Sound Financial Bancorp, Inc. 10-K

Item 8. Financial Statements and Supplementary Data Report of Independent Registered Public Accounting Firm To the Shareholders and the Board of Directors of Sound Financial Bancorp, Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheet s of Sound Financial Bancorp, Inc. and Subsidiary (the “Company”) as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for the years then ended, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2021 and 2020, and the consolidated results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. Basis for Opinion These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provides a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing a separate opinion on the critical audit matters or on the accounts or disclosures to which they relate. Allowance for Loan Losses As described in Notes 1 and 5 to the consolidated financial statements, the Company’s allowance for loan losses balance was $6.3 million at December 31, 2021. The allowance for loan losses is maintained to provide for probable incurred losses in the loan portfolio based upon evaluating known and inherent risks in the loan portfolio. The level of the allowance reflects the Company’s view of trends in loan loss activity, current loan portfolio quality and present economic, political and regulatory conditions. The allowance is provided based upon management's ongoing assessments of the pertinent factors underlying the quality of the loan portfolio. These factors include, but are not limited to, changes in the size and composition of the loan portfolio, delinquency levels, actual loan loss experience, current economic conditions, and detailed analysis of individual loans for which full collectability may not be 63 Table of Contents assured. The Company uses internally assigned loan grades to stratify loans into pools and to estimate inherent loss rates for each of the loan pools, which are used in the calculation of the allowance for loan losses. The Company includes an additional factor to the allowance to account for loans with certain assigned grades that represent a higher credit risk. We identified management’s internally assigned grades of loans and the estimation of qualitative factors, both of which are used in the allowance for loan losses calculation, as critical audit matters. Determination of the assigned loan grades involves significant management judgement. The qualitative factors are used to estimate losses related to factors that are not captured in the historical loss rates and are based on management’s evaluation of available internal and external data and involves significant management judgement. Auditing management’s judgments relating to the determination of internally assigned grades and qualitative factors involved a high degree of subjective auditor judgment. The primary procedures we performed to address this critical audit matter included: • Obtain an understanding of the design and implementation of controls relating to management’s calculation of the allowance for loan losses, including controls over the accuracy of assigned loan grades and the determination of the qualitative factors used. • Testing a risk-based, targeted selection of loans to gain substantive evidence that the Company is appropriately grading these loans in accordance with its policies, and that the assigned loan grades are reasonable. • Obtaining management’s analysis and supporting documentation related to the qualitative factors and testing whether the qualitative factors used in the calculation of the allowance for loan losses are supported by the analysis provided by management. • Testing the appropriateness of the methodology and assumptions used in the calculation of the allowance for loan losses, and testing the calculation itself, including completeness and accuracy of the data used in the calculation, application of the assigned loan grades determined by management and used in the calculation, application of the qualitative factors determined by management and used in the calculation, and recalculation of the allowance for loan losses balance. /s/ Moss Adams LLP Everett, Washington March 14, 2022 We have served as the Company’s auditor since 2002. 64 Table of Contents SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY Consolidated Balance Sheets (In thousands, except share and per share amounts) December 31, 2021 2020 ASSETS Cash and cash equivalents $ 183,590 $ 193,828 Available-for-sale securities, at fair value 8,419 10,218 Loans held-for-sale 3,094 11,604 Loans held for portfolio 686,398 613,363 Allowance for loan losses ( 6,306 ) ( 6,000 ) Total loans held for portfolio, net 680,092 607,363 Accrued interest receivable 2,217 2,254 Bank-owned life insurance ("BOLI"), net 21,095 14,588 Other real estate owned ("OREO") and repossessed assets, net 659 594 Mortgage servicing rights ("MSR"), at fair value 4,273 3,780 Federal Home Loan Bank ("FHLB") stock, at cost 1,046 877 Premises and equipment, net 5,819 6,270 Lease right of use assets, net 5,811 6,722 Other assets 3,576 3,304 Total assets $ 919,691 $ 861,402 LIABILITIES Deposits Interest-bearing $ 607,854 $ 615,491 Noninterest-bearing demand 190,466 132,490 Total deposits 798,320 747,981 Borrowings — — Accrued interest payable 200 369 Lease liabilities 6,242 7,134 Other liabilities 8,571 7,674 Advance payments from borrowers for taxes and insurance 1,366 1,168 Subordinated notes, net 11,634 11,592 Total liabilities 826,333 775,918 COMMITMENTS AND CONTINGENCIES (Notes 12 and 18) STOCKHOLDERS' EQUITY Preferred stock, $ 0.01 par value, 10,000,000 shares authorized, none issued or outstanding — — Common stock, $ 0.01 par value, 40,000,000 shares authorized, 2,613,768 and 2,592,587 issued and outstanding at December 31, 2021 and 2020, respectively 26 25 Additional paid-in capital 27,956 27,106 Unearned shares - Employee Stock Ownership Plan ("ESOP") — ( 113 ) Retained earnings 65,237 58,226 Accumulated other comprehensive income, net of tax 139 240 Total stockholders' equity 93,358 85,484 Total liabilities and stockholders' equity $ 919,691 $ 861,402 See notes to consolidated financial statements 65 Table of Contents SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY Consolidated Statements of Income (In thousands, except share and per share amounts) Year Ended December 31, 2021 2020 INTEREST INCOME Loans, including fees $ 33,389 $ 34,439 Interest and dividends on investments, cash and cash equivalents 485 497 Total interest income 33,874 34,936 INTEREST EXPENSE Deposits 3,282 7,004 Borrowings — 255 Subordinated notes 672 191 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 NONINTEREST INCOME 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 MSRs ( 808 ) ( 1,857 ) Net gain on sale of loans 4,190 6,022 Total noninterest income 7,329 7,445 NONINTEREST EXPENSE Salaries and benefits 14,257 12,083 Operations 5,765 5,461 Regulatory assessments 379 590 Occupancy 1,748 1,881 Data processing 3,263 2,658 Net (gain)/loss and expenses on OREO and repossessed assets ( 16 ) 5 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 Earnings per common share: Basic $ 3.52 $ 3.46 Diluted $ 3.46 $ 3.42 Weighted average number of common shares outstanding: Basic 2,582,775 2,562,650 Diluted 2,626,516 2,592,532 See notes to consolidated financial statements 66 Table of Contents SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY Consolidated Statements of Comprehensive Income (In thousands) Year Ended December 31, 2021 2020 Net income $ 9,156 $ 8,937 Available for sale securities: Unrealized (losses)/gains arising during the year ( 128 ) 82 Income tax benefit/(expense) related to unrealized losses/gains 27 ( 17 ) Other comprehensive (loss)/income, net of tax ( 101 ) 65 Comprehensive income $ 9,055 $ 9,002 See notes to consolidated financial statements 67 Table of Contents SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY Consolidated Statements of Stockholders' Equity (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 December 31, 2020 2,592,587 $ 25 $ 27,106 $ ( 113 ) $ 58,226 $ 240 $ 85,484 Net income 9,156 9,156 Other comprehensive loss, net of tax benefit ( 101 ) ( 101 ) Share-based compensation 360 360 Restricted stock awards issued 10,168 — Cash dividends on common stock ($ 0.78 per share) ( 2,039 ) ( 2,039 ) Common stock repurchased ( 3,657 ) — ( 46 ) — ( 106 ) 0 ( 152 ) Common stock surrendered ( 4,091 ) — — — Restricted shares forfeited ( 1,890 ) — Common stock options exercised 20,651 1 181 182 Allocation of ESOP shares 355 113 468 Balance at December 31, 2021 2,613,768 $ 26 $ 27,956 $ — $ 65,237 $ 139 $ 93,358 Shares Common Stock Additional Paid-in Capital Unearned ESOP Shares Retained Earnings Accumulated Other Comprehensive Income, net of tax Total Stockholders' Equity Balance at December 31, 2019 2,567,389 $ 25 $ 26,343 $ ( 227 ) $ 51,410 $ 175 $ 77,726 Net income 8,937 8,937 Other comprehensive income, net of tax 65 65 Share-based compensation 338 338 Restricted stock awards issued 13,600 — Cash dividends on common stock ($ 0.80 per share) ( 2,072 ) ( 2,072 ) Common stock surrendered ( 3,423 ) — Common stock repurchased ( 2,477 ) ( 24 ) ( 49 ) ( 73 ) Restricted shares forfeited ( 1,915 ) — Common stock options exercised 19,413 239 239 Allocation of ESOP shares 210 114 324 Balance at December 31, 2020 2,592,587 $ 25 $ 27,106 $ ( 113 ) $ 58,226 $ 240 $ 85,484 See notes to consolidated financial statements 68 Table of Contents SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY Consolidated Statements of Cash Flows (In thousands) Year Ended December 31, 2021 2020 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 9,156 $ 8,937 Adjustments to reconcile net income to net cash from operating activities: Amortization of net discounts on investments 134 160 Provision for loan losses 425 925 Depreciation and amortization 676 905 Compensation expense related to stock options and restricted stock 360 338 Fair value adjustment on mortgage servicing rights 808 1,857 Right of use assets amortization 911 919 Change in lease liabilities ( 892 ) ( 876 ) Increase in cash surrender value of BOLI ( 416 ) ( 348 ) Net change in advances from borrowers for taxes and insurance 198 ( 137 ) Deferred income tax ( 43 ) 355 Net gain on sale of loans ( 4,190 ) ( 6,022 ) Proceeds from sale of loans held-for-sale 150,325 258,531 Originations of loans held-for-sale ( 138,926 ) ( 265,448 ) Net gain on OREO and repossessed assets ( 16 ) — Change in operating assets and liabilities: Accrued interest receivable 37 ( 48 ) Other assets ( 202 ) 19 Accrued interest payable ( 169 ) 143 Other liabilities 897 ( 694 ) Net cash provided by (used in) operating activities 19,073 ( 484 ) CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of available-for-sale securities ( 1,950 ) ( 8,889 ) Proceeds from principal payments, maturities and sales of available-for-sale securities 3,529 7,909 Net increase in loans ( 73,238 ) 5,940 Purchase of BOLI ( 6,091 ) ( 57 ) Purchases of premises and equipment, net ( 225 ) ( 407 ) Proceeds from sale of OREO and other repossessed assets 35 — Net cash (used in) provided by investing activities ( 77,940 ) 4,496 CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in deposits 50,339 131,263 Proceeds from borrowings — 174,291 Repayment of borrowings — ( 181,791 ) Proceeds from subordinated notes, net — 11,582 FHLB stock purchased ( 169 ) 283 Common stock repurchases ( 152 ) ( 73 ) Allocation of ESOP shares 468 324 Dividends paid on common stock ( 2,039 ) ( 2,072 ) Proceeds from common stock option exercises 182 239 Net cash provided by financing activities 48,629 134,046 Net change in cash and cash equivalents ( 10,238 ) 138,058 69 Table of Contents Cash and cash equivalents, beginning of period 193,828 55,770 Cash and cash equivalents, end of period $ 183,590 $ 193,828 SUPPLEMENTAL CASH FLOW INFORMATION: Cash paid for income taxes $ 2,895 $ 1,960 Interest paid on deposits, borrowings and subordinated debt 4,123 7,307 Loans transferred from loans held-for-portfolio to OREO and repossessed assets 84 19 Noncash transfer from assets in process to premises and equipment 144 692 See notes to consolidated financial statements 70 Table of Contents SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements Note 1— Organization and Significant Accounting Policies Sound Financial Bancorp, a Maryland corporation ("Sound Financial Bancorp" or the "Company"), is the parent holding company for its wholly owned subsidiary, Sound Community Bank (the "Bank") and the Bank's wholly-owned subsidiary, Sound Community Insurance Agency, Inc. Substantially all of Sound Financial Bancorp's business is conducted through Sound Community Bank, a Washington state-chartered commercial bank. As a Washington commercial bank, the Bank's regulators are the Washington State Department of Financial Institutions ("WDFI") and the Federal Deposit Insurance Corporation ("FDIC"). The Board of Governors of the Federal Reserve System ("Federal Reserve") is the primary federal regulator for Sound Financial Bancorp. The Company’s business activities generally are limited to passive investment activities and oversight of its investment in the Bank. Accordingly, the information set forth in this report relates primarily to the Bank. Subsequent events – The Company has evaluated subsequent events for potential recognition and disclosure. See "Note 21—Subsequent Events" for further information. Basis of Presentation and Use of Estimates – The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the fair value of MSRs, valuations of impaired loans and OREO, and the realization of deferred taxes. The accompanying consolidated financial statements include the accounts of Sound Financial Bancorp and its wholly-owned subsidiaries, Sound Community Bank and Sound Community Insurance Agency, Inc. All significant intercompany balances and transactions between Sound Financial Bancorp and its subsidiaries have been eliminated in consolidation. Cash and cash equivalents – For purposes of reporting cash flows, cash and cash equivalents include cash on hand and in banks and interest-bearing deposits. All have original maturities of three months or less and may exceed federally insured limits. Investment securities – Investment securities are classified into one of three categories: (1) held-to-maturity, (2) available-for-sale or (3) trading. The Company had no held-to-maturity or trading securities at December 31, 2021 or 2020. Available-for-sale securities consist of debt securities that the Company has the intent and ability to hold for an indefinite period, but not necessarily to maturity. Such securities may be sold to implement the Company's asset/liability management strategies and/or in response to changes in interest rates and similar factors. Available-for-sale securities are reported at fair value. Dividend and interest income are recognized when earned. Unrealized gains and losses, net of the related deferred tax effect, are reported as a net amount in accumulated other comprehensive income (loss) on available-for-sale securities in the consolidated balance sheets. Realized gains and losses on available-for-sale securities, determined using the specific identification method, are included in earnings. Amortization of premiums and accretion of discounts are recognized as adjustments to interest income using the interest method over the period to the earlier of call date or maturity. The Company reviews investment securities on an ongoing basis for the presence of other-than-temporary impairment ("OTTI") or permanent impairment, taking into consideration current market conditions, fair value in relation to cost, extent and nature of the change in fair value, issuer rating changes and trends, whether the Company intends to sell a security or if it is likely that the Company will be required to sell the security before recovery of its amortized cost basis of the investment, which may be maturity, and other factors. For debt securities, if the Company intends to sell the security or it is likely that it will be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in earnings as an OTTI. If the Company does not intend to sell the security and it is not likely that we will be required to sell the security but we do not expect to recover the entire amortized cost basis of the security, only the portion of the impairment loss representing credit losses would be recognized in earnings. The credit loss on a security is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected. Projected cash flows are discounted by the original or current effective interest rate depending on the nature of the security being measured for potential OTTI. The remaining impairment related to all other factors, the difference between the present value of the cash flows expected to be collected and the fair value, is recognized as a charge to other comprehensive income. The Company does not intend to sell 71 Table of Contents these securities and it is more likely than not that it will not be required to sell the securities before anticipated recovery of the remaining amortized cost basis. The Company closely monitors its investment securities for changes in credit risk. Loans held-for-sale – To mitigate interest-rate sensitivity, from time to time, certain fixed-rate mortgage loans are identified as held-for-sale in the secondary market. Accordingly, such loans are classified as held-for-sale in the consolidated balance sheets and are carried at the lower of cost or estimated fair market value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income. Mortgage loans held-for-sale are generally sold with the mortgage servicing rights retained by the Company. Gains or losses on sales of loans are recognized based on the difference between the selling price and the carrying value of the related loans sold based on the specific identification method. Loans – The Company grants mortgage, commercial, and consumer loans to clients. A substantial portion of the loan portfolio is represented by loans secured by real estate located throughout the Puget Sound region, especially King, Snohomish and Pierce Counties, and in Clallam and Jefferson Counties of Washington State. The ability of the Company's debtors to honor their contracts is dependent upon employment, real estate and general economic conditions in these areas. Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balance adjusted for any charge-offs, allowance for loan losses, and any deferred fees or costs on origination of loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method over the contractual life of the loan for term loans or the straight-line method for open-ended loans. The accrual of interest is discontinued at the time the loan is 90 days past due or if, in management's opinion, the borrower may be unable to meet payment of obligations as they become due, as well as when required by regulatory provisions. Loans are typically charged off no later than 120 days past due, unless secured by collateral. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not collected for loans that are placed on nonaccrual or charged-off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all of the principal and interest amounts contractually due are brought current, future payments are reasonably assured and payments have been received for six consecutive months. A loan is considered impaired when it is probable that the Company will be unable to collect all amounts (principal and interest) due according to the contractual terms of the original loan agreement. When a loan has been identified as being impaired, the amount of the impairment is measured by using discounted cash flows, except when, as a practical expedient, the current fair value of the collateral, reduced by costs to sell, is used. When the measurement of the impaired loan is less than the recorded investment in the loan (including accrued interest), impairment is recognized by charging off the impaired portion or creating or adjusting a specific allocation of the allowance for loan losses. The Company recognizes interest income on impaired loans, including cash receipts, based on its existing methods of recognizing interest income on nonaccrual loans. A loan is classified as a troubled debt restructuring ("TDR") when certain concessions have been made to the contractual terms, such as reductions of interest rates or deferrals of interest or principal payments due to the borrower's deteriorated financial condition. All TDRs are reported and accounted for as impaired loans. In March 2020, the Company began offering short-term loan modifications to assist borrowers during the novel coronavirus disease 2019 ("COVID-19") pandemic. The Coronavirus Aid, Relief and Economic Security Act ("CARES Act") and related bank regulatory guidance provides that a short-term modification made in response to COVID-19 and which meets certain criteria does not need to be placed on nonaccrual status or accounted for as a TDR, pursuant to applicable accounting and regulatory guidance until the earlier of 60 days after the national emergency termination date or January 1, 2022. At December 31, 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. The Company continues to monitor these loans through its normal credit risk processes. Allowance for loan losses – The allowance for loan losses is a reserve established through a provision for loan losses charged to expense and represents management's best estimate of probable losses incurred within the existing loan portfolio as of the balance sheet date. The level of the allowance reflects management's view of trends in loan loss activity, current loan portfolio quality and present economic, political and regulatory conditions. Portions of the allowance may be allocated for specific loans; however, the allowance is available for any loan that is charged off. The allowance is increased by provisions charged to earnings and by recoveries of amounts previously charged off, and is reduced by charge-offs on loans (or portions thereof) deemed to be uncollectible. Loan charge-offs are recognized when management believes the collectability of the principal 72 Table of Contents balance outstanding is unlikely. Full or partial charge-offs on collateral dependent impaired loans are generally recognized when the collateral is deemed to be insufficient to support the carrying value of the loan. The allowance for loan losses is maintained at a level sufficient to provide for probable credit losses based upon evaluating known and inherent risks in the loan portfolio. The allowance is provided based upon management's continuing analysis of the pertinent factors underlying the quality of the loan portfolio. These factors include changes in the size and composition of the loan portfolio, delinquency levels, actual loan loss experience, current economic conditions, and detailed analysis of individual loans for which full collectability may not be assured. The detailed analysis includes techniques to estimate the fair value of loan collateral and the existence of potential alternative sources of repayment. The allowance consists of specific, general and unallocated components. The general component of the allowance for loan losses covers non-impaired loans and is determined using a formula-based approach. The formula first incorporates either the historical loss rates of the Company or the historical loss rates of its peer group if minimal loss history exists. This historical loss rate factor is then adjusted for qualitative factors. Qualitative factors are used to estimate losses related to factors that are not captured in the historical loss rates and are based on management’s evaluation of available internal and external data and involve significant management judgement. Qualitative factors include changes in lending standards, changes in economic conditions, changes in the nature and volume of loans, changes in lending management, changes in delinquencies, changes in the loan review system, changes in the value of collateral, the existence of concentrations, and the impact of other external factors. Finally, the general component of the allowance for loan losses is adjusted for changes in the assigned grades of loans, which include the following: pass, watch, special mention, substandard, doubtful, and loss. As loans are downgraded from watch to the lower categories, they are assigned an additional factor to account for the increased credit risk. Loan grades involve significant management judgment. For such loans that are also classified as impaired, a specific component within the allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan are lower than the carrying value of that loan. An unallocated component is maintained to cover uncertainties that could affect management's estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. The Company considers installment loans to be pools of smaller balance, homogenous loans that are collectively evaluated for impairment, unless such loans are subject to a TDR agreement. The appropriateness of the allowance for loan losses is estimated based upon those factors and trends identified by management at the time consolidated financial statements are prepared. When available information confirms that specific loans or portions thereof are uncollectible, identified amounts are charged against the allowance for loan losses. The existence of some or all of the following criteria will generally confirm that a loss has been incurred: the loan is significantly delinquent and the borrower has not demonstrated the ability or intent to bring the loan current; the Company has no recourse to the borrower, or if it does, the borrower has insufficient assets to pay the debt; the estimated fair value of the loan collateral is significantly below the current loan balance, and there is little or no near-term prospect for improvement. The ultimate recovery of all loans is susceptible to future market factors beyond the Company's control. These factors may result in losses or recoveries differing significantly from those provided in the consolidated financial statements. Transfers of financial assets – Transfers of an entire financial asset, or a participating interest in an entire financial asset, are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when: (1) a group of financial assets or a participating interest in an entire financial asset has been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. Mortgage servicing rights – MSRs represent the value associated with servicing residential mortgage loans, when the mortgage loans have been sold into the secondary market and the related servicing has been retained by the Company. The Company may also purchase MSRs. The value is determined through a discounted cash flow analysis, which uses interest rates, prepayment speeds and delinquency rate assumptions as inputs. All of these assumptions require a significant degree of management judgment. The Company measures its mortgage servicing assets at fair value and reports changes in fair value through earnings under the caption fair value adjustment on MSRs in other income in the period in which the change occurs. The fair values of servicing rights are subject to significant fluctuations as a result of changes in estimates and actual prepayment speeds and default rates and losses. Currently, we do not hedge the effects of changes in fair value of our servicing assets. 73 Table of Contents Premises and equipment – Premises, leasehold improvements and furniture and equipment are carried at cost, less accumulated depreciation and amortization. Furniture and equipment are depreciated using the straight-line method over the estimated useful lives of the assets, which range from 1 to 10 years. The cost of leasehold improvements is amortized using the straight-line method over the terms of the related leases. The cost of premises is amortized using the straight-line method over the estimated useful life of the building, up to 39 years. Management reviews premises, leasehold improvements and furniture and equipment for impairment when factors exist indicating potential impairment. Bank-owned life insurance, net – The carrying amount of BOLI approximates its fair value, and is estimated using the cash surrender value, net of any surrender charges. Federal Home Loan Bank stock – The Company is a member of the FHLB of Des Moines. FHLB stock represents the Company's investment in the FHLB and is carried at par value, which reasonably approximates its fair value. As a member of the FHLB, the Company is required to maintain a minimum level of investment in FHLB stock based on specific percentages of its outstanding mortgages, total assets, or FHLB advances. At December 31, 2021 and 2020, the Company's minimum required investment in FHLB stock was $ 1.0 million and $ 877 thousand, respectively. Typically, the Company may request redemption at par value of any stock in excess of the minimum required investment. Stock redemptions are at the discretion of the FHLB. Other real estate owned and repossessed assets – OREO and repossessed assets represent real estate and other assets which the Company has taken control of in partial or full satisfaction of loans. At the time of foreclosure, OREO and repossessed assets are recorded at fair value less estimated costs to sell, which becomes the new basis. Any write-downs based on the asset's fair value at the date of acquisition are charged to the allowance for loan and lease losses. After foreclosure, management periodically performs valuations such that the property is carried at the lower of its new cost basis or fair value, net of estimated costs to sell. Revenue and expenses from operations and subsequent adjustments to the carrying amount of the property are included in other noninterest expense in the consolidated statements of income. In some instances, the Company may make loans to facilitate the sales of OREO. Management reviews all sales for which it is the lending institution. Any gains related to sales of other real estate owned may be deferred until the buyer has a sufficient investment in the property. Leases – We determine if an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use assets and operating lease liabilities in our consolidated balance sheets. Right-of-use assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease right-of-use assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we generally use our incremental borrowing rate based on the estimated rate of interest for collateralized borrowing over a similar term of the lease payments at commencement date. The operating lease right-of-use asset also includes any lease payments made and excludes lease incentives. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term. Additionally, for equipment leases, we apply a portfolio approach to effectively account for the operating lease right-of-use assets and liabilities. The Company has not entered into leases that meet the definition of a financing lease. Income Taxes – Income taxes are accounted for using the asset and liability method. Under this method a deferred tax asset or liability is determined based on the enacted tax rates which will be in effect when the differences between the financial statement carrying amounts and tax basis of existing assets and liabilities are expected to be reported in the Company's income tax returns. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established to reduce the net carrying amount of deferred tax assets if it is determined to be more likely than not, that all or some portion of the potential deferred tax asset will not be realized. Segment reporting – The Company operates in one segment and makes management decisions based on consolidated results. The Company's operations are solely in the financial services industry and include providing to its clients traditional banking and other financial services. Off-balance-sheet credit-related financial instruments – 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 customers' requests for funding and take the form of loan commitments, letters of credit and lines of credit. Such financial instruments are recorded when they are funded. The Company also maintains a separate allowance for off-balance sheet credit commitments. Management estimates anticipated losses using historical data and utilization assumptions. The allowance for off-balance sheet credit commitments totaled $ 405 thousand and $ 256 thousand at December 31, 2021 and 2020 and is included in other liabilities on the consolidated balance sheets. 74 Table of Contents Advertising costs – The Company expenses advertising costs as they are incurred. Advertising costs, including other marketing expenses were $ 415 thousand and $ 249 thousand for the years ended December 31, 2021 and 2020, respectively. Comprehensive income – Accounting principles generally require that recognized revenue, expenses, gains, and losses be included in net income. Certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale investments, are reported as a separate component of the equity section of the consolidated balance sheets, net of tax. Such items, along with net income, are components of comprehensive income. Intangible assets – At December 31, 2021 and 2020, the Company had $ 97 thousand and $ 128 thousand, respectively, of identifiable intangible assets included in other assets as a result of the acquisition of deposits from other institutions. These assets are amortized using the straight-line method over a period of eight to ten years and have a remaining weighted average life of 3.3 years. Management reviews intangible assets for impairment on an annual basis. No impairment losses have been recognized in the periods presented. Employee stock ownership plan – The Company sponsors a internally-leveraged ESOP. As shares are committed to be released, compensation expense is recorded equal to the market price of the shares, and the shares become outstanding for purposes of earnings per share calculations. Cash dividends on allocated shares (those credited to ESOP participants' accounts) are recorded as a reduction of stockholders' equity and distributed directly to participants' accounts. Cash dividends on unallocated shares (those held by the ESOP not yet credited to participants' accounts) are used to pay administrative expenses and debt service requirements of the ESOP. See "Note 14—Employee Benefits" for further information. Unearned ESOP shares are shown as a reduction of stockholders' equity. When the shares are released, unearned common shares held by the ESOP are reduced by the cost of the ESOP shares released and the differential between the fair value and the cost is charged to additional paid in capital. The loan receivable from the ESOP to the Company is not reported as an asset nor is the debt of the ESOP reported as a liability on the Company's consolidated statements of condition. Earnings Per Common Share – Earnings per share is computed using the two-class method. Basic earnings per share is computed by dividing net income available to common shares by the weighted average number of common shares outstanding during the period, excluding any participating securities. Participating securities include unvested restricted shares. Unvested restricted shares are considered participating securities because holders of these securities receive non-forfeitable dividends at the same rate as the holders of the Company's common stock. Diluted earnings per share is computed by dividing net income available to common stockholders adjusted for reallocation of undistributed earnings of unvested restricted shares by the weighted average number of common shares determined for the basic earnings per share plus the dilutive effect of common stock equivalents using the treasury stock method based on the average market price for the period. Some stock options are anti-dilutive and therefore are not included in the calculation of diluted earnings per share. Fair value – Fair value is the price that would be received when an asset is sold or a liability is transferred in an orderly transaction between market participants at the measurement date. Fair values of the Company's financial instruments are based on the fair value hierarchy which requires an entity to maximize the use of observable inputs, typically market data obtained from third parties, and minimize the use of unobservable inputs, which reflects its estimates for market assumptions, when measuring fair value. Three levels of valuation inputs are ranked in accordance with the prescribed fair value hierarchy as follows: Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2: Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active. Level 3: Assets or liabilities whose significant value drivers are unobservable. In determining the appropriate levels, the Company performs a detailed analysis of the assets and liabilities that are subject to fair value measurements. In certain cases, the inputs used to measure fair value of an asset or liability may fall into different levels of the fair value hierarchy. The level within which the fair value measurement is categorized is based on the lowest level unobservable input that is significant to the fair value measurement in its entirety. Therefore, an item may be classified in Level 3 even though there may be some significant inputs that are readily observable. Share-Based Compensation – The Company measures the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award. These costs are recognized on a straight-line basis over the vesting period during which an employee is required to provide services in exchange for the award, also known as the requisite service period. The Company uses the Black-Scholes option pricing model to estimate the fair value of stock options granted. When determining the estimated fair value of stock options granted, the Company utilizes various assumptions regarding the expected volatility of the stock price, the risk-free interest rate for periods within the contractual life of the stock option, and the 75 Table of Contents expected dividend yield that the Company expects over the expected life of the options granted. Reductions in compensation expense associated with forfeited options are expensed based on actual forfeiture experience. The Company measures the fair value of the restricted stock using the closing market price of the Company's common stock on the date of grant. The Company expenses the grant date fair value of the Company's stock options and restricted stock with a corresponding increase in equity. When shares are required to be issued under share-based awards, it is typically the Company’s policy to issue new shares of stock. Reclassifications – Certain amounts reported in prior years' consolidated financial statements may be reclassified to conform to the current presentation. The results of the reclassifications are typically not considered material and have no effect on previously reported net income, earnings per share or stockholders' equity. There were no reclassifications to prior year amounts in the current year. 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 Company adopted this ASU effective January 1, 2021. The adoption of ASU 2018-13 did not have a material impact on the Company's consolidated financial statements. On March 2020, the FASB issued ASU No. 2020-04, " Reference Rate Reform" ("Topic 848"). This ASU applies to contracts, hedging relationships, and other transactions that reference LIBOR or other rate references expected to be discontinued because of reference rate reform. The ASU permits an entity to make necessary modifications to eligible contracts or transactions without requiring contract re-measurement or reassessment of a previous accounting determination. In January 2021, ASU 2021-01 clarifies 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. A portion of the Bank’s commercial real estate loans and its interest rate swap-related transactions are the majority of the Company's LIBOR exposure. Effective January 25, 2021, the Company adhered to the Interbank Offered Rate Fallbacks Protocol as published by the International Swaps and Derivatives Association, Inc. and recommended by the Alternative Reference Rates Committee.This ASU is effective for all entities as of 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- 76 Table of Contents 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 Company adopted this ASU effective January 1, 2021. 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. Note 3— Restricted Cash Federal Reserve System ("Federal Reserve") regulations require that the Company maintain certain minimum reserve balances either as cash on hand or on deposit with the Federal Reserve Bank, based on a percentage of deposits. In March 2020, the Federal Reserve announced that it would be reducing the reserve requirement for all depository institutions to zero percent effective March 26, 2020. The Company' reserve balances were zero at December 31, 2021 and 2020, respectively. 77 Table of Contents Note 4— Investments The amortized cost and fair value of available-for-sale securities and the corresponding amounts of gross unrealized gains and losses at December 31, 2021 and 2020 were as follows (in thousands): Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value December 31, 2021 Municipal bonds $ 5,931 $ 148 $ ( 13 ) $ 6,066 Agency mortgage-backed securities 2,312 53 ( 12 ) 2,353 Total available-for-sale securities $ 8,243 $ 201 $ ( 25 ) $ 8,419 December 31, 2020 Municipal bonds $ 5,209 $ 204 $ — $ 5,413 Agency mortgage-backed securities 4,706 105 ( 6 ) 4,805 Total available-for-sale securities $ 9,915 $ 309 $ ( 6 ) $ 10,218 The following table details the amortized cost and fair value of available-for-sale securities at December 31, 2021, by contractual maturity (in thousands). Expected maturities of available-for-sale securities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Investments not due at a single maturity date, primarily mortgage-backed securities, are shown separately. December 31, 2021 Amortized Cost Fair Value Weighted-Average Yield Due within one year $ 260 $ 266 3.80 % Due in one to five years 151 160 2.58 Due after five to ten years 1,226 1,319 5.27 Due after ten years 4,294 4,321 2.68 Mortgage-backed securities 2,312 2,353 1.81 Total $ 8,243 $ 8,419 3.12 % There were no pledged securities at December 31, 2021 and 2020. There were no sales of available-for-sale securities during the years ended December 31, 2021 and 2020. The following tables summarize the aggregate fair value and gross unrealized loss by length of time of those investments that have been in a continuous unrealized loss position at December 31, 2021 and 2020 (in thousands): December 31, 2021 Less Than 12 Months 12 Months or Longer Total Fair Value Unrealized Loss Fair Value Unrealized Loss Fair Value Unrealized Loss Municipal bonds $ 1,632 $ ( 13 ) $ — $ — $ 1,632 $ ( 13 ) Agency mortgage-backed securities $ — $ — $ 402 $ ( 12 ) $ 402 $ ( 12 ) Total $ 1,632 $ ( 13 ) $ 402 $ ( 12 ) $ 2,034 $ ( 25 ) 78 Table of Contents 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 during the years ended December 31, 2021 and 2020 relating to the Company's securities. At December 31, 2021, the securities portfolio consisted of 10 agency mortgage-backed securities and 10 municipal securities with a fair value of $ 8.4 million. At December 31, 2020, the securities portfolio consisted of 16 agency mortgage-backed securities and 10 municipal bonds with a fair value of $ 10.2 million. At December 31, 2021, there were two securities in an unrealized loss position for less than 12 months, and there was one security in an unrealized loss position for more than 12 months. At December 31, 2020, there were six 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. For both the 2021 and 2020 periods, the unrealized losses were caused by changes in market interest rates or the widening of market spreads subsequent to the initial purchase of these securities, and not related to the underlying credit of the issuers or the underlying collateral. It is expected that these securities will not be settled at a price less than the amortized cost of each investment. The unrealized losses on these investments are not considered OTTI losses during the years ended December 31, 2021 and 2020, 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 . Note 5— Loans The composition of the loan portfolio, excluding loans held-for-sale, at December 31, 2021 and 2020 is as follows (in thousands): December 31, 2021 2020 Real estate loans: One-to-four family $ 207,660 $ 130,657 Home equity 13,250 16,265 Commercial and multifamily 278,175 265,774 Construction and land 63,105 62,752 Total real estate loans 562,190 475,448 Consumer loans: Manufactured homes 21,636 20,941 Floating homes 59,268 39,868 Other consumer 16,748 15,024 Total consumer loans 97,652 75,833 Commercial business loans 28,026 64,217 Total loans 687,868 615,498 Premiums for purchased loans (1) 897 — Deferred fees ( 2,367 ) ( 2,135 ) Total loans, gross 686,398 613,363 Allowance for loan losses ( 6,306 ) ( 6,000 ) Total loans, net $ 680,092 $ 607,363 (1) Includes premiums of $ 556 thousand related to one-to-four family loans, $ 181 thousand related to commercial and multifamily loans, and $ 160 thousand related to commercial business loans as of December 31, 2021. 79 Table of Contents The Company was automatically authorized to participate in the Small Business Administration's (“SBA”) Paycheck Protection Program (“PPP”) as a qualified U.S. SBA lender. The Bank began originating PPP loans following the enactment of the CARES Act in April 2020. PPP loans are fully guaranteed by the SBA, intended for businesses impacted by the COVID-19 pandemic and designed to provide near term relief to help small businesses sustain operations. These loans have either a two-year or five-year maturity date and earn interest at 1%. The Bank also earns a fee based on the size of the loan, which is recognized over the life of the loan. Through December 31, 2021, the Bank had funded PPP loans totaling $ 119.2 million, $ 4.2 million of which remained outstanding at December 31, 2021. PPP loans are included in commercial business loans above. During the year ended December 31, 2021, the Company purchased $ 24.1 million of one-to-four family real estate loans and $ 4.3 million of commercial business participations with the United States Department of Agriculture. The Company purchased no loans during the year ended December 31, 2020. The following table presents the balance in the allowance for loan losses and the unpaid principal balance in loans, net of partial charge-offs by portfolio segment and based on impairment method at December 31, 2021 (in thousands): Allowance: Individually Evaluated for Impairment Allowance: Collectively Evaluated for Impairment Ending Balance Loans Held for Investment: Individually Evaluated for Impairment Loans Held for Investment: Collectively Evaluated for Impairment Ending Balance One-to-four family $ 112 $ 1,290 $ 1,402 $ 4,066 $ 203,594 $ 207,660 Home equity 7 86 93 215 13,035 13,250 Commercial and multifamily — 2,340 2,340 2,380 275,795 278,175 Construction and land 4 646 650 68 63,037 63,105 Manufactured homes 144 331 475 221 21,415 21,636 Floating homes — 372 372 493 58,775 59,268 Other consumer 26 284 310 106 16,642 16,748 Commercial business — 269 269 176 27,850 28,026 Unallocated — 395 395 — — — Total $ 293 $ 6,013 $ 6,306 $ 7,725 $ 680,143 $ 687,868 The following table presents the balance in the allowance for loan losses and the unpaid principal balance in loans, net of partial charge-offs by portfolio segment and based on impairment method at December 31, 2020 (in thousands): Allowance: Individually Evaluated for Impairment Allowance: Collectively Evaluated for Impairment Ending Balance Loans Held for Investment: Individually Evaluated for Impairment Loans Held for Investment: Collectively Evaluated for Impairment Ending Balance One-to-four family $ 165 $ 898 $ 1,063 $ 3,705 $ 126,952 $ 130,657 Home equity 14 133 147 293 15,972 16,265 Commercial and multifamily — 2,370 2,370 353 265,421 265,774 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 80 Table of Contents The following table summarizes the activity in the allowance for loan losses for the year ended December 31, 2021 (in thousands): Beginning Allowance Charge-offs Recoveries (Recapture)/ Provision Ending Allowance One-to-four family $ 1,063 $ ( 76 ) $ — $ 415 $ 1,402 Home equity 147 ( 8 ) 6 ( 52 ) 93 Commercial and multifamily 2,370 — — ( 30 ) 2,340 Construction and land 578 — — 72 650 Manufactured homes 529 ( 2 ) 3 ( 55 ) 475 Floating homes 328 — — 44 372 Other consumer 288 ( 50 ) 6 66 310 Commercial business 291 — 2 ( 24 ) 269 Unallocated 406 — — ( 11 ) 395 $ 6,000 $ ( 136 ) $ 17 $ 425 $ 6,306 The following table summarizes the activity in the allowance for loan losses for the year ended December 31, 2020 (in thousands): Beginning Allowance Charge-offs Recoveries (Recapture)/ Provision Ending Allowance One-to-four family $ 1,120 $ ( 20 ) $ 63 $ ( 100 ) $ 1,063 Home equity 178 ( 2 ) 46 ( 75 ) 147 Commercial and multifamily 1,696 — — 674 2,370 Construction and land 492 — — 86 578 Manufactured homes 480 — 2 47 529 Floating homes 283 — — 45 328 Other consumer 112 ( 48 ) 14 210 288 Commercial business 331 ( 620 ) — 580 291 Unallocated 948 — — ( 542 ) 406 $ 5,640 $ ( 690 ) $ 125 $ 925 $ 6,000 Credit Quality Indicators. Federal regulations provide for the classification of lower quality assets as substandard, doubtful or loss. An asset is considered substandard if it is inadequately protected by the current net worth and payment capacity of the borrower or of any collateral pledged. Substandard assets include those characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Assets classified as doubtful have all the weaknesses inherent in assets classified substandard with the added characteristic that the weaknesses make collection or liquidation of the assets in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Assets classified as loss are those considered uncollectible and of such little value that their continuance as assets without establishment of a specific loss reserve is not warranted. When the Company classifies problem loans as either substandard or doubtful, it may establish a specific allowance in an amount we deem prudent to address the risk specifically (if the loan is impaired) or it may allow the loss to be addressed in the general allowance (if the loan is not impaired). General allowances represent loss reserves which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been specifically allocated to particular problem assets. When the Company classifies problem loans as a loss, it charges-off such loans in the period in which they are deemed uncollectible. Assets that do not currently expose the Company to sufficient risk to warrant classification as substandard or doubtful but possess identified weaknesses are classified as either watch or special mention loans. Determination as to the classification of our assets and the amount of our valuation allowances is subject to review by the FDIC, the Bank's federal regulator, and the WDFI, the Bank's state banking regulator, both of whom can order the establishment of additional loss allowances. Pass rated loans are loans that are not otherwise classified or criticized. 81 Table of Contents The following table represents the internally assigned grades at December 31, 2021, by type of loan (in thousands): One-to-four Family Home Equity Commercial and Multifamily Construction and Land Manufactured Homes Floating Homes Other Consumer Commercial Business Total Grade: Pass $ 203,883 $ 12,904 $ 233,300 $ 56,310 $ 21,137 $ 58,171 $ 16,728 $ 23,713 $ 626,146 Watch 363 23 32,770 4,347 305 — — 3,561 41,369 Special Mention — — 4,553 830 — 604 — 211 6,198 Substandard 3,414 323 7,552 1,618 194 493 20 541 14,155 Doubtful — — — — — — — — — Loss — — — — — — — — — Total $ 207,660 $ 13,250 $ 278,175 $ 63,105 $ 21,636 $ 59,268 $ 16,748 $ 28,026 $ 687,868 The following table represents the internally assigned grades at December 31, 2020, by type of loan (in thousands): 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 Doubtful — — — — — — — — — Loss — — — — — — — — — 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, 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. 82 Table of Contents The following table presents the recorded investment in nonaccrual loans at December 31, 2021 and 2020, by type of loan (in thousands): December 31, 2021 2020 One-to-four family $ 2,207 $ 1,668 Home equity 140 156 Commercial and multifamily 2,380 353 Construction and land 33 40 Manufactured homes 122 149 Floating homes 493 518 Commercial business 176 — Total $ 5,552 $ 2,884 The following table represents the aging of the recorded investment in past due loans (excluding COVID-19 modified loans) at December 31, 2021, by type of loan (in thousands): 30-59 Days Past Due 60-89 Days Past Due Greater than 90 Days Past Due Recorded Investment > 90 Days and Accruing Total Past Due Current Total Loans One-to-four family $ 1,805 $ 58 $ 87 $ — $ 1,950 $ 205,710 $ 207,660 Home equity — — 140 — 140 13,110 13,250 Commercial and multifamily — — — — — 278,175 278,175 Construction and land 837 — — — 837 62,268 63,105 Manufactured homes 123 — 59 — 182 21,454 21,636 Floating homes — — 244 — 244 59,024 59,268 Other consumer 2 76 — — 78 16,670 16,748 Commercial business 6 — 176 — 182 27,844 28,026 Total $ 2,773 $ 134 $ 706 $ — $ 3,613 $ 684,255 $ 687,868 The following table represents the aging of the recorded investment in past due loans (excluding COVID-19 modified loans) at December 31, 2020, by type of loan (in thousands): 30-59 Days Past Due 60-89 Days Past Due Greater Than 90 Days Past Due Recorded Investment > 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 83 Table of Contents Nonperforming Loans. Loans are considered nonperforming when they are placed on nonaccrual. The following table represents the credit risk profile based on payment activity at December 31, 2021, by type of loan (in thousands): One-to-four Family Home Equity Commercial and Multifamily Construction and Land Manufactured Homes Floating Homes Other Consumer Commercial Business Total Performing $ 205,453 $ 13,110 $ 275,795 $ 63,072 $ 21,514 $ 58,775 $ 16,748 $ 27,850 $ 682,316 Nonperforming 2,207 140 2,380 33 122 493 — 176 5,552 Total $ 207,660 $ 13,250 $ 278,175 $ 63,105 $ 21,636 $ 59,268 $ 16,748 $ 28,026 $ 687,868 The following table represents the credit risk profile based on payment activity at December 31, 2020, by type of loan (in thousands): 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 it is determined that the Company may not be able to collect payments of principal or interest when due under the terms of the loan. In the process of identifying loans as impaired, the Company takes into consideration factors which include payment history and status, collateral value, financial condition of the borrower, and the probability of collecting scheduled payments in the future. Minor payment delays and insignificant payment shortfalls typically do not result in a loan being classified as impaired. The significance of payment delays and shortfalls is considered on a case-by-case basis, after taking into consideration the totality of circumstances surrounding the 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. Impaired loans at December 31, 2021 and 2020, by type of loan were as follows (in thousands): December 31, 2021 Recorded Investment Unpaid Principal Balance Without Allowance With Allowance Total Recorded Investment Related Allowance One-to-four family $ 4,177 $ 3,109 $ 957 $ 4,066 $ 112 Home equity 215 140 75 215 7 Commercial and multifamily 2,380 2,380 — 2,380 — Construction and land 68 33 35 68 4 Manufactured homes 221 44 177 221 144 Floating homes 493 493 — 493 — Other consumer 106 — 106 106 26 Commercial business 176 176 — 176 — Total $ 7,836 $ 6,375 $ 1,350 $ 7,725 $ 293 84 Table of Contents 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 The following table provides the average recorded investment and interest income on impaired loans for the year ended December 31, 2021 and 2020, by type of loan (in thousands): Year Ended December 31, 2021 Year Ended December 31, 2020 Average Recorded Investment Interest Income Recognized Average Recorded Investment Interest Income Recognized One-to-four family $ 3,471 $ 198 $ 6,067 $ 175 Home equity 287 16 332 17 Commercial and multifamily 617 138 398 19 Construction and land 111 4 479 4 Manufactured homes 239 17 366 24 Floating homes 508 18 429 30 Other consumer 110 5 130 5 Commercial business 318 2 1,062 19 Total $ 5,661 $ 398 $ 9,263 $ 293 Forgone interest on nonaccrual loans was $ 312 thousand and $ 168 thousand for the year ended December 31, 2021 and 2020, respectively. Troubled debt restructurings. TDRs, accounted for under ASC 310-40, are loans which have renegotiated loan terms to assist borrowers who are unable to meet the original terms of their loans. Such modifications to loan terms may include a lower interest rate, a reduction in principal, or a longer term to maturity. Once a TDR has performed according to its modified terms for six months and the collection of principal and interest under the revised terms is deemed probable, we remove the TDR from nonperforming status. Loans classified as TDRs totaled $ 2.6 million and $ 3.2 million at December 31, 2021 and 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 Modifications: 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. Combination Modification : Any other type of modification, including the use of multiple categories above. 85 Table of Contents There was one loan totaling $ 25 thousand that was modified as a TDR during the year ended December 31, 2021. The following TDR loans were paid off during the year ended December 31, 2021: one commercial loans totaling $ 429 thousand and one home equity loan totaling $ 57 thousand. There were no TDRs for which there was a payment default within the first 12 months of modification during the year ended December 31, 2021. There was one TDR totaling $ 161 thousand for which there was a payment default within the first 12 months of modification during the year ended December 31, 2020. There was one commercial business TDR loan totaling $ 45 thousand that was charged off during the year ended December 31, 2021 and one commercial business TDR loan totaling $ 97 thousand that was charged off during the year ended December 31, 2020. The Company had no commitments to extend additional credit to borrowers owing receivables whose terms have been modified into TDRs. In the ordinary course of business, the Company makes loans to its employees, officers and directors. Certain loans to employees, officers and directors are offered at discounted rates as compared to other clients as permitted by federal regulations. Employees, officers, and directors are eligible for mortgage loans with an adjustable rate that resets annually to 1.0 % - 1.5 % over the Bank's rolling cost of funds. Employees, officers and directors are also eligible for consumer loans that are 1.00 % below the market loan rate at the time of origination. Director and officer loans are summarized as follows (in thousands): December 31, 2021 2020 Balance, beginning of period $ 3,995 $ 3,225 Advances — 196 New / (reclassified) loans, net 551 1,233 Repayments ( 181 ) ( 659 ) Balance, end of period $ 4,365 $ 3,995 At December 31, 2021 and 2020, loans totaling $ 7.3 million and $ 11.8 million, respectively, represented real estate secured loans that had current loan-to-value ratios above supervisory guidelines. Note 6— Mortgage Servicing Rights The Company’s MSR portfolio totaled $ 508.1 million at December 31, 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 December 31, 2021 and 2020 was $ 504.1 million and $ 481.6 million, respectively. The unpaid principal balances of loans serviced for other financial institutions at December 31, 2021 and 2020, totaled $ 4.0 million and $ 7.1 million, respectively. Loans serviced for Fannie Mae and others are not included in the Company’s financial statements as they are not assets of the Company. 86 Table of Contents A summary of the change in the balance of mortgage servicing assets at December 31, 2021 and 2020 were as follows (in thousands): December 31, 2021 2020 Beginning balance, at fair value $ 3,780 $ 3,239 Servicing rights that result from transfers and sale of financial assets 1,301 2,398 Changes in fair value: Due to changes in model inputs or assumptions (1) ( 808 ) ( 1,857 ) Ending balance, at fair value $ 4,273 $ 3,780 (1) Includes 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: December 31, 2021 2020 Prepayment speed (Public Securities Association "PSA" model) 205 % 247 % Weighted-average life 5.8 years 5.2 years Yield to maturity 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 Consolidated Statements of Income and totaled $ 1.3 million and $ 1.0 million for the years ended December 31, 2021 and 2020, respectively. See "Note 1—Organization and Significant Accounting Policies" and "Note 11— Fair Measurements" for additional information on MSRs. Note 7— Premises and Equipment Premises and equipment at December 31, 2021 and 2020 are summarized as follows (in thousands): December 31, 2021 2020 Land $ 920 $ 920 Buildings and improvements 7,059 6,944 Furniture and equipment 5,804 5,694 13,783 13,558 Less: Accumulated depreciation and amortization ( 7,964 ) ( 7,288 ) Premises and equipment, net $ 5,819 $ 6,270 Depreciation and amortization expense was $ 676 thousand and $ 905 thousand for the years ended December 31, 2021 and 2020, respectively. The Company leases office space in several buildings as well as certain equipment. See "Note 12—Leases" for additional information on our leased facilities and equipment. 87 Table of Contents Note 8— Other Real Estate Owned and Repossessed Assets The following table presents activity related to OREO and other repossessed assets for the periods shown (in thousands): Year Ended December 31, 2021 2020 Beginning balance, January 1 $ 594 $ 575 Additions to OREO and repossessed assets 84 19 Sales ( 19 ) — Write-downs/Losses — — Ending balance, December 31 $ 659 $ 594 As of December 31, 2021, there was one one-to-four family loans totaling $ 39 thousand that was in process of foreclosure. Note 9— Deposits A summary of deposit accounts with the corresponding weighted-average cost of funds at December 31, 2021 and 2020, are presented below (dollars in thousands): December 31, 2021 December 31, 2020 Deposit Balance Wtd. Avg Rate Deposit Balance Wtd. Avg Rate Noninterest-bearing demand $ 187,684 — % $ 129,299 — % Interest-bearing demand 307,061 0.19 230,492 0.44 Savings 103,401 0.08 83,778 0.27 Money market 91,670 0.21 65,748 0.39 Certificates 105,722 1.57 235,473 2.36 Escrow (1) 2,782 — 3,191 — Total $ 798,320 0.41 % $ 747,981 1.01 % (1) Escrow balances shown in noninterest-bearing deposits on the Consolidated Balance Sheets. Scheduled maturities of time deposits at December 31, 2021, are as follows (in thousands): Year Ending December 31, Amount 2022 $ 55,552 2023 39,061 2024 4,217 2025 4,558 2026 2,225 Thereafter 109 $ 105,722 Savings, demand, and money market accounts have no contractual maturity. Certificates of deposit have maturities of five years or less. The aggregate amount of time deposits in denominations of more than $ 250 thousand at December 31, 2021 and 2020, totaled $ 19.1 million and $ 79.9 million, respectively. Deposits in excess of $ 250 thousand are not federally insured. There were no brokered deposits outstanding at December 31, 2021 and 2020, respectively. Deposits from related parties held by the Company were $ 4.9 million and $ 6.4 million at December 31, 2021 and 2020, respectively. 88 Table of Contents Note 10— Borrowings, FHLB Stock and Subordinated Notes The Company utilizes a loan agreement with the FHLB of Des Moines, the terms of which call for a blanket pledge of a portion of the Company's mortgage and commercial and multifamily portfolios based on the outstanding balance. At December 31, 2021 and 2020, the maximum amount available to borrow under this credit facility was $ 417.7 million and $ 390.5 million, respectively, subject to eligible pledged collateral. At December 31, 2021, the credit facility was collateralized as follows: one-to-four family mortgage loans with an advance equivalent of $ 59.7 million, commercial and multifamily mortgage loans with an advance equivalent of $ 52.9 million and home equity loans with an advance equivalent of $ 482 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 December 31, 2021 and 2020. The weighted-average interest rate of the Company's borrowings under this agreement was — % and 3.10 % for the years ended December 31, 2021 and 2020, respectively. The maximum amount outstanding from FHLB advances during 2021 was $ — and during 2020 was $ 10.1 million. The average balance outstanding was $ 0.0 million during 2021 and $ 7.1 million during 2020. Additionally, the Company had outstanding letters of credit from the FHLB of Des Moines with a notional amount of $ 11.5 million and $ 21.6 million at December 31, 2021 and 2020, respectively, to secure public deposits. At December 31, 2021 and 2020, the remaining amount available to borrow from the FHLB of Des Moines was $ 101.5 million and $ 213.7 million, respectively. As a member of the FHLB system, the Bank is required to maintain a minimum level of investment in the FHLB of Des Moines stock based on specific percentages of its outstanding FHLB advances. At December 31, 2021 and 2020, the Company had an investment of $ 1.0 million and $ 877 thousand, respectively, in FHLB of Des Moines stock. The Company participates in the Federal Reserve Bank Borrower-in-Custody program, which gives the Company access to the discount window and, beginning in 2020, the Paycheck Protection Program Liquidity Facility ("PPPLF"). Extensions of credit under the PPPLF concluded on July 30, 2021. The terms of both programs call for a pledge of specific assets. The Company pledges commercial and consumer loans as collateral for this borrower-in-custody line of credit and PPP loans for the PPPLF. The Company had unused borrowing capacity of $ 22.4 million and $ 23.6 million under the borrower-in-custody program at December 31, 2021 and 2020 and $ — and $ 43.3 million under the PPPLF at December 31, 2021 and 2020. The Company had no outstanding borrowings under either program at December 31, 2021 and 2020. The Company has access to an unsecured Fed Funds line of credit from the Pacific Coast Banker's Bank. The line has a one-year term maturing on June 30, 2022 and is renewable annually. At December 31, 2021, the amount available under this line of credit was $ 20.0 million. There was no balance on this line of credit at December 31, 2021 and 2020, respectively. Sound Financial Bancorp completed a private placement of $ 12.0 million in aggregate principal of 5.25 % Fixed-to-Floating Rate Subordinated Notes (the "subordinated notes") due 2030 resulting in net proceeds, after placement fees and offering expenses, of approximately $ 11.6 million during the quarter ended September 30, 2020. The subordinated notes have a stated maturity of October 1, 2030 and bear interest at a fixed rate of 5.25 % per year until October 1, 2025. From October 1, 2025 to the maturity date or early redemption date, the interest rate will reset quarterly at a variable rate equal to the then current three-month term secured overnight financing rate (“SOFR”), plus 513 basis points. As provided in the subordinated notes, the interest rate on the subordinated notes during the applicable floating rate period may be determined based on a rate other than three-month term SOFR. Prior to October 1, 2025, Sound Financial Bancorp may redeem the subordinated notes, in whole but not in part, only under certain limited circumstances set forth in the subordinated notes. On or after October 1, 2025, Sound Financial Bancorp may redeem the subordinated notes, in whole or in part, at its option, on any interest payment date. Any redemption by Sound Financial Bancorp would be at a redemption price equal to 100 % of the principal amount of the subordinated notes being redeemed, together with any accrued and unpaid interest on the subordinated notes being redeemed to but excluding the date of redemption. The Notes are unsecured obligations and are subordinated in right of payment to all existing and future indebtedness, deposits and other liabilities of Sound Financial Bancorp 's current and future subsidiaries, including the Bank’s deposits as well as Sound Financial Bancorp 's subsidiaries' liabilities to general creditors and liabilities arising during the ordinary course of business. The Notes may be included in Tier 2 capital for Sound Financial Bancorp under current regulatory guidelines and interpretations. At December 31, 2021 and 2020, subordinated notes included $ 366 thousand and $ 408 thousand of unamortized debt issuance costs. 89 Table of Contents Note 11— Fair Value Measurements The Company determines the fair values of its financial instruments based on the requirements established in ASC 820, Fair Value Measurements , 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 December 31, 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. Treasury Bills - The estimated fair value is equal to the carrying amount. Available-for-Sale Securities - Available-for-sale securities are recorded at fair value based on quoted market prices, if available. If quoted market prices are not available, management utilizes third-party pricing services or broker quotations from dealers in the specific instruments. Level 2 securities include those traded on an active exchange, as well as U.S. government securities. Loans Held-for-Sale - Residential mortgage loans held-for-sale are recorded at the lower of cost or fair value. The fair value of fixed-rate residential loans is based on whole loan forward prices obtained from government-sponsored enterprises. At December 31, 2021 and 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 estimate fair value of loans-held-for-portfolio reflect exit price assumptions. The liquidity premiums/discounts are part of the valuation for exit pricing. Mortgage Servicing Rights -The fair value of mortgage servicing rights is determined through a discounted cash flow analysis, which uses interest rates, prepayment speeds, discount rates, and delinquency rate assumptions as inputs. FHLB stock - The estimated fair value is equal to the par value of the stock. 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 Notes- The fair value of subordinated notes t is estimated using discounted cash flows based on current lending rates for similar long-term debt instruments with similar terms and remaining time to maturity. A description of the valuation methodologies used for impaired loans and OREO is as follows: 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. 90 Table of Contents The following tables present information about the level in the fair value hierarchy for the Company’s financial assets and liabilities, whether or not recognized or recorded at fair value as December 31, 2021 and 2020 (in thousands): December 31, 2021 Fair Value Measurements Using: Carrying Value Estimated Fair Value Level 1 Level 2 Level 3 FINANCIAL ASSETS: Cash and cash equivalents $ 183,590 $ 183,590 $ 183,590 $ — $ — Available for sale securities 8,419 8,419 — 8,419 — Loans held-for-sale 3,094 3,094 — 3,094 — Loans held for portfolio, net 680,092 675,154 — — 675,154 Accrued interest receivable 2,217 2,217 2,217 — — Mortgage servicing rights 4,273 4,273 — — 4,273 FHLB Stock 1,046 1,046 — 1,046 — FINANCIAL LIABILITIES: Non-maturity deposits 692,598 692,598 — 692,598 — Time deposits 105,722 106,834 — 106,834 — Subordinated notes 11,634 11,634 — 11,634 — Accrued interest payable 200 200 200 — — 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 Accrued interest receivable 2,254 2,254 2,254 — — 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 — Borrowings 11,592 11,592 — 11,592 — Accrued interest payable 369 369 369 — — 91 Table of Contents The following tables present the balance of assets measured at fair value on a recurring basis at December 31, 2021 and 2020 (in thousands): Fair Value at December 31, 2021 Description Total Level 1 Level 2 Level 3 Municipal bonds $ 6,066 $ — $ 6,066 $ — Agency mortgage-backed securities 2,353 — 2,353 — Mortgage servicing rights 4,273 — — 4,273 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 For the years ended December 31, 2021 and 2020, there were no transfers between Level 1 and Level 2 or between Level 2 and Level 3. The following table provides a description of the valuation technique, unobservable input, and qualitative information about the unobservable inputs for the Company's assets and liabilities classified as Level 3 and measured at fair value on a recurring basis at December 31, 2021: Financial Instrument Valuation Technique Unobservable Input(s) Range (Weighted Average) Mortgage Servicing Rights Discounted cash flow Prepayment speed assumption 204 %- 344 % ( 205 %) Discount rate 10.5 %- 14.5 % ( 12.5 %) The following table provides a description of the valuation technique, unobservable input, and qualitative information about the unobservable inputs for the Company's assets and liabilities classified as Level 3 and measured at fair value on a recurring basis at December 31, 2020: 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. As a result of the difficulty in observing certain significant valuation inputs affecting our “Level 3” fair value assets, we are required to make judgments regarding these items’ fair values. Different persons in possession of the same facts may reasonably arrive at different conclusions as to the inputs to be applied in valuing these assets and their fair values. Such differences may result in significantly different fair value measurements. 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 years ended December 31, 2021 and 2020. Mortgage servicing rights are measured at fair value using significant unobservable input (Level 3) on a recurring basis and a reconciliation of this asset can be found in "Note 6—Mortgage Servicing Rights." 92 Table of Contents The following table presents the balance of assets measured at fair value on a nonrecurring basis and the total losses resulting from these fair value adjustments (in thousands): Fair Value at December 31, 2021 Description Total Level 1 Level 2 Level 3 OREO and repossessed assets $ 659 $ — $ — $ 659 Impaired loans 7,725 — — 7,725 Fair Value at December 31, 2020 Description 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 December 31, 2021 and 2020. The following table provides a description of the valuation technique, observable input, and qualitative information about the unobservable inputs for the Company's assets and liabilities classified as Level 3 and measured at fair value on a nonrecurring basis at December 31, 2021: December 31, 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 % ( 4 %) 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 12— Leases We have operating leases for branch locations, loan production offices, our corporate office and certain equipment. The lease term for our leases begins on the date we become legally obligated for the rent payments or we take possession of the building, whichever is earlier. Generally, our real estate leases have initial terms of three to 10 years and typically include one renewal option. Our leases have remaining lease terms of two months to 7.5 years. The operating leases require us to pay property taxes and operating expenses for the properties. The following table represents the Consolidated Balance Sheet classification of the Company’s right of use assets and lease liabilities (in thousands): December 31, 2021 2020 Operating lease right-of-use assets $ 5,811 $ 6,722 Operating lease liabilities 6,242 7,134 93 Table of Contents The following table represents the components of lease expense (in thousands): Year Ended December 31, 2021 2020 Operating lease expense: Office leases $ 1,134 $ 1,160 Equipment leases — 10 Sublease income ( 11 ) ( 12 ) Net lease expense $ 1,123 $ 1,158 The following table represents the maturity of lease liabilities: December 31, 2021 Office Leases Equipment Leases Operating Lease Commitments 2022 $ 1,016 $ — 2023 989 — 2024 968 — 2025 885 — 2026 862 — Thereafter 2,150 — Total lease payments 6,870 — Less: Present value discount 628 — Present value of lease liabilities $ 6,242 $ — Lease term and discount rate by lease type consist of the following: December 31, 2021 2020 Weighted-average remaining lease term: Office leases 7.0 years 7.9 years Equipment leases 0.0 years 1.4 years Weighted-average discount rate (annualized): Office leases 2.67 % 2.66 % Equipment leases — % 1.62 % Supplemental cash flow information related to leases was as follows (in thousands): Year Ended December 31, 2021 2020 Cash paid for amounts included in the measurement of lease liabilities for operating leases: Operating cash flows Office leases $ 1,042 $ 1,097 Equipment leases — 20 94 Table of Contents Note 13— Earnings Per Share Basic earnings per common share is computed by dividing net income 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 pursuant to the two-class method. 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. Earnings per share are summarized for the periods presented in the following table (in thousands, except per share data): Year Ended December 31, 2021 2020 Net income $ 9,156 $ 8,937 Weighted average number of shares outstanding, basic 2,583 2,563 Effect of potentially dilutive common shares 44 30 Weighted average number of shares outstanding, diluted 2,627 2,593 Earnings per share, basic $ 3.52 $ 3.46 Earnings per share, diluted $ 3.46 $ 3.42 There were no anti-dilutive securities for the year ended December 31, 2021 or 2020. Note 14— Employee Benefits The Company has a 401(k) retirement plan that allows employees to defer a portion of their salary into the 401(k) plan. The Company matches a portion of employees' salary deferrals. 401(k) costs are accrued and funded on a current basis. The Company contributed $ 230 thousand and $ 217 thousand to the plan for the years ended December 31, 2021 and 2020, respectively. The Bank maintains a deferred compensation account for the benefit of Ms. Stewart, established in 1994 in connection with an incentive plan which is no longer active. Ms. Stewart was fully vested in her benefits under this plan as of January 2005. Pursuant to the terms of the plan, payments in an amount equal to the fair market value of the assets in the deferred compensation account shall be made to Ms. Stewart (or to her designated beneficiary in the event of her death) in 120 equal monthly installments commencing on the last day of the month following the month in which her employment with the Bank is terminated. In the event of the death of Ms. Stewart and her designated beneficiary prior to the account being fully paid, the remaining value of the account shall be paid in a lump sum to the beneficiary’s estate. The assets in the deferred compensation account consist of cash which is held in a certificate of deposit at the Bank and earns interest at market rates. At December 31, 2021, the amounts held in the certificates of deposit at the Bank were $ 111 thousand, compared to $ 109 thousand at December 31, 2020. The Bank maintains a nonqualified deferred compensation plan (the “NQDC Plan”), which was effective on January 1, 2017. The purpose of the NQDC Plan is to provide a select group of management or highly-compensated employees of the Bank with an opportunity to defer the receipt of up to eighty percent ( 80 %) of their annual base salary, bonus, performance-based compensation and any commission income and to assist the Company in attracting, retaining and motivating employees of high caliber and experience. In addition to elective deferrals, the Bank may make discretionary and other contributions to be credited to the account of any or all participants, subject to the vesting requirements set forth in the NQDC Plan. Discretionary contributions by the Bank become 100 % vested upon the completion of three years of service from a participant’s effective date of participation in the NQDC Plan (with accelerated vesting upon death, disability or a change in control), while other Bank contributions (including matching contributions) vest at the rate of 20 % per year, beginning with the participant’s two-year anniversary of his or her date of hire. During the years ended December 31, 2021, and 2020, the Bank made discretionary contributions to the NQDC Plan in the amount of $ 93 thousand and $ 90 thousand, respectively. 95 Table of Contents Each participant’s deferred compensation account is credited with an investment return determined as if the account was invested in one or more investment funds. Each participant elects the investment funds in which his or her account shall be deemed to be invested. Distributions of vested account balances are made upon death, disability, separation from service, or a specified in-service date unforeseeable emergency. Distributions shall be made in a single cash payment or, at the election of the participant, in annual installments for a period of up to ten ( 10 ) years in the case of a separation from service and in annual installments for a period of up to five ( 5 ) years in the case of an in-service distribution. The obligations of the Bank under the NQDC Plan are general unsecured obligations of the Bank to pay deferred compensation in the future to eligible participants in accordance with the terms of the NQDC Plan from the general assets of the Bank, although the Bank may establish a trust to hold amounts which the Bank may use to satisfy NQDC Plan distributions from time to time. Distributions from the NQDC Plan are governed by the Internal Revenue Code and the NQDC Plan. The Company may, at any time, in its sole discretion, terminate the NQDC Plan or amend or modify the NQDC Plan, in whole or in part, except that no such termination, amendment or modification shall have any retroactive effect to reduce any amounts deemed to be accrued and vested prior to such amendment. Supplemental Executive Retirement Plans. The Company maintains two supplemental executive retirement plans for the benefit of Ms. Stewart, which are intended to be unfunded, non-contributory defined benefit plans maintained primarily to provide her with supplemental retirement income. The first supplemental executive retirement plan ("SERP 1") was effective as of August 14, 2007. The second supplemental executive retirement plan ("SERP 2") was effective as of December 30, 2011, at which time the benefits under SERP 1 were frozen. Under the terms of SERP 1, as amended, Ms. Stewart is entitled to receive $ 53,320 per year for life commencing on the first day of the month following her separation from service (as defined in SERP 1) for any reason from Sound Community Bank, subject to a six-month delay if required by Section 409A of the Internal Revenue Code. No payments will be made under SERP 1 in the event of Ms. Stewart's death and any payments that have commenced will cease upon death. In the event Ms. Stewart is involuntarily terminated in connection with a change in control (as defined in SERP 1), she will be entitled to receive the annual benefit described in the first sentence of this paragraph commencing upon such termination. Under the terms of SERP 2, as amended, upon Ms. Stewart's termination of employment with Sound Community Bank for any reason other than death, she will be entitled to receive additional retirement benefits of $ 96,390 per year for life commencing on the first day of the month following her separation from service (as defined in SERP 2) from Sound Community Bank, subject to a six-month delay if required by Section 409A of the Internal Revenue Code. In the event of Ms. Stewart's death, her beneficiary will be entitled to a single lump sum payment within 90 days thereafter in an amount equal to the Bank's accrual for her retirement benefit under SERP 2 as of the date of death, or approximately $ 1.1 million at December 31, 2021. If a change in control occurs (as defined in SERP 2), Ms. Stewart will receive her full retirement benefit under SERP 2 commencing upon the first day of the month following her separation from service from Sound Community Bank. Stock Options and Restricted Stock The Company currently has one active stockholder approved equity incentive 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. At December 31, 2021, on an adjusted basis, awards for stock options totaling 271,854 shares and awards for restricted stock totaling 142,201 shares of Company common stock have been granted in the aggregate, net of any forfeitures, under the 2008 Plan and 2013 Plan to participants. During the years ended December 31, 2021 and 2020, share-based compensation expense totaled $ 360 thousand and $ 338 thousand, respectively. Stock Option Awards All stock option awards granted under the 2008 Plan vest in 20 percent 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 96 Table of Contents 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 plan award activity during the period ended December 31, 2021: 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 $ 1,045,041 Granted 12,250 32.46 Exercised ( 20,651 ) 15.99 Forfeited ( 1,170 ) 34.93 Expired ( 90 ) 33.88 Outstanding at December 31, 2021 91,316 24.59 4.77 1,772,667 Exercisable 73,393 22.38 3.89 1,586,949 Expected to vest, assuming a 0 % forfeiture rate over the vesting term 91,316 $ 24.59 4.77 $ 1,772,667 At December 31, 2021, there was $ 81 thousand of total unrecognized compensation cost related to non-vested stock options granted under the Plan. The cost is expected to be recognized over the remaining weighted-average vesting period of 2.4 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 in 2021 and 2020 were determined using the following weighted-average assumptions as of the grant date. Year Ended December 31, 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 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. 97 Table of Contents The following is a summary of the Company's non-vested restricted stock awards for the year ended December 31, 2021: Non-vested Shares 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 ( 7,806 ) 33.99 Forfeited ( 1,890 ) 34.93 Expired — — Non-vested at December 31, 2021 17,586 34.02 $ 44.00 Expected to vest assuming a 0 % forfeiture rate over the vesting term 17,586 $ 34.02 $ 44.00 At December 31, 2021, there was $ 401 thousand of unrecognized compensation cost related to non-vested restricted stock granted under the Plan. The cost is expected to be recognized over the weighted-average vesting period of 2.2 years. The total fair value of shares vested for the years ended December 31, 2021 and 2020 was $ 265 thousand and $ 237 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 for $ 1.1 million is being repaid principally by the Bank through contributions to the ESOP over a period of 10 years. The interest rate on the loan is fixed at 2.25 %, per annum. At December 31, 2021, the remaining balance of the ESOP loan was zero . Neither the loan balance nor the related interest expense is reflected on the consolidated financial statements. For the years ended December 31, 2021 and 2020, the ESOP was committed to release 11,340 shares of the Company's common stock to participants. There are no unallocated ESOP shares remaining to be released in 2022. The funds to purchase shares in the ESOP come from contributions the Bank makes twice a year to the Plan. For the years ended December 31, 2021 and 2020, the ESOP trustee purchased 7,343 shares and 10,483 shares of the Company's common stock for inclusion in the Plan. The number of allocated shares was 131,805 and 139,678 at December 31, 2021 and 2020, respectively. The fair value of the 150,497 restricted shares held by the ESOP trust was $ 6.6 million at December 31, 2021. ESOP compensation expense included in salaries and benefits was $ 781 thousand and $ 606 thousand for the years ended December 31, 2021 and 2020, respectively. Note 15— Income Taxes The provision for income taxes at December 31, 2021 and 2020 was as follows (in thousands): December 31, 2021 2020 Current $ 2,315 $ 2,036 Deferred ( 43 ) 355 Total tax expense $ 2,272 $ 2,391 98 Table of Contents A reconciliation of the provision for income taxes for the years ended December 31, 2021 and 2020, with amounts determined by applying the statutory U.S. federal income tax rate to income before income taxes, is as follows (dollars in thousands): Year Ended December 31, 2021 2020 Provision at statutory rate $ 2,400 $ 2,380 Tax-exempt income ( 203 ) ( 186 ) Other 75 197 $ 2,272 $ 2,391 Federal Tax Rate 21.0 % 21.0 % Tax exempt rate ( 1.8 ) ( 1.6 ) Other 0.7 1.7 Effective tax rate 19.9 % 21.1 % The following table reflects the temporary differences that gave rise to the components of the Company's deferred tax assets at December 31, 2021 and 2020 (in thousands): December 31, 2021 2020 Deferred tax assets Deferred compensation and supplemental retirement $ 381 $ 340 Equity based compensation 120 68 Intangible assets 46 55 Lease liabilities 1,311 1,498 Other, net 71 29 Allowance for loan losses 1,324 1,260 Total deferred tax assets 3,253 3,250 Deferred tax liabilities Prepaid expenses ( 100 ) ( 85 ) FHLB stock dividends ( 40 ) ( 39 ) Unrealized gain on securities ( 37 ) ( 64 ) Depreciation ( 165 ) ( 251 ) Mortgage servicing rights ( 568 ) ( 387 ) Deferred loan costs ( 739 ) ( 698 ) Right of use assets ( 1,220 ) ( 1,412 ) Total deferred tax liabilities ( 2,869 ) ( 2,936 ) Net deferred tax asset $ 384 $ 314 At December 31, 2021 and 2020, the Company had no unrecognized tax benefits. The Company recognizes interest accrued and penalties related to unrecognized tax benefits in "Provision for income taxes" in the Consolidated Statements of Income. During the years ended December 31, 2021 and 2020, the Company recognized no interest and penalties related to income taxes. The Company or its subsidiary files an income tax return in the U.S. federal jurisdiction. With few exceptions, the Company is no longer subject to U.S. federal income tax examinations by tax authorities for years before 2018. Note 16— Capital Sound Financial Bancorp is a bank holding company under the supervision of the Federal Reserve. Bank holding companies are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended, and the regulations of the Federal Reserve, except that, pursuant to the Economic Growth, Regulatory Relief and Consumer Protection Act, effective August 30, 2018, a bank holding company with consolidated assets of less than $3.0 billion is 99 Table of Contents generally not subject to the Federal Reserve’s capital regulations, which parallel the FDIC’s capital regulations.The Bank is a state-chartered, federally insured institution and thereby is subject to the capital requirements established by the FDIC. Failure to meet minimum capital requirements can initiate certain mandatory and, possibly, additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital regulations that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies. At December 31, 2021, according to the most recent notification from the FDIC, the Bank was categorized as "well capitalized" under the regulatory framework for prompt corrective action. There are no conditions or events since the notification that management believes have changed the Bank’s category. Prior to January 1, 2020, Sound Community Bank followed the FDIC’s prompt corrective actions standards. In order to be considered well-capitalized under the prompt corrective action standards, a bank must have a ratio of Common Equity Tier 1 ("CET1") capital to risk-weighted assets of at least 6.5%, a ratio of Tier 1 capital to risk-weighted assets of at least 8%, a ratio of total capital to risk-weighted assets of at least 10%, and a leverage ratio of at least 5%, and the bank must not be subject to a regulatory capital requirement imposed on it as an individual bank. In order to be considered adequately capitalized, a bank must have the minimum capital ratios described above. Effective January 1, 2020, the Bank elected to use the Community Bank Leverage Ratio (“CBLR”) framework as provided for in the Economic Growth, Regulatory Relief and Consumer Protection Act. To be eligible to utilize the CBLR, the Bank must have total consolidated assets of less than $10 billion, off-balance sheet exposures of 25% or less of its total consolidated assets, and trading assets and trading liabilities of 5.0% or less of its total consolidated assets, all as of the end of the most recent quarter. Under the CBLR framework, a bank 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 CBLR greater than 9.0%. A bank electing the framework that ceases to meet any qualifying criteria in a future period and that has a leverage ratio greater than 8% will be allowed a grace period of two reporting periods to satisfy the CBLR qualifying criteria or comply with the generally applicable capital requirements. A bank may opt out of the framework at any time, without restriction, by reverting to the generally applicable risk-based capital rule. At December 31, 2021, the Bank’s CBLR was 10.92 %. 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 at December 31, 2021 was 10.09 % During the years ended December 31, 2021 and 2020, the Company repurchased a total of 3,657 and 2,477 shares of Company common stock at an average price of $ 41.68 and $ 29.42 per share pursuant to the Company’s stock repurchase program, leaving $ 1.8 million available for future repurchase under the existing program. Note 17— Concentrations of Credit Risk Most of the Company's business activity is with clients located in the state of Washington. A substantial portion of the loan portfolio is represented by real estate loans throughout western Washington. The ability of the Company's debtors to honor their contracts is dependent upon the real estate and general economic conditions in the area. Loans to one borrower are generally limited by federal banking regulations to 15 % of the Company's unimpaired capital and surplus. Note 18— Commitments and Contingencies The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its clients. These financial instruments generally represent a commitment to extend credit in the form of loans. The instruments involve, to varying degrees, elements of credit- and interest-rate risk in excess of the amount recognized in the consolidated balance sheets. The Company's exposure to credit loss, in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, is represented by the contractual notional amount of those instruments. The Company uses the same credit policies in making commitments as it does for on-balance-sheet instruments. 100 Table of Contents Commitments to extend credit are agreements to lend to a client as long as there is no violation of any condition established by the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Because many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. These commitments are not reflected in the consolidated financial statements. The Company evaluates each client's creditworthiness on a case-by-case basis. The amount of collateral obtained, if it is deemed necessary by the Company, is based on management's credit evaluation of the client. Financial instruments whose contract amount represents credit risk were as follow (in thousands): December 31, 2021 2020 Residential mortgage commitments $ 6,663 $ 3,312 Unfunded construction commitments 89,797 18,981 Unused lines of credit 35,036 34,075 Irrevocable letters of credit 151 151 Total loan commitments $ 131,647 $ 56,519 At December 31, 2021, fixed-rate loan commitments totaled $ 6.7 million and had a weighted-average interest rate of 4.27 %. At December 31, 2020, fixed-rate loan commitments totaled $ 3.3 million and had a weighted-average interest rate of 6.08 %. At December 31, 2021 and 2020, the Company had letters of credit issued by the FHLB with a notional amount of $ 11.5 million and $ 21.6 million, respectively, in order to secure Washington State Public Funds. In the ordinary course of business, the Company sells loans without recourse that may have to be subsequently repurchased due to defects that occurred during the origination of the loan. The defects are categorized as documentation errors, underwriting errors, early payment defaults, and fraud. When a loan sold to an investor without recourse fails to perform, the investor will typically review the loan file to determine whether defects in the origination process occurred. If a defect is identified, the Company may be required to either repurchase the loan or indemnify the investor for losses sustained. If there are no defects, the Company has no commitment to repurchase the loan. At December 31, 2021 and 2020, the maximum amount of these guarantees totaled $ 508.1 million and $ 488.7 million, respectively. These amounts represent the unpaid principal balances of the Company's loans serviced for others' portfolios. There was $ 284 thousand of loans repurchased during the year ended December 31, 2021 and no loans repurchased during the year ended 2020. The Company pays certain medical, dental, prescription, and vision claims for its employees, on a self-insured basis. The Company has purchased stop-loss insurance to cover claims that exceed stated limits and has recorded estimated reserves for the ultimate costs for both reported claims and claims incurred but not reported, which were not considered significant at December 31, 2021. At December 31, 2021, the Company recorded no stop loss medical insurance claims exceeding stated coverage limits. At various times, the Company may be the defendant in various legal proceedings arising in connection with its business. It is the opinion of management that the financial position and the results of operations of the Company will not be materially adversely affected by the outcome of these legal proceedings and that adequate provision has been made in the accompanying consolidated balance sheets. 101 Table of Contents Note 19— Parent Company Financial Information The Balance Sheets, Statements of Income, and Statements of Cash Flows for Sound Financial Bancorp (Parent Only) are presented below (dollars in thousands): Balance sheets December 31, 2021 2020 Assets Cash and cash equivalents $ 4,215 $ 6,837 Investment in Sound Community Bank 100,986 90,568 Other assets 58 65 Total assets $ 105,259 $ 97,470 Liabilities and Stockholders' Equity Subordinated notes, net $ 11,634 $ 11,592 Other liabilities 267 394 Total liabilities 11,901 11,986 Stockholders' equity 93,358 85,484 Total liabilities and stockholders' equity $ 105,259 $ 97,470 Statements of Income Year Ended December 31, 2021 2020 Interest expense on subordinated notes $ ( 673 ) $ ( 190 ) Other expenses ( 550 ) ( 572 ) Loss before income tax benefit and equity in undistributed net income of subsidiary ( 1,223 ) ( 762 ) Income tax benefit 257 160 Equity in undistributed earnings of subsidiary 9,690 9,539 Net income $ 8,724 $ 8,937 102 Table of Contents Statements of Cash Flows Year Ended December 31, 2021 2020 Cash flows from operating activities: Net income $ 8,724 $ 8,937 Adjustments to reconcile net income to net cash provided by operating activities: Other, net ( 78 ) 70 Expense allocation to holding company — 129 Equity in undistributed earnings of subsidiary ( 9,690 ) ( 9,539 ) Net cash used in operating activities ( 1,044 ) ( 403 ) Cash flows from investing activities: ESOP shares released 431 324 Net cash provided by investing activities 431 324 Cash flows from financing activities: Proceeds from issuance of subordinated notes, net — 11,582 Transfer of proceeds from issuance of debt to subsidiary — ( 5,500 ) Dividends paid ( 2,039 ) ( 2,072 ) Repurchase of stock ( 152 ) ( 73 ) Stock options exercised 182 239 Net cash (used in) provided by financing activities ( 2,009 ) 4,176 Net (decrease) increase in cash ( 2,622 ) 4,097 Cash and cash equivalents at beginning of year 6,837 2,740 Cash and cash equivalents at end of year $ 4,215 $ 6,837 Note 20— Revenue from Contracts with Customers All of the Company's revenue from contracts with customers in the scope of ASC 606— Revenue from Contracts with Customers ("ASC 606") is recognized in Noninterest Income with the exception of the net loss on OREO and repossessed assets, which is included in Noninterest Expense. The following table presents the Company's sources of Noninterest Income for the year ended December 31, 2021 and 2020 (in thousands). Items outside of the scope of ASC 606 are noted as such. Year Ended December 31, 2021 2020 Noninterest income: Service charges and fee income Account maintenance fees $ 311 $ 274 Transaction-based and overdraft service charges 356 327 Debit/ATM interchange fees 1,322 1,016 Credit card interchange fees 27 23 Loan fees (a) 178 205 Other fees (a) 53 60 Total service charges and fee income 2,247 1,905 Earnings on cash surrender value of bank-owned life insurance (a) 416 348 Mortgage servicing income (a) 1,284 1,027 Fair value adjustment on MSRs (a) ( 808 ) ( 1,857 ) Net gain on sale of loans (a) 4,190 6,022 Total noninterest income $ 7,329 $ 7,445 (a) Not within scope of ASC 606 103 Table of Contents Account maintenance fees and transaction-based and overdraft service charges The Company earns fees from its customers for account maintenance, transaction-based and overdraft services. Account maintenance fees consist primarily of account fees and analyzed account fees charged on deposit accounts on a monthly basis.The performance obligation is satisfied and fees are recognized on a monthly basis as the service period is completed. Transaction-based fees and overdraft service fees on deposit accounts are charged to deposit customers for specific services provided to the customer, such as non-sufficient funds, overdraft, and wire services. The performance obligation is completed as the transaction occurs and the fees are recognized at the time each specific service is provided to the customer. Debit/ATM and credit card interchange income Debit/ATM interchange income represent fees earned when a debit card issued by the Bank is used for a transaction. The Bank earns interchange fees from debit cardholder transactions through the MasterCard payment network. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder. The performance obligation is satisfied and the fees are earned when the cost of the transaction is charged to the cardholders' account. Certain expenses directly associated with the debit card are recorded on a net basis with the interchange income. The Company utilizes a third-party agency relationship to brand credit cards with fees for originating new accounts paid by the issuing bank. Credit card interchange income represents fees earned when a credit card is issued by the third-party agent. Similar to debit card interchange fees, the Bank earns an interchange fee for each transaction made with Sound Community Bank's branded credit cards. The performance obligation is satisfied and the fees are earned when the cost of the transaction is charged to the cardholders' credit card. Certain expenses and rebates directly related to the credit card interchange contract are recorded net of the interchange income. Net loss on OREO and repossessed assets We record a gain or loss from the sale of other real estate owned when control of the property transfers to the buyer, which generally occurs at the time of an executed deed of trust. When the Bank finances the sale of OREO to the buyer, the Company assesses whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the OREO asset is derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer. In determining the gain or loss on sale, we adjust the transaction price and related gain or loss on sale if a significant financing component is present. The Company generated income/incurred expenses, net of gain/losses on sale of OREO, on our OREO properties of $( 16 ) thousand and $ 5 thousand for the years ended December 31, 2021 and 2020, respectively, included in noninterest expense on the Consolidated Statements of Income. Note 21— Subsequent Events On January 28, 2022, the Company declared on Company common stock a quarterly cash dividend of $ 0.17 per common share and a special cash dividend of $ 0.10 per share, payable on February 24, 2022 to stockholders of record at the close of business February 10, 2022. 104 Table of Contents Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None.