Sound Financial Bancorp(US:SFBC)2021-03-29 22:49PART I Business The company, a bank holding company, primarily attracts deposits to fund a diversified loan portfolio, focusing on growth in higher-yielding commercial and consumer loans while maintaining asset quality - Consolidated Financial Highlights as of December 31, 2020 | Metric | Amount (in millions) | | :--- | :--- | | Total Consolidated Assets | $861.4 | | Loans Held for Portfolio | $613.4 | | Deposits | $748.0 | | Stockholders' Equity | $85.5 | - The company's principal business is attracting retail and commercial deposits to invest in a variety of loans, including one-to-four family residences, commercial and multifamily real estate, construction, and consumer loans20 - A key part of the business model is originating residential mortgage loans, selling conforming loans to Fannie Mae while retaining servicing rights to generate noninterest income and maintain customer relationships20 Lending Activities The $615.5 million loan portfolio as of December 31, 2020, is diversified across commercial, residential, consumer, and construction loans, with a significant portion in PPP loans - Loan Portfolio Composition (December 31, 2020) | Loan Type | Amount (in thousands) | Percentage of Total | | :--- | :--- | :--- | | Commercial and multifamily | $265,774 | 43.2% | | One-to-four family | $130,657 | 21.2% | | Consumer loans | $75,833 | 12.4% | | Commercial business loans | $64,217 | 10.4% | | Construction and land | $62,752 | 10.2% | | Total Loans | $615,498 | 100.0% | - Commercial business loans increased significantly to 10.4% of the portfolio in 2020 from 6.3% in 2019, largely due to the origination of 909 PPP loans totaling $74.8 million, of which $43.3 million remained outstanding at year-end6263 - Total loan originations increased significantly in 2020 to $575.2 million from $309.1 million in 2019, driven by high activity in one-to-four family residential loans, commercial business loans, and construction loans80 Asset Quality Asset quality improved in 2020 with nonperforming assets decreasing to $3.5 million (0.40% of total assets), while the allowance for loan losses increased to $6.0 million (0.98% of total loans) - Nonperforming Assets Trend (in thousands) | Category | Dec 31, 2020 | Dec 31, 2019 | | :--- | :--- | :--- | | Nonaccrual loans | $2,884 | $4,657 | | OREO and repossessed assets | $594 | $575 | | Total Nonperforming Assets | $3,478 | $5,232 | | NPA as % of Total Assets | 0.40% | 0.73% | - Allowance for Loan Losses Activity (in thousands) | Metric | 2020 | 2019 | | :--- | :--- | :--- | | Beginning Balance | $5,640 | $5,774 | | Provision / (Recapture) | $925 | ($125) | | Net Charge-offs | ($565) | ($9) | | Ending Balance | $6,000 | $5,640 | | Allowance as % of Total Loans | 0.98% | 0.91% | - The increase in net charge-offs in 2020 was primarily driven by a $514,000 loss on a single commercial line of credit due to borrower bankruptcy and depressed collateral value100 Sources of Funds Total deposits grew 21.3% to $748.0 million in 2020, primarily from non-maturity deposits, enabling the payoff of FHLB advances and supplementing funding with $12.0 million in subordinated notes - Deposit Composition (in thousands) | Deposit Type | Dec 31, 2020 | Dec 31, 2019 | | :--- | :--- | :--- | | Noninterest-bearing demand | $129,299 | $94,973 | | Interest-bearing demand | $230,492 | $159,774 | | Savings & Money market | $149,526 | $108,273 | | Certificates of deposit | $235,473 | $251,387 | | Total Deposits | $747,981 | $616,718 | - In September 2020, the company completed a private placement of $12.0 million in 5.25% Fixed-to-Floating Rate Subordinated Notes due 2030, resulting in net proceeds of approximately $11.6 million119 - FHLB advances were paid down to zero at the end of 2020, compared to $7.5 million outstanding at the end of 2019120 Regulation The company and its bank subsidiary are regulated by the Federal Reserve, WDFI, and FDIC, operating under the CBLR framework and maintaining a 10.4% ratio, qualifying as "well-capitalized" - Effective January 1, 2020, the Company and Bank elected to use the Community Bank Leverage Ratio (CBLR) framework for capital adequacy139 - As of December 31, 2020, the Bank's CBLR was 10.4%, exceeding the temporary 8% requirement set by the CARES Act, and was considered "well-capitalized"140141 - The Bank received a "satisfactory" rating in its most recent Community Reinvestment Act (CRA) evaluations from both the FDIC and the WDFI148 Risk Factors The company faces significant risks from the COVID-19 pandemic, economic downturns in its market, credit quality deterioration, interest rate fluctuations, cybersecurity threats, and regulatory changes - The COVID-19 pandemic presents significant uncertainty, potentially impacting credit quality, net interest income, and operational costs, with unpredictable ultimate financial impact190193196 - A high concentration of loans in Washington state exposes the company to risks from local economic downturns, which could increase nonperforming loans and reduce collateral values197199 - The loan portfolio contains higher-risk assets, including commercial real estate, construction, and consumer loans, which are more sensitive to economic changes than traditional residential mortgages, with PPP loans introducing specific credit and forgiveness risks200202 - The company is exposed to cybersecurity risks, including data breaches and fraudulent activity, which could lead to financial losses, reputational damage, and increased costs215217 Properties The company operates nine offices, six of which are leased, with total rental expense of $1.2 million in 2020, and considers its facilities adequate - The company operates nine offices, six of which are leased properties238 - Total rental expense was $1.2 million for the year ended December 31, 2020238 Legal Proceedings The company is involved in routine legal actions but does not anticipate any material liability from such litigation - The company is periodically involved in legal actions but does not expect them to result in material liability240 PART II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's common stock trades on NASDAQ under "SFBC"; a $2.0 million stock repurchase program was authorized in October 2020, with $1.9 million remaining at year-end - The company's common stock is listed on The NASDAQ Capital Market under the ticker symbol "SFBC"243 - A stock repurchase program of up to $2.0 million was authorized in October 2020. By December 31, 2020, 2,477 shares had been repurchased, with approximately $1.9 million remaining available under the plan246247 Selected Financial Data Net income increased to $8.9 million in 2020, driving ROA to 1.10% and ROE to 10.94%, while total assets grew to $861.4 million and asset quality improved - Selected Financial Data (in thousands, except ratios) | Metric | 2020 | 2019 | | :--- | :--- | :--- | | Total Assets | $861,402 | $719,853 | | Total Loans, net | $607,363 | $614,247 | | Total Deposits | $747,981 | $616,718 | | Stockholders' Equity | $85,484 | $77,726 | | Net Interest Income | $27,486 | $26,964 | | Net Income | $8,937 | $6,679 | | Return on Assets (ROA) | 1.10% | 0.95% | | Return on Equity (ROE) | 10.94% | 8.90% | | NPA to Total Assets | 0.40% | 0.73% | Management's Discussion and Analysis of Financial Condition and Results of Operations Net income increased to $8.9 million in 2020, driven by higher gain on loan sales and net interest income, despite increased loan loss provisions, with total assets growing 19.7% to $861.4 million funded by deposit growth - Net income for 2020 was $8.9 million ($3.42 per diluted share), up from $6.7 million ($2.57 per diluted share) in 2019307 - The increase in net income was primarily due to a $4.6 million increase in gain on sale of loans and higher net interest income, partially offset by a higher provision for loan losses307321 - Total assets increased by $141.5 million (19.7%) to $861.4 million, largely due to a $131.3 million (21.3%) increase in total deposits284298 - The company participated in the Paycheck Protection Program (PPP), funding $74.8 million in loans and providing payment relief on $56.2 million of other commercial and residential loans in response to the COVID-19 pandemic277279 Comparison of Financial Condition Total assets increased 19.7% to $861.4 million driven by cash growth from deposits, while net loans slightly decreased, and stockholders' equity grew 10.0% to $85.5 million - Cash and cash equivalents increased by $138.1 million, or 247.6%, to $193.8 million at year-end 2020, fueled by deposit growth and proceeds from subordinated notes285 - Commercial business loans grew by $25.3 million (65.0%), mainly from PPP loan originations, while one-to-four family loans decreased by $18.7 million (12.5%) due to increased sales to the secondary market288 - Nonperforming assets decreased by 33.5% to $3.5 million, representing 0.40% of total assets, down from 0.73% in the prior year291 Comparison of Results of Operation Net income rose to $8.9 million in 2020, driven by a $3.4 million increase in noninterest income from loan sales, despite net interest margin compression to 3.57% - Key Performance Metrics | Metric | 2020 | 2019 | | :--- | :--- | :--- | | Net Interest Income | $27.5M | $27.0M | | Net Interest Margin | 3.57% | 4.06% | | Provision for Loan Losses | $925K | ($125K) | | Noninterest Income | $7.4M | $4.0M | | Noninterest Expense | $22.7M | $22.8M | | Net Income | $8.9M | $6.7M | - The net interest margin decreased by 49 basis points to 3.57%, impacted by downward pressure on asset yields from the low interest-rate environment and the addition of lower-yielding PPP loans315 - Noninterest income surged primarily due to a $4.6 million increase in the net gain on sale of loans, which rose to $6.0 million in 2020 from $1.4 million in 2019, driven by high mortgage refinancing activity321 Quantitative and Qualitative Disclosures About Market Risk The company's primary market risk is interest-rate risk, managed via an EVE model, indicating an asset-sensitive position with a 10.0% EVE increase for a 100 basis point rate rise - The company's primary market risk is interest-rate risk, arising from the mismatch in maturities and re-pricing characteristics of its assets and liabilities343 - Economic Value of Equity (EVE) Sensitivity Analysis (Dec 31, 2020) | Change in Interest Rates (bps) | EVE ($ Amount in thousands) | % Change | | :--- | :--- | :--- | | +400 | $140,541 | +26.49% | | +300 | $135,754 | +22.18% | | +200 | $129,996 | +17.00% | | +100 | $122,123 | +10.00% | | 0 | $111,112 | 0.00% | - The EVE analysis shows the company is asset-sensitive at year-end 2020, with its economic value of equity projected to increase in a rising rate environment352 Financial Statements and Supplementary Data This section presents the audited consolidated financial statements for 2020 and 2019, with the auditor identifying the allowance for loan losses as a critical audit matter - The financial statements were audited by Moss Adams LLP, which issued an unqualified opinion356 - The auditor identified the Allowance for Loan Losses as a critical audit matter, highlighting the subjective judgments required for internally assigned loan grades and qualitative factor estimations361363 Notes to Consolidated Financial Statements The notes detail accounting policies, the $615.5 million loan portfolio, $6.0 million allowance for loan losses, $748.0 million deposit base, 10.4% CBLR, and $3.8 million mortgage servicing rights - In response to COVID-19, the company provided payment relief on 49 commercial loans ($37.2 million) and 84 residential loans ($19.0 million), not classified as TDRs under CARES Act guidance398 - The mortgage servicing rights (MSR) portfolio totaled $488.7 million in unpaid principal balance, with a fair value of $3.8 million recorded on the balance sheet468470 - The company has access to $213.7 million in borrowing capacity from the FHLB and $66.9 million from the Federal Reserve (including the PPPLF), with no outstanding balances at year-end 2020480482 Controls and Procedures Management concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2020, with no material changes identified - The CEO and interim CFO concluded that the company's disclosure controls and procedures were effective as of December 31, 2020559 - Management's assessment, based on the COSO framework, concluded that the company's internal control over financial reporting was effective as of December 31, 2020563 PART III Directors, Executive Officers and Corporate Governance Information on directors, executive officers, and corporate governance is incorporated by reference from the 2021 proxy statement - Information for this section is incorporated by reference from the company's definitive proxy statement for its 2021 Annual Meeting of Stockholders568 Executive Compensation Information concerning executive compensation is incorporated by reference from the 2021 proxy statement - Information for this section is incorporated by reference from the company's definitive proxy statement for its 2021 Annual Meeting of Stockholders573 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Security ownership information is incorporated by reference from the 2021 proxy statement, detailing 100,979 securities under equity compensation plans - Equity Compensation Plan Information (as of Dec 31, 2020) | Category | Number of Securities to be Issued Upon Exercise | Weighted-Average Exercise Price | Number of Securities Remaining for Future Issuance | | :--- | :--- | :--- | :--- | | Equity Incentive Plan | 100,979 | $22.00 | 80,771 | PART IV Exhibits, Financial Statement Schedules This section lists financial statements from Item 8 and provides an index of all exhibits filed with the Form 10-K - This section lists the financial statements filed with the report and provides an index of exhibits, such as corporate governance documents and material agreements581585