Sound Financial Bancorp, Inc. 10-Q

Item 1. Financial Statements SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY Condensed Consolidated Balance Sheets (unaudited) (In thousands, except share and per share amounts) June 30, 2020 December 31, 2019 ASSETS Cash and cash equivalents $ 130,537 $ 55,770 Available-for-sale securities, at fair value 10,198 9,306 Loans held-for-sale 7,364 1,063 Loans held-for-portfolio 690,703 619,887 Allowance for loan losses ( 6,031 ) ( 5,640 ) Total loans held-for-portfolio, net 684,672 614,247 Accrued interest receivable 2,346 2,206 Bank-owned life insurance (“BOLI”), net 14,281 14,183 Other real estate owned (“OREO”) and repossessed assets, net 575 575 Mortgage servicing rights, at fair value 3,113 3,239 Federal Home Loan Bank (“FHLB”) stock, at cost 1,164 1,160 Premises and equipment, net 6,675 6,767 Right of use assets 7,166 7,641 Other assets 3,570 3,696 Total assets $ 871,661 $ 719,853 LIABILITIES Deposits Interest-bearing $ 551,841 $ 519,434 Noninterest-bearing demand 142,481 97,284 Total deposits 694,322 616,718 Borrowings 79,841 7,500 Accrued interest payable 204 226 Lease liabilities 7,561 8,010 Other liabilities 8,335 8,368 Advance payments from borrowers for taxes and insurance 1,163 1,305 Total liabilities 791,426 642,127 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, 2,593,152 and 2,567,389 shares issued and outstanding as of June 30, 2020 and December 31, 2019, respectively 25 25 Additional paid-in capital 26,894 26,343 Unearned shares - Employee Stock Ownership Plan (“ESOP”) ( 170 ) ( 227 ) Retained earnings 53,224 51,410 Accumulated other comprehensive income, net of tax 262 175 Total stockholders’ equity 80,235 77,726 Total liabilities and stockholders’ equity $ 871,661 $ 719,853 See notes to condensed consolidated financial statements 3 SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY Condensed Consolidated Statements of Income (unaudited) (In thousands, except share and per share amounts) Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 INTEREST INCOME Loans, including fees $ 8,631 $ 7,916 $ 17,040 $ 16,319 Interest and dividends on investments, cash and cash equivalents 77 424 314 838 Total interest income 8,708 8,340 17,354 17,157 INTEREST EXPENSE Deposits 1,749 1,622 3,607 3,088 Borrowings 63 256 123 574 Total interest expense 1,812 1,878 3,730 3,662 Net interest income 6,896 6,462 13,624 13,495 PROVISION (RECAPTURE) FOR LOAN LOSSES 400 ( 200 ) 650 ( 400 ) Net interest income after provision (recapture) for loan losses 6,496 6,662 12,974 13,895 NONINTEREST INCOME Service charges and fee income 429 479 923 925 Earnings on cash surrender value of bank-owned life insurance 90 78 105 186 Mortgage servicing income 235 256 479 498 Fair value adjustment on mortgage servicing rights ( 437 ) ( 162 ) ( 800 ) ( 486 ) Net gain on sale of loans 1,262 204 1,581 695 Total noninterest income 1,579 855 2,288 1,818 NONINTEREST EXPENSE Salaries and benefits 2,818 2,654 6,053 6,293 Operations 1,326 1,450 2,720 3,084 Regulatory assessments 120 115 369 228 Occupancy 497 546 995 1,052 Data processing 645 460 1,215 960 Net loss on OREO and repossessed assets — 7 — 9 Total noninterest expense 5,406 5,232 11,352 11,626 Income before provision for income taxes 2,669 2,285 3,910 4,087 Provision for income taxes 541 468 802 826 Net income $ 2,128 $ 1,817 $ 3,108 $ 3,261 Earnings per common share: Basic $ 0.83 $ 0.72 $ 1.21 $ 1.29 Diluted $ 0.82 $ 0.71 $ 1.20 $ 1.27 Weighted-average number of common shares outstanding: Basic 2,559,879 2,521,901 2,553,369 2,516,095 Diluted 2,579,869 2,572,190 2,584,796 2,572,704 See notes to condensed consolidated financial statements 4 SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY Condensed Consolidated Statements of Comprehensive Income (unaudited) (In thousands) Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 Net income $ 2,128 $ 1,817 $ 3,108 $ 3,261 Available for sale securities: Unrealized holding gains arising during the period 134 39 110 92 Income tax expense related to unrealized gains/losses ( 28 ) ( 8 ) ( 23 ) ( 19 ) Other comprehensive income, net of tax 106 31 87 73 Comprehensive income $ 2,234 $ 1,848 $ 3,195 $ 3,334 See notes to condensed consolidated financial statements 5 SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY Condensed Consolidated Statements of Stockholders’ Equity For the Three and Six Months Ended June 30, 2020 and 2019 (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 March 31, 2020 2,591,494 $ 25 $ 26,776 $ ( 198 ) $ 51,488 $ 156 $ 78,247 Net income 2,128 2,128 Other comprehensive income, net of tax 106 106 Share-based compensation 46 46 Cash dividends paid on common stock ($ 0.15 per share) ( 389 ) ( 389 ) Common stock surrendered ( 581 ) — Restricted shares forfeited ( 1,510 ) — Common stock options exercised 3,749 34 34 Allocation of ESOP shares 38 28 ( 3 ) 63 Balance, at June 30, 2020 2,593,152 $ 25 $ 26,894 $ ( 170 ) $ 53,224 $ 262 $ 80,235 Balance, at December 31, 2019 2,567,389 $ 25 $ 26,343 $ ( 227 ) $ 51,410 $ 175 $ 77,726 Net income 3,108 3,108 Other comprehensive income, net of tax 87 87 Share-based compensation 231 231 Restricted stock awards issued 13,600 — Cash dividends paid on common stock ($ 0.50 per share) ( 1,294 ) ( 1,294 ) Common stock surrendered ( 581 ) — Restricted shares forfeited ( 1,690 ) — Common stock options exercised 14,434 216 216 Allocation of ESOP shares 104 57 — 161 Balance, at June 30, 2020 2,593,152 $ 25 $ 26,894 $ ( 170 ) $ 53,224 $ 262 $ 80,235 6 Shares Common Stock Additional Paid -in Capital Unearned ESOP Shares Retained Earnings Accumulated Other Comprehensive Income, net of tax Total Stockholders’ Equity Balance, at March 31, 2019 2,563,828 $ 25 $ 25,802 $ ( 312 ) $ 47,252 $ 156 $ 72,923 Net income 1,817 1,817 Other comprehensive income, net of tax 31 31 Share-based compensation 48 48 Cash dividends paid on common stock ($ 0.14 per share) ( 359 ) ( 359 ) Common stock surrendered ( 1,290 ) — Restricted shares forfeited — — Common stock options exercised 950 6 6 Allocation of ESOP shares 70 29 99 Balance, at June 30, 2019 2,563,488 $ 25 $ 25,926 $ ( 283 ) $ 48,710 $ 187 $ 74,565 Balance, at December 31, 2018 2,544,059 $ 25 $ 25,663 $ ( 340 ) $ 46,165 $ 114 $ 71,627 Net income 3,261 3,261 Other comprehensive income, net of tax 73 73 Share-based compensation 87 87 Cash dividends paid on common stock ($ 0.28 per share) ( 716 ) ( 716 ) Common stock surrendered ( 2,778 ) — Restricted stock awards issued 15,925 — Common stock options exercised 6,282 38 38 Allocation of ESOP shares 138 57 195 Balance, at June 30, 2019 2,563,488 $ 25 $ 25,926 $ ( 283 ) $ 48,710 $ 187 $ 74,565 See notes to condensed consolidated financial statements 7 SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY Condensed Consolidated Statements of Cash Flows (unaudited) (In thousands) Six Months Ended June 30, 2020 2019 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 3,108 $ 3,261 Adjustments to reconcile net income to net cash from operating activities: Amortization of net discounts on investments 58 16 Provision (recapture) for loan losses 650 ( 400 ) Depreciation and amortization 486 470 Compensation expense related to stock options and restricted stock 231 87 Fair value adjustment on mortgage servicing rights 800 486 Change in right of use assets amortization 475 503 Change in lease liabilities ( 449 ) ( 416 ) Increase in cash surrender value of BOLI ( 105 ) ( 186 ) Net change in advances from borrowers for taxes and insurance ( 142 ) ( 20 ) Net gain on sale of loans ( 1,581 ) ( 695 ) Proceeds from sale of loans held-for-sale 89,662 37,962 Originations of loans held-for-sale ( 95,644 ) ( 37,405 ) Net loss on OREO and repossessed assets — 9 Change in operating assets and liabilities: Accrued interest receivable ( 140 ) 179 Other assets 126 565 Accrued interest payable ( 22 ) 58 Other liabilities ( 33 ) ( 132 ) Net cash (used in) provided by operating activities ( 2,520 ) 4,342 CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of available-for-sale securities ( 2,489 ) ( 52 ) Proceeds from principal payments, maturities and sales of available-for-sale securities 1,649 120 Net (increase) decrease in loans ( 70,557 ) 54,248 Reduction in (purchase of) BOLI 55 ( 229 ) Purchases of premises and equipment, net ( 395 ) ( 109 ) Net cash (used in) provided by investing activities ( 71,737 ) 53,978 CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in deposits 77,604 25,901 Proceeds from borrowings 87,991 81,075 Repayment of borrowings ( 15,650 ) ( 148,825 ) FHLB stock redeemed (purchased) ( 4 ) 2,624 Allocation of ESOP shares 161 195 Dividends paid on common stock ( 1,294 ) ( 716 ) Proceeds from common stock option exercises 216 38 Net cash provided by (used in) financing activities 149,024 ( 39,708 ) Net change in cash and cash equivalents 74,767 18,612 Cash and cash equivalents, beginning of period 55,770 61,810 Cash and cash equivalents, end of period $ 130,537 $ 80,422 8 SUPPLEMENTAL CASH FLOW INFORMATION: Cash paid for income taxes $ — $ 225 Interest paid on deposits and borrowings 3,730 3,604 Loans transferred from loans held-for-portfolio to OREO and repossessed assets — 494 Leases right of use assets obtained in exchange for operating lease liabilities: Right of use assets — 8,136 Lease Liabilities — 8,408 See notes to condensed consolidated financial statements 9 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 (“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 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, 2019, as filed with the SEC on March 12, 2020 (“2019 Form 10-K”). The results for the interim periods are not necessarily indicative of results for a full year. 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, retained earnings, stockholders’ equity or earnings per share. Note 2 – Accounting Pronouncements Recently Issued or Adopted On March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), which 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 ASC 310-40 for loan modifications related to the coronavirus disease (“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 the COVID-19 pandemic, 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. In March 2020, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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 10 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. The amendments in this update are effective for all entities as of 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 (ASU 2019-12). 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 Company does not expect the adoption of ASU 2019-12 to have a material impact on its 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 Company does not expect the adoption of ASU 2018-14 to have a material impact on its consolidated financial statements. In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement: Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. This ASU modifies the disclosure requirements on fair value measurements by removing the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, the policy for timing of transfers between levels, and the valuation processes for Level 3 fair value measurements. This ASU clarifies that the measurement uncertainty disclosure is to communicate information about the uncertainty in measurement as of the reporting date. The ASU adds disclosure requirements for Level 3 measurements, including changes in unrealized gains and losses for the period included in other comprehensive income for the recurring Level 3 fair value measurements held at the end of the reporting period, and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. Amendments in this ASU are effective for fiscal years beginning after December 15, 2019, 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. In June 2018, the FASB issued ASU No. 2018-07, Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. This ASU amends the accounting for share-based payments awards to nonemployees to align with the accounting for employee awards. Under the new guidance, the existing employee guidance will apply to nonemployee share-based transactions (as long as the transaction is not effectively a form of financing), with the exception of specific guidance related to the attribution of compensation cost. The cost of nonemployee awards will continue to be recorded as if the grantor had paid cash for the goods or services. In addition, the contractual term will be able to be used in lieu of an expected term in the option-pricing model for nonemployee awards. Amendments in this ASU are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018 and early adoption is permitted. The adoption of ASU No. 2018-07 on January 1, 2019 did not have a material impact on the Company's consolidated financial statements. In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. This ASU amends the hedge accounting recognition and presentation requirements in ASC 815 to improve the transparency and understandability of information conveyed to financial statement users about an entity's risk management activities by better aligning the entity's financial reporting for hedging relationships with those risk management activities and reduce the complexity of and simplify the application of hedge accounting by preparers. The amendments in this ASU permit hedge accounting for hedging relationships involving nonfinancial risk and interest rate risk by removing certain limitations in cash flow and fair value hedging relationships. In addition, the ASU requires an entity to present 11 the earnings effect of the hedging instrument in the same income statement line item in which the earnings effect of the hedged item is reported. The amendments in this ASU are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018 and early adoption is permitted. The adoption of ASU No. 2017-12 on January 1, 2019, did not have a material impact on the Company's consolidated financial statements. In March 2017, the FASB issued ASU No. 2017-08, Receivables-Nonrefundable Fees and Other Costs (Subtopic 310-20) . ASU 2017-08 is intended to amend the amortization period for certain purchased callable debt securities held at a premium. Under ASU 2017-08, the FASB is shortening the amortization period for the premium to the earliest call date. Under current GAAP, entities generally amortize the premium as an adjustment of yield over the contractual life of the instrument. ASU 2017-08 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018. The adoption of ASU No. 2017-08 on January 1, 2019 did not have a material impact on the Company's consolidated financial statements. In January 2017, the FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment , or ASU 2017-04, which eliminates Step 2 from the goodwill impairment test. ASU 2017-04 also eliminates the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. Adoption of ASU 2017-04 is required for annual or interim goodwill impairment tests in fiscal years beginning after December 15, 2019 with early adoption permitted for annual or interim goodwill impairment tests performed on testing dates after January 1, 2017. The Company’s adoption of ASU 2017-04 did not have a material impact on its 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 FASB issued ASU 2019-10, Financial Instruments- Credit Losses (Topic 326) , delaying implementation of ASU 2016-13 for SEC smaller reporting company filers until fiscal year beginning after 2022. The Bank meets the requirements of a smaller reporting company and delayed implementation of ASU 2016-13. In February 2016, FASB issued ASU No. 2016-02, Leases (Topic 842) . ASU No. 2016-02 requires lessees to recognize, on the balance sheet, the assets and liabilities arising from operating leases. A lessee should recognize a liability to make lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term. A lessee should include payments to be made in an optional period only if the lessee is reasonably certain to exercise an option to extend the lease or not to exercise an option to terminate the lease. For a finance lease, interest payments should be recognized separately from amortization of the right-of-use asset in the statement of comprehensive income. For operating leases, the lease cost should be allocated over the lease term on a generally straight-line basis. In July 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842), Targeted Improvements . This ASU amended the new leases standard to give entities another option for transition and to provide lessors with a practical expedient. The transition option allows entities to not apply the new leases standard in the comparative periods they present in their financial statements in the year of adoption. The practical expedient provides lessors with an option to not separate non-lease components from the associated lease components when certain criteria are met and requires them to account for the combined component in accordance with the new revenue standard if the associated non-lease components are the predominant components. The Company adopted these ASUs on January 1, 2019. In March 2019, FASB issued ASU 2019-01, Leases (Topic 842), Codification Improvements . The amendments in this ASU include determining the fair value of the underlying asset by lessors that are not manufacturers or dealers, requiring cash received from lessors from sales-type and direct financing leases to be presented in the cash flow statement within investing activities, and clarifying interim disclosure requirements. The effective date and transition requirements for the first and second items of this ASU are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2019 and early adoption is permitted. We have adopted the third item of this ASU and provided the required interim disclosures in this report. See Note 12- Leases for further information. 12 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 June 30, 2020 Municipal bonds $ 4,161 $ 202 $ — $ 4,363 Agency mortgage-backed securities 5,706 129 — 5,835 Total $ 9,867 $ 331 $ — $ 10,198 December 31, 2019 Municipal bonds $ 3,197 $ 173 $ — $ 3,370 Agency mortgage-backed securities 5,888 56 ( 8 ) 5,936 Total $ 9,085 $ 229 $ ( 8 ) $ 9,306 The amortized cost and fair value of AFS securities at June 30, 2020, 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. June 30, 2020 Amortized Cost Fair Value Due within one year $ 1,043 $ 1,046 Due after one year through five years 490 508 Due after five years through ten years 1,433 1,485 Due after ten years 1,195 1,324 Mortgage-backed securities 5,706 5,835 Total $ 9,867 $ 10,198 There were no pledged securities at June 30, 2020 or December 31, 2019. There were no sales of AFS securities during the three and six months ended June 30, 2020 or 2019. There were no securities in gross unrealized position at June 30, 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 December 31, 2019 (in thousands): December 31, 2019 Less Than 12 Months 12 Months or Longer Total Fair Value Unrealized Loss Fair Value Unrealized Loss Fair Value Unrealized Loss Municipal bonds $ 3,387 $ ( 8 ) $ — $ — $ 3,387 $ ( 8 ) Total $ 3,387 $ ( 8 ) $ — $ — $ 3,387 $ ( 8 ) There were no credit losses recognized in earnings during the three and six months ended June 30, 2020 or 2019 relating to the Company’s securities. At June 30, 2020, the securities portfolio consisted of 14 agency mortgage-backed securities and nine municipal securities with a total portfolio fair value of $ 10.2 million. At December 31, 2019, the securities portfolio consisted of 13 agency mortgage- 13 backed securities and eight municipal securities with a fair value of $ 9.3 million. At June 30, 2020, there were no securities in an unrealized loss position for less than 12 months or more than 12 months. At December 31, 2019, there were five 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 June 30, 2020, 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 . Additional 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. 14 Note 4 – Loans During the second quarter of 2020, as a qualified U.S. Small Business Administration’s (“SBA”) lender, the Company was automatically authorized to participate in the SBA Paycheck Protection Program (“PPP”). As of June 30, 2020, the Bank had funded PPP loans totaling $ 73.1 million. The composition of the loans-held-for portfolio at the dates indicated, excluding loans held-for-sale, was as follows (in thousands): June 30, 2020 December 31, 2019 Real estate loans: One-to-four family $ 137,988 $ 149,393 Home equity 19,286 23,845 Commercial and multifamily 273,084 261,268 Construction and land 76,089 75,756 Total real estate loans 506,447 510,262 Consumer loans: Manufactured homes 21,227 20,613 Floating homes 46,256 43,799 Other consumer 10,585 8,302 Total consumer loans 78,068 72,714 Commercial business loans 109,719 38,931 Total loans held-for-portfolio 694,234 621,907 Deferred fees ( 3,531 ) ( 2,020 ) Total loans held-for-portfolio, gross 690,703 619,887 Allowance for loan losses ( 6,031 ) ( 5,640 ) Total loans held-for-portfolio, net $ 684,672 $ 614,247 The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of June 30, 2020 (in thousands): 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 $ 199 $ 950 $ 1,149 $ 5,994 $ 131,994 $ 137,988 Home equity 19 135 154 378 18,908 19,286 Commercial and multifamily — 1,991 1,991 353 272,731 273,084 Construction and land 6 617 623 38 76,051 76,089 Manufactured homes 214 148 362 365 20,862 21,227 Floating homes — 324 324 282 45,974 46,256 Other consumer 49 78 127 136 10,449 10,585 Commercial business 242 259 501 1,533 108,186 109,719 Unallocated — 800 800 — — — $ 729 $ 5,302 $ 6,031 $ 9,079 $ 685,155 $ 694,234 15 The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of December 31, 2019 (in thousands): 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 $ 205 $ 915 $ 1,120 $ 8,620 $ 140,773 $ 149,393 Home equity 25 153 178 335 23,510 23,845 Commercial and multifamily — 1,696 1,696 353 260,915 261,268 Construction and land 7 485 492 1,215 74,541 75,756 Manufactured homes 349 131 480 440 20,173 20,613 Floating homes — 283 283 290 43,509 43,799 Other consumer 54 58 112 143 8,159 8,302 Commercial business 84 247 331 997 37,934 38,931 Unallocated — 948 948 — — — Total $ 724 $ 4,916 $ 5,640 $ 12,393 $ 609,514 $ 621,907 The following tables summarize the activity in the allowance for loan losses for the three and six months ended June 30, 2020 (in thousands): Beginning Allowance Charge-offs Recoveries Provision (Recapture) Ending Allowance One-to-four family $ 1,129 $ — $ 4 $ 16 $ 1,149 Home equity 166 — 37 ( 49 ) 154 Commercial and multifamily 1,918 — — 73 1,991 Construction and land 499 — — 124 623 Manufactured homes 482 — — ( 120 ) 362 Floating homes 318 — — 6 324 Other consumer 121 ( 11 ) 8 9 127 Commercial business 395 ( 300 ) — 406 501 Unallocated 865 — — ( 65 ) 800 Total $ 5,893 $ ( 311 ) $ 49 $ 400 $ 6,031 16 Beginning Allowance Charge-offs Recoveries Provision (Recapture) Ending Allowance One-to-four family $ 1,120 $ — $ 8 $ 21 $ 1,149 Home equity 178 — 39 ( 63 ) 154 Commercial and multifamily 1,696 — — 295 1,991 Construction and land 492 — — 131 623 Manufactured homes 480 — — ( 118 ) 362 Floating homes 283 — — 41 324 Other consumer 112 ( 17 ) 11 21 127 Commercial business 331 ( 300 ) — 470 501 Unallocated 948 — — ( 148 ) 800 Total $ 5,640 $ ( 317 ) $ 58 $ 650 $ 6,031 The following tables summarize the activity in the allowance for loan losses for the three and six months ended June 30, 2019 (in thousands): Beginning Allowance Charge-offs Recoveries (Recapture) Provision Ending Allowance One-to-four family $ 1,189 $ — $ — $ ( 50 ) $ 1,139 Home equity 229 — 4 ( 68 ) 165 Commercial and multifamily 1,035 — — 432 1,467 Construction and land 996 — — ( 532 ) 464 Manufactured homes 511 — — ( 48 ) 463 Floating homes 254 — — 8 262 Other consumer 120 ( 12 ) — 12 120 Commercial business 424 — 1 84 509 Unallocated 819 — — ( 38 ) 781 Total $ 5,577 $ ( 12 ) $ 5 $ ( 200 ) $ 5,370 17 Beginning Allowance Charge-offs Recoveries Provision (Recapture) Ending Allowance One-to-four family $ 1,314 $ — $ — $ ( 175 ) $ 1,139 Home equity 202 — 7 ( 44 ) 165 Commercial and multifamily 1,638 — — ( 171 ) 1,467 Construction and land 431 — — 33 464 Manufactured homes 427 — — 36 463 Floating homes 265 — — ( 3 ) 262 Other consumer 112 ( 32 ) 20 20 120 Commercial business 356 — 1 152 509 Unallocated 1,029 — — ( 248 ) 781 Total $ 5,774 $ ( 32 ) $ 28 $ ( 400 ) $ 5,370 Credit Quality Indicators. Federal regulations provide for the classification of lower quality loans as substandard, doubtful or loss. An asset is considered substandard if it is inadequately protected by the current net worth and payment capacity of the borrower or of any collateral pledged. Substandard assets include those characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. Assets classified as doubtful have all the weaknesses inherent in assets classified substandard with the added characteristic that the weaknesses make collection or liquidation of the assets 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 establishment of a specific loss reserve is not warranted. When we classify problem loans as either substandard or doubtful, we may establish a specific allowance in an amount we deem prudent to address the risk specifically (if the loan is impaired) or we may allow the loss to be addressed in the general allowance (if the loan is not impaired). General allowances represent loss reserves 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 loans. When the Company classifies problem loans as a loss, we charge-off such assets in the period in which they are deemed uncollectible. Assets that do not currently expose us to sufficient risk to warrant classification as substandard, doubtful or loss, but possess identified weaknesses, are classified as either watch or special mention assets. 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, the Bank’s federal regulator, and the Washington Department of Financial Institutions, the Bank’s state banking regulator, both of whom can order the establishment of additional loss allowances. Pass rated loans are loans that are not otherwise classified or criticized. The following table presents the internally assigned grades as of June 30, 2020, by type of loan (in thousands): One-to- four family Home equity Commercial and multifamily Construction and land Manufactured homes Floating homes Other consumer Commercial business Total Grade: Pass $ 118,686 $ 17,920 $ 231,980 $ 25,788 $ 19,966 $ 45,725 $ 10,542 $ 105,242 $ 575,849 Watch 14,470 735 31,262 42,989 1,030 — — 1,159 91,645 Special Mention — — 4,950 7,263 — — — 519 12,732 Substandard 4,832 631 4,892 49 231 531 43 2,799 14,008 Doubtful — — — — — — — — — Loss — — — — — — — — — Total $ 137,988 $ 19,286 $ 273,084 $ 76,089 $ 21,227 $ 46,256 $ 10,585 $ 109,719 $ 694,234 18 The following table presents the internally assigned grades as of December 31, 2019, by type of loan (in thousands): One-to- four family Home equity Commercial and multifamily Construction and land Manufactured homes Floating homes Other consumer Commercial business Total Grade: Pass $ 138,900 $ 23,206 $ 256,139 $ 68,268 $ 20,204 $ 43,509 $ 8,250 $ 35,347 $ 593,823 Watch — — 217 2,634 124 — — 378 3,353 Special Mention 2,484 — 2,178 3,677 — — — 1,649 9,988 Substandard 8,009 639 2,734 1,177 285 290 52 1,557 14,743 Doubtful — — — — — — — — — Loss — — — — — — — — — Total $ 149,393 $ 23,845 $ 261,268 $ 75,756 $ 20,613 $ 43,799 $ 8,302 $ 38,931 $ 621,907 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. Loans are not placed on nonaccrual for short-term loan modifications made in response to the COVID-19 pandemic. The following table presents the recorded investment in nonaccrual loans as of June 30, 2020, and December 31, 2019, by type of loan (in thousands): June 30, 2020 December 31, 2019 One-to-four family $ 1,670 $ 2,090 Home equity 222 261 Commercial and multifamily 352 353 Construction and land — 1,177 Manufactured homes 117 226 Floating homes 282 290 Commercial business 837 260 Total $ 3,480 $ 4,657 19 The following table presents the aging of the recorded investment in past due loans as of June 30, 2020, by type of loan (in thousands): 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 $ 161 $ 44 $ 1,669 $ — $ 1,874 $ 136,114 $ 137,988 Home equity 170 2 222 — 394 18,892 19,286 Commercial and multifamily — — 353 — 353 272,731 273,084 Construction and land — — — — — 76,089 76,089 Manufactured homes 85 54 117 — 256 20,971 21,227 Floating homes — 249 282 — 531 45,725 46,256 Other consumer 2 1 — — 3 10,582 10,585 Commercial business — 675 162 — 837 108,882 109,719 Total $ 418 $ 1,025 $ 2,805 $ — $ 4,248 $ 689,986 $ 694,234 The following table presents the aging of the recorded investment in past due loans as of December 31, 2019, by type of loan (in thousands): 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 $ 789 $ 105 $ 1,810 $ — $ 2,704 $ 146,689 $ 149,393 Home equity 81 161 197 — 439 23,406 23,845 Commercial and multifamily 1,742 — 353 — 2,095 259,173 261,268 Construction and land 3,340 1,100 50 — 4,490 71,266 75,756 Manufactured homes 324 43 125 — 492 20,121 20,613 Floating homes 297 250 290 — 837 42,962 43,799 Other consumer 19 2 — — 21 8,281 8,302 Commercial business 226 — 162 — 388 38,543 38,931 Total $ 6,818 $ 1,661 $ 2,987 $ — $ 11,466 $ 610,441 $ 621,907 Nonperforming Loans. Loans are considered nonperforming when they are placed on nonaccrual. The following table presents the credit risk profile of our loan portfolio based on payment activity as of June 30, 2020, by type of loan (in thousands): One-to-four family Home equity Commercial and multifamily Construction and land Manufactured homes Floating homes Other consumer Commercial business Total Performing $ 136,318 $ 19,064 $ 272,732 $ 76,089 $ 21,110 $ 45,974 $ 10,585 $ 108,882 $ 690,754 Nonperforming 1,670 222 352 — 117 282 — 837 3,480 Total $ 137,988 $ 19,286 $ 273,084 $ 76,089 $ 21,227 $ 46,256 $ 10,585 $ 109,719 $ 694,234 20 The following table presents the credit risk profile of our loan portfolio based on payment activity as of December 31, 2019, by type of loan (in thousands): One-to-four family Home equity Commercial and multifamily Construction and land Manufactured homes Floating homes Other consumer Commercial business Total Performing $ 147,303 $ 23,584 $ 260,915 $ 74,579 $ 20,387 $ 43,509 $ 8,302 $ 38,671 $ 617,250 Nonperforming 2,090 261 353 1,177 226 290 — 260 4,657 Total $ 149,393 $ 23,845 $ 261,268 $ 75,756 $ 20,613 $ 43,799 $ 8,302 $ 38,931 $ 621,907 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 June 30, 2020 and December 31, 2019, by type of loan were as follows (in thousands): June 30, 2020 Recorded Investment Unpaid Principal Balance Without Allowance With Allowance Total Recorded Investment Related Allowance One-to-four family $ 6,114 $ 4,463 $ 1,531 $ 5,994 $ 199 Home equity 378 233 145 378 19 Commercial and multifamily 353 353 — 353 — Construction and land 38 — 38 38 6 Manufactured homes 371 103 262 365 214 Floating homes 282 282 — 282 — Other consumer 136 — 136 136 49 Commercial business 1,834 714 819 1,533 242 Total $ 9,506 $ 6,148 $ 2,931 $ 9,079 $ 729 December 31, 2019 Recorded Investment Unpaid Principal Balance Without Allowance With Allowance Total Recorded Investment Related Allowance One-to-four family $ 8,748 $ 7,236 $ 1,384 $ 8,620 $ 205 Home equity 335 256 79 335 25 Commercial and multifamily 353 353 — 353 — Construction and land 1,215 1,177 38 1,215 7 Manufactured homes 445 46 394 440 349 Floating homes 290 290 — 290 — Other consumer 143 — 143 143 54 Commercial business 997 714 283 997 84 Total $ 12,526 $ 10,072 $ 2,321 $ 12,393 $ 724 21 The following tables present the average recorded investment and interest income recognized on impaired loans for the three and six months ended June 30, 2020 and 2019, respectively, by loan types (in thousands): Three Months Ended June 30, 2020 Three Months Ended June 30, 2019 Average Recorded Investment Interest Income Recognized Average Recorded Investment Interest Income Recognized One-to-four family $ 5,961 $ 74 $ 2,536 $ 61 Home equity 368 4 549 9 Commercial and multifamily 353 5 585 8 Construction and land 255 ( 13 ) 124 2 Manufactured homes 396 6 475 18 Floating homes 403 — — — Other consumer 138 2 158 5 Commercial business 1,542 18 933 19 Total $ 9,416 $ 96 $ 5,360 $ 122 Six Months Ended June 30, 2020 Six Months Ended June 30, 2019 Average Recorded Investment Interest Income Recognized Average Recorded Investment Interest Income Recognized One-to-four family $ 6,847 $ 147 $ 3,590 $ 99 Home equity 357 9 682 15 Commercial and multifamily 353 10 1,607 15 Construction and land 575 1 424 4 Manufactured homes 411 15 431 28 Floating homes 366 8 — — Other consumer 139 4 163 8 Commercial business 1,360 41 1,274 37 Total $ 10,408 $ 235 $ 8,171 $ 206 Forgone interest on nonaccrual loans was $ 109,000 and $ 91,000 for the six months ended June 30, 2020 and 2019, respectively. There were no commitments to lend additional funds to borrowers whose loans were classified as nonaccrual or impaired at June 30, 2020 and December 31, 2019. Troubled debt restructurings. TDRs are accounted for under ASC 310-40, are loans 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 $ 5.7 million and $ 7.9 million at June 30, 2020 and December 31, 2019, 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. 22 There was one loan totaling $ 431,000 modified as a TDR during the three months ended June 30, 2020 and three loans totaling $ 649,000 modified as TDRs during the six months ended June 30, 2020. There was one TDR loan totaling $ 2.8 million paid-off during the six months ended June 30, 2020. There were no loans modified as TDRs during the three and six months ended June 30, 2019. Two TDR loans totaling $ 40,000 were paid off during the three months ended June 30, 2019, and three TDR loans totaling $ 145,000 were paid-off during the six months ended June 30, 2019. 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 six months ended June 30, 2020 and 2019. There was one loan totaling $ 161,000 modified as a TDR for which there was a payment default within the first 12 months of modification during the six months ended June 30, 2020. During the six months ended June 30, 2019, there were six loans totaling $ 297,000 modified as TDRs for which there was a payment default within the first 12 months of modification. 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 related bank regulatory guidance provides that a short-term modification made in response to COVID-19 and which meets certain criteria does not need to be accounted for as a TDR. As of June 30, 2020, the Company had approved 122 loan modifications related to the COVID-19 pandemic with an outstanding loan balance totaling $ 51.3 million in accordance with the CARES Act. Accordingly, the Company does not account for such loan modifications as TDRs. Loan modifications in accordance with the CARES Act and related regulatory guidance are still subject to an evaluation in regard to determining whether or not a loan is deemed to be impaired. See “Note 2 – Accounting Pronouncements Recently Issued or Adopted”. Note 5 – Fair Value Measurements The Company determines the fair values of its financial instruments based on the requirements established in Accounting Standards Codification (“ASC”) 820, Fair Value Measurements , 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 June 30, 2020 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 - Residential mortgage loans held-for-sale are recorded at the lower of cost or fair value. The fair value of fixed-rate residential loans is based on whole loan forward prices obtained from government sponsored enterprises. At June 30, 2020 and December 31, 2019, 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. 23 Borrowings - The fair value of borrowings are estimated using the Company’s current incremental borrowing rates for similar types of borrowing arrangements. 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 are 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. 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 June 30, 2020 and December 31, 2019 (in thousands): June 30, 2020 Fair Value Measurements Using: Carrying Value Estimated Fair Value Level 1 Level 2 Level 3 FINANCIAL ASSETS: Cash and cash equivalents $ 130,537 $ 130,537 $ 130,537 $ — $ — Available-for-sale securities 10,198 10,198 — 10,198 — Loans held-for-sale 7,364 7,364 — 7,364 — Loans held-for-portfolio, net 684,672 696,385 — — 696,385 Mortgage servicing rights 3,113 3,113 — — 3,113 FHLB stock 1,164 1,164 — 1,164 — FINANCIAL LIABILITIES: Non-maturity deposits 455,480 455,480 — 455,480 — Time deposits 238,842 243,721 — 243,721 — FHLB and other Borrowings 79,841 79,841 — 79,841 — December 31, 2019 Fair Value Measurements Using: Carrying Value Estimated Fair Value Level 1 Level 2 Level 3 FINANCIAL ASSETS: Cash and cash equivalents $ 55,770 $ 55,770 $ 55,770 $ — $ — Available-for-sale securities 9,306 9,306 — 9,306 — Loans held-for-sale 1,063 1,063 — 1,063 — Loans held-for-portfolio, net 614,247 622,147 — — 622,147 Mortgage servicing rights 3,239 3,239 — — 3,239 FHLB stock 1,160 1,160 — 1,160 — FINANCIAL LIABILITIES: Non-maturity deposits 365,331 365,331 — 365,331 — Time deposits 251,387 255,261 — 255,261 — FHLB Borrowings 7,500 7,500 — 7,500 — 24 The following tables present the balance of assets measured at fair value on a recurring basis as of June 30, 2020 and December 31, 2019 (in thousands): Fair Value at June 30, 2020 Description Total Level 1 Level 2 Level 3 Municipal bonds $ 4,363 $ — $ 4,363 $ — Agency mortgage-backed securities 5,835 — 5,835 — Mortgage servicing rights 3,113 — — 3,113 Fair Value at December 31, 2019 Description Total Level 1 Level 2 Level 3 Municipal bonds $ 3,370 $ — $ 3,370 $ — Agency mortgage-backed securities 5,936 — 5,936 — Mortgage servicing rights 3,239 — — 3,239 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 at June 30, 2020 and December 31, 2019: June 30, 2020 Financial Instrument Valuation Technique Unobservable Input(s) Range (Weighted-Average) Mortgage Servicing Rights Discounted cash flow Prepayment speed assumption 152 %- 238 % ( 216 %) Discount rate 10 %- 12 % ( 10.1 %) December 31, 2019 Financial Instrument Valuation Technique Unobservable Input(s) Range (Weighted-Average) Mortgage Servicing Rights Discounted cash flow Prepayment speed assumption 132 %- 485 % ( 187 %) Discount rate 12.5 %- 13.5 % ( 12.5 %) 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 six months ended June 30, 2020 and June 30, 2019. 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. 25 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 June 30, 2020 Total Level 1 Level 2 Level 3 OREO and repossessed assets $ 575 $ — $ — $ 575 Impaired loans 9,079 — — 9,079 Fair Value at December 31, 2019 Total Level 1 Level 2 Level 3 OREO and repossessed assets $ 575 $ — $ — $ 575 Impaired loans 12,393 — — 12,393 There were no liabilities carried at fair value, measured on a recurring or nonrecurring basis, at June 30, 2020 and December 31, 2019. 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 June 30, 2020 and December 31, 2019: June 30, 2020 Financial Instrument Valuation Technique(s) Unobservable Input(s) Range (Weighted Average) OREO Market approach Adjustment for differences between comparable sales 0 - 0 % ( 0 %) Impaired loans Market approach Adjustment for differences between comparable sales 0 - 100 % ( 8 %) December 31, 2019 Financial Instrument Valuation Technique(s) Unobservable Input(s) Range (Weighted Average) OREO Market approach Adjusted for difference between comparable sales 0 - 0 % ( 0 %) Impaired loans Market approach Adjusted for difference between comparable sales 0 - 100 % ( 6 %) Note 6 – Mortgage Servicing Rights The Company’s mortgage servicing rights portfolio totaled $ 397.2 million at June 30, 2020 compared to $ 377.3 million at December 31, 2019. Of this total balance, the unpaid principal balance of loans serviced for Federal National Mortgage Association (“Fannie Mae”) at June 30, 2020 and December 31, 2019 were $ 385.9 million and $ 363.3 million, respectively. The unpaid principal balance of loans serviced for other financial institutions at June 30, 2020 and December 31, 2019, totaled $ 11.3 million and $ 14.0 million, respectively. Loans serviced for others are not included in the Company’s financial statements as they are not assets of the Company. 26 A summary of the change in the balance of mortgage servicing assets during the three and six months ended June 30, 2020 and 2019 were as follows (in thousands): Three Months Ended March 31, Six Months Ended June 30, 2020 2019 2020 2019 Beginning balance, at fair value $ 2,996 $ 3,286 $ 3,239 $ 3,414 Servicing rights that result from transfers and sale of financial assets 554 81 674 277 Changes in fair value: Due to changes in model inputs or assumptions and other (1) ( 437 ) ( 162 ) ( 800 ) ( 486 ) Ending balance, at fair value $ 3,113 $ 3,205 $ 3,113 $ 3,205 (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: June 30, 2020 December 31, 2019 Prepayment speed (Public Securities Association “PSA” model) 216 % 187 % Weighted-average life 5.5 years 6.2 years Discount rate 10.1 % 12.5 % 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 $ 235,000 and $ 479,000 for the three and six months ended June 30, 2020, respectively, and $ 256,000 and $ 498,000 for the three and six months ended June 30, 2019, 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 and FHLB Stock The Company utilizes 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 June 30, 2020 and December 31, 2019, the amount available to borrow under this credit facility was $ 332.0 million and $ 321.9 million, respectively, subject to eligible pledged collateral. At June 30, 2020, the credit facility was collateralized as follows: one-to-four family mortgage loans with an advance equivalent of $ 109.9 million, commercial and multifamily mortgage loans with an advance equivalent of $ 130.0 million and home equity loans with an advance equivalent of $ 5.8 million. At December 31, 2019, the credit facility was collateralized as follows: one-to-four family mortgage loans with an advance equivalent of $ 111.4 million, commercial and multifamily mortgage loans with an advance equivalent of $ 126.1 million and home equity loans with an advance equivalent of $ 6.9 million. The Company had outstanding borrowings under this arrangement of $ 7.5 million at both June 30, 2020 and December 31, 2019. The weighted-average interest rate of our borrowings was 3.05 % at both June 30, 2020 and December 31, 2019. Additionally, the Company had outstanding letters of credit from the FHLB of Des Moines with a notional amount of $ 19.6 million and $ 19.1 million at June 30, 2020 and December 31, 2019, respectively, to secure public deposits. The remaining amount available to borrow as of June 30, 2020 and December 31, 2019, was $ 218.7 million and $ 217.8 million, respectively. 27 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 June 30, 2020 and December 31, 2019, the Company had an investment of $ 1.2 million in FHLB of Des Moines stock. The Company participates in the Federal Reserve Bank Borrower-in-Custody program, which gives the Company access to the discount window and the PPP Liquidity Facility. The terms of both programs call for a pledge of specific assets. The Company pledges commercial and consumer loans as collateral for this borrower-in-custody line of credit. The Company had unused borrowing capacity of $ 33.4 million and $ 41.7 million and no outstanding borrowings under this program at June 30, 2020 and December 31, 2019, respectively. At June 30, 2020, the Company pledged $ 72.3 million PPP loans supporting the same amount of borrowings under the PPP Liquidity Facility. The Company has access to an unsecured Fed Funds line of credit from Pacific Coast Banker’s Bank. The line has a 1 year term maturing on June 30, 2021 and is renewable annually. As of June 30, 2020, the amount available under this line of credit was $ 10.0 million. There was no balance on this line of credit as of June 30, 2020 and December 31, 2019, respectively. The Company has access to an unsecured Fed Funds line of credit from The Independent Bank. As of June 30, 2020, the amount available under this line of credit was $ 10.0 million. The agreement may be terminated by either party. There was no balance on this line of credit as of June 30, 2020 and December 31, 2019, respectively. 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 pursuant to the two-class method. 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 June 30, Six Months Ended June 30, 2020 2019 2020 2019 Net income available to common shareholders $ 2,113 $ 1,817 $ 3,094 $ 3,261 Weighted-average number of shares outstanding, basic 2,560 2,522 2,553 2,516 Effect of potentially dilutive common shares 20 50 32 57 Weighted-average number of shares outstanding, diluted 2,580 2,572 2,585 2,573 Earnings per share, basic $ 0.83 $ 0.72 $ 1.21 $ 1.29 Earnings per share, diluted $ 0.82 $ 0.71 $ 1.20 $ 1.27 There were 6,809 anti-dilutive securities at June 30, 2020 and no anti-dilutive securities at June 30, 2019. Note 10 – Stock-based Compensation Stock Options and Restricted Stock 28 The Company currently has one active shareholder approved Equity Incentive 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 June 30, 2020, on an adjusted basis, awards for stock options totaling 267,752 shares and awards for restricted stock totaling 134,148 shares of Company common stock have been granted, net of any forfeitures, to participants in the Plans. Share-based compensation expense was $ 46,000 and $ 231,000 for the three and six months ended June 30, 2020, respectively, and was $ 48,000 and $ 87,000 or the three and six months ended June 30, 2019, respectively. Stock Option Awards All stock option awards granted under the 2008 Plan vest in 20 percent 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 six months ended June 30, 2020: Shares Weighted- Average Exercise Price Weighted-Average Remaining Contractual Term in Years Aggregate Intrinsic Value Outstanding at January 1, 2020 121,260 $ 20.80 5.33 $ 1,842,687 Granted 8,225 36.26 Exercised ( 14,434 ) 15.99 Forfeited ( 2,205 ) 29.25 Outstanding at June 30, 2020 112,846 22.38 4.74 501,807 Exercisable 97,046 20.65 4.14 489,312 Expected to vest, assuming a 0 % forfeiture rate over the vesting term 16,169 $ 34.19 7.86 $ 1,662 As of June 30, 2020, there was $ 89,000 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 2.89 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 six months ended June 30, 2020 and 2019 were determined using the following weighted-average assumptions as of the grant date. June 30, 2020 June 30, 2019 Annual dividend yield 1.60 % 1.72 % Expected volatility 21.67 % 21.68 % Risk-free interest rate 1.38 % 2.64 % Expected term 6.50 years 6.50 years Weighted-average grant date fair value per option granted $ 7.14 $ 7.24 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 29 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 six months ended June 30, 2020: Shares Weighted-Average Grant-Date Fair Value Per Share Aggregate Intrinsic Value Per Share Non-vested at January 1, 2020 12,290 $ 33.32 Granted 13,600 36.26 Vested ( 6,816 ) 34.60 Forfeited ( 1,690 ) 34.15 Non-Vested at June 30, 2020 17,384 $ 35.03 $ 24.15 Expected to vest assuming a 0 % forfeiture rate over the vesting term 17,384 $ 35.03 $ 24.15 As of June 30, 2020, there was $ 535,000 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 3.12 years. The total fair value of shares vested for the six months ended June 30, 2020 and 2019 was $ 236,000 and $ 95,000 , 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 June 30, 2020, the remaining balance of the ESOP loan was $ 126,000 . Neither the loan balance nor the related interest expense is reflected on the condensed consolidated financial statements. For the calendar year 2020, the ESOP was committed to release 11,340 shares of the Company’s common stock to participants and held 11,340 unallocated shares remaining to be released in 2021. The fair value of the 142,463 shares held by the ESOP trust was $ 3.4 million at June 30, 2020. ESOP compensation expense included in salaries and benefits was $ 174,000 and $ 348,000 for the three and six months ended June 30, 2020, respectively, and was $ 168,000 and $ 336,000 for the three and six months ended June 30, 2019, respectively. Note 11 – Revenue from Contracts with Customers All of the Company's revenue from contracts with customers in the scope of ASC 606 - Revenue from Contracts with Customers ("ASC 606") is recognized in Noninterest Income with the exception of the net loss on OREO and repossessed assets, which is included in Noninterest Expense. The following table presents the Company's sources of Noninterest Income for the three and six months ended June 30, 2020 and 2019 (in thousands). Items outside of the scope of ASC 606 are noted as such. 30 Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 Noninterest income: Service charges and fee income Account maintenance fees $ 45 $ 45 $ 139 $ 96 Transaction-based and overdraft service charges 58 115 158 219 Debit/ATM interchange fees 242 250 472 463 Credit card interchange fees 5 7 12 13 Loan fees (a) 63 45 112 105 Other fees (a) 16 17 30 29 Total service charges and fee income 429 479 923 925 Earnings on cash surrender value of bank-owned life insurance (a) 90 78 105 186 Mortgage servicing income (a) 235 256 479 498 Fair value adjustment on mortgage servicing rights (a) ( 437 ) ( 162 ) ( 800 ) ( 486 ) Net gain on sale of loans (a) 1,262 204 1,581 695 Total noninterest income $ 1,579 $ 855 $ 2,288 $ 1,818 (a) Not within scope of Topic 606 Account maintenance fees and transaction-based and overdraft service charges The Company earns fees from its customers for account maintenance, transaction-based and overdraft services. Account maintenance fees consist primarily of account fees and analyzed account fees charged on deposit accounts on a monthly basis. The performance obligation is satisfied and fees are recognized on a monthly basis as the service period is completed. Transaction-based fees and overdraft service fees on deposit accounts are charged to deposit customers for specific services provided to the customer, such as non-sufficient funds, overdraft, and wire services. The performance obligation is completed as the transaction occurs and the fees are recognized at the time each specific service is provided to the customer. Debit/ATM and credit card interchange income Debit/ATM interchange income represent fees earned when a debit card issued by the Bank is used for a transaction. The Bank earns interchange fees from debit cardholder transactions through the MasterCard payment network. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder. The performance obligation is satisfied and the fees are earned when the cost of the transaction is charged to the cardholders' account. Certain expenses directly associated with the debit card are recorded on a net basis with the interchange income. The Company utilizes a third-party agency relationship to brand credit cards with fees for originating new accounts paid by the issuing bank. Credit card interchange income represents fees earned when a credit card is issued by the third-party agent. Similar to debit card interchange fees, the Bank earns an interchange fee for each transaction made with Sound Community Bank's branded credit cards. The performance obligation is satisfied and the fees are earned when the cost of the transaction is charged to the cardholders' credit card. Certain expenses and rebates directly related to the credit card interchange contract are recorded net of the interchange income. Net loss on OREO and repossessed assets We record a gain or loss from the sale of other real estate owned when control of the property transfers to the buyer, which generally occurs at the time of an executed deed of trust. When the Bank finances the sale of other real estate owned to the buyer, the Company assesses whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the other real estate owned asset is derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer. In determining the gain or loss on sale, we adjust the transaction price and related gain or loss on sale if a significant financing component is present. The 31 Company incurred expenses on OREO properties of zero for the three and six months ended June 30, 2020, compared to $ 7,000 and $ 9,000 for the three and six months ended 2019, respectively, which are included in Noninterest Expense on the Company’s Condensed Consolidated Statements of Income. Note 12 – Leases We have operating leases for branch locations, loan production offices, our corporate office and 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 10 years and typically include one renewal option. Our leases have remaining lease terms of 1 year to 10 years. The operating leases generally contain renewal options and require us to pay property taxes and operating expenses for the properties. The following table represents the lease right-of-use assets and lease liabilities recorded on the condensed consolidated balance sheet at June 30, 2020 and December 31, 2019 (in thousands): June 30, 2020 December 31, 2019 Operating lease right-of-use assets $ 7,166 $ 7,641 Operating lease liabilities $ 7,561 $ 8,010 The following table represents the components of lease expense (in thousands): Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 Operating lease expense Office leases $ 307 $ 305 $ 614 $ 610 Equipment leases 5 5 10 10 Sublease income ( 3 ) ( 4 ) ( 6 ) ( 6 ) Net lease expense $ 309 $ 306 $ 618 $ 614 The following table represents the maturity of lease liabilities: June 30, 2020 Office leases Equipment leases Operating Lease Commitments Remainder of 2020 $ 515 $ 10 2021 1,042 20 2022 1,017 9 2023 989 — 2024 968 — Thereafter 3,896 — Total lease payments 8,427 39 Less: Present value discount 904 1 Present value of lease liabilities $ 7,523 $ 38 32 Lease term and discount rate by lease type consist of the following: June 30, 2020 Weighted-average remaining lease term (in years): Office leases 8.34 Equipment leases 1.92 Weighted-average discount rate (annualized): Office leases 2.65 % Equipment leases 1.62 % Supplemental cash flow information related to leases was as follows (in thousands): Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 Cash paid for amounts included in the measurement of lease liabilities for operating leases: Operating cash flows Office leases $ 291 $ 232 $ 582 $ 517 Equipment leases $ 5 $ 5 $ 10 $ 10 Note 13 – Subsequent Event On July 24, 2020, the Board of Directors of the Company declared a quarterly cash dividend of $ 0.15 per common share, payable on August 19, 2020 to stockholders of record at the close of business on August 5, 2020.