UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2005
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission file number 000-24811
SOUND FEDERAL BANCORP, INC.
(Exact name of registrant as specified in its charter)
Delaware 22-3887679
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1311 Mamaroneck Ave., White Plains, New York 10605
(Address of principal executive offices)
(Zip Code)
(914) 761-3636
(Registrant's telephone number including area code)
N/A
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed from last Report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding twelve months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No .
Indicate by check mark whether the Registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer (as defined in Rule
12b-2 of the Securities Exchange Act of 1934). Large accelerated filer ____
Accelerated filer X Non-accelerated filer ____.
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes _____ No X .
Indicate the number of shares outstanding of each of the issuer's classes
of common stock as of the latest practicable date.
Class Shares
---------------- Outstanding at
Common Stock, February 6, 2006
par value, $0.01 ----------------
12,322,206
TABLE OF CONTENTS
PART I -- FINANCIAL INFORMATION
-------------------------------
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets at December 31, 2005
and March 31, 2005................................................. 1
Consolidated Statements of Income for the Three Months and
Nine Months Ended December 31, 2005 and 2004....................... 2
Consolidated Statement of Changes in Stockholders' Equity
for the Nine Months Ended December 31, 2005........................ 3
Consolidated Statements of Cash Flows for the Nine Months
Ended December 31, 2005 and 2004................................... 4
Notes to Unaudited Consolidated Financial Statements............... 5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.............................................. 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk......... 24
Item 4. Controls and Procedures............................................ 24
PART II -- OTHER INFORMATION
----------------------------
Item 1. Legal Proceedings.................................................. 25
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds........ 25
Item 3. Defaults upon Senior Securities.................................... 25
Item 4. Submission of Matters to a Vote of Security Holders................ 25
Item 5. Other Information.................................................. 25
Item 6. Exhibits........................................................... 25
Signatures......................................................... 26
i
Part 1. - FINANCIAL INFORMATION
Item 1. Financial Statements
Sound Federal Bancorp, Inc. and Subsidiary
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Dollars in thousands) December 31, March 31,
2005 2005
------------ -----------
Assets
Cash and due from banks $ 12,591 $ 11,512
Federal funds sold and other overnight deposits 44,116 31,095
----------- -----------
Total cash and cash equivalents 56,707 42,607
----------- -----------
Securities:
Available for sale, at fair value (including $33,237
and $37,831 pledged as collateral for borrowings
under repurchase agreements at December 31,
2005 and March 31, 2005, respectively) 227,537 276,154
Held to maturity, at amortized cost (fair value of
$106,474 and $78,728 at December 31, 2005 and
March 31, 2005, respectively) 107,931 79,489
----------- -----------
Total securities 335,468 355,643
----------- -----------
Loans, net:
Mortgage loans 707,288 558,662
Consumer and commercial loans 6,698 5,100
Allowance for loan losses (Note 5) (3,236) (3,011)
----------- -----------
Total loans, net 710,750 560,751
----------- -----------
Accrued interest receivable 4,764 4,277
Federal Home Loan Bank stock 3,157 5,738
Premises and equipment, net 5,687 6,214
Goodwill 13,970 13,970
Bank-owned life insurance 10,747 10,464
Prepaid pension costs 4,299 3,057
Deferred income taxes 1,977 2,236
Other assets 1,800 1,993
----------- -----------
Total assets $ 1,149,326 $ 1,006,950
=========== ===========
Liabilities and Stockholders' Equity
Liabilities:
Deposits $ 969,702 $ 831,768
Borrowings (Note 6) 35,000 38,000
Mortgagors' escrow funds 7,302 5,264
Due to brokers for securities purchased 5,867 2,513
Accrued expenses and other liabilities 2,804 2,245
----------- -----------
Total liabilities 1,020,675 879,790
----------- -----------
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; 12,322,206
and 12,377,206 shares outstanding at December 31, 2005
and March 31, 2005, respectively) 136 136
Additional paid-in capital 104,630 103,728
Treasury stock, at cost (1,313,964 and 1,258,964 shares
at December 31, 2005 and March 31, 2005, respectively) (19,013) (18,131)
Common stock held by Employee Stock Ownership Plan ("ESOP") (5,675) (6,053)
Unearned stock awards (3,548) (4,435)
Retained earnings 55,356 54,638
Accumulated other comprehensive loss, net of taxes (Note 7) (3,235) (2,723)
----------- -----------
Total stockholders' equity 128,651 127,160
----------- -----------
Total liabilities and stockholders' equity $ 1,149,326 $ 1,006,950
=========== ===========
See accompanying notes to unaudited consolidated financial statements.
1
Sound Federal Bancorp, Inc. and Subsidiary
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except per share data)
For the Three Months Ended For the Nine Months Ended
December 31, December 31,
-------------------------- -------------------------
2005 2004 2005 2004
---- ---- ---- ----
Interest and Dividend Income
Loans $ 9,834 $ 7,482 $26,972 $21,733
Mortgage-backed and other securities 3,166 3,101 9,392 8,917
Federal funds sold and other overnight deposits 290 113 666 245
Other earning assets 88 32 240 87
------- ------- ------- -------
Total interest and dividend income 13,378 10,728 37,270 30,982
------- ------- ------- -------
Interest Expense
Deposits 6,286 3,677 16,377 10,002
Borrowings 362 371 1,084 1,126
Other interest-bearing liabilities 7 5 18 15
------- ------- ------- -------
Total interest expense 6,655 4,053 17,479 11,143
------- ------- ------- -------
Net interest income 6,723 6,675 19,791 19,839
Provision for loan losses (Note 5) 75 75 225 225
------- ------- ------- -------
Net interest income after provision for loan losses 6,648 6,600 19,566 19,614
------- ------- ------- -------
Non-Interest Income
Service charges and fees 251 244 885 740
Income on bank-owned life insurance 95 121 283 287
Gain on sale of assets -- 17 325 17
------- ------- ------- -------
Total non-interest income 346 382 1,493 1,044
------- ------- ------- -------
Non-Interest Expense
Compensation and benefits 2,969 2,538 8,637 7,412
Occupancy and equipment 748 673 2,236 1,967
Data processing service fees 264 314 910 878
Advertising and promotion 303 189 828 679
Other 961 886 2,638 2,557
------- ------- ------- -------
Total non-interest expense 5,245 4,600 15,249 13,493
------- ------- ------- -------
Income before income tax expense 1,749 2,382 5,810 7,165
Income tax expense 703 956 2,281 2,811
------- ------- ------- -------
Net income $ 1,046 $ 1,426 $ 3,529 $ 4,354
======= ======= ======= =======
Earnings per share (Note 4):
Basic earnings per share $ 0.09 $ 0.12 $ 0.31 $ 0.37
======= ======= ======= =======
Diluted earnings per share $ 0.09 $ 0.12 $ 0.30 $ 0.36
======= ======= ======= =======
See accompanying notes to unaudited consolidated financial statements.
2
Sound Federal Bancorp, Inc. and Subsidiary
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
For the Nine Months Ended December 31, 2005
(Unaudited)
(Dollars in thousands, except per share data)
Common Accumulated
Additional Stock Unearned Other Total
Common Paid-in Treasury Held by Stock Retained Comprehensive Stockholders'
Stock Capital Stock ESOP Awards Earnings Loss Equity
--------- ---------- ---------- ---------- --------- --------- ------------- -------------
Balance at March 31, 2005 $ 136 $ 103,728 $ (18,131) $ (6,053) $ (4,435) $ 54,638 $ (2,723) $ 127,160
Net income -- -- -- -- -- 3,529 -- 3,529
Other comprehensive loss
(Note 7) -- -- -- -- -- -- (512) (512)
---------
Total comprehensive income 3,017
Dividends paid ($0.21 per
share), net of dividends
on unallocated ESOP shares -- -- -- -- -- (2,450) -- (2,450)
Purchases of treasury stock
(87,300 shares) -- -- (1,349) -- -- -- -- (1,349)
Reissuance of treasury stock
for exercise of stock
options (32,300 shares) -- -- 467 -- -- (361) -- 106
Tax benefit from exercise of
stock options -- 171 -- -- -- -- -- 171
Vesting of stock awards and
related tax benefits -- 53 -- -- 887 -- -- 940
ESOP shares committed to be
released for allocation -- 678 -- 378 -- -- -- 1,056
--------- --------- --------- --------- --------- --------- --------- ---------
Balance at December 31, 2005 $ 136 $ 104,630 $ (19,013) $ (5,675) $ (3,548) $ 55,356 $ (3,235) $ 128,651
========= ========= ========= ========= ========= ========= ========= =========
See accompanying notes to unaudited consolidated financial statements.
3
Sound Federal Bancorp, Inc. and Subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In Thousands)
For the Nine Months Ended
December 31,
---------------------------
2005 2004
--------- -------
Operating Activities
Net income $ 3,529 $ 4,354
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 225 225
Depreciation, amortization and accretion 1,728 1,830
ESOP and stock award expense 1,943 1,769
Income taxes 712 525
Origination of loans held for sale -- (777)
Proceeds from sales of loans held for sale -- 794
Gain on sale of assets (325) (17)
Pension costs (1,242) (407)
Other adjustments, net 23 159
-------- --------
Net cash provided by operating activities 6,593 8,455
-------- --------
Investing Activities
Purchases of securities:
Available for sale (1,000) (31,015)
Held to maturity (38,524) (68,620)
Proceeds from payments, maturities and calls of securities:
Available for sale 48,267 65,263
Held to maturity 13,340 3,092
Net disbursements for loan originations and principal repayments (148,025) (64,137)
Purchase of mortgage loans (2,532) --
Purchases of Federal Home Loan Bank stock (647) (435)
Proceeds from redemption of Federal Home Loan Bank stock 3,228 --
Proceeds from sale of real estate 396 --
Purchases of premises and equipment (275) (1,013)
-------- --------
Net cash used in investing activities (125,772) (96,865)
-------- --------
Financing Activities
Net increase in deposits 137,934 94,660
Proceeds from borrowings -- 3,000
Repayment of borrowings (3,000) --
Net increase in mortgagors' escrow funds 2,038 1,490
Purchases of treasury stock (1,349) (8,324)
Proceeds from exercise of stock options 106 193
Payment of cash dividends on common stock (2,450) (2,177)
-------- --------
Net cash provided by financing activities 133,279 88,842
-------- --------
Increase in cash and cash equivalents 14,100 432
Cash and cash equivalents at beginning of period 42,607 31,211
-------- --------
Cash and cash equivalents at end of period $56,707 $ 31,643
======== ========
Supplemental Information
Interest paid $ 17,418 $ 11,102
Income taxes paid 1,593 2,270
Increase (decrease) in due to brokers for securities purchased 3,354 (84)
======== ========
See accompanying notes to unaudited consolidated financial statements.
4
Sound Federal Bancorp, Inc. and Subsidiary
NOTES TO UNAUDITED 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 its conversion to a fully public holding company structure. 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".
2. Basis of Presentation
The consolidated financial statements included herein have been prepared
by the Company without audit. In the opinion of management, the unaudited
consolidated financial statements include all adjustments, consisting of normal
recurring accruals, necessary for a fair presentation of the financial position
and results of operations for the periods presented. Certain information and
footnote disclosures normally included in annual financial statements prepared
in conformity with U.S. generally accepted accounting principles have been
condensed or omitted pursuant to the rules and regulations of the Securities and
Exchange Commission; however, the Company believes that the disclosures are
adequate to make the information presented not misleading. The operating results
for the periods presented are not necessarily indicative of results to be
expected for any other interim period or for the entire fiscal year ending March
31, 2006.
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 in Note 5.
The unaudited interim consolidated financial statements presented herein
should be read in conjunction with the annual audited consolidated financial
statements of the Company for the fiscal year ended March 31, 2005, included in
the Company's 2005 Annual Report on Form 10-K.
3. Stock-Based Compensation
Statement of Financial Accounting Standards ("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
5
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.
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:
Three Months Ended Nine Months Ended
December 31, December 31,
------------------ ------------------
2005 2004 2005 2004
------ ------ ------ ------
(In thousands, except per share data)
Net income, as reported $1,046 $1,426 $3,529 $4,354
Add stock award expense included in reported
net income, net of related tax effects 180 181 539 542
Deduct stock award and stock option expense
determined under the fair-value-based
method, net of related tax effects (296) (296) (887) (905)
------ ------ ------ ------
Pro forma net income $ 930 $1,311 $3,181 $3,991
====== ====== ====== ======
Earnings per share:
Basic, as reported $ 0.09 $ 0.12 $ 0.31 $ 0.37
====== ====== ====== ======
Basic, pro forma $ 0.08 $ 0.11 $ 0.28 $ 0.34
====== ====== ====== ======
Diluted, as reported $ 0.09 $ 0.12 $ 0.30 $ 0.36
====== ====== ====== ======
Diluted, pro forma $ 0.08 $ 0.11 $ 0.27 $ 0.33
====== ====== ====== ======
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, generally 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, generally over the applicable vesting period. This
accounting treatment differs significantly from the previous accounting for
fixed stock options under APB Opinion No. 25 which generally required expense
recognition only when the exercise price of the option was less than the market
price of the underlying stock on the grant date. 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
6
grant-date fair value of those awards calculated for purposes of SFAS No. 123
pro forma disclosures. The additional compensation cost for the Company's stock
options outstanding at December 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.
4. Earnings Per Share
Weighted average common shares used in calculating basic and diluted
earnings per share for the three months ended December 31, 2005 were 11,447,061
and 11,778,153 respectively. For the three months ended December 31, 2004,
weighted average common shares used in calculating basic and diluted earnings
per share were 11,558,608 and 11,815,966, respectively.
For the nine months ended December 31, 2005, weighted average shares used
in calculating basic and diluted earnings per share were 11,448,692 and
11,746,826, respectively. For the nine months ended December 31, 2004, the
respective weighted average shares were 11,662,230 and 11,931,624.
5. 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 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.
Activity in the allowance for loan losses for the periods indicated is
summarized as follows:
Three Months Ended Nine Months Ended Year Ended
December 31, December 31, March 31,
--------------------- -------------------- ----------
2005 2004 2005 2004 2005
--------------------- -------------------- ------
(In thousands)
Balance at beginning of period $3,161 $2,862 $3,011 $2,712 $2,712
Provision for loan losses 75 75 225 225 300
Charge-offs -- -- -- -- (1)
------ ------ ------ ------ ------
Balance at end of period $3,236 $2,937 $3,236 $2,937 $3,011
====== ====== ====== ====== ======
7
6. Borrowings
The Company had the following outstanding borrowings under securities
repurchase agreements with the Federal Home Loan Bank of New York (the "FHLB")
at December 31, 2005:
Maturity Date Coupon Rate Borrowings
------------- ----------- ----------
(dollars in thousands)
January 2008(1) 5.42% $ 10,000
December 2008(1) 4.72 5,000
March 2006 2.27 7,000
March 2007 2.65 7,000
March 2008 4.13 6,000
--------
$ 35,000
========
Weighted average interest rate 3.91%
Accrued interest payable $ 186
(1) Callable quarterly
The securities transferred to the FHLB subject to the repurchase
agreements consist of U.S. Government and agency securities available for sale
with a carrying value of $18.3 million and mortgage-backed securities available
for sale with a carrying value of $15.0 million. Accrued interest receivable on
the securities was $149,000 at December 31, 2005.
7. Comprehensive Income (Loss)
Comprehensive income or 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. The Company reports its total
comprehensive income (loss) in the consolidated statement of changes in
stockholders' equity.
The Company's other comprehensive income (loss) is summarized as follows:
Three Months Ended Nine Months Ended
December 31, December 31,
------------------ -----------------
2005 2004 2005 2004
(In thousands)
Net unrealized holding (loss)
gain arising during
the period on securities available
for sale $(876) $264 $(853) $(3,256)
Related deferred income tax effect 350 (105) 341 1,285
----- ---- ----- -------
Other comprehensive (loss) income $(526) $159 $(512) $(1,971)
===== ==== ===== =======
8
The Company's accumulated other comprehensive loss, which is included in
stockholders' equity, is summarized as follows:
December 31, March 31,
2005 2005
------------ ---------
(In thousands)
Net unrealized holding loss on
securities available for sale $(5,387) $(4,534)
Related deferred income taxes 2,152 1,811
------- -------
Accumulated other comprehensive loss $(3,235) $(2,723)
======= =======
8. Postretirement 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. Contributions of $1.4 million and $1.6 million
were made during the three and nine months ended December 31, 2005,
respectively. The contribution made during the three months ended December 31,
2005 was based on an estimated actuarial valuation using a December 31, 2005
measurement date and considering among other things, the maximum deductible
contribution limits for tax purposes and the amount required to fully fund the
accumulated benefit obligation. The Company does not expect to make any further
contributions 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 components of the net periodic expense for the plans were as follows:
Three Months Ended Nine Months Ended
December 31, December 31,
------------------- -----------------
2005 2004 2005 2004
----- ----- ----- -----
(In thousands)
Service cost $ 115 $ 91 $ 345 $ 273
Interest cost 172 160 516 480
Expected return on plan assets (231) (225) (693) (675)
Recognized net actuarial loss 52 -- 156 --
Amortization of prior service cost 1 28 3 84
----- ----- ----- -----
Net periodic pension expense $ 109 $ 54 $ 327 $ 162
===== ===== ===== =====
9
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 preceding 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.
The components of the net periodic expense for the plan were as follows:
Three Months Ended Nine Months Ended
December 31, December 31,
------------------ -----------------
2005 2004 2005 2004
----- ----- ----- -----
(In thousands)
Service cost $ 36 $ 16 $ 108 $ 48
Interest cost 29 24 87 72
Recognized net actuarial gain (3) (4) (9) (12)
Amortization of prior service cost 33 45 99 135
----- ----- ----- -----
Net periodic expense $ 95 $ 81 $ 285 $ 243
===== ===== ===== =====
10
Item 2. 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 and borrowings. 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 report on Form 10-Q, 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. We do not intend to
update these 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.
11
Financial Condition
Assets. The Company's total assets amounted to $1.1 billion at December
31, 2005 as compared to $1.0 billion at March 31, 2005. The $142.4 million
increase in assets primarily consisted of a $150.0 million increase in net loans
to $710.8 million, partially offset by a decrease in total securities of $20.2
million. Our asset growth was funded principally by an $137.9 million increase
in deposits to $969.7 million.
Liabilities. Total deposits were $969.7 million at December 31, 2005, an
increase of $137.9 million as compared to $831.8 million at March 31, 2005.
Certificates of deposit increased $145.2 million to $698.1 million from $552.9
million; savings and club accounts decreased $16.9 million to $133.6 million
from $150.5 million; and money market, NOW and commercial checking accounts
increased $9.6 million to $138.0 million from $128.4 million. The increase in
deposits, primarily certificates of deposits, reflects deposit growth in two
branches opened during the fourth quarter of fiscal 2005 as well as growth in
our existing branches. We have used our certificates of deposit product as a
promotional product to attract new customers to our branches. Borrowings totaled
$35.0 million at December 31, 2005 and $38.0 million at March 31, 2005.
Stockholders' Equity. Total stockholders' equity increased $1.5 million to
$128.7 million at December 31, 2005 as compared to $127.2 million at March 31,
2005. The increase reflects net income of $3.5 million and increases of $2.3
million related to stock options, stock awards and ESOP shares, partially offset
by common stock purchases at a cost of $1.3 million, dividends paid of $2.5
million and an increase of $512,000 in the accumulated other comprehensive loss.
The accumulated other comprehensive loss of $3.2 million at December 31,
2005 represents the after-tax net unrealized loss on securities available for
sale ($5.4 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 at December 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 December 31, 2005.
12
Comparison of Results of Operations for the Three Months Ended December 31, 2005
and 2004
Average Balance Sheets. The following table sets forth average balance
sheets, average yields and costs, and certain other information for the three
months ended December 31, 2005 and 2004. The table reflects the annualized
average yield on interest-earning assets and the annualized average cost of
interest-bearing liabilities (derived by dividing the annualized interest income
or expense by the monthly 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 the 2005 and 2004 periods has been reduced
by amortization of net deferred loan origination costs of $78,000 and $136,000,
respectively. Interest income on mortgage-backed securities has been reduced by
amortization of purchase premiums (net of discounts) of $187,000 and $245,000
for those same respective periods.
For the Three Months Ended December 31,
------------------------------------------------------------------------------------
2005 2004
------------------------------------------------------------------------------------
Average Average
Outstanding Average Outstanding Average
Balance Interest Yield/Rate Balance Interest Yield/Rate
------- -------- ---------- ------- -------- ----------
(Dollars in thousands)
Interest-earning assets:
Loans (1) $ 691,217 9,834 5.64% $ 534,924 7,482 5.55%
Mortgage-backed securities (2) 221,194 2,121 3.80% 262,272 2,319 3.51%
Other securities (2) 113,998 1,045 3.64% 95,115 782 3.26%
Federal funds sold and other
overnight deposits (3) 36,752 290 3.13% 30,436 113 1.47%
Other (4) 5,721 88 6.10% 5,871 32 2.16%
---------- ------ --------- ------
Total interest-earning assets 1,068,882 13,378 4.97% 928,618 10,728 4.58%
------ ------
Non-interest earning assets 46,593 45,253
---------- ---------
Total assets $1,115,475 $ 973,871
========== =========
Interest-bearing liabilities:
Savings and club accounts $ 135,763 199 0.58% $ 152,068 205 0.53%
Money market accounts 38,115 119 1.24% 47,346 97 0.81%
NOW accounts 70,659 103 0.58% 60,880 38 0.25%
Certificates of deposit 668,790 5,865 3.48% 520,719 3,337 2.54%
Borrowings 35,000 362 4.10% 38,000 371 3.87%
Mortgagors' escrow funds 5,547 7 0.50% 4,458 5 0.44%
---------- ------ --------- ------
Total interest-bearing liabilities 953,874 6,655 2.77% 823,471 4,053 1.95%
------ ------
Non-interest-bearing liabilities 33,922 21,316
---------- ---------
Total liabilities 987,796 844,787
Stockholders' equity 127,679 129,084
---------- ---------
Total liabilities and
stockholders' equity $1,115,475 $ 973,871
========== =========
Net interest income 6,723 6,675
====== ======
Net interest rate spread (5) 2.20% 2.63%
Net earning assets (6) $ 115,008 $ 105,147
========== =========
Net interest margin (7) 2.50% 2.85%
Ratio of interest-earning assets
to interest-bearing liabilities 1.12 x 1.13 x
(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.
13
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, 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 Three Months Ended December 31,
2005 vs. 2004
------------------------------------------
Increase (Decrease) Due to
-------------------------- Total Increase
Volume Rate (Decrease)
-----------------------------------------
(In thousands)
Interest-earning assets:
Loans $ 2,228 $ 124 $2,352
Mortgage-backed securities (1,126) 928 (198)
Other securities 166 97 263
Federal funds and other
overnight deposits 28 149 177
Other (5) 61 56
------- ------ ------
Total interest-earning assets 1,291 1,359 2,650
------- ------ ------
Interest-bearing liabilities:
Savings and club accounts (84) 78 (6)
Money market accounts (104) 126 22
NOW accounts 7 58 65
Certificates of deposit 1,098 1,430 2,528
Borrowings (105) 96 (9)
Mortgage escrow funds 1 1 2
------- ------ ------
Total interest-bearing liabilities 813 1,789 2,602
------- ------ ------
Net interest income $ 478 $ (430) $ 48
Net Income. Net income amounted to $1.05 million or diluted earnings per
share of $0.09 for the quarter ended December 31, 2005 as compared to $1.43
million or diluted earnings per share of $0.12 for the quarter ended December
31, 2004. Net income decreased $380,000 for the quarter ended December 31, 2005
which is primarily attributable to a $645,000 increase in non-interest expense,
partially offset by a $48,000 increase in net interest income and a $253,000
decrease in income tax expense.
Interest Income. Interest income increased $2.7 million to $13.4 million
for the quarter ended December 31, 2005, as compared to $10.7 million for the
quarter ended December 31, 2004. The increase reflects a $140.3 million increase
in average interest-earning assets to $1.1 billion during the quarter ended
December 31, 2005 as compared to $928.6 million for the same quarter in the
prior year and a 39 basis point increase in the average yield on
interest-earning assets to 4.97%. The increase in the average balance of
interest-earning assets was due primarily to a $156.3 million increase in the
average balance of net loans to $691.2 million, partially offset by a $22.2
million decrease in the average balance of total securities to $335.2 million.
The increase in average interest-earning assets was funded principally by
deposit growth in the Bank's branches. The increase in the average yield on
interest-earning assets reflects the purchase of securities
14
at higher rates than the existing portfolio and increased yields earned on
Federal funds as a result of recent increases in short-term market interest
rates.
Loans. Interest income on loans increased $2.3 million, or 31.4%, to $9.8
million for the quarter ended December 31, 2005 as compared to $7.5 million for
the same quarter in 2004. This increase is due to a $156.3 million increase in
the average balance of loans to $691.2 million and a 9 basis point increase in
the yield earned to 5.64%. While short-term interest rates have increased,
longer-term interest rates have remained substantially unchanged at December 31,
2005. The interest rates on loan products are typically based on longer-term
interest rates, such as the 10-year Treasury bond. As a result, the rates on new
mortgage loans have remained substantially unchanged at December 31, 2005. Loans
originated during the quarter ended December 31, 2005 amounted to $71.7 million.
If long-term market interest rates increase, our average yield on loans should
increase, however loan originations 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 $2.1 million for the quarter ended December 31, 2005, a
decrease of $198,000 from the same quarter in 2004. The decrease is due to a
$41.1 million decrease in the average balance of mortgage-backed securities to
$221.2 million, partially offset by a 29 basis point increase in the average
yield to 3.80% during the current quarter. The increase in the average yield is
due primarily to rising short-term interest rates. Mortgage-backed securities
with adjustable rates amounted to $117.7 million or 54.5% of total
mortgage-backed securities at December 31, 2005. The interest rates on these
securities typically adjust using an index that is based on the yield of the
1-year Treasury bill.
Interest on other securities increased $263,000 to $1.0 million for the
quarter ended December 31, 2005, as compared to $782,000 for the same quarter in
2004. The increase is due to an $18.9 million increase in the average balance of
other securities to $114.0 million and a 38 basis point increase in the average
yield to 3.64%. The increase in both the average balance and the average yield
of other securities is due primarily to recent purchases of bonds, issued by
Government-sponsored entities, with maturity or call dates of less than three
years. As a result of recent increases in market interest rates in this maturity
timeframe, securities purchased during fiscal 2006 have been at higher rates
than the existing portfolio.
Federal Funds Sold and Other Overnight Deposits. For the quarter ended
December 31, 2005, interest on Federal funds sold and other overnight deposits
increased $177,000 to $290,000, reflecting a 166 basis point increase in the
average yield to 3.13%, and a $6.3 million increase in the average balance to
$36.8 million. The increase in the average yield is a result of increases by the
Federal Reserve in the Federal funds rate.
Other Earning Assets. Other earning assets consist primarily of FHLB of
New York common stock. Dividends on FHLB of New York common stock amounted to
$84,000 for the quarter ended December 31, 2005 as compared to $32,000 for the
same quarter in 2004.
Interest Expense. Interest expense for the quarter ended December 31, 2005
increased $2.6 million to $6.7 million, as compared to $4.1 million for the
quarter ended December 31, 2004. The average balance of interest-bearing
liabilities increased $130.4 million to $953.9 million for the quarter ended
December 31, 2005 as compared to $823.5 million for the same quarter in the
prior year, while the average cost of these liabilities increased 82 basis
points to 2.77%. The increase in the average balance of interest-bearing
liabilities includes deposit growth in the most recently opened branches as well
as growth in the existing branches. The increase in the average cost of
liabilities is a result of increasing short-term market interest rates and an
increase in certificates of deposit accounts as a percentage of total deposits.
The average balance of certificates of deposit represented 70.1% of the average
balance of total interest-bearing liabilities for the quarter ended December 31,
2005, as compared to 63.2% for the quarter ended December 31, 2004. Certificates
of deposit are generally offered at higher rates than savings accounts and we
have used these accounts to attract customers to our recently opened branch
locations.
15
Interest expense on certificates of deposit amounted to $5.9 million for
the current quarter as compared to $3.3 million for the same quarter in 2004.
The increase is due primarily to a $148.1 million increase in the average
balance to $668.8 million from $520.7 million for the same quarter last year,
while the average cost of certificates of deposit increased 94 basis points to
3.48%.
Interest on savings accounts amounted to $199,000 for the current quarter
as compared to $205,000 for the quarter ended December 31, 2004. This decrease
is the result of a $16.3 million decrease in the average balance of savings
accounts to $135.8 million for the quarter ended December 31, 2005 as compared
to $152.1 million for the same quarter in 2004, partially offset by an increase
of 5 basis points in the average cost of savings accounts to 0.58%.
Interest expense on NOW and money market accounts amounted to $222,000 for
quarter ended December 31, 2005 as compared to $135,000 for the same quarter in
the prior year. The average cost increased 32 basis points to 0.81% and the
average balance of these accounts increased $548,000 to $108.8 million.
For the quarter ended December 31, 2005, interest expense on borrowings
amounted to $362,000 as compared to $371,000 for the same quarter in 2004. The
average balance of borrowings for the current quarter was $35.0 million and the
average cost was 4.10%, an increase of 23 basis points from the same quarter
last year.
Net Interest Income. Net interest income for the quarter ended December
31, 2005 increased $48,000 to $6.72 million as compared to $6.68 million for the
same quarter in the prior year. The net interest rate spread was 2.20% and 2.63%
for the quarters ended December 31, 2005 and 2004, respectively. The net
interest margin for those periods was 2.50% and 2.85%, respectively. The
decreases in interest rate spread and net interest margin are primarily the
result of a decrease in the spread between short- and long-term market interest
rates. At December 31, 2005, the spread between the 1-month and 10-year Treasury
yield rates was 38 basis points as compared to 205 basis points at December 31,
2004. As a result, the Company's average cost of interest-bearing liabilities
has increased faster than the yield on interest-earning assets which are
affected by longer-term interest rates.
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 single-family residential
mortgage loans, which represented 84.6% of total loans at December 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 $75,000 for the quarters ended December
31, 2005 and 2004. Non-performing loans amounted to $2.7 million or 0.38% of
total loans at December 31, 2005, as compared to $734,000 or 0.14% of total
loans at December 31, 2004. The allowance for loan losses amounted to $3.2
million and $3.0 million at December 31, 2005 and March 31, 2005, 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 December 31, 2005, adjustable rate loans
accounted for 45.2% of total loans as compared to 37.8% at March 31, 2005.
16
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 bank-owned life insurance ("BOLI"). Service charges and fees
totaled $251,000 and $244,000 for the quarters ended December 31, 2005 and 2004,
respectively. The increase in service charges and fees is primarily due to
service charges on deposits as a result of increases in the fee structure and
deposit account growth. The increase in the cash surrender value of the BOLI
amounted to $95,000 and $121,000 for those same respective periods.
Non-Interest Expense. Non-interest expense totaled $5.2 million for the
quarter ended December 31, 2005 as compared to $4.6 million for the quarter
ended December 31, 2004. This increase is primarily due to increases of $431,000
in compensation and benefits expense, $75,000 in occupancy and equipment
expense, $114,000 in advertising and promotion expense and $75,000 in other
non-interest expense. These increases were partially offset by a decrease of
$50,000 in data processing service fees. The increases include costs
attributable to two new branches opened during the fourth quarter of fiscal
2005.
The increase in compensation and benefits expense is due primarily to a
$170,000 increase in compensation costs due primarily to additional staff to
support the growth in the Company's lending operations and the new branches. The
adoption of SFAS No. 123R will result in additional compensation costs with
respect to stock options beginning April 1, 2006, as described in Note 3 of the
Notes to Unaudited Consolidated Financial Statements in Item 1.
Income Taxes. Income tax expense amounted to $703,000 and $956,000 for
the quarters ended December 31, 2005 and 2004, respectively. The effective tax
rates for those same periods were 40.2% and 40.1%, respectively.
17
Comparison of Results of Operations for the Nine Months Ended December 31, 2005
and 2004
Average Balance Sheets. The following table sets forth average balance
sheets, average yields and costs, and certain other information for the nine
months ended December 31, 2005 and 2004. The table reflects the annualized
average yield on interest-earning assets and the annualized average cost of
interest-bearing liabilities (derived by dividing the annualized interest income
or expense by the monthly 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 the 2005 and 2004 periods has been reduced
by amortization of net deferred loan origination costs of $333,000 and $412,000,
respectively. Interest income on mortgage-backed securities has been reduced by
amortization of purchase premiums (net of discounts) of $593,000 and $742,000
for those same respective periods.
For the Nine Months Ended December 31,
------------------------------------------------------------------------------------
2005 2004
------------------------------------------------------------------------------------
Average Average
Outstanding Average Outstanding Average
Balance Interest Yield/Rate Balance Interest Yield/Rate
------- -------- ---------- ------- -------- ----------
(Dollars in thousands)
Interest-earning assets:
Loans (1) $ 637,920 26,972 5.61% $ 511,669 21,733 5.64%
Mortgage-backed securities (2) 238,325 6,507 3.62% 258,305 6,753 3.47%
Other securities (2) 108,006 2,885 3.55% 90,827 2,164 3.16%
Federal funds sold and other
overnight deposits (3) 32,715 666 2.70% 30,991 245 1.05%
Other (4) 6,338 240 5.03% 5,824 87 1.98%
---------- ------ ---------- ------
Total interest-earning assets 1,023,304 37,270 4.83% 897,616 30,982 4.58%
------ ------
Non-interest earning assets 48,713 43,960
---------- ----------
Total assets $1,072,017 $ 941,576
========== ==========
Interest-bearing liabilities:
Savings and club accounts $ 141,738 585 0.55% $ 151,278 596 0.52%
Money market accounts 41,181 358 1.15% 46,717 275 0.78%
NOW accounts 66,136 235 0.47% 58,783 110 0.25%
Certificates of deposit 620,891 15,199 3.25% 493,267 9,021 2.43%
Borrowings 35,971 1,084 4.00% 37,029 1,126 4.04%
Mortgagors' escrow funds 5,381 18 0.44% 4,299 15 0.46%
---------- ------ ---------- ------
Total interest-bearing liabilities 911,298 17,479 2.55% 791,373 11,143 1.87%
------ ------
Non-interest-bearing liabilities 33,036 21,069
---------- ----------
Total liabilities 944,334 812,442
Stockholders' equity 127,683 129,134
---------- ----------
Total liabilities and
stockholders' equity $1,072,017 $ 941,576
========== ==========
Net interest income 19,791 19,839
====== ======
Net interest rate spread (5) 2.28% 2.71%
Net earning assets (6) $ 112,006 $ 106,243
========== ==========
Net interest margin (7) 2.57% 2.93%
Ratio of interest-earning assets
to interest-bearing liabilities 1.12 x 1.13 x
(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.
18
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, 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 Nine Months Ended December 31,
2005 vs. 2004
-------------------------------------------
Increase (Decrease) Due to
-------------------------- Total Increase
Volume Rate (Decrease)
-------------------------------------------
(In thousands)
Interest-earning assets:
Loans $ 5,430 $ (191) $ 5,239
Mortgage-backed securities (655) 409 (246)
Other securities 436 285 721
Federal funds and other
overnight deposits 14 407 421
Other 8 145 153
------- ------- -------
Total interest-earning assets 5,233 1,055 6,288
------- ------- -------
Interest-bearing liabilities:
Savings and club accounts (53) 42 (11)
Money market accounts (52) 135 83
NOW accounts 15 110 125
Certificates of deposit 2,681 3,497 6,178
Borrowings (31) (11) (42)
Mortgage escrow funds 4 (1) 3
------- ------- -------
Total interest-bearing liabilities 2,564 3,772 6,336
------- ------- -------
Net interest income $ 2,669 $(2,717) $ (48)
======= ======= =======
Net Income. Net income amounted to $3.53 million or diluted earnings per
share of $0.30 for the nine months ended December 31, 2005, as compared to $4.35
million or diluted earnings per share of $0.36 for the nine months ended
December 31, 2004, a decrease of $825,000 or 18.9% in net income. The decrease
in net income for the nine months ended December 31, 2005 is primarily
attributable to a $1.7 million increase in non-interest expense, partially
offset by a $449,000 increase in non-interest income and a $530,000 decrease in
income tax expense.
Interest Income. Interest income increased $6.3 million to $37.3 million
for the nine months ended December 31, 2005, as compared to $31.0 million for
the nine months ended December 31, 2004. The increase reflects a $125.7 million
increase in average interest-earning assets to $1.0 billion during the nine
months ended December 31, 2005 as compared to $897.6 million for the same period
in the prior year and a 25 basis point increase in the average yield on
interest-earning assets to 4.83%. The increase in the average balance of
interest-earning assets was due primarily to a $126.3 million increase in the
average balance of net loans to $637.9 million, partially offset by a $2.8
million decrease in the average balance of total securities to $346.3 million.
The increase in average interest-earning assets was funded principally by
deposit growth in
19
the Bank's branches. The increase in the average yield on interest-earning
assets reflects the purchase of securities at higher rates than the existing
portfolio and increased yields earned on Federal funds as a result of recent
increases in short-term market interest rates.
Loans. Interest income on loans increased $5.3 million, or 24.1%, to $27.0
million for the nine months ended December 31, 2005 as compared to $21.7 million
for the same period in 2004. This increase is due to a $126.3 million increase
in the average balance of loans to $637.9 million, partially offset by a 3 basis
point decrease in the yield earned to 5.61%. While short-term interest rates
have increased, longer-term interest rates have remained substantially unchanged
at December 31, 2005. The interest rates on loan products are typically based on
longer-term interest rates, such as the 10-year Treasury bond. As a result, the
rates on new mortgage loans have remained substantially unchanged at December
31, 2005. Loans originated during the nine months ended December 31, 2005
amounted to $246.3 million. If long-term market interest rates increase, our
average yield on loans should increase, however loan originations 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 $6.5 million for the nine months ended December 31, 2005, a
decrease of 246,000 from the nine months ended December 31, 2004. The decrease
is due to a $20.0 million decrease in the average balance of mortgage-backed
securities to $238.3 million, partially offset by a 15 basis point increase in
the average yield to 3.62%. The increase in the average yield is due primarily
to rising short-term interest rates. Mortgage-backed securities with adjustable
rates amounted to $117.7 million or 54.5% of total mortgage-backed securities at
December 31, 2005. The interest rates on these securities typically adjust using
an index that is based on the yield of the 1-year Treasury bill.
Interest on other securities increased $721,000 to $2.9 million for the
nine months ended December 31, 2005, as compared to $2.2 million for the same
nine months in 2004. The increase is due to a $17.2 million increase in the
average balance of other securities to $108.0 million and a 39 basis point
increase in the average yield to 3.55%. The increase in both the average balance
and the average yield of other securities is due primarily to recent purchases
of bonds, issued by Government-sponsored entities, with maturity or call dates
of less than three years. As a result of recent increases in market interest
rates in this maturity timeframe, securities purchased during fiscal 2006 have
been at higher rates than the existing portfolio.
Federal Funds Sold and Other Overnight Deposits. For the nine months ended
December 31, 2005, interest on Federal funds sold and other overnight deposits
increased $421,000 to $666,000, reflecting a 165 basis point increase in the
average yield to 2.70%, and a $1.7 million increase in the average balance to
$32.7 million. The increase in the average yield is a result of increases by the
Federal Reserve in the Federal funds rate.
Other Earning Assets. Other earning assets consist primarily of FHLB of
New York common stock. Dividends on FHLB of New York common stock amounted to
$230,000 for nine months ended December 31, 2005 as compared to $82,000 for the
same nine months in 2004.
Interest Expense. Interest expense for the nine months ended December 31,
2005 increased $6.4 million to $17.5 million, as compared to $11.1 million for
the nine months ended December 31, 2004. The average balance of interest-bearing
liabilities increased $119.9 million to $911.3 million during the nine months
ended December 31, 2005 as compared to $791.4 million for the same period in
2004, while the average cost of these liabilities increased 68 basis points to
2.55%. The increase in the average balance of interest-bearing liabilities
includes deposit growth in the most recently opened branches as well as growth
in the existing branches. The increase in the average cost of liabilities is a
result of increasing short-term market interest rates and an increase in
certificates of deposit accounts as a percentage of total deposits. The average
balance of certificates of deposit represented 68.1% of the average balance of
total interest-bearing liabilities for the nine months ended December 31, 2005,
as compared to 62.3% for the nine months ended December 31, 2004. Certificates
of deposit are generally offered at higher rates than savings accounts and we
have used these accounts to attract customers to our recently opened branch
locations.
20
Interest expense on certificates of deposit amounted to $15.2 million for
the nine months ended December 31, 2005 as compared to $9.0 million for the nine
months ended December 31, 2004. The increase is due primarily to a $127.6
million increase in the average balance to $620.9 million from $493.3 million,
and an 82 basis point increase in the average cost of certificates of deposit to
3.25%.
Interest on savings accounts amounted to $585,000 for the nine months
ended December 31, 2005 as compared to $596,000 for the nine months ended
December 31, 2004. This decrease is the result of a $9.6 million decrease in the
average balance of savings accounts to $141.7 million for the nine months ended
December 31, 2005 as compared to $151.3 million for the same period in 2004,
while the average cost of savings accounts increased 3 basis points to 0.55%.
Interest expense on NOW and money market accounts amounted to $593,000 for
nine months ended December 31, 2005 as compared to $385,000 for the same nine
months in the prior year. The average cost of these deposits increased 25 basis
points to 0.73% and the average balance of these accounts increased $1.8 million
to $107.3 million.
For the nine months ended December 31, 2005, interest expense on
borrowings amounted to $1.08 million as compared to $1.13 million for the same
nine months in 2004. The average balance of borrowings for the nine months ended
December 31, 2005 was $36.0 million as compared to $37.0 million for the same
period in 2004. The average cost of borrowings decreased 4 basis points to
4.00%.
Net Interest Income. Net interest income for the nine months ended
December 31, 2005 decreased $48,000 to $19.79 million as compared to $19.84
million for the same nine months in the prior year. The net interest rate spread
was 2.28% and 2.71% for the nine months ended December 31, 2005 and 2004,
respectively. The net interest margin for those same respective periods was
2.57% and 2.93%. The decreases in interest rate spread and net interest margin
are primarily the result of a decrease in the spread between short- and
long-term market interest rates. At December 31, 2005, the spread between the
1-month and 10-year Treasury yield rates was 38 basis points as compared to 205
basis points at December 31, 2004. As a result, the Company's average cost of
interest-bearing liabilities has increased faster than the yield on
interest-earning assets which are affected by longer-term interest rates.
Provision for Loan Losses. The provision for loan losses was $225,000 for
the nine months ended December 31, 2005 and 2004. Non-performing loans amounted
to $2.7 million or 0.38% of total loans at December 31, 2005, as compared to
$734,000 or 0.14% of total loans at December 31, 2004. The allowance for loan
losses amounted to $3.2 million and $3.0 million at December 31, 2005 and March
31, 2005, 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
December 31, 2005, adjustable rate loans accounted for 45.2% of total loans as
compared to 37.8% at March 31, 2005.
Non-Interest Income. Service charges and fees totaled $885,000 and
$740,000 for the nine months ended December 31, 2005 and 2004, respectively. The
increase in service charges and fees is primarily due to an increase in
prepayment fees on loans and to service charges on deposits as a result of
increases in the fee structure and deposit account growth. The increase in the
cash surrender value of the BOLI amounted to $283,000 and $287,000 for those
same respective periods. The Company also had a gain on the sale of real estate
of $325,000 during the nine months ended December 31, 2005. The property sold
was contiguous to an existing branch site. Management determined that this
property was not going to be used in connection with the operation of the
branch.
21
Non-Interest Expense. Non-interest expense totaled $15.2 million for the
nine months ended December 31, 2005 as compared to $13.5 million for the nine
months ended December 31, 2004. This increase is primarily due to increases of
$1.2 million in compensation expense, $269,000 in occupancy and equipment
expense, $32,000 in data processing service fees, $149,000 in advertising and
promotion expense and $81,000 in other non-interest expense. These increases
include costs attributable to the two new branches opened during the fourth
quarter of fiscal 2005.
The increase in compensation and benefits expense is due primarily to a
$576,000 increase in compensation costs due primarily to additional staff to
support the growth in the Company's lending operations and the new branches. The
adoption of SFAS No. 123R will result in additional compensation costs with
respect to stock options beginning April 1, 2006, as described in Note 3 of the
Notes to Unaudited Consolidated Financial Statements in Item 1.
Income Taxes. Income tax expense amounted to $2.3 million and $2.8 million
for the nine months ended December 31, 2005 and 2004, respectively. The
effective tax rates for those same periods were 39.3% and 39.2%, respectively.
Liquidity and Capital Resources
The Company's primary sources of funds are deposits, the proceeds from
principal and interest payments on loans and mortgage-backed securities, and the
proceeds from maturities of investments. While maturities and scheduled
amortization of loans and securities are a predictable source of funds, deposit
flows and mortgage prepayments are greatly influenced by general interest rates,
economic conditions and competition.
The Company's primary investing activities are the origination of mortgage
loans, and the purchase of short-term investments, government agency bonds,
mortgage-backed securities and collateralized mortgage obligations. These
activities are funded primarily by deposit growth and principal repayments on
loans, mortgage-backed securities and other investment securities. During the
nine months ended December 31, 2005, the Company originated loans of $246.3
million, purchased loans of $2.5 million and purchased securities of $39.5
million. These disbursements were funded by $61.6 million in principal payments,
maturities and calls of securities and $99.3 million in loan principal
repayments. During the year ended March 31, 2005, the Company originated $207.9
million of loans and purchased $113.3 million of securities.
Liquidity management for the Company is both a daily and long-term process
which is part of the Company's overall management strategy. Excess funds are
generally invested in short-term investments such as Federal funds and
certificates of deposit. In the event that the Bank should require additional
sources of funds, it could borrow from the FHLB under an available line of
credit.
At December 31, 2005, the Company had outstanding loan commitments of
$98.5 million. The Company anticipates that it will have sufficient funds
available to meet its current loan commitments. Certificates of deposits
scheduled to mature in one year or less from December 31, 2005, totaled $513.7
million. Management believes that a significant portion of such deposits will
remain with the Company.
The Bank is subject to certain minimum leverage, tangible and risk-based
capital requirements established by regulations of the OTS. These regulations
require savings associations to meet three minimum capital standards: a tangible
capital ratio requirement of 1.5% of total assets as adjusted under the OTS
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. The OTS prompt
corrective action regulations impose a 4.0% core capital requirement for
categorization as an "adequately capitalized" thrift and a 5.0% core capital
requirement for categorization as a "well capitalized" thrift. Goodwill and most
other intangible assets are deducted in determining regulatory capital for
purposes of all capital ratios. In determining the amount of risk-weighted
assets for purposes of the risk-based capital requirement, a savings association
must compute its risk-based assets by multiplying its assets and certain
off-
22
balance sheet items by risk-weights, which range from 0% for cash and
obligations issued by the United States Government or its agencies to 100% for
consumer and commercial loans, as assigned by the OTS capital regulations. At
December 31, 2005, the Bank exceeded all of the OTS minimum regulatory capital
requirements, and was classified as a well-capitalized institution for
regulatory purposes.
The following table sets forth the capital position of the Bank as of
December 31, 2005 and March 31, 2005. The actual capital amounts and ratios set
forth below are for the Bank only and, accordingly, do not include additional
capital retained by the Holding Company.
OTS Requirements
--------------------------------------------------
Minimum Capital Classification as Well
Bank Actual Adequacy Capitalized
---------------------- --------------------- ----------------------
Amount Ratio Amount Ratio Amount Ratio
---------------------- --------------------- ----------------------
(Dollars in thousands)
December 31, 2005
- -----------------
Tangible capital $106,279 9.4% $ 16,910 1.5%
Tier I (core) capital 106,279 9.4 45,094 4.0 $ 56,368 5.0%
Risk-based capital:
Tier I 106,279 20.1 21,124 4.0 31,685 6.0
Total 109,515 20.7 42,247 8.0 52,809 10.0
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
Accounting Standards
In May 2005, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 154, "Accounting Changes and Error
Corrections," which replaces APB Opinion No. 20, "Accounting Changes," and SFAS
No. 3, "Reporting Accounting Changes in Interim Financial Statements," and
changes the requirements for the accounting for and reporting of a change in
accounting principle. SFAS No. 154 applies to all voluntary changes in
accounting principle and to changes required by an accounting pronouncement when
the pronouncement does not include specific transition provisions. SFAS No. 154
requires retrospective application of a change in accounting principle to prior
periods' financial statements unless it is impracticable to determine either the
period-specific effects or the cumulative effect of the change. APB Opinion No.
20 previously required that most voluntary changes in accounting principle be
recognized by including the cumulative effect of the change in net income for
the period of the change in accounting principle. SFAS No. 154 carries forward
without change the guidance contained in APB Opinion No. 20 for reporting the
correction of an error in previously issued financial statements and a change in
accounting estimate. SFAS No. 154 also carries forward the guidance in APB
Opinion No. 20 requiring justification of a change in accounting principle on
the basis of preferability. SFAS No. 154 is effective for accounting changes and
corrections of errors made in fiscal years beginning after December 15, 2005,
with early adoption permitted. The Company's adoption of SFAS No. 154 is not
expected to have an impact on its financial condition or results of operations.
See Note 3 of the Notes to Unaudited Consolidated Financial Statements in
Item 1 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.
FASB Staff Position No. FAS 115-1 and FAS 124-1, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments" (the
"FSP"), was issued in November 2005 and
23
addresses the determination of when an investment is considered impaired;
whether the impairment is other than temporary; and how to measure an impairment
loss. The FSP also addresses accounting considerations subsequent to the
recognition of an other-than-temporary impairment on a debt security, and
requires certain disclosures about unrealized losses that have not been
recognized as other-than-temporary impairments. The FSP replaces the impairment
guidance in EITF Issue No. 03-1 with references to existing authoritative
literature concerning other-than-temporary determinations (principally SFAS No.
115 and SEC Staff Accounting Bulletin 59). Under the FSP, impairment losses must
be recognized in earnings equal to the entire difference between the security's
cost and its fair value at the financial statement date, without considering
partial recoveries subsequent to that date. The FSP also requires that an
investor recognize an other-than-temporary impairment loss when a decision to
sell a security has been made and the investor does not expect the fair value of
the security to fully recover prior to the expected time of sale. The FSP is
effective for reporting periods beginning after December 15, 2005. The Company
does not expect that the application of the FSP will have a material impact on
its financial condition, results of operations or financial statement
disclosures.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company's most significant form of market risk is interest rate risk,
as the majority of the Company's assets and liabilities are sensitive to changes
in interest rates. The Company's assets consist primarily of fixed rate mortgage
loans, which have longer maturities than the Company's liabilities which consist
primarily of deposits. The Company's mortgage loan portfolio, consisting
primarily of loans secured by residential real property located in Westchester
County, New York and Fairfield County, Connecticut, is also subject to risks
associated with the local economy. The Company does not own any trading assets.
At December 31, 2005, the Company did not have any hedging transactions in
place, such as interest rate swaps and caps. The Company's interest rate risk
management program focuses primarily on evaluating and managing the composition
of the Company's 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.
During the nine months ended December 31, 2005, there were no significant
changes in the Company's assessment of market risk.
Item 4. Controls and Procedures
The Company's management, including the Chief Executive Officer and Chief
Financial Officer, evaluated the effectiveness of the design and operation of
the Company's disclosure controls and procedures (as defined in Rule 13a-14(c)
under the Securities Exchange Act of 1934, as amended) (the "Exchange Act") as
of December 31, 2005 (the "Evaluation Date"). Based upon that evaluation, the
Company's management, including the Chief Executive Officer and Chief Financial
Officer, concluded that, as of the Evaluation Date, the Company's disclosure
controls and procedures were effective to ensure that information required to be
disclosed in the reports the Company files and submits under the Exchange Act is
recorded, processed, summarized and reported as and when required and that such
information is accumulated and communicated to management as appropriate to
allow timely decisions regarding required disclosure.
There were no changes in the Company's internal control over financial
reporting during the period covered by this report that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
24
Part II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company is not involved in any pending legal proceedings other than
routine legal proceedings occurring in the ordinary course of business. Such
routine legal proceedings in the aggregate are believed by management to be
immaterial to the Company's financial condition and results of operations.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Information regarding Company purchases of its equity securities (common
stock) during the three months ended December 31, 2005 is summarized below:
Total number of
shares purchased Maximum number of
under a publicly shares that may yet
Total number of Average price paid announced repurchase be purchased under
shares purchased per share plan (1) repurchase plan (1)
---------------- ------------------ -------------------- -------------------
October 1-October 31 -- -- -- 321,544
November 1-November 30 -- -- -- 321,544
December1-December 31 -- -- -- 321,544
(1) On June 11, 2004, the Company announced a program to repurchase up to
658,844 shares of its common stock. This program has no expiration date.
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits
(a) Exhibit 31.1 - Certification of Chief Executive Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
(b) Exhibit 31.2 - Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
(c) Exhibit 32.1 - Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Sound Federal Bancorp, Inc.
----------------------------------------
(Registrant)
By: /s/ Anthony J. Fabiano
----------------------------------------
Anthony J. Fabiano
Duly Authorized and Chief Financial and
Accounting Officer
February 7, 2006
26