Sound Financial Bancorp, Inc. 10-K

Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion and analysis reviews our consolidated financial statements and other relevant statistical data and is intended to enhance your understanding of our financial condition and results of operations. The information in this section has been derived from the Consolidated Financial Statements and footnotes thereto that appear in "Part II. Item 8. Financial Statements and Supplementary Data" of this Form 10-K. The information contained in this section should be read in conjunction with these Consolidated Financial Statements and footnotes and the business and financial information provided in this Form 10-K. Overview Our principal business consists of attracting retail and commercial deposits from the general public and investing those funds, along with borrowed funds, in loans secured by first and second mortgages on one-to-four family residences (including home equity loans and lines of credit), commercial and multifamily real estate, construction and land, and consumer and commercial business loans. Our commercial business loans include unsecured lines of credit and secured term loans and lines of credit secured by inventory, equipment and accounts receivable. We also offer a variety of secured and unsecured consumer loan products, including manufactured home loans, floating home loans, automobile loans, boat loans and recreational vehicle loans. As part of our business, we focus on residential mortgage loan originations, a portion of which we sell to Fannie Mae and other investors and the remainder of which we retain for our loan portfolio consistent with our asset/liability objectives. We sell loans which conform to the underwriting standards of Fannie Mae (“conforming”) in which we retain the servicing of the loan in order to maintain the direct customer relationship and to generate noninterest income. Residential loans which do not conform to the underwriting standards of Fannie Mae (“non-conforming”), are either held in our loan portfolio or sold with servicing released. We originate and retain a significant amount of commercial real estate loans, including those secured by owner-occupied and nonowner-occupied commercial real estate, multifamily property, mobile home parks and construction and land development loans. We originated $321.3 million, $129.0 million and $112.5 million of one-to-four family residential mortgage loans during the years ended December 31, 2020, 2019 and 2018, respectively. During these same periods, we sold $258.2 million, $78.9 million and $50.0 million, respectively, of one-to-four family residential mortgage loans. Our operating revenues are derived principally from earnings on interest-earning assets, service charges and fees, and gains on the sale of loans. Our primary sources of funds are deposits (both retail and brokered), FHLB advances, borrowings through the Federal Reserve, and payments received on loans and securities. We offer a variety of deposit accounts that provide a wide range of interest rates and terms, including savings, money market, NOW, interest-bearing and noninterest-bearing demand accounts, and certificates of deposit. Our noninterest expenses consist primarily of salaries, employee benefits, incentive pay, expenses for occupancy, online and mobile services, marketing, professional fees, data processing, charitable contributions, FDIC deposit insurance premiums and regulatory expenses. Salaries and benefits consist primarily of the salaries paid to our employees, payroll taxes, directors' fees, retirement expenses, share-based compensation and other employee benefits. Occupancy expenses, which are the fixed and variable costs of buildings and equipment, consist primarily of lease payments, property taxes, depreciation charges, maintenance and the cost of utilities. Our strategic plan targets consumers, small- and medium-size businesses, and professionals in our market area for loans and deposits. In pursuit of these goals and by managing the size of our loan portfolio, we focus on including a significant amount of commercial business and commercial and multifamily real estate loans in our portfolio. A significant portion of these loans have adjustable rates, higher yields or shorter terms and higher credit risk than traditional fixed-rate mortgages. Our commercial loan portfolio (commercial and multifamily real estate and commercial business loans) increased to $330.0 million or 53.6% of our loan portfolio at December 31, 2020, from $300.2 million or 48.3% of our loan portfolio at December 31, 2019, and $291.4 million or 46.9% of our loan portfolio at December 31, 2018. In addition to higher balances in commercial lending, we also benefit from lending opportunities in our consumer loan portfolio. Our consumer loan portfolio, which includes manufactured and floating homes and other consumer loans, increased to $75.8 million or 12.4% of our loan portfolio at December 31, 2020, from $72.7 million or 11.7% of our loan portfolio at December 31, 2019, and $67.6 million or 10.9% of our loan portfolio at December 31, 2018. Additional commercial and multifamily real estate and consumer loans have improved our net interest income and helped diversify our loan portfolio mix. Our provision for loan losses was $925,000 for the year ended December 31, 2020, compared to a recapture of loan loss expense of $125,000 for the year ended December 31, 2019 and a provision for loan losses of $525,000 for the year ended December 31, 2018. 50 Table of Conten t s Recent Accounting Standards For a discussion of recent accounting standards, see "Note 2—Accounting Pronouncements Recently Issued or Adopted" in the Notes to Consolidated Financial Statements contained in "Part II. Item 8. Financial Statements and Supplementary Data" of this report on Form 10-K. Critical Accounting Policies Certain of our accounting policies are important to an understanding of our financial condition, since they require management to make difficult, complex or subjective judgments, which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Facts and circumstances that could affect these judgments include, but are not limited to, changes in interest rates, changes in the performance of the economy and changes in the financial condition of borrowers. Management believes that its critical accounting policies include determining the allowance for loan losses, accounting for other-than-temporary impairment of securities, accounting for MSRs, accounting for other real estate owned, and accounting for deferred income taxes. For additional information on our accounting policies see "Note 1—Organization and Significant Accounting Policies" in the Notes to Consolidated Financial Statements contained in "Part II. Item 8. Financial Statements and Supplementary Data" of this report on Form 10-K. Allowance for Loan Loss. The allowance for loan losses is the amount estimated by management as necessary to cover losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which is charged to income. Determining the amount of the allowance for loan losses necessarily involves a high degree of subjectivity and requires us to make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. The allowance consists of specific, general and unallocated components. 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. 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. Management reviews the level of the allowance at least quarterly. To strengthen our loan review and classification process, we engage an independent consultant to review our classified loans and a significant sample of recently originated non-classified loans annually. We also enhanced our credit administration policies and procedures to improve our maintenance of updated financial data on commercial borrowers. While we believe the estimates and assumptions used in our determination of the adequacy of the allowance are reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future provisions will not exceed the amount of past provisions or that any increased provisions that may be required will not adversely impact our financial condition and results of operations. In addition, the determination of the amount of our allowance for loan losses is subject to review by bank regulators as part of the routine examination process, which may result in the adjustment of reserves based upon their judgment of information available to them at the time of their examination. 51 Table of Conten t s Other-Than-Temporary Impairment of Securities . Management reviews investment securities on an ongoing basis for the presence of OTTI, taking into consideration current market conditions; fair value in relationship to cost; extent and nature of the change in fair value; issuer rating changes and trends; whether management intends to sell a security or if it is likely that we will be required to sell the security before recovery of the amortized cost basis of the investment, which may be upon maturity; and other factors. For debt securities, if management intends to sell the security or it is likely that we will be required to sell the security before recovering our cost basis, the entire impairment loss would be recognized in earnings as an OTTI loss. If management does not intend to sell the security and it is not more likely than not that we will be required to sell the security, but management does not expect to recover the entire amortized cost basis of the security, only the portion of the impairment loss representing credit losses would be recognized in earnings. The credit loss on a security is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected. 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, i.e., the difference between the present value of the cash flows expected to be collected and fair value, is recognized as a charge to other comprehensive income (loss). Impairment losses related to all other factors are presented as separate components within accumulated other comprehensive income (loss). Mortgage Servicing Rights . We record MSRs on loans sold to Fannie Mae with servicing retained as well as for acquired servicing rights. We stratify our capitalized MSRs based on the type, term and interest rates of the underlying loans. MSRs are carried at fair value. 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. If our assumptions prove to be incorrect, the value of our MSRs could be negatively impacted. We use a third party to assist us in the preparation of the analysis of the market value each quarter. Other Real Estate Owned . OREO represents real estate that we have taken control of in partial or full satisfaction of significantly delinquent loans. At the time of foreclosure, OREO is recorded at the fair value less costs to sell, which becomes the property's new basis. Any write-downs based on the asset's fair value at the date of acquisition are charged to the allowance for loan losses. After foreclosure, management periodically performs valuations such that the real estate is carried at the lower of its new cost basis or fair value, net of estimated costs to sell. Subsequent valuation adjustments are recognized within net (loss) gain on OREO. Revenue and expenses from operations and subsequent adjustments to the carrying amount of the property are included in other noninterest expense in the consolidated statements of income. In some instances, we may make loans to facilitate the sales of OREO. Management reviews all sales for which it is the lending institution for compliance with sales treatment under provisions established by Accounting Standards Codification ("ASC") Topic 360, "Accounting for Sales of Real Estate" . Any gains related to sales of OREO are deferred until the buyer has a sufficient initial and continuing investment in the property. Income Taxes . Income taxes are reflected in our financial statements to show the tax effects of the operations and transactions reported in the financial statements and consist of taxes currently payable plus deferred taxes. ASC Topic 740, "Accounting for Income Taxes," requires the asset and liability approach for financial accounting and reporting for deferred income taxes. Deferred tax assets and liabilities result from differences between the financial statement carrying amounts and the tax bases of assets and liabilities. They are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled and are determined using the assets and liability method of accounting. The deferred income provision represents the difference between net deferred tax asset/liability at the beginning and end of the reported period. In formulating our deferred tax asset, we are required to estimate our income and taxes in the jurisdiction in which we operate. This process involves estimating our actual current tax exposure for the reported period together with assessing temporary differences resulting from differing treatment of items, such as depreciation and the provision for loan losses, for tax and financial reporting purposes. Valuation allowances are established to reduce the net carrying amount of deferred tax assets if it is determined to be more likely than not all or some portion of the potential deferred tax asset will not be realized. Business and Operating Strategies and Goals Our goal is to deliver returns to stockholders by increasing higher-yielding assets (including consumer, commercial and multifamily real estate and commercial business loans), increasing lower-cost core deposit balances, managing expenses, managing problem assets and exploring expansion opportunities. We seek to achieve these results by focusing on the following objectives: Focusing on Asset Quality. We believe that strong asset quality is a key to our long-term financial success. We are focused on monitoring existing performing loans, resolving nonperforming assets and selling foreclosed assets. Nonperforming assets were $3.5 million, or 0.40% of total assets, at December 31, 2020 compared to $5.2 million or 0.73% of total assets, at December 31, 2019. We continue to seek to reduce the level of nonperforming assets through collections, modifications and sales of OREO. 52 Table of Conten t s We also take proactive steps to resolve our non-performing loans, including negotiating payment plans, forbearances, loan modifications and loan extensions on delinquent loans when such actions have been deemed appropriate. Our goal is to maintain or improve upon our level of nonperforming assets by managing all segments of our loan portfolio in order to proactively identify and mitigate risk. Improving Earnings by Expanding Product Offerings. We intend to prudently maintain the percentage of our assets consisting of higher-yielding commercial and multifamily real estate and commercial business loans, which offer higher risk-adjusted returns, shorter maturities and more sensitivity to interest-rate fluctuations than one-to-four family mortgage loans, while maintaining our focus on residential lending. In addition, we continue to focus on consumer products, such as floating and manufactured home loans. With our long experience and expertise in residential lending we believe we can be effective in capturing mortgage banking opportunities and grow consumer deposits. We continue to develop correspondent relationships to sell nonconforming mortgage loans servicing released. We also intend to selectively add additional products to further diversify revenue sources and to capture more of each client's banking relationship by offering additional services to our clients. We continue to refine our products and services for additional business and automate services, such as automating consumer loans originations this past year, in an effort to improve customer service. We intend to further build relationships with medium and small businesses through new and improving existing service offerings, including remote deposit. Emphasizing Lower Cost Core Deposits to Manage the Funding Costs of Our Loan Growth. Our strategic focus is to emphasize total relationship banking with our clients to internally fund our loan growth. We also emphasize reducing wholesale funding sources, including FHLB advances, through the continued growth of core deposits. We believe that a continued focus on client relationships will help increase the level of core deposits and retail certificates of deposit from consumers and businesses in our market area. We intend to increase demand deposits by growing retail and business banking relationships. New technology and services are generally reviewed for business development and cost saving opportunities. We continue to experience growth in client use of our online and mobile banking services, which allow clients to conduct a full range of services on a real-time basis, including balance inquiries, transfers and electronic bill paying, while providing our clients greater flexibility and convenience in conducting their banking. In addition to our retail branches, we maintain state of the art technology-based products, such as business cash management, business remote deposit products, business and consumer mobile banking applications and consumer remote deposit products. Total deposits increased to $748.0 million at December 31, 2020, from $616.7 million at December 31, 2019, and $553.6 million at December 31, 2018. At December 31, 2020, core deposits, which we define as our non-time deposit accounts and time deposit accounts of less than $250,000, increased $129.7 million to $668.1 million, while FHLB advances decreased $7.5 million to zero from the balance at December 31, 2019. Maintaining Our Client Service Focus. Exceptional service, local involvement (including volunteering and contributing to the communities where we do business) and timely decision-making are integral parts of our business strategy. Our employees understand the importance of delivering exemplary customer service and seeking opportunities to build relationships with our clients to enhance our market position and add profitable growth opportunities. We compete with other financial service providers by relying on the strength of our customer service and relationship banking approach. We believe that one of our strengths is that our employees are also significant stockholders through our ESOP and 401(k) plans. We also offer incentives that are designed to reward employees for achieving high-quality client relationship growth. Expanding Our Presence, Including Through Digital Channels and Streamlining Operations, Within Our Existing and Contiguous Market Areas and by Capturing Business Opportunities Resulting from Changes in the Competitive Environment. We believe that opportunities currently exist within our market area to grow our franchise. We anticipate continued organic growth as the local economy and loan demand remains strong, through our marketing efforts and as a result of the opportunities created as a result of the consolidation of financial institutions that is occurring in our market area. In addition, by delivering high-quality, client-focused products and services, we expect to attract additional borrowers and depositors and thus increase our market share and revenue generation. We continue to be disciplined as it pertains to future expansion, acquisitions and de novo branching focusing on the markets in Western Washington, which we know and understand. COVID 19 Response In response to the COVID-19 pandemic, the Company is offering a variety of relief options designed to support our clients and communities we serve. Paycheck Protection Program Participation. The CARES Act was signed into law on March 27, 2020, and authorized the SBA to temporarily guarantee loans under a loan program called the PPP. As a qualified SBA lender, the Company was automatically authorized to originate PPP loans upon commencement of the program in April 2020. The SBA guarantees 100% of the PPP loans made to eligible borrowers. PPP loans have: (a) an interest rate of 1.0%, (b) a two-year loan term to maturity; 53 Table of Conten t s and (c) principal and interest payments deferred for six months from the date of disbursement. The entire principal amount of the borrower’s PPP loan, including any accrued interest, is eligible to be forgiven and repaid by the SBA. Through the conclusion of the PPP on August 8, 2020, we funded $74.8 million in PPP loans, with an average loan amount of $82,000. Many of the PPP applications have been from our existing clients but we are also serving those in our communities who have not had a banking relationship with us in the past. In addition to the 1% interest earned on these loans, the SBA pays us fees for processing PPP loans in the following amounts: (i) 5% for loans of not more than $350,000; (ii) 3% for loans of more than $350,000 and less than $2,000,000; and (iii) 1% for loans of at least $2,000,000. We may not collect any fees from the loan applicants. The following table summarizes our PPP participation at December 31, 2020 (dollars in thousands): Funded At December 31, 2020 Total Outstanding Number of Loans Average Loan Amount Outstanding Number of Loans Existing clients $ 31,555 363 $ 87 $ 11,322 $ 170 New clients 43,221 546 79 31,947 412 Total PPP loans $ 74,776 909 $ 82 $ 43,269 582 The SBA processing fees for the approved PPP loans totaled $2.9 million for the year ended December 31, 2020. These fees are deferred and recognized in interest income over the life of the PPP loans. For the year ended December 31, 2020, interest income included $467,000 in fees earned related to PPP loans. Recent legislation reopened the PPP through March 31, 2021, by authorizing $284.5 billion in funding for eligible small businesses and non-profits. In January 2021, the Bank began accepting and processing loan applications under this second PPP program and will continue working with clients to assist them with accessing other borrowing options, including SBA and other government-sponsored lending programs, as appropriate. Loan Modifications. We are providing payment relief for both consumer and business clients due to the COVID-19 pandemic. At December 31, 2020, we are continuing to provide payment relief for both consumer and business clients, most of which relief involves interest only or payment deferrals that range from 90 to 180 days. Deferred loans are re-evaluated at the end of the deferral period and will either return to the original loan terms or be reassessed at that time to determine if a further modification should be granted and if a downgrade in risk rating is appropriate. 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 have resumed their normal loan payments, matured, or have paid-off. The $4.4 million of residential loans that are still under payment relief at December 31, 2020, include eight residential loans totaling $907,000 that have entered into a second payment forbearance agreement with a weighted average loan-to-value of 66%, 10 residential loans totaling $2.0 million that have entered into a third payment forbearance agreement with a weighted average loan-to value of 57%, and three residential loans totaling $525,000 that have entered into a fourth forbearance agreement with a weighted average loan-to-value of 65%. The $8.1 million in commercial loans that are still under payment relief at December 31, 2020, include three commercial loans totaling $1.7 million that have entered into a second interest-only payment agreement with a weighted average loan-to-value of 65%, and one commercial loan totaling $2.4 million that has entered into a third interest-only payment agreement with a loan-to-value of 47%. The COVID-19 loan modifications discussed above were not classified as TDRs in accordance with the guidance of the CARES Act and related regulatory banking guidance. The CARES Act provides that the short-term modification of loans as a result of the COVID-19 pandemic, made on a good faith basis to borrowers who were current as defined under the CARES Act prior to any relief, are not TDRs. This includes short-term (up to twelve months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers are considered current under the CARES Act (as extended by the CAA, 2021) and related regulatory banking guidance if they are less than 30 days past due on their contractual payments at the time a modification program is implemented and the relief is executed prior to December 31, 2020 or the earlier of 60 days after the national emergency termination date or January 1 2022, whichever is earlier. As of December 31, 2020, we had no new pending requests for payment relief. We believe the steps we are taking are necessary to effectively manage our portfolio and assist our clients through the ongoing uncertainty surrounding the duration, impact and government response to the COVID-19 pandemic. S upport for Clients, Employees and Community during Pandemic. Our retail locations continue to operate with full service, in compliance with various mandates and recommendations including masks, distancing and capacity management. The majority of back office and administrative employees have worked remotely throughout the pandemic. We monitor and 54 Table of Conten t s conform our practices based on updates from the Center for Disease Control, World Health Organization, Financial Regulatory Agencies, and local and state health departments. We continue to work closely with our borrowers to evaluate pandemic related challenges. We also continue to support our not-for-profit organizations, although most activity is virtual. Comparison of Financial Condition at December 31, 2020 and December 31, 2019 General. Total assets increased by $141.5 million, or 19.7%, to $861.4 million at December 31, 2020, from $719.9 million at December 31, 2019. The increase was primarily a result of a higher balances in cash and cash equivalents and loans held-for-sale. Cash and Securities. Cash, cash equivalents and our available-for-sale securities increased by $139.0 million, or 213.6%, to $204.0 million at December 31, 2020. Cash and cash equivalents increased $138.1 million, or 247.6%, to $193.8 million at December 31, 2020. The increase in total cash and cash equivalents was due to deposit growth and the proceeds from the issuance of $12 million in subordinated notes during the third quarter of 2020. Available-for-sale securities, which consist of agency mortgage-backed securities and municipal bonds, increased $912,000, or 9.8%, to $10.2 million at December 31, 2020, from $9.3 million at December 31, 2019, primarily due to the purchase of investment securities during the year. At December 31, 2020, our securities portfolio consisted of 16 agency mortgage-backed securities and 10 municipal bonds with a fair value of $10.2 million. At December 31, 2019, our securities portfolio consisted of 13 agency mortgage-backed securities and eight municipal bonds with a fair value of $9.3 million. During the year ended December 31, 2020 we did not recognize any non-cash OTTI losses on our investment securities. At December 31, 2020, six agency mortgage-backed securities had unrealized losses of $6,000, but management determined the decline in value was not related to specific credit deterioration. The unrealized losses were caused by changes in interest rates and the widening of market spreads subsequent to purchase of these securities. We do not intend to sell these securities and it is more likely than not that we will not be required to sell these securities before anticipated recovery of the remaining amortized cost basis. Loans. Loans held-for-portfolio, net, decreased $6.9 million, or 1.1%, to $607.4 million at December 31, 2020 from $614.2 million at December 31, 2019. Loans held-for-sale increased to $11.6 million at December 31, 2020 from $1.1 million at December 31, 2019. The following table reflects the changes in the loan mix, excluding deferred fees, of our portfolio at December 31, 2020, as compared to December 31, 2019 (dollars in thousands): December 31, Amount Percent 2020 2019 Change Change One-to-four family $ 130,657 $ 149,393 $ (18,736) (12.5) % Home equity 16,265 23,845 (7,580) (31.8) Commercial and multifamily 265,774 261,268 4,506 1.7 Construction and land 62,752 75,756 (13,004) (17.2) Manufactured homes 20,941 20,613 328 1.6 Floating homes 39,868 43,799 (3,931) (9.0) Other consumer 15,024 8,302 6,722 81.0 Commercial business 64,217 38,931 25,286 65.0 Total loans $ 615,498 $ 621,907 $ (6,409) (1.0) % The largest dollar increases in the loan portfolio were in commercial business loans, which increased $25.3 million or 65.0% to $64.2 million, driven by the origination of PPP loans, other consumer loans, which increased $6.7 million or 81.0%, to $15.0 million, and commercial and multifamily real estate loans, which increased $4.5 million or 1.7%, to $265.8 million. These increases were offset by decreases in the one-to-four family loans portfolio, which decreased $18.7 million, or 12.5%, to $130.7 million, primarily as a result of increased sales of conforming one-to-four family loans to Fannie Mae rather than retaining the loans for portfolio, construction and land loans, which decreased $13.0 million or 17.2%, to $62.8 million, home equity loans, which decreased $7.6 million, or 31.8%, to $16.3 million, and floating home loans which decreased $3.9 million, or 9.0%, to $39.9 million. 55 Table of Conten t s The loan portfolio remains well-diversified with commercial and multifamily real estate loans accounting for 43.2% of the portfolio, one-to-four family real estate loans, including home equity loans, accounting for approximately 23.8% of the portfolio and consumer loans, consisting of manufactured homes, floating homes, and other consumer loans accounting for 12.4% of the total loan portfolio at December 31, 2020. Construction and land loans accounted for 10.2% of the portfolio and commercial business loans accounted for the remaining 10.4% of the portfolio at December 31, 2020. Mortgage Servicing Rights. The fair value of mortgage servicing rights was $3.8 million at December 31, 2020, compared to $3.2 million at December 31, 2019. We record mortgage servicing rights on loans sold with servicing retained and upon acquisition of a servicing portfolio. We stratify our capitalized mortgage servicing rights based upon the type, term and interest rates of the underlying loans. Mortgage servicing rights are carried at fair value. If the fair value of our mortgage servicing rights fluctuates significantly, our financial results could be materially impacted. Nonperforming Assets. At December 31, 2020, our nonperforming assets totaled $3.5 million, or 0.40% of total assets, compared to $5.2 million, or 0.73% of total assets, at December 31, 2019. The table below sets forth the amounts and categories of nonperforming assets in our loan portfolio at the dates indicated (dollars in thousands): December 31, Amount Percent 2020 2019 Change Change Nonaccrual loans $ 2,884 $ 4,657 $ (1,773) (38.1) % OREO and repossessed assets 594 575 19 3.3 Total nonperforming assets $ 3,478 $ 5,232 $ (1,754) (33.5) % Nonaccrual loans decreased $1.8 million or 38.1%, to $2.9 million at December 31, 2020, compared to the prior year. Nonaccrual loans were 0.47% of total loans at December 31, 2020, compared to 0.75% of total loans at December 31, 2019. We had no loans greater than 90 days delinquent and still accruing at December 31, 2020 and 2019. OREO and repossessed assets were $594,000 and $575,000 at December 31, 2020 and 2019, respectively. OREO and repossessed assets at December 31, 2020 and 2019 primarily consisted of a former bank branch property located in Port Angeles, Washington which was acquired in 2015 as a part of three branches purchased from another financial institution. It is currently leased to a not-for-profit organization headquartered in our market area at a below market rate. The addition to OREO and repossessed assets in 2020 is a manufactured home located in Everett, Washington. Allowance for Loan Losses. The allowance for loan losses is maintained to cover losses that are probable and can be estimated on the date of evaluation in accordance with generally accepted accounting principles in the U.S. It is our best estimate of probable incurred credit losses in our loan portfolio. The following table reflects the adjustments in our allowance during 2020 and 2019 (dollars in thousands): Year Ended December 31, 2020 2019 Balance at beginning of period $ 5,640 $ 5,774 Charge-offs (690) (52) Recoveries 125 43 Net (charge-offs) recoveries (565) (9) Provision (recapture) charged to operations 925 (125) Balance at end of period $ 6,000 $ 5,640 Ratio of net (charge-offs) recoveries during the period to average loans outstanding during the period (0.08) % — % Allowance as a percentage of nonperforming loans 208.04 % 121.11 % Allowance as a percentage of total loans (end of period) 0.98 % 0.91 % Our allowance for loan losses increased $360,000, or 6.4%, to $6.0 million at December 31, 2020, from $5.6 million at December 31, 2019. We recorded a provision for loan losses of $925,000 for the year ended December 31, 2020, compared to a 56 Table of Conten t s recapture from the allowance for loan losses of $125,000 for the year ended December 31, 2019. Our allowance for loan losses at December 31, 2020 not only reflects probable credit losses based upon the conditions that existed at December 31, 2020, but also gives consideration to potential losses from impacts of the COVID-19 pandemic. Specific loan loss reserves decreased to $378,000 at December 31, 2020 compared to $724,000 at December 31, 2019, while general loan loss reserves increased to $5.2 million at December 31, 2020 from $4.0 million at December 31, 2019, and the unallocated reserve decreased to $406,000 at December 31, 2020, compared to $948,000 at December 31, 2019. Loans individually evaluated for impairment decreased by $6.5 million to $5.9 million at December 31, 2020, compared to $12.4 million at December 31, 2019. Net charge-offs were $565,000 for the year ended December 31, 2020, compared to net charge-offs of $9,000 for the year ended December 31, 2019. The increase in 2020 charge-offs is primarily related to one commercial borrower who was forced into bankruptcy after a tragic vehicle accident. Our line of credit to this borrower was approved in July, 2019 for $975,000, secured by business assets including 19 vehicles, and fully advanced at the time of bankruptcy. Because the vehicles were specialized for offering land and sea tours, their value was depressed due to the pandemic. As a result, our liquidation of the collateral resulted in a loss of $514,000. At December 31, 2020, the allowance for loan losses as a percentage of total loans and nonperforming loans was 0.98% and 208.04%, respectively, compared to 0.91% and 121.11%, respectively, at December 31, 2019. Deposits. Total deposits increased $131.3 million, or 21.3%, to $748.0 million at December 31, 2020 from $616.7 million at December 31, 2019. The increase was due to growth in all deposit categories, except for certificates of deposit. Interest-bearing demand deposits increased $70.7 million, or 44.3%, to $230.5 million at December 31, 2020 from $159.8 million at December 31, 2019. Noninterest-bearing demand deposits increased $34.3 million, or 36.1%, to $129.3 million at December 31, 2020 from $95.0 million at December 31, 2019. Savings deposits increased $25.8 million or 44.6%, to $83.8 million at December 31, 2020 from $57.9 million at December 31, 2019, and money market deposits increased $15.4 million, or 30.6%, to $65.7 million at December 31, 2020, from $50.3 million at December 31, 2019. These increases were partially offset by a decrease of $15.9 million, or 6.3%, in certificates of deposit to $235.5 million at December 31, 2020 from $251.4 million at December 31, 2019. The increase in total deposits at December 31, 2020 compared to December 31, 2019 was the result of developing relationships with PPP borrowers who were not previously clients, adding new consumer clients, and expanding relationships with existing clients, as well as reduced withdrawals, reflecting changes in customer spending habits due to the COVID-19 pandemic. A summary of deposit accounts with the corresponding weighted-average cost at December 31, 2020 and 2019 is presented below (dollars in thousands): December 31, 2020 December 31, 2019 Amount Wtd. Avg. Rate Amount Wtd. Avg. Rate 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 of deposit 235,473 2.43 251,387 2.23 Escrow 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. Borrowings . FHLB advances decreased $7.5 million to zero at December 31, 2020, as we utilized our increase in deposits for funding needs. We rely on FHLB advances to fund interest-earning assets when deposits alone cannot fully fund interest-earning asset growth. In September 2020, we completed a private placement of $12.0 million in aggregate principal of subordinated notes, resulting in net proceeds, after placement fees and offering expenses, of approximately $11.6 million. Stockholders' Equity. Total stockholders' equity increased $7.8 million, or 10.0%, to $85.5 million at December 31, 2020, from $77.7 million December 31, 2019. This increase primarily reflects net income of $8.9 million, stock-based compensation of $338,000, ESOP share allocations of $324,000 and proceeds of $239,000 received in connection with stock option exercises, partially offset by cash dividends paid to stockholders of $2.1 million and repurchases of the Company's stock of $73,000. 57 Table of Conten t s Average Balances, Net Interest Income, Yields Earned and Rates Paid The following table presents, for the periods indicated, the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates. Income and yields on tax-exempt obligations have not been computed on a tax equivalent basis. All average balances are daily average balances. Nonaccrual loans have been included in the table as loans carrying a zero yield for the period they have been on nonaccrual (dollars in thousands). December 31, 2020 2019 2018 Average Outstanding Balance Interest Earned/ Paid Yield/ Rate Average Outstanding Balance Interest Earned/ Paid Yield/ Rate Average Outstanding Balance Interest Earned/ Paid Yield/ Rate Interest-earning assets: Loans (1) $ 665,389 $ 34,439 5.18 % $ 599,944 $ 33,090 5.52 % $ 589,205 $ 31,881 5.41 % Investments and interest-bearing accounts 104,328 497 0.48 64,386 1,491 2.32 60,628 1,286 2.12 Total interest-earning assets (1) 769,717 34,936 4.54 664,330 34,581 5.21 649,833 33,167 5.10 Interest-bearing liabilities: Savings and money market accounts 128,038 346 0.27 103,482 386 0.37 100,639 200 0.20 Demand and NOW accounts 189,643 909 0.48 154,738 924 0.60 170,518 874 0.51 Certificate accounts 242,963 5,749 2.37 235,363 5,555 2.36 174,922 2,765 1.58 Subordinated notes 3,365 191 5.67 — — — — — — Borrowings 16,610 255 1.54 24,406 752 3.08 69,900 1,521 2.18 Total interest-bearing liabilities 580,619 7,450 1.28 % 517,989 7,617 1.47 % 515,979 5,360 1.04 % Net interest income $ 27,486 $ 26,964 $ 27,807 Net interest rate spread 3.26 % 3.74 % 4.06 % Net earning assets $ 189,098 $ 146,341 $ 133,854 Net interest margin 3.57 % 4.06 % 4.28 % Average interest-earning assets to average interest-bearing liabilities 132.57 % 128.25 % 125.94 % (1) Calculated net of deferred loan fees, loan discounts and loans in process. 58 Table of Conten t s Rate/Volume Analysis The following schedule presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between changes related to outstanding balances and changes due to interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate multiplied by old volume). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate (dollars in thousands). Year Ended December 31, 2020 vs. 2019 Year Ended December 31, 2019 vs. 2018 Increase (Decrease) due to Total Increase (Decrease) Increase (Decrease) due to Total Increase (Decrease) Volume Rate Volume Rate Interest-earning assets: Loans $ 3,387 $ (2,038) $ 1,349 $ 592 $ 617 $ 1,209 Investments and interest-bearing accounts 190 (1,184) (994) 87 118 205 Total interest-earning assets 3,577 (3,222) 355 679 735 1,414 Interest-bearing liabilities: Savings and Money Market accounts 66 (106) $ (40) 11 175 186 Demand and NOW accounts 167 (182) (15) (94) 145 51 Certificate accounts 180 14 194 1,426 1,363 2,789 Subordinated debt 191 — 191 Borrowings (120) (377) (497) (1,401) 632 (769) Total interest-bearing liabilities $ 484 $ (651) $ (167) $ (58) $ 2,315 $ 2,257 Change in net interest income $ 522 $ (843) Comparison of Results of Operation for the Years Ended December 31, 2020 and 2019 General. Net income increased $2.3 million to $8.9 million, or $3.42 per diluted common share, for the year ended December 31, 2020, from $6.7 million, or $2.57 per diluted common share, for the year ended December 31, 2019. The increase in net income in 2020 compared to 2019 was primarily due to higher noninterest income, particularly gain on sale of loans, and increased net interest income, partially offset by an increase in the provision for loan losses and an increase in income tax expense. Interest Income. Total interest income increased by $355,000, or 1.0%, to $34.9 million for the year ended December 31, 2020, from $34.6 million for the year ended December 31, 2019. Interest income on loans increased $1.3 million, or 4.1%, to $34.4 million for the year ended December 31, 2020, compared to $33.1 million for the year ended December 31, 2019, due to higher average loan balances, partially offset by a decrease in average yield. The average loans held-for-portfolio balance was $665.4 million for the year ended December 31, 2020, compared to $599.9 million for the year ended December 31, 2019. The average yield on loans held-for-portfolio was 5.18% for the year ended December 31, 2020, compared to 5.52% for the year ended December 31, 2020. The average yield on loans decreased compared to the same period in the prior year due primarily to decreases in interest rates on adjustable-rate instruments, following decreases to short-term rates over the last year, including the emergency 150-basis point reduction in the targeted federal funds rate in March 2020 due to the COVID-19 pandemic, and secondarily, due to the impact of PPP loans. For the year ended December 31, 2020, the average balance of PPP loans was $46.7 million and the average yield on PPP loans was 4.32%, including the recognition of the net deferred fees. Interest income included $467,000 in fees earned related to PPP loans during 2020 compared to none in the prior year. The impact of PPP loans on loan yields will change during any period based on the volume of prepayments or amounts forgiven by the SBA as certain criteria are met but is expected to cease completely after the two- or five-year maturity of the loans. The change in interest income on investments and interest-bearing accounts was primarily due to the decline in short-term interest rates in 2020 discussed above. Interest Expense. Interest expense decreased $167,000, or 2.2%, to $7.5 million during the year ended December 31, 2020, compared to $7.6 million during the year ended December 31, 2019, primarily due to lower average balances and rates paid on 59 Table of Conten t s borrowings and lower rates paid on interest-bearing deposits, partially offset by higher average interest-bearing deposit balances and the issuance of subordinated notes, with its commensurate interest expense. Interest expense on deposits increased $139,000, or 2.0%, to $7.0 million for the year ended December 31, 2020, compared to the prior year, primarily driven by an increase of $67.1 million, or 13.6%, in the average balance of interest-bearing deposit accounts to $560.6 million. Average balances in all types of interest-bearing deposits increased in 2020. The resulting negative impact to interest expense was partially offset by 15-basis point decrease in the weighted-average rate paid on interest-bearing deposits, which decreased to 1.01% for the year ended December 31, 2020, from 1.16% for the year ended December 31, 2019. Although the average balance of certificate accounts accounted for 11.3% of the increase in the average balance in interest-bearing deposits year over year, due to the average rate paid on this type of account relative to other deposits, it contributed $194,000 to the increase in interest expense year over year. In September 2020, we completed a private placement of $12.0 million in aggregate principal of subordinated notes, resulting in net proceeds after placement fees and offering expenses, of approximately $11.6 million. Interest expense on our subordinated notes totaled $191,000 for the year ended December 31, 2020. Interest expense on borrowings, which include FHLB advances and Federal Reserve discount window and the PPPLF program, decreased $497,000, or 66.1%, to $255,000 for the year ended December 31, 2020 from $752,000 for the year ended December 31, 2019, due to a $7.8 million, or 31.9% decrease in the average balance of borrowings to $16.6 million for the year ended December 31, 2020, from $24.4 million for the year ended December 31, 2019. The weighted-average interest rate on borrowings was 1.54% in 2020 and 3.08% in 2019. The need for borrowings declined significantly in 2020 due to increased liquidity resulting from growth in customer deposits. Our overall weighted-average cost of interest-bearing liabilities was 1.28% for the year ended December 31, 2020, compared to 1.47% for the year ended December 31, 2019. Net Interest Income. Net interest income increased $522,000, or 1.9%, to $27.5 million for the year ended December 31, 2020, from $27.0 million for the year ended December 31, 2019, primarily as a result of higher interest income on loans and lower overall interest expense. Our net interest margin was 3.57% for the year ended December 31, 2020, compared to 4.06% for the year ended December 31, 2019. The low interest-rate environment putting downward pressure on income from adjustable-rate loans and investments and an increase in costs related to interest-bearing deposits adversely impacted net interest margin for the current year. The decreases were also due to yields earned on interest-earning assets declining at a faster rate than interest rates paid on interest-bearing liabilities as changes in the average rate paid on interest-bearing deposits tend to lag changes in market interest rate. The lower average yield on PPP loans, including recognition of deferred loan fees, also contributed to the decline in the net interest margin. Provision (Recapture) for Loan Losses. We establish our allowance for loan losses through provisions for loan losses, which are charged to earnings, at a level required to reflect management's best estimate of the probable incurred credit losses in the loan portfolio. In evaluating the level of the allowance for loan losses, management considers historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect borrowers' ability to repay, estimated value of any underlying collateral, peer group data, prevailing economic conditions, and other qualitative factors. Large groups of smaller balance homogeneous loans, such as one-to four-family, commercial and multifamily real estate, home equity and consumer loans, including floating homes and manufactured homes, are evaluated in the aggregate using historical loss factors adjusted for current economic conditions and other relevant data. Loans, for which management has concerns about the borrowers' ability to repay, are evaluated individually, and specific loss allocations are provided for these loans when necessary. We recorded a provision for loan losses of $925,000 for the year ended December 31, 2020, compared to a recapture from the allowance for loan losses of $125,000 for the year ended December 31, 2019. The increase in the provision primarily reflects current economic conditions and gives consideration of probable loan losses due to the potential effects from higher forecasted unemployment rates and lower gross domestic product, as well as the impact on other economic conditions from COVID-19. The recapture in the prior year was due to changes in the composition of our loan portfolio during the year. Net loan charge-offs were $565,000 and $9,000 for the years ended December 31, 2020 and 2019. Nonperforming loans decreased $1.8 million during the year to $2.9 million at December 31, 2020, compared to $4.7 million a year ago. Nonperforming loans to total loans decreased to 0.47% at December 31, 2020 from 0.75% at December 31, 2019. The allowance for loan losses increased to $6.0 million at December 31, 2020 compared to $5.6 million at December 31, 2019. See "—Comparison of Financial Condition at December 31, 2020 and December 31, 2019— Delinquencies and Nonperforming Assets" for more information on nonperforming loans. While we believe the estimates and assumptions used in our determination of the adequacy of the allowance are reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual 60 Table of Conten t s amount of future provisions will not exceed the amount of past provisions or that any increased provisions that may be required will not adversely impact our financial condition and results of operations. In addition, the determination of the amount of our allowance for loan losses is subject to review by bank regulators as part of the routine examination process, which may result in the adjustment of reserves based upon their judgment of information available to them at the time of their examination. Noninterest Income. Noninterest income increased $3.4 million, or 84.9%, to $7.4 million for the year ended December 31, 2020, as compared to $4.0 million for the year ended December 31, 2019 as reflected below (dollars in thousands): Year Ended December 31, Amount Percent 2020 2019 Change Change Service charges and fee income $ 1,905 $ 1,954 $ (49) (2.5) % Earnings on cash surrender value of bank owned life insurance 348 381 (33) (8.7) Mortgage servicing income 1,027 1,002 25 2.5 Fair value adjustment on MSRs (1,857) (760) (1,097) 144.3 Net gain on sale of loans 6,022 1,449 4,573 315.6 Total noninterest income $ 7,445 $ 4,026 $ 3,419 84.9 % The increase in noninterest income from one year ago was primarily due to a $4.6 million increase in gain on sale of loans, partially offset by a $1.1 million decrease in the mark-to-market adjustment on fair value of MSRs during the year ended December 31, 2020. Demand for one-to-four family loans grew significantly in 2020 as homeowners, taking advantage of historically low interest rates, refinanced their homes. In addition, the pandemic increased demand for single-family homes outside downtown metropolitan areas. Noninterest Expense . Noninterest expense decreased $107,000, or 0.5%, to $22.7 million for the year ended December 31, 2020, from the year ended December 31, 2019, as reflected below (dollars in thousands): Year Ended December 31, Amount Percent 2020 2019 Change Change Salaries and benefits $ 12,083 $ 12,402 $ (319) (2.6) % Operations 5,461 5,905 (444) (7.5) Regulatory assessments 590 279 311 111.5 Occupancy 1,881 2,060 (179) (8.7) Data processing 2,658 2,104 554 26.3 Losses and expenses on OREO and repossessed assets 5 35 (30) (85.7) Total noninterest expense $ 22,678 $ 22,785 $ (107) (0.5) % Salaries and benefits decreased $319,000 due to an increase in deferred loan origination costs which had the effect of lowering up-front commission expense. Operations expense decreased due to decreases in professional and consulting fees, travel and conference and marketing and advertising expense. Data processing expense increased due to technology investments and variable costs associated with loan origination activity. Regulatory assessments increased $311,000 to its pre-2019 level, as the Bank utilized all of its remaining regulatory assessment credits in 2019. The efficiency ratio, which is noninterest expense as a percentage of net interest income and noninterest income, for the year ended December 31, 2020 was 64.90%, compared to 73.52% for the year ended December 31, 2019. The improvement in the efficiency ratio compared to the prior year was primarily due to the increase in noninterest income earned during the current year. Income Tax Expense . The provision for income taxes increased $740,000, or 44.8% to $2.4 million for the year ended December 31, 2020, compared to $1.7 million for the year ended December 31, 2019, due to an increase in taxable net income and higher effective tax rate. The effective tax rates for the years ended December 31, 2020 and 2019 were 21.1% and 19.8%, respectively. Liquidity Liquidity management is both a daily and longer-term function of management. Excess liquidity is generally invested in short-term investments, such as overnight deposits and federal funds. On a longer-term basis, we maintain a strategy of investing in 61 Table of Conten t s various loan products and investment securities, including mortgage-backed securities. We use our sources of funds primarily to meet ongoing commitments, pay maturing deposits, fund deposit withdrawals and fund loan commitments. We maintain cash and investments that qualify as liquid assets to maintain adequate liquidity to ensure safe and sound operations and meet demands for client funds (particularly withdrawals of deposits). At December 31, 2020, we had $204.0 million in cash and available-for-sale investment securities and $11.6 million in loans held-for-sale. We can also obtain funds from borrowings, primarily FHLB advances. At December 31, 2020, we had the ability to borrow an additional $213.7 million in FHLB advances, subject to certain collateral requirements and we had access to additional borrowings of $23.6 million through the Federal Reserve's discount window and PPPLF program, subject to certain collateral requirements. We had no outstanding advances or borrowings with the Federal Reserve at December 31, 2020. In addition, we also had available $20.0 million of credit facilities with other financial institutions, with no balance outstanding at December 31, 2020 or 2019. We are required to have adequate cash and investments that qualify as liquid assets in order to maintain sufficient liquidity to ensure safe and sound operations. Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans. Historically, we have maintained liquid assets above levels believed to be adequate to meet the requirements of normal operations, including potential deposit outflows. Cash flow projections are regularly reviewed and updated to assure that adequate liquidity is maintained. Liquidity management involves the matching of cash flow requirements of clients, who may be either depositors desiring to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs and our ability to manage those requirements. We strive to maintain an adequate liquidity position by managing the balances and maturities of interest-earning assets and interest-bearing liabilities so that the balance we have in short-term investments at any given time will adequately cover any reasonably anticipated, immediate need for funds. Additionally, we maintain relationships with correspondent banks, which could provide funds on short-term notice if needed. Our liquidity, represented by cash and cash-equivalents, is a product of our operating, investing and financing activities. As disclosed in our "Consolidated Statements of Cash Flows" in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K, cash and cash equivalents increased $138.1 million to $193.8 million at December 31, 2020, from $55.8 million at December 31, 2019. Net cash used in operating activities was $484,000 for the year ended December 31, 2020. Net cash of $4.5 million was provided by investing activities for the year ended December 31, 2020, primarily provided by loan maturities. Net cash provided by financing activities of $134.0 million for the year ended December 31, 2020, primarily consisted of a $131.3 million increase in deposits and $11.6 million in net proceeds from the issuance of subordinated notes, partially offset by $7.5 million decrease in FHLB advances. Sound Financial Bancorp is a separate legal entity from Sound Community Bank and must provide for its own liquidity. In addition to its own operating expenses (many of which are paid to Sound Community Bank), Sound Financial Bancorp is responsible for paying any dividends declared to its stockholders, and interest and principal on outstanding debt. Sound Financial Bancorp's primary source of funds is dividends from Sound Community Bank, which are subject to regulatory limits. During the third quarter of 2020, the Company completed a private placement of $12.0 million in aggregate principal of subordinated notes resulting in net proceeds, after placement fees and offering expenses, of approximately $11.6 million. The Company contributed $5.5 million of the net proceeds from the sale of the subordinated notes to the Bank and retained the remaining net proceeds to be used for general corporate purposes. At December 31, 2020 Sound Financial Bancorp, on an unconsolidated basis, had $6.8 million in cash, noninterest-bearing deposits and liquid investments generally available for its cash needs. Our liquidity, represented by cash and cash equivalents and investment securities, is a product of our operating, investing and financing activities. Our primary sources of funds are deposits, amortization, prepayments and maturities of outstanding loans and mortgage-backed securities, maturities of investment securities and other short-term investments and funds provided from operations. While scheduled payments from the amortization of loans and mortgage-backed securities and maturing investment securities and short-term investments are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates. We also generate cash through borrowings. We utilize FHLB advances to leverage our capital base and provide funds for our lending and investment activities, and to enhance our interest rate risk management. We use our sources of funds primarily to meet ongoing commitments, pay maturing deposits and fund withdrawals, and to fund loan commitments. At December 31, 2020, the approved outstanding loan commitments, including unused lines and letters of credit, amounted to $56.5 million. Certificates of deposit scheduled to mature in one year or less at December 31, 2020, totaled $180.4 million. It is management's policy to offer deposit rates that are competitive with other local financial institutions. Based on this management strategy, we believe that a majority of maturing deposits will remain with us. See also the "Consolidated Statements of Cash Flows" included in Item 8. Financial Statements and Supplementary Data of this Form 10-K, for further information. 62 Table of Conten t s Off-Balance Sheet Activities In the normal course of operations, we engage in a variety of financial transactions that are not recorded in our financial statements. These transactions involve varying degrees of off-balance sheet credit, interest rate and liquidity risks. These transactions are used primarily to manage clients' requests for funding and take the form of loan commitments and lines of credit. For the year ended December 31, 2020, we did not engage in any off-balance sheet transactions likely to have a material effect on our financial condition, results of operations or cash flows. A summary of our off-balance sheet loan commitments at December 31, 2020, is as follows (in thousands): Off-balance sheet loan commitments: Amoun t Residential mortgage commitments $ 3,312 Unfunded construction commitments 18,981 Unused lines of credit 34,075 Irrevocable letters of credit 151 Total loan commitments $ 56,519 Capital Sound Community Bank is subject to minimum capital requirements imposed by regulations of the FDIC. Capital adequacy requirements are quantitative measures established by regulation that require Sound Community Bank to maintain minimum amounts and ratios of capital. Based on its capital levels at December 31, 2020, Sound Community Bank exceeded these requirements at that date. Consistent with our goals to operate a sound and profitable organization, our policy is for Sound Community Bank to maintain a "well-capitalized" status under the regulatory capital categories of the FDIC. Beginning January 2020, the Bank elected to use the CBLR framework. A bank that elects to use the 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 8.0% 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 9.0% 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 25.0% 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.At December 31, 2020, the Bank’s CBLR was 10.40%. For additional details, see “Note 16—Capital” in the Notes to Consolidated Financial Statements contained in "Item 8. Financial Statements and Supplementary Data" and "Item 1. Business—How We Are Regulated—Regulation of Sound Community Bank—Capital Rules" of this Form 10-K. 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 CET1 capital to risk-weighted assets of at least 6.5%, a ratio of Tier 1 capital to risk-weighted assets of at least 8.0%, a ratio of total capital to risk-weighted assets of at least 10.0%, and a leverage ratio of at least 5.0%, and the bank must not be subject to a regulatory capital requirement imposed on it as an individual bank. 63 Table of Conten t s 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 4.0 % $ 36,226 5.0 % Common Equity Tier 1 to risk-weighted assets (2) 74,031 12.07 27,601 4.5 39,868 6.5 Tier 1 Capital to risk-weighted assets (2) 74,031 12.07 36,801 6.0 49,068 8.0 Total Capital to risk-weighted assets (2) $ 79,974 13.04 % $ 49,068 8.0 % $ 61,335 10.0 % (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. 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, 2020, Sound Financial Bancorp would have exceeded all regulatory capital requirements. The estimated CBLR calculated for Sound Financial Bancorp for Sound Financial Bancorp at December 31, 2020 was 10.40%.