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Item 8. Financial Statements and Supplementary Data

2021-03-30 compared with 2020-03-12 · 613 added, 362 removed, 908 unchanged (52% of the section changed)

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Sound Financial Bancorp, Inc.

Opinions on the Financial Statements and Internal Control over Financial Reporting

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Sound Financial Bancorp, Inc.

and Subsidiary (the “Company”) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for the years then ended, and the related notes (collectively referred to as the “consolidated financial statements”).

We also have audited the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2019 and 2018, and the consolidated results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO.

Basis for Opinions

The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control over Financial Reporting included in Item 9A.

Our responsibility is to express an opinion on the Company’s consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.

In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2020 and 2019, and the consolidated results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management.

Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits.

We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S.

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We conducted our audits in accordance with the standards of the PCAOB.

Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures to respond to those risks.

Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.

The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting in accordance with the standards of the PCAOB.

As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting in accordance with the standards of the PCAOB.

Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures to respond to those risks.

Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements.

Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.

Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk.

Our audits also included performing such other procedures as we considered necessary in the circumstances.

We believe that our audits provide a reasonable basis for our opinions.

Definition and Limitations of Internal Control Over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company;

(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company;

and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or

disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.

Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

We believe that our audits provide a reasonable basis for our opinion.

Critical Audit Matters

The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments.

The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing a separate opinion on the critical audit matters or on the accounts or disclosures to which they relate.

Allowance for Loan Losses

As described in Notes 1 and 5 to the consolidated financial statements, the Company’s allowance for loan losses balance was $6.0 million at December 31, 2020.

The allowance for loan losses is maintained to provide for probable inherent losses in the loan portfolio based on evaluating risks in the loan portfolio.

The level of the allowance reflects the Company’s view of trends in loan loss activity, current loan portfolio quality and present economic, political and regulatory conditions.

The allowance is provided based upon management's continuing analysis of the pertinent factors underlying the quality of the loan portfolio.

These factors include, but are not limited to, changes in the size and composition of the loan portfolio, delinquency levels,

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actual loan loss experience, current economic conditions, and detailed analysis of individual loans for which full collectability may not be assured.

We identified management’s internally assigned grades of loans and the estimation of qualitative factors, both of which are used in the allowance for loan losses calculation, as critical audit matters.

The Company uses internally assigned loan grades to stratify loans into pools and to estimate inherent loss rates for each of the loan pools, which are used in the calculation of the allowance for loan losses.

Determination of the assigned loan grades involves significant management judgment.

The qualitative factors are used to estimate losses related to factors that are not captured in the historical loss rates and are based on management’s evaluation of available internal and external data and involves significant management judgment.

Auditing management’s judgments relating to the determination of internally assigned grades and qualitative factors involved a high degree of subjective auditor judgment.

The primary procedures we performed to address this critical audit matter included:

• Obtain an understanding of the design and implementation of controls relating to management’s calculation of the allowance for loan losses, including controls over the accuracy of assigned loan grades and the determination of the qualitative factors used.

• Testing a risk-based, targeted selection of loans to gain substantive evidence that the Company is appropriately grading these loans in accordance with its policies, and that the assigned loan grades are reasonable.

• Obtaining management’s analysis and supporting documentation related to the qualitative factors and testing whether the qualitative factors used in the calculation of the allowance for loan losses are supported by the analysis provided by management.

• Testing the appropriateness of the methodology and assumptions used in the calculation of the allowance for loan losses, and testing the calculation itself, including completeness and accuracy of the data used in the calculation, application of the assigned loan grades determined by management and used in the calculation, application of the qualitative factors determined by management and used in the calculation, and recalculation of the allowance for loan losses balance.

/s/ Moss Adams LLP

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We have served as the Company’s auditor since 2002.

Table of Conten t s

SOUND FINANCIAL BANCORP, INC.

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Accrued interest receivable 2,254 2,206

Bank-owned life insurance, net

Bank-owned life insurance ("BOLI"), net 14,588 14,183

Other real estate owned ("OREO") and repossessed assets, net 594 575

Mortgage servicing rights, at fair value

Mortgage servicing rights ("MSR"), at fair value 3,780 3,239

Federal Home Loan Bank ("FHLB") stock, at cost 877 1,160

Premises and equipment, net 6,270 6,767

Lease right of use assets

Lease right of use assets, net 6,722 7,641

Other assets 3,304 3,696

Total assets $ 861,402 $ 719,853

Interest-bearing $ 615,491 $ 519,434

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Total deposits 747,981 616,718

Borrowings — 7,500

Accrued interest payable 369 226

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Advance payments from borrowers for taxes and insurance 1,168 1,305

Subordinated notes, net 11,592 —

Total liabilities 775,918 642,127

COMMITMENTS AND CONTINGENCIES (NOTE 17 and 20)

COMMITMENTS AND CONTINGENCIES (Notes 12 and 18)

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, 2,567,389 and 2,544,059 issued and outstanding as of December 31, 2019 and 2018, respectively

Common stock, $ 0.01 par value, 40,000,000 shares authorized, 2,592,587 and 2,567,389 issued and outstanding at December 31, 2020 and 2019, respectively

Additional paid-in capital 27,106 26,343

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See notes to consolidated financial statements

Table of Conten t s

SOUND FINANCIAL BANCORP, INC.

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INTEREST EXPENSE

Deposits 7,004 6,865

Borrowings 446 752

Total interest expense 7,450 7,617

Net interest income 27,486 26,964

(RECAPTURE) PROVISION FOR LOAN LOSSES

Net interest income after (recapture) provision for loan losses

PROVISION (RECAPTURE) FOR LOAN LOSSES 925 ( 125 )

Net interest income after provision (recapture) for loan losses 26,561 27,089

NONINTEREST INCOME

Service charges and fee income 1,905 1,954

Earnings on cash surrender value of bank-owned life insurance

Earnings on cash surrender value of BOLI 348 381

Mortgage servicing income 1,027 1,002

Fair value adjustment on mortgage servicing rights

Fair value adjustment on MSRs ( 1,857 ) ( 760 )

Net gain on sale of loans 6,022 1,449

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Salaries and benefits 12,083 12,402

Operations 5,461 5,905

Regulatory assessments 590 279

Occupancy 1,881 2,060

Data processing 2,658 2,104

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Provision for income taxes 2,391 1,651

Net income $ 8,937 $ 6,679

Earnings per common share:

Basic $ 3.46 $ 2.63

Diluted $ 3.42 $ 2.57

Weighted average number of common shares outstanding:

Basic 2,562,650 2,527,329

Diluted 2,592,532 2,583,312

See notes to consolidated financial statements

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SOUND FINANCIAL BANCORP, INC.

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Year Ended December 31,

Net income $ 8,937 $ 6,679

Available for sale securities:

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See notes to consolidated financial statements

Table of Conten t s

SOUND FINANCIAL BANCORP, INC.

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(In thousands, except share and per share amounts)

Paid-in Capital

Accumulated Other Comprehensive

Income, net of tax

Shares Common Stock Additional

Paid-in Capital Unearned

ESOP Shares Retained

Earnings Accumulated Other Comprehensive

Income, net of tax Total

Stockholders' Equity

Balance at December 31, 2019 2,567,389 $ 25 $ 26,343 $ ( 227 ) $ 51,410 $ 175 $ 77,726

Net income 8,937 8,937

Other comprehensive income, net of tax 65 65

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Cash dividends on common stock ($ 0.80 per share)

( 2,072 ) ( 2,072 )

Common stock surrendered ( 3,423 ) —

Common stock repurchased ( 2,477 ) ( 24 ) ( 49 ) ( 73 )

Restricted shares forfeited ( 1,915 ) —

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Balance at December 31, 2020 2,592,587 $ 25 $ 27,106 $ ( 113 ) $ 58,226 $ 240 $ 85,484

Paid-in Capital

Accumulated Other Comprehensive

Income, net of tax

Shares Common Stock Additional

Paid-in Capital Unearned

ESOP Shares Retained

Earnings Accumulated Other Comprehensive

Income, net of tax Total

Stockholders' Equity

Balance at December 31, 2018 2,544,059 $ 25 $ 25,663 $ ( 340 ) $ 46,165 $ 114 $ 71,627

Other comprehensive loss, net of tax

Net income 6,679 6,679

Other comprehensive income, net of tax 61 61

Share-based compensation 267 267

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Cash dividends on common stock ($ 0.56 per share)

Common stock repurchased

( 1,434 ) ( 1,434 )

Common stock surrendered ( 3,487 ) —

Restricted shares forfeited ( 880 ) —

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See notes to consolidated financial statements

Table of Conten t s

SOUND FINANCIAL BANCORP, INC.

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CASH FLOWS FROM OPERATING ACTIVITIES:

Net income $ 8,937 $ 6,679

Adjustments to reconcile net income to net cash from operating activities:

Amortization of net premiums/discounts on investments 160 50

(Recapture) provision for loan losses

Provision (recapture) for loan losses 925 ( 125 )

Depreciation and amortization 905 931

Compensation expense related to stock options and restricted stock 338 267

Change in fair value of mortgage servicing rights

Change in right of use assets amortization

Fair value adjustment on MSRs 1,857 760

Right of use assets amortization 919 592

Change in lease liabilities ( 876 ) ( 480 )

Increase in cash surrender value of BOLI

Earnings on cash surrender value of BOLI ( 348 ) ( 381 )

Net change in advances from borrowers for taxes and insurance ( 137 ) 616

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Originations of loans held-for-sale ( 265,448 ) ( 77,241 )

Net loss on OREO and repossessed assets

Net loss on sale of OREO and repossessed assets — 21

Change in operating assets and liabilities:

Accrued interest receivable ( 48 ) 81

Other assets 19 762

Accrued interest payable 143 89

Other liabilities ( 694 ) 1,944

Net cash provided by operating activities

Net cash (used in) provided by operating activities ( 484 ) 11,063

CASH FLOWS FROM INVESTING ACTIVITIES:

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Purchases of available for sale securities ( 8,889 ) ( 5,166 )

Net increase in loans

Purchase of BOLI

Net decrease (increase) in loans held-for-portfolio 5,940 ( 847 )

Purchase of BOLI/Company-owned life insurance ( 57 ) ( 437 )

Proceeds from sale of OREO and other repossessed assets — 473

Purchases of premises and equipment, net ( 407 ) ( 654 )

Net cash used in investing activities

Net cash provided by (used in) investing activities 4,496 ( 5,786 )

CASH FLOWS FROM FINANCING ACTIVITIES

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Repayment of borrowings ( 181,791 ) ( 243,300 )

FHLB stock redeemed (purchased)

FHLB stock redeemed 283 2,974

Net proceeds from issuance of subordinated notes 11,582 —

ESOP shares released 324 395

Repurchases of common stock ( 73 ) —

Proceeds from common stock option exercises 239 131

Dividends paid on common stock ( 2,072 ) ( 1,434 )

Net cash (used in) provided by financing activities

Net (decrease) increase in cash and cash equivalents

Net cash provided by (used in) financing activities 134,046 ( 11,317 )

Net increase (decrease) in cash and cash equivalents 138,058 ( 6,040 )

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Cash and cash equivalents, beginning of year 55,770 61,810

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Noncash net transfer from loans to OREO and repossessed assets 19 494

Noncash transfer from assets in process to premises and equipment 692 —

Leases right of use assets obtained in exchange for operating lease liabilities:

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See notes to consolidated financial statements

Table of Conten t s

SOUND FINANCIAL BANCORP, INC.

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Note 1— Organization and Significant Accounting Policies

Sound Financial Bancorp, a Maryland corporation ("Sound Financial Bancorp" or the "Company"), is a bank holding company for its wholly owned subsidiary, Sound Community Bank (the "Bank").

Sound Financial Bancorp, a Maryland corporation ("Sound Financial Bancorp" or the "Company"), is the parent holding company for its wholly owned subsidiary, Sound Community Bank (the "Bank") and the Bank's wholly-owned subsidiary, Sound Community Insurance Agency, Inc.

Substantially all of Sound Financial Bancorp's business is conducted through Sound Community Bank, a Washington state-chartered commercial bank.

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Subsequent events – The Company has evaluated subsequent events for potential recognition and disclosure.

See Note 21 in the Notes to Consolidated Financial Statements contained in Item 8 of this report on Form 10-K.

Basis of Presentation and Use of Estimates – The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of income and expenses during the reporting period.

See "Note 21—Subsequent Events" for further information.

Basis of Presentation and Use of Estimates – The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America ("U.S.

GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of income and expenses during the reporting period.

Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the fair value of mortgage servicing rights, valuations of impaired loans and OREO, and the realization of deferred taxes.

The accompanying consolidated financial statements include the accounts of Sound Financial Bancorp and its wholly-owned subsidiary Sound Community Bank.

All significant intercompany balances and transactions between Sound Financial Bancorp and its subsidiary have been eliminated in consolidation.

Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the fair value of MSRs, valuations of impaired loans and OREO, and the realization of deferred taxes.

The accompanying consolidated financial statements include the accounts of Sound Financial Bancorp and its wholly-owned subsidiaries Sound Community Bank and Sound Community Insurance Agency, Inc.

All significant intercompany balances and transactions between Sound Financial Bancorp and its subsidiaries have been eliminated in consolidation.

Cash and cash equivalents – For purposes of reporting cash flows, cash and cash equivalents include cash on hand and in banks and interest-bearing deposits.

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Investment securities – Investment securities are classified into one of three categories:

(1) held-to-maturity, (2) available-for-sale ("AFS"), or (3) trading.

(1) held-to-maturity, (2) available-for-sale or (3) trading.

The Company had no held-to-maturity or trading securities at December 31, 2020 or 2019.

AFS securities consist of debt securities that the Company has the intent and ability to hold for an indefinite period, but not necessarily to maturity.

Available-for-sale securities consist of debt securities that the Company has the intent and ability to hold for an indefinite period, but not necessarily to maturity.

Such securities may be sold to implement the Company's asset/liability management strategies and/or in response to changes in interest rates and similar factors.

AFS securities are reported at fair value.

Available-for-sale securities are reported at fair value.

Dividend and interest income are recognized when earned.

Unrealized gains and losses, net of the related deferred tax effect, are reported as a net amount in accumulated other comprehensive income (loss) on AFS securities in the consolidated balance sheets.

Realized gains and losses on AFS securities, determined using the specific identification method, are included in earnings.

Unrealized gains and losses, net of the related deferred tax effect, are reported as a net amount in accumulated other comprehensive income (loss) on available-for-sale securities in the consolidated balance sheets.

Realized gains and losses on available-for-sale securities, determined using the specific identification method, are included in earnings.

Amortization of premiums and accretion of discounts are recognized as adjustments to interest income using the interest method over the period to the earlier of call date or maturity.

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Projected cash flows are discounted by the original or current effective interest rate depending on the nature of the security being measured for potential OTTI.

The remaining impairment related to all other factors, the difference between the present value of the cash flows expected to be collected and the fair value, is recognized as a charge to other comprehensive income ("OCI").

The Company does not intend to

sell these securities and it is more likely than not that it will not be required to sell the securities before anticipated recovery of the remaining amortized cost basis.

The Company does not intend to sell

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these securities and it is more likely than not that it will not be required to sell the securities before anticipated recovery of the remaining amortized cost basis.

The Company closely monitors its investment securities for changes in credit risk.

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All TDRs are reported and accounted for as impaired loans.

In March 2020, the Company began offering short-term loan modifications to assist borrowers during the novel coronavirus disease 2019 ("COVID-19") pandemic.

The Coronavirus Aid, Relief and Economic Security Act ("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 placed on nonaccrual status or accounted for as a TDR, pursuant to applicable accounting and regulatory guidance until the earlier of 60 days after the national emergency termination date or January 1, 2022.

At December 31, 2020, we have provided payment relief related to COVID-19 on 49 commercial loans totaling $ 37.2 million and 84 residential loans totaling $ 19.0 million, of which 40 commercial loans totaling $ 29.1 million and 55 residential loans totaling $ 14.6 million have resumed their normal loan payments, matured, or have paid-off.

We continue to monitor these loans through our normal credit risk processes.

Allowance for loan losses – The allowance for loan losses is a reserve established through a provision for loan losses charged to expense and represents management's best estimate of probable losses incurred within the existing loan portfolio as of the balance sheet date.

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Full or partial charge-offs on collateral dependent impaired loans are generally recognized when the collateral is deemed to be insufficient to support the carrying value of the loan.

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The allowance for loan losses is maintained at a level sufficient to provide for probable credit losses based upon evaluating known and inherent risks in the loan portfolio.

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These factors include changes in the size and composition of the loan portfolio, delinquency levels, actual loan loss experience, current economic conditions, and detailed analysis of individual loans for which full collectability may not be assured.

The detailed analysis includes techniques to estimate the fair value of

loan collateral and the existence of potential alternative sources of repayment.

The detailed analysis includes techniques to estimate the fair value of loan collateral and the existence of potential alternative sources of repayment.

The allowance consists of specific, general and unallocated components.

The Company considers installment loans to be pools of smaller balance, homogenous loans that are collectively evaluated for impairment, unless such loans are subject to a TDR agreement.

The general component of the allowance for loan losses covers non-impaired loans and is determined using a formula-based approach.

The formula first incorporates either the historical loss rates of the Company or the historical loss rates of their peer group if minimal loss history exists.

This historical loss rate factor is then adjusted for qualitative factors.

Qualitative factors are used to estimate losses related to factors that are not captured in the historical loss rates and are based on management’s evaluation of available internal and external data and involve significant management judgement.

Qualitative factors include changes in lending standards, changes in economic conditions, changes in the nature and volume of loans, changes in lending management, changes in delinquencies, changes in the loan review system, changes in the value of collateral, the existence of concentrations, and the impact of other external factors.

Finally, the general component of the allowance for loan losses is adjusted for changes in the assigned grades of loans, which include the following:

pass, watch, special mention, substandard, doubtful, and loss.

As loans are downgraded from watch to the lower categories, they are assigned an additional factor to account for the increased credit risk.

Loan grades involve significant management judgment.

For such loans that are also classified as impaired, a specific component within the allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan are lower than the carrying value of that loan.

The general component covers non-impaired loans and is based upon historical loss experience adjusted for qualitative factors.

An unallocated component is maintained to cover uncertainties that could affect management's estimate of probable losses.

The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

The Company considers installment loans to be pools of smaller balance, homogenous loans that are collectively evaluated for impairment, unless such loans are subject to a TDR agreement.

The appropriateness of the allowance for loan losses is estimated based upon those factors and trends identified by management at the time consolidated financial statements are prepared.

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(1) a group of financial assets or a participating interest in an entire financial asset has been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

Mortgage servicing rights ("MSR") – Mortgage servicing rights represent the value associated with servicing residential mortgage loans, when the mortgage loans have been sold into the secondary market and the related servicing has been retained by the Company.

The Company may also purchase mortgage servicing rights.

Mortgage servicing rights – MSRs represent the value associated with servicing residential mortgage loans, when the mortgage loans have been sold into the secondary market and the related servicing has been retained by the Company.

The Company may also purchase MSRs.

The value is determined through a discounted cash flow analysis, which uses interest rates, prepayment speeds and delinquency rate assumptions as inputs.

All of these assumptions require a significant degree of management judgment.

The Company measures its mortgage servicing assets at fair value and reports changes in fair value through earnings under the caption mortgage banking revenue in the period in which the change occurs.

The Company measures its mortgage servicing assets at fair value and reports changes in fair value through earnings under the caption fair value adjustment on MSRs in other income in the period in which the change occurs.

Premises and equipment – Premises, leasehold improvements and furniture and equipment are carried at cost, less accumulated depreciation and amortization.

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The cost of leasehold improvements is amortized using the straight-line method over the terms of the related leases.

The cost of premises is amortized using the straight-line method over the estimated useful life of the building, up to 39 years.

The cost of premises is amortized using the straight-line method over

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the estimated useful life of the building, up to 39 years.

Management reviews premises, leasehold improvements and furniture and equipment for impairment on an annual basis.

Bank-owned life insurance, net – The carrying amount of bank owned life insurance approximates its fair value, and is estimated using the cash surrender value, net of any surrender charges.

Federal Home Loan Bank stock – The Company is a member of the Federal Home Loan Bank of Des Moines ("FHLB").

Bank-owned life insurance, net – The carrying amount of BOLI approximates its fair value, and is estimated using the cash surrender value, net of any surrender charges.

Federal Home Loan Bank stock – The Company is a member of the FHLB of Des Moines.

FHLB stock represents the Company's investment in the FHLB and is carried at par value, which reasonably approximates its fair value.

As a member of the FHLB, the Company is required to maintain a minimum level of investment in FHLB stock based on specific percentages of its outstanding mortgages, total assets, or FHLB advances.

At December 31, 2019 and 2018 , the Company's minimum required investment in FHLB stock was $1.2 million and $4.1 million , respectively.

At December 31, 2020 and 2019, the Company's minimum required investment in FHLB stock was $ 877,000 and $ 1.2 million, respectively.

Typically, the Company may request redemption at par value of any stock in excess of the minimum required investment.

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Leases – We determine if an arrangement is a lease at inception.

Operating leases are included in operating lease right-of-use (“ROU”) assets and operating lease liabilities in our consolidated balance sheets.

ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease.

Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term.

Operating leases are included in operating lease right-of-use assets and operating lease liabilities in our consolidated balance sheets.

Right-of-use assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease.

Operating lease right-of-use assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term.

As most of our leases do not provide an implicit rate, we generally use our incremental borrowing rate based on the estimated rate of interest for collateralized borrowing over a similar term of the lease payments at commencement date.

The operating lease ROU asset also includes any lease payments made and excludes lease incentives.

The operating lease right-of-use asset also includes any lease payments made and excludes lease incentives.

Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option.

Lease expense for lease payments is recognized on a straight-line basis over the lease term.

Additionally, for equipment leases, we apply a portfolio approach to effectively account for the operating lease ROU assets and liabilities.

Additionally, for equipment leases, we apply a portfolio approach to effectively account for the operating lease right-of-use assets and liabilities.

The Company has not entered into leases that meet the definition of a financing lease.

Income Taxes – Income taxes are accounted for using the asset and liability method.

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Such items, along with net income, are components of comprehensive income.

Table of Conten t s

Intangible assets – At December 31, 2020 and 2019, the Company had $ 128,000 and $ 158,000 , respectively, of identifiable intangible assets included in other assets as a result of the acquisition of deposits from other institutions.

These assets are amortized using the straight-line method over a period of 8 - 10 years and have a remaining weighted average life of 5.2 years .

These assets are amortized using the straight-line method over a period of eight to ten years and have a remaining weighted average life of 4.2 years.

Management reviews intangible assets for impairment on an annual basis.

No impairment losses have been recognized in the periods presented.

Employee stock ownership plan (ESOP) – The Company sponsors a leveraged ESOP.

Employee stock ownership plan – The Company sponsors a leveraged ESOP.

As shares are committed to be released, compensation expense is recorded equal to the market price of the shares, and the shares become outstanding for purposes of earnings per share calculations.

Cash dividends on allocated shares (those credited to ESOP participants' accounts) are recorded as a reduction of stockholders' equity and distributed directly to participants' accounts.

Cash dividends on unallocated shares

(those held by the ESOP not yet credited to participants' accounts) are used to pay administrative expenses and debt service requirements of the ESOP.

Cash dividends on unallocated shares (those held by the ESOP not yet credited to participants' accounts) are used to pay administrative expenses and debt service requirements of the ESOP.

See "Note 14—Employee Benefits" for further information.

At December 31, 2019 , there were 22,680 unallocated shares in the plan.

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.

Shares released on December 31, 2020 totaled 11,340 and will be credited to plan participants' accounts in 2021.

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The loan receivable from the ESOP to the Company is not reported as an asset nor is the debt of the ESOP reported as a liability on the Company's consolidated statements of condition.

Earnings Per Common Share – Earnings per share ("EPS") is computed using the two-class method.

Basic EPS is computed by dividing net income available to common shares by the weighted average number of common shares outstanding during the period, excluding any participating securities.

Earnings Per Common Share – Earnings per share is computed using the two-class method.

Basic earnings per share is computed by dividing net income available to common shares by the weighted average number of common shares outstanding during the period, excluding any participating securities.

Participating securities include unvested restricted shares.

Unvested restricted shares are considered participating securities because holders of these securities receive non-forfeitable dividends at the same rate as the holders of the Company's common stock.

Diluted EPS is computed by dividing net income available to common stockholders adjusted for reallocation of undistributed earnings of unvested restricted shares by the weighted average number of common shares determined for the basic EPS plus the dilutive effect of common stock equivalents using the treasury stock method based on the average market price for the period.

Some stock options are anti-dilutive and therefore are not included in the calculation of diluted EPS.

Diluted earnings per share is computed by dividing net income available to common stockholders adjusted for reallocation of undistributed earnings of unvested restricted shares by the weighted average number of common shares determined for the basic earnings per share plus the dilutive effect of common stock equivalents using the treasury stock method based on the average market price for the period.

Some stock options are anti-dilutive and therefore are not included in the calculation of diluted earnings per share.

Fair value – Fair value is the price that would be received when an asset is sold or a liability is transferred in an orderly transaction between market participants at the measurement date.

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Reductions in compensation expense associated with forfeited options are estimated at the date of grant, and this estimated forfeiture rate is adjusted monthly based on actual forfeiture experience.

The Company measures the fair value of the restricted stock using the closing market price of the Company's common stock on the date of grant.

The Company measures the fair value of the restricted stock using the closing market price of the Company's common stock on the date of

Table of Conten t s

The Company expenses the grant date fair value of the Company's stock options and restricted stock with a corresponding increase in equity.

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Note 2— Accounting Pronouncements Recently Issued or Adopted

In December 2019, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No.

On March 27, 2020, President Trump signed into law the CARES Act, which provides relief from certain accounting and financial reporting requirements under U.S.

Section 4013 of the CARES Act provides temporary relief from the accounting and reporting requirements for TDRs under Accounting Standards Codification ("ASC") 310-40 for loan modifications related to the 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.

On March 2020, the FASB issued ASU No.

2020-04, " Reference Rate Reform" ("Topic 848") .

This ASU provides optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting.

The amendments in this update apply to contract modifications that replace a reference rate affected by reference rate reform (including rates referenced in fallback provisions) and contemporaneous modifications of other contract terms related to the replacement of the reference rate (including contract modifications to add or change fallback provisions).

The following optional expedients for applying the requirements of certain Topics or Industry Subtopics in the Codification are permitted for contracts that are modified because of reference rate reform and that meet certain scope guidance:

1) Modifications of contracts within the scope of Topics 310, Receivables, and 470, Debt, should be accounted for by prospectively adjusting the effective interest rate;

2) Modifications of contracts within the scope of Topics 840, Leases, and 842, Leases, should be accounted for as a continuation of the existing contracts with no reassessments of the lease classification and the discount rate (for example, the incremental borrowing rate) or remeasurements of lease payments that otherwise would be required under those Topics for modifications not accounted for as separate contracts;

and 3) Modifications of contracts do not require an entity to reassess its original conclusion about whether that contract contains an embedded derivative that is clearly and closely related to the economic characteristics and risks of the host contract under Subtopic 815-15, Derivatives and Hedging— Embedded Derivatives.

The amendments in this update have differing effective dates, beginning with interim period including and subsequent to March 12, 2020 through December 31, 2022.

The Company does not expect the adoption of ASU 2020-04 to have a material impact on its consolidated financial statements.

In December 2019, the FASB issued ASU No.

2019-12, Income Taxes (Topic 740):

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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.

This ASU is effective for fiscal years, and interim periods

Table of Conten t s

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.

6 unchanged sentences

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.

The adoption of ASU No.

2018-14 did not have a material impact on the Company's consolidated financial statements.

In August 2018, the FASB issued ASU No.

5 unchanged sentences

Amendments in this ASU are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years.

Early adoption is permitted for any removed or modified disclosures.

The adoption of ASU 2018-13 is not expected to have a material impact on the Company's consolidated financial statements.

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.

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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.

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.

5 unchanged sentences

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.

2017-08 is intended to amend the amortization period for certain purchased callable debt securities held at a premium.

Under ASU No.

2017-08, the FASB is shortening the amortization period for the premium to the earliest call date.

ASU 2017-08 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018.

1 unchanged sentence

2017-08 on January 1, 2019 did not have a material impact on the Company's consolidated financial statements.

Table of Conten t s

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.

Simplifying the Test for Goodwill Impairment (" 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.

1 unchanged sentence

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 does not expect the adoption of ASU 2017-04 to have a material impact on its consolidated financial statements.

The adoption of ASU 2017-04 did not have a material impact on the Company's consolidated financial statements.

In June 2016, the FASB issued ASU No.

5 unchanged sentences

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 December 15, 2022.

The Bank meets the requirements of a smaller reporting company and will delay implementation of ASU 2016-13.

The FASB issued ASU No.

2019-10, Financial Instruments - Credit Losses (Topic 326) , delaying implementation of ASU No.

2016-13 for SEC smaller reporting company filers until fiscal year beginning after December 15, 2022.

The Bank meets the requirements of a smaller reporting company and will delay implementation of ASUNo.

In February 2016, FASB issued ASU No.

11 unchanged sentences

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 annual disclosures in this report.

In March 2019, FASB issued ASU No.

2019-01, Leases (Topic 842), Codification Improvements .

The amendments in this ASU include guidance on 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 adoption of ASU No.

2019-01 did not have a material impact on the Company's consolidated financial statements and have provided the required annual disclosures in this report.

Refer to "Note 12—Leases" for further information.

Note 3— Restricted Cash

Federal Reserve Board regulations require that the Company maintain certain minimum reserve balances either as cash on hand or on deposit with the Federal Reserve Bank, based on a percentage of deposits.

The reserve balances were $12.4 million and $13.8 million at December 31, 2019 and 2018 , respectively.

Federal Reserve System ("Federal Reserve") regulations require that the Company maintain certain minimum reserve balances either as cash on hand or on deposit with the Federal Reserve Bank, based on a percentage of deposits.

In March 2020, the Federal Reserve announced that it would be reducing the reserve requirement for all depository institutions to zero percent effective March 26, 2020.

The Company' reserve balances were zero and $ 12.4 million at December 31, 2020 and 2019, respectively.

Table of Conten t s

Note 4— Investments

The amortized cost and fair value of AFS securities and the corresponding amounts of gross unrealized gains and losses at December 31, 2019 and 2018 were as follows (in thousands):

Unrealized Gains

Unrealized Losses

The amortized cost and fair value of available-for-sale securities and the corresponding amounts of gross unrealized gains and losses at December 31, 2020 and 2019 were as follows (in thousands):

Unrealized Gains Gross

Unrealized Losses Estimated

December 31, 2020

1 unchanged sentence

Agency mortgage-backed securities 4,706 105 ( 6 ) 4,805

Total available-for-sale securities $ 9,915 $ 309 $ ( 6 ) $ 10,218

December 31, 2019

1 unchanged sentence

Agency mortgage-backed securities 5,888 56 ( 8 ) 5,936

The amortized cost and fair value of AFS securities at December 31, 2019 , 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.

Total available-for-sale securities $ 9,085 $ 229 $ ( 8 ) $ 9,306

The following table details the amortized cost and fair value of available-for-sale securities at December 31, 2020, by contractual maturity (in thousands).

Expected maturities of available-for-sale 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 securities, are shown separately.

December 31, 2020

Weighted-Average Yield

Value Weighted-Average Yield

Due within one year $ 228 $ 231 1.46 %

3 unchanged sentences

Mortgage-backed securities 4,706 4,805 2.31

Total $ 9,915 $ 10,218 2.84 %

There were no pledged securities at December 31, 2020 and 2019.

There were no sales of AFS securities during the years ended December 31, 2019 and 2018 .

There were no sales of available-for-sale securities during the years ended December 31, 2020 and 2019.

The following tables summarize 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, 2020 and 2019 (in thousands):

December 31, 2020

Less Than 12 Months

12 Months or Longer

Less Than 12 Months 12 Months or Longer Total

Value Unrealized

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

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

December 31, 2019

Less Than 12 Months

12 Months or Longer

Municipal bonds

Less Than 12 Months 12 Months or Longer Total

Value Unrealized

Agency mortgage-backed securities $ 3,387 $ ( 8 ) $ — $ — $ 3,387 $ ( 8 )

Total $ 3,387 $ ( 8 ) $ — $ — $ 3,387 $ ( 8 )

Table of Conten t s

There were no credit losses recognized in earnings during the years ended December 31, 2020 and 2019 relating to the Company's securities.

At December 31, 2019 , the securities portfolio consisted of 13 agency mortgage-backed securities and eight municipal securities with a fair value of $9.3 million .

At December 31, 2018 , the securities portfolio consisted of six agency mortgage-backed securities and eight municipal bonds with a fair value of $5.0 million .

At December 31, 2019, there were five agency 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, 2018 , there were no securities in an unrealized loss position for less than 12 months, and there were three municipal securities in an unrealized loss position for more than 12 months.

At December 31, 2020, the securities portfolio consisted of 16 agency mortgage-backed securities and 10 municipal securities with a fair value of $ 10.2 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 December 31, 2020, there were six agency 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 municipal securities in an unrealized loss position for more than 12 months.

For both the 2020 and 2019 periods, 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") during the years ended December 31, 2019 and 2018 , 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 .

The unrealized losses on these investments are not considered OTTI losses during the years ended December 31, 2020 and 2019, 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 .

Table of Conten t s

Note 5— Loans

The composition of the loan portfolio, excluding loans held-for-sale, at December 31, 2020 and 2019 is as follows (in thousands):

At December 31,

Real estate loans:

One-to-four family $ 130,657 $ 149,393

Home equity 16,265 23,845

Commercial and multifamily 265,774 261,268

7 unchanged sentences

Commercial business loans 64,217 38,931

Total loans 615,498 621,907

Deferred fees ( 2,135 ) ( 2,020 )

2 unchanged sentences

Total loans, net $ 607,363 $ 614,247

The following table presents the balance in the allowance for loan losses and the unpaid principal balance in loans, net of partial charge-offs by portfolio segment and based on impairment method as of December 31, 2019 (in thousands):

Individually evaluated for impairment

Collectively evaluated for impairment

Ending balance

Loans held for investment:

Individually evaluated for impairment

Loans held for investment:

Collectively evaluated for impairment

Ending balance

The Company was automatically authorized to participate in the Small Business Administration'ss Paycheck Protection Program ("PPP") as a qualified U.S.

At December 31, 2020, the Bank had funded PPP loans totaling $ 74.8 million, $ 43.3 million of which remained outstanding and are included in commercial business loans above.

Individually Evaluated for Impairment Allowance:

Collectively Evaluated for Impairment Ending Balance Loans Held for Investment:

Individually Evaluated for Impairment Loans Held for Investment:

Collectively Evaluated for Impairment Ending Balance

One-to-four family $ 165 $ 898 $ 1,063 $ 3,705 $ 126,952 $ 130,657

Home equity 14 133 147 293 15,972 16,265

Commercial and multifamily — 2,370 2,370 353 265,421 265,774

4 unchanged sentences

Commercial business — 291 291 615 63,602 64,217

Individually evaluated for impairment

Collectively evaluated for impairment

Ending balance

Loans held for investment:

Individually evaluated for impairment

Loans held for investment:

Collectively evaluated for impairment

Ending balance

Unallocated — 406 406 — — —

Total $ 378 $ 5,622 $ 6,000 $ 5,940 $ 609,558 $ 615,498

Table of Conten t s

Individually Evaluated for Impairment Allowance:

Collectively Evaluated for Impairment Ending Balance Loans Held for Investment:

Individually Evaluated for Impairment Loans Held for Investment:

Collectively Evaluated for Impairment 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

4 unchanged sentences

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 table summarizes the activity in the allowance for loan losses for the year ended December 31, 2020 (in thousands):

(Recapture)/ Provision

Allowance Charge-offs Recoveries (Recapture)/ Provision Ending

One-to-four family $ 1,120 $ ( 20 ) $ 63 $ ( 100 ) $ 1,063

Home equity 178 ( 2 ) 46 ( 75 ) 147

Commercial and multifamily 1,696 — — 674 2,370

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Commercial business 331 ( 620 ) — 580 291

Unallocated 948 — — ( 542 ) 406

$ 5,640 $ ( 690 ) $ 125 $ 925 $ 6,000

The following table summarizes the activity in the allowance for loan losses for the year ended December 31, 2019 (in thousands):

(Recapture)/ Provision

Allowance Charge-offs Recoveries (Recapture)/ Provision Ending

One-to-four family $ 1,314 $ — $ 6 $ ( 200 ) $ 1,120

Home equity 202 — 10 ( 34 ) 178

Commercial and multifamily 1,638 — — 58 1,696

4 unchanged sentences

Commercial business 356 — 3 ( 28 ) 331

Unallocated 1,029 — — ( 81 ) 948

$ 5,774 $ ( 52 ) $ 43 $ ( 125 ) $ 5,640

Table of Conten t s

Credit Quality Indicators.

Federal regulations provide for the classification of lower quality loans as substandard, doubtful or loss.

A loan is considered substandard if it is inadequately protected by the current net worth and pay capacity of the borrower or of any collateral pledged.

Substandard loans include those characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

Loans classified as doubtful have all the weaknesses of currently existing facts, conditions and values.

Loans 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 the Company classifies problem loans as either substandard or doubtful, it may establish a specific allowance in an amount it deems prudent to address the risk specifically (if the loan is impaired) or it may allow the loss to be addressed in the general allowance (if the loan is not impaired).

Federal regulations provide for the classification of lower quality assets 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 the Company 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 the Company classifies problem loans as either substandard or doubtful, it may establish a specific allowance in an amount we deem prudent to address the risk specifically (if the loan is impaired) or it 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 assets.

When the Company classifies problem loans as a loss, it charges-off such loans in the period in which they are deemed uncollectible.

Loans that do not currently expose the Company to sufficient risk to warrant classification as substandard or doubtful but possess identified weaknesses are classified as either watch or special mention loans.

The Company's determination as the classification of its loans and the amount of its valuation allowances is subject to review by the FDIC, which can order the establishment of additional loss allowances.

Assets that do not currently expose the Company to sufficient risk to warrant classification as substandard or doubtful but possess identified weaknesses are classified as either watch or special mention loans.

Determination as to the classification of our assets and the amount of our valuation allowances is subject to review by the FDIC, the Bank's federal regulator, and the WDFI, 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 represents the internally assigned grades as of December 31, 2019 , by type of loan (in thousands):

and multifamily

The following table represents the internally assigned grades at December 31, 2020, by type of loan (in thousands):

Equity Commercial

and Multifamily Construction

and Land Manufactured

Homes Floating

Consumer Commercial

Business Total

Pass $ 113,185 $ 15,556 $ 228,652 $ 44,360 $ 19,606 $ 38,746 $ 15,000 $ 56,743 $ 531,848

Watch 15,142 245 22,945 13,808 1,115 604 — 5,202 59,061

Special Mention — — 10,813 3,939 — — — 310 15,062

The following table represents the internally assigned grades as of December 31, 2018 , by type of loan (in thousands):

and multifamily

Substandard 2,330 464 3,364 645 220 518 24 1,962 9,527

Doubtful — — — — — — — — —

Loss — — — — — — — — —

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

The following table represents the internally assigned grades at December 31, 2019, by type of loan (in thousands):

Equity Commercial

and Multifamily Construction

and Land Manufactured

Homes Floating

Consumer Commercial

Business Total

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 automatically placed on nonaccrual once the loan is 90 days past due or if, in management's opinion, the borrower may be unable to meet payment of obligations as they become due, as well as when required by regulatory provisions.

The following table presents the recorded investment in nonaccrual loans as of December 31, 2019 and 2018 , by type of loan (in thousands):

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.

Table of Conten t s

The following table presents the recorded investment in nonaccrual loans at December 31, 2020 and 2019, by type of loan (in thousands):

One-to-four family $ 1,668 $ 2,090

Home equity 156 261

Commercial and multifamily 353 353

3 unchanged sentences

Commercial business — 260

The following table represents the aging of the recorded investment in past due loans as of December 31, 2019 , by type of loan (in thousands):

Greater than 90

Days Past Due

Recorded Investment

> 90 Days and Accruing

Total $ 2,884 $ 4,657

The following table represents the aging of the recorded investment in past due loans (excluding COVID-19 modified loans) at December 31, 2020, by type of loan (in thousands):

Past Due 60-89 Days

Past Due Greater than 90

Days Past Due Recorded Investment

> 90 Days and Accruing Total

Past Due Current Total

One-to-four family $ 498 $ 362 $ 1,407 $ — $ 2,267 $ 128,390 $ 130,657

Home equity 102 — 112 — 214 16,051 16,265

Commercial and multifamily — — 353 — 353 265,421 265,774

4 unchanged sentences

Commercial business 583 — — — 583 63,634 64,217

The following table represents the aging of the recorded investment in past due loans as of December 31, 2018 , by type of loan (in thousands):

Greater Than 90

Days Past Due

Recorded Investment

> 90 Days and Accruing

Total $ 2,047 $ 706 $ 2,310 $ — $ 5,063 $ 610,435 $ 615,498

The following table represents the aging of the recorded investment in past due loans at December 31, 2019, by type of loan (in thousands):

Past Due 60-89 Days

Past Due Greater Than 90

Days Past Due Recorded Investment

> 90 Days and Accruing Total

Past Due Current Total

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

4 unchanged sentences

Commercial business 226 — 162 — 388 38,543 38,931

Total $ 6,818 $ 1,661 $ 2,987 $ — $ 11,466 $ 610,441 $ 621,907

Table of Conten t s

Nonperforming Loans.

Loans are considered nonperforming when they are placed on nonaccrual.

The following table represents the credit risk profile based on payment activity as of December 31, 2019 , by type of loan (in thousands):

and multifamily

The following table represents the credit risk profile based on payment activity at December 31, 2020, by type of loan (in thousands):

Equity Commercial

and Multifamily Construction

and Land Manufactured

Homes Floating

Consumer Commercial

Business Total

Performing $ 128,989 $ 16,109 $ 265,421 $ 62,712 $ 20,792 $ 39,350 $ 15,024 $ 64,217 $ 612,614

Nonperforming 1,668 156 353 40 149 518 — — 2,884

The following table represents the credit risk profile based on payment activity as of December 31, 2018 , by type of loan (in thousands):

and multifamily

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

The following table represents the credit risk profile based on payment activity at December 31, 2019, by type of loan (in thousands):

Equity Commercial

and Multifamily Construction

and Land Manufactured

Homes Floating

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 the Company has determined that it may be unable to collect payments of principal or interest when due under the terms of the loan.

A loan is considered impaired when it is determined that the Company may not be able to collect payments of principal or interest when due under the terms of the loan.

In the process of identifying loans as impaired, the Company takes 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 loans and the borrowers, including payment history and amounts of any payment shortfall, length and reason for delay, and likelihood of return to stable performance.

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.

4 unchanged sentences

Unpaid Principal

Balance Without

Allowance With

Allowance Total

Investment Related

One-to-four family $ 3,791 $ 2,392 $ 1,313 $ 3,705 $ 165

Home equity 293 156 137 293 14

Commercial and multifamily 353 353 — 353 —

4 unchanged sentences

Commercial business 615 615 — 615 —

Total $ 6,029 $ 4,121 $ 1,819 $ 5,940 $ 378

Table of Conten t s

December 31, 2019

1 unchanged sentence

Unpaid Principal

Balance Without

Allowance With

Allowance Total

Investment Related

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 —

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Commercial business 997 714 283 997 84

Total $ 12,526 $ 10,072 $ 2,321 $ 12,393 $ 724

The following table provides the average recorded investment and interest income on impaired loans for the year ended December 31, 2020 and 2019, by type of loan (in thousands):

December 31, 2019

December 31, 2020 Year Ended

December 31, 2019

Interest Income

Investment Interest Income

Recognized Average

Investment Interest Income

One-to-four family $ 6,067 $ 175 $ 4,788 $ 280

Home equity 332 17 1,109 19

Commercial and multifamily 398 19 888 19

4 unchanged sentences

Commercial business 1,062 19 1,082 56

Total $ 9,263 $ 293 $ 8,998 $ 593

Forgone interest on nonaccrual loans was $ 168,000 and $ 370,000 for the year ended December 31, 2020 and 2019, respectively.

There were no commitments to lend additional funds to borrowers whose loans were classified as nonaccrual, TDR or impaired at December 31, 2019 and 2018 .

Troubled debt restructurings.

TDRs, 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 $ 3.2 million and $ 7.9 million at December 31, 2020 and 2019, respectively, and are included in impaired loans.

A TDR is a loan to a borrower that is experiencing financial difficulty that has been modified from its original terms and conditions in such a way that the Company is granting the borrower a concession of some kind.

The Company has granted, in its TDRs, a variety of concessions to borrowers in the form of loan modifications.

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

There were eight loans totaling $5.7 million , that were modified as a TDR during the year ended December 31, 2019 .

There were four loans totaling $ 795,000 , that were modified as a TDR during the year ended December 31, 2020.

The following TDR loans were paid off during the year ended December 31, 2020:

three one-to-four family residential loans totaling $262,000 and three home equity loans totaling $165,000 , one manufactured home loan totaling $19,000 and one land loan totaling $4,000 .

five one-to-four family residential loans totaling $ 5,236,000 and one manufactured home loan totaling $ 40,000 .

Table of Conten t s

There was one TDR totaling $ 161,000 for which there was a payment default within the first 12 months of modification during the year ended December 31, 2020.

There were three TDRs totaling $362,000 for which there was a payment default within the first 12 months of modification during the year ended December 31, 2018 .

There was one TDR totaling $ 49,000 for which there was a payment default within the first 12 months of modification during the year ended December 31, 2019.

There was one commercial business TDR loan totaling $ 97,000 that was charged off during the year ended December 31, 2020.

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

In March 2020, the Company began offering short-term loan modifications to assist borrowers during the COVID-19 pandemic.

The CARES Act and 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 placed on nonaccrual status or accounted for as a TDR, pursuant to applicable accounting and regulatory guidance until the earlier of 60 days after the national emergency termination date or January 1, 2022.

We continue to monitor these loans through our normal credit risk processes.

See “Note 2—Accounting Pronouncements Recently Issued or Adopted.”

In the ordinary course of business, the Company makes loans to its employees, officers and directors.

Certain loans to employees, officers and directors are offered at discounted rates as compared to other clients as permitted by federal regulations.

Employees, officers, and directors are eligible for mortgage loans with an adjustable rate that resets annually to 1.0% - 1.5% over the rolling cost of funds.

Employees, officers, and directors are eligible for mortgage loans with an adjustable rate that resets annually to 1.0 % - 1.5 % over the Bank's rolling cost of funds.

Employees, officers and directors are also eligible for consumer loans that are 1.00 % below the market loan rate at the time of origination.

1 unchanged sentence

Balance, beginning of period $ 3,225 $ 3,370

Advances 196 88

New / (reclassified) loans, net 1,233 515

Repayments ( 659 ) ( 748 )

Balance, end of period $ 3,995 $ 3,225

(1) Reclassified loans relate to changes in related parties during the year.

At December 31, 2020 and 2019, loans totaling $ 11.8 million and $ 19.9 million, respectively, represented real estate secured loans that had current loan-to-value ratios above supervisory guidelines.

Note 6— Mortgage Servicing Rights

The Company’s mortgage servicing rights portfolio totaled $377.3 million at December 31, 2019 , compared to $378.7 million at December 31, 2018 .

The Company’s MSR portfolio totaled $ 488.7 million at December 31, 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 December 31, 2020 and 2019 was $ 481.6 million and $ 363.3 million, respectively.

1 unchanged sentence

Loans serviced for Fannie Mae and others are not included in the Company’s financial statements as they are not assets of the Company.

Table of Conten t s

A summary of the change in the balance of mortgage servicing assets at December 31, 2020 and 2019 were as follows (in thousands):

At December 31,

Beginning balance, at fair value $ 3,239 $ 3,414

2 unchanged sentences

Due to changes in model inputs or assumptions (1)

( 1,857 ) ( 760 )

Ending balance, at fair value $ 3,780 $ 3,239

1 unchanged sentence

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

At December 31,

Prepayment speed (Public Securities Association "PSA" model) 247 % 187 %

Weighted-average life

Weighted-average life 5.2 years 6.2 years

Yield to maturity discount rate 10.0 % 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 Consolidated Statements of Income and totaled $1.0 million and $1.1 million , for the years ended December 31, 2019 and 2018 , respectively.

The amount of contractually specified servicing, late and ancillary fees earned on the mortgage servicing rights are included in mortgage servicing income on the Consolidated Statements of Income and totaled $ 1.0 million for each of the years ended December 31, 2020 and 2019.

See "Note 1—Organization and Significant Accounting Policies" and "Note 11— Fair Measurements" for additional information on MSRs.

Note 7— Premises and Equipment

Premises and equipment at December 31, 2020 and 2019 are summarized as follows (in thousands):

At December 31,

Land $ 920 $ 920

Buildings and improvements 6,944 7,067

Furniture and equipment 5,694 5,163

13,558 13,150

Accumulated depreciation and amortization ( 7,288 ) ( 6,383 )

1 unchanged sentence

Depreciation and amortization expense was $ 905,000 and $ 931,000 for the years ended December 31, 2020 and 2019, respectively.

The Company leases office space in several buildings.

Generally, operating leases contain renewal options and provisions requiring the Company to pay property taxes and operating expenses over base period amounts.

All rental payments are dependent only upon the lapse of time.

The total rental expense for the years ended December 31, 2019 and 2018 for all facilities leased under operating leases was approximately $1.2 million and $1.4 million , respectively.

The Company leases office space in several buildings as well as certain equipment.

See "Note 12—Leases" for additional information on our leased facilities and equipment.

Table of Conten t s

Note 8— Other Real Estate Owned and Repossessed Assets

1 unchanged sentence

Year Ended December 31,

Beginning balance

Beginning balance, January 1 $ 575 $ 575

Additions to OREO and repossessed assets 19 494

Sales — ( 473 )

Write-downs/Losses — ( 21 )

Ending balance, December 31 $ 594 $ 575

Note 9— Deposits

A summary of deposit accounts with the corresponding weighted-average cost of funds at December 31, 2020 and 2019, are presented below (dollars in thousands):

As of December 31, 2019

As of December 31, 2018

December 31, 2020 December 31, 2019

Noninterest-bearing demand $ 129,299 — % $ 94,973 — %

Interest-bearing demand 230,492 0.44 159,774 0.54

Savings 83,778 0.27 57,936 0.33

Money market 65,748 0.39 50,337 0.49

Certificates 235,473 2.43 251,387 2.23

3,191 — 2,311 —

Total $ 747,981 1.01 % $ 616,718 1.16 %

(1) Escrow balances shown in noninterest-bearing deposits on the Consolidated Balance Sheets.

Scheduled maturities of time deposits at December 31, 2020, are as follows (in thousands):

Year Ending December 31,

Year Ending December 31, Amount

2021 $ 180,352

Thereafter 4,475

Savings, demand, and money market accounts have no contractual maturity.

Certificates of deposit have maturities of five years or less.

The aggregate amount of time deposits in denominations of more than $250,000 at December 31, 2019 and 2018 , was approximately $78.3 million and $52.7 million , respectively.

The aggregate amount of time deposits in denominations of more than $ 250,000 at December 31, 2020 and 2019, totaled $ 79.9 million and $ 78.3 million, respectively.

Deposits in excess of $250,000 are not federally insured.

There were $8.0 million brokered deposits outstanding at December 31, 2019 , compared to no brokered deposits at December 31, 2018.

There were zero and $ 8.0 million of brokered deposits outstanding at December 31, 2020 and 2019, respectively.

Deposits from related parties held by the Company were $ 6.4 million and $ 2.9 million at December 31, 2020 and 2019, respectively.

Note 10 – Borrowings

The Company utilizes a loan agreement with the FHLB.

The terms of the agreement call for a blanket pledge of a portion of the Company's mortgage and commercial and multifamily portfolio based on the outstanding balance.

At December 31, 2019 and 2018 , the amount available to borrow under this credit facility was $321.9 million and $321.5 million , respectively, subject to the amount of pledged collateral.

Table of Conten t s

Note 10— Borrowings, FHLB Stock and Subordinated Notes

The Company utilizes a loan agreement with the FHLB of Des Moines, the terms of which call for a blanket pledge of a portion of the Company's mortgage and commercial and multifamily portfolios based on the outstanding balance.

At December 31, 2020 and 2019, the maximum amount available to borrow under this credit facility was $ 390.5 million and $ 321.9 million, respectively, subject to eligible pledged collateral.

At December 31, 2020, the credit facility was collateralized as follows:

2 unchanged sentences

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 and $84.0 million at December 31, 2019 and 2018 , respectively.

The weighted-average interest rate of the Company's borrowings was 3.05% at December 31, 2019 and was 2.72% at December 31, 2018 .

Additionally, the Company had outstanding letters of credit from the FHLB of Des Moines with a notional amount of $19.1 million and $14.5 million at December 31, 2019 and 2018 , respectively, to secure public deposits.

The remaining amount available to borrow as of December 31, 2019 and 2018 , was $217.8 million and $156.0 million , respectively.

Fixed rate advances of $7.5 million , with a weighted-average interest rate of 3.05% are due within a year.

The maximum amount outstanding from the FHLB under term advances at month-end during 2019 was $72.8 million and during 2018 was $99.5 million .

The Company had no outstanding borrowings under this arrangement at December 31, 2020 and outstanding borrowings of $ 7.5 million at December 31, 2019.

The weighted-average interest rate of the Company's borrowings under this agreement was 3.10 % and 3.05 % for the years ended December 31, 2020 and 2019, respectively.

The maximum amount outstanding from FHLB advances during 2020 was $ 10.1 million and during 2019 was $ 72.8 million.

The average balance outstanding was $ 7.1 million during 2020 and $ 24.4 million during 2019.

The weighted-average interest rate on the borrowings was 3.08% in 2019 and 2.18% in 2018 .

Additionally, the Company had outstanding letters of credit from the FHLB of Des Moines with a notional amount of $ 21.6 million and $ 19.1 million at December 31, 2020 and 2019, respectively, to secure public deposits.

At December 31, 2020 and 2019, the remaining amount available to borrow from the FHLB of Des Moines was $ 213.7 million and $ 217.8 million, respectively.

As a member of the FHLB system, the Bank is required to maintain a minimum level of investment in the FHLB of Des Moines stock based on specific percentages of its outstanding FHLB advances.

At December 31, 2019 and 2018 , the Company had an investment of $1.2 million and $4.1 million , respectively, 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.

The terms of the program call for a pledge of specific assets.

The Company pledges commercial and consumer loans as collateral for this line of credit.

The Company had unused borrowing capacity of $41.7 million and $47.3 million and no outstanding borrowings under this program at December 31, 2019 and 2018 , respectively.

At December 31, 2020 and 2019, the Company had an investment of $ 877,000 and $ 1.2 million, respectively, 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, beginning in 2020, 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 $ 23.6 million and $ 41.7 million under the borrower-in-custody program at December 31, 2020 and 2019 and $ 43.3 million under the PPPLF at December 31, 2020.

The Company had no outstanding borrowings under either program at December 31, 2020 and 2019.

The Company has access to an unsecured Fed Funds line of credit from the Pacific Coast Banker's Bank.

The line has a one-year term maturing on June 30, 2021 and is renewable annually.

As of December 31, 2019 , the amount available under this line of credit was $10.0 million .

There was no balance on this line of credit as of December 31, 2019 and 2018 , respectively.

At December 31, 2020, the amount available under this line of credit was $ 10.0 million.

There was no balance on this line of credit at December 31, 2020 and 2019, respectively.

The Company has access to an unsecured Fed Funds line of credit from The Independent Bank.

As of December 31, 2019 , the amount available under this line of credit was $10.0 million .

At December 31, 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 December 31, 2019 and 2018 , respectively.

There was no balance on this line of credit at December 31, 2020 and 2019, respectively.

The Company completed a private placement of $ 12.0 million in aggregate principal of 5.25 % Fixed-to-Floating Rate Subordinated Notes (the "subordinated notes") due 2030 resulting in net proceeds, after placement fees and offering expenses, of approximately $ 11.6 million during the quarter ended September 30, 2020.

The subordinated notes have a stated maturity of October 1, 2030 and bear interest at a fixed rate of 5.25 % per year until October 1, 2025.

From October 1, 2025 to the maturity date or early redemption date, the interest rate will reset quarterly at a variable rate equal to the then current three-month term secured overnight financing rate (“SOFR”), plus 513 basis points.

As provided in the subordinated notes, the interest rate on the subordinated notes during the applicable floating rate period may be determined based on a rate other than three-month term SOFR.

Prior to October 1, 2025, the Company may redeem the subordinated notes, in whole but not in part, only under certain limited circumstances set forth in the subordinated notes.

On or after October 1, 2025, the Company may redeem the subordinated notes, in whole or in part, at its option, on any interest payment date.

Any redemption by the Company would be at a redemption price equal to 100 % of the principal amount of the subordinated notes being redeemed, together with any accrued and unpaid interest on the subordinated notes being redeemed to but excluding the date of redemption.

Table of Conten t s

Note 11— Fair Value Measurements

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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.

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.

3 unchanged sentences

At December 31, 2020 and 2019, loans held-for-sale were carried at cost, as no impairment was required.

Loans Held for Portfolio - The estimated fair value of loans 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.

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 estimate fair value of loans-held-for-portfolio reflect exit price assumptions.

The liquidity premiums/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.

1 unchanged sentence

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.

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 Notes- The fair value of subordinated notes t 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:

1 unchanged sentence

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.

Off-Balance Sheet Financial Instruments - The fair value for the Company's off-balance sheet loan commitments is estimated based on fees charged to others to enter into similar agreements taking into account the remaining terms of the agreements and credit standing of the Company's clients.

The estimated fair value of these commitments is not significant.

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 December 31, 2019 and 2018 (in thousands):

December 31, 2019

Fair Value Measurements Using:

Table of Conten t s

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 December 31, 2020 and 2019 (in thousands):

December 31, 2020 Fair Value Measurements Using:

Value Estimated

Fair Value Level 1 Level 2 Level 3

FINANCIAL ASSETS:

4 unchanged sentences

Mortgage servicing rights 3,780 3,780 — — 3,780

FHLB Stock 877 877 — 877 —

FINANCIAL LIABILITIES:

1 unchanged sentence

Time deposits 235,474 238,629 — 238,629 —

December 31, 2018

Fair Value Measurements Using:

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

December 31, 2019 Fair Value Measurements Using:

Value Estimated

Fair Value Level 1 Level 2 Level 3

FINANCIAL ASSETS:

4 unchanged sentences

Mortgage servicing rights 3,239 3,239 — — 3,239

FHLB Stock 1,160 1,160 — 1,160 —

FINANCIAL LIABILITIES:

1 unchanged sentence

Time deposits 251,387 255,261 — 255,261 —

The following tables present the balance of assets measured at fair value on a recurring basis as of December 31, 2019 and 2018 (in thousands):

Borrowings 7,500 7,500 — 7,500 —

The following tables present the balance of assets measured at fair value on a recurring basis at December 31, 2020 and 2019 (in thousands):

Fair Value at December 31, 2020

Description Total Level 1 Level 2 Level 3

Municipal bonds $ 5,413 $ — $ 5,413 $ —

2 unchanged sentences

Fair Value at December 31, 2019

Description Total Level 1 Level 2 Level 3

Municipal bonds $ 3,370 $ — $ 3,370 $ —

1 unchanged sentence

Mortgage servicing rights 3,239 — — 3,239

Table of Conten t s

For the years ended December 31, 2020 and 2019, there were no transfers between Level 1 and Level 2 or between Level 2 and Level 3.

The following table provides 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 December 31, 2020:

Unobservable Input(s)

Instrument Valuation

Technique Unobservable Input(s) Range

(Weighted Average)

Mortgage Servicing Rights

Discounted cash flow

Prepayment speed assumption

132-485% (187%)

Mortgage Servicing Rights Discounted cash flow Prepayment speed assumption 178 %- 276 % ( 247 %)

Discount rate 10 %- 12 % ( 10 %)

12.5%-13.5% (12.5%)

Unobservable Input(s)

Instrument Valuation

Technique Unobservable Input(s) Range

(Weighted Average)

Mortgage Servicing Rights

Discounted cash flow

Prepayment speed assumption

80-515% (123%)

Mortgage Servicing Rights Discounted cash flow Prepayment speed assumption 132 %- 485 % ( 187 %)

Discount rate 12.5 %- 13.5 % ( 12.5 %)

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).

5 unchanged sentences

Fair Value at December 31, 2020

Description Total Level 1 Level 2 Level 3

OREO and repossessed assets $ 594 $ — $ — $ 594

1 unchanged sentence

Fair Value at December 31, 2019

Description Total Level 1 Level 2 Level 3

OREO and repossessed assets $ 575 $ — $ — $ 575

1 unchanged sentence

There were no liabilities carried at fair value, measured on a recurring or nonrecurring basis, at December 31, 2020 or December 31, 2019.

Table of Conten t s

The following table provides 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 December 31, 2020:

Unobservable Input(s)

Instrument Valuation

Technique(s) Unobservable Input(s) Range

(Weighted Average)

Market approach

Adjusted for difference

OREO Market approach Adjusted for difference

between comparable sales 0 - 0 % ( 0 %)

Impaired loans

Market approach

Adjusted for difference

Impaired loans Market approach Adjusted for difference

between comparable sales 0 - 100 % ( 6 %)

Unobservable Input(s)

Instrument Valuation

Technique(s) Unobservable Input(s) Range

(Weighted Average)

Market approach

Adjusted for difference

OREO Market approach Adjusted for difference

between comparable sales 0 - 0 % ( 0 %)

Impaired loans

Market approach

Adjusted for difference

Impaired loans Market approach Adjusted for difference

between comparable sales 0 - 100 % ( 6 %)

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 one to nine years .

The operating leases require us to pay property taxes and operating expenses for the properties.

The following table represents the Consolidated Balance Sheet classification of the Company’s right of use assets and lease liabilities (in thousands):

Operating lease right-of-use assets $ 6,722 $ 7,641

Operating lease liabilities 7,134 8,010

The following table represents the components of lease expense (in thousands):

Year Ended December 31,

Operating lease expense:

Office leases $ 1,160 $ 1,223

Equipment leases 10 20

Sublease income ( 12 ) ( 12 )

Net lease expense $ 1,158 $ 1,231

Table of Conten t s

The following table represents the maturity of lease liabilities:

December 31, 2020 December 31, 2019

Leases Equipment

Leases Office

Leases Equipment

Operating Lease Commitments

2020 $ — $ — $ 1,097 $ 8

2021 1,042 20 1,042 —

2022 1,016 9 1,016 —

2023 989 — 989 —

2024 968 — 968 —

Thereafter 3,897 — 3,897 —

Total lease payments 7,912 29 9,009 8

Present value discount 807 — 1,007 —

Present value of lease liabilities $ 7,105 $ 29 $ 8,002 $ 8

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

December 31, 2020 December 31, 2019

Weighted-average remaining lease term:

Office leases 7.9 years 8.7 years

Equipment leases 1.4 years 0.4 years

Weighted-average discount rate (annualized):

Office leases 2.66 % 2.64 %

Equipment leases 1.62 % 1.62 %

Supplemental cash flow information related to leases was as follows (in thousands):

Year Ended December 31,

Cash paid for amounts included in the measurement of lease liabilities for operating leases:

Operating cash flows

Office leases $ 1,097 $ 1,099

Equipment leases 20 20

Note 13— Earnings Per Share

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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.

Table of Conten t s

Earnings per share are summarized for the periods presented in the following table (in thousands, except per share data):

Year Ended December 31,

Net income $ 8,937 $ 6,679

Weighted average number of shares outstanding, basic 2,563 2,527

22 unchanged sentences

Discretionary contributions by the Bank become 100% vested upon the completion of three years of service from a participant’s effective date of participation in the NQDC Plan (with accelerated vesting upon death, disability or a change in control), while other Bank contributions (including matching contributions) vest at the rate of 20 % per year, beginning with the participant’s two-year anniversary of his or her date of hire.

The board of directors of the Bank agreed that in the event Ms.

Stewart has a separation from service prior to January 1, 2020, the date she becomes vested in her discretionary contributions, then the Bank shall amend the NQDC Plan to provide for immediate vesting as of the date of the separation from service.

During the years ended December 31, 2020, and 2019, the Bank made discretionary contributions to the NQDC Plan in the amount of $ 90,000 and $ 90,000 , respectively.

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The Company may, at any time, in its sole discretion, terminate the NQDC Plan or amend or modify the NQDC Plan, in whole or in part, except that no such termination, amendment or modification shall have any retroactive effect to reduce any amounts deemed to be accrued and vested prior to such amendment.

Table of Conten t s

Supplemental Executive Retirement Plans.

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The second supplemental executive retirement plan ("SERP 2") was effective as of December 30, 2011, at which time the benefits under SERP 1 were frozen.

At that time, the Company also entered into a Confidentiality, Non-Competition, and Non-Solicitation Agreement with Ms.

Stewart, which is discussed below.

Under the terms of SERP 1, as amended, Ms.

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On December 13, 2019, the Bank entered into an Amended and Restated Confidentiality, Non-competition, and Non-solicitation Agreement (the “Amended Non-Compete Agreement”) with Ms.

This Amended Non-compete Agreement amends and restates the Confidentiality, Non-Competition, and Non-Solicitation Agreement between the Bank and Ms.

Stewart as originally adopted effective December 30, 2011, as amended and restated on November 23, 2015 and January 25, 2019.

The Amended Non-Compete Agreement provides that the term of the non-compete and non-solicitation periods applicable to Ms.

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Stewart (other than for good reason), Ms.

Stewart will be entitled to receive a bi-monthly payment, in an amount equal to Three Thousand Five Hundred Forty-Two Dollars ( $3,542 ), which amount shall be paid in equal bi-monthly payments during the Restricted Period beginning on the fifth day of the month following her separation from service with the Bank.

Stewart will be entitled to receive a bi-monthly payment, in an amount equal to $ 3,542 , which amount shall be paid in equal bi-monthly payments during the Restricted Period beginning on the fifth day of the month following her separation from service with the Bank.

Stewart’s termination of employment with the Bank for any reason other than set forth in the preceding sentence, she will be entitled to receive an amount equal to 150 % of her then-base salary plus the average of her past three years short term bonus pay, or approximately $ 804,000 at December 31, 2020, payable in 12 monthly installments beginning on the first day of the month following her termination.

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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 December 31, 2019 , on an adjusted basis, awards for stock options totaling 261,732 shares and awards for restricted stock totaling 122,238 shares of Company common stock have been granted in the aggregate, net of any forfeitures, under the 2008 Plan and 2013 Plan to participants.

At December 31, 2020, on an adjusted basis, awards for stock options totaling 260,864 shares and awards for restricted stock totaling 133,923 shares of Company common stock have been granted in the aggregate, net of any forfeitures, under the 2008 Plan and 2013 Plan to participants.

During the years ended December 31, 2020 and 2019, share-based compensation expense totaled $ 338,000 and $ 267,000 , respectively.

Table of Conten t s

Stock Option Awards

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The following is a summary of the Company's stock option plan award activity during the period ended December 31, 2020:

Weighted-Average

Exercise Price

Weighted-Average

Shares Weighted-Average

Exercise Price Weighted-Average

Remaining Contractual

Term In Years

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 ( 2,360 ) 29.62

Expired ( 6,733 ) 28.96

Outstanding at December 31, 2020 100,979 22.00 4.71 1,045,041

Exercisable 87,513 20.01 4.12 1,045,041

Expected to vest, assuming a 0 % forfeiture rate over the vesting term

As of December 31, 2019 , there was $72,000 of total unrecognized compensation cost related to non-vested stock options granted under the Plan.

13,466 $ 34.95 8.52 $ —

At December 31, 2020, there was $ 73,000 of total unrecognized compensation cost related to non-vested stock options granted under the Plan.

The cost is expected to be recognized over the remaining weighted-average vesting period of 2.6 years.

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Risk-free interest rate 1.38 % 2.64 %

Expected term

Expected term 6.50 years 6.50 years

Weighted-average grant date fair value per option granted $ 7.14 $ 7.24

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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.

Table of Conten t s

The following is a summary of the Company's non-vested restricted stock awards for the year ended December 31, 2020:

Non-vested Shares

Weighted-Average

Non-vested Shares Shares Weighted-Average

Grant-Date Fair Value

Per Share Aggregate

Intrinsic Value

Non-vested at January 1, 2020 12,290 $ 33.32

Granted 13,600 36.26

Vested ( 6,861 ) 34.61

Forfeited ( 1,915 ) 34.25

Non-vested at December 31, 2020 17,114 35.03 $ 31.75

Expected to vest assuming a 0 % forfeiture rate over the vesting term

As of December 31, 2019 , there was $313,000 of unrecognized compensation cost related to non-vested restricted stock granted under the Plan.

17,114 $ 35.03 $ 31.75

At December 31, 2020, there was $ 440,000 of unrecognized compensation cost related to non-vested restricted stock granted under the Plan.

The cost is expected to be recognized over the weighted-average vesting period of 2.6 years.

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Employee Stock Ownership Plan

In January 2008, the ESOP borrowed $1.2 million from the Company to purchase common stock of the Company.

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 first loan for $1.2 million was paid off in 2017.

The remaining loan for $1.1 million is being repaid principally by the Bank through contributions to the ESOP over a period of 10 years .

The loan for $ 1.1 million is being repaid principally by the Bank through contributions to the ESOP over a period of 10 years.

The interest rate on the loan is fixed at 2.25 %, per annum.

As of December 31, 2019 , the remaining balance of the ESOP loan was $244,000 .

At December 31, 2020, the remaining balance of the ESOP loan was $ 126,000 .

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

For the calendar year 2019, the ESOP was committed to release 11,340 shares of the Company's common stock to participants and held 22,680 unallocated shares remaining to be released in future years.

For the each of calendar years 2020 and 2019, the ESOP was committed to release 11,340 shares of the Company's common stock to participants.

The ESOP held 11,340 unallocated shares remaining to be released in 2021.

The funds to purchase shares in the ESOP come from contributions the Bank makes twice a year to the Plan.

For the year ended December 31, 2020, the ESOP trustee purchased 10,483 shares of the Company's common stock for inclusion in the Plan.

The number of allocated shares was 139,678 and 143,331 at December 31, 2020 and 2019, respectively.

The fair value of the 145,554 restricted shares held by the ESOP trust was $ 4.6 million at December 31, 2020.

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The provision for income taxes at December 31, 2020 and 2019 was as follows (in thousands):

At December 31,

Current $ 2,036 $ 1,918

Deferred 355 ( 267 )

Total tax expense $ 2,391 $ 1,651

Table of Conten t s

A reconciliation of the provision for income taxes for the years ended December 31, 2020 and 2019, with amounts determined by applying the statutory U.S.

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Tax-exempt income ( 186 ) ( 174 )

$ 2,391 $ 1,651

Federal Tax Rate 21.0 % 21.0 %

Tax exempt rate ( 1.6 ) ( 2.1 )

Other 1.7 0.9

Effective tax rate 21.1 % 19.8 %

The following table reflects the temporary differences that gave rise to the components of the Company's deferred tax assets at December 31, 2020 and 2019 (in thousands):

At December 31,

Deferred tax assets

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Lease liabilities 1,498 1,682

Other, net 29 107

Allowance for loan losses 1,260 1,184

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Unrealized gain on securities ( 64 ) ( 47 )

Depreciation ( 251 ) ( 198 )

Mortgage servicing rights ( 387 ) ( 263 )

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Net deferred tax asset $ 314 $ 686

As of December 31, 2019 and 2018 , the Company had no unrecognized tax benefits.

At December 31, 2020 and 2019, the Company had no unrecognized tax benefits.

The Company recognizes interest accrued and penalties related to unrecognized tax benefits in "Provision for income taxes" in the Consolidated Statements of Income.

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federal income tax examinations by tax authorities for years before 2017.

Note 15 – Minimum Regulatory Capital Requirements

Note 16— Capital

The Company is a bank holding company under the supervision of the Federal Reserve.

Bank holding companies are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended, and the regulations of the Federal Reserve Board, except that, pursuant to the Economic Growth, Regulatory Relief and Consumer Protection Act, effective August 30, 2018, a bank holding company with consolidated assets of less than $3.0 billion is generally not subject to the Federal Reserve’s capital regulations, which parallel the FDIC’s capital regulations.The Bank is a state-chartered, federally insured institution and thereby is subject to the capital requirements established by the FDIC.

Table of Conten t s

subject to the Federal Reserve’s capital regulations, which parallel the FDIC’s capital regulations.The Bank is a state-chartered, federally insured institution and thereby is subject to the capital requirements established by the FDIC.

Failure to meet minimum capital requirements can initiate certain mandatory and, possibly, additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements.

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Prompt corrective action provisions are not applicable to bank holding companies.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital to risk-weighted assets (as defined in the regulations) and of Tier 1 capital to average assets.

As of December 31, 2019 , according to the most recent notification from the FDIC, the Bank was categorized as well capitalized under the regulatory framework for prompt corrective action.

At December 31, 2020, according to the most recent notification from the FDIC, the Bank was categorized as "well capitalized" under the regulatory framework for prompt corrective action.

There are no conditions or events since the notification that management believes have changed the Bank’s category.

The Bank's actual capital amounts (in thousands) and ratios as of December 31, 2019 and 2018 are presented in the following table:

Minimum Capital

Minimum Required to be

Well-Capitalized Under Prompt Corrective Action Provisions

As of December 31, 2019

Tier 1 Capital to total adjusted assets (1)

Common Equity Tier 1 risk-based capital ratio (2)

Tier 1 Capital to risk-weighted assets (2)

Total Capital to risk-weighted assets (2)

As of December 31, 2018

Tier 1 Capital to total adjusted assets (3)

Common Equity Tier 1 risk-based capital ratio (4)

Prior to January 1, 2020, Sound Community Bank followed the FDIC’s prompt corrective actions standards.

In order to be considered well-capitalized under the prompt corrective action standards, a bank must have a ratio of Common Equity Tier 1 ("CET1") capital to risk-weighted assets of at least 6.5%, a ratio of Tier 1 capital to risk-weighted assets of at least 8%, a ratio of total capital to risk-weighted assets of at least 10%, and a leverage ratio of at least 5%, and the bank must not be subject to a regulatory capital requirement imposed on it as an individual bank.

In order to be considered adequately capitalized, a bank must have the minimum capital ratios described above.

Institutions with lower capital ratios are assigned to lower capital categories.

Based on safety and soundness concerns, the FDIC may assign an institution to a lower capital category than would originally apply based on its capital ratios.

The FDIC is also authorized to require Sound Community Bank to maintain additional amounts of capital in connection with concentrations of assets, interest rate risk, and certain other items.

The FDIC has not imposed such a requirement on Sound Community Bank.

Effective January 1, 2020, a bank that elects to use the Community Bank Leverage Ratio (“CBLR”) framework as provided for in the Economic Growth, Regulatory Relief and Consumer Protection Act will generally be considered well-capitalized and to have met the risk-based and leverage capital requirements of the capital regulations if it has a leverage ratio greater than 9.0%.

As required by the CARES Act, the FDIC has temporarily lowered the CBLR to 8% beginning in the second quarter of 2020 through the end of the year.

Beginning in 2021, the CBLR will increase to 8.5% for that calendar year.

The CBLR will return to 9% on January 1, 2022.

To be eligible to utilize the CBLR, the Bank also must have total consolidated assets of less than $10 billion, off-balance sheet exposures of 25% or less of its total consolidated assets, and trading assets and trading liabilities of 5.0% or less of its total consolidated assets, all as of the end of the most recent quarter.

Beginning January 2020, the Bank elected to use the CBLR framework.

At December 31, 2020, the Bank’s CBLR was 10.40 %.

The following table shows the capital ratios of Sound Community Bank at December 31, 2019 (dollars in thousands):

Actual Minimum Capital

Requirements Minimum Required to be

Well-Capitalized Under Prompt

Corrective Action Provisions

Amount Ratio Amount Ratio Amount Ratio

Tier 1 Capital to average total adjusted assets (1)

$ 74,031 10.22 % $ 28,981 4.00 % $ 36,226 5.00 %

Common Equity Tier 1 to risk-weighted assets (2)

74,031 12.07 % 27,601 4.50 % 39,868 6.50 %

Tier 1 Capital to risk-weighted assets (2)

74,031 12.07 % 36,801 6.00 % 49,068 8.00 %

Total Capital to risk-weighted assets (2)

Based on total adjusted assets of $724,527 at December 31, 2019 .

Based on risk-weighted assets of $613,354 at December 31, 2019 .

$ 79,974 13.04 % $ 49,067 8.00 % $ 61,335 10.00 %

(1) Based on total adjusted assets of $ 724,527 at December 31, 2019.

(2) Based on risk-weighted assets of $ 613,354 at December 31, 2019.

In addition to the minimum common equity Tier 1 capital ratio (“CET1”) and total capital ratios, the Bank must maintain a capital conservation buffer consisting of additional CET1 capital greater than 2.5% of risk-weighted assets above the required minimum risk-based capital levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses.

At December 31, 2019 , the conservation buffer requirement was 2.50% and the Bank's actual conservation buffer was 5.04% .

For a bank holding company with less than $3.0 billion in assets, the capital guidelines apply on a bank-only basis and the Federal Reserve expects the holding company's subsidiary banks to be well-capitalized under the prompt corrective action regulations.

If Sound Financial Bancorp was subject to regulatory guidelines for bank holding companies with $3.0 billion or more in assets, at December 31, 2019 and 2018, Sound Financial Bancorp would have exceeded all regulatory capital requirements.

The estimated regulatory capital ratios calculated for Sound Financial Bancorp as of December 31, 2019 were 9.55% for Tier 1 Capital to total adjusted assets (leverage ratio), 11.08% for both Common Equity Tier 1 risk-based capital and Tier 1 Capital to risk-based assets, and 11.94% for Total Capital to risk weighted assets.

If Sound Financial Bancorp was subject to regulatory guidelines for bank holding companies with $3.0 billion or more in assets, at December 31, 2020, Sound Financial Bancorp would have exceeded all regulatory capital requirements.

The estimated CBLR calculated for Sound Financial Bancorp at December 31, 2020 was 10.40 %

Table of Conten t s

During the quarter ended December 31, 2020, the Company repurchased a total of 2,477 shares of Company common stock at an average price of $ 29.42 per share pursuant to the Company’s stock repurchase program, leaving $ 1.9 million available for future repurchase under the existing program.

Note 17— Concentrations of Credit Risk

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At December 31,

Commitments to make loans

Residential mortgage commitments $ 3,312 $ 4,384

Unfunded construction commitments 18,981 40,181

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If there are no defects, the Company has no commitment to repurchase the loan.

As of December 31, 2019 and 2018 , the maximum amount of these guarantees totaled $377.3 million and $376.5 million , respectively.

At December 31, 2020 and 2019, the maximum amount of these guarantees totaled $ 488.7 million and $ 377.3 million, respectively.

These amounts represent the unpaid principal balances of the Company's loans serviced for others' portfolios.

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The Company pays certain medical, dental, prescription, and vision claims for its employees, on a self-insured basis.

The Company has purchased stop-loss insurance to cover claims that exceed stated limits and has recorded estimated reserves for the ultimate costs for both reported claims and claims incurred but not reported, which were not considered significant at December 31, 2019 .

At December 31, 2018, the Company recorded $239,000 in stop loss medical insurance claim which is included in other assets on the consolidated statements of financial condition.

Table of Conten t s

December 31, 2020.

At December 31, 2020, the Company recorded no stop loss medical insurance claims exceeding stated coverage limits.

At various times, the Company may be the defendant in various legal proceedings arising in connection with its business.

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The Balance Sheets, Statements of Income, and Statements of Cash Flows for Sound Financial Bancorp (Parent Only) are presented below (dollars in thousands):

Balance sheets

Balance sheets December 31,

Cash and cash equivalents $ 6,837 $ 2,740

Investment in Sound Community Bank 90,568 75,141

Other assets 65 41

Total assets $ 97,470 $ 77,922

Liabilities and Stockholders' Equity

Subordinated notes, net $ 11,592 $ —

Other liabilities 394 196

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Total liabilities and stockholders' equity $ 97,470 $ 77,922

Statements of Income

Year Ended December 31,

Statements of Income Year Ended December 31,

Interest expense on subordinated notes $ ( 190 ) $ —

Other expenses ( 572 ) ( 792 )

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Equity in undistributed earnings of subsidiary 9,539 7,305

Statements of Cash Flows

Year Ended December 31,

Net income $ 8,937 $ 6,679

Table of Conten t s

Statements of Cash Flows Year Ended December 31,

Cash flows from operating activities:

Net income $ 8,937 $ 6,679

Adjustments to reconcile net income to net cash provided by operating activities

Other, net 70 ( 166 )

Expense allocation to holding company 129 196

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Cash flows from financing activities:

Proceeds from issuance of subordinated notes, net 11,582 —

Transfer of proceeds from issuance of debt to subsidiary ( 5,500 ) —

Dividends paid ( 2,072 ) ( 1,434 )

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Stock repurchase funding from subsidiary — 1,750

Repurchase of stock ( 73 ) —

Stock options exercised 239 131

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Mortgage servicing income (a) 1,027 1,002

Fair value adjustment on mortgage servicing rights (a)

Fair value adjustment on MSRs (a) ( 1,857 ) ( 760 )

Net gain on sale of loans (a) 6,022 1,449

Other income (a)

Total noninterest income $ 7,445 $ 4,026

Table of Conten t s

(a) Not within scope of ASC 606

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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 arerecorded net of the interchange income.

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.

When the Bank finances the sale of OREO 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 OREO 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.

Company incurred expenses on our OREO properties of $35,000 and $86,000 for the years ended December 31, 2019 and 2018, respectively, included in noninterest expense on the Consolidated Statements of Income.

Note 20 – 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 require us to pay property taxes and operating expenses for the properties.

The following table represents the Consolidated Balance Sheet classification of the Company’s right of use assets and lease liabilities (in thousands):

December 31, 2019

Operating lease right-of-use assets

Operating lease liabilities

The following table represents the components of lease expense (in thousands):

December 31, 2019

Operating lease expense

Office leases

Equipment leases

Sublease income

Net lease expense

The following table represents the maturity of lease liabilities:

December 31, 2019

Office leases

Equipment leases

Operating Lease Commitments

Total lease payments

Present value discount

Present value of lease liabilities

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

December 31, 2019

Weighted-average remaining lease term (in years):

Office leases

Equipment leases

Weighted-average discount rate (annualized):

Office leases

Equipment leases

Supplemental cash flow information related to leases was as follows (in thousands):

December 31, 2019

Cash paid for amounts included in the measurement of lease liabilities for operating leases:

Operating cash flows

Office leases

Equipment leases

The Company incurred expenses on our OREO properties of $ 5,000 and $ 35,000 for the years ended December 31, 2020 and 2019, respectively, included in noninterest expense on the Consolidated Statements of Income.

Note 21— Subsequent Events

On January 28, 2021, the Company declared on Company common stock a quarterly cash dividend of $ 0.17 per common share and a special cash dividend of $ 0.10 per share, payable on February 24, 2021 to stockholders of record at the close of business February 10, 2021.

Table of Conten t s

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 8. Financial Statements and Supplementary Data