Sound Financial Bancorp, Inc. 10-Q

Item 1. Financial Statements SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY Condensed Consolidated Balance Sheets (unaudited) (In thousands, except share and per share amounts) September 30, 2021 December 31, 2020 ASSETS Cash and cash equivalents $ 206,702 $ 193,828 Available-for-sale securities, at fair value 7,060 10,218 Loans held-for-sale 3,884 11,604 Loans held-for-portfolio 667,551 613,363 Allowance for loan losses ( 6,327 ) ( 6,000 ) Total loans held-for-portfolio, net 661,224 607,363 Accrued interest receivable 2,231 2,254 Bank-owned life insurance (“BOLI”), net 20,926 14,588 Other real estate owned (“OREO”) and repossessed assets, net 659 594 Mortgage servicing rights, at fair value 4,211 3,780 Federal Home Loan Bank (“FHLB”) stock, at cost 1,052 877 Premises and equipment, net 5,941 6,270 Right of use assets 6,033 6,722 Other assets 8,188 3,304 Total assets $ 928,111 $ 861,402 LIABILITIES Deposits Interest-bearing $ 612,805 $ 615,491 Noninterest-bearing demand 194,848 132,490 Total deposits 807,653 747,981 Accrued interest payable 48 369 Lease liabilities 6,462 7,134 Other liabilities 8,711 7,674 Advance payments from borrowers for taxes and insurance 1,708 1,168 Subordinated notes, net 11,623 11,592 Total liabilities 836,205 775,918 COMMITMENTS AND CONTINGENCIES (NOTE 7) — — STOCKHOLDERS’ EQUITY Preferred stock, $ 0.01 par value, 10,000,000 shares authorized, none issued or outstanding — — Common stock, $ 0.01 par value, 40,000,000 shares authorized, 2,617,425 and 2,592,587 shares issued and outstanding as of September 30, 2021 and December 31, 2020, respectively 26 25 Additional paid-in capital 27,835 27,106 Unearned shares - Employee Stock Ownership Plan (“ESOP”) ( 28 ) ( 113 ) Retained earnings 63,905 58,226 Accumulated other comprehensive income, net of tax 168 240 Total stockholders’ equity 91,906 85,484 Total liabilities and stockholders’ equity $ 928,111 $ 861,402 See notes to condensed consolidated financial statements 3 SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY Condensed Consolidated Statements of Income (unaudited) (In thousands, except share and per share amounts) Three Months Ended September 30, Nine Months Ended September 30, 2021 2020 2021 2020 INTEREST INCOME Loans, including fees $ 8,967 $ 8,422 $ 25,152 $ 25,463 Interest and dividends on investments, cash and cash equivalents 135 86 365 400 Total interest income 9,102 8,508 25,517 25,863 INTEREST EXPENSE Deposits 617 1,738 2,807 5,346 Borrowings — 87 — 209 Subordinated notes 168 23 504 23 Total interest expense 785 1,848 3,311 5,578 Net interest income 8,317 6,660 22,206 20,285 PROVISION FOR LOAN LOSSES 175 275 425 925 Net interest income after provision for loan losses 8,142 6,385 21,781 19,360 NONINTEREST INCOME Service charges and fee income 556 510 1,615 1,433 Earnings on cash surrender value of bank-owned life insurance 104 102 281 207 Mortgage servicing income 328 260 961 739 Fair value adjustment on mortgage servicing rights ( 125 ) ( 623 ) ( 694 ) ( 1,423 ) Net gain on sale of loans 568 1,819 3,683 3,399 Total noninterest income 1,431 2,068 5,846 4,355 NONINTEREST EXPENSE Salaries and benefits 3,512 2,880 10,470 8,933 Operations 1,466 1,390 4,033 4,109 Regulatory assessments 91 111 283 480 Occupancy 441 442 1,298 1,437 Data processing 808 707 2,400 1,923 Net gain on OREO and repossessed assets — — ( 16 ) — Total noninterest expense 6,318 5,530 18,468 16,882 Income before provision for income taxes 3,255 2,923 9,159 6,833 Provision for income taxes 663 588 1,865 1,390 Net income $ 2,592 $ 2,335 $ 7,294 $ 5,443 Earnings per common share: Basic $ 1.00 $ 0.90 $ 2.81 $ 2.11 Diluted $ 0.98 $ 0.90 $ 2.76 $ 2.09 Weighted-average number of common shares outstanding: Basic 2,586,966 2,563,018 2,581,517 2,558,475 Diluted 2,633,459 2,589,241 2,624,632 2,588,101 See notes to condensed consolidated financial statements 4 SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY Condensed Consolidated Statements of Comprehensive Income (unaudited) (In thousands) Three Months Ended September 30, Nine Months Ended September 30, 2021 2020 2021 2020 Net income $ 2,592 $ 2,335 $ 7,294 $ 5,443 Available for sale securities: Unrealized (losses) gains arising during the period ( 34 ) ( 4 ) ( 91 ) 106 Income tax benefit (expense) related to unrealized gains/losses 7 1 19 ( 22 ) Other comprehensive (loss) income, net of tax ( 27 ) ( 3 ) ( 72 ) 84 Comprehensive income $ 2,565 $ 2,332 $ 7,222 $ 5,527 See notes to condensed consolidated financial statements 5 SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY Condensed Consolidated Statements of Stockholders’ Equity For the Three and Nine Months Ended September 30, 2021 and 2020 (unaudited) (In thousands, except share and per share amounts) Shares Common Stock Additional Paid -in Capital Unearned ESOP Shares Retained Earnings Accumulated Other Comprehensive Income, net of tax Total Stockholders’ Equity Balance, at June 30, 2021 2,614,329 $ 26 $ 27,613 $ ( 57 ) $ 61,758 $ 195 $ 89,535 Net income — — — — 2,592 — 2,592 Other comprehensive loss, net of tax — — — — — ( 27 ) ( 27 ) Share-based compensation — — 65 — — — 65 Cash dividends paid on common stock ($ 0.17 per share) — — — — ( 445 ) — ( 445 ) Common stock surrendered ( 100 ) — — — — — — Restricted shares forfeited ( 420 ) — — — — — — Common stock options exercised 3,616 — 59 — — — 59 Allocation of ESOP shares — — 98 29 — — 127 Balance, at September 30, 2021 2,617,425 $ 26 $ 27,835 $ ( 28 ) $ 63,905 $ 168 $ 91,906 Balance, at December 31, 2020 2,592,587 $ 25 $ 27,106 $ ( 113 ) $ 58,226 $ 240 $ 85,484 Net income — — — — 7,294 — 7,294 Other comprehensive loss, net of tax — — — — — ( 72 ) ( 72 ) Share-based compensation — — 295 — — — 295 Restricted stock awards issued 10,168 — — — — — Cash dividends paid on common stock ($ 0.61 per share) — — — — ( 1,594 ) — ( 1,594 ) Common stock repurchased — — ( 9 ) — ( 21 ) — ( 30 ) Common stock surrendered ( 4,091 ) — — — — — Restricted shares forfeited ( 1,890 ) — — — — — — Common stock options exercised 20,651 1 181 — — — 182 Allocation of ESOP shares — — 262 85 — — 347 Balance, at September 30, 2021 2,617,425 $ 26 $ 27,835 $ ( 28 ) $ 63,905 $ 168 $ 91,906 6 SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY Condensed Consolidated Statements of Stockholders’ Equity (unaudited) (In thousands, except share and per share amounts) Shares Common Stock Additional Paid -in Capital Unearned ESOP Shares Retained Earnings Accumulated Other Comprehensive Income, net of tax Total Stockholders’ Equity Balance, at June 30, 2020 2,593,152 $ 25 $ 26,894 $ ( 170 ) $ 53,224 $ 262 $ 80,235 Net income — — — — 2,335 — 2,335 Other comprehensive loss, net of tax — — — — — ( 3 ) ( 3 ) Share-based compensation — — 52 — — — 52 Common stock surrendered ( 2,842 ) — — — — — — Cash dividends paid on common stock ($ 0.15 per share) — — — — ( 389 ) — ( 389 ) Common stock options exercised 4,979 — 23 — — — 23 Allocation of ESOP shares — — 49 28 — — 77 Balance, at September 30, 2020 2,595,289 $ 25 $ 27,018 $ ( 142 ) $ 55,170 $ 259 $ 82,330 Balance, at December 31, 2019 2,567,389 $ 25 $ 26,343 $ ( 227 ) $ 51,410 $ 175 $ 77,726 Net income — — — — 5,443 — 5,443 Other comprehensive loss, net of tax — — — — — 84 84 Share-based compensation — — 283 — — — 283 Common stock surrendered ( 3,423 ) — — — — — — Cash dividends paid on common stock ($ 0.65 per share) — — — — ( 1,683 ) — ( 1,683 ) Restricted stock forfeited ( 1,690 ) — — — — — — Restricted stock awards issued 13,600 — — — — — — Common stock options exercised 19,413 — 239 — — — 239 Allocation of ESOP shares — — 153 85 — — 238 Balance, at September 30, 2020 2,595,289 $ 25 $ 27,018 $ ( 142 ) $ 55,170 $ 259 $ 82,330 See notes to condensed consolidated financial statements 7 SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY Condensed Consolidated Statements of Cash Flows (unaudited) (In thousands) Nine Months Ended September 30, 2021 2020 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 7,294 $ 5,443 Adjustments to reconcile net income to net cash from operating activities: Amortization of net discounts on investments 108 104 Provision for loan losses 425 925 Depreciation and amortization 502 696 Compensation expense related to stock options and restricted stock 295 283 Fair value adjustment on mortgage servicing rights 694 1,423 Right of use assets amortization 689 696 Change in lease liabilities ( 672 ) ( 662 ) Increase in cash surrender value of BOLI ( 281 ) ( 207 ) Net change in advances from borrowers for taxes and insurance 540 373 Net gain on sale of loans ( 3,683 ) ( 3,399 ) Proceeds from sale of loans held-for-sale 130,890 179,244 Originations of loans held-for-sale ( 120,612 ) ( 193,892 ) Net gain on OREO and repossessed assets ( 16 ) — Change in operating assets and liabilities: Accrued interest receivable 23 ( 330 ) Other assets ( 4,865 ) 314 Accrued interest payable ( 321 ) ( 13 ) Other liabilities 1,037 ( 585 ) Net cash provided by (used in) operating activities 12,047 ( 9,587 ) CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of available-for-sale securities — ( 7,177 ) Proceeds from principal payments, maturities and sales of available-for-sale securities 2,990 3,190 Net increase in loans ( 54,370 ) ( 68,622 ) Purchase of BOLI ( 6,057 ) ( 14 ) Purchases of premises and equipment, net ( 173 ) ( 396 ) Proceeds from sale of OREO and other repossessed assets 35 — Net cash used in investing activities ( 57,575 ) ( 73,019 ) CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in deposits 59,672 132,132 Proceeds from borrowings — 87,991 Repayment of borrowings — ( 87,991 ) Proceeds from subordinated debt, net — 11,676 FHLB stock purchased ( 175 ) ( 4 ) Common stock repurchases ( 30 ) — Allocation of ESOP shares 347 238 Dividends paid on common stock ( 1,594 ) ( 1,683 ) Proceeds from common stock option exercises 182 239 Net cash provided by financing activities 58,402 142,598 Net change in cash and cash equivalents 12,874 59,992 Cash and cash equivalents, beginning of period 193,828 55,770 Cash and cash equivalents, end of period $ 206,702 $ 115,762 SUPPLEMENTAL CASH FLOW INFORMATION: Cash paid for income taxes $ 2,290 $ 1,270 Interest paid on deposits and borrowings 3,632 5,591 Loans transferred from loans held-for-portfolio to OREO and repossessed assets 84 — See notes to condensed consolidated financial statements 8 SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY Notes to Condensed Consolidated Financial Statements (unaudited) Note 1 – Basis of Presentation The accompanying financial information is unaudited and has been prepared from the consolidated financial statements of Sound Financial Bancorp, Inc., and its wholly owned subsidiaries, Sound Community Bank and Sound Community Insurance Agency, Inc. References in this document to Sound Financial Bancorp refer to Sound Financial Bancorp, Inc. and references to the “Bank” refer to Sound Community Bank. References to “we,” “us,” and “our” or the “Company” refers to Sound Financial Bancorp and its wholly-owned subsidiaries, Sound Community Bank and Sound Community Insurance Agency, Inc., unless the context otherwise requires. These unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission (“SEC”). In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the financial position and results of operations for the periods presented have been included. Certain information and disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to the rules and regulations of the SEC. These unaudited financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, as filed with the SEC on March 30, 2021 (“2020 Form 10-K”). The results for the interim periods are not necessarily indicative of results for a full year or any other future period. Certain amounts in the prior period’s consolidated financial statements have been reclassified to conform to the current presentation. These classifications do not have an impact on previously reported consolidated net income, stockholders’ equity or earnings per share. Note 2 – Accounting Pronouncements Recently Issued or Adopted The Coronavirus Aid, Relief and Economic Security Act ("CARES Act"), signed into law on March 27, 2020, provides relief from certain accounting and financial reporting requirements under U.S. GAAP. Section 4013 of the CARES Act provides temporary relief from the accounting and reporting requirements for troubled debt restructurings (“TDRs”) under Accounting Standards Codification ("ASC") 310-40 for loan modifications related to the novel coronavirus disease 2019 ("COVID-19") pandemic. In addition, on April 7, 2020, a group of banking agencies issued an interagency statement (“Interagency Statement”) for evaluating whether loan modifications that occur in response to the COVID-19 pandemic are TDRs. The Interagency Statement was originally issued on March 22, 2020, but the banking agencies revised it to address the relationship between their TDR accounting and disclosure guidance and the TDR guidance in Section 4013 of the CARES Act. Section 4013 of the CARES Act permits the suspension of ASC 310-40 for loan modifications that are made by financial institutions in response to the COVID-19 pandemic if (1) the borrower was not more than 30 days past due as of December 31, 2019, and (2) the modifications are related to arrangements that defer or delay the payment of principal or interest, or change the interest rate on the loan. The Interagency Statement indicates that a lender can conclude that a borrower is not experiencing financial difficulty if either (1) short-term (e.g., six months) modifications are made in response to COVID-19, such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant related to loans in which the borrower is less than 30 days past due on its contractual payments at the time a modification program is implemented, or (2) the modification or deferral program is mandated by the federal government or a state government. Accordingly, any loan modification made in response to the COVID-19 pandemic that meets either of these practical expedients would not be considered a TDR. The Company adopted this guidance effective March 27, 2020. On December 27, 2020, the Consolidated Appropriations Act 2021 (“CAA 2021”) was signed into law. Among other purposes, CAA 2021 provides coronavirus emergency response and relief, including extending relief offered under the CARES Act related to restructured loans as a result of COVID-19 through January 1, 2022 or 60 days after the end of the national emergency declared by the President, whichever is earlier. In October 2020, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2020-08, “ Receivables – Nonrefundable Fees and Other Costs ” (“ASU 2020-08”). ASU 2020-08 clarifies that the Company should reevaluate whether a callable debt security is within the scope of paragraph 310-20-35-33 for each reporting period. ASU 2020-08 is effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. The adoption of ASU 2018-13 did not have a material impact on the Company's consolidated financial statements. 9 On March 2020, the FASB issued ASU No. 2020-04, " Reference Rate Reform" ("Topic 848"). This ASU provides optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting. The amendments in this update apply to contract modifications that replace a reference rate affected by reference rate reform (including rates referenced in fallback provisions) and contemporaneous modifications of other contract terms related to the replacement of the reference rate (including contract modifications to add or change fallback provisions). The following optional expedients for applying the requirements of certain Topics or Industry Subtopics in the Codification are permitted for contracts that are modified because of reference rate reform and that meet certain scope guidance: 1) Modifications of contracts within the scope of Topics 310, Receivables, and 470, Debt, should be accounted for by prospectively adjusting the effective interest rate; 2) Modifications of contracts within the scope of Topics 840, Leases, and 842, Leases, should be accounted for as a continuation of the existing contracts with no reassessments of the lease classification and the discount rate (for example, the incremental borrowing rate) or remeasurements of lease payments that otherwise would be required under those Topics for modifications not accounted for as separate contracts; and 3) Modifications of contracts do not require an entity to reassess its original conclusion about whether that contract contains an embedded derivative that is clearly and closely related to the economic characteristics and risks of the host contract under Subtopic 815-15, Derivatives and Hedging— Embedded Derivatives. In January 2021, ASU 2021-01 updated amendments in the new ASU to clarify that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. The ASU also amends the expedients and exceptions in Topic 848 to capture the incremental consequences of the scope clarification. The amendments in this ASU have differing effective dates, beginning with interim period including and subsequent to March 12, 2020 through December 31, 2022. The Company does not expect the adoption of ASU 2020-04 to have a material impact on its consolidated financial statements. In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. This ASU simplifies the accounting for income taxes by removing the exception to the incremental approach for intra-period tax allocation when there is a loss from continuing operations and income or a gain from other items, removing the requirement to recognize a deferred tax liability for equity method investments when a foreign subsidiary becomes an equity method investment, and removing the general methodology for calculating income taxes in an interim period when a year-to-date loss exceeds the anticipated loss for the year. This ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. The adoption of ASU 2019-12 did not have a material impact on the Company's consolidated financial statements. In August 2018, the FASB issued ASU No. 2018-14, Compensation - Retirement Benefits - Defined Benefit Plans - General (Subtopic 715-20): Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans. This ASU modifies disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. Disclosure requirements removed from FASB Subtopic 715-20 include the amounts in accumulated other comprehensive income expected to be recognized as components of net periodic benefit cost over the next fiscal year, the amount and timing of plan assets expected to be returned to the employer, related party disclosures about the amount of future annual benefits covered by insurance and annuity contracts and significant transactions between the employer or related parties and the plan, and, for public entities, the effects of a one-percentage-point change in assumed health care cost trend rates on the aggregate of the service and interest cost components of net periodic benefit costs and benefit obligation for postretirement health care benefits. Disclosure requirements added to FASB Subtopic 715-20 include the weighted-average interest crediting rates for cash balance plans and other plans with promised interest crediting rates, and an explanation of the reasons for significant gains and losses related to changes in the benefit obligation for the period. This ASU is effective for fiscal years ending after December 15, 2020. The adoption of ASU No. 2018-14 did not have a material impact on the Company's consolidated financial statements. In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments . This ASU replaces the existing incurred loss impairment methodology that recognizes credit losses when a probable loss has been incurred with new methodology where loss estimates are based upon lifetime expected credit losses. The amendments in this ASU require a financial asset that is measured at amortized cost to be presented at the net amount expected to be collected. The income statement would then reflect the measurement of credit losses for newly recognized financial assets as well as changes to the expected credit losses that have taken place during the reporting period. The change in allowance recognized as a result of adoption will occur through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the ASU is adopted. The new guidance may result in an increase in the allowance for loan losses; however, the Company is still in the process of determining the magnitude of the change and its impact on the Company's consolidated financial statements. The FASB issued ASU No. 2019-10, Financial Instruments - Credit Losses (Topic 326) , delaying implementation of ASU No. 2016-13 for SEC smaller reporting company filers until fiscal years beginning after December 15, 2022. The Bank meets the requirements of a smaller reporting company and will delay implementation of ASU No. 2016-13 . 10 Note 3 – Investments The amortized cost and fair value of our available-for-sale (“AFS”) securities and the corresponding amounts of gross unrealized gains and losses at the dates indicated were as follows (in thousands): Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value September 30, 2021 Municipal bonds $ 4,216 $ 160 $ ( 6 ) $ 4,370 Agency mortgage-backed securities 2,631 70 ( 11 ) 2,690 Total $ 6,847 $ 230 $ ( 17 ) $ 7,060 December 31, 2020 Municipal bonds $ 5,209 $ 204 $ — $ 5,413 Agency mortgage-backed securities 4,706 105 ( 6 ) 4,805 Total $ 9,915 $ 309 $ ( 6 ) $ 10,218 The amortized cost and fair value of AFS securities at September 30, 2021, by contractual maturity, are shown below (in thousands). Expected maturities of AFS securities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Investments not due at a single maturity date, primarily mortgage-backed investments, are shown separately. September 30, 2021 Amortized Cost Fair Value Due within one year $ 226 $ 226 Due after one year through five years 260 268 Due after five years through ten years 457 492 Due after ten years 3,273 3,384 Agency mortgage-backed securities 2,631 2,690 Total $ 6,847 $ 7,060 There were no pledged securities at September 30, 2021 or December 31, 2020. There were no sales of AFS securities during the three and nine months ended September 30, 2021 or 2020. 11 The following table summarizes the aggregate fair value and gross unrealized loss by length of time of those investments that have been in a continuous unrealized loss position at the dates indicated (in thousands): September 30, 2021 Less Than 12 Months 12 Months or Longer Total Fair Value Unrealized Loss Fair Value Unrealized Loss Fair Value Unrealized Loss Municipal bonds $ 660 $ ( 6 ) $ — $ — $ 660 $ ( 6 ) Agency mortgage-backed securities 434 ( 11 ) — — 434 ( 11 ) Total $ 1,094 $ ( 17 ) $ — $ — $ 1,094 $ ( 17 ) December 31, 2020 Less Than 12 Months 12 Months or Longer Total Fair Value Unrealized Loss Fair Value Unrealized Loss Fair Value Unrealized Loss Agency mortgage-backed securities $ 1,618 $ ( 6 ) $ — $ — $ 1,618 $ ( 6 ) Total $ 1,618 $ ( 6 ) $ — $ — $ 1,618 $ ( 6 ) There were no credit losses recognized in earnings related to other than temporary impairments during the three and nine months ended September 30, 2021 or 2020. At September 30, 2021, the securities portfolio consisted of 11 agency mortgage-backed securities and nine municipal bonds with a total portfolio fair value of $ 7.1 million. At December 31, 2020, the securities portfolio consisted of 16 agency mortgage-backed securities and ten municipal bonds with a fair value of $ 10.2 million. At September 30, 2021, there were three securities in an unrealized loss position for less than 12 months, and there were no securities in an unrealized loss position for more than 12 months. At December 31, 2020, there were three securities in an unrealized loss position for less than 12 months, and there were no securities in an unrealized loss position for more than 12 months. The unrealized losses were caused by changes in market interest rates or the widening of market spreads subsequent to the initial purchase of these securities, and not related to the underlying credit of the issuers or the underlying collateral. It is expected that these securities will not be settled at a price less than the amortized cost of each investment. The unrealized losses on these investments are not considered other-than-temporary impairment ("OTTI") as of September 30, 2021, because the decline in fair value is not attributable to credit quality and because we do not intend, and it is not likely that we will be required, to sell these securities before recovery of their amortized cost basis . Deterioration in market and economic conditions related to the COVID-19 pandemic may, however, have an adverse impact on credit quality in the future and result in OTTI charges. 12 Note 4 – Loans The composition of the loans-held-for portfolio at the dates indicated, excluding loans held-for-sale, was as follows (in thousands): September 30, 2021 December 31, 2020 Real estate loans: One-to-four family $ 194,346 $ 130,657 Home equity 14,012 16,265 Commercial and multifamily 246,794 265,774 Construction and land 81,576 62,752 Total real estate loans 536,728 475,448 Consumer loans: Manufactured homes 21,459 20,941 Floating homes 58,358 39,868 Other consumer 15,732 15,024 Total consumer loans 95,549 75,833 Commercial business loans 36,620 64,217 Total loans held-for-portfolio 668,897 615,498 Deferred fees, net ( 1,346 ) ( 2,135 ) Total loans held-for-portfolio, gross 667,551 613,363 Allowance for loan losses ( 6,327 ) ( 6,000 ) Total loans held-for-portfolio, net $ 661,224 $ 607,363 The Company was automatically authorized to participate in the U.S. Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”), as a qualified lender since the inception of the program. As of September 30, 2021, the Bank had funded PPP loans totaling $ 119.2 million, $ 11.8 million of which remained outstanding and are included in commercial business loans above. PPP loans are 100% guaranteed by the SBA. The following tables present the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of the dates indicated (in thousands): September 30, 2021 Allowance: Individually evaluated for impairment Allowance: Collectively evaluated for impairment Allowance: Ending balance Loans held for investment: Individually evaluated for impairment Loans held for investment: Collectively evaluated for impairment Loans held for investment: Ending balance One-to-four family $ 137 $ 1,183 $ 1,320 $ 3,791 $ 190,555 $ 194,346 Home equity 7 87 94 226 13,786 14,012 Commercial and multifamily — 1,857 1,857 — 246,794 246,794 Construction and land 5 771 776 255 81,321 81,576 Manufactured homes 105 198 303 201 21,258 21,459 Floating homes — 383 383 504 57,854 58,358 Other consumer 27 179 206 108 15,624 15,732 Commercial business — 426 426 182 36,438 36,620 Unallocated — 962 962 — — — Total $ 281 $ 6,046 $ 6,327 $ 5,267 $ 663,630 $ 668,897 13 December 31, 2020 Allowance: Individually evaluated for impairment Allowance: Collectively evaluated for impairment Allowance: Ending balance Loans held for investment: Individually evaluated for impairment Loans held for investment: Collectively evaluated for impairment Loans held for investment: Ending balance One-to-four family $ 165 $ 898 $ 1,063 $ 3,705 $ 126,952 $ 130,657 Home equity 14 133 147 293 15,972 16,265 Commercial and multifamily — 2,370 2,370 353 265,421 265,774 Construction and land 6 572 578 77 62,675 62,752 Manufactured homes 163 366 529 265 20,676 20,941 Floating homes — 328 328 518 39,350 39,868 Other consumer 30 258 288 114 14,910 15,024 Commercial business — 291 291 615 63,602 64,217 Unallocated — 406 406 — — — Total $ 378 $ 5,622 $ 6,000 $ 5,940 $ 609,558 $ 615,498 The following tables summarize the activity in the allowance for loan losses for the periods indicated (in thousands): Three Months Ended September 30, 2021 Beginning Allowance Charge-offs Recoveries Provision (Recapture) Ending Allowance One-to-four family $ 1,292 $ — $ — $ 28 $ 1,320 Home equity 111 — 2 ( 19 ) 94 Commercial and multifamily 1,987 — — ( 130 ) 1,857 Construction and land 700 — — 76 776 Manufactured homes 367 — 1 ( 65 ) 303 Floating homes 318 — — 65 383 Other consumer 201 ( 8 ) — 13 206 Commercial business 693 — — ( 267 ) 426 Unallocated 488 — — 474 962 Total $ 6,157 $ ( 8 ) $ 3 $ 175 $ 6,327 Nine Months Ended September 30, 2021 Beginning Allowance Charge-offs Recoveries Provision (Recapture) Ending Allowance One-to-four family $ 1,063 $ ( 76 ) $ — $ 333 $ 1,320 Home equity 147 ( 8 ) 4 ( 49 ) 94 Commercial and multifamily 2,370 — — ( 513 ) 1,857 Construction and land 578 — — 198 776 Manufactured homes 529 ( 2 ) 3 ( 227 ) 303 Floating homes 328 — — 55 383 Other consumer 288 ( 27 ) 6 ( 61 ) 206 Commercial business 291 — 2 133 426 Unallocated 406 — — 556 962 Total $ 6,000 $ ( 113 ) $ 15 $ 425 $ 6,327 14 Three Months Ended September 30, 2020 Beginning Allowance Charge-offs Recoveries (Recapture) Provision Ending Allowance One-to-four family $ 1,149 $ ( 20 ) $ 4 $ 37 $ 1,170 Home equity 154 ( 2 ) 7 ( 17 ) 142 Commercial and multifamily 1,991 — — 16 2,007 Construction and land 623 — — ( 43 ) 580 Manufactured homes 362 — 1 ( 33 ) 330 Floating homes 324 — — ( 31 ) 293 Other consumer 127 ( 4 ) 2 ( 10 ) 115 Commercial business 501 ( 306 ) — 68 263 Unallocated 800 — — 288 1,088 Total $ 6,031 $ ( 332 ) 0 $ 14 $ 275 $ 5,988 Nine Months Ended September 30, 2020 Beginning Allowance Charge-offs Recoveries (Recapture) Provision Ending Allowance One-to-four family $ 1,120 $ ( 20 ) $ 12 $ 58 $ 1,170 Home equity 178 ( 2 ) 46 ( 80 ) 142 Commercial and multifamily 1,696 — — 311 2,007 Construction and land 492 — — 88 580 Manufactured homes 480 — 1 ( 151 ) 330 Floating homes 283 — — 10 293 Other consumer 112 ( 20 ) 13 10 115 Commercial business 331 ( 607 ) — 539 263 Unallocated 948 — — 140 1,088 Total $ 5,640 $ ( 649 ) $ 72 $ 925 $ 5,988 Credit Quality Indicators. Federal regulations provide for the classification of lower quality loans and other assets (such as OREO and repossessed assets), debt and equity securities considered as "substandard," "doubtful" or "loss." An asset is considered "substandard" if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. "Substandard" assets include those characterized by the "distinct possibility" that the insured institution will sustain "some loss" if the deficiencies are not corrected. Assets classified as "doubtful" have all of the weaknesses in those classified "substandard," with the added characteristic that the weaknesses present make "collection or liquidation in full," on the basis of currently existing facts, conditions and values, "highly questionable and improbable." Assets classified as "loss" are those considered "uncollectible" and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. When we classify problem assets as either substandard or doubtful, we may establish a specific allowance in an amount we deem prudent to address specific impairments. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been specifically allocated to particular problem assets. When an insured institution classifies problem assets as a loss, it is required to charge off those assets in the period in which they are deemed uncollectible. Our determination as to the classification of our assets and the amount of our valuation allowances is subject to review by the Federal Deposit Insurance Corporation (“FDIC”), the Bank's federal regulator, and, since our conversion to a Washington-chartered commercial bank, the Washington Department of Financial Institutions, the Bank's state banking regulator, which can order the establishment of additional loss allowances. Assets which do not currently expose us to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are required to be designated as special mention. 15 The following tables present the internally assigned grades as of the dates indicated, by type of loan (in thousands): September 30, 2021 One-to- four family Home equity Commercial and multifamily Construction and land Manufactured homes Floating homes Other consumer Commercial business Total Grade: Pass $ 190,857 $ 13,654 $ 200,617 $ 67,021 $ 21,025 $ 57,250 $ 15,711 $ 30,242 $ 596,377 Watch 299 23 29,061 11,962 243 604 — 4,059 46,251 Special Mention — — 9,958 837 — — — 1,746 12,541 Substandard 3,190 335 7,158 1,756 191 504 21 573 13,728 Total $ 194,346 $ 14,012 $ 246,794 $ 81,576 $ 21,459 $ 58,358 $ 15,732 $ 36,620 $ 668,897 December 31, 2020 One-to- four family Home equity Commercial and multifamily Construction and land Manufactured homes Floating homes Other consumer Commercial business Total Grade: Pass $ 113,185 $ 15,556 $ 228,652 $ 44,360 $ 19,606 $ 38,746 $ 15,000 $ 56,743 $ 531,848 Watch 15,142 245 22,945 13,808 1,115 604 — 5,202 59,061 Special Mention — — 10,813 3,939 — — — 310 15,062 Substandard 2,330 464 3,364 645 220 518 24 1,962 9,527 Total $ 130,657 $ 16,265 $ 265,774 $ 62,752 $ 20,941 $ 39,868 $ 15,024 $ 64,217 $ 615,498 Nonaccrual and Past Due Loans . Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on nonaccrual once the loan is 90 days past due or sooner if, 16 in management’s opinion, the borrower may be unable to meet payment of obligations as they become due, as well as when required by regulatory provisions. The following table presents the recorded investment in nonaccrual loans as of the dates indicated, by type of loan (in thousands): September 30, 2021 December 31, 2020 One-to-four family $ 1,915 $ 1,668 Home equity 150 156 Commercial and multifamily — 353 Construction and land 220 40 Manufactured homes 98 149 Floating homes 504 518 Commercial business 182 — Total $ 3,069 $ 2,884 The following tables present the aging of the recorded investment in past due loans as of the dates indicated, by type of loan (in thousands): September 30, 2021 30-59 Days Past Due 60-89 Days Past Due 90 Days and Greater Past Due > 90 Days and Accruing Total Past Due Current Total Loans One-to-four family $ — $ 604 $ 1,571 $ — $ 2,175 $ 192,171 $ 194,346 Home equity 16 — 134 — 150 13,862 14,012 Commercial and multifamily 2,429 — — — 2,429 244,365 246,794 Construction and land — — — — — 81,576 81,576 Manufactured homes 33 79 97 — 210 21,249 21,459 Floating homes — — 247 — 247 58,111 58,358 Other consumer 20 2 — — 22 15,710 15,732 Commercial business — — 182 — 182 36,438 36,620 Total $ 2,498 $ 685 $ 2,231 $ — $ 5,413 $ 663,484 $ 668,897 December 31, 2020 30-59 Days Past Due 60-89 Days Past Due 90 Days and Greater Past Due > 90 Days and Accruing Total Past Due Current Total Loans One-to-four family $ 498 $ 362 $ 1,407 $ — $ 2,267 $ 128,390 $ 130,657 Home equity 102 — 112 — 214 16,051 16,265 Commercial and multifamily — — 353 — 353 265,421 265,774 Construction and land 690 — 40 — 730 62,022 62,752 Manufactured homes 159 74 149 — 382 20,559 20,941 Floating homes — 269 249 — 518 39,350 39,868 Other consumer 15 1 — — 16 15,008 15,024 Commercial business 583 — — — 583 63,634 64,217 Total $ 2,047 $ 706 $ 2,310 $ — $ 5,063 $ 610,435 $ 615,498 17 Nonperforming Loans. Loans are considered nonperforming when they are placed on nonaccrual. The following tables present the credit risk profile of our loan portfolio based on payment activity as of the dates indicated, by type of loan (in thousands): September 30, 2021 One-to-four family Home equity Commercial and multifamily Construction and land Manufactured homes Floating homes Other consumer Commercial business Total Performing $ 192,431 $ 13,862 $ 246,794 $ 81,356 $ 21,361 $ 57,854 $ 15,732 $ 36,438 $ 665,828 Nonperforming 1,915 150 — 220 98 504 — 182 3,069 Total $ 194,346 $ 14,012 $ 246,794 $ 81,576 $ 21,459 $ 58,358 $ 15,732 $ 36,620 $ 668,897 December 31, 2020 One-to-four family Home equity Commercial and multifamily Construction and land Manufactured homes Floating homes Other consumer Commercial business Total Performing $ 128,989 $ 16,109 $ 265,421 $ 62,712 $ 20,792 $ 39,350 $ 15,024 $ 64,217 $ 612,614 Nonperforming 1,668 156 353 40 149 518 — — 2,884 Total $ 130,657 $ 16,265 $ 265,774 $ 62,752 $ 20,941 $ 39,868 $ 15,024 $ 64,217 $ 615,498 Impaired Loans. A loan is considered impaired when we determine that we may be unable to collect payments of principal or interest when due under the terms of the loan. In the process of identifying loans as impaired, we take into consideration factors which include payment history and status, collateral value, financial condition of the borrower, and the probability of collecting scheduled payments in the future. Minor payment delays and insignificant payment shortfalls typically do not result in a loan being classified as impaired. The significance of payment delays and shortfalls is considered on a case by case basis, after taking into consideration the totality of circumstances surrounding the loan and the borrower, including payment history. Impairment is measured on a loan by loan basis for all loans in the portfolio. All TDRs are also classified as impaired loans and are included in the loans individually evaluated for impairment in the calculation of the allowance for loan losses. 18 Impaired loans at the dates indicated, by type of loan were as follows (in thousands): September 30, 2021 Recorded Investment Unpaid Principal Balance Without Allowance With Allowance Total Recorded Investment Related Allowance One-to-four family $ 3,901 $ 2,749 $ 1,042 $ 3,791 $ 137 Home equity 226 150 76 226 7 Commercial and multifamily — — — — — Construction and land 256 220 35 255 5 Manufactured homes 201 45 156 201 105 Floating homes 504 504 — 504 — Other consumer 108 — 108 108 27 Commercial business 182 182 — 182 — Total $ 5,378 $ 3,850 $ 1,417 $ 5,267 $ 281 December 31, 2020 Recorded Investment Unpaid Principal Balance Without Allowance With Allowance Total Recorded Investment Related Allowance One-to-four family $ 3,791 $ 2,392 $ 1,313 $ 3,705 $ 165 Home equity 293 156 137 293 14 Commercial and multifamily 353 353 — 353 — Construction and land 77 40 37 77 6 Manufactured homes 268 47 218 265 163 Floating homes 518 518 — 518 — Other consumer 114 — 114 114 30 Commercial business 615 615 — 615 — Total $ 6,029 $ 4,121 $ 1,819 $ 5,940 $ 378 19 The following table presents the average recorded investment and interest income recognized on impaired loans for the periods indicated, by loan types (in thousands): Three Months Ended September 30, 2021 2020 Average Recorded Investment Interest Income Recognized Average Recorded Investment Interest Income Recognized One-to-four family $ 3,069 $ 60 $ 6,027 $ 69 Home equity 321 3 336 3 Commercial and multifamily — — 465 16 Construction and land 166 11 315 20 Manufactured homes 225 3 349 5 Floating homes 507 5 405 15 Other consumer 109 1 127 — Commercial business 93 1 1,076 12 Total $ 4,490 $ 84 $ 9,100 $ 140 Nine Months Ended September 30, 2021 2020 Average Recorded Investment Interest Income Recognized Average Recorded Investment Interest Income Recognized One-to-four family $ 3,322 $ 118 $ 6,650 $ 208 Home equity 305 11 341 12 Commercial and multifamily 176 — 409 26 Construction and land 121 12 579 21 Manufactured homes 244 12 391 19 Floating homes 511 12 406 23 Other consumer 111 4 134 4 Commercial business 353 1 1,174 12 Total $ 5,143 $ 170 $ 10,084 $ 325 Forgone interest on nonaccrual loans was $ 89 thousand and $ 62 thousand for the three months ended September 30, 2021 and 2020, respectively, and $ 138 thousand and $ 126 thousand for the nine months ended September 30, 2021 and 2020, respectively. There were no commitments to lend additional funds to borrowers whose loans were classified as nonaccrual or impaired at September 30, 2021 and December 31, 2020. Troubled debt restructurings. TDRs are loans accounted for under ASC 310-40, which have renegotiated loan terms to assist borrowers who are unable to meet the original terms of their loans. Such modifications to loan terms may include a lower interest rate, a reduction in principal, or a longer term to maturity. Once a TDR has performed according to its modified terms for six months and the collection of principal and interest under the revised terms is deemed probable, we remove the TDR from nonperforming status. Loans classified as TDRs totaled $ 2.6 million and $ 3.2 million at September 30, 2021 and December 31, 2020, respectively, and are included in impaired loans. The Company has granted, in its TDRs, a variety of concessions to borrowers in the form of loan modifications. The modifications granted can generally be described in the following categories: Rate Modification : A modification in which the interest rate is changed. Term Modification : A modification in which the maturity date, timing of payments or frequency of payments is changed. Payment Modification : A modification in which the dollar amount of the payment is changed. Interest only modifications in which a loan is converted to interest only payments for a period of time are included in this category. 20 Combination Modification : Any other type of modification, including the use of multiple categories above. There were no loans modified as a TDR during the three and nine months ended September 30, 2021. There were two TDRs totaling $ 484 thousand that were paid off during the nine months ended September 30, 2021. There was one loan totaling $ 146 thousand modified as a TDR during the three months ended September 30, 2020 and four loans totaling $ 795 thousand modified as TDRs during the nine months ended September 30, 2020. There were two TDR loan totaling $ 2.9 million that were paid off during the nine months ended September 30, 2020. There were no post-modification changes for the unpaid principal balance in loans, net of partial charge-offs, that were recorded as a result of the TDRs for the three and nine months ended September 30, 2021 and 2020. There were no loans modified as a TDR for which there was a payment default within the first 12 months of modification during the three and nine months ended September 30, 2021. There was one loan totaling $ 161 thousand modified as a TDR for which there was a payment default within the first 12 months of modification during the nine months ended September 30, 2020. The Company had no commitments to extend additional credit to borrowers owing receivables whose terms have been modified into TDRs. In March 2020, the Company began offering short-term loan modifications to assist borrowers during the COVID-19 pandemic. The CARES Act, and the Interagency Statement provides that a short-term modification made to a loan in response to COVID-19 which meets certain criteria does not need to be placed on nonaccrual status or accounted for as a TDR pursuant to applicable accounting and regulatory guidance until the earlier of 60 days after the national emergency termination date or January 1, 2022. The majority of these borrowers had resumed making payments as of September 30, 2021, and as of that date, there were six residential loans totaling $ 933 thousand on deferral status under COVID-19 loan modification forbearance agreements. We continue to monitor these loans through our normal credit risk processes and any request for continuation of relief beyond the initial modification is reassessed at that time to determine if a further modification should be granted and if a downgrade in risk rating is appropriate. As of September 30, 2021, there was one one-to-four family loans totaling $ 39 thousand that was in process of foreclosure. Note 5 – Fair Value Measurements The Company determines the fair values of its financial instruments based on the requirements established in ASC 820 , Fair Value Measurements (“ASC 820”), which provides a framework for measuring fair value in accordance with U.S. GAAP and requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. ASC 820 defines fair values for financial instruments as the exit price, the price that would be received for an asset or paid to transfer a liability, in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date under current market conditions. The Company’s fair values for financial instruments at September 30, 2021 were determined based on these requirements. The following methods and assumptions were used to estimate the fair value of other financial instruments: Cash and cash equivalents - The estimated fair value is equal to the carrying amount. Available-for-Sale Securities – Available-for-sale securities are recorded at fair value based on quoted market prices, if available. If quoted market prices are not available, management utilizes third-party pricing services or broker quotations from dealers in the specific instruments. Level 2 securities include those traded on an active exchange, as well as U.S. government securities. Loans Held-for-Sale - One-to-four family mortgage loans held-for-sale are recorded at the lower of cost or fair value. The fair value of fixed-rate one-to-four family loans is based on whole loan forward prices obtained from government sponsored enterprises. At September 30, 2021 and December 31, 2020, loans held-for-sale were carried at cost, as no impairment was required. Loans Held-for-Portfolio - The estimated fair value of loans-held-for portfolio consists of a credit adjustment to reflect the estimated adjustment to the carrying value of the loans due to credit-related factors and a yield adjustment, to reflect the estimated adjustment to the carrying value of the loans due to a differential in yield between the portfolio loan yields and estimated current market rate yields on loans with similar characteristics. The estimated fair values of loans held for portfolio reflect exit price assumptions. The liquidity premium/discounts are part of the valuation for exit pricing. Mortgage Servicing Rights –The fair value of mortgage servicing rights is determined through a discounted cash flow analysis, which uses interest rates, prepayment speeds, discount rates, and delinquency rate assumptions as inputs. FHLB stock - The estimated fair value is equal to the par value of the stock. 21 Non-maturity deposits - The estimated fair value is equal to the carrying amount. Time deposits - The estimated fair value of time deposits is based on the difference between interest costs paid on the Company’s time deposits and current market rates for time deposits with comparable characteristics. Borrowings - The fair value of borrowings are estimated using the Company’s current incremental borrowing rates for similar types of borrowing arrangements. Subordinated Debt - The fair value of subordinated debt is estimated using discounted cash flows based on current lending rates for similar long-term debt instruments with similar terms and remaining time to maturity. A description of the valuation methodologies used for impaired loans and OREO is as follows: Impaired Loans - The fair value of collateral dependent loans is based on the current appraised value of the collateral less estimated costs to sell, or internally developed models utilizing a calculation of expected discounted cash flows which contain management’s assumptions. OREO and Repossessed Assets – The fair value of OREO and repossessed assets is based on the current appraised value of the collateral less estimated costs to sell. Off-balance sheet financial instruments - The fair value for the Company’s off-balance sheet loan commitments is estimated based on fees charged to others to enter into similar agreements taking into account the remaining terms of the agreements and credit standing of the Company’s clients. The estimated fair value of these commitments is not significant. In certain cases, the inputs used to measure fair value may fall into different levels of the hierarchy. In such cases, the lowest level of inputs that is significant to the measurement is used to determine the hierarchy for the entire asset or liability. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Company’s quarterly valuation process. There were no transfers between levels during the three and nine months ended September 30, 2021 and 2020. 22 The following tables present information about the level in the fair value hierarchy for the Company’s financial assets and liabilities, whether or not recognized or recorded at fair value as of the dates indicated (in thousands): September 30, 2021 Fair Value Measurements Using: Carrying Value Estimated Fair Value Level 1 Level 2 Level 3 FINANCIAL ASSETS: Cash and cash equivalents $ 206,702 $ 206,702 $ 206,702 $ — $ — Available-for-sale securities 7,060 7,060 — 7,060 — Loans held-for-sale 3,884 3,884 — 3,884 — Loans held-for-portfolio, net 661,224 658,604 — — 658,604 Mortgage servicing rights 4,211 4,211 — — 4,211 FHLB stock 1,052 1,052 — 1,052 — FINANCIAL LIABILITIES: Non-maturity deposits 688,212 688,212 — 688,212 — Time deposits 119,441 120,798 — 120,798 — Subordinated notes 11,623 11,623 — 11,623 — December 31, 2020 Fair Value Measurements Using: Carrying Value Estimated Fair Value Level 1 Level 2 Level 3 FINANCIAL ASSETS: Cash and cash equivalents $ 193,828 $ 193,828 $ 193,828 $ — $ — Available-for-sale securities 10,218 10,218 — 10,218 — Loans held-for-sale 11,604 11,604 — 11,604 — Loans held-for-portfolio, net 607,363 608,575 — — 608,575 Mortgage servicing rights 3,780 3,780 — — 3,780 FHLB stock 877 877 — 877 — FINANCIAL LIABILITIES: Non-maturity deposits 512,508 512,508 — 512,508 — Time deposits 235,473 238,629 — 238,629 — Subordinated notes 11,592 11,592 — 11,592 — 23 The following tables present the balance of assets measured at fair value on a recurring basis as of the dates indicated (in thousands): Fair Value at September 30, 2021 Description Total Level 1 Level 2 Level 3 Municipal bonds 4,370 — 4,370 — Agency mortgage-backed securities 2,690 — 2,690 — Mortgage servicing rights 4,211 — — 4,211 Fair Value at December 31, 2020 Description Total Level 1 Level 2 Level 3 Municipal bonds $ 5,413 $ — $ 5,413 $ — Agency mortgage-backed securities 4,805 — 4,805 — Mortgage servicing rights 3,780 — — 3,780 The following tables provide a description of the valuation technique, unobservable input, and qualitative information about the unobservable inputs for the Company’s assets and liabilities classified as Level 3 and measured at fair value on a recurring basis as of the dates indicated: September 30, 2021 Financial Instrument Valuation Technique Unobservable Input(s) Range (Weighted-Average) Mortgage Servicing Rights Discounted cash flow Prepayment speed assumption 214 %- 503 % ( 217 %) Discount rate 10.5 %- 14.5 % ( 12.5 %) December 31, 2020 Financial Instrument Valuation Technique Unobservable Input(s) Range (Weighted-Average) Mortgage Servicing Rights Discounted cash flow Prepayment speed assumption 178 %- 276 % ( 247 %) Discount rate 10 %- 12 % ( 10 %) Generally, any significant increases in the constant prepayment rate and discount rate utilized in the fair value measurement of the mortgage servicing rights will result in a negative fair value adjustment (and decrease in the fair value measurement). Conversely, a decrease in the constant prepayment rate and discount rate will result in a positive fair value adjustment (and increase in the fair value measurement). An increase in the weighted-average life assumptions will result in a decrease in the constant prepayment rate and conversely, a decrease in the weighted-average life will result in an increase of the constant prepayment rate. There were no assets or liabilities (excluding mortgage servicing rights) measured at fair value using significant unobservable inputs (Level 3) on a recurring basis during the three and nine months ended September 30, 2021 and 2020. Mortgage servicing rights are measured at fair value using a significant unobservable input (Level 3) on a recurring basis - additional information is included in “Note 6—Mortgage Servicing Rights.” 24 The following tables present the balance of assets measured at fair value on a nonrecurring basis at the dates indicated (in thousands): Fair Value at September 30, 2021 Total Level 1 Level 2 Level 3 OREO and repossessed assets $ 659 $ — $ — $ 659 Impaired loans 5,267 — — 5,267 Fair Value at December 31, 2020 Total Level 1 Level 2 Level 3 OREO and repossessed assets $ 594 $ — $ — $ 594 Impaired loans 5,940 — — 5,940 There were no liabilities carried at fair value, measured on a recurring or nonrecurring basis, at September 30, 2021 and December 31, 2020. The following tables provide a description of the valuation technique, observable input, and qualitative information about the unobservable inputs for the Company’s assets and liabilities classified as Level 3 and measured at fair value on a nonrecurring basis at the dates indicated: September 30, 2021 Financial Instrument Valuation Technique(s) Unobservable Input(s) Range (Weighted Average) OREO Third Party Appraisals No discounts N/A Impaired loans (1) Discounted Cash Flow Discount Rate 0 - 10 % ( 5 %) Impaired loans (2) Third Party Appraisals No discounts N/A (1) Represents troubled debt restructurings included within impaired loans. (2) Excludes troubled debt restructurings. December 31, 2020 Financial Instrument Valuation Technique(s) Unobservable Input(s) Range (Weighted Average) OREO Third Party Appraisals No discounts N/A Impaired loans (1) Discounted Cash Flow Discount Rate 0 - 10 % ( 6 %) Impaired loans (2) Third Party Appraisals No discounts N/A (1) Represents troubled debt restructurings included within impaired loans. (2) Excludes troubled debt restructurings. Note 6 – Mortgage Servicing Rights The Company’s mortgage servicing rights portfolio totaled $ 514.0 million at September 30, 2021 compared to $ 488.7 million at December 31, 2020. Of this total balance, the unpaid principal balance of loans serviced for Federal National Mortgage Association (“Fannie Mae”) at September 30, 2021 and December 31, 2020 were $ 507.8 million and $ 481.6 million, respectively. The unpaid principal balance of loans serviced for other financial institutions at September 30, 2021 and December 31, 2020, totaled $ 6.2 million and $ 7.1 million, respectively. Loans serviced for others are not included in the Company’s financial statements as they are not assets of the Company. 25 A summary of the change in the balance of mortgage servicing assets during the periods indicated were as follows (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2021 2020 2021 2020 Beginning balance, at fair value $ 4,151 $ 3,113 $ 3,780 $ 3,239 Servicing rights that result from transfers and sale of financial assets 185 849 1,125 1,523 Changes in fair value: Due to changes in model inputs or assumptions and other (1) ( 125 ) ( 623 ) ( 694 ) ( 1,423 ) Ending balance, at fair value $ 4,211 $ 3,339 $ 4,211 $ 3,339 (1) Represents changes due to collection/realization of expected cash flows and curtailments. The key economic assumptions used in determining the fair value of mortgage servicing rights at the dates indicated are as follows: September 30, 2021 December 31, 2020 Prepayment speed (Public Securities Association “PSA” model) 217 % 247 % Weighted-average life 5.6 years 5.2 years Discount rate 12.5 % 10.0 % The amount of contractually specified servicing, late and ancillary fees earned on the mortgage servicing rights are included in mortgage servicing income on the Condensed Consolidated Statements of Income and totaled $ 328 thousand and $ 961 thousand for the three and nine months ended September 30, 2021, respectively, and $ 260 thousand and $ 739 thousand for the three and nine months ended September 30, 2020, respectively. Note 7 – Commitments and Contingencies In the normal course of operations, the Company engages in a variety of financial transactions that are not recorded in our financial statements. These transactions involve varying degrees of off-balance sheet credit, interest rate and liquidity risks. These transactions are used primarily to manage clients’ requests for funding and take the form of loan commitments and lines of credit. Note 8 – Borrowings, FHLB Stock and Subordinated Notes The Company has a loan agreement with the FHLB of Des Moines. The terms of the agreement call for a blanket pledge of a portion of the Company’s mortgage and commercial and multifamily loan portfolio based on the outstanding balance. At September 30, 2021 and December 31, 2020, the amount available to borrow under this credit facility was $ 397.9 million and $ 390.5 million, respectively, subject to eligible pledged collateral. At September 30, 2021, the credit facility was collateralized as follows: one-to-four family mortgage loans with an advance equivalent of $ 77.2 million, commercial and multifamily mortgage loans with an advance equivalent of $ 61.4 million and home equity loans with an advance equivalent of $ 569 thousand. At December 31, 2020, the credit facility was collateralized as follows: one-to-four family mortgage loans with an advance equivalent of $ 103.6 million, commercial and multifamily mortgage loans with an advance equivalent of $ 128.9 million and home equity loans with an advance equivalent of $ 2.8 million. The Company had no outstanding borrowings under this arrangement at both September 30, 2021 and December 31, 2020. The weighted-average interest rate of the Company’s borrowings under this agreement at December 31, 2020 was 3.10 %. Additionally, the Company had outstanding letters of credit from the FHLB of Des Moines with a notional amount of $ 17.6 million and $ 21.6 million at September 30, 2021 and December 31, 2020, respectively, to secure public deposits. The remaining amount available to borrow as of September 30, 2021 and December 31, 2020, was $ 121.6 million and $ 213.7 million, respectively. 26 As a member of the FHLB, the Company is required to maintain a minimum level of investment in FHLB of Des Moines stock based on specific percentages of its outstanding FHLB advances. At September 30, 2021 and December 31, 2020, the Company had an investment of $ 1.1 million and $ 877 thousand, respectively in FHLB of Des Moines stock. The Company has access to an unsecured Fed Funds line of credit from Pacific Coast Banker’s Bank. The line has a one year term maturing on June 30, 2022 and is renewable annually. As of September 30, 2021, the amount available under this line of credit was $ 20.0 million. There was no balance on this line of credit as of September 30, 2021 and December 31, 2020, respectively. In September 2020, the Company issued $ 12.0 million of fixed to floating rate subordinated notes that mature in 2030. The subordinated notes have an initial fixed interest rate of 5.25 % to, but excluding, October 1, 2025, payable semi-annually in arrears. From, and including, October 1, 2025, the interest rate on the subordinated notes will reset quarterly to a floating rate per annum equal to a benchmark rate, which is expected to be the then-current three-month term Secured Overnight Financing Rate, or SOFR, plus 513 basis points, payable quarterly in arrears. The subordinated notes mature on May 15, 2030. Prior to October 1, 2025, the Company may redeem these notes, in whole but not in part, only under certain limited circumstances set forth in the notes and are redeemable by the Company in whole or in part beginning with the interest payment date of October 1, 2025. As of both September 30, 2021 and December 31, 2020, the balance of the subordinated notes was $ 11.6 million. Note 9 – Earnings Per Common Share Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding for the period, reduced for average unallocated ESOP shares and average unvested restricted stock awards. Unvested share-based awards containing non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and are included in the computation of earnings per share. Diluted earnings per common share reflect the potential dilution that could occur if securities or other contracts to issue common stock (such as stock awards and options) were exercised or converted to common stock or resulted in the issuance of common stock that then shared in the Company’s earnings. Diluted earnings per common share is computed by dividing net income by the weighted-average number of common shares outstanding for the period increased for the dilutive effect of unexercised stock options and unvested restricted stock awards. The dilutive effect of the unexercised stock options and unvested restricted stock awards is calculated under the treasury stock method utilizing the average market value of the Company's stock for the period. The following table summarizes the calculation of earnings per share for the periods indicated (in thousands, except per share data): Three Months Ended September 30, Nine Months Ended September 30, 2021 2020 2021 2020 Net income $ 2,592 $ 2,319 $ 7,294 $ 5,407 Weighted-average number of shares outstanding, basic 2,587 2,563 2,582 2,558 Effect of potentially dilutive common shares 46 26 43 30 Weighted-average number of shares outstanding, diluted 2,633 2,589 2,625 2,588 Earnings per share, basic (1)(2) $ 1.00 $ 0.90 $ 2.81 $ 2.11 Earnings per share, diluted (1)(2) $ 0.98 $ 0.90 $ 2.76 $ 2.09 (1) The basic and diluted earnings per share amounts for the three and nine months ended September 30, 2021 include the impact of income allocated to participating securities of $ 17 thousand and $ 50 thousand, respectively. (2) The difference between the basic and diluted earnings per share amounts for the three and nine months ended September 30, 2021 and 2020 under the Treasury Stock Method and the Two-Class Method, as prescribed in FASB ASC 260-10, Earnings Per Share, is immaterial. There were no anti-dilutive securities at September 30, 2021 and 19,281 anti-dilutive securities at September 30, 2020. 27 Note 10 – Stock-based Compensation Stock Options and Restricted Stock The Company currently has one active shareholder approved stock-based compensation plan, the Amended and Restated 2013 Equity Incentive Plan (the "2013 Plan"). The 2013 Plan permits the grant of restricted stock, restricted stock units, stock options, and stock appreciation rights. The equity incentive plan approved by stockholders in 2008 (the"2008 Plan") expired in November 2018 and no further awards may be made under the 2008 Plan; provided, however, all awards outstanding under the 2008 Plan remain outstanding in accordance with their terms. Under the 2013 Plan, 181,750 shares of common stock were approved for awards for stock options and stock appreciation rights and 116,700 shares of common stock were approved for awards for restricted stock and restricted stock units. As of September 30, 2021, on an adjusted basis, awards for stock options totaling 271,874 shares and awards for restricted stock totaling 142,201 shares of Company common stock have been granted, net of any forfeitures, to participants in the 2013 Plan and the 2008 Plan. Share-based compensation expense was $ 65 thousand and $ 295 thousand for the three and nine months ended months ended September 30, 2021, respectively, and was $ 52 thousand and $ 283 thousand for the three and nine months ended September 30, 2020, respectively. Stock Option Awards All stock option awards granted under the 2008 Plan vest in 20 % annual increments commencing one year from the grant date in accordance with the requirements of the 2008 Plan. The stock option awards granted to date under the 2013 Plan provide for immediate vesting of a portion of the award with the balance of the award vesting on the anniversary date of each grant date in equal annual installments over periods of one -to- four years subject to the continued service of the participant with the Company. All of the options granted under the 2008 Plan and the 2013 Plan are exercisable for a period of 10 years from the date of grant, subject to vesting. The following is a summary of the Company’s stock option award activity during the three months ended September 30, 2021 (dollars in thousands, except per share amounts): Shares Weighted- Average Exercise Price Weighted-Average Remaining Contractual Term in Years Aggregate Intrinsic Value Outstanding at July 1, 2021 95,202 $ 24.35 5.21 $ 1,818 Granted — — Exercised ( 3,616 ) 17.55 Forfeited ( 250 ) 33.58 Expired — — Outstanding at September 30, 2021 91,336 24.59 5.02 1,858 Exercisable 72,843 22.28 4.12 1,650 Expected to vest, assuming a 0 % forfeiture rate over the vesting term 91,336 $ 24.59 5.02 $ 1,858 28 The following is a summary of the Company’s stock option award activity during the nine months ended September 30, 2021 (dollars in thousands, except per share amounts): Shares Weighted- Average Exercise Price Weighted-Average Remaining Contractual Term in Years Aggregate Intrinsic Value Outstanding at January 1, 2021 100,977 $ 22.00 4.71 $ 1,045 Granted 12,250 32.46 Exercised ( 20,651 ) 15.99 Forfeited ( 1,170 ) 34.93 Expired ( 70 ) 34.29 Outstanding at September 30, 2021 91,336 24.59 5.02 1,858 Exercisable 72,843 22.28 4.12 1,650 Expected to vest, assuming a 0 % forfeiture rate over the vesting term 91,336 $ 24.59 5.02 $ 1,858 As of September 30, 2021, there was $ 91 thousand of total unrecognized compensation cost related to non-vested stock options granted under the Plans. The cost is expected to be recognized over the remaining weighted-average vesting period of approximately 2.6 years. The fair value of each option grant is estimated as of the grant date using the Black-Scholes option-pricing model. The fair value of options granted for the nine months ended September 30, 2021 and 2020 were determined using the following weighted-average assumptions as of the grant date. Nine Months Ended September 30, 2021 2020 Annual dividend yield 1.60 % 1.60 % Expected volatility 21.67 % 21.67 % Risk-free interest rate 0.60 % 1.38 % Expected term 6.50 years 6.50 years Weighted-average grant date fair value per option granted $ 5.64 $ 7.14 There were no options granted during the three months ended September 30, 2021 or 2020. Restricted Stock Awards The fair value of the restricted stock awards is equal to the fair value of the Company's stock at the date of grant. Compensation expense is recognized over the vesting period that the awards are based. The restricted stock awards granted under the 2008 Plan vest in 20 % annual increments commencing one year from the grant date. The restricted stock awards granted to date under the 2013 Plan provide for immediate vesting of a portion of the award with the balance of the award vesting on the anniversary date of each of the grant date in equal annual installments over periods of one -to- four years subject to the continued service of the participant with the Company. 29 The following is a summary of the Company’s non-vested restricted stock award activity during the three months ended September 30, 2021: Shares Weighted-Average Grant-Date Fair Value Per Share Aggregate Intrinsic Value Per Share Non-Vested at July 1, 2021 18,050 $ 34.01 Granted — — Vested — — Forfeited ( 420 ) 33.45 Non-Vested at September 30, 2021 17,630 -0.0094814404432133 $ 34.02 $ 44.94 Expected to vest assuming a 0 % forfeiture rate over the vesting term 17,630 $ 34.02 $ 44.94 The following is a summary of the Company’s non-vested restricted stock award activity during the nine months ended September 30, 2021: Shares Weighted-Average Grant-Date Fair Value Per Share Aggregate Intrinsic Value Per Share Non-Vested at January 1, 2021 17,114 $ 35.03 Granted 10,168 32.46 Vested ( 7,762 ) 33.99 Forfeited ( 1,890 ) 34.93 Non-Vested at September 30, 2021 17,630 $ 34.02 $ 44.94 Expected to vest assuming a 0 % forfeiture rate over the vesting term 17,630 $ 34.02 $ 44.94 As of September 30, 2021, there was $ 455 thousand of unrecognized compensation cost related to non-vested restricted stock granted under the Plans. The cost is expected to be recognized over the weighted-average vesting period of 2.5 years. The total fair value of shares vested for the nine months ended September 30, 2021 and 2020 was $ 264 thousand and $ 236 thousand, respectively. Employee Stock Ownership Plan In January 2008, the ESOP borrowed $ 1.2 million from the Company to purchase common stock of the Company which was paid in full in 2017. In August 2012, in conjunction with the Company’s conversion to a full stock company from the mutual holding company structure, the ESOP borrowed an additional $ 1.1 million from the Company to purchase common stock of the Company. The loan is being repaid principally by the Bank through contributions to the ESOP over a period of ten years . The interest rate on the loan is fixed at 2.25 % per annum. As of September 30, 2021, the remaining balance of the ESOP loan was $ 126 thousand. Neither the loan balance nor the related interest expense is reflected on the condensed consolidated financial statements. At September 30, 2021, the ESOP held and is committed to release 11,340 shares of the Company’s common stock to participants during 2021. The fair value of the 147,766 shares held by the ESOP trust was $ 6.8 million at September 30, 2021. ESOP compensation expense included in salaries and benefits was $ 180 thousand and $ 530 thousand for the three and nine months ended September 30, 2021, respectively, and $ 126 thousand and $ 474 thousand for the three and nine months ended September 30, 2020, respectively. Note 11 – Leases We have operating leases for branch locations, a loan production office, our corporate office and in the past, for certain equipment. The lease term for our leases begins on the date we become legally obligated for the rent payments or we take possession of the building, whichever is earlier. Generally, our real estate leases have initial terms of three to ten years and 30 typically include one renewal option. Our leases have remaining lease terms of less than one year to eight years . The operating leases generally contain renewal options and require us to pay property taxes and operating expenses for the properties. The following table presents the lease right-of-use assets and lease liabilities recorded on the condensed consolidated balance sheet at the dates indicated (in thousands): September 30, 2021 December 31, 2020 Operating lease right-of-use assets $ 6,033 $ 6,722 Operating lease liabilities $ 6,462 $ 7,134 The following table presents the components of lease expense for the periods indicated (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2021 2020 2021 2020 Operating lease expense Office leases $ 272 $ 268 $ 817 $ 882 Equipment leases — 5 — 15 Sublease income ( 3 ) ( 3 ) ( 9 ) ( 9 ) Net lease expense $ 269 $ 270 $ 808 $ 888 The following table presents the maturity of lease liabilities at the date indicated: September 30, 2021 Remainder of 2021 $ 263 2022 1,016 2023 989 2024 968 2025 885 Thereafter 3,012 Total lease payments 7,133 Less: Present value discount 671 Present value of lease liabilities $ 6,462 Lease term and discount rate by lease type consist of the following at the dates indicated: September 30, 2021 December 31, 2020 Weighted-average remaining lease term: Office leases 7.24 years 7.89 years Equipment leases 0.00 years 1.42 years Weighted-average discount rate (annualized): Office leases 2.66 % 2.66 % Equipment leases — % 1.62 % 31 Supplemental cash flow information related to leases was as follows for the periods indicated (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2021 2020 2021 2020 Cash paid for amounts included in the measurement of lease liabilities for operating leases: Operating cash flows Office leases $ 263 $ 257 $ 779 $ 839 Equipment leases $ — $ 5 $ — $ 15 Note 12 – Subsequent Events On October 26, 2021, the Board of Directors of the Company declared a quarterly cash dividend of $ 0.17 per common share, payable on November 24, 2021 to stockholders of record at the close of business on November 10, 2021. On October 26, 2021, the Company’s Board of Directors adopted a new stock repurchase program. Under this new repurchase program, the Company may repurchase its outstanding shares in the open market in an amount up to $ 2.0 million, based on prevailing market prices, or in privately negotiated transactions, over a period beginning on October 29, 2021, continuing until the earlier of the completion of the repurchase or the next six months, depending upon market conditions. 32 Table of Contents