FINANCIAL BANCORP, INC.
the rewards of
ease, access & transparency
2019 Annual Report
A MESSAGE FROM THE PRESIDENT & CEO
Dear Shareholders,
On behalf of our team of bankers and the Board of Directors, please accept our heartfelt thanks for your trust and for
investing in us. Our company achieved growth in commercial, multifamily, construction, and land loans as well as
consumer and floating homes, despite a loan sale of $16.2 million. We helped consumers and businesses achieve their
financial dreams. We also increased total deposits 11.4%, materially improving our loan to deposit ratio and diminishing
our reliance on borrowings. This means we are less sensitive to overnight rates. Credit quality remains strong with
negligible charge offs in 2019.
In addition to focusing on strong financial performance, we continued to demonstrate our core values. We ranked
first in the Puget Sound Business Journal Top Corporate Philanthropists in the small business category, giving
more than $315,000 to our communities. We again ranked first in per capita giving to Food Lifeline, helping feed hungry
children and families throughout our market area. We were named the 20th largest bank in the state and the 55th largest
public company. For the 4th year in a row, we were recognized by American Banker as one of the top performing publicly
traded community banks across the nation. In October 2019, I was honored to be elected Chair of the American Bankers
Association, representing banks of all sizes across the nation and lending our voice to developing good public policy.
We continue to demonstrate a commitment to stakeholders, the communities we serve, and
employees. Our goal is to make it ‘Simply better here’ and we focus on these results every day.
In addition to reviewing our Annual Report, I hope you take time to learn more about the faces
of our organization by reviewing our Sustainability Report.
Most sincerely,
Laura Lee (Laurie) Stewart
The American Bankers Association (ABA) proudly
represents banks of all sizes and their two million
dedicated employees and $14.5 trillion in deposits and
$10.5 trillion in loans. Chair of the ABA Board of
Directors, Sound Community Bank President & CEO
Laurie Stewart, leads the oversight and strategic
direction of this national trade association.
Board of Directors – left to right: Kathleen B. Cook, Laura Lee Stewart (President
& CEO), Robert F. Carney, David S. Haddad Jr. (Vice Chairman), Debra L. Jones,
Tyler K. Myers (Chairman), Rogelio Riojas, James E. Sweeney
About the Cover: For nearly 140 years, the West Point Lighthouse has guarded the entrance to
Seattle’s Elliott Bay and the Southern Puget Sound region in Washington State. Erected in
1881, the lighthouse is part of Seattle’s beloved Discovery Park. Intended to safely guide
seafarers into the historic Seattle and Tacoma ports, avoiding the rocky outcrop which begins to
form Elliott Bay, it is one of the many hallmarks of the regions long oceanic history. From air,
land, or sea, the West Point Lighthouse is a symbol of the region’s pioneering sustainability
efforts and exemplifies our holistic commitment to sustainability in four categories: financial
stewardship, excellence in the workplace, a commitment to the communities we serve, and the
environment. For more information regarding our efforts in this area, please take a moment to
review our 2019 Sustainability Report.
Sound Financial Bancorp, Inc. Corporate Information
Sound Financial Bancorp, Inc.
is a bank holding company, regulated by
the Board of Governors of the Federal
Reserve System. Our principal business
is operating our wholly-owned subsidiary,
Sound Community Bank.
Sound Financial Bancorp, Inc.’s executive
offices are located at 2400 3rd Avenue,
Suite 150, Seattle, Washington 98121 and
the telephone number is (206) 448-0884.
Sound Community Bank
is a Washington State chartered
commercial bank with eight full-service
banking offices and one loan production
office in the greater Puget Sound area of
Washington State.
It is a community focused institution,
primarily engaging in attracting deposits
from the general public and originating
loans to individuals and businesses.
Board of Directors of
Sound Financial Bancorp, Inc.
and Sound Community Bank
Tyler K. Myers, Chairman
President, General Partner,
The Myers Group
David S. Haddad, Jr.
Vice Chairman, Retired
Laura Lee Stewart
President/Chief Executive Officer,
Sound Financial Bancorp, Inc. &
Sound Community Bank
Robert F. Carney
Director of Meat and Seafood
Merchandising, Scolaris Food
& Drug Company
Debra L. Jones, CPA
Retired Vice President of
Administrative Services,
Bellingham Technical College
Rogelio Riojas
Chief Executive Officer,
Sea Mar Community Health Centers
James E. Sweeney
Retired Vice President,
Vitamin Shoppe, Inc.
Kathleen B. Cook
Retired Vice President of
Regulatory Compliance, FannieMae
Retiring effective May 26, 2020
Executive Officers
Laura Lee Stewart
President/Chief Executive Officer
Sound Financial Bancorp, Inc. &
Sound Community Bank
Daphne Kelley
Executive Vice President,
Chief Financial Officer
Sound Financial Bancorp, Inc.
& Sound Community Bank
Erin Nicolaus
Executive Vice President,
Chief Human Resources Officer
Sound Community Bank
Wesley Ochs
Executive Vice President,
Chief Strategy Officer
Sound Community Bank
Elliott Pierce
Executive Vice President,
Chief Credit Officer
Sound Community Bank
David A. Raney
Executive Vice President,
Chief Banking Officer
Sound Community Bank
Heidi J. Sexton
Executive Vice President,
Chief Operating Officer
Sound Community Bank
Sound Financial Bancorp, Inc. Shareholder Information
Annual Report on Form 10-K
Our Annual Report on Form 10-K for
the year ended December 31, 2019 is
included in this Annual Report of
Shareholders. Additional copies of the
Company's Form 10-K, as filed with the
Securities and Exchange Commission,
may be obtained without charge by
contacting Daphne Kelley EVP/CFO at
Sound Financial Bancorp, Inc., 2400
3rd Avenue, Suite 150, Seattle,
Washington 98121. This information is
also available at soundcb.com under
Investor Relations.
Annual Meeting
The Annual Meeting of Shareholders
of Sound Financial Bancorp, Inc. will
be held on May 26, 2020, 10:30 AM,
2400 3rd Avenue, Suite 150, Seattle,
WA 98121.
Stock Listing & Dividends
Sound Financial Bancorp, Inc.
common stock is traded on the
NASDAQ Capital Market under the
symbol “SFBC”.
The Board of Directors and
management of Sound Financial
Bancorp, Inc. continually review our
ability to pay cash dividends on
common stock. Sound Financial
Bancorp, Inc. paid dividends totaling
56 cents a share during 2019.
Stockholder and General Inquiries
Sound Financial Bancorp, Inc. files annual,
quarterly and current reports, proxy
statements and other information with the
SEC, which can be accessed free of charge
at www.sec.gov. You also may obtain copies
of the information that Sound Financial
Bancorp, Inc. files with the SEC, free of
charge, by accessing the Company’s
website at www.soundcb.com under the tab
“Investor Relations” and then “SEC Filings.”
Alternatively, these documents, when
available, may be obtained free of charge
upon written request to Sound Financial
Bancorp, Inc., Chief Financial Officer, 2400 3rd
Avenue, Suite 150, Seattle, Washington
98121 or by calling (206) 448-0884, extension
305. Requests for these reports, as well as
inquiries from shareholders, analysts, and
others seeking information about Sound
Financial Bancorp, Inc. should be directed
to Daphne Kelley, EVP/CFO, 2400 3rd
Avenue, Suite 150, Seattle, Washington
98121, telephone (206) 448-0884, extension
305.
We are new commercial account holders with Sound Community
Bank. We became clients over a year ago when we were reeling
from a fire, which destroyed our apartment building. Sound
Community Bank’s commercial bankers, Patti Kelly, Elliott Pierce,
and all the folks at the Bank had confidence in our project and in
us. They provided us with a large construction loan to
rebuild. Our project is complete, and we are looking
forward to a long and continued relationship with Sound
Community Bank. We find it refreshing to do business with
a financial institution where we are treated as people rather
than accounts. We love the personal attention from a bank
that can make big things happen. We know Sound
Community Bank will be our partner for years to come.
Jim & Rosy Addington
Property Owners/Managers
Carl Colson, Architect PLLC, has provided quality
architectural services for over forty years to residential and
commercial clients. Creating sustainable new and
remodeled projects is one of the guiding forces in all of my
projects. These goals include: creating architecture meeting
the goals and dreams of the client, while designing homes
and buildings that are cost efficient, maximize the use of
space, are designed appropriately for the region, and are visually
appealing now and into the future. Sound Community
Bank’s excellent services, extremely helpful management,
and personnel are crucial factors in the success of my firm.
Their goals of friendliness, efficiency, and great service are
greatly appreciated. I value our shared common goals.
Carl Colson
Architect, PPLC
Owner
I am pleased to say I am a happy client of the Sound Community
Bank family! Each time I walk in through the door, I am immediately
welcomed by one of the staff members and given the "VIP treatment".
This is an experience which sets this bank apart from the big
commercial banks. You are treated like family, not a number. Maria
Carbullido and Sean Spencer do a great job whenever I need their
assistance, and any questions I have are always a priority. I thank
Sound Community Bank for being there for my family and me.
Thank you for making our banking simple.
Hadi Elbasiony
Kiro Motors, LLC
Owner
Image360 is a national franchise producing all types of signs and
graphics. Our business is fast moving and always in need of
something from Sound Community Bank. We are a relationship
business and Sound Community Bank operates in the same manner.
They always take care of us. We really appreciate the relationship we
have with the employees at Sound Community Bank!
Al Mednick, CEO
Rose Mednick, President
Image360
For over a decade, Peninsula Friends of
Animals, a donor supported, cage-less, no
kill animal-welfare organization, has trusted
the financial services provided by our local
Sound Community Bank. We appreciate their
excellent client service and dedication to the
community, including supporting our vital
work of spay/neuter and rescue.
Danette Grady
Executive Director, Peninsula Friends
of Animals
Over fifteen years ago, and after an unsatisfactory relationship
with a major bank, we decided to move our accounts to a local
and friendlier business. Sound Community Bank certainly fit our
criteria. Within those fifteen years, Sound Community Bank
supported us in the development and growth of three
bars/restaurants and properties. Their professional approach and
friendly service is a major reason for our lasting partnership.
Colin & Donna Pickering
Owners, The Whisky Bar
.....................
(Left to Right) 1. Bank employees David, Meghan, Erin, and Brady pose with Anthony, Residential Lending Marketing Specialist, at the Hiring Our Heroes
graduation. The Hiring Our Heroes program assists military members and families transition from service to civilian life. 2. Our Sequim branch hosted a
Business Education Seminar for local businesses, which covered fraud detection and prevention, merchant service education, and ideas to simplify banking
needs of businesses. 3. Employee Christian proudly stands with Sean, Myriah, and Wes at graduation from the Washington Bankers Association Executive
Development Program. 4. Bank Consultant Roberta and Washington Bankers Association Executive Vice President Liz snap a fun shot at Diana’s graduation
from the Washington Bankers Association Enterprise Risk Management Program. 5. Team members Maria and Dulci sport Bank volunteer shirts as they
participate in the South Sound Beach Cleanup. 6. Executive Vice President Heidi proudly presents Financial Beginnings Washington a pledge from the Bank,
furthering the great financial literacy work the organization provides. 7. In 2019, the Bank debuted Echo, the orca car! This converted Volkswagen Beetle
finds her way throughout the Puget Sound region as new monthly employees enter to win the chance to drive. Her fin is modeled after that of a J-Pod orca
whale, the resident “pod” in the Pacific Northwest. 8. Teams from Mountlake Terrace, Seattle, Administration, and Tacoma braved a 5 AM shift at KISS 106.1’s
One Big Kiss for Children radiothon event. They answered phones and took donations from callers. 9. Employees proudly support the work Plymouth
Housing does helping solve Seattle’s homeless crisis. 10. Port Angeles team members promote the Bank during the annual Run-a-Muck event. 11. Several
Sequim employees pose with Sequim Farmer’s Market board members, presenting a check to fund the fresh food match program, helping low-income
individuals and family purchase twice the amount of fresh, wholesome food. 12. Volunteer board members from the Orca Conservancy celebrate a
successful fundraiser with Bank employees. The Bank helped underwrite the cost of a high school program in which students designed an “Orca Star
Certification” for businesses whose environmental practices benefit the local resident orca whale population.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2019
OR
□ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from
to
COMMISSION FILE NUMBER 001-35633
Sound Financial Bancorp, Inc.
(Exact Name of Registrant as Specified in its Charter)
Maryland
(State or other jurisdiction of incorporation or organization)
45-5188530
(I.R.S. Employer Identification No.)
2400 3rd Avenue, Suite 150, Seattle Washington
(Address of principal executive offices)
98121
(Zip Code)
Registrant’s telephone number, including area code: (206) 448-0884
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, par value $0.01 per share
SFBC
The NASDAQ Stock Market LLC
Securities Registered Pursuant to Section 12(g) of the Act:
None
Indicate by checkmark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
YES □ NO ☒
Indicate by checkmark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
YES □ NO ☒
Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days.
YES ☒ NO □
Indicate by checkmark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to
Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was
required to submit such files).
YES ☒ NO □
Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company,
or an emerging growth company. See the definition of ‘‘large accelerated filer,’’ ‘‘accelerated filer,’’ ‘‘smaller reporting company’’ and ‘‘emerging
growth company’’ in Rule 12b-2 of the Exchange Act.
Large accelerated filer □
Non-accelerated filer □
Accelerated filer ☒
Smaller reporting company ☒
Emerging growth company □
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with
any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. □
Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES □ NO ☒
The aggregate market value of the voting and non-voting common equity held by non-affiliates as of June 30, 2019, the last business day of the
registrant’s most recently completed second fiscal quarter, was approximately $74.0 million. (The exclusion from such amount of the market
value of the shares owned by any person shall not be deemed an admission by the registrant that such person is an affiliate of the registrant.)
Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of the latest practicable date: As of March 10,
2020, there were 2,584,787 shares of the registrant’s common stock outstanding.
PART III of Form 10-K – Portions of the Registrant’s Proxy Statement for its 2020 Annual Meeting of Stockholders.
DOCUMENTS INCORPORATED BY REFERENCE
SOUND FINANCIAL BANCORP, INC.
FORM 10-K
TABLE OF CONTENTS
Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Risk Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unresolved Staff Comments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Mine Safety Disclosures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Management’s Discussion and Analysis of Financial Condition and Results of Operations . . .
Quantitative and Qualitative Disclosures About Market Risk . . . . . . . . . . . . . . . . . . . . . . . . . . .
Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure . . .
Controls and Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Directors, Executive Officers and Corporate Governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Certain Relationships and Related Transactions, and Director Independence . . . . . . . . . . . . . .
Principal Accounting Fees and Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Page
3
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PART I
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
PART II
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
PART III
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
PART IV
Item 15.
Item 16.
Exhibits, Financial Statement Schedules
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Form 10-K Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
110
112
[THIS PAGE INTENTIONALLY LEFT BLANK]
Item 1.
Business
Special Note Regarding Forward-Looking Statements
PART I
Certain matters discussed in this Form 10-K 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:
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
fluctuations in the demand for loans, the number of unsold homes, land and other properties, and
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;
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 loan losses or to write-down assets, change Sound Community Bank’s regulatory capital
position or affect our ability to borrow funds or maintain or increase deposits, which could adversely
affect our liquidity and earnings;
our ability to attract and retain deposits;
the risks of lending and investing activities, including changes in the level and direction of loan
delinquencies and write-offs and changes in estimates of the adequacy of our allowance for loan losses;
inability of key third-party providers to perform their obligations to us;
competitive pressures among financial services companies;
our ability to successfully integrate any assets, liabilities, clients, systems, and management personnel
we may acquire into our operations 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 fair value of certain of our assets, which estimates may prove to be
incorrect and result in significant declines in valuation;
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 consumer spending, borrowing and savings habits;
changes in accounting policies and practices, as may be adopted by the financial institution regulatory
agencies or the Financial Accounting Standards Board, including additional guidance and interpretation
on accounting issues and details of the implementation of new accounting methods;
3
•
•
changes in economic conditions, either nationally or in our market area;
legislative or regulatory changes such as the Dodd-Frank Wall Street Reform and Consumer Protection
Act (the ‘‘Dodd-Frank Act’’) and its implementing regulations that adversely affect our business, and
the availability of resources to address such changes;
• monetary and fiscal policies of the Board of Governors of the Federal Reserve System (‘‘Federal
Reserve’’) and the U.S. Government and other governmental initiatives affecting the financial services
industry;
•
•
•
•
•
•
•
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 possibility of other-than-temporary impairments of securities held in our securities portfolio; and
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 this
Form 10-K and our other filings with the U.S. Securities and Exchange Commission (the ‘‘SEC’’).
We wish to advise readers not to place undue reliance on any forward-looking statements and that the factors
listed above could materially affect our financial performance and could cause our actual results for future
periods to differ materially from any such forward-looking statements expressed with respect to future periods
and could negatively affect our stock price performance.
We 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
References in this document to Sound Financial Bancorp or the Company refer to Sound Financial Bancorp, Inc.
and references to the ‘‘Bank’’ refer to Sound Community Bank. References to ‘‘we,’’ ‘‘us,’’ and ‘‘our’’ means
Sound Financial Bancorp and its wholly-owned subsidiary, Sound Community Bank, unless the context otherwise
requires.
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, the Bank’s
regulators are the Washington State Department of Financial Institutions (‘‘WDFI’’) and the Federal Deposit
Insurance Corporation (‘‘FDIC’’). The Federal Reserve is the primary federal regulator for Sound Financial
Bancorp. We also sell insurance products and services for consumer clients through Sound Community Insurance
Agency, Inc., a wholly owned subsidiary of the Bank.
Sound Community Bank’s deposits are insured up to applicable limits by the FDIC. At December 31, 2019,
Sound Financial Bancorp had total consolidated assets of $719.9 million, including $619.9 million of loans held
for portfolio, deposits of $616.7 million and stockholders’ equity of $77.7 million. The shares of Sound Financial
Bancorp are traded on The NASDAQ Capital Market under the symbol ‘‘SFBC.’’ Our executive offices are
located at 2400 3rd Avenue, Suite 150, Seattle, Washington, 98121 and our telephone number is 206-448-0884.
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, 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,
4
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 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 owner-occupied and nonowner-occupied commercial real estate, multifamily
property, mobile home parks and construction and land development loans.
Market Area
We serve the Seattle Metropolitan Statistical Area (‘‘MSA’’), which includes King County (which includes the
city of Seattle), Pierce County and Snohomish County within the Puget Sound region, and also serve Clallam
and Jefferson Counties, on the North Olympic Peninsula of Washington. We serve these markets through our
headquarters in Seattle, eight branch offices, five of which are located in the Seattle MSA, two that are located
in Clallam County and one that is located in Jefferson County. We also have two loan production offices, one
located in the Madison Park neighborhood of Seattle and one located in Sequim. Based on the most recent
branch deposit data provided by the FDIC, our share of deposits was approximately 0.12% in King County,
approximately 0.46% in Pierce County and in Snohomish County approximately 0.34%. In Clallam County and
Jefferson County, we have approximately 17.7% and 7.8%, respectively, of the deposits in those markets. See
‘‘– Competition.’’
Our market area includes a diverse population of management, professional and sales personnel, office
employees, health care workers, manufacturing and transportation workers, service industry workers and
government employees, as well as retired and self-employed individuals. The population has a skilled work force
with a wide range of education levels and ethnic backgrounds. Major employment sectors include information
and communications technology, financial services, aerospace, military, manufacturing, maritime, biotechnology,
education, health and social services, retail trades, transportation and professional services. The largest employers
headquartered in our market area include U.S. Joint Base Lewis-McChord, Navy Region Northwest, Microsoft,
University of Washington, and Providence Health. Other significant employers include Costco, Boeing,
Nordstrom, Amazon.com, Starbucks, Alaska Air Group and Weyerhaeuser.
Economic conditions in our markets continue to improve over the last year. Recent trends in housing prices and
unemployment rates in our market areas reflect continuing improvement. For the month of December 2019, the
preliminary Seattle metropolitan statistical area (MSA) reported an unemployment rate of 2.9%, as compared to
the national average of 3.5%, according to the latest available information from the Bureau of Labor Statistics.
Home prices in our markets also improved over the past year. Based on information from Case-Shiller, the
average home price in the Seattle MSA increased 2.5% in 2019. This compares to the national average home
price index increase in 2019 of 3.3%.
King County has the largest population of any county in the state of Washington with approximately 2.2 million
residents and a median household income of approximately $88,000. Based on information from the Northwest
Multiple Listing Service (‘‘MLS’’), the median home sales price in King County in December 2019 was
$615,000, a 3.02% increase from December 2018’s median home sales price of $597,000.
Pierce County has approximately 891,000 residents and a median household income of approximately $64,000.
Based on information from the MLS, the median home sales price in Pierce County in December 2019 was
$369,000, an 8.6% increase from December 2018’s median home sales price of $340,000.
Snohomish County has approximately 805,000 residents and a median household income of approximately
$80,000. Based on information from the MLS, the median home sales price in Snohomish County as of
December 2019 was $495,000, an 8.8% increase from December 2018’s median home sales price of $455,000.
Clallam County, with a population of approximately 77,000, has a median household income of approximately
$62,000. The economy of Clallam County is primarily manufacturing and shipping. The Sequim Dungeness
Valley continues to be a growing retirement location. Based on information from the MLS, the median home
sales price in Clallam County in December 2019 was $309,000, an 14.4% increase from December 2018’s
median home sales price of $270,000.
5
Jefferson County, with a population of approximately 32,000, has a median household income of approximately
$52,000. Based on information from the MLS, the average home sales price in Jefferson County as of December
2019 was $375,000, an 11.8% increase from December 2018’s median home sales price of $335,000.
Lending Activities
The following table presents information concerning the composition of our loan portfolio, excluding loans
held-for-sale, by the type of loan for the dates indicated (dollars in thousands):
2019
2018
December 31,
2017
2016
2015
Amount
Percent
Amount
Percent
Amount
Percent
Amount
Percent
Amount
Percent
Real estate loans:
One- to four-family . . . . . . . .
Home equity . . . . . . . . . . . .
Commercial and multifamily . .
Construction and land. . . . . . .
Total real estate loans. . . . .
Consumer loans:
Manufactured homes . . . . . . .
Floating homes . . . . . . . . . . .
Other consumer. . . . . . . . . . .
Total consumer loans . . . . .
Commercial business loans . . .
Total loans . . . . . . . . . . . . . .
Less:
Deferred fees and discounts . . .
Allowance for loan losses . . . .
Total loans, net . . . . . . . . .
$149,393
23,845
261,268
75,756
510,262
20,613
43,799
8,302
72,714
38,931
621,907
(2,020)
(5,640)
$614,247
24.0% $169,830
3.8%
27,655
42.0% 252,644
12.2%
65,259
82.0% 515,388
27.3% $157,417
4.4%
28,379
40.6% 211,269
10.6%
61,482
82.9% 458,547
28.5% $152,386
27,771
181,004
70,915
432,076
5.2
38.4
11.2
83.3
30.3% $141,125
31,573
175,312
57,043
405,053
5.5
36.1
14.1
86.0
3.3%
7.1%
1.3%
11.7%
6.3%
20,145
40,806
6,628
67,579
38,804
100.0% 621,771
3.2%
6.6%
1.1%
10.9%
6.2%
17,111
29,120
4,902
51,133
40,829
100.0% 550,509
3.1
5.3
0.9
9.3
7.4
15,494
23,996
3,932
43,422
26,331
100.0% 501,829
3.1
4.8
0.8
8.7
5.3
13,798
18,226
4,804
36,828
19,295
100.0% 461,176
30.5%
6.9
38.0
12.4
87.8
3.0
4.0
1.0
8.0
4.2
100.0%
(2,228)
(5,774)
$613,769
(1,914)
(5,241)
$543,354
(1,828)
(4,822)
$495,179
(1,707)
(4,636)
$454,833
The following table shows the composition of our loan portfolio in dollar amounts and in percentages by fixed
and adjustable rate loans for the dates indicated (dollars in thousands):
2019
2018
December 31,
2017
2016
2015
Amount
Percent
Amount
Percent
Amount
Percent
Amount
Percent
Amount
Percent
Fixed-rate loans:
Real estate loans:
One-to-four family. . . . . . . . .
Home equity . . . . . . . . . . . .
Commercial and multifamily . .
Construction and land. . . . . . .
Total real estate loans. . . . .
Manufactured homes . . . . . . .
Floating homes . . . . . . . . . . .
Other consumer. . . . . . . . . . .
Commercial business . . . . . . .
Total fixed-rate loans . . . . .
Adjustable- rate loans:
Real estate loans:
One-to-four family. . . . . . . . .
Home equity . . . . . . . . . . . .
Commercial and multifamily . .
Construction and land. . . . . . .
Total real estate loans. . . . .
Floating homes . . . . . . . . . . .
Other consumer. . . . . . . . . . .
Commercial business . . . . . . .
Total adjustable-rate loans . .
Total loans . . . . . . . . . . . . . .
Less:
Deferred fees and discounts . . .
Allowance for loan losses . . . .
Total loans, net . . . . . . . . .
$ 79,304
12,505
106,161
43,193
241,163
20,613
34,539
7,777
7,411
311,503
70,089
11,340
155,107
32,563
269,099
9,260
525
31,520
310,404
621,907
(2,020)
(5,640)
$614,247
12.8% $ 94,237
11,052
102,907
51,259
259,455
20,145
40,806
6,090
9,705
336,201
2.0
17.1
6.9
38.8
3.3
5.6
1.3
1.2
50.2
1.8%
16.5%
8.2%
15.2% $117,590
11,373
89,094
57,247
41.7% 275,304
17,111
29,120
4,316
16,889
54.1% 342,740
3.2%
6.6%
1.0%
1.6%
21.3% $142,537
9,102
2.1
77,285
16.2
69,398
10.4
298,322
50.0
15,494
3.1
23,996
5.3
3,297
0.8
12,581
3.1
353,690
62.3
28.4% $129,762
11,042
1.8
92,205
15.4
51,572
13.9
284,581
59.5
13,798
3.1
18,226
4.8
4,082
0.6
9,392
2.5
330,079
70.5
75,593
11.3
16,603
1.8
149,737
24.8
14,000
5.2
255,933
43.1
—
1.5
538
0.1
29,099
5.1
49.8
285,570
100.0% 621,771
39,827
12.2%
17,007
2.7%
122,175
24.0
4,235
2.3
183,244
41.2
—
—
585
0.1
23,940
4.6
207,769
45.9
100.0% 550,509
7.2
3.1
22.2
0.8
33.3
—
0.1
4.3
37.7
9,849
18,669
103,719
1,517
133,754
—
635
13,750
148,139
100.0% 501,829
2.0
3.7
20.7
0.3
26.7
—
0.1
2.7
29.5
11,363
20,531
83,107
5,471
120,472
—
722
9,903
131,097
100.0% 461,176
(2,228)
(5,774)
$613,769
(1,914)
(5,241)
$543,354
(1,828)
(4,822)
$495,179
(1,707)
(4,636)
$454,833
6
28.1%
2.4
20.0
11.2
61.7
3.0
4.0
0.9
2.0
71.6
2.5
4.4
18.0
1.2
26.1
—
0.2
2.1
28.4
100.0%
As of December 31, 2019 and 2018, we had floating or variable rate loans totaling $310.4 million and
$285.6 million, respectively. As of December 31, 2019, a total of $170.0 million have interest rate floors, of
which $67.2 million are at their floors.
The following table illustrates the contractual maturity of our construction and land and commercial business
loans at December 31, 2019 (dollars in thousands). Loans that have adjustable or renegotiable interest rates are
shown as maturing in the period during which the contract is due. The total amount of loans due after
December 31, 2020, which have predetermined interest rates, is $14.1 million, while the total amount of loans
due after such date, which have floating or adjustable interest rates, is $36.7 million. The table does not reflect
the effects of possible prepayments or enforcement of due-on-sale clauses.
Amount
2020(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . $50,899
21,782
2021 to 2024 . . . . . . . . . . . . . . . . . . . . . . .
2025 and thereafter . . . . . . . . . . . . . . . . . .
3,075
Total(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . $75,756
Construction and Land
Weighted
Average Rate
Commercial Business
Weighted
Average Rate
Amount
Total
Amount
Weighted
Average Rate
6.01% $12,938
18,045
6.30
7,948
6.28
5.24% $ 63,837
39,827
5.17
11,023
5.66
6.10% $38,931
5.29% $114,687
5.85%
5.79
5.83
5.83%
(1)
Includes demand loans, loans having no stated maturity and overdraft loans.
(2) Excludes deferred fees of $494,000.
Lending Authority. Our President and Chief Executive Officer (‘‘CEO’’) may approve unsecured loans up to
$1.0 million and all types of secured loans up to 30% of our legal lending limit, or approximately $4.8 million as
of December 31, 2019. Our Executive Vice President and Chief Credit Officer (‘‘CCO’’) may approve unsecured
loans up to $400,000 and secured loans up to 15% of our legal lending limit, or approximately $2.4 million as of
December 31, 2019. Any loans over the CEO’s lending authority or loans significantly outside our general
underwriting guidelines must be approved by the Loan Committee consisting of four independent directors, the
CEO and the CCO. Lending authority is also granted to certain other lending staff at lower amounts. The Chief
Banking Offer has lending authority of up to 7.5% of our legal lending limit for real estate and other secured
loans, and $50,000 for unsecured loans.
Largest Borrowing Relationships. At December 31, 2019, the maximum amount under federal law that we could
lend to any one borrower and the borrower’s related entities was approximately $15.5 million. Our five largest
relationships totaled $55.6 million in the aggregate, or 8.9% of our $621.9 million total loan portfolio, at
December 31, 2019. At December 31, 2019, the largest lending relationship totaled $13.0 million consisting of an
$8.5 million loan to a business and a $4.5 million loan to an individual, both collateralized by separate
multifamily real estate properties. The second largest relationship consisted of two loans to businesses both
collateralized by two separate multifamily real estate properties and totaled $11.4 million. The third largest
relationship totaled $11.2 million consisting of two loans to businesses and a loan and line of credit to an
individual, all collateralized by separate multifamily real estate properties. The fourth and fifth largest
relationships consisted of a $10.0 million line of credit loan participation to a third party loan originator secured
by an assignment of promissory notes from their borrowers for construction projects, and two lines of credit loan
participations totaling $10.0 million to third party loan originators with common ownership, collateralized by an
assignment of promissory notes from their borrowers for construction projects. These top five borrowers had
unused commitments totaling $17.7 million at December 31, 2019. At December 31, 2019, we had five other
lending relationships that exceeded $6.3 million. All of the foregoing loans were performing in accordance with
their repayment terms as of December 31, 2019.
One- to-Four Family Real Estate Lending. One of our primary lending activities is the origination of loans
secured by first mortgages on one- to four-family residences, substantially all of which are secured by property
located in our geographic lending area. We originate both fixed-rate and adjustable-rate loans. During 2019, our
fixed rate, one-to-four family loan originations increased $36.5 million, or 53.8% to $104.3 million compared to
$67.8 million in 2018, while one-to-four family adjustable rate mortgage (‘‘ARM’’) loan originations decreased
7
$20.1 million, or 44.9% to $24.6 million compared to $44.7 million in 2018. In 2019, we identified demand in
the marketplace for one-to-four family, residential fixed rate mortgage loans, especially jumbo loans (loans above
$484,400, the conforming Fannie Mae limit in our market area). In 2019, the average loan amount was $579,000
for adjustable rate, one-to-four family mortgages.
Most of our loans are underwritten using generally-accepted secondary market underwriting guidelines. A portion
of the one- to four-family loans we originate are retained in our portfolio and the remaining loans are sold into
the secondary market to Fannie Mae or other private investors. Loans that are sold into the secondary market to
Fannie Mae are sold with the servicing retained to maintain the client relationship and to generate noninterest
income. We also originate a small portion of government guaranteed and jumbo loans for sale servicing released
to certain correspondent purchasers. The sale of mortgage loans provides a source of non-interest income through
the gain on sale, reduces our interest rate risk, provides a stream of servicing income, enhances liquidity and
enables us to originate more loans at our current capital level than if we held the loans in our loan portfolio. Our
pricing strategy for mortgage loans includes establishing interest rates that are competitive with other financial
institutions and consistent with our internal asset and liability management objectives. At December 31, 2019,
one-to-four family residential mortgage loans (excluding loans held-for-sale) totaled $149.4 million, or 24.0%, of
our gross loan portfolio, of which $79.3 million were fixed-rate loans and $70.0 million were ARM loans,
compared to $169.8 million (excluding loans held-for-sale), or 27.3 % of our gross loan portfolio as of
December 31, 2018, of which $94.2 million were fixed-rate loans and $75.6 million were ARM loans.
Substantially all of the one- to four-family residential mortgage loans we retain in our portfolio consist of loans
that do not satisfy acreage limits, income, credit, conforming loan limits (i.e., jumbo mortgages) or various other
requirements imposed by Fannie Mae or private investors. Some of these loans are also originated to meet the
needs of borrowers who cannot otherwise satisfy Fannie Mae credit requirements because of personal and
financial reasons (i.e., bankruptcy, length of time employed, etc.), and other aspects, which do not conform to
Fannie Mae’s guidelines. Such borrowers may have higher debt-to-income ratios, or the loans are secured by
unique properties in rural markets for which there are no sales of comparable properties to support the value
according to secondary market requirements. We may require additional collateral or lower loan-to-value ratios to
reduce the risk of these loans. We believe that these loans satisfy the needs of borrowers in our market area. As a
result, subject to market conditions, we intend to continue to originate these types of loans. We also retain jumbo
loans which exceed the conforming loan limits and therefore, are not eligible to be purchased by Fannie Mae. At
December 31, 2019, $91.7 million or 61.0 % of our one-to-four family loan portfolio consisted of jumbo loans.
We generally underwrite our one- to four-family loans based on the applicant’s employment and credit history
and the appraised value of the subject property. We generally lend up to 80% of the lesser of the appraised value
or purchase price for one- to four-family first mortgage loans and non-owner occupied first mortgage loans. For
first mortgage loans with a loan-to-value ratio in excess of 80%, we may require private mortgage insurance or
other credit enhancement to help mitigate the risk. Properties securing our one- to four-family loans are typically
appraised by independent fee appraisers who are selected in accordance with criteria approved by the Loan
Committee. For loans that are less than $250,000, we may use an automated valuation model, in lieu of an
appraisal. We require title insurance policies on all first mortgage real estate loans originated. Homeowners,
liability, fire and, if required, flood insurance policies are also required for one-to-four family loans. Our real
estate loans generally contain a ‘‘due on sale’’ clause allowing us to declare the unpaid principal balance due and
payable upon the sale of the security property. The average balance of our one- to four-family residential loans
was approximately $313,000 at December 31, 2019.
Fixed-rate loans secured by one- to four-family residences have contractual maturities of up to 30 years. All of
these loans are fully amortizing, with payments due monthly. Our portfolio of fixed-rate loans also includes
$4.6 million of loans with an initial seven year term and a 30-year amortization period with a borrower
refinancing option at a fixed rate at the end of the initial term as long as the loan has met certain performance
criteria. In addition, we had $14.5 million one- to four- family loans with a five-year call option at December 31,
2019. Prior to 2012, we originated for portfolio five and seven year balloon reset loans (which are loans that are
originated with a fixed interest rate for the initial five or seven years, and thereafter incur one interest rate
change based on current market interest rates in which the new rate remains in effect for the remainder of the
loan term) based on a 30-year amortization period.
ARM loans are offered with annual adjustments and life-time rate caps that vary based on the product, generally
with a maximum annual rate change of 2.0% and a maximum overall rate change of 6.0%. We generally use the
8
rate on one-year LIBOR to re-price our ARM loans, however, $7.9 million of our ARM loans are to employees
and directors that re-price annually based on a margin of 1%-1.50% over our average 12 month cost of funds. As
a consequence of using caps, the interest rates on ARM loans may not be as rate sensitive as our cost of funds.
Furthermore, because loan indexes may not respond perfectly to changes in market interest rates, upward
adjustments on loans may occur more slowly than increases in our cost of interest-bearing liabilities, especially
during periods of rapidly increasing interest rates. Because of these characteristics, future yields on ARM loans
may not be sufficient to offset increases in our cost of funds.
We continue to offer our fully amortizing ARM loans with a fixed interest rate for the first one, three, five or
seven years, followed by a periodic adjustable interest rate for the remaining term. Given the recent increase in
market rates over the past year, the origination of ARM loans has increased significantly as borrowers are
beginning to favor ARM loans over fixed-rate mortgages. Although adjustable-rate mortgage loans may reduce to
an extent our vulnerability to changes in market interest rates because they periodically re-price, as interest rates
increase the required payments due from the borrower also increase (subject to rate caps), increasing the potential
for default by the borrower. At the same time, the ability of the borrower to repay the loan and the marketability
of the underlying collateral may be adversely affected by higher interest rates. Upward adjustments of the
contractual interest rate are also limited by our maximum periodic and lifetime rate adjustments. Moreover, the
interest rates on most of our adjustable-rate loans do not adjust within the next year and may not adjust for up to
ten years after origination. As a result, the effectiveness of adjustable-rate mortgage loans in compensating for
changes in general interest rates may be limited during periods of rapidly rising interest rates.
At December 31, 2019, $20.7 million, or 13.9% of our one-to-four family residential portfolio consisted of
non-owner occupied loans, compared to $50.2 million, or 29.6% of our one-to-four family residential portfolio at
December 31, 2018. At December 31, 2019, our average non-owner occupied residential loan had a balance of
$284,000. Loans secured by rental properties represent potentially higher risk. As a result, we adhere to more
stringent underwriting guidelines which may include, but are not limited to, annual financial statements, a budget
factoring in a rental income cash flow analysis of the borrower as well as the net operating income of the
property, information concerning the borrower’s expertise, credit history and profitability, and the value of the
underlying property. In addition, these loans are generally secured by a first mortgage on the underlying
collateral property along with an assignment of rents and leases. Of primary concern in non-owner occupied real
estate lending is the consistency of rental income of the property. Payments on loans secured by rental properties
may depend primarily on the tenants’ continuing ability to pay rent to the property owner, the character of the
borrower or, if the property owner is unable to find a tenant, the property owner’s ability to repay the loan
without the benefit of a rental income stream. In addition, successful operation and management of non-owner
occupied properties, including property maintenance standards, may affect repayment. As a result, repayment of
such loans may be subject to adverse conditions in the real estate market or the economy. If the borrower has
multiple rental property loans with us, the loans are typically not cross collateralized.
In 2016, in order to enable individuals to secure the purchase of a new residence before selling their existing
residence, we commenced a loan program designed to allow borrowers to access the equity in their current
residence to apply towards the purchase of a new residence. The loan or loans to purchase the new residence are
generally originated in an amount in excess of $1.0 million and secured by the borrowers existing and/or new
residences, with a maximum combined LTV of up to 80%. These loans provide for repayment upon the earlier of
the sale of the current residence or the loan maturity date, which is typically up to 12 months. Upon the sale of
the borrower’s current residence, we may refinance the new residence using our traditional jumbo mortgage loan
underwriting guidelines. During 2019, we originated $14.6 million of loans under this program, compared to
$4.9 million in 2018. At December 31, 2019, we had $12.0 million of these interest only residential loans in our
one- to four-family residential mortgage loan portfolio.
The primary focus of our underwriting guidelines for interest only residential loans is on the value of the
collateral rather than the ability of the borrower to repay the loan. As a result, this type of lending exposes us to
an increased risk of loss due to the larger loan balance and our inability to sell them to Fannie Mae, similar to
the risks associated with jumbo one- to four-family residential loans. In addition, a decline in residential real
estate values resulting from a downturn in the Washington housing market may reduce the value of the real
estate collateral securing these types of loans and increase our risk of loss if borrowers’ default on their loans.
Home Equity Lending. We originate home equity loans that consist of fixed-rate fully amortizing loans and
variable-rate lines of credit. We typically originate home equity loans in amounts of up to 90% of the value of
9
the collateral, minus any senior liens on the property; however, prior to 2010 we originated home equity loans in
amounts of up to 100% of the value of the collateral, minus any senior liens on the property. Home equity lines
of credit are typically originated for up to $250,000 with an adjustable rate of interest, based on the one-year
Treasury Bill rate or the Wall Street Journal Prime rate, plus a margin. Home equity lines of credit generally
have a three, five or 12 year draw period, during which time the funds may be paid down and redrawn up to the
committed amount. Once the draw period has lapsed, the payment is amortized over either a 12, 19 or 21 year
period based on the loan balance at that time. We charge a $50 annual fee on each home equity line of credit and
require monthly interest-only payments on the entire amount drawn during the draw period. At December 31,
2019, home equity loans totaled $23.8 million, or 3.8% of our total loan portfolio, compared to $27.7 million, or
4.4% of our total loan portfolio at December 31, 2018. Adjustable-rate home equity lines of credit at
December 31, 2019 totaled $11.3 million, or 1.8 % of our total loan portfolio, compared to $16.6 million, or
2.7% of our total loan portfolio as of December 31, 2018. At December 31, 2019, unfunded commitments on
home equity lines of credit totaled $13.4 million.
Our fixed-rate home equity loans generally have terms of up to 15 years and are fully amortizing. At
December 31, 2019, fixed-rate home equity loans totaled $12.5 million, or 2.0% of our gross loan portfolio,
compared to $11.1 million, or 1.8% of our total loan portfolio as of December 31, 2018.
Commercial and Multifamily Real Estate Lending. We offer a variety of commercial and multifamily real estate
loans. Most of these loans are secured by owner-occupied and non-owner-occupied commercial income
producing properties, multifamily apartment buildings, warehouses, office buildings, gas station/convenience
stores and mobile home parks located in our market area. At December 31, 2019, commercial and multifamily
real estate loans totaled $261.3 million, or 42.0% of our total loan portfolio, compared to $252.6 million, or
40.6% of our total loan portfolio as of December 31, 2018.
Loans secured by commercial and multifamily real estate are generally originated with a variable interest rate,
fixed for an initial three to ten-year term and a 20- to 25-year amortization period. At the end of the initial term,
the balance is due in full or the loan re-prices based on an independent index plus a margin over the applicable
index of 1% to 4% for another five years. Loan-to-value ratios on our commercial and multifamily real estate
loans typically do not exceed 80% of the lower of cost or appraised value of the property securing the loan at
origination.
Loans secured by commercial and multifamily real estate are generally underwritten based on the net operating
income of the property, quality and location of the real estate, the credit history and financial strength of the
borrower and the quality of management involved with the property. The net operating income, which is the
income derived from the operation of the property less all operating expenses, must be sufficient to cover the
payments related to the outstanding debt plus an additional coverage requirement. We generally impose a
minimum debt service coverage ratio of 1.20 for originated loans secured by income producing commercial
properties. If the borrower is other than an individual, we typically require the personal guaranty of the principal
owners of the borrowing entity. We also generally require an assignment of rents in order to be assured that the
cash flow from the project will be used to repay the debt. Appraisals on properties securing commercial and
multifamily real estate loans are performed by independent state certified licensed fee appraisers. In order to
monitor the adequacy of cash flows on income-producing properties, the borrower is required to provide annual
financial information. From time to time we also acquire participation interests in commercial and multifamily
real estate loans originated by other financial institutions secured by properties located in our market area.
Historically, loans secured by commercial and multifamily properties generally involve different credit risks than
one- to four-family properties. These loans typically involve larger balances to single borrowers or groups of
related borrowers. Because payments on loans secured by commercial and multifamily properties are often
dependent on the successful operation or management of the properties, repayment of these loans may be subject
to adverse conditions in the real estate market or the economy. Repayments of loans secured by non-owner
occupied properties depend primarily on the tenant’s continuing ability to pay rent to the property owner, who is
our borrower, or, if the property owner is unable to find a tenant, the property owner’s ability to repay the loan
without the benefit of a rental income stream. If the cash flow from the project is reduced, or if leases are not
obtained or renewed, the borrower’s ability to repay the loan may be impaired. Commercial and multifamily real
estate loans also expose a lender to greater credit risk than loans secured by one-to-four family because the
collateral securing these loans typically cannot be sold as easily as one-to-four family. In addition, most of our
commercial and multifamily real estate loans are not fully amortizing and include balloon payments upon
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maturity. Balloon payments may require the borrower to either sell or refinance the underlying property in order
to make the payment, which may increase the risk of default or non-payment. The largest single commercial and
multifamily real estate loan at December 31, 2019, totaled $7.3 million and is collateralized by multifamily
property. At December 31, 2019, this loan was performing in accordance with its repayment terms.
The following table provides information on commercial and multifamily real estate loans by type at
December 31, 2019 and 2018 (dollars in thousands):
2019
2018
Amount
Percent
Amount
Percent
Multifamily residential. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Owner-occupied commercial real estate retail . . . . . . . . . . . . . . . . . .
Owner-occupied commercial real estate office buildings. . . . . . . . . .
Owner-occupied commercial real estate other(1) . . . . . . . . . . . . . . . .
Non-owner occupied commercial real estate retail . . . . . . . . . . . . . .
Non-owner occupied commercial real estate office buildings . . . . . .
Non-owner occupied commercial real estate other(1). . . . . . . . . . . . .
Warehouses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Gas station/Convenience store. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Mobile Home Parks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 73,891
7,051
19,859
16,857
11,324
11,267
82,488
15,524
13,933
9,074
28.3% $ 86,307
9,031
20,262
19,851
9,057
14,202
64,590
12,818
8,835
7,691
2.7
7.6
6.5
4.3
4.3
31.6
5.9
5.3
3.5
34.1%
3.6
8.0
7.9
3.6
5.6
25.6
5.1
3.5
3.0
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$261,268
100.0% $252,644
100.0%
(1) Other commercial real estate loans include schools, churches, storage facilities, restaurants, etc.
Construction and Land Lending. We originate construction loans secured by single-family residences and
commercial and multifamily real estate. We also originate land acquisition and development loans, which are
secured by raw land or developed lots on which the borrower intends to build a residence. At December 31,
2019, our construction and land loans totaled $75.8 million, or 12.2% of our total loan portfolio, compared to
$65.3 million, or 10.6 % of our total loan portfolio at December 31, 2018. At December 31, 2019, unfunded
construction loan commitments totaled $40.2 million.
Construction loans to individuals and contractors for the construction of personal residences, including
speculative residential construction, totaled $27.1 million, or 35.7%, of our construction and land portfolio at
December 31, 2019. In addition to custom home construction loans to individuals, we originate loans that are
termed ‘‘speculative’’ which are those loans where the builder does not have, at the time of loan origination, a
signed contract with a buyer for the home or lot who has a commitment for permanent financing with either us
or another lender. At December 31, 2019, construction loans to contractors for homes that were considered
speculative totaled $14.9 million, or 19.6%, of our construction and land portfolio. The composition of, and
location of underlying collateral securing, our construction and land loan portfolio, excluding loan commitments,
at December 31, 2019 was as follows (in thousands):
Puget
Sound
Olympic
Peninsula
Other
Total
Commercial and multifamily construction . . . . . . . . . . . . . . . . . . . . .
Speculative residential construction . . . . . . . . . . . . . . . . . . . . . . . . . .
Land acquisition and development and lot loans . . . . . . . . . . . . . . . .
Residential lot loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Residential construction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$31,079
13,062
1,513
2,920
8,115
$ — $ 8,728
1,027
38
1,084
3,503
773
530
2,806
578
$39,807
14,862
2,081
6,810
12,196
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$56,689
$4,687
$14,380
$75,756
Our residential construction loans generally provide for the payment of interest only during the construction
phase, which is typically twelve to eighteen months. At the end of the construction phase, the construction loan
generally either converts to a longer term mortgage loan or is paid off with a permanent loan from another
lender. Residential construction loans are made up to the lesser of a maximum loan-to-value ratio of 100% of
cost or 80% of appraised value at completion; however, we generally do not originate construction loans which
exceed these limits without some form of credit enhancement to mitigate the higher loan to value.
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At December 31, 2019, our largest residential construction loan commitment was for $2.8 million, $1.6 million
of which had been disbursed. This loan was performing according to its repayment terms at December 31, 2019.
The average outstanding residential construction loan balance was approximately $678,000 at December 31,
2019. Before making a commitment to fund a construction loan, we require an appraisal of the subject property
by an independent approved appraiser. During the construction phase, we make periodic inspections of the
construction site and loan proceeds are disbursed directly to the contractors or borrowers as construction
progresses. Loan proceeds are disbursed after inspection based on the percentage of completion method. We also
require general liability, builder’s risk hazard insurance, title insurance, and flood insurance, for properties
located in or to be built in a designated flood hazard area, on all construction loans.
We also originate developed lot and raw land loans to individuals intending to construct a residence in the future
on the property. We will generally originate these loans in an amount up to 75% of the lower of the purchase
price or appraisal. These lot and land loans are secured by a first lien on the property and have a fixed rate of
interest with a maximum amortization of 20 years.
We make land acquisition and development loans to experienced builders or residential lot developers in our
market area. The maximum loan-to-value limit applicable to these loans is generally 75% of the appraised market
value upon completion of the project. We may not require cash equity from the borrower if there is sufficient
equity in the land being used as collateral. Development plans are required prior to making the loan. Our loan
officers visit the proposed site of the development and the sites of competing developments. We require that
developers maintain adequate insurance coverage. Land acquisition and development loans generally are
originated with a loan term up to 24 months, have adjustable rates of interest based on the Wall Street Journal
Prime Rate or the three or five- year rate charged by the Federal Home Loan Bank of Des Moines (‘‘FHLB’’)
and require interest only payment during the term of the loan. Land acquisition and development loan proceeds
are disbursed periodically in increments as construction progresses and as an inspection by our approved
inspector warrants. We also require these loans to be paid on an accelerated basis as the lots are sold, so that we
are repaid before all the lots are sold. At December 31, 2019, land acquisition and development and lot loans
totaled $8.9 million, or 11.7% of our construction and land portfolio all of which were lot loans.
We also offer commercial and multifamily construction loans. These loans are underwritten as interest only with
financing typically up to 24 months under terms similar to our residential construction loans. Commercial and
multifamily construction loans are made up to the lesser of a maximum loan-to-value ratio of 100% of cost or
80% of appraised value at completion. Most of our commercial and multifamily construction loans provide for
disbursement of loan funds during the construction period and conversion to a permanent loan when the
construction is complete, and either tenant lease-up provisions or prescribed debt service coverage ratios are met.
At December 31, 2019, commercial and multifamily construction loans totaled $39.8 million, or 52.5% of our
construction and land portfolio, compared to $30.4 million, or 46.6% of our construction and land portfolio at
December 31, 2018. The three largest commercial and multifamily construction loans at December 31, 2019
included a $4.8 million loan secured by a multifamily residential and retail building, a $4.3 million loan secured
by a multifamily residential and mixed use project and a $3.7 million loans secured by a multifamily residential
and mixed use project, all located in Washington.
Our construction and land development loans are based upon estimates of costs in relation to values associated
with the completed project. Construction/land lending involves additional risks when compared with permanent
residential lending because funds are advanced upon the collateral for the project based on an estimate of costs
that will produce a future value at completion. Because of the uncertainties inherent in estimating construction
costs, as well as the market value of the completed project and the effects of governmental regulation on real
property, it is relatively difficult to evaluate accurately the total funds required to complete a project and the
completed project loan-to-value ratio. Changes in the demand, such as for new housing and higher than
anticipated building costs may cause actual results to vary significantly from those estimated. For these reasons,
this type of lending also typically involves higher loan principal amounts and is often concentrated with a small
number of builders. A downturn in housing, or the real estate market, could increase loan delinquencies, defaults
and foreclosures, and significantly impair the value of our collateral and our ability to sell the collateral upon
foreclosure. Some of our builders have more than one loan outstanding with us and also have residential
mortgage loans for rental properties with us. Consequently, an adverse development with respect to one loan or
one credit relationship can expose us to a significantly greater risk of loss.
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In addition, during the term of most of our construction loans, no payment from the borrower is required since
the accumulated interest is added to the principal of the loan through an interest reserve. As a result, these loans
often involve the disbursement of funds with repayment substantially dependent on the success of the ultimate
project and the ability of the borrower to sell or lease the property or obtain permanent take-out financing, rather
than the ability of the borrower or guarantor to repay principal and interest. If our appraisal of the value of a
completed project proves to be overstated, we may have inadequate security for the repayment of the loan upon
completion of construction of the project and may incur a loss. Because construction loans require active
monitoring of the building process, including cost comparisons and on-site inspections, these loans are more
difficult and costly to monitor. Increases in market rates of interest may have a more pronounced effect on
construction loans by rapidly increasing the end purchasers’ borrowing costs, thereby reducing the overall
demand for the project. Properties under construction may be difficult to sell and typically must be completed in
order to be successfully sold which also complicates the process of resolving problem construction loans. This
may require us to advance additional funds and/or contract with another builder to complete construction.
Furthermore, in the case of speculative construction loans, there is the added risk associated with identifying an
end-purchaser for the finished project. Land loans also pose additional risk because of the lack of income being
produced by the property and the potential illiquid nature of the collateral. These risks can also be significantly
impacted by supply and demand conditions. A downturn in housing, or the real estate market, could increase loan
delinquencies, defaults and foreclosures, and significantly impair the value of our collateral and our ability to sell
the collateral upon foreclosure.
Commercial Business Lending. At December 31, 2019, commercial business loans totaled $38.9 million, or
6.3% of our total loan portfolio, compared to $38.8 million, or 6.2% of our total loan portfolio at December 31,
2018. Substantially all of our commercial business loans have been to borrowers in our market area. Our
commercial business lending activities encompass loans with a variety of purposes and security, including loans
to finance commercial vehicles and equipment and loans secured by accounts receivable and/or inventory.
Approximately $1.0 million or 2.6% of our commercial business loans at December 31, 2019 were unsecured.
Our commercial business lending policy includes an analysis of the borrower’s background, capacity to repay the
loan, the adequacy of the borrower’s capital and collateral, as well as an evaluation of other conditions affecting
the borrower. Analysis of the borrower’s past, present and future cash flows is also an important aspect of our
credit analysis. We generally require personal guarantees on both our secured and unsecured commercial business
loans. Nonetheless, commercial business loans are believed to carry higher credit risk than residential mortgage
and commercial real estate loans.
Our interest rates on commercial business loans are dependent on the type of loan. Our secured commercial
business loans typically have a loan to value ratio of up to 80% and are term loans ranging from three to seven
years. Secured commercial business term loans generally have a fixed rated based on the commensurate FHLB
amortizing rate or prime rate as reported in the West Coast edition of the Wall Street Journal plus 1% to 3%. In
addition, we typically charge loan fees of 1% to 2% of the principal amount at origination, depending on the
credit quality and account relationships of the borrower. Business lines of credit are usually adjustable-rate and
are based on the prime rate plus 1% to 3%, and are generally originated with both a floor and ceiling to the
interest rate. Our business lines of credit generally have terms ranging from 12 months to 24 months and provide
for interest-only monthly payments during the term.
Our commercial business loans are primarily based on the cash flow of the borrower and secondarily on the
underlying collateral provided by the borrower. The borrowers’ cash flow may be unpredictable, and collateral
securing these loans may fluctuate in value. This collateral may consist of accounts receivable, inventory,
equipment or real estate. In the case of loans secured by accounts receivable, the availability of funds for the
repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due
from its customers. Other collateral securing loans may depreciate over time, may be difficult to appraise, may
be illiquid and may fluctuate in value based on the specific type of business and equipment. As a result, the
availability of funds for the repayment of commercial business loans may be substantially dependent on the
success of the business itself which, in turn, is often dependent in part upon general economic conditions.
Consumer Lending. We offer a variety of secured and unsecured consumer loans, including new and used
manufactured homes, floating homes, automobiles, boats and recreational vehicle loans, and loans secured by
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deposit accounts. We also offer unsecured consumer loans. We originate our consumer loans primarily in our
market area. All of our consumer loans are originated on a direct basis. At December 31, 2019, our consumer
loans totaled $72.7 million, or 11.7% of our total loan portfolio, compared to $67.6 million, or 10.9% of our
total loan portfolio at December 31, 2018.
We typically originate new and used manufactured home loans to borrowers who intend to use the home as a
primary residence. The yields on these loans are higher than that on our other residential lending products and
the portfolio has performed reasonably well with an acceptable level of risk and loss in exchange for the higher
yield. Our weighted-average yield on manufactured home loans at December 31, 2019 was 8.40%, compared to
4.62% for one-to-four family mortgages, excluding loans held-for-sale. At December 31, 2019, these loans
totaled $20.6 million, or 28.3% of our consumer loans and 3.3% of our total loan portfolio. For used
manufactured homes, loans are generally made up to 90% of the lesser of the appraised value or purchase price
up to $200,000, and with terms typically up to 20 years. On new manufactured homes, loans are generally made
up to 90% of the lesser of the appraised value or purchase price up to $200,000, and with terms typically up to
20 years. We generally charge a 1% fee at origination. We underwrite these loans based on our review of
creditworthiness of the borrower, including credit scores, and the value of the collateral, for which we hold a
security interest under Washington law.
Manufactured home loans are higher risk than loans secured by residential real property, though this risk is
reduced if the owner also owns the land on which the home is located. A small portion of our manufactured
home loans involve properties on which we also have financed the land for the owner. The primary risk in
manufactured home loans is the difficulty in obtaining adequate value for the collateral due to the cost and
limited ability to move the collateral. These loans tend to be made to retired individuals and first-time
homebuyers. First-time homebuyers of manufactured homes tend to be a higher credit risk than first-time
homebuyers of single-family residences, due to more limited financial resources. As a result, these loans may
have a higher probability of default and higher delinquency rates than single-family residential loans and other
types of consumer loans. We take into account this additional risk as a component of our allowance for loan
losses. We attempt to work out delinquent loans with the borrower and, if that is not successful, any past due
manufactured homes are repossessed and sold. At December 31, 2019, there were seven nonperforming
manufactured home loans totaling $226,000.
We originate floating home, houseboat and house barge loans typically located on cooperative or condominium
moorages. Terms vary from five to 20 years and have a fixed rate of interest. We lend up to 90% of the lesser of
the appraised value or purchase price. The primary risk in floating home loans is the unique nature of the
collateral and the challenges of relocating such collateral to a location other than where such housing is
permitted. The process for securing the deed and/or the condominium or cooperative dock is also unique
compared to other types of lending we participate in. As a result, these loans may have higher collateral recovery
costs than for one- to four-family mortgage loans and other types of consumer loans. We take into account these
additional risks as a part of our underwriting criteria. At December 31, 2019, floating home loans totaled
$43.8 million, or 60.2% of our consumer loan portfolio and 7.1% of our total loan portfolio. Houseboats and
house barge loans, which are included in other consumer loans, totaled $5.8 million, or 8.0% of our consumer
loan portfolio and 0.9% of our total loan portfolio.
The balance of our consumer loans include loans secured by new and used automobiles, new and used boats,
motorcycles and recreational vehicles, loans secured by deposits and unsecured consumer loans, all of which, at
December 31, 2019, totaled $8.3 million, or 11.4% of our consumer loan portfolio and 1.3% of our total loan
portfolio. Our automobile loan portfolio totaled $1.2 million at December 31, 2019, or 1.6% of our consumer
loan portfolio and 0.2% of our total loan portfolio. Automobile loans may be written for a term up to 72 months
and have fixed rates of interest. Loan-to-value ratios are up to 100% of the lesser of the purchase price or the
National Automobile Dealers Association value for used automobiles, including tax, licenses, title and mechanical
breakdown and gap insurance.
Loans secured by boats, motorcycles and recreational vehicles typically have terms from five to 20 years
depending on the collateral and loan-to-value ratios up to 90%. These loans may be made with fixed or
adjustable interest rates. Our unsecured consumer loans have either a fixed rate of interest generally for a
maximum term of 48 months, or are revolving lines of credit of generally up to $25,000. At December 31, 2019,
unsecured consumer loans totaled $923,000 and unfunded commitments on our unsecured consumer lines of
credit totaled $1.0 million. At that date, the average outstanding balance on these lines was less than $1,000.
14
Consumer loans (other than our manufactured and floating homes) generally have shorter terms to maturity,
which reduces our exposure to changes in interest rates. In addition, management believes that offering consumer
loan products helps to expand and create stronger ties to our existing client base by increasing the number of
client relationships and providing additional marketing opportunities.
Consumer loans generally entail greater risk than do one- to four-family residential mortgage loans, particularly
in the case of consumer loans that are secured by rapidly depreciable assets, such as manufactured homes,
automobiles, boats and recreational vehicles. In these cases, any repossessed collateral for a defaulted loan may
not provide an adequate source of repayment of the outstanding loan balance. As a result, consumer loan
collections are dependent on the borrower’s continuing financial stability and, thus, are more likely to be
adversely affected by job loss, divorce, illness or personal bankruptcy.
Loan Originations, Purchases, Sales, Repayments and Servicing
We originate both fixed-rate and adjustable-rate loans. Our ability to originate loans, however, is dependent upon
client demand for loans in our market area. Over the past several years, we have continued to originate
residential and consumer loans, and increased our emphasis on commercial and multifamily real estate,
construction and land, and commercial business lending. Demand is affected by competition and the interest rate
environment. During the past few years, we, like many other financial institutions, have experienced significant
prepayments on loans due to the prevailing low interest rate environment in the United States. In periods of
economic uncertainty, the ability of financial institutions, including us, to originate large dollar volumes of real
estate loans may be substantially reduced or restricted, with a resultant decrease in interest income. If a proposed
loan exceeds our internal lending limits, we may originate the loan on a participation basis with another financial
institution. From time to time, we also participate with other financial institutions on loans they originate. We
sold commercial loan participations in the amount of $3.7 million in 2019, zero in 2018 and $3.1 million in
2017, respectively. We underwrite loan purchases and participations to the same standards as internally originated
loans. We had no purchases of commercial business loan participations from other financial institutions in 2019
and 2018, and purchased two commercial business loan participations from other financial institutions totaling
$15.5 million in 2017.
We originate loans that may meet one or more of the credit characteristics commonly associated with subprime
lending. The term ‘subprime’ refers to the credit characteristics of individual borrowers which may include
payment delinquencies, judgements, foreclosures, bankruptcies, low credit scores and/or high debt-to-income
ratios. In exchange for the additional risk we take with such borrowers, we may require borrowers to pay a
higher interest rates, require a lower debt-to-income ratio or require other enhancements to manage the additional
risk. While no single credit characteristic defines a subprime loan, one commonly used indicator is a loan
originated to a borrower with a credit score of 660 or lower. At December 31, 2019, of the $104.3 million in
one-to-four-family loans originated in 2019, $10.3 million or 9.8% were to borrowers with a credit score under
660. Additionally, of the $5.6 million in manufactured home loans originated in 2019, $541,000 or 9.7% were to
borrowers with a credit score of 660 or lower. At December 31, 2019 and 2018, the total amount of residential
and consumer loans held in our loan portfolio to borrowers with a credit score of 660 or lower were
$34.9 million and $27.5 million, respectively. We do not engage in originating negative amortization or option
adjustable rate loans and have no established program to originate or purchase these loans.
In addition to interest earned on loans and loan origination fees, we receive fees for loan commitments, late
payments and other miscellaneous services.
We also sell whole one-to-four family loans without recourse to Fannie Mae and other investors, subject to a
provision for repurchase upon breach of representation, warranty or covenant. These loans are fixed-rate
mortgages, which primarily are sold to reduce our interest rate risk and generate noninterest income. These loans
are generally sold for cash in amounts equal to the unpaid principal amount of the loans determined using
present value yields to the buyer. These sales allow for a servicing fee on loans when the servicing is retained by
us. Most one- to four-family loans are sold with servicing retained. In October 2015, we acquired a $45.9 million
loans servicing portfolio from another bank, which loans are 100% owned by Fannie Mae. At December 31,
2019, we were servicing a $363.3 million portfolio of residential mortgage loans for Fannie Mae and
$14.0 million for other investors. We did not repurchase any loans in 2019 or 2018. These mortgage servicing
15
rights are carried at fair value and had a value at December 31, 2019 of $3.2 million. We earned mortgage
servicing income of $1.0 million, $1.1 million and $1.1 million for the years ended December 31, 2019, 2018
and 2017, respectively. See Note 6 in the Notes to Consolidated Financial Statements contained in Item 8 of this
report on Form 10-K.
Sales of whole real estate loans are beneficial to us since these sales may generate income at the time of sale,
produce future servicing income on loans where servicing is retained, provide funds for additional lending, and
increase liquidity. We sold $78.9 million of conforming one- to four- family loans during the year ended
December 31, 2019, of which $16.2 million were sale to other investors in first quarter of 2019. We sold
$50.0 million and $52.0 million of conforming one- to four- family loans during the years ended 2018 and 2017,
respectively. Gains, losses and transfer fees on sales of one-to-four family loans and participations are recognized
at the time of the sale. Our net gain on sales of residential loans for the years ended December 31, 2019, 2018
and 2017 was $1.4 million, $1.0 million and $1.1 million, respectively. In addition to loans sold to Fannie Mae
and others on a servicing retained basis, we also sell nonconforming residential loans to correspondent banks on
a servicing released basis. In 2019 and 2018, we sold $13.2 million and $7.6 million, respectively, of loans
servicing released.
The following table shows our loan origination, sale and repayment activities, including loans held-for-sale, for
the periods indicated (in thousands):
Originations by type:
Fixed-rate:
One-to-four family . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Home equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial and multifamily . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Construction and land. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Manufactured homes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Floating homes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other consumer. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total fixed-rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Adjustable rate:
One-to-four family . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Home equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial and multifamily . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Construction and land. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Floating homes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other consumer. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total adjustable-rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total loans originated . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Purchases by type:
Commercial business participations . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total loan participations purchased . . . . . . . . . . . . . . . . . . . . . . . . . . .
Sales, repayments and participations sold:
One-to-four family . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial and multifamily . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total loans sold and loan participations . . . . . . . . . . . . . . . . . . . . . . .
Total principal repayments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total reductions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net increase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Year Ended December 31,
2018
2017
2019
$104,343
7,587
38,458
35,573
5,603
1,807
3,021
1,553
$197,945
24,634
3,060
53,885
15,093
11,966
160
2,360
$111,158
$309,103
$ 67,823
4,459
94,725
24,303
7,313
20,660
3,402
2,277
$224,962
44,726
9,705
55,945
—
—
48
17,202
$127,626
$352,588
$ 73,560
4,538
34,438
49,771
5,106
7,409
2,360
10,440
$187,622
36,130
5,832
33,155
6,094
—
86
7,527
$ 88,824
$276,446
—
—
$
—
—
15,450
$ 15,450
$
78,906
3,706
82,612
226,256
308,868
235
$
49,966
—
49,966
231,627
281,593
$ 70,995
51,959
3,136
55,095
188,121
243,216
$ 48,680
16
The decrease in overall originations in 2019 compared to 2018 was primarily due to competition for commercial,
multifamily and commercial business loans in our market area. Demand for other loans, particularity one-to-four
family loans, grew in 2019 due to refinance activity driven by lower interest rates during the period. Demand for
construction loans, including new homes and apartment buildings increased due to appreciation in market prices,
declining supplies of homes for sale and continued strong rental demand in our market area. Floating homes,
home equity and manufactured home loan originations decreased due to competition for loans in our market area.
Asset Quality
When a borrower fails to make a required payment on a one-to-four family loan, we attempt to cure the
delinquency by contacting the borrower. In the case of loans secured by a one-to-four family property, a late
notice typically is sent 15 days after the due date. Generally, a pre-foreclosure loss mitigation letter is also
mailed to the borrower 30 days after the due date. All delinquent accounts are reviewed by a loan officer or
branch manager who attempts to cure the delinquency by contacting the borrower. If the account becomes
120 days delinquent and an acceptable foreclosure alternative has not been agreed upon, we generally refer the
account to legal counsel with instructions to prepare a notice of default. The notice of default begins the
foreclosure process. If foreclosure is completed, typically we take title to the property and sell it directly through
a real estate broker.
Delinquent consumer loans are handled in a similar manner to one-to-four family loans. Our procedures for
repossession and sale of consumer collateral are subject to various requirements under the applicable consumer
protection laws as well as other applicable laws and the determination by us that it would be beneficial from a
cost basis.
Once a loan is 90 days past due, it is classified as nonaccrual. Generally, delinquent consumer loans are
charged-off at 120 days past due, unless we have a reasonable basis to justify additional collection and recovery
efforts.
Delinquent Loans. The following table sets forth our loan delinquencies by type, by amount and by percentage
of type at December 31, 2019 (dollars in thousands):
Loans Delinquent For:
30-89 Days
90 Days and Over
Total Delinquent Loans
Percent of
Loan
Percent of
Loan
Number Amount
Category Number Amount
Category Number Amount
Percent of
Loan
Category
One- to four- family . . . . .
Home equity . . . . . . . . . . .
Commercial and
Multifamily . . . . . . . . . .
Construction and land. . . .
Manufactured homes . . . .
Floating homes . . . . . . . . .
Other consumer. . . . . . . . .
Commercial Business . . . .
Total. . . . . . . . . . . . . . . . . .
13
4
4
3
13
2
13
2
54
$ 894
242
0.6%
1.0
1,742
4,440
367
547
21
226
0.7
5.9
1.8
1.2
0.2
0.6
$8,479
1.4%
9
4
1
1
4
1
—
3
23
$1,810
197
1.2%
0.8
353
50
125
290
—
162
0.1
0.1
0.6
0.7
—
0.4
$2,987
0.5%
22
8
5
4
17
3
13
5
77
$ 2,704
439
1.8%
1.8
2,095
4,490
492
837
21
388
0.8
5.9
2.4
1.9
0.2
1.0
$11,466
1.8%
17
Nonperforming Assets. The table below sets forth the amounts and categories of nonperforming assets in our
loan portfolio (in thousands). Loans are placed on nonaccrual status when the collection of principal and/or
interest become doubtful or when the loan is more than 90 days past due. Other real estate owned (‘‘OREO’’)
and repossessed assets include assets acquired in settlement of loans.
2019
2018
December 31,
2017
2016
2015
Nonaccrual loans(1):
One- to four-family . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Home equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial and multifamily . . . . . . . . . . . . . . . . . . . . . . . .
Construction and land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Manufactured homes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Floating homes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other consumer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial business. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total nonaccrual loans. . . . . . . . . . . . . . . . . . . . . . . . . . . .
OREO and repossessed assets:
One- to four-family . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial and multifamily . . . . . . . . . . . . . . . . . . . . . . . .
Manufactured homes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$2,090
261
353
1,177
226
290
—
260
$4,657
$1,120
359
534
123
214
—
—
317
$2,667
$ 837
722
201
92
206
—
8
217
$2,283
$2,216
553
218
—
120
—
—
242
$3,349
$ — $ — $ — $ 562
600
10
600
10
575
—
575
—
Total OREO and repossessed assets . . . . . . . . . . . . . . . . .
Total nonperforming assets . . . . . . . . . . . . . . . . . . . . . .
$ 575
$5,232
$ 575
$3,242
$ 610
$2,893
$1,172
$4,521
$1,640
428
—
—
62
—
—
—
$2,130
$ 159
600
10
$ 769
$2,899
Nonperforming assets as a percentage of total assets . . . . .
0.73%
0.45%
0.45%
0.77%
0.54%
Performing restructured loans:
One- to four- family . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Home equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial and multifamily . . . . . . . . . . . . . . . . . . . . . . . .
Construction and land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Manufactured homes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other consumer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial business. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total performing restructured loans . . . . . . . . . . . . . . . . .
$6,638
59
—
38
172
123
264
$7,294
$1,511
60
—
44
130
131
97
$1,973
$2,876
158
—
49
150
36
—
$3,269
$1,977
144
361
83
160
40
—
$2,765
$2,415
232
1,966
91
255
—
114
$5,073
(1) Nonaccrual loans include $588,000, $817,000, $445,000, $683,000 and $971,000 in nonperforming troubled
debt restructurings as of December 31, 2019, 2018, 2017, 2016 and 2015, respectively. We had no accruing
loan 90 days or more delinquent for the periods reported.
Nonaccrual loans, including nonaccrual TDRs, increased $2.0 million to $4.7 million at December 31, 2019 from
$2.7 million at December 31, 2018. Our largest nonperforming loan at December 31, 2019 was a $1.1 million.
Nonperforming one- to four- family loans at December 31, 2019 consisted of 12 loans to different borrowers
with an average loan balance of $174,000. There were seven manufactured home loans, five home equity loans,
four commercial business loans, three construction and land loans, one commercial and multifamily real estate
loan and one floating home loan classified as nonperforming at December 31, 2019.
For the year ended December 31, 2019, gross interest income that would have been recorded had the nonaccrual
loans been current in accordance with their original terms amounted to $370,000, all of which was excluded
from interest income for the year ended December 31, 2019. See ‘‘Management’s Discussion and Analysis of
Financial Condition and Results of Operations — Financial Condition at December 31, 2019 Compared to
December 31, 2018 — Delinquencies and Nonperforming Assets’’ contained in Item 7 of this report on
Form 10-K for more information on troubled assets.
18
Troubled Debt Restructured Loans. Troubled debt restructurings (‘‘TDRs’’), which are accounted for under
ASC 310-40, are loans which have renegotiated loan terms to assist borrowers who are unable to meet the
original terms of their loans. Such modifications to loan terms may include a lower interest rate, a reduction in
principal, or a longer term to maturity. All TDRs are initially classified as impaired regardless of whether the
loan was performing at the time it was restructured. At December 31, 2019, we had $7.3 million of loans that
were classified as performing TDRs and still on accrual, compared to $2.0 million at December 31, 2018.
Included in nonaccrual loans at December 31, 2019 and 2018 were nonaccrual TDRs of $588,000 and $817,000,
respectively.
OREO and Repossessed Assets. OREO and repossessed assets include assets acquired in settlement of loans. At
December 31, 2019, OREO and repossessed assets totaled $575,000. Our OREO at December 31, 2019,
consisted of a former bank branch property located in Port Angeles, Washington which was acquired in 2015 as a
part of three branches purchased from another financial institution. It is currently leased to a local not-for-profit
organization at a below market rate.
Other Loans of Concern. In addition to the nonperforming assets set forth in the table above, as of
December 31, 2019, there were 43 loans totaling $10.1 million about which known information of possible credit
or other problems caused management to have doubts as to the ability of the borrowers to comply with present
loan repayment terms and which may result in the future inclusion of such items in the nonperforming asset
categories. The two largest loans of concern at December 31, 2019, were a $2.7 million loan and $2.0 million
loan both secured by one- to four-family residential real estate located in King County, Washington. Additionally,
other loans of concern included, $2.4 million in commercial and multifamily real estate loans, $1.3 million in
commercial business loans, $1.0 million in one-to four-family, $378,000 in home equity loans, $59,000 in
manufactured homes, and $52,000 in other consumer loans.
Classified Assets. Federal regulations provide for the classification of lower quality loans and other assets (such
as OREO and repossessed assets), debt and equity securities considered as ‘‘substandard,’’ ‘‘doubtful’’ or ‘‘loss.’’
An asset is considered ‘‘substandard’’ if it is inadequately protected by the current net worth and paying capacity
of the obligor or of the collateral pledged, if any. ‘‘Substandard’’ assets include those characterized by the
‘‘distinct possibility’’ that the insured institution will sustain ‘‘some loss’’ if the deficiencies are not corrected.
Assets classified as ‘‘doubtful’’ have all of the weaknesses in those classified ‘‘substandard,’’ with the added
characteristic that the weaknesses present make ‘‘collection or liquidation in full,’’ on the basis of currently
existing facts, conditions and values, ‘‘highly questionable and improbable.’’ Assets classified as ‘‘loss’’ are those
considered ‘‘uncollectible’’ and of such little value that their continuance as assets without the establishment of a
specific loss reserve is not warranted.
When we classify problem assets as either substandard or doubtful, we may establish a specific allowance in an
amount we deem prudent to address specific impairments. General allowances represent loss allowances which
have been established to recognize the inherent risk associated with lending activities, but which, unlike specific
allowances, have not been specifically allocated to particular problem assets. When an insured institution
classifies problem assets as a loss, it is required to charge off those assets in the period in which they are
deemed uncollectible. Our determination as to the classification of our assets and the amount of our valuation
allowances is subject to review by the FDIC and, since our conversion to a Washington chartered commercial
bank, the WDFI, which can order the establishment of additional loss allowances. Assets which do not currently
expose us to sufficient risk to warrant classification in one of the aforementioned categories but possess
weaknesses are required to be designated as special mention. At December 31, 2019, special mention assets
totaled $10.0 million.
We regularly review the problem assets in our portfolio to determine whether any assets require classification in
accordance with applicable regulations. On the basis of management’s review of our assets, at December 31,
2019, we had classified $15.3 million of our assets as substandard, of which $14.7 million represented a variety
of outstanding loans and $575,000 represented the balance of our OREO and repossessed assets. At that date, we
had no assets classified as doubtful or loss. This total amount of classified assets represented 19.7% of our equity
capital and 2.1% of our assets at December 31, 2019. Classified assets totaled $11.7 million, or 16.3% of our
equity capital and 1.6% of our assets at December 31, 2018.
Allowance for Loan Losses. We maintain an allowance for loan losses to absorb probable loan losses in the loan
portfolio. The allowance is based on ongoing, monthly assessments of the estimated probable incurred losses in
19
the loan portfolio. In evaluating the level of the allowance for loan losses, management considers the types of
loans and the amount of loans in the loan portfolio, peer group information, historical loss experience, adverse
situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and
prevailing economic conditions. Large groups of smaller balance homogeneous loans, such as one-to-four family,
small commercial and multifamily real estate, home equity and consumer loans, including floating homes and
manufactured homes, are evaluated in the aggregate using historical loss factors and peer group data adjusted for
current economic conditions. More complex loans, such as commercial and multifamily real estate loans and
commercial business loans are evaluated individually for impairment, primarily through the evaluation of the
borrower’s net operating income and available cash flow and their possible impact on collateral values.
At December 31, 2019, our allowance for loan losses was $5.6 million, or 0.91% of our total loan portfolio,
compared to $5.8 million, or 0.93% of our total loan portfolio in 2018. Specific valuation reserves totaled
$724,000 and $736,000 at December 31, 2019 and 2018, respectively.
Assessing the allowance for loan losses is inherently subjective as it requires making material estimates,
including the amount and timing of future cash flows expected to be received on impaired loans that may be
susceptible to significant change. In the opinion of management, the allowance, when taken as a whole, properly
reflects estimated probable loan losses inherent in our loan portfolio. See Notes 1 and 5 in the Notes to
Consolidated Financial Statements contained in Item 8 of this report on Form 10-K. The following table sets
forth an analysis of our allowance for loan losses at the dates indicated (dollars in thousands):
Balance at beginning of period . . . . . . . . . . . . . . . . . . . .
Charge-offs:
One- to four-family. . . . . . . . . . . . . . . . . . . . . . . . . . . .
Home equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial and multifamily . . . . . . . . . . . . . . . . . . . .
Construction and land. . . . . . . . . . . . . . . . . . . . . . . . . .
Manufactured homes . . . . . . . . . . . . . . . . . . . . . . . . . .
Other consumer. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial business . . . . . . . . . . . . . . . . . . . . . . . . . .
Total charge-offs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Recoveries:
One- to four-family. . . . . . . . . . . . . . . . . . . . . . . . . . . .
Home equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial and multifamily . . . . . . . . . . . . . . . . . . . .
Construction and land. . . . . . . . . . . . . . . . . . . . . . . . . .
Manufactured homes . . . . . . . . . . . . . . . . . . . . . . . . . .
Other consumer. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial business . . . . . . . . . . . . . . . . . . . . . . . . . .
Total recoveries. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net (charge-offs) recoveries . . . . . . . . . . . . . . . . . . . . .
(Recapture from)/Provision charged to operations . . .
Balance at end of period . . . . . . . . . . . . . . . . . . . . . . . . .
Net (charge-offs) recoveries during the period as a
percentage of average loans outstanding during the
period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net (charge-offs) recoveries during the period as a
percentage of average nonperforming assets . . . . . . . .
Allowance as a percentage of nonperforming loans . . . .
Allowance as a percentage of total loans (end of
2019
$ 5,774
2018
$ 5,241
December 31,
2017
$ 4,822
2016
$ 4,636
2015
$ 4,387
—
—
—
—
—
(52)
—
(52)
—
(7)
—
—
(12)
(31)
—
(50)
—
(89)
(24)
—
(12)
(18)
—
(143)
(72)
(15)
(314)
—
—
(42)
(29)
(472)
(21)
(35)
—
(40)
(37)
(77)
—
(210)
6
10
—
—
—
24
3
43
(9)
(125)
$ 5,640
1
44
—
—
—
12
1
58
8
525
$ 5,774
—
33
1
—
8
20
—
62
(81)
500
$ 5,241
47
78
—
18
8
53
—
204
(268)
454
$ 4,822
—
36
—
—
8
15
—
59
(151)
400
$ 4,636
—%
—%
(0.02)% (0.06)% (0.03)%
(0.17)%
(2.12)% (6.27)% (5.26)%
121.11% 216.50% 229.57% 143.98% 217.65%
0.30%
period) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
0.91%
0.93%
0.96%
0.96%
1.01%
Economic conditions have been favorable in our market areas. Housing prices have experienced continued
growth throughout 2019, with historically low inventory levels. Unemployment rates in many of our market areas
20
remain low as the job market is competitive. The allowance for loan losses as a percentage of nonperforming
loans was 121.11% and 216.50% as of December 31, 2019 and 2018, respectively. The recapture from the
allowance for loan losses totaled $125,000 for the year ended December 31, 2019, compared to a provision for
loan losses of $525,000 for the year ended December 31, 2018. The recapture in the current year was due to
changes in the composition and size of our loan portfolio during the year.
The distribution of our allowance for losses on loans at the dates indicated is summarized as follows (dollars in
thousands):
2019
2018
December 31,
2017
2016
2015
Percent
of loans
in each
category
to total
loans
Amount
Percent
of loans
in each
category
to total
loans
Percent
of loans
in each
category
to total
loans
Percent
of loans
in each
category
to total
loans
Amount
Percent
of loans
in each
category
to total
loans
Amount
Amount
Amount
Allocated at end of
period to:
One- to four-family . . . .
Home equity . . . . . . . . .
Commercial and
multifamily . . . . . . . .
Construction and land . .
Manufactured homes . . .
Floating homes . . . . . . .
Other consumer . . . . . . .
Commercial business . . .
Unallocated . . . . . . . . . .
$1,120
178
24.0% $1,314
202
3.8
27.3% $1,436
293
4.4
28.5% $1,542
378
5.2
30.3% $1,839
607
5.5
30.5%
6.9
1,696
492
480
283
112
331
948
42.0
12.2
3.3
7.1
1.3
6.3
—
1,638
431
427
265
112
356
1,029
40.6
10.6
3.2
6.6
1.1
6.2
—
1,250
378
355
169
80
372
908
38.4
11.2
3.1
5.3
0.9
7.4
—
1,144
459
168
132
112
175
712
36.1
14.1
3.1
4.8
0.8
5.3
—
921
382
301
102
86
157
241
38.0
12.4
3.0
4.0
1.0
4.2
—
Total . . . . . . . . . . . . .
$5,640
100.0% $5,774
100.0% $5,241
100.0% $4,822
100.0% $4,636
100.0%
Investment Activities
State chartered commercial banks have the authority to invest in various types of liquid assets, including United
States Treasury obligations, securities of various federal agencies, including callable agency securities, certain
certificates of deposit of insured commercial banks and savings banks, certain bankers’ acceptances, repurchase
agreements and federal funds. Subject to various restrictions, state commercial banks may also invest their assets
in investment grade commercial paper and corporate debt securities and mutual funds whose assets conform to
the investments that the institution is otherwise authorized to make directly. See ‘‘— How We Are Regulated —
Sound Community Bank’’ for a discussion of additional restrictions on our investment activities.
Our Chief Executive Officer and Chief Financial Officer have the responsibility for the management of our
investment portfolio, subject to the direction and guidance of the Board of Directors. These officers consider
various factors when making decisions, including the marketability, maturity and tax consequences of the
proposed investment. The maturity structure of investments will be affected by various market conditions,
including the current and anticipated slope of the yield curve, the level of interest rates, the trend of new deposit
inflows, and the anticipated demand for funds via deposit withdrawals and loan originations and purchases.
The general objectives of our investment portfolio are to provide liquidity when loan demand is high, to assist in
maintaining earnings when loan demand is low and to maximize earnings while satisfactorily managing risk,
including credit risk, reinvestment risk, liquidity risk and interest rate risk. Our investment quality emphasizes
safer investments with the yield on those investments secondary to not taking unnecessary risk with the available
funds. See ‘‘Quantitative and Qualitative Disclosures About Market Risk’’ for additional information about our
interest rate risk management contained in Item 7A. of this report on Form 10-K.
At December 31, 2019, we owned $1.2 million of stock issued by the FHLB. As a condition of membership in
the FHLB, we are required to purchase and hold a certain amount of FHLB stock.
The following table sets forth the composition of our securities portfolio and other investments at the dates
indicated. At December 31, 2019, our securities portfolio did not contain securities of any issuer with an
21
aggregate book value in excess of 10% of our equity capital. All of our investment securities, other than FHLB
stock, are currently categorized as available for sale. See Note 4 in the Notes to Consolidated Financial
Statements contained in Item 8 of this report on Form 10-K.
Securities
Municipal bonds. . . . . . . . . . . . . . . . . . . . .
Agency mortgage-backed securities . . . . .
Total available for sale securities . . . . . . .
FHLB stock . . . . . . . . . . . . . . . . . . . . . . . .
2019
December 31,
2018
Amortized
Cost
$ 3,197
5,888
9,085
1,160
Fair
Value
Amortized
Cost
$ 3,370
5,936
9,306
1,160
$3,218
1,594
4,812
4,134
Fair
Value
$3,317
1,640
4,957
4,134
2017
Amortized
Cost
$3,240
2,030
5,270
3,065
Fair
Value
$3,369
2,066
5,435
3,065
Total securities . . . . . . . . . . . . . . . . . . . .
$10,245
$10,466
$8,946
$9,091
$8,335
$8,500
We review investment securities on an ongoing basis for the presence of other-than-temporary impairment
(‘‘OTTI’’) taking into consideration current market conditions, fair value in relationship to cost, extent and nature
of the change in fair value, issuer rating changes and trends, whether we intend to sell a security or if it is likely
that we will be required to sell the security before recovery of our amortized cost basis of the investment, which
may be maturity, and other factors. For debt securities, if we intend to sell the security or it is likely that we will
be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in
earnings as an OTTI. If we do not intend to sell the security and it is not more likely than not that we will be
required to sell the security but we do not expect to recover the entire amortized cost basis of the security, only
the portion of the impairment loss representing credit losses would be recognized in earnings. The credit loss on
a security is measured as the difference between the amortized cost basis and the present value of the cash flows
expected to be collected.
Projected cash flows are discounted by the original or current effective interest rate depending on the nature of
the security being measured for potential OTTI. The remaining impairment related to all other factors, the
difference between the present value of the cash flows expected to be collected and the fair value, is recognized
as a charge to other comprehensive income. Impairment losses related to all other factors are presented as
separate categories within other comprehensive income.
During the year ended December 31, 2019, we did not recognize any non-cash OTTI charges on our investment
securities. There were five agency securities that had unrealized losses although management determined the
decline in value was not related to specific credit deterioration. We do not intend to sell these securities and it is
more likely than not that we will not be required to sell any securities before anticipated recovery of the
remaining amortized cost basis. We closely monitor our investment securities for changes in credit risk. The
current market environment significantly limits our ability to mitigate our exposure to valuation changes in these
securities by selling them. If market conditions deteriorate and we determine our holdings of these or other
investment securities are OTTI, our future earnings, stockholders’ equity, regulatory capital and continuing
operations could be materially adversely affected.
Sources of Funds
General. Our sources of funds are primarily deposits (including deposits from public entities), borrowings,
payments of principal and interest on loans and investments and funds provided from operations.
Deposits. We offer a variety of deposit accounts to both consumers and businesses with a wide range of interest
rates and terms. Our deposits consist of savings accounts, money market deposit accounts, NOW accounts,
demand accounts and certificates of deposit. We solicit deposits primarily in our market area; however, at
December 31, 2019, approximately 3.9% of our deposits were from persons outside the State of Washington. As
of December 31, 2019, core deposits, which we define as our non-time deposit accounts and time deposit
accounts less than $250,000 (excluding brokered deposits and public funds), represented approximately 79.7% of
total deposits, compared to 84.7% and 90.8% as of December 31, 2018 and December 31, 2017, respectively. We
primarily rely on competitive pricing policies, marketing and client service to attract and retain these deposits
and we expect to continue these practices in the future.
22
The flow of deposits is influenced significantly by general economic conditions, changes in money market and
prevailing interest rates and competition. The variety of deposit accounts we offer has allowed us to be
competitive in obtaining funds and to respond with flexibility to changes in consumer demand. We manage the
pricing of our deposits in keeping with our asset/liability management, liquidity and profitability objectives,
subject to competitive factors. Based on our experience, we believe that our deposits are relatively stable sources
of funds. Despite this stability, our ability to attract and maintain these deposits and the rates paid on them is and
will continue to be significantly affected by market conditions.
The following table sets forth our deposit flows during the periods indicated (dollars in thousands):
Opening balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Interest credited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Ending balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Year Ended December 31,
2018
2017
2019
$553,601
56,252
6,865
$616,718
$514,400
35,362
3,839
$553,601
$467,731
43,648
3,021
$514,400
Net increase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Percent increase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 63,117
$ 39,201
$ 46,669
11.4%
7.6%
10.0%
The following table sets forth the dollar amount of deposits in the various types of deposit programs offered by
us at the dates indicated (dollars in thousands):
2019
December 31,
2018
2017
Percent of
total
Amount
Percent of
total
Amount
Percent of
total
Noninterest-bearing demand . . . . . .
Interest-bearing demand . . . . . . . . .
Savings . . . . . . . . . . . . . . . . . . . . . .
Money market . . . . . . . . . . . . . . . . .
Escrow . . . . . . . . . . . . . . . . . . . . . . .
Amount
$ 94,973
159,774
57,936
50,337
2,311
15.4% $ 93,823
164,919
25.8
54,102
9.4
46,689
8.2
2,243
0.4
17.0% $ 69,094
173,413
29.8
49,450
9.8
54,860
8.4
3,029
0.4
Total non-maturity deposits . . . . . .
365,331
59.2
361,776
65.4
349,846
Certificates of deposit: . . . . . . . . . .
1.99% or below . . . . . . . . . . . . . . . .
2.00 - 3.99% . . . . . . . . . . . . . . . . . .
Total certificates of deposit. . . . . . .
60,747
190,640
251,387
9.9
30.9
40.8
118,478
73,347
191,825
21.4
13.2
34.6
154,102
10,452
164,554
13.4%
33.7
9.6
10.7
0.6
68.0
30.0
2.0
32.0
Total deposits . . . . . . . . . . . . . . . . .
$616,718
100.0% $553,601
100.0% $514,400
100.0%
Noninterest-bearing demand accounts increased $1.1 million, or 1.2%, in 2019 compared to 2018. The
certificates of deposits increased $59.6 million, or 31.1%, in 2019 compared to 2018. The increase in certificate
accounts over the past year was as a result of our marketing emphasis on our competitively priced certificates of
deposits products.
We are a public funds depository and as of December 31, 2019, we had $39.1 million in public funds compared
to $29.0 million in public funds at December 31, 2018. These funds consisted of $38.9 million in certificates of
deposit, $100,000 in money market accounts and $118,000 in checking accounts at December 31, 2019. These
accounts must be 50% collateralized if the amount on deposit exceeds FDIC insurance of $250,000. We use
letters of credit from the FHLB as collateral for these funds.
23
The following table shows rate and maturity information for our certificates of deposit at December 31, 2019
(dollars in thousands):
Certificate accounts maturing in quarter ending:
March 31, 2020 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
June 30, 2020 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
September 30, 2020 . . . . . . . . . . . . . . . . . . . . . . . . . . .
December 31, 2020 . . . . . . . . . . . . . . . . . . . . . . . . . . .
March 31, 2021 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
June 30, 2021 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
September 30, 2021 . . . . . . . . . . . . . . . . . . . . . . . . . . .
December 31, 2021 . . . . . . . . . . . . . . . . . . . . . . . . . . .
March 31, 2022 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
June 30, 2022 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
September 30, 2022 . . . . . . . . . . . . . . . . . . . . . . . . . . .
December 31, 2022 . . . . . . . . . . . . . . . . . . . . . . . . . . .
Thereafter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
0.00-1.99%
2.00-3.99%
Total
$15,129
6,946
5,856
4,700
4,849
4,079
6,894
7,247
1,999
1,388
1,013
524
123
$60,747
$
6,617
13,824
13,060
20,434
50,016
35,881
22,455
2,682
132
540
45
3,323
21,631
$190,640
$ 21,746
20,770
18,916
25,134
54,865
39,960
29,349
9,929
2,131
1,928
1,058
3,847
21,754
$251,387
Percent of
Total
8.7%
8.3
7.5
10.0
21.8
15.9
11.7
3.9
0.8
0.8
0.4
1.5
8.7
100.0%
Percent of total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
24.2%
75.8%
100.0%
The following table indicates the amount of our certificates of deposit and other deposits by time remaining until
maturity as of December 31, 2019 (in thousands):
Certificates of deposit less than $100,000 . . . . . . . . .
Certificates of deposit of $100,000 or more. . . . . . . .
Maturity
3 months
or less
$ 7,405
14,341
Over 3 to
6 months
$ 5,043
15,727
Over 6 to
12 months
$16,897
27,153
Over 12
months
Total
$ 50,841
113,980
$ 80,186
171,201
Total certificates of deposit . . . . . . . . . . . . . . . . . . .
$21,746
$20,770
$44,050
$164,821
$251,387
Borrowings. Although deposits are our primary source of funds, we may utilize borrowings as a cost-effective
source of funds when they can be invested at a positive interest rate spread, for additional capacity to fund loan
demand, or to meet our asset/liability management goals. Our borrowings currently consist of advances from the
FHLB. See Note 10 in the Notes to Consolidated Financial Statements contained in Item 8 of this report on
Form 10-K.
We are a member of and obtain advances from the FHLB, which is part of the Federal Home Loan Bank
System. The eleven regional Federal Home Loan Banks provide a central credit facility for their member
institutions. These advances are provided upon the security of certain of our mortgage loans and
mortgage-backed securities. These advances may be made pursuant to several different credit programs, each of
which has its own interest rate, range of maturities and call features, and all long-term advances are required to
provide funds for residential home financing. We have entered into a loan agreement with the FHLB pursuant to
which Sound Community Bank may borrow up to approximately 45% of total assets, secured by a blanket
pledge on a portion of our residential mortgage portfolio including one-to-four family loans, commercial and
multifamily real estate loans and home equity loans. Based on eligible collateral, the total amount available under
this agreement as of December 31, 2019 was $321.9 million. At the same date, we had $7.5 million in FHLB
advances outstanding with maturities within one year. We also had outstanding letters of credit from the FHLB
with a notional amount of $19.1 million at December 31, 2019. We plan to rely in part on FHLB advances to
fund asset and loan growth. We also use short-term advances to meet short term liquidity needs. We are required
to own stock in the FHLB based on the amount of our advances.
From time to time, we also may borrow from the Federal Reserve Bank of San Francisco’s ‘‘discount window’’
for overnight liquidity needs, although we have not borrowed from the discount window in recent years.
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The following table sets forth the maximum balance and average balance of borrowings for the periods indicated
(dollars in thousands):
Year Ended December 31,
2018
2017
2019
Maximum balance:
FHLB advances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Average balances:
FHLB advances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Weighted average interest rate:
FHLB advances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$72,750
$99,500
$61,500
$24,530
$69,900
$29,791
3.08%
2.18%
1.16%
The following table sets forth certain information about our borrowings at the dates indicated (dollars in
thousands):
FHLB advances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Weighted-average interest rate:
FHLB advances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Subsidiary and Other Activities
As of December 31,
2018
2017
2019
$7,500
$84,000
$59,000
3.05%
2.72%
1.63%
Sound Financial Bancorp has one subsidiary, Sound Community Bank. In 2019, Sound Community Bank formed
Sound Community Insurance Agency, Inc. as a wholly owned subsidiary for purposes of selling a full range of
insurance products.
Competition
We face competition in attracting deposits and originating loans. Competition in originating real estate loans
comes primarily from commercial banks, credit unions, life insurance companies, mortgage brokers and more
recently financial technology (or ‘‘FinTech’’) companies. Commercial banks, credit unions and finance
companies, including FinTech companies, provide vigorous competition in consumer lending. Commercial
business competition is primarily from local commercial banks, but credit unions also compete for this business.
We compete by consistently delivering high-quality, personal service to our clients which results in a high level
of client satisfaction.
Our market area has a high concentration of financial institutions, many of which are branches of large money
center and regional banks that have resulted from the consolidation of the banking industry in Washington and
other western states. These include such large national lenders as US Bank, JP Morgan Chase, Wells Fargo, Bank
of America, Key Bank and others in our market area that have greater resources than we do.
We attract our deposits through our branch offices and web site. Competition for those deposits is principally
from savings banks, commercial banks and credit unions, as well as mutual funds, FinTech companies and other
alternative investments. We compete for these deposits by offering superior service, online and mobile access and
a variety of deposit accounts at competitive rates. Based on the most recent data provided by the FDIC, there are
approximately 50 other commercial banks and savings banks operating in the Seattle MSA, which includes King,
Snohomish and Pierce Counties. Based on the most recent branch deposit data provided by the FDIC, our share
of deposits in the Seattle MSA is approximately 0.18%. The five largest financial institutions in that area have
71.6% of those deposits. In Clallam County there are nine other commercial banks and savings banks. Our share
of deposits in Clallam County was the second highest in the county at approximately 17.7%, with the five largest
institutions in that county having 76.7% of the deposits. In Jefferson County there are six other commercial
banks and savings banks. Our share of deposits in Jefferson County is approximately 7.8%, while the five largest
institutions in that county have 81.6% of those deposits.
How We Are Regulated
General. Sound Community Bank is a Washington state-chartered commercial bank. The regulators of Sound
Community Bank as a commercial bank are the WDFI and the FDIC. The Federal Reserve is the primary federal
regulator for Sound Financial Bancorp. A brief description of certain laws and regulations that are applicable to
25
Sound Financial Bancorp and Sound Community Bank is set forth below. This description of these laws and
regulations, as well as descriptions of laws and regulations contained elsewhere herein, does not purport to be
complete and is qualified in its entirety by reference to the applicable laws and regulations. Legislation is
introduced from time to time in the United States Congress or the Washington State Legislature that may affect
the operations of Sound Financial Bancorp and Sound Community Bank. In addition, the regulations governing
us may be amended from time to time. Any such legislation or regulatory changes in the future could adversely
affect our operations and financial condition.
The WDFI and FDIC have extensive enforcement authority over Sound Community Bank. The Federal Reserve
has the same type of authority over Sound Financial Bancorp. This enforcement authority includes, among other
things, the ability to assess civil money penalties, issue cease-and-desist orders and removal orders and initiate
injunctive actions. In general, these enforcement actions may be initiated for violations of laws and regulations
and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action,
including misleading or untimely reports filed with the regulators.
2018 Regulatory Reform
In May 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act (the ‘‘Act’’), was enacted
to amend or remove certain rules and regulations and modify certain aspects of the regulatory framework for
depository institutions with assets of less than $10 billion and for large banks with assets of more than
$50 billion. Many of these changes could result in meaningful regulatory changes for community banks such as
Sound Community Bank, and their holding companies.
The Act, among other matters, expands the definition of qualified mortgages which may be held by a financial
institution and simplifies the regulatory capital rules for financial institutions and their holding companies with
total consolidated assets of less than $10 billion by instructing the federal banking regulators to establish a single
Community Bank Leverage Ratio of between 8 and 10 percent. Any qualifying depository institution or its
holding company that exceeds that ratio will be considered to have met generally applicable leverage and
risk-based regulatory capital requirements and any qualifying depository institution that exceeds the new ratio
will be considered to be ‘‘well capitalized’’ under the prompt corrective action rules.
The Act also expands the category of holding companies that may rely on the Small Bank Holding Company and
Savings and Loan Holding Company Policy Statement of the Federal Reserve by raising the maximum amount
of assets a qualifying holding company may have from $1 billion to $3 billion. A major effect of this change is
to exclude such holding companies from the minimum capital requirements of the Dodd-Frank Act. In addition,
the Act includes regulatory relief for community banks regarding regulatory examination cycles, call reports, the
Volcker Rule (proprietary trading prohibitions), mortgage disclosures and risk weights for certain high-risk
commercial real estate loans.
It is difficult at this time to predict when or how any new standards under the Act will ultimately be applied to
us or what specific impact the Act and the implementing rules and regulations will have on community banks.
Regulation of Sound Community Bank
General. Sound Community Bank, as a state-chartered commercial bank, is subject to applicable provisions of
Washington law and to regulations and examinations of the WDFI. As an insured institution, it also is subject to
examination and regulation by the FDIC, which insures the deposits of Sound Community Bank to the maximum
permitted by law. During state or federal regulatory examinations, the examiners may require Sound Community
Bank to provide for higher general or specific loan loss reserves, which can impact our capital and earnings. This
regulation of Sound Community Bank is intended for the protection of depositors and the Deposit Insurance
Fund (the ‘‘DIF’’) of the FDIC and not for the purpose of protecting stockholders of Sound Community Bank or
Sound Financial Bancorp. Sound Community Bank is required to maintain minimum levels of regulatory capital
and is subject to certain limitations on the payment of dividends to Sound Financial Bancorp. See ‘‘— Capital
Rules’’ and ‘‘— Limitations on Dividends and Other Capital Distributions.’’
Regulation by the WDFI and the FDIC. State law and regulations govern Sound Community Bank’s ability to
take deposits and pay interest, to make loans on or invest in residential and other real estate, to make other loans,
to invest in securities, to offer various banking services, and to establish branch offices. As a state commercial
bank, Sound Community Bank must pay semi-annual assessments, examination costs and certain other charges to
the WDFI.
26
Washington law generally provides the same powers for Washington commercial banks as federally and
other-state chartered savings banks with branches in Washington. Washington law allows Washington commercial
banks to charge the maximum interest rates on loans and other extensions of credit to Washington residents
which are allowable for a national bank in another state if higher than Washington limits. In addition, the WDFI
may approve applications by Washington commercial banks to engage in an otherwise unauthorized activity, if it
determines that the activity is closely related to banking, and Sound Community Bank is otherwise qualified
under the statute. Federal law and regulations generally limit the activities and equity investments of Sound
Community Bank to those that are permissible for national banks, unless approved by the FDIC, and govern our
relationship with our depositors and borrowers to a great extent, especially with respect to disclosure
requirements.
The FDIC has adopted regulatory guidelines establishing safety and soundness standards on such matters as loan
underwriting and documentation, asset quality, earnings standards, internal controls and information systems,
audit systems, interest rate risk exposure and compensation and other benefits. If the FDIC determines that
Sound Community Bank fails to meet any standard prescribed by these guidelines, it may require Sound
Community Bank to submit an acceptable plan to achieve compliance with the standard. Among these safety and
soundness standards are FDIC regulations that require Sound Community Bank to adopt and maintain written
policies that establish appropriate limits and standards for real estate loans. These standards, which must be
consistent with safe and sound banking practices, establish loan portfolio diversification standards, prudent
underwriting standards (including loan-to-value ratio limits) that are clear and measurable, loan administration
procedures, and documentation, approval and reporting requirements. Sound Community Bank is obligated to
monitor conditions in its real estate markets to ensure that its standards continue to be appropriate for current
market conditions. Sound Community Bank’s board of directors is required to review and approve Sound
Community Bank’s standards at least annually. The FDIC has published guidelines for compliance with these
regulations, including supervisory limitations on loan-to-value ratios for different categories of real estate loans.
Under the guidelines, the aggregate level of all loans in excess of the supervisory loan-to-value ratios should not
exceed an aggregate limit of 100% of total capital, and within the aggregate limit, the total of all loans for
commercial, agricultural, multifamily or other non-one-to-four family residential properties should not exceed
30% of total capital.
Loans in excess of the supervisory loan-to-value ratio limitations must be identified in Sound Community Bank’s
records and reported at least quarterly to Sound Community Bank’s Board of Directors. Sound Community Bank
is in compliance with the records and reporting requirements. As of December 31, 2019, Sound Community
Bank’s aggregate loans in excess of the supervisory loan-to-value ratios were $19.9 million and were within the
aggregate limits set forth in the preceding paragraph.
The FDIC and the WDFI must approve any merger transaction involving Sound Community Bank as the
acquirer, including an assumption of deposits from another depository institution. The FDIC generally is
authorized to approve interstate merger transactions without regard to whether the transaction is prohibited by the
law of any state. Interstate acquisitions of branches are permitted only if the law of the state in which the branch
is located permits such acquisitions. Interstate mergers and branch acquisitions are also be subject to the
nationwide and statewide insured deposit concentration amounts described below. The Dodd-Frank Act permits
de novo interstate branching for banks.
Insurance of Accounts. The FDIC insures deposit accounts in Sound Community Bank up to $250,000 per
separately insured deposit ownership right or category.
The FDIC assesses deposit insurance premiums quarterly on each FDIC-insured institution applied to its deposit
base, which is their average consolidated total assets minus its Tier 1 capital. No institution may pay a dividend
if it is in default on its federal deposit insurance assessment.
The FDIC calculates assessments for small institutions (those with assets of less than $10 billion) based on an
institution’s weighted average CAMELS component ratings and certain financial ratios. Currently, assessment
rates range from 3 to 16 basis points for institutions with CAMELS composite ratings of 1 or 2, 6 to 30 basis
points for those with CAMELS composite ratings of 3, and 16 to 30 basis points for those with CAMELS
composite ratings of 4 or 5, all subject to certain adjustments. Assessment rates are expected to decrease in the
future as the reserve ratio increases in specified increments.
27
As required by the Dodd Frank Act, the FDIC has adopted a rule to offset the effect of the increase in the
minimum reserve ratio of the DIF on small institutions by imposing a surcharge on institutions with assets of
$10 billion or more commencing on July 1, 2016 and ending when the reserve ratio reaches 1.35%, which, the
FDIC announced occurred on September 30, 2018. When the reserve ratio reaches 1.38%, small institutions will
receive credits for the portions of their regular assessments that contributed to growth in the reserve ratio
between 1.15% and 1.35%. Subject to certain limitations, the credits will apply to reduce regular assessments
until exhausted.
Transactions with Related Parties. Transactions between Sound Community Bank and its affiliates are required
to be on terms as favorable to Sound Community Bank as transactions with non-affiliates, and certain of these
transactions, such as loans to an affiliate, are restricted to a percentage of Sound Community Bank’s capital and
require eligible collateral in specified amounts. Sound Financial Bancorp is an affiliate of Sound Community
Bank.
The Sarbanes-Oxley Act of 2002 generally prohibits loans by Sound Financial Bancorp to its executive officers
and directors. However, the law contains a specific exception for loans by a depository institution to its executive
officers and directors in compliance with federal banking laws. Under such laws, Sound Community Bank’s
authority to extend credit to executive officers, directors and 10% or greater stockholders (‘‘insiders’’), as well as
entities such persons’ control, is limited. The laws limit both the individual and aggregate amount of loans that
Sound Community Bank may make to insiders based, in part, on Sound Community Bank’s capital level and
requires that certain board approval procedures be followed. Such loans are required to be made on terms
substantially the same as those offered to unaffiliated borrowers and must not involve more than the normal risk
of repayment. There is an exception for loans made pursuant to a benefit or compensation program that is widely
available to all employees of the institution and does not give preference to insiders over other employees. Loans
to executive officers are subject to additional limitations based on the type of loan involved.
Capital Rules. Sound Community Bank is subject to the capital regulations adopted by the Federal Reserve and
the FDIC pursuant to the Dodd-Frank Act. Under these capital regulations, the minimum capital ratios are: (1) a
common equity Tier 1 (‘‘CET1’’) capital ratio of 4.5% of risk-weighted assets; (2) a Tier 1 capital ratio of 6.0%
of risk-weighted assets; (3) a total capital ratio of 8.0% of risk-weighted assets, and (4) a leverage ratio (the ratio
of Tier 1 capital to average total adjusted assets) of 4.0%. CET1 generally consists of common stock, retained
earnings, accumulated other comprehensive income (‘‘AOCI’’) unless an institution elects to exclude AOCI from
regulatory capital, as discussed below, and certain minority interests, all subject to applicable regulatory
adjustments and deductions. Tier 1 capital generally includes CET1 and noncumulative perpetual preferred stock,
less most intangible assets, subject to certain adjustments. Total capital consists of Tier 1 and Tier 2 Capital.
Tier 2 capital, which is limited to 100 percent of Tier 1 capital, includes such items as qualifying general loan
loss reserves, cumulative perpetual preferred stock, mandatory convertible debt, term subordinated debt and
limited life preferred stock; however, the amount of term subordinated debt and intermediate term preferred stock
that may be included in Tier 2 capital is limited to 50 percent of Tier 1 capital. Risk-weighted assets are
determined under the capital regulations, which assign risk-weights to all assets and to certain off-balance sheet
items.
These regulations include the phasing-out of certain instruments as qualifying capital. Mortgage servicing and
deferred tax assets over designated percentages of CET1 are deducted from capital. In addition, Tier 1 capital
includes AOCI, which includes all unrealized gains and losses on available for sale debt and equity securities,
unless an institution elects to opt out of such inclusion, if eligible to do so. We have elected to permanently
opt-out of the inclusion of AOCI in our capital calculations.
The capital regulations include a 150% risk weight for certain high volatility commercial real estate acquisition,
development and construction loans and for non-residential mortgage loans that are 90 days past due or
otherwise in nonaccrual status; a 20% risk weight for the unused portion of a commitment with an original
maturity of one year or less that is not unconditionally cancellable; and a 250% risk weight for mortgage
servicing and deferred tax assets that are not deducted from capital.
In addition to the minimum CET1, Tier 1 and total capital ratios, Sound Financial Bancorp and Sound
Community Bank must maintain a capital conservation buffer consisting of additional CET1 capital greater than
2.5% of risk-weighted assets above the required minimum risk-based capital levels in order to avoid limitations
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on paying dividends, engaging in share repurchases, and paying discretionary bonuses. The capital conservation
buffer requirement began to phase in on January 1, 2016, when a buffer greater than 0.625% of risk-weighted
assets was required, which amount increased each year until the buffer requirement was fully implemented on
January 1, 2019.
Under the FDIC’s prompt corrective action standards, in order to be considered well-capitalized, a bank must
have a ratio of CET1 capital to risk-weighted assets of at least 6.5%, a ratio of Tier 1 capital to risk-weighted
assets of at least 8%, a ratio of total capital to risk-weighted assets of at least 10%, and a leverage ratio of at
least 5%, and the bank must not be subject to a regulatory capital requirement imposed on it as an individual
bank. In order to be considered adequately capitalized, a bank must have the minimum capital ratios described
above. Institutions with lower capital ratios are assigned to lower capital categories. Based on safety and
soundness concerns, the FDIC may assign an institution to a lower capital category than would originally apply
based on its capital ratios. The FDIC is also authorized to require Sound Community Bank to maintain additional
amounts of capital in connection with concentrations of assets, interest rate risk, and certain other items. The
FDIC has not imposed such a requirement on Sound Community Bank. ‘‘Effective January 1, 2020, a bank that
elects to use the Community Bank Leverage Ratio will generally be considered well-capitalized and to have met
the risk-based and leverage capital requirements of the capital regulations if it has a leverage ratio greater than
9.0%. To be eligible to elect the Community Bank Leverage Ratio, the bank also must have total consolidated
assets of less than $10 billion, off-balance sheet exposures of 25% or less of its total consolidated assets, and
trading assets and trading liabilities of 5.0% or less of its total consolidated assets, all as of the end of the most
recent quarter.
An institution that is not well capitalized is subject to certain restrictions on brokered deposits and interest rates
on deposits. An institution that is not at least adequately capitalized is subject to numerous additional restrictions,
and a guaranty by its holding company is required. An institution with a ratio of tangible equity to total assets of
2.0% or less is subject to appointment of the FDIC as receiver if its capital level does not improve in timely
fashion. When the FDIC as receiver liquidates an institution, the claims of depositors and the FDIC as their
successor have priority over other unsecured claims against the institution.
The Financial Accounting Standards Board has adopted a new accounting standard for US Generally Accepted
Accounting Principles that are effective for us beginning January 1, 2023. This standard, referred to as Current
Expected Credit Loss, or CECL, requires FDIC-insured institutions and their holding companies (banking
organizations) to recognize credit losses expected over the life of certain financial assets. CECL covers a broader
range of assets than the current method of recognizing credit losses and generally results in earlier recognition of
credit losses. Upon adoption of CECL, a banking organization must record a one-time adjustment to its credit
loss allowances as of the beginning of the fiscal year of adoption equal to the difference, if any, between the
amount of credit loss allowances under the current methodology and the amount required under CECL. For a
banking organization, implementation of CECL is generally likely to reduce retained earnings, and to affect other
items, in a manner that reduces its regulatory capital.
The federal banking regulators (the Federal Reserve, the Office of the Comptroller of the Currency and the
FDIC) have adopted a rule that gives a banking organization the option to phase in over a three-year period the
day-one adverse effects of CECL on its regulatory capital.
As of December 31, 2019, Sound Community Bank was well capitalized under applicable regulations and met
the conservation buffer requirement.
Community Reinvestment and Consumer Protection Laws. In connection with its lending and other activities,
Sound Community Bank is subject to a number of federal and state laws designed to protect clients and promote
lending to various sectors of the economy and population. These include, among others, the Equal Credit
Opportunity Act, the Truth-in-Lending Act, the Home Mortgage Disclosure Act, the Real Estate Settlement
Procedures Act, and the Community Reinvestment Act (‘‘CRA’’). Among other things, these laws:
•
•
•
•
require lenders to disclose credit terms in meaningful and consistent ways;
prohibit discrimination against an applicant in a credit transaction;
prohibit discrimination in housing-related lending activities;
require certain lenders to collect and report applicant and borrower data regarding home loans;
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•
•
•
•
require lenders to provide borrowers with information regarding the nature and cost of real estate
settlements;
prohibit certain lending practices and limit escrow account amounts with respect to real estate loan
transactions;
require financial institutions to implement identity theft prevention programs and measures to protect
the confidentiality of consumer financial information; and
prescribe possible penalties for violations of the requirements of consumer protection statutes and
regulations.
The Consumer Financial Protection Bureau (‘‘CFPB’’), an independent agency within the Federal Reserve, has
the authority to amend existing federal consumer protection regulations and implement new regulations, and is
charged with examining the compliance of financial institutions with assets in excess of $10 billion with these
rules. Sound Community Bank’s compliance with consumer protection rules is examined by the WDFI and the
FDIC.
In addition, federal regulations limit the ability of banks and other financial institutions to disclose nonpublic
consumer information to non-affiliated third parties. The regulations require disclosure of privacy policies and
allow consumers to prevent certain personal information from being shared with non-affiliated parties.
The CRA requires the appropriate federal banking agency to assess the bank’s record in meeting the credit needs
of the communities served by the bank, including low and moderate income neighborhoods. The FDIC examines
Sound Community Bank for compliance with its CRA obligations. Under the CRA, institutions are assigned a
rating of ‘‘outstanding,’’ ‘‘satisfactory,’’ ‘‘needs to improve,’’ or ‘‘substantial non-compliance’’ and the appropriate
federal banking agency is to take this rating into account in the evaluation of certain applications of the
institution, such as an application relating to a merger or the establishment of a branch. An unsatisfactory rating
may be the basis for the denial of such an application. The CRA also requires that all institutions make public
disclosures of their CRA ratings. Sound Community Bank received a ‘‘satisfactory’’ rating in its most recent
CRA evaluation. Under the law of the state of Washington, Sound Community Bank has a similar obligation to
meet the credit needs of the communities it serves, and is subject to examination by the WDFI for this purpose,
including assignment of a rating. An unsatisfactory rating may be the basis for denial of certain applications by
the WDFI.
Bank Secrecy Act / Anti-Money Laundering Laws. Sound Community Bank is subject to the Bank Secrecy Act
and other anti-money laundering laws and regulations, including the USA PATRIOT Act of 2001. These laws and
regulations require Sound Community Bank to implement policies, procedures, and controls to detect, prevent,
and report money laundering and terrorist financing and to verify the identity of their clients. Violations of these
requirements can result in substantial civil and criminal sanctions. In addition, provisions of the USA PATRIOT
Act require the federal financial institution regulatory agencies to consider the effectiveness of a financial
institution’s anti-money laundering activities when reviewing mergers and acquisitions.
Federal Home Loan Bank System. Sound Community Bank is a member of the FHLB, one of the 11 regional
Federal Home Loan Banks in the Federal Home Loan Bank System. The Federal Home Loan Bank System
provides a central credit facility for member institutions. As a member of the FHLB, the Bank is required to hold
shares of capital stock in that FHLB. At December 31, 2019, the Bank had $1.2 million in FHLB stock, which
was in compliance with this requirement. Sound Community Bank received $89,000 in dividends from the FHLB
for the year ended December 31, 2019.
The Federal Home Loan Banks have continued to contribute to low- and moderately-priced housing programs
through direct loans or interest subsidies on advances targeted for community investment and low- and
moderate-income housing projects. These contributions have affected adversely the level of dividends paid by the
FHLB and could continue to do so in the future. These contributions could also have an adverse effect on the
value of FHLB stock in the future. A reduction in value of Sound Community Bank’s FHLB stock may result in
a corresponding reduction in its capital.
Regulation of Sound Financial Bancorp
General. Sound Financial Bancorp, as the sole stockholder of Sound Community Bank, is a bank holding
company registered with the Federal Reserve. Bank holding companies are subject to comprehensive regulation
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by the Federal Reserve under the Bank Holding Company Act of 1956, as amended, and the regulations
promulgated thereunder. This regulation and oversight is generally intended to ensure that Sound Financial
Bancorp limits its activities to those allowed by law and that it operates in a safe and sound manner without
endangering the financial health of Sound Community Bank. A bank holding company must serve as a source of
financial strength to its subsidiary banks, with the ability to provide financial assistance to a subsidiary bank in
financial distress.
As a bank holding company, Sound Financial Bancorp is required to file quarterly and annual reports with the
Federal Reserve and any additional information required by the Federal Reserve and is subject to regular
examinations by the Federal Reserve and to examination by the WDFI.
A merger or acquisition of Sound Financial Bancorp, or an acquisition of control of Sound Financial Bancorp, is
generally subject to approval by the Federal Reserve and WDFI. In general, control for this purpose means 25%
of voting stock, but such approval can be required in other circumstances, including but not limited to an
acquisition of as low as 5% of voting stock.
Permissible Activities. Under the Bank Holding Company Act, the Federal Reserve may approve the ownership
of shares by a bank holding company in any company the activities of which the Federal Reserve has determined
to be so closely related to the business of banking or managing or controlling banks as to be a proper incident
thereto. The Bank Holding Company Act prohibits a bank holding company, with certain exceptions, from
acquiring ownership or control of more than 5% of the voting shares of any company that is not a bank or bank
holding company and from engaging in activities other than those of banking, managing or controlling banks, or
providing services for its subsidiaries. A bank holding company that meets certain supervisory and financial
standards and elects to be designed as a financial holding company may also engage in certain securities,
insurance and merchant banking activities and other activities determined to be financial in nature or incidental
to financial activities.
The Federal Reserve must approve an application of a bank holding company to acquire control of, or acquire all
or substantially all of the assets of, a bank, and may approve an acquisition located in a state other than the
holding company’s home state, without regard to whether the transaction is prohibited by the laws of any state,
but may not approve the acquisition of a bank that has not been in existence for the minimum time period, not
exceeding five years, specified by the law of the host state, or an application where the applicant controls or
would control more than 10% of the insured deposits in the United States or 30% or more of the deposits in the
target bank’s home state or in any state in which the target bank maintains a branch. Federal law does not affect
the authority of states to limit the percentage of total insured deposits in the state that may be held or controlled
by a bank holding company to the extent such limitation does not discriminate against out-of-state banks or bank
holding companies. Individual states may also waive the 30% state-wide concentration limit contained in the
federal law. The Federal Reserve also takes into consideration the CRA performance of a bank when evaluating
acquisition proposals involving the bank’s holding company.
Capital Requirements for Sound Financial Bancorp. The capital regulations discussed above generally apply to
a bank holding company with less than $3.0 billion in assets on a bank only basis. If Sound Financial Bancorp
were subject to regulatory guidelines for bank holding companies with $3.0 billion or more in assets at
December 31, 2019, Sound Financial Bancorp would have exceeded all regulatory capital requirements, with
estimated regulatory capital ratio of 9.55% for Tier 1 leverage-based capital, 11.08% for both Common Equity
Tier 1 risk-based capital and Tier 1 Capital to risk-based assets, and 11.94% for total risk-based capital. The
Federal Reserve expects a holding company’s subsidiary banks to be well capitalized under the prompt corrective
action regulations. In addition, a bank holding company must serve as a source of financial strength for its
depository institution subsidiaries.
Federal Securities Law. The stock of Sound Financial Bancorp is registered with the SEC under the Securities
Exchange Act of 1934, as amended. Sound Financial Bancorp is subject to the information, proxy solicitation,
insider trading restrictions and other requirements of the SEC under the Securities Exchange Act of 1934 (the
‘‘Exchange Act’’).
Sound Financial Bancorp stock held by persons who are affiliates of Sound Financial Bancorp may not be resold
without registration unless sold in accordance with certain resale restrictions. For this purpose, affiliates are
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generally considered to be officers, directors and principal stockholders. If Sound Financial Bancorp meets
specified current public information requirements, each affiliate of Sound Financial Bancorp will be able to sell
in the public market, without registration, a limited number of shares in any three-month period.
The SEC has adopted regulations and policies under the Sarbanes-Oxley Act of 2002 that apply to Sound
Financial Bancorp as a registered company under the Exchange Act. The stated goals of these requirements are
to increase corporate responsibility, provide for enhanced penalties for accounting and auditing improprieties at
publicly traded companies and to protect investors by improving the accuracy and reliability of corporate
disclosures pursuant to the securities laws. The SEC and Sarbanes-Oxley-related regulations and policies include
very specific additional disclosure requirements and corporate governance rules.
Limitations on Dividends and Stock Repurchases
Sound Financial Bancorp. Sound Financial Bancorp’s ability to declare and pay dividends is subject to the
Federal Reserve’s limits and Maryland law, and may depend on its ability to receive dividends from Sound
Community Bank, which is subject to the capital conservation buffer requirement.
A policy of the Federal Reserve limits the payment of a cash dividend by a bank holding company if the holding
company’s net income for the past year is not sufficient to cover both the cash dividend and a rate of earnings
retention that is consistent with capital needs, asset quality and overall financial condition. A bank holding
company that does not meet any applicable capital standard would not be able to pay any cash dividends under
this policy. A bank holding company subject to the Small Bank Holding Company Policy Statement, such as
Sound Financial Bancorp, is expected not to pay dividends unless its debt-to-equity ratio is less than 1:1 and it
meets certain additional criteria. The Federal Reserve also has indicated that it is inappropriate for a company
experiencing serious financial problems to borrow funds to pay dividends.
Except for a company that meets the well-capitalized standard for bank holding companies, is well managed, and
is not subject to any unresolved supervisory issues, a bank holding company is required to give the Federal
Reserve prior written notice of any purchase or redemption of its outstanding equity securities if the gross
consideration for the purchase or redemption, when combined with the net consideration paid for all such
purchases or redemptions during the preceding 12 months, is equal to 10% or more of the company’s
consolidated net worth. The Federal Reserve may disapprove such a purchase or redemption if it determines that
the proposal would constitute an unsafe or unsound practice or would violate any law, regulation or regulatory
order, condition, or written agreement with the Federal Reserve. Regardless of its asset size, a bank holding
company is considered well-capitalized if on a consolidated basis it has a total risk-based capital ratio of at least
10.0% and a Tier 1 risk-based capital ratio of 6.0% or more, and is not subject to an agreement, order, or
directive to maintain a specific level for any capital measure.
Under Maryland corporate law, Sound Financial Bancorp generally may not pay dividends if after that payment it
would not be able to pay its liabilities as they become due in the usual course of business, or its total assets
would be less than the sum of its total liabilities.
Sound Community Bank. The amount of dividends payable by Sound Community Bank to Sound Financial
Bancorp depends upon Sound Community Bank’s earnings and capital position, and is limited by federal and
state laws, regulations and policies, including the capital conservation buffer requirement. Sound Community
Bank may not declare or pay a cash dividend on its capital stock if the payment would cause its net worth to be
reduced below the amount required for its liquidation account. Dividends on Sound Community Bank’s capital
stock may not be paid in an aggregate amount greater than the aggregate retained earnings of Sound Community
Bank without the approval of the WDFI.
The amount of dividends actually paid during any one period will be strongly affected by Sound Community
Bank’s policy of maintaining a strong capital position. Federal law further provides that without prior approval
no insured depository institution may pay a cash dividend if it would cause the institution to be less than
adequately capitalized as defined in the prompt corrective action regulations. Moreover, the FDIC has the general
authority to limit the dividends paid by insured banks if such payments are deemed to constitute an unsafe and
unsound practice. In addition, dividends may not be declared or paid if Sound Community Bank is in default in
payment of any assessment due the FDIC.
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Federal Taxation
General. We are subject to federal income taxation in the same general manner as other corporations, with some
exceptions discussed below. The following discussion of federal taxation is intended only to summarize certain
pertinent federal income tax matters and is not a comprehensive description of the tax rules applicable to Sound
Financial Bancorp or Sound Community Bank. Our federal income tax returns have never been audited by the
Internal Revenue Service.
Method of Accounting. For federal income tax purposes, we currently report our income and expenses on the
accrual method of accounting and use a fiscal year ending on December 31 for filing our federal income tax
return.
Intercompany Dividends-Received Deduction. Sound Financial Bancorp has elected to file a consolidated
return with Sound Community Bank. Therefore any dividends Sound Financial Bancorp receives from Sound
Community Bank will not be included as income to Sound Financial Bancorp.
State Taxation
We are subject to a business and occupation tax imposed under Washington state law at the rate of 1.5% of gross
receipts, as well as personal property and sales tax. Interest received and servicing income both on loans secured
by mortgages or deeds of trust on residential properties and certain investment securities are exempt from
business and occupation tax.
Employees
At December 31, 2019, we had a total of 117 full-time employees and 15 part-time employees. Our employees
are not represented by any collective bargaining group. Management considers its employee relations to be good.
Executive Officers of Sound Financial Bancorp and Sound Community Bank
Officers are elected annually to serve for a one year term. There are no arrangements or understandings between
the officers and any other person pursuant to which he or she was or is to be selected as an officer.
Laura Lee Stewart. Ms. Stewart, age 70, is currently President and Chief Executive Officer of Sound
Community Bank and Sound Financial Bancorp. Prior to joining Sound Community Bank as its President in
1989, when it was a credit union, Ms. Stewart was Senior Vice President/Retail Banking at Great Western Bank.
Ms. Stewart was selected as an inaugural member of the FDIC Community Bank Advisory Board and completed
her term in 2011. In 2011, Ms. Stewart was appointed to the inaugural Consumer Financial Protection Bureau
board and completed her term in 2013. She also served as Chair of the American Bankers Association’s (ABA)
Government Relations Council and is the past Chair of the Washington Bankers Association. The American
Banker magazine honored her as one of the top 25 Women to Watch in banking in 2011, 2015, 2016, 2017, 2018
and as one of the most powerful women in Banking in 2019. In 2016, Ms. Stewart was recognized as a Women
of Influence by the Puget Sound Business Journal. In 2018, she was named Community Banker of the year by
American Banker. Ms. Stewart also is Chair of the National Arthritis Foundation’s board of directors as well as
serving as the Past Chair of the board of directors of Woodland Park Zoo. In October 2019, Ms. Stewart was
elected Chair of the ABA. Her many years of service in all areas of the financial institution operations and duties
as President and Chief Executive Officer of Sound Financial Bancorp and Sound Community Bank bring a
special knowledge of the financial, economic and regulatory challenges we face, and she is well suited to
educating the Board on these matters.
Elliott Pierce. Mr. Pierce, age 63, was appointed Senior Vice President and Chief Credit Officer of Sound
Community Bank in April 2015 and was appointed Executive Vice President in January 2016. Mr. Pierce is
responsible for management of the Bank’s Credit Administration functions, and is a member of the Bank’s Loan
Committee. Prior to joining Sound Community Bank, Mr. Pierce was a Senior Vice President and Credit
Administrator with Union Bank N.A. Mr. Pierce received his Bachelor of Arts Degree from the University of
Washington and his Master of Business Administration from Seattle Pacific University. Mr. Pierce is also a
graduate of the Pacific Coast Banking School.
Heidi Sexton. Ms. Sexton, age 44, was appointed Executive Vice President and Chief Operating Officer of
Sound Community Bank during 2018. Ms. Sexton is responsible for identification and mitigation of risk through
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oversight of the Enterprise Risk management and Compliance Management functions. In addition, Ms. Sexton is
responsible for Information Technology, Systems Support and Operations, Project Management and Policies and
Procedures. Ms. Sexton joined Sound Community Bank in 2007 and previously served as the Vice President of
Operations managing deposit, electronic, and lending operations. Ms. Sexton received a Bachelor’s of Arts in
Accounting from the University of Wisconsin-Eau Claire. She currently holds a number of professional
certifications including Certified Internal Auditor, Certified Regulatory Compliance Manager and is a graduate of
the Washington Bankers Association’s Executive Development Program. Ms. Sexton is also a member of the
Consumer Financial Protection Bureau’s (CFPB) Community Bank Advisory Counsel and American Bankers
Association’s (ABA) Compliance Administrative Committee. She serves on the Board of Financial Beginnings, a
non-profit that provides youth to adult financial education programs at no cost.
Daphne D. Kelley. Ms. Kelley, age 48, is currently Executive Vice President, Chief Financial Officer at Sound
Financial Bancorp and Sound Community Bank. Prior to joining the Bank in July 2018, Ms. Kelley was Senior
Vice President, Controller of HomeStreet Bank where she was employed for three years and was responsible for
SEC and regulatory reporting, accounting operations, corporate tax and Sarbanes-Oxley. Additional experience
includes Controller at the Federal Home Loan Bank of Seattle for eight years as well as various positions at GE
Capital, Toyota and Ernst & Young. Ms. Kelley received a Bachelor’s of Science degree from the University of
California at Berkeley and a Masters of Business Administration from UCLA Anderson School of Management.
She currently holds a Certified Public Accountant license in the State of Washington and the State of California
and serves on the Board of Family Law CASA.
Website
We maintain a website; www.soundcb.com. The information contained on our website is not included as a part
of, or incorporated by reference into, this Annual Report on Form 10-K. Other than an investor’s own internet
access charges, we make available free of charge through its website the Annual Report on Form 10-K, quarterly
reports on Form 10-Q and current reports on Form 8-K, and amendments to these reports, as soon as reasonably
practicable after we have electronically filed such material with, or furnished such material to, the SEC.
Information pertaining to us, including SEC filings, can be found by clicking the link on our site called ‘‘Investor
Relations.’’ For more information regarding access to these filings on our website, please contact our Corporate
Secretary, Sound Financial Bancorp, Inc., 2400 3rd Avenue, Suite 150, Seattle, Washington, 98121 or by calling
(206) 448-0884.
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Item 1A. Risk Factors
We assume and manage a certain degree of risk in order to conduct our business strategy. In addition to
the risk factors described below, other risks and uncertainties not specifically mentioned, or that are
currently known to, or deemed to be immaterial by management, also may materially and adversely affect
our financial position, results of operations and cash flows. Before making an investment decision, you
should carefully consider the risks described below together with all of the other information included in
this Form 10-K and our other filings with the SEC. If any of the circumstances described in the following
risk factors actually occur to a significant degree, the value of our common stock could decline, and you
could lose all or part of your investment. This report is qualified in its entirety by these risk factors.
Risks Related to Our Operations
A worsening of economic conditions in our market area could reduce demand for our products and services
and result in increases in our level of non-performing loans, which could adversely affect our operations,
financial condition and earnings.
Substantially all our loans are to businesses and individuals in the state of Washington. Accordingly, local
economic conditions have a significant impact on the ability of our borrowers to repay loans and the value of the
collateral securing loans which could have a material adverse effect on our business, financial condition, results
of operations and prospects. A deterioration in economic conditions could have the following consequences, any
of which could have a material adverse effect on our business, financial condition, liquidity and results of
operations:
•
•
•
•
•
•
demand for our products and services may decline;
loan delinquencies, problem assets and foreclosures may increase;
we may increase our allowance for loan losses;
collateral for loans, especially real estate, may decline in value, thereby reducing customers’ future
borrowing power, and reducing the value of assets and collateral associated with existing loans;
the net worth and liquidity of loan guarantors may decline, impairing their ability to honor
commitments to us; and
the amount of our low-cost or noninterest-bearing deposits may decrease.
Moreover, a significant decline in general local, regional or national economic conditions caused by inflation,
recession, severe weather, natural disasters, widespread disease or pandemics, acts of terrorism, an outbreak of
hostilities or other international or domestic calamities, unemployment or other factors beyond our control could
further impact these local economic conditions and could further negatively affect the financial results of our
banking operations. Such events could affect the stability of our deposit base, impair the ability of borrowers to
repay outstanding loans and leases, impair the value of collateral securing loans, cause significant property
damage, result in loss of revenue or cause us to incur additional expenses.
Weakness in the global economy also may adversely affect many businesses operating in our markets that are
dependent upon international trade and it is not known how the recent changes in tariffs being imposed on
international trade may have affected these businesses.
Our loan portfolio includes loans with a higher risk of loss.
In addition to one- to four- family residential loans, we originate commercial and multifamily real estate,
construction and land, consumer and commercial business loans, primarily within our market areas. These loans
typically present different risks to us for a number of reasons, including those discussed below:
•
Construction and Land Loans. This type of lending is subject to the inherent difficulties in estimating
both a property’s value at completion of a project and the estimated cost (including interest) of the
project. Because of the uncertainties inherent in estimating construction costs, as well as the market
value of a completed project and the effects of governmental regulation on real property, it is difficult
to evaluate accurately the total funds required to complete a project and the completed project’s
loan-to-value ratio. If the estimate of construction cost proves to be inaccurate, we may be required to
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advance funds beyond the amount originally committed to ensure completion of the project. If our
appraisal of the value of a completed project proves to be overstated, we may have inadequate security
for the repayment of the loan upon completion of construction of the project and may incur a loss.
Disagreements between borrowers and builders and the failure of builders to pay subcontractors may
also jeopardize projects. This type of lending also typically involves higher loan principal amounts and
may be concentrated with a small number of builders. A downturn in housing or the real estate market
could increase delinquencies, defaults and foreclosures, and significantly impair the value of our
collateral and our ability to sell the collateral upon foreclosure. Some of the builders we deal with have
more than one loan outstanding with us. Consequently, an adverse development with respect to one
loan or one credit relationship can expose us to a significantly greater risk of loss. In addition, during
the term of some of our construction loans, no payment from the borrower is required since the
accumulated interest is added to the principal of the loan through an interest reserve. Increases in
market rates of interest may have a more pronounced effect on construction loans by rapidly increasing
the end-purchaser’s borrowing costs, thereby possibly reducing the homeowner’s ability to finance the
home upon completion or the overall demand for the project. Properties under construction are often
difficult to sell and typically must be completed in order to be successfully sold which also complicates
the process of managing our problem construction loans. This may require us to advance additional
funds and/or contract with another builder to complete construction and assume the market risk of
selling the project at a future market price, which may or may not enable us to fully recover unpaid
loan funds and associated construction and liquidation costs. Loans on land under development or held
for future construction also pose additional risk because of the lack of income being produced by the
property and the potential illiquid nature of the collateral. These risks can be significantly impacted by
supply and demand. As a result, this type of lending often involves the disbursement of substantial
funds with repayment dependent on the success of the ultimate project and the ability of the borrower
to sell or lease the property or obtain permanent take-out financing, rather than the ability of the
borrower or guarantor to independently repay principal and interest.
Construction loans made by us include those with a sales contract or permanent loan in place for the
finished homes and those for which purchasers for the finished homes may not be identified either
during or following the construction period, known as speculative construction loans. Speculative
construction loans to a builder pose a greater potential risk to us than construction loans to individuals
on their personal residences. We attempt to mitigate this risk by actively monitoring the number of
unsold homes in our construction loan portfolio and local housing markets to attempt to maintain an
appropriate balance between home sales and new loan originations. In addition, the maximum number
of speculative construction loans (loans that are not pre-sold) approved for each builder is based on a
combination of factors, including the financial capacity of the builder, the market demand for the
finished product and the ratio of sold to unsold inventory the builder maintains. We have also
attempted to diversify the risk associated with speculative construction lending by doing business with
a large number of small and mid-sized builders spread over a relatively large geographic region
representing numerous sub-markets within our service area.
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Commercial and Multifamily Real Estate Loans. These loans typically involve higher principal amounts
than other types of loans and some of our commercial borrowers have more than one loan outstanding
with us. Consequently, an adverse development with respect to one loan or one credit relationship can
expose us to a significantly greater risk of loss compared to an adverse development with respect to a
one- to four-family residential mortgage loan. Repayment of these loans is dependent upon income
being generated from the property securing the loan in amounts sufficient to cover operating expenses
and debt service, which may be adversely affected by changes in the economy or local market
conditions. In addition, many of our commercial and multifamily real estate loans are not fully
amortizing and contain large balloon payments upon maturity. Such balloon payments may require the
borrower to either sell or refinance the underlying property in order to make the payment, which may
increase the risk of default or non-payment. If we foreclose on a commercial or multifamily real estate
loan, our holding period for the collateral typically is longer than for one- to four-family residential
loans because there are fewer potential purchasers of the collateral.
Commercial Business Loans. Our commercial business loans are primarily made based on the cash flow
of the borrower and secondarily on the underlying collateral provided by the borrower. A borrower’s
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•
cash flow may prove to be unpredictable, and collateral securing these loans may fluctuate in value.
Most often, this collateral includes accounts receivable, inventory, equipment or real estate. In the case
of loans secured by accounts receivable, the availability of funds for the repayment of these loans may
be substantially dependent on the ability of the borrower to collect amounts due from its customers.
Other collateral securing loans may depreciate over time, may be difficult to appraise, may be illiquid
and may fluctuate in value based on the success of the business.
Consumer Loans. Generally, we consider these loans to involve a different degree of risk compared to
first mortgage loans on one- to four-family residential properties. As a result of our large portfolio of
these loans, it may become necessary to increase the level of our provision for loan losses, which could
decrease our profits. Consumer loans generally entail greater risk than do one- to four-family residential
mortgage loans, particularly in the case of loans that are secured by rapidly depreciable assets, such as
floating homes, manufactured homes, automobiles and recreational vehicles. In these cases, any
repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the
outstanding loan balance. Manufactured homes are a more risky form of collateral, though this risk is
reduced if the owner also owns the land on which the home is located, because they are costly and
difficult to relocate when repossessed, and difficult to sell due to the diminishing number of
manufactured home parks in the Puget Sound area. Additionally, a good portion of our manufactured
home loan borrowers are first-time home buyers, who tend to be a higher credit risk than first-time
home buyers of single family residences, due to more limited financial resources. As a result, these
loans tend to have a higher probability of default, higher delinquency rates and greater servicing costs
than other types of consumer loans. Our floating home, houseboat and house barge loans are typically
located on cooperative or condominium moorages. The primary risk in floating home loans is the
unique nature of the collateral and the challenges of relocating such collateral to a location other than
where such housing is permitted. The process for securing the deed and/or the condominium or
cooperative dock is also unique compared to other types of lending we participate in. As a result, these
loans may have higher collateral recovery costs than for one- to four-family mortgage loans and other
types of consumer loans.
Our business may be adversely affected by credit risk associated with residential property and declining
property values.
Our first-lien one- to four-family real estate loans are primarily made based on the repayment ability of the
borrower and the collateral securing these loans. Home equity lines of credit generally entail greater risk than do
one- to four-family residential mortgage loans where we are in the first lien position. For those home equity lines
secured by a second mortgage, it is less likely that we will be successful in recovering all of our loan proceeds
in the event of default. Our foreclosure on these loans requires that the value of the property be sufficient to
cover the repayment of the first mortgage loan, as well as the costs associated with foreclosure.
This type of lending is generally sensitive to regional and local economic conditions that significantly impact the
ability of borrowers to meet their loan payment obligations, making loss levels difficult to predict. A downturn in
the economy or the housing market in our market areas or a rapid increase in interest rates may reduce the value
of the real estate collateral securing these types of loans and increase the risk that we would incur losses if
borrowers default on their loans. Residential loans with high combined loan-to-value ratios generally will be
more sensitive to declining property values than those with lower combined loan-to-value ratios and therefore
may experience a higher incidence of default and severity of losses. In addition, if the borrowers sell their
homes, the borrowers may be unable to repay their loans in full from the sale proceeds. As a result, these loans
may experience higher rates of delinquencies, defaults and losses, which will in turn adversely affect our
financial condition and results of operations. A majority of our residential loans are ‘‘non-conforming’’ because
they are adjustable rate mortgages which contain interest rate floors or do not satisfy credit or other requirements
due to personal and financial reasons (i.e. divorce, bankruptcy, length of time employed, etc.), conforming loan
limits (i.e. jumbo mortgages), and other requirements imposed by secondary market purchasers. Some of these
borrowers have higher debt-to-income ratios, or the loans are secured by unique properties in rural markets for
which there are no sales of comparable properties to support the value according to secondary market
requirements. We may require additional collateral or lower loan-to-value ratios to reduce the risk of these loans.
We believe that these loans satisfy a need in our local market areas. As a result, subject to market conditions, we
intend to continue to originate these types of loans.
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Our allowance for loan losses may prove inadequate or we may be negatively affected by credit risk exposures.
Future additions to our allowance for loan losses, as well as charge-offs in excess of reserves, will reduce our
earnings.
Our business depends on the creditworthiness of our customers. As with most financial institutions, we maintain
an allowance for loan losses to reflect potential defaults and nonperformance, which represents management’s
best estimate of probable incurred losses inherent in the loan portfolio. Management’s estimate is based on our
continuing evaluation of specific credit risks and loan loss experience, current loan portfolio quality, present
economic, political and regulatory conditions, industry concentrations and other factors that may indicate future
loan losses. The determination of the appropriate level of the allowance for loan losses inherently involves a high
degree of subjectivity and judgment and requires us to make estimates of current credit risks and future trends,
all of which may undergo material changes. There is no certainty that the allowance for loan losses will be
adequate over time to cover credit losses in the loan portfolio because of unanticipated adverse changes in the
economy, market conditions or events adversely affecting specific customers, industries or markets. If the credit
quality of our loan portfolio materially decreases, if the risk profile of a market, industry or group of customers
changes materially, or if the allowance for loan losses is not adequate, our business, financial condition, liquidity,
capital, and results of operations could be materially adversely affected.
A tightening of credit markets and liquidity risk could impair our ability to fund operations and jeopardize our
financial condition.
We must maintain sufficient funds to respond to the needs of depositors and borrowers. As a part of our liquidity
management, we use a number of funding sources in addition to core deposit growth and repayments and
maturities of loans and investments, including Federal Home Loan Bank advances, proceeds from the sale of
loans, and brokered deposits. Factors that could detrimentally impact our access to liquidity sources include a
decrease in the level of our business activity as a result of a downturn in the markets in which our loans are
concentrated, negative operating results, or adverse regulatory action against us. Our ability to borrow could also
be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views
and expectations about the prospects for the financial services industry or deterioration in credit markets. Any
decline in available funding in amounts adequate to finance our activities or on terms which are acceptable could
adversely impact our ability to originate loans, invest in securities, meet our expenses, or fulfill obligations such
as repaying our borrowings or meeting deposit withdrawal demands, any of which could, in turn, have a material
adverse effect on our business, financial condition and results of operations.
Change in the programs offered by Fannie Mae or our ability to qualify for their programs may reduce our
mortgage revenues, which would negatively impact our non-interest income.
The sale of residential mortgage loans to Fannie Mae provides a significant portion of our non-interest income.
Any future changes in their program, our eligibility to participate in such program, the criteria for loans to be
accepted or laws that significantly affect the activity of Fannie Mae could, in turn, materially adversely affect our
results of operations if we could not find other purchasers. Mortgage banking is generally considered a volatile
source of income because it depends largely on the level of loan volume which, in turn, depends largely on
prevailing market interest rates. In a rising or higher interest rate environment, the demand for mortgage loans,
particularly refinancing of existing mortgage loans, tends to fall and our originations of mortgage loans may
decrease, resulting in fewer loans that are available to be sold. This would result in a decrease in mortgage
revenues and a corresponding decrease in non-interest income. In addition, our results of operations are affected
by the amount of non-interest expense associated with our loan sale activities, such as salaries and employee
benefits, occupancy, equipment and data processing expense and other operating costs. During periods of reduced
loan demand, our results of operations may be adversely affected to the extent that we are unable to reduce
expenses commensurate with the decline in loan originations. In addition, although we sell loans to Fannie Mae
or into the secondary market without recourse, we are required to give customary representations and warranties
about the loans we sell. If we breach those representations and warranties, we may be required to repurchase the
loans and we may incur a loss on the repurchase.
Our growth or future losses may require us to raise additional capital in the future, but that capital may not
be available when it is needed, or the cost of that capital may be very high.
We are required by federal regulatory authorities to maintain adequate levels of capital to support our operations.
At some point, we may need to raise additional capital to support our growth or replenish future losses. Our
ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which
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are outside our control, and on our financial condition and performance. If we are able to raise capital it may not
be on terms that are acceptable to us. Accordingly, we cannot make assurances that we will be able to raise
additional capital if needed on terms that are acceptable to us, or at all. If we cannot raise additional capital
when needed, our ability to further expand our operations could be materially impaired and our financial
condition and liquidity could be materially and adversely affected. In addition, any additional capital we obtain
may result in the dilution of the interests of existing holders of our common stock. Further, if we are unable to
raise additional capital when required by our bank regulators, we may be subject to adverse regulatory action.
Severe weather, natural disasters, or other catastrophes could significantly impact or business.
Severe weather, natural disasters, widespread disease or pandemics, acts of war or terrorism or other adverse
external events could have a significant impact on our ability to conduct business. In addition, such events could
affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans and leases,
impair the value of collateral securing loans, cause significant property damage, result in loss of revenue or cause
us to incur additional expenses. The occurrence of any of these events in the future could have a material
adverse effect on our business, financial condition or results of operations.
Our framework for managing risks may not be effective in mitigating risk and loss to us.
We have established processes and procedures intended to identify, measure, monitor, report, analyze and control
the types of risk to which we are subject. These risks include liquidity risk, credit risk, market risk, interest rate
risk, operational risk, legal and compliance risk, and reputational risk, among others. We also maintain a
compliance program to identify, measure, assess, and report on our adherence to applicable laws, policies and
procedures. While we assess and improve these programs on an ongoing basis, there can be no assurance that our
risk management or compliance programs, along with other related controls, will effectively mitigate all risk and
limit losses in our business. As with any risk management framework, there are inherent limitations to our risk
management strategies as there may exist, or develop in the future, risks that we have not appropriately
anticipated or identified. If our risk management framework proves ineffective, we could suffer unexpected losses
which could have a material adverse effect on our financial condition and results of operations.
Our business may be adversely affected by an increasing prevalence of fraud and other financial crimes.
As a bank, we are susceptible to fraudulent activity that may be committed against us or our customers which
may result in financial losses or increased costs to us or our customers, disclosure or misuse of our information
or our customer’s information, misappropriation of assets, privacy breaches against our customers, litigation or
damage to our reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud,
wire fraud, phishing, social engineering and other dishonest acts. Nationally, reported incidents of fraud and other
financial crimes have increased. We have also experienced losses due to apparent fraud and other financial
crimes. While we have policies and procedures designed to prevent such losses, there can be no assurance that
such losses will not occur.
As a community bank, maintaining our reputation in our market area is critical to the success of our
business, and the failure to do so may materially adversely affect our performance.
We are a community bank and our reputation is one of the most valuable components of our business. A key
component of our business strategy is to rely on our reputation for customer service and knowledge of local
markets to expand our presence by capturing new business opportunities from existing and prospective customers
in our current market and contiguous areas. As such, we strive to conduct our business in a manner that enhances
our reputation. This is done, in part, by recruiting, hiring and retaining employees who share our core values of
being an integral part of the communities we serve, delivering superior service to our customers and caring about
our customers and associates. We provide many different financial products and rely on the ability of our
employees and systems to process a significant number of transactions. If our reputation is negatively affected by
the actions of our employees, by our inability to conduct our operations in a manner that is appealing to current
or prospective customers, or otherwise, our business and, therefore, our operating results may be materially
adversely affected.
Market-Related Risks
Fluctuating interest rates can adversely affect our profitability.
The rates we earn on our assets and the rates we pay on our liabilities are generally fixed for a contractual
period of time. Like many financial institutions, our liabilities generally have shorter contractual maturities than
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our assets. This imbalance can create significant earnings volatility because market interest rates change over
time. In addition, changes in interest rates can affect the average life of loans and mortgage-backed and related
securities. In a period of rising interest rates, the interest income we earn on our assets may not increase as
rapidly as the interest we pay on our liabilities. A decline in interest rates results in increased prepayments of
loans and mortgage-backed and related securities as borrowers refinance their debt to reduce their borrowing
costs. This creates reinvestment risk, which is the risk that we may not be able to reinvest prepayments at rates
that are comparable to the rates we earned on the prepaid loans or securities. Furthermore, an inverted interest
rate yield curve, where short-term interest rates (which are usually the rates at which financial institutions borrow
funds) are higher than long-term interest rates (which are usually the rates at which financial institutions lend
funds for fixed-rate loans) can reduce a financial institution’s net interest margin and create financial risk for
financial institutions that originate longer-term, fixed-rate mortgage loans.
Any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on
our financial condition, liquidity and results of operations. Changes in the level of interest rates also may
negatively affect the value of our assets and liabilities and ultimately affect our earnings. Interest rates are highly
sensitive to many factors that are beyond our control, including general economic conditions and policies of
various governmental and regulatory agencies, and in particular the Federal Reserve Board. We principally
manage interest rate risk by managing our volume and mix of our earning assets and funding liabilities. Changes
in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans
and investments and the amount of interest we pay on deposits and borrowings, but these changes could also
affect our ability to originate and/or sell loans and obtain deposits, the fair value of our financial assets and
liabilities, which could negatively impact shareholders’ equity, and our ability to realize gains from the sale of
such assets, and the ability of our borrowers to repay adjustable or variable rate loans. If the interest rates paid
on deposits and borrowings increase at a faster rate than the interest received on loans and other investments, our
net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely
affected if the interest rates received on loans and other investments decline more rapidly than the interest rates
paid on deposits and other borrowings. In a changing interest rate environment, we may not be able to manage
this risk effectively. If we are unable to manage interest rate risk effectively, our business, financial condition and
results of operations could be materially affected.
In an attempt to help the overall economy, the Federal Reserve kept interest rates low through its targeted Fed
Funds rate for a number of years, however, the Federal Reserve steadily increased the targeted Fed Funds rate in
2018 and 2017. Beginning in August 2019 the Federal Reserve has reduced the targeted Fed Funds rate 25 basis
points three times to a range of 1.50% to 1.75% at December 31, 2019 in response to some recent weaknesses in
economic data and indicated possible further decreases, subject to economic conditions. In a rare emergency
move, the Federal Reserve Board further lowered the targeted federal funds rate in March 2020, by a half-point
to a range of 1% to 1.25% in response to the evolving risks the coronavirus outbreak poses to the economy. If
the Federal Reserve decreases the targeted federal funds rates further, overall interest rates will likely decline,
which may negatively impact our net interest income. If the Federal Reserve increases the targeted federal funds
rates, overall interest rates will likely rise, which will positively impact our net interest income but may
negatively impact both the housing market by reducing refinancing activity and new home purchases and the
U.S. economy. For further discussion of how changes in interest rates could impact us, see ‘‘Part II, Item 7A.
Quantitative and Qualitative Disclosures About Market Risk’’ for additional information about our interest rate
risk management.
Changes in the valuation of our securities portfolio could hurt our profits and reduce our capital levels.
Our securities portfolio may be impacted by fluctuations in market value, potentially reducing accumulated other
comprehensive income and/or earnings. Fluctuations in market value may be caused by changes in market
interest rates, lower market prices for securities and limited investor demand. Management evaluates securities
for other-than-temporary impairment on a quarterly basis, with more frequent evaluation for selected issues. In
analyzing a debt issuer’s financial condition, management considers whether the securities are issued by the
federal government or its agencies, whether downgrades by bond rating agencies have occurred and industry
analysts’ reports. Changes in interest rates can also have an adverse effect on our financial condition, as our
available-for-sale securities are reported at their estimated fair value, and therefore are impacted by fluctuations
in interest rates. We increase or decrease our stockholders’ equity by the amount of change in the estimated fair
value of the available-for-sale securities, net of taxes. Declines in market value could result in
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other-than-temporary impairments of these assets, which would lead to accounting charges that could have a
material adverse effect on our net income and capital levels. As of December 31, 2019, we have no securities
that are deemed impaired.
Uncertainty relating to the London Interbank Offered Rate (‘‘LIBOR’’) calculation process and potential
phasing out of LIBOR may adversely affect our results of operations.
On July 27, 2017, the Chief Executive of the United Kingdom Financial Conduct Authority, which regulates
LIBOR, announced that it intends to stop persuading or compelling banks to submit rates for the calibration of
LIBOR to the administrator of LIBOR after 2021. The announcement indicates that the continuation of LIBOR
on the current basis cannot and will not be guaranteed after 2021. It is impossible to predict whether and to what
extent banks will continue to provide LIBOR submissions to the administrator of LIBOR or whether any
additional reforms to LIBOR may be enacted in the United Kingdom or elsewhere. At this time, no consensus
exists as to what rate or rates may become acceptable alternatives to LIBOR and it is impossible to predict the
effect of any such alternatives on the value of LIBOR-based securities and variable rate loans, or other securities
or financial arrangements, given LIBOR’s role in determining market interest rates globally. The Federal Reserve
Board, in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large
U.S. financial institutions, is considering replacing U.S. dollar LIBOR with a new index calculated by short-term
repurchase agreements, backed by Treasury securities (‘‘SOFR’’). SOFR is observed and backward looking,
which stands in contrast with LIBOR under the current methodology, which is an estimated forward-looking rate
and relies, to some degree, on the expert judgment of submitting panel members. Given that SOFR is a secured
rate backed by government securities, it will be a rate that does not consider bank credit risk (as is the case with
LIBOR). SOFR is therefore likely to be lower than LIBOR and is less likely to correlate with the funding costs
of financial institutions. Whether or not SOFR attains market traction as a LIBOR replacement tool remains in
question, although some transactions using SOFR have been completed in 2019, including by Fannie Mae. Both
Fannie Mae and Freddie Mac have recently announced that they will cease accepting adjustable rate mortgages
tied to LIBOR by the end of 2020 and will soon begin accepting mortgages based on SOFR. Uncertainty as to
the nature of alternative reference rates and as to potential changes or other reforms to LIBOR may adversely
affect LIBOR rates and the value of LIBOR-based loans, and securities in our portfolio. If LIBOR rates are no
longer available, and we are required to implement substitute indices for the calculation of interest rates under
our loan agreements with our borrowers, we may experience significant expenses in effecting the transition
which could have an adverse effect on our results of operations.
We may incur losses in the fair value of our mortgage servicing rights due to changes in prepayment rates.
Our mortgage servicing rights carry interest rate risk because the total amount of servicing fees earned, as well
as changes in fair-market value, fluctuate based on expected loan prepayments (affecting the expected average
life of a portfolio of residential mortgage servicing rights). The rate of prepayment of residential mortgage loans
may be influenced by changing national and regional economic trends, such as recessions or stagnating real
estate markets, as well as the difference between interest rates on existing residential mortgage loans relative to
prevailing residential mortgage rates. During periods of declining interest rates, many residential borrowers
refinance their mortgage loans. Changes in prepayment rates are therefore difficult for us to predict. The loan
administration fee income (related to the residential mortgage loan servicing rights corresponding to a mortgage
loan) decreases as mortgage loans are prepaid. Consequently, in the event of an increase in prepayment rates, we
would expect the fair value of portfolios of residential mortgage loan servicing rights to decrease along with the
amount of loan administration income received.
Risks Related to Information Systems and Security
A failure in or breach of our security systems or infrastructure, including breaches resulting from
cyber-attacks, could disrupt our businesses, result in the disclosure or misuse of confidential or proprietary
information, damage our reputation, increase our costs and cause losses.
Information security risks for financial institutions have increased in recent years in part because of the
proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct
financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists,
activists, and other external parties. Those parties also may attempt to fraudulently induce employees, customers,
or other users of our systems to disclose confidential information in order to gain access to our data or that of
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our customers. Our operations rely on the secure processing, transmission and storage of confidential information
in our computer systems and networks, either managed directly by us or through our data processing vendors. In
addition, to access our products and services, our customers may use personal computers, smartphones, tablet
PCs, and other mobile devices that are beyond our control systems. Although we believe we have robust
information security procedures and controls, we rely heavily on our third party vendors, technologies, systems,
networks and our customers’ devices all of which may become the target of cyber-attacks, computer viruses,
malicious code, unauthorized access, hackers or information security breaches that could result in the
unauthorized release, gathering, monitoring, misuse, loss, theft or destruction of our confidential, proprietary and
other information or that of our customers, or disrupt our operations or those of our customers or third parties.
To date we have not incurred any material losses relating to cyber-attacks or other information security breaches,
but there can be no assurance that we will not suffer such attacks, breaches and losses in the future. Our risk and
exposure to these matters remains heightened because of, among other things, the evolving nature of these threats
and our plans to continue to evolve our Internet banking and mobile banking channel. As a result, the continued
development and enhancement of our information security controls, processes and practices designed to protect
customer information, our systems, computers, software, data and networks from attack, damage or unauthorized
access remain a priority for our management. As cyber threats continue to evolve, we may be required to expend
significant additional resources to insure, modify or enhance our protective measures or to investigate and
remediate important information security vulnerabilities or exposures; however, our measures may be insufficient
to prevent all physical and electronic break-ins, denial of service and other cyber-attacks or security breaches.
Disruptions or failures in the physical infrastructure or operating systems that support our businesses and
customers, or cyber-attacks or security breaches of the networks, systems or devices that our customers use to
access our products and services could result in customer attrition, uninsured financial losses, the inability of our
customers to transact business with us, employee productivity losses, technology replacement costs, incident
response costs, violations of applicable privacy and other laws, regulatory fines, penalties or intervention,
additional regulatory scrutiny, reputational damage, litigation, reimbursement or other compensation costs, and/or
additional compliance costs, any of which could materially and adversely affect our results of operations or
financial condition.
The failure to protect our customers’ confidential information and privacy could adversely affect our business.
We are subject to federal and state privacy regulations and confidentiality obligations that, among other things
restrict the use and dissemination of, and access to, certain information that we produce, store or maintain in the
course of our business. We also have contractual obligations to protect certain confidential information we obtain
from our existing vendors and customers.
These obligations generally include protecting such confidential information in the same manner and to the same
extent as we protect our own confidential information, and in some instances may impose indemnity obligations
on us relating to unlawful or unauthorized disclosure of any such information.
If we do not properly comply with privacy regulations and contractual obligations that require us to protect
confidential information, or if we experience a security breach or network compromise, we could experience
adverse consequences, including regulatory sanctions, penalties or fines, increased compliance costs, remedial
costs such as providing credit monitoring or other services to affected customers, litigation and damage to our
reputation, which in turn could result in decreased revenues and loss of customers, all of which would have a
material adverse effect on our business, financial condition and results of operations.
The network and computer systems on which we depend could fail for reasons not related to security
breaches.
Our computer systems could be vulnerable to unforeseen problems other than a cyber-attack or other security
breach. Because we conduct a part of our business over the Internet and outsource several critical functions to
third parties, operations will depend on our ability, as well as the ability of third-party service providers, to
protect computer systems and network infrastructure against damage from fire, power loss, telecommunications
failure, physical break-ins or similar catastrophic events. Any damage or failure that causes interruptions in
operations may compromise our ability to perform critical functions in a timely manner (or may give rise to
perceptions of such compromise) and could have a material adverse effect on our business, financial condition
and results of operations as well as our reputation and customer or vendor relationships.
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We continually encounter technological change, and we may have fewer resources than many of our
competitors to invest in technological improvements.
The financial services industry is undergoing rapid technological changes with frequent introductions of new
technology-driven products and services. The effective use of technology increases efficiency and enables
financial institutions to better serve customers and to reduce costs. Our future success will depend, in part, upon
our ability to address the needs of our clients by using technology to provide products and services that will
satisfy client demands for convenience, as well as to create additional efficiencies in our operations. Many
national vendors provide turn-key services to community banks, such as Internet banking and remote deposit
capture that allow smaller banks to compete with institutions that have substantially greater resources to invest in
technological improvements. We may not be able, however, to effectively implement new technology-driven
products and services or be successful in marketing these products and services to our customers.
Regulatory-Related Risks
We are subject to extensive regulation that may restrict our activities, including declaring cash dividends or
capital distributions, and imposing financial requirements or limitations on the conduct of our business.
Our operations are subject to extensive regulation by federal, state and local governmental authorities, including
the FDIC, the Washington Department of Financial Institutions and the Federal Reserve Board, and to various
laws and judicial and administrative decisions imposing requirements and restrictions on part or all of our
operations. The laws, rules and regulations to which we are subject evolve and change frequently, including
changes that come from judicial or regulatory agency interpretations of laws and regulations outside of the
legislative process that may be more difficult to anticipate. We are subject to various examinations by our
regulators during the course of the year. Regulatory authorities who conduct these examinations have extensive
discretion in their supervisory and enforcement activities, including the authority to restrict our operations,
adversely reclassify our assets, determine the level of deposit insurance premiums assessed, require us to increase
our allowance for loan losses, require customer restitution and impose fines or other penalties.
Changes in regulation of our industry have the potential to create higher costs of compliance, including
short-term costs to meet new compliance standards, limit our ability to pursue business opportunities and increase
our exposure to potential litigation.
We operate in a highly regulated environment and may be adversely affected by changes in federal and state
laws and regulations that could increase our costs of operations.
The banking industry is extensively regulated. Federal banking regulations are designed primarily to protect the
deposit insurance funds and consumers, not to benefit a company’s shareholders. These regulations may
sometimes impose significant limitations on our operations. Certain significant federal and state banking
regulations that affect us are described in this report under the heading ‘‘Item 1. Business — How We Are
Regulated.’’ These regulations, along with the currently existing tax, accounting, securities, insurance, and
monetary laws, regulations, rules, standards, policies, and interpretations control the methods by which financial
institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting
and disclosures. These laws, regulations, rules, standards, policies, and interpretations are constantly evolving and
may change significantly over time. Any new regulations or legislation, change in existing regulation or
oversight, whether a change in regulatory policy or a change in a regulator’s interpretation of a law or regulation,
could have a material impact on our operations, increase our costs of regulatory compliance and of doing
business and adversely affect our profitability. In this regard, the U.S. Department of the Treasury’s Financial
Crimes Enforcement Network (‘‘FinCEN’’), published guidelines in 2014 for financial institutions servicing
marijuana businesses that are legal under state law. These guidelines generally allow us to work with
marijuana-related businesses that are operating in accordance with state laws and regulations, so long as we
comply with required regulatory oversight of their accounts with us. In addition, a marijuana financial services
bill is currently pending in Congress that would allow banks and financial institutions to serve marijuana
businesses in states where it is legal without any risk of federal prosecution. At December 31, 2019,
approximately 0.59% of our total deposits and a portion of our service charges from deposits are from legal
marijuana-related businesses. Any adverse change in this FinCEN guidance, any new regulations or legislation,
any change in existing regulations or oversight, whether a change in regulatory policy or a change in a
regulator’s interpretation of a law or regulation, could have a negative impact on our non-interest income, as well
as the cost of our operations, increasing our cost of regulatory compliance and of doing business and/or
otherwise affect us, which may materially affect our profitability.
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Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, or other laws and regulations could result in
fines or sanctions and limit our ability to get regulatory approval of acquisitions.
The USA PATRIOT and Bank Secrecy Acts require financial institutions to develop programs to prevent financial
institutions from being used for money laundering and terrorist activities. If such activities are suspected,
financial institutions are obligated to file suspicious activity reports with the U.S. Treasury’s Office of Financial
Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying
and verifying the identity of customers seeking to open new financial accounts. Failure to comply with these
regulations could result in fines or sanctions, including restrictions on pursuing acquisitions or establishing new
branches. The policies and procedures we have adopted that are designed to assist in compliance with these laws
and regulations may not be effective in preventing violations of these laws and regulations. Furthermore, these
rules and regulations continue to evolve and expand. Although to date we have not been subject to any fines or
other sanctions related to these rules and regulations, there can be no assurance that we will not suffer any
penalties or other consequences in the future.
Our accounting policies and methods are fundamental to how we report our financial condition and results of
operations, and we use estimates in determining the fair value of certain of our assets, which estimates may
prove to be imprecise and result in significant changes in valuation.
A portion of our assets are carried on the balance sheet at fair value, including investment securities available for
sale, mortgage servicing rights related to single family loans, and single family loans held for sale. Generally, for
assets that are reported at fair value, we use quoted market prices or valuation models that use observable market
data inputs to estimate their fair value. In certain cases, observable market prices and data may not be readily
available, or their availability may be diminished due to market conditions. We use financial models to value
certain of these assets. These models are complex and use asset-specific collateral data and market inputs for
interest rates. Although we have processes and procedures in place governing valuation models and their review,
such assumptions are complex as we must make judgments about the effect of matters that are inherently
uncertain. Different assumptions could result in significant changes in valuation, which in turn could affect
earnings or result in significant changes in the dollar amount of assets reported on the balance sheet.
Item 1B. Unresolved Staff Comments
Not applicable.
Item 2. Properties
Seven of our ten offices are leased. The operating leases contain renewal options and require us to pay property
taxes and operating expenses for the properties. Our total rental expense for each of the years ended
December 31, 2019 and 2018 was $1.2 million and $1.4 million, respectively. The aggregate net book value of
our land, buildings, leasehold improvements, furniture and equipment was $6.8 million at December 31, 2019.
See also Note 7 in the Notes to Consolidated Financial Statements contained in Item 8 of this report on
Form 10-K. In the opinion of management, the facilities are adequate and suitable for our current needs. We may
open additional banking offices to better serve current clients and to attract new clients in subsequent years.
We maintain depositor and borrower client files in a service bureau environment, utilizing a telecommunications
network, portions of which are leased. Management has a disaster recovery plan in place with respect to the data
processing system, as well as our operations as a whole.
Item 3. Legal Proceedings
From time to time we are involved as plaintiff or defendant in various legal actions arising in the normal course
of business. We do not anticipate incurring any material legal fees or other material liability as a result of such
litigation.
Item 4. Mine Safety Disclosures
Not applicable.
44
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities
The common stock of Sound Financial Bancorp is listed on The NASDAQ Capital Market under the symbol
‘‘SFBC.’’ There were approximately 276 stockholders of record of our common stock as of March 10, 2020
Our cash dividend payout policy is reviewed regularly by management and the Board of Directors. Any
dividends declared and paid in the future would depend upon a number of factors, including capital requirements,
our financial condition and results of operations, tax considerations, statutory and regulatory limitations, and
general economic conditions. No assurances can be given that any dividends will be paid or that, if paid, will not
be reduced or eliminated in future periods. Our future payment of dividends may depend, in part, upon receipt of
dividends from Sound Community Bank, which are restricted by federal regulations.
Equity Compensation Plan Information
The equity compensation plan information presented in Part III, Item 12 of this Form 10-K is incorporated herein
by reference.
Issuer Purchases of Equity Securities
The following table sets forth information with respect to our repurchases of our outstanding common shares
during the three months ended December 31, 2019:
Total Number
of Shares
Purchased
Average Price
Paid per Share
October 1, 2019 - October 31, 2019 . . . . . . . . .
November 1, 2019 - November 30, 2019 . . . . .
December 1, 2019 - December 31, 2019 . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
—
—
—
—
$—
—
—
$—
Total number of
shares purchased
as part of
publicly
announced plans
or programs
Approximated
dollar value of
shares that may yet
be purchased under
the plans or
programs (1)
—
—
—
—
$1,750,000
1,750,000
1,750,000
$1,750,000
(1) The Company may repurchase shares of its common stock from time-to-time in open market transactions.
The timing, volume and price of purchases are made at our discretion, and are contingent upon our overall
financial condition, as well as general market conditions.
In July 2019, the Company’s Board of Directors extended the existing stock repurchase program until the earlier
of the completion of the repurchase program or February 5, 2020. Under this repurchase program, the Company
may repurchase its outstanding shares in the open market in an amount up to $1,750,000, based on prevailing
market prices, or in privately negotiated transactions.
45
Item 6. Selected Financial Data
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
The following table sets forth certain information concerning the Company’s consolidated financial position and
results of operations at and for the dates indicated and have been derived from the audited consolidated financial
statements. The information below is qualified in its entirety by the detailed information included elsewhere
herein and should be read along with Item 7., ‘‘Management’s Discussion and Analysis of Financial Condition
and Results of Operations’’ and Item 8., ‘‘Financial Statements and Supplementary Data.’’ (In thousands)
Selected Financial Condition Data:
Total assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total loans held for portfolio, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loans held-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Available for sale securities, at fair value . . . . . . . . . . . . . . . . . . . . . . . . . .
Bank-owned life insurance, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other real estate owned and repossessed assets, net . . . . . . . . . . . . . . . . . .
FHLB stock, at cost. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total deposits. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Borrowings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Selected Operations Data:
Total interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(Recapture) provision for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net interest income after (recapture) provision for loan losses . . . . . . . . .
Service charges and fee income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Earnings on cash surrender value of Bank Owned Life Insurance. . . . . . .
Mortgage servicing income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fair value adjustment on mortgage servicing rights . . . . . . . . . . . . . . . . . .
Net gain on sale of loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total noninterest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Salaries and benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Operations expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Occupancy expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net losses and expenses on OREO and repossessed assets . . . . . . . . . . . .
Other noninterest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total noninterest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income before provision for income taxes. . . . . . . . . . . . . . . . . . . . . . . . . .
Provision for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
As of December 31,
2018
2017
2019
$719,853
614,247
1,063
9,306
14,183
575
1,160
616,718
7,500
$ 77,726
$716,735
613,769
1,172
4,957
13,365
575
4,134
553,601
84,000
$ 71,627
$645,244
543,354
1,777
5,435
12,750
610
3,065
514,400
59,000
$ 65,160
Year Ended December 31,
2018
2017
2019
$34,581
7,617
26,964
(125)
27,089
1,954
381
1,002
(760)
1,449
—
4,026
12,402
5,905
2,060
35
2,383
22,785
8,330
1,651
$33,167
5,360
27,807
525
27,282
1,876
320
1,075
(513)
1,038
490
4,286
12,775
5,472
2,139
86
2,351
22,823
8,745
1,706
$27,449
3,368
24,081
500
23,581
1,895
327
1,106
(540)
1,071
—
3,859
10,733
4,348
1,889
110
2,167
19,247
8,193
3,068
Net income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 6,679
$ 7,039
$ 5,125
46
Year Ended December 31,
2018
2017
2019
Selected Financial Ratios and Other Data:
Performance ratios:
Return on assets (ratio of net income to average total assets). . . . . . . . . . . . .
Return on equity (ratio of net income to average equity) . . . . . . . . . . . . . . . .
Dividend payout ratio. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Interest rate spread information: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Average during period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
End of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net interest margin(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Noninterest income to total net revenue (2). . . . . . . . . . . . . . . . . . . . . . . . . . . .
Noninterest expense to average total assets . . . . . . . . . . . . . . . . . . . . . . . . . . .
Average interest-earning assets to average interest-bearing liabilities . . . . . . .
Efficiency ratio (3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Asset quality ratios:
Nonperforming assets to total assets at end of period . . . . . . . . . . . . . . . . . . .
Nonperforming loans to total loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Allowance for loan losses to nonperforming loans . . . . . . . . . . . . . . . . . . . . .
Allowance for loan losses to total loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net charge-offs to average loans outstanding . . . . . . . . . . . . . . . . . . . . . . . . . .
Capital ratios:
Equity to total assets at end of period. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Average equity to average assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other data:
Number of full service offices. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
0.95%
8.90
21.47
1.03%
10.24
19.42
0.87%
8.13
29.37
3.74
3.83
4.06
12.99
3.23
128.25
73.52
4.06
4.11
4.28
13.35
3.34
125.94
71.12
4.15
3.95
4.30
13.81
3.25
123.93
68.89
0.73%
0.75
121.11
0.91
—
0.45%
0.43
216.50
0.93
—
0.45%
0.42
229.57
0.96
0.02
10.80%
10.64%
9.99%
10.08%
10.10%
10.64%
8
8
7
(1) Net interest income divided by average interest earning assets.
(2) Noninterest income divided by the sum of noninterest income and net interest income.
(3) Noninterest expense divided by total revenue (net interest income and noninterest income).
47
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This discussion and analysis reviews our consolidated financial statements and other relevant statistical data and
is intended to enhance your understanding of our financial condition and results of operations. The information in
this section has been derived from the Consolidated Financial Statements and footnotes thereto that appear in
Item 8 of this Form 10-K. The information contained in this section should be read in conjunction with these
Consolidated Financial Statements and footnotes and the business and financial information provided in this
Form 10-K.
Overview
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, 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 owner-occupied and nonowner-occupied commercial
real estate, multifamily property, mobile home parks and construction and land development loans.
We originated $129.0 million, $112.5 million and $109.7 million of one-to four-family residential mortgage loans
during the years ended December 31, 2019, 2018 and 2017, respectively. During these same periods, we sold
$78.9 million, $50.0 million and $52.0 million, respectively, of one- to four-family residential mortgage loans.
Our operating revenues are derived principally from earnings on interest earning assets, service charges and fees,
and gains on the sale of loans. Our primary sources of funds are deposits (both retail and brokered), FHLB
advances, and payments received on loans and securities. We offer a variety of deposit accounts that provide a
wide range of interest rates and terms, including savings, money market, NOW, interest bearing and noninterest
bearing demand accounts, and certificates of deposit.
Our noninterest expenses consist primarily of salaries, employee benefits, incentive pay, expenses for occupancy,
online and mobile services, marketing, professional fees, data processing, charitable contributions, FDIC deposit
insurance premiums and regulatory expenses. Salaries and benefits consist primarily of the salaries paid to our
employees, payroll taxes, directors’ fees, retirement expenses, share-based compensation and other employee
benefits. Occupancy expenses, which are the fixed and variable costs of buildings and equipment, consist
primarily of lease payments, property taxes, depreciation charges, maintenance and the cost of utilities.
Our strategic plan targets consumers, small and medium size businesses, and professionals in our market area for
loans and deposits. In pursuit of these goals and by managing the size of our loan portfolio, we focus on
including a significant amount of commercial business and commercial and multifamily real estate loans in our
portfolio. A significant portion of these loans have adjustable rates, higher yields or shorter terms and higher
credit risk than traditional fixed-rate mortgages. Our commercial loan portfolio (commercial and multifamily real
estate and commercial business loans) increased to $300.2 million or 48.3% of our loan portfolio at
December 31, 2019, from $291.4 million or 46.8% of our loan portfolio at December 31, 2018, and
$252.1 million or 45.8% of our loan portfolio at December 31, 2017. In addition to higher balances in
commercial lending, we also benefit from additional lending opportunities in our consumer loan portfolio. Our
consumer loan portfolio, which includes manufactured and floating homes and other consumer loans, increased to
$72.7 million or 11.7% of our loan portfolio at December 31, 2019, from $67.6 million or 10.9% of our loan
portfolio at December 31, 2018, and $51.1 million or 9.3% of our loan portfolio as of December 31, 2017.
Additional commercial and multifamily real estate and consumer loans have improved our net interest income
and helped diversify our loan portfolio mix.
48
Our recapture from the allowance for loan losses was $125,000 for the year ended December 31, 2019, compared
to a provision for loan losses expense of $525,000 and $500,000 for the years ended December 31, 2018 and
2017, respectively. The recapture in the current year was due to changes in the composition and size of our loan
portfolio during the year.
Recent Accounting Standards
For a discussion of recent accounting standards, please see Note 2 - Accounting Pronouncements Recently Issued
or Adopted in the Notes to Consolidated Financial Statements contained in Item 8 of this report on Form 10-K.
Critical Accounting Policies
Certain of our accounting policies are important to an understanding of our financial condition, since they require
management to make difficult, complex or subjective judgments, which may relate to matters that are inherently
uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in
facts and circumstances. Facts and circumstances that could affect these judgments include, but are not limited
to, changes in interest rates, changes in the performance of the economy and changes in the financial condition
of borrowers. Management believes that its critical accounting policies include determining the allowance for
loan losses, accounting for other-than-temporary impairment of securities, accounting for mortgage servicing
rights, accounting for other real estate owned, and accounting for deferred income taxes. For additional
information on our accounting policies see ‘‘Note 1 — Organization and Significant Accounting Policies’’ in the
Notes to Consolidated Financial Statements contained in Item 8 of this report on Form 10-K.
Allowance for Loan Loss. The allowance for loan losses is the amount estimated by management as necessary
to cover losses inherent in the loan portfolio as of the balance sheet date. The allowance is established through
the provision for loan losses, which is charged to income. Determining the amount of the allowance for loan
losses necessarily involves a high degree of subjectivity and requires us to make various assumptions and
judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the
value of the real estate and other assets serving as collateral for the repayment of many of our loans. Among the
material estimates required to establish the allowance are: loss exposure at default; the amount and timing of
future cash flows on impaired loans; value of collateral; and determination of historical and current loss factors
to be applied to the various elements of the portfolio. All of these estimates are susceptible to significant change.
Management reviews the level of the allowance at least quarterly and establishes the provision for loan losses
based upon an evaluation of the portfolio, past loss experience, current economic conditions and other factors
related to the collectability of the loan portfolio. To strengthen our loan review and classification process, we
engage an independent consultant to review our classified loans and a significant sample of recently originated
non-classified loans annually. We also enhanced our credit administration policies and procedures to improve our
maintenance of updated financial data on commercial borrowers. While we believe the estimates and assumptions
used in our determination of the adequacy of the allowance are reasonable, there can be no assurance that such
estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future
provisions will not exceed the amount of past provisions or that any increased provisions that may be required
will not adversely impact our financial condition and results of operations. In addition, the determination of the
amount of our allowance for loan losses is subject to review by bank regulators as part of the routine
examination process, which may result in the adjustment of reserves based upon their judgment of information
available to them at the time of their examination.
Other-than-temporary impairment of securities. Management reviews investment securities on an ongoing
basis for the presence of other-than-temporary impairment (‘‘OTTI’’), taking into consideration current market
conditions; fair value in relationship to cost; extent and nature of the change in fair value; issuer rating changes
and trends; whether management intends to sell a security or if it is likely that we will be required to sell the
security before recovery of the amortized cost basis of the investment, which may be upon maturity; and other
factors. For debt securities, if management intends to sell the security or it is likely that we will be required to
sell the security before recovering our cost basis, the entire impairment loss would be recognized in earnings as
an OTTI. If management does not intend to sell the security and it is not more likely than not that we will be
required to sell the security, but management does not expect to recover the entire amortized cost basis of the
security, only the portion of the impairment loss representing credit losses would be recognized in earnings. The
credit loss on a security is measured as the difference between the amortized cost basis and the present value of
the cash flows expected to be collected. Projected cash flows are discounted by the original or current effective
49
interest rate depending on the nature of the security being measured for potential OTTI. The remaining
impairment related to all other factors, i.e., the difference between the present value of the cash flows expected
to be collected and fair value, is recognized as a charge to other comprehensive income (loss). Impairment losses
related to all other factors are presented as separate components within accumulated other comprehensive income
(loss).
Mortgage Servicing Rights. We record mortgage servicing rights on loans sold to Fannie Mae with servicing
retained as well as for acquired servicing rights. We stratify our capitalized mortgage servicing rights based on
the type, term and interest rates of the underlying loans. Mortgage servicing rights are carried at fair value. The
value is determined through a discounted cash flow analysis, which uses interest rates, prepayment speeds and
delinquency rate assumptions as inputs. All of these assumptions require a significant degree of management
judgment. If our assumptions prove to be incorrect, the value of our mortgage servicing rights could be
negatively impacted. We use a third party to assist us in the preparation of the analysis of the market value each
quarter.
Other Real Estate Owned. Other real estate owned (‘‘OREO’’) represents real estate that we have taken control
of in partial or full satisfaction of significantly delinquent loans. At the time of foreclosure, OREO is recorded at
the fair value less costs to sell, which becomes the property’s new basis. Any write-downs based on the asset’s
fair value at the date of acquisition are charged to the allowance for loan and lease losses. After foreclosure,
management periodically performs valuations such that the real estate is carried at the lower of its new cost basis
or fair value, net of estimated costs to sell. Subsequent valuation adjustments are recognized within net (loss)
gain on OREO. Revenue and expenses from operations and subsequent adjustments to the carrying amount of the
property are included in other non-interest expense in the consolidated statements of income. In some instances,
we may make loans to facilitate the sales of OREO. Management reviews all sales for which it is the lending
institution for compliance with sales treatment under provisions established by ASC Topic 360, ‘‘Accounting for
Sales of Real Estate’’. Any gains related to sales of OREO are deferred until the buyer has a sufficient initial and
continuing investment in the property.
Income Taxes. Income taxes are reflected in our financial statements to show the tax effects of the operations
and transactions reported in the financial statements and consist of taxes currently payable plus deferred taxes.
ASC Topic 740, ‘‘Accounting for Income Taxes,’’ requires the asset and liability approach for financial
accounting and reporting for deferred income taxes. Deferred tax assets and liabilities result from differences
between the financial statement carrying amounts and the tax bases of assets and liabilities. They are reflected at
currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are
expected to be realized or settled and are determined using the assets and liability method of accounting. The
deferred income provision represents the difference between net deferred tax asset/liability at the beginning and
end of the reported period. In formulating our deferred tax asset, we are required to estimate our income and
taxes in the jurisdiction in which we operate. This process involves estimating our actual current tax exposure for
the reported period together with assessing temporary differences resulting from differing treatment of items,
such as depreciation and the provision for loan losses, for tax and financial reporting purposes. Valuation
allowances are established to reduce the net carrying amount of deferred tax assets if it is determined to be more
likely than not all or some portion of the potential deferred tax asset will not be realized.
Business and Operating Strategies and Goals
Our goal is to deliver returns to stockholders by increasing higher-yielding assets (including consumer,
commercial and multifamily real estate and commercial business loans), increasing lower costing core deposit
balances, managing expenses, managing problem assets and exploring expansion opportunities. We seek to
achieve these results by focusing on the following objectives:
Focusing on Asset Quality. We believe that strong asset quality is a key to our long-term financial success. We
are focused on monitoring existing performing loans, resolving nonperforming assets and selling foreclosed
assets. Nonperforming assets were $5.2 million, or 0.73% of total assets, at December 31, 2019 compared to
$3.2 million or 0.45% of total assets, at December 31, 2018. We continue to seek to reduce the level of
non-performing assets through collections, modifications and sales of OREO. We also take proactive steps to
resolve our non-performing loans, including negotiating payment plans, forbearances, loan modifications and loan
extensions on delinquent loans when such actions have been deemed appropriate. Our goal is to maintain or
improve upon our level of nonperforming assets by managing all segments of our loan portfolio in order to
proactively identify and mitigate risk.
50
Improving Earnings by Expanding Product Offerings. We intend to prudently maintain the percentage of our
assets consisting of higher-yielding commercial and multifamily real estate and commercial business loans, which
offer higher risk-adjusted returns, shorter maturities and more sensitivity to interest rate fluctuations than
one-to-four family mortgage loans while maintaining our focus on residential lending. In addition, we continue to
focus on consumer products, such as floating and manufactured homes loans. With our long experience and
expertise in residential lending we believe we can be effective in capturing mortgage banking opportunities and
grow consumer deposits. We continue to develop correspondent relationships to sell nonconforming mortgage
loans servicing-released. We also intend to selectively add additional products to further diversify revenue
sources and to capture more of each client’s banking relationship by offering additional services to our clients.
We continue to refine our products and services for additional business and automate services, such as
automating consumer loans originations this past year, in an effort to improve customer service. We intend to
further build relationships with medium and small businesses through new and improving existing service
offerings including remote deposit.
Emphasizing lower cost core deposits to manage the funding costs of our loan growth. Our strategic focus is
to emphasize total relationship banking with our clients to internally fund our loan growth. We also emphasize
reducing wholesale funding sources, including FHLB advances, through the continued growth of core deposits.
We believe that a continued focus on client relationships will help increase the level of core deposits and retail
certificates of deposit from consumers and businesses in our market area. We intend to increase demand deposits
by growing retail and business banking relationships. New technology and services are generally reviewed for
business development and cost saving opportunities. We continue to experience growth in client use of our online
and mobile banking services, which allow clients to conduct a full range of services on a real-time basis,
including balance inquiries, transfers and electronic bill paying while providing our clients greater flexibility and
convenience in conducting their banking. In addition to our retail branches, we maintain state of the art
technology-based products, such as business cash management, business remote deposit products, business and
consumer mobile banking applications and consumer remote deposit products. Total deposits increased to
$616.7 million, which includes $8.0 million of brokered deposits at December 31, 2019, from $553.6 million at
December 31, 2018, and $514.4 million at December 31, 2017. At December 31, 2019, core deposits, which we
define as our non-time deposit accounts and time deposit accounts of less than $250,000, increased $22.1 million
to $491.3 million, while FHLB advances decreased $76.5 million to $7.5 million from December 31, 2018.
Maintaining Our Client Service Focus. Exceptional service, local involvement (including volunteering and
contributing to the communities where we do business) and timely decision-making are integral parts of our
business strategy. Our employees understand the importance of delivering exemplary customer service and
seeking opportunities to build relationships with our clients to enhance our market position and add profitable
growth opportunities. We compete with other financial service providers by relying on the strength of our
customer service and relationship banking approach. We believe that one of our strengths is that our employees
are also significant stockholders through our employee stock ownership (‘‘ESOP’’) and 401(k) plans. We also
offer incentives that are designed to reward employees for achieving high quality client relationship growth.
Expanding our presence, including through digital channels and streamlining operations, within our
existing and contiguous market areas and by capturing business opportunities resulting from changes in
the competitive environment. We believe that opportunities currently exist within our market area to grow our
franchise. We anticipate continued organic growth as the local economy and loan demand remains strong,
through our marketing efforts and as a result of the opportunities created as a result of the consolidation of
financial institutions that is occurring in our market area. In addition, by delivering high quality, client-focused
products and services, we expect to attract additional borrowers and depositors and thus increase our market
share and revenue generation. We continue to be disciplined as it pertains to future expansion, acquisitions and
de novo branching focusing on the markets in Western Washington, which we know and understand.
Comparison of Financial Condition at December 31, 2019 and December 31, 2018
General. Total assets increased by $3.2 million, or 0.4%, to $719.9 million at December 31, 2019 from
$716.7 million at December 31, 2018. The increase was primarily a result of the capitalization of right of use
assets of $7.6 million, combined with a higher balance in available for sale securities, which increased
$4.3 million, partially offset by decreases in cash and cash equivalents of $6.0 million and in FHLB stock. FHLB
51
stock decreased $2.9 million to $1.2 million at December 31, 2019, from $4.1 million at December 31, 2018, as
a result of reduced borrowing needs due to deposit growth. The adoption of accounting guidance for leases
(‘‘ASU 2016-02’’) in 2019 required the Company to recognize right of use lease assets and corresponding lease
liabilities on the balance sheet.
Cash and Securities. Cash, cash equivalents and our available-for-sale securities decreased $1.7 million, or
2.5%, to $65.1 million at December 31, 2019. Cash and cash equivalents decreased $6.0 million, or 9.8%, to
$55.8 million at December 31, 2019. The decrease in total cash and cash equivalents, combined with our deposit
growth was primarily utilized to fund loan originations, purchases of investment securities and reduce FHLB
borrowings during the year. Available-for-sale securities, which consist primarily of agency mortgage-backed
securities, increased $4.3 million, or 86.0%, to $9.3 million at December 31, 2019 from $5.0 million at
December 31, 2018, primarily as a result of investment securities purchased during the year.
At December 31, 2019, our securities portfolio consisted of 13 agency mortgage-backed securities and eight
municipal securities with a fair value of $9.3 million. At December 31, 2018, our securities portfolio consisted of
six agency mortgage-backed securities and eight municipal bonds with a fair value of $5.0 million.
During the year ended December 31, 2019 we did not recognize any non-cash OTTI charges on our investment
securities. At December 31, 2019, five agency mortgage-backed securities had unrealized losses but management
determined the decline in value was not related to specific credit deterioration. The unrealized losses were caused
by changes in interest rates and the widening of market spreads subsequent to purchase of these securities. We do
not intend to sell these securities and it is more likely than not that we will not be required to sell these
securities before anticipated recovery of the remaining amortized cost basis.
Loans. Loans held for portfolio, net, excluding loans held-for-sale, increased $478,000, or 0.1%, to
$614.2 million at December 31, 2019 from $613.8 million at December 31, 2018. Loans held-for-sale decreased
to $1.1 million at December 31, 2019 from $1.2 million at December 31, 2018.
The following table reflects the changes in the loan mix, excluding deferred fees, of our portfolio at
December 31, 2019, as compared to December 31, 2018 (dollars in thousands):
December 31,
2019
2018
Amount
Change
Percent
Change
One-to-four family . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Home equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial and multifamily . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Construction and land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Manufactured homes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Floating homes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other consumer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$149,393
23,845
261,268
75,756
20,613
43,799
8,302
38,931
$169,830
27,655
252,644
65,259
20,145
40,806
6,628
38,804
$(20,437)
(3,810)
8,624
10,497
468
2,993
1,674
127
(12.0)%
(13.8)
3.4
16.1
2.3
7.3
25.3
0.3
Total loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$621,907
$621,771
$
136
—%
All categories of our loan portfolio increased at December 31, 2019, compared to December 31, 2018, except for
one-to-four family and home equity loan portfolios. The largest dollar increases in the loan portfolio were in
construction and land loans which increased $10.5 million, or 16.1%, to $75.8 million, commercial and
multifamily loans which increased $8.6 million, or 3.4%, to $261.3 million, floating homes loans which
increased $3.0 million, or 7.3%, to $43.8 million, and other consumer loans which increased $1.7 million, or
25.3%, to $8.3 million. These increases were offset by decreases in the one-to-four family loans portfolio, which
decreased $20.4 million, or 12.0%, to $149.4 million primarily as a result of the sale of $16.2 million of
residential loans during the first quarter of 2019, and the home equity loan portfolio, which decreased
$3.8 million, or 13.8%, to $23.8 million.
The increase in our commercial and multifamily real estate loan portfolio was primarily a result of opportunities
in the markets where we do business and an emphasis by our commercial lenders to originate these types of
loans. Commercial and multifamily real estate loans are generally higher yielding loans and have contributed to
diversifying our loan portfolio. We have also experienced appreciation in residential market prices and have low
inventory of homes for sale due to continued strong demand. Floating and manufactured home loans increased as
52
a result of increased demand for these types of loans by well-qualified borrowers coupled with less competition
for these types of loans. The loan portfolio remains well-diversified with commercial and multifamily real estate
loans accounting for 42.0% of the portfolio, one-to-four family real estate loans, including home equity loans
accounting for approximately 27.9% of the portfolio and consumer loans, consisting of manufactured homes,
floating homes, and other consumer loans accounting for 11.7% of the total loans portfolio at December 31,
2019. Construction and land loans accounted for 12.2% of the portfolio and commercial business loans accounted
for the remaining 6.3% of the portfolio at December 31, 2019.
Mortgage Servicing Rights. The fair value of mortgage servicing rights was $3.2 million at December 31, 2019,
compared to $3.4 million at December 31, 2018. We record mortgage servicing rights on loans sold with
servicing retained and upon acquisition of a servicing portfolio. We stratify our capitalized mortgage servicing
rights based upon the type, term and interest rates of the underlying loans. Mortgage servicing rights are carried
at fair value. If the fair value of our mortgage servicing rights fluctuates significantly, our financial results could
be materially impacted.
Nonperforming Assets. At December 31, 2019, our nonperforming assets totaled $5.2 million, or 0.73% of total
assets, compared to $3.2 million, or 0.45% of total assets at December 31, 2018.
The table below sets forth the amounts and categories of nonperforming assets in our loan portfolio at the dates
indicated (dollars in thousands):
Nonaccrual loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
OREO and repossessed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total nonperforming assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
December 31,
2019
$4,657
575
$5,232
2018
$2,667
575
$3,242
Amount
Change
$1,990
—
$1,990
Percent
Change
74.6%
—
61.4%
Nonaccrual loans increased $2.0 million or 74.6%, to $4.7 million at December 31, 2019, compared to the prior
year. Nonaccrual loans were 0.75% of total loans at December 31, 2019, compared to 0.43% of total loans at
December 31, 2018. We had no loans greater than 90 days delinquent and still accruing at December 31, 2019
and 2018.
OREO and repossessed assets were $575,000 at both December 31, 2019 and 2018. OREO and repossessed
assets at December 31, 2019 consisted solely of a former bank branch property located in Port Angeles,
Washington which was acquired in 2015 as a part of three branches purchased from another financial institution.
It is currently leased to a not-for-profit organization headquartered in our market area at a below market rate. We
sold one residential OREO property during 2019 resulting in a net loss of $21,000 and one residential OREO
property in 2018 resulting in a net loss of $74,000.
Allowance for Loan Losses. The allowance for loan losses is maintained to cover losses that are probable and
can be estimated on the date of evaluation in accordance with generally accepted accounting principles in the
United States. It is our best estimate of probable incurred credit losses in our loan portfolio.
53
The following table reflects the adjustments in our allowance during 2019 and 2018 (dollars in thousands):
Balance at beginning of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Charge-offs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Recoveries. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 5,774
(52)
43
$ 5,241
(50)
58
Net (charge-offs) recoveries. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(Recapture) provision charged to operations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(9)
(125)
8
525
Balance at end of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 5,640
$ 5,774
Year Ended December 31,
2019
2018
Ratio of net (charge-offs) recoveries during the period to average loans outstanding
during the period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Allowance as a percentage of nonperforming loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Allowance as a percentage of total loans (end of period) . . . . . . . . . . . . . . . . . . . . . . . . . . . .
—%
—%
121.11% 216.50%
0.93%
0.91%
Our allowance for loan losses decreased $134,000, or 2.32%, to $5.6 million at December 31, 2019, from
$5.8 million at December 31, 2018. We recorded a recapture from the allowance for loan losses of $125,000 for
the year ended December 31, 2019, compared to a provision for loan losses of $525,000 for the year ended
December 31, 2018. The recapture in the current year was due to changes in the composition and size of our
loan portfolio during the year.
Specific loan loss reserves decreased to $724,000 at December 31, 2019 compared to $736,000 at December 31,
2018, while general loan loss reserves stayed consistent at $4.0 million at December 31, 2019 and 2018,
respectively, and the unallocated reserve decreased to $948,000 at December 31, 2019, compared to $1.0 million
at December 31, 2018.
The overall decrease in the allowance for loan losses was primarily due to changes in the composition of our
loan portfolio during the year, largely as a result of the sale of $16.2 million of residential loans during the first
quarter of 2019. Loans individually evaluated for impairment increased to $12.4 million at December 31, 2019,
compared to $5.9 million at December 31, 2018. Net charge-offs were $9,000 for the year ended December 31,
2019, compared to net recoveries of $8,000 for the year ended December 31, 2018. At December 31, 2019, the
allowance for loan losses as a percentage of total loans and nonperforming loans was 0.91% and 121.11%,
respectively, compared to 0.93% and 216.50%, respectively, at December 31, 2018.
Deposits. Total deposits increased $63.1 million, or 11.4%, to $616.7 million at December 31, 2019 from
$553.6 million at December 31, 2018. The increase was primarily due to increases in certificates of deposit,
savings and money market deposits, partially offset by a $5.1 million, or 3.1% decrease in interest bearing
demand deposits. The certificates of deposits increased $59.6 million, or 31.1%, to $251.4 million at
December 31, 2019 from $164.9 million at December 31, 2018, savings increased $3.8 million, or 7.1%, to
$57.9 million at December 31, 2019 from $54.1 million at December 31, 2018, and money market deposits
increased $3.6 million, or 7.8%, to $50.3 million at December 31, 2019 from $46.7 million at December 31,
2018. The increase at December 31, 2019 compared to December 31, 2018 was a result of our effort to grow
deposits, which allowed us to reduce our reliance on higher cost FHLB borrowings and stabilize our cost of
funds during the year. The year over year increase in deposits included $8.0 million of brokered deposits at
December 31, 2019. There were no brokered deposits outstanding at December 31, 2018.
54
A summary of deposit accounts with the corresponding weighted-average cost at December 31, 2019 and 2018 is
presented below (dollars in thousands):
December 31, 2019
December 31, 2018
Noninterest-bearing demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Interest-bearing demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Savings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Money market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Certificates. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Escrow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amount
$ 94,973
159,774
57,936
50,337
251,387
2,311
$616,718
Wtd. Avg.
Rate
Amount
—% $ 93,823
164,919
54,102
46,689
191,825
2,243
1.16% $553,601
0.54
0.33
0.49
2.23
—
Wtd. Avg.
Rate
—%
0.47
0.29
0.24
1.58
—
0.71%
Borrowings. FHLB advances decreased $76.5 million, or 91.1%, to $7.5 million at December 31, 2019, with a
weighted-average cost of 3.05%, from $84.0 million at December 31, 2018, with a weighted-average cost of
2.72%, as we utilized our increase in deposits for funding needs. We rely on FHLB advances to fund
interest-earning assets when deposits alone cannot fully fund interest-earning asset growth.
Stockholders’ Equity. Total stockholders’ equity increased $6.1 million, or 8.5%, to $77.7 million at
December 31, 2019, from $71.6 million December 31, 2018. This increase primarily reflects net income of
$6.7 million, stock-based compensation of $267,000, and ESOP share allocations of $395,000, partially offset by
cash dividends of $1.4 million.
Average Balances, Net Interest Income, Yields Earned and Rates Paid
The following table presents, 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).
2019
December 31,
2018
2017
Average
Outstanding
Balance
Interest
Earned/
Paid
Yield/
Rate
Average
Outstanding
Balance
Interest
Earned/
Paid
Yield/
Rate
Average
Outstanding
Balance
Interest
Earned/
Paid
Yield/
Rate
$599,944
$33,090
5.52% $589,205
$31,881
5.41% $508,520
$26,707
5.25%
64,386
664,330
1,491
34,581
2.32
5.21
60,628
649,833
1,286
33,167
2.12
5.10
51,747
560,267
742
27,449
1.43
4.90
Interest-earning assets:
Loans (1) . . . . . . . . . . . . . . . . . .
Investments and interest bearing
accounts . . . . . . . . . . . . . . . .
Total interest-earning assets (1) . . .
Interest-bearing liabilities:
Savings and money market
accounts . . . . . . . . . . . . . . . .
Demand and NOW accounts . . . .
Certificate accounts . . . . . . . . . .
Borrowings . . . . . . . . . . . . . . . .
Total interest-bearing liabilities . .
103,482
154,738
235,363
24,406
517,989
386
924
5,555
752
7,617
0.37
0.60
2.36
3.08
100,639
170,518
174,922
69,900
1.47% 515,979
Net interest income . . . . . . . . . .
$26,964
Net interest rate spread . . . . . . . .
Net earning assets . . . . . . . . . . .
$146,341
3.74%
4.06%
$133,854
Net interest margin . . . . . . . . . . .
Average interest-earning assets to
average interest-bearing
liabilities . . . . . . . . . . . . . . . .
200
874
2,765
1,521
5,360
$27,807
0.20
0.51
1.58
2.18
101,717
163,009
157,575
29,791
1.04% 452,092
4.06%
4.28%
$108,175
164
744
2,113
347
3,368
$24,081
0.16
0.46
1.34
1.16
0.74
4.15%
4.30%
128.25%
125.94%
123.93%
(1) Calculated net of deferred loan fees, loan discounts and loans in process.
55
Rate/Volume Analysis
The following schedule presents 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).
Year Ended December 31,
2019 vs. 2018
Year Ended December 31,
2018 vs. 2017
Increase
(Decrease) due to
Rate
Volume
Total
Increase
(Decrease)
Increase
(Decrease) due to
Rate
Volume
Total
Increase
(Decrease)
Interest-earning assets:
Loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Investments and interest bearing accounts . . . .
Total interest-earning assets . . . . . . . . . . . . . .
Interest-bearing liabilities:
Savings and Money Market accounts . . . . . . . .
Demand and NOW accounts . . . . . . . . . . . . . . .
Certificate accounts . . . . . . . . . . . . . . . . . . . . . .
Borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
592
87
679
$ 617
118
735
$1,209
205
1,414
$4,336
188
4,524
11
(94)
1,426
(1,401)
175
145
1,363
632
186
51
2,789
(769)
(2)
38
274
873
$618
356
974
38
92
378
301
Total interest-bearing liabilities . . . . . . . . . . .
$
(58)
$2,315
$2,257
$1,183
$809
Change in net interest income . . . . . . . . . . . . . .
$ (843)
$4,954
544
5,498
36
130
652
1,174
$1,992
$3,506
Comparison of Results of Operation for the Years Ended December 31, 2019 and 2018
General. Net income decreased $360,000 to $6.7 million, or $2.57 per diluted common share for the year ended
December 31, 2019, from $7.0 million, or $2.74 per diluted common share for the year ended December 31,
2018. The primary reasons for the decrease in net income in 2019 compared to 2018 was due to a lower net
interest income and noninterest income, partially offset by a recapture from the allowance for loan losses of
$125,000.
Interest Income. Total interest income increased by $1.4 million, or 4.3%, to $34.6 million for the year ended
December 31, 2019, from $33.2 million for the year ended December 31, 2018. Interest income on loans
increased $1.2 million, or 3.8%, to $33.1 million for the year ended December 31, 2019, compared to
$31.9 million for the year ended December 31, 2018, due to higher average loan balances and yields. The
average loans held-for-portfolio balance was $599.9 million for the year ended December 31, 2019, compared to
$589.2 million for the year ended December 31, 2018. The average yield on loans held-for-portfolio was 5.52%
for the year ended December 31, 2019, compared to 5.41% for the year ended December 31, 2018. The increase
in the average loan yield during 2019 was due to the change in the composition of the loan portfolio, with an
increase in higher yielding commercial and multifamily real estate and construction and land loans.
Interest income on the investment portfolio increased $205,000, or 15.9%, to $1.5 million during the year ended
December 31, 2019, compared to $1.3 million during the year ended December 31, 2018, due to higher average
investment balance and yields in 2019.
Interest Expense. Interest expense increased $2.3 million, or 42.1%, to $7.6 million during the year ended
December 31, 2019, compared to $5.4 million during the year ended December 31, 2018 as a result of both a
higher weighted average cost and balance of deposits, partially offset by a decrease in the average balance of
Federal Home Loan Bank (″FHLB″) borrowings.
Interest expense on deposits increased $3.0 million, or 78.8%, to $6.9 million for the year ended December 31,
2019, compared to the prior year, driven by an increase of $47.5 million, or 10.6%, in the average balance of
interest-bearing deposits to $493.6 million, and a 45 basis point increase in the weighted average rate paid on
interest-bearing deposits to 1.16% for the year ended December 31, 2019, from 0.71% for the year ended
56
December 31, 2018. The average balance of total deposits increased $52.8 million, to $590.0 million for the year
ended December 31, 2019 as compared to $537.2 million for the same period in 2018.
Interest expense on FHLB borrowings decreased $769,000, or 50.6%, to $752,000 for the year ended
December 31, 2019 from $1.5 million for the year ended December 31, 2018, due to a $45.5 million, or 65.1%
decrease in the average balance of FHLB borrowings to $24.4 million from $69.9 million for the year ended
December 31, 2018. Our overall weighted-average cost of interest-bearing liabilities was 1.47% for the year
ended December 31, 2019, compared to 1.04% for the year ended December 31, 2018.
Net Interest Income. Net interest income decreased $843,000, or 3.0%, to $27.0 million for the year ended
December 31, 2019, from $27.8 million for the year ended December 31, 2018. The decrease primarily resulted
from an increase in net interest expense due to rates paid on deposits and higher average deposit balances,
partially offset by increased interest income on loans and investments and decreased interest expense paid on
FHLB borrowings. Our net interest margin was 4.06% for the year ended December 31, 2019, compared to
4.28% for the year ended December 31, 2018. The decrease was primarily due to yields earned on
interest-earning assets declining at a faster rate than interest rates paid on interest-bearing liabilities.
Provision for Loan Losses. We establish our allowance for loan losses through provisions for loan losses, which
are charged to earnings, at a level required to reflect management’s best estimate of the probable incurred credit
losses in the loan portfolio. In evaluating the level of the allowance for loan losses, management considers
historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that
may affect borrowers’ ability to repay, estimated value of any underlying collateral, peer group data, prevailing
economic conditions, and other qualitative factors. Large groups of smaller balance homogeneous loans, such as
one-to four-family, commercial and multifamily real estate, home equity and consumer loans, including floating
homes and manufactured homes, are evaluated in the aggregate using historical loss factors adjusted for current
economic conditions and other relevant data. Loans, for which management has concerns about the borrowers’
ability to repay, are evaluated individually, and specific loss allocations are provided for these loans when
necessary.
We recorded a recapture from the allowance for loan losses of $125,000 for the year ended December 31, 2019,
compared to a provision for loan losses of $525,000 for the year ended December 31, 2018. The recapture in the
current year was due to changes in the composition of our loan portfolio during the year. Net loan charge-offs
were $9,000 for the year ended December 31, 2019, compared to net recoveries of $8,000 for the year ended
December 31, 2018. Nonperforming loans increased $2.0 million during the year to $4.7 million at December 31,
2019, compared to $2.7 million a year ago.
Nonperforming loans to total loans increased to 0.75% at December 31, 2019 from 0.43% at December 31, 2018.
The allowance for loan losses decreased to $5.6 million at December 31, 2019 compared to $5.8 million at
December 31, 2018. See ‘‘— Comparison of Financial Condition at December 31, 2019 and December 31, 2018
— Delinquencies and Nonperforming Assets’’ for more information on nonperforming loans in 2019.
While we believe the estimates and assumptions used in our determination of the adequacy of the allowance are
reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the
future, or that the actual amount of future provisions will not exceed the amount of past provisions or that any
increased provisions that may be required will not adversely impact our financial condition and results of
operations. In addition, the determination of the amount of our allowance for loan losses is subject to review by
bank regulators as part of the routine examination process, which may result in the adjustment of reserves based
upon their judgment of information available to them at the time of their examination.
57
Noninterest Income. Noninterest income decreased $260,000, or 6.1%, to $4.0 million for the year ended
December 31, 2019, as compared to $4.3 million for the year ended December 31, 2018 as reflected below
(dollars in thousands):
Service charges and fee income . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Earnings on cash surrender value of bank owned life insurance . . .
Mortgage servicing income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fair value adjustment on mortgage servicing rights . . . . . . . . . . . . .
Net gain on sale of loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total noninterest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
NM = not meaningful
Year Ended December 31,
2019
$1,954
381
1,002
(760)
1,449
—
$4,026
2018
$1,876
320
1,075
(513)
1,038
490
$4,286
Amount
Change
Percent
Change
$ 78
61
(73)
(247)
411
(490)
$(260)
4.2%
19.1
(6.8)
48.1
39.6
NM
(6.1)%
The decrease in noninterest income from one year ago was primarily due to a $247,000 decrease in the
mark-to-market adjustment on fair value of mortgage servicing rights during the year ended December 31, 2019,
combined with one-time proceeds of $490,000 recognized in other noninterest income from the sale of Visa B
Shares during year ended December 31, 2018. The decrease was partially offset by a $411,000 increase in the net
gain on sale of loans.
Noninterest Expense. Noninterest expense remained relatively flat, decreasing $38,000, or 0.2%, to
$22.8 million for the year ended December 31, 2019, from the year ended December 31, 2018, as reflected
below (dollars in thousands):
Year Ended December 31,
2019
2018
Amount
Change
Percent
Change
Salaries and benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Regulatory assessments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Occupancy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Data processing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Losses and expenses on OREO and repossessed assets. . . . . . . . . . .
Total noninterest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$12,402
5,905
279
2,060
2,104
35
$22,785
$12,775
5,472
432
2,139
1,919
86
$22,823
$(373)
433
(153)
(79)
185
(51)
$ (38)
(2.9)%
7.9
(35.4)
(3.7)
9.6
(59.3)
(0.2)%
Salaries and benefits decreased $373,000 as a result of lower commissions on loan originations paid during the
year and regulatory assessments decreased $153,000 as a result of a small bank credit awarded by the Federal
Deposit Insurance Corporation (‘‘FDIC’’). These decreases were partially offset by a $433,000 increase in
operations expense and $185,000 increase in data processing expense. Operations expense increased due to
increases in marketing and adverting expense of $133,000, wire fraud expenses of $114,000, travel and
conference expense of $88,000, charitable contributions of $81,000 and consulting expenses of $37,000.
The efficiency ratio, which is noninterest expense as a percentage of net interest income and noninterest income,
for the year ended December 31, 2019 was 73.52%, compared to 71.12% for the year ended December 31, 2018.
The increase in the efficiency ratio compared to the prior year was primarily due to higher interest expense on
deposits.
Income Tax Expense. The provision for income taxes decreased $55,000, or 3.2% to $1.7 million for the year
ended December 31, 2019, compared to the year ended December 31, 2018 due to a decrease in taxable net
income. The effective tax rates for the years ended December 31, 2019 and 2018 were 19.8% and 19.5%,
respectively.
58
Liquidity
Liquidity management is both a daily and longer-term function of management. Excess liquidity is generally
invested in short-term investments, such as overnight deposits and federal funds. On a longer term basis, we
maintain a strategy of investing in various loan products and investment securities, including mortgage-backed
securities. We use our sources of funds primarily to meet ongoing commitments, pay maturing deposits, fund
deposit withdrawals and fund loan commitments.
We maintain cash and investments that qualify as liquid assets to maintain adequate liquidity to ensure safe and
sound operations and meet demands for client funds (particularly withdrawals of deposits). At December 31,
2019, we had $65.1 million in cash and investment securities available for sale and $1.1 million in loans
held-for-sale. We can also obtain funds from borrowings, primarily FHLB advances. At December 31, 2019, we
had the ability to borrow an additional $217.8 million in FHLB advances, subject to certain collateral
requirements and we had access to additional borrowings of $41.7 million through the Federal Reserve’s
Discount Window, subject to certain collateral requirements. In addition, we also had available $20.0 million of
credit facilities with other financial institutions, with no balance outstanding at December 31, 2019 or 2018.
We are required to have adequate cash and investments that qualify as liquid assets in order to maintain
sufficient liquidity to ensure safe and sound operations. Liquidity may increase or decrease depending upon the
availability of funds and comparative yields on investments in relation to the return on loans. Historically, we
have maintained liquid assets above levels believed to be adequate to meet the requirements of normal
operations, including potential deposit outflows. Cash flow projections are regularly reviewed and updated to
assure that adequate liquidity is maintained.
Liquidity management involves the matching of cash flow requirements of clients, who may be either depositors
desiring to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their
credit needs and our ability to manage those requirements. We strive to maintain an adequate liquidity position
by managing the balances and maturities of interest-earning assets and interest-bearing liabilities so that the
balance we have in short-term investments at any given time will adequately cover any reasonably anticipated,
immediate need for funds. Additionally, we maintain relationships with correspondent banks, which could provide
funds on short-term notice if needed. Our liquidity, represented by cash and cash-equivalents, is a product of our
operating, investing and financing activities.
As disclosed in our Consolidated Statements of Cash Flows in Item 8 of this Annual Report on Form 10-K, cash
and cash equivalents decreased $6.0 million to $55.8 million as of December 31, 2019, from $61.8 million at
December 31, 2018. Net cash provided by operating activities was $11.1 million for the year ended
December 31, 2019. Net cash of $5.8 million was used in investing activities for the year ended December 31,
2019 and consisted principally of purchase of investment securities. There was $11.3 million of cash used in
financing activities for the year ended December 31, 2019 which primarily consisted of a $76.5 million net
decrease in FHLB advances, partially offset by a $63.1 million increase in deposits.
Sound Financial Bancorp is a separate legal entity from Sound Community Bank and must provide for its own
liquidity. In addition to its own operating expenses (many of which are paid to Sound Community Bank), Sound
Financial Bancorp is responsible for paying any dividends declared to its stockholders, and interest and principal
on outstanding debt. Sound Financial Bancorp’s primary source of funds is dividends from Sound Community
Bank, which are subject to regulatory limits. At December 31, 2019 Sound Financial Bancorp, on an
unconsolidated basis, had $2.7 million in cash, noninterest-bearing deposits and liquid investments generally
available for its cash needs.
Our liquidity, represented by cash and cash equivalents and investment securities, is a product of our operating,
investing and financing activities. Our primary sources of funds are deposits, amortization, prepayments and
maturities of outstanding loans and mortgage-backed securities, maturities of investment securities and other
short-term investments and funds provided from operations. While scheduled payments from the amortization of
loans and mortgage-backed securities and maturing investment securities and short-term investments are
relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general
interest rates. We also generate cash through borrowings. We utilize FHLB advances to leverage our capital base
and provide funds for our lending and investment activities, and to enhance our interest rate risk management.
We use our sources of funds primarily to meet ongoing commitments, pay maturing deposits and fund
withdrawals, and to fund loan commitments. At December 31, 2019, the approved outstanding loan
59
commitments, including unused lines and letters of credit, amounted to $86.0 million. Certificates of deposit
scheduled to mature in one year or less at December 31, 2019, totaled $86.6 million. It is management’s policy
to offer deposit rates that are competitive with other local financial institutions. Based on this management
strategy, we believe that a majority of maturing deposits will remain with us. See also the Consolidated
Statements of Cash Flows, included in Item 8, ‘‘Financial Statements and Supplementary Data,’’ of this
Form 10-K, for further information.
Off-Balance Sheet Activities
In the normal course of operations, we engage in a variety of financial transactions that are not recorded in our
financial statements. These transactions involve varying degrees of off-balance sheet credit, interest rate and
liquidity risks. These transactions are used primarily to manage clients’ requests for funding and take the form of
loan commitments and lines of credit. For the year ended December 31, 2019, we did not engage in any
off-balance sheet transactions likely to have a material effect on our financial condition, results of operations or
cash flows.
A summary of our off-balance sheet loan commitments at December 31, 2019, is as follows (in thousands):
Off-balance sheet loan commitments:
Residential mortgage commitments. . . . . . . . . .
Unfunded construction commitments . . . . . . . .
Unused lines of credit . . . . . . . . . . . . . . . . . . . .
Irrevocable letters of credit . . . . . . . . . . . . . . . .
Total loan commitments. . . . . . . . . . . . . . . . .
Amount
$ 4,968
40,181
39,605
1,240
$85,994
Capital
Sound Community Bank is subject to minimum capital requirements imposed by regulations of the FDIC. Based
on its capital levels at December 31, 2019, Sound Community Bank exceeded these requirements as of that date.
Consistent with our goals to operate a sound and profitable organization, our policy is for Sound Community
Bank to maintain a ‘‘well-capitalized’’ status under the regulatory capital categories of the FDIC. Based on
capital levels at December 31, 2019, Sound Community Bank was considered to be well-capitalized.
Management monitors the capital levels to provide for current and future business opportunities and to maintain
Sound Community Bank’s ‘‘well-capitalized’’ status. For additional details see Note 15 in the Notes to
Consolidated Financial Statements contained in ‘‘Item 8. Financial Statements and Supplementary Data’’ and
‘‘Item 1. ‘‘Business — How We Are Regulated — Regulation of Sound Community Bank — Capital Rules’’ of
this Form 10-K.
The following table shows the capital ratios of Sound Community Bank at December 31, 2019 (dollars in
thousands):
Actual
Minimum Capital
Requirements
Amount
Ratio
Amount
Ratio
Minimum Required
to be Well-Capitalized
Under Prompt
Corrective
Action Provisions
Amount
Ratio
Tier 1 Capital to average total adjusted assets(1) . . . .
Common Equity Tier 1 to risk-weighted assets(2) . . .
Tier 1 Capital to risk-weighted assets(2) . . . . . . . . . . .
Total Capital to risk-weighted assets(2) . . . . . . . . . . . .
$74,031
74,031
74,031
$79,974
10.22% $28,981
27,601
12.07
12.07
36,801
13.04% $49,068
4.0% $36,226
39,868
4.5
6.0
49,068
8.0% $61,335
5.0%
6.5
8.0
10.0%
(1) Based on total adjusted assets of $724,527 at December 31, 2019.
(2) Based on risk-weighted assets of $613,354 at December 31, 2019.
In addition to the minimum CET1, Tier 1 and total capital ratios, Sound Financial Bancorp and Sound
Community Bank must maintain a capital conservation buffer consisting of additional CET1 capital greater than
60
2.5% of risk-weighted assets above the required minimum risk-based capital levels in order to avoid limitations
on paying dividends, engaging in share repurchases, and paying discretionary bonuses. At December 31, 2019,
the conservation buffer requirement was 2.50% and the Bank’s actual conservation buffer was 5.04%.
For a bank holding company with less than $3.0 billion in assets, the capital guidelines apply on a bank only
basis and the Federal Reserve expects the holding company’s subsidiary banks to be well-capitalized under the
prompt corrective action regulations. If Sound Financial Bancorp was subject to regulatory guidelines for bank
holding companies with $3.0 billion or more in assets, at December 31, 2019, Sound Financial Bancorp would
have exceeded all regulatory capital requirements. The estimated regulatory capital ratios calculated for Sound
Financial Bancorp as of December 31, 2019 were 9.55% for Tier 1 Capital to total adjusted assets (leverage
ratio), 11.08% for both Common Equity Tier 1 risk-based capital, and Tier 1 Capital to risk-based assets, and
11.94% for Total Capital to risk weighted assets.
61
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Asset/Liability Management
Our Risk When Interest Rates Change. The rates of interest we earn on assets and pay on liabilities generally
are established contractually for a period of time. Market rates change over time. Like other financial institutions,
our results of operations are impacted by changes in interest rates and the interest rate sensitivity of our assets
and liabilities. The risk associated with changes in interest rates and our ability to adapt to these changes is
known as interest rate risk and is our most significant market risk.
How We Measure Our Risk of Interest Rate Changes. As part of efforts to manage our exposure to changes in
interest rates and comply with applicable regulations, we monitor our interest rate risk. In doing so, we analyze
and manage assets and liabilities based on their interest rates and payment streams, timing of maturities,
re-pricing opportunities, and sensitivity to actual or potential changes in market interest rates.
We are subject to interest rate risk to the extent that our interest-bearing liabilities, primarily deposits and FHLB
advances, re-price more rapidly or at different rates than our interest-earning assets. In order to minimize the
potential for adverse effects of material prolonged increases or decreases in interest rates on our results of
operations, we have adopted an asset and liability management policy. Our Board of Directors approves the asset
and liability policy, which is implemented by the asset/liability committee.
The purpose of the asset/liability committee is to communicate, coordinate, and control asset/liability
management consistent with our business plan and board-approved policies. The committee establishes and
monitors the volume and mix of assets and funding sources, taking into account relative costs and spreads,
interest rate sensitivity and liquidity needs. The objectives are to manage assets and funding sources to produce
results that are consistent with liquidity, capital adequacy, growth, risk and profitability goals.
The committee generally meets monthly to, among other things, protect capital through earnings stability over
the interest rate cycle; maintain our well-capitalized status; and provide a reasonable return on investment. The
committee recommends appropriate strategy changes based on this review. The committee is responsible for
reviewing and reporting the effects of the policy implementations and strategies to the board of directors at least
quarterly. Senior managers oversee the process on a daily basis.
A key element of our asset/liability management plan is to protect net earnings by managing the maturity or
re-pricing mismatch between our interest-earning assets and our rate-sensitive liabilities. We seek to reduce
exposure to earnings by extending funding maturities through the use of FHLB advances, through the use of
adjustable rate loans and through the sale of certain fixed rate loans in the secondary market.
As part of our efforts to monitor and manage interest rate risk, we maintain an interest rate risk model and utilize
software and resources provided by a third party. The model contains several assumptions that are based upon a
combination of proprietary and market data that reflect historical results and current market conditions. These
assumptions relate to interest rates, prepayments, deposit decay rates and the market value of certain assets under
the various interest rate scenarios. The model’s capital at risk measure, also known as the Economic Value of
Equity (‘‘EVE’’), evaluates the change in the projected EVE over a two-year period given an immediate increase
or decrease in interest rates. The EVE presents a hypothetical valuation of equity and is defined as the present
value of projected asset cash flows less the present value of projected liability cash flows. EVE values only the
current position of the balance sheet at December 31, 2019, and therefore does not incorporate any new business
assumptions that might be inherent in a simulation of net interest income. The following table projections assume
instantaneous parallel shifts upward of the yield curve of 100, 200, 300 and 400 basis points and downward of
the yield curve 100 and 200 basis points occurring immediately. Given that the targeted Federal Funds Rate at
December 31, 2019 was a range of 1.50 to 1.75%, a 300 and 400 basis point reduction in rates is not reported.
Management and the Board of Directors review these measurements on a quarterly basis to determine whether
our interest rate exposure is within the limits established by the Board of Directors.
Our asset/liability management strategy dictates acceptable limits on the amounts of change in given changes in
interest rates. For interest rate increases of 100, 200, 300 and 400 basis points, our internal policy states that our
EVE percentage change should not decrease greater than 10%, 20%, 25% and 30%, respectively and that our
EVE ratio should not fall below 9%, 8%, 6% and 5%, respectively. For interest rate decreases of 100 and 200
basis points, our internal policy states that our EVE percentage change should not decrease greater than 10% and
20%, respectively, and that our EVE ratio should not fall below 9% and 8%, respectively.
62
As indicated in the following table (dollars in thousands), our EVE shows an asset sensitive position at
December 31, 2019 due to the duration of our interest-bearing liabilities exceeding our interest-earning assets.
Since EVE measures the discounted present value of cash flows over the estimated lives of instruments, the
change in EVE does not directly correlate to the degree that earnings would be impacted over a shorter time
horizon.
Change in
Interest
Rates in
Basis Points (bps)
+400
+300
+200
+100
0
-100
-200
December 31, 2019
Economic Value of Equity
$ Change
$ 13,006
11,483
9,219
5,560
—
(6,998)
$(16,127)
$ Amount
$84,853
83,330
81,065
77,406
71,846
64,849
$55,719
% Change
18.10%
15.98
12.83
7.74
—
(9.74)
(22.45)%
EVE
Ratio %
12.8%
12.4
11.8
11.1
10.1
9.0
7.6%
In addition to monitoring selected measures of EVE, management also monitors effects on net interest income
resulting from increases or decrease in rates. This process is used in conjunction with EVE measures to identify
excessive interest rate risk. In managing our assets/liability mix, depending on the relationship between long- and
short-term interest rates, market conditions and consumer preference, we may place somewhat greater emphasis
on maximizing our net interest margin than on strictly matching the interest rate sensitivity of assets and
liabilities. Management also believes that the increased net income which may result from an acceptable
mismatch in the actual maturity or re-pricing of its asset and liability portfolios can, during periods of declining
or stable interest rates, provide sufficient returns to justify the increased exposure to sudden and unexpected
increases in interest rates which may result from such a mismatch. Management believes that our level of interest
rate risk is acceptable under this approach.
In evaluating our exposure to interest rate movements, certain shortcomings inherent in the method of analysis
presented in the foregoing table must be considered. For example, although certain assets and liabilities may
have similar maturities or re-pricing periods, they may react in different degrees to changes in market interest
rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in
market interest rates, while interest rates on other types may lag behind changes in interest rates. Additionally,
certain assets, such as adjustable rate mortgages, have features which restrict changes in interest rates on a
short-term basis and over the life of the asset. Further, in the event of a significant change in interest rates,
prepayment and early withdrawal levels would likely deviate significantly from those assumed above. Finally, the
ability of many borrowers to service their debt may decrease in the event of an interest rate increase. We
consider all of these factors in monitoring our exposure to interest rate risk.
63
Item 8.
Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors of
Sound Financial Bancorp, Inc.
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Sound Financial Bancorp, Inc. and Subsidiary
(the ‘‘Company’’) as of December 31, 2019 and 2018, the related consolidated statements of income,
comprehensive income, stockholders’ equity and cash flows for the years then ended, and the related notes
(collectively referred to as the ‘‘consolidated financial statements’’). We also have audited the Company’s internal
control over financial reporting as of December 31, 2019, based on criteria established in Internal Control -
Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the
consolidated financial position of the Company as of December 31, 2019 and 2018, and the consolidated results
of its operations and its cash flows for the years then ended, in conformity with accounting principles generally
accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2019, based on criteria established in
Internal Control - Integrated Framework (2013) issued by COSO.
Basis for Opinions
The Company’s management is responsible for these consolidated financial statements, for maintaining effective
internal control over financial reporting, and for its assessment of the effectiveness of internal control over
financial reporting, included in the accompanying Management Report on Internal Control over Financial
Reporting included in Item 9A. Our responsibility is to express an opinion on the Company’s consolidated
financial statements and an opinion on the Company’s internal control over financial reporting based on our
audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United
States) (‘‘PCAOB’’) and are required to be independent with respect to the Company in accordance with the U.S.
federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and
the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are
free of material misstatement, whether due to error or fraud, and whether effective internal control over financial
reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material
misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures
to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts
and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting
principles used and significant estimates made by management, as well as evaluating the overall presentation of
the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an
understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and
testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our
audits also included performing such other procedures as we considered necessary in the circumstances. We
believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company’s internal control over financial reporting
includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable
assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance
64
with generally accepted accounting principles, and that receipts and expenditures of the company are being made
only in accordance with authorizations of management and directors of the company; and (3) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the
company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
/s/ Moss Adams, LLP
Everett, Washington
March 12, 2020
We have served as the Company’s auditor since 2002.
65
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Consolidated Balance Sheets
(In thousands, except share and per share amounts)
ASSETS
Cash and cash equivalents. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Available-for-sale securities, at fair value. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loans held-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loans held for portfolio. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Allowance for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total loans held for portfolio, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accrued interest receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Bank-owned life insurance, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other real estate owned (‘‘OREO’’) and repossessed assets, net . . . . . . . . . . . . . . .
Mortgage servicing rights, at fair value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Federal Home Loan Bank (‘‘FHLB’’) stock, at cost . . . . . . . . . . . . . . . . . . . . . . . . .
Premises and equipment, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Lease right of use assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
December 31,
2019
2018
$ 55,770
9,306
1,063
619,887
(5,640)
614,247
2,206
14,183
575
3,239
1,160
6,767
7,641
3,696
$ 61,810
4,957
1,172
619,543
(5,774)
613,769
2,287
13,365
575
3,414
4,134
7,044
—
4,208
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$719,853
$716,735
LIABILITIES
Deposits
Interest-bearing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Noninterest-bearing demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accrued interest payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Lease liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Advance payments from borrowers for taxes and insurance . . . . . . . . . . . . . . . . . . .
Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
COMMITMENTS AND CONTINGENCIES (NOTE 17 and 20)
STOCKHOLDERS’ EQUITY
Preferred stock, $0.01 par value, 10,000,000 shares authorized, none issued or
$519,434
97,284
616,718
7,500
226
8,010
8,368
1,305
642,127
$457,535
96,066
553,601
84,000
137
—
6,681
689
645,108
outstanding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
—
—
Common stock, $0.01 par value, 40,000,000 shares authorized, 2,567,389 and
2,544,059 issued and outstanding as of December 31, 2019 and 2018,
respectively. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unearned shares - Employee Stock Ownership Plan (‘‘ESOP’’). . . . . . . . . . . . . . . .
Retained earnings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accumulated other comprehensive income, net of tax . . . . . . . . . . . . . . . . . . . . . . .
Total stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
25
26,343
(227)
51,410
175
77,726
25
25,663
(340)
46,165
114
71,627
Total liabilities and stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$719,853
$716,735
See notes to consolidated financial statements
66
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Income
(In thousands, except share and per share amounts)
INTEREST INCOME
Loans, including fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Interest and dividends on investments, cash and cash equivalents . . . . . . . . . . . .
$
Total interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
INTEREST EXPENSE
Deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(RECAPTURE) PROVISION FOR LOAN LOSSES
Net interest income after (recapture) provision for loan losses. . . . . . . . . . . . . . .
NONINTEREST INCOME
Service charges and fee income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Earnings on cash surrender value of bank-owned life insurance . . . . . . . . . . . . .
Mortgage servicing income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fair value adjustment on mortgage servicing rights . . . . . . . . . . . . . . . . . . . . . . .
Net gain on sale of loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total noninterest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
NONINTEREST EXPENSE
Salaries and benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Regulatory assessments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Occupancy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Data processing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net loss and expenses on OREO and repossessed assets . . . . . . . . . . . . . . . . . . .
Total noninterest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income before provision for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Provision for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Earnings per common share:
Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Weighted average number of common shares outstanding:
$
$
$
Year Ended December 31,
2019
2018
33,090
1,491
34,581
6,865
752
7,617
26,964
(125)
27,089
1,954
381
1,002
(760)
1,449
—
4,026
12,402
5,905
279
2,060
2,104
35
22,785
8,330
1,651
6,679
2.63
2.57
$
$
$
$
31,881
1,286
33,167
3,839
1,521
5,360
27,807
525
27,282
1,876
320
1,075
(513)
1,038
490
4,286
12,775
5,472
432
2,139
1,919
86
22,823
8,745
1,706
7,039
2.82
2.74
Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2,527,329
2,583,312
2,498,161
2,567,165
See notes to consolidated financial statements
67
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Comprehensive Income
(In thousands)
Net income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Available for sale securities:
Unrealized gains arising during the year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income tax expense related to unrealized gains. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other comprehensive income, net of tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Year Ended December 31,
2019
$6,679
2018
$7,039
78
(17)
61
7
(2)
5
Comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$6,740
$7,044
See notes to consolidated financial statements
68
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Stockholders’ Equity
(In thousands, except share and per share amounts)
Common
Stock
Additional
Paid-in
Capital
Unearned
ESOP
Shares
Retained
Earnings
Shares
Balance at December 31, 2018. . . . 2,544,059
Net income . . . . . . . . . . . . . . . . . . .
Other comprehensive income, net
$25
$25,663
$(340) $46,165
6,679
of tax . . . . . . . . . . . . . . . . . . . . . .
Share-based compensation . . . . . . .
Restricted stock awards issued . . . .
Cash dividends on common stock
($0.56 per share) . . . . . . . . . . . . .
Common stock surrendered . . . . . .
Restricted shares forfeited . . . . . . .
Common stock options exercised. .
Allocation of ESOP shares . . . . . . .
15,925
(3,487)
(880)
11,772
267
131
282
113
(1,434)
Accumulated
Other
Comprehensive
Income,
net of tax
$114
61
Total
Stockholders’
Equity
$71,627
6,679
61
267
—
(1,434)
—
—
131
395
Balance at December 31, 2019. . . . 2,567,389
$25
$26,343
$(227) $51,410
$175
$77,726
Common
Stock
Additional
Paid-in
Capital
Unearned
ESOP
Shares
Retained
Earnings
Shares
Balance at December 31, 2017. . . . 2,511,127
Net income . . . . . . . . . . . . . . . . . . .
Other comprehensive loss, net of
$25
$24,986
$(453) $40,493
7,039
tax . . . . . . . . . . . . . . . . . . . . . . . .
Share-based compensation . . . . . . .
Restricted stock awards issued . . . .
Cash dividends on common stock
($0.54 per share) . . . . . . . . . . . . .
Common stock repurchased . . . . . .
Restricted shares forfeited . . . . . . .
Common stock options exercised. .
Allocation of ESOP shares . . . . . . .
323
(16,314)
(343)
49,266
(22)
273
118
308
113
(1,367)
Accumulated
Other
Comprehensive
Income,
net of tax
$109
5
Total
Stockholders’
Equity
$65,160
7,039
(17)
273
—
(1,367)
—
—
118
421
Balance at December 31, 2018. . . . 2,544,059
$25
$25,663
$(340) $46,165
$114
$71,627
See notes to consolidated financial statements
69
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Adjustments to reconcile net income to net cash from operating activities:
Amortization of net premiums/discounts on investments . . . . . . . . . . . . . . . . . . .
(Recapture) provision for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Depreciation and amortization. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Compensation expense related to stock options and restricted stock . . . . . . . . . .
Change in fair value of mortgage servicing rights. . . . . . . . . . . . . . . . . . . . . . . . .
Change in right of use assets amortization. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Change in lease liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Increase in cash surrender value of BOLI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net change in advances from borrowers for taxes and insurance . . . . . . . . . . . . .
Deferred income tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net gain on sale of loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Proceeds from sale of loans held-for-sale. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Originations of loans held-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net loss on OREO and repossessed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Change in operating assets and liabilities:
Accrued interest receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accrued interest payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash provided by operating activities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from principal payments, maturities and sales of available for sale
securities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Purchases of available for sale securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net increase in loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Purchase of BOLI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Proceeds from sale of OREO and other repossessed assets . . . . . . . . . . . . . . . . .
Purchases of premises and equipment, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash used in investing activities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Proceeds from borrowings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Repayment of borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
FHLB stock redeemed (purchased). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
ESOP shares released. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Proceeds from common stock option exercises . . . . . . . . . . . . . . . . . . . . . . . . . . .
Dividends paid on common stock. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash (used in) provided by financing activities. . . . . . . . . . . . . . . . . . . . . .
Net (decrease) increase in cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . .
Cash and cash equivalents, beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash and cash equivalents, end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Interest paid on deposits and borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Noncash net transfer from loans to OREO and repossessed assets. . . . . . . . . .
Leases right of use assets obtained in exchange for operating lease
liabilities:
Right of use assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Lease Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
See notes to consolidated financial statements
70
Year Ended December 31,
2019
2018
$
6,679
$
7,039
50
(125)
931
267
760
592
(480)
(381)
616
(267)
(1,449)
78,214
(77,241)
21
81
762
89
1,944
11,063
845
(5,166)
(847)
(437)
473
(654)
(5,786)
63,117
166,800
(243,300)
2,974
395
131
(1,434)
(11,317)
(6,040)
61,810
$ 55,770
$
$
915
7,528
494
8,490
8,233
41
525
989
273
513
—
—
(320)
54
69
(1,038)
49,121
(47,979)
74
(310)
505
60
709
10,325
416
—
(70,995)
(295)
16
(641)
(71,499)
39,201
262,000
(237,000)
(1,069)
421
118
(1,367)
62,304
1,130
60,680
$ 61,810
$
$
2,670
5,300
55
—
—
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
Note 1 - Organization and significant accounting policies
Sound Financial Bancorp, a Maryland corporation (‘‘Sound Financial Bancorp’’ or the ‘‘Company’’), is a bank
holding company for its wholly owned subsidiary, Sound Community Bank (the ‘‘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, the Bank’s regulators are the Washington State Department
of Financial Institutions (‘‘WDFI’’) and the Federal Deposit Insurance Corporation (‘‘FDIC’’). The Board of
Governors of the Federal Reserve System (‘‘Federal Reserve’’) is the primary federal regulator for Sound
Financial Bancorp. The Company’s business activities generally are limited to passive investment activities and
oversight of its investment in the Bank. Accordingly, the information set forth in this report relates primarily to
the Bank.
Subsequent events – The Company has evaluated subsequent events for potential recognition and disclosure. See
Note 21 in the Notes to Consolidated Financial Statements contained in Item 8 of this report on Form 10-K.
Basis of Presentation and Use of Estimates – The preparation of consolidated financial statements in
conformity with accounting principles generally accepted in the United States of America requires management
to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of
contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of
income and expenses during the reporting period. Actual results could differ from those estimates. Material
estimates that are particularly susceptible to significant change in the near term relate to the determination of the
allowance for loan losses, the fair value of mortgage servicing rights, valuations of impaired loans and OREO,
and the realization of deferred taxes.
The accompanying consolidated financial statements include the accounts of Sound Financial Bancorp and its
wholly-owned subsidiary Sound Community Bank. All significant intercompany balances and transactions
between Sound Financial Bancorp and its subsidiary have been eliminated in consolidation.
Cash and cash equivalents – For purposes of reporting cash flows, cash and cash equivalents include cash on
hand and in banks and interest-bearing deposits. All have original maturities of three months or less and may
exceed federally insured limits.
Investment securities – Investment securities are classified into one of three categories: (1) held-to-maturity,
(2) available-for-sale (‘‘AFS’’), or (3) trading. The Company had no held-to-maturity or trading securities at
December 31, 2019 or 2018. AFS securities consist of debt securities that the Company has the intent and ability
to hold for an indefinite period, but not necessarily to maturity. Such securities may be sold to implement the
Company’s asset/liability management strategies and/or in response to changes in interest rates and similar
factors. AFS securities are reported at fair value. Dividend and interest income are recognized when earned.
Unrealized gains and losses, net of the related deferred tax effect, are reported as a net amount in accumulated
other comprehensive income (loss) on AFS securities in the consolidated balance sheets. Realized gains and
losses on AFS securities, determined using the specific identification method, are included in earnings.
Amortization of premiums and accretion of discounts are recognized as adjustments to interest income using the
interest method over the period to the earlier of call date or maturity.
The Company reviews investment securities on an ongoing basis for the presence of other-than-temporary
impairment (‘‘OTTI’’) or permanent impairment, taking into consideration current market conditions, fair value in
relation to cost, extent and nature of the change in fair value, issuer rating changes and trends, whether the
Company intends to sell a security or if it is likely that the Company will be required to sell the security before
recovery of its amortized cost basis of the investment, which may be maturity, and other factors. For debt
securities, if the Company intends to sell the security or it is likely that it will be required to sell the security
before recovering its cost basis, the entire impairment loss would be recognized in earnings as an OTTI. If the
Company does not intend to sell the security and it is not likely that we will be required to sell the security but
we do not expect to recover the entire amortized cost basis of the security, only the portion of the impairment
71
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
loss representing credit losses would be recognized in earnings. The credit loss on a security is measured as the
difference between the amortized cost basis and the present value of the cash flows expected to be collected.
Projected cash flows are discounted by the original or current effective interest rate depending on the nature of
the security being measured for potential OTTI.
The remaining impairment related to all other factors, the difference between the present value of the cash flows
expected to be collected and the fair value, is recognized as a charge to other comprehensive income (‘‘OCI’’).
The Company does not intend to sell these securities and it is more likely than not that it will not be required to
sell the securities before anticipated recovery of the remaining amortized cost basis. The Company closely
monitors its investment securities for changes in credit risk.
Loans held-for-sale – To mitigate interest rate sensitivity, from time to time, certain fixed rate mortgage loans
are identified as held-for-sale in the secondary market. Accordingly, such loans are classified as held-for-sale in
the consolidated balance sheets and are carried at the lower of cost or estimated fair market value in the
aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income.
Mortgage loans held-for-sale are generally sold with the mortgage servicing rights retained by the Company.
Gains or losses on sales of loans are recognized based on the difference between the selling price and the
carrying value of the related loans sold based on the specific identification method.
Loans – The Company grants mortgage, commercial, and consumer loans to clients. A substantial portion of the
loan portfolio is represented by loans secured by real estate located throughout the Puget Sound region,
especially King, Snohomish and Pierce Counties, and in Clallam and Jefferson Counties of Washington State.
The ability of the Company’s debtors to honor their contracts is dependent upon employment, real estate and
general economic conditions in these areas.
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off
generally are reported at their outstanding unpaid principal balance adjusted for any charge-offs, allowance for
loan losses, and any deferred fees or costs on origination of loans. Interest income is accrued on the unpaid
principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an
adjustment of the related loan yield using the interest method over the contractual life of the loan for term loans
or the straight-line method for open ended loans.
The accrual of interest is discontinued at the time the loan is 90 days past due or if, in management’s opinion,
the borrower may be unable to meet payment of obligations as they become due, as well as when required by
regulatory provisions. Loans are typically charged off no later than 120 days past due, unless secured by
collateral. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual
or charged off at an earlier date if collection of principal or interest is considered doubtful.
All interest accrued but not collected for loans that are placed on nonaccrual or charged-off is reversed against
interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until
qualifying for return to accrual. Loans are returned to accrual status when all of the principal and interest
amounts contractually due are brought current, future payments are reasonably assured and payments have been
received for six consecutive months.
A loan is considered impaired when it is probable that the Company will be unable to collect all amounts
(principal and interest) due according to the contractual terms of the original loan agreement. When a loan has
been identified as being impaired, the amount of the impairment is measured by using discounted cash flows,
except when, as a practical expedient, the current fair value of the collateral, reduced by costs to sell, is used.
When the measurement of the impaired loan is less than the recorded investment in the loan (including accrued
interest), impairment is recognized by charging off the impaired portion or creating or adjusting a specific
allocation of the allowance for loan losses.
A loan is classified as a troubled debt restructuring (‘‘TDR’’) when certain concessions have been made to the
contractual terms, such as reductions of interest rates or deferrals of interest or principal payments due to the
borrower’s deteriorated financial condition. All TDRs are reported and accounted for as impaired loans.
Allowance for loan losses – The allowance for loan losses is a reserve established through a provision for loan
losses charged to expense and represents management’s best estimate of probable losses incurred within the
72
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
existing loan portfolio as of the balance sheet date. The level of the allowance reflects management’s view of
trends in loan loss activity, current loan portfolio quality and present economic, political and regulatory
conditions. Portions of the allowance may be allocated for specific loans; however, the allowance is available for
any loan that is charged off. The allowance is increased by provisions charged to earnings and by recoveries of
amounts previously charged off, and is reduced by charge-offs on loans (or portions thereof) deemed to be
uncollectible. Loan charge-offs are recognized when management believes the collectability of the principal
balance outstanding is unlikely. Full or partial charge-offs on collateral dependent impaired loans are generally
recognized when the collateral is deemed to be insufficient to support the carrying value of the loan.
The allowance for loan losses is maintained at a level sufficient to provide for probable credit losses based upon
evaluating known and inherent risks in the loan portfolio. The allowance is provided based upon management’s
continuing analysis of the pertinent factors underlying the quality of the loan portfolio. These factors include
changes in the size and composition of the loan portfolio, delinquency levels, actual loan loss experience, current
economic conditions, and detailed analysis of individual loans for which full collectability may not be assured.
The detailed analysis includes techniques to estimate the fair value of loan collateral and the existence of
potential alternative sources of repayment. The allowance consists of specific, general, and unallocated
components.
The Company considers installment loans to be pools of smaller balance, homogenous loans that are collectively
evaluated for impairment, unless such loans are subject to a TDR agreement.
For such loans that are also classified as impaired, a specific component within the allowance is established
when the discounted cash flows (or collateral value or observable market price) of the impaired loan are lower
than the carrying value of that loan. The general component covers non-impaired loans and is based upon
historical loss experience adjusted for qualitative factors.
An unallocated component is maintained to cover uncertainties that could affect management’s estimate of
probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the
underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
The appropriateness of the allowance for loan losses is estimated based upon those factors and trends identified
by management at the time consolidated financial statements are prepared. When available information confirms
that specific loans or portions thereof are uncollectible, identified amounts are charged against the allowance for
loan losses.
The existence of some or all of the following criteria will generally confirm that a loss has been incurred: the
loan is significantly delinquent and the borrower has not demonstrated the ability or intent to bring the loan
current; the Company has no recourse to the borrower, or if it does, the borrower has insufficient assets to pay
the debt; the estimated fair value of the loan collateral is significantly below the current loan balance, and there
is little or no near-term prospect for improvement.
The ultimate recovery of all loans is susceptible to future market factors beyond the Company’s control. These
factors may result in losses or recoveries differing significantly from those provided in the consolidated financial
statements.
Transfers of financial assets – Transfers of an entire financial asset, or a participating interest in an entire
financial asset, are accounted for as sales when control over the assets has been surrendered. Control over
transferred assets is deemed to be surrendered when: (1) a group of financial assets or a participating interest in
an entire financial asset has been isolated from the Company, (2) the transferee obtains the right (free of
conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and
(3) the Company does not maintain effective control over the transferred assets through an agreement to
repurchase them before their maturity.
Mortgage servicing rights (‘‘MSR’’) – Mortgage servicing rights represent the value associated with servicing
residential mortgage loans, when the mortgage loans have been sold into the secondary market and the related
servicing has been retained by the Company. The Company may also purchase mortgage servicing rights. The
value is determined through a discounted cash flow analysis, which uses interest rates, prepayment speeds and
delinquency rate assumptions as inputs. All of these assumptions require a significant degree of management
73
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
judgment. The Company measures its mortgage servicing assets at fair value and reports changes in fair value
through earnings under the caption mortgage banking revenue in the period in which the change occurs.
Premises and equipment – Premises, leasehold improvements and furniture and equipment are carried at cost,
less accumulated depreciation and amortization. Furniture and equipment are depreciated using the straight-line
method over the estimated useful lives of the assets, which range from 1 to 10 years. The cost of leasehold
improvements is amortized using the straight-line method over the terms of the related leases. The cost of
premises is amortized using the straight-line method over the estimated useful life of the building, up to
39 years. Management reviews premises, leasehold improvements and furniture and equipment for impairment on
an annual basis.
Bank-owned life insurance, net – The carrying amount of bank owned life insurance approximates its fair
value, and is estimated using the cash surrender value, net of any surrender charges.
Federal Home Loan Bank stock – The Company is a member of the Federal Home Loan Bank of Des Moines
(‘‘FHLB’’). FHLB stock represents the Company’s investment in the FHLB and is carried at par value, which
reasonably approximates its fair value. As a member of the FHLB, the Company is required to maintain a
minimum level of investment in FHLB stock based on specific percentages of its outstanding mortgages, total
assets, or FHLB advances. At December 31, 2019 and 2018, the Company’s minimum required investment in
FHLB stock was $1.2 million and $4.1 million, respectively. Typically, the Company may request redemption at
par value of any stock in excess of the minimum required investment. Stock redemptions are at the discretion of
the FHLB.
Other real estate owned and repossessed assets – OREO and repossessed assets represent real estate and other
assets which the Company has taken control of in partial or full satisfaction of loans. At the time of foreclosure,
OREO and repossessed assets are recorded at fair value less estimated costs to sell, which becomes the new
basis. Any write-downs based on the asset’s fair value at the date of acquisition are charged to the allowance for
loan and lease losses. After foreclosure, management periodically performs valuations such that the property is
carried at the lower of its new cost basis or fair value, net of estimated costs to sell. Revenue and expenses from
operations and subsequent adjustments to the carrying amount of the property are included in other noninterest
expense in the consolidated statements of income.
In some instances, the Company may make loans to facilitate the sales of OREO. Management reviews all sales
for which it is the lending institution. Any gains related to sales of other real estate owned may be deferred until
the buyer has a sufficient investment in the property.
Leases – We determine if an arrangement is a lease at inception. Operating leases are included in operating lease
right-of-use (‘‘ROU’’) assets and operating lease liabilities in our consolidated balance sheets. ROU assets
represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to
make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at
commencement date based on the present value of lease payments over the lease term. As most of our leases do
not provide an implicit rate, we generally use our incremental borrowing rate based on the estimated rate of
interest for collateralized borrowing over a similar term of the lease payments at commencement date. The
operating lease ROU asset also includes any lease payments made and excludes lease incentives. Our lease terms
may include options to extend or terminate the lease when it is reasonably certain that we will exercise that
option. Lease expense for lease payments is recognized on a straight-line basis over the lease term. Additionally,
for equipment leases, we apply a portfolio approach to effectively account for the operating lease ROU assets
and liabilities.
Income Taxes – Income taxes are accounted for using the asset and liability method. Under this method a
deferred tax asset or liability is determined based on the enacted tax rates which will be in effect when the
differences between the financial statement carrying amounts and tax basis of existing assets and liabilities are
expected to be reported in the Company’s income tax returns. The effect on deferred taxes of a change in tax
rates is recognized in income in the period that includes the enactment date. Valuation allowances are established
to reduce the net carrying amount of deferred tax assets if it is determined to be more likely than not, that all or
some portion of the potential deferred tax asset will not be realized.
74
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
Segment reporting – The Company operates in one segment and makes management decisions based on
consolidated results. The Company’s operations are solely in the financial services industry and include providing
to its clients traditional banking and other financial services.
Off-balance-sheet credit-related financial instruments – In the normal course of operations, the Company
engages in a variety of financial transactions that are not recorded in our financial statements. These transactions
involve varying degrees of off-balance sheet credit, interest rate and liquidity risks. These transactions are used
primarily to manage customers’ requests for funding and take the form of loan commitments, letters of credit and
lines of credit. Such financial instruments are recorded when they are funded.
Advertising costs – The Company expenses advertising costs as they are incurred. Advertising costs, including
other marketing expenses were $376,000 and $244,000 for the years ended December 31, 2019 and 2018,
respectively.
Comprehensive income – Accounting principles generally require that recognized revenue, expenses, gains, and
losses be included in net income. Certain changes in assets and liabilities, such as unrealized gains and losses on
available-for-sale investments, are reported as a separate component of the equity section of the consolidated
balance sheets, net of tax. Such items, along with net income, are components of comprehensive income.
Intangible assets – At December 31, 2019 and 2018, the Company had $158,000 and $209,000, respectively, of
identifiable intangible assets included in other assets as a result of the acquisition of deposits from other
institutions. These assets are amortized using the straight-line method over a period of 8-10 years and have a
remaining weighted average life of 5.2 years. Management reviews intangible assets for impairment on an annual
basis. No impairment losses have been recognized in the periods presented.
Employee stock ownership plan (ESOP) – The Company sponsors a leveraged ESOP. As shares are committed
to be released, compensation expense is recorded equal to the market price of the shares, and the shares become
outstanding for purposes of earnings per share calculations. Cash dividends on allocated shares (those credited to
ESOP participants’ accounts) are recorded as a reduction of stockholders’ equity and distributed directly to
participants’ accounts. Cash dividends on unallocated shares (those held by the ESOP not yet credited to
participants’ accounts) are used to pay administrative expenses and debt service requirements of the ESOP. See
Note 13 – Employee Benefits for further information. At December 31, 2019, there were 22,680 unallocated
shares in the plan. Shares released on December 31, 2019 totaled 11,340 and will be credited to plan
participants’ accounts in 2020.
Unearned ESOP shares are shown as a reduction of stockholders’ equity. When the shares are released, unearned
common shares held by the ESOP are reduced by the cost of the ESOP shares released and the differential
between the fair value and the cost is charged to additional paid in capital. The loan receivable from the ESOP to
the Company is not reported as an asset nor is the debt of the ESOP reported as a liability on the Company’s
consolidated statements of condition.
Earnings Per Common Share – Earnings per share (‘‘EPS’’) is computed using the two-class method. Basic
EPS is computed by dividing net income available to common shares by the weighted average number of
common shares outstanding during the period, excluding any participating securities. Participating securities
include unvested restricted shares. Unvested restricted shares are considered participating securities because
holders of these securities receive non-forfeitable dividends at the same rate as the holders of the Company’s
common stock. Diluted EPS is computed by dividing net income available to common stockholders adjusted for
reallocation of undistributed earnings of unvested restricted shares by the weighted average number of common
shares determined for the basic EPS plus the dilutive effect of common stock equivalents using the treasury stock
method based on the average market price for the period. Some stock options are anti-dilutive and therefore are
not included in the calculation of diluted EPS.
Fair value – Fair value is the price that would be received when an asset is sold or a liability is transferred in an
orderly transaction between market participants at the measurement date.
Fair values of the Company’s financial instruments are based on the fair value hierarchy which requires an entity
to maximize the use of observable inputs, typically market data obtained from third parties, and minimize the use
of unobservable inputs, which reflects its estimates for market assumptions, when measuring fair value.
75
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
Three levels of valuation inputs are ranked in accordance with the prescribed fair value hierarchy as follows:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2: Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar
assets or liabilities in markets that are not active.
Level 3: Assets or liabilities whose significant value drivers are unobservable.
In determining the appropriate levels, the Company performs a detailed analysis of the assets and liabilities that
are subject to fair value measurements. In certain cases, the inputs used to measure fair value of an asset or
liability may fall into different levels of the fair value hierarchy. The level within which the fair value
measurement is categorized is based on the lowest level unobservable input that is significant to the fair value
measurement in its entirety. Therefore, an item may be classified in Level 3 even though there may be some
significant inputs that are readily observable.
Share-Based Compensation – The Company measures the cost of employee services received in exchange for
an award of equity instruments based on the grant date fair value of the award. These costs are recognized on a
straight-line basis over the vesting period during which an employee is required to provide services in exchange
for the award, also known as the requisite service period. The Company uses the Black-Scholes option pricing
model to estimate the fair value of stock options granted. When determining the estimated fair value of stock
options granted, the Company utilizes various assumptions regarding the expected volatility of the stock price,
estimated forfeitures using historical data on employee terminations, the risk-free interest rate for periods within
the contractual life of the stock option, and the expected dividend yield that the Company expects over the
expected life of the options granted. Reductions in compensation expense associated with forfeited options are
estimated at the date of grant, and this estimated forfeiture rate is adjusted monthly based on actual forfeiture
experience. The Company measures the fair value of the restricted stock using the closing market price of the
Company’s common stock on the date of grant. The Company expenses the grant date fair value of the
Company’s stock options and restricted stock with a corresponding increase in equity.
Reclassifications – Certain amounts reported in prior years’ consolidated financial statements have been
reclassified to conform to the current presentation. The results of the reclassifications are not considered material
and have no effect on previously reported net income, earnings per share or stockholders’ equity.
Note 2 – Accounting Pronouncements Recently Issued or Adopted
In December 2019, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update
(ASU) No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (ASU 2019-12).
This ASU simplifies the accounting for income taxes by removing the exception to the incremental approach for
intra-period tax allocation when there is a loss from continuing operations and income or a gain from other
items, removing the requirement to recognize a deferred tax liability for equity method investments when a
foreign subsidiary becomes an equity method investment, and removing the general methodology for calculating
income taxes in an interim period when a year-to-date loss exceeds the anticipated loss for the year. This ASU is
effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. The
Company does not expect the adoption of ASU 2019-12 to have a material impact on its consolidated financial
statements.
In August 2018, the FASB issued ASU No. 2018-14, Compensation - Retirement Benefits - Defined Benefit
Plans - General (Subtopic 715-20): Disclosure Framework - Changes to the Disclosure Requirements for Defined
Benefit Plans. This ASU modifies disclosure requirements for employers that sponsor defined benefit pension or
other postretirement plans. Disclosure requirements removed from FASB Subtopic 715-20 include the amounts in
accumulated other comprehensive income expected to be recognized as components of net periodic benefit cost
over the next fiscal year, the amount and timing of plan assets expected to be returned to the employer, related
party disclosures about the amount of future annual benefits covered by insurance and annuity contracts and
significant transactions between the employer or related parties and the plan, and, for public entities, the effects
of a one-percentage-point change in assumed health care cost trend rates on the aggregate of the service and
interest cost components of net periodic benefit costs and benefit obligation for postretirement health care
benefits. Disclosure requirements added to FASB Subtopic 715-20 include the weighted-average interest crediting
76
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
rates for cash balance plans and other plans with promised interest crediting rates, and an explanation of the
reasons for significant gains and losses related to changes in the benefit obligation for the period. This ASU is
effective for fiscal years ending after December 15, 2020. The Company does not expect the adoption of ASU
2018-14 to have a material impact on its consolidated financial statements.
In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement: Disclosure Framework - Changes
to the Disclosure Requirements for Fair Value Measurement. This ASU modifies the disclosure requirements on
fair value measurements by removing the amount of and reasons for transfers between Level 1 and Level 2 of
the fair value hierarchy, the policy for timing of transfers between levels, and the valuation processes for Level 3
fair value measurements. This ASU clarifies that the measurement uncertainty disclosure is to communicate
information about the uncertainty in measurement as of the reporting date. The ASU adds disclosure
requirements for Level 3 measurements, including changes in unrealized gains and losses for the period included
in other comprehensive income for the recurring Level 3 fair value measurements held at the end of the reporting
period, and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value
measurements. Amendments in this ASU are effective for fiscal years beginning after December 15, 2019,
including interim periods within those fiscal years. Early adoption is permitted for any removed or modified
disclosures. The adoption of ASU 2018-13 is not expected to have a material impact on the Company’s
consolidated financial statements.
In June 2018, the FASB issued ASU No. 2018-07, Compensation - Stock Compensation (Topic 718):
Improvements to Nonemployee Share-Based Payment Accounting. This ASU amends the accounting for
share-based payments awards to nonemployees to align with the accounting for employee awards. Under the new
guidance, the existing employee guidance will apply to nonemployee share-based transactions (as long as the
transaction is not effectively a form of financing), with the exception of specific guidance related to the
attribution of compensation cost. The cost of nonemployee awards will continue to be recorded as if the grantor
had paid cash for the goods or services. In addition, the contractual term will be able to be used in lieu of an
expected term in the option-pricing model for nonemployee awards. Amendments in this ASU are effective for
annual periods, and interim periods within those annual periods, beginning after December 15, 2018 and early
adoption is permitted. The adoption of ASU No. 2018-07 on January 1, 2019 did not have a material impact on
the Company’s consolidated financial statements.
In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted
Improvements to Accounting for Hedging Activities. This ASU amends the hedge accounting recognition and
presentation requirements in ASC 815 to improve the transparency and understandability of information
conveyed to financial statement users about an entity’s risk management activities by better aligning the entity’s
financial reporting for hedging relationships with those risk management activities and reduce the complexity of
and simplify the application of hedge accounting by preparers. The amendments in this ASU permit hedge
accounting for hedging relationships involving nonfinancial risk and interest rate risk by removing certain
limitations in cash flow and fair value hedging relationships. In addition, the ASU requires an entity to present
the earnings effect of the hedging instrument in the same income statement line item in which the earnings effect
of the hedged item is reported. The amendments in this ASU are effective for annual periods, and interim periods
within those annual periods, beginning after December 15, 2018 and early adoption is permitted. The adoption of
ASU No. 2017-12 on January 1, 2019, did not have a material impact on the Company’s consolidated financial
statements.
In March 2017, the FASB issued ASU No. 2017-08, Receivables-Nonrefundable Fees and Other Costs
(Subtopic 310-20). ASU 2017-08 is intended to amend the amortization period for certain purchased callable debt
securities held at a premium. Under ASU 2017-08, the FASB is shortening the amortization period for the
premium to the earliest call date. ASU 2017-08 is effective for annual periods, and interim periods within those
annual periods, beginning after December 15, 2018. The adoption of ASU No. 2017-08 on January 1, 2019 did
not have a material impact on the Company’s consolidated financial statements.
In January 2017, the FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying
the Test for Goodwill Impairment, or ASU 2017-04, which eliminates Step 2 from the goodwill impairment test.
ASU 2017-04 also eliminates the requirements for any reporting unit with a zero or negative carrying amount to
perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment
77
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
test. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the
quantitative impairment test is necessary. Adoption of ASU 2017-04 is required for annual or interim goodwill
impairment tests in fiscal years beginning after December 15, 2019 with early adoption permitted for annual or
interim goodwill impairment tests performed on testing dates after January 1, 2017. The Company does not
expect the adoption of ASU 2017-04 to have a material impact on its consolidated financial statements.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326):
Measurement of Credit Losses on Financial Instruments. This ASU replaces the existing incurred loss impairment
methodology that recognizes credit losses when a probable loss has been incurred with new methodology where
loss estimates are based upon lifetime expected credit losses. The amendments in this ASU require a financial
asset that is measured at amortized cost to be presented at the net amount expected to be collected. The income
statement would then reflect the measurement of credit losses for newly recognized financial assets as well as
changes to the expected credit losses that have taken place during the reporting period. The change in allowance
recognized as a result of adoption will occur through a cumulative-effect adjustment to retained earnings as of
the beginning of the first reporting period in which the ASU is adopted. The FASB issued ASU 2019-10,
Financial Instruments - Credit Losses (Topic 326), delaying implementation of ASU 2016-13 for SEC smaller
reporting company filers until fiscal year beginning after December 15, 2022. The Bank meets the requirements
of a smaller reporting company and will delay implementation of ASU 2016-13.
In February 2016, FASB issued ASU No. 2016-02, Leases (Topic 842). ASU No. 2016-02 requires lessees to
recognize, on the balance sheet, the assets and liabilities arising from operating leases. A lessee should recognize
a liability to make lease payments and a right-of-use asset representing its right to use the underlying asset for
the lease term. A lessee should include payments to be made in an optional period only if the lessee is
reasonably certain to exercise an option to extend the lease or not to exercise an option to terminate the lease.
For a finance lease, interest payments should be recognized separately from amortization of the right-of-use asset
in the statement of comprehensive income. For operating leases, the lease cost should be allocated over the lease
term on a generally straight-line basis. In July 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842),
Targeted Improvements. This ASU amended the new leases standard to give entities another option for transition
and to provide lessors with a practical expedient. The transition option allows entities to not apply the new leases
standard in the comparative periods they present in their financial statements in the year of adoption. The
practical expedient provides lessors with an option to not separate non-lease components from the associated
lease components when certain criteria are met and requires them to account for the combined component in
accordance with the new revenue standard if the associated non-lease components are the predominant
components. The Company adopted these ASUs on January 1, 2019. In March 2019, FASB issued ASU 2019-01,
Leases (Topic 842), Codification Improvements. The amendments in this ASU include determining the fair value
of the underlying asset by lessors that are not manufacturers or dealers, requiring cash received from lessors from
sales-type and direct financing leases to be presented in the cash flow statement within investing activities, and
clarifying interim disclosure requirements. The effective date and transition requirements for the first and second
items of this ASU are effective for annual periods, and interim periods within those annual periods, beginning
after December 15, 2019 and early adoption is permitted. We have adopted the third item of this ASU and
provided the required annual disclosures in this report. Refer to Note 20 - Leases for further information.
Note 3 – Restricted Cash
Federal Reserve Board regulations require that the Company maintain certain minimum reserve balances either as
cash on hand or on deposit with the Federal Reserve Bank, based on a percentage of deposits. The reserve
balances were $12.4 million and $13.8 million at December 31, 2019 and 2018, respectively.
78
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
Note 4 – Investments
The amortized cost and fair value of AFS securities and the corresponding amounts of gross unrealized gains and
losses at December 31, 2019 and 2018 were as follows (in thousands):
December 31, 2019
Municipal bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Agency mortgage-backed securities . . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
December 31, 2018
Municipal bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Agency mortgage-backed securities . . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair Value
$3,197
5,888
$9,085
$3,218
1,594
$4,812
$173
56
$229
$122
46
$168
$ —
(8)
$ (8)
$(23)
—
$(23)
$3,370
5,936
$9,306
$3,317
1,640
$4,957
The amortized cost and fair value of AFS securities at December 31, 2019, by contractual maturity, are shown
below (in thousands). Expected maturities of AFS securities may differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Investments not due at a single maturity date, primarily mortgage-backed securities, are shown separately.
Due within one year. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Due in one to five years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Due after five to ten years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Due after ten years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Mortgage-backed securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
December 31, 2019
Amortized
Cost
$1,052
492
459
1,194
5,888
$9,085
Fair
Value
$1,053
505
496
1,315
5,937
$9,306
Weighted-
Average
Yield
1.55%
2.83
4.77
5.43
3.07
3.28%
There were no pledged securities at December 31, 2019 and 2018. There were no sales of AFS securities during
the years ended December 31, 2019 and 2018.
The following tables summarize the aggregate fair value and gross unrealized loss by length of time of those
investments that have been in a continuous unrealized loss position at December 31, 2019 and 2018 (in
thousands):
Less Than 12 Months
Unrealized
Loss
Fair
Value
December 31, 2019
12 Months or Longer
Unrealized
Fair
Loss
Value
Total
Fair
Value
Unrealized
Loss
Agency mortgage-backed securities . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$3,387
$3,387
$(8)
$(8)
$—
$—
$—
$—
$3,387
$3,387
$(8)
$(8)
Less Than 12 Months
Unrealized
Fair
Loss
Value
December 31, 2018
12 Months or Longer
Unrealized
Loss
Fair
Value
Total
Fair
Value
Unrealized
Loss
Municipal bonds . . . . . . . . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$—
$—
$—
$—
$1,283
$1,283
$(23)
$(23)
$1,283
$1,283
$(23)
$(23)
79
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
There were no credit losses recognized in earnings during the years ended December 31, 2019 and 2018 relating
to the Company’s securities.
At December 31, 2019, the securities portfolio consisted of 13 agency mortgage-backed securities and eight
municipal securities with a fair value of $9.3 million. At December 31, 2018, the securities portfolio consisted of
six agency mortgage-backed securities and eight municipal bonds with a fair value of $5.0 million. At
December 31, 2019, there were five agency securities in an unrealized loss position for less than 12 months, and
there were no securities in an unrealized loss position for more than 12 months. At December 31, 2018, there
were no securities in an unrealized loss position for less than 12 months, and there were three municipal
securities in an unrealized loss position for more than 12 months. For both the 2019 and 2018 periods, the
unrealized losses were caused by changes in market interest rates or the widening of market spreads subsequent
to the initial purchase of these securities, and not related to the underlying credit of the issuers or the underlying
collateral. It is expected that these securities will not be settled at a price less than the amortized cost of each
investment. The unrealized losses on these investments are not considered other-than-temporary impairment
(‘‘OTTI’’) during the years ended December 31, 2019 and 2018, because the decline in fair value is not
attributable to credit quality and because we do not intend, and it is not likely that we will be required, to sell
these securities before recovery of their amortized cost basis.
Note 5 – Loans
The composition of the loan portfolio, excluding loans held-for-sale, at December 31, 2019 and 2018 is as
follows (in thousands):
Real estate loans:
One-to-four family . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Home equity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial and multifamily. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Construction and land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total real estate loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Consumer loans:
Manufactured homes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Floating homes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other consumer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total consumer loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial business loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total loans, gross . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Allowance for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
At December 31,
2019
2018
$149,393
23,845
261,268
75,756
510,262
20,613
43,799
8,302
72,714
38,931
621,907
(2,020)
619,887
(5,640)
$169,830
27,655
252,644
65,259
515,388
20,145
40,806
6,628
67,579
38,804
621,771
(2,228)
619,543
(5,774)
Total loans, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$614,247
$613,769
80
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
The following table presents the balance in the allowance for loan losses and the unpaid principal balance in
loans, net of partial charge-offs by portfolio segment and based on impairment method as of December 31, 2019
(in thousands):
Allowance:
Individually
evaluated for
impairment
Allowance:
Collectively
evaluated for
impairment
Ending balance
Loans held for
investment:
Individually
evaluated for
impairment
Loans held for
investment:
Collectively
evaluated for
impairment
Ending balance
One-to-four family . . . . . .
Home equity . . . . . . . . . . .
Commercial and
multifamily . . . . . . . . . .
Construction and land. . . .
Manufactured homes . . . .
Floating homes . . . . . . . . .
Other consumer. . . . . . . . .
Commercial business . . . .
Unallocated . . . . . . . . . . . .
Total. . . . . . . . . . . . . . . .
$205
25
—
7
349
—
54
84
—
$724
$ 915
153
1,696
485
131
283
58
247
948
$4,916
$1,120
178
1,696
492
480
283
112
331
948
$5,640
$ 8,620
335
353
1,215
440
290
143
997
—
$12,393
$140,773
23,510
260,915
74,541
20,173
43,509
8,159
37,934
—
$609,514
$149,393
23,845
261,268
75,756
20,613
43,799
8,302
38,931
—
$621,907
The following table presents the balance in the allowance for loan losses and the unpaid principal balance in
loans, net of partial charge-offs by portfolio segment and based on impairment method as of December 31, 2018
(in thousands):
Allowance:
Individually
evaluated for
impairment
Allowance:
Collectively
evaluated for
impairment
Ending balance
Loans held for
investment:
Individually
evaluated for
impairment
Loans held for
investment:
Collectively
evaluated for
impairment
Ending balance
One-to-four family . . . . . .
Home equity . . . . . . . . . . .
Commercial and
multifamily . . . . . . . . . .
Construction and land. . . .
Manufactured homes . . . .
Floating homes . . . . . . . . .
Other consumer. . . . . . . . .
Commercial business . . . .
Unallocated . . . . . . . . . . . .
Total. . . . . . . . . . . . . . . .
$228
25
—
8
299
—
64
112
—
$736
$1,086
177
1,638
423
128
265
48
244
1,029
$5,038
$1,314
202
1,638
431
427
265
112
356
1,029
$5,774
$2,760
440
702
163
424
—
157
1,192
—
$5,838
$167,070
27,215
251,942
65,096
19,721
40,806
6,471
37,612
—
$615,933
$169,830
27,655
252,644
65,259
20,145
40,806
6,628
38,804
—
$621,771
The following table summarizes the activity in the allowance for loan losses for the year ended December 31,
2019 (in thousands):
One-to-four family . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Home equity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial and multifamily. . . . . . . . . . . . . . . . . . . .
Construction and land . . . . . . . . . . . . . . . . . . . . . . . . .
Manufactured homes . . . . . . . . . . . . . . . . . . . . . . . . . .
Floating homes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other consumer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial business . . . . . . . . . . . . . . . . . . . . . . . . . .
Unallocated. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Charge-offs
$ —
—
—
—
—
—
(52)
—
—
$(52)
Recoveries
$ 6
10
—
—
—
—
24
3
—
$43
(Recapture)
/ Provision
$(200)
(34)
58
61
53
18
28
(28)
(81)
$(125)
Ending
Allowance
$1,120
178
1,696
492
480
283
112
331
948
$5,640
Beginning
Allowance
$1,314
202
1,638
431
427
265
112
356
1,029
$5,774
81
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
The following table summarizes the activity in the allowance for loan losses for the year ended December 31,
2018 (in thousands):
One-to-four family . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Home equity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial and multifamily. . . . . . . . . . . . . . . . . . . .
Construction and land . . . . . . . . . . . . . . . . . . . . . . . . .
Manufactured homes . . . . . . . . . . . . . . . . . . . . . . . . . .
Floating homes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other consumer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial business . . . . . . . . . . . . . . . . . . . . . . . . . .
Unallocated. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Beginning
Allowance
Charge-offs
Recoveries
(Recapture)
/ Provision
Ending
Allowance
$1,436
293
1,250
378
355
169
80
372
908
$5,241
$ —
(7)
—
—
(12)
—
(31)
—
—
$(50)
$ 1
44
—
—
—
—
12
1
—
$58
$(123)
(128)
388
53
84
96
51
(17)
121
$ 525
$1,314
202
1,638
431
427
265
112
356
1,029
$5,774
Credit Quality Indicators. Federal regulations provide for the classification of lower quality loans as substandard,
doubtful or loss. A loan is considered substandard if it is inadequately protected by the current net worth and pay
capacity of the borrower or of any collateral pledged. Substandard loans include those characterized by the
distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Loans classified
as doubtful have all the weaknesses of currently existing facts, conditions and values. Loans classified as loss are
those considered uncollectible and of such little value that their continuance as assets without establishment of a
specific loss reserve is not warranted.
When the Company classifies problem loans as either substandard or doubtful, it may establish a specific
allowance in an amount it deems prudent to address the risk specifically (if the loan is impaired) or it may allow
the loss to be addressed in the general allowance (if the loan is not impaired). General allowances represent loss
reserves which have been established to recognize the inherent risk associated with lending activities, but which,
unlike specific allowances, have not been specifically allocated to particular problem assets. When the Company
classifies problem loans as a loss, it charges off such loans in the period in which they are deemed uncollectible.
Loans that do not currently expose the Company to sufficient risk to warrant classification as substandard or
doubtful but possess identified weaknesses are classified as either watch or special mention loans. The
Company’s determination as the classification of its loans and the amount of its valuation allowances is subject
to review by the FDIC, which can order the establishment of additional loss allowances. Pass rated loans are
loans that are not otherwise classified or criticized.
The following table represents the internally assigned grades as of December 31, 2019, by type of loan (in
thousands):
One-to-
four
family
Home
equity
Commercial
and
multifamily
Construction
and land
Manufactured
homes
Floating
homes
Other
consumer
Commercial
business
Total
Grade:
Pass . . . . . . . . . . . $138,900 $23,206
—
Watch . . . . . . . . . .
—
Special Mention . .
639
Substandard. . . . . .
—
Doubtful . . . . . . . .
—
Loss . . . . . . . . . . .
—
2,484
8,009
—
—
$256,139
217
2,178
2,734
—
—
Total . . . . . . . . . . . $149,393 $23,845
$261,268
$68,268
2,634
3,677
1,177
—
—
$75,756
$20,204
124
—
285
—
—
$43,509
—
—
290
—
—
$8,250
—
—
52
—
—
$35,347
378
1,649
1,557
—
—
$593,823
3,353
9,988
14,743
—
—
$20,613
$43,799
$8,302
$38,931
$621,907
82
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
The following table represents the internally assigned grades as of December 31, 2018, by type of loan (in
thousands):
One-to-
four
family
Home
equity
Commercial
and
multifamily
Construction
and land
Manufactured
homes
Floating
homes
Other
consumer
Commercial
business
Total
Grade:
Pass . . . . . . . . . . . $163,655 $27,150
—
Watch . . . . . . . . . .
—
Special Mention . .
505
Substandard. . . . . .
—
Doubtful . . . . . . . .
—
Loss . . . . . . . . . . .
—
—
6,175
—
—
$246,907
1,139
2,497
2,101
—
—
Total . . . . . . . . . . . $169,830 $27,655
$252,644
$55,916
5,968
3,252
123
—
—
$65,259
$19,860
—
—
285
—
—
$40,806
—
—
—
—
—
$6,576
—
—
52
—
—
$35,876
689
367
1,872
—
—
$596,746
7,796
6,116
11,113
—
—
$20,145
$40,806
$6,628
$38,804
$621,771
Nonaccrual and Past Due Loans. Loans are considered past due if the required principal and interest payments
have not been received as of the date such payments were due. Loans are automatically placed on nonaccrual
once the loan is 90 days past due or if, in management’s opinion, the borrower may be unable to meet payment
of obligations as they become due, as well as when required by regulatory provisions.
The following table presents the recorded investment in nonaccrual loans as of December 31, 2019 and 2018, by
type of loan (in thousands):
One-to-four family. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Home equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial and multifamily . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Construction and land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Manufactured homes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Floating homes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial business. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2019
$2,090
261
353
1,177
226
290
260
$4,657
2018
$1,075
360
534
123
214
—
235
$2,541
The following table represents the aging of the recorded investment in past due loans as of December 31, 2019,
by type of loan (in thousands):
30-59 Days
Past Due
60-89 Days
Past Due
Greater
than 90
Days Past
Due
Recorded
Investment
> 90 Days
and
Accruing
One-to-four family . . . . . . . . . .
Home equity . . . . . . . . . . . . . . .
Commercial and multifamily . .
Construction and land . . . . . . . .
Manufactured homes. . . . . . . . .
Floating homes . . . . . . . . . . . . .
Other consumer . . . . . . . . . . . . .
Commercial business . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . .
$ 789
81
1,742
3,340
324
297
19
226
$6,818
$ 105
161
—
1,100
43
250
2
—
$1,661
$1,810
197
353
50
125
290
—
162
$2,987
$—
—
—
—
—
—
—
—
$—
Total
Past Due
$ 2,704
439
2,095
4,490
492
837
21
388
Current
$146,689
23,406
259,173
71,266
20,121
42,962
8,281
38,543
Total
Loans
$149,393
23,845
261,268
75,756
20,613
43,799
8,302
38,931
$11,466
$610,441
$621,907
83
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
The following table represents the aging of the recorded investment in past due loans as of December 31, 2018,
by type of loan (in thousands):
30-59 Days
Past Due
60-89 Days
Past Due
Greater
Than 90
Days Past
Due
Recorded
Investment
> 90 Days
and
Accruing
One-to-four family . . . . . . . . . .
Home equity . . . . . . . . . . . . . . .
Commercial and multifamily . .
Construction and land . . . . . . . .
Manufactured homes. . . . . . . . .
Floating homes . . . . . . . . . . . . .
Other consumer . . . . . . . . . . . . .
Commercial business . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . .
$1,362
298
139
650
78
—
11
228
$2,766
$167
149
—
—
129
—
5
177
$627
$ 514
284
353
50
199
—
—
122
$1,522
$—
—
—
—
—
—
—
—
$—
Total
Past Due
$2,043
731
492
700
406
—
16
527
Current
$167,787
26,924
252,152
64,559
19,739
40,806
6,612
38,277
Total
Loans
$169,830
27,655
252,644
65,259
20,145
40,806
6,628
38,804
$4,915
$616,856
$621,771
Nonperforming Loans. Loans are considered nonperforming when they are placed on nonaccrual.
The following table represents the credit risk profile based on payment activity as of December 31, 2019, by
type of loan (in thousands):
One-to-
four
family
Home
equity
Commercial
and
multifamily
Construction
and land
Manufactured
homes
Floating
homes
Other
consumer
Commercial
business
Total
Performing . . . . . $147,303 $23,584 $260,915
353
2,090
Nonperforming . .
261
$74,579
1,177
$20,387
226
$43,509 $8,302
—
290
$38,671 $617,250
4,657
260
Total . . . . . . . . $149,393 $23,845 $261,268
$75,756
$20,613
$43,799 $8,302
$38,931 $621,907
The following table represents the credit risk profile based on payment activity as of December 31, 2018, by
type of loan (in thousands):
One-to-
four
family
Home
equity
Commercial
and
multifamily
Construction
and land
Manufactured
homes
Floating
homes
Other
consumer
Commercial
business
Total
Performing . . . . . $168,755 $27,295 $252,110
534
1,075
Nonperforming . .
360
$65,136
123
$19,931
214
$40,806 $6,628
—
—
$38,569 $619,230
2,541
235
Total . . . . . . . . $169,830 $27,655 $252,644
$65,259
$20,145
$40,806 $6,628
$38,804 $621,771
Impaired Loans. A loan is considered impaired when the Company has determined that it may be unable to
collect payments of principal or interest when due under the terms of the loan. In the process of identifying loans
as impaired, the Company takes into consideration factors which include payment history and status, collateral
value, financial condition of the borrower, and the probability of collecting scheduled payments in the future.
Minor payment delays and insignificant payment shortfalls typically do not result in a loan being classified as
impaired. The significance of payment delays and shortfalls is considered on a case by case basis, after taking
into consideration the totality of circumstances surrounding the loans and the borrowers, including payment
history and amounts of any payment shortfall, length and reason for delay, and likelihood of return to stable
performance. Impairment is measured on a loan by loan basis for all loans in the portfolio. All TDRs are also
classified as impaired loans and are included in the loans individually evaluated for impairment in the calculation
of the allowance for loan losses.
84
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
Impaired loans at December 31, 2019 and 2018, by type of loan were as follows (in thousands):
One-to-four family . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Home equity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial and multifamily. . . . . . . . . . . . . . . . . . . .
Construction and land . . . . . . . . . . . . . . . . . . . . . . . . .
Manufactured homes . . . . . . . . . . . . . . . . . . . . . . . . . .
Floating homes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other consumer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial business . . . . . . . . . . . . . . . . . . . . . . . . . .
Unpaid
Principal
Balance
$ 8,748
335
353
1,215
445
290
143
997
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$12,526
$10,072
December 31, 2019
Recorded Investment
Without
Allowance
With
Allowance
Total
Recorded
Investment
Related
Allowance
$ 7,236
256
353
1,177
46
290
—
714
$1,384
79
—
38
394
—
143
283
$2,321
$ 8,620
335
353
1,215
440
290
143
997
$12,393
$205
25
—
7
349
—
54
84
$724
One-to-four family . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Home equity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial and multifamily. . . . . . . . . . . . . . . . . . . .
Construction and land . . . . . . . . . . . . . . . . . . . . . . . . .
Manufactured homes . . . . . . . . . . . . . . . . . . . . . . . . . .
Other consumer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial business . . . . . . . . . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
December 31, 2018
Recorded Investment
Unpaid
Principal
Balance
$2,894
520
702
163
430
156
1,192
$6,057
Without
Allowance
With
Allowance
Total
Recorded
Investment
Related
Allowance
$1,085
359
702
123
—
—
659
$2,928
$1,675
81
—
40
424
157
533
$2,910
$2,760
440
702
163
424
157
1,192
$5,838
$228
25
—
8
299
64
112
$736
The following table provides the average recorded investment and interest income on impaired loans for the year
ended December 31, 2019 and 2018, by type of loan (in thousands):
Year Ended
December 31, 2019
Year Ended
December 31, 2018
Average
Recorded
Investment
Interest
Income
Recognized
Average
Recorded
Investment
Interest
Income
Recognized
One-to-four family . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Home equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial and multifamily . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Construction and land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Manufactured homes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Floating homes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other consumer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$4,788
1,109
888
462
456
58
155
1,082
$8,998
$280
19
19
156
39
16
8
56
$593
$ 4,704
740
2,564
726
414
—
169
1,854
$11,171
$214
29
140
95
35
—
9
140
$662
Forgone interest on nonaccrual loans was $370,000 and $172,000 for the year ended December 31, 2019 and
2018, respectively. There were no commitments to lend additional funds to borrowers whose loans were
classified as nonaccrual, TDR or impaired at December 31, 2019 and 2018.
85
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
Troubled debt restructurings. Loans classified as TDRs totaled $7.9 million and $2.8 million at December 31,
2019 and 2018, respectively, and are included in impaired loans. A TDR is a loan to a borrower that is
experiencing financial difficulty that has been modified from its original terms and conditions in such a way that
the Company is granting the borrower a concession of some kind. The Company has granted, in its TDRs, a
variety of concessions to borrowers in the form of loan modifications. The modifications granted can generally
be described in the following categories:
Rate Modification: A modification in which the interest rate is changed.
Term Modification: A modification in which the maturity date, timing of payments or frequency of payments is
changed.
Payment Modifications: A modification in which the dollar amount of the payment is changed. Interest only
modifications in which a loan is converted to interest only payments for a period of time are included in this
category.
Combination Modification: Any other type of modification, including the use of multiple categories above.
There were eight loans totaling $5.7 million, that were modified as a TDR during the year ended December 31,
2019. The following TDR loans were paid off during the year ended December 31, 2019: three one-to-four
family residential loans totaling $262,000 and three home equity loans totaling $165,000, one manufactured
home loan totaling $19,000 and one land loan totaling $4,000.
There was one TDR totaling $49,000 for which there was a payment default within the first 12 months of
modification during the year ended December 31, 2019. There were three TDRs totaling $362,000 for which
there was a payment default within the first 12 months of modification during the year ended December 31,
2018.
In the ordinary course of business, the Company makes loans to its employees, officers and directors. Certain
loans to employees, officers and directors are offered at discounted rates as compared to other clients as
permitted by federal regulations. Employees, officers, and directors are eligible for mortgage loans with an
adjustable rate that resets annually to 1.0% - 1.5% over the rolling cost of funds. Employees, officers and
directors are also eligible for consumer loans that are 1.0% below the market loan rate at the time of origination.
Director and officer loans are summarized as follows (in thousands):
Balance, beginning of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Advances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
New / (reclassified) loans, net(1). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Repayments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Balance, end of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
December 31,
2019
$3,370
88
515
(748)
$3,225
2018
$4,012
291
(526)
(407)
$3,370
(1) Reclassified loans relate to changes in related parties during the year.
At December 31, 2019 and 2018, loans totaling $19.9 million and $5.8 million, respectively, represented real
estate secured loans that had current loan-to-value ratios above supervisory guidelines.
Note 6 – Mortgage Servicing Rights
The Company’s mortgage servicing rights portfolio totaled $377.3 million at December 31, 2019, compared to
$378.7 million at December 31, 2018. Of this total balance, the unpaid principal balance of loans serviced for
Federal National Mortgage Association (‘‘Fannie Mae’’) at December 31, 2019 and 2018 was $363.3 million and
$376.5 million, respectively. The unpaid principal balances of loans serviced for other financial institutions at
December 31, 2019 and 2018, totaled $14.0 million and $2.2 million, respectively. Loans serviced for Fannie
Mae and others are not included in the Company’s financial statements as they are not assets of the Company.
86
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
A summary of the change in the balance of mortgage servicing assets at December 31, 2019 and 2018 were as
follows (in thousands):
Beginning balance, at fair value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Servicing rights that result from transfers and sale of financial assets. . . . . . . . . . . . . . . .
Changes in fair value:
Due to changes in model inputs or assumptions(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Ending balance, at fair value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
At December 31,
2019
$3,414
585
2018
$3,426
481
(760)
(493)
$3,239
$3,414
(1) Represents changes due to collection/realization of expected cash flows and curtailments.
The key economic assumptions used in determining the fair value of mortgage servicing rights at the dates
indicated are as follows:
Prepayment speed (Public Securities Association ‘‘PSA’’ model). . . . . . . . . . . . . . . . . . . .
Weighted-average life . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Yield to maturity discount rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
187%
6.2 years
12.5%
123%
7.7 years
12.5%
The amount of contractually specified servicing, late and ancillary fees earned on the mortgage servicing rights
are included in mortgage servicing income on the Consolidated Statements of Income and totaled $1.0 million
and $1.1 million, for the years ended December 31, 2019 and 2018, respectively.
At December 31,
2019
2018
Note 7 – Premises and Equipment
Premises and equipment at December 31, 2019 and 2018 are summarized as follows (in thousands):
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Buildings and improvements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Furniture and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
At December 31,
$
2019
920
7,067
5,163
$
2018
920
6,393
5,203
Less: Accumulated depreciation and amortization. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(6,383)
(5,472)
Premises and equipment, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 6,767
$ 7,044
Depreciation and amortization expense was $931,000 and $989,000, for the years ended December 31, 2019 and
2018, respectively.
The Company leases office space in several buildings. Generally, operating leases contain renewal options and
provisions requiring the Company to pay property taxes and operating expenses over base period amounts. All
rental payments are dependent only upon the lapse of time.
The total rental expense for the years ended December 31, 2019 and 2018 for all facilities leased under operating
leases was approximately $1.2 million and $1.4 million, respectively.
87
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
Note 8 – Other Real Estate Owned and Repossessed Assets
The following table presents activity related to OREO and other repossessed assets for the periods shown (in
thousands):
Beginning balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Additions to OREO and repossessed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Write-downs/Losses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Year Ended December 31,
2019
$ 575
494
(473)
(21)
$ 575
2018
$610
55
(16)
(74)
$575
Note 9 – Deposits
A summary of deposit accounts with the corresponding weighted average cost of funds at December 31, 2019
and 2018, are presented below (dollars in thousands):
As of December 31, 2019
Wtd. Avg
Deposit
Rate
Balance
As of December 31, 2018
Wtd. Avg
Deposit
Rate
Balance
Noninterest-bearing demand . . . . . . . . . . . . . . . . . . . . . . . . .
Interest-bearing demand . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Savings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Money market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Certificates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Escrow(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 94,973
159,774
57,936
50,337
251,387
2,311
$616,718
—%
0.54
0.33
0.49
2.23
—
1.16%
$ 93,823
164,919
54,102
46,689
191,825
2,243
$553,601
—%
0.47
0.29
0.24
1.58
—
0.71%
(1) Escrow balances shown in noninterest-bearing deposits on the Consolidated Balance Sheets.
Scheduled maturities of time deposits at December 31, 2019, are as follows (in thousands):
Year Ending
December 31,
2020
2021
2022
2023
Thereafter
Amount
$ 86,566
134,104
8,964
20,124
1,629
$251,387
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 December 31, 2019 and 2018,
was approximately $78.3 million and $52.7 million, respectively. Deposits in excess of $250,000 are not
federally insured. There were $8.0 million brokered deposits outstanding at December 31, 2019, compared to no
brokered deposits at December 31, 2018.
Deposits from related parties held by the Company were $2.9 million and $2.8 million at December 31, 2019
and 2018, respectively.
88
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
Note 10 – Borrowings
The Company utilizes a loan agreement with the FHLB. The terms of the agreement call for a blanket pledge of
a portion of the Company’s mortgage and commercial and multifamily portfolio based on the outstanding
balance. At December 31, 2019 and 2018, the amount available to borrow under this credit facility was
$321.9 million and $321.5 million, respectively, subject to the amount of pledged collateral. At December 31,
2019, the credit facility was collateralized as follows: one- to four- family mortgage loans with an advance
equivalent of $111.4 million, commercial and multifamily mortgage loans with an advance equivalent of
$126.1 million and home equity loans with an advance equivalent of $6.9 million. At December 31, 2018, the
credit facility was collateralized as follows: one-to-four family mortgage loans with an advance equivalent of
$128.4 million, commercial and multifamily mortgage loans with an advance equivalent of $119.8 million and
home equity loans with an advance equivalent of $6.3 million. The Company had outstanding borrowings under
this arrangement of $7.5 million and $84.0 million at December 31, 2019 and 2018, respectively. The
weighted-average interest rate of the Company’s borrowings was 3.05% at December 31, 2019 and was 2.72% at
December 31, 2018. Additionally, the Company had outstanding letters of credit from the FHLB of Des Moines
with a notional amount of $19.1 million and $14.5 million at December 31, 2019 and 2018, respectively, to
secure public deposits. The remaining amount available to borrow as of December 31, 2019 and 2018, was
$217.8 million and $156.0 million, respectively. Fixed rate advances of $7.5 million, with a weighted-average
interest rate of 3.05% are due within a year.
The maximum amount outstanding from the FHLB under term advances at month-end during 2019 was
$72.8 million and during 2018 was $99.5 million. The average balance outstanding was $24.4 million during
2019 and $69.9 million during 2018. The weighted-average interest rate on the borrowings was 3.08% in 2019
and 2.18% in 2018.
As a member of the FHLB system, the Bank is required to maintain a minimum level of investment in the FHLB
of Des Moines stock based on specific percentages of its outstanding FHLB advances. At December 31, 2019
and 2018, the Company had an investment of $1.2 million and $4.1 million, respectively, in FHLB of
Des Moines stock.
The Company participates in the Federal Reserve Bank Borrower-in-Custody program, which gives the Company
access to the discount window. The terms of the program call for a pledge of specific assets. The Company
pledges commercial and consumer loans as collateral for this line of credit. The Company had unused borrowing
capacity of $41.7 million and $47.3 million and no outstanding borrowings under this program at December 31,
2019 and 2018, respectively.
The Company has access to an unsecured Fed Funds line of credit from the Pacific Coast Banker’s Bank. The
line has a one-year term maturing on June 30, 2020 and is renewable annually. As of December 31, 2019, the
amount available under this line of credit was $10.0 million. There was no balance on this line of credit as of
December 31, 2019 and 2018, respectively.
The Company has access to an unsecured Fed Funds line of credit from The Independent Bank. As of
December 31, 2019, the amount available under this line of credit was $10.0 million. The agreement may be
terminated by either party. There was no balance on this line of credit as of December 31, 2019 and 2018,
respectively.
Note 11 – Fair Value Measurements
The Company determines the fair values of its financial instruments based on the requirements established in
ASC 820, Fair Value Measurements, which provides a framework for measuring fair value in accordance with
U.S. GAAP and requires an entity to maximize the use of observable inputs and minimize the use of
unobservable inputs when measuring fair value. ASC 820 defines fair values for financial instruments as the exit
price, the price that would be received for an asset or paid to transfer a liability, in the principal or most
advantageous market for the asset or liability in an orderly transaction between market participants on the
measurement date under current market conditions. The Company’s fair values for financial instruments at
December 31, 2019 were determined based on these requirements.
89
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
The following methods and assumptions were used to estimate the fair value of other financial instruments:
Cash and cash equivalents - The estimated fair value is equal to the carrying amount.
Available-for-Sale Securities - Available-for-sale securities are recorded at fair value based on quoted market
prices, if available. If quoted market prices are not available, management utilizes third-party pricing services or
broker quotations from dealers in the specific instruments. Level 2 securities include those traded on an active
exchange, as well as U.S. government securities.
Loans Held-for-Sale - Residential mortgage loans held-for-sale are recorded at the lower of cost or fair value.
The fair value of fixed-rate residential loans is based on whole loan forward prices obtained from government
sponsored enterprises. At December 31, 2019 and 2018, loans held-for-sale were carried at cost, as no
impairment was required.
Loans Held for Portfolio - The estimated fair value of loans consists of a credit adjustment to reflect the
estimated adjustment to the carrying value of the loans due to credit-related factors and a yield adjustment, to
reflect the estimated adjustment to the carrying value of the loans due to a differential in yield between the
portfolio loan yields and estimated current market rate yields on loans with similar characteristics.
Mortgage Servicing Rights - The fair value of mortgage servicing rights is determined through a discounted
cash flow analysis, which uses interest rates, prepayment speeds, discount rates, and delinquency rate
assumptions as inputs.
FHLB stock - The estimated fair value is equal to the par value of the stock.
Non-maturity deposits - The estimated fair value is equal to the carrying amount.
Time deposits - The estimated fair value of time deposits is based on the difference between interest costs paid
on the Company’s time deposits and current market rates for time deposits with comparable characteristics.
Borrowings - The fair value of borrowings are estimated using the Company’s current incremental borrowing
rates for similar types of borrowing arrangements.
A description of the valuation methodologies used for impaired loans and OREO is as follows:
Impaired Loans - The fair value of collateral dependent loans is based on the current appraised value of the
collateral less estimated costs to sell, or internally developed models utilizing a calculation of expected
discounted cash flows which contain management’s assumptions.
OREO and Repossessed Assets - The fair value of OREO and repossessed assets is based on the current
appraised value of the collateral less estimated costs to sell.
Off-balance sheet financial instruments - The fair value for the Company’s off-balance sheet loan
commitments are estimated based on fees charged to others to enter into similar agreements taking into account
the remaining terms of the agreements and credit standing of the Company’s clients. The estimated fair value of
these commitments is not significant.
90
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
The following tables present information about the level in the fair value hierarchy for the Company’s financial
assets and liabilities, whether or not recognized or recorded at fair value as December 31, 2019 and 2018 (in
thousands):
FINANCIAL ASSETS:
Cash and cash equivalents . . . . . . . . . . . . . . .
Available for sale securities . . . . . . . . . . . . . .
Loans held-for-sale. . . . . . . . . . . . . . . . . . . . .
Loans held for portfolio, net . . . . . . . . . . . . .
Mortgage servicing rights . . . . . . . . . . . . . . .
FHLB Stock . . . . . . . . . . . . . . . . . . . . . . . . . .
FINANCIAL LIABILITIES:
Non-maturity deposits . . . . . . . . . . . . . . . . . .
Time deposits . . . . . . . . . . . . . . . . . . . . . . . . .
Borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . .
FINANCIAL ASSETS:
Cash and cash equivalents . . . . . . . . . . . . . . .
Available for sale securities . . . . . . . . . . . . . .
Loans held-for-sale. . . . . . . . . . . . . . . . . . . . .
Loans held for portfolio, net . . . . . . . . . . . . .
Mortgage servicing rights . . . . . . . . . . . . . . .
FHLB Stock . . . . . . . . . . . . . . . . . . . . . . . . . .
FINANCIAL LIABILITIES:
Non-maturity deposits . . . . . . . . . . . . . . . . . .
Time deposits . . . . . . . . . . . . . . . . . . . . . . . . .
Borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . .
December 31, 2019
Fair Value Measurements Using:
Carrying
Value
Estimated
Fair Value
Level 1
Level 2
Level 3
$ 55,770
9,306
1,063
614,247
3,239
1,160
365,331
251,387
7,500
$ 55,770
9,306
1,063
622,147
3,239
1,160
365,331
255,261
7,500
$55,770
—
—
—
—
—
$
— $
9,306
1,063
—
—
1,160
—
—
—
365,331
255,261
7,500
—
—
—
622,147
3,239
—
—
—
—
December 31, 2018
Fair Value Measurements Using:
Carrying
Value
Estimated
Fair Value
Level 1
Level 2
Level 3
$ 61,810
4,957
1,172
613,769
3,414
4,134
361,776
191,825
84,000
$ 61,810
4,957
1,172
613,371
3,414
4,134
361,776
191,679
84,000
$61,810
—
—
—
—
—
$
— $
4,957
1,172
—
—
4,134
—
—
—
361,776
191,679
84,000
—
—
—
613,371
3,414
—
—
—
—
The following tables present the balance of assets measured at fair value on a recurring basis as of December 31,
2019 and 2018 (in thousands):
Description
Municipal bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Agency mortgage-backed securities . . . . . . . . . . . . . . . . . . . . . . . .
Mortgage servicing rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Description
Municipal bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Agency mortgage-backed securities . . . . . . . . . . . . . . . . . . . . . . . .
Mortgage servicing rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fair Value at December 31, 2019
Level 1
$—
—
—
Level 2
$3,370
5,936
—
Fair Value at December 31, 2018
Level 1
$—
—
—
Level 2
$3,317
1,640
—
Level 3
$ —
—
3,239
Level 3
$ —
—
3,414
Total
$3,370
5,936
3,239
Total
$3,317
1,640
3,414
For the years ended December 31, 2019 and 2018, there were no transfers between Level 1 and Level 2 or
between Level 2 and Level 3.
91
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
The following table provides a description of the valuation technique, unobservable input, and qualitative
information about the unobservable inputs for the Company’s assets and liabilities classified as Level 3 and
measured at fair value on a recurring basis at December 31, 2019:
Financial Instrument
Valuation
Technique
Mortgage Servicing Rights
Discounted cash flow
Unobservable Input(s)
Prepayment speed
assumption
Discount rate
Range
(Weighted Average)
132-485% (187%)
12.5%-13.5% (12.5%)
The following table provides a description of the valuation technique, unobservable input, and qualitative
information about the unobservable inputs for the Company’s assets and liabilities classified as Level 3 and
measured at fair value on a recurring basis at December 31, 2018:
Financial Instrument
Valuation
Technique
Mortgage Servicing Rights
Discounted cash flow
Unobservable Input(s)
Prepayment speed
assumption
Discount rate
Range
(Weighted Average)
80-515% (123%)
12.5%-13.5% (12.5%)
Generally, any significant increases in the constant prepayment rate and discount rate utilized in the fair value
measurement of the mortgage servicing rights will result in a negative fair value adjustment (and decrease in the
fair value measurement). Conversely, a decrease in the constant prepayment rate and discount rate will result in a
positive fair value adjustment (and increase in the fair value measurement). An increase in the weighted average
life assumptions will result in a decrease in the constant prepayment rate and conversely, a decrease in the
weighted average life will result in an increase of the constant prepayment rate.
There were no assets or liabilities (excluding mortgage servicing rights) measured at fair value using significant
unobservable inputs (Level 3) on a recurring basis during the years ended December 31, 2019 and 2018.
Mortgage servicing rights are measured at fair value using significant unobservable input (Level 3) on a
recurring basis and a reconciliation of this asset can be found in Note 6 – Mortgage Servicing Rights.
The following table presents the balance of assets measured at fair value on a nonrecurring basis and the total
losses resulting from these fair value adjustments (in thousands):
Description
Fair Value at December 31, 2019
Total
Level 1
Level 2
Level 3
OREO and repossessed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Impaired loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
575
12,393
$—
—
$—
—
$
575
12,393
Description
OREO and repossessed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Impaired loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fair Value at December 31, 2018
Level 1
Level 2
$—
—
$—
—
Level 3
$ 575
5,838
Total
$ 575
5,838
There were no liabilities carried at fair value, measured on a recurring or nonrecurring basis, at December 31,
2019 or December 31, 2018.
92
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
The following table provides a description of the valuation technique, observable input, and qualitative
information about the unobservable inputs for the Company’s assets and liabilities classified as Level 3 and
measured at fair value on a nonrecurring basis at December 31, 2019:
Financial Instrument
Valuation
Technique(s)
OREO
Market approach
Impaired loans
Market approach
Unobservable Input(s)
Adjusted for difference
between comparable sales
Adjusted for difference
between comparable sales
Range
(Weighted Average)
0-0% (0%)
0-100% (6%)
The following table provides a description of the valuation technique, observable input, and qualitative
information about the unobservable inputs for the Company’s assets and liabilities classified as Level 3 and
measured at fair value on a nonrecurring basis at December 31, 2018:
Financial Instrument
Valuation
Technique(s)
OREO
Market approach
Impaired loans
Market approach
Unobservable Input(s)
Adjusted for difference
between comparable sales
Adjusted for difference
between comparable sales
Range
(Weighted Average)
0-0% (0%)
0-100% (13%)
Note 12 – Earnings Per Share
Basic earnings per common share is computed by dividing net income by the weighted-average number of
common shares outstanding for the period, reduced for average unallocated ESOP shares and average unvested
restricted stock awards. Unvested share-based awards containing non-forfeitable rights to dividends or dividend
equivalents (whether paid or unpaid) are participating securities and are included in the computation of earnings
per share pursuant to the two-class method. Diluted earnings per common share reflect the potential dilution that
could occur if securities or other contracts to issue common stock (such as stock awards and options) were
exercised or converted to common stock or resulted in the issuance of common stock that then shared in the
Company’s earnings. Diluted earnings per common share is computed by dividing net income by the
weighted-average number of common shares outstanding for the period increased for the dilutive effect of
unexercised stock options and unvested restricted stock awards. The dilutive effect of the unexercised stock
options and unvested restricted stock awards is calculated under the treasury stock method utilizing the average
market value of the Company’s stock for the period.
Earnings per share are summarized for the periods presented in the following table (in thousands, except per
share data):
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Weighted average number of shares outstanding, basic. . . . . . . . . . . . . . . . . . . . . . .
Effect of potentially dilutive common shares. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Weighted average number of shares outstanding, diluted . . . . . . . . . . . . . . . . . . . . .
Earnings per share, basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Earnings per share, diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
There were no anti-dilutive securities at December 31, 2019 or 2018.
Year Ended December 31,
2019
$6,679
2,527
56
2,583
$ 2.63
$ 2.57
2018
$7,039
2,498
69
2,567
$ 2.82
$ 2.74
93
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
Note 13 – Employee Benefits
The Company has a 401(k) retirement plan that allows employees to defer a portion of their salary into the
401(k) plan. The Company matches a portion of employees’ salary deferrals. 401(k) costs are accrued and funded
on a current basis. The Company contributed $180,000 and $172,000 to the plan for the years ended
December 31, 2019 and 2018, respectively.
The Bank maintains a deferred compensation account for the benefit of Ms. Stewart, established in 1994 in
connection with an incentive plan which is no longer active. Ms. Stewart was fully vested in her benefits under
this plan as of January 2005. Pursuant to the terms of the plan, payments in an amount equal to the fair market
value of the assets in the deferred compensation account shall be made to Ms. Stewart (or to her designated
beneficiary in the event of her death) in 120 equal monthly installments commencing on the last day of the
month following the month in which her employment with the Bank is terminated. In the event of the death of
Ms. Stewart and her designated beneficiary prior to the account being fully paid, the remaining value of the
account shall be paid in a lump sum to the beneficiary’s estate. The assets in the deferred compensation account
consist of cash which is held in a certificate of deposit at the Bank and earns interest at market rates. At
December 31, 2019, the amounts held in the certificates of deposit at the Bank were $106,000, compared to
$104,000 at December 31, 2018.
The Bank maintains a nonqualified deferred compensation plan (the ‘‘NQDC Plan’’), which was effective on
January 1, 2017. The purpose of the NQDC Plan is to provide a select group of management or
highly-compensated employees of the Bank with an opportunity to defer the receipt of up to eighty percent
(80%) of their annual base salary, bonus, performance-based compensation and any commission income and to
assist the Company in attracting, retaining and motivating employees of high caliber and experience. In addition
to elective deferrals, the Bank may make discretionary and other contributions to be credited to the account of
any or all participants, subject to the vesting requirements set forth in the NQDC Plan. Discretionary
contributions by the Bank become 100% vested upon the completion of three years of service from a
participant’s effective date of participation in the NQDC Plan (with accelerated vesting upon death, disability or
a change in control), while other Bank contributions (including matching contributions) vest at the rate of 20%
per year, beginning with the participant’s two-year anniversary of his or her date of hire. The board of directors
of the Bank agreed that in the event Ms. Stewart has a separation from service prior to January 1, 2020, the date
she becomes vested in her discretionary contributions, then the Bank shall amend the NQDC Plan to provide for
immediate vesting as of the date of the separation from service. During the years ended December 31, 2019, and
2018, the Bank made discretionary contributions to the 2017 NQDC Plan in the amount of $90,000 and $75,000,
respectively.
Each participant’s deferred compensation account is credited with an investment return determined as if the
account was invested in one or more investment funds. Each participant elects the investment funds in which his
or her account shall be deemed to be invested. Distributions of vested account balances are made upon death,
disability, separation from service, or a specified in-service date unforeseeable emergency. Distributions shall be
made in a single cash payment or, at the election of the participant, in annual installments for a period of up to
ten (10) years in the case of a separation from service and in annual installments for a period of up to five (5)
years in the case of an in-service distribution.
The obligations of the Bank under the NQDC Plan are general unsecured obligations of the Bank to pay deferred
compensation in the future to eligible participants in accordance with the terms of the NQDC Plan from the
general assets of the Bank, although the Bank may establish a trust to hold amounts which the Bank may use to
satisfy NQDC Plan distributions from time to time. Distributions from the NQDC Plan are governed by the
Internal Revenue Code and the NQDC Plan. The Company may, at any time, in its sole discretion, terminate the
NQDC Plan or amend or modify the NQDC Plan, in whole or in part, except that no such termination,
amendment or modification shall have any retroactive effect to reduce any amounts deemed to be accrued and
vested prior to such amendment.
Supplemental Executive Retirement Plans.
The Company maintains two supplemental executive retirement plans for the benefit of Ms. Stewart, which are
intended to be unfunded, non-contributory defined benefit plans maintained primarily to provide her with
94
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
supplemental retirement income. The first supplemental executive retirement plan (‘‘SERP 1’’) was effective as
of August 2007. The second supplemental executive retirement plan (‘‘SERP 2’’) was effective as of
December 30, 2011, at which time the benefits under SERP 1 were frozen. At that time, the Company also
entered into a Confidentiality, Non-Competition, and Non-Solicitation Agreement with Ms. Stewart, which is
discussed below.
Under the terms of SERP 1, as amended, Ms. Stewart is entitled to receive $53,320 per year for life commencing
on the first day of the month following her separation from service (as defined in SERP 1) for any reason from
Sound Community Bank. No payments will be made under SERP 1 in the event of Ms. Stewart’s death and any
payments that have commenced will cease upon death. In the event Ms. Stewart is involuntarily terminated in
connection with a change in control (as defined in SERP 1), she will be entitled to receive the annual benefit
described in the first sentence of this paragraph commencing upon such termination (subject to any applicable
cutback for payments after a change in control as required by Section 280G of the Internal Revenue Code).
Under the terms of SERP 2, as amended, upon Ms. Stewart’s termination of employment with Sound Community
Bank for any reason other than death, she will be entitled to receive additional retirement benefits of $96,390 per
year for life commencing on the first day of the month following the later of age 70 or her separation from
service (as defined in SERP 2) from Sound Community Bank. In the event of Ms. Stewart’s death, her
beneficiary will be entitled to a single lump sum payment within 90 days thereafter in an amount equal to the
account value as of the death benefit valuation date, or approximately $1.1 million at December 31, 2019. If a
change in control occurs (as defined in SERP 2), Ms. Stewart will receive her full retirement benefit under
SERP 2 commencing upon the first day of the month following her separation from service from Sound
Community Bank.
Confidentiality, Non-Competition, and Non-Solicitation Agreement.
On December 13, 2019, the Bank entered into an Amended and Restated Confidentiality, Non-competition, and
Non-solicitation Agreement (the ‘‘Amended Non-compete Agreement’’) with Ms. Stewart. This Amended
Non-compete Agreement amends and restates the Confidentiality, Non-Competition, and Non-Solicitation
Agreement between the Bank and Ms. Stewart as originally adopted effective December 30, 2011, as amended
and restated on November 23, 2015 and January 25, 2019.
The Amended Non-Compete Agreement provides that the term of the non-compete and non-solicitation periods
applicable to Ms. Stewart is a fixed period of 18 months following the date of Ms. Stewart’s separation from
service with the Company and the Bank (the ‘‘Restricted Period’’). Under the terms of the Amended
Non-compete Agreement, upon Ms. Stewart’s termination of employment by the Bank for cause or voluntarily by
Ms. Stewart (other than for good reason), Ms. Stewart will be entitled to receive a bi-monthly payment, in an
amount equal to Three Thousand Five Hundred Forty-Two Dollars ($3,542), which amount shall be paid in equal
bi-monthly payments during the Restricted Period beginning on the fifth day of the month following her
separation from service with the Bank. Upon Ms. Stewart’s termination of employment with the Bank for any
reason other than set forth in the preceding sentence, she will be entitled to receive an amount equal to 150% of
her then-base salary plus the average of her past three years short term bonus pay, or approximately $835,000 at
December 31, 2019, payable in 12 monthly installments beginning on the first day of the month following her
termination. If Ms. Stewart breaches any of the covenants contained in the Amended Non-compete Agreement,
her right to any of the payments specified above after the date of the breach shall be forever forfeited.
Notwithstanding the foregoing, under her Amended Non-compete Agreement, if Ms. Stewart’s employment with
the Bank is involuntarily terminated or she terminates her employment with the Bank for good reason at any
time within 24 months following a change in control, Ms. Stewart will be entitled to receive an amount equal to
150% of her then-base salary plus the average of her past three years short term bonus, payable in a lump sum.
Stock Options and Restricted Stock
The Company currently has one active stockholder approved Equity Incentive Plan, the Amended and Restated
2013 Equity Incentive Plan (the ‘‘2013 Plan’’). The 2013 Plan permits the grant of restricted stock, restricted
stock units, stock options, and stock appreciation rights. The equity incentive plan approved by stockholders in
2008 (the‘‘2008 Plan’’) expired in November 2018 and no further awards may be made under the 2008 Plan;
95
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
provided, however, all awards outstanding under the 2008 Plan remain outstanding in accordance with their
terms. Under the 2013 Plan, 181,750 shares of common stock were approved for awards for stock options and
stock appreciation rights and 116,700 shares of common stock were approved for awards for restricted stock and
restricted stock units.
As of December 31, 2019, on an adjusted basis, awards for stock options totaling 261,732 shares and awards for
restricted stock totaling 122,238 shares of Company common stock have been granted in the aggregate, net of
any forfeitures, under the 2008 Plan and 2013 Plan to participants. During the years ended December 31, 2019
and 2018, share-based compensation expense totaled $267,000 and $273,000, respectively.
Stock Option Awards
All stock option awards granted under the 2008 Plan vest in 20 percent annual increments commencing one year
from the grant date in accordance with the requirements of the 2008 Plan. The stock option awards granted to
date under the 2013 Plan provide for immediate vesting of a portion of the award with the balance of the award
vesting on the anniversary date of each grant date in equal annual installments over periods of one-to-four years
subject to the continued service of the participant with the Company. All of the options granted under the 2008
Plan and the 2013 Plan are exercisable for a period of 10 years from the date of grant, subject to vesting.
The following is a summary of the Company’s stock option plan award activity during the period ended
December 31, 2019:
Outstanding at January 1, 2019 . . . . . . . . . . . . . . . . . . . . . .
Granted. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Forfeited. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expired. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Shares
133,176
12,425
(11,772)
(1,400)
(11,169)
Outstanding at December 31, 2019 . . . . . . . . . . . . . . . . . . .
121,260
Exercisable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
106,492
Expected to vest, assuming a 0% forfeiture rate over the
Weighted-
Average
Exercise
Price
$19.66
33.50
20.33
34.51
19.88
20.80
19.44
Weighted-
Average
Remaining
Contractual
Term In Years
Aggregate
Intrinsic
Value
5.89
$1,716,306
5.33
4.93
1,842,687
1,763,206
vesting term . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
14,768
$30.62
8.23
$
79,481
As of December 31, 2019, there was $72,000 of total unrecognized compensation cost related to non-vested
stock options granted under the Plan. The cost is expected to be recognized over the remaining weighted-average
vesting period of 2.59 years.
The fair value of each option grant is estimated as of the grant date using the Black-Scholes option-pricing
model. The fair value of options granted in 2019 and 2018 were determined using the following
weighted-average assumptions as of the grant date.
Annual dividend yield. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expected volatility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Risk-free interest rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expected term . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Weighted-average grant date fair value per option granted . . . . .
2019
2018
1.72%
21.68%
2.64%
6.50 years
$ 7.24
1.72%
21.75%
2.95%
6.50 years
$ 7.63
Restricted Stock Awards
The fair value of the restricted stock awards is equal to the fair value of the Company’s stock at the date of
grant. Compensation expense is recognized over the vesting period that the awards are based. The restricted stock
96
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
awards granted under the 2008 Plan vest in 20% annual increments commencing one year from the grant date.
The restricted stock awards granted to date under the 2013 Plan provide for immediate vesting of a portion of
the award with the balance of the award vesting on the anniversary date of each of the grant date in equal annual
installments over periods of one to four years subject to the continued service of the participant with the
Company.
The following is a summary of the Company’s non-vested restricted stock awards for the year ended
December 31, 2019:
Non-vested Shares
Non-vested at January 1, 2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Granted. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Vested. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Forfeited. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expired. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Shares
858
15,925
(3,613)
(880)
—
Non-vested at December 31, 2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
12,290
Expected to vest assuming a 0% forfeiture rate over the vesting term . . .
12,290
Weighted-
Average Grant-
Date Fair Value
Per Share
Aggregate
Intrinsic Value
Per Share
$26.96
33.50
32.54
33.66
—
33.32
$33.32
$36.00
$36.00
As of December 31, 2019, there was $313,000 of unrecognized compensation cost related to non-vested
restricted stock granted under the Plan. The cost is expected to be recognized over the weighted-average vesting
period of 3.08 years. The total fair value of shares vested for the years ended December 31, 2019 and 2018 was
$118,000 and $206,000, respectively.
Employee Stock Ownership Plan
In January 2008, the ESOP borrowed $1.2 million from the Company to purchase common stock of the
Company. In August 2012, in conjunction with the Company’s conversion to a full stock company from the
mutual holding company structure, the ESOP borrowed an additional $1.1 million from the Company to purchase
common stock of the Company. The first loan for $1.2 million was paid off in 2017. The remaining loan for
$1.1 million is being repaid principally by the Bank through contributions to the ESOP over a period of 10 years.
The interest rate on the loan is fixed at 2.25%, per annum. As of December 31, 2019, the remaining balance of
the ESOP loan was $244,000.
Neither the loan balance nor the related interest expense is reflected on the consolidated financial statements.
For the calendar year 2019, the ESOP was committed to release 11,340 shares of the Company’s common stock
to participants and held 22,680 unallocated shares remaining to be released in future years. The funds to purchase
shares in the ESOP come from contributions the Bank makes twice a year to the Plan. For the year ended
December 31, 2019, the ESOP trustee purchased 6,874 shares of the Company’s common stock for inclusion in
the Plan. The fair value of the 162,520 restricted shares held by the ESOP trust was $5.9 million at
December 31, 2019. ESOP compensation expense included in salaries and benefits was $627,000 and $652,000
for the years ended December 31, 2019 and 2018, respectively.
Note 14 – Income Taxes
The provision for income taxes at December 31, 2019 and 2018 was as follows (in thousands):
Current . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
At December 31,
2019
$1,918
(267)
$1,651
2018
$1,637
69
$1,706
97
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
A reconciliation of the provision for income taxes for the years ended December 31, 2019 and 2018, with
amounts determined by applying the statutory U.S. federal income tax rate to income before income taxes, is as
follows (dollars in thousands):
Provision at statutory rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Tax-exempt income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Federal Tax Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Tax exempt rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Effective tax rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Year Ended December 31,
2019
$1,749
(174)
76
$1,651
21.0%
(2.1)
0.9
19.8%
2018
$1,836
(79)
(51)
$1,706
21.0%
(0.9)
(0.6)
19.5%
The following table reflects the temporary differences that gave rise to the components of the Company’s
deferred tax assets at December 31, 2019 and 2018 (in thousands):
Deferred tax assets
Deferred compensation and supplemental retirement . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity based compensation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Intangible assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Lease liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Allowance for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred tax liabilities
Prepaid expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
FHLB stock dividends. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unrealized gain on securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Depreciation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Mortgage servicing rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred loan costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Right of use assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total deferred tax liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net deferred tax asset . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
At December 31,
2019
2018
$
508
110
58
1,682
107
1,184
3,649
(59)
(52)
(47)
(198)
(263)
(739)
(1,605)
(2,963)
686
$
$
411
35
66
—
89
1,212
1,813
(59)
(87)
(30)
(312)
(161)
(728)
—
(1,377)
436
$
As of December 31, 2019 and 2018, the Company had no unrecognized tax benefits. The Company recognizes
interest accrued and penalties related to unrecognized tax benefits in ‘‘Provision for income taxes’’ in the
Consolidated Statements of Income. During the years ended December 31, 2019 and 2018, the Company
recognized no interest and penalties related to income taxes.
The Company or its subsidiary files an income tax return in the U.S. federal jurisdiction. With few exceptions,
the Company is no longer subject to U.S. federal income tax examinations by tax authorities for years before
2016.
Note 15 – Minimum Regulatory Capital Requirements
The Company is a bank holding company under the supervision of the Federal Reserve. Bank holding companies
are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of
1956, as amended, and the regulations of the Federal Reserve Board, except that, pursuant to the Economic
Growth, Regulatory Relief and Consumer Protection Act, effective August 30, 2018, a bank holding company
with consolidated assets of less than $3.0 billion is generally not subject to the Federal Reserve’s capital
regulations, which parallel the FDIC’s capital regulations. The Bank is a state-chartered, federally insured
98
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
institution and thereby is subject to the capital requirements established by the FDIC. Failure to meet minimum
capital requirements can initiate certain mandatory and, possibly, additional discretionary actions by regulators
that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific
capital regulations that involve quantitative measures of their assets, liabilities, and certain off-balance- sheet
items as calculated under regulatory accounting practices.
The capital amounts and classifications are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank
holding companies.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain
minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital to risk-weighted assets
(as defined in the regulations) and of Tier 1 capital to average assets.
As of December 31, 2019, according to the most recent notification from the FDIC, the Bank was categorized as
well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events
since the notification that management believes have changed the Bank’s category.
The Bank’s actual capital amounts (in thousands) and ratios as of December 31, 2019 and 2018 are presented in
the following table:
Actual
Minimum Capital
Requirements
Minimum Required
to be Well-Capitalized
Under Prompt
Corrective
Action Provisions
As of December 31, 2019
Tier 1 Capital to total adjusted assets(1) . . . . . . . . .
Common Equity Tier 1 risk-based capital ratio(2)
. .
Tier 1 Capital to risk-weighted assets(2) . . . . . . . . .
Total Capital to risk-weighted assets (2)
. . . . . . . . .
As of December 31, 2018
Tier 1 Capital to total adjusted assets(3) . . . . . . . . .
Common Equity Tier 1 risk-based capital ratio(4)
. .
Tier 1 Capital to risk-weighted assets(4) . . . . . . . . .
Total Capital to risk-weighted assets(4) . . . . . . . . . .
Amount
Ratio
Amount
Ratio
Amount
Ratio
$74,031
74,031
74,031
$79,974
$69,685
69,685
69,685
$75,874
10.22% $28,981
27,601
12.07
12.07
36,801
13.04% $49,068
9.73% $28,659
26,665
11.76
11.76
35,553
12.80% $47,404
4.0%
4.5
6.0
8.0%
4.0%
4.5
6.0
8.0%
$36,226
39,868
49,068
$61,335
$35,824
38,516
47,404
$59,255
5.0%
6.5
8.0
10.0%
5.0%
6.5
8.0
10.0%
(1) Based on total adjusted assets of $724,527 at December 31, 2019.
(2) Based on risk-weighted assets of $613,354 at December 31, 2019.
(3) Based on total adjusted assets of $716,475 at December 31, 2018.
(4) Based on risk-weighted assets of $592,551 at December 31, 2018.
In addition to the minimum common equity Tier 1 capital ratio (‘‘CET1’’) and total capital ratios, the Bank must
maintain a capital conservation buffer consisting of additional CET1 capital greater than 2.5% of risk-weighted
assets above the required minimum risk-based capital levels in order to avoid limitations on paying dividends,
engaging in share repurchases, and paying discretionary bonuses. At December 31, 2019, the conservation buffer
requirement was 2.50% and the Bank’s actual conservation buffer was 5.04%.
For a bank holding company with less than $3.0 billion in assets, the capital guidelines apply on a bank only
basis and the Federal Reserve expects the holding company’s subsidiary banks to be well capitalized under the
prompt corrective action regulations. If Sound Financial Bancorp was subject to regulatory guidelines for bank
holding companies with $3.0 billion or more in assets, at December 31, 2019 and 2018, Sound Financial
Bancorp would have exceeded all regulatory capital requirements. The estimated regulatory capital ratios
99
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
calculated for Sound Financial Bancorp as of December 31, 2019 were 9.55% for Tier 1 Capital to total adjusted
assets (leverage ratio), 11.08% for both Common Equity Tier 1 risk-based capital and Tier 1 Capital to risk-based
assets, and 11.94% for Total Capital to risk weighted assets.
Note 16 – Concentrations of Credit Risk
Most of the Company’s business activity is with clients located in the state of Washington. A substantial portion
of the loan portfolio is represented by real estate loans throughout western Washington. The ability of the
Company’s debtors to honor their contracts is dependent upon the real estate and general economic conditions in
the area. Loans to one borrower are generally limited by federal banking regulations to 15% of the Company’s
unimpaired capital and surplus.
Note 17 – Commitments and Contingencies
The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to
meet the financing needs of its clients. These financial instruments generally represent a commitment to extend
credit in the form of loans. The instruments involve, to varying degrees, elements of credit and interest rate risk
in excess of the amount recognized in the consolidated balance sheets.
The Company’s exposure to credit loss, in the event of nonperformance by the other party to the financial
instrument for commitments to extend credit, is represented by the contractual notional amount of those
instruments. The Company uses the same credit policies in making commitments as it does for on-balance-sheet
instruments.
Commitments to extend credit are agreements to lend to a client as long as there is no violation of any condition
established by the contract. Commitments generally have fixed expiration dates or other termination clauses and
may require payment of a fee. Because many of the commitments are expected to expire without being drawn
upon, the total commitment amounts do not necessarily represent future cash requirements. These commitments
are not reflected in the consolidated financial statements. The Company evaluates each client’s creditworthiness
on a case-by-case basis. The amount of collateral obtained, if it is deemed necessary by the Company, is based
on management’s credit evaluation of the client.
Financial instruments whose contract amount represents credit risk were as follow (in thousands):
Commitments to make loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unfunded construction commitments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unused lines of credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Irrevocable letters of credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total loan commitments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
At December 31,
2019
2018
$ 4,968
40,181
39,605
1,240
$85,994
$ 3,176
60,632
45,315
1,460
$110,583
At December 31, 2019, fixed rate loan commitments totaled $6.1 million and had a weighted-average interest
rate of 3.87%. At December 31, 2018, fixed rate loan commitments totaled $4.1 million and had a
weighted-average interest rate of 4.93%.
At December 31, 2019 and 2018, the Company had letters of credit issued by the FHLB with a notional amount
of $19.1 million and $14.5 million, respectively, in order to secure Washington State Public Funds.
In the ordinary course of business, the Company sells loans without recourse that may have to be subsequently
repurchased due to defects that occurred during the origination of the loan. The defects are categorized as
documentation errors, underwriting errors, early payment defaults, and fraud. When a loan sold to an investor
without recourse fails to perform, the investor will typically review the loan file to determine whether defects in
the origination process occurred. If a defect is identified, the Company may be required to either repurchase the
loan or indemnify the investor for losses sustained. If there are no defects, the Company has no commitment to
repurchase the loan. As of December 31, 2019 and 2018, the maximum amount of these guarantees totaled
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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
$377.3 million and $376.5 million, respectively. These amounts represent the unpaid principal balances of the
Company’s loans serviced for others’ portfolios. There were no loans repurchased during the years ended
December 31, 2019 and 2018.
The Company pays certain medical, dental, prescription, and vision claims for its employees, on a self-insured
basis. The Company has purchased stop-loss insurance to cover claims that exceed stated limits and has recorded
estimated reserves for the ultimate costs for both reported claims and claims incurred but not reported, which
were not considered significant at December 31, 2019. At December 31, 2018, the Company recorded $239,000
in stop loss medical insurance claim which is included in other assets on the consolidated statements of financial
condition.
At various times, the Company may be the defendant in various legal proceedings arising in connection with its
business. It is the opinion of management that the financial position and the results of operations of the Company
will not be materially adversely affected by the outcome of these legal proceedings and that adequate provision
has been made in the accompanying consolidated balance sheets.
101
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
Note 18 – Parent Company Financial Information
The Balance Sheets, Statements of Income, and Statements of Cash Flows for Sound Financial Bancorp (Parent
Only) are presented below (dollars in thousands):
Balance sheets
Assets
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Investment in Sound Community Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Liabilities and Stockholders’ Equity
Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
December 31,
2019
2018
$ 2,740
75,141
41
$77,922
$
18
70,785
824
$71,627
$
196
196
$ —
—
Stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
77,726
71,627
Total liabilities and stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$77,922
$71,627
Statements of Income
Year Ended December 31,
2019
2018
Other expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ (792)
$ (310)
Income before income tax benefit and equity in undistributed net
Income of subsidiary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income tax benefit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity in undistributed earnings of subsidiary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(792)
166
7,305
(310)
65
7,284
Net income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$6,679
$7,039
Statements of Cash Flows
Cash flows from operating activities:
Net income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Adjustments to reconcile net income to net cash provided by operating activities
Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expense allocation to holding company. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Change in undistributed equity of subsidiary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash used in operating activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash flows from investing activities:
ESOP shares released . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash provided by investing activities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash flows from financing activities:
Dividends paid. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Dividends received from subsidiary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Stock repurchase funding from subsidiary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Stock options exercised. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash provided by (used in) financing activities . . . . . . . . . . . . . . . . . . . . . . . . . .
Net increase (decrease) in cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash and cash equivalents at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Year Ended December 31,
2019
2018
$ 6,679
$ 7,039
(166)
196
(7,305)
(596)
716
716
(1,434)
2,155
1,750
131
2,602
2,722
18
(65)
—
(7,284)
(310)
—
—
(1,367)
711
—
102
(554)
(864)
882
Cash and cash equivalents at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 2,740
$
18
102
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
Note 19 – Revenue from Contracts with Customers
All of the Company’s revenue from contracts with customers in the scope of ASC 606 - Revenue from Contracts
with Customers (‘‘ASC 606’’) is recognized in Noninterest Income with the exception of the net loss on OREO
and repossessed assets, which is included in Noninterest Expense. The following table presents the Company’s
sources of Noninterest Income for the year ended December 31, 2019 and 2018 (in thousands). Items outside of
the scope of ASC 606 are noted as such.
Year Ended December 31,
2019
2018
Noninterest income:
Service charges and fee income
Account maintenance fees. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Transaction-based and overdraft service charges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Debit/ATM interchange fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Credit card interchange fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loan fees(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other fees(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total service charges and fee income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Earnings on cash surrender value of bank-owned life insurance (a) . . . . . . . . . . . . . . . . .
Mortgage servicing income(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fair value adjustment on mortgage servicing rights(a). . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net gain on sale of loans(a). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other income(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total noninterest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 199
447
982
27
239
60
1,954
381
1,002
(760)
1,449
—
$ 192
481
927
40
188
48
1,876
320
1,075
(513)
1,038
490
$4,026
$4,286
(a) Not within scope of ASC 606
Account maintenance fees and transaction-based and overdraft service charges
The Company earns fees from its customers for account maintenance, transaction-based and overdraft services.
Account maintenance fees consist primarily of account fees and analyzed account fees charged on deposit
accounts on a monthly basis. The performance obligation is satisfied and fees are recognized on a monthly basis
as the service period is completed. Transaction-based fees and overdraft service fees on deposit accounts are
charged to deposit customers for specific services provided to the customer, such as non-sufficient funds,
overdraft, and wire services. The performance obligation is completed as the transaction occurs and the fees are
recognized at the time each specific service is provided to the customer.
Debit/ATM and credit card interchange income
Debit/ATM interchange income represent fees earned when a debit card issued by the Bank is used for a
transaction. The Bank earns interchange fees from debit cardholder transactions through the MasterCard payment
network. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value
and are recognized daily, concurrently with the transaction processing services provided to the cardholder. The
performance obligation is satisfied and the fees are earned when the cost of the transaction is charged to the
cardholders’ account. Certain expenses directly associated with the debit card are recorded on a net basis with
the interchange income.
The Company utilizes a third party agency relationship to brand credit cards with fees for originating new
accounts paid by the issuing bank. Credit card interchange income represents fees earned when a credit card is
issued by the third party agent. Similar to debit card interchange fees, the Bank earns an interchange fee for each
103
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
transaction made with Sound Community Bank’s branded credit cards. The performance obligation is satisfied
and the fees are earned when the cost of the transaction is charged to the cardholders’ credit card. Certain
expenses and rebates directly related to the credit card interchange contract are recorded net of the interchange
income.
Net loss on OREO and repossessed assets
We record a gain or loss from the sale of other real estate owned when control of the property transfers to the
buyer, which generally occurs at the time of an executed deed of trust. When the Bank finances the sale of other
real estate owned to the buyer, the Company assesses whether the buyer is committed to perform their
obligations under the contract and whether collectability of the transaction price is probable. Once these criteria
are met, the other real estate owned asset is derecognized and the gain or loss on sale is recorded upon the
transfer of control of the property to the buyer. In determining the gain or loss on sale, we adjust the transaction
price and related gain or loss on sale if a significant financing component is present. Company incurred expenses
on our OREO properties of $35,000 and $86,000 for the years ended December 31, 2019 and 2018, respectively,
included in noninterest expense on the Consolidated Statements of Income.
Note 20 – Leases
We have operating leases for branch locations, loan production offices, our corporate office and certain
equipment. The lease term for our leases begins on the date we become legally obligated for the rent payments
or we take possession of the building, whichever is earlier. Generally, our real estate leases have initial terms of
three to 10 years and typically include one renewal option. Our leases have remaining lease terms of 1 year to
10 years. The operating leases require us to pay property taxes and operating expenses for the properties.
The following table represents the Consolidated Balance Sheet classification of the Company’s right of use assets
and lease liabilities (in thousands):
December 31, 2019
Operating lease right-of-use assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Operating lease liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$7,641
$8,010
The following table represents the components of lease expense (in thousands):
Year Ended
December 31, 2019
Operating lease expense
Office leases. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equipment leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Sublease income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net lease expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,223
20
(12)
$1,231
104
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
The following table represents the maturity of lease liabilities:
December 31, 2019
Office leases
Equipment leases
Operating Lease Commitments
2020 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2021 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2022 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Thereafter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total lease payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less: Present value discount . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,097
1,042
1,016
989
4,865
9,009
1,007
8
—
—
—
—
8
—
Present value of lease liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$8,002
$ 8
Lease term and discount rate by lease type consist of the following:
Weighted-average remaining lease term (in years):
Office leases. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equipment leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Weighted-average discount rate (annualized): . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Office leases. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equipment leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
8.72
0.42
2.64%
1.62%
Supplemental cash flow information related to leases was as follows (in thousands):
December 31, 2019
Year Ended
December 31, 2019
Cash paid for amounts included in the measurement of lease liabilities for operating leases:
Operating cash flows
Office leases. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equipment leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,099
20
$
Note 21 – Subsequent Events
On January 28, 2020, the Company declared on Company common stock a quarterly cash dividend of $0.15 per
common share and a special cash dividend of $0.20 per share, payable on February 24, 2020 to stockholders of
record at the close of business February 10, 2020.
105
Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
An evaluation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities
Exchange Act of 1934 (the ‘‘Exchange Act’’)) as of December 31, 2019, was carried out under the supervision
and with the participation of the our Chief Executive Officer, Chief Financial Officer and several other members
of our senior management team within the 90-day period preceding the filing of this annual report. Our Chief
Executive Officer and Chief Financial Officer concluded that, as of December 31, 2019, our disclosure controls
and procedures were effective in ensuring that the information required to be disclosed by us in the reports we
file or submit under the Exchange Act is (i) accumulated and communicated to our management (including our
Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed,
summarized and reported within the time periods specified in the SEC’s rules and forms.
We intend to continually review and evaluate the design and effectiveness of the Company’s disclosure controls
and procedures and to improve the Company’s controls and procedures over time and to correct any deficiencies
that we may discover in the future. The goal is to ensure that senior management has timely access to all
material financial and non-financial information concerning the Company’s business. While we believe the
present design of the disclosure controls and procedures is effective to achieve its goal, future events affecting its
business may cause the Company to modify its disclosure controls and procedures.
The Company does not expect that its disclosure controls and procedures will prevent all error and all fraud. A
control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute,
assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control
procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of
fraud, if any, within the Company have been detected. These inherent limitations include the realities that
judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake.
Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more
people, or by management override of the control. The design of any control procedure also is based in part upon
certain assumptions about the likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions; over time, controls may become
inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may
deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error
or fraud may occur and not be detected.
(b) Internal Control Over Financial Reporting
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of Sound Financial Bancorp is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). The Company’s internal
control over financial reporting is a process designed to provide reasonable assurance to the Company’s
management and board of directors regarding the reliability of financial reporting and the preparation of the
financial statements for external purposes in accordance with accounting principles generally accepted in the
United States of America. There are inherent limitations in the effectiveness of any system of internal control
over financial reporting, including the possibility of human error and circumvention or overriding of controls.
Accordingly, even an effective system of internal control over financial reporting can provide only reasonable
assurance with respect to financial statement preparation. Projections of any evaluation of effectiveness to future
periods are subject to the risks that controls may become inadequate because of changes in conditions or that the
degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of
December 31, 2019. In making this assessment, it used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013). Based on
this assessment, we concluded that, as of December 31, 2019, the Company’s internal control over financial
reporting was effective based on those criteria.
106
Moss Adams, LLP, the Company’s independent registered public accounting firm that audited our consolidated
financial statements at and, for, the year ended December 31, 2019, included in this annual report on Form 10-K,
has issued an attestation report on the effectiveness of the Company’s internal control over financial reporting.
The attestation report is included above in Item 8.
(c) Changes in Internal Controls over Financial Reporting
As required by Rule 13a-15(d), our management, including our Chief Executive Officer and Chief Financial
Officer, also conducted an evaluation of our internal control over financial reporting to determine whether any
changes occurred during quarter ended December 31, 2019 that have materially affected, or are reasonably likely
to materially affect, our internal control over financial reporting. There were no changes in our internal controls
over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the quarter
ended December 31, 2019, that have materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
Item 9B. Other Information
None.
107
Item 10. Directors, Executive Officers and Corporate Governance
Directors
PART III
Information concerning the Company’s directors is incorporated herein by reference from the Company’s
definitive proxy statement for its Annual Meeting of Stockholders to be held in May 2020, a copy of which will
be filed with the SEC not later than 120 days after the close of the fiscal year.
Executive Officers
Information concerning the executive officers of the Company and the Bank is contained under the heading
‘‘Executive Officers’’ under Part I, Item 1 of this Form 10-K and is incorporated herein by reference.
Code of Ethics
We have adopted a code of ethics that applies to our principal executive officer, principal financial officer,
principal accounting officer, and person performing similar functions, and to all of our other employees and our
directors. You may obtain a copy of the code of ethics free of charge by writing to the Corporate Secretary of
Sound Financial Bancorp, 2400 3rd Avenue, Suite 150, Seattle, Washington, 98121 or by calling (206) 448-0884.
In addition, the code of ethics is available on our website at www.soundcb.com under ‘‘Investor Relations –
Governance.’’
Corporate Governance
Nominating Procedures. There have been no material changes to the procedures by which stockholders may
recommend nominees to our Board of Directors since last disclosed to stockholders.
Audit Committee and Audit Committee Financial Expert. Sound Financial Bancorp has an Audit Committee
that is appointed by the Board of Directors to provide assistance to the Board in fulfilling its oversight
responsibility relating to the integrity of our consolidated financial statements and the financial reporting
processes, the systems of internal accounting and financial controls, compliance with legal and regulatory
requirements, the annual independent audit of our consolidated financial statements, the independent auditors’
qualifications and independence, the performance of our internal audit function and independent auditors and any
other areas of potential financial risk to Sound Financial Bancorp specified by its Board of Directors. The Audit
Committee also is responsible for the appointment, retention and oversight of our independent auditors, including
pre-approval of all audit and non-audit services to be performed by the independent auditors. During 2019, the
Audit Committee was comprised of Directors Jones (chair), Carney, Cook, Riojas and Haddad, each of whom is
‘‘independent’’ as that term is defined for audit committee members in the Nasdaq Rules. The Board of Directors
has determined that Director Jones is an ‘‘audit committee financial expert’’ as defined in Item 407(e) of
Regulation S-K of the Securities and Exchange Commission and that all of the Audit Committee members meet
the financial literacy requirements under the NASDAQ listing standards. Additional information concerning the
Audit Committee is incorporated herein by reference from the Company’s definitive proxy statement for its
Annual Meeting of Stockholders to be held in May 2020 (except for information contained under the heading
‘‘Report of the Audit Committee’’), a copy of which will be filed with the SEC not later than 120 days after the
close of the fiscal year.
Item 11. Executive Compensation
Information concerning executive compensation is incorporated herein by reference from the Company’s
definitive proxy statement for its Annual Meeting of Stockholders to be held in May 2020 (except for
information contained under the heading ‘‘Report of the Audit Committee’’), a copy of which will be filed with
the SEC not later than 120 days after the close of the fiscal year.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
Information concerning security ownership of certain beneficial owners and management is incorporated herein
by reference from the Company’s definitive proxy statement for its Annual Meeting of Stockholders to be held in
May 2020, a copy of which will be filed with the SEC not later than 120 days after the close of the fiscal year.
108
The Company is not aware of any arrangements, including any pledge by any person of securities of the
Company, the operation of which may at a subsequent date result in a change in control of Sound Financial
Bancorp, Inc.
Equity Compensation Plan Information. The following table sets forth information as of December 31, 2019
with respect to the Company’s equity compensation plans, all of which were approved by the Company’s
shareholders.
Plan Category
Number of
securities
to be issued
upon exercise of
outstanding options,
warrants and rights
Weighted average
exercise price of
outstanding options,
warrants and rights
Number of securities
remaining available
for future issuance
under equity
compensation plan(1)
Equity Incentive Plan approved by
security holders . . . . . . . . . . . . . . . . . . .
121,260
Equity Incentive Plan not approved by
security holders . . . . . . . . . . . . . . . . . . .
—
Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
121,260
$20.80
—
$20.80
85,756
—
85,756
(1)
Includes 44,876 shares available for issuance for stock awards, other than awards of stock options and stock
appreciation rights.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Information concerning certain relationships and related transactions, our independent directors and our audit and
nominating committee charters is incorporated herein by reference from the Company’s definitive proxy
statement for its Annual Meeting of Stockholders to be held in May 2020, a copy of which will be filed with the
SEC not later than 120 days after the close of the fiscal year.
Item 14. Principal Accounting Fees and Services
Information concerning principal accountant fees and services is incorporated herein by reference from the
Company’s definitive proxy statement for its Annual Meeting of Stockholders to be held in May 2020 (except
for information contained under the heading ‘‘Report of the Audit Committee’’) a copy of which will be filed
with the SEC not later than 120 days after the close of the fiscal year.
109
PART IV
Item 15. Exhibits and Financial Statement Schedules
(a)(1) List of Financial Statements
The following are contained in Item 8:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at December 31, 2019 and 2018
Consolidated Statements of Income for the Years Ended December 31, 2019 and 2018
Consolidated Statements of Comprehensive Income for the Years December 31, 2019 and 2018
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2019 and 2018
Consolidated Statements of Cash Flows for the Years Ended December 31, 2019 and 2018
Notes to Consolidated Financial Statements
(a)(2) List of Financial Statement Schedules:
All financial statement schedules have been omitted as the information is not required under the related
instructions or is not applicable.
(a)(3) List of Exhibits:
(b) Exhibits:
110
Exhibits:
3.1
3.2
4.1
4.2
10.1
10.2
10.3
10.4
10.5
10.6
10.7
10.8
10.9
10.10
10.11
10.12
10.13
10.14
EXHIBIT INDEX
Articles of Incorporation of Sound Financial Bancorp, Inc. (incorporated herein by reference to the
Registration Statement on Form S-1 filed with the SEC on March 27, 2012 (File No. 333-180385))
Bylaws of Sound Financial Bancorp, Inc. (incorporated herein by reference to the Current Report on
Form 8-K filed with the SEC on February 3, 2015 (File No. 001-35633))
Form of Common Stock Certificate of Sound Financial Bancorp, Inc. (incorporated herein by
reference to the Registration Statement on Form S-1 filed with the SEC on March 27, 2012 (File
No. 333-180385))
Description of capital stock
Amended and Restated Employment Agreement dated January 25, 2019, among Sound Financial
Bancorp, Inc., Sound Community Bank and Laura Lee Stewart (incorporated herein by reference to
the Current Report on Form 8-K filed with the SEC on January 30, 2019 (File No. 001-35633))
Amended and Restated Supplemental Executive Retirement Agreement by and between Sound
Community Bank and Laura Lee Stewart (incorporated herein by reference to the Current Report on
Form 8-K filed with the SEC on November 27, 2015 (File No. 001-35633))
Amended and Restated Long Term Compensation Agreement by and between Sound Community
Bank and Laura Lee Stewart (incorporated herein by reference to the Current Report on Form 8-K
filed with the SEC on November 27, 2015 (File No. 001-35633))
Amended and Restated Confidentiality, Non-Competition and Non-Solicitation Agreement by and
between Sound Community Bank and Laura Lee Stewart (incorporated herein by reference to the
Current Report on Form 8-K filed with the SEC on December 16, 2019 (File No. 001-35633))
2008 Equity Incentive Plan (incorporated herein by reference to the Annual Report on Form 10-K
filed with the SEC on March 30, 2009 (File No. 000-52889))
Forms of Incentive Stock Option Agreement, Non-Qualified Stock Option Agreement and Restricted
Stock Agreements under the 2008 Equity Incentive Plan (incorporated herein by reference to the
Current Report on Form 8-K filed with the SEC on January 29, 2009 (File No. 000-52889))
Summary of Annual Bonus Plan (incorporated herein by reference to the Current Report on
Form 8-K filed with the SEC on February 3, 2020 (File No. 000-35633))
2013 Equity Inventive Plan (included as Exhibit 10.13 to the Registrant’s Quarterly Report on
Form 10-Q for the quarter ended September 30, 2013 and incorporated herein by reference (File
No. 001-35633))
Form of Incentive Stock Option Agreement, Non-Qualified Stock Option Agreement and Restricted
Stock Agreement under the 2013 Equity Incentive Plan (included as Exhibit 10.14 to the Registrant’s
Quarterly Report on Form 10-Q for the quarter ended September 30, 2013 and incorporated herein by
reference (File No. 001-35633))
Change of Control Agreement dated June 21, 2016, by and among Sound Financial Bancorp, Inc.,
Sound Community Bank and Elliott Pierce (included as Exhibit 10.11 to the Registrant’s Quarterly
Report on Form 10-Q for the quarter ended March 31, 2017 and incorporated herein by reference
(File No. 001-35633))
Adoption Agreement for the Sound Community Bank Nonqualified Deferred Compensation Plan
(incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on
March 24, 2017 (File No. 001-35633))
The Sound Community Bank Nonqualified Deferred Compensation Plan (incorporated herein by
reference to the Current Report on Form 8-K filed with the SEC on March 24, 2017 (File
No. 001-35633))
Change of Control Agreement dated October 25, 2018, by and among Sound Financial Bancorp, Inc.,
Sound Community Bank and Daphne Kelley (incorporated herein by reference to the Current Report
on Form 8-K filed with the SEC on October 26, 2018 (File No. (001-35633))
Change of Control Agreement dated October 25, 2018, by and among Sound Financial Bancorp, Inc.,
Sound Community Bank and Heidi Sexton (incorporated herein by reference to the Current Report on
Form 8-K filed with the SEC on October 26, 2018 (File No. (001-35633))
111
Exhibits:
10.15
21
23
24
31.1
31.2
32
101
Credit Union of the Pacific Incentive Compensation Achievement Plan, dated January 1, 1994
(incorporated herein by reference to the Annual Report on Form 10-K filed with the SEC on
March 14, 2019 (File No. (001-35633))
Subsidiaries of Sound Financial Bancorp, Inc.
Consent of Accountants
Power of Attorney (set forth on signature page)
CEO 302 Certification. Filed herewith.
CFO 302 Certification. Filed herewith.
CEO and CFO 906 Certification. Furnished herewith.
Interactive Data File
(c) Financial Statements Schedules - None
Item 16. Form 10-K Summary - None
112
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SIGNATURES
Date: March 12, 2020
By:
/s/ Laura Lee Stewart
Sound Financial Bancorp, Inc.
Laura Lee Stewart, President and Chief Executive Officer
(Duly Authorized Representative)
113
DESCRIPTION OF THE REGISTRANT’S SECURITIES
REGISTERED PURSUANT TO SECTION 12 OF THE
SECURITIES EXCHANGE ACT OF 1934
Exhibit 4.2
The authorized capital stock of Sound Financial Bancorp, Inc., a Maryland corporation (the ‘‘Company,’’
‘‘we,’’ ‘‘us’’ or ‘‘our’’), currently consists of:
•
•
40,000,000 shares of common stock, $0.01 par value per share; and
10,000,000 shares of preferred stock, $0.01 value per share.
No shares of our preferred stock are currently outstanding. The Company’s common stock is listed on the
NASDAQ Capital Market under the symbol ‘‘SFBC.’’
The following description of our common stock is a summary and does not purport to be complete. It is
subject to and qualified in its entirety by reference to our charter and bylaws, each of which is incorporated by
reference as an exhibit to the Annual Report on Form 10-K of which this Exhibit 4 is a part, and to applicable
provisions of law.
Common Stock - General
General. Each share of common stock has the same relative rights and is identical in all respects with every
other share of common stock. Common stockholders do not have the right to vote cumulatively in the election of
directors. Subject to any superior rights of any holders of preferred shares, each outstanding share of common
stock entitles its holder to such dividends as may be declared from time to time by our board of directors out of
legally available funds. In the event of a liquidation, dissolution or winding up of the Company, common
stockholders will be entitled to their proportionate share of any assets remaining after payment of liabilities and
any amounts due to any holders of preferred stock. Common stockholders have no preemptive rights and no right
to convert or exchange their shares of common stock into any other securities.
Anti-Takeover Effects
Certain provisions of our charter and bylaws and Maryland and federal law may have the effect of delaying,
deferring or preventing a change in control of our company and that would operate only with respect to
extraordinary corporate transactions, such as a merger, reorganization, tender offer, sale or transfer of
substantially all assets, or liquidation. These provisions may have the effect of discouraging a future transaction
that individual stockholders may believe is in their best interests or in which stockholders may receive a
substantial premium for their shares over the then current market price. As a result, if you want to participate in
such a transaction, you might not have an opportunity to do so.
Authorized Shares. Our charter authorizes the issuance of 40,000,000 shares of common stock and
10,000,000 shares of preferred stock. These shares of common stock and preferred stock provide our board of
directors with as much flexibility as possible to effect, among other transactions, financings, acquisitions, stock
dividends, stock splits and the exercise of employee stock options. However, these additional authorized shares
may also be used by the board of directors, consistent with its fiduciary duties, to deter future attempts to gain
control of us. The board of directors also has sole authority to determine the terms of any one or more series of
preferred stock, including voting rights, conversion rights and liquidation preferences. As a result of the ability to
fix voting rights for a series of preferred stock, the board has the power, to the extent consistent with its
fiduciary duties, to issue a series of preferred stock to persons friendly to management in order to attempt to
block a tender offer, merger or other transaction by which a third party seeks control of us, and thereby assist
members of management to retain their positions.
Voting Limitation. Our charter provides generally that any person who beneficially owns in excess of 10%
of the outstanding shares of our common stock may not vote the excess shares. This provision limits the voting
power of a beneficial owner of more than 10% of our outstanding shares of common stock in a proxy contest or
on other matters on which such person is entitled to vote.
114
The Maryland General Corporation Law contains a control share acquisition statute which, in general terms,
provides that where a stockholder acquires issued and outstanding shares of a corporation’s voting stock (referred
to as control shares) within one of several specified ranges (one-tenth or more but less than one-third, one-third
or more but less than a majority, or a majority or more), approval by a supermajority vote of stockholders of the
control share acquisition must be obtained before the acquiring stockholder may vote the control shares. A
corporation may opt-out of the control share statute through a provision in its articles of incorporation or bylaws,
which we have done pursuant to our bylaws. Accordingly, the Maryland control share acquisition statute does not
apply to acquisitions of shares of our common stock.
Board of Directors. Except with respect to any directors who may be elected by any class or series of
preferred stock, our board of directors is divided into three classes, each of which contains approximately
one-third of the members of the board. The members of each class are elected for a term of three years, with the
terms of office of all members of one class expiring each year so that approximately one-third of the total
number of directors is elected each year. The classification of directors, together with the provisions in our
charter described below that limit the ability of stockholders to remove directors and that permit only the
remaining directors to fill any vacancies on the board of directors, have the effect of making it more difficult for
stockholders to change the composition of the board of directors. As a result, at least two annual meetings of
stockholders will be required for the stockholders to change a majority of the directors, whether or not a change
in the board of directors would be beneficial and whether or not a majority of stockholders believe that such a
change would be desirable. Our charter provides that stockholders may not cumulate their votes in the election of
directors.
Our bylaws provide that we will have the number of directors as may be fixed from time to time by our
board of directors. Our bylaws also provide that vacancies on the board of directors may be filled by a majority
vote of the directors then in office, though less than a quorum, and any director so chosen shall hold office for
the remainder of the full term of the class of directors in which the vacancy occurs and until his or her successor
is duly elected and qualified. Our charter provides that, subject to the rights of the holders of any series of
preferred stock then outstanding, directors may be removed from office only for cause and only by the vote of
the holders of at least a two-thirds of the voting power of the outstanding shares of capital stock entitled to vote
generally in the election of directors (after giving effect to the 10% voting limitation in our charter as described
above under ‘‘-Voting Limitation’’), voting together as a single class.
The foregoing description of our board of directors does not apply with respect to directors that may be
elected by the holders of any class or series of preferred stock.
Special Meetings of Stockholders. Our bylaws provide that special meetings of stockholders may be called
by the President or by the board of directors by vote of a majority of the whole board. In addition, our bylaws
provide that a special meeting of stockholders shall be called by the Secretary of the Company on the written
request of stockholders entitled to cast at least a majority of all votes entitled to be cast at the meeting.
Action by Stockholders Without A Meeting. Our bylaws provide that, except as described in the following
sentence, any action required or permitted to be taken at a meeting of stockholders may instead be taken without
a meeting if a unanimous consent which sets forth the action is given in writing or by electronic transmission by
each stockholder entitled to vote on the matter. The bylaws also provide that, unless our charter provides
otherwise, the holders of any class of our stock, other than common stock, that is entitled to vote generally in the
election of directors may act by consent without a meeting if the consent is given in writing or by electronic
transmission by the holders entitled to cast the minimum number of votes that would be necessary to approve the
action at a meeting of stockholders.
Business Combinations with Certain Persons. Our charter provides that certain business combinations (for
example, mergers, share exchanges, significant asset sales and significant stock issuances) involving ‘‘interested
stockholders’’ of the Company require, in addition to any vote required by law, the approval of (i) the holders of
at least 80% of the voting power of the outstanding shares of stock entitled to vote generally in the election of
directors (after giving effect to the 10% voting limitation in our charter as described above under ‘‘-Voting
Limitation’’), voting together as a single class, unless either (a) a majority of the disinterested directors have
115
approved the business combination or (b) certain fair price and procedure requirements are satisfied. An
‘‘interested stockholder’’ for purposes of this provision generally means a person who is a greater than 10%
stockholder of the Company or who is an affiliate of the Company and at any time within the prior two years
was a greater than 10% stockholder of the Company.
The Maryland General Corporation Law contains a business combination statute that prohibits a business
combination between a corporation and an interested stockholder (one who beneficially owns 10% or more of the
voting power) for a period of five years after the interested stockholder first becomes an interested stockholder,
unless the transaction has been approved by the board of directors before the interested stockholder became an
interested stockholder or the corporation has exempted itself from the statute pursuant to a provision in its
articles of incorporation. After the five-year period has elapsed, a corporation subject to the statute may not
consummate a business combination with an interested stockholder unless (i) the transaction has been
recommended by the board of directors and (ii) the transaction has been approved by (a) 80% of the outstanding
shares entitled to be cast and (b) two-thirds of the votes entitled to be cast other than shares owned by the
interested stockholder. This approval requirement need not be met if certain fair price and terms criteria have
been satisfied. We have opted-out of the Maryland business combination statute through a provision in our
charter.
Prevention of Greenmail. Our charter generally prohibits us from acquiring any of our own publicly traded
equity securities from a beneficial owner of 5% or more of our voting stock unless: (i) the acquisition is
approved by the holders of at least 80% of our voting stock not owned by the seller (after giving effect to the
10% voting limitation in our charter as described under ‘‘-Voting Limitation’’), voting together as a single class;
(ii) the acquisition is made as part of a tender or exchange offer by us or a subsidiary of ours to purchase
securities of the same class on the same terms to all holders of such securities; (iii) the acquisition is pursuant to
an open market purchase program approved by a majority of our board of directors, including a majority of the
disinterested directors; or (iv) the acquisition is at or below the market price of the class of equity securities to
be acquired and is approved by a majority of our board of directors, including a majority of the disinterested
directors.
Amendment of Charter and Bylaws. Our charter may be amended in accordance with the Maryland General
Corporation Law, which generally requires the approval of the board of directors and the holders of a majority of
the outstanding shares of our common stock. The amendment of certain provisions of our charter, however,
requires the vote of the holders of at least 80% of the voting power of all of the outstanding shares of capital
stock entitled to vote generally in the election of directors, (after giving effect to the 10% voting limitation in our
charter as described above under ‘‘-Voting Limitation’’), voting together as a single class. These include
provisions relating to: the ability of the board of directors to designate and set the terms of series of preferred
stock; the voting limitations on greater than 10% stockholders; the number, classification, election and removal
of directors; certain business combinations with greater than 10% stockholders; certain acquisitions of our
publicly traded equity securities from 5% or greater stockholders; indemnification of directors and officers;
limitation on liability of directors and officers; and amendments to the charter and bylaws.
Our bylaws may be amended either by our board of directors, by a vote of a majority of the whole board,
or by our stockholders, by the vote of the holders of at least 80% of the outstanding shares of capital stock
entitled to vote generally in the election of directors (after giving effect to the 10% voting limitation in our
charter as described above under ‘‘-Voting Limitation’’), voting together as a single class.
Advance Notice Provisions. Our bylaws provide that we must receive written notice of any stockholder
proposal for business at an annual meeting of stockholders not less than 90 days or more than 120 days before
the anniversary of the preceding year’s annual meeting. If the date of the current year annual meeting is
advanced by more than 20 days or delayed by more than 60 days from the anniversary date of the preceding
year’s annual meeting, we must receive written notice of the proposal no earlier than the close of business on the
120th day prior to the date of the annual meeting and no later than the close of business on the later of the 90th
day prior to the annual meeting or the 10th day following the day on which notice of the date of the meeting is
mailed or public announcement of the date of the meeting date is first made, whichever occurs first.
Our bylaws also provide that we must receive written notice of any stockholder director nomination for a
meeting of stockholders not less than 90 days or more than 120 days before the date of the meeting. If, however,
116
less than 100 days’ notice or prior public announcement of the date of the meeting is given or made to
stockholders, we must receive notice of the nomination no later than the tenth day following the day on which
notice of the date of the meeting is mailed or public announcement of the date of the meeting date is first made,
whichever occurs first.
Federal Law. Federal banking law also restricts acquisitions of control of bank holding companies such as
the Company.
117
Parent
Subsidiary
Exhibit 21
State of
Incorporation
or Organization
of Subsidiary
Percentage
of Ownership
Sound Financial Bancorp, Inc. . . . . . .
Sound Community Bank
100%
Washington
Sound Community Bank . . . . . . . . . . .
Sound Community Insurance Agency, Inc.
100%
Washington
118
Consent of Independent Registered Public Accounting Firm
We consent to the incorporation by reference in these Registration Statements (Form S-8, Nos. 333-184223,
333-192345, and 333-225548) of Sound Financial Bancorp, Inc. of our report dated March 12, 2020, with respect
to the consolidated financial statements and the effectiveness of internal control over financial reporting of Sound
Financial Bancorp, Inc. and Subsidiary, appearing in this Annual report on Form 10-K for the year ended
December 31, 2019.
Exhibit 23
/s/ Moss Adams, LLP
Everett, Washington
March 12, 2020
119
POWER OF ATTORNEY
We, the undersigned officers and directors of Sound Financial Bancorp, Inc., hereby severally and individually
constitute and appoint Laura Lee Stewart and Daphne D. Kelley, and each of them, the true and lawful attorneys
and agents of each of us to execute in the name, place and stead of each of us (individually and in any capacity
stated below) any and all amendments to this Annual Report on Form 10-K and all instruments necessary or
advisable in connection therewith and to file the same with the Securities and Exchange Commission, each of
said attorneys and agents to have the power to act with or without the others and to have full power and
authority to do and perform in the name and on behalf of each of the undersigned every act whatsoever
necessary or advisable to be done in the premises as fully and to all intents and purposes as any of the
undersigned might or could do in person, and we hereby ratify and confirm our signatures as they may be signed
by our said attorneys and agents or each of them to any and all such amendments and instruments.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the Registrant and in the capacities and on the dates indicated.
/s/ Laura Lee Stewart
/s/ Tyler K. Myers
Laura Lee Stewart, President and Director
(Principal Executive Officer)
Date: March 12, 2020
Tyler K. Myers, Chairman of the Board
Date: March 12, 2020
/s/ David S. Haddad, Jr.
David S. Haddad, Jr., Director
Date: March 12, 2020
/s/ Debra Jones
Debra Jones, Director
Date: March 12, 2020
/s/ James E. Sweeney
James E. Sweeney, Director
Date: March 12, 2020
/s/ Daphne D. Kelley
Daphne D. Kelley, Executive Vice President and Chief
Financial Officer
(Principal Financial and Accounting Officer)
Date: March 12, 2020
/s/ Robert F. Carney
Robert F. Carney, Director
Date: March 12, 2020
/s/ Rogelio Riojas
Rogelio Riojas, Director
Date: March 12, 2020
/s/ Kathleen B. Cook
Kathleen B. Cook, Director
Date: March 12, 2020
120
CERTIFICATION
I, Laura Lee Stewart, certify that:
Exhibit 31.1
1.
I have reviewed this annual report on Form 10-K of Sound Financial Bancorp, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to
state a material fact necessary to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this
report, fairly present in all material respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this report;
4.
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and
internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for
the registrant and have:
a. Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being prepared;
b. Designed such internal control over financial reporting, or caused such internal control over
financial reporting to be designed under our supervision, to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of financial reporting and the preparation
of financial statements for external purposes in accordance with generally accepted accounting
principles;
c.
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in
this report our conclusions about the effectiveness of the disclosure controls and procedures, as of
the end of the period covered by this report based on such evaluation; and
d. Disclosed in this report any change in the registrant’s internal control over financial reporting that
occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth quarter in the
case of an annual report) that has materially affected, or is reasonably likely to materially affect,
the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of
internal control over financial reporting to the registrant’s auditors and the audit committee of
registrant’s board of directors (or persons performing the equivalent functions):
a. All significant deficiencies and material weaknesses in the design or operation of internal control
over financial reporting, which are reasonably likely to adversely affect the registrant’s ability to
record, process, summarize and report financial information; and
b. Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant’s internal control over financial reporting.
Date: March 12, 2020
By:
/s/ Laura Lee Stewart
Laura Lee Stewart
President/Chief Executive Officer
(Principal Executive Officer)
121
CERTIFICATION
I, Daphne D. Kelley, certify that:
Exhibit 31.2
1.
I have reviewed this annual report on Form 10-K of Sound Financial Bancorp, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to
state a material fact necessary to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this
report, fairly present in all material respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this report;
4.
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and
internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for
the registrant and have:
a. Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being prepared;
b. Designed such internal control over financial reporting, or caused such internal control over
financial reporting to be designed under our supervision, to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of financial reporting and the preparation
of financial statements for external purposes in accordance with generally accepted accounting
principles;
c.
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in
this report our conclusions about the effectiveness of the disclosure controls and procedures, as of
the end of the period covered by this report based on such evaluation; and
d. Disclosed in this report any change in the registrant’s internal control over financial reporting that
occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth quarter in the
case of an annual report) that has materially affected, or is reasonably likely to materially affect,
the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of
internal control over financial reporting to the registrant’s auditors and the audit committee of
registrant’s board of directors (or persons performing the equivalent functions):
a. All significant deficiencies and material weaknesses in the design or operation of internal control
over financial reporting, which are reasonably likely to adversely affect the registrant’s ability to
record, process, summarize and report financial information; and
b. Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant’s internal control over financial reporting.
Date: March 12, 2020
By:
/s/ Daphne D. Kelley
Daphne D. Kelley
Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
122
SECTION 1350 CERTIFICATION
Each of the undersigned hereby certifies in his or her capacity as an officer of Sound Financial, Inc. (the
″Registrant″) that the Annual Report of the Registrant on Form 10-K for the year ended December 31, 2019 fully
complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that the
information contained in the report fairly presents, in all material respects, the consolidated financial condition of
the Registrant at the end of such period and the results of operations of the Registrant for such period.
Exhibit 32
Date: March 12, 2020
By:
/s/ Laura Lee Stewart
Laura Lee Stewart
President and Chief Executive Officer
Date: March 12, 2020
By:
/s/ Daphne D. Kelley
Daphne D. Kelley
Executive Vice President and Chief Financial Officer
123
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SOUND FINANCIAL BANCORP, INC.
IMPORTANT INFORMATION
Independent Auditors
Moss Adams LLP
2707 Colby Avenue
Everett, WA 98201
Special Counsel
Silver, Freedman, Taff & Tiernan LLP
3299 K Street NW, Suite 100
Washington, D.C. 20007
Transfer Agent
Shareholders should direct inquiries concerning their
stock, change of name, address or ownership, report
lost certificates or consolidate accounts to our transfer
agent at 877-830-4936 or write:
Broadridge Corporate Issuer Solutions, Inc.
1717 Arch Street, Suite 1300
Philadelphia, PA 19103
SOUND FINANCIAL BANCORP, INC.
Corporate Offices
2400 3rd Avenue
Suite 150
Seattle, WA 98121
SOUND COMMUNITY BANK: BRANCH OFFICE LOCATIONS
Port Angeles
Sequim
Village
Sequim
Creekside
Port Ludlow
Mountlake
Terrace
Belltown
Madison
Park
Recycled Paper
used for printing
this Annual Report
Tacoma
University Place
Sequim
Village
645 W. Washington St.
Sequim, WA
98382
Madison
Park
Loan Office
3101 E. Madison Street
Seattle, WA 98112
Belltown
2400 3rd Avenue,
Suite 100
Seattle, WA 98121
Sequim
Creekside
990 E. Washington Street
Suite F
Sequim, WA 98382
Port
Angeles
110 N. Alder Street
Port Angeles, WA
98362
Mountlake
Terrace
22807 44th Avenue W.
Mountlake Terrace, WA
98043
Tacoma
2941 S. 38th Street
Tacoma, WA 98409
University Place
4922 Bridgeport Way West
University Place, WA 98467
Port
Ludlow
9500 Oak Bay Road
Suite A
Port Ludlow, WA 98365