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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2015
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

None
(Former name, former address and former fiscal year, if changed since last report)

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   YES ☒  NO ☐
 
Indicate by checkmark whether the registrant has submitted electronically 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 ☒   NO ☐
 
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,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer ☐
Accelerated filer ☐
Non-accelerated filer ☐
Smaller reporting company☒
   
(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 ☒
 
Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of the latest practicable date.
 
As of August 6, 2015, there were 2,465,730 shares of the registrant’s common stock outstanding.
 


SOUND FINANCIAL BANCORP, INC.
FORM 10-Q
TABLE OF CONTENTS

 
Page Number
PART I
FINANCIAL INFORMATION  
 
Item 1.
Financial Statements  
 
3
 
4
 
5
 
6
 
7
 
8
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
26
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
36
 
Item 4.
Controls and Procedures
36
 
PART II
OTHER INFORMATION
 
 
Item 1.
37
 
Item 1A
37
 
Item 2.
37
 
Item 3.
37
 
Item 4.
37
 
Item 5.
37
 
Item 6.
38
 
39
 
 
 
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Condensed Consolidated Balance Sheets (unaudited)
(In thousands, except share amounts)

   
June 30,
2015
   
December 31,
2014
 
ASSETS
       
Cash and cash equivalents
 
$
34,087
   
$
29,289
 
Available-for-sale securities, at fair value
   
7,901
     
11,524
 
Loans held for sale
   
3,061
     
810
 
Loans
   
434,597
     
430,360
 
Allowance for loan losses
   
(4,572
)
   
(4,387
)
Total Loans, net
   
430,025
     
425,973
 
Accrued interest receivable
   
1,494
     
1,497
 
Bank-owned life insurance (“BOLI”), net
   
11,576
     
11,408
 
Other real estate owned (“OREO”) and repossessed assets, net
   
382
     
323
 
Mortgage servicing rights, at fair value
   
3,271
     
3,028
 
Federal Home Loan Bank (“FHLB”) stock, at cost
   
1,645
     
2,224
 
Premises and equipment, net
   
5,739
     
5,555
 
Other assets
   
4,266
     
3,556
 
Total assets
 
$
503,447
   
$
495,187
 
LIABILITIES
               
Deposits
               
Interest-bearing
 
$
367,172
   
$
363,456
 
Noninterest-bearing demand
   
51,457
     
44,353
 
Total deposits
   
418,629
     
407,809
 
Borrowings
   
26,256
     
30,578
 
Accrued interest payable
   
79
     
76
 
Other liabilities
   
6,214
     
5,606
 
Advance payments from borrowers for taxes and insurance
   
481
     
474
 
Total liabilities
   
451,659
     
444,543
 
COMMITMENTS AND CONTINGENCIES (NOTE 7)
               
STOCKHOLDERS' EQUITY
               
Preferred stock, $0.01 par value, 1,000,000 shares authorized, none issued or outstanding
   
-
     
-
 
Common stock, $0.01 par value, 40,000,000 shares authorized, 2,465,730  and 2,524,645 shares issued and outstanding as of June 30, 2015 and December 31, 2014, respectively
   
25
     
25
 
Additional paid-in capital
   
22,515
     
23,552
 
Unearned shares - Employee Stock Ownership Plan (“ESOP”)
   
(1,140
)
   
(1,140
)
Retained earnings
   
30,202
     
28,024
 
Accumulated other comprehensive income, net of tax
   
186
     
183
 
Total stockholders’ equity
   
51,788
     
50,644
 
Total liabilities and stockholders’ equity
 
$
503,447
   
$
495,187
 

See notes to condensed consolidated financial statements
 
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Income (unaudited)
(In thousands, except per share amounts)

   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2015
   
2014
   
2015
   
2014
 
INTEREST INCOME
               
Loans, including fees
 
$
5,363
   
$
5,179
   
$
10,685
   
$
10,348
 
Interest and dividends on investments, cash and cash equivalents
   
47
     
61
     
102
     
95
 
Total interest income
   
5,410
     
5,240
     
10,787
     
10,443
 
INTEREST EXPENSE
                               
Deposits
   
661
     
552
     
1,322
     
1,112
 
Borrowings
   
19
     
44
     
47
     
94
 
Total interest expense
   
680
     
596
     
1,369
     
1,206
 
Net interest income
   
4,730
     
4,644
     
9,418
     
9,237
 
PROVISION FOR LOAN LOSSES
   
200
     
200
     
300
     
400
 
Net interest income after provision for loan losses
   
4,530
     
4,444
     
9,118
     
8,837
 
NONINTEREST INCOME
                               
Service charges and fee income
   
671
     
700
     
1,316
     
1,234
 
Earnings on cash surrender value of bank-owned life insurance
   
84
     
86
     
168
     
167
 
Mortgage servicing income
   
214
     
80
     
469
     
33
 
Fair value adjustment on mortgage servicing rights
   
347
     
144
     
169
     
284
 
Loss on sale of securities
   
-
     
-
     
(31
)
   
-
 
Net gain on sale of loans
   
390
     
110
     
786
     
187
 
Total noninterest income
   
1,706
     
1,120
     
2,877
     
1,905
 
NONINTEREST EXPENSE
                               
Salaries and benefits
   
2,205
     
1,958
     
4,460
     
4,025
 
Operations
   
1,053
     
1,009
     
1,957
     
1,901
 
Regulatory assessments
   
230
     
75
     
296
     
135
 
Occupancy
   
448
     
327
     
773
     
613
 
Data processing
   
454
     
328
     
856
     
672
 
Net loss on OREO and repossessed assets
   
10
     
78
     
82
     
161
 
Total noninterest expense
   
4,400
     
3,775
     
8,424
     
7,507
 
Income before provision for income taxes
   
1,836
     
1,789
     
3,571
     
3,235
 
Provision for income taxes
   
589
     
573
     
1,116
     
1,032
 
Net income
 
$
1,247
   
$
1,216
   
$
2,455
   
$
2,203
 
                                 
Earnings per common share:
                               
Basic
 
$
0.50
   
$
0.48
   
$
0.98
   
$
0.88
 
Diluted
 
$
0.48
   
$
0.47
   
$
0.94
   
$
0.85
 
Weighted average number of common shares outstanding:
                               
Basic
   
2,511
     
2,510
     
2,518
     
2,508
 
Diluted
   
2,602
     
2,601
     
2,603
     
2,602
 

See notes to condensed consolidated financial statements
 
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Comprehensive Income (unaudited)
(In thousands)

   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2015
   
2014
   
2015
   
2014
 
Net income
 
$
1,247
   
$
1,216
   
$
2,455
   
$
2,203
 
Available for sale securities:
                               
Unrealized gains (losses) arising during the period, net of tax provision (benefits) of ($9), $135, ($18) and $202, respectively
   
21
     
261
     
(70
)
   
392
 
Reclassification adjustments for the net losses realized in earnings, net of tax benefit of $0, $0, $35 and $0
   
-
     
-
     
73
     
-
 
Other comprehensive income, net of tax
   
21
     
261
     
3
     
392
 
Comprehensive income
 
$
1,268
   
$
1,477
   
$
2,458
   
$
2,595
 

See notes to condensed consolidated financial statements
 
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Stockholders’ Equity
For the Six Months Ended June 30, 2015 and 2014 (unaudited)
(Dollars in thousands, except per share amounts)

   
Shares
   
Common
Stock
   
Additional Paid-
in Capital
   
Unearned
ESOP Shares
   
Retained
Earnings
   
Accumulated
Other
Comprehensive
Income (Loss),
net of tax
   
Total
Stockholders’
Equity
 
Balances at December 31, 2013
   
2,510,810
   
$
25
   
$
23,829
   
$
(1,369
)
 
$
24,288
   
$
(269
)
 
$
46,504
 
Net income
                                   
2,203
             
2,203
 
Other comprehensive income, net of tax
                                           
392
     
392
 
Share-based compensation
                   
244
                             
244
 
Cash dividends on common stock ($0.05 per share)
                                   
(252
)
           
(252
)
Restricted stock awards issued
   
45,565
                                                 
Common stock repurchased
   
(53,340
)
           
(904
)
                           
(904
)
Exercise of options
   
12,885
                                                 
Balances at June 30, 2014
   
2,515,920
   
$
25
   
$
23,169
   
$
(1,369
)
 
$
26,239
   
$
123
   
$
48,187
 

   
Shares
   
Common
Stock
   
Additional Paid-
in Capital
   
Unearned
ESOP Shares
   
Retained
Earnings
   
Accumulated
Other
Comprehensive
Income (Loss),
net of tax
   
Total
Stockholders’
Equity
 
Balances at December 31, 2014
   
2,524,645
   
$
25
   
$
23,552
   
$
(1,140
)
 
$
28,024
   
$
183
   
$
50,644
 
Net income
                                   
2,455
             
2,455
 
Other comprehensive income, net of tax
                                           
3
     
3
 
Share-based compensation
                   
207
                             
207
 
Cash dividends paid in first quarter on common stock ($0.05 per share)
                                   
(125
)
           
(125
)
Cash dividends paid in second quarter on common stock ($0.06 per share)
                                   
(152
)
           
(152
)
Restricted stock awards issued
   
10,208
                                                 
Restricted stock forfeited and retired
   
(7,535
)
                                               
Common stock repurchased
   
(63,371
)
           
(1,261
)
                           
(1,261
)
                                                         
Exercise of options
   
1,783
             
17
                             
17
 
Balances at June 30, 2015
   
2,465,730
   
$
25
   
$
22,515
   
$
(1,140
)
 
$
30,202
   
$
186
   
$
51,788
 

See notes to condensed consolidated financial statements
 
 SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Cash Flows (unaudited)
(In thousands)
 
Six Months Ended June 30,
   
2015
   
2014
 
CASH FLOWS FROM OPERATING ACTIVITIES:
       
Net income
 
$
2,455
   
$
2,203
 
Adjustments to reconcile net income to net cash from operating activities:
               
Accretion of net discounts on investments
   
79
     
232
 
Loss on sale of securities
   
31
     
-
 
Provision for loan losses
   
300
     
400
 
Depreciation and amortization
   
295
     
246
 
Compensation expense related to stock options and restricted stock
   
207
     
244
 
Fair value adjustment on mortgage servicing rights
   
(169
)
   
(284
)
Additions to mortgage servicing rights
   
(436
)
   
(185
)
Amortization of mortgage servicing rights
   
362
     
460
 
Increase in cash surrender value of BOLI
   
(168
)
   
(167
)
Gain on sale of loans
   
(786
)
   
(187
)
Proceeds from sale of loans
   
44,610
     
18,992
 
Originations of loans held for sale
   
(46,075
)
   
(20,596
)
Net Loss on sale and write-downs of OREO and repossessed assets
   
22
     
52
 
Change in operating assets and liabilities:
               
Accrued interest receivable
   
3
     
(25
)
Other assets
   
(710
)
   
(383
)
Accrued interest payable
   
3
     
(11
)
Other liabilities
   
608
     
2,394
 
Net cash from (used by) operating activities
   
631
     
3,385
 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Proceeds from principal payments, maturities and sales of available for sale securities
   
3,516
     
1,701
 
FHLB stock redeemed
   
579
     
44
 
Net increase in loans
   
(4,833
)
   
(13,709
)
Improvements to OREO and other repossessed assets
   
-
     
(12
)
Proceeds from sale of OREO and other repossessed assets
   
400
     
1,130
 
Purchases of premises and equipment, net
   
(479
)
   
(114
)
Net cash used by investing activities
   
(817
)
   
(10,960
)
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Net increase in deposits
   
10,820
     
25,573
 
Proceeds from borrowings
   
36,000
     
88,500
 
Repayment of borrowings
   
(40,322
)
   
(91,822
)
Dividends paid on common stock
   
(277
)
   
(252
)
Net change in advances from borrowers for taxes and insurance
   
7
     
12
 
Proceeds from stock option exercises
   
17
     
-
 
Repurchase of common stock
   
(1,261
)
   
(904
)
Net cash from financing activities
   
4,984
     
21,107
 
Net decrease in cash and cash equivalents
   
4,798
     
13,532
 
Cash and cash equivalents, beginning of period
   
29,289
     
15,334
 
Cash and cash equivalents, end of period
   
34,087
   
$
28,866
 
SUPPLEMENTAL CASH FLOW INFORMATION:
               
Cash paid for income taxes
 
$
625
   
$
375
 
Interest paid on deposits and borrowings
 
$
1,366
   
$
1,217
 
Noncash net transfer from loans to OREO and repossessed assets
 
$
481
   
$
311
 

See notes to condensed consolidated financial statements
 
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)
 
Note 1 – Basis of Presentation

The accompanying financial information is unaudited and has been prepared from the consolidated financial statements of Sound Financial Bancorp, Inc., and its wholly owned subsidiary, Sound Community Bank.  References in this document to Sound Financial Bancorp 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” or the “Company” means Sound Financial Bancorp and its wholly-owned subsidiary, Sound Community Bank unless the context otherwise requires.

These unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission (“SEC”).  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the financial position and results of operations for the periods presented have been included.  Certain information and disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the rules and regulations of the SEC.  These unaudited financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, as filed with the SEC on March 31, 2015 (“2014 Form 10-K”).  The results for the interim periods are not necessarily indicative of results for a full year.  For further information, refer to the consolidated financial statements and footnotes for the year ended December 31, 2014, included in the 2014 Form 10-K.  Certain amounts in the prior quarters’ consolidated financial statements have been reclassified to conform to the current presentation.  These classifications do not have an impact on previously reported consolidated net income, retained earnings, stockholders’ equity or earnings per share.

Note 2 – Accounting Pronouncements Recently Issued or Adopted

In January 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) FASB issued ASU No.2015-1, Income Statement-Extraordinary and Unusual Items (Subtopic 225-20). The objective of this ASU is to simplify the income statement presentation requirements in Subtopic 225-20 by eliminating the concept of extraordinary items. Extraordinary items are events and transactions that are distinguished by their unusual nature and by the infrequency of their occurrence. Eliminating the extraordinary classification simplifies income statement presentation by altogether removing the concept of extraordinary items from consideration. This ASU is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015 with early adoption permitted. The adoption of ASU 2015-1 is not expected to have a material impact on the Company’s consolidated financial statements.
 
In February 2015, the FASB issued ASU No. 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis, which is intended to improve targeted areas of consolidation guidance for legal entities such as limited partnerships, limited liability corporations, and securitization structures (collateralized debt obligations, collateralized loan obligations, and mortgage-backed security transactions). The ASU focuses on simplifying the consolidation evaluation for reporting organizations that are required to evaluate whether they should consolidate certain legal entities by reducing the number of consolidation model from four to two, among other changes.  The ASU will be effective for periods beginning after December 31, 2015, while early adoption is permitted.  The Company does not expect this ASU to have a material impact on the Company's consolidated financial statements.
 
In April 2015, the FASB issued ASU No. 2015-03, Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. The amendments in this ASU require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected. ASU No 2015-03 is effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years.  ASU No. 2015-03 should be applied on a retrospective basis.  The Company is currently evaluating the impacts of this ASU on the Company's consolidated financial statements.
 
In April 2015, FASB issued ASU No. 2015-05, Customer's  Accounting for Fees Paid in a Cloud Computing Arrangement.  The amendments in this ASU provide guidance to customers in cloud computing arrangements about whether a cloud computing arrangement includes a software license.  If a cloud computing arrangement includes a software license, the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses.  If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract.  The amendments are effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2015.  Early adoption is permitted.  This ASU is not expected to have a material effect on the Company's consolidated financial statements.
 
In June 2015, FASB issued ASU No. 2015-10, Technical Corrections and Improvements.  On November 10, 2010 FASB added a standing project that will facilitate the FASB Accounting Standards Codification (‘Codification”) updates for technical corrections, clarifications, and improvements.  These amendments are referred to as Technical Corrections and Improvements.  Maintenance updates include non-substantive corrections to the Codification, such as editorial corrections, various link-related changes, and changes to source fragment information.  This update contains amendments that will affect a wide variety of Topics in the Codification.  The amendments in this ASU will apply to all reporting entities within the scope of the affected accounting guidance and generally fall into one of four categories: amendments related to differences between original guidance and the Codification, guidance clarification and reference corrections, simplification, and minor improvements.  In summary, the amendments in this ASU represent changes to clarify the Codification, correct unintended application of guidance, or make minor improvements to the Codification that are not expected to have a significant effect on current accounting practice.  Transition guidance varies based on the amendments in this ASU.  The amendments in this ASU that require transition guidance are effective for fiscal years and interim reporting periods after December 15, 2015.  Early adoption is permitted including adoption in an interim period.  All other amendments are effective upon the issuance of this ASU.  ASU 2015-10 did not have a material impact on the Company's consolidated financial statements.
 
Note 3 – Investments

The amortized cost and fair value of our available-for-sale (“AFS”) securities and the corresponding amounts of gross unrealized gains and losses at the dates indicated were as follows (in thousands):

   
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Estimated
Fair Value
 
June 30, 2015
               
Municipal bonds
 
$
1,912
   
$
138
   
$
-
   
$
2,050
 
Agency mortgage-backed securities
   
5,259
     
135
     
(26
)
   
5,368
 
Non-agency mortgage-backed securities
   
506
     
-
     
(23
)
   
483
 
Total
 
$
7,677
   
$
273
   
$
(49
)
 
$
7,901
 
December 31, 2014
                               
Municipal bonds
 
$
1,911
   
$
172
   
$
-
   
$
2,083
 
Agency mortgage-backed securities
   
7,024
     
110
     
(38
)
   
7,096
 
Non-agency mortgage-backed securities
   
2,312
     
83
     
(50
)
   
2,345
 
Total
 
$
11,247
   
$
365
   
$
(88
)
 
$
11,524
 
 
The amortized cost and fair value of AFS securities at June 30, 2015, by contractual maturity, are shown below (in thousands).  Expected maturities of AFS securities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

   
At June 30, 2015
 
   
Amortized
Cost
   
Fair
Value
 
Due in five to ten years
 
$
1,912
   
$
2,050
 
Due after ten years
   
5,765
     
5,851
 
Total
 
$
7,677
   
$
7,901
 

No securities were pledged to secure Washington State Public Funds as of June 30, 2015.

There were no sales of AFS securities during the three months ended June 30, 2015. We sold $1.7 million of non-agency mortgage-backed securities generating gross losses of $31,000 and no gross gains during the six months ended June 30, 2015. There were no sales of AFS securities during the three or six months ended June 30, 2014.
 
The following tables summarize at the dates indicated the aggregate fair value and gross unrealized loss by length of time of those investments that have been continuously in an unrealized loss position (in thousands):

   
June 30, 2015
 
   
Less Than 12 Months
   
12 Months or Longer
   
Total
 
   
Fair
Value
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
 
Agency mortgage-backed securities
 
$
-
   
$
-
   
$
1,500
   
$
(26
)
 
$
1,500
   
$
(26
)
Non-agency mortgage-backed securities
   
-
     
-
     
483
     
(23
)
   
483
     
(23
)
Total
 
$
-
   
$
-
   
$
1,983
   
$
(49
)
 
$
1,983
   
$
(49
)

   
December 31, 2014
 
   
Less Than 12 Months
   
12 Months or Longer
   
Total
 
   
Fair
Value
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
 
Agency mortgage-backed securities
 
$
627
   
$
(6
)
 
$
2,216
   
$
(32
)
 
$
2,843
   
$
(38
)
Non-agency mortgage-backed securities
   
-
     
-
     
507
     
(50
)
   
507
     
(50
)
Total
 
$
627
   
$
(6
)
 
$
2,723
   
$
(82
)
 
$
3,350
   
$
(88
)
 
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)

The following table presents the cumulative roll forward of credit losses recognized in earnings during the three and six months ended June 30, 2015 and 2014 relating to the Company’s non-U.S. agency mortgage-backed securities (in thousands):

   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2015
   
2014
   
2015
   
2014
 
Estimated credit losses, beginning balance
 
$
-
   
$
450
   
$
450
   
$
450
 
Additions for credit losses not previously recognized
   
-
     
-
     
-
     
-
 
Reduction for increases in cash flows
   
-
     
-
     
-
     
-
 
Reduction of related OTTI due to sales
   
-
     
-
     
(450
)
   
-
 
Reduction for realized losses
   
-
     
-
     
-
     
-
 
Estimated credit losses, ending balance
 
$
-
   
$
450
   
$
-
   
$
450
 

At June 30, 2015, our securities portfolio consisted of 14 agency mortgage-backed securities, one non-agency mortgage-backed security and five municipal securities with a fair value of $7.9 million.  At December 31, 2014, our securities portfolio consisted of 15 agency mortgage-backed securities, five non-agency mortgage-backed securities and five municipal bonds with a fair value of $11.5 million.  At June 30, 2015, one of the 14 agency mortgage-backed securities was in an unrealized loss position compared to three of the 15 agency mortgage-backed securities at December 31, 2014.  All of the agency mortgage-backed securities in an unrealized loss position at June 30, 2015 and December 31, 2014 were issued or guaranteed by U.S. governmental agencies.  The unrealized losses were caused by changes in market interest rates or the widening of market spreads subsequent to the initial purchase of these securities, and not related to the underlying credit of the issuers or the underlying collateral.  It is expected that these securities will not be settled at a price less than the amortized cost of each investment.  Because the decline in fair value is attributable to changes in interest rates or widening market spreads and not credit quality, and because we do not intend to sell the securities in this class and it is not likely that we will be required to sell these securities before recovery of their amortized cost basis, which may include holding each security until contractual maturity, the unrealized losses on these investments are not considered an other-than-temporary impairment (“OTTI”).

As of June 30, 2015, the only non-agency mortgage-backed security in our portfolio was in an unrealized loss position compared to one of the five non-agency mortgage-backed securities contained in our portfolio at December 31, 2014.  The unrealized loss was caused by changes in interest rates and market illiquidity causing a decline in the fair value subsequent to the purchase.  The contractual term of this investment does not permit the issuer to settle the security at a price less than par.  Because the decline in fair value is attributable to changes in interest rates or widening market spreads and not credit quality, and because we do not intend to sell the security and it is not likely that we will be required to sell this security before recovery of its amortized cost basis, which may include holding the security until contractual maturity, the unrealized loss on this investment is not considered an OTTI.

Note 4 – Loans

The composition of the loan portfolio at the dates indicated, excluding loans held for sale, was as follows (in thousands):
 
   
At June 30,
2015
   
At December 31,
2014
 
Real estate loans:
       
One- to four- family
 
$
131,362
   
$
133,031
 
Home equity
   
32,844
     
34,675
 
Commercial and multifamily
   
176,025
     
168,952
 
Construction and land
   
44,348
     
46,279
 
Total real estate loans
 
$
384,579
     
382,937
 
Consumer loans:
               
Manufactured homes
   
12,945
     
12,539
 
Other consumer
   
17,542
     
16,875
 
Total consumer loans
   
30,487
     
29,414
 
Commercial business loans
   
21,058
     
19,525
 
Total loans
   
436,124
     
431,876
 
Deferred fees
   
(1,527
)
   
(1,516
)
Total loans, gross
   
434,597
     
430,360
 
Allowance for loan losses
   
(4,572
)
   
(4,387
)
Total loans, net
 
$
430,025
   
$
425,973
 
 
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of June 30, 2015 (in thousands):

   
One- to
four- family
   
Home
equity
   
Commercial
and multifamily
   
Construction
and land
   
Manufactured
homes
   
Other
consumer
   
Commercial
business
   
Unallocated
   
Total
 
Allowance for loan losses:
                                   
Individually evaluated for impairment
 
$
477
   
$
70
   
$
206
   
$
18
   
$
62
   
$
8
   
$
8
   
$
-
   
$
849
 
Collectively evaluated for impairment
   
1,117
     
439
     
1,301
     
327
     
131
     
175
     
137
     
96
     
3,723
 
Ending balance
 
$
1,594
   
$
509
   
$
1,507
   
$
345
   
$
193
   
$
183
   
$
145
   
$
96
   
$
4,572
 
Loans receivable:
                                                                       
Individually evaluated for impairment
 
$
5,534
   
$
1,098
   
$
2,800
   
$
136
   
$
370
   
$
103
   
$
119
   
$
-
   
$
10,160
 
Collectively evaluated for impairment
   
125,828
     
31,746
     
173,225
     
44,212
     
12,575
     
17,439
     
20,939
     
-
     
425,964
 
Ending balance
 
$
131,362
   
$
32,844
   
$
176,025
   
$
44,348
   
$
12,945
   
$
17,542
   
$
21,058
   
$
-
   
$
436,124
 

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of December 31, 2014 (in thousands):

   
One-to-
four family
   
Home
equity
   
Commercial
and multifamily
   
Construction and land
   
Manufactured
homes
   
Other
consumer
   
Commercial
business
   
Unallocated
   
Total
 
Allowance for  loan losses:
                                   
Individually evaluated for impairment
 
$
258
   
$
28
   
$
8
   
$
14
   
$
41
   
$
18
   
$
-
   
$
-
   
$
367
 
Collectively evaluated for impairment
   
1,184
     
573
     
1,236
     
385
     
152
     
149
     
108
     
233
     
4,020
 
Ending balance
 
$
1,442
   
$
601
   
$
1,244
   
$
399
   
$
193
   
$
167
   
$
108
   
$
233
   
$
4,387
 
Loans  receivable:
                                                                       
Individually evaluated for impairment
 
$
4,186
   
$
1,247
   
$
2,956
   
$
180
   
$
404
   
$
51
   
$
124
   
$
-
   
$
9,148
 
Collectively evaluated for impairment
   
128,845
     
33,428
     
165,996
     
46,099
     
12,135
     
16,824
     
19,401
     
-
     
422,728
 
Ending balance
 
$
133,031
   
$
34,675
   
$
168,952
   
$
46,279
   
$
12,539
   
$
16,875
   
$
19,525
   
$
-
   
$
431,876
 
 
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)

The following table summarizes the activity in loan losses for the three months ended June 30, 2015 (in thousands):

   
Beginning Allowance
   
Charge-offs
   
Recoveries
   
Provision
   
Ending Allowance
 
One-to four- family
 
$
1,429
   
$
-
   
$
-
   
$
165
   
$
1,594
 
Home equity
   
514
     
-
     
6
     
(11
)
   
509
 
Commercial and multifamily
   
1,406
     
-
     
-
     
101
     
1,507
 
Construction and land
   
414
     
(40
)
   
-
     
(29
)
   
345
 
Manufactured homes
   
184
     
(32
)
   
2
     
39
     
193
 
Other consumer
   
154
     
(3
)
   
3
     
29
     
183
 
Commercial business
   
104
     
-
     
-
     
41
     
145
 
Unallocated
   
231
     
-
     
-
     
(135
)
   
96
 
Total
 
$
4,436
   
$
(75
)
 
$
11
   
$
200
   
$
4,572
 

The following table summarizes the activity in loan losses for the six months ended June 30, 2015 (in thousands):

   
Beginning Allowance
   
Charge-offs
   
Recoveries
   
Provision
   
Ending Allowance
 
One-to four- family
 
$
1,442
   
$
(21
)
 
$
-
   
$
173
   
$
1,594
 
Home equity
   
601
     
(19
)
   
10
     
(83
)
   
509
 
Commercial and multifamily
   
1,244
     
-
     
-
     
263
     
1,507
 
Construction and land
   
399
     
(40
)
   
-
     
(14
)
   
345
 
Manufactured homes
   
193
     
(32
)
   
5
     
27
     
193
 
Other consumer
   
167
     
(27
)
   
9
     
34
     
183
 
Commercial business
   
108
     
-
     
-
     
37
     
145
 
Unallocated
   
233
     
-
     
-
     
(137
)
   
96
 
Total
 
$
4,387
   
$
(139
)
 
$
24
   
$
300
   
$
4,572
 

The following table summarizes the activity in loan losses for the three months ended June 30, 2014 (in thousands):

   
Beginning Allowance
   
Charge-offs
   
Recoveries
   
Provision
   
Ending Allowance
 
One-to four- family
 
$
925
   
$
-
   
$
-
   
$
(53
)
 
$
872
 
Home equity
   
529
     
(74
)
   
4
     
(13
)
   
446
 
Commercial and multifamily
   
1,832
     
(8
)
   
-
     
(34
)
   
1,790
 
Construction and land
   
240
     
-
     
-
     
20
     
260
 
Manufactured homes
   
186
     
(89
)
   
4
     
36
     
137
 
Other consumer
   
100
     
(26
)
   
4
     
9
     
87
 
Commercial business
   
99
     
-
     
-
     
38
     
137
 
Unallocated
   
265
     
-
     
-
     
197
     
462
 
Total
 
$
4,176
   
$
(197
)
 
$
12
   
$
200
   
$
4,191
 

The following table summarizes the activity in loan losses for the six months ended June 30, 2014 (in thousands):

   
Beginning
Allowance
   
Charge-offs
   
Recoveries
   
Provision
   
Ending
Allowance
 
One-to four- family
 
$
1,915
   
$
(65
)
 
$
1
   
$
(979
)
 
$
872
 
Home equity
   
781
     
(108
)
   
33
     
(260
)
   
446
 
Commercial and multifamily
   
300
     
(46
)
   
1
     
1,537
     
1,790
 
Construction and land
   
318
     
-
     
-
     
(58
)
   
260
 
Manufactured homes
   
209
     
(177
)
   
5
     
98
     
137
 
Other consumer
   
109
     
(37
)
   
7
     
8
     
87
 
Commercial business
   
102
     
-
     
-
     
35
     
137
 
Unallocated
   
443
     
-
     
-
     
19
     
462
 
Total
 
$
4,177
   
$
(433
)
 
$
47
   
$
400
   
$
4,191
 
 
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)

Credit Quality Indicators.  Federal regulations provide for the classification of lower quality loans as substandard, doubtful or loss.  An asset is considered substandard if it is inadequately protected by the current net worth and payment capacity of the borrower or of any collateral pledged.  Substandard assets include those characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected.  Assets classified as doubtful have all the weaknesses of currently existing facts, conditions and values.  Assets classified as loss are those considered uncollectible and of such little value that their continuance as assets without establishment of a specific loss reserve is not warranted.
 
When we classify problem loans as either substandard or doubtful, we may establish a specific allowance in an amount we deem prudent to address the risk specifically (if the loan is impaired) or we may allow the loss to be addressed in the general allowance (if the loan is not impaired).  General allowances represent loss reserves which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been specifically allocated to particular problem loans.  When the Company classifies problem loans as a loss, we charge off such assets in the period in which they are deemed uncollectible.  Assets that do not currently expose us to sufficient risk to warrant classification as substandard, doubtful or loss but possess identified weaknesses are classified as either watch or special mention assets.  Our determination as to the classification of our assets and the amount of our valuation allowances is subject to review by the Federal Deposit Insurance Corporation (“FDIC”), which can order the establishment of additional loss allowances.  Pass rated loans are loans that are not otherwise classified or criticized.
 
The following table represents the internally assigned grades as of June 30, 2015 by type of loan (in thousands):

   
One- to
four- family
   
Home
equity
   
Commercial
and multifamily
   
Construction
and land
   
Manufactured
homes
   
Other
consumer
   
Commercial
business
   
Total
 
Grade:
                               
Pass
 
$
126,618
   
$
31,124
   
$
170,238
   
$
44,141
   
$
12,664
   
$
17,383
   
$
20,952
   
$
423,120
 
Watch
   
2,384
     
1,297
     
4,093
     
166
     
203
     
56
     
106
     
8,305
 
Special Mention
   
1,268
     
-
     
-
     
-
     
34
     
-
     
-
     
1,302
 
Substandard
   
1,092
     
423
     
1,694
     
41
     
44
     
103
     
-
     
3,397
 
Doubtful
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Loss
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Total
 
$
131,362
   
$
32,844
   
$
176,025
   
$
44,348
   
$
12,945
   
$
17,542
   
$
21,058
   
$
436,124
 

The following table represents the internally assigned grades as of December 31, 2014 by type of loan (in thousands):

   
One- to
four- family
   
Home
equity
   
Commercial
and multifamily
   
Construction
and land
   
Manufactured
homes
   
Other
consumer
   
Commercial
business
   
Total
 
Grade:
                               
Pass
 
$
120,152
   
$
30,785
   
$
163,573
   
$
45,427
   
$
11,427
   
$
16,587
   
$
18,919
   
$
406,870
 
Watch
   
11,793
     
3,322
     
3,740
     
852
     
1,038
     
240
     
606
     
21,591
 
Special Mention
   
-
     
-
     
-
     
-
     
24
     
-
     
-
     
24
 
Substandard
   
1,086
     
568
     
1,639
     
-
     
50
     
48
     
-
     
3,391
 
Doubtful
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Loss
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Total
 
$
133,031
   
$
34,675
   
$
168,952
   
$
46,279
   
$
12,539
   
$
16,875
   
$
19,525
   
$
431,876
 

Nonaccrual and Past Due Loans.  Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due.  Loans are automatically placed on nonaccrual once the loan is 90 days past due or sooner if, in management’s opinion, the borrower may be unable to meet payment of obligations as they become due, as well as when required by regulatory authorities.

The following table presents the recorded investment in nonaccrual loans as of June 30, 2015 and December 31, 2014, by type of loan (in thousands):

   
June 30,
2015
   
December
31, 2014
 
One- to four- family
 
$
1,045
   
$
1,092
 
Home equity
   
159
     
258
 
Commercial and multifamily
   
82
     
-
 
Construction and land
   
41
     
81
 
Manufactured homes
   
5
     
6
 
Other consumer
   
90
     
27
 
Total
 
$
1,422
   
$
1,464
 
 
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)

The following table represents the aging of the recorded investment in past due loans as of June 30, 2015 by type of loan (in thousands):

   
30-59 Days
Past Due
   
60-89 Days
Past Due
   
90 Days
and Greater Past Due
   
90 Days and Greater Past Due and Still Accruing
   
Total Past Due
   
Current
   
Total Loans
 
One-to four- family
 
$
-
   
$
734
   
$
391
   
$
-
   
$
1,125
   
$
130,237
   
$
131,362
 
Home equity
   
971
     
-
     
107
     
-
     
1,078
     
31,766
     
32,844
 
Commercial and multifamily
   
-
     
-
     
82
     
-
     
82
     
175,943
     
176,025
 
Construction and land
   
775
     
-
     
41
     
-
     
816
     
43,532
     
44,348
 
Manufactured homes
   
116
     
58
     
-
     
-
     
174
     
12,771
     
12,945
 
Other consumer
   
33
     
13
     
90
     
-
     
136
     
17,406
     
17,542
 
Commercial business
   
168
     
-
     
-
     
-
     
168
     
20,890
     
21,058
 
Total
 
$
2,063
   
$
805
   
$
711
   
$
-
   
$
3,579
   
$
432,545
   
$
436,124
 

The following table represents the aging of the recorded investment in past due loans as of December 31, 2014 by type of loan (in thousands):

   
30-59 Days
Past Due
   
60-89 Days
Past Due
   
90 Days
and Greater Past Due
   
90 Days and Greater Past Due and Still Accruing
   
Total Past Due
   
Current
   
Total Loans
 
One-to four- family
 
$
1,300
   
$
167
   
$
720
   
$
-
   
$
2,187
   
$
130,844
   
$
133,031
 
Home equity
   
585
     
109
     
203
     
-
     
897
     
33,778
     
34,675
 
Commercial and multifamily
   
-
     
-
     
-
     
-
     
-
     
168,952
     
168,952
 
Construction and land
   
-
     
-
     
81
     
-
     
81
     
46,198
     
46,279
 
Manufactured homes
   
197
     
42
     
27
     
114
     
380
     
12,159
     
12,539
 
Other consumer
   
23
     
7
     
-
     
-
     
30
     
16,845
     
16,875
 
Commercial business
   
430
     
-
     
-
     
-
     
430
     
19,095
     
19,525
 
Total
 
$
2,535
   
$
325
   
$
1,031
   
$
114
   
$
4,005
   
$
427,871
   
$
431,876
 

Nonperforming Loans.  Loans are considered nonperforming when they are placed on nonaccrual and/or when they are considered to be nonperforming troubled debt restructurings (“TDRs”) and/or when they are 90 days or greater past due and still accruing.  A TDR is a loan to a borrower that is experiencing financial difficulty that has been modified from its original terms and conditions in such a way that the Company is granting the borrower a concession of some kind.  Nonperforming TDRs include TDRs that do not have sufficient payment history (typically greater than six months) to be considered performing or TDRs that have become 31 or more days past due.

The following table represents the credit risk profile of our loan portfolio based on payment activity as of June 30, 2015 by type of loan (in thousands):

   
One- to four- family
   
Home equity
   
Commercial and multifamily
   
Construction
and land
   
Manufactured homes
   
Other consumer
   
Commercial business
   
Total
 
Performing
 
$
130,067
   
$
32,341
   
$
175,776
   
$
44,307
   
$
12,891
   
$
17,451
   
$
21,058
   
$
433,891
 
Nonperforming
   
1,295
     
503
     
249
     
41
     
54
     
91
     
-
     
2,233
 
Total
 
$
131,362
   
$
32,844
   
$
176,025
   
$
44,348
   
$
12,945
   
$
17,542
   
$
21,058
   
$
436,124
 

The following table represents the credit risk profile of our loan portfolio based on payment activity as of December 31, 2014 by type of loan (in thousands):

   
One- to four- family
   
Home equity
   
Commercial and multifamily
   
Construction
and land
   
Manufactured homes
   
Other consumer
   
Commercial business
   
Total
 
Performing
 
$
131,519
   
$
34,289
   
$
167,313
   
$
46,198
   
$
12,344
   
$
16,846
   
$
19,525
   
$
428,034
 
Nonperforming
   
1,512
     
386
     
1,639
     
81
     
195
     
29
     
-
     
3,842
 
Total
 
$
133,031
   
$
34,675
   
$
168,952
   
$
46,279
   
$
12,539
   
$
16,875
   
$
19,525
   
$
431,876
 
 
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)

Impaired Loans.  A loan is considered impaired when we have determined that we may be unable to collect payments of principal or interest when due under the terms of the loan.  In the process of identifying loans as impaired, we take into consideration factors which include payment history and status, collateral value, financial condition of the borrower, and the probability of collecting scheduled payments in the future.  Minor payment delays and insignificant payment shortfalls typically do not result in a loan being classified as impaired.  The significance of payment delays and shortfalls is considered on a case by case basis, after taking into consideration the totality of circumstances surrounding the loans and the borrowers, including payment history. Impairment is measured on a loan by loan basis for all loans in the portfolio.  All TDRs are also classified as impaired loans and are included in the loans individually evaluated for impairment in the calculation of the allowance for loan losses.

The following table presents loans individually evaluated for impairment as of June 30, 2015 by type of loan (in thousands):

   
Recorded Investment
   
Unpaid Principal Balance
   
Related Allowance
 
With no related allowance recorded:
           
One-to four- family
 
$
2,241
   
$
2,418
   
$
-
 
Home equity
   
345
     
345
     
-
 
Commercial and multifamily
   
250
     
271
     
-
 
Construction and land
   
41
     
41
     
-
 
Manufactured homes
   
29
     
29
     
-
 
Other consumer
   
6
     
6
     
-
 
Commercial business
   
-
     
-
     
-
 
Total
   
2,912
     
3,110
     
-
 
With an allowance recorded:
                       
One-to four- family
   
3,293
     
3,293
     
477
 
Home equity
   
753
     
847
     
70
 
Commercial and multifamily
   
2,550
     
2,550
     
206
 
Construction and land
   
95
     
95
     
18
 
Manufactured homes
   
341
     
348
     
62
 
Other consumer
   
97