What changed in this filing

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Item 2. Management’s Discussion and Analysis

2021-05-13 compared with 2020-11-09 · 194 added, 249 removed, 164 unchanged (73% of the section changed)

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Government and other governmental initiatives affecting the financial services industry;

• fluctuations in the demand for loans, the number of unsold homes, land and other properties, and fluctuations in real estate values and both residential and commercial and multifamily real estate market conditions in our market area;

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

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

• our ability to access cost-effective funding;

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

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

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

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

• other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services, including the Coronavirus Aid, Relief, and Economic Security Act of 2020 ("CARES Act");

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

• the other risks described from time to time in our filings with the U.S.

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Sound Community Bank’s deposits are insured up to applicable limits by the FDIC.

At September 30, 2020, Sound Financial Bancorp, on a consolidated basis, had assets of $867.4 million, net loans held-for-portfolio of $683.4 million, deposits of $748.9 million and stockholders’ equity of $82.3 million.

At March 31, 2021, Sound Financial Bancorp, on a consolidated basis, had assets of $936.7 million, net loans held-for-portfolio of $608.4 million, deposits of $816.7 million and stockholders’ equity of $87.6 million.

The shares of Sound Financial Bancorp are traded on NASDAQ Capital Market under the symbol “SFBC.” Our executive offices are located at 2400 3rd Avenue, Suite 150, Seattle, Washington, 98121.

Our principal business consists of attracting retail and commercial deposits from the general public and investing those funds, 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, consumer and commercial business loans.

Our principal business consists of attracting retail and commercial deposits from the general public and investing those funds, in loans secured by first and second mortgages on one- to four- family residences (including home equity loans and lines of credit), commercial and multifamily real estate, construction and land, consumer and commercial business loans.

Our commercial business loans include unsecured lines of credit and secured term loans and lines of credit secured by inventory, equipment and accounts receivable.

We also offer a variety of secured and unsecured consumer loan products, including manufactured home loans, floating home loans, automobile loans, boat loans and recreational vehicle

We also offer a variety of secured and unsecured consumer loan products, including manufactured home loans, floating home loans, automobile loans, boat loans and recreational vehicle loans.

As part of our business, we focus on residential mortgage loan originations, a significant portion of which we sell to Fannie Mae and other correspondents and the remainder of which we retain for our loan portfolio consistent with our asset/liability objectives.

We sell loans which conform to the underwriting standards of Fannie Mae (“conforming”) in which we retain the servicing of the loan in order to maintain the direct customer relationship and to generate noninterest income.

Residential loans which do not conform to the underwriting standards of Fannie Mae (“non-conforming”), are either held in our loan portfolio or sold with servicing retained.

Residential loans which do not conform to the underwriting standards of Fannie Mae (“non-conforming”), are held in our loan portfolio.

We originate and retain a significant amount of commercial real estate loans, including those secured by owner-occupied and nonowner-occupied commercial real estate, multifamily property, mobile home parks and construction and land development loans.

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Management believes that its critical accounting policies include determining the allowance for loan losses, accounting for other-than-temporary impairment of securities, accounting for mortgage servicing rights, accounting for other real estate owned and accounting for deferred income taxes.

Our methodologies for analyzing the allowance for loan losses, other-than-temporary impairment, mortgage servicing rights, other real estate owned and deferred tax asset accounts are described in our 2019 Form 10-K.

Our methodologies for analyzing the allowance for loan losses,

other-than-temporary impairment, mortgage servicing rights, other real estate owned and deferred tax asset accounts are described in our 2020 Form 10-K.

COVID-19 Response

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.

The Company continues to offer a variety of relief options designed to support our clients and communities we serve during the ongoing COVID-19 pandemic.

Paycheck Protection Program ("PPP") Participation.

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The entire principal amount of the borrower’s PPP loan, including any accrued interest, is eligible to be forgiven and repaid by the SBA.

The deadline for PPP loan applications to the SBA was extended to August 8, 2020.

Through the conclusion of the PPP on August 8, 2020, we have 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 as of September 30, 2020 (dollars in thousands):

Total Outstanding Number of Loans Average Loan Amount

Existing clients $ 31,555 363 $ 87

New clients 43,221 546 79

The first round of the program expired on August 8, 2020, and a second round reopened the program beginning January 1, 2021 through May 31, 2021.

During the first quarter of 2021, we continued our participation in the initial SBA PPP by processing applications for PPP loan forgiveness.

As of March 31, 2021, we had received SBA forgiveness for 807 PPP loans totaling $52.7 million out of the $74.8 million in PPP loans funded during the first PPP program.

During the first quarter of 2021, we began accepting and processing loan applications under the second PPP program enacted in December 2020.

As of March 31, 2021, we have funded 471 PPP loans totaling $39.1 million under the second PPP program.

As of March 31, 2021, there was a total of 573 PPP loans outstanding totaling $61.2 million.

The following table summarizes our PPP participation as of March 31, 2021 (dollars in thousands):

Funded At March 31, 2021

Total Number of Loans Average Loan Amount Outstanding Number of Loans

First PPP $ 74,776 909 $ 82 $ 22,093 102

Second PPP 39,108 471 83 39,108 471

Total PPP loans $ 113,884 1,380 $ 83 $ 61,201 573

The SBA processing fees for the approved loans totaled $2.9 million at September 30, 2020.

The SBA processing fees for the approved loans totaled $4.6 million at March 31, 2021.

Loan Modifications.

We are providing payment relief for both consumer and business clients due to the COVID-19 pandemic.

As of September 30, 2020, we have provided payment relief related to COVID-19, in accordance with the CARES Act, on 49 commercial loans totaling $37.4 million and 72 residential loans totaling $16.3 million, of which 12 commercial loans totaling $14.7 million and 25 residential loans totaling $4.7 have resumed their normal loan payments or matured.

The $34.3 million of loans under payment relief at September 30, 2020, include 26 residential loans totaling $9.2 million that have entered into a second payment forbearance agreement and eight residential loans totaling $808,000 with a weighted average loan-to value of 76% that have entered into a third payment forbearance agreement.

All loans modified due to the COVID-19 pandemic will be separately monitored and any request for continuation of relief beyond the initial modification will be reassessed at that time to determine if further modifications should be granted and if a downgrade in risk rating is appropriate.

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.

As of March 31, 2021, we had $3.6 million of residential loans under payment relief related to COVID-19, which consisted of six residential loans totaling $926,000 that have entered into a second payment forbearance agreement with a weighted-average loan-to-value of 74%, four residential loans totaling $586,000 that have entered into a third payment forbearance agreement with a weighted-average loan-to value of 61%, and seven residential loans totaling $1.9 million that have entered into a fourth forbearance agreement with a weighted-average loan-to-value of 64%.

We had $9.1 million in commercial loans still under payment relief related to COVID-19 at March 31, 2021, which consisted of one commercial loan totaling $1.5 million that is subject to a second interest-only payment agreement with a loan-to-value of 49%, and four commercial loans totaling $4.1 million that are subject to a third interest-only payment agreement with a weighted-average loan-to-value of 52%.

The foregoing weighted-average loan-to-values are based on appraisals obtained at the time of loan origination and the current loan amount.

All of these loan modifications have been made in response to the COVID-19 pandemic and are not classified as troubled debt restructurings pursuant to applicable accounting and regulatory guidance until the earlier of 60 days after the national emergency termination date or January 1, 2022.

We believe the steps we are taking are necessary to effectively manage our portfolio and assist our clients through the ongoing uncertainty surrounding the duration, impact and government response to the COVID-19 pandemic.

The following is a summary of the type and amount of loan modifications made by the Company as of September 30, 2020 (dollars in thousands):

Payment Relief

Interest only Principal & Interest Forbearance

90 days 180 days 365 days 90 days 180 days 365 days Total % of Total Loans

Real estate loans:

One-to-four family $ — $ 6,529 $ 188 $ 911 $ 1,594 $ 696 $ 9,918 1.44 %

Home equity — — — — 98 84 182 0.03

Construction and land — 48 — 315 — — 363 0.05

Commercial and multifamily 2,448 15,841 2,291 — — — 20,580 2.99

Total real estate loans 2,448 22,418 2,479 1,226 1,692 780 31,043

Consumer loans:

Manufactured homes — — 12 227 509 119 867 0.13

Floating homes — — — — 249 — 249 0.04

Other consumer loans — — — — — — —

Total consumer loans — — 12 227 758 119 1,116

Commercial business loans 1,350 832 — — — — 2,182 0.32

Total $ 3,798 $ 23,250 $ 2,491 $ 1,453 $ 2,450 $ 899 $ 34,341 4.98 %

The 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 provided 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 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 60 days after the national emergency declared on March 13, 2020 ceases, whichever is earlier.

Support for Clients, Employees and Community during Pandemic.

With the continued partial opening of the communities we serve, our retail locations continue to operate with full service and in compliance with various mandates and recommendations including masks, distancing and capacity management.

The majority of back office and administrative employees continue to work remotely.

We continuously monitor and 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 remain focused on keeping our employees safe and the Bank running effectively to serve its clients.

The Bank is managing branch access and occupancy levels in relation to cases and close contact scenarios, following governmental restrictions and public health authority guidelines, and encouraging remote work and supporting employees with paid time off.

As of March 31, 2021, all of our branch lobbies were open.

We continue to work closely with our borrowers to evaluate pandemic related challenges.

We also continue to support our not-for-profit organizations albeit most activity is virtual.

Comparison of Financial Condition at September 30, 2020 and December 31, 2019

Total assets increased $147.5 million, or 20.5%, to $867.4 million at September 30, 2020 from $719.9 million at December 31, 2019.

The increase was primarily a result of a higher balances in loans held-for-portfolio, cash and cash equivalents, loans held-for-sale, and available-for-sale securities.

Comparison of Financial Condition at March 31, 2021 and December 31, 2020

Total assets increased $75.2 million, or 8.7%, to $936.7 million at March 31, 2021 from $861.4 million at December 31, 2020.

The increase was primarily a result of a higher balances in cash and cash equivalents, and the origination of PPP loans.

Cash and Securities.

Cash and cash equivalents increased $60.0 million, or 107.6%, to $115.8 million at September 30, 2020 from $55.8 million at December 31, 2019 primarily due to an increase in deposits, the pay downs in residential loans, including home equity loans and lines of credit, and the proceeds received from the issuance of subordinated debt.

Available-for-sale securities, which consist of treasury bills, municipal bonds and agency mortgage-backed securities increased $4.0 million, or 42.9%, to $13.3 million at September 30, 2020 from $9.3 million at December 31, 2019 as a result of investment securities purchased during the year.

Our loans held-for-portfolio, net, increased $69.2 million, or 11.3%, to $683.4 million at September 30, 2020 from $614.2 million at December 31, 2019, primarily driven by our origination of PPP loans.

The following table reflects the changes in the loan mix of our loan portfolio at September 30, 2020, as compared to December 31, 2019 (dollars in thousands):

September 30, 2020 December 31, 2019 Amount

Cash and cash equivalents increased $75.8 million, or 39.1%, to $269.6 million at March 31, 2021 from $193.8 million at December 31, 2020 primarily due to deposit growth.

Available-for-sale securities, which consist of municipal bonds and agency mortgage-backed securities decreased $1.1 million, or 11.2%, to $9.1 million at March 31, 2021 from $10.2 million at December 31, 2020 as a result of normal pay downs in investment securities during the quarter.

Loans held-for-portfolio, net, increased $1.1 million, or 0.2%, to $608.4 million at March 31, 2021 from $607.4 million at December 31, 2020, driven by our origination of PPP loans.

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

March 31, 2021 December 31, 2020 Amount

Change Percent

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Total loans held-for-portfolio, net $ 608,442 $ 607,363 $ 1,079 0.2 %

The largest increase in the loan portfolio was in commercial business loans which increased $72.1 million, or 185.2%, to $111.0 million, at September 30, 2020, compared to $38.9 million at December 31, 2019, driven by our origination of 909 PPP loans totaling $74.8 million at September 30, 2020.

The largest increase in the loan portfolio was in commercial business loans which increased $19.5 million, or 30.3%, to $83.7 million, at March 31, 2021, compared to $64.2 million at December 31, 2020, driven by our origination of 471 PPP loans totaling $39.1 million during the three months ended March 31, 2021.

PPP loans are 100% guaranteed by the SBA.

At September 30, 2020, our loan portfolio, net of deferred loan fees, remained well-diversified.

Commercial and multifamily real estate loans accounted for 39.8% of total loans, one-to-four family loans, including home equity loans accounted for 22.8% of total loans, commercial business loans accounted for 16.0% of total loans, and consumer loans, consisting of manufactured homes, floating homes, and other consumer loans accounted for 10.9% of total loans at September 30, 2020.

Construction and land loans accounted for 10.4% of total loans at September 30, 2020.

At March 31, 2021, our loan portfolio, net of deferred loan fees, remained well-diversified.

Commercial and multifamily real estate loans accounted for 40.7% of total loans, one-to-four family loans, including home equity loans accounted for 23.3% of total loans, commercial business loans accounted for 13.6% of total loans, and consumer loans, consisting of manufactured homes, floating homes, and other consumer loans accounted for 12.2% of total loans at March 31, 2021.

Construction and land loans accounted for 10.2% of total loans at March 31, 2021.

Allowance for Loan Losses.

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on the date of evaluation in accordance with generally accepted accounting principles in the United States.

It is our best estimate

of probable credit losses inherent in our loan portfolio.

It is our best estimate of probable credit losses inherent in our loan portfolio.

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

Three Months Ended September 30, Nine Months Ended September 30,

2020 2019 2020 2019

Three Months Ended March 31,

Balance at beginning of period $ 6,000 $ 5,640

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Recoveries 6 9

Net recoveries/(charge-offs) (318) (2) (577) (6)

Provision (recapture) for loan losses during the period 275 250 925 (150)

Net (charge-offs)/recoveries (65) 3

Provision for loan losses during the period — 250

Balance at end of period $ 5,935 $ 5,893

Ratio of net recoveries/(charge-offs) during the period to average loans outstanding during the period — % — % — % — %

September 30, 2020 December 31, 2019

Ratio of net (charge-offs)/recoveries during the period to average loans outstanding during the period (0.01) % — %

March 31, 2021 December 31, 2020

Allowance as a percentage of nonperforming loans (end of period) 218.92 % 208.04 %

Allowance as a percentage of total loans (end of period) 0.97 % 0.98 %

Our allowance for loan losses increased $348,000, or 6.2%, to $6.0 million at September 30, 2020, from $5.6 million at December 31, 2019.

The increase in provision for loan losses not only reflects probable credit losses based upon the conditions that existed as of September 30, 2020, but also gives consideration to the inherent losses from impacts of the COVID-19 pandemic.

Specific loan loss reserves decreased to $446,000 at September 30, 2020, compared to $724,000 at December 31, 2019, while general loan loss reserves increased to $4.4 million at September 30, 2020, compared to $4.0 million at December 31, 2019 and the unallocated reserve increased to $1.1 million at September 30, 2020, compared to $948,000 at December 31, 2019.

The increase in the general reserve was a result of the higher balance on loans held-for-portfolio.

Net charge-offs for the three and nine months ended September 30, 2020 were $318,000 and $577,000 respectively, compared to net charge-offs of $2,000 and $6,000 for the three and nine months ended September 30, 2019, respectively.

At September 30, 2020, the allowance for loan losses as a percentage of total loans and nonperforming loans was 0.87% and 180.58%, respectively, compared to 0.91% and 121.11%, respectively, at December 31, 2019.

The allowance for loan losses to total loans increases 10 basis points when the $74.8 million of PPP loans are excluded from the $689.4 million of total loans at September 30, 2020.

PPP loans are fully guaranteed by the SBA and management expects that the great majority of PPP borrowers will seek full or partial forgiveness of their loan obligations from the SBA within a short time frame, which in turn will reimburse the Bank for the amount forgiven.

Our allowance for loan losses decreased $65,000, or 1.1%, to $5.9 million at March 31, 2021, from $6.0 million at December 31, 2020.

Specific loan loss reserves decreased to $334,000 at March 31, 2021, compared to $378,000 at December 31, 2020, while general loan loss reserves decreased to $5.0 million at March 31, 2021, compared to $5.2 million at December 31, 2020 and the unallocated reserve increased to $570,000 at March 31, 2021, compared to $406,000 at December 31, 2020.

The decrease in the general reserve was a result of declining loan balances as substantially all of the increase in loans held-for-portfolio during the quarter resulted from the origination of PPP loans.

The $61.2 million balance of PPP loans was omitted from the calculation for the allowance for loan losses at March 31, 2021, as these loans are 100% guaranteed by the SBA and management expects that the great majority of PPP borrowers will seek full or partial forgiveness of their loan obligations from the SBA within a short time frame, which in turn will reduce the Bank’s loan balance for the amount forgiven.

Net charge-offs for the three months ended March 31, 2021 totaled $65,000, compared to net recoveries of $3,000 for the three months ended March 31, 2020.

At March 31, 2021, the allowance for loan losses as a percentage of total loans and nonperforming loans was 0.97% and 218.92%, respectively, compared to 0.98% and 208.04%, respectively, at December 31, 2020.

Mortgage Servicing Rights.

The fair value of mortgage servicing rights was $3.3 million at September 30, 2020, an increase of $100,000 or 3.1% from $3.2 million at December 31, 2019.

The fair value of mortgage servicing rights was $4.1 million at March 31, 2021, an increase of $329,000 or 8.7% from $3.8 million at December 31, 2020.

We record mortgage servicing rights on loans sold with servicing retained and upon acquisition of a servicing portfolio.

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Nonperforming Assets.

At September 30, 2020, nonperforming assets totaled $3.9 million, or 0.45% of total assets, compared to $5.2 million, or 0.73% of total assets at December 31, 2019.

At March 31, 2021, nonperforming assets totaled $3.3 million, or 0.35% of total assets, compared to $3.5 million, or 0.40% of total assets at December 31, 2020.

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

Nonperforming Assets

September 30, 2020 December 31, 2019 Amount

March 31, 2021 December 31, 2020 Amount

Change Percent

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Total nonperforming assets $ 3,286 $ 3,478 $ (192) (5.5) %

Nonaccrual loans decreased $1.3 million, or 28.8%, to $3.3 million at September 30, 2020 from $4.7 million at December 31, 2019.

The percentage of nonaccrual loans to total loans was 0.48% at September 30, 2020, compared to 0.75% of total loans at December 31, 2019.

OREO and repossessed assets were $575,000 at both September 30, 2020 and December 31, 2019.

At September 30, 2020, OREO and repossessed assets consisted solely 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.

Nonaccrual loans decreased $173,000, or 6.00%, to $2.7 million at March 31, 2021 from $2.9 million at December 31, 2020.

The percentage of nonaccrual loans to total loans was 0.44% at March 31, 2021, compared to 0.47% of total loans at December 31, 2020.

OREO and repossessed assets were $575,000 at March 31, 2021 and $594,000 at December 31, 2020.

At March 31, 2021, OREO and repossessed assets consisted solely 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.

Total deposits increased $132.1 million, or 21.4%, to $748.9 million at September 30, 2020 from $616.7 million at December 31, 2019.

The increase was due primarily to disbursements of PPP loan funds into borrowers’ deposit accounts as well as reduced withdrawals reflecting changes in customer spending habits due to the COVID-19 pandemic.

We continue our efforts to grow noninterest-bearing deposits, which increased $55.0 million, or 56.5%, to $152.2 million at September 30, 2020, compared to $97.3 million at December 31, 2019.

Total deposits increased $68.7 million, or 9.2%, to $816.7 million at March 31, 2021 from $748.0 million at December 31, 2020.

The increase was due primarily to disbursements of PPP loan proceeds into borrowers’ deposit accounts as well as stimulus funds deposited and reduced withdrawals reflecting changes in customer spending habits due to the COVID-19 pandemic.

We continue our efforts to grow noninterest-bearing deposits, which increased $56.2 million, or 42.4%, to $188.7 million at March 31, 2021, compared to $132.5 million at December 31, 2020.

Noninterest-bearing deposits represented 23.1% of total deposits at March 31, 2021, compared to 17.7% at December 31, 2020.

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

September 30, 2020 December 31, 2019

March 31, 2021 December 31, 2020

Rate Amount Wtd.

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

Borrowings and subordinated debt .

Borrowings, consisting of FHLB advances and subordinated debt increased $11.7 million, to $19.2 million at September 30, 2020 from $7.5 million at December 31, 2019.

The increase in borrowing is attributable entirely to our issuance of subordinated debt during the current quarter.

During the quarter ended September 30, 2020, the Company completed a private placement of $12.0 million in aggregate principal amount of 5.25% Fixed-to-Floating Rate Subordinated Notes due 2030 (“Notes”) resulting in net proceeds, after placement fees and offering expenses, of approximately $11.7 million.

The Company contributed $5.5 million of the net proceeds from the sale of the Notes to the Bank and intends to use the remaining net proceeds for general corporate purposes, including stock repurchases and to pay dividends on Company common stock.

Stockholders’ Equity.

Total stockholders’ equity increased $4.6 million, or 5.9%, to $82.3 million at September 30, 2020 from $77.7 million at December 31, 2019.

This increase primarily reflects $5.4 million in net income for the nine months ended September 30, 2020, partially offset by the payment of cash dividends of $1.7 million to common stockholders during the nine months ended September 30, 2020.

Comparison of Results of Operation for the Three and Nine Months Ended September 30, 2020 and 2019

Net income increased $787,000, or 50.8%, to $2.3 million or $0.90 per diluted common share, for the three months ended September 30, 2020, compared to $1.5 million, or $0.60 per diluted common share, for the three months ended September 30, 2019.

Net income increased $634,000, or 13.2%, to $5.4 million or $2.09 per diluted common share, for the nine months ended September 30, 2020, compared to $4.8 million, or $1.87 per diluted common share, for the nine months ended September 30, 2019.

The increases primarily were a result of an increase in noninterest income of $1.0 million and $1.5 million for the three and nine months ended September 30, 2020, respectively.

Total stockholders’ equity increased $2.1 million, or 2.4%, to $87.6 million at March 31, 2021 from $85.5 million at December 31, 2020.

This increase primarily reflects $2.5 million in net income for the three months ended March 31, 2021, partially offset by the payment of cash dividends of $702,000 to common stockholders during the three months ended March 31, 2021.

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

The following table presents, for the periods indicated, the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates.

Income and yields on tax-exempt obligations have not been computed on a tax equivalent basis.

All average balances are daily average balances.

Nonaccrual loans have been included in the table as loans carrying a zero yield for the period they have been on nonaccrual (dollars in thousands).

Balance Interest

Rate Annualized Average

Balance Interest

Rate Annualized

Interest-earning assets:

Loan $ 628,397 $ 7,886 5.09 % $ 621,306 $ 8,408 5.43 %

Investments and interest-bearing accounts 228,752 113 0.20 61,607 238 1.58

Total interest-earning assets (1)

857,149 7,999 3.77 682,913 8,646 5.09

Interest-bearing liabilities:

Savings and money market accounts 155,854 64 0.17 110,594 93 0.34

Demand and NOW accounts 248,887 185 0.30 161,689 232 0.58

Certificate accounts 214,517 1,046 1.98 246,990 1,534 2.50

Subordinated notes 11,596 168 5.88 — — —

Borrowings — — — 7,785 59 3.05

Total interest-bearing liabilities 630,854 1,463 0.94 % 527,058 1,918 1.46 %

Net interest income $ 6,536 $ 6,728

Net interest rate spread 2.83 % 3.63 %

Net earning assets $ 226,295 $ 155,855

Net interest margin 3.09 % 3.96 %

Average interest-earning assets to average interest-bearing liabilities 135.87 % 129.57 %

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

Rate/Volume Analysis

The following schedule presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities.

It distinguishes between changes related to outstanding balances and changes due to interest rates.

For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate multiplied by old volume).

For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate (dollars in thousands).

Three Months Ended March 31, 2021 vs.

Increase (Decrease) due to Total

Increase (Decrease)

Interest-earning assets:

Loans $ 89 $ (611) $ (522)

Investments and interest-bearing accounts 83 (208) (125)

Total interest-earning assets 172 (819) (647)

Interest-bearing liabilities:

Savings and Money Market accounts 19 (48) $ (29)

Demand and NOW accounts 65 (112) (47)

Certificate accounts (158) (330) (488)

Subordinated debt 168 — 168

Borrowings — (59) (59)

Total interest-bearing liabilities $ 94 $ (549) $ (455)

Change in net interest income $ (192)

Comparison of Results of Operation for the Three Months Ended March 31, 2021 and 2020

Net income increased $1.5 million, or 149.8%, to $2.5 million, or $0.93 per diluted common share, for the three months ended March 31, 2021, compared to $981,000, or $0.38 per diluted common share, for the three months ended March 31, 2020.

The increase was primarily a result of an increase in noninterest income of $2.0 million for the three months ended March 31, 2021, driven by an increase of $1.7 million in gains on sale of loans.

Interest Income.

Interest income decreased $68,000, or 0.8%, to $8.5 million for the three months ended September 30, 2020, from $8.6 million for the three months ended September 30, 2019 and increased $130,000, or 0.5%, to $25.9 million for the nine months ended September 30, 2020.

The decrease for the three months ended period was due to lower interest income on

investments, partially offset by higher interest income on higher average loan balances resulting primarily from loans

made by the Bank through its participation in the U.S.

Small Business Administration’s (“SBA”) PPP.

Interest income on loans increased $227,000, or 2.8%, to $8.4 million for the three months ended September 30, 2020, due to higher average loan balances resulting primarily from PPP loans made by the Bank.

The average balance of loans held-for-portfolio was $694.1 million for the three months ended September 30, 2020, compared to $585.8 million for the three months ended September 30, 2019.

The average yield on loans held-for-portfolio was 4.82% for three months ended September 30, 2020, compared to 5.54% for the three months ended September 30, 2019.

Interest income on the investment portfolio and cash and cash equivalents decreased $295,000, or 77.4%, compared to $381,000 for the three months ended September 30, 2019.

The decrease in the interest income on investment securities and cash and cash equivalents compared to the same period a year ago was due to lower average yields.

The average yield on investments and cash and cash equivalents was 0.29% for the three months ended September 30, 2020, compared to 2.30% for the three months ended September 30, 2019.

Interest income increased $130,000, or 0.5%, to $25.9 million for the nine months ended September 30, 2020, from $25.7 million for the nine months ended September 30, 2019.

The increase was primarily a result of increased interest income on loans due to higher average loan balances, partially offset by a lower interest income on investments.

Interest income on loans increased $949,000, or 3.9%, to $25.5 million for the nine months ended September 30, 2020, due to higher average loan balances resulting primarily from PPP loans made by the Bank.

The average balance of loans held-for-portfolio was $666.6 million for the nine months ended September 30, 2020, compared to $591.9 million for the nine months ended September 30, 2019.

The average yield on loans held-for-portfolio was 5.09% for the nine months ended September 30, 2020, compared to 5.54% for the nine months ended September 30, 2019.

Interest income on the investment portfolio and cash and cash equivalents decreased $819,000, or 67.2%, to $400,000 for the nine months ended September 30, 2020, compared to $1.2 million for the nine months ended September 30, 2019.

The decrease in the interest income on investment securities and cash and cash equivalents compared to the same period a year ago was due to lower average yields.

The average yield on investments including interest-bearing cash was 0.65% for the nine months ended September 30, 2020, compared to 2.57% for the nine months ended September 30, 2019.

The average balance of investments, which included interest-bearing cash balances and available-for-sale securities increased $18.2 million, or 28.6%, compared to a year ago.

The average yield on net 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 nine months ended September 30, 2020, the average balance of PPP loans was $42.5 million and the average yield on PPP loans was 2.64%, including the recognition of the net deferred fees.

Interest income included $840,000 in fees earned related to PPP loans in the nine months ended September 30, 2020 compared to none in same period a year ago.

Interest income decreased $647,000, or 7.5%, to $8.0 million for the three months ended March 31, 2021, from $8.6 million for the three months ended March 31, 2020, primarily due to a 34 basis point decline in average loan yields.

Interest income on loans decreased $522,000, or 6.2%, to $7.9 million for the three months ended March 31, 2020, despite higher average total loan balances resulting primarily from PPP loans made by the Bank.

The average balance of total loans was $628.4 million for the three months ended March 31, 2021, compared to $621.3 million for the three months ended March 31, 2020.

The average yield on total loans was 5.09% for three months ended March 31, 2021, compared to 5.43% for the three months ended March 31, 2020.

The average yield on loans decreased primarily due to decreases in interest rates on resetting 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, the effects of which were partially offset by the impact of PPP loans.

For the three months ended March 31, 2021, the average balance of PPP loans was $53.9 million and the average yield on PPP loans was 5.68%, including the recognition of the net deferred fees.

Interest income included $755,000 in fees earned related to PPP loans in the three months ended March 31, 2021 compared to none in same period a year ago.

At March 31, 2021, PPP deferred loan origination fees of $1.9 million remain to be accreted into interest income during the remaining life of the loans.

The impact of PPP loans on loan yields will change during any period based on the volume of prepayments or amounts forgiven by the SBA as certain criteria are met, but is expected to cease completely after the two- or five-year maturity of the loans.

Interest income on the investment portfolio and cash and cash equivalents decreased $125,000, or 52.5%, to $113,000 for the three months ended March 31, 2021, compared to $238,000 for the three months ended March 31, 2020.

The decrease in the interest income on investment securities and cash and cash equivalents was due to lower average yields primarily due to downward adjustments for adjustable rate investment securities reflecting the decrease in market interest rates and secondarily

due to lower yields on purchases of new investment securities compared to the existing portfolio.

The average yield on investments and cash and cash equivalents was 0.20% for the three months ended March 31, 2021, compared to 1.58% for the three months ended March 31, 2020.

Interest Expense.

Interest expense decreased $82,000, or 4.2%, to $1.8 million for the three months ended September 30, 2020, from $1.9 million for the three months ended September 30, 2019.

Interest expense decreased $13,000, or 0.2%, to $5.6 million for the nine months ended September 30, 2020, from $5.6 million for the nine months ended September 30, 2019.

The decrease in interest expense compared to the three and nine month periods a year ago was a result of a higher percentage of noninterest bearing deposits to total deposits and a lower cost of borrowings.

Interest expense on deposits decreased $92,000, or 5.0%, to $1.7 million for the three months ended September 30, 2020, compared to $1.8 million for the same period a year ago.

Interest expense on deposits increased $429,000, or 8.7%, to $5.3 million for the nine months ended September 30, 2020, compared to $4.9 million for the same period in 2019.

The decrease for

the three month period primarily was due to the lower weighted average interest rate paid on deposits.

The increase for the nine month period was primarily due to the increase in average balance of deposits.

The average balance of deposits was $715.2 million and $673.0 million during the three and nine months ended September 30, 2020, respectively, compared to $594.4 million and $579.7 million during the three and nine months ended September 30, 2019, respectively.

The weighted average rate paid on deposits was 0.96% and 1.06% for the three and nine months ended September 30, 2020, respectively, compared to 1.22% and 1.13% for the three months ended September 30, 2019, respectively.

The average rate paid on deposits declined due to a reduction in market interest rates over the last year, primarily as a result of the 150 basis point reduction in the targeted federal funds rate discussed above.

Interest expense on borrowings, including the Notes, increased $10,000, or 10.0%, to $110,000 for the three months ended September 30, 2020 and decreased $442,000, or 65.6%, to $232,000 for the nine months ended September 30, 2020, compared to the comparable periods a year ago.

The increase for the three months ended September 30, 2020 was a result of higher weighted-average balance of borrowings, including the Notes, partially offset by a lower weighted average cost of borrowings.

The decrease for the nine months ended September 30, 2020 was a result of a lower weighted average balance of borrowings and lower weighted average cost of borrowings.

The weighted average balance of borrowings outstanding for the three and nine months ended September 30, 2020 was $42.2 million and $20.8 million, respectively, compared to $8.5 million and $28.8 million for the three and nine months ended September 30, 2019, respectively.

On September 18, 2020, the Company completed a private placement of the Notes resulting in net proceeds, after placement fees and offering expenses, of approximately $11.7 million.

The weighted average cost of borrowings was 1.04% and 1.49% for the three and nine months ended September 30, 2020, respectively, compared to 4.65% and 3.13% for the three and nine months ended September 30, 2019, respectively.

Interest expense decreased $455,000, or 23.7%, to $1.5 million for the three months ended March 31, 2021, from $1.9 million for the three months ended March 31, 2020, primarily as a result of declining deposit costs and a higher percentage of noninterest bearing deposits to total deposits.

Interest expense on deposits decreased $564,000, or 30.3%, to $1.3 million for the three months ended March 31, 2021, compared to $1.9 million for the same period a year ago.

The decrease was primarily the result of a decline in the weighted-average cost of deposits reflecting reduce rates paid on deposits.

In addition, deposit costs were favorably impacted by a $59.4 million increase in average noninterest bearing deposits to $161.1 million for the three months ended March 31, 2021, compared to $101.7 million for the same period last year.

The weighted-average cost of total deposits decreased 53 basis points to 0.67% for the quarter ended March 31, 2021, from 1.20% for the quarter ended March 31, 2020.

In September 2020, we completed a private placement of $12.0 million in aggregate principal amount of 5.25% Fixed-to-Floating Rate Subordinated Notes due 2030, resulting in net proceeds after placement fees and offering expenses, of approximately $11.6 million.

Interest expense on borrowings, comprised solely of interest expense on our subordinated notes, increased $109,000, or 184.7%, to $168,000 for the three months ended March 31, 2021, compared to $59,000 for the three months ended March 31, 2020, which was related solely to FHLB advances.

Average borrowings increased $3.8 million, to $11.6 million at March 31, 2021, consisting solely of subordinated notes, from $7.8 million at March 31, 2020, which consisted of solely FHLB advances.

The weighted-average cost of the subordinated notes was 5.88% at March 31, 2021, while the weighted-average cost of the FHLB advances was 3.05% at March 31, 2020.

Net Interest Income.

Net interest income increased $14,000, or 0.2%, to $6.7 million for the three months ended September 30, 2020, from $6.6 million for the three months ended September 30, 2019.

Net interest income increased $143,000, or 0.7%, to $20.3 million for the nine months ended September 30, 2020, from $20.1 million compared to the same period a year ago.

The increase for the three and nine months ended September 30, 2020 primarily was a result of higher interest income on loans and lower interest expense.

Our net interest margin was 3.26% and 3.61% for three and nine months ended September 30, 2020, respectively, compared to 4.03% and 4.10% for the three and nine months ended September 30, 2019, respectively.

The low interest rate environment putting downward pressure on adjustable rate instruments combined with the impact of the low loan yields of the PPP loan portfolio, and a significant increase in low yielding 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 average yield on PPP loans was 2.79% and 2.64% during the three and nine months ended September 30, 2020, including the recognition of the net deferred fees, resulting in a negative impact to the net interest margin.

Net interest income decreased $192,000, or 2.9%, to $6.5 million for the three months ended March 31, 2021, from $6.7 million for the three months ended March 31, 2020.

Our net interest margin was 3.09% and 3.96% for the three months ended March 31, 2021 and 2020, respectively.

The decreases in both net interest income and net interest margin were primarily due to yields earned on interest-earning assets declining at a faster rate than interest rates paid on interest-bearing liabilities as changes in the average rate paid on interest-bearing deposits tend to lag changes in market interest rate.

During the quarter ended March 31, 2021, the average yield earned on PPP loans, including the recognition of the net deferred fees for PPP loans repaid and forgiven by the SBA, resulted in a positive impact in the net interest margin of six basis points, compared to no impact for the quarter ended March 31, 2020 as PPP loans were not being originated during that time.

Provision/(Recapture) for Loan Losse s.

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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.

The Company recorded a provision for loan losses of $275,000 and $925,000 for the three and nine months ended September 30, 2020, respectively, compared to a provision for loan losses of $250,000 for the three months ended September 30, 2019 and a recapture from the allowance for loan losses of $150,000 for the nine months ended September 30, 2019, respectively.

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.

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.

No provision for loan losses was recorded for the three months ended March 31, 2021, compared to a provision for loan losses of $250,000 for the three months ended March 31, 2020.

The decrease in the provision for loan losses was primarily due to decreases in the balance of loans held-for-portfolio and to a lesser extent a $961,000 decrease in non-performing loans.

Our allowance for loan losses as of March 31, 2021, not only reflects probable and inherent credit losses based upon the economic conditions that existed as of March 31, 2021, but also gives consideration to the potential losses from impacts of the COVID-19 pandemic which have declined as the economy in our markets improve as initial COVID-19 restrictions have been lifted.

Net charge-offs for the three months ended March 31, 2021 totaled $65,000, compared to net recoveries of $3,000 for the three months ended March 31, 2020.

A further decline in national and local economic conditions, as a result of the COVID-19 pandemic or other factors, could result in a material increase in the allowance for loan losses and may adversely affect the Company’s financial condition and results of operations.

In addition, the determination of the amount of our allowance for loan losses is subject to review by bank regulators as part of the routine examination process, which may result in the adjustment of reserves based upon their judgment of information available to them at the time of their examination.

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 $1.0 million, or 93.8%, to $2.1 million for the three months ended September 30, 2020, as compared to $1.1 million for the three months ended September 30, 2019, as reflected below (dollars in thousands):

Three Months Ended September 30, Amount

Change Percent

Service charges and fee income $ 510 $ 512 $ (2) (0.4) %

Earnings on cash surrender value of BOLI 102 81 21 25.9

Mortgage servicing income 260 259 1 0.4

Fair value adjustment on mortgage servicing rights (623) (90) (533) 592.2

Net gain on sale of loans 1,819 305 1,514 496.4

Total noninterest income $ 2,068 $ 1,067 $ 1,001 93.8 %

The increase in noninterest income during the three months ended September 30, 2020 compared to the same period in 2019 was primarily due to increases in gain on sale of loans, partially offset by an increase in the downward adjustment on the fair value of mortgage servicing rights.

Loans sold during the three months ended September 30, 2020, totaled $89.5 million, compared to $16.6 million during the three months ended September 30, 2019, as the volume of loans originated for sale increased significantly due to refinance activity increasing as a result of the recent reductions in market interest rates.

Noninterest income increased $1.5 million, or 51.0%, to $4.4 million for the nine months ended September 30, 2020, as compared to $2.9 million for the nine months ended September 30, 2019, as reflected below (dollars in thousands):

Nine Months Ended September 30, Amount

Noninterest income increased $2.0 million, or 281.4%, to $2.7 million for the three months ended March 31, 2021, as compared to $709,000 for the three months ended March 31, 2020, as reflected below (dollars in thousands):

Three Months Ended March 31, Amount

Change Percent

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Fair value adjustment on mortgage servicing rights (275) (362) 87 (24.0)

Net gain on sale of loans 3,399 1,000 2,399 239.9

Net gain on sale of loans 2,053 318 1,735 nm

Total noninterest income $ 2,704 $ 709 $ 1,995 281.4 %

The increase in noninterest income during the nine months ended September 30, 2020 compared to the same period in 2019 was primarily due to increases in gain on sale of loans, partially offset by an increase in the downward adjustment on the fair value of mortgage servicing rights.

Loans sold during the nine months ended September 30, 2020, totaled $176.0 million, compared to $54.5 million during the nine months ended September 30, 2019, as the volume of loans originated for sale increased significantly primarily due to refinance activity as a result of low market interest rates.

The increase in noninterest income during the three months ended March 31, 2021 compared to the same period in 2020 was primarily due to increases in gain on sale of loans.

As a result of reductions in market interest rates, refinance and home purchases have increased significantly over the last year, increasing our residential loans originated for sale.

Loans sold during the three months ended March 31, 2021, totaled $68.1 million, compared to $14.1 million during the three months ended March 31, 2020.

Noninterest Expense.

Noninterest expense increased $10,000, or 0.02%, to $5.5 million during the three months ended September 30, 2020, compared to $5.5 million during the three months ended September 30, 2019, as reflected below (dollars in thousands):

Three Months Ended September 30, Amount

Change Percent

Salaries and benefits $ 2,880 $ 3,075 $ (195) (6.3) %

Operations 1,390 1,397 (7) (0.5)

Regulatory assessments 111 (49) 160 (326.5)

Occupancy 442 509 (67) (13.2)

Data processing 707 587 120 20.4

Net loss on OREO and repossessed assets — 1 (1) (100.0)

Total noninterest expense $ 5,530 $ 5,520 $ 10 0.2 %

The slight increase in noninterest expense during the three months ended September 30, 2020 compared to the same period in 2019 was primarily due to increases of $160,000 in regulatory assessments and $120,000 in data processing expense, partially offset by a $195,000 decrease in salaries and benefits expense.

Data processing expense increased due to technology investments and variable costs associated with loan origination activity.

Salaries and benefits expense decreased primarily due to an increase in deferred loan origination costs related to the PPP loans.

Regulatory assessments increased to normal levels as the Bank utilized all of its remaining regulatory assessment credits last year.

Noninterest expense decreased $264,000, or 1.5%, to $16.9 million during the nine months ended September 30, 2020 as compared to $17.1 million during the nine months ended September 30, 2019, as reflected below (dollars in thousands):

Nine Months Ended September 30, Amount

Noninterest expense increased $216,000, or 3.6%, to $6.2 million during the three months ended March 31, 2021, compared to $5.9 million during the three months ended March 31, 2020, as reflected below (dollars in thousands):

Three Months Ended March 31, Amount

Change Percent

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Data processing 779 570 209 36.7

Net loss on OREO and repossessed assets — 11 (11) (100.0)

Net gain on OREO and repossessed assets (16) — (16) nm

Total noninterest expense $ 6,162 $ 5,946 $ 216 3.6 %

The decrease in noninterest expense during the nine months ended September 30, 2020 compared to the same period in 2019 was primarily due to decreases of $436,000 in salaries and benefits, $372,000 in operations and $123,000 in occupancy expense, partially offset by increases of $376,000 in data processing and $302,000 in regulatory assessments expense.

Salaries and benefits expense decreased primarily due to an increase in deferred loan origination costs related to the PPP loans.

Operations expense decreased due to decreases in professional and consulting fees, travel and conference and marketing and advertising expense.

Data processing expense increased for the same reason set forth above.

Regulatory assessments increased to normal levels as the Bank utilized all of its remaining regulatory assessment credits last year and due to costs for the DFI examination paid during the nine months ended September 30, 2020.

The efficiency ratio for the quarter ended September 30, 2020 was 63.36%, compared to 71.57% for the quarter ended September 30, 2019 and was 68.51% for the nine months ended September 30, 2020, compared to 74.46% for the nine months ended September 30, 2019.

The improvement in the efficiency ratio primarily was due to higher interest income and noninterest income, and for the nine month period, lower noninterest expense.

The increase in noninterest expense during the three months ended March 31, 2021 compared to the same period in 2020 was primarily due to increases of $409,000 in salaries and benefits and $209,000 in data processing expense, partially offset by a $188,000 decrease in operation expense and a $149,000 decrease in regulatory assessments.

Salaries and benefits increased primarily due to discretionary bonuses paid for added efforts associated with the Company's COVID-19 response and implementation and execution of the SBA's PPP, higher stock compensation expense related to the vesting of stock awards during the quarter ended March 31, 2021, and higher nonqualified deferred compensation.

Data processing expense increased due to technology investments and variable costs associated with loan origination system activity.

Operations expense decreased primarily due to lower loan expenses and office operations, and regulatory assessments decreased as the three months ended March 31, 2020 included regulatory examination costs.

The efficiency ratio for the quarter ended March 31, 2021 was 66.69%, compared to 79.95% for the quarter ended March 31, 2020.

The improvement in the efficiency ratio was primarily due to higher noninterest income for the three months ended March 31, 2021.

Income Tax Expense .

We incurred income tax expense of $588,000 and $1.4 million for the three and nine months ended September 30, 2020, respectively, as compared $395,000 and $1.2 million for the same periods in 2019, respectively.

effective tax rates for the three and nine months ended September 30, 2020 were 20.1% and 20.3%, respectively.

The effective tax rates for the three and nine months ended September 30, 2019 were 20.3% and 20.2%, respectively.

We incurred income tax expense of $627,000 for the three months March 31, 2021, as compared $260,000 for the same period in 2020.

The effective tax rates for the three months ended March 31, 2021 and March 31, 2020 were 20.37% and 20.95%, respectively.

Liquidity and Capital Resources

The Management Discussion and Analysis in Item 7 of the Company’s 2020 Form 10-K contains an overview of Sound Financial Bancorp’s and the Bank’s liquidity management, sources of liquidity and cash flows.

This discussion updates that disclosure for the nine months ended September 30, 2020.

This discussion updates that disclosure for the three months ended March 31, 2021.

The Bank’s primary sources of funds are deposits, principal and interest payments on loans and borrowings.

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The Bank maintains liquidity levels it believes to be adequate to fund loan commitments, investment opportunities, deposit withdrawals and other financial commitments.

At September 30, 2020, the Bank had $129.1 million in cash and investment securities available-for-sale and $16.1 million in loans held-for-sale generally available for its cash needs.

Also, at September 30, 2020, the Bank had the ability to borrow an additional $198.6 million in FHLB advances based on existing collateral pledged, and could access $29.4 million through the Federal Reserve’s Discount Window.

Additionally, as of September 30, 2020, the Bank was approved to utilize the PPPLF.

At March 31, 2021, the Bank had $278.7 million in cash and investment securities available-for-sale and $10.7 million in loans held-for-sale generally available for its cash needs.

Also, at March 31, 2021, the Bank had the ability to borrow an additional $204.8 million in FHLB advances based on existing collateral pledged, and could access $23.7 million through the Federal Reserve’s Discount Window.

Additionally, as of March 31, 2021, the Bank was approved to utilize the PPPLF.

The Bank may utilize the PPPLF pursuant to which the Bank will pledge PPP loans at face value as collateral to obtain FRB non-recourse loans.

During the quarter ended and as of September 30, 2020, the Bank did not utilize the PPPLF as it held a substantial cash and cash equivalent position as a result of PPP disbursed funds remaining unused in borrower deposit accounts and due to deposit customers increasing their balances due to COVID-19.

At September 30, 2020, we also had available a total of $20.0 million in credit facilities with other financial institutions, with no balance outstanding.

During the quarter ended and as of March 31, 2021, the Bank did not utilize the PPPLF as it held a substantial cash and cash equivalent position as a result of PPP disbursed funds remaining unused in borrower deposit accounts and due to deposit customers increasing their balances due to COVID-19.

At March 31, 2021, we also had available a total of $20.0 million in credit facilities with other financial institutions, with no balance outstanding.

The Bank uses these sources of funds primarily to meet ongoing commitments, pay maturing deposits and fund withdrawals and loan commitments.

At September 30, 2020, outstanding loan commitments, including unused lines and letters of credit totaled $144.6 million, including $27.8 million of undisbursed construction and land loans.

Certificates of deposit scheduled to mature in one year or less at September 30, 2020, totaled $186.6 million.

Cash and cash equivalents increased $60.0 million to $115.8 million as of September 30, 2020, from $55.8 million as of December 31, 2019.

Net cash used in operating activities was $9.6 million for the nine months ended September 30, 2020.

Net cash used in investing activities totaled $73.0 million during the nine months ended September 30, 2020 and consisted primarily of increases in net loans and available-for-sale securities.

The $142.6 million of net cash provided by financing activities during the nine months ended September 30, 2020 primarily was the result of a $132.1 million net increase in deposits and the net proceeds received from the issuance and sale of the Notes as discussed above.

As a separate legal entity from the Bank, the Company must provide for its own liquidity.

During the quarter ended September 30, 2020, the Company completed a private placement of $12.0 million in aggregate principal amount of the Notes resulting in net proceeds, after placement fees and offering expenses, of approximately $11.7 million.

The Company contributed $5.5 million of the net proceeds from the sale of the Notes to the Bank and intends to use the remaining net proceeds from the sale of the notes for general corporate purposes, including stock repurchases and to pay dividends on Company common stock.

At September 30, 2020, the Company, on an unconsolidated basis, had $7.6 million in cash, noninterest-bearing deposits and liquid investments generally available for its cash needs.

At March 31, 2021, outstanding loan commitments, including unused lines and letters of credit totaled $83.0 million, including $27.8 million of undisbursed construction and land loans.

Certificates of deposit scheduled to mature in one year or less at March 31, 2021, totaled $133.9 million.

Cash and cash equivalents increased $75.8 million to $269.6 million as of March 31, 2021, from $193.8 million as of December 31, 2020.

Net cash provided by operating activities was $7.8 million for the three months ended March 31, 2021.

Net cash used in investing activities totaled $54,000 during the three months ended March 31, 2021 and consisted primarily of increases in proceeds from principal payments.

The $68.0 million of net cash provided by financing activities during the three months ended March 31, 2021 primarily was the result of a $68.7 million net increase in deposits.

At March 31, 2021, the Company, on an unconsolidated basis, had $5.8 million in cash, noninterest-bearing deposits and liquid investments generally available for its cash needs.

The Company’s principal source of liquidity is dividends and ESOP loan repayments from the Bank.

The long-term ability of the Company to pay dividends to its stockholders is based primarily upon the ability of the Bank to make capital distributions to the Company.

So long as the Bank remains well capitalized after each capital distribution (as evidenced by maintaining a Community Bank Leverage Ratio ("CBLR") greater than the required percentage), as discussed below, and operates in a safe and sound manner, it is management's belief that its banking regulators will continue to allow the Bank to distribute its earnings to the Company, although no assurance can be given in this regard.

Except as set forth above, management is not aware of any trends, events, or uncertainties that will have, or that are reasonably likely to have a material impact on liquidity, capital resources or operations.

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.

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These transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit.

A summary of our off-balance sheet loan commitments at September 30, 2020, is as follows (in thousands):

September 30, 2020

A summary of our off-balance sheet loan commitments at March 31, 2021, is as follows (in thousands):

March 31, 2021

Commitments to make loans $ 30,312

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Total loan commitments $ 82,969

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.

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%, 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 September 30, 2020, the Bank’s CBLR was 10.42%.

Management monitors the capital levels to provide for current and future business opportunities and to maintain Sound Community Bank’s “well-capitalized” status.

As of September 30, 2020, Sound Community Bank had CBLR in excess of the Federal Reserve’s minimum and well capitalized definitions requirements.

As of December 31, 2019, Sound Community Bank had regulatory capital in excess of the Federal Reserve’s minimum and well capitalized requirement.

The actual regulatory capital amounts and ratios calculated for Sound Community Bank at December 31, 2019, were as follows (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 $ 74,031 10.22 % $ 28,981 4.0 % $ 36,226 5.0 %

Common Equity Tier 1 to risk-weighted assets 74,031 12.07 27,601 4.5 39,868 6.5

Tier 1 Capital to risk-weighted assets 74,031 12.07 36,801 6.0 49,068 8.0

Total Capital to risk-weighted assets $ 79,974 13.04 % $ 49,068 8.0 % $ 61,335 10.0 %

Pursuant to the capital regulations of the FDIC and the other federal banking agencies, 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 levels of risk-based CET1 capital, tier 1 capital and total capital in order to avoid limitations on paying dividends, repurchasing shares, and paying discretionary bonuses.

At December 31, 2019, the Bank’s CET1 capital exceeded the required capital conservation buffer.

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 September 30, 2020, Sound Financial Bancorp would have exceeded all regulatory capital requirements.

The estimated Community Bank Leverage Ratio calculated for Sound Financial Bancorp as of September 30, 2020 was 10.42%.

Regulatory Capital

Consistent with our goal to operate a sound and profitable financial organization, we actively seek to maintain a well-capitalized status for the Bank per the regulatory framework for prompt corrective action ("PCA").

Qualifying institutions that elect to use the CBLR framework, such as the Bank and the Company, that maintain the required minimum leverage ratio will

be considered to have satisfied the generally applicable risk-based and leverage capital requirements in the regulatory agencies' capital rules, and to have met the capital requirements for the well capitalized category under the agencies’ PCA framework.

As of March 31, 2021, both the Bank’s and Company’s CBLR was 10.32%, which exceeded the minimum requirements.

See "Part I, Item 1.

Business – Regulation of Sound Community Bank – Capital Rules " in the Company's 2020 Form 10-K for additional information related to regulatory capital.

Quantitative and Qualitative Disclosures About Market Risk

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What changed 10-Q

Item 2. Management’s Discussion and Analysis