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, 2006
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OF THE EXCHANGE ACT
FOR THE TRANSITION PERIOD
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)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act)
Yes [ ] No [X]
Transitional small business disclosure format: Yes [ ] No [X]
The Registrant had 1,891,759 common shares outstanding as of July 28, 2006.
CROSS REFERENCE INDEX
PART I
Page
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Item 1 Consolidated Statements of Financial Condition as of June 30, 2006 and December 31, 2005 (unaudited). 4
Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2006
and 2005 (unaudited). 5
Consolidated Statements of Changes in Stockholders' Equity for the Six Months Ended June 30, 2006
and the Year Ended December 31, 2005 (unaudited). 6
Consolidated Statements of Cash Flows for the Three and Six Months Ended June 30, 2006
and 2005 (unaudited). 7
Notes to Consolidated Financial Statements for the Three and Six Months Ended June 30, 2006
and 2005 (unaudited). 8 to 15
Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 15 to 24
Item 3 Control and Procedures 24 to 25
PART II
Item 1 Legal Proceedings 25
Signature Page 26
Exhibit 31.1, 31.2, 32.1, 32.2 27 to 30
2
Forward-Looking Statements
When used in this periodic report, or in any written or oral statement
made by us or our officers, directors or employees, the words and phrases "will
result," "expect," "will continue," "anticipate," "estimate," "project," or
similar terms are intended to identify "forward-looking statements." A variety
of factors could cause our actual results and experiences to differ materially
from the anticipated results or other expectations expressed in any
forward-looking statements. Some of the risks and uncertainties that may affect
our operations, performance, development and results, the interest rate
sensitivity of our assets and liabilities, and the adequacy of our loan loss
allowance, include, but are not limited to:
o deterioration in local, regional, national or global economic
conditions which could result in, among other things, an increase
in loan delinquencies, a decrease in property values, or a change
in the real estate turnover rate;
o changes in market interest rates or changes in the speed at which
market interest rates change;
o changes in laws and regulations affecting the financial service
industry;
o changes in competition; and
o changes in consumer preferences by our customers or the customers
of our business borrowers.
Please do not place undue reliance on any forward-looking statement,
which speaks only as of the date made. There are many factors, including those
described above, that could affect our future business activities or financial
performance and could cause our actual future results or circumstances to differ
materially from those we anticipate or project. We do not undertake any
obligation to update any forward-looking statement after it is made.
3
VSB Bancorp, Inc.
Consolidated Statements of Financial Condition
(unaudited)
June 30, December 31,
2006 2005
------------- -------------
Assets:
Cash and due from banks $ 27,828,917 $ 31,324,147
Investment securities, available for sale 117,998,456 106,023,293
Loans receivable 71,935,506 73,944,105
Allowance for loan loss (1,240,851) (1,153,298)
------------- -------------
Loans receivable, net 70,694,655 72,790,807
Bank premises and equipment, net 1,712,873 1,441,087
Accrued interest receivable 830,467 728,627
Deferred taxes 3,154,451 2,298,195
Other assets 1,497,103 1,169,556
------------- -------------
Total assets $ 223,716,922 $ 215,775,712
============= =============
Liabilities and stockholders' equity:
Liabilities:
Deposits:
Demand and checking $ 69,349,228 $ 66,692,436
NOW 24,783,295 23,574,056
Money market 18,562,940 20,177,240
Savings 12,730,971 14,809,010
Time 75,524,560 67,731,273
------------- -------------
Total Deposits 200,950,994 192,984,015
Escrow deposits 274,772 267,144
Subordinated debt 5,155,000 5,155,000
Accounts payable and accrued expenses 2,195,454 2,553,208
------------- -------------
Total liabilities 208,576,220 200,959,367
------------- -------------
Employee Stock Ownership Plan Repurchase Obligation 315,845 284,411
Stockholders' equity:
Common stock, ($.0001 par value, 3,000,000 shares
authorized, 1,891,009 issued and outstanding at
June 30, 2006 and 1,509,822 issued and
outstanding at December 31, 2005) 189 151
Additional paid in capital 8,753,050 8,743,200
Retained earnings 9,799,374 8,621,693
Unallocated ESOP Shares (1,324,444) (1,408,983)
Accumulated other comprehensive loss,
net of taxes of $2,096,429 and $1,242,278,
respectively (2,403,312) (1,424,127)
------------- -------------
Total stockholders' equity 14,824,857 14,531,934
------------- -------------
Total liabilities and stockholders'
equity $ 223,716,922 $ 215,775,712
============= =============
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, 2006 June 30, 2005 June 30, 2006 June 30, 2005
------------- ------------- ------------- -------------
Interest and dividend income:
Loans receivable $ 1,758,136 $ 1,352,333 $ 3,506,909 $ 2,652,969
Investment securities 1,320,669 1,235,763 2,526,431 2,555,248
Other interest earning assets 133,179 83,142 312,627 145,260
------------- ------------- ------------- -------------
Total interest income 3,211,984 2,671,238 6,345,967 5,353,477
Interest expense:
NOW 26,442 27,871 49,645 49,896
Money market 95,447 51,953 179,663 106,000
Savings 21,044 20,111 39,378 38,338
Subordinated debt 89,039 89,039 178,079 178,079
Time 531,071 263,269 984,954 450,386
------------- ------------- ------------- -------------
Total interest expense 763,043 452,243 1,431,719 822,699
Net interest income 2,448,941 2,218,995 4,914,248 4,530,778
Provision (credit) for loan loss -- (45,000) 25,000 (75,000)
------------- ------------- ------------- -------------
Net interest income
after provision for loan loss 2,448,941 2,263,995 4,889,248 4,605,778
------------- ------------- ------------- -------------
Non-interest income:
Loan fees 17,533 33,635 40,300 57,094
Service charges on deposits 386,972 440,590 776,728 844,607
Net rental income 3,374 10,542 6,749 21,605
Other income 70,593 29,410 138,244 54,493
------------- ------------- ------------- -------------
Total non-interest income 478,472 514,177 962,021 977,799
------------- ------------- ------------- -------------
Non-interest expenses:
Salaries and benefits 969,643 935,254 2,001,720 1,873,750
Occupancy expenses 279,590 239,982 539,050 486,742
Legal expense 103,447 23,451 162,321 33,375
Professional fees 42,000 51,000 90,000 126,000
Computer expense 62,097 60,138 122,625 114,950
Directors' fees 57,550 43,750 113,450 86,925
Other expenses 312,606 261,005 617,040 494,648
------------- ------------- ------------- -------------
Total non-interest expenses 1,826,933 1,614,580 3,646,206 3,216,390
------------- ------------- ------------- -------------
Income before income taxes 1,100,480 1,163,592 2,205,063 2,367,187
Provision/(benefit) for income taxes:
Current 509,513 526,438 1,029,487 1,084,740
Deferred 3,197 15,693 (2,105) 18,194
------------- ------------- ------------- -------------
Total provision for income taxes 512,710 542,131 1,027,382 1,102,934
------------- ------------- ------------- -------------
Net income $ 587,770 $ 621,461 $ 1,177,681 $ 1,264,253
============= ============= ============= =============
Basic income per common share $ 0.32 $ 0.35 $ 0.65 $ 0.70
============= ============= ============= =============
Diluted net income per share $ 0.31 $ 0.33 $ 0.63 $ 0.68
============= ============= ============= =============
Comprehensive income $ 134,591 $ 1,421,335 $ 198,496 $ 1,173,943
============= ============= ============= =============
Book value per common share $ 8.01 $ 7.56 $ 8.01 $ 7.56
============= ============= ============= =============
All per share data has been adjusted for the 5 for 4 stock split, in the form of
a 25% stock dividend, paid on May 18, 2006.
See notes to consolidated financial statements.
5
VSB Bancorp, Inc.
Consolidated Statements of Changes in Stockholders' Equity
Year Ended December 31, 2005 and Six Months Ended June 30, 2006
(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, 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 169,078 169,078
Amortization of excess fair
value over cost - ESOP 18,742 18,742
Transfer from ESOP repurchase
obligation (157,586) (157,586)
Comprehensive income:
Net income 2,567,429 2,567,429
Other comprehensive income,
net:
Unrealized holding loss
arising during the year -- -- -- -- -- (959,082) (959,082)
------------ ------------ ------------ ------------ ------------ ------------ ------------
Total comprehensive income 1,608,347
Balance at December 31, 2005 1,509,822 $ 151 $ 8,743,200 $ 8,621,693 $ (1,408,983) $ (1,424,127) $ 14,531,934
------------ ------------ ------------ ------------ ------------ ------------ ------------
Exercise of stock option 3,000 42,170 42,170
Amortization of earned portion
of ESOP common stock 84,539 84,539
5 for 4 stock split and purchase
of fractional shares 378,187 38 (367) (329)
Amortization of excess fair
value over cost - ESOP (519) (519)
Transfer from ESOP repurchase
obligation (31,434) (31,434)
Comprehensive income:
Net income 1,177,681 1,177,681
Other comprehensive income,
net:
Unrealized holding loss
arising during the year -- -- -- -- -- (979,185) (979,185)
------------ ------------ ------------ ------------ ------------ ------------ ------------
Total comprehensive income 198,496
Balance at June 30, 2006 1,891,009 $ 189 $ 8,753,050 $ 9,799,374 $ (1,324,444) $ (2,403,312) $ 14,824,857
============ ============ ============ ============ ============ ============ ============
All per share data has been adjusted for the 5 for 4 stock split, in the form of
a 25% stock dividend, paid on May 18, 2006.
See notes to consolidated financial statements.
6
VSB Bancorp, Inc.
Consolidated Statements of Cash Flows
(unaudited)
Three months Three months Six months Six months
ended ended ended ended
June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
------------- ------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 587,770 $ 621,461 $ 1,177,681 $ 1,264,253
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation and amortization 115,233 115,147 217,558 229,083
Accretion of income, net of amortization of premium (96,770) (13,423) (187,392) (38,360)
ESOP compensation expense 43,772 44,358 84,020 87,537
Provision/(credit) for loan losses -- (45,000) 25,000 (75,000)
Decrease/(increase)in prepaid and other assets 164,586 (97,647) (327,547) (318,553)
(Increase)/decrease in accrued interest receivable (78,609) (21,295) (101,840) 2,241
Decrease/(increase) in deferred income taxes 3,197 15,693 (2,105) 18,194
(Increase)/decrease in accrued expenses and other liabilities (363,402) (142,118) (357,754) 204,561
------------- ------------- ------------- -------------
Net cash provided by operating activities 375,777 477,176 527,621 1,373,956
------------- ------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase)/decrease in loan receivable (896,471) (9,557,842) 2,272,731 (7,887,938)
Proceeds from repayment of investment securities,
available for sale 5,308,655 6,793,035 10,121,487 13,920,944
Purchases of investment securities, afs (12,974,093) -- (23,944,173) --
Purchases of premises and equipment (467,110) (15,979) (489,344) (23,396)
------------- ------------- ------------- -------------
Net cash (used in)/provided by investing activities (9,029,019) (2,780,786) (12,039,299) 6,009,610
------------- ------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase/(decrease) in deposits 5,513,510 (6,739,871) 7,974,607 (18,484,623)
Exercise stock option 42,170 40,776 42,170 40,776
5 for 4 stock split and the purchase of fractional shares (329) -- (329) --
------------- ------------- ------------- -------------
Net cash (used in)/provided by financing activities 5,555,351 (6,699,095) 8,016,448 (18,443,847)
------------- ------------- ------------- -------------
NET (DECREASE)/INCREASE IN CASH
AND CASH EQUIVALENTS (3,097,891) (9,002,705) (3,495,230) (11,060,281)
------------- ------------- ------------- -------------
CASH AND CASH EQUIVALENTS,
BEGINNING OF PERIOD 30,926,808 33,601,497 31,324,147 35,659,073
------------- ------------- ------------- -------------
CASH AND CASH EQUIVALENTS,
END OF PERIOD $ 27,828,917 $ 24,598,792 $ 27,828,917 $ 24,598,792
============= ============= ============= =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid during the period for:
Interest $ 646,527 $ 408,849 $ 1,441,226 $ 771,849
============= ============= ============= =============
Taxes $ 841,170 $ 1,039,075 $ 1,226,059 $ 1,276,887
============= ============= ============= =============
See notes to consolidated financial statements.
7
VSB Bancorp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE AND SIX MONTHS ENDED
JUNE 30, 2006 AND 2005 (UNAUDITED)
--------------------------------------------------------------------------------
1. GENERAL
VSB Bancorp, Inc. ("Bancorp" or "Company") became the holding company for
Victory State Bank ("Bank"), a New York State chartered commercial bank on May
30, 2003 as the result of a reorganization of the Bank into the holding company
form of organization. Through the Bank, the Company is primarily engaged in the
business of commercial banking, and to a lesser extent retail banking, in Staten
Island New York. The stockholders of the Bank became the stockholders of VSB
Bancorp, Inc. as a result of the reorganization, receiving three shares of VSB
Bancorp, Inc. stock for each two shares of Victory State Bank stock. Each
stockholder owned the same percentage interest in VSB Bancorp immediately after
the reorganization that the stockholder owned in the Bank immediately before the
reorganization, subject to immaterial differences due to adjustments for cash in
lieu of fractional shares. VSB Bancorp now owns 100% of the capital stock of the
Bank. No stockholders of the Bank exercised dissenter's rights to receive cash
instead of shares of the Company. The transaction between these entities under
common control was accounted for at historical cost on an "as if pooled basis".
Through the Bank, the Company is primarily engaged in the business of
commercial banking, and to a lesser extent retail banking. The Bank gathers
deposits from individuals and businesses primarily in Staten Island, New York
and makes loans throughout that community. The Bank invests funds that are not
used for lending primarily in government securities, mortgage backed securities
and collateralized mortgage obligations. Customer deposits are insured, up to
the applicable limit, by the Federal Deposit Insurance Corporation ("FDIC"). The
Bank is supervised by the New York State Banking Department and the FDIC.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following is a description of the significant accounting and reporting
policies followed in preparing and presenting the accompanying consolidated
financial statements. These policies conform with accounting principles
generally accepted in the United States of America ("GAAP").
Principles of Consolidation - The consolidated financial statements of the
Company include the accounts of the Company, including its subsidiary Victory
State Bank. All significant inter-company accounts and transactions between the
Company and Bank have been eliminated in consolidation.
Use of Estimates - The preparation of financial statements in conformity
with GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities at the date of the financial statements and the amounts
of revenues and expenses during the reporting period. Actual results can differ
from those estimates. The allowance for loan losses, prepayment estimates on the
mortgage-backed securities and Collateralized Mortgage Obligation portfolios,
contingencies and fair values of financial instruments are particularly subject
to change.
Reclassifications - Some items in the prior year financial statements were
reclassified to conform to the current presentation.
Cash and Cash Equivalents - Cash and cash equivalents consists of cash on
hand, due from banks and interest-bearing deposits. Net cash flows are reported
for customer loan and deposit transactions and interest-bearing deposits.
Regulation D of the Board of Governors of the Federal Reserve system requires
that Victory State Bank maintain non-interest-bearing deposits or cash on hand
as reserves against its demand deposits. The amount of reserves which Victory
8
State Bank is required to maintain depends upon its level of transaction
accounts. During the fourteen day period from June 22, 2006 through July 5,
2006, Victory State Bank was required to maintain reserves, after deducting
vault cash, of $4,247,000. Reserves are required to be maintained on a fourteen
day basis, so, from time to time, Victory State Bank may use available cash
reserves on a day to day basis, so long as the fourteen day average reserves
satisfy Regulation D requirements. Victory State Bank is required to report
transaction account levels to the Federal Reserve on a weekly basis.
Interest-bearing bank balances - Interest-bearing bank balances mature
overnight and are carried at cost.
Investment Securities, Available for Sale - Investment securities,
available for sale, are to be held for an unspecified period of time and include
securities that management intends to use as part of its asset/liability
strategy. These securities may be sold in response to changes in interest rates,
prepayments or other factors and are carried at estimated fair value. Gains or
losses on the sale of such securities are determined by the specific
identification method. Interest income includes amortization of purchase premium
and accretion of purchase discount. Premiums and discounts are recognized in
interest income using a method that approximates the level yield method without
anticipating prepayments, except for mortgage-backed securities where
prepayments are estimated. Unrealized holding gains or losses, net of deferred
income taxes, are excluded from earnings and reported as other comprehensive
income in a separate component of stockholders' equity until realized. Declines
in the fair value of securities below their cost that are other than temporary
are reflected as realized losses. In estimating other-than-temporary losses,
management considers: (1) the length of time and extent that fair value has been
less than cost, (2) the financial condition and near term prospects of the
issuer, and (3) the Company's ability and intent to hold the security for a
period sufficient to allow for any anticipated recovery in fair value.
The Company invests primarily in agency Collateralized Mortgage-Backed
Obligations ("CMOs") with estimated average lives primarily under 4.5 years and
Mortgage-Backed Securities. These securities are primarily issued by the Federal
National Mortgage Association ("FNMA"), the Government National Mortgage
Association ("GNMA") or the Federal Home Loan Mortgage Corporation ("FHLMC") and
are primarily comprised of mortgage pools guaranteed by FNMA, GNMA or FHLMC. The
Company also invests in whole loan CMOs, all of which are AAA rated. These
securities expose the Company to risks such as interest rate, prepayment and
credit risk and thus pay a higher rate of return than comparable treasury
issues.
Loans Receivable - Loans receivable, that management has the intent and
ability to hold for the foreseeable future or until maturity or payoff, are
stated at unpaid principal balances, adjusted for deferred net origination and
commitment fees and the allowance for loan losses. Interest income on loans is
credited as earned.
It is the policy of the Company to provide a valuation allowance for
probable incurred losses on loans based on the Company's past loan loss
experience, known and inherent risks in the portfolio, adverse situations which
may affect the borrower's ability to repay, estimated value of underlying
collateral and current economic conditions in the Company's lending area. The
allowance is increased by provisions for loan losses charged to earnings and is
reduced by charge-offs, net of recoveries. While management uses available
information to estimate losses on loans, future additions to the allowance may
be necessary based upon the expected growth of the loan portfolio and any
changes in economic conditions beyond management's control. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the Bank's allowance for loan losses. Such agencies may
require the Bank to recognize additions to the allowance based on judgments
different from those of management. Management believes, based upon all relevant
and available information, that the allowance for loan losses is 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.
9
Loan origination fees and certain direct loan origination costs are
deferred and the net amount recognized over the contractual loan terms using the
level-yield method, adjusted for periodic prepayments in certain circumstances.
The Company considers a loan to be impaired when, based on current
information, it is probable that the Company will be unable to collect all
principal and interest payments due according to the contractual terms of the
loan agreement. Loans that experience insignificant payment delays and payment
shortfalls generally are not classified as impaired. Impairment is measured on a
loan by loan basis for commercial and construction loans. Impaired loans are
measured based on the present value of expected future cash flows discounted at
the loan's effective interest rate or, as a practical expedient, at the loan's
observable market price or the fair value of the collateral. The fair value of
the collateral, as reduced by costs to sell, is utilized if a loan is collateral
dependent. Large groups of smaller balance homogeneous loans, such as consumer
loans and residential loans, are collectively evaluated for impairment.
Long-Lived Assets - The Company periodically evaluates the recoverability
of long-lived assets, such as premises and equipment, to ensure the carrying
value has not been impaired. In performing the review for recoverability, the
Company would estimate the future cash flows expected to result from the use of
the asset. If the sum of the expected future cash flows is less than the
carrying amount an impairment will be recognized. The Company reports these
assets at the lower of the carrying value or fair value.
Subordinated Debt - In August of 2003, the Company formed VSB Capital
Trust I (the "Trust"). The Trust is a statutory business trust organized under
Delaware law and the Company owns all of its common securities. The Trust issued
$5.0 million of Trust Preferred Capital Securities to an independent investor
and $155,000 of common securities to the Company. The Company issued a $5.16
million subordinated debenture to the Trust. The subordinated debenture is the
sole asset of the Trust. The subordinated debenture and the Trust Preferred
Capital Securities pay interest and dividends, respectively, on a quarterly
basis, at a rate of 6.909%, for the first five years. They mature thirty years
after the issuance of the securities and are non-callable for five years. After
the first five years, the Trust Preferred Securities may be called by the
Company at any quarterly interest payment date at par and the rate of interest
that fluctuates quarterly based upon 300 basis points over the 90 day LIBOR
rate. The Trust is not consolidated with the Company.
Premises and Equipment - Premises, leasehold improvements, and furniture
and equipment are stated at cost less accumulated depreciation and amortization.
Depreciation and amortization are accumulated by the straight-line method over
the estimated useful lives of the respective assets, which range from three to
ten years. Leasehold improvements are amortized at the lesser of their useful
life or the term of the lease.
Federal Home Loan Bank (FHLB) Stock - The Bank is a member of the FHLB
system. Members are required to own a certain amount of stock based on the level
of borrowings and other factors, and may invest in additional amounts. FHLB
stock is carried at cost, classified as a restricted security, and periodically
evaluated for impairment. Because this stock is viewed as a long term
investment, impairment is based on ultimate recovery of par value. Both cash and
stock dividends are reported as income.
Income Taxes - The Company utilizes the liability method to account for
income taxes. Under this method, deferred tax assets and liabilities are
determined on differences between financial reporting and the tax bases of
assets and liabilities and are measured using the enacted tax rates and laws
expected to be in effect when the differences are expected to reverse. As
changes in tax laws or rates are enacted, deferred tax assets and liabilities
are adjusted through the provision for income taxes.
Financial Instruments - In the ordinary course of business, the Company
has entered into off-balance sheet financial instruments, primarily consisting
of commitments to extend credit.
10
Basic and Diluted Net Income Per Common Share - Basic net income per share
of common stock is based on 1,817,155 and 1,800,698, the weighted average number
of common shares outstanding for the three months ended June 30, 2006 and 2005,
respectively. Diluted net income per share of common stock is based on 1,869,463
and 1,863,361, the weighted average number of common shares and potentially
dilutive common shares outstanding for the three months ended June 30, 2006 and
2005, 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 76,487 and 62,215 shares for the three months ended June
30, 2006 and 2005, respectively. Common stock equivalents were calculated using
the treasury stock method. All per share data throughout this report has been
adjusted to reflect, retroactively, a 5 for 4 stock split, in the form of a 25%
stock dividend, that was declared by the Board of Directors to stockholders of
record on May 3, 2006.
The reconciliation of the numerators and the denominators of the basic and
diluted per share computations for the three and six months ended June 30, are
as follows:
11
Reconciliation of EPS Three Months Ended Three Months Ended
--------------------- June 30, 2006 June 30, 2005
------------------------------------------ ------------------------------------------
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 $ 587,770 1,817,155 $ 0.32 $ 621,461 1,800,698 $ 0.35
============ ============
Effect of dilutive shares
-------------------------
Weighted average
shares, if converted 52,308 62,663
------------ ------------
Diluted net income per
common share
-------------------------
Net income available to
common stockholders $ 587,770 1,869,463 $ 0.31 $ 621,461 1,863,361 $ 0.33
============ ============ ============ ============ ============ ============
Reconciliation of EPS Six Months Ended Six Months Ended
--------------------- June 30, 2006 June 30, 2005
------------------------------------------ ------------------------------------------
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 $ 1,177,681 1,814,545 $ 0.65 $ 1,264,253 1,798,047 $ 0.70
============ ============
Effect of dilutive shares
-------------------------
Weighted average
shares, if converted 49,560 62,238
------------ ------------
Diluted net income per
common share
-------------------------
Net income available to
common stockholders $ 1,177,681 1,864,105 $ 0.63 $ 1,264,253 1,860,285 $ 0.68
============ ============ ============ ============ ============ ============
All per share data has been adjusted for the 5 for 4 stock split, in the form of
a 25% stock dividend, paid on May 18, 2006.
Stock Based Compensation - FAS 123, Revised, required companies to record
compensation expense for stock options provided to employees in return for
employment service. The cost is measured at the fair value of the options when
granted, and this cost is expensed over the employment service period, which is
normally the vesting period of the options. This applies to awards granted or
modified in fiscal years beginning in 2006. Compensation cost will also be
recorded for prior option grants that vest after the date of adoption. The
effect of result on operations will depend on the level of future option grants
and the calculation of the fair value of the options granted at such future
date, as well as the vesting periods provided, and so cannot currently be
predicted. In December 2005, the Board authorized the acceleration of the
vesting of all outstanding stock options issued to both employees and directors.
The decision to accelerate the vesting of these options, which the Company
12
believes is in the best interest of its stockholders, was made primarily to
reduce non-cash compensation expense, approximately $169,000 of future
compensation expense, net of taxes, that would have been recorded in its income
statement in future periods upon the adoption of Financial Accounting Standards
Board Statement No. 123R (Share-Based Payment) in January 2006.
If compensation cost for 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:
Three Months Six Months
Ended Ended
June 30, 2005 June 30, 2005
------------- -------------
Net Income
As reported $ 621,461 $ 1,264,253
Less: Total stock-based compensation expense
determined under the fair value method for
all rewards, net of related tax effects 13,562 27,026
------------- -------------
Pro-forma $ 607,899 $ 1,237,227
============= =============
Three Months Six Months
Ended Ended
June 30, 2005 June 30, 2005
------------- -------------
Basic earnings per common share
As reported $ 0.35 $ 0.70
Less: Total stock-based compensation expense
determined under the fair value method for
all rewards, net of related tax effects 0.01 0.01
------------- -------------
Pro-forma $ 0.34 $ 0.69
============= =============
Three Months Six Months
Ended Ended
June 30, 2005 June 30, 2005
------------- -------------
Diluted earnings per common share
As reported $ 0.33 $ 0.68
Less: Total stock-based compensation expense
determined under the fair value method for
all rewards, net of related tax effects -- 0.01
------------- -------------
Pro-forma $ 0.33 $ 0.67
============= =============
All per share data throughout this report has been adjusted to reflect,
retroactively, a 5 for 4 stock split, in the form of a 25% stock dividend,
that was declared by the Board of Directors to stockholders of record on
May 3, 2006.
Stock Options
Options to buy stock are granted to directors, officers and employees
under the VSB Bancorp, Inc. 2000 Incentive Plan, the 1998 Incentive Plan, the
2004 Directors' Plan, the 2000 Directors' Plan and the 1998 Directors' Plan
which, in the aggregate, provide for issue up to 243,750 options. Exercise price
is the market price at the date of grant, and compensation expense will be
recognized in the income statement in accordance with FAS 123, Revised. The
maximum option term is ten years, and the options vesting period is up to five
years.
As of December 31, 2005 the Board accelerated the vesting on all
outstanding options so that they became immediately exercisable. By accelerating
the vesting of these options, we estimated that approximately $169,000 of future
compensation expense, net of taxes, was eliminated.
13
There were no stock option grants in 2006 and 2005.
The stock option components of the 2000 Incentive Plan, the 1998 Incentive
Plan and the 2004 Directors' Plan, the 2000 Directors' Plan and the 1998
Directors' Plan, as of June 30, 2006, and changes during the three months ended,
consist of the following:
2006
------------------------------------------
Weighted
Average Aggregate
Exercise Intrinsic
Shares (2) Price Value (1)
------------ ------------ ------------
Options outstanding 182,498 $ 10.31
at the beginning of the year
Granted -- --
Canceled -- --
Exercised 3,750 6.40
------------
Options outstanding at June 30, 2006 178,748 $ 10.35 $ 1,385,297
============ ============ ============
Options exercisable at June 30, 2006 178,748 $ 10.35 $ 1,385,297
============ ============ ============
Weighted average remaining contractual life of
options outstanding at June 30, 2006 5.2 Years
(1) The aggregate intrinsic value is determined by taking the difference
between the closing price at June 30, 2006 ($18.10, as adjusted for
the 5 for 4 stock split) and the weighted average exercise price and
then multiplying the result by the options outstanding at June 30,
2006.
(2) All per share data throughout this report has been adjusted to
reflect, retroactively, a 5 for 4 stock split, in the form of a 25%
stock dividend, that was declared by the Board of Directors to
stockholders of record on May 3, 2006.
Described below is the range of exercise prices for options granted under
the following option plans as of June 30, 2006:
Range of Number of Weighted Average Weighted Average
Plan Description Exercise Prices Exercisable Shares Exercise Price Contractual Life
------------------------------------- --------------------- ------------------ -------------- ----------------
1998 Director Stock Option Plan From $4.90 to $6.40 23,750 $ 6.13 2.61
1998 Incentive Stock Option Plan From $4.75 to $6.40 33,000 5.76 2.54
2000 Director Stock Option Plan $4.75 25,000 4.39 3.90
2000 Incentive Stock Option Plan $4.75 and $15.60 41,998 10.40 5.83
2004 Director Stock Option Plan $17.60 55,000 17.60 8.00
------------------ -------------- ----------------
All Plans 178,748 $ 10.35 5.19
================== ============== ================
All per share data throughout this report has been adjusted to reflect,
retroactively, a 5 for 4 stock split, in the form of a 25% stock dividend,
that was declared by the Board of Directors to stockholders of record on
May 3, 2006.
Employee Stock Ownership Plan - The cost of shares issued to the ESOP, but
not yet allocated to participants, is shown as a reduction of stockholders'
equity. Compensation expense is based on the market price of shares as they are
committed to be released to participant accounts. Cash dividends on allocated
ESOP shares reduce retained earnings; cash dividends on unearned ESOP shares
reduce debt and accrued interest. As participants may put their ESOP shares back
to the Company upon termination, an amount of equity equal to these shares times
the current market price is reclassified out of stockholders' equity.
14
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.
Item 2
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Financial Condition at June 30, 2006
Total assets were $223,716,922 at June 30, 2006, an increase of $7,941,210
or, 3.7%, from December 31, 2005. The increase was due to the investment of the
proceeds of a $10 million New York State jumbo CD deposit and a $10 million New
York City jumbo CD deposit we received in connection with the opening of our
Rosebank branch under the state's and city's Bank Development District programs.
There is a non-binding commitment from the municipalities to renew these CDs for
two years and the interest rates are adjusted periodically during that time. The
deposit increase from these two CDs was partially offset by the reduction in the
balance of jumbo CDs that were opened in conjunction with the establishment of
various IRS Section 1031 exchange trusts, which have a maximum maturity of 6
months. The net increase in deposits provided funds for us to invest. We
invested these funds, together with funds resulting from a $2,096,152 decrease
in net loans receivable, primarily in investment securities available for sale,
which increased by $11,975,163. We purchased investment securities, in part, to
offset the decline in loans and to increase investment collateral available to
pledge for the municipal CD deposits.
Our deposits (including escrow deposits) were $201,225,766 at June 30,
2006, an increase of $7,974,607, or 4.1%, from December 31, 2005. The increase
in deposits resulted from increases of $2,664,420 in non-interest demand
deposits, $1,209,239 in NOW accounts and $7,793,287 in time deposits, partially
offset by decreases of $2,078,039 in savings accounts and $1,614,300 in money
market accounts. The net increase in time deposits was primarily attributed to
the $20 million in municipal CDs, partially offset by the decline in IRS Section
1031 exchange trust deposits, as discussed above. These trusts are created by
attorneys in real estate transactions. The deposits have a maximum term of six
months and cannot be renewed. Our ability to attract these deposits tends to
fluctuate with activity in the real estate markets and competitive pressures, so
the volume of these deposits tends to fluctuate from period to period more
dramatically than other types of deposits.
Total stockholders' equity was $14,824,857 at June 30, 2006, an increase
of $292,923 from December 31, 2005. The increase reflected net income of
$1,177,681 for the six months ended June 30, 2006, reduced by an increase of
$979,185 in other comprehensive loss, due to an increase in the unrealized loss
in securities available for sale during the first six months of 2006. The
unrealized loss increased due to the increase in market interest rates, which
drove down the market value of our fixed rate bond portfolio. 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 in the demand for funds may change management's plans with respect to
the securities portfolio. If there is a material increase in interest rates, the
market value of the available for sale portfolio may decline further. Management
believes that the principal and interest payments on this portfolio, combined
with the existing liquidity, will be sufficient to fund loan growth and
potential deposit outflow.
The change in stockholders' equity also included an increase of $9,850 in
additional paid in capital primarily due to the receipt of $42,170 upon the
exercise of stock options under our stock option plans which was offset by a
$31,434 increase in the magnitude of our statutorily mandated ESOP repurchase
obligation caused by an increase in our stock price. We also reported a decrease
in unearned ESOP shares of $84,539 reflecting the effect of the gradual payment
of the loan we made to fund the ESOP's purchase of our stock.
15
For financial statement reporting purposes, we record the compensation
expense related to the ESOP when shares are committed to be released from the
security interest for the loan. The amount of the compensation expense is based
upon the fair market value of the shares at that time, not the original purchase
price. The initial sale of shares to the ESOP did not increase our capital by
the amount of the purchase price because the purchase price was paid by the loan
we made to the ESOP. Instead, capital increases as the shares are allocated or
committed to be allocated to employee accounts (i.e., as the ESOP loan is
gradually repaid), based upon the fair market value of the shares at that time.
When we calculate earnings per share, only shares allocated or committed to be
allocated to employee accounts are considered to be outstanding. However, all
shares that the ESOP owns are legally outstanding, so they have voting rights
and, if we pay dividends, dividends will be paid on all ESOP shares.
Results of Operations for the Three Months Ended June 30, 2006 and June 30, 2005
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 $587,770 for the quarter ended June 30,
2006, compared to net income of $621,461 for the comparable quarter in 2005. The
principal categories which make up the 2006 net income are:
o Interest income of $3,211,984
o Reduced by interest expense of $763,043
o Increased by non-interest income of $478,472
o Reduced by non-interest expense of $1,826,933
o Reduced by $512,710 in income tax expense
We discuss each of these categories individually and the reasons for the
differences between the quarters ended June 30, 2006 and 2005 in the following
paragraphs.
Interest Income. Interest income was $3,211,984 for the quarter ended June
30, 2006, compared to $2,671,238 for the quarter ended June 30, 2005, an
increase of $540,746, or 20.24%. We accomplished the increase in interest
income, despite a decrease in total average interest-earning assets of
$1,828,426, or 0.9%, principally because of increases in the yields on our
prime-based loans, which make up most of our loan portfolio, and to a lesser
degree the increase in yield on our investment securities and other
interest-earning assets. The decrease in average interest-earning assets was
composed of a decrease in the average balance of investment securities of
$1,246,410 and a $715,050 decrease in other interest earning assets, partially
offset by a $133,034 increase in the average balance of the loan portfolio.
The yields on all principal asset categories increased as the Fed Funds
rate increased, causing increases in other interest rate indexes, such as the
prime rate, and market interest rates generally. The yields on our loan
portfolio and our other interest earning assets, principally short term liquid
assets, increased more rapidly than the yield on our investment securities. This
occurred because most of our loans and liquid assets tend to have interest rates
that adjust more quickly as market interest rates change while the rates we earn
on our investment securities are primarily either fixed rates or rates that
adjust at less frequent intervals than our the rates on our loans.
The average balance of our loans increased to $71,051,439 for the quarter
ended June 30, 2006 from $70,918,405, or 0.19%, during the 2005 quarter. In
conjunction with the increase in volume, the average yield on loans increased by
224 basis points, from 7.65% to 9.89%, as the prime rate, upon which many of our
loans are based on, rose to the point where the interest rates on our loans
increased above the interest rate floors, which had been effective when the
16
prime rate was at historically low levels. The interest rates on all of our
prime-based loans have risen above their interest rate floors and will generally
re-price upwards in the event of future increases in the prime rate, but a
decline in the prime rate will also now result in a decline in loan yields until
loan rates drop to the interest rate floors. The combined effect of the increase
in yield and the slight increase in average volume was a $405,803 increase in
interest income from our loan portfolio.
The average yield on our investment securities portfolio increased 34
basis points, from 4.23% to 4.57%, also due to increases in market interest
rates. The yield on investment securities increased more slowly than the yield
on loans because our loans tend to have significantly shorter average terms to
maturity or repricing than the bonds in our investment portfolio. The average
balance of our investment portfolio declined by $1,246,410, or 1.10%, between
the periods. We generated the decline in the investment portfolio deliberately
through maturities and payments, but not sales, in order to fund loans and an
increase in other interest earning assets. Other interest earning assets have
lower yields than investment securities, but as market interest rates increased,
the rate differential narrowed, and we elected to invest more funds in overnight
investments than in investment securities during the latter part of 2005 to
maintain flexibility to meet future investment needs. The increase in yield,
partially offset by the decline in volume, resulted in an overall $84,906
increase in interest income from investment securities. The investment
securities portfolio represented 90.8% of average non-loan interest earning
assets in the 2006 period compared to 90.4% in the 2005 period.
Finally, we had a $50,037 increase in income from overnight funds and
other interest earning assets due to the higher market rates on short term and
overnight investments. The yield on these investments increased 188 basis points
from the second quarter of 2005 to the second quarter of 2006, reflecting the
rise in the federal funds rate. The rate increase more than offset the $715,050,
or 5.75%, decline in the average balance of overnight investments between the
periods.
Interest Expense. Interest expense was $763,043 for the quarter ended June
30, 2006, compared to $452,243 for the quarter ended June 30, 2005, an increase
of 68.7%. The increase was primarily the result of an increase in the rates we
paid on deposits, coupled with increases in the average balance of
interest-bearing deposits, primarily time deposits. The average balance of time
deposits increased more rapidly than other interest-bearing deposits because it
includes the $20 million of municipal CDs that we received in connection with
the opening of our Rosebank branch. The increase caused by those municipal
deposits was offset by the reduction in the average balance of large balance
time deposit accounts for like-kind exchange trusts.
Our average cost of funds increased from 1.44% to 2.40% between the two
periods, primarily due to an increase of 138 basis points in the average rate we
paid on time deposits from 1.84% to 3.22%. In addition, time deposits, our
highest cost deposits, increased from 45.5% of average interest bearing
liabilities in the 2005 quarter to 52.0% in the 2006 quarter. Competition and
the increase in prevailing market interest rates required an increase in the
rates we offered on both new and renewing time deposits. Future increases in our
cost of funds are likely if market interest rates continue their upward trend.
While we have been able to impose greater limits on interest rate increases 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 to maintain our competitive
posture. Any further increase in competition may accelerate the increase in our
cost of funds resulting from increases in market interest rates as more banks
compete for customer deposits.
Net Interest Income Before Provision for Loan Losses. Net interest income
before the provision for loan losses was $2,448,941 for the quarter ended June
30, 2006, an increase of $229,946, or 10.4% over the $2,218,995 in the
comparable 2005 quarter. The increase was driven primarily by an increase in our
yield on loans, and to a lesser extent the increase in the yields on other
interest earning asset categories. These were partially offset by the increase
in our cost of funds and a decline in the average balance of investment
securities and other interest earning assets. Our interest rate spread and net
interest margin increased to 4.07% and 4.93% in the second quarter of 2006
compared to 3.90% and 4.44% in the second quarter of 2005, respectively. On the
asset side, the average yield of earning assets in the 2006 period increased to
6.47% from 5.34% in the June 2005 period, or an increase of 113 basis points. On
17
the liability side, there was an increase in our cost of funds of 96 basis
points. The resulting 17 basis point improvement in spread was the result of the
combined effect of a variety of strategies. Many of our loans are short term
loans to the building trades industry and we have continued our efforts to
originate comparable prime-based loans at market rates as those existing loans
mature, resulting in an increase in yields as market rates increase. We have
also sought to limit increases in the rates that we offer on some deposit
categories to the extent that market rates and competitive pressures allow us to
do so.
Our non-interest checking accounts, which represent a no-cost funding
source, have declined recently. Management seeks to maintain a high level of
non-interest checking accounts through 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 make interest-bearing deposit products more attractive to
customers and may cause funds to shift from non-interest checking into
interest-bearing deposit products.
Provision for Loan Losses. We did not take a provision for loan losses for
the quarter ended June 30, 2006, compared to $45,000 credit to the provision for
loan losses, for the quarter ended June 30, 2005. There was no provision in the
June 2006 quarter due to the recovery to the allowance for loan loss of loans
that were previously charged-off. 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 adequate, after taking into account charge offs and
recoveries. Our allowance for loan losses is based on management's evaluation of
the risks inherent in our loan portfolio and the general economy. Management
periodically evaluates both broad categories of performing loans and problem
loans individually to assess the appropriate level of the allowance.
Although management uses available information to assess the adequacy 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 loss represented 1.72% of total loans at June
30, 2006, 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 $478,472 for the three months
ended June 30, 2006, compared to $514,177 during the same period last year. The
$35,705, or 6.94%, decrease in non-interest income was a direct result of a
$41,183 increase in other income offset by a $16,102 decrease in loan fees and a
$53,618 decrease in service charges on deposits (primarily non-sufficient fund
fees). The increase in other income is a direct result of the Bank taking on a
select, limited group of licensed consumer check cashing companies as deposit
customers. These companies generate fee income through per item charges on their
deposits. Service fees on deposit accounts, principally non-sufficient funds
fees, declined from 2005 to 2006 as customers reduced the frequency with which
they overdrew their deposit accounts.
Non-interest Expense. Non-interest expense was $1,826,933 for the quarter
ended June 30, 2006, compared to $1,614,580 for the quarter ended June 30, 2005.
The principal causes of the $212,353 increase were:
o $34,389 in higher salary and benefits costs due to normal salary
increases, an increase in staffing to support branch expansion and higher
benefit costs.
o $39,608 in higher occupancy expenses due to the opening of our fifth
branch and the costs involved in the construction and renting of our sixth
branch location.
o $79,996 increase in higher legal expenses incurred in connection with a
number of pending lawsuits involving a former customer of the Bank and
other collection expenses.
o $51,601 more of "other expenses," primarily pre-opening expenses for our
fifth branch, and, to a lesser extent, our planned sixth branch which we
expect to open by the end of 2006.
Income Tax Expense. Income tax expense was $512,710 for the quarter ended
June 30, 2006, compared to income tax expense of $542,131 for the quarter ended
June 30, 2005. The reduction in income tax expense was due to the $63,112
18
decrease in income before income taxes in the 2006 quarter. Our effective tax
rate remained the same for the quarters ended June 30, 2006 and 2005 at 46.6%.
Results of Operations for the Six Months Ended June 30, 2006 and June 30, 2005
General. We had net income of $1,177,681 for the six months ended June 30,
2006, compared to net income of $1,264,253 for the comparable period in 2005.
The principal categories which make up the 2006 net income are:
o Interest income of $6,345,967
o Reduced by interest expense of $1,431,719
o Reduced by the provision for loan losses of $25,000
o Increased by non-interest income of $962,021
o Reduced by non-interest expense of $3,646,206
o Reduced by $1,027,382 in income tax expense
We discuss each of these categories individually and the reasons for the
differences between the periods ended June 30, 2006 and 2006 in the following
paragraphs.
Interest Income. Interest income was $6,345,967 for the six months ended
June 30, 2006, compared to $5,353,477 for the six months ended June 30, 2005, an
increase of $992,490, or 18.54%. We accomplished the increase in interest
income, despite a decrease in total average interest-earning assets of
$2,562,949, or 1.27%, principally because of increases in the yields on our
prime-based loans, which make up most of our loan portfolio, and to a more
limited extent, the increase in yield on investment securities and other
interest earning assets. The decrease in average interest-earning assets was
composed of a decrease in the average balance of investment securities of
$8,840,406, partially offset by a $3,549,125 increase in the average balance of
the loan portfolio and a $2,728,332 increase in other interest-earning assets.
The yields on all principal asset categories increased as the Fed Funds
rate increased, causing increases in other interest rate indexes, such as the
prime rate, and market interest rates generally. The yields on our loan
portfolio and our other interest earning assets, principally short term liquid
assets, increased more rapidly than the yield on our investment securities. This
occurred because most of our loans and liquid assets tend to have interest rates
that adjust more quickly as market interest rates change while the rates we earn
on our investment securities are primarily either fixed rates or rates that
adjust at less frequent intervals than the rates on our loans.
The average balance of our loans increased to $72,110,348 for the six
months ended June 30, 2006 from $68,561,223, or 5.18%, during the 2005 period.
In conjunction with the increase in volume, the average yield on loans increased
by 193 basis points, from 7.76% to 9.69%, as the prime rate, upon which many of
our loans are based on, 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. The interest rates on all of our
prime-based loans have risen above their interest rate floors and will now
generally adjust as the prime rate adjusts. The combined effect of the increase
in yield and the increase in average volume was a $853,940 increase in interest
income from our loan portfolio.
The average yield on our investment securities portfolio increased 28
basis points, from 4.26% to 4.54%, also due to increases in market interest
rates, while the average balance of our investment portfolio declined by
$8,840,406, or 7.30%, between the periods. The overall effect of the decline in
volume coupled with the increase in yield was a $28,817 decline in interest
income from investment securities. The investment securities portfolio
represented 88.5% of average non-loan interest earning assets in the first half
of 2006 compared to 91.1% in the first half of 2005.
19
Finally, we had a $167,367 increase in income from overnight funds and
other interest earning assets due to the higher market rates on short term and
overnight investments. The yield on these investments increased 185 basis points
from the first half of 2005 to the first half of 2006, reflecting the rise in
the federal funds rate, and the average balance of increased $2,728,332, or
23.01%. As noted above, we increased the average balance of overnight
investments because they provide us with greater reinvestment flexibility and
the gap between the rates on those investments versus the rates on investment
securities narrowed as short-term market rates rose to a larger degree while
longer-term rates rose at a more moderated pace.
Interest Expense. Interest expense was $1,431,719 for the six months ended
June 30, 2006, compared to $822,699 for the six months ended June 30, 2005, an
increase of 74.0%. The increase was primarily the result of an increase in the
rates we paid on deposits, coupled with increases in the average balance of
interest-bearing deposits, primarily time deposits. The average balance of time
deposits increased more rapidly than other interest-bearing deposits because of
the $20 million of municipal CDs, partially offset by the reduction in IRS
Section 1031 like-kind exchange deposits, both as discussed above.
Our average cost of funds increased from 1.37% to 2.27% between the two
periods, primarily due to the effect of time deposits, our highest cost deposit
category, on our overall cost of funds. Time deposits increased from 45.2% of
average interest bearing liabilities in the 2005 period to 52.5% in the 2006
period. The average rate on these deposits increased 132 basis points from 1.66%
in the 2005 period to 2.98% in the 2006 period. The increase in the rates we
paid on deposits was caused by the combined effect of increases in market
interest rates and increases in local competitive pressures. Competition and the
increase in prevailing market interest rates required an increase in the rates
we offered on both new and renewing time deposits and, to a lesser degree, the
rates we paid on other deposit categories. We do not have and we do not seek
brokered time deposits.
Net Interest Income Before Provision for Loan Losses. Net interest income
before the provision for loan losses was $4,914,248 for the six months ended
June 30, 2006, an increase of $383,470, or 8.5% over the $4,530,778 in the
comparable 2005 period. The increase was driven primarily by an increase in our
yields on loans, investment securities and other interest earning assets,
partially offset by an increase in our cost of funds and a decline in investment
securities. Our interest rate spread and net interest margin increased to 4.12%
and 4.94% in the first six months of 2006 compared to 3.97% and 4.52% in the
first six months of 2005, respectively. On the asset side, the average yield of
earning assets in the 2006 period increased to 6.39% from 5.34% in the June 2005
period, or an increase of 105 basis points. On the liability side, there was an
increase in our cost of funds of 90 basis points. The resulting 15 basis point
improvement in spread was the result of the combined effect of a variety of
strategies as discussed above.
Our non-interest checking accounts have declined recently. Management
seeks to maintain a high level of non-interest checking accounts through
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.
Provision for Loan Losses. The provision for loan losses was $25,000 for
the six months ended June 30, 2006, compared to $75,000 credit to the provision
for loan losses, for the six months ended June 30, 2005. The increase in the
provision was primarily due to an increase in loan delinquencies at the
beginning of the first half of 2006 and further increases in the provision were
mitigated later in the period due to the recovery of loans previously
charged-off. 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 adequate, after taking into account charge offs and recoveries. Our
allowance for loan losses is based on management's evaluation of the risks
inherent in our loan portfolio and the general economy. Management periodically
evaluates both broad categories of performing loans and problem loans
individually to assess the appropriate level of the allowance.
20
Although management uses available information to assess the adequacy 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 1.72% of total loans at
June 30, 2006, 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 $962,021 for the six months
ended June 30, 2006, compared to $977,799 during the same period last year. The
$15,778, or 1.6%, decrease in non-interest income was a direct result of an
$83,751 increase in other income offset by a $67,879 decrease in service charges
on deposits (primarily non-sufficient fund fees). The increase in other income
is a direct result of per item charges on a limited group of licensed consumer
check cashing companies we have recently added as deposit customers. Service
fees on deposit accounts declined from 2005 to 2006 as the volume of deposit
account transactions generating fee income declined. Service fees on deposit
accounts, principally non-sufficient funds fees, declined from 2005 to 2006 as
customers reduced the frequency with which they overdrew their deposit accounts.
Non-interest Expense. Non-interest expense was $3,646,206 for the six
months ended June 30, 2006, compared to $3,216,390 for the six months ended June
30, 2005. The principal causes of the $429,816 increase were:
o $127,970 in higher salary and benefits costs due to normal salary
increases, an increase in staffing to support branch expansion and higher
benefit costs.
o $52,308 in higher occupancy expenses due to the opening of our fifth
branch and the rental expense of our planned sixth branch.
o $128,946 increase in higher legal expenses incurred in connection with a
number of pending lawsuits involving a former customer of the Bank and
increased collection expenses.
o $122,392 more of "other expenses," primarily opening expenses for our
fifth branch and pre-opening expenses of our sixth branch.
Income Tax Expense. Income tax expense was $1,027,382 for the six months
ended June 30, 2006, compared to income tax expense of $1,102,934 for the six
months ended June 30, 2005. The reduction in income tax expense was due to the
$162,124 decrease in income before income taxes in the 2006 period. Our
effective tax rate remained the same for the periods ended June 30, 2006 and
2005 at 46.6%.
21
VSB Bancorp, Inc.
Consolidated Average Balance Sheets
(unaudited)
Three Three
Months Ended Months Ended
June 30, 2006 June 30, 2005
------------------------------------------- -------------------------------------------
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
------------ ------------ ------------ ------------ ------------ ------------
Assets:
Interest-earning assets:
Loans receivable $ 71,051,439 $ 1,758,136 9.89% $ 70,918,405 $ 1,352,333 7.65%
Investment securities, afs 115,972,102 1,320,669 4.57 117,218,512 1,235,763 4.23
Other interest-earning assets 11,714,329 133,179 4.56 12,429,379 83,142 2.68
------------ ------------ ------------ ------------
Total interest-earning assets 198,737,870 3,211,984 6.47 200,566,296 2,671,238 5.34
Non-interest earning assets 14,098,652 12,605,933
------------ ------------
Total assets $212,836,522 $213,172,229
============ ============
Liabilities and equity:
Interest-bearing liabilities:
Savings accounts $ 12,885,962 21,044 0.66 $ 16,011,291 20,111 0.50
Time accounts 66,200,312 531,071 3.22 57,465,469 263,269 1.84
Money market accounts 20,816,866 95,447 1.84 21,235,658 51,953 0.98
Now accounts 22,221,904 26,442 0.48 26,445,152 27,871 0.42
Subordinated debt 5,155,000 89,039 6.91 5,155,000 89,039 6.91
------------ ------------ ------------ ------------
Total interest-bearing liabilities 127,280,044 763,043 2.40 126,312,570 452,243 1.44
Checking accounts 68,214,024 70,887,187
------------ ------------
Total deposits and subordinated debt 195,494,068 197,199,757
Other liabilities 2,257,210 2,407,203
------------ ------------
Total liabilities 197,751,278 199,606,960
Equity 15,085,244 13,565,269
------------ ------------
Total liabilities and equity $212,836,522 $213,172,229
============ ============
Net interest income/net interest
rate spread $ 2,448,941 4.07% $ 2,218,995 3.90%
============ ============ ============ ============
Net interest earning assets/net
interest margin $ 71,457,826 4.93% $ 74,253,726 4.44%
============ ============ ============ ============
Ratio of interest-earning assets
to interest-bearing liabilities 1.56 x 1.59 x
============ ============
Return on Average Assets (1) 1.10% 1.17%
============ ============
Return on Average Equity (1) 15.53% 18.38%
============ ============
Tangible Equity to Total Assets 6.63% 6.46%
============ ============
22a
VSB Bancorp, Inc.
Consolidated Average Balance Sheets
(unaudited)
Six Six
Months Ended Months Ended
June 30, 2006 June 30, 2005
------------------------------------------- -------------------------------------------
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
------------ ------------ ------------ ------------ ------------ ------------
Assets:
Interest-earning assets:
Loans receivable $ 72,110,348 $ 3,506,909 9.69% $ 68,561,223 $ 2,652,969 7.76%
Investment securities, afs 112,259,202 2,526,431 4.54 121,099,608 2,555,248 4.26
Other interest-earning assets 14,584,282 312,627 4.32 11,855,950 145,260 2.47
------------ ------------ ------------ ------------
Total interest-earning assets 198,953,832 6,345,967 6.39 201,516,781 5,353,477 5.34
Non-interest earning assets 14,124,383 12,932,913
------------ ------------
Total assets $213,078,215 $214,449,694
============ ============
Liabilities and equity:
Interest-bearing liabilities:
Savings accounts $ 13,836,486 39,378 0.57 $ 15,343,521 38,338 0.50
Time accounts 66,760,861 984,954 2.98 54,749,671 450,386 1.66
Money market accounts 20,353,010 179,663 1.78 22,058,472 106,000 0.97
Now accounts 21,182,701 49,645 0.47 23,778,689 49,896 0.42
Subordinated debt 5,155,000 178,079 6.91 5,155,000 178,079 6.91
------------ ------------ ------------ ------------
Total interest-bearing liabilities 127,288,058 1,431,719 2.27 121,085,353 822,699 1.37
Checking accounts 68,253,077 77,529,495
------------ ------------
Total deposits and subordinated debt 195,541,135 198,614,848
Other liabilities 2,461,396 2,410,810
------------ ------------
Total liabilities 198,002,531 201,025,658
Equity 15,075,684 13,424,036
------------ ------------
Total liabilities and equity $213,078,215 $214,449,694
============ ============
Net interest income/net interest
rate spread $ 4,914,248 4.12% $ 4,530,778 3.97%
============ ============ ============ ============
Net interest earning assets/net
interest margin $ 71,665,774 4.94% $ 80,431,428 4.52%
============ ============ ============ ============
Ratio of interest-earning assets
to interest-bearing liabilities 1.56 x 1.66 x
============ ============
Return on Average Assets (1) 1.09% 1.18%
============ ============
Return on Average Equity (1) 15.45% 18.86%
============ ============
Tangible Equity to Total Assets 6.63% 6.46%
============ ============
(1) Ratios have been annualized.
22b
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 six months ended June 30, 2006, our retail banking activities
generated a net increase in deposits of $7,974,607 and we had a net decrease in
loans receivable of $2,272,731, which combined to generate $10,247,388 in cash.
In addition, we received proceeds from repayment of investment securities of
$10,121,487. We used $23,944,173 of available funds to purchase new investment
securities, resulting in an overall reduction in cash and cash equivalents of
$3,495,230. We applied available funds principally to purchase the $23,944,173
of investment securities to increase investment collateral available to pledge
for the $20 million in municipal CDs that we received in the second quarter of
2006 in connection with our opening of our Rosebank branch.
In contrast, during the comparable period of 2005, our principal source of
cash was the proceeds from the repayment of investment securities of
$13,920,944. We used these funds, plus $11,060,281 of existing cash and cash
equivalents, 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 Bank satisfied all capital ratio requirements of the Federal Deposit
Insurance Corporation at June 30, 2006, with a Tier I Leverage Capital ratio of
10.23%, a ratio of Tier I Capital to Risk-Weighted Assets ratio of 21.38%, and a
Total Capital to Risk-Weighted Assets ratio of 22.60%.
VSB Bancorp, Inc. satisfied all capital ratio requirements of the Federal
Reserve at June 30, 2006, with a Tier I Leverage Capital ratio of 10.59%, a
ratio of Tier I Capital to Risk-Weighted Assets ratio of 22.11%, and a Total
Capital to Risk-Weighted Assets ratio of 23.32%.
In the first six months of 2006, we experienced a $3,495,230 decrease in
cash and cash equivalents compared to an $11,060,281 decrease in cash and cash
equivalents during the first six months of 2005. Total cash and cash equivalents
at June 30, 2006 were $27,828,917. 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.
The following table sets forth our contractual obligations and commitments
for future lease payments, time deposit maturities and loan commitments.
23
Contractual Obligations and Commitments at June 30, 2006
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 $ 450,854 $ 788,986 $ 810,403 $ 2,845,249 $ 4,895,492
Remaining contractual maturities of time
deposits 72,150,872 1,049,026 2,324,662 -- 75,524,560
------------ ------------ ------------ ------------ ------------
Total contractual cash obligations $ 72,601,726 $ 1,838,012 $ 3,135,065 $ 2,845,249 $ 80,420,052
============ ============ ============ ============ ============
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 $ 12,261,247 $ 5,388,048 $ 100,000 $ -- $ 17,749,295
============ ============ ============ ============ ============
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
We are required to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements and the amounts of revenues
and expenses during the reporting period. The allowance for loan losses,
prepayment estimates on the mortgage-backed securities and Collateralized
Mortgage Obligation portfolios, contingencies and fair values of financial
instruments are particularly subject to change and to management's estimates.
Actual results can differ from those estimates and may have an impact on our
financial statements.
Item 3 - Controls and Procedures
Evaluation of Disclosure Controls and Procedures: As of June 30, 2006, 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
24
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 Bank is a defendant in an action pending in Supreme Court, Richmond County,
commenced by IndyMac Bank, F.S.B. against the Bank, LaMattina & Associates, Inc.
("LAI") and various individuals and entities alleged to be officers, directors
or otherwise to have relationships with LAI. LAI was a deposit customer of the
Bank engaged in the business of providing real estate settlement services to
lenders making residential mortgage loans. The plaintiff alleges that it was
such a lender and that it had provided funds to LAI by wiring those funds to an
account of LAI at the Bank to use to fund mortgage loans to be made by the
plaintiff, only to have LAI not use those funds for their intended purpose. The
action was commenced in August 2005. In November 2005, the plaintiff amended its
complaint to add the Bank as a defendant. The Plaintiff has served a third
amended complaint asserting claims against the Bank based upon alleged
negligence, misappropriation and deceptive business practices under the New York
General Business Law and requesting monetary damages against the Bank of
$1,817,041 plus recovery of attorney's fees. The Bank intends to defend
aggressively the amended claims and has made a motion to dismiss the third
amended complaint. The Bank has referred the litigation to its insurance
carrier, which has indicated that at least some of the claims are covered by
insurance.
25
Signature Page
In accordance with the requirements of the Exchange Act, the registrant
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
VSB Bancorp, Inc.
Date: August 9, 2006 /s/ MERTON CORN
-------------------------------------
Merton Corn
President and Chief Executive Officer
Date: August 9, 2006 /s/ RAFFAELE M. BRANCA
-------------------------------------
Raffaele M. Branca
Executive Vice President and Chief
Financial Officer
EXHIBIT INDEX
Exhibit
Number Description of Exhibit
------ ----------------------
31.1 Rule 13A-14(a)/15D-14(a) Certification of Chief Executive Officer
31.2 Rule 13A-14(a)/15D-14(a) Certification of Chief Financial Officer
32.1 Certification by CEO pursuant to 18 U.S.C. 1350.
32.2 Certification by CFO pursuant to 18 U.S.C. 1350.
--------------------------------------------
Item 6 - Exhibits
Exhibit
Number Description of Exhibit
------ ----------------------
31.1 Rule 13A-14(a)/15D-14(a) Certification of Chief Executive Officer
31.2 Rule 13A-14(a)/15D-14(a) Certification of Chief Financial Officer
32.1 Certification by CEO pursuant to 18 U.S.C. 1350.
32.2 Certification by CFO pursuant to 18 U.S.C. 1350.
26