SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------------
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission file number 000-24811
SOUND FEDERAL BANCORP
(Exact name of registrant as specified in its charter)
Federal 13-4029393
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
300 Mamaroneck Ave., Mamaroneck, New York 10543
(Address of principal executive offices)
(Zip Code)
(914) 698-6400
(Registrant's telephone number including area code)
N/A
--------------------------------------------------------
(Former name, former address and former fiscal year,
if changed from last Report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding twelve months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes No X .
Indicate the number of shares outstanding of each of the issuer's classes
of common stock as of the latest practicable date.
Class Shares
----- Outstanding at
Common Stock, February 5, 1999
----------------
par value, $0.10 5,212,218
TABLE OF CONTENTS
PART I -- FINANCIAL INFORMATION
-------------------------------
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets at December 31, 1998 and
March 31,1998.........................................................1
Consolidated Statements of Operations for the Quarter and Nine months
ended December 31, 1998 and 1997......................................2
Consolidated Statement of Changes in Stockholders' Equity for the
Nine months ended December 31, 1998...................................3
Consolidated Statements of Cash Flows for the Nine months
ended December 31, 1998 and 1997......................................4
Notes to Unaudited Consolidated Financial Statements..................5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................ 8
Item 3. Quantitative and Qualitative Disclosures about Market Risk...........15
PART II -- OTHER INFORMATION
----------------------------
Item 1. Legal Proceedings....................................................16
Item 2. Changes in Securities and Use of Proceeds............................16
Item 3. Defaults upon Senior Securities......................................16
Item 4. Submission of Matters to a Vote of Security Holders..................16
Item 5. Other Information....................................................16
Item 6. Exhibits and Reports on Form 8-K.....................................16
Signatures...........................................................17
i
Item 1. Financial Statements
Sound Federal Bancorp and Subsidiary
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share data) December 31, March 31,
1998 1998
----------------------- ------------
Assets
Cash and due from banks............................................ $ 5,493 $ 5,711
Federal funds sold................................................. 50,000 36,400
Certificates of deposit............................................ 10,092 11,483
Securities:
Held-to-maturity, at amortized cost (fair value of $53,898 and
$65,091 at December 31 and March 31, 1998, respectively) 54,369 64,898
Available-for-sale, at fair value............................... 22,493 2,994
------------ ------------
Total securities............................................. 76,862 67,892
------------ ------------
Loans, net:
Mortgage loans................................................... 138,436 127,515
Consumer loans................................................... 1,246 2,027
Allowance for loan losses........................................ (1,134) (984)
------------ ------------
Total loans, net.............................................. 138,548 128,558
------------ ------------
Accrued interest receivable....................................... 1,445 888
Federal Home Loan Bank stock...................................... 1,745 1,745
Premises and equipment, net....................................... 1,700 1,552
Other assets...................................................... 1,074 520
----------- ------------
Total assets.................................................... $ 286,959 $ 254,749
============ ============
Liabilities and Stockholders' Equity
Liabilities:
Deposits..................................................... $ 229,701 $ 219,913
Mortgagors' escrow deposits................................. 2,354 2,364
Accrued expenses and other liabilities....................... 485 571
------------ ------------
Total liabilities............................................. 232,540 222,848
------------ ------------
Stockholders' equity (note 1):
Preferred stock ($0.10 par value; 10,000,000 shares
authorized; none issued and outstanding)........... - -
Common stock ($0.10 par value; 20,000,000 shares 521 -
authorized; 5,212,218 shares issued and outstanding at
December 31, 1998).........................................
Additional paid-in capital.................................... 22,437 -
Retained earnings............................................. 33,223 31,905
Unallocated common stock held by ESOP ........................ (1,729) -
Accumulated other comprehensive income (net unrealized loss
on securities available for sale, net of taxes)............... (33) (4)
------------ ------------
Total stockholders' equity................................... 54,419 31,901
------------ ------------
Total liabilities and stockholders' equity................... $ 286,959 $ 254,749
============ ============
See accompanying notes to the unaudited consolidated financial statements.
1
Sound Federal Bancorp and Subsidiary
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share data)
For the Quarter Ended For the Nine Months Ended
December 31, December 31,
--------------------- -------------------------
1998 1997 1998 1997
---- ------ ---- -----
Interest and Dividend Income
Loans........................................................ $ 2,791 $ 2,635 $ 8,263 $ 7,800
Securities................................................... 1,003 1,054 3,141 3,236
Federal funds sold and certificates of deposit............... 860 657 2,271 2,029
Other earning assets......................................... 39 39 130 112
--------- --------- --------- ----------
Total interest and dividend income........................... 4,693 4,385 13,805 13,177
--------- --------- --------- ----------
Interest Expense
Deposits..................................................... 2,278 2,191 6,839 6,494
Other interest-bearing liabilities.......................... 14 11 61 32
--------- --------- --------- ----------
Total interest expense....................................... 2,292 2,202 6,900 6,526
--------- --------- --------- ----------
Net interest income.......................................... 2,401 2,183 6,905 6,651
Provision for loan losses.................................... 71 7 222 83
--------- --------- --------- ----------
Net interest income after provision for loan losses.......... 2,330 2,176 6,683 6,568
--------- --------- --------- ----------
Non-Interest Income
Service charges and fees..................................... 44 42 133 141
--------- --------- --------- ----------
Non-Interest Expense
Compensation and benefits.................................... 793 544 2,073 1,588
Occupancy and equipment...................................... 157 92 305 289
Federal deposit insurance costs.............................. 32 38 99 105
Data processing service fees................................. 100 61 220 170
Advertising and promotion.................................... 54 54 122 137
Contribution of common stock to the Sound Federal
Savings and Loan Association Charitable Foundation
(note 1).................................................... 1,022 - 1,022 -
Other........................................................ 253 231 697 662
--------- --------- --------- ----------
Total non-interest expense................................... 2,411 1,020 4,538 2,951
--------- --------- --------- ----------
Income (loss) before income tax expense...................... (37) 1,198 2,278 3,758
Income tax expense........................................... 57 499 960 1,566
--------- --------- --------- ----------
Net income (loss)............................................ $ (94) $ 699 $ 1,318 $ 2,192
========== ========= ========= ==========
Basic and diluted loss per share, from date of
stock conversion (October 8, 1998) (note 3)
............... $ (0.02) $ (0.02)
======= =======
See accompanying notes to the unaudited consolidated financial statements.
2
Sound Federal Bancorp and Subsidiary
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
For the Nine Months Ended December 31, 1998
(Unaudited)
(Dollars in thousands)
Accumulated
Additional Unallocated Other
Preferred Common Paid-In Retained ESOP Comprehensive
Stock Stock Capital Earnings Stock Income Total
----- ----- ------- -------- ----- ------ -----
Balance at March 31, 1998......... $ -- $ -- $ -- $ 31,905 $ -- $ (4) $ 31,901
Net income........................ -- -- -- 1,318 -- -- 1,318
Issuance of 5,212,218 common
shares.......................... -- 521 22,444 -- -- -- 22,965
Shares purchased by ESOP
(192,130 shares)................ -- -- -- -- (1,921) -- (1,921)
ESOP shares released for
allocation (19,213 shares)...... -- -- (7) -- 192 -- 185
Change in net unrealized loss on
securities available for sale,
net of tax effect............... -- -- -- -- -- (29) (29)
------- ----- -------- -------- ------- ---------- ----------
Balance at December 31, 1998 $ -- $ 521 $ 22,437 $ 233,223 $ (1,729) $ (33) $ 54,419
======== ======= ======== ========== ======== ========== ==========
See accompanying notes to the unaudited consolidated financial statements.
3
Sound Federal Bancorp and Subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
In thousands)
For the Nine Months Ended
December 31,
--------------------------------
1998 1997
----------------- -----------
OPERATING ACTIVITIES
Net income............................................................... $ 1,318 $ 2,192
Adjustments to reconcile net income to net
cash provided by operating activities:
Contribution of common stock to the Sound Federal Savings and
Loan Association Charitable Foundation................................ 1,022 --
Provision for loan losses................................................ 222 83
Depreciation expense..................................................... 117 86
ESOP expense............................................................. 185 --
Amortization of deferred fees, premiums and discounts, net............... 135 (69)
Deferred income tax (benefit) expense.................................... (15) 2
Other adjustments, net................................................... (907) (252)
----------- ------------
Net cash provided by operating activities.............................. 2,077 2,042
---------- ------------
INVESTING ACTIVITIES
Purchases of securities:
Held-to-maturity........................................................ (9,976) (12,215)
Available-for-sale...................................................... (19,776) (1,000)
Proceed from principal payments, maturities and calls of
securities ........................................................... 20,338 10,737
Disbursements for loan originations...................................... (30,051) (21,077)
Principal collection on loans............................................ 19,842 15,889
Net decrease in certificates of deposit.................................. 1,391 603
Purchases of premises and equipment...................................... (263) (226)
----------- -------------
Net cash used in investing activities............................... (18,495) (7,289)
----------- -------------
FINANCING ACTIVITIES
Net increase in deposits.................................................. 9,788 4,710
Net decrease in mortgage escrow deposits.................................. (10) (86)
Net proceeds from stock Offering.......................................... 20,022 -
------------ -----------
Net cash provided by financing activities.......................... 29,800 4,624
------------ -----------
Increase (decrease) in cash and cash equivalents......................... 13,382 (623)
Cash and cash equivalents at beginning of period......................... 42,111 39,552
------------ -----------
Cash and cash equivalents at end of period............................... $ 55,493 $ 38,929
============ ===========
SUPPLEMENTAL INFORMATION
Interest paid............................................................ $ 6,838 $ 6,491
Income taxes paid........................................................ 1,360 1,595
Loans transferred to real estate owned................................... 357 -
============ ===========
See accompanying notes to the unaudited consolidated financial statements.
4
Sound Federal Bancorp and Subsidiary
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. Reorganization and Offering
On October 8 1998, Sound Federal Bancorp (the "Company") completed the
issuance of 5,212,218 shares of common stock (the "Offering") in connection with
a Plan of Reorganization ("the "Reorganization"). As part of the Reorganization,
Sound Federal Savings and Loan Association (the "Bank") converted from a
federally chartered mutual savings association to a federally chartered stock
savings association and became a wholly-owned subsidiary of the Company. The
Company became the majority-owned subsidiary of Sound Federal, MHC (the "Mutual
Holding Company" or "MHC"), a federal mutual holding company. The Bank provides
banking services primarily to individuals from its main office in Mamaroneck and
three full-service branches in Rye Brook, Harrison and New City, New York.
The Mutual Holding Company owns 53.92% or 2,810,510 shares of the Company's
outstanding common stock. The remaining 46.08% (or 2,401,708 shares) of the
common stock is owned by the minority stockholders (the "Minority Stockholders")
and the Sound Federal Savings and Loan Association Charitable Foundation (the
"Foundation"). The Company contributed 1.96% or 102,200 shares of the Company's
common stock issued in the Reorganization to the Charitable Foundation, which
resulted in a charge to expense equal to the fair value of those shares
(approximately $1.0 million before taxes) in the quarter ended December 31,
1998. The Bank's Employee Stock Ownership Plan ("ESOP") purchased 192,130 shares
in the Offering using the proceeds of a loan provided by the Company.
The following is an analysis of the net increase in the Company's
consolidated stockholders' equity and the net cash proceeds from the Offering
(dollars in thousands):
Issuance of 2,401,708 shares to Minority Stockholders at $10
per share........................................................$ 24,017
Issuance of 2,810,510 shares to the MHC.......................... --
Less Offering costs.............................................. (1,052)
------
Net increase in common stock and additional paid-in-capital
from issuance of 5,212,218 shares................................ 22,965
Less 192,130 shares purchased by the ESOP using the proceeds
of a loan provided by the Company................................ (1,921)
------
Net increase in stockholders' equity............................. 21,044
Less 102,200 shares contributed to the Foundation (1,022)
------
Net cash proceeds from the Offering..............................$ 20,022
======
2. Basis of Presentation
The consolidated financial statements included herein have been prepared by
the Company without audit. In the opinion of management, the unaudited
consolidated financial statements include all adjustments, consisting of normal
recurring accruals, necessary for a fair presentation of the financial position
and results of operations for the periods presented. Certain information and
footnote disclosures normally included in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to the rules and
regulations of the Securities and Exchange Commission. The Company believes that
the disclosures are adequate to make the information presented not misleading;
however, the results for the periods presented are not necessarily indicative of
results to be expected for the entire fiscal year ending March 31, 1999.
5
The unaudited quarterly and year-to-date consolidated financial statements
presented herein should be read in conjunction with the annual audited financial
statements of the Bank for the fiscal year ended March 31, 1998, included in the
Company's prospectus dated August 13, 1998.
3. Earnings Per Share
The Company completed the Reorganization and Offering on October 8, 1998.
As a result, per share data has not been presented for the quarter and nine
months ended December 31, 1997 and per share data for the nine months ended
December 31, 1998 is for the three month period following the Offering. Weighted
average common shares of 5,039,318 were used in calculating basic and diluted
earnings per share for the quarter ended December 31, 1998. In computing both
basic and diluted EPS, outstanding shares include all shares issued to the MHC
and the Foundation, but exclude unallocated ESOP shares that have not been
committed to be released to participants.
4. Allowance for Loan Losses
The allowance for loan losses is increased by provisions for loan losses
charged to income and decreased by charge-offs (net of recoveries). Loans 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 evaluation of the
adequacy of the allowance is based on the Company's past loan experience, known
and inherent risks in the portfolio adverse situations that may affect the
borrowers' ability to repay, the estimated value of underlying collateral and
current economic conditions. Management believes that the allowance for loan
losses is adequate to absorb probable losses in the existing loan portfolio.
Establishing the allowance for loan losses involves significant management
judgements utilizing the best information available at the time of the review.
Those judgements are subject to further review by various sources, including the
Company's regulators. Adjustments to the allowance may be necessary in the
future based on changes in economic and real estate market conditions, further
information obtained regarding known problem loans, the identification of
additional problem loans and other factors, certain of which are outside of
management's control.
Activity in the allowance for loan losses for the periods indicated is
summarized as follows:
Quarter Ended Nine Months Ended Year Ended
December 31, December 31, March 31,
--------------------------------- ------------------------------ ------------
1998 1997 1998 1997 1998
---------------- ---------------- ----------- -------------- ------------
(Dollars in thousands)
Balance at beginning of period....... $ 1,063 $ 905 $ 984 $ 845 $ 845
Provision for loan losses............ 71 7 222 83 155
LOANS CHARGED OFF
Mortgage........................ - - (72) (16) (16)
Consumer loans.................. - - - - -
-------------- -------------- --------- ------------- ---------
Total loans charged off.............. - - (72) (16) (16)
-------------- -------------- --------- ------------- ---------
RECOVERIES
Mortgage........................ - - - - -
Consumer loans.................. - - - - -
-------------- -------------- --------- ------------- ---------
Total recoveries................ - - - - -
-------------- -------------- --------- ------------- ---------
Net charge-offs................. - - (72) (16) (16)
-------------- -------------- --------- ------------- ---------
Balance at end of period............. $ 1,134 $ 912 $ 1,134 $ 912 $ 984
============== ============== ========= ============= =========
Ratio of net charge-offs to average
net loans outsta--%ing (annualized.. --% --% 0.07% 0.02% 0.01%
============== ============== ========= ============= =========
6
5. Comprehensive Income
The Company has adopted the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 130, "Reporting Comprehensive Income" which establishes
standards for reporting and display of comprehensive income and its components
(revenues, expenses, gains, and losses) in a full set of general-purpose
financial statements. In accordance with the provisions of SFAS No. 130, the
Company's total comprehensive income (loss) for the quarter and nine months
ended December 31, 1998 was $(117,000) and $1,289,000, respectively. For those
same periods in 1997, total comprehensive income was $695,000 and $2,191,000,
respectively. The difference between the Company's net income and total
comprehensive income for these periods equals the change in the net unrealized
loss on securities available for sale during the applicable periods.
6. Legal Proceedings
The Company is not involved in any pending legal proceedings other than
routine legal proceedings occurring in the ordinary course of business. Such
routine legal proceedings in the aggregate are believed by management to be
immaterial to the Company's financial condition and results of operations.
7
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
General
As discussed in Note 1 to the unaudited consolidated financial statements,
on October 8, 1998, the Company completed the issuance of 5,212,218 shares of
common stock in connection with the Reorganization and the Bank converted from a
federally chartered mutual savings association to a federally chartered stock
savings association and became a wholly-owned subsidiary of the Company. The
Company became the majority-owned subsidiary of the Mutual Holding Company,
which owns 53.92% or 2,810,510 shares of the Company's outstanding common stock.
The remaining 46.08% (or 2,401,708 shares) of the common stock is owned by the
Minority Stockholders and the Foundation which was established in furtherance of
the Bank's commitment to its local community.
The financial condition and results of operations of the Company are
primarily dependent upon those of the Bank. The Bank's principal business has
historically consisted of Offering savings and other deposits to the general
public and using the funds from such deposits to make loans secured by
residential real estate. The Bank's results of operations depend primarily upon
its net interest income, which is the difference between the interest income
earned on its loan and securities portfolios an its cost of funds, consisting
primarily of the interest paid on its deposits. The Bank's net income is also
affected by, among other things, provisions for loan losses and non-interest
expense. The Bank's principal operating expenses, other than interest expense,
consist of compensation and benefits, occupancy expenses, federal deposit
insurance premiums and other general and administrative expenses. Operating
results are also significantly affected 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.
This report on Form 10-Q contains certain forward-looking statements
consisting of estimates with respect to the financial condition, results of
operations and business of the Company and the Bank. These estimates are subject
to various factors that could cause actual results to differ materially from
these estimates. Such factors include (i) the effect that an adverse movement in
interest rates could have on net interest income, (ii) customer preferences,
(iii) national and local economic and market conditions, (iv) higher than
anticipated operating expenses and (v) a lower level of or higher cost for
deposits than anticipated. The Company disclaims any obligation to publicly
announce future events or developments that may affect the forward-looking
statements herein.
Capability of the Bank's Data Processing to Accommodate the Year 2000
Like many financial institutions, the Bank relies upon computers for the
daily conduct of its business and for data processing generally. There is a
concern that on January 1, 2000 computers will be unable to "read" the new year
and as a consequence, there may be widespread computer malfunctions. Management
has developed a formal plan to resolve the Year 2000 issue and has been
addressing this issue with the Bank's data processing service center (the "Data
Center"). The Data Center has advised the Bank that the Year 2000 issue should
not affect the Bank's external data processing. The Bank is in the process of
testing its computer applications and hardware to ensure that they will be able
to read the Year 2000. The Data Center completed the first round of tests and
identified problem areas and failed tests. These exceptions were addressed and
Phase 2 testing began on February 1, 1999. This phase is expected to be
completed by March 1, 1999. The Data Center and the Bank will then begin the
final phase of testing which is expected to be completed by March 31, 1999.
Given the near-term timing of the test plan, the Bank has not completed its
contingency plan, but anticipates doing so by March 1, 1999.
The Bank has contacted each of its other vendors to ensure that they will
be able to provide service in light of the Year 2000 issue. Most vendors have
represented to management that they are addressing the Year
8
2000 issue and expect to be able to provide the services for which the Bank has
contracted. In addition, since over 98% of the Bank's loans are secured by real
property and the remaining portion of the loan portfolio is composed of consumer
loans and personal loans, the ability of the Bank's borrowers to be Year 2000
compliant is not material to the Bank's lending operations. Management will
continue to monitor this issue and report to the Board of Directors on a
quarterly basis until full compliance is obtained from all vendors.
Costs related to the year 2000 issue will be expensed as incurred except
for the costs, if any, for new hardware and software that is purchased, which
will be capitalized. At December 31, 1998, the costs incurred to address the
Year 2000 issue amounted to approximately $127,000, which includes capitalized
expenditures of approximately $110,000. The Company anticipates that the total
costs for this project will be approximately $400,000. The costs of the Year
2000 project are based on managemen s best estimates, which were derived
utilizing numerous assumptions of future events including the continued
availability of certain resources, third party modification plans and other
factors. However, there can be no guarantee that these estimates will be
achieved, and actual results could differ materially from those plans. Specific
factors that might cause such material differences include, but are not limited
to, the availability and cost of personnel trained in this area, the ability to
locate and correct all relevant computer codes and similar uncertainties. In
addition, there can be no guarantee that the systems of other companies on which
the Bank's systems rely will be timely converted, or that a failure to convert
by another company, or that a conversion that is incompatible with the Bank's
systems, would not have a material adverse effect on the Bank.
Financial Condition
The Company's total assets were $287.0 million and $254.7 million at
December 31, 1998 and March 31, 1998, respectively. The $32.2 million increase
was due primarily to net Offering proceeds of $20.0 million and a $9.8 million
increase in deposits. The net proceeds from the Offering were primarily invested
in Federal funds, which totaled $50.0 million at December 31, 1998 as compared
to $36.4 million at March 31, 1998. The increase in total assets also reflects a
$10.0 million increase in net loans to $138.5 million at December 31, 1998. Loan
demand was strong in the first half of fiscal 1999 but slowed during the current
quarter. Total deposits amounted to $229.7 million at December 31, 1998, as
compared to $219.9 million at March 31, 1998. Total equity increased $22.5
million to $54.4 million at December 31, 1998 as compared to $31.9 million at
March 31, 1998, primarily due to the Offering.
Results of Operations
General. The Company reported a net loss of $94,000 for the quarter
ended December 31, 1998, as compared to net income of $699,000 for the quarter
ended December 31, 1997. For the nine months ended December 31, 1998, the
Company earned $1.3 million as compared to $2.2 million for the same period in
1997. The results for the quarter and nine months ended December 31, 1998
included a $1,022,000 pre-tax charge for the contribution of 102,200 shares of
the Company's common stock to the Foundation. The results for the 1998 quarter
also include a pre-tax charge of $185,000 attributable to a full-year
contribution to the ESOP, which was made during the quarter in accordance with
the terms of that plan. Since the Reorganization was completed in the quarter
ended December 31, 1998, and the ESOP plan year ends on December 31, the entire
cost was charged to expense in the current quarter. Net income for the current
quarter would have been approximately $633,000, excluding the contribution t the
Foundation and assuming quarterly ESOP expense of $46,000. Excluding the
contribution to the Foundation and assuming ESOP expense of $138,000 for the
nine-month period, net income for the nine months ended December 31, 1998 would
have been approximately $2.0 million.
Net Interest Income. Net interest income for the quarter ended December 31,
1998 amounted to $2.4 million, a $218,000 increase from the same period in the
prior year. The Company's interest rate
9
spread was 2.93% and 3.20% for the quarters ended December 31, 1998 and 1997,
respectively. The Company's net interest margin for those periods was 3.47% and
3.60%, respectively. Average net interest earning assets totaled $44.9 million
during the quarter ended December 31, 1998 as compared to $24.1 million for the
same quarter in the prior year. For the nine months ended December 31, 1998, net
interest income increased $254,000 to $6.9 million as compared to $6.7 million
for the same period in the prior year. The Company's interest rate spread was
3.07% for the nine months ended December 31, 1998 as compared to 3.29% for the
same period in the prior year. For those same periods, the net interest margin
was 3.53% and 3.69%, respectively. For the nine months ended December 31, 1998,
average net interest earning assets totaled $31.7 million as compared to $23.6
million for the same period in 1997. The decreases in the Company's interest
rate spread and net interest margin are a result of the general decrease in
interest rates on loans and mortgage-backed securities.
Interest Income. Interest income totaled $4.7 million in the quarter ended
December 31, 1998 as compared to $4.4 million for the same period in the prior
year. This increase is due to an increase in average interest-earning assets to
$274.6 million during the quarter ended December 31, 1998 as compared to $240.6
million for the same quarter in the prior year, partially offset by a 45 basis
point decrease in the average yield earned on interest-earning assets to 6.78%.
The increase in the average balance of interest-earning assets was due to an
increase in deposits and the net proceeds from the Company's Offering.
Interest income on loans increased $156,000 or 5.9% to $2.8 million for the
current quarter, due primarily to a $12.3 million increase in the average
balance to $138.3 million. The increase in the average balance was partially
offset by a 29 basis point decrease in the yield earned to 8.00% for the quarter
ended December 31, 1998 as compared to the same quarter in the prior year. The
growth of the loan portfolio is a result of the low interest rate environment,
which has created a strong demand for fixed rate loans (the Company's primary
mortgage loan product). The low interest rates have also created a strong market
for home purchases and the refinancing of existing mortgage loans in the
Company's market area. The new loan production and the refinancing activity were
also the primary reason for the decrease in the yields earned on mortgage loans
since the rates on these loans are lower than those of the existing portfolio.
Interest on Federal funds increased $218,000 to $693,000 for the quarter ended
December 31, 1998 as compared to $475,000 for the same quarter in 1997. The
average balance of Federal funds was $54.1 million for the quarter ended
December 31, 1998 as compared to $33.6 million for the same quarter in the prior
year. The increase in the average balance was partially offset by a 53 basis
point decrease in the yield earned to 5.08%. Interest earned on certificates of
deposit at other financial institutions decreased $15,000 to $167,000 for the
1998 quarter as compared to $182,000 for the quarter ended December 31, 1997.
Interest income on mortgage-backed securities amounted to $753,000 for the
quarter ended December 31, 1998 as compared to $868,000 for the same quarter in
1997. This decrease is due to a $266,000 decrease in the average balance of
mortgage-backed securities to $53.7 million and an 82 basis point decrease in
the yield earned to 5.56%. Many of these mortgage-backed securities have rates
that adjust annually, typically based on Treasury bill rates. As a result, these
securities have also experienced declining yields. In addition, principal
prepayments have resulted in declining yields on the mortgage-backed securities
portfolio from the acceleration of premium amortization. Interest income on
other securities amounted to $250,000 for the quarter ended December 31, 1998 as
compared to $186,000 for the same quarter in the prior year. This increase
reflects a 65 basis point increase in the average yield earned to 6.30% and a
$2.7 million increase in the average balance of other securities to $15.8
million for the 1998 quarter from $13.1 million for the same quarter in 1997.
For the nine months ended December 31, 1998, interest income increased
$628,000 or 4.8% to $13.8 million as compared to $13.2 million for the nine
months ended December 31, 1997. For those same periods, average interest-earning
assets increased $20.5 million to $259.9 million from $239.4 million. The
increase in interest-earning assets was partially offset by a 25 basis point
decrease in the average yield earned on total interest-earning assets to 7.05%.
Interest income on loans totaled $8.3 million during the nine months
ended December 31, 1998 as compared to $7.8 million for the same period in 1997,
due primarily to a $10.7 million increase in the average
10
balance to $134.2 million. The increase in the average balance was partially
offset by a 21 basis point decrease in the yield earned to 8.17% during the nine
months ended December 31, 1998 as compared to 8.38% for the same period in 1997.
Interest earned on Federal funds increased $287,000 to $1.8 million for the nine
months ended December 31, 1998 as compared to $1.5 million for the same period
in 1997. This increase was due to a $9.2 million increase in the average balance
to $43.5 million for the nine months ended December 31, 1998 as compared to
$34.4 million for the same period in 1997, partially offset by a 32 basis point
decrease in the yield earned to 5.34%. Interest income on certificates of
deposit decreased $46,000 to $519,000. Interest income on mortgage-backed
securities amounted to $2.4 million for the nine months ended December 31, 1998
as compared to $2.6 million for the same period in 1997. This decrease is due
primarily to a 43 basis point decrease in the yield earned to 6.07%. Interest
income on other securities amounted to $706,000 during the nine months ended
December 31, 1998 as compared to $622,000 for the same period in 1997. The
average balance of other securities increased $1.6 million to $15.2 million from
$13.6 million for those same periods and the yield earned increased to 6.18%
from 6.08%.
Interest Expense. Interest expense for the quarter ended December 31, 1998
totaled $2.3 million as compared to $2.2 million for the quarter ended December
31, 1997. The average balance of interest-bearing liabilities increased $13.2
million to $229.7 million for the quarter ended December 31, 1998 from $216.5
million for the same quarter in the prior year. The increase in the average
balance is due primarily to a $9.5 million increase in the average balance of
deposits to $224.0 million. Th average cost of interest-bearing liabilities
decreased 18 basis points to 3.85% for the quarter ended December 31, 1998 as
compared to the same quarter in the prior year.
Interest on time deposits totaled $1.6 million for the current quarter as
compared to $1.5 million for the same quarter in 1997. This increase is
primarily a result of a $12.2 million or 10.8% increase in the average balance
of time deposits to $125.5 million for the quarter ended December 31, 1998 as
compared to the same quarter in 1997. The increase in the average balance of
time deposits was partially offset by a 19 basis point decrease in the average
cost to 5.21%. Total interest expense on other deposit accounts (passbook, club,
money market and NOW accounts) amounted to $631,000 for the quarter ended
December 31, 1998 as compared to $650,000 for the same quarter in the prior
year. The average balance of these accounts was $98.5 million for the 1998
quarter as compared to $101.2 million for the same quarter in 1997, and the
overall average rate was 2.54% and 2.55% for the respective periods.
For the nine months ended December 31, 1998, interest expense totaled $6.9
million as compared to $6.5 million for the corresponding period in the prior
year, due primarily to a $344,000 increase in interest on deposits to $6.8
million. The average balance of interest-bearing liabilities for these same
periods increased $12.3 million to $228.2 million and the average cost of these
liabilities decreased 3 basis points to 3.98%. The increase in the average
balance of interest-bearing liabilities is due primarily to a $10.0 million
increase in the average balance of deposits to $224.0 million for the nine
months ended December 31, 1998 from $214.0 million for the same period in the
prior year.
Interest expense on time deposits totaled $4.9 million for the nine months
ended December 31, 1998 as compared to $4.6 million for the same period in the
prior year. This increase was due primarily to a $10.7 million increase in the
average balance of time deposits to $123.3 million for the nine months ended
December 31, 1998 as compared to $112.6 million for the same period in 1997. The
average cost of these deposits decreased 7 basis points to 5.32%. Total interest
expense on other deposit accounts amounted to $1.9 million for both the nine
months ended December 31, 1998 and 1997. For those same periods, the average
balance of these deposits totaled $100.7 million and $101.4 million,
respectively and the average cost was 2.50% and 2.52%, respectively.
Provision for Loan Losses. The provision for loan losses was $71,000 for
the quarter ended December 31, 1998 as compared to $7,000 for the quarter ended
December 31, 1997. For the nine months
11
ended December 31, 1998 and 1997, the provision for loan losses amounted to
$222,000 and $83,000, respectively. Non-performing loans amounted to $1.5
million or 1.06% of total loans at December 31, 1998 as compared to $2.0 million
or 1.50% of total loans at March 31, 1998 and $1.7 million or 1.33% of total
loans at December 31, 1997. The allowance for loan losses amounted to $1.1
million at December 31, 1998 as compared to $984,000 at March 31, 1998.
Charge-offs, net of recoveries, were none and $72,000 for the quarter and nine
months ended December 31, 1998, respectively, as compared to none and $16,000
for the quarter and nine months ended December 31, 1997, respectively.
In determining the adequacy of the allowance for loan losses, management
considers historical loan loss experience, the level of non-performing loans,
the volume and type of lending conducted and general economic conditions in the
Company's market area. Although the Company maintains its allowance for loan
losses at a level which it considers to be adequate to provide for probable
losses on existing loans, there can be no assurance that such losses will not
exceed the current estimated amounts. As a result, higher provisions for loan
losses may be necessary in future periods which would adversely affect operating
results.
Non-Interest Income. Non-interest income totaled $44,000 and $42,000 for
the quarters ended December 31, 1998 and 1997, respectively. For the nine months
ended December 31, 1998 and 1997, non-interest income totaled $133,000 and
$141,000, respectively. Non-interest income consists principally of service
charges on deposit accounts, late charges on loans and various other service
fees.
Non-Interest Expense. Non-interest expense totaled $2.4 million for the
quarter ended December 31, 1998 as compared to $1.0 million for the quarter
ended December 31, 1997. This increase is due primarily to the expense of $1.0
million recognized in the 1998 quarter for the fair value of shares contributed
to the Foundation. In addition, compensation and benefits increased $249,000 to
$793,000 in the quarter ended December 31, 1998 as compared to $544,000 in the
quarter ended December 31, 1997. The increase in compensation and benefits was
due primarily to the Bank's contribution to the ESOP in the quarter ended
December 31, 1998 which represented the full annual contribution for the ESOP's
plan year ended December 31, 1998. The contribution resulted in the allocation
of 19,213 shares (or 10% of total ESOP shares) to plan participants and the
recognition of $185,000 in expense equal to the average fair value of those
shares for the quarter. Occupancy and equipment increased $65,000 to $157,000
due primarily to rental expense on two new branch locations. For the nine months
ended December 31, 1998, non-interest expense, including the $1.0 million
contribution to the Foundation, totaled $4.5 million as compared to $3.0 million
for the same period last year. In addition to the contribution to the
Foundation, this increase reflects a $485,000 increase in compensation and
benefits to $2.1 million, a $50,000 increase in data processing fees to
$220,000, and a $35,000 increase in other non-interest expenses to $697,000. The
increase in compensation and benefits is primarily due to the contribution to
the ESOP, increased costs associated with the Reorganization and Offering, and
normal salary increases. The increase in data processing fees is due primarily
to upgrades being made by the Company and the service bureau in preparation for
the Year 2000.
Income Taxes. Income tax expense amounted to $57,000 for the quarter ended
December 31, 1998 as compared to $499,000 for the same period in the prior year.
For the nine months ended December 31, 1998, income tax expense amounted to
$960,000 as compared to $1.6 million for the same period in 1997, resulting in
effective tax rates of 42.1% and 41.7%, respectively.
Liquidity and Capital Resources
The Company's primary sources of funds are deposits, the proceeds from
principal and interest payments on loans and mortgage-backed securities, and the
proceeds from maturities of investments. While maturities and scheduled
amortization of loans and securities are a predictable source of funds, deposit
flows and mortgage prepayments are greatly influenced by general interest rates,
economic conditions and competition.
12
The Bank is required to maintain an average daily balance of liquid assets
as a percentage of net withdrawable deposit accounts plus short-term borrowings
as defined by the regulations of the Office of Thrift Supervision ("OTS"). The
minimum required liquidity ratio is currently 4.0%. At December 31, 1998, the
Bank's liquidity ratio under OTS regulations was approximately 32.6%.
The primary investing activities of the Company are the origination of
loans and the purchase of securities. For the quarter and nine months ended
December 31, 1998 and for the year ended March 31, 1998, the Company originated
loans totaling $7.2 million, $30.1 million and $29.4 million, respectively. The
Company purchased securities, including mortgage-backed securities, totaling
$29.8 million for the nine months ended December 31, 1998 and $22.4 million for
the year ended March 31, 1998.
Liquidity management for the Company is both a daily and long-term process
which is part of the Company's overall management strategy. Excess funds are
generally invested in short-term investments such as Federal funds and
certificates of deposit. In the event that the Bank should require additional
sources of funds, it could borrow from the Federal Home Loan Bank of New York
under an available line of credit.
At December 31, 1998, the Company had outstanding loan commitments of $20.5
million. The Company anticipates that it will have sufficient funds available to
meet its current loan commitments. Time deposits scheduled to mature in one year
or less from December 31, 1998, totaled $118.5 million. Management believes that
a significant portion of such deposits will remain with the Company.
The Bank is subject to certain minimum leverage, tangible and risk-based
capital requirements established by regulations of the OTS. These regulations
require savings associations to meet three minimum capital standards: a tangible
capital ratio requirement of 1.5% of total assets as adjusted under the OTS
regulations; a leverage ratio requirement of 3.0% of core capital to such
adjusted total assets; and a risk-based capital ratio requirement of 8.0% of
core and supplementary capital to total risk-based assets. The 3.0% core capital
requirement has been effectively superseded by the OTS prompt corrective action
regulations, which impose a 4.0% core capital requirement for categorization as
an "adequately capitalized" thrift and a 5.0% core capital requirement for
categorization as a "well capitalized" thrift. In determining the amount of
risk-weighted assets for purposes of the risk-based capital requirement, a
savings association must compute its risk-based assets by multiplying its assets
and certain off-balance sheet items by risk-weights, which range from 0% for
cash and obligations issued by the United States Government or its agencies to
100% for consumer and commercial loans, as assigned by the OTS capital
regulation based on the risks OTS believes are inherent in the type of assets.
At December 31, 1998, the Bank exceeded all of the OTS minimum regulatory
capital requirements.
13
The following table sets forth the capital position of the Bank as
calculated at December 31, 1998. The increase in the Bank's capital level during
the nine months ended December 31, 1998 reflects the receipt of $9.1 million
from the Company for the Bank's issuance of common stock, equal to 50% of the
net proceeds received by the Company in the Offering.
OTS Requirements
-------------------------------------------------
Minimum Capital Classification as
Bank Actual Adequacy Well Capitalized
---------------- -------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(Dollars in thousands)
December 31, 1998
- -----------------
Tangible capital.................... $42,958 15.0% 4,305 $ 1.5%
Tier I (core) capital............... 42,958 15.0 8,611 3.0 $ 14,352 5.0%
Risk-based capital:
Tier I........................... 42,958 40.5 6,360 6.0
Total............................ 43,930 41.4 8,480 8.0 10,600 10.0
March 31, 1998
- --------------
Tangible capital.................... $31,901 12.5% 3,821 $ 1.5%
Tier I (core) capital............... 31,901 12.5 7,642 3.0 $ 12,737 5.0%
Risk-based capital:
Tier I........................... 31,901 33.9 5,645 6.0
Total............................ 32,885 34.9 7,527 8.0 9,409 10.0
The following is a reconciliation of the Bank's equity under generally
accepted accounting principles ("GAAP") and its regulatory capital (in
thousands):
December 31, March 31,
1998 1998
---- ----
GAAP equity (equals tangible, tier I core and tier I risk-based capital) $ 42,958 $ 31,901
General allowance for loan losses........................................... 972 984
----------- ----------
Total risk-based capital...........................................$ 43,930 $ 32,885
=========== ==========
14
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company's most significant form of market risk is interest rate risk,
as the majority of the Company's assets and liabilities are sensitive to changes
in interest rates. The Company's assets consist primarily of fixed rate mortgage
loans, which have longer maturities than the Company's liabilities which consist
primarily of deposits. The Company's mortgage loan portfolio, consisting
primarily of loans secured by residential real property located in Westchester
County, is also subject to risk associated with the local economy. The Company
does not own any trading assets. At December 31, 1998, the Company did not have
any hedging transactions in place, such as interest rate swaps and caps. The
Company's interest rate risk management program focuses primarily on evaluating
and managing the composition of the Company's assets and liabilities in the
context of various interest rate scenarios. Factors beyond management's control,
such as market interest rates and competition, also have an impac on interest
income and interest expense.
During the nine months ended December 31, 1998, there were no significant
changes in the Company's assessment of market risk.
15
Part II--OTHER INFORMATION
-----------------
Item 1. Legal Proceedings
The information set forth in Note 6 to the unaudited consolidated
financial statements ("Legal Proceedings") in Part I, Item 1, is incorporated
herein by reference.
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit 27--Financial Data schedule*
(b) Reports on Form 8-K
None
* Submitted only with filing in electronic format.
16
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Sound Federal Bancorp
---------------------------------------
(Registrant)
By: /s/ Anthony J. Fabiano
---------------------------------------
Anthony J. Fabiano
Duly Authorized and Chief Financial and
Accounting Officer
February 5, 1999
17