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EX-32 - EXHIBIT 32 - Sound Financial Bancorp, Inc.ex32.htm
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EX-31.1 - EXHIBIT 31.1 - Sound Financial Bancorp, Inc.ex31_1.htm

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 September 30, 2016
 
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 November 9, 2016, there were 2,498,604 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.   
24
     
Item 3.   
33
     
Item 4.   
33
     
PART II
OTHER INFORMATION
 
     
Item 1.
34
     
Item 1A
34
     
Item 2.
34
     
Item 3.
34
     
Item 4.
34
     
Item 5.
34
     
Item 6.
35
     
 
   
EXHIBITS
 
 
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Condensed Consolidated Balance Sheets
(In thousands, except share and per share amounts)

   
September 30,
2016
(unaudited)
   
December 31,
2015
 
ASSETS
           
Cash and cash equivalents
 
$
55,275
   
$
48,264
 
Available-for-sale securities, at fair value
   
6,996
     
6,696
 
Loans held for sale
   
2,424
     
2,091
 
Loans
   
477,066
     
459,469
 
Allowance for loan losses
   
(4,859
)
   
(4,636
)
Total loans, net
   
472,207
     
454,833
 
Accrued interest receivable
   
1,630
     
1,608
 
Bank-owned life insurance (“BOLI”), net
   
11,998
     
11,746
 
Other real estate owned (“OREO”) and repossessed assets, net
   
884
     
769
 
Mortgage servicing rights, at fair value
   
3,039
     
3,249
 
Federal Home Loan Bank (“FHLB”) stock, at cost
   
2,146
     
2,212
 
Premises and equipment, net
   
5,274
     
5,335
 
Other assets
   
4,333
     
3,957
 
Total assets
 
$
566,206
   
$
540,760
 
LIABILITIES
               
Deposits
               
Interest-bearing
 
$
395,114
   
$
389,151
 
Noninterest-bearing demand
   
68,369
     
50,873
 
Total deposits
   
463,483
     
440,024
 
Borrowings
   
37,453
     
40,435
 
Accrued interest payable
   
62
     
72
 
Other liabilities
   
5,859
     
5,140
 
Advance payments from borrowers for taxes and insurance
   
1,032
     
569
 
Total liabilities
   
507,889
     
486,240
 
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, 2,498,604 and 2,469,206 shares issued and outstanding as of September 30, 2016 and December 31, 2015, respectively
   
25
     
25
 
Additional paid-in capital
   
23,520
     
23,002
 
Unearned shares - Employee Stock Ownership Plan (“ESOP”)
   
(911
)
   
(911
)
Retained earnings
   
35,496
     
32,240
 
Accumulated other comprehensive income, net of tax
   
187
     
164
 
Total stockholders’ equity
   
58,317
     
54,520
 
Total liabilities and stockholders’ equity
 
$
566,206
   
$
540,760
 

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

   
Three Months Ended
September 30,
   
Nine months Ended
September 30,
 
   
2016
   
2015
   
2016
   
2015
 
INTEREST INCOME
                       
Loans, including fees
 
$
6,050
   
$
5,537
   
$
18,053
   
$
16,222
 
Interest and dividends on investments, cash and cash equivalents
   
98
     
39
     
279
     
141
 
Total interest income
   
6,148
     
5,576
     
18,332
     
16,363
 
INTEREST EXPENSE
                               
Deposits
   
678
     
662
     
2,020
     
1,985
 
Borrowings
   
52
     
23
     
136
     
70
 
Total interest expense
   
730
     
685
     
2,156
     
2,055
 
Net interest income
   
5,418
     
4,891
     
16,176
     
14,308
 
PROVISION FOR LOAN LOSSES
   
0
     
100
     
250
     
400
 
Net interest income after provision for loan losses
   
5,418
     
4,791
     
15,926
     
13,908
 
NONINTEREST INCOME
                               
Service charges and fee income
   
743
     
641
     
1,988
     
1,958
 
Earnings on cash surrender value of bank-owned life insurance
   
84
     
85
     
252
     
253
 
Mortgage servicing income
   
223
     
202
     
636
     
671
 
Fair value adjustment on mortgage servicing rights
   
16
     
(22
)
   
(174
)
   
147
 
Loss on sale of securities
   
-
     
-
     
-
     
(31
)
Net gain on sale of loans
   
477
     
360
     
1,028
     
1,146
 
Total noninterest income
   
1,543
     
1,266
     
3,730
     
4,144
 
NONINTEREST EXPENSE
                               
Salaries and benefits
   
2,632
     
2,251
     
7,813
     
6,711
 
Operations
   
1,181
     
1,064
     
3,237
     
3,021
 
Regulatory assessments
   
124
     
180
     
404
     
476
 
Occupancy
   
376
     
413
     
1,141
     
1,186
 
Data processing
   
434
     
378
     
1,264
     
1,233
 
Net loss on OREO and repossessed assets
   
3
     
96
     
9
     
178
 
Total noninterest expense
   
4,750
     
4,382
     
13,868
     
12,805
 
Income before provision for income taxes
   
2,211
     
1,675
     
5,788
     
5,247
 
Provision for income taxes
   
757
     
560
     
1,974
     
1,677
 
Net income
 
$
1,454
   
$
1,115
   
$
3,814
   
$
3,570
 
                                 
Earnings per common share:
                               
Basic
 
$
0.58
   
$
0.45
   
$
1.54
   
$
1.43
 
Diluted
 
$
0.57
   
$
0.44
   
$
1.48
   
$
1.38
 
Weighted average number of common shares outstanding:
                               
Basic
   
2,490,089
     
2,465,371
     
2,483,004
     
2,500,088
 
Diluted
   
2,568,457
     
2,552,229
     
2,556,949
     
2,585,736
 

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
September 30,
   
Nine months Ended
September 30,
 
   
2016
   
2015
   
2016
   
2015
 
Net income
 
$
1,454
   
$
1,115
   
$
3,814
   
$
3,570
 
Available for sale securities:
                               
Unrealized gains (losses) arising during the period, net of tax provision (benefits) of $(19), $(10), $13 and $(19), respectively
   
(35
)
   
(19
)
   
23
     
(36
)
Reclassification adjustments for the net losses realized in earnings, net of tax benefit of $0, $0, $0 and $11
   
-
     
-
     
-
     
20
 
Other comprehensive income (loss), net of tax
   
(35
)
   
(19
)
   
23
     
(16
)
Comprehensive income
 
$
1,419
   
$
1,096
   
$
3,837
   
$
3,554
 

See notes to condensed consolidated financial statements
 
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Stockholders’ Equity
For the Nine months ended September 30, 2016 and 2015 (unaudited)
(Dollars in thousands, except per share amounts)

   
Shares
   
Common
Stock
   
Additional Paid-
in Capital
   
Unearned
ESOP Shares
   
Retained
Earnings
   
Accumulated
Other
Comprehensive
Income net of
tax
   
Total
Stockholders’
Equity
 
Balances at December 31, 2014
   
2,524,645
   
$
25
   
$
23,552
   
$
(1,140
)
 
$
28,024
   
$
183
   
$
50,644
 
Net income
                                   
3,570
             
3,570
 
Other comprehensive loss, net of tax
                                           
(16
)
   
(16
)
Share-based compensation
                   
322
                             
322
 
                                                         
Cash dividends paid on common stock ($0.11 per share)
                                   
(426
)
           
(426
)
Restricted stock awards issued
   
10,208
                                                 
Restricted stock forfeited and retired common stock
   
(8,981
)
                                               
Common stock repurchased
   
(63,371
)
           
(1,261
)
                           
(1,261
)
Exercise of options
   
3,406
             
30
                             
30
 
Balances at September 30, 2015
   
2,465,907
   
$
25
   
$
22,643
   
$
(1,140
)
 
$
31,168
   
$
167
   
$
52,863
 

   
Shares
   
Common
Stock
   
Additional Paid-
in Capital
   
Unearned
ESOP Shares
   
Retained
Earnings
   
Accumulated
Other
Comprehensive
Income net of
tax
   
Total
Stockholders’
Equity
 
Balances at December 31, 2015
   
2,469,206
   
$
25
   
$
23,002
   
$
(911
)
 
$
32,240
   
$
164
   
$
54,520
 
Net income
                                   
3,814
             
3,814
 
Other comprehensive income, net of tax
                                           
23
     
23
 
Share-based compensation
                   
354
                             
354
 
                                                         
Cash dividends paid on common stock ($0.23 per share)
                                   
(558
)
           
(558
)
Commom Stock repurchase in conjunction with stock option exercise
   
(2,805
)
                                           
-
 
Restricted stock awards issued
   
11,606
                                             
-
 
Restricted stock forfeited and retired
                                                       
common stock
   
(1,059
)
                                               
Exercise of options
   
21,656
             
164
                             
164
 
Balances at September 30, 2016
   
2,498,604
   
$
25
   
$
23,520
   
$
(911
)
 
$
35,496
   
$
187
   
$
58,317
 

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

   
Nine months Ended
September 30,
 
   
2016
   
2015
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net income
 
$
3,814
   
$
3,570
 
Adjustments to reconcile net income to net cash from operating activities:
               
Accretion of net discounts on investments
   
32
     
96
 
Loss on sale of securities
   
-
     
31
 
Provision for loan losses
   
250
     
400
 
Depreciation and amortization
   
593
     
515
 
Compensation expense related to stock options and restricted stock
   
354
     
322
 
Net change to mortgage servicing rights
   
210
     
(198
)
Increase in cash surrender value of BOLI
   
(252
)
   
(253
)
Gain on sale of loans
   
(1,028
)
   
(1,146
)
Proceeds from sale of loans held for sale
   
58,464
     
60,280
 
Originations of loans held for sale
   
(57,769
)
   
(59,096
)
Net loss on sale and write-downs of OREO and repossessed assets
   
3
     
95
 
Change in operating assets and liabilities:
               
Accrued interest receivable
   
(22
)
   
44
 
Other assets
   
(330
)
   
926
 
Accrued interest payable
   
(10
)
   
(15
)
Other liabilities
   
719
     
(1,075
)
Net cash from operating activities
   
5,028
     
4,496
 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Proceeds from principal payments, maturities and sales of available for sale securities
   
1,008
     
4,233
 
Purchases of available for sale securities
   
(1,363
)
   
-
 
FHLB stock redeemed
   
66
     
666
 
Net increase in loans
   
(17,873
)
   
(6,024
)
Proceeds from sale of OREO and other repossessed assets
   
131
     
501
 
Purchases of premises and equipment, net
   
(532
)
   
(540
)
Net cash used by investing activities
   
(18,563
)
   
(1,164
)
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Net increase in deposits
   
23,459
     
11,766
 
Proceeds from borrowings
   
106,000
     
64,000
 
Repayment of borrowings
   
(108,982
)
   
(70,482
)
Dividends paid on common stock
   
(558
)
   
(426
)
Net change in advances from borrowers for taxes and insurance
   
463
     
421
 
Proceeds from stock option exercises
   
164
     
30
 
Repurchase of common stock
   
-
     
(1,261
)
Net cash from financing activities
   
20,546
     
4,048
 
Net change in cash and cash equivalents
   
7,011
     
7,380
 
Cash and cash equivalents, beginning of period
   
48,264
     
29,289
 
Cash and cash equivalents, end of period
 
$
55,275
     
36,669
 
SUPPLEMENTAL CASH FLOW INFORMATION:
               
Cash paid for income taxes
 
$
2,290
   
$
2,325
 
Interest paid on deposits and borrowings
 
$
2,166
   
$
2,070
 
Noncash net transfer from loans to OREO and repossessed assets
 
$
249
   
$
450
 

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 condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission (“SEC”).  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the financial position and results of operations for the periods presented have been included.  Certain information and disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the rules and regulations of the SEC.  These unaudited financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, as filed with the SEC on March 30, 2016 (“2015 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, 2015, included in the 2015 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 May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606), which creates Topic 606 and supersedes Topic 605, Revenue Recognition. In August 2015, FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606), which postponed the effective date of 2014-09. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net, which amended the principal versus agent implementation guidance set for in ASU 2014-09. Among other things, ASU 2016-08 clarifies that an entity should evaluate whether it is the principal or the agent for each specified good or service promised in a contract with a customer. In April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing. The ASU amends certain aspects of the guidance set forth in the FASB's new revenue standard related to identifying performance obligations and licensing implementation. The core principle of Topic 606 is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In general, the new ASU requires companies to use more judgment and make more estimates than under current guidance, including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation.  In May 2016, the FASB issued ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, which provides clarifying guidance in certain narrow areas and adds some practical expedients, but does not change the core revenue recognition principle in Topic 606. This ASU  is effective for for interim and annual periods beginning after December 15, 2017; early adoption is not permitted. For financial reporting purposes, the ASU allows for either full retrospective adoption, meaning this ASU is applied to all of the periods presented, or modified retrospective adoption, meaning the ASU  is applied only to the most current period presented in the financial statements with the cumulative effect of initially applying the ASU is recognized at the date of initial application. The Company is currently evaluating the provisions to determine the potential impact the new standard will have on the Company's consolidated financial statements.

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10), Recognition and Measurement of Financial Assets and Financial Liabilities. The new guidance is intended to improve the recognition and measurement of financial instruments. This ASU requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. In addition, the ASU requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes and requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements. This ASU also eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. The ASU also requires a reporting organization to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument specific credit risk (also referred to as “own credit”) when the organization has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. ASU No. 2016-01 is effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted for certain provisions. The Company is currently evaluating the impact of this ASU on the Company's consolidated financial statements

In February 2016, FASB issued ASU No. 2016-02, Leases (Topic 842). ASU No. 2016-02 requires lessees to recognize, on the balance sheet, the assets and liabilities arising from operating leases. A lessee should recognize a liability to make lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term. A lessee should include payments to be made in an optional period only if the lessee is reasonably certain to exercise an option to extend the lease or not to exercise an option to terminate the lease. For a finance lease, interest payments should be recognized separately from amortization of the right-of-use asset in the statement of comprehensive income. For operating leases, the lease cost should be allocated over the lease term on a generally straight-line basis. The amendments in ASU 2016-02 are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application of the amendments in the ASU is permitted. The adoption of ASU 2016-02 is not expected to have a material impact on the Company's consolidated financial statements.
 
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)

In March 2016, the FASB issued ASU No. 2016-06, Derivatives and Hedging (Topic 815): Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships. A contract novation refers to replacing one of the parties to a derivative instrument with a new party. This ASU clarifies that a change in counterparty in a derivative instrument does not, in and of itself, require dedesignation of that hedging relationship and therefore discontinue the application of hedge accounting. ASU 2016-05 is effective for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. Early adoption is permitted in any interim or annual period.  The adoption of ASU 2016-05 is not expected to have a material impact on the Company's consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-07, Investments - Equity Method and Joint Ventures (Topic 323): Simplifying the Transition to the Equity Method of Accounting. The ASU eliminates the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an adjustment must be made to the investment, results of operations, and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods that the investment had been held. The ASU is effective for annual periods beginning after December 15, 2016, including interim periods within those fiscal years. Early adoption of the update is permitted. The Company does not expect this ASU to have a material impact on the Company’s consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting, which amends ASC Topic 718, Compensation - Stock Compensation. The ASU includes provisions intended to simplify various aspects related to how share-based payments are accounted for and presented in the financial statements. The ASU is effective for annual and interim periods beginning after December 15, 2016. The adoption of ASU is being reviewed for any material impact there may be on the Company's consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments- Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This ASU replaces the existing incurred loss impairment methodology that recognizes credit losses when a probable loss has been incurred with new methodology where loss estimates are based upon lifetime expected credit losses. The amendments in this ASU require a financial asset that is measured at amortized cost to be presented at the net amount expected to be collected. The income statement would then reflect the measurement of credit losses for newly recognized financial assets as well as changes to the expected credit losses that have taken place during the reporting period. The measurement of expected credit losses will be based on historical information, current conditions, and reasonable and supportable forecasts that impact the collectability of the reported amount. Available-for-sale securities will bifurcate the fair value mark and establish an allowance for credit losses through the income statement for the credit portion of that mark. The interest portion will continue to be recognized through accumulated other comprehensive income or loss. The change in allowance recognized as a result of adoption will occur through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the ASU is adopted. The amendments in this ASU are effective for fiscal years beginning after December 15, 2019 with early adoption permitted after December 15, 2018. The Company is currently evaluating the impact of this ASU on the Company's consolidated financial statements.

In August 2016, FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments.  This ASU addresses the appropriate classification of eight specific cash flow issues on the cash flow statement. Debt prepayment costs should be classified as an outflow for financing activities. Settlement of zero-coupon debt instruments divides the interest portion as an outflow for operating activities and the principal portion as an outflow for financing activities. Contingent consideration payments made after a business combination should be classified as outflows for financing and operating activities. Proceeds from the settlement of bank-owned life insurance policies should be classified as inflows from investing activities. Other specific areas are identified in the ASU as to the appropriate classification of the cash inflows or outflows.  The amendments in this ASU are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted and must be applied using a retrospective transition method to each period presented. The Company does not expect this ASU to 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
 
September 30, 2016
                       
Municipal bonds
 
$
3,267
   
$
235
   
$
(1
)
 
$
3,501
 
Agency mortgage-backed securities
   
3,074
     
80
     
(14
)
   
3,140
 
Non-agency mortgage-backed securities
   
372
     
-
     
(17
)
   
355
 
Total
 
$
6,713
   
$
315
   
$
(32
)
 
$
6,996
 
December 31, 2015
                               
Municipal bonds
 
$
1,912
   
$
184
   
$
-
   
$
2,096
 
Agency mortgage-backed securities
   
4,088
     
102
     
(18
)
   
4,172
 
Non-agency mortgage-backed securities
   
449
     
-
     
(21
)
   
428
 
Total
 
$
6,449
   
$
286
   
$
(39
)
 
$
6,696
 
 
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)

The amortized cost and fair value of AFS securities at September 30, 2016, 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 September 30, 2016
 
   
Amortized
Cost
   
Fair
Value
 
Due within five years
 
$
1,111
   
$
1,111
 
Due in five to ten years
   
504
     
529
 
Due after ten years
   
5,098
     
5,356
 
Total
 
$
6,713
   
$
6,996
 

No securities were pledged to secure Washington State Public Funds as of September 30, 2016 and December 31, 2015.

There were no sales of AFS securities during the three or nine months ended September 30, 2016. There were no sales of AFS securities during the three months ended September 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 nine months ended September 30, 2015.

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):

   
September 30, 2016
 
   
Less Than 12 Months
   
12 Months or Longer
   
Total
 
   
Fair
Value
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
 
Municipal bonds
 
$
890
   
$
(1
)
 
$
-
   
$
-
   
$
890
   
$
(1
)
Agency mortgage-backed securities
 
$
1,169
   
$
(14
)
 
$
-
   
$
-
   
$
1,169
   
$
(14
)
Non-agency mortgage-backed securities
 
$
-
   
$
-
   
$
355
   
$
(17
)
 
$
355
   
$
(17
)
Total
 
$
2,059
   
$
(15
)
 
$
355
   
$
(17
)
 
$
2,414
   
$
(32
)

   
December 31, 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
 
$
-
   
$
-
   
$
1,370
   
$
(18
)
 
$
1,370
   
$
(18
)
Non-agency mortgage-backed securities
   
-
     
-
     
428
     
(21
)
   
428
     
(21
)
Total
 
$
     
$
     
$
1,798
   
$
(39
)
 
$
1,798
   
$
(39
)

The following table presents the cumulative roll forward of credit losses recognized in earnings during the three and nine months ended September 30, 2016 and 2015 relating to the Company’s non-U.S. agency mortgage-backed securities (in thousands):

   
Three Months Ended September 30,
   
Nine months Ended September 30,
 
   
2016
   
2015
   
2016
   
2015
 
Estimated credit losses, beginning balance
 
$
-
   
$
-
   
$
-
   
$
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
 
$
-
   
$
-
   
$
-
   
$
-
 
 
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)

Note 4 – Loans

The composition of the loan portfolio at the dates indicated, excluding loans held for sale, was as follows (in thousands):
 
   
At September
30, 2016
   
At December
31, 2015
 
Real estate loans:
           
One- to four- family
 
$
151,992
   
$
141,125
 
Home equity
   
30,297
     
31,573
 
Commercial and multifamily
   
170,258
     
175,312
 
Construction and land
   
58,902
     
57,043
 
Total real estate loans
 
$
411,449
   
$
405,053
 
Consumer loans:
               
Manufactured homes
   
15,525
     
13,798
 
Other consumer
   
25,570
     
23,030
 
Total consumer loans
   
41,095
     
36,828
 
Commercial business loans
   
26,439
     
19,295
 
Total loans
   
478,983
     
461,176
 
Deferred fees
   
(1,917
)
   
(1,707
)
Total loans, gross
   
477,066
     
459,469
 
Allowance for loan losses
   
(4,859
)
   
(4,636
)
Total loans, net
 
$
472,207
   
$
454,833
 

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 September 30, 2016 (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
 
$
629
   
$
97
   
$
389
   
$
23
   
$
53
   
$
23
   
$
30
   
$
-
   
$
1,244
 
Collectively evaluated for impairment
 
$
1,029
   
$
327
   
$
971
   
$
350
   
$
124
   
$
175
   
$
151
   
$
488
   
$
3,615
 
Ending balance
 
$
1,658
   
$
424
   
$
1,360
   
$
373
   
$
177
   
$
198
   
$
181
   
$
488
   
$
4,859
 
                                                                         
Loans receivable:
                                                                       
Individually evaluated for impairment
 
$
5,278
   
$
885
   
$
3,869
   
$
85
   
$
372
   
$
23
   
$
633
   
$
-
   
$
11,145
 
Collectively evaluated for impairment
 
$
146,714
   
$
29,412
   
$
166,389
   
$
58,817
   
$
15,153
   
$
25,547
   
$
25,806
   
$
-
   
$
467,838
 
Ending balance
 
$
151,992
   
$
30,297
   
$
170,258
   
$
58,902
   
$
15,525
   
$
25,570
   
$
26,439
   
$
-
   
$
478,983
 
 
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 December 31, 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
 
$
647
   
$
110
   
$
36
   
$
18
   
$
63
   
$
-
   
$
8
   
$
-
   
$
882
 
Collectively evaluated for impairment
   
1,192
     
497
     
885
     
364
     
238
     
188
     
149
     
241
     
3,754
 
Ending balance
 
$
1,839
   
$
607
   
$
921
   
$
382
   
$
301
   
$
188
   
$
157
   
$
241
   
$
4,636
 
                                                                         
Loans  receivable:
                                                                       
Individually evaluated for impairment
 
$
5,779
   
$
904
   
$
1,966
   
$
91
   
$
361
   
$
5
   
$
114
   
$
-
   
$
9,220
 
Collectively evaluated for impairment
   
135,346
     
30,669
     
173,346
     
56,952
     
13,437
     
23,025
     
19,181
     
-
     
451,956
 
Ending balance
 
$
141,125
   
$
31,573
   
$
175,312
   
$
57,043
   
$
13,798
   
$
23,030
   
$
19,295
   
$
-
   
$
461,176
 

The following table summarizes the activity in the allowance for loan losses for the three months ended September 30, 2016 (in thousands):

   
Beginning
Allowance
   
Charge-offs
   
Recoveries
   
Provision
   
Ending
Allowance
 
One-to four- family
 
$
1,713
   
$
-
   
$
-
   
$
(55
)
 
$
1,658
 
Home equity
   
501
     
(14
)
   
10
     
(73
)
   
424
 
Commercial and multifamily
   
1,377
     
-
     
-
     
(17
)
   
1,360
 
Construction and land
   
388
     
-
     
18
     
(33
)
   
373
 
Manufactured homes
   
189
     
-
     
2
     
(14
)
   
177
 
Other consumer
   
221
     
(10
)
   
15
     
(28
)
   
198
 
Commercial business
   
171
     
-
     
-
     
10
     
181
 
Unallocated
   
278
     
-
     
-
     
210
     
488
 
Total
 
$
4,838
   
$
(24
)
 
$
45
   
$
0
   
$
4,859
 

The following table summarizes the activity in the allowance for loan losses for the nine months ended September 30, 2016 (in thousands):

   
Beginning
Allowance
   
Charge-offs
   
Recoveries
   
Provision
   
Ending
Allowance
 
One-to four- family
 
$
1,839
   
$
(72
)
 
$
-
   
$
(109
)
 
$
1,658
 
Home equity
   
607
     
(14
)
   
-
     
(169
)
   
424
 
Commercial and multifamily
   
921
     
-
     
-
     
439
     
1,360
 
Construction and land
   
382
     
-
     
18
     
(27
)
   
373
 
Manufactured homes
   
301
     
-
     
75
     
(199
)
   
177
 
Other consumer
   
188
     
(31
)
   
7
     
34
     
198
 
Commercial business
   
157
     
(29
)
   
19
     
34
     
181
 
Unallocated
   
241
     
-
     
-
     
247
     
488
 
Total
 
$
4,636
   
$
(146
)
 
$
119
   
$
250
   
$
4,859
 
 
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)

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

   
Beginning
Allowance
   
Charge-offs
   
Recoveries
   
Provision
   
Ending
Allowance
 
One-to four- family
 
$
1,594
   
$
-
   
$
-
   
$
174
   
$
1,768
 
Home equity
   
509
     
-
     
25
     
(15
)
   
519
 
Commercial and multifamily
   
1,507
     
-
     
-
     
(166
)
   
1,341
 
Construction and land
   
345
     
-
     
1
     
(229
)
   
117
 
Manufactured homes
   
193
     
-
     
-
     
(1
)
   
192
 
Other consumer
   
183
     
(18
)
   
2
     
2
     
169
 
Commercial business
   
145
     
-
     
-
     
(11
)
   
134
 
Unallocated
   
96
     
-
     
-
     
346
     
442
 
Total
 
$
4,572
   
$
(18
)
 
$
28
   
$
100
   
$
4,682
 

The following table summarizes the activity in the allowance for loan losses for the nine months ended September 30, 2015 (in thousands):

   
Beginning
Allowance
   
Charge-offs
   
Recoveries
   
Provision
   
Ending
Allowance
 
One-to four- family
 
$
1,442
   
$
(21
)
 
$
-
   
$
347
   
$
1,768
 
Home equity
   
601
     
(19
)
   
35
     
(98
)
   
519
 
Commercial and multifamily
   
1,244
     
-
     
-
     
97
     
1,341
 
Construction and land
   
399
     
(40
)
   
1
     
(242
)
   
117
 
Manufactured homes
   
193
     
(32
)
   
5
     
24
     
192
 
Other consumer
   
167
     
(45
)
   
11
     
37
     
169
 
Commercial business
   
108
     
-
     
-
     
26
     
134
 
Unallocated
   
233
     
-
     
-
     
209
     
442
 
Total
 
$
4,387
   
$
(157
)
 
$
52
   
$
400
   
$
4,682
 

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”), the Bank’s federal regulatory, and the Washington Department of Financial Institutions, the Bank’s state banking regulator, 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 September 30, 2016 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
 
$
148,008
   
$
29,106
   
$
164,970
   
$
58,057
   
$
15,277
   
$
25,496
   
$
26,037
   
$
466,951
 
Watch
   
1,167
     
537
     
1,943
     
845
     
77
     
51
     
22
     
4,642
 
Special Mention
   
1,408
     
-
     
-
     
-
     
31
     
-
     
-
     
1,439
 
Substandard
   
1,409
     
654
     
3,345
     
-
     
140
     
23
     
380
     
5,951
 
Doubtful
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Loss
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Total
 
$
151,992
   
$
30,297
   
$
170,258
   
$
58,902
   
$
15,525
   
$
25,570
   
$
26,439
   
$
478,983
 
 
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)

The following table represents the internally assigned grades as of December 31, 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
 
$
136,879
   
$
30,310
   
$
169,072
   
$
55,984
   
$
13,621
   
$
22,967
   
$
18,449
   
$
447,282
 
Watch
   
1,015
     
609
     
4,810
     
1,059
     
96
     
58
     
846
     
8,493
 
Special Mention
   
1,409
     
-
     
1,430
     
-
     
33
     
-
     
-
     
2,872
 
Substandard
   
1,822
     
654
     
-
     
-
     
48
     
5
     
-
     
2,529
 
Doubtful
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Loss
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Total
 
$
141,125
   
$
31,573
   
$
175,312
   
$
57,043
   
$
13,798
   
$
23,030
   
$
19,295
   
$
461,176
 

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 September 30, 2016 and December 31, 2015, by type of loan (in thousands):

   
September
30, 2016
   
December
31, 2015
 
One- to four- family
 
$
1,189
   
$
1,157
 
Home equity
   
427
     
344
 
Commercial and multifamily
   
2,337
     
-
 
Construction and land
   
-
     
-
 
Manufactured homes
   
112
     
27
 
Other consumer
   
154
     
-
 
Total
 
$
4,219
   
$
1,528
 

The following table represents the aging of the recorded investment in past due loans as of September 30, 2016 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
 
$
-
   
$
459
   
$
977
   
$
-
   
$
1,436
   
$
150,556
   
$
151,992
 
Home equity
   
348
     
153
     
231
     
-
     
732
     
29,565
     
30,297
 
Commercial and multifamily
   
-
     
-
     
228
     
-
     
228
     
170,030
     
170,258
 
Construction and land
   
-
     
-
     
-
     
-
     
-
     
58,902
     
58,902
 
Manufactured homes
   
177
     
-
     
112
     
-
     
289
     
15,236
     
15,525
 
Other consumer
   
1
     
28
     
-
     
-
     
29
     
25,541
     
25,570
 
Commercial business
   
147
     
-
     
-
     
-
     
147
     
26,292
     
26,439
 
Total
 
$
673
   
$
640
   
$
1,548
   
$
-
   
$
2,861
   
$
476,122
   
$
478,983
 

The following table represents the aging of the recorded investment in past due loans as of December 31, 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
 
$
2,453
   
$
265
   
$
881
   
$
117
   
$
3,716
   
$
137,409
   
$
141,125
 
Home equity
   
352
     
60
     
296
     
-
     
708
     
30,865
     
31,573
 
Commercial and multifamily
   
203
     
-
     
-
     
-
     
203
     
175,109
     
175,312
 
Construction and land
   
65
     
-
     
-
     
-
     
65
     
56,978
     
57,043
 
Manufactured homes
   
103
     
27
     
-
     
-
     
130
     
13,668
     
13,798
 
Other consumer
   
17
     
26
     
-
     
-
     
43
     
22,987
     
23,030
 
Commercial business
   
154
     
8
     
-
     
-
     
162
     
19,133
     
19,295
 
Total
 
$
3,347
   
$
386
   
$
1,177
   
$
117
   
$
5,027
   
$
456,149
   
$
461,176
 
 
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)

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 nine months) to be considered performing or TDRs that have become 30 or more days past due.

The following table represents the credit risk profile of our loan portfolio based on payment activity as of September 30, 2016 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
 
$
150,437
   
$
29,717
   
$
167,921
   
$
58,902
   
$
15,377
   
$
25,570
   
$
26,190
   
$
474,114
 
Nonperforming
   
1,555
     
580
     
2,337
     
-
     
148
     
-
     
249
     
4,869
 
Total
 
$
151,992
   
$
30,297
   
$
170,258
   
$
58,902
   
$
15,525
   
$
25,570
   
$
26,439
   
$
478,983
 

The following table represents the credit risk profile of our loan portfolio based on payment activity as of December 31, 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
 
$
139,484
   
$
31,146
   
$
175,312
   
$
57,043
   
$
13,736
   
$
23,030
   
$
19,295
   
$
459,046
 
Nonperforming
   
1,641
     
427
     
-
     
-
     
62
     
-
     
-
     
2,130
 
Total
 
$
141,125
   
$
31,573
   
$
175,312
   
$
57,043
   
$
13,798
   
$
23,030
   
$
19,295
   
$
461,176
 

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.
 
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (unaudited)

Impaired loans at September 30, 2016  and December 31, 2015 by type of loan were as follows (in thousands):

   
September 30, 2016
 
         
Recorded Investment
       
   
Unpaid
Principal
Balance
   
Without
Allowance
   
With
Allowance
   
Related
Allowance
 
                         
One- to four- family
 
$
5,617
   
$
2,405
   
$
2,873
   
$
629
 
Home equity
   
985
     
445
     
440
     
97
 
Commercial and multifamily
   
3,871
     
1,237
     
2,632
     
389
 
Construction and land
   
85
     
-
     
85
     
23
 
Manufactured homes
   
387
     
112
     
260
     
53
 
Other consumer
   
23
     
-
     
23
     
23
 
Commercial business
   
638
     
146
     
487
     
30
 
Total
 
$
11,606
   
$
4,345
   
$
6,800
   
$
1,244
 
                                 
   
December 31, 2015