EXHIBIT 13
2006 ANNUAL REPORT TO STOCKHOLDERS
Selected Consolidated Financial Information
(In thousands)
At or for the Years Ended March 31,
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(In thousands, except per share data) 2006 2005 2004 2003 2002
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Results of Operations:
Net interest income $ 26,821 $ 26,423 $ 26,192 $ 25,839 $ 18,906
Provision for loan losses 300 300 275 275 175
Non-interest income 1,855 1,447 1,041 890 731
Non-interest expense 21,209 18,568 16,106 12,709 10,316
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Income before income tax expense 7,167 9,002 10,852 13,745 9,146
Income tax expense 3,003 3,533 4,234 5,219 3,376
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Net income $ 4,164 $ 5,469 $ 6,618 $ 8,526 $ 5,770
===================================================================================================================================
Financial Condition:
Total assets $1,169,591 $1,006,950 $ 890,541 $ 796,088 $ 623,985
Loans, net 741,589 560,751 478,455 427,684 418,368
Mortgage-backed securities:
Available for sale 140,053 199,745 255,853 212,484 104,134
Held to maturity 65,303 59,777 -- -- --
Other securities:
Available for sale 75,402 76,409 81,877 82,564 46,097
Held to maturity 45,943 19,712 -- -- --
Deposits 1,003,691 831,768 708,330 604,260 519,905
Borrowings 28,000 38,000 35,000 35,000 34,922
Stockholders' equity 128,686 127,160 137,059 138,321 61,015
Performance Ratios:
Return on average assets 0.38% 0.57% 0.79% 1.23% 1.01%
Return on average equity 3.26 4.23 4.87 10.50 9.85
Average interest rate spread (1) 2.29 2.69 2.98 3.71 3.31
Net interest margin (2) 2.57 2.91 3.24 3.93 3.51
Efficiency ratio (3) 72.90 66.85 59.14 47.65 52.72
Dividend payout ratio (4) 79.17 51.06 40.74 20.90 22.22
Per Common Share Data:
Basic earnings per share $ 0.36 $ 0.47 $ 0.54 $ 0.67 $ 0.45
Diluted earnings per share 0.35 0.46 0.52 0.65 0.44
Book value per share (5) 10.43 10.27 10.40 10.44 4.62
Tangible book value per share (5) 9.30 9.15 9.34 9.39 3.56
Dividends per share 0.285 0.24 0.22 0.14 0.10
Capital Ratios:
Average equity to average total assets (consolidated) 11.70% 13.59% 16.15% 11.68% 10.26%
Tier 1 leverage capital at end of period (Bank only) 9.34 10.26 10.92 11.29 6.54
Asset Quality Data:
Total non-performing loans $ 2,893 $ 580 $ 1,981 $ 477 $ 755
Total non-performing assets 2,893 580 1,981 477 869
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(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.
1
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.
On February 8, 2006 the Company entered into an Agreement and Plan of
Merger (the "Merger Agreement") pursuant to which it would be acquired by Hudson
City Bancorp, Inc. ("Hudson City"). Shareholders of the Company will receive
$20.75 in cash for each share of Sound Federal Bancorp, Inc. common stock they
own. The acquisition is subject to the receipt of regulatory and shareholder
approvals. It is expected that the acquisition will be completed during the
Company's second fiscal quarter.
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 may involve a high degree of judgment and
subjectivity in the assumptions utilized.
2
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.
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 decreases in market interest rates, with no effect given to any actions that
management might take to counter the effect of interest rate movements.
The table below sets forth, as of March 31, 2006, 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
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(Dollars in thousands)
+300 $ 47,925 $(81,767) (63.0)% (27.6)%
+200 78,449 (51,243) (39.5) (18.0)
+100 105,856 (23,836) (18.4) (8.7)
0 129,692 -- -- --
-100 148,302 18,610 14.3 7.3
-200 159,208 29,516 22.8 10.7
-300 167,749 38,057 29.3 9.2
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(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.
3
The above table indicates that at March 31, 2006, in the event of a 100
basis point decrease in interest rates, we would expect to experience a 14.3%
increase in NPV and a 7.3% increase in NII. In the event of a 200 basis point
increase in interest rates, we would expect to experience a 39.5% decrease in
NPV and an 18.0% decrease in NII. Subsequent to March 31, 2006, 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 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, 2006 and 2005
Assets.
The Company's total assets amounted to $1.2 billion at March 31, 2006 as
compared to $1.0 billion at March 31, 2005. The $162.6 million increase in
assets primarily consisted of a $180.8 million increase in net loans to $741.6
million, partially offset by a decrease in total securities of $28.9 million.
Our asset growth was funded principally by a $171.9 million increase in deposits
to $1.0 billion.
Liabilities.
Total deposits were $1.0 billion at March 31, 2006, an increase of $171.9
million as compared to $831.8 million at March 31, 2005. Certificates of deposit
increased $170.3 million to $723.2 million from $552.9 million; savings and club
accounts decreased $20.9 million to $129.6 million from $150.5 million; and
money market, NOW and commercial checking accounts increased $22.5 million to
$150.9 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 $28.0 million at March
31, 2006 and $38.0 million at March 31, 2005.
Stockholders' Equity.
Total stockholders' equity increased $1.5 million to $128.7 million at
March 31, 2006 as compared to $127.2 million at March 31, 2005. The increase
reflects net income of $4.2 million and total increases of $3.2 million related
to stock options, stock awards and ESOP shares, partially offset by common stock
repurchases at a cost of $1.4 million, dividends paid of $3.3 million and an
increase of $1.2 million in the accumulated other comprehensive loss.
The accumulated other comprehensive loss of $3.9 million at March 31, 2006
represents the after-tax net unrealized loss on securities available for sale
($6.5 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 at March 31, 2006 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 and intent 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, 2006.
4
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, 2006, 2005 and 2004.
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 2006, 2005 and 2004 has been
reduced by amortization of net deferred loan origination costs of $408,000,
$568,000 and $981,000, respectively. Interest income on mortgage-backed
securities has been reduced by amortization of purchase premiums (net of
discounts) of $701,000, $1.1 million and $631,000 for those same respective
years.
For the Years Ended March 31,
------------------------------------------------------------------------------------------------------
2006 2005 2004
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Average Average Average Average Average Average
Outstanding Yield/ Outstanding Yield/ Outstanding Yield/
(Dollars in thousands) Balance Interest Rate Balance Interest Rate Balance Interest Rate
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Interest - earning assets:
Loans (1) $ 658,776 37,395 5.68% $ 521,558 29,430 5.64% $ 442,466 26,819 6.06%
Mortgage-backed
securities (2) 232,722 8,674 3.73% 259,897 9,058 3.49% 243,952 8,909 3.65%
Other securities (2) 111,772 4,087 3.66% 91,725 2,940 3.21% 85,868 2,629 3.06%
Federal funds sold and
other overnight
deposits (3) 32,807 972 2.96% 28,702 340 1.18% 30,283 240 0.79%
Other (4) 5,638 313 5.55% 5,850 132 2.26% 5,460 142 2.60%
-------------------- -------------------- ---------------------
Total interest - earning
assets 1,041,715 51,441 4.94% 907,732 41,900 4.62% 808,029 38,739 4.79%
------ ------ ------
Non-interest - earning
assets 48,391 44,608 33,941
---------- ---------- ----------
Total assets $1,090,106 $ 952,340 $ 841,970
========== ========== ==========
Interest - bearing
liabilities:
Savings and club accounts $ 139,356 767 0.55% $ 151,077 783 0.52% $ 143,926 856 0.59%
Money market accounts 39,982 497 1.24% 46,216 372 0.80% 45,923 375 0.82%
NOW accounts 68,159 369 0.54% 59,876 154 0.26% 53,420 172 0.32%
Certificates of deposit 641,465 21,574 3.36% 503,695 12,659 2.51% 405,837 9,601 2.37%
Borrowings 35,233 1,390 3.95% 37,268 1,489 4.00% 39,208 1,495 3.81%
Mortgage escrow funds 5,207 23 0.44% 4,282 20 0.47% 3,800 48 1.26%
-------------------- -------------------- ---------------------
Total interest - bearing
liabilities 929,402 24,620 2.65% 802,414 15,477 1.93% 692,114 12,547 1.81%
------ ------ ------
Non - interest-bearing
liabilities 33,129 20,531 13,910
---------- ---------- ----------
Total liabilities 962,531 822,945 706,024
Stockholders' equity 127,575 129,395 135,946
---------- ---------- ----------
Total liabilities and
stockholders' equity $1,090,106 $ 952,340 $ 841,970
========== ========== ==========
Net interest income 26,821 26,423 26,192
====== ====== ======
Average interest rate
spread (5) 2.29% 2.69% 2.98%
Net earning assets (6) $ 112,313 $ 105,318 $ 115,915
========== ========== ==========
Net interest margin (7) 2.57% 2.91% 3.24%
Ratio of interest -
earning assets to
interest - bearing
liabilities 1.12x 1.13x 1.17x
(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.
5
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,
--------------------------------------------------------------------------
2006 vs. 2005 2005 vs. 2004
----------------------------------- -----------------------------------
Increase (Decrease) Increase (Decrease)
Due to Total Due to Total
-------------------- Increase -------------------- Increase
Volume Rate (Decrease) Volume Rate (Decrease)
----------------------------------- -----------------------------------
(In thousands)
Interest-earning assets:
Loans $ 7,756 $ 209 $ 7,965 $ 4,560 $(1,949) $ 2,611
Mortgage-backed securities (984) 600 (384) 556 (407) 149
Other securities 699 448 1,147 181 130 311
Federal funds and other overnight deposits 54 578 632 (13) 113 100
Other (5) 186 181 10 (20) (10)
--------------------------------------------------------------------------
Total interest-earning assets 7,520 2,021 9,541 5,294 (2,133) 3,161
--------------------------------------------------------------------------
Interest-bearing liabilities:
Savings and club accounts (61) 45 (16) 38 (111) (73)
Money market accounts (56) 181 125 3 (6) (3)
NOW accounts 25 190 215 18 (36) (18)
Certificates of deposit 3,983 4,932 8,915 2,456 602 3,058
Borrowings (80) (19) (99) (77) 71 (6)
Mortgage escrow funds 4 (1) 3 5 (33) (28)
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Total interest-bearing liabilities 3,815 5,328 9,143 2,443 487 2,930
--------------------------------------------------------------------------
Net interest income $ 3,705 $(3,307) $ 398 $ 2,851 $(2,620) $ 231
==========================================================================
6
Comparison of Results of Operations for the Years Ended March 31, 2006 and 2005
Net Income. Net income amounted to $4.2 million or diluted earnings per
share of $0.35 for the year ended March 31, 2006, as compared to $5.5 million or
diluted earnings per share of $0.46 for the year ended March 31, 2005, a
decrease of $1.3 million or 23.9% in net income. Operating results for fiscal
2006 included $541,000 of merger-related costs in connection with the Company's
announced merger with Hudson City. The decrease in net income for the year ended
March 31, 2006 is primarily attributable to a $2.6 million increase in
non-interest expense, including the merger-related costs, partially offset by
increases of $408,000 in non-interest income, $398,000 in net interest income
and a $530,000 decrease in income tax expense.
Interest Income. Interest income increased $9.5 million to $51.4 million
for the year ended March 31, 2006, as compared to $41.9 million for the year
ended March 31, 2005. The increase reflects a $134.0 million increase in average
interest-earning assets to $1.0 billion during the year ended March 31, 2006 as
compared to $907.7 million for the prior year and a 32 basis point increase in
the average yield on interest-earning assets to 4.94%. The increase in the
average balance of interest-earning assets was due primarily to a $137.2 million
increase in the average balance of net loans to $658.8 million, partially offset
by a $7.1 million decrease in the average balance of total securities to $344.5
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 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 $8.0 million, or 27.1%, to $37.4
million for the year ended March 31, 2006 as compared to $29.4 million for
fiscal 2005. This increase is due to a $137.2 million increase in the average
balance of loans to $658.8 million and a 4 basis point increase in the yield
earned to 5.68%. While short-term interest rates have increased, longer-term
interest rates remained substantially unchanged during fiscal 2006. 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 mortgage loans
originated during fiscal 2006 remained substantially unchanged. Loans originated
during the year ended March 31, 2006 amounted to $303.6 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 $8.7 million for the year ended March 31, 2006, a decrease of
384,000 from fiscal 2005. The decrease is due to a $27.2 million decrease in the
average balance of mortgage-backed securities to $232.7 million, partially
offset by a 24 basis point increase in the average yield to 3.73%. The increase
in the average yield is due primarily to rising short-term interest rates.
Mortgage-backed securities with adjustable rates amounted to $113.0 million or
55.0% of total mortgage-backed securities at March 31, 2006. 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 $1.2 million to $4.1 million for
the year ended March 31, 2006, as compared to $2.9 million for fiscal 2005. The
increase is due to a $20.0 million increase in the average balance of other
securities to $111.8 million and a 45 basis point increase in the average yield
to 3.66%. 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 year ended March
31, 2006, interest on Federal funds sold and other overnight deposits increased
$632,000 to $972,000, reflecting a 178 basis point increase in the average yield
to 2.96%, and a $4.1 million increase in the average balance to $32.8 million.
The increase in the average yield is a result of increases by the Federal
Reserve in the Federal funds rate.
7
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
$299,000 for year ended March 31, 2006 as compared to $126,000 for fiscal 2005.
Interest Expense. Interest expense for the year ended March 31, 2006
increased $9.1 million to $24.6 million, as compared to $15.5 million for the
year ended March 31, 2005. The average balance of interest-bearing liabilities
increased $127.0 million to $929.4 million during the year ended March 31, 2006
as compared to $802.4 million for fiscal 2005, while the average cost of these
liabilities increased 72 basis points to 2.65%. 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 69.0% of the average balance of total interest-bearing liabilities
for the year ended March 31, 2006, as compared to 62.8% for fiscal 2005.
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.
Interest expense on certificates of deposit amounted to $21.6 million for
the year ended March 31, 2006 as compared to $12.7 million for the year ended
March 31, 2005. The increase is due primarily to a $137.8 million increase in
the average balance to $641.5 million from $503.7 million, and an 85 basis point
increase in the average cost of certificates of deposit to 3.36%.
Interest on savings accounts amounted to $767,000 for the year ended March
31, 2006 as compared to $783,000 for the year ended March 31, 2005. This
decrease is the result of an $11.7 million decrease in the average balance of
savings accounts to $139.4 million for the year ended March 31, 2006 as compared
to $151.1 million for fiscal 2005, while the average cost of savings accounts
increased 3 basis points to 0.55%.
Interest expense on NOW and money market accounts amounted to $866,000 for
fiscal 2006 as compared to $526,000 for fiscal 2005. The average cost of these
deposits increased 30 basis points to 0.80% and the average balance of these
accounts increased $2.0 million to $108.1 million.
For fiscal 2006, interest expense on borrowings amounted to $1.4 million
as compared to $1.5 million for fiscal 2005. The average balance of borrowings
decreased to $35.2 million for fiscal 2006 as compared to $37.3 million for the
prior year. The average cost of borrowings decreased 5 basis points to 3.95%.
Net Interest Income. Net interest income for the year ended March 31, 2006
increased $398,000 to $26.8 million as compared to $26.4 million for the prior
year. The net interest rate spread was 2.29% and 2.69% for the years ended March
31, 2006 and 2005, respectively. The net interest margin for those same
respective periods was 2.57% and 2.91%. 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 March 31, 2006, the
spread between the 1-month and 10-year Treasury yield rates was 21 basis points
as compared to 187 basis points at March 31, 2005. 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 primarily 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 U.S. 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 84.1% of total
loans at March 31, 2006, 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 the years ended March 31,
2006 and 2005. Non-performing loans amounted to $2.9 million or 0.39% of total
loans at March 31, 2006, as compared to $580,000 or 0.10% of total
8
loans at March 31, 2005. The allowance for loan losses amounted to $3.3 million
and $3.0 million at March 31, 2006 and March 31, 2005, respectively. Charge-offs
amounted to $2,000 and $1,000 for fiscal years 2006 and 2005, respectively.
There were no recoveries for these periods. 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, 2006, adjustable rate loans accounted for 45.6% of
total loans as compared to 37.8% at March 31, 2005.
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 $1.1 million and $953,000 for the years ended March 31, 2006 and 2005,
respectively. The increase in service charges and fees is primarily due to an
increase in 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 BOLI amounted to $381,000 and $379,000 for fiscal years 2006 and 2005,
respectively. The Company also had gains on the sale of real estate of $325,000
and $93,000 during fiscal years 2006 and 2005, respectively. Both properties
sold were contiguous to an existing branch site. Management determined that
these properties were not going to be used in connection with the operation of
the branch.
Non-Interest Expense. Non-interest expense totaled $21.2 million for the
year ended March 31, 2006 as compared to $18.6 million for the year ended March
31, 2005. This increase is primarily due to increases of $1.8 million in
compensation expense, $301,000 in occupancy and equipment expense, $96,000 in
advertising and promotion expense and $541,000 in merger-related costs due to
the Company's announced merger with Hudson City.
The increase in compensation and benefits is due primarily to a $692,000
increase in compensation costs, a $215,000 increase in director fees and an
$839,000 increase in benefit plans expense. The increase in compensation costs
is due primarily to normal salary increases and increases in staff to support
the growth in the Company's lending operations and new branches. The increase in
director fees is due primarily to an increased number of meetings as the Board
of Directors considered the actions to take in the months preceeding the
announcement of the merger with Hudson City. The increase in benefit plans
expense includes a $287,000 increase in ESOP expense, a $218,000 increase in
pension expense and a $169,000 increase in expense related to the Director
Retirement Plan. The increase in ESOP expense is due primarily to an increase in
the market value of shares committed to be released for allocation. Compensation
expense is recognized for the ESOP equal to the fair value of shares committed
to be released for allocation to participant accounts.
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.
Income Taxes. For the years ended March 31, 2006 and 2005, income tax
expense amounted to $3.0 million and $3.5 million, respectively. The effective
tax rates for those same periods were 41.9% and 39.2%, respectively. The higher
effective tax rate in fiscal 2006 was due primarily to merger-related costs that
are not deductible for tax purposes.
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.
9
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 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%.
10
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 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. 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 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. 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.
11
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.
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.
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 2006, the Company
originated loans of $303.6 million and purchased securities of $53.1 million.
These were funded by $76.9 million in principal payments, maturities and calls
of securities, $125.9 million in loan principal repayments and an increase in
deposits of $171.9 million.
At March 31, 2006, we had $95.6 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 $100.0 million are available from the Federal
Home Loan Bank of New York. At March 31, 2006, approximately $574.2 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, 2006. Further information
concerning borrowings, loan commitments and lease commitments is included in
Notes 8 and 11 to the Consolidated Financial Statements.
Payments Due In
-------------------------------------------------------------------
Total Less Than 1-3 3 - 5 More Than
Payments 1 Year Years Years 5 Years
- ------------------------------------------------------------------------------------------------------------------------------------
(In thousands)
Borrowings $ 28,000 $ 7,000 $ 21,000 $ -- $ --
Loan commitments 95,614 95,614 -- -- --
Lease commitments 6,272 1,072 1,961 1,023 2,216
- ------------------------------------------------------------------------------------------------------------------------------------
Total $129,886 $103,686 $ 22,961 $ 1,023 $ 2,216
====================================================================================================================================
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, 2006 with
tangible and leverage
12
capital ratios of 9.3% and a total risk-based capital ratio of 20.3%, 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.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections", which replaces APB No. 20, "Accounting Changes", and SFAS No. 3,
"Reporting Changes in Interim Financial Statements". SFAS No. 154 changes the
accounting for, and reporting of, a change in accounting principle. SFAS No. 154
requires retrospective application to prior period's financial statements of
voluntary changes in accounting principle and changes required by new accounting
standards when the standard does not include specific transition provisions,
unless it is impracticable to do so. SFAS No. 154 is effective for accounting
changes and corrections of errors in fiscal years beginning after December 15,
2005 and will only affect the Company's consolidated financial statements upon
adoption of a voluntary change in accounting principle or a new standard that
does not include specific transition provisions.
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 addresses the determination of when an
investment is considered impaired; whether the impairment loss 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 loss 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
13
application of the FSP did not affect the Company's financial condition, results
of operations or financial statement disclosures.
14
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, 2006. 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, 2006, 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 the following
page.
15
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, 2006, 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, 2006, 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, 2006, based on criteria established in Internal
Control--Integrated Framework issued by COSO.
16
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, 2006 and 2005, 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,
2006, and our report dated June 8, 2006 expressed an unqualified opinion on
those consolidated financial statements.
/s/ KPMG LLP
Stamford, Connecticut
June 8, 2006
17
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, 2006 and 2005, 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,
2006. 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, 2006 and 2005, and the results of
their operations and their cash flows for each of the years in the three-year
period ended March 31, 2006, 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, 2006 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
8, 2006 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 8, 2006
18
SOUND FEDERAL BANCORP, INC. AND SUBSIDIARY
Consolidated Balance Sheets
- -----------------------------------------------------------------------------------------------------------------------------------
March 31, March 31,
(In thousands, except share and per share data) 2006 2005
- -----------------------------------------------------------------------------------------------------------------------------------
Assets
Cash and due from banks $ 12,194 $ 11,512
Federal funds sold and other overnight deposits 42,092 31,095
- -----------------------------------------------------------------------------------------------------------------------------------
Total cash and cash equivalents 54,286 42,607
- -----------------------------------------------------------------------------------------------------------------------------------
Securities:
Available for sale, at fair value (including
$29,144 and $37,831 pledged as collateral for
borrowings under repurchase agreements at
March 31, 2006 and 2005, respectively) (Notes
3 and 8) 215,455 276,154
Held to maturity, at amortized cost (fair value
of $109,410 and $78,728 at March 31, 2006 and
2005, respectively) (Note 4) 111,246 79,489
- -----------------------------------------------------------------------------------------------------------------------------------
Total securities 326,701 355,643
- -----------------------------------------------------------------------------------------------------------------------------------
Loans, net (Note 5):
Mortgage loans 737,274 558,662
Consumer and commercial loans 7,624 5,100
Allowance for loan losses (3,309) (3,011)
- -----------------------------------------------------------------------------------------------------------------------------------
Total loans, net 741,589 560,751
- -----------------------------------------------------------------------------------------------------------------------------------
Accrued interest receivable 5,319 4,277
Federal Home Loan Bank stock 2,842 5,738
Premises and equipment, net (Note 6) 5,546 6,214
Goodwill 13,970 13,970
Bank-owned life insurance 10,845 10,464
Prepaid pension costs (Note 10) 4,177 3,057
Deferred income taxes (Note 9) 2,645 2,236
Other assets 1,671 1,993
- -----------------------------------------------------------------------------------------------------------------------------------
Total assets $ 1,169,591 $ 1,006,950
===================================================================================================================================
Liabilities and Stockholders' Equity
Liabilities:
Deposits (Note 7) $ 1,003,691 $ 831,768
Borrowings (Note 8) 28,000 38,000
Mortgagors' escrow funds 6,160 5,264
Due to brokers for securities purchased -- 2,513
Accrued expenses and other liabilities (Note 10) 3,054 2,245
- -----------------------------------------------------------------------------------------------------------------------------------
Total liabilities 1,040,905 879,790
- -----------------------------------------------------------------------------------------------------------------------------------
Commitments and contingencies (Note 11)
Stockholders' equity (Note 12):
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; 12,336,040
and 12,377,206 shares outstanding at March 31,
2006 and March 31, 2005, respectively) 136 136
Additional paid-in capital 105,092 103,728
Treasury stock, at cost (1,300,130 and 1,258,964
shares at March 31, 2006 and March 31, 2005,
respectively) (18,813) (18,131)
Common stock held by Employee Stock Ownership Plan
("ESOP") (Note 10) (5,549) (6,053)
Unearned stock awards (Note 10) (3,252) (4,435)
Retained earnings 54,960 54,638
Accumulated other comprehensive loss, net of taxes
(Note 13) (3,888) (2,723)
- -----------------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 128,686 127,160
- -----------------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 1,169,591 $ 1,006,950
===================================================================================================================================
See accompanying notes to consolidated financial statements.
19
SOUND FEDERAL BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Income
Years Ended March 31,
- ------------------------------------------------------------------------------------------------------------------------------------
(In thousands, except per share data) 2006 2005 2004
- ------------------------------------------------------------------------------------------------------------------------------------
Interest and Dividend Income
Loans $37,395 $29,430 $26,819
Mortgage-backed and other securities 12,761 11,998 11,538
Federal funds sold and other overnight deposits 972 340 240
Other earning assets 313 132 142
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest and dividend income 51,441 41,900 38,739
- ------------------------------------------------------------------------------------------------------------------------------------
Interest Expense
Deposits (Note 7) 23,207 13,968 11,004
Borrowings 1,390 1,489 1,495
Other interest-bearing liabilities 23 20 48
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest expense 24,620 15,477 12,547
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income 26,821 26,423 26,192
Provision for loan losses (Note 5) 300 300 275
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 26,521 26,123 25,917
- ------------------------------------------------------------------------------------------------------------------------------------
Non-Interest Income
Service charges and fees 1,149 953 955
Income on bank-owned life insurance 381 379 86
Gain on sales of real estate 325 93 --
Gain on sales of mortgage loans -- 22 --
- ------------------------------------------------------------------------------------------------------------------------------------
Total non-interest income 1,855 1,447 1,041
- ------------------------------------------------------------------------------------------------------------------------------------
Non-Interest Expense
Compensation and benefits (Note 10) 11,697 9,945 8,733
Occupancy and equipment 3,018 2,717 2,291
Data processing service fees 1,230 1,218 1,025
Advertising and promotion 1,215 1,119 1,020
Merger-related costs 541 -- --
Other 3,508 3,569 3,037
- ------------------------------------------------------------------------------------------------------------------------------------
Total non-interest expense 21,209 18,568 16,106
- ------------------------------------------------------------------------------------------------------------------------------------
Income before income tax expense 7,167 9,002 10,852
Income tax expense (Note 9) 3,003 3,533 4,234
- ------------------------------------------------------------------------------------------------------------------------------------
Net income $ 4,164 $ 5,469 $ 6,618
====================================================================================================================================
Earnings per share (Note 14):
Basic $ 0.36 $ 0.47 $ 0.54
- ------------------------------------------------------------------------------------------------------------------------------------
Diluted 0.35 0.46 0.52
- ------------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
20
SOUND FEDERAL BANCORP INC. AND SUBSIDIARY
Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended March 31, 2006, 2005 and 2004
(In thousands, except share and per share data)
Accumulated
Common Other
Additional Stock Unearned Comprehensive Total
Common Paid-in Treasury Held by Stock Retained (Loss) Stockholders'
Stock Capital Stock ESOP Awards Earnings Income Equity
- ------------------------------------------------------------------------------------------------------------------------------------
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
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
- ------------------------------------------------------------------------------------------------------------------------------------
(Continued)
21
SOUND FEDERAL BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Changes in Stockholders' Equity, continued
For the Years Ended March 31, 2006, 2005 and 2004
(In thousands, except share and per share data)
Accumulated
Common Other
Additional Stock Unearned Comprehensive Total
Common Paid-in Treasury Held by Stock Retained (Loss) Stockholders'
Stock Capital Stock ESOP Awards Earnings Income Equity
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at March 31, 2005 $ 136 $103,728 $(18,131) $(6,053) $(4,435) $54,638 $(2,723) $127,160
Net income -- -- -- -- -- 4,164 -- 4,164
Other comprehensive loss (Note 13) -- -- -- -- -- -- (1,165) (1,165)
--------
Total comprehensive income 2,999
Dividends paid ($0.285 per share) -- -- -- -- -- (3,327) -- (3,327)
Purchases of treasury stock (87,300
shares) -- -- (1,349) -- -- -- -- (1,349)
Reissuance of treasury stock for
exercise of stock options
(46,134 shares) -- -- 667 -- -- (515) -- 152
Tax benefit from exercise of
stock options -- 265 -- -- -- -- -- 265
Vesting of stock awards and related
tax benefits -- 53 -- -- 1,183 -- -- 1,236
ESOP shares committed to be released
for allocation -- 973 -- 504 -- -- -- 1,477
Tax benefit for dividends on
unallocated ESOP shares -- 73 -- -- -- -- -- 73
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at March 31, 2006 $ 136 $105,092 $(18,813) $(5,549) $(3,252) $54,960 $(3,888) $128,686
====================================================================================================================================
See accompanying notes to consolidated financial statements.
22
SOUND FEDERAL BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
Years Ended March 31,
- ------------------------------------------------------------------------------------------------------------------------------------
(In thousands) 2006 2005 2004
- ------------------------------------------------------------------------------------------------------------------------------------
Operating Activities
Net income $ 4,164 $ 5,469 $ 6,618
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 300 300 275
Depreciation, amortization and accretion 2,182 2,570 2,549
ESOP and stock award expense 2,660 2,388 1,625
Income taxes 1,004 348 (800)
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 sales of real estate (325) (93) --
Pension costs (1,120) (510) 81
Other adjustments, net (677) (448) (777)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 8,188 10,024 9,571
- ------------------------------------------------------------------------------------------------------------------------------------
Investing Activities
Purchases of securities:
Available for sale (1,000) (31,015) (198,707)
Held to maturity (52,126) (82,297) --
Proceeds from payments, maturities and calls of securities:
Available for sale 59,175 81,894 146,415
Held to maturity 17,738 5,274 --
Net disbursements for loan originations and principal repayments (178,946) (83,164) (52,027)
Purchase of mortgage loans (2,532) -- --
Purchases of Federal Home Loan Bank stock (647) (435) (1,162)
Proceeds from redemption of Federal Home Loan Bank stock 3,543 -- --
Proceeds from sales of real estate 396 174 --
Purchases of premises and equipment (405) (1,519) (968)
Purchase of bank-owned life insurance -- -- (10,000)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (154,804) (111,088) (116,449)
- ------------------------------------------------------------------------------------------------------------------------------------
Financing Activities
Net increase in deposits 171,923 123,438 104,070
Proceeds from borrowings -- 9,000 47,000
Repayment of borrowings (10,000) (6,000) (47,000)
Net increase (decrease) in mortgagors' escrow funds 896 742 (81)
Purchases of treasury stock (1,349) (12,087) (8,417)
Proceeds from exercise of stock options 152 258 268
Payment of cash dividends on common stock (3,327) (2,891) (2,648)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 158,295 112,460 93,192
- ------------------------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents 11,679 11,396 (13,686)
Cash and cash equivalents at beginning of year 42,607 31,211 44,897
- ------------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 54,286 $ 42,607 $ 31,211
====================================================================================================================================
Supplemental Information
Interest paid $ 24,588 $ 15,415 $ 12,711
Income taxes paid 1,997 3,145 4,921
Decrease in due to brokers for securities purchased (2,513) (1,487) (6,495)
====================================================================================================================================
See accompanying notes to consolidated financial statements.
23
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
(1) Reorganization, Stock Offerings and Pending Merger
Initial Public Offering
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").
Second-Step Conversion
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 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.
Pending Merger
On February 8, 2006, the Holding Company entered into an Agreement and
Plan of Merger (the "Merger Agreement") pursuant to which it would be
acquired by Hudson City Bancorp, Inc. Shareholders of the Holding Company
will receive $20.75 in cash for each share of the Holding Company common
stock they own. The acquisition is subject to the receipt of regulatory
and shareholder approvals. It is expected that the acquisition will be
completed during the Company's second fiscal quarter.
(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.
24
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, Inc., First Federal REIT, Inc. and
Mamaroneck Advisors, Inc. Sound REIT, Inc. and First Federal REIT, Inc.
are real estate investment trusts that hold a portion of the Company's
mortgage-related assets. On June 8, 2006, a plan of dissolution was
adopted for First Federal REIT, Inc. The dissolution would result in the
transfer of substantially all of the subsidiary's assets and liabilities
to the Bank and, accordingly, would have an insignificant effect on the
Company's consolidated financial statements. 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
25
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
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.
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. Loan prepayment fees are recognized in non-interest
income, at the time of prepayment, when the borrower does not refinance
with the Company or when the terms (including effective yield) of a
refinanced loan are at least as favorable as the terms of comparable loans
to borrowers of similar creditworthiness. Prepayment fees included in
non-interest income were $194,000, $164,000 and $180,000 in fiscal years
2006, 2005 and 2004, respectively.
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
26
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
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, 2006, 2005 and 2004.
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-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.
27
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
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. BOLI policies
were purchased in consideration of the Company's obligations under the
supplemental executive retirement plan and the Director Retirement Plan,
which are described in Note 10. The amount by which death benefits
retained by the Company (net of split-dollar endorsements) exceeds a
policy's cash surrender value is recorded in non-interest income at the
time of receipt. No death benefits were received in fiscal years 2006,
2005 and 2004.
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.
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:
(In thousands, except per share data) 2006 2005 2004
- ------------------------------------------------------------------------------------------------------------------------------------
Net income, as reported $ 4,164 $ 5,469 $ 6,618
Add stock award expense included in reported
net income, net of related tax effects 718 723 242
Deduct stock award and stock option expense determined
under the fair-value-based method, net of
related tax effects (1,183) (1,188) (768)
- ------------------------------------------------------------------------------------------------------------------------------------
Pro forma net income $ 3,699 $ 5,004 $ 6,092
====================================================================================================================================
Earnings per share:
Basic, as reported $ 0.36 $ 0.47 $ 0.54
====================================================================================================================================
Basic, pro forma $ 0.32 $ 0.43 $ 0.49
====================================================================================================================================
Diluted, as reported $ 0.35 $ 0.46 $ 0.52
====================================================================================================================================
Diluted, pro forma $ 0.32 $ 0.42 $ 0.48
====================================================================================================================================
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 2006). The fair value
28
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
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 Company will adopt SFAS No. 123R by recognizing
compensation expense for (i) any 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
Company's stock options outstanding at March 31, 2006 that will 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.
29
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
(In thousands) Cost Gains Losses Value
- ------------------------------------------------------------------------------------------------------------------------------------
March 31, 2006
Pass-through securities issued by:
Ginnie Mae $ 45,941 $ 44 $ (437) $ 45,548
Fannie Mae 24,122 43 (771) 23,394
Freddie Mac 9,361 41 (211) 9,191
Collateralized mortgage obligations issued by:
Ginnie Mae 1,783 -- (46) 1,737
Fannie Mae 24,917 -- (1,191) 23,726
Freddie Mac 38,245 -- (1,788) 36,457
- ------------------------------------------------------------------------------------------------------------------------------------
Total mortgage-backed securities 144,369 128 (4,444) 140,053
U.S. Government and agency securities 53,688 -- (1,677) 52,011
Municipal securities 866 100 -- 966
Mutual fund shares 23,008 -- (583) 22,425
- ------------------------------------------------------------------------------------------------------------------------------------
Total securities $221,931 $ 228 $ (6,704) $215,455
====================================================================================================================================
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
====================================================================================================================================
Debt securities available for sale at March 31, 2006 consisted of
adjustable rate securities and fixed rate securities with amortized costs
of $72.7 million and $126.2 million, and weighted average yields of 4.57%
and 3.75%, respectively. 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.
There were no sales of securities available for sale during the years
ended March 31, 2006, 2005 and 2004.
30
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, 2006 and 2005, the aggregate fair values and gross
unrealized losses by length of time those securities had been in a
continuous unrealized loss position at the respective dates:
Less Than 12 Months 12 Months or Longer Total
- -------------------------------------------------------------------------------------------------------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
(In thousands) Value Losses Value Losses Value Losses
- -------------------------------------------------------------------------------------------------------------------------
March 31, 2006
Pass-through securities issued by:
Ginnie Mae $ 19,397 $ (164) $ 18,375 $ (273) $ 37,772 $ (437)
Fannie Mae 4,433 (42) 16,826 (729) 21,259 (771)
Freddie Mac 2,634 (40) 4,751 (171) 7,385 (211)
Collateralized mortgage obligations issued by:
Ginnie Mae -- -- 1,734 (46) 1,734 (46)
Fannie Mae 1,215 (11) 22,511 (1,180) 23,726 (1,191)
Freddie Mac 2,896 (80) 33,561 (1,708) 36,457 (1,788)
U.S. Government and agency securities 2,506 (53) 49,469 (1,624) 51,975 (1,677)
Mutual fund shares 6,862 (146) 15,563 (437) 22,425 (583)
- -------------------------------------------------------------------------------------------------------------------------
Total temporarily-impaired securities $ 39,943 $ (536) $162,790 $ (6,168) $202,733 $ (6,704)
- -------------------------------------------------------------------------------------------------------------------------
March 31, 2005
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 debt securities comprised of
mortgage-backed securities issued by Ginnie Mae, Fannie Mae and Freddie
Mac, as well as U.S. Government and Agency securities. The Company also
invests in two mutual funds that invest primarily in mortgage-related
assets. The unrealized losses on debt securities at March 31, 2006 and
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, 2006 and 2005. At March 31, 2006,
a total of 151 securities were in a continuous unrealized loss position
for less than 12 months, and 261 securities for 12 months or longer (174
securities and 134 securities, respectively, at March 31, 2005). 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
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, 2006 and 2005.
The following is a summary of the amortized cost and fair value of debt
securities available for sale at March 31, 2006, with amounts shown by
remaining term to contractual maturity for categories other than mortgage-
31
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
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
(In thousands) Cost Value
- --------------------------------------------------------------------------------
Mortgage-backed securities $144,369 $140,053
U.S. Government and agency
securities due:
Less than one year 6,500 6,378
Over one to five years 37,372 36,045
Over five to ten years 3,148 3,095
Over ten years 6,668 6,493
Municipal securities due:
Over five to ten years 336 370
Over ten years 530 596
- --------------------------------------------------------------------------------
Total debt securities $198,923 $193,030
================================================================================
(4) Securities Held to Maturity
The following is a summary of securities held to maturity:
Gross Unrealized
Amortized -------------------- Fair
(In thousands) Cost Gains Losses Value
- -------------------------------------------------------------------------------------------
March 31, 2006
Mortgage-backed securities issued by:
Ginnie Mae $ 32,489 $ 24 $ (553) $ 31,960
Fannie Mae 7,528 65 (20) 7,573
Freddie Mac 1,184 -- (22) 1,162
Collateralized mortgage obligations issued by:
Fannie Mae 6,966 -- (222) 6,744
Freddie Mac 17,136 -- (449) 16,687
- -------------------------------------------------------------------------------------------
Total mortgage-backed securities 65,303 89 (1,266) 64,126
U.S. Government and agency securities 45,943 -- (659) 45,284
- -------------------------------------------------------------------------------------------
Total $111,246 $ 89 $ (1,925) $109,410
===========================================================================================
March 31, 2005
Mortgage-backed securities 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
===========================================================================================
The amortized cost of the portfolio at March 31, 2006 consisted of
adjustable rate securities and fixed rate securities with amortized costs
of $41.2 million and $70.0 million, with weighted average yields of 4.44%
32
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
and 4.26%, respectively. Adjustable rate and fixed rate securities at
March 31, 2005 totaled $39.2 million and $40.3 million, with 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, 2006, 2005 and 2004.
The following table summarizes, for all securities in an unrealized loss
position at March 31, 2006 and 2005, the aggregate fair values and gross
unrealized losses by length of time those securities had been in a
continuous unrealized loss position at the respective dates:
Less Than 12 Months 12 Months or Longer Total
- -----------------------------------------------------------------------------------------------------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
(In thousands) Value Losses Value Losses Value Losses
- -----------------------------------------------------------------------------------------------------------------------
March 31, 2006
Pass-through securities issued by:
Ginnie Mae $ 15,630 $ (159) $ 14,134 $ (394) $ 29,764 $ (553)
Fannie Mae 1,284 (16) 471 (4) 1,755 (20)
Freddie Mac -- -- 1,162 (22) 1,162 (22)
Collateralized mortgage obligations issued by:
Fannie Mae 1,874 (44) 4,870 (178) 6,744 (222)
Freddie Mac 8,579 (138) 8,108 (311) 16,687 (449)
U.S. Government and agency securities 30,654 (358) 14,630 (301) 45,284 (659)
- -----------------------------------------------------------------------------------------------------------------------
Total temporarily-impaired securities $ 58,021 $ (715) $ 43,375 $ (1,210) $101,396 $ (1,925)
=======================================================================================================================
March 31, 2005
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)
=======================================================================================================================
The Company invests primarily in debt securities comprised of
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, 2006 and 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, 2006
and 2005. At March 31, 2006, a total of 55 securities were in a continuous
unrealized loss position for less than 12 months, and 41 securities for 12
months or longer. 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, 2006 and 2005.
The following is a summary of the amortized cost and fair value of
securities held to maturity at March 31, 2006, with information on U.S.
Government and agency securities shown by remaining term to contractual
33
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
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
(In thousands) Cost Value
- --------------------------------------------------------------------------------
Mortgage-backed securities $ 65,303 $ 64,126
U. S. Government and agency securities:
Less than one year 4,000 3,955
Over one to five years 37,582 37,038
Over five to ten years 3,496 3,452
Over ten years 865 839
- --------------------------------------------------------------------------------
Total $111,246 $109,410
================================================================================
(5) Loans
Loans are summarized as follows:
March 31,
- --------------------------------------------------------------------------------
(In thousands) 2006 2005
- --------------------------------------------------------------------------------
Mortgage loans:
Residential properties:
One-to-four family $ 569,415 $ 441,655
Home equity lines of credit 54,449 42,052
Multi-family 8,124 9,807
Commercial properties 61,945 45,645
Construction loans 40,371 17,416
- --------------------------------------------------------------------------------
734,304 556,575
- --------------------------------------------------------------------------------
Consumer loans:
Secured personal loans 1,286 1,164
Other loans 1,355 1,004
Commercial loans 4,978 2,932
- --------------------------------------------------------------------------------
7,619 5,100
- --------------------------------------------------------------------------------
Total loans 741,923 561,675
Deferred loan origination costs, net 2,975 2,087
Allowance for loan losses (3,309) (3,011)
- --------------------------------------------------------------------------------
Total loans, net $ 741,589 $ 560,751
================================================================================
Gross principal balances at March 31, 2006 consisted of fixed rate loans
of $402.6 million and adjustable rate loans of $339.3 million, with
weighted average yields of 6.15% and 5.55%, respectively. Fixed rate and
adjustable rate loans at March 31, 2005 totaled $349.1 million and $212.5
million, with weighted average yields of 6.05% and 5.10%, respectively.
There were no loans held for sale at March 31, 2006 and 2005.
Adjustable rate loans are primarily one-to-four family mortgage loans with
fixed rates for initial terms of three, five, seven or ten years followed
by one-year rate adjustment periods for the remaining term of the loan.
Total adjustable rate loans include one-to-family loans of $90.1 million
at March 31, 2006 ($7.8 million at March 31, 2005) that provide for
interest-only payments during the initial fixed rate period. Interest-only
loans are subject to the same underwriting standards as the Company's
other adjustable rate mortgage loans, except that a more stringent
loan-to-value ratio requirement applies to interest-only loans. The
Company's interest-only loans do not provide for negative amortization of
the principal balance.
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.
34
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
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.
Activity in the allowance for loan losses is summarized as follows for the
years ended March 31:
- -------------------------------------------------------------------------
(In thousands) 2006 2005 2004
- -------------------------------------------------------------------------
Balance at beginning of year $ 3,011 $ 2,712 $ 2,442
Provision for loan losses 300 300 275
Charge-offs (2) (1) (5)
- -------------------------------------------------------------------------
Balance at end of year $ 3,309 $ 3,011 $ 2,712
=========================================================================
The principal balances of nonaccrual loans past due ninety days or more at March
31 are as follows:
- ------------------------------------------------------------------
(In thousands) 2006 2005 2004
- ------------------------------------------------------------------
Mortgage loans:
One-to-four family $2,075 $ 510 $1,359
Home equity lines of credit 809 70 617
Consumer loans 9 -- 5
- ------------------------------------------------------------------
Total nonaccrual loans $2,893 $ 580 $1,981
==================================================================
Gross interest income that would have been recorded if the foregoing
nonaccrual loans had remained current in accordance with their contractual
terms totaled $189,000, $40,000 and $124,000 for the years ended March 31,
2006, 2005 and 2004, respectively, compared to interest income actually
recognized of $63,000, $16,000 and $71,000, respectively.
The Company had no impaired loans at March 31, 2006 and 2005 within the
scope of SFAS No. 114, Accounting by Creditors for Impairment of a Loan.
Provisions for losses and other activity in the allowance for losses on
real estate owned were insignificant during the years ended March 31,
2006, 2005 and 2004.
(6) Premises and Equipment
A summary of premises and equipment at March 31 follows:
- ----------------------------------------------------------------------
(In thousands) 2006 2005
- ----------------------------------------------------------------------
Land $ 592 $ 592
Buildings and improvements 4,406 4,313
Leasehold improvements 3,222 3,217
Furniture and equipment 3,642 3,508
- ----------------------------------------------------------------------
11,862 11,630
Less accumulated depreciation and amortization (6,316) (5,416)
- ----------------------------------------------------------------------
Premises and equipment, net $ 5,546 $ 6,214
======================================================================
35
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
(7) Deposits
The following is a summary of deposit balances and weighted average stated
interest rates at March 31:
2006 2005
- -------------------------------------------------------------------------------------------------------------
(Dollars in thousands) Rate Amount Rate Amount
- -------------------------------------------------------------------------------------------------------------
Savings and club accounts 0.58% $ 129,640 0.51% $ 150,455
Money market accounts 2.30 56,147 0.97 52,881
NOW accounts 0.75 74,308 0.35 61,357
Commercial checking -- 20,415 -- 14,201
- -------------------------------------------------------------------------------------------------------------
Total 0.93 280,510 0.54 278,894
- -------------------------------------------------------------------------------------------------------------
Certificates of deposit by remaining term to contractual maturity:
Within one year 3.70 574,166 2.30 260,659
After one but within two years 4.08 105,274 3.15 199,952
After two but within three years 3.74 13,334 3.60 59,822
After three years 4.44 30,407 4.23 32,441
- -------------------------------------------------------------------------------------------------------------
Total 3.78 723,181 2.86 552,874
- -------------------------------------------------------------------------------------------------------------
Total deposits 2.73% $1,003,691 1.90% $ 831,768
=============================================================================================================
Certificates of deposit with denominations of $100,000 or more totaled
$195.0 million and $138.7 million at March 31, 2006 and 2005,
respectively.
Interest expense on deposits is summarized as follows for the years ended
March 31:
(In thousands) 2006 2005 2004
- ------------------------------------------------------------
Savings and club accounts $ 767 $ 783 $ 856
Money market and NOW accounts 866 526 547
Certificates of deposit 21,574 12,659 9,601
- ------------------------------------------------------------
Total $23,207 $13,968 $11,004
============================================================
(8) Borrowings
Borrowings under securities repurchase agreements with the FHLB are
summarized as follows:
March 31,
Maturity Date Coupon -------------------
(Dollars in thousands) Rate 2006 2005
- ----------------------------------------------------------------
January 2008 (1) 5.42% $10,000 $10,000
December 2008 (1) 4.72 5,000 5,000
June 2005 2.47 -- 3,000
March 2006 2.27 -- 7,000
March 2007 2.65 7,000 7,000
March 2008 4.13 6,000 6,000
------------------
Total borrowings $28,000 $38,000
==================
Weighted average interest rate 4.33% 3.80%
Accrued interest payable $ 147 $ 165
(1) Callable quarterly.
36
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
The securities transferred to the FHLB in repurchase agreements include
U.S. Government and agency securities and mortgage-backed securities of
$14.9 million and $14.2 million, respectively, at March 31, 2006 ($14.1
million and $23.7 million, respectively, at March 31, 2005). Accrued
interest receivable on these securities totaled $239,000 and $258,000 at
March 31, 2006 and 2005, respectively.
In addition to securities repurchase agreements, the Bank may have
outstanding borrowings from the FHLB of up to approximately $100.0 million
at March 31, 2006, 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, 2006 and 2005.
(9) Income Taxes
Income tax expense consists of the following components for the years
ended March 31:
(In thousands) 2006 2005 2004
- ----------------------------------------------------------------------
Federal:
Current $ 2,329 $ 3,129 $ 3,627
Deferred 285 (39) 11
- ----------------------------------------------------------------------
2,614 3,090 3,638
- ----------------------------------------------------------------------
State:
Current 306 458 575
Deferred 83 (15) 21
- ----------------------------------------------------------------------
389 443 596
- ----------------------------------------------------------------------
Total:
Current 2,635 3,587 4,202
Deferred 368 (54) 32
- ----------------------------------------------------------------------
$ 3,003 $ 3,533 $ 4,234
======================================================================
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:
(Dollars in thousands) 2006 2005 2004
- --------------------------------------------------------------------------------
Taxes at Federal statutory rate $ 2,437 $ 3,061 $ 3,690
State tax expense, net of Federal tax benefit 257 292 390
Nondeductible ESOP expense 331 239 248
Nondeductible merger costs 149 -- --
Increase in cash surrender value of BOLI (129) (129) (29)
Other reconciling items, net (42) 70 (65)
- --------------------------------------------------------------------------------
Actual income tax expense $ 3,003 $ 3,533 $ 4,234
================================================================================
Effective income tax rate 41.9% 39.2% 39.0%
37
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:
(In thousands) 2006 2005
- --------------------------------------------------------------------------------
Deferred tax assets:
Net unrealized loss on securities available for sale $2,588 $1,811
Allowance for loan losses 1,324 1,204
Deferred compensation 627 571
Director retirement plan 489 340
Accrued pension costs 214 173
Stock benefit plan accruals 197 197
Other deductible temporary differences 208 144
- --------------------------------------------------------------------------------
Total deferred tax assets 5,647 4,440
- --------------------------------------------------------------------------------
Deferred tax liabilities:
Prepaid pension costs 1,671 1,223
Deferred loan costs 1,190 835
Purchase accounting adjustment on buildings 141 146
- --------------------------------------------------------------------------------
Total deferred tax liabilities 3,002 2,204
- --------------------------------------------------------------------------------
Net deferred tax asset $2,645 $2,236
================================================================================
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, 2006 and 2005.
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, 2006 and 2005, and $14.5 million
and $14.0 million for New York State tax purposes at March 31, 2006 and
2005, 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 $4.1 million and $3.9 million at March 31, 2006 and 2005,
respectively.
38
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 does
not expect to make any contributions to the plans in fiscal 2007.
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 4.5 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.
39
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.
(In thousands) 2006 2005
- --------------------------------------------------------------------------------
Change in projected benefit obligations:
Beginning of year $ 11,692 $ 10,451
Service cost 459 366
Interest cost 687 638
Actuarial loss 1,199 747
Benefits paid (521) (510)
- --------------------------------------------------------------------------------
End of year 13,516 11,692
- --------------------------------------------------------------------------------
Change in fair value of plan assets:
Beginning of year 11,040 10,239
Actual return on plan assets 273 246
Employer contributions 1,712 1,065
Benefits paid (521) (510)
- --------------------------------------------------------------------------------
End of year 12,504 11,040
- --------------------------------------------------------------------------------
Funded status at the measurement date (1,012) (652)
Employer contributions after the measurement date -- 150
Unrecognized net actuarial loss (1) 5,155 3,520
Unrecognized past service liability 34 39
- --------------------------------------------------------------------------------
Prepaid pension costs at March 31 $ 4,177 $ 3,057
================================================================================
(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 being amortized over the average remaining service period of
active plan participants.
The plans' accumulated benefit obligations were $11.5 million and $10.1
million at March 31, 2006 and 2005, respectively.
Pension benefits expected to be paid for the fiscal years ending March 31
are $629,000 in 2007, $648,000 in 2008, $680,000 in 2009, $709,000 in
2010, $729,000 in 2011 and a total of $4.2 million in 2012-2016. These
amounts are based on the same assumptions used to measure the benefit
obligation at March 31, 2006 and include estimated future employee
service.
40
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:
(Dollars in thousands) 2006 2005 2004
- --------------------------------------------------------------------------------
Service cost $ 459 $ 366 $ 341
Interest cost 687 638 623
Expected return on plan assets (924) (900) (700)
Recognized net actuarial loss 208 108 111
Amortization of prior service cost and net
transition obligation 5 5 5
- --------------------------------------------------------------------------------
Net periodic pension expense $ 435 $ 217 $ 380
================================================================================
Weighted-average assumptions used to determine
projected benefit obligations at
March 31:
Discount rate 5.75% 6.00% 6.25%
Rate of compensation increase 3.00% 3.50% 3.50%
Weighted-average assumptions used to determine net
periodic pension expense for
the years ended March 31:
Discount rate 6.00% 6.25% 6.50%
Expected long-term rate of
return on plan assets 8.50% 8.50% 8.50%
Rate of compensation increase 3.50% 3.50% 4.00%
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 $536,000 and $431,000 at March 31,
2006 and 2005, respectively, and the related expense was $105,000, $98,000
and $38,000 for the years ended March 31, 2006, 2005 and 2004,
respectively.
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.
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.
41
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
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.
A discount rate of 5.75% was used to determine the projected benefit
obligation.
(In thousands) 2006 2005
- --------------------------------------------------------------------------------
Change in projected benefit obligation:
Beginning of year $ 2,024 $ 1,633
Service cost 165 48
Interest cost 128 104
Actuarial loss 209 282
Benefits paid (43) (43)
- --------------------------------------------------------------------------------
End of year 2,483 2,024
Fair value of plan assets -- --
- --------------------------------------------------------------------------------
Funded status (2,483) (2,024)
Unrecognized net actuarial loss (gain) 129 (92)
Unrecognized prior service cost 1,132 1,265
- --------------------------------------------------------------------------------
Accrued benefit cost at end of year $(1,222) $ (851)
================================================================================
The components of the net periodic expense for the plan were as follows:
(Dollars in thousands) 2006 2005 2004
- --------------------------------------------------------------------------------
Service cost $ 165 $ 48 $ 11
Interest cost 128 104 48
Recognized net actuarial gain (12) (40) --
Amortization of prior service cost 133 133 79
- --------------------------------------------------------------------------------
Net periodic expense $ 414 $ 245 $ 138
================================================================================
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.
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
42
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
make principal and interest payments on the loans, which had total unpaid
principal balances of $6.1 million and $6.4 million at March 31, 2006 and
2005, 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 $1.5 million, $1.2 million and $1.2 million for the years
ended March 31, 2006, 2005 and 2004, 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 (635,402 shares and
698,606 shares at March 31, 2006 and 2005, respectively). The fair value
of these shares was approximately $13.1 million and $10.8 million at March
31, 2006 and 2005, 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 were fully vested at March 31, 2006 and 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.
In February 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. In February 2004, initial grants were made under the ISB
Plan for 665,253 shares at an exercise price of $15.20 per share. 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. At March 31, 2006 and 2005, there were 35,013 shares available for
future option grants.
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).
Stock option activity is summarized below:
Options Outstanding Options Exercisable
- --------------------------------------------------------------------------------
Weighted Average Weighted Average
Number Exercise Price Number Exercise Price
- --------------------------------------------------------------------------------
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
Exercised (46,134) 3.298
- -----------------------------------
At March 31, 2006 990,751 11.290 724,641 9.854
===================================
43
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Additional information for outstanding and exercisable options at March
31, 2006 follows:
Options Options
Exercise Price Outstanding Exercisable
- --------------------------------------------------------------------------------
$ 3.298 325,498 325,498
15.200 665,253 399,143
- --------------------------------------------------------------------------------
990,751 724,641
================================================================================
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, 2006, 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, $1.2 million and
$395,000 for the years ended March 31, 2006, 2005 and 2004, respectively.
(11) Commitments and Contingencies
Off-Balance Sheet Financial Instruments
The Company's off-balance sheet financial instruments at March 31, 2006
and 2005 were limited to loan origination commitments of $42.2 million and
$66.0 million, respectively, and unused lines of credit (principally fixed
rate home equity lines) extended to customers of $53.4 million and $47.6
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, 2006 consisted of adjustable rate and fixed rate commitments of $30.6
million and $11.6 million, respectively, with weighted average yields of
7.19% and 6.10%, respectively. 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
5.79% and 6.15%, 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.
44
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
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 $1.1 million, $1.0 million and $808,000 for the years
ended March 31, 2006, 2005 and 2004, respectively. At March 31, 2006, the
future minimum rental payments under operating lease agreements for the
fiscal years ending March 31 are $1.1 million in 2007, $1.1 million in
2008, $905,000 in 2009, $667,000 in 2010, $357,000 in 2011, and a total of
$2.2 million for 2012 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, 2006 and 2005, 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
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.
45
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
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
Minimum as Well
Bank Actual Capital Adequacy Capitalized
- --------------------------------------------------------------------------------
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
- --------------------------------------------------------------------------------
March 31, 2006
Tangible capital $107,796 9.3% $ 17,311 1.5%
Tier I (core) capital 107,796 9.3 46,163 4.0 $ 57,704 5.0%
Risk-based capital:
Tier I 107,796 19.7 21,931 4.0 32,897 6.0
Total 111,105 20.3 43,863 8.0 54,829 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
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. At March 31, 2006, the Bank's
retained net income for fiscal 2006 and 2005 was $10.1 million.
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, 2006, a total of 337,300
shares had been purchased at an average price of $15.16 per share. The
repurchase program has no expiration date. However, under the terms of the
Merger Agreement, the Company has agreed to not repurchase any additional
shares.
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
46
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
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.
(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:
(In thousands) 2006 2005 2004
- --------------------------------------------------------------------------------
Net unrealized holding loss arising during
the period on securities available for sale $(1,942) $(5,677) $(2,352)
Reversal of adjustment for additional
minimum pension liability -- -- 3,468
Related deferred income tax effect 777 2,252 (430)
- --------------------------------------------------------------------------------
Other comprehensive (loss) income $(1,165) $(3,425) $ 686
================================================================================
The Company's accumulated other comprehensive (loss) income, which is
included in stockholders' equity, is summarized as follows at March 31:
(In thousands) 2006 2005
- --------------------------------------------------------------------------------
Net unrealized holding loss on securities
available for sale $(6,476) $(4,534)
Related deferred income taxes 2,588 1,811
- --------------------------------------------------------------------------------
Accumulated other comprehensive loss $(3,888) $(2,723)
================================================================================
47
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,
- --------------------------------------------------------------------------------
(In thousands, except per share data) 2006 2005 2004
- --------------------------------------------------------------------------------
Net income $ 4,164 $ 5,469 $ 6,618
================================================================================
Weighted average common shares
outstanding for computation of
basic EPS (1) 11,471 11,651 12,367
Common-equivalent shares for the
dilutive effect of stock options and
stock awards (2) 330 267 346
- --------------------------------------------------------------------------------
Weighted average common shares for
computation of diluted EPS 11,801 11,918 12,713
================================================================================
Earnings per common share:
Basic $ 0.36 $ 0.47 $ 0.54
Diluted 0.35 0.46 0.52
================================================================================
(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.
(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.
48
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
The following is a summary of the carrying amounts and estimated fair
values of the Company's financial assets and liabilities at March 31:
2006 2005
- --------------------------------------------------------------------------------
Carrying Fair Carrying Fair
(In millions) Amount Value Amount Value
- --------------------------------------------------------------------------------
Financial assets:
Cash and cash equivalents $ 54.3 $ 54.3 $ 42.6 $ 42.6
Securities available for sale 215.5 215.5 276.2 276.2
Securities held to maturity 111.2 109.4 79.5 78.7
Loans, net 741.6 735.4 560.8 563.0
Accrued interest receivable 5.3 5.3 4.3 4.3
FHLB stock 2.8 2.8 5.7 5.7
Financial liabilities:
Savings certificate accounts 723.2 723.2 552.9 552.9
Other deposit accounts 280.5 280.5 278.9 278.9
Borrowings 28.0 27.6 38.0 37.9
Mortgagors' escrow funds 6.2 6.2 5.3 5.3
================================================================================
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.
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.
49
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
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, 2006 and 2005, the fair values of these instruments approximated the
related carrying amounts.
(16) Parent Company Condensed Financial Statements
Set forth below are condensed financial statements of the Holding Company:
Condensed Balance Sheets March 31,
- --------------------------------------------------------------------------------
(In thousands) 2006 2005
- --------------------------------------------------------------------------------
Assets
Interest-bearing deposits at subsidiary bank $ 3,911 $ 10,416
Loans receivable from ESOP 6,065 6,448
Investment in subsidiary bank 117,895 113,065
Due from subsidiary bank 4,952 826
Other assets 1,496 2,504
- --------------------------------------------------------------------------------
Total assets $134,319 $133,259
================================================================================
Liabilities $ 5,633 $ 6,099
Stockholders' Equity 128,686 127,160
- --------------------------------------------------------------------------------
Total liabilities and stockholders' equity $134,319 $133,259
================================================================================
Condensed Statements of Income Years Ended March 31,
- --------------------------------------------------------------------------
(In thousands) 2006 2005 2004
- --------------------------------------------------------------------------
Interest income $ 412 $ 339 $ 499
Non-interest expenses (946) (381) (397)
- --------------------------------------------------------------------------
Income (loss) before income taxes and
equity in undistributed earnings of
subsidiary bank (534) (42) 102
Income tax expense (benefit) (55) (12) 90
- --------------------------------------------------------------------------
Income (loss) before equity in
undistributed earnings of
subsidiary bank (479) (30) 12
Equity in undistributed earnings of
subsidiary bank 4,643 5,499 6,606
- --------------------------------------------------------------------------
Net income $ 4,164 $ 5,469 $ 6,618
==========================================================================
50
Sound Federal Bancorp, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Condensed Statements of Cash Flows Years Ended March 31,
- ----------------------------------------------------------------------------------------------
(In thousands) 2006 2005 2004
- ----------------------------------------------------------------------------------------------
Operating Activities
Net income $ 4,164 $ 5,469 $ 6,618
Adjustments to reconcile net income to
net cash (used in) provided by operating activities:
Equity in undistributed earnings of
subsidiary bank (4,643) (5,499) (6,606)
(Increase) decrease in due from subsidiary bank (4,126) 3,364 (3,581)
Other 2,241 (279) (158)
- ----------------------------------------------------------------------------------------------
Net cash (used in) provided by
operating activities (2,364) 3,055 (3,727)
- ----------------------------------------------------------------------------------------------
Investing Activities
ESOP loan repayments 383 370 367
- ----------------------------------------------------------------------------------------------
Net cash provided by investing activities 383 370 367
- ----------------------------------------------------------------------------------------------
Financing Activities
Purchases of treasury stock (1,349) (12,087) (8,417)
Proceeds from exercise of stock options 152 258 268
Payment of cash dividends on common stock (3,327) (2,891) (2,648)
- ----------------------------------------------------------------------------------------------
Net cash used in financing activities (4,524) (14,720) (10,797)
- ----------------------------------------------------------------------------------------------
Net decrease in cash and cash equivalents (6,505) (11,295) (14,157)
Cash and cash equivalents at beginning of year 10,416 21,711 35,868
- ----------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 3,911 $ 10,416 $ 21,711
==============================================================================================
51
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, 2006 and 2005:
First Second Third Fourth
(In thousands, except per share data) Quarter Quarter Quarter Quarter
- --------------------------------------------------------------------------------
Year Ended March 31, 2006
Interest and dividend income $11,554 $12,338 $13,378 $14,171
Interest expense 5,034 5,790 6,655 7,141
- --------------------------------------------------------------------------------
Net interest income 6,520 6,548 6,723 7,030
Provision for loan losses 75 75 75 75
Non-interest income 369 778 346 362
Non-interest expense 4,970 5,034 5,245 5,960
- --------------------------------------------------------------------------------
Income before income tax expense 1,844 2,217 1,749 1,357
Income tax expense 720 858 703 722
- --------------------------------------------------------------------------------
Net income $ 1,124 $ 1,359 $ 1,046 $ 635
================================================================================
Basic earnings per common share $ 0.10 $ 0.12 $ 0.09 $ 0.06
Diluted earnings per common share 0.10 0.12 0.09 0.05
================================================================================
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
================================================================================
52