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, 2005
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OF THE EXCHANGE ACT
FOR THE TRANSITION PERIOD FROM _______ TO _______
COMMISSION FILE NUMBER 0-50237
VSB Bancorp, Inc.
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(Name of Small Business Issuer in its charter)
New York
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(State or other jurisdiction of incorporation or organization)
11 - 3680128
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(I. R. S. Employer Identification No.)
3155 Amboy Road, Staten Island, New York 10306
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(Address of principal executive offices)
(718) 979-1100
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Issuer's telephone number
Common Stock
----------------
(Title of Class)
The Registrant had 1,508,822 common shares outstanding as of July 29, 2005.
CROSS REFERENCE INDEX
PART I
Page
----
Item 1 Consolidated Statements of Financial Condition as of
June 30, 2005 and December 31, 2004 (unaudited). 4
Consolidated Statements of Operations for the Three
and Six Months Ended June 30, 2005 and 2004 (unaudited). 5
Consolidated Statements of Changes in Stockholders'
Equity for the Six Months Ended June 30, 2005
and the Year Ended December 31, 2004 (unaudited). 6
Consolidated Statements of Cash Flows for the Three
and Six Months Ended June 30, 2005 and 2004 (unaudited). 7
Notes to Consolidated Financial Statements for the Three
and Six Months Ended June 30, 2005 and 2004 (unaudited). 8 to 13
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 13 to 24
Item 3 Control and Procedures 24
PART II
Signature Page 25
Exhibit 31.1, 31.2, 32.1, 32.2 26 to 29
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.
Please do not place undue reliance on any forward-looking statement,
which speaks only as of the date we make it. There are many factors, including
those we have 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.
3
VSB Bancorp, Inc.
Consolidated Statements of Financial Condition
(unaudited)
June 30, December 31,
2005 2004
------------- -------------
Assets:
Cash and cash equivalents $ 24,598,792 $ 35,659,073
Investment securities, available for sale 114,369,789 128,532,767
Loans receivable 76,232,249 68,046,885
Allowance for loan loss (1,410,640) (1,299,520)
------------- -------------
Loans receivable, net 74,821,609 66,747,365
Bank premises and equipment, net 1,611,597 1,817,284
Accrued interest receivable 743,127 745,368
Deferred taxes 1,523,524 1,462,940
Other assets 1,038,223 719,670
------------- -------------
Total assets $ 218,706,661 $ 235,684,467
============= =============
Liabilities and stockholders' equity:
Liabilities:
Deposits:
Demand and checking $ 73,825,298 $ 101,560,932
NOW 29,005,794 21,574,053
Money market 20,890,547 23,388,850
Savings 16,439,161 14,159,026
Time 56,496,039 54,470,507
------------- -------------
Total Deposits 196,656,839 215,153,368
Escrow deposits 282,011 270,105
Subordinated debt 5,155,000 5,155,000
Accounts payable and accrued expenses 2,354,109 2,149,548
------------- -------------
Total liabilities 204,447,959 222,728,021
------------- -------------
Employee Stock Ownership Plan Repurchase Obligation 122,550 126,825
Stockholders' equity:
Common stock, ($.0001 par value, 3,000,000 shares
authorized, 1,508,822 issued and outstanding at
June 30, 2005 and 1,505,022 issued and
outstanding at December 31, 2004) 151 150
Additional paid in capital 8,866,361 8,818,313
Retained earnings 7,318,517 6,054,264
Unallocated ESOP Shares (1,493,522) (1,578,061)
Accumulated other comprehensive loss,
net of taxes of $484,441 and $405,662,
respectively (555,355) (465,045)
------------- -------------
Total stockholders' equity 14,136,152 12,829,621
------------- -------------
Total liabilities and stockholders'
equity $ 218,706,661 $ 235,684,467
============= =============
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, 2005 June 30, 2004 June 30, 2005 June 30, 2004
------------- ------------- ------------- -------------
Interest and dividend income:
Loans receivable $ 1,352,333 $ 1,303,760 $ 2,652,969 $ 2,617,500
Investment securities 1,235,763 897,417 2,555,248 1,741,064
Other interest earning assets 83,142 43,986 145,260 67,720
------------- ------------- ------------- -------------
Total interest income 2,671,238 2,245,163 5,353,477 4,426,284
Interest expense:
NOW 27,871 26,892 49,896 50,674
Money market 51,953 50,506 106,000 96,774
Savings 20,111 14,742 38,338 28,180
Subordinated debt 89,039 89,039 178,079 178,079
Time 263,269 81,882 450,386 159,994
------------- ------------- ------------- -------------
Total interest expense 452,243 263,061 822,699 513,701
Net interest income 2,218,995 1,982,102 4,530,778 3,912,583
Provision (credit) for loan loss (45,000) 50,000 (75,000) 100,000
------------- ------------- ------------- -------------
Net interest income
after provision for loan loss 2,263,995 1,932,102 4,605,778 3,812,583
------------- ------------- ------------- -------------
Non-interest income:
Loan fees 33,635 18,674 57,094 34,197
Service charges on deposits 440,590 407,976 844,607 835,666
Net rental income 10,542 11,762 21,605 19,794
Other income 29,410 17,595 54,493 44,293
------------- ------------- ------------- -------------
Total non-interest income 514,177 456,007 977,799 933,950
------------- ------------- ------------- -------------
Non-interest expenses:
Salaries and benefits 935,254 834,101 1,873,750 1,630,368
Occupancy expenses 239,982 228,150 486,742 459,477
Legal expense 23,451 53,423 33,375 84,298
Professional fees 51,000 49,527 126,000 95,777
Computer expense 60,138 70,532 114,950 135,226
Other expenses 304,755 236,103 581,573 490,506
------------- ------------- ------------- -------------
Total non-interest expenses 1,614,580 1,471,836 3,216,390 2,895,652
------------- ------------- ------------- -------------
Income before income taxes 1,163,592 916,273 2,367,187 1,850,881
Provision/(benefit) for income taxes:
Current 526,438 516,217 1,084,740 994,130
Deferred 15,693 (89,252) 18,194 (131,727)
------------- ------------- ------------- -------------
Total provision for income taxes 542,131 426,965 1,102,934 862,403
------------- ------------- ------------- -------------
Net income $ 621,461 $ 489,308 $ 1,264,253 $ 988,478
============= ============= ============= =============
Basic income per common share $ 0.43 $ 0.34 $ 0.88 $ 0.70
============= ============= ============= =============
Diluted net income per share $ 0.42 $ 0.33 $ 0.85 $ 0.67
============= ============= ============= =============
Comprehensive income/(loss) $ 1,421,335 $ (958,821) $ 1,173,943 $ (216,577)
============= ============= ============= =============
Book value per common share $ 9.45 $ 7.06 $ 9.45 $ 7.06
============= ============= ============= =============
See notes to consolidated financial statements.
5
VSB Bancorp, Inc.
Consolidated Statements of Changes in Stockholders' Equity
Year Ended December 31, 2004 and Six Months Ended June 30, 2005
(unaudited)
Accumulated
Number of Additional Unallocated Other Total
Common Common Paid-In Retained ESOP Comprehensive Stockholders'
Shares Stock Capital Earnings Shares Loss Equity
--------- ------ ------------ ----------- ------------ ---------- ------------
Balance at December 31, 2003 1,055,998 $ 106 $ 7,076,486 $ 3,779,686 $ -- $ (169,666) $ 10,686,612
Exercise of stock option 22,720 2 177,802 177,804
4 for 3 stock split and purchase
of fractional shares 351,984 35 (368) (333)
Purchase of newly issued
common stock by ESOP 74,320 7 1,690,773 1,690,780
Issuance of ESOP shares (1,690,780) (1,690,780)
Amortization of earned portion
of ESOP common stock 112,719 112,719
Amortization of excess fair
value over cost - ESOP 445 445
Transfer to ESOP repurchase
obligation (126,825) (126,825)
Comprehensive income:
Net income 2,274,578 2,274,578
Other comprehensive income, net:
Unrealized holding loss arising
during the year -- -- -- -- -- (295,379) (295,379)
--------- ------ ------------ ----------- ------------ ---------- ------------
Total comprehensive income 1,979,199
Balance at December 31, 2004 1,505,022 $ 150 $ 8,818,313 $ 6,054,264 $ (1,578,061) $ (465,045) $ 12,829,621
--------- ------ ------------ ----------- ------------ ---------- ------------
Exercise of stock option 3,800 1 40,775 40,776
Amortization of earned portion
of ESOP common stock 84,539 84,539
Amortization of excess fair
value over cost - ESOP 2,998 2,998
Transfer from ESOP repurchase
obligation 4,275 4,275
Comprehensive income:
Net income 1,264,253 1,264,253
Other comprehensive income, net:
Unrealized holding loss arising
during the year -- -- -- -- -- (90,310) (90,310)
--------- ------ ------------ ----------- ------------ ---------- ------------
Total comprehensive income 1,173,943
Balance at June 30, 2005 1,508,822 $ 151 $ 8,866,361 $ 7,318,517 $ (1,493,522) $ (555,355) $ 14,136,152
========= ====== ============ =========== ============ ========== ============
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, 2005 June 30, 2004 June 30, 2005 June 30, 2004
------------- ------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 621,461 $ 489,308 $ 1,264,253 $ 988,478
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation and amortization 115,147 128,930 229,083 254,873
Accretion of income, net of amortization of premium (13,423) (25,861) (38,360) (44,673)
ESOP compensation expense 44,358 28,774 87,537 28,773
Provision/(credit) for loan losses (45,000) 50,000 (75,000) 100,000
(Increase)/decrease in prepaid and other assets (97,647) (88,228) (318,553) (84,127)
(Increase)/decrease in accrued interest receivable (21,295) (34,974) 2,241 (6,912)
Decrease/(increase) in deferred income taxes 15,693 (89,252) 18,194 (131,726)
Decrease/(increase) in accrued expenses and other liabilities (142,118) 718,428 204,561 921,119
------------- ------------- ------------- -------------
Net cash provided by operating activities 477,176 1,177,125 1,373,956 2,025,805
------------- ------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in loan receivable (9,557,842) (3,556,833) (7,887,938) (3,029,334)
Proceeds from maturities of money market investments -- 1,971,834 -- 2,332,660
Proceeds from repayment of investments securities,
available for sale 6,793,035 8,905,657 13,920,944 13,572,306
Purchases of money market investments -- (2,045,123) -- (2,346,477)
Purchases of investment securities, afs -- (27,231,164) -- (27,231,164)
Purchases of premises and equipment (15,979) (45,349) (23,396) (53,772)
------------- ------------- ------------- -------------
Net cash (used in)/provided by investing activities (2,780,786) (22,000,978) 6,009,610 (16,755,781)
------------- ------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (decrease)/increase in deposits (6,739,871) 21,483,889 (18,484,623) 22,689,693
Exercise stock option 40,776 118,580 40,776 167,604
Proceeds from ESOP loan -- 1,690,780 -- 1,690,780
Purchase of ESOP shares -- (1,690,780) -- (1,690,780)
4 for 3 stock split and the purchase of fractional shares -- -- -- (333)
------------- ------------- ------------- -------------
Net cash (used in)/provided by financing activities (6,699,095) 21,602,469 (18,443,847) 22,856,964
------------- ------------- ------------- -------------
NET (DECREASE)/INCREASE IN CASH
AND CASH EQUIVALENTS (9,002,705) 778,616 (11,060,281) 8,126,988
------------- ------------- ------------- -------------
CASH AND CASH EQUIVALENTS,
BEGINNING OF PERIOD 33,601,497 37,536,113 35,659,073 30,187,741
------------- ------------- ------------- -------------
CASH AND CASH EQUIVALENTS,
END OF PERIOD $ 24,598,792 $ 38,314,729 $ 24,598,792 $ 38,314,729
============= ============= ============= =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid during the period for:
Interest $ 408,849 $ 258,755 $ 771,849 $ 589,916
============= ============= ============= =============
Taxes $ 1,039,075 $ 728,050 $ 1,276,887 $ 933,201
============= ============= ============= =============
See notes to consolidated financial statements.
7
VSB Bancorp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE AND SIX MONTHS ENDED
JUNE 30, 2005 AND 2004 (UNAUDITED)
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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 Victory State Bank into the
holding company form of organization. The stockholders of Victory State 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. VSB Bancorp owns 100% of the capital stock of Victory State
Bank. 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 FDIC. The Bank is supervised by the New York State
Banking Department and the Federal Deposit Insurance Corporation ("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 (the "Bank"). All significant inter-company accounts and transactions
between the Company and Bank have been eliminated in consolidation. All
adjustments, consisting of normal recurring accruals, which in the opinion of
management are necessary for fair presentation of the consolidated financial
statements, have been included.
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,
and fair values of financial instruments are particularly subject to change.
Reclassifications - Some items in the prior year financial statements, as
restated, 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. 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 accounts. During the fourteen day
period from June 23, 2005 through July 6, 2005, Victory State Bank was required
to maintain reserves, after deducting vault cash, of $4,509,000. Reserves are
required to be maintained on a fourteen day basis, so, from time to time,
8
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
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. Premiums and discounts are recognized in interest income
using a method that approximates the level yield method. 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 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
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 adequate.
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. On a limited basis, the Company may apply a payment to interest on
a non-accrual loan if there is no impairment or no estimatible 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.
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.
9
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. 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.
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 and its eventual disposition. 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,
less the cost to sell.
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.
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.
Basic Income Per Common Share and Diluted Net Income Per Common Share -
Basic income per share of common stock is based on 1,440,559 shares and
1,425,128 shares, the weighted average number of common shares outstanding for
the three months ended June 30, 2005 and 2004, respectively. Diluted net income
per share of common stock is based on 1,490,689 shares and 1,474,561 shares, the
weighted average number of common shares and potentially dilutive common shares
outstanding for the three months ended June 30, 2005 and 2004, 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 49,772 and 49,216 shares for the for the three months ended June 30, 2005 and
2004, respectively. Common stock equivalents were calculated using the treasury
stock method.
The reconciliation of the numerators and the denominators of the basic and
diluted per share computations for the three months ended June 30, are as
follows:
10
Reconciliation of EPS
---------------------
Three Months Ended Three Months Ended
June 30, 2005 June 30, 2004
------------------------------------------ ------------------------------------------
Weighted Weighted
Net Average Per Share Net Average Per Share
Income Shares Amount Income Shares Amount
------------ ------------ ------------ ------------ ------------ ------------
Basic income per
common share
-------------------------
Net income available to
common stockholders $ 621,461 1,440,559 $ 0.43 $ 489,308 1,425,128 $ 0.34
============ ============
Effect of dilutive shares
-------------------------
Weighted average
shares, if converted 50,130 49,433
------------ ------------
Diluted net income per
common share
-------------------------
Net income available to
common stockholders $ 621,461 1,490,689 $ 0.42 $ 489,308 1,474,561 $ 0.33
============ ============ ============ ============ ============ ============
Reconciliation of EPS
---------------------
Six Months Ended Six Months Ended
June 30, 2005 June 30, 2004
------------------------------------------ ------------------------------------------
Weighted Weighted
Net Average Per Share Net Average Per Share
Income Shares Amount Income Shares Amount
------------ ------------ ------------ ------------ ------------ ------------
Basic income per
common share
-------------------------
Net income available to
common stockholders $ 1,264,253 1,438,426 $ 0.88 $ 988,478 1,417,989 $ 0.70
============ ============
Effect of dilutive shares
-------------------------
Weighted average
shares, if converted 49,802 64,953
------------ ------------
Diluted net income per
common share
-------------------------
Net income available to
common stockholders $ 1,264,253 1,488,228 $ 0.85 $ 988,478 1,482,942 $ 0.67
============ ============ ============ ============ ============ ============
Stock Based Compensation - At June 30, 2005, the Company had stock-based
employee compensation plans. The Company accounts for these plans under
Accounting Principles Board Opinion, ("APB Opinion") No. 25, "Accounting for
Stock Issued to Employees," and related interpretations. No stock-based employee
compensation expense has been reflected in net income for stock options as all
rights and options to purchase the Company's stock granted under these plans
have an exercise price equal to the market value of the underlying stock on the
date of grant.
If compensation cost for the Stock Plan and Director's Stock Plan awards had
been measured based on the fair value of the stock options awarded at the grant
dates, net income and basic and diluted earnings per common share would have
been reduced to the pro-forma amounts on the table below for the three and six
months ended June 30, 2005 and 2004.
11
Three months Three months Six months Six months
ended ended ended ended
June 30, 2005 June 30, 2004 June 30, 2005 June 30, 2004
-------------- -------------- -------------- --------------
Net Income
As reported $ 621,461 $ 489,308 $ 1,264,253 $ 988,478
Less: Total stock-based compensation expense
determined under the fair value method for
all rewards, net of related tax effects 13,562 10,966 27,026 21,932
-------------- -------------- -------------- --------------
Pro-forma $ 607,899 $ 478,342 $ 1,237,227 $ 966,546
============== ============== ============== ==============
Three months Three months Six months Six months
ended ended ended ended
June 30, 2005 June 30, 2004 June 30, 2005 June 30, 2004
-------------- -------------- -------------- --------------
Basic income per common share
As reported $ 0.43 $ 0.34 $ 0.88 $ 0.70
Less: Total stock-based compensation expense
determined under the fair value method for
all rewards, net of related tax effects 0.01 -- 0.02 0.02
-------------- -------------- -------------- --------------
Pro-forma $ 0.42 $ 0.34 $ 0.86 $ 0.68
============== ============== ============== ==============
Three months Three months Six months Six months
ended ended ended ended
June 30, 2005 June 30, 2004 June 30, 2005 June 30, 2004
-------------- -------------- -------------- --------------
Diluted net income per common share
As reported $ 0.42 $ 0.33 $ 0.85 $ 0.67
Less: Total stock-based compensation expense
determined under the fair value method for
all rewards, net of related tax effects 0.01 0.01 0.02 0.02
-------------- -------------- -------------- --------------
Pro-forma $ 0.41 $ 0.32 $ 0.83 $ 0.65
============== ============== ============== ==============
Employee Stock Ownership Plan - The cost of shares issued to the Employee
Stock Ownership Plan ("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. Dividends on allocated ESOP shares reduce retained earnings; dividends
on unearned ESOP shares reduce debt and accrued interest. As participants may
put their ESOP shares back to the Company upon termination, an amount of equity
equal to these shares multiplied by the current market price is reclassified out
of stockholders' equity and is then classified as the Employee Stock Ownership
Plan Obligation.
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 - In December 2004, FASB issued
Statement of Financial Accounting Standards No 123 Revised "Share Based
Payments" ("SFAS 123R") which requires all public companies to record
compensation cost for stock options provided to employees in return for employee
service. The cost is measured at the fair value of the options when granted, and
this cost is expensed over the employee service period, which is normally the
vesting period of the options. As a small business filer, SFAS 123R will apply
12
to awards granted or modified after the first quarter or year beginning after
December 15, 2005. Compensation cost will also be recorded for prior option
grants that vest after the date of adoption. The effect on results 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 the effect cannot currently be predicted. There will be no
significant effect on financial position as total equity will not change. The
effect of these other new standards on the Company's financial position and
results of operations is not expected to be material upon and after adoption.
Management continuously monitors emerging issues and accounting bulletins, some
of which could potentially impact the Company's financial statements
Item 2
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Changes in Financial Condition
Our total assets were $218,706,661 at June 30, 2005, a decrease of
$16,977,806, or 7.2%, since December 31, 2004. The decrease resulted from
deposit outflow, mainly from demand accounts, which was primarily funded by the
principal paydowns received on investment securities available for sale and from
a reduction in cash and cash equivalents. The deposit outflow was concentrated
in attorney escrow accounts used to fund mortgage closings, as the level of
pending mortgage financings has been reduced from levels seen in 2004, which
reduces the deposit balance in those related accounts. Our asset mix changed as
net loans receivable increased during the six months of 2005 because of our
efforts to increase our loan portfolio, while cash equivalents and investment
securities decreased in order to fund loan growth and the deposit outflow.
Our deposits (including escrow deposits) were $196,938,850 at June 30,
2005, a decrease of $18,484,623, or 8.6%, from December 31, 2004. The decrease
in deposits includes a $27,723,728 decrease in non-interest demand deposits and
a $2,498,303 decrease in money market accounts, partially offset by an increase
of $7,431,741 in NOW accounts, a $2,025,532 increase in time deposits and a
$2,280,135 increase in savings accounts.
Total stockholders' equity was $14,136,152 at June 30, 2005, an increase of
$1,306,531 from December 31, 2004. The increase reflected net income of
$1,264,253 for the six months ended June 30, 2005 and a net reduction of $90,310
in other comprehensive income due to an increase in the unrealized loss for
securities available for sale during the first six months of 2005. The
unrealized loss increased due to the recent increases in short-term market
interest rates. This 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 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 further. Management believes that the principal and
interest payments on this portfolio, combined with the existing liquidity, will
be sufficient to fund loan growth.
The increase in stockholders' equity also included an increase of $40,775
in additional paid in capital due to the exercise of options to purchase 3,800
shares of common stock, the transfer of $4,275 to additional paid in capital
from the Employee Stock Ownership Plan Obligation and a decrease in unearned
ESOP shares of $84,539 reflecting the effect of the gradual payment of the
ten-year loan we made to our ESOP to fund the ESOP's purchase of our stock. In
May of 2004, the ESOP purchased 74,320 shares of our common stock out of our
authorized but unissued shares, which had no net effect on capital on the
purchase date. The purchase price was $22.75 per share, the fair market value at
that time, for a total purchase price of $1.7 million. As payments are made to
reduce the ESOP loan, stock is released from the security interest for the loan,
resulting in an increase in capital equal to the market value of the ESOP stock
as it is released. However, under federal law regarding employee stock ownership
plans, since our stock is not considered to be "readily tradable on an
13
established market," employees who receive a distribution of stock from the ESOP
upon termination of employment have the right to require that we repurchase the
stock at fair value. We reflect this contingent repurchase obligation on our
balance sheet as a reclassification of additional paid in capital to mezzanine
capital, based upon our quoted price on June 30, 2005 and December 31, 2004,
respectively, but the amounts still qualify as capital for regulatory purposes.
For financial statement reporting purposes, we record the compensation
expense related to the ESOP when shares are to be released from the security
interest for the loan. The amount of the compensation expense will be based upon
the fair market value of the shares at that time, not the original purchase
price. 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.
On August 28, 2003, we received the net proceeds of $4.86 million from the
issuance of subordinated debt to VSB Capital Trust I and the Trust's subsequent
issuance of $5 million of trust preferred securities. We can include the
proceeds from the trust preferred securities, up to 25% of our total capital, as
Tier 1 capital, when determining compliance with Federal Reserve regulatory
capital requirements for bank holding companies. We contributed substantially
all of the proceeds of the trust preferred offering to the Bank, thus increasing
its capital and allowing it to satisfy its regulatory capital requirements while
growth continues. However, trust preferred securities generate interest expense
at the holding company level.
VSB Bancorp, Inc. satisfied all capital ratio requirements of the Federal
Reserve at June 30, 2005, with a Tier I Leverage Capital ratio of 9.27%, a ratio
of Tier I Capital to Risk-Weighted Assets ratio of 18.74%, and a Total Capital
to Risk-Weighted Assets ratio of 20.04%.
Victory State Bank is a state-chartered, stock commercial bank, which
opened for business in November 1997. Our primary market is Staten Island, New
York. Since Victory State Bank opened for business, management has worked to
grow the Bank's franchise. From one office in 1997, the Bank now has four
offices. From no deposits, no loans and less than $7.0 million of assets on the
day it opened for business in 1997, the Bank has grown to total assets of $218.4
million, total deposits of $196.9 million and capital of $18.5 million by June
30, 2005. The Bank has recently received approval to open its fifth banking
office.
Management intends to exert efforts to grow our company in the future.
However, both internal and external factors could adversely affect our future
growth. The current economy and competition has made it more difficult for us to
originate new loans that meet our underwriting standards. Not only does that
cause us to invest available funds in lower-yielding securities and deposits
with other banks, but it also slows the development of non-loan relationships
which sometimes flow from cross-selling to loan customers.
Because our activities are concentrated in Staten Island, adverse economic
conditions in the borough could make it difficult for us to execute our growth
plans. Furthermore, regulatory capital requirements could have a negative effect
on our ability to grow if growth outpaces our ability to support that growth
with increased capital.
Results of Operations for the Quarters Ended June 30, 2005 and June 30, 2004
Our results of operations are dependent primarily on net interest income,
which is the difference between the income earned on our loan and investment
portfolios and our costs of funds, consisting primarily of interest paid on our
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.
14
As described in detail below, most of our improvement in net income from
2004 to 2005 was the result of growth between the periods. However, the first
six months of 2005 showed a reversal of the constant growth we experienced since
we opened for business in 1997, with average interest-earning assets declining
from $202.8 million in the first quarter of 2005 to $200.6 million in the second
quarter of 2005. A decline in deposits, causing a decline in funds we have
available for investment, could result in a decline in net interest income.
Management intends to seek additional funds for further investment through
opening new branches and the personal solicitation of new business at our
existing offices, but there can be no guaranty that we will be able to continue
to grow our franchise and increase interest income in the future.
General. We had net income of $621,461 for the quarter ended June 30, 2005,
compared to net income of $489,308 for the comparable quarter in 2004. The
principal categories which make up the 2005 net income are:
o Interest income of $2,671,238
o Reduced by interest expense of $452,243
o Increased by a credit provision for loan loss of $45,000
o Increased by non-interest income of $514,177
o Reduced by non-interest expenses of $1,614,580
o Reduced by $542,131 in income tax expense.
We discuss each of these categories individually and the reasons for the
differences between the quarter ended June 30, 2005 and the comparable quarter
in 2004 in the following paragraphs. The over-riding factor affecting the
changes in our operating results in all these categories is our implementation
of our growth strategy during 2004 which resulted in an increase in total assets
of $51.2 million during the year. The implementation of our ESOP beginning in
2004 increases compensation expense as we make contributions to the ESOP.
Interest Income. Interest income was $2,671,238 for the quarter ended June
30, 2005, compared to $2,245,163 for the quarter ended June 30, 2004, an
increase of $426,075, or 19.0%. The principal reason for the increase was a
$31,006,304 increase in the average balance of investment securities, as we
deployed the cash from a higher level of average deposits into investment
securities. We chose to invest new deposits in investment securities, rather
than other short-term liquid assets, to take advantage of the higher yields
available for investment securities pending planned redeployment of the funds
into loans as, when and if appropriate opportunities are available. The increase
in the volume of investment securities, coupled with a 0.04% increase in the
average yield on those securities, generated a $338,346 increase in interest
earned on investment securities.
The average balance of our loans increased by $1,567,599 or 2.3%, from
$69,350,806 during the 2004 quarter to $70,918,405 during the 2005 quarter as a
result of our efforts to increase our loan portfolio, which is our highest
yielding asset category. The increase in loan volume was the principal reason
for the $48,573 increase in interest income from loans. We also had a $39,156
increase in income from overnight funds and other interest earning assets as the
Federal Reserve Board's periodic increases in the target federal funds rate
beginning in mid-2004 had a direct and virtually immediate effect on our yield
on overnight investments. Although the average balance of overnight investments
decreased $9,062,405, because we chose to invest in higher-yielding investment
securities, the yield on overnight investments increased 186 basis points.
Due to interest rate floors on many of our prime-based loans, our loan
yields have been relatively constant in recent quarters. In contrast, the
average yield on other (non-loan) interest earning assets was approximately
4.08% during the 2005 quarter, compared to approximately 3.52% during the 2004
quarter. This improvement resulted from our strategy to invest available funds
not required to fund loans in investment securities rather than overnight
investments because overnight investments have much lower yields. The investment
securities represented 90.4% of average non-loan interest earning assets in the
2005 quarter compared to 80.1% in the 2004 quarter.
15
Most of our loans have interest rates that are based upon the fluctuating
prime rate, which was 6.00% at the end of the second quarter of 2005 as compared
to 4.00% in the second quarter of 2004. Seeking to limit the adverse effects of
low market interest rates, we changed our lending strategy in 2003 to require
minimum rates on a larger portion of our prime-based loan portfolio. As a
result, many of our prime-based loans now have interest rate floors. The loans,
which are most commonly made at interest rates from 100 to 150 basis points
above the prime rate, have interest rate floors that are typically between 7.00%
and 8.00%. As the prime rate increases, the rate of interest on these loans does
not increase until the prime rate reaches at least 6.00%(which occurred on June
30, 2005), and in most cases more than 6.25%, while our cost of funds can be
expected to increase gradually throughout any increase in market interest rates.
Interest Expense. Interest expense was $452,243 for the quarter ended June
30, 2005, compared to $263,061 for the quarter ended June 30, 2004, an increase
of 71.9%. The increase was the direct result of increases in the average balance
of deposits, primarily the time deposit category, coupled with an increase in
the rates we paid on time deposits. The average balance of time deposits
increased more rapidly than other interest-bearing deposit categories because we
have opened large balance time deposit accounts for like-kind exchange trusts
created by attorneys in real estate transactions which have a maximum term of
six months. Our average cost of funds increased from 1.05% to 1.44% between the
periods, primarily due to an increase of 89 basis points in the average rate we
paid on time deposits. Competition and the increase in market interest rates
compelled an increase in the rates we offered on both new and renewing time
deposits. While we were able to hold the line on some interest rates in other
deposit categories as market interest rates began to rise, further increases in
market rates, if they occur, can be expected to compel increases in the rates we
offer on other deposit categories.
Net Interest Income Before Provision for Loan Losses. Net interest income
before the provision for loan losses was $2,218,995 for the quarter ended June
30, 2005, an increase of $236,893, or 12.0% over the $1,982,102 we had in the
comparable 2004 quarter. The increase was driven entirely by the increase in the
volume of interest-earning assets, but was partially offset by a 15 basis point
decline in our interest rate spread and a 6 basis point decline in our net
interest margin. The spread and margin declined principally due to a shift in
the mix of both our asset and liability portfolios. On the asset side, loans,
our highest yield asset category, decreased as a percentage of total assets,
while on the deposit side, time deposits, our highest cost deposit category,
represented most of the increase in interest-bearing deposits.
Loans represented a lower percentage of average earning assets in the
second quarter of 2005 (35.4%) than they represented in the second quarter of
2004 (39.2%). This decline reduced our overall average yield on interest earning
assets because instead of being able to invest available funds in higher
yielding loans, we deployed those funds into lower yielding investment
securities.
Changes in our time deposit portfolio contributed to the reduction in our
spread and margin for two reasons. First, time deposits comprised 91% of the
increase in average interest-bearing liabilities, and increased from 34.2% of
average interest bearing liabilities in the 2004 quarter to 45.5% in the 2005
quarter. The increase in the average rate we paid on time deposits, as discussed
above, also contributed to the declining spread.
Our spread declined more than our net interest margin because of the effect
of our non-interest checking accounts, which provide a source of funds for
investment without any interest cost. Maintaining a high percentage of
non-interest checking accounts is particularly advantageous as interest rates
increase because those zero-cost funds can be invested at increasing yields.
However, an increase in market interest rates may also make interest-bearing
deposit products more attractive and cause customers to shift funds from
non-interest checking into interest-bearing deposit types.
Credit Provision for Loan Losses. For the quarter ended June 30, 2005, we
reversed $45,000 which had previously been charged to expense, compared to the
provision for loan losses of $50,000 for the quarter ended June 30, 2004. The
$95,000 change was primarily due to a moderate decrease in the rate of
delinquencies in the loan portfolio and the recovery of a $177,000 unsecured
commercial loan previously charged off, which was added back to the allowance
16
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 reflects probable incurred losses based on
management's evaluation of the 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 1.85% of total loans at June 30, 2005, 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 $514,177 for the three months
ended June 30, 2005, compared to $456,007 during the same period last year. The
$58,170, or 12.8%, increase in non-interest income was a direct result of a
$32,614 increase in service charges on deposits (primarily non-sufficient fund
fees) as the number of deposit accounts grew, a $14,961 increase in loan fees
due an increase in late fees as the volume of loans increased and a modest
increase in delinquencies and an $11,815 increase in other income.
Non-interest Expense. Non-interest expense was $1,614,580 for the quarter
ended June 30, 2005, compared to $1,471,836 for the quarter ended June 30, 2004.
The principal causes of the $142,744 increase were:
o $101,153 in higher salary and benefits costs due to normal salary
increases, of which $44,537 was compensation expense associated with
the ESOP, a slight increase in staffing to support growth, and higher
benefit costs.
o $11,832 in additional occupancy expense.
o $68,652 more of "other expenses," reflecting the effects of growth on
other expense categories and increased costs of service providers.
o $29,972 less in legal expenses due to the recovery of legal fees on a
paid off non-accrual loan.
o $10,394 less in computer expenses.
Income Tax Expense. Income tax expense was $542,131 for the quarter ended
June 30, 2005, compared to income tax expense of $426,965 for the quarter ended
June 30, 2004, due to the $247,319 increase of income before income taxes in the
2005 quarter. Our effective tax rate remained the same for the quarter ended
June 30, 2005 and 2004 at 46.6%.
Results of Operations for the Six Months Ended June 30, 2005 and June 30, 2004
As described in detail below, most of our improvement in net income from
2004 to 2005 was the result of growth between the periods. However, as noted
above, the first six months of 2005 showed a reversal of the constant growth we
experienced since we opened for business in 1997.
General. We had net income of $1,264,253 for the six months ended June 30,
2005, compared to net income of $988,478 for the comparable period in 2004. The
principal categories which make up the 2005 net income are:
o Interest income of $5,353,477
o Reduced by interest expense of $822,699
o Increased by a credit provision of $75,000
o Increased by non-interest income of $977,799
o Reduced by non-interest expense of $3,216,390
o Reduced by $1,102,934 in income tax expense.
17
We discuss each of these categories individually and the reasons for the
differences between the six months ended June 30, 2005 and the comparable period
in 2004 in the following paragraphs. The over-riding factor affecting the
changes in our operating results in all these categories is our implementation
of our growth strategy during 2004 which resulted in an increase in total assets
of $51.2 million during the year.
Interest Income. Interest income was $5,353,477 for the six months ended
June 30, 2005, compared to $4,426,284 for the six months ended June 30, 2004, an
increase of $927,193, or 21.00%. The principal reason for the increase was a
$37,446,556 increase in the average balance of investment securities, as we
deployed the cash from our deposit growth into investment securities. We
invested new deposits in investment securities rather than other short-term
liquid assets, pending planned redeployment in loans as, when and if appropriate
opportunities are available. The increase in the volume of investment
securities, coupled with a 0.07% increase in the average yield on those
securities, generated an $814,184 increase in interest earned on investment
securities. The reported yield grew in the first six months of 2005 due to
higher investment opportunities as short-term market rates increased in 2005.
The average balance of our loans decreased by $271,174 or 0.39%, from
$68,832,397 during the 2004 period to $68,561,223 during the 2005 period as
competitive pressures and the local economy made it more difficult to originate
loans. This had a moderating effect on the increase in interest income because
our loans generally have higher yields than other investment alternatives.
Finally, we had a $77,540 increase in income from overnight funds and other
interest earning assets as the Federal Reserve Board's increases in the target
federal funds rate beginning in mid-2004 had a direct and virtually immediate
effect on our yield on overnight investments. Although the average balance of
overnight investments decreased $5,020,152, or 29.75%the yield increased 166
basis points, or more than 200%, so that overall we had an increase in interest
income from this category despite the decline in volume.
Many of our prime-based loans have interest rate floors so that, in recent
periods with very low prime rates, the interest rates on those loans have been
greater than the prime rate plus the margin used to determine interest rate
adjustments. As a result, our loan yields have been relatively constant in
recent quarters. In contrast, the average yield on other (non-loan) interest
earning assets was approximately 4.10% during the 2005 period, compared to
approximately 3.62% during the 2004 period. This improvement resulted from the
combined effect of our strategy to invest available funds not required to fund
loans in investment securities rather than overnight investments because
overnight investments have much lower yields, coupled with the increase in
market interest rate conditions. The investment securities represented 91.1% of
average non-loan interest earning assets in the 2005 period compared to 83.2% in
the 2004 period.
Our prime based loans with interest rate floors have interest rates equal
to from 100 to 150 basis points above the prime rate, with a minimum interest
rate typically between 7.00% and 8.00%. As the prime rate increased in recent
periods, the rate of interest on these loans did not increase because the
minimum interest rate was greater than the prime rate plus the margin. However,
on June 30, 2005, the prime rate reached 6.25% and thus the rates on our
prime-based loans have begun to increase. In contrast, our cost of funds
generally increased throughout the period of market interest rate increases that
began in mid-2004.
Interest Expense. Interest expense was $822,699 for the six months ended
June 30, 2005, compared to $513,701 for the six months ended June 30, 2004, an
increase of $308,998 or 60.2%. The increase was the direct result of increases
in the average balance of deposits, primarily the time deposit category, coupled
with an increase in the rates we paid on time deposits. The average balance of
time deposits increased more rapidly than other interest-bearing deposit
categories because we have opened large balance time deposit accounts for
like-kind exchange trusts created by attorneys in real estate transactions which
have a maximum term of six months. Our average cost of funds increased from
18
1.07% to 1.37% between the periods, primarily due to an increase of 69 basis
points in the average rate we paid on time deposits. We were also able to hold
down the increase in interest expense by increasing the volume of non-interest
checking accounts as a zero cost funding source between the periods, which
represented 21.4% of the growth in average total deposits, although such
accounts decreased as a percentage of average deposits to 40.1% in the first six
months of 2005 as compared to 43.6% in the same period in 2004. The increase in
non-interest checking was a direct result of our efforts to increase our low
cost funding sources.
Net Interest Income Before Provision for Loan Losses. Net interest income
before the provision for loan losses was $4,530,778 for the six months ended
June 30, 2005, an increase of $618,195, or 15.8% over the $3,912,583 we had in
the comparable 2004 period. The increase was driven entirely by the increase in
the volume of interest-earning assets, but was partially offset by a 20 basis
point decline in our interest rate spread and an 11 basis point decline in our
net interest margin. The spread and margin declined principally due to a shift
in the mix of both our asset and liability portfolios. On the asset side, loans,
our highest yield asset category, decreased as a percentage of total assets,
while on the deposit side, time deposits, our highest cost deposit category,
accounted for most of the increase in interest-bearing deposits. Additionally,
the yield on our prime-based loans did not increase significantly as the prime
rate increased due to the imposition of interest rate floors on those loans.
Loans represented a lower percentage of average earning assets in the first
six months of 2005 (34.0%) than they represented in the first six months of 2004
(40.6%). This decline, which occurred as the result of market conditions and
competition for loans in our marketplace despite our efforts to originate a
higher volume of loans, reduced our overall average yield on interest earning
assets. Instead of being able to invest available funds in higher yielding
loans, we were forced to invest them in lower yielding investment securities.
Changes in our time deposit portfolio contributed to the reduction in our
spread and margin for two reasons. First, time deposits comprised 89% of the
increase in average interest-bearing liabilities, and increased from 34.2% of
average interest bearing liabilities in the 2004 period to 45.2% in the 2005
period. The increase in the average rate we paid on time deposits, as discussed
above, also contributed to the declining spread.
Our spread declined more than our net interest margin because of the effect
of our non-interest checking accounts, which provide a source of funds for
investment without any interest cost. Maintaining a high percentage of
non-interest checking accounts is particularly advantageous as interest rates
increase because those zero-cost funds can be invested at increasing yields.
However, an increase in market interest rates may also make interest-bearing
deposit products more attractive and cause customers to shift funds from
non-interest checking into interest-bearing deposit types.
Credit Provision for Loan Losses. For the six months ended June 30, 2005,
we reversed $75,000 which had previously been charged to expense, compared to
the provision for loan losses of $100,000 for the six months ended June 30,
2004. The $175,000 change was primarily due to a moderate decrease in the rate
of delinquencies in the loan portfolio and the recovery of a $177,000 unsecured
commercial loan previously charged off, which was added back to the allowance
for loan losses.
Non-interest Income. Non-interest income was $977,799 for the six months
ended June 30, 2005, compared to $933,950 during the same period last year. The
$43,849, or 4.7% increase was a direct result of a $22,897 increase in loan fees
due to increased letter of credit fees, an $8,941 increase in service charges on
deposits (primarily non-sufficient fund fees) due to an increase in the
aggregate number of deposit accounts and an increase in other income of $10,200.
Non-interest Expense. Non-interest expense was $3,216,390 for the six
months ended June 30, 2005, compared to $2,895,652 for the six months ended June
30, 2004. The principal causes of the $320,738 increase were:
19
o $243,382 in higher salary and benefits costs due to normal salary
increases, $87,537 of additional compensation expense associated with
the ESOP, a slight increase in staffing to support growth, and higher
benefit costs.
o $30,223 in higher professional fees primarily due to increased costs of
both external and internal audits and expenses related to gearing up
for the implementation of Sarbanes Oxley Act Section 404 regarding the
assessment of internal controls.
o $27,265 in additional occupancy expense due to increased real estate
taxes and general repair.
o $91,067 more of "other expenses," reflecting the effects of growth on
other expense categories and the higher costs of service providers.
o $50,923 less in legal expenses due to the recovery of legal fees paid
on an unsecured commercial loan that was previously charged off.
Income Tax Expense. Income tax expense was $1,102,934 for the six months
ended June 30, 2005, compared to income tax expense of $862,403 for the six
months ended June 30, 2004, due to the $516,306 increase of income before income
taxes in the 2005 period. Our effective tax rate remained the same for the six
months ended June 30, 2005 and 2004 at 46.6%.
20
VSB Bancorp, Inc.
Consolidated Average Balance Sheets
(unaudited)
Three Three
Months Ended Months Ended
June 30, 2005 June 30, 2004
-------------------------------- ------------------------------------
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
------------ ---------- ------ ------------ ------------ ------
Assets:
Interest-earning assets:
Loans receivable $ 70,918,405 $1,352,333 7.65% $ 69,350,806 $ 1,303,760 7.56%
Investment securities, afs 117,218,512 1,235,763 4.23 86,212,208 897,417 4.19
Other interest-earning assets 12,429,379 83,142 2.68 21,491,784 43,986 0.82
------------ ---------- ------------ ------------
Total interest-earning assets 200,566,296 2,671,238 5.34 177,054,798 2,245,163 5.10
Non-interest earning assets 12,605,933 11,393,920
------------ ------------
Total assets $213,172,229 $188,448,718
============ ============
Liabilities and equity:
Interest-bearing liabilities:
Savings accounts $ 16,011,291 20,111 0.50 $ 11,918,814 14,742 0.50
Time accounts 57,465,469 263,269 1.84 34,571,649 81,882 0.95
Money market accounts 21,235,658 51,953 0.98 23,680,057 50,506 0.86
Now accounts 26,445,152 27,871 0.42 25,798,759 26,892 0.42
Subordinated debt 5,155,000 89,039 6.91 5,155,000 89,039 6.91
------------ ---------- ------------ ------------
Total interest-bearing liabilities 126,312,570 452,243 1.44 101,124,279 263,061 1.05
Checking accounts 70,887,187 73,689,060
------------ ------------
Total deposits and subordinated debt 197,199,757 174,813,339
Other liabilities 2,407,203 1,819,698
------------ ------------
Total liabilities 199,606,930 176,633,037
Equity 13,565,269 11,815,681
------------ ------------
Total liabilities and equity $213,172,229 $188,448,718
============ ============
Net interest income/net interest
rate spread $2,218,995 3.90% $ 1,982,102 4.05%
========== ====== ============ ======
Net interest earning assets/net
interest margin $ 74,253,726 4.44% $ 75,930,519 4.50%
============ ====== ============ ======
Ratio of interest-earning assets
to interest-bearing liabilities 1.59x 1.75x
============ ============
Return on Average Assets 1.17% 1.04%
============ ============
Return on Average Equity 18.38% 16.66%
============ ============
Tangible Equity to Total Assets 6.46% 5.06%
============ ============
Six Six
Months Ended Months Ended
June 30, 2005 June 30. 2004
---------------------------------- --------------------------------
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
------------ ------------ ------ ------------ ---------- ------
Assets:
Interest-earning assets:
Loans receivable $ 68,561,223 $ 2,652,969 7.76% $ 68,832,397 $2,617,500 7.62%
Investment securities, afs 121,099,608 2,555,248 4.26 83,653,052 1,741,064 4.19
Other interest-earning assets 11,855,950 145,260 2.47 16,876,102 67,720 0.81
------------ ------------ ------------ ----------
Total interest-earning assets 201,516,781 5,353,477 5.34 169,361,551 4,426,284 5.24
Non-interest earning assets 12,932,913 11,529,789
------------ -----------
Total assets $214,449,694 $180,891,340
============ ============
Liabilities and equity:
Interest-bearing liabilities:
Savings accounts $ 15,343,521 38,338 0.50 $ 11,333,850 28,180 0.50
Time accounts 54,749,671 450,386 1.66 33,140,654 159,994 0.97
Money market accounts 22,058,472 106,000 0.97 22,932,498 96,774 0.85
Now accounts 23,778,689 49,896 0.42 24,245,495 50,674 0.42
Subordinated debt 5,155,000 178,079 6.91 5,155,000 178,079 6.91
------------ ------------ ------------ ----------
Total interest-bearing liabilities 121,085,353 822,699 1.37 96,807,497 513,701 1.07
Checking accounts 77,529,495 70,916,101
------------ -----------
Total deposits and subordinated debt 198,614,848 167,723,598
Other liabilities 2,410,810 1,764,644
------------ -----------
Total liabilities 201,025,658 169,488,242
Equity 13,424,036 11,403,098
------------ -----------
Total liabilities and equity $214,449,694 $180,891,340
============ ============
Net interest income/net interest
rate spread $ 4,530,778 3.97% $3,912,583 4.17%
============ ====== ========== ======
Net interest earning assets/net
interest margin $ 80,431,428 4.52% $ 72,554,054 4.63%
============ ====== ============ ======
Ratio of interest-earning assets
to interest-bearing liabilities 1.66x 1.75x
============ ============
Return on Average Assets 1.18% 1.09%
============ ============
Return on Average Equity 18.86% 17.27%
============ ============
Tangible Equity to Total Assets 6.46% 5.06%
============ ============
21
Liquidity and Capital Resources
Our primary sources of funds are the proceeds from the repayment of
investment securities and, until the two most recent quarters, increases in
deposits. We use these funds principally to purchase new investment securities
and to fund increases in our loan portfolio.
During the six months ended June 30, 2005, our principal sources of cash
were proceeds from the repayment of investment securities of $13,920,944 and the
reduction of $11,060,281 in cash and cash equivalents, which were used to fund a
net increase in loans receivable of $7,887,938 and a net decrease in deposits of
$18,484,623. We did not need to sell any investment securities prior to maturity
to fund the deposit outflow. The decrease in deposits reflects the volatile
nature of our demand deposit base, specifically attorney related mortgage
funding accounts, which fluctuate with the conditions of the mortgage
origination market. As origination and refinancing of mortgages decrease, the
aggregate balance in these deposit accounts also decreases.
In contrast, during the six months ended June 30, 2004, we had a net
increase in deposits of $22,689,693 and proceeds from repayment of investment
securities totaled $13,572,306. We used those funds to finance a $3,029,334
increase in our loan portfolio and to purchase $27,231,164 of investment
securities. That increase in deposits was primarily attributable to deposit
increases at all our branches and a $5 million time deposit from the City of New
York, into our St. George branch, under the City's new Bank Development District
deposit program.
Victory State Bank satisfied all capital ratio requirements of the Federal
Deposit Insurance Corporation, at June 30, 2005, with a Tier I Leverage Capital
ratio of 8.94%, a ratio of Tier I Capital to Risk-Weighted Assets ratio of
18.11%, and a Total Capital to Risk-Weighted Assets ratio of 19.37%.
In the first six months of 2005, we experienced an $11,060,281 decrease in
cash and cash equivalents due to a net decrease in deposits, compared to an
$8,126,988 increase in cash and cash equivalents during the first six months of
2004. Total cash and cash equivalents at June 30, 2005 were $24,598,792. One of
the important tasks facing management in upcoming periods is to balance the
level of cash and cash equivalents for liquidity purposes and the reinvestment
opportunities into higher yielding interest-earning assets such as loans or
securities.
The following table sets forth our contractual obligations and commitments
for future lease payments, time deposit maturities and loan commitments.
22
Contractual Obligations and Commitments at June 30, 2005
Contractual Obligations
Payment due by Period
-------------------------------------------------------------------
One to Over three Total
Less than three years to five After Amounts
One Year years years five years committed
----------- ----------- ----------- ----------- -----------
Minimum annual rental payments under
non-cancelable operating leases $ 335,031 $ 495,168 $ 449,693 $ 1,283,016 $ 2,562,908
Remaining contractual maturities of
time deposits 53,318,293 1,538,129 1,639,617 -- 56,496,039
Principal payment of subordinated debt -- -- 5,155,000 -- 5,155,000
----------- ----------- ----------- ----------- -----------
Total contractual cash obligations $53,653,324 $ 2,033,297 $ 7,244,310 $ 1,283,016 $64,213,947
=========== =========== =========== =========== ===========
Other commitments Amount of commitment Expiration by Period
-------------------------------------------------------------------
One to Over three Total
Less than three years to five After Amounts
One Year years years five years committed
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Loan commitments $13,742,850 $14,586,007 $ -- $ -- $28,328,857
=========== =========== =========== =========== ===========
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 risks upon
fluctuations in market rates. We consider the amount of outstanding commitments
when we assess our allowance for loan losses.
Critical Accounting Policies and Judgments
The Company's consolidated financial statements are prepared based on the
application of certain accounting policies, the most significant of which are
described in Note 2 "Summary of Significant Accounting Policies" in the Notes to
the Consolidated Financial Statements and in the "Management's Discussion and
Analysis of Financial Condition and Results of Operations: Impact of New
Accounting Pronouncements" in the Company's report on Form 10-KSB as filed on
March 29, 2005. Certain of these policies require numerous estimates and
strategic or economic assumptions that may prove inaccurate or subject to
variations and may significantly affect the Company's reported results and
financial position for the period or future periods. The use of estimates,
assumptions, and judgments are necessary when financial assets and liabilities
are required to be recorded at, or adjusted to reflect, fair value. The
Company's assets and liabilities that are carried at fair value inherently
result in more financial statement volatility. Fair values and the information
used to record valuation adjustments for certain assets and liabilities are
based on either quoted market prices or provided by other independent
third-party sources, when available. When such information is not available, the
Company's management estimates valuation adjustments primarily by using internal
cash flow and other financial modeling techniques. Changes in underlying
factors, assumptions, or estimates in any of these areas could have a material
impact on the Company's future financial condition and results of operations. We
consider the methodology for determining the allowance for loan losses to be a
critical accounting policy.
Allowance for Loan Losses - The Company's Allowance for Loan Losses is
established through a provision for loan losses based on management's evaluation
of the risks inherent in its loan portfolio and the general economy. Such
evaluation, which includes a review of all loans on which full collectibility
may not be reasonably assured, considers among other matters, the estimated net
realizable value of the underlying collateral, economic conditions, any
historical loan loss experience and other factors that warrant recognition in
providing for an appropriate loan loss allowance. The Company identifies and
evaluates the following pools of similar loan categories when analyzing the
Allowance for Loan Losses: (i) Commercial Loans - Secured and Unsecured; (ii)
Real Estate Loans - Commercial and One-to-four family; (iii) Construction Loans
- Commercial and One-to-four family and (iv) Other Loans - Consumer and Other
Loans.
23
It is the policy of the Company to provide a valuation allowance for
estimated losses on loans to reflect probable incurred losses 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 Bank's
lending area. The allowance is increased by provisions for loan losses charged
to operations 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 adequate.
Item 3 - Controls and Procedures
Evaluation of Disclosure Controls and Procedures: As of June 30, 2005, we
undertook an evaluation of our disclosure controls and procedures under the
supervision and with the participation of Merton Corn, our President and CEO,
and Raffaele M. Branca, our 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 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.
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 9, 2005 /s/ MERTON CORN
-----------------------------------------
Merton Corn
President and Chief Executive Officer
Date: August 9, 2005 /s/ RAFFAELE M. BRANCA
-----------------------------------------
Raffaele M. Branca
Executive Vice President and
Chief Financial Officer
25
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.
26