UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
| x | QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2005
| ¨ | 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: 000-51037
SFSB, INC.
(Exact name of small business issuer as specified in its charter)
| United States | 20-2077715 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
1614 Churchville Road, Bel Air, Maryland 21015
Address of principal executive offices
(443) 265-5570
Issuer’s telephone number
Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes x No
State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date:
At November 10, 2005, there were 2,975,625 shares of the issuer’s Common Stock, par value $0.01 per share, outstanding.
Transitional Small Business Disclosure Format (Check One): Yes ¨ No x
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
SFSB, Inc.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
| Sept. 30, 2005 | December 31, 2004 | |||||||
| (Unaudited) | (Audited) | |||||||
| ASSETS | ||||||||
Cash and due from banks | $ | 851,934 | $ | 745,668 | ||||
Federal funds sold | 3,073,981 | 14,851,279 | ||||||
Cash and cash equivalents | 3,925,915 | 15,596,947 | ||||||
Investment securities - available for sale | 8,089,316 | 7,980,711 | ||||||
Investment securities - held to maturity | 3,997,774 | 3,995,547 | ||||||
Mortgage backed securities - held to maturity | 5,033,971 | 6,981,460 | ||||||
Loans receivable - net of allowance for loan losses of 2005 $460,300; 2004 $413,000 | 137,214,661 | 117,900,265 | ||||||
Federal Home Loan Bank of Atlanta stock at cost | 1,685,500 | 1,445,600 | ||||||
Premises and equipment, at cost, less accumulated depreciation | 5,732,150 | 5,842,373 | ||||||
Accrued interest receivable | 484,055 | 426,633 | ||||||
Other assets | 327,028 | 263,863 | ||||||
Total assets | $ | 166,490,370 | $ | 160,433,399 | ||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
Liabilities | ||||||||
Deposits | $ | 109,851,784 | $ | 109,711,368 | ||||
Checks outstanding in excess of bank balance | 2,822,863 | 627,445 | ||||||
Borrowings | 30,000,000 | 26,500,000 | ||||||
Advance payments by borrowers for taxes and insurance | 660,499 | 329,387 | ||||||
Other liabilities | 331,246 | 645,098 | ||||||
Total liabilities | 143,666,392 | 137,813,298 | ||||||
Commitments and Contingencies | ||||||||
Stockholders’ Equity | ||||||||
Preferred stock, no par value, 1,000,000 shares authorized, none issued and outstanding | — | — | ||||||
Common stock, par value $.01, 9,000,000 shares authorized, 2,975,625 shares issued and outstanding at September 30, 2005 and December 31, 2004 | 29,756 | 29,756 | ||||||
Additional paid-in capital | 12,684,749 | 12,680,644 | ||||||
Retained earnings (substantially restricted) | 11,347,438 | 11,135,940 | ||||||
Unearned Employee Stock Ownership Plan shares | (1,122,560 | ) | (1,166,300 | ) | ||||
Accumulated other comprehensive loss | (115,405 | ) | (59,939 | ) | ||||
Total stockholders’ equity | 22,823,978 | 22,620,101 | ||||||
Total liabilities and stockholders’ equity | $ | 166,490,370 | $ | 160,433,399 | ||||
See notes to consolidated financial statements.
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SFSB, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||
| 2005 | 2004 | 2005 | 2004 | ||||||||||
Interest and fees on loans | $ | 1,710,602 | $ | 1,557,777 | $ | 4,958,894 | $ | 4,220,510 | |||||
Interest and dividends on investment securities | 112,296 | 85,804 | 313,397 | 248,866 | |||||||||
Interest on mortgage backed securities | 48,018 | 66,409 | 158,940 | 227,663 | |||||||||
Other interest income | 30,098 | 25,097 | 175,302 | 55,973 | |||||||||
Total interest income | 1,901,014 | 1,735,087 | 5,606,533 | 4,753,012 | |||||||||
Interest on deposits | 782,621 | 638,070 | 2,165,242 | 1,844,476 | |||||||||
Interest on short-term borrowings | 17,976 | 123,213 | 95,977 | 171,646 | |||||||||
Interest on long-term borrowings | 170,371 | 54,353 | 407,674 | 213,590 | |||||||||
Other interest expense | 30 | 35 | 94 | 100 | |||||||||
Total interest expense | 970,998 | 815,671 | 2,668,987 | 2,229,812 | |||||||||
Net interest income | 930,016 | 919,416 | 2,937,546 | 2,523,200 | |||||||||
Provision for loan losses | 12,017 | 12,000 | 43,867 | 36,000 | |||||||||
Net interest income after provision for loan losses | 917,999 | 907,416 | 2,893,679 | 2,487,200 | |||||||||
Non-Interest Income (Loss) | |||||||||||||
Loss on sale of ground rents | — | — | — | (102,166 | ) | ||||||||
Rental income | 35,159 | 28,046 | 100,297 | 77,492 | |||||||||
Other income | 36,852 | 17,382 | 70,720 | 53,372 | |||||||||
Gain on sale of loans | — | — | 1,163 | — | |||||||||
Total non-interest income | 72,011 | 45,428 | 172,180 | 28,698 | |||||||||
Non-Interest Expenses | |||||||||||||
Compensation and other related expenses | 444,752 | 339,141 | 1,303,926 | 1,043,078 | |||||||||
Occupancy expense | 115,365 | 100,132 | 319,864 | 295,637 | |||||||||
Advertising expense | 53,430 | 50,664 | 144,933 | 149,380 | |||||||||
Service bureau expense | 37,745 | 37,420 | 115,604 | 107,635 | |||||||||
Furniture, fixtures and equipment | 58,940 | 53,229 | 171,569 | 161,499 | |||||||||
Telephone, postage and delivery | 23,581 | 22,893 | 65,237 | 63,298 | |||||||||
Other expenses | 219,667 | 114,799 | 600,828 | 361,704 | |||||||||
Total non-interest expenses | 953,480 | 718,278 | 2,721,961 | 2,182,231 | |||||||||
Income before income tax provision | 36,530 | 234,566 | 343,898 | 333,667 | |||||||||
Income tax provision | 15,400 | 96,094 | 132,400 | 130,600 | |||||||||
Net income | $ | 21,130 | $ | 138,472 | $ | 211,498 | $ | 203,067 | |||||
Basic earnings per share | $ | 0.01 | N/A | $ | 0.07 | N/A | |||||||
See notes to consolidated financial statements.
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SFSB, Inc.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||
Net income | $ | 21,130 | $ | 138,472 | $ | 211,498 | $ | 203,067 | ||||||||
Net unrealized loss on securities available for sale during the period (net of taxes of $12,771, $13, $34,899 and $18,521) | (20,299 | ) | (20 | ) | (55,466 | ) | (29,436 | ) | ||||||||
Total Comprehensive Income | $ | 831 | $ | 138,452 | $ | 156,032 | $ | 173,631 | ||||||||
See notes to consolidated financial statements.
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SFSB, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Nine Months Ended September 30, | ||||||||
| 2005 | 2004 | |||||||
Cash Flows From Operating Activities | ||||||||
Net income | $ | 211,498 | $ | 203,067 | ||||
Adjustments to Reconcile Net Income to Net Cash | ||||||||
Provided by Operating Activities: | ||||||||
Non-cash compensation under Employee Stock Ownership Plan | 40,280 | — | ||||||
Non-cash compensation under Stock Option Plan | 7,565 | — | ||||||
Net amortization of premiums and discounts | 21,720 | 31,740 | ||||||
Amortization of deferred loan fees | (54,481 | ) | (202,139 | ) | ||||
Provision for loan losses | 43,867 | 36,000 | ||||||
Gain on sale of loans | (1,163 | ) | — | |||||
Loans originated for sale | (155,000 | ) | — | |||||
Proceeds from loans sold | 156,163 | — | ||||||
Loss on ground rents | — | 102,166 | ||||||
Provision for depreciation | 241,713 | 244,000 | ||||||
Increase in accrued interest receivable and other assets | (120,587 | ) | (262,618 | ) | ||||
Increase in accrued interest payable | 22,668 | 22,135 | ||||||
(Decrease) increase in other liabilities | (292,264 | ) | 40,361 | |||||
Net Cash Provided by Operating Activities | 121,979 | 214,712 | ||||||
Cash Flows from Investing Activities | ||||||||
Purchase of available for sale securities | 198,971 | (134,440 | ) | |||||
Net increase in loans | (19,303,782 | ) | (23,126,861 | ) | ||||
Principal collected on mortgage backed securities | 1,923,542 | 2,562,118 | ||||||
Purchase of Federal Home Loan Bank of Atlanta stock | (464,900 | ) | (650,000 | ) | ||||
Redemption of Federal Home Loan Bank of Atlanta stock | 225,000 | — | ||||||
Purchases of premises and equipment | (131,490 | ) | (70,172 | ) | ||||
Proceeds from redemption of ground rents | — | 53,300 | ||||||
Net Cash Used in Investing Activities | (17,950,601 | ) | (21,366,055 | ) | ||||
Cash Flows from Financing Activities | ||||||||
Net increase in deposits | 131,061 | 8,177,623 | ||||||
Increase (decrease) in checks outstanding in excess of bank balance | 2,195,418 | (254,948 | ) | |||||
Proceeds from borrowings | 8,500,000 | 13,000,000 | ||||||
Repayment of borrowings | (5,000,000 | ) | — | |||||
Increase in advance payments by borrowers for taxes and insurance | 331,111 | 377,548 | ||||||
Net Cash Provided by Financing Activities | 6,159,590 | 21,300,223 | ||||||
(Decrease) increase in cash and cash equivalents | (11,671,032 | ) | 148,880 | |||||
Cash and cash equivalents at beginning of year | 15,596,947 | 3,497,626 | ||||||
Cash and cash equivalents at end of period | $ | 3,925,915 | $ | 3,646,506 | ||||
Supplemental Disclosures of Cash Flows Information: | ||||||||
Cash paid during the year for: | ||||||||
Income taxes | $ | 289,250 | $ | 80,900 | ||||
Interest expense | $ | 2,646,319 | $ | 2,229,713 | ||||
See notes to consolidated financial statements.
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SLAVIE FEDERAL SAVINGS BANK
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Note 1 – Principles of Consolidation
The consolidated financial statements include the accounts of SFSB, Inc. (“the Company”), its wholly-owned subsidiary, Slavie Federal Savings Bank (“the Bank”) and the Bank’s wholly-owned subsidiaries, Slavie Holdings, LLC (“Holdings”) and Slavie Financial Services, LLC. The accompanying consolidated financial statements include the accounts and transactions of these companies on a consolidated basis since inception. All intercompany transactions have been eliminated in the consolidated financial statements.
On December 30, 2004, the Bank reorganized from a federally chartered mutual savings bank to a federally chartered stock savings bank. Simultaneously, the Bank consummated the formation of a new holding company, SFSB, Inc. Also simultaneously, a mutual holding company was formed, Slavie Bancorp, MHC. In connection with the reorganization, the Company issued 2,975,625 shares of its common stock. A majority of that stock (1,636,594 shares) was issued to Slavie Bancorp, MHC. The remainder was sold and issued to depositors of the Bank and the Employee Stock Ownership Plan for a total price of $13,390,310. Costs associated with the conversion, totaling $679,910 were deducted from the sale proceeds. Prior to the consummation of the reorganization, the Company had no assets or liabilities. Accordingly, the Company’s financial statements consist of those of the Bank for periods prior to December 30, 2004.
Note 2 – Business
The Company’s primary business is the ownership and operation of the Bank. The Bank’s primary business activity is the acceptance of deposits from the general public and the use of the proceeds for investments and loan originations. The Bank is subject to competition from other financial institutions. The Bank is subject to the regulations of certain federal agencies and undergoes periodic examinations by those regulatory authorities.
Holdings, formed on August 18, 1999 as a Maryland limited liability company, was created to acquire and manage certain real property located at 1614 Churchville Road, Bel Air, Maryland. This property includes the main office and corporate headquarters of the Bank. In addition, the property houses mixed use office space which is available for lease. As of September 30, 2005, approximately 81% of the available space to non-affiliated tenants was leased. During the year ended December 31, 2004, the Company dissolved its subsidiary, Slavie Financial Services, LLC.
Note 3 – Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and with the instructions to SEC Form 10-QSB. Accordingly, they do not include all the information and footnotes required by GAAP for complete financial statements.
The foregoing consolidated financial statements are unaudited; but in the opinion of management include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation thereof. The balances as of December 31, 2004 have been derived from the audited consolidated financial statements. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-KSB. The results of operations for the nine months ended September 30, 2005 are not necessarily indicative of the results that may be expected for the full year.
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Note 4 – Earnings Per Share
Basic earnings per share for the three and nine months ended September 30, 2005 is computed by dividing net income by the weighted average number of common shares outstanding of 2,862,878 and 2,861,434 for the respective periods. Unearned Employee Stock Ownership Plan (ESOP) shares are not included in outstanding shares. Stock options were anti-dilutive at September 30, 2005. Earnings per share does not apply to the three and nine months ended September 30, 2004 since the company was not a stock company at that time.
Note 5 – Regulatory Capital Requirements
At September 30, 2005, the Bank met each of the three minimum regulatory capital requirements. The following table summarizes the Bank’s regulatory capital position at September 30, 2005.
| Actual | For Capital Adequacy Purposes | To Be Well Capitalized Under Prompt Corrective Action Provision | ||||||||||||||||
September 30, 2005 | Amount | % | Amount | % | Amount | % | ||||||||||||
| (Unaudited) | ||||||||||||||||||
Tangible (1) | $ | 16,543,825 | 9.91 | % | $ | 2,504,220 | 1.50 | % | N/A | N/A | ||||||||
Tier I capital (2) | 16,543,825 | 18.79 | % | N/A | N/A | $ | 5,283,486 | 6.00 | % | |||||||||
Core (leverage) (1) | 16,543,825 | 9.91 | % | 6,677,919 | 4.00 | % | 8,347,398 | 5.00 | % | |||||||||
Risk-weighted (2) | 17,004,125 | 19.31 | % | 7,044,648 | 8.00 | % | 8,805,810 | 10.00 | % | |||||||||
| (1) | To adjusted total assets. |
| (2) | To risk-weighted assets. |
Note 6 - Stock-Based Compensation
The Company has two share based compensation plans as described below. The compensation cost that has been charged against income for those plans was $21,413 for the three and nine months ended September 30, 2005. The total income tax benefit recognized in the income statement for share based compensation arrangements was $5,991 for the three and nine months ended September 30, 2005. No share based compensation plans were in effect for the three and nine months ended September 30, 2004.
On July 21,2005, stockholders approved long-term stock-based benefit plans that enable the Company to grant stock options, restricted stock awards and other equity based awards to employees and directors. The Company has elected to early implement the requirements of SFAS No. 123, as amended by SFAS No. 148,Accounting for Stock-Based Compensation - Transition and Disclosure - An Amendment of FASB Statement No. 123.
As of September 30, 2005, the Company granted stock options covering 102,061 shares of common stock to certain employees and directors of the Company. The options were granted at the then fair market value, vest over five years and expire 10 years from the date of grant. The company estimated the grant date fair value of each option awarded in fiscal 2005 using the Black-Scholes Option-Pricing model with the following assumptions: dividend yield 0%, risk-free rate interest rate of 4.22%, and expected lives of 7 years. The assumption for the expected volatility was 11.42%. The estimated fair value of each option granted was computed to be $2.53.
As of September 30, 2005, the Company granted 40,824 shares of restricted stock to certain employees and directors of the Company. The awards vest over a five-year period and, therefore, the cost of such awards will be accrued ratably over a five-year period as compensation expense.
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Note 7 - Recent Accounting Pronouncements
In December, 2004, the Financial Accounting Standards Board (FASB) issued SFAS 123R, “Share-Based Payment” (“SFAS 123R”). This revised standard addresses the accounting for share-based payment transactions in which a company receives employee services in exchange for either equity instruments of the company or that are based on a fair value of the company’s equity instruments or that may be settled by the issuance of such equity instruments. Under the new standard, companies will no longer be able to account for share-based compensation transactions using the intrinsic method in accordance with APB 25. Instead, companies will be required to account for such transactions using a fair-value method and recognize the expense in the consolidated statement of income. For the Company, SFAS 123R will be effective for annual periods beginning after December 15, 2005. The Company has early adopted this standard in the third quarter of 2005 (see note 6 above).
In January 2003, the FASB’s Emerging Issues Task Force (EITF) issued EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investors” (“EITF 03-1”), and in March 2004, the EITF issued an update. EITF 03-1 addresses the meaning of other-than-temporary impairment and its application to certain debt and equity securities. EITF 03-1 aids in the determination of impairment of an investment and gives guidance as to the measurement of impairment loss and the recognition and disclosures of other-than-temporary investments. EITF 03-1 also provides a model to determine other-than-temporary impairment using evidence-based judgment about the recovery of the fair value up to the cost of the investment by considering the severity and duration of the impairment in relation to the forecasted recovery of the fair value. In July 2005, FASB adopted the recommendation of its staff to nullify key parts of EITF 03-1. The staff’s recommendations were to nullify the guidance on the determination of whether an investment is impaired as set forth in paragraphs 10-18 of Issue 03-1 and not to provide additional guidance on the meaning of other-than-temporary impairment. Instead, the staff recommends entities recognize other-than-temporary impairments by applying existing accounting literature such as paragraph 16 of SFAS 115.
In July 2005, the FASB issued a proposed interpretation of FAS 109, “Accounting for Income Taxes”, to clarify certain aspects of accounting for uncertain tax positions, including issues related to the recognition and measurement of those tax positions. If adopted as proposed, the interpretation would be effective in the fourth quarter of 2005, and any adjustments required to be recorded as a result of adopting the interpretation would be reflected as a cumulative effect from a change in accounting principle. We are currently in the process of determining the impact of adoption of the interpretation as proposed on our financial position or results of operations.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Introduction
Some of the matters discussed below include forward-looking statements. Forward-looking statements often use words such as “believe,” “expect,” “plan,” “may,” “will,” “should,” “project,” “contemplate,” “anticipate,” “forecast,” “intend” or other words of similar meaning. You can also identify them by the fact that they do not relate strictly to historical or current facts. Our actual results and the actual outcome of our expectations and strategies could be different from those anticipated or estimated for the reasons discussed below and the reasons under the heading “Information Regarding Forward Looking Statements.”
SFSB, Inc. (the “Company”) had not been organized as of September 30, 2004. References to “we” or “our” with respect to the three and nine months ended September 30, 2004 refers to Slavie Federal Savings Bank (the “Bank”).
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Overview
The Company’s loan growth continued to improve in the third quarter, following a second quarter improvement, after relatively flat loan growth during the first three months of 2005. Earnings declined for the three months ended September 30, 2005 as compared to the same period in 2004 primarily due to the addition of security guards at our Bel Air location, the impact of a decision to place a non-performing commercial land acquisition and development participation loan on non-accrual status and the resultant reversal of $48,830 of previously accrued but unpaid interest, and the costs associated with becoming a public company at the end of 2004. Earnings improved for the nine months ended September 30, 2005 as compared to the same period in 2004 primarily due to a $414,346, or 16.42%, increase in net interest income and a $143,482, or 499.97%, increase in non-interest income, offset by a $539,730, or 24.73%, increase in non-interest expenses. Total non-interest income improved because we recognized a loss of $102,166 on the sale of our ground rent portfolio during the second quarter of 2004.
Assets increased during the nine months of 2005 primarily because we increased our loan portfolio by $19,314,396, or 16.38%, to $137,214,661 at September 30, 2005 from $117,900,265 at December 31, 2004. The increase was offset by a decrease in cash and cash equivalents of $11,671,032, or 74.83%, to $3,925,915 at September 30, 2005 from $15,596,947 at December 31, 2004.
We hold a 19% participation (approximately $1,080,183 in unpaid principal balance) in the acquisition and development loan referred to above. Although this loan became delinquent earlier in the year, we had continued to accrue interest on the loan because we believed that collection of all principal and interest on the loan was probable. Previously, we reported that we expected a national homebuilder would purchase the property to build residential units as soon as the borrower developed the property to the “record plat” stage, at which time the loan would be paid in full, and that we expected that to occur prior to the end of the year. As of the date of this filing, the national homebuilder has agreed to release the borrower from its purchase agreement with the national homebuilder. The participating banks are negotiating a 95-day forbearance agreement with the borrower for the purpose of allowing the borrower to negotiate the sale of the property. We anticipate that the forbearance agreement will be conditioned upon a new bank contracted appraisal with a minimum “as is” value of $7,500,000, versus a current whole loan outstanding balance of principal and unpaid interest of approximately $6,100,000 at September 30, 2005. Due to these circumstances, we determined that placing the loan on non-accrual status was appropriate at this time. We continue to believe that the project is viable and that the land value provides adequate collateral protection. Ultimately, we believe we will receive all interest and principal on this loan, although there can be no assurance that that will be the case.
Opened in November 2001, our Edgewood branch has been an active part of the community it serves, but it has been unable to generate the business necessary to keep it a viable part of our strategic plan. In October 2005, the Board of Directors approved the closing of our Edgewood location and we expect to close the branch on February 24, 2006. We anticipate that we will incur approximately $157,000 in expenses in the first quarter of 2006 in connection with closing the branch, primarily related to the write-off of leasehold improvements. Long term, the branch closing will have a positive effect on earnings as we will cease to incur some of the costs associated with branch operations, yet retain in our portfolio the loans that were originated from the branch. The Edgewood branch personnel is expected to remain with us and will be reassigned to positions at one of our other branches.
Key measurements and events for the three-month and nine-month periods ended September 30, 2005 include the following:
| • | Total assets at September 30, 2005 increased by 3.78% to $166,490,370 as compared to $160,433,399 as of December 31, 2004. |
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| • | Net loans outstanding increased by 16.38% from $117,900,265 as of December 31, 2004 to $137,214,661 as of September 30, 2005. |
| • | Nonperforming loans at September 30, 2005 totaled $1,245,543. We believe an appropriate allowance for loan losses continues to be maintained. |
| • | Deposits at September 30, 2005 were $109,851,784, an increase of $140,416 or 0.13% from $109,711,368 at December 31, 2004. |
| • | SFSB, Inc. realized net income of $21,130 and $211,498 for the three-month and nine-month periods ended September 30, 2005. This compares to net income of $138,472 and $203,067 for the three-month and nine-month periods ended September 30, 2004. |
| • | Net interest income, our main source of income, was $930,016 and $2,937,546 during the three-month and nine-month periods ended September 30, 2005 compared to $919,416 and $2,523,200 for the same periods in 2004. This represents an increase of 1.15% and 16.42% for the three-months and nine-months ended September 30, 2005 as compared to the same periods in 2004. |
| • | We had an automobile loan charge-off during the nine month period ending September 30, 2005 of $2,296. There were no loan charge-offs during the nine month period ending September 30, 2004. |
| • | Non-interest income increased by $26,583 and $143,482, or 58.52% and 499.97%, for the three-month and nine-month periods ended September 30, 2005, as compared to the three-month and nine-month periods ended September 30, 2004. The increase between the nine-month periods was due to a non-recurring loss on the sale of our ground rent portfolio during the second quarter of 2004 of $102,166. |
| • | Non-interest expenses increased by $235,202 and $539,730, or 32.75% and 24.73%, for the three-month and nine-month periods ended September 30, 2005, as compared to the same periods ended September 30, 2004. |
A detailed discussion of the factors leading to these changes can be found in the discussion below.
Critical Accounting Policies
The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America or GAAP, and follow general practices within the industry in which we operate. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation allowance to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available.
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Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for loan losses as the accounting area that requires the most subjective or complex judgments, and as such could be most subject to revision as new information becomes available.
Management’s judgment is inherent in the determination of the provision and allowance for loan losses, including in connection with the valuation of collateral and the financial condition of the borrower. The establishment of allowance factors is a continuing exercise and allowance factors may change over time, resulting in an increase or decrease in the amount of the provision or allowance based upon the same volume and classification of loans.
Changes in allowance factors or in management’s interpretation of those factors will have a direct impact on the amount of the provision, and a corresponding effect on income and assets. Also, errors in management’s perception and assessment of the allowance factors could result in the allowance not being adequate to cover losses in the portfolio, and may result in additional provisions or charge-offs, which would adversely affect income and capital. For additional information regarding the allowance for loan losses, see “Results of Operations for the Three and Nine Months Ended September 30, 2005 and 2004 -Provision for Loan Losses and Analysis of Allowance for Loan Losses.”
Results of Operations for the Three and Nine Months Ended September 30, 2005 and 2004
General. Net income decreased $117,342 to $21,130 for the three months ended September 30, 2005 compared to $138,472 for the same period in the prior year. The decrease was due primarily to a $235,202 increase in non-interest expense, partially offset by a $10,600 increase in net interest income and a $26,583 increase in non-interest income. During the three months ended September 30, 2005, we reversed $48,830 of interest income as a result of placing the commercial land acquisition and development participation loan on non-accrual status. During the three months ended September 30, 2004, we recognized interest income of $14,179 on this loan.
Net income increased $8,431, to $211,498 for the nine months ended September 30, 2005 compared to $203,067 for the same period in the prior year. The increase was due primarily to an increase in interest income of $853,521, or 17.96%, to $5,606,533 for the nine months ended September 30, 2005 compared to $4,753,012 during the nine months ended September 30, 2004 and an increase in non-interest income of $143,482, or 499.97%, to $172,180 for the nine months ended September 30, 2005 compared to $28,698 during the nine months ended September 30, 2004, offset by an increase in non-interest expense of $539,730, or 24.73%, to $2,721,961 for the nine months ended September 30, 2005 compared to $2,182,231 during the nine months ended September 30, 2004. Non interest income increased in 2005 because the second quarter of 2004 included a loss of $102,166 on the sale of our ground rent portfolio. During the nine months ended September 30, 2004, we recognized interest income of $41,277 on the commercial land acquisition and development loan referred to above compared to none for the nine months ended September 30, 2005.
Average Balances, Net Interest Income, Yields Earned and Rates Paid.The following tables present for the periods indicated the total dollar amount of interest income from average interest earning assets and the resultant yields, as well as the interest expense on average interest bearing liabilities, expressed both in dollars and rates. No tax equivalent adjustments were made and no income was exempt from federal income taxes. All average balances are monthly average balances. We do not believe that the monthly averages differ materially from what the daily averages would have been. Non-accruing loans have been included in the table as loans carrying a zero yield. The amortization of loan fees is included in computing interest income, however, such fees are not material.
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Three Months Ended September 30, 2005 | Three Months Ended September 30, 2004 | |||||||||||||||||
Average Outstanding Balance | Interest Earned/ Paid | Yield/ Rate | Average Outstanding Balance | Interest Earned/ Paid | Yield/ Rate | |||||||||||||
| Dollars in Thousands | Dollars in Thousands | |||||||||||||||||
Interest-earning assets: | ||||||||||||||||||
Loans receivable(1) | $ | 132,238 | $ | 1,711 | 5.18 | % | $ | 116,559 | $ | 1,558 | 5.35 | % | ||||||
Mortgage-backed securities | 5,313 | 48 | 3.61 | 7,911 | 67 | 3.39 | ||||||||||||
Investment securities (available for sale) | 8,070 | 74 | 3.67 | 7,925 | 47 | 2.37 | ||||||||||||
Investment securities (held to maturity) | 3,998 | 38 | 3.80 | 3,994 | 39 | 3.91 | ||||||||||||
Other interest-earning assets | 2,827 | 30 | 4.24 | 4,818 | 25 | 2.06 | ||||||||||||
Total interest-earning assets | 152,446 | 1,901 | 4.99 | % | 141,207 | 1,736 | 4.92 | % | ||||||||||
Non-interest earning assets | 7,290 | 7,277 | ||||||||||||||||
Total assets | $ | 159,736 | $ | 148,484 | ||||||||||||||
Interest-bearing liabilities: | ||||||||||||||||||
Savings deposits | $ | 32,481 | 108 | 1.33 | % | $ | 33,293 | 81 | .97 | % | ||||||||
Demand and NOW accounts | 2,274 | 3 | 0.53 | 2,224 | 3 | 0.54 | ||||||||||||
Certificates of deposit | 74,323 | 672 | 3.62 | 68,774 | 555 | 3.23 | ||||||||||||
Escrows | 11 | — | — | 11 | — | — | ||||||||||||
Borrowings | 24,833 | 188 | 3.03 | 31,500 | 177 | 2.25 | ||||||||||||
Total interest-bearing liabilities | 133,922 | 971 | 2.90 | % | 135,802 | 816 | 2.40 | % | ||||||||||
Non-interest bearing liabilities | 2,986 | 1,608 | ||||||||||||||||
Total liabilities | 136,908 | 137,410 | ||||||||||||||||
Total equity(2) | 22,828 | 11,074 | ||||||||||||||||
Total liabilities and equity | $ | 159,736 | $ | 148,484 | ||||||||||||||
Net interest income | $ | 930 | $ | 920 | ||||||||||||||
Interest rate spread(3) | 2.09 | % | 2.52 | % | ||||||||||||||
Net interest-earning assets | $ | 18,524 | $ | 5,405 | ||||||||||||||
Net interest margin(4) | 2.44 | % | 2.61 | % | ||||||||||||||
Ratio of interest earning assets to interest bearing liabilities | 1.14x | 1.04x | ||||||||||||||||
| (1) | Loans receivable are net of the allowance for loan losses. |
| (2) | Total equity includes retained earnings and accumulated other comprehensive income (loss). |
| (3) | Net interest rate spread represents the difference between the average yield on interest earning assets and the average cost of interest bearing liabilities. |
| (4) | Net interest margin represents net interest income as a percentage of average interest earning assets. |
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Nine Months Ended September 30, 2005 | Nine Months Ended September 30, 2004 | |||||||||||||||||
Average Outstanding Balance | Interest Earned/ Paid | Yield/ Rate | Average Outstanding Balance | Interest Earned/ Paid | Yield/ Rate | |||||||||||||
| Dollars in Thousands | Dollars in Thousands | |||||||||||||||||
Interest-earning assets: | ||||||||||||||||||
Loans receivable(1) | $ | 124,702 | $ | 4,959 | 5.30 | % | $ | 104,363 | $ | 4,221 | 5.39 | % | ||||||
Mortgage-backed securities | 5,989 | 159 | 3.54 | 8,848 | 228 | 3.44 | ||||||||||||
Investment securities (available for sale) | 8,037 | 199 | 3.30 | 7,894 | 134 | 2.27 | ||||||||||||
Investment securities (held to maturity) | 3,997 | 114 | 3.80 | 3,994 | 115 | 3.83 | ||||||||||||
Other interest-earning assets | 7,180 | 175 | 3.25 | 4,126 | 56 | 1.82 | ||||||||||||
Total interest-earning assets | 149,905 | 5,606 | 4.99 | % | 129,225 | 4,754 | 4.91 | % | ||||||||||
Non-interest earning assets | 7,246 | 7,353 | ||||||||||||||||
Total assets | $ | 157,151 | $ | 136,578 | ||||||||||||||
Interest-bearing liabilities: | ||||||||||||||||||
Savings deposits | $ | 34,865 | 337 | 1.29 | % | $ | 30,755 | 208 | 0.90 | % | ||||||||
Demand and NOW accounts | 2,282 | 10 | 0.57 | 2,131 | 9 | 0.56 | ||||||||||||
Certificates of deposit | 70,586 | 1,818 | 3.43 | 67,490 | 1,628 | 3.22 | ||||||||||||
Escrows | 16 | — | — | 16 | — | — | ||||||||||||
Borrowings | 23,722 | 504 | 2.83 | 22,944 | 385 | 2.24 | ||||||||||||
Total interest-bearing liabilities | 131,471 | $ | 2,669 | 2.71 | % | 123,336 | 2,230 | 2.41 | % | |||||||||
Non-interest bearing liabilities | 2,925 | 2,233 | ||||||||||||||||
Total liabilities | 134,396 | 125,569 | ||||||||||||||||
Total equity(2) | 22,755 | 11,009 | ||||||||||||||||
Total liabilities and equity | $ | 157,151 | $ | 136,578 | ||||||||||||||
Net interest income | $ | 2,937 | $ | 2,524 | ||||||||||||||
Interest rate spread(3) | 2.28 | % | 2.50 | % | ||||||||||||||
Net interest-earning assets | $ | 18,434 | $ | 5,889 | ||||||||||||||
Net interest margin(4) | 2.61 | % | 2.60 | % | ||||||||||||||
Ratio of interest earning assets to interest bearing liabilities | 1.14x | 1.05x | ||||||||||||||||
| (1) | Loans receivable are net of the allowance for loan losses. |
| (2) | Total equity includes retained earnings and accumulated other comprehensive income (loss). |
| (3) | Net interest rate spread represents the difference between the average yield on interest earning assets and the average cost of interest bearing liabilities. |
| (4) | Net interest margin represents net interest income as a percentage of average interest earning assets. |
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Net Interest Income.
Three months ended September 30, 2005 compared to three months ended September 30, 2004.
Net interest income increased $10,600, or 1.15%, to $930,016 for the three months ended September 30, 2005 from $919,416 for the three months ended September 30, 2004. The increase was due primarily to an increase of $11,239,000 or 7.96%, in average interest earning assets to $152,446,000 from $141,207,000 and a decrease of $1,880,000 or 1.38%, in average interest bearing liabilities to $133,922,000 from $135,802,000. During the three months ended September 30, 2005, we reversed $48,830 of interest income as a result of placing the commercial land acquisition and development participation loan on non-accrual status.
The yield on average interest earning assets and the cost of interest-bearing liabilities increased 7 and 50 basis points, respectively, during the three months ended September 30, 2005 as compared to the three months ended September 30, 2004, from 4.92% to 4.99% for the yield and 2.40% to 2.90% for the cost. Accordingly, the interest rate spread was 2.09% and 2.52% respectively for the three months ended September 30, 2005 and 2004.
The decline in our net interest rate spread to 2.09% from 2.52%, reflected the more rapid increase in the cost of our average interest bearing liabilities as compared to the increase in the yield of our average interest earning assets. Our net interest margin decreased to 2.44% from 2.61% because the growth in average interest earning assets was not enough to offset the growth in average interest bearing liabilities and the increase in the cost of these liabilities. The ratios were adversely affected by the commercial land acquisition and development loan referred to above.
The ratio of interest earning assets to interest bearing liabilities improved to 1.14 times for the three months ended September 30, 2005 from 1.04 times for 2004.
Nine months ended September 30, 2005 compared to nine months ended September 30, 2004.
Net interest income increased $414,346, or 16.42%, to $2,937,546 for the nine months ended September 30, 2005 from $2,523,200 for the nine months ended September 30, 2004.
The increase was due primarily to an increase of $20,680,000 or 16.00%, in average interest earning assets to $149,905,000 from $129,225,000 and an 8 basis point increase in the yield on average interest earning assets. These increases were partially offset by an increase of $8,135,000, or 6.60%, in average interest bearing liabilities to $131,471,000 from $123,336,000 and a 30 basis point increase in the cost of average interest-bearing liabilities.
Our interest rate spread decreased to 2.28% from 2.50%, reflecting the more rapid increase in the cost of our average interest bearing liabilities as compared to the increase in the yield of our average interest earning assets. Our net interest margin increased to 2.61% from 2.60% due to average interest earning assets growing at a faster rate than average interest bearing liabilities and more than offsetting the increase in the cost of average interest-bearing liabilities. The ratios were adversely affected by the commercial land acquisition and development loan referred to above.
The ratio of interest earning assets to interest bearing liabilities improved to 1.14 times for the nine months ended September 30, 2005 from 1.05 times for 2004.
Interest Income.
Three months ended September 30, 2005 compared to three months ended September 30, 2004.
Interest income increased by $165,927, or 9.56%, to $1,901,014 for the three months ended September 30, 2005, from $1,735,087 for the three months ended September 30, 2004. The increase in interest income resulted primarily from increases of $152,825, or 9.81%, in interest and fee income from loans, $26,492, or 30.88%, in interest income from investment securities, and $5,001, or 19.93%, in interest income from other interest earning assets (primarily consisting of interest earned on cash and cash equivalents and Federal Home Loan Bank Stock), partially offset by a decrease of $18,391, or 27.69%, in interest income from mortgage backed securities.
The increase in interest income reflected a $11,239,000 or 7.96% increase in the average balance of interest-earning assets to $152,446,000 from $141,207,000, and a 7 basis point increase in the yield on average interest-earning assets to 4.99% for the three months ended September 30, 2005 from 4.92% for the three months ended September 30, 2004, reflecting an increase in market interest rates.
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The increase in interest income and fees on loans was due primarily to a $15,679,000 or 13.45% increase in average net loans receivable, from $116,559,000 to $132,238,000, offset by a 17 basis point decrease in the yield on average net loans receivable due to continued mortgage loan refinancings to lower rate products. Also, as described above, interest income for the three months ended September 30, 2005 was adversely affected by the non-accruing acquisition and development loan. During the three months ended on September 30, 2005, we reversed $48,830 of interest income as a result of this action. During the three months ended September 30, 2004, we recognized interest income of $14,179 on this loan.
Nine months ended September 30, 2005 compared to nine months ended September 30, 2004.
Interest income increased by $853,521, or 17.96%, to $5,606,533 for the nine months ended September 30, 2005, from $4,753,012 for the nine months ended September 30, 2004. The increase in interest income resulted primarily from an increase of $738,384, or 17.50%, in interest and fee income from loans, $64,531, or 25.93%, in interest income from investment securities and $119,329, or 213.19%, in interest income from other interest earning assets (primarily consisting of interest earned on cash and cash equivalents and Federal Home Loan Bank stock), partially offset by a decrease of $68,723, or 30.19%, in interest income from mortgage backed securities.
The increase in interest income reflected a $20,680,000, or 16.00% increase in the average balance of interest-earning assets to $149,905,000 from $129,225,000, and an 8 basis point increase in the yield on average interest-earning assets to 4.99% for the nine months ended September 30, 2005 from 4.91% for the nine months ended September 30, 2004, reflecting an increase in market interest rates.
The increase in interest income and fees on loans was due to a $20,339,000, or 19.49% increase in average net loans receivable, from $104,363,000 to $124,702,000, offset by a 9 basis point decrease in average yield on net loans receivable. The yield declined because long term interest rates generally declined throughout the second part of 2004, and we made a large number of long-term fixed rate mortgage loans during that period. Also, as described above, interest income for the nine months ended September 30, 2005 was adversely affected by the non-accruing acquisition and development loan. During the nine months ended on September 30, 2005, we reversed $48,830 of interest income as a result of this action. During the three months ended September 30, 2004, we recognized interest income of $41,277 on this loan.
The increase in interest income from other interest earning assets was due to a $3,054,000, or 74.02% increase in average other interest earning assets, from $4,126,000 to $7,180,000, and a 143 basis point increase in the average yield on these assets (as a result of increases in short term market interest rates). Other interest earning assets increased primarily as a result of the additional capital received from the stock offering.
Interest Expense.
Three months ended September 30, 2005 compared to three months ended September 30, 2004.
Interest expense, which consists of interest paid on deposits and borrowings, increased by $155,327, or 19.04%, to $970,998 for the three months ended September 30, 2005 from $815,671 for the three months ended September 30, 2004. The increase in interest expense resulted from an increase in the average cost of interest-bearing liabilities. The average balance of deposits increased to $109,078,000 from $104,291,000 and the average cost of deposits increased by 42 basis points as a result of increased market interest rates. The average cost of borrowings increased by 78 basis points as a result of longer term borrowing at higher interest rates, offset by the average balance of borrowings decreasing to $24,833,000 from $31,500,000.
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Nine months ended September 30, 2005 compared to nine months ended September 30, 2004.
Interest expense increased by $439,175, or 19.70%, to $2,668,987 for the nine months ended September 30, 2005 from $2,229,812 for the nine months ended September 30, 2004. The increase in interest expense resulted from an increase in the average balance and average cost of interest-bearing liabilities. The average balance of deposits increased to $107,733,000 from $100,376,000 and the average cost of deposits increased by 23 basis points as a result of increased market interest rates. The average balance of borrowings increased to $23,722,000 from $22,944,000 and the average cost of borrowings increased by 59 basis points as a result of longer term borrowings at higher interest rates.
Provision for Loan Losses and Analysis of Allowance for Loan Losses. We establish provisions for loan losses, which are charged to operations, at a level estimated as necessary to absorb known and inherent losses that are both probable and reasonably estimable at the date of the financial statements. In evaluating the level of the allowance for loan losses, management considers, among other things, historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions (particularly as such conditions relate to our market area). We charge losses on loans against the allowance when we believe that collection of loan principal is unlikely. Recoveries on loans previously charged off are added back to the allowance.
Based on our evaluation of these factors, management made a provision of $12,017 and $12,000 for the three months ended September 30, 2005 and September 30, 2004, and a provision of $43,867 and $36,000 for the nine months ended September 30, 2005 and September 30, 2004. We had an automobile loan charge-off of $2,296 during the three and nine-month periods ended September 30, 2005. There were no loan charge-offs during the three and nine-month periods ended September 30, 2004. We used the same methodology and generally similar assumptions in assessing the allowance for these periods.
We have developed a methodology for assessing the adequacy of the allowance for loan losses. Our methodology consists of three key elements: (1) specific allowances for identified problem loans, including certain impaired or collateral-dependent loans; (2) a general valuation allowance on certain identified problem loans; and (3) a general valuation allowance on the remainder of the loan portfolio.
Specific Allowance on Identified Problem Loans. The loan portfolio is segregated first between loans that are on our “watch list” and loans that are not. Our watch list includes:
| • | loans 90 or more days delinquent; |
| • | loans with anticipated losses; |
| • | loans referred to attorneys for collection or in the process of foreclosure; |
| • | nonaccrual loans; |
| • | loans classified as substandard, doubtful or loss by either our internal classification system or by regulators during the course of their examination of us; and |
| • | troubled debt restructurings and other non-performing loans. |
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Two of our officers review each loan on the watch list and establish an individual allowance allocation on certain loans based on such factors as: (1) the strength of the customer’s personal or business cash flow; (2) the availability of other sources of repayment; (3) the amount due or past due; (4) the type and value of collateral; (5) the strength of our collateral position; (6) the estimated cost to sell the collateral; and (7) the borrower’s effort to cure the delinquency.
We also review and establish, if necessary, an allowance for certain impaired loans for the amounts by which the discounted cash flows (or collateral value or observable market price) are lower than the carrying value of the loan. Under current accounting guidelines, a loan is defined as impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due under the contractual terms of the loan agreement.
General Valuation Allowance on Certain Identified Problem Loans.We also establish a general allowance for watch list loans that do not have an individual allowance. We segregate these loans by loan category and assign allowance percentages to each category based on inherent losses associated with each type of lending and consideration that these loans, in the aggregate, represent an above-average credit risk and that more of these loans will prove to be uncollectible compared to loans in the general portfolio.
General Valuation Allowance on the Remainder of the Loan Portfolio. We establish another general allowance for loans that are not on the watch list to recognize the inherent losses associated with lending activities, but which, unlike specific allowances, has not been allocated to particular problem assets. This general valuation allowance is determined by segregating the loans by loan category and assigning allowance percentages based on our historical loss experience and delinquency trends. The allowance may be adjusted for significant factors that, in management’s judgment, affect the collectibility of the portfolio as of the evaluation date. These significant factors may include changes in lending policies and procedures, changes in existing general economic and business conditions affecting our primary lending areas, credit quality trends, collateral value, loan volumes and concentrations, seasoning of the loan portfolio, specific industry conditions within portfolio segments, recent loss experience in a particular segment of the portfolio, duration of the current business cycle and bank regulatory examination results. The applied loss factors are reevaluated annually to ensure their relevance in the current environment.
Although we believe that we use the best information available to establish the allowance for loan losses, the evaluation is inherently subjective as it requires estimates that are susceptible to significant revisions as more information becomes available or as future events change. If circumstances differ substantially from the assumptions used in making our determinations, future adjustments to the allowance for loan losses may be necessary and our results of operations could be adversely affected. In addition, the Office of Thrift Supervision, as an integral part of its examination process, periodically reviews our allowance for loan losses. The Office of Thrift Supervision may require us to increase the allowance for loan losses based on its judgments about information available to it at the time of its examination, which would adversely affect our results of operations.
The allowance for loan losses totaled $460,300 or 0.33% of gross loans outstanding of $138,917,747 at September 30, 2005, compared to an allowance for loan losses of $399,189, or 0.34% of gross loans outstanding of $117,494,002 at September 30, 2004.
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The following table summarizes the activity in the provision for loan losses for the three and nine months ended September 30, 2005 and 2004.
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||
| (Dollars in Thousands) | ||||||||||||||||
Balance at beginning of period | $ | 447 | $ | 387 | $ | 413 | $ | 362 | ||||||||
Charge-offs | 2 | — | 2 | — | ||||||||||||
Recoveries | 3 | — | 5 | 1 | ||||||||||||
Net charge-offs | 1 | — | 3 | 1 | ||||||||||||
Provision for loan losses | 12 | 12 | 44 | 36 | ||||||||||||
Ending balance | $ | 460 | $ | 399 | $ | 460 | $ | 399 | ||||||||
Ratio of net charge-offs (recoveries) during the period to average loans outstanding, net, during the period | — | — | — | — | ||||||||||||
Ratio of allowance of loan losses to total loans outstanding | 0.33 | % | 0.34 | % | 0.33 | % | 0.34 | % | ||||||||
Allowance for loan losses as a percent of total non-performing loans | 32.63 | % | 112.67 | % | 32.63 | % | 112.67 | % | ||||||||
Other Income.
Three months ended September 30, 2005 compared to three months ended September 30, 2004.
Historically, our non-interest income has been relatively modest and one of our strategic initiatives is to increase our non-interest income. Non-interest income increased $26,583, or 58.52%, to $72,011 for the three months ended September 30, 2005, as compared to $45,428 for the three months ended September 30, 2004. Rental income from our headquarters building increased modestly by $7,113 during the third quarter of 2005 as compared to the third quarter of 2004. As of September 30, 2005, we had leased 81% of the total leaseable space in our headquarters building. Currently, we intend to utilize the remaining space for future expansion and have ceased actively attempting to lease the remaining space. Our other income increased by $19,470, or 112.01%, to $36,852 for the three months ended September 30, 2005, as compared to $17,382 for the three months ended September 30, 2004. The increase is a result of receiving an additional $18,233 in connection with the sale of our ground rents, which occurred in June 2004. The additional proceeds are due to a purchase price adjustment on the sale.
Nine months ended September 30, 2005 compared to nine months ended September 30, 2004.
Non-interest income increased $143,482, or 499.97%, to $172,180 for the nine months ended September 30, 2005, as compared to $28,698 for the nine months ended September 30, 2004. The primary reason for the increase is because of the loss during the second quarter of 2004 on the sale of the ground rent portfolio. Rental income from our headquarters building increased $22,805 for the nine months ended September 30, 2005 compared to the nine months ended September 30, 2004. Our other income increased by $17,348, or 32.50%, to $70,720 for the nine months ended September 30, 2005, as compared to $53,372 for the nine months ended September 30, 2004. The increase is a result of receiving additional proceeds of $18,233 from the sale of our ground rents, as described above.
Non-interest Expense.
Three months ended September 30, 2005 compared to three months ended September 30, 2004.
Non-interest expense was $953,480 for the three months ended September 30, 2005 as compared to $718,278 for the three months ended September 30, 2004, an increase of $235,202, or 32.75%. The
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increase was due primarily to a $105,611 increase in compensation and related expenses and a $104,868 increase in other expenses, consisting primarily of network support and maintenance, professional services, and office supplies. The increase in compensation and related expenses reflected, among other items, the hiring of temporary security personnel at the Bel Air location in response to a robbery in January 2005, annual salary and insurance premium increases, and the accrual of non-cash compensation expenses under the Employee Stock Ownership Plan, Stock Option Plan and Recognition and Retention Awards Plan in the current quarter (none in 2004). We have determined that security at the Bel Air location is adequate and we will cease incurring this additional expense after November 2005. Much of the increase in professional services expenses is directly related to the legal fees associated with being a public company.
Nine months ended September 30, 2005 compared to nine months ended September 30, 2004.
Non-interest expense was $2,721,961 for the nine months ended September 30, 2005, as compared to $2,182,231 for the nine months ended September 30, 2004, an increase of $539,730 or 24.73%. The increase was due primarily to a $260,848, or 25.01%, increase in compensation and related expenses and a $239,124, or 66.11%, increase in other expenses, consisting primarily of network support and maintenance, professional services, office supplies and a robbery loss. Compensation and related expenses increased due to the hiring of a residential loan officer in March 2004, a commercial lender in April 2004, the hiring of temporary security personnel at our Bel Air location in March 2005, annual salary and insurance premium expenses and the accrual of non-cash compensation expenses under the Employee Stock Ownership Plan, Stock Option Plan and Recognition and Retention Awards Plan in the current quarter (none in 2004). The security related costs will terminate after November 2005. Much of the increase in professional services expenses is directly related to the legal fees associated with being a public company.
Income Tax Expense.
Three months ended September 30, 2005 compared to three months ended September 30, 2004.
The provision for income taxes decreased to $15,400 for the three months ended September 30, 2005 from $96,094 for the three months ended September 30, 2004, representing a decrease of $80,694. The decrease in the provision for income taxes was primarily due to our lower level of income before taxes.
Nine months ended September 30, 2005 compared to nine months ended September 30, 2004.
The provision for income taxes increased to $132,400 for the nine months ended September 30, 2005 from $130,600 for the nine months ended September 30, 2004, representing an increase of $1,800. The increase in the provision for income taxes was due to our higher level of income before taxes of $343,898 for the nine months ended September 30, 2005, as compared to $333,667 for the nine months ended September 30, 2004.
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Analysis of Financial Condition
Assets.
General.
Our total assets increased by $6,056,971 or 3.78%, to $166,490,370 at September 30, 2005, from $160,433,399 at December 31, 2004. The increase in total assets resulted primarily from a $19,314,396, or 16.38% increase in net loans receivable, from $117,900,265 at December 31, 2004 to $137,214,661 at September 30, 2005. The increase was offset by a $1,947,489, or 27.90% decrease in mortgage backed securities-held to maturity, from $6,981,460 at December 31, 2004 to $5,033,971 at September 30, 2005 and an $11,671,032, or 74.83% decrease in cash and cash equivalents, from $15,596,947 at December 31, 2004 to $3,925,915 at September 30, 2005.
Cash and cash equivalents declined primarily because we invested the cash into new loans, and returned $1,452,720 of funds deposited with us by potential purchasers in our stock offering whose subscription funds were returned in January 2005.
Investment Securities.
The investment portfolio at September 30, 2005 amounted to $17,121,061, a decrease of $1,836,657, or 9.68%, from $18,957,718 at December 31, 2004. Investment securities – available for sale, increased $108,605, or 1.36%, to $8,089,316 at September 30, 2005 from $7,980,711 at December 31, 2004, primarily as a result of dividends credited to the account. Mortgage backed securities – held to maturity, decreased $1,947,489, or 27.90%, to $5,033,971 at September 30, 2005 from $6,981,460 at December 31, 2004, as a result of principal repayments.
The carrying value of available for sale securities includes a net unrealized loss of $188,018 at September 30, 2005 (reflected as accumulated other comprehensive loss of $115,405 in equity after deferred taxes) as compared to a net unrealized loss of $97,652 ($59,939 net of taxes) as of December 31, 2004. In general, this increase in unrealized loss was a result of rising interest rates.
Loan Portfolio.
Loans receivable, net, increased $19,314,396, or 16.38%, to $137,214,661 at September 30, 2005 from $117,900,265 at December 31, 2004. The commercial loan portfolio increased $2,156,401, or 45.31%, to $6,915,534 at September 30, 2005 from $4,759,133 at December 31, 2004. One-to-four family residential loans increased $16,279,745, or 15.53% to $121,134,272 at September 30, 2005 from $104,854,527 at December 31, 2004. Our loan customers are generally located in Baltimore City, Baltimore County and Harford County, Maryland.
Asset Quality.
Loans are reviewed on a regular basis and are generally placed on non-accrual status when they become more than 90 days delinquent. When we classify a loan as non-accrual, we no longer accrue interest on such loan and reverse any interest previously accrued but not collected. Typically, payments received on a non-accrual loan are applied to the outstanding principal and interest as determined at the time of collection of the loan. We return a non-accrual loan to accrual status when factors indicating doubtful collection no longer exist and the loan has been brought current.
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Loans classified as nonaccrual and the associated unrecorded interest is as follows:
| September 30, | December 31, | ||||||||
| 2005 | 2004 | 2004 | |||||||
Nonaccrual loans | $ | 1,245,543 | $ | 354,306 | $ | 365,233 | |||
Unrecorded interest on nonaccrual loans | $ | 55,788 | $ | 19,097 | $ | 22,732 | |||
Of the non-accrual loans, $1,080,183 consisted of the commercial land acquisition and development participation loan discussed above and $165,360 consisted of one-to-four residential mortgage loans at September 30, 2005.
We hold a 19% participation (approximately $1,080,183 in unpaid principal balance) in the commercial real estate acquisition and development loan referred to above. Although this loan became delinquent earlier in the year, we had continued to accrue interest on the loan because we believed that collection of all principal and interest on the loan was probable. Previously, we reported that we expected that a national homebuilder would purchase the property to build residential units as soon as the borrower developed the property to the “record plat stage,” at which time the loan would be paid in full, and that we expected that to occur prior to the end of the year.
As of the date of this filing, the national homebuilder has agreed to release the borrower from its purchase agreement with the national homebuilder. The participating banks are negotiating a 95-day forbearance agreement with the borrower for the purpose of allowing the borrower to negotiate the sale of the property. We anticipate that the forbearance agreement will be conditioned upon a new bank contracted appraisal with a minimum “as is” value of $7,500,000, versus a current whole loan outstanding balance of principal and unpaid interest of approximately $6,100,000 at September 30, 2005.
Due to these circumstances, we determined that placing the loan on non-accrual status was appropriate at this time. We continue to believe that the project is viable and that the land value provides adequate collateral protection. Ultimately, we believe we will receive all principal and interest on this loan, although there can be no assurance that that will be the case.
Non-accrual loans totaled 0.91% and .30% of net loans receivable at September 30, 2005 and September 30, 2004, respectively, and 0.31% of net loans receivable at December 31, 2004.
Real estate and other assets that we acquire as a result of foreclosure or by deed-in-lieu of foreclosure or repossession on collateral-dependent loans are classified as real estate owned or other repossessed assets until sold. Such assets are recorded at foreclosure or other repossession and updated quarterly at the lower of cost or estimated fair value less estimated selling costs. Any portion of the outstanding loan balance in excess of fair value is charged off against the allowance for loan losses. If, upon ultimate disposition of the property, net sales proceeds exceed the net carrying value of the property, a gain on sale of real estate or other assets is recorded. We did not have any real estate owned or other repossessed assets at September 30, 2005 or December 31, 2004.
Under current accounting guidelines, a loan is defined as impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due under the contractual terms of the loan agreement. We consider one- to four-family mortgage loans and consumer installment loans to be homogeneous and, therefore, do not separately evaluate them for impairment. All other loans are evaluated for impairment on an individual basis. We generally classify non-accrual loans
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as impaired and we are doing so in this instance, even though management feels that we will be able to collect all amounts due under the contractual terms of the loan agreement. As of September 30, 2005, no loan had been identified as impaired other than the non-accrual acquisition and development loan described above. We had no loans that were considered impaired at December 31, 2004.
Other than as disclosed, there are no other loans at September 30, 2005 about which management has serious doubts concerning the ability of the borrowers to comply with the present loan repayment terms.
Liabilities.
General.
Total liabilities increased by $5,853,094, or 4.07%, to $143,666,392 at September 30, 2005, from $137,813,298 at December 31, 2004. The increase in total liabilities primarily resulted from a $3,500,000, or 13.21% increase in borrowings, a $2,195,418, or 349.90% increase in checks outstanding in excess of bank balance, and a $331,112, or 100.52% increase in advance payments by borrowers for taxes and insurance, offset by a $313,852, or 48.65% decrease in other liabilities. Advance payments by borrowers for taxes and insurance increased because of the growth to the loan portfolio. The other liabilities consist primarily of accrued federal and state income taxes and accrued interest on Federal Home Loan Bank borrowings.
Deposits.
Deposits increased $140,416, or 0.13%, to $109,851,784 at September 30, 2005 from $109,711,368 at December 31, 2004. Certificates of deposits increased $8,275,669 to $75,762,588 at September 30, 2005 from $67,486, 919 at December 31, 2004. Savings and money market deposits decreased by $7,045,388 to $31,140,611 at September 30, 2005 from $38,185,999 at December 31, 2004, and demand and NOW accounts, which decreased by $1,089,865 to $2,948,585 at September 30, 2005 from $4,038,450 at December 31, 2004. We believe that, as savings deposit rates are beginning to rise, some customers are moving funds into higher-yielding investments, thus accounting for the increase in certificates of deposits and the decline in savings and money market deposits. In addition, the decrease in savings and money market deposits reflects $1,452,720 of funds deposited with us during the fourth quarter of 2004 by potential purchasers in our stock offering whose subscription funds were returned to them in January 2005.
Borrowings.
At September 30, 2005, we were permitted to borrow up to $94,015,403 from the Federal Home Loan Bank of Atlanta. We had $30,000,000 and $26,500,000 of Federal Home Loan Bank advances as of September 30, 2005 and December 31, 2004, respectively, and we averaged $23,722,222 and $23,916,667 of Federal Home Loan Bank advances during the nine months ended September 30, 2005 and the year ended December 31, 2004, respectively. The increase in borrowings reflects a new $8,500,000 Federal Home Loan Bank advance, offset by a maturing advance of $5,000,000 in March, 2005. We have relied on borrowing to a significant extent since the third quarter of 2003 to fund loan growth.
Liquidity Management
Liquidity is the ability to meet current and future financial obligations of a short-term nature. Our primary sources of funds consist of deposit inflows, borrowings from the Federal Home Loan Bank of Atlanta, scheduled amortization and prepayment of loans and mortgage-backed securities, maturities and calls of held to maturity investment securities and earnings and funds provided from operations. While scheduled principal repayments on loans and mortgage-backed securities are a relatively predictable source of funds, deposit flows, calls of securities and loan prepayments are greatly influenced by market interest rates, economic conditions, and rates offered by our competition.
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We regularly adjust our investments in liquid assets based upon our assessment of (1) expected loan demand, (2) expected deposit flows, (3) yields available on interest-earning deposits and securities and (4) the objectives of our asset/liability management policy.
Our most liquid assets are cash and cash equivalents. The levels of these assets depend on our operating, financing, lending and investing activities during any given period. At September 30, 2005, cash and cash equivalents totaled $3,925,915. Securities classified as available-for-sale, which can provide additional sources of liquidity, totaled $8,089,316 at September 30, 2005. However, because all of these securities were in an unrealized loss position at September 30, 2005, and because management has the intent and ability to hold these securities until recovery or maturity, management does not consider these securities as a source of liquidity at September 30, 2005. Also, at September 30, 2005, we had advances outstanding of $30,000,000 from the Federal Home Loan Bank of Atlanta. On that date, we had the ability to borrow an additional $64,015,403.
At September 30, 2005, we had outstanding commitments to originate loans of $5,032,362 (excluding the undisbursed portions of loans). These commitments do not necessarily represent future cash requirements since certain of these instruments may expire without being funded. We also extend lines of credit to customers, primarily home equity lines of credit. The borrower is able to draw on these lines as needed, thus the funding is generally unpredictable. Unused home equity lines of credit amounted to $4,367,498 at September 30, 2005. Since the majority of unused lines of credit expire without being funded, it is anticipated that our obligation to fund the above commitment amount will be substantially less than the amounts reported.
Certificates of deposit accounts scheduled to mature within one year totaled $30,620,718 or 27.87% of total deposits at September 30, 2005. Management believes that the large percentage of deposits in shorter-term certificates of deposit reflects customers’ hesitancy to invest their funds in long-term certificates of deposit in the current low interest rate environment. If these deposits do not remain with us, we will be required to seek other sources of funds, including other certificates of deposit and/or additional borrowings. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit due on or before September 30, 2006. We believe, however, that, based on past experience, a significant portion of our certificates of deposit will remain with us. We believe we have the ability to attract and retain deposits by adjusting the interest rates offered.
Our borrowings are with the Federal Home Loan Bank of Atlanta and are secured by Federal Home Loan Bank of Atlanta stock that we own and a blanket lien on mortgages. Borrowings at September 30, 2005 consisted of $6,500,000 of long term fixed rate advances with rates ranging from 2.83% to 4.90% and $23,500,000 of long term convertible rate advances with fixed rates ranging from 3.08% to 3.92%. If not repaid or converted to a different product, the convertible rate advances will convert from a fixed to a floating rate after periods ranging from one to five years.
Our primary investing activity is the origination of loans, primarily one- to four-family residential mortgage loans, and the purchase of securities. Our primary financing activity consists of activity in deposit accounts and Federal Home Loan Bank of Atlanta advances. Asset growth has outpaced deposit growth over the past 15-18 months and the increased liquidity needed to fund the asset growth has been provided through increased Federal Home Loan Bank borrowings. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors and other factors. We generally manage the pricing of our deposits to be competitive.
We are not aware of any known trends, events or uncertainties that will have or are reasonably likely to have a material effect on our liquidity, capital or operations, nor are we aware of any current recommendation by regulatory authorities, which if implemented, would have a material effect on liquidity, capital or operations.
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Stockholders’ Equity
Total stockholders’ equity increased $203,877, or 0.90%, to $22,823,978 at September 30, 2005 from $22,620,101 at December 31, 2004 primarily as a result of net income of $211,498, partially offset by a $55,466 increase in accumulated other comprehensive loss (resulting from unrealized losses on investments available for sale, net of tax). We are considered “well capitalized” under the risk-based capital guidelines applicable to us.
Off-balance Sheet Arrangements
In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate, and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit.
Our exposure to credit loss from non-performance by the other party to the above-mentioned financial instruments is represented by the contractual amount of those instruments. We use the same credit policies in making commitments and conditional obligations as we do for on-balance-sheet instruments. In general, we do not require collateral or other security to support financial instruments with off-balance-sheet credit risk.
Financial Instruments Whose Contract Amount Represents Credit Risk | Contract Amount At | |||||
September 30, 2005 | December 31, 2004 | |||||
Lines of credit-home equity | $ | 4,367,498 | $ | 3,602,774 | ||
Lines of credit-overdraft checking | 96,739 | 13,523 | ||||
Mortgage loan commitments | 5,032,362 | 2,428,520 | ||||
Lines of credit-home equity are lines of credit secured by second deeds of trust on residential real estate. They have fixed expiration dates as long as there is no violation of any condition established in the contract. We evaluate each customer’s credit worthiness on a case-by-case basis.
Our outstanding commitments to make mortgages are at fixed rates ranging from 5.00% to 7.50% and 4.875% to 5.75% at September 30, 2005 and December 31, 2004, respectively. Loan commitments expire 60 days from the date of the commitment.
For the nine months ended September 30, 2005, we engaged in no off-balance-sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows.
Information Regarding Forward-Looking Statements
In addition to the historical information contained in Part I of this Quarterly Report on Form 10-QSB, the discussion in Part I of this Quarterly Report on Form 10-QSB contains certain forward-looking statements. Forward-looking statements often use words such as “believe,” “expect,” “plan,” “may,”
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“will,” “should,” “project,” “contemplate,” “anticipate,” “forecast,” “intend” or other words of similar meaning. You can also identify them by the fact that they do not relate strictly to historical or current facts.
Our goals, objectives, expectations and intentions, including statements regarding profitability, growth and operating strategy, liquidity, asset quality of our loan and investment portfolio, the allowance for loan losses, interest rate sensitivity, liquidity management, market risk and financial and other goals are forward looking. These statements are based on our beliefs, assumptions and on information available to us as of the date of this filing, and involve risks and uncertainties. These risks and uncertainties include, among others, those discussed in this Quarterly Report on Form 10-QSB; the effect of rising interest rates on our profits and asset values; risks related to our intended increased focus on commercial real estate and commercial business loans; our limited recognition and reputation in our markets; adverse economic conditions in our market area; the dependence on key personnel; competitive factors within our market area; the effect of developments in technology on our business; adverse changes in the overall national economy as well as adverse economic conditions in our specific market area; adequacy of the allowance for loan losses; expenses as a result of our stock benefit plans; and changes in regulatory requirements and/or restrictive banking legislation.
Our actual results could differ materially from those discussed herein and you should not put undue reliance on any forward-looking statements. All forward-looking statements speak only as of the date of this filing, and we undertake no obligation to make any revisions to the forward-looking statements to reflect events or circumstances after the date of this filing or to reflect the occurrence of unanticipated events.
Item 3. Controls and Procedures
As of the end of the period covered by this quarterly report on Form 10-QSB, SFSB, Inc.’s Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of SFSB, Inc.’s and Slavie Federal Savings Bank’s disclosure controls and procedures. Based upon that evaluation, SFSB, Inc.’s and Slavie Federal Savings Bank’s Chief Executive Officer and Chief Financial Officer concluded that SFSB, Inc.’s and Slavie Federal Savings Bank’s disclosure controls and procedures are effective. Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by SFSB, Inc. in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
In addition, there were no changes in SFSB, Inc.’s or Slavie Federal Savings Bank’s internal controls over financial reporting (as defined in Rule 13a-15 or Rule 15d-15) under the Securities Act of 1934, as amended) during the quarter ended September 30, 2005, that have materially affected, or are reasonably likely to materially affect, SFSB, Inc.’s or Slavie Federal Savings Bank’s internal control over financial reporting.
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PART II - OTHER INFORMATION
| Item 1. | Legal Proceedings. |
None.
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds. |
None.
| Item 3. | Defaults Upon Senior Securities. |
Not applicable.
| Item 4. | Submission of Matters to a Vote of Securities Holders. |
None
| Item 5. | Other Information. |
Not applicable.
| Item 6. | Exhibits. |
| 31.1 | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 31.2 | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 32 | Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SFSB, Inc. | ||||
Date: November 18, 2005 | By: | /s/ Philip E. Logan | ||
Philip E. Logan, President | ||||
(Principal Executive Officer) | ||||
Date: November 18, 2005 | By: | /s/ Sophie Torin Wittelsberger | ||
Sophie Torin Wittelsberger, Chief Financial Officer | ||||
(Principal Accounting and Financial Officer) | ||||
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