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Section 1: 10-Q (FORM 10-Q)

Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 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
 
45-5188530
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
2400 3rd Avenue, Suite 150, Seattle, Washington
 
98121
(Address of principal executive offices)
 
(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, $0.01 par value
SFBC
The NASDAQ Stock Market LLC
None
(Former name, former address and former fiscal year, if changed since last report)
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 check mark 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 definitions of “large accelerated filer,” accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☐
Accelerated filer ☒
 
 
Non-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 ☒

Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of the latest practicable date.
As of August 6, 2019, there were 2,565,688 shares of the registrant’s common stock outstanding. 


Table of Contents

SOUND FINANCIAL BANCORP, INC.
FORM 10-Q
TABLE OF CONTENTS
 
Page Number
PART I    FINANCIAL INFORMATION
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2



PART I - FINANCIAL INFORMATION
Item 1. Financial Statements

SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Condensed Consolidated Balance Sheets (unaudited)
(In thousands, except share and per share amounts)
 
June 30,
2019
 
December 31,
2018
ASSETS
 
 
 
Cash and cash equivalents
$
80,422

 
$
61,810

Available-for-sale securities, at fair value
4,964

 
4,957

Loans held-for-sale
738

 
1,172

Loans held-for-portfolio
565,351

 
619,543

Allowance for loan losses
(5,370
)
 
(5,774
)
Total loans held-for-portfolio, net
559,981

 
613,769

Accrued interest receivable
2,108

 
2,287

Bank-owned life insurance (“BOLI”), net
13,750

 
13,365

Other real estate owned (“OREO”) and repossessed assets, net
1,069

 
575

Mortgage servicing rights, at fair value
3,205

 
3,414

Federal Home Loan Bank (“FHLB”) stock, at cost
1,510

 
4,134

Premises and equipment, net
6,683

 
7,044

Right of use assets
7,883

 

Other assets
3,643

 
4,208

Total assets
$
685,956

 
$
716,735

LIABILITIES
 
 
 
Deposits
 
 
 
Interest-bearing
$
483,310

 
$
457,535

Noninterest-bearing demand
96,192

 
96,066

Total deposits
579,502

 
553,601

Borrowings
16,250

 
84,000

Accrued interest payable
195

 
137

Lease liabilities
8,226

 

Other liabilities
6,549

 
6,681

Advance payments from borrowers for taxes and insurance
669

 
689

Total liabilities
611,391

 
645,108

COMMITMENTS AND CONTINGENCIES (NOTE 7)
 
 
 
STOCKHOLDERS’ EQUITY
 
 
 
Preferred stock, $0.01 par value, 10,000,000 shares authorized, none issued or outstanding

 

Common stock, $0.01 par value, 40,000,000 shares authorized, 2,563,488 and 2,544,059 shares issued and outstanding as of June 30, 2019 and December 31, 2018, respectively
25

 
25

Additional paid-in capital
25,926

 
25,663

Unearned shares - Employee Stock Ownership Plan (“ESOP”)
(283
)
 
(340
)
Retained earnings
48,710

 
46,165

Accumulated other comprehensive income, net of tax
187

 
114

Total stockholders’ equity
74,565

 
71,627

Total liabilities and stockholders’ equity
$
685,956

 
$
716,735

See notes to condensed consolidated financial statements

3



SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Income (unaudited)
(In thousands, except share and per share amounts)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
2019
 
2018
 
2019
 
2018
INTEREST INCOME
 
 
 
 
 
 
 
Loans, including fees
$
7,812

 
$
7,850

 
$
16,171

 
$
15,054

Interest and dividends on investments, cash and cash equivalents
424

 
264

 
838

 
510

Total interest income
8,236

 
8,114

 
17,009

 
15,564

INTEREST EXPENSE
 
 
 
 
 
 
 
Deposits
1,622

 
881

 
3,088

 
1,691

Borrowings
256

 
341

 
574

 
554

Total interest expense
1,878

 
1,222

 
3,662

 
2,245

Net interest income
6,358

 
6,892

 
13,347

 
13,319

(RECAPTURE) PROVISION FOR LOAN LOSSES
(200
)
 
150

 
(400
)
 
250

Net interest income after (recapture) provision for loan losses
6,558

 
6,742

 
13,747

 
13,069

NONINTEREST INCOME
 
 
 
 
 
 
 
Service charges and fee income
479

 
461

 
925

 
921

Earnings on cash surrender value of bank-owned life insurance
78

 
80

 
186

 
159

Mortgage servicing income
256

 
295

 
498

 
547

Fair value adjustment on mortgage servicing rights
(162
)
 
(89
)
 
(486
)
 
(121
)
Net gain on sale of loans
308

 
392

 
843

 
766

Total noninterest income
959

 
1,139

 
1,966

 
2,272

NONINTEREST EXPENSE
 
 
 
 
 
 
 
Salaries and benefits
2,654

 
3,055

 
6,293

 
6,196

Operations
1,450

 
1,198

 
3,084

 
2,437

Regulatory assessments
115

 
91

 
228

 
192

Occupancy
546

 
573

 
1,052

 
1,047

Data processing
460

 
461

 
960

 
914

Net loss on OREO and repossessed assets
7

 
25

 
9

 
52

Total noninterest expense
5,232

 
5,403

 
11,626

 
10,838

Income before provision for income taxes
2,285

 
2,478

 
4,087

 
4,503

Provision for income taxes
468

 
512

 
826

 
935

Net income
$
1,817

 
$
1,966

 
$
3,261

 
$
3,568

 
 
 
 
 
 
 
 
Earnings per common share:
 
 
 
 
 
 
 
Basic
$
0.72

 
$
0.79

 
$
1.29

 
$
1.44

Diluted
$
0.71

 
$
0.77

 
$
1.27

 
$
1.39

Weighted-average number of common shares outstanding:
 
 
 
 
 
 
 
Basic
2,521,901

 
2,489,294

 
2,516,095

 
2,484,708

Diluted
2,572,190

 
2,561,247

 
2,572,704

 
2,560,823

 
See notes to condensed consolidated financial statements 


4



SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Comprehensive Income (unaudited)
(In thousands)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2019
 
2018
 
2019
 
2018
Net income
$
1,817

 
$
1,966

 
$
3,261

 
$
3,568

Available for sale securities:
 
 
 
 
 
 
 
Unrealized holding gains/(losses) arising during the period
39

 
1

 
92

 
(38
)
Income tax (expense)/benefit related to unrealized gains/losses
(8
)
 

 
(19
)
 
8

Other comprehensive income/(loss), net of tax
31

 
1

 
73

 
(30
)
Comprehensive income
$
1,848

 
$
1,967

 
$
3,334

 
$
3,538

See notes to condensed consolidated financial statements

5



SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Stockholders’ Equity
For the Three and Six Months Ended June 30, 2019 and 2018 (unaudited)
(In thousands, except share and per share amounts)

 
Shares
 
Common
Stock
 
Additional Paid
-in Capital
 
Unearned
ESOP Shares
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income, net of tax
 
Total
Stockholders’
Equity
Balance, at March 31, 2019
2,563,828

 
$
25

 
$
25,802

 
$
(312
)
 
$
47,252

 
$
156

 
$
72,923

Net income
 
 
 
 
 
 
 
 
1,817

 
 
 
1,817

Other comprehensive income, net of tax
 
 
 
 
 
 
 
 
 
 
31

 
31

Share-based compensation
 
 
 
 
48

 
 
 
 
 
 
 
48

Cash dividends paid on common stock ($0.14 per share)
 
 
 
 
 
 
 
 
(359
)
 
 
 
(359
)
Common stock repurchased
(1,290
)
 
 
 
 
 
 
 
 
 
 
 

Common stock options exercised
950

 
 
 
6

 
 
 
 
 
 
 
6

Allocation of ESOP shares
 
 
 
 
70

 
29

 
 
 
 
 
99

Balance, at June 30, 2019
2,563,488

 
$
25

 
$
25,926

 
$
(283
)
 
$
48,710

 
$
187

 
$
74,565

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, at December 31, 2018
2,544,059

 
$
25

 
$
25,663

 
$
(340
)
 
$
46,165

 
$
114

 
$
71,627

Net income
 
 
 
 
 
 
 
 
3,261

 
 
 
3,261

Other comprehensive income, net of tax
 
 
 
 
 
 
 
 
 
 
73

 
73

Share-based compensation
 
 
 
 
87

 
 
 
 
 
 
 
87

Restricted stock awards issued
15,925

 
 
 
 
 
 
 
 
 
 
 

Cash dividends paid on common stock ($0.28 per share)
 
 
 
 
 
 
 
 
(716
)
 
 
 
(716
)
Common stock repurchased
(2,778
)
 
 
 
 
 
 
 
 
 
 
 

Common stock options exercised
6,282

 
 
 
38

 
 
 
 
 
 
 
38

Allocation of ESOP shares
 
 
 
 
138

 
57

 
 
 
 
 
195

Balance, at June 30, 2019
2,563,488

 
$
25

 
$
25,926

 
$
(283
)
 
$
48,710

 
$
187

 
$
74,565



6



 
Shares
 
Common
Stock
 
Additional Paid
-in Capital
 
Unearned
ESOP Shares
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income, net of tax
 
Total
Stockholders’
Equity
Balance, at March 31, 2018
2,524,346

 
$
25

 
$
25,104

 
$
(453
)
 
$
41,792

 
$
78

 
$
66,546

Net income
 
 
 
 
 
 
 
 
1,966

 
 
 
1,966

Other comprehensive income, net of tax
 
 
 
 
 
 
 
 
 
 
1

 
1

Share-based compensation
 
 
 
 
89

 
 
 
 
 
 
 
89

Cash dividends paid on common stock ($0.14 per share)
 
 
 
 
 
 
 
 
(353
)
 
 
 
(353
)
Common stock repurchased
(10,184
)
 
 
 
 
 
 
 
 
 
 
 

Restricted shares forfeited
(343
)
 
 
 
 
 
 
 
 
 
 
 

Common stock options exercised
25,995

 
 
 
29

 
 
 
 
 
 
 
29

Allocation of ESOP shares
 
 
 
 
149

 
56

 
 
 
 
 
205

Balance, at June 30, 2018
2,539,814

 
$
25

 
$
25,371

 
$
(397
)
 
$
43,405

 
$
79

 
$
68,483

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, at December 31, 2017
2,511,127

 
$
25

 
$
24,986

 
$
(453
)
 
$
40,493

 
$
109

 
$
65,160

Net income
 
 
 
 
 
 
 
 
3,568

 
 
 
3,568

Other comprehensive loss, net of tax
 
 
 
 
 
 
 
 
 
 
(30
)
 
(30
)
Share-based compensation
 
 
 
 
134

 
 
 
 
 
 
 
134

Cash dividends paid on common stock ($0.26 per share)
 
 
 
 
 
 
 
 
(656
)
 
 
 
(656
)
Common stock repurchased
(15,390
)
 
 
 
 
 
 
 
 
 
 
 

Restricted shares forfeited
(343
)
 
 
 
 
 
 
 
 
 
 
 

Common stock options exercised
44,420

 
 
 
102

 
 
 
 
 
 
 
102

Allocation of ESOP shares
 
 
 
 
149

 
56

 
 
 
 
 
205

Balance, at June 30, 2018
2,539,814

 
$
25

 
$
25,371

 
$
(397
)
 
$
43,405

 
$
79

 
$
68,483




See notes to condensed consolidated financial statements

7



SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Cash Flows (unaudited)
(In thousands)
 
Six Months Ended June 30,
 
2019
 
2018
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
3,261

 
$
3,568

Adjustments to reconcile net income to net cash from operating activities:
 
 
 
Amortization of net discounts on investments
16

 
28

(Recapture) provision for loan losses
(400
)
 
250

Depreciation and amortization
470

 
489

Compensation expense related to stock options and restricted stock
87

 
134

Change in fair value of mortgage servicing rights
486

 
121

Increase in cash surrender value of BOLI
(186
)
 
(159
)
Net change in advances from borrowers for taxes and insurance
(20
)
 
(159
)
Net gain on sale of loans
(843
)
 
(766
)
Proceeds from sale of loans held-for-sale
38,197

 
29,896

Originations of loans held-for-sale
(37,405
)
 
(28,260
)
Net loss on OREO and repossessed assets
9

 
52

Change in operating assets and liabilities:
 
 
 
Accrued interest receivable
179

 
(247
)
Other assets
565

 
(260
)
Accrued interest payable
58

 
5

Other liabilities
(132
)
 
794

Net cash provided by operating activities
4,342

 
5,486

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchase of available-for-sale securities
(52
)
 

Proceeds from principal payments, maturities and sales of available-for-sale securities
120

 
289

Net decrease (increase) in loans
54,248

 
(42,161
)
Purchase of BOLI
(229
)
 
(246
)
Purchases of premises and equipment, net
(109
)
 
(571
)
Net cash provided by (used in) investing activities
53,978

 
(42,689
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Net increase in deposits
25,901

 
25,016

Proceeds from borrowings
81,075

 
28,000

Repayment of borrowings
(148,825
)
 
(15,956
)
FHLB stock redeemed (purchased)
2,624

 
(549
)
ESOP shares released
195

 

Proceeds from common stock option exercises
38

 
102

Dividends paid on common stock
(716
)
 
(656
)
Net cash (used in) provided by financing activities
(39,708
)
 
35,957

Net change in cash and cash equivalents
18,612

 
(1,246
)
Cash and cash equivalents, beginning of period
61,810

 
60,680

Cash and cash equivalents, end of period
$
80,422

 
$
59,434

 
 
 
 
SUPPLEMENTAL CASH FLOW INFORMATION:
 
 
 
Cash paid for income taxes
$
225

 
$
1,500

Interest paid on deposits and borrowings
3,604

 
2,240

Loans transferred from loans held-for-portfolio to OREO and repossessed assets
494

 

See notes to condensed consolidated financial statements


8



SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited) 
Note 1 – Basis of Presentation
The accompanying financial information is unaudited and has been prepared from the consolidated financial statements of Sound Financial Bancorp, Inc., and its wholly owned subsidiaries, Sound Community Bank and Sound Community Insurance Agency, Inc.  References in this document to Sound Financial Bancorp refer to Sound Financial Bancorp, Inc. and references to the “Bank” refer to Sound Community Bank. References to “we,” “us,” and “our” or the “Company” refers to Sound Financial Bancorp and its wholly-owned subsidiaries, Sound Community Bank and Sound Community Insurance Agency, Inc., unless the context otherwise requires.
These unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission (“SEC”).  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the financial position and results of operations for the periods presented have been included.  Certain information and disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the rules and regulations of the SEC. These unaudited financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2018, as filed with the SEC on March 14, 2019 (“2018 Form 10-K”).  The results for the interim periods are not necessarily indicative of results for a full year.
Certain amounts in the prior period’s consolidated financial statements have been reclassified to conform to the current presentation.  These classifications do not have an impact on previously reported consolidated net income, retained earnings, stockholders’ equity or earnings per share.

Note 2 – Accounting Pronouncements Recently Issued or Adopted
In August 2018, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2018-13, "Fair Value Measurement: Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement" ("ASU 2018-13"). This ASU modifies the disclosure requirements on fair value measurements. The following disclosure requirements were removed from FASB Accounting Standards Codification ("ASC") Topic 820 - Fair Value Measurement: (1) the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy; (2) the policy for timing of transfers between levels; and (3) 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 the following disclosure requirements for Level 3 measurements: (1) 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 (2) 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

9



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. Under current GAAP, entities generally amortize the premium as an adjustment of yield over the contractual life of the instrument. 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 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 measurement of expected credit losses will be based on historical information, current conditions, and reasonable and supportable forecasts that impact the collectability of the reported amount. Available-for-sale securities will bifurcate the fair value mark and establish an allowance for credit losses through the income statement for the credit portion of that mark. The interest portion will continue to be recognized through accumulated other comprehensive income or loss. 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. In May 2019, the FASB issued ASU No. 2019-05, “Financial Instruments-Credit Losses (Topic 326): Targeted Transition Relief” (ASU 2019-05). This ASU provides transition relief for entities adopting the FASB’s credit losses standard, ASU 2016-13 and allows companies to irrevocably elect, upon adoption of ASU 2016-13, the fair value option for certain financial instruments. In April 2019, the FASB issued ASU No. 2019-04, “Codification Improvements to Topic 326, Financial Instruments-Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments” (ASU 2019-04). This ASU clarifies certain aspects of accounting for credit losses, hedging activities, and financial instruments. The amendments in these ASUs are effective for fiscal years beginning after December 15, 2019 with early adoption permitted. The Company is evaluating its current expected loss methodology on the loan and investment portfolios to identify the necessary modifications in accordance with this standard and expects a change in the processes and procedures to calculate the allowance for loan losses, including changes in assumptions and estimates to consider expected credit losses over the life of the loan versus the current accounting practice that utilizes the incurred loss model. The Company is in the process of compiling historical data that will be used to calculate expected credit losses on the loan portfolio to ensure that it is fully compliant with the ASU at the adoption date and is evaluating the potential impact adoption of this ASU will have on its consolidated financial statements. While the Company has not quantified the impact of these ASUs, it does expect changing from the current incurred loss model to an expected loss model will result in an earlier recognition of losses. The Company also expects that once adopted the allowance for loan losses will increase, however, until its evaluation is complete the magnitude of the increase will be unknown.

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

10



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. See Note 12 - Leases of this report for more information.

In March 2019, FASB issued ASU 2019-01, Leases (Topic 842), Codification Improvements. The amendments in this ASU include the following items: (i) determining the fair value of the underlying asset by lessors that are not manufacturers or dealers; (ii) requiring cash received from lessors from sales-type and direct financing leases to be presented in the cash flow statement within investing activities; and (iii) 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 interim disclosures in this report.  The Company does not expect the adoption of items (i) and (ii) of ASU 2019-01 to have a material impact on its consolidated financial statements.



Note 3 – Investments
The amortized cost and fair value of our available-for-sale (“AFS”) securities and the corresponding amounts of gross unrealized gains and losses at the dates indicated were as follows (in thousands):
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
June 30, 2019
 
 
 
 
 
 
 
Treasury bills
$
52

 
$

 
$

 
$
52

Municipal bonds
3,207

 
172

 
(3
)
 
3,376

Agency mortgage-backed securities
1,469

 
67

 

 
1,536

Total
$
4,728

 
$
239

 
$
(3
)
 
$
4,964

 
 
 
 
 
 
 
 
December 31, 2018
 
 
 
 
 
 
 
Municipal bonds
$
3,218

 
$
122

 
$
(23
)
 
$
3,317

Agency mortgage-backed securities
1,594

 
46

 

 
1,640

Total
$
4,812

 
$
168

 
$
(23
)
 
$
4,957

The amortized cost and fair value of AFS securities at June 30, 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 investments, are shown separately.
 
June 30, 2019
 
Amortized
Cost
 
Fair
Value
Due within one year
$
52

 
$
52

Due after one year through five years
1,555

 
1,564

Due after five years through ten years
459

 
498

Due after ten years
1,193

 
1,314

Mortgage-backed securities
1,469

 
1,536

Total
$
4,728

 
$
4,964

There were no pledged securities at June 30, 2019 or December 31, 2018.
There were no sales of AFS securities during the three and six months ended June 30, 2019 or 2018.

11



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 the dates indicated (in thousands):
 
June 30, 2019
 
Less Than 12 Months
 
12 Months or Longer
 
Total
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
Municipal bonds
$

 
$

 
$
1,292

 
$
(3
)
 
$
1,292

 
$
(3
)
Total
$

 
$

 
$
1,292

 
$
(3
)
 
$
1,292

 
$
(3
)
 
December 31, 2018
 
Less Than 12 Months
 
12 Months or Longer
 
Total
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
Municipal bonds
$

 
$

 
$
1,283

 
$
(23
)
 
$
1,283

 
$
(23
)
Total
$

 
$

 
$
1,283

 
$
(23
)
 
$
1,283

 
$
(23
)
There were no credit losses recognized in earnings during the three and six months ended June 30, 2019 or 2018 relating to the Company’s securities.

At June 30, 2019, the securities portfolio consisted of six agency mortgage-backed securities, eight municipal securities and two short-term securities with a total portfolio fair value of $5.0 million . At December 31, 2018, the securities portfolio consisted of six agency mortgage-backed securities and eight municipal securities with a fair value of $5.0 million . At both June 30, 2019 and 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. 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") as of June 30, 2019, 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


12



Note 4 – Loans
The composition of the loans-held-for portfolio at the dates indicated, excluding loans held-for-sale, was as follows (in thousands):
 
June 30,
2019
 
December 31,
2018
Real estate loans:
 
 
 
One-to-four family
$
145,593

 
$
169,830

Home equity
23,095

 
27,655

Commercial and multifamily
226,299

 
252,644

Construction and land
70,205

 
65,259

Total real estate loans
465,192

 
515,388

Consumer loans:
 
 
 
Manufactured homes
20,685

 
20,145

Floating homes
40,247

 
40,806

Other consumer
7,583

 
6,628

Total consumer loans
68,515

 
67,579

Commercial business loans
33,509

 
38,804

Total loans held-for-portfolio
567,216

 
621,771

Deferred fees
(1,865
)
 
(2,228
)
Total loans, gross held-for-portfolio
565,351

 
619,543

Allowance for loan losses
(5,370
)
 
(5,774
)
Total loans held-for-portfolio, net
$
559,981

 
$
613,769


The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of June 30, 2019 (in thousands):
 
Allowance: Individually evaluated for impairment
 
Allowance: Collectively evaluated for impairment
 
Allowance:
Ending balance
 
Loans held for investment: Individually evaluated for impairment
 
Loans held for investment: Collectively evaluated for impairment
 
Loans held for investment:
Ending balance
 
 
 
 
 
 
 
 
 
 
 
 
One-to-four family
$
209

 
$
930

 
$
1,139

 
$
2,476

 
$
143,117

 
$
145,593

Home equity
19

 
146

 
165

 
625

 
22,470

 
23,095

Commercial and multifamily

 
1,467

 
1,467

 
649

 
225,650

 
226,299

Construction and land
8

 
456

 
464

 
122

 
70,083

 
70,205

Manufactured homes
332

 
131

 
463

 
448

 
20,237

 
20,685

Floating homes

 
262

 
262

 

 
40,247

 
40,247

Other consumer
66

 
54

 
120

 
156

 
7,427

 
7,583

Commercial business
296

 
213

 
509

 
694

 
32,815

 
33,509

Unallocated

 
781

 
781

 

 

 

 
930

 
4,440

 
5,370

 
5,170

 
562,046

 
567,216


13



The following table presents the balance in the allowance for loan losses and the recorded investment in loans 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
 
Allowance:
Ending balance
 
Loans held for investment: Individually evaluated for impairment
 
Loans held for investment: Collectively evaluated for impairment
 
Loans held for investment:
Ending balance
 
 
 
 
 
 
 
 
 
 
 
 
One-to-four family
$
228

 
$
1,086

 
$
1,314

 
$
2,760

 
$
167,070

 
$
169,830

Home equity
25

 
177

 
202

 
440

 
27,215

 
27,655

Commercial and multifamily

 
1,638

 
1,638

 
702

 
251,942

 
252,644

Construction and land
8

 
423

 
431

 
163

 
65,096

 
65,259

Manufactured homes
299

 
128

 
427

 
424

 
19,721

 
20,145

Floating homes

 
265

 
265

 

 
40,806

 
40,806

Other consumer
64

 
48

 
112

 
157

 
6,471

 
6,628

Commercial business
112

 
244

 
356

 
1,192

 
37,612

 
38,804

Unallocated

 
1,029

 
1,029

 

 

 

Total
$
736

 
$
5,038

 
$
5,774

 
$
5,838

 
$
615,933

 
$
621,771

The following table summarizes the activity in the allowance for loan losses for the three months ended June 30, 2019 (in thousands):
 
Beginning
Allowance
 
Charge-offs
 
Recoveries
 
(Recapture) provision
 
Ending
Allowance
One-to-four family
$
1,189

 
$

 
$

 
$
(50
)
 
$
1,139

Home equity
229

 

 
4

 
(68
)
 
165

Commercial and multifamily
1,035

 

 

 
432

 
1,467

Construction and land
996

 

 

 
(532
)
 
464

Manufactured homes
511

 

 

 
(48
)
 
463

Floating homes
254

 

 

 
8

 
262

Other consumer
120

 
(12
)
 

 
12

 
120

Commercial business
424

 

 
1

 
84

 
509

Unallocated
819

 

 

 
(38
)
 
781

Total
$
5,577

 
$
(12
)
 
$
5

 
$
(200
)
 
$
5,370


The following table summarizes the activity in the allowance for loan losses for the six months ended June 30, 2019 (in thousands):
 
Beginning
Allowance
 
Charge-offs
 
Recoveries
 
Provision
 
Ending
Allowance
One-to-four family
$
1,314

 
$

 
$

 
$
(175
)
 
$
1,139

Home equity
202

 

 
7

 
(44
)
 
165

Commercial and multifamily
1,638

 

 

 
(171
)
 
1,467

Construction and land
431

 

 

 
33

 
464

Manufactured homes
427

 

 

 
36

 
463

Floating homes
265

 

 

 
(3
)
 
262

Other consumer
112

 
(32
)
 
20

 
20

 
120

Commercial business
356

 

 
1

 
152

 
509

Unallocated
1,029

 

 

 
(248
)
 
781

Total
$
5,774

 
$
(32
)
 
$
28

 
$
(400
)
 
$
5,370


14




The following table summarizes the activity in the allowance for loan losses for the three months ended June 30, 2018 (in thousands):
 
Beginning
Allowance
 
Charge-offs
 
Recoveries
 
Provision (recapture)
 
Ending
Allowance
One-to-four family
$
1,514

 
$

 
$
1

 
$
64

 
$
1,579

Home equity
276

 

 
35

 
(100
)
 
211

Commercial and multifamily
1,295

 

 

 
106

 
1,401

Construction and land
375

 

 

 
10

 
385

Manufactured homes
434

 
(12
)
 

 
(96
)
 
326

Floating homes
169

 

 

 
26

 
195

Other consumer
86

 

 
1

 
29

 
116

Commercial business
533

 

 

 
20

 
553

Unallocated
646

 

 

 
91

 
737

Total
$
5,328

 
$
(12
)
 
$
37

 
$
150

 
$
5,503


The following table summarizes the activity in the allowance for loan losses for the six months ended June 30, 2018 (in thousands):
 
Beginning
Allowance
 
Charge-offs
 
Recoveries
 
Provision
 
Ending
Allowance
One-to-four family
$
1,436

 
$

 
$
1

 
$
142

 
$
1,579

Home equity
293

 
(7
)
 
38

 
(113
)
 
211

Commercial and multifamily
1,250

 

 

 
151

 
1,401

Construction and land
378

 

 

 
7

 
385

Manufactured homes
355

 
(12
)
 

 
(17
)
 
326

Floating homes
169

 

 

 
26

 
195

Other consumer
80

 
(13
)
 
5

 
44

 
116

Commercial business
372

 

 

 
181

 
553

Unallocated
908

 

 

 
(171
)
 
737

Total
$
5,241

 
$
(32
)
 
$
44

 
$
250

 
$
5,503

Credit Quality Indicators.   Federal regulations provide for the classification of lower quality loans as substandard, doubtful or loss.  An asset is considered substandard if it is inadequately protected by the current net worth and payment capacity of the borrower or of any collateral pledged. Substandard assets include those characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected.  Assets classified as doubtful have all the weaknesses inherent in assets classified substandard with the added characteristic that the weaknesses make collection or liquidation of the assets in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.  Assets classified as loss are those considered uncollectible and of such little value that their continuance as assets without establishment of a specific loss reserve is not warranted.
When we classify problem loans as either substandard or doubtful, we may establish a specific allowance in an amount we deem prudent to address the risk specifically (if the loan is impaired) or we 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 loans.  When the Company classifies problem loans as a loss, we charge-off such assets in the period in which they are deemed uncollectible.  Assets that do not currently expose us to sufficient risk to warrant classification as substandard, doubtful or loss, but possess identified weaknesses, are classified as either watch or special mention assets.  Our determination as to the classification of our assets and the amount of our valuation allowances is subject to review by the Federal Deposit Insurance Corporation (“FDIC”), the Bank’s federal regulator, and the Washington Department of Financial Institutions (“WDFI”), the Bank’s state banking regulator, both which can order the establishment of additional loss allowances.  Pass rated loans are loans that are not otherwise classified or criticized.

15



The following table presents the internally assigned grades as of June 30, 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
$
139,501

 
$
22,344

 
$
218,232

 
$
64,002

 
$
20,357

 
$
40,247

 
$
7,527

 
$
30,502

 
$
542,712

Watch

 

 
4,645

 
2,925

 
1

 

 

 
953

 
8,524

Special Mention

 

 
2,261

 
3,154

 

 

 

 
340

 
5,755

Substandard
6,092

 
751

 
1,161

 
124

 
327

 

 
56

 
1,714

 
10,225

Doubtful

 

 

 

 

 

 

 

 

Loss

 

 

 

 

 

 

 

 

Total
$
145,593

 
$
23,095

 
$
226,299

 
$
70,205

 
$
20,685

 
$
40,247

 
$
7,583

 
$
33,509

 
$
567,216

The Bank had $1.8 million in performing loans identified as TDRs at June 30, 2019, that were not classified as special mention or substandard.
The following table presents 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

 
$
246,907

 
$
55,916

 
$
19,860

 
$
40,806

 
$
6,576

 
$
35,876

 
$
596,746

Watch

 

 
1,139

 
5,968

 

 

 

 
689

 
7,796

Special Mention

 

 
2,497

 
3,252

 

 

 

 
367

 
6,116

Substandard
6,175

 
505

 
2,101

 
123

 
285

 

 
52

 
1,872

 
11,113

Doubtful

 

 

 

 

 

 

 

 

Loss

 

 

 

 

 

 

 

 

Total
$
169,830

 
$
27,655

 
$
252,644

 
$
65,259

 
$
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 sooner if, in management’s opinion, the borrower may be unable to meet payment of obligations as they become due, as well as when required by regulatory authorities.
The following table presents the recorded investment in nonaccrual loans as of June 30, 2019, and December 31, 2018, by type of loan (in thousands):
 
June 30, 2019
 
December 31, 2018
One-to-four family
$
936

 
$
1,075

Home equity
557

 
360

Commercial and multifamily
649

 
534

Construction and land
81

 
123

Manufactured homes
240

 
214

Floating homes

 

Other consumer

 

Commercial business
353

 
235

Total
$
2,816

 
$
2,541


16



The following table presents the aging of the recorded investment in past due loans as of June 30, 2019, by type of loan (in thousands):
 
30-59 Days
Past Due
 
60-89 Days
Past Due
 
90 Days and Greater Past Due
 
Recorded Investment
> 90 Days and Accruing
 
Total Past
Due
 
Current
 
Total Loans
One-to-four family
$
151

 
$
197

 
$
647

 
$

 
$
995

 
$
144,598

 
$
145,593

Home equity
252

 
69

 
489

 

 
810

 
22,285

 
23,095

Commercial and multifamily
128

 

 
352

 

 
480

 
225,819

 
226,299

Construction and land

 

 
51

 

 
51

 
70,154

 
70,205

Manufactured homes
67

 
44

 
240

 

 
351

 
20,334

 
20,685

Floating homes

 

 

 

 

 
40,247

 
40,247

Other consumer
34

 
3

 

 

 
37

 
7,546

 
7,583

Commercial business
108

 

 
64

 

 
172

 
33,337

 
33,509

Total
$
740

 
$