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 SEPTEMBER 30, 2005
[ ] 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.)
3155 Amboy Road, Staten Island, New York 10306
----------------------------------------------
(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]
The Registrant had 1,509,311 common shares outstanding as of November 1, 2005.
CROSS REFERENCE INDEX
PART I
Page
----
Item 1 Consolidated Statements of Financial Condition as of
September 30, 2005 and December 31, 2004 (unaudited). 4
Consolidated Statements of Operations for the Three and
Nine Months Ended September 30, 2005 and 2004
(unaudited). 5
Consolidated Statements of Changes in Stockholders' Equity
for the Nine Months Ended September 30, 2005 and the
Year Ended December 31, 2004 (unaudited). 6
Consolidated Statements of Cash Flows for the Three and
Nine Months Ended September 30, 2005 and 2004
(unaudited). 7
Notes to Consolidated Financial Statements for the Three
and Nine Months Ended September 30, 2005 and 2004
(unaudited). 8 to 12
Item 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations 13 to 23
Item 3 Control and Procedures 23
PART II
Item 1 Legal Proceedings 23
Signature Page 24
Exhibit 31.1, 31.2, 32.1, 32.2 25 to 28
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)
September 30, December 31,
2005 2004
------------- -------------
Assets:
Cash and due from banks $ 42,429,608 $ 35,659,073
Investment securities, available for sale 105,466,369 128,532,767
Loans receivable 76,122,690 68,046,885
Allowance for loan loss (1,409,645) (1,299,520)
------------- -------------
Loans receivable, net 74,713,045 66,747,365
Bank premises and equipment, net 1,523,076 1,817,284
Accrued interest receivable 712,752 745,368
Deferred taxes 2,037,193 1,462,940
Other assets 1,117,425 719,670
------------- -------------
Total assets $ 227,999,468 $ 235,684,467
============= =============
Liabilities and stockholders' equity:
Liabilities:
Deposits:
Demand and checking $ 74,597,681 $ 101,560,932
NOW 28,712,347 21,574,053
Money market 19,439,898 23,388,850
Savings 16,291,566 14,159,026
Time 65,786,923 54,470,507
------------- -------------
Total Deposits 204,828,415 215,153,368
Escrow deposits 364,090 270,105
Subordinated debt 5,155,000 5,155,000
Accounts payable and accrued expenses 3,253,128 2,149,548
------------- -------------
Total liabilities 213,600,633 222,728,021
------------- -------------
Employee Stock Ownership Plan Repurchase Obligation 123,120 126,825
Stockholders' equity:
Common stock, ($.0001 par value, 3,000,000 shares
authorized, 1,509,822 issued and outstanding
at September 30, 2005 and 1,505,022 issued and
outstanding at December 31, 2004) 151 150
Additional paid in capital 8,887,700 8,818,313
Retained earnings 7,976,091 6,054,264
Unallocated ESOP Shares (1,451,253) (1,578,061)
Accumulated other comprehensive loss,
net of taxes of $991,792 and $405,662,
respectively (1,136,974) (465,045)
------------- -------------
Total stockholders' equity 14,275,715 12,829,621
------------- -------------
Total liabilities and stockholders'
equity $ 227,999,468 $ 235,684,467
============= =============
See notes to consolidated financial statements.
4
VSB Bancorp, Inc.
Consolidated Statements of Operations
(unaudited)
Three months Three months Nine months Nine months
ended ended ended ended
Sep. 30, 2005 Sep. 30, 2004 Sep. 30, 2005 Sep. 30, 2004
------------- ------------- ------------- -------------
Interest and dividend income:
Loans receivable $ 1,540,973 $ 1,335,491 $ 4,193,942 $ 3,952,991
Investment securities 1,160,153 1,074,385 3,715,401 2,815,449
Other interest earning assets 171,029 85,560 316,289 153,280
------------- ------------- ------------- -------------
Total interest income 2,872,155 2,495,436 8,225,632 6,921,720
Interest expense:
NOW 28,455 25,494 78,351 76,168
Money market 55,768 49,295 161,768 146,069
Savings 20,897 16,910 59,235 45,090
Subordinated debt 89,040 89,040 267,119 267,119
Time 330,917 107,626 781,303 267,620
------------- ------------- ------------- -------------
Total interest expense 525,077 288,365 1,347,776 802,066
Net interest income 2,347,078 2,207,071 6,877,856 6,119,654
Provision for loan loss (15,000) 30,000 (90,000) 130,000
------------- ------------- ------------- -------------
Net interest income
after provision for loan loss 2,362,078 2,177,071 6,967,856 5,989,654
------------- ------------- ------------- -------------
Non-interest income:
Loan fees 22,914 23,109 80,008 57,306
Service charges on deposits 450,172 428,587 1,294,779 1,264,253
Net rental income 149,129 3,799 170,734 23,593
Other income 49,259 18,790 103,752 63,083
------------- ------------- ------------- -------------
Total non-interest income 671,474 474,285 1,649,273 1,408,235
------------- ------------- ------------- -------------
Non-interest expenses:
Salaries and benefits 958,331 853,144 2,832,081 2,483,512
Occupancy expenses 238,295 248,119 725,037 707,596
Legal expense 84,057 36,890 117,432 121,188
Professional fees 51,000 49,814 177,000 145,591
Computer expense 62,045 60,914 176,995 196,140
Other expenses 408,468 244,175 990,041 734,681
------------- ------------- ------------- -------------
Total non-interest expenses 1,802,196 1,493,056 5,018,586 4,388,708
Income before income taxes 1,231,356 1,158,300 3,598,543 3,009,181
------------- ------------- ------------- -------------
Provision/(benefit) for income taxes:
Current 580,100 589,434 1,664,840 1,583,564
Deferred (6,318) (49,975) 11,876 (181,702)
------------- ------------- ------------- -------------
Total provision for income taxes 573,782 539,459 1,676,716 1,401,862
------------- ------------- ------------- -------------
Net income $ 657,574 $ 618,841 $ 1,921,827 $ 1,607,319
============= ============= ============= =============
Basic income per common share $ 0.46 $ 0.43 $ 1.33 $ 1.13
============= ============= ============= =============
Diluted net income per share $ 0.44 $ 0.41 $ 1.29 $ 1.08
============= ============= ============= =============
Comprehensive income $ 75,955 $ 1,435,201 $ 1,249,898 $ 1,218,624
============= ============= ============= =============
Book value per common share $ 9.54 $ 8.05 $ 9.54 $ 8.05
============= ============= ============= =============
See notes to consolidated financial statements.
All per share data has been adjusted for the 4 for 3 stock split, payable on
March 8, 2004.
5
VSB Bancorp, Inc.
Consolidated Statements of Changes in Stockholders' Equity
Year Ended December 31, 2004 and Nine Months Ended September 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 4,800 1 63,731 63,732
Amortization of earned
portion of ESOP
common stock 126,808 126,808
Amortization of excess
fair value over
cost - ESOP 1,951 1,951
Transfer from ESOP
repurchase
obligation 3,705 3,705
Comprehensive income:
Net income 1,921,827 1,921,827
Other comprehensive
income, net:
Unrealized holding
loss arising
during the year -- -- -- -- -- (671,929) (671,929)
------------ ------------ ------------ ------------ ------------ ------------ ------------
Total comprehensive
income 1,249,898
Balance at
September 30, 2005 1,509,822 $ 151 $ 8,887,700 $ 7,976,091 $ (1,451,253) $ (1,136,974) $ 14,275,715
============ ============ ============ ============ ============ ============ ============
See notes to consolidated financial statements.
6
VSB Bancorp, Inc.
Consolidated Statements of Cash Flows
(unaudited)
Three months Three months Nine months Nine months
ended ended ended ended
Sep. 30, 2005 Sep. 30, 2004 Sep. 30, 2005 Sep. 30, 2004
------------- ------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 657,574 $ 618,841 $ 1,921,827 $ 1,607,319
Adjustments to reconcile net income to net cash
used in operating activities
Depreciation and amortization 110,658 121,602 339,741 376,475
Accretion of income, net of amortization of premium (48,290) (56,450) (86,650) (101,123)
ESOP compensation expense 41,222 42,411 128,759 71,185
Provision for loan losses (15,000) 30,000 (90,000) 130,000
(Increase)/decrease in prepaid and other assets (79,202) (47,078) (397,755) (131,205)
Increase in accrued interest receivable 30,375 (68,918) 32,616 (75,830)
(Increase)/decrease in deferred income taxes (6,318) (49,975) 11,876 (181,702)
(Decrease)/increase in accrued expenses and other liabilities 899,019 (350,634) 1,103,580 570,485
------------- ------------- ------------- -------------
Net cash provided by operating activities 1,590,038 239,799 2,963,994 2,265,604
------------- ------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net decrease/(increase) in loan receivable 202,071 2,310,484 (7,685,867) (718,850)
Proceeds from maturities of money market investments -- 333,114 -- 2,665,774
Proceeds from repayment of investments securities,
available for sale 7,784,233 9,305,693 21,705,177 22,877,999
Purchases of money market investments -- (305,683) -- (2,652,160)
Purchase of investments securities, available for sale -- (23,303,371) -- (50,534,535)
Purchases of premises and equipment (22,137) (81,814) (45,533) (135,586)
(Loss)/gain on the sale of other assets -- (3,188) -- (3,188)
------------- ------------- ------------- -------------
Net cash used in investing activities 7,964,167 (11,744,765) 13,973,777 (28,500,546)
------------- ------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase/(decrease) in deposits 8,253,655 23,944,240 (10,230,968) 46,633,933
Exercise stock option 22,956 10,200 63,732 177,804
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 provided by financing activities 8,276,611 23,954,440 (10,167,236) 46,811,404
------------- ------------- ------------- -------------
NET INCREASE/(DECREASE) IN CASH
AND CASH EQUIVALENTS 17,830,816 12,449,474 6,770,535 20,576,462
------------- ------------- ------------- -------------
CASH AND CASH EQUIVALENTS,
BEGINNING OF PERIOD 24,598,792 38,314,729 35,659,073 30,187,741
------------- ------------- ------------- -------------
CASH AND CASH EQUIVALENTS,
END OF PERIOD $ 42,429,608 $ 50,764,203 $ 42,429,608 $ 50,764,203
============= ============= ============= =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid during the period for:
Interest $ 734,962 $ 286,180 $ 1,506,811 $ 876,096
============= ============= ============= =============
Taxes $ 554,897 $ 658,331 $ 1,831,784 $ 1,591,532
============= ============= ============= =============
See notes to consolidated financial statements.
7
VSB Bancorp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE AND NINE MONTHS ENDED
SEPTEMBER 30, 2005 AND 2004 (UNAUDITED)
--------------------------------------------------------------------------------
1. GENERAL
VSB Bancorp, Inc. ("Bancorp" or "Company") became the holding company for
Victory State Bank (the "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 stock of the
Bank. 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 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. 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 the Bank is required to maintain
depends upon its level of transaction accounts. During the fourteen day period
from September 27, 2005 through October 10, 2005, the Bank was required to
8
maintain reserves, after deducting vault cash, of $5,169,000. Reserves are
required to be maintained on a fourteen day basis, so, from time to time, the
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
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 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 apparent 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 1,444,290 shares and
1,432,088 shares, the weighted average number of common shares outstanding for
the three months ended September 30, 2005 and 2004, respectively. Diluted net
income per share of common stock is based on 1,489,047 shares and 1,497,324
shares, the weighted average number of common shares and potentially dilutive
common shares outstanding for the three months ended September 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 58,116 and 43,309 shares for the for the three months
ended September 30, 2005 and 2004, respectively. Common stock equivalents were
calculated using the treasury stock method.
The following table presents a reconciliation of the components used to
compute basic and diluted earnings per share for the three and nine month period
ended September 30, 2005 and 2004.
10
Reconciliation of EPS Three Months Ended Three Months Ended
--------------------- September 30, 2005 September 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 $ 657,574 1,444,290 $ 0.46 $ 618,841 1,432,088 $ 0.43
=========== ===========
Effect of dilutive shares
--------------------------
Weighted average
shares, if converted 44,758 65,236
----------- -----------
Diluted net income per
common share
--------------------------
Net income available to
common stockholders $ 657,574 1,489,048 $ 0.44 $ 618,841 1,497,324 $ 0.41
=========== =========== =========== =========== =========== ===========
Reconciliation of EPS Nine Months Ended Nine Months Ended
--------------------- September 30, 2005 September 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 $ 1,921,827 1,440,410 $ 1.33 $ 1,607,319 1,422,723 $ 1.13
=========== ===========
Effect of dilutive shares
--------------------------
Weighted average
shares, if converted 48,242 64,365
----------- -----------
Diluted net income per
common share
--------------------------
Net income available to
common stockholders $ 1,921,827 1,488,652 $ 1.29 $ 1,607,319 1,487,088 $ 1.08
=========== =========== =========== =========== =========== ===========
Stock Based Compensation - At September 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 nine
months ended September 30, 2005 and 2004.
The following table illustrates the effect on net income and earnings per
share if expense was measured using fair value recognition of FASB Statement No.
123, Accounting for Stock-Based Compensation.
11
Three Months Ended Nine Months Ended
September 30, September 30,
2005 2004 2005 2004
------------- ------------- ------------- -------------
Net income as reported $ 657,574 $ 618,841 $ 1,921,827 $ 1,607,319
Deduct: Stock-based compensation expense
determined under the fair value based method (13,513) (10,966) (40,539) (32,898)
------------- ------------- ------------- -------------
Pro forma net income 644,061 607,875 1,881,288 1,574,421
Basic earnings per share as reported $ 0.46 $ 0.43 $ 1.33 $ 1.13
Pro forma basic earnings per share $ 0.45 $ 0.42 $ 1.31 $ 1.11
Diluted earnings per share as reported $ 0.44 $ 0.41 $ 1.29 $ 1.08
Pro forma diluted earnings per share $ 0.43 $ 0.41 $ 1.26 $ 1.06
All per share data has been adjusted for the 4 for 3 stock split, payable on
March 8, 2004 .
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
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.
12
Item 2
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Financial Condition at September 30, 2005
Total assets were $227,999,468 at September 30, 2005, a decrease of
$7,684,999, or 3.3%, from December 31, 2004. The decline in total assets
resulted from a need to fund a decline in deposits, principally demand accounts.
We funded the decline in deposits with principal paydowns on investment
securities. We also used principal paydowns on investment securities to fund an
increase in loans and cash and equivalents. Our asset mix changed as net loans
receivable increased during the nine months of 2005 due to our efforts to grow
our loan portfolio, while investment securities decreased in order to fund loan
growth and the deposit outflow. Management believes that the principal and
interest payments on the investment securities portfolio, combined with the
existing liquidity, will be sufficient to fund loan growth.
Deposits (including escrow deposits) were $205,192,505 at September 30,
2005 a decrease of $10,230,968, or 4.8%, from December 31, 2004. The decline in
deposits resulted from a decrease of $26,963,251 in demand deposits and
$3,948,952 in money market accounts, partially offset by increases of $7,138,294
in NOW accounts, $2,132,540 in savings and $11,316,416 in time deposits. The
deposit outflow was primarily concentrated in accounts used to fund mortgage
closings by other lenders. The level of pending mortgage financings has been
reduced from levels seen in 2004, and one settlement company that maintained
substantial deposits has ceased operations, which combined to reduce the deposit
balances in mortgage funding and related accounts.
Total stockholders' equity was $14,275,715 at September 30, 2005, an
increase of $1,446,094 during the first nine months of 2005. The increase
represented net income of $1,921,827 for the nine months ended September 30,
2005, offset in part by an increase of $671,929 in other comprehensive losses
due to an increase in the unrealized loss in securities available for sale
during the first nine months of 2005 as rising market interest rates had an
adverse effect on the market value of some securities in our investment
portfolio. The market value decrease 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.
The increase in stockholders' equity also included an increase of $63,732
in additional paid in capital due to the exercise of options to purchase 4,800
shares of common stock, the transfer of $3,705 to additional paid in capital due
to a decline in the amount of our Employee Stock Ownership Plan repurchase
obligation and a decrease in unearned ESOP shares of $126,808 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 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
13
additional paid in capital to mezzanine capital, based upon our quoted price at
the date of the applicable financial statement, 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 continued. However, subordinated debt generates interest expense at the
holding company level.
The Bank is a state-chartered, stock commercial bank, which opened for
business in November 1997. Our primary market is Staten Island, New York. Since
the Bank opened for business, management has worked to grow the Bank's
franchise. From one office in 1997, the Bank now has four offices and has
received regulatory approval to open two more branches on Staten Island. 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 $227.6 million, total
deposits of $205.8 million and capital of $18.6 million by September 30, 2005.
Management intends to exert efforts to grow the 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. Competition for
deposits has also increased, making it more difficult for us to generate an
increase in deposits to fund asset growth.
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 Three Months Ended September 30, 2005 and
September 30, 2004
Our results of operations are dependent 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 $657,574 for the quarter ended September 30,
2005, compared to net income of $618,841 for the comparable quarter in 2004. The
principal categories which make up the 2005 net income are:
o Interest income of $2,872,155
o Reduced by interest expense of $525,077
14
o Increased by a credit to the provision for loan losses of $15,000
o Increased by non-interest income of $671,474
o Reduced by non-interest expense of $1,802,196
o Reduced by $573,782 in income tax expense
We discuss each of these categories individually and the reasons for the
differences between the quarter ended September 30, 2005 and the comparable
quarter in 2004 in the following paragraphs. The implementation of our growth
strategy in 2004 provided a significant increase in funds for investments, which
allowed us to increase net income through the investment of those funds at
yields higher than the expense of the interest we paid to our depositors.
However, in 2005, total assets declined during the first quarter and then
increased moderately during the second and third quarters. Therefore, the
relatively steady increase in earning assets that we have experienced since we
opened for business has moderated in 2005
During 2005, average earning assets were $202,477,097 in the first quarter,
$200,566,296 in the second quarter and $205,552,158 in the third quarter,
evidencing a more moderate upward trend than we had experienced in the past.
Management is seeking to continue to implement its growth strategy by generating
new deposits at both our existing branches and the two new branches we plan to
open in 2006. The proceeds of the increase in deposits will then be used to fund
an increase in earning assets. However, there can be no assurance that we will
be able to generate the increase in deposits or that we will be able to invest
the increase at satisfactory yields.
Interest Income. Interest income was $2,872,155 for the quarter ended
September 30, 2005, compared to $2,495,436 for the quarter ended September 30,
2004, an increase of $376,719, or 15.10%. The increase in interest income was
due to an increase in average balances of $5,997,237 in the loan portfolio and
$13,320,694 in the investment securities portfolio. The average balance
increases were the result of efforts to increase the size of our bank. In
addition to the volume increase, yields on loans receivable and overnight
investments increased.
The average balance of our loans increased by 8.78%, from $68,317,088
during the 2004 period to $74,314,325 during the 2005 period. In conjunction
with the increase in volume, the average yield on loans increased by 41 basis
points as the prime rate, upon which many of our loans are based, rose to the
point where the interest rates on our loans increased above the interest rate
floors which had been effective when the prime rate was at historically low
levels.. Finally, we had an $85,469 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 the yield on overnight investments. Although the average
balance of overnight investments decreased $6,331,674, or 23.48%, from the third
quarter of 2004 to the third quarter of 2005, the yield increased 203 basis
points, or more than 160%, so that the overall effect was an increase in
interest income from this category despite the decline in the average balance.
Our prime based loans with interest rate floors have 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%. In recent periods with very low prime rates,
the interest rates on those loans had been greater than the prime rate plus the
margin used to determine interest rate adjustments. As a result, our loan yields
had been relatively constant in recent quarters. As of the third quarter of
2005, the interest rates on all of our prime-based loans have risen above the
interest rate floor and will now re-price with future increases in the prime
rate.
The average yield on other (non-loan) interest earning assets was
approximately 4.01% during the third quarter of 2005, compared to approximately
3.71% during the third quarter of 2004. 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 lower yields, coupled with the increase in market
interest rate conditions. The investment securities portfolio represented 84.3%
of average non-loan interest earning assets in the 2005 period compared to 78.3%
in the 2004 period.
15
Interest Expense. Interest expense was $525,077 for the quarter ended
September 30, 2005, compared to $288,365 for the quarter ended September 30,
2004, an increase of 82.1%. The increase was the result of increases in the
average balance of interest-bearing deposits, primarily time deposits, coupled
with an increase in the rates we paid on these deposits. The average balance of
time deposits increased more rapidly than other interest-bearing deposits
because we have opened a number of large balance time deposit accounts for
like-kind exchange trusts. These trusts are created by attorneys in real estate
transactions and have a maximum term of six months. There can be no assurance
that we can replace these funds when these time deposits mature.
Our average cost of funds increased from 1.05% to 1.61% between the two
periods, primarily due to an increase of 112 basis points in the average rate we
paid on time 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 have been able to keep interest rate increases
to a minimum 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 these deposit categories. 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 $2,347,078 for the quarter ended
September 30, 2005, an increase of $140,007, or 6.3% over the $2,207,071 in the
comparable 2004 quarter. The increase in income was driven by a volume increase
in earning assets, partially offset by a decline of 19 basis points in the
interest rate spread and a decline of 4 basis points in the interest margin. The
spread and margin declined principally due to the rising cost of funds outpacing
the increase in the yield of earning assets. On the asset side, the average
yield of earning assets in the 2005 period increased to 5.53% from 5.16% in the
September 2004 period, or an increase of 37 basis points. On the liability side,
a greater increase in our cost of funds of 56 basis points caused the decline in
spread and margin.
Changes in our time deposit portfolio, our highest cost product,
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 39.6% of average interest bearing liabilities in
the 2004 quarter to 47.9% in the 2005 quarter. Also contributing to the
declining spread was the increase in the average rate paid on time deposits, as
discussed above. The average rate on these deposits increased 112 basis points,
from 0.99% in the 2004 quarter to 2.11% in the 2005 quarter. We do not have and
we do not seek brokered time deposits.
Our spread declined more than our net interest margin because of the effect
of our non-interest checking accounts, which provides a source of funds for
investment without any interest cost. Our non-interest checking accounts have
declined recently due primarily to a reduction in mortgage funding accounts,as
discussed above. Management seeks to maintain a high level of non-interest
checking accounts though developing relationships with local businesses.
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, an increase in market interest rates may
make interest-bearing deposit products more attractive to customers and cause
funds to shift from non-interest checking into interest-bearing deposit
products.
Credit Provision for Loan Losses. For the quarter ended September 30, 2005,
we reversed $15,000 which had previously been charged to expense, compared to a
provision for loan losses of $30,000 for the quarter ended September 30, 2004.
The $45,000 change was primarily due to a moderate decrease in the rate of
delinquencies in the loan portfolio. 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.
16
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 September 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 $671,474 for the three months
ended September 30, 2005, compared to $474,285 during the same period last year.
The $197,189, or 41.6%, increase in non-interest income was a direct result of a
$21,585 increase in service charges on deposits (primarily non-sufficient fund
fees) as the number of deposit accounts grew, a $30,469 increase in other income
and an increase in rental income of $145,330. The increase in rental income is
due to a one-time payment of $119,000 resulting from the termination of a
sub-lease agreement by the tenant in which the Bank is the lessor. This payment
satisfies all conditions of the sub-lease agreement.
Non-interest Expense. Non-interest expense was $1,802,196 for the quarter
ended September 30, 2005, compared to $1,493,056 for the quarter ended September
30, 2004. The principal causes of the $309,140 increase were:
o $105,187 in higher salary and benefits costs due to normal salary
increases, a slight increase in staffing to support growth and higher
benefit costs.
o $164,293 increase in "other expenses," reflecting the effects of
growth on other expense categories, increased costs of service
providers and a $100,000 expense associated with the establishment of
a reserve for an unasserted claim. The reserve involves a transaction
between other parties that was processed by the Company.
o $47,167 increase in legal expenses primarily the result of expenses
incurred in connection with a number of pending lawsuits in which the
Bank is either a garnishee or the holder of extensive subpoenaed
records.
Income Tax Expense. Income tax expense was $573,782 for the quarter ended
September 30, 2005, compared to income tax expense of $539,459 for the quarter
ended September 30, 2004, due to the $73,056 increase in income before income
taxes in the 2005 quarter. Our effective tax rate remained the same for the
quarters ended September 30, 2005 and 2004 at 46.6%.
Results of Operations for the Nine Months Ended September 30, 2005 and September
30, 2004
General. We had net income of $1,921,827 for the nine months ended
September 30, 2005, compared to net income of $1,607,319 for the comparable nine
months in 2004. The principal categories which make up the 2005 net income are:
o Interest income of $8,225,632
o Reduced by interest expense of $1,347,776
o Increased by a credit to the provision for loan losses of $90,000
o Increased by non-interest income of $1,649,273
o Reduced by non-interest expense of $5,018,586
o Reduced by $1,676,716 in income tax expense
We discuss each of these categories individually and the reasons for the
differences between the nine months ended September 30, 2005 and the comparable
nine months in 2004 in the following paragraphs. The implementation of our
growth strategy in 2004 provided a significant increase in funds for
investments. However, in 2005, total assets declined during the first quarter
17
and then increase moderately during the second and third quarters. Therefore,
the relatively steady increase in earning assets that we have experienced since
we opened for business has moderated in 2005.
Interest Income. Interest income was $8,225,632 for the nine months ended
September 30, 2005, compared to $6,921,720 for the nine months ended September
30, 2004, an increase of $1,303,912 or 18.8%. The principal reason for the
increase was a $29,332,990 increase in the average balance of investment
securities, as available funds were deployed into investment securities that had
higher yields than available short-term investments, such as overnight bank
deposits. The average balance of loans increased $1,840,624, or 2.68%, between
the periods as management's efforts to increase the loan portfolio were offset
by increased competition for available loan opportunities and a high level of
payoffs in the Bank's short-term construction loan portfolio. The average yield
on loans increased by 25 basis points.
The reported average yield on interest earning assets of 5.41% in the first
nine months of 2005 was greater than the average yield of 5.22% in the 2004
period due to a higher yield on loans and overnight funds. The increase in
average loan yields of 25 basis points occurred because the yields on our all of
our prime-based loan accounts have increased above the interest rate floors
which had been in effect in prior quarters. These loans generally have minimum
interest rates between 7.00% and 8.00%, and when the prime rate was at a very
low level, the yields on these loans did not begin to rise until the prime rate
exceeded 6.0% to 6.5%. Yields on these loans will continue to rise with future
increases in the prime rate. Yields on overnight funds have also increased as
the federal funds rate increased.
Interest Expense. Interest expense was $1,347,776 for the nine months ended
September 30, 2005, compared to $802,066 for the nine months ended September 30,
2004, an increase of 68.0%. The increase was the result of an increase in the
average balance of interest-bearing deposits along with higher rates paid on
those balances. Our average cost of funds increased from 1.06% to 1.45% between
the periods. In particular, the increase of $20,745,574 in the average balance
of time deposits, along with an increase of 85 basis points in the average rate
on those deposits, contributed to increased interest expense.
Net Interest Income Before Provision for Loan Losses. Net interest income
before the provision for loan losses was $6,877,856 for the nine months ended
September 30, 2005, an increase of $758,202, or 12.3% over the $6,119,654 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 8 basis point decline in our
net interest margin. The spread and margin declined because the cost of
interest-bearing liabilities increased more than the yield on interest-earning
assets.
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 36.0% of
average interest bearing liabilities in the 2004 period to 46.2% in the 2005
period. The increase in the average rate we paid on time deposits, going from an
average rate of 0.98% in the 2004 period to an average rate of 1.83% in the 2005
period, 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. Although average non-interest checking
account volumes were substantially similar in the first nine months of 2005
compared to the same period in 2004, we experienced a significant decline in
such accounts during the third quarter of 2005, as noted above. Maintaining a
high percentage of non-interest checking accounts is particularly advantageous
as interest rates increase because those no cost funds can be invested at
increasing yields. However, an increase in market interest rates may make
interest-bearing deposit products more attractive to customers and cause funds
to shift from non-interest checking into interest-bearing deposit products.
18
Credit Provision for Loan Losses. For the nine months ended September 30,
2005, we reversed $90,000 which had previously been charged to expense, compared
to a provision for loan losses of $130,000 for the nine months ended September
30, 2004. The $220,000 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 $1,649,273 for the nine months
ended September 30, 2005, compared to $1,408,235 during the same period last
year. The $241,038, or 17.1% increase was a direct result of a $22,702 increase
in loan fees due to a larger volume of loan closings, a $30,526 increase in
service charges on deposits (primarily non-sufficient fund fees) due to an
increase in the aggregate number of deposit accounts, an increase in other
income of $40,669 and an increase in rental income of $147,141. The increase in
rental income is due primarily to a one-time payment of $119,000 resulting from
the termination of a sub-lease agreement by the tenant in which the Bank is the
lessor. This payment satisfies all conditions of the sub-lease agreement.
Non-interest Expense. Non-interest expense was $5,018,586 for the nine
months ended September 30, 2005, compared to $4,388,708 for the nine months
ended September 30, 2004. The principal causes of the $629,878 increase were:
o $348,569 in higher salary and benefits costs due to normal salary
increases, $15,595 of additional compensation expense associated with
the ESOP, an increase in staffing to support growth and higher benefit
costs.
o $31,409 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 $17,441 in additional occupancy expense due to increased real estate
taxes and general repair.
o $255,360 more of "other expenses," reflecting the effects of growth on
other expense categories, the higher costs of service providers and
the expense associated with the establishment of a reserve for the
unasserted claim discussed above..
o $19,145 less in computer expense due to the full amortization of
computer hardware and software.
Income Tax Expense. Income tax expense was $1,921,827 for the nine months
ended September 30, 2005, compared to income tax expense of $1,607,319 for the
nine months ended September 30, 2004, due to the $589,362 increase in income
before income taxes in the 2005 period. Our effective tax rate remained the same
for the nine months ended September 30, 2005 and 2004 at 46.6%.
19
VSB Bancorp, Inc.
Consolidated Average Balance Sheets
(unaudited)
Three Three
Months Ended Months Ended
Sep. 30, 2005 Sep. 30, 2004
----------------------------------------- ------------------------------------------
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
-------------- ------------ --------- ------------- ------------ ---------
Assets:
Interest-earning assets:
Loans receivable $ 74,314,325 $ 1,540,973 8.19% $ 68,317,088 $ 1,335,491 7.78%
Investment securities, AFS 110,601,443 1,160,153 4.16 97,280,749 1,074,385 4.39
Other interest-earning assets 20,636,390 171,029 3.29 26,968,064 85,560 1.26
-------------- ------------ ------------- ------------
Total interest-earning assets 205,552,158 2,872,155 5.53 192,565,901 2,495,436 5.16
Non-interest earning assets 13,034,084 15,021,216
-------------- -------------
Total assets $ 218,586,242 $ 207,587,117
============== =============
Liabilities and equity:
Interest-bearing liabilities:
Savings accounts $ 16,605,006 20,897 0.50 $ 13,449,113 16,910 0.50
Time accounts 62,123,134 330,917 2.11 43,112,683 107,626 0.99
Money market accounts 19,599,583 55,768 1.13 23,147,249 49,295 0.85
Now accounts 26,224,204 28,455 0.43 23,996,409 25,494 0.42
Trust preferred 5,155,000 89,040 6.91 5,155,000 89,040 6.91
-------------- ------------ ------------- ------------
Total interest-bearing liabilities 129,706,927 525,077 1.61 108,860,454 288,365 1.05
Checking accounts 71,722,399 85,524,196
-------------- -------------
Total deposits 201,429,326 194,384,650
Other liabilities 2,659,775 2,210,716
-------------- -------------
Total liabilities 204,089,101 196,595,366
Equity 14,497,141 10,991,751
-------------- -------------
Total liabilities and equity $ 218,586,242 $ 207,587,117
============== =============
Net interest income/net interest
rate spread $ 2,347,078 3.92% $ 2,207,071 4.11%
============ ========= ============ =========
Net interest earning assets/net
interest margin $ 75,845,231 4.52% $ 83,705,447 4.56%
============== ========= ============= =========
Ratio of interest-earning assets to
interest-bearing liabilities 1.58 x 1.77 x
============== =============
Return on Average Assets 1.19% 1.19%
============== =============
Return on Average Equity 18.00% 22.40%
============== =============
Tangible Equity to Total Assets 6.26% 5.18%
============== =============
Nine Nine
Months Ended Months Ended
Sep. 30, 2005 Sep. 30, 2004
----------------------------------------- ------------------------------------------
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
-------------- ------------ --------- ------------- ------------ ---------
Assets:
Interest-earning assets:
Loans receivable $ 70,499,997 $ 4,193,942 7.93% $ 68,659,373 $ 3,952,991 7.68%
Investment securities, AFS 117,561,765 3,715,401 4.23 88,228,775 2,815,449 4.26
Other interest-earning assets 14,814,926 316,289 2.85 20,264,644 153,280 1.01
-------------- ------------ -------------- -------------
Total interest-earning assets 202,876,688 8,225,632 5.41 177,152,792 6,921,720 5.22
Non-interest earning assets 12,967,008 13,084,585
-------------- --------------
Total assets $ 215,843,696 $ 190,237,377
============== ==============
Liabilities and equity:
Interest-bearing liabilities:
Savings accounts $ 15,768,637 59,235 0.50 $ 12,044,085 45,090 0.50
Time accounts 57,234,501 781,303 1.83 36,488,927 267,620 0.98
Money market accounts 21,229,835 161,768 1.02 23,387,096 146,069 0.84
Now accounts 24,602,818 78,351 0.43 24,161,860 76,168 0.42
Trust preferred 5,155,000 267,119 6.91 5,155,000 267,119 6.93
-------------- ------------ -------------- -------------
Total interest-bearing liabilities 123,990,791 1,347,776 1.45 101,236,968 802,066 1.06
Checking accounts 75,572,525 75,821,008
-------------- --------------
Total deposits 199,563,316 177,057,976
Other liabilities 2,494,712 1,919,346
-------------- --------------
Total liabilities 202,058,028 178,977,322
Equity 13,785,668 11,260,055
-------------- --------------
Total liabilities and equity $ 215,843,696 $ 190,237,377
============== ==============
Net interest income/net interest
rate spread $ 6,877,856 3.96% $ 6,119,654 4.16%
============ ========= ============ ========
Net interest earning assets/net
interest margin $ 78,885,897 4.53% $ 75,915,824 4.61%
============== ======== ============== ========
Ratio of interest-earning assets to
interest-bearing liabilities 1.64 x 1.75 x
============== ==============
Return on Average Assets 1.19% 1.13%
============== ==============
Return on Average Equity 18.60% 19.01%
============== ==============
Tangible Equity to Total Assets 6.26% 5.18%
============== ==============
20
Liquidity and Capital Resources
Our primary sources of funds are increases in deposits and proceeds from
the repayment of investment securities. We use these funds principally to
purchase new investment securities and to fund new and renewing loans in our
loan portfolio.
During the nine months ended September 30, 2005, we had a net decrease in
deposits of $10,230,968 and proceeds from repayment of investment securities
totaled $23,066,398. We used the resulting net increase in funds primarily to
finance $8,075,805 in new and renewing loans, with substantially all of the
remainder being used to fund an increase in overnight investments and other
short-term interest-earning assets. The deposit outflow was concentrated in
business checking accounts used to fund mortgage closings, as discussed above.
In contrast, during the comparable period of 2004, deposits increased by
$46,633,933 and proceeds from the repayment of investment securities totaled
$22,877,999. We used those funds to finance a $718,850 increase in our loan
portfolio and to purchase $53,186,695 of investment securities and money market
investments. The 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 Bank Development District
deposit program.
The Bank satisfied all capital ratio requirements of the Federal Deposit
Insurance Corporation, at September 30, 2005, with a Tier I Leverage Capital
ratio of 9.05%, a ratio of Tier I Capital to Risk-Weighted Assets ratio of
18.41%, and a Total Capital to Risk-Weighted Assets ratio of 19.66%.
VSB Bancorp, Inc. satisfied all capital ratio requirements of the Federal
Reserve at September 30, 2005, with a Tier I Leverage Capital ratio of 9.39%, a
ratio of Tier I Capital to Risk-Weighted Assets ratio of 19.08%, and a Total
Capital to Risk-Weighted Assets ratio of 20.32%.
In the first nine months of 2005, we experienced a $6,770,535 decrease in
cash and cash equivalents due to a net decrease in deposits, compared to a
$20,576,462 increase in cash and cash equivalents during the first nine months
of 2004. Total cash and cash equivalents at September 30, 2005 were $42,429,608.
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.
21
Contractual Obligations and Commitments at September 30, 2005
Contractual Obligations Payment due by Period
------------------------------------------------------------------------------------
Less than One to three Four to five After Total Amounts
One Year years years five years committed
--------------- --------------- -------------- -------------- -----------------
Minimum annual rental payments under
non-cancelable operating leases $ 440,084 $ 814,017 $ 801,131 $ 3,138,613 $ 5,193,845
Remaining contractual maturities of time
deposits 62,540,840 1,456,525 1,789,558 - 65,786,923
--------------- --------------- -------------- -------------- -----------------
Total contractual cash obligations $ 62,980,924 $ 2,270,542 $ 2,590,689 $ 3,138,613 $ 70,980,768
=============== =============== ============== ============== =================
Other commitments Amount of commitment Expiration by Period
------------------------------------------------------------------------------------
Less than One to three Four to five After Total Amounts
One Year years years five years committed
--------------- --------------- -------------- -------------- -----------------
--------------- --------------- -------------- -------------- -----------------
Loan commitments $ 24,748,779 $ 9,127,359 $ - $ - $ 33,876,138
=============== =============== ============== ============== =================
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. 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.
Allowance for Loan Losses - We consider the methodology for determining the
allowance for loan losses to be a critical accounting policy. 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
22
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.
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 September 30, 2005,
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.
Part II
Item 1 - Legal Proceedings
The plaintiff in a pending lawsuit against customers of the Bank has said that
it plans to amend its complaint, adding a claim that the Bank aided and abetted
its customer in breaching a fiduciary duty. The damages claimed exceed $1.8
million. The Bank has forwarded the matter to its insurance carrier and intends
to contest the claim vigorously when and if the Bank is formally joined as a
defendant. However, at this stage, it is impossible to evaluate the likelihood
of an adverse outcome.
23
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: November 8, 2005 /s/ MERTON CORN
----------------------------------------
Merton Corn
President and Chief Executive Officer
Date: November 8, 2005 /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.
24