SOUND FINANCIAL BANCORP, INC.
This discussion and analysis reviews our consolidated financial statements and
other relevant statistical data and is intended to enhance your understanding of
our financial condition and results of operations. The information in this
section has been derived from the Consolidated Financial Statements and
footnotes thereto that appear in "Part II. Item 8. Financial Statements and
Supplementary Data" of this Form 10-K. The information contained in this section
should be read in conjunction with these Consolidated Financial Statements and
footnotes and the business and financial information provided in this Form 10-K.
Overview
Our principal business consists of attracting retail and commercial deposits
from the general public and investing those funds, along with borrowed funds, in
loans secured by first and second mortgages on one-to-four family residences
(including home equity loans and lines of credit), commercial and multifamily
real estate, construction and land, and consumer and commercial business
loans. Our commercial business loans include unsecured lines of credit and
secured term loans and lines of credit secured by inventory, equipment and
accounts receivable. We also offer a variety of secured and unsecured consumer
loan products, including manufactured home loans, floating home loans,
automobile loans, boat loans and recreational vehicle loans. As part of our
business, we focus on residential mortgage loan originations, a portion of which
we sell to Fannie Mae and other investors and the remainder of which we retain
for our loan portfolio consistent with our asset/liability objectives. We sell
loans which conform to the underwriting standards of Fannie Mae ("conforming")
in which we retain the servicing of the loan in order to maintain the direct
customer relationship and to generate noninterest income. Residential loans
which do not conform to the underwriting standards of Fannie Mae
("non-conforming"), are either held in our loan portfolio or sold with servicing
released. We originate and retain a significant amount of commercial real estate
loans, including those secured by owner-occupied and nonowner-occupied
commercial real estate, multifamily properties and mobile home parks, and
construction and land development loans.
We originated $125.6 million and $243.9 million of one-to-four family
residential mortgage loans during the years ended December 31, 2022 and 2021,
respectively. We had no purchases of one-to-four family residential mortgage
loans during the year ended December 31, 2022 and $24.1 million of purchases
during the year ended December 31, 2021 . During those two years, we sold $20.3
million and $147.4 million , respectively, of one-to-four family residential
mortgage loans.
Our strategic plan targets consumers, small- and medium-size businesses, and
professionals in our market area for loans and deposits. In managing the size
of, and concentrations within, our loan portfolio we typically focus on
including a significant amount of commercial business and commercial and
multifamily real estate loans. A significant portion of our commercial business
and commercial and multifamily real estate loans have adjustable rates, higher
yields and shorter terms, and higher credit risk than traditional residential
fixed-rate mortgage loans. During 2022, however, due to a generally illiquid
jumbo loan market, we retained a higher proportion of jumbo loans than we have
historically, resulting in commercial business and commercial and multifamily
real estate loans making up a lower percentage of our overall portfolio. Our
commercial loan portfolio (commercial and multifamily real estate and commercial
business loans) increased to $337.2 million at December 31, 2022 from $306.2
million at December 31, 2021 , but decreased as a percentage of our total loan
portfolio to 38.9% from 44.5% at December 31, 2022 and 2021, respectively. Our
consumer loan portfolio, which includes manufactured and floating homes and
other consumer loans, increased to $119.3 million or 13.8% of our loan portfolio
at December 31, 2022 , from $97.7 million or 14.2% of our loan portfolio at
December 31, 2021 .
Our operating revenues are derived principally from earnings on interest-earning
assets, service charges and fees, and gains on the sale of loans. The increasing
interest rate environment is expected to continue to put downward pressure on
our net gain on sale of loans, as well as increase borrowing costs which may
adversely affect our net interest income and net interest margin in 2023. Our
primary sources of funds are deposits (both retail and brokered), FHLB advances,
borrowings through the Federal Reserve , and payments received on loans and
securities. We offer a variety of deposit accounts that provide a wide range of
interest rates and terms, including savings, money market, NOW, interest-bearing
and noninterest-bearing demand accounts, and certificates of deposit.
An offset to net interest income is the provision for loan losses, or the
recapture of the provision for loan losses, that is required to establish the
allowance for loan losses at a level that adequately provides for probable
incurred losses in our loan portfolio. As our loan portfolio increases, or due
to an increase for probable incurred losses in our loan portfolio, our provision
for loan losses may increase, resulting in a decrease to net income.
Improvements in loan risk ratings, increases in property values, or receipt of
recoveries of amounts previously charged off may partially or fully offset any
required increase to allowance for loan losses due to loan growth or an increase
in probable incurred losses on loans. Our provision for loan losses was $1.2
million for the year ended December 31, 2022 , compared to $425 thousand for the
year ended December 31, 2021 , primarily due to loan growth.
49
--------------------------------------------------------------------------------
Table of Contents
Effective January 1, 2023 , the Company adopted Accounting Standards Update
("ASU") No. 2016-13, Financial Instruments - Credit Losses (Topic 326):
Measurement of Credit Losses on Financial Instruments, also known as CECL. CECL
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. Adoption of this
guidance is expected to result in an increase to our allowance for credit losses
and reserve for unfunded commitments totaling between $1.0 million to $2.0
million in the aggregate. This estimate may change as the Company continues to
improve and refine its processes and methodology. See "Note 2-Accounting
Pronouncements Recently Issued or Adopted" in the Notes to Consolidated
Financial Statements contained in "Part II. Item 8. Financial Statements and
Supplementary Data" of this report on Form 10-K.
Our noninterest expenses consist primarily of salaries, employee benefits,
incentive pay, expenses for occupancy, online and mobile services, marketing,
professional fees, data processing, charitable contributions, FDIC deposit
insurance premiums and regulatory expenses. Salaries and benefits consist
primarily of the salaries paid to our employees, payroll taxes, directors' fees,
retirement expenses, share-based compensation and other employee benefits.
Occupancy expenses, which are the fixed and variable costs of buildings and
equipment, consist primarily of lease payments, property taxes, depreciation
charges, maintenance and the cost of utilities.
Recent Accounting Standards
For a discussion of recent accounting standards, see "Note 2-Accounting Pronouncements Recently Issued or Adopted" in the Notes to Consolidated Financial Statements contained in "Part II. Item 8. Financial Statements and Supplementary Data" of this report on Form 10-K.
Critical Accounting Estimates
We prepare our consolidated financial statements in accordance with GAAP. In
doing so, we have to make estimates and assumptions. Our critical accounting
estimates are those estimates that involve a significant level of uncertainty at
the time the estimate was made, and changes in the estimate that are reasonably
likely to occur from period to period, or use of different estimates that we
reasonably could have used in the current period, would have a material impact
on our financial condition or results of operations. Accordingly, actual results
could differ materially from our estimates. We base our estimates on past
experience and other assumptions that we believe are reasonable under the
circumstances, and we evaluate these estimates on an ongoing basis. Facts and
circumstances that could affect these judgments include, but are not limited to,
changes in interest rates, changes in the performance of the economy and changes
in the financial condition of borrowers. We have reviewed our critical
accounting estimates with the audit committee of our Board of Directors.
See "Note 1-Organization and Significant Accounting Policies" in the Notes to
Consolidated Financial Statements contained in "Part II. Item 8. Financial
Statements and Supplementary Data" of this report on Form 10-K for a summary of
significant accounting policies.
Allowance for Loan Loss. The allowance for loan losses is the amount estimated
by management as necessary to cover losses inherent in the loan portfolio at the
balance sheet date. The allowance is established through the provision for loan
losses, which is charged to income. Determining the amount of the allowance for
loan losses necessarily involves a high degree of subjectivity and requires us
to make various assumptions and judgments about the collectability of our loan
portfolio, including the creditworthiness of our borrowers and the value of the
real estate and other assets serving as collateral for the repayment of many of
our loans.
The allowance consists of specific, general and unallocated components. The
general component of the allowance for loan losses covers non-impaired loans and
is determined using a formula-based approach. The formula first incorporates
either the historical loss rates of the Company or the historical loss rates of
their peer group if minimal loss history exists. This historical loss rate
factor is then adjusted for qualitative factors. Qualitative factors are used to
estimate losses related to factors that are not captured in the historical loss
rates and are based on management's evaluation of available internal and
external data and involve significant management judgement. Qualitative factors
include changes in lending standards, changes in economic conditions, changes in
the nature and volume of loans, changes in lending management, changes in
delinquencies, changes in the loan review system, changes in the value of
collateral, the existence of concentrations, and the impact of other external
factors. Finally, the general component of the allowance for loan losses is
adjusted for changes in the assigned grades of loans, which include the
following: pass, watch, special mention, substandard, doubtful, and loss. As
loans are downgraded from watch to the lower categories, they are assigned an
additional factor to account for the increased credit risk. Loan grades involve
significant management judgment. For such loans that are also classified as
impaired, a specific component within the allowance is established when the
discounted cash flows (or collateral value or observable market price) of the
impaired loan are lower than the carrying value of that loan. An unallocated
component is maintained to cover uncertainties that could affect
50
--------------------------------------------------------------------------------
Table of Contents
management's estimate of probable losses. The unallocated component of the
allowance reflects the margin of imprecision inherent in the underlying
assumptions used in the methodologies for estimating specific and general losses
in the portfolio.
Management reviews the level of the allowance at least quarterly and performs a
sensitivity analysis on the significant assumptions utilized in estimating the
allowance for loan losses for collectively evaluated loans. Utilizing a range of
potential positive and negative changes to qualitative loss factors ranging from
5 to 20 basis points, the Bank's allowance for loan losses would change by a
range of approximately $433 thousand to $1.7 million , respectively. This
sensitivity analysis and related range of impact on the Bank's allowance for
loan losses is a hypothetical analysis and is not intended to represent
management's judgments or assumptions of qualitative loss factors that were
utilized at December 31, 2022 .
To strengthen our loan review and classification process, we engage an
independent consultant to review our classified loans and a significant sample
of recently originated non-classified loans annually. We also enhanced our
credit administration policies and procedures to improve our maintenance of
updated financial data on commercial borrowers. While we believe the estimates
and assumptions used in our determination of the adequacy of the allowance are
reasonable, there can be no assurance that such estimates and assumptions will
not be proven incorrect in the future, or that the future provisions will not
exceed past provisions or that any increased provisions that may be required
will not adversely impact our financial condition and results of operations. In
addition, the determination of the amount of our allowance for loan losses is
subject to review by bank regulators as part of the routine examination process,
which may result in the adjustment of reserves based upon their judgment of
information available to them at the time of their examination.
Other-Than-Temporary Impairment of Securities. Management reviews investment
securities on an ongoing basis for the presence of OTTI, taking into
consideration current market conditions; fair value in relationship to cost;
extent and nature of the change in fair value; issuer rating changes and trends;
whether management intends to sell a security or if it is likely that we will be
required to sell the security before recovery of the amortized cost basis of the
investment, which may be upon maturity; and other factors. For debt securities,
if management intends to sell the security or it is likely that we will be
required to sell the security before recovering our cost basis, the entire
impairment loss would be recognized in earnings as an OTTI loss. If management
does not intend to sell the security and it is not more likely than not that we
will be required to sell the security, but management does not expect to recover
the entire amortized cost basis of the security, only the portion of the
impairment loss representing credit losses would be recognized in earnings. The
credit loss on a security is measured as the difference between the amortized
cost basis and the present value of the cash flows expected to be collected.
Projected cash flows are discounted by the original or current effective
interest rate depending on the nature of the security being measured for
potential OTTI. The remaining impairment related to all other factors, i.e., the
difference between the present value of the cash flows expected to be collected
and fair value, is recognized as a charge to other comprehensive income (loss).
Impairment losses related to all other factors are presented as separate
components within accumulated other comprehensive income (loss).
Mortgage Servicing Rights. We record MSRs on loans sold to Fannie Mae with
servicing retained as well as for acquired servicing rights. We stratify our
capitalized MSRs based on the type, term and interest rates of the underlying
loans. MSRs are carried at fair value. The value is determined through a
discounted cash flow analysis, which uses interest rates, prepayment speeds and
delinquency rate assumptions as inputs. All of these assumptions require a
significant degree of management judgment. If our assumptions prove to be
incorrect, the value of our MSRs could be negatively impacted. We use a third
party to assist us in the preparation of the analysis of the market value each
quarter.
Other Real Estate Owned. OREO represents real estate that we have taken control
of in partial or full satisfaction of significantly delinquent loans. At the
time of foreclosure, OREO is recorded at the fair value less costs to sell,
which becomes the property's new basis. Any write-downs based on the asset's
fair value at the date of acquisition are charged to the allowance for loan
losses. After foreclosure, management periodically performs valuations such that
the real estate is carried at the lower of its new cost basis or fair value, net
of estimated costs to sell. Subsequent valuation adjustments are recognized
within net (loss) gain on OREO. Revenue and expenses from operations and
subsequent adjustments to the carrying amount of the property are included in
other noninterest expense in the consolidated statements of income. In some
instances, we may make loans to facilitate the sales of OREO. Management reviews
all sales for which it is the lending institution for compliance with sales
treatment under provisions established by ASC Topic 360, "Accounting for Sales
of Real Estate". Any gains related to sales of OREO are deferred until the buyer
has a sufficient initial and continuing investment in the property.
Income Taxes. Income taxes are reflected in our financial statements to show
the tax effects of the operations and transactions reported in the financial
statements and consist of taxes currently payable plus deferred taxes. ASC Topic
740, "Accounting for Income Taxes," requires the asset and liability approach
for financial accounting and reporting for deferred income taxes. Deferred tax
assets and liabilities result from differences between the financial statement
carrying amounts and the tax bases of assets and liabilities. They are reflected
at currently enacted income tax rates applicable to the period in which the
deferred tax assets or liabilities are expected to be realized or settled and
are determined using the assets and liability method of accounting. The deferred
income provision represents the difference between net deferred tax
asset/liability at the beginning
51
--------------------------------------------------------------------------------
Table of Contents
and end of the reported period. In formulating our deferred tax asset, we are
required to estimate our income and taxes in the jurisdiction in which we
operate. This process involves estimating our actual current tax exposure for
the reported period together with assessing temporary differences resulting from
differing treatment of items, such as depreciation and the provision for loan
losses, for tax and financial reporting purposes. Valuation allowances are
established to reduce the net carrying amount of deferred tax assets if it is
determined to be more likely than not all or some portion of the potential
deferred tax asset will not be realized.
Business and Operating Strategies and Goals
Our goal is to deliver returns to stockholders by increasing higher-yielding assets (including consumer, commercial and multifamily real estate and commercial business loans), increasing lower-cost core deposit balances, managing expenses, managing problem assets and exploring expansion opportunities. We seek to achieve these results by focusing on the following objectives: Focusing on Asset Quality. We believe that strong asset quality is a key to our long-term financial success. We are focused on monitoring existing performing loans, resolving nonperforming assets and selling foreclosed assets. Nonperforming assets were$3.6 million , or 0.37% of total assets, atDecember 31, 2022 compared to$6.2 million or 0.68% of total assets, atDecember 31, 2021 . We continually seek to reduce the level of nonperforming assets through collections, modifications and sales of OREO. We also take proactive steps to resolve our non-performing loans, including negotiating payment plans, forbearances, loan modifications and loan extensions on delinquent loans when such actions have been deemed appropriate. Our goal is to maintain or improve upon our level of nonperforming assets by managing all segments of our loan portfolio in order to proactively identify and mitigate risk. Improving Earnings by Expanding Product Offerings. We intend to prudently maintain the percentage of our assets consisting of higher-yielding commercial and multifamily real estate and commercial business loans, which offer higher risk-adjusted returns, shorter maturities and more sensitivity to interest-rate fluctuations than one-to-four family mortgage loans, while maintaining our focus on residential lending. In addition, we continue to focus on consumer products, such as floating and manufactured home loans. With our long experience and expertise in residential lending we believe we can be effective in capturing mortgage banking opportunities and grow consumer deposits. We continue to develop correspondent relationships to sell nonconforming mortgage loans servicing released. We also intend to selectively add products to further diversify revenue sources and to capture more of each client's banking relationship by offering additional services. We continue to refine our products and services for additional business and automate services, such as automating consumer loan originations this past year, in an effort to improve customer service. We intend to further build relationships with medium and small businesses through new and improving existing service offerings, including remote deposit. Emphasizing Lower Cost Core Deposits to Manage the Funding Costs of Our Loan Growth. Our strategic focus is to emphasize total relationship banking with our clients to internally fund our loan growth. We also emphasize reducing wholesale funding sources, including FHLB advances, through the continued growth of core deposits. We believe that a continued focus on client relationships will help increase the level of core deposits and retail certificates of deposit from consumers and businesses in our market area. We intend to increase demand deposits by growing retail and business banking relationships. New technology and services are generally reviewed for business development and cost saving opportunities. We continue to experience growth in client use of our online and mobile banking services, which allow clients to conduct a full range of services on a real-time basis, including balance inquiries, transfers and electronic bill paying, while providing our clients greater flexibility and convenience in conducting their banking. In addition to our retail branches, we maintain state of the art technology-based products, such as business cash management, business remote deposit products, business and consumer mobile banking applications and consumer remote deposit products. Total deposits increased to$808.8 million atDecember 31, 2022 , from$798.3 million atDecember 31, 2021 . AtDecember 31, 2022 , core deposits, which we define as our non-time deposit accounts and time deposit accounts of less than$250 thousand , decreased$9.5 million to$745.7 million from$755.2 million atDecember 31, 2021 . As a result of the decreased liquidity from core deposits, we increased our rates paid on certificates of deposit and borrowed against our FHLB lines of credit. Maintaining Our Client Service Focus. Exceptional service, local involvement (including volunteering and contributing to the communities where we do business) and timely decision-making are integral parts of our business strategy. Our employees understand the importance of delivering exemplary customer service and seeking opportunities to build relationships with our clients to enhance our market position and add profitable growth opportunities. We compete with other financial service providers by relying on the strength of our customer service and relationship banking approach. We believe that one of our strengths is that our employees are also significant stockholders through our ESOP and 401(k) plans. We also offer incentives that are designed to reward employees for achieving high-quality client relationship growth. 52 -------------------------------------------------------------------------------- Table of Contents Expanding Our Presence, Including Through Digital Channels and Streamlining Operations, Within Our Existing and Contiguous Market Areas and by Capturing Business Opportunities Resulting from Changes in the Competitive Environment. We believe that opportunities currently exist within our market area to grow our franchise. We anticipate continued organic growth as the local economy and loan demand remains strong, through our marketing efforts and as a result of the opportunities created from the consolidation of financial institutions occurring in our market area. In addition, by delivering high-quality, client-focused products and services, we expect to attract additional borrowers and depositors and thus increase our market share and revenue generation. We continue to be disciplined as it pertains to future expansion, acquisitions and de novo branching focusing on the markets inWestern Washington , which we know and understand. Comparison of Financial Condition atDecember 31, 2022 andDecember 31, 2021 As of December 31, 2022 2021 Selected Financial Condition Data: Total assets$ 976,351 $
919,691
Cash and cash equivalents 57,836 183,590
Total loans held for portfolio, net 858,382 680,092
Loans held-for-sale - 3,094
Available-for-sale securities, at fair value 10,207 8,419
Held-to-maturity securities, at amortized cost 2,199
-
Bank-owned life insurance ("BOLI"), net 21,314 21,095
OREO and repossessed assets, net 659 659
FHLB stock, at cost 2,832 1,046
Total deposits 808,763 798,320
Borrowings 43,000 -
Subordinated notes, net 11,676 11,634
Stockholders' equity 97,705 93,358
General. Total assets increased by $56.7 million , or 6.2%, to $976.4 million at
December 31, 2022 , from $919.7 million at December 31, 2021 . The increase was
primarily a result of an increase in loans held-for-portfolio and investment
securities, partially offset by lower balances in cash and cash equivalents and
decreases in loans held-for-sale.
Cash and Securities . Cash, cash equivalents, available-for-sale securities and
held-to-maturity securities decreased by $121.8 million , or 63.4%, to $70.2
million at December 31, 2022 compared to the prior year. Cash and cash
equivalents decreased $125.8 million , or 68.5%, to $57.8 million due to
deploying cash earning a nominal yield into higher earning loans and
investments. Available-for-sale securities, which consist of agency
mortgage-backed securities and municipal bonds, increased $1.8 million , or
21.2%, to $10.2 million at December 31, 2022 , primarily due to purchases of
securities during the year outpacing calls of securities and regularly scheduled
payments and maturities. Held-to-maturity securities totaled $2.2 million at
December 31, 2022 , compared to none at December 31, 2021 , due to the purchase of
$2.2 million in municipal bonds and agency mortgage-backed securities.
Loans. Loans held-for-portfolio, net, increased $178.3 million , or 26.2%, to
$858.4 million at December 31, 2022 from $680.1 million at December 31,
2021 . Loans held-for-sale decreased to $0 at December 31, 2022 from $3.1 million
at December 31, 2021 primarily due to a decline in mortgage originations,
reflecting reduced refinance activity and the timing of originations.
53
--------------------------------------------------------------------------------
Table of Contents
The following table reflects the changes in the loan mix, excluding premiums and
deferred fees, of our portfolio at December 31, 2022 , as compared to
December 31, 2021 (dollars in thousands):
December 31, Amount Percent
2022 2021 Change Change
One-to-four family $ 274,638 $ 207,660 $ 66,978 32.3 %
Home equity 19,548 13,250 6,298 47.5Commercial and multifamily 313,358 278,175 35,183 12.6
Construction and land 116,878 63,105 53,773 85.2
Manufactured homes 26,953 21,636
5,317 24.6
Floating homes 74,443 59,268 15,175 25.6
Other consumer 17,923 16,748 1,175 7.0
Commercial business 23,815 28,026
(4,211) (15.0)
Total loans $ 867,556 $ 687,868 $ 179,688 26.1
The largest dollar increases in the loan portfolio were in one-to-four family
loans, which increased $67.0 million , or 32.3%, to $274.6 million , driven
equally by jumbo and conforming residential mortgages, construction and land
loans, which increased $53.8 million , or 85.2%, to $116.9 million , and
commercial and multifamily real estate loans, which increased $35.2 million or
12.6%, to $313.4 million . We also saw increases in our floating homes and
manufactured housing loan portfolios. The increase in loans held-for-portfolio
primarily resulted from focused marketing campaigns, increased utilization of
digital marketing tools and the addition of experienced lending staff. These
increases were partially offset by a decrease in commercial business loans,
which decreased $4.2 million or 15.0% to $23.8 million , primarily from the SBA
loan forgiveness on PPP loans of $5.2 million . We had 2 PPP loans outstanding
totaling $17 thousand as of December 31, 2022 .
The loan portfolio remains well-diversified with commercial and multifamily real
estate loans accounting for 36.1% of the portfolio, one-to-four family real
estate loans, including home equity loans, accounting for approximately 33.9% of
the portfolio and consumer loans, consisting of manufactured homes, floating
homes, and other consumer loans, accounting for 13.8% of the total loan
portfolio at December 31, 2022 . Construction and land loans accounted for 13.5%
of the portfolio and commercial business loans accounted for the remaining 2.7%
of the portfolio at December 31, 2022 .
Nonperforming Assets. At December 31, 2022 , our nonperforming assets totaled
$3.6 million , or 0.37% of total assets, compared to $6.2 million , or 0.68% of
total assets, at December 31, 2021 .
The table below sets forth the amounts and categories of nonperforming assets in our loan portfolio at the dates indicated (dollars in thousands):
December 31,
Amount Percent
2022 2021 Change Change
Nonaccrual loans $ 2,855 $ 5,130 $ (2,275) (44.3) %
Nonperforming TDRs 103 422 (319) (75.5)
Total nonperforming loans 2,959 5,552 (2,593) (46.7)
OREO and repossessed assets 659 659 - -
Total nonperforming assets $ 3,618 $ 6,211 $ (2,593) (41.8) %
Nonperforming loans decreased $2.6 million or 46.7%, to $3.0 million at
December 31, 2022 , compared to the prior year-end primarily due to the payoff of
a $2.3 million commercial and multifamily loan. One-to-four family loans
(consisting of nine loans) made up the largest portion of our nonperforming loan
portfolio at December 31, 2022 , accounting for $2.1 million or 72.2% of total
nonperforming loans. Subsequent to December 31, 2022 , $1.5 million of the $2.1
million one-to-four family nonperforming loans were paid off in full.
Nonperforming loans were 0.34% of total loans at December 31, 2022 , compared to
0.81% of total loans at December 31, 2021 . We had no loans greater than 90 days
delinquent and still accruing at December 31, 2022 and 2021.
54
--------------------------------------------------------------------------------
Table of Contents
Allowance for Loan Losses. The allowance for loan losses is maintained to cover
losses that are probable and can be estimated on the date of evaluation in
accordance with generally accepted accounting principles in the U.S. It is our
best estimate of probable incurred credit losses in our loan portfolio.
The following table reflects the adjustments in our allowance during 2022 and 2021 (dollars in thousands):
Year Ended
2022 2021
Balance at beginning of period $ 6,306 $ 6,000
Charge-offs (124) (136)
Recoveries 192 17
Net (charge-offs) recoveries 68 (119)
Provision charged to operations 1,225 425
Balance at end of period $ 7,599 $ 6,306 Ratio of net recoveries (charge-offs) during the period to average loans outstanding during the period
0.01 % (0.02) %
Allowance as a percentage of nonperforming loans 256.81 % 113.58 %
Allowance as a percentage of total loans (end of period) 0.88 % 0.92 %
Our allowance for loan losses increased
Specific loan loss reserves decreased to$184 thousand atDecember 31, 2022 , compared to$293 thousand atDecember 31, 2021 , while general loan loss reserves increased to$6.9 million atDecember 31, 2022 , compared to$5.6 million atDecember 31, 2021 and the unallocated reserve increased to$488 thousand atDecember 31, 2022 , compared to$395 thousand atDecember 31, 2021 . The increase in the unallocated reserve was primarily a result of the increase in the loan portfolio atDecember 31, 2022 , partially offset by a negative adjustment in the qualitative factors applied to construction loans and manufactured homes loans as a result of the rising interest rate environment. Deposits. Total deposits increased$10.4 million , or 1.3%, to$808.8 million atDecember 31, 2022 from$798.3 million atDecember 31, 2021 . The increase was primarily due to an increase in certificate accounts, which was primarily used to fund organic loan growth in 2022. While we continue our efforts to grow noninterest-bearing deposits, the increasing interest rate environment has increased competition for lower interest-bearing deposits and clients have transitioned funds back into higher yielding accounts. As a result, our noninterest-bearing demand balances (including escrow accounts) decreased$17.3 million , or 9.1%, to$173.2 million atDecember 31, 2022 , compared to$190.5 million atDecember 31, 2021 . Noninterest-bearing (including escrow accounts) deposits represented 21.4% of total deposits atDecember 31, 2022 , compared to 23.9% atDecember 31, 2021 .
A summary of deposit accounts with the corresponding weighted-average cost at
December 31, 2022 December 31, 2021
Amount Wtd. Avg. Rate Amount Wtd. Avg. Rate
Noninterest-bearing demand $ 170,549 - % $ 187,684 - %
Interest-bearing demand 254,982 0.21 307,061 0.19
Savings 95,641 0.05 103,401 0.08
Money market 74,639 0.28 91,670 0.21
Certificates of deposit 210,305 0.97 105,722 1.57
Escrow(1) 2,647 - 2,782 -
Total $ 808,763 0.37 % $ 798,320 0.41 %
(1)Escrow balances shown in noninterest-bearing deposits on the Consolidated Balance Sheets.
55
--------------------------------------------------------------------------------
Table of Contents
Borrowings. FHLB advances increased to $43.0 million at December 31, 2022 ,
reaching as high as $114 million during 2022, as we utilized our FHLB line of
credit to offset the decrease in deposits for funding needs. There were no FHLB
advances at December 31, 2021 . We rely on FHLB advances to fund interest-earning
assets when deposits alone cannot fully fund interest-earning asset
growth. Subordinated notes, net totaled $11.7 million and $11.6 million at
December 31, 2022 and 2021, respectively. For additional information regarding
our borrowings, see "Note 10-Borrowings, FHLB Stock and Subordinated Notes" in
the Notes to Consolidated Financial Statements contained in "Part II. Item 8.
Financial Statements and Supplementary Data" of this report on Form 10-K.
Stockholders' Equity. Total stockholders' equity increased $4.3 million , or
4.7%, to $97.7 million at December 31, 2022 , from $93.4 million at December 31,
2021 . This increase primarily reflects $8.8 million in net income for the year
ended December 31, 2022 , partially offset by the payment of cash dividends of
$2.0 million to common stockholders, the repurchase of $1.7 million of common
stock and unrealized losses on our securities portfolio resulting in an other
comprehensive loss, net of tax benefit, of $1.3 million during the year ended
December 31, 2022 .
Average Balances, Net Interest Income, Yields Earned and Rates Paid
The following table presents, for the periods indicated, the total dollar amount
of interest income from average interest-earning assets and the resultant
yields, as well as the interest expense on average interest-bearing liabilities,
expressed both in dollars and rates. Income and yields on tax-exempt obligations
have not been computed on a tax equivalent basis. All average balances are daily
average balances. Nonaccrual loans have been included in the table as loans
carrying a zero yield for the period they have been on nonaccrual (dollars in
thousands).
Year Ended December 31,
2022 2021
Average Interest Average Interest
Outstanding Earned/ Yield/ Outstanding Earned/ Yield/
Balance Paid Rate Annualized Balance Paid Rate Annualized
Interest-earning assets:
Loans receivable $ 783,372 $ 38,177 4.87 % $ 650,045 $ 33,389 5.14 %
Investments, cash and cash equivalents 124,331 1,618 1.30 221,577 485 0.22
Total interest-earning assets (1) 907,703 39,795 4.38 % 871,622 33,874 3.89
Interest-bearing liabilities:
Savings and money market accounts 188,478 211 0.11 171,406 180 0.11
Demand and NOW accounts 295,919 690 0.23 289,096 611 0.21
Certificate accounts 129,011 2,049 1.59 158,649 2,491 1.57
Subordinated notes 11,653 672 5.77 11,611 672 5.79
Borrowings 27,273 878 3.22 1 - -
Total interest-bearing liabilities 652,334 4,500 0.69 % 630,763 3,954 0.63 %
Net interest income $ 35,295 $ 29,920
Net interest rate spread 3.69 % 3.26 %
Net earning assets $ 255,369 $ 240,859
Net interest margin 3.89 % 3.43 %
Average interest-earning assets to
average interest-bearing liabilities 139.15 % 138.19 %
Total deposits 803,521 2,950 0.37 % 797,686 3,282 0.41 %
Total funding(2) 842,447 4,500 0.53 % 809,298 3,954 0.49 %
(1) Calculated net of deferred loan fees, loan discounts and loans in process.
(2) Total funding is the sum of average interest-bearing liabilities and average
noninterest-bearing deposits. The cost of total funding is calculated as
annualized total interest expense divided by average total funding.
56
--------------------------------------------------------------------------------
Table of Contents
Rate/Volume Analysis
The following schedule presents the dollar amount of changes in interest income
and interest expense for major components of interest-earning assets and
interest-bearing liabilities. It distinguishes between changes related to
outstanding balances and changes due to interest rates. For each category of
interest-earning assets and interest-bearing liabilities, information is
provided on changes attributable to (i) changes in volume (i.e., changes in
volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate
multiplied by old volume). For purposes of this table, changes attributable to
both rate and volume, which cannot be segregated, have been allocated
proportionately to the change due to volume and the change due to rate (dollars
in thousands).
Year Ended December 31,
2022 vs. 2021
Increase (Decrease) due to Total
Increase
Volume Rate (Decrease)
Interest-earning assets:
Loans $ 6,498 $ (1,710) $ 4,788
Investments and interest-bearing accounts (1,266) 2,399 1,133
Total interest-earning assets 5,232 689 5,921
Interest-bearing liabilities:
Savings and Money Market accounts 19 12 $ 31
Demand and NOW accounts 16 63 79
Certificate accounts (471) 29 (442)
Subordinated notes 2 (2) -
Borrowings 878 - 878
Total interest-bearing liabilities $ 444 $ 102 $ 546
Change in net interest income $ 5,375
57--------------------------------------------------------------------------------
Table of Contents
Comparison of Results of Operation for the Years EndedDecember 31, 2022 and 2021 Year Ended December 31, 2022 2021 Selected Operations Data: Total interest income$ 39,795 $ 33,874 Total interest expense 4,500 3,954 Net interest income 35,295 29,920 Provision for loan losses 1,225 425 Net interest income after provision for loan losses 34,070 29,495 Service charges and fee income 2,368 2,247 Earnings on cash surrender value of BOLI 219 416 Mortgage servicing income 1,242 1,284 Fair value adjustment on mortgage servicing rights ("MSRs") 207 (808) Net gain on sale of loans 546 4,190 Total noninterest income 4,582 7,329 Salaries and benefits 16,415 14,257 Operations expense 5,812 5,765 Occupancy expense 1,737 1,748 Net losses and expenses on OREO and repossessed assets - (16) Other noninterest expense 3,812 3,642 Total noninterest expense 27,776 25,396 Income before provision for income taxes 10,876 11,428 Provision for income taxes 2,072 2,272 Net income$ 8,804 $ 9,156 General. Net income decreased$352 thousand , or 3.8%, to$8.8 million , or$3.35 per diluted common share, for the year endedDecember 31, 2022 , compared to$9.2 million , or$3.46 per diluted common share, for the year endedDecember 31, 2021 . The decrease was primarily a result of$2.7 million decrease in noninterest income, a$2.4 million increase in noninterest expense, a$546 thousand increase in interest expense and a$800 thousand increase in the provision for loan losses for the year endedDecember 31, 2022 , partially offset by a$5.9 million increase in interest income. Interest Income. Interest income increased$5.9 million , or 17.5%, to$39.8 million for the year endedDecember 31, 2022 , from$33.9 million for the year endedDecember 31, 2021 . The increase was primarily due to a$133.3 million increase in the average balance of outstanding loans, and, to a lesser extent, a 108 basis point increase in the average yield on investments and interest-bearing cash and cash equivalents. Interest income on loans increased$4.8 million , or 14.3%, to$38.2 million for the year endedDecember 31, 2022 , compared to$33.4 million for the year endedDecember 31, 2021 , driven by the increase in the average balance of total loans outstanding. This increase was partially offset a 27 basis points decline in the average yield on loans due to the decline in the percentage of higher yielding commercial and multifamily real estate and commercial business loans as a percentage of the total loan portfolio, as previously discussed, and the effects of the SBA's loan forgiveness on PPP loans. The average balance of total loans was$783.4 million for the year endedDecember 31, 2022 , compared to$650.0 million for the year endedDecember 31, 2021 . The average yield on total loans was 4.87% for the year endedDecember 31, 2022 , compared to 5.14% for the year endedDecember 31, 2021 . For the year endedDecember 31, 2022 , the average balance of PPP loans was$1.1 million and the average yield on PPP loans was 13.41%, including the recognition of the net deferred fees, with a positive impact on average loan yield of one basis point. For the year endedDecember 31, 2021 , the average balance of PPP loans was$35.3 million and the average yield on PPP loans was 8.55%, including the recognition of deferred fees, with a positive impact on average loan yield of 20 basis points. Interest income included$148 thousand in fees earned related to PPP loans in the year endedDecember 31, 2022 , compared to$3.0 million in the prior year. Interest income on the investment portfolio and cash and cash equivalents increased$1.1 million , or 233.6%, to$1.6 million for the year endedDecember 31, 2022 , compared to$485 thousand for the year endedDecember 31, 2021 . The increase was due to higher average yields, partially offset by lower average balances. The average yield on investments and cash and cash equivalents was 1.30% for the year endedDecember 31, 2022 , compared to 0.22% for the year endedDecember 31, 2021 , 58
--------------------------------------------------------------------------------
Table of Contents
primarily due to the deployment of a portion of cash and cash equivalents earning a nominal yield into higher yielding investment securities and the impact of rising rates.
Interest Expense. Interest expense increased$546 thousand , or 13.8%, to$4.5 million for the year endedDecember 31, 2022 , from$4.0 million for the year endedDecember 31, 2021 , primarily as a result of an increase in the average balance of borrowings, partially offset by a decrease in the average balance of certificate accounts and, to a lesser extent, lower total deposit costs. Interest expense on deposits decreased$332 thousand , or 10.1%, to$3.0 million for the year endedDecember 31, 2022 , compared to$3.3 million for the same period a year ago. The decrease was primarily the result of a decline in the average cost of deposits reflecting reduced market rates paid on deposits through the middle of 2022, partially offset by the change in the mix of deposits in the latter half of 2022 reflecting the impact of the rising interest rate environment. The average cost of total deposits decreased four basis points to 0.37% for the year endedDecember 31, 2022 , from 0.41% for the year endedDecember 31, 2021 . Interest expense on borrowings and subordinated notes increased$878 thousand , or 130.7%, to$1.6 million for the year endedDecember 31, 2022 , which was comprised of interest expense on subordinated notes and FHLB advances, compared to$672 thousand for the year endedDecember 31, 2021 , which was comprised solely of interest expense on our subordinated notes. Average borrowings and subordinated notes increased$27.3 million , to$38.9 million for the year endedDecember 31, 2022 , which consisted of both FHLB advances and subordinated notes, from$11.6 million for the year endedDecember 31, 2021 , which consisted solely of subordinated notes. The average cost of the subordinated notes and FHLB advances was 3.98% for the year endedDecember 31, 2022 , compared to 5.79% for the year endedDecember 31, 2021 . Net Interest Income. Net interest income increased$5.4 million , or 18.0%, to$35.3 million for the year endedDecember 31, 2022 , from$29.9 million for the year endedDecember 31, 2021 . Our net interest margin was 3.89% and 3.43% for the years endedDecember 31, 2022 and 2021, respectively. The increase in net interest income primarily resulted from the increase in the average loan balance and an increase in the average rate paid on investments and interest-bearing cash, partially offset by an increase in the average balance of and rate paid on interest-bearing liabilities and declines in the average rate paid on loans and the average balance of investments and interest-bearing cash. The increase in net interest margin was primarily due to an increase in yields earned on interest-earning assets exceeding the increase in rates paid on interest-bearing liabilities. During the year endedDecember 31, 2022 , the average yield earned on PPP loans, including the recognition of the net deferred fees for PPP loans repaid and forgiven by the SBA, resulted in a positive impact to the net interest margin of one basis point, compared to a positive impact of 22 basis points from our origination of PPP loans in 2021. Provision for Loan Losses. We establish provisions for loan losses, which are charged to earnings, based on our review of the level of the allowance for loan losses required to reflect management's best estimate of the probable incurred credit losses in the loan portfolio. In evaluating the level of the allowance for loan losses, management considers historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect borrowers' ability to repay, estimated value of any underlying collateral, peer group data, prevailing economic conditions, and current factors. Large groups of smaller balance homogeneous loans, such as one- to four- family, small commercial and multifamily, home equity and consumer loans, are evaluated in the aggregate using historical loss factors adjusted for current economic conditions and other relevant data. Loans for which management has concerns about the borrowers' ability to repay, are evaluated individually and specific loss allocations are provided for these loans when necessary. A provision for loan losses of$1.2 million was recorded for the year endedDecember 31, 2022 , compared to$425 thousand provision for loan losses for the year endedDecember 31, 2021 . The$800 thousand increase in the provision for loan losses during the year was primarily due to an increase in the average balance of loans held-for-portfolio between the periods, a negative adjustment to the qualitative factors applied to construction and manufactured homes loans as a result of inflation and the impact of the rising interest rate environment, partially offset by a$2.6 million decrease in non-performing loans fromDecember 31, 2021 . Our allowance for loan losses as ofDecember 31, 2022 , reflects probable and inherent credit losses based upon the economic conditions that existed as ofDecember 31, 2022 . Net recoveries for the year endedDecember 31, 2022 totaled$68 thousand , compared to net charge-offs of$119 thousand for the year endedDecember 31, 2021 . While we believe the estimates and assumptions used in our determination of the adequacy of the allowance are reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, that future provisions will not exceed past provisions, or that any increased provisions which may be required in the future will not materially impact our financial condition and results of operations. In addition, the determination of the amount of our allowance for loan losses is subject to review by bank regulators as part of the routine examination process, which may result in the adjustment of reserves based upon their judgment of information available to them at the time of their examination. 59 -------------------------------------------------------------------------------- Table of Contents Noninterest Income. Noninterest income decreased$2.7 million , or 37.5%, to$4.6 million for the year endedDecember 31, 2022 , as compared to$7.3 million for the year endedDecember 31, 2021 , as reflected below (dollars in thousands): Year Ended December 31, Amount Percent 2022 2021 Change Change Service charges and fee income$ 2,368 $ 2,247 $ 121 5.4 % Earnings on cash surrender value of BOLI 219 416 (197) (47.4) Mortgage servicing income 1,242 1,284 (42) (3.3) Fair value adjustment on mortgage servicing rights 207 (808) 1,015 (125.6) Net gain on sale of loans 546 4,190 (3,644) (87.0) Total noninterest income$ 4,582 $ 7,329 $ (2,747) (37.5) % The decrease in noninterest income during the year endedDecember 31, 2022 , compared to the same period in 2021 primarily was due to the decrease in net gain on sale of loans, and decreases in mortgage servicing income and earnings on cash surrender value of BOLI, partially offset by improvement in the fair value adjustment on mortgage servicing rights, and increases in service charges and fees. Net gain on sale of loans decreased due to the decrease in sales volume, primarily due to lower originations due to reduced refinance activity and the rising interest rate environment, in addition to lower gross margins on sale. Loans sold during the year endedDecember 31, 2022 , totaled$20.9 million , compared to$149.4 million during the year endedDecember 31, 2021 . Earnings on cash surrender value of BOLI decreased as a result of declining market values. Mortgage servicing income was lower as a result of our mortgage servicing portfolio decreasing to$472.5 million atDecember 31, 2022 compared to$508.1 million atDecember 31, 2021 . The increase in the fair value adjustment on mortgage servicing rights was primarily due to the decreased prepayment speeds as a result of the rising interest rate environment. Service charges and fee income increased primarily from higher ATM and consumer deposit activity fees. Noninterest Expense. Noninterest expense increased$2.4 million , or 9.4%, to$27.8 million during the year endedDecember 31, 2022 , compared to$25.4 million during the year endedDecember 31, 2021 , as reflected below (dollars in thousands): Year Ended December 31, Amount Percent 2022 2021 Change Change Salaries and benefits$ 16,415 $ 14,257 $ 2,158 15.1 % Operations 5,812 5,765 47 0.8 Regulatory assessments 452 379 73 19.3 Occupancy 1,737 1,748 (11) (0.6) Data processing 3,360 3,263 97 3.0 Net gain on OREO and repossessed assets - (16) 16 (100.0) Total noninterest expense$ 27,776 $ 25,396 $ 2,380 9.4 % Salaries and benefits, the largest driver of noninterest expense, increased primarily due to higher wages, lower deferred compensation and higher medical expenses, partially offset by a decrease in incentive compensation as a result of a lower percentage earned on loans originated, changes to incentive compensation programs, such as the addition of non-production performance requirements, and lower commission expense related to a decline in mortgage originations. Data processing expense increased due to technology investments and contract rate increases. Regulatory assessments increased due to higherFDIC assessments in 2022 as a result of the increase in our asset size. The efficiency ratio for the year endedDecember 31, 2022 was 69.65%, compared to 68.18% for the year endedDecember 31, 2021 . The weakening in the efficiency ratio for the year endedDecember 31, 2022 was primarily due to higher noninterest expense. Income Tax Expense. The provision for income taxes decreased$200 thousand , or 8.8% to$2.1 million for the year endedDecember 31, 2022 , compared to$2.3 million for the year endedDecember 31, 2021 , due to a lower effective tax rate and a decrease in taxable net income. The effective tax rates for the years endedDecember 31, 2022 and 2021 were 19.1% and 19.9%, respectively. 60 -------------------------------------------------------------------------------- Table of Contents Capital and Liquidity Capital. Shareholders' equity totaled$97.7 million atDecember 31, 2022 and$93.4 million atDecember 31, 2021 . In addition to net income of$8.8 million , other sources of capital during 2022 included$223 thousand in proceeds from stock option exercises and$475 thousand related to stock-based compensation. Uses of capital during 2022 included$2.0 million of dividends paid on common stock, other comprehensive loss, net of tax, of$1.3 million and$1.7 million of stock repurchases. We paid regular quarterly dividends of$0.17 per common share and a special dividend of$0.10 per common share during both 2022 and 2021. This equates to a dividend payout ratio of 23.1% in 2022 and 22.3% in 2021. The Company currently expects to continue the current practice of paying quarterly cash dividends on common stock subject to the Board of Directors' discretion to modify or terminate this practice at any time and for any reason without prior notice. Assuming continued payment during 2023 at this rate of$0.17 per share, our average total dividend paid each quarter would be approximately$442 thousand based on the number of our outstanding shares atDecember 31, 2022 . The dividends, if any, we may pay may be limited as more fully discussed under "Business-How We Are Regulated-Limitations on Dividends and Stock Repurchases" contained in Item 1, Part I of this Form 10-K. Stock Repurchase Plans. From time to time, our board of directors has authorized stock repurchase plans. In general, stock repurchase plans allow us to proactively manage our capital position and return excess capital to shareholders. Shares purchased under such plans may also provide us with shares of common stock necessary to satisfy obligations related to stock compensation awards. The Company's current stock repurchase program authorizes us to repurchase up to$4.0 million of Company common stock, of which approximately$2.1 million remained available for future repurchases as ofDecember 31, 2022 . The current stock repurchase program is set to expire onJuly 31, 2023 . The actual timing, number and value of shares repurchased under the stock repurchase program will depend on a number of factors, including constraints specified pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of theSEC , price, general business and market conditions, and alternative investment opportunities. See "Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases ofEquity Securities " contained in Item 5, Part II of this Form 10-K for additional information relating to stock repurchases. Liquidity. Liquidity measures the ability to meet current and future cash flow needs as they become due. The liquidity of a financial institution reflects its ability to meet loan requests, to accommodate possible outflows in deposits and to take advantage of interest rate market opportunities. The ability of a financial institution to meet its current financial obligations is a function of its balance sheet structure, its ability to liquidate assets and its access to alternative sources of funds. The objective of our liquidity management is to manage cash flow and liquidity reserves so that they are adequate to fund our operations and to meet obligations and other commitments on a timely basis and at a reasonable cost. We seek to achieve this objective and ensure that funding needs are met by maintaining an appropriate level of liquid funds through asset/liability management, which includes managing the mix and time to maturity of financial assets and financial liabilities on our balance sheet. Our liquidity position is enhanced by our ability to raise additional funds as needed in the wholesale markets. Asset liquidity is provided by liquid assets which are readily marketable or pledgeable or which will mature in the near future. Liquid assets generally include cash, interest-bearing deposits in banks, securities available for sale, maturities and cash flow from securities, sales of fixed rate residential mortgage loans in the secondary market and federal funds sold. Liability liquidity generally is provided by access to funding sources which include core deposits and advances from the FHLB and other borrowing relationships with third party financial institutions. Our liquidity position is continuously monitored and adjustments are made to the balance between sources and uses of funds as deemed appropriate. Liquidity risk management is an important element in our asset/liability management process. We regularly model liquidity stress scenarios to assess potential liquidity outflows or funding problems resulting from economic disruptions, volatility in the financial markets, unexpected credit events or other significant occurrences deemed problematic by management. These scenarios are incorporated into our contingency funding plan, which provides the basis for the identification of our liquidity needs. 61 -------------------------------------------------------------------------------- Table of Contents As ofDecember 31, 2022 , we had$68.0 million in cash and available-for-sale investment securities and no loans held-for-sale. AtDecember 31, 2022 , we had the ability to borrow an additional$199.0 million in FHLB advances and access to additional borrowings of$20.8 million through theFederal Reserve's discount window, in each case subject to certain collateral requirements. We had$43.0 million in outstanding advances with the FHLB atDecember 31, 2022 and no outstanding borrowings with theFederal Reserve atDecember 31, 2022 . In addition, we also had available$20.0 million of credit facilities with other financial institutions, with no balance outstanding atDecember 31, 2022 . Subject to market conditions, we expect to utilize these borrowing facilities from time to time in the future to fund loan originations and deposit withdrawals, to satisfy other financial commitments, repay maturing debt and to take advantage of investment opportunities to the extent feasible. As ofDecember 31, 2022 , management is not aware of any events that are reasonably likely to have a material adverse effect on our liquidity, capital resources or operations. In addition, management is not aware of any regulatory recommendations regarding liquidity that would have a material adverse effect on us. For additional details, see "Note 10-Borrowings, FHLB Stock and Subordinated Notes" in the Notes to Consolidated Financial Statements contained in "Item 8. Financial Statements and Supplementary Data" of this Form 10-K. In the ordinary course of business, we have entered into contractual obligations and have made other commitments to make future payments. Refer to the accompanying notes to consolidated financial statements elsewhere in this report for the expected timing of such payments as ofDecember 31, 2022 . These include payments related to (i) short and long-term borrowings (Note 10-Borrowings, FHLB Stock and Subordinated Notes), (ii) time deposits with stated maturity dates (Note 9-Deposits) (iii) operating leases (Note 12-Leases) and (iv) commitments to extend credit and standby letters of credit (Note 18-Commitments and Contingencies). In addition, we incur capital expenditures on an ongoing basis to expand and improve our product offerings, enhance and modernize our technology infrastructure, and to introduce new technology-based products to compete effectively in our markets. We evaluate capital expenditure projects based on a variety of factors, including expected strategic impacts (such as forecasted impact on revenue growth, productivity, expenses, service levels and customer retention) and our expected return on investment. The amount of capital investment is influenced by, among other things, current and projected demand for our services and products, cash flow generated by operating activities, cash required for other purposes and regulatory considerations. Based on current capital allocation objectives, there are no projects scheduled for capital investments in premises and equipment during the year endingDecember 31, 2023 that would materially impact liquidity.Sound Financial Bancorp is a separate legal entity fromSound Community Bank and must provide for its own liquidity. In addition to its own operating expenses (many of which are paid toSound Community Bank ),Sound Financial Bancorp is responsible for paying for any stock repurchases, dividends declared to its stockholders, interest and principal on outstanding debt, and other general corporate expenses.Sound Financial Bancorp is a holding company and does not conduct operations; its sources of liquidity are generally dividends up-streamed fromSound Community Bank , interest on investment securities, if any, and borrowings from outside sources. Banking regulations may limit the dividends that may be paid to us bySound Community Bank . See, "Business - How We Are Regulated - Limitations on Dividends and Stock Repurchases" contained in Item 1, Part I of this Form 10-K. During the year endedDecember 31, 2020 , the Company completed a private placement of$12.0 million in aggregate principal of subordinated notes resulting in net proceeds, after placement fees and offering expenses, of approximately$11.6 million . The Company contributed$5.5 million of the net proceeds from the sale of the subordinated notes to the Bank and retained the remaining net proceeds to be used for general corporate purposes. AtDecember 31, 2022 Sound Financial Bancorp , on an unconsolidated basis, had$2.2 million in cash, noninterest-bearing deposits and liquid investments generally available for its cash needs.
See also the "Consolidated Statements of Cash Flows" included in "Item 8. Financial Statements and Supplementary Data" of this Form 10-K, for further information.
Regulatory Capital .Sound Community Bank is subject to minimum capital requirements imposed by regulations of theFDIC . Capital adequacy requirements are quantitative measures established by regulation that requireSound Community Bank to maintain minimum amounts and ratios of capital. Based on its capital levels atDecember 31, 2022 ,Sound Community Bank exceeded these requirements at that date. Consistent with our goals to operate a sound and profitable organization, our policy is forSound Community Bank to maintain a "well-capitalized" status under the regulatory capital categories of theFDIC . BeginningJanuary 2020 , the Bank elected to use the CBLR framework. A bank that elects to use the CBLR framework as provided for in the Economic Growth, Regulatory Relief and Consumer Protection Act will generally be considered "well-capitalized" and to have met the risk-based and leverage capital requirements of the capital regulations if it has a leverage ratio greater than 9.0%. AtDecember 31, 2022 , the Bank's CBLR was 10.83%, which exceeded the minimum requirements. For additional details, see "Note 16-Capital" in the Notes to Consolidated Financial Statements contained in "Item 8. Financial 62
--------------------------------------------------------------------------------
Table of Contents Statements and Supplementary Data" and "Item 1. Business-How We Are Regulated-Regulation of Sound Community Bank-Capital Rules" of this Form 10-K.
For a bank holding company with less than$3.0 billion in assets, the capital guidelines apply on a bank-only basis and theFederal Reserve expects the holding company's subsidiary banks to be "well-capitalized" under the prompt corrective action regulations. IfSound Financial Bancorp was subject to regulatory guidelines for bank holding companies with$3.0 billion or more in assets, atDecember 31, 2022 ,Sound Financial Bancorp would have exceeded all regulatory capital requirements. The estimated CBLR calculated forSound Financial Bancorp atDecember 31, 2022 was 9.86%.
© Edgar Online, source
