VSB Bancorp, Inc.
VSB BANCORP, INC.
1. GENERAL
VSB Bancorp, Inc. (referred to using terms such as “we,” “us,” or the “Company”) became the holding company for Victory State Bank (the “Bank”), a New York chartered commercial bank. Our primary business is owning all of the issued and outstanding stock of the Bank. Our common stock is listed on the NASDAQ Global Market, effective on August 4, 2008. We continue to trade under the symbol “VSBN”.
Through the Bank, the Company is primarily engaged in the business of commercial banking, and to a lesser extent retail banking. The Bank gathers deposits from individuals and businesses primarily in Staten Island, New York and makes loans throughout that community. Therefore, the Company’s exposure to credit risk is significantly affected by changes in the local Staten Island economic and real estate markets. The Bank invests funds that are not used for lending primarily in government securities, mortgage backed securities and collateralized mortgage obligations. Customer deposits are insured, up to the applicable limit, by the Federal Deposit Insurance Corporation (“FDIC”). The Bank is supervised by the New York State Banking Department and the FDIC.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following is a description of the significant accounting and reporting policies followed in preparing and presenting the accompanying consolidated financial statements. These policies conform with accounting principles generally accepted in the United States of America (“GAAP”).
Principles of Consolidation - The consolidated financial statements of the Company include the accounts of the Company, including its subsidiary Victory State Bank. All significant inter-company accounts and transactions between the Company and Bank have been eliminated in consolidation.
Use of Estimates - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the amounts of revenues and expenses during the reporting period. Actual results can differ from those estimates. The allowance for loan losses, prepayment estimates on the mortgage-backed securities and Collateralized Mortgage Obligation portfolios, contingencies and fair values of financial instruments are particularly subject to change.
Reclassifications – Some items in the prior year financial statements were reclassified to conform to the current presentation.
Cash and Cash Equivalents – Cash and cash equivalents consists of cash on hand, due from banks and interest-bearing deposits. Net cash flows are reported for customer loan and deposit transactions and interest-bearing deposits with original maturities of 90 days or less. Regulation D of the Board of Governors of the Federal Reserve System requires that Victory State Bank maintain interest-bearing deposits or cash on hand as reserves against its demand deposits. The amount of reserves which Victory State Bank is required to maintain depends upon its level of transaction accounts. During the fourteen day period from March 25, 2010 through April 7, 2010, Victory State Bank was required to maintain reserves, after deducting vault cash, of $3,605,000. Reserves are required to be maintained on a fourteen day basis, so, from time to time, Victory State Bank may use available cash reserves on a day to day basis, so long as the fourteen day average reserves satisfy Regulation D requirements. Victory State Bank is required to report transaction account levels to the Federal Reserve on a weekly basis.
Interest-bearing bank balances – Interest-bearing bank balances mature overnight and are carried at cost.
Investment Securities, Available for Sale - Investment securities, available for sale, are to be held for an unspecified period of time and include securities that management intends to use as part of its asset/liability strategy. These securities may be sold in response to changes in interest rates, prepayments or other factors and are carried at estimated fair value. Gains or losses on the sale of such securities are determined by the specific identification method. Interest income includes amortization of purchase premium and accretion of purchase discount. Premiums and discounts are recognized in interest income using a method that approximates the level yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are estimated. Unrealized holding gains or losses, net of deferred income taxes, are excluded from earnings and reported as other comprehensive income in a separate component of stockholders’ equity until realized. Declines in the fair value of securities below their cost that are other than temporary are reflected as realized losses. In estimating other-than-temporary losses, management considers: (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, and (3) the Company’s intent and probability of being required to sell the securities.
The Company invests primarily in agency Collateralized Mortgage-Backed Obligations (“CMOs”) with estimated average lives primarily under 4.5 years and Mortgage-Backed Securities. These securities are primarily issued by the Federal National Mortgage Association (“FNMA”), the Government National Mortgage Association (“GNMA”) or the Federal Home Loan Mortgage Corporation (“FHLMC”) and are primarily comprised of mortgage pools guaranteed by FNMA, GNMA or FHLMC. The Company also invests in whole loan CMOs, all of which are AAA rated. These securities expose the Company to risks such as interest rate, prepayment and credit risk and thus pay a higher rate of return than comparable treasury issues.
Loans Receivable - Loans receivable, that management has the intent and ability to hold for the foreseeable future or until maturity or payoff, are stated at unpaid principal balances, adjusted for deferred net origination and commitment fees and the allowance for loan losses. Interest income on loans is credited as earned.
It is the policy of the Company to provide a valuation allowance for probable incurred losses on loans based on the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations which may affect the borrower’s ability to repay, estimated value of underlying collateral and current economic conditions in the Company’s lending area. The allowance is increased by provisions for loan losses charged to earnings and is reduced by charge-offs, net of recoveries. While management uses available information to estimate losses on loans, future additions to the allowance may be necessary based upon the expected growth of the loan portfolio and any changes in economic conditions beyond management’s control. In addition, various regulatory agencies, as an integral part of their examination p rocess, periodically review the Bank’s allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on judgments different from those of management. Management believes, based upon all relevant and available information, that the allowance for loan losses is appropriate.
The Company has a policy that all loans 90 days past due are placed on non-accrual status. It is the Company’s policy to cease the accrual of interest on loans to borrowers past due less than 90 days where a probable loss is estimated and to reverse out of income all interest that is due. The Company applies payments received on non-accrual loans to the outstanding principal balance due before applying any amount to interest, until the loan is restored to an accruing status. On a limited basis, the Company may apply a payment to interest on a non-accrual loan if there is no impairment or no estimated loss on this asset. The Company continues to accrue interest on construction loans that are 90 days past contractual maturity date if the loan is expected to be paid in full in the next 60 days and all interest is paid up to date.
Loan origination fees and certain direct loan origination costs are deferred and the net amount recognized over the contractual loan terms using the level-yield method, adjusted for periodic prepayments in certain circumstances.
The Company considers a loan to be impaired when, based on current information, it is probable that the Company will be unable to collect all principal and interest payments due according to the contractual terms of the loan agreement. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Impairment is measured on a loan by loan basis for commercial and construction loans. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral. The fair value of the collateral, as reduced by costs to sell, is utilized if a loan is collateral dependent. Loans with modified terms that the Company would n ot normally consider, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired. Large groups of smaller balance homogeneous loans, such as consumer loans and residential loans, are collectively evaluated for impairment.
Long-Lived Assets - The Company periodically evaluates the recoverability of long-lived assets, such as premises and equipment, to ensure the carrying value has not been impaired. In performing the review for recoverability, the Company would estimate the future cash flows expected to result from the use of the asset. If the sum of the expected future cash flows is less than the carrying amount an impairment will be recognized. The Company reports these assets at the lower of the carrying value or fair value.
Premises and Equipment - Premises, leasehold improvements, and furniture and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are accumulated by the straight-line method over the estimated useful lives of the respective assets, which range from three to fifteen years. Leasehold improvements are amortized at the lesser of their useful life or the term of the lease.
Federal Home Loan Bank (FHLB) Stock - The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment. Because this stock is viewed as a long term investment, impairment is based on ultimate recovery of par value, which is the price the Bank pays for the FHLB Stock. Both cash and stock dividends are reported as income.
Income Taxes - The Company utilizes the liability method to account for income taxes. Under this method, deferred tax assets and liabilities are determined on differences between financial reporting and the tax bases of assets and liabilities and are measured using the enacted tax rates and laws expected to be in effect when the differences are expected to reverse. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. As such, a tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit t hat is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.
The Company recognizes interest and/or penalties related to income tax matters in income tax expense.
Financial Instruments - In the ordinary course of business, the Company has entered into off-balance sheet financial instruments, primarily consisting of commitments to extend credit.
Basic and Diluted Net Income Per Common Share - Basic net income per share of common stock is based on 1,725,522 shares and 1,807,984 shares, the weighted average number of common shares outstanding for the three months ended March 31, 2010 and 2009, respectively. Diluted net income per share of common stock is based on 1,744,620 and 1,830,651, the weighted average number of common shares and potentially dilutive common shares outstanding for the three months ended March 31, 2010 and 2009, respectively. The weighted average number of potentially dilutive common shares excluded in calculating diluted net income per common share due to the anti-dilutive effect is 34,120 and 75,758 shares for the three months ended March 31, 2010 and 2009, respectively. Common stock equivalents were calculated using the treasury stock method.
The reconciliation of the numerators and the denominators of the basic and diluted per share computations for the three months ended March 31, are as follows:
| Reconciliation of EPS | | Three months ended March 31, 2010 | | | Three months ended March 31, 2009 | |
| | | Net Income | | | Weighted Average Shares | | | Per Share Amount | | | Net Income | | | Weighted Average Shares | | | Per Share Amount | |
| | | | | | | | | | | | | | | | | | | |
| Basic earnings per common share | | | | | | | | | | | | | | | | | | |
| Net income available to common stockholders | | $ | 432,222 | | | | 1,725,522 | | | $ | 0.25 | | | $ | 373,051 | | | | 1,807,984 | | | $ | 0.21 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Effect of dilutive shares | | | | | | | | | | | | | | | | | | | | | | | | |
| Weighted average shares, if converted | | | | | | | 19,098 | | | | | | | | | | | | 22,667 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Diluted earnings per common share | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income available to common stockholders | | $ | 432,222 | | | | 1,744,620 | | | $ | 0.25 | | | $ | 373,051 | | | | 1,830,651 | | | $ | 0.20 | |
Stock Based Compensation - The Company records compensation expense for stock options provided to employees in return for employment service. The cost is measured at the fair value of the options when granted, and this cost is expensed over the employment service period, which is normally the vesting period of the options.
Employee Stock Ownership Plan (“ESOP”) - The cost of shares issued to the ESOP, but not yet allocated to participants, is shown as a reduction of stockholders’ equity. Compensation expense is based on the market price of shares as they are committed to be released to participant accounts. Cash dividends on allocated ESOP shares reduce retained earnings; cash dividends on unearned ESOP shares reduce debt and accrued interest.
Stock Repurchase Programs - On September 8, 2008, the Company announced that its Board of Directors had authorized a Rule 10b5-1 stock repurchase program for the repurchase of up to 100,000 shares of the Company’s common stock. On April 21, 2009, the Company announced that its Board of Directors had authorized a second Rule 10b5-1 stock repurchase program for the repurchase of up to an additional 100,000 shares of the Company’s common stock. At March 31, 2010, the Company had repurchased a total of 182,943 shares of its common stock under these stock repurchase programs. Stock repurchases under the program have and will be accounted for using the cost method, in which the Company will refle ct the entire cost of repurchased shares as a separate reduction of stockholders’ equity on its balance sheet.
Comprehensive Income - Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses, net of taxes, on securities available for sale which are also recognized as separate components of equity.
Recently-Adopted Accounting Standards - In April 2009, the FASB issued Staff Position (FSP) No. 115-2 and No. 124-2, Recognition and Presentation of Other-Than-Temporary Impairments, which now falls under ASC 320, which amends existing guidance for determining whether impairment is other-than-temporary for debt securities. The FSP requires an entity to assess whether it intends to sell, or it is more likely than not that it will be required to sell a security in an unrealized loss position before recovery of its amortized cost basis. If either of these criteria is met, the entire difference between amortized cost and fair value is recognized in earnings. For securities that do not meet the aforementioned criteria, the amount of impairment recognized in earnings is limited to the amount related to credit losses, while impairment related to other factors is recognized in other comprehensive income. Additionally, the FSP expands and increases the frequency of existing disclosures about other-than-temporary impairments for debt and equity securities. This FSP is effective for interim and annual reporting periods ending after June 15, 2009. The adoption of this standard did not have a material effect on the Company’s results of operations or financial position.
In April 2009, the FASB issued Staff Position (FSP) No. 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset and Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, which now falls under ASC 820. This FSP emphasizes that even if there has been a significant decrease in the volume and level of activity, the objective of a fair value measurement remains the same. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants. The FSP provides a number of factors to consider when evaluating whether there has been a significant decr ease in the volume and level of activity for an asset or liability in relation to normal market activity. In addition, when transactions or quoted prices are not considered orderly, adjustments to those prices based on the weight of available information may be needed to determine the appropriate fair value. The FSP also requires increased disclosures. This FSP is effective for interim and annual reporting periods ending after June 15, 2009, and shall be applied prospectively. The adoption of this standard did not have a material effect on the Company’s results of operations or financial position.
On June 29, 2009, the FASB issued FASB Statement No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles – A Replacement of FASB Statement No. 162, which is now ASC 105. With the issuance of this statement, the FASB Accounting Standards CodificationTM (Codification) became the source of authoritative U.S. generally accepted accounting principles (GAAP) recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. On the effective date of this Statement, the Codification superseded all then-existing non-SEC accounting and reporting standards. All other nongrandfathered non-SEC accounting literature not included in the Codification became nonauthoritative. The issuance of the Codification is not intended to change GAAP. This Statement is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The adoption of this standard did not have a material impact on the Company’s results of operations or financial position.
In August 2009, the FASB issued Accounting Standards Update (ASU) 2009-05, “Measuring Liabilities at Fair Value”, as a subset of Topic 820 – “Fair Value Measurements and Disclosure”. Among other clarifying points, ASU 2009-05 provides clarification that in circumstance in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using one or more of the following techniques: (1) The quoted price of the identical liability when traded as an asset, (2) Quoted prices for similar liabilities or similar liabilities when traded as assets, or (3) Another valuation technique that is consistent with the principles of Topic 820 such as an income approach or market approach. The ASU was effective as of September 30, 2009. The adoption of this standard did not have a material impact on the Company’s results of operations or financial position.
In June 2009, the FASB amended previous guidance relating to transfers of financial assets and eliminated the concept of a qualifying special purpose entity. This guidance must be applied as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. This guidance must be applied to transfers occurring on or after the effective date. Additionally, on and after the effective date, the concept of a qualifying special-purpose entity is no longer relevant for accounting purposes. Therefore, formerly qualifying special-purpose entities should be evaluated for consolidation by reporting entities on and after the effective date in accordance with the applicable consolidat ion guidance. The disclosure provisions were also amended and apply to transfers that occurred both before and after the effective date of this guidance. The adoption of this standard did not have a material effect on the Company’s results of operations or financial position.
In June 2009, the FASB amended guidance for consolidation of variable interest entity guidance by replacing the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a variable interest entity with an approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. Additional disclosures about an enterprise’s involvement in variable interest entities are also required. This guidance is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim per iods within that first annual reporting period, and for interim and annual reporting periods thereafter. Early adoption is prohibited. The adoption of this standard did not have a material effect on the Company’s results of operations or financial position.
Recently Issued but Not Yet Effective Standards - In January 2010, the FASB issued guidance to improve disclosure requirements related to fair value measurements and disclosures. The guidance requires that a reporting entity should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers and that activity in Level 3 should be presented on a gross basis rather than one net number for information about purchases, issuances, and settlements. The guidance also requires that a reporting entity should provide fair value measurement disclosures for each class of assets and liabilities and about the valuation techniques and inputs used to measure fair value for both recurr ing and nonrecurring fair value measurements. This guidance is effective for interim and annual reporting periods beginning after December 31, 2009 except for the roll forward of activity in Level 3 which is effective for interim and annual reporting periods beginning after December 31, 2010. Adopting this pronouncement did not have a material effect on the results of operations or financial condition of the Company.
3. INVESTMENT SECURITIES, AVAILABLE FOR SALE
The following table summarizes the amortized cost and fair value of the available-for-sale investment securities portfolio at March 31, 2010 and December 31, 2009 and the corresponding amounts of unrealized gains and losses therein:
| | | March 31, 2010 | |
| | | Amortized | | | Unrealized | | | Unrealized | | | Fair | |
| | | Cost | | | Gains | | | Losses | | | Value | |
| | | | | | | | | | | | | |
| FNMA MBS - Residential | | $ | 4,693,683 | | | $ | 192,628 | | | $ | — | | | $ | 4,886,311 | |
| GNMA MBS - Residential | | | 1,227,408 | | | | 66,356 | | | | — | | | | 1,293,764 | |
| Whole Loan MBS - Residential | | | 1,703,238 | | | | 32,036 | | | | — | | | | 1,735,274 | |
| Collateralized mortgage obligations | | | 101,956,598 | | | | 3,244,389 | | | | (127,186 | ) | | | 105,073,801 | |
| | | $ | 109,580,927 | | | $ | 3,535,409 | | | $ | (127,186 | ) | | $ | 112,989,150 | |
| | | December 31, 2009 | |
| | | Amortized | | | Unrealized | | | Unrealized | | | Fair | |
| | | Cost | | | Gains | | | Losses | | | Value | |
| | | | | | | | | | | | | |
| FNMA MBS - Residential | | $ | 4,855,213 | | | $ | 185,607 | | | $ | — | | | $ | 5,040,820 | |
| GNMA MBS - Residential | | | 1,265,428 | | | | 55,812 | | | | — | | | | 1,321,240 | |
| Whole Loan MBS - Residential | | | 1,860,603 | | | | 15,135 | | | | (18,845 | ) | | | 1,856,893 | |
| Collateralized mortgage obligations | | | 102,933,529 | | | | 3,085,224 | | | | (325,302 | ) | | | 105,693,451 | |
| | | $ | 110,914,773 | | | $ | 3,341,778 | | | $ | (344,147 | ) | | $ | 113,912,404 | |
There were no sales of investment securities for the three months ended March 31, 2010 and the year ended December 31, 2009.
The amortized cost and fair value of the investment securities portfolio are shown by expected maturity. Expected maturities may differ from contractual maturities, especially for collateralized mortgage obligations, if borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
| | | March 31, 2010 | |
| Securities, Available for Sale | | Amortized | | | Fair | |
| Expected Maturity | | Cost | | | Value | |
| | | | | | | | | |
| Less than one year | | $ | — | | | $ | — | |
| Due after one year through five years | | | 4,044,070 | | | | 4,204,744 | |
| Due after five years through ten years | | | 37,797,063 | | | | 39,457,122 | |
| Due after ten years | | | 67,739,794 | | | | 69,327,284 | |
| | | $ | 109,580,927 | | | $ | 112,989,150 | |
The following table summarizes the investment securities with unrealized losses at March 31, 2010 and December 31, 2009 by aggregated major security type and length of time in a continuous unrealized loss position:
| March 31, 2010 | | Less than 12 months | | | More than 12 months | | | Total | |
| | | Fair | | | Unrealized | | | Fair | | | Unrealized | | | Fair | | | Unrealized | |
| | | Value | | | Loss | | | Value | | | Loss | | | Value | | | Loss | |
| | | | | | | | | | | | | | | | | | | |
| FNMA MBS | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
| GNMA MBS | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
| Whole Loan MBS | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
| Collateralized mortgage obligations | | | 10,401,975 | | | | (109,296 | ) | | | 1,276,720 | | | | (17,890 | ) | | | 11,678,695 | | | | (127,186 | ) |
| | | $ | 10,401,975 | | | $ | (109,296 | ) | | $ | 1,276,720 | | | $ | (17,890 | ) | | $ | 11,678,695 | | | $ | (127,186 | ) |
| December 31, 2009 | | Less than 12 months | | | More than 12 months | | | Total | |
| | | Fair | | | Unrealized | | | Fair | | | Unrealized | | | Fair | | | Unrealized | |
| | | Value | | | Loss | | | Value | | | Loss | | | Value | | | Loss | |
| | | | | | | | | | | | | | | | | | | |
| FNMA MBS | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
| GNMA MBS | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
| Whole Loan MBS | | | — | | | | — | | | | 433,666 | | | | (18,845 | ) | | | 433,666 | | | | (18,845 | ) |
| Collateralized mortgage obligations | | | 10,036,242 | | | | (280,961 | ) | | | 1,750,950 | | | | (44,341 | ) | | | 11,787,192 | | | | (325,302 | ) |
| | | $ | 10,036,242 | | | $ | (280,961 | ) | | $ | 2,184,616 | | | $ | (63,186 | ) | | $ | 12,220,858 | | | $ | (344,147 | ) |
The Company evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition.
At March 31, 2010, the unrealized loss on investment securities was caused by interest rate increases. We expect that these securities, at maturity, will not be settled for less than the amortized cost of the investment. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the securities and it is not more likely than not the Company will be required to sell the securities before recovery of the amortized cost basis less any current-period loss, these investments are not considered other-than-temporarily impaired. At March 31, 2010, there were no debt securities with unrealized losses with aggregate depreciation of 5% or more from the Company’s amortized cost basis.
Securities pledged had a carrying amount of $58,283,802 and $54,199,477 at March 31, 2010 and December 31, 2009, respectively and were pledged to secure public deposits and balances in excess of the deposit insurance limit on certain customer accounts.
4. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of FASB ASC 820, “Financial Instruments”. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
The following methods and assumptions were used by the Company in estimating fair values of financial instruments:
| | Interest-bearing Bank Balances – Interest-bearing bank balances mature within one year and are carried at cost which are estimated to be reasonably close to fair value. |
| | |
| | Money Market Investments – The fair value of these securities approximates their carrying value due to the relatively short time to maturity |
| | |
| | Investment Securities, Available For Sale – The estimated fair value of these securities is determined by using available market information and appropriate valuation methodologies. The estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. |
| | |
| | Loans Receivable - The fair value of commercial and construction loans are approximated by the carrying value as the loans are tied directly to the Prime Rate and are subject to change on a daily basis. The fair value of the remainder of the portfolio is determined by discounting the future cash flows of the loans using the appropriate discount rate. |
| | |
| | Other Financial Assets - The fair value of these assets, principally accrued interest receivable, approximates their carrying value due to their short maturity. |
| | |
| | Non-Interest Bearing and Interest Bearing Deposits - The fair value disclosed for non-interest bearing deposits is equal to the amount payable on demand at the reporting date. The fair value of interest bearing deposits is based upon the current rates for instruments of the same remaining maturity. Interest bearing deposits with a maturity of greater than one year are estimated using a discounted cash flow approach that applies interest rates currently being offered. |
| | |
| | Other Liabilities - The estimated fair value of other liabilities, which primarily include accrued interest payable, approximates their carrying amount. |
| | The carrying amounts and estimated fair values of financial instruments, at March 31, 2010 and December 31, 2009 are as follows: |
| | | March 31, 2010 | | | December 31, 2009 | |
| | | Carrying | | | Fair | | | Carrying | | | Fair | |
| | | Amount | | | Value | | | Amount | | | Value | |
| Financial Assets: | | | | | | | | | | | | |
| Cash and cash equivalents | | $ | 44,640,167 | | | $ | 44,640,167 | | | $ | 39,716,919 | | | $ | 39,716,919 | |
| Investment securities, available for sale | | | 112,989,150 | | | | 112,989,150 | | | | 113,912,404 | | | | 113,912,404 | |
| Loans receivable | | | 76,836,016 | | | | 77,822,706 | | | | 77,770,702 | | | | 78,515,058 | |
| Other financial assets | | | 658,764 | | | | 658,764 | | | | 722,228 | | | | 722,228 | |
| | | | | | | | | | | | | | | | | |
| Total Financial Assets | | $ | 235,124,097 | | | $ | 236,110,787 | | | $ | 232,122,253 | | | $ | 232,866,609 | |
| | | | | | | | | | | | | | | | | |
| Financial Liabilities: | | | | | | | | | | | | | | | | |
| Non-interest bearing deposits | | $ | 70,205,702 | | | $ | 70,205,702 | | | $ | 70,688,777 | | | $ | 70,688,777 | |
| Interest bearing deposits | | | 142,445,116 | | | | 142,333,430 | | | | 140,297,309 | | | | 140,258,492 | |
| Other liabilities | | | 16,874 | | | | 16,874 | | | | 45,695 | | | | 45,695 | |
| | | | | | | | | | | | | | | | | |
| Total Financial Liabilities | | $ | 212,667,692 | | | $ | 212,556,006 | | | $ | 211,031,781 | | | $ | 210,992,964 | |
ASC 825 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
| | Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date. |
| | |
| | Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data. |
| | |
| | Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing and asset or liability. |
The fair value of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used to in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).
| | | Fair Value Measurements at March 31, 2010 Using | |
| | | | | | | | | Significant | | | | |
| | | | | | Quoted Prices in | | | Other | | | Significant | |
| | | | | | Active Markets for | | | Observable | | | Unobservable | |
| | | March 31, | | | Identical Assets | | | Inputs | | | Inputs | |
| | | 2010 | | | (Level 1) | | | (Level 2) | | | (Level 3) | |
| Assets: | | | | | | | | | | | | |
| FNMA MBS - Residential | | $ | 4,886,311 | | | $ | — | | | $ | 4,886,311 | | | $ | — | |
| GNMA MBS - Residential | | | 1,293,764 | | | | — | | | | 1,293,764 | | | | — | |
Whole Loan MBS - Residential | | | 1,735,274 | | | | — | | | | 1,735,274 | | | | — | |
| Collateralized mortgage obligations | | | 105,073,801 | | | | — | | | | 105,073,801 | | | | — | |
Total Available for sale Securities | | $ | 112,989,150 | | | $ | — | | | $ | 112,989,150 | | | $ | — | |
| | | Fair Value Measurements at December 31, 2009 Using | |
| | | | | | | | | Significant | | | | |
| | | | | | Quoted Prices in | | | Other | | | Significant | |
| | | | | | Active Markets for | | | Observable | | | Unobservable | |
| | | December 31, | | | Identical Assets | | | Inputs | | | Inputs | |
| | | 2009 | | | (Level 1) | | | (Level 2) | | | (Level 3) | |
| Assets: | | | | | | | | | | | | |
| FNMA MBS - Residential | | $ | 5,040,820 | | | $ | — | | | $ | 5,040,820 | | | $ | — | |
| GNMA MBS - Residential | | | 1,321,240 | | | | — | | | | 1,321,240 | | | | — | |
Whole Loan MBS - Residential | | | 1,856,893 | | | | — | | | | 1,856,893 | | | | — | |
| Collateralized mortgage obligations | | | 105,693,451 | | | | — | | | | 105,693,451 | | | | — | |
Total Available for sale Securities | | $ | 113,912,404 | | | $ | — | | | $ | 113,912,404 | | | $ | — | |
Certain financial assets and financial liabilities are measured at fair value on a nonrecurring basis, that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).
There were no collateral dependent impaired loans with an allowance allocated at March 31, 2010 and December 31, 2009.
Financial Condition at March 31, 2010
Total assets were $239,765,951 at March 31, 2010, an increase of $2,766,079 or, 1.2%, from December 31, 2009. The increase resulted from the investment of funds available to us as the result of an increase in deposits. The deposit increase was caused generally by our efforts to grow our franchise and specifically by the deposit increases at our branch offices. We invested these funds primarily in cash and cash equivalents. The net increase in assets can be summarized as follows:
| ● | A $4,923,248 net increase in cash and cash equivalents, partially offset by |
| ● | A $923,254 net decrease in investment securities available for sale and |
| ● | A $934,686 net decrease in net loans receivable. |
In addition to these changes in major asset categories, we also experienced changes in other asset categories due to normal fluctuations in operations.
Our deposits (including escrow deposits) were $212,650,818 at March 31, 2010, an increase of $1,664,732 or 0.79%, from December 31, 2009. The increase in deposits resulted from increases of $1,032,292 in money market accounts, $882,528 in NOW accounts, $193,394 in time deposits, $67,083 in escrow deposits and $39,593 in savings accounts, partially offset by a decrease of $550,158 in non-interest demand deposits.
Total stockholders’ equity was $25,063,007 at March 31, 2010, an increase of $579,058 from December 31, 2009. The increase reflected (i) net income of $432,222 for the three months ended March 31, 2010, (ii) an increase in the net unrealized gain on securities available for sale of $222,746 reflecting the positive effect of low market interest rates on the fair value of our securities portfolio and (iii) a reduction of $42,270 in Unearned ESOP shares reflecting the gradual payment of the loan we made to fund the ESOP’s purchase of our stock. These increases were partially offset by $103,542 of dividends paid, representing a $0.06 per share cash dividend for the first quarter of 2010.
The unrealized gain on securities available for sale is excluded from the calculation of regulatory capital. Management does not anticipate selling securities in this portfolio, but changes in market interest rates or in the demand for funds may change management’s plans with respect to the securities portfolio. If there is a material increase in interest rates, the market value of the available for sale portfolio may decline. Management believes that the principal and interest payments on this portfolio, combined with the existing liquidity, will be sufficient to fund loan growth and potential deposit outflow.
For financial statement reporting purposes, we record the compensation expense related to the ESOP when shares are committed to be released from the security interest for the loan. The amount of the compensation expense is based upon the fair market value of the shares at that time, not the original purchase price. The initial sale of shares to the ESOP did not increase our capital by the amount of the purchase price because the purchase price was paid by the loan we made to the ESOP. Instead, capital increases as the shares are allocated or committed to be allocated to employee accounts (i.e., as the ESOP loan is gradually repaid), based upon the fair market value of the shares at that time. When we calculate earnings per share, only shares allocated or committed to be allocated to employee accounts are considered to be outstanding. How ever, all shares that the ESOP owns are legally outstanding, so they have voting rights and, if we pay dividends, dividends will be paid on all ESOP shares.
The Current Economic Turmoil
The economy in the United States, including the economy in Staten Island, was and may still be in a recession. Although some analysts report that the economy is recovering, the extent and speed of the recovery is far from clear. There is substantial stress on many financial institutions and financial products. The federal government has intervened by making hundreds of billions of dollars in capital contributions to the banking industry. We draw a substantial portion of our customer base from local businesses, especially those in the building trades and related industries. Our customers are already being adversely affected by the economic downturn, and if adverse conditions in the local economy continue, it will become more difficult for us to conduct prudent and profitable business in our community.
Making permanent residential mortgage loans is not a material part of our business, and our investments in mortgage-backed securities and collateralized mortgage obligations have been made with a view towards avoiding the types of securities that are backed by low quality mortgage-related assets. However, one of the primary focuses of our local business is receiving deposits from, and making loans to, businesses involved in the construction and building trades industry on Staten Island. Construction loans represented a significant component of our loan portfolio, reaching 39.8% of total loans at year end 2005. As we monitored the economy and the strength of the local construction industry, we elected to reduce our portfolio of construction loans. By March 31, 2010, the percentage had declin ed to 17.5%. However, developers and builders provide not only a source of loans, but they also provide us with deposits and other business. If the weakness in the economy continues or worsens, then that could have a substantial adverse effect on our customers and potential customers, making it more difficult for us to find satisfactory loan opportunities and low-cost deposits. This could compel us to invest in lower yielding securities instead of higher-yielding loans and could also reduce low cost funding sources such as checking accounts and require that we replace them with higher cost deposits such as time deposits. Either or both of those shifts could reduce our net income.
Changes in FDIC Assessment Rates
In the past two years, there have been many failures and near-failures among financial institutions. The number of FDIC-insured banks that have failed has increased, and the FDIC insurance fund reserve ratio, representing the ratio of the fund to the level of insured deposits, has declined due to losses caused by bank failures. As a result, the FDIC has increased its deposit insurance premiums on remaining institutions, including well-capitalized institutions like Victory State Bank, in order to replenish the insurance fund. If bank failures continue to occur, and more so if the level of failures increases, the FDIC insurance fund will further decline, and the FDIC is likely to continue to impose higher premiums on healthy banks. Thus, despite the prudent steps we may take to avoid the mist akes made by other banks, our costs of operations may increase as a result of those mistakes by others.
Our FDIC regular insurance premium was $79,563 in the first quarter of 2010 compared to $30,047 in the first quarter of 2009, an increase of 164.8%. In contrast, the level of deposits, on which the FDIC insurance premium is based, increased only 12.2%. In 2009, the FDIC announced an increase in deposit insurance premiums so institutions like our Bank, even though we are in the lowest regulatory risk category, will be subject to an assessment rate between seven (7) and twelve (12) basis points per annum, which is higher than the assessment rate in 2008 of from five (5) to seven (7) basis points. Additionally, the FDIC imposed a 5 basis point special assessment, based on June 30, 2009 total assets net of Tier 1 capital, that we paid on September 30, 2009. The special assessment amounted to $1 01,950 and we accrued it prior to the quarter in which it was paid because it was based upon assets at June 30. The increase in the assessment rate and the special assessment had significantly increased our deposit insurance expense in 2009. The FDIC also required that FDIC-insured banks prepay, in a lump sum that was paid at the end of 2009, their entire projected FDIC premium assessment through the end of 2012. The prepaid amount is expensed for financial reporting purposes gradually each quarter during the prepayment period. If our actual FDIC assessment during that period is less than the amount we prepay, the excess prepayment will be applied to future premiums we owe, and any excess prepayment remaining on December 31, 2014 would be refunded to us. Although the prepayment had no direct income statement effect when made, it reduced the funds we had available for investment in interest-earning assets because the FDIC will not pay interest on the prepayment.
Possible Adverse Effects on Our Net Income Due to Fluctuations in Market Rates
Our principal source of income is the difference between the interest income we earn on interest-earning assets, such as loans and securities, and our cost of funds, principally interest paid on deposits. These rates of interest change from time to time, depending upon a number of factors, including general market interest rates. However, the frequency of the changes varies among different types of assets and liabilities. For example, for a five-year loan with an interest rate based upon the prime rate, the interest rate may change every time the prime rate changes. In contrast, the rate of interest we pay on a five-year certificate of deposit adjusts only every five years, based upon changes in market interest rates.
In general, the interest rates we pay on deposits adjust more slowly than the interest rates we earn on loans because our loan portfolio consists primarily of loans with interest rates that fluctuate based upon the prime rate. In contrast, although many of our deposit categories have interest rates that could adjust immediately, such as interest checking accounts and savings accounts, changes in the interest rates on those accounts are at our discretion. Thus, the rates on those accounts, as well as the rates we pay on certificates of deposit, tend to adjust more slowly. As a result, the declines in market interest rates that occurred through the end of 2008 initially had an adverse effect on our net income because the yields we earn on our loans declined more rapidly than our cost of funds. However, many of our prime-based loans had mini mum interest rates, or floors, below which the interest rate does not decline despite further decreases in the prime rate. As our loans reached their interest rate floors, our loan yields stabilized while our deposit costs continued to decline. This had a positive effect on our net interest income. When market interest rates begin increasing, which we expect will occur at some point in the future, we anticipate an initial adverse effect on our net income. We anticipate that this will occur because our deposit rates should begin to rise, while loan yields remain relatively steady until the prime rate increases sufficiently that our loans begin to reprice above their interest rate floors. Once our loan rates exceed the interest rate floors, increases in market interest rates should increase our net interest income because our cost of deposits should probably increase more slowly than the yields on our loans. However, customer preferences and competitive pressures may negate this positive effect because custome rs may choose to move funds into higher-earning deposit types as higher interest rates make them more attractive, or competitors offer premium rates to attract deposits. We also have a substantial portfolio of investment securities with fixed rates of interest, most of which are mortgage-backed securities with an estimated average life of not more than 5 years.
Results of Operations for the Three Months Ended March 31, 2010 and March 31, 2009
Our results of operations depend primarily on net interest income, which is the difference between the income we earn on our loan and investment portfolios and our cost of funds, consisting primarily of interest we pay on customer deposits. Our operating expenses principally consist of employee compensation and benefits, occupancy expenses, professional fees, advertising and marketing expenses and other general and administrative expenses. Our results of operations are significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government policies and actions of regulatory authorities.
General. We had net income of $432,222 for the quarter ended March 31, 2010, compared to net income of $373,051 for the comparable quarter in 2009. The principal categories which make up the 2010 net income are:
| | ● | Interest income of $2,561,725 |
| | ● | Reduced by interest expense of $273,315 |
| | ● | Reduced by a provision for loan losses of $90,000 |
| | ● | Increased by non-interest income of $601,674 |
| | ● | Reduced by non-interest expense of $2,003,376 |
| | ● | Reduced by income tax expense of $364,486 |
We discuss each of these categories individually and the reasons for the differences between the quarters ended March 31, 2010 and 2009 in the following paragraphs.
Interest Income. Interest income was $2,561,725 for the quarter ended March 31, 2010, compared to $2,718,066 for the quarter ended March 31, 2009, a decrease of $156,341, or 5.8%. There were two principal reasons for the decline. First, a $6.4 million decrease in average balance in investment securities between the periods coupled with a decline in market interest rates, was the primary cause of $220,397 decline in interest income on investment securities. Second, the increase in the average balance of other interest-earning assets shifted our asset mix toward our lowest interest-earning asset category due to our decision to become more liquid to provide increased flexibility in the event of an interest rate increase. On the positive side, interest income on loans increased by $59, 590.
During the quarter ended March 31, 2010, loans, our highest-yielding asset category, had an $11,806,660 increase in average balance from the quarter ended March 31, 2009 to the quarter ended March 31, 2010, partially offset by a 47 basis point drop in our loan yield. A major contributor to the 47 basis point drop in our loan yield was a $5.2 million increase in our non-performing loans from yearend 2009. The interest rate floors on our loans have helped to stabilize interest income from the loan portfolio, but these floors also have the effect of limiting increases in our income until the prime rate rises above 6%.
We experienced a 52 basis point decrease in the average yield on our investment securities portfolio, from 4.61% to 4.09%, due to the purchase of new investment securities at lower market rates than the yields on the principal paydowns we received. The average balance of our investment portfolio decreased by $6,431,776, or 5.28%, between the periods. The investment securities portfolio represented 78.3% of average non-loan interest earning assets in the 2010 period compared to 86.8% in the 2009 period as we deliberately limited our investment of available funds in investment securities due to the low yields available to us in the quarter ended March 31, 2010 and our desire to avoid locking in those low yields for long periods.
The average yield on other interest earning assets (principally overnight investments) increased 2 basis points from 0.10% for the quarter ended March 31, 2009 to 0.12% for the quarter ended March 31, 2010 and we had an increase in average balance of other interest earning assets of $13,460,004 from the quarter ended March 31, 2009 to the quarter ended March 31, 2010. This increase in average balance occurred because we chose to invest the excess proceeds from our deposit growth into overnight investments as a tool to increase our liquidity in a volatile market and to help establish a buffer for when market interest rates begin to rise.
Interest Expense. Interest expense was $273,315 for the quarter ended March 31, 2010, compared to $410,948 for the quarter ended March 31, 2009, a decrease of $137,633 or 33.5%. The decrease was primarily the result of a reduction in the rates we paid on deposits, principally on time deposits, reflecting a 67 basis point decrease in the cost of time deposits between the periods, due to a general decline in market interest rates. As a result, our average cost of funds, excluding the effect of interest-free demand deposits, decreased to 0.79% from 1.28% between the periods.
Net Interest Income Before Provision for Loan Losses. Net interest income before the provision for loan losses was $2,288,410 for the quarter ended March 31, 2010, a decrease of $18,708, or 0.8% over the $2,307,118 in the comparable 2009 period. The decrease was primarily due to the decline in the average yield on interest earning assets of 59 basis points, from the quarter ended March 31, 2009 to the quarter ended March 31, 2010, which was partially offset by the reduction in our cost of funds of 49 basis points from the same period. Our interest rate spread decreased 10 basis points to 3.79% for the quarter ended March 31, 2010 from 3.89% in the same period of 2009. The spread declined because our lowest yielding assets, overnight investments, were a larger percentage of the earn ing asset mix in 2010.
Our net interest margin decreased to 4.09% for the quarter ended March 31, 2010 from 4.37% in the same period of 2009. The interest rate margin decreased because the proceeds from payments on investment securities were reinvested at lower rates because of the dramatic decline in market interest rates. The margin is higher than the spread because it takes into account the effect of interest free demand deposits and capital. However, the average margin declined more rapidly than the spread because those interest free sources of funds are less valuable during periods of low market interest rates because we are able to invest them in lower average yielding assets. In addition, we shifted more marginal, excess funds not needed to fund loans into overnight investments rather than purchasing investment securities to position ourselves to better address an increase in market interest rates that many experts are predicting will occur in the foreseeable future.
Provision for Loan Losses. We took a provision for loan losses of $90,000 for the quarter ended March 31, 2010 compared to a provision for loan losses of $275,000 for the quarter ended March 31, 2009. The $185,000 decrease in the provision was due to a lower level of charge-offs in the 2010 period, which totaled $16,286 for the quarter ended March 31, 2010 as compared to $350,023 in the same period in 2009. We are aggressively collecting these charged-off loans in an effort to recover the amounts charged off whenever we believe that collection efforts are likely to be fruitful.
The provision for loan losses in any period depends upon the amount necessary to bring the allowance for loan losses to the level management believes is appropriate, after taking into account charge offs and recoveries. Our allowance for loan losses is based on management’s evaluation of the risks inherent in our loan portfolio and the general economy. Management periodically evaluates both broad categories of performing loans and problem loans individually to assess the appropriate level of the allowance.
Although management uses available information to assess the appropriateness of the allowance on a quarterly basis in consultation with outside advisors and the board of directors, changes in national or local economic conditions, the circumstances of individual borrowers, or other factors, may change, increasing the level of problem loans and requiring an increase in the level of the allowance. The allowance for loan losses represented 1.49% of total loans at March 31, 2010. There can be no assurance that a higher level, or a higher provision for loan losses, will not be necessary in the future.
Non-interest Income. Non-interest income was $601,674 for the quarter ended March 31, 2010, compared to $613,169 during the same period last year. The $11,495, or 1.9%, decrease in non-interest income was a direct result of normal fluctuations in retail banking transactions and the fees derived from them, such as insufficient funds fees, in 2010. Loan fees decreased as an increase in non-accrual loans during the 2010 period required that we reverse more loan late fees.
Non-interest Expense. Non-interest expense was $2,003,376 for the quarter ended March 31, 2010, compared to $1,952,463 for the quarter ended March 31, 2009, an increase of $50,913 or 2.6%. The principal shifts in the individual categories were:
| | ● | $51,633 increase in salaries and benefits due to higher related benefit costs and increased salary and benefits due to normal raises; |
| | ● | $18,500 increase in FDIC and NYSBD assessments due to an increase in the FDIC assessment rate and assessment base over the prior year; and |
| | ● | $14,872 increase in legal expense primarily due to increased collection costs. |
We had reduction in some non-interest expense categories such as occupancy, professional fees and other expenses that helped offset some on the overall increase in our non-interest expense.
Income Tax Expense. Income tax expense was $364,486 for the quarter ended March 31, 2010, compared to income tax expense of $319,773 for the same period ended 2009. The increase in income tax expense was due to the $103,884 increase in income before income taxes in the 2010 period. Our effective tax rate for the quarter ended March 31, 2010 was 45.7% and for the quarter ended March 31, 2009 was 46.2%.
VSB Bancorp, Inc.
Consolidated Average Balance Sheets
(unaudited)
| | | Three Months Ended March 31, 2010 | | | Three Months Ended March 31, 2009 | |
| | | Average | | | | | | | | | | | | | | | Yield/ | |
| | | Balance | | | Interest | | | Cost(1) | | | Balance | | | Interest | | | Cost(1) | |
| | | | | | | | | | | | | | | | | | | |
| Assets: | | | | | | | | | | | | | | | | | | |
| Interest-earning assets: | | | | | | | | | | | | | | | | | | |
| Loans receivable | | $ | 79,657,521 | | | $ | 1,390,296 | | | | 7.08 | % | | $ | 67,850,861 | | | $ | 1,330,706 | | | | 7.55 | % |
| Investment securities, afs | | | 115,269,647 | | | | 1,162,222 | | | | 4.09 | | | | 121,701,423 | | | | 1,382,619 | | | | 4.61 | |
| Other interest-earning assets | | | 31,983,896 | | | | 9,207 | | | | 0.12 | | | | 18,523,892 | | | | 4,741 | | | | 0.10 | |
| Total interest-earning assets | | | 226,911,064 | | | | 2,561,725 | | | | 4.58 | | | | 208,076,176 | | | | 2,718,066 | | | | 5.17 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Non-interest earning assets | | | 9,146,946 | | | | | | | | | | | | 5,518,760 | | | | | | | | | |
| Total assets | | $ | 236,058,010 | | | | | | | | | | | $ | 213,594,936 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Liabilities and equity: | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Savings accounts | | $ | 14,964,564 | | | | 11,460 | | | | 0.31 | | | $ | 12,717,607 | | | | 13,102 | | | | 0.42 | |
| Time accounts | | | 64,468,177 | | | | 160,117 | | | | 1.01 | | | | 75,067,561 | | | | 310,552 | | | | 1.68 | |
| Money market accounts | | | 29,005,089 | | | | 62,486 | | | | 0.87 | | | | 23,432,674 | | | | 60,511 | | | | 1.05 | |
| Now accounts | | | 32,725,644 | | | | 39,252 | | | | 0.49 | | | | 18,498,973 | | | | 26,783 | | | | 0.59 | |
| Total interest-bearing liabilities | | | 141,163,474 | | | | 273,315 | | | | 0.79 | | | | 129,716,815 | | | | 410,948 | | | | 1.28 | |
| Checking accounts | | | 67,545,187 | | | | | | | | | | | | 58,806,306 | | | | | | | | | |
| Escrow deposits | | | 419,279 | | | | | | | | | | | | 428,070 | | | | | | | | | |
| Total deposits | | | 209,127,940 | | | | | | | | | | | | 188,951,191 | | | | | | | | | |
| Other liabilities | | | 1,929,055 | | | | | | | | | | | | 1,281,238 | | | | | | | | | |
| Total liabilities | | | 211,056,995 | | | | | | | | | | | | 190,232,429 | | | | | | | | | |
| Equity | | | 25,001,015 | | | | | | | | | | | | 23,362,507 | | | | | | | | | |
| Total liabilities and equity | | $ | 236,058,010 | | | | | | | | | | | $ | 213,594,936 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest income/net interest rate spread | | | | | | $ | 2,288,410 | | | | 3.79 | % | | | | | | $ | 2,307,118 | | | | 3.89 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest earning assets/net interest margin | | $ | 85,747,590 | | | | | | | | 4.09 | % | | $ | 78,359,361 | | | | | | | | 4.37 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Ratio of interest-earning assets to interest-bearing liabilities | | | 1.61 | x | | | | | | | | | | | 1.60 | x | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Return on Average Assets (1) | | | 0.74 | % | | | | | | | | | | | 0.64 | % | | | | | | | | |
| Return on Average Equity (1) | | | 7.01 | % | | | | | | | | | | | 5.85 | % | | | | | | | | |
| Tangible Equity to Total Assets | | | 10.45 | % | | | | | | | | | | | 10.75 | % | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| (1) Annualized. | | | | | | | | | | | | | | | | | | | | | | | | |
Liquidity and Capital Resources
Our primary sources of funds are increases in deposits, proceeds from the repayment of investment securities, and the repayment of loans. We use these funds to purchase new investment securities and to fund new and renewing loans in our loan portfolio. Remaining funds are invested in short-term liquid assets such as overnight federal funds loans and bank deposits.
During the three months ended March 31, 2010, we had a net increase in total deposits of $1,664,732 due to increases of $1,032,292 in money market accounts, $882,528 in NOW accounts, $193,394 in time deposits, $67,083 in escrow deposits and $39,593 in savings accounts, partially offset by a decrease of $550,158 in non-interest demand deposits. We also received proceeds from repayment of investment securities of $10,242,054. We used $8,941,161 of available funds to purchase new investment securities and we had a net loan decrease of $868,869. These changes resulted in an overall increase in cash and cash equivalents of $4,923,248.
In contrast, during the three months ended March 31, 2009, we had a net increase in total deposits of $8,923,103 due to increases of $16,828,064 in NOW accounts, $1,706,632 in non-interest demand deposits, $1,233,673 in savings accounts and $975,623 in money market accounts, partially offset by a decrease of $11,820,889 in time deposits. We also received proceeds from repayment of investment securities of $7,343,401. We used $5,799,823 of available funds to purchase new investment securities and we had a net loan increase of $2,780,229. These changes resulted in an overall increase in cash and cash equivalents of $8,249,720.
At March 31, 2010, cash and cash equivalents represented 19% of total assets. We anticipate, based upon historical experience that these funds, combined with cash inflows we anticipate from payments on our loan and investment securities portfolios, will be sufficient to fund loan growth and unanticipated deposit outflows. As a secondary source of liquidity, at March 31, 2010 we had $113 million of investment securities classified available for sale. The disposition of these securities prior to maturity is an option available to us in the event, which we believe is unlikely, that our primary sources of liquidity and expected cash flows are insufficient to meet our need for funds. Additionally, we have the ability to borrow funds at the Federal Home Loan Bank of New York and the Federal Reserve Bank of New York using securities in our inve stment portfolio as collateral if the need arises. Based upon our assets size and the amount of our securities portfolio that qualifies as eligible collateral, we had more than $61.6 million of unused borrowing capability from the FHLBNY at March 31, 2010. Victory State Bank also has a $2 million unsecured credit facility with Atlantic Central Bankers Bank, which the Bank has not drawn upon. We do not anticipate a need for additional capital resources and do not expect to raise funds through a stock offering in the near future. As a result of our strong capital resources and available liquidity, we did not apply for or participate in the Treasury Departments TARP Capital Purchase Program. We have sufficient resources to allow us to continue to make loans as appropriate opportunities arise without having to rely on government funds to support our lending activities.
Victory State Bank satisfied all capital ratio requirements of the Federal Deposit Insurance Corporation at March 31, 2010, with a Tier I Leverage Capital ratio of 9.71%, a ratio of Tier I Capital to Risk-Weighted Assets ratio of 22.74%, and a Total Capital to Risk-Weighted Assets ratio of 23.89%.
VSB Bancorp, Inc. satisfied all capital ratio requirements of the Federal Reserve at March 31, 2010, with a Tier I Leverage Capital ratio of 9.83%, a ratio of Tier I Capital to Risk-Weighted Assets ratio of 23.71%, and a Total Capital to Risk-Weighted Assets ratio of 24.75%.
The following table sets forth our contractual obligations and commitments for future lease payments, time deposit maturities and loan commitments.
Contractual Obligations and Commitments at March 31, 2010
| Contractual Obligations | | Payment due by Period | |
| | | Less than | | | One to three | | | Four to five | | | After | | | Total Amounts | |
| | | One Year | | | years | | | years | | | five years | | | committed | |
| | | | | | | | | | | | | | | | |
| Minimum annual rental payments under non-cancelable operating leases | | $ | 406,866 | | | $ | 838,256 | | | $ | 794,095 | | | $ | 1,315,761 | | | $ | 3,354,978 | |
| Remaining contractual maturities of time deposits | | | 60,645,728 | | | | 1,460,835 | | | | 2,755,959 | | | | — | | | | 64,862,522 | |
| Total contractual cash obligations | | $ | 61,052,594 | | | $ | 2,299,091 | | | $ | 3,550,054 | | | $ | 1,315,761 | | | $ | 68,217,500 | |
| | | | | | | | | | | | | | | | | | | | | |
| Other commitments | | Amount of commitment Expiration by Period | |
| | | Less than | | | One to three | | | Four to five | | | After | | | Total Amounts | |
| | | One Year | | | years | | | years | | | five years | | | committed | |
| | | | | | | | | | | | | | | | | | | | | |
| Loan commitments | | $ | 22,421,261 | | | $ | 4,488,504 | | | $ | — | | | $ | — | | | $ | 26,909,765 | |
Our loan commitments shown in the above table represent both commitments to make new loans and obligations to make additional advances on existing loans, such as construction loans in process and lines of credit. Substantially all of these commitments involve loans with fluctuating interest rates, so the outstanding commitments do not expose us to interest rate risk upon fluctuation in market rates.
Non-Performing Loans
Management closely monitors non-performing loans and other assets with potential problems on a regular basis. We had sixteen non-performing loans, totaling $6,882,873, at March 31, 2010, compared to ten non-performing loans, totaling $1,697,151, at December 31, 2009. We believe that the increase was the result of the effect of adverse economic conditions on some of our borrowers. The following is information about the eight largest non-performing loans, totaling $5,907,290 in outstanding principal balance at March 31, 2010. Management believes it has taken appropriate steps with a view towards maximizing recovery and minimizing loss on these loans.
| ● | $2,450,326 in two loans to a retail business, which are fully secured by commercial real estate collateral. We have entered into a modified repayment arrangement with the borrower and we have obtained confessions of judgment. We have collected a large portion of their arrears and the borrowers have agreed to pay all remaining arrears over the upcoming year. We maintain the personal guaranties of the principals on these loans. |
| ● | $2,200,000 in two residential mortgage loans that are fully collateralized. We have entered into modified repayment arrangements with the borrowers and we have obtained confessions of judgment. We have collected a large portion of their arrears and the borrowers have agreed to pay all remaining arrears over the upcoming year. |
| ● | $859,968 in three construction loans to a builder secured and cross-collateralized by first mortgage liens on three lots in Staten Island on which single-family houses are near completion. The loans are past maturity and we commenced foreclosure actions in 2008. The foreclosure sale was held in January 2010 and the Bank was the successful bidder. We have an agreement with a builder to assign our bid to the builder upon the payment to us of an amount sufficient to exceed the value of the loans on our books, and thus we will not record any loss upon the foreclosure sale and the subsequent assignment of our bid to the builder. The loans remain classified as non-performing loans at March 31, 2010 because the delivery of the deed in the foreclosure sale had not yet occurred by that date. |
| ● | $396,996 in a loan to a local business in which we are a participant in the loan with another bank. We are not the lead lender. The loan is in arrears and the lead lender has commenced a foreclosure action. The loan is secured by a first mortgage on a commercial building, a security interest in the business, and the personal guaranties of the principals. |
Critical Accounting Policies and Judgments
We are required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the amounts of revenues and expenses during the reporting period. The allowance for loan losses, prepayment estimates on the mortgage-backed securities and Collateralized Mortgage Obligation portfolios, contingencies and fair values of financial instruments are particularly subject to change and to management’s estimates. Actual results can differ from those estimates and may have an impact on our financial statements.
Evaluation of Disclosure Controls and Procedures: As of March 31, 2010, we undertook an evaluation of our disclosure controls and procedures under the supervision and with the participation of Raffaele M. Branca, President, CEO and CFO and Jonathan B. Lipschitz, Vice President and Controller. Disclosure controls are the systems and procedures we use that are designed to ensure that information we are required to disclose in the reports we file or submit under the Securities Exchange Act of 1934 (such as annual reports on Form 10-K and quarterly periodic reports on Form 10-Q) is recorded, processed, summarized and reported, in a manner which will allow senior management to make timely decisions on the public disclosure of that information. Mr. Branca concluded that our curre nt disclosure controls and procedures are effective in ensuring that such information is (i) collected and communicated to senior management in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Since our last evaluation of our disclosure controls, we have not made any significant changes in, or taken corrective actions regarding, either our internal controls or other factors that could significantly affect those controls.
We intend to continually review and evaluate the design and effectiveness of our disclosure controls and procedures and to correct any deficiencies that we may discover. Our goal is to ensure that senior management has timely access to all material financial and non-financial information concerning our business so that they can evaluate that information and make determinations as to the nature and timing of disclosure of that information. While we believe the present design of our disclosure controls and procedures is effective to achieve this goal, future events may cause us to modify our disclosure controls and procedures.
In the legal action pending in Supreme Court, Richmond County, commenced by IndyMac Bank, F.S.B. against the Bank, LaMattina & Associates, Inc. and others which was described in the report on Form 10-K for the company for the year ended December 31, 2009, the Bank made a motion for summary judgment and the oral arguments on the motion were held in March 2010. We await the decision of the court.
VSB Bancorp, Inc. is not involved in any pending legal proceedings. The Bank, from time to time, is involved in routine collection proceedings in the ordinary course of business on loans in default. Management believes that such other routine legal proceedings in the aggregate are immaterial to our financial condition or results of operations.
In accordance with the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | VSB Bancorp, Inc. |
| | |
| Date: May 11, 2010 | /s/ Raffaele M. Branca |
| | Raffaele M. Branca, President & CEO |
| | and Principal Executive Officer and |
| | |
| Date: May 11, 2010 | /s/ Jonathan B. Lipschitz |
| | Jonathan B. Lipschitz, |
| | Vice President, Controller and Principal |
| | Accounting Officer |
EXHIBIT INDEX
| Exhibit | | |
| Number | | Description of Exhibit |
| 31.1 | | Rule 13A-14(a)/15D-14(a) Certification of Chief Executive Officer |
| 31.2 | | Rule 13A-14(a)/15D-14(a) Certification of Principal Accounting Officer |
| 32.1 | | Certification by CEO pursuant to 18 U.S.C. 1350. |
| 32.2 | | Certification by Principal Accounting Officer pursuant to 18 U.S.C. 1350. |
Item 6 - Exhibits
| Exhibit | | |
| Number | | Description of Exhibit |
| 31.1 | | Rule 13A-14(a)/15D-14(a) Certification of Chief Executive Officer |
| 31.2 | | Rule 13A-14(a)/15D-14(a) Certification of Principal Accounting Officer |
| 32.1 | | Certification by CEO pursuant to 18 U.S.C. 1350. |
| 32.2 | | Certification by Principal Accounting Officer pursuant to 18 U.S.C. 1350. |
