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) September 30, 2020 December 31, 2019 ASSETS Cash and cash equivalents $ 115,762 $ 55,770 Available-for-sale securities, at fair value 13,296 9,306 Loans held-for-sale 16,063 1,063 Loans held-for-portfolio 689,434 619,887 Allowance for loan losses ( 5,988 ) ( 5,640 ) Total loans held-for-portfolio, net 683,446 614,247 Accrued interest receivable 2,536 2,206 Bank-owned life insurance (“BOLI”), net 14,404 14,183 Other real estate owned (“OREO”) and repossessed assets, net 575 575 Mortgage servicing rights, at fair value 3,339 3,239 Federal Home Loan Bank (“FHLB”) stock, at cost 1,164 1,160 Premises and equipment, net 6,466 6,767 Right of use assets 6,945 7,641 Other assets 3,382 3,696 Total assets $ 867,378 $ 719,853 LIABILITIES Deposits Interest-bearing $ 596,613 $ 519,434 Noninterest-bearing demand 152,237 97,284 Total deposits 748,850 616,718 Borrowings 7,500 7,500 Accrued interest payable 213 226 Lease liabilities 7,348 8,010 Other liabilities 7,783 8,368 Advance payments from borrowers for taxes and insurance 1,678 1,305 Subordinated debt, net 11,676 — Total liabilities 785,048 642,127 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, 2,595,289 and 2,567,389 shares issued and outstanding as of September 30, 2020 and December 31, 2019, respectively 25 25 Additional paid-in capital 27,018 26,343 Unearned shares - Employee Stock Ownership Plan (“ESOP”) ( 142 ) ( 227 ) Retained earnings 55,170 51,410 Accumulated other comprehensive income, net of tax 259 175 Total stockholders’ equity 82,330 77,726 Total liabilities and stockholders’ equity $ 867,378 $ 719,853 3 Table of Contents See notes to condensed consolidated financial statements 4 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, 2020 2019 2020 2019 INTEREST INCOME Loans, including fees $ 8,422 $ 8,195 $ 25,463 $ 24,514 Interest and dividends on investments, cash and cash equivalents 86 381 400 1,219 Total interest income 8,508 8,576 25,863 25,733 INTEREST EXPENSE Deposits 1,738 1,830 5,346 4,917 Borrowings 110 100 232 674 Total interest expense 1,848 1,930 5,578 5,591 Net interest income 6,660 6,646 20,285 20,142 PROVISION (RECAPTURE) FOR LOAN LOSSES 275 250 925 ( 150 ) Net interest income after provision (recapture) for loan losses 6,385 6,396 19,360 20,292 NONINTEREST INCOME Service charges and fee income 510 512 1,433 1,437 Earnings on cash surrender value of bank-owned life insurance 102 81 207 267 Mortgage servicing income 260 259 739 756 Fair value adjustment on mortgage servicing rights ( 623 ) ( 90 ) ( 1,423 ) ( 576 ) Net gain on sale of loans 1,819 305 3,399 1,000 Total noninterest income 2,068 1,067 4,355 2,884 NONINTEREST EXPENSE Salaries and benefits 2,880 3,075 8,933 9,369 Operations 1,390 1,397 4,109 4,481 Regulatory assessments 111 ( 49 ) 480 178 Occupancy 442 509 1,437 1,560 Data processing 707 587 1,923 1,547 Net loss on OREO and repossessed assets — 1 — 11 Total noninterest expense 5,530 5,520 16,882 17,146 Income before provision for income taxes 2,923 1,943 6,833 6,030 Provision for income taxes 588 395 1,390 1,221 Net income $ 2,335 $ 1,548 $ 5,443 $ 4,809 Earnings per common share: Basic $ 0.90 $ 0.61 $ 2.11 $ 1.90 Diluted $ 0.90 $ 0.60 $ 2.09 $ 1.87 Weighted-average number of common shares outstanding: Basic 2,563,018 2,526,240 2,558,475 2,521,393 Diluted 2,589,241 2,578,287 2,588,101 2,572,499 See notes to condensed consolidated financial statements 5 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, 2020 2019 2020 2019 Net income $ 2,335 $ 1,548 $ 5,443 $ 4,809 Available for sale securities: Unrealized holding (losses) gains arising during the period ( 4 ) ( 3 ) 106 90 Income tax expense (benefit) related to unrealized gains/losses 1 1 ( 22 ) ( 19 ) Other comprehensive (loss) income, net of tax ( 3 ) ( 2 ) 84 71 Comprehensive income $ 2,332 $ 1,546 $ 5,527 $ 4,880 See notes to condensed consolidated financial statements 6 SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY Condensed Consolidated Statements of Stockholders’ Equity For the Three and Nine Months Ended September 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 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 Cash dividends paid on common stock ($ 0.15 per share) ( 389 ) ( 389 ) Common stock surrendered ( 2,842 ) — 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 income, net of tax 84 84 Share-based compensation 283 283 Restricted stock awards issued 13,600 — Cash dividends paid on common stock ($ 0.65 per share) ( 1,683 ) ( 1,683 ) Common stock surrendered ( 3,423 ) — Restricted shares forfeited ( 1,690 ) — 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 7 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, 2019 2,563,488 $ 25 $ 25,926 $ ( 283 ) $ 48,710 $ 187 $ 74,565 Net income 1,548 1,548 Other comprehensive loss, net of tax ( 2 ) ( 2 ) Share-based compensation 72 72 Cash dividends paid on common stock ($ 0.14 per share) ( 359 ) ( 359 ) Common stock surrendered ( 1,032 ) — Common stock options exercised 5,490 93 93 Allocation of ESOP shares 71 28 99 Balance, at September 30, 2019 2,567,946 $ 25 $ 26,162 $ ( 255 ) $ 49,899 $ 185 $ 76,016 Balance, at December 31, 2018 2,544,059 $ 25 $ 25,663 $ ( 340 ) $ 46,165 $ 114 $ 71,627 Net income 4,809 4,809 Other comprehensive income, net of tax 71 71 Share-based compensation 159 159 Cash dividends paid on common stock ($ 0.42 per share) ( 1,075 ) ( 1,075 ) Common stock surrendered ( 3,810 ) — Restricted stock awards issued 15,925 — Common stock options exercised 11,772 131 131 Allocation of ESOP shares 209 85 294 Balance, at September 30, 2019 2,567,946 $ 25 $ 26,162 $ ( 255 ) $ 49,899 $ 185 $ 76,016 See notes to condensed consolidated financial statements 8 SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY Condensed Consolidated Statements of Cash Flows (unaudited) (In thousands) Nine Months Ended September 30, 2020 2019 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 5,443 $ 4,809 Adjustments to reconcile net income to net cash from operating activities: Amortization of net discounts on investments 104 27 Provision (recapture) for loan losses 925 ( 150 ) Depreciation and amortization 696 799 Compensation expense related to stock options and restricted stock 283 159 Fair value adjustment on mortgage servicing rights 1,423 576 Right of use assets amortization 696 756 Increase in cash surrender value of BOLI ( 207 ) ( 267 ) Net change in advances from borrowers for taxes and insurance 373 514 Net gain on sale of loans ( 3,399 ) ( 1,000 ) Proceeds from sale of loans held-for-sale 179,244 54,430 Originations of loans held-for-sale ( 193,892 ) ( 54,683 ) Net loss on OREO and repossessed assets — 11 Change in operating assets and liabilities: Accrued interest receivable ( 330 ) 81 Other assets 314 859 Accrued interest payable ( 13 ) 75 Change in lease liabilities ( 662 ) ( 656 ) Other liabilities ( 585 ) 883 Net cash (used in) provided by operating activities ( 9,587 ) 7,223 CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of available-for-sale securities ( 7,177 ) ( 3,066 ) Proceeds from principal payments, maturities and sales of available-for-sale securities 3,190 245 Net (increase) decrease in loans ( 68,622 ) 6,694 Reduction in (purchase of) BOLI ( 14 ) ( 402 ) Purchases of premises and equipment, net ( 396 ) ( 227 ) Net cash (used in) provided by investing activities ( 73,019 ) 3,244 CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in deposits 132,132 56,020 Proceeds from borrowings 87,991 91,225 Repayment of borrowings ( 87,991 ) ( 162,775 ) Proceeds from subordinated debt, net 11,676 — FHLB stock (purchased) redeemed ( 4 ) 2,776 Allocation of ESOP shares 238 294 Dividends paid on common stock ( 1,683 ) ( 1,075 ) Proceeds from common stock option exercises 239 131 Net cash provided by (used in) financing activities 142,598 ( 13,404 ) Net change in cash and cash equivalents 59,992 ( 2,937 ) Cash and cash equivalents, beginning of period 55,770 61,810 Cash and cash equivalents, end of period $ 115,762 $ 58,873 9 SUPPLEMENTAL CASH FLOW INFORMATION: Cash paid for income taxes $ 1,270 $ 425 Interest paid on deposits and borrowings 5,591 5,516 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 10 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 novel coronavirus disease of 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. 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 Company does not expect the adoption of ASU 2020-08 to have a material impact on its consolidated financial statements. In 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) 11 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. 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. 12 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 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 13 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. 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, 2020 Treasury bills $ 1,976 $ — $ — $ 1,976 Municipal bonds 5,060 196 ( 2 ) 5,254 Agency mortgage-backed securities 5,932 135 ( 1 ) 6,066 Total $ 12,968 $ 331 $ ( 3 ) $ 13,296 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 September 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. September 30, 2020 Amortized Cost Fair Value Due within one year $ 3,014 $ 3,016 Due after one year through five years 489 506 Due after five years through ten years 1,426 1,479 Due after ten years 2,107 2,228 Mortgage-backed securities 5,932 6,067 Total $ 12,968 $ 13,296 There were no pledged securities at September 30, 2020 or December 31, 2019. There were no sales of AFS securities during the three and nine months ended September 30, 2020 or 2019. 14 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, 2020 Less Than 12 Months 12 Months or Longer Total Fair Value Unrealized Loss Fair Value Unrealized Loss Fair Value Unrealized Loss Treasury bills $ 1,033 $ — $ — $ — $ 1,033 $ — Municipal bonds 909 ( 2 ) — — 909 ( 2 ) Agency mortgage-backed securities 210 ( 1 ) — — 210 ( 1 ) $ 2,152 $ ( 3 ) $ — $ — $ 2,152 $ ( 3 ) 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 nine months ended September 30, 2020 or 2019 relating to the Company’s securities. At September 30, 2020, the securities portfolio consisted of 16 agency mortgage-backed securities, ten municipal bonds and three short-term treasury bills with a total portfolio fair value of $ 13.3 million. At December 31, 2019, the securities portfolio consisted of 13 agency mortgage-backed securities and eight municipal bonds with a fair value of $ 9.3 million. At September 30, 2020, there were four 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, 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 September 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. 15 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, 2020 December 31, 2019 Real estate loans: One-to-four family $ 140,356 $ 149,393 Home equity 17,727 23,845 Commercial and multifamily 275,876 261,268 Construction and land 72,166 75,756 Total real estate loans 506,125 510,262 Consumer loans: Manufactured homes 20,948 20,613 Floating homes 42,399 43,799 Other consumer 12,252 8,302 Total consumer loans 75,599 72,714 Commercial business loans 111,025 38,931 Total loans held-for-portfolio 692,749 621,907 Deferred fees, net ( 3,315 ) ( 2,020 ) Total loans held-for-portfolio, gross 689,434 619,887 Allowance for loan losses ( 5,988 ) ( 5,640 ) Total loans held-for-portfolio, net $ 683,446 $ 614,247 The Company was automatically authorized to participate in the SBA Paycheck Protection Program (“PPP”), as a qualified U.S. Small Business Administration’s (“SBA”) lender. As of September 30, 2020, the Bank had funded PPP loans totaling $ 74.8 million, which are included in commercial business loans above. 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 September 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 $ 207 $ 963 $ 1,170 $ 6,059 $ 134,297 $ 140,356 Home equity 18 124 142 294 17,433 17,727 Commercial and multifamily — 2,007 2,007 577 275,299 275,876 Construction and land 6 574 580 592 71,574 72,166 Manufactured homes 184 146 330 333 20,615 20,948 Floating homes — 293 293 529 41,870 42,399 Other consumer 31 84 115 117 12,135 12,252 Commercial business — 263 263 617 110,408 111,025 Unallocated — 1,088 1,088 — — — Total $ 446 $ 5,542 $ 5,988 $ 9,118 $ 683,631 $ 692,749 16 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 nine months ended September 30, 2020 (in thousands): Three Months Ended September 30, 2020 Beginning Allowance Charge-offs Recoveries Provision (Recapture) 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 ) $ 14 $ 275 $ 5,988 17 Nine Months Ended September 30, 2020 Beginning Allowance Charge-offs Recoveries Provision (Recapture) 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 The following tables summarize the activity in the allowance for loan losses for the three and nine months ended September 30, 2019 (in thousands): Three Months Ended September 30, 2019 Beginning Allowance Charge-offs Recoveries (Recapture) Provision Ending Allowance One-to-four family $ 1,139 $ — $ 3 $ 23 $ 1,165 Home equity 165 — 2 10 177 Commercial and multifamily 1,467 — — 186 1,653 Construction and land 464 ( 1 ) — 36 499 Manufactured homes 463 — — 32 495 Floating homes 262 — — 1 263 Other consumer 120 ( 8 ) 1 ( 3 ) 110 Commercial business 509 — 1 ( 191 ) 319 Unallocated 781 — — 156 937 Total $ 5,370 $ ( 9 ) $ 7 $ 250 $ 5,618 18 Nine Months Ended September 30, 2019 Beginning Allowance Charge-offs Recoveries Provision (Recapture) Ending Allowance One-to-four family $ 1,314 $ — $ 3 $ ( 152 ) $ 1,165 Home equity 202 — 8 ( 33 ) 177 Commercial and multifamily 1,638 — — 15 1,653 Construction and land 431 — — 68 499 Manufactured homes 427 — — 68 495 Floating homes 265 — — ( 2 ) 263 Other consumer 112 ( 41 ) 23 16 110 Commercial business 356 — 1 ( 38 ) 319 Unallocated 1,029 — — ( 92 ) 937 Total $ 5,774 $ ( 41 ) $ 35 $ ( 150 ) $ 5,618 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 September 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 $ 120,789 $ 16,906 $ 235,013 $ 25,748 $ 19,670 $ 41,870 $ 12,197 $ 102,864 $ 575,057 Watch 15,100 269 25,147 42,149 1,033 — 13 5,859 89,570 Special Mention — — 10,852 3,666 — — — 395 14,913 Substandard 4,467 552 4,864 603 245 529 42 1,907 13,209 Doubtful — — — — — — — — — Loss — — — — — — — — — Total $ 140,356 $ 17,727 $ 275,876 $ 72,166 $ 20,948 $ 42,399 $ 12,252 $ 111,025 $ 692,749 19 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 September 30, 2020, and December 31, 2019, by type of loan (in thousands): September 30, 2020 December 31, 2019 One-to-four family $ 1,602 $ 2,090 Home equity 146 261 Commercial and multifamily 353 353 Construction and land 555 1,177 Manufactured homes 131 226 Floating homes 529 290 Other consumer — — Commercial business — 260 Total $ 3,316 $ 4,657 20 The following table presents the aging of the recorded investment in past due loans as of September 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 $ 179 $ 1,602 $ — $ 1,942 $ 138,414 $ 140,356 Home equity 19 8 146 — 173 17,554 17,727 Commercial and multifamily 2,196 999 353 — 3,548 272,328 275,876 Construction and land — — 555 — 555 71,611 72,166 Manufactured homes 48 41 131 — 220 20,728 20,948 Floating homes — — 529 — 529 41,870 42,399 Other consumer 15 11 — — 26 12,226 12,252 Commercial business 275 — — — 275 110,750 111,025 Total $ 2,714 $ 1,238 $ 3,316 $ — $ 7,268 $ 685,481 $ 692,749 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 September 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 $ 138,754 $ 17,581 $ 275,523 $ 71,611 $ 20,817 $ 41,870 $ 12,252 $ 111,025 $ 689,433 Nonperforming 1,602 146 353 555 131 529 — — 3,316 Total $ 140,356 $ 17,727 $ 275,876 $ 72,166 $ 20,948 $ 42,399 $ 12,252 $ 111,025 $ 692,749 21 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 September 30, 2020 and December 31, 2019, by type of loan were as follows (in thousands): September 30, 2020 Recorded Investment Unpaid Principal Balance Without Allowance With Allowance Total Recorded Investment Related Allowance One-to-four family $ 6,122 $ 4,517 $ 1,542 $ 6,059 $ 207 Home equity 294 151 143 294 18 Commercial and multifamily 574 577 — 577 — Construction and land 592 555 37 592 6 Manufactured homes 330 90 243 333 184 Floating homes 529 529 — 529 — Other consumer 117 — 117 117 31 Commercial business 616 617 — 617 — Total $ 9,174 $ 7,036 $ 2,082 $ 9,118 $ 446 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 22 The following tables present the average recorded investment and interest income recognized on impaired loans for the three and nine months ended September 30, 2020 and 2019, respectively, by loan types (in thousands): Three Months Ended September 30, 2020 Three Months Ended September 30, 2019 Average Recorded Investment Interest Income Recognized Average Recorded Investment Interest Income Recognized One-to-four family $ 6,027 $ 69 $ 4,011 $ 65 Home equity 336 3 1,998 14 Commercial and multifamily 465 16 501 — Construction and land 315 20 121 1 Manufactured homes 349 5 462 14 Floating homes 405 15 — — Other consumer 127 — 150 2 Commercial business 1,076 12 694 — Total $ 9,100 $ 140 $ 7,937 $ 96 Nine Months Ended September 30, 2020 Nine Months Ended September 30, 2019 Average Recorded Investment Interest Income Recognized Average Recorded Investment Interest Income Recognized One-to-four family $ 6,650 $ 208 $ 3,831 $ 125 Home equity 341 12 1,302 23 Commercial and multifamily 409 26 1,022 8 Construction and land 579 21 273 3 Manufactured homes 391 19 460 31 Floating homes 406 23 — — Other consumer 134 4 157 6 Commercial business 1,174 12 1,103 20 Total $ 10,084 $ 325 $ 8,148 $ 216 Forgone interest on nonaccrual loans was $ 62,000 and $ 126,000 for the three and nine months ended September 30, 2020, respectively, compared to $ 74,000 and $ 165,000 for the three and nine months ended September 30, 2019, respectively. There were no commitments to lend additional funds to borrowers whose loans were classified as nonaccrual or impaired at September 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 $ 5.6 million and $ 7.9 million at September 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. 23 Combination Modification : Any other type of modification, including the use of multiple categories above. There was one loan totaling $ 146,000 modified as a TDR during the three months ended September 30, 2020 and four loans totaling $ 795,000 modified as TDRs during the nine months ended September 30, 2020. One TDR loan totaling $ 161,000 was paid-off during the three months ended September 30, 2020 and two TDR loan totaling $ 2.9 million were paid-off during the nine months ended September 30, 2020. There were four loans totaling $ 5.1 million modified as TDRs during the three and nine months ended September 30, 2019. There were no TDR loans paid off during the three months ended September 30, 2019, and three TDR loans totaling $ 145,000 were paid-off during the nine months ended September 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 nine months ended September 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 nine months ended September 30, 2020. During the nine months ended September 30, 2019, there was one loan totaling $ 97,000 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 September 30, 2020, we have provided payment relief related to COVID-19 on 49 commercial loans totaling $ 37.4 million and 72 residential loans totaling $ 16.3 million, of which 12 commercial loans totaling $ 14.7 million and 25 residential loans totaling $ 4.7 million have resumed their normal loan payments or matured. There were $ 34.3 million of loans still under payment relief at September 30, 2020. 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 September 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. Treasury Bills - 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 September 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. 24 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 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 September 30, 2020 and December 31, 2019 (in thousands): September 30, 2020 Fair Value Measurements Using: Carrying Value Estimated Fair Value Level 1 Level 2 Level 3 FINANCIAL ASSETS: Cash and cash equivalents $ 115,762 $ 115,762 $ 115,762 $ — $ — Available-for-sale securities 13,296 13,296 — 13,296 — Loans held-for-sale 16,063 16,063 — 16,063 — Loans held-for-portfolio, net 683,446 689,125 — — 689,125 Mortgage servicing rights 3,339 3,339 — — 3,339 FHLB stock 1,164 1,164 — 1,164 — FINANCIAL LIABILITIES: Non-maturity deposits 507,812 507,812 — 507,812 — Time deposits 241,038 245,062 — 245,062 — Borrowings 7,500 7,500 — 7,500 — Subordinated debt 11,676 11,676 — 11,676 — 25 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 — Borrowings 7,500 7,500 — 7,500 — The following tables present the balance of assets measured at fair value on a recurring basis as of September 30, 2020 and December 31, 2019 (in thousands): Fair Value at September 30, 2020 Description Total Level 1 Level 2 Level 3 Treasury bills $ 1,976 $ 1,976 $ — $ — Municipal bonds 5,253 — 5,253 — Agency mortgage-backed securities 6,067 — 6,067 — Mortgage servicing rights 3,339 — — 3,339 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 September 30, 2020 and December 31, 2019: September 30, 2020 Financial Instrument Valuation Technique Unobservable Input(s) Range (Weighted-Average) Mortgage Servicing Rights Discounted cash flow Prepayment speed assumption 168 %- 265 % ( 244 %) 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 %) 26 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, 2020 and September 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. 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, 2020 Total Level 1 Level 2 Level 3 OREO and repossessed assets $ 575 $ — $ — $ 575 Impaired loans 9,118 — — 9,118 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 September 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 September 30, 2020 and December 31, 2019: September 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 % ( 4.9 %) 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 %) 27 Note 6 – Mortgage Servicing Rights The Company’s mortgage servicing rights portfolio totaled $ 444.3 million at September 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 September 30, 2020 and December 31, 2019 were $ 433.2 million and $ 363.3 million, respectively. The unpaid principal balance of loans serviced for other financial institutions at September 30, 2020 and December 31, 2019, totaled $ 11.1 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. A summary of the change in the balance of mortgage servicing assets during the three and nine months ended September 30, 2020 and 2019 were as follows (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Beginning balance, at fair value $ 3,113 $ 3,205 $ 3,239 $ 3,414 Servicing rights that result from transfers and sale of financial assets 849 111 1,523 388 Changes in fair value: Due to changes in model inputs or assumptions and other (1) ( 623 ) ( 90 ) ( 1,423 ) ( 576 ) Ending balance, at fair value $ 3,339 $ 3,226 $ 3,339 $ 3,226 (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, 2020 December 31, 2019 Prepayment speed (Public Securities Association “PSA” model) 244 % 187 % Weighted-average life 5.2 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 $ 260,000 and $ 739,000 for the three and nine months ended September 30, 2020, respectively, and $ 259,000 and $ 756,000 for the three and nine months ended September 30, 2019, respectively. 28 Table of Contents 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 Debt 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 September 30, 2020 and December 31, 2019, the amount available to borrow under this credit facility was $ 392.3 million and $ 321.9 million, respectively, subject to eligible pledged collateral. At September 30, 2020, the credit facility was collateralized as follows: one-to-four family mortgage loans with an advance equivalent of $ 96.8 million, commercial and multifamily mortgage loans with an advance equivalent of $ 126.2 million and home equity loans with an advance equivalent of $ 3.7 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 September 30, 2020 and December 31, 2019. The weighted-average interest rate of our borrowings was 3.05 % at both September 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 $ 20.6 million and $ 19.1 million at September 30, 2020 and December 31, 2019, respectively, to secure public deposits. The remaining amount available to borrow as of September 30, 2020 and December 31, 2019, was $ 198.6 million and $ 217.8 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, 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 Paycheck Protection Program Liquidity Facility (“PPPLF”). 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 and PPP loans for the PPPLF. The Company had unused borrowing capacity of $ 29.4 million and $ 41.7 million and no outstanding borrowings under these programs at September 30, 2020 and December 31, 2019, respectively. 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 September 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 September 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 September 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 September 30, 2020 and December 31, 2019, respectively. The Company completed a private placement of $ 12.0 million in aggregate principal amount of 5.25 % Fixed-to-Floating Rate Subordinated Notes due 2030 resulting in net proceeds, after placement fees and offering expenses, of approximately $ 11.7 million during the quarter ended September 30, 2020. The Company contributed $ 5.5 million of the net proceeds from the sale of the Notes to the Bank and intends to use the remaining net proceeds from the sale of the notes for general corporate purposes, including stock repurchases and to pay dividends on Company common stock. 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 29 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, 2020 2019 2020 2019 Net income available to common shareholders $ 2,319 $ 1,548 $ 5,407 $ 4,809 Weighted-average number of shares outstanding, basic 2,563 2,526 2,558 2,521 Effect of potentially dilutive common shares 26 52 30 51 Weighted-average number of shares outstanding, diluted 2,589 2,578 2,588 2,572 Earnings per share, basic $ 0.90 $ 0.61 $ 2.11 $ 1.90 Earnings per share, diluted $ 0.90 $ 0.60 $ 2.09 $ 1.87 There were 19,281 anti-dilutive securities at September 30, 2020 and no anti-dilutive securities at September 30, 2019. Note 10 – Stock-based Compensation Stock Options and Restricted Stock 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 September 30, 2020, on an adjusted basis, awards for stock options totaling 261,019 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 2013 Plan and the 2008 Plan. Share-based compensation expense was $ 52,000 and $ 283,000 for the three and nine months ended September 30, 2020, respectively, and was $ 72,000 and $ 159,000 or the three and nine months ended September 30, 2019, respectively. 30 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 nine months ended September 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 ( 19,413 ) 17.22 Forfeited ( 2,205 ) 29.25 Expired ( 6,733 ) 28.96 Outstanding at September 30, 2020 101,134 22.02 4.97 873,423 Exercisable 85,334 19.99 4.36 851,612 Expected to vest, assuming a 0 % forfeiture rate over the vesting term 14,099 $ 34.96 8.75 $ — As of September 30, 2020, there was $ 82,000 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 2.83 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, 2020 and 2019 were determined using the following weighted-average assumptions as of the grant date. September 30, 2020 September 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 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. 31 The following is a summary of the Company’s non-vested restricted stock award activity during the nine months ended September 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 September 30, 2020 17,384 $ 35.03 $ 29.63 Expected to vest assuming a 0 % forfeiture rate over the vesting term 17,384 $ 35.03 $ 29.63 As of September 30, 2020, there was $ 490,000 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 2.87 years. The total fair value of shares vested for the nine months ended September 30, 2020 and 2019 was $ 236,000 and $ 365,000 , 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 September 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 140,679 shares held by the ESOP trust was $ 4.2 million at September 30, 2020. ESOP compensation expense included in salaries and benefits was $ 126,000 and $ 474,000 for the three and nine months ended September 30, 2020, respectively, and was $ 168,000 and $ 504,000 for the three and nine months ended September 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 nine months ended September 30, 2020 and 2019 (in thousands). Items outside of the scope of ASC 606 are noted as such. 32 Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Noninterest income: Service charges and fee income Account maintenance fees $ 74 $ 48 $ 209 $ 143 Transaction-based and overdraft service charges 74 118 235 338 Debit/ATM interchange fees 270 264 742 728 Credit card interchange fees 5 7 18 21 Loan fees (a) 72 59 183 163 Other fees (a) 15 16 46 44 Total service charges and fee income 510 512 1,433 1,437 Earnings on cash surrender value of bank-owned life insurance (a) 102 81 207 267 Mortgage servicing income (a) 260 259 739 756 Fair value adjustment on mortgage servicing rights (a) ( 623 ) ( 90 ) ( 1,423 ) ( 576 ) Net gain on sale of loans (a) 1,819 305 3,399 1,000 Total noninterest income $ 2,068 $ 1,067 $ 4,355 $ 2,884 (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 33 Company incurred no expenses on OREO properties for the three and nine months ended September 30, 2020, compared to $ 1,000 and $ 11,000 for the three and nine months ended 2019, respectively, which are included in Noninterest Expense on the Company’s Condensed Consolidated Statements of Income. 34 Note 12 – Leases We have operating leases for branch locations, a loan production office, 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 September 30, 2020 and December 31, 2019 (in thousands): September 30, 2020 December 31, 2019 Operating lease right-of-use assets $ 6,945 $ 7,641 Operating lease liabilities $ 7,348 $ 8,010 The following table represents the components of lease expense (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Operating lease expense Office leases $ 268 $ 306 $ 882 $ 916 Equipment leases 5 5 15 15 Sublease income ( 3 ) ( 3 ) ( 9 ) ( 9 ) Net lease expense $ 270 $ 308 $ 888 $ 922 The following table represents the maturity of lease liabilities: September 30, 2020 Office leases Equipment leases Operating Lease Commitments Remainder of 2020 $ 257 $ 5 2021 1,042 20 2022 1,017 9 2023 989 — 2024 968 — Thereafter 3,897 — Total lease payments 8,170 34 Less: Present value discount 856 — Present value of lease liabilities $ 7,314 $ 34 35 Lease term and discount rate by lease type consist of the following: September 30, 2020 Weighted-average remaining lease term (in years): Office leases 8.11 Equipment leases 1.67 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 September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Cash paid for amounts included in the measurement of lease liabilities for operating leases: Operating cash flows Office leases $ 257 $ 290 $ 839 $ 808 Equipment leases $ 5 $ 5 $ 15 $ 15 36 Table of Contents Note 13 – Subsequent Event On October 27, 2020, the Board of Directors of the Company declared a quarterly cash dividend of $ 0.15 per common share, payable on November 24, 2020 to stockholders of record at the close of business on November 10, 2020. On October 27, 2020, the Company announced that its Board of Directors authorized a stock repurchase program. Under this 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 28, 2020, 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.