What changed in this filing

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Item 2. Management’s Discussion and Analysis

2023-05-15 compared with 2022-11-10 · 188 added, 269 removed, 264 unchanged (63% of the section changed)

8 unchanged sentences

Our actual results, performance, or achievements may differ materially from those suggested, expressed, or implied by forward-looking statements as a result of a wide variety or range of factors including, but not limited to:

• potential adverse impacts to economic conditions in the Company’s local market areas, other markets where the Company has lending relationships, or other aspects of the Company’s business operations or financial markets, including, without limitation, as a result of employment levels, labor shortages and the effects of inflation, a potential recession or slowed economic growth caused by increasing political instability from acts of war including Russia’s invasion of Ukraine, as well as increasing oil prices and supply chain disruptions, and any governmental or societal responses to the novel coronavirus disease 2019 (“COVID-19”) pandemic, including the possibility of new COVID-19 variants;

Congress to increase the debt ceiling, or slowed economic growth caused by increasing political instability from acts of war including Russia’s invasion of Ukraine, as well as increasing oil prices and supply chain disruptions, and any governmental or societal responses to recent bank failures or new COVID-19 variants;

• changes in consumer spending, borrowing and savings habits;

• the risks of lending and investing activities, including changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of our allowance for loan losses;

• monetary and fiscal policies of the Board of Governors of the Federal Reserve System ("Federal Reserve") and the U.S.

2 unchanged sentences

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

• our ability to access cost-effective funding;

• the future of the London Interbank Offered Rate (“LIBOR”), and the transition away from LIBOR toward new interest-rate benchmarks;

• our ability to access cost-effective funding, including maintaining the confidence of depositors;

• the possibility that unexpected outflows of uninsured deposits may require us to sell investment securities at a loss;

• the transition away from the London Interbank Offered Rate (“LIBOR”) toward new interest-rate benchmarks;

• our ability to control operating costs and expenses;

1 unchanged sentence

• fluctuations in interest rates;

• results of examinations of Sound Financial Bancorp and Sound Community Bank by their regulators, including the possibility that the regulators may, among other things, require us to increase our allowance for loan losses or to write-down assets, change Sound Community Bank's regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings;

• results of examinations of Sound Financial Bancorp and Sound Community Bank by their regulators, including the possibility that the regulators may, among other things, require us to increase our allowance for credit losses or to write-down assets, change Sound Community Bank's regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings;

• inability of key third-party providers to perform their obligations to us;

15 unchanged sentences

• other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services;

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

• the other risks described from time to time in our reports filed with or furnished to the U.S.

Securities and Exchange Commission (the "SEC"), including this Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2022 (“2022 Form 10-K”).

We wish to advise readers not to place undue reliance on any forward-looking statements and that the factors listed above could materially affect our financial performance and could cause our actual results for future periods to differ materially from any such forward-looking statements expressed with respect to future periods and could negatively affect our stock price performance.

We caution readers not to place undue reliance on any forward-looking statements and that the factors listed above could materially affect our financial performance and could cause our actual results for future periods to differ materially from any such forward-looking statements expressed with respect to future periods and could negatively affect our stock price performance.

We do not undertake and specifically decline any obligation to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

1 unchanged sentence

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 Department of Financial Institutions and the Federal Deposit Insurance Corporation (the “FDIC”).

The Federal Reserve is the primary federal regulator for Sound Financial Bancorp.

As a Washington commercial bank, that is not a member of the Federal Reserve System, the Bank’s regulators are the Washington Department of Financial Institutions and the Federal Deposit Insurance Corporation (the “FDIC”).

As a bank holding company, Sound Financial Bancorp is regulated by the Federal Reserve.

We also sell insurance products and services for clients through Sound Community Insurance Agency, Inc., a wholly owned subsidiary of the Bank.

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

At September 30, 2022, Sound Financial Bancorp, on a consolidated basis, had assets of $982.2 million, net loans held-for-portfolio of $844.0 million, deposits of $815.4 million and stockholders’ equity of $95.0 million.

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

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

At March 31, 2023, Sound Financial Bancorp, on a consolidated basis, had assets of $1.00 billion, net loans held-for-portfolio of $862.0 million, deposits of $841.6 million and stockholders’ equity of $98.6 million.

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

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

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

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

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

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

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

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

Critical Accounting Policies

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

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

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

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

Critical Accounting Estimates

Certain of our accounting policies require management to make difficult, complex or subjective judgments, which may relate to matters that are inherently uncertain.

Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances.

Facts and circumstances that could affect these judgments include, but are not limited to, changes in interest rates, changes in the performance of the economy and changes in the financial condition of borrowers.

Management believes that its critical accounting policies include determining the allowance for loan losses, accounting for other-than-temporary impairment of securities, accounting for mortgage servicing rights, accounting for other

real estate owned and accounting for deferred income taxes.

There have been no material changes in the Company’s critical accounting policies and estimates as previously disclosed in the Company’s 2021 Form 10-K

Comparison of Financial Condition at September 30, 2022 and December 31, 2021

Total assets increased $62.6 million, or 6.8%, to $982.2 million at September 30, 2022 from $919.7 million at December 31, 2021.

The increase primarily was a result of increases in loans held-for-portfolio and investment securities, partially offset by lower balances in cash and cash equivalents.

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

There have been no material changes in the Company’s critical accounting policies and estimates as previously disclosed in the Company’s 2022 Form 10-K, except as disclosed in “Note 1 —Basis of Presentation” in the Notes to Condensed Consolidated Financial Statements in this report.

Comparison of Financial Condition at March 31, 2023 and December 31, 2022

Total assets increased $28.0 million, or 2.9%, to $1.00 billion at March 31, 2023 from $976.4 million at December 31, 2022.

The increase primarily was a result of loan growth and an increase in cash and cash equivalents.

Cash and Securities.

Cash and cash equivalents decreased $107.5 million, or 58.6%, to $76.1 million at September 30, 2022 from $183.6 million at December 31, 2021, primarily due to deploying cash earning a nominal yield into higher interest-earning loans and investments securities.

Investment securities increased $4.2 million, or 49.7%, to $12.6 million at September 30, 2022, compared to $8.4 million at December 31, 2021.

Held-to-maturity securities totaled $2.2 million at September 30, 2022, compared to none at December 31, 2021, due to the purchase of $2.2 million in municipal bonds and agency mortgage-backed securities.

Available-for-sale securities totaled $10.4 million at September 30, 2022, compared to $8.4 million at December 31, 2021.

The increase in available-for-sale securities was primarily due the purchase of $4.4 million in treasury bills, municipal bonds and agency mortgage-backed securities, partially offset by regularly scheduled payments and maturities.

Loans held-for-portfolio, net, increased $163.9 million, or 24.1%, to $844.0 million at September 30, 2022 from $680.1 million at December 31, 2021, driven by increases across all loan classes, excluding commercial business loans.

The increases primarily resulted from focused marketing campaigns, increased utilization of digital marketing tools and the addition of experienced lending staff during 2021.

These increases were partially offset by the decrease in commercial business loans resulting from forgiveness by the U.S.

Small Business Administration (“SBA”) of loans originated under the Paycheck Protection Program (“PPP”).

The following table reflects the changes in the loan mix of our loan portfolio at September 30, 2022, as compared to December 31, 2021 (dollars in thousands):

September 30,

Cash and cash equivalents increased $23.7 million, or 41.1%, to $81.6 million at March 31, 2023 from $57.8 million at December 31, 2022, primarily due to due to an increase in deposits, primarily certificate and money market accounts, partially offset by the repayment of FHLB overnight advances.

Investment securities decreased $1.6 million, or 13.0%, to $10.8 million at March 31, 2023, compared to $12.4 million at December 31, 2022.

Held-to-maturity securities totaled $2.2 million at March 31, 2023 and December 31, 2022.

Available-for-sale securities totaled $8.6 million at March 31, 2023, compared to $10.2 million at December 31, 2022.

The decrease in available-for-sale securities was primarily due the maturity of $1.6 million in treasury bills and regularly scheduled payments and maturities.

Loans held-for-portfolio, net, increased $3.6 million, or 0.4%, to $862.0 million at March 31, 2023 from $858.4 million at December 31, 2022, driven by increases in construction and land, commercial business and manufactured home loans, partially offset by declines in commercial real estate, multifamily, floating homes and other consumer loans.

The increase from December 31, 2022 in total loans held-for-portfolio primarily resulted from the funding of commercial construction projects and a new commercial and industrial relationship.

The following table reflects the changes in the loan mix of our loan portfolio at March 31, 2023, as compared to December 31, 2022 (dollars in thousands):

2023 December 31,

11 unchanged sentences

Total loans held-for-portfolio, gross 870,545 865,981 4,564 0.5

Allowance for loan losses (7,489) (6,306) (1,183) 18.8

Allowance for credit losses — loans (8,532) (7,599) (933) 12.3

Total loans held-for-portfolio, net $ 862,013 $ 858,382 $ 3,631 0.4 %

The increase in one-to-four family loans was driven primarily by the origination of $57.8 million in jumbo loans during 2022 and the origination of $33.4 million of conforming and non-conforming conventional loans in our portfolio.

The increase in commercial and multifamily loans during the period was primarily due to the origination of $45.7 million of multifamily loans and $30.2 million of commercial non-owner occupied loans.

The increase in construction and land loans during the period was primarily due to the origination and advances of new commercial construction loans.

These increases were partially offset by payoffs and paydowns during the period.

The decrease in our commercial business loan portfolio was primarily due to SBA forgiveness of PPP loans.

At September 30, 2022, our loan portfolio, net of deferred loan fees, remained well-diversified.

Commercial and multifamily real estate loans accounted for 37.0% of total loans, one-to-four family loans, including home equity loans accounted for 33.7% of total loans, commercial business loans accounted for 2.8% of total loans, and consumer loans, consisting of manufactured homes, floating homes, and other consumer loans accounted for 13.4% of total loans at September 30, 2022.

Construction and land loans accounted for 13.2% of total loans at September 30, 2022.

Loans held-for-sale totaled $1.9 million at September 30, 2022, compared to $3.1 million at December 31, 2021.

The decrease was primarily due to a decline in mortgage originations reflecting reduced refinance activity.

Allowance for Loan Losses.

The allowance for loan losses is maintained to cover losses that are probable and can be estimated

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

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

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

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

2022 2021 2022 2021

The increase in construction and land loans during the period was primarily due to advances of commercial construction loans.

The increase in commercial business loans was primarily the result of a new commercial business relationship.

These increases were partially offset by payoffs and paydowns during the period, including the payoff of $2.7 million related to two multifamily loans.

At March 31, 2023, our loan portfolio, net of deferred loan fees, remained well-diversified.

Commercial and multifamily real estate loans accounted for 35.3% of total loans, one-to-four family loans, including home equity loans, accounted for 33.7% of total loans, commercial business loans accounted for 2.9% of total loans, and consumer loans, consisting of manufactured homes, floating homes, and other consumer loans, accounted for 13.6% of total loans at March 31, 2023.

Construction and land loans accounted for 14.4% of total loans at March 31, 2023.

Loans held-for-sale totaled $1.4 million at March 31, 2023, compared to none at December 31, 2022.

The increase was primarily due to timing of mortgage originations and sales.

Allowance for Credit Losses.

The following table reflects the adjustments in our allowance for credit losses (“ACL”) during the periods indicated (dollars in thousands):

Three Months Ended March 31,

Allowance for Credit Losses — Loans:

Balance at beginning of period $ 7,599 $ 6,306

Impact of Adoption of ASU 2016-16 760 —

Charge-offs (79) (32)

Recoveries 7 8

Net (charge-offs) recoveries (3) (5) 82 (98)

Provision for loan losses during the period 375 175 1,101 425

Net charge-offs (72) (24)

Provision for credit losses during the period 245 125

Balance at end of period 8,532 $ 6,407

Our allowance for loan losses increased $1.2 million, or 18.8%, to $7.5 million at September 30, 2022, from $6.3 million at December 31, 2021.

Specific loan loss reserves decreased to $239 thousand at September 30, 2022, compared to $293 thousand at December 31, 2021, while general loan loss reserves increased to $6.6 million at September 30, 2022, compared to $5.6 million at December 31, 2021, and the unallocated reserve increased to $653 thousand at September 30, 2022, compared to $395 thousand at December 31, 2021.

The increase in general loss reserves and the unallocated reserve was primarily a result of the increase in the loan portfolio at September 30, 2022.

Net charge-offs for the three months ended September 30, 2022 totaled $3 thousand and net recoveries totaled $82 thousand for the nine months ended September 30, 2022, compared to net charge-offs of $5 thousand and $98 thousand for the three and nine months ended September 30, 2021, respectively.

At September 30, 2022, the allowance for loan losses as a percentage of total loans and nonperforming loans was 0.88% and 301.24%, compared to 0.92% and 113.58%, at December 31, 2021, respectively.

See “Comparison of Results of Operations for the Three and Nine Months Ended September 30, 2022 and 2021 — Provision for Loan Losses.”

The following tables show certain credit ratios at and for the periods indicated and each component of the ratio's calculations.

September 30,

Reserve for Unfunded Commitments:

Balance at beginning of period 335 404

Adoption of ASU 2016-13 695 —

(Reversal of) provision for credit losses (235) 15

Balance at end of period 795 419

Allowance for credit losses $ 9,327 $ 6,826

Ratio of net charge-offs during the period to average loans outstanding during the period (0.03) % (0.01) %

Our ACL — loans increased $933 thousand, or 12.3%, to $8.5 million at March 31, 2023, from $7.6 million at December 31, 2022.

The change in the ACL - loans from December 31, 2022 to March 31, 2023 was primarily a result of the adjustment for the adoption of ASU 2016-16.

The provision for credit losses had a minimal impact on the change in the ACL as a result of the growth in the loan portfolio primarily related to construction advances that were outstanding at December 31, 2022 funding during the three months ended March 31, 2023, thus reducing the reserve for unfunded commitments and increasing the ACL - loans.

Net charge-offs for the three months ended March 31, 2023 totaled $72 thousand, compared to net charge-offs of $24 thousand for the three months ended March 31, 2022.

At March 31, 2023, the ACL - loans as a percentage of total loans and nonperforming loans was 0.98% and 659.97%, compared to 0.88% and 256.81%, at December 31, 2022, respectively.

See “Comparison of Results of Operations for the Three Months Ended March 31, 2023 and 2022 — Provision for Credit Losses.”

The following tables show certain credit ratios at and for the periods indicated and each component of the ratio's calculations (dollars in thousands).

2023 December 31,

Allowance for loan losses as a percentage of total loans outstanding at period end 0.88 % 0.92 %

Allowance for loan losses 7,489 6,306

Allowance for credit losses - loans as a percentage of total loans outstanding at period end 0.98 % 0.88 %

Allowance for credit losses — loans $ 8,532 $ 7,599

Total loans outstanding $ 871,912 $ 867,556

Non-accrual loans as a percentage of total loans outstanding at period end

Nonaccrual loans as a percentage of total loans outstanding at period end

0.15 % 0.34 %

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Total loans outstanding $ 871,912 $ 867,556

Allowance for loan losses as a percentage of non-accrual loans at period end

Allowance for credit losses - loans as a percentage of nonaccrual loans at period end

659.94 % 256.81 %

Allowance for loan losses 7,489 6,306

Allowance for credit losses — loans $ 8,532 $ 7,599

Total nonaccrual loans $ 1,293 $ 2,959

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

2022 2021 2022 2021

Allowance for credit losses as a percentage of total loans outstanding at period end 1.07 % 0.91 %

Allowance for credit losses $ 9,327 $ 7,934

Total loans outstanding $ 871,912 $ 867,556

Allowance for credit losses as a percentage of nonaccrual loans at period end 721.46 % 268.13 %

Allowance for credit losses $ 9,327 $ 7,934

Total nonaccrual loans $ 1,293 $ 2,959

Three Months Ended March 31,

($ in thousands)

1 unchanged sentence

One-to-four family:

— % — % 0.03 % (0.07) %

Net recoveries (charge-offs)

1 unchanged sentence

$ 274,261 $ 211,315

— % 0.05 % 0.51 % (0.04) %

Net recoveries (charge-offs)

2 unchanged sentences

Commercial and multifamily real estate:

— % — % — % — %

Net (charge-offs) recoveries

2 unchanged sentences

Construction and land:

— % — % — % — %

Net (charge-offs) recoveries

2 unchanged sentences

Manufactured homes:

— % 0.02 % 0.07 % 0.01 %

Net recoveries

2 unchanged sentences

Floating homes:

— % — % — % — %

Net (charge-offs) recoveries

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Commercial business:

— % — % — % — %

Net recoveries

Net (charge-offs)

Average loans outstanding

1 unchanged sentence

(0.03) % (0.01) %

Net (charge-offs) recoveries

Net recoveries (charge-offs)

$ (72) $ (24)

2 unchanged sentences

Nonperforming Assets.

At September 30, 2022, nonperforming assets, which are comprised of nonaccrual loans including nonperforming troubled debt restructurings (“TDRs”), and other real estate owned (“OREO”), totaled $3.1 million, or 0.32% of total assets, compared to $6.2 million, or 0.68% of total assets at December 31, 2021.

At March 31, 2023, nonperforming assets, which are comprised of nonaccrual loans and other real estate owned (“OREO”), totaled $1.9 million, or 0.19% of total assets, compared to $3.6 million, or 0.37% of total assets at December 31, 2022.

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

Nonperforming Assets

September 30,

2023 December 31,

Change Percent

Nonaccrual loans $ 2,378 $ 5,130 $ (2,752) (53.6) %

Nonperforming TDRs 108 422 (314) (74.4)

Total nonperforming loans $ 1,293 $ 2,958 $ (1,665) (56.3)

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Total nonperforming assets $ 1,868 $ 3,617 $ (1,749) (48.4) %

Nonperforming loans, which are comprised of nonaccrual loans and nonperforming TDRs, decreased $3.1 million, or 55.2%, to $2.5 million at September 30, 2022 from $5.6 million at December 31, 2021.

The decrease in nonperforming loans primarily was due to the payoff of a $2.3 million nonperforming multifamily loan during the three months ended September 30, 2022.The percentage of nonperforming loans to total loans was 0.29% at September 30, 2022, compared to 0.81% of total loans at December 31, 2021.

Loans classified as TDRs totaled $2.0 million and $2.6 million at September 30, 2022 and December 31, 2021, of which $108 thousand and $422 thousand were nonperforming pursuant to their contractual repayment terms at those dates, respectively.

Nonperforming assets, which are comprised of nonaccrual loans, nonperforming modified loans and OREO, decreased $1.7 million, or 48.4%, to $1.9 million at March 31, 2023 from $3.6 million at December 31, 2022.

The decrease in nonperforming

assets primarily was due to the payoff of $1.5 million in nonperforming one-to-four family loans related to a single borrower and the write-off of one residential property for $84 thousand during the three months ended March 31, 2023.

The percentage of nonperforming loans to total loans was 0.15% at March 31, 2023, compared to 0.34% of total loans at December 31, 2022.

Mortgage Servicing Rights.

The fair value of mortgage servicing rights was $4.8 million at September 30, 2022, an increase of $514 thousand, or 12.0%, from $4.3 million at December 31, 2021.

The fair value of mortgage servicing rights was $4.6 million at March 31, 2023, a decrease of $100 thousand, or 2.1%, from $4.7 million at December 31, 2022.

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

2 unchanged sentences

Deposits and Borrowings.

Total deposits increased $17.1 million, or 2.1%, to $815.4 million at September 30, 2022 from $798.3 million at December 31, 2021.

The increase was primarily a result of an increase in certificate accounts.

The increase in our certificate accounts was primarily used to fund organic loan growth.

Noninterest-bearing deposits increased $1.8 million, or 0.9%, to $192.3 million at September 30, 2022, compared to $190.5 million at December 31, 2021.

Noninterest-bearing deposits represented 23.6% of total deposits at September 30, 2022, compared to 23.9% at December 31, 2021.

Total deposits increased $32.9 million, or 4.1%, to $841.6 million at March 31, 2023 from $808.8 million at December 31, 2022.

The increase was primarily a result of higher balances in certificate and money market accounts, partially offset by lower balances in all other deposit products, largely driven by consumer behavior to move funds from lower rate deposit products into higher rate deposit products.

Noninterest-bearing deposits decreased $117 thousand, or 0.1%, to $173.1 million at March 31, 2023, compared to $173.2 million at December 31, 2022.

Noninterest-bearing deposits represented 20.6% of total deposits at March 31, 2023, compared to 21.4% at December 31, 2022.

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

September 30, 2022 December 31, 2021

March 31, 2023 December 31, 2022

Rate Amount Wtd.

6 unchanged sentences

Total deposits $ 841,647 1.05 % $ 808,763 0.37 %

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

Scheduled maturities of time deposits at September 30, 2022, are as follows (in thousands):

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

Scheduled maturities of time deposits at March 31, 2023, are as follows (in thousands):

Year Ending December 31, Amount

2 unchanged sentences

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 $250,000 at September 30, 2022 and December 31, 2021, totaled $37.3 million and $19.1 million, respectively.

Certificates of deposit have maturities of six years or less.

The aggregate amount of time deposits in denominations of more than $250,000 at March 31, 2023 and December 31, 2022, totaled $82.1 million and $56.1 million, respectively.

Deposit amounts in excess of $250,000 are not federally insured.

Borrowings comprised of FHLB advances increased $44.5 million at September 30, 2022 from zero at December 31, 2021, primarily to support loan growth.

Subordinated notes, net totaled $11.7 million and $11.6 million at September 30, 2022 and December 31, 2021.

As of March 31, 2023, uninsured deposits totaled $174.1 million, which represented 20.7% of total deposits, as compared to uninsured deposits of $161.9 million, or 20.0% of total deposits as of December 31, 2022.

The uninsured amounts are estimates based on the methodologies and assumptions used for the Bank’s regulatory reporting requirements.

The increase in uninsured deposits primarily related to the increase in certificates of deposit.

Borrowings, comprised of FHLB advances, decreased $8.0 million to $35.0 million at March 31, 2023 from $43.0 million at December 31, 2022, primarily as a result of paydowns of our FHLB advances due to the increase in deposits.

Subordinated notes, net totaled $11.7 million at both March 31, 2023 and December 31, 2022.

Stockholders’ Equity.

Total stockholders’ equity increased $1.6 million, or 1.7%, to $95.0 million at September 30, 2022, from $93.4 million at December 31, 2021.

This increase primarily reflects $5.9 million in net income for the nine months ended September 30, 2022 and $384 thousand related to stock-based compensation, partially offset by the payment of cash dividends of $1.6 million to common stockholders, repurchases of common stock of $1.7 million, and an unrealized loss, net of tax, of $1.4 million on our available-for-sale securities as a result of declining fair market values related to increases in market interest rates this year.

Total stockholders’ equity increased $900 thousand, or 0.9%, to $98.6 million at March 31, 2023, from $97.7 million at December 31, 2022.

This increase primarily reflects $2.2 million of net income earned during the current quarter, a $83 thousand decrease in accumulated other comprehensive loss, net of tax, and $247 thousand in proceeds from exercises of stock options, partially offset by the payment of $442 thousand in dividends to the Company’s stockholders.

In addition, stockholders' equity was impacted by the adoption of CECL in the first quarter of 2023, which as of January 1, 2023, resulted in an after-tax decrease to opening retained earnings of $1.1 million.

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

3 unchanged sentences

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

Three Months Ended September 30,

Balance Interest

Rate Annualized Average

Balance Interest

Rate Annualized

Interest-earning assets:

Loans receivable $ 833,195 $ 10,327 4.92 % $ 652,251 $ 8,967 5.45 %

Investments, cash and cash equivalents 88,812 449 2.01 230,905 135 0.23

Total interest-earning assets (1)

922,007 10,776 4.64 883,156 9,102 4.09

Interest-bearing liabilities:

Savings and money market accounts 188,276 63 0.13 179,164 42 0.09

Demand and NOW accounts 290,106 164 0.22 311,273 141 0.18

Certificate accounts 130,541 503 1.53 135,757 434 1.27

Subordinated notes 11,658 168 5.72 11,616 168 5.74

Borrowings 46,462 281 2.40 2 — —

Total interest-bearing liabilities 667,043 1,179 0.70 % 637,812 785 0.49 %

Net interest income $ 9,597 $ 8,317

Net interest rate spread 3.94 % 3.60 %

Net earning assets $ 254,964 $ 245,344

Net interest margin 4.13 % 3.74 %

Average interest-earning assets to average interest-bearing liabilities 138.22 % 138.47 %

Noninterest-bearing deposits $ 189,379 $ 182,503

Total deposits 798,302 730 0.36 % 808,697 617 0.30 %

Total funding (2)

856,422 1,179 0.55 % 820,315 785 0.38 %

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

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

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

Nine Months Ended September 30,

Three Months Ended March 31,

Balance Interest

31 unchanged sentences

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

Three Months Ended September 30, 2022 vs.

Nine Months Ended September 30, 2022 vs.

Three Months Ended March 31, 2023 vs.

Increase (Decrease) due to Total

Increase (Decrease) Increase (Decrease) due to Total

Increase (Decrease)

Volume Rate Volume Rate

Interest-earning assets:

10 unchanged sentences

Change in net interest income $ 1,753

Comparison of Results of Operation for the Three and Nine Months Ended September 30, 2022 and 2021

Comparison of Results of Operation for the Three Months Ended March 31, 2023 and 2022

Q1 2023 vs Q1 2022 .

Net income decreased $46 thousand, or 1.8%, to $2.5 million, or $0.97 per diluted common share, for the three months ended September 30, 2022, compared to $2.6 million, or $0.98 per diluted common share, for the three months ended September 30, 2021.

The decrease was primarily the result of a $405 thousand decrease in noninterest income, a $718 thousand increase in noninterest expense, and a $200 thousand increase in the provision for loan losses, partially offset by a $1.3 million increase in net interest income.

Net income decreased $1.4 million, or 19.4%, to $5.9 million, or $2.23 per diluted common share, for the nine months ended September 30, 2022, compared to $7.3 million, or $2.76 per diluted common share, for the nine months ended September 30, 2021.

The decrease was primarily a result of a $2.3 million decrease in noninterest income, a $2.2 million increase in noninterest expense and a $676 thousand increase in the provision for loan losses, partially offset by a $3.4 million increase in net interest income.

Net income increased $445 thousand, or 25.8%, to $2.2 million, or $0.83 per diluted common share, for the three months ended March 31, 2023, compared to $1.7 million, or $0.65 per diluted common share, for the three months ended March 31, 2022.

The increase was primarily the result of a $1.8 million increase in net interest income and a $130 thousand decrease in the provision for credit losses, partially offset by a $554 thousand decrease in noninterest income and a $795 thousand increase in noninterest expense.

Interest Income

Q1 2023 vs Q1 2022 .

Interest income increased $1.7 million, or 18.4%, to $10.8 million for the three months ended September 30, 2022, from $9.1 million for the three months ended September 30, 2021, primarily due to higher average loan balances and a 177 basis point increase in average yield on investments and interest-bearing cash, partially offset by a 54 basis point decline in the average loan yield and a lower average balance of investments and interest-bearing cash.

Interest income on loans increased $1.4 million, or 15.2%, to $10.3 million for the three months ended September 30, 2022, compared to $9.0 million for the three months ended September 30, 2021.

The average balance of total loans was $833.2 million for the three months ended September 30, 2022, compared to $652.3 million for the three months ended September 30, 2021 resulting from increased balances in all loan categories, except for commercial business loans which declined as a result of the SBA’s repayment of PPP loans.

The average yield on total loans was 4.92% for three months ended September 30, 2022, compared to 5.45% for the three months ended September 30, 2021.

The average yield on total loans decreased primarily due to the decrease in the recognition of net deferred fees due to loan repayments from SBA loan forgiveness of PPP loans during the quarter.

Interest income included $24 thousand in fees earned related to PPP loans in the three months ended September 30, 2022, compared to $1.1 million in the same quarter a year ago.

For the three months ended September 30, 2022, the average balance of PPP loans was $157 thousand and the average yield on PPP loans was 60.68%, including the recognition of the net deferred fees, with a positive impact on loan yield of one basis point.

For the three months ended September 30, 2021, the average balance of PPP loans was $19.0 million and the average yield on PPP loans was 22.37%, including the recognition of

deferred fees, with a positive impact on loan yield of 51 basis points.

At September 30, 2022, no PPP deferred loan origination fees remain to be accreted into interest income.

Interest income on the investment portfolio and cash and cash equivalents increased $314 thousand, or 232.6%, to $449 thousand for the three months ended September 30, 2022, compared to $135 thousand for the three months ended September 30, 2021.

Interest income increased $4.0 million, or 48.2%, to $12.2 million for the three months ended March 31, 2023, from $8.2 million for the three months ended March 31, 2022, primarily due to higher average loan balances, a 61 basis point increase in the average loan yield and a 371 basis point increase in the average yield on investments and interest-bearing cash, partially offset by a lower average balance of investments and interest-bearing cash.

Interest income on loans increased $3.3 million, or 40.9%, to $11.4 million for the three months ended March 31, 2023, compared to $8.1 million for the three months ended March 31, 2022.

The average balance of total loans was $867.7 million for the three months ended March 31, 2023, compared to $694.9 million for the three months ended March 31, 2022 primarily resulting from increased balances related to construction advances, partially offset by a decrease in commercial and multifamily loans resulting from the payoff of a few large multifamily loans during the past year.

The average yield on total loans was 5.32% for three months ended March 31, 2023, compared to 4.71% for the three months ended March 31, 2022.

The average yield on total loans increased primarily due to variable rate loans adjusting to higher market interest rates and new loan originations at higher interest rates.

Interest income on the investment portfolio and cash and cash equivalents increased $655 thousand, or 474.6%, to $793 thousand for the three months ended March 31, 2023, compared to $138 thousand for the three months ended March 31, 2022.

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

The average balance on investments and cash and cash equivalents was $88.8 million for the three months ended September 30, 2022, compared to $230.9 million for the three months ended September 30, 2021.

The average balance on investments and cash and cash equivalents was $80.2 million for the three months ended March 31, 2023, compared to $190.4 million for the three months ended March 31, 2022.

The decrease in average balances was due to lower average cash balances as we redeployed funds into higher interest-earning assets, specifically loans and, to a lesser extent, investment securities.

The average yield on investments and cash and cash equivalents increased to 2.01% for the three months ended September 30, 2022, compared to 0.23% for the three months ended September 30, 2021, as a result of the rising interest rate environment and the increase in the average balance of our investment securities portfolio.

Interest income increased $2.5 million, or 9.6%, to $28.0 million for the nine months ended September 30, 2022, from $25.5 million for the nine months ended September 30, 2021.

The increase primarily was due to higher average loan balances and a 65 basis point increase in the average yield earned on investments and cash balances, partially offset by a 49 basis point decline in the average loan yield and lower average investment and cash balances.

Interest income on loans increased $1.9 million, or 7.7%, to $27.1 million for the nine months ended September 30, 2022, compared to $25.2 million for the nine months ended September 30, 2021, driven by higher average total loans, partially offset a 49 basis points decline in the average yield on loans.

The average balance of total loans was $757.1 million for the nine months ended September 30, 2022, compared to $636.4 million for the nine months ended September 30, 2021.

The average yield on total loans was 4.79% for the nine months ended September 30, 2022, compared to 5.28% for the nine months ended September 30, 2021.

For the nine months ended September 30, 2022, the average balance of PPP loans was $1.5 million and the average yield on PPP loans was 12.83%, including the recognition of the net deferred fees, with a positive impact on average loan yield of two basis points.

For the nine months ended September 30, 2021, the average balance of PPP loans was $44.2 million and the average yield on PPP loans was 8.55%, including the recognition of deferred fees, with a positive impact on average loan yield of 24 basis points.

Interest income included $141 thousand in fees earned related to PPP loans in the nine months ended September 30, 2022, compared to $2.8 million in the same period a year ago.

Interest income on the investment portfolio and cash and cash equivalents increased $511 thousand, or 140.0%, to $876 thousand for the nine months ended September 30, 2022, compared to $365 thousand for the nine months ended September 30, 2021.

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

The average yield on investments and cash and cash equivalents was 0.86% for the nine months ended September 30, 2022, compared to 0.21% for the nine months ended September 30, 2021, primarily due to the deployment of cash balances into higher-yielding investment balances.

The average yield on investments and cash and cash equivalents increased to 4.01% for the three months ended March 31, 2023, compared to 0.29% for the three months ended March 31, 2022, as a result of the rising interest rate environment.

Interest Expense

Q1 2023 vs Q1 2022 .

Interest expense increased $394 thousand, or 50.2%, to $1.2 million for the three months ended September 30, 2022, from $785 thousand for the three months ended September 30, 2021.

Interest expense on deposits increased $113 thousand, or 18.3%, to $730 thousand for the three months ended September 30, 2022, compared to $617 thousand for the same period a year ago.

The increase was primarily the result of a $46.5 million increase in the average balance of borrowings and higher rates paid on all interest-bearing deposits, partially offset by a $17.3 million decrease in the average balance of interest-bearing deposits.Compared to the same period last year, total deposit costs were negatively impacted by the higher rates paid on deposits and favorably impacted by the $6.9 million increase in the average balance of noninterest bearing deposits from $182.5 million at September 30, 2021.

The increase in the rate paid on certificate accounts contributed to a six basis point increase in the average cost of total deposits to 0.36% for the quarter ended September 30, 2022, from 0.30% for the quarter ended September 30, 2021.

Interest expense on borrowings, comprised solely of FHLB advances, was $281 thousand for the three months ended September 30, 2022, compared to none for the three months ended September 30, 2021, reflecting the increased use of lower cost FHLB advances during the third quarter of 2022 to supplement our liquidity needs.

Interest expense on subordinated notes was $168 thousand for both the three months ended September 30, 2022 and 2021.

Interest expense decreased $943 thousand, or 28.5%, to $2.4 million for the nine months ended September 30, 2022, from $3.3 million for the nine months ended September 30, 2021, primarily as a result of a decline in the average balance of certificate accounts and rates paid on all deposits, partially offset by a lower percentage of noninterest bearing deposits to total deposits and an increase in the average balance of borrowings.

Interest expense on deposits decreased $1.2 million, or 44.0%, to $1.6 million for the nine months ended September 30, 2022, compared to $2.8 million for the same period a year ago.

The decrease was primarily the result of a decline in the average cost of deposits reflecting reduced market rates paid on deposits for the majority of 2022.

The average cost of total deposits decreased 21 basis points to 0.26% for the nine months ended September 30, 2022, from 0.47% for the nine months ended September 30, 2021.

Interest expense increased $2.2 million, or 371.1%, to $2.8 million for the three months ended March 31, 2023, from $595 thousand for the three months ended March 31, 2022.

Interest expense on deposits increased $1.7 million, or

400.2%, to $2.1 million for the three months ended March 31, 2023, compared to $427 thousand for the same period a year ago.

The increase was primarily the result of a $44.9 million increase in the average balance of borrowings and a $144.3 million increase in the average balance of certificate accounts, as well as higher average rates paid on all interest-bearing deposits, partially offset by a $106.0 million decrease in the average balance of interest-bearing deposits other than certificate accounts.

The increase in the rate paid on certificate accounts contributed to a 84 basis point increase in the average cost of total deposits to 1.05% for the quarter ended March 31, 2023, from 0.21% for the quarter ended March 31, 2022.

Interest expense on borrowings, comprised solely of FHLB advances, was $499 thousand for the three months ended March 31, 2023, compared to none for the three months ended March 31, 2022, reflecting the increased use of FHLB advances to supplement our liquidity needs.

Interest expense on subordinated notes was $168 thousand for both three month periods ended March 31, 2023 and 2022.

Net Interest Income.

Q1 2023 vs Q1 2022 .

Net interest income increased $1.3 million, or 15.4%, to $9.6 million for the three months ended September 30, 2022, from $8.3 million for the three months ended September 30, 2021.

Our net interest margin was 4.13% and 3.74% for the three months ended September 30, 2022 and 2021, respectively.

Net interest income increased $1.8 million, or 23.0%, to $9.4 million for the three months ended March 31, 2023, from $7.6 million for the three months ended March 31, 2022.

Our net interest margin was 4.01% and 3.49% for the three months ended March 31, 2023 and 2022, respectively.

The increase in net interest income primarily was the result of higher interest income earned on loans, investments and interest-bearing cash, partially offset by higher interest expense paid on deposits and borrowings.

The increase in net interest margin primarily was due to the higher interest income earned on interest-earning assets, driven by the higher average balance of loans and the higher average yield earned on investments and interest-bearing cash, partially offset by lower recognition of net deferred fees related to PPP loan repayments from SBA loan forgiveness, the increase in rates paid on interest-bearing liabilities and the higher average balance of borrowings.

During the third quarter of 2022, the average yield earned on PPP loans, including the recognition of the net deferred fees for PPP loans repaid and forgiven by the SBA, resulted in a positive impact to the net interest margin of one basis point, compared to a positive impact of 41 basis points during the quarter ended September 30, 2021.

Net interest income increased $3.4 million, or 15.3%, to $25.6 million for the nine months ended September 30, 2022, from $22.2 million for the nine months ended September 30, 2021.

Our net interest margin was 3.83% and 3.40% for the nine months ended September 30, 2022 and 2021, respectively.

The increase in net interest income primarily resulted from the decline in the average rate paid on deposits, higher average interest-earning assets balances, partially offset by a decline in the average loan yield.

The increase in net interest margin primarily was due to average yields earned on interest-earning assets increasing coupled with the declines in average interest rates paid on interest-bearing liabilities, partially offset by an increase in average borrowings.

During the nine months ended September 30, 2022, the average yield earned on PPP loans, including the recognition of the net deferred fees for PPP loans repaid and forgiven by the SBA, resulted in a positive impact to the net interest margin of one basis points, compared to a positive impact of 27 basis points for the nine months ended September 30, 2021.

Since March 2022, in response to inflation, the Federal Open Market Committee of the Federal Reserve has increased the target range for the federal funds rate by 300 basis points, including 150 basis points during the third quarter of 2022, to a range of 3.00% to 3.25% as of September 30, 2022.

In November 2022, the FOMC increased the target range for the federal funds rate another 75 basis points to a range of 3.75% to 4.00%.

Provision for Loan Losse s.

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

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

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

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

A provision for loan losses of $375 thousand and $1.1 million was recorded for the three and nine months ended September 30, 2022, compared to $175 thousand and $425 thousand, for the three and nine months ended September 30, 2021, respectively.

The increase in the provision for loan losses resulted primarily from the increase in our loan portfolio, partially offset by a shift in the loan portfolio composition to loan types requiring a lower general loan allowance as balances of lower risk one-to-four family loans and multifamily residential loans increased, thereby reducing the related general loan allowance.

The allowance for loan losses as of September 30, 2022, not only reflects probable and inherent credit losses based upon the economic conditions that existed as of September 30, 2022, but also reflects the inherent uncertainty related to the economic environment as a result of local, national and global events.

Net recoveries for the nine months ended September 30, 2022 totaled $82 thousand, compared to net charge-offs of $98 thousand for the nine months ended September 30, 2021.

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

A further decline in national and local economic conditions, as a result of the effects of inflation, a potential recession or slowed economic growth, and any governmental or societal responses to the COVID- 19 pandemic or, among other factors, could result in a material increase in the allowance for loan losses and may adversely affect the Company’s financial condition and results of operations.

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

The increase in net interest margin primarily was due to the higher interest income earned on interest-earning assets, driven by the higher average balance of and yield earned on loans, the increase in rates paid on interest-bearing liabilities and the higher average balance of borrowings.

Since March 2022, in response to inflation, the Federal Open Market Committee of the Federal Reserve has increased the target range for the federal funds rate by 475 basis points, including 50 basis points during the first quarter of 2023, to a range of 4.75% to 5.00% as of March 31, 2023.

In May 2023, the FOMC increased the target range for the federal funds rate another 25 basis points to a range of 5.00% to 5.25%.

Provision for Credit Losse s.

A provision for credit losses of $10 thousand was recorded for the three months ended March 31, 2023, consisting of a provision for credit losses on loans of $245 thousand and a release of reserve for unfunded loan commitments of $235 thousand.

This compared to a provision for credit losses of $140 thousand for the three months ended March 31, 2022, consisting of a provision for loan losses and unfunded loan commitments of $125 thousand and $15 thousand respectively.

The decrease in the provision for credit losses resulted primarily from changes in methodology used to reserve for credit losses.

The Company adopted the CECL standard as of January 1, 2023, which resulted in a one-time upward adjustment to the ACL - loans of $760 thousand and an ACL - unfunded loan commitments of $695 thousand, and an after-tax decrease to opening retained earnings of $1.1 million.

All amounts prior to January 1, 2023 were calculated using the previous incurred loss methodology to compute our allowance for loan losses, which is not directly comparable to the new current expected credit losses methodology.

The provision for credit losses for the three months ended March 31, 2023 also reflects assumptions related to our forecast concerning the economic environment as a result of local, national and global events, including recent bank failures.

In addition, expected loss estimates consider various factors, including customer-specific information, changes in risk ratings, projected delinquencies, and the impact of economic conditions on borrowers' ability to repay.

Net charge-offs for the three months ended March 31, 2023 totaled $72 thousand, compared to net charge-offs of $24 thousand for the three months ended March 31, 2022.

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

A further decline in national and local economic conditions, as a result of the effects of inflation, and a potential recession or slowed economic growth, among other factors, could result in a material increase in the ACL and have a material adverse impact on our financial condition and results of operations.

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

Noninterest Income.

Noninterest income decreased $405 thousand, or 28.3%, to $1.0 million for the three months ended September 30, 2022, as compared to $1.4 million for the three months ended September 30, 2021, as reflected below (dollars in thousands):

Three Months Ended September 30, Amount

Change Percent

Service charges and fee income $ 604 $ 556 $ 48 8.6 %

Earnings on cash surrender value of BOLI 59 104 (45) (43.3)

Mortgage servicing income 306 328 (22) (6.7)

Fair value adjustment on mortgage servicing rights 9 (125) 134 (107.2)

Net gain on sale of loans 48 568 (520) (91.5)

Total noninterest income $ 1,026 $ 1,431 $ (405) (28.3) %

The decrease in noninterest income during the three months ended September 30, 2022 compared to the same quarter in 2021 primarily was due to a $520 thousand decrease in net gain on sale of loans as a result of a decline in both the amount of loans originated for sale and gross margins earned on loans sold and a $45 thousand decrease in earnings on cash surrender value of BOLI reflecting recent declines in the securities markets, partially offset by a $134 thousand increase in the fair value adjustment on mortgage servicing rights due primarily from recent higher market interest rates causing a reduction in prepayment speeds and a $48 thousand increase in service fees and income primarily resulting from higher commercial loan fees and consumer deposit activity fees .

Loans sold during the quarter ended September 30, 2022, totaled $2.3 million, compared to $20.3 million during the quarter ended September 30, 2021.

Noninterest income decreased $2.3 million, or 39.0%, to $3.6 million for the nine months ended September 30, 2022, as compared to $5.8 million for the nine months ended September 30, 2021, as reflected below (dollars in thousands):

Nine Months Ended September 30, Amount

Noninterest income decreased $554 thousand, or 36.4%, to $1.0 million for the three months ended March 31, 2023, as compared to $1.5 million for the three months ended March 31, 2022, as reflected below (dollars in thousands):

Three Months Ended March 31, Amount

Change Percent

5 unchanged sentences

Total noninterest income $ 969 $ 1,523 $ (554) (36.4) %

The decrease in noninterest income during the nine months ended September 30, 2022, compared to the same period in 2021 primarily was due to a $3.2 million decrease in net gain on sale of loans and a $236 thousand decrease in earnings on cash surrender value of BOLI, partially offset by an $1.0 million improvement in the fair value adjustment on mortgage servicing rights and a $134 thousand increase in service fees and fee income for the same reasons as set forth for the three months ended September 30, 2022, discussed above.

Loans sold during the nine months ended September 30, 2022, totaled $17.4 million, compared to $128.3 million during the nine months ended September 30, 2021.

The decrease in noninterest income during the three months ended March 31, 2023 compared to the same quarter in 2022 primarily was due to a $287 thousand decrease in net gain on sale of loans as a result of a decline in both the amount of loans originated for sale and gross margins earned on loans sold and a $408 thousand decrease in the fair value adjustment on mortgage servicing rights due primarily to a decrease in the servicing portfolio, partially offset by a $130 thousand increase in earnings on cash surrender value of BOLI, reflecting recent price increases in the securities markets.

Loans sold during the quarter ended March 31, 2023, totaled $3.9 million, compared to $12.2 million during the quarter ended March 31, 2022.

Noninterest Expense.

Noninterest expense increased $718 thousand, or 11.4%, to $7.0 million during the three months ended September 30, 2022, compared to $6.3 million during the three months ended September 30, 2021, as reflected below (dollars in thousands):

Three Months Ended September 30, Amount

Change Percent

Salaries and benefits $ 4,044 $ 3,512 $ 532 15.1 %

Operations 1,581 1,466 115 7.8

Regulatory assessments 116 91 25 27.5

Occupancy 447 441 6 1.4

Data processing 848 808 40 5.0

Total noninterest expense $ 7,036 $ 6,318 $ 718 11.4 %

The increase in noninterest expense during the three months ended September 30, 2022 compared to the same quarter in 2021 primarily was due to an increase in salaries and benefits of $532 thousand as a result of upward market pressure on wages and increased medical expenses and lower deferred compensation as a result of a decline in mortgage originations, partially offset by a decrease in incentive compensation as a result of a lower percentage allocated and changes to the incentive compensation programs and lower commission expense related to a decline in mortgage originations.

Operations expense increased $115 thousand compared to the quarter ended September 30, 2021 due to increases in various accounts including marketing and travel expenses, legal fees associated with higher commercial loan volume, and debit card processing, partially offset by lower loan origination costs due to lower mortgage origination volume.

The efficiency ratio for the quarter ended September 30, 2022 was 66.23%, compared to 64.81% for the quarter ended September 30, 2021.

The weakening in the efficiency ratio for the current quarter compared to the same period in the prior year is primarily due to higher noninterest expense related to increased salaries and benefits and lower noninterest income primarily due to lower gain on sale of loans from mortgage banking, partially offset by higher net interest income primarily as a result of a higher average balance of loans held-for-portfolio at higher yields than prior investments.

Noninterest expense increased $2.2 million, or 11.8%, to $20.7 million during the nine months ended September 30, 2022, compared to $18.5 million during the nine months ended September 30, 2021, as reflected below (dollars in thousands):

Nine Months Ended September 30, Amount

Noninterest expense increased $795 thousand, or 11.7%, to $7.6 million during the three months ended March 31, 2023, compared to $6.8 million during the three months ended March 31, 2022, as reflected below (dollars in thousands):

Three Months Ended March 31, Amount

Change Percent

4 unchanged sentences

Data processing 993 821 172 21.0

Net gain on OREO and repossessed assets — (16) 16 (100.0)

Total noninterest expense $ 7,615 $ 6,820 $ 795 11.7 %

The increase in noninterest expense during the nine months ended September 30, 2022 compared to the same period in 2021 was primarily due to increases of $1.7 million in salaries and benefits, $290 thousand in operations expense and $118 thousand in data processing expense.

Salaries and benefits increased primarily due to higher wages and incentive compensation, hiring for strategic initiatives, higher medical expenses and lower deferred compensation, partially offset by a decrease in commission expense related to a decline in mortgage activity in 2022 as compared to the same period in 2021.

Operations expense increased primarily due to increases in various accounts including marketing expenses, travel related expenses, and professional fees.

Data processing expense increased due to technology investments and contract rate increases.

The efficiency ratio was 70.81% for the nine months ended September 30, 2022, compared to 65.83% for the nine months ended September 30, 2021.

The weakening in the efficiency ratio for the nine months ended September 30, 2022 was primarily due to the increase in noninterest expense outpacing the increase in total revenues as described above.

The increase in noninterest expense during the three months ended March 31, 2023 compared to the same quarter in 2022 was mainly attributable to an increase in salaries and benefits of $318 thousand, primarily due to higher wages and lower deferred compensation, partially offset by a decrease in incentive compensation as a result of a lower percentage earned on loans originated, changes to incentive compensation programs, such as the addition of non-production performance requirements, and lower commission expense related to a decline in mortgage originations.

Operations expense increased $142 thousand compared to the quarter ended March 31, 2022 due to increases in various accounts including travel expenses, debit card processing, audit fees, fixed assets, state and local taxes, charitable contributions and office expenses.

These increases were partially offset by lower loan origination costs due to lower mortgage origination volume and decreases in various accounts, including marketing, legal and professional fees.

The efficiency ratio for the quarter ended March 31, 2023 was 73.65%, compared to 74.61% for the quarter ended March 31, 2022.

The improvement in the efficiency ratio for the current quarter compared to the same period in the prior year is primarily due to net interest income rising at a faster rate than the increase in noninterest expense and the decline in noninterest income.

Income Tax Expense .

We incurred income tax expense of $666 thousand and $1.5 million for the three and nine months ended September 30, 2022, compared to $663 thousand and $1.9 million for the same periods in 2021, respectively.

The effective tax rates for the three and nine months ended September 30, 2022 were 20.73% and 20.68%, respectively.

The effective tax rates for the three and nine months ended September 30, 2021 were 20.37% and 20.36%, respectively.

We incurred income tax expense of $547 thousand for the three months ended March 31, 2023, compared to $458 thousand for the same period in 2022.

The effective tax rates for the three months ended March 31, 2023 and March 31, 2022 were 20.15% and 21.00%, respectively.

Capital and Liquidity

The Management Discussion and Analysis in Item 7 of the Company’s 2022 Form 10-K contains an overview of Sound Financial Bancorp’s and the Bank’s liquidity management, sources of liquidity and cash flows.

Although, there have been no material changes in our liquidity management, sources of liquidity and cash flows since our 2021 Form 10-K, this discussion updates that disclosure for the nine months ended September 30, 2022.

Shareholders’ equity totaled $95.0 million at September 30, 2022 and $93.4 million at December 31, 2021.

In addition to net income of $5.9 million, other sources of capital during the nine months ended September 30, 2022 included $195 thousand in proceeds from stock option exercises and $384 thousand related to stock-based compensation.

Uses of capital during the nine months ended September 30, 2022 primarily included $1.6 million of dividends paid on common stock, other comprehensive loss, net of tax, of $1.4 million and $1.7 million of stock repurchases.

We paid regular quarterly dividends of $0.17 per common share and a special dividend of $0.10 per common share during the nine months ended September 30, 2022 and 2021, which equates to a dividend payout ratio of 27.05% in 2022 and 21.85% in 2021.

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

Assuming continued payment of the regular quarterly cash dividend during the remainder of 2022 at this rate of $0.17 per share, our average total dividend paid each quarter would be approximately $439 thousand based on the number of our current outstanding shares (which assumes no increases or decreases in the number of shares, except in connection with the anticipated vesting of currently outstanding equity awards).

Although, there have been no

material changes in our liquidity management, sources of liquidity and cash flows since our 2022 Form 10-K, this discussion updates that disclosure for the three months ended March 31, 2023.

Stockholders’ equity totaled $98.6 million at March 31, 2023 and $97.7 million at December 31, 2022.

In addition to net income of $2.2 million, other sources of capital during the three months ended March 31, 2023 included $247 thousand in proceeds from stock option exercises and other comprehensive income, net of tax, of $83 thousand.

Uses of capital during the three months ended March 31, 2023 primarily included $442 thousand of dividends paid on common stock and $9 thousand of stock repurchases.

We paid regular quarterly dividends of $0.17 per common share during the three months ended March 31, 2023 and regular quarterly dividends of $0.17 per common share and a special dividend of $0.10 per common share during the three months ended March 31, 2022, which equates to a dividend payout ratio of 20.39% in the first quarter of 2023 and 41.15% in the first quarter of 2022.

The Company expects to continue paying quarterly cash dividends on its common stock, subject to the Board of Directors' discretion to change this practice at any time and for any reason, without prior notice.

Assuming continued payment of the regular quarterly cash dividend during the remainder of 2023 at the new rate of $0.19 per share, which the Company announced in April 2023, our average total dividend paid each quarter would be approximately $494 thousand based on the number of our current outstanding shares as of March 31, 2023.

The dividends, if any, we may pay may be limited as more fully discussed under “Business—How We Are Regulated—Limitations on Dividends and Stock Repurchases” contained in Item 1, Part I of the Company’s 2022 Form 10-K.

Stock Repurchase Plans.

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

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

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

As of September 30, 2022, the Company’s existing stock repurchase program authorized it to repurchase, during the period ending October 29, 2022, up to $2.0 million of the Company’s outstanding shares in the open market, based on prevailing market prices, or in privately negotiated transactions, or pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the Securities and Exchange Commission.

On July 26, 2022 the Company announced that its Board of Directors amended its existing stock repurchase program to increase the authorized repurchase amount to $4.0 million effective immediately and to extend the program maturity to January 31, 2023.

The actual timing, number and value of shares repurchased under the stock repurchase program will depend on a number of factors, including constraints specified pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the Securities and Exchange Commission, price, general business and market conditions, and alternative investment opportunities.

As of November 9, 2022, approximately $2.1 million of our common stock remains available for repurchase under this program.

See “Unregistered Sales of Equity Securities and Use of Proceeds” contained in Item 2, Part II of this Form 10-Q for additional information relating to stock repurchases.

Stock Repurchase Programs.

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

In general, stock repurchases allow us to proactively manage our capital position and return excess capital to stockholders.

Stock repurchases may also provide us with shares of common stock necessary to satisfy obligations related to stock compensation awards.

As of March 31, 2023, approximately $2.1 million of our common stock remained available for repurchase under our existing stock repurchase program.

Purchases under the Company’s existing stock repurchase program may be made through open market purchases, privately-negotiated transactions, or otherwise in compliance with Rule 10b-18 under the Securities Exchange Act of 1934, as well as any constraints specified in any trading plan that may be adopted in accordance with SEC Rule 10b5-1.

The repurchase program may be suspended, terminated or modified at any time for any reason, including market conditions, the cost of repurchasing shares, the availability of alternative investment opportunities, liquidity, and other factors deemed appropriate.

The Company’s stock repurchase program does not obligate the Company to purchase any particular number of shares.

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

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

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

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

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

As of September 30, 2022, we had $86.5 million in cash and available-for-sale investment securities and $1.9 million in loans held-for-sale.

At September 30, 2022, we had the ability to borrow $180.9 million in FHLB advances and access to additional borrowings of $21.2 million through the Federal Reserve's discount window, in each case subject to certain collateral requirements.

We had $44.5 million in outstanding advances with the FHL B and none with the Federal Reserve at September 30, 2022.

We also had a $20.0 million credit facility with PCBB available, with no balance outstanding at September 30, 2022.

As of March 31, 2023, we had $92.4 million in cash and available-for-sale investment securities and $1.4 million in loans held-for-sale.

At March 31, 2023, we had the ability to borrow $197.0 million in FHLB advances and access to additional borrowings of $22.0 million through the Federal Reserve's discount window, in each case subject to certain collateral requirements.

We had $35.0 million in outstanding advances with the FHL B and none with the Federal Reserve at March 31, 2023.

We also had a $20.0 million credit facility with PCBB available, with no balance outstanding at March 31, 2023.

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

As of September 30, 2022, management is not aware of any events that are reasonably likely to have a material adverse effect on our liquidity, capital resources or operations.

As of March 31, 2023, management is not aware of any events that are reasonably likely to have a material adverse effect on our liquidity, capital resources or operations.

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

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

Refer to the accompanying notes to consolidated financial statements elsewhere in this report for the expected timing of such payments as of September 30, 2022.

Refer to the accompanying Notes to Condensed Consolidated Financial Statements elsewhere in this report for the expected timing of such payments as of March 31, 2023.

These include payments related to (i) long-term borrowings (Note 8—Borrowings, FHLB Stock and Subordinated Notes) and (ii) operating leases (Note 11—Leases).

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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 instruments involve, to varying degrees, elements of credit- and interest-rate risk in excess of the amount recognized in the Condensed 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.

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 to extend credit are agreements to lend to a client as long as there is no violation of any condition established by the agreement.

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.

These commitments are not reflected in the condensed consolidated financial statements.

The Company evaluates each client's creditworthiness on a case-by-case basis.

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Financial instruments whose contract amount represents credit risk were as follow (in thousands):

September 30, 2022 December 31, 2021

March 31, 2023 December 31, 2022

Residential mortgage commitments $ 8,693 $ 3,184

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

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

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

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

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

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

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

See “Business — How We Are Regulated — Limitations on Dividends and Stock Repurchases” contained in Item 1, Part I of the Company’s 2022 Form 10-K.

At September 30, 2022 Sound Financial Bancorp, on an unconsolidated basis, had $2.6 million in cash, noninterest-bearing deposits and liquid investments generally available for its cash needs.

See also the "Consolidated Statements of Cash Flows" included in “Item 1.

At March 31, 2023 Sound Financial Bancorp, on an unconsolidated basis, had $2.2 million in cash, noninterest-bearing deposits and liquid investments generally available for its cash needs.

See also the “Condensed Consolidated Statements of Cash Flows” included in “Item 1.

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

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Qualifying institutions that elect to use the Community Bank Leverage Ratio, or CBLR, framework, such as the Bank and the Company, that maintain the required minimum leverage ratio will be considered to have satisfied the generally applicable risk-based and leverage capital requirements in the regulatory agencies' capital rules, and to have met the capital requirements for the well capitalized category under the agencies’ PCA framework.

As of September 30, 2022, the Bank and Company’s CBLR was 10.79% and 9.87%, respectively, which exceeded the minimum requirement of 9%.

As of March 31, 2023, the Bank and Company’s CBLR was 10.94% and 9.93%, respectively, which exceeded the minimum requirement of 9%.

In February 2019, the U.S.

federal bank regulatory agencies approved a final rule modifying their regulatory capital rules and providing an option to phase-in over a three-year period the Day 1 adverse regulatory capital effects of the CECL accounting standard.

The capital relief is phased into regulatory capital at 25% per year over a three-year transition period.

The final rule was adopted and became effective in September 2020.

The Company implemented the CECL model commencing January 1, 2023 and elected to phase in the full effect of CECL on regulatory capital over the three-year transition period.

See "Part I, Item 1.

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

What changed 10-Q

Item 2. Management’s Discussion and Analysis