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; • 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; 31 • 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, civil unrest 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, 2023 (“2023 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 March 31, 2024, Sound Financial Bancorp, on a consolidated basis, had assets of $1.09 billion, net loans held-for-portfolio of $889.3 million, deposits of $916.9 million and stockholders’ equity of $101.0 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, along with borrowed 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, and consumer 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 portion of which we sell to Fannie Mae and other investors 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 either held in our loan portfolio or sold with servicing released. We originate and retain a significant amount of commercial real estate loans, including those secured by 32 owner-occupied and nonowner-occupied commercial real estate, multifamily properties and mobile home parks, and 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 and accounting for mortgage servicing rights. There have been no material changes in the Company’s critical accounting policies and estimates as previously disclosed in the Company’s 2023 Form 10-K. Comparison of Financial Condition at March 31, 2024 and December 31, 2023 General. Total assets increased $91.5 million, or 9.2%, to $1.09 billion at March 31, 2024 from $995.2 million at December 31, 2023. The increase primarily was a result of an increase in cash and cash equivalents reflecting increased deposits and, to a lesser extent, an increase in loans held-for-portfolio. Cash and Securities, and Investment Securities. Cash and cash equivalents increased $88.3 million, or 177.7%, to $138.0 million at March 31, 2024 from $49.7 million at December 31, 2023. The increase was primarily due to the strategic decision to sell reciprocal deposits at the end of 2023, which reduced our cash balances. These reciprocal deposits returned to our balance sheet in the first quarter of 2024, which included deposits that had been generated during the fourth quarter of 2023 and subsequently sold. Investment securities decreased $181 thousand, or 1.7%, to $10.3 million at March 31, 2024, compared to $10.5 million at December 31, 2023. Held-to-maturity securities totaled $2.2 million at both March 31, 2024 and December 31, 2023. Available-for-sale securities totaled $8.1 million at March 31, 2024, compared to $8.3 million at December 31, 2023. The decrease in available-for-sale securities was primarily due to higher net unrealized losses resulting from an increase in municipal bond yields during the current quarter, offset by regularly scheduled payments. Loans. Loans held-for-portfolio, net, increased $3.6 million, or 0.4%, to $889.3 million at March 31, 2024 from $885.7 million at December 31, 2023. The following table reflects the changes in the mix of our loan portfolio at March 31, 2024, as compared to December 31, 2023 (dollars in thousands): March 31, 2024 December 31, 2023 Amount Change Percent Change One-to-four family $ 279,213 $ 279,448 $ (235) (0.1) % Home equity 24,380 23,073 1,307 5.7 Commercial and multifamily 324,483 315,280 9,203 2.9 Construction and land 111,726 126,758 (15,032) (11.9) Manufactured homes 37,583 36,193 1,390 3.8 Floating homes 84,237 75,108 9,129 12.2 Other consumer 18,847 19,612 (765) (3.9) Commercial business 19,075 20,688 (1,613) (7.8) Premiums for purchased loans 808 829 (21) (2.5) Deferred loan fees (2,475) (2,511) 36 (1.4) Total loans held-for-portfolio, gross 897,877 894,478 3,399 0.4 Allowance for credit losses — loans (8,598) (8,760) 162 (1.8) Total loans held-for-portfolio, net $ 889,279 $ 885,718 $ 3,561 0.4 % As noted in the table above, increases in the loan portfolio were driven primarily by increases in commercial and multifamily and floating home loans and, to a lesser extent, increases in home equity and manufactured home loans. The increase in commercial and multifamily loans was primarily due to the conversion of construction projects to permanent financing, while the increase in floating home loans was due to the funding of a large portfolio of individual loans that had been delayed in our pipeline. 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 33 efficiencies in how we process these loans. These increases were partially offset by decreases in construction and land loans, which was primarily due to projects completing and either paying off or converting to permanent financing, and decreases in other consumer and commercial business loans, which were primarily due to payoffs and paydowns, including the payoff of $2.1 million related to one commercial business loan that was previously on nonaccrual. At March 31, 2024, our loan portfolio, net of deferred loan fees, remained well-diversified. At that date, commercial and multifamily real estate loans accounted for 36.1% of total loans, one-to-four family loans, including home equity loans, accounted for 33.7% of total loans, commercial business loans accounted for 2.1% of total loans, and consumer loans, consisting of manufactured homes, floating homes, and other consumer loans, accounted for 15.7% of total loans. Construction and land loans accounted for 12.4% of total loans at March 31, 2024. Loans held-for-sale totaled $351 thousand at March 31, 2024, compared to $603 thousand at December 31, 2023. The decrease was primarily due to timing of mortgage originations and sales. 34 Allowance for Credit Losses. The following table reflects the activity in our allowance for credit losses (“ACL”) during the periods indicated (dollars in thousands): Three Months Ended March 31, 2024 2023 Allowance for Credit Losses — Loans: Balance at beginning of period $ 8,760 $ 7,599 Impact of Adoption of ASU 2016-13 — 760 Charge-offs (62) (79) Recoveries 6 7 Net charge-offs (56) (72) (Release of) provision for credit losses (106) 245 Balance at end of period 8,598 8,532 Reserve for Unfunded Commitments: Balance at beginning of period 193 335 Impact of Adoption of ASU 2016-13 — 695 Provision for (release of) credit losses 73 (235) Balance at end of period 266 795 Allowance for credit losses $ 8,864 $ 9,327 Ratio of net charge-offs during the period to average loans outstanding during the period (0.03) % (0.03) % Our ACL — loans decreased $162 thousand, or 1.8%, to $8.6 million at March 31, 2024, from $8.8 million at December 31, 2023. The decrease in the ACL - loans from December 31, 2023 to March 31, 2024 was primarily a result of lower reserves on our other consumer loan portfolio and residential loan portfolios due to qualitative adjustments for changes in concentration and market conditions, partially offset by the increase in the allowance for credit losses on loans due to portfolio growth, and an increase in nonaccrual loans and the weighted average life of the portfolio. See “Comparison of Results of Operations for the Three Months Ended March 31, 2024 and 2023 — 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). At March 31, 2024 At December 31, 2023 Allowance for credit losses - loans as a percentage of total loans outstanding 0.96 % 0.98 % Allowance for credit losses — loans $ 8,598 $ 8,760 Total loans outstanding $ 899,544 $ 896,160 Nonaccrual loans as a percentage of total loans outstanding 1.01 % 0.40 % Total nonaccrual loans $ 9,053 $ 3,556 Total loans outstanding $ 899,544 $ 896,160 Allowance for credit losses - loans as a percentage of nonaccrual loans 94.97 % 246.34 % Allowance for credit losses — loans $ 8,598 $ 8,760 Total nonaccrual loans $ 9,053 $ 3,556 Allowance for credit losses as a percentage of total loans outstanding 0.99 % 1.00 % Allowance for credit losses $ 8,864 $ 8,953 Total loans outstanding $ 899,544 $ 896,160 Allowance for credit losses as a percentage of nonaccrual loans 97.91 % 251.77 % Allowance for credit losses $ 8,864 $ 8,953 Total nonaccrual loans $ 9,053 $ 3,556 35 Three Months Ended March 31, 2024 2023 ($ in thousands) Net recoveries (charge-offs) during period to average loans outstanding: One-to-four family: — % — % Net (charge-offs)/recoveries $ — $ — Average loans outstanding $ 278,472 $ 274,261 Home equity: — % — % Net (charge-offs)/recoveries $ — $ — Average loans outstanding $ 23,300 $ 19,580 Commercial and multifamily real estate: — % — % Net (charge-offs)/recoveries $ — $ — Average loans outstanding $ 313,139 $ 310,960 Construction and land: — % — % Net (charge-offs)/recoveries $ — $ — Average loans outstanding $ 125,643 $ 120,704 Manufactured homes: (0.25) % — % Net (charge-offs)/recoveries $ (23) $ — Average loans outstanding $ 36,716 $ 27,279 Floating homes: — % — % Net (charge-offs)/recoveries $ — $ — Average loans outstanding $ 78,797 $ 74,043 Other consumer: (0.70) % (1.68) % Net (charge-offs) $ (33) $ (72) Average loans outstanding $ 18,945 $ 17,333 Commercial business: — % — % Net (charge-offs)/recoveries $ — $ — Average loans outstanding $ 21,198 $ 24,107 Total loans: (0.03) % (0.03) % Net (charge-offs) $ (56) $ (72) Average loans outstanding $ 896,210 $ 868,267 Nonperforming Assets. Nonperforming assets (“NPAs”), which are comprised of nonperforming loans (nonaccrual loans and nonperforming modified loans), other real estate owned (“OREO”) and repossessed assets, increased $5.6 million, or 135.9%, to $9.7 million, or 0.90% of total assets, at March 31, 2024 from $4.1 million, or 0.42% of total assets, at December 31, 2023. 36 The table below sets forth the amounts and categories of NPAs at the dates indicated (dollars in thousands): Nonperforming Assets March 31, 2024 December 31, 2023 Amount Change Percent Change Total nonperforming loans $ 9,053 $ 3,556 $ 5,497 154.6 OREO and repossessed assets 690 575 115 20.0 Total nonperforming assets $ 9,743 $ 4,131 $ 5,612 135.9 % The increase in NPAs primarily was due to the addition of $8.0 million to nonaccrual status, which included a $3.7 million matured commercial real estate loan in process of securing financing from another lender, $3.2 million for two floating homes loans to a single borrower, and a $1.0 million commercial real estate loan, all of which are well secured, and one manufactured home loan of $115 thousand that was repossessed in the first quarter of 2024. These increases in NPAs were partially offset by the payoff of one large commercial business loan totaling $2.1 million, the return of three loans to accrual status, and normal payment amortization. The percentage of nonperforming loans to total loans was 1.01% at March 31, 2024, compared to 0.40% of total loans at December 31, 2023. Mortgage Servicing Rights. The fair value of mortgage servicing rights was $4.6 million at both March 31, 2024 and December 31, 2023. 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 $90.3 million, or 10.9%, to $916.9 million at March 31, 2024 from $826.5 million at December 31, 2023. The increase was largely a result of the movement of reciprocal deposits off balance sheet for strategic objectives at year-end, followed by the return of those deposits to our balance sheet in the first quarter of 2024. Additionally, the increase related to higher balances for existing depositors and an increase in certificate accounts, partially offset by lower public funds accounts and brokered money market deposits. Noninterest-bearing deposits increased $1.9 million, or 1.5%, to $128.7 million at March 31, 2024, compared to $126.7 million at December 31, 2023. Noninterest-bearing deposits represented 14.0% of total deposits at March 31, 2024, compared to 15.3% at December 31, 2023. A summary of deposit accounts with the corresponding weighted-average cost of funds at the dates indicated is presented below (dollars in thousands): March 31, 2024 December 31, 2023 Amount Wtd. Avg. Rate Amount Wtd. Avg. Rate Noninterest-bearing demand $ 124,085 — % $ 124,134 — % Interest-bearing demand 159,178 0.32 168,346 0.75 Savings 65,723 0.10 69,461 0.07 Money market 241,976 3.42 154,044 1.39 Time deposits 321,340 4.61 307,962 3.45 Escrow (1) 4,581 — 2,592 — Total deposits $ 916,883 2.54 % $ 826,539 1.64 % (1) Escrow balances shown in noninterest-bearing deposits on the Condensed Consolidated Balance Sheets. Scheduled maturities of time deposits at March 31, 2024, are as follows (in thousands): Year Ending December 31, Amount 2024 $ 240,103 2025 73,467 2026 5,540 2027 1,150 2028 1,009 Thereafter 71 $ 321,340 37 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 March 31, 2024 and December 31, 2023, totaled $94.0 million and $88.3 million, respectively. Deposit amounts in excess of $250,000 are not federally insured. As of March 31, 2024, uninsured deposits totaled $166.7 million, which represented 18.2% of total deposits, as compared to uninsured deposits of $140.1 million, or 17.0% of total deposits as of December 31, 2023. 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 jumbo tier pricing offered on some of our deposit products, as well as normal fluctuation within deposit accounts. Borrowings, comprised of FHLB advances, remained flat at $40.0 million at both March 31, 2024 and December 31, 2023. FHLB advances are primarily used to support organic loan growth and to maintain liquidity ratios in line with our asset/liability objectives. FHLB advances outstanding at March 31, 2024 had maturities ranging from late 2024 through early 2028. Subordinated notes, net totaled $11.7 million at both March 31, 2024 and December 31, 2023. Stockholders’ Equity. Total stockholders’ equity increased $338 thousand, or 0.3%, to $101.0 million at March 31, 2024, from $100.7 million at December 31, 2023. This increase primarily reflects $770 thousand of net income earned during the three months ended March 31, 2024 and a $62 thousand decrease in accumulated other comprehensive loss, net of tax, partially offset by the cash payment of $486 thousand in dividends to the Company’s stockholders. 38 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 March 31, 2024 2023 Average Outstanding Balance Interest Earned/ Paid Yield/ Rate Annualized Average Outstanding Balance Interest Earned/ Paid Yield/ Rate Annualized Interest-earning assets: Loans receivable $ 895,430 $ 12,233 5.49 % $ 867,724 $ 11,381 5.32 % Investments 14,038 111 3.18 15,637 122 3.16 Cash and cash equivalents 107,361 1,416 5.30 64,607 671 4.21 Total interest-earning assets (1) 1,016,829 13,760 5.44 947,968 12,174 5.21 Interest-bearing liabilities: Savings and money market accounts 284,455 1,866 2.64 164,270 127 0.31 Demand and NOW accounts 159,762 141 0.35 241,088 233 0.39 Certificate accounts 315,495 3,696 4.71 246,578 1,776 2.92 Subordinated notes 11,724 168 5.76 11,683 168 5.83 Borrowings 40,000 429 4.31 44,911 499 4.51 Total interest-bearing liabilities 811,436 6,300 3.12 % 708,530 2,803 1.60 % Net interest income $ 7,460 $ 9,371 Net interest rate spread 2.32 % 3.60 % Net earning assets $ 205,393 $ 239,438 Net interest margin 2.95 % 4.01 % Average interest-earning assets to average interest-bearing liabilities 125.31 % 133.79 % Noninterest-bearing deposits $ 132,438 $ 172,805 Total deposits $ 892,150 $ 5,703 2.57 % $ 824,741 $ 2,136 1.05 % Total funding (2) $ 943,874 $ 6,300 2.68 % $ 881,335 $ 2,803 1.29 % (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). 39 Three Months Ended March 31, 2024 vs. 2023 Increase (Decrease) due to Total Increase (Decrease) Volume Rate Interest-earning assets: Loans receivable $ 379 $ 473 $ 852 Investments (13) 2 (11) Cash and cash equivalents 564 181 745 Total interest-earning assets 930 656 1,586 Interest-bearing liabilities: Savings and Money Market accounts 788 951 1,739 Demand and NOW accounts (72) (20) (92) Certificate accounts 807 1,113 1,920 Subordinated notes 1 (1) — Borrowings (53) (17) (70) Total interest-bearing liabilities $ 1,471 $ 2,026 $ 3,497 Change in net interest income $ (1,911) Comparison of Results of Operation for the Three Months Ended March 31, 2024 and 2023 General. Q1 2024 vs Q1 2023 . Net income decreased $1.4 million, or 64.5%, to $770 thousand, or $0.30 per diluted common share, for the three months ended March 31, 2024, compared to $2.2 million, or $0.83 per diluted common share, for the three months ended March 31, 2023. The decrease was the result of a $1.9 million decrease in net interest income and a $41 thousand increase in noninterest expense, partially offset by a $43 thousand decrease in the provision for credit losses, a $127 thousand increase in noninterest income and a $384 thousand decrease in the provision for income taxes. Interest Income Q1 2024 vs Q1 2023 . Interest income increased $1.6 million, or 13.0%, to $13.8 million for the three months ended March 31, 2024, from $12.2 million for the three months ended March 31, 2023, primarily due to higher average balances of loans and interest-bearing cash, a 17 basis point increase in the average yield on loans, a 109 basis point increase in the average yield on interest-bearing cash, and a two basis point increase in the average yield on investments, partially offset by a decline in the average balance of investments. Interest income on loans increased $852 thousand, or 7.5%, to $12.2 million for the three months ended March 31, 2024, compared to $11.4 million for the three months ended March 31, 2023. The average balance of total loans was $895.4 million for the three months ended March 31, 2024, compared to $867.7 million for the three months ended March 31, 2023, resulting from increased balances in all loan categories, except commercial business loans. The average yield on total loans was 5.49% for three months ended March 31, 2024, compared to 5.32% for the three months ended March 31, 2023. 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 decreased $11 thousand, or 9.0%, to $111 thousand for the three months ended March 31, 2024, compared to $122 thousand for the three months ended March 31, 2023. The decrease was primarily due to lower average balances, slightly offset by an increase in the average yield. The average balance of investments was $14.0 million for the three months ended March 31, 2024, compared to $15.6 million for the three months ended March 31, 2023, while the average yield on investments increased two basis points to 3.18% for the three months ended March 31, 2024, compared to 3.16% for the three months ended March 31, 2023. Interest income on cash and cash equivalents increased $745 thousand, or 111.0% to $1.4 million for the three months ended March 31, 2024, compared to $671 thousand for the three months ended March 31, 2023. The increase was due to higher average balances of and yields on our cash and cash equivalents. The average yield on cash and cash equivalents increased to 5.30% for the three months ended March 31, 2024, compared to 4.21% for the three months ended March 31, 2023, as a result of the high interest rate environment. The average balance of cash and cash equivalents was $107.4 million for the three months ended March 31, 2024, compared to $64.6 million for the three months ended March 31, 2023. The increase in the average 40 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. Interest Expense Q1 2024 vs Q1 2023 . Interest expense increased $3.5 million, or 124.8%, to $6.3 million for the three months ended March 31, 2024, from $2.8 million for the three months ended March 31, 2023. The increase was primarily the result of a $68.9 million increase in the average balance of certificate accounts and an $120.2 million increase in the average balance of savings and money market accounts, as well as higher average rates paid on all interest-bearing liabilities (excluding subordinated notes), partially offset by a $81.3 million decrease in the average balance of demand and NOW accounts and a $4.9 million decrease in the average balance of FHLB advances. The 179 basis point increase in the rate paid on certificate accounts and the 233 basis point increase in the rate paid on savings and money market accounts contributed to an overall 152 basis point increase in the average cost of total deposits to 2.57% for the quarter ended March 31, 2024, from 1.05% for the quarter ended March 31, 2023. Interest expense on borrowings, comprised solely of FHLB advances, was $429 thousand for the three months ended March 31, 2024, compared to $499 thousand for the three months ended March 31, 2023, primarily due to a 20 basis point decline in the average cost of FHLB advances to 4.31% for the quarter ended March 31, 2024, compared to 4.51% for the same quarter in 2023. The average balance of FHLB advances was $40.0 million for the three months ended March 31, 2024, compared to $44.9 million for the three months ended March 31, 2023. Interest expense on subordinated notes was $168 thousand for both the three months ended March 31, 2024 and 2023. Net Interest Income. Q1 2024 vs Q1 2023 . Net interest income decreased $1.9 million, or 20.4%, to $7.5 million for the three months ended March 31, 2024, from $9.4 million for the three months ended March 31, 2023. The decrease in net interest income was primarily the result of increased funding costs, primarily the rates paid on and balances of money market and certificate accounts, partially offset by an increase in the average balance of and yield earned on interest-earning assets. Net interest margin (annualized) was 2.95% and 4.01% for the three months ended March 31,2024 and 2023, respectively. 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 savings and money market accounts and certificates of deposits, partially offset by higher interest income earned on interest-earning assets. During 2023, in response to inflation, the Federal Open Market Committee of the Federal Reserve has increased the target range for the federal funds rate by 100 basis points, to a range of 5.25% to 5.50% as of March 31, 2024. 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 March 31, 2024 2023 (Release of) provision for credit losses on loans $ (106) $ 245 Provision for (release of) credit losses on unfunded loan commitments 73 (235) (Release of) provision for credit losses $ (33) $ 10 During the three months ended March 31, 2024, the provision for credit losses on loans primarily related to lower reserves on our other consumer loan portfolio and residential loan portfolios due to qualitative adjustments for changes in concentration and market conditions, partially offset by the increase in the allowance for credit losses on loans due to portfolio growth, and an increase in nonaccrual loans and the weighted average life of the portfolio. The provision for credit losses on unfunded loan commitments during the current period related to new originations in our construction and land portfolios as of March 31, 2024. Net charge-offs for the three months ended March 31, 2024 totaled $56 thousand, compared to net charge-offs of $72 thousand for the three months ended March 31, 2023. 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 41 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 increased $127 thousand, or 13.1%, to $1.1 million for the three months ended March 31, 2024, as compared to $1.0 million for the three months ended March 31, 2023, as reflected below (dollars in thousands): Three Months Ended March 31, Amount Change Percent Change 2024 2023 Service charges and fee income $ 612 $ 581 $ 31 5.3 % Earnings on BOLI 177 151 26 17.2 Mortgage servicing income 282 299 (17) (5.7) Fair value adjustment on mortgage servicing rights (65) (140) 75 (53.6) Net gain on sale of loans 90 78 12 15.4 Total noninterest income $ 1,096 $ 969 $ 127 13.1 % The increase in noninterest income was due to a $31 thousand increase in service charges and fee income, a $26 thousand increase in the cash surrender value of BOLI due to higher market rates, a $75 thousand improvement in the fair value adjustment on mortgage servicing rights due to higher market rates and a $12 thousand increase in net gain on sale of loans as a result of increased sales volume, partially offset by a decrease in mortgage servicing income as a result of the portfolio paying down at a faster speed than we are replacing the loans. Loans sold during the quarter ended March 31, 2024, totaled $4.2 million, compared to $3.9 million during the quarter ended March 31, 2023. Noninterest Expense. Noninterest expense increased $41 thousand, or 0.5%, to $7.7 million during the three months ended March 31, 2024, compared to $7.6 million during the three months ended March 31, 2023, as reflected below (dollars in thousands): Three Months Ended March 31, Amount Change Percent Change 2024 2023 Salaries and benefits $ 4,543 $ 4,485 $ 58 1.3 % Operations 1,457 1,441 16 1.1 Regulatory assessments 189 153 36 23.5 Occupancy 444 459 (15) (3.3) Data processing 1,017 993 24 2.4 Net gain on OREO and repossessed assets 6 84 (78) (92.9) Total noninterest expense $ 7,656 $ 7,615 $ 41 0.5 % The increase in noninterest expense was mainly attributable to an increase in salaries and benefits of $58 thousand, reflecting an increase in incentive compensation as a result of deposit and loan production, and higher medical expense, partially offset by lower salaries due to the restructuring of positions at the Bank, lower deferred compensation, lower stock compensation and higher deferred salaries. Data processing expenses increased due to software-related costs for new technology being implemented at the Bank and higher processing charges related to a higher volume of transactional activity and regulatory assessments increased $36 thousand due to the change in the assessment rate during 2023. These increases were partially offset by a decrease in net (gain) loss on OREO and repossessed assets as a result of the write-off of one OREO property in the first quarter of 2023. The efficiency ratio for the quarter ended March 31, 2024 was 89.48%, compared to 73.65% for the quarter ended March 31, 2023. The deterioration in the efficiency ratio was primarily due to lower net interest income resulting from a faster increase in interest expense compared to interest income, and a slight increase in noninterest expense, partially offset by a slight increase in noninterest income. 42 Income Tax Expense . The provision for income taxes was $163 thousand and $547 thousand for the three months ended March 31, 2024 and March 31, 2023, respectively. The effective tax rates for the three months ended March 31, 2024 and March 31, 2023 were 17.47% and 20.15%, respectively. The effective tax rate for the three months ended March 31, 2024 was lower than the same period the prior year as a result of a higher portion of nontaxable income related to earnings on BOLI and nontaxable AFS securities during the current period in 2024 as compared to the same period in 2023. Capital and Liquidity The Management’s Discussion and Analysis in Item 7 of the Company’s 2023 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 2023 Form 10-K, this discussion updates that disclosure for the three months ended March 31, 2024. Capital. Stockholders’ equity totaled $101.0 million at March 31, 2024 and $100.7 million at December 31, 2023. In addition to net income of $770 thousand, other sources of capital during the three months ended March 31, 2024 primarily included $26 thousand in proceeds from stock option exercises. Uses of capital during the three months ended March 31, 2024 primarily included $486 thousand of dividends paid on common stock. We paid a quarterly dividend of $0.19 per common share during the three months ended March 31, 2024 and $0.17 per common share during the three months ended March 31, 2023, which equates to a dividend payout ratio of 63.12% and 20.39%, respectively. 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 2024 at the rate of $0.19 per share, our average total dividend paid each quarter would be approximately $486 thousand based on the number of outstanding shares as of March 31, 2024. 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 2023 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 March 31, 2024, approximately $1.5 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. 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 43 management. These scenarios are incorporated into our contingency funding plan, which provides the basis for the identification of our liquidity needs. As of March 31, 2024, we had $146.1 million in cash and cash equivalents and available-for-sale investment securities, and $351 thousand in loans held-for-sale. At March 31, 2024, we had the ability to borrow $180.9 million in FHLB advances and access to additional borrowings of $19.5 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 FHLB and none from the Federal Reserve at March 31, 2024. We also had a $20.0 million credit facility with Pacific Coast Banker’s Bank available, with no balance outstanding at March 31, 2024. 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 March 31, 2024, 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 March 31, 2024. 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 March 31, 2024 and December 31, 2023, financial instrument contract amounts representing credit risk were as follows (in thousands): March 31, 2024 December 31, 2023 Residential mortgage commitments $ 11,396 $ 10,465 Unfunded construction commitments 38,217 34,667 Unused lines of credit 24,889 27,245 Irrevocable letters of credit 277 277 Total loan commitments $ 74,779 $ 72,654 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 2023 Form 10-K. At March 31, 2024 Sound Financial Bancorp, on an unconsolidated basis, had $1.9 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. 44 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 March 31, 2024, the Bank and Company’s CBLR was 10.55% and 9.55%, 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 2023 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 2023 Form 10-K. There have been no material changes in our market risk since our 2023 Form 10-K.