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EX-32 - EXHIBIT 32 - Sound Financial Bancorp, Inc.ex32.htm
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EX-10.14 - EXHIBIT 10.14 - Sound Financial Bancorp, Inc.ex10_14.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, 2017
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from               to

COMMISSION FILE NUMBER 001-35633

Sound Financial Bancorp, Inc.
(Exact Name of Registrant as Specified in its Charter)

Maryland
 
45-5188530
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
2400 3rd Avenue, Suite 150, Seattle, Washington
 
98121
(Address of principal executive offices)
 
(Zip Code)

Registrant's telephone number, including area code:  (206) 448-0884

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 check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See the definitions of "large accelerated filer," accelerated filer," "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer
Accelerated filer
 
 
Non-accelerated filer
Smaller reporting company
(Do not check if a smaller reporting company)
 
 
Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  YES     NO
 
Indicate the number of shares outstanding of each of the registrant's classes of common stock as of the latest practicable date.

As of November 8, 2017, there were 2,510,045 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
 
 
 
Condensed Consolidated Balance Sheets as of September 30, 2017 and December 31, 2016 (unaudited)
3
 
 
Condensed Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2017 and 2016 (unaudited)
4
 
 
Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2017 and 2016 (unaudited)
5
 
 
Condensed Consolidated Statements of Stockholders' Equity for the Nine Months Ended September 30, 2017 and 2016 (unaudited)
6
 
 
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2017 and 2016 (unaudited)
7
 
 
Selected Notes to Condensed Consolidated Financial Statements (unaudited)
8
 
 
Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations
25
 
 
Item 3.    Quantitative and Qualitative Disclosures About Market Risk
33
 
 
Item 4.    Controls and Procedures
33
 
 
PART II   OTHER INFORMATION
 
 
 
Item 1.    Legal Proceedings
34
 
 
Item 1A. Risk Factors
34
 
 
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds
34
 
 
Item 3.    Defaults Upon Senior Securities
34
 
 
Item 4.    Mine Safety Disclosures
35
 
 
Item 5.    Other Information
34
 
 
Item 6.    Exhibits
34
 
 
SIGNATURES
36
 
 
EXHIBITS
38
 


SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Condensed Consolidated Balance Sheets (unaudited)
(In thousands, except share and per share amounts)
 
 
 
September 30,
2017
   
December 31,
2016
 
ASSETS
           
Cash and cash equivalents
 
$
60,651
   
$
54,582
 
Available-for-sale securities, at fair value
   
5,688
     
6,604
 
Loans held for sale
   
296
     
871
 
Loans
   
528,208
     
500,001
 
Allowance for loan losses
   
(4,991
)
   
(4,822
)
Total loans, net
   
523,217
     
495,179
 
Accrued interest receivable
   
1,943
     
1,816
 
Bank-owned life insurance ("BOLI"), net
   
12,602
     
12,082
 
Other real estate owned ("OREO") and repossessed assets, net
   
1,032
     
1,172
 
Mortgage servicing rights, at fair value
   
3,370
     
3,561
 
Federal Home Loan Bank ("FHLB") stock, at cost
   
1,825
     
2,840
 
Premises and equipment, net
   
7,338
     
5,549
 
Other assets
   
4,574
     
4,127
 
Total assets
 
$
622,536
   
$
588,383
 
LIABILITIES
               
Deposits
               
Interest-bearing
 
$
448,291
   
$
403,990
 
Noninterest-bearing demand
   
76,526
     
63,741
 
Total deposits
   
524,817
     
467,731
 
Borrowings
   
28,000
     
54,792
 
Accrued interest payable
   
68
     
73
 
Other liabilities
   
5,241
     
4,874
 
Advance payments from borrowers for taxes and insurance
   
1,066
     
638
 
Total liabilities
   
559,192
     
528,108
 
COMMITMENTS AND CONTINGENCIES (NOTE 7)
               
STOCKHOLDERS' EQUITY
               
Preferred stock, $0.01 par value, 10,000,000 shares authorized, none issued or outstanding
   
-
     
-
 
Common stock, $0.01 par value, 40,000,000 shares authorized, 2,510,045 and 2,498,804 shares issued and outstanding as of September 30, 2017 and December 31, 2016, respectively
   
25
     
25
 
Additional paid-in capital
   
24,297
     
23,979
 
Unearned shares - Employee Stock Ownership Plan ("ESOP")
   
(683
)
   
(683
)
Retained earnings
   
39,558
     
36,873
 
Accumulated other comprehensive income, net of tax
   
147
     
81
 
Total stockholders' equity
   
63,344
     
60,275
 
Total liabilities and stockholders' equity
 
$
622,536
   
$
588,383
 
 
See notes to condensed consolidated financial statements


 
SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Income (unaudited)
(In thousands, except share and per share amounts)
 
 
 
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
 
 
2017
   
2016
   
2017
   
2016
 
INTEREST INCOME
                       
Loans, including fees
 
$
6,832
   
$
6,050
   
$
19,630
   
$
18,053
 
Interest and dividends on investments, cash and cash equivalents
   
234
     
98
     
544
     
279
 
Total interest income
   
7,066
     
6,148
     
20,174
     
18,332
 
INTEREST EXPENSE
                               
Deposits
   
808
     
678
     
2,199
     
2,020
 
Borrowings
   
72
     
52
     
238
     
136
 
Total interest expense
   
880
     
730
     
2,437
     
2,156
 
Net interest income
   
6,186
     
5,418
     
17,737
     
16,176
 
PROVISION FOR LOAN LOSSES
   
250
     
-
     
250
     
250
 
Net interest income after provision for loan losses
   
5,936
     
5,418
     
17,487
     
15,926
 
NONINTEREST INCOME
                               
Service charges and fee income
   
439
     
743
     
1,442
     
1,988
 
Earnings on cash surrender value of bank-owned life insurance
   
82
     
84
     
245
     
252
 
Mortgage servicing income
   
18
     
239
     
399
     
462
 
Net gain on sale of loans
   
287
     
477
     
720
     
1,028
 
Total noninterest income
   
826
     
1,543
     
2,806
     
3,730
 
NONINTEREST EXPENSE
                               
Salaries and benefits
   
2,777
     
2,632
     
8,130
     
7,813
 
Operations
   
1,002
     
1,181
     
3,052
     
3,237
 
Regulatory assessments
   
80
     
124
     
340
     
404
 
Occupancy
   
520
     
376
     
1,415
     
1,141
 
Data processing
   
448
     
434
     
1,293
     
1,264
 
Net loss on OREO and repossessed assets
   
109
     
3
     
123
     
9
 
Total noninterest expense
   
4,936
     
4,750
     
14,353
     
13,868
 
Income before provision for income taxes
   
1,826
     
2,211
     
5,940
     
5,788
 
Provision for income taxes
   
604
     
757
     
2,001
     
1,974
 
Net income
 
$
1,222
   
$
1,454
   
$
3,939
   
$
3,814
 
 
                               
Earnings per common share:
                               
Basic
 
$
0.49
   
$
0.58
   
$
1.57
   
$
1.54
 
Diluted
 
$
0.48
   
$
0.57
   
$
1.54
   
$
1.48
 
Weighted-average number of common shares outstanding:
                               
Basic
   
2,506,863
     
2,490,089
     
2,502,399
     
2,483,004
 
Diluted
   
2,562,373
     
2,568,457
     
2,562,606
     
2,556,949
 
 
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,
 
 
 
2017
   
2016
   
2017
   
2016
 
Net income
 
$
1,222
   
$
1,454
   
$
3,939
   
$
3,814
 
Available for sale securities:
                               
Unrealized gains/(losses) arising during the period, net of tax provision/(benefit) of $4, $(19), $34 and $13, respectively
   
8
     
(35
)
   
66
     
23
 
Other comprehensive income, net of tax
   
8
     
(35
)
   
66
     
23
 
Comprehensive income
 
$
1,230
   
$
1,419
   
$
4,005
   
$
3,837
 
 
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, 2017  and 2016 (unaudited)
(In thousands, except share and per share amounts)
 
 
 
Shares
   
Common
Stock
   
Additional Paid
-in Capital
   
Unearned
ESOP Shares
   
Retained
Earnings
   
Accumulated
Other
Comprehensive
Income, net of
tax
   
Total
Stockholders'
Equity
 
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
)
Common Stock repurchase in conjunction with stock option exercise
   
(2,805
)
                                           
-
 
Restricted stock awards issued
   
11,606
                                             
-
 
Restricted stock forfeited and retired
   
(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
 
 
 
 
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, 2016
   
2,498,804
   
$
25
   
$
23,979
   
$
(683
)
 
$
36,873
   
$
81
   
$
60,275
 
Net income
                                   
3,939
             
3,939
 
Other comprehensive income, net of tax
                                           
66
     
66
 
Share-based compensation
                   
285
                             
285
 
Cash dividends paid on common stock ($0.50 per share)
                                   
(1,254
)
           
(1,254
)
Common stock surrendered
   
(3,353
)
                                           
-
 
Restricted stock awards issued
   
576
                                             
-
 
Exercise of options
   
14,018
             
33
                             
33
 
Balances at September 30, 2017
   
2,510,045
   
$
25
   
$
24,297
   
$
(683
)
 
$
39,558
   
$
147
   
$
63,344
 
 
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,
 
 
 
2017
   
2016
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net income
 
$
3,939
   
$
3,814
 
Adjustments to reconcile net income to net cash from operating activities:
               
Accretion of net discounts on investments
   
(16
)
   
32
 
Provision for loan losses
   
250
     
250
 
Depreciation and amortization
   
706
     
593
 
Compensation expense related to stock options and restricted stock
   
285
     
354
 
Net change in mortgage servicing rights
   
191
     
210
 
Increase in cash surrender value of BOLI
   
(245
)
   
(252
)
Net gain on sale of loans
   
(720
)
   
(1,028
)
Proceeds from sale of loans
   
35,818
     
58,464
 
Originations of loans held-for-sale
   
(34,522
)
   
(57,769
)
Net loss on sale and write-downs of OREO and repossessed assets
   
109
     
3
 
Change in operating assets and liabilities:
               
Accrued interest receivable
   
(127
)
   
(22
)
Other assets
   
(482
)
   
(330
)
Accrued interest payable
   
(5
)
   
(10
)
Other liabilities
   
367
     
719
 
Net cash provided by operating activities
   
5,548
     
5,028
 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Proceeds from principal payments, maturities and sales of available-for-sale securities
   
1,032
     
1,008
 
Purchases of available-for-sale securities
   
-
     
(1,363
)
FHLB stock redeemed
   
1,015
     
66
 
Net increase in loans
   
(28,505
)
   
(17,873
)
Purchase of BOLI
   
(275
)
   
-
 
Proceeds from sale of OREO and other repossessed assets
   
248
     
131
 
Purchases of premises and equipment, net
   
(2,495
)
   
(532
)
Net cash received from branch acquisition
   
13,671
     
-
 
Net cash used by investing activities
   
(15,309
)
   
(18,563
)
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Net increase in deposits
   
43,415
     
23,459
 
Proceeds from borrowings
   
137,000
     
106,000
 
Repayment of borrowings
   
(163,792
)
   
(108,982
)
Dividends paid on common stock
   
(1,254
)
   
(558
)
Net change in advances from borrowers for taxes and insurance
   
428
     
463
 
Proceeds from stock option exercises
   
33
     
164
 
Net cash used by financing activities
   
15,830
     
20,546
 
Net change in cash and cash equivalents
   
6,069
     
7,011
 
Cash and cash equivalents, beginning of period
   
54,582
     
48,264
 
Cash and cash equivalents, end of period
 
$
60,651
   
$
55,275
 
 
               
SUPPLEMENTAL CASH FLOW INFORMATION:
               
Cash paid for income taxes
 
$
1,910
   
$
2,290
 
Interest paid on deposits and borrowings
   
2,442
     
2,166
 
Noncash net transfer from loans to OREO and repossessed assets
   
-
     
249
 
Assets acquired in acquisition of branch
   
14,474
     
-
 
 
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 references to the "Bank" refer to Sound Community Bank. References to "we," "us," and "our" or the "Company" refers to Sound Financial Bancorp and its wholly-owned 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, 2016, as filed with the SEC on March 27, 2017 ("2016 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, 2016, included in the 2016 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 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 recognized at the date of initial application. As a financial institution, the Company's largest component of revenue, interest income, is excluded from the scope of this ASU. Accordingly, the adoption of ASU No. 2014-09 is not expected to have a material impact 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 adoption of ASU No. 2016-01is not expected to have a material impact on the Company's consolidated financial statements. Management is in the planning stages of developing processes and procedures to comply with the disclosure requirements of this ASU, which could impact the disclosures the Company makes related to the fair value of its financial instruments.
 
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. Although an estimate of the impact of the new leasing standard has not yet been determined, once adopted, we expect to report higher assets and liabilities as a result of including right-of-use assets and lease liabilities related to certain banking offices and certain equipment under noncancelable operating lease agreements, however, based on current leases the adoption is not expected to have a material impact 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 has begun the process to implement this new standard by working with a vendor that specializes in this area.  While the Company has not quantified the impact of this ASU, it does expect changing from the current incurred loss model to an expected loss model will result in an earlier recognition of losses. The Company also expects that once adopted the allowance for loan losses will increase, however, until its evaluation is complete the magnitude of the increase will be unknown.
 
In 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.
 
In March 2017, the FASB issued ASU 2017-08, Receivables-Nonrefundable Fees and Other Costs (Subtopic 310-20). ASU 2017-08 is intended to amend the amortization period for certain purchased callable debt securities held at a premium. Under ASU 2017-08, the FASB is shortening the amortization period for the premium to the earliest call date. Under current GAAP, entities generally amortize the premium as an adjustment of yield over the contractual life of the instrument. ASU 2017-08 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018. The Company is reviewing its securities portfolio to assess the impact the adoption of this ASU will have on the Company's consolidated financial statements but does not expect this ASU to have a material impact on the Company's consolidated financial statements.
 
In May 2017, the FASB issued ASU No. 2017-09, Compensation--Stock Compensation (Topic 718): Scope of Modification Accounting. The ASU was issued to provide clarity as to when to apply modification accounting when there is a change in the terms or conditions of a share-based payment award. According to this ASU, an entity should account for the effects of a modification unless the fair value, vesting conditions, and balance sheet classification of the award is the same after the modification as compared to the original award prior to the modification. The standard is effective for reporting periods beginning after December 15, 2017, with early adoption permitted. The adoption of ASU No. 2017-09 is not expected to have a material impact on the Company's consolidated financial statements.

In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. This ASU amends the hedge accounting recognition and presentation requirements in ASC 815 to (1) improve the transparency and understandability of information conveyed to financial statement users about an entity's risk management activities by better aligning the entity's financial reporting for hedging relationships with those risk management activities and (2) reduce the complexity of and simplify the application of hedge accounting by preparers. The amendments in this ASU permit hedge accounting for hedging relationships involving nonfinancial risk and interest rate risk by removing certain limitations in cash flow and fair value hedging relationships. In addition, the ASU requires an entity to present the earnings effect of the hedging instrument in the same income statement line item in which the earnings effect of the hedged item is reported. The amendments in this ASU are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018 and early adoption is permitted. The adoption of ASU No. 2017-12 is not expected 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, 2017
                       
Municipal bonds
 
$
3,245
   
$
175
   
$
(3
)
 
$
3,417
 
Agency mortgage-backed securities
   
2,221
     
50
     
-
     
2,271
 
Total
 
$
5,466
   
$
225
   
$
(3
)
 
$
5,688
 
 
                               
December 31, 2016
                               
Municipal bonds
 
$
3,262
   
$
127
   
$
(36
)
 
$
3,353
 
Agency mortgage-backed securities
   
2,858
     
49
     
(3
)
   
2,904
 
Non-agency mortgage-backed securities
   
362
     
-
     
(15
)
   
347
 
Total
 
$
6,482
   
$
176
   
$
(54
)
 
$
6,604
 
 

The amortized cost and fair value of AFS securities at September 30, 2017, by contractual maturity, are shown below (in thousands).  Expected maturities of AFS securities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.  Investments not due at a single maturity date, primarily mortgage-backed investments, are shown separately.
 
 
 
September 30, 2017
 
 
 
Amortized
Cost
   
Fair
Value
 
Due after one year through five years
 
$
1,333
   
$
1,329
 
Due after five years through ten years
   
413
     
443
 
Due after ten years
   
1,499
     
1,645
 
Mortgage-backed securities
   
2,221
     
2,271
 
Total
 
$
5,466
   
$
5,688
 

There were no pledged securities at September 30, 2017 and December 31, 2016.
 
There were no sales of AFS securities during the three or nine months ended September 30, 2017 and 2016.

The following tables summarize the aggregate fair value and gross unrealized loss by length of time of those investments that have been in a continuous unrealized loss position at the dates indicated (in thousands):
 
 
 
September 30, 2017
 
 
 
Less Than 12 Months
   
12 Months or Longer
   
Total
 
 
 
Fair
Value
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
 
Municipal bonds
 
$
456
   
$
(1
)
 
$
874
   
$
(2
)
 
$
1,330
   
$
(3
)
Agency mortgage-backed securities
   
-
     
-
     
-
     
-
     
-
     
-
 
Total
 
$
456
   
$
(1
)
 
$
874
   
$
(2
)
 
$
1,330
   
$
(3
)
 
 
 
December 31, 2016
 
 
 
Less Than 12 Months
   
12 Months or Longer
   
Total
 
 
 
Fair
Value
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
 
Municipal bonds
 
$
1,313
   
$
(36
)
 
$
-
   
$
-
   
$
1,313
   
$
(36
)
Agency mortgage-backed securities
   
-
     
-
     
1,125
     
(3
)
   
1,125
     
(3
)
Non-agency mortgage-backed securities
   
-
     
-
     
347
     
(15
)
   
347
     
(15
)
Total
 
$
1,313
   
$
(36
)
 
$
1,472
   
$
(18
)
 
$
2,785
   
$
(54
)

There were no credit losses recognized in earnings during the three and nine months ended September 30, 2017 or 2016 relating to the Company's securities.
 
At September 30, 2017, two municipal securities were in an unrealized loss position for less than 12 months and one municipal security was in an unrealized loss position for over 12 months.  At December 31, 2016, three municipal securities were in an unrealized loss position for less than 12 months and one agency security and one non-agency mortgage-backed security were in a loss position for over 12 months.  The agency mortgage-backed security in an unrealized loss position at December 31, 2016 was guaranteed by a U.S. governmental agency.  The non-agency mortgage-backed security was fully redeemed during the third quarter of 2017.  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") during the three and nine months ended September 30, 2017 or the year ended December 31, 2016.
 

Note 4 – Loans

The composition of the loan portfolio at the dates indicated, excluding loans held-for-sale, was as follows (in thousands):
 
 
 
September 30,
2017
   
December 31,
2016
 
Real estate loans:
           
One- to four- family
 
$
156,871
   
$
152,386
 
Home equity
   
29,129
     
27,771
 
Commercial and multifamily
   
201,411
     
181,004
 
Construction and land
   
54,921
     
70,915
 
Total real estate loans
 
$
442,332
   
$
432,076
 
Consumer loans:
               
Manufactured homes
   
16,864
     
15,494
 
Floating homes
   
26,699
     
23,996
 
Other consumer
   
5,032
     
3,932
 
Total consumer loans
   
48,595
     
43,422
 
Commercial business loans
   
39,158
     
26,331
 
Total loans
   
530,085
     
501,829
 
Deferred fees
   
(1,877
)
   
(1,828
)
Total loans, gross
   
528,208
     
500,001
 
Allowance for loan losses
   
(4,991
)
   
(4,822
)
Total loans, net
 
$
523,217
   
$
495,179
 

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, 2017 (in thousands):
 
 
 
One- to
four-
family
   
Home
equity
   
Commercial
and
multifamily
   
Construction
and land
   
Manufactured
homes
   
Floating
homes
   
Other
consumer
   
Commercial
business
   
Unallocated
   
Total
 
Allowance for loan losses:
                                                           
Individually evaluated for impairment
 
$
377
   
$
168
   
$
-
   
$
32
   
$
70
   
$
-
   
$
57
   
$
276
   
$
-
   
$
980
 
Collectively evaluated for impairment
   
874
     
183
     
1,185
     
327
     
110
     
154
     
41
     
231
     
906
     
4,011
 
Ending balance
 
$
1,251
   
$
351
   
$
1,185
   
$
359
   
$
180
   
$
154
   
$
98
   
$
507
   
$
906
   
$
4,991
 
Loans receivable:
                                                                               
Individually evaluated for impairment
 
$
6,664
   
$
1,007
   
$
1,717
   
$
99
   
$
309
   
$
-
   
$
57
   
$
357
   
$
-
   
$
10,210
 
Collectively evaluated for impairment
   
150,207
     
28,122
     
199,694
     
54,822
     
16,555
     
26,699
     
4,975
     
38,801
     
-
     
519,875
 
Ending balance
 
$
156,871
   
$
29,129
   
$
201,411
   
$
54,921
   
$
16,864
   
$
26,699
   
$
5,032
   
$
39,158
   
$
-
   
$
530,085
 

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, 2016 (in thousands):

 
 
One- to
four-
family
   
Home
equity
   
Commercial
and
multifamily
   
Construction
and land
   
Manufactured
homes
   
Floating
homes
   
Other
consumer
   
Commercial
business
   
Unallocated
   
Total
 
Allowance for loan losses:
                                                           
Individually evaluated for impairment
 
$
536
   
$
121
   
$
24
   
$
35
   
$
59
   
$
-
   
$
65
   
$
23
   
$
-
   
$
863
 
Collectively evaluated for impairment
   
1,006
     
257
     
1,120
     
424
     
109
     
132
     
47
     
152
     
712
     
3,959
 
Ending balance
 
$
1,542
   
$
378
   
$
1,144
   
$
459
   
$
168
   
$
132
   
$
112
   
$
175
   
$
712
   
$
4,822
 
Loans receivable:
                                                                               
Individually evaluated for impairment
 
$
4,749
   
$
832
   
$
1,582
   
$
83
   
$
312
   
$
-
   
$
62
   
$
616
   
$
-
   
$
8,236
 
Collectively evaluated for impairment
   
147,637
     
26,939
     
179,422
     
70,832
     
15,182
     
23,996
     
3,870
     
25,715
     
-
     
493,593
 
Ending balance
 
$
152,386
   
$
27,771
   
$
181,004
   
$
70,915
   
$
15,494
   
$
23,996
   
$
3,932
   
$
26,331
   
$
-
   
$
501,829
 
 

The following table summarizes the activity in the allowance for loan losses for the three months ended September 30, 2017 (in thousands):

 
 
Beginning
Allowance
   
Charge-offs
   
Recoveries
   
Provision
   
Ending
Allowance
 
One- to four- family
 
$
1,302
   
$
-
   
$
-
   
$
(51
)
 
$
1,251
 
Home equity
   
431
     
(89
)
   
1
     
8
     
351
 
Commercial and multifamily
   
1,153
     
-
     
-
     
32
     
1,185
 
Construction and land
   
352
     
-
     
-
     
7
     
359
 
Manufactured homes
   
178
     
(7
)
   
-
     
9
     
180
 
Floating homes
   
146
     
-
     
-
     
8
     
154
 
Other consumer
   
98
     
(1
)
   
2
     
(1
)
   
98
 
Commercial business
   
364
     
-
     
-
     
143
     
507
 
Unallocated
   
811
     
-
     
-
     
95
     
906
 
Total
 
$
4,835
   
$
(97
)
 
$
3
   
$
250
   
$
4,991
 
 
The following table summarizes the activity in the allowance for loan losses for the nine months ended September 30, 2017 (in thousands):
 
 
 
Beginning
Allowance
   
Charge-offs
   
Recoveries
   
Provision
   
Ending
Allowance
 
One- to four- family
 
$
1,542
   
$
-
   
$
-
   
$
(291
)
 
$
1,251
 
Home equity
   
378
     
(89
)
   
30
     
32
     
351
 
Commercial and multifamily
   
1,144
     
(24
)
   
1
     
64
     
1,185
 
Construction and land
   
459
     
-
     
-
     
(100
)
   
359
 
Manufactured homes
   
168
     
(13
)
   
3
     
22
     
180
 
Floating homes
   
132
     
-
     
-
     
22
     
154
 
Other consumer
   
112
     
(8
)
   
19
     
(25
)
   
98
 
Commercial business
   
175
     
-
     
-
     
332
     
507
 
Unallocated
   
712
     
-
     
-
     
194
     
906
 
Total
 
$
4,822
   
$
(134
)
 
$
53
   
$
250
   
$
4,991
 
 
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
 
Floating homes
   
132
     
-
     
-
     
-
     
132
 
Other consumer
   
89
     
(10
)
   
15
     
(28
)
   
66
 
Commercial business
   
171
     
-
     
-
     
10
     
181
 
Unallocated
   
278
     
-
     
-
     
210
     
488
 
Total
 
$
4,838
   
$
(24
)
 
$
45
   
$
-
   
$
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
 
Floating homes
   
111
     
-
     
-
     
21
     
132
 
Other consumer
   
77
     
(31
)
   
7
     
13
     
66
 
Commercial business
   
157
     
(29
)
   
19
     
34
     
181
 
Unallocated
   
241
     
-
     
-
     
247
     
488
 
Total
 
$
4,636
   
$
(146
)
 
$
119
   
$
250
   
$
4,859
 


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 regulator, and the Washington Department of Financial Institutions ("WDFI"), 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, 2017, by type of loan (in thousands):
 
 
 
One- to
four- family
   
Home
equity
   
Commercial
and multifamily
   
Construction
and land
   
Manufactured
homes
   
Floating
homes
   
Other
consumer
   
Commercial
business
   
Total
 
Grade:
                                                     
Pass
 
$
151,786
   
$
28,321
   
$
192,817
   
$
54,872
   
$
16,711
   
$
26,699
   
$
4,975
   
$
38,396
   
$
514,577
 
Watch
   
246
     
-
     
6,876
     
-
     
-
     
-
     
-
     
494
     
7,616
 
Special Mention
   
138
     
-
     
360
     
-
     
-
     
-
     
-
     
134
     
632
 
Substandard
   
4,701
     
808
     
1,358
     
49
     
153
     
-
     
57
     
134
     
7,260
 
Doubtful
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Loss
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Total
 
$
156,871
   
$
29,129
   
$
201,411
   
$
54,921
   
$
16,864
   
$
26,699
   
$
5,032
   
$
39,158
   
$
530,085
 
 
The following table represents the internally assigned grades as of December 31, 2016, by type of loan (in thousands):
 
 
 
One- to
four- family
   
Home
equity
   
Commercial
and multifamily
   
Construction
and land
   
Manufactured
homes
   
Floating
homes
   
Other
consumer
   
Commercial
business
   
Total
 
Grade:
                                                     
Pass
 
$
148,617
   
$
26,547
   
$
171,678
   
$
67,539
   
$
15,288
   
$
23,996
   
$
3,821
   
$
25,625
   
$
483,111
 
Watch
   
998
     
536
     
8,105
     
3,376
     
78
     
-
     
49
     
326
     
13,468
 
Special Mention
   
139
     
-
     
-
     
-
     
30
     
-
     
-
     
-
     
169
 
Substandard
   
2,632
     
688
     
1,221
     
-
     
98
     
-
     
62
     
380
     
5,081
 
Doubtful
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Loss
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Total
 
$
152,386
   
$
27,771
   
$
181,004
   
$
70,915
   
$
15,494
   
$
23,996
   
$
3,932
   
$
26,331
   
$
501,829
 

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, 2017, and December 31, 2016, by type of loan (in thousands):
 
 
 
September 30,
2017
   
December 31,
2016
 
One- to four- family
 
$
878
   
$
2,169
 
Home equity
   
700
     
536
 
Commercial and multifamily
   
206
     
218
 
Construction and land
   
49
     
-
 
Manufactured homes
   
133
     
72
 
Commercial business
   
134
     
149
 
Total
 
$
2,100
   
$
3,144
 


The following table represents the aging of the recorded investment in past due loans as of September 30, 2017, 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
 
$
64
   
$
1,723
   
$
705
   
$
-
   
$
2,492
   
$
154,379
   
$
156,871
 
Home equity
   
346
     
28
     
607
     
-
     
981
     
28,148
     
29,129
 
Commercial and multifamily
   
206
     
-
     
-
     
-
     
206
     
201,205
     
201,411
 
Construction and land
   
43
     
49
     
49
     
-
     
141
     
54,780
     
54,921
 
Manufactured homes
   
23
     
103
     
107
     
-
     
233
     
16,631
     
16,864
 
Floating homes
   
-
     
-
     
-
     
-
     
-
     
26,699
     
26,699
 
Other consumer
   
49
     
6
     
-
     
-
     
55
     
4,977
     
5,032
 
Commercial business
   
409
     
47
     
-
     
-
     
456
     
38,702
     
39,158
 
Total
 
$
1,140
   
$
1,956
   
$
1,468
   
$
-
   
$
4,564
   
$
525,521
   
$
530,085
 
 
The following table represents the aging of the recorded investment in past due loans as of December 31, 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
 
$
2,476
   
$
161
   
$
1,787
   
$
-
   
$
4,424
   
$
147,962
   
$
152,386
 
Home equity
   
460
     
-
     
494
     
-
     
954
     
26,817
     
27,771
 
Commercial and multifamily
   
-
     
-
     
-
     
-
     
-
     
181,004
     
181,004
 
Construction and land
   
440
     
-
     
-
     
-
     
440
     
70,475
     
70,915
 
Manufactured homes
   
321
     
28
     
62
     
-
     
411
     
15,083
     
15,494
 
Floating homes
   
-
     
-
     
-
     
-
     
-
     
23,996
     
23,996
 
Other consumer
   
26
     
1
     
-
     
-
     
27
     
3,905
     
3,932
 
Commercial business
   
149
     
-
     
-
     
-
     
149
     
26,182
     
26,331
 
Total
 
$
3,872
   
$
190
   
$
2,343
   
$
-
   
$
6,405
   
$
495,424
   
$
501,829
 

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 interest.  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 has granted 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 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, 2017, by type of loan (in thousands):
 
 
 
One- to
four-
family
   
Home
equity
   
Commercial
and
multifamily
   
Construction
and land
   
Manufactured
homes
   
Floating
homes
   
Other
consumer
   
Commercial
business
   
Total
 
Performing
 
$
154,679