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 JUNE 30, 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 1,775,809 common shares outstanding as of August 9, 2012.
CROSS REFERENCE INDEX
PART I
| 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 |
See notes to consolidated financial statements.
| 4 |
See notes to consolidated financial statements.
| 5 |
See notes to consolidated financial statements.
| 6 |
See notes to consolidated financial statements.
| 7 |
See notes to consolidated financial statements.
| 8 |
VSB BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 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 June 28, 2012 through July 11, 2012, Victory State Bank was required to maintain reserves, after deducting vault cash, of $3,935,000. 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.
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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 1,746,917 shares and 1,768,485 shares, the weighted average number of common shares outstanding for the three months ended June 30, 2012 and 2011, respectively. Diluted net income per share of common stock is based on 1,746,917 and 1,770,836, the weighted average number of common shares outstanding plus potentially dilutive common shares for the three months ended June 30, 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 47,132 and 28,223 shares for the three months ended June 30, 2012 and 2011, respectively. Common stock equivalents were calculated using the treasury stock method.
Basic net income per share of common stock is based on 1,746,200 shares and 1,765,138 shares, the weighted average number of common shares outstanding for the six months ended June 30, 2012 and 2011, respectively. Diluted net income per share of common stock is based on 1,746,200 and 1,767,043, the weighted average number of common shares outstanding plus potentially dilutive common shares for the six months ended June 30, 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 48,759 and 29,413 shares for the six months ended June 30, 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 and six months ended June 30, are as follows:
| Reconciliation of EPS | ||||||||
| Three months ended | Three months ended | |||||||
| June 30, 2012 | June 30, 2011 | |||||||
| Basic | ||||||||
| Distributed earnings allocated to common stock | $ | 104,815 | $ | 106,109 | ||||
| Undistributed earnings allocated to common sock | 262,038 | 314,243 | ||||||
| Net earnings allocated to common stock | $ | 366,853 | $ | 420,352 | ||||
| Weighted common shares outstanding including participating securities | 1,770,746 | 1,799,414 | ||||||
| Less: Participating securities | (23,829 | ) | (30,929 | ) | ||||
| Weighted average shares | 1,746,917 | 1,768,485 | ||||||
| Basic EPS | $ | 0.21 | $ | 0.24 | ||||
| Diluted | ||||||||
| Net earnings allocated to common stock | $ | 366,853 | $ | 420,352 | ||||
| Weighted average shares for basic | 1,746,917 | 1,768,485 | ||||||
| Dilutive effects of: | ||||||||
| Stock Options | — | 2,351 | ||||||
| Unvested shares not considered particpating securtities | — | — | ||||||
| 1,746,917 | 1,770,836 | |||||||
| Diluted EPS | $ | 0.21 | $ | 0.24 | ||||
| 12 |
| Reconciliation of EPS | ||||||||
| Six months ended | Six months ended | |||||||
| June 30, 2012 | June 30, 2011 | |||||||
| Basic | ||||||||
| Distributed earnings allocated to common stock | $ | 209,544 | $ | 211,817 | ||||
| Undistributed earnings allocated to common sock | 434,312 | 631,810 | ||||||
| Net earnings allocated to common stock | $ | 643,856 | $ | 843,627 | ||||
| Weighted common shares outstanding including participating securities | 1,772,314 | 1,798,340 | ||||||
| Less: Participating securities | (26,114 | ) | (33,202 | ) | ||||
| Weighted average shares | 1,746,200 | 1,765,138 | ||||||
| Basic EPS | $ | 0.37 | $ | 0.48 | ||||
| Diluted | ||||||||
| Net earnings allocated to common stock | $ | 643,856 | $ | 843,627 | ||||
| Weighted average shares for basic | 1,746,200 | 1,765,138 | ||||||
| Dilutive effects of: | ||||||||
| Stock Options | — | 1,905 | ||||||
| Unvested shares not considered particpating securtities | — | — | ||||||
| 1,746,200 | 1,767,043 | |||||||
| Diluted EPS | $ | 0.37 | $ | 0.48 | ||||
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.
Stock Repurchase Programs – On 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 June 30, 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.
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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 April 27, 2012, an additional 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 six months ended June 30, 2012, the Company recognized $40,371 of compensation expense related to the shares awarded. The income tax benefit resulting from this expense was $18,469. As of June 30, 2012, there was approximately $212,924 of unrecognized compensation costs related to the shares awarded. These costs are expected to be recognized over the next 2.75 years.
A summary of the status of the Company’s non-vested plan shares as of June 30, 2012 is as follows:
| For the Six Months Ended June 30, 2012: | ||||||||
| Weighted Average | ||||||||
| Shares | Grant Date Share Value | |||||||
| Non vested at beginning of period | 28,400 | $ | 11.46 | |||||
| Granted | — | |||||||
| Vested | 6,400 | $ | — | |||||
| Non vested at end of period | 22,000 | $ | 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.
Recently-Adopted Accounting Standards - 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.
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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 June 30, 2012 and December 31, 2011 and the corresponding amounts of unrealized gains and losses herein:
| June 30, 2012 | ||||||||||||||||
| Amortized | Unrealized | Unrealized | Fair | |||||||||||||
| Cost | Gains | Losses | Value | |||||||||||||
| FNMA MBS - Residential | $ | 29,907,116 | $ | 370,302 | $ | (6,416 | ) | $ | 30,271,002 | |||||||
| GNMA MBS - Residential | 5,882,061 | 113,246 | — | 5,995,307 | ||||||||||||
| Whole Loan MBS - Residential | 608,638 | 17,396 | — | 626,034 | ||||||||||||
| Collateralized mortgage obligations | 78,224,532 | 2,051,281 | — | 80,275,813 | ||||||||||||
| $ | 114,622,347 | $ | 2,552,225 | $ | (6,416 | ) | $ | 117,168,156 | ||||||||
| 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 six months ended June 30, 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.
| June 30, 2012 | ||||||||
| Amortized | Fair | |||||||
| Cost | Value | |||||||
| Less than one year | $ | — | $ | — | ||||
| Due after one year through five years | 14,294,445 | 14,472,104 | ||||||
| Due after five years through ten years | 27,349,149 | 27,949,924 | ||||||
| Due after ten years | 72,978,753 | 74,746,128 | ||||||
| $ | 114,622,347 | $ | 117,168,156 | |||||
| 15 |
The following table summarizes the investment securities with unrealized losses at June 30, 2012 and December 31, 2011 by aggregated major security type and length of time in a continuous unrealized loss position:
| June 30, 2012 | Less than 12 months | More than 12 months | Total | |||||||||||||||||||||
| Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
| Value | Loss | Value | Loss | Value | Loss | |||||||||||||||||||
| FNMA MBS | $ | 3,898,747 | $ | (6,416 | ) | $ | — | $ | — | $ | 3,898,747 | $ | (6,416 | ) | ||||||||||
| GNMA MBS | — | — | — | — | — | — | ||||||||||||||||||
| Whole Loan MBS | — | — | — | — | — | — | ||||||||||||||||||
| Collateralized mortgage obligations | — | — | — | — | — | — | ||||||||||||||||||
| $ | 3,898,747 | $ | (6,416 | ) | $ | — | $ | — | $ | 3,898,747 | $ | (6,416 | ) | |||||||||||
| 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 June 30, 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 June 30, 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 $57,523,315 and $55,080,059 at June 30, 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 MEASUREMENTS |
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.
| 16 |
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.
The carrying amounts and estimated fair values of financial instruments, at June 30, 2012 and December 31, 2011 are as follows:
| Fair Value Measurements at June 30, 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 | $ | 46,173,650 | $ | 4,143,985 | $ | 42,029,665 | $ | — | $ | 46,173,650 | ||||||||||
| Investment securities, available for sale | 117,168,156 | — | 117,168,156 | — | 117,168,156 | |||||||||||||||
| Loans receivable | 84,329,024 | — | — | 85,031,955 | 85,031,955 | |||||||||||||||
| Accrued interest receivable | 558,568 | — | 304,086 | 254,482 | 558,568 | |||||||||||||||
| Total Financial Assets | $ | 248,229,398 | $ | 4,143,985 | $ | 159,501,907 | $ | 85,286,437 | $ | 248,932,329 | ||||||||||
| Financial Liabilities: | ||||||||||||||||||||
| Deposits | $ | 223,728,853 | $ | 75,166,728 | $ | 148,558,737 | $ | — | $ | 223,725,465 | ||||||||||
| Accrued interest payable | 9,824 | — | 9,824 | — | 9,824 | |||||||||||||||
| Total Financial Liabilities | $ | 223,738,677 | $ | 75,166,728 | $ | 148,568,561 | $ | — | $ | 223,735,289 | ||||||||||
| 17 |
| 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 and 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).
| Fair Value Measurements at June 30, 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 | $ | 30,271,002 | $ | — | $ | 30,271,002 | $ | — | ||||||||
| GNMA MBS - Residential | 5,995,307 | — | 5,995,307 | — | ||||||||||||
| Whole Loan MBS- Residential | 626,034 | — | 626,034 | — | ||||||||||||
| Collateralized mortgage obligations | 80,275,813 | — | 80,275,813 | — | ||||||||||||
| Total Available for sale Securities | $ | 117,168,156 | $ | — | $ | 117,168,156 | $ | — | ||||||||
| 18 |
| 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 June 30, 2012.
| 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 $348,321. | |||||||
| Fair Value Measurements at June 30, 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 | $ | 1,323,144 | — | — | $ | 1,323,144 | ||||||||||
| Other real estate owned | 348,321 | — | — | 348,321 | ||||||||||||
| 19 |
| 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 June 30, 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 $1,776,829, with a valuation allowance of $453,685 at that date. The valuation allowance increased $107,590 from December 31, 2011 to June 30, 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.
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 June 30, 2012.
| Fair | Valuation | Unobservable | |||||||
| Value | Techniques | Inputs | Range | ||||||
| Impaired loans- | |||||||||
| Commercial real estate | $ | 604,163 | Third Party Appraisal | Discount adjustment for differences in various costs. | 0.01% | ||||
| 87,876 | Third Party Appraisal | Adjustments for differences between comparable sales. | 2.7%-12.6% | ||||||
| 189,406 | Third Party Appraisal | Adjustments for differences in net operating income expectations | 10% - 27% | ||||||
| 441,699 | Third Party Appraisal | Adjustments for differences in net operating income expectations | 0%-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% | ||||||||
| Other real estate owned - residential | 81,075 | Third Party Appraisal | Adjustments for differences between comparable sales | 2% - 6% | |||||
| 20 |
| 5. | LOANS RECEIVABLE, NET |
Loans receivable, net at June 30, 2012 and December 31, 2011 are summarized as follows:
| June 30, | December 31, | |||||||
| 2012 | 2011 | |||||||
| Commercial loans (principally variable rate): | ||||||||
| Secured | $ | 1,681,827 | $ | 1,522,639 | ||||
| Unsecured | 15,103,446 | 12,997,139 | ||||||
| Total commercial loans | 16,785,273 | 14,519,778 | ||||||
| Real estate loans: | ||||||||
| Commercial | 60,837,471 | 59,376,008 | ||||||
| Residential | 2,303,786 | 2,309,899 | ||||||
| Total real estate loans | 63,141,257 | 61,685,907 | ||||||
| Construction loans (net of undisbursed funds of $2,419,500 and $2,215,000, respectively) | 4,822,483 | 4,610,000 | ||||||
| Consumer loans | 561,964 | 602,144 | ||||||
| Other loans | 832,849 | 717,261 | ||||||
| 1,394,813 | 1,319,405 | |||||||
| Total loans receivable | 86,143,826 | 82,135,090 | ||||||
| Less: | ||||||||
| Unearned loans fees, net | (232,405 | ) | (224,100 | ) | ||||
| Allowance for loan losses | (1,582,397 | ) | (1,343,020 | ) | ||||
| Total | $ | 84,329,024 | $ | 80,567,970 | ||||
Nonaccrual loans outstanding at June 30, 2012 and December 31, 2011 are summarized as follows:
| June 30, | December 31, | |||||||
| 2012 | 2011 | |||||||
| Nonaccrual loans: | ||||||||
| Commercial real estate | $ | 6,222,592 | $ | 8,265,397 | ||||
| Residential real estate | — | 2,200,000 | ||||||
| Construction | — | 397,500 | ||||||
| Total nonaccrual loans | $ | 6,222,592 | $ | 10,862,897 | ||||
| June 30, | December 31, | |||||||
| 2012 | 2011 | |||||||
| Interest income that would have been recorded during the period on nonaccrual loans outstanding in accordance with original terms | $ | 238,373 | $ | 595,946 | ||||
At June 30, 2012 and December 31, 2011, there were no loans 90 days past due and still accruing interest.
| 21 |
The following table presents the aging of the past due loan balances as of June 30, 2012 and December 31, 2011 by class of loans:
| June 30, 2012 | 30-59 | 60-89 | Greater than 90 | Loans | ||||||||||||||||||||
| Days | Days | Days | Total | Not | ||||||||||||||||||||
| Total | Past Due | Past Due | Past Due | Past Due | Past Due | |||||||||||||||||||
| Commercial loans: | ||||||||||||||||||||||||
| Unsecured | $ | 15,103,446 | $ | 2,882 | $ | — | $ | — | $ | 2,882 | $ | 15,100,564 | ||||||||||||
| Secured | 1,681,827 | 3,616 | — | — | 3,616 | 1,678,211 | ||||||||||||||||||
| Real Estate loans | ||||||||||||||||||||||||
| Commercial | 60,837,471 | 77,500 | 49,900 | 6,222,592 | 6,349,992 | 54,487,479 | ||||||||||||||||||
| Residential | 2,303,786 | — | — | — | — | 2,303,786 | ||||||||||||||||||
| Construction loans | 4,822,483 | — | — | — | — | 4,822,483 | ||||||||||||||||||
| Consumer loans | 561,964 | 6,121 | 257 | — | 6,378 | 555,586 | ||||||||||||||||||
| Other loans | 832,849 | — | — | — | — | 832,849 | ||||||||||||||||||
| Total loans | $ | 86,143,826 | $ | 90,119 | $ | 50,157 | $ | 6,222,592 | $ | 6,362,868 | $ | 79,780,958 | ||||||||||||
| December 31, 2011 | 30-59 | 60-89 | Greater than 90 | Loans | ||||||||||||||||||||
| Days | Days | Days | Total | 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 | ||||||||||||
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:
| June 30, | December 31, | |||||||
| 2012 | 2011 | |||||||
| Loans with no allocated allowance for loan losses: | ||||||||
| Commercial real estate | $ | 4,212,383 | $ | 6,662,331 | ||||
| Construction | — | 397,500 | ||||||
| Residential real estate | — | 2,200,000 | ||||||
| Loans with allocated allowance for loan losses: | ||||||||
| Commercial real estate | 1,776,829 | 1,350,374 | ||||||
| $ | 5,989,212 | $ | 10,610,205 | |||||
| Amount of the allowance for loan losses allocated: | ||||||||
| Commercial real estate | $ | 453,685 | $ | 346,095 | ||||
| $ | 453,685 | $ | 346,095 | |||||
| 22 |
The following table sets forth certain information about impaired loans with a measured impairment:
| Three Months | Six Months | |||||||
| Ended | Ended | |||||||
| June 30, | June 30, | |||||||
| 2012 | 2012 | |||||||
| Average of individually impaired loans during period: | ||||||||
| Commercial real estate | $ | 6,209,432 | $ | 6,972,044 | ||||
| Construction | — | 198,750 | ||||||
| Residential real estate | — | 733,333 | ||||||
| $ | 6,209,432 | $ | 7,904,127 | |||||
| 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 $32,905 and $3,412 of specific reserves to customers whose loan terms have been modified in trouble debt restructurings (“TDRs”) as of June 30, 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 June 30, 2012 was $4,803,810 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.
The terms of certain other loans were modified during the six months ended June 30, 2012 that did not meet the definition of a TDR. These loans have a total recorded investment as of June 30, 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 six months ending June 30, 2012:
| Pre-Modification | Post-Modification | |||||||||||
| Number | Outstanding Recorded | Outstanding Recorded | ||||||||||
| of Loans | Investment | Investment | ||||||||||
| Troubled Debt Restructurings: | ||||||||||||
| Commerical real estate | 3 | $ | 2,011,459 | $ | 2,011,459 | |||||||
| 23 |
The troubled debt restructurings described above did not require an additional allowance during the period ending June 30, 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.
The following table sets forth at June 30, 2012 and December 31, 2011, the aggregate carrying value of our assets categorized as Special Mention, Substandard and Doubtful according to asset type:
| At June 30, 2012 | ||||||||||||||||||||
| Special | Not | |||||||||||||||||||
| Mention | Substandard | Doubtful | Classified | Total | ||||||||||||||||
| Commercial Loans: | ||||||||||||||||||||
| Secured | $ | — | $ | — | $ | — | $ | 1,681,827 | $ | 1,681,827 | ||||||||||
| Unsecured | 36,788 | 28,890 | — | 15,037,768 | 15,103,446 | |||||||||||||||
| Commercial Real Estate | 5,895,285 | 6,730,149 | — | 48,212,037 | 60,837,471 | |||||||||||||||
| Residential Real Estate | — | 2,196,705 | — | 107,081 | 2,303,786 | |||||||||||||||
| Construction | — | — | — | 4,822,483 | 4,822,483 | |||||||||||||||
| Consumer | 7,943 | — | — | 554,021 | 561,964 | |||||||||||||||
| Other | 4,458 | — | — | 828,391 | 832,849 | |||||||||||||||
| Total loans | $ | 5,944,474 | $ | 8,955,744 | $ | — | $ | 71,243,608 | $ | 86,143,826 | ||||||||||
| Real estate owned | — | 348,321 | — | — | 348,321 | |||||||||||||||
| Total assets | $ | 5,944,474 | $ | 9,304,065 | $ | — | $ | 71,243,608 | $ | 86,492,147 | ||||||||||
| 24 |
| 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 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 June 30, 2012 and December 31, 2011:
| June 30, 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 | $ | 2,889 | $ | — | $ | — | $ | 465,105 | $ | — | $ | — | $ | 467,994 | ||||||||||||||
| Collectively evaluated for impairment | 544,732 | 13,678 | 37,186 | 465,778 | 2,190 | 50,839 | 1,114,403 | |||||||||||||||||||||
| Total ending allowance balance | $ | 547,621 | $ | 13,678 | $ | 37,186 | $ | 930,883 | $ | 2,190 | $ | 50,839 | $ | 1,582,397 | ||||||||||||||
| Loans: | ||||||||||||||||||||||||||||
| Individually evaluated for impairment | $ | 28,890 | $ | — | $ | — | $ | 6,730,149 | $ | 2,196,705 | $ | — | $ | 8,955,744 | ||||||||||||||
| Collectively evaluated for impairment | 15,074,556 | 1,681,827 | 4,822,483 | 54,107,322 | 107,081 | 1,394,813 | 77,188,082 | |||||||||||||||||||||
| Total ending loans balance | $ | 15,103,446 | $ | 1,681,827 | $ | 4,822,483 | $ | 60,837,471 | $ | 2,303,786 | $ | 1,394,813 | $ | 86,143,826 | ||||||||||||||
| 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 and six months ended June 30, 2012 and June 30, 2011.
| Three months ended June 30, 2012 | ||||||||||||||||||||||||||||
| Commercial | Commercial | Commerical | Residential Real | Other | ||||||||||||||||||||||||
| Unsecured | Secured | Construction | Real Estate | Estate | Loans | Total | ||||||||||||||||||||||
| Allowance for loan losses: | ||||||||||||||||||||||||||||
| Beginning balance | $ | 501,779 | $ | 13,650 | $ | 40,687 | $ | 836,141 | $ | 4,042 | $ | 45,614 | $ | 1,441,913 | ||||||||||||||
| Provision for loan losses | (18,576 | ) | 28 | (3,501 | ) | 111,417 | (29,493 | ) | 5,125 | 65,000 | ||||||||||||||||||
| Loans charged-off | — | — | — | (16,675 | ) | — | — | (16,675 | ) | |||||||||||||||||||
| Recoveries | 64,418 | — | — | — | 27,641 | 100 | 92,159 | |||||||||||||||||||||
| Total ending allowance balance | $ | 547,621 | $ | 13,678 | $ | 37,186 | $ | 930,883 | $ | 2,190 | $ | 50,839 | $ | 1,582,397 | ||||||||||||||
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| Three months ended June 30, 2011 | ||||||||||||||||||||||||||||
| Commercial | Commercial | Commerical | Residential Real | Other | ||||||||||||||||||||||||
| Unsecured | Secured | Construction | Real Estate | Estate | Loans | Total | ||||||||||||||||||||||
| Allowance for loan losses: | ||||||||||||||||||||||||||||
| Beginning balance | $ | 500,280 | $ | 10,320 | $ | 40,709 | $ | 714,786 | $ | 5,874 | $ | 29,629 | $ | 1,301,598 | ||||||||||||||
| Provision for loan losses | 176,910 | 1,381 | (3,192 | ) | (150,334 | ) | (701 | ) | 936 | 25,000 | ||||||||||||||||||
| Loans charged-off | (147,257 | ) | — | — | — | — | — | (147,257 | ) | |||||||||||||||||||
| Recoveries | 12,625 | — | — | 500 | — | 164 | 13,289 | |||||||||||||||||||||
| Total ending allowance balance | $ | 542,558 | $ | 11,701 | $ | 37,517 | $ | 564,952 | $ | 5,173 | $ | 30,729 | $ | 1,192,630 | ||||||||||||||
| Six months ended June 30, 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 | 84,724 | 1,322 | 3,002 | 166,738 | (26,123 | ) | 10,337 | 240,000 | ||||||||||||||||||||
| Loans charged-off | (100,757 | ) | — | — | (16,675 | ) | — | — | (117,432 | ) | ||||||||||||||||||
| Recoveries | 88,968 | — | — | — | 27,641 | 200 | 116,809 | |||||||||||||||||||||
| Total ending allowance balance | $ | 547,621 | $ | 13,678 | $ | 37,186 | $ | 930,883 | $ | 2,190 | $ | 50,839 | $ | 1,582,397 | ||||||||||||||
| Six months ended June 30, 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 | 170,359 | (1,785 | ) | (14,621 | ) | (93,910 | ) | (2,001 | ) | (3,042 | ) | 55,000 | ||||||||||||||||
| Loans charged-off | (185,054 | ) | — | — | — | — | — | (185,054 | ) | |||||||||||||||||||
| Recoveries | 36,300 | — | — | 5,500 | — | 3,664 | 45,464 | |||||||||||||||||||||
| Total ending allowance balance | $ | 542,558 | $ | 11,701 | $ | 37,517 | $ | 564,952 | $ | 5,173 | $ | 30,729 | $ | 1,192,630 | ||||||||||||||
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Financial Condition at June 30, 2012
Total assets were $252,334,956 at June 30, 2012, an increase of $10,488,501, or 4.3%, 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 and to fund new loans. The principal changes resulting in the net increase in assets can be summarized as follows:
| • | a $8,667,667 net increase in investment securities available for sale |
| • | a $3,761,054 net increase in loans receivable and |
| • | a $1,934,023 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 $223,728,853 at June 30, 2012, an increase of $10,505,948 or 4.9%, from December 31, 2011 as a result of our active solicitation of retail deposits to increase funds for investment. The aggregate increase in deposits resulted from increases of $4,498,488 in money market accounts, $4,064,597 in NOW accounts, $2,459,571 in non-interest demand deposits, $627,553 in savings accounts and $19,536 in escrow deposits partially offset by a decrease of $1,163,797 in time deposits.
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Total stockholders’ equity was $27,354,580 at June 30, 2012, an increase of $252,320, or 0.93%, from December 31, 2011. The increase reflected: (i) a $439,479 increase in retained earnings due to net income of $653,485 for the six months ended June 30, 2012, partially offset by $214,006 of dividends paid in 2012; (ii) a reduction of $84,539 in Unearned ESOP shares reflecting the gradual payment of the loan we made to fund the ESOP’s purchase of our stock; partially offset by (iii) a decrease in the net unrealized gain on securities available for sale of $171,631. 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 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 June 30, 2012, the percentage had declined to 5.6%. 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.
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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 June 30, 2012 and June 30, 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 $371,857 for the three months ended June 30, 2012, compared to net income of $427,704 for the comparable period in 2011. The principal categories which make up the 2012 net income are:
| • | Interest income of $2,322,033 | |
| • | Reduced by interest expense of $192,990 |
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| • | Reduced by a provision for loan losses of $65,000 | |
| • | Increased by non-interest income of $628,231 | |
| • | Reduced by non-interest expense of $2,006,779 | |
| • | Reduced by income tax expense of $313,638 |
We discuss each of these categories individually and the reasons for the differences between the quarters ended June 30, 2012 and 2011 in the following paragraphs.
Interest Income. Interest income was $2,322,033 for the quarter ended June 30, 2012, compared to $2,377,517 for the quarter ended June 30, 2011, a decrease of $55,484 or 2.3%. The main reason for the decline was a 63 basis point decrease in the yield and a $2,451,778 decrease in average balance on investment securities between the periods, which combined to cause a $208,022 decline in interest income on investment securities. This was partially offset by the $141,723 increase in interest income on loans.
Interest income on loans increased by $141,723 as a result of an increase of $60,359 of interest collected on loans previously on non-accrual, from $2,378 in the second quarter of 2011 to $62,737 in the same period in 2012. In addition, the average balance of loans increased by $3.7 million and the yield on loans increased by 18 basis points from the second quarter of 2011 to the second quarter of 2012, both of which contributed to the increase in interest income on loans. The increase in the average balance was the result of our efforts to increase our loan portfolio, which represents our highest yielding asset category. There was a $516,711 increase in our average non-performing loans, from $6.2 million in the quarter ending June 30, 2011, to $6.7 million in the second 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 second quarter of 2012, our average loan yield would have been approximately 43 basis points higher. In contrast, we estimate that the comparable effect in 2011 period would have been approximately a 75 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 63 basis point decrease in the average yield on our investment securities portfolio, from 3.34% to 2.71%, 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 $2.5 million, or 2.1%, between the periods, as we limited our purchases of new investment securities due to the low yields available. The investment securities portfolio represented 72.1% of average non-loan interest earning assets in the 2012 period compared to 77.9% in the 2011 period.
Interest income from other interest earning assets (principally overnight investments) increased by $10,815 due to an increase in the yield of 6 basis points from 0.16% for the quarter ended June 30, 2011 to 0.22% for the quarter ended June 30, 2012. In addition, the average balance of our interest earning assets increased by $11.5 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 $192,990 for the quarter ended June 30, 2012, compared to $216,447 for the quarter ended June 30, 2011, a decrease of $23,457 or 10.8%. The decrease was primarily the result of a reduction in the rates we paid on deposits, principally time deposits, reflecting a 10 basis point decrease in the cost of time 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 0.52% from 0.63% between the periods.
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Net Interest Income Before Provision for Loan Losses. Net interest income before the provision for loan losses was $2,129,043 for the quarter ended June 30, 2012, compared to $2,161,070 for the quarter ended June 30, 2011, a decrease of $32,027, or 1.5%. 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 June 30, 2012 to the same period ended 2011. The average yield on interest earning assets declined by 37 basis points, while the average cost of funds declined by 11 basis points. The reduction in the yield on assets was principally due to the 63 basis point drop in the yield on investment securities partially offset by the 18 basis point increase in the yield on loans. The decline in the cost of funds was driven principally by the 10 basis point drop in the cost of time deposits. Overall, our interest rate spread declined 26 basis points, from 3.43% to 3.17% between the periods. Correspondingly, our net interest margin decreased to 3.38% for the quarter ended June 30, 2012 from 3.69% 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.
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 increase in the average balance of other interest earning assets, our lowest yielding asset class. 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 $65,000 for the quarter ended June 30, 2012 compared to a provision for loan losses of $25,000 for the quarter ended June 30, 2011. The $40,000 increase in the provision was a result of increased write downs on impaired loans between the periods, due to the reduction in the fair value of underlying collateral, which was partially offset by the increased level of recoveries in the 2012 period.
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 a decrease of $648,065 in non-performing loans from $6,870,657 at June 30, 2011 to $6,222,592 at June 30, 2012. These 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 $16,675 for the quarter ended June 30, 2012 as compared to charge-offs of $147,257 for the quarter ended June 30, 2011. We also had recoveries (which are added back to the allowance for loan losses) of $92,159 for the quarter ended June 30, 2012 as compared to $13,289 in the same period of 2011. After increasing the provision for loan losses for the quarter ended June 30, 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 June 30, 2012 was appropriate to address probable and incurred 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 $1,192,630, or 1.44% of total loans, at June 30, 2011 to $1,582,397 or 1.84% of total loans, at June 30, 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 $628,231 for the quarter ended June 30, 2012, compared to $623,293 during the same period last year. The $4,938, or 0.8%, increase in non-interest income was a direct result of a $12,409 increase in service charges on deposits, partially offset by a $9,131 decrease in other income. 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 $2,006,779 for the quarter ended June 30, 2012, compared to $1,971,018 for the quarter ended June 30, 2011, an increase of $35,761 or 1.8%. The principal shifts in the individual categories were:
| • | a $35,302 increase in legal expense due to a higher level of collections; | |
| • | a $24,952 increase in other non-interest expenses due to an increase in the cost of holding real estate acquired in the collection of mortgage loans; | |
| • | a $14,500 increase in FDIC and NYSDFS assessments due to a lower regulatory assessment rate in the second quarter of 2011 partially offset by; | |
| • | a $49,683 decrease in salaries and benefits costs due to reduced staff. |
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 $313,638 for the quarter ended June 30, 2012, compared to income tax expense of $360,641 for the same period ended 2011. The decrease in income tax expense was due to the $102,850 decrease in income before income taxes in the 2012 period. Our effective tax rate for the quarters ended June 30, 2012 and 2011 was 45.8%.
Results of Operations for the Six Months Ended June 30, 2012 and June 30, 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 $653,485 for the six months ended June 30, 2012, compared to net income of $859,495 for the comparable period in 2011. The principal categories which make up the 2012 net income are:
| • | Interest income of $4,634,705 | |
| • | Reduced by interest expense of $407,481 | |
| • | Reduced by a provision for loan losses of $240,000 | |
| • | Increased by non-interest income of $1,248,956 | |
| • | Reduced by non-interest expense of $4,031,524 | |
| • | Reduced by income tax expense of $551,171 |
We discuss each of these categories individually and the reasons for the differences between the six months ended June 30, 2012 and 2011 in the following paragraphs.
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Interest Income. Interest income was $4,634,705 for the six months ended June 30, 2012, compared to $4,855,499 for the six months ended June 30, 2011, a decrease of $220,794 or 4.6%. The main reason for the decline was a 61 basis point decrease in the yield and a $5,236,729 decrease in average balance on investment securities between the periods, which combined caused a $428,004 decline in interest income on investment securities. This was partially offset by the $183,879 increase in interest income on loans.
Interest income on loans increased by $183,879 as a result of an increase of $130,428 of interest collected on loans previously on non-accrual, from $23,065 in the first six months of 2011 to $153,493 in the same period in 2012. The average balance of loans increased by $2.1 million and the yield on loans increased by 9 basis points, from the first six months of 2011 to the first six months 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. There was a $2.1 million increase in our average non-performing loans, from $6.3 million in the first six months of 2011, to $8.4 million in the first six months 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 six months of 2012, our average loan yield would have been approximately 39 basis points higher. In contrast, we estimate that the comparable effect in 2011 period would have been approximately a 55 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 61 basis point decrease in the average yield on our investment securities portfolio, from 3.41% to 2.80%, 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 $8.0 million, or 6.8%, between the periods. The investment securities portfolio represented 71.7% of average non-loan interest earning assets in the 2012 period compared to 79.0% in the 2011 period.
Interest income from other interest earning assets (principally overnight investments) increased by $23,331 due to an increase in the yield of 6 basis points from 0.16% for the six months ended June 30, 2011 to 0.22% for the same period ended June 30, 2012. In addition, the average balance of our interest earning assets increased by $13.3 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 $407,481 for the six months ended June 30, 2012, compared to $443,117 for the six months ended June 30, 2011, a decrease of $35,636 or 8.0%. The decrease was primarily the result of a reduction in the rates we paid on deposits, principally a 5 basis point decrease in time deposits and a 10 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 0.56% from 0.64% between the periods.
Net Interest Income Before Provision for Loan Losses. Net interest income before the provision for loan losses was $4,227,224 for the six months ended June 30, 2012, compared to $4,412,382 for the six months ended June 30, 2011, a decrease of $185,158, or 4.2%. The decrease was primarily because the reduction in our interest income was greater than the reduction in our cost of funds when comparing the six months ended June 30, 2012 to the same period ended 2011. The average yield on interest earning assets declined by 43 basis points, while the average cost of funds declined by 8 basis points. The reduction in the yield on assets was principally due to the 61 basis point drop in the yield on investment securities partially offset by the 9 basis point increase in the yield on loans. The decline in the cost of funds was driven principally by the 5 basis point decrease in time deposits and the 10 basis point drop in the cost of NOW account deposits. Overall, our interest rate spread declined 35 basis points, from 3.57% to 3.22% between the periods. Correspondingly, our net interest margin decreased to 3.45% for the six months ended June 30, 2012 from 3.82% 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 and on other interest earning assets, our lowest yielding asset class.
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 $240,000 for the six months ended June 30, 2012 compared to a provision for loan losses of $55,000 for the six months ended June 30, 2011. The $185,000 increase in the provision was a result of increased write downs on impaired loans between the periods, due to the reduction in the fair value of underlying collateral, partially offset by the higher level of recoveries between the periods.
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 a decrease of $648,065 in non-performing loans from $6,870,657 at June 30, 2011 to $6,222,592 at June 30, 2012. These 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 $117,432 for the six months ended June 30, 2012 as compared to charge-offs of $185,054 for the six months ended June 30, 2011. We also had recoveries (which are added back to the allowance for loan losses) of $116,809 for the six months ended June 30, 2012 as compared to $45,464 in the same period of 2011. After increasing the provision for loan losses for the six months ended June 30, 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 June 30, 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 $1,192,630, or 1.44% of total loans, at June 30, 2011 to $1,582,397 or 1.84% of total loans, at June 30, 2012. There can be no assurance that a higher level, or a higher provision for loan losses, will not be necessary in the future.
Non-interest Income. Non-interest income was $1,248,956 for the six months ended June 30, 2012, compared to $1,230,996 during the same period last year. The $17,960, or 1.5%, increase in non-interest income was a direct result of a $42,890 increase in service charges on deposits, partially offset by a $21,014 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.
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Non-interest Expense. Non-interest expense was $4,031,524 for the six months ended June 30, 2012, compared to $4,004,068 for the six months ended June 30, 2011, an increase of $27,456 or 0.7%. The principal shifts in the individual categories were:
| • | a $50,024 increase in legal expense due to a higher level of collections and a recovery of legal fees in 2011 previously expensed on a settled lawsuit; | |
| • | a $32,173 increase in other non-interest expenses due to an increase in the cost of holding real estate acquired in the collection of mortgage loans and increased costs of regulatory filings; | |
| • | a $19,750 increase in director’s fee due to increased meetings partially offset by: | |
| • | a $41,403 decrease in salaries and benefits due to reduced staff; | |
| • | a $21,901 decrease in computer expenses due to reduced contract expense; and | |
| • | an $18,000 decrease in FDIC and NYSDFS assessments due to change in the FDIC’s methodology for calculating the FDIC assessment rate. |
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 $551,171 for the six months ended June 30, 2012, compared to income tax expense of $724,815 for the same period ended 2011. The decrease in income tax expense was due to the $379,654 decrease in income before income taxes in the 2012 period. Our effective tax rate for the six months ended June 30, 2012 and 2011 was 45.8%.
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VSB Bancorp, Inc.
Consolidated Average Balance Sheets
(unaudited)
| Three Months Ended June 30, 2012 | Three Months Ended June 30, 2011 | Six Months Ended June 30, 2012 | Six Months Ended June 30, 2011 | |||||||||||||||||||||||||||||||||||||||||||||
| Average | Yield/ | Average | Yield/ | Average | Yield/ | Average | Yield/ | |||||||||||||||||||||||||||||||||||||||||
| Balance | Interest | Cost | Balance | Interest | Cost | Balance | Interest | Cost | Balance | Interest | Cost | |||||||||||||||||||||||||||||||||||||
| Assets: | ||||||||||||||||||||||||||||||||||||||||||||||||
| Interest-earning assets: | ||||||||||||||||||||||||||||||||||||||||||||||||
| Loans receivable | $ | 84,754,773 | $ | 1,507,750 | 6.93 | % | $ | 81,033,439 | $ | 1,366,027 | 6.75 | % | $ | 83,601,269 | $ | 3,004,198 | 7.04 | % | $ | 81,491,744 | $ | 2,820,319 | 6.95 | % | ||||||||||||||||||||||||
| Investment securities, afs | 117,383,585 | 789,865 | 2.71 | 119,835,363 | 997,887 | 3.34 | 113,679,962 | 1,582,435 | 2.80 | 118,916,691 | 2,010,439 | 3.41 | ||||||||||||||||||||||||||||||||||||
| Other interest-earning assets | 45,497,686 | 24,418 | 0.22 | 34,037,827 | 13,603 | 0.16 | 44,871,876 | 48,072 | 0.22 | 31,605,943 | 24,741 | 0.16 | ||||||||||||||||||||||||||||||||||||
| Total interest-earning assets | 247,636,044 | 2,322,033 | 3.69 | 234,906,629 | 2,377,517 | 4.06 | 242,153,107 | 4,634,705 | 3.78 | 232,014,378 | 4,855,499 | 4.21 | ||||||||||||||||||||||||||||||||||||
| Non-interest earning assets | 6,678,572 | 6,866,466 | 6,949,970 | 6,955,598 | ||||||||||||||||||||||||||||||||||||||||||||
| Total assets | $ | 254,314,616 | $ | 241,773,095 | $ | 249,103,077 | $ | 238,969,976 | ||||||||||||||||||||||||||||||||||||||||
| Liabilities and equity: | ||||||||||||||||||||||||||||||||||||||||||||||||
| Interest-bearing liabilities: | ||||||||||||||||||||||||||||||||||||||||||||||||
| Savings accounts | $ | 17,803,181 | 9,592 | 0.22 | $ | 17,091,175 | 13,278 | 0.31 | $ | 17,601,805 | 19,200 | 0.22 | $ | 16,572,161 | 25,974 | 0.32 | ||||||||||||||||||||||||||||||||
| Time accounts | 64,561,077 | 103,897 | 0.65 | 63,501,639 | 118,885 | 0.75 | 65,090,906 | 229,852 | 0.71 | 63,581,610 | 240,391 | 0.76 | ||||||||||||||||||||||||||||||||||||
| Money market accounts | 31,655,393 | 58,159 | 0.74 | 28,532,598 | 61,101 | 0.86 | 30,129,220 | 114,871 | 0.77 | 28,296,113 | 120,480 | 0.86 | ||||||||||||||||||||||||||||||||||||
| Now accounts | 34,021,833 | 21,342 | 0.25 | 28,419,262 | 23,183 | 0.33 | 32,230,174 | 43,558 | 0.27 | 30,492,021 | 56,272 | 0.37 | ||||||||||||||||||||||||||||||||||||
| Total interest-bearing liabilities | 148,041,484 | 192,990 | 0.52 | 137,544,674 | 216,447 | 0.63 | 145,052,105 | 407,481 | 0.56 | 138,941,905 | 443,117 | 0.64 | ||||||||||||||||||||||||||||||||||||
| Checking accounts | 77,174,913 | 75,218,675 | 75,127,052 | 71,418,435 | ||||||||||||||||||||||||||||||||||||||||||||
| Escrow deposits | 453,235 | 426,759 | 379,112 | 386,939 | ||||||||||||||||||||||||||||||||||||||||||||
| Total deposits | 225,669,632 | 213,190,108 | 220,558,269 | 210,747,279 | ||||||||||||||||||||||||||||||||||||||||||||
| Other liabilities | 1,192,644 | 1,937,696 | 1,218,605 | 1,811,345 | ||||||||||||||||||||||||||||||||||||||||||||
| Total liabilities | 226,862,276 | 215,127,804 | 221,776,874 | 212,558,624 | ||||||||||||||||||||||||||||||||||||||||||||
| Equity | 27,452,340 | 26,645,291 | 27,326,203 | 26,411,352 | ||||||||||||||||||||||||||||||||||||||||||||
| Total liabilities and equity | $ | 254,314,616 | $ | 241,773,095 | $ | 249,103,077 | $ | 238,969,976 | ||||||||||||||||||||||||||||||||||||||||
| Net interest income/net interest rate spread | $ | 2,129,043 | 3.17 | % | $ | 2,161,070 | 3.43 | % | $ | 4,227,224 | 3.22 | % | $ | 4,412,382 | 3.57 | % | ||||||||||||||||||||||||||||||||
| Net interest earning assets/net interest margin | $ | 99,594,560 | 3.38 | % | $ | 97,361,955 | 3.69 | % | $ | 97,101,002 | 3.45 | % | $ | 93,072,473 | 3.82 | % | ||||||||||||||||||||||||||||||||
| Ratio of interest-earning assets to interest-bearing liabilities | 1.67 | x | 1.71 | x | 1.67 | x | 1.67 | x | ||||||||||||||||||||||||||||||||||||||||
| Return on Average Assets (1) | 0.55 | % | 0.71 | % | 0.49 | % | 0.72 | % | ||||||||||||||||||||||||||||||||||||||||
| Return on Average Equity (1) | 5.07 | % | 6.42 | % | 4.50 | % | 6.51 | % | ||||||||||||||||||||||||||||||||||||||||
| Tangible Equity to Total Assets | 10.84 | % | 11.04 | % | 10.84 | % | 11.04 | % | ||||||||||||||||||||||||||||||||||||||||
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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 six months ended June 30, 2012, we had a net increase in total deposits of $10,505,948 due to increases of $4,498,488 in money market accounts, $4,064,597 in NOW accounts, $2,459,571 in non-interest demand deposits, $627,553 in savings accounts and $19,536 in escrow deposits partially offset by a decrease of $1,163,797 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 $18,683,742. We used $27,900,082 of available funds to purchase new investment securities and we had a net loan increase of $4,081,675. These changes resulted in an overall decrease in cash and cash equivalents of $1,934,023. Total cash and cash equivalents at June 30, 2012 were $46,173,650.
In contrast, during the six months ended June 30, 2011, we had a net increase in total deposits of $8,643,855 due to increases of $8,797,730 in non-interest demand deposits, $2,543,642 in savings accounts and $1,920,660 in money market accounts, partially offset by a decrease of $4,046,213 in NOW accounts, $559,653 in time deposits and $12,311 in escrow deposits. These were also all “retail” deposits rather than “wholesale” deposits that some banks obtain from deposit brokers. We also received proceeds from repayment of investment securities of $16,948,321. We used $15,614,398 of available funds to purchase new investment securities and we had a net loan increase of $1,272,170. These changes resulted in an overall increase in cash and cash equivalents of $9,857,285.
At June 30, 2012, cash and cash equivalents represented 18.3% 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. 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 June 30, 2012 we had $117.2 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 $80.7 million of unused borrowing capability from the FHLBNY at June 30, 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 June 30, 2012, with a Tier I Leverage Capital ratio of 9.97%, a Tier I Capital to Risk-Weighted Assets ratio of 25.06%, and a Total Capital to Risk-Weighted Assets ratio of 26.32%.
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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 June 30, 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 | $ | 425,604 | $ | 778,049 | $ | 568,660 | $ | 656,059 | $ | 2,428,372 | ||||||||||
| Remaining contractual maturities of time deposits | 57,041,006 | 2,717,955 | 4,971,778 | — | 64,730,739 | |||||||||||||||
| Total contractual cash obligations | $ | 57,466,610 | $ | 3,496,004 | $ | 5,540,438 | $ | 656,059 | $ | 67,159,111 | ||||||||||
| Other commitments | Amount of commitment Expiration by Period | |||||||||||||||||||
| Less than One Year | One to three years | Four to five years | After five years | Total Amounts committed | ||||||||||||||||
| Loan commitments | $ | 19,611,683 | $ | 4,212,965 | $ | 12,000 | $ | 2,311 | $ | 23,838,959 | ||||||||||
Non-Performing Loans
Management closely monitors non-performing loans and other assets with potential problems on a regular basis. We had seventeen non-performing loans, totaling $6,222,592 at June 30, 2012, compared to twenty three non-performing loans, totaling $10,862,897 at December 31, 2011. Non-performing loans totaled 7.22% of total loans at June 30, 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 seven largest non-performing loans and the associated relationships, totaling $4,837,638, or 77.7% of our non-performing loans, by outstanding principal balance at June 30, 2012. Management believes it has taken appropriate steps with a view towards maximizing recovery and minimizing loss, if any, on these loans.
| • | $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. After June 30, 2012, but before the filing of this report, we received a principal payment of $150,000. |
| 37 |
| • | $1,362,648 in two commercial real estate loans. The real estate loans are secured by a second mortgage on property in Staten Island and by a first mortgage on property in Queens. The real estate property in Staten Island is being foreclosed upon by the first mortgagee. The loans are guaranteed personally by the principals of the borrowers. We have commenced foreclosure proceedings on the property in Queens and a money judgment action against the borrowers on the loan secured by property in Staten Island. |
| • | $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 principals of the borrower. We have commenced foreclosure proceedings. |
| • | $601,079 in a commercial real estate loan. The loan is secured by a second mortgage on the property in Staten Island. The loan is guaranteed personally by the principals of the borrower. The borrower has signed a modified repayment agreement and we have held the previously commenced foreclosure action in abeyance as long as it performs under the terms of the modified repayment arrangement. We received a $125,000 upfront payment and the borrower has been making payments under the terms of the modified agreement since May 2012. |
| • | $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 guaranteed personally by the principals of the borrower 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.
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.
| 38 |
Item 4 – Controls and Procedures
Evaluation of Disclosure Controls and Procedures: As of June 30, 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.
| 39 |
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.
| 40 |
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: August 14, 2012 | /s/ Raffaele M. Branca |
| Raffaele M. Branca | |
| President, CEO and Principal Executive Officer |
| Date: August 14, 2012 | /s/ Jonathan B. Lipschitz |
| Jonathan B. Lipschitz | |
| Vice President, Controller and Principal | |
| Accounting Officer |
| 41 |
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) |
42