sfbc-20210930

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


☒			QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2021


☐			TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

COMMISSION FILE NUMBER 001-35633


Sound Financial Bancorp, Inc.
(Exact Name of Registrant as Specified in its Charter)


Maryland						45-5188530
(State or other jurisdiction of incorporation or organization)						(I.R.S. Employer Identification No.)

2400 3rd Avenue, Suite 150, Seattle, Washington						98121
(Address of principal executive offices)						(Zip Code)

Registrant’s telephone number, including area code: (206) 448-0884

None

(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:


Title of each class	Trading Symbol(s)	Name of each exchange on which registered

Common Stock, $0.01 par value	SFBC	The NASDAQ Stock Market LLC

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 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 ☒ No ☐

Indicate by checkmark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an 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	☒	Smaller reporting company	☒

		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 checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of the latest practicable date.

As of November 3, 2021, there were 2,617,425 shares of the registrant’s common stock outstanding.

Table of Contents

SOUND FINANCIAL BANCORP, INC.

FORM 10-Q

TABLE OF CONTENTS


			Page Number
PART I FINANCIAL INFORMATION

Item 1. Financial Statements

Condensed Consolidated Balance Sheets as of September 30, 2021 and December 31, 2020 (unaudited)			4

Condensed Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2021 and 2020 (unaudited)			5

Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2021 and 2020 (unaudited)			6

Condensed Consolidated Statements of Stockholders’ Equity for the Three and Nine Months Ended September 30, 2021 and 2020 (unaudited)			7

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2021 and 2020 (unaudited)			9

Notes to Condensed Consolidated Financial Statements (unaudited)			10

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations			34

Item 3. Quantitative and Qualitative Disclosures About Market Risk			49

Item 4. Controls and Procedures			49

PART II OTHER INFORMATION

Item 1. Legal Proceedings			50

Item 1A. Risk Factors			50

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			50

Item 3. Defaults Upon Senior Securities			50

Item 4. Mine Safety Disclosures			50

Item 5. Other Information			51

Item 6. Exhibits			52

SIGNATURES			53

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Condensed Consolidated Balance Sheets (unaudited)

(In thousands, except share and per share amounts)


	September 30, 2021		December 31, 2020
ASSETS
Cash and cash equivalents	$	206,702	$	193,828
Available-for-sale securities, at fair value	7,060		10,218
Loans held-for-sale	3,884		11,604
Loans held-for-portfolio	667,551		613,363
Allowance for loan losses	(6,327)		(6,000)
Total loans held-for-portfolio, net	661,224		607,363
Accrued interest receivable	2,231		2,254
Bank-owned life insurance (“BOLI”), net	20,926		14,588
Other real estate owned (“OREO”) and repossessed assets, net	659		594
Mortgage servicing rights, at fair value	4,211		3,780
Federal Home Loan Bank (“FHLB”) stock, at cost	1,052		877
Premises and equipment, net	5,941		6,270
Right of use assets	6,033		6,722
Other assets	8,188		3,304
Total assets	$	928,111	$	861,402
LIABILITIES
Deposits
Interest-bearing	$	612,805	$	615,491
Noninterest-bearing demand	194,848		132,490
Total deposits	807,653		747,981

Accrued interest payable	48		369
Lease liabilities	6,462		7,134
Other liabilities	8,711		7,674
Advance payments from borrowers for taxes and insurance	1,708		1,168
Subordinated notes, net	11,623		11,592
Total liabilities	836,205		775,918
COMMITMENTS AND CONTINGENCIES (NOTE 7)	—		—
STOCKHOLDERS’ EQUITY
Preferred stock, $0.01 par value, 10,000,000 shares authorized, none issued or outstanding	—		—
Common stock, $0.01 par value, 40,000,000 shares authorized, 2,617,425 and 2,592,587 shares issued and outstanding as of September 30, 2021 and December 31, 2020, respectively	26		25
Additional paid-in capital	27,835		27,106
Unearned shares - Employee Stock Ownership Plan (“ESOP”)	(28)		(113)
Retained earnings	63,905		58,226
Accumulated other comprehensive income, net of tax	168		240
Total stockholders’ equity	91,906		85,484
Total liabilities and stockholders’ equity	$	928,111	$	861,402

See notes to condensed consolidated financial statements

SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Condensed Consolidated Statements of Income (unaudited)

(In thousands, except share and per share amounts)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
INTEREST INCOME
Loans, including fees	$	8,967	$	8,422	$	25,152	$	25,463
Interest and dividends on investments, cash and cash equivalents	135		86		365		400
Total interest income	9,102		8,508		25,517		25,863
INTEREST EXPENSE
Deposits	617		1,738		2,807		5,346
Borrowings	—		87		—		209
Subordinated notes	168		23		504		23
Total interest expense	785		1,848		3,311		5,578
Net interest income	8,317		6,660		22,206		20,285
PROVISION FOR LOAN LOSSES	175		275		425		925
Net interest income after provision for loan losses	8,142		6,385		21,781		19,360
NONINTEREST INCOME
Service charges and fee income	556		510		1,615		1,433
Earnings on cash surrender value of bank-owned life insurance	104		102		281		207
Mortgage servicing income	328		260		961		739
Fair value adjustment on mortgage servicing rights	(125)		(623)		(694)		(1,423)
Net gain on sale of loans	568		1,819		3,683		3,399

Total noninterest income	1,431		2,068		5,846		4,355
NONINTEREST EXPENSE
Salaries and benefits	3,512		2,880		10,470		8,933
Operations	1,466		1,390		4,033		4,109
Regulatory assessments	91		111		283		480
Occupancy	441		442		1,298		1,437
Data processing	808		707		2,400		1,923
Net gain on OREO and repossessed assets	—		—		(16)		—
Total noninterest expense	6,318		5,530		18,468		16,882
Income before provision for income taxes	3,255		2,923		9,159		6,833
Provision for income taxes	663		588		1,865		1,390
Net income	$	2,592	$	2,335	$	7,294	$	5,443

Earnings per common share:
Basic	$	1.00	$	0.90	$	2.81	$	2.11
Diluted	$	0.98	$	0.90	$	2.76	$	2.09
Weighted-average number of common shares outstanding:
Basic	2,586,966		2,563,018		2,581,517		2,558,475
Diluted	2,633,459		2,589,241		2,624,632		2,588,101

See notes to condensed consolidated financial statements

SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Condensed Consolidated Statements of Comprehensive Income (unaudited)

(In thousands)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
Net income	$	2,592	$	2,335	$	7,294	$	5,443
Available for sale securities:
Unrealized (losses) gains arising during the period	(34)		(4)		(91)		106
Income tax benefit (expense) related to unrealized gains/losses	7		1		19		(22)
Other comprehensive (loss) income, net of tax	(27)		(3)		(72)		84
Comprehensive income	$	2,565	$	2,332	$	7,222	$	5,527

See notes to condensed consolidated financial statements

SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Condensed Consolidated Statements of Stockholders’ Equity

For the Three and Nine Months Ended September 30, 2021 and 2020 (unaudited)

(In thousands, except share and per share amounts)


	Shares	Common Stock		Additional Paid -in Capital		Unearned ESOP Shares		Retained Earnings		Accumulated Other Comprehensive Income, net of tax		Total Stockholders’ Equity
Balance, at June 30, 2021	2,614,329	$	26	$	27,613	$	(57)	$	61,758	$	195	$	89,535
Net income	—	—		—		—		2,592		—		2,592
Other comprehensive loss, net of tax	—	—		—		—		—		(27)		(27)
Share-based compensation	—	—		65		—		—		—		65

Cash dividends paid on common stock ($0.17 per share)	—	—		—		—		(445)		—		(445)
Common stock surrendered	(100)	—		—		—		—		—		—
Restricted shares forfeited	(420)	—		—		—		—		—		—
Common stock options exercised	3,616	—		59		—		—		—		59
Allocation of ESOP shares	—	—		98		29		—		—		127
Balance, at September 30, 2021	2,617,425	$	26	$	27,835	$	(28)	$	63,905	$	168	$	91,906

Balance, at December 31, 2020	2,592,587	$	25	$	27,106	$	(113)	$	58,226	$	240	$	85,484
Net income	—	—		—		—		7,294		—		7,294
Other comprehensive loss, net of tax	—	—		—		—		—		(72)		(72)
Share-based compensation	—	—		295		—		—		—		295
Restricted stock awards issued	10,168	—		—		—		—		—
Cash dividends paid on common stock ($0.61 per share)	—	—		—		—		(1,594)		—		(1,594)
Common stock repurchased	—	—		(9)		—		(21)		—		(30)
Common stock surrendered	(4,091)	—		—				—		—		—
Restricted shares forfeited	(1,890)	—		—		—		—		—		—
Common stock options exercised	20,651	1		181		—		—		—		182
Allocation of ESOP shares	—	—		262		85		—		—		347
Balance, at September 30, 2021	2,617,425	$	26	$	27,835	$	(28)	$	63,905	$	168	$	91,906

SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Condensed Consolidated Statements of Stockholders’ Equity

(unaudited)

(In thousands, except share and per share amounts)


	Shares	Common Stock		Additional Paid -in Capital		Unearned ESOP Shares		Retained Earnings		Accumulated Other Comprehensive Income, net of tax		Total Stockholders’ Equity
Balance, at June 30, 2020	2,593,152	$	25	$	26,894	$	(170)	$	53,224	$	262	$	80,235
Net income	—	—		—		—		2,335		—		2,335
Other comprehensive loss, net of tax	—	—		—		—		—		(3)		(3)
Share-based compensation	—	—		52		—		—		—		52
Common stock surrendered	(2,842)	—		—		—		—		—		—
Cash dividends paid on common stock ($0.15 per share)	—	—		—		—		(389)		—		(389)


Common stock options exercised	4,979	—		23		—		—		—		23
Allocation of ESOP shares	—	—		49		28		—		—		77
Balance, at September 30, 2020	2,595,289	$	25	$	27,018	$	(142)	$	55,170	$	259	$	82,330

Balance, at December 31, 2019	2,567,389	$	25	$	26,343	$	(227)	$	51,410	$	175	$	77,726
Net income	—	—		—		—		5,443		—		5,443
Other comprehensive loss, net of tax	—	—		—		—		—		84		84
Share-based compensation	—	—		283		—		—		—		283
Common stock surrendered	(3,423)	—		—		—		—		—		—
Cash dividends paid on common stock ($0.65 per share)	—	—		—		—		(1,683)		—		(1,683)
Restricted stock forfeited	(1,690)	—		—		—		—		—		—
Restricted stock awards issued	13,600	—		—		—		—		—		—
Common stock options exercised	19,413	—		239		—		—		—		239
Allocation of ESOP shares	—	—		153		85		—		—		238
Balance, at September 30, 2020	2,595,289	$	25	$	27,018	$	(142)	$	55,170	$	259	$	82,330

See notes to condensed consolidated financial statements

SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Condensed Consolidated Statements of Cash Flows (unaudited)

(In thousands)


	Nine Months Ended September 30,
	2021		2020
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	7,294	$	5,443
Adjustments to reconcile net income to net cash from operating activities:
Amortization of net discounts on investments	108		104
Provision for loan losses	425		925
Depreciation and amortization	502		696
Compensation expense related to stock options and restricted stock	295		283
Fair value adjustment on mortgage servicing rights	694		1,423
Right of use assets amortization	689		696
Change in lease liabilities	(672)		(662)
Increase in cash surrender value of BOLI	(281)		(207)
Net change in advances from borrowers for taxes and insurance	540		373
Net gain on sale of loans	(3,683)		(3,399)
Proceeds from sale of loans held-for-sale	130,890		179,244
Originations of loans held-for-sale	(120,612)		(193,892)
Net gain on OREO and repossessed assets	(16)		—
Change in operating assets and liabilities:
Accrued interest receivable	23		(330)
Other assets	(4,865)		314
Accrued interest payable	(321)		(13)
Other liabilities	1,037		(585)
Net cash provided by (used in) operating activities	12,047		(9,587)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of available-for-sale securities	—		(7,177)
Proceeds from principal payments, maturities and sales of available-for-sale securities	2,990		3,190
Net increase in loans	(54,370)		(68,622)
Purchase of BOLI	(6,057)		(14)
Purchases of premises and equipment, net	(173)		(396)
Proceeds from sale of OREO and other repossessed assets	35		—
Net cash used in investing activities	(57,575)		(73,019)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits	59,672		132,132
Proceeds from borrowings	—		87,991
Repayment of borrowings	—		(87,991)
Proceeds from subordinated debt, net	—		11,676
FHLB stock purchased	(175)		(4)
Common stock repurchases	(30)		—
Allocation of ESOP shares	347		238
Dividends paid on common stock	(1,594)		(1,683)
Proceeds from common stock option exercises	182		239
Net cash provided by financing activities	58,402		142,598
Net change in cash and cash equivalents	12,874		59,992
Cash and cash equivalents, beginning of period	193,828		55,770
Cash and cash equivalents, end of period	$	206,702	$	115,762
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for income taxes	$	2,290	$	1,270
Interest paid on deposits and borrowings	3,632		5,591
Loans transferred from loans held-for-portfolio to OREO and repossessed assets	84		—

See notes to condensed consolidated financial statements

SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements (unaudited)

Note 1 – Basis of Presentation

The accompanying financial information is unaudited and has been prepared from the consolidated financial statements of Sound Financial Bancorp, Inc., and its wholly owned subsidiaries, Sound Community Bank and Sound Community Insurance Agency, Inc. References in this document to Sound Financial Bancorp refer to Sound Financial Bancorp, Inc. and references to the “Bank” refer to Sound Community Bank. References to “we,” “us,” and “our” or the “Company” refers to Sound Financial Bancorp and its wholly-owned subsidiaries, Sound Community Bank and Sound Community Insurance Agency, Inc., unless the context otherwise requires.

These unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission (“SEC”). In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the financial position and results of operations for the periods presented have been included. Certain information and disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to the rules and regulations of the SEC. These unaudited financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, as filed with the SEC on March 30, 2021 (“2020 Form 10-K”). The results for the interim periods are not necessarily indicative of results for a full year or any other future period.

Certain amounts in the prior period’s consolidated financial statements have been reclassified to conform to the current presentation. These classifications do not have an impact on previously reported consolidated net income, stockholders’ equity or earnings per share.

Note 2 – Accounting Pronouncements Recently Issued or Adopted

The Coronavirus Aid, Relief and Economic Security Act ("CARES Act"), signed into law on March 27, 2020, provides relief from certain accounting and financial reporting requirements under U.S. GAAP. Section 4013 of the CARES Act provides temporary relief from the accounting and reporting requirements for troubled debt restructurings (“TDRs”) under Accounting Standards Codification ("ASC") 310-40 for loan modifications related to the novel coronavirus disease 2019 ("COVID-19") pandemic. In addition, on April 7, 2020, a group of banking agencies issued an interagency statement (“Interagency Statement”) for evaluating whether loan modifications that occur in response to the COVID-19 pandemic are TDRs. The Interagency Statement was originally issued on March 22, 2020, but the banking agencies revised it to address the relationship between their TDR accounting and disclosure guidance and the TDR guidance in Section 4013 of the CARES Act. Section 4013 of the CARES Act permits the suspension of ASC 310-40 for loan modifications that are made by financial institutions in response to the COVID-19 pandemic if (1) the borrower was not more than 30 days past due as of December 31, 2019, and (2) the modifications are related to arrangements that defer or delay the payment of principal or interest, or change the interest rate on the loan. The Interagency Statement indicates that a lender can conclude that a borrower is not experiencing financial difficulty if either (1) short-term (e.g., six months) modifications are made in response to COVID-19, such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant related to loans in which the borrower is less than 30 days past due on its contractual payments at the time a modification program is implemented, or (2) the modification or deferral program is mandated by the federal government or a state government. Accordingly, any loan modification made in response to the COVID-19 pandemic that meets either of these practical expedients would not be considered a TDR. The Company adopted this guidance effective March 27, 2020. On December 27, 2020, the Consolidated Appropriations Act 2021 (“CAA 2021”) was signed into law. Among other purposes, CAA 2021 provides coronavirus emergency response and relief, including extending relief offered under the CARES Act related to restructured loans as a result of COVID-19 through January 1, 2022 or 60 days after the end of the national emergency declared by the President, whichever is earlier.

In October 2020, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2020-08, “Receivables – Nonrefundable Fees and Other Costs” (“ASU 2020-08”). ASU 2020-08 clarifies that the Company should reevaluate whether a callable debt security is within the scope of paragraph 310-20-35-33 for each reporting period. ASU 2020-08 is effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. The adoption of ASU 2018-13 did not have a material impact on the Company's consolidated financial statements.

On March 2020, the FASB issued ASU No. 2020-04, "Reference Rate Reform" ("Topic 848"). This ASU provides optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting. The amendments in this update apply to contract modifications that replace a reference rate affected by reference rate reform (including rates referenced in fallback provisions) and contemporaneous modifications of other contract terms related to the replacement of the reference rate (including contract modifications to add or change fallback provisions). The following optional expedients for applying the requirements of certain Topics or Industry Subtopics in the Codification are permitted for contracts that are modified because of reference rate reform and that meet certain scope guidance: 1) Modifications of contracts within the scope of Topics 310, Receivables, and 470, Debt, should be accounted for by prospectively adjusting the effective interest rate; 2) Modifications of contracts within the scope of Topics 840, Leases, and 842, Leases, should be accounted for as a continuation of the existing contracts with no reassessments of the lease classification and the discount rate (for example, the incremental borrowing rate) or remeasurements of lease payments that otherwise would be required under those Topics for modifications not accounted for as separate contracts; and 3) Modifications of contracts do not require an entity to reassess its original conclusion about whether that contract contains an embedded derivative that is clearly and closely related to the economic characteristics and risks of the host contract under Subtopic 815-15, Derivatives and Hedging— Embedded Derivatives. In January 2021, ASU 2021-01 updated amendments in the new ASU to clarify that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. The ASU also amends the expedients and exceptions in Topic 848 to capture the incremental consequences of the scope clarification. The amendments in this ASU have differing effective dates, beginning with interim period including and subsequent to March 12, 2020 through December 31, 2022. The Company does not expect the adoption of ASU 2020-04 to have a material impact on its consolidated financial statements.

In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. This ASU simplifies the accounting for income taxes by removing the exception to the incremental approach for intra-period tax allocation when there is a loss from continuing operations and income or a gain from other items, removing the requirement to recognize a deferred tax liability for equity method investments when a foreign subsidiary becomes an equity method investment, and removing the general methodology for calculating income taxes in an interim period when a year-to-date loss exceeds the anticipated loss for the year. This ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. The adoption of ASU 2019-12 did not have a material impact on the Company's consolidated financial statements.

In August 2018, the FASB issued ASU No. 2018-14, Compensation - Retirement Benefits - Defined Benefit Plans - General (Subtopic 715-20): Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans. This ASU modifies disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. Disclosure requirements removed from FASB Subtopic 715-20 include the amounts in accumulated other comprehensive income expected to be recognized as components of net periodic benefit cost over the next fiscal year, the amount and timing of plan assets expected to be returned to the employer, related party disclosures about the amount of future annual benefits covered by insurance and annuity contracts and significant transactions between the employer or related parties and the plan, and, for public entities, the effects of a one-percentage-point change in assumed health care cost trend rates on the aggregate of the service and interest cost components of net periodic benefit costs and benefit obligation for postretirement health care benefits. Disclosure requirements added to FASB Subtopic 715-20 include the weighted-average interest crediting rates for cash balance plans and other plans with promised interest crediting rates, and an explanation of the reasons for significant gains and losses related to changes in the benefit obligation for the period. This ASU is effective for fiscal years ending after December 15, 2020. The adoption of ASU No. 2018-14 did not have a material impact on the Company's consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This ASU replaces the existing incurred loss impairment methodology that recognizes credit losses when a probable loss has been incurred with new methodology where loss estimates are based upon lifetime expected credit losses. The amendments in this ASU require a financial asset that is measured at amortized cost to be presented at the net amount expected to be collected. The income statement would then reflect the measurement of credit losses for newly recognized financial assets as well as changes to the expected credit losses that have taken place during the reporting period. The change in allowance recognized as a result of adoption will occur through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the ASU is adopted. The new guidance may result in an increase in the allowance for loan losses; however, the Company is still in the process of determining the magnitude of the change and its impact on the Company's consolidated financial statements. The FASB issued ASU No. 2019-10, Financial Instruments - Credit Losses (Topic 326), delaying implementation of ASU No. 2016-13 for SEC smaller reporting company filers until fiscal years beginning after December 15, 2022. The Bank meets the requirements of a smaller reporting company and will delay implementation of ASU No. 2016-13.

Note 3 – Investments

The amortized cost and fair value of our available-for-sale (“AFS”) securities and the corresponding amounts of gross unrealized gains and losses at the dates indicated were as follows (in thousands):


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
September 30, 2021

Municipal bonds	$	4,216	$	160	$	(6)	$	4,370
Agency mortgage-backed securities	2,631		70		(11)		2,690

Total	$	6,847	$	230	$	(17)	$	7,060

December 31, 2020

Municipal bonds	$	5,209	$	204	$	—	$	5,413
Agency mortgage-backed securities	4,706		105		(6)		4,805

Total	$	9,915	$	309	$	(6)	$	10,218

The amortized cost and fair value of AFS securities at September 30, 2021, by contractual maturity, are shown below (in thousands). Expected maturities of AFS securities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Investments not due at a single maturity date, primarily mortgage-backed investments, are shown separately.


	September 30, 2021
	Amortized Cost		Fair Value
Due within one year	$	226	$	226
Due after one year through five years	260		268
Due after five years through ten years	457		492
Due after ten years	3,273		3,384
Agency mortgage-backed securities	2,631		2,690
Total	$	6,847	$	7,060

There were no pledged securities at September 30, 2021 or December 31, 2020.

There were no sales of AFS securities during the three and nine months ended September 30, 2021 or 2020.

The following table summarizes the aggregate fair value and gross unrealized loss by length of time of those investments that have been in a continuous unrealized loss position at the dates indicated (in thousands):


	September 30, 2021
	Less Than 12 Months				12 Months or Longer				Total
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss

Municipal bonds	$	660	$	(6)	$	—	$	—	$	660	$	(6)
Agency mortgage-backed securities	434		(11)		—		—		434		(11)

Total	$	1,094	$	(17)	$	—	$	—	$	1,094	$	(17)


	December 31, 2020
	Less Than 12 Months				12 Months or Longer				Total
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss


Agency mortgage-backed securities	$	1,618	$	(6)	$	—	$	—	$	1,618	$	(6)

Total	$	1,618	$	(6)	$	—	$	—	$	1,618	$	(6)

There were no credit losses recognized in earnings related to other than temporary impairments during the three and nine months ended September 30, 2021 or 2020.

At September 30, 2021, the securities portfolio consisted of 11 agency mortgage-backed securities and nine municipal bonds with a total portfolio fair value of $7.1 million. At December 31, 2020, the securities portfolio consisted of 16 agency mortgage-backed securities and ten municipal bonds with a fair value of $10.2 million. At September 30, 2021, there were three securities in an unrealized loss position for less than 12 months, and there were no securities in an unrealized loss position for more than 12 months. At December 31, 2020, there were three securities in an unrealized loss position for less than 12 months, and there were no securities in an unrealized loss position for more than 12 months. The unrealized losses were caused by changes in market interest rates or the widening of market spreads subsequent to the initial purchase of these securities, and not related to the underlying credit of the issuers or the underlying collateral. It is expected that these securities will not be settled at a price less than the amortized cost of each investment. The unrealized losses on these investments are not considered other-than-temporary impairment ("OTTI") as of September 30, 2021, because the decline in fair value is not attributable to credit quality and because we do not intend, and it is not likely that we will be required, to sell these securities before recovery of their amortized cost basis. Deterioration in market and economic conditions related to the COVID-19 pandemic may, however, have an adverse impact on credit quality in the future and result in OTTI charges.

Note 4 – Loans

The composition of the loans-held-for portfolio at the dates indicated, excluding loans held-for-sale, was as follows (in thousands):


	September 30, 2021		December 31, 2020
Real estate loans:
One-to-four family	$	194,346	$	130,657
Home equity	14,012		16,265
Commercial and multifamily	246,794		265,774
Construction and land	81,576		62,752
Total real estate loans	536,728		475,448
Consumer loans:
Manufactured homes	21,459		20,941
Floating homes	58,358		39,868
Other consumer	15,732		15,024
Total consumer loans	95,549		75,833
Commercial business loans	36,620		64,217
Total loans held-for-portfolio	668,897		615,498
Deferred fees, net	(1,346)		(2,135)
Total loans held-for-portfolio, gross	667,551		613,363
Allowance for loan losses	(6,327)		(6,000)
Total loans held-for-portfolio, net	$	661,224	$	607,363

The Company was automatically authorized to participate in the U.S. Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”), as a qualified lender since the inception of the program. As of September 30, 2021, the Bank had funded PPP loans totaling $119.2 million, $11.8 million of which remained outstanding and are included in commercial business loans above. PPP loans are 100% guaranteed by the SBA.

The following tables present the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of the dates indicated (in thousands):


	September 30, 2021
	Allowance: Individually evaluated for impairment		Allowance: Collectively evaluated for impairment		Allowance: Ending balance		Loans held for investment: Individually evaluated for impairment		Loans held for investment: Collectively evaluated for impairment		Loans held for investment: Ending balance
One-to-four family	$	137	$	1,183	$	1,320	$	3,791	$	190,555	$	194,346
Home equity	7		87		94		226		13,786		14,012
Commercial and multifamily	—		1,857		1,857		—		246,794		246,794
Construction and land	5		771		776		255		81,321		81,576
Manufactured homes	105		198		303		201		21,258		21,459
Floating homes	—		383		383		504		57,854		58,358
Other consumer	27		179		206		108		15,624		15,732
Commercial business	—		426		426		182		36,438		36,620
Unallocated	—		962		962		—		—		—
Total	$	281	$	6,046	$	6,327	$	5,267	$	663,630	$	668,897


	December 31, 2020
	Allowance: Individually evaluated for impairment		Allowance: Collectively evaluated for impairment		Allowance: Ending balance		Loans held for investment: Individually evaluated for impairment		Loans held for investment: Collectively evaluated for impairment		Loans held for investment: Ending balance
One-to-four family	$	165	$	898	$	1,063	$	3,705	$	126,952	$	130,657
Home equity	14		133		147		293		15,972		16,265
Commercial and multifamily	—		2,370		2,370		353		265,421		265,774
Construction and land	6		572		578		77		62,675		62,752
Manufactured homes	163		366		529		265		20,676		20,941
Floating homes	—		328		328		518		39,350		39,868
Other consumer	30		258		288		114		14,910		15,024
Commercial business	—		291		291		615		63,602		64,217
Unallocated	—		406		406		—		—		—
Total	$	378	$	5,622	$	6,000	$	5,940	$	609,558	$	615,498

The following tables summarize the activity in the allowance for loan losses for the periods indicated (in thousands):


	Three Months Ended September 30, 2021
	Beginning Allowance		Charge-offs		Recoveries		Provision (Recapture)		Ending Allowance
One-to-four family	$	1,292	$	—	$	—	$	28	$	1,320
Home equity	111		—		2		(19)		94
Commercial and multifamily	1,987		—		—		(130)		1,857
Construction and land	700		—		—		76		776
Manufactured homes	367		—		1		(65)		303
Floating homes	318		—		—		65		383
Other consumer	201		(8)		—		13		206
Commercial business	693		—		—		(267)		426
Unallocated	488		—		—		474		962
Total	$	6,157	$	(8)	$	3	$	175	$	6,327


	Nine Months Ended September 30, 2021
	Beginning Allowance		Charge-offs		Recoveries		Provision (Recapture)		Ending Allowance
One-to-four family	$	1,063	$	(76)	$	—	$	333	$	1,320
Home equity	147		(8)		4		(49)		94
Commercial and multifamily	2,370		—		—		(513)		1,857
Construction and land	578		—		—		198		776
Manufactured homes	529		(2)		3		(227)		303
Floating homes	328		—		—		55		383
Other consumer	288		(27)		6		(61)		206
Commercial business	291		—		2		133		426
Unallocated	406		—		—		556		962
Total	$	6,000	$	(113)	$	15	$	425	$	6,327


	Three Months Ended September 30, 2020
	Beginning Allowance		Charge-offs			Recoveries		(Recapture) Provision		Ending Allowance
One-to-four family	$	1,149	$	(20)		$	4	$	37	$	1,170
Home equity	154		(2)			7		(17)		142
Commercial and multifamily	1,991		—			—		16		2,007
Construction and land	623		—			—		(43)		580
Manufactured homes	362		—			1		(33)		330
Floating homes	324		—			—		(31)		293
Other consumer	127		(4)			2		(10)		115
Commercial business	501		(306)			—		68		263
Unallocated	800		—			—		288		1,088
Total	$	6,031	$	(332)	0	$	14	$	275	$	5,988


	Nine Months Ended September 30, 2020
	Beginning Allowance		Charge-offs		Recoveries		(Recapture) Provision		Ending Allowance
One-to-four family	$	1,120	$	(20)	$	12	$	58	$	1,170
Home equity	178		(2)		46		(80)		142
Commercial and multifamily	1,696		—		—		311		2,007
Construction and land	492		—		—		88		580
Manufactured homes	480		—		1		(151)		330
Floating homes	283		—		—		10		293
Other consumer	112		(20)		13		10		115
Commercial business	331		(607)		—		539		263
Unallocated	948		—		—		140		1,088
Total	$	5,640	$	(649)	$	72	$	925	$	5,988

Credit Quality Indicators. Federal regulations provide for the classification of lower quality loans and other assets (such as OREO and repossessed assets), debt and equity securities considered as "substandard," "doubtful" or "loss." An asset is considered "substandard" if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. "Substandard" assets include those characterized by the "distinct possibility" that the insured institution will sustain "some loss" if the deficiencies are not corrected. Assets classified as "doubtful" have all of the weaknesses in those classified "substandard," with the added characteristic that the weaknesses present make "collection or liquidation in full," on the basis of currently existing facts, conditions and values, "highly questionable and improbable." Assets classified as "loss" are those considered "uncollectible" and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.

When we classify problem assets as either substandard or doubtful, we may establish a specific allowance in an amount we deem prudent to address specific impairments. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been specifically allocated to particular problem assets. When an insured institution classifies problem assets as a loss, it is required to charge off those assets in the period in which they are deemed uncollectible. Our determination as to the classification of our assets and the amount of our valuation allowances is subject to review by the Federal Deposit Insurance Corporation (“FDIC”), the Bank's federal regulator, and, since our conversion to a Washington-chartered commercial bank, the Washington Department of Financial Institutions, the Bank's state banking regulator, which can order the establishment of additional loss allowances. Assets which do not currently expose us to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are required to be designated as special mention.

The following tables present the internally assigned grades as of the dates indicated, by type of loan (in thousands):


	September 30, 2021
	One-to- four family		Home equity		Commercial and multifamily		Construction and land		Manufactured homes		Floating homes		Other consumer		Commercial business		Total
Grade:
Pass	$	190,857	$	13,654	$	200,617	$	67,021	$	21,025	$	57,250	$	15,711	$	30,242	$	596,377
Watch	299		23		29,061		11,962		243		604		—		4,059		46,251
Special Mention	—		—		9,958		837		—		—		—		1,746		12,541
Substandard	3,190		335		7,158		1,756		191		504		21		573		13,728


Total	$	194,346	$	14,012	$	246,794	$	81,576	$	21,459	$	58,358	$	15,732	$	36,620	$	668,897


	December 31, 2020
	One-to- four family		Home equity		Commercial and multifamily		Construction and land		Manufactured homes		Floating homes		Other consumer		Commercial business		Total
Grade:
Pass	$	113,185	$	15,556	$	228,652	$	44,360	$	19,606	$	38,746	$	15,000	$	56,743	$	531,848
Watch	15,142		245		22,945		13,808		1,115		604		—		5,202		59,061
Special Mention	—		—		10,813		3,939		—		—		—		310		15,062
Substandard	2,330		464		3,364		645		220		518		24		1,962		9,527


Total	$	130,657	$	16,265	$	265,774	$	62,752	$	20,941	$	39,868	$	15,024	$	64,217	$	615,498

Nonaccrual and Past Due Loans. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on nonaccrual once the loan is 90 days past due or sooner if,

in management’s opinion, the borrower may be unable to meet payment of obligations as they become due, as well as when required by regulatory provisions.

The following table presents the recorded investment in nonaccrual loans as of the dates indicated, by type of loan (in thousands):


	September 30, 2021		December 31, 2020
One-to-four family	$	1,915	$	1,668
Home equity	150		156
Commercial and multifamily	—		353
Construction and land	220		40
Manufactured homes	98		149
Floating homes	504		518

Commercial business	182		—
Total	$	3,069	$	2,884

The following tables present the aging of the recorded investment in past due loans as of the dates indicated, by type of loan (in thousands):


	September 30, 2021
	30-59 Days Past Due		60-89 Days Past Due		90 Days and Greater Past Due		> 90 Days and Accruing		Total Past Due		Current		Total Loans
One-to-four family	$	—	$	604	$	1,571	$	—	$	2,175	$	192,171	$	194,346
Home equity	16		—		134		—		150		13,862		14,012
Commercial and multifamily	2,429		—		—		—		2,429		244,365		246,794
Construction and land	—		—		—		—		—		81,576		81,576
Manufactured homes	33		79		97		—		210		21,249		21,459
Floating homes	—		—		247		—		247		58,111		58,358
Other consumer	20		2		—		—		22		15,710		15,732
Commercial business	—		—		182		—		182		36,438		36,620
Total	$	2,498	$	685	$	2,231	$	—	$	5,413	$	663,484	$	668,897


	December 31, 2020
	30-59 Days Past Due		60-89 Days Past Due		90 Days and Greater Past Due		> 90 Days and Accruing		Total Past Due		Current		Total Loans
One-to-four family	$	498	$	362	$	1,407	$	—	$	2,267	$	128,390	$	130,657
Home equity	102		—		112		—		214		16,051		16,265
Commercial and multifamily	—		—		353		—		353		265,421		265,774
Construction and land	690		—		40		—		730		62,022		62,752
Manufactured homes	159		74		149		—		382		20,559		20,941
Floating homes	—		269		249		—		518		39,350		39,868
Other consumer	15		1		—		—		16		15,008		15,024
Commercial business	583		—		—		—		583		63,634		64,217
Total	$	2,047	$	706	$	2,310	$	—	$	5,063	$	610,435	$	615,498

Nonperforming Loans. Loans are considered nonperforming when they are placed on nonaccrual.

The following tables present the credit risk profile of our loan portfolio based on payment activity as of the dates indicated, by type of loan (in thousands):


	September 30, 2021
	One-to-four family		Home equity		Commercial and multifamily		Construction and land		Manufactured homes		Floating homes		Other consumer		Commercial business		Total
Performing	$	192,431	$	13,862	$	246,794	$	81,356	$	21,361	$	57,854	$	15,732	$	36,438	$	665,828
Nonperforming	1,915		150		—		220		98		504		—		182		3,069
Total	$	194,346	$	14,012	$	246,794	$	81,576	$	21,459	$	58,358	$	15,732	$	36,620	$	668,897


	December 31, 2020
	One-to-four family		Home equity		Commercial and multifamily		Construction and land		Manufactured homes		Floating homes		Other consumer		Commercial business		Total
Performing	$	128,989	$	16,109	$	265,421	$	62,712	$	20,792	$	39,350	$	15,024	$	64,217	$	612,614
Nonperforming	1,668		156		353		40		149		518		—		—		2,884
Total	$	130,657	$	16,265	$	265,774	$	62,752	$	20,941	$	39,868	$	15,024	$	64,217	$	615,498

Impaired Loans. A loan is considered impaired when we determine that we may be unable to collect payments of principal or interest when due under the terms of the loan. In the process of identifying loans as impaired, we take into consideration factors which include payment history and status, collateral value, financial condition of the borrower, and the probability of collecting scheduled payments in the future. Minor payment delays and insignificant payment shortfalls typically do not result in a loan being classified as impaired. The significance of payment delays and shortfalls is considered on a case by case basis, after taking into consideration the totality of circumstances surrounding the loan and the borrower, including payment history. Impairment is measured on a loan by loan basis for all loans in the portfolio. All TDRs are also classified as impaired loans and are included in the loans individually evaluated for impairment in the calculation of the allowance for loan losses.

Impaired loans at the dates indicated, by type of loan were as follows (in thousands):


	September 30, 2021
			Recorded Investment
	Unpaid Principal Balance		Without Allowance		With Allowance		Total Recorded Investment		Related Allowance
One-to-four family	$	3,901	$	2,749	$	1,042	$	3,791	$	137
Home equity	226		150		76		226		7
Commercial and multifamily	—		—		—		—		—
Construction and land	256		220		35		255		5
Manufactured homes	201		45		156		201		105
Floating homes	504		504		—		504		—
Other consumer	108		—		108		108		27
Commercial business	182		182		—		182		—
Total	$	5,378	$	3,850	$	1,417	$	5,267	$	281


	December 31, 2020
			Recorded Investment
	Unpaid Principal Balance		Without Allowance		With Allowance		Total Recorded Investment		Related Allowance
One-to-four family	$	3,791	$	2,392	$	1,313	$	3,705	$	165
Home equity	293		156		137		293		14
Commercial and multifamily	353		353		—		353		—
Construction and land	77		40		37		77		6
Manufactured homes	268		47		218		265		163
Floating homes	518		518		—		518		—
Other consumer	114		—		114		114		30
Commercial business	615		615		—		615		—
Total	$	6,029	$	4,121	$	1,819	$	5,940	$	378

The following table presents the average recorded investment and interest income recognized on impaired loans for the periods indicated, by loan types (in thousands):


	Three Months Ended September 30,
	2021				2020
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
One-to-four family	$	3,069	$	60	$	6,027	$	69
Home equity	321		3		336		3
Commercial and multifamily	—		—		465		16
Construction and land	166		11		315		20
Manufactured homes	225		3		349		5
Floating homes	507		5		405		15
Other consumer	109		1		127		—
Commercial business	93		1		1,076		12
Total	$	4,490	$	84	$	9,100	$	140


	Nine Months Ended September 30,
	2021				2020
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
One-to-four family	$	3,322	$	118	$	6,650	$	208
Home equity	305		11		341		12
Commercial and multifamily	176		—		409		26
Construction and land	121		12		579		21
Manufactured homes	244		12		391		19
Floating homes	511		12		406		23
Other consumer	111		4		134		4
Commercial business	353		1		1,174		12
Total	$	5,143	$	170	$	10,084	$	325

Forgone interest on nonaccrual loans was $89 thousand and $62 thousand for the three months ended September 30, 2021 and 2020, respectively, and $138 thousand and $126 thousand for the nine months ended September 30, 2021 and 2020, respectively. There were no commitments to lend additional funds to borrowers whose loans were classified as nonaccrual or impaired at September 30, 2021 and December 31, 2020.

Troubled debt restructurings. TDRs are loans accounted for under ASC 310-40, which have renegotiated loan terms to assist borrowers who are unable to meet the original terms of their loans. Such modifications to loan terms may include a lower interest rate, a reduction in principal, or a longer term to maturity. Once a TDR has performed according to its modified terms for six months and the collection of principal and interest under the revised terms is deemed probable, we remove the TDR from nonperforming status. Loans classified as TDRs totaled $2.6 million and $3.2 million at September 30, 2021 and December 31, 2020, respectively, and are included in impaired loans. The Company has granted, in its TDRs, a variety of concessions to borrowers in the form of loan modifications. The modifications granted can generally be described in the following categories:

Rate Modification: A modification in which the interest rate is changed.

Term Modification: A modification in which the maturity date, timing of payments or frequency of payments is changed.

Payment Modification: A modification in which the dollar amount of the payment is changed. Interest only modifications in which a loan is converted to interest only payments for a period of time are included in this category.

Combination Modification: Any other type of modification, including the use of multiple categories above.

There were no loans modified as a TDR during the three and nine months ended September 30, 2021. There were two TDRs totaling $484 thousand that were paid off during the nine months ended September 30, 2021.

There was one loan totaling $146 thousand modified as a TDR during the three months ended September 30, 2020 and four loans totaling $795 thousand modified as TDRs during the nine months ended September 30, 2020. There were two TDR loan totaling $2.9 million that were paid off during the nine months ended September 30, 2020.

There were no post-modification changes for the unpaid principal balance in loans, net of partial charge-offs, that were recorded as a result of the TDRs for the three and nine months ended September 30, 2021 and 2020. There were no loans modified as a TDR for which there was a payment default within the first 12 months of modification during the three and nine months ended September 30, 2021. There was one loan totaling $161 thousand modified as a TDR for which there was a payment default within the first 12 months of modification during the nine months ended September 30, 2020.

The Company had no commitments to extend additional credit to borrowers owing receivables whose terms have been modified into TDRs.

In March 2020, the Company began offering short-term loan modifications to assist borrowers during the COVID-19 pandemic. The CARES Act, and the Interagency Statement provides that a short-term modification made to a loan in response to COVID-19 which meets certain criteria does not need to be placed on nonaccrual status or accounted for as a TDR pursuant to applicable accounting and regulatory guidance until the earlier of 60 days after the national emergency termination date or January 1, 2022. The majority of these borrowers had resumed making payments as of September 30, 2021, and as of that date, there were six residential loans totaling $933 thousand on deferral status under COVID-19 loan modification forbearance agreements. We continue to monitor these loans through our normal credit risk processes and any request for continuation of relief beyond the initial modification is reassessed at that time to determine if a further modification should be granted and if a downgrade in risk rating is appropriate.

As of September 30, 2021, there was one one-to-four family loans totaling $39 thousand that was in process of foreclosure.

Note 5 – Fair Value Measurements

The Company determines the fair values of its financial instruments based on the requirements established in ASC 820, Fair Value Measurements (“ASC 820”), which provides a framework for measuring fair value in accordance with U.S. GAAP and requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. ASC 820 defines fair values for financial instruments as the exit price, the price that would be received for an asset or paid to transfer a liability, in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date under current market conditions. The Company’s fair values for financial instruments at September 30, 2021 were determined based on these requirements.

The following methods and assumptions were used to estimate the fair value of other financial instruments:

Cash and cash equivalents - The estimated fair value is equal to the carrying amount.

Available-for-Sale Securities – Available-for-sale securities are recorded at fair value based on quoted market prices, if available. If quoted market prices are not available, management utilizes third-party pricing services or broker quotations from dealers in the specific instruments. Level 2 securities include those traded on an active exchange, as well as U.S. government securities.

Loans Held-for-Sale - One-to-four family mortgage loans held-for-sale are recorded at the lower of cost or fair value. The fair value of fixed-rate one-to-four family loans is based on whole loan forward prices obtained from government sponsored enterprises. At September 30, 2021 and December 31, 2020, loans held-for-sale were carried at cost, as no impairment was required.

Loans Held-for-Portfolio - The estimated fair value of loans-held-for portfolio consists of a credit adjustment to reflect the estimated adjustment to the carrying value of the loans due to credit-related factors and a yield adjustment, to reflect the estimated adjustment to the carrying value of the loans due to a differential in yield between the portfolio loan yields and estimated current market rate yields on loans with similar characteristics. The estimated fair values of loans held for portfolio reflect exit price assumptions. The liquidity premium/discounts are part of the valuation for exit pricing.

Mortgage Servicing Rights –The fair value of mortgage servicing rights is determined through a discounted cash flow analysis, which uses interest rates, prepayment speeds, discount rates, and delinquency rate assumptions as inputs.

FHLB stock - The estimated fair value is equal to the par value of the stock.

Non-maturity deposits - The estimated fair value is equal to the carrying amount.

Time deposits - The estimated fair value of time deposits is based on the difference between interest costs paid on the Company’s time deposits and current market rates for time deposits with comparable characteristics.

Borrowings - The fair value of borrowings are estimated using the Company’s current incremental borrowing rates for similar types of borrowing arrangements.

Subordinated Debt - The fair value of subordinated debt is estimated using discounted cash flows based on current lending rates for similar long-term debt instruments with similar terms and remaining time to maturity.

A description of the valuation methodologies used for impaired loans and OREO is as follows:

Impaired Loans - The fair value of collateral dependent loans is based on the current appraised value of the collateral less estimated costs to sell, or internally developed models utilizing a calculation of expected discounted cash flows which contain management’s assumptions.

OREO and Repossessed Assets – The fair value of OREO and repossessed assets is based on the current appraised value of the collateral less estimated costs to sell.

Off-balance sheet financial instruments - The fair value for the Company’s off-balance sheet loan commitments is estimated based on fees charged to others to enter into similar agreements taking into account the remaining terms of the agreements and credit standing of the Company’s clients. The estimated fair value of these commitments is not significant.

In certain cases, the inputs used to measure fair value may fall into different levels of the hierarchy. In such cases, the lowest level of inputs that is significant to the measurement is used to determine the hierarchy for the entire asset or liability. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Company’s quarterly valuation process. There were no transfers between levels during the three and nine months ended September 30, 2021 and 2020.

The following tables present information about the level in the fair value hierarchy for the Company’s financial assets and liabilities, whether or not recognized or recorded at fair value as of the dates indicated (in thousands):


	September 30, 2021				Fair Value Measurements Using:
	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
FINANCIAL ASSETS:
Cash and cash equivalents	$	206,702	$	206,702	$	206,702	$	—	$	—
Available-for-sale securities	7,060		7,060		—		7,060		—
Loans held-for-sale	3,884		3,884		—		3,884		—
Loans held-for-portfolio, net	661,224		658,604		—		—		658,604
Mortgage servicing rights	4,211		4,211		—		—		4,211
FHLB stock	1,052		1,052		—		1,052		—
FINANCIAL LIABILITIES:
Non-maturity deposits	688,212		688,212		—		688,212		—
Time deposits	119,441		120,798		—		120,798		—

Subordinated notes	11,623		11,623		—		11,623		—


	December 31, 2020				Fair Value Measurements Using:
	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
FINANCIAL ASSETS:
Cash and cash equivalents	$	193,828	$	193,828	$	193,828	$	—	$	—
Available-for-sale securities	10,218		10,218		—		10,218		—
Loans held-for-sale	11,604		11,604		—		11,604		—
Loans held-for-portfolio, net	607,363		608,575		—		—		608,575
Mortgage servicing rights	3,780		3,780		—		—		3,780
FHLB stock	877		877		—		877		—
FINANCIAL LIABILITIES:
Non-maturity deposits	512,508		512,508		—		512,508		—
Time deposits	235,473		238,629		—		238,629		—

Subordinated notes	11,592		11,592		—		11,592		—

The following tables present the balance of assets measured at fair value on a recurring basis as of the dates indicated (in thousands):


	Fair Value at September 30, 2021
Description	Total	Level 1	Level 2	Level 3
Municipal bonds	4,370	—	4,370	—
Agency mortgage-backed securities	2,690	—	2,690	—

Mortgage servicing rights	4,211	—	—	4,211


	Fair Value at December 31, 2020
Description	Total		Level 1		Level 2		Level 3
Municipal bonds	$	5,413	$	—	$	5,413	$	—
Agency mortgage-backed securities	4,805		—		4,805		—

Mortgage servicing rights	3,780		—		—		3,780

The following tables provide a description of the valuation technique, unobservable input, and qualitative information about the unobservable inputs for the Company’s assets and liabilities classified as Level 3 and measured at fair value on a recurring basis as of the dates indicated:

September 30, 2021

Financial Instrument

Valuation Technique

Unobservable Input(s)

Range
(Weighted-Average)

Mortgage Servicing Rights

Discounted cash flow

Prepayment speed assumption

214%-503% (217%)

Discount rate

10.5%-14.5% (12.5%)

December 31, 2020

Financial Instrument

Valuation Technique

Unobservable Input(s)

Range
(Weighted-Average)

Mortgage Servicing Rights

Discounted cash flow

Prepayment speed assumption

178%-276% (247%)

Discount rate

10%-12% (10%)

Generally, any significant increases in the constant prepayment rate and discount rate utilized in the fair value measurement of the mortgage servicing rights will result in a negative fair value adjustment (and decrease in the fair value measurement). Conversely, a decrease in the constant prepayment rate and discount rate will result in a positive fair value adjustment (and increase in the fair value measurement). An increase in the weighted-average life assumptions will result in a decrease in the constant prepayment rate and conversely, a decrease in the weighted-average life will result in an increase of the constant prepayment rate.

There were no assets or liabilities (excluding mortgage servicing rights) measured at fair value using significant unobservable inputs (Level 3) on a recurring basis during the three and nine months ended September 30, 2021 and 2020.

Mortgage servicing rights are measured at fair value using a significant unobservable input (Level 3) on a recurring basis - additional information is included in “Note 6—Mortgage Servicing Rights.”

The following tables present the balance of assets measured at fair value on a nonrecurring basis at the dates indicated (in thousands):


	Fair Value at September 30, 2021
	Total		Level 1		Level 2		Level 3
OREO and repossessed assets	$	659	$	—	$	—	$	659
Impaired loans	5,267		—		—		5,267


	Fair Value at December 31, 2020
	Total		Level 1		Level 2		Level 3
OREO and repossessed assets	$	594	$	—	$	—	$	594
Impaired loans	5,940		—		—		5,940

There were no liabilities carried at fair value, measured on a recurring or nonrecurring basis, at September 30, 2021 and December 31, 2020.

The following tables provide a description of the valuation technique, observable input, and qualitative information about the unobservable inputs for the Company’s assets and liabilities classified as Level 3 and measured at fair value on a nonrecurring basis at the dates indicated:

September 30, 2021

Financial
Instrument

Valuation Technique(s)

Unobservable Input(s)

Range (Weighted Average)

OREO

Third Party Appraisals

No discounts

N/A

Impaired loans(1)

Discounted Cash Flow

Discount Rate

0-10% (5%)

Impaired loans(2)

Third Party Appraisals

No discounts

N/A

(1) Represents troubled debt restructurings included within impaired loans.

(2) Excludes troubled debt restructurings.

December 31, 2020

Financial
Instrument

Valuation Technique(s)

Unobservable Input(s)

Range
(Weighted Average)

OREO

Third Party Appraisals

No discounts

N/A

Impaired loans(1)

Discounted Cash Flow

Discount Rate

0-10% (6%)

Impaired loans(2)

Third Party Appraisals

No discounts

N/A

(1) Represents troubled debt restructurings included within impaired loans.

(2) Excludes troubled debt restructurings.

Note 6 – Mortgage Servicing Rights

The Company’s mortgage servicing rights portfolio totaled $514.0 million at September 30, 2021 compared to $488.7 million at December 31, 2020. Of this total balance, the unpaid principal balance of loans serviced for Federal National Mortgage Association (“Fannie Mae”) at September 30, 2021 and December 31, 2020 were $507.8 million and $481.6 million, respectively. The unpaid principal balance of loans serviced for other financial institutions at September 30, 2021 and December 31, 2020, totaled $6.2 million and $7.1 million, respectively. Loans serviced for others are not included in the Company’s financial statements as they are not assets of the Company.

A summary of the change in the balance of mortgage servicing assets during the periods indicated were as follows (in thousands):


	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
Beginning balance, at fair value	$	4,151	$	3,113	$	3,780	$	3,239
Servicing rights that result from transfers and sale of financial assets	185		849		1,125		1,523
Changes in fair value:
Due to changes in model inputs or assumptions and other(1)	(125)		(623)		(694)		(1,423)

Ending balance, at fair value	$	4,211	$	3,339	$	4,211	$	3,339

(1) Represents changes due to collection/realization of expected cash flows and curtailments.

The key economic assumptions used in determining the fair value of mortgage servicing rights at the dates indicated are as follows:


	September 30, 2021		December 31, 2020
Prepayment speed (Public Securities Association “PSA” model)	217	%	247	%
Weighted-average life	5.6 years		5.2 years
Discount rate	12.5	%	10.0	%

The amount of contractually specified servicing, late and ancillary fees earned on the mortgage servicing rights are included in

mortgage servicing income on the Condensed Consolidated Statements of Income and totaled $328 thousand and $961 thousand for the three and nine months ended September 30, 2021, respectively, and $260 thousand and $739 thousand for the three and nine months ended September 30, 2020, respectively.

Note 7 – Commitments and Contingencies

In the normal course of operations, the Company engages 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 clients’ requests for funding and take the form of loan commitments and lines of credit.

Note 8 – Borrowings, FHLB Stock and Subordinated Notes

The Company has a loan agreement with the FHLB of Des Moines. The terms of the agreement call for a blanket pledge of a portion of the Company’s mortgage and commercial and multifamily loan portfolio based on the outstanding balance. At September 30, 2021 and December 31, 2020, the amount available to borrow under this credit facility was $397.9 million and $390.5 million, respectively, subject to eligible pledged collateral. At September 30, 2021, the credit facility was collateralized as follows: one-to-four family mortgage loans with an advance equivalent of $77.2 million, commercial and multifamily mortgage loans with an advance equivalent of $61.4 million and home equity loans with an advance equivalent of $569 thousand. At December 31, 2020, the credit facility was collateralized as follows: one-to-four family mortgage loans with an advance equivalent of $103.6 million, commercial and multifamily mortgage loans with an advance equivalent of $128.9 million and home equity loans with an advance equivalent of $2.8 million. The Company had no outstanding borrowings under this arrangement at both September 30, 2021 and December 31, 2020. The weighted-average interest rate of the Company’s borrowings under this agreement at December 31, 2020 was 3.10%.

Additionally, the Company had outstanding letters of credit from the FHLB of Des Moines with a notional amount of $17.6 million and $21.6 million at September 30, 2021 and December 31, 2020, respectively, to secure public deposits. The remaining amount available to borrow as of September 30, 2021 and December 31, 2020, was $121.6 million and $213.7 million, respectively.

As a member of the FHLB, the Company is required to maintain a minimum level of investment in FHLB of Des Moines stock based on specific percentages of its outstanding FHLB advances. At September 30, 2021 and December 31, 2020, the Company had an investment of $1.1 million and $877 thousand, respectively in FHLB of Des Moines stock.

The Company has access to an unsecured Fed Funds line of credit from Pacific Coast Banker’s Bank. The line has a one year term maturing on June 30, 2022 and is renewable annually. As of September 30, 2021, the amount available under this line of credit was $20.0 million. There was no balance on this line of credit as of September 30, 2021 and December 31, 2020, respectively.

In September 2020, the Company issued $12.0 million of fixed to floating rate subordinated notes that mature in 2030. The subordinated notes have an initial fixed interest rate of 5.25% to, but excluding, October 1, 2025, payable semi-annually in arrears. From, and including, October 1, 2025, the interest rate on the subordinated notes will reset quarterly to a floating rate per annum equal to a benchmark rate, which is expected to be the then-current three-month term Secured Overnight Financing Rate, or SOFR, plus 513 basis points, payable quarterly in arrears. The subordinated notes mature on May 15, 2030. Prior to October 1, 2025, the Company may redeem these notes, in whole but not in part, only under certain limited circumstances set forth in the notes and are redeemable by the Company in whole or in part beginning with the interest payment date of October 1, 2025. As of both September 30, 2021 and December 31, 2020, the balance of the subordinated notes was $11.6 million.

Note 9 – Earnings Per Common Share

Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding for the period, reduced for average unallocated ESOP shares and average unvested restricted stock awards. Unvested share-based awards containing non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and are included in the computation of earnings per share. Diluted earnings per common share reflect the potential dilution that could occur if securities or other contracts to issue common stock (such as stock awards and options) were exercised or converted to common stock or resulted in the issuance of common stock that then shared in the Company’s earnings. Diluted earnings per common share is computed by dividing net income by the weighted-average number of common shares outstanding for the period increased for the dilutive effect of unexercised stock options and unvested restricted stock awards. The dilutive effect of the unexercised stock options and unvested restricted stock awards is calculated under the treasury stock method utilizing the average market value of the Company's stock for the period.

The following table summarizes the calculation of earnings per share for the periods indicated (in thousands, except per share data):


	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
Net income	$	2,592	$	2,319	$	7,294	$	5,407
Weighted-average number of shares outstanding, basic	2,587		2,563		2,582		2,558
Effect of potentially dilutive common shares	46		26		43		30
Weighted-average number of shares outstanding, diluted	2,633		2,589		2,625		2,588
Earnings per share, basic(1)(2)	$	1.00	$	0.90	$	2.81	$	2.11
Earnings per share, diluted(1)(2)	$	0.98	$	0.90	$	2.76	$	2.09

(1)The basic and diluted earnings per share amounts for the three and nine months ended September 30, 2021 include the impact of income allocated to participating securities of $17 thousand and $50 thousand, respectively.

(2)The difference between the basic and diluted earnings per share amounts for the three and nine months ended September 30, 2021 and 2020 under the Treasury Stock Method and the Two-Class Method, as prescribed in FASB ASC 260-10, Earnings Per Share, is immaterial.

There were no anti-dilutive securities at September 30, 2021 and 19,281 anti-dilutive securities at September 30, 2020.

Note 10 – Stock-based Compensation

Stock Options and Restricted Stock

The Company currently has one active shareholder approved stock-based compensation plan, the Amended and Restated 2013 Equity Incentive Plan (the "2013 Plan"). The 2013 Plan permits the grant of restricted stock, restricted stock units, stock options, and stock appreciation rights. The equity incentive plan approved by stockholders in 2008 (the"2008 Plan") expired in November 2018 and no further awards may be made under the 2008 Plan; provided, however, all awards outstanding under the 2008 Plan remain outstanding in accordance with their terms. Under the 2013 Plan, 181,750 shares of common stock were approved for awards for stock options and stock appreciation rights and 116,700 shares of common stock were approved for awards for restricted stock and restricted stock units.

As of September 30, 2021, on an adjusted basis, awards for stock options totaling 271,874 shares and awards for restricted stock totaling 142,201 shares of Company common stock have been granted, net of any forfeitures, to participants in the 2013 Plan and the 2008 Plan. Share-based compensation expense was $65 thousand and $295 thousand for the three and nine months ended months ended September 30, 2021, respectively, and was $52 thousand and $283 thousand for the three and nine months ended September 30, 2020, respectively.

Stock Option Awards

All stock option awards granted under the 2008 Plan vest in 20% annual increments commencing one year from the grant date in accordance with the requirements of the 2008 Plan. The stock option awards granted to date under the 2013 Plan provide for immediate vesting of a portion of the award with the balance of the award vesting on the anniversary date of each grant date in equal annual installments over periods of one-to-four years subject to the continued service of the participant with the Company. All of the options granted under the 2008 Plan and the 2013 Plan are exercisable for a period of 10 years from the date of grant, subject to vesting.

The following is a summary of the Company’s stock option award activity during the three months ended September 30, 2021 (dollars in thousands, except per share amounts):


	Shares	Weighted- Average Exercise Price		Weighted-Average Remaining Contractual Term in Years	Aggregate Intrinsic Value
Outstanding at July 1, 2021	95,202	$	24.35	5.21	$	1,818
Granted	—	—
Exercised	(3,616)	17.55
Forfeited	(250)	33.58
Expired	—	—
Outstanding at September 30, 2021	91,336	24.59		5.02	1,858
Exercisable	72,843	22.28		4.12	1,650
Expected to vest, assuming a 0% forfeiture rate over the vesting term	91,336	$	24.59	5.02	$	1,858

The following is a summary of the Company’s stock option award activity during the nine months ended September 30, 2021 (dollars in thousands, except per share amounts):


	Shares	Weighted- Average Exercise Price		Weighted-Average Remaining Contractual Term in Years	Aggregate Intrinsic Value
Outstanding at January 1, 2021	100,977	$	22.00	4.71	$	1,045
Granted	12,250	32.46
Exercised	(20,651)	15.99
Forfeited	(1,170)	34.93
Expired	(70)	34.29
Outstanding at September 30, 2021	91,336	24.59		5.02	1,858
Exercisable	72,843	22.28		4.12	1,650
Expected to vest, assuming a 0% forfeiture rate over the vesting term	91,336	$	24.59	5.02	$	1,858

As of September 30, 2021, there was $91 thousand of total unrecognized compensation cost related to non-vested stock options granted under the Plans. The cost is expected to be recognized over the remaining weighted-average vesting period of approximately 2.6 years.

The fair value of each option grant is estimated as of the grant date using the Black-Scholes option-pricing model. The fair value of options granted for the nine months ended September 30, 2021 and 2020 were determined using the following weighted-average assumptions as of the grant date.


	Nine Months Ended September 30,
		2021			2020
Annual dividend yield		1.60		%	1.60		%
Expected volatility		21.67		%	21.67		%
Risk-free interest rate		0.60		%	1.38		%
Expected term		6.50 years			6.50 years
Weighted-average grant date fair value per option granted		$	5.64		$	7.14

There were no options granted during the three months ended September 30, 2021 or 2020.

Restricted Stock Awards

The fair value of the restricted stock awards is equal to the fair value of the Company's stock at the date of grant. Compensation expense is recognized over the vesting period that the awards are based. The restricted stock awards granted under the 2008 Plan vest in 20% annual increments commencing one year from the grant date. The restricted stock awards granted to date under the 2013 Plan provide for immediate vesting of a portion of the award with the balance of the award vesting on the anniversary date of each of the grant date in equal annual installments over periods of one-to-four years subject to the continued service of the participant with the Company.

The following is a summary of the Company’s non-vested restricted stock award activity during the three months ended September 30, 2021:


	Shares		Weighted-Average Grant-Date Fair Value Per Share		Aggregate Intrinsic Value Per Share
Non-Vested at July 1, 2021	18,050		$	34.01
Granted	—		—
Vested	—		—
Forfeited	(420)		33.45
Non-Vested at September 30, 2021	17,630	-0.0094814404432133	$	34.02	$	44.94
Expected to vest assuming a 0% forfeiture rate over the vesting term	17,630		$	34.02	$	44.94

The following is a summary of the Company’s non-vested restricted stock award activity during the nine months ended September 30, 2021:


	Shares	Weighted-Average Grant-Date Fair Value Per Share		Aggregate Intrinsic Value Per Share
Non-Vested at January 1, 2021	17,114	$	35.03
Granted	10,168	32.46
Vested	(7,762)	33.99
Forfeited	(1,890)	34.93
Non-Vested at September 30, 2021	17,630	$	34.02	$	44.94
Expected to vest assuming a 0% forfeiture rate over the vesting term	17,630	$	34.02	$	44.94

As of September 30, 2021, there was $455 thousand of unrecognized compensation cost related to non-vested restricted stock granted under the Plans. The cost is expected to be recognized over the weighted-average vesting period of 2.5 years. The total fair value of shares vested for the nine months ended September 30, 2021 and 2020 was $264 thousand and $236 thousand, respectively.

Employee Stock Ownership Plan

In January 2008, the ESOP borrowed $1.2 million from the Company to purchase common stock of the Company which was paid in full in 2017. In August 2012, in conjunction with the Company’s conversion to a full stock company from the mutual holding company structure, the ESOP borrowed an additional $1.1 million from the Company to purchase common stock of the Company. The loan is being repaid principally by the Bank through contributions to the ESOP over a period of ten years. The interest rate on the loan is fixed at 2.25% per annum. As of September 30, 2021, the remaining balance of the ESOP loan was $126 thousand.

Neither the loan balance nor the related interest expense is reflected on the condensed consolidated financial statements.

At September 30, 2021, the ESOP held and is committed to release 11,340 shares of the Company’s common stock to participants during 2021. The fair value of the 147,766 shares held by the ESOP trust was $6.8 million at September 30, 2021. ESOP compensation expense included in salaries and benefits was $180 thousand and $530 thousand for the three and nine months ended September 30, 2021, respectively, and $126 thousand and $474 thousand for the three and nine months ended September 30, 2020, respectively.

Note 11 – Leases

We have operating leases for branch locations, a loan production office, our corporate office and in the past, for certain equipment. The lease term for our leases begins on the date we become legally obligated for the rent payments or we take possession of the building, whichever is earlier. Generally, our real estate leases have initial terms of three to ten years and

typically include one renewal option. Our leases have remaining lease terms of less than one year to eight years. The operating leases generally contain renewal options and require us to pay property taxes and operating expenses for the properties.

The following table presents the lease right-of-use assets and lease liabilities recorded on the condensed consolidated balance sheet at the dates indicated (in thousands):


	September 30, 2021		December 31, 2020
Operating lease right-of-use assets	$	6,033	$	6,722
Operating lease liabilities	$	6,462	$	7,134

The following table presents the components of lease expense for the periods indicated (in thousands):


	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
Operating lease expense
Office leases	$	272	$	268	$	817	$	882
Equipment leases	—		5		—		15
Sublease income	(3)		(3)		(9)		(9)
Net lease expense	$	269	$	270	$	808	$	888

The following table presents the maturity of lease liabilities at the date indicated:


	September 30, 2021
Remainder of 2021	$	263
2022	1,016
2023	989
2024	968
2025	885
Thereafter	3,012
Total lease payments	7,133
Less: Present value discount	671
Present value of lease liabilities	$	6,462

Lease term and discount rate by lease type consist of the following at the dates indicated:


	September 30, 2021		December 31, 2020
Weighted-average remaining lease term:
Office leases	7.24 years		7.89 years
Equipment leases	0.00 years		1.42 years
Weighted-average discount rate (annualized):
Office leases	2.66	%	2.66	%
Equipment leases	—	%	1.62	%

Supplemental cash flow information related to leases was as follows for the periods indicated (in thousands):


	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
Cash paid for amounts included in the measurement of lease liabilities for operating leases:
Operating cash flows
Office leases	$	263	$	257	$	779	$	839
Equipment leases	$	—	$	5	$	—	$	15

Note 12 – Subsequent Events

On October 26, 2021, the Board of Directors of the Company declared a quarterly cash dividend of $0.17 per common share, payable on November 24, 2021 to stockholders of record at the close of business on November 10, 2021.

On October 26, 2021, the Company’s Board of Directors adopted a new stock repurchase program. Under this new repurchase program, the Company may repurchase its outstanding shares in the open market in an amount up to $2.0 million, based on prevailing market prices, or in privately negotiated transactions, over a period beginning on October 29, 2021, continuing until the earlier of the completion of the repurchase or the next six months, depending upon market conditions.

Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Special Note Regarding Forward-Looking Statements

Certain matters discussed in this Form 10-Q constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our financial condition, results of operations, plans, objectives, future performance or business. Forward-looking statements are not statements of historical fact, are based on certain assumptions and are generally identified by use of the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future or conditional verbs such as “may,” “will,” “should,” “would” and “could.” Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about, among other things, expectations of the business environment in which we operate, projections of future performance or financial items, perceived opportunities in the market, potential future credit experience, and statements regarding our mission and vision. These forward-looking statements are based upon current management expectations and may, therefore, involve risks and uncertainties. Our actual results, performance, or achievements may differ materially from those suggested, expressed, or implied by forward-looking statements as a result of a wide variety or range of factors including, but not limited to:

•the effect of the novel coronavirus disease 2019 (“COVID-19”) pandemic, including on our credit quality and business operations, as well as its impact on general economic and financial market conditions and other uncertainties resulting from the COVID-19 pandemic, such as the extent and duration of the impact on public health, the U.S. and global economies, and consumer and corporate clients, including economic activity, employment levels and market liquidity;

•changes in consumer spending, borrowing and savings habits;

•changes in economic conditions, either nationally or in our market area;

•the risks of lending and investing activities, including changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of our allowance for loan losses;

•monetary and fiscal policies of the Board of Governors of the Federal Reserve System ("Federal Reserve") and the U.S. Government and other governmental initiatives affecting the financial services industry;

•fluctuations in the demand for loans, the number of unsold homes, land and other properties;

•fluctuations in real estate values and both residential and commercial and multifamily real estate market conditions in our market area;

•our ability to access cost-effective funding;

•the potential transition away from LIBOR toward new interest rate benchmarks;

•our ability to control operating costs and expenses;

•secondary market conditions for loans and our ability to sell loans in the secondary market;

•fluctuations in interest rates;

•results of examinations of Sound Financial Bancorp and Sound Community Bank by their regulators, including the possibility that the regulators may, among other things, require us to increase our allowance for loan losses or to write-down assets, change Sound Community Bank's regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings;

•inability of key third-party providers to perform their obligations to us;

•our ability to attract and retain deposits;

•competitive pressures among financial services companies;

•our ability to successfully integrate any assets, liabilities, clients, systems, and management personnel we may acquire into our operations and our ability to realize related revenue synergies and expected cost savings and other benefits within the anticipated time frames or at all;

•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;

•our ability to keep pace with technological changes, including our ability to identify and address cyber-security risks such as data security breaches, "denial of service" attacks, "hacking" and identity theft, and other attacks on our information technology systems or on the third-party vendors who perform several of our critical processing functions;

•changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods, including as a result of the Coronavirus Aid, Relief, and Economic Securities Act of 2020 ("CARES Act") and the Consolidated Appropriations Act, 2021 ("CAA 2021");

•legislative or regulatory changes such as the Dodd-Frank Wall Street Reform and Consumer Protection Act and its implementing regulations that adversely affect our business, and the availability of resources to address such changes;

•our ability to retain or attract key employees or members of our senior management team;

•costs and effects of litigation, including settlements and judgments;

•our ability to implement our business strategies;

•staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges;

•our ability to pay dividends on our common stock;

•the possibility of other-than-temporary impairments of securities held in our securities portfolio;

•other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services, including the CARES Act, CAA 2021 and recent COVID 19 vaccination and stimulus efforts, and

•the other risks described from time to time in our filings with the U.S. Securities and Exchange Commission (the "SEC"), including this Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2020 (“2020 Form 10-K”).

We wish to advise readers not to place undue reliance on any forward-looking statements and that the factors listed above could materially affect our financial performance and could cause our actual results for future periods to differ materially from any such forward-looking statements expressed with respect to future periods and could negatively affect our stock price performance.

We do not undertake and specifically decline any obligation to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

General

Sound Financial Bancorp, a Maryland corporation, is a bank holding company for its wholly owned subsidiary, Sound Community Bank. Substantially all of Sound Financial Bancorp’s business is conducted through Sound Community Bank, a Washington state-chartered commercial bank. As a Washington commercial bank, the Bank’s regulators are the Washington Department of Financial Institutions and the Federal Deposit Insurance Corporation (the “FDIC”). The Federal Reserve is the primary federal regulator for Sound Financial Bancorp. We also sell insurance products and services for clients through Sound Community Insurance Agency, Inc., a wholly owned subsidiary of the Bank.

Sound Community Bank’s deposits are insured up to applicable limits by the FDIC. At September 30, 2021, Sound Financial Bancorp, on a consolidated basis, had assets of $928.1 million, net loans held-for-portfolio of $661.2 million, deposits of $807.7 million and stockholders’ equity of $91.9 million. The shares of Sound Financial Bancorp are traded on NASDAQ Capital Market under the symbol “SFBC.” Our executive offices are located at 2400 3rd Avenue, Suite 150, Seattle, Washington, 98121.

Our principal business consists of attracting retail and commercial deposits from the general public and investing those funds, in loans secured by first and second mortgages on one-to-four family residences (including home equity loans and lines of credit), commercial and multifamily real estate, construction and land, consumer and commercial business loans. Our commercial business loans include unsecured lines of credit and secured term loans and lines of credit secured by inventory, equipment and accounts receivable. We also offer a variety of secured and unsecured consumer loan products, including manufactured home loans, floating home loans, automobile loans, boat loans and recreational vehicle loans. As part of our business, we focus on residential mortgage loan originations, a significant portion of which we sell to Fannie Mae and other correspondents and the remainder of which we retain for our loan portfolio consistent with our asset/liability objectives. We sell loans which conform to the underwriting standards of Fannie Mae (“conforming”) in which we retain the servicing of the loan in order to maintain the direct customer relationship and to generate noninterest income. Residential loans which do not conform to the underwriting standards of Fannie Mae (“non-conforming”), are held in our loan portfolio. We originate and retain a significant amount of commercial real estate loans, including those secured by owner-occupied and nonowner-occupied commercial real estate, multifamily property, mobile home parks and construction and land development loans.

Critical Accounting Policies

Certain of our accounting policies require management to make difficult, complex or subjective judgments, which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Facts and circumstances that could affect these judgments include, but are not limited to, changes in interest rates, changes in the performance of the economy and changes in the financial condition of borrowers. Management believes that its critical accounting policies include determining the allowance for loan losses, accounting for other-than-temporary impairment of securities, accounting for mortgage servicing rights, accounting for other real estate owned and accounting for deferred income taxes. Our methodologies for analyzing the allowance for loan losses, other-than-temporary impairment, mortgage servicing rights, other real estate owned and deferred tax asset accounts are described in our 2020 Form 10-K.

COVID-19 Response

Paycheck Protection Program ("PPP") Participation. The CARES Act was signed into law on March 27, 2020, and authorized the Small Business Administration (“SBA”) to temporarily guarantee loans under a loan program called the Paycheck Protection Program, or PPP. As a qualified SBA lender, the Company was automatically authorized to originate PPP loans upon commencement of the program in April 2020. PPP loans have: (a) an interest rate of 1.0%, (b) a two-year loan term to maturity; and (c) principal and interest payments deferred for six months from the date of disbursement. The SBA guarantees 100% of the PPP loans made to eligible borrowers. The entire principal amount of the borrower’s PPP loan, including any accrued interest, is eligible to be forgiven and repaid by the SBA. The first round of the program expired on August 8, 2020, and a second round reopened the program beginning January 1, 2021 through May 31, 2021.

As of September 30, 2021, we had received SBA forgiveness for 899 PPP loans totaling $74.7 million out of the $76.4 million in PPP loans funded during the first PPP. During the nine months ended September 30, 2021, we began accepting and processing loan applications under the second PPP enacted in December 2020. As of September 30, 2021, we had funded 599 PPP loans totaling $42.8 million and had received SBA forgiveness for 550 PPP loans totaling $32.7 million under the second PPP. We had 66 PPP loans outstanding totaling $11.8 million as of September 30, 2021.

The following table summarizes our PPP participation as of September 30, 2021 (dollars in thousands):


	Funded					At September 30, 2021
	Total		Number of Loans	Average Loan Amount		Outstanding		Number of Loans
First PPP	$	76,384	916	$	83,389	$	1,674	17
Second PPP	42,787		599	71,431		10,115		49
Total PPP loans	$	119,171	1,515	$	78,661	$	11,789	66

During the three and nine months ended September 30, 2021, we recorded in interest income SBA processing fees of $1.0 million and $2.5 million, respectively, and $473 thousand and $521 thousand for the three and nine months ended September 30, 2020. In addition, interest income earned on PPP loans totaled $46 thousand and $323 thousand for the three and nine months ended September 30, 2021 and $49 thousand and $318 thousand for the three and nine months ended September 30, 2020.

Loan Modifications. We are continuing to provide payment relief for both consumer and business clients, most of which relief involves interest only or payment deferrals that range from 90 to 180 days. Deferred loans are re-evaluated at the end of the deferral period and will either return to the original loan terms or be reassessed at that time to determine if a further modification should be granted and if a downgrade in risk rating is appropriate. All of these loan modifications have been made in response to the COVID-19 pandemic.

The following table summarizes our loans under payment relief related to COVID-19 as of September 30, 2021 (dollars in thousands):


	Second Request			Third Request			Fourth Request			Total
	# of Loans	Amount		# of Loans	Amount		# of Loans	Amount		# of Loans	Amount
Residential loans (1)	1	$	67	2	$	189	3	$	677	6	$	933

(1)Entered into a forbearance agreement with a weighted-average loan-to-value of 75%, 37% and 72% for loans under their second, third or fourth request, respectively. The weighted-average loan-to-values are based on appraisals obtained at the time of loan origination and the current loan amount.

Of the six total loans presented above, five of these loans, or $777 thousand of the $933 thousand, are not classified as troubled debt restructurings (“TDRs”) pursuant to applicable accounting and regulatory guidance until the earlier of 60 days after the national emergency termination date or January 1, 2022. We believe the steps we are taking are necessary to effectively manage our portfolio and assist our clients through the ongoing uncertainty surrounding the duration, impact and government response to the COVID-19 pandemic.

Support for Clients, Employees and Community during Pandemic. We remain focused on keeping our employees safe and the Bank running effectively to serve its clients. The Bank is managing branch access and occupancy levels in relation to cases and close contact scenarios, following governmental restrictions and considering public health authority guidelines, and encouraging remote work and supporting employees with paid time off. As of September 30, 2021, all of our branch lobbies were open. The Company is aware of the surge in COVID-19 infections arising out of the so-called Delta variant and is prepared to restore other protocols, as may prove to be necessary.

We continue to work closely with our borrowers to evaluate pandemic related challenges. We also continue to support our not-for-profit organizations with volunteering, donations and support of both virtual and live fund raising activities.

Comparison of Financial Condition at September 30, 2021 and December 31, 2020

General. Total assets increased $66.7 million, or 7.7%, to $928.1 million at September 30, 2021 from $861.4 million at December 31, 2020. The increase was primarily a result of higher balances in loans held-for-portfolio and cash and cash equivalents, partially offset by a decrease in loans held-for-sale.

Cash and Securities. Cash and cash equivalents increased $12.9 million, or 6.6%, to $206.7 million at September 30, 2021 from $193.8 million at December 31, 2020 primarily due to significant deposit growth due to new PPP relationships and growth of existing client balances. Available-for-sale securities, which consist of municipal bonds and agency mortgage-backed securities decreased $3.2 million, or 30.9%, to $7.1 million at September 30, 2021 from $10.2 million at December 31, 2020 as a result of normal pay downs in investment securities during the nine months ended September 30, 2021 and the call of a municipal bond for $950 thousand during the second quarter of 2021.

Loans. Loans held-for-portfolio, net, increased $53.9 million, or 8.9%, to $661.2 million at September 30, 2021 from $607.4 million at December 31, 2020, driven by a $63.7 million, or 48.7%, increase in one-to-four family loans, an $18.8 million increase in construction and land loans and an $18.5 million increase in loans for floating homes during 2021, partially offset by a $27.6 million decrease in commercial business loans, resulting from the forgiveness by the SBA of $75.9 million of PPP loans, and a $19.0 million decrease in commercial and multifamily loans during the period.

The following table reflects the changes in the loan mix of our loan portfolio at September 30, 2021, as compared to December 31, 2020 (dollars in thousands):


	September 30, 2021		December 31, 2020		Amount Change		Percent Change
One-to-four family	$	194,346	$	130,657	$	63,689	48.7	%
Home equity	14,012		16,265		(2,253)		(13.9)
Commercial and multifamily	246,794		265,774		(18,980)		(7.1)
Construction and land	81,576		62,752		18,824		30.0
Manufactured homes	21,459		20,941		518		2.5
Floating homes	58,358		39,868		18,490		46.4
Other consumer	15,732		15,024		708		4.7
Commercial business	36,620		64,217		(27,597)		(43.0)
Deferred loan fees	(1,346)		(2,135)		789		(37.0)
Total loans held-for-portfolio, gross	667,551		613,363		54,188		8.8
Allowance for loan losses	(6,327)		(6,000)		(327)		5.5
Total loans held-for-portfolio, net	$	661,224	$	607,363	$	53,861	8.9	%

The increase in one-to-four family loans was driven primarily by the purchase of $24.1 million in jumbo loans during the second quarter of 2021 and the origination of $48.6 million of conforming and non-conforming jumbo loans in our portfolio. The increase in construction and land loans during the period was primarily due to new originations and disbursement of advances on previously originated loans and the increase in loans on floating homes was primarily a result of larger loan sizes, seasonal activity and a small competitive market for these types of loans. The decrease in commercial and multifamily loans was primarily due to increased payoff activity. The decrease in our commercial business loan portfolio was primarily due to SBA loan forgiveness, partially offset by our origination of 599 PPP loans totaling $42.8 million during the nine months ended September 30, 2021. At September 30, 2021, our loan portfolio, net of deferred loan fees, remained well-diversified. Commercial and multifamily real estate loans accounted for 36.9% of total loans, one-to-four family loans, including home equity loans accounted for 31.2% of total loans, commercial business loans accounted for 5.6% of total loans, and consumer loans, consisting of manufactured homes, floating homes, and other consumer loans accounted for 14.3% of total loans at

September 30, 2021. Construction and land loans accounted for 12.2% of total loans at September 30, 2021.

Allowance for Loan Losses. The allowance for loan losses is maintained to cover losses that are probable and can be estimated

on the date of evaluation in accordance with generally accepted accounting principles in the United States. It is our best estimate of probable credit losses inherent in our loan portfolio.

The following table reflects the adjustments in our allowance during the periods indicated (dollars in thousands):


	Three Months Ended September 30,						Nine Months Ended September 30,
	2021			2020			2021			2020
Balance at beginning of period	$	6,157		$	6,031		$	6,000		$	5,640
Charge-offs	(8)			(332)			(113)			(649)
Recoveries	3			14			15			72
Net charge-offs	(5)			(318)			(98)			(577)
Provision for loan losses during the period	175			275			425			925
Balance at end of period	$	6,327		$	5,988		$	6,327		$	5,988

Ratio of net charge-offs during the period to average loans outstanding during the period	—		%	(0.18)		%	(0.02)		%	(0.12)		%


	September 30, 2021		December 31, 2020
Allowance as a percentage of nonperforming loans (end of period)	206.16	%	208.04	%
Allowance as a percentage of total loans (end of period)	0.95	%	0.98	%

Our allowance for loan losses increased $327 thousand, or 5.5%, to $6.3 million at September 30, 2021, from $6.0 million at December 31, 2020.

Specific loan loss reserves decreased to $281 thousand at September 30, 2021, compared to $378 thousand at December 31, 2020, while general loan loss reserves decreased to $5.1 million at September 30, 2021, compared to $5.2 million at December 31, 2020 and the unallocated reserve increased to $962 thousand at September 30, 2021, compared to $406 thousand at December 31, 2020. The increase in the unallocated reserve was primarily a result of the increase in the loan portfolio at September 30, 2021, partially offset by a positive adjustment in the qualitative factors applied to real estate related loans as a result of the improvement in economic conditions related to the strong housing market. The $11.8 million balance of PPP loans was omitted from the calculation for the allowance for loan losses at September 30, 2021, as these loans are 100% guaranteed by the SBA and management expects that the majority of the remaining PPP borrowers will seek full or partial forgiveness of their loan obligations from the SBA within a short time frame, which in turn will reduce the Bank’s loan balance for the amount forgiven. Net charge-offs for the three and nine months ended September 30, 2021 totaled $5 thousand and $98 thousand, respectively, compared to net charge-offs of $318 thousand and $577 thousand for the three and nine months ended September 30, 2020, respectively. At September 30, 2021, the allowance for loan losses as a percentage of total loans and nonperforming loans was 0.95% and 206.16%, respectively, compared to 0.98% and 208.04%, respectively, at December 31, 2020. See “Comparison of Results of Operations for the Three and Nine Months Ended September 30, 2021 and 2020 — Provision for Loan Losses.”

Mortgage Servicing Rights. The fair value of mortgage servicing rights was $4.2 million at September 30, 2021, an increase of $431 thousand, or 11.4%, from $3.8 million at December 31, 2020. We record mortgage servicing rights on loans sold with servicing retained and upon acquisition of a servicing portfolio. Mortgage servicing rights are carried at fair value. If the fair value of our mortgage servicing rights fluctuates significantly, our financial results could be materially impacted.

Nonperforming Assets. At September 30, 2021, nonperforming assets totaled $3.7 million, or 0.40% of total assets, compared to $3.5 million, or 0.40% of total assets at December 31, 2020.

The table below sets forth the amounts and categories of nonperforming assets at the dates indicated (dollars in thousands):


	Nonperforming Assets
	September 30, 2021		December 31, 2020		Amount Change		Percent Change
Nonaccrual loans	$	2,658	$	2,710	$	(52)	(1.9)	%
Nonperforming TDRs	411		174		237		135.9
Total nonperforming loans	3,069		2,884		185		6.4
OREO and repossessed assets	659		594		65		10.9
Total nonperforming assets	$	3,728	$	3,478	$	250	7.2	%

Nonperforming loans increased $185 thousand, or 6.4%, to $3.1 million at September 30, 2021 from $2.9 million at December 31, 2020. The percentage of nonperforming loans to total loans was 0.46% at September 30, 2021, compared to 0.47% of total loans at December 31, 2020.

Deposits. Total deposits increased $59.7 million, or 8.0%, to $807.7 million at September 30, 2021 from $748.0 million at December 31, 2020. The increase was due primarily to stimulus funds deposited, developing further relationships with PPP borrowers who were not previously clients, as well as reduced withdrawals reflecting changes in customer spending habits due to the COVID-19 pandemic. We continue our efforts to grow noninterest-bearing deposits, which increased $62.4 million, or 47.1%, to $194.8 million at September 30, 2021, compared to $132.5 million at December 31, 2020. Noninterest-bearing deposits represented 24.1% of total deposits at September 30, 2021, compared to 17.7% at December 31, 2020.

A summary of deposit accounts with the corresponding weighted-average cost of funds at the dates indicated is presented below (dollars in thousands):


	September 30, 2021				December 31, 2020
	Amount		Wtd. Avg. Rate		Amount		Wtd. Avg. Rate
Noninterest-bearing demand	$	190,284	—	%	$	129,299	—	%
Interest-bearing demand	311,303		0.21		230,492		0.44
Savings	99,747		0.09		83,778		0.27
Money market	82,314		0.22		65,748		0.39
Time deposits	119,441		1.67		235,473		2.40
Escrow (1)	4,564		—		3,191		—
Total deposits	$	807,653	0.47	%	$	747,981	1.06	%

(1) Escrow balances shown in noninterest-bearing deposits on the consolidated balance sheets.

Scheduled maturities of time deposits at September 30, 2021, are as follows (in thousands):


Year Ending December 31,	Amount
2021	$	21,405
2022	49,085
2023	38,421
2024	3,940
2025	4,800
Thereafter	1,790
	$	119,441

Savings, demand, and money market accounts have no contractual maturity. Certificates of deposit have maturities of five years or less.

The aggregate amount of time deposits in denominations of more than $250,000 at September 30, 2021 and December 31, 2020, totaled $25.5 million and $79.9 million, respectively. Deposits in excess of $250,000 are not federally insured.

Stockholders’ Equity. Total stockholders’ equity increased $6.4 million, or 7.5%, to $91.9 million at September 30, 2021, from $85.5 million at December 31, 2020. This increase primarily reflects $7.3 million in net income for the nine months ended September 30, 2021, partially offset by the payment of cash dividends of $1.6 million to common stockholders during the nine months ended September 30, 2021.

Average Balances, Net Interest Income, Yields Earned and Rates Paid

The following table presents, for the periods indicated, the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates. Income and yields on tax-exempt obligations have not been computed on a tax equivalent basis. All average balances are daily average balances. Nonaccrual loans have been included in the table as loans carrying a zero yield for the period they have been on nonaccrual (dollars in thousands).


	Three Months Ended September 30,
	2021							2020
	Average Outstanding Balance		Interest Earned/ Paid			Yield/ Rate Annualized		Average Outstanding Balance		Interest Earned/ Paid			Yield/ Rate Annualized
Interest-earning assets:
Loans receivable	$	652,251	$	8,967		5.45	%	$	693,524	$	8,422		4.83	%
Investments, cash and cash equivalents	229,802		135			0.23		117,660		86			0.29
Total interest-earning assets (1)	882,053		9,102			4.09		811,184		8,508			4.17
Interest-bearing liabilities:
Savings and money market accounts	179,164		42			0.09		132,271		85			0.26
Demand and NOW accounts	311,273		141			0.18		199,021		242			0.48
Certificate accounts	135,757		434			1.27		239,296		1,411			2.35
Subordinated notes	11,616		168			5.74		1,692		23			5.41
Borrowings	2		—			—		40,527		87			0.85
Total interest-bearing liabilities	637,812		785			0.49	%	612,807		1,848			1.20	%
Net interest income			$	8,317						$	6,660
Net interest rate spread						3.61	%						2.97	%
Net earning assets	$	244,241						$	198,377
Net interest margin						3.74	%						3.27	%
Average interest-earning assets to average interest-bearing liabilities			138.29		%					132.37		%
Total deposits	808,697		617			0.30	%	715,231		1,738			0.97	%
Total funding(2)	820,315		785			0.38	%	757,450		1,848			0.97	%

(1) Calculated net of deferred loan fees, loan discounts and loans in process.

(2) Total funding is the sum of average interest-bearing liabilities and average noninterest-bearing deposits. The cost of total funding is calculated as annualized total interest expense divided by average total funding.


	Nine Months Ended September 30,
	2021							2020
	Average Outstanding Balance		Interest Earned/ Paid			Yield/ Rate Annualized		Average Outstanding Balance		Interest Earned/ Paid			Yield/ Rate Annualized
Interest-earning assets:
Loans receivable	$	636,352	$	25,152		5.28	%	$	666,090	$	25,463		5.09	%
Investments, cash and cash equivalents	236,495		365			0.21		82,799		400			0.64
Total interest-earning assets (1)	872,847		25,517			3.91	%	748,889		25,863			4.60
Interest-bearing liabilities:
Savings and money market accounts	167,253		144			0.12		122,545		252			0.27
Demand and NOW accounts	281,933		485			0.23		178,712		688			0.51
Certificate accounts	174,712		2,178			1.67		244,480		4,406			2.40
Subordinated notes	11,606		504			5.81		568		23			5.39
Borrowings	1		—			—		20,244		209			1.38
Total interest-bearing liabilities	635,505		3,311			0.70	%	566,549		5,578			1.31	%
Net interest income			$	22,206						$	20,285
Net interest rate spread						3.21	%						3.29	%
Net earning assets	$	237,342						$	182,340
Net interest margin						3.40	%						3.61	%
Average interest-earning assets to average interest-bearing liabilities			137.35		%					132.18		%
Total deposits	798,384		2,807			0.47	%	673,042		5,346			1.06	%
Total funding(2)	809,991		3,311			0.55	%	693,854		5,578			1.07	%

(1) Calculated net of deferred loan fees, loan discounts and loans in process.

Rate/Volume Analysis

The following schedule presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between changes related to outstanding balances and changes due to interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate multiplied by old volume). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate (dollars in thousands).


	Three Months Ended September 30, 2021 vs. 2020						Nine Months Ended September 30, 2021 vs. 2020
	Increase (Decrease) due to				Total Increase (Decrease)		Increase (Decrease) due to				Total Increase (Decrease)
	Volume		Rate				Volume		Rate
Interest-earning assets:
Loans receivable	$	(567)	$	1,112	$	545	$	(1,175)	$	864	$	(311)
Investments, cash and cash equivalents	66		(17)		49		237		(272)		(35)
Total interest-earning assets	(501)		1,095		594		(938)		592		(346)
Interest-bearing liabilities:
Savings and Money Market accounts	11		(54)		(43)		38		(146)		(108)
Demand and NOW accounts	51		(152)		(101)		178		(381)		(203)
Certificate accounts	(331)		(646)		(977)		(870)		(1,358)		(2,228)
Subordinated notes	144		1		145		479		2		481
Borrowings	—		(87)		(87)		—		(209)		(209)
Total interest-bearing liabilities	$	(125)	$	(938)	$	(1,063)	$	(175)	$	(2,092)	$	(2,267)
Change in net interest income					$	1,657					$	1,921

Comparison of Results of Operation for the Three and Nine Months Ended September 30, 2021 and 2020

General.

Q3 2021 vs Q3 2020. Net income increased $257 thousand, or 11.0%, to $2.6 million, or $0.98 per diluted common share, for the three months ended September 30, 2021, compared to $2.3 million, or $0.90 per diluted common share, for the three months ended September 30, 2020. The increase in net income was primarily the result of higher interest income, lower interest expense paid on deposits and a lower provision for loan losses, partially offset by a decrease in noninterest income, higher interest expense paid on subordinated notes, and an increase in noninterest expense.

YTD 2021 vs. YTD 2020. Net income increased $1.9 million, or 34.0%, to $7.3 million, or $2.76 per diluted common share, for the nine months ended September 30, 2021, compared to $5.4 million, or $2.09 per diluted common share, for the nine months ended September 30, 2020. The increase was primarily a result of a $2.3 million decrease in interest expense, an increase in noninterest income of $1.5 million and a $500 thousand decrease in the provision for loan losses for the nine months ended September 30, 2021, partially offset by a $1.6 million increase in noninterest expense.

Interest Income

Q3 2021 vs Q3 2020. Interest income increased $594 thousand, or 7.0%, to $9.1 million for the three months ended September 30, 2021, from $8.5 million for the three months ended September 30, 2020, primarily due to a 62 basis point increase in the average loan yield, partially offset by lower average loan balances. Interest income on loans increased $545 thousand, or 6.5%, to $9.0 million for the three months ended September 30, 2021, compared to $8.4 million for the three months ended September 30, 2020. The average balance of total loans was $652.3 million for the three months ended September 30, 2021, compared to $693.5 million for the three months ended September 30, 2020 resulting primarily from the decline in commercial and multifamily loans and commercial business loans. The average yield on total loans was 5.45% for three months ended September 30, 2021, compared to 4.83% for the three months ended September 30, 2020. The average yield on loans increased primarily due to the recognition of net deferred fees from SBA’s forgiveness of PPP loans during the period, partially offset by adjustable rate loans resetting downward. For the three months ended September 30, 2021, the average balance of PPP loans was $19.0 million and the average yield on PPP loans was 22.37%, including the recognition of the net deferred fees, with a positive impact on loan yield of 51 basis points. For the three months ended September 30, 2020, the average balance of PPP loans was $74.3 million and the average yield on PPP loans was 2.80%, including the recognition of deferred fees, with a negative impact on loan yield of 24 basis points. Interest income included $1.1 million in fees earned related to PPP loans in the three months ended September 30, 2021, compared to $522 thousand in the same period a year ago. At September 30, 2021, PPP deferred loan origination fees of $300 thousand remain to be accreted into interest income during the remaining life of the loans. The impact of PPP loans on loan yields will change during any period based on the volume of

prepayments or amounts forgiven by the SBA as certain criteria are met, but is expected to cease completely after the two- or five-year maturity of the loans.

Interest income on the investment portfolio and cash and cash equivalents increased $49 thousand, or 57.0%, to $135 thousand for the three months ended September 30, 2021, compared to $86 thousand for the three months ended September 30, 2020. The increase in the interest income on investment securities and cash and cash equivalents was due to significantly higher average balances, partially offset by lower average yields. The average balance on investments and cash and cash equivalents was $229.8 million for the three months ended September 30, 2021, compared to $117.7 million for the three months ended September 30, 2020. The substantial increase was due to higher average cash balances primarily due to the increase in deposit balances related to new and existing clients increasing their deposit balances. This excess liquidity negatively impacted the average yield on investments and cash and cash equivalents, which decreased to 0.23% for the three months ended September 30, 2021, compared to 0.29% for the three months ended September 30, 2020.

YTD 2021 vs. YTD 2020. Interest income decreased $346 thousand, or 1.3%, to $25.5 million for the nine months ended September 30, 2021, from $25.9 million for the nine months ended September 30, 2020. The decrease was primarily due to a 69 basis point decline in average yield on interest-earning assets. Interest income on loans decreased $311 thousand, or 1.2%, to $25.2 million for the nine months ended September 30, 2021, compared to $25.5 million for the nine months ended September 30, 2020, driven by lower average total loans resulting primarily from the decline in commercial and multifamily loans and commercial business loans, partially offset a 19 basis points increase in the average yield on loans. The average balance of total loans was $636.4 million for the nine months ended September 30, 2021, compared to $666.1 million for the nine months ended September 30, 2020. The average yield on total loans was 5.28% for the nine months ended September 30, 2021, compared to 5.09% for the nine months ended September 30, 2020. For the nine months ended September 30, 2021, the average balance of PPP loans was $44.2 million and the average yield on PPP loans was 8.55%, including the recognition of the net deferred fees, with a positive impact on average loan yield of 24 basis points. For the nine months ended September 30, 2020, the average balance of PPP loans was $42.4 million and the average yield on PPP loans was 2.64%, including the recognition of deferred fees, with a negative impact on average loan yield of 17 basis points. Interest income included $2.8 million in fees earned related to PPP loans in the nine months ended September 30, 2021, compared to $840 thousand in the same period a year ago.

Interest income on the investment portfolio and cash and cash equivalents decreased $35 thousand, or 8.8%, to $365 thousand for the nine months ended September 30, 2021, compared to $400 thousand for the nine months ended September 30, 2020. The decrease in the interest income on investment securities and cash and cash equivalents was due to lower average yields, partially offset by higher average balances. The average yield on investments and cash and cash equivalents was 0.21% for the nine months ended September 30, 2021, compared to 0.64% for the nine months ended September 30, 2020, primarily due to the substantial increase in cash and cash equivalents earning a nominal yield.

Interest Expense

Q3 2021 vs Q3 2020. Interest expense decreased $1.1 million, or 57.5%, to $785 thousand for the three months ended September 30, 2021, from $1.8 million for the three months ended September 30, 2020, primarily as a result of declining deposit costs, a higher percentage of noninterest bearing deposits to total deposits and repayment of FHLB advances, partially offset by the interest expense on subordinated notes issued in the third quarter of 2020.

Interest expense on deposits decreased $1.1 million, or 64.5%, to $617 thousand for the three months ended September 30, 2021, compared to $1.7 million for the same period a year ago. The decrease was primarily the result of a decline in the average cost of deposits reflecting reduced rates paid on all deposits and a $103.5 million or 43.3% decline in the average balance of higher cost certificate accounts. In addition, deposit costs were favorably impacted by a $37.9 million increase in average noninterest bearing deposits to $182.5 million for the three months ended September 30, 2021, compared to $144.6 million for the same period last year. The average cost of total deposits decreased 67 basis points to 0.30% for the quarter ended September 30, 2021, from 0.97% for the quarter ended September 30, 2020.

Interest expense on borrowings and subordinated notes increased $58 thousand, or 52.7%, to $168 thousand for the three months ended September 30, 2021, comprised solely of interest expense on our subordinated notes, compared to $110 thousand for the three months ended September 30, 2020, comprised primarily of interest expense on our FHLB advances. Average borrowings and subordinated notes decreased $30.6 million, to $11.6 million at September 30, 2021, consisting solely of subordinated notes, from $42.2 million at September 30, 2020, which consisted primarily of FHLB advances. The average cost of subordinated notes was 5.74% for the three months ended September 30, 2021, and the average cost of the subordinated notes and FHLB advances was 1.04% for the three months ended September 30, 2020.

YTD 2021 vs. YTD 2020. Interest expense decreased $2.3 million, or 40.6%, to $3.3 million for the nine months ended September 30, 2021, from $5.6 million for the nine months ended September 30, 2020, primarily as a result of declining deposit costs and a higher percentage of noninterest bearing deposits to total deposits.

Interest expense on deposits decreased $2.5 million, or 47.5%, to $2.8 million for the nine months ended September 30, 2021, compared to $5.3 million for the same period a year ago. The decrease was primarily the result of a decline in the average cost of deposits reflecting reduced market rates paid on deposits. The average cost of total deposits decreased 59 basis points to 0.47% for the nine months ended September 30, 2021, from 1.06% for the nine months ended September 30, 2020.

Interest expense on borrowings and subordinated notes increased $272 thousand, or 117.2%, to $504 thousand for the nine months ended September 30, 2021, comprised solely of interest expense on our subordinated notes, compared to $232 thousand for the nine months ended September 30, 2020, which was related primarily to FHLB advances. Average borrowings and subordinated notes decreased $9.2 million, to $11.6 million at September 30, 2021, consisting solely of subordinated notes, from $20.8 million at September 30, 2020, which consisted primarily of FHLB advances. The average cost of the subordinated notes and FHLB advances was 5.81% for the nine months ended September 30, 2021, compared to 1.48% for the nine months ended September 30, 2020.

Net Interest Income.

Q3 2021 vs Q3 2020. Net interest income increased $1.7 million, or 24.9%, to $8.3 million for the three months ended September 30, 2021, from $6.7 million for the three months ended September 30, 2020. Our net interest margin was 3.74% and 3.27% for the three months ended September 30, 2021 and 2020, respectively. The increase in net interest income primarily resulted from the decline in the average rate paid on deposits and higher interest income. The increase in net interest margin was primarily due to decline in rates paid on interest-bearing liabilities following decreases in the short-term market rates in the second quarter of 2020 exceeding the decline in yields earned on interest-earning assets. During the third quarter of 2021, the average yield earned on PPP loans, including the recognition of the net deferred fees for PPP loans repaid and forgiven by the SBA, resulted in a positive impact to the net interest margin of 41 basis points, compared to a negative impact of five basis points from our origination of low yielding PPP loans during the quarter ended September 30, 2020.

YTD 2021 vs. YTD 2020. Net interest income increased $1.9 million, or 9.5%, to $22.2 million for the nine months ended September 30, 2021, from $20.3 million for the nine months ended September 30, 2020. Our net interest margin was 3.40% and 3.61% for the nine months ended September 30, 2021, respectively. The increase in net interest income primarily resulted from the decline in the average rate paid on deposits, partially offset by a decline in the average loan balance. The decrease in net interest margin was primarily due to yields earned on interest-earning assets declining at a faster rate than interest rates paid on interest-bearing liabilities as changes in the average rate paid on interest-bearing deposits tend to lag changes in market interest rate. During the nine months ended September 30, 2021, the average yield earned on PPP loans, including the recognition of the net deferred fees for PPP loans repaid and forgiven by the SBA, resulted in a positive impact to the net interest margin of 27 basis points, compared to a negative impact of six basis points from our origination of low yielding PPP loans during the same period in 2020.

Provision for Loan Losses. We establish provisions for loan losses, which are charged to earnings, based on our review of the level of the allowance for loan losses required to reflect management’s best estimate of the probable incurred credit losses in the loan portfolio. In evaluating the level of the allowance for loan losses, management considers 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, peer group data, prevailing economic conditions, and current factors. Large groups of smaller balance homogeneous loans, such as one- to four- family, small commercial and multifamily, home equity and consumer loans, are evaluated in the aggregate using historical loss factors adjusted for current economic conditions and other relevant data. Loans for which management has concerns about the borrowers’ ability to repay, are evaluated individually and specific loss allocations are provided for these loans when necessary.

A provision for loan losses of $175 thousand and $425 thousand was recorded for the three and nine months ended September 30, 2021, as compared to $275 thousand and $925 thousand for the three and nine months ended September 30, 2020, respectively. The decrease in the provision for loan losses in the current quarter and nine-month period compared to the comparable periods in 2020 was primarily due to a decrease in the average balance of loans held-for-portfolio between the periods, a positive adjustment to the qualitative factors applied to real estate related loans as a result of improvement in economic conditions related to the strong housing market, and to a lesser extent a $247 thousand decrease in non-performing loans from September 30, 2020. Our allowance for loan losses as of September 30, 2021, not only reflects probable and inherent credit losses based upon the economic conditions that existed as of September 30, 2021, but also reflects the inherent economic improvements in our markets as initial COVID-19 restrictions implemented in the second quarter of last year have

been lifted. Net charge-offs for the three and nine months ended September 30, 2021 totaled $5 thousand and $98 thousand, respectively, compared to net charge-offs of $318 thousand and $577 thousand for the three and nine months ended September 30, 2020, respectively.

While we believe the estimates and assumptions used in our 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 provisions will not exceed the amount of past provisions or that any increased provisions that may be required will not adversely impact our financial condition and results of operations. Recently, we have seen most of our market areas reporting a fairly significant increase in COVID transmissions, which we understand from our public health authorities is largely attributed to lagging vaccination rates and an increase in cases related to the Delta variant. To date, we are not seeing renewed business activity restrictions in our primary markets. To the extent business activity restrictions are renewed, due to COVID-19 or otherwise, this will likely affect our business operations which may, in turn, result in a material increase our provision for loan and lease losses which would adversely affect the Company’s 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 the adjustment of reserves based upon their judgment of information available to them at the time of their examination.

Noninterest Income. Noninterest income decreased $637 thousand, or 30.8%, to $1.4 million for the three months ended September 30, 2021, as compared to $2.1 million for the three months ended September 30, 2020, as reflected below (dollars in thousands):


	Three Months Ended September 30,				Amount Change		Percent Change
	2021		2020
Service charges and fee income	$	556	$	510	$	46	9.0	%
Earnings on cash surrender value of BOLI	104		102		2		2.0
Mortgage servicing income	328		260		68		26.2
Fair value adjustment on mortgage servicing rights	(125)		(623)		498		(79.9)
Net gain on sale of loans	568		1,819		(1,251)		(68.8)
Total noninterest income	$	1,431	$	2,068	$	(637)	(30.8)	%

The decrease in noninterest income during the three months ended September 30, 2021 compared to the same period in 2020 was primarily due to the decrease in our net gain on sale of loans, partially offset by a $498 thousand improvement in the fair value adjustment on mortgage servicing rights and increases in both our mortgage servicing income of $68 thousand and service charges and fee income of $46 thousand. As a result of refinance activity slowing over the past six months, our residential loans originated for sale decreased. Loans sold during the quarter ended September 30, 2021, totaled $20.3 million, compared to $89.5 million during the quarter ended September 30, 2020. The improvement in the fair value adjustment on mortgage servicing rights resulted from loan prepayment speeds slowing during the quarter as mortgage interest rates moved slightly higher. The increase in the service charges and fee income primarily resulted from an increase in the number of checking accounts and an increase in debit card interchange fees.

Noninterest income increased $1.5 million, or 34.2%, to $5.8 million for the nine months ended September 30, 2021, as compared to $4.4 million for the nine months ended September 30, 2020, as reflected below (dollars in thousands):


	Nine Months Ended September 30,				Amount Change		Percent Change
	2021		2020
Service charges and fee income	$	1,615	$	1,433	$	182	12.7	%
Earnings on cash surrender value of BOLI	281		207		74		35.7
Mortgage servicing income	961		739		222		30.0
Fair value adjustment on mortgage servicing rights	(694)		(1,423)		729		(51.2)
Net gain on sale of loans	3,683		3,399		284		8.4
Total noninterest income	$	5,846	$	4,355	$	1,491	34.2	%

The increase in noninterest income during the nine months ended September 30, 2021, compared to the same period in 2020 was primarily due to improvement in the fair value adjustment on mortgage servicing rights, and increases in both gain on sale of loans and in mortgage servicing income. Net gain on sale of loans increased due to higher margins on our sales offsetting the

decrease in sales volume. Loans sold during the nine months ended September 30, 2021, totaled $128.3 million, compared to $176.0 million during the nine months ended September 30, 2020. Mortgage servicing income was higher as a result of our mortgage servicing portfolio increasing to $514.0 million at September 30, 2021 compared to $444.3 million at September 30, 2020.

Noninterest Expense. Noninterest expense increased $788 thousand, or 14.2%, to $6.3 million during the three months ended September 30, 2021, compared to $5.5 million during the three months ended September 30, 2020, as reflected below (dollars in thousands):


	Three Months Ended September 30,				Amount Change		Percent Change
	2021		2020
Salaries and benefits	$	3,512	$	2,880	$	632	21.9	%
Operations	1,466		1,390		76		5.5
Regulatory assessments	91		111		(20)		(18.0)
Occupancy	441		442		(1)		(0.2)
Data processing	808		707		101		14.3

Total noninterest expense	$	6,318	$	5,530	$	788	14.2	%

The increase in noninterest expense during the three months ended September 30, 2021 compared to the same period in 2020 was due to an increase in salaries and benefits of $632 thousand primarily due to higher wages and incentive compensation and lower deferred compensation, partially offset by a decrease in commission expense related to a decline in mortgage activity in third quarter of 2021 as compared to the same period in 2020. Data processing expense also increased $101 thousand due to technology investments.

Noninterest expense increased $1.6 million, or 9.4%, to $18.5 million during the nine months ended September 30, 2021, compared to $16.9 million during the nine months ended September 30, 2020, as reflected below (dollars in thousands):


	Nine Months Ended September 30,				Amount Change		Percent Change
	2021		2020
Salaries and benefits	$	10,470	$	8,933	$	1,537	17.2	%
Operations	4,033		4,109		(76)		(1.8)
Regulatory assessments	283		480		(197)		(41.0)
Occupancy	1,298		1,437		(139)		(9.7)
Data processing	2,400		1,923		477		24.8
Net gain on OREO and repossessed assets	(16)		—		(16)		(100.0)
Total noninterest expense	$	18,468	$	16,882	$	1,586	9.4	%

The increase in noninterest expense during the nine months ended September 30, 2021 compared to the same period in 2020 was primarily due to increases of $1.5 million in salaries and benefits and $477 thousand in data processing expense, partially offset by a $76 thousand decrease in operations expense, a $197 thousand decrease in regulatory assessments and a $139 thousand decrease in occupancy expense. Salaries and benefits increased primarily due to discretionary bonuses paid for added efforts associated with the Company's COVID-19 response, higher wages, lower deferred compensation and higher medical expenses during 2021 as compared to 2020. Data processing expense increased due to technology investments and variable costs associated with increased loan originations. Operations expense decreased primarily due to lower loan expenses and office operations, and regulatory assessments decreased as the nine months ended September 30, 2020 included regulatory examination costs. Occupancy expense decreased due to the closure of one branch location in June 2020.

The efficiency ratio for the quarter ended September 30, 2021 was 64.81%, compared to 63.36% for the quarter ended September 30, 2020, and was 65.83% for the nine months ended September 30, 2021, compared to 68.51% for the nine months ended September 30, 2020. The weakening in the efficiency ratio for the current quarter compared to the same period in the prior year is primarily due to higher noninterest expense, partially offset by slightly higher revenues. The improvement in the efficiency ratio for the nine months ended September 30, 2021 was primarily due to higher revenues, partially offset by higher noninterest expense.

Income Tax Expense. We incurred income tax expense of $663 thousand and $1.9 million for the three and nine months ended September 30, 2021, respectively, as compared $588 thousand and $1.4 million for the same periods in 2020. The effective tax rates for the three and nine months ended September 30, 2021 were 20.37% and 20.36%, respectively. The effective tax rates for the three and nine months ended September 30, 2020 were 20.12% and 20.34%, respectively.

Liquidity and Capital Resources

The Management Discussion and Analysis in Item 7 of the Company’s 2020 Form 10-K contains an overview of Sound Financial Bancorp’s and the Bank’s liquidity management, sources of liquidity and cash flows. This discussion updates that disclosure for the nine months ended September 30, 2021.

The Bank’s primary sources of funds are deposits, principal and interest payments on loans and borrowings. While maturities and scheduled amortization of loans are a predictable source of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. The Bank’s primary investing activity is loan originations. The Bank maintains liquidity levels it believes to be adequate to fund loan commitments, investment opportunities, deposit withdrawals and other financial commitments. At September 30, 2021, the Bank had $213.8 million in cash and investment securities available-for-sale and $3.9 million in loans held-for-sale generally available for its cash needs. Also, at September 30, 2021, the Bank had the ability to borrow an additional $121.6 million in FHLB advances based on existing collateral pledged, and could access $22.6 million through the Federal Reserve’s Discount Window. At September 30, 2021, we also had available a total of $20.0 million in credit facilities with other financial institutions, with no balance outstanding. The Bank uses these sources of funds primarily to meet ongoing commitments, pay maturing deposits and fund withdrawals and loan commitments. At September 30, 2021, outstanding loan commitments totaled $84.5 million, including unused lines and letters of credit of $34.5 million and undisbursed construction and land loans of $43.1 million. Certificates of deposit scheduled to mature in one year or less at September 30, 2021, totaled $57.8 million.

Cash and cash equivalents increased $12.9 million to $206.7 million as of September 30, 2021, from $193.8 million as of December 31, 2020. Net cash provided by operating activities was $12.0 million for the nine months ended September 30, 2021. Net cash used in investing activities totaled $57.6 million during the nine months ended September 30, 2021 and consisted primarily of increases in loans and the purchase of BOLI, partially offset by principal payments on and maturities of investment securities. The $58.4 million of net cash provided by financing activities during the nine months ended September 30, 2021 primarily was the result of a $59.7 million net increase in deposits, partially offset by the payment of $1.6 million of dividends on our common stock.

At September 30, 2021, the Company, on an unconsolidated basis, had $4.6 million in cash, noninterest-bearing deposits and liquid investments generally available for its cash needs. The Company’s principal source of liquidity is dividends and ESOP loan repayments from the Bank. The long-term ability of the Company to pay dividends to its stockholders is based primarily upon the ability of the Bank to make capital distributions to the Company. As long as the Bank remains well capitalized after each capital distribution (as evidenced by maintaining a Community Bank Leverage Ratio ("CBLR") greater than the required percentage), as discussed below, and operates in a safe and sound manner, it is management's belief that its banking regulators will continue to allow the Bank to distribute its earnings to the Company, although no assurance can be given in this regard.

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.

A summary of our off-balance sheet loan commitments at September 30, 2021, is as follows (in thousands):


	September 30, 2021
Commitments to make loans	$	6,774
Unfunded construction commitments	43,081
Unused lines of credit	34,467
Irrevocable letters of credit	150
Total loan commitments	$	84,472

Regulatory Capital

Consistent with our goal to operate a sound and profitable financial organization, we actively seek to maintain a well-capitalized status for the Bank per the regulatory framework for prompt corrective action (“PCA”). Qualifying institutions that elect to use the CBLR framework, such as the Bank and the Company, that maintain the required minimum leverage ratio will be considered to have satisfied the generally applicable risk-based and leverage capital requirements in the regulatory agencies' capital rules, and to have met the capital requirements for the well capitalized category under the agencies’ PCA framework. As of September 30, 2021, the Bank and Company’s CBLR was 10.56% and 9.80%, respectively, which exceeded the minimum requirements. See "Part I, Item 1. Business – Regulation of Sound Community Bank – Capital Rules " in the Company's 2020 Form 10-K for additional information related to regulatory capital.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The Company provided information about market risk in Item 7A of its 2020 Form 10-K. There have been no material changes in our market risk since our 2020 Form 10-K.

Item 4. Controls and Procedures

(a)Evaluation of Disclosure Controls and Procedures.

An evaluation of the Company’s disclosure controls and procedures (as defined in Rule 13a -15(e) under the Securities Exchange Act of 1934 (the “Act”), as of September 30, 2021, was carried out under the supervision and with the participation of the Company’s principal executive officer and principal financial officer, and several other members of the Company’s senior management. The Company’s principal executive officer and principal financial officer concluded that, as of September 30, 2021, the Company’s disclosure controls and procedures 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 Company’s principal executive officer and principal 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.

We intend to continually review and evaluate the design and effectiveness of the Company’s disclosure controls and procedures and to improve the Company’s controls and procedures over time and to correct any deficiencies that we may discover in the future. The goal is to ensure that senior management has timely access to all material financial and non-financial information concerning the Company’s business. While we believe the present design of the disclosure controls and procedures is effective to achieve this goal, future events affecting our business may cause the Company to modify its disclosure controls and procedures.

The Company does not expect that its disclosure controls and procedures 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 errors or mistakes. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any control procedure is also 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 and 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 (as defined in Rule 13a-15(f) under the Act) that occurred during the three months ended September 30, 2021, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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

There have been no material changes in the Risk Factors previously disclosed in Item 1A of our 2020 Form 10-K.

Item 2 Unregistered Sales of Equity Securities and use of Proceeds

(a) Not applicable.

(b)Not applicable.

(c)On April 28, 2021, the Company announced that its Board of Directors authorized a stock repurchase program. Under this repurchase program, the Company could repurchase its outstanding shares in the open market in an amount up to $2.0 million, based on prevailing market prices, or in privately negotiated transactions, over a period beginning on April 29, 2021, and expiring on October 28, 2021. The Company purchased $30 thousand of its shares under this program. On October 26, 2021, the Company’s Board of Directors adopted a new stock repurchase program. Under this new repurchase program, the Company may repurchase its outstanding shares in the open market in an amount up to $2.0 million, based on prevailing market prices, or in privately negotiated transactions, over a period beginning on October 29, 2021, continuing until the earlier of the completion of the repurchase or the next six months, depending upon market conditions. The Company’s Board of Directors also authorized management to enter into a trading plan with a registered broker-dealer in accordance with Rule 10b5-1 of the Securities Exchange Act of 1934, as amended, to facilitate repurchases of its common stock pursuant to the above-mentioned stock repurchase program.

The following table sets forth information with respect to our repurchases of our outstanding common shares during the three months ended September 30, 2021:


	Total Number of Shares Purchased(1)	Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Approximated Dollar Value of Shares That May Yet be Purchased Under the Plans or Programs (2)
July 1, 2021 - July 31, 2021	—	$	—	—	$	1,970,289
August 1, 2021 - August 31, 2021	100	$	45.25	—	1,970,289
September 1, 2021 - September 30, 2021	—	$	—	—	1,970,289
Total	100	$	45.25	—	$	1,970,289

________________________

(1) Includes the surrender of shares of Company common stock that the participants already own as payment of the exercise price for stock options. Shares surrendered by participants in the equity incentive plans are repurchased pursuant to the terms of the plan and applicable award agreement and not pursuant to publicly announced share repurchase programs.

(2) The Company may repurchase shares of its common stock from time-to-time in open market transactions. The timing, volume and price of purchases are made at our discretion, and are contingent upon our overall financial condition, as well as general market conditions.

Item 3 Defaults Upon Senior Securities

Nothing to report.

Item 4. Mine Safety Disclosures

Table of Contents

Not Applicable.

Item 5. Other Information

Nothing to report.

Item 6. Exhibits


Exhibits:
3.1			Articles of Incorporation of Sound Financial Bancorp, Inc. (incorporated herein by reference to the Registration Statement on Form S-1 filed with the SEC on March 27, 2012 (File No. 333-180385))
3.2			Amended and Restated Bylaws of Sound Financial Bancorp, Inc. (incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on October 26, 2021 (File No. 001-35633))
4.1			Form of Common Stock Certificate of Sound Financial Bancorp, Inc. (incorporated herein by reference to the Registration Statement on Form S-1 filed with the SEC on March 27, 2012 (File No. 333-180385))
4.2			Description of capital stock (incorporated herein by reference to the Annual Report on Form 10-K for the year ended December 31, 2019 (File No. 001-35633))
4.3			Forms of 5.25% Fixed-to-Floating Rate Subordinated Note due October 1, 2030 (included as Exhibit A to the Subordinate Note Purchase Agreement included in Exhibit 10.16) (incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on September 21, 2020 (File No. 001-35633)).
10.1			Amended and Restated Employment Agreement dated January 25, 2019, by and between Sound Community Bank and Laura Lee Stewart (incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on January 30, 2019 (File No. 001-35633))
10.2			Amended and Restated Supplemental Executive Retirement Agreement by and between Sound Community Bank and Laura Lee Stewart (incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on November 27, 2015 (File No. 001-35633))
10.3			Amended and Restated Long Term Compensation Agreement by and between Sound Community Bank and Laura Lee Stewart (incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on November 27, 2015 (File No. 001-35633))
10.4			Amended and Restated Confidentiality, Non-Competition and Non-Solicitation Agreement by and between Sound Community Bank and Laura Lee Stewart (incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on December 16, 2019 (File No. 001-35633))
10.5			2008 Equity Incentive Plan (incorporated herein by reference to the Annual Report on Form 10-K filed with the SEC on March 31, 2009 (File No. 000-52889))
10.6			Forms of Incentive Stock Option Agreement, Non-Qualified Stock Option Agreement and Restricted Stock Agreements under the 2008 Equity Incentive Plan (incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on January 29, 2009 (File No. 000-52889))
10.7			Summary of Annual Bonus Plan (incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on February 3, 2020 (File No. 000-35633))
10.8			2013 Equity Incentive Plan (included as Exhibit 10.13 to the Registrant's Quarterly Report on Form 10-Q/A for the quarter ended September 30, 2013 and incorporated herein by reference (File No. 001-35633))
10.9			Form of Incentive Stock Option Agreement, Non-Qualified Stock Option Agreement and Restricted Stock Agreement under the 2013 Equity Incentive Plan (included as Exhibit 10.14 to the Registrant's Quarterly Report on Form 10-Q/A for the quarter ended September 30, 2013 and incorporated herein by reference (File No. 001-35633))
10.10			Form of Adoption Agreement for the Sound Community Bank Nonqualified Deferred Compensation Plan (incorporated herein by reference to the Annual Report on Form 10-K filed with the SEC on March 30, 2021 (File No. (001-35633))
10.11			The Sound Community Bank Nonqualified Deferred Compensation Plan (incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on March 24, 2017 (File No. 001-35633))
10.12			Change of Control Agreement dated October 25, 2018, by and among Sound Financial Bancorp, Inc., Sound Community Bank and Heidi Sexton (incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on October 26, 2018 (File No. (001-35633))
10.13			Credit Union of the Pacific Incentive Compensation Achievement Plan, dated January 1, 1994 (incorporated herein by reference to the Annual Report on Form 10-K filed with the SEC on March 14, 2019 (File No. (001-35633))
10.14			Form of Subordinated Note Purchase Agreement, dated September 18, 2020, by and among Sound Financial Bancorp, Inc. and the Purchasers (incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on September 21, 2020 (File No. 001-35633)).
10.15			Change in Control Agreement dated August 25, 2021 by and among Sound Financial Bancorp, Inc., Sound Community Bank and Wes Ochs (incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on August 31, 2021 (File No. 001-35633)).
31.1			Rule 13(a)-14(a) Certification (Chief Executive Officer)
31.2			Rule 13(a)-14(a) Certification (Chief Financial Officer)
32			Section 1350 Certification
101			The following financial statements from the Sound Financial Bancorp, Inc. Quarterly Report on Form 10-Q for the three months ended September 30, 2021, formatted in Extensive Business Reporting Language (XBRL): (i) condensed consolidated balance sheets, (ii) condensed consolidated statements of income, (iii) condensed consolidated statements of comprehensive income, (iv) condensed consolidated statements of equity (v) condensed consolidated statements of cash flows and (vi) the notes to condensed consolidated financial statements
104			Cover Page Interactive Data File (embedded within the Inline XBRL document)

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.


Sound Financial Bancorp, Inc.

Date: November 8, 2021	By:	/s/ Laura Lee Stewart
		Laura Lee Stewart
		President/Chief Executive Officer
		(Principal Executive Officer)

	By:	/s/ Wes Ochs
		Wes Ochs
		Executive Vice President/Chief Strategy Officer and Chief Financial Officer
		(Principal Financial Officer)