Sound Financial Bancorp, Inc. - FORM 10-Q

Attached files

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

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2018

☐	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 May 7, 2018, there were 2,524,003 shares of the registrant's common stock outstanding.

Table of Contents

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 March 31, 2018 and December 31, 2017 (unaudited)	3

Condensed Consolidated Statements of Income for the Three Months Ended March 31, 2018 and 2017 (unaudited)	4

Condensed Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2018 and 2017 (unaudited)	5

Condensed Consolidated Statements of Stockholders' Equity for the Three Months Ended March 31, 2018 and 2017 (unaudited)	6

Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2018 and 2017 (unaudited)	7

Notes to Condensed Consolidated Financial Statements (unaudited)	8

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations	32

Item 3. Quantitative and Qualitative Disclosures About Market Risk	43

Item 4. Controls and Procedures	43

PART II OTHER INFORMATION

Item 1. Legal Proceedings	44

Item 1A. Risk Factors	44

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	44

Item 3. Defaults Upon Senior Securities	44

Item 4. Mine Safety Disclosures	44

Item 5. Other Information	44

Item 6. Exhibits	45

SIGNATURES	46

EXHIBITS	47

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Condensed Consolidated Balance Sheets (unaudited)

(In thousands, except share and per share amounts)

	March 31, 2018			December 31, 2017
ASSETS
Cash and cash equivalents	$	64,689		$	60,680
Available-for-sale securities, at fair value		5,268			5,435
Loans held for sale		950			1,777
Loans		559,979			548,595
Allowance for loan losses		(5,328	)		(5,241	)
Total loans, net		554,651			543,354
Accrued interest receivable		1,962			1,977
Bank-owned life insurance ("BOLI"), net		13,075			12,750
Other real estate owned ("OREO") and repossessed assets, net		638			610
Mortgage servicing rights, at fair value		3,532			3,426
Federal Home Loan Bank ("FHLB") stock, at cost		3,014			3,065
Premises and equipment, net		7,545			7,392
Other assets		4,207			4,778
Total assets	$	659,531		$	645,244
LIABILITIES
Deposits
Interest-bearing	$	444,918		$	442,277
Noninterest-bearing demand		84,275			72,123
Total deposits		529,193			514,400
Borrowings		56,000			59,000
Accrued interest payable		81			77
Other liabilities		6,605			5,972
Advance payments from borrowers for taxes and insurance		1,106			635
Total liabilities		592,985			580,084
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, 2,524,346 and 2,511,127 shares issued and outstanding as of March 31, 2018 and December 31, 2017, respectively		25			25
Additional paid-in capital		25,104			24,986
Unearned shares - Employee Stock Ownership Plan ("ESOP")		(453	)		(453	)
Retained earnings		41,792			40,493
Accumulated other comprehensive income, net of tax		78			109
Total stockholders' equity		66,546			65,160
Total liabilities and stockholders' equity	$	659,531		$	645,244

See notes to condensed consolidated financial statements

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Condensed Consolidated Statements of Income (unaudited)

(In thousands, except share and per share amounts)

	Three Months Ended March 31,
	2018		2017
INTEREST INCOME
Loans, including fees	$	7,246	$	6,442
Interest and dividends on investments, cash and cash equivalents		246		150
Total interest income		7,492		6,592
INTEREST EXPENSE
Deposits		810		703
Borrowings		213		92
Total interest expense		1,023		795
Net interest income		6,469		5,797
PROVISION FOR LOAN LOSSES		100		—
Net interest income after provision for loan losses		6,369		5,797
NONINTEREST INCOME
Service charges and fee income		460		511
Earnings on cash surrender value of bank-owned life insurance		79		81
Mortgage servicing income		220		233
Net gain on sale of loans		332		171
Total noninterest income		1,091		996
NONINTEREST EXPENSE
Salaries and benefits		3,141		2,691
Operations		1,239		1,021
Regulatory assessments		101		124
Occupancy		474		373
Data processing		453		407
Net loss on OREO and repossessed assets		27		3
Total noninterest expense		5,435		4,619
Income before provision for income taxes		2,025		2,174
Provision for income taxes		423		760
Net income	$	1,602	$	1,414

Earnings per common share:
Basic	$	0.65	$	0.57
Diluted	$	0.63	$	0.54
Weighted-average number of common shares outstanding:
Basic		2,477,235		2,499,502
Diluted		2,558,418		2,596,519

See notes to condensed consolidated financial statements

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Condensed Consolidated Statements of Comprehensive Income (unaudited)

(In thousands)

	Three Months Ended March 31,
	2018			2017
Net income	$	1,602		$	1,414
Available for sale securities:
Unrealized gain/(loss) arising during the period		(39	)		51
Income tax benefit/(expense) related to unrealized gains/losses		8			(17	)
Other comprehensive income/(loss), net of tax		(31	)		34
Comprehensive income	$	1,571		$	1,448

See notes to condensed consolidated financial statements

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Condensed Consolidated Statements of Stockholders' Equity

For the Three Months Ended March 31, 2018 and 2017 (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, 2016		2,498,804	$	25	$	23,979	$	(683	)	$	36,873		$	81	$	60,275
Net income											1,414					1,414
Other comprehensive income, net of tax														34		34
Share-based compensation						144										144
Cash dividends paid on common stock ($0.10 per share)											(250	)				(250	)
Restricted stock awards issued		576														-
Exercise of options		500				11										11
Balances at March 31, 2017		2,499,880	$	25	$	24,134	$	(683	)	$	38,037		$	115	$	61,628

	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, 2017		2,511,127		$	25	$	24,986	$	(453	)	$	40,493		$	109		$	65,160
Net income												1,602						1,602
Other comprehensive loss, net of tax															(31	)		(31	)
Share-based compensation							45											45
Cash dividends paid on common stock ($0.12 per share)												(303	)					(303	)
Common stock repurchased		(5,206	)															-
Exercise of options		18,425					73											73
Balances at March 31, 2018		2,524,346		$	25	$	25,104	$	(453	)	$	41,792		$	78		$	66,546

See notes to condensed consolidated financial statements

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Condensed Consolidated Statements of Cash Flows (unaudited)

(In thousands)

	Three Months Ended March 31,
	2018			2017
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	1,602		$	1,414
Adjustments to reconcile net income to net cash from operating activities:
Accretion of net discounts on investments		10			12
Provision for loan losses		100			—
Depreciation and amortization		237			203
Compensation expense related to stock options and restricted stock		45			144
Net change in mortgage servicing rights		(106	)		3
Increase in cash surrender value of BOLI		(79	)		(81	)
Net change in advances from borrowers for taxes and insurance		471			528
Net gain on sale of loans		(332	)		(171	)
Proceeds from sale of loans		15,800			14,044
Originations of loans held-for-sale		(14,641	)		(14,972	)
Net loss on OREO and repossessed assets		27			3
Change in operating assets and liabilities:
Accrued interest receivable		15			62
Other assets		571			482
Accrued interest payable		4			14
Other liabilities		633			1,168
Net cash provided by operating activities		4,357			2,853
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from principal payments, maturities and sales of available-for-sale securities		159			285
FHLB stock redeemed		51			1,109
Net (increase)/decrease in loans		(11,485	)		10,727
Purchase of BOLI		(246	)		—
Proceeds from sale of OREO and other repossessed assets		—			223
Purchases of premises and equipment, net		(390	)		(663	)
Net cash (used)/provided by investing activities		(11,911	)		11,681
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits		14,793			13,091
Proceeds from borrowings		76,000			16,000
Repayment of borrowings		(79,000	)		(45,161	)
Dividends paid on common stock		(303	)		(250	)
Proceeds from stock option exercises		73			11
Net cash provided/(used) by financing activities		11,563			(16,309	)
Net change in cash and cash equivalents		4,009			(1,775	)
Cash and cash equivalents, beginning of period		60,680			54,582
Cash and cash equivalents, end of period	$	64,689		$	52,807

SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for income taxes	$	—		$	650
Interest paid on deposits and borrowings		1,019			781

See notes to condensed consolidated financial statements

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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, 2017, as filed with the SEC on March 27, 2018 ("2017 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, 2017, included in the 2017 Form 10-K. Certain amounts in the prior quarter's 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). In August 2015, FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606) which postponed the effective date of 2014-09. Subsequently, in March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations. This amendment clarifies that an entity should determine if 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 core principle of Topic 606 is that an entity must recognize revenue when it has satisfied a performance obligation of transferring promised goods or services to a customer. These standards were effective for interim and annual periods beginning after December 15, 2017. The Company has analyzed its revenue sources of noninterest income to determine when the satisfaction of the performance obligation occurs and the appropriate recognition of revenue. For further information, see Note 11 - Revenue from Contracts with Customers of this report. The adoption of these ASUs did not have a material impact on the Company's consolidated financial statements, other than the additional disclosures included in Note 11 of this report.

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements (unaudited)

In January 2016, FASB issued ASU No. 2016-01, Financial Instruments - Overall, Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-01 requires equity investments (except those accounted for under the equity method of accounting) to be measured at fair value with changes in fair value recognized in net income. In addition, the amendments in this ASU require an entity to disclose the fair value of financial instruments using the exit price notion. Exit price is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The methods of determining the fair value of assets and liabilities are consistent with our methodologies disclosed in Note 11 - Fair Value Measurements of the Company's 2017 Form 10-K, except for the valuation of loans held-for-investment which was impacted by the adoption of ASU 2016-01. Prior to adopting the amendments included in the standard, the Company was allowed to measure fair value under an entry price notion. The entry price notion previously applied by the Company used a discounted cash flows technique to calculate the present value of expected future cash flows for a financial instrument. The exit price notion uses the same approach, but also incorporates other factors, such as enhanced credit risk, illiquidity risk and market factors that sometimes exist in exit prices in dislocated markets. As of March 31, 2018, the technique used by the Company to estimate the exit price of the loan portfolio consists of similar procedures to those used as of December 31, 2017, but with added emphasis on both illiquidity risk and credit risk not captured by the previously applied entry price notion. This credit risk assumption is intended to approximate the fair value that a market participant would realize in a hypothetical orderly transaction. The Company's loan portfolio is initially fair valued using a segmented approach, using the eight categories as disclosed in Note 4 - Loans. Loans are considered a Level 3 classification. 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 amendments in this ASU were effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company has used the exit price notion in the fair value disclosure of financial instruments in Note 5 of this report. The adoption of ASU 2016-01 did not have a material impact on the Company's consolidated financial statements.

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

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements (unaudited)

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 were effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company does not currently have items on its cash flow statement that were impacted by adoption of this ASU and therefore adoption of ASU 2016-15 did not 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 was effective for reporting periods beginning after December 15, 2017. The Company has not had any modifications on share-based payment awards and therefore the adoption of ASU No. 2017-09 did not 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.

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements (unaudited)

In February 2018, FASB issued ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220). This ASU was issued to allow a reclassification from accumulated other comprehensive income to retained earnings from stranded tax effects resulting from the revaluation of the net deferred tax asset ("DTA") to the new corporate tax rate of 21% as a result of the Tax Cuts and Jobs Act of 2017 ("Tax Act"). The ASU is effective for reporting periods beginning after December 15, 2018 with early adoption permitted. The adoption of ASU No. 2018-02 is not expected to have a material impact on the Company's consolidated financial statements.

In March 2018, FASB issued ASU No. 2018-05, Income Taxes (Topic 740). This ASU was issued to provide guidance on the income tax accounting implications of the Tax Act and allows for entities to report provisional amounts for specific income tax effects of the Act for which the accounting under Topic 740 was not yet complete, but a reasonable estimate could be determined. A measurement period of one-year is allowed to complete the accounting effects under Topic 740 and revise any previous estimates reported. Any provisional amounts or subsequent adjustments included in an entity's financial statements during the measurement period should be included in income from continuing operations as an adjustment to tax expense in the reporting period the amounts are determined. The Company adopted this ASU with the provisional adjustments as reported in the Consolidated Financial Statements on Form 10-K as of December 31, 2017. As of March 31, 2018, the Company did not incur any adjustments to the provisional recognition.

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
March 31, 2018
Municipal bonds	$	3,234	$	134	$	(28	)	$	3,340
Agency mortgage-backed securities		1,908		20		-			1,928
Total	$	5,142	$	154	$	(28	)	$	5,268

December 31, 2017
Municipal bonds	$	3,240	$	155	$	(26	)	$	3,369
Agency mortgage-backed securities		2,030		36		-			2,066
Total	$	5,270	$	191	$	(26	)	$	5,435

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements (unaudited)

The amortized cost and fair value of AFS securities at March 31, 2018, 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.

	March 31, 2018
	Amortized Cost		Fair Value
Due after one year through five years	$	1,582	$	1,562
Due after five years through ten years		153		161
Due after ten years		1,499		1,617
Mortgage-backed securities		1,908		1,928
Total	$	5,142	$	5,268

There were no pledged securities at March 31, 2018 and December 31, 2017.

There were no sales of AFS securities during the three months ended March 31, 2018 and 2017.

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):

	March 31, 2018
	Less Than 12 Months				12 Months or Longer					Total
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
Municipal bonds	$	-	$	-	$	1,294	$	(28	)	$	1,294	$	(28	)
Total	$	-	$	-	$	1,294	$	(28	)	$	1,294	$	(28	)

	December 31, 2017
	Less Than 12 Months				12 Months or Longer					Total
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
Municipal bonds	$	-	$	-	$	1,302	$	(26	)	$	1,302	$	(26	)
Total	$	-	$	-	$	1,302	$	(26	)	$	1,302	$	(26	)

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements (unaudited)

There were no credit losses recognized in earnings during the three months ended March 31, 2018 or 2017 relating to the Company's securities.

At March 31, 2018, there were no securities in an unrealized loss position for less than 12 months and there were three municipal securities in an unrealized loss position for over 12 months. At December 31, 2017, there were no securities in an unrealized loss position for less than 12 months and there were three municipal securities in an unrealized loss position for more than 12 months. 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 months ended March 31, 2018 and 2017.

Note 4 – Loans

The composition of the loan portfolio at the dates indicated, excluding loans held-for-sale, was as follows (in thousands):

	March 31, 2018			December 31, 2017
Real estate loans:
One- to four- family	$	162,294		$	157,417
Home equity		27,638			28,379
Commercial and multifamily		221,255			211,269
Construction and land		60,789			61,482
Total real estate loans	$	471,976		$	458,547
Consumer loans:
Manufactured homes		17,480			17,111
Floating homes		29,110			29,120
Other consumer		5,462			4,902
Total consumer loans		52,052			51,133
Commercial business loans		37,854			40,829
Total loans		561,882			550,509
Deferred fees		(1,903	)		(1,914	)
Total loans, gross		559,979			548,595
Allowance for loan losses		(5,328	)		(5,241	)
Total loans, net	$	554,651		$	543,354

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements (unaudited)

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of March 31, 2018 (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	$	603	$	116	$	-	$	13	$	335	$	-	$	45	$	317	$	-	$	1,429
Collectively evaluated for impairment		911		160		1,295		362		99		169		41		216		646		3,899
Ending balance	$	1,514	$	276	$	1,295	$	375	$	434	$	169	$	86	$	533	$	646	$	5,328
Loans receivable:
Individually evaluated for impairment	$	6,405	$	906	$	3,147	$	130	$	459	$	-	$	195	$	1,546	$	-	$	12,788
Collectively evaluated for impairment		155,889		26,732		218,108		60,659		17,021		29,110		5,267		36,308		-		549,094
Ending balance	$	162,294	$	27,638	$	221,255	$	60,789	$	17,480	$	29,110	$	5,462	$	37,854	$	-	$	561,882

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, 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	$	360	$	109	$	-	$	10	$	247	$	-	$	40	$	130	$	-	$	896
Collectively evaluated for impairment		881		173		1,250		365		97		169		37		237		1,136		4,345
Ending balance	$	1,241	$	282	$	1,250	$	375	$	344	$	169	$	77	$	367	$	1,136	$	5,241
Loans receivable:
Individually evaluated for impairment	$	6,256	$	1,028	$	1,699	$	141	$	385	$	-	$	194	$	1,000	$	-	$	10,703
Collectively evaluated for impairment		151,161		27,351		209,570		61,341		16,726		29,120		4,708		39,829		-		539,806
Ending balance	$	157,417	$	28,379	$	211,269	$	61,482	$	17,111	$	29,120	$	4,902	$	40,829	$	-	$	550,509

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements (unaudited)

The following table summarizes the activity in the allowance for loan losses for the three months ended March 31, 2018 (in thousands):

	Beginning Allowance		Charge-offs			Recoveries		Provision/ (Benefit)			Ending Allowance
One- to four- family	$	1,241	$	-		$	-	$	273		$	1,514
Home equity		282		(7	)		4		(3	)		276
Commercial and multifamily		1,250		-			-		45			1,295
Construction and land		375		-			-		-			375
Manufactured homes		344		-			-		90			434
Floating homes		169		-			-		-			169
Other consumer		77		(14	)		4		19			86
Commercial business		367		-			-		166			533
Unallocated		1,136		-			-		(490	)		646
Total	$	5,241	$	(21	)	$	8	$	100		$	5,328

The following table summarizes the activity in the allowance for loan losses for the three months ended March 31, 2017 (in thousands):

	Beginning Allowance		Charge-offs			Recoveries		Provision/ (Benefit)			Ending Allowance
One- to four- family	$	1,542	$	-		$	-	$	(7	)	$	1,535
Home equity		378		-			27		(157	)		248
Commercial and multifamily		1,144		(24	)		1		(8	)		1,113
Construction and land		459		-			-		(46	)		413
Manufactured homes		168		-			2		(22	)		148
Floating homes		132		-			-		5			137
Other consumer		112		(5	)		15		(24	)		98
Commercial business		175		-			-		(21	)		154
Unallocated		712		-			-		280			992
Total	$	4,822	$	(29	)	$	45	$	-		$	4,838

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.

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements (unaudited)

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 March 31, 2018, 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	$	160,394	$	27,028	$	213,842	$	60,707	$	17,167	$	29,110	$	5,404	$	35,906	$	549,558
Watch		-		-		4,266		-		-		-		-		488		4,754
Special Mention		-		-		1,467		-		-		-		-		1,267		2,734
Substandard		1,900		610		1,680		82		313		-		58		193		4,836
Doubtful		-		-		-		-		-		-		-		-		-
Loss		-		-		-		-		-		-		-		-		-
Total	$	162,294	$	27,638	$	221,255	$	60,789	$	17,480	$	29,110	$	5,462	$	37,854	$	561,882

The following table represents the internally assigned grades as of December 31, 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	$	153,793	$	27,493	$	199,887	$	61,390	$	16,877	$	29,120	$	4,708	$	39,089	$	532,357
Watch		244		-		9,683		-		-		-		-		827		10,754
Special Mention		137		-		357		-		-		-		-		784		1,278
Substandard		3,243		886		1,342		92		234		-		194		129		6,120
Doubtful		-		-		-		-		-		-		-		-		-
Loss		-		-		-		-		-		-		-		-		-
Total	$	157,417	$	28,379	$	211,269	$	61,482	$	17,111	$	29,120	$	4,902	$	40,829	$	550,509

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements (unaudited)

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 March 31, 2018, and December 31, 2017, by type of loan (in thousands):

	March 31, 2018		December 31, 2017
One- to four- family	$	736	$	791
Home equity		452		722
Commercial and multifamily		197		201
Construction and land		82		92
Manufactured homes		200		206
Other consumer		–		8
Commercial business		126		129
Total	$	1,793	$	2,149

The following table represents the aging of the recorded investment in past due loans as of March 31, 2018, 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	$	851	$	300	$	446	$	-	$	1,597	$	160,697	$	162,294
Home equity		305		54		414		-		773		26,865		27,638
Commercial and multifamily		42		-		-		-		42		221,213		221,255
Construction and land		-		-		-		-		-		60,789		60,789
Manufactured homes		41		56		176		-		273		17,207		17,480
Floating homes		-		-		-		-		-		29,110		29,110
Other consumer		1		-		-		-		1		5,461		5,462
Commercial business		223		-		-		-		223		37,631		37,854
Total	$	1,463	$	410	$	1,036	$	-	$	2,909	$	558,973	$	561,882

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements (unaudited)

The following table represents the aging of the recorded investment in past due loans as of December 31, 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	$	2,092	$	1,819	$	727	$	-	$	4,638	$	152,779	$	157,417
Home equity		521		5		633		-		1,159		27,220		28,379
Commercial and multifamily		313		-		-		-		313		210,956		211,269
Construction and land		51		-		92		-		143		61,339		61,482
Manufactured homes		185		50		197		-		432		16,679		17,111
Floating homes		-		-		-		-		-		29,120		29,120
Other consumer		15		-		-		-		15		4,887		4,902
Commercial business		400		-		-		-		400		40,429		40,829
Total	$	3,577	$	1,874	$	1,649	$	-	$	7,100	$	543,409	$	550,509

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 March 31, 2018, 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	$	161,512	$	27,186	$	221,058	$	60,707	$	17,280	$	29,110	$	5,462	$	37,642	$	559,957
Nonperforming		782		452		197		82		200		-		-		212		1,925
Total	$	162,294	$	27,638	$	221,255	$	60,789	$	17,480	$	29,110	$	5,462	$	37,854	$	561,882

The following table represents the credit risk profile of our loan portfolio based on payment activity as of December 31, 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	$	156,580	$	27,657	$	211,068	$	61,390	$	16,905	$	29,120	$	4,894	$	40,612	$	548,226
Nonperforming		837		722		201		92		206		-		8		217		2,283
Total	$	157,417	$	28,379	$	211,269	$	61,482	$	17,111	$	29,120	$	4,902	$	40,829	$	550,509

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements (unaudited)

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

Impaired loans at March 31, 2018 and December 31, 2017, by type of loan were as follows (in thousands):

	March 31, 2018
			Recorded Investment
	Unpaid Principal Balance		Without Allowance		With Allowance		Total Recorded Investment		Related Allowance

One- to four- family	$	6,586	$	3,038	$	3,367	$	6,405	$	603
Home equity		1,008		740		166		906		116
Commercial and multifamily		3,174		3,147		-		3,147		-
Construction and land		135		89		41		130		13
Manufactured homes		490		22		437		459		335
Other consumer		195		124		71		195		45
Commercial business		1,564		739		807		1,546		317
Total	$	13,152	$	7,899	$	4,889	$	12,788	$	1,429

	December 31, 2017
			Recorded Investment
	Unpaid Principal Balance		Without Allowance		With Allowance		Total Recorded Investment		Related Allowance

One- to four- family	$	6,562	$	3,197	$	3,059	$	6,256	$	360
Home equity		1,149		677		351		1,028		109
Commercial and multifamily		1,722		1,699		-		1,699		-
Construction and land		141		100		41		141		10
Manufactured homes		409		23		362		385		247
Other consumer		194		125		69		194		40
Commercial business		1,017		784		216		1,000		130
Total	$	11,194	$	6,605	$	4,098	$	10,703	$	896

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements (unaudited)

Income on impaired loans for the three months ended March 31, 2018 and December 31, 2017 by type of loan were as follows (in thousands):

	Three Months Ended March 31, 2018				Three Months Ended March 31, 2017
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized

One- to four- family	$	6,341	$	73	$	4,959	$	84
Home equity		968		7		965		10
Commercial and multifamily		2,426		45		1,852		27
Construction and land		136		5		82		1
Manufactured homes		422		10		302		5
Other consumer		195		3		63		1
Commercial business		1,275		20		505		5
Total	$	11,763	$	163	$	8,728	$	133

Forgone interest on nonaccrual loans was $2,000 and $4,000 for the three months ended March 31, 2018 and 2017, respectively. There were no commitments to lend additional funds to borrowers whose loans were classified as nonaccrual or impaired at March 31, 2018 and December 31, 2017.

Troubled debt restructurings. Loans classified as TDRs totaled $3.7 million at both March 31, 2018 and December 31, 2017, and are included in impaired loans. The Company has granted, in its TDRs, a variety of concessions to borrowers in the form of loan modifications. The modifications granted can generally be described in the following categories:

Rate Modification: A modification in which the interest rate is changed.

Term Modification: A modification in which the maturity date, timing of payments or frequency of payments is changed.

Payment Modification: A modification in which the dollar amount of the payment is changed. Interest only modifications in which a loan is converted to interest only payments for a period of time are included in this category.

Combination Modification: Any other type of modification, including the use of multiple categories above.

There were no loans modified as TDRs or payoffs of any TDRs during the three months ended March 31, 2018 and 2017.

There were no post-modification changes for the unpaid principal balance in loans, net of partial charge-offs, that were recorded as a result of the TDRs for the three months ended March 31, 2018 and 2017. There were no TDRs for which there was a payment default within the first 12 months of modification during the three months ended March 31, 2018 and 2017.

The Company had no commitments to extend additional credit to borrowers owing receivables whose terms have been modified in TDRs. All TDRs are also classified as impaired loans and are included in the loans individually evaluated for impairment in the calculation of the allowance for loan losses.

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements (unaudited)

Note 5 – Fair Value Measurements

The following tables present information about the level in the fair value hierarchy for the Company's financial assets and liabilities, whether or not recognized or recorded at fair value as of March 31, 2018 and December 31, 2017 (in thousands):

	March 31, 2018				Fair Value Measurements Using:
	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
FINANCIAL ASSETS:
Cash and cash equivalents	$	64,689	$	64,689	$	64,689	$	-	$	-
Available-for-sale securities		5,268		5,268		-		5,268		-
Loans held-for-sale		950		950		-		950		-
Loans receivable, net ⁽¹⁾		554,651		556,294		-		-		556,294
Accrued interest receivable		1,962		1,962		1,962		-		-
Mortgage servicing rights		3,532		3,532		-		-		3,532
FHLB stock		3,014		3,014		-		-		3,014
FINANCIAL LIABILITIES:
Non-maturity deposits		362,697		362,697		-		362,697		-
Time deposits ⁽¹⁾		166,496		167,807		-		167,807		-
Borrowings		56,000		56,000		-		56,000		-
Accrued interest payable		81		81		-		81		-

	December 31, 2017				Fair Value Measurements Using:
	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
FINANCIAL ASSETS:
Cash and cash equivalents	$	60,680	$	60,680	$	60,680	$	-	$	-
Available-for-sale securities		5,435		5,435		-		5,435		-
Loans held for sale		1,777		1,777		-		1,777		-
Loans receivable, net		543,354		543,400		-		-		543,400
Accrued interest receivable		1,977		1,977		1,977		-		-
Mortgage servicing rights		3,426		3,426		-		-		3,426
FHLB Stock		3,065		3,065		-		-		3,065
FINANCIAL LIABILITIES:
Non-maturity deposits		349,846		349,846		-		349,846		-
Time deposits		164,554		163,485		-		163,485		-
Borrowings		59,000		59,000		-		59,000		-
Accrued interest payable		77		77		-		77		-

^{_______________________________}

⁽¹⁾ The estimated fair values of loans receivable, net and time deposits for March 31, 2018 reflect exit price assumptions. The December

31, 2017 fair value estimates are not based on exit price assumptions.

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements (unaudited)

The following tables present the balance of assets measured at fair value on a recurring basis as of March 31, 2018 and December 31, 2017 (in thousands):

	Fair Value at March 31, 2018
Description	Total		Level 1		Level 2		Level 3
Municipal bonds	$	3,340	$	-	$	3,340	$	-
Agency mortgage-backed securities		1,928		-		1,928		-
Mortgage servicing rights		3,532		-		-		3,532

	Fair Value at December 31, 2017
Description	Total		Level 1		Level 2		Level 3
Municipal bonds	$	3,369	$	-	$	3,369	$	-
Agency mortgage-backed securities		2,066		-		2,066		-
Mortgage servicing rights		3,426		-		-		3,426

For the three months ended March 31, 2018 and 2017 there were no transfers between Level 1 and Level 2 nor between Level 2 and Level 3.

The following tables provide a description of the valuation technique, unobservable input, and qualitative information about the unobservable inputs for the Company's assets and liabilities classified as Level 3 and measured at fair value on a recurring basis at March 31, 2018 and December 31, 2017:

March 31, 2018
Financial Instrument	Valuation Technique	Unobservable Input(s)	Range (Weighted-Average)
Mortgage Servicing Rights	Discounted cash flow	Prepayment speed assumption		95-328% (136%)
		Discount rate		13-15% (13%)

December 31, 2017
Financial Instrument	Valuation Technique	Unobservable Input(s)	Range (Weighted-Average)
Mortgage Servicing Rights	Discounted cash flow	Prepayment speed assumption		103-412% (160%)
		Discount rate		13%-15% (13%)

Generally, any significant increases in the constant prepayment rate and discount rate utilized in the fair value measurement of the mortgage servicing rights will result in a negative fair value adjustment (and decrease in the fair value measurement). Conversely, a decrease in the constant prepayment rate and discount rate will result in a positive fair value adjustment (and increase in the fair value measurement). An increase in the weighted average life assumptions will result in a decrease in the constant prepayment rate and conversely, a decrease in the weighted-average life will result in an increase of the constant prepayment rate.

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements (unaudited)

There were no assets or liabilities (excluding mortgage servicing rights) measured at fair value using significant unobservable inputs (Level 3) on a recurring basis during the three months ended March 31, 2018. The following table provides a reconciliation of assets and liabilities measured at fair value using significant unobservable inputs (Level 3) on a recurring basis during the three months ended March 31, 2017 (in thousands):

	Three Months Ended March 31,
	2017
Beginning balance, at fair value	$	347
OTTI impairment losses		-
Sales and principal payments		(24	)
Change in unrealized loss		(1	)
Ending balance, at fair value	$	322

Mortgage servicing rights are measured at fair value using a significant unobservable input (Level 3) on a recurring basis - additional information is included in Note 6 – Mortgage Servicing Rights.

The following tables present the balance of assets measured at fair value on a nonrecurring basis at the dates indicated (in thousands):

	Fair Value at March 31, 2018
	Total		Level 1		Level 2		Level 3
OREO and repossessed assets	$	638	$	-	$	-	$	638
Impaired loans		12,789		-		-		12,789

	Fair Value at December 31, 2017
	Total		Level 1		Level 2		Level 3
OREO and repossessed assets	$	610	$	-	$	-	$	610
Impaired loans		10,703		-		-		10,703

There were no liabilities carried at fair value, measured on a recurring or nonrecurring basis, at March 31, 2018 and December 31, 2017.

The following tables provide a description of the valuation technique, observable input, and qualitative information about the unobservable inputs for the Company's assets and liabilities classified as Level 3 and measured at fair value on a nonrecurring basis at March 31, 2018 and December 31, 2017:

March 31, 2018
Financial Instrument	Valuation Technique(s)	Unobservable Input(s)	Range (Weighted Average)
OREO	Market approach	Adjusted for differences between comparable sales		0-0% (0%)
Impaired loans	Market approach	Adjusted for differences between comparable sales		0-100% (9%)

December 31, 2017
Financial Instrument	Valuation Technique(s)	Unobservable Input(s)	Range(Weighted Average)
OREO	Market approach	Adjusted for difference between comparable sales		0-0% (0%)
Impaired loans	Market approach	Adjusted for difference between comparable sales		0-100% (8%)

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements (unaudited)

A description of the valuation methodologies used for impaired loans and OREO is as follows:

Impaired Loans - The fair value of collateral dependent loans is based on the current appraised value of the collateral or internally developed models utilizing a calculation of expected discounted cash flows which contain management's assumptions.

OREO and Repossessed Assets – The fair value of OREO and repossessed assets is based on the current appraised value of the collateral less estimated costs to sell.

The following methods and assumptions were used to estimate the fair value of other financial instruments:

Cash and cash equivalents, and accrued interest receivable and payable - The estimated fair value is equal to the carrying amount.

AFS Securities – AFS securities are recorded at fair value based on quoted market prices, if available. If quoted market prices are not available, management utilizes third-party pricing services or broker quotations from dealers in the specific instruments. Level 2 securities include those traded on an active exchange, as well as U.S. government and its agencies securities. Level 3 securities include private label mortgage-backed securities.

Loans Held-for-Sale - Residential mortgage loans held-for-sale are recorded at the lower of cost or fair value. The fair value of fixed-rate residential loans is based on whole loan forward prices obtained from government sponsored enterprises. At March 31, 2018 and December 31, 2017, loans held-for-sale were carried at cost, as no impairment was required.

Mortgage Servicing Rights –The fair value of mortgage servicing rights is determined through a discounted cash flow analysis, which uses interest rates, prepayment speeds, discount rates, and delinquency rate assumptions as inputs.

FHLB stock - The estimated fair value is equal to the par value of the stock, which approximates fair value.

Bank-owned Life Insurance. - The estimated fair value is equal to the cash surrender value of polices, net of surrender charges.

Borrowings - The fair value of borrowings are estimated using discounted cash flow analyses, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements.

Off-balance sheet financial instruments - The fair value for the Company's off-balance sheet loan commitments are estimated based on fees charged to others to enter into similar agreements taking into account the remaining terms of the agreements and credit standing of the Company's clients. The estimated fair value of these commitments is not significant.

The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Company's financial instruments will change when interest rate levels change, which may be favorable or unfavorable to it. Management attempts to match maturities of assets and liabilities to the extent necessary or possible to minimize interest rate risk. However, borrowers with fixed-rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed-rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by establishing early withdrawal penalties for certificates of deposit, creating interest rate floors for certain variable rate loans, adjusting terms of new loans and deposits, by borrowing at fixed-rates for fixed-terms and investing in securities with terms that mitigate the Company's overall interest rate risk.

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements (unaudited)

Note 6 – Mortgage Servicing Rights

The unpaid principal balances of loans serviced for Federal National Mortgage Association ("Fannie Mae") at March 31, 2018 and December 31, 2017, totaled $389.3 million and $392.6 million, respectively, and are not included in the Company's financial statements. We also service loans for other financial institutions for which a servicing fee is received. The unpaid principal balances of loans serviced for other financial institutions at March 31, 2018 and December 31, 2017, totaled $21.4 million and $19.9 million, respectively, and are not included in the Company's financial statements.

The key economic assumptions used in determining the fair value of mortgage servicing rights at the dates indicated are as follows:

	March 31, 2018		December 31, 2017
Prepayment speed (Public Securities Association "PSA" model)		136%		160%
Weighted-average life		7.4 years		6.9 years
Yield to maturity discount rate		13%		13%

The amounts of contractually specified servicing, late and ancillary fees earned and recorded, net of fair value market adjustments to the mortgage servicing rights, are included in mortgage servicing income on the Condensed Consolidated Statements of Income which were $220,000 and $233,000 for the three months ended March 31, 2018 and 2017, respectively.

Note 7 – Commitments and Contingencies

In the normal course of operations, the Company engages in a variety of financial transactions that are not recorded in our financial statements. These transactions involve varying degrees of off-balance sheet credit, interest rate and liquidity risks. These transactions are used primarily to manage clients' requests for funding and take the form of loan commitments and lines of credit.

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements (unaudited)

Note 8 – Borrowings and FHLB Stock

The Company utilizes a loan agreement with the FHLB of Des Moines. The terms of the agreement call for a blanket pledge of a portion of the Company's mortgage and commercial and multifamily loan portfolio based on the outstanding balance. At March 31, 2018 and December 31, 2017, the amount available to borrow under this credit facility was $225.6 million and $217.6 million, respectively. At March 31, 2018, the credit facility was collateralized as follows: one- to four- family mortgage loans with an advance equivalent of $116.1 million, commercial and multifamily mortgage loans with an advance equivalent of $105.6 million and home equity loans with an advance equivalent of $14.8 million. At December 31, 2017, the credit facility was collateralized as follows: one- to four- family mortgage loans with an advance equivalent of $111.5 million, commercial and multifamily mortgage loans with an advance equivalent of $103.0 million and home equity loans with an advance equivalent of $15.2 million. The Company had outstanding borrowings under this arrangement of $56.0 million and $59.0 million at March 31, 2018 and December 31, 2017, respectively. Additionally, the Company had outstanding letters of credit from the FHLB of Des Moines with a notional amount of $14.5 million both at March 31, 2018 and December 31, 2017, respectively, to secure public deposits. The remaining amount available to borrow as of March 31, 2018 and December 31, 2017, was $155.1 million and $144.1 million, respectively. All contractual principal repayments of $56.0 million, with a weighted-average interest rate of 1.72%, at March 31, 2018 are due within one year.

As a member of the FHLB system, the Bank is required to maintain a minimum level of investment in FHLB of Des Moines stock based on specific percentages of its outstanding FHLB advances. At March 31, 2018 and December 31, 2017, the Company had an investment of $3.0 million and $3.1 million, respectively, in FHLB of Des Moines stock.

The Company participates in the Federal Reserve Bank Borrower-in-Custody program, which gives the Company access to the discount window. The terms of the program call for a pledge of specific assets. The Company pledges commercial and consumer loans as collateral for this line of credit. The Company had unused borrowing capacity of $49.7 million and $51.2 million and no outstanding borrowings under this program at March 31, 2018 and December 31, 2017, respectively.

The Company has access to an unsecured Fed Funds line of credit from Pacific Coast Banker's Bank. The line has a one-year term maturing on June 30, 2018 and is renewable annually. As of March 31, 2018, the amount available under this line of credit was $2.0 million. There was no balance on this line of credit as of March 31, 2018 and December 31, 2017, respectively.

The Company has access to a Fed Funds line of credit from Zions Bank under a Fed Funds Sweep and Line Agreement. The agreement allows access to a Fed Funds line of up to $9.0 million and requires the Company to maintain cash balances with Zions Bank of $250,000. The agreement may be terminated by either party. There was no balance on this line of credit as of March 31, 2018 and December 31, 2017, respectively.

The Company has access to an unsecured Fed Funds line of credit from The Independent Bank. As of March 31, 2018, the amount available under this line of credit was $10.0 million. The agreement may be terminated by either party. There was no balance on this line of credit as of March 31, 2018 and December 31, 2017, respectively.

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements (unaudited)

Note 9 – Earnings Per Common Share

Basic earnings per common share is computed by dividing net income by the weighted-average number of common shares outstanding for the period, reduced for average unallocated ESOP shares and average unvested restricted stock awards. Unvested share-based awards containing non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and are included in the computation of earnings per share pursuant to the two-class method described in ASC 260-10-45-60B. Diluted earnings per common share reflects the potential dilution that could occur if securities or other contracts to issue common stock (such as stock awards and options) were exercised or converted to common stock or resulted in the issuance of common stock that then shared in the Company's earnings. Diluted earnings per common share is computed by dividing net income by the weighted-average number of common shares outstanding for the period increased for the dilutive effect of unexercised stock options and unvested restricted stock awards. The dilutive effect of the unexercised stock options and unvested restricted stock awards is calculated under the treasury stock method utilizing the average market value of the Company's stock for the period.

Earnings per share are summarized for the periods presented in the following table (in thousands, except per share data):

	Three Months Ended March 31,
	2018		2017
Net income	$	1,602	$	1,414
Weighted-average number of shares outstanding, basic		2,477		2,500
Effect of potentially dilutive common shares ⁽¹⁾		81		97
Weighted-average number of shares outstanding, diluted		2,558		2,597
Earnings per share, basic	$	0.65	$	0.57
Earnings per share, diluted	$	0.63	$	0.54

^{___________________________________}

⁽¹⁾ Represents the effect of the assumed exercise of stock options and vesting of non-participating restricted shares, based on the

treasury stock method.

There were no anti-dilutive securities at either March 31, 2018 or March 31, 2017.

Note 10 – Stock-based Compensation

Stock Options and Restricted Stock

The Company currently has two existing Equity Incentive Plans, a 2008 Equity Inventive Plan (the "2008 Plan") and a 2013 Equity Incentive Plan (the "2013 Plan"), collectively (the "Plans"), both of which were approved by stockholders. The Plans permit the grant of restricted stock, restricted stock units, stock options, and stock appreciation rights. Under the 2008 Plan, 126,287 shares of common stock were approved for awards for stock options and stock appreciation rights and 50,514 shares of common stock were approved for awards for restricted stock and restricted stock units. Under the 2013 Plan, 141,750 shares of common stock were approved for awards for stock options and stock appreciation rights and 56,700 shares of common stock were approved for awards for restricted stock and restricted stock units.

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements (unaudited)

As of March 31, 2018, on an adjusted basis, awards for stock options totaling 258,780 shares and awards for restricted stock totaling 106,870 shares of Company common stock have been granted, net of any forfeitures, to participants in the Plans. During the three months ended March 31, 2018 and 2017, share-based compensation expense totaled $45,000 and $144,000, respectively.

Stock Option Awards

The stock option awards granted to date under the 2008 Plan vest in 20 percent annual increments commencing one year from the grant date in accordance with the requirements of the 2008 Plan. The stock option awards granted to date under the 2013 Plan vest in equal annual installments of either two or four years. All of the options granted under the Plans are exercisable for a period of 10 years from the date of grant, subject to vesting. The following is a summary of the Company's stock option award activity during the three months ended March 31, 2018:

	Shares			Weighted- Average Exercise Price		Weighted-Average Remaining Contractual Term in Years		Aggregate Intrinsic Value
Outstanding at January 1, 2017		186,363		$	18.04		6.26	$	2,977,279
Granted		-			-
Exercised		(18,425	)		13.77
Forfeited		(7,017	)		17.55
Expired		-			-
Outstanding at March 31, 2018		160,921			18.55		6.24		2,928,762
Exercisable		132,632			17.87		6.02	$	2,504,092
Expected to vest, assuming a 0% forfeiture rate over the vesting term		28,289		$	21.74		7.27	$	424,670

As of March 31, 2018, there was $188,000 of total unrecognized compensation cost related to non-vested stock options granted under the Plans. The cost is expected to be recognized over the remaining weighted-average vesting period of 1.1 years.

There were no stock options granted during three months ended March 31, 2018. The fair value of options granted for the three months ended March 31, 2017 was determined using the following weighted-average assumptions as of the grant date.

Annual dividend yield		1.28	%
Expected volatility		22.99	%
Risk-free interest rate		2.20	%
Expected term	6.50 years
Weighted-average grant date fair value per option granted	$	6.62

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements (unaudited)

Restricted Stock Awards

The fair value of the restricted stock awards is equal to the fair value of the Company's stock at the date of grant. Compensation expense is recognized over the vesting period that the awards are based. The restricted stock awards granted to date under the 2008 Plan provide for vesting in 20% annual increments commencing one year from the grant date. The restricted stock awards granted to date under the 2013 Plan provide for immediate vesting of 33.33% of a recipient's award with the balance of an individual's award under the 2013 Plan vesting in two equal annual installments commencing one year from the grant date.

The following is a summary of the Company's non-vested restricted stock award activity during the three months ended March 31, 2018:

	Shares			Weighted-Average Grant-Date Fair Value Per Share		Aggregate Intrinsic Value Per Share
Non-vested at January 1, 2017		11,785		$	19.05
Granted		-			-
Vested		(10,906	)		21.94
Forfeited		(343	)		18.36
Expired		—			—
Non-vested at March 31, 2018		536			21.95		36.75
Expected to vest assuming a 0% forfeiture rate over the vesting term		536		$	21.95	$	36.75

As of March 31, 2018, there was $26,000 of unrecognized compensation cost related to non-vested restricted stock granted under the Plans. The cost is expected to be recognized over the weighted-average vesting period of 1.47 years. The total fair value of shares vested for the three months ended March 31, 2018 and 2017 was $239,000 and $283,000, respectively.

Employee Stock Ownership Plan

In January 2008, the ESOP borrowed $1.2 million from the Company to purchase common stock of the Company which was paid in full in 2017. In August 2012, in conjunction with the Company's conversion to a full stock company from the mutual holding company structure, the ESOP borrowed an additional $1.1 million from the Company to purchase common stock of the Company. The loan is being repaid principally by the Bank through contributions to the ESOP over a period of ten years. The interest rate on the loan is fixed at 2.25%, per annum. As of March 31, 2018, the remaining balance of the ESOP loan was $477,000.

Neither the loan balance nor the related interest expense is reflected on the condensed consolidated financial statements.

At March 31, 2018, the ESOP was committed to release 11,340 shares of the Company's common stock to participants and held 34,020 unallocated shares remaining to be released in future years. The fair value of the 176,964 restricted shares held by the ESOP trust was $6.5 million at March 31, 2018. ESOP compensation expense included in salaries and benefits was $174,000 and $168,000 for the three months ended March 31, 2018 and 2017, respectively.

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements (unaudited)

Note 11 – Revenue from Contracts with Customers

All of the Company's revenue from contracts with customers in the scope of ASC 606 is recognized in Noninterest Income with the exception of the net loss on OREO and repossessed assets, which is included in Noninterest Expense. The following table presents the Company's sources of Noninterest Income for the three months ended March 31, 2018 and 2017 (in thousands). Items outside of the scope of ASC 606 are noted as such.

	Three Months Ended March 31,
	2018		2017
Noninterest income:
Service charges and fee income
Account maintenance fees	$	53	$	44
Transaction-based and overdraft service charges		120		101
Debit/ATM interchange fees		214		235
Credit card and interchange fees		12		9
Loan fees ^(a)		50		110
Other fees ^(a)		11		12
Total service charges and fee income		460		511
Earnings on cash surrender value of bank-owned life insurance ^(a)		79		81
Mortgage servicing income ^(a)		220		233
Net gain on sale of loans ^(a)		332		171
Total noninterest income	$	1,091	$	996

_______________

^(a) Not within scope of ASC 606

Account maintenance fees and transaction-based and overdraft service charges

The Company earns fees from its customers for account maintenance, transaction-based and overdraft services. Account maintenance fees consist primarily of account fees and analyzed account fees charged on deposit accounts on a monthly basis. The performance obligation is satisfied and the fees are recognized on a monthly basis as the service period is completed. Transaction-based fees on deposit accounts are charged to deposit customers for specific services provided to the customer, such as non-sufficient funds fees, overdraft fees, and wire fees. The performance obligation is completed as the transaction occurs and the fees are recognized at the time each specific service is provided to the customer.

Debit/ATM and credit card interchange income

Debit/ATM interchange income represent fees earned when a debit card issued by the Bank is used for a transaction. The Bank earns interchange fees from debit cardholder transactions through the Mastercard payment network. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder. The performance obligation is satisfied and the fees are earned when the cost of the transaction is charged to the cardholders' account. Certain expenses directly associated with the debit card are recorded on a net basis with the interchange income.

The Company utilizes a third party agency relationship to issue credit cards. Credit card interchange income represent fees earned when a credit card is issued by the third party agent. Similar to debit card interchange fees, the Bank earns an interchange fee for each transaction made with Sound Community Bank's branded credit cards. The performance obligation is satisfied and the fees are earned when the cost of the transaction is charged to the cardholders' credit card. Certain expenses and rebates directly related to the credit card interchange contract are recorded net to the interchange income.

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SOUND FINANCIAL BANCORP, INC. AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements (unaudited)

Net loss on OREO and repossessed assets

We record a gain or loss from the sale of other real estate owned when control of the property transfers to the buyer, which generally occurs at the time of an executed deed of trust. When the Bank finances the sale of other real estate owned to the buyer, the Company assesses whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the other real estate owned asset is derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer. In determining the gain or loss on sale, we adjust the transaction price and related gain or loss on sale if a significant financing component is present. For the three months ended March 31, 2018 and 2017, the Company had a loss on the sale of OREO of $27,000 and $3,000, respectively, included in Noninterest Expense.

Note 12 – Subsequent Event

On April 26, 2018, the Company declared a quarterly cash dividend of $0.14 per common share, payable May 25, 2018 to stockholders of record at the close of business May 10, 2018.

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Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operation

MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Special Note Regarding Forward-Looking Statements

Certain matters discussed in this Form 10-Q constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our financial condition, results of operations, plans, objectives, future performance or business. Forward-looking statements are not statements of historical fact, are based on certain assumptions and are generally identified by use of the words "believes," "expects," "anticipates," "estimates," "forecasts," "intends," "plans," "targets," "potentially," "probably," "projects," "outlook" or similar expressions or future or conditional verbs such as "may," "will," "should," "would" and "could." Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about, among other things, expectations of the business environment in which we operate, projections of future performance or financial items, perceived opportunities in the market, potential future credit experience, and statements regarding our mission and vision. These forward-looking statements are based upon current management expectations and may, therefore, involve risks and uncertainties. Our actual results, performance, or achievements may differ materially from those suggested, expressed, or implied by forward-looking statements as a result of a wide variety or range of factors including, but not limited to:



changes in economic conditions, either nationally or in our market area;



fluctuations in interest rates;



the risks of lending and investing activities, including changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of our allowance for loan losses;



the possibility of other-than-temporary impairments of securities held in our securities portfolio;



our ability to access cost-effective funding;



fluctuations in the demand for loans, the number of unsold homes, land and other properties, and fluctuations in real estate values and both residential and commercial and multifamily real estate market conditions in our market area;



secondary market conditions for loans and our ability to sell loans in the secondary market;



our ability to attract and retain deposits;



our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we may acquire into our operations and our ability to realize related revenue synergies and expected cost savings and other benefits within the anticipated time frames or at all, including the recent University Place branch acquisition;



legislative or regulatory changes such as the Dodd-Frank Wall Street Reform and Consumer Protection Act and its implementing regulations that adversely affect our business, as well as changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules including changes related to Basel III;



monetary and fiscal policies of the Board of Governors of the Federal Reserve System ("Federal Reserve") and the U.S. Government and other governmental initiatives affecting the financial services industry;



results of examinations of Sound Financial Bancorp and Sound Community Bank by their regulators, including the possibility that the regulators may, among other things, require us to increase our allowance for loan losses or to write-down assets, change Sound Community Bank's regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings;



increases in premiums for deposit insurance;



our ability to control operating costs and expenses;



the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation;



difficulties in reducing risks associated with the loans on our balance sheet;



staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges;



our ability to keep pace with technological changes, including our ability to identify and address cyber-security risks such as data security breaches, "denial of service" attacks, "hacking" and identity theft;



our ability to retain key members of our senior management team;



costs and effects of litigation, including settlements and judgments;



our ability to implement our business strategies;



increased competitive pressures among financial services companies;



changes in consumer spending, borrowing and savings habits;



the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;



our ability to pay dividends on our common stock;



adverse changes in the securities markets;



the inability of key third-party providers to perform their obligations to us;



changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; and



other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and the other risks described from time to time in our filings with the SEC, including this Form 10-Q and our 2017 Form 10-K.

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We wish to advise readers not to place undue reliance on any forward-looking statements and that the factors listed above could materially affect our financial performance and could cause our actual results for future periods to differ materially from any such forward-looking statements expressed with respect to future periods and could negatively affect our stock price performance.

We do not undertake and specifically decline any obligation to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

General

Sound Financial Bancorp, a Maryland corporation, is a bank holding company for its wholly owned subsidiary, Sound Community Bank. Substantially all of Sound Financial Bancorp's business is conducted through Sound Community Bank, a Washington state-chartered commercial bank. As a Washington commercial bank, the Bank's regulators are the WDFI and the FDIC. The Federal Reserve is the primary federal regulator for Sound Financial Bancorp.

Sound Community Bank's deposits are insured up to applicable limits by the FDIC. At March 31, 2018, Sound Financial Bancorp had total consolidated assets of $659.5 million, net loans of $554.7 million, deposits of $529.2 million and stockholders' equity of $66.5 million. The shares of Sound Financial Bancorp are traded on The NASDAQ Capital Market under the symbol "SFBC." Our executive offices are located at 2400 3rd Avenue, Suite 150, Seattle, Washington, 98121.

Our principal business consists of attracting deposits from the general public and local governments 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, consumer and commercial business loans and construction and land loans. We offer a wide variety of secured and unsecured consumer loan products, including manufactured home loans, floating home loans, automobile loans, boat loans and recreational vehicle loans. We intend to continue emphasizing our residential mortgage, commercial and multifamily real estate and commercial business lending, while continuing to originate home equity and consumer loans. As part of our business, we focus on residential mortgage loan originations, many of which we sell to Fannie Mae and a portion of which we retain for our loan portfolio consistent with our asset/liability objectives. We sell many of these loans with servicing retained to maintain the direct client relationship and continue our emphasis on strong client service.

Our operating revenues are derived principally from earnings on interest earning assets, service charges and fees, and gains on the sale of loans. Our primary sources of funds are deposits, FHLB advances, 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.

Our noninterest expenses consist primarily of salaries, incentive pay, commissions, and employee benefits, 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 and wages 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.

Critical Accounting Policies

Certain of our accounting policies are important to an understanding of our financial condition, since they require management to make difficult, complex or subjective judgments, which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. 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. Management believes that its critical accounting policies include determining the allowance for loan losses, accounting for other-than-temporary impairment of securities, accounting for mortgage servicing rights, accounting for other real estate owned and accounting for deferred income taxes. Our methodologies for analyzing the allowance for loan losses, other-than-temporary impairment, mortgage servicing rights, other real estate owned and deferred tax asset accounts are described in our 2017 Form 10-K. There have been no significant changes in the Company's application of accounting policies since December 31, 2017.

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Comparison of Financial Condition at March 31, 2018 and December 31, 2017

General. Total assets increased $14.3 million, or 2.2%, to $659.5 million at March 31, 2018 from $645.2 million at December 31, 2017. This increase was primarily the result of an $11.3 million, or 2.1%, increase in the net loan portfolio and a $4.0 million, or 6.6%, increase in cash and cash equivalents. Excess liquidity from a $14.8 million, or 2.9%, increase in deposits was used to fund loan originations and pay down borrowings by $3.0 million.

Cash and Securities. Cash and cash equivalents increased $4.0 million, or 6.6%, to $64.7 million at March 31, 2018 from $60.7 million at December 31, 2017. Available-for-sale securities, which consist primarily of municipal bonds and agency mortgage-backed securities, decreased $167,000, or 3.1%, to $5.3 million at March 31, 2018 from $5.4 million at December 31, 2017 as a result of principal repayments. There were no purchases or sales of securities during the three months ended March 31, 2018 and 2017. For further analysis on our investment securities, see Note 3 - Investments in the Notes to Consolidated Financial Statements under Item 1 of this report.

Loans Held-for-Sale. Loans held-for-sale decreased $827,000, or 46.5%, to $950,000 at March 31, 2018 from $1.8 million at December 31, 2017. The decrease in loans held-for-sale was due to the timing of loan sales.

Loans. Our gross loan portfolio increased $11.4 million, or 2.1%, to $560.0 million at March 31, 2018 from $548.6 million at December 31, 2017.

The following table reflects the changes in the types of loans in our loan portfolio at March 31, 2018, as compared to December 31, 2017 (dollars in thousands):

	March 31, 2018			December 31, 2017			Amount Change			Percent Change
One- to four-family	$	162,294		$	157,417		$	4,877			3.1	%
Home equity		27,638			28,379			(741	)		(2.6	)
Commercial and multifamily		221,255			211,269			9,986			4.7
Construction and land		60,789			61,482			(693	)		(1.1	)
Manufactured homes		17,480			17,111			369			2.2
Floating homes		29,110			29,120			(10	)		—
Other consumer		5,462			4,902			560			11.4
Commercial business		37,854			40,829			(2,975	)		(7.3	)
Deferred loan fees		(1,903	)		(1,914	)		11			(0.6	)
Total loans, gross	$	559,979		$	548,595		$	11,384			2.1	%

The increase in our loan portfolio for the quarter was primarily a result of the $10.0 million, or 4.7% increase in our commercial and multifamily loan portfolio and the $4.9 million, or 3.1% increase in our one- to four-family loan portfolio. At March 31, 2018, commercial and multifamily real estate loans accounted for 39.4% of the gross loan portfolio and one- to four-family loans, including home equity loans, accounted for 33.8% of the portfolio. Consumer loans, consisting of manufactured homes, floating homes and other consumer loans accounted for 9.3% of the portfolio at that date. Construction and land loans accounted for 10.8% of the portfolio and commercial business loans accounted for 6.7% of the portfolio at March 31, 2018.

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Mortgage Servicing Rights. At March 31, 2018, the fair value of our mortgage servicing rights was $3.5 million an increase of $106,000 or 3.1% from December 31, 2017. The increase was attributable to the current interest rate environment. We record mortgage servicing rights on loans sold to Fannie Mae and other financial institutions with servicing retained and upon acquisition of a servicing portfolio. We stratify our capitalized mortgage servicing rights based on the type, term and interest rates of the underlying loans. Mortgage servicing rights are carried at fair value. If the fair value of our mortgage servicing rights fluctuates significantly our financial results could be materially impacted.

Nonperforming Assets. At March 31, 2018, nonperforming assets totaled $2.6 million, or 0.39% of total assets, compared to $2.9 million, or 0.45% of total assets at December 31, 2017.

The table below sets forth the amounts and categories of nonperforming assets at the dates indicated (dollars in thousands):

	Nonperforming Assets
	March 31, 2018		December 31, 2017		Amount Change			Percent Change
Nonaccrual loans	$	1,793	$	2,149	$	(356	)		(16.6	)%
Nonperforming TDRs		132		134		(2	)		(1.5	)
Total nonperforming loans		1,925		2,283		(358	)		(15.7	)
OREO and repossessed assets		638		610		28			4.6
Total nonperforming assets	$	2,563	$	2,893	$	(330	)		(11.4	)%

Nonperforming loans, consisting of nonaccrual loans and nonperforming TDRs, decreased to $1.9 million, or 0.34% of total loans, at March 31, 2018 from $2.3 million, or 0.42% of total loans, at December 31, 2017. This decrease reflects the improving economic environment within the Bank's lending area and continued diligence by the Bank's lending personnel in identifying troubled loans and working with the loan clients to resolve any issues.

OREO and repossessed assets increased $28,000, or 4.6%, to $638,000 at March 31, 2018 from $610,000 at December 31, 2017. At March 31, 2018, OREO and repossessed assets consisted of three properties, a $600,000 former bank branch property originally classified as a fixed asset in 2016 which was reclassified to OREO the same year, a single-family residence with a carrying amount of $28,000 and a manufactured home that was written down to $10,000.

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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 United States. It is our best estimate of probable credit losses inherent in our loan portfolio. The following table reflects the adjustments in our allowance during the periods indicated (dollars in thousands):

	Three Months Ended March 31,
	2018			2017
Balance at beginning of period	$	5,241		$	4,822
Charge-offs		(20	)		(29	)
Recoveries		7			45
Net (charge-offs)/recoveries		(13	)		16
Provisions charged to operations		100			-
Balance at end of period	$	5,328		$	4,838

Ratio of net (charge-offs)/recoveries during the period to average loans outstanding during the period		—			0.01	%

	March 31, 2018		December 31, 2017
Allowance as a percentage of nonperforming loans (end of period)		276.78%		229.57%
Allowance as a percentage of total loans (end of period)		0.95%		0.96%

Our allowance for loan losses at March 31, 2018 and December 31, 2017 was $5.3 million and $5.2 million, respectively. The overall increase in the allowance for loan losses was due to the increase in the gross loan portfolio from $548.6 million at December 31, 2017 to $560.0 million at March 31, 2018.

Specific loan loss reserves increased to $1.4 million at March 31, 2018 compared to $896,000 at December 31, 2017, while general loan loss reserves increased to $3.3 million at March 31, 2018, compared to $3.2 million at December 31, 2017 and the unallocated reserve decreased to $646,000 at March 31, 2018 compared to $1.1 million at December 31, 2017. During the quarter, more commercial business loans migrated to the specific reserve pool as a result of the maturing of this portfolio. As a result of the loan by loan analysis, not all of these loans have specific reserves set aside but are being monitored more closely. Net charge-offs for the three months ended March 31, 2018 were $13,000 compared to net recoveries of $16,000 for the three months ended March 31, 2017. As of March 31, 2018, the allowance for loan losses as a percentage of gross loans receivable and as a percentage of nonperforming loans were 0.95% and 276.78%, respectively, compared to 0.96% and 229.57%, respectively, at December 31, 2017. The improvement in the allowance as a percentage of nonperforming loans ratio was due to a decrease in total nonperforming loans as we continue to grow our loans and monitor the credit quality of our portfolio.

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Deposits. Total deposits increased $14.8 million, or 2.9%, to $529.2 million at March 31, 2018 from $514.4 million at December 31, 2017, as a result of a $2.6 million, or 0.6%, increase in interest-bearing accounts and a $12.2 million, or 16.8%, increase in noninterest-bearing accounts. The increase in deposits for the first quarter of 2018 compared to the fourth quarter of 2017 was due to our continued focus on generating low cost deposits.

A summary of deposit accounts with the corresponding weighted-average cost of funds at the dates indicated is presented below (dollars in thousands):

	March 31, 2018					December 31, 2017
	Amount		Wtd. Avg. Rate			Amount		Wtd. Avg. Rate
Noninterest-bearing demand ⁽¹⁾	$	80,084		0.00	%	$	69,094		0.00	%
Interest-bearing demand		178,629		0.39			173,413		0.43
Savings		50,336		0.21			49,450		0.21
Money market		49,457		0.19			54,860		0.21
Time deposits		166,496		1.26			164,554		1.33
Escrow ⁽¹⁾		4,191		0.00			3,029		0.00
Total deposits	$	529,193		0.63	%	$	514,400		0.61	%

_____________

⁽¹⁾ Escrow balances shown in noninterest-bearing deposits on the consolidated balance sheets.

Borrowings. FHLB advances decreased $3.0 million, or 5.1%, to $56.0 million at March 31, 2018, with a weighted-average cost of 1.73%, from $59.0 million at December 31, 2017, with a weighted-average cost of 1.63%. The increase in the average rate was due to the an increase in the overnight borrowing rate in the current period compared to December 31, 2017, reflecting the recent increase in the federal funds rate. Excess funds from increased deposits and loan repayments during the quarter ended March 31, 2018 were used to reduce borrowings. We rely on FHLB advances to fund interest-earning assets when deposits alone cannot fully fund interest-earning asset growth. This reliance on borrowings, rather than deposits, may increase our overall cost of funds.

Stockholders' Equity. Total stockholders' equity increased $1.4 million, or 2.1%, to $66.5 million at March 31, 2018 from $65.2 million at December 31, 2017. This increase primarily reflects $1.6 million in net income and share-based compensation of $45,000, partially offset by the payment of a cash dividend of $303,000 to common stockholders during the current quarter.

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Comparison of Results of Operation for the Three Months Ended March 31, 2018 and 2017

General. Net income increased $188,000 to $1.6 million, or $0.62 per diluted common share, for the three months ended March 31, 2018, compared to $1.4 million, or $0.54 per diluted common share, for the three months ended March 31, 2017. The primary reasons for the increase in net income were increases in net interest income and noninterest income and a decrease in the provision for income taxes. Net interest income increased primarily as a result of higher average loan balances and the increase in noninterest income was primarily the result of an increase in net gain on sales of loans. The provision for income taxes decreased due to the Tax Act which was signed into law on December 22, 2017, which reduced our federal corporate income tax rate from 35% during the first quarter of 2017 to 21% for the first quarter of 2018. These changes were partially offset by increases in the provision for loan losses and noninterest expense. The provision for loan losses increased due to an increase in the balance of the loan portfolio. Noninterest expense increased primarily as a result of increases in salaries and benefits, operations and occupancy expenses.

Interest Income. Interest income increased $900,000, or 13.7%, to $7.5 million for the three months ended March 31, 2018, from $6.6 million for the three months ended March 31, 2017. The increase in interest income primarily reflected an increase in the average balance of interest-earning assets and an increase in the yield on loans and cash and cash equivalents as the Fed Funds rate has increased over the past year.

The average balance of loans receivable increased $54.1 million, or 10.9%, to $549.7 million for the three months ended March 31, 2018, as compared to $495.6 million for the same period last year. The weighted-average yield on loans increased seven basis points to 5.27% for the three months ended March 31, 2018 from 5.20% for the three months ended March 31, 2017 due to the general rise in market interest rates. Our weighted-average yield on interest-earning assets was 5.00% for the three months ended March 31, 2018, compared to 4.87% for the three months ended March 31, 2017. The weighted-average yield on investments and interest-bearing cash was 1.84% for the three months ended March 31, 2018, compared to 1.20% for the three months ended March 31, 2017. The average balance of the investment portfolio, which included interest-bearing cash balances and available-for-sale securities increased $3.7 million, or 7.3%. The overall yield on the investment portfolio increased 64 basis points as a result of the increase in rates paid on overnight deposits due to the increase in the Fed Funds rate over the past year.

Interest Expense. Interest expense increased $228,000 or 28.7%, to $1.0 million for the three months ended March 31, 2018, from $795,000 for the three months ended March 31, 2017. This increase reflects a $48.5 million, or 10.3%, increase in the average balances of deposits and a $7.4 million, or 17.6%, increase in the average balances of FHLB advances for the three months ended March 31, 2018, as compared to the same period last year. Our weighted-average cost of interest-bearing liabilities was 0.83% for the three months ended March 31, 2018, compared to 0.71% for the same period one year ago.

Interest paid on deposits increased $107,000, or 15.2%, to $810,000 for the three months ended March 31, 2018, from $703,000 for the three months ended March 31, 2017. The average balances of interest-bearing deposits outstanding for the quarter ended March 31, 2018 increased $39.3 million, or 9.7%, to $442.4 million from $403.1 million for the same period a year ago. Our weighted-average cost of deposits during the three months ended March 31, 2018 was 0.63%, as compared to 0.60% during the three months ended March 31, 2017.

Interest expense on borrowings increased $121,000, or 131.5%, to $213,000 for the three months ended March 31, 2018, from $92,000 for the three months ended March 31, 2017. The increased cost of borrowings was a result of an increase in overnight borrowing rates in the current quarter compared to the same quarter one year ago reflecting the increases in the federal funds target rate as well as an increase of $30.4 million in total borrowings during the first quarter of 2018 compared to the same quarter one year ago. Our average cost of borrowings was 1.73% for the three months ended March 31, 2018, compared to 0.88% for the three months ended March 31, 2017.

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Net Interest Income. Net interest income increased $672,000, or 11.6%, to $6.5 million for the three months ended March 31, 2018, from $5.8 million for the three months ended March 31, 2017. The increase was a result of higher interest income due to higher average loan balances and cash and cash equivalents, partially offset by the increase in the average balance of deposits and the rise in the cost of borrowings, as discussed above. Our net interest margin increased to 4.32% for the three months ended March 31, 2018, compared to 4.28% for the three months ended March 31, 2017 primarily due to higher average loan balances and loan yields.

Provision for Loan Losses. We establish our allowance for loan losses through provisions for loan losses, which are charged to earnings, at a level 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 other qualitative factors. Large groups of smaller balance homogeneous loans, such as one- to four-family, commercial and multifamily real estate, home equity and consumer loans, including floating homes and manufactured homes, 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.

The provision for loan losses was $100,000 for the three months ended March 31, 2018, compared to no provision for the three months ended March 31, 2017. The increased provision during the current period primarily reflects the $70.7 million increase in the gross loan portfolio during the first quarter of 2018 compared to one year ago. Net charge-offs for the quarter totaled $13,000 compared to net recoveries of $16,000 for the same quarter in 2017.

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 actual amount of future provisions will not exceed the amount of 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.

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Noninterest Income. Noninterest income increased $95,000, or 9.5%, to $1.1 million for the three months ended March 31, 2018, as compared to $996,000 for the three months ended March 31, 2017, as reflected below (dollars in thousands):

	Three Months Ended March 31,				Amount			Percent
	2018		2017		Change			Change
Service charges and fee income	$	460	$	511	$	(51	)		(10.0	)%
Earnings on cash surrender value of BOLI		79		81		(2	)		(2.5	)
Mortgage servicing income		220		233		(13	)		(5.6	)
Net gain on sale of loans		332		171		161			94.2
Total noninterest income	$	1,091	$	996	$	95			9.5	%

The increase in noninterest income compared to a year ago was the result of an increase of $161,000 in net gain on sale of loans, partially offset by decreases in service charges and fee income totaling $51,000. The decrease in service charges and fee income included a decrease in loan fees, partially offset by an increase in early withdrawal penalties on certificates of deposit. The decrease in loan fees was primarily due to the deferral of additional loan fees in the current quarter compared to the same period in 2017. Penalties received as a result of the early withdrawal of certificates of deposit increased $15,000 in the first quarter of 2018 to $20,000 compared to $5,000 in the first quarter of 2017.

Noninterest Expense. Noninterest expense increased $816,000, or 17.7%, to $5.4 million during the three months ended March 31, 2018, as compared to $4.6 million during the three months ended March 31, 2017, as reflected below (dollars in thousands):

	Three Months Ended March 31,				Amount			Percent
	2018		2017		Change			Change
Salaries and benefits	$	3,141	$	2,691	$	450			16.7	%
Operations		1,239		1,021		218			21.4
Regulatory assessments		101		124		(23	)		(18.5	)
Occupancy		474		373		101			27.1
Data processing		453		407		46			11.3
Net loss on OREO and repossessed assets		27		3		24			800.0
Total noninterest expense	$	5,435	$	4,619	$	816			17.7	%

The increase in noninterest expense was primarily due to higher salaries and benefits, operations, and occupancy expenses. Salaries and benefits expense increased $450,000 compared to the first quarter of 2017 primarily due to an increase in the number of full-time equivalent employees as a result of the addition of our University Place and Belltown branches, as well as the opening of our loan production office in Sequim, WA. Operations expense increased $218,000 primarily due to a $124,000 provision for off-balance sheet commitments due to a loss on a loan sold with recourse and increases in audit fees and charitable contributions.

The efficiency ratio for the quarter ended March 31, 2018 was 71.89%, compared to 67.99% for the first quarter of 2017. The increase in the efficiency ratio was primarily due to an increase in salaries and benefits expense.

Provision for Income Taxes. As of January 1, 2018, our statutory income tax rate is 21%, as compared to 35% for prior years as a result of the Tax Act. The provision for income taxes decreased $337,000, or 44.3%, for the first quarter of 2018 to $423,000 from $760,000 for the comparable quarter in 2017.

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Liquidity

The Management Discussion and Analysis in Item 7 of the Company's 2017 Form 10-K contains an overview of Sound Financial Bancorp's and the Bank's liquidity management, sources of liquidity and cash flows. This discussion updates that disclosure for the three months ended March 31, 2018.

The Bank's primary sources of funds are deposits, principal and interest payments on loans and borrowings. While maturities and scheduled amortization of loans are a predictable source of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. The Bank's primary investing activity is loan originations. The Bank maintains liquidity levels it believes to be adequate to fund loan commitments, investment opportunities, deposit withdrawals and other financial commitments. At March 31, 2018, the Bank had $70.0 million in cash and investment securities available-for-sale and $950,000 in loans held-for-sale generally available for its cash needs. Also, at March 31, 2018, the Bank had the ability to borrow an additional $155.1 million in FHLB advances based on existing collateral pledged, and could access $49.7 million through the Federal Reserve's Discount Window. At March 31, 2018, we also had available a total of $21.0 million in credit facilities with other financial institutions, with no balance outstanding. The Bank uses these sources of funds primarily to meet ongoing commitments, pay maturing deposits and fund withdrawals, and to fund loan commitments. At March 31, 2018, outstanding loan commitments, including unused lines and letters of credit totaled $75.8 million, including $35.8 million of undisbursed construction and land loans. Certificates of deposit scheduled to mature in one year or less at March 31, 2018, totaled $96.9 million. Based on our competitive pricing, we believe that a majority of maturing deposits will remain with the Bank.

Cash and cash equivalents increased $4.0 million to $64.7 million as of March 31, 2018, from $60.7 million as of December 31, 2017. Net cash provided by operating activities was $4.4 million for the three months ended March 31, 2018. Net cash used by investing activities totaled $11.9 million during the three months ended March 31, 2018 and was principally used to fund loan growth of $11.5 million, net of principal repayments. The $11.6 million of cash provided by financing activities during the three months ended March 31, 2018 was primarily a result of a net increase in deposits of $14.8 million, partially offset by a $3.0 million decrease in FHLB advances.

As a separate legal entity from the Bank, the Company must provide for its own liquidity. At March 31, 2018, the Company, on an unconsolidated basis, had $591,000 in cash, noninterest-bearing deposits and liquid investments generally available for its cash needs. The Company's principal source of liquidity is dividends and ESOP loan repayments from the Bank.

Except as set forth above, management is not aware of any trends, events, or uncertainties that will have, or that are reasonably likely to have a material impact on liquidity, capital resources or operations.

Off-Balance Sheet Activities

In the normal course of operations, we engage in a variety of financial transactions that are not recorded in our financial statements. These transactions involve varying degrees of off-balance sheet credit, interest rate and liquidity risks. These transactions are used primarily to manage clients' requests for funding and take the form of loan commitments and lines of credit. For the three months ended March 31, 2018, we engaged in no off-balance sheet transactions likely to have a material effect on our financial condition, results of operations or cash flows.

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A summary of our off-balance sheet loan commitments at March 31, 2018, is as follows (in thousands):

	March 31, 2018
Residential mortgage commitments	$	4,584
Undisbursed portion of loans originated		35,785
Unused lines of credit		34,005
Irrevocable letters of credit		1,400
Total loan commitments	$	75,774

Capital

Sound Community Bank is subject to minimum capital requirements imposed by regulations of the FDIC. Capital adequacy requirements are quantitative measures established by regulation that require Sound Community Bank to maintain minimum amounts and ratios of capital.

Based on its capital levels at March 31, 2018, Sound Community Bank exceeded all regulatory capital requirements as of that date. Consistent with our goals to operate a sound and profitable organization, our policy is for Sound Community Bank to maintain a "well-capitalized" status under the regulatory capital categories of the FDIC. Based on capital levels at March 31, 2018, Sound Community Bank was considered to be well-capitalized under applicable regulatory requirements. Management monitors the capital levels to provide for current and future business opportunities and to maintain Sound Community Bank's "well-capitalized" status.

The actual regulatory capital amounts and ratios calculated for Sound Community Bank at March 31, 2018, were as follows (dollars in thousands):

	Actual					Minimum for Capital Adequacy Purposes			To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio	Amount		Ratio
Tier 1 Capital to average assets	$	64,019		10.04	%	$	25,516	> 4.0%	$	31,895	> 5.0%
Common Equity Tier 1 ("CET1") risk-based capital ratio		64,019		12.15	%		23,704	> 4.5%		34,240	> 6.5%
Tier 1 Capital to risk-weighted assets		64,019		12.15	%		31,606	> 6.0%		42,141	> 8.0%
Total Capital to risk-weighted assets		69,542		13.20	%		42,141	> 8.0%		52,676	> 10.0%

Pursuant to the capital regulations of the FDIC and the other federal banking agencies, the Bank must maintain a capital conservation buffer consisting of additional CET1 capital greater than 2.5% of risk-weighted assets above the required minimum levels of risk-based CET1 capital, tier 1 capital and total capital in order to avoid limitations on paying dividends, repurchasing shares, and paying discretionary bonuses. For our fiscal year ending December 31, 2018, the capital conservation buffer rule requires a buffer of greater than 1.875% of risk-weighted assets, which amount will increase by 0.625% yearly until the requirement is fully phased-in on January 1, 2019, when the buffer must exceed 2.5% of risk-weighted assets. As March 31, 2018, the Bank's CET1 capital exceeded the required capital conservation buffer of 1.875%.

For a bank holding company with less than $1.0 billion in assets, the capital guidelines apply on a bank only basis and the Federal Reserve expects the holding company's subsidiary banks to be well capitalized under the prompt corrective action regulations. If Sound Financial Bancorp was subject to regulatory guidelines for bank holding companies with $1.0 billion or more in assets, at March 31, 2018 Sound Financial Bancorp would have exceeded all regulatory capital requirements. The estimated regulatory capital ratios calculated for Sound Financial Bancorp as of March 31, 2018 were 10.23% for Tier 1 leverage-based capital, 12.39% for both Common Equity Tier 1 risk-based capital, Tier 1 Capital to risk-based assets and 13.44% for total risk-based capital.

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Item 3.

Quantitative and Qualitative Disclosures About Market Risk

The Company provided information about market risk in Item 7A of its 2017 Form 10-K. There have been no material changes in our market risk since our 2017 Form 10-K.

Item 4.

Controls and Procedures

(a)

Evaluation of Disclosure Controls and Procedures.

An evaluation of the Company's disclosure controls and procedures (as defined in Rule 13a -15(e) under the Securities Exchange Act of 1934 (the "Act")), as of March 31, 2018, was carried out under the supervision and with the participation of the Company's Chief Executive Officer and Interim Chief Financial Officer, and several other members of the Company's senior management. The Chief Executive Officer and Interim Chief Financial Officer concluded that, as of March 31, 2018, the Company's disclosure controls and procedures were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is: (i) accumulated and communicated to the Company's management (including the Chief Executive Officer and Interim Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms.

We intend to continually review and evaluate the design and effectiveness of the Company's disclosure controls and procedures and to improve the Company's controls and procedures over time and to correct any deficiencies that we may discover in the future. The goal is to ensure that senior management has timely access to all material financial and non-financial information concerning the Company's business. While we believe the present design of the disclosure controls and procedures is effective to achieve this goal, future events affecting our business may cause the Company to modify its disclosure controls and procedures.

The Company does not expect that its disclosure controls and procedures will prevent all error and all fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any control procedure is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies and procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.

(b)

Changes in Internal Control over Financial Reporting.

There were no changes in our internal control over financial reporting (as defined in Rule 13a - 15(f) under the Act) that occurred during the three months ended March 31, 2018, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II

OTHER INFORMATION

Item 1

Legal Proceedings

In the normal course of business, the Company occasionally becomes involved in various legal proceedings. In the opinion of management, any liability from such proceedings would not have a material adverse effect on the business or financial condition of the Company.

Item 1A

Risk Factors

Not required; the Company is a smaller reporting company.

Item 2

Unregistered Sales of Equity Securities and use of Proceeds

a)	Not applicable

(b)	Not applicable

(c)	The following table sets forth information with respect to our repurchases of our outstanding common shares during the three months ended March 31, 2018:

	Total Number of Shares Purchase⁽¹⁾		Average Price Paid per Share		Total number of shares purchased as part of publicly announced plans or programs		Maximum number of shares that may yet be purchased under the plans or programs
January 1, 2018 - January 31, 2018		-	$	-		-		-
February 1, 2018 - February 28, 2018		5,206		34.75		-		-
March 1, 2018 - March 31, 2018		-		-		-		-
Total		5,206	$	34.75		-		-

________________

⁽¹⁾ Reflects shares of previously owned Company common stock surrendered to the Company by the option holders as

payment of the exercise price of their incentive stock options.

The Company may repurchase shares of its common stock from time-to-time in open market transactions. The timing, volume and price of purchases are made at our discretion, and are contingent upon our overall financial condition, as well as general market conditions. As of March 31, 2018, the Company did not have any publicly announced stock repurchase programs.

Item 3

Defaults Upon Senior Securities

Nothing to report.

Item 4

Mine Safety Disclosures

Not Applicable

Item 5.

Other Information

Nothing to report.

Table of Contents

Item 6.

Exhibits

Exhibits:
3.1	Articles of Incorporation of Sound Financial Bancorp, Inc. (incorporated herein by reference to the Registration Statement on Form S-1 filed with the SEC on March 27, 2012 (File No. 333-180385))
3.2	Bylaws of Sound Financial Bancorp, Inc. (incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on February 3, 2015 (File No. 001-35633))
4.0	Form of Common Stock Certificate of Sound Financial Bancorp, Inc. (incorporated herein by reference to the Registration Statement on Form S-1 filed with the SEC on March 27, 2012 (File No. 333-180385))
10.1	Form of Amended and Restated Employment Agreement dated August 30, 2016, among Sound Financial Bancorp, Inc., Sound Community Bank and Laura Lee Stewart (incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on September 1, 2016 (File No. 001-35633))
10.2	Amended and Restated Supplemental Executive Retirement Agreement by and between Sound Community Bank and Laura Lee Stewart (incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on November 27, 2015 (File No. 001-35633))
10.3	Amended and Restated Long Term Compensation Agreement by and between Sound Community Bank and Laura Lee Stewart (incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on November 27, 2015 (File No. 001-35633))
10.4	Amended and Restated Confidentiality, Non-Competition and Non-Solicitation Agreement by and between Sound Community Bank and Laura Lee Stewart (incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on November 27, 2015 (File No. 001-35633))
10.5	2008 Equity Incentive Plan (incorporated herein by reference to the Annual Report on Form 10-K filed with the SEC on March 31, 2009 (File No. 000-52889))
10.6	Forms of Incentive Stock Option Agreement, Non-Qualified Stock Option Agreement and Restricted Stock Agreements under the 2008 Equity Incentive Plan (incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on January 29, 2009 (File No. 000-52889))
10.7	Summary of Annual Bonus Plan (incorporated herein by reference to the Registration Statement on Form SB-2 filed with the SEC on September 20, 2007 (File No. 333-146196))
10.8	2013 Equity Incentive Plan (incorporated herein by reference to the Quarterly Report on Form 10-Q for the quarter ended September 30, 2013 (File No. 001-35633))
10.9	Form of Incentive Stock Option Agreement, Non-Qualified Stock Option Agreement and Restricted Stock Agreement under the 2013 Equity Incentive Plan (incorporated herein by reference to the Quarterly Report on Form 10-Q for the quarter ended September 30, 2013 (File No. 001-35633))
10.10	Amended and Restated Change of Control Agreement dated June 21, 2016, by and among Sound Financial Bancorp, Inc., Sound Community Bank and Matthew P. Deines (incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on June 24, 2016 (File No. 001-35633))
10.11	Change of Control Agreement dated June 21, 2016, by and among Sound Financial Bancorp, Inc., Sound Community Bank and Elliott Pierce (incorporated herein by reference to the Quarterly Report on Form 10-Q for the quarter ended March 31, 2017 (File No. 001-35633))
10.12	Adoption Agreement for the Sound Community Bank Nonqualified Deferred Compensation Plan (incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on March 24, 2017 (File No. (001-35633))
10.13	The Sound Community Bank Nonqualified Deferred Compensation Plan (incorporated herein by reference to the Current Report on Form 8-K filed with the SEC on March 24, 2017 (File No. 001-35633))
10.14	Change of Control Agreement dated June 22, 2016, by and among Sound Financial Bancorp, Inc., Sound Community Bank and Christina Gehrke (incorporated herein by reference to the Registrants Quarterly Report on Form 10-Q for the quarter ended September 30, 2017 (File No.001-35633))
10.15	Separation Agreement and Release of All Claims entered into between Matthew P. Deines and Sound Community Bank (incorporated herein by reference to the Current Report on Form 8-K/A filed with the SEC on April 12, 2018 (File No. 001-35633))
11	Statement re computation of per share earnings (See Note 9 of the Notes to Condensed Consolidated Financial Statements contained in Item 1, Part I of this Current Report on Form 10-Q.)
31.1	Rule 13(a)-14(a) Certification (Chief Executive Officer)
32	Section 1350 Certification
101	Interactive Data Files

Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Sound Financial Bancorp, Inc.

Date: May 14, 2018	By:	/s/ Laura Lee Stewart
		Laura Lee Stewart
		President/Chief Executive Officer and Interim CFO
		(Principal Executive Officer and Principal Financial Officer and Principal Accounting Officer)

Sound Financial Bancorp, Inc. - FORM 10-Q - May 14, 2018

Attached files

Sound Financial Bancorp, Inc. Reports