EXHIBIT 13
2005 ANNUAL REPORT TO STOCKHOLDERS
Exhibit 13
Dear Stockholder:
The past year has seen Sound Federal pass the $1.0 billion asset mark.
While this is a milestone that we are very proud of, this notable achievement is
equally significant for what it does not state. It does not adequately reflect
the 114 years of dedicated care and diligence that so many people have devoted
to our Company and to the community. It does not tell the story of the
generations of dedicated employees who envisioned and then molded and shaped
Sound Federal into the Company you see today. Nor does it adequately acknowledge
the loyalty of our valued customers over the years. It certainly does not
reflect the tragedies and triumphs of the last 114 years that we have shared
with the communities we serve and that are woven into the fabric of who and what
we are. We are fortunate to be the stewards of Sound Federal to mark this
milestone as others have marked milestones before us.
As we reflect on passing the $1.0 billion asset mark, we are proud of this
year's principal accomplishments:
o The opening of our Carmel, New York and Bethel, Connecticut
branches, bringing our total number of branches to fourteen.
o The growth of our loan portfolio by 17.2% to $560.8 million.
o The growth of our deposits by 17.4% to $831.8 million.
o The continued high quality of our loan portfolio, with
non-performing loans consisting of only $580,000 or 0.10% of total
loans.
As our franchise continues to grow, changes in the economy continue to challenge
us. The yield curve flattened during fiscal 2005 as short-term interest rates
began to increase. As a result, our net interest margin and net interest rate
spread have decreased. As rates continue to rise, we expect to see further
decreases in net interest margin and net interest rate spread. Several years
ago, we began to restructure our balance sheet in order to mitigate our interest
rate risk. Adjustable rate loans, which accounted for only 1.6% our loan
portfolio at March 31, 2000, now account for 37.8% of total loans.
Adjustable-rate mortgage-backed securities now represent 41% of our total
securities portfolio. We continue to strive to lengthen the terms of deposit
accounts.
While rising interest rates continue to challenge us, we remain focused on the
fundamentals of building a solid franchise. We are confident that the growth of
the franchise will provide growth in stockholder
1
value. However, franchise growth must be accompanied by strong operating
principles and discipline. This discipline has resulted in operating expenses
that are 1.95% of average assets - well below our peers. Equally significant, we
believe our market area provides Sound Federal with excellent growth
opportunities.
Our success is due in no small measure to the customers and communities that
have supported Sound Federal for 114 years and to a talented and dedicated
banking staff. As the stewards of Sound Federal, the Board of Directors and
Management remain focused on our customers and our stockholders. Building a
strong franchise depends on it. Building a strong franchise in our market area
is the cornerstone of our business model which is designed to grow stockholder
value.
We look forward to fiscal 2006 with enthusiasm and pride. On behalf of all of us
at Sound Federal, thank you for your support.
/s/ Richard P. McStravick /s/ Bruno J. Gioffre
2
Selected Consolidated Financial Information
(In thousands)
At or for the Years Ended March 31,
------------------------------------------------------------------------------
2005 2004 2003 2002 2001
------------------------------------------------------------------------------
Results of Operations:
Net interest income $ 26,423 $ 26,192 $ 25,839 $ 18,906 $ 14,568
Provision for loan losses 300 275 275 175 208
Non-interest income 1,447 1,041 890 731 382
Non-interest expense 18,568 16,106 12,709 10,316 10,033
---------- ---------- ---------- ---------- ----------
Income before income tax expense 9,002 10,852 13,745 9,146 4,709
Income tax expense 3,533 4,234 5,219 3,376 2,050
---------- ---------- ---------- ---------- ----------
Net income $ 5,469 $ 6,618 $ 8,526 $ 5,770 $ 2,659
========== ========== ========== ========== ==========
Financial Condition:
Total assets $1,006,950 $ 890,541 $ 796,088 $ 623,985 $ 552,934
Loans, net 560,751 478,455 427,684 418,368 293,807
Mortgage-backed securities:
Available for sale 199,745 255,853 212,484 104,134 115,931
Held to maturity 59,777 -- -- -- 25,177
Other securities:
Available for sale 76,409 81,877 82,564 46,097 41,595
Held to maturity 19,712 -- -- -- 3,038
Deposits 831,768 708,330 604,260 519,905 473,546
Borrowings 38,000 35,000 35,000 34,922 14,698
Stockholders' equity 127,160 137,059 138,321 61,015 56,929
3
Selected Consolidated Financial Information (continued)
(Dollars in thousands, except per share data)
At or for the Years Ended March 31,
----------------------------------------------------------------
2005 2004 2003 2002 2001
----------------------------------------------------------------
Performance Ratios:
Return on average assets 0.57% 0.79% 1.23% 1.01% 0.56%
Return on average equity 4.23 4.87 10.50 9.85 4.89
Average interest rate spread (1) 2.69 2.98 3.71 3.31 2.96
Net interest margin (2) 2.91 3.24 3.93 3.51 3.26
Efficiency ratio (3) 66.85 59.14 47.65 52.72 64.80
Dividend payout ratio (4) 51.06 40.74 20.90 22.22 50.00
Per Common Share Data:
Basic earnings per share $0.47 $0.54 $0.67 $0.45 $0.20
Diluted earnings per share 0.46 0.52 0.65 0.44 0.20
Book value per share (5) 10.27 10.40 10.44 4.62 4.28
Tangible book value per share (5) 9.15 9.34 9.39 3.56 3.23
Dividends per share 0.24 0.22 0.14 0.10 0.10
Capital Ratios:
Average equity to average total assets (consolidated) 13.59% 16.15% 11.68% 10.26% 11.42%
Tier 1 leverage capital at end of period (Bank only) 10.26 10.92 11.29 6.54 6.35
Asset Quality Data:
Total non-performing loans $580 $1,981 $477 $755 $933
Total non-performing assets 580 1,981 477 869 1,130
(1) Represents the difference between the weighted average yield on
interest-earning assets and the weighted average cost of interest-bearing
liabilities.
(2) Represents net interest income as a percent of average interest-earning
assets.
(3) Computed by dividing non-interest expense by the sum of net interest
income and non-interest income.
(4) Calculated by dividing cash dividends per share by basic earnings per
share for the period.
(5) Computed based on total common shares issued, less treasury shares.
Tangible book value excludes goodwill.
4
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
Our principal business has historically consisted of offering savings and
other deposits to the general public and using the funds from these deposits to
make loans secured by residential real estate. Our net income depends primarily
upon our net interest income, which is the difference between interest income
earned on interest-earning assets, such as loans and investments, and the
interest expense paid on deposits. To a much lesser degree, our net income is
affected by non-interest income, such as banking service charges and fees. Net
income is also affected by, among other things, provisions for loan losses and
non-interest expenses. Our principal non-interest expenses consist of
compensation and benefits, occupancy and equipment, data processing service
fees, advertising and promotion and other expenses, such as ATM expenses,
professional fees and insurance premiums. Our net income also is affected
significantly by general economic and competitive conditions, particularly
changes in market interest rates; government legislation and policies affecting
fiscal affairs, housing and financial institutions; monetary policies of the
Federal Reserve System; and the actions of bank regulatory authorities.
Forward-Looking Statements
When used in this Annual Report, the words or phrases "will likely
result," "are expected to," "will continue," "is anticipated," "estimate,"
"project" or similar expressions are intended to identify "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. Such statements reflect our current view with respect to future-looking
events and are subject to certain risks and uncertainties that could cause
actual results to differ materially from Management's current expectations.
Among others, these risks and uncertainties include changes in general economic
conditions, changes in policies by regulatory agencies, hostilities involving
the United States, fluctuations in interest rates, demand for loans in the
Company's market area, changes in the quality or composition of the Company's
loan and investment portfolios, changes in accounting principles, policies or
guidelines and other economic, competitive, governmental and technological
factors affecting our operations, markets and products. The Company wishes to
caution readers not to place undue reliance on any such forward-looking
statements, which speak only as of the date made. The Company wishes to advise
readers that the factors listed above could affect the Company's financial
performance and could cause the Company's actual results for future periods to
differ materially from its forward-looking statements.
Critical Accounting Policies
Accounting policies considered particularly critical to our financial
results include the allowance for loan losses and accounting for goodwill. The
methodology for determining the allowance for loan losses is considered a
critical accounting policy by management due to the high degree of judgment
involved, the subjectivity of the assumptions utilized and the potential for
changes in the economic environment that could result in changes to the amount
of the allowance for loan losses considered necessary. Management considers
accounting for goodwill to be a critical policy because goodwill must be tested
for impairment at least annually using an approach that involves the estimation
of fair values. Estimating fair values involves a high degree of judgment and
subjectivity in the assumptions utilized.
Management of Market Risk
Our most significant form of market risk is interest rate risk. Our assets
consist primarily of mortgage loans, which have longer maturities than our
liabilities, which consist primarily of deposits. Our interest rate risk
management program focuses primarily on evaluating and managing the composition
of assets and liabilities in the context of various interest rate scenarios.
Factors beyond management's control, such as market interest rates and
competition, also have an impact on interest income and interest expense. We do
not own any trading assets and have not engaged in hedging transactions such as
interest rate swaps and caps.
5
We attempt to manage interest rate risk and to minimize the exposure of
earnings to changes in market interest rates. During the low interest rate
environment that has existed in recent years, we have followed the following
strategies to manage interest rate risk: (i) purchasing adjustable rate
mortgage-backed securities issued by Fannie Mae, Freddie Mac or Ginnie Mae, (ii)
purchasing securities with an average life of five years or less and (iii)
originating a greater volume of adjustable rate mortgage loans. By investing in
shorter term and adjustable rate financial instruments, we believe we are better
positioned to react to increases in market interest rates. However, these
financial instruments generally bear lower yields than longer term or fixed rate
instruments. Thus, during the recent sustained period of relatively low interest
rates, these strategies have resulted in lower levels of interest income than
would be obtained by investing in longer term fixed rate instruments. Management
believes, however, that maintaining a significant portion of our assets in
shorter term and adjustable rate assets enables us to take advantage of
increases in interest rates, reduces the exposure of earnings to interest rate
fluctuations and enhances long-term profitability.
Management monitors interest rate sensitivity through the use of a model
that estimates the change in the Bank's net portfolio value ("NPV") and net
interest income ("NII") in response to a range of assumed changes in market
interest rates. NPV is the present value of expected cash flows from assets,
liabilities, and off-balance sheet items. Management is not aware of any known
trends that would significantly affect the timing or amount of the expected cash
flows utilized in the model. The model, as currently used, estimates the effect
on NPV and NII of instantaneous and permanent 100 to 300 basis point increases
and 100 to 200 basis point decreases in market interest rates, with no effect
given to any actions that management might take to counter the effect of
interest rate movements. We historically estimated the effects of 100 to 300
basis point decreases in interest rates. However, given the current low level of
market interest rates and the low probability of further significant declines in
absolute rates, we did not calculate the effects of interest rate decreases
greater than 200 basis points.
The table below sets forth, as of March 31, 2005, the estimated changes in
the Bank's NPV and NII that would result from the designated instantaneous
changes in interest rates. The interest rate changes are assumed to occur
uniformly across the yield curve.
Estimated Increase Estimated Increase
Changes in (Decrease) in NPV (1) (Decrease) in NII
Interest Rates Estimated ----------------------- --------------------
(Basis Points) NPV Amount Percent Percent
-------------- --------- ----------- --------- --------------------
(Dollars in thousands)
+300 $ 71,492 $ (59,449) (45.4)% (10.5)%
+200 92,820 (38,121) (29.1) (5.8)
+100 113,502 (17,439) (13.3) (2.4)
0 130,941 -- -- --
-100 141,788 10,847 8.3 0.9
-200 149,051 18,110 13.8 (0.9)
- ----------
(1) Represents the decrease in the estimated NPV at the indicated change in
interest rates compared to the NPV assuming no change in interest rates.
Computations of prospective effects of hypothetical interest rate changes
are based on numerous assumptions including relative levels of market interest
rates, loan prepayments and deposit decay, and should not be relied upon as
indicative of actual results. Further, the computations do not reflect any
actions management may undertake in response to changes in interest rates.
The above table indicates that at March 31, 2005, in the event of a 100
basis point decrease in interest rates, we would expect to experience an 8.3%
increase in NPV and a 0.9% increase in NII. In the event of a 200 basis point
increase in interest rates, we would expect to experience a 29.1% decrease in
NPV and a 5.8% decrease in NII. Subsequent to March 31, 2005, there have been no
significant changes in our interest rate risk exposures or how those exposures
would be managed.
Certain shortcomings are inherent in the methodology used to model changes
in NPV and NII. The model requires that management make certain assumptions that
may or may not reflect the manner in which yields and costs will actually
respond to changes in market interest rates. Further, the computations do not
reflect any actions
6
management may undertake in response to changes in interest rates. In this
regard, the table presented assumes that (i) the composition of the interest
sensitive assets and liabilities existing at the beginning of a period will
remain constant over the period being measured and (ii) a particular change in
interest rates is reflected uniformly across the yield curve regardless of the
duration or repricing of specific assets and liabilities. Accordingly, although
the table provides an indication of interest rate risk exposure at a particular
point in time, these measurements are not intended to and do not provide a
precise forecast of the effect of changes in market interest rates on our net
interest income, and will differ from actual results. We will not necessarily
limit projected changes in NPV if the required action would present a
disproportionate risk to continued profitability.
Comparison of Financial Condition at March 31, 2005 and 2004
Assets. The Company's total assets amounted to $1.0 billion at March 31, 2005 as
compared to $890.5 million at March 31, 2004. The $116.4 million increase in
assets primarily consisted of an $82.3 million increase in net loans to $560.8
million and a $17.9 million increase in securities to $355.6 million. Our asset
growth was funded principally by a $123.5 million increase in deposits to $831.8
million.
The increase in securities consisted of a $79.5 million increase in securities
classified as held to maturity and a $61.6 million decrease in securities
available for sale. In June 2004, the Company began to classify substantially
all securities purchases as held to maturity. This decision was based on the
size of the portfolio classified as available for sale relative to
interest-earning assets and stockholders' equity, the Company's liquidity
position (which allows the Company to hold securities until maturity) and an
increase in market interest rates. As these factors change in the future, the
Company will evaluate the classification of future securities purchases.
Liabilities. Total deposits were $831.8 million at March 31, 2005 as compared to
$708.3 million at March 31, 2004, an increase of $123.5 million. Certificates of
deposit increased $107.2 million to $552.9 million from $445.7 million; savings
and club accounts increased $2.3 million to $150.5 million from $148.2 million;
and money market, NOW and commercial checking accounts increased $14.0 million
to $128.4 million from $114.4 million.
Stockholders' Equity. Total stockholders' equity decreased $9.9 million to
$127.2 million at March 31, 2005 as compared to $137.1 million at March 31,
2004. The decrease reflects treasury stock purchases at a cost of $12.1 million,
dividends paid of $2.9 million and a decrease of $3.4 million attributable to
the change in accumulated other comprehensive income or loss, partially offset
by net income of $5.5 million and proceeds of $258,000 from the issuance of
treasury shares for stock options exercised.
The accumulated other comprehensive loss of $2.7 million at March 31, 2005
represents the after-tax net unrealized loss on securities available for sale
($4.5 million pre-tax). The Company invests primarily in mortgage-backed
securities issued by Ginnie Mae, Fannie Mae and Freddie Mac, as well as U.S.
Government and Agency securities. The unrealized losses on these securities at
March 31, 2005 were caused by increases in market yields subsequent to purchase.
There were no debt securities past due or securities for which the Company
currently believes it is not probable that it will collect all amounts due
according to the contractual terms of the security. Because the Company has the
ability to hold securities with unrealized losses until a market price recovery
(which, for debt securities may be until maturity), the Company did not consider
these securities to be other-than-temporarily impaired at March 31, 2005.
7
Average Balance Sheets
The following table sets forth average balance sheets, average yields and costs,
and certain other information for the years ended March 31, 2005, 2004 and 2003.
The table reflects the average yield on interest-earning assets and the average
cost of interest-bearing liabilities (derived by dividing interest income or
expense by the daily average balance of interest-earning assets or
interest-bearing liabilities, respectively), as well as the net yield on
interest-earning assets. No tax-equivalent yield adjustments were made, as the
effect thereof was not material. Nonaccrual loans were included in the
computation of average balances and therefore have a zero yield. The yields set
forth below include the effect of deferred loan origination fees and costs, and
purchase discounts and premiums, that are amortized or accreted to interest
income. Interest income on loans for fiscal years 2005, 2004 and 2003 has been
reduced by amortization of net deferred loan origination costs of $568,000,
$981,000 and $633,000, respectively. Interest income on mortgage-backed
securities has been reduced by amortization of purchase premiums (net of
discounts) of $1.1 million, $631,000 and $15,000 for those same respective
years.
For the Years Ended March 31,
-----------------------------------------------------------------------------------------------
2005 2004 2003
-----------------------------------------------------------------------------------------------
Average Average Average Average Average Average
Outstanding Yield/ Outstanding Yield/ Outstanding Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
----------- -------- ------- ----------- -------- ------- ----------- -------- -------
(Dollars in thousands)
Interest - earning assets:
Loans (1) $ 521,558 29,430 5.64% $ 442,466 26,819 6.06% $ 433,824 29,906 6.89%
Mortgage-backed securities (2) 259,897 9,058 3.49% 243,952 8,909 3.65% 123,009 6,676 5.43%
Other securities (2) 91,725 2,940 3.21% 85,868 2,629 3.06% 52,232 2,264 4.33%
Federal funds sold and other
overnight deposits (3) 28,702 340 1.18% 30,283 240 0.79% 43,524 526 1.21%
Other (4) 5,850 132 2.26% 5,460 142 2.60% 4,320 206 4.77%
------------------ ------------------- -------------------
Total interest - earning assets 907,732 41,900 4.62% 808,029 38,739 4.79% 656,909 39,578 6.02%
------- ------- -------
Non-interest - earning assets 44,608 33,941 38,728
--------- --------- ---------
Total assets $ 952,340 $ 841,970 $ 695,637
========= ========= =========
Interest - bearing liabilities:
Savings and club accounts $ 151,077 783 0.52% $ 143,926 856 0.59% $ 124,931 1,185 0.95%
Money market accounts 46,216 372 0.80% 45,923 375 0.82% 38,828 453 1.17%
NOW accounts 59,876 154 0.26% 53,420 172 0.32% 46,158 272 0.59%
Certificates of deposit 503,695 12,659 2.51% 405,837 9,601 2.37% 342,011 10,098 2.95%
Borrowings 37,268 1,489 4.00% 39,208 1,495 3.81% 34,977 1,630 4.66%
Subscription funds from stock
offering -- -- -- -- -- -- 4,150 31 0.75%
Mortgage escrow funds 4,282 20 0.47% 3,800 48 1.26% 4,501 70 1.56%
------------------ ------------------- -------------------
Total interest - bearing liabilities 802,414 15,477 1.93% 692,114 12,547 1.81% 595,556 13,739 2.31%
------- ------- -------
Non - interest-bearing liabilities 20,531 13,910 18,845
--------- --------- ---------
Total liabilities 822,945 706,024 614,401
Stockholders' equity 129,395 135,946 81,236
--------- --------- ---------
Total liabilities and
stockholders' equity $ 952,340 $ 841,970 $ 695,637
========= ========= =========
Net interest income 26,423 26,192 25,839
======= ======= =======
Average interest rate spread (5) 2.69% 2.98% 3.71%
Net earning assets (6) $ 105,318 $ 115,915 $ 61,353
========= ========= =========
Net interest margin (7) 2.91% 3.24% 3.93%
Ratio of interest - earning assets
to interest - bearing liabilities 1.13x 1.17x 1.10x
(1) Balances are net of the allowance for loan losses.
(2) Average outstanding balances are based on amortized cost. As a result, the
average balances and yields do not include the effect of changes in fair
value of securities available for sale.
(3) Other overnight deposits represent an interest-earning demand account at
the Federal Home Loan Bank of New York.
(4) Consists primarily of Federal Home Loan Bank Stock.
(5) Net interest rate spread represents the difference between the yield on
average interest-earning assets and the cost of average interest - bearing
liabilities.
(6) Net earning assets represent total interest- earning assets less total
interest - bearing liabilities.
(7) Net interest margin represents net interest income divided by average
total interest - earning assets.
8
Rate/Volume Analysis
The following table presents the dollar amount of changes in interest income and
interest expense for the major categories of interest-earning assets and
interest-bearing liabilities. Information is provided for each category of
interest-earning assets and interest-bearing liabilities, with respect to (i)
changes attributable to changes in volume (i.e., changes in balances multiplied
by the prior-period rate) and (ii) changes attributable to rate (i.e., changes
in rate multiplied by prior-period balances). For purposes of this table,
changes attributable to both rate and volume, which cannot be segregated, have
been allocated proportionately to the change due to volume and the change due to
rate.
For the Years Ended March 31,
----------------------------------------------------------------------------
2005 vs. 2004 2004 vs. 2003
------------------------------------- ------------------------------------
Increase (Decrease) Due to Total Increase (Decrease) Due to Total
-------------------------- Increase -------------------------- Increase
Volume Rate (Decrease) Volume Rate (Decrease)
------------------------------------- ------------------------------------
(In thousands)
Interest-earning assets:
Loans $ 4,560 $(1,949) $ 2,611 $ 584 $(3,671) $(3,087)
Mortgage-backed securities 556 (407) 149 4,959 (2,726) 2,233
Other securities 181 130 311 1,162 (797) 365
Federal funds and other overnight deposits (13) 113 100 (134) (152) (286)
Other 10 (20) (10) 45 (109) (64)
------- ------- ------- ------- ------- -------
Total interest-earning assets 5,294 (2,133) 3,161 6,616 (7,455) (839)
------- ------- ------- ------- ------- -------
Interest-bearing liabilities:
Savings and club accounts 38 (111) (73) 163 (492) (329)
Money market accounts 3 (6) (3) 74 (152) (78)
NOW accounts 18 (36) (18) 38 (138) (100)
Certificates of deposit 2,456 602 3,058 1,690 (2,187) (497)
Borrowings (77) 71 (6) 183 (318) (135)
Subscription funds from stock offering -- -- -- (31) -- (31)
Mortgage escrow funds 5 (33) (28) (10) (12) (22)
------- ------- ------- ------- ------- -------
Total interest-bearing liabilities 2,443 487 2,930 2,107 (3,299) (1,192)
------- ------- ------- ------- ------- -------
Net interest income $ 2,851 $(2,620) $ 231 $ 4,509 $(4,156) $ 353
======= ======= ======= ======= ======= =======
9
Comparison of Results of Operations for the Years Ended March 31, 2005 and 2004
Net Income. Net income amounted to $5.5 million or diluted earnings per
share of $0.46 for the year ended March 31, 2005, as compared to $6.6 million or
diluted earnings per share of $0.52 for the year ended March 31, 2004, a
decrease of 17.4% in net income. The decrease in net income for the year ended
March 31, 2005 is primarily attributable to a $2.5 million increase in
non-interest expense, partially offset by a $231,000 increase in net interest
income, a $406,000 increase in non-interest income and a $701,000 decrease in
income tax expense.
Interest Income. Interest income increased $3.2 million to $41.9 million
for the year ended March 31, 2005, as compared to $38.7 million for fiscal 2004.
The increase reflects a $99.7 million increase in average interest-earning
assets to $907.7 million during the year ended March 31, 2005 as compared to
$808.0 million for the prior year, partially offset by a 17 basis point decrease
in the average yield on interest-earning assets to 4.62%. The increase in the
average balance of interest-earning assets was due primarily to a $79.1 million
increase in net loans to $521.6 million, a $15.9 million increase in
mortgage-backed securities to $259.9 million and a $5.9 million increase in the
average balance of other securities to $91.7 million. The increase in average
interest-earning assets was funded principally by deposit growth in the Bank's
branches. The decrease in the average yield on interest-earning assets reflects
the origination of loans at lower rates than the existing portfolio, the
purchase of securities at lower rates than the existing portfolio and the
downward repricing of adjustable-rate securities as a result of market interest
rates.
Loans. Interest income on loans increased $2.6 million or 9.7% to $29.4
million for the year ended March 31, 2005 as compared to $26.8 million for the
prior year. This increase is due to a $79.1 million increase in the average
balance of loans to $521.6 million, partially offset by a 42 basis point
decrease in the yield earned to 5.64%. Loans originated during the year ended
March 31, 2005 amounted to $207.9 million. The decrease in the yield earned is
primarily a result of loan originations during the first half of fiscal 2005 and
during fiscal 2004 that were at rates lower than the average yield being earned
on the loan portfolio during those periods. Loans originated in the fourth
quarter of fiscal 2005 have generally been at rates higher than the yield being
earned on the loan portfolio. However, as market interest rates increase, the
volume of loans originated may decrease which would result in slower growth or a
decrease in the loan portfolio.
Mortgage-Backed and Other Securities. Interest on mortgage-backed
securities totaled $9.1 million for fiscal 2005, an increase of $149,000 from
fiscal 2004. This increase is due to a $15.9 million increase in the average
balance of mortgage-backed securities to $259.9 million, partially offset by a
16 basis decrease in the average yield to 3.49% for fiscal 2005.
Interest on other securities increased $311,000 to $2.9 million for fiscal
2005, as compared to $2.6 million for fiscal 2004. The increase is due to a $5.9
million increase in the average balance of other securities to $91.7 million and
a 15 basis point increase in the average yield to 3.21%.
Federal Funds Sold and Other Overnight Deposits. Interest on Federal funds
sold and other overnight deposits increased $100,000 to $340,000 during fiscal
2005, reflecting a 39 basis point increase in the average yield to 1.18%
partially offset by a $1.6 million decrease in the average balance to $28.7
million.
Other Earning Assets. Other earning assets at March 31, 2005 consist
primarily of an investment of $5.7 million in FHLB of New York common stock.
Dividends on FHLB of New York common stock amounted to $126,000 for fiscal 2005
as compared to $142,000 for fiscal 2004.
Interest Expense. Interest expense for the year ended March 31, 2005
increased $3.0 million to $15.5 million, as compared to $12.5 million for the
year ended March 31, 2004. The average balance of interest-bearing liabilities
increased $110.3 million to $802.4 million for fiscal 2005 from $692.1 million
for fiscal 2004, and the average cost of these liabilities increased 12 basis
points to 1.93%. The increase in the average balance of interest-bearing
liabilities includes deposit growth in three new branches that opened in fiscal
2005, a new branch that opened in the second quarter of fiscal 2004, and growth
in the existing branches. The increase in the average cost of liabilities is a
result of the rising short-term market interest rates in fiscal 2005 and an
increase in certificates of deposit accounts as a percentage of total
interest-bearing liabilities. The average balance of certificates of deposit
represented 62.8% of the
10
average balance of total interest-bearing liabilities for fiscal 2005, as
compared to 58.6% for fiscal 2004. Certificates of deposit are generally offered
at higher rates than savings accounts and we have used these accounts to attract
customers to the new branches.
Interest expense on certificates of deposit amounted to $12.7 million for
fiscal 2005 as compared to $9.6 million for fiscal 2004. The increase is due
primarily to a $97.9 million increase in the average balance to $503.7 million
from $405.8 million for fiscal 2004, while the average cost of certificates of
deposit increased 14 basis points to 2.51%.
Interest on savings accounts amounted to $783,000 for the current year as
compared to $856,000 for fiscal 2004. This decrease is the result of a 7 basis
point decrease in the average cost of savings accounts to 0.52%, partially
offset by a $7.2 million increase in the average balance of savings accounts to
$151.1 million for fiscal 2005, as compared to $143.9 million for fiscal 2004.
Interest expense on NOW and money market accounts amounted to $526,000 for
fiscal 2005 as compared to $547,000 for fiscal 2004. The average cost decreased
5 basis points to 0.50% and the average balance of these accounts increased $6.8
million to $106.1 million.
For fiscal 2005, interest expense on borrowings amounted to $1.5 million,
unchanged from fiscal 2004. The average balance of borrowings decreased to $37.3
million for fiscal 2005 as compared to $39.2 million for the prior year. The
average cost of borrowings increased 19 basis points to 4.00%, as compared to
3.81% for fiscal 2004.
Net Interest Income. Net interest income amounted to $26.4 million for
fiscal 2005 as compared to $26.2 million for fiscal 2004. The net interest rate
spread was 2.69% and 2.98% and the net interest margin was 2.91% and 3.24% for
the respective fiscal years. The decreases in net interest rate spread and net
interest margin are primarily the result of the effect of mortgage refinancings
and lower returns on our investment portfolio as interest rates remained near
40-year lows. During fiscal 2005, the Federal Reserve raised the Federal funds
rate by 175 basis points to 2.75%. However, long term rates remained
substantially unchanged, resulting in a flattening yield curve. As short-term
interest rates increased, the cost of our interest-bearing liabilities increased
faster than the yield on interest-earning assets which are primarily affected by
longer-term interest rates. The decrease in net interest rate spread and net
interest margin was also a result of the decrease in the ratio of
interest-earning assets to interest-bearing liabilities to 1.13x for fiscal 2005
from 1.17x for fiscal 2004, reflecting treasury stock purchases and an
investment in bank-owned life insurance ("BOLI").
In December 2003, the Company purchased a BOLI product for $10.0 million.
The BOLI purchase was funded from interest-earning assets; however, the BOLI
asset is classified separately from interest-earning assets on the consolidated
balance sheet, resulting in a decrease in the ratio of average interest-earning
assets to average interest-bearing liabilities. The changes in the cash
surrender value of the BOLI are recognized as non-interest income.
Provision for Loan Losses. Management regularly reviews the loan portfolio
and makes provisions for loan losses in amounts required to maintain the
allowance for loan losses in accordance with generally accepted accounting
principles. The allowance consists of losses that are both probable and
estimable at the date of the financial statements. The allowance for loan losses
consists of amounts allocated to specific nonperforming loans and to loans in
each major portfolio category. Loan categories such as one-to-four family
residential mortgage and home equity loans, which represented 86.1% of total
loans at March 31, 2005, are generally evaluated on an aggregate or "pool"
basis. Our allowance for loan losses is predominately determined on a pool basis
by applying loss factors to the current balances of the various loan categories.
The loss factors are determined by management based on an evaluation of our
historical loss experience, delinquency trends, volume and type of lending
conducted, and the impact of current economic conditions in our market area.
The provision for loan losses was $300,000 for fiscal 2005 as compared to
$275,000 for fiscal 2004. Non-performing loans amounted to $580,000 or 0.10% of
total loans at March 31, 2005, as compared to $2.0 million or 0.41% of total
loans at March 31, 2004. The allowance for loan losses amounted to $3.0 million
and $2.7 million at March 31, 2005 and 2004, respectively. Charge-offs amounted
to $1,000 and $5,000 for fiscal years 2005 and 2004, respectively. There were no
recoveries for these periods. The increase in the allowance for
11
loan losses is primarily due to an increase in the origination of
adjustable-rate mortgage loans, commercial mortgage loans and commercial loans
(not secured by real estate) as well as overall portfolio growth.
Adjustable-rate mortgage loans can involve greater credit risk than fixed-rate
loans because as interest rates increase, the underlying payments by the
borrower increase, thus increasing the risk of default by the borrower. At the
same time, the marketability of the underlying collateral may be adversely
affected by higher interest rates. At March 31, 2005, adjustable rate loans
accounted for 37.8% of total loans as compared to 27.1% at March 31, 2004.
Non-Interest Income. Non-interest income consists principally of service
charges on deposit accounts, fees earned on the sale of investment products,
late charges on loans, various other service fees and changes in the cash
surrender value of the BOLI. Service charges and fees totaled $953,000 and
$955,000 for fiscal years 2005 and 2004, respectively. The increase in the cash
surrender value of the BOLI amounted to $379,000 and $86,000 for those same
respective periods. During fiscal 2005, the Company sold a parcel of land that
is contiguous to a branch location. Management determined that this parcel was
not going to be used in connection with the operation of the branch. The Company
recognized a $93,000 gain on the sale of the land.
Non-Interest Expense. Non-interest expense totaled $18.6 million for
fiscal 2005 as compared to $16.1 million for fiscal 2004. This increase is due
to increases of $1.2 million in compensation and benefits, $426,000 in occupancy
and equipment expense, $193,000 in data processing service fees, $99,000 in
advertising and promotion expense and $532,000 in other non-interest expense.
The increases in non-interest expenses include costs attributable to the new
branches which opened during fiscal 2005.
The increase in compensation and benefits expense is due primarily to a
$787,000 increase in expense related to stock awards made pursuant to the
Company's 2004 Stock Incentive Plan and a $586,000 increase in compensation
costs due primarily to additional staff to support the growth in the Company's
lending operations and the new branches, which opened during fiscal 2005. At
March 31, 2005, we had 138 full-time equivalent employees as compared to 119 at
March 31, 2004.
The adoption of Statement of Financial Accounting Standards ("SFAS") No.
123 (revised 2004), Share-Based Payment ("SFAS No. 123R"), will result in the
recognition, for the first time, of compensation costs for stock options
beginning in the first quarter of fiscal 2007. See Note 2 of the Notes to
Consolidated Financial Statements for a discussion of SFAS No. 123R.
Other non-interest expense for the year ended March 31, 2005 included
$367,000 of costs related to the Company's implementation of the internal
controls and procedures provisions of the Sarbanes-Oxley Act of 2002. There were
no comparable costs in fiscal 2004.
Income Taxes. For the years ended March 31, 2005 and 2004, income tax
expense amounted to $3.5 million and $4.2 million, respectively. The effective
tax rates for those same periods were 39.2% and 39.0%, respectively. The 16.6%
decrease in fiscal 2005 income tax expense primarily reflects the 17.0% decrease
in pre-tax income.
12
Comparison of Results of Operations for the Years Ended March 31, 2004 and 2003
Net Income. Net income amounted to $6.6 million or diluted earnings per
share of $0.52 for the year ended March 31, 2004, as compared to $8.5 million or
diluted earnings per share of $0.65 for the prior year. The decrease in net
income for the year ended March 31, 2004 was due to an increase of $3.4 million
in non-interest expense, partially offset by increases of $353,000 in net
interest income and $151,000 in non-interest income and a decrease of $985,000
in income tax expense.
Interest Income. Interest income totaled $38.7 million for the year ended
March 31, 2004, as compared to $39.6 million for the prior year. The decrease in
interest income reflects a 123 basis point decrease in the average yield on
interest-earning assets to 4.79% from 6.02%, partially offset by an increase of
$151.1 million in average interest-earning assets to $808.0 million as compared
to $656.9 million for the prior year. The increase in the average balance of
interest-earning assets was due primarily to increases of $154.6 million in
securities available for sale and $8.7 million in net loans, partially offset by
a $13.2 million decrease in federal funds sold and other overnight deposits. The
decrease in the average yield on interest-earning assets reflects the
origination of loans at lower rates than the existing portfolio, the purchase of
securities at lower rates than the existing portfolio and the downward repricing
of adjustable-rate securities during recent periods of declining interest rates.
Loans. For the year ended March 31, 2004, interest income on loans
amounted to $26.8 million as compared to $29.9 million for the prior year. This
decrease was due to an 83 basis point decrease in the yield earned to 6.06% from
6.89%, partially offset by an $8.7 million increase in the average balance to
$442.5 million from $433.8 million. We originated $186.7 million of new loans
during fiscal 2004. In addition, $151.3 million of existing mortgage loans were
refinanced with us. These loans were originated at rates lower than the average
yield being earned on the existing loan portfolio. As a result, the decline in
average yield earned on the loan portfolio continued during fiscal 2004.
Mortgage-Backed and Other Securities. Interest on mortgage-backed
securities increased $2.2 million to $8.9 million for fiscal 2004 as compared to
$6.7 million for the prior year. The increase was due to an increase of $120.9
million in the average balance to $244.0 million, partially offset by a decrease
of 178 basis points in the average yield to 3.65% from 5.43%. The increase in
the average balance of mortgage-backed securities reflects the investment of the
net proceeds from the Company's January 2003 stock offering, as well as the
investment of funds from deposit growth. The decrease in the average yield is a
result of the downward repricing of adjustable-rate mortgage-backed securities
and the accelerated amortization of purchase premiums as a result of prepayments
on mortgage-backed securities. In addition, fiscal 2004 purchases of
mortgage-backed securities were at lower rates than the existing portfolio.
Interest on other securities increased $365,000 to $2.6 million for fiscal
2004 as compared to $2.3 million for 2003. The increase was due to an increase
of $33.6 million in the average balance to $85.9 million for the year ended
March 31, 2004, partially offset by a decrease of 127 basis points in the
average yield to 3.06% from 4.33%.
Federal Funds Sold and Other Overnight Deposits. For the year ended March
31, 2004, interest on federal funds and other overnight deposits decreased
$286,000 to $240,000, reflecting a 42 basis point decrease in the average yield
to 0.79% and a decrease of $13.2 million in the average balance to $30.3
million. The decrease in the average yield is the result of the continued low
market interest rates.
Other Earning Assets. Other earning assets consist primarily of FHLB of
New York common stock. The FHLB of New York suspended the October 2003 dividend
on this stock and declared a dividend in January 2004
13
that was less than the amounts previously paid. Dividends on FHLB of New York
common stock amounted to $141,000 in fiscal 2004 as compared to $195,000 in
fiscal 2003.
Interest Expense. For the year ended March 31, 2004, interest expense on
interest-bearing liabilities decreased $1.2 million to $12.5 million, as
compared to $13.7 million for the year ended March 31, 2003. The decrease in
interest expense was due to a 50 basis point decrease in the average cost of
these liabilities to 1.81% from 2.31%, partially offset by an increase of $96.6
million in the average balance of interest-bearing liabilities to $692.1
million. The increase in the average balance of interest-bearing liabilities
includes deposit growth in the Somers branch, which opened in July 2002, and in
the Stamford branch, which opened in September 2003, as well as growth in the
existing branches. The decrease in the average cost of liabilities is the result
of declining market interest rates during recent periods.
Interest expense on certificates of deposit amounted to $9.6 million for
fiscal 2004 as compared to $10.1 million for fiscal 2003. The decrease was due
to a 58 basis point decrease in the average cost to 2.37%, partially offset by a
$63.8 million increase in the average balance of certificates of deposit to
$405.8 million as compared to $342.0 million for the prior year. The increase in
the average balance includes growth at the Bank's new branch offices as well as
at our existing branches.
Interest on savings accounts decreased $329,000 to $856,000 in fiscal 2004
as compared to $1.2 million in fiscal 2003. The average cost of savings accounts
decreased 36 basis points to 0.59%, partially offset by an increase of $19.0
million in the average balance of savings accounts to $143.9 million.
Interest expense on money market and NOW accounts amounted to $547,000 for
fiscal 2004 as compared to $725,000 for the prior year. The average cost of
these accounts decreased 40 basis points to 0.73%, partially offset by an
increase of $14.4 million in the average balance of these accounts to $99.3
million.
Interest expense on borrowings was $1.5 million for fiscal 2004 as
compared to $1.6 million for fiscal 2003. The decrease in interest expense was
due to an 85 basis points decrease in the average cost of borrowings to 3.81%,
partially offset by a $4.2 million increase in the average balance of borrowings
to $39.2 million.
Net Interest Income. For the year ended March 31, 2004, net interest
income amounted to $26.2 million as compared to $25.8 million for the prior
year. The interest rate spread was 2.98% and 3.71% and the net interest margin
was 3.24% and 3.93% for the respective fiscal years. The decreases in interest
rate spread and net interest margin are primarily the result of the effect of
mortgage refinancings and lower returns on our investment portfolio as interest
rates remained at 40 year lows. The adverse effect on net interest income of the
decreases in interest rate spread and net interest margin was substantially
offset by earning asset growth and an increase in the ratio of interest-earning
assets to interest-bearing liabilities to 1.17 for the year ended March 31, 2004
from 1.10 for fiscal 2003. The higher ratio in fiscal 2004 was due primarily to
the investment of net proceeds from the Company's stock offering.
Provision for Loan Losses. The provision for loan losses was $275,000 for
fiscal years 2004 and 2003. Non-performing loans amounted to $2.0 million or
0.41% of total loans at March 31, 2004, as compared to $477,000 or 0.11% of
total loans at March 31, 2003. The increase in non-performing loans is primarily
the result of the delinquency of one borrower's mortgage and home equity loans
which totaled $805,000 at March 31, 2004. The loans are secured by a single
family home with a loan-to-value ratio of less than 60%. The allowance for loan
losses amounted to $2.7 million or 0.57% of total loans at March 31, 2004 and
$2.4 million or 0.57% of total loans at March 31, 2003. Charge-offs amounted to
$5,000 and $54,000 for the years ended March 31, 2004 and 2003, respectively.
The increase in the allowance for loan losses is primarily due to an increase in
the origination of adjustable rate mortgage loans, commercial mortgage loans and
commercial loans (not secured by real estate) as well as overall portfolio
growth. Adjustable-rate mortgage loans can involve greater credit risk than
fixed-rate loans because as interest rates increase, the underlying payments by
the borrower increase, thus increasing the risk of default by the borrower. At
the same time, the marketability of the underlying collateral may be adversely
affected by higher interest rates. At March 31, 2004, adjustable rate loans
accounted for 27.1% of total loans as compared to 19.7% at March 31, 2003.
14
Non-Interest Income. Non-interest income totaled $1.0 million for fiscal
2004 as compared to $890,000 for fiscal 2003. The increase in non-interest
income was primarily due to higher levels of income from service charges on
deposit accounts, late charges on loans and various other service fees.
Non-Interest Expense. For the year ended March 31, 2004, non-interest
expense increased $3.4 million to $16.1 million as compared to $12.7 million for
the prior year. This increase was due primarily to increases of $2.2 million in
compensation and benefits, $545,000 in occupancy and equipment expense and
$457,000 in other non-interest expense.
The increase in compensation and benefits is primarily due to an $800,000
increase in compensation expense and a $698,000 increase in expense related to
the Employee Stock Ownership Plan ("ESOP"). The increase in compensation expense
is due primarily to normal salary increases and increases in staff to support
the growth in the Company's lending and branch operations. The Company had 119
full-time equivalent employees at March 31, 2004 as compared to 110 full-time
equivalent employees at March 31, 2003. The increase in ESOP expense reflects
the increase in shares committed to be released for allocation as a result of
the second-step conversion and the increase in the market value of those shares.
Compensation expense is recognized for the ESOP equal to the fair value of
shares committed to be released for allocation to participant accounts. The
difference between the fair value at that time and the ESOP's original
acquisition cost is charged or credited to stockholders' equity. For fiscal
2004, the difference credited to stockholders' equity amounted to $727,000 as
compared to $261,000 for 2003.
The increase in occupancy and equipment expense is primarily due to new
branch locations and the Company's new corporate office which opened in April
2003.
Income Taxes. For the years ended March 31, 2004 and 2003, income tax
expense amounted to $4.2 million and $5.2 million, respectively. The effective
tax rates for those same periods were 39.0% and 38.0%, respectively. The 18.9%
decrease in fiscal 2004 income tax expense primarily reflects the 21.0% decrease
in pre-tax income.
Liquidity and Capital Resources
Our liquidity management objective is to ensure the availability of
sufficient cash flows to meet all financial commitments and to capitalize on
opportunities for expansion. Liquidity management addresses our ability to meet
deposit withdrawals on demand or at contractual maturity, to repay borrowings as
they mature, and to fund new loans and investments as opportunities arise.
Our primary investing activities are the origination of mortgage loans,
and the purchase of short-term investments, government agency bonds and
adjustable rate mortgage-backed securities. These activities are funded
primarily by deposit growth and principal repayments on loans, mortgage-backed
securities and other investment securities. During fiscal 2005, the Company
originated loans of $207.9 million and purchased securities of $113.3 million.
These were funded by $87.2 million in principal payments, maturities and calls
of securities, $124.8 million in loan principal repayments and an increase in
deposits of $123.4 million.
At March 31, 2005, we had $113.6 million of outstanding loan origination
commitments and unused lines of credit extended to customers. If we require
funds beyond our internal funding capabilities, borrowings other than securities
repurchase agreements, of up to $88.6 million are available from the Federal
Home Loan Bank of New York. At March 31, 2005, approximately $260.7 million in
certificates of deposit were scheduled to mature within one year. The Bank
anticipates that most of these certificates of deposit maturing within one year
will remain with the Bank. However, should market interest rates continue to
increase, the Bank's cost of funds may significantly increase or we may
experience a significant loss of deposits.
The following table summarizes the contractual obligations of the Company
by contractual payment period as of March 31, 2005. Further information
concerning borrowings, loan commitments and lease commitments is included in
Notes 8 and 11 to the Consolidated Financial Statements.
15
Payments Due In
-------------------------------------------------------------
Less Than 1-3 3 - 5 More Than
Total 1 Year Years Years 5 Years
-------------------------------------------------------------------------------
(In thousands)
Borrowings $ 38,000 $ 10,000 $23,000 $5,000 $ --
Loan commitments 113,597 113,597 -- -- --
Lease commitments 7,197 1,019 2,082 1,562 2,534
Securities purchases 2,513 2,513 -- -- --
------------------------------------------------------------------------------
Total $161,307 $127,129 $25,082 $6,562 $2,534
==============================================================================
Office of Thrift Supervision regulations require savings associations,
such as Sound Federal Savings, to meet three minimum capital standards: a
tangible capital ratio requirement of 1.5% of total assets as adjusted under the
Office of Thrift Supervision regulations; a leverage ratio requirement of 4.0%
of core capital to such adjusted total assets; and a risk-based capital ratio
requirement of 8.0% of core and supplementary capital to total risk-based
assets. We satisfied these minimum capital standards at March 31, 2005 with
tangible and leverage capital ratios of 10.3% and a total risk-based capital
ratio of 23.6%, and we were classified as a well-capitalized institution for
regulatory purposes. In determining the amount of risk-weighted assets for
purposes of the risk-based capital requirement, a savings association multiplies
its assets and credit equivalent amounts for certain off-balance sheet items by
risk-weights, which range from 0% for cash and obligations issued by the U.S.
Government or its agencies to 100% for assets such as consumer and commercial
loans, as assigned by the Office of Thrift Supervision capital regulations.
These capital requirements, which are applicable to Sound Federal Savings only,
do not consider additional capital retained by Sound Federal Bancorp, Inc.
Impact of Inflation and Changing Prices
The Consolidated Financial Statements and related Notes have been prepared
in conformity with U.S. generally accepted accounting principles, which require
the measurement of financial position and operating results without considering
the change in the relative purchasing power of money over time due to inflation.
The impact of inflation is reflected in the increased cost of our operations.
Unlike industrial companies, nearly all of our assets and liabilities are
financial in nature. As a result, our net income is directly impacted by changes
in interest rates, which are influenced by inflationary expectations. Our
ability to match the interest sensitivity of our financial assets to the
interest sensitivity of our financial liabilities as part of our interest rate
risk management program may reduce the effect that changes in interest rates
have on our net income. Changes in interest rates do not necessarily move to the
same extent as changes in prices of goods and services. In the current interest
rate environment, liquidity and the maturity structure of our assets and
liabilities are critical to the maintenance of acceptable levels of net income.
Management believes that by maintaining a significant portion of our assets in
short-term investments, adjustable rate mortgage-backed securities and
adjustable rate loans, we are in a better position to manage our interest rate
risk in a rising rate environment.
Accounting Standards
See Note 2 of the Notes to Consolidated Financial Statements for a
discussion of SFAS No. 123R, which will result in a change in the Company's
accounting for stock options beginning April 1, 2006.
On September 30, 2004, the Financial Accounting Standards Board ("FASB")
issued Staff Position No. EITF Issue 03-1-1, "Effective Date of Paragraphs 10-20
of EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments," which delays the effective date for the
impairment measurement and recognition guidance contained in Emerging Issues
Task Force ("EITF") Issue No. 03-1. EITF Issue No. 03-1 provides guidance for
evaluating whether an investment is other-than-temporarily impaired and was
originally to be effective for impairment evaluations made in reporting periods
beginning after June 15, 2004 (July 1, 2004 for the Company). The delay in the
effective date for the measurement and recognition guidance contained in EITF
Issue No. 03-1 does not suspend the requirement to recognize
other-than-temporary impairments as required by existing authoritative
literature. The disclosure guidance in paragraphs 21 and 22 of EITF Issue 03-1
remains effective. The FASB also issued a proposal, Staff
16
Position No. EITF Issue 03-1-a, to provide implementation guidance on matters
such as impairment evaluations for declines in value caused by increases in
interest rates and/or sector spreads. Subsequently, the FASB announced that it
would begin a full reconsideration of authoritative literature relating to
other-than-temporary impairment of securities. The impact of this
reconsideration on the Company's financial condition and results of operations
cannot be predicted at the present time.
17
Management Report on Internal Control Over Financial Reporting
Management of the Company is responsible for establishing and maintaining
effective internal control over financial reporting. The Company's system of
internal controls is designed to provide reasonable assurance to the Company's
management and board of directors regarding the preparation and fair
presentation of published financial statements.
All internal control systems have inherent limitations. Therefore, even
those systems determined to be effective can provide only reasonable assurance
with respect to financial statement preparation and presentation. Also,
projections of any evaluation of effectiveness to future periods are subject to
the risk that controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may
deteriorate.
Management assessed the Company's internal control over financial
reporting as of March 31, 2005. This assessment was based on criteria for
effective internal control over financial reporting established in Internal
Control- Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on this assessment, we have
concluded that, as of March 31, 2005, the Company's disclosure controls and
procedures and internal control over financial reporting are effective.
The Company's independent registered public accounting firm has issued an
audit report on our assessment of, and the effective operation of, the Company's
internal control over financial reporting. This report appears on page 19.
18
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Sound Federal Bancorp, Inc.:
We have audited management's assessment, included in the accompanying Management
Report on Internal Control Over Financial Reporting, that Sound Federal Bancorp,
Inc. and subsidiary (the "Company") maintained effective internal control over
financial reporting as of March 31, 2005, based on criteria established in
Internal Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission ("COSO"). The Company's management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting. Our responsibility is to express an opinion on management's
assessment and an opinion on the effectiveness of the Company's internal control
over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that the Company maintained effective
internal control over financial reporting as of March 31, 2005, is fairly
stated, in all material respects, based on criteria established in Internal
Control--Integrated Framework issued by COSO. Also, in our opinion, the Company
maintained, in all material respects, effective internal control over financial
reporting as of March 31, 2005, based on criteria established in Internal
Control--Integrated Framework issued by COSO.
19
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of
Sound Federal Bancorp, Inc. and subsidiary as of March 31, 2005 and 2004, and
the related consolidated statements of income, changes in stockholders' equity,
and cash flows for each of the years in the three-year period ended March 31,
2005, and our report dated June 10, 2005 expressed an unqualified opinion on
those consolidated financial statements.
/s/ KPMG LLP
Stamford, Connecticut
June 10, 2005
20
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Sound Federal Bancorp, Inc.:
We have audited the accompanying consolidated balance sheets of Sound Federal
Bancorp, Inc. and subsidiary (the "Company") as of March 31, 2005 and 2004, and
the related consolidated statements of income, changes in stockholders' equity,
and cash flows for each of the years in the three-year period ended March 31,
2005. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Sound Federal
Bancorp, Inc. and subsidiary as of March 31, 2005 and 2004, and the results of
their operations and their cash flows for each of the years in the three-year
period ended March 31, 2005, in conformity with U.S. generally accepted
accounting principles.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the Company's
internal control over financial reporting as of March 31, 2005 based on criteria
established in Internal Control-Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission, and our report dated June
10, 2005 expressed an unqualified opinion on management's assessment of, and the
effective operation of, internal control over financial reporting.
/s/ KPMG LLP
Stamford, Connecticut
June 10, 2005
21
SOUND FEDERAL BANCORP, INC. AND SUBSIDIARY
Consolidated Balance Sheets
(In thousands, except share and per share data) March 31, March 31,
2005 2004
----------- ---------
Assets
Cash and due from banks $ 11,512 $ 10,455
Federal funds sold and other overnight deposits 31,095 20,756
----------- ---------
Total cash and cash equivalents 42,607 31,211
----------- ---------
Securities:
Available for sale, at fair value (including
$37,831 and $38,000 pledged as collateral
for borrowings under repurchase agreements
at March 31, 2005 and 2004, respectively)
(Notes 3 and 8) 276,154 337,730
Held to maturity, at amortized cost (fair value
of $78,728) (Note 4) 79,489 --
----------- ---------
Total securities 355,643 337,730
----------- ---------
Loans, net (Note 5):
Mortgage loans 558,662 477,771
Consumer and commercial loans 5,100 3,396
Allowance for loan losses (3,011) (2,712)
----------- ---------
Total loans, net 560,751 478,455
----------- ---------
Accrued interest receivable 4,277 3,623
Federal Home Loan Bank stock 5,738 5,303
Premises and equipment, net (Note 6) 6,214 5,630
Goodwill 13,970 13,970
Bank-owned life insurance 10,464 10,085
Prepaid pension costs (Note 10) 3,057 2,547
Deferred income taxes (Note 9) 2,236 --
Other assets 1,993 1,987
----------- ---------
Total assets $ 1,006,950 $ 890,541
=========== =========
Liabilities and Stockholder' Equity
Liabilities:
Deposits (Note 7) $ 831,768 $ 708,330
Borrowings (Note 8) 38,000 35,000
Mortgagors' escrow funds 5,264 4,522
Due to brokers for securities purchased 2,513 4,000
Accrued expenses and other liabilities (Note 10) 2,245 1,630
----------- ---------
Total liabilities 879,790 753,482
----------- ---------
Commitments and contingencies (Note 11)
Stockholders' equity:
Preferred stock ($0.01 par value; 1,000,000
shares authorized; none issued and
outstanding) -- --
Common stock ($0.01 par value; 24,000,000
shares authorized; 13,636,170 shares issued) 136 136
Additional paid-in capital 103,728 102,637
Treasury stock, at cost (1,258,964 and
459,297 shares at March 31, 2005 and
March 31, 2004, respectively) (18,131) (7,150)
Common stock held by Employee Stock
Ownership Plan ("ESOP") (Note 10) (6,053) (6,556)
Unearned stock awards (Note 10) (4,435) (5,618)
Retained earnings 54,638 52,908
Accumulated other comprehensive (loss)
income, net of taxes (Note 13) (2,723) 702
----------- ---------
Total stockholders' equity 127,160 137,059
----------- ---------
Total liabilities and stockholders' equity $ 1,006,950 $ 890,541
=========== =========
See accompanying notes to consolidated financial statements.
22
SOUND FEDERAL BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Income
Years Ended March 31,
---------------------------------
(In thousands, except per share data) 2005 2004 2003
------- ------- -------
Interest and Dividend Income
Loans $29,430 $26,819 $29,906
Mortgage-backed and other securities 11,998 11,538 8,940
Federal funds sold and other overnight deposits 340 240 526
Other earning assets 132 142 206
------- ------- -------
Total interest and dividend income 41,900 38,739 39,578
------- ------- -------
Interest Expense
Deposits (Note 7) 13,968 11,004 12,008
Borrowings 1,489 1,495 1,630
Other interest-bearing liabilities 20 48 101
------- ------- -------
Total interest expense 15,477 12,547 13,739
------- ------- -------
Net interest income 26,423 26,192 25,839
Provision for loan losses (Note 5) 300 275 275
------- ------- -------
Net interest income after provision for loan losses 26,123 25,917 25,564
------- ------- -------
Non-Interest Income
Service charges and fees 953 955 831
Income on bank-owned life insurance 379 86 --
Gain on sale of land 93 -- --
Gain on sales of mortgage loans 22 -- --
Other non-interest income -- -- 59
------- ------- -------
Total non-interest income 1,447 1,041 890
------- ------- -------
Non-Interest Expense
Compensation and benefits (Note 10) 9,945 8,733 6,540
Occupancy and equipment 2,717 2,291 1,746
Data processing service fees 1,218 1,025 959
Advertising and promotion 1,119 1,020 884
Other 3,569 3,037 2,580
------- ------- -------
Total non-interest expense 18,568 16,106 12,709
------- ------- -------
Income before income tax expense 9,002 10,852 13,745
Income tax expense (Note 9) 3,533 4,234 5,219
------- ------- -------
Net income $ 5,469 $ 6,618 $ 8,526
======= ======= =======
Earnings per share (Note 14):
Basic $ 0.47 $ 0.54 $ 0.67
Diluted 0.46 0.52 0.65
======= ======= =======
See accompanying notes to consolidated financial statements.
23
SOUND FEDERAL BANCORP INC. AND SUBSIDIARY
Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended March 31, 2005, 2004 and 2003
(In thousands, except share and per share data)
Accumulated
Common Other Total
Additional Stock Unearned Comprehensive Stock-
Common Paid-in Treasury Held by Stock Retained (Loss) holders'
Stock Capital Stock ESOP Awards Earnings Income Equity
------- ---------- -------- ------- -------- -------- ------------- -------
Balance at March 31, 2002 $ 522 $ 22,525 $(4,350) $(1,105) $ (244) $ 42,566 $ 1,101 $ 61,015
Net income -- -- -- -- -- 8,526 -- 8,526
Other comprehensive loss (Note 13) -- -- -- -- -- -- (1,085) (1,085)
---------
Total comprehensive income 7,441
Dividends paid ($0.14 per share) -- -- -- -- -- (1,155) -- (1,155)
Issuance of common stock for exercise
of stock options -- 188 -- -- -- -- -- 188
Reorganization and related stock
offering (Note 1):
Merger of Sound Federal, MHC (281) 647 -- -- -- -- -- 366
Treasury stock retired (44) (4,306) 4,350 -- -- -- -- --
Exchange of common stock (1,967,782
shares exchanged for 5,444,263
shares) (143) 141 -- -- -- -- -- (2)
Proceeds from stock offering, net
of related costs
(7,780,737 shares issued) 78 75,832 -- -- -- -- -- 75,910
Common stock acquired by ESOP
(622,458 shares) -- -- -- (6,225) -- -- -- (6,225)
Vesting of stock awards and related
tax benefits -- 107 -- -- 144 -- -- 251
ESOP shares committed to be released
for allocation -- 261 -- 271 -- -- -- 532
------- --------- ------- ------- ------- -------- ------- ---------
Balance at March 31, 2003 132 95,395 -- (7,059) (100) 49,937 16 138,321
Net income -- -- -- -- -- 6,618 -- 6,618
Other comprehensive income (Note 13) -- -- -- -- -- -- 686 686
---------
Total comprehensive income 7,304
Dividends paid ($0.22 per share) -- -- -- -- -- (2,648) -- (2,648)
Common stock issued for grants of
stock awards 4 5,909 -- -- (5,913) -- -- --
Purchases of treasury stock
(540,482 shares) -- -- (8,417) -- -- -- -- (8,417)
Reissuance of treasury stock for
exercise of stock options
(81,185 shares) -- -- 1,267 -- -- (999) -- 268
Tax benefit from exercise of
stock options -- 373 -- -- -- -- -- 373
Vesting of stock awards and
related tax benefits -- 153 -- -- 395 -- -- 548
ESOP shares committed to be
released for allocation -- 727 -- 503 -- -- -- 1,230
Tax benefit for dividends on
unallocated ESOP shares -- 80 -- -- -- -- -- 80
------- --------- ------- ------- ------- -------- ------- ---------
Balance at March 31, 2004 136 102,637 (7,150) (6,556) (5,618) 52,908 702 137,059
24
SOUND FEDERAL BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended March 31, 2005, 2004 and 2003
(In thousands, except share and per share data)
Accumulated
Common Other Total
Additional Stock Unearned Comprehensive Stock-
Common Paid-in Treasury Held by Stock Retained (Loss) holders'
Stock Capital Stock ESOP Awards Earnings Income Equity
------- ---------- -------- ------- -------- -------- ------------- -------
Balance at March 31, 2004 $ 136 $ 102,637 $ (7,150) $(6,556) $(5,618) $ 52,908 $ 702 $ 137,059
Net income -- -- -- -- -- 5,469 -- 5,469
Other comprehensive loss
(Note 13) -- -- -- -- -- -- (3,425) (3,425)
---------
Total comprehensive income -- -- -- -- -- -- -- 2,044
Dividends paid ($0.24 per share) -- -- -- -- -- (2,891) -- (2,891)
Purchases of treasury stock
(877,332 shares) -- -- (12,087) -- -- -- -- (12,087)
Reissuance of treasury stock
for exercise of stock
options (77,665 shares) -- -- 1,106 -- -- (848) -- 258
Tax benefit from exercise
of stock options -- 340 -- -- -- -- -- 340
Vesting of stock awards -- (19) -- -- 1,183 -- -- 1,164
ESOP shares committed to be
released for allocation -- 702 -- 503 -- -- -- 1,205
Tax benefit for dividends on
unallocated ESOP shares -- 68 -- -- -- -- -- 68
------ --------- -------- ------- ------- -------- ------- ---------
Balance at March 31, 2005 $ 136 $ 103,728 $(18,131) $(6,053) $(4,435) $ 54,638 $(2,723) $ 127,160
====== ========= ======== ======= ======= ======== ======= =========
See accompanying notes to consolidated financial statements.
25
SOUND FEDERAL BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
(In thousands)
Years Ended March 31,
---------------------------------------------
2005 2004 2003
--------- --------- ---------
Operating Activities
Net income $ 5,469 $ 6,618 $ 8,526
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 300 275 275
Depreciation, amortization and accretion 2,570 2,549 1,458
ESOP and stock award expense 2,388 1,625 676
Income taxes 348 (800) 1,095
Origination of loans held for sale (1,066) -- --
Proceeds from sales of loans held for sale 1,088 -- --
Gain on sales of mortgage loans (22) -- --
Gain on sale of land (93) -- --
Pension costs (510) 81 (2,612)
Other adjustments, net (448) (777) (414)
--------- --------- ---------
Net cash provided by operating activities 10,024 9,571 9,004
--------- --------- ---------
Investing Activities
Purchases of securities:
Available for sale (31,015) (198,707) (229,693)
Held to maturity (82,297) -- --
Proceeds from payments, maturities and calls of securities:
Available for sale 81,894 146,415 96,724
Held to maturity 5,274 -- --
Net disbursements for loan originations and principal repayments (83,164) (52,027) (10,395)
Purchases of Federal Home Loan Bank stock (435) (1,162) --
Purchase of bank-owned life insurance -- (10,000) --
Proceeds from sale of land 174 -- --
Purchases of premises and equipment (1,519) (968) (714)
Proceeds from sales of real estate owned -- -- 344
--------- --------- ---------
Net cash used in investing activities (111,088) (116,449) (143,734)
--------- --------- ---------
Financing Activities
Net increase in deposits 123,438 104,070 84,355
Proceeds from borrowings 9,000 47,000 7,000
Repayment of borrowings (6,000) (47,000) (7,082)
Net increase (decrease) in mortgagors' escrow funds 742 (81) (418)
Purchases of treasury stock (12,087) (8,417) --
Proceeds from stock offering, net of related costs -- -- 70,051
Proceeds from exercise of stock options 258 268 100
Payment of cash dividends on common stock (2,891) (2,648) (1,155)
Cash payment in lieu of fractional shares in reorganization -- -- (2)
--------- --------- ---------
Net cash provided by financing activities 112,460 93,192 152,849
--------- --------- ---------
Increase (decrease) in cash and cash equivalents 11,396 (13,686) 18,119
Cash and cash equivalents at beginning of year 31,211 44,897 26,778
--------- --------- ---------
Cash and cash equivalents at end of year $ 42,607 $ 31,211 $ 44,897
========= ========= =========
Supplemental Information
Interest paid $ 15,415 $ 12,711 $ 13,699
Income taxes paid 3,145 4,921 4,104
Loans transferred to real estate owned -- -- 171
(Decrease) increase in due to brokers for securities purchased (1,487) (6,495) 10,495
========= ========= =========
See accompanying notes to consolidated financial statements.
26
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
(1) Reorganization and Stock Offerings
On October 8, 1998, Sound Federal Bancorp issued shares of its common
stock in connection with a Plan of Reorganization ("the "Reorganization")
and related Subscription and Community Offering. In the Reorganization,
Sound Federal Savings and Loan Association converted from a federally
chartered mutual savings association to a federally chartered stock
savings association. Sound Federal Savings and Loan Association became the
wholly-owned subsidiary of Sound Federal Bancorp, which became the
majority-owned subsidiary of Sound Federal, MHC (the "Mutual Holding
Company").
On January 6, 2003, Sound Federal Bancorp and the Mutual Holding Company
completed a conversion to a fully-public holding company structure (the
"Conversion"). At that time, the Mutual Holding Company merged into Sound
Federal Savings and Loan Association, and no longer exists. Sound Federal
Bancorp was succeeded by a new Delaware corporation named Sound Federal
Bancorp, Inc. (the "Holding Company"). Shares of common stock representing
the ownership interest of the Mutual Holding Company were sold in a
subscription offering and a community offering. Shares owned by public
shareholders (shareholders other than the Mutual Holding Company) were
converted into the right to receive new shares of Holding Company common
stock determined pursuant to an exchange ratio. As part of these
transactions, Sound Federal Savings and Loan Association changed its name
to Sound Federal Savings (the "Bank"), which is now a wholly-owned
subsidiary of the Holding Company. The Bank and the Holding Company are
referred to herein as "the Company".
The Holding Company sold 7,780,737 shares of common stock at $10.00 per
share in the offering, including 622,458 shares purchased by the Company's
Employee Stock Ownership Plan ("ESOP"). In addition, each of the
outstanding shares of common stock of Sound Federal Bancorp (1,967,782
shares, net of 444,926 treasury shares) was converted into 2.7667 shares
of the Holding Company resulting in 5,444,263 outstanding shares. A total
of 13,225,000 shares were outstanding as a result of the offering and
share exchange.
Net cash proceeds from the offering were as follows (in thousands):
Total cash proceeds (7,780,737 shares) $ 77,807
Offering costs (1,897)
--------
Net offering proceeds 75,910
Assets received from the Mutual Holding Company 366
--------
Increase in common stock and additional paid-in capital 76,276
Shares purchased by the ESOP (622,458 shares) (6,225)
--------
Net cash proceeds $ 70,051
========
The Conversion and related transactions were accounted for at historical
cost, with no resulting change in the historical carrying amounts of
assets and liabilities. Consolidated stockholders' equity increased by the
net cash proceeds from the offering. Share and per share data for all
periods have been adjusted to reflect the additional shares outstanding as
a result of the offering and share exchange.
(2) Summary of Significant Accounting Policies
The Bank is a community-oriented savings institution whose business
primarily consists of accepting deposits from customers within its market
area and investing those funds in mortgage loans secured by one-to-four
family residences and in mortgage-backed and other securities. To a
significantly lesser extent, funds are invested in commercial mortgage,
construction and consumer loans. The Bank's primary market area is
Westchester and Putnam Counties in New York and Fairfield County,
Connecticut. A full-service office is also located in Rockland County, New
York.
27
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Deposits are insured up to applicable limits of the Federal Deposit
Insurance Corporation ("FDIC"). As a federally-chartered savings
association, the Bank's primary regulator is the Office of Thrift
Supervision ("OTS"). The Holding Company is also subject to supervision
and regulation by the OTS.
Basis of Presentation
The consolidated financial statements include the accounts of the Holding
Company, the Bank, Sound REIT, First Federal REIT and Mamaroneck Advisors,
Inc. Sound REIT and First Federal REIT are real estate investment trusts
that hold a portion of the Company's mortgage-related assets. Mamaroneck
Advisors, Inc. is a wholly-owned subsidiary of the Bank that offered
investment products and services to the Bank's customers. Beginning in
December 2003, these services are provided to customers directly by the
Bank. All significant intercompany accounts and transactions have been
eliminated in consolidation.
The consolidated financial statements have been prepared in conformity
with U.S. generally accepted accounting principles. In preparing the
consolidated financial statements, management is required to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, income and expense. Actual results could differ significantly
from these estimates. A material estimate that is particularly susceptible
to near-term change is the allowance for loan losses, which is discussed
below.
Certain reclassifications have been made to prior year amounts to conform
to the current year presentation. For purposes of reporting cash flows,
cash equivalents consist of federal funds sold and other overnight
deposits.
Securities
The Company may classify its securities as held-to-maturity,
available-for-sale or trading. Securities classified as held to maturity
are limited to debt securities for which the entity has the positive
intent and ability to hold to maturity. Trading securities are debt and
equity securities that are bought principally for the purpose of selling
them in the near term. All other debt and equity securities are classified
as available for sale.
Management determines the appropriate classification of securities at the
purchase date. Securities held to maturity are carried at amortized cost.
Trading securities are carried at fair value, with unrealized gains and
losses recognized in earnings. Securities available for sale are carried
at fair value, with unrealized gains and losses excluded from earnings and
reported on a net-of-tax basis as a separate component of stockholders'
equity (accumulated other comprehensive income or loss).
Premiums and discounts on debt securities are amortized to interest income
on a level-yield basis over the terms of the securities. Realized gains
and losses on sales of securities are determined based on the amortized
cost of the specific securities sold. Unrealized losses on securities are
charged to earnings when the decline in fair value of a security is judged
to be other than temporary.
Allowance for Loan Losses
The allowance for loan losses is increased by provisions for loan losses
charged to income. Losses are charged to the allowance when all or a
portion of a loan is deemed to be uncollectible. Recoveries of loans
previously charged-off are credited to the allowance for loan losses when
realized. Management's periodic determination of the allowance is based on
continuing reviews of the portfolio, using a consistently-applied
methodology. The allowance for loan losses consists of losses that are
both probable and estimable at the date of the financial statements. In
determining the allowance for loan losses, management considers factors
such as the Company's past loan loss experience, known risks in the
portfolio, adverse situations affecting a borrower's ability to repay, the
estimated value of underlying collateral, and current economic conditions.
Determining the allowance for loan losses involves significant management
judgments utilizing the best information available. Those judgments are
subject to further review by various sources, including the Company's
regulators. Changes in the allowance may be necessary in the future based
on changes in economic and real estate
28
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
market conditions, new information obtained regarding known problem loans,
the identification of additional problem loans and other factors, certain
of which are outside of management's control.
A loan is considered to be impaired when, based on current information and
events, it is probable that the Company will be unable to collect all
principal and interest contractually due. The Company reviews loans for
impairment that are individually evaluated for collectibility in
accordance with the Company's normal loan review procedures (principally
loans in the multi-family, commercial mortgage and construction loan
portfolios). Smaller-balance homogeneous loans, such as residential
mortgage and consumer loans, are collectively evaluated for impairment.
The measurement of an impaired loan is based on (i) the present value of
expected future cash flows discounted at the loan's effective interest
rate, (ii) the loan's observable market price or (iii) the fair value of
the collateral if the loan is collateral dependent. If the measure of an
impaired loan is less than its recorded investment, an impairment loss is
recognized as part of the allowance for loan losses.
Loans
Loans are reported at amortized cost less the allowance for loan losses,
except for mortgage loans held for sale which are reported at the lower of
cost or estimated market value in the aggregate. Gains and losses on sales
of loans are recorded at settlement using the specific identification
method.
Interest is accrued monthly based on outstanding principal balances unless
management considers the collection of interest to be doubtful (generally,
when loans are contractually past due ninety days or more). When loans are
placed on nonaccrual status, unpaid interest is reversed by charging
interest income and crediting an allowance for uncollected interest.
Interest payments received on nonaccrual loans (including impaired loans)
are recognized as income unless future collections are doubtful. Loans are
returned to accrual status when collectibility is no longer considered
doubtful (generally, when all payments have been brought current).
Loan origination fees and certain direct loan origination costs are
deferred and the net fee or cost is amortized to interest income, using
the level-yield method, over the contractual term of the related loan.
Unamortized fees and costs are recognized in interest income when a loan
is sold or prepaid.
Federal Home Loan Bank Stock
As a member of the Federal Home Loan Bank ("FHLB") of New York, the Bank
is required to hold a certain amount of FHLB stock. This stock is
considered to be a non-marketable equity security and, accordingly, is
carried at cost.
Goodwill
Statement of Financial Accounting Standards ("SFAS") No. 142, Goodwill and
Other Intangible Assets, requires that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead be tested for
impairment at least annually using a fair-value-based approach. The
Company did not recognize any impairment of goodwill during the years
ended March 31, 2005, 2004 and 2003.
Real Estate Owned
Real estate properties acquired through foreclosure are recorded initially
at fair value less estimated sales costs, with the resulting writedown
charged to the allowance for loan losses. Thereafter, an allowance for
losses on real estate owned is established by a charge to expense to
reflect any subsequent declines in fair value. Fair value estimates are
based on recent appraisals and other available information. Costs incurred
to develop or improve properties are capitalized, while holding costs are
charged to expense.
Premises and Equipment
Land is carried at cost. Buildings and improvements, leasehold
improvements, and furniture and equipment are carried at cost less
accumulated depreciation and amortization. Depreciation expense is
recognized on a straight-
29
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
line basis over the estimated useful lives of the related assets, which
are 40 years for buildings and improvements and 3 to 7 years for furniture
and equipment. Amortization of leasehold improvements is recognized on a
straight-line basis over the shorter of the terms of the respective leases
or the estimated useful lives of the assets, resulting in amortization
periods ranging from 5 to 20 years. Costs incurred to improve or extend
the life of existing assets are capitalized. Repairs and maintenance are
charged to expense.
Securities Repurchase Agreements
The Company is a party to securities repurchase agreements with the FHLB.
These agreements provide for the transfer of securities to the FHLB under
an agreement to repurchase the identical securities at a fixed price in
the future. These agreements are accounted for as secured financings. The
proceeds from the transaction are recorded as borrowed funds and the
underlying securities are included in the Company's securities portfolio.
Income Taxes
Income taxes are accounted for under the asset and liability method.
Deferred taxes are recognized for the estimated future tax effects
attributable to "temporary differences" between the financial statement
carrying amounts of existing assets and liabilities and their respective
tax bases. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in future years. The effect
on deferred tax assets and liabilities of an enacted change in tax laws or
rates is recognized in income tax expense in the period that includes the
enactment date of the change.
Deferred tax liabilities are recognized for all temporary differences that
will result in future taxable income. Deferred tax assets are recognized
for all temporary differences that will result in future tax deductions,
subject to reduction of the assets by a valuation allowance in certain
circumstances. This valuation allowance is recognized if, based on an
analysis of available evidence, management determines that it is more
likely than not that a portion or all of the deferred tax assets will not
be realized. The valuation allowance is subject to adjustment based on
changes in circumstances that affect management's judgment about the
realizability of the deferred tax assets. Adjustments to increase or
decrease the valuation allowance are charged or credited, respectively, to
income tax expense.
Bank-Owned Life Insurance
The cash surrender value of bank-owned life insurance ("BOLI") is recorded
on the Company's consolidated balance sheet as an asset and the change in
the cash surrender value is recorded as non-interest income. The amount by
which any death benefits received exceeds a policy's cash surrender value
is recorded in non-interest income at the time of receipt. BOLI policies
were purchased in consideration of the Company's obligations under the
supplemental executive retirement plan and the Directors Retirement Plan,
which are described in Note 10.
Stock-Based Compensation Plans
Compensation expense is recognized for the ESOP equal to the fair value of
shares committed to be released for allocation to participant accounts.
Any difference between the fair value at that time and the ESOP's original
acquisition cost is charged or credited to stockholders' equity
(additional paid-in capital). The cost of unallocated ESOP shares (shares
not yet committed to be released) is deducted from stockholders' equity.
SFAS No. 123, Accounting for Stock-Based Compensation, encourages the use
of a fair-value-based method of accounting for employee stock compensation
plans, but permits the continued use of the intrinsic-value-based method
of accounting prescribed by Accounting Principles Board ("APB") Opinion
No. 25. Under SFAS No. 123, the grant-date fair value of options is
recognized as compensation expense over the vesting period. The Company
has elected to continue to apply APB Opinion No. 25 and disclose the pro
forma information required by SFAS No. 123. In accordance with APB Opinion
No. 25, compensation expense is not recognized for fixed stock options if
the exercise price of the option equals the fair value of the underlying
stock on the date of the grant. The fair value of stock awards, measured
at the grant date, is recognized as unearned compensation (a deduction
from stockholders' equity) and amortized to compensation expense as the
shares become vested.
30
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Had stock-based compensation expense been recognized in accordance with
SFAS No. 123, the Company's net income and earnings per share would have
been adjusted to the following pro forma amounts for the years ended March
31:
2005 2004 2003
-------- -------- ---------
(In thousands, except per share data)
Net income, as reported $ 5,469 $ 6,618 $ 8,526
Add stock award expense included
in reported net income, net
of related tax effects 723 242 89
Deduct stock award and stock
option expense determined
under the fair-value-based
method, net of related tax
effects (1,188) (768) (168)
-------- -------- ---------
Pro forma net income $ 5,004 $ 6,092 $ 8,447
======== ======== =========
Earnings per share:
Basic, as reported $ 0.47 $ 0.54 $ 0.67
======== ======== =========
Basic, pro forma $ 0.43 $ 0.49 $ 0.66
======== ======== =========
Diluted, as reported $ 0.46 $ 0.52 $ 0.65
======== ======== =========
Diluted, pro forma $ 0.42 $ 0.48 $ 0.64
======== ======== =========
The per-share fair value of stock options was estimated on the grant date
using the Black-Scholes option pricing model. Stock option grants were
made in fiscal 2004 (none in fiscal 2005 and 2003). The fair value of the
options granted in fiscal 2004 was $4.19 per share, computed using the
Black-Scholes option pricing model and the following assumptions: dividend
yield of 1.6%, volatility rate of approximately 21%, risk-free interest
rate of 4.7% and expected option life of 7 years.
In December 2004, the Financial Accounting Standards Board (the "FASB")
issued SFAS No. 123 (revised 2004), "Share-Based Payment" ("SFAS No.
123R"), which requires entities to measure the cost of employee services
received in exchange for an award of equity instruments based on the
grant-date fair value of the award (with limited exceptions). The cost is
recognized as an expense over the period during which the employee is
required to provide service in exchange for the award, which is usually
the vesting period. The scope of SFAS No. 123R includes the Company's
Incentive Stock Benefit Plan (the "ISB Plan") which provides for stock
awards and stock option grants. For stock awards under the ISB Plan, the
grant-date fair value of the shares will be recognized as compensation
expense on a straight-line basis over the applicable vesting period, which
is the same accounting previously required under APB Opinion No. 25. For
options granted under the ISB Plan, the Company will recognize the
grant-date fair value of options as compensation expense on a
straight-line basis over the applicable vesting period. This accounting
treatment differs significantly from the previous accounting for fixed
stock options under APB Opinion No. 25. As required by SFAS No. 123R, the
Company will estimate the fair value of stock options on each grant date,
using an appropriate valuation approach such as the Black-Scholes option
pricing model. SFAS No. 123R did not change existing accounting principles
applicable to employee stock ownership plans.
SFAS No. 123R applies to all awards granted after its effective date and
to awards modified, repurchased, or cancelled after that date. SFAS No.
123R is effective as of the beginning of the first annual reporting period
beginning after June 15, 2005 (i.e., the Company's fiscal year beginning
April 1, 2006). The standard permits different transition methods. The
Company expects to adopt SFAS No. 123R by recognizing compensation expense
for (i) all stock options granted after April 1, 2006 and (ii) the portion
of previously granted stock options for which the requisite service had
not been rendered as of April 1, 2006, based on the grant-date fair value
of those options calculated for purposes of SFAS No. 123 pro forma
disclosures. The additional annual compensation cost for the
31
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Company's stock options outstanding at March 31, 2005 that is expected to
be recognized in the fiscal year beginning April 1, 2006, as a result of
the adoption of SFAS No. 123R, is approximately $557,000 before taxes.
Earnings Per Share
Basic earnings per share ("EPS") is computed by dividing net income
applicable to common stock by the weighted average number of common shares
outstanding for the period. Unearned stock awards are not included in
outstanding shares until they become vested. Diluted EPS is computed in a
manner similar to basic EPS, except that the weighted average number of
common shares outstanding is increased to include the number of additional
common shares that would have been outstanding if all potentially dilutive
common shares (such as stock options and unearned stock awards) were
issued or became vested during the reporting period. For purposes of
computing both basic and diluted EPS, outstanding shares exclude
unallocated ESOP shares that have not been committed to be released to
participants.
Segment Information
SFAS No. 131, Disclosures about Segments of an Enterprise and Related
Information, requires public companies to report certain financial
information about significant revenue-producing segments of the business
for which such information is available and utilized by the chief
operating decision maker. As a community-oriented financial institution,
substantially all of the Company's operations involve the delivery of loan
and deposit products to customers. Management makes operating decisions
and assesses performance based on an ongoing review of these community
banking operations, which constitute the Company's only operating segment
for financial reporting purposes.
32
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
(3) Securities Available for Sale
The following are summaries of securities available for sale:
Gross Unrealized
Amortized ----------------------- Fair
Cost Gains Losses Value
--------- ------ ------- --------
(In thousands)
March 31, 2005
- --------------
Pass-through securities issued by:
Ginnie Mae $ 69,759 $ 267 $ (221) $ 69,805
Fannie Mae 33,896 138 (650) 33,384
Freddie Mac 13,032 94 (164) 12,962
Collateralized mortgage obligations
issued by:
Ginnie Mae 5,358 -- (89) 5,269
Fannie Mae 32,621 4 (1,062) 31,563
Freddie Mac 48,097 -- (1,335) 46,762
-------- ------ ------- --------
Total mortgage-backed securities 202,763 503 (3,521) 199,745
U.S. Government and agency securities 55,058 1 (1,415) 53,644
Municipal securities 860 120 -- 980
Mutual fund shares 22,007 23 (245) 21,785
-------- ------ ------- --------
Total securities $280,688 $ 647 $(5,181) $276,154
======== ====== ======= ========
March 31, 2004
- --------------
Pass-through securities issued by:
Ginnie Mae $ 89,213 $ 464 $ (349) $ 89,328
Fannie Mae 44,359 426 (133) 44,652
Freddie Mac 18,626 241 (28) 18,839
Collateralized mortgage obligations
issued by:
Ginnie Mae 8,815 27 (38) 8,804
Fannie Mae 36,824 127 (316) 36,635
Freddie Mac 57,350 426 (181) 57,595
-------- ------ ------- --------
Total mortgage-backed securities 255,187 1,711 (1,045) 255,853
U.S. Government and agency securities 59,546 277 (42) 59,781
Municipal securities 854 148 -- 1,002
Mutual fund shares 21,000 177 (83) 21,094
-------- ------ ------- --------
Total securities $336,587 $2,313 $(1,170) $337,730
======== ====== ======= ========
Debt securities available for sale at March 31, 2005 consisted of
adjustable rate securities and fixed rate securities with amortized costs
of $108.2 million and $150.5 million, and weighted average yields of 4.36%
and 3.72%, respectively. Debt securities available for sale at March 31,
2004 consisted of adjustable rate securities and fixed rate securities
with amortized costs of $141.1 million and $174.5 million, and weighted
average yields of 2.92% and 3.60%, respectively.
There were no sales of securities available for sale during the years
ended March 31, 2005, 2004 and 2003.
33
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
The following table summarizes, for all securities in an unrealized loss
position at March 31, 2005, the aggregate fair values and gross unrealized
losses by length of time those securities had been in a continuous
unrealized loss position:
Less Than 12 Months 12 Months or Longer Total
- ----------------------------------------------------------------------------------------------------------------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
(In thousands) Value Losses Value Losses Value Losses
- ----------------------------------------------------------------------------------------------------------------------------------
Pass-through securities issued by:
Ginnie Mae $ 13,254 $ (66) $ 26,973 $ (155) $ 40,227 $ (221)
Fannie Mae 15,305 (228) 10,775 (422) 26,080 (650)
Freddie Mac 5,433 (74) 2,959 (90) 8,392 (164)
Collateralized mortgage obligations
issued by:
Ginnie Mae 2,670 (37) 2,599 (52) 5,269 (89)
Fannie Mae 17,337 (387) 13,231 (675) 30,568 (1,062)
Freddie Mac 28,511 (588) 18,251 (747) 46,762 (1,335)
U.S. Government and agency securities 40,997 (980) 12,341 (435) 53,338 (1,415)
Mutual fund shares -- -- 15,756 (245) 15,756 (245)
------------------------------------------------------------------------
Total temporarily-impaired securities $123,507 $(2,360) $102,885 $(2,821) $226,392 $(5,181)
========================================================================
The Company invests primarily in mortgage-backed securities issued by
Ginnie Mae, Fannie Mae and Freddie Mac, as well as U.S. Government and
Agency securities. The unrealized losses on these securities at March 31,
2005 were caused by increases in market yields subsequent to purchase.
There were no individual securities with unrealized losses that were
significant dollar amounts at March 31, 2005. A total of 174 securities
were in a continuous unrealized loss position for less than 12 months, and
134 securities for 12 months or longer. There were no debt securities past
due or securities for which the Company currently believes it is not
probable that it will collect all amounts due according to the contractual
terms of the security. Because the Company has the ability to hold
securities with unrealized losses until a market price recovery (which,
for debt securities may be until maturity), the Company did not consider
these securities to be other-than-temporarily impaired at March 31, 2005.
The following is a summary of the amortized cost and fair value of debt
securities available for sale at March 31, 2005, with amounts shown by
remaining term to contractual maturity for categories other than
mortgage-backed securities. Actual maturities may differ from these
amounts because certain issuers have the right to call or redeem their
obligations prior to contractual maturity.
Amortized Fair
Cost Value
--------- -----
(In thousands)
Mortgage-backed securities $202,763 $199,745
U.S. Government and agency
securities due:
Less than one year 1,000 984
Over one to five years 42,369 41,224
Over five to ten years 4,626 4,549
Over ten years 7,063 6,887
Municipal securities due:
Over five to ten years 210 237
Over ten years 650 743
-------- --------
Total debt securities $258,681 $254,369
======== ========
34
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
(4) Securities Held to Maturity
The following is a summary of securities held to maturity at March 31,
2005:
Gross Unrealized
Amortized ------------------------ Fair
Cost Gains Losses Value
-=------- ------- ------- -------
(In thousands)
Mortgage-backed securties issued by:
Ginnie Mae $35,268 $ 62 $ (250) $35,080
Fannie Mae 2,339 8 (3) 2,344
Freddie Mac 1,577 -- (21) 1,556
Collateralized mortgage obligations issued by:
Fannie Mae 8,796 -- (126) 8,670
Freddie Mac 11,797 -- (210) 11,587
------- ------- ------- -------
Total mortgage-backed securities 59,777 70 (610) 59,237
U.S. Government and agency securities 19,712 -- (221) 19,491
------- ------- ------- -------
Total $79,489 $ 70 (831) $78,728
======= ======= ======= =======
At March 31, 2005, these securities consisted of adjustable rate
securities and fixed rate securities with amortized costs of $39.2 million
of $40.3 million, and weighted average yields of 4.63% and 3.86%,
respectively.
There were no sales of securities held to maturity during the years ended
March 31, 2005, 2004 and 2003.
The following table summarizes, for all securities in an unrealized loss
position at March 31, 2005, the aggregate fair values and gross unrealized
losses by length of time those securities had been in a continuous
unrealized loss position:
Less Than 12 Months 12 Months or Longer Total
- --------------------------------------------------------------------------------------------------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
(In thousands) Value Losses Value Losses Value Losses
- --------------------------------------------------------------------------------------------------------------------
Pass-through securities issued by:
Ginnie Mae $ 19,627 $ (250) $ -- $ -- $ 19,627 $ (250)
Fannie Mae 674 (3) -- -- 674 (3)
Freddie Mac 1,556 (21) -- -- 1,556 (21)
Collateralized mortgage obligations
issued by:
Fannie Mae 8,670 (126) -- -- 8,670 (126)
Freddie Mac 11,587 (210) -- -- 11,587 (210)
U.S. Government and agency securities 17,491 (221) -- -- 17,491 (221)
------------------------------------------------------------------
Total temporarily-impaired securities $ 59,605 $ (831) $ -- $ -- $ 59,605 $ (831)
==================================================================
35
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
The Company invests primarily in mortgage-backed securities issued by
Ginnie Mae, Fannie Mae and Freddie Mac, as well as U.S. Government and
Agency securities. The unrealized losses at March 31, 2005 were caused by
increases in market yields subsequent to purchase. There were no
individual securities with unrealized losses that were significant dollar
amounts at March 31, 2005. A total of 49 securities were in a continuous
unrealized loss position for less than 12 months. There were no debt
securities past due or securities for which the Company currently believes
it is not probable that it will collect all amounts due according to the
contractual terms of the security. Because the Company has the ability and
intent to hold securities with unrealized losses until maturity, the
Company did not consider these securities to be other-than-temporarily
impaired at March 31, 2005.
The following is a summary of the amortized cost and fair value of
securities held to maturity at March 31, 2005, with information on U.S.
Government and agency securities shown by remaining term to contractual
maturity. Actual maturities may differ from these amounts because certain
issuers have the right to call or redeem their obligations prior to
contractual maturity.
Amortized Fair
Cost Value
--------- -------
(In thousands)
Mortgage-backed securities $59,777 $59,237
U.S. Government and agency securities:
Over one to five years 16,850 16,675
Over five to ten years 999 975
Over ten years 1,863 1,841
------- -------
Total $79,489 $78,728
======= =======
36
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
(5) Loans
Loans are summarized as follows:
March 31,
------------------------
2005 2004
--------- ---------
(In thousands)
Mortgage loans:
Residential properties:
One-to-four family $ 441,655 $ 375,714
Home equity lines of credit 42,052 35,185
Multi-family 9,807 8,472
Commercial properties 45,645 43,153
Construction loans 17,416 13,723
------------------------
556,575 476,247
------------------------
Consumer loans:
Secured personal loans 1,164 2,293
Other loans 1,004 305
Commercial loans 2,932 798
------------------------
5,100 3,396
------------------------
Total loans 561,675 479,643
Deferred loan origination costs, net 2,087 1,524
Allowance for loan losses (3,011) (2,712)
------------------------
Total loans, net $ 560,751 $ 478,455
========================
Gross principal balances at March 31, 2004 consisted of fixed rate loans
of $349.1 million and adjustable rate loans of $212.5 million, with
weighted average yields of 6.05% and 5.10%, respectively. Fixed rate and
adjustable rate loans at March 31, 2004 totaled $349.5 million and $130.1
million, with weighted average yields of 6.25% and 5.05%, respectively.
There were no loans held for sale at March 31, 2005 and 2004.
The Company primarily originates mortgage loans secured by existing
single-family residential properties. The Company also originates
multi-family and commercial mortgage loans, construction loans, commercial
loans and consumer loans. Substantially all of the mortgage loan portfolio
is secured by real estate properties located in Westchester and Putnam
Counties in New York, and Fairfield County, Connecticut. The ability of
the Company's borrowers to make principal and interest payments is
dependent upon, among other things, the level of overall economic activity
and the real estate market conditions prevailing within the Company's
concentrated lending area.
37
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Activity in the allowance for loan losses is summarized as follows for the
years ended March 31:
2005 2004 2003
---- ---- ----
(In thousands)
Balance at beginning of year $ 2,712 $ 2,442 $ 2,221
Provision for loan losses 300 275 275
Charge-offs (1) (5) (54)
-----------------------------
Balance at end of year $ 3,011 $ 2,712 $ 2,442
=============================
The principal balances of nonaccrual loans past due ninety days or more at
March 31 are as follows:
2005 2004 2003
---- ---- ----
(In thousands)
Mortgage loans:
One-to-four family $ 510 $1,359 $ 449
Home equity lines of credit 70 617 18
Consumer loans -- 5 10
--------------------------
Total nonaccrual loans $ 580 $1,981 $ 477
==========================
Gross interest income that would have been recorded if the foregoing
nonaccrual loans had remained current in accordance with their contractual
terms totaled $40,000, $124,000 and $43,000 for the years ended March 31,
2005, 2004 and 2003, respectively, compared to interest income actually
recognized of $16,000, $71,000 and $20,000, respectively.
The Company had no impaired loans at March 31, 2005 and 2004 within the
scope of SFAS No. 114, Accounting by Creditors for Impairment of a Loan.
The average recorded investment in impaired loans was $54,000 for the year
ended March 31, 2003 (none in fiscal years 2005 and 2004). No interest
income was recognized on impaired loans while such loans were considered
to be impaired.
Provisions for losses and other activity in the allowance for losses on
real estate owned were insignificant during the years ended March 31,
2005, 2004 and 2003.
38
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
(6) Premises and Equipment
A summary of premises and equipment at March 31 follows:
2005 2004
---- ----
(In thousands)
Land $ 592 $ 592
Buildings and improvements 4,313 4,313
Leasehold improvements 3,217 2,364
Furniture and equipment 3,508 2,842
--------------------
11,630 10,111
Less accumulated depreciation and amortization (5,416) (4,481)
--------------------
Premises and equipment, net $ 6,214 $ 5,630
====================
(7) Deposits
The following is a summary of deposit balances and weighted average stated
interest rates at March 31:
2005 2004
- --------------------------------------------------------------------------------------------------------
Rate Amount Rate Amount
- --------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Savings and club accounts 0.51% $150,455 0.51% $148,231
Money market accounts 0.97 52,881 0.73 47,338
NOW accounts 0.35 61,357 0.24 54,616
Commercial checking -- 14,201 -- 12,404
- --------------------------------------------------------------------------------------------------------
Total 0.54 278,894 0.47 262,589
- --------------------------------------------------------------------------------------------------------
Certificates of deposit by remaining
term to contractual maturity:
Within one year 2.30 260,659 1.87 321,473
After one but within two years 3.15 199,952 2.66 40,517
After two but within three years 3.60 59,822 3.09 56,753
After three years 4.23 32,441 4.24 26,998
- --------------------------------------------------------------------------------------------------------
Total 2.86 552,874 2.24 445,741
- --------------------------------------------------------------------------------------------------------
Total deposits 1.90% $831,768 1.58% $708,330
========================================================================================================
Certificates of deposit with denominations of $100,000 or more totaled
$138.7 million and $108.8 million at March 31, 2005 and 2004,
respectively.
39
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Interest expense on deposits is summarized as follows for the years ended
March 31:
2005 2004 2003
------- ------- -------
(In thousands)
Savings and club accounts $ 783 $ 856 $ 1,185
Money market and NOW accounts 526 547 725
Certificates of deposit 12,659 9,601 10,098
------- ------- -------
Total $13,968 $11,004 $12,008
======= ======= =======
(8) Borrowings
Borrowings under securities repurchase agreements with the FHLB are
summarized as follows:
March 31,
Coupon --------------------
Maturity Date Rate 2005 2004
------------- ------ ------- -------
(Dollars in thousands)
January 2008 (1) 5.42% $10,000 $10,000
December 2008 (1) 4.72 5,000 5,000
March 2005 4.22 -- 6,000
June 2005 2.47 3,000 --
March 2006 2.27 7,000 7,000
March 2007 2.65 7,000 7,000
March 2008 4.13 6,000 --
------- -------
Total borrowings $38,000 $35,000
======= =======
Weighted average interest rate 3.80% 3.93%
Accrued interest payable $ 165 $ 131
(1) Callable quarterly.
The securities transferred to the FHLB in repurchase agreements include
U.S. Government and agency securities and mortgage-backed securities of
$14.1 million and $23.7 million, respectively, at March 31, 2005 ($14.1
million and $23.9 million, respectively, at March 31, 2004). Accrued
interest receivable on these securities totaled $258,000 and $225,000 at
March 31, 2005 and 2004, respectively.
In addition to securities repurchase agreements, the Bank may have
outstanding borrowings from the FHLB of up to approximately $88.6 million
at March 31, 2005, in a combination of term advances and overnight funds
secured by the Bank's investment in FHLB stock and by a blanket security
agreement. This agreement requires the Bank to maintain as collateral
certain qualifying assets (such as one-to-four family residential mortgage
loans) with a fair value, as defined, at least equal to 110% of any
outstanding advances. There were no such borrowings outstanding at March
31, 2005 and 2004.
40
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
(9) Income Taxes
Income tax expense consists of the following components for the years
ended March 31:
2005 2004 2003
------- ------- -------
(In thousands)
Federal:
Current $ 3,129 $ 3,627 $ 3,553
Deferred (39) 11 1,033
------- ------- -------
3,090 3,638 4,586
------- ------- -------
State:
Current 458 575 436
Deferred (15) 21 197
------- ------- -------
443 596 633
------- ------- -------
Total:
Current 3,587 4,202 3,989
Deferred (54) 32 1,230
------- ------- -------
$ 3,533 $ 4,234 $ 5,219
======= ======= =======
The following is a reconciliation of expected income taxes (computed at
the applicable Federal statutory tax rate) to the Company's actual income
tax expense for the years ended March 31:
2005 2004 2003
------- ------- -------
(Dollars in thousands)
Taxes at Federal statutory rate $ 3,061 $ 3,690 $ 4,811
State tax expense, net of
Federal tax benefit 292 390 411
Nondeductible ESOP expense 239 248 72
Increase in cash surrender
value of BOLI (129) (29) --
Other reconciling items, net 70 (65) (75)
------- ------- -------
Actual income tax expense $ 3,533 $ 4,234 $ 5,219
======= ======= =======
Effective income tax rate 39.2% 39.0% 38.0%
41
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
The tax effects of temporary differences that give rise to the Company's
deferred tax assets and liabilities are as follows at March 31:
2005 2004
---- ----
(In thousands)
Deferred tax assets:
Net unrealized loss on securities available for sale $1,811 $ --
Allowance for loan losses 1,204 1,085
Deferred compensation 571 494
Director retirement plan 340 259
Accrued pension costs 173 133
Purchase accounting adjustments on loans and securities 41 125
Other deductible temporary differences 300 50
====== ======
Total deferred tax assets 4,440 2,146
====== ======
Deferred tax liabilities:
Prepaid pension costs 1,223 1,015
Deferred loan costs 835 609
Net unrealized gain on securities available for sale -- 441
Purchase accounting adjustment on buildings 146 151
====== ======
Total deferred tax liabilities 2,204 2,216
====== ======
Net deferred tax asset (liability) $2,236 $ (70)
====== ======
In assessing the realizability of the Company's total deferred tax assets,
management considers whether it is more likely than not that some portion
or all of those assets will not be realized. Based upon management's
consideration of historical and anticipated future pre-tax income, as well
as the reversal period for the items giving rise to the deferred tax
assets and liabilities, a valuation allowance for deferred tax assets was
not considered necessary at March 31, 2005 and 2004.
As a thrift institution, the Bank is subject to special provisions in the
Federal and New York State tax laws regarding its allowable tax bad debt
deductions and related tax bad debt reserves. These deductions
historically were determined using methods based on loss experience or a
percentage of taxable income. Tax bad debt reserves represent the excess
of allowable deductions over actual bad debt losses, and include a defined
base-year amount. SFAS No. 109 requires recognition of deferred tax
liabilities with respect to reserves in excess of the base-year amount, as
well as any portion of the base-year amount that is expected to become
taxable (or "recaptured") in the foreseeable future.
The Bank's base-year tax bad debt reserves totaled $9.0 million for
Federal tax purposes at both March 31, 2005 and 2004, and $14.0 million
and $12.3 million for New York State tax purposes at March 31, 2005 and
2004, respectively. In accordance with SFAS No. 109, deferred tax
liabilities have not been recognized with respect to these reserves, since
the Company does not expect that these amounts will become taxable in the
foreseeable future. Under the tax laws, events that would result in
taxation of these reserves include (i) redemptions of the Bank's stock or
certain excess distributions by the Bank to the Holding Company, and (ii)
failure of the Bank to maintain a specified qualifying assets ratio or
meet other thrift definition tests for New York State tax purposes. The
unrecognized deferred tax liabilities with respect to the Bank's base-year
reserves totaled $3.9 million at March 31, 2005 and 2004.
42
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
(10) Employee Benefit and Stock-Based Compensation Plans
Pension Plans
The Company maintains two non-contributory defined benefit pension plans
that cover substantially all full-time employees who meet certain age and
service requirements. Benefits are based on the employee's years of
accredited service and average compensation for the three consecutive
years that produce the highest average. The Company's funding policy is to
contribute the amounts required by applicable regulations, although
additional amounts may be contributed from time to time. The Company
expects to contribute $150,000 to the plans in fiscal 2006.
Plan assets are invested in the Guaranteed Deposit Fund ("GDF") which is a
group annuity insurance product issued by Prudential Retirement Insurance
and Annuity Company ("PRIAC"). Deposits to the GDF are deposited into
PRIAC's general account. Payment obligations under the GDF represent an
insurance claim supported by all general account assets. The guarantee
from PRIAC is based on the claims-paying ability of PRIAC and not the
value of securities held in the GDF. As such, the GDF does not operate
like a mutual fund, annuity product or other similar investment. The GDF
is an intermediate-term, high-grade fixed income portfolio consisting of
commercial mortgages, private placement bonds, publicly traded debt
securities and asset-backed securities. The underlying securities in the
GDF have an average life of 5.6 years.
The investment goal is to achieve a long-term rate of return sufficient to
provide for benefit obligations, including the effect of future
compensation levels, while minimizing investment risks such as credit risk
and interest rate risk.
The expected long-term rate of return on plan assets used to determine net
periodic benefit expense was based principally on the actual long-term
historical yield earned on the GDF.
43
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
The following table summarizes changes in the plans' projected benefit
obligations and the fair value of the plans' assets. The table also
provides a reconciliation of the funded status to the prepaid pension
costs recognized in the consolidated balance sheets. The Company uses a
measurement date of December 31 for accounting and disclosure purposes.
2005 2004
-------- --------
(In thousands)
Change in projected benefit obligations:
Beginning of year $ 10,451 $ 9,807
Service cost 366 341
Interest cost 638 623
Actuarial loss 747 147
Benefits paid (510) (467)
-------- --------
End of year 11,692 10,451
-------- --------
Change in fair value of plan assets:
Beginning of year 10,239 7,098
Actual return on plan assets 246 746
Employer contributions 1,065 2,862
Benefits paid (510) (467)
-------- --------
End of year 11,040 10,239
-------- --------
Funded status at the measurement date (652) (212)
Employer contributions after the measurement date 150 488
Unrecognized net actuarial loss (1) 3,520 2,227
Unrecognized past service liability 39 44
-------- --------
Prepaid pension costs at March 31 $ 3,057 $ 2,547
======== ========
(1) Unrecognized net actuarial gains and losses in excess of 10% of the
greater of the projected benefit obligation or the fair value of
plan assets are amortized over the average remaining service period
of active plan participants.
The plans' accumulated benefit obligations were $10.1 million and $9.1
million at March 31, 2005 and 2004, respectively.
Pension benefits expected to be paid for the fiscal years ending March 31
are $610,000 in 2006, $620,000 in 2007, $634,000 in 2008, $649,000 in
2009, $669,000 in 2010, and a total of $3.7 million in 2011-2015. These
amounts are based on the same assumptions used to measure the benefit
obligation at March 31, 2005 and include estimated future employee
service.
44
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
The components of the net periodic pension expense and the significant
actuarial assumptions were as follows:
2005 2004 2003
----- ----- -----
(Dollars in thousands)
Service cost $ 366 $ 341 $ 259
Interest cost 638 623 589
Expected return on plan assets (900) (700) (600)
Recognized net actuarial loss 108 111 59
Amortization of prior service
cost and net transition obligation 5 5 10
----- ----- -----
Net periodic pension expense $ 217 $ 380 $ 317
===== ===== =====
Weighted-average assumptions used
to determine projected benefit
obligations at March 31:
Discount rate 6.00% 6.25% 6.50%
Rate of compensation increase 3.50% 3.50% 4.00%
Weighted-average assumptions
used to determine net periodic
benefit expense for the years
ended March 31:
Discount rate 6.25% 6.50% 7.00%
Expected long-term rate of
return on plan assets 8.50% 8.50% 9.00%
Rate of compensation increase 3.50% 4.00% 4.25%
The Company also has a supplemental executive retirement plan which is a
non-qualified plan providing benefits to certain key employees. The
supplemental benefits represent the difference between the pension and
ESOP benefits the executive would be entitled to receive under those
plans, without considering the applicable limitations under the tax law,
and the actual benefits after considering such limitations. The accrued
liability for the supplemental plan was $431,000 and $333,000 at March 31,
2005 and 2004, respectively, and the related expense was $98,000 and
$38,000 for the years then ended.
Director Retirement Plan
The Company maintains a non-qualified, unfunded Director Retirement Plan
which is an amendment and restatement of the former Director Emeritus
Plan. Under the Director Retirement Plan, any person who was a director on
January 1, 2004, who retires or dies after age 70 and who completes 15
years of continuous service as a director becomes entitled to an annual
retirement benefit for the longer of 20 years or his/her lifetime, equal
to the amount of annual fees paid for attendance at regular monthly board
meetings during the preceeding twelve months, plus the amount of any
annual stipend paid to such director in that year. The Director Retirement
Plan also provides for benefits in the event of early retirement or
disability. In the event of a change in control, directors will be
credited with years of service as if they had remained members of the
Board of Directors until age 70 and be entitled to benefits payable in a
lump sum, at the time of the change in control. A retired director will
receive the present value of the remaining benefit, paid in a lump sum at
the time of a change in control.
45
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Under the former Director Emeritus Plan, benefit payments would be made
for a period not to exceed 15 years or to age 85 or until the death of the
director emeritus, whichever came first. Directors would qualify for
emeritus status upon attaining age 70 with at least 15 years of board
service. The effect of adopting the Director Retirement Plan during fiscal
2004 was an increase of $1.1 million in the projected benefit obligation.
The following table summarizes changes in the plan's projected benefit
obligation. The table also provides a reconciliation of the funded status
to the accrued benefit cost recognized in the consolidated balance sheets.
2005 2004
------- -------
(In thousands)
Change in projected benefit obligation:
Beginning of year $ 1,633 $ 796
Service cost 48 11
Interest cost 104 48
Actuarial (gain) loss 282 (261)
Plan amendments -- 1,082
Benefits paid (43) (43)
------- -------
End of year 2,024 1,633
Fair value of plan assets -- --
------- -------
Funded status (2,024) (1,633)
Unrecognized net actuarial loss (92) (325)
Unrecognized prior service cost 1,265 1,398
------- -------
Accrued benefit cost at end of year $ (851) $ (560)
======= =======
The components of the net periodic expense for the plan and the discount
rates used to determine the projected benefit obligation were as follows:
2005 2004 2003
---- ---- ----
(Dollars in thousands)
Service cost $ 48 $ 11 $ 9
Interest cost 104 48 52
Recognized net actuarial gain (40) -- (3)
Amortization of prior service cost 133 79 79
----- ----- -----
Net periodic expense $ 245 $ 138 $ 137
===== ===== =====
Discount rate used to determine the
projected benefit obligation at March 31 5.75% 5.75% 6.25%
Savings Plan
The Company maintains an employee savings plan under Section 401(k) of the
Internal Revenue Code. Eligible employees are able to make contributions
to the plan of up to 10% of their compensation. Prior to February 1, 1999,
the Company made matching contributions equal to 50% of the participant's
contributions to the plan. The Company ceased its matching contributions
effective February 1, 1999.
46
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Employee Stock Ownership Plan
In connection with the initial stock offering in October 1998, the Company
established an ESOP for eligible employees who meet certain age and
service requirements. In fiscal 1999, the ESOP borrowed approximately $1.9
million from Sound Federal Bancorp and used the funds to purchase 531,563
shares of common stock sold in the Offering. This loan has a 10-year term
and bears interest at the prime rate. In fiscal 2003, the ESOP purchased
622,458 shares of common stock in the second-step conversion with the
proceeds of a $6.2 million loan from the Company, which has a 20-year term
and bears interest at 6.0%. The Bank makes periodic contributions to the
ESOP sufficient to satisfy the debt service requirements of the loans. The
ESOP uses these contributions and any dividends received by the ESOP on
unallocated shares to make principal and interest payments on the loans,
which had total unpaid principal balances of $6.4 million and $6.8 million
at March 31, 2005 and 2004, respectively.
Shares purchased by the ESOP are held in a suspense account by the plan
trustee until allocated to participant accounts. Shares released from the
suspense account are allocated to participants on the basis of their
relative compensation in the year of allocation. Participants become
vested in the allocated shares over a period not to exceed five years. Any
forfeited shares are allocated to other participants in the same
proportion as contributions.
ESOP expense was $1.2 million, $1.2 million and $532,000 for the years
ended March 31, 2005, 2004 and 2003, respectively. The cost of the ESOP
shares that have not yet been allocated or committed to be released to
participants is deducted from stockholders' equity (698,606 shares and
782,944 shares at March 31, 2005 and 2004, respectively). The fair value
of these shares was approximately $10.8 million and $11.5 million at March
31, 2005 and 2004, respectively.
Stock Options
In October 1999, the stockholders approved the Sound Federal Bancorp 1999
Stock Option Plan (the "Stock Option Plan") and option grants were made
for 583,048 shares at an exercise price of $3.298 per share. These options
have a 10-year term and are fully vested at March 31, 2005. Each option
entitles the holder to purchase one share of common stock at an exercise
price equal to the fair market value of the stock on the grant date.
On February 4, 2004, the stockholders approved the Sound Federal Bancorp,
Inc. Incentive Stock Benefit Plan (the "ISB Plan"). A total of 700,266
shares of authorized but unissued common stock were reserved for issuance
under this plan. On February 5, 2004, initial grants were made under the
ISB Plan for 665,253 shares at an exercise price of $15.20 per share,
resulting in 35,013 shares available for future option grants. Options
have a 10-year term and may be either non-qualified stock options or
incentive stock options. The options vest at a rate of 20% on each of five
annual vesting dates, with the first vesting occurring in February 2004.
Each option entitles the holder to purchase one share of common stock at
an exercise price equal to the fair market value of the stock on the grant
date.
Options granted under both plans include a reload feature, limited stock
appreciation rights upon a change in control (as defined), and dividend
equivalent rights upon the declaration of an extraordinary dividend (as
defined).
47
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Stock option activity is summarized below:
Options Outstanding Options Exercisable
---------------------- ---------------------
Weighted Weighted
Average Average
Exercise Exercise
Number Price Number Price
----------- -------- -------- --------
At March 31, 2002 560,915 $ 3.298 348,723 $3.298
Exercised (30,433) 3.298
---------
At March 31, 2003 530,482 3.298 428,818 3.298
Granted 665,253 15.200
Exercised (81,185) 3.298
---------
At March 31, 2004 1,114,550 10.402 582,347 6.014
Exercised (77,665) 3.298
---------
At March 31, 2005 1,036,885 10.934 637,724 8.264
=========
Additional information for outstanding and exercisable options at March
31, 2005 follows:
Options Options
Exercise Price Outstanding Exercisable
-------------- ----------- -----------
$ 3.298 371,632 371,632
15.200 665,253 266,092
--------- -------
1,036,885 637,724
========= =======
Stock Awards
The Company granted stock awards pursuant to the Recognition and Retention
Plan (the "RRP") established in October 1999 and the ISB Plan established
in February 2004. The purpose of both plans is to provide officers and
directors of the Company with a proprietary interest in the Company in a
manner designed to encourage their retention. Through March 31, 2005, a
total of 389,037 and 291,524 shares have been awarded under the ISB Plan
and RRP, respectively. The awards vest at a rate of 20% on each of five
annual vesting dates. The shares awarded pursuant to the RRP became fully
vested during the year ended March 31, 2004. The first vesting date for
shares awarded under the ISB Plan was in November 2004. The expense
recognized for stock awards amounted to $1.2 million, $395,000 and
$144,000 for the years ended March 31, 2005, 2004 and 2003, respectively.
(11) Commitments and Contingencies
Off-Balance Sheet Financial Instruments
The Company's off-balance sheet financial instruments at March 31, 2005
and 2004 were limited to loan origination commitments of $66.0 million and
$34.0 million, respectively, and unused lines of credit (principally fixed
rate home equity lines) extended to customers of $47.6 million and $40.9
million, respectively. Substantially all of these commitments and lines of
credit have been provided to customers within the Company's primary
lending area described in Note 5. Loan origination commitments at March
31, 2005 consisted of adjustable rate and fixed rate commitments of $34.9
million and $31.1 million, respectively, with weighted average yields of
48
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
5.79% and 6.15%, respectively. Loan origination commitments at March 31,
2004 consisted of adjustable rate and fixed rate commitments of $23.0
million and $11.0 million, respectively, with weighted average yields of
4.63% and 6.07%, respectively.
Loan origination commitments and lines of credit are contractual
agreements to lend to customers within specified time periods at interest
rates and on other terms specified in the agreements. These financial
instruments involve elements of credit risk and interest rate risk in
addition to the amounts for funded loans recognized in the consolidated
balance sheets. The contractual amounts of commitments and lines of credit
represent the Company's maximum potential exposure to credit loss
(assuming that the agreements are fully funded and any collateral proves
to be worthless), but do not necessarily represent future cash
requirements since certain agreements may expire without being fully
funded. Loan commitments generally have fixed expiration dates (ranging up
to three months) or other termination clauses and may require the payment
of a fee by the customer. Commitments and lines of credit are subject to
the same credit approval process applied in the Company's general lending
activities, including a case-by-case evaluation of the customer's
creditworthiness and related collateral requirements.
Operating Lease Commitments
The Company is obligated under non-cancelable operating leases for ten
branch offices and the Company's corporate office. Rent expense under
operating leases was $1.0 million, $808,000 and $433,000 for the years
ended March 31, 2005, 2004 and 2003, respectively. At March 31, 2005, the
future minimum rental payments under operating lease agreements for the
fiscal years ending March 31 are $1.0 million in 2006, $1.0 million in
2007, $1.1 million in 2008, $906,000 in 2009, $656,000 in 2010, and a
total of $2.5 million for 2011 and thereafter.
Legal Proceedings
In the normal course of business, the Company is involved in various
outstanding legal proceedings. In the opinion of management, after
consultation with legal counsel, the outcome of such legal proceedings
should not have a material effect on the Company's financial condition,
results of operations or liquidity.
(12) Regulatory Matters
Regulatory Capital Requirements
OTS regulations require savings institutions to maintain a minimum ratio
of tangible capital to total adjusted assets of 1.5%, a minimum ratio of
Tier I (core) capital to total adjusted assets of 4.0%, and a minimum
ratio of Total (core and supplementary) capital to risk-weighted assets of
8.0%.
Under its prompt corrective action regulations, the OTS is required to
take certain supervisory actions with respect to an undercapitalized
institution. Such actions could have a direct material effect on the
institution's financial statements. The regulations establish a framework
for the classification of depository institutions into five categories:
well capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized, and critically undercapitalized. Generally, an
institution is considered well capitalized if it has a Tier I (core)
capital ratio of at least 5.0%, a Tier I risk-based capital ratio of at
least 6.0%, and a Total risk-based capital ratio of at least 10.0%.
The foregoing capital ratios are based in part on specific quantitative
measures of assets, liabilities and certain off-balance sheet items as
calculated under regulatory accounting practices. Capital amounts and
classifications are also subject to qualitative judgments by the OTS about
capital components, risk weightings and other factors. These capital
requirements apply only to the Bank, and do not consider additional
capital retained by the Holding Company.
Management believes that, as of March 31, 2005 and 2004, the Bank met all
capital adequacy requirements to which it was subject. Further, the most
recent OTS notification categorized the Bank as a well-capitalized
49
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
institution under the prompt corrective action regulations. There have
been no conditions or events since that notification that management
believes have changed the Bank's capital classification.
The following is a summary of the Bank's actual capital amounts and
ratios, compared to the OTS requirements for minimum capital adequacy and
for classification as a well-capitalized institution. In accordance with
the applicable regulatory requirements, the Bank's actual tangible and
Tier 1 capital amounts exclude goodwill and the after-tax net unrealized
gain or loss on securities available for sale, while the Total risk-based
capital amounts include the allowance for loan losses.
OTS Requirements
--------------------------------------------------------
Classification as Well
Bank Actual Minimum Capital Adequacy Capitalized
------------------------- -------------------------- -------------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(Dollars in thousands)
March 31, 2005
Tangible capital $101,814 10.3% $ 14,888 1.5%
Tier I (core) capital 101,814 10.3 39,703 4.0 $ 49,627 5.0%
Risk-based capital:
Tier I 101,814 22.9 17,729 4.0 26,591 6.0
Total 104,825 23.6 35,455 8.0 44,319 10.0
March 31, 2004
Tangible capital $ 95,143 10.9% $ 13,071 1.5%
Tier I (core) capital 95,143 10.9 34,858 4.0 $ 43,571 5.0%
Risk-based capital:
Tier I 95,143 24.3 15,689 4.0 23,533 6.0
Total 97,855 25.0 31,377 8.0 39,221 10.0
Dividend Limitations
Under OTS regulations, savings associations such as the Bank generally may
declare annual cash dividends up to an amount equal to net income for the
current year plus retained net income for the two preceding years.
Dividends in excess of this amount require OTS approval. Unlike the Bank,
the Holding Company is not subject to OTS regulatory limitations on the
payment of dividends to its shareholders.
Stock Repurchase Program
In June 2004, the Company announced a program to repurchase up to 658,844
shares of its common stock. Through March 31, 2005, a total of 250,000
shares had been purchased at an average price of $15.05 per share. The
repurchase program has no expiration date.
Liquidation Rights
Upon completion of the second-step conversion in January 2003, the Bank
established a special "liquidation account" in accordance with OTS
regulations. The account was established for the benefit of Eligible
Account Holders and Supplemental Eligible Account Holders (as defined in
the plan of conversion) in an amount equal to the greater of (i) the
Mutual Holding Company's ownership interest in the retained earnings of
Sound Federal Bancorp as of the date of its latest balance sheet contained
in the prospectus, or (ii) the retained earnings of the Bank at the time
that the Bank reorganized into the Mutual Holding Company in 1998. Each
Eligible Account Holder and Supplemental Eligible Account Holder that
continues to maintain his or her deposit account at the Bank would be
entitled, in the event of a complete liquidation of the Bank, to a pro
rata interest in the liquidation account prior to any payment to the
stockholders of the Holding Company. The liquidation account is reduced
annually on December 31 to the extent that Eligible Account Holders and
Supplemental Eligible Account Holders have reduced their qualifying
deposits as of each anniversary date. Subsequent increases in deposits do
not restore such account holder's interest in the liquidation account. The
Bank may not pay cash dividends or make other capital distributions if the
effect thereof would be to reduce its stockholder's equity below the
amount of the liquidation account.
50
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
(13) Comprehensive Income (Loss)
Comprehensive income (loss) represents the sum of net income and items of
"other comprehensive income or loss" that are reported directly in
stockholders' equity, such as the change during the period in the
after-tax net unrealized gain or loss on securities available for sale and
minimum pension liability adjustments. The Company has reported its total
comprehensive income in the consolidated statements of changes in
stockholders' equity.
The Company's other comprehensive (loss) income is summarized as follows
for the years ended March 31:
2005 2004 2003
------- ------- -------
(In thousands)
Net unrealized holding (loss) gain
arising during the period on
securities available for sale $(5,677) $(2,352) $ 1,533
Additional minimum pension liability -- 3,468 (3,298)
Related deferred income tax effect 2,252 (430) 680
------- ------- -------
Other comprehensive (loss) income $(3,425) $ 686 $(1,085)
======= ======= =======
The Company's accumulated other comprehensive (loss) income, which is
included in stockholders' equity, is summarized as follows at March 31:
2005 2004
------- -------
(In thousands)
Net unrealized holding (loss) gain
on securities available for sale $(4,534) $ 1,143
Related deferred income taxes 1,811 (441)
------- -------
Accumulated other comprehensive (loss) income $(2,723) $ 702
======= =======
51
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
(14) Earnings Per Share
The following is a summary of the Company's earnings per share
calculations. For purposes of computing basic EPS, net income applicable
to common stock equaled net income for each year presented.
Years Ended March 31,
-------------------------------------
2005 2004 2003
------- ------- -------
(In thousands, except per share data)
Net income $ 5,469 $ 6,618 $ 8,526
======= ======= =======
Weighted average common shares
outstanding for computation
of basic EPS (1) 11,651 12,367 12,801
Common-equivalent shares for the
dilutive effect of stock
options and stock awards (2) 267 346 312
------- ------- -------
Weighted average common shares for
computation of diluted EPS 11,918 12,713 13,113
======= ======= =======
Earnings per common share:
Basic $ 0.47 $ 0.54 $ 0.67
Diluted 0.46 0.52 0.65
======= ======= =======
(1) Excludes shares under stock awards that have not vested and
unallocated ESOP shares that have not been released or committed to
be released to participants.
(2) Represents an incremental number of shares, computed using the
treasury stock method, with respect to outstanding stock options and
unvested stock awards.
52
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
(15) Fair Values of Financial Instruments
SFAS No. 107, Disclosures about Fair Value of Financial Instruments,
requires disclosures for financial instruments for which it is practicable
to estimate fair value. The definition of a financial instrument includes
many of the assets and liabilities recognized in the Company's
consolidated balance sheets, as well as certain off-balance sheet items.
Fair value is defined in SFAS No. 107 as the amount at which a financial
instrument could be exchanged in a current transaction between willing
parties, other than in a forced sale or liquidation.
Quoted market prices are used to estimate fair values when those prices
are available. However, active markets do not exist for many types of
financial instruments. Consequently, fair values for these instruments
must be estimated by management using techniques such as discounted cash
flow analysis and comparison to similar instruments. Estimates developed
using these methods are highly subjective and require judgments regarding
significant matters such as the amount and timing of future cash flows and
the selection of discount rates that appropriately reflect market and
credit risks. Changes in these judgments often have a material effect on
the fair value estimates. Since these estimates are made as of a specific
point in time, they are susceptible to material near-term changes. Fair
values disclosed in accordance with SFAS No. 107 do not reflect any
premium or discount that could result from the sale of a large volume of a
particular financial instrument, nor do they reflect possible tax
ramifications or estimated transaction costs.
The following is a summary of the carrying amounts and estimated fair
values of the Company's financial assets and liabilities (none of which
were held for trading purposes) at March 31:
2005 2004
---------------------------------- ----------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
---------------- ---------------- ---------------- ----------------
(In millions)
Financial assets:
Cash and cash equivalents $ 42.6 $ 42.6 $ 31.2 $ 31.2
Securities available for sale 276.2 276.2 337.7 337.7
Securities held to maturity 79.5 78.7 -- --
Loans, net 560.8 563.0 478.5 484.4
Accrued interest receivable 4.3 4.3 3.6 3.6
FHLB stock 5.7 5.7 5.3 5.3
Financial liabilities:
Savings certificate accounts 552.9 552.9 445.7 448.8
Other deposit accounts 278.9 278.9 262.6 262.6
Borrowings 38.0 37.9 35.0 36.2
Mortgagors' escrow funds 5.3 5.3 4.5 4.5
======== ======== ======== ========
The following is a description of the valuation methods used by the
Company to estimate the fair values of its financial instruments:
Securities
The fair values of securities were based on market prices or dealer
quotes.
53
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Loans
For valuation purposes, the loan portfolio was segregated into its
significant categories, such as residential mortgage loans and consumer
loans. These categories were further analyzed, where appropriate, into
components based on significant financial characteristics such as type of
interest rate (fixed or adjustable). Generally, management estimated fair
values by discounting the anticipated cash flows at current market rates
for loans with similar terms to borrowers of similar credit quality.
Deposit Liabilities
The fair values of savings certificate accounts represent contractual cash
flows discounted using interest rates currently offered on certificates
with similar characteristics and remaining maturities (but are not less
than the net amount at which depositors could settle their accounts). In
accordance with SFAS No. 107, the fair values of other deposit accounts
(those with no stated maturity, such as passbook and money market
accounts) are equal to the carrying amounts payable on demand. These fair
values do not include the value of core deposit relationships that
comprise a significant portion of the Company's deposit base. Management
believes that these core deposit relationships provide a relatively
stable, low-cost funding source that has a substantial unrecognized value
separate from the deposit balances.
Borrowings
The fair value of securities repurchase agreements represents contractual
repayments discounted using interest rates currently available on
borrowings with similar characteristics and remaining maturities.
Other Financial Instruments
The remaining financial assets and liabilities listed in the preceding
table have fair values that approximate the respective carrying amounts in
the consolidated balance sheets because the instruments are payable on
demand or have short-term maturities and present relatively low credit
risk and interest rate risk. Fair values of the loan origination
commitments and unused lines of credit described in Note 11 were estimated
based on an analysis of the interest rates and fees currently charged to
enter into similar transactions, considering the remaining terms of the
instruments and the creditworthiness of the potential borrowers. At March
31, 2005 and 2004, the fair values of these instruments approximated the
related carrying amounts.
54
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
(16) Parent Company Condensed Financial Statements
Set forth below are condensed financial statements of the Holding Company:
March 31,
---------------------
Condensed Balance Sheets 2005 2004
-------- --------
(In thousands)
Assets
Interest-bearing deposits at subsidiary bank $ 10,416 $ 21,711
Loans receivable from ESOP 6,448 6,818
Investment in subsidiary bank 113,065 109,820
Due from subsidiary bank 826 4,190
Other assets 2,504 1,102
-------- --------
Total assets $133,259 $143,641
======== ========
Liabilities $ 6,099 $ 6,582
Stockholders' Equity 127,160 137,059
-------- --------
Total liabilities and stockholders' equity $133,259 $143,641
======== ========
Years Ended March 31,
-----------------------------
Condensed Statements of Income 2005 2004 2003
------- ------- -------
(In thousands)
Interest income $ 339 $ 499 $ 167
Other expenses (381) (397) (251)
------- ------- -------
Income (loss) before income taxes and
equity in undistributed earnings of
subsidiary bank (42) 102 (84)
Income tax expense (benefit) (12) 90 (14)
------- ------- -------
Income (loss) before equity in
undistributed earnings of
subsidiary bank (30) 12 (70)
Equity in undistributed earnings of
subsidiary bank 5,499 6,606 8,596
------- ------- -------
Net income $ 5,469 $ 6,618 $ 8,526
======= ======= =======
55
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Years Ended March 31,
---------------------------------------------
Condensed Statements of Cash Flows 2005 2004 2003
-------- -------- --------
(In thousands)
Operating Activities
Net income $ 5,469 $ 6,618 $ 8,526
Adjustments to reconcile net income to
net cash provided by (used in) operating activities:
Equity in undistributed earnings of
subsidiary bank (5,499) (6,606) (8,596)
Decrease (increase) in due from subsidiary bank 3,364 (3,581) (94)
Other (279) (158) (60)
-------- -------- --------
Net cash provided by (used in)
operating activities 3,055 (3,727) (224)
-------- -------- --------
Investing Activities
Cash contributed to subsidiary bank -- -- (38,323)
ESOP loan repayments 370 367 192
-------- -------- --------
Net cash provided by (used in)
investing activities 370 367 (38,131)
-------- -------- --------
Financing Activities
Purchases of treasury stock (12,087) (8,417) --
Proceeds from stock offering, net -- -- 70,051
Proceeds from exercise of stock options 258 268 100
Payment of cash dividends on common stock (2,891) (2,648) (1,155)
Cash payment in lieu of fractional shares -- -- (2)
-------- -------- --------
Net cash (used in) provided by financing
activities (14,720) (10,797) 68,994
-------- -------- --------
Net (decrease) increase in cash and cash equivalents (11,295) (14,157) 30,639
Cash and cash equivalents at beginning of year 21,711 35,868 5,229
-------- -------- --------
Cash and cash equivalents at end of year $ 10,416 $ 21,711 $ 35,868
======== ======== ========
56
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
(17) Quarterly Results of Operations (Unaudited)
The following is a condensed summary of quarterly results of operations
for the years ended March 31, 2005 and 2004:
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(In thousands, except per share data)
Year Ended March 31, 2005
Interest and dividend income $ 9,769 $10,485 $10,728 $10,918
Interest expense 3,311 3,779 4,053 4,334
------- ------- ------- -------
Net interest income 6,458 6,706 6,675 6,584
Provision for loan losses 75 75 75 75
Non-interest income 352 310 382 403
Non-interest expense 4,292 4,601 4,600 5,075
------- ------- ------- -------
Income before income tax expense 2,443 2,340 2,382 1,837
Income tax expense 946 909 956 722
------- ------- ------- -------
Net income $ 1,497 $ 1,431 $ 1,426 $ 1,115
======= ======= ======= =======
Basic earnings per common share $ 0.13 $ 0.12 $ 0.12 $ 0.10
Diluted earnings per common share 0.12 0.12 0.12 0.10
======= ======= ======= =======
Year Ended March 31, 2004
Interest and dividend income $ 9,791 $ 9,272 $ 9,873 $ 9,803
Interest expense 3,261 3,067 3,186 3,033
------- ------- ------- -------
Net interest income 6,530 6,205 6,687 6,770
Provision for loan losses 50 75 75 75
Non-interest income 285 228 252 276
Non-interest expense 3,984 3,648 3,936 4,538
------- ------- ------- -------
Income before income tax expense 2,781 2,710 2,928 2,433
Income tax expense 1,064 1,060 1,133 977
------- ------- ------- -------
Net income $ 1,717 $ 1,650 $ 1,795 $ 1,456
======= ======= ======= =======
Basic earnings per common share $ 0.14 $ 0.13 $ 0.15 $ 0.12
Diluted earnings per common share 0.14 0.13 0.14 0.12
======= ======= ======= =======
57
Corporate Information
Headquarters
1311 Mamaroneck Avenue
White Plains, New York 10605
914-761-3636
Transfer Agent
Registrar and Transfer Company
10 Commerce Drive
Cranford, New Jersey 07016
1-800-866-1340
Annual Meeting
August 11, 2005 4:00 p.m.
Sound Federal Bancorp, Inc.
Corporate Headquarters
1311 Mamaroneck Avenue
White Plains, NY 10605
Common Stock Information
The Company's common stock is traded on the
Nasdaq National Market under the symbol
"SFFS." At March 31, 2005, the common stock
was held by 1,936 stockholders of record.
Market prices and dividends for the
indicated fiscal quarter were as follows:
Market Price
------------
Quarter Ended High Low Dividends
------------- ------ ------ ---------
June 30, 2003 $14.05 $12.53 $0.05
September 30, 2003 16.42 13.10 0.05
December 31, 2003 17.35 14.44 0.06
March 31, 2004 16.26 14.52 0.06
June 30, 2004 15.00 12.51 0.06
September 30, 2004 14.78 12.67 0.06
December 31, 2004 16.25 13.99 0.06
March 31, 2005 16.23 14.75 0.06
General Counsel
James Staudt, Esquire
Special Counsel
Luse Gorman Pomerenk & Schick, P.C.
5335 Wisconsin Avenue, N.W.
Suite 400
Washington, DC 20015
Independent Registered Public Accounting Firm
KPMG LLP
3001 Summer Street
Stamford, Connecticut 06905
Investor Relations
Anthony J. Fabiano
Senior Vice-President, Chief Financial Officer
and Corporate Secretary
Sound Federal Bancorp, Inc.
1311 Mamaroneck Avenue
White Plains, New York 10605
914-761-3636
Annual Report on Form 10-K
A copy of the Company's Form 10-K, as filed
with the Securities and Exchange Commission,
is available without charge by written
request to Investor Relations at the address
set forth above.
58
Directors of the Company and the Bank
Bruno J. Gioffre, Chairman of the Board
Richard P. McStravick, President and Chief
Executive Officer
Roberta I. Bernhardt
Joseph Dinolfo
Donald H. Heithaus
Joseph A. Lanza
Eldorus Maynard
James Staudt
Samuel T. Telerico
Directors Emeriti
Paul F. Starck, Chairman Emeritus
George W. Brown
Arthur C. Phillips
Officers of the Company and the Bank
Richard P. McStravick, President and
Chief Executive Officer
Anthony J. Fabiano, Senior Vice-President,
Chief Financial Officer and Corporate
Secretary
Officers of the Bank
Accounting
Frank Rossi, Vice President and Controller
Terri Anne Stollmer, Assistant Vice President
Mark Madoff, Assistant Vice President
Branches
Michael Bulgia, Assistant Vice-President
Doreen Leonard, Assistant Vice-President
Arthur Murphy, Assistant Vice-President
Heather Smeriglio, Assistant Vice-President
Marie Stacy, Assistant Vice-President
John Anderson, Assistant Treasurer
Sylvia Astrologo, Assistant Treasurer
Henry Benvenuto, Assistant Treasurer
Thomas W. Burns, Assistant Treasurer
Debra Caffrey, Assistant Treasurer
Lisa Greco, Assistant Treasurer
Maria Jose, Assistant Treasurer
Debra LoBello, Assistant Treasurer
Marianne Lubbers, Assistant Treasurer
Patricia Soravilla, Assistant Treasurer
Lynne Vaughn, Assistant Treasurer
Branch Operations
Sheila V. Torpey, Vice-President
Sara Ricci, Assistant Vice-President
Business Development
William J. LaCalamito, Vice-President
Richard Bruce, Assistant Vice-President
Richard L. Perna, Assistant Vice-President
Commercial Lending
Vito LaRusso, Vice-President
Compliance
Michael J. Ceruzzi, Vice-President
Executive Secretary
Linda Lunapiena, Assistant Vice-President
Human Resources
Judy E. Malinowski, Vice-President
Lending
Joseph Filanowski, Vice-President
Mary K. Harrison, Vice-President
Timothy Murphy, Vice-President
Lorenzo Aperocho, Assistant Vice-President
Janice Holiday, Assistant Treasurer
Mary A. Maida, Assistant Secretary
Jennifer Penrod, Assistant Vice-President
Information Technology
Jean Degl, Vice-President
Marketing
Robert V. Galante Jr., Vice-President
Audit
Charles Zivian, Vice-President
Branch Locations
Mamaroneck
300 Mamaroneck Avenue
Mamaroneck, New York 10543
914-698-6400
Harrison
389 Halstead Avenue
Harrison, New York 10528
914-835-0500
Rye Brook
115 South Ridge Street
Rye Brook, New York 10573
914-939-0100
New City
180 South Main Street
New City, New York 10956
845-639-3400
Cos Cob
100 East Putnam Avenue
Cos Cob, Connecticut 06807
203-862-8400
Peekskill
1019 Park Street
Peekskill, New York 10566
914-737-2777
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Yorktown Heights
1961 Commerce Street
Yorktown Heights, New York 10598
914-962-3883
Cortlandt Town Center
Route 6
Cortlandt, New York 10547
914-528-1117
New Rochelle
88 Fourth Street
New Rochelle, New York 10801
914-633-0345
Somers
302 Somers Commons
Baldwin Place, New York 10589
914-621-2111
Stamford
599 Newfield Avenue
Stamford, Connecticut 06905
203-348-8800
Brookfield
247 Federal Road
Brookfield, Connecticut 06804
203-744-1200
Carmel
190 Gleneida Avenue
Carmel, New York 10512
845-228-0008
Bethel
146 Greenwood Avenue
Bethel, Connecticut 06801
203-792-2500
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