Sound Financial Bancorp, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Special Note Regarding Forward-Looking Statements Certain matters discussed in this Form 10-Q constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our financial condition, results of operations, plans, objectives, future performance or business. Forward-looking statements are not statements of historical fact, are based on certain assumptions and are generally identified by use of the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future or conditional verbs such as “may,” “will,” “should,” “would” and “could.” Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about, among other things, expectations of the business environment in which we operate, projections of future performance or financial items, perceived opportunities in the market, potential future credit experience, and statements regarding our mission and vision. These forward-looking statements are based upon current management expectations and may, therefore, involve risks and uncertainties. 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; • changes in the interest rate environment, including the recent increases in the Board of Governors of the Federal Reserve System (the Federal Reserve) benchmark rate and duration at which such increased interest rate levels are maintained, which could adversely affect our revenues and expenses, the values of our assets and obligations, and the availability and cost of capital and liquidity; • the impact of continuing high inflation and the current and future monetary policies of the Federal Reserve in response thereto; • the effects of any federal government shutdown; • 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 credit losses; • monetary and fiscal policies of the Federal Reserve and the U.S. Government and other governmental initiatives affecting the financial services industry; • the impact of bank failures or adverse developments at other banks and related negative press about the banking industry in general on investor and depositor sentiment; • fluctuations in the demand for loans, the number of unsold homes, land and other properties; • fluctuations in real estate values and both residential and commercial and multifamily real estate market conditions in our market area; • our ability to access cost-effective funding, 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 from the London Interbank Offered Rate (“LIBOR”) to new interest-rate benchmarks; • our ability to control operating costs and expenses; • secondary market conditions for loans and our ability to sell loans in the secondary market; • 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 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; • the inability of key third-party providers to perform their obligations to us; • our ability to attract and retain deposits; • competitive pressures among financial services companies; • our ability to successfully integrate into our operations any assets, liabilities, clients, systems, and management personnel we may acquire and our ability to realize related revenue synergies and expected cost savings and other benefits within the anticipated time frames or at all; • the use of estimates in determining the fair values of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation; 35 • our ability to keep pace with technological changes, including our ability to identify and address cyber-security risks such as data security breaches, "denial of service" attacks, "hacking" and identity theft, and other attacks on our information technology systems or on the third-party vendors who perform several of our critical processing functions; • changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies, the Financial Accounting Standards Board, the U.S. Securities and Exchange Commission (the “SEC”), or the Public Company Accounting Oversight Board (“PCAOB”); • legislative or regulatory changes that adversely affect our business, including changes in banking, securities and tax law, in regulatory policies and principles, or the interpretation of regulatory capital or other rules, and other governmental initiatives affecting the financial services industry and the availability of resources to address such changes; • our ability to retain or attract key employees or members of our senior management team; • costs and effects of litigation, including settlements and judgments; • our ability to implement our business strategies; • staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges; • our ability to pay dividends on our common stock; • the quality and composition of our securities portfolio and the impact of any adverse changes in the securities markets; • disruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information technology systems or on third-party vendors who perform several of our critical processing functions; • the effects of climate change, severe weather events, natural disasters, pandemics, epidemics and other public health crises, acts of war or terrorism, and other external events on our business; • other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services; and • the other risks described from time to time in our reports filed with or furnished to 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 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 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. General Sound Financial Bancorp, a Maryland corporation, is a bank holding company for its wholly owned subsidiary, Sound Community Bank. 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 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 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, 2023, Sound Financial Bancorp, on a consolidated basis, had assets of $1.03 billion, net loans held-for-portfolio of $867.0 million, deposits of $860.9 million and stockholders’ equity of $100.2 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 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 36 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 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 September 30, 2023 and December 31, 2022 General. Total assets increased $53.8 million, or 5.5%, to $1.03 billion at September 30, 2023 from $976.4 million at December 31, 2022. The increase primarily was a result of increases in cash and cash equivalents and loans, partially offset by lower balances in investment securities. Cash and Securities, and Investment Securities. Cash and cash equivalents increased $44.1 million, or 76.2%, to $101.9 million at September 30, 2023 from $57.8 million at December 31, 2022. The increase was primarily from an increase in deposits, primarily certificate and money market accounts. Investment securities decreased $2.3 million, or 18.2%, to $10.2 million at September 30, 2023, compared to $12.4 million at December 31, 2022. Held-to-maturity securities totaled $2.2 million, at both September 30, 2023 and December 31, 2022. Available-for-sale securities totaled $8.0 million at September 30, 2023, compared to $10.2 million at December 31, 2022. The decrease in available-for-sale securities was primarily due to the maturity of $1.6 million in treasury bills and regularly scheduled payments and maturities. Loans. Loans held-for-portfolio, net, increased $8.6 million, or 1.0%, to $867.0 million at September 30, 2023 from $858.4 million at December 31, 2022. The following table reflects the changes in the mix of our loan portfolio at September 30, 2023, as compared to December 31, 2022 (dollars in thousands): September 30, 2023 December 31, 2022 Amount Change Percent Change One-to-four family $ 280,556 $ 274,638 $ 5,918 2.2 % Home equity 21,313 19,548 1,765 9.0 Commercial and multifamily 304,252 313,358 (9,106) (2.9) Construction and land 118,619 116,878 1,741 1.5 Manufactured homes 34,652 26,953 7,699 28.6 Floating homes 73,716 74,443 (727) (1.0) Other consumer 18,710 17,923 787 4.4 Commercial business 25,033 23,815 1,218 5.1 Premiums for purchased loans 850 973 (123) (12.6) Deferred loan fees (2,267) (2,548) 281 (11.0) Total loans held-for-portfolio, gross 875,434 865,981 9,453 1.1 Allowance for credit losses — loans (8,438) (7,599) (839) 11.0 Total loans held-for-portfolio, net $ 866,996 $ 858,382 $ 8,614 1.0 % The increase in one-to-four family loans was partially driven by an increase in short-term bridge loans and related party loans, while the increase in home equity loans was primarily driven by homeowners utilizing the equity in their homes. The increase in manufactured home loans was primarily the result of affordability of these homes in the current market and internal efficiencies in how we process these loans. The increase in other consumer loans was a result of high demand attributable to successful marketing campaigns. These increases were partially offset by decreases in commercial and multifamily real estate loans and floating home loans, which were primarily due to payoffs and paydowns, including the payoff of $10.0 million related to three multifamily loans and $3.7 million related to two floating homes loans. At September 30, 2023, our loan portfolio, net of deferred loan fees, remained well-diversified. At that date, commercial and multifamily real estate loans 37 accounted for 34.7% of total loans, one-to-four family loans, including home equity loans, accounted for 34.3% 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 14.5% of total loans. Construction and land loans accounted for 13.5% of total loans at September 30, 2023. Loans held-for-sale totaled $1.2 million at September 30, 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 September 30, Nine Months Ended September 30, 2023 2022 2023 2022 Allowance for Credit Losses — Loans: Balance at beginning of period $ 8,217 $ 7,117 $ 7,599 $ 6,306 Impact of Adoption of ASU 2016-13 — — 760 — Charge-offs (27) (6) (184) (48) Recoveries 24 3 36 130 Net charge-offs (3) (3) (148) 82 Provision for credit losses 224 375 227 1,101 Balance at end of period 8,438 $ 7,489 $ 8,438 $ 7,489 Reserve for Unfunded Commitments: Balance at beginning of period 706 411 335 404 Impact of Adoption of ASU 2016-13 — — 695 — (Release of) provision for credit losses (149) (29) (473) (22) Balance at end of period 557 382 557 382 Allowance for credit losses $ 8,995 $ 7,871 $ 8,995 $ 7,871 Ratio of net charge-offs during the period to average loans outstanding during the period — % — % (0.02) % 0.01 % Our ACL — loans increased $839 thousand, or 11.0%, to $8.4 million at September 30, 2023, from $7.6 million at December 31, 2022. The increase in the ACL - loans from December 31, 2022 to September 30, 2023 was primarily a result of the adjustment for the adoption of ASU 2016-16. The payoff of three large multifamily loans and the completion of construction projects resulted in a decrease in the ACL - loans, while construction advances that were outstanding at December 31, 2022 and funded during the nine months ended September 30, 2023 reduced the reserve for unfunded commitments and increased the ACL - loans. Also contributing to the increase in the ACL- loans was an adjustment to our forecast related to the interest rate environment, which was applied to certain loan portfolios and resulted in a larger provision for credit losses. See “Comparison of Results of Operations for the Three and Nine Months Ended September 30, 2023 and 2022 — Provision for Credit Losses.” The following tables show certain credit ratios at and for the dates and periods indicated and the components of each ratio's calculation (dollars in thousands). 38 At September 30, 2023 At December 31, 2022 Allowance for credit losses - loans as a percentage of total loans outstanding 0.96 % 0.88 % Allowance for credit losses — loans $ 8,438 $ 7,599 Total loans outstanding $ 876,851 $ 867,556 Nonaccrual loans as a percentage of total loans outstanding 0.20 % 0.34 % Total nonaccrual loans $ 1,762 $ 2,959 Total loans outstanding $ 876,851 $ 867,556 Allowance for credit losses - loans as a percentage of nonaccrual loans 478.89 % 256.81 % Allowance for credit losses — loans $ 8,438 $ 7,599 Total nonaccrual loans $ 1,762 $ 2,959 Allowance for credit losses as a percentage of total loans outstanding 1.03 % 0.91 % Allowance for credit losses $ 8,995 $ 7,934 Total loans outstanding $ 876,851 $ 867,556 Allowance for credit losses as a percentage of nonaccrual loans 510.50 % 268.13 % Allowance for credit losses $ 8,995 $ 7,934 Total nonaccrual loans $ 1,762 $ 2,959 39 Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 ($ in thousands) Net recoveries (charge-offs) during period to average loans outstanding: One-to-four family: — % — % — % 0.03 % Net recoveries $ — $ — — 45 Average loans outstanding $ 275,850 $ 260,712 274,731 234,914 Home equity: — % — % (0.17) % 0.51 % Net (charge-offs) recoveries $ — $ — (25) 58 Average loans outstanding $ 20,501 $ 17,013 19,938 15,223 Commercial and multifamily real estate: — % — % — % — % Net (charge-offs) recoveries $ — $ — — — Average loans outstanding $ 300,234 $ 313,615 305,543 294,055 Construction and land: — % — % — % — % Net (charge-offs) recoveries $ — $ — — — Average loans outstanding $ 118,827 $ 107,824 120,363 84,163 Manufactured homes: — % — % — % 0.07 % Net recoveries $ — $ — — 12 Average loans outstanding $ 32,918 $ 24,299 29,971 22,918 Floating homes: — % — % — % — % Net (charge-offs) recoveries $ — $ — — — Average loans outstanding $ 72,710 $ 68,610 73,328 63,636 Other consumer: (0.07) % (0.07) % (0.93) % (0.25) % Net (charge-offs) $ (3) $ (3) (123) (33) Average loans outstanding $ 18,110 $ 17,930 17,660 17,756 Commercial business: — % — % — % — % Net (charge-offs) recoveries $ — $ — — — Average loans outstanding $ 23,294 $ 24,537 23,892 24,717 Total loans: — % — % (0.02) % 0.01 % Net (charge-offs) recoveries $ (3) $ (3) (148) 82 Average loans outstanding $ 862,444 $ 834,540 865,426 757,382 Nonperforming Assets. Nonperforming assets, which are comprised of nonperforming loans (nonaccrual loans and nonperforming modified loans) and other real estate owned (“OREO”) and repossessed assets, decreased $1.3 million, or 35.4%, to $2.3 million, or 0.23% of total assets, at September 30, 2023 from $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, 2022 Amount Change Percent Change Total nonperforming loans $ 1,762 $ 2,958 $ (1,196) (40.4) OREO and repossessed assets 575 659 (84) (12.7) Total nonperforming assets $ 2,337 $ 3,617 $ (1,280) (35.4) % 40 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 , a $262 thousand other co nsumer loan, a $296 thousand land loan and the write-off of one residential property for $84 thousand, partially offset by $1.1 million in additions, which included $654 thousand in one-to-four family real estate loans during the same period. The percentage of nonperforming loans to total loans was 0.20% at September 30, 2023, compared to 0.34% of total loans at December 31, 2022. Mortgage Servicing Rights. The fair value of mortgage servicing rights was $4.7 million at both September 30, 2023, and December 31, 2022. We record mortgage servicing rights on loans sold with servicing retained and upon acquisition of a servicing portfolio. Mortgage servicing rights are carried at fair value. If the fair value of our mortgage servicing rights fluctuates significantly, our financial results could be materially impacted. Deposits and Borrowings. Total deposits increased $52.1 million, or 6.4%, to $860.9 million at September 30, 2023 from $808.8 million at December 31, 2022. The overall increase was largely driven by one new related party depositor relationship for $32.6 million in the current quarter. We also experienced a shift in deposits to certificate and money market accounts, from demand and savings accounts, largely driven by consumer behavior to move funds from lower rate deposit products into higher rate deposit products. Noninterest-bearing deposits decreased $19.3 million, or 11.1%, to $153.9 million at September 30, 2023, compared to $173.2 million at December 31, 2022. Noninterest-bearing deposits represented 17.9% of total deposits at September 30, 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, 2023 December 31, 2022 Amount Wtd. Avg. Rate Amount Wtd. Avg. Rate Noninterest-bearing demand $ 148,918 — % $ 170,549 — % Interest-bearing demand 185,441 0.60 254,982 0.21 Savings 76,729 0.07 95,641 0.05 Money market 143,558 1.19 74,639 0.28 Time deposits 301,226 3.19 210,305 0.97 Escrow (1) 5,003 — 2,647 — Total deposits $ 860,875 1.45 % $ 808,763 0.37 % (1) Escrow balances shown in noninterest-bearing deposits on the Condensed Consolidated Balance Sheets. Scheduled maturities of time deposits at September 30, 2023, are as follows (in thousands): Year Ending December 31, Amount 2023 $ 34,506 2024 223,273 2025 35,695 2026 5,047 2027 1,736 Thereafter 969 $ 301,226 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, 2023 and December 31, 2022, totaled $87.4 million and $56.1 million, respectively. Deposit amounts in excess of $250,000 are not federally insured. As of September 30, 2023, uninsured deposits totaled $148.6 million, which represented 17.3% 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 decrease in uninsured deposits primarily related to the increased customer use of deposit insurance products, such as ICS® (Insured Cash Sweep) and CDARS® (Certificate of Deposit Registry Service), that reduced the level of uninsured deposits following the failures of some banks during 2023. 41 Borrowings, comprised of FHLB advances, decreased $3.0 million to $40.0 million at September 30, 2023 from $43.0 million at December 31, 2022. Subordinated notes, net totaled $11.7 million at both September 30, 2023 and December 31, 2022. Stockholders’ Equity. Total stockholders’ equity increased $2.5 million, or 2.6%, to $100.2 million at September 30, 2023, from $97.7 million at December 31, 2022. This increase primarily reflects $6.2 million of net income earned during the nine months ended September 30, 2023 and $320 thousand in proceeds from exercises of stock options, partially offset by $1.4 million in stock repurchases and the cash payment of $1.4 million in dividends to the Company’s stockholders. In addition, stockholders' equity was negatively 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. 42 Average Balances, Net Interest Income, Yields Earned and Rates Paid The following tables present, for the periods indicated, the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates. Income and yields on tax-exempt obligations have not been computed on a tax equivalent basis. All average balances are daily average balances. Nonaccrual loans have been included in the table as loans carrying a zero yield for the period they have been on nonaccrual (dollars in thousands). Three Months Ended September 30, 2023 2022 Average Outstanding Balance Interest Earned/ Paid Yield/ Rate Annualized Average Outstanding Balance Interest Earned/ Paid Yield/ Rate Annualized Interest-earning assets: Loans receivable $ 862,397 $ 11,505 5.29 % $ 833,195 $ 10,327 4.92 % Investments, cash and cash equivalents 96,409 1,181 4.86 88,812 449 2.01 Total interest-earning assets (1) 958,806 12,686 5.25 922,007 10,776 4.64 Interest-bearing liabilities: Savings and money market accounts 192,214 720 1.49 188,276 63 0.13 Demand and NOW accounts 194,561 173 0.35 290,106 164 0.22 Certificate accounts 293,820 2,984 4.03 130,541 503 1.53 Subordinated notes 11,703 168 5.70 11,658 168 5.72 Borrowings 42,815 473 4.38 46,462 281 2.40 Total interest-bearing liabilities 735,113 4,518 2.44 % 667,043 1,179 0.70 % Net interest income $ 8,168 $ 9,597 Net interest rate spread 2.81 % 3.94 % Net earning assets $ 223,693 $ 254,964 Net interest margin 3.38 % 4.13 % Average interest-earning assets to average interest-bearing liabilities 130.43 % 138.22 % Noninterest-bearing deposits $ 151,298 $ 189,379 Total deposits 831,893 3,877 1.85 % 798,302 730 0.36 % Total funding (2) 886,411 4,518 2.02 % 856,422 1,179 0.55 % (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. 43 Nine Months Ended September 30, 2023 2022 Average Outstanding Balance Interest Earned/ Paid Yield/ Rate Annualized Average Outstanding Balance Interest Earned/ Paid Yield/ Rate Annualized Interest-earning assets: Loans receivable $ 865,357 $ 34,437 5.32 % $ 757,086 $ 27,099 4.79 % Investments, cash and cash equivalents 84,056 2,836 4.51 136,899 876 0.86 Total interest-earning assets (1) 949,413 37,273 5.25 % 893,985 27,975 4.18 Interest-bearing liabilities: Savings and money market accounts 173,319 1,197 0.92 193,219 122 0.08 Demand and NOW accounts 216,753 587 0.36 305,651 412 0.18 Certificate accounts 273,564 7,182 3.51 109,713 1,037 1.26 Subordinated notes 11,693 504 5.76 11,648 504 5.79 Borrowings 45,280 1,520 4.49 16,463 293 2.38 Total interest-bearing liabilities 720,609 10,990 2.04 % 636,694 2,368 0.50 % Net interest income $ 26,283 $ 25,607 Net interest rate spread 3.21 % 3.69 % Net earning assets $ 228,804 $ 257,291 Net interest margin 3.70 % 3.83 % Average interest-earning assets to average interest-bearing liabilities 131.75 % 140.41 % Noninterest-bearing deposits $ 161,051 $ 192,240 Total deposits 824,687 8,966 1.45 % 800,823 1,571 0.26 % Total funding (2) 881,660 10,990 1.67 % 828,934 2,368 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. Rate/Volume Analysis The following table presents, for the periods indicated, the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between changes related to outstanding balances and changes due to interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate multiplied by old volume). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate (dollars in thousands). 44 Three Months Ended September 30, 2023 vs. 2022 Nine Months Ended September 30, 2023 vs. 2022 Increase (Decrease) due to Total Increase (Decrease) Increase (Decrease) due to Total Increase (Decrease) Volume Rate Volume Rate Interest-earning assets: Loans receivable $ 390 $ 788 $ 1,178 $ 4,309 $ 3,029 $ 7,338 Investments, cash and cash equivalents 93 639 732 (1,783) 3,743 1,960 Total interest-earning assets 483 1,427 1,910 2,526 6,772 9,298 Interest-bearing liabilities: Savings and Money Market accounts 15 642 657 (137) 1,212 1,075 Demand and NOW accounts (85) 94 9 (241) 416 175 Certificate accounts 1,658 823 2,481 4,302 1,843 6,145 Subordinated notes 1 (1) — 2 (2) — Borrowings (40) 232 192 967 260 1,227 Total interest-bearing liabilities $ 1,549 $ 1,790 $ 3,339 $ 4,893 $ 3,729 $ 8,622 Change in net interest income $ (1,429) $ 676 Comparison of Results of Operation for the Three and Nine Months Ended September 30, 2023 and 2022 General. Q3 2023 vs Q3 2022 . Net income decreased $1.4 million, or 54.1%, to $1.2 million, or $0.45 per diluted common share, for the three months ended September 30, 2023, compared to $2.5 million, or $0.97 per diluted common share, for the three months ended September 30, 2022. The decrease was primarily the result of a $1.4 million decrease in net interest income and a $645 thousand increase in noninterest expense, partially offset by a $271 thousand decrease in the provision for credit losses and a $55 thousand increase in noninterest income. YTD 2023 vs. YTD 2022 . Net income increased $347 thousand, or 5.9%, to $6.2 million, or $2.39 per diluted common share, for the nine months ended September 30, 2023, compared to $5.9 million, or $2.23 per diluted common share, for the nine months ended September 30, 2022. The increase was primarily a result of a $676 thousand increase in net interest income, a $1.3 million decrease in the provision for credit losses and a $376 thousand increase in noninterest income, partially offset by a $2.1 million increase in noninterest expense. Interest Income Q3 2023 vs Q3 2022 . Interest income increased $1.9 million, or 17.7%, to $12.7 million for the three months ended September 30, 2023, from $10.8 million for the three months ended September 30, 2022, primarily due to a 38 basis point increase in the average loan yield and a 285 basis point increase in the average yield on investments, cash and cash equivalents and, to a lesser extent, higher average balance of loans, investments, and cash and cash equivalents. Interest income on loans increased $1.2 million, or 11.4%, to $11.5 million for the three months ended September 30, 2023, compared to $10.3 million for the three months ended September 30, 2022. The average balance of total loans was $862.4 million for the three months ended September 30, 2023, compared to $833.2 million for the three months ended September 30, 2022, resulting from increased balances in all loan categories, except commercial and multifamily loans and floating home loans. The average yield on total loans was 5.29% for three months ended September 30, 2023, compared to 4.92% for the three months ended September 30, 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 investments and cash and cash equivalents increased $732 thousand, or 163.0%, to $1.2 million for the three months ended September 30, 2023, compared to $449 thousand for the three months ended September 30, 2022. The increase was due to higher average yields and, to a lesser extent, higher average balances. The average yield on investments and cash and cash equivalents increased to 4.86% for the three months ended September 30, 2023, compared to 2.01% for the three months ended September 30, 2022, as a result of the rising interest rate environment. The average balance of investments and 45 cash and cash equivalents was $96.4 million for the three months ended September 30, 2023, compared to $88.8 million for the three months ended September 30, 2022. The increase in the average balance was due to higher average cash balances as deposits increased during the period at a faster pace than we were able to increase loans. YTD 2023 vs. YTD 2022 . Interest income increased $9.3 million, or 33.2%, to $37.3 million for the nine months ended September 30, 2023, from $28.0 million for the nine months ended September 30, 2022, primarily due to higher average loan balances, a 53 basis point increase in the average loan yield and a 365 basis point increase in the average yield earned on investments, cash and cash equivalents, partially offset by a lower average balance of investments, cash and cash equivalents. Interest income on loans increased $7.3 million, or 27.1%, to $34.4 million for the nine months ended September 30, 2023, compared to $27.1 million for the nine months ended September 30, 2022, driven by higher average total loans and a 53 basis points increase in the average yield on loans. The average balance of total loans was $865.4 million for the nine months ended September 30, 2023, compared to $757.1 million for the nine months ended September 30, 2022, resulting from increased balances related to all loan categories, except commercial and multifamily loans and floating home loans. The average yield on total loans was 5.32% for the nine months ended September 30, 2023, compared to 4.79% for the nine months ended September 30, 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 investments and cash and cash equivalents increased $2.0 million, or 223.7%, to $2.8 million for the nine months ended September 30, 2023, compared to $876 thousand for the nine months ended September 30, 2022. The increase was due to higher average yields, partially offset by lower average balances. The average yield on investments and cash and cash equivalents increased 365 basis points to 4.51% for the nine months ended September 30, 2023, compared to 0.86% for the nine months ended September 30, 2022, as a result of the rising interest rate environment. Interest Expense Q3 2023 vs Q3 2022 . Interest expense increased $3.3 million, or 283.2%, to $4.5 million for the three months ended September 30, 2023, from $1.2 million for the three months ended September 30, 2022. Interest expense on deposits increased $3.1 million, or 431.1%, to $3.9 million for the three months ended September 30, 2023, compared to $730 thousand for the same period a year ago. The increase was primarily the result of a $163.3 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 $91.6 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 149 basis point increase in the average cost of total deposits to 1.85% for the quarter ended September 30, 2023, from 0.36% for the quarter ended September 30, 2022. Interest expense on borrowings, comprised solely of FHLB advances, was $473 thousand for the three months ended September 30, 2023, compared to $281 thousand for the three months ended September 30, 2022, primarily due to a 198 basis point increase in the average cost of FHLB advances to 4.38% for the quarter ended September 30, 2023, compared to 2.40% for the same quarter in 2022. Interest expense on subordinated notes was $168 thousand for both the three months ended September 30, 2023 and 2022. YTD 2023 vs. YTD 2022 . Interest expense increased $8.6 million, or 364.1%, to $11.0 million for the nine months ended September 30, 2023, from $2.4 million for the nine months ended September 30, 2022. Interest expense on deposits increased $7.4 million, or 470.7%, to $9.0 million for the nine months ended September 30, 2023, compared to $1.6 million for the nine months ended September 30, 2022. The increase was primarily the result of an increase in the average balance of certificate accounts, as well as higher average rates paid on all interest-bearing deposits, partially offset by a $108.8 million decrease in the average balance of interest-bearing deposits other than certificate accounts. The average cost of total deposits increased 119 basis points to 1.45% for the nine months ended September 30, 2023, from 0.26% for the nine months ended September 30, 2022. Interest expense on borrowings, comprised solely of FHLB advances, was $1.5 million for the nine months ended September 30, 2023, compared to $293 thousand for the nine months ended September 30, 2022, reflecting the increased use of FHLB advances to supplement our liquidity needs. The cost of FHLB advances increased 211 basis points to 4.49% for the nine months ended September 30, 2023, compared to 2.38% for the same period in 2022. The average balance of FHLB advances was $45.3 million for the nine months ended September 30, 2023, compared to $16.5 million for the nine months ended September 30, 2022. Interest expense on subordinated notes was $504 thousand for both the nine months ended September 30, 2023 and 2022. Net Interest Income. Q3 2023 vs Q3 2022 . Net interest income decreased $1.4 million, or 14.9%, to $8.2 million for the three months ended September 30, 2023, from $9.6 million for the three months ended September 30, 2022. Net interest margin was 3.38% and 4.13% for the three months ended September 30, 2023 and 2022, respectively. The decrease in net interest income primarily 46 was the result of a higher average balance of and rate paid on interest-bearing liabilities, partially offset by a higher average balance of and yield earned on interest-earning assets. The decrease in net interest margin primarily was due to the higher interest expense on interest-bearing liabilities, driven by the increase in rates paid on interest-bearing liabilities and the higher average balances of certificates of deposits and borrowings, partially offset by higher interest income earned on interest-earning assets. YTD 2023 vs. YTD 2022 . Net interest income increased $676 thousand, or 2.6%, to $26.3 million for the nine months ended September 30, 2023, from $25.6 million for the nine months ended September 30, 2022. Net interest margin was 3.70% and 3.83% for the nine months ended September 30, 2023 and 2022, respectively. The increase in net interest income primarily resulted from higher average balances and yield earned on interest-earning assets, partially offset by an increase in the average balances of and rate paid on deposits and borrowings The decrease in net interest margin primarily was due to average interest rates paid on interest-bearing liabilities increasing at a faster pace than the average yields earned on interest-earning assets and an increase in average 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 525 basis points, including 100 basis points during 2023, to a range of 5.25% to 5.50% as of September 30, 2023. Provision for Credit Losse s. The following table reflects the components of the provision for (release of) credit losses during the periods indicated (dollars in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 Provision for credit losses on loans $ 224 $ 375 $ 227 $ 1,101 (Release of) provision for credit losses on unfunded loan commitments (149) (29) (473) (22) Provision for (release of) credit losses $ 75 $ 346 $ (246) $ 1,079 The change in the provision for (release of) credit losses for both periods in 2023 from the comparable periods in 2022 resulted primarily from changes in methodology used to reserve for credit losses. The Company adopted the CECL standard as of January 1, 2023. 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. During the three months ended September 30, 2023, the provision for credit losses on loans resulted primarily from the increase in our loans held-for-portfolio and an additional adjustment to our forecast related to the interest rate environment. The release of credit losses on unfunded loan commitments related to construction advances funding and moving into the ACL - loans. The increase in construction advances in the loans held-for-portfolio balance were offset by declines in our commercial construction portfolio as projects were completed. During the nine months ended September 30, 2023, the provision for credit losses on loans primarily relates to the mix of the loan portfolio and improved credit quality, partially offset by the increase in the balance of the loan portfolio and adjustments applied to certain loan portfolios within our forecast related to interest rate risk. The release of credit losses on unfunded loan commitments occurred for the same reasons discussed above for the three months ended September 30, 2023. Under CECL, the provision for credit losses for the three and nine months ended September 30, 2023 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 nine months ended September 30, 2023 totaled $148 thousand, compared to net recoveries of $82 thousand for the nine months ended September 30, 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. 47 Noninterest Income. Noninterest income increased $55 thousand, or 5.4%, to $1.1 million for the three months ended September 30, 2023, as compared to $1.0 million for the three months ended September 30, 2022, as reflected below (dollars in thousands): Three Months Ended September 30, Amount Change Percent Change 2023 2022 Service charges and fee income $ 700 $ 604 $ 96 15.9 % Earnings on BOLI 88 59 29 49.2 Mortgage servicing income 295 306 (11) (3.6) Fair value adjustment on mortgage servicing rights (78) 9 (87) (966.7) Net gain on sale of loans 76 48 28 58.3 Total noninterest income $ 1,081 $ 1,026 $ 55 5.4 % The increase in noninterest income during the three months ended September 30, 2023 compared to the same quarter in 2022 primarily was due to a $96 thousand increase in service charges and fee income primarily resulting from $70 thousand in miscellaneous income related to our co-branded credit card agreement with Mastercard, $29 thousand increase in earnings on BOLI, reflecting an increase in the cash surrender value due to fluctuating market rates, and a $28 thousand increase in net gain on sale of loans as a result of an increase in the rate earned on loans originated for sale, partially offset by a $87 thousand downward adjustment in the fair value of mortgage servicing rights and a decrease in mortgage servicing income due to the size of the servicing portfolio shrinking at a faster rate than we are replacing the loans due to the current interest rate environment. Loans sold during the quarter ended September 30, 2023, totaled $4.4 million, compared to $2.3 million during the quarter ended September 30, 2022. Noninterest income increased $376 thousand, or 10.5%, to $3.9 million for the nine months ended September 30, 2023, as compared to $3.6 million for the nine months ended September 30, 2022, as reflected below (dollars in thousands): Nine Months Ended September 30, Amount Change Percent Change 2023 2022 Service charges and fee income $ 1,951 $ 1,749 $ 202 11.5 % Earnings on BOLI 957 45 912 2,026.7 Mortgage servicing income 891 939 (48) (5.1) Fair value adjustment on mortgage servicing rights (123) 334 (457) (136.8) Net gain on sale of loans 264 497 (233) (46.9) Total noninterest income $ 3,940 $ 3,564 $ 376 10.5 % The increase in noninterest income during the nine months ended September 30, 2023, compared to the same period in 2022 primarily was due to a $912 thousand increase in earnings on BOLI reflecting $567 thousand in earnings on death benefits paid under our BOLI policies and an increase in the cash surrender value due to recent price increases in the securities market and a $202 thousand increase in service fees and fee income which included $70 thousand in miscellaneous income related to an agreement with Mastercard and an insurance settlement received during the second quarter of 2023 on a prior OREO property. These increases were partially offset by a $457 thousand downward adjustment in the fair value of mortgage servicing rights, a $233 thousand decrease in net gain on sale of loans resulting from lower mortgage activity and a $48 thousand decline in mortgage servicing income for the same reasons discussed above for the three months ended September 30, 2023. Loans sold during the nine months ended September 30, 2023, totaled $14.7 million, compared to $17.4 million during the nine months ended September 30, 2022. 48 Noninterest Expense. Noninterest expense increased $645 thousand, or 9.1%, to $7.7 million during the three months ended September 30, 2023, compared to $7.1 million during the three months ended September 30, 2022, as reflected below (dollars in thousands): Three Months Ended September 30, Amount Change Percent Change 2023 2022 Salaries and benefits $ 4,148 $ 4,044 $ 104 2.6 % Operations 1,625 1,610 15 0.9 Regulatory assessments 183 116 67 57.8 Occupancy 458 447 11 2.5 Data processing 1,296 848 448 52.8 Total noninterest expense $ 7,710 $ 7,065 $ 645 9.1 % The increase in noninterest expense during the three months ended September 30, 2023 compared to the same quarter in 2022 was mainly attributable to an increase in data processing expense of $448 thousand reflecting $317 thousand in software costs related to new technology being implemented at the Bank and higher processing charges related to a higher volume of transactional activity. Salaries and benefits expensed increased $104 thousand reflecting higher wages and lower deferred compensation, partially offset by a decrease in incentive compensation as a result of fewer loans originated, changes to incentive compensation programs, including the addition of non-production performance requirements, and lower commission expense related to a decline in mortgage originations. Regulatory assessments rose due to an increase in our deposit insurance assessment rate and our increased asset size. The efficiency ratio for the quarter ended September 30, 2023 was 83.36%, compared to 66.51% for the quarter ended September 30, 2022. The change in the efficiency ratio for the current quarter compared to the same quarter the prior year was primarily due to lower net interest income as a result of interest expense rising at a faster rate than the yield on interest-earning assets and an increase in noninterest expense. Noninterest expense increased $2.1 million, or 10.4%, to $22.8 million during the nine months ended September 30, 2023, compared to $20.7 million during the nine months ended September 30, 2022, as reflected below (dollars in thousands): Nine Months Ended September 30, Amount Change Percent Change 2023 2022 Salaries and benefits $ 13,333 $ 12,181 $ 1,152 9.5 % Operations 4,557 4,345 212 4.9 Regulatory assessments 490 316 174 55.1 Occupancy 1,352 1,318 34 2.6 Data processing 3,077 2,518 559 22.2 Net loss on OREO and repossessed assets 13 — 13 (100.0) Total noninterest expense $ 22,822 $ 20,678 $ 2,144 10.4 % Salaries and benefits increased primarily due to higher wages, hiring for strategic initiatives, higher medical expenses and lower deferred compensation, partially offset by a decrease in incentive compensation and commission expense related to a decline in loan origination activity in 2023 as compared to the same period in 2022. Operations expense increased primarily due to increases in various accounts including legal fees, audit fees, state and local taxes, charitable contributions, office expenses and costs related to our deposit products, specifically debit card processing expenses, partially offset by lower marketing costs, professional fees and loan origination fees. Regulatory assessments rose due to an increase in our deposit insurance assessment rate and our increased asset size. Data processing expense increased due to $317 thousand in software costs related to new technology being implemented at the Bank and higher processing charges related to a higher volume of transactional activity. The net loss on OREO relates to the sale of a former OREO property that was charged off during the first quarter of 2023. Income Tax Expense . We incurred income tax expense of $295 thousand and $1.4 million for the three and nine months ended September 30, 2023, compared to $666 thousand and $1.5 million for the same periods in 2022, respectively. The effective tax rates for the three and nine months ended September 30, 2023 were 20.15% and 18.56%, 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 rate for the nine months ended September 30, 2023 was lower than the same period the prior year as a result of nontaxable income related to the BOLI death benefit received during 2023. 49 Capital and Liquidity The Management’s 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 2022 Form 10-K, this discussion updates that disclosure for the nine months ended September 30, 2023. Capital. Stockholders’ equity totaled $100.2 million at September 30, 2023 and $97.7 million at December 31, 2022. In addition to net income of $6.2 million, other sources of capital during the nine months ended September 30, 2023 primarily included $320 thousand in proceeds from stock option exercises. Uses of capital during the nine months ended September 30, 2023 primarily included $1.4 million of dividends paid on common stock and $1.4 million of stock repurchases. In addition, stockholders' equity was negatively 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. We paid regular quarterly dividends of $0.55 per common share during the nine months ended September 30, 2023 and regular quarterly dividends of $0.51 per common share and a special dividend of $0.10 per common share during the nine months ended September 30, 2022, which equates to a dividend payout ratio of 22.88% in the first nine months of 2023 and 27.05% in the first nine months 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 rate of $0.19 per share, which the Company announced in April 2023, our average total dividend paid each quarter would be approximately $488 thousand based on the number of outstanding shares as of September 30, 2023. The dividends, if any, we 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 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 offset the dilutive effects of stock compensation awards. As of September 30, 2023, approximately $741 thousand 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. For additional details on our stock repurchase program, see “Unregistered Sales of Equity Securities and Use of Proceeds” contained in Part II, Item 2 of this Form 10-Q. Liquidity. Liquidity measures the ability to meet current and future cash flow needs. The liquidity of a financial institution reflects its ability to meet loan requests, to accommodate possible outflows in deposits and to take advantage of interest rate market opportunities. The ability of a financial institution to meet its current financial obligations is a function of its balance sheet structure, its ability to liquidate assets and its access to alternative sources of funds. The objective of our liquidity management is to manage cash flow and liquidity reserves so that they are adequate to fund our operations and to meet obligations and other commitments on a timely basis and at a reasonable cost. We seek to achieve this objective and ensure that funding needs are met by maintaining an appropriate level of liquid funds through asset/liability management, which includes managing the mix and time to maturity of financial assets and financial liabilities on our balance sheet. Our liquidity position is enhanced by our ability to raise additional funds as needed in the wholesale markets. Asset liquidity is provided by assets that are readily marketable or pledgeable or that will mature in the near future. Liquid assets generally include cash, interest-bearing deposits in banks, securities available for sale, maturities and cash flow from securities, sales of fixed rate residential mortgage loans in the secondary market and federal funds sold. Liability liquidity generally is provided by access to funding sources, which include core deposits and advances from the FHLB and other borrowing relationships with third party financial institutions. Our liquidity position is continuously monitored and adjustments are made to the balance between sources and uses of funds as deemed appropriate. Liquidity risk management is an important element in our asset/liability management process. We regularly model liquidity stress scenarios to assess potential liquidity outflows or funding 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. 50 As of September 30, 2023, we had $112.0 million in cash and cash equivalents and available-for-sale investment securities, and $1.2 million in loans held-for-sale. At September 30, 2023, we had the ability to borrow $178.5 million in FHLB advances and access to additional borrowings of $17.5 million through the Federal Reserve's discount window, in each case subject to certain collateral requirements. We had $40.0 million in outstanding advances from the FHL B and none from the Federal Reserve at September 30, 2023. We also had a $20.0 million credit facility with Pacific Coast Banker’s Bank available, with no balance outstanding at September 30, 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, 2023, management was not aware of any events reasonably likely to have a material adverse effect on our liquidity, capital resources or operations. In addition, management is not aware of any regulatory recommendations regarding liquidity that would have a material adverse effect on us. For additional details, see “Note 8—Borrowings, FHLB Stock and Subordinated Notes” in the Notes to Condensed Consolidated Financial Statements contained in "Item 1. Financial Statements" of this Form 10-Q. In the ordinary course of business, we enter into contractual obligations and other commitments to make future payments. Refer to the accompanying Notes to Condensed Consolidated Financial Statements elsewhere in this report for the expected timing of such payments as of September 30, 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). See the discussion below for commitments to extend credit and standby letters of credit. 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 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 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 condensed 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. At September 30, 2023 and December 31, 2022, financial instrument contract amounts representing credit risk were as follows (in thousands): September 30, 2023 December 31, 2022 Residential mortgage commitments $ 5,081 $ 3,184 Unfunded construction commitments 35,036 65,072 Unused lines of credit 26,477 32,793 Irrevocable letters of credit 277 275 Total loan commitments $ 66,871 $ 101,324 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 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 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, 2023 Sound Financial Bancorp, on an unconsolidated basis, had $433 thousand 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. 51 Regulatory Capital Consistent with our goal to operate a sound and profitable financial organization, we actively seek to maintain a well-capitalized status for the Bank per the regulatory framework for prompt corrective action (“PCA”). Qualifying institutions that elect to use the 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, 2023, the Bank and Company’s CBLR was 11.23% and 10.05%, 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. Business – Regulation of Sound Community Bank – Capital Rules " in the Company's 2022 Form 10-K for additional information related to regulatory capital. Item 3. Quantitative and Qualitative Disclosures About Market Risk The Company provided information about market risk in Item 7A of its 2022 Form 10-K. There have been no material changes in our market risk since our 2022 Form 10-K.