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EX-32 - Sunshine Financial, Inc.ex-32.htm
EX-31.2 - Sunshine Financial, Inc.ex31-2.htm
EX-31.1 - Sunshine Financial, Inc.ex31-1.htm

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q


(Mark One)

[X]           QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2011

[  ]           TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT

For the transition period from _______ to ________

Commission file number:   001-54280


SUNSHINE FINANCIAL, INC.
(Exact name of registrant as specified in its charter)

Maryland
36-4678532
(State or other jurisdiction of incorporation of organization)
(IRS Employer Identification No.)

1400 East Park Avenue, Tallahassee, Florida  32301
(Address of principal executive offices; Zip Code)

(850) 219-7200
(Registrant’s telephone number, including area code)

None
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 and 15(d) of the Exchange Act during the preceding 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in rule 12b-2 of the Exchange Act.
 
Large accelerated filer [  ]                                                                                         Accelerated filer [  ]
 
Non-accelerated filer   [  ] (Do not check if a smaller reporting company)Smaller reporting company [X]
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X]
 
APPLICABLE ONLY TO CORPORATE ISSUERS
 
State the number of shares outstanding of each issuer's classes of common equity, as of the latest practicable date:
 
At May 13, 2011, there were issued and outstanding 1,234,454 shares of the issuer’s common stock.

 
 
 
 

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Index

 
Page Number
PART I                                                                             FINANCIAL INFORMATION
 
 
Item 1.     Financial Statements
 
   
Condensed Consolidated Balance Sheets as of March 31, 2011 (Unaudited) and December 31, 2010
 
2
   
Condensed Consolidated Statements of Earnings for the Three-Month Periods Ended March 31, 2011 and 2010 (Unaudited)
 
3
   
Condensed Consolidated Statements of Retained Earnings for the Three-Month Periods Ended March 31, 2011 and 2010 (Unaudited)
 
 
4
   
Condensed Consolidated Statements of Cash Flows For the Three-Month Periods Ended March 31, 2011 and 2010 (Unaudited)
 
5
   
Notes to Condensed Consolidated Financial Statements
6-17
   
Item 2.     Management's Discussion and Analysis of Financial Conditionand Results of Operations
 
18-25
   
Item 4.     Controls and Procedures
26
   
PART II  OTHER INFORMATION
 
   
Item 1.     Legal Proceedings
27
   
Item 1A.   Risk Factors
27
   
Item 2.     Unregistered Sales of Equity Securities and Use
                          of Proceeds
 
27
   
Item 3.     Defaults Upon Senior Securities
27
   
Item 4.     Submission of Matters to a Vote of Security
                          Holders
 
27
   
Item 5.     Other Information
27
   
Item 6.     Exhibits
27
   
SIGNATURES
28
   
EXHIBIT INDEX
 

 
 
 
 

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

Condensed Consolidated Balance Sheets
(In thousands)
   
At March 31,
2011
   
At December 31,
2010
 
   
(Unaudited)
       
Assets
           
             
Cash and due from banks
  $ 1,729       1,036  
Interest-bearing deposits with banks
    3,668       1,709  
Federal funds sold
    27,613       16,579  
                 
Cash and cash equivalents
    33,010       19,324  
                 
Securities held to maturity (fair value of $2,880 and $3,241)
    2,682       3,027  
Loans, net of allowance for loan losses of $1,705 and $1,621
    114,465       118,060  
Premises and equipment, net
    3,871       3,979  
Federal Home Loan Bank stock, at cost
    298       298  
Deferred income taxes
    2,223       2,228  
Accrued interest receivable
    504       551  
Foreclosed real estate
    599       596  
Other assets
    1,973       1,861  
                 
Total assets
  $ 159,625       149,924  
                 
Liabilities and Retained Earnings
               
                 
Liabilities:
               
Noninterest-bearing deposit accounts
    22,630       19,985  
Money-market deposit accounts
    23,793       23,562  
Savings accounts
    44,626       33,098  
Time deposits
    52,102       57,112  
                 
Total deposits
    143,151       133,757  
                 
Official checks
    807       520  
Advances by borrowers for taxes and insurance
    197       112  
Other liabilities
    423       496  
                 
Total liabilities
    144,578       134,885  
                 
Retained earnings
    15,047       15,039  
                 
Total liabilities and retained earnings
  $ 159,625       149,924  


See accompanying Notes to Condensed Consolidated Financial Statements.

 
2
 
 

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Earnings (Unaudited)
(In thousands)


   
Three Months Ended
 
   
March 31,
 
   
2011
   
2010
 
Interest income:
           
Loans
  $ 1,707       1,964  
Mortgage-backed securities
    38       54  
Other
    10       1  
                 
Total interest income
    1,755       2,019  
                 
Interest expense-
               
Deposit accounts
    303       501  
                 
Net interest income
    1,452       1,518  
                 
Provision for loan losses
    225       300  
                 
Net interest income after provision for loan losses
    1,227       1,218  
                 
Noninterest income:
               
Fees and service charges on deposit accounts
    560       542  
Fees and charges on loans
    21       20  
                 
Total noninterest income
    581       562  
                 
Noninterest expenses:
               
Salaries and employee benefits
    892       839  
Occupancy and equipment
    269       296  
Data processing services
    179       160  
Professional fees
    139       119  
Federal Deposit Insurance Corporation insurance
    46       58  
Advertising and promotion
    14       19  
Stationary and supplies
    17       9  
Other
    239       257  
                 
Total noninterest expenses
    1,795       1,757  
                 
Earnings before income taxes
    13       23  
                 
Income taxes
    5       9  
                 
Net earnings
  $ 8       14  
                 

See accompanying Notes to Condensed Consolidated Financial Statements.

 
3
 
 

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Retained Earnings (Unaudited)
(In thousands)



 
    March 31,   
   
2011
   
2010
 
   
 
       
Retained earnings at beginning of period
  $ 15,039       14,653  
                 
Net earnings
    8       14  
                 
Retained earnings at end of period
  $ 15,047       14,667  
                 
                 
                 


































See accompanying Notes to Condensed Consolidated Financial Statements.



 
4
 
 

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows (Unaudited)
(In thousands)
 
    Three Months Ended March 31,   
   
2011
   
2010
 
Cash flows from operating activities:
           
Net earnings
  $ 8       14  
Adjustments to reconcile net earnings to net cash from operating activities:
               
Depreciation
    122       148  
Provision for loan losses
    225       300  
Deferred income taxes
    5       9  
Accretion of discounts on securities
    (3 )     (3 )
Net amortization of deferred loan fees and costs
    2       7  
Decrease in accrued interest receivable
    47       13  
(Increase) decrease in other assets
    (112 )     278  
Increase (decrease) in official checks
    287       (225 )
Net increase in advances by borrowers for taxes and insurance
    85       106  
(Decrease) increase in other liabilities
    (73 )     80  
Capital expenditures for foreclosed real estate
    (3 )     -  
                 
Net cash provided by operating activities
    589       727  
 
Cash flows from investing activities:
               
Net repayment of held-to-maturity securities
    348       326  
Net decrease in loans
    3,368       1,481  
Net purchases of premises and equipment
    (14 )     -  
                 
Net cash provided by investing activities
    3,702       1,807  
                 
Cash flows from financing activity-
               
Net decrease in deposits
    9,394       (4,803 )
                 
Increase (decrease) in cash and cash equivalents
    13,686       (2,269 )
                 
Cash and cash equivalents at beginning of period
    19,324       11,147  
                 
Cash and cash equivalents at end of period
  $ 33,010       8,878  
                 
Supplemental disclosure of cash flow information-
               
Cash paid during the period for:
               
Income taxes
  $ -       -  
                 
Interest
  $ 303       501  
                 
Noncash transaction-
               
Transfer from loans to foreclosed real estate
  $ -       56  
                 

See accompanying Notes to Condensed Consolidated Financial Statements.


 
5
 
 

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited)


1.         Organization and Basis of Presentation
 
Sunshine Financial, Inc. ("Sunshine Financial" or the "Holding Company"), a Maryland corporation, is the holding company for Sunshine Savings Bank (the "Bank") and owns all the outstanding common stock of the Bank.  The Bank completed its reorganization from the mutual to stock holding company form of organization on April 5, 2011. A total of 1,234,454 shares of common stock were sold in the subscription and community offerings at a price of $10.00 per share.  In accordance with the Plan of Conversion and Reorganization (the "Plan"), the Holding Company has succeeded to all rights and obligations of Sunshine Savings MHC and the old Sunshine Financial, Inc. ("Old Sunshine").  See Note 12 for details of the conversion.  The transaction was accounted as a reorganization of entities under common control at historical cost and, the financial data for periods presented include the results of the Bank.  The unaudited, condensed consolidated financial statements include the consolidated results of operations of Old Sunshine and its subsidiary, the Bank.  These condensed consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q and Article 8-03 of Regulation S-X and do not include all disclosures required by generally accepted accounting principles for a complete presentation of the Company's financial condition and results of operations.

 
 
The Holding Company's only business is the operation of the Bank.  The Bank through its four banking offices provides a variety of retail community banking services to individuals and businesses primarily in Leon County, Florida. The Bank's deposits are insured up to the applicable limits by the Federal Deposit Insurance Corporation. The Bank's subsidiary is Sunshine Member Insurance Services, Inc. ("SMSI"), which was established to sell automobile warranty and credit life and disability insurance products associated with loan products. Collectively the entities are referred to the "Company."

 
 
In the opinion of management, the information reflects all adjustments (consisting only of normal recurring adjustments) which are necessary in order to make the financial statements not misleading and for a fair representation of the results of operations for such periods.  The results for the three- month period ended March 31, 2011 should not be considered as indicative of results for a full year.

 
(continued)

 
6
 
 

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited)


2.         Recent Accounting Standards Update
 
In January 2010, the FASB issued ASU No. 2010-06, Improving Disclosures about Fair Value Measurements (Topic 820), which amends the guidance for fair value measurements and disclosures.  The guidance in ASU 2010-06 requires a reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and to describe the reasons for the transfers. Furthermore, ASU 2010-06 requires a reporting entity to present separately information about purchases, sales, issuances, and settlements in the reconciliation for fair value measurements using significant unobservable inputs; clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value; and amends guidance on employers' disclosures about postretirement benefit plan assets to require that disclosures be provided by classes of assets instead of by major categories of assets.  The ASU was effective for interim and annual reporting periods beginning January 1, 2010, except for the disclosures about purchases, sales, issuances, and settlements in the rollforward of activity in Level 3 fair value measurements. Those disclosures were effective January 1, 2011 and for interim periods thereafter. In the period of initial adoption, entities will not be required to provide the amended disclosures for any previous periods presented for comparative purposes.  The adoption of this guidance did not have a material impact on the Company's financial statements.

 
 
In July 2010, the FASB issued ASU No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. The new disclosures will require significantly more information about credit quality in a financial institution's loan portfolio. This statement addresses only disclosures and does not change recognition or measurement of the allowance.  For public entities, the disclosures as of the end of a reporting period was effective for interim and annual reporting periods ending on December 31, 2010. The disclosures about activity that occurs during a reporting period was effective for interim and annual reporting periods beginning on or after January 1, 2011.  For nonpublic entities, the disclosures are effective for annual reporting periods ending on or after December 15, 2011.  The adoption of the ASU did not have a material impact on the Company's financial statements.

 
 
In January 2011, the FASB issued ASU No. 2011-01, Receivables (Topic 310) Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20. The amendments in this Update delay the effective date of the disclosures about troubled debt restructurings in Update 2010-20 for public entities. The effective date of the new disclosures about troubled debt restructurings for public entities and the guidance for determining what constitutes a troubled debt restructuring is effective as outlined in ASU No. 2011-02. The adoption of the ASU is not expected to have a material impact on the Company's financial statements.

 
(continued)

 
7
 
 

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued


2.         Recent Accounting Standards Update, Continued
 
In April 2011, the FASB issued ASU No. 2011-02, Receivables (Topic 310) A Creditor's Determination of Whether a Restructuring Is a Troubled Debt Restructuring. This amends the guidance for troubled debt restructurings.  The guidance clarifies the guidance on a creditor's evaluation of whether it has granted a concession and whether a debtor is experiencing financial difficulties. For public entities, the amendments are effective for first interim or annual period beginning on or after June 15, 2011 and should be applied retrospectively to the beginning of the annual period of adoption. For nonpublic entities, the amendments are effective for annual periods ending on or after December 15, 2012, including interim periods within those annual periods. The adoption of the ASU is not expected to have a material impact on the Company's financial statements.

3.         Securities Held to Maturity
 
Securities have been classified as held to maturity according to management intent.  The carrying amount of securities and their fair values are as follows (in thousands):

         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
   
Cost
   
Gains
   
Losses
   
Value
 
At March 31, 2011-
                       
Mortgage-backed securities
  $ 2,682       198       -       2,880  
                                 
At December 31, 2010-
                               
Mortgage-backed securities
  $ 3,027       214       -       3,241  

 
There were no sales of securities during the three months ended March 31, 2011 or the three months ended March 31, 2010, respectively. There were no securities pledged at March 31, 2011 or December 31, 2010.


(continued)

 
8
 
 

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued


4.      Loans
         The components of loans are as follows (in thousands):

   
March 31,
   
December 31,
 
   
2011
   
2010
 
   
(Unaudited)
       
Real estate loans:
           
One-to-four-family
  $ 77,343       78,891  
Lot loans
    9,580       9,900  
Construction or development
    207       349  
                 
Total real estate loans
    87,130       89,140  
                 
Consumer loans:
               
Home equity
    15,026       15,613  
Automobile
    2,545       2,979  
Credit cards and unsecured
    8,409       8,945  
Deposit account
    812       820  
Other
    2,070       2,205  
                 
Total consumer loans
    28,862       30,562  
                 
Total loans
    115,992       119,702  
                 
Less:
               
Loans in process
    (219 )     (18 )
Deferred fees and discounts
    41       39  
Allowance for losses
    1,705       1,621  
                 
Total loans, net
  $ 114,465       118,060  

 
The Company grants real estate and consumer loans to customers primarily in the State of Florida with the majority of such loans in the Tallahassee, Florida area.  Therefore, the Company's exposure to credit risk could be significantly affected by changes in the economy and real estate market in the Tallahassee, Florida area.

 
(continued)





 
9
 
 

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued


4.      Loans, Continued
         An analysis of the change in the allowance for loan losses follows (in thousands):

 

    
For the Three Months Ending March 31,
 
   
2011
 
   
One-to
Four
Family
   
Lot
Loans
   
Construction
or
Development
   
Home
Equity
   
Automobile
   
Credit
Cards and
Unsecured
   
Deposit
Accounts
   
Other
   
Total
   
2010
Total
 
                                                             
Beginning balance
  $ 623       59       2       252       39       503       -       143       1,621       1,410  
Provision for loan loss
    118       -       -       104       -       (14 )     -       17       225       300  
Charge-offs
    -       -       -       (38 )     (2 )     (109 )     -       (16 )     (165 )     (273 )
Recoveries
    -       -       -       -       4       18       -       2       24       62  
                                                                                 
Ending balance
  $ 741       59       2       318       42       398       -       145       1,705       1,499  
Individually evaluated for
    impairment:
                                                                               
    Recorded investment
  $ 3,258       142       -       333       -       -       -       -       3,733          
    Balance in allowance
        for loan losses
  $ 607       46       -       193       -       -       -       -       846          
                                                                                 
Collectively evaluated for
    impairment:
                                                                               
    Recorded investment
  $ 74,085       9,438       207       14,693       2,545       8,409       812       2,070       112,259          
    Balance in allowance
        for loan losses
  $ 134       13       2       125       42       398       -       145       859          

         The following summarizes the loan credit quality (in thousands):
 
Credit Risk
 
One to
         
Construction
               
Credit
                   
Profile by Internally
 
Four
   
Lot
   
or
   
Home
         
Cards and
   
Deposit
             
Assigned Grade:
 
Family
   
Loans
   
Development
   
Equity
   
Automobile
   
Unsecured
   
Accounts
   
Other
   
Total
 
At March 31, 2011:
                                                     
  Grade:
                                                     
    Pass
  $ 73,798       9,438       207       14,172       2,499       8,404       812       2,070       111,400  
    Special mention
    -       -       -       261       2       4       -       -       267  
    Substandard
    2,938       96       -       400       28       -       -       -       3,462  
    Doubtful
    -       -       -       -       16       1       -       -       17  
    Loss
    607       46       -       193       -       -       -       -       846  
                                                                         
  Total
  $ 77,343       9,580       207       15,026       2,545       8,409       812       2,070       115,992  
                                                                         
At December 31, 2010:
                                                                       
  Grade:
                                                                       
    Pass
    74,664       9,758       349       14,843       2,926       8,904       820       2,168       114,432  
    Special mention
    1,504       -       -       451       7       33       -       -       1,995  
    Substandard
    2,288       51       -       126       43       7       -       37       2,552  
    Doubtful
    -       -       -       -       3       1       -       -       4  
    Loss
    435       91       -       193       -       -       -       -       719  
                                                                         
  Total
  $ 78,891       9,900       349       15,613       2,979       8,945       820       2,205       119,702  

 
(continued)


 
10
 
 

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

4.         Loans, Continued
 
Internally assigned loan grades are defined as follows:

 
Pass – A Pass loan's primary source of loan repayment is satisfactory, with secondary sources very likely to be realized if necessary.

 
Special Mention – A Special Mention loan has potential weaknesses that deserve management's close attention.  If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset or the Company's credit position at some future date.  Special Mention loans are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.

 
Substandard – A Substandard loan is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any.  Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

 
Doubtful – A loan classified Doubtful has all the weaknesses inherent in one classified Substandard with the added characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

 
Loss – A loan classified Loss is considered uncollectible and of such little value that continuance as a bankable asset is not warranted.  This classification does not mean that the asset has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future.

 
The following summarizes the amount of impaired loans (in thousands):

    
With No Related
Allowance Recorded
   
With an Allowance Recorded
   
Total
 
   
Recorded
Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
   
Recorded
Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
   
Recorded
Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
 
At March 31, 2011:
                                                     
  Real estate loans:
                                                     
    One-to-four family
  $ 861       861       -       1,789       2,396       607       2,650       3,257       607  
    Lot loans
    -       -       -       96       142       46       96       142       46  
    Consumer loans-
                                                                       
    Home equity
    64       64       -       76       269       193       140       333       193  
                                                                         
    $ 925       925       -       1,961       2,807       846       2,886       3,732       846  
                                                                         
At December 31, 2010:
                                                                       
  Real estate loans:
                                                                       
    One-to-four family
    401       401       -       1,429       1,864       435       1,830       2,265       435  
    Lot loans
    -       -       -       51       142       91       51       142       91  
    Consumer loans-
                                                                       
    Home equity
    82       82       -       -       193       193       82       275       193  
                                                                         
    $ 483       483       -       1,480       2,199       719       1,963       2,682       719  

(continued)

 
11
 
 

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued


4.  Loans, Continued
 
At March 31, 2011 and December 31, 2010, the Company's loan portfolio included primarily large groups of smaller balance homogeneous loans.  The Company considers individual single family home loans which are in the process of foreclosure for impairment.

 
The average net investment in impaired loans and interest income recognized and received on impaired loans are as follows (in thousands):

   
Three Months
       
   
Ended
   
Year Ended
 
   
March 31,
   
December 31,
 
   
2011
   
2010
 
   
(Unaudited)
       
             
Interest income recognized on impaired loans
  $ -       -  
                 
Interest income received on impaired loans
  $ -       2  
                 
Average net recorded investment in impaired loans
  $ 2,872       644  

 
Age analysis of past-due loans is as follows (in thousands):

    
Accruing Loans
             
               
Greater
                         
      30-59       60-89    
Than 90
   
Total
                   
   
Days
   
Days
   
Days
   
Past
         
Nonaccrual
   
Total
 
   
Past Due
   
Past Due
   
Past Due
   
Due
   
Current
   
Loans
   
Loans
 
At March 31, 2011:
                                             
    Real estate loans:
                                             
        One-to-four family
  $ 1,613       -       -       1,613       71,896       3,834       77,343  
        Lot loans
    -       -       -       -       9,438       142       9,580  
        Construction or development
    -       -       -       -       207       -       207  
    Consumer loans:
                                                       
        Home equity
    140       202       -       342       14,033       651       15,026  
        Automobile
    10       2       -       12       2,480       53       2,545  
        Credit cards and unsecured
    82       -       -       82       8,314       13       8,409  
        Deposit account
    -       -       -       -       812       -       812  
        Other
    99       -       -       99       1,971       -       2,070  
                                                         
    Total
  $ 1,944       204       -       2,148       109,151       4,693       115,992  
                                                         
At December 31, 2010:
                                                       
    Real estate loans:
                                                       
        One-to-four family
    1,292       316       -       1,608       73,310       3,973       78,891  
        Lot loans
    54       -       -       54       9,704       142       9,900  
        Construction or development
    -       -       -       -       349       -       349  
    Consumer loans:
                                                       
        Home equity
    444       146       -       590       14,307       716       15,613  
        Automobile
    35       6       -       41       2,886       52       2,979  
        Credit cards and unsecured
    52       23       -       75       8,829       41       8,945  
        Deposit account
    -       -       -       -       820       -       820  
        Other
    35       -       -       35       2,133       37       2,205  
                                                         
    Total
  $ 1,912       491       -       2,403       112,338       4,961       119,702  

 
(continued)

 
12
 
 

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued


4.         Loans, Continued
 
At March 31, 2011 and December 31, 2010, there were no loans past due ninety days or more but still accruing.

5.         Foreclosed Real Estate
 
Expenses applicable to foreclosed assets are included in other noninterest expense and include operating expenses of $11,000 and $19,000 for the three months ended March 31, 2011 and 2010, respectively.  There were no write-downs or sales of foreclosed real estate during the three months ended March 31, 2011 and 2010.

6.         Line of Credit
 
The Company also has an unsecured federal funds line of credit for $1.0 million with a correspondent bank and a $15.2 million line with the Federal Home Loan Bank of Atlanta collateralized by a blanket lien on qualifying loans. At March 31, 2011 and December 31, 2010, the Company had no outstanding balances on these lines.

7.         Off-Balance-Sheet Financial Instruments
 
The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments are unused lines of credit and commitments to extend credit and may involve, to varying degrees, elements of credit and interest-rate risk in excess of the amount recognized in the balance sheets.  The contract amounts of these instruments reflect the extent of involvement the Company has in these financial instruments.

 
The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for unused lines of credit and commitments to extend credit is represented by the contractual amount of those instruments.  The Company uses the same credit policies in making commitments as it does for on-balance-sheet instruments.

 
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  The Company evaluates each customer's credit worthiness on a case-by-case basis.  The amount of collateral obtained if deemed necessary by the Company upon extension of credit is based on management's credit evaluation of the counterparty.

(continued)

 
13
 
 

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued


7.         Off-Balance-Sheet Financial Instruments, Continued
 
Unused lines of credit and commitments to extend credit typically result in loans with a market interest rate when funded.  A summary of the amounts of the Company's financial instruments, with off-balance-sheet risk follows at March 31, 2011 (in thousands):

   
Contract
 
   
Amount
 
Unused lines of credit (rates range from
     
    3.25% to 18.00%)
  $ 14,761  
         
Commitments to extend credit (all fixed rates
       
    ranging from 3.00% to 11.90%)
  $ 246  

8.         Fair Value of Financial Instruments
 
The estimated fair values of the Company's financial instruments are as follows (in thousands):

   
At March 31, 2011
   
At December 31, 2010
 
   
Carrying
   
Fair
   
Carrying
   
Fair
 
   
Amount
   
Value
   
Amount
   
Value
 
Financial assets:
                       
    Cash and cash equivalents
  $ 33,010       33,010       19,324       19,324  
    Securities held to maturity
    2,682       2,880       3,027       3,241  
    Loans
    114,465       114,027       118,060       119,072  
    Federal Home Loan Bank stock
    298       298       298       298  
    Accrued interest receivable
    504       504       551       551  
                                 
Financial liabilities:
                               
    Deposits
    133,135       129,151       133,757       131,056  
                                 
Off-balance-sheet financial instruments
    -       -       -       -  

9.         Employee Benefit Plans
 
The Company has a 401(k) plan for its employees who meet certain age and length-of-service requirements. Eligible employees can contribute up to $16,500 of their compensation to the plan on a pre-tax basis. Employer matching contributions are made at 100 percent of employee contribution up to five percent. Employer contributions made to the 401(k) plan were approximately $33,000 and $15,000 for the three-months ended March 31, 2011 and 2010, respectively.

 
(continued)

 
14
 
 

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued


10.  Fair Value Measurements
 
Impaired collateral-dependent loans are carried at fair value when the current collateral value is lower than the carrying value of the loan.  Those impaired collateral-dependent loans which are measured at fair value on a nonrecurring basis are as follows (in thousands):

    
 
Fair
Value
   
 
 
Level 1
   
 
 
Level 2
   
 
 
Level 3
   
 
Total
Losses
   
Losses
Recorded
During the
Period
 
At March 31, 2011:
                                   
One-to-four family
  $ 1,789       -       -       1,789       607       127  
Lot loans
    96       -       -       96       45       -  
Home equity
    76       -       -       76       194       1  
                                                 
Total
  $ 1,961       -       -       1,961       846       128  
                                                 
At December 31, 2010:
                                               
One-to-four family
    1,429       -       -       1,429       435       435  
Lot loans
    51       -       -       51       91       91  
                                                 
Total
  $ 1,480       -       -       1,480       526       526  
 
 
In addition, loans with a carrying value of $925,000 and $483,000 at March 31, 2011 and December 31, 2010, respectively, were measured for impairment using Level 3 inputs and had a fair value in excess of carrying value.

 
Foreclosed real estate is recorded at fair value less estimated costs to sell.  Foreclosed real estate which is measured at fair value on a nonrecurring basis is summarized below (in thousands):

          
Quoted Prices
                         
         
In Active
   
Significant
                   
         
Markets for
   
Other
   
Significant
         
Losses
 
         
Identical
   
Observable
   
Unobservable
         
Recorded
 
   
Fair
   
Assets
   
Inputs
   
Inputs
   
Total
   
During the
 
   
Value
   
(Level 1)
   
(Level 2)
   
(Level 3)
   
Losses
   
Period
 
At March 31, 2011-
                                   
    Foreclosed real estate
  $ 599       -       -       599       40       -  
                                                 
At December 31, 2010-
                                               
    Foreclosed real estate
  $ 596       -       -       596       40       5  

(continued)

 
15
 
 

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued


11.        Regulatory Matters
 
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies.  Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's and the Bank's financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices.  The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

 
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined).  Management believes, as of March 31, 2011, that the Bank meets all capital adequacy requirements to which it is subject.

 
At March 31, 2011, the Bank was categorized as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table.  There are no conditions or events since that notification that management believes have changed the institution's category.

 
The Bank's actual regulatory capital amounts and percentages are presented in the table ($ in thousands).

    
Actual
   
Minimum
For Capital Adequacy
Purposes
   
Minimum
To Be Well
Capitalized Under
Prompt and Corrective
Action Provisions
 
   
Amount
   
%
   
Amount
   
%
   
Amount
   
%
 
At March 31, 2011:
                                   
    Total Capital to Risk-
                                   
        Weighted Assets
  $ 12,848       13.29 %   $ 7,732       8.00 %   $ 9,665       10.00 %
    Tier I Capital to Risk-
                                               
        Weighted Assets
    13,707       14.18       3,866       4.00       5,799       6.00  
    Tier I Capital
                                               
        to Total Assets
    13,707       8.21       4,697       3.00       7,829       5.00  
                                                 
At December 31, 2010:
                                               
    Total Capital to Risk-
                                               
        Weighted Assets
    13,989       14.38       7,785       8.00       9,731       10.00  
    Tier I Capital to Risk-
                                               
        Weighted Assets
    13,087       13.45       3,893       4.00       5,839       6.00  
    Tier I Capital
                                               
        to Total Assets
    13,087       8.87       4,427       3.00       7,379       5.00  

(continued)

 
16
 
 

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued


12.       Adoption of Plan of Reorganization and Subsequent Stock Issuance
 
On April 5, 2011, in accordance with a Plan of Conversion and Reorganization (the “Plan”) adopted by its Board of Directors and approved by its members, the Bank converted from a mutual holding company to a stock holding company form of organization, with the Bank becoming a wholly owned subsidiary of the Holding Company.  The conversion and reorganization was accomplished through the sale and issuance of 1,234,454 shares of common stock at a price of $10.00 per share, through which the Holding Company received proceeds of approximately $11.5 million, net of offering expenses of approximately $847,000.  In connection with the conversion and reorganization, the Board of Directors adopted an employee stock ownership plan (ESOP) which subscribed for 8% of the shares sold in the offering, or 98,756 shares of common stock.

 
In accordance with Office of Thrift Supervision (OTS) regulations, upon the completion of the conversion, the Bank restricted retained earnings by establishing a liquidation account. The liquidation account will be maintained for the benefit of eligible account holders who continue to maintain their accounts at the Bank after conversion. The liquidation account will be reduced annually to the extent that eligible account holders have reduced their qualifying deposits. Subsequent increases will not restore an eligible account holder’s interest in the liquidation account. In the event of a complete liquidation of the Bank, and only in such event, each account holder will be entitled to receive a distribution from the liquidation account in an amount proportionate to the adjusted qualifying account balances then held. The Bank may not pay dividends if those dividends would reduce equity capital below the required liquidation account amount.

13.       Subsequent Event
 
Effective April 5, 2011, upon closing of the stock offering, the Holding Company established a stock ownership plan which acquired 8% of the total number of shares of common stock sold during the offering.  A total of 98,756 shares were acquired for proceeds of $988,000 and will be distributed over a 10 year period.  The employee stock ownership plan borrowed the funds to purchase the shares from the Holding Company, which funded the loan from net proceeds of the offering.  The loan will accrue interest at the prime rate as published in the Wall Street Journal, which is currently 3.25%.





 
17
 
 

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Item 2.
Management's Discussion and Analysis of
 
Financial Condition and Results of Operations


Forward-Looking Statements

When used in this report and in future filings by Sunshine Financial with the SEC, in Sunshine Financial's press releases or other public or shareholder communications, or in oral statements made with the approval of an authorized executive officer, the words or phrases, "anticipate," "believes," "expects," "would be," "will allow," "intends to," "will likely result," "are expected to," "will continue," "is anticipated," "estimated," "projected," or similar expressions are intended to identify forward-looking statements.  These forward-looking statements include, but are not limited to:

·  
statements of our goals, intentions and expectations;
·  
statements regarding our business plans, prospects, growth and operating strategies;
·  
statements regarding the asset quality of our loan and investment portfolios; and
·  
estimates of our risks and future costs and benefits.

These forward-looking statements are based on current beliefs and expectations of our management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control.  In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change.

The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:

·  
the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets;
·  
changes in general economic conditions, either nationally or in our market area;
·  
changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources;
·  
fluctuations in the demand for loans, the number of unsold homes, land and other properties and fluctuations in real estate values in our market area;
·  
results of examinations of us by the OTS or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our reserve for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings;
·  
legislative or regulatory changes that adversely affect our business including the effect of the Dodd-Frank Act, changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules;
·  
our ability to attract and retain deposits;
·  
further increases in premiums for deposit insurance;
·  
our ability to control operating costs and expenses;
·  
the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation;
·  
difficulties in reducing risks associated with the loans on our balance sheet;
·  
staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges;
·  
computer systems on which we depend could fail or experience a security breach;
·  
our ability to retain key members of our senior management team;

 
18
 
 

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES


·  
costs and effects of litigation, including settlements and judgments;
·  
our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we may in the future acquire into our operations and out ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto;
·  
increased competitive pressures among financial services companies;
·  
changes in consumer spending, borrowing and savings habits;
·  
the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;
·  
our ability to pay dividends on our common stock;
·  
adverse changes in the securities markets;
·  
inability of key third-party providers to perform their obligations to us;
·  
changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies, the Public Company Accounting Oversight Board or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods including relating to fair value accounting and loan loss reserve requirements; and
·  
other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and the other risks described elsewhere in this prospectus.

Any of the forward-looking statements are based upon management's beliefs and assumptions at the time they are made.  We undertake no obligation to publicly update or revise any forward-looking statements included in this report or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise.  In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this report might not occur and you should not put undue reliance on any forward-looking statements.

General

On July 1, 2007, Sunshine Savings Bank converted its charter from a state-chartered credit union to a federally chartered savings bank.  On that date the name was changed from Sunshine State Credit Union to Sunshine Savings Bank, and we became a taxable organization.  In January 2009, we reorganized into a mutual holding company structure, with Sunshine Savings Bank as a wholly owned subsidiary of Sunshine Financial, Inc., a federal corporation (“Old Sunshine”), which was the wholly owned subsidiary of Sunshine Savings MHC (the “MHC”).  On April 5, 2011, in accordance with a Plan of Conversion and Reorganization (the “Plan”) adopted by its Board of Directors and approved by its members, we converted from a mutual to a stock holding company form of organization, with the MHC and Old Sunshine being merged into a new holding company, Sunshine Financial, Inc. (“Sunshine Financial” or the “Holding Company”), and the Bank becoming a wholly owned subsidiary of the Holding Company.  See Notes 1 and 12 to the Notes to Condensed Consolidated Financial Statements.  References to we, us and our throughout this document refer to Sunshine Financial and Sunshine Savings Bank, as the context requires.

We currently operate out of four full service branch offices serving the Tallahassee, Florida metropolitan area.  Our principal business consists of attracting retail deposits from the general public and investing those funds in loans secured by first and second mortgages on one- to four-family residences, home equity loans and lines of credit, lot loans, and direct automobile, credit card and other consumer loans.


 
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SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES


We offer a variety of deposit accounts, which are our primary source of funding for our lending activities.  We have adopted a plan of conversion and reorganization, primarily to increase our capital to grow our loan portfolio and to continue to build our franchise.

The Bank is significantly affected by prevailing economic conditions as well as government policies and regulations concerning, among other things, monetary and fiscal affairs, housing and financial institutions.  Deposit flows are influenced by a number of factors, including interest rates paid on competing time deposits, other investments, account maturities, and the overall level of personal income and savings.  Lending activities are influenced by the demand for funds, the number and quality of lenders, and regional economic cycles.  Sources of funds for lending activities of the Bank include primarily deposits, borrowings, payments on loans and income provided from operations.

Our primary source of pre-tax income is net interest income. Net interest income is the difference between interest income, which is the income that we earn on our loans and investments, and interest expense, which is the interest that we pay on our deposits and borrowings. Changes in levels of interest rates affect our net interest income. A secondary source of income is noninterest income, which includes revenue we receive from providing products and services. Our noninterest expense has typically exceeded our net interest income and we have relied primarily upon noninterest income to supplement our net interest income and to achieve earnings.

Our operating expenses consist primarily of salaries and employee benefits, general and administrative, occupancy and equipment, data processing services, professional services and marketing expenses. Salaries and benefits consist primarily of the salaries and wages paid to our employees, payroll taxes, expenses for retirement and other employee benefits. Occupancy and equipment expenses, which are the fixed and variable costs of building and equipment, consist primarily of lease payments, taxes, depreciation charges, maintenance and costs of utilities.

Critical Accounting Policies

Certain of our accounting policies are important to the portrayal of our financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain.  Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances.  Facts and circumstances which could affect these judgments include, but are not limited to, changes in interest rates, changes in the performance of the economy and changes in the financial condition of borrowers.  Management believes that its critical accounting policies include, determining the allowance for loan losses, the valuation of foreclosed assets and accounting for deferred income taxes.

Allowance for Loan Loss.  The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to operations.  Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed.  Subsequent recoveries, if any, are credited to the allowance.

Foreclosed Real Estate.  Real estate acquired through foreclosure is carried at fair value less estimated selling costs.  Costs associated with foreclosed real estate for maintenance, repair, property tax, etc., are expensed during the period incurred. Foreclosed real estate is reviewed monthly for potential impairment.  When impairment is indicated the impairment is charged against current period operating results and netted against the carrying value of the property.  At disposition any residual difference is either charged to current period earnings as a loss on sale or reflected as income in a gain on sale.

 
20
 
 

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES


The allowance for loan losses is evaluated on a regular basis by management and is based upon management's periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of specific and general components.  The specific component relates to loans that are classified as impaired.  For such loans, an allowance is established when the discounted cash flows, collateral value or observable market price of the impaired loan is lower than the carrying value of that loan.  The general component covers all other loans and is based on historical industry loss experience adjusted for qualitative factors.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for residential mortgage loans by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral if the loan is collateral-dependent.

Deferred Tax Assets.  Income taxes are reflected in our financial statements to show the tax effects of the operations and transactions reported in the financial statements and consist of taxes currently payable plus deferred taxes.  Generally accepted accounting principles require the asset and liability approach for financial accounting and reporting for deferred income taxes.  Deferred tax assets and liabilities result from differences between the financial statement carrying amounts and the tax bases of assets and liabilities.  They are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled and are determined using the assets and liability method of accounting.  The deferred income provision represents the difference between net deferred tax asset/liability at the beginning and end of the reported period.  In formulating our deferred tax asset, we are required to estimate our income and taxes in the jurisdiction in which we operate.  This process involves estimating our actual current tax exposure for the reported period together with assessing temporary differences resulting from differing treatment of items, such as depreciation and the provision for loan losses, for tax and financial reporting purposes.  Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates.  The realization of deferred tax assets is dependent on results of future operations.  A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.

 
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SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Results of Operations

The following table sets forth, for the periods indicated, information regarding (i) the total dollar amount of interest and dividend income of the Company from interest-earning assets and the resultant average yields; (ii) the total dollar amount of interest expense on interest-bearing liabilities and the resultant average cost; (iii) net interest income; (iv) interest-rate spread; and (v) net interest margin.

    
Three Months Ended March 31,
 
   
2011
   
2010
 
   
Average
Balance
   
Interest
and
Dividends
   
Average
Yield/
Rate
   
Average
Balance
   
Interest
and
Dividend
   
Average
Yield/
Rate
 
Interest-earning assets:
                                   
    Loans receivable (1)
  $ 116,216     $ 1,707       5.88 %   $ 129,677     $ 1,964       6.06 %
    Investments held to maturity
    2,866       38       5.22       4,199       54       5.11  
    Other interest-earning assets (2)
    18,360       10       0.22       3,727       1       0.21  
                                                 
        Total interest-earning assets
    137,442       1,755       5.11       137,603       2,019       5.87  
                                                 
Noninterest-earning assets
    10,724                       13,562                  
                                                 
        Total assets
  $ 148,166                     $ 151,165                  
                                                 
Interest-bearing liabilities:
                                               
    MMDA and statement savings
    59,098       111       0.75       53,699       168       1.25  
    Time deposits
    55,074       192       1.40       63,197       333       2.10  
                                                 
        Total interest-bearing liabilities
    114,172       303       1.06       116,896       501       1.71  
                                                 
Noninterest-bearing liabilities
    18,954                       19,062                  
Equity
    15,040                       15,207                  
                                                 
        Total liabilities and equity
  $ 148,166                     $ 151,165                  
                                                 
Net interest income
          $ 1,452                     $ 1,518          
                                                 
Net interest rate spread (3)
                    4.05 %                     4.16 %
                                                 
Net interest margin (4)
                    4.22 %                     4.41 %
                                                 
Ratio of average interest-earning assets
                                               
    to average interest-bearing liabilities
    1.20                       1.18                  
_________________
(1)
Includes nonaccrual loans.
(2)
Other interest-earnings assets including federal funds sold, Federal Home Loan Bank stock and interest-bearing deposits.
(3)
Interest-rate spread represents the difference between the average yield on interest-earning assets and the average rate of interest-bearing liabilities.
(4)
Net interest margin is net interest income divided by average interest-earning assets (annualized).



 
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SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Comparison of Financial Condition at March 31, 2011 and December 31, 2010

General.  Total assets increased $9.7 million, or 6.4%, to $159.6 million at March 31, 2011 from $149.9 million at December 31, 2010. The increase in total assets was due primarily to increases in funds received in connection with our recent stock offering which were invested during the offering period in federal funds sold.  Our federal funds sold increased $11.0 million since December 31, 2010, funded primarily by a $10.0 million increase in deposits received in the form of nonrefundable stock subscriptions.

Loans.  Our loan portfolio decreased $3.6 million, to $114.5 million at March 31, 2011 from $118.1 million at December 31, 2010.  One- to four-family real estate mortgage loans decreased $1.9 million while consumer loans decreased $1.7 million. The decrease in loans receivable was due primarily to loan repayments exceeding loan originations.  The decrease in loan originations was primarily attributable to the weakness in the housing market and the economy. In addition, management made the strategic decision to compete less aggressively for one- to four family real estate mortgage loans by not matching low loan rates offered by competitors that do not meet the investment objectives for loans held by us. In an attempt to increase future one- to four family real estate mortgage loan originations and generate income we recently have been approved to originate and sell residential loans to Freddie Mac.

Allowance for Loan Losses.  Our allowance for loan losses at March 31, 2011 was $1.7 million, or 1.49% of net loans receivable, compared to $1.6 million, or 1.37% of net loans receivable, at December 31, 2010.  Nonperforming loans decreased slightly to $4.7 million at March 31, 2011 from $5.0 million at December 31, 2010.  Nonperforming loans to total loans decreased to 4.05% at March 31, 2011 from 4.14% at December 31, 2010.  Loans on nonaccrual which were less than ninety days past due totaled $397,000 at March 31, 2011 compared to $1.6 million at December 31, 2010.

Deposits.  Total deposits increased $9.4 million, or 7.0%, to $143.2 million at March 31, 2011 from $133.8 million at December 31, 2010.  This increase was due primarily to $10.0 funds received in connection with our recent stock offering.

Equity.  Total equity increased $8,000 to $15.0 million at March 31, 2011, from $15.0 million at December 31, 2010.  This increase was solely due to the net income for the three months ended March 31, 2011.

 
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SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Comparison of the Three Months Ended March 31, 2011 and 2010

General.  Net earnings for the three months ended March 31, 2011 was $8,000 compared to a net earnings of $14,000 for the three months ended March 31, 2010, resulting in an annualized return on average assets of 0.02% for the three months ended March 31, 2011 and 0.04% for the three months ended March 31, 2010.  The decrease in net earnings was due primarily to a decrease in our net interest margin and a slight increase on total noninterest expense, offset by a decrease in provision for loan loss.  Net interest income decreased $66,000 from the three months ended March 31, 2010 to the three months ended March 31, 2011, while total noninterest expense increased $38,000 and our provision for loan loss decreased $75,000.

Net Interest Income.  Net interest income decreased $66,000, or 4.3%, to $1,452,000 for the three months ended March 31, 2011 from $1,518,000 for the same period in 2010, primarily due to the decline in average balance and yield of our loan portfolio, partially offset by our lower cost of deposits.  Our interest-rate-spread decreased to 4.05% for the three months ended March 31, 2011 from 4.16% for the same period in 2010, while our net interest margin decreased to 4.22% at March 31, 2011 from 4.41% at March 31, 2010.  The ratio of average interest-earning assets to average interest-bearing liabilities for the three months ended March 31, 2011 increased to 1.20, from 1.18 for the three months ended March 31, 2010.

Interest Income. Interest income for the three months ended March 31, 2011 decreased $264,000, or 13.08%, to $1.7 million from $2.0 million for the same period ended March 31, 2010.  The decrease in interest income for the three months ended March 31, 2011 was primarily due to lower average balances of interest-earning assets, in particular, loans receivable.  Average interest-earning loans decreased to $116.2 million during the three months ended March 31, 2011 compared to $129.7 million for the three months ended March 31, 2010.

Interest Expense. Interest expense for the three months ended March 31, 2011 was $303,000 compared to $501,000 for the same period in 2010, a decrease of $198,000 or 39.5%.  The decrease was primarily the result of decreases in both the average balance of and the average rate paid on time deposits.  The average balance of time deposits decreased to $55.1 million for the three month period ended March 31, 2011 from $63.2 million for the same period in 2010 and the average rate paid on certificates of deposit decreased to 1.40% from 2.10%.

Provision for Loan Losses.  We recorded a provision for loan losses of $225,000 for the three months ended March 31, 2011 and $300,000 for the same period in 2010.  The provision for loan losses reflected the decrease in the size of our loan portfolio and in loan charge-offs between these two periods as well as the change in the mix of loans. Net charge-offs for the three months ended March 31, 2011 were $141,000 compared to $211,000 for the three months ended March 31, 2010. For the first quarter of 2011, net charge-offs consisted of $91,000 for credit card and unsecured loans, $38,000 for second mortgage loans, $15,000 for other secured consumer loans, and a net recovery of $2,000 for automobile loans.  For the same period in 2010, net charge-offs consisted of $208,000 for credit card and unsecured loans, $7,000 for automobile loans, $1,000 for other secured consumer loans, and a recovery of $5,000 for one- to four-family mortgage loans.  Nonperforming loans to total loans at March 31, 2011 were 4.05% compared to 4.14% at March 31, 2010.  The allowance for loan losses to net loans receivable was 1.49% at March 31, 2011 compared to 1.29% at March 31, 2010.

 
24
 
 

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Comparison of the Three Months Ended March 31, 2011 and 2010, Continued

As mentioned above, this decrease was due to a decline in the overall size of the loan portfolio. In addition, based on our loan loss experience, loans secured by residential properties have historically resulted in a lower loss rate compared to our other loans.  Accordingly, we generally provide a lower allowance factor for these loans than for other categories of loans in the portfolio, thus requiring a smaller contribution to the allowance for loan losses than if the increase in non-performing loans consisted of higher risk loans. In addition, the amount of our allowance for loan losses was favorably impacted by continuing declines in our automobile, credit card and unsecured loans which have historically had a higher allowance factor and loss rate compared to one- to four-family mortgage loans.

Management considers the allowance for loan losses at March 31, 2011 to be adequate to cover losses inherent in the loan portfolio based on the assessment of the above-mentioned factors affecting the loan portfolio. While management believes the estimates and assumptions used in its determination of the adequacy of the allowance are reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future losses will not exceed the amount of the established allowance for loan losses or that any increased allowance for loan losses that may be required will not adversely impact our financial condition and results of operations. In addition, the determination of the amount of our allowance for loan losses is subject to review by bank regulators, as part of the routine examination process, which may result in additions to our provision for loan losses based upon their judgment of information available to them at the time of their examination.

Noninterest Income. Noninterest income for the three months ended March 31, 2011 increased $19,000, or 3.4%, to $581,000 compared to $562,000 for the same period in 2010. Loan fees increased $1,000 and service charges on deposit accounts increased by $18,000 for the three months ended March 31, 2011, compared to the three months ended March 31, 2010.

Noninterest Expense. Noninterest expense for the three months ended March 31, 2011 was $1.8 million compared to $1.8 million for the same period in 2010, an increase of $38,000 or 2.2%.  The largest increase occurred in salaries and employee benefits expense, which increased $53,000, or 6.3%, to $892,000 for the three months ended March 31, 2011, from $839,000 for the same period last year.  The increase in salaries and employee benefits expense primarily was due a one time bonus paid to employees (excluding senior management) in March in lieu of salary increases.

Income Taxes. For the three months ended March 31, 2011, we recorded income tax expense of $5,000 on before tax earnings of $13,000.  For the three months ended March 31, 2010, we recorded income tax expense of $9,000 on a before tax income of $23,000.  Our effective tax rate for the three months ended March 31, 2011 was 37.6% as compared to 37.6% for the same time period in 2010.


 
25
 
 

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Item 3.  Quantitative and Qualitative Disclosure About Market Risk

Not required by smaller reporting companies.

Item 4.  Controls and Procedures

An evaluation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934 (the "Act")) as of March 31, 2011, was carried out under the supervision and with the participation of the Company's Chief Executive Officer, Chief Financial Officer and several other members of the Company's senior management. The Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures in effect as of March 31, 2011, were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is: (i) accumulated and communicated to the Company's management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms.

In addition, there have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Act) that occurred during the quarter ended March 31, 2011, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

The Company does not expect that its disclosure controls and procedures and internal control over financial reporting will prevent all error and all fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls may be circumvented by the individual acts of some persons, by collusion of two or more people, or by override of the control. The design of any control procedure also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.





 
26
 
 

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

 
PART II.  OTHER INFORMATION


Item 1.       Legal Proceedings

In the normal course of business, the Company occasionally becomes involved in various legal proceedings.  In the opinion of management, any liability from such proceedings would not have a material adverse effect on the business or financial condition of the Company.

Item 1A.     Risk Factors

Not required for smaller reporting companies.

Item 2.        Unregistered Sales of Equity Securities and use of Proceeds

The effective date of the Company’s Registration Statement on Form S-1 (File No. 333-169555) was February 11, 2011. The class of securities registered with the SEC was Sunshine Financial, Inc. common stock, par value $0.01 per share.  A total of 1,388,625 shares of common stock for an aggregate price of $13,886,250 were registered with the SEC.  The amount of securities sold in the offering was $12,344,450, or 1,234,445 shares, of common stock, all of which shares were sold to in a subscription and community offering at a price per share of $10.00. The offering was consummated on April 5, 2011.  Keefe, Bruyette & Wood, Inc. acted as marketing agent for the offering. The net proceeds resulting from the offering after deducting all expenses related to the offering were $11.5 million.  The net proceeds have initially been invested in securities and cash and cash equivalents.

Item 3.        Defaults Upon Senior Securities

Nothing to report.

Item 4.        Submission of Matters to a Vote of Security Holders

Nothing to report.

Item 5.        Other Information

Nothing to report.
 
Item 6.        Exhibits

See Exhibit Index


 
27
 
 

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

SIGNATURES


Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
   
SUNSHINE FINANICAL, INC.
 
     
     
Date:  May 16, 2011
By:
/s/ Louis O. Davis, Jr.
   
Louis O. Davis, Jr.
   
President and Chief Executive Officer
   
(Duly Authorized Officer)
     
Date:  May 16, 2011
By:
/s/ Scott A. Swain
   
Scott A, Swain
   
Senior Vice President, Treasurer and
   
Chief Financial Officer
   
(Principal Financial Officer)



 
28
 
 

EXHIBIT INDEX

 
Exhibits:
2.0
Plan of Conversion and Reorganization (incorporated herein by reference to Exhibit 2.0 to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-169555))
   
3.1
Articles of Incorporation of Sunshine Financial, Inc. (incorporated herein by reference to Exhibit 3.1 to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-169555))
   
3.2
Bylaws of Sunshine Financial, Inc. (incorporated herein by reference to Exhibit 3.2 to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-169555))
   
4.0
Form of Common Stock Certificate of Sunshine Financial, Inc. (incorporated herein by reference to Exhibit 4.0 to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-169555))
   
10.1
Employment Agreement by and between Sunshine Savings Bank and Louis O Davis, Jr. (incorporated herein by reference to Exhibit 10.1 to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-169555))
   
10.2
Form of Change of Control Agreement by and between Sunshine Financial, Inc. and Louis O. Davis Jr. (incorporated herein by reference to Exhibit 10.2 to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-169555))
   
10.3
Form of Change of Control Agreement by and between Sunshine Financial, Inc. and each of Brian P. Baggett and Scott A. Swain(incorporated herein by reference to Exhibit 10.3 to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-169555))
   
10.4
Employee Severance Policy(incorporated herein by reference to Exhibit 10.4 to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-169555))
   
10.5
Director Fee Arrangements(incorporated herein by reference to Exhibit 10.5 to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-169555))
   
31.1
Rule 13a-14(a) Certification of the Chief Executive Officer
   
31.2
Rule 13a-14(a) Certification of the Chief Financial Officer
   
32.0
Section 1350 Certification