================================================================================
UNITED STATES
SECURITY AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20849
FORM 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTER ENDED JUNE 30, 2007
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OF THE EXCHANGE ACT
FOR THE TRANSITION PERIOD
COMMISSION FILE NUMBER 0-50237
VSB BANCORP, INC.
----------------------------------------------
(Name of Small Business Issuer 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
-------------------------
Issuer's telephone number
Common Stock
----------------
(Title of Class)
Check whether the issuer (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 [X] No [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act) Yes [ ] No [X]
Transitional small business disclosure format: Yes [ ] No [X]
The Registrant had 1,891,759 common shares outstanding as of July 30, 2007.
================================================================================
CROSS REFERENCE INDEX
Page
--------
PART I
Item 1 Consolidated Statements of Financial Condition as of June 30, 2007 and
December 31, 2006 (unaudited). 4
Consolidated Statements of Operations for the Three and Six Months Ended
June 30, 2007 and 2006 (unaudited) 5
Consolidated Statements of Changes in Stockholders' Equity for the Six
Months Ended June 30, 2007 and the Year Ended December 31, 2006 (unaudited) 6
Consolidated Statements of Cash Flows for the Three and Six Months Ended
June 30, 2007 and 2006 (unaudited) 7
Notes to Consolidated Financial Statements for the Three and Six Months
Ended June 30, 2007 and 2006 (unaudited) 8 to 14
Item 2 Management's Discussion and Analysis of Financial Condition and Results
of Operations 14 to 24
Item 3 Control and Procedures 24
PART II
Item 1 Legal Proceedings 25
Signature Page 26
Exhibit 31.1, 31.2, 32.1, 32.2 27 to 30
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:
o 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;
o changes in market interest rates or changes in the speed at which
market interest rates change;
o changes in laws and regulations affecting the financial service
industry;
o changes in competition; and
o changes in consumer preferences by our customers or the customers
of our business borrowers.
Please do not place undue reliance on any forward-looking statement, which
speaks only as of the date made. There are many factors, including those
described above, that could affect our future business activities or financial
performance and could cause our actual future results or circumstances to differ
materially from those we anticipate or project. We do not undertake any
obligation to update any forward-looking statement after it is made.
3
VSB BANCORP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(UNAUDITED)
JUNE 30, DECEMBER 31,
2007 2006
------------- -------------
ASSETS:
Cash and due from banks $ 34,983,022 $ 25,363,069
Investment securities, available for sale 112,098,277 113,770,611
Loans receivable 60,890,255 66,410,677
Allowance for loan loss (1,023,205) (1,128,824)
------------- -------------
Loans receivable, net 59,867,050 65,281,853
Bank premises and equipment, net 4,144,342 1,554,363
Accrued interest receivable 795,325 805,681
Deferred taxes 2,150,208 2,030,647
Other assets 1,111,310 3,078,535
------------- -------------
Total assets $ 215,149,534 $ 211,884,759
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY:
Liabilities:
Deposits:
Demand and checking $ 64,287,827 $ 67,371,582
NOW 20,810,121 19,935,769
Money market 23,703,782 18,359,007
Savings 11,762,026 12,526,485
Time 68,942,839 68,229,244
------------- -------------
Total Deposits 189,506,595 186,422,087
Escrow deposits 219,844 261,063
Subordinated debt 5,155,000 5,155,000
Accounts payable and accrued expenses 1,650,851 2,306,312
------------- -------------
Total liabilities 196,532,290 194,144,462
------------- -------------
Employee Stock Ownership Plan Repurchase Obligation - 399,026
STOCKHOLDERS' EQUITY:
Common stock, ($.0001 par value, 3,000,000 shares authorized, 1,891,759 issued
and outstanding at June 30, 2007 and December 31, 2006) 189 189
Additional paid in capital 9,053,691 8,667,665
Retained earnings 12,330,992 11,293,200
Unearned Employee Stock Ownership Plan shares (1,155,366) (1,239,905)
Accumulated other comprehensive loss,
net of taxes of $1,406,390 and $1,203,679,
respectively (1,612,262) (1,379,878)
------------- -------------
Total stockholders' equity 18,617,244 17,341,271
------------- -------------
Total liabilities and stockholders'
equity $ 215,149,534 $ 211,884,759
============= =============
See notes to consolidated financial statements.
4
VSB BANCORP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
JUNE 30, 2007 JUNE 30, 2006 JUNE 30, 2007 JUNE 30, 2006
------------- ------------- ------------- -------------
Interest and dividend income:
Loans receivable $ 1,501,344 $ 1,758,136 $ 3,073,697 $ 3,506,909
Investment securities 1,293,698 1,320,669 2,594,158 2,526,431
Other interest earning assets 264,761 133,179 511,826 312,627
------------- ------------- ------------- -------------
Total interest income 3,059,803 3,211,984 6,179,681 6,345,967
Interest expense:
NOW 29,960 26,442 58,749 49,645
Money market 97,559 95,447 183,409 179,663
Savings 25,355 21,044 49,783 39,378
Subordinated debt 89,039 89,039 178,079 178,079
Time 627,874 531,071 1,243,010 984,954
------------- ------------- ------------- -------------
Total interest expense 869,787 763,043 1,713,030 1,431,719
Net interest income 2,190,016 2,448,941 4,466,651 4,914,248
Provision (credit) for loan loss - - (30,000) 25,000
------------- ------------- ------------- -------------
Net interest income
after provision for loan loss 2,190,016 2,448,941 4,496,651 4,889,248
------------- ------------- ------------- -------------
Non-interest income:
Loan fees 20,532 17,533 48,000 40,300
Service charges on deposits 445,491 386,972 862,399 776,728
Net rental income/(loss) (13,121) 3,374 1,692 6,749
Other income 82,291 70,593 164,465 138,244
------------- ------------- ------------- -------------
Total non-interest income 535,193 478,472 1,076,556 962,021
------------- ------------- ------------- -------------
Non-interest expenses:
Salaries and benefits 937,988 969,643 1,955,318 2,001,720
Occupancy expenses 341,750 279,590 679,725 539,050
Legal expense/(recovery) (16,160) 103,447 (1,634) 162,321
Professional fees 44,700 42,000 96,300 90,000
Computer expense 70,155 62,097 137,371 122,625
Directors' fees 55,700 57,550 107,850 113,450
Other expenses 339,818 312,606 655,177 617,040
------------- ------------- ------------- -------------
Total non-interest expenses 1,773,951 1,826,933 3,630,107 3,646,206
------------- ------------- ------------- -------------
Income before income taxes 951,258 1,100,480 1,943,100 2,205,063
Provision/(benefit) for income taxes:
Current 405,809 509,513 848,539 1,029,487
Deferred 37,428 3,197 56,769 (2,105)
------------- ------------- ------------- -------------
Total provision for income taxes 443,237 512,710 905,308 1,027,382
------------- ------------- ------------- -------------
Net income $ 508,021 $ 587,770 $ 1,037,792 $ 1,177,681
============= ============= ============= =============
Basic income per common share $ 0.28 $ 0.32 $ 0.57 $ 0.65
============= ============= ============= =============
Diluted net income per share $ 0.27 $ 0.31 $ 0.55 $ 0.63
============= ============= ============= =============
Comprehensive income/(loss) $ (56,821) $ 134,591 $ 805,408 $ 198,496
============= ============= ============= =============
Book value per common share $ 9.84 $ 8.01 $ 9.84 $ 8.01
============= ============= ============= =============
All per share data has been adjusted for the 5 for 4 stock split, in the form of
a 25% stock dividend, paid on May 18, 2006. See notes to consolidated financial
statements.
5
VSB BANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEAR ENDED DECEMBER 31, 2006 AND SIX MONTHS ENDED JUNE 30, 2007
(UNAUDITED)
ACCUMULATED
NUMBER OF ADDITIONAL UNEARNED OTHER TOTAL
COMMON COMMON PAID-IN RETAINED ESOP COMPREHENSIVE STOCKHOLDERS'
SHARES STOCK CAPITAL EARNINGS SHARES LOSS EQUITY
---------- ---------- ---------- ----------- ----------- ------------- -------------
Balance at December 31, 2005 1,509,822 $ 151 $8,743,200 $ 8,621,693 $(1,408,983) $ (1,424,127) $ 14,531,934
Reclass due to the adoption of
SEC SAB 108 - - - 125,914 - - 125,914
---------- ---------- ---------- ----------- ----------- ------------- -------------
Balance at January 1, 2006 1,509,822 151 8,743,200 8,747,607 (1,408,983) (1,424,127) 14,657,848
Exercise of stock option,
including tax benefit 3,750 46,232 46,232
Amortization of earned portion
of ESOP common stock 169,078 169,078
5 for 4 stock split and purchase
of fractional shares 378,187 38 (367) (329)
Amortization of deficit fair
value of cost - ESOP (6,785) (6,785)
Transfer to ESOP repurchase
obligation (114,615) (114,615)
Comprehensive income:
Net income 2,545,593 2,545,593
Other comprehensive income, net:
Change in unrealized loss on
securities available for
sale, net of tax effects - - - - - 44,249 44,249
---------- ---------- ---------- ----------- ----------- ------------- -------------
Total comprehensive income 2,589,842
Balance at December 31, 2006 1,891,759 189 8,667,665 11,293,200 (1,239,905) (1,379,878) 17,341,271
---------- ---------- ---------- ----------- ----------- ------------- -------------
Amortization of earned portion
of ESOP common stock 84,539 84,539
Amortization of deficit fair
value of cost - ESOP (13,000) (13,000)
Transfer from ESOP repurchase
obligation 399,026 399,026
Comprehensive income:
Net income 1,037,792 1,037,792
Other comprehensive income, net:
Change in unrealized loss on
securities available for
sale, net of tax effects - - - - - (232,384) (232,384)
---------- ---------- ---------- ----------- ----------- ------------- -------------
Total comprehensive income 805,408
Balance at June 30, 2007 1,891,759 $ 189 $9,053,691 $12,330,992 $(1,155,366) $ (1,612,262) $ 18,617,244
========== ========== ========== =========== =========== ============= =============
All per share data has been adjusted for the 5 for 4 stock split, in the form of
a 25% stock dividend, paid on May 18, 2006. See notes to consolidated financial
statements.
6
VSB BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
JUNE 30, 2007 JUNE 30, 2006 JUNE 30, 2007 JUNE 30, 2006
------------- ------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 508,021 $ 587,770 $ 1,037,792 $ 1,177,681
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation and amortization 164,171 115,233 308,022 217,558
Accretion of income, net of amortization of premium (50,272) (96,770) (107,984) (187,392)
ESOP compensation expense 35,006 43,772 71,539 84,020
Provision/(credit) for loan losses - - (30,000) 25,000
(Increase)/decrease in prepaid and other assets (127,960) 164,586 (175,641) (327,547)
(Increase)/decrease in accrued interest receivable 13,062 (78,609) 10,356 (101,840)
Decrease/(increase) in deferred income taxes 63,809 3,197 83,150 (2,105)
(Decrease)/increase in accrued expenses and other liabilities (350,643) (363,402) (655,461) (357,754)
------------- ------------- ------------- -------------
Net cash provided by operating activities 255,194 375,777 541,773 527,621
------------- ------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net decrease/(increase) in loan receivable 593,894 (896,471) 5,541,952 2,272,731
Proceeds from repayment of investment securities,
available for sale 7,093,447 5,308,655 12,759,728 10,121,487
Purchases of investment securities, available for sale (11,511,654) (12,974,093) (11,511,654) (23,944,173)
Purchases of premises and equipment (71,412) (467,110) (755,135) (489,344)
------------- ------------- ------------- -------------
Net cash (used in)/provided by investing activities (3,895,725) (9,029,019) 6,034,891 (12,039,299)
------------- ------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase/(decrease) in deposits 7,121,912 5,513,510 3,043,289 7,974,607
Exercise stock option - 42,170 - 42,170
5 for 4 stock split and the purchase of fractional shares - (329) - (329)
------------- ------------- ------------- -------------
Net cash provided by financing activities 7,121,912 5,555,351 3,043,289 8,016,448
------------- ------------- ------------- -------------
NET INCREASE/(DECREASE) IN CASH
AND CASH EQUIVALENTS 3,481,381 (3,097,891) 9,619,953 (3,495,230)
------------- ------------- ------------- -------------
CASH AND CASH EQUIVALENTS,
BEGINNING OF PERIOD 31,501,641 30,926,808 25,363,069 31,324,147
------------- ------------- ------------- -------------
CASH AND CASH EQUIVALENTS,
END OF PERIOD $ 34,983,022 $ 27,828,917 $ 34,983,022 $ 27,828,917
============= ============= ============= =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid during the period for:
Interest $ 1,056,311 $ 646,527 $ 2,051,408 $ 1,441,226
============= ============= ============= =============
Taxes $ 666,165 $ 841,170 $ 1,207,459 $ 1,226,059
============= ============= ============= =============
Transfer of construction in progress to premises and
equipment $ - $ - $ 2,142,866 $ -
============= ============= ============= =============
See notes to consolidated financial statements.
7
VSB BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE AND SIX MONTHS ENDED
JUNE 30, 2007 AND 2006
1. GENERAL
VSB Bancorp, Inc. ("Bancorp" or "Company") became the holding company for
Victory State Bank ("Bank"), a New York State chartered commercial bank on May
30, 2003 as the result of a reorganization of the Bank into the holding company
form of organization. The stockholders of the Bank became the stockholders of
VSB Bancorp, Inc. as a result of the reorganization, receiving three shares of
VSB Bancorp, Inc. stock for each two shares of Victory State Bank stock. Each
stockholder owned the same percentage interest in VSB Bancorp immediately after
the reorganization that the stockholder owned in the Bank immediately before the
reorganization, subject to immaterial differences due to adjustments for cash in
lieu of fractional shares. VSB Bancorp now owns 100% of the capital stock of the
Bank. No stockholders of the Bank exercised dissenter's rights to receive cash
instead of shares of the Company. The transaction between these entities under
common control was accounted for at historical cost on an "as if pooled basis".
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. 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 Banking Department 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 consists of cash on
hand, due from banks and interest-bearing deposits. Net cash flows are reported
for customer loan and deposit transactions and interest-bearing deposits.
Regulation D of the Board of Governors of the Federal Reserve system requires
that Victory State Bank maintain non-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
8
accounts. During the fourteen day period from June 21, 2007 through July 4,
2007, Victory State Bank was required to maintain reserves, after deducting
vault cash, of $2,591,000. 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.
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. Declines
in the fair value of securities below their cost that are other than temporary
are reflected as realized losses. In estimating other-than-temporary losses,
management considers: (1) the length of time and extent that fair value has been
less than cost, (2) the financial condition and near term prospects of the
issuer, and (3) the Company's ability and intent to hold the security for a
period sufficient to allow for any anticipated recovery in fair value.
The Company invests primarily in agency Collateralized Mortgage-Backed
Obligations ("CMOs") with estimated average lives primarily under 4.5 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. 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. 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
this asset. 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.
9
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.
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. Large groups of smaller balance homogeneous loans, such as consumer
loans and residential 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.
Subordinated Debt - In August of 2003, the Company formed VSB Capital Trust
I (the "Trust"). The Trust is a statutory business trust organized under
Delaware law and the Company owns all of its common securities. The Trust issued
$5.0 million of Trust Preferred Capital Securities to an independent investor
and $155,000 of common securities to the Company. The Company issued a $5.16
million subordinated debenture to the Trust. The subordinated debenture is the
sole asset of the Trust. The subordinated debenture and the Trust Preferred
Capital Securities pay interest and dividends, respectively, on a quarterly
basis, at a rate of 6.909%, for the first five years. They mature thirty years
after the issuance of the securities and are non-callable for five years. After
the first five years, the Trust Preferred Securities may be called by the
Company at any quarterly interest payment date at par and the rate of interest
that fluctuates quarterly based upon 300 basis points over the 90 day LIBOR
rate. The Trust is not consolidated with the Company.
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
ten 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. 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.
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.
10
Basic and Diluted Net Income Per Common Share - Basic net income per share
of common stock is based on 1,828,982 shares and 1,817,155 shares, the weighted
average number of common shares outstanding for the three months ended June 30,
2007 and 2006, respectively. Diluted net income per share of common stock is
based on 1,877,695 and 1,869,463, the weighted average number of common shares
and potentially dilutive common shares outstanding for the three months ended
June 30, 2007 and 2006, 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 52,412 and 76,487 shares for the three
months ended June 30, 2007 and 2006, respectively. Common stock equivalents were
calculated using the treasury stock method. All per share data throughout this
report has been adjusted to reflect, retroactively, a 5-for-4 stock split, in
the form of a 25% stock dividend that was declared by the Board of Directors to
stockholders of record on May 3, 2006.
Basic net income per share of common stock is based on 1,827,758 shares and
1,814,545 shares, the weighted average number of common shares outstanding for
the six months ended June 30, 2007 and 2006, respectively. Diluted net income
per share of common stock is based on 1,877,098 and 1,864,105, the weighted
average number of common shares and potentially dilutive common shares
outstanding for the six months ended June 30, 2007 and 2006, 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 51,785 and 69,193 shares for the six months ended June 30, 2007 and 2006,
respectively. Common stock equivalents were calculated using the treasury stock
method. All per share data throughout this report has been adjusted to reflect,
retroactively, a 5-for-4 stock split, in the form of a 25% stock dividend that
was declared by the Board of Directors to stockholders of record on May 3, 2006.
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:
11
Three Months Ended Three Months Ended
June 30, 2007 June 30, 2006
--------------------------------------------- ---------------------------------------------
Weighted Weighted
Net Average Per Share Net Average Per Share
Reconciliation of EPS Income Shares Amount Income Shares Amount
--------------------------- ------------- ------------- ------------- ------------- ------------- -------------
Basic income per
common share
---------------------------
Net income available to
common stockholders $ 508,021 1,828,982 $ 0.28 $ 587,770 1,817,155 $ 0.32
============= =============
Effect of dilutive shares
---------------------------
Weighted average
shares, if converted 48,713 52,308
------------- -------------
Diluted net income per
common share
---------------------------
Net income available to
common stockholders $ 508,021 1,877,695 $ 0.27 $ 587,770 1,869,463 $ 0.31
============= ============= ============= ============= ============= =============
Six Months Ended Six Months Ended
June 30, 2007 June 30, 2006
--------------------------------------------- ---------------------------------------------
Weighted Weighted
Net Average Per Share Net Average Per Share
Reconciliation of EPS Income Shares Amount Income Shares Amount
--------------------------- ------------- ------------- ------------- ------------- ------------- -------------
Basic income per
common share
---------------------------
Net income available to
common stockholders $ 1,037,792 1,827,758 $ 0.57 $ 1,177,681 1,814,545 $ 0.65
============= =============
Effect of dilutive shares
---------------------------
Weighted average
shares, if converted 49,340 49,560
------------- -------------
Diluted net income per
common share
---------------------------
Net income available to
common stockholders $ 1,037,792 1,877,098 $ 0.55 $ 1,177,681 1,864,105 $ 0.63
============= ============= ============= ============= ============= =============
All per share data has been adjusted for the 5 for 4 stock split, in the form of
a 25% stock dividend, paid on May 18, 2006.
Stock Based Compensation - FAS 123, Revised, requires companies to record
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. This applies to awards granted or
modified in fiscal years beginning in 2006. Compensation cost will also be
recorded for prior option grants that vest after the date of adoption. The
effect on result of operations will depend on the level of future option grants
and the calculation of the fair value of the options granted at such future
date, as well as the vesting periods provided, and so cannot currently be
predicted.
12
STOCK OPTIONS
Options to buy stock are granted to directors, officers and employees under
five stock option plans approved by stockholders between 1998 and 2004 which, in
the aggregate, provide for issue up to 243,750 options. Exercise price is the
market price at the date of grant, and compensation expense will be recognized
in the income statement in accordance with FAS 123, Revised. The maximum option
term is ten years, and the options vesting period is up to five years.
There were no stock option grants in 2007 and 2006.
The stock option components of the five stock option plans, as of June 30,
2007, and changes during the six months ended, consist of the following:
2007
------------------------------------------
Weighted
Average Aggregate
Exercise Intrinsic
Shares Price Value
------------ ------------ ------------
Options outstanding 177,998 $ 10.36
at the beginning of the year
Granted - -
Canceled - -
Exercised - -
------------
Options outstanding at June 30, 2007 177,998 $ 10.36 $ 533,994
============ ============ ============
Options exercisable at June 30, 2007 177,998 $ 10.36 $ 533,994
============ ============ ============
Weighted average remaining contractual life of
options outstanding at June 30 , 2007 4.2 Years
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. As the Company now lists
on a national exchange, NASDAQ Capital Markets, it is no longer required to
reclassify out of stockholders' equity an amount equal to the put option of the
allocated ESOP shares.
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-Issued Accounting Standards - SFAS No. 157, "Fair Value
Measurements." SFAS 157 defines fair value, establishes a framework for
measuring fair value in generally accepted accounting principles, and expands
disclosures about fair value measurements. SFAS 157 is effective for the Company
on January 1, 2008 and is not expected to have a significant impact on the
Company's financial statements.
SFAS No. 159, "The Fair Value Option for Financial Assets and Financial
Liabilities-Including an amendment of FASB Statement No. 115." SFAS 159 permits
entities to choose to measure eligible items at fair value at specified election
dates. Unrealized gains and losses on items for which the fair value option has
been elected are reported in earnings at each subsequent reporting date. The
fair value option (i) may be applied
13
instrument by instrument, with certain exceptions, (ii) is irrevocable (unless a
new election date occurs) and (iii) is applied only to entire instruments and
not to portions of instruments. SFAS 159 is effective for the Company on January
1, 2008 and is not expected to have a significant impact on the Company's
financial statements.
In July 2006, the FASB issued FASB Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109" ("FIN
48"), which prescribes a recognition threshold and measurement attribute for a
tax position taken or expected to be taken in a tax return. FIN 48 also provides
guidance on derecognition, classification, interest and penalties, accounting in
interim periods, disclosure and transition. The Company adopted FIN 48 as of
January 1, 2007. 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 has a greater than 50% likelihood of being
realized on examination. For tax positions not meeting the "more likely than
not" test, no tax benefit is recorded. The adoption had no affect on the
Company's consolidated financial position or results of operations.
The Company and its subsidiaries are subject to U.S. federal income tax as
well as income tax of the state of New York. The Company is no longer subject to
examination by taxing authorities for years before 2002. The Company does not
expect the total amount of unrecognized tax benefits to significantly increase
in the next twelve months.
The Company recognizes interest related to income tax matters as interest
expense and penalties related to income tax matters as other expense. The
Company did not have any amounts accrued for interest and penalties at January
1, 2007 and June 30, 2007.
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
FINANCIAL CONDITION AT JUNE 30, 2007
Total assets were $215,149,534 at June 30, 2007, an increase of $3,264,775 or,
1.5%, from December 31, 2006. The increase resulted from the investment of funds
which were available to us as the result of an increase in deposits. The deposit
increase was caused generally by our efforts to grow our franchise and
specifically by the deposit increases at all our branch offices. The net
increase in assets can be summarized as follows:
o A $9,619,953 increase in cash and equivalents; offset by
o A $5,414,803 decrease in net loans receivable; and
o A $1,672,334 decrease in investment securities available for sale; and
$2,142,866, reported as construction in progress at December 31, 2006
was transferred to premises and equipment when we opened and occupied our new
main office at 4142 Hylan Boulevard on February 20, 2007. In addition, we also
experienced changes in other asset categories due to normal fluctuations in
operations.
The decline in loans, our highest yielding asset category, was the
result of a number of factors. The largest component of our loans represent
loans to the residential building trades and related businesses on Staten
Island. A slow down in the housing market has reduced business activity among
our customers. In addition, we have experienced an increase in competition as
the number of banks with offices on Staten Island has increased and some
existing local banks have been acquired by larger banks with greater resources.
14
Our deposits (including escrow deposits) were $189,726,439 at June 30,
2007, an increase of $3,043,289, or 1.6%, from December 31, 2006. The increase
in deposits resulted from increases of $874,352 in NOW accounts, $5,344,775 in
money market accounts, and $713,595 in time deposits, partially offset by
decreases of $3,124,974 in non-interest demand deposit and $764,459 in savings
accounts. The decrease in non-interest bearing accounts was due to the normal
fluctuations associated with the demand accounts and a softening of the real
estate market, which lowers our aggregate real estate related demand deposits.
Total stockholders' equity was $18,617,244 at June 30, 2007, an
increase of $1,275,973 from December 31, 2006. The increase reflected net income
of $1,037,792 for the six months ended June 30, 2007 increased by a reduction of
$84,539 in Unearned ESOP shares reflecting the effect of the gradual payment of
the loan we made to fund the ESOP's purchase of our stock. The increase in
stockholders' equity was partially offset by the $232,384 increase of the
unrealized loss on securities available for sale for the six months ended June
30, 2007 principally due to the increase in market interest rates, which drove
down the market value of our fixed rate bond portfolio, the prepayment of the
investment securities and the change in market interest rates. The unrealized
loss 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 change in stockholders' equity also included an increase of
$386,026 in additional paid in capital primarily due to a $399,026 transfer from
the ESOP repurchase obligation back to additional paid in capital. Our common
stock is now listed on the NASDAQ Capital Market and therefore we no longer have
an obligation to repurchase stock that the ESOP distributes to participants.
For financial statement reporting purposes, we record the compensation
expense related to the ESOP when shares are committed to be released from the
security interest for the loan. The amount of the compensation expense is based
upon the fair market value of the shares at that time, not the original purchase
price. The initial sale of shares to the ESOP did not increase our capital by
the amount of the purchase price because the purchase price was paid by the loan
we made to the ESOP. Instead, capital increases as the shares are allocated or
committed to be allocated to employee accounts (i.e., as the ESOP loan is
gradually repaid), based upon the fair market value of the shares at that time.
When we calculate earnings per share, only shares allocated or committed to be
allocated to employee accounts are considered to be outstanding. However, all
shares that the ESOP owns are legally outstanding, so they have voting rights
and, if we pay dividends, dividends will be paid on all ESOP shares.
EFFECT OF ADVERSE CONDITIONS IN THE RESIDENTIAL MORTGAGE MARKET.
We do not expect that adverse conditions in the residential mortgage
market throughout the United States will have a direct adverse effect on our
financial condition or results of operations. We are not a residential mortgage
lender. At June 30, 2007, we owned $103.6 million of securities that are either
collateralized by residential mortgage loans or that represent shares in pools
of such loans. However, 92.3% of those securities are issued or guaranteed by
FNMA, GNMA or FHLMC. The remainder of the securities' portfolio are all
investment grade securities rated AAA. We do not hold any loans in our portfolio
of the type that are commonly known as subprime residential mortgage loans
Many of our customers, both loan and deposit customers, are involved
in the residential construction business in Staten Island. A slow down in the
housing market or a reduction in the availability of residential mortgage loans
could have an adverse effect on our customers and reduce their business
activity. This could, in turn, cause a reduction in their demand for loans from
us, such as construction loans to build new homes. It could also affect the
level of deposits they maintain.
15
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2007 AND JUNE 30, 2006
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 $508,021 for the quarter ended June 30,
2007, compared to net income of $587,770 for the comparable quarter in 2006. The
principal categories which make up the 2007 net income are:
o Interest income of $3,059,803
o Reduced by interest expense of $869,787
o Increased by non-interest income of $535,193
o Reduced by non-interest expense of $1,773,951
o Reduced by $443,237 in income tax expense
We discuss each of these categories individually and the reasons for
the differences between the quarters ended June 30, 2007 and 2006 in the
following paragraphs. In general, the principal reasons for the decline in net
income when comparing the second quarter of 2007 with the same quarter in 2006
were a reduction in interest-earning assets, primarily in the loan portfolio,
which reduced interest income, and an increase in the cost of deposits, which
increased interest expense.
Interest Income. Interest income was $3,059,803 for the quarter ended
June 30, 2007, compared to $3,211,984 for the quarter ended June 30, 2006, a
decrease of $152,181, or 4.7%. The principal reason for this decrease was a
$10,640,572 decrease in the average balance of our loan portfolio. The decline
in the average balance of loans was the principal component of a $6,619,831
decline in average earning assets from $198,737,870 for the second quarter of
2006 to $192,118,039 for the second quarter of 2007. Loans are our highest
yielding asset category, and to the extent that we are unable to invest
available funds in satisfactory loans, we must invest those funds in lower
yielding investment securities and overnight investments at lower yields.
Therefore, the reduction in loans not only reduced the overall volume of
interest earning assets but also had the effect of reducing average yields. The
decrease in interest income from the decline in average loans and a decrease of
$5,445,049 in the average balance of investment securities was partially
mitigated by an increase of $9,465,790 in the average balance of other
interest-earning assets, coupled with the increase in the average yields on
those assets.
Our average loan yield declined slightly because we experienced a
higher level of loan prepayments in the second quarter of 2006, which resulted
in the accelerated recognition of origination fee income. The yields on all
other principal asset categories increased as the Fed Funds rate increased
during the first half of 2006, causing increases in other interest rate indexes,
such as the Prime Rate, and market interest rates generally. The yields on our
other interest earning assets, principally short-term liquid assets, increased
more rapidly than the yield on our investment securities. This occurred because
liquid assets have short terms and their yields adjust more quickly as market
interest rates change while the rates we earn on our investment securities are
primarily either fixed rates or rates that adjust at less frequent intervals.
The average balance of our loans decreased 15.0% to $60,410,867 for
the quarter ended June 30, 2007 from $71,051,439 during the 2006 quarter. The
decrease in average balance reflects the volatility inherent in the shorter
maturity loans, the increase in competition for such loans and the general
softening of the real estate market. The average yield on loans decreased by 11
basis points, from 9.89% to 9.78%. The decline in average
16
loan balance was the primary cause of a $256,792 decrease in interest income
from our loan portfolio. In the future, fluctuations in the prime rate will have
a direct effect on our loan yields, except to the extent that a significant
future decline in the prime rate may cause a lesser reduction in yield because
many of our loans have interest rate floors that would be triggered if such a
decline occurs.
The average yield on our investment securities portfolio increased 12
basis points, from 4.57% to 4.69%, due to purchase of new investment securities
at higher market rates than the yields on the principal paydowns we received.
The yield on investment securities increased slowly because most of the bonds
and notes in our investment portfolio have either fixed interest rates or
interest rates that react more slowly to changes in market interest rate
conditions. The average balance of our investment portfolio decreased by
$5,445,049, or 4.70%, between the periods. The decrease in volume, partially
offset by the increase in yield, resulted in an overall $26,971 decrease in
interest income from investment securities. The investment securities portfolio
represented 83.9% of average non-loan interest earning assets in the 2007 period
compared to 90.8% in the 2006 period.
Finally, we had a $131,582 increase in income from overnight funds and
other interest earning assets due to the higher market rates on short term and
overnight investments and an increase in average balance. The yield on these
investments increased 45 basis points from the second quarter of 2006 to the
second quarter of 2007, reflecting the effect of increases in the federal funds
rate during the first half of 2006. We increased the average balance of
overnight investments because they provide us with greater reinvestment
flexibility as we exert efforts to increase our loan portfolio and because the
gap between the rates on overnight investments versus the rates on investment
securities narrowed as short-term market rates rose while longer term rates
remained more steady.
Interest Expense. Interest expense was $869,787 for the quarter ended
June 30, 2007, compared to $763,043 for the quarter ended June 30, 2006, an
increase of 14.0%. More than 91%, or $96,803, of the $106,744 increase in
interest expense was represented by an increase in the cost of our time
deposits. The average balance of time accounts increased by $895,093 (or 1.4%),
and there was a 53 basis point increase in the average cost of time deposits.
The increase in cost was due to the increase in market rates between the two
comparable quarters.
Our average cost of funds increased from 2.40% to 2.84% between the
periods, primarily due to the increase in the cost of time deposits and, to a
lesser extent, the increased cost of other interest bearing deposits.
Competition and the increase in prevailing market interest rates required an
increase in the rates we offered on both new and renewing time deposits. While
we were able to limit interest rate increases in other deposit categories as
market interest rates rose, further increases in market rates, if they occur,
can be expected to compel increases in the rates we offer on these deposit
categories to maintain our competitive posture. Any further increase in
competition may accelerate the increase in our cost of funds resulting from
increases in market interest rates as more banks compete for customer deposits.
Net Interest Income Before Provision for Loan Losses. Net interest
income before the provision for loan losses was $2,190,016 for the quarter ended
June 30, 2007, a decrease of $258,925, or 10.6% over the $2,448,941 in the
comparable 2006 quarter. The decrease resulted principally from an increase in
our cost of funds and a decline in the average balance of our loan portfolio.
Our net interest spread decreased to 3.49% in the second quarter of 2007
compared to 4.07% in the second quarter of 2006 and our net interest margin
decreased to 4.51% in the second quarter of 2007 compared to 4.93% in the second
quarter of 2006, respectively. On the asset side, the average yield on earning
assets in the 2007 period declined to 6.33% from 6.47% in the June 2006 period,
or a decrease of 14 basis points. Although market rates increased, the reduction
in average loans and the deployment of funds into lower yielding liquid assets
had a greater effect on our average yields. On the liability side, there was an
increase in our cost of funds of 44 basis points from 2006 due principally to
the increased cost of time deposits.
Our margin declined more slowly than our spread because, as most of
the average yields on our assets increase, checking accounts, which represent a
no-cost funding source, become more valuable because we can invest the proceeds
of those deposits at higher yields. However, our average volume of checking
accounts has
17
declined recently. This has resulted from a softening real estate market, which
causes the aggregate balance of demand deposits to decline due to our strategy
of attracting deposits from attorneys and other customers linked to the real
estate businesses. Management continually seeks to maintain a high level of
non-interest checking accounts through developing relationships with local
businesses and attorneys. Maintaining a high percentage of non-interest checking
accounts is particularly advantageous in a rising rate environment because these
no-cost funds can be invested at the higher yields. However, increases in market
interest rates make interest-bearing deposit products more attractive to
customers and may cause funds to shift from non-interest checking into
interest-bearing deposit products.
Provision for Loan Losses. We did not take a provision for loan losses
for the quarters ended June 30, 2007 and 2006. 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. Our allowance for loan losses is based on
management's evaluation of the risks inherent in our loan portfolio and the
general economy. Management periodically evaluates both broad categories of
performing loans and problem loans individually to assess the appropriate level
of the allowance.
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. The allowance for loan losses
represented 1.68% of total loans at June 30, 2007, but 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 $535,193 for the three
months ended June 30, 2007, compared to $478,472 during the same period last
year. The $56,721, or 11.9%, increase in non-interest income was a direct result
of a $58,519 increase in service charges on deposits (primarily non-sufficient
fund fees), and a $14,523 increase in other income offset by a decrease in net
rental income of $16,495. Service fees on deposit accounts, principally
non-sufficient funds fees, increased from 2006 to 2007 as the volume of deposit
account transactions generating fee income increased. The increase in other
income is a direct result of the Bank taking on a select, limited group of
licensed consumer check cashing companies as deposit customers. These companies
generate fee income through per item charges on their deposits.
Non-interest Expense. Non-interest expense was $1,773,951 for the
quarter ended June 30, 2007, compared to $1,826,933 for the quarter ended June
30, 2006. The principal causes of the $52,982 decrease were:
o a $31,655 decrease in salaries and benefits expense, due to a
reduction in our incentive compensation accrual and a decrease in SAR
related expense due to a decline in our stock price, partially offset
by normal salary increases, a slight increase in staffing and higher
benefit costs.
o $62,160 in higher occupancy expenses due to the operation of our
branch in Rosebank and the opening of our new main office in Great
Kills.
o a $119,607 decrease in legal expenses due in part to the reimbursement
from our insurance company of legal fees previously expensed.
Income Tax Expense. Income tax expense was $443,237 for the quarter
ended June 30, 2007, compared to income tax expense of $512,710 for the quarter
ended June 30, 2006. The reduction in income tax expense was due to the $149,222
decrease in income before income taxes in the 2007 quarter. Our effective tax
rate remained the same for the quarters ended June 30, 2007 and 2006 at 46.6%.
RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2007 AND JUNE 30, 2006
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
18
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 $1,037,792 for the six months ended June
30, 2007, compared to net income of $1,177,681 for the comparable six months in
2006. The principal categories which make up the 2007 net income are:
o Interest income of $6,179,681
o Reduced by interest expense of $1,713,030
o Increased by a credit to the provision for loan losses of
$30,000
o Increased by non-interest income of $1,076,556
o Reduced by non-interest expense of $3,630,107
o Reduced by $905,308 in income tax expense
We discuss each of these categories individually and the reasons for
the differences between the six months ended June 30, 2007 and 2006 in the
following paragraphs. In general, the principal reasons for the decline in net
income when comparing the first six months of 2007 with the same period in 2006
were a reduction in average interest-earning assets and higher costs of
deposits, which reduced net interest income, and an increase in occupancy
expenses due to the addition of one new branch office and our new main office,
which was partially offset by a recovery of legal fees that were previously
expensed.
Interest Income. Interest income was $6,179,681 for the six months
ended June 30, 2007, compared to $6,345,967 for the six months ended June 30,
2006, a decrease of $166,286, or 2.6%. The principal reason for this decrease
was a $10,287,107 decrease in the average balance of our loan portfolio. The
decline in the average balance of loans was the principal component of a
$5,489,516 decline in average earning assets from $198,953,832 for the six
months of 2006 to $193,464,316 for the first six months of 2007. This decline in
average loans was partially offset by an increase in the average loan yield. The
decrease in interest income from the decline in average loans was partially
mitigated by an increase of $6,029,538 in the average balance of other
interest-earning assets, coupled with the increase in the average yields on
investment securities and other interest earning assets. Loans are our highest
yielding asset category, and to the extent that we are unable to invest
available funds in satisfactory loans, we must invest those funds in lower
yielding investment securities and overnight investments at lower yields.
The yields on all principal asset categories increased as the Fed
Funds rate increased, during the first half of 2006, causing increases in other
interest rate indexes, such as the Prime Rate, and market interest rates
generally. The yields on our loan portfolio and our other interest earning
assets, principally short term liquid assets, increased more rapidly than the
yield on our investment securities. This occurred because most of our loans and
liquid assets tend to have interest rates that adjust more quickly as market
interest rates change while the rates we earn on our investment securities are
primarily either fixed rates or rates that adjust at less frequent intervals.
The average balance of our loans decreased 14.3% to $61,823,241 for
the six months ended June 30, 2007 from $72,110,348 during the 2006 period. The
decrease in average balance reflects the volatility inherent in the shorter
maturity loans, the increase in competition for such loans and the general
softening of the real estate market. The average yield on loans increased by 25
basis points, from 9.69% to 9.94%, as the Prime Rate rose during the first six
months of 2006. The increase in average yield had a less significant effect than
the decline in average loan balance resulting in a $433,212 decrease in interest
income from our loan portfolio. In the future, fluctuations in the prime rate
will have a direct effect on our loan yields, except to the extent that the
effect of a significant future decline in the prime rate may cause a lesser
reduction in yield because many of our loans have interest rate floors that
would be triggered if such a decline occurs.
19
The average yield on our investment securities portfolio increased 17
basis points, from 4.54% to 4.71%, due to the purchases of securities at higher
market interest rates than the yields on the paydown of existing securities we
received. The yield on investment securities increased more slowly than the
yield on loans because most of the bonds and notes in our investment portfolio
have either fixed interest rates or interest rates that react more slowly than
our loans to changes in market interest rate conditions. The average balance of
our investment portfolio decreased by $1,231,947, or 1.1%, between the periods.
The increase in yield and decrease in volume resulted in an overall $67,727
increase in interest income from investment securities. The investment
securities portfolio represented 84.3% of average non-loan interest earning
assets in the 2007 period compared to 88.5% in the 2006 period.
Finally, we had a $199,199 increase in income from overnight funds and
other interest earning assets due to the higher market rates on short term and
overnight investments and an increase in average balance. The yield on these
investments increased 69 basis points from the first six months of 2006 to the
first six months of 2007, reflecting the effect of increases in the federal
funds rate during the first half of 2006. We increased the average balance of
overnight investments because they provide us with greater reinvestment
flexibility as we exert efforts to increase our loan portfolio and because the
gap between the rates on overnight investments versus the rates on investment
securities narrowed as short-term market rates rose while longer term rates
remained more steady.
Interest Expense. Interest expense was $1,713,030 for the six months
ended June 30, 2007, compared to $1,431,719 for the six months ended June 30,
2006, an increase of 19.7%. More than 92%, or $258,056, of the $281,311 increase
in interest expense was represented by an increase in the cost of our time
deposits. While the average balance of time accounts only increased by $167,310,
there was a 77 basis point increase in the average cost of time deposits. The
increase in rate was due to the increase in market rates between the two
comparable periods.
Our average cost of funds increased from 2.27% to 2.80% between the
periods, primarily due to the increase in the cost of time deposits and to a
lesser extent, the increased cost of other interest bearing deposits.
Competition and the increase in prevailing market interest rates required an
increase in the rates we offered on both new and renewing time deposits. While
we were able to limit interest rate increases in other deposit categories as
market interest rates rose, further increases in market rates, if they occur,
can be expected to compel increases in the rates we offer on these deposit
categories to maintain our competitive posture. Any further increase in
competition may accelerate the increase in our cost of funds resulting from
increases in market interest rates as more banks compete for customer deposits.
Net Interest Income Before Provision for Loan Losses. Net interest
income before the provision for loan losses was $4,466,651 for the six months
ended June 30, 2007, a decrease of $447,597, or 9.1% over the $4,914,248 in the
comparable 2006 period. The decrease resulted principally from the increase in
our cost of funds and the decline in the average balance of our loan portfolio.
Our net interest spread decreased to 3.61% in the first six months of 2007
compared to 4.12% in the first six months of 2006 and our net interest margin
decreased to 4.63% in the first six months of 2007 compared to 4.94% in the
first six months of 2006, respectively. On the asset side, the average yield on
earning assets in the 2007 period rose to 6.41% from 6.39% in the June 2006
period, or an increase of 2 basis points. Although the yield on such asset
categories increased by more than 2 basis points, the reduction in loans as a
percentage of interest earning assets put downward pressure on average yields.
On the liability side, there was an increase in our cost of funds of 53 basis
points from 2006.
Our margin declined more slowly than our spread because, as the
average yields on our assets increase, checking accounts, which represent a
no-cost funding source, become more valuable because we can invest the proceeds
of those deposits at higher yields. However, our average volume of checking
accounts has declined recently. This has resulted from a softening real estate
market, which causes the aggregate balance of demand deposits to decline due to
our strategy of attracting deposits from attorneys and other customers linked to
the real estate businesses. Management continually seeks to maintain a high
level of non-interest checking accounts through developing relationships with
local businesses and attorneys. Maintaining a high percentage of non-interest
checking accounts is particularly advantageous in a rising rate environment
because these no-cost funds
20
can be invested at the higher yields. However, increases in market interest
rates make interest-bearing deposit products more attractive to customers and
may cause funds to shift from non-interest checking into interest-bearing
deposit products.
Provision for Loan Losses. For the six months ended June 30, 2007, we
took a $30,000 credit to the provision for loan losses, compared to a $25,000
provision for loan losses for the six months ended June 30, 2006. The credit to
the provision for loan losses was due to the decline the loan portfolio balance,
and the level of recoveries on loans previously charged-off, which are added to
the allowance 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. Our allowance for loan losses is based on management's
evaluation of the risks inherent in our loan portfolio and the general economy.
Management periodically evaluates both broad categories of performing loans and
problem loans individually to assess the appropriate level of the allowance.
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. The allowance for loan losses
represented 1.68% of total loans at June 30, 2007, but 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 $1,076,556 for the six
months ended June 30, 2007, compared to $962,021 during the same period last
year. The $114,535, or 11.9%, increase in non-interest income was a direct
result of a $85,671 increase in service charges on deposits (primarily
non-sufficient fund fees) and a $26,221 increase in other income. Service fees
on deposit accounts, principally non-sufficient funds fees, increased from 2006
to 2007 as the volume of deposit account transactions generating fee income
increased. The increase in other income is a direct result of the Bank taking on
a select, limited group of licensed consumer check cashing companies as deposit
customers. These companies generate fee income through per item charges on their
deposits.
Non-interest Expense. Non-interest expense was $3,630,107 for the six
months ended June 30, 2007, compared to $3,646,206 for the six months ended June
30, 2006. The principal causes of the $16,099 decrease were:
o a $46,402 decrease in salaries and benefits expense, due to a
reduction in our incentive compensation accrual and a decrease in SAR
related expenses, due to a decline in our stock price, partially
offset by normal salary increases, a slight increase in staffing and
higher benefit costs.
o $140,675 in higher occupancy expenses due to the operation of our
branch in Rosebank and the opening of our new main office in Great
Kills.
o a $163,955 decrease in legal expenses due to the reimbursement from
our insurance company of legal fees previously expensed and a
reduction in attorney fees from the 2006 period.
Income Tax Expense. Income tax expense was $905,308 for the six months
ended June 30, 2007, compared to income tax expense of $1,027,382 for the six
months ended June 30, 2006. The $122,074 reduction in income tax expense was due
to the $261,963 decrease in income before income taxes in the 2007 period. Our
effective tax rate remained the same for the six months ended June 30, 2007 and
2006 at 46.6%.
21
VSB BANCORP, INC.
CONSOLIDATED AVERAGE BALANCE SHEETS
(UNAUDITED)
Three Three
Months Ended Months Ended
June 30, 2007 June 30, 2006
---------------------------------------- ---------------------------------------
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
------------- ------------- -------- ------------- ------------- --------
ASSETS:
Interest-earning assets:
Loans receivable $ 60,410,867 $ 1,501,344 9.78% $ 71,051,439 $ 1,758,136 9.89%
Investment securities, afs 110,527,053 1,293,698 4.69 115,972,102 1,320,669 4.57
Other interest-earning assets 21,180,119 264,761 5.01 11,714,329 133,179 4.56
------------- ------------- ------------- -------------
Total interest-earning assets 192,118,039 3,059,803 6.33 198,737,870 3,211,984 6.47
Non-interest earning assets 14,599,860 14,098,652
------------- -------------
Total assets $ 206,717,899 $ 212,836,522
============= =============
LIABILITIES AND EQUITY:
Interest-bearing liabilities:
Savings accounts $ 12,158,415 25,355 0.84 $ 12,885,962 21,044 0.66
Time accounts 67,095,405 627,874 3.75 66,200,312 531,071 3.22
Money market accounts 20,014,699 97,559 1.96 20,816,866 95,447 1.84
Now accounts 19,785,685 29,960 0.61 22,221,904 26,442 0.48
Subordinated debt 5,155,000 89,039 6.91 5,155,000 89,039 6.91
------------- ------------- ------------- -------------
Total interest-bearing liabilities 124,209,204 869,787 2.84 127,280,044 763,043 2.40
Checking accounts 62,044,199 68,214,024
------------- -------------
Total deposits and subordinated debt 186,253,403 195,494,068
Other liabilities 1,638,568 2,257,210
------------- -------------
Total liabilities 187,891,971 197,751,278
Equity 18,825,928 15,085,244
------------- -------------
Total liabilities and equity $ 206,717,899 $ 212,836,522
============= =============
Net interest income/net interest
rate spread $ 2,190,016 3.49% $ 2,448,941 4.07%
============= ======== ============= ========
Net interest earning assets/net
interest margin $ 67,908,835 4.51% $ 71,457,826 4.93%
============= ======== ============= ========
Ratio of interest-earning assets
to interest-bearing liabilities 1.55x 1.56x
============= =============
Return on Average Assets (1) 0.96% 1.10%
============= =============
Return on Average Equity (1) 10.50% 15.53%
============= =============
Tangible Equity to Total Assets 8.65% 6.63%
============= =============
Six Six
Months Ended Months Ended
June 30, 2007 June 30, 2006
---------------------------------------- ---------------------------------------
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
------------- ------------- --------- ------------- ------------- --------
ASSETS:
Interest-earning assets:
Loans receivable $ 61,823,241 $ 3,073,697 9.94% $ 72,110,348 $ 3,506,909 9.69%
Investment securities, afs 111,027,255 2,594,158 4.71 112,259,202 2,526,431 4.54
Other interest-earning assets 20,613,820 511,826 5.01 14,584,282 312,627 4.32
------------- ------------- ------------- -------------
Total interest-earning assets 193,464,316 6,179,681 6.41 198,953,832 6,345,967 6.39
Non-interest earning assets 15,596,744 14,124,383
------------- -------------
Total assets $ 209,061,060 $ 213,078,215
============= =============
LIABILITIES AND EQUITY:
Interest-bearing liabilities:
Savings accounts $ 12,284,927 49,783 0.82 $ 13,836,486 39,378 0.57
Time accounts 66,928,171 1,243,010 3.75 66,760,861 984,954 2.98
Money market accounts 19,194,558 183,409 1.93 20,353,010 179,663 1.78
Now accounts 19,775,262 58,749 0.60 21,182,701 49,645 0.47
Subordinated debt 5,155,000 178,079 6.91 5,155,000 178,079 6.91
------------- ------------- ------------- -------------
Total interest-bearing liabilities 123,337,918 1,713,030 2.80 127,288,058 1,431,719 2.27
Checking accounts 65,037,639 68,253,077
------------- -------------
Total deposits and subordinated debt 188,375,557 195,541,135
Other liabilities 2,213,557 2,461,396
------------- -------------
Total liabilities 190,589,114 198,002,531
Equity 18,471,946 15,075,684
------------- -------------
Total liabilities and equity $ 209,061,060 $ 213,078,215
============= =============
Net interest income/net interest
rate spread $ 4,466,651 3.61% $ 4,914,248 4.12%
============= ======== ============= ========
Net interest earning assets/net
interest margin $ 70,126,398 4.63% $ 71,665,774 4.94%
============= ======== ============= ========
Ratio of interest-earning assets
to interest-bearing liabilities 1.57x 1.56x
============= =============
Return on Average Assets (1) 0.99% 1.09%
============= =============
Return on Average Equity (1) 11.18% 15.45%
============= =============
Tangible Equity to Total Assets 8.65% 6.63%
============= =============
(1) Ratios have been annualized.
22
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, 2007, we had a net increase in
total deposits of $3,043,289 as a result of a $5,344,775 increase in money
market accounts, a $874,352 increase in NOW accounts and a $713,595 increase in
time deposits, partially offset by a $3,124,974 decrease in demand and checking
accounts and a $764,459 decrease in savings accounts. We received proceeds from
repayment of investment securities of $12,759,728. We used $11,511,654 of
available funds to purchase new investment securities. We had a net loan
reduction of $3,043,289 and we used $2,898,001 of cash for capitalized leasehold
improvements and equipment for our new main office in Great Kills. These changes
resulted in an overall increase in cash and cash equivalents of $9,619,953.
In contrast, during the six months ended June 30, 2006, our retail
banking activities generated a net increase in deposits of $7,974,607 and we had
a net decrease in loans receivable of $2,272,731, which combined to generate
$10,247,388 in cash. In addition, we received proceeds from repayment of
investment securities of $10,121,487. We used $23,944,173 of available funds to
purchase new investment securities, resulting in an overall reduction in cash
and cash equivalents of $3,495,230. We applied available funds principally to
purchase the $23,944,173 of investment securities to increase investment
collateral available to pledge for the $35 million in municipal CDs that we
received in 2006 in connection with the establishment of the banking development
districts in Staten Island.
Victory State Bank satisfied all capital ratio requirements of the
Federal Deposit Insurance Corporation at June 30, 2007, with a Tier I Leverage
Capital ratio of 11.87%, a ratio of Tier I Capital to Risk-Weighted Assets ratio
of 27.34%, and a Total Capital to Risk-Weighted Assets ratio of 28.49%.
VSB Bancorp, Inc. satisfied all capital ratio requirements of the
Federal Reserve at June 30, 2007, with a Tier I Leverage Capital ratio of
12.20%, a ratio of Tier I Capital to Risk-Weighted Assets ratio of 28.10%, and a
Total Capital to Risk-Weighted Assets ratio of 29.24%.
The following table sets forth our contractual obligations and
commitments for future lease payments, time deposit maturities and loan
commitments.
23
CONTRACTUAL OBLIGATIONS AND COMMITMENTS AT JUNE 30, 2007
Payment due by Period
-------------------------------------------------------------------------
Less than One to three Four to five After Total Amounts
Contractual Obligations One Year years years five years committed
------------------------------------- ------------ ------------ ------------ ------------ -------------
Minimum annual rental payments under
non-cancelable operating leases $ 392,314 $ 798,263 $ 825,690 $ 2,428,371 $ 4,444,638
Remaining contractual maturities of
time deposits 65,947,448 1,275,392 1,719,999 - 68,942,839
------------ ------------ ------------ ------------ -------------
Total contractual cash obligations $ 66,339,762 $ 2,073,655 $ 2,545,689 $ 2,428,371 $ 73,387,477
============ ============ ============ ============ =============
Amount of commitment Expiration by Period
-------------------------------------------------------------------------
Less than One to three Four to five After Total Amounts
Other commitments One Year years years five years committed
------------------------------------- ------------ ------------ ------------ ------------ -------------
Loan commitments $ 13,632,338 $ 9,296,338 $ 595,000 $ - $ 23,523,676
============ ============ ============ ============ =============
Our loan commitments shown in the above table represent both
commitments to make new loans and obligations to make additional advances on
existing loans, such as construction loans in process and lines of credit.
Substantially all of these commitments involve loans with fluctuating interest
rates, so the outstanding commitments do not expose us to interest rate risk
upon fluctuation in market rates.
CRITICAL ACCOUNTING POLICIES AND JUDGMENTS
We are required to make estimates and assumptions that affect the
reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities at the date of the financial statements and the amounts
of revenues and expenses during the reporting period. The allowance for loan
losses, prepayment estimates on the mortgage-backed securities and
Collateralized Mortgage Obligation portfolios, contingencies and fair values of
financial instruments are particularly subject to change and to management's
estimates. Actual results can differ from those estimates and may have an impact
on our financial statements.
ITEM 3 - CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures: As of June 30, 2007,
we undertook an evaluation of our disclosure controls and procedures under the
supervision and with the participation of Merton Corn, President and CEO, and
Raffaele M. Branca, Executive Vice President and CFO. 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-KSB and
quarterly periodic reports on Form 10-QSB) 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. Messrs. Corn and Branca
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 corrective actions taken 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.
24
PART II
ITEM 1 - LEGAL PROCEEDINGS
The Bank is a defendant in an action pending in Supreme Court, Richmond County,
commenced by IndyMac Bank, F.S.B. against the Bank, LaMattina & Associates, Inc.
("LAI") and various individuals and entities alleged to be officers, directors
or otherwise to have relationships with LAI. LAI was a deposit customer of the
Bank engaged in the business of providing real estate settlement services to
lenders making residential mortgage loans. The plaintiff alleges that it was
such a lender and that it had provided funds to LAI by wiring those funds to an
account of LAI at the Bank to use to fund mortgage loans to be made by the
plaintiff, only to have LAI not use those funds for their intended purpose. The
action was commenced in August 2005. In November 2005, the plaintiff amended its
complaint to add the Bank as a defendant. The plaintiff amended its complaint
again and the Bank moved to dismiss the claims. In February 2007, the court
dismissed two of the claims against the Bank but allowed the Plaintiff to
proceed and conduct discovery with respect to two claims, one for negligence and
the other for conversion.
The amended complaint requests monetary damages against the Bank of $1,817,041.
The Bank intends to defend aggressively the amended claims and has referred the
litigation to its insurance carrier, which has indicated that the claims
asserted against the Bank are covered by insurance. The Bank has also asserted
cross-claims against various former customers, principals of those customers,
and other related persons on the grounds that if the Bank is held liable to the
plaintiff, then the liability is the result of the misdeeds or negligence of
those other parties.
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.
25
SIGNATURE PAGE
In accordance with the requirements of the Exchange Act, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
VSB BANCORP, INC.
Date: August 14, 2007 /s/ Merton Corn
-------------------------------------
Merton Corn
President and Chief Executive Officer
Date: August 14, 2007 /s/ Raffaele M. Branca
-------------------------------------
Raffaele M. Branca
Executive Vice President and
Chief Financial Officer
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 Chief Financial Officer
32.1 Certification by CEO pursuant to 18 U.S.C. 1350.
32.2 Certification by CFO pursuant to 18 U.S.C. 1350.
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 Chief Financial Officer
32.1 Certification by CEO pursuant to 18 U.S.C. 1350.
32.2 Certification by CFO pursuant to 18 U.S.C. 1350.
26