What changed in this filing

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Item 7. Management’s Discussion and Analysis

2022-03-15 compared with 2021-03-30 · 213 added, 271 removed, 252 unchanged (66% of the section changed)

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

We originated $321.3 million, $129.0 million and $112.5 million of one-to-four family residential mortgage loans during the years ended December 31, 2020, 2019 and 2018, respectively.

During these same periods, we sold $258.2 million, $78.9 million and $50.0 million, respectively, of one-to-four family residential mortgage loans.

We originated $243.9 million and $321.3 million of one-to-four family residential mortgage loans during the years ended December 31, 2021 and 2020, respectively.

We also purchased $24.1 million of one-to-four family residential mortgage loans during the year ended December 31, 2021.

During these same periods, we sold $147.4 million and $258.2 million, respectively, of one-to-four family residential mortgage loans.

Our strategic plan targets consumers, small- and medium-size businesses, and professionals in our market area for loans and deposits.

In pursuit of these goals and by managing the size of our loan portfolio, we focus on including a significant amount of commercial business and commercial and multifamily real estate loans in our portfolio.

A significant portion of these loans have adjustable rates, higher yields or shorter terms and higher credit risk than traditional fixed-rate mortgages.

Our commercial loan portfolio (commercial and multifamily real estate and commercial business loans) decreased to $306.2 million or 44.5% of our loan portfolio at December 31, 2021, from $330.0 million or 53.6% of our loan portfolio at December 31, 2020, as most of the PPP loans held in our commercial business loan portfolio have been repaid to us by the SBA.

Our consumer loan portfolio, which includes manufactured and floating homes and other consumer loans, increased to $97.7 million or 14.2% of our loan portfolio at December 31, 2021, from $75.8 million or 12.4% of our loan portfolio at December 31, 2020.

Our operating revenues are derived principally from earnings on interest-earning assets, service charges and fees, and gains on the sale of loans.

The continuing low interest rate environment is expected to continue to put downward pressure on loan yields and the yields on other floating rate interest earning assets as well, which may adversely affect our net interest income and net interest margin in 2021.

Our primary sources of funds are deposits (both retail and brokered), FHLB advances, borrowings through the Federal Reserve, and payments received on loans and securities.

We offer a variety of deposit accounts that provide a wide range of interest rates and terms, including savings, money market, NOW, interest-bearing and noninterest-bearing demand accounts, and certificates of deposit.

An offset to net interest income is the provision for loan losses, or the recapture of the provision for loan losses, that is required to establish the allowance for loan losses at a level that adequately provides for probable losses inherent in our loan portfolio.

As our loan portfolio increases, or due to an increase for probable losses inherent in our loan portfolio, our allowance for loan losses may increase, resulting in a decrease to net interest income after the provision.

Improvements in loan risk ratings, increases in property values, or receipt of recoveries of amounts previously charged off may partially or fully offset any required increase to allowance for loan losses due to loan growth or an increase in probable loan losses.

Our provision for loan losses was $425 thousand for the year ended December 31, 2021, compared to $925 thousand for the year ended December 31, 2020, primarily due to economic improvements in our markets as initial COVID-19 restrictions implemented in the second quarter of last year have been lifted.

Our noninterest expenses consist primarily of salaries, employee benefits, incentive pay, expenses for occupancy, online and mobile services, marketing, professional fees, data processing, charitable contributions, FDIC deposit insurance premiums and regulatory expenses.

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Occupancy expenses, which are the fixed and variable costs of buildings and equipment, consist primarily of lease payments, property taxes, depreciation charges, maintenance and the cost of utilities.

Our strategic plan targets consumers, small- and medium-size businesses, and professionals in our market area for loans and deposits.

A significant portion of these loans have adjustable rates, higher yields or shorter terms and higher credit risk than traditional fixed-rate mortgages.

Our commercial loan portfolio (commercial and multifamily real estate and commercial business loans) increased to $330.0 million or 53.6% of our loan portfolio at December 31, 2020, from $300.2 million or 48.3% of our loan portfolio at December 31, 2019, and $291.4 million or 46.9% of our loan portfolio at December 31, 2018.

In addition to higher balances in commercial lending, we also benefit from lending opportunities in our consumer loan portfolio.

Our consumer loan portfolio, which includes manufactured and floating homes and other consumer loans, increased to $75.8 million or 12.4% of our loan portfolio at December 31, 2020, from $72.7 million or 11.7% of our loan portfolio at December 31, 2019, and $67.6 million or 10.9% of our loan portfolio at December 31, 2018.

Additional commercial and multifamily real estate and consumer loans have improved our net interest income and helped diversify our loan portfolio mix.

Our provision for loan losses was $925,000 for the year ended December 31, 2020, compared to a recapture of loan loss expense of $125,000 for the year ended December 31, 2019 and a provision for loan losses of $525,000 for the year ended December 31, 2018.

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Recent Accounting Standards

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Financial Statements and Supplementary Data" of this report on Form 10-K.

Critical Accounting Policies

Summary of Critical Accounting Policies and Estimates

Certain of our accounting policies are important to an understanding of our financial condition, since they require management to make difficult, complex or subjective judgments, which may relate to matters that are inherently uncertain.

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

Management reviews the level of the allowance at least quarterly.

Management reviews the level of the allowance at least quarterly and performs a sensitivity analysis on the assumptions utilized in the estimate.

To strengthen our loan review and classification process, we engage an independent consultant to review our classified loans and a significant sample of recently originated non-classified loans annually.

We also enhanced our credit administration policies and procedures to improve our maintenance of updated financial data on commercial borrowers.

While we believe the estimates and assumptions used in our determination of the adequacy of the allowance are reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future provisions will not exceed the amount of past provisions or that any increased provisions that may be required will not adversely impact our financial condition and results of operations.

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

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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 future provisions will not exceed past provisions or that any increased provisions that may be required will not adversely impact our financial condition and results of operations.

In addition, the determination of the amount of our allowance for loan losses is subject to

review by bank regulators as part of the routine examination process, which may result in the adjustment of reserves based upon their judgment of information available to them at the time of their examination.

Other-Than-Temporary Impairment of Securities .

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We are focused on monitoring existing performing loans, resolving nonperforming assets and selling foreclosed assets.

Nonperforming assets were $3.5 million, or 0.40% of total assets, at December 31, 2020 compared to $5.2 million or 0.73% of total assets, at December 31, 2019.

Nonperforming assets were

$6.2 million, or 0.68% of total assets, at December 31, 2021 compared to $3.5 million or 0.40% of total assets, at December 31, 2020.

We continue to seek to reduce the level of nonperforming assets through collections, modifications and sales of OREO.

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We also take proactive steps to resolve our non-performing loans, including negotiating payment plans, forbearances, loan modifications and loan extensions on delinquent loans when such actions have been deemed appropriate.

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In addition to our retail branches, we maintain state of the art technology-based products, such as business cash management, business remote deposit products, business and consumer mobile banking applications and consumer remote deposit products.

Total deposits increased to $748.0 million at December 31, 2020, from $616.7 million at December 31, 2019, and $553.6 million at December 31, 2018.

At December 31, 2020, core deposits, which we define as our non-time deposit accounts and time deposit accounts of less than $250,000, increased $129.7 million to $668.1 million, while FHLB advances decreased $7.5 million to zero from the balance at December 31, 2019.

Total deposits increased to $798.3 million at December 31, 2021, from $748.0 million at December 31, 2020.

At December 31, 2021, core deposits, which we define as our non-time deposit accounts and time deposit accounts of less than $250 thousand, increased $131.3 million to $755.2 million from $623.9 million at December 31, 2020.

As a result of the increased liquidity from core deposits, we did not borrow against our lines of credit.

Maintaining Our Client Service Focus.

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We continue to be disciplined as it pertains to future expansion, acquisitions and de novo branching focusing on the markets in Western Washington, which we know and understand.

COVID 19 Response

In response to the COVID-19 pandemic, the Company is offering a variety of relief options designed to support our clients and communities we serve.

Paycheck Protection Program Participation.

The CARES Act was signed into law on March 27, 2020, and authorized the SBA to temporarily guarantee loans under a loan program called the PPP.

As a qualified SBA lender, the Company was automatically authorized to originate PPP loans upon commencement of the program in April 2020.

The SBA guarantees 100% of the PPP loans made to eligible borrowers.

PPP loans have:

(a) an interest rate of 1.0%, (b) a two-year loan term to maturity;

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and (c) principal and interest payments deferred for six months from the date of disbursement.

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

Through the conclusion of the PPP on August 8, 2020, we funded $74.8 million in PPP loans, with an average loan amount of $82,000.

Many of the PPP applications have been from our existing clients but we are also serving those in our communities who have not had a banking relationship with us in the past.

In addition to the 1% interest earned on these loans, the SBA pays us fees for processing PPP loans in the following amounts:

(i) 5% for loans of not more than $350,000;

(ii) 3% for loans of more than $350,000 and less than $2,000,000;

and (iii) 1% for loans of at least $2,000,000.

We may not collect any fees from the loan applicants.

The following table summarizes our PPP participation at December 31, 2020 (dollars in thousands):

Funded At December 31, 2020

Total Outstanding Number of Loans Average Loan Amount Outstanding Number of Loans

Existing clients $ 31,555 363 $ 87 $ 11,322 $ 170

New clients 43,221 546 79 31,947 412

Total PPP loans $ 74,776 909 $ 82 $ 43,269 582

The SBA processing fees for the approved PPP loans totaled $2.9 million for the year ended December 31, 2020.

These fees are deferred and recognized in interest income over the life of the PPP loans.

For the year ended December 31, 2020, interest income included $467,000 in fees earned related to PPP loans.

Recent legislation reopened the PPP through March 31, 2021, by authorizing $284.5 billion in funding for eligible small businesses and non-profits.

In January 2021, the Bank began accepting and processing loan applications under this second PPP program and will continue working with clients to assist them with accessing other borrowing options, including SBA and other government-sponsored lending programs, as appropriate.

Loan Modifications.

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

At December 31, 2020, we are continuing to provide payment relief for both consumer and business clients, most of which relief involves interest only or payment deferrals that range from 90 to 180 days.

Deferred loans are re-evaluated at the end of the deferral period and will either return to the original loan terms or be reassessed at that time to determine if a further modification should be granted and if a downgrade in risk rating is appropriate.

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

The $4.4 million of residential loans that are still under payment relief at December 31, 2020, include eight residential loans totaling $907,000 that have entered into a second payment forbearance agreement with a weighted average loan-to-value of 66%, 10 residential loans totaling $2.0 million that have entered into a third payment forbearance agreement with a weighted average loan-to value of 57%, and three residential loans totaling $525,000 that have entered into a fourth forbearance agreement with a weighted average loan-to-value of 65%.

The $8.1 million in commercial loans that are still under payment relief at December 31, 2020, include three commercial loans totaling $1.7 million that have entered into a second interest-only payment agreement with a weighted average loan-to-value of 65%, and one commercial loan totaling $2.4 million that has entered into a third interest-only payment agreement with a loan-to-value of 47%.

The COVID-19 loan modifications discussed above were not classified as TDRs in accordance with the guidance of the CARES Act and related regulatory banking guidance.

The CARES Act provides that the short-term modification of loans as a result of the COVID-19 pandemic, made on a good faith basis to borrowers who were current as defined under the CARES Act prior to any relief, are not TDRs.

This includes short-term (up to twelve months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant.

Borrowers are considered current under the CARES Act (as extended by the CAA, 2021) and related regulatory banking guidance if they are less than 30 days past due on their contractual payments at the time a modification program is implemented and the relief is executed prior to December 31, 2020 or the earlier of 60 days after the national emergency termination date or January 1 2022, whichever is earlier.

As of December 31, 2020, we had no new pending requests for payment relief.

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

S upport for Clients, Employees and Community during Pandemic.

Our retail locations continue to operate with full service, in compliance with various mandates and recommendations including masks, distancing and capacity management.

The majority of back office and administrative employees have worked remotely throughout the pandemic.

We monitor and

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conform our practices based on updates from the Center for Disease Control, World Health Organization, Financial Regulatory Agencies, and local and state health departments.

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

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

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

As of December 31,

Selected Financial Condition Data:

Total assets $ 919,691 $ 861,402

Total loans held for portfolio, net 680,092 607,363

Loans held-for-sale 3,094 11,604

Available-for-sale securities, at fair value 8,419 10,218

Bank-owned life insurance ("BOLI"), net 21,095 14,588

OREO and repossessed assets, net 659 594

FHLB stock, at cost 1,046 877

Total deposits 798,320 747,981

Subordinated notes, net 11,634 11,592

Stockholders' equity $ 93,358 $ 85,484

Total assets increased by $58.3 million, or 6.8%, to $919.7 million at December 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 loans held-for-sale.

The increase was primarily a result of an increase in loans held-for-portfolio and BOLI, partially offset by lower balances in cash and cash equivalents and decreases in loans held-for-sale.

Cash and Securities.

Cash, cash equivalents and our available-for-sale securities increased by $139.0 million, or 213.6%, to $204.0 million at December 31, 2020.

Cash and cash equivalents increased $138.1 million, or 247.6%, to $193.8 million at December 31, 2020.

The increase in total cash and cash equivalents was due to deposit growth and the proceeds from the issuance of $12 million in subordinated notes during the third quarter of 2020.

Available-for-sale securities, which consist of agency mortgage-backed securities and municipal bonds, increased $912,000, or 9.8%, to $10.2 million at December 31, 2020, from $9.3 million at December 31, 2019, primarily due to the purchase of investment securities during the year.

At December 31, 2020, our securities portfolio consisted of 16 agency mortgage-backed securities and 10 municipal bonds with a fair value of $10.2 million.

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

During the year ended December 31, 2020 we did not recognize any non-cash OTTI losses on our investment securities.

At December 31, 2020, six agency mortgage-backed securities had unrealized losses of $6,000, but management determined the decline in value was not related to specific credit deterioration.

The unrealized losses were caused by changes in interest rates and the widening of market spreads subsequent to purchase of these securities.

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

Loans held-for-portfolio, net, decreased $6.9 million, or 1.1%, to $607.4 million at December 31, 2020 from $614.2 million at December 31, 2019.

Loans held-for-sale increased to $11.6 million at December 31, 2020 from $1.1 million at December 31, 2019.

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

Cash, cash equivalents and our available-for-sale securities decreased by $12.0 million, or 5.9%, to $192.0 million at December 31, 2021 compared to the prior year.

Cash and cash equivalents decreased $10.2 million, or 5.3%, to $183.6 million due to deploying cash earning a nominal yield into higher earning loans and investments.

Available-for-sale securities, which consist of agency mortgage-backed securities and municipal bonds, decreased $1.8 million, or 17.6%, to $8.4 million at December 31, 2021, primarily due to calls of securities, regularly scheduled payments and maturities outpacing purchases of securities during the year.

Loans held-for-portfolio, net, increased $72.7 million, or 12.0%, to $680.1 million at December 31, 2021 from $607.4 million at December 31, 2020.

Loans held-for-sale decreased to $3.1 million at December 31, 2021 from $11.6 million at December 31, 2020 primarily due to a decline in mortgage originations reflecting reduced refinance activity.

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

December 31, Amount Percent

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Total loans $ 687,868 $ 615,498 $ 72,370 11.8

The largest dollar increases in the loan portfolio were in commercial business loans, which increased $25.3 million or 65.0% to $64.2 million, driven by the origination of PPP loans, other consumer loans, which increased $6.7 million or 81.0%, to $15.0 million, and commercial and multifamily real estate loans, which increased $4.5 million or 1.7%, to $265.8 million.

These increases were offset by decreases in the one-to-four family loans portfolio, which decreased $18.7 million, or 12.5%, to $130.7 million, primarily as a result of increased sales of conforming one-to-four family loans to Fannie Mae rather than retaining the loans for portfolio, construction and land loans, which decreased $13.0 million or 17.2%, to $62.8 million, home equity loans, which decreased $7.6 million, or 31.8%, to $16.3 million, and floating home loans which decreased $3.9 million, or 9.0%, to $39.9 million.

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The largest dollar increases in the loan portfolio were in one-to-four family loans portfolio, which increased $77.0 million, or 58.9%, to $207.7 million driven largely by jumbo residential mortgages, floating home loans which increased $19.4 million, or 48.7%, to $59.3 million, and commercial and multifamily real estate loans, which increased $12.4 million or 4.7%, to $278.2 million.

These increases were partially offset by decreases in commercial business loans, which decreased $36.2 million or 56.4% to $28.0 million, resulting from the forgiveness by the SBA of $82.8 million of PPP loans, and a decrease in home

equity loans of $3.0 million, or 18.5%, to $13.3 million.

We had 32 PPP loans outstanding totaling $4.2 million as of December 31, 2021.

The loan portfolio remains well-diversified with commercial and multifamily real estate loans accounting for 40.4% of the portfolio, one-to-four family real estate loans, including home equity loans, accounting for approximately 32.1% of the portfolio and consumer loans, consisting of manufactured homes, floating homes, and other consumer loans accounting for 14.2% of the total loan portfolio at December 31, 2021.

Construction and land loans accounted for 9.2% of the portfolio and commercial business loans accounted for the remaining 4.1% of the portfolio at December 31, 2021.

Mortgage Servicing Rights.

The fair value of mortgage servicing rights was $3.8 million at December 31, 2020, compared to $3.2 million at December 31, 2019.

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

We stratify our capitalized mortgage servicing rights based upon the type, term and interest rates of the underlying loans.

Mortgage servicing rights are carried at fair value.

If the fair value of our mortgage servicing rights fluctuates significantly, our financial results could be materially impacted.

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.

All of these loan modifications have been made in response to the COVID-19 pandemic.

At December 31, 2021, there were two one-to-four family residential loans totaling $64 thousand operating under forbearance agreements due to COVID-19.

Since these loans were performing loans that were current on their payments prior to the COVID-19 pandemic, these modifications are not considered TDRs pursuant to applicable accounting and regulatory guidance until January 1, 2022.

Nonperforming Assets.

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

December 31, Amount Percent

2020 2019 Change Change

2021 2020 Amount

Change Percent

Nonaccrual loans $ 5,130 $ 2,710 $ 2,420 89.3 %

Nonperforming TDRs 422 174 248 142.5

Total nonperforming loans 5,552 2,884 2,668 92.5

OREO and repossessed assets 659 594 65 10.9

Total nonperforming assets $ 6,211 $ 3,478 $ 2,733 78.6 %

Nonaccrual loans decreased $1.8 million or 38.1%, to $2.9 million at December 31, 2020, compared to the prior year.

Nonaccrual loans were 0.47% of total loans at December 31, 2020, compared to 0.75% of total loans at December 31, 2019.

Nonperforming loans increased $2.7 million or 92.5%, to $5.6 million at December 31, 2021, compared to the prior year primarily due to a $2.4 million commercial and multifamily loan.

Nonperforming loans were 0.81% of total loans at December 31, 2021, compared to 0.47% of total loans at December 31, 2020.

We had no loans greater than 90 days delinquent and still accruing at December 31, 2021 and 2020.

OREO and repossessed assets were $594,000 and $575,000 at December 31, 2020 and 2019, respectively.

OREO and repossessed assets at December 31, 2020 and 2019 primarily consisted of a former bank branch property located in Port Angeles, Washington which was acquired in 2015 as a part of three branches purchased from another financial institution.

It is currently leased to a not-for-profit organization headquartered in our market area at a below market rate.

The addition to OREO and repossessed assets in 2020 is a manufactured home located in Everett, Washington.

Allowance for Loan Losses.

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Net (charge-offs) recoveries (119) (565)

Provision (recapture) charged to operations 925 (125)

Provision charged to operations 425 925

Balance at end of period $ 6,306 $ 6,000

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Allowance as a percentage of total loans (end of period) 0.92 % 0.98 %

Our allowance for loan losses increased $360,000, or 6.4%, to $6.0 million at December 31, 2020, from $5.6 million at December 31, 2019.

We recorded a provision for loan losses of $925,000 for the year ended December 31, 2020, compared to a

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recapture from the allowance for loan losses of $125,000 for the year ended December 31, 2019.

Our allowance for loan losses at December 31, 2020 not only reflects probable credit losses based upon the conditions that existed at December 31, 2020, but also gives consideration to potential losses from impacts of the COVID-19 pandemic.

Specific loan loss reserves decreased to $378,000 at December 31, 2020 compared to $724,000 at December 31, 2019, while general loan loss reserves increased to $5.2 million at December 31, 2020 from $4.0 million at December 31, 2019, and the unallocated reserve decreased to $406,000 at December 31, 2020, compared to $948,000 at December 31, 2019.

Loans individually evaluated for impairment decreased by $6.5 million to $5.9 million at December 31, 2020, compared to $12.4 million at December 31, 2019.

Net charge-offs were $565,000 for the year ended December 31, 2020, compared to net charge-offs of $9,000 for the year ended December 31, 2019.

The increase in 2020 charge-offs is primarily related to one commercial borrower who was forced into bankruptcy after a tragic vehicle accident.

Our line of credit to this borrower was approved in July, 2019 for $975,000, secured by business assets including 19 vehicles, and fully advanced at the time of bankruptcy.

Because the vehicles were specialized for offering land and sea tours, their value was depressed due to the pandemic.

As a result, our liquidation of the collateral resulted in a loss of $514,000.

Our allowance for loan losses increased $306 thousand, or 5.1%, to $6.3 million at December 31, 2021, from $6.0 million at December 31, 2020.

Specific loan loss reserves decreased to $293 thousand at December 31, 2021, compared to $378 thousand at December 31, 2020, while general loan loss reserves increased to $5.6 million at December 31, 2021, compared to $5.2 million at December 31, 2020 and the unallocated reserve decreased to $395 thousand at December 31, 2021, compared to $406 thousand at December 31, 2020.

The decrease in the unallocated reserve was primarily a result of the increase in the loan portfolio at December 31, 2021, partially offset by a positive adjustment in the qualitative factors applied to real estate related loans as a result of the improvement in economic conditions related to the strong housing market.

The $4.2 million balance of PPP loans was omitted from the calculation for the allowance for loan losses at December 31, 2021, as these loans are 100% guaranteed by the SBA and management expects that the majority of the remaining 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 year ended December 31, 2021 totaled $119 thousand, compared to $565 thousand for the year ended December 31, 2020.

At December 31, 2021, the allowance for loan losses as a percentage of total loans and nonperforming loans was 0.92% and 113.59%, respectively, compared to 0.98% and 208.04%, respectively, at December 31, 2020.

Total deposits increased $50.3 million, or 6.7%, to $798.3 million at December 31, 2021 from $748.0 million at December 31, 2020.

The increase was due to growth in all deposit categories, except for certificates of deposit.

Interest-bearing demand deposits increased $70.7 million, or 44.3%, to $230.5 million at December 31, 2020 from $159.8 million at December 31, 2019.

Noninterest-bearing demand deposits increased $34.3 million, or 36.1%, to $129.3 million at December 31, 2020 from $95.0 million at December 31, 2019.

Savings deposits increased $25.8 million or 44.6%, to $83.8 million at December 31, 2020 from $57.9 million at December 31, 2019, and money market deposits increased $15.4 million, or 30.6%, to $65.7 million at December 31, 2020, from $50.3 million at December 31, 2019.

These increases were partially offset by a decrease of $15.9 million, or 6.3%, in certificates of deposit to $235.5 million at December 31, 2020 from $251.4 million at December 31, 2019.

The increase in total deposits at December 31, 2020 compared to December 31, 2019 was the result of developing relationships with PPP borrowers who were not previously clients, adding new consumer clients, and expanding relationships with existing clients, as well as reduced withdrawals, reflecting changes in customer spending habits due to the COVID-19 pandemic.

The increase was due primarily due to higher balances in existing client accounts, developing further relationships with PPP borrowers who were not previously clients, 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 $58.0 million, or 43.8%, to $190.5 million at December 31, 2021, compared to $132.5 million at December 31, 2020.

Noninterest-bearing deposits represented 23.9% of total deposits at December 31, 2021, compared to 17.7% at December 31, 2020.

A summary of deposit accounts with the corresponding weighted-average cost at December 31, 2021 and 2020 is presented below (dollars in thousands):

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

FHLB advances decreased $7.5 million to zero at December 31, 2020, as we utilized our increase in deposits for funding needs.

FHLB advances remained at zero throughout 2021, as we utilized our increase in deposits for funding needs.

We rely on FHLB advances to fund interest-earning assets when deposits alone cannot fully fund interest-earning asset growth.

In September 2020, we completed a private placement of $12.0 million in aggregate principal of subordinated notes, resulting in net proceeds, after placement fees and offering expenses, of approximately $11.6 million.

Subordinated notes, net totaled $11.6 million at each of December 31, 2021 and 2020.

For additional information regarding our borrowings, see "Note 10—Borrowings, FHLB Stock and Subordinated Notes" in the Notes to Consolidated Financial Statements contained in "Part II.

Financial Statements and Supplementary Data" of this report on Form 10-K.

Stockholders' Equity.

Total stockholders' equity increased $7.8 million, or 10.0%, to $85.5 million at December 31, 2020, from $77.7 million December 31, 2019.

This increase primarily reflects net income of $8.9 million, stock-based compensation of $338,000, ESOP share allocations of $324,000 and proceeds of $239,000 received in connection with stock option exercises, partially offset by cash dividends paid to stockholders of $2.1 million and repurchases of the Company's stock of $73,000.

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Total stockholders’ equity increased $7.9 million, or 9.2%, to $93.4 million at December 31, 2021, from $85.5 million at December 31, 2020.

This increase primarily reflects $9.2 million in net income for the year ended December 31, 2021, partially offset by the payment of cash dividends of $2.0 million to common stockholders during the year ended December 31, 2021.

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

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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).

2020 2019 2018

Balance Interest

Year Ended December 31,

Balance Interest

Rate Annualized Average

Balance Interest

Rate Annualized

Interest-earning assets:

$ 665,389 $ 34,439 5.18 % $ 599,944 $ 33,090 5.52 % $ 589,205 $ 31,881 5.41 %

Investments and interest-bearing accounts 104,328 497 0.48 64,386 1,491 2.32 60,628 1,286 2.12

Loans receivable $ 650,045 $ 33,389 5.14 % $ 665,389 $ 34,439 5.16 %

Investments, cash and cash equivalents 221,577 485 0.22 102,539 497 0.48

Total interest-earning assets (1)

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Average interest-earning assets to average interest-bearing liabilities 138.19 % 132.26 %

Total deposits 797,686 3,282 0.41 % 691,359 7,004 1.01 %

Total funding (2)

809,298 3,954 0.49 % 711,314 7,450 1.04 %

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

Table of Conten t s

(2) Total funding is the sum of average interest-bearing liabilities and average noninterest-bearing deposits.

The cost of total funding is calculated as annualized total interest expense divided by average total funding.

Rate/Volume Analysis

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Year Ended December 31,

2019 Year Ended December 31,

Increase (Decrease) due to Total

Increase (Decrease) Increase (Decrease) due to Total

Increase (Decrease)

Volume Rate Volume Rate

Interest-earning assets:

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Certificate accounts (1,324) (1,934) (3,258)

Subordinated debt 191 — 191

Subordinated notes 478 3 481

Borrowings — (255) (255)

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Comparison of Results of Operation for the Years Ended December 31, 2021 and 2020

Net income increased $2.3 million to $8.9 million, or $3.42 per diluted common share, for the year ended December 31, 2020, from $6.7 million, or $2.57 per diluted common share, for the year ended December 31, 2019.

The increase in net income in 2020 compared to 2019 was primarily due to higher noninterest income, particularly gain on sale of loans, and increased net interest income, partially offset by an increase in the provision for loan losses and an increase in income tax expense.

Year Ended December 31,

Selected Operations Data:

Total interest income $ 33,874 $ 34,936

Total interest expense 3,954 7,450

Net interest income 29,920 27,486

Provision for loan losses 425 925

Net interest income after provision for loan losses 29,495 26,561

Service charges and fee income 2,247 1,905

Earnings on cash surrender value of BOLI 416 348

Mortgage servicing income 1,284 1,027

Fair value adjustment on mortgage servicing rights ("MSRs") (808) (1,857)

Net gain on sale of loans 4,190 6,022

Other income — —

Total noninterest income 7,329 7,445

Salaries and benefits 14,257 12,083

Operations expense 5,765 5,461

Occupancy expense 1,748 1,881

Net losses and expenses on OREO and repossessed assets (16) 5

Other noninterest expense 3,642 3,248

Total noninterest expense 25,396 22,678

Income before provision for income taxes 11,428 11,328

Provision for income taxes 2,272 2,391

Net income $ 9,156 $ 8,937

Net income increased $219 thousand, or 2.5%, to $9.2 million, or $3.46 per diluted common share, for the year ended December 31, 2021, compared to $8.9 million, or $3.42 per diluted common share, for the year ended December 31, 2020.

The increase was primarily a result of a $3.5 million decrease in interest expense and a $500 thousand decrease in the provision for loan losses for the year ended December 31, 2021, partially offset by a $1.1 million decrease in interest income and a $2.7 million increase in noninterest expense.

Interest Income.

Total interest income increased by $355,000, or 1.0%, to $34.9 million for the year ended December 31, 2020, from $34.6 million for the year ended December 31, 2019.

Interest income on loans increased $1.3 million, or 4.1%, to $34.4 million for the year ended December 31, 2020, compared to $33.1 million for the year ended December 31, 2019, due to higher average loan balances, partially offset by a decrease in average yield.

The average loans held-for-portfolio balance was $665.4 million for the year ended December 31, 2020, compared to $599.9 million for the year ended December 31, 2019.

The average yield on loans held-for-portfolio was 5.18% for the year ended December 31, 2020, compared to 5.52% for the year ended December 31, 2020.

The average yield on loans decreased compared to the same period in the prior year due primarily to decreases in interest rates on adjustable-rate instruments, following decreases to short-term rates over the last year, including the emergency 150-basis point reduction in the targeted federal funds rate in March 2020 due to the COVID-19 pandemic, and secondarily, due to the impact of PPP loans.

For the year ended December 31, 2020, the average balance of PPP loans was $46.7 million and the average yield on PPP loans was 4.32%, including the recognition of the net deferred fees.

Interest income included $467,000 in fees earned related to PPP loans during 2020 compared to none in the prior year.

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

The change in interest income on investments and interest-bearing accounts was primarily due to the decline in short-term interest rates in 2020 discussed above.

Interest income decreased $1.1 million, or 3.0%, to $33.9 million for the year ended December 31, 2021, from $34.9 million for the year ended December 31, 2020.

The decrease was primarily due to a 65 basis point decline in average yield on interest-earning assets and a $15.3 million decline in the average balance of outstanding loans.

Interest income on loans decreased $1.1 million, or 3.0%, to $33.4 million for the year ended December 31, 2021, compared to $34.4 million for the year ended December 31, 2020, driven by lower average total loans resulting primarily from the decline in commercial and multifamily loans and commercial business loans, partially offset a two basis points decline in the average yield on loans.

The average balance of total loans was $650.0 million for the year ended December 31, 2021, compared to $665.4 million for the year ended December 31, 2020.

The average yield on total loans was 5.14% for the year ended December 31, 2021, compared to 5.16% for the year ended December 31, 2020.

For the year ended December 31, 2021, the average balance of PPP loans was $35.3 million and the average yield on PPP loans was 8.55%, including the recognition of the net deferred fees, with a positive impact on average loan yield of 20 basis points.

For the year ended December 31, 2020, the average balance of PPP loans was $46.7 million and the average yield on PPP loans was 4.30%, including the recognition of deferred fees, with a negative impact on average loan yield of six basis points.

Interest income included $3.0 million in fees earned related to PPP loans in the year ended December 31, 2021, compared to $2.0 million in the same period a year ago.

Interest income on the investment portfolio and cash and cash equivalents decreased $12 thousand, or 2.4%, to $485 thousand for the year ended December 31, 2021, compared to $497 thousand for the year ended December 31, 2020.

The decrease in the interest income on investment securities and cash and cash equivalents was due to lower average yields, partially offset by higher average balances.

The average yield on investments and cash and cash equivalents was 0.22% for the year ended December 31, 2021, compared to 0.48% for the year ended December 31, 2020, primarily due to the substantial increase in cash and cash equivalents earning a nominal yield.

Interest Expense.

Interest expense decreased $167,000, or 2.2%, to $7.5 million during the year ended December 31, 2020, compared to $7.6 million during the year ended December 31, 2019, primarily due to lower average balances and rates paid on

Table of Conten t s

borrowings and lower rates paid on interest-bearing deposits, partially offset by higher average interest-bearing deposit balances and the issuance of subordinated notes, with its commensurate interest expense.

Interest expense on deposits increased $139,000, or 2.0%, to $7.0 million for the year ended December 31, 2020, compared to the prior year, primarily driven by an increase of $67.1 million, or 13.6%, in the average balance of interest-bearing deposit accounts to $560.6 million.

Average balances in all types of interest-bearing deposits increased in 2020.

The resulting negative impact to interest expense was partially offset by 15-basis point decrease in the weighted-average rate paid on interest-bearing deposits, which decreased to 1.01% for the year ended December 31, 2020, from 1.16% for the year ended December 31, 2019.

Although the average balance of certificate accounts accounted for 11.3% of the increase in the average balance in interest-bearing deposits year over year, due to the average rate paid on this type of account relative to other deposits, it contributed $194,000 to the increase in interest expense year over year.

In September 2020, we completed a private placement of $12.0 million in aggregate principal of subordinated notes, resulting in net proceeds after placement fees and offering expenses, of approximately $11.6 million.

Interest expense on our subordinated notes totaled $191,000 for the year ended December 31, 2020.

Interest expense on borrowings, which include FHLB advances and Federal Reserve discount window and the PPPLF program, decreased $497,000, or 66.1%, to $255,000 for the year ended December 31, 2020 from $752,000 for the year ended December 31, 2019, due to a $7.8 million, or 31.9% decrease in the average balance of borrowings to $16.6 million for the year ended December 31, 2020, from $24.4 million for the year ended December 31, 2019.

The weighted-average interest rate on borrowings was 1.54% in 2020 and 3.08% in 2019.

The need for borrowings declined significantly in 2020 due to increased liquidity resulting from growth in customer deposits.

Our overall weighted-average cost of interest-bearing liabilities was 1.28% for the year ended December 31, 2020, compared to 1.47% for the year ended December 31, 2019.

Interest expense decreased $3.5 million, or 46.9%, to $4.0 million for the year ended December 31, 2021, from $7.5 million for the year ended December 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 $3.7 million, or 53.1%, to $3.3 million for the year ended December 31, 2021, compared to $7.0 million for the same period a year ago.

The decrease was primarily the result of a decline in the average cost of deposits reflecting reduced market rates paid on deposits and the change in the mix of deposits reflecting the managed runoff of higher cost certificates of deposit.

The average cost of total deposits decreased 60 basis points to 0.41% for the year ended December 31, 2021, from 1.01% for the year ended December 31, 2020.

Interest expense on borrowings and subordinated notes increased $226 thousand, or 50.7%, to $672 thousand for the year ended December 31, 2021, which was comprised solely of interest expense on our subordinated notes, compared to $446 thousand for the year ended December 31, 2020, which was comprised of interest expense on subordinated notes for one quarter in 2020 and FHLB advances.

Average borrowings and subordinated notes decreased $8.3 million, to $11.6 million for the year ended December 31, 2021, which consisted solely of subordinated notes, from $20.0 million for the year ended December 31, 2020, which consisted of both FHLB advances and subordinated notes.

The average cost of the subordinated notes and FHLB advances was 5.79% for the year ended December 31, 2021, compared to 2.23% for the year ended December 31, 2020.

Net Interest Income.

Net interest income increased $522,000, or 1.9%, to $27.5 million for the year ended December 31, 2020, from $27.0 million for the year ended December 31, 2019, primarily as a result of higher interest income on loans and lower overall interest expense.

Our net interest margin was 3.57% for the year ended December 31, 2020, compared to 4.06% for the year ended December 31, 2019.

The low interest-rate environment putting downward pressure on income from adjustable-rate loans and investments and an increase in costs related to interest-bearing deposits adversely impacted net interest margin for the current year.

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

The lower average yield on PPP loans, including recognition of deferred loan fees, also contributed to the decline in the net interest margin.

Provision (Recapture) for Loan Losses.

We establish our allowance for loan losses through provisions for loan losses, which are charged to earnings, at a level required to reflect management's best estimate of the probable incurred credit losses in the loan portfolio.

In evaluating the level of the allowance for loan losses, management considers historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect borrowers' ability to repay, estimated value of any underlying collateral, peer group data, prevailing economic conditions, and other qualitative factors.

Large groups of smaller balance homogeneous loans, such as one-to four-family, commercial and multifamily real estate, home equity and consumer loans, including floating homes and manufactured homes, are evaluated in the aggregate using historical loss factors adjusted for current economic conditions and other relevant data.

Net interest income increased $2.4 million, or 8.9%, to $29.9 million for the year ended December 31, 2021, from $27.5 million for the year ended December 31, 2020.

Our net interest margin was 3.43% and 3.57% for the years ended December 31, 2021 and 2020, respectively.

The increase in net interest income primarily resulted from the decline in the average rate paid on deposits and a decline in the average balance of certificates of deposit accounts, partially offset by a decline in the average loan balance.

The decrease in net interest margin was primarily due to a decline in rates paid on interest-bearing liabilities exceeding the decline in yields earned on interest-earning assets.

During the year ended December 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 to the net interest margin of 22 basis points, compared to a positive impact of five basis points from our origination of low yielding PPP loans during the same period in 2020.

Provision for Loan Losses.

We establish provisions for loan losses, which are charged to earnings, based on our review of the level of the allowance for loan losses required to reflect management’s best estimate of the probable incurred credit losses in the loan portfolio.

In evaluating the level of the allowance for loan losses, management considers historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect borrowers’ ability to repay, estimated value of any underlying collateral, peer group data, prevailing economic conditions, and current factors.

Large groups of smaller balance homogeneous loans, such as one- to four- family, small commercial and multifamily, home equity and consumer loans, are evaluated in the aggregate using historical loss factors adjusted for current economic conditions and other relevant data.

Loans for which management has concerns about the borrowers’ ability to repay, are evaluated individually and specific loss allocations are provided for these loans when necessary.

We recorded a provision for loan losses of $925,000 for the year ended December 31, 2020, compared to a recapture from the allowance for loan losses of $125,000 for the year ended December 31, 2019.

The increase in the provision primarily reflects current economic conditions and gives consideration of probable loan losses due to the potential effects from higher forecasted unemployment rates and lower gross domestic product, as well as the impact on other economic conditions from COVID-19.

The recapture in the prior year was due to changes in the composition of our loan portfolio during the year.

Net loan charge-offs were $565,000 and $9,000 for the years ended December 31, 2020 and 2019.

Nonperforming loans decreased $1.8 million during the year to $2.9 million at December 31, 2020, compared to $4.7 million a year ago.

Nonperforming loans to total loans decreased to 0.47% at December 31, 2020 from 0.75% at December 31, 2019.

The allowance for loan losses increased to $6.0 million at December 31, 2020 compared to $5.6 million at December 31, 2019.

See "—Comparison of Financial Condition at December 31, 2020 and December 31, 2019— Delinquencies and Nonperforming Assets" for more information on nonperforming loans.

Table of Conten t s

amount of future provisions will not exceed the amount of past provisions or that any increased provisions that may be required will not adversely impact our financial condition and results of operations.

A provision for loan losses of $425 thousand was recorded for the year ended December 31, 2021, compared to $925 thousand provision for loan losses for the year ended December 31, 2020.

The $500 thousand decrease in the provision for loan losses during the year was primarily due to a decrease in the average balance of loans held-for-portfolio between the periods, a positive adjustment to the qualitative factors applied to real estate related loans as a result of improvement in economic conditions related to the strong housing market, partially offset by a $2.7 million increase in non-performing loans from December 31, 2020.

Our allowance for loan losses as of December 31, 2021, not only reflects probable and inherent credit losses based upon the economic conditions that existed as of December 31, 2021, but also reflects the inherent economic improvements in our markets as initial COVID-19 restrictions implemented in the second quarter of last year have been lifted.

Net charge-offs for the year ended December 31, 2021 totaled $119 thousand, compared to $565 thousand for the year ended December 31, 2020.

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, that future provisions will not exceed past provisions, or that any increased provisions which may be required in the future will not adversely impact our financial condition and results of operations.

Noninterest Income.

Noninterest income increased $3.4 million, or 84.9%, to $7.4 million for the year ended December 31, 2020, as compared to $4.0 million for the year ended December 31, 2019 as reflected below (dollars in thousands):

Year Ended December 31, Amount Percent

2020 2019 Change Change

Noninterest income decreased $116 thousand, or 1.6%, to $7.3 million for the year ended December 31, 2021, as compared to $7.4 million for the year ended December 31, 2020, as reflected below (dollars in thousands):

Year Ended December 31, Amount

Change Percent

Service charges and fee income $ 2,247 $ 1,905 $ 342 18.0 %

Earnings on cash surrender value of bank owned life insurance 348 381 (33) (8.7)

Earnings on cash surrender value of BOLI 416 348 68 19.5

Mortgage servicing income 1,284 1,027 257 25.0

Fair value adjustment on MSRs (1,857) (760) (1,097) 144.3

Fair value adjustment on mortgage servicing rights (808) (1,857) 1,049 (56.5)

Net gain on sale of loans 4,190 6,022 (1,832) (30.4)

Total noninterest income $ 7,329 $ 7,445 $ (116) (1.6) %

The increase in noninterest income from one year ago was primarily due to a $4.6 million increase in gain on sale of loans, partially offset by a $1.1 million decrease in the mark-to-market adjustment on fair value of MSRs during the year ended December 31, 2020.

Demand for one-to-four family loans grew significantly in 2020 as homeowners, taking advantage of historically low interest rates, refinanced their homes.

In addition, the pandemic increased demand for single-family homes outside downtown metropolitan areas.

The decrease in noninterest income during the year ended December 31, 2021, compared to the same period in 2020 primarily was due to the decrease in net gain on sale of loans, partially offset by improvement in the fair value adjustment on mortgage servicing rights, and increases in service charges and fees, and mortgage servicing income.

Net gain on sale of loans decreased due to the decrease in sales volume, primarily due to lower originations due to reduced refinance activity, partially offset by higher margins on sale.

Loans sold during the year ended December 31, 2021, totaled $147.4 million, compared to $176.0 million during the year ended December 31, 2020.

Service charges and fee income increased primarily due to higher debit/ATM interchange fees.

Mortgage servicing income was higher as a result of our mortgage servicing portfolio increasing to $508.1 million at December 31, 2021 compared to $488.7 million at December 31, 2020.

Noninterest Expense .

Noninterest expense decreased $107,000, or 0.5%, to $22.7 million for the year ended December 31, 2020, from the year ended December 31, 2019, as reflected below (dollars in thousands):

Year Ended December 31, Amount Percent

2020 2019 Change Change

Noninterest expense increased $2.7 million, or 12.0%, to $25.4 million during the year ended December 31, 2021, compared to $22.7 million during the year ended December 31, 2020, as reflected below (dollars in thousands):

Year Ended December 31, Amount

Change Percent

Salaries and benefits $ 14,257 $ 12,083 $ 2,174 18.0 %

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Data processing 3,263 2,658 605 22.8

Losses and expenses on OREO and repossessed assets 5 35 (30) (85.7)

Net gain on OREO and repossessed assets (16) 5 (21) (420.0)

Total noninterest expense $ 25,396 $ 22,678 $ 2,718 12.0 %

Salaries and benefits decreased $319,000 due to an increase in deferred loan origination costs which had the effect of lowering up-front commission expense.

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

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

Regulatory assessments increased $311,000 to its pre-2019 level, as the Bank utilized all of its remaining regulatory assessment credits in 2019.

The efficiency ratio, which is noninterest expense as a percentage of net interest income and noninterest income, for the year ended December 31, 2020 was 64.90%, compared to 73.52% for the year ended December 31, 2019.

The improvement in the efficiency ratio compared to the prior year was primarily due to the increase in noninterest income earned during the current year.

Salaries and benefits, the largest driver of noninterest expense, increased primarily due to discretionary bonuses paid for added efforts associated with the Company's COVID-19 response, higher wages, lower deferred compensation and higher medical expenses, partially offset by a decrease in commission expense related to a decline in mortgage originations during 2021 as compared to 2020.

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

Operations expense increased primarily due to increases in marketing expenses, reserve for unfunded commitments, and professional fees.

The increase in the reserve for unfunded commitments primarily resulted from an increase in construction loan commitments.

Regulatory assessments decreased due to lower FDIC assessments in 2021 and regulatory exam costs included in the 2020 balance.

Occupancy expense decreased due to the closure of one branch location in June 2020.

The efficiency ratio for the year ended December 31, 2021 was 68.18%, compared to 64.92% for the year ended December 31, 2020.

The weakening in the efficiency ratio for the year ended December 31, 2021 was primarily due to higher noninterest expense and lower revenues.

Income Tax Expense .

The provision for income taxes increased $740,000, or 44.8% to $2.4 million for the year ended December 31, 2020, compared to $1.7 million for the year ended December 31, 2019, due to an increase in taxable net income and higher effective tax rate.

The provision for income taxes decreased $119 thousand, or 5.0% to $2.3 million for the year ended December 31, 2021, compared to $2.4 million for the year ended December 31, 2020, due to a lower effective tax rate, partially offset by an increase in taxable net income.

The effective tax rates for the years ended December 31, 2021 and 2020 were 19.9% and 21.1%, respectively.

Liquidity management is both a daily and longer-term function of management.

Excess liquidity is generally invested in short-term investments, such as overnight deposits and federal funds.

On a longer-term basis, we maintain a strategy of investing in

Table of Conten t s

various loan products and investment securities, including mortgage-backed securities.

We use our sources of funds primarily to meet ongoing commitments, pay maturing deposits, fund deposit withdrawals and fund loan commitments.

We maintain cash and investments that qualify as liquid assets to maintain adequate liquidity to ensure safe and sound operations and meet demands for client funds (particularly withdrawals of deposits).

At December 31, 2020, we had $204.0 million in cash and available-for-sale investment securities and $11.6 million in loans held-for-sale.

We can also obtain funds from borrowings, primarily FHLB advances.

At December 31, 2020, we had the ability to borrow an additional $213.7 million in FHLB advances, subject to certain collateral requirements and we had access to additional borrowings of $23.6 million through the Federal Reserve's discount window and PPPLF program, subject to certain collateral requirements.

We had no outstanding advances or borrowings with the Federal Reserve at December 31, 2020.

In addition, we also had available $20.0 million of credit facilities with other financial institutions, with no balance outstanding at December 31, 2020 or 2019.

We are required to have adequate cash and investments that qualify as liquid assets in order to maintain sufficient liquidity to ensure safe and sound operations.

Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans.

Historically, we have maintained liquid assets above levels believed to be adequate to meet the requirements of normal operations, including potential deposit outflows.

Cash flow projections are regularly reviewed and updated to assure that adequate liquidity is maintained.

Liquidity management involves the matching of cash flow requirements of clients, who may be either depositors desiring to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs and our ability to manage those requirements.

We strive to maintain an adequate liquidity position by managing the balances and maturities of interest-earning assets and interest-bearing liabilities so that the balance we have in short-term investments at any given time will adequately cover any reasonably anticipated, immediate need for funds.

Additionally, we maintain relationships with correspondent banks, which could provide funds on short-term notice if needed.

Our liquidity, represented by cash and cash-equivalents, is a product of our operating, investing and financing activities.

As disclosed in our "Consolidated Statements of Cash Flows" in Item 8.

Financial Statements and Supplementary Data of this Annual Report on Form 10-K, cash and cash equivalents increased $138.1 million to $193.8 million at December 31, 2020, from $55.8 million at December 31, 2019.

Net cash used in operating activities was $484,000 for the year ended December 31, 2020.

Net cash of $4.5 million was provided by investing activities for the year ended December 31, 2020, primarily provided by loan maturities.

Net cash provided by financing activities of $134.0 million for the year ended December 31, 2020, primarily consisted of a $131.3 million increase in deposits and $11.6 million in net proceeds from the issuance of subordinated notes, partially offset by $7.5 million decrease in FHLB advances.

Capital and Liquidity

Shareholders’ equity totaled $93.4 million at December 31, 2021 and $85.5 million at December 31, 2020.

In addition to net income of $9.2 million, other sources of capital during 2021 included $182 thousand in proceeds from stock option exercises, $468 thousand related to the allocation of ESOP shares during the year and $360 thousand related to stock-based compensation.

Uses of capital during 2021 included $2.0 million of dividends paid on common stock, other comprehensive loss, net of tax, of $101 thousand and $152 thousand of stock repurchases.

We paid regular quarterly dividends of $0.17 per common share and a special dividend of $0.10 per common share during 2021, and regularly quarterly dividends per share of $0.15 per share during 2020 and a special dividend of $0.20 per common share during 2020.

This equates to a dividend payout ratio of 22.3% in 2021 and 23.2% in 2020.

The Company currently expects to continue the current practice of paying quarterly cash dividends on common stock subject to the Board of Directors' discretion to modify or terminate this practice at any time and for any reason without prior notice.

Assuming continued payment during 2022 at this rate of $0.17 per share, our average total dividend paid each quarter would be approximately $446 thousand based on the number of our current outstanding shares (which assumes no increases or decreases in the number of shares, except in connection with the anticipated vesting of currently outstanding equity awards).

The dividends, if any, we may pay may be limited as more fully discussed under “Business—How We Are Regulated—Limitations on Dividends and Stock Repurchases” contained in Item 1, Part I of this Form 10-K.

Stock Repurchase Plans.

From time to time, our board of directors has authorized stock repurchase plans.

In general, stock repurchase plans allow us to proactively manage our capital position and return excess capital to shareholders.

Shares purchased under such plans may also provide us with shares of common stock necessary to satisfy obligations related to stock compensation awards.

On April 28, 2021, the Company’s board of directors authorized a stock repurchase program to allow the Company to repurchase, over a six-month period, up to $2.0 million of the Company’s outstanding shares in the open market or in privately negotiated transactions.

On October 27, 2021, the Company’s board of directors authorized a new stock repurchase, effective upon the expiration of the prior stock repurchase program on October 28, 2021, with the same parameters as the prior stock repurchase program.

See “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” contained in Item 5, Part II of this Form 10-K for additional information relating to stock repurchases.

Liquidity measures the ability to meet current and future cash flow needs as they become due.

The liquidity of a financial institution reflects its ability to meet loan requests, to accommodate possible outflows in deposits and to take advantage of interest rate market opportunities.

The ability of a financial institution to meet its current financial obligations is a function of its balance sheet structure, its ability to liquidate assets and its access to alternative sources of funds.

The objective of our liquidity management is to manage cash flow and liquidity reserves so that they are adequate to fund our operations and to meet obligations and other commitments on a timely basis and at a reasonable cost.

We seek to achieve this objective and ensure that funding needs are met by maintaining an appropriate level of liquid funds through asset/liability management, which includes managing the mix and time to maturity of financial assets and financial liabilities on our balance sheet.

Our liquidity position is enhanced by our ability to raise additional funds as needed in the wholesale markets.

Asset liquidity is provided by liquid assets which are readily marketable or pledgeable or which will mature in the near future.

Liquid assets generally include cash, interest-bearing deposits in banks, securities available for sale, maturities and cash flow from securities, sales of fixed rate residential mortgage loans in the secondary market and federal funds sold.

Liability liquidity generally is provided by access to funding sources which include core deposits and advances from the FHLB and other borrowing relationships with third party financial institutions.

Our liquidity position is continuously monitored and adjustments are made to the balance between sources and uses of funds as deemed appropriate.

Liquidity risk management is an important element in our asset/liability management process.

We regularly model liquidity stress scenarios to assess potential liquidity outflows or funding problems resulting from economic disruptions, volatility in the financial markets, unexpected credit events or other significant occurrences deemed problematic by management.

These scenarios are incorporated into our contingency funding plan, which provides the basis for the identification of our liquidity needs.

As of December 31, 2021, we had $192.0 million in cash and available-for-sale investment securities and $3.1 million in loans held-for-sale.

At December 31, 2021, we had the ability to borrow an additional $101.5 million in FHLB advances and access to additional borrowings of $22.4 million through the Federal Reserve's discount window, in each case subject to certain collateral requirements.

We had no outstanding advances or borrowings with the FHLB or Federal Reserve at December 31, 2021.

In addition, we also had available $20.0 million of credit facilities with other financial institutions, with no balance outstanding at December 31, 2021.

Subject to market conditions, we expect to utilize these borrowing facilities from time to time in the future to fund loan originations and deposit withdrawals, to satisfy other financial commitments, repay maturing debt and to take advantage of investment opportunities to the extent feasible.

As of December 31, 2021, management is not aware of any events that are reasonably likely to have a material adverse effect on our liquidity, capital resources or operations.

In addition, management is not aware of any regulatory recommendations regarding liquidity that would have a material adverse effect on us.

For additional details, see “Note 10—Borrowings, FHLB Stock and Subordinated Notes” in the Notes to Consolidated Financial Statements contained in "Item 8.

Financial Statements and Supplementary Data" of this Form 10-K.

In the ordinary course of business, we have entered into contractual obligations and have made other commitments to make future payments.

Refer to the accompanying notes to consolidated financial statements elsewhere in this report for the expected timing of such payments as of December 31, 2021.

These include payments related to (i) long-term borrowings (Note 10—Borrowings, FHLB Stock and Subordinated Notes), (ii) time deposits with stated maturity dates (Note 9—Deposits) (iii) operating leases (Note 12—Leases) and (iv) commitments to extend credit and standby letters of credit (Note 18—Commitments and Contingencies).

Sound Financial Bancorp is a separate legal entity from Sound Community Bank and must provide for its own liquidity.

In addition to its own operating expenses (many of which are paid to Sound Community Bank), Sound Financial Bancorp is responsible for paying any dividends declared to its stockholders, and interest and principal on outstanding debt.

Sound Financial Bancorp's primary source of funds is dividends from Sound Community Bank, which are subject to regulatory limits.

In addition to its own operating expenses (many of which are paid to Sound Community Bank), Sound Financial Bancorp is responsible for paying for any stock repurchases, dividends declared to its stockholders, interest and principal on outstanding debt, and other general corporate expenses.

Sound Financial Bancorp is a holding company and does not conduct operations;

its sources of liquidity are generally dividends up-streamed from Sound Community Bank, interest on investment securities, if any, and borrowings from outside sources.

Banking regulations may limit the dividends that may be paid to us by Sound Community Bank.

See, “Business — How We Are Regulated — Limitations on Dividends and Stock Repurchases” contained in Item 1, Part I of this Form 10-K.

During the third quarter of 2020, the Company completed a private placement of $12.0 million in aggregate principal of subordinated notes resulting in net proceeds, after placement fees and offering expenses, of approximately $11.6 million.

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At December 31, 2021 Sound Financial Bancorp, on an unconsolidated basis, had $4.2 million in cash, noninterest-bearing deposits and liquid investments generally available for its cash needs.

Our liquidity, represented by cash and cash equivalents and investment securities, is a product of our operating, investing and financing activities.

Our primary sources of funds are deposits, amortization, prepayments and maturities of outstanding loans and mortgage-backed securities, maturities of investment securities and other short-term investments and funds provided from operations.

While scheduled payments from the amortization of loans and mortgage-backed securities and maturing investment securities and short-term investments are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates.

We also generate cash through borrowings.

We utilize FHLB advances to leverage our capital base and provide funds for our lending and investment activities, and to enhance our interest rate risk management.

We use our sources of funds primarily to meet ongoing commitments, pay maturing deposits and fund withdrawals, and to fund loan commitments.

At December 31, 2020, the approved outstanding loan commitments, including unused lines and letters of credit, amounted to $56.5 million.

Certificates of deposit scheduled to mature in one year or less at December 31, 2020, totaled $180.4 million.

It is management's policy to offer deposit rates that are competitive with other local financial institutions.

Based on this management strategy, we believe that a majority of maturing deposits will remain with us.

See also the "Consolidated Statements of Cash Flows" included in “Item 8.

Financial Statements and Supplementary Data” of this Form 10-K, for further information.

Table of Conten t s

Off-Balance Sheet Activities

In the normal course of operations, we engage in a variety of financial transactions that are not recorded in our financial statements.

These transactions involve varying degrees of off-balance sheet credit, interest rate and liquidity risks.

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

For the year ended December 31, 2020, we did not engage in any off-balance sheet transactions likely to have a material effect on our financial condition, results of operations or cash flows.

A summary of our off-balance sheet loan commitments at December 31, 2020, is as follows (in thousands):

Off-balance sheet loan commitments:

Residential mortgage commitments $ 3,312

Unfunded construction commitments 18,981

Unused lines of credit 34,075

Irrevocable letters of credit 151

Total loan commitments $ 56,519

Regulatory Capital.

Sound Community Bank is subject to minimum capital requirements imposed by regulations of the FDIC.

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A bank that elects to use the CBLR framework as provided for in the Economic Growth, Regulatory Relief and Consumer Protection Act will generally be considered "well-capitalized" and to have met the risk-based and leverage capital requirements of the capital regulations if it has a leverage ratio greater than 9.0%.

As required by the CARES Act, the FDIC has temporarily lowered the CBLR to 8.0% beginning in the second quarter of 2020 through the end of the year.

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

The CBLR will return to 9.0% on January 1, 2022.

To be eligible to utilize the CBLR, the Bank also must have total consolidated assets of less than $10 billion, off-balance sheet exposures of 25.0% or less of its total consolidated assets, and trading assets and trading liabilities of 5.0% or less of its total consolidated assets, all as of the end of the most recent quarter.At December 31, 2020, the Bank’s CBLR was 10.40%.

At December 31, 2021, the Bank’s CBLR was 10.92%, which exceeded the minimum requirements.

For additional details, see “Note 16—Capital” in the Notes to Consolidated Financial Statements contained in "Item 8.

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Business—How We Are Regulated—Regulation of Sound Community Bank—Capital Rules" of this Form 10-K.

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

In order to be considered well-capitalized under the prompt corrective action standards, a bank must have a ratio of CET1 capital to risk-weighted assets of at least 6.5%, a ratio of Tier 1 capital to risk-weighted assets of at least 8.0%, a ratio of total capital to risk-weighted assets of at least 10.0%, and a leverage ratio of at least 5.0%, and the bank must not be subject to a regulatory capital requirement imposed on it as an individual bank.

Table of Conten t s

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

Actual Minimum Capital

Requirements Minimum Required to be

Well-Capitalized Under Prompt

Corrective Action Provisions

Amount Ratio Amount Ratio Amount Ratio

Tier 1 Capital to average total adjusted assets (1)

$ 74,031 10.22 % $ 28,981 4.0 % $ 36,226 5.0 %

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

74,031 12.07 27,601 4.5 39,868 6.5

Tier 1 Capital to risk-weighted assets (2)

74,031 12.07 36,801 6.0 49,068 8.0

Total Capital to risk-weighted assets (2)

$ 79,974 13.04 % $ 49,068 8.0 % $ 61,335 10.0 %

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

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

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

If Sound Financial Bancorp was subject to regulatory guidelines for bank holding companies with $3.0 billion or more in assets, at December 31, 2021, Sound Financial Bancorp would have exceeded all regulatory capital requirements.

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

The estimated CBLR calculated for Sound Financial Bancorp at December 31, 2021 was 10.09%.

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

What changed 10-K

Item 7. Management’s Discussion and Analysis