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EX-32 - SECTION 1350 CERTIFICATION - Sunshine Financial, Inc.ex32.htm
EX-31.2 - RULE 13A-14(A) CERTIFICATION OF THE CHIEF FINANCIAL OFFICER - Sunshine Financial, Inc.ex312.htm
EX-31.1 - RULE 13A-14(A) CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER - Sunshine Financial, Inc.ex311.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 September 30, 2017

[  ]          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, smaller reporting company or emerging growth company.  See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth 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]
Emerging growth company [  ]

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  [  ]
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 November 14, 2017, there were issued and outstanding 1,030,539 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 September 30, 2017 (Unaudited) and December 31, 2016
2
     
 
Condensed Consolidated Statements of Operations for the Three- and Nine-Months Ended September 30, 2017 and 2016 (Unaudited)
3
     
 
Condensed Consolidated Statements of Stockholders' Equity for the Nine-Months Ended September 30, 2017 and 2016 (Unaudited)
4
     
 
Condensed Consolidated Statements of Cash Flows For the Nine-Months Ended September 30, 2017 and 2016 (Unaudited)
5
     
 
Notes to Condensed Consolidated Financial Statements (unaudited)
6-22
     
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
23-34
     
Item 3.
Quantitative and Qualitative Disclosure About Market Risk
34
     
Item 4.
Controls and Procedures
34-35
     
PART II
OTHER INFORMATION
 
     
Item 1.
Legal Proceedings
36
     
Item 1A.
Risk Factors
36
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
36
     
Item 3.
Defaults Upon Senior Securities
36
     
Item 4.
Mine Safety Disclosures
36
     
Item 5.
Other Information
36
     
Item 6.
Exhibits
37
     
SIGNATURES
 
38
     
EXHIBIT INDEX
   
 
 
1

 
 
SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

Condensed Consolidated Balance Sheets
($ in thousands)
   
At September 30,
2017
   
At December 31,
2016
 
   
(Unaudited)
       
Assets
           
             
Cash and due from banks
 
$
1,869
     
2,705
 
Interest-bearing deposits with banks
   
7,272
     
8,608
 
                 
Cash and cash equivalents
   
9,141
     
11,313
 
                 
Securities held to maturity (fair value of $13,774 and $16,294)
   
13,873
     
16,512
 
Loans, net of allowance for loan losses of $1,098 and $924
   
159,541
     
134,077
 
Premises and equipment, net
   
3,519
     
3,662
 
Bank owned life insurance
   
3,239
     
3,172
 
Federal Home Loan Bank stock, at cost
   
1,346
     
684
 
Deferred income taxes
   
2,287
     
2,550
 
Accrued interest receivable
   
506
     
449
 
Foreclosed real estate
   
137
     
141
 
Other assets
   
501
     
649
 
                 
Total assets
 
$
194,090
     
173,209
 
                 
Liabilities and Stockholders' Equity
               
                 
Liabilities:
               
Noninterest-bearing deposit accounts
 
$
34,793
     
31,247
 
Money-market deposit accounts
   
41,403
     
39,633
 
Savings accounts
   
47,188
     
46,989
 
Time deposits
   
18,284
     
20,033
 
                 
Total deposits
   
141,668
     
137,902
 
                 
Federal home loan bank advances
   
28,000
     
12,750
 
Official checks
   
747
     
541
 
Other liabilities
   
1,446
     
360
 
                 
Total liabilities
   
171,861
     
151,553
 
                 
Stockholders' equity:
               
Preferred stock, $0.01 par value, 1,000,000 authorized, none
      issued and outstanding
   
-
     
-
 
Common stock, $.01 par value, 6,000,000 shares authorized,
     1,030,039 shares issued and outstanding
   
10
     
10
 
Additional paid in capital
   
7,440
     
7,374
 
Retained earnings
   
15,173
     
14,743
 
Unearned Employee Stock Ownership Plan shares
   
(394
)
   
(471
)
                 
Total stockholders' equity
   
22,229
     
21,656
 
                 
Total liabilities and stockholders' equity
 
$
194,090
     
173,209
 

See accompanying Notes to Condensed Consolidated Financial Statements.
 
2

 
 
 
SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Operations (Unaudited)
(In thousands, except per share information)


   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2017
   
2016
   
2017
   
2016
 
Interest income:
                       
Loans
 
$
1,805
   
$
1,492
     
5,183
     
4,389
 
Securities
   
72
     
88
     
229
     
286
 
Other
   
26
     
13
     
59
     
38
 
Total interest income
   
1,903
     
1,593
     
5,471
     
4,713
 
                                 
Interest expense:
                               
Deposits
   
94
     
95
     
279
     
278
 
Borrowings
   
73
     
6
     
138
     
15
 
Total interest expense
   
167
     
101
     
417
     
293
 
                                 
Net interest income
   
1,736
     
1,492
     
5,054
     
4,420
 
                                 
Provision for loan losses
   
50
     
45
     
155
     
135
 
                                 
Net interest income after provision for loan losses
   
1,686
     
1,447
     
4,899
     
4,285
 
                                 
Noninterest income:
                               
Fees and service charges on deposits
   
346
     
357
     
1,041
     
1,064
 
Gain on sale of loans
   
2
     
15
     
13
     
39
 
Gain on sale of foreclosed real estate
   
-
     
14
     
30
     
14
 
Fees and charges on loans
   
44
     
39
     
151
     
115
 
Income from bank owned life insurance
   
22
     
24
     
67
     
73
 
Other
   
5
     
37
     
20
     
83
 
Total noninterest income
   
419
     
486
     
1,322
     
1,388
 
                                 
Noninterest expenses:
                               
Salaries and employee benefits
   
813
     
829
     
2,422
     
2,590
 
Occupancy and equipment
   
238
     
262
     
751
     
820
 
Data processing services
   
316
     
307
     
941
     
916
 
Professional fees
   
157
     
172
     
537
     
533
 
Deposit insurance
   
28
     
31
     
60
     
94
 
Stationery and supplies
   
14
     
17
     
60
     
55
 
Telephone and postage
   
23
     
26
     
74
     
78
 
Credit card expense
   
30
     
41
     
132
     
124
 
Other
   
148
     
197
     
551
     
521
 
Total noninterest expenses
   
1,767
     
1,882
     
5,528
     
5,731
 
                                 
Earnings (loss) before income taxes (benefit)
   
338
     
51
     
693
     
(58
)
Income taxes (benefit)
   
123
     
16
     
263
     
(8
)
                                 
Net earnings (loss)
 
$
215
   
$
35
     
430
     
(50
)
                                 
Basic earnings (loss) per common share
 
$
0.22
   
$
0.04
     
0.45
     
(0.05
)
                                 
Diluted earnings (loss) per common share
 
$
0.22
   
$
0.04
     
0.43
     
(0.05
)
                                 
Dividends per common share
 
$
-
   
$
-
     
-
     
-
 
                                 
See accompanying Notes to Condensed Consolidated Financial Statements.
 
3

 
 
 
SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Stockholders' Equity

Nine Months Ended September 30, 2017 and 2016
 ($ in thousands)

                           
Unearned
       
                           
Employee
       
                           
Stock
       
               
Additional
         
Ownership
   
Total
 
   
Common Stock
   
Paid In
   
Retained
   
Plan
   
Stockholders'
 
   
Shares
   
Amount
   
Capital
   
Earnings
   
Shares
   
Equity
 
                                     
Balance, December 31, 2015
   
1,030,898
   
$
10
     
7,285
     
14,633
     
(570
)
   
21,358
 
                                                 
Net loss (unaudited)
   
-
     
-
     
-
     
(50
)
   
-
     
(50
)
                                                 
Stock based compensation  expense (unaudited)
   
-
     
-
     
152
     
-
     
-
     
152
 
                                                 
Stock issued for options exercised (unaudited)
   
1,000
             
11
                     
11
 
                                                 
Common stock allocated to ESOP participants (unaudited)
   
-
     
-
     
(69
)
   
-
     
74
     
5
 
                                                 
Balance, September 30, 2016 (unaudited)
   
1,031,898
   
$
10
     
7,379
     
14,583
     
(496
)
   
21,476
 
                                                 
Balance, December 31, 2016
   
1,030,039
   
$
10
     
7,374
     
14,743
     
(471
)
   
21,656
 
                                                 
Net earnings (unaudited)
   
-
     
-
     
-
     
430
     
-
     
430
 
                                                 
Stock based compensation  expense (unaudited)
   
-
     
-
     
148
     
-
     
-
     
148
 
                                                 
Common stock allocated to ESOP participants (unaudited)
   
-
     
-
     
(82
)
   
-
     
77
     
(5
)
                                                 
Balance, September 30, 2017 (unaudited)
   
1,030,039
   
$
10
     
7,440
     
15,173
     
(394
)
   
22,229
 



See accompanying Notes to Condensed Consolidated Financial Statements.
 
 

 
4

 

 
SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows (Unaudited)
(In thousands)
 
   
Nine-Months Ended
September 30,
 
   
2017
   
2016
 
Cash flows from operating activities:
           
Net earnings (loss)
 
$
430
     
(50
)
Adjustments to reconcile net earnings (loss) to net cash provided by operating activities:
               
Depreciation
   
234
     
271
 
Provision for loan losses
   
155
     
135
 
Deferred income taxes
   
263
     
10
 
Net amortization of premiums on securities
   
18
     
34
 
Net amortization of deferred loan fees and costs
   
122
     
90
 
Income from bank owned life insurance
   
(67
)
   
(73
)
Loans originated for sale
   
(541
)
   
(1,085
)
Proceeds from loans sold
   
554
     
1,124
 
Gain on sale of loans
   
(13
)
   
(39
)
ESOP compensation expense
   
(5
)
   
5
 
Stock-based compensation expense
   
148
     
152
 
Increase in accrued interest receivable
   
(57
)
   
(45
)
Decrease in other assets
   
148
     
116
 
Gain on sale of foreclosed real estate
   
(30
)
   
(14
)
Write-down of foreclosed real estate
   
-
     
27
 
Increase in official checks
   
206
     
39
 
Increase in other liabilities
   
1,086
     
691
 
                 
Net cash provided by operating activities
   
2,651
     
1,388
 
                 
Cash flows from investing activities:
               
Principal pay-downs on securities held-to-maturity
   
2,621
     
3,331
 
Net increase in loans
   
(25,741
)
   
(10,340
)
Net purchases of premises and equipment
   
(91
)
   
(168
)
Purchase of Federal Home Loan Bank stock
   
(662
)
   
(28
)
Proceeds from sale of foreclosed real estate
   
34
     
106
 
Capital expenditures to foreclosed real estate
   
-
     
(14
)
                 
Net cash used in investing activities
   
(23,839
)
   
(7,113
)
                 
Cash flows from financing activities:
               
Net increase in deposits
   
3,766
     
8,149
 
Cash proceeds from stock options exercised
   
-
     
11
 
Repayments of Federal Home Loan Bank advances
   
(158,250
)
   
(42,500
Proceeds from Federal Home Loan Bank advances
   
173,500
     
43,000
 
                 
Net cash provided by financing activities
   
19,016
     
8,660
 
                 
(Decrease) increase in cash and cash equivalents
   
(2,172
)
   
2,935
 
                 
Cash and cash equivalents at beginning of period
   
11,313
     
10,862
 
                 
Cash and cash equivalents at end of period
 
$
9,141
     
13,797
 
                 
Supplemental disclosure of cash flow information:
               
Cash paid during the period for:
               
Income taxes
 
$
-
     
-
 
                 
Interest
 
$
417
     
293
 
                 
Noncash transaction-
               
Transfer from loans to foreclosed real estate
 
$
-
     
98
 
                 
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 Community Bank (the "Bank") and owns all the outstanding common stock of the Bank.

The Holding Company's only business is the operation of the Bank.  The Bank through its five 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, credit life and disability insurance products associated with loan products. Collectively the entities are referred to as the "Company."

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 accounting principles generally accepted in the United States of America ("GAAP") for a complete presentation of the Company's consolidated financial condition and consolidated results of operations.

In the opinion of management, the accompanying condensed consolidated financial statements of the Company reflect all adjustments (consisting only of normal recurring accruals) which are necessary in order to present fairly the consolidated financial position at September 30, 2017 and the results of operations for the three- and nine-month periods ended September 30, 2017 and 2016. It is recommended that these unaudited condensed consolidated financial statements be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 2016 filed with the U.S. Securities and Exchange Commission ("SEC") on March 30, 2017 ("2016 Form 10-K").  The results of operations for the three- and nine-month periods ended September 30, 2017, are not necessarily indicative of the results to be expected for the full year or for any other period.

2.  Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customer (Topic 606). In August 2015, FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606) which postponed the effective date.  Subsequently, in March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations. This amendment clarifies that an entity should determine if it is the principal or the agent for each specified good or service promised in a contract with a customer. In April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing. The core principle of Topic 606 is that an entity must recognize revenue when it has satisfied a performance obligation of transferring promised goods or services to a customer. The standard is effective for public entities for interim and annual periods beginning after December 15, 2017; early adoption is not permitted. The standard allows for full retrospective
 
6


 

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited)

2.    Recent Accounting Pronouncements,  Continued

adoption for all periods presented or modified retrospective adoption to only the most current period presented in the financial statements. The cumulative effect of initially applying the standard is recognized at the date of the initial application. The Company's primary source of revenue is interest income from financial instruments which is scoped out of this ASU. The Company does not expect implementation of this standard to have a material impact on our consolidated financial statements.

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10), Recognition and Measurement of Financial Assets and Financial Liabilities. The new guidance is intended to improve the recognition and measurement of financial instruments. This ASU requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. In addition, the ASU requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes and requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements. This ASU also eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. The ASU also requires a reporting organization to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument specific credit risk (also referred to as "own credit") when the organization has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. ASU No. 2016-01 is effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted for certain provisions. The adoption of ASU No. 2016-01 is not expected to have a material impact on our consolidated financial statements. Management is in the planning stages of developing processes and procedures to comply with the disclosure requirements of this ASU, which could impact the disclosures we make related to the fair value of its financial instruments.

In February 2016, the FASB issued ASU 2016-2, Leases (Topic 842) which will require lessees to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases with term of more than twelve months. Consistent with current GAAP, the recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification as a finance or operating lease.  The new ASU will require both types of leases to be recognized on the balance sheet.  The ASU also will require disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. These disclosures include qualitative and quantitative requirements, providing additional information about the amounts recorded in the financial statements.  The ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted. 
 
7

 
 

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited)

 
2.  Recent Accounting Pronouncements, Continued
 
The Company is in the process of determining the effect of the ASU on its consolidated financial statements.  Once adopted, the Company expects to report higher assets and liabilities.

In June 2016, FASB issued Accounting Standards Update ("ASU") No. 2016-13 Financial Instruments-Credit Losses (Topic 326).  The ASU requires the Company to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. The Company will continue to use judgment to determine which loss estimation method is appropriate for their circumstances. The ASU requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization's portfolio.
 
These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements. Additionally, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The ASU will take effect for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019.  Early adoption is permitted. The Company is in the process of determining the effect of the ASU on its consolidated financial statements. Once adopted, we expect our allowance for loan losses to increase; however, until our evaluation is complete the magnitude of the increase will be unknown.
 
In August 2016, FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments.  This ASU addresses the appropriate classification of eight specific cash flow issues on the cash flow statement. Debt prepayment costs should be classified as an outflow for financing activities. Settlement of zero-coupon debt instruments divides the interest portion as an outflow for operating activities and the principal portion as an outflow for financing activities. Contingent consideration payments made after a business combination should be classified as outflows for financing and operating activities. Proceeds from the settlement of bank-owned life insurance policies should be classified as inflows from investing activities. Other specific areas are identified in the ASU as to the appropriate classification of the cash inflows or outflows.  The amendments in this ASU are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted and must be applied using a retrospective transition method to each period presented. We do not expect this ASU to have a material impact on our consolidated financial statements.
 
 
8

 
 
 
SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

2.  Recent Accounting Pronouncements, Continued
In March 2017, the FASB issued ASU No. 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20):  Premium Amortization on Purchased Callable Debt Securities. The ASU shortens the amortization period for certain callable debt securities held at a premium, the amendments require the premium to be amortized to the earliest call date.  The ASU will take effect for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018.  The adoption of ASU No. 2017-08 is not expected to have a material impact on the Company's consolidated financial statements.

In May 2017, the FASB issued ASU No. 2017-09, Compensation--Stock Compensation (Topic 718): Scope of Modification Accounting. The ASU was issued to provide clarity as to when to apply modification accounting when there is a change in the terms or conditions of a share-based payment award. According to this ASU, an entity should account for the effects of a modification unless the fair value, vesting conditions, and balance sheet classification of the award is the same after the modification as compared to the original award prior to the modification. The standard is effective for reporting periods beginning after December 15, 2017, with early adoption permitted. The adoption of ASU No. 2017-09 is not expected to have a material impact on the Company's consolidated financial statements.

In August 2017, the FASB issued ASU No. 2017-12, which amends the hedge accounting recognition and presentation requirements in ASC 815. The Board's objectives in issuing the ASU are to improve the transparency and understandability of information conveyed to financial statement users about an entity's risk management activities by better aligning the entity's financial reporting for hedging relationships with those risk management activities and to reduce the complexity of and simplify the application of hedge accounting by preparers. For public business entities, the ASU is effective for fiscal years beginning after December 15, 2018, early adoption is permitted. The Company currently has no hedging relationships. As a result, the adoption of this guidance is not expected to have a material impact on the Company's consolidated financial statements.
 
 
 
 
 
9


 
SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

3.  Earnings (Loss) Per Share

Earnings (loss) per share ("EPS") has been computed on the basis of the weighted-average number of shares of common stock outstanding. For the three- and nine-months ended September 30, 2017, and the three-months ended September 30, 2016, the outstanding stock options are considered dilutive securities for purposes of calculating diluted EPS which was computed using the treasury stock method.   For the nine-months September 30, 2016, the outstanding stock options were not considered dilutive securities due to the net loss incurred by the Company.  The shares purchased by the ESOP are included in the weighted-average shares when they are committed to be released ($ in thousands, except per share amounts):

   
2017
   
2016
 
         
Weighted-
   
Per
         
Weighted-
   
Per
 
         
Average
   
Share
         
Average
   
Share
 
   
Earnings
   
Shares
   
Amount
   
Earnings
   
Shares
   
Amount
 
Three Months Ended September 30:
                                   
  Basic EPS:
                                   
    Net earnings
 
$
215
     
956,861
   
$
0.22
   
$
35
     
945,606
   
$
0.04
 
  Effect of dilutive securities:
                                               
    Incremental shares from assumed conversion of options
           
40,047
                     
34,309
         
                                                 
  Diluted EPS:
                                               
    Net earnings
 
$
215
     
996,908
   
$
0.22
   
$
35
     
979,915
   
$
0.04
 

   
2017
   
2016
 
         
Weighted-
   
Per
         
Weighted-
   
Per
 
         
Average
   
Share
         
Average
   
Share
 
   
Earnings
   
Shares
   
Amount
   
Loss
   
Shares
   
Amount
 
Nine Months Ended September 30:
                                   
  Basic EPS:
                                   
    Net earnings (loss)
 
$
430
     
954,392
   
$
0.45
   
$
(50
)
   
943,137
   
$
(0.05
)
  Effect of dilutive securities:
                                               
    Incremental shares from assumed conversion of options
           
39,067
                     
-
         
                                                 
  Diluted EPS:
                                               
    Net earnings (loss)
 
$
430
     
993,459
   
$
0.43
   
$
(50
)
   
943,137
   
$
(0.05
)


(continued)
 
10

 
 
SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

4.  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 September 30, 2017:
                       
  Agency mortgage-backed securities
 
$
471
     
16
     
-
     
487
 
  Agency collateralized mortgage obligations
   
13,402
     
34
     
(149
)
   
13,287
 
                                 
  Total
 
$
13,873
     
50
     
(149
)
   
13,774
 
                                 
At December 31, 2016:
                               
  Agency mortgage-backed securities
   
697
     
24
     
-
     
721
 
  Agency collateralized mortgage obligations
   
15,815
     
15
     
(257
)
   
15,573
 
                                 
  Total
 
$
16,512
     
39
     
(257
)
   
16,294
 

There were no securities pledged at September 30, 2017 or December 31, 2016.

Securities with gross unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous loss position at the date indicated, are as follows (in thousands):

   
Less than Twelve Months
   
Twelve Months or Longer
 
   
Gross
         
Gross
       
   
Unrealized
   
Fair
   
Unrealized
   
Fair
 
   
Losses
   
Value
   
Losses
   
Value
 
At September 30, 2017:
                       
Agency collateralized mortgage obligations
 
$
(40
)
   
3,202
     
(109
)
   
4,210
 
                                 
At December 31, 2016:
                               
Agency collateralized mortgage obligations
 
$
(102
)
   
10,523
     
(155
)
   
3,941
 

At September 30, 2017 and December 31, 2016, the unrealized losses on sixteen securities and twenty one securities, respectively are considered by management to be attributable to changes in market interest rates and not attributable to credit risk on the part of the issuer. Accordingly, if market rates were to decline, much or all of the decline in market value would likely be recovered through market appreciation. As management has the ability and intent to hold debt securities until maturity, or for the foreseeable future, no declines in the fair value below amortized cost are deemed to be other than temporary.

(continued)
 
11

 
 
 
SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

5.  Loans
The loan portfolio segments and classes as of the dates indicated are as follows (in thousands):

   
September 30,
   
December 31,
 
   
2017
   
2016
 
Real estate mortgage loans:
           
  One-to four-family
 
$
62,905
     
56,601
 
  Commercial real estate
   
71,379
     
52,960
 
  Construction and lot
   
4,922
     
4,247
 
                 
    Total real estate mortgage loans
   
139,206
     
113,808
 
                 
Commercial loans
   
4,325
     
4,217
 
                 
Consumer loans:
               
  Home equity
   
6,811
     
7,166
 
  Automobile and other
   
4,473
     
4,498
 
  Credit cards and unsecured
   
5,580
     
5,796
 
                 
    Total consumer loans
   
16,864
     
17,460
 
                 
    Total loans
   
160,395
     
135,485
 
                 
Add (deduct):
               
  Loans in process
   
83
     
(522
)
  Deferred costs, fees and discounts, net
   
161
     
38
 
  Allowance for loan losses
   
(1,098
)
   
(924
)
                 
    Total loans, net
 
$
159,541
     
134,077
 


(continued)
 
12

 
 
 
SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

5.  Loans, Continued
The Company has divided the loan portfolio into three portfolio segments and seven classes, each with different risk characteristics and methodologies for assessing risk. The portfolio segments identified by the Company are as follows:

Real Estate Mortgage Loans.  Real estate mortgage loans are loans comprised of three classes: One- to four-family, Commercial real estate and Construction and lot loans. The Company generally originates one- to four-family mortgage loans in amounts up to 80% of the lesser of the appraised value or purchase price of a mortgaged property, but will also permit loan-to-value ratios of up to 95%. For one- to four-family loans exceeding an 80% loan-to-value ratio, the Company generally requires the borrower to obtain private mortgage insurance covering any loss on the amount of the loan in excess of 80% in the event of foreclosure. Commercial real estate loans are generally originated at 75% or less loan-to-value ratio and have amortization terms of up to 20 years and maturities of up to ten years.  Construction loans to borrowers are to finance the construction of one- to four-family and owner occupied properties. These loans are categorized as construction loans during the construction period, later converting to one-to four-family real estate loans after the construction is complete and amortization of the loan begins. Real estate construction loan funds are disbursed periodically based on the percentage of construction completed.  If the estimate of construction cost proves to be inaccurate, the Company may be compelled to advance additional funds to complete the construction with repayment dependent, in part, on the success of the ultimate project rather than the ability of a borrower to repay the loan.  The Company carefully monitors these loans with on-site inspections and requires the receipt of lien waivers on funds advanced. Construction loans are typically secured by the properties under construction. The Company also makes loans for the purchase of developed lots for future construction of the borrower's primary residence.  The Company will generally originate lot loans in an amount up to 75% of the lower of the purchase price or appraisal and have a maximum amortization of up to 20 years and maturities up to 20 years. Construction and lot loan lending is generally considered to involve a higher degree of credit risk than long-term permanent financing of residential properties.

Commercial Loans.  Commercial loans are comprised of non-real estate secured and unsecured loans.  The Company offers these commercial loans generally to its commercial real estate borrowers.

Consumer Loans.  Consumer loans are comprised of three classes: Home Equity, Automobile and Other, and Credit cards and unsecured.  The Company offers a variety of secured consumer loans, including home equity, new and used automobile, boat and other recreational vehicle loans, and loans secured by deposit accounts.  The Company also offers unsecured consumer loans including a credit card product.  The Company originates its consumer loans primarily in its market area.  Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Loans to consumers are extended after a credit evaluation, including the creditworthiness of the borrower(s), the
(continued)
 
 
13

 
 
SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

5.  Loans, Continued
purpose of the credit, and the secondary source of repayment. Consumer loans are made at fixed and variable interest rates and may be made on terms of up to twenty years. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.

An analysis of the change in the allowance for loan losses for the periods indicated, is as follows (in thousands):

   
Real Estate
Mortgage
Loans
   
Commercial
Loans
   
Consumer Loans
   
Unallocated
   
Total
 
Three Months Ended September 30, 2017:
                             
Beginning balance
 
$
514
     
68
     
338
     
157
     
1,077
 
Provision (credit) for loan loss
   
27
     
14
     
35
     
(26
)
   
50
 
Charge-offs
   
-
     
-
     
(46
)
   
-
     
(46
)
Recoveries
   
5
     
-
     
12
     
-
     
17
 
Ending balance
 
$
546
     
82
     
339
     
131
     
1,098
 
                                         
Three Months Ended September 30, 2016:
                                       
Beginning balance
 
$
481
     
27
     
356
     
61
     
925
 
Provision (credit) for loan loss
   
59
     
14
     
33
     
(61
)
   
45
 
Charge-offs
   
(53
)
   
-
     
(42
)
   
-
     
(95
)
Recoveries
   
9
     
-
     
8
     
-
     
17
 
Ending balance
 
$
496
     
41
     
355
     
-
     
892
 
                                         
Nine Months Ended September 30, 2017:
                                       
Beginning balance
 
$
558
     
74
     
292
     
-
     
924
 
Provision (credit) for loan loss
   
(101
)
   
8
     
117
     
131
     
155
 
Charge-offs
   
-
     
-
     
(100
)
   
-
     
(100
)
Recoveries
   
89
     
-
     
30
     
-
     
119
 
Ending balance
 
$
546
     
82
     
339
     
131
     
1,098
 
                                         
Nine  Months Ended September 30, 2016:
                                       
Beginning balance
 
$
503
     
10
     
381
     
1
     
895
 
Provision (credit) for loan loss
   
46
     
31
     
59
     
(1
)
   
135
 
Charge-offs
   
(67
)
   
-
     
(132
)
   
-
     
(199
)
Recoveries
   
14
     
-
     
47
     
-
     
61
 
Ending balance
 
$
496
     
41
     
355
     
-
     
892
 
                                         
At September 30, 2017:
                                       
Individually evaluated for impairment:
                                       
Recorded investment
 
$
2,017
     
-
     
151
     
-
     
2,168
 
                                         
Balance in allowance for loan losses
 
$
44
     
-
     
28
     
-
     
72
 
Collectively evaluated for impairment:
                                       
Recorded investment
 
$
137,189
     
4,325
     
16,713
     
-
     
158,227
 
                                         
Balance in allowance for loan losses
 
$
502
     
82
     
311
     
131
     
1,026
 
                                         
At December 31, 2016:
                                       
Individually evaluated for impairment:
                                       
Recorded investment
 
$
2,559
     
-
     
162
     
-
     
2,721
 
                                         
Balance in allowance for loan losses
 
$
44
     
-
     
28
     
-
     
72
 
Collectively evaluated for impairment:
                                       
Recorded investment
 
$
111,249
     
4,217
     
17,298
     
-
     
132,764
 
                                         
Balance in allowance for loan losses
 
$
514
     
74
     
264
     
-
     
852
 

(continued)
 
14

 
 
 
SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued


5.  Loans, Continued
The following summarizes the loan credit quality by loan grade and class at the dates indicated (in thousands):

Credit Risk
 Profile by
 
One-to
   
Commercial
   
Constru-
                     
Credit
       
Internally
 
Four-
   
Real
   
ction and
   
Comme-
   
Home
   
Automobile
   
Cards and
       
Assigned Grade:
 
Family
   
Estate
   
Lot
   
rcial
   
Equity
   
and Other
   
Unsecured
   
Total
 
At September 30, 2017:
                                               
  Grade:
                                               
    Pass
 
$
60,231
     
71,379
     
4,884
     
4,325
     
6,415
     
4,335
     
5,486
     
157,055
 
    Special mention
   
756
     
-
     
-
     
-
     
172
     
7
     
-
     
935
 
    Substandard
   
1,918
     
-
     
38
     
-
     
224
     
131
     
94
     
2,405
 
                                                                 
  Total
 
$
62,905
     
71,379
     
4,922
     
4,325
     
6,811
     
4,473
     
5,580
     
160,395
 
                                                                 
At December 31, 2016:
                                                               
  Grade:
                                                               
    Pass
 
$
53,573
     
52,960
     
4,218
     
4,217
     
6,843
     
4,393
     
5,760
     
131,964
 
    Special mention
   
807
     
-
     
-
     
-
     
-
     
-
     
4
     
811
 
    Substandard
   
2,221
     
-
     
29
     
-
     
323
     
105
     
32
     
2,710
 
                                                                 
  Total
 
$
56,601
     
52,960
     
4,247
     
4,217
     
7,166
     
4,498
     
5,796
     
135,485
 

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 net 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.

(continued)
 
15

 
 
 
SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued


5.  Loans, Continued

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.

Age analysis of past-due loans at the dates indicated is as follows (in thousands):


   
Accruing Loans
             
               
90 Days
                         
     
30-59
     
60-89
   
and
   
Total
                   
   
Days
   
Days
   
Greater
   
Past
         
Nonaccrual
   
Total
 
   
Past Due
   
Past Due
   
Past Due
   
Due
   
Current
   
Loans
   
Loans
 
At September 30, 2017:
                                             
  Real estate mortgage loans:
                                             
    One-to four-family
 
$
834
     
233
     
-
     
1,067
     
59,920
     
1,918
     
62,905
 
    Commercial real estate
   
532
     
-
     
-
     
532
     
70,847
     
-
     
71,379
 
    Construction and lot
   
50
     
-
     
-
     
50
     
4,834
     
38
     
4,922
 
  Commercial loans
   
50
     
-
     
-
     
50
     
4,275
     
-
     
4,325
 
  Consumer loans:
                                                       
    Home equity
   
18
     
170
     
-
     
188
     
6,318
     
305
     
6,811
 
    Automobile and other
   
104
     
17
     
-
     
121
     
4,221
     
131
     
4,473
 
    Credit cards and unsecured
   
30
     
20
     
26
     
76
     
5,410
     
94
     
5,580
 
                                                         
  Total
 
$
1,618
     
440
     
26
     
2,084
     
155,825
     
2,486
     
160,395
 
                                                         
At December 31,  2016:
                                                       
  Real estate mortgage loans:
                                                       
    One-to four-family
 
$
772
     
277
     
-
     
1,049
     
53,465
     
2,087
     
56,601
 
    Commercial real estate
   
-
     
-
     
-
     
-
     
52,960
     
-
     
52,960
 
    Construction and lot
   
85
     
-
     
-
     
85
     
4,162
     
-
     
4,247
 
  Commercial loans
   
17
     
-
     
-
     
17
     
4,200
     
-
     
4,217
 
  Consumer loans:
                                                       
    Home equity
   
60
     
-
     
-
     
60
     
6,786
     
320
     
7,166
 
    Automobile and other
   
21
     
-
     
-
     
21
     
4,373
     
104
     
4,498
 
    Credit cards and unsecured
   
138
     
4
     
7
     
149
     
5,614
     
33
     
5,796
 
                                                         
  Total
 
$
1,093
     
281
     
7
     
1,381
     
131,560
     
2,544
     
135,485
 


(continued)
 
16

 
 
 
SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued


5.  Loans, Continued
The following summarizes the amount of impaired loans at the dates indicated (in thousands):

   
With No Related
Allowance Recorded
   
With an Allowance Recorded
   
Total
 
   
Recorded
Investment
   
Unpaid
Principal
Balance
   
Recorded
Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
   
Recorded
Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
 
At September 30, 2017:
                                               
  Real estate mortgage loans:
                                               
    One-to four-family
 
$
1,449
     
1,493
     
568
     
584
     
44
     
2,017
     
2,077
     
44
 
  Consumer loans:
                                                               
    Home equity
   
117
     
127
     
34
     
43
     
28
     
151
     
170
     
28
 
                                                                 
   
$
1,566
     
1,620
     
602
     
627
     
72
     
2,168
     
2,247
     
72
 
                                                                 
At December 31, 2016:
                                                               
  Real estate mortgage loans:
                                                               
    One-to four-family
 
$
1,985
     
2,037
     
574
     
591
     
44
     
2,559
     
2,628
     
44
 
  Consumer loans:
                                                               
    Home equity
   
126
     
137
     
36
     
45
     
28
     
162
     
182
     
28
 
                                                                 
   
$
2,111
     
2,174
     
610
     
636
     
72
     
2,721
     
2,810
     
72
 

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

   
Three Months Ended September 30,
 
   
2017
   
2016
 
   
Average
   
Interest
   
Interest
   
Average
   
Interest
   
Interest
 
   
Recorded
   
Income
   
Income
   
Recorded
   
Income
   
Income
 
   
Investment
   
Recognized
   
Received
   
Investment
   
Recognized
   
Received
 
Real estate mortgage loans:
                                   
  One-to-four family
 
$
1,973
     
44
     
42
     
2,578
     
34
     
36
 
Consumer loans:
                                               
  Home equity
   
123
     
4
     
4
     
181
     
3
     
2
 
                                                 
  Total
 
$
2,096
     
48
     
46
   
$
2,759
     
37
     
38
 

   
Nine Months Ended September 30,
 
   
2017
   
2016
 
   
Average
   
Interest
   
Interest
   
Average
   
Interest
   
Interest
 
   
Recorded
   
Income
   
Income
   
Recorded
   
Income
   
Income
 
   
Investment
   
Recognized
   
Received
   
Investment
   
Recognized
   
Received
 
Real estate mortgage loans:
                                   
  One-to-four family
 
$
1,984
     
92
     
92
     
2,587
     
110
     
113
 
Consumer loans:
                                               
  Home equity
   
126
     
7
     
7
     
184
     
10
     
10
 
                                                 
  Total
 
$
2,110
     
99
     
99
   
$
2,771
     
120
     
123
 


(continued)
 
17

 
 
 
SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

5.  Loans, Continued
The Company had no troubled debt restructurings (TDR) entered into during the three and nine months ended September 30, 2017 or 2016. The Company had no commitments to extend additional credit to borrowers whose terms have been modified in TDRs.

6.   Lines of Credit
The Company has an unsecured federal funds line of credit for $6.0 million with a correspondent bank and a $46.0 million line with the Federal Home Loan Bank of Atlanta collateralized by a blanket lien on qualifying loans. At September 30, 2017, the Company had $28.0 million outstanding in FHLB advances that mature in 2017 at a weighted average fixed rate of 1.17%.  At December 31, 2016, the Company had $12.8 million outstanding in FHLB advances that mature in 2017 at a weighted average fixed rate of 0.63%.  At September 30, 2017 and December 31, 2016, the Company had no outstanding balances on the federal funds line of credit.

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.

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 at September 30, 2017, as follows (in thousands):

   
Contract
 
   
Amount
 
Unused lines of credit
 
$
19,908
 
         
Commitments to extend credit
 
$
-
 
(continued)
 
18

 
 
 
SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued


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

   
At September 30, 2017
   
At December 31, 2016
 
   
Carrying
   
Fair
         
Carrying
   
Fair
       
   
Amount
   
Value
   
Level
   
Amount
   
Value
   
Level
 
Financial assets:
                                   
  Cash and cash equivalents
 
$
9,141
     
9,141
     
1
     
11,313
     
11,313
     
1
 
  Securities held to maturity
   
13,873
     
13,774
     
2
     
16,512
     
16,294
     
2
 
  Loans
   
159,541
     
166,613
     
3
     
134,077
     
132,454
     
3
 
  Federal Home Loan Bank stock
   
1,346
     
1,346
     
3
     
684
     
684
     
3
 
  Accrued interest receivable
   
506
     
506
     
3
     
449
     
449
     
3
 
                                                 
Financial liabilities:
                                               
  Deposits
   
141,668
     
135,271
     
3
     
137,902
     
132,280
     
3
 
  Federal Home Loan Bank
                                               
      advances
   
28,000
     
28,001
     
3
     
12,750
     
12,750
     
3
 
  Off-balance-sheet financial
                                               
      instruments
   
-
     
-
     
3
     
-
     
-
     
3
 

Discussion regarding the assumptions used to compute the estimated fair values of financial instruments can be found in Note 1 to the consolidated financial statements included in the 2016 Form 10-K.


9.  Employee Stock Ownership Plan
The Holding Company has established an ESOP which acquired 98,756 shares of common stock in exchange for a $988,000 note payable from the Bank to the Holding Company.  The note bears interest at a fixed rate of 4.25%, is payable in annual installments and is due in 2021.  The ESOP expense was $1,000 for the three-months ended September 30, 2017 and $7,000 for the three-months ended September 30, 2016.  The ESOP expense was $10,000 for the nine-months ended September 30, 2017 and $23,000 for the nine-months ended September 30, 2016.  At September 30, 2017 and December 31, 2016, there were 32,096 and 41,971 shares, respectively, that had not been allocated under the ESOP.

 (continued)
 
19

 
 
 
SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued


10.  Equity Incentive Plan
On May 23, 2012, the Holding Company's stockholders approved the 2012 Equity Incentive Plan ("Plan"). The Plan authorizes the grant of options for up to 123,445 shares of the Holding Company's common stock of which 41,945 shares were available for grant at September 30, 2017. The options granted have ten year terms and vest from one to five years.  A summary of the activity in stock options under the Plan is as follows:

             
Weighted-
       
         
Weighted-
 
Average
       
         
Average
 
Remaining
     
Aggregate
   
Number of
   
Exercise
 
Contractual
     
Intrinsic
   
Options
   
Price
 
Term
     
Value
                           
Outstanding at December 31, 2015
   
81,500
   
$
11.62
            
Exercised
   
(1,000
)
   
10.75
            
                               
Outstanding at September 30, 2016
   
80,500
   
$
11.63
 
6.38 years
       
                               
Outstanding at December 31, 2016
   
80,500
     
11.63
            
Exercised
   
-
     
-
            
                               
Outstanding at September 30, 2017
   
80,500
   
$
11.63
 
5.38 years
    $
875,375
                               
Exercisable at September 30, 2017
   
10,500
   
$
10.75
 
  5.20 years
    $
123,375

At September 30, 2017, there was approximately $18,000 of unrecognized compensation expense related to non-vested stock options granted under the Plan. The cost is expected to be recognized over a weighted average period of twenty-two months.  The total fair value of shares vesting and recognized as compensation expense was $11,000 and $12,000 for the three-months ended September 30, 2017 and 2016, respectively.  The total fair value of shares vesting and recognized as compensation expense was $34,000 for both the nine-months ended September 30, 2017 and 2016.









(continued)
 
20

 
 
 
SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued


10.  Equity Incentive Plan, Continued
The Plan also authorizes the grant of up to 49,378 shares of restricted stock of which 4,078 shares remain available for grant at September 30, 2017.  The restricted stock awarded under the Plan vests equally over five years from the date of grant. Restricted stock awards are forfeited if employment is terminated before the restriction period expires.  The record holder of the Holding Company's restricted stock possesses all the rights of a holder of the Holding Company common stock, including the right to receive dividends on and to vote the restricted stock. The restricted stock may not be sold, transferred, pledged, assigned, encumbered, or otherwise alienated or hypothecated until they become fully vested and transferable in accordance with the agreements. Compensation expense for restricted stock totaled $38,000 for the three-months ended September 30, 2017 and $39,000 for the three-months ended September 30, 2016. Compensation expense for restricted stock totaled $114,000 for the nine-months ended September 30, 2017 and $118,000 for the nine-months ended September 30, 2016. The income tax benefit recognized was $15,000 and $15,000 for the three months ended September 30, 2017 and September 30, 2016, respectively, and $43,000 and $45,000 for the nine-months ended September 30, 2017 and September 30, 2016, respectively.

A summary of the status of the Company's restricted stock and changes during the periods then ended are presented below:

   
Number of
Shares
   
Weighted-Average
Grant-Date
Fair Value
 
             
             
Outstanding at December 31, 2015
   
28,700
   
$
16.92
 
  Vested shares
   
(800
)
   
18.25
 
Outstanding at September 30, 2016
   
27,900
     
16.88
 
                 
Outstanding at December 31, 2016
   
19,400
     
16.94
 
  Forfeited
   
(1,200
)
   
18.25
 
  Vested shares
   
(400
)
   
18.25
 
Outstanding at September 30, 2017
   
17,800
   
$
16.82
 

Total unrecognized compensation cost related to these non-vested shares of restricted stock amounted to approximately $168,000 at September 30, 2017.  This cost is expected to be recognized monthly over the related vesting period using the straight-line method through 2019.

(continued)
 
21

 
 
 
SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued


11.  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 September 30, 2017:
                                   
One-to four-family
 
$
568
     
-
     
-
     
568
     
44
     
-
 
Home equity
   
34
     
-
     
-
     
34
     
28
     
-
 
                                                 
Total
 
$
602
     
-
     
-
     
602
     
72
     
-
 
                                                 
At December 31, 2016:
                                               
One-to four-family
 
$
574
     
-
     
-
     
574
     
44
     
-
 
Home equity
   
36
     
-
     
-
     
36
     
28
     
-
 
                                                 
Total
 
$
610
     
-
     
-
     
610
     
72
     
-
 
                                                 
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 September 30, 2017:
                                   
    Foreclosed real estate
 
$
137
     
-
     
-
     
137
     
-
     
-
 
                                                 
At December 31, 2016:
                                               
    Foreclosed real estate
 
$
141
     
-
     
-
     
141
     
32
     
27
 
                                                 
(continued)
 
22

 
 
 
SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued


12.  Regulatory Matters

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 September 30, 2017:
                                   
    Total Capital to Risk-
                                   
        Weighted Assets
 
$
18,563
     
12.53
%
 
$
11,849
     
8.00
%
 
$
14,811
     
10.00
%
    Tier I Capital to Risk-
                                               
        Weighted Assets
   
17,465
     
11.79
     
8,887
     
6.00
     
11,849
     
8.00
 
    Tier I Capital
                                               
        to Total Assets
   
17,465
     
9.70
     
7,204
     
4.00
     
9,005
     
5.00
 
Common equity Tier 1 Capital to
     Risk-Weighted Assets
   
17,465
     
11.79
     
6,665
     
4.50
     
9,627
     
6.50
 
                                                 
At December 31, 2016:
                                               
    Total Capital to Risk-
                                               
        Weighted Assets
   
19,539
     
15.34
     
10,191
     
8.00
     
12,739
     
10.00
 
    Tier I Capital to Risk-
                                               
        Weighted Assets
   
18,615
     
14.61
     
7,643
     
6.00
     
10,191
     
8.00
 
    Tier I Capital
                                               
        to Total Assets
   
18,615
     
11.42
     
6,519
     
4.00
     
8,148
     
5.00
 
 Common equity Tier 1 Capital to
    Risk-Weighted Assets
   
18,615
     
14.61
     
5,733
     
4.50
     
8,280
     
6.50
 

Pursuant to the capital regulations of the FDIC and the other federal banking agencies, the Bank must maintain a capital conservation buffer consisting of additional common equity tier 1 ("CET1") capital greater than 2.5% of risk-weighted assets above the required minimum levels of risk-based CET1 capital, tier 1 capital and total capital in order to avoid limitations on paying dividends, repurchasing shares, and paying discretionary bonuses.  For our fiscal year ending December 31, 2017, the capital conservation buffer rule requires a buffer of greater than 1.25% of risk-weighted assets, which amount will increase by 0.625% yearly until the requirement is fully phased-in on January 1, 2019, when the buffer must exceed 2.5% of risk-weighted assets.  As September 30, 2017, the Bank's CET1 capital exceeded the required capital conservation buffer.
 
23

 
 

 
SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES
 
 
Item 2.  Management's Discussion and Analysis of
Financial Condition and Results of Operations

Forward-Looking Statements

As used in this report, the terms "we," "our," "us," "Sunshine Financial" and "Company" refer to Sunshine Financial, Inc. including its wholly-owned subsidiary, Sunshine Community Bank, unless the context indicates otherwise.

"Safe Harbor" statement under the Private Securities Litigation Reform Act of 1995: When used in this report, as well as in future filings by us with the U.S. Securities and Exchange Commission ("SEC"), in our press releases or other public or shareholder communications, or in oral statements made with the approval or 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 Florida Office of Financial Regulation ("FOFR"), the Federal Deposit Insurance Corporation ("FDIC") 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;
 
24

 
 
 
 
·
legislative or regulatory changes that adversely affect our business, changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules, including as a result of Basel III;
·
our ability to attract and retain deposits;
·
changes 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;
·
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 our 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;
·
the impact of changes in financial services laws and regulations, including laws concerning taxes, banking, securities, consumer protection and insurance and the impact of other governmental initiatives affecting the financial services industry;
·
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 report and our Form 10-K for the year ended December 31, 2016 filed on March 30, 2017 ("2016 Form 10-K") and our other reports filed with the SEC.

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.
 
25

 
 

 
SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

General

Sunshine Financial, a Maryland corporation, is the holding company for its wholly owned subsidiary, Sunshine Community Bank.  Sunshine Community Bank was originally chartered as a credit union in 1952 as Sunshine State Credit Union to serve state government employees in the metropolitan Tallahassee area.  On July 1, 2007, we converted from a state-chartered credit union known as Sunshine State Credit Union to a federal mutual savings bank known as Sunshine Savings Bank, and in 2009 reorganized into the mutual holding company structure.  On April 5, 2011, the Company completed a public offering as part of Sunshine Saving Bank's conversion and reorganization from a mutual holding company to a public stock holding company structure.

On July 1, 2016, Sunshine Savings Bank completed its conversion from a federal savings bank charter to a Florida state bank charter, changing its name to Sunshine Community Bank.  As a Florida-chartered financial institution, the FOFR is the primary regulator for Sunshine Community Bank, with additional federal oversight provided by the FDIC.  Sunshine Financial is regulated by the Board of Governors of the Federal Reserve System.

We currently operate out of five 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 (including residential construction loans), lot loans, commercial real estate loans, commercial business loans and consumer loans.  We offer a wide variety of secured and unsecured consumer loan products, including home equity, direct automobile loans and credit card loans in our market area.

We offer a variety of deposit accounts, which are our primary source of funding for our lending activities.  Our operations are 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 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.

 
26


 

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Our operating expenses consist primarily of salaries and employee benefits, occupancy and equipment, data processing services, and professional fees. 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, amortization expense, maintenance and costs of utilities.

Critical Accounting Policies

The Company has identified several accounting policies that as a result of judgments, estimates and assumptions inherent in those policies, are critical to an understanding of the Company's Condensed Consolidated Financial Statements. Critical accounting policies and estimates are discussed in the Company's 2016 Form 10-K under Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operation – Critical Accounting Policies." That discussion highlights estimates the Company makes that involve uncertainty or potential for substantial change. There have been no material changes in the Company's critical accounting policies and estimates as previously disclosed in the Company's 2016 Form 10-K.
Comparison of Financial Condition at September 30, 2017 and December 31, 2016

General.  Total assets increased $20.9 million, or 12.1%, to $194.1 million at September 30, 2017 from $173.2 million at December 31, 2016 primarily funded by a $15.3 million increase in Federal Home Loan Bank advances, and a $3.8 million increase in deposits. The composition of total assets changed during the nine months ended September 30, 2017 reflecting a $25.4 million increase in net loans, a $2.2 million decrease in cash and cash equivalents and a $2.6 million decrease in securities held to maturity.

Loans.  Our net loan portfolio increased $25.4 million, to $159.5 million at September 30, 2017 from $134.1 million at December 31, 2016.  The increase in loans was primarily due to a $25.4 million increase in total real estate loans, including an $18.4 million increase in commercial real estate loans, partially offset by a small decrease in consumer loans.

Allowance for Loan Losses.  Our allowance for loan losses at September 30, 2017 was $1.1 million, or 0.69% of loans, compared to $924,000, or 0.69% of loans, at December 31, 2016.  Nonperforming loans remained stable at $2.5 million at September 30, 2017 and December 31, 2016.  Nonperforming loans to total loans decreased to 1.55% at September 30, 2017 from 1.88% at December 31, 2016 as a result of the increase in the net loan portfolio.

Deposits.  Total deposits increased $3.8 million, or 2.7%, to $141.7 million at September 30, 2017 from $137.9 million at December 31, 2016.  This increase was due to a $3.5 million increase in noninterest bearing deposits, a $1.8 million increase money-market deposit accounts ("MMDA") and a $199,000 increase in savings accounts, partially offset by a $1.7 million decrease in time deposits.

Borrowings.  Total FHLB borrowings increased $15.3 million to $28.0 million at September 30, 2017 from $12.8 million at December 31, 2016, providing additional funds for loan growth.

27

 

 
SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Equity.  Total stockholders' equity increased $573,000 to $22.2 million at September 30, 2017.  This increase was primarily due to net earnings of $430,000, for the nine-months ended September 30, 2017.

Results of Operations

The following tables set forth, for the periods indicated, information regarding (i) the total dollar amount of interest and dividend income earned from interest-earning assets and the resultant average yields; (ii) the total dollar amount of interest expense paid on interest-bearing liabilities and the resultant average rates; (iii) net interest income; (iv) interest-rate spread; and (v) net interest margin. Income and yields on tax-exempt obligations have not been computed on a tax equivalent basis.  All average balances are daily average balances.

   
Three Months Ended September 30,
 
   
2017
   
2016
 
   
Average
Balance
   
Interest
and
Dividends
   
Average
Yield/
Rate
   
Average
Balance
   
Interest
and
Dividend
   
Average
Yield/
Rate
 
               
($ in thousands)
             
Interest-earning assets:
                                   
    Loans (1)
 
$
152,935
   
$
1,805
     
4.72
%
 
$
120,905
   
$
1,492
     
4.94
%
    Securities held to maturity
   
14,361
     
72
     
2.01
     
18,356
     
88
     
1.92
 
    Other interest-earning assets (2)
   
4,504
     
26
     
2.31
     
7,876
     
13
     
0.66
 
                                                 
        Total interest-earning assets
   
171,800
     
1,903
     
4.43
     
147,137
     
1,593
     
4.33
 
                                                 
Noninterest-earning assets
   
14,046
                     
14,891
                 
                                                 
        Total assets
 
$
185,846
                   
$
162,028
                 
                                                 
Interest-bearing liabilities:
                                               
    MMDA and statement savings
  $
89,065
     
72
     
0.32
    $
85,220
     
69
     
0.32
 
    Time deposits
   
18,430
     
22
     
0.48
     
21,746
     
26
     
0.48
 
    FHLB advances
   
24,839
     
73
     
1.18
     
5,466
     
6
     
0.44
 
                                                 
        Total interest-bearing liabilities
   
132,334
     
167
     
0.50
     
112,432
     
101
     
0.36
 
                                                 
Noninterest-bearing liabilities
   
31,367
                     
28,153
                 
Equity
   
22,145
                     
21,443
                 
                                                 
        Total liabilities and equity
 
$
185,846
                   
$
162,028
                 
                                                 
Net interest income
         
$
1,736
                   
$
1,492
         
                                                 
Net interest rate spread (3)
                   
3.93
%
                   
3.97
%
                                                 
Net interest margin (4)
                   
4.04
%
                   
4.06
%
                                                 
Ratio of average interest-earning assets
                                               
    to average interest-bearing liabilities
   
1.30
x
                   
1.31
x
               
                                                 

(1)
Does not include interest on loans in non-accrual status.  Calculated net of deferred loan fees, loan discounts, loans in process and allowance for loan losses.
(2)
Other interest-earnings assets consist of Federal Home Loan Bank stock and interest-bearing deposits.
(3)
Interest-rate spread represents the difference between the average yield earned on interest-earning assets and the average rate paid on interest-bearing liabilities.
(4)
Net interest margin is net interest income divided by average interest-earning assets (annualized).
 
28

 
 
 
SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES


   
Nine Months Ended September 30,
 
   
2017
   
2016
 
   
Average
Balance
   
Interest
and
Dividends
   
Average
Yield/
Rate
   
Average
Balance
   
Interest
and
Dividend
   
Average
Yield/
Rate
 
               
($ in thousands)
             
Interest-earning assets:
                                   
    Loans (1)
 
$
145,319
   
$
5,183
     
4.76
%
 
$
117,135
   
$
4,389
     
5.00
%
    Securities held to maturity
   
15,238
     
229
     
2.00
     
19,506
     
286
     
1.95
 
    Other interest-earning assets (2)
   
4,368
     
59
     
1.80
     
7,443
     
38
     
0.68
 
                                                 
        Total interest-earning assets
   
164,925
     
5,471
     
4.42
     
144,084
     
4,713
     
4.36
 
                                                 
Noninterest-earning assets
   
13,848
                     
15,121
                 
                                                 
        Total assets
 
$
178,773
                   
$
159,205
                 
                                                 
Interest-bearing liabilities:
                                               
    MMDA and statement savings
 
$
88,590
     
212
     
0.32
    $
82,628
     
197
     
0.32
 
    Time deposits
   
19,076
     
67
     
0.47
     
22,601
     
81
     
0.48
 
    FHLB advances
   
18,611
     
138
     
0.99
     
4,669
     
15
     
0.43
 
                                                 
                                                 
        Total interest-bearing liabilities
   
126,277
     
417
     
0.44
     
109,898
     
293
     
0.36
 
                                                 
Noninterest-bearing liabilities
   
30,550
                     
27,928
                 
Equity
   
21,946
                     
21,379
                 
                                                 
        Total liabilities and equity
 
$
178,773
                   
$
159,205
                 
                                                 
Net interest income
         
$
5,054
                   
$
4,420
         
                                                 
Net interest rate spread (3)
                   
3.98
%
                   
4.00
%
                                                 
Net interest margin (4)
                   
4.09
%
                   
4.09
%
                                                 
Ratio of average interest-earning assets
                                               
    to average interest-bearing liabilities
   
1.31
x
                   
1.31
x
               
                                                 

(1)
Does not include interest on loans in non-accrual status.  Calculated net of deferred loan fees, loan discounts, loans in process and allowance for loan losses.
(2)
Other interest-earnings assets consist of Federal Home Loan Bank stock and interest-bearing deposits.
(3)
Interest-rate spread represents the difference between the average yield earned on interest-earning assets and the average rate paid on interest-bearing liabilities.
(4)
Net interest margin is net interest income divided by average interest-earning assets (annualized).
 
29

 
 

 
SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Comparison of the Three Months Ended September 30, 2017 and 2016

General. Net earnings for the three months ended September 30, 2017 was $215,000, compared to net earnings of $35,000 for the three months ended September 30, 2016, resulting in an annualized return on average assets of 0.46% for the three months ended September 30, 2017 and 0.09% for the three months ended September 30, 2016.  The increase in net earnings was due primarily to an increase in our net interest income and decreases in our noninterest expense, slightly offset by decreases in noninterest income.  Basic and diluted earnings per share were $0.22 for the three months ended September 30, 2017 and $0.04 for the same period in 2016.

Net Interest Income.  Net interest income increased $244,000, or 16.4%, to $1.7 million for the three months ended September 30, 2017 compared to $1.5 million for the three months ended September 30, 2016. The increase was primarily due to a $310,000 increase in interest income, slightly offset by a $66,000 increase in interest expense.  The increase in interest income resulted primarily from an increase in average loans outstanding during the three months ended September 30, 2017 compared to the three months ended September 30, 2016, partially offset by a decrease in our average yield on loans.  Our net interest rate spread decreased to 3.93% for the three months ended September 30, 2017 from 3.97% for the same period in 2016, while our net interest margin decreased to 4.04% from 4.06% between the same periods.  The ratio of average interest-earning assets to average interest-bearing liabilities for the three months ended September 30, 2017 was 1.30x compared to 1.31x for the same period in 2016.

Interest Income. Interest income for the three months ended September 30, 2017 increased $310,000, or 19.4%, to $1.9 million compared to the three month period ended September 30, 2016.  The increase in interest income for the three months ended September 30, 2017 was primarily due to a $32.0 million increase in average loans outstanding during the three months ended September 30, 2017 compared to the three months ended 2016, partially offset by a 22 basis point decrease in our average yield on loans during the same period.  Average loans outstanding increased to $152.9 million for the three months ended September 30, 2017, from $120.9 million for the same period in 2016.  The average yield on loans decreased to 4.72% for the three months ended September 30, 2017 compared to 4.94% for the three months ended September 30, 2016.

Interest Expense. Interest expense for the three months ended September 30, 2017 increased $66,000, or 65.3%, to $167,000 from $101,000 for the same period ended September 30, 2016.  The increase in interest expense for the three months ended September 30, 2017 was primarily due to the cost of $24.8 million in average outstanding FHLB advances compared to $5.5 million outstanding during the same period in 2016.  The average rate paid on borrowings for the three months ended September 30, 2017 was 1.18% compared to 0.44% for the three months ended September 30, 2016 reflecting increases in interest rates over the last year.  The average rate paid on deposits for the three months ended September 30, 2017 remained unchanged from the average rates paid for the three months ended September 30, 2016.

Provision for Loan Losses.  We establish an allowance for loan losses by charging amounts to the loan provision at a level required to reflect estimated credit losses in the loan portfolio.  In evaluating the level of the allowance for loan losses, management considers, among other factors, historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect borrowers' ability to repay, estimated value of any underlying collateral, prevailing economic conditions and current risk factors specifically related to each loan type.  See "- Critical Accounting Policies -- Allowance for Loan Loss" in our 2016 Form 10-K for a more detailed description of the manner in which the provision for loan losses is established.
 
30

 
 

 
SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Comparison of the Three Months Ended September 30, 2017 and 2016 (continued)

Based on management's evaluation of the foregoing factors, we recorded a provision for loan losses of $50,000 for the three months ended September 30, 2017 compared to $45,000 for the three months ended September 30, 2016.  The provision for loan losses primarily reflected historical and incurred/probable loan losses, the increase in the size of our loan portfolio as well as the change in the mix of loans, in particular the increase in our commercial real estate loan portfolio.  Net charge-offs for the three months ended September 30, 2017 were $29,000 compared to net charge-offs of $78,000 for the three months ended September 30, 2016. Nonperforming loans to total loans at September 30, 2017 were 1.55% compared to 1.88% at December 31, 2016.  The allowance for loan losses to total loans was 0.69% at both September 30, 2017 and December 31, 2016.

Management considers the allowance for loan losses at September 30, 2017 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 September 30, 2017 decreased $67,000, or 13.8%, to $419,000 compared to $486,000 for the same period in 2016 as a result of decreases in the gains on sales of loans, fees and charges on deposit accounts, gain on the sale of foreclosed real estate and in other noninterest income, slightly offset by an increase in fees and charges on loans. The largest decrease was in other noninterest income, which decreased $32,000, due to the gain on sale of stock invested in a credit union service organization sold during the three months ended September 30, 2016.

Noninterest Expense. Noninterest expense for the three months ended September 30, 2017 decreased $115,000, or 6.1%, to $1.8 million compared to $1.9 million during the same period in 2016.  The largest decreases were in occupancy and equipment, salaries and employee benefits, professional fees and other noninterest expense.  The decrease in occupancy and equipment expense was due to the sale of a branch office in December 2016.  The decrease in salaries and employee benefits was due to an increase in deferred loan origination costs associated with the increase in commercial real estate lending volume.  The decrease in other expense was primarily due to decreases in foreclosed real estate expense and marketing expense.

Income Taxes. For the three months ended September 30, 2017, we recorded income taxes of $123,000 on a before tax earnings of $338,000.  For the three months ended September 30, 2016, we recorded income taxes of $16,000 on before tax earnings of $51,000.  Our effective tax rate for the three months ended September 30, 2017 was 36.4% compared to 31.4% for the same time period in 2016.
 
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SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Comparison of the Nine Months Ended September 30, 2017 and 2016

General. Net earnings for the nine months ended September 30, 2017 was $430,000 compared to a net loss of $50,000 for the nine months ended September 30, 2016, resulting in an annualized return (loss) on average assets of 0.32% for the nine months ended September 30, 2017 and (0.04)% for the nine months ended September 30, 2016.  The increase in net earnings was due primarily to an increase in our net interest income and a decrease in noninterest expense.   Basic earnings per share were $0.45 for the nine months ended September 30, 2017 and a loss of $0.05 per share for the same period in 2016.  Diluted earnings (loss) per share were $0.43 for the nine months ended September 30, 2017 and a ($0.05) per share for the same period in 2016.

Net Interest Income.  Net interest income increased $634,000, or 14.3%, to $5.1 million for the nine months ended September 30, 2017 compared to $4.4 million for the nine months ended September 30, 2016. The increase was primarily due to a $758,000 increase in interest income, partially offset by a $124,000 increase in interest expense.  The increase in interest income resulted from an increase in average loans outstanding during the nine months ended September 30, 2017 compared to the nine months ended September 30, 2016, partially offset by a 24 basis point decrease in our average yield on loans.  Our net interest rate spread decreased to 3.98% for the nine months ended September 30, 2017 from 4.00% for the same period in 2016, while our net interest margin remained at 4.09% at both September 30, 2017 and September 30, 2016.  The ratio of average interest-earning assets to average interest-bearing liabilities for the nine months ended September 30, 2017 and 2016 remained at 1.31x.

Interest Income. Interest income for the nine months ended September 30, 2017 increased $758,000, or 16.1%, to $5.5 million compared to the nine month period ended September 30, 2016.  The increase in interest income for the nine months ended September 30, 2017 was primarily due to a $28.2 million increase in average loans outstanding during the nine months ended September 30, 2017 compared to the nine months ended September 30, 2016, partially offset by a 24 basis point decrease in our average yield on loans during the same period.  Average loans outstanding increased to $145.3 million for the nine months ended September 30, 2017, from $117.1 million for the same period in 2016.  The average yield on loans decreased to 4.76% for the nine months ended September 30, 2017 compared to 5.00% for the nine months ended September 30, 2016.

Interest Expense. Interest expense for the nine months ended September 30, 2017 increased $124,000, or 42.3%, to $417,000 from $293,000 for the same period ended September 30, 2016.  The increase in interest expense for the nine months ended September 30, 2017 was primarily due to the cost of $18.6 million in average outstanding FHLB advances compared to $4.7 million outstanding during the same period in 2016.  The average rate paid on borrowings for the nine months ended September 30, 2017 was 0.99% compared to 0.43% for the same period in 2016.  The average rate paid on deposits for the nine months ended September 30, 2017 remained relatively unchanged from the average rates paid for the nine months ended September 30, 2016.

Provision for Loan Losses.  We recorded a provision for loan losses of $155,000 for the nine months ended September 30, 2017 compared to $135,000 for the nine months ended September 30, 2016.  The provision for loan losses reflected historical and incurred loan losses, the increase in the size of our loan portfolio as well as the change in the mix of loans. Net recoveries for the nine months ended September 30, 2017 were $19,000 compared to net charge-offs of $138,000 for the nine months ended September 30, 2016.
 
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SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Comparison of the Nine Months Ended September 30, 2017 and 2016, Continued

Noninterest Income. Noninterest income for the nine months ended September 30, 2017 decreased $66,000, or 4.8%, to $1.3 million compared to $1.4 million for the same period in 2016 primarily as a result of decreases in fees and service charges on deposit accounts and in other noninterest income, offset by increases in gains on sale of foreclosed assets and in fees and charges on loans.  The decrease in other noninterest income was due to the decline in other noninterest income due a gain on sale of stock invested in a credit union service organization sold in the same period of 2016. The increase in fees and charges on loans was a result of an increased volume of commercial real estate lending.

Noninterest Expense. Noninterest expense for the nine months ended September 30, 2017 decreased $203,000, or 3.5%, to $5.5 million as compared to the same period in 2016.  The largest decreases were in salaries and employee benefits, occupancy and equipment, and deposit insurance, partially offset by increases in data processing and other noninterest expense.  The decrease in salaries and employee benefits was due to an increase in deferred loan origination costs because of the increase in commercial real estate lending volume.  The decrease in occupancy and equipment expense was due to the sale of a branch office in December 2016 and the decrease in deposit insurance was due to lower FDIC insurance rates.  The increase in data processing was due to converting our credit card processing to a new company in 2017 and the issuance of new credit cards for all customers.

Income Taxes. For the nine months ended September 30, 2017, we recorded an income tax expense of $263,000 on before tax earnings of $693,000.  For the nine months ended September 30, 2016, we recorded an income tax benefit of $8,000 on a before tax loss of $58,000.  Our effective tax rate for the nine months ended September 30, 2017 was 38.0% compared to an effective tax benefit rate of 13.8% for the same time period in 2016.

Liquidity
Liquidity describes our ability to meet the financial obligations that arise in the ordinary course of business.  Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of our customers and to fund current and planned expenditures.  Our primary sources of funds are deposits, principal and interest payments on loans and securities, FHLB advances, and proceeds from maturities and calls of securities.  The Company has an unsecured federal funds line of credit for $6.0 million with a correspondent bank and a $46.0 million line with the Federal Home Loan Bank of Atlanta collateralized by a blanket lien on qualifying loans. At September 30, 2017 the Company had $28.0 million outstanding in FHLB advances that mature in 2017 at a weighted average fixed rate of 1.17%.  At December 31, 2016, the Company had $12.8 million outstanding in FHLB advances that mature in 2017 at a weighted average fixed rate of 0.63%.
While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions, and competition. Our most liquid assets are cash and short-term investments, including interest-bearing demand deposits with banks. The levels of these assets are dependent on our operating, financing, lending and investing activities during any given period.
 
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SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Our cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities, and financing activities.  For the nine-months ended September 30, 2017, cash provided by operating activities totaled $2.6 million.  Net cash used by investing activities, which consists primarily of disbursements for loan originations, offset by principal collections on loans and proceeds from pay-downs on securities, totaled $23.8 million for the nine-months ended September 30, 2017.  Net cash provided by financing activities, consisting primarily of the activity in FHLB advances and deposit accounts, was $19.0 million for the nine-months ended September 30, 2017.
In addition to its operating expenses, the Company is responsible for paying any dividends declared to its shareholders and funds paid out for Company stock repurchases, when and if declared by the Board.  The Company has the ability to receive dividends or capital distributions from the Bank, although there are regulatory restrictions on the ability of the Bank to pay dividends.

On June 28, 2017, with the approval of the FDIC, the Bank repurchased shares from the Holding Company totaling $2.0 million.  The effect of this transaction was to increase cash at the Holding Company and decrease the Holding Company's investment in the Bank. At September 30, 2017, the Company (on an unconsolidated basis) had liquid assets of $2.3 million.

We are committed to maintaining a strong liquidity position.  We monitor our liquidity position on a daily basis.  We anticipate that we will have sufficient funds to meet our current funding commitments.  Based on our deposit retention experience and current pricing strategy, we anticipate that a significant portion of maturing time deposits will be retained.
Off-Balance Sheet Activities
In the normal course of operations, we engage in a variety of financial transactions that are not recorded in our financial statements.  These transactions involve varying degrees of off-balance sheet credit, interest rate and liquidity risks.  These transactions are used primarily to manage customers' requests for funding and take the form of loan commitments and lines of credit.  For the nine-months ended September 30, 2017, we engaged in no off-balance sheet transactions likely to have a material effect on our financial condition, results of operations or cash flows.  A summary of our off-balance sheet commitments at September 30, 2017, is as follows (in thousands):

Unused lines of credit
 
$
19,908
 
Commitments to extend credit
 
$
-
 


Capital Resources
At September 30, 2017, the Bank exceeded all regulatory capital requirements.
 
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SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES


Consistent with our goals to operate a sound and profitable organization, our policy is for Sunshine Community Bank to maintain a "well-capitalized" status under the capital categories of the Bank regulations.  At September 30, 2017, Sunshine Community Bank exceeded all regulatory capital requirements to be categorized as well capitalized under applicable regulatory guidelines with a CET1 capital ratio of 11.79% of risk-weighted assets, which is above the required level of 6.5%, a Tier 1 leverage capital level of 9.70% of adjusted total assets, which is above the required level of 5.00%, Tier I capital to risk-weighted assets of 11.79%, which is above the required level of 8.00% and total risk-based capital to risk-weighted assets of 12.53%, which is above the required level of 10.00%.

Management is not aware of any conditions or events that would change our category. For additional information see Note 12 of the Notes to Condensed Consolidated Financial Statements contained in Item1, Part 1 of this Form 10-Q.

At September 30, 2017, stockholders' equity at Sunshine Community Bank totaled $19.7 million. Management monitors the capital levels of Sunshine Community Bank to provide for current and future business opportunities and to meet regulatory guidelines for "well-capitalized" institutions.
For a bank holding company with less than $1.0 billion in assets, the capital guidelines apply on a bank only basis and the Federal Reserve expects the holding company's subsidiary banks to be well capitalized under the prompt corrective action regulations.  If Sunshine Financial was subject to regulatory guidelines for bank holding companies with $1.0 billion or more in assets, at September 30, 2017 Sunshine Financial would have exceeded all regulatory capital requirements.
Item 3.  Quantitative and Qualitative Disclosure About Market Risk

The Company provided information about market risk in Item 7A of its 2016 Form 10-K.  There have been no material changes in our market risk since our 2016 Form 10-K.

          Item 4.  Controls and Procedures

(a)   Evaluation of Disclosure 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 September 30, 2017, 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.  Based on this evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures in effect as of September 30, 2017, 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.
 
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SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

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.

(b)
Changes in Internal Control over Financial Reporting
 
          There were no changes in our internal control over financial reporting during the fiscal quarter ended September 30, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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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

(a) Not applicable

(b) Not applicable

(c)  Nothing to report.

Item 3.    Defaults Upon Senior Securities

Nothing to report.

Item 4.    Mine Safety Disclosures

Nothing to report.

Item 5.    Other Information

Nothing to report.
 
 
 
 
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Item 6.
Exhibits

(a)  Exhibits

 
Exhibits:
   
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))
   
Bylaws, as amended, of Sunshine Financial, Inc. (incorporated herein by reference to Exhibit 3.2 to the Registrant's Current Report on Form 8-K filed with the SEC on August 28, 2013 (File No. 000-54280))
   
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))
   
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))
   
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))
   
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))
   
Sunshine Financial, Inc. 2012 Equity Incentive Plan (incorporated herein by reference to Appendix A to the Registrant's Definitive Proxy Statement filed on Schedule 14A on April 20, 2012 (File No. 000-54280))
   
10.5
Forms of Incentive Stock Option, Non-Qualified Stock Option and Restricted Stock Agreements under the 2012 Equity Incentive Plan (incorporated by reference to the Exhibits to the Registrant's Registration Statement on Form S-8 filed with the SEC on June 29, 2012 (File No. 333-182450))
   
Agreement, dated February 5, 2016, by and among, Sunshine Financial, Inc., Sunshine Savings Bank, Stilwell Value Partners VII, L.P., Stilwell Activist Fund, L.P., Stilwell Activist Investments, L.P., Stilwell Partners, L.P. and Stilwell Value LLC, and Corissa J. Briglia (incorporated by reference to the Registrant's Current Report on Form 8-K filed on February 8, 2016 (File No. 000-54280))
   
Statement re computation of per share earnings (See Note 3 of the Notes to Condensed Consolidated Financial Statements (Unaudited) included in this Form10-Q).
   
Rule 13a-14(a) Certification of the Chief Executive Officer
   
Rule 13a-14(a) Certification of the Chief Financial Officer
   
Section 1350 Certification
   
101
Interactive Data Files

 
 
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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:  November 14, 2017
By:
/s/ Louis O. Davis, Jr.
   
Louis O. Davis, Jr.
   
President and Chief Executive Officer
   
(Duly Authorized Officer)
     
Date:  November 14, 2017
By:
/s/ Scott A. Swain
   
Scott A, Swain
   
Senior Vice President, Treasurer and
   
Chief Financial Officer
   
(Principal Financial Officer)
 
 
 
 
 
 
 
 
 
 
 
 
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