Sound Financial Bancorp, Inc. (SFBC)

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 but 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 range of factors including, but not limited to:

•adverse economic conditions in our market areas, and other markets where we have lending relationships;

•effects of employment levels, inflation, a recession, or slowed economic growth;

•changes in interest rate levels and volatility, and the timing and pace of such changes, including actions by the Board of Governors of the Federal Reserve System (the “Federal Reserve”), which could adversely affect our revenues and expenses, the values of our assets and obligations, and the availability and cost of capital and liquidity;

•the impact of inflation and related monetary and fiscal policy responses thereto, including their effects on consumer and business behavior;

•the effects of any federal government shutdown, debt ceiling standoff, or other fiscal uncertainties;

•changes in consumer spending, borrowing and savings habits;

•the risks of lending and investing activities, including delinquencies, write-offs and changes in our allowance for credit losses, and provision for credit losses;

•monetary and fiscal policies of the Federal Reserve and the U.S. Government and other governmental initiatives affecting the financial services industry;

•bank failures or adverse developments at other banks and related negative publicity about the banking industry on investor and depositor sentiment;

•fluctuations in the demand for loans, unsold homes, land and other properties;

•fluctuations in real estate values and both residential and commercial and multifamily real estate market conditions in our market area;

•our ability to access cost-effective funding, including maintaining the confidence of depositors;

•the possibility that unexpected outflows of deposits may require us to sell investment securities at a loss;

•our ability to control operating costs and expenses;

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

•results of examinations of us by regulatory authorities and the possibility that any such regulatory authority may, among other things, limit our business activities, require us to increase our allowance for credit losses, write- down asset values or increase our capital levels, or affect our ability to borrow funds or maintain or increase deposits;

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

•our ability to attract and retain deposits, including the risk that changes to federal deposit insurance limits or coverage rules, or customer concerns regarding the safety of uninsured deposits, could adversely affect deposit stability;

•competitive pressures among financial services companies;

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

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

•our ability to adapt to rapid technological changes, including advancements related to artificial intelligence (“AI”), the use of AI models in credit decisioning, customer service, and operations, including risks of model error, bias, regulatory scrutiny under fair lending laws, and third-party AI dependencies, digital banking platforms, and cybersecurity;

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•risk associated with the evolving regulatory and market environment for digital assets and cryptocurrency, including potential impacts on customer behavior, deposit flows, and our ability to offer or support related products or services;

•changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies, the Financial Accounting Standards Board, the U.S. Securities and Exchange Commission (the “SEC”), or the Public Company Accounting Oversight Board (“PCAOB”);

•legislative or regulatory changes that adversely affect our business, including changes in banking, securities and tax laws, in regulatory policies and principles, or the interpretation of regulatory capital or other rules, and other governmental initiatives affecting the financial services industry and the availability of resources to address such changes;

•our ability to retain or attract key employees or members of our senior management team;

•costs and effects of litigation, including settlements and judgments;

•our ability to implement our business strategies, including expectations regarding key growth initiatives and strategic priorities;

•environmental, social and governance matters;

•staffing fluctuations in response to product demand or corporate implementation strategies;

•our ability to pay dividends on and repurchase our common stock;

•the quality and composition of our securities portfolio and the impact of any adverse changes in the securities markets;

•vulnerabilities in information systems or third-party service providers, including disruptions, breaches, or attacks;

•geopolitical developments and international conflicts, or the imposition of new or increased tariffs and trade restrictions, any of which may disrupt financial markets, global supply chains, commodity prices, or economic activity in specific industry sectors;

•the effects of climate change, severe weather events, natural disasters, pandemics, epidemics and other public health crises, acts of war or terrorism, domestic civil unrest and other external events;

•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 documents filed with or furnished to the U.S. Securities and Exchange Commission (the “SEC”), including this Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2025 (“2025 Form 10-K”).

We caution readers not to place undue reliance on any forward-looking statements. The factors listed above could materially affect our financial performance and cause our actual results for future periods to differ materially from any forward-looking statements expressed or implied 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 dates 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 that is not a member of the Federal Reserve System, the Bank’s regulators are the Washington Department of Financial Institutions and the Federal Deposit Insurance Corporation (the “FDIC”). As a bank holding company, Sound Financial Bancorp is regulated by the Federal Reserve. We also sell insurance products and services through Sound Community Insurance Agency, Inc., a wholly owned subsidiary of the Bank.

Sound Community Bank’s deposits are insured up to applicable limits by the FDIC. At June 30, 2026, Sound Financial Bancorp, on a consolidated basis, had total assets of $1.07 billion, net loans held-for-portfolio of $883.5 million, deposits of $930.9 million and stockholders’ equity of $112.6 million. The common stock of Sound Financial Bancorp is listed 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 retail and commercial deposits from the general public and investing those funds, along with borrowed funds, in loans secured by first and second mortgages on one-to-four family residences (including home equity loans and lines of credit), commercial and multifamily real estate loans, construction and land loans, and consumer and commercial business loans. Our commercial business loans include unsecured lines of credit, secured term loans and lines of credit secured by inventory, equipment and accounts receivable. We also offer a variety of secured and unsecured consumer loan products, including manufactured home loans, floating home loans, automobile loans, boat loans and recreational vehicle loans. As part of our business, we focus on residential mortgage loan originations, a portion of which we sell to Fannie Mae and other investors and the remainder of which we retain for our loan portfolio consistent with our asset/liability objectives. We sell

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loans which conform to the underwriting standards of Fannie Mae (“conforming”) and retain the servicing of such loans in order to maintain the direct customer relationship and to generate noninterest income. Residential loans which do not conform to the underwriting standards of Fannie Mae (“non-conforming”) are either held in our loan portfolio or sold with servicing released. We originate and retain a significant amount of commercial real estate loans, including those secured by owner-occupied and nonowner-occupied commercial real estate, multifamily properties and mobile home parks, and construction and land development loans.

Critical Accounting Estimates

Certain of our accounting policies 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, other changes in economic conditions and changes in the financial condition and performance of borrowers.  Management believes that its critical accounting estimates include determining the allowance for credit losses and accounting for mortgage servicing rights. There have been no material changes in the Company’s critical accounting policies and estimates as p

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Item 7.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This discussion and analysis reviews our consolidated financial statements and other relevant statistical data and is intended to enhance your understanding of our financial condition and results of operations. The discussion and analysis should be read in conjunction with our Consolidated Financial Statements and related notes included in Part II, Item 8 of this Form 10-K.

Overview

Our principal business consists of attracting retail and commercial deposits from the general public and investing those funds, along with borrowed funds, in loans secured by first and second mortgages on one-to-four family residences (including home equity loans and lines of credit), commercial and multifamily real estate, construction and land, and consumer and commercial business loans. Our commercial business loans include unsecured lines of credit and secured term loans and lines of credit secured by inventory, equipment and accounts receivable. We also offer a variety of secured and unsecured consumer loan products, including manufactured home loans, floating home loans, automobile loans, boat loans and recreational vehicle loans. As part of our business, we focus on residential mortgage loan originations, a portion of which we sell to Fannie Mae and other investors and the remainder of which we retain for our loan portfolio consistent with our asset/liability objectives. We sell loans which conform to the underwriting standards of Fannie Mae (“conforming”) in which we retain the servicing of the loan in order to maintain the direct customer relationship and to generate noninterest income. Residential loans which do not conform to the underwriting standards of Fannie Mae (“non-conforming”), are either held in our loan portfolio or sold with servicing released.

We originated $32.0 million and $39.9 million of one-to-four family loans during the years ended December 31, 2025 and 2024, respectively. We had no purchases of one-to-four family loans during the years ended December 31, 2025 and 2024. During those two years, we sold $14.0 million and $14.2 million, respectively, of one-to-four family loans.

Our strategic plan targets consumers, small- and medium-sized businesses, and professionals within our market area for loans and deposits. In managing the size and concentrations of our loan portfolio, we focus on including a significant amount of commercial business and commercial and multifamily real estate loans. A significant portion of our commercial business and commercial and multifamily real estate loans have adjustable rates, higher yields and shorter terms, and higher credit risk than traditional residential fixed-rate mortgage loans.

Our commercial loan portfolio (commercial and multifamily real estate and commercial business loans) totaled $425.1 million or 46.8% of our loan portfolio at December 31, 2025, up from $387.1 million or 42.9% of our loan portfolio at December 31, 2024. Our consumer loan portfolio, which includes manufactured and floating homes and other consumer loans, was $147.0 million or 16.1% of our loan portfolio at December 31, 2025, compared to $145.3 million or 16.2% of our loan portfolio at December 31, 2024.

Our operating revenues are derived principally from earnings on interest-earning assets, service charges and fees, and gains on the sale of loans. During 2025, the elevated interest rate environment continued to exert downward pressure on our net gain on sale of loans and contributed to higher borrowing costs, which modestly affected our net interest income and net interest margin. While interest expense on deposits also increased, the rates earned on our loan portfolio continued to reprice at higher yields, partially offsetting these pressures. Deposit costs began trending downward during the latter part of 2025 following rate reductions by the Federal Reserve Board.

To meet our funding requirements, we rely on a variety of sources, including retail and brokered deposits, FHLB advances, borrowings through the Federal Reserve, and cash received from loan and securities payments. We offer a broad range of deposit accounts, including savings, money market, NOW (negotiable order of withdrawal), interest-bearing and noninterest-bearing demand accounts, and certificates of deposit, providing customers with flexibility in interest rates and account terms to meet their financial needs.

The provision for credit losses, or the release of such provision, is essential for maintaining the ACL at a level sufficient to cover estimated lifetime credit losses in our loan portfolio, including unfunded loan commitments. An increase in our loan portfolio or a rise in estimated lifetime credit losses may result in additional provisions for credit losses, thereby decreasing net income. However, improvements in loan risk ratings, increased property values, or recoveries of previously charged-off amounts may partially or fully offset the required increase in the ACL due to factors such as loan growth or an increase in estimated lifetime losses on loans and unfunded loan commitments. We recorded a provision for credit losses of $127 thousand for the year ended December 31, 2025, consisting of a provision for credit losses on loans of $212 thousand and a release of provision for credit losses on unfunded commitments of $86 thousand, compared to a release of provision for credit losses of $120 thousand for the year ended December 31, 2024, consisting of a release of provision for credit losses on loans of $161

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thousand and a provision for credit losses on unfunded commitments of $41 thousand. The provision recorded in 2025 primarily reflected loan growth and changes in portfolio composition, partially offset by stable credit quality trends.

Our noninterest expenses consist primarily of salaries, employee benefits, incentive pay, expenses for occupancy, online and mobile services, marketing, professional fees, data processing, charitable contributions, FDIC deposit insurance premiums and regulatory expenses. Salaries and benefits consist primarily of the salaries paid to our employees, payroll taxes, directors' fees, retirement expenses, share-based compensation and other employee benefits. Occupancy expenses, which are the fixed and variable costs of buildings and equipment, consist primarily of lease payments, property taxes, depreciation charges, maintenance and the cost of utilities.

Recent Accounting Standards

For a discussion of recent accounting standards, see “Note 2—Accounting Pronouncements Recently Issued or Adopted” in the Notes to Consolidated Financial Statements contained in “Part II. Item 8. Financial Statements and Supplementary Data” of this report on Form 10-K.

Critical Accounting Estimates

We prepare our consolidated financial statements in accordance with GAAP. In doing so, we must make estimates and assumptions. Our critical accounting estimates are those estimates that involve a significant level of uncertainty at the time the estimate was made, and changes in the estimate that are reasonably likely to occur from period to period, or use of different estimates that we reasonably could have used in the current period, would have a material impact on our financial condition or results of operations. Accordingly, actual results could differ materially from our estimates. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. Facts and circumstances that could affect these judgments include, but are not limited to, changes in interest rates, changes in the performance of the economy and changes in the financial condition of borrowers. We have reviewed our critical accounting estimates with the audit committee of our Board of Directors.

See "Note 1—Organization and Significant Accounting Policies" in the Notes to Consolidated Financial Statements contained in "Part II. Item 8. Financial Statements and Supplementary Data" of this report on Form 10-K for a summary of significant accounting policies.

Allowance for Credit Losses. The level of the ACL is established using the CECL approach for financial instruments measured at amortized cost and other commitments to extend credit. CECL requires the immediate recognition of estimated credit losses expected to occur over the estimated remaining life of the asset. The forward-looking concept of CECL requires loss estimates to consider historical experience, current conditions and reasonable and supportable forecasts. The ACL consists of two elements: (1) identification of loans that do not share risk characteristics with collectively evaluated loan pools, which are individually analyzed for expected credit loss and (2) establishment of an ACL for collectively evaluated loan pools based upon loans that share similar risk characteristics.

We estimate the ACL using relevant and reliable information from internal and external sources, related to past events, current conditions, and a reasonable and supportable forecast. Historical credit loss experience for both the Company and segment-specific peers provides the basis for the estimate of expected credit losses. Segments are based upon federal call report segmentation.

We continuously evaluate and update our critical accounting estimates and judgments based on changing conditions. As part of our ongoing enhancement of the ACL methodology, during the year ended December 31, 2025, we made changes to benchmark ratios and the annual loss driver analysis. This change in the ACL is not considered a change in accounting estimate as per ASC 250-10 provisions.

While our policies and procedures used to estimate the ACL, as well as the resulting provision for credit losses reported on the Consolidated Statements of Income, are reviewed periodically by regulators, model validators and internal audit, they are necessarily approximate and imprecise. There are factors beyond our control, such as changes in projected economic conditions, real estate markets or particular industry conditions, which may materially impact asset quality and the adequacy of the ACL and thus the resulting provision for credit losses.

Our ACL analysis is prepared utilizing a qualitative scorecard framework, which establishes bounds for the estimation of loss between a minimum (“Low Watermark”) and a maximum (“High Watermark”) for each segment. The Low Watermark indicates zero credit losses. The High Watermark is established by utilizing the same historical loss rate model used to establish

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modified loss rates, assuming a worse-case economic scenario. Risk levels are categorized as minor, moderate, major, no change, and improvement, segmenting the gap between the Low Watermark and High Watermark.

In evaluating the results of the sensitivity analysis, the qualitative factor adjustment provided the largest change in the ACL. If all qualitative factors were adjusted from the base model to the High Watermark, the estimated ACL on loans would increase to $26.6 million (2.96%). However, considering all relevant information, management estimated pooled loan losses to range between the base model of $6.6 million (0.73%) and, with all qualitative factors assigned a minor risk level, $13.3 million (1.47%). This evaluation included an assessment of changes to business risks and alignment with the Company’s overall strategy and objectives. Management determined that the Company’s overall strategy and objectives remained constant during the quarter compared to the look-back period. The historical look-back period and loss rate serve as the foundation of the ACL methodology, considering both our loss history and peer loss rates. No historical or recent exper

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