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EX-32 - SFBC FORM 10-K EXHIBIT 32 - Sound Financial Bancorp, Inc.exhibit32123114.htm
EX-32 - SFBC FORM 10-K EXHIBIT 23 - Sound Financial Bancorp, Inc.exhibit23123114.htm
EX-31.2 - SFBC FORM 10-K EXHIBIT 31.2 - Sound Financial Bancorp, Inc.exhibit312123114.htm
EX-31.1 - SFBC FORM 10-K EXHIBIT 31.1 - Sound Financial Bancorp, Inc.exhibit311123114.htm
EXCEL - IDEA: XBRL DOCUMENT - Sound Financial Bancorp, Inc.Financial_Report.xls
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
__________
FORM 10-K

[X]
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2014
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.)
 
 
 
2005 5th Avenue, Suite 200, 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:
Common Stock, par value $.01 per share

Securities Registered Pursuant to Section 12(g) of the Act:
Title of each class
None

Indicate by checkmark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  YES [   ]    NO [X]

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 [X]

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 [X]  NO [   ]

Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted 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 and post such files).   YES [X]   NO [   ]

Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting Company.  See definition of "large accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Act.

Large accelerated filer [  ]
Accelerated filer [  ]
Non-accelerated filer [  ]
Smaller reporting Company [X]
 
 
(Do not check if smaller reporting Company)
 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  YES [   ]    NO [X]

The aggregate market value of the voting and non-voting common equity held by non-affiliates as of June 30, 2014, the last business day of the registrant's most recently completed second fiscal quarter, was approximately $38.8 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 30, 2015, there were 2,528,451 shares of the registrant's common stock outstanding.
 
DOCUMENTS INCORPORATED BY REFERENCE

PART III of Form 10-K – Portions of the Registrant's Proxy Statement for its 2015 Annual Meeting of Shareholders.




PART I
Item 1.    Business
Special Note Regarding Forward-Looking Statements
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:
·
changes in economic conditions, either nationally or in our market area;
·
fluctuations in interest rates;
·
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;
·
the possibility of other-than-temporary impairments of securities held in our securities portfolio;
·
our ability to access cost-effective funding;
·
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;
·
secondary market conditions for loans and our ability to sell loans in the secondary market;
·
our ability to attract and retain  deposits;
·
our ability to successfully integrate any assets, liabilities, customers, 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 including in particular, our recent acquisition of three branches from Columbia State Bank;
·
legislative or regulatory changes such as the Dodd-Frank Wall Street Reform and Consumer Protection Act and its implementing regulations that adversely affect our business, as well as changes in regulatory policies and principles, or  the interpretation of regulatory capital or other rules including changes related to Basel III;
·
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;
·
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;
·
increases in premiums for deposit insurance;
·
our ability to control operating costs and expenses;
·
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;
·
difficulties in reducing risks associated with the loans on our balance sheet;
·
staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges;
2

·
computer systems on which we depend could fail or experience a security breach;
·
our ability to retain key members of our senior management team;
·
costs and effects of litigation, including settlements and judgments;
·
our ability to implement our business strategies;
·
increased competitive pressures among financial services companies;
·
changes in consumer spending, borrowing and savings habits;
·
the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;
·
our ability to pay dividends on our common stock;
·
adverse changes in the securities markets;
·
the inability of key third-party providers to perform their obligations to us;
·
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; 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 its predecessor, Sound Financial, Inc., a federal corporation, 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.
Sound Community Bank's deposits are insured up to applicable limits by the FDIC.  At December 31, 2014, Sound Financial Bancorp had total consolidated assets of $495.2 million, net loans of $426.0 million, deposits of $407.8 million and stockholders' equity of $50.6 million.  The shares of Sound Financial Bancorp are traded on The NASDAQ Capital Market under the symbol "SFBC."  Our executive offices are located at 2005 5th Avenue, Suite 200, Seattle, Washington, 98121.
Our principal business consists of attracting retail and commercial deposits from the general public and investing those funds, along with borrowed funds, in loans secured by first and second mortgages on one- to four-family residences (including home equity loans and lines of credit), commercial and multifamily, consumer and commercial business loans and construction and land loans.  We offer a variety of secured and unsecured consumer loan products, including manufactured home loans, floating homes, automobile loans, boat loans and recreational vehicle loans.  As part of our business, we focus on residential mortgage loan originations, some of which we sell to Fannie Mae.  We sell the majority of these loans with servicing retained to maintain the direct customer relationship and to continue providing strong customer service to our borrowers.  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, manufactured home parks and construction and land development loans.
3


Market Area
We serve the Seattle Metropolitan Statistical Area ("MSA"), which includes the city of Seattle, King County, Snohomish County, and Pierce County within the Puget Sound region, and Clallam and Jefferson Counties, Washington.  We serve these markets through our main office in Seattle, five branch offices, two of which are located in the Seattle MSA, two that are located in Clallam County and one that is located in Jefferson County, and a loan production office located in the Madison Park neighborhood of Seattle.  Based on the most recent branch deposit data provided by the FDIC, our share of deposits in the Seattle-Tacoma-Bellevue MSA was approximately 0.21%, in King County approximately 0.15%, in Pierce County approximately 0.44% and in Snohomish County approximately 0.36%.  In Clallam County and Jefferson County, we have approximately 13.67% and 4.04%, respectively, of the deposits in those markets.  See "– Competition."
Our market area includes a diverse population of management, professional and sales personnel, office employees, 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, manufacturing, maritime, biotechnology, education, health and social services, retail trades, transportation and professional services.  The largest employers headquartered in our market area include Boeing, U.S. Joint Base Lewis-McChord, Navy Region Northwest, Microsoft, University of Washington, and Providence Health.  Other significant employers include Costco, Nordstrom, Amazon.com, Inc., Starbucks, Alaska Air Group and Weyerhaeuser.
Weak economic conditions and ongoing strains in the financial and housing markets which began in 2008, generally started to improve in 2012 in portions of the United States, including our market area. While the effects during this period presented an unusually challenging environment for banks and their holding companies, including us, trends in housing prices and unemployment are generally improving. For the month of December 2014, the Seattle MSA reported an unemployment rate of 4.8%, as compared to the national average of 5.6%, 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 6.6% in 2014 from 2013. This compares favorably to the national average home price index increase in 2014 of 4.6%.
King County has the largest population of any county in the state of Washington, covers approximately 2,100 square miles, and is located on the Puget Sound.  It has approximately 2.0 million residents and a median household income of approximately $71,000.  King County has a diversified economic base with many industries including shipping and transportation (Port of Seattle, Paccar, Inc. and Expeditors International of Washington, Inc.), retail (Amazon.com, Inc., Starbucks Corp. and Nordstrom, Inc.) aerospace (the Boeing Company) and computer technology (Microsoft Corp.) and biotech industries.  Based on information from the Northwest Multiple Listing Service ("MLS"), the median sales price in King County in December 2014 was $391,000, a 5.1% increase from December 2013's median sale price of $372,000.
Pierce County has the second largest population of any county in the State of Washington, covers approximately 1,700 square miles and is located along western Puget Sound.  It has approximately 811,000 residents and a median household income of approximately $59,000. The Pierce County economy is diversified with the presence of military related government employment (Fort Lewis Army Base and McChord Air Force Base), transportation and shipping employment (Port of Tacoma), and aerospace related employment (Boeing). Based on information from the MLS, the median sale price in Pierce County in December 2014 was $230,000, a 3.6% increase from December 2013's median sales price of $222,000.
Snohomish County has the third largest population of any county in the state of Washington, covers approximately 2,100 square miles and is located on Puget Sound touching the northern border of King County.  It has approximately 733,000 residents and a median household income of approximately $68,000. The economy of Snohomish County is diversified with the presence of military related government employment (Everett Homeport Naval Base), aerospace related employment (Boeing) and retail trade.  Based on information from the MLS, the median sales price in Snohomish County as of December 31, 2014 was $300,000, a 1.4% increase from December 2013's median sales price of $296,000.
Clallam County, with a population of approximately 71,000, is ranked 18th among the counties in the state of Washington.  It is bordered by the Pacific Ocean and the Strait of Juan de Fuca and covers 1,700 square miles, including the westernmost portion of the continental United States.  It has approximately 36,000 households and median household income of approximately $46,000. The economy of Clallam County is primarily manufacturing and shipping. The Sequim Dungeness Valley continues to be a growing retirement location.  Our offices are in Port Angeles and Sequim, the two largest cities in the county.  Based on information from the MLS, the median sales price in Clallam County in December 2014 was $199,000, a 12.4% increase from 2013's median sales price of $177,000.
4


Jefferson County, with a population of approximately 30,000, is the 27th largest county in the state of Washington.  It is bordered by Clallam County and the Strait of Juan de Fuca to the north and the Hood Canal on the west and covers 2,200 square miles.  The majority of the population of the county lives in the northwestern portion of the county.  Our office is located in Port Ludlow which is the third largest community in the county.  Port Ludlow ranks 16th of 522 ranked areas in the state of Washington and is the most affluent area of Jefferson County.  The economy of Jefferson County is primarily based on tourism, agriculture, lumber, fish processing and ship repair and maintenance.  Port Ludlow is a popular retirement community and is a well-known port of call for leisure craft sailing between Puget Sound and the San Juan Islands.  Based on information from the MLS, the average home price in Jefferson County as of December 2014 was $147,000, a 3.3% decrease from 2013's median price of $152,000.

There have been indications over the last several years that the U.S. job market, including the job market in our market area, is improving, however the unemployment rate in certain of our market areas remain relatively high..  According to the latest available information from the Bureau of Labor Statistics, King and Snohomish Counties reported an unemployment rate of 4.1% and 4.5%, respectively, as of December 2014, which are lower than the state and national unemployment rates of 6.3% and 5.6%, respectively.  The unemployment rates for Clallam and Pierce Counties are above the state and national rates as of December 2014.  The unemployment rate in Clallam County increased from 9.0% as of December 2013 to 9.3% as of December 2014, while the unemployment rate in Pierce County decreased from 7.3% as of December 2013 to 7.2% as of December 2014.  The unemployment rate in Jefferson County increased from 8.4% as of December 2013 to 8.6% as of December 2014.

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):
 
December 31,
 
 
2014
   
2013
   
2012
   
2011
   
2010
 
 
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
 
Real estate loans:
                                       
One- to four-family
 
$
133,031
     
30.80
%
 
$
117,739
     
30.02
%
 
$
94,059
     
28.71
%
 
$
94,498
     
31.45
%
 
$
98,314
     
32.81
%
Home equity
   
34,675
     
8.03
     
35,155
     
8.96
     
35,364
     
10.80
     
39,656
     
13.20
     
44,829
     
14.96
 
Commercial and multifamily
   
168,952
     
39.12
     
157,516
     
40.17
     
133,620
     
40.79
     
106,016
     
35.28
     
93,053
     
31.05
 
Construction and land
   
46,279
     
10.72
     
44,300
     
11.30
     
25,458
     
7.77
     
17,805
     
5.93
     
16,650
     
5.56
 
  Total real estate loans
   
382,937
     
88.67
     
354,710
     
90.45
     
288,501
     
88.07
     
257,975
     
85.85
     
252,846
     
84.37
 
Consumer loans:
                                                                               
Manufactured homes
   
12,539
     
2.90
     
13,496
     
3.44
     
16,232
     
4.96
     
18,444
     
6.14
     
20,043
     
6.69
 
Other consumer
   
16,875
     
3.91
     
10,284
     
2.62
     
8,650
     
2.64
     
10,920
     
3.63
     
12,110
     
4.04
 
  Total consumer loans
   
29,414
     
6.81
     
23,780
     
6.06
     
24,882
     
7.60
     
29,364
     
9.77
     
32,153
     
10.73
 
Commercial business loans
   
19,525
     
4.52
     
13,668
     
3.49
     
14,193
     
4.33
     
13,163
     
4.38
     
14,678
     
4.90
 
Total loans
   
431,876
     
100.00
%
   
392,158
     
100.00
%
   
327,576
     
100.00
%
   
300,502
     
100.00
%
   
299,677
     
100.00
%
Less:
                                                                               
Deferred fees and discounts
   
1,516
             
1,232
             
832
             
406
             
431
         
Allowance for loan losses
   
4,387
             
4,177
             
4,248
             
4,455
             
4,436
         
  Total loans, net
 
$
425,973
           
$
386,749
           
$
322,496
           
$
295,641
           
$
294,810
         

5

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):
 
December 31,
 
 
2014
   
2013
   
2012
   
2011
   
2010
 
 
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
 
Fixed- rate loans:
   
Real estate loans:
                                       
One- to four-family
 
$
118,083
     
27.34
%
 
$
103,756
     
26.46
%
 
$
79,020
     
24.12
%
 
$
78,145
     
26.00
%
 
$
79,930
     
26.67
%
Home equity
   
12,003
     
2.78
     
13,530
     
3.45
     
9,605
     
2.93
     
9,276
     
3.09
     
10,294
     
3.44
 
Commercial and multifamily
   
103,303
     
23.92
     
100,031
     
25.51
     
76,957
     
23.49
     
45,034
     
14.99
     
40,491
     
13.51
 
Construction and land
   
39,147
     
9.07
     
37,668
     
9.61
     
22,346
     
6.82
     
17,458
     
5.81
     
10,907
     
3.64
 
  Total real estate loans
   
272,536
     
63.11
     
254,985
     
65.03
     
187,928
     
57.37
     
149,913
     
49.89
     
141,622
     
47.26
 
Manufactured homes
   
12,539
     
2.90
     
13,496
     
3.44
     
16,232
     
4.96
     
18,444
     
6.14
     
20,043
     
6.69
 
Other consumer
   
16,129
     
3.74
     
9,495
     
2.42
     
7,767
     
2.37
     
9,730
     
3.24
     
10,772
     
3.59
 
Commercial business
   
11,024
     
2.55
     
5,603
     
1.43
     
9,268
     
2.83
     
8,041
     
2.68
     
8,293
     
2.77
 
  Total fixed-rate  loans
   
312,226
     
72.30
     
283,579
     
72.32
     
221,195
     
67.52
     
186,128
     
61.94
     
180,730
     
60.31
 
Adjustable- rate loans:
                                                                               
Real estate loans:
                                                                               
One- to four-family
   
14,948
     
3.46
     
13,983
     
3.57
     
15,039
     
4.59
     
16,353
     
5.44
     
18,384
     
6.13
 
Home equity
   
22,672
     
5.25
     
21,625
     
5.51
     
25,759
     
7.86
     
30,380
     
10.11
     
34,535
     
11.52
 
Commercial and multifamily
   
65,649
     
15.20
     
57,485
     
14.66
     
56,663
     
17.30
     
60,982
     
20.29
     
52,562
     
17.54
 
Construction and land
   
7,132
     
1.65
     
6,632
     
1.69
     
3,112
     
0.95
     
347
     
0.12
     
5,743
     
1.92
 
  Total real estate loans
   
110,401
     
25.56
     
99,725
     
25.43
     
100,573
     
30.70
     
108,062
     
35.96
     
111,224
     
37.11
 
Other consumer
   
746
     
0.17
     
789
     
0.20
     
883
     
0.27
     
1,190
     
0.40
     
1,338
     
0.45
 
Commercial business
   
8,501
     
1.97
     
8,065
     
2.05
     
4,925
     
1.50
     
5,122
     
1.70
     
6,385
     
2.13
 
  Total adjustable-rate loans
   
119,648
     
27.70
     
108,579
     
27.68
     
106,381
     
32.48
     
114,374
     
38.06
     
118,947
     
39.69
 
Total loans
   
431,876
     
100.00
%
   
392,158
     
100.00
%
   
327,576
     
100.00
%
   
300,502
     
100.00
%
   
299,677
     
100.00
%
Less:
                                                                               
Deferred fees and discounts
   
1,516
             
1,232
             
832
             
406
             
431
         
Allowance for loan losses
   
4,387
             
4,177
             
4,248
             
4,455
             
4,436
         
  Total loans, net
 
$
425,973
           
$
386,749
           
$
322,496
           
$
295,641
           
$
294,810
         


6

The following table illustrates the contractual maturity of our loan portfolio at December 31, 2014 (dollars in thousands).  Mortgages 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, 2015, which have predetermined interest rates, is $266.8 million, while the total amount of loans due after such date, which have floating or adjustable interest rates, is $105.1 million.  The table does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.
 
 
Real Estate Mortgages
   
   
   
   
   
   
   
   
 
 
 
One- to Four-
   
Home Equity
   
Commercial and
   
Construction
   
   
   
   
   
Commercial
   
   
 
 
 
Family
   
Loans
   
Multifamily
   
and Land
   
Manufactured Homes
   
Other Consumer
   
Business
   
Total(1)
 
 
 
   
Weighted
   
   
Weighted
   
   
Weighted
   
   
Weighted
   
   
Weighted
   
   
Weighted
   
   
Weighted
   
   
Weighted
 
 
 
   
Average
   
   
Average
   
   
Average
   
   
Average
   
   
Average
   
   
Average
   
   
Average
   
   
Average
 
 
 
Amount
   
Rate
   
Amount
   
Rate
   
Amount
   
Rate
   
Amount
   
Rate
   
Amount
   
Rate
   
Amount
   
Rate
   
Amount
   
Rate
   
Amount
   
Rate
 
2015(2)
 
$
4,041
     
4.29
%
 
$
800
     
5.36
%
 
$
12,324
     
5.07
%
 
$
30,643
     
5.52
%
 
$
155
     
7.31
%
 
$
3,830
     
6.59
%
 
$
8,218
     
5.22
%
 
$
60,011
     
5.38
%
2016
   
8,531
     
5.50
     
900
     
5.05
     
9,761
     
4.64
     
6,329
     
5.65
     
53
     
7.88
     
815
     
6.04
     
922
     
5.36
     
27,401
     
5.22
 
2017
   
3,134
     
4.40
     
2,701
     
5.15
     
6,185
     
5.11
     
1,389
     
7.24
     
112
     
7.61
     
403
     
6.10
     
1,376
     
4.67
     
15,300
     
5.17
 
2018
   
5,284
     
4.52
     
2,119
     
4.99
     
4,348
     
4.30
     
1,625
     
6.52
     
263
     
8.40
     
456
     
6.47
     
1,426
     
4.87
     
15,521
     
4.89
 
2019 to 2021
   
29,883
     
4.71
     
14,963
     
5.44
     
26,775
     
5.50
     
1,727
     
7.34
     
2,252
     
8.44
     
1,819
     
5.68
     
5,254
     
5.13
     
82,673
     
5.30
 
2022 to 2025
   
19,848
     
4.18
     
3,985
     
4.99
     
90,291
     
4.80
     
2,732
     
6.64
     
3,850
     
8.55
     
,511
     
5.44
     
689
     
5.59
     
122,906
     
4.88
 
2026 to 2029
   
17,768
     
4.24
     
2,492
     
6.17
     
9,783
     
4.98
     
2,732
     
6.17
     
5,043
     
7.76
     
6,406
     
4.80
     
1,482
     
6.56
     
44,671
     
5.14
 
2030 and following
   
44,542
     
4.63
     
6,715
     
4.93
     
9,485
     
4.88
     
137
     
6.15
     
811
     
6.54
     
1,63
     
5.88
     
158
     
6.00
     
63,393
     
4.76
 
Total(1)
 
$
133,031
     
4.56
%
 
$
34,675
     
5.28
%
 
$
168,952
     
4.94
%
 
$
46,279
     
5.79
%
 
$
12,539
     
8.05
%
 
$
16,875
     
5.60
%
 
$
19,525
     
5.26
%
 
$
431,876
     
5.07
%
___________________________________________
(1)  Excludes deferred fees and discounts of $1.5 million.
(2)  Includes demand loans, loans having no stated maturity and overdraft loans.


7

Lending Authority.  Our President and Chief Executive Officer may approve unsecured loans up to $1,000,000 and all types of secured loans up to 30% of our legal lending limit, or approximately $3.2 million as of December 31, 2014.  Our Executive Vice President and Chief Credit Officer may approve unsecured loans up to $400,000 and secured loans up to 15% of our legal lending limit, or approximately $2.1 million as of December 31, 2014.  Any loans over the President and Chief Executive Officer's lending authority or loans otherwise outside our general underwriting guidelines must be approved by the Board Loan Committee.  Lending authority is also granted to certain other bank officers at lower amounts, generally up to 7.5% of our legal lending limit for real estate secured loans and $50,000 for unsecured loans provided the loan has no policy exceptions.

Largest Borrowing Relationships.  At December 31, 2014, the maximum amount under federal law that we could lend to any one borrower and the borrower's related entities was approximately $10.5 million.  Our five largest relationships totaled $18.7 million in the aggregate, or 4.3% of our $430.4 million gross loan portfolio, at December 31, 2014.  The largest relationship was for $7.7 million in loans to businesses with common ownership collateralized by commercial real estate.  The second largest relationship consists of a $7.5 million line of credit to a business collateralized by the borrower's real estate collateral pool and assignment of specific promissory notes and underlying deeds of trust.  There was $1.7 million outstanding on the line at December 31, 2014.  The total credit facility to this borrower is $15.0 million and there is another participating financial institution.  The next three largest lending relationships at December 31, 2014, were: $7.2 million in loans to businesses with common ownership collateralized by multifamily real estate; a $6.4 million loan collateralized by commercial real estate; and $5.2 million in loans to businesses with common ownership collateralized by multifamily real estate.  At December 31, 2014, we had five other lending relationships that exceeded $4.0 million.  All of the loans in these relationships were performing in accordance with their repayment terms as of December 31, 2014.

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. Over the past two years, the overwhelming majority of our one- to four-family loan originations were fixed rate.

Most of our loans are underwritten using secondary market generally-accepted underwriting guidelines, and are readily saleable to Fannie Mae or other private investors.  A portion of the one- to four-family loans we originate are retained in our portfolio while the majority are sold into the secondary market to Fannie Mae, with servicing retained for continued customer contact, relationship building and to increase noninterest income.  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 them in portfolio.  We are currently selling all our conforming fixed-rate loans, on a servicing retained basis.   Our pricing strategy for mortgage loans includes establishing interest rates that are competitive with other local financial institutions and consistent with our internal asset and liability management objectives.  During the year ended December 31, 2014, we originated $81.1 million of one- to four-family fixed-rate mortgage loans and $1.2 million one- to four-family adjustable rate mortgage ("ARM") loans.  See "- Loan Originations, Purchases, Sales, Repayments and Servicing."  At December 31, 2014, one- to four-family residential mortgage loans (excluding loans held-for-sale) totaled $133.0 million, or 30.8%, of our gross loan portfolio, of which $118.1 million were fixed-rate loans and $14.9 million were ARM loans, compared to $117.7 million (excluding loans held-for-sale), or 30.0% of our gross loan portfolio as of December 31, 2013, of which $103.8 million were fixed-rate loans and $13.5 million were ARM loans.

Substantially all of the one- to four-family residential mortgage loans we retain in our portfolio consist of loans that are "non-conforming" because they do not satisfy acreage limits, income, credit, conforming loan limits (i.e., jumbo mortgages) or various other requirements imposed by Fannie Mae.  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., divorce, 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 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 generally require private mortgage insurance in order to reduce our exposure to 80% or we charge a higher interest rate.  Properties securing our one- to four-family loans are generally appraised by independent fee appraisers who are selected in accordance with criteria approved by the Board of Directors.  For loans that are less than $250,000, we may use an automated valuation model developed by Freddie Mac, called the Home Value Estimator, in lieu of an appraisal.  We typically 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 size of our one- to four-family residential loans was approximately $252,000 at December 31, 2014.

Fixed-rate loans secured by one- to four-family residences have contractual maturities of up to 30 years; however, at December 31, 2014 we had $1.9 million of one- to four-family loans with an original contractual maturity of 40 years which were originated prior to 2009.  All of these loans are fully amortizing, with payments due monthly.  Our portfolio of fixed-rate loans also includes $17.2 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 criterion.  In addition, we had $23.7 million of one- to four- family loans with a five-year call option at December 31, 2014.  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.
8


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 rate on one-year Treasury Bills to re-price our ARM loans, however, $5.2 million of our ARM loans are to employees that re-price annually based on a margin of 1% 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, yields on ARM loans may not be sufficient to offset increases in our cost of funds.
ARM loans generally pose different credit risks than fixed-rate loans, primarily because as interest rates rise, the borrower's payment rises, which increases the potential for default.  The majority of these loans have been originated within the past several years, when rates were historically low.  We continued to expand our fully amortizing ARM loans, by offering 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 market environment, however, the production of ARM loans has been substantially reduced because borrowers favor fixed rate mortgages.
Home Equity Lending.  We originate home equity loans that consist of fixed-rate loans and variable-rate lines of credit.  We originate home equity loans in amounts of up to 80% of the value of 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 plus a marginHome equity lines of credit generally have up to a twelve-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 a twelve-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 drawn amount during the draw period.  At December 31, 2014, home equity loans totaled $34.7 million, or 8.0% of our gross loan portfolio compared to $35.2 million, or 9.0% of our gross loan portfolio at December 31, 2013.  Variable-rate home equity lines of credit at December 31, 2014 totaled $22.7 million, or 5.3% of our gross loan portfolio, compared to $21.6 million, or 5.5% of our gross loan portfolio as of December 31, 2013.  At December 31, 2014, unfunded commitments on home equity lines of credit totaled $10.3 million.
Our fixed-rate home equity loans are originated in amounts, together with the amount of the existing first mortgage, of up to 80% of the appraised value of the subject property.  These loans may have terms of up to 20 years and are fully amortizing.  At December 31, 2014, fixed-rate home equity loans totaled $12.0 million, or 2.8% of our gross loan portfolio, compared to $13.5 million, or 3.5% of our gross loan portfolio as of December 31, 2013.

Commercial and Multifamily Real Estate Lending.  We offer a variety of commercial and multifamily loans.  Most of these loans are secured by commercial income producing properties, including retail centers, multifamily apartment buildings, warehouses, and office buildings located in our market area.  At December 31, 2014, commercial and multifamily loans totaled $169.0 million, or 39.1% of our gross loan portfolio, compared to $157.5 million, or 40.2% of our gross loan portfolio as of December 31, 2013.
Loans secured by commercial and multifamily real estate are generally originated with a variable interest rate, fixed for a five to ten-year term and a 20- to 25-year amortization period.  At the end of the initial term, there is a balloon payment or the loan re-prices based on an independent index plus a margin of 1% to 4% for another five years.  Loan-to-value ratios on our commercial and multifamily 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 coverage ratio of approximately 1.20 for originated loans secured by income producing commercial properties.  If the borrower is other than an individual, we generally require the personal guaranty of the borrower. We also generally require an assignment of rents or leases 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 loans are performed by independent state certified licensed fee appraisers and approved by the Board Loan Committee.  In order to monitor the adequacy of cash flows on income-producing properties, the borrower is required to provide, at a minimum, annual financial information.  From time to time we also acquire participation interests in commercial and multifamily loans originated by other financial institutions secured by properties located in our market area.  On a case by case basis, we will consider loan participations where the collateral is located outside of our market area. At December 31, 2014, we held one commercial business loan participation totaling $1.2 million where the collateral is located outside of 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.  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 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 loans are not fully amortizing and contain large balloon payments upon 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.  Our largest single commercial and multifamily borrowing relationship at December 31, 2014, totaled $7.7 million and is collateralized by five commercial real estate notes.  At December 31, 2014, these loans were performing in accordance with their repayment terms.
9


The following table displays information on commercial and multifamily real estate loans by type at December 31, 2014 and 2013 (dollars in thousands):
 
 
2014
   
2013
 
 
 
Amount
   
Percent
   
Amount
   
Percent
 
Multifamily residential
 
$
48,799
     
28.88
%
 
$
53,042
     
33.67
%
Warehouses
   
23,648
     
14.00
     
22,113
     
14.04
 
Office buildings
   
8,792
     
5.20
     
9,756
     
6.19
 
Mobile Home Parks
   
4,734
     
2.80
     
6,865
     
4.36
 
Gas station / Convenience store
   
9,688
     
5.73
     
7,555
     
4.80
 
Other non-owner occupied commercial real estate
   
46,555
     
27.56
     
34,094
     
21.64
 
Other owner-occupied commercial real estate
   
26,736
     
15.83
     
24,091
     
15.29
 
Total
 
$
168,952
     
100.00
%
 
$
157,516
     
100.00
%

Construction and Land Lending.  We originate construction loans secured by single-family residences and commercial and multifamily real estate.  We also originate land and lot loans, which are secured by raw land or developed lots on which the borrower intends to build a residence, and land acquisition and development loans.  At December 31, 2014, our construction and land loans totaled $46.3 million, or 10.7% of our gross loan portfolio, compared to $44.3 million, or 11.3% of our gross loan portfolio at December 31, 2013.  At December 31, 2014, unfunded construction loan commitments totaled $37.3 million.

Construction loans to individuals and contractors for the construction and acquisition of personal residences totaled $6.5 million, or 14.1% of our construction and land portfolio at December 31, 2014.  We originate these loans whether or not the collateral property underlying the loan is under contract for sale.  At December 31, 2014, construction loans to contractors for homes that were considered speculative totaled $9.0 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, 2014 was as follows (in thousands):
 
 
Olympic Peninsula
   
Puget Sound
   
Other
   
Total
 
Commercial and multifamily construction
 
$
-
   
$
19,935
   
$
-
   
$
19,935
 
Residential construction
   
248
     
6,637
     
-
     
6,885
 
Land and lot loans
   
2,942
     
4,558
     
2,418
     
9,918
 
Speculative residential construction
   
-
     
9,054
     
-
     
9,054
 
Commercial land developments
   
487
     
-
     
-
     
487
 
Total
 
$
3,677
   
$
40,184
   
$
2,418
   
$
46,279
 

Our residential construction loans generally provide for the payment of interest only during the construction phase, which is typically up to nine months.  At the end of the construction phase, the construction loan generally either converts to a longer term mortgage loan or is paid off through 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 securing adequate private mortgage insurance or other form of credit enhancement to mitigate the higher loan to value.

At December 31, 2014, our largest residential construction loan commitment was for $2.2 million, all of which had been disbursed.  This loan was performing according to its repayment terms.  The average outstanding residential construction loan balance was approximately $653,000 at December 31, 2014.  Before making a commitment to fund a residential construction loan, we require an appraisal of the subject property by an independent licensed 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.  Typically, disbursements are made in monthly draws during the construction period. 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 (as applicable, for properties located or to be built in a designated flood hazard area) on all construction loans.

We also originate developed lot and land loans to individuals intending to construct in the future a residence 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. At December 31, 2014, lot and land loans totaled $10.4 million, or 22.5% of our construction and land portfolio.

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 do not require any cash equity from the borrower if there is sufficient equity in the land being used as collateral.  Development plans are required from developers prior to making the loan.  Our loan officers are required to personally 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 three or five- year Seattle Federal Home Loan Bank ("FHLB") Rate 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 inspection by our approved inspectors warrant.  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, 2014, we had a single $487,000 land acquisition and development loan secured by 9.1 acres of undeveloped land zoned for residential lot development.  At December 31, 2014, this loan was performing in accordance with its repayment terms.
10


We also offer commercial and multifamily construction loans.  These loans are underwritten with terms similar to our permanent commercial real estate loans with special construction financing for up to 18 months under terms similar to our residential construction loans.  At December 31, 2014, commercial and multifamily construction loans totaled $19.9 million, or 43.1% of our construction and land portfolio.
Construction and land financing is generally considered to involve a higher degree of credit risk than long-term financing on improved, owner-occupied real estate.  Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the value of the property at completion of construction compared to the estimated cost (including interest) of construction and other assumptions.  If the estimate of construction costs is inaccurate, we may be required to advance funds beyond the amount originally committed in order to protect the value of the property and may have to hold the property for an indeterminate period of time.  Additionally, if the estimate of value is inaccurate, we may be confronted with a project that, when completed, has a value that is insufficient to generate full payment.  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.  The value of the lots securing our loans may be affected by the success of the development in which they are located.  As a result, construction loans and land loans often involve the disbursement of funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property or refinance the indebtedness, rather than the ability of the borrower or guarantor to repay principal and interest.  The nature of these loans is also such that they are generally more difficult to monitor.  In addition, speculative construction loans to a builder are often associated with homes that are not pre-sold, and thus pose a greater potential risk than construction loans to individuals on their personal residences.
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 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, 2014, our consumer loans totaled $29.4 million, or 6.4% of our gross loan portfolio, compared to $23.8 million, or 6.1% of our gross loan portfolio at December 31, 2013.
We 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, 2014 was 8.1%, compared to 4.6% for one- to four-family mortgages, excluding loans held-for-sale.  At December 31, 2014, these loans totaled $12.5 million, or 42.6% of our consumer loans and 2.9% of our gross loan portfolio.  For used manufactured homes, loans are generally made for 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 for up to 80% 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 additional 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 have a higher probability of default, higher delinquency rates and greater servicing and collateral recovery costs 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 methodology.  We attempt to work out delinquent loans with the borrower and, if that is not successful, any repossessed manufactured homes are repossessed and sold.  At December 31, 2014, there were five nonperforming manufactured home loan totaling $195,000 and we held three manufactured homes valued at $54,000 in our other real estate owned ("OREO") and repossessed assets portfolio.
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 80% of the lesser of the appraised value or purchase price.  At December 31, 2014, floating home loans totaled $11.7 million, or 39.7% of our consumer loan portfolio and 2.7% of our gross 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, 2014, totaled $5.2 million or 17.7% of our consumer loan portfolio and 3.9% of our gross loan portfolio.  Our automobile loan portfolio totaled $545,000 at December 31, 2014, or 1.9% of our consumer loan portfolio and 0.1% of our gross 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 auto loans, including tax, licenses, title and mechanical breakdown and gap insurance.

Loans secured by boats, motorcycles and recreational vehicles typically have terms from five to twenty 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, 2014, unsecured consumer loans totaled $1.5 million and unfunded commitments on our unsecured consumer lines of credit totaled $1.5 million.  At that date, the average outstanding balance on these lines was less than $1,000.

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 customer base by increasing the number of customer relationships and providing cross-marketing opportunities.
11


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.
Commercial Business Lending.  At December 31, 2014, commercial business loans totaled $19.5 million, or 4.5% of our gross loan portfolio, compared to $13.7 million, or 3.5% of our gross loan portfolio at December 31, 2013.  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.  Approximately $2.1 million of our commercial business loans at December 31, 2014 were unsecured.  Our commercial business lending policy includes credit file documentation and 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 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 made 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.  Most often, this collateral is 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 used.  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).
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 customer demand for loans in our market area.  Over the past few years, we have continued to originate residential and consumer loans, and increased our emphasis on commercial and multifamily, 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 low interest rate environment prevailing 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.  As a result, from time to time we will purchase whole loans or enter into loan participations with other financial institutions.  In 2014, 2013 and 2012, we engaged in commercial loan participations with other financial institutions in the amount of $11.3 million, $8.4 million and $4.5 million, respectively and purchased no whole loans during these years.  We underwrite loan purchases and participations to the same standards as an internally-originated loan.
We do not actively engage in originating "alt A" loans, option adjustable rate or subprime loans and have no established program to originate or purchase these loans.  We do offer interest-only one- to four- family loans to well-qualified borrowers and at December 31, 2014, we held $10.3 million of such loans in our loan portfolio, representing 2.4% of our gross loan portfolio.  Subprime loans are defined by regulators as loans that at the time of loan origination had a FICO credit score of less than 660.  Of the $82.3 million in one- to four- family loans originated in 2014, only $2.4 million, or 2.9%, were to borrowers with a credit score under 660.  We obtain updated FICO scores on all of our borrowers periodically and based on the most recently updated score, $21.1 million, or 4.9% of our gross loan portfolio would be deemed subprime at December 31, 2014.  Based on the FICO score as of December 31, 2014, our subprime portfolio, included approximately $13.1 million in one- to four-family mortgage loans, $4.8 million in home equity loans, $2.0 million in manufactured home loans, $622,000 in construction and land loans, and $252.000 in other consumer 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, subject to a provision for repurchase upon breach of representation, warranty or covenant.  These loans are fixed-rate mortgages, which primarily are sold to improve our interest rate risk.  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 sold by us are sold with servicing retained.  Three loans were repurchased from Fannie Mae totaling $453,000 in 2014 and two were repurchased from Fannie Mae totaling $431,000 in 2013.  We earned mortgage servicing income of $509,000, $457,000 and $550,000, respectively, for the years ended December 31, 2014, 2013 and 2012.  In November 2009, we acquired a $340.1 million loan servicing portfolio from Leader Financial Services.  These loans are 100% owned by Fannie Mae and are subserviced under an agreement with a third party loan servicer who performs all servicing including payment processing, reporting and collections.  At December 31, 2014, we were servicing a $357.8 million portfolio of residential mortgage loans for Fannie Mae.
12


These mortgage servicing rights are carried at fair value and had a value at December 31, 2014 of $3.0 million.  See Note 6 to the Consolidated Financial Statements.
Sales of whole real estate loans can be beneficial to us since these sales generally 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 $50.5 million, $104.3 million and $95.1 million of one- to four- family loans during the years ended December 31, 2014, 2013 and 2012, 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 all of 2014, 2013 and 2012 was $624,000, $967,000 and $2.1 million, respectively.  If a proposed loan exceeds our internal lending limits, we may originate the loan on a participation basis with another financial institution.  We also from time to time participate with other financial institutions on loans they originate.
The following table shows our loan origination, sale and repayment activities, including loans held-for-sale, for the periods indicated (in thousands):
 
For the year ended December 31,
 
Originations by type:
 
2014
   
2013
   
2012
 
Fixed-rate:
           
One- to four-family
 
$
81,130
   
$
118,217
   
$
143,189
 
Home equity
   
2,812
     
8,450
     
4,130
 
Commercial and multifamily
   
25,342
     
35,468
     
50,202
 
Construction and land
   
48,490
     
55,591
     
24,417
 
Manufactured homes
   
2,068
     
1,198
     
1,305
 
Other consumer
   
9,652
     
3,804
     
1,961
 
Commercial business
   
5,146
     
8,530
     
5,866
 
Total fixed-rate
   
174,640
     
231,258
     
231,070
 
Adjustable rate:
                       
One- to four-family
   
1,199
     
552
     
-
 
Home equity
   
3,550
     
294
     
-
 
Commercial and multifamily
   
25,789
     
14,524
     
22,821
 
Construction and land
   
8,228
     
1,478
     
2,280
 
Other consumer
   
264
     
280
     
24
 
Commercial business
   
4,193
     
5,226
     
1,979
 
Total adjustable-rate
   
43,223
     
22,354
     
27,104
 
Total loans originated
   
217,863
     
253,612
     
258,174
 
Purchases by type:
                       
Commercial and multifamily participations
   
-
     
983
     
-
 
Commercial business participations
   
166
     
4,325
     
4,500
 
Total loan participations purchased
   
166
     
5,308
     
4,500
 
Sales, repayments and participations sold:
                       
One- to four-family
   
52,696
     
108,870
     
95,055
 
Commercial and multifamily
   
5,445
     
2,676
     
-
 
Total loans sold and loan participations
   
58,141
     
111,546
     
95,055
 
Total principal repayments
   
119,774
     
79,479
     
140,764
 
Total reductions
   
177,915
     
191,025
     
235,819
 
Net increase
 
$
40,114
   
$
62,587
   
$
26,855
 

The decrease in originations in 2014 compared to 2013 and 2012 was due to a modest increase in interest rates in 2014 compared to 2013 and 2012 which reduced demand for refinancing.  One- to four- family home purchases continued to be strong in our market area due to the economic environment and the rate of unemployment in our markets although it has somewhat been hampered due to the lack of overall supply, especially in the Seattle area.  Demand for multi-family and construction loans continued to be strong in our markets due to demand for new homes and apartments.

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, and the borrower is contacted by phone within 30 days after the due date.  Generally, a delinquency letter is mailed to the borrower.  All delinquent accounts are reviewed by a loan officer or branch manager who attempts to cure the delinquency by contacting the borrower once the loan is 30 days past due.  If the account becomes 60 days delinquent and an acceptable repayment plan has not been agreed upon, we generally refer the account to legal counsel with instructions to prepare a notice of intent to foreclose.  The notice of intent to foreclose allows the borrower up to 30 days to bring the account current.  If foreclosed, typically we take title to the property and sell it directly through a real estate broker.
13


Delinquent consumer loans, as well as delinquent home equity loans and lines of credit, are handled in a similar manner to one-to four-family loans, except that appropriate action may be taken to collect any loan payment that is delinquent for more than 15 days.  Once the loan is 90 days past due, it is classified as nonaccrual.  Generally, credits are charged-off at 120 days past due, unless the Loss Mitigation Department provides support for continuing its collection efforts.  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.
Delinquent loans are initially handled by the loan officer in charge of the loan, who is responsible for contacting the borrower.  The Loss Mitigation Department also works with the loan officers to see that the necessary steps are taken to collect delinquent loans.  In addition, management meets with all of the loan officers weekly and reviews past due and classified loans, as well as other loans that management feels may present possible collection problems, which are reported to the board on a quarterly basis.  If an acceptable workout of a delinquent loan cannot be agreed upon, we generally initiate foreclosure or repossession proceedings on any collateral securing the loan.
Delinquent Loans.  The following table sets forth our loan delinquencies by type, by amount and by percentage of type at December 31, 2014 (dollars in thousands):
 
 
Loans Delinquent For:
   
 
 
 
60-89 Days
   
90 Days and Over
   
90+ Days and accruing
   
Total Delinquent Loans
 
 
 
Number
   
Amount
   
Percent of Loan Category
   
Number
   
Amount
   
Percent of Loan Category
   
Number
   
Amount
   
Percent of Loan Category
   
Number
   
Amount
   
Percent of Loan Category
 
One- to four- family
   
3
   
$
167
     
0.13
%
   
11
   
$
720
     
0.54
%
   
-
   
$
-
     
-
     
14
   
$
887
     
0.67
%
Home equity
   
1
     
109
     
0.31
     
5
     
203
     
0.59
     
-
     
-
     
-
     
6
     
312
     
0.90
 
Construction and land
   
-
     
-
     
-
     
1
     
81
     
0.18
     
-
     
-
     
-
     
1
     
81
     
0.18
 
Manufactured homes
   
3
     
42
     
0.33
     
1
     
27
     
0.22
     
1
     
114
     
0.91
     
5
     
183
     
1.24
 
Other consumer
   
4
     
7
     
0.04
     
-
     
-
     
-
     
-
             
-
     
4
     
7
     
0.20
 
Total
   
11
   
$
325
     
0.08
%
   
18
   
$
1,031
     
0.24
%
   
1
   
$
114
     
0.03
%
   
30
   
$
1,470
     
0.34
%

14


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.  OREO and repossessed assets include assets acquired in settlement of loans.  We had one accruing loan 90 days or more delinquent for the 2014 period reported totaling $114,000.
 
December 31,
 
 
2014
   
2013
   
2012
   
2011
   
2010
 
Nonperforming loans(1):
   
One- to four- family
 
$
1,512
   
$
772
   
$
1,143
   
$
4,401
   
$
2,729
 
Home equity
   
386
     
222
     
717
     
873
     
517
 
Commercial and multifamily
   
1,639
     
820
     
1,347
     
1,219
     
-
 
Construction and land
   
81
     
-
     
471
     
80
     
-
 
Manufactured homes
   
195
     
106
     
29
                 
Other consumer
   
29
     
1
     
8
     
64
     
-
 
Commercial business
   
-
     
-
     
197
     
-
     
-
 
Total nonperforming loans
 
$
3,842
   
$
1,921
     
3,912
     
6,637
     
3,246
 
OREO and repossessed assets:
                                       
One- to four-family
 
$
269
   
$
1,086
   
$
1,318
   
$
478
   
$
1,102
 
Commercial and multifamily
   
-
     
-
     
1,073
     
2,225
     
1,302
 
Construction and land
   
-
     
-
     
-
     
-
     
70
 
Manufactured homes
   
54
     
92
     
112
     
118
         
Other consumer
   
-
     
-
     
-
     
-
     
151
 
Total OREO and repossessed assets
   
323
     
1,178
     
2,503
     
2,821
     
2,625
 
Total nonperforming assets
 
$
4,165
   
$
3,099
   
$
6,415
   
$
9,458
   
$
5,871
 
Nonperforming assets as a percentage of total assets
   
0.84
%
   
0.70
%
   
1.68
%
   
2.78
%
   
1.75
%
Performing restructured loans:
                                       
One- to four- family
 
$
2,619
   
$
3,195
   
$
3,198
   
$
2,508
   
$
2,836
 
Home equity
   
679
     
704
     
356
     
812
     
967
 
Commercial and multifamily
   
1,317
     
761
     
776
     
785
     
-
 
Construction and land
   
99
     
106
     
100
     
-
     
230
 
Manufactured homes
   
279
     
496
     
602
     
-
     
-
 
Other consumer
   
1
     
9
     
19
     
4
     
15
 
Commercial business
   
123
     
133
     
564
     
26
     
-
 
Total performing restructured loans
 
$
5,117
   
$
5,404
   
$
5,615
   
$
4,135
   
$
4,048
 
_________________________________
(1) Nonperforming loans include $2.5 million, $1.0 million, $828,000, $2.8 million and $348,000 in nonperforming troubled debt restructurings as of December 31, 2014, 2013, 2012, 2011 and 2010, respectively.

Nonperforming commercial and multifamily estate loans increased $819,000 to $1.6 million at December 31, 2014 from $820,000 at December 31, 2013 and is primarily comprised of a $1.5 million commercial real estate loan which was restructured during the third quarter of 2014, and as of December 31, 2014, was performing as agreed under the new loan repayment terms. Nonperforming one- to four- family loans increased $740,000 to $1.5 million at December 31, 2014 from $772,000 at December 31, 2013 due primarily to a $1.2 million increase in nonperforming one- to four- family TDRs.  Our largest nonperforming loan at December 31, 2014 was the commercial real estate loan discussed above totaling $1.5 million.  The balance in nonperforming one- to four- family loans at December 31, 2014 consisted of 12 loans to different borrowers with an average loan balance of $126,000. The balance in nonperforming one- to four- family loans at December 31, 2013 consisted of eight loans to different borrowers with an average loan balance of $96,000.


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For the year ended December 31, 2014, gross interest income that would have been recorded had the nonaccrual loans been current in accordance with their original terms amounted to $78,000, all of which was excluded from interest income for the year ended December 31, 2014.  See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition at December 31, 2014 Compared to December 31, 2013 -- Delinquencies and Nonperforming Assets" for more information on troubled assets.

Troubled Debt Restructured Loans.  Troubled debt restructurings ("TDRs), which are accounted for under Accounting Codification Standard ("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.  Once a troubled debt restructuring has performed according to its modified terms for six months and the collection of principal and interest under the revised terms is deemed probable, we remove the TDR from nonperforming status.  At December 31, 2014, we had $5.1 million of loans that were classified as performing TDRs and still on accrual.  Included in nonperforming loans at December 31, 2014 and 2013 were troubled debt restructured loans of $2.3 million and $1.0 million, respectively.

OREO and Repossessed Assets.  OREO and repossessed assets include assets acquired in settlement of loans.  At December 31, 2014 OREO and repossessed assets consisted of three single family residences totaling $269,000 and three manufactured homes totaling $54,000.

Other Loans of Concern.   In addition to the nonperforming assets set forth in the table above, as of December 31, 2014, there were 18 loans totaling $916,000 with respect to which known information about the possible credit problems of the borrowers have 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 majority of these loans have been considered individually in management's determination of our allowance for loan losses.  The largest loans of concern at December 31, 2014, were a $187,000 loan secured by residential property in Snohomish County, Washington and a $163,000 loan secured by residential property in King County, Washington.  Other loans of concern included $515,000 in residential first mortgages, $296,000 in home equity loans, $47,000 in manufactured home loans, $33,000 in construction and land loans, and $25,000 in other consumer loans.  Loans of concern had specific loan loss reserves of $3,000 at December 31, 2014.

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, 2014, special mention assets, consisting solely of one loan, totaled $24,000.

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, 2014, we had classified $6.1 million of our assets as substandard, of which $3.4 million represented a variety of outstanding loans, $2.3 million represented non-agency mortgage backed securities, and the remaining balance OREO and repossessed assets.  At that date, we had no assets classified as doubtful or loss.  This total amount of classified assets represented 12.0% of our equity capital and 1.2% of our assets at December 31, 2014.  Classified assets totaled $7.2 million, or 15.5% of our equity capital and 1.6% of our assets at December 31, 2013.

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 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, home equity and consumer loans, 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 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, 2014, our allowance for loan losses was $4.4 million, or 1.02% of our gross loan portfolio, compared to $4.2 million, or 1.1% of our gross loan portfolio in 2013.  Specific valuation reserves totaled $367,000 and $709,000 at December 31, 2014 and 2013, respectively.
16


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 in our loan portfolio.  See Notes 1 and 5 of the Notes to Consolidated Financial Statements.  The following table sets forth an analysis of our allowance for loan losses at the dates indicated (dollars in thousands):
 
December 31,
 
 
2014
   
2013
   
2012
   
2011
   
2010
 
Balance at beginning of period
 
$
4,177
   
$
4,248
   
$
4,455
   
$
4,436
   
$
3,468
 
Charge-offs:
                                       
One-to four-family
   
127
     
560
     
2,740
     
834
     
843
 
Home equity
   
295
     
593
     
1,084
     
1,652
     
1,291
 
Commercial and multifamily
   
47
     
194
     
503
     
1,353
     
940
 
Construction and land
           
7
     
222
     
159
     
-
 
Manufactured homes
   
197
     
143
     
152
     
239
     
-
 
Other consumer
   
77
     
41
     
286
     
255
     
649
 
Commercial business
   
-
     
46
     
44
     
310
     
221
 
Total charge-offs
   
743
     
1,584
     
5,031
     
4,802
     
3,944
 
Recoveries:
                                       
One-to four-family
   
64
     
-
     
4
     
11
     
-
 
Home equity
   
52
     
19
     
158
     
10
     
222
 
Commercial and multifamily
   
2
     
32
     
83
     
96
     
-
 
Construction and land
   
-
     
-
     
-
     
-
     
-
 
Manufactured homes
   
14
     
3
     
11
     
8
     
-
 
Other consumer
   
21
     
31
     
33
     
53
     
38
 
Commercial business
   
-
     
78
     
10
     
43
     
2
 
Total recoveries
   
153
     
163
     
299
     
221
     
262
 
Net charge-offs
   
590
     
1,421
     
4,732
     
4,581
     
3,682
 
Additions charged to operations
   
800
     
1,350
     
4,525
     
4,600
     
4,650
 
Balance at end of period
 
$
4,387
   
$
4,177
   
$
4,248
   
$
4,455
   
$
4,436
 
Net charge-offs during the period as a percentage of average loans outstanding during the period
   
0.14
%
   
0.40
%
   
1.55
%
   
1.53
%
   
1.22
%
Net charge-offs during the period as a percentage of average nonperforming assets
   
18.65
%
   
41.16
%
   
35.15
%
   
48.04
%
   
31.22
%
Allowance as a percentage of nonperforming loans
   
114.19
%
   
217.44
%
   
110.88
%
   
67.12
%
   
136.66
%
Allowance as a percentage of total loans (end of period)
   
1.02
%
   
1.07
%
   
1.30
%
   
1.47
%
   
1.48
%

Weak economic conditions and strains in the financial and housing markets which began in 2008, generally started to improve in 2012 in most major regions of the United States, and have steadily continued to improve, including in our market areas. While the effects during this period presented an unusually challenging environment for banks and their holding companies, including us, during 2013 and 2014 housing prices and unemployment rates generally started improving. Prior to 2012, our  market area had experienced substantial home price declines, historically low levels of existing home sale activity, high levels of foreclosures and above average unemployment rates negatively affecting  the values of real estate collateral supporting our loans and resulting in increased loan delinquencies and defaults and net charge-offs during these periods.

The decrease in our allowance for loan losses as a percentage of nonperforming loans ratio was a result of an increase in nonperforming loans during the period.  The allowance for loan losses as a percentage of total loans ratio was 1.02% and 1.07% as of December 31, 2014 and 2013, respectively.

17

The distribution of our allowance for losses on loans at the dates indicated is summarized as follows (dollars in thousands):
 
December 31,
 
 
2014
   
2013
   
2012
   
2011
   
2010
 
 
Amount
   
Percent
of loans
in each
category
to total
loans
   
Amount
   
Percent
of loans
in each
category
to total
loans
   
Amount
   
Percent
of loans
in each
category
to total
loans
   
Amount
   
Percent
of loans
in each
category
to total
loans
   
Amount
   
Percent
of loans
in each
category
to total
loans
 
Allocated at end of period to:
                                       
One- to four- family
 
$
1,442
     
30.80
%
 
$
1,915
     
30.02
%
 
$
1,417
     
28.71
%
 
$
1,117
     
31.45
%
 
$
909
     
32.81
%
Home equity
   
601
     
8.03
     
781
     
8.96
     
997
     
10.80
     
1,426
     
13.20
     
1,380
     
14.96
 
Commercial and multifamily
   
1,244
     
39.12
     
300
     
40.17
     
492
     
40.79
     
969
     
35.28
     
659
     
31.05
 
Construction and land
   
399
     
10.72
     
318
     
11.30
     
217
     
7.77
     
105
     
5.93
     
205
     
5.56
 
Manufactured homes
   
193
     
2.90
     
209
     
3.44
     
260
     
4.96
     
290
     
6.14
     
321
     
6.69
 
Other consumer
   
167
     
3.91
     
109
     
2.62
     
146
     
2.64
     
213
     
3.63
     
381
     
4.04
 
Commercial business
   
108
     
4.52
     
102
     
3.49
     
218
     
4.33
     
254
     
4.38
     
163
     
4.90
 
Unallocated
   
233
     
-
     
443
     
-
     
501
     
-
     
81
     
-
     
418
     
-
 
Total
 
$
4,387
     
100.00
%
 
$
4,177
     
100.00
%
 
$
4,248
     
100.00
%
 
$
4,455
     
100.00
%
 
$
4,436
     
100.00
%
18

Investment Activities
State 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 banks and savings institutions, 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 will be 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 will emphasize safer investments with the yield on those investments secondary to not taking unnecessary risk with the available funds.  See "Management's Discussion and Analysis of Financial Condition and Results of Operations – Asset/Liability Management."
At December 31, 2014, we owned $2.2 million in Federal Home Loan Bank of Seattle stock.  As a condition of membership at the FHLB, we are required to purchase and hold a certain amount of FHLB stock.
Our stock purchase requirement is based, in part, upon the outstanding principal balance of advances from the FHLB and is calculated in accordance with the Capital Plan of the FHLB of Seattle.  Our FHLB stock has a par value of $100, is carried at cost, and is subject to recoverability testing.  Management periodically evaluates FHLB stock for other-than-temporary or permanent impairment.  Management's determination of whether these investments are impaired is based on its assessment of the ultimate recoverability of cost rather than be recognizing temporary declines in value.  The determination of whether a decline affects the ultimate recoverability of cost is influenced by criteria such as the significance of any decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted, commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, the impact of legislative and regulatory changes on financial institutions (i.e. the customer base of the FHLB, and the liquidity position of the FHLB.  As of December 31, 2014, our management determined that our FHLB stock was not impaired.  On September 25, 2014 the FHLB of Seattle and the FHLB of Des Moines announced a proposed merger.  Under this proposal, Sound Community Bank would become a member of the FHLB of Des Moines and all shares of our FHLB of Seattle stock would convert to equal shares of FHLB of Des Monies stock.  If the merger is terminated by either the FHLB of Des Moines or the FHLB of Seattle, the terminating FHLB must pay $57 million in termination fees.  If the FHLB of Seattle were to terminate the agreement, this could result in significant impairment to our investment in the FHLB of Seattle, potentially decreasing our earnings and shareholders' equity.

The following table sets forth the composition of our securities portfolio and other investments at the dates indicated.  At December 31, 2014, our securities portfolio did not contain securities of any issuer with an aggregate book value in excess of 10% of our equity capital.

 
December 31,
 
 
2014
   
2013
   
2012
 
Securities available for sale
 
Amortized
Cost
   
Fair
Value
   
Amortized
Cost
   
Fair
Value
   
Amortized
Cost
   
Fair
Value
 
Municipal bonds
 
$
1,911
   
$
2,083
   
$
1,911
   
$
1,931
   
$
-
   
$
-
 
Agency mortgage-backed securities
   
7,024
     
7,096
     
11,228
     
11,071
     
20,378
     
20,127
 
Non-agency mortgage-backed securities(1)
   
2,312
     
2,345
     
2,689
     
2,419
     
3,273
     
2,773
 
Total available for sale securities
   
11,247
     
11,524
     
15,828
     
15,421
     
23,651
     
22,900
 
FHLB stock
   
2,224
     
2,224
     
2,314
     
2,314
     
2,401
     
2,401
 
     Total securities
 
$
13,471
   
$
13,748
   
$
18,142
   
$
17,735
   
$
26,052
   
$
25,301
 
________________________
(1) One non-agency mortgage backed securities had an unrealized loss of $50,000 as of December 31, 2014.  All of the non-agency securities were purchased at a discount in 2008 and 2009.  Each of these securities has performed and paid principal and interest each month as contractually committed.
The composition and maturities of our investment securities portfolio at December 31, 2014, excluding FHLB stock, are as follows:  Municipal bonds with an amortized cost of $1.9 million and a fair value of $2.1 million and a final maturity in five to ten years, federal agency mortgage-backed securities with an amortized cost of $7.0 million and a fair value of $7.1 million and a final maturity greater than ten years and non-agency mortgage-backed securities with an amortized cost of $2.3 million and a fair value of $2.3 million and a final maturity greater than ten years.
19


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, 2014, we recognized no non-cash OTTI charges on our non-agency mortgage-backed securities.  One non-agency mortgage-backed security had an unrealized loss but 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 the 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.  Accordingly, if market conditions deteriorate further and we determine our holdings of these or other investment securities are OTTI, our future earnings, shareholders' 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 having a wide range of interest rates and terms.  Our deposits consist of savings accounts, money market deposit accounts, demand accounts and certificates of deposit.  We solicit deposits primarily in our market area; however, at December 31, 2014, approximately 3.4% of our deposits were from persons outside the State of Washington.  As of December 31, 2014, core deposits, which we define as our non-time deposit accounts and time deposit accounts less than $250,000, represented approximately 86.9% of total deposits, compared to 87.0% and 86.5% as of December 31, 2013 and December 31, 2012, respectively.  We primarily rely on competitive pricing policies, marketing and customer service to attract and retain these deposits and we expect to continue these practices in the future.
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 have become more susceptible to short-term fluctuations in deposit flows as customers have become more interest rate sensitive.  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 has been 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):
 
For the year ended December 31,
 
 
2014
   
2013
   
2012
 
Opening balance
 
$
348,339
   
$
312,083
   
$
299,997
 
Net deposits
   
57,201
     
34,160
     
9,951
 
Interest credited
   
2,269
     
2,096
     
2,135
 
Ending balance
 
$
407,809
   
$
348,339
   
$
312,083
 
Net increase
 
$
59,470
   
$
36,256
   
$
12,086
 
Percent increase
   
17.1
%
   
11.6
%
   
4.0
%

20

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):
 
   
December 31,
 
   
2014
   
2013
   
2012
 
   
Amount
   
Percent
of total
   
Amount
   
Percent
of total
   
Amount
   
Percent
of total
 
Noninterest-bearing demand
   
$
41,773
     
10.24
%
 
$
31,877
     
9.15
%
 
$
31,427
     
10.07
%
Interest-bearing demand
     
103,048
     
25.27
     
70,639
     
20.28
     
28,540
     
9.15
 
Savings
     
33,233
     
8.15
     
26,509
     
7.61
     
27,174
     
8.71
 
Money market
     
55,236
     
13.54
     
59,069
     
16.96
     
86,149
     
27.60
 
Escrow
     
2,580
     
0.63
     
2,717
     
0.78
     
3,807
     
1.22
 
    Total non-maturity deposits
     
235,870
     
57.83
     
190,811
     
54.78
     
177,097
     
56.75
 
Certificates of deposit:
                                                 
      1.99% or below
     
156,690
     
38.43
     
140,139
     
40.23
     
114,165
     
36.58
 
 
2.00 - 3.99
 
   
15,217
     
3.73
     
17,300
     
4.97
     
17,522
     
5.61
 
 
4.00 - 5.99
 
   
32
     
0.01
     
89
     
0.02
     
3,299
     
1.06
 
    Total certificates of deposit
     
171,939
     
42.17
     
157,528
     
45.22
     
134,986
     
43.25
 
        Total deposits