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UNITED STATES

SECURITY AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20849

 

FORM 10-Q

 

S  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTER ENDED MARCH 31, 2012

 

£  TRANSITION REPORT PURSUANT TO SECTION 13 OF THE EXCHANGE ACT FOR THE TRANSITION PERIOD

 

COMMISSION FILE NUMBER 0-50237

 

VSB Bancorp, Inc.

(Exact name of registrant as specified in its charter)

 

New York

(State or other jurisdiction of incorporation or organization)

 

11 - 3680128

(I. R. S. Employer Identification No.)

 

4142 Hylan Boulevard, Staten Island, New York 10308

(Address of principal executive offices)

 

(718) 979-1100

Registrant's telephone number

 

Common Stock

(Title of Class)

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 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   S   No   £

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes   S   No   £

 

Indicate by check mark whether the registrant is a large accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer   £   Accelerated Filer  £   Non-Accelerated Filer  £   Smaller Reporting Company  S

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):   Yes   £   No   S

 

Par Value: $0.0001 Class of Common Stock

 

The Registrant had 1,787,809 common shares outstanding as of May 4, 2012.

 

 
   

 

CROSS REFERENCE INDEX

 

    PART I    
        Page
Item 1   Consolidated Statements of Financial Condition as of March 31, 2012 and December 31, 2011 (unaudited)  
    Consolidated Statements of Operations for the Three Months Ended March 31, 2012 and 2011 (unaudited)  
    Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2012 and 2011 (unaudited)  
    Consolidated Statements of Changes in Stockholders’ Equity for the Three Months Ended March 31, 2012 and the Year Ended December 31, 2011 (unaudited)   
    Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2012 and 2011 (unaudited)  
    Notes to Consolidated Financial Statements for the Three Months Ended March 31, 2012 and 2011 (unaudited)   9 to 26
         
Item 2   Management's Discussion and Analysis of Financial Condition and Results of Operations   27 to 38
Item 3   Control and Procedures   38
    PART II    
         
Item 1   Legal Proceedings   39
         
Signature Page   40
         
   Exhibit 31.1, 31.2, 32.1, 32.2   42 to 45

 

2
 

 

Forward-Looking Statements

 

When used in this periodic report , or in any written or oral statement made by us or our officers, directors or employees, the words and phrases “will result,” “expect,” “will continue,” “anticipate,” “estimate,” “project,” or similar terms are intended to identify “forward-looking statements.” A variety of factors could cause our actual results and experiences to differ materially from the anticipated results or other expectations expressed in any forward-looking statements. Some of the risks and uncertainties that may affect our operations, performance, development, and results, the interest rate sensitivity of our assets and liabilities, and the adequacy of our loan loss allowance, include, but are not limited to:

 

deterioration in local, regional, national or global economic conditions which could result in, among other things, an increase in loan delinquencies, a decrease in property values, or a change in the real estate turnover rate;
changes in market interest rates or changes in the speed at which market interest rates change;
increases in inflation;
technology changes requiring additional capital investment;
breaches of security or other criminal acts affecting our operations;
changes in laws and regulations affecting the financial service industry;
changes in accounting rules;
changes in the public’s perception of financial institutions in general and banks in particular;
changes in borrowers’ attitudes towards their moral and legal obligations to repay their debts;
the health and soundness of other financial institutions;
changes in the securities or real estate markets;
weather, geologic or climatic conditions;
changes in government monetary or fiscal policy or other government political changes;
changes in competition; and
changes in consumer preferences by our customers or the customers of our business borrowers.

 

Please do not place undue reliance on any forward-looking statement, which speaks only as of the date made. There are many factors, including those described above, that could affect our future business activities or financial performance and could cause our actual future results or circumstances to differ materially from those we anticipate or project. We do not undertake any obligation to update any forward-looking statement after it is made.

  

3
 

 

VSB Bancorp, Inc.

Consolidated Statements of Financial Condition

(unaudited)

 

   March 31,   December 31, 
   2012   2011 
           
Assets:          
Cash and due from banks  $46,372,193   $48,107,673 
Investment securities, available for sale   117,872,400    108,500,489 
Loans receivable   82,763,548    81,910,990 
Allowance for loan loss   (1,441,913)   (1,343,020)
Loans receivable, net   81,321,635    80,567,970 
Bank premises and equipment, net   2,260,559    2,332,727 
Accrued interest receivable   578,118    582,942 
Other assets   1,797,921    1,754,654 
Total assets  $250,202,826   $241,846,455 
           
Liabilities and stockholders’ equity:          
Liabilities:          
Deposits:          
Demand and checking  $76,489,542   $72,507,555 
NOW   31,858,211    30,553,003 
Money market   30,595,865    26,909,220 
Savings   17,452,647    17,178,525 
Time   65,099,038    65,894,536 
Total deposits   221,495,303    213,042,839 
Escrow deposits   306,960    180,066 
Accounts payable and accrued expenses   1,276,243    1,521,290 
Total liabilities   223,078,506    214,744,195 
           
Stockholders' equity:          
Common stock ($.0001 par value, 10,000,000 shares authorized, 1,989,509 issued, 1,787,809 outstanding at March 31, 2012 and 1,797,809 outstanding at December 31, 2011)   199    199 
Additional paid in capital   9,307,574    9,304,789 
Retained earnings   18,749,276    18,574,651 
Treasury stock, at cost (201,700 shares at March 31, 2012 and 191,700 shares at December 31, 2011)   (2,041,664)   (1,935,596)
Unearned Employee Stock Ownership Plan shares   (352,246)   (394,516)
Accumulated other comprehensive income, net of taxes of $1,232,240 and $1,309,447, respectively   1,461,181    1,552,733 
           
Total stockholders’ equity   27,124,320    27,102,260 
           
Total liabilities and stockholders’ equity  $250,202,826   $241,846,455 

 

See notes to consolidated financial statements.

 

4
 

 

VSB Bancorp, Inc.

Consolidated Statements of Operations

(unaudited)

 

   Three months   Three months 
   ended   ended 
   March 31, 2012   March 31, 2011 
Interest and dividend income:          
Loans receivable  $1,496,448   $1,454,292 
Investment securities   792,570    1,012,552 
Other interest earning assets   23,654    11,138 
Total interest income   2,312,672    2,477,982 
           
Interest expense:          
NOW   22,216    33,089 
Money market   56,712    59,379 
Savings   9,608    12,696 
Time   125,955    121,506 
Total interest expense   214,491    226,670 
           
Net interest income   2,098,181    2,251,312 
Provision for loan loss   175,000    30,000 
Net interest income after provision for loan loss   1,923,181    2,221,312 
           
Non-interest income:          
Loan fees   9,010    27,570 
Service charges on deposits   552,718    522,237 
Net rental income   10,059    11,613 
Other income   48,938    46,283 
Total non-interest income   620,725    607,703 
           
Non-interest expenses:          
Salaries and benefits   988,283    980,003 
Occupancy expenses   371,145    376,563 
Legal expense   79,708    64,986 
Professional fees   83,000    80,451 
Computer expense   51,488    65,322 
Directors' fees   73,125    62,450 
FDIC and NYSBD assessments   61,500    94,000 
Other expenses   316,496    309,275 
Total non-interest expenses   2,024,745    2,033,050 
           
Income before income taxes   519,161    795,965 
           
Provision/(benefit) for income taxes:          
Current   297,246    414,690 
Deferred   (59,713)   (50,516)
Total provision for income taxes   237,533    364,174 
           
Net income  $281,628   $431,791 
Earnings per share:          
Basic  $0.16   $0.24 
Diluted  $0.16   $0.24 
Book value per common share  $15.17   $14.32 

 

See notes to consolidated financial statements.

 

5
 

 

VSB Bancorp, Inc.

Consolidated Statements of Comprehensive Income

(unaudited)

  

   Three months   Three months 
   ended   ended 
   March 31, 2012   March 31, 2011 
           
Net Income  $281,628   $431,791 
Other comprehensive income:          
    Unrealized gains on securities:          
         Change in unrealized gain on securties available for sale   (168,760)   (519,752)
         Tax effects   (77,208)   (237,786)
         Net of tax   (91,552)   (281,966)
Comprehensive income  $190,076   $149,825 

 

See notes to consolidated financial statements.

 

6
 

 

VSB Bancorp, Inc.

Consolidated Statements of Changes in Stockholders' Equity

Year Ended December 31, 2011 and For the Quarter Ended March 31, 2012

(unaudited)

 

     Number of                             Accumulated      
     Common         Additional         Treasury    Unearned    Other    Total 
     Shares    Common    Paid-In    Retained    Stock,    ESOP    Comprehensive    Stockholders’ 
     Outstanding    Stock    Capital    Earnings    at cost    Shares    Income    Equity 
                                         
Balance at January 1, 2011   1,825,009   $199   $9,249,600   $17,563,435   $(1,643,797)  $(563,594)  $1,439,013   $26,044,856 
                                         
Stock-based compensation             95,952                        95,952 
Amortization of earned portion                                        
   of ESOP common stock                            169,078         169,078 
Amortization of cost over                                        
   fair value - ESOP             (40,763)                       (40,763)
Cash dividends declared                                        
   ($0.24 per share)                  (433,235)                  (433,235)
Purchase of treasury stock, at cost   (27,200)                  (291,799)             (291,799)
Comprehensive income:                                        
Net income                  1,444,451                   1,444,451 
Other comprehensive income, net:                                        
Change in unrealized gain on securities available for sale, net of tax effects                           113,720    113,720 
                                         
Balance at December 31, 2011   1,797,809   $199   $9,304,789   $18,574,651   $(1,935,596)  $(394,516)  $1,552,733   $27,102,260 
                                         
Stock-based compensation             23,445                        23,445 
Amortization of earned portion of ESOP common stock                            42,270         42,270 
Amortization of cost over fair value - ESOP             (20,660)                       (20,660)
Cash dividends declared ($0.06 per share)                  (107,003)                  (107,003)
Purchase of treasury stock, at cost   (10,000)                  (106,068)             (106,068)
Comprehensive income:                                        
Net income                  281,628                   281,628 
Other comprehensive income, net:                                        
Change in unrealized gain on securities available for sale, net of tax effects                           (91,552)   (91,552)
                                         
Balance at March 31, 2012   1,787,809   $199   $9,307,574   $18,749,276   $(2,041,664)  $(352,246)  $1,461,181   $27,124,320 

 

See notes to consolidated financial statements.

 

7
 

 

VSB Bancorp, Inc.

Consolidated Statements of Cash Flows

(unaudited)

 

   Three months   Three months 
   ended   ended 
   March 31, 2012   March 31, 2011 
CASH FLOWS FROM OPERATING ACTIVITIES:          
Net income  $281,628   $431,791 
Adjustments to reconcile net income to net cash provided by operating activities          
Depreciation and amortization   149,624    148,541 
Accretion of income, net of amortization of premium   96,681    33,344 
ESOP compensation expense   21,610    25,517 
Stock-based compensation expense   23,445    23,390 
Provision for loan losses   175,000    30,000 
Decrease in prepaid and other assets   93,654    173,527 
Decrease in accrued interest receivable   4,824    49,728 
Decrease in deferred income taxes   (59,713)   (50,516)
(Decrease)/increase in accrued expenses and other liabilities   (245,047)   36,492 
Net cash provided by operating activities   541,706    901,814 
           
CASH FLOWS FROM INVESTING ACTIVITIES:          
Net change in loan receivable   (910,888)   1,667,929 
Proceeds from repayment and calls of investment securities, available for sale   9,100,838    9,431,300 
Purchases of investment securities, available for sale   (18,755,966)   (6,075,129)
Purchases of premises and equipment   (77,457)   (20,442)
Net cash (used in)/provided by investing activities   (10,643,473)   5,003,658 
           
CASH FLOWS FROM FINANCING ACTIVITIES:          
Net increase in deposits   8,579,358    3,099,004 
Purchase of treasury stock, at cost   (106,068)    
Cash dividends paid   (107,003)   (108,716)
Net cash provided by financing activities   8,366,287    2,990,288 
           
NET (DECREASE)/INCREASE IN CASH AND CASH EQUIVALENTS   (1,735,480)   8,895,760 
           
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD   48,107,673    28,764,987 
           
CASH AND CASH EQUIVALENTS, END OF PERIOD  $46,372,193   $37,660,747 
           
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:          
Cash paid during the period for:          
Interest  $210,552   $231,064 
Taxes  $130,610   $186,900 

 

See notes to consolidated financial statements.

 

8
 

 

VSB BANCORP, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE MONTHS ENDED

MARCH 31, 2012 AND 2011 (UNAUDITED)

 

 

1.    GENERAL

 

VSB Bancorp, Inc. (referred to using terms such as “we,” “us,” or the “Company”) is the holding company for Victory State Bank (the “Bank”), a New York chartered commercial bank. Our primary business is owning all of the issued and outstanding stock of the Bank. Our common stock is listed on the NASDAQ Global Market. We trade under the symbol “VSBN”.

 

Through the Bank, the Company is primarily engaged in the business of commercial banking, and to a lesser extent retail banking. The Bank gathers deposits from individuals and businesses primarily in Staten Island, New York and makes loans throughout that community. Therefore, the Company’s exposure to credit risk is significantly affected by changes in the local Staten Island economic and real estate markets. The Bank invests funds that are not used for lending primarily in government securities, mortgage backed securities and collateralized mortgage obligations. Customer deposits are insured, up to the applicable limit, by the Federal Deposit Insurance Corporation (“FDIC”). The Bank is supervised by the New York State Department of Financial Services (“NYDFS”) and the FDIC.

 

2.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

The following is a description of the significant accounting and reporting policies followed in preparing and presenting the accompanying consolidated financial statements. These policies conform with accounting principles generally accepted in the United States of America (“GAAP”).

 

Principles of Consolidation - The consolidated financial statements of the Company include the accounts of the Company, including its subsidiary Victory State Bank. All significant inter-company accounts and transactions between the Company and Bank have been eliminated in consolidation.

 

Use of Estimates - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the amounts of revenues and expenses during the reporting period. Actual results can differ from those estimates. The allowance for loan losses, prepayment estimates on the mortgage-backed securities and collateralized mortgage obligation portfolios, contingencies and fair values of financial instruments are particularly subject to change.

 

Reclassifications – Some items in the prior year financial statements were reclassified to conform to the current presentation.

 

Cash and Cash Equivalents – Cash and cash equivalents consist of cash on hand, due from banks and interest-bearing deposits. Interest-bearing deposits with original maturities of 90 days or less are included in this category. Customer loan and deposit transactions are reported on a net cash basis. Regulation D of the Board of Governors of the Federal Reserve System requires that Victory State Bank maintain interest-bearing deposits or cash on hand as reserves against its demand deposits. The amount of reserves which Victory State Bank is required to maintain depends upon its level of transaction accounts. During the fourteen day period from March 22, 2012 through April 4, 2012, Victory State Bank was required to maintain reserves, after deducting vault cash, of $3,220,000. Reserves are required to be maintained on a fourteen day basis, so, from time to time, Victory State Bank may use available cash reserves on a day to day basis, so long as the fourteen day average reserves satisfy Regulation D requirements. Victory State Bank is required to report transaction account levels to the Federal Reserve on a weekly basis.

 

9
 

  

Interest-bearing bank balances – Interest-bearing bank balances mature overnight and are carried at cost.

 

Investment Securities, Available for Sale - Investment securities, available for sale, are to be held for an unspecified period of time and include securities that management intends to use as part of its asset/liability strategy. These securities may be sold in response to changes in interest rates, prepayments or other factors and are carried at estimated fair value. Gains or losses on the sale of such securities are determined by the specific identification method. Interest income includes amortization of purchase premium and accretion of purchase discount. Premiums and discounts are recognized in interest income using a method that approximates the level yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are estimated. Unrealized holding gains or losses, net of deferred income taxes, are excluded from earnings and reported as other comprehensive income in a separate component of stockholders’ equity until realized. For debt securities with other than temporary impairment (OTTI) that management does not intend to sell or expect to be required to sell, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis.

 

The Company invests primarily in agency collateralized mortgage-Backed obligations (“CMOs”) with estimated average lives primarily under 7 Years and mortgage-backed securities. These securities are primarily issued by the Federal National Mortgage Association (“FNMA”), the Government National Mortgage Association (“GNMA”) or the Federal Home Loan Mortgage Corporation (“FHLMC”) and are primarily comprised of mortgage pools guaranteed by FNMA, GNMA or FHLMC. The Company also invests in whole loan CMOs, all of which are AAA rated at the time of purchase. These securities expose the Company to risks such as interest rate, prepayment and credit risk and thus pay a higher rate of return than comparable treasury issues.

 

Loans Receivable - Loans receivable, that management has the intent and ability to hold for the foreseeable future or until maturity or payoff, are stated at unpaid principal balances, adjusted for deferred net origination and commitment fees and the allowance for loan losses. Interest income on loans is credited as earned.

 

It is the policy of the Company to provide a valuation allowance for probable incurred losses on loans based on the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations which may affect the borrower’s ability to repay, estimated value of underlying collateral and current economic conditions in the Company’s lending area. The allowance is increased by provisions for loan losses charged to earnings and is reduced by charge-offs, net of recoveries. While management uses available information to estimate losses on loans, future additions to the allowance may be necessary based upon the expected growth of the loan portfolio and any changes in economic conditions beyond management’s control. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on judgments different from those of management. Management believes, based upon all relevant and available information, that the allowance for loan losses is appropriate.

 

The Company has a policy that all loans 90 days past due are placed on non-accrual status. It is the Company’s policy to cease the accrual of interest on loans to borrowers past due less than 90 days where a probable loss is estimated and to reverse out of income all interest that is due but has not been paid. The Company applies payments received on non-accrual loans to the outstanding principal balance due before applying any amount to interest, until the loan is restored to an accruing status. On a limited basis, the Company may apply a payment to interest on a non-accrual loan if there is no impairment or no estimated loss on these assets. The Company continues to accrue interest on construction loans that are 90 days past contractual maturity date if the loan is expected to be paid in full in the next 60 days and all interest is paid up to date.

 

Loan origination fees and certain direct loan origination costs are deferred and the net amount recognized over the contractual loan terms using the level-yield method, adjusted for periodic prepayments in certain circumstances.

 

10
 

 

The Company considers a loan to be impaired when, based on current information, it is probable that the Company will be unable to collect all principal and interest payments due according to the contractual terms of the loan agreement. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Impairment is measured on a loan by loan basis for commercial and construction loans. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral. The fair value of the collateral, as reduced by costs to sell, is utilized if a loan is collateral dependent. The fair value of the collateral is estimated by obtaining a new appraisal, if the loan amount exceeds $100,000, or by adjusting the most recent appraisal to reflect the current market if the loan is less than $100,000 or a more recent appraisal has yet to be received. Loans with modified terms that the Company would not normally consider, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired. Large groups of homogeneous loans are collectively evaluated for impairment.

 

Long-Lived Assets - The Company periodically evaluates the recoverability of long-lived assets, such as premises and equipment, to ensure the carrying value has not been impaired. In performing the review for recoverability, the Company would estimate the future cash flows expected to result from the use of the asset. If the sum of the expected future cash flows is less than the carrying amount, an impairment will be recognized. The Company reports these assets at the lower of the carrying value or fair value.

 

Premises and Equipment - Premises, leasehold improvements, and furniture and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are accumulated by the straight-line method over the estimated useful lives of the respective assets, which range from three to fifteen years. Leasehold improvements are amortized at the lesser of their useful life or the term of the lease.

 

Federal Home Loan Bank (FHLB) Stock - The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment. Because this stock is viewed as a long term investment, impairment is based on ultimate recovery of par value, which is the price the Bank pays for the FHLB Stock. Both cash and stock dividends are reported as income.

 

Income Taxes - The Company utilizes the liability method to account for income taxes. Under this method, deferred tax assets and liabilities are determined on differences between financial reporting and the tax bases of assets and liabilities and are measured using the enacted tax rates and laws expected to be in effect when the differences are expected to reverse. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. As such, a tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.

 

The Company recognizes interest and/or penalties related to income tax matters in income tax expense.

 

Financial Instruments - In the ordinary course of business, the Company has entered into off-balance sheet financial instruments, primarily consisting of commitments to extend credit.

 

Basic and Diluted Net Income Per Common Share - The Company has stock compensation awards with non-forfeitable dividend rights which are considered participating securities. As such, earnings per share is computed using the two-class method. Basic earnings per common share is computed by dividing net income allocated to common stock by the weighted average number of common shares outstanding during the period which excludes the participating securities. Diluted earnings per common share includes the dilutive effect of additional potential common shares from stock-based compensation plans, but excludes awards considered participating securities. Earnings and dividends per share are restated for all stock splits and stock dividends through the date of issuance of the financial statements.

 

11
 

 

Basic net income per share of common stock is based on 1,745,483 shares and 1,761,754 shares, the weighted average number of common shares outstanding for the three months ended March 31, 2012 and 2011, respectively. Diluted net income per share of common stock is based on 1,745,483 and 1,766,550, the weighted average number of common shares outstanding plus potentially dilutive common shares for the three months ended March 31, 2012 and 2011, respectively. The weighted average number of potentially dilutive common shares excluded in calculating diluted net income per common share due to the anti-dilutive effect is 50,418 and 23,171 shares for the three months ended March 31, 2012 and 2011, respectively. Common stock equivalents were calculated using the treasury stock method.

 

The reconciliation of the numerators and the denominators of the basic and diluted per share computations for the three months ended March 31, are as follows:

  

Reconciliation of EPS        
   Three months ended   Three months ended 
   March 31, 2012   March 31, 2011 
Basic          
Distributed earnings allocated to common stock  $104,729   $105,705 
Undistributed earnings allocated to common sock   172,390    317,557 
Net earnings allocated to common stock  $277,119   $423,262 
           
Weighted common shares outstanding including participating securities   1,773,883    1,797,254 
Less: Participating securities (non-vested RRP shares)   (28,400)   (35,500)
Weighted average shares   1,745,483    1,761,754 
           
Basic EPS  $0.16   $0.24 
           
Diluted          
Net earnings allocated to common stock  $277,119   $423,262 
           
Weighted average shares for basic   1,745,483    1,761,754 
Dilutive effects of:          
Stock Options       4,796 
Unvested shares not considered particpating securtities        
    1,745,483    1,766,550 
           
Diluted EPS  $0.16   $0.24 

  

Net earnings allocated to common stock for the period are distributed earnings during the period, such as dividends on common shares outstanding, plus a proportional amount of retained income for the period based on restricted shares granted but unvested compared to the total common shares outstanding.

 

Stock Based Compensation - The Company records compensation expense for stock options provided to employees in return for employment service. The cost is measured at the fair value of the options when granted, and this cost is expensed over the employment service period, which is normally the vesting period of the options.

 

Employee Stock Ownership Plan (“ESOP”) - The cost of shares issued to the ESOP, but not yet allocated to participants, is shown as a reduction of stockholders’ equity. Compensation expense is based on the market price of shares as they are committed to be released to participant accounts. Cash dividends on allocated ESOP shares reduce retained earnings; cash dividends on unearned ESOP shares reduce debt and accrued interest.

 

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Stock Repurchase ProgramsOn September 8, 2008, the Company announced that its Board of Directors had authorized a Rule 10b5-1 stock repurchase program for the repurchase of up to 100,000 shares of the Company’s common stock. On April 21, 2009, the Company announced that its Board of Directors had authorized a second Rule 10b5-1 stock repurchase program for the repurchase of up to an additional 100,000 shares of the Company’s common stock. The Company has repurchased a total of 200,000 shares of its common stock under these stock repurchase programs, which were completed by the end of 2010. On September 14, 2011, the Company announced that its Board of Directors had authorized a third Rule 10b5-1 stock repurchase program for the repurchase of up to an additional 100,000 shares of the Company’s common stock. At March 31, 2012, the Company had repurchased a total of 37,200 shares of its common stock under this third stock repurchase program. Stock repurchases under the programs have been accounted for using the cost method, in which the Company will reflect the entire cost of repurchased shares as a separate reduction of stockholders’ equity on its balance sheet.

 

Retention and Recognition Plan – At the April 27, 2010 Annual Meeting, the stockholders of VSB Bancorp, Inc. approved the adoption of the 2010 Retention and Recognition Plan (the “RRP”). The RRP authorizes the award of up to 50,000 shares of its common stock to directors, officers and employees. In conjunction with the approval the RRP, stockholders approved the award of 4,000 shares of stock to each of its eight directors who had at least five years of service. The director awards will vest over five years, with 20% vesting annually for each of the first five years after the award is made, subject to acceleration and forfeiture. On April 27, 2011, 6,400 shares or 20% of the 32,000 shares of stock awarded to its eight directors who had at least five years of service had vested. On June 8, 2010, an additional 3,500 shares of stock were awarded to the President and CEO of the Company, which will vest over a 65 month period, with 20% vesting annually for each of the first five years starting in November 2011, subject to acceleration and forfeiture. On November 16, 2011, 700 shares or 20% of the 3,500 shares of stock awarded to the President and CEO of the Company had vested. The recipient of an award will not be required to make any payment to receive the award or the stock covered by the award. The Company recognizes compensation expense for the shares awarded under the RRP gradually as the shares vest, based upon the market price of the shares on the date of the award. For the three months ended March 31, 2012, the Company recognized $20,186 of compensation expense related to the shares awarded. The income tax benefit resulting from this expense was $9,235. As of March 31, 2012, there was approximately $233,109 of unrecognized compensation costs related to the shares awarded. These costs are expected to be recognized over the next 3 years.

 

A summary of the status of the Company’s non-vested plan shares as of March 31, 2012 is as follows:

 

For the Three Months Ended March 31, 2012:    
       Weighted Average 
   Shares   Grant Date Share Value 
         
Non vested at beginning of period   28,400   $11.46 
Granted         
Vested      $ 
Non vested at end of period   28,400   $11.46 

 

Comprehensive Income - Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses, net of taxes, on securities available for sale which are also recognized as separate components of equity.

 

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Recently-Adopted Accounting Standards - In September 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2011-8, “Intangibles – Goodwill and Other (Topic 350) Testing Goodwill for Impairment” (“ASU 2011-8”). ASU 2011-8 clarifies the guidance for goodwill impairment testing by allowing companies to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. The company would not be required to calculate the fair value of a reporting unit unless the company determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. ASU 2011-8 includes a number of events and circumstances for companies to consider in conducting the qualitative assessment. ASU 2011-8 is effective for interim and annual reporting periods ending on or after December 15, 2011. Early adoption is permitted. Early adoption of AUS 2011-8 did not have a material impact on the Company.

 

In December 2011, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update No. 2011-12, “Comprehensive Income (Topic 220) Deferral of the Effective Date for Amendments to the Presentation of Reclassification of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05”. In order to defer only those changes in Update 2011-05 that relate to the presentation of reclassification adjustments, the paragraphs in this Update supersede certain pending paragraphs in Update 2011-05. The amendments are being made to allow the FASB Board time to redeliberate whether to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented. While the Board is considering the operational concerns about the presentation requirements for reclassification adjustments and the needs of financial statement users for additional information about reclassification adjustments, entities should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before Update 2011-05.

 

In June 2011, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update No.2011-5, “Comprehensive Income (Topic 220)” (“ASU 2011-5”). ASU 2011-5 gives companies the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, the company is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. ASU 2011-5 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. The amendments in this guidance do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. ASU 2011-5 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Adoption of ASU 2011-5 did not have a material impact on the Company.

 

In May 2011, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update No.2011-4, “Fair Value Measurement and Disclosures (Topic 820)” (“ASU 2011-4”). ASU 2011-4 clarifies the guidance for determining fair value including some instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. This Update results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with current accounting guidance. ASU 2011-4 is effective for interim and annual reporting periods ending on or after December 15, 2011. Adoption of ASU 2011-4 did not have a material impact on the Company.

  

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3.     INVESTMENT SECURITIES, AVAILABLE FOR SALE

 

The following table summarizes the amortized cost and fair value of the available-for-sale investment securities portfolio at March 31, 2012 and December 31, 2011 and the corresponding amounts of unrealized gains and losses herein:

 

   March 31, 2012 
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
                     
FNMA MBS - Residential  $21,012,617   $149,080   $(80,783)  $21,080,914 
GNMA MBS - Residential   6,373,404    141,785    (17,289)   6,497,900 
Whole Loan MBS - Residential   687,228    17,565        704,793 
Collateralized mortgage obligations   87,105,731    2,483,075    (13)   89,588,793 
   $115,178,980   $2,791,505   $(98,085)  $117,872,400 

 

   December 31, 2011 
    Amortized    Unrealized    Unrealized    Fair 
    Cost    Gains     Losses    Value 
                     
FNMA MBS - Residential  $5,080,697   $109,069   $   $5,189,766 
GNMA MBS - Residential   6,748,239    228,105        6,976,344 
Whole Loan MBS - Residential   786,085    20,531        806,616 
Collateralized mortgage obligations   93,023,287    2,504,478    (2)   95,527,763 
   $105,638,308   $2,862,183   $(2)  $108,500,489 

  

There were no sales of investment securities for the three months ended March 31, 2012 and 2011.

 

The amortized cost and fair value of the investment securities portfolio are shown by expected maturity. Expected maturities may differ from contractual maturities, especially for collateralized mortgage obligations, if borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

 

   March 31, 2012 
    Amortized    Fair 
    Cost    Value 
           
Less than one year  $   $ 
Due after one year through five years   28,893    28,883 
Due after five years through ten years   11,483,832    11,667,119 
Due after ten years   103,666,255    106,176,398 
   $115,178,980   $117,872,400 

 

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The following table summarizes the investment securities with unrealized losses at March 31, 2012 and December 31, 2011 by aggregated major security type and length of time in a continuous unrealized loss position:

 

March 31, 2012  Less than 12 months   More than 12 months   Total 
                         
    Fair    Unrealized    Fair    Unrealized    Fair    Unrealized 
    Value    Loss    Value    Loss    Value    Loss 
                               
FNMA MBS  $12,883,131   $(80,783)  $   $   $12,883,131   $(80,783)
GNMA MBS   3,076,087    (17,289)           3,076,087    (17,289)
Whole Loan MBS                        
Collateralized mortgage obligations   48,604    (13)           48,604    (13)
   $16,007,822   $(98,085)  $   $   $16,007,822   $(98,085)

 

December 31, 2011  Less than 12 months   More than 12 months   Total 
                         
    Fair    Unrealized    Fair    Unrealized    Fair    Unrealized 
    Value    Loss    Value    Loss    Value    Loss 
                               
FNMA MBS  $   $   $   $   $   $ 
GNMA MBS                        
Whole Loan MBS                        
Collateralized mortgage obligations   5,038    (2)           5,038    (2)
   $5,038   $(2)  $   $   $5,038   $(2)

  

The Company evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition.

 

At March 31, 2012, the unrealized loss on investment securities was caused by average life increases. We expect that these securities, at maturity, will be settled for at least the amortized cost of the investment. Because the decline in fair value is attributable to changes in average life and not credit quality, and because the Company does not intend to sell the securities and it is not more likely than not that the Company will be required to sell the securities before recovery of the amortized cost basis less any current-period loss, these investments are not considered other-than-temporarily impaired. At March 31, 2012, there were no debt securities with unrealized losses with aggregate depreciation of 5% or more from the Company’s amortized cost basis.

 

Securities pledged had a fair value of $54,544,243 and $55,080,059 at March 31, 2012 and December 31, 2011, respectively and were pledged to secure public deposits and balances in excess of the deposit insurance limit on certain customer accounts.

 

4.    FAIR VALUE OF FINANCIAL INSTRUMENTS

 

The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of FASB ASC 820, “Financial Instruments”. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

 

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The following methods and assumptions were used by the Company in estimating fair values of financial instruments:

 

Interest-bearing Bank Balances – Interest-bearing bank balances mature within one year and are carried at cost, which are estimated to be reasonably close to fair value.

 

Money Market Investments – The fair value of these securities approximates their carrying value due to the relatively short time to maturity

 

Investment Securities, Available For Sale – The estimated fair value of these securities is determined by using available market information and appropriate valuation methodologies. The estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange.

 

Federal Home Loan Bank Stock - It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.

 

Loans Receivable - The fair value of commercial and construction loans is approximated by the carrying value as the loans are tied directly to the Prime Rate and are subject to change on a daily basis, subject to the applicable interest rate floors. The fair value of the remainder of the portfolio is determined by discounting the future cash flows of the loans using the appropriate discount rate.

 

Other Financial Assets - The fair value of these assets, principally accrued interest receivable, approximates their carrying value due to their short maturity.

 

Non-Interest Bearing and Interest Bearing Deposits - The fair value disclosed for non-interest bearing deposits is equal to the amount payable on demand at the reporting date. The fair value of interest bearing deposits is based upon the current rates for instruments of the same remaining maturity. Interest bearing deposits with a maturity of greater than one year are estimated using a discounted cash flow approach that applies interest rates currently being offered.

 

Other Liabilities - The estimated fair value of other liabilities, which primarily include accrued interest payable, approximates their carrying amount.

 

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The carrying amounts and estimated fair values of financial instruments, at March 31, 2012 and December 31, 2011 are as follows:

 

   Fair Value Measurements at March 31, 2012 Using        
   Carrying   Quoted Prices in Active Markets for Identical Assets   Significant Other Observable Inputs   Significant Unobservable Inputs     
   Value   (Level 1)   (Level 2)   (Level 3)   Total 
Financial Assets:                         
Cash and cash equivalents  $46,372,193   $3,957,864   $42,414,329   $   $46,372,193 
Investment securities, available for sale   117,872,400        117,872,400        117,872,400 
Loans receivable   81,321,635            82,215,808    82,215,808 
Accrued interest receivable   578,118        322,695    255,423    578,118 
Total Financial Assets  $246,144,346   $3,957,864   $160,609,424   $82,471,231   $247,038,519 
                          
Financial Liabilities:                         
Deposits  $221,802,263   $76,796,502   $144,948,766   $   $221,745,268 
Accrued interest payable   20,951        20,951        20,951 
Total Financial Liabilities  $221,823,214   $76,796,502   $144,969,717   $   $221,766,219 

 

   Fair Value Measurements at December 31, 2011 Using     
   Carrying   Quoted Prices in Active Markets for Identical Assets   Significant Other Observable Inputs   Significant Unobservable Inputs     
   Value   (Level 1)   (Level 2)   (Level 3)   Total 
Financial Assets:                         
Cash and cash equivalents  $48,107,673   $3,384,186   $44,723,487   $   $48,107,673 
Investment securities, available for sale   108,500,489        108,500,489        108,500,489 
Loans receivable   80,567,970            81,722,136    81,722,136 
Accrued interest receivable   582,942        315,760    267,182    582,942 
Total Financial Assets  $237,759,074   $3,384,186   $153,539,736   $81,989,318   $238,913,240 
                          
Financial Liabilities:                         
Deposits  $213,222,905   $72,687,621   $140,454,934   $   $213,142,555 
Accrued interest payable   17,011        17,011        17,011 
Total Financial Liabilities  $213,239,916   $72,687,621   $140,471,945   $   $213,159,566 

 

ASC 820 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

 

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

 

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

 

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

 

The fair value of securities available for sale is determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or using matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).

 

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   Fair Value Measurements at March 31, 2012 Using 
        Quoted Prices in Active Markets for Identical Assets   Significant Other Observable Inputs   Significant Unobservable Inputs 
   Total   (Level 1)    (Level 2)    (Level 3) 
Assets:                    
FNMA MBS - Residential  $21,080,914   $   $21,080,914   $ 
GNMA MBS - Residential   6,497,900        6,497,900     
Whole Loan MBS- Residential   704,793        704,793     
Collateralized mortgage obligations   89,588,793        89,588,793     
Total Available for sale                    
Securities  $117,872,400   $   $117,872,400   $ 

  

   Fair Value Measurements at December 31, 2011 Using 
        Quoted Prices in Active Markets for Identical Assets   Significant Other Observable Inputs   Significant Unobservable Inputs 
   Total   (Level 1)   (Level 2)   (Level 3) 
Assets:                    
FNMA MBS - Residential  $5,189,766   $   $5,189,766   $ 
GNMA MBS - Residential   6,976,344        6,976,344     
Whole Loan MBS- Residential   806,616        806,616     
Collateralized mortgage obligations   95,527,763        95,527,763     
Total Available for sale                    
Securities  $108,500,489   $   $108,500,489   $ 
                     

  

Certain financial assets are measured at fair value on a nonrecurring basis, that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).

 

There were no transfers between levels from December 31, 2011 to March 31, 2012. 

 

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Assets Measured on a Non-Recurring Basis

 

Assets measured at fair value on a non-recurring basis are summarized below:

 

Impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral. Collateral values are estimated using Level 3 inputs based on internally customized discounting criteria and updated appraisals when received.

 

Other real estate owned measured at fair value less cost to sell, had a net carrying amount of $267,246.

 

   Fair Value Measurements at March 31, 2012 Using 
        Quoted Prices in Active Markets for Identical Assets   Significant Other Observable Inputs   Significant Unobservable Inputs 
   Total   (Level 1)   (Level 2)   (Level 3) 
Assets:                    
Impaired loans                    
Commercial Real Estate  $972,988           $972,988 
                     
Other real estate owned   267,246            267,246 

 

   Fair Value Measurements at December 31, 2011 Using 
        Quoted Prices in Active Markets for Identical Assets    Significant Other Observable Inputs   Significant Unobservable Inputs 
   Total   (Level 1)   (Level 2)   (Level 3) 
Assets:                    
Impaired loans                    
Commercial Real Estate  $1,004,279           $1,004,279 
                     
Other real estate owned   267,246            267,246 

 

As of March 31, 2012, we had four impaired loans with specific reserves that were collateral dependent. Collateral dependent impaired loans, which are measured for impairment using the fair value of the collateral, had a carrying amount of $1,339,181, with a valuation allowance of $366,193 at that date. The valuation allowance increased $20,098 from December 31, 2011 to March 31, 2012.

 

As of December 31, 2011, we had four impaired loans with specific reserves that were collateral dependent. Collateral dependent impaired loans, which are measured for impairment using the fair value of the collateral, had a carrying amount of $1,350,374, with a valuation allowance of $346,095 at that date.

 

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The following table presents quantitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at March 31, 2012.

  

                 
    Fair   Valuation   Unobservable  
    Value   Techniques   Inputs   Range
Impaired loans-                
Commercial real estate   $ 624,826   Third Party Appraisal   Discount adjustment for differences in various costs.    0.01%
                   
                    152,382   Third Party Appraisal   Adjustments for differences between comparable sales.    2.7%-12.6%
                   
                    195,780   Third Party Appraisal   Adjustments for differences in net operating income expectations    10% - 27%
                   
               Capitalization Rate   8.10%
                   
Other real estate owned - commercial     267,246   Third Party Appraisal   Adjustments for differences in net operating income expectations    17% - 26%
                   
              Capitalization Rate   8.00%

 

5.    LOANS RECEIVABLE, NET

 

Loans receivable, net at March 31, 2012 and December 31, 2011 are summarized as follows:

 

   March 31,   December 31, 
   2012   2011 
           
Commercial loans (principally variable rate):          
Secured  $1,579,340   $1,522,639 
Unsecured   13,638,323    12,997,139 
Total commercial loans   15,217,663    14,519,778 
           
Real estate loans:          
Commercial   58,699,313    59,376,008 
Residential   2,308,504    2,309,899 
Total real estate loans   61,007,817    61,685,907 
           
Construction loans (net of undisbursed funds of $2,200,000 and $2,215,000, respectively)   5,604,995    4,610,000 
           
Consumer loans   674,493    602,144 
Other loans   479,584    717,261 
    1,154,077    1,319,405 
           
Total loans receivable   82,984,552    82,135,090 
           
Less:          
Unearned loans fees, net   (221,004)   (224,100)
Allowance for loan losses   (1,441,913)   (1,343,020)
           
Total  $81,321,635   $80,567,970 

 

21
 

  

Nonaccrual loans outstanding at March 31, 2012 and December 31, 2011 are summarized as follows:

  

   March 31,   December 31, 
   2012   2011 
Nonaccrual loans:          
Commercial real estate  $6,763,736   $8,265,397 
Residential real estate       2,200,000 
Construction   397,500    397,500 
           
Total nonaccrual loans  $7,161,236   $10,862,897 

 

   March 31,   December 31, 
   2012   2011 
Interest income that would have been recorded during the period on nonaccrual loans outstanding in accordance with original terms  $133,365   $595,946 

 

At March 31, 2012 and December 31, 2011, there were no loans 90 days past due and still accruing interest.

 

The following table presents the aging of the past due loan balances as of March 31, 2012 and December 31, 2011 by class of loans:

 

March 31, 2012       30-59 Days   60-89 Days   Greater than 90 Days   Total   Loans Not 
   Total   Past Due   Past Due   Past Due   Past Due   Past Due 
                               
Commercial loans:                              
Unsecured  $13,638,323   $50,000   $   $   $50,000   $13,588,323 
Secured   1,579,340    4,133            4,133    1,575,207 
Real Estate loans                              
Commercial   58,699,313    988,987    350,000    6,763,736    8,102,723    50,596,590 
Residential   2,308,504                    2,308,504 
Construction loans   5,604,995            397,500    397,500    5,207,495 
Consumer loans   674,493    10,324            10,324    664,169 
Other loans   479,584                    479,584 
Total loans  $82,984,552   $1,053,444   $350,000   $7,161,236   $8,564,680   $74,419,872 

  

December 31, 2011       30-59 Days   60-89 Days   Greater than 90 Days   Total   Loans Not 
   Total   Past Due   Past Due   Past Due   Past Due   Past Due 
                               
Commercial loans:                              
Unsecured  $12,997,139   $84,529   $16,260   $   $100,789   $12,896,350 
Secured   1,522,639                    1,522,639 
Real Estate loans                              
Commercial   59,376,008    997,740    359,620    8,265,397    9,622,757    49,753,251 
Residential   2,309,899            2,200,000    2,200,000    109,899 
Construction loans   4,610,000            397,500    397,500    4,212,500 
Consumer loans   602,144    678            678    601,466 
Other loans   717,261                    717,261 
Total loans  $82,135,090   $1,082,947   $375,880   $10,862,897   $12,321,724   $69,813,366 

 

22
 

  

Nonaccrual loans include smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.

 

Loans individually evaluated for impairment were as follows:

 

   March 31,   December 31, 
   2012   2011 
          
Loans with no allocated allowance for loan losses:          
      Commercial real estate  $5,180,794   $6,662,331 
      Construction   397,500    397,500 
      Residential real estate       2,200,000 
Loans with allocated allowance for loan losses:          
      Commercial real estate   1,339,181    1,350,374 
   $6,917,475   $10,610,205 
           
Amount of the allowance for loan losses allocated:    
      Commercial real estate  $366,193   $346,095 
           
   $366,193   $346,095 

 

The following table sets forth certain information about impaired loans with a measured impairment:

 

   Three Months   Three Months 
   Ended   Ended 
   March 31,   March 31, 
   2012   2011 
           
Average of individually impaired loans during period:          
Commercial real estate  $7,734,655   $2,556,203 
Construction   397,500     
Commercial unsecured       37,149 
Residential real estate   1,466,667     
   $9,598,822   $2,593,352 
           
Interest income recognized during time period that loans were impaired, using accrual or cash-basis method of accounting  $   $ 
           

 

Troubled Debt Restructurings:

 

The Company has allocated $3,153 and $3,412 of specific reserves to customers whose loan terms have been modified in trouble debt restructurings (“TDRs”) as of March 31, 2012 and December 31, 2011. The Company has not committed to lend any additional amounts to customers with outstanding loans that are classified as TDRs.

 

The outstanding principal balance of trouble debt restructurings at March 31, 2012 was $4,178,682 and at December 31, 2011 was $4,576,997. None of the loans currently classified as TDRs have defaulted during this period. The TDR’s that are being reported on are all current and are paying under the modified arrangements.

 

23
 

 

The terms of certain other loans were modified during the three months ended March 31, 2012 that did not meet the definition of a TDR. These loans have a total recorded investment as of March 31, 2012 of $105,994. The modification of these loans involved either a modification of the terms of a loan to borrowers who were not experiencing financial difficulties or a delay in a payment that was considered to be insignificant. 

 

In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification.

 

The following table presents loans by class modified as troubled debt restructurings that occurred during the period ending March 31, 2012:

 

       Pre-Modification   Post-Modification 
   Number   Outstanding Recorded   Outstanding Recorded 
   of Loans   Investment   Investment 
Troubled Debt Restructurings:               
    Commerical real estate   2   $1,410,380   $1,410,380 

 

The troubled debt restructurings described above did not require an additional allowance during the period ending March 31, 2012.

 

Credit Quality Indicators:

 

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debts such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis is performed on a quarterly basis. The Company uses the following definitions for risk ratings:

 

Special Mention. Loans categorized as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position as some future date.

 

Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

 

Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.

 

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The following table sets forth at March 31, 2012 and December 31, 2011, the aggregate carrying value of our assets categorized as Special Mention, Substandard and Doubtful according to asset type:

 

   At March 31, 2012 
                     
   Special             Not      
   Mention   Substandard   Doubtful   Classified   Total 
                          
Commercial Loans:                         
Secured  $   $   $   $1,579,340   $1,579,340 
Unsecured   37,688    31,528        13,569,107    13,638,323 
Commercial Real Estate   3,981,679    7,175,791        47,541,843    58,699,313 
Residential Real Estate       2,200,000        108,504    2,308,504 
Construction       397,500        5,207,495    5,604,995 
Consumer   10,325            664,168    674,493 
Other   4,863            474,721    479,584 
Total loans  $4,034,555   $9,804,819   $   $69,145,178   $82,984,552 
                          
Real estate owned       267,246            267,246 
Total assets  $4,034,555   $10,072,065   $   $69,145,178   $83,251,798 

 

   At December 31, 2011 
                     
   Special             Not      
   Mention   Substandard   Doubtful   Classified   Total 
                          
Commercial Loans:                         
Secured  $   $   $   $1,522,639   $1,522,639 
Unsecured   127,132    50,379        12,819,628    12,997,139 
Commercial Real Estate   2,012,188    9,039,881        48,323,939    59,376,008 
Residential Real Estate       2,200,000        109,899    2,309,899 
Construction       397,500        4,212,500    4,610,000 
Consumer   12,682            589,462    602,144 
Other   5,306            711,955    717,261 
Total loans  $2,157,308   $11,687,760   $   $68,290,022   $82,135,090 
                          
Real estate owned       267,246            267,246 
Total assets  $2,157,308   $11,955,006   $   $68,290,022   $82,402,336 

 

The activity in the allowance for loan losses, for the three months ended March 31, 2012 and 2011:

 

   For the Three   For the Three 
   Months Ended   Months Ended 
   March 31, 2012   March 31, 2011 
           
Beginning balance  $1,343,020   $1,277,220 
Charge-offs:          
Commercial Loans:          
Unsecured   (100,757)   (37,797)
Total charge-offs   (100,757)   (37,797)
Recoveries:          
Commercial Loans:          
Unsecured   24,550    23,675 
Commercial Real Estate       5,000 
Other   100    3,500 
Total recoveries   24,650    32,175 
Provision   175,000    30,000 
           
Ending balance  $1,441,913   $1,301,598 
           

 

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The following table presents the balance in the allowance for loan losses and the recorded balance in loans, by portfolio segment, and based on impairment method as of March 31, 2012 and December 31, 2011:

 

March 31, 2012                            
                             
   Commercial   Commercial       Commerical   Residential Real   Other     
   Unsecured   Secured   Construction   Real Estate   Estate   Loans   Total 
                                    
Allowance for loan losses:                                   
Ending allowance balance attributable to loans                                   
Individually evaluated for impairment  $3,153   $   $   $375,464   $   $   $378,617 
Collectively  evaluated for impairment   498,626    13,650    40,687    460,677    4,042    45,614    1,063,296 
Total ending allowance balance  $501,779   $13,650   $40,687   $836,141   $4,042   $45,614   $1,441,913 
                                    
Loans:                                   
Individually evaluated for impairment  $31,528   $   $397,500   $7,175,791   $2,200,000   $   $9,804,819 
Collectively evaluated for impairment   13,606,795    1,579,340    5,207,495    51,523,522    108,504    1,154,077    73,179,733 
Total ending loans balance  $13,638,323   $1,579,340   $5,604,995   $58,699,313   $2,308,504   $1,154,077   $82,984,552 

  

December 31, 2011                            
                             
   Commercial   Commercial       Commerical   Residential Real   Other     
   Unsecured   Secured   Construction   Real Estate   Estate   Loans   Total 
                             
Allowance for loan losses:                            
Ending allowance balance attributable to loans                            
Individually evaluated for impairment  $6,664   $   $   $363,520   $   $   $370,184 
Collectively  evaluated for impairment   468,022    12,356    34,184    417,300    672    40,302    972,836 
Total ending allowance balance  $474,686   $12,356   $34,184   $780,820   $672   $40,302   $1,343,020 
                                    
Loans:                                   
Individually evaluated for impairment  $50,379   $   $397,500   $9,039,881   $2,200,000   $   $11,687,760 
Collectively evaluated for impairment   12,946,760    1,522,639    4,212,500    50,336,127    109,899    1,319,405    70,447,330 
Total ending loans balance  $12,997,139   $1,522,639   $4,610,000   $59,376,008   $2,309,899   $1,319,405   $82,135,090 

 

The following table presents the activity in the allowance for loan losses by portfolio segment for the three months ended March 31, 2012 and the year ended December 31, 2011.

 

Three months ended March 31, 2012                        
                             
    Commercial    Commercial         Commerical    Residential Real    Other      
    Unsecured    Secured    Construction    Real Estate     Estate    Loans    Total 
                                    
Allowance for loan losses:                                   
Beginning balance  $474,686   $12,356   $34,184   $780,820   $672   $40,302   $1,343,020 
Provision for loan losses   103,300    1,294    6,503    55,321    3,370    5,212    175,000 
Loans charged-off   (100,757)                       (100,757)
Recoveries   24,550                    100    24,650 
Total ending allowance balance  $501,779   $13,650   $40,687   $836,141   $4,042   $45,614   $1,441,913 

 

Year ended December 31, 2011                        
                             
    Commercial    Commercial         Commerical    Residential Real    Other      
    Unsecured    Secured    Construction    Real Estate     Estate    Loans    Total 
                                    
Allowance for loan losses:                                   
Beginning balance  $520,953   $13,486   $52,138   $653,362   $7,174   $30,107   $1,277,220 
Provision for loan losses   368,559    (1,130)   (17,954)   196,470    38,713    10,342    595,000 
Loans charged-off   (532,957)           (74,512)   (57,715)   (3,811)   (668,995)
Recoveries   118,131            5,500    12,500    3,664    139,795 
Total ending allowance balance  $474,686   $12,356   $34,184   $780,820   $672   $40,302   $1,343,020 

  

26
 

 

Item 2

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Financial Condition at March 31, 2012

 

Total assets were $250,202,826 at March 31, 2012, an increase of $8,356,371, or 3.5%, from December 31, 2011. The increase resulted from the investment of funds available to us as the result of retained earnings and an increase in deposits. The deposit increase was caused generally by our efforts to grow our franchise and specifically by the deposit increases at our branch offices. We invested these funds primarily in the purchase of new investment securities. The principal changes resulting in the net increase in assets can be summarized as follows:

 

a $9,371,911 net increase in investment securities available for sale
a $ 753,665 net increase in loans receivable and
a $1,735,480 net decrease in cash and cash equivalents.

 

In addition to these changes in major asset categories, we also experienced changes in other asset categories due to normal fluctuations in operations.

 

Our deposits (including escrow deposits) were $221,802,263 at March 31, 2012, an increase of $8,579,358 or 4.0%, from December 31, 2011 as a result of our active solicitation of retail deposits to increase funds for investment. The increase in deposits resulted from increases of $3,981,987 in non-interest demand deposits, $3,686,645 in money market accounts, $1,305,208 in NOW accounts, $274,122 in savings accounts and $126,894 in escrow deposits partially offset by a decrease of $795,498 in time deposits.

 

Total stockholders’ equity was $27,124,320 at March 31, 2012, an increase of $22,060, or 0.08%, from December 31, 2011. The increase reflected: (i) $174,625 of retained earnings due to net income of $281,628 for the three months ended March 31, 2012, partially offset by $107,003 of dividends paid in 2012; (ii) a decrease in the net unrealized gain on securities available for sale of $91,552; and (iii) a reduction of $42,270 in Unearned ESOP shares reflecting the gradual payment of the loan we made to fund the ESOP’s purchase of our stock. Additionally, there was a $106,068 increase in Treasury shares representing the cost of 10,000 shares of common stock we repurchased in the first quarter of 2012 under our Company’s third stock repurchase plan.

 

The unrealized gain on securities available for sale is excluded from the calculation of regulatory capital. Management does not anticipate selling securities in this portfolio, but changes in market interest rates or in the demand for funds may change management’s plans with respect to the securities portfolio. If there is a material increase in interest rates, the market value of the available for sale portfolio may decline. Management believes that the principal and interest payments on this portfolio, combined with the existing liquidity, will be sufficient to fund loan growth and potential deposit outflow.

 

The Dodd-Frank Wall Street Reform and Consumer Protection Law

 

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Law was adopted. It has been described as the greatest legislative change in the supervision of financial institutions since the 1930s. Its effect on Victory State Bank and VSB Bancorp, Inc. cannot now be judged with certainty because the interpretation and implementation of the law, as well as the numerous regulations and studies required or permitted by it, are still evolving. However, we believe that the following areas, among others, will be or may be significant to our future operations:

 

27
 

 

1.The law exempts smaller reporting companies filing with the Securities and Exchange Commission, such as our company, from the internal controls attestation rules of Section 404(b) of the Sarbanes-Oxley Act. Thus far, we have incurred expenses to prepare for compliance but we have not been governed by Section 404(b) due to temporary SEC extensions of the compliance deadline. The permanent exemption means that we will not be required to incur the expense of actual compliance as long as we continue to qualify as a smaller reporting company.
   
2.Securities brokers may not vote shares held in “street name” unless they receive instructions from their customers on the election of directors, executive compensation or any other significant matter, as determined by the SEC. This may increase our costs of holding annual stockholder meetings if it becomes necessary for us to retain the services of a proxy solicitor to increase shareholder participation in our meetings or to obtain approval of matters that the Board presents to stockholders. However, we did not experience any difficulties or additional expense related to this issue in connection with our 2011 annual meeting of stockholders.
   
3.At least every three years, we will be required to submit to our stockholders, for a non-binding vote, our executive compensation. This requirement may increase the cost of holding some stockholder meetings. The law also requires that the SEC implement other requirements for enhanced compensation disclosures. The SEC adopted a temporary exemption for smaller reporting companies, such as our company, until annual meetings occurring on or after January 21, 2013.
   
4.The law includes a number of changes to expand FDIC insurance coverage, as well as changes to the premiums banks must pay for insurance coverage, and the requirements applicable to the reserve ratio (the ratio of the deposit insurance fund to the amount of insured deposits). One important change is that, in the future, deposit insurance premiums we pay will be based upon total assets minus tangible capital, rather than based upon deposits. Since we do not use material borrowings to provide funds for asset growth, and we do not have material intangible assets that are excluded from capital such as goodwill, our share of the total deposit premiums paid by all banks appears to have declined. However, other factors, such as required replenishment of the current reserve fund, which must be increased to 1.35% of total insured deposits by September 30, 2020, as well as future failures of banks that may further deplete the fund, may result in an increase in our future deposit insurance premium. The FDIC must provide an offset for smaller banks negating the adverse effect of requiring a reserve ratio in excess of 1.15%, but reaching even the 1.15% ratio may require additional burdens on smaller banks. The FDIC approved final regulations implementing these changes on February 25, 2011, effective April 1, 2011. According to the FDIC, the substantial majority of banks will see reduced deposit insurance premiums as a result of the new rules. We believe that will be the case for us as long as all other relevant factors remain unchanged. Our FDIC regular insurance premium was $238,823 in 2011 compared to $345,226 in 2010, a decrease of 30.8%. The decrease was principally the result of the change from a deposit-based premium calculation to an assets-based premium calculation.
   
5.The law increases the amount of each customer’s deposits that are subject to FDIC insurance. The general limit has been permanently increased from $100,000 to $250,000. In addition, non-interest bearing transaction accounts will be fully insured, without limit, from December 31, 2010 to December 31, 2012.
   
6.The law repeals the prohibition on paying interest on demand deposit accounts, effective in July 2011. Interest-free demand deposits represent a substantial portion of our deposit base. We are not currently offering a demand deposit product that pays interest. Other banks in our community are now offering interest-bearing demand deposits and that competitive pressure may require that we offer interest checking accounts to businesses in order to retain deposits. That could have a direct adverse effect on our cost of funds. Although current market interest rates are very low, and such deposits are unlikely to carry high rates of interest, an increase in market interest rates could result in significant additional costs in order to maintain the level of such deposits.

  

28
 

 

7.The law makes interstate branching by banks much easier than in the past. We have no plans to branch outside New York State, but the law facilitates out of state banks branching into our market area, thus potentially increasing competition.
   
8.The law creates a new federal agency – the Consumer Financial Protection Bureau (“Bureau”) – which has substantial authority to regulate consumer financial transactions, effective July 21, 2011. Our loans are primarily made to businesses rather than individual consumers, so the Bureau will not have a direct effect on many of our loan transactions. However, the Bureau also has authority to regulate other non-loan consumer transactions, such as deposits and electronic banking transactions. The implementation of new consumer regulations may increase our operating costs in a manner we cannot predict until regulations are adopted.

 

The Current Economic Turmoil

 

The economy in the United States, including the economy in Staten Island, was and may still be in a recession. Although some analysts report that the economy is recovering, the extent and speed of the recovery is far from clear and some analysts predict a darker road ahead. There is substantial stress on many financial institutions and financial products. The federal government has intervened by making hundreds of billions of dollars in capital contributions to the banking industry. We draw a substantial portion of our customer base from local businesses, especially those in the building trades and related industries, and we believe that there continue to be substantial weaknesses in the business economy in our market area. Our customers have been adversely affected by the economic downturn, and if adverse conditions in the local economy continue, it will become more difficult for us to conduct prudent and profitable business in our community.

 

Making permanent residential mortgage loans is not a material part of our business, and our investments in mortgage-backed securities and collateralized mortgage obligations have been made with a view towards avoiding the types of securities that are backed by low quality mortgage-related assets. However, one of the primary focuses of our local business is receiving deposits from, and making loans to, businesses involved in the construction and building trades industry on Staten Island. Construction loans represented a significant component of our loan portfolio, reaching 39.8% of total loans at year end 2005. As we monitored the economy and the strength of the local construction industry, we elected to reduce our portfolio of construction loans. By March 31, 2012, the percentage had declined to 6.8%. However, developers and builders provide not only a source of loans, but they also provide us with deposits and other business. If the weakness in the economy continues or worsens, then that could have a substantial adverse effect on our customers and potential customers, making it more difficult for us to find satisfactory loan opportunities and low-cost deposits. This could compel us to invest in lower yielding securities instead of higher-yielding loans and could also reduce low cost funding sources such as checking accounts and require that we replace them with higher cost deposits such as time deposits. Either or both of those shifts could reduce our net income.

 

Possible Adverse Effects on Our Net Income Due to Fluctuations in Market Rates

 

Our principal source of income is the difference between the interest income we earn on interest-earning assets, such as loans and securities, and our cost of funds, principally interest paid on deposits. These rates of interest change from time to time, depending upon a number of factors, including general market interest rates. However, the frequency of the changes varies among different types of assets and liabilities. For example, for a five-year loan with an interest rate based upon the prime rate, the interest rate may change every time the prime rate changes. In contrast, the rate of interest we pay on a five-year certificate of deposit adjusts only every five years, based upon changes in market interest rates.

 

29
 

 

In general, the interest rates we pay on deposits adjust more slowly than the interest rates we earn on loans because our loan portfolio consists primarily of loans with interest rates that fluctuate based upon the prime rate. In contrast, although many of our deposit categories have interest rates that could adjust immediately, such as interest checking accounts and savings accounts, changes in the interest rates on those accounts are at our discretion. Thus, the rates on those accounts, as well as the rates we pay on certificates of deposit, tend to adjust more slowly. As a result, the declines in market interest rates that occurred through the end of 2008 initially had an adverse effect on our net income because the yields we earn on our loans declined more rapidly than our cost of funds. However, many of our prime-based loans have minimum interest rates, or floors, below which the interest rate does not decline despite further decreases in the prime rate. As our loans reached their interest rate floors, our loan yields stabilized while our deposit costs continued to decline. This had a positive effect on our net interest income.

 

When market interest rates begin increasing, which we expect will occur at some point in the future, we anticipate an initial adverse effect on our net income. We anticipate that this will occur because our deposit rates should begin to rise, while loan yields remain relatively steady until the prime rate increases sufficiently that our loans begin to reprice above their interest rate floors. For most of our prime-rate based loans, this will not occur until the prime rate increases above 6%. Once our loan rates exceed the interest rate floors, increases in market interest rates should increase our net interest income because our cost of deposits should probably increase more slowly than the yields on our loans. However, customer preferences and competitive pressures may negate this positive effect because customers may choose to move funds into higher-earning deposit types as higher interest rates make them more attractive, or competitors offer premium rates to attract deposits. We also have a substantial portfolio of investment securities with fixed rates of interest, most of which are mortgage-backed securities with an estimated average life of not more than 7 years.

 

Delays in Foreclosure Proceedings

 

The length of time it takes to prosecute a foreclosure action and be able to sell real estate collateral in New York has substantially lengthened. It is not unusual for it to take more than a full year from the date a foreclosure action is commenced until the property is sold even in uncontested cases, and some uncontested cases can take as long as two years. This problem, if it continues or gets worse, could have a substantial adverse effect on the value of our collateral for loans in default. Especially in the case of construction loans, where property value deterioration during a lengthy foreclosure is more likely, the inability to realize upon collateral increases our loss in the event of a default.

 

Results of Operations for the Three Months Ended March 31, 2012 and March 31, 2011

 

Our results of operations depend primarily on net interest income, which is the difference between the income we earn on our loan and investment portfolios and our cost of funds, consisting primarily of interest we pay on customer deposits. Our operating expenses principally consist of employee compensation and benefits, occupancy expenses, professional fees, advertising and marketing expenses and other general and administrative expenses. Our results of operations are significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government policies and actions of regulatory authorities.

 

General. We had net income of $281,628 for the three months ended March 31, 2012, compared to net income of $431,791 for the comparable period in 2011. The principal categories which make up the 2012 net income are:

 

Interest income of $2,312,672
Reduced by interest expense of $214,491
Reduced by a provision for loan losses of $175,000
Increased by non-interest income of $620,725
Reduced by non-interest expense of $2,024,745
Reduced by income tax expense of $237,533

 

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We discuss each of these categories individually and the reasons for the differences between the quarters ended March 31, 2012 and 2011 in the following paragraphs.

 

Interest Income. Interest income was $2,312,672 for the quarter ended March 31, 2012, compared to $2,477,982 for the quarter ended March 31, 2011, a decrease of $165,310 or 6.7%. The main reason for the decline was a 58 basis point decrease in the yield on investment securities and an $8,021,688 decrease in average balance between the periods, which combined caused a $219,982 decline in interest income on investment securities.

 

Interest income on loans increased by $42,156 as a result of an increase of $70,069 of interest collected on loans previously on non-accrual, from $20,687 in the first quarter of 2011 to $90,756 in the same period in 2012. The average balance of loans increased by $491,720, while the yield on loans decreased by 15 basis points from the first quarter of 2011 to the first quarter of 2012. The increase in the average balance was the result of our efforts to increase our loan portfolio, which represents our highest yielding asset category. A major contributor to the 15 basis point drop in our loan yield was a $3.8 million increase in our average non-performing loans, from $6.5 million in the quarter ending March 31, 2011, to $10.3 million in the first quarter of 2012. During the period in which interest is not being paid, non-performing loans continue to be included in the calculation of average loan yield, but with an effective yield of zero. We estimate that if all non-performing loans were performing according to their contractual terms during the first quarter of 2012, our average loan yield would have been approximately 56 basis points higher. In contrast, we estimate that the comparable effect in 2011 period would have been approximately a 38 basis point increase in average loan yield. Substantially all of the non-accrual loans are secured by mortgages on real estate. Interest rate floors on most of our loans have helped to stabilize interest income from the loan portfolio, but these floors will have the effect of limiting increases in our income until the prime rate rises above 6%.

 

We experienced a 58 basis point decrease in the average yield on our investment securities portfolio, from 3.48% to 2.90%, due to the purchase of new investment securities at lower market rates than the rates we had been earning on the investment securities previously purchased that were gradually being repaid. The average balance of our investment portfolio decreased by $8,021,688, or 6.8%, between the periods. The investment securities portfolio represented 71.3% of average non-loan interest earning assets in the 2012 period compared to 80.2% in the 2011 period.

 

Interest income from other interest earning assets (principally overnight investments) increased by $12,516 due to an increase in the yield of 6 basis points from 0.16% for the quarter ended March 31, 2011 to 0.22% for the quarter ended March 31, 2012. In addition, the average balance of our interest earning assets increased by $15.1 million between the periods because we elected to invest available funds in overnight investments rather than tie them up in longer term investment securities which were available only at relatively low yields.

 

Interest Expense. Interest expense was $214,491 for the quarter ended March 31, 2012, compared to $226,670 for the quarter ended March 31, 2011, a decrease of $12,179 or 5.4%. The decrease was primarily the result of a reduction in the rates we paid on deposits, principally Now accounts, reflecting a 12 basis point decrease in the cost of Now account deposits between the periods, due to the continuing low market interest rates. As a result, our average cost of funds, excluding the effect of interest-free demand deposits, decreased to 0.61% from 0.65% between the periods.

 

Net Interest Income Before Provision for Loan Losses. Net interest income before the provision for loan losses was $2,098,181 for the quarter ended March 31, 2012, compared to $2,251,312 for the quarter ended March 31, 2011, a decrease of $153,131, or 6.8%. The decrease was primarily because the reduction in our interest income was greater than the reduction in our cost of funds when comparing the quarter ended March 31, 2012 to the same period ended 2011. The average yield on interest earning assets declined by 55 basis points, while the average cost of funds declined by 4 basis points. The reduction in the yield on assets was principally due to the 58 basis point drop in the yield on investment securities. The decline in the cost of funds was driven principally by the 12 basis point drop in the cost of NOW account deposits. Overall, our interest rate spread declined 51 basis points, from 3.71% to 3.20% between the periods. Correspondingly, our net interest margin decreased to 3.45% for the quarter ended March 31, 2012 from 3.98% in the same period of 2011. The margin is higher than the spread because it takes into account the effect of interest free demand deposits and capital.

 

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The spread and margin both decreased because of the combined effect of the decline in earnings we were able to obtain on our investments securities and the adverse effect of the decrease in interest received on problem loans. These declines could not be offset by corresponding declines in the cost of deposits because the rates we paid on deposits were already low due to low markets rates so that we could not reduce them as much as the decline in the earnings on investment securities. In addition, we continued to incur interest expense on deposits that funded the non-performing loans that did not earn interest.

 

Provision for Loan Losses. The provision for loan losses in any period depends upon the amount necessary to bring the allowance for loan losses to the level management believes is appropriate, after taking into account charge–offs and recoveries. We took a provision for loan losses of $175,000 for the quarter ended March 31, 2012 compared to a provision for loan losses of $30,000 for the quarter ended March 31, 2011. The $145,000 increase in the provision was a result of increased net charge-offs between the periods and increased write downs on impaired loans between the periods, due to the reduction in the fair value of underlying collateral.

 

Our allowance for loan losses is based on management's evaluation of the risks inherent in our loan portfolio and the general economy. We use the following framework each calendar quarter to evaluate the appropriateness of our allowance for loan losses. We conduct a loan by loan evaluation of credit losses in all non-performing or classified loans and we conduct a collective analysis of homogenous groups of performing loans to estimate credit losses in those loans on a group by group basis. Our individual evaluation of non-performing mortgage loans, which represent most of our non-performing loans, is based primarily upon updated appraisals. Our evaluation of homogenous groups of performing loans takes into account historical charge off rates we have experienced, as adjusted for pertinent current factors that may affect the extent to which we should rely upon our charge off history.

 

We experienced an increase of $2,819,194 in non-performing loans from $4,342,042 at March 31, 2011 to $7,161,236 at March 31, 2012. Most of those loans are secured by real estate. We individually evaluated the non-performing mortgage loans based primarily upon updated appraisals as part of our analysis of the appropriate level of our allowance for loan and lease losses. We had charge-offs of $100,757 for the quarter ended March 31, 2012 as compared to charge-offs of $37,797 for the quarter ended March 31, 2011. We also had recoveries (which are added back to the allowance for loan losses) of $24,650 for the quarter ended March 31, 2012 as compared to $32,175 in the same period of 2011. After increasing the provision for loan losses for the quarter ended March 31, 2012 compared to the same period in 2011, and considering other matters that increased or decreased the allowance, we determined that the level of our allowance at March 31, 2012 was appropriate to address inherent losses. We are aggressively collecting charged-off loans in an effort to recover the amounts charged off whenever we believe that collection efforts are likely to be fruitful.

 

Although management uses available information to assess the appropriateness of the allowance on a quarterly basis in consultation with outside advisors and the board of directors, changes in national or local economic conditions, the circumstances of individual borrowers, or other factors, may change, increasing the level of problem loans and requiring an increase in the level of the allowance. Overall, our allowance for loan losses increased from $1,301,598, or 1.62% of total loans, at March 31, 2011 to $1,441,913 or 1.74% of total loans, at March 31, 2012. There can be no assurance that a higher level, or a higher provision for loan losses, will not be necessary in the future.

 

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Non-interest Income. Non-interest income was $620,725 for the quarter ended March 31, 2012, compared to $607,703 during the same period last year. The $13,022, or 2.1%, increase in non-interest income was a direct result of a $30,481 increase in service charges on deposits, partially offset by an $18,560 decrease in loan fees. Service charges on deposits consist mainly of insufficient fund fees, which are inherently volatile, and are based upon the number of items being presented for payment against insufficient funds.

 

Non-interest Expense. Non-interest expense was $2,024,745 for the quarter ended March 31, 2012, compared to $2,033,050 for the quarter ended March 31, 2011, a decrease of $8,305 or 0.4%. Although the decrease was modest, the principal shifts in the individual categories were:

 

a $32,500 decrease in FDIC and NYSDFS assessments due to change in the FDIC’s methodology for calculating the FDIC assessment rate;
a $13,834 decrease in computer expenses due to reduced contract expense partially offset by;
a $14,722 increase in legal expense due to a higher level of collections; and
a $10,675 increase in director fees because of the increased number of meetings in 2012.

 

In addition to these changes, we also experienced changes in the various other non-interest expenses categories due to normal fluctuations in operations.

 

Income Tax Expense. Income tax expense was $237,533 for the quarter ended March 31, 2012, compared to income tax expense of $364,174 for the same period ended 2011. The decrease in income tax expense was due to the $276,804 decrease in income before income taxes in the 2012 period. Our effective tax rate for the quarters ended March 31, 2012 and 2011 was 45.8%.

 

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VSB Bancorp, Inc.

Consolidated Average Balance Sheets

(unaudited)

 

  Three     Three  
   Months Ended      Months Ended  
  March 31, 2012     March 31, 2011  
  Average             Yield/     Average             Yield/  
  Balance     Interest     Cost     Balance     Interest     Cost  
                                               
Assets:                                              
Interest-earning assets:                                              
Loans receivable $ 82,459,455     $ 1,496,448       6.97 %   $ 81,967,735     $ 1,454,292       7.12 %
Investment securities, afs   109,975,800       792,570       2.90       117,997,488       1,012,552       3.48  
Other interest-earning assets   44,215,778       23,654       0.22       29,137,683       11,138       0.16  
Total interest-earning assets   236,651,033       2,312,672       3.81       229,102,906       2,477,982       4.36  
                                               
Non-interest earning assets   7,220,609                       7,037,555                  
Total assets $ 243,871,642                     $ 236,140,461                  
                                               
Liabilities and equity:                                              
Interest-bearing liabilities:                                              
Savings accounts $ 17,400,080       9,608       0.22     $ 16,046,503       12,696       0.32  
Time accounts   65,622,245       125,955       0.77       63,672,474       121,506       0.77  
Money market accounts   28,608,240       56,712       0.80       28,058,147       59,379       0.86  
Now accounts   30,432,546       22,216       0.29       32,594,336       33,089       0.41  
Total interest-bearing liabilities   142,063,111       214,491       0.61       140,371,460       226,670       0.65  
Checking accounts   73,057,277                       67,565,709                  
Escrow deposits   305,576                       347,297                  
Total deposits   215,425,964                       208,284,466                  
Other liabilities   1,244,726                       1,675,380                  
Total liabilities   216,670,690                       209,959,846                  
Equity   27,200,952                       26,180,615                  
Total liabilities and equity $ 243,871,642                     $ 236,140,461                  
                                               
Net interest income/net interest                                              
 rate spread         $ 2,098,181       3.20 %           $ 2,251,312       3.71 %
                                               
Net interest earning assets/net interest margin $ 94,587,922               3.45 %   $ 88,731,446               3.96 %
                                               
Ratio of interest-earning assets to interest-bearing liabilities   1.67 x                   1.63 x              
                                               
Return on Average Assets (1)   0.40                     0.73                
Return on Average Equity (1)   3.62                     6.56                
Tangible Equity  to Total Assets   10.84                     10.97                

 

(1) Ratios have been annualized.

 

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Liquidity and Capital Resources

 

Our primary sources of funds are increases in deposits, proceeds from the repayment of investment securities, and the repayment of loans. We use these funds to purchase new investment securities and to fund new and renewing loans in our loan portfolio. Remaining funds are invested in short-term liquid assets such as overnight federal funds loans and bank deposits.

 

During the three months ended March 31, 2012, we had a net increase in total deposits of $8,579,358 due to increases of $3,981,987 in non-interest demand deposits, $3,686,645 in money market accounts, $1,305,208 in NOW accounts, $274,122 in savings accounts and $126,894 in escrow deposits, partially offset by a decrease of $795,498 in time deposits. These are all what are commonly known as “retail” deposits that we obtain through the efforts of our branch network rather than “wholesale” deposits that some banks obtain from deposit brokers. We also received proceeds from repayment of investment securities of $9,100,838. We used $18,755,966 of available funds to purchase new investment securities and we had a net loan increase of $910,888. These changes resulted in an overall decrease in cash and cash equivalents of $1,735,480. Total cash and cash equivalents at March 31, 2012 were $46,372,193.

 

In contrast, during the three months ended March 31, 2011, we had a net increase in total deposits of $3,099,004 due to increases of $4,214,731 in non-interest demand deposits, $1,014,134 in savings accounts, $858,319 in time deposits, $679,458 in money market accounts and $101,374 in escrow deposits, partially offset by a decrease of $3,769,012 in NOW accounts. These were all retail deposits. We also received proceeds from repayment of investment securities of $9,431,300. We used $6,075,129 of available funds to purchase new investment securities and we had a net loan decrease of $1,667,929. These changes resulted in an overall increase in cash and cash equivalents of $8,895,760.

 

At March 31, 2012, cash and cash equivalents represented 18.5% of total assets. Our cash and cash equivalents decreased as we deployed more funds into investment securities and loans. We maintain a higher level of cash and cash equivalents to help buffer the adverse effects of potential, future rising interest rates. We anticipate, based upon historical experience that these funds, combined with cash inflows we anticipate from payments on our loan and investment securities portfolios, will be sufficient to fund loan growth and unanticipated deposit outflows. As noted above, the federal legal prohibition on paying interest on demand deposit accounts was repealed effective July 2011. Depending upon competitive pressures, we may need to implement interest-paying business checking in order to maintain demand deposits at historical levels or to increase such deposits.

 

As a secondary source of liquidity, at March 31, 2012 we had $117.9 million of investment securities classified available for sale. The disposition of these securities prior to maturity is an option available to us in the event, which we believe is unlikely, that our primary sources of liquidity and expected cash flows are insufficient to meet our need for funds. Additionally, we have the ability to borrow funds at the Federal Home Loan Bank of New York and the Federal Reserve Bank of New York using securities in our investment portfolio as collateral if the need arises. Based upon our assets size and the amount of our securities portfolio that qualifies as eligible collateral, we had more than $80.4 million of unused borrowing capability from the FHLBNY at March 31, 2012. Victory State Bank also has a $2 million unsecured credit facility with Atlantic Central Bankers Bank, which the Bank has not drawn upon. We do not anticipate a need for additional capital resources and do not expect to raise funds through a stock offering in the near future. We have sufficient resources to allow us to continue to make loans as appropriate opportunities arise without having to rely on government funds to support our lending activities.

 

Victory State Bank satisfied all capital ratio requirements of the Federal Deposit Insurance Corporation at March 31, 2012, with a Tier I Leverage Capital ratio of 10.44%, a Tier I Capital to Risk-Weighted Assets ratio of 25.97%, and a Total Capital to Risk-Weighted Assets ratio of 27.22%.

 

35
 

 

The following table sets forth our contractual obligations and commitments for future lease payments, time deposit maturities and loan commitments.

 

Contractual Obligations and Commitments at March 31, 2012

 

Contractual Obligations  Payment due by Period 
                     
   Less than   One to three   Four to five   After   Total Amounts 
   One Year   years   years   five years   committed 
                          
Minimum annual rental  payments under non-cancelable operating leases  $423,290   $794,095   $609,395   $706,366   $2,533,146 
Remaining contractual maturities of time                         
     deposits   58,497,912    2,296,592    4,304,534        65,099,038 
Total contractual cash obligations  $58,921,202   $3,090,687   $4,913,929   $706,366   $67,632,184 

 

Other commitments  Amount of commitment Expiration by Period 
                          
   Less than   One to three   Four to five   After   Total Amounts 
   One Year   years   years   five years   committed 
                          
 Loan commitments  $16,584,006   $5,230,981   $   $   $21,814,987 

 

Non-Performing Loans

 

Management closely monitors non-performing loans and other assets with potential problems on a regular basis. We had twenty one non-performing loans, totaling $7,161,236 at March 31, 2012, compared to twenty three non-performing loans, totaling $10,862,897 at December 31, 2011. Non-performing loans totaled 8.63% of total loans at March 31, 2012 compared to 13.23% at December 31, 2011. We have always followed a hands-on approach to dealing with our past due borrowers that we believe is sufficiently aggressive to maximize recovery.

 

As noted in the discussion below regarding specific loans, many of our non-performing loans are secured by real estate, and thus we expect substantial if not complete recovery of the loan amount. However, it is inevitable that we will experience some charge-offs of non-performing loans. All of the loans discussed individually below were evaluated separately for impairment under ASC 310 and we have included a component of our allowance for loan and lease losses representing our measurement of the impairment on those loans. However, the process by which we estimate the potential loss on those loans is necessarily imprecise and subject to changing future events, facts that may be unknown to us, and other uncertainties. Thus, although we believe that our allowance for loan losses is appropriate to address the weaknesses in those loans, we may be required to increase our provision for loan losses in the future if actual impairment exceeds our expectations.

 

The following is information about the eleven largest non-performing loans and the associated relationships, totaling $5,744,423, or 80.2% of our non-performing loans, by outstanding principal balance at March 31, 2012. Management believes it has taken appropriate steps with a view towards maximizing recovery and minimizing loss, if any, on these loans.

 

$1,460,398 in two commercial real estate loans and one co-op loan. The real estate loans are secured by a first mortgage and second mortgage on property in Staten Island and by a first mortgage on property in Queens. The real estate loans are guaranteed personally by the principals of the borrowers. The principal, and his wife, are personally obligated on the co-op loan. We have commenced collection and foreclosure proceedings.

 

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$1,374,198 in two commercial real estate loans. The loans, made to two individuals, are secured by a first mortgage and second mortgage on two pieces of real estate in Staten Island. The borrowers have signed a modified repayment agreement and confessions of judgment. The borrowers have been making payments as agreed since December 2011.
$1,000,713 in a commercial real estate loan. The loan is secured by a first mortgage on the property in Staten Island. The loan is guaranteed personally by the three principals. We have commenced foreclosure proceedings.
$737,614 in a commercial real estate loan. The loan is secured by a second mortgage on the property in Staten Island. The loan is secured by the personal guarantees of the principals. The borrower has signed a modified repayment agreement and we have held the previously commenced foreclosure action in abeyance as long as they perform under the terms of the modified repayment arrangement. After March 31, 2012 but before the filing of this report, we received a $125,000 upfront payment and the first monthly payment.
$672,500 in two commercial real estate loans and a construction loan to a local business. The loans are secured by a first, second and third mortgage on real estate collateral. The loans are guaranteed by the principal. We have commenced foreclosure proceedings. The borrower has entered into two contracts of sale for part of the mortgaged property. The sales have closed after March 31, 2012 but before the filing of this report and the loans have now been paid in full.
$499,000 in a commercial real estate loan on property in Staten Island that is leased to a restaurant. The loan is secured by a first mortgage on the property and a second mortgage on other commercial real estate collateral. The loan is also secured by the personal guaranties of the principals and we have a security interest in the business. We have commenced foreclosure proceedings.

 

From time to time, the Bank will enter into agreements with borrowers to modify the terms of their loans when we believe that a modification will maximize our recovery. In most cases, we do not agree to reduce the rate of interest or forgive the repayment of principal when we agree to the loan modification, and we did not do so in any of the modifications described above. Instead, we seek to modify terms on an interim basis to allow the borrower to reduce payments for a short duration and thus give the borrower an opportunity to get back on its feet. We prefer to develop repayment plans for our borrowers that provide them with cash flow relief while requiring that they ultimately pay all amounts that they owe. However, we are not averse to commencing legal action to foreclose on mortgages or obtain personal judgments against obligors when we perceive that as the appropriate strategy. Unfortunately, in recent years, many courts have taken a very pro-borrower stance in foreclosure actions, which has resulted in delays in our ability to realize upon real estate collateral.

 

If loans with modifications are on non-accrual status when they are modified, we do not immediately restore them to accruing status.  For those loans, as well as other loans on non-accrual status when the borrower makes payments, we initially record payments received either as a reduction of principal or as interest received on a cash basis. The choice between those alternatives depends upon the magnitude of the concessions, if any, we have given to the borrower, the nature of the collateral and the related loan to value ratio, and other factors affecting the likelihood that we will continue to receive regular payments.

 

Once a loan is categorized as a non-accrual loan, the loan may be restored to accruing status after a period of consistent on-time performance. The length of on-time performance required to restore a loan to accruing status varies from a minimum of six months on loans with minor modifications or less-severe weaknesses to as long as a year or more on loans for which we have granted more significant concessions to the borrower or which otherwise have more significant weaknesses.

 

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Critical Accounting Policies and Judgments

 

We are required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the amounts of revenues and expenses during the reporting period. The allowance for loan losses, prepayment estimates on the mortgage-backed securities and Collateralized Mortgage Obligation portfolios, contingencies and fair values of financial instruments are particularly subject to change and to management’s estimates. Actual results can differ from those estimates and may have an impact on our financial statements.

 

Item 4 –Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures: As of March 31, 2012, we undertook an evaluation of our disclosure controls and procedures under the supervision and with the participation of Raffaele M. Branca, President and CEO and Jonathan B. Lipschitz, Vice President and Controller. Disclosure controls are the systems and procedures we use that are designed to ensure that information we are required to disclose in the reports we file or submit under the Securities Exchange Act of 1934 (such as annual reports on Form 10-K and quarterly periodic reports on Form 10-Q) is recorded, processed, summarized and reported, in a manner which will allow senior management to make timely decisions on the public disclosure of that information. Mr. Branca and Mr. Lipschitz concluded that our current disclosure controls and procedures are effective in ensuring that such information is (i) collected and communicated to senior management in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Since our last evaluation of our disclosure controls, we have not made any significant changes in, or taken corrective actions regarding, either our internal controls or other factors that could significantly affect those controls.

 

We intend to continually review and evaluate the design and effectiveness of our disclosure controls and procedures and to correct any deficiencies that we may discover. Our goal is to ensure that senior management has timely access to all material financial and non-financial information concerning our business so that they can evaluate that information and make determinations as to the nature and timing of disclosure of that information. While we believe the present design of our disclosure controls and procedures is effective to achieve this goal, future events may cause us to modify our disclosure controls and procedures.

 

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Part II

 

Item 1 – Legal Proceedings

 

VSB Bancorp, Inc. is not involved in any pending legal proceedings. The Bank, from time to time, is involved in routine collection proceedings in the ordinary course of business on loans in default. Management believes that such other routine legal proceedings in the aggregate are immaterial to our financial condition or results of operations.

 

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Signature Page

 

In accordance with the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

  

    VSB Bancorp, Inc.
     
Date: May 11, 2012   /s/ Raffaele M. Branca
    Raffaele M. Branca
    President, CEO and Principal Executive Officer
     
Date: May 11, 2012   /s/ Jonathan B. Lipschitz
    Jonathan B. Lipschitz
    Vice President, Controller and Principal
    Accounting Officer

 

40
 

 

EXHIBIT INDEX

 

Exhibit    
Number   Description of Exhibit
31.1   Rule 13A-14(a)/15D-14(a) Certification of Chief Executive Officer
31.2   Rule 13A-14(a)/15D-14(a) Certification of Principal Accounting Officer
32.1   Certification by CEO pursuant to 18 U.S.C. 1350.
32.2   Certification by Principal Accounting Officer pursuant to 18 U.S.C. 1350.
101.INS   XBRL Instance Document (furnished herewith)
101.SCH   XBRL Taxonomy Extension Schema Document (furnished herewith)
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document (furnished herewith)
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document (furnished herewith)
101.LAB   XBRL Taxonomy Extension Label Linkbase Document (furnished herewith)
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document (furnished herewith)

--------------------------------------------

 

Item 6 - Exhibits

 

Exhibit    
Number   Description of Exhibit
31.1   Rule 13A-14(a)/15D-14(a) Certification of Chief Executive Officer
31.2   Rule 13A-14(a)/15D-14(a) Certification of Principal Accounting Officer
32.1   Certification by CEO pursuant to 18 U.S.C. 1350.
32.2   Certification by Principal Accounting Officer pursuant to 18 U.S.C. 1350.
101.INS   XBRL Instance Document (furnished herewith)
101.SCH   XBRL Taxonomy Extension Schema Document (furnished herewith)
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document (furnished herewith)
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document (furnished herewith)
101.LAB   XBRL Taxonomy Extension Label Linkbase Document (furnished herewith)
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document (furnished herewith)

  

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