assets:
 
(In thousands)
 
Cash and cash equivalents
  $ 12,727     $ 12,727     $ -     $ -  
Available for sale securities
    22,900       -       20,127       2,773  
FHLB Stock
    2,401       -       -       2,401  
Loans held for sale
    1,725       -       1,725       -  
Loans, net
    327,078       -       -       327,078  
Accrued interest receivable
    1,280       1,280       -       -  
Bank owned life insurance, net
    7,220               7,220       -  
Mortgage servicing rights
    2,306       -       -       2,306  
                                 
Financial liabilities:
                               
Non-maturity deposits
    177,097       -       177,097       -  
Time deposits
    134,007       -       134,007       -  
Borrowings
    21,708       -       21,708       -  
Accrued interest payable
    83       -       83       -  
Advance payments from borrowers for taxes and insurance
    331       -       331       -  


 
 

 


SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)
 


The following table presents the balance of assets measured at fair value on a recurring basis as of March 31, 2013 and December 31, 2012:
   
Fair Value at March 31, 2013
 
Description
 
Total
   
Level 1
   
Level 2
   
Level 3
 
   
(In thousands)
 
Agency mortgage-backed securities
  $ 17,016     $ -     $ 17,016     $ -  
Non-agency mortgage-backed securities
    2,697       -       -       2,697  
Mortgage servicing rights
    2,396       -       -       2,396  
       
   
Fair Value at December 31, 2012
 
Description
 
Total
   
Level 1
   
Level 2
   
Level 3
 
   
(In thousands)
 
Agency mortgage-backed securities
  $ 20,127     $ -     $ 20,127     $ -  
Non-agency mortgage-backed securities
    2,773       -       -       2,773  
Mortgage servicing rights
    2,306       -       -       2,306  

For the three months ended March 31, 2013 and 2012 there were no transfers between Level 1 and Level 2 nor between Level 2 and Level 3.

The following table provides a description of the valuation technique, unobservable input, and qualitative information about the unobservable inputs for the Company’s assets and liabilities classified as Level 3 and measured at fair value on a recurring basis at March 31, 2013:

Financial Instrument
 
Valuation Technique
 
Unobservable Input(s)
 
Range
(Weighted Average)
Mortgage Servicing Rights
 
Discounted cash flow
 
Prepayment speed assumption
 
284-550% (310%)
       
Discount rate
 
8-12% (10%)
             
Non-agency mortgage-backed securities
 
Discounted cash flow
 
Discount rate
 
(8%)

Generally, any significant increases in the constant prepayment rate and discount rate utilized in the fair value measurement of the mortgage servicing rights will result in a negative fair value adjustment (and decrease in the fair value measurement).  Conversely, a decrease in the constant prepayment rate and discount rate will result in a positive fair value adjustment (and increase in the fair value measurement).  An increase in the weighted average life assumptions will result in a decrease in the constant prepayment rate and conversely, a decrease in the weighted average life will result in an increase of the constant prepayment rate.

The following table provides a reconciliation of assets and liabilities measured at fair value using significant unobservable inputs (Level 3) on a recurring basis during the three months ended March 31, 2013 and 2012:

   
Three Months Ended  March 31,
 
   
2013
   
2012
 
   
(In thousands)
 
Beginning balance, at fair value
  $ 2,773     $ 2,933  
OTTI impairment losses
    (19 )     (91 )
Sales and principal payments
    (133 )     (131 )
Change in unrealized loss
    76       266  
Ending balance, at fair value
  $ 2,697     $ 2,977  

 
 

 

SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)


Mortgage servicing rights are measured at fair value using significant unobservable input (Level 3) on a recurring basis and a reconciliation of this asset can be found in Note 7 – Mortgage Servicing Rights.

The following table presents the balance of assets measured at fair value on a nonrecurring basis at the dates indicated:

   
Fair Value at March 31, 2013
 
Description
 
Total
   
Level 1
   
Level 2
   
Level 3
 
   
(in thousands)
 
OREO and repossessed assets
  $ 2,453     $ -     $ -     $ 2,453  
Impaired loans
    10,869       -       -       10,869  

   
Fair Value at December 31, 2012
 
Description
 
Total
   
Level 1
   
Level 2
   
Level 3
 
   
(in thousands)
 
OREO and repossessed assets
  $ 2,503     $ -     $ -     $ 2,503  
Impaired loans
    11,993       -       -       11,993  

 
The following table presents the total losses during the three months ended March 31, 2013 and 2012 resulting from fair value adjustments:
 
   
Three Months Ended March 31,
 
Description
 
2013
   
2012
 
   
(in thousands)
 
OREO and repossessed assets
  $ 675     $ 469  
Impaired loans
    494       1,615  
 
There were no liabilities carried at fair value, measured on a recurring or nonrecurring basis, at March 31, 2013 or December 31, 2012.

The following table provides a description of the valuation technique, observable input, and qualitative information about the unobservable inputs for the Company’s assets and liabilities classified as Level 3 and measured at fair value on a nonrecurring basis at March 31, 2013:

Financial Instrument
 
Valuation Technique(s)
 
Unobservable Input(s)
 
Range (Weighted Average)
OREO
 
Market approach
 
Adjusted for difference between comparable sales
 
0-44% (12%)
             
Impaired loans
 
Market approach
 
Adjusted for difference between comparable sales
 
0-100% (7%)

A description of the valuation methodologies used for impaired loans and OREO is as follows:

Impaired Loans - The fair value of collateral dependent loans is based on the current appraised value of the collateral or internally developed models utilizing a calculation of expected discounted cash flows which contain
management’s assumptions.

 
 

 

SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)


OREO and Repossessed Assets – The fair value of OREO and repossessed assets is based on the current appraised value of the collateral or internally developed models utilizing a calculation of expected discounted cash flows which contain management’s assumptions.
 
The following methods and assumptions were used to estimate the fair value of other financial instruments:
 
Cash and cash equivalents, accrued interest receivable and payable, and advance payments from borrowers for taxes and insurance - The estimated fair value is equal to the carrying amount.

AFS Securities – AFS securities are recorded at fair value based on quoted market prices, if available.  If quoted market prices are not available, management utilizes third-party pricing services or broker quotations from dealers in the specific instruments.  Level 2 securities include those traded on an active exchange, as well as U.S. government and its agencies securities.  Level 3 securities include private label mortgage-backed securities.
 
Loans Held for Sale - Residential mortgage loans held for sale are recorded at the lower of cost or fair value. The fair value of fixed-rate residential loans is based on whole loan forward prices obtained from government sponsored enterprises. At March 31, 2013 and December 31, 2012, loans held for sale were carried at cost.
 
Loans - The estimated fair value for all fixed rate loans is determined by discounting the estimated cash flows using the current rate at which similar loans would be made to borrowers with similar credit ratings and maturities. The estimated fair value for variable rate loans is the carrying amount. The fair value for all loans also takes into account projected loan losses as a part of the estimate.

Mortgage Servicing Rights –The fair value of mortgage servicing rights is determined though a discounted cash flow analysis, which uses interest rates, prepayment speeds, discount rates,  and delinquency rate assumptions as inputs.
 
FHLB stock - The estimated fair value is equal to the par value of the stock, which approximates fair value.
 
Bank-owned Life Insurance - The estimated fair value is equal to the cash surrender value of policies, net of surrender charges.
 
Deposits - The estimated fair value of deposit accounts (savings, demand deposit, and money market accounts) is the carrying amount. The fair values of fixed-maturity time certificates of deposit are estimated by discounting the estimated cash flows using the current rate at which similar certificates would be issued.

Borrowings - The fair value of borrowings are estimated using discounted cash flow analyses, based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.
 
Off-balance-sheet financial instruments - The fair value for the Company’s off-balance-sheet loan commitments are estimated based on fees charged to others to enter into similar agreements taking into account the remaining terms of the agreements and credit standing of the Company’s customers. The estimated fair value of these commitments is not significant.
 
We assume interest rate risk (the risk that general interest rate levels will change) as a result of our normal operations. As a result, the fair values of our financial instruments will change when interest rate levels change, which may be favorable or unfavorable to us. Management attempts to match maturities of assets and liabilities to the extent necessary or possible to minimize interest rate risk. However, borrowers with fixed-rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by establishing early withdrawal penalties for certificates of deposit, creating interest rate floors for certain variable rate loans, adjusting terms of new loans and deposits, by borrowing at fixed rates for fixed terms and investing in securities with terms that mitigate our overall interest rate risk.


 
 

 

SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)
 
 
 
Note 7 – Mortgage Servicing Rights
 
The unpaid principal balances of loans serviced for Federal National Mortgage Association (“FNMA”) at March 31, 2013 and December 31, 2012, totaled approximately $363.1 million and $365.7 million, respectively, and were not included in the Company’s financial statements.
 
A summary of the change in the balance of mortgage servicing assets during the three months ended March 31, 2013 and 2012 were as follows:
 
   
Three Months Ended March 31,
 
   
2013
   
2012
 
   
(in thousands)
 
Beginning balance, at fair value
  $ 2,306     $ 2,437  
Servicing rights that result from transfers of financial assets
    217       185  
Changes in fair value:
               
Due to changes in model inputs or assumptions(1)
    135       384  
Other(2)
    (262 )     (215 )
Ending balance, at fair value
  $ 2,396     $ 2,791  
__________________
 
(1) Represents changes in discount rates and prepayment speed assumptions, which are primarily affected by changes in interest rates
 
(2) Represents changes due to collection or realization of expected cash flows over time.
 
 
The key economic assumptions used in determining the fair value of mortgage servicing rights at the dates indicated are as follows:
 
   
At March 31,
 
   
2013
   
2012
 
Prepayment speed (PSA)
    310 %     272 %
Weighted-average life (years)
    4.5       4.7  
Yield to maturity discount rate
    10.0 %     9.0 %
                 

The amount of contractually specified servicing, late and ancillary fees earned, recorded in mortgage servicing income on the Consolidated Statements of Income was $127,000 and $177,000 for the three months ended March 31, 2013 and 2012, respectively.

Note 8 – Commitments and Contingencies
 
In the normal course of operations, the Company engages in a variety of financial transactions that are not recorded in our financial statements.  These transactions involve varying degrees of off-balance sheet credit, interest rate and liquidity risks.  These transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit.

 
Note 9 – Borrowings
 
The Company utilizes a loan agreement with the FHLB of Seattle. The terms of the agreement call for a blanket pledge of a portion of the Company’s mortgage and commercial and multifamily portfolio based on the outstanding balance.  At March 31, 2013, the amount available to borrow under this agreement was approximately 35% of total assets, or up to $136.7 million, subject to the availability of eligible collateral.  Based on eligible collateral, the total amount available under this agreement as of March 31, 2013 and December 31, 2012 was $105.6 million and $90.7 million, respectively.  The Company had outstanding borrowings under this arrangement of $25.7 million and $21.9 million at March 31, 2013 and December 31, 2012, respectively.  Additionally, the Company had outstanding letters of credit from the FHLB with a notional amount of $24.5 million and $31.5 million at March 31, 2013 and December 31, 2012, respectively, to secure public deposits.  The net remaining amount available as of March 31, 2013 and December 31, 2012, was $47.7 million and $37.3 million, respectively.

 
 

 


SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)
 

 

The Company participates in the Federal Reserve Bank (“FRB”) Borrower-in-Custody program, which gives the Company access to the discount window.  The terms of the program call for a pledge of specific assets.  The Company had unused borrowing capacity of $10.2 million and $11.8 and no outstanding borrowings under this program at March 31, 2013 and December 31, 2012, respectively.

The Company has access to an unsecured line of credit from the Pacific Coast Banker’s Bank.  The line has a two-year term maturing on June 30, 2014 and is renewable biannually.  At March 31, 2013, the amount available under this line of credit was $2.0 million.  There was no balance on this line of credit as of March 31, 2013 and December 31, 2012, respectively.

 
Note 10 – Earnings Per Common Share
 
Non-vested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents are participating securities and are included in the computation of earnings per share pursuant to the two-class method.  The two-class method is an earnings allocation formula that determines earnings per share for each class of common stock and participating security according to dividends declared (or accumulated) and participation rights in undistributed earnings. Certain of the Company’s non-vested restricted stock awards qualify as participating securities. 
 
Net earnings, less any preferred dividends accumulated for the period (whether or not declared), is allocated between the common stock and participating securities pursuant to the two-class method.  Basic earnings per common share is computed by dividing net earnings available to common shareholders by the weighted average number of common shares outstanding during the period, excluding participating non-vested restricted shares. 
 
Diluted earnings per common share is computed in a similar manner, except that first the denominator is increased to include the number of additional common shares that would have been outstanding if potentially dilutive common shares, excluding the participating securities, were issued using the treasury stock method.  For all periods presented, stock options, certain restricted stock awards and restricted stock units are the only potentially dilutive non-participating instruments issued by the Company.  Next, we determine and include in diluted earnings per common share calculation the more dilutive effect of the participating securities using the treasury stock method or the two-class method.  Undistributed losses are not allocated to the non-vested share-based payment awards (the participating securities) under the two-class method as the holders are not contractually obligated to share in the losses of the Company.
 
ESOP shares are considered outstanding for basic and diluted earnings per share when the shares are committed to be released.

Earnings per common share are summarized in the following table:

   
Three Months Ended March 31,
 
   
2013
   
2012
 
   
(In thousands, except per share amounts)
 
Net income
  $ 797     $ 546  
Less net income attributable to participating securities(1)
    17       9  
Net income available to common shareholders
  $ 780     $ 537  
                 
Weighted average number of shares outstanding, basic
    2,588       2,582  
Effect of potentially dilutive common shares(2)
    57       22  
Weighted average number of shares outstanding, diluted
    2,645       2,604  
                 
Earnings per share, basic
  $ 0.31     $ 0.21  
Earnings per share, diluted
  $ 0.30     $ 0.21  
___________________
(1) Represents dividends paid and undistributed earnings allocated to non-vested restricted stock awards.
(2) Represents the effect of the assumed exercise of warrants, assumed exercise of stock options, vesting of non-participating restricted shares, and vesting of restricted stock units, based on the treasury stock method.

There were no shares considered anti-dilutive for the three months ended March 31, 2013 or 2012.

 
 

 


SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)
 
 
Note 11 – Stock-based Compensation
 
Stock Options and Restricted Stock
 
In 2008, the Board of Directors adopted and stockholders approved an Equity Incentive Plan (the “Plan”) which was assumed by the Company in connection with the Conversion.  The Plan permits the grant of restricted stock, restricted stock units, stock options, and stock appreciation rights.  Under the Plan, 126,287 shares of common stock were approved for awards for stock options and stock appreciation rights and 50,514 shares of common stock were approved for awards for restricted stock and restricted stock units, in each case, as adjusted for the Conversion exchange ratio.
 
As of March 31, 2013, on an adjusted basis, awards for stock options totaling 123,906 shares and awards for restricted stock totaling 48,134 shares of Company common stock have been granted, net of any forfeitures, to participants in the Plan.  During the three months ended March 31, 2013 and 2012, share-based compensation expense totaled $43,000 and $33,000, respectively.  All of the awards vest in 20 percent annual increments commencing one year from the grant date.  The options are exercisable for a period of 10 years from the date of grant, subject to vesting.

The following is a summary of the Company’s stock option plan awards during the period ended March 31, 2013: 

   
Shares
   
Weighted-
Average
Exercise Price
   
Weighted-Average Remaining Contractual Term
In Years
   
Aggregate Intrinsic
Value
 
Outstanding at the beginning of the year
    123,906     $ 8.94       6.33     $ 180,903  
Granted
    -       -                  
Exercised
    -       -                  
Forfeited
    -       -                  
Expired
    -       -                  
Outstanding at March 31, 2013
    123,906     $ 8.94       6.09     $ 460,930  
Exercisable
    84,869     $ 9.03       5.54     $ 308,074  
Expected to vest, assuming a 0% forfeiture rate over the vesting term
    123,906     $ 8.94       6.09     $ 460,930  

As of March 31, 2013, there was $111,000 of total unrecognized compensation cost related to non-vested stock options granted under the Plan.  The cost is expected to be recognized over the remaining weighted-average vesting period of 5.5 years.

The fair value of each option award is estimated on the date of grant using a Black-Scholes model that uses the assumptions noted in the table below.  The dividend yield is based on the current quarterly dividend in effect at the time of the grant.  

The Company (including the predecessor entity) became a publicly held company in January 2008, so the amount of historical stock price information available is limited.  As a result, the Company elected to use a weighted-average of its peers’ historical stock prices, as well as the Company’s own historical stock prices to estimate volatility.  The Company bases the risk-free interest rate on the U.S. Treasury Constant Maturity Indices in effect on the date of the grant.  The Company elected to use the Staff Accounting Bulletin No. 110, “Share-Based Payments” permitted by the Securities and Exchange Commission to calculate the expected term.  This simplified method uses the vesting term of an option along with the contractual term, setting the expected life at a midpoint in between.


 
 

 


SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)


Restricted Stock Awards
 
The fair value of the restricted stock awards is equal to the fair value of the Company’s stock at the date of grant.  Compensation expense is recognized over the vesting period that the awards are based. Shares awarded as restricted stock vest ratably over a five-year period beginning at the grant date with 20% vesting on the anniversary date of each grant date.

The following is a summary of the Company’s non-vested restricted stock awards during the three months ended March 31, 2013:

Non-vested Shares
 
Shares
   
Weighted-Average Grant-Date
Fair Value Per Share
   
Aggregate Intrinsic
Value Per Share
 
Non-vested at January 1, 2013
    24,747     $ 8.44        
Granted
    -                
Vested
    -                
Forfeited
    -                
Expired
    -                
Non-vested at March 31, 2013
    24,747     $ 8.44     $ 12.66  
                         
Expected to vest assuming a 0% forfeiture rate over the vesting term
    24,747     $ 8.44     $ 12.66  

The aggregate intrinsic value of the non-vested restricted stock options as of March 31, 2013 was $313,000.

As of March 31, 2013, there was $82,000 of unrecognized compensation cost related to non-vested restricted stock granted under the Plan remaining.  The cost is expected to be recognized over the weighted-average vesting period of 2.0 years.

Employee Stock Ownership Plan

In January 2008, the ESOP borrowed $1.2 million from the Company to purchase common stock of the Company.  In August 2012, in conjunction with the Conversion, the ESOP borrowed an additional $1.1 million from the Company to purchase common stock of the Company.  Both loans are being repaid principally by the Bank through contributions to the ESOP over a period of ten years.  The interest rate on the loans is fixed at 4.0% and 2.25%, per annum, respectively.  At March 31, 2013, the remaining balances of the ESOP loans were $638,000 and $1.0 million, respectively.

Neither the loan balances nor the related interest expense are reflected on the condensed consolidated financial statements.

At March 31, 2013, the ESOP was committed to release 21,443 shares of the Company’s common stock to participants and held 152,572 unallocated shares remaining to be released in future years.  The fair value of the 202,755 restricted shares held by the ESOP trust was $2.6 million at March 31, 2013.  ESOP compensation expense included in salaries and benefits was $76,000 and $25,000 for the three months ended March 31, 2013 and 2012, respectively.

Subsequent to quarter end, on April 30, 2013, the Company declared a quarterly cash dividend of $0.05 per common share, payable on May 28, 2013 to shareholders of record at the close of business May 13, 2013.

 
 

 


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, 2102, 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 Federal Deposit Insurance Corporation (“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 March 31, 2013, Sound Financial Bancorp had total consolidated assets of $390.7 million, net loans of $334.8 million, deposits of $316.7 million and stockholders’ equity of $44.3 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, to a lesser extent, 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 maintain our emphasis on 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 computer services 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 March 31, 2013 and December 31, 2012
 
General.   Total assets increased by $9.6 million, or 2.5% to $390.7 million at March 31, 2013 from $381.0 million at December 31, 2012.  This increase was primarily the result of a $12.3 million, or 3.8% increase in our net loan portfolio and a $3.6 million, or 49.6% increase in the cash surrender value of bank-owned life insurance offset partially by a $3.9 million or 30.9% decrease in cash and cash equivalents and a $3.2 million or 13.9% decrease in available for sale securities.  Asset growth was funded by a $4.6 million increase in deposits, a $3.8 million increase in FHLB advances and a $884,000 increase in shareholders’ equity primarily as a result of earnings.
 
 
 

 
 
Cash and Securities.  Cash, cash equivalents and our available-for-sale securities decreased by $7.1 million, or 20.0%, to $28.5 million at March 31, 2013.  Cash and cash equivalents decreased by $3.9 million, or 30.9%, to $8.8 million at March 31, 2013, as excess cash balances were transferred into interest-bearing assets such as loans and bank-owned life insurance.  Available-for-sale securities, which consist primarily of agency mortgage-backed securities, decreased by $3.2 million, or 13.9%, from $22.9 million at December 31, 2012 to $19.7 million at March 31, 2013.
 
At March 31, 2013, our available-for-sale securities portfolio consisted of $2.7 million of non-agency mortgage-backed securities.  These securities present a higher credit risk than U.S. agency mortgage-backed securities, of which we had $17.0 million at March 31, 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 three months ended March 31, 2013, recorded an other-than-temporary impairment charge of $19,000 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 $11.6 million, or 3.5%, from $329.3 million at December 31, 2012 to $340.9 million at March 31, 2013.  Loans held for sale increased from $1.7 million at December 31, 2012 to $2.1 million at March 31, 2013, reflecting primarily the timing of transactions and increase in refinancing transaction volume.
 
The following table reflects the changes in the types of loans in our portfolio at March 31, 2013, as compared to December 31, 2012:

   
March 31, 2013
   
December 31, 2012
   
Amount Change
   
Percent Change
 
   
(Dollars in thousands)
 
One-to-four-family
  $ 98,993     $ 95,784     $ 3,209       3.4 %
Home equity
    35,339       35,364       (25 )     (0.1 )
Commercial and multifamily
    133,178       133,620       (442 )     (0.3 )
Construction and land
    34,513       25,458       9,055       35.6  
Manufactured homes
    15,576       16,232       (656 )     (4.0 )
Other consumer
    8,779       8,650       129       1.5  
Commercial business
    14,571       14,193       378       2.7  
Total loans
  $ 340,949     $ 329,301     $ 11,648       3.5 %

 
The most significant change in our loan portfolio were a result of increases in construction and land loans and one- to four- family mortgage loans, consistent with our operating strategy of originating quality on balance sheet loans and maintaining the diversification of our loan portfolio.  The growth in construction and land loans is primarily a result of increased demand for new homes in the marketplace which is improving due to a lack of overall construction starts in recent years.  We work with a small number of well-established single family home builders in our markets.  Management monitors our exposure on construction loans closely and a third party evaluates each project’s percentage of completion before any draw is allowed.  The increase in our one- to four- family loans was primarily a result of increases in jumbo mortgage loans and other portfolio one-to four- family mortgage loans. 
 
Mortgage Servicing Rights.  At March 31, 2013, we had $2.4 million in mortgage servicing rights recorded at fair value compared to $2.3 million at December 31, 2012.  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, 2013, our nonperforming assets totaled $4.7 million, or 1.21% 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:
 
   
Nonperforming Assets
 
   
At March 31, 2013
   
At December 31, 2012
   
Amount Change
   
Percent Change
 
   
(Dollars in thousands)
 
Nonaccrual loans
  $ 1,555     $ 3,003     $ (1,448 )     (48.2 )%
Accruing loans 90 days or more delinquent
    -       81       (81 )     (100.0 )
Nonperforming restructured loans
    740       828       (88 )     (10.6 )
OREO and repossessed assets
    2,453       2,503       (50 )     (2.0 )
Total loans
  $ 4,748     $ 6,415     $ (1,667 )     (26.0 )%
 
Nonperforming loans to total loans decreased to 0.67% of total loans at March 31, 2013 from 1.19% at December 31, 2012.  This decrease reflects a $1.8 million decrease in nonperforming loans.  Our largest nonperforming loans at March 31, 2013 consisted of a $335,000 home equity loan and a $270,000 one- to four- family loan.
 
OREO and repossessed assets decreased during the three months ended March 31, 2013 primarily due to slightly improving economic conditions in our market and our continued focus on credit administration.  During the three months ended March 31, 2013, we repossessed four personal residences, one commercial land development and four manufactured homes.  We sold four personal residences and four manufactured homes at an aggregate loss of $99,000.  Our largest OREO at March 31, 2013, consisted of a mobile home park with a recorded value of $648,000 located in Spanaway, Washington.  Our next largest OREO properties were a $549,000 personal residence located in Carnation, Washington and a $306,000 residential lot development located in Sequim.  Subsequent to quarter end, we sold the mobile home park and residential lot development at an anticipated aggregate loss of $84,000.
 
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, 2013 was $4.0 million, or 1.19% of total loans receivable, compared to $4.2 million, or 1.30% of total loans receivable at December 31, 2012.  The $202,000, or 4.8% decrease in the allowance for loan losses reflects the $250,000 provision for loan losses established during the three months ended March 31, 2013 as a result of the growth in our loan portfolio, loan charge-offs and decreases in nonperforming loans during this period.
 
The following table reflects the adjustments in our allowance during the periods indicated:
 
   
Three Months Ended March 31,
 
   
2013
   
2012
 
   
(Dollars in thousands)
 
Balance at beginning of period
  $ 4,248     $ 4,455  
Charge-offs
    (494 )     (1,615 )
Recoveries:
    42       10  
Net charge-offs
    (452 )     (1,605 )
Provisions charged to operations
    250       1,500  
Balance at end of period
  $ 4,046     $ 4,350  
                 
Ratio of net charge-offs during the period to average loans outstanding during the period
    0.54 %     2.14 %
                 
Allowance as a percentage of nonperforming loans
    176.30 %     56.30 %
                 
Allowance as a percentage of total loans (end of period)
    1.19 %     1.45 %

Specific loan loss reserves decreased $12,000, while general loan loss reserves decreased $190,000 at March 31, 2013, compared to the prior year end.  Net charge-offs for the three months ended March 31, 2013 were $452,000, or 0.54% of average loans on an annualized basis, compared to $1.6 million, or 2.14% of average loans for the same period in 2012.  The decrease in net charge-offs was primarily due to the slightly improving economic conditions in our market area and continued credit administration efforts.  As of March 31, 2013, the allowance for loan losses as a percentage of total loans receivable and nonperforming loans was 1.19% and 176.30%, respectively, compared to 1.45% and 56.30%,
respectively, at December 31,2012.  The allowance for loan losses as a percentage of average loans receivable decreased due to the increase in our loan portfolio during the period.  The allowance for loan losses as a percentage of nonperforming loans increased due to the decrease in nonperforming loans.

 
 

 

 
Deposits.  Total deposits increased by $4.6 million, or 1.5%, to $316.7 million at March 31, 2013 from $312.1 million at December 31, 2012, primarily as a result of a $9.9 million or 7.3% increase in certificates.  NOW accounts increased $1.2 million, or 4.3%, saving accounts increased $412,000, or 1.5%, and escrow accounts increased $73,000.  Money market accounts decreased $6.7 million, or 7.8%, and noninterest checking decreased $278,000, or 0.9%.  The increases were primarily a result of various marketing efforts during the period as we continued our emphasis on attracting low-cost core deposit accounts.  The decrease in money market accounts was primarily of result of customers placing these funds in certificate accounts or other higher yielding investments.
 
A summary of deposit accounts with the corresponding weighted average cost of funds is presented below:
 
   
As of March 31, 2013
   
As of December 31, 2012
 
   
Amount
   
Wtd. Avg. Rate
   
Amount
   
Wtd. Avg. Rate
 
   
(In thousands)
         
(In thousands)
       
Checking (noninterest)
  $ 31,149       0.00 %   $ 31,427       0.00 %
NOW (interest)
    29,765       0.16       28,540       0.10  
Savings
    27,586       0.12       27,174       0.08  
Money market
    79,471       0.30       86,149       0.32  
Certificates
    144,876       1.20       134,986       1.33  
Escrow
    3,880       0.00       3,807       0.00  
     Total
  $ 316,727       0.63 %   $ 312,083       0.69 %

 
Borrowings.  FHLB advances increased $3.8 million, or 17.6%, to $25.7 million at March 31, 2013, with a weighted-average cost of 0.94%, 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 $884,000, or 2.0%, to $44.3 million at March 31, 2013.  This increase primarily reflects $797,000 in net income.
 
Comparison of Results of Operation for the Three Months Ended March 31, 2013 and 2012
 
General. Net income increased $251,000 to $797,000 for the three months ended March 31, 2013, compared to $546,000 for the three months ended March 31, 2012.  The primary reason for this improvement was a decrease in the provision for loan losses.
 
Interest Income.  Interest income increased by $73,000, or 1.6%, to $4.6 million for the three months ended March 31, 2013, from $4.6 million for the three months ended March 31, 2012.  The increase in interest income for the period primarily reflected the increase in the average balance of interest-earning assets, in particular our average balance of available for sale securities which outpaced the decline in the weighted average yield on our interest-earning assets during the three months ended March 31, 2013 as compared to the same period last year.
 
Our weighted average yield on interest-earning assets was 5.19% for the three months ended March 31, 2013, compared to 6.01% for the three months ended March 31, 2012. The weighted average yield on loans decreased from 6.01% for the three months March 31, 2012, to 5.37% for the three months ended March 31, 2013.  The decrease was primarily the result of the continued historically low interest rate environment throughout the year.  The decrease in weighted average yield on loans however, was tempered by the increase in commercial real estate loans - which typically have higher yields, as a percentage of the entire loan portfolio.  The average balance of loans receivable, net increased $15.2 million, or 5.1% for the three months ended March 31, 2013 as compared to the same period last year.  The weighted average yield on available-for-sale securities was 2.12% for the three months ended March 31, 2013 compared to 7.48% for the three months ended March 31, 2012, reflecting higher average balances of agency mortgage-backed securities, which produced a much lower yield than the non-agency mortgage-backed securities.  The average balance of available-for-sale securities increased $18.4 million, or 625.3% for the three months ended March 31, 2013 as compared to the same period last year.
 

 
 

 


Interest Expense.  Interest expense decreased $32,000, or 5.3%, to $569,000 for the three months ended March 31, 2013, from $601,000 for the three months ended March 31, 2012.  This decrease reflects overall lower interest rates paid on deposits and FHLB advances notwithstanding an increase in the average balances of deposits and FHLB advances during the period.  Our weighted average cost of interest-bearing liabilities was 0.74% for the three months ended March 31, 2013, compared to 0.86% for the three months ended March 31, 2012.
 
Interest paid on deposits decreased $45,000, or 8.2%, to $501,000 for the three months ended March 31, 2013, from $546,000 for the three months ended March 31, 2012.  This decrease resulted from a decrease in the weighted average cost of deposits, which was partially offset by a $10.0 million increase in the average balance of deposits outstanding for the period.  We experienced an eight basis point decrease in the average rate paid on deposits during the three months ended March 31, 2013 compared to the same period in 2012.  This decrease in average rates was primarily a result of the re-pricing of matured certificates of deposit, most of which we were able to retain at lower rates.
 
Interest expense on borrowings increased $13,000, or 23.6%, to $68,000 for the three months ended March 31, 2013 from $55,000 for the three months ended March 31, 2012.  The increase primarily resulted from a $20.7 million, or 246.7% increase in our average balance of outstanding borrowings at the FHLB.  This increase was partially offset by the 169 basis point decrease in our cost of borrowings which went from 2.62% during the three months ended March 31, 2012 to 0.93% for the three months ended March 31, 2013 due to the maturity of higher rate fixed rate FHLB advances.
 
Net Interest Income.  Net interest income increased $105,000, or 2.7% to $4.1 million for the three months ended March 31, 2013, from $4.0 for the three months ended March 31, 2012.  The increase for the three months ended March 31, 2013 primarily resulted from lower rates paid on deposits during the quarter as compared to the same period last year.  In addition, lower rates on loans were realized on our loan portfolio due to the historically low rate environment, especially for loans to well-qualified borrowers.  Our net interest margin was 4.55% for the three months ended March 31, 2013, compared to 5.23% for the three months ended March 31, 2012.
 
Provision for Loan Losses.   We establish provisions for loan losses, which are charged to earnings, at a level required to reflect management’s best estimate of the probable incurred credit losses in the loan portfolio.  In evaluating the level of the allowance for loan losses, management considers historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect borrowers’ ability to repay, estimated value of any underlying collateral, peer group data, prevailing economic conditions, and current factors.  Large groups of smaller balance homogeneous loans, such as one-to four-family, small commercial and multifamily, home equity and consumer loans, are evaluated in the aggregate using historical loss factors adjusted for current economic conditions and other relevant data.  Loans for which management has concerns about the borrowers’ ability to repay, are evaluated individually, and specific loss allocations are provided for these loans when necessary.
 
A provision of $250,000 was made during the three months ended March 31, 2013, compared to a provision of $1.5 million during the three months ended March 31, 2012.  The provision primarily reflects declines in loan charge-offs and nonperforming loans.  Although the amount of our nonperforming assets and loan charge-offs have declined significantly over the last year, we believe that higher than historical levels of nonperforming assets and charge-offs will continue until the housing market, unemployment, and general economic market conditions further recover in our market area.
 
For the three months ended March 31, 2013, the annualized percentage of net charge-offs to average loans decreased 160 basis points to 0.54% from 2.14% for the three months ended March 31, 2012.  The ratio of nonperforming loans to total loans decreased from 2.57% at March 31, 2012 to 0.63% at March 31, 2013

 
 

 


Noninterest Income.  Noninterest income increased $29,000, or 2.2% to $1.4 million for the three months ended March 31, 2013, as compared to $1.3 million for the three months ended March 31, 2012 as reflected below:
 
   
Three Months Ended March 31,
   
Amount
   
Percent
 
   
2013
   
2012
   
Change
   
Change
 
   
(Dollars in thousands)
 
Service charges and fee income
  $ 598     $ 550     $ 48       8.7 %
Mortgage servicing income
    127       177       (50 )     (28.2 )
Fair value adjustment on mortgage servicing rights
    135       384       (249 )     (64.8 )
Other-than-temporary impairment losses
    (19 )     (91 )     72       (79.1 )
Net gain on sale of loans
    447       251       196       78.1  
Earnings on cash surrender value of bank owned  life insurance
    78       66       12       18.2  
        Total noninterest income
  $ 1,366     $ 1,337     $ 29       2.2 %

The gain on sale of loans increased as a result of more loans originated and sold to Fannie Mae during the three months ended March 31, 2013 at more favorable rates as compared to the same period last year.  We sold $25.0 million and $20.2 million of loans to Fannie Mae during the three months ended March 31, 2013 and 2012, respectively. The fair value adjustment on mortgage servicing rights was negatively impacted primarily due to faster prepayment speeds, offsetting growth in the mortgage servicing portfolio during the current three month period.
 
Noninterest Expense.  Noninterest expense increased $1.0 million, or 33.5%, to $4.0 million during the three months ended March 31, 2013 as compared to $3.0 million during the three months ended March 31, 2012, as reflected below:
 
   
Three Months Ended March 31,
   
Amount
   
Percent
 
   
2013
   
2012
   
Change
   
Change
 
   
(Dollars in thousands)
 
Salaries and benefits
  $ 1,687     $ 1,283     $ 404       31.5 %
Operations
    967       582       385       66.2  
Regulatory assessments
    100       122       (22 )     (18.0 )
Occupancy
    299       310       (11 )     (3.5 )
Data processing
    288       242       46       19.0  
Losses and expenses on OREO and repossessed assets
    675       469       206       43.9  
Total noninterest expense
  $ 4,016     $ 3,008     $ 1,008       33.5 %

Salaries and benefits expense increased during the three months ended March 31, 2013 primarily due to increased loan production by existing loan officers and from a modest increase in FTEs in 2012 and 2013.  Operations expense increased during the period primarily as a result of a $231,000 loss on repurchased FNMA loans accrued for during the current quarter.  This loss is not expected to be recurring nor indicative of possible future repurchases or losses.  In addition, we had higher education and training expenses during the three months ended March 31, 2013 due to a corporate initiative to expand our investment in our employees.  Regulatory assessments were lower due to a decrease in FDIC insurance assessments as a result of a decrease in the FDIC’s assessment rate as well as a change in the assessment base from total deposits to average total assets less tangible equity.  Losses and expenses on OREO and repossessed assets increased during the three months ended March 31, 2013 due to  higher net losses on disposition of OREO properties as several large commercial properties were sold during the current three month period.
 
Income Tax Expense.   For the three months ended March 31, 2013, we had in income tax expense of $370,000 on our pre-tax income as compared to $245,000 for the three months ended March 31, 2012.  The effective tax rates for the three months ended March 31, 2013 and 2012 were 31.7% and 31.0%, respectively.
 

 
 

 


Liquidity

The Management Discussion and Analysis in Item 7 of the Company’s 2012 Form 10-K contains an overview of the Company’s and the Bank’s liquidity management, sources of liquidity and cash flows.  This discussion updates that disclosure for the three months ended March 31, 2013.
 
The Bank’s primary sources of funds are deposits, principal and interest payments on loans and borrowings.  While maturities and scheduled amortization of loans are a predictable source of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition.  The Bank’s primary investing activity is loan originations.  The Bank maintains liquidity levels it believes to be adequate to fund loan commitments, investment opportunities, deposit withdrawals and other financial commitments.  At March 31, 2013, the Bank had $28.5 million in cash and investment securities available for sale and $2.1 million in loans held for sale generally available for its cash needs.  Also, based on existing collateral pledged, the Bank had the ability to borrow an additional $55.4 million in Federal Home Loan Bank advances, $10.2 million through the Federal Reserve’s Discount Window and $2.0 million through Pacific Coast Banker’s Bank.  The Bank uses these sources of funds primarily to meet ongoing commitments, pay maturing deposits and fund withdrawals, and to fund loan commitments.  At March 31, 2013, outstanding loan commitments, including unused lines and letters of credit totaled $55.7 million.  Certificates of deposit scheduled to mature in one year or less at March 31, 2013, totaled $73.2 million.  Based on our competitive pricing, we believe that a majority of maturing deposits will remain with the Bank.

As disclosed in our Condensed Consolidated Statements of Cash Flows in Item 1 of this Quarterly Report on Form 10-Q, cash and cash equivalents decreased $3.9 million to $8.8 million as of March 31, 2013, from $12.7 million as of December 31, 2012.  Net cash provided by operating activities was $952,000 for the three months ended March 31, 2013.  Net cash of $13.6 million was used in investing activities during the three months ended March 31, 2013 and consisted principally of loan originations, net of principal repayments and purchases of bank-owned life insurance.  The $8.7 million of cash provided by financing activities during the three months ended March 31, 2013 primarily consisted of $4.6 million net increase in deposits and $3.8 million in FHLB advances.
As a separate legal entity from the Bank, the Company must provide for its own liquidity.  At March 31, 2013, the Company, on an unconsolidated basis, had $4.1 million in cash, interest-bearing deposits and liquid investments generally available for its cash needs.  The Company’s principal source of liquidity is dividends from the Bank.

Except as set forth above, management is not aware of any trends, events, or uncertainties that will have, or that are reasonably likely to have a material impact on liquidity, capital resources or operations.

Off-Balance Sheet Activities
 
In the normal course of operations, we engage in a variety of financial transactions that are not recorded in our financial statements.  These transactions involve varying degrees of off-balance sheet credit, interest rate and liquidity risks.  These transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit.  For the three months ended March 31, 2013, we engaged in no off-balance sheet transactions likely to have a material effect on our financial condition, results of operations or cash flows.
 
A summary of our off-balance sheet loan commitments at March 31, 2013, is as follows (in thousands):
 
Off-balance sheet loan commitments:
   At March 31, 2013  
      (In thousands)  
Residential mortgage commitments
  $ 7,058  
Undisbursed portion of loans closed
    19,292  
Unused lines of credit
    28,879  
Irrevocable letters of credit
    508  
     Total loan commitments
  $ 55,737  


 
 

 


Capital
 
Sound Community Bank is subject to minimum capital requirements imposed by regulations of the FDIC.  Based on its capital levels at March 31, 2013, Sound Community Bank exceeded these requirements as of that date.  Consistent with our goals to operate a sound and profitable organization, our policy is for Sound Community Bank to maintain a “well-capitalized” status under the regulatory capital categories of the FDIC.  Based on capital levels at March 31, 2013, Sound Community Bank was considered to be well-capitalized under applicable regulatory requirements.  Management monitors the capital levels to provide for current and future business opportunities and to maintain Sound Community Bank’s “well-capitalized” status.

The actual regulatory capital amounts and ratios calculated for Sound Community Bank at March 31, 2013 were as follows:

 
Actual
 
For Capital
Adequacy Purposes
 
To Be Well Capitalized
Under Prompt Corrective
Action Provisions
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
As of March 31, 2013
(Dollars in thousands)
Tier 1 Capital to average assets
$  39,214
 
10.11%
 
$  15,510
4.0%
 
$  19,387
5.0%
Tier 1 Capital to risk-weighted assets
$  39,214
 
13.10%
 
$  11,974
4.0%
 
$  17,961
6.0%
Total Capital to risk-weighted assets
$  42,960
 
14.35%
 
$  23,948
8.0%
 
$  29,935
10.0%

The actual regulatory capital amounts and ratios calculated for Sound Financial Bancorp at March 31, 2013 were as follows:

 
Actual
 
Amount
 
Ratio
As of March 31, 2013
  (Dollars in thousands)
Tier 1 Capital to average assets
$  43,831
 
11.31 %
Tier 1 Capital to risk-weighted assets
$  43,831
 
14.64 %
Total Capital to risk-weighted assets
$  47,577
 
15.89 %


 
 

 


Item 3.   Quantitative and Qualitative Disclosures About Market Risk
 
The Company provided information about market risk in Item 7A of its 2012 Form 10-K.  There have been no material changes in our market risk since our 2012 Form 10-K.
 
Item 4.  Controls and Procedures

(a)  
Evaluation of Disclosure Controls and Procedures.

An evaluation of the Company's disclosure controls and procedures (as defined in Rule 13a -15(e) under the Securities Exchange Act of 1934 (the "Act")), as of March 31, 2013, was carried out under the supervision and with the participation of the Company's Chief Executive Officer, Chief Financial Officer and several other members of the Company's senior management. The Chief Executive Officer and Chief Financial Officer concluded that, as of March 31, 2013, the Company's disclosure controls and procedures were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is: (i) accumulated and communicated to the Company's management (including the Chief Executive Officer and the Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
 
We intend to continually review and evaluate the design and effectiveness of the Company’s disclosure controls and procedures and to improve the Company’s controls and procedures over time and to correct any deficiencies that we may discover in the future. The goal is to ensure that senior management has timely access to all material financial and non-financial information concerning the Company's business. While we believe the present design of the disclosure controls and procedures is effective to achieve this goal, future events affecting our business may cause the Company to modify its disclosure controls and procedures.
 
The Company does not expect that its disclosure controls and procedures will prevent all error and all fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any control procedure is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies and procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.
 
(b)  
Changes in Internal Control over Financial Reporting.
 
There were no changes in our internal control over financial reporting (as defined in Rule 13a - 15(f) under the Act) that occurred during the quarter ended March 31, 2013, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 

 
 

 


 
PART II OTHER INFORMATION
 
Item 1   Legal Proceedings

In the normal course of business, the Company occasionally becomes involved in various legal proceedings.  In the opinion of management, any liability from such proceedings would not have a material adverse effect on the business or financial condition of the Company.

Item 1A Risk Factors

Not required; the Company is a smaller reporting company.
 
Item 2    Unregistered Sales of Equity Securities and use of Proceeds

Nothing to report.

Item 3     Defaults Upon Senior Securities

Nothing to report.

Item 4     Mine Safety Disclosures

Not Applicable

Item 5.    Other Information
 
Nothing to report.

 
 

 

EXHIBIT INDEX
Exhibits:
3.1
Articles of Incorporation of Sound Financial Bancorp, Inc. (incorporated herein by reference to the Registration Statement on Form S-1 filed with the SEC on March 27, 2012 (File No. 333-180385))
3.2
Bylaws of Sound Financial Bancorp, Inc. (incorporated herein by reference to the Registration Statement on Form S-1 filed with the SEC on March 27, 2012 (File No. 333-180385))
4.0
Form of Common Stock Certificate of Sound Financial Bancorp, Inc. (incorporated herein by reference to the Registration Statement on Form S-1 filed with the SEC on March 27, 2012 (File No. 333-180385))
10.1
Employment Agreement by and between Sound Community Bank and Laura Lee Stewart (incorporated herein by reference to the Registration Statement on Form SB-2 filed with the SEC on September 20, 2007 (File No. 333-146196))
10.2
Executive Long Term Compensation Agreement effective August 14, 2007 by and between Sound Community Bank and Laura Lee Stewart (incorporated herein by reference to the Registration Statement on Form SB-2 filed with the SEC on September 20, 2007 (File No. 333-146196))
10.3
Amendment to Freeze Benefit Accruals Under the Executive Long Term Compensation Agreement effective August 14, 2007, by and between Sound Community Bank (incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on January 5, 2012 (File No. 000-52889))
10.4
Supplemental Executive Long Term Compensation Agreement effective December 31, 2011 by and between Sound Community Bank and Laura Lee Stewart (incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on January 5, 2012 (File No. 000-52889))
10.5
Confidentiality, Non-Competition and Non-Solicitation Agreement  by and between Sound Community Bank and Laura Lee Stewart (incorporated herein by reference to the Report on Form 8-K filed with the SEC on January 5, 2012 (File No. 000-52889)) 
10.6
Employment Agreement by and between Sound Community Bank and Matthew Deines (incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on November 5, 2009 (File No. 000-52889)) 
10.7
Employment Agreement by and between Sound Community Bank and Matthew Moran (incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on November 5, 2009 (File No. 000-52889)) 
10.8
Addendums to the Employment Agreements by and between Sound Community Bank and each of Matthew Deines and Matthew Moran (incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on January 3, 2012 (File No. 000-52889)) 
10.9
Summary of Director Board Fee Arrangements (incorporated herein by reference to the Annual Report on Form 10-K filed with the SEC on March 31, 2011 (File No. 000-52889))
10.10
Sound Financial Bancorp, Inc. 2008 Equity Incentive Plan (incorporated herein by reference to the Annual Report on Form 10-K filed with the SEC on March 31, 2009 (File No. 000-52889))
10.11
Forms of Incentive Stock Option Agreement, Non-Qualified Stock Option Agreement and Restricted Stock Agreements under the 2008 Equity Incentive Plan (incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on January 29, 2009 (File No. 000-52889))
10.12
Summary of Annual Bonus Plan (incorporated herein by reference to the Registration Statement on Form SB-2 filed with the SEC on September 20, 2007 (File No. 333-146196))
11
Statement re computation of per share earnings (See Note 9 of the Notes to Condensed Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q.)
31.1
Rule 13(a)-14(a) Certification (Chief Executive Officer)
31.2
Rule 13(a)-14(a) Certification (Chief Financial Officer)
32
Section 1350 Certification
101
Interactive Data Files*
¯             In accordance with Rule 406T of Regulation S-T, these interactive data files are deemed not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are not deemed filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to            liability under those section.
 
 

 
 

 

SIGNATURES


Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

                                                                                                                                                                                                   Sound Financial Bancorp, Inc.

Date:  May 15, 2013
By:
/s/  Laura Lee Stewart
 
   
Laura Lee Stewart
 
   
President and Chief Executive Officer
 
       
       
       
Date:  May 15, 2013
By:
/s/  Matthew P. Deines
 
   
Matthew P. Deines
 
   
Executive Vice President and Chief Financial Officer