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EX-31.2 - EXHIBIT 31.2 - Sound Financial Bancorp, Inc.exhibt312.htm
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EX-32 - EXHIBIT 32 - Sound Financial Bancorp, Inc.exhibit32.htm

 
 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2012

OR

[  ]           TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE EXCHANGE ACT

For the transition period from _______ to ________

Commission file number:    333-180385

SOUND FINANCIAL BANCORP, INC.
(Exact name of registrant as specified in its charter)

United States
 
45-5188530
(State or other jurisdiction of incorporation of organization)
 
(IRS Employer Identification No.)

2005 5th Avenue, Second Floor, Seattle, Washington 98121
(Address of principal executive offices)

(206) 448-0884
(Registrant’s telephone number)

None
(Former name, former address and former fiscal year, if changed since last report)


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 [X]  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 [X]   No [   ]

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

Large accelerated filer                Accelerated filer                Non-accelerated filer                Smaller reporting company    X   

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  YES [   ]    NO [ X ]
 
Indicate the number of shares outstanding of each issuer's classes of common stock, as of the latest practicable date:
 

 
As of August 13, 2012, there were no shares of the registrant’s common stock outstanding.


 
 

 
 
Explanatory Note:
 
Sound Financial Bancorp, Inc., a Maryland corporation (the “Registrant”), was organized to facilitate the “second-step” conversion of Sound Community Bank (the “Bank”) from the mutual holding company structure to the stock holding company structure (the “Conversion”).  The Conversion is expected to be consummated in the third quarter of 2012, at which time the Registrant will become the holding company for the Bank and will own all of the issued and outstanding shares of the Bank’s common stock.  As part of the Conversion, shares of the Registrant’s common stock will be issued and sold in an offering to certain depositors of the Bank and others and will also be issued in exchange for the currently issued and outstanding shares of Sound Financial, Inc., a federal corporation, the current mid-tier holding company for the Bank (“SFI”) held by persons other than Sound Community MHC (“MHC”).  The Registrant filed a registration statement on Form S-1 (File No. 333-180385) with the Securities and Exchange Commission (the “SEC”) on March 27, 2012, which was declared effective by the SEC on June 29, 2012.  The Conversion and related offering were conditionally approved by the Federal Reserve Board on June 29, 2012.  Completion of the Conversion and related offering is subject to, among other things, the receipt of final regulatory approvals and approval by SFI’s shareholders and the members of Sound Community Bank MHC.  The information in this Form 10-Q is for SFI; certain information contained within may not be relevant for the Registrant.  Separate financial statements for the Registrant have not been included in this report because the Registrant, which has not issued any shares and has engaged only in organizational activities to date, has no significant assets, contingent or other liabilities, equity, revenues or expenses.
 
The Board of Directors of Sound Community MHC (“MHC”), the Company and Sound Community Bank (the “Bank”) adopted a Plan of Conversion and Reorganization (the “Plan”) on January 27, 2012. Pursuant to the Plan, MHC will convert from the mutual holding company form of organization to a stock form of organization.  MHC will be merged into the Company, and MHC will no longer exist. Pursuant to the Plan, the Company, which owns 100% of the Bank, also will be succeeded by a new Maryland corporation, named Sound Financial Bancorp, Inc.  As part of the conversion, MHC’s ownership interest of the Company will be offered for sale in a public offering. The existing publicly held shares of the Company, which represents the remaining ownership interest in the Company, will be exchanged for new shares of common stock of Sound Financial Bancorp, Inc., the new Maryland corporation. The exchange ratio will ensure that immediately after the conversion and public offering, the public stockholders of the Company will own the same aggregate percentage of Sound Financial, Inc. common stock that they owned of the Company common stock immediately prior to that time. When the conversion and public offering are completed, all of the outstanding capital stock of the Bank will be owned by Sound Financial Bancorp, Inc. and all of the outstanding capital stock of Sound Financial Bancorp, Inc.  will be owned by the public.  The conversion and reorganization is expected to be completed by the third quarter of 2012, subject to the receipt of final regulatory approvals and approval by the Company’s shareholders and the members of MHC.
 
The Plan provides for the establishment, upon the completion of the reorganization, of special “liquidation accounts” at Sound Financial Bancorp, Inc.  and at the Bank for the benefit of certain depositors of the Bank in an amount equal to MHC’s ownership interest in the retained earnings of the Company as of the date of the latest balance sheet contained in the prospectus for the public offering. Following the completion of the reorganization, neither Sound Financial Bancorp, Inc.  nor the Bank, will be permitted to pay dividends on its capital stock to its stockholders, if stockholders’ equity would be reduced below the amount of its liquidation account.
 
Direct costs of the conversion and public offering will be deferred and reduce the proceeds from the shares sold in the public offering.  If the conversion and public offering are not completed, all costs will be charged to expense in the period in which the public offering is terminated.  As of June 30, 2012, the Bank had deferred $581,000 in costs related to the offering.
 

 
 

 
SOUND FINANCIAL, INC.
FORM 10-Q
TABLE OF CONTENTS

 
Page Number
PART I         FINANCIAL INFORMATION
 
 
Item 1.           Financial Statements
 
 
Condensed Consolidated Balance Sheets as of June 30, 2012 (unaudited) and December 31, 2011
 
3
Condensed Consolidated Statements of Income for the Three and Six Month Periods Ended June 30, 2012 and 2011 (unaudited)`
 
4
Condensed Consolidated Statements of Comprehensive Income for the Three and Six Month Periods Ended June 30, 2012 and 2011 (unaudited)
 
5
Condensed Consolidated Statement of Stockholders’ Equity for the Six Month Periods Ended June 30, 2012 and 2011(unaudited)
 
6
Condensed Consolidated Statements of Cash Flows for the Six Month Periods Ended June 30, 2012 and 2011 (unaudited)
 
7
Selected Notes to Condensed Consolidated Financial Statements
 
8
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
 
35
Item 3. Quantitative and Qualitative Disclosures About Market Risk
 
47
Item 4. Controls and Procedures
 
47
PART II       OTHER INFORMATION
 
 
Item 1. Legal Proceedings
 
48
Item 1A Risk Factors
 
48
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
 
48
Item 3. Defaults Upon Senior Securities
 
48
Item 4. Mine Safety Disclosures
 
48
Item 5. Other Information
 
48
Item 6. Exhibits
 
49
SIGNATURES
 
 
EXHIBITS
 


 
2

 


PART I        FINANCIAL INFORMATION
 
Financial Statements

SOUND FINANCIAL, INC AND SUBSIDIARY
 
Condensed Consolidated Balance Sheets
 
(Unaudited)
 
   
June 30,
   
December 31,
 
   
2012
   
2011
 
   
(Dollars in thousands)
 
ASSETS
           
Cash and cash equivalents
  $ 19,400     $ 17,031  
Available-for-sale securities, at fair value
    9,033       2,992  
Federal Home Loan Bank stock, at cost
    2,444       2,444  
Loans held for sale
    1,053       1,807  
Loans
    306,394       300,096  
Less allowance for loan losses
    (4,449 )     (4,455 )
Total loans, net
    301,945       295,641  
                 
Accrued interest receivable
    1,234       1,234  
Bank-owned life insurance, net
    7,099       6,981  
Mortgage servicing rights, at fair value
    2,558       2,437  
Other real estate owned and repossessed assets, net
    2,839       2,821  
Premises and equipment, net
    2,233       2,385  
Other assets
    5,234       3,967  
Total assets
  $ 355,072     $ 339,740  
                 
LIABILITIES
               
Deposits
               
Interest-bearing
    277,607       269,421  
Noninterest-bearing demand
    36,122       30,576  
Total deposits
    313,729       299,997  
                 
Borrowings
    8,185       8,506  
Accrued interest payable
    78       84  
Other liabilities
    2,778       2,149  
Advance payments from borrowers for taxes and insurance
    260       291  
Total liabilities
    325,030       311,027  
                 
COMMITMENTS AND CONTINGENCIES (NOTE 6)
               
                 
STOCKHOLDERS' EQUITY
               
Preferred stock, $0.01 par value, 1,000,000 shares authorized, none outstanding
    -       -  
Common stock, $0.01 par value, 24,000,000 shares authorized, 2,960,045 and 2,949,045 issued and outstanding as of June 30, 2012 and December 31, 2011, respectively
    30       30  
Additional paid-in capital
    12,005       11,939  
Unearned shares - Employee Stock Ownership Plan (“ESOP”)
    (693 )     (693 )
Retained earnings
    19,235       18,096  
Accumulated other comprehensive loss, net of tax
    (535 )     (659 )
Total stockholders’ equity
    30,042       28,713  
Total liabilities and stockholders’ equity
  $ 355,072     $ 339,740  

See notes to condensed consolidated financial statements

 
3

 

SOUND FINANCIAL, INC. AND SUBSIDIARY
                        Condensed Consolidated Statements of Income
               (Unaudited)
   
Three Months Ended
   
Six Months Ended
   
June 30,
   
June 30,
   
2012
   
2011
   
2012
   
2011
   
(Dollars in thousands, except per share amounts)
INTEREST INCOME
   
Loans, including fees
  $ 4,514     $ 4,645     $ 9,022     $ 9,232  
Interest and dividends on investments, cash and cash equivalents
    84       56       139       118  
Total interest income
    4,598       4,701       9,161       9,350  
                                 
INTEREST EXPENSE
                               
Deposits
    531       618       1,076       1,266  
Borrowings
    57       65       112       169  
Total interest expense
    588       683       1,188       1,435  
                                 
NET INTEREST INCOME
    4,010       4,018       7,973       7,915  
                                 
PROVISION FOR LOAN LOSSES
    1,100       1,225       2,600       2,050  
                                 
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
    2,910       2,793       5,373       5,865  
                                 
NONINTEREST INCOME
                               
Service charges and fee income
    513       476       1,064       999  
Earnings on cash surrender value of bank-owned life insurance
    52       66       118       128  
Mortgage servicing income
    21       123       199       207  
Fair value adjustment on mortgage servicing rights
    (76 )     208       308       257  
Loss on sale of securities
    -       -       -       (34 )
Other-than-temporary impairment losses on securities
    (32 )     -       (124 )     (39 )
Loss on sale of assets
    -       (80 )     -       (80 )
Gain on sale of loans
    308       102       559       137  
Total noninterest income
    786       895       2,124       1,575  
                                 
NONINTEREST EXPENSE
                               
Salaries and benefits
    1,423       1,287       2,705       2,753  
Operations
    728       598       1,310       1,266  
Regulatory assessments
    99       125       221       351  
Occupancy
    294       253       604       548  
Data processing
    262       228       505       467  
Losses and expenses on other real estate owned and repossessed assets
    22       545       492       684  
Total noninterest expense
    2,828       3,036       5,837       6,069  
                                 
INCOME BEFORE PROVISION FOR INCOME TAXES
    868       652       1,660       1,371  
                                 
PROVISION FOR INCOME TAXES
    275       198       520       421  
                                 
NET INCOME
  $ 593     $ 454     $ 1,139     $ 950  
                                 
BASIC EARNINGS PER SHARE
  $ 0.20     $ 0.16     $ 0.39     $ 0.33  
DILUTED EARNINGS PER SHARE
  $ 0.20     $ 0.16     $ 0.39     $ 0.33  

See notes to condensed consolidated financial statements

 
4

 

SOUND FINANCIAL, INC. AND SUBSIDIARY
 Condensed Consolidated Statements of Comprehensive Income
(Unaudited)


   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2012
   
2011
   
2012
   
2011
 
                   
Net income
  $ 593     $ 454     $ 1,139     $ 950  
Other comprehensive income, net of tax
                               
Unrealized holding gain on available for sale securities, net of
                               
taxes (benefit) of $(17), $(63), $22 and $5, respectively
    (33 )     (121 )     42       10  
Reclassification adjustments for realized losses on
                               
sales of securities, net of taxes of $0, $0, $0 and $12, respectively
    -       -       -       22  
Reclassification adjustments for other-than-temporary
                               
impairment on securities, net of taxes of $11, $0, $42 and $13, respectively
    21       -       82       26  
                                 
Other comprehensive income
  $ (12 )   $ (121 )   $ 124     $ 58  
                                 
Comprehensive income (loss)
  $ 581     $ 333     $ 1,263     $ 1,008  
                                 

See notes to condensed consolidated financial statements

 
5

 

SOUND FINANCIAL, INC. AND SUBSIDIARY
Condensed Consolidated Statement of Stockholders’ Equity
For the Six Months Ended June 30, 2012 and 2011
(unaudited)


   
Shares
   
Common Stock
   
Additional Paid-in Capital
   
Unearned
ESOP Shares
   
Retained Earnings
   
Accumulated Other Comprehensive Loss, net of tax
   
Total Stockholders’ Equity
 
   
(in thousands)
 
BALANCE, December 31, 2010
    2,954     $ 30     $ 11,808     $ (809 )   $ 16,545     $ (671 )   $ 26,903  
                                                         
Net income
                                    950               950  
                                                         
Net unrealized gain in fair value of available for sale securities, net of tax of $30
                                            58       58  
                                                         
Share-based compensation
                    66                               66  
                                                         
BALANCE, June 30, 2011
 
    2,954     $ 30     $ 11,874     $ (809 )   $ 17,495     $ (613 )   $ 27,977  
                                                         


   
Shares
   
Common Stock
   
Additional Paid-in Capital
   
Unearned
ESOP Shares
   
Retained Earnings
   
Accumulated Other Comprehensive Loss, net of tax
   
Total Stockholders’ Equity
 
   
(in thousands)
 
BALANCE, December 31, 2011
    2,949     $ 30     $ 11,939     $ (693 )   $ 18,096     $ (659 )   $ 28,713  
                                                         
Net income
                                    1,139               1,139  
                                                         
Net unrealized gain in fair value of available for sale securities, net of tax of $90
                                            124       124  
                                                         
Restricted stock awards
    11                                               -  
                                                         
Share-based compensation
                    66                               66  
                                                         
BALANCE, June 30, 2012
    2,960     $ 30     $ 12,005     $ (693 )   $ 19,235     $ (535 )   $ 30,042  
                                                         

See notes to condensed consolidated financial statements

 
6

 
SOUND FINANCIAL, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Cash Flows
(unaudited)
 
 
   
Six Months Ended June 30,
 
   
2012
   
2011
 
CASH FLOWS FROM OPERATING ACTIVITIES
     
Net income
  $ 1,139     $ 950  
Adjustments to reconcile net income to net cash from operating activities
               
Accretion of net premium on investments
    (9 )     -  
Loss on sale of available for sale securities
    -       34  
Other-than-temporary impairment losses on securities
    124       39  
Provision for loan losses
    2,600       2,050  
Depreciation and amortization
    180       196  
Compensation expense related to stock options and restricted stock
    66       66  
Fair value adjustment on mortgage servicing rights
    (308 )     (257 )
Additions to mortgage servicing rights
    (328 )     (216 )
Amortization of mortgage servicing rights
    515       399  
Increase in cash surrender value of bank owned life insurance
    (118 )     (128 )
Proceeds from sale of loans
    33,046       22,841  
Originations of loans held for sale
    (31,733 )     (22,194 )
Loss on sale of other real estate owned and repossessed assets
    169       395  
Loss on sale of fixed assets
    -       80  
Gain on sale of loans
    (559 )     (137 )
Change in operating assets and liabilities
               
Accrued interest receivable
    -       41  
Other assets
    (1,331 )     759  
Accrued interest payable
    (6 )     (45 )
Other liabilities
    629       (1,241 )
                 
Net cash provided by operating activities
    4,076       3,632  
                 
CASH FLOWS FROM INVESTING ACTIVITIES
               
Proceeds from principal payments, maturities and sales of available for sale securities
    263       1,263  
Purchase of available for sale securities
    (6,231 )     -  
Net increase in loans
    (10,583 )     (4,246 )
Improvements to other real estate owned (“OREO”) and other repossessed assets
    (358 )     (30 )
Proceeds from sale of OREO and other repossessed assets
    1,850       1,474  
Purchases of premises and equipment
    (28 )     702  
                 
Net cash used by investing activities
    (15,087 )     (837 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES
               
Net increase in deposits
    13,732       9,142  
Proceeds from borrowings
    -       51,700  
Repayment of borrowings
    (321 )     (57,721 )
Net change in advances from borrowers for taxes and insurance
    (31 )     (74 )
                 
Net cash provided by financing activities
    13,380       3,047  
                 
INCREASE IN CASH AND CASH EQUIVALENTS
    2,369       5,842  
                 
CASH AND CASH EQUIVALENTS, beginning of period
    17,031       9,092  
                 
CASH AND CASH EQUIVALENTS, end of period
  $ 19,400     $ 14,934  
                 
SUPPLEMENTAL CASH FLOW INFORMATION
               
Cash paid for income taxes
  $ 75     $ 1,125  
Interest paid on deposits and borrowings
  $ 1,194     $ 1,480  
Net transfer of loans to other real estate owned
  $ 1,679     $ 2,791  
See notes to condensed consolidated financial statements

 
7

 


SOUND FINANCIAL, INC. AND SUBSIDIARY
Selected Notes to Condensed Consolidated Financial Statement (unaudited)

Note 1 – Basis of Presentation

The accompanying financial information is unaudited and has been prepared from the consolidated financial statements of Sound Financial, Inc. (“we,” “us,” “our,” “Sound Financial,” or the “Company”) and its wholly owned subsidiary, Sound Community Bank (the “Bank”).  These unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission (“SEC”).  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the financial position and results of operations for the periods presented have been included.  Certain information and disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the rules and regulations of the SEC.  These unaudited financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the SEC.  The results for the interim periods are not necessarily indicative of results for a full year.  For further information, refer to the consolidated financial statements and footnotes for the year ended December 31, 2011, included in the Company's Annual Report on Form 10-K.

Certain amounts in the prior quarters’ financial statements have been reclassified to conform to the current presentation.  These classifications do not have an impact on previously reported net income, retained earnings or earnings per share.

Note 2 – Accounting Pronouncements Recently Issued or Adopted

 
In April 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-03, Reconsideration of Effective Control for Repurchase Agreements.  The ASU amends existing guidance to remove from the assessment of effective control, the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee and, as well, the collateral maintenance implementation guidance related to that criterion.  ASU No. 2011-03 is effective for the Company’s reporting period beginning on or after December 15, 2011.  The guidance applies prospectively to transactions or modification of existing transactions that occur on or after the effective date and early adoption is not permitted.  The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.
 

 
In April 2011, the FASB issued ASU No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.  The ASU amends existing guidance regarding the highest and best use and valuation premise by clarifying these concepts are only applicable to measuring the fair value of nonfinancial assets.  The ASU also clarifies that the fair value measurement of financial assets and financial liabilities which have offsetting market risks or counterparty credit risks that are managed on a portfolio basis, when several criteria are met, can be measured at the net risk position.  Additional disclosures about Level 3 fair value measurements are required including a quantitative disclosure of the unobservable inputs and assumptions used in the measurement, a description of the valuation process in place, and discussion of the sensitivity of fair value changes in unobservable inputs and interrelationships about those inputs as well disclosure of the level of the fair value of items that are not measured at fair value in the financial statements but disclosure of fair value is required. The provisions of ASU No. 2011-04 are effective for the Company’s reporting period beginning after December 15, 2011 and are applied prospectively.  The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.

 
8

 


SOUND FINANCIAL, INC. AND SUBSIDIARY
Selected Notes to Condensed Consolidated Financial Statement (unaudited)
 

 
In June 2011, the FASB issued ASU No. 2011-05, Presentation of Comprehensive Income.  The ASU amends current guidance to allow a company the option of presenting 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.  The provisions do not change the items that must be reported in other comprehensive income or when an item of other comprehensive must to reclassified to net income.  The amendments do not change the option for a company to present components of other comprehensive income either net of related tax effects or before related tax effects, with one amount shown for the aggregate income tax expense (benefit) related to the total of other comprehensive income items.  The amendments do not
 
affect how earnings per share is calculated or presented.  The provisions of ASU No. 2011-05 are effective for the Company’s reporting period beginning after December 15, 2011 and are applied retrospectively.  Early adoption was permitted and there are no required transition disclosures. In December 2011, the FASB issued ASU No. 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.  The ASU defers indefinitely the requirement to present reclassification adjustments and the effect of those reclassification adjustments on the face of the financial statements where net income is presented, by component of net income, and on the face of the financial statements where other comprehensive income is presented, by component of other comprehensive income.  The adoption of the ASUs did not have a material impact on the Company’s consolidated financial statements.
 
In September 2011, the FASB issued ASU No. 2011-08, Testing Goodwill for Impairment.  With the ASU, a company testing goodwill for impairment now has the option of performing a qualitative assessment before calculating the fair value of the reporting unit (the first step of goodwill impairment test).  If, on the basis of qualitative factors, the fair value of the reporting unit is more likely than not greater than the carrying amount, a quantitative calculation would not be needed.  Additionally, new examples of events and circumstances that an entity should consider in performing its qualitative assessment about whether to proceed to the first step of the goodwill impairment have been made to the guidance and replace the previous guidance for triggering events for interim impairment assessment.  The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011.  The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.
 

 
In December 2011, the FASB issued ASU No. 2011-11, Disclosures about Offsetting Assets and Liabilities.  The ASU requires an entity to offset, and present as a single net amount, a recognized eligible asset and a recognized eligible liability when it has an unconditional and legally enforceable right of setoff and intends either to settle the asset and liability on a net basis or to realize the asset and settle the liability simultaneously.  The ASU requires an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position.  The amendments are effective for annual and interim reporting periods beginning on or after January 1, 2013.  The Company is currently in the process of evaluating the ASU but does not expect it will have a material impact on the Company’s consolidated financial statements.

 
9

 

SOUND FINANCIAL, INC. AND SUBSIDIARY
Selected Notes to Condensed Consolidated Financial Statement (unaudited)
 

 
In December 2011, the FASB issued ASU No. 2011-12, Deferral of the Effective Date for Amendments to Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update 2011-05 (“ASU 2011-12”). This ASU defers only those changes in ASU 2011-05 that relate to the presentation of reclassification adjustments. ASU 2011-12 was issued in order to allow the FASB 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 FASB 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, the Company will continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before the issuance of ASU 2011-05. ASU 2011-12 was effective for the Company’s financial statements for annual and interim periods beginning after December 31, 2011, and was applied prospectively. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
 
 
In July 2012, the FASB issued ASU No. 2011-02, Testing Indefinite-Lived Intangible Assets for Impairment.  With the ASU, a company testing indefinite-lived intangibles for impairment now has the option to assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired.  If, after assessing the totality of events and circumstances, an entity concludes that it is not more likely than not that the indefinite-lived intangible asset is impaired, then the entity is not required to take further action.  However, if an entity concludes otherwise, then it is required to determine the fair value of the indefinite-lived intangible asset and perform the quantitative impairment test by comparing the fair value with the carrying amount in accordance with current guidance.  An entity also has the option to bypass the qualitative assessment for any indefinite-lived intangible asset in any period and proceed directly to performing the quantitative impairment test.  An entity will be able to resume performing the qualitative assessment in any subsequent period.  The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after September 15, 2012.  The Company is currently in the process of evaluating the ASU but does not expect it will have a material impact on the Company’s consolidated financial statements.

 
10

 


SOUND FINANCIAL, INC. AND SUBSIDIARY
Selected Notes to Condensed Consolidated Financial Statements (unaudited)

Note 3 – Investments
 
The amortized cost and fair value of our available for sale securities and the corresponding amounts of gross unrealized gains and losses were as follows:
 
         
Gross Unrealized
       
   
Amortized
Cost
   
Gains
   
Losses 1 Year
or Less
   
Losses Greater
Than 1 Year
   
Estimated Fair
Value
 
June 30, 2012
 
(in thousands)
 
Agency mortgage-backed securities
  $ 6,273     $ 6     $ (47 )   $ -     $ 6,232  
Non-agency mortgage-backed securities
    3,571       -       -       (770 )     2,801  
Total
  $ 9,844     $ 6     $ (47 )   $ (770 )   $ 9,033  
                                         
   
           
Gross Unrealized
         
   
Amortized
Cost
   
Gains
   
Losses 1 Year
or Less
   
Losses Greater
Than 1 Year
   
Estimated Fair
Value
 
December 31, 2011
 
(in thousands)
 
Agency mortgage-backed securities
  $ 53     $ 6     $ -     $ -     $ 59  
Non-agency mortgage-backed securities
    3,939       -       -       (1,006 )     2,933  
Total
  $ 3,992     $ 6     $ -     $ (1,006 )   $ 2,992  
                                         

The amortized cost and fair value of mortgage-backed securities by contractual maturity, at June 30, 2012, are shown below.  Expected maturities of mortgage-backed securities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

   
June 30, 2012
 
   
Amortized Cost
   
Fair Value
 
   
(in thousands)
 
Due after ten years
  $ 9,844     $ 9,033  

Securities with a carrying value of $58,000 at June 30, 2012 were pledged to secure Washington State Public Funds.  Additionally, the Company has letters of credit with a notional amount of $31.5 million to secure public deposits.

 
11

 


SOUND FINANCIAL, INC. AND SUBSIDIARY
Selected Notes to Condensed Consolidated Financial Statements (unaudited)
 

Sales of available for sale securities were as follows:

   
Six Months Ended June 30,
 
   
2012
   
2011
 
   
(in thousands)
 
Proceeds
  $ -     $ 1,118  
Gross gains
    -       3  
Gross losses
    -       (37 )

The following table summarizes the aggregate fair value and gross unrealized loss by length of time those investments have been continuously in an unrealized loss position:

   
June 30, 2012
 
   
Less Than 12 Months
   
12 Months or Longer
   
Total
 
   
Fair Value
   
Unrealized Loss
   
Fair Value
   
Unrealized Loss
   
Fair Value
   
Unrealized Loss
 
   
(in thousands)
 
Agency mortgage-backed securities
  $ 6,174     $ (47 )   $ -     $ -     $ 6,174     $ (47 )
Non-agency mortgage-backed securities
    -       -       2,801       (770 )     2,801       (770 )
Total
  $ 6,174     $ (47 )   $ 2,801     $ (770 )   $ 8,975     $ (817 )
                                                 
   
December 31, 2011
 
   
Less Than 12 Months
   
12 Months or Longer
   
Total
 
   
Fair Value
   
Unrealized Loss
   
Fair Value
   
Unrealized Loss
   
Fair Value
   
Unrealized Loss
 
   
(in thousands)
 
Non-agency mortgage-backed securities
  $ -     $ -     $ 2,933     $ (1,006 )   $ 2,933     $ (1,006 )
Total
  $ -     $ -     $ 2,933     $ (1,006 )   $ 2,933     $ (1,006 )


The following table presents the cumulative roll forward of credit losses recognized in earnings relating to the Company’s non-U.S. agency mortgage backed securities:
   
Six Months Ended
 
   
June 30,
 
   
2012
   
2011
 
   
(in thousands)
 
Estimated credit losses, beginning balance
  $ 347     $ 160  
Additions for credit losses not previously recognized
    124       39  
Reduction for increases in cash flows
    -       -  
Reduction for realized losses
    -       -  
Estimated losses, ending balance
  $ 471     $ 199  


 
12

 


SOUND FINANCIAL, INC. AND SUBSIDIARY
Selected Notes to Condensed Consolidated Financial Statements (unaudited)
 

As of June 30, 2012, our securities portfolio consisted of six U.S. agency and five non-U.S. agency mortgage backed securities with a fair value of $9.0 million, of which all five non-U.S. agency securities and four U.S. agency securities were in an unrealized loss position.  The unrealized losses were primarily caused by changes in interest rates and a lack of market liquidity causing a decline in the fair value subsequent to the purchase.  The contractual terms of these investments do not permit the issuer to settle the securities at a price less than par.  While management does not intend to sell the securities, and it is unlikely that the Company will be required to sell these securities before recovery of its amortized cost basis, management’s impairment evaluation indicates that certain securities possess qualitative and quantitative factors that suggest an other-than-temporary impairment (OTTI).  These factors include, but are not limited to: the length of time and extent of the fair value declines, ratings agency down grades, the potential for an increased level of actual defaults, and the extension in duration of the securities. In addition to the qualitative factors, management’s evaluation includes an assessment of quantitative evidence that involves the use of cash flow modeling and present value calculations as determined by considering the applicable OTTI accounting guidance.  The Company compares the present value of the current estimated cash flows to the present value of the previously estimated cash flows.  Accordingly, if the present value of the current estimated cash flows is less than the present value of the previous period’s present value, an adverse change is considered to exist and the security is considered OTTI.  The associated “credit loss” is the amount by which the security’s amortized cost exceeds the present value of the current estimated cash flows.  Based upon the results of the cash flow modeling as of June 30, 2012, four securities reflected OTTI during the six month period ended June 30, 2012.  Estimating the expected cash flows and determining the present values of the cash flows involves the use of a variety of assumptions and complex modeling.  In developing its assumptions, the Company considers all available information relevant to the collectability of the applicable security, including information about past events, current conditions, and reasonable and supportable forecasts.  Furthermore, the Company asserts that the cash flows used in the determination of OTTI are its “best estimate” of cash flows.

The Company engages a third party to assist management with modeling cash flows.  The model includes each individual non-agency mortgage backed securities’ structural features.  The modeled cash flows are discounted and they incorporate additional projected defaults based upon risk analysis of the financial condition and performance. Utilizing the quantitative change in the net present value of the cash flows compared to the amortized cost of the security, the Company recognized additional credit losses of $124,000 in non-cash pre-tax impairment charges for the six months ended June 30, 2012.  Cumulative at June 30, 2012, the Company has recognized a total of $471,000 of OTTI on four of the five non-agency mortgage backed securities.


 
13

 


SOUND FINANCIAL, INC. AND SUBSIDIARY
Selected Notes to Condensed Consolidated Financial Statements (unaudited)
 

Note 4 – Loans

The composition of the loan portfolio, including loans held for sale, is as follows:
 
   
June 30,
2012
   
December 31,
2011
 
   
(in thousands)
 
Real Estate Loans:
           
One-to four- family
  $ 95,657     $ 96,305  
Home equity
    38,175       39,656  
Commercial and multifamily
    111,804       106,016  
Construction and land
    20,564       17,805  
Total real estate loans
    266,200       259,782  
                 
Consumer loans:
               
Manufactured homes
    17,463       18,444  
Other consumer
    9,861       10,920  
Total consumer loans
    27,324       29,364  
                 
Commercial business loans
    14,556       13,163  
                 
Total loans
    308,080       302,309  
Deferred fees
    (633 )     (406 )
Loans held for sale
    (1,053 )     (1,807 )
Total loans, gross
    306,394       300,096  
Allowance for loan losses
    (4,449 )     (4,455 )
Total loans, net
  $ 301,945     $ 295,641  

 
14

 

SOUND FINANCIAL, INC. AND SUBSIDIARY
Selected Notes to Condensed Consolidated Financial Statements (unaudited)


The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of June 30, 2012:

   
One- to four- family
   
Home equity
   
Commercial and multifamily
   
Construction and land
   
Manufactured homes
   
Other consumer
   
Commercial business
   
Unallocated
   
Total
 
   
(In thousands)
 
Allowance for loan losses:
                             
Ending balance: individually evaluated for impairment
  $ 845     $ 212     $ 21     $ 75     $ 140     $ 60     $ 107     $ -     $ 1,460  
Ending balance: collectively evaluated for impairment
    831       1,000       626       106       196       113       108       9     $ 2,989  
Ending balance
  $ 1,676     $ 1,212     $ 647     $ 181     $ 336     $ 173     $ 215     $ 9     $ 4,449  
   
Loans receivable:
                                     
Ending balance: individually evaluated for impairment
  $ 7,511     $ 2,169     $ 2,218     $ 816     $ 772     $ 171     $ 966     $ -     $ 14,623  
Ending balance: collectively evaluated for impairment
    88,146       36,006       109,586       19,748       16,691       9,690       13,590       -       293,457  
Ending balance
  $ 95,657     $ 38,175     $ 111,804     $ 20,564     $ 17,463     $ 9,861     $ 14,556     $ -     $ 308,080  
                                                                         

 
15

 


 
SOUND FINANCIAL, INC. AND SUBSIDIARY
Selected Notes to Condensed Consolidated Financial Statements (unaudited)

 

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

 
   
One- to four- family
   
Home equity
   
Commercial and multifamily
   
Construction and land
   
Manufactured homes
   
Other consumer
   
Commercial business
   
Unallocated
   
Total
 
   
(In thousands)
                         
Allowance for loan losses:
                             
Ending balance: individually evaluated for impairment
  $ 541     $ 447     $ 38     $ 37     $ 11     $ 48     $ 132     $ -     $ 1,254  
Ending balance: collectively evaluated for impairment
    576       979       931       68       279       165       122       81       3,201  
Ending balance
  $ 1,117     $ 1,426     $ 969     $ 105     $ 290     $ 213     $ 254     $ 81     $ 4,455  
   
Loans receivable:
                                     
Ending balance: individually evaluated for impairment
  $ 8,260     $ 1,784     $ 2,003     $ 902     $ 122     $ 101     $ 447     $ -     $ 13,619  
Ending balance: collectively evaluated for impairment
    88,045       37,872       104,013       16,903       18,322       10,819       12,716       -       288,690  
Ending balance
  $ 96,305     $ 39,656     $ 106,016     $ 17,805     $ 18,444     $ 10,920     $ 13,163     $ -     $ 302,309  
                                                                         

 
16

 

SOUND FINANCIAL, INC. AND SUBSIDIARY
Selected Notes to Condensed Consolidated Financial Statements (unaudited)

 

 
The following table summarizes the activity in loan losses for the three months ended June 30, 2012:
 
   
Beginning
Allowance
   
Charge-offs
   
Recoveries
   
Provision
   
Ending
Allowance
 
   
(in thousands)
 
One-to four- family
  $ 1,582     $ (650 )   $ 4     $ 740     $ 1,676  
Home equity
    1,410       (20 )     130       (308 )     1,212  
Commercial and multifamily
    508       (503 )     83       559       647  
Construction and land
    66       (4 )     -       119       181  
Manufactured homes
    377       (32 )     -       (9 )     336  
Other consumer
    142       (27 )     9       49       173  
Commercial business
    234       (1 )     10       (28 )     215  
Unallocated
    31       -       -       (22 )     9  
    $ 4,350     $ (1,237 )   $ 236     $ 1,100     $ 4,449  

The following table summarizes the activity in loan losses for the six months ended June 30, 2012:
 
   
Beginning
Allowance
   
Charge-offs
   
Recoveries
   
Provision
   
Ending
Allowance
 
   
(in thousands)
 
One-to four- family
  $ 1,117     $ (1,399 )   $ 4     $ 1,954     $ 1,676  
Home equity
    1,426       (735 )     132       389       1,212  
Commercial and multifamily
    969       (503 )     83       98       647  
Construction and land
    105       (41 )     -       117       181  
Manufactured homes
    290       (60 )     -       106       336  
Other consumer
    213       (106 )     16       50       173  
Commercial business
    254       (7 )     10       (42 )     215  
Unallocated
    81       -       -       (72 )     9  
    $ 4,455     $ (2,851 )   $ 245     $ 2,600     $ 4,449  

The following table summarizes the activity in loan losses for the three months ended June 30, 2011:

   
Beginning
Allowance
   
Charge-offs
   
Recoveries
   
Provision
   
Ending
Allowance
 
   
(in thousands)
 
One-to four- family
  $ 863     $ (290 )   $ -     $ 254     $ 827  
Home equity
    1,405       (360 )     -       560       1,605  
Commercial and multifamily
    1,300       (434 )     18       329       1,213  
Manufactured
    287       (100 )     29       86       273  
Other consumer
    197       (132 )     -       114       208  
Commercial business
    209       (9 )     -       (28 )     172  
Unallocated
    155       -       -       (90 )     65  
    $ 4,416     $ (1,325 )   $ 47     $ 1,225     $ 4,363  



 
17

 


SOUND FINANCIAL, INC. AND SUBSIDIARY
Selected Notes to Condensed Consolidated Financial Statements (unaudited)


The following table summarizes the activity in loan losses for the six months ended June 30, 2011:

   
Beginning
Allowance
   
Charge-offs
   
Recoveries
   
Provision
   
Ending
Allowance
 
   
(in thousands)
 
One-to four- family
  $ 909     $ (533 )   $ 12     $ 439     $ 827  
Home equity
    1,480       (792 )     6       911       1,605  
Commercial and multifamily
    664       (504 )     18       1,035       1,213  
Manufactured
    294       (201 )     -       180       273  
Other consumer
    309       (162 )     40       21       208  
Commercial business
    163       (8 )     1       16       172  
Unallocated
    617       -       -       (552 )     65  
    $ 4,436     $ (2,200 )   $ 77     $ 2,050     $ 4,363  

 
Credit Quality Indicators.  Federal regulations provide for the classification of lower quality loans and other assets, such as debt and equity securities, as substandard, doubtful or loss.  An asset is considered substandard if it is inadequately protected by the current net worth and payment capacity of the borrower or of any collateral pledged.  Substandard assets include those characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected.  Assets classified as doubtful have all the weaknesses of currently existing facts, conditions and values.  Assets classified as loss are those considered uncollectible and of such little value that their continuance as assets without establishment of a specific loss reserve is not warranted.
 
When we classify problem assets as either substandard or doubtful, we may establish a specific allowance in an amount we deem prudent to address the risk specifically or we may allow the loss to be addressed in the general allowance.  General allowances represent loss reserves which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been specifically allocated to particular problem assets.  When an insured institution classifies problem assets as a loss, it is required to charge off such assets in the period in which they are deemed uncollectible.  Assets that do not currently expose us to sufficient risk to warrant classification as substandard or doubtful but possess identified weaknesses are required to be classified as either watch or special mention assets.  Our determination as to the classification of our assets and the amount of our valuation allowances is subject to review by the OCC, which can order the establishment of additional loss allowances.
 
Early indicator loan grades are used to identify and track potential problem loans which do not rise to the levels described for substandard, doubtful or loss.  The grades for watch and special mention are assigned to loans which have been criticized based upon known characteristics such as periodic payment delinquency or stale financial information from the borrower and/or guarantors.  Loans identified as criticized (watch and special mention) or classified (substandard, doubtful or loss) are subject to monthly problem loan reporting.
 

 
18

 


SOUND FINANCIAL, INC. AND SUBSIDIARY
Selected Notes to Condensed Consolidated Financial Statements (unaudited)

 
The following table represents the internally assigned grades as of June 30, 2012 by type of loan:
 
   
One-to four- family
   
Home equity
   
Commercial and multifamily
   
Construction and
land
   
Manufactured homes
   
Other consumer
   
Commercial Business
   
Total
 
Grade:
 
(in thousands)
 
Pass
  $ 76,053     $ 30,292     $ 105,903     $ 19,092     $ 14,934     $ 8,689     $ 11,854     $ 266,817  
Watch
    15,497       6,447       3,866       759       2,452       1,064       2,141       32,226  
Special Mention
    499       506       600       -       53       -       -       1,658  
Substandard
    3,608       930       1,435       713       24       108       561       7,379  
Doubtful
    -       -       -       -       -       -       -       -  
Loss
    -       -       -       -       -       -       -       -  
Total
  $ 95,657     $ 38,175     $ 111,804     $ 20,564     $ 17,463     $ 9,861     $ 14,556     $ 308,080  

 

 
The following table represents the internally assigned grades as of December 31, 2011 by type of loan:
 

 
   
One-to four- family
   
Home equity
   
Commercial and multifamily
   
Construction and land
   
Manufactured homes
   
Other consumer
   
Commercial Business
   
Total
 
Grade:
 
(in thousands)
 
Pass
  $ 70,392     $ 31,943     $ 100,002     $ 16,087     $ 16,062     $ 9,507     $ 10,331     $ 254,324  
Watch
    18,088       6,138       4,048       778       2,260       1,312       2,385       35,009  
Special Mention
    1,505       183       -       -       -       4       11       1,703  
Substandard
    6,320       1,392       1,966       940       122       97       436       11,273  
Doubtful
    -       -       -       -       -       -       -       -  
Loss
    -       -       -       -       -       -       -       -  
Total
  $ 96,305     $ 39,656     $ 106,016     $ 17,805     $ 18,444     $ 10,920     $ 13,163     $ 302,309  

 

 
Nonaccrual and Past Due Loans.  Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due.  Loans are automatically placed on nonaccrual once the loan is 90 days past due or if, in management’s opinion, the borrower may be unable to meet payment of obligations as they become due, as well as when required by regulatory provisions.
 

 
The following table presents the recorded investment in nonaccrual loans as of June 30, 2012 and December 31, 2011 by type of loan:
 
   
June 30,
 2012
   
December 31,
 2011
 
   
(in thousands)
 
One- to four- family
  $ 1,918     $ 3,124  
Home equity
    623       731  
Commercial and multifamily
    1,189       1,299  
Other consumer
    100       64  
Total
  $ 3,830     $ 5,218  

 

 
19

 


SOUND FINANCIAL, INC. AND SUBSIDIARY
Selected Notes to Condensed Consolidated Financial Statements (unaudited)

 

 
The following table represents the aging of the recorded investment in past due loans as of June 30, 2012 by type of loan:
 
   
30-59 Days Past Due
   
60-89 Days Past Due
   
Greater Than 90 Days Past Due
   
Recorded Investment > 90 Days and Accruing
   
Total Past Due
   
Current
   
Total Loans
 
   
(in thousands)
 
One- to four- family
  $ -     $ 395     $ 2,896     $ -     $ 3,291     $ 92,366