UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal Year Ended September 30, 2009 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 0-23333
TIMBERLAND BANCORP, INC.
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(Exact name of registrant as specified in its charter)
Washington 91-1863696
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(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
624 Simpson Avenue, Hoquiam, Washington 98550
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (360) 533-4747
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Securities registered pursuant to Section 12(b) of the Act:
Common Stock, par value $.01 per share The Nasdaq Stock Market LLC
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(Title of Each Class) (Name of Each Exchange on
Which Registered)
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the Registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. YES NO X
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Indicate by check mark if the Registrant is not required to file reports
pursuant to Section 13 of Section 15(d) of the Act. YES NO X
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Indicate by check mark 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 X NO
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Indicate by check mark whether the registrant has submitted
electronically and posted on its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of
Regulation S-T (Section 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
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Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. X
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Indicate by check mark whether the Registrant is a large accelerated
filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of "large accelerated filer," "accelerated
filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act:
Large accelerated filer Accelerated filer
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Non-accelerated filer Smaller reporting company X
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Indicate by check mark whether the Registrant is a shell company (as
defined in Rule 12b-2 of the Act). YES NO X
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As of November 30, 2009, the Registrant had 7,045,036 shares of Common
Stock issued and outstanding. The aggregate market value of the Common Stock
held by nonaffiliates of the Registrant, based on the closing sales price of
the Registrant's common stock as quoted on the NASDAQ Global Select Market on
March 31, 2009, was $36.4 million (7,045,036 shares at $5.16). For purposes
of this calculation, Common Stock held by officers and directors of the
Registrant and the Timberland Bank Employee Stock Ownership Plan and Trust are
considered nonaffiliates.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of Definitive Proxy Statement for the 2010 Annual Meeting of
Stockholders (Part III).
TIMBERLAND BANCORP, INC.
2009 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I. Page
Item 1. Business
General.................................................. 1
Recent Developments...................................... 1
Market Area.............................................. 2
Lending Activities....................................... 3
Investment Activities.................................... 22
Deposit Activities and Other Sources of Funds............ 23
Bank Owned Life Insurance................................ 28
Regulation of the Bank................................... 28
Regulation of the Company................................ 36
Taxation................................................. 38
Competition.............................................. 39
Subsidiary Activities.................................... 39
Personnel................................................ 39
Executive Officers of the Registrant..................... 39
Item 1A. Risk Factors.............................................. 40
Item 1B. Unresolved Staff Comments................................. 50
Item 2. Properties................................................. 51
Item 3. Legal Proceedings.......................................... 52
Item 4. Submission of Matters to a Vote of Security Holders........ 52
PART II.
Item 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities.......... 53
Item 6. Selected Financial Data.................................... 56
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................. 58
General.................................................. 58
Special Note Regarding Forward-Looking Statements........ 58
Critical Accounting Policies and Estimates............... 59
New Accounting Pronouncements............................ 60
Operating Strategy....................................... 61
Market Risk and Asset and Liability Management........... 61
Comparison of Financial Condition at September 30,
2009 and September 30, 2008.............................. 63
Comparison of Operating Results for Years Ended
September 30, 2009 and 2008.............................. 65
Comparison of Operating Results for Years Ended
September 30, 2008 and 2007.............................. 68
Average Balances, Interest and Average Yields/Cost....... 71
Rate/Volume Analysis..................................... 73
Liquidity and Capital Resources.......................... 73
Effect of Inflation and Changing Prices.................. 75
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk...................................................... 75
Item 8. Financial Statements and Supplementary Data................ 76
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure................................... 129
Item 9A. Controls and Procedures................................... 129
Item 9B. Other Information......................................... 129
i
PART III.
Item 10. Directors, Executive Officers and Corporate Governance
Item 11. Executive Compensation.................................... 129
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters................ 130
Item 13. Certain Relationships and Related Transactions, and
Director Independence..................................... 130
Item 14. Principal Accounting Fees and Services.................... 131
PART IV.
Item 15. Exhibits, Financial Statement Schedules................... 131
PART I
Item 1. Business
General
Timberland Bancorp, Inc. ("Company"), a Washington corporation, was
organized on September 8, 1997 for the purpose of becoming the holding company
for Timberland Savings Bank, SSB ("Bank") upon the Bank's conversion from a
Washington-chartered mutual savings bank to a Washington-chartered stock
savings bank ("Conversion"). The Conversion was completed on January 12, 1998
through the sale and issuance of 13,225,000 shares of common stock by the
Company. At September 30, 2009, the Company had total assets of $701.7
million, total deposits of $505.7 million and total shareholders' equity of
$87.2 million. The Company's business activities generally are limited to
passive investment activities and oversight of its investment in the Bank.
Accordingly, the information set forth in this report, including consolidated
financial statements and related data, relates primarily to the Bank and its
subsidiary.
The Bank was established in 1915 as "Southwest Washington Savings and
Loan Association." In 1935, the Bank converted from a state-chartered mutual
savings and loan association to a federally chartered mutual savings and loan
association, and in 1972, changed its name to "Timberland Federal Savings and
Loan Association." In 1990, the Bank converted to a federally chartered
mutual savings bank under the name "Timberland Savings Bank, FSB." In 1991,
the Bank converted to a Washington-chartered mutual savings bank and changed
its name to "Timberland Savings Bank, SSB." On December 29, 2000, the Bank
changed its name to "Timberland Bank." The Bank's deposits are insured up to
applicable legal limits by the Federal Deposit Insurance Corporation ("FDIC").
The Bank has been a member of the Federal Home Loan Bank ("FHLB") System since
1937. The Bank is regulated by the Washington Department of Financial
Institutions, Division of Banks ("Division" or "DFI") and the FDIC.
The Bank is a community-oriented bank which has traditionally offered a
variety of savings products to its retail customers while concentrating its
lending activities on real estate mortgage loans. Lending activities have
been focused primarily on the origination of loans secured by real estate,
including an emphasis on construction loans, one- to four-family residential
loans, multi-family loans, commercial real estate loans and land loans. The
Bank originates adjustable-rate residential mortgage loans that do not qualify
for sale in the secondary market under Federal Home Loan Mortgage Corporation
("FHLMC") guidelines. The Bank also originates commercial business loans and
in 1998 established a business banking division to increase the origination of
these loans.
The Company maintains a website at www.timberlandbank.com. The
information contained on that website is not included as a part of, or
incorporated by reference into, this Annual Report on Form 10-K. Other than
an investor's own internet access charges, the Company makes available free of
charge through that website the Company's Annual Report on Form 10-K,
quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments
to these reports, as soon as reasonably practicable after these materials have
been electronically filed with, or furnished to, the Securities and Exchange
Commission ("SEC").
Recent Developments
In December 2009, the FDIC determined that the Bank required supervisory
attention and agreed to terms on a pending Memorandum of Understanding, or
MOU, with the Bank. The terms of the MOU restrict the Bank from certain
activities, and require that the Bank obtain the prior written approval, or
nonobjection, of the FDIC and/or the DFI to engage in certain activities. For
additional information regarding the MOU, see "Item 1A, Risk Factors -- Risks
Related to Our Business -- We are required to comply with the terms of a
pending memorandum of understanding issued by the FDIC and the Division and
lack of compliance could result in additional regulatory actions."
1
Market Area
The Bank considers Grays Harbor, Thurston, Pierce, King, Kitsap and Lewis
Counties, Washington as its primary market areas. The Bank conducts
operations from:
* its main office in Hoquiam (Grays Harbor County);
* five branch offices in Grays Harbor County (Ocean Shores, Montesano,
Elma, and two branches in Aberdeen);
* a branch office in King County (Auburn);
* five branch offices in Pierce County (Edgewood, Puyallup, Spanaway,
Tacoma, and Gig Harbor);
* five branch offices in Thurston County (Olympia, Yelm, Tumwater, and
two branches in Lacey);
* two branch offices in Kitsap County (Poulsbo and Silverdale); and
* three branch offices in Lewis County (Winlock, Toledo and Chehalis).
See "Item 2. Properties."
Hoquiam, with a population of approximately 9,000, is located in Grays
Harbor County which is situated along Washington State's central Pacific
coast. Hoquiam is located approximately 110 miles southwest of Seattle and
145 miles northwest of Portland, Oregon.
The Bank considers its primary market area to include six submarkets:
primarily rural Grays Harbor County with its historical dependence on the
timber and fishing industries; Pierce, Thurston and Kitsap Counties with their
dependence on state and federal government; King County with its broadly
diversified economic base; and Lewis County with its dependence on retail
trade, manufacturing, industrial services and local government. Each of these
markets presents operating risks to the Bank. The Bank's expansion into
Pierce, Thurston, King, Kitsap and Lewis Counties represents the Bank's
strategy to diversify its primary market area to become less reliant on the
economy of Grays Harbor County.
Grays Harbor County has a population of 71,000 according to the U.S.
Census Bureau 2008 estimates and a median family income of $54,500 according
to 2009 HUD estimates. The economic base in Grays Harbor has been
historically dependent on the timber and fishing industries. Other industries
that support the economic base are tourism, agriculture, shipping,
transportation and technology. According to the Washington State Employment
Security Department, the unemployment rate in Grays Harbor County increased to
11.9% at September 30, 2009 from 7.5% at September 30, 2008. The median price
of a resale home in Grays Harbor County for the quarter ended September 30,
2009 decreased 13.2% to $134,500 as compared to the quarter one year prior.
The number of home sales decreased 29.5% for the quarter ended September 30,
2009 compared the same quarter one year earlier. The Bank has six branches
(including its home office) located throughout the county. The recent
downturn in Grays Harbor County's economy and the decline in real estate
values have had a negative effect on the Bank's profitability in this market
area.
Pierce County is the second most populous county in the state and has a
population of 786,000 according to the U.S. Census Bureau 2008 estimates. The
county's median family income is $68,100 according to 2009 HUD estimates. The
economy in Pierce County is diversified with the presence of military related
government employment (Fort Lewis Army Base and McChord Air Force Base),
transportation and shipping employment (Port of Tacoma), and aerospace related
employment (Boeing). According to the Washington State Employment Security
Department, the unemployment rate for the Pierce County area increased to 9.0%
at September 30, 2009 from 5.9% at September 30, 2008. The median price of a
resale home in Pierce County for the quarter ended September 30, 2009
decreased 9.6% to $230,000 as compared to the quarter one year prior. The
number of home sales increased 11.6% for the quarter ended
2
September 30, 2009 compared the same quarter one year earlier. The Bank has
five branches in Pierce County and these branches have historically been
responsible for a substantial portion of the Bank's construction lending
activities. The recent downturn in Pierce County's economy and the decline in
real estate values have had a negative effect on the Bank's profitability in
this market area.
Thurston County has a population of 245,000 according to the U.S. Census
Bureau 2008 estimates and a median family income of $70,000 according to 2009
HUD estimates. Thurston County is home of Washington State's capital
(Olympia) and its economic base is largely driven by state government related
employment. According to the Washington State Employment Security Department,
the unemployment rate for the Thurston County area increased to 7.2% at
September 30, 2009 from 5.2% at September 30, 2008. The median price of a
resale home in Thurston County for the quarter ended September 30, 2009
decreased 3.0% to $243,100 as compared to the same quarter one year earlier.
The number of home sales increased 1.5% for the quarter ended September 30,
2009 compared to the same quarter one year earlier. The Bank has five
branches in Thurston County. This county has historically had a stable
economic base primarily attributable to the state government presence; however
the downturn in Thurston County's economy and the decline in real estate
values have had a negative effect on the Bank's profitability in this market
area.
Kitsap County has a population of 240,000 according to the U.S. Census
Bureau 2008 estimates and a median family income of $70,900 according to 2009
HUD estimates. The Bank has two branches in Kitsap County. The economic base
of Kitsap County is largely supported by military related government
employment through the United States Navy. According to the Washington State
Employment Security Department, the unemployment rate for the Kitsap County
area increased to 7.3% at September 30, 2009 from 5.3% at September 30, 2008.
The median price of a resale home in Kitsap County for the quarter ended
September 30, 2009 decreased 7.4% to $249,900, as compared to the same quarter
one year earlier. The number of home sales increased 14.2% for the quarter
ended September 30, 2009 compared to the same quarter one year earlier. The
recent downturn in Kitsap County's economy and the decline in real estate
values have had a negative effect on the Bank's profitability in this market
area.
King County is the most populous county in the state and has a population
of 1.9 million according to the U.S. Census Bureau 2008 estimates. The Bank
has one branch in King County. The county's median family income is $84,300
according to 2009 HUD estimates. King County's economic base is diversified
with many industries including shipping, transportation, aerospace (Boeing),
computer technology and biotech industries. According to the Washington State
Employment Security Department, the unemployment rate for the King County area
increased to 8.8% at September 30, 2009 from 4.6% at September 30, 2008. The
median price of a resale home in King County for the quarter ended September
30, 2009 decreased 10.5% to $382,000, as compared to the same quarter one year
earlier. The number of home sales increased 14.2% for the quarter ended
September 30, 2009 compared to the same quarter one year earlier. The recent
downturn in King County's economy and the decline in real estate values have
had a negative effect on the Bank's profitability in this market area.
Lewis County has a population of 74,000 according to the U.S. Census
Bureau 2008 estimates and a median family income of $54,000 according to 2009
HUD estimates. The economic base in Lewis County is supported by
manufacturing, retail trade, local government and industrial services.
According to the Washington State Employment Security Department, the
unemployment rate in Lewis County increased to 12.1% at September 30, 2009
from 7.7% at September 30, 2008. The median price of a resale home in Lewis
County for the quarter ended September 30, 2009 decreased 6.7% to $163,300, as
compared to the same quarter one year earlier. The number of home sales
increased 16.7% for the quarter ended September 30, 2009 compared to the same
quarter one year earlier. The Bank currently has three branches located in
Lewis County after it consolidated its loan production office into a new full
service branch in May 2009. The recent downturn in Lewis County's economy and
the decline in real estate values have had a negative effect on the Bank's
profitability in this market area.
Lending Activities
General. Historically, the principal lending activity of the Bank has
consisted of the origination of loans secured by first mortgages on
owner-occupied, one- to four-family residences, loans secured by commercial
real estate and loans for the construction of one- to four-family residences.
The Bank's net loans receivable, including loans held
3
for sale, totaled $547.2 million at September 30, 2009, representing 77.9% of
consolidated total assets, and at that date construction and land development
loans (including undisbursed loans in process), and loans secured by
commercial properties were $327.9 million, or 55.1%, of total loans.
Construction and land development loans and commercial real estate loans
typically have higher rates of return than one- to four-family loans; however,
they also present a higher degree of risk. See "- Lending Activities -
Construction and Land Development Lending" and "- Lending Activities -
Commercial Real Estate Lending."
The Bank's internal loan policy limits the maximum amount of loans to one
borrower to 25% of its Tier 1 capital. At September 30, 2009, the maximum
amount which the Bank could have lent to any one borrower and the borrower's
related entities was approximately $17.0 million under this policy. At
September 30, 2009, the largest amount outstanding to any one borrower and the
borrower's related entities was $11.8 million (including $371,000 in
undisbursed loans in process balance). These loans represent two condominium
construction projects, several one- to four-family speculative construction
projects, and commercial real estate holdings. All of the loans are secured
by projects located in Grays Harbor County, except for one of the condominium
construction projects which is located in Clatsop County, Oregon. These loans
were performing according to the required loan repayment terms at September
30, 2009. The next largest amount outstanding to any one borrower and the
borrower's related entities was $11.5 million (including $3.6 million in
undisbursed loans in process balance.) These loans were secured by commercial
buildings being constructed in Pierce County and a land parcel, all of which
were performing according to loan repayment terms at September 30, 2009.
Loan Portfolio Analysis. The following table sets forth the composition
of the Bank's loan portfolio by type of loan as of the dates indicated.
At September 30,
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2009 2008 2007 2006 2005
---------------- ---------------- ---------------- ---------------- ----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in thousands)
Mortgage Loans:
One- to four-
family(1)....$110,556 18.58% $112,299 18.35% $102,434 17.40% $ 98,709 20.11% $101,763 23.24%
Multi-family.. 25,638 4.31 25,927 4.24 35,157 5.97 17,689 3.60 20,170 4.61
Commercial.... 188,205 31.62 146,223 23.90 127,866 21.72 137,609 28.04 124,849 28.51
Construction
and land.....
development 139,728 23.48 186,344 30.46 186,261 31.64 146,855 29.92 112,470 25.68
Land.......... 65,642 11.03 60,701 9.92 60,706 10.30 29,598 6.03 24,981 5.71
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total mortgage
loans....... 529,769 89.02 531,494 86.87 512,424 87.03 430,460 87.70 384,233 87.75
Consumer Loans:
Home equity
and second
mortgage..... 41,746 7.01 48,690 7.96 47,269 8.02 37,435 7.63 32,298 7.38
Other......... 9,827 1.66 10,635 1.73 10,922 1.86 11,127 2.27 9,330 2.13
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total consumer
loans....... 51,573 8.67 59,325 9.69 58,191 9.88 48,562 9.90 41,628 9.51
Commercial
business
loans......... 13,775 2.31 21,018 3.44 18,164 3.09 11,803 2.40 12,013 2.74
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans.. 595,117 100.00% 611,837 100.00% 588,779 100.00% 490,825 100.00% 437,874 100.00%
-------- ====== -------- ====== -------- ====== -------- ====== -------- ======
Less:
Undisbursed
portion of
construction
loans in
process...... (31,298) (43,353) (65,673) (59,260) (42,771)
Deferred loan
origination
fees......... (2,439) (2,747) (2,968) (2,798) (2,895)
Allowance for
loan losses.. (14,172) (8,050) (4,797) (4,122) (4,099)
-------- -------- -------- -------- --------
Total loans
receivable,
net...........$547,208 $557,687 $515,341 $424,645 $388,109
======== ======== ======== ======== ========
-----------
(1) Includes loans held-for-sale.
Residential One- to Four-Family Lending. At September 30, 2009, $110.6
million, or 18.6%, of the Bank's loan portfolio consisted of loans secured by
one- to four-family residences. The Bank originates both fixed-rate loans and
adjustable-rate loans.
4
Generally, one-to-four family fixed-rate loans and five and seven year
balloon reset loans (which are loans that are originated with a fixed interest
rate for the initial five or seven years, and thereafter incur one interest
rate change in which the new rate remains in effect for the remainder of the
loan term) are originated to meet the requirements for sale in the secondary
market to the FHLMC. From time to time, however, a portion of these
fixed-rate loans, which include five and seven year balloon reset loans, may
be retained in the loan portfolio to meet the Bank's asset/liability
management objectives. The Bank periodically retains some fixed rate loans
including five and seven year balloon reset loans in its loan portfolio and
classifies them as held-to-maturity. The Bank uses an automated underwriting
program, which preliminarily qualifies a loan as conforming to FHLMC
underwriting standards when the loan is originated. At September 30, 2009,
$55.9 million, or 50.6%, of the Bank's one- to four-family loan portfolio
consisted of fixed-rate mortgage loans.
The Bank also offers adjustable-rate mortgage ("ARM") loans. All of the
Bank's ARM loans are retained in its loan portfolio and not sold. The Bank
offers several ARM products which adjust annually after an initial period
ranging from one to five years subject to a limitation on the annual increase
of 2% and an overall limitation of 6%. These ARM products are priced
utilizing the weekly average yield on one year U.S. Treasury securities
adjusted to a constant maturity of one year plus a margin of 2.875% to 4.00%.
Loans tied to the prime rate or to LIBOR indices typically do not have
periodic, or lifetime adjustment limits. Loans tied to these indices normally
have margins ranging up to 3.5%. ARM loans held in the Bank's portfolio do
not permit negative amortization of principal. Borrower demand for ARM loans
versus fixed-rate mortgage loans is a function of the level of interest rates,
the expectations of changes in the level of interest rates and the difference
between the initial interest rates and fees charged for each type of loan.
The relative amount of fixed-rate mortgage loans and ARM loans that can be
originated at any time is largely determined by the demand for each in a
competitive environment. At September 30, 2009, $54.7 million, or 49.4%, of
the Bank's one- to four- family loan portfolio consisted of ARM loans.
A portion of the Bank's ARM loans are "non-conforming" because they do not
satisfy acreage limits, or various other requirements imposed by the FHLMC.
Some of these loans are also originated to meet the needs of borrowers who
cannot otherwise satisfy the FHLMC credit requirements because of personal and
financial reasons (i.e., divorce, bankruptcy, length of time employed, etc.),
and other aspects, which do not conform to the FHLMC's guidelines. Many of
these borrowers have higher debt-to-income ratios, or the loans are secured by
unique properties in rural markets for which there are no sales of comparable
properties to support value according to secondary market requirements. These
loans are known as non-conforming loans and the Bank may require additional
collateral or lower loan-to-value ratios to reduce the risk of these loans.
The Bank believes that these loans satisfy a need in its local market area.
As a result, subject to market conditions, the Bank intends to continue to
originate these types of loans.
The retention of ARM loans in the Bank's loan portfolio helps reduce the
Bank's exposure to changes in interest rates. There are, however,
unquantifiable credit risks resulting from the potential of increased interest
to be paid by the customer as a result of increases in interest rates. It is
possible that during periods of rising interest rates the risk of default on
ARM loans may increase as a result of repricing and the increased costs to the
borrower. Furthermore, because the ARM loans originated by the Bank generally
provide, as a marketing incentive, for initial rates of interest below the
rates which would apply were the adjustment index used for pricing initially,
these loans are subject to increased risks of default or delinquency. The
Bank attempts to reduce the potential for delinquencies and defaults on ARM
loans by qualifying the borrower based on the borrower's ability to repay the
ARM loan assuming that the maximum interest rate that could be charged at the
first adjustment period remains constant during the loan term. Another
consideration is that although ARM loans allow the Bank to increase the
sensitivity of its asset base due to changes in the interest rates, the extent
of this interest sensitivity is limited by the periodic and lifetime interest
rate adjustment limits. Because of these considerations, the Bank has no
assurance that yield increases on ARM loans will be sufficient to offset
increases in the Bank's cost of funds.
While fixed-rate, single-family residential mortgage loans are normally
originated with 15 to 30 year terms, these loans typically remain outstanding
for substantially shorter periods because borrowers often prepay their loans
in full upon sale of the property pledged as security or upon refinancing the
original loan. In addition, substantially all mortgage loans in the Bank's
loan portfolio contain due-on-sale clauses providing that the Bank may declare
the unpaid amount due and payable upon the sale of the property securing the
loan. Typically, the Bank enforces these due-on-sale
5
clauses to the extent permitted by law and as business judgment dictates.
Thus, average loan maturity is a function of, among other factors, the level
of purchase and sale activity in the real estate market, prevailing interest
rates and the interest rates received on outstanding loans.
The Bank requires that fire and extended coverage casualty insurance be
maintained on all of its real estate secured loans. Loans originated since
1994 also require flood insurance, if appropriate.
The Bank's lending policies generally limit the maximum loan-to-value
ratio on mortgage loans secured by owner-occupied properties to 95% of the
lesser of the appraised value or the purchase price. However, the Bank
usually obtains private mortgage insurance ("PMI") on the portion of the
principal amount that exceeds 80% of the appraised value of the security
property. The maximum loan-to-value ratio on mortgage loans secured by
non-owner-occupied properties is generally 80% (90% for loans originated for
sale in the secondary market to the FHLMC). At September 30, 2009 seven
single family loans totaling $1.34 million were not performing according to
their terms. See "- Lending Activities - Non-performing Assets and
Delinquencies."
Construction and Land Development Lending. Prompted by unfavorable
economic conditions in its primary market area in the 1980s, the Bank sought
to establish a market niche and, as a result, began originating construction
loans outside of Grays Harbor County. In recent periods, construction lending
activities have been primarily in the Pierce, King, Thurston, Grays Harbor,
and Kitsap County markets.
The Bank currently originates three types of residential construction
loans: (i) custom construction loans, (ii) owner/builder construction loans
and (iii) speculative construction loans (on a very limited basis). The Bank
believes that its computer tracking system has enabled it to establish
processing and disbursement procedures to meet the needs of these borrowers.
The Bank also originates construction loans for the development of
multi-family and commercial properties.
At September 30, 2009 and 2008, the composition of the Bank's construction
and land development loan portfolio was as follows:
At September 30,
------------------------------------------------
2009 2008
----------------------- -----------------------
Outstanding Percent of Outstanding Percent of
Balance Total Balance Total
----------- ---------- ----------- ----------
(In thousands)
Custom and owner/builder
construction.............. $ 35,414 25.34% $ 47,168 25.31%
Speculative construction... 16,959 12.14 30,895 16.58
Multi-family (including
condominium).............. 18,800 13.46 40,509 21.74
Land development........... 19,158 13.71 28,152 15.11
Commercial real estate..... 49,397 35.35 39,620 21.26
-------- ------ -------- ------
Total.................... $139,728 100.00% $186,344 100.00%
======== ====== ======== ======
Custom construction loans are made to home builders who, at the time of
construction, have a signed contract with a home buyer who has a commitment to
purchase the finished home. Custom construction loans are generally
originated for a term of six to 12 months, with fixed interest rates currently
ranging from 7.0% to 7.5% and with loan-to-value ratios of 80% of the
appraised estimated value of the completed property or sales price, whichever
is less. During the construction period, the borrower is required to make
monthly payments of accrued interest on the outstanding loan balance, a
portion, or all of which may be paid from an interest reserve.
Owner/builder construction loans are originated to the home owner rather
than the home builder as a single loan that automatically converts to a
permanent loan at the completion of construction. The construction phase of
an owner/builder construction loan generally lasts up to 12 months with fixed
interest rates currently ranging from 7.0%
6
to 7.5%, and with loan-to-value ratios of 80% (or up to 95% with PMI) of the
appraised estimated value of the completed property. During the construction
period, the borrower is required to make monthly payments of accrued interest
on the outstanding loan balance, a portion, or all of which may be paid from
an interest reserve. At the completion of construction, the loan converts
automatically to either a fixed-rate mortgage loan, which conforms to
secondary market standards, or an ARM loan for retention in the Bank's
portfolio. At September 30, 2009, custom and owner/builder construction loans
totaled $35.4 million, or 25.3%, of the total construction loan portfolio. At
September 30, 2009, the largest outstanding custom and owner/builder
construction loan had an outstanding balance of $1.1 million (including
$71,000 of undisbursed loans in process balance) and was performing according
to its repayment terms.
Speculative construction loans are made to home builders and are termed
"speculative" because the home builder does not have, at the time of loan
origination, a signed contract with a home buyer who has a commitment for
permanent financing with either the Bank or another lender for the finished
home. The home buyer may be identified either during or after the
construction period, with the risk that the builder will have to debt service
the speculative construction loan and finance real estate taxes and other
carrying costs of the completed home for a significant time after the
completion of construction until the home buyer is identified and a sale is
consummated. Historically, the Bank has originated loans to approximately 50
builders located in the Bank's primary market area, each of which generally
would have one to eight speculative loans outstanding from the Bank during a
12 month period. Rather than originating lines of credit to home builders to
construct several homes at once, the Bank generally originates and underwrites
a separate loan for each home. Speculative construction loans are generally
originated for a term of 12 months, with current rates ranging from 6.5% to
7.5%, and with a loan-to-value ratio of no more than 80% of the appraised
estimated value of the completed property. During this 12 month period, the
borrower is required to make monthly payments of accrued interest on the
outstanding loan balance, a portion, or all of which may be paid from an
interest reserve. At September 30, 2009, speculative construction loans
totaled $17.0 million, or 12.1%, of the total construction loan portfolio. At
September 30, 2009, the Bank had nine borrowers each with aggregate
outstanding speculative loan balances of more than $500,000. The largest
aggregate outstanding balance to one borrower for speculative construction
loans totaled $3.2 million (including $86,000 of undisbursed loans in process
balance), all of which were performing according to the loan repayment terms.
The largest outstanding balance for a single speculative loan was $746,000 and
was performing according to its terms. At September 30, 2009, eight out of 53
speculative construction loans with an aggregate balance of $3.4 million were
not performing according to their terms. These non-performing loans were
located in Pierce County, Thurston County and King County. See "- Lending
Activities - Non-performing Assets and Delinquencies."
The Bank historically originated loans to real estate developers with whom
it has established relationships for the purpose of developing residential
subdivisions (i.e., installing roads, sewers, water and other utilities)
(generally with ten to 50 lots). The Bank is not currently originating any new
land development loans. At September 30, 2009, the Bank had 18 land
development loans totaling $19.2 million, or 13.7% of construction and land
development loans receivable. Land development loans are secured by a lien on
the property and typically made for a period of two to five years with fixed
or variable interest rates, and are made with loan-to-value ratios generally
not exceeding 75%. Monthly interest payments are required during the term of
the loan. Land development loans are generally structured so that the Bank is
repaid in full upon the sale by the borrower of approximately 80% of the
subdivision lots. A majority of the Bank's land development loans are secured
by property located in its primary market area. In addition, in the case of a
corporate borrower, the Bank also generally obtains personal guarantees from
corporate principals and reviews their personal financial statements. At
September 30, 2009, the Bank had seven land development loans totaling $8.8
million that were non-performing. The non-performing loans consisted of:
* Four loans totaling $5.5 million secured by land development projects
in King County;
* Two loans totaling $1.6 million secured by land development projects
in Pierce County;
* One loan with a balance of $876,000 secured by a land development
project in Thurston County; and
* An $804,000 participation interest in a loan secured by a land
development project in Clark County.
Land development loans secured by land under development involve greater
risks than one- to four-family residential mortgage loans because these loans
are advanced upon the predicted future value of the developed property upon
completion. If the estimate of the future value proves to be inaccurate, in
the event of default and foreclosure the Bank may be confronted with a
property the value of which is insufficient to assure full repayment. The
Bank has
7
historically attempted to minimize this risk by generally limiting the maximum
loan-to-value ratio on land loans to 75% of the estimated developed value of
the secured property. The Bank is not currently originating any new land
development loans.
The Bank also provides construction financing for multi-family and
commercial properties. At September 30, 2009, these loans amounted to $18.8
million, or 13.5% of construction loans. These loans are secured by
condominiums, apartment buildings, mini-storage facilities, office buildings
and retail rental space predominantly located in the Bank's primary market
area. At September 30, 2009, the largest outstanding multi-family
construction loan was secured by a condominium project and had a balance of
$4.1 million (including $12,000 of undisbursed loans in process balance) and
was performing according to its repayment terms. At September 30, 2009, the
largest outstanding commercial real estate construction loan had a balance of
$6.3 million (including $2.0 million of undisbursed loans in process balance).
This loan was secured by a medical office facility being constructed in Pierce
County and was performing according to its repayment terms.
All construction loans must be approved by a member of one of the Bank's
Loan Committees or the Bank's Board of Directors, or in the case of one- to
four-family construction loans meeting FHLMC guidelines, by a qualified
underwriter. See "- Lending Activities - Loan Solicitation and Processing."
Prior to preliminary approval of any construction loan application, an
independent fee appraiser inspects the site and the Bank reviews the existing
or proposed improvements, identifies the market for the proposed project and
analyzes the pro forma data and assumptions on the project. In the case of a
speculative or custom construction loan, the Bank reviews the experience and
expertise of the builder. After preliminary approval has been given, the
application is processed, which includes obtaining credit reports, financial
statements and tax returns on the borrowers and guarantors, an independent
appraisal of the project, and any other expert reports necessary to evaluate
the proposed project. In the event of cost overruns, the Bank generally
requires that the borrower increase the funds available for construction by
depositing its own funds into a secured savings account, the proceeds of which
are used to pay construction costs.
Loan disbursements during the construction period are made to the builder,
materials' supplier or subcontractor, based on a line item budget. Periodic
on-site inspections are made by qualified inspectors to document the
reasonableness of draw requests. For most builders, the Bank disburses loan
funds by providing vouchers to suppliers, which when used by the builder to
purchase supplies are submitted by the supplier to the Bank for payment.
The Bank regularly monitors the construction loan disbursements using an
internal monitoring system which the Bank believes reduces many of the risks
inherent with construction lending.
The Bank originates construction loan applications primarily through
customer referrals, contacts in the business community and occasionally real
estate brokers seeking financing for their clients.
Construction lending affords the Bank the opportunity to achieve higher
interest rates and fees with shorter terms to maturity than does its
single-family permanent mortgage lending. Construction lending, however, is
generally considered to involve a higher degree of risk than single-family
permanent mortgage lending because of the inherent difficulty in estimating
both a property's value at completion of the project and the estimated cost of
the project. The nature of these loans is such that they are generally more
difficult to evaluate and monitor. If the estimate of construction cost
proves to be inaccurate, the Bank may be required to advance funds beyond the
amount originally committed to permit completion of the project. If the
estimate of value upon completion proves to be inaccurate, the Bank may be
confronted with a project whose value is insufficient to assure full repayment
and it may incur a loss. Projects may also be jeopardized by disagreements
between borrowers and builders and by the failure of builders to pay
subcontractors. Loans to builders to construct homes for which no purchaser
has been identified carry more risk because the payoff for the loan depends on
the builder's ability to sell the property prior to the time that the
construction loan is due. The Bank has sought to address these risks by
adhering to strict underwriting policies, disbursement procedures, and
monitoring practices. The Bank's construction loans are primarily secured by
properties in its primary market area, and changes in the local and state
economies and real estate markets have adversely affected the Bank's
construction loan portfolio.
8
Multi-Family Lending. At September 30, 2009, the Bank had $25.6 million,
or 4.3% of the Bank's total loan portfolio, secured by multi-family dwelling
units (more than four units) located primarily in the Bank's primary market
area. Multi-family loans are generally originated with variable rates of
interest ranging from 2.00% to 3.50% over the one-year constant maturity U.S.
Treasury Bill Index or a matched term FHLB advance, with principal and
interest payments fully amortizing over terms of up to 30 years. At September
30, 2009, the largest multi-family loan had an outstanding principal balance
of $5.0 million and was secured by an apartment building located in the Bank's
primary market area. At September 30, 2009, this loan was performing
according to its terms.
The maximum loan-to-value ratio for multi-family loans is generally
limited to not more than 80%. The Bank generally requests its multi-family
loan borrowers with loan balances in excess of $750,000 to submit financial
statements and rent rolls on the subject property annually. The Bank also
inspects the subject property annually. The Bank generally imposes a minimum
debt coverage ratio of approximately 1.20 times for loans secured by
multi-family properties.
Multi-family mortgage lending affords the Bank an opportunity to receive
interest at rates higher than those generally available from one- to four-
family residential lending. However, loans secured by multi-family properties
usually are greater in amount, more difficult to evaluate and monitor and,
therefore, involve a greater degree of risk than one- to four-family
residential mortgage loans. Because payments on loans secured by multi-family
properties are often dependent on the successful operation and management of
the properties, repayment of such loans may be affected by adverse conditions
in the real estate market or the economy. The Bank seeks to minimize these
risks by scrutinizing the financial condition of the borrower, the quality of
the collateral and the management of the property securing the loan. If the
borrower is other than an individual, the Bank also generally obtains personal
guarantees from the principals based on a review of personal financial
statements.
Commercial Real Estate Lending. Commercial real estate loans totaled
$188.2 million, or 31.6% of the total loan portfolio at September 30, 2009.
The Bank originated $43.8 million of commercial real-estate loans during the
year ended September 30, 2009 compared to $29.3 million originated during the
year ended September 30, 2008. The Bank originates commercial real estate
loans generally at variable interest rates and these loans are secured by
properties, such as restaurants, motels, mini-storage facilities, office
buildings and retail/wholesale facilities, located in the Bank's primary
market area. At September 30, 2009, the largest commercial real estate loan
was secured by a mini-storage facility in Pierce County, had a balance of $4.5
million and was 60 days past due. At September 30, 2009, seven commercial
real estate loans totaling $5.0 million were not performing according to their
terms. See "- Lending Activities - Non-performing Assets and Delinquencies."
The Bank typically requires appraisals of properties securing commercial
real estate loans. For loans that are less than $250,000, the Bank may use
the tax assessed value and a property inspection in lieu of an appraisal.
Appraisals are performed by independent appraisers designated by the Bank, all
of which are reviewed by management. The Bank considers the quality and
location of the real estate, the credit history of the borrower, the cash flow
of the project and the quality of management involved with the property. The
Bank generally imposes a minimum debt coverage ratio of approximately 1.20 for
originated loans secured by income producing commercial properties.
Loan-to-value ratios on commercial real estate loans are generally limited to
not more than 80%. If the borrower is other than an individual, the Bank also
generally obtains personal guarantees from the principals based on a review of
personal financial statements.
Commercial real estate lending affords the Bank an opportunity to receive
interest at rates higher than those generally available from one- to
four-family residential lending. However, loans secured by such properties
usually are greater in amount, more difficult to evaluate and monitor and,
therefore, involve a greater degree of risk than one- to four-family
residential mortgage loans. Because payments on loans secured by commercial
properties often depend upon the successful operation and management of the
properties, repayment of these loans may be affected by adverse conditions in
the real estate market or the economy. The Bank seeks to minimize these risks
by generally limiting the maximum loan-to-value ratio to 80% and strictly
scrutinizing the financial condition of the borrower, the quality of the
collateral and the management of the property securing the loan. The Bank
also requests annual financial information and rent rolls on the subject
property from the borrowers on loans over $750,000.
9
Land Lending. The Bank originates loans for the acquisition of land upon
which the purchaser can then build or make improvements necessary to build or
to sell as improved lots. At September 30, 2009, land loans totaled $65.6
million, or 11.0% of the Bank's total loan portfolio as compared to $60.7
million, or 9.9% of the Bank's total loan portfolio at September 30, 2008.
Land loans originated by the Bank are generally fixed-rate loans and have
maturities of five to ten years. The largest land loan had an outstanding
balance of $3.0 million at September 30, 2009 and was performing according to
its repayment terms. At September 30, 2009, 16 land loans totaling $5.0
million were not performing according to their terms. See "- Lending
Activities - Non-performing Assets and Delinquencies."
Loans secured by undeveloped land or improved lots involve greater risks
than one- to four-family residential mortgage loans because these loans are
more difficult to evaluate. If the estimate of value proves to be inaccurate,
in the event of default and foreclosure the Bank may be confronted with a
property the value of which is insufficient to assure full repayment. The
Bank attempts to minimize this risk by generally limiting the maximum
loan-to-value ratio on land loans to 75%.
Consumer Lending. Consumer loans generally have shorter terms to maturity
and higher interest rates than mortgage loans. Consumer loans include home
equity lines of credit, second mortgage loans, savings account loans,
automobile loans, boat loans, motorcycle loans, recreational vehicle loans and
unsecured loans. Consumer loans are made with both fixed and variable
interest rates and with varying terms. At September 30, 2009, consumer loans
amounted to $51.6 million, or 8.7%, of the total loan portfolio.
At September 30, 2009, the largest component of the consumer loan
portfolio consisted of second mortgage loans and home equity lines of credit,
which totaled $41.7 million, or 7.0%, of the total loan portfolio. Home
equity lines of credit and second mortgage loans are made for purposes such as
the improvement of residential properties, debt consolidation and education
expenses, among others. The majority of these loans are made to existing
customers and are secured by a first or second mortgage on residential
property. The Bank occasionally solicits these loans. The loan- to-value
ratio is typically 80% or less, when taking into account both the first and
second mortgage loans. Second mortgage loans typically carry fixed interest
rates with a fixed payment over a term between five and 15 years. Home equity
lines of credit are generally made at interest rates tied to the prime rate or
the 26 week Treasury Bill. Second mortgage loans and home equity lines of
credit have greater credit risk than one- to four-family residential mortgage
loans because they are secured by mortgages subordinated to the existing first
mortgage on the property, which may or may not be held by the Bank.
Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of consumer loans that are unsecured or secured by
rapidly depreciating assets such as automobiles. In such cases, any
repossessed collateral for a defaulted consumer loan may not provide an
adequate source of repayment of the outstanding loan balance as a result of
the greater likelihood of damage, loss or depreciation. The remaining
deficiency often does not warrant further substantial collection efforts
against the borrower beyond obtaining a deficiency judgment. In addition,
consumer loan collections are dependent on the borrower's continuing financial
stability, and are more likely to be adversely affected by job loss, divorce,
illness or personal bankruptcy. Furthermore, the application of various
federal and state laws, including federal and state bankruptcy and insolvency
laws, may limit the amount that can be recovered on such loans. The Bank
believes that these risks are not as prevalent in the case of the Bank's
consumer loan portfolio because a large percentage of the portfolio consists
of second mortgage loans and home equity lines of credit that are underwritten
in a manner such that they result in credit risk that is substantially similar
to one- to four-family residential mortgage loans. At September 30, 2009,
nine consumer loans totaling $258,000 were delinquent in excess of 90 days.
See "- Lending Activities - Non-performing Assets and Delinquencies."
Commercial Business Lending. Commercial business loans totaled $13.8
million, or 2.3% of the loan portfolio at September 30, 2009, and consisted of
117 loans. Commercial business loans are generally secured by business
equipment, accounts receivable, inventory or other property and are made at
variable rates of interest equal to a negotiated margin above the prime rate.
The Bank also generally obtains personal guarantees from the principals based
on a review of personal financial statements. The largest commercial business
loan had an outstanding balance of $1.1 million at September 30, 2009 and was
performing according to its terms. At September 30, 2009, two commercial
10
business loans totaling $65,000 were not performing according to their
repayment terms. See "- Lending Activities - Non-performing Assets and
Delinquencies."
Commercial business lending generally involves greater risk than
residential mortgage lending and involves risks that are different from those
associated with residential and commercial real estate lending. Real estate
lending is generally considered to be collateral based lending with loan
amounts based on predetermined loan to collateral values and liquidation of
the underlying real estate collateral is viewed as the primary source of
repayment in the event of borrower default. Although commercial business
loans are often collateralized by equipment, inventory, accounts receivable or
other business assets, the liquidation of collateral in the event of a
borrower default is often an insufficient source of repayment because accounts
receivable may be uncollectible and inventories and equipment may be obsolete
or of limited use, among other things. Accordingly, the repayment of a
commercial business loan depends primarily on the creditworthiness of the
borrower (and any guarantors), while liquidation of collateral is a secondary
and often insufficient source of repayment.
Loan Maturity. The following table sets forth certain information at
September 30, 2009 regarding the dollar amount of loans maturing in the Bank's
portfolio based on their contractual terms to maturity, but does not include
scheduled payments or potential prepayments. Loans having no stated maturity
and overdrafts are reported as due in one year or less.
After After After
1 Year 3 Years 5 Years
Within Through Through Through After
1 Year 3 Years 5 Years 10 Years 10 Years Total
------ ------- ------- -------- -------- -----
(In thousands)
Mortgage loans:
One- to four-family
(1)................. $ 1,835 $ 2,941 $ 3,544 $ 8,381 $ 93,855 $110,556
Multi-family......... 4,672 1,817 689 17,386 1,074 25,638
Commercial........... 14,878 10,127 28,531 122,766 11,903 188,205
Construction and land
development(2)...... 139,265 114 349 -- -- 139,728
Land................. 35,889 12,553 12,524 2,980 1,696 65,642
Consumer loans:
Home equity and
second mortgage..... 11,539 1,578 910 5,782 21,937 41,746
Other................ 2,693 1,330 1,242 509 4,053 9,827
Commercial business
loans................ 5,427 4,128 695 2,087 1,438 13,775
-------- ------- ------- -------- -------- --------
Total................ $216,198 $34,588 $48,484 $159,891 $135,956 595,117
======== ======= ======= ======== ======== ========
Less:
Undisbursed portion
of construction
loans in process.... (31,298)
Deferred loan
origination fees.... (2,439)
Allowance for loan
losses.............. (14,172)
Loans receivable, --------
net................. $547,208
========
-----------
(1) Includes $630,000 of loans held-for-sale.
(2) Includes construction/permanent loans that convert to permanent mortgage
loans once construction is completed.
11
The following table sets forth the dollar amount of all loans due after
one year from September 30, 2009, which have fixed interest rates and have
floating or adjustable interest rates.
Fixed Floating or
Rates Adjustable Rates Total
------- ---------------- -------
(In thousands)
Mortgage loans:
One- to four-family(1)............... $ 54,083 $ 54,638 $108,721
Multi-family......................... 2,455 18,512 20,967
Commercial........................... 22,916 150,411 173,327
Construction and land development.... 348 114 462
Land................................. 24,300 5,453 29,753
Consumer loans:
Home equity and second mortgage...... 20,428 9,779 30,207
Other................................ 6,972 162 7,134
Commercial business loans............. 4,223 4,125 8,348
-------- -------- --------
Total............................... $135,725 $243,194 $378,919
======== ======== ========
-------------
(1) Includes loans held-for-sale.
Scheduled contractual principal repayments of loans do not reflect the
actual life of these assets. The average life of loans is substantially less
than their contractual terms because of prepayments. In addition, due-on-sale
clauses on loans generally give the Bank the right to declare loans
immediately due and payable in the event, among other things, that the
borrower sells the real property subject to the mortgage and the loan is not
repaid. The average life of mortgage loans tends to increase, however, when
current mortgage loan interest rates are substantially higher than interest
rates on existing mortgage loans and, conversely, decrease when interest rates
on existing mortgage loans are substantially higher than current mortgage loan
interest rates.
Loan Solicitation and Processing. Loan originations are obtained from a
variety of sources, including walk-in customers, and referrals from builders
and realtors. Upon receipt of a loan application from a prospective borrower,
a credit report and other data are obtained to verify specific information
relating to the loan applicant's employment, income and credit standing. An
appraisal of the real estate offered as collateral generally is undertaken by
an appraiser retained by the Bank and certified by the State of Washington.
Loan applications are initiated by loan officers and are required to be
approved by an authorized loan underwriter, one of the Bank's Loan Committees
or the Bank's Board of Directors. The Bank's Consumer Loan Committee, which
consists of three underwriters, each of whom can approve one-to four-family
mortgage loans and other consumer loans up to and including the current FHLMC
single-family limit. Certain consumer loans up to and including $25,000 may
be approved by individual loan officers and the Bank's Consumer Lending
Department Manager may approve consumer loans up to and including $75,000.
The Bank's Regional Manager of Commercial Lending has individual lending
authority for loans up to and including $250,000, excluding speculative
construction loans and unsecured loans. The Bank's Commercial Loan Committee,
which consists of the Bank's President, Chief Credit Administrator, Executive
Vice President of Commercial Lending, Executive Vice President of Community
Lending, and Regional Manager of Commercial Lending, may approve commercial
real estate loans and commercial business loans up to and including $1.5
million. The Bank's President, Executive Vice President of Commercial Lending
and Executive Vice President of Community Lending also have individual lending
authority for loans up to and including $750,000. The Bank's Board Loan
Committee, which consists of two rotating non-employee Directors and the
Bank's President, may approve loans up to and including $3.0 million. Loans
in excess of $3.0 million, as well as loans of any amount granted to a single
borrower whose aggregate loans exceed $3.0 million, must be approved by the
Bank's Board of Directors.
Loan Originations, Purchases and Sales. During the years ended September
30, 2009 and 2008, the Bank's total gross loan originations were $295.3
million and $258.6 million, respectively. Periodically, the Bank purchases
12
participation interests in construction and land development loans, commercial
real estate loans, and multi-family loans, secured by properties generally
located in Washington State, from other lenders. These purchases are
underwritten to the Bank's underwriting guidelines and are without recourse to
the seller other than for fraud. During the years ended September 30, 2009
and 2008, the Bank purchased loan participation interests of $1.6 million and
$2.9 million, respectively. See "- Lending Activities - Construction and Land
Development Lending" and "- Lending Activities - Multi-Family Lending."
Consistent with its asset/liability management strategy, the Bank's policy
generally is to retain in its portfolio all ARM loans originated and to sell
fixed rate one-to four-family mortgage loans in the secondary market to the
FHLMC; however, from time to time, a portion of fixed-rate loans may be
retained in the Bank's portfolio to meet its asset-liability objectives.
Loans sold in the secondary market are generally sold on a servicing retained
basis. At September 30, 2009, the Bank's loan servicing portfolio totaled
$251.8 million.
The Bank also periodically sells participation interests in construction
and land development loans, commercial real estate loans, and land loans to
other lenders. These sales are usually made to avoid concentrations in a
particular loan type or concentrations to a particular borrower. The Bank did
not sell any loan participation interests to other lenders during the year
ended September 30, 2009.
The following table shows total loans originated, purchased, sold and
repaid during the periods indicated.
Year Ended September 30,
--------------------------------
2009 2008 2007
--------- --------- ---------
Loans originated: (In thousands)
Mortgage loans:
One- to four-family...................... $ 165,972 $ 45,844 $ 33,252
Multi-family............................. 1,036 4,710 4,397
Commercial............................... 43,821 29,306 35,886
Construction and land development........ 56,287 118,186 127,082
Land..................................... 6,519 25,858 35,066
Consumer.................................. 14,080 22,411 32,354
Commercial business loans................. 7,601 12,268 11,020
--------- --------- ---------
Total loans originated................... 295,316 258,583 279,057
Loans purchased:
Mortgage loans:
One- to four-family...................... -- -- --
Multi-family............................. -- -- 5,200
Commercial............................... 1,606 -- --
Construction and land development........ -- 2,862 15,175
Land..................................... -- -- --
--------- --------- ---------
Total loans purchased................... 1,606 2,862 20,375
--------- --------- ---------
Total loans originated and purchased... 296,922 261,445 299,432
Loans sold:
Whole loans sold.......................... (162,913) (45,269) (29,893)
Participation loans sold.................. -- (17,035) (6,650)
--------- --------- ---------
Total loans sold.......................... (162,913) (62,304) (36,543)
Loan principal repayments.................. (150,729) (176,083) (164,935)
Decrease (increase) in other items, net.... 6,241 19,288 (7,258)
--------- --------- ---------
Net increase (decrease) in loans
receivable............................... $ (10,479) $ 42,346 $ 90,696
========= ========= =========
13
Loan Origination Fees. The Bank receives loan origination fees on many
of its mortgage loans and commercial business loans. Loan fees are a
percentage of the loan which are charged to the borrower for funding the loan.
The amount of fees charged by the Bank is generally 0.0% to 2.0% of the loan
amount. Current accounting principles generally accepted in the United States
of America require fees received and certain loan origination costs for
originating loans to be deferred and amortized into interest income over the
contractual life of the loan. Net deferred fees or costs associated with
loans that are prepaid are recognized as income at the time of prepayment.
Unamortized deferred loan origination fees totaled $2.4 million at September
30, 2009.
Non-performing Loans and Delinquencies. The Bank assesses late fees or
penalty charges on delinquent loans of approximately 5% of the monthly loan
payment amount. A majority of loan payments are due on the first day of the
month; however, the borrower is given a 15 day grace period to make the loan
payment. When a mortgage loan borrower fails to make a required payment when
due, the Bank institutes collection procedures. A notice is mailed to the
borrower 16 days after the date the payment is due. Attempts to contact the
borrower by telephone generally begin on or before the 30th day of
delinquency. If a satisfactory response is not obtained, continuous follow-up
contacts are attempted until the loan has been brought current. Before the
90th day of delinquency, attempts are made to establish (i) the cause of the
delinquency, (ii) whether the cause is temporary, (iii) the attitude of the
borrower toward the debt, and (iv) a mutually satisfactory arrangement for
curing the default.
If the borrower is chronically delinquent and all reasonable means of
obtaining payment on time have been exhausted, foreclosure is initiated
according to the terms of the security instrument and applicable law.
Interest income on loans in foreclosure is reduced by the full amount of
accrued and uncollected interest.
When a consumer loan borrower or commercial business borrower fails to
make a required payment on a loan by the payment due date, the Bank institutes
similar collection procedures as for its mortgage loan borrowers. Loans
becoming 90 days or more past due are placed on non-accrual status, with any
accrued interest reversed against interest income, unless they are well
secured and in the process of collection.
The Bank's Board of Directors is informed monthly as to the status of
loans that are delinquent by more than 30 days, and the status of all
foreclosed and repossessed property owned by the Bank.
14
The following table sets forth information with respect to the Company's
non-performing assets at the dates indicated.
At September 30,
----------------------------------------------
2009 2008 2007 2006 2005
------ ------ ------ ------ ------
Loans accounted for on a
non-accrual basis: (In thousands)
Mortgage loans:
One- to four-family........ $ 1,343 $ 300 $ 252 $ 80 $ 2,208
Commercial................. 5,004 714 90 -- 261
Construction and land
development............... 17,594 9,840 1,000 -- --
Land....................... 5,023 726 28 -- 23
Consumer loans............. 258 160 -- -- 133
Commercial business loans.. 65 250 120 -- 301
-------- -------- -------- -------- --------
Total.................... 29,287 11,990 1,490 80 2,926
Accruing loans which are
contractually past due 90
days or more............... 796 -- -- -- --
Total of non-accrual and 90
days past due loans........ 30,083 11,990 1,490 80 2,926
Non-accrual investment
securities................. 477 -- -- -- --
Other real estate owned and
other repossessed assets... 8,185 511 -- 15 509
-------- -------- -------- -------- --------
Total non-performing
assets (1).............. $ 37,949 $ 12,501 $ 1,490 $ 95 $ 3,435
======== ======== ======== ======== ========
Troubled debt restructured
loans (2).................. $ 9,492 $ 272 $ -- $ -- $ --
Non-accrual and 90 days or
more past due loans as a
percentage of loans
receivable, net............ 5.36% 2.12% 0.29% 0.02% 0.75%
Non-accrual and 90 days or
more past due loans as a
percentage of total assets. 4.28% 1.76% 0.23% 0.01% 0.53%
Non-performing assets as a
percentage of total assets. 5.41% 1.83% 0.23% 0.02% 0.62%
Loans receivable, net (3)... $561,380 $565,737 $520,138 $428,767 $392,208
======== ======== ======== ======== ========
Total assets................ $702,547 $681,883 $644,848 $577,087 $552,765
======== ======== ======== ======== ========
------------
(1) Includes non-accrual loans, non-accrual investment securities, other real
estate owned and other repossessed assets. Loans considered impaired are
not included if they are still on accrual status. Loans classified as
troubled debt restructurings are not included if they are on accrual
status.
(2) At September 30, 2009, troubled debt restructured loans totaling $9,492
were on non-accrual status and included in total non-performing assets.
(3) Includes loans held-for-sale and is before the allowance for loan losses.
The Bank's non-accrual loans increased by $17.3 million to $29.3 million
at September 30, 2009 from $12.0 million at September 30, 2008, primarily as a
result of a $7.8 million increase in construction and land development loans
on non-accrual status, a $4.3 million increase in land loans on non-accrual
status and a $4.3 million increase in commercial real estate loans on
non-accrual status. The largest non-performing loan was secured by a
condominium construction project in King County and had a balance of $3.7
million at September 30, 2009. Management's evaluation of the collateral
determined no impairment existed at September 30, 2009. A discussion of our
largest non-performing loans is set forth below under "Asset Classification."
Additional interest income which would have been recorded for the year
ended September 30, 2009 had non-accruing loans been current in accordance
with their original terms totaled $2.1 million.
15
Other Real Estate Owned and Other Repossessed Items. Real estate acquired
by the Bank as a result of foreclosure or by deed-in-lieu of foreclosure is
classified as other real estate owned until sold. When property is acquired,
it is recorded at the lower of its cost, which is the unpaid principal balance
of the related loan plus foreclosure costs, or fair market value less
estimated costs to sell, which becomes the new cost. Subsequent to
foreclosure, the property is recorded at the lower of the cost or fair value,
less estimated selling costs. At September 30, 2009, the Bank had $8.2
million of other real estate owned and other repossessed items consisting of
26 individual properties representing 14 relationships. The properties
consisted of 12 single family homes totaling $3.5 million, one land
development project with a balance of $2.3 million, a multi-family property
with a balance of $1.1 million, ten land parcels totaling $734,000 and two
commercial real estate properties totaling $612,000.
Restructured Loans. Under accounting principles generally accepted in the
United States of America, the Bank is required to account for certain loan
modifications or restructuring as a "troubled debt restructuring." In
general, the modification or restructuring of a debt constitutes a troubled
debt restructuring if the Bank for economic or legal reasons related to the
borrower's financial difficulties grants a concession to the borrowers that
the Bank would not otherwise consider. Debt restructuring or loan
modifications for a borrower does not necessarily always constitute troubled
debt restructuring, however, and troubled debt restructurings do not
necessarily result in non-accrual loans. The Bank had restructured loans
totaling $9.5 million at September 30, 2009, all of which were on non-accrual
status.
Impaired Loans. A loan is considered impaired when it is probable the
Bank will be unable to collect all contractual principal and interest payments
due in accordance with the original or modified terms of the loan agreement.
Impaired loans are measured based on the estimated fair value of the
collateral less estimated cost to sell if the loan is considered collateral
dependent. Impaired loans not considered to be collateral dependent are
measured based on the present value of expected future cash flows.
The categories of non-accrual loans and impaired loans overlap, although
they are not coextensive. The Bank considers all circumstances regarding the
loan and borrower on an individual basis when determining whether an impaired
loan should be placed on non-accrual status, such as the financial strength of
the borrower, the collateral value, reasons for delay, payment record, the
amount of past due and the number of days past due. At September 30, 2009,
the Bank had $47.6 million in impaired loans. For additional information on
impaired loans, see Note 4 of the Notes to the Consolidated Financial
Statements included in Item 8 of this Annual Report on Form 10-K.
Other Loans of Concern. Loans not reflected in the table above, but where
known information about possible credit problems of borrowers causes
management to have doubts as to the ability of the borrower to comply with
present repayment terms and that may result in disclosure of such loans as
non-performing assets in the future are commonly referred to as "other loans
of concern" or "potential problem loans." The amount included in potential
problem loans results from an evaluation, on a loan-by-loan basis, of loans
classified as "substandard" and "special mention," as those terms are defined
under "Asset Classification" below. The amount of potential problem loans and
non-performing loans was $84.9 million at September 30, 2009 and $42.8 million
at September 30, 2008. The vast majority of these loans are collateralized by
real estate. See "- Asset Classification" below for additional information
regarding our problem loans.
Asset Classification. Applicable regulations require that each insured
institution review and classify its assets on a regular basis. In addition,
in connection with examinations of insured institutions, regulatory examiners
have authority to identify problem assets and, if appropriate, require them to
be classified. There are three classifications for problem assets:
substandard, doubtful and loss. Substandard assets have one or more defined
weaknesses and are characterized by the distinct possibility that the insured
institution will sustain some loss if the deficiencies are not corrected.
Doubtful assets have the weaknesses of substandard assets with the additional
characteristic that the weaknesses make collection or liquidation in full on
the basis of currently existing facts, conditions and values questionable, and
there is a high possibility of loss. An asset classified as loss is
considered uncollectible and of such little value that continuance as an asset
of the institution is not warranted. When an insured institution classifies
problem assets as either substandard or doubtful, it is required to establish
general allowances for loan losses in an amount deemed prudent by management.
These allowances represent loss allowances which have been established to
recognize the inherent risk associated with lending activities and the risks
associated with particular problem assets. When an insured institution
classifies problem assets as loss, it charges off the balance of the asset
against the allowance for loan losses.
16
Assets which do not currently expose the insured institution to sufficient
risk to warrant classification in one of the aforementioned categories but
possess weaknesses are required to be designated as special mention. The
Bank's determination of the classification of its assets and the amount of its
valuation allowances is subject to review by the FDIC and the Division which
can order the establishment of additional loss allowances.
The aggregate amounts of the Bank's classified and special mention loans
(as determined by the Bank), and of the Bank's allowances for loan losses at
the dates indicated, were as follows:
At September 30,
-----------------------------
2009 2008 2007
------- ------- -------
(In thousands)
Loss............................. $ -- $ -- $ --
Doubtful......................... -- -- --
Substandard(1)(2)................ 63,188 24,603 8,812
Special mention(1)............... 21,711 18,225 6,917
------- ------- -------
Total classified and special
mention loans.................. $84,899 $42,828 $15,729
======= ======= =======
Allowance for loan losses........ $14,172 $ 8,050 $ 4,797
----------------
(1) For further information concerning the change in classified assets, see
"- Lending Activities - Non-performing Assets and Delinquencies."
(2) Includes non-performing loans.
The Bank's classified and special mention loans increased by $42.1
million from September 30, 2008 to September 30, 2009, primarily as a result
of a $38.6 million increase in loans classified as substandard and a $3.5
million increase in loans classified as special mention.
Special mention loan are defined as those credits deemed by management
to have some potential weakness that deserve management's close attention. If
left uncorrected these potential weaknesses may result in the deterioration of
the payment prospects of the loan. Assets in this category are not adversely
classified and currently do not expose the Bank to sufficient risk to warrant
a substandard classification. Seven individual loans comprise $14.3 million,
or 65.8%, of the $21.7 million in loans classified as special mention. They
include a $4.3 million loan secured by a multi-family building in King County,
a $3.2 million loan secured by a mixed-use building in Thurston County, a $2.5
million loan secured by a multi-family construction project in Grays Harbor
County, a $1.2 million loan secured by land in Thurston County, a $1.1 million
commercial business loan to a mini-storage facility business in Pierce County,
a $1.1 million loan secured by a commercial building in Grays Harbor County,
and a $945,000 loan secured by a motel in Grays Harbor County. At September
30, 2009 these loans were current and paying in accordance with their required
terms.
Substandard loans are classified as those loans that are inadequately
protected by the current net worth, and paying capacity of the obligor, or of
the collateral pledged. Assets classified as substandard have a well-defined
weakness, or weaknesses that jeopardize the repayment of the debt. If the
weakness, or weaknesses are not corrected there is the distinct possibility
that some loss will be sustained. The aggregate amount of loans classified as
substandard at September 30, 2009 increased by $38.6 million to $63.1 million
from $24.6 million at September 30, 2008. At September 30, 2009, 121 loans
were classified as substandard compared to 68 at September 30, 2008.
Fifteen credit relationships comprise $42.4 million, or 67.1%, of the
$63.2 million in loans classified as substandard (including non-performing
loans). These credit relationships classified as substandard are summarized
below.
* $8.5 million in loans secured by two mini-storage facilities and a
commercial building site. One of the facilities is located in King
County and one is located in Pierce County. The commercial building
17
lot is located in Pierce County adjacent to the mini-storage
facility. These three loans were considered impaired at September
30, 2009. Management's evaluation of the collateral determined that
there was no principal impairment.
* $5.9 million in loans secured by three land parcels and two land
development projects in King County. These loans were considered
impaired at September 30, 2009, primarily due to decreased appraisal
valuations. Management's evaluation of the collateral determined a
potential principal impairment of $1.9 million existed at September
30, 2009 which was factored into the Bank's allowance for loan
loss analysis.
* $2.1 million in loans secured by two land development projects in
King County. Management's evaluation of the collateral supporting
the two loans determined that a potential impairment of $1.0
million existed at September 30, 2009 which was factored into the
Bank's allowance for loan loss analysis. This borrower is also a
guarantor on two of the loans noted in the bullet point directly
above in the amount of $2.0 million.
* $3.7 million loan secured by condominium units located in King
County. At September 30, 2009 the loan was not performing in
accordance with its terms and was considered impaired. Management's
evaluation of the collateral determined that there was no principal
impairment.
* $2.7 million loan secured by commercial building lots in Kitsap
County. The loan was considered impaired at September 30, 2009.
Management's evaluation of the collateral determined that there was
no principal impairment.
* $3.2 million participation interest in a condominium conversion loan
in King County. The loan was considered impaired at September 30,
2009. Management's evaluation of the collateral and the
guarantors' financial capacity determined that there was no
principal impairment.
* $2.5 million loan secured by commercial/industrial land in Lewis
County. The loan was considered impaired at September 30, 2009.
Management's evaluation of the collateral determined that there was
no principal impairment.
* $2.4 million loan secured by condominium units in King County that
was performing in accordance with its repayment terms at September
30, 2009.
* $2.3 million in loans secured by two speculative single family
residential houses and seven building lots in King County. These
loans were considered impaired at September 30, 2009 primarily due
to decreased appraisal valuations. Management's evaluation of the
collateral determined a potential principal impairment of $465,000
existed at September 30, 2009 which was factored into the Bank's
allowance for loan loss analysis.
* $1.7 million in loans secured by a residential plat and a completed
single family dwelling in Pierce County which were not performing in
accordance with their terms at September 30, 2009. Management's
evaluation of the collateral determined that there was no principal
impairment.
* $1.7 million loan secured by a motel and recreational vehicle park
in Grays Harbor County. The loan was considered impaired at
September 30, 2009. Management's evaluation of the collateral
determined that there was no principal impairment.
* $1.6 million loan secured by residential condominiums and excess
land in Oregon which was performing in accordance with its terms at
September 30, 2009.
18
* $1.4 million loan secured by a commercial building in Pierce County.
The loan was considered impaired at September 30, 2009.
Management's evaluation of the collateral determined that there was
no principal impairment.
* $1.4 million loan secured by commercial building lots in Lewis
County that was performing in accordance with its repayment terms at
September 30, 2009.
* $1.3 million in loans secured by a single family house nearing
completion and three commercial condominium units in Pierce County
that were performing in accordance with their repayment terms at
September 30, 2009.
Allowance for Loan Losses. The allowance for loan losses is maintained
to cover estimated losses in the loan portfolio. The Bank has established a
comprehensive methodology for the determination of provisions for loan losses
that takes into consideration the need for an overall general valuation
allowance. The Bank's methodology for assessing the adequacy of its allowance
for loan losses is based on its historic loss experience for various loan
segments; adjusted for changes in economic conditions, delinquency rates, and
other factors. Using these loss estimate factors, management develops a range
of probable loss for each loan category. Certain individual loans for which
full collectibility may not be assured are evaluated individually with loss
exposure based on estimated discounted cash flows or collateral values. The
total estimated range of loss based on these two components of the analysis is
compared to the loan loss allowance balance. Based on this review, management
will adjust the allowance as necessary to maintain directional consistency
with trends in the loan portfolio.
In originating loans, the Bank recognizes that losses will be experienced
and that the risk of loss will vary with, among other things, the type of loan
being made, the creditworthiness of the borrower over the term of the loan,
general economic conditions and, in the case of a secured loan, the quality of
the security for the loan. The Bank increases its allowance for loan losses
by charging provisions for loan losses against the Bank's income.
The Board of Directors reviews the adequacy of the allowance for loan
losses at least quarterly based on management's assessment of current economic
conditions, past loss and collection experience, and risk characteristics of
the loan portfolio.
At September 30, 2009, the Bank's allowance for loan losses totaled $14.2
million. This represents 2.52% of the total loans receivable and 48.39% of
non-performing loans. The Bank's allowance for loan losses as a percentage of
total loans receivable has increased to 2.52% at September 30, 2009 from 1.42%
at September 30, 2008 primarily due to uncertainties in the housing market and
the economy, and an increased level of charge-offs (which has translated into
higher loss factors assigned to certain loan categories), increased levels of
non-performing loans, and increased levels of classified loans.
Management believes that the amount maintained in the allowance is
adequate to absorb probable losses in the portfolio. Although management
believes that it uses the best information available to make its
determinations, future adjustments to the allowance for loan losses may be
necessary and results of operations could be significantly and adversely
affected if circumstances differ substantially from the assumptions used in
making the determinations.
While the Bank believes it has established its existing allowance for
loan losses in accordance with accounting principles generally accepted in the
United States of America, there can be no assurance that regulators, in
reviewing the Bank's loan portfolio, will not request the Bank to increase
significantly its allowance for loan losses. In addition, because future
events affecting borrowers and collateral cannot be predicted with certainty,
there can be no assurance that the existing allowance for loan losses is
adequate or that substantial increases will not be necessary should the
quality of any loans deteriorate as a result of the factors discussed above.
Any material increase in the allowance for loan losses may adversely affect
the Bank's financial condition and results of operations.
19
The following table sets forth an analysis of the Bank's allowance for
loan losses for the periods indicated.
Year Ended September 30,
--------------------------------------------
2009 2008 2007 2006 2005
------- ------ ------ ------ ------
(Dollars in thousands)
Allowance at beginning of year...$ 8,050 $4,797 $4,122 $4,099 $3,991
Provision for loan losses........ 10,734 3,900 686 -- 141
Allocated to loan commitments.... (169) -- -- -- --
Recoveries:
Mortgage loans:
Land............................ 83 -- -- -- --
Consumer loans:
Home equity and second mortgage. -- -- -- -- 5
Other........................... 5 1 1 5 3
Commercial business loans........ -- -- -- 20 9
------- ------ ------ ------ ------
Total recoveries 88 1 1 25 17
Charge-offs:
Mortgage loans:
One- to four-family............. 46 -- -- -- --
Multi-family.................... -- -- -- -- 1
Construction.................... 3,108 648 -- -- --
Commercial...................... 235 -- -- -- --
Land............................ 705 -- -- -- 1
Consumer loans:
Home equity and second mortgage. 162 -- -- -- --
Other........................... 25 -- 12 2 12
Commercial business loans........ 250 -- -- -- 36
------- ------ ------ ------ ------
Total charge-offs............... 4,531 648 12 2 50
------- ------ ------ ------ ------
Net charge-offs (recoveries).... 4,443 647 11 (23) 33
------- ------ ------ ------ ------
Balance at end of year..........$14,172 $8,050 $4,797 $4,122 $4,099
======= ====== ====== ====== ======
Allowance for loan losses as a
percentage of total loans
receivable (net)(1) outstanding
at the end of the year.......... 2.52% 1.42% 0.92% 0.96% 1.05%
Net charge-offs (recoveries) as
a percentage of average loans
outstanding during the year..... 0.79% 0.12% 0.00% (0.01%) 0.01%
Allowance for loan losses as a
percentage of non-performing
loans at end of year excluding
troubled debt restructurings.... 48.39% 67.14% 321.95% 5,152.50% 140.09%
------------
(1) Total loans receivable (net) includes loans held for sale and is before
the allowance for loan losses.
20
The following table sets forth the allocation of the allowance for loan losses by loan category at the
dates indicated.
At September 30,
----------------------------------------------------------------------------------------------
2009 2008 2007 2006 2005
----------------- ------------------ ---------------- ----------------- ------------------
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loans
in in in in in
Category Category Category Category Category
to Total to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------- -------- -------- -------- ------ -------- ------- -------- ------- ---------
(Dollars in thousands)
Mortgage loans:
One- to four-
family.......$ 616 18.58% $ 476 18.35% $ 396 17.40% $ 502 20.11% $ 494 23.24%
Multi-family.. 431 4.31 248 4.24 200 5.97 112 3.60 194 4.61
Commercial.... 2,719 31.63 1,521 23.90 1,368 21.72 1,222 28.04 1,544 28.51
Construction.. 5,132 23.48 3,254 30.46 1,047 31.64 761 29.92 652 25.68
Land.......... 3,348 11.03 1,435 9.92 549 10.30 275 6.03 255 5.71
Non-mortgage loans:
Consumer
loans........ 1,216 8.66 457 9.69 412 9.88 497 9.90 255 9.51
Commercial
business
loans........ 710 2.31 659 3.44 825 3.09 753 2.40 705 2.74
------- ------ ------ ------ ------ ------ ------ ------ ------ ------
Total
allowance
for loan
losses......$14,172 100.00% $8,050 100.00% $4,797 100.00% $4,122 100.00% $4,099 100.00%
======= ====== ====== ====== ====== ====== ====== ====== ====== ======
21
Investment Activities
The investment policies of the Company are established and monitored by
the Board of Directors. The policies are designed primarily to provide and
maintain liquidity, to generate a favorable return on investments without
incurring undue interest rate and credit risk, and to compliment the Bank's
lending activities. These policies dictate the criteria for classifying
securities as either available-for-sale or held-to-maturity. The policies
permit investment in various types of liquid assets permissible under
applicable regulations, which includes U.S. Treasury obligations, securities
of various federal agencies, certain certificates of deposit of insured banks,
banker's acceptances, federal funds, mortgage-backed securities, and mutual
funds. The Company's investment policy also permits investment in equity
securities in certain financial service companies.
At September 30, 2009, the Company's investment portfolio totaled $20.6
million, primarily consisting of $12.5 million of mortgage-backed securities
available-for-sale, $968,000 of mutual funds available-for-sale, and $7.1
million of mortgaged-backed securities held-to-maturity. The Company does not
maintain a trading account for any investments. This compares with a total
investment portfolio of $31.3 million at September 30, 2008, primarily
consisting of $936,000 of mutual funds available-for-sale, $16.2 million of
mortgage-backed securities available-for-sale, and $14.2 million of
mortgage-backed securities held-to-maturity. The composition of the
portfolios by type of security, at each respective date is presented in the
following table.
At September 30,
--------------------------------------------------------
2008 2007 2006
----------------- ----------------- ------------------
Percent Percent Percent
Recorded of Recorded of Recorded of
Value Total Value Total Value Total
-------- ------- -------- ------- -------- --------
(Dollars in thousands)
Held-to-Maturity:
U.S. agency
securities........ $ 27 0.13% $ 28 0.09% $ -- --%
Mortgage-backed
securities........ 7,060 34.34 14,205 45.34 71 0.11
Available-for-Sale
(at fair value):
U.S. agency
securities........ -- -- -- -- 18,976 29.66
Mortgage-backed
securities........ 12,503 60.82 16,162 51.58 13,047 20.39
Mutual funds....... 968 4.71 936 2.99 31,875 49.84
------- ------ ------- ------ ------- ------
Total portfolio..... $20,558 100.00% $31,331 100.00% $63,969 100.00%
======= ====== ======= ====== ======= ======
22
The following table sets forth the maturities and weighted average yields
of the investment and mortgage-backed securities in the Company's investment
securities portfolio at September 30, 2009. Mutual funds, which by their
nature do not have maturities, are classified in the one year or less
category.
After One to After Five to After Ten
One Year or Less Five Years Ten Years Years
---------------- ---------------- ---------------- ----------------
Amount Yield Amount Yield Amount Yield Amount Yield
------ ----- ------ ----- ------ ----- ------ -----
(Dollars in thousands)
Held-to-Maturity:
U.S. agency securities... $ -- --% $ 14 3.25% $ 14 3.98% $ -- --%
Mortgage-backed
securities.............. -- -- -- -- 43 4.66 7,016 5.31
Available-for-Sale:
Mortgage-backed
securities.............. -- -- 418 2.11 256 5.92 11,829 3.35
Mutual funds............. 968 3.78 -- -- -- -- -- --
---- ---- ---- ---- ---- ---- ------- ----
Total portfolio.......... $968 3.78% $432 2.14% $313 5.65% $18,845 4.01%
==== ==== ==== ==== ==== ==== ======= ====
There were no securities which had an aggregate book value in excess of
10% of the Company's total equity at September 30, 2009. At September 30,
2009, the Company had 29 private label mortgage backed securities totaling
$477,000 on non-accrual status. For additional information regarding
investment securities, see "Item 1A, Risk Factors - Risks Related to Our
Business - Other-than-temporary impairment charges in our investment
securities portfolio could result in significant losses and adversely affect
our continuing operations" and Note 3 of the Notes to the Consolidated
Financial Statements included in Item 8 of this Annual Report on Form 10-K.
Deposit Activities and Other Sources of Funds
General. Deposits and loan repayments are the major sources of the Bank's
funds for lending and other investment purposes. Scheduled loan repayments
are a relatively stable source of funds, while deposit inflows and outflows
and loan prepayments are influenced significantly by general interest rates
and money market conditions. Borrowings through the FHLB-Seattle, the Federal
Reserve Bank ("FRB") and Pacific Coast Bankers' Bank ("PCBB") may be used to
compensate for reductions in the availability of funds from other sources.
Deposit Accounts. Substantially all of the Bank's depositors are
residents of Washington. Deposits are attracted from within the Bank's market
area through the offering of a broad selection of deposit instruments,
including money market deposit accounts, checking accounts, regular savings
accounts and certificates of deposit. Deposit account terms vary, according
to the minimum balance required, the time periods the funds must remain on
deposit and the interest rate, among other factors. In determining the terms
of its deposit accounts, the Bank considers current market interest rates,
profitability to the Bank, matching deposit and loan products and its customer
preferences and concerns. The Bank actively seeks consumer and commercial
checking accounts through a checking account acquisition marketing program
that was implemented in 2000. At September 30, 2009, the Bank had 33.2% of
total deposits in non-interest bearing accounts and NOW checking accounts.
At September 30, 2009 the Bank had $77.9 million of jumbo certificates of
deposit of $100,000 or more. The Bank also had brokered certificates of
deposits totaling $3.8 million at September 30, 2009. The $3.8 million in
brokered deposits consisted of reciprocal deposits in the Certificate of
Deposits Account Registry Service ("CDARS") program. The Bank believes that
its jumbo certificates of deposit and its brokered deposits, which represented
16.2% of total deposits at September 30, 2009, present similar interest rate
risk compared to its other deposits.
23
The following table sets forth information concerning the Bank's deposits
at September 30, 2009.
Weighted Percentage
Average of Total
Category Interest Rate Amount Deposits
---------------------------------------- ------------- --------- ----------
(In thousands)
Non-interest bearing....................... -% $ 50,295 9.95%
Negotiable order of withdrawal ("NOW")
checking.................................. 1.05 117,357 23.21
Savings.................................... 0.71 58,609 11.59
Money market............................... 1.68 62,478 12.36
Subtotal.................................. 1.14 288,739 57.11
Certificates of Deposit(1)
----------------------------------------
Maturing within 1 year 2.51 182,285 36.04
Maturing after 1 year but within 2 years... 2.71 22,587 4.47
Maturing after 2 years but within 5 years.. 3.64 11,734 2.32
Maturing after 5 years..................... 2.75 316 0.06
Total certificates of deposit............. 2.59 216,922 42.89
---- -------- ------
Total deposits........................... 1.76% $505,661 100.00%
==== ======== ======
-------------
(1) Based on remaining maturity of certificates.
The following table indicates the amount of the Bank's jumbo certificates
of deposit by time remaining until maturity as of September 30, 2009. Jumbo
certificates of deposit have principal balances of $100,000 or more and the
rates paid on these accounts are generally negotiable.
Maturity Period Amount
----------------------------------- --------
(In thousands)
Three months or less............... $23,459
Over three through six months...... 16,934
Over six through twelve months..... 26,117
Over twelve months................. 11,416
-------
Total............................ $77,926
=======
24
Deposit Flow. The following table sets forth the balances of deposits in the various types of accounts
offered by the Bank at the dates indicated.
At September 30,
------------------------------------------------------------------------------------
2009 2008 2007
------------------------------ ----------------------------- -------------------
Percent Percent Percent
of Increase of Increase of
Amount Total (Decrease) Amount Total (Decrease) Amount Total
-------- ------- ---------- -------- -------- ---------- ------- --------
(Dollars in thousands)
Non-interest-bearing $ 50,295 9.95% $(1,660) $ 51,955 10.42% $ (3,007) $ 54,962 11.77%
NOW checking 117,357 23.21 26,889 90,468 18.15 10,096 80,372 17.22
Savings 58,609 11.59 2,218 56,391 11.31 (21) 56,412 12.09
Money market 62,478 12.36 (7,901) 70,379 14.11 22,311 48,068 10.30
Certificates of deposit
which mature:
Within 1 year 182,285 36.04 6,468 175,817 35.26 (32,513) 208,330 44.63
After 1 year, but
within 2 years 22,587 4.47 (23,820) 46,407 9.31 33,668 12,739 2.73
After 2 years, but
within 5 years 11,734 2.32 4,975 6,759 1.36 1,028 5,731 1.23
Certificates maturing
thereafter 316 0.06 (80) 396 0.08 275 121 0.03
-------- ------ ------ -------- ------ -------- -------- ------
Total $505,661 100.00% $7,089 $498,572 100.00% $ 31,837 $466,735 100.00%
======== ====== ====== ======== ====== ======== ======== ======
25
Certificates of Deposit by Rates. The following table sets forth the
certificates of deposit in the Bank classified by rates as of the dates
indicated.
At September 30,
------------------------------
2009 2008 2007
-------- -------- --------
(In thousands)
0.00 - 1.99%........................... $ 59,466 $ 866 $ 676
2.00 - 3.99%........................... 146,513 203,859 46,810
4.00 - 5.99%........................... 10,569 24,274 179,008
6.00% - and over....................... 374 380 427
-------- -------- --------
Total.................................. $216,922 $229,379 $226,921
======== ======== ========
Certificates of Deposit by Maturities. The following table sets forth the
amount and maturities of certificates of deposit at September 30, 2009.
Amount Due
-------------------------------------------------
After
One to Two to
Less Than Two Five After
One Year Years Years Five Years Total
--------- ------- ------- ---------- -------
(In thousands)
0.00 - 1.99%.............. $ 55,350 $ 3,865 $ 169 $ 82 $ 59,466
2.00 - 3.99%.............. 117,421 18,325 10,533 234 146,513
4.00 - 5.99%.............. 9,200 337 1,032 -- 10,569
6.00% and over............ 314 60 -- -- 374
-------- ------- ------- ---- --------
Total..................... $182,285 $22,587 $11,734 $316 $216,922
======== ======= ======= ==== ========
Deposit Activities. The following table sets forth the savings activities
of the Bank for the periods indicated.
Year Ended September 30,
------------------------------
2009 2008 2007
-------- -------- --------
(In thousands)
Beginning balance....................... $498,572 $466,735 $431,061
Net deposits (withdrawals) before
interest credited..................... (2,383) 20,075 24,382
Interest credited....................... 9,472 11,762 11,292
-------- -------- --------
Net increase in deposits................ 7,089 31,837 35,674
-------- -------- --------
Ending balance.......................... $505,661 $498,572 $466,735
======== ======== ========
Borrowings. Deposits and loan repayments are generally the primary source
of funds for the Bank's lending and investment activities and for general
business purposes. The Bank has the ability to use advances from the
FHLB-Seattle to supplement its supply of lendable funds and to meet deposit
withdrawal requirements. The FHLB-Seattle functions as a central reserve bank
providing credit for member financial institutions. As a member of the
FHLB-Seattle, the Bank is required to own capital stock in the FHLB-Seattle
and is authorized to apply for advances on the security of such stock and
certain mortgage loans and other assets (principally securities which are
obligations of, or guaranteed by, the United States government) provided
certain creditworthiness standards have been met. Advances are made pursuant
to several different credit programs. Each credit program has its own
interest rate and range of maturities. Depending on the program, limitations
on the amount of advances are based on the financial condition of the member
institution and the adequacy of collateral pledged to secure the credit. At
September 30, 2009, the Bank maintained an uncommitted credit facility with
the FHLB-Seattle that provided for immediately available advances up to an
aggregate amount of 30% of the Bank's total assets, limited by available
collateral, under which $95.0 million was outstanding.
26
The Bank also utilizes overnight repurchase agreements with customers. These
overnight repurchase agreements are classified as other borrowings and totaled
$777,000 at September 30, 2009. The Bank also maintains a short-term
borrowing line with the FRB with total credit based on eligible collateral.
At September 30, 2009, the Bank had $10.0 million outstanding and $6.3 million
in unused borrowing capacity on this borrowing line. The Bank has also been
approved for a $10.0 million overnight borrowing line with PCBB. The
borrowing line must be collateralized. At September 30, 2009, the Bank had
not pledged any collateral for this borrowing line and there was no
outstanding balance.
The following table sets forth certain information regarding borrowings by
the Bank at the end of and during the periods indicated:
At or For the
Year Ended September 30,
------------------------------
2009 2008 2007
-------- -------- --------
(Dollars in thousands)
Average total borrowings.............. $ 97,393 $108,858 $ 85,599
Weighted average rate paid on total
borrowings........................... 4.14% 4.27% 5.24%
Total borrowings outstanding at end
of period............................ $105,777 $105,386 $100,292
The following table sets forth certain information regarding short-term
borrowings by the Bank at the end of and during the periods indicated.
Borrowings are considered short-term when the original maturity is less than
one year.
At or For the
Year Ended September 30,
------------------------------
2009 2008 2007
-------- -------- --------
(Dollars In thousands)
Maximum amount outstanding at any
month end:
FHLB advances......................... $ -- $42,600 $72,750
Repurchase agreements................. 844 1,884 4,460
PCBB advances......................... -- -- --
FRB advances.......................... 10,000 -- --
Average outstanding during period:
FHLB advances......................... 15 $13,366 $34,156
Repurchase agreements................. 624 943 1,019
PCBB advances......................... 6 12 32
FRB advances.......................... 27 -- --
------- ------- -------
Total average outstanding during
period................................. $ 672 $14,321 $35,207
======= ======= =======
Weighted average rate paid during period:
FHLB advances......................... 0.71% 4.44% 5.58%
Repurchase agreements................. 0.08 2.12 4.61
PCBB advances......................... 1.48 5.27 6.45
FRB advances.......................... 0.50 -- --
Total weighted average rate paid during
period................................. 0.12 4.29% 5.55%
(table continued on following page)
27
At or For the
Year Ended September 30,
------------------------------
2009 2008 2007
-------- -------- --------
(Dollars In thousands)
Outstanding at end of period:
FHLB advances......................... $ -- $ -- $30,000
Repurchase agreements................. 777 758 595
PCBB advances......................... -- -- --
FRB advances.......................... 10,000 -- --
------- ------- -------
Total outstanding at end of period...... $10,777 $ 758 $30,595
======= ======= =======
Weighted average rate at end of period:
FHLB advances......................... --% --% 5.19%
Repurchase agreements................. 0.05 1.05 4.42
PCBB advances......................... -- -- --
FRB advances.......................... 0.50 -- --
Total weighted average rate at end of
period................................. 0.50% 1.05% 5.17%
Bank Owned Life Insurance
The Bank has purchased life insurance policies covering certain officers.
These policies are recorded at their cash surrender value, net of any policy
premium charged. Increases in cash surrender value, net of policy premiums,
and proceeds from death benefits are recorded in non-interest income. At
September 30, 2009, the Bank had $12.9 million in bank owned life insurance.
Regulation of the Bank
General. The Bank, as a state-chartered savings bank, is subject to
regulation and oversight by the Division and the applicable provisions of
Washington law and regulations of the Division adopted thereunder. The Bank
also is subject to regulation and examination by the FDIC, which insures the
deposits of the Bank to the maximum extent permitted by law, and requirements
established by the Federal Reserve. State law and regulations govern the
Bank's ability to take deposits and pay interest thereon, to make loans on or
invest in residential and other real estate, to make consumer loans, to invest
in securities, to offer various banking services to its customers, and to
establish branch offices. Under state law, savings banks in Washington also
generally have all of the powers that federal savings banks have under federal
laws and regulations. The Bank is subject to periodic examination and
reporting requirements by and of the Division and the FDIC.
In December 2009, the FDIC and the Division agreed to terms on an informal
supervisory agreement, a MOU, which will be reviewed for approval by the Board
on December 22, 2009. The MOU restricts certain operations of the Bank and
requires the Bank to maintain a higher level of regulatory capital. The Board
and Bank management do not believe that this agreement will constrain the
Bank's business plan and furthermore, we believe that the Bank is currently in
compliance with many of the requirements through its normal business
operations. These requirements will remain in effect until modified or
terminated by the FDIC and the Division. For more information about the MOU
and its impact on the Bank, see "Item 1A, Risk Factors Risks Related to Our
Business We are required to comply with the terms of a pending memoranda of
understanding issued by the FDIC and the Division and lack of compliance could
result in additional regulatory actions."
Recent Legislative and Regulatory Initiatives to Address Financial and
Economic Crises. The Congress, Treasury Department and the federal banking
regulators, including the FDIC, have taken broad action since early September
2008 to address volatility in the U.S. banking system.
28
In October 2008, the Emergency Economic Stabilization Act of 2008 ("EESA")
was enacted which, among other measures, authorized the Treasury Secretary to
establish the Troubled Asset Relief Program ("TARP"). EESA gives broad
authority to Treasury to purchase, manage, modify, sell and insure the
troubled mortgage related assets that triggered the current economic crisis as
well as other "troubled assets." EESA includes additional provisions directed
at bolstering the economy, including:
* Authority for the Federal Reserve to pay interest on depository
institution balances;
* Mortgage loss mitigation and homeowner protection;
* Temporary increase in FDIC insurance coverage from $100,000 to
$250,000 through December 31, 2013; and
* Authority to the Securities and Exchange Commission (the "SEC") to
suspend mark-to-market accounting requirements for any issuer or
class of category of transactions.
Under the TARP, the Treasury has created a capital purchase program
("CPP"), pursuant to which it is providing access to capital to financial
institutions through a standardized program to acquire preferred stock
(accompanied by warrants) from eligible financial institutions that will serve
as Tier 1 capital.
On December 23, 2008, pursuant to the CPP established by the United States
Department of the Treasury (the "Treasury"), the Company issued and sold to
the Treasury for an aggregate purchase price of $16.6 million in cash (i)
16,641 shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series
A, par value $.01 per share, having a liquidation preference of $1,000 per
share (the "Series A Preferred Stock"), and (ii) a ten-year warrant to
purchase up to 370,889 shares of common stock, par value $.01 per share, of
the Company ("Common Stock"), at an initial exercise price of $6.73 per share,
subject to certain anti-dilution and other adjustments (the "Warrant").
The Series A Preferred Stock pays cumulative dividends at a rate of 5% per
annum on the liquidation preference for the first five years, and thereafter
at a rate of 9% per annum. The Series A Preferred Stock has no maturity date
and ranks senior to the Common Stock with respect to the payment of dividends
and distributions and amounts payable in the unlikely event of any future
liquidation or dissolution of the Company. Prior to December 23, 2011, unless
the Company has redeemed the Series A Preferred Stock or the Treasury has
transferred the Series A Preferred Stock to a third party, the consent of the
Treasury will be required for the Company to increase its Common Stock
dividend above the amount of the last quarterly cash dividend per share
declared on the Common Stock on October 29, 2008, or repurchase its Common
Stock or other equity or capital securities, other than in certain
circumstances specified in the Securities Purchase Agreement (the "Agreement")
entered into between the parties.
The Warrant is immediately exercisable. The Warrant provides for the
adjustment of the exercise price and the number of shares of Common Stock
issuable upon exercise pursuant to customary anti-dilution provisions, such as
upon stock splits or distributions of securities or other assets to holders of
Common Stock, and upon certain issuances of Common Stock at or below a
specified price relative to the then-current market price of Common Stock. The
Warrant expires ten years from the issuance date. If, on or prior to December
31, 2009, the Company receives aggregate gross cash proceeds of not less than
the purchase price of the Series A Preferred Stock from one or more "qualified
equity offerings," the number of shares of Common Stock issuable pursuant to
the Treasury's exercise of the Warrant will be reduced by one-half of the
original number of shares, taking into account all adjustments, underlying the
Warrant. Pursuant to the Agreement, the Treasury has agreed not to exercise
voting power with respect to any shares of Common Stock issued upon exercise
of the Warrant.
EESA also contains a number of significant employee benefit and executive
compensation provisions, some of which apply to employee benefit plans
generally, and others which impose on financial institutions that participate
in the CPP restrictions on executive compensation.
EESA followed, and has been followed by, numerous actions by the Federal
Reserve, Congress, Treasury, the SEC and others to address the liquidity and
credit crisis that has followed the sub-prime crisis that commenced in 2007.
These measures include homeowner relief that encourage loan restructuring and
modification; the establishment of significant liquidity and credit facilities
for financial institutions and investment banks; the lowering of the federal
funds
29
rate; action against short selling practices; a temporary guaranty program for
money market funds; the establishment of a commercial paper funding facility
to provide back-stop liquidity to commercial paper issuers; coordinated
international efforts to address illiquidity and other weaknesses in the
banking sector.
In addition, the Internal Revenue Service has issued an unprecedented wave
of guidance in response to the credit crisis, including a relaxation of limits
on the ability of financial institutions that undergo an "ownership change" to
utilize their pre-change net operating losses and net unrealized built-in
losses. The relaxation of these limits may make it significantly more
attractive to acquire financial institutions whose tax basis in their loan
portfolios significantly exceeds the fair market value of those portfolios.
Temporary Liquidity Guaranty Program. Following a systemic risk
determination, the FDIC established a Temporary Liquidity Guarantee Program
("TLGP") on October 14, 2008. The TLGP includes the Transaction Account
Guarantee Program, which provides unlimited deposit insurance coverage through
December 31, 2009 for noninterest-bearing transaction accounts (typically
business checking accounts) and certain funds swept into noninterest-bearing
savings accounts ("TAGP"). Institutions participating in the TAGP pay a 10
basis point fee (annualized) on the balance of each covered account in excess
of $250,000, while the extra deposit insurance is in place. The TLGP also
includes the Debt Guarantee Program ("DGP"), under which the FDIC guarantees
certain senior unsecured debt of FDIC-insured institutions and their holding
companies. The TAGP and DGP are in effect for all eligible entities, unless
the entity opted out on or before December 5, 2008. The Company did not opt
out of the program. At September 30, 2009, the DGP coverage limit is equal to
2% of the Bank's liabilities; however, the Bank did not have any senior
unsecured debt which was being guaranteed under the DGP at that time.
Insurance of Accounts and Regulation by the FDIC. As insurer, the FDIC
imposes deposit insurance premiums and is authorized to conduct examinations
of and to require reporting by FDIC-insured institutions. It also may
prohibit any FDIC-insured institution from engaging in any activity the FDIC
determines by regulation or order to pose a serious risk to the insurance
fund. The FDIC also has the authority to initiate enforcement actions against
savings institutions, after giving the OTS an opportunity to take such action,
and may terminate the deposit insurance if it determines that the institution
has engaged in unsafe or unsound practices or is in an unsafe or unsound
condition.
The Bank is a member of the Deposit Insurance Fund ("DIF"), which is
administered by the FDIC. Deposits are insured up to the applicable limits by
the FDIC, backed by the full faith and credit of the United States Government.
Under new legislation, during the period from October 3, 2008 through December
31, 2013, the basic deposit insurance limit is $250,000, instead of the
$100,000 limit in effect previously.
The FDIC assesses deposit insurance premiums on each FDIC-insured
institution quarterly based on annualized rates for one of four risk
categories applied to its deposits subject to certain adjustments. Each
institution is assigned to one of four risk categories based on its capital,
supervisory ratings and other factors. Well capitalized institutions that are
financially sound with only a few minor weaknesses are assigned to Risk
Category I. Risk Categories II, III and IV present progressively greater risks
to the DIF. Under FDIC's risk-based assessment rules, effective April 1, 2009,
the initial base assessment rates prior to adjustments range from 12 to 16
basis points for Risk Category I, and are 22 basis points for Risk Category
II, 32 basis points for Risk Category III, and 45 basis points for Risk
Category IV. Initial base assessment rates are subject to adjustments based
on an institution's unsecured debt, secured liabilities and brokered deposits,
such that the total base assessment rates after adjustments range from 7 to 24
basis points for Risk Category I, 17 to 43 basis points for Risk Category II,
27 to 58 basis points for Risk Category III, and 40 to 77.5 basis points for
Risk Category IV. Rates increase uniformly by 3 basis points effective
January 1, 2011.
In addition to the regular quarterly assessments, due to losses and
projected losses attributed to failed institutions, the FDIC imposed a special
assessment of 5 basis points on the amount of each depository institution's
assets reduced by the amount of its Tier 1 capital (not to exceed 10 basis
points of its assessment base for regular quarterly premiums) as of June 30,
2009, which was collected on September 30, 2009.
As a result of a decline in the reserve ratio (the ratio of the DIF to
estimated insured deposits) and concerns about expected failure costs and
available liquid assets in the DIF, the FDIC has adopted a rule requiring each
insured institution
30
to prepay on December 30, 2009 the estimated amount of its quarterly
assessments for the fourth quarter of 2009 and all quarters through the end of
2012 (in addition to the regular quarterly assessment for the third quarter
which is due on December 30, 2009). The prepaid amount is recorded as an
asset with a zero risk weight and the institution will continue to record
quarterly expenses for deposit insurance. For purposes of calculating the
prepaid amount, assessments are measured at the institution's assessment rate
as of September 30, 2009, with a uniform increase of 3 basis points effective
January 1, 2011, and are based on the institution's assessment base for the
third quarter of 2009, with growth assumed quarterly at annual rate of 5%. If
events cause actual assessments during the prepayment period to vary from the
prepaid amount, institutions will pay excess assessments in cash or receive a
rebate of prepaid amounts not exhausted after collection of assessments due on
June 13, 2013, as applicable. Collection of the prepayment does not preclude
the FDIC from changing assessment rates or revising the risk-based assessment
system in the future. The rule includes a process for exemption from the
prepayment for institutions whose safety and soundness would be affected
adversely.
The FDIC estimates that the reserve ratio (the ratio of the net worth of
the DIF to estimated insured deposits) will reach the designated reserve ratio
of 1.15% by 2017 as required by statute.
FDIC insured institutions are required to pay a Financing Corporation
assessment, in order to fund the interest on bonds issued to resolve thrift
failures in the 1980s. For the quarterly period ended September 30, 2009, the
Financing Corporation assessment equaled 1.02 basis points for each $100 in
domestic deposits. These assessments, which may be revised based upon the
level of deposits, will continue until the bonds mature in the years 2017
through 2019.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations or has violated any applicable law,
regulation, rule, order or condition imposed by the FDIC. It also may suspend
deposit insurance temporarily during the hearing process for the permanent
termination of insurance, if the institution has no tangible capital. If
insurance of accounts is terminated, the accounts at the institution at the
time of the termination, less subsequent withdrawals, shall continue to be
insured for a period of six months to two years, as determined by the FDIC.
Management of the Bank is not aware of any practice, condition or violation
that might lead to termination of the Bank's deposit insurance.
Prompt Corrective Action. Federal statutes establish a supervisory
framework based on five capital categories: well capitalized, adequately
capitalized, undercapitalized, significantly undercapitalized and critically
undercapitalized. An institution's category depends upon where its capital
levels are in relation to relevant capital measures, which include a
risk-based capital measure, a leverage ratio capital measure and certain other
factors. The federal banking agencies have adopted regulations that implement
this statutory framework. Under these regulations, an institution is treated
as well capitalized if its ratio of total capital to risk-weighted assets is
10% or more, its ratio of core capital to risk-weighted assets is 6% or more,
its ratio of core capital to adjusted total assets (leverage ratio) is 5% or
more, and it is not subject to any federal supervisory order or directive to
meet a specific capital level. In order to be adequately capitalized, an
institution must have a total risk-based capital ratio of not less than 8%, a
Tier 1 risk-based capital ratio of not less than 4%, and a leverage ratio of
not less than 4%. Any institution which is neither well capitalized nor
adequately capitalized is considered undercapitalized.
Undercapitalized institutions are subject to certain prompt corrective
action requirements, regulatory controls and restrictions which become more
extensive as an institution becomes more severely undercapitalized. Failure
by institutions to comply with applicable capital requirements would, if
unremedied, result in progressively more severe restrictions on their
respective activities and lead to enforcement actions, including, but not
limited to, the issuance of a capital directive to ensure the maintenance of
required capital levels and, ultimately, the appointment of the FDIC as
receiver or conservator. Banking regulators will take prompt corrective
action with respect to depository institutions that do not meet minimum
capital requirements. Additionally, approval of any regulatory application
filed for their review may be dependent on compliance with capital
requirements.
At September 30, 2009, the Bank was categorized as "well capitalized"
under the prompt corrective action regulations of the FDIC.
31
Standards for Safety and Soundness. The federal banking regulatory
agencies have prescribed, by regulation, guidelines for all insured depository
institutions relating to: internal controls, information systems and internal
audit systems, loan documentation, credit underwriting, interest rate risk
exposure, asset growth, asset quality, earnings, and compensation, fees and
benefits. The guidelines set forth the safety and soundness standards that
the federal banking agencies use to identify and address problems at insured
depository institutions before capital becomes impaired. Each insured
depository institution must implement a comprehensive written information
security program that includes administrative, technical, and physical
safeguards appropriate to the institution's size and complexity and the nature
and scope of its activities. The information security program also must be
designed to ensure the security and confidentiality of customer information,
protect against any unanticipated threats or hazards to the security or
integrity of such information, protect against unauthorized access to or use
of such information that could result in substantial harm or inconvenience to
any customer, and ensure the proper disposal of customer and consumer
information. Each insured depository institution must also develop and
implement a risk-based response program to address incidents of unauthorized
access to customer information in customer information systems. If the FDIC
determines that the Bank fails to meet any standard prescribed by the
guidelines, the agency may require the Bank to submit to the agency an
acceptable plan to achieve compliance with the standard. FDIC regulations
establish deadlines for the submission and review of such safety and soundness
compliance plans. Management of the Bank is not aware of any conditions
relating to these safety and soundness standards which would require
submission of a plan of compliance.
Capital Requirements. Federally insured savings institutions, such as the
Bank, are required to maintain a minimum level of regulatory capital. FDIC
regulations recognize two types, or tiers, of capital: core ("Tier 1") capital
and supplementary ("Tier 2") capital. Tier 1 capital generally includes
common shareholders' equity and noncumulative perpetual preferred stock, less
most intangible assets. Tier 2 capital, which is limited to 100% of Tier 1
capital, includes such items as qualifying general loan loss reserves,
cumulative perpetual preferred stock, mandatory convertible debt, term
subordinated debt and limited life preferred stock; however, the amount of
term subordinated debt and intermediate term preferred stock (original
maturity of at least five years but less than 20 years) that may be included
in Tier 2 capital is limited to 50% of Tier 1 capital.
The FDIC currently measures an institution's capital using a leverage
limit together with certain risk-based ratios. The FDIC's minimum leverage
capital requirement specifies a minimum ratio of Tier 1 capital to average
total assets. Most banks are required to maintain a minimum leverage ratio of
at least 4% to 5% of total assets. At September 30, 2009, the Bank had a Tier
1 leverage capital ratio of 10.1%. The FDIC retains the right to require a
particular institution to maintain a higher capital level based on the its
particular risk profile.
FDIC regulations also establish a measure of capital adequacy based on
ratios of qualifying capital to risk-weighted assets. Assets are placed in
one of four categories and given a percentage weight based on the relative
risk of that category. In addition, certain off-balance-sheet items are
converted to balance-sheet credit equivalent amounts, and each amount is then
assigned to one of the four categories. Under the guidelines, the ratio of
total capital (Tier 1 capital plus Tier 2 capital) to risk-weighted assets
must be at least 8%, and the ratio of Tier 1 capital to risk-weighted assets
must be at least 4%. In evaluating the adequacy of a bank's capital, the FDIC
may also consider other factors that may affect a bank's financial condition.
Such factors may include interest rate risk exposure, liquidity, funding and
market risks, the quality and level of earnings, concentration of credit risk,
risks arising from nontraditional activities, loan and investment quality, the
effectiveness of loan and investment policies, and management's ability to
monitor and control financial operating risks. At September 30, 2009, the
Bank's ratio of total capital to risk-weighted assets was 13.3% and the ratio
of Tier 1 capital to risk-weighted assets was 12.0%.
The Division requires that net worth equal at least 5% of total assets.
Intangible assets must be deducted from net worth and assets when computing
compliance with this requirement. At September 30, 2009, the Bank had a net
worth of 9.5% of total assets.
The table below sets forth the Bank's capital position relative to its
FDIC capital requirements at September 30, 2009. The definitions of the terms
used in the table are those provided in the capital regulations issued by the
FDIC and reflect the higher Tier 1 leverage capital ratio that the Bank will
be required to comply with in connection with the pending MOU. As previously
discussed, in December 2009, the Bank reached an agreement with the FDIC and
DFI on
32
the terms of a pending MOU. For additional information regarding the MOU, see
"Item 1A, Risk Factors -- Risks Related to Our Business -- We are required to
comply with the terms of a memoranda of understanding issued by the FDIC and
the Division and lack of compliance could result in additional regulatory
actions."
At September 30, 2009
-----------------------------
Percent of Adjusted
Amount Total Assets (1)
------ -------------------
(Dollars in thousands)
Tier 1 (leverage) capital (2)................ $67,780 10.1%
Tier 1 (leverage) capital requirement (3).... 66,934 10.0
------- ----
Excess....................................... $ 846 0.1%
======= ====
Tier 1 risk adjusted capital................. $67,780 12.0%
Tier 1 risk adjusted capital requirement..... 22,576 4.0
------- ----
Excess....................................... $45,204 8.0%
======= ====
Total risk-based capital..................... $74,923 13.3%
Total risk-based capital requirement......... 45,152 8.0
------- ----
Excess....................................... $29,771 5.3%
======= ====
------------
(1) For the Tier 1 (leverage) capital and Washington regulatory capital
calculations, percent of total average assets of $669.3 million. For the
Tier 1 risk-based capital and total risk-based capital calculations,
percent of total risk-weighted assets of $566.5 million.
(2) As a Washington-chartered savings bank, the Bank is subject to the
capital requirements of the FDIC and the Division. The FDIC requires
state-chartered savings banks, including the Bank, to have a minimum
leverage ratio of Tier 1 capital to total assets of at least 3%,
provided, however, that all institutions, other than those (i) receiving
the highest rating during the examination process and (ii) not
anticipating any significant growth, are required to maintain a ratio of
1% to 2% above the stated minimum, with an absolute
total capital to risk-weighted assets of at least 8%. Under the pending
MOU, the Bank will be required to maintain at least a 10.0% Tier 1
leverage capital ratio.
(3) Reflects the higher Tier 1 leverage capital ratio that the Bank will be
required to comply with under the agreed upon terms of the pending MOU.
At September 30, 2009 the Bank's required Tier 1 (leverage) capital
requirement was 4.0%, or $26,774.
Events beyond the control of the Bank, such as a downturn in the economy
in areas where the Bank has most of its loans, could adversely affect future
earnings and, consequently, the ability of the Bank to meet its capital
requirements under the MOU. See "Item 1A, Risk Factors --Risks Related to Our
Business -- We are required to comply with the terms of a memoranda of
understanding issued by the FDIC and the Division and lack of compliance could
result in additional regulatory actions."
Real Estate Lending Standards. FDIC regulations require the Bank to adopt
and maintain written policies that establish appropriate limits and standards
for real estate loans. These standards, which must be consistent with safe
and sound banking practices, must establish loan portfolio diversification
standards, prudent underwriting standards (including loan-to-value ratio
limits) that are clear and measurable, loan administration procedures, and
documentation, approval and reporting requirements. The Bank is obligated to
monitor conditions in its real estate markets to ensure that its standards
continue to be appropriate for current market conditions. The Bank's Board of
Directors is required to review and approve the Bank's standards at least
annually. The FDIC has published guidelines for compliance with these
regulations, including supervisory limitations on loan-to-value ratios for
different categories of real estate loans. Under the guidelines, the
aggregate amount of all loans in excess of the supervisory loan-to-value
ratios should not exceed 100% of total capital, and the total of all loans for
commercial, agricultural, multifamily or other non-one-to-four-family
residential properties should not exceed 30% of total capital. Loans in
excess of the supervisory loan-to-value
33
ratio limitations must be identified in the Bank's records and reported at
least quarterly to the Bank's Board of Directors. The Bank is in compliance
with the record and reporting requirements. As of September 30, 2009, the
Bank's aggregate loans in excess of the supervisory loan-to-value ratios were
22% of total capital and the Bank's loans on commercial, agricultural,
multifamily or other non-one-to-four-family residential properties in excess
of the supervisory loan-to-value ratios were 17% of total capital.
Activities and Investments of Insured State-Chartered Financial
Institutions. Federal law generally limits the activities and equity
investments of FDIC-insured, state-chartered banks to those that are
permissible for national banks. An insured state bank is not prohibited from,
among other things, (i) acquiring or retaining a majority interest in a
subsidiary, (ii) investing as a limited partner in a partnership the sole
purpose of which is direct or indirect investment in the acquisition,
rehabilitation or new construction of a qualified housing project, provided
that such limited partnership investments may not exceed 2% of the bank's
total assets, (iii) acquiring up to 10% of the voting stock of a company that
solely provides or reinsures directors', trustees' and officers' liability
insurance coverage or bankers' blanket bond group insurance coverage for
insured depository institutions, and (iv) acquiring or retaining the voting
shares of a depository institution if certain requirements are met.
Washington state has enacted a law regarding financial institution parity.
Primarily, the law affords Washington-chartered commercial banks the same
powers as Washington-chartered savings banks. In order for a bank to exercise
these powers, it must provide 30 days notice to the Director of the Washington
Division of Financial Institutions and the Director must authorize the
requested activity. In addition, the law provides that Washington-chartered
commercial banks may exercise any of the powers that the Federal Reserve has
determined to be closely related to the business of banking and the powers of
national banks, subject to the approval of the Director in certain situations.
The law also provides that Washington-chartered savings banks may exercise any
of the powers of Washington-chartered commercial banks, national banks and
federally-chartered savings banks, subject to the approval of the Director in
certain situations. Finally, the law provides additional flexibility for
Washington-chartered commercial and savings banks with respect to interest
rates on loans and other extensions of credit. Specifically, they may charge
the maximum interest rate allowable for loans and other extensions of credit
by federally-chartered financial institutions to Washington residents.
Environmental Issues Associated With Real Estate Lending. The
Comprehensive Environmental Response, Compensation and Liability Act
("CERCLA"), a federal statute that generally imposes strict liability on all
prior and present "owners and operators" of sites containing hazardous waste.
However, Congress asked to protect secured creditors by providing that the
term "owner and operator" excludes a person whose ownership is limited to
protecting its security interest in the site. Since the enactment of the
CERCLA, this "secured creditor exemption" has been the subject of judicial
interpretations which have left open the possibility that lenders could be
liable for cleanup costs on contaminated property that they hold as collateral
for a loan.
To the extent that legal uncertainty exists in this area, all creditors,
including the Bank, that have made loans secured by properties with potential
hazardous waste contamination (such as petroleum contamination) could be
subject to liability for cleanup costs, which costs often substantially exceed
the value of the collateral property.
Federal Reserve System. The Federal Reserve Board requires that all
depository institutions maintain reserves on transaction accounts or
non-personal time deposits. These reserves may be in the form of cash or
non-interest-bearing deposits with the regional Federal Reserve Bank.
Negotiable order of withdrawal accounts and other types of accounts that
permit payments or transfers to third parties fall within the definition of
transaction accounts and are subject to reserve requirements, as are any
non-personal time deposits at a savings bank. As of September 30, 2009, the
Bank's deposit with the Federal Reserve and vault cash exceeded its Regulation
D reserve requirements.
Affiliate Transactions. The Company and the Bank are separate and
distinct legal entities. Federal laws strictly limit the ability of banks to
engage in certain transactions with their affiliates, including their bank
holding companies. Transactions deemed to be a "covered transaction" under
Section 23A of the Federal Reserve Act and between a subsidiary bank and its
parent company or the nonbank subsidiaries of the bank holding company are
limited to 10% of the bank subsidiary's capital and surplus and, with respect
to the parent company and all such nonbank subsidiaries, to an aggregate of
20% of the bank subsidiary's capital and surplus. Further, covered
transactions that are
34
loans and extensions of credit generally are required to be secured by
eligible collateral in specified amounts. Federal law also requires that
covered transactions and certain other transactions listed in Section 23B of
the Federal Reserve Act between a bank and its affiliates be on terms as
favorable to the bank as transactions with non-affiliates.
Community Reinvestment Act. Banks are also subject to the provisions of
the Community Reinvestment Act of 1977, which requires the appropriate federal
bank regulatory agency to assess a bank's record in meeting the credit needs
of the community serviced by the bank, including low and moderate income
neighborhoods. The regulatory agency's assessment of the bank's record is
made available to the public. Further, an assessment is required of any bank
which has applied to establish a new branch office that will accept deposits,
relocate an existing office or merge or consolidate with, or acquire the
assets or assume the liabilities of, a federally regulated financial
institution. The Bank received a "satisfactory" rating during its most recent
examination.
Dividends. Dividends from the Bank constitute the major source of funds
for dividends which may be paid by the Company shareholders. The amount of
dividends payable by the Bank to the Company depends upon the Bank's earnings
and capital position, and is limited by federal and state laws, regulations
and policies. According to Washington law, the Bank may not declare or pay a
cash dividend on its capital stock if it would cause its net worth to be
reduced below (i) the amount required for liquidation accounts or (ii) the net
worth requirements, if any, imposed by the Director of the Division. In
addition, dividends on the Bank's capital stock may not be paid in an
aggregate amount greater than the aggregate retained earnings of the Bank,
without the approval of the Director of the Division.
The amount of dividends actually paid during any one period will be
strongly affected by the Bank's management policy of maintaining a strong
capital position. Federal law further provides that no insured depository
institution may pay a cash dividend if it would cause the institution to be
"undercapitalized," as defined in the prompt corrective action regulations.
Moreover, the federal bank regulatory agencies also have the general authority
to limit the dividends paid by insured banks if such payments should be deemed
to constitute an unsafe and unsound practice.
Privacy Standards. The Gramm-Leach-Bliley Financial Services
Modernization Act of 1999 ("GLBA") modernized the financial services industry
by establishing a comprehensive framework to permit affiliations among
commercial banks, insurance companies, securities firms and other financial
service providers. The Bank is subject to FDIC regulations implementing the
privacy protection provisions of the GLBA. These regulations require the Bank
to disclose its privacy policy, including informing consumers of its
information sharing practices and informing consumers of their rights to opt
out of certain practices.
Other Consumer Protection Laws and Regulations. The Bank is subject to a
broad array of federal and state consumer protection laws and regulations that
govern almost every aspect of its business relationships with consumers.
While the list set forth below is not exhaustive, these include the
Truth-in-Lending Act, the Truth in Savings Act, the Electronic Fund Transfer
Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act,
the Fair Housing Act, the Real Estate Settlement Procedures Act, the Home
Mortgage Disclosure Act, the Fair Credit Reporting Act, the Fair Debt
Collection Practices Act, the Right to Financial Privacy Act, the Home
Ownership and Equity Protection Act, the Consumer Leasing Act, the Fair Credit
Billing Act, the Homeowners Protection Act, the Check Clearing for the 21st
Century Act, laws governing flood insurance, laws governing consumer
protections in connection with the sale of insurance, federal and state laws
prohibiting unfair and deceptive business practices, and various regulations
that implement some or all of the foregoing. These laws and regulations
mandate certain disclosure requirements and regulate the manner in which
financial institutions must deal with customers when taking deposits, making
loans, collecting loans, and providing other services. Failure to comply with
these laws and regulations can subject the Bank to various penalties,
including but not limited to, enforcement actions, injunctions, fines, civil
liability, criminal penalties, punitive damages, and the loss of certain
contractual rights.
The Americans with Disabilities Act requires employers with 15 or more
employees and all businesses operating "commercial facilities" or "public
accommodations" to accommodate disabled employees and customers. The
Americans with Disabilities Act has two major objectives: (i) to prevent
discrimination against disabled job applicants, job candidates and employees,
and (ii) to provide disabled persons with ready access to commercial
facilities and public
35
accommodations. Commercial facilities, such as the Bank, must ensure that all
new facilities are accessible to disabled persons, and in some instances may
be required to adapt existing facilities to make them accessible.
Regulation of the Company
General. The Company, as the sole shareholder of the Bank is a bank
holding company and is registered as such with the Federal Reserve. Bank
holding companies are subject to comprehensive regulation by the Federal
Reserve under the Bank Holding Company Act of 1956, as amended ("BHCA"), and
the regulations of the Federal Reserve. As a bank holding company, the
Company is required to file with the Federal Reserve annual reports and such
additional information as the Federal Reserve may require and will be subject
to regular examinations by the Federal Reserve. The Federal Reserve also has
extensive enforcement authority over bank holding companies, including, among
other things, the ability to assess civil money penalties, to issue cease and
desist or removal orders and to require that a holding company divest
subsidiaries (including its bank subsidiaries). In general, enforcement
actions may be initiated for violations of law and regulations and unsafe or
unsound practices.
The Bank Holding Company Act. Under the Bank Holding Company Act, the
Company is supervised by the Federal Reserve. The Federal Reserve has a
policy that a bank holding company is required to serve as a source of
financial and managerial strength to its subsidiary banks and may not conduct
its operations in an unsafe or unsound manner. In addition, the Federal
Reserve provides that bank holding companies should serve as a source of
strength to its subsidiary banks by being prepared to use available resources
to provide adequate capital funds to its subsidiary banks during periods of
financial stress or adversity, and should maintain the financial flexibility
and capital raising capacity to obtain additional resources for assisting its
subsidiary banks. A bank holding company's failure to meet its obligation to
serve as a source of strength to its subsidiary banks will generally be
considered by the Federal Reserve to be an unsafe and unsound banking practice
or a violation of the Federal Reserve's regulations or both.
The Company is required to file quarterly and periodic reports with the
Federal Reserve and provide additional information as the Federal Reserve may
require. The Federal Reserve may examine the Company, and any of its
subsidiaries, and charge the Company for the cost of the examination.
The Company and any subsidiaries that it may control are considered
"affiliates" within the meaning of the Federal Reserve Act, and transactions
between our bank subsidiary and affiliates are subject to numerous
restrictions. With some exceptions, the Company and its subsidiaries, are
prohibited from tying the provision of various services, such as extensions of
credit, to other services offered by the Company, or its affiliates.
Acquisitions. The BHCA prohibits a bank holding company, with certain
exceptions, from acquiring direct or indirect ownership or control of more
than 5% of the voting shares of any company that is not a bank or bank holding
company and from engaging directly or indirectly in activities other than
those of banking, managing or controlling banks, or providing services for its
subsidiaries. Under the BHCA, the Federal Reserve is authorized to approve
the ownership of shares by a bank holding company in any company, the
activities of which the Federal Reserve has determined to be so closely
related to the business of banking or managing or controlling banks as to be a
proper incident thereto. The list of activities determined by regulation to
be closely related to banking within the meaning of the BHCA includes, among
other things: operating a savings institution, mortgage company, finance
company, credit card company or factoring company; performing certain data
processing operations; providing certain investment and financial advice;
underwriting and acting as an insurance agent for certain types of
credit-related insurance; leasing property on a full-payout, non-operating
basis; selling money orders, travelers' checks and U.S. Savings Bonds; real
estate and personal property appraising; providing tax planning and
preparation services; and, subject to certain limitations, providing
securities brokerage services for customers.
Interstate Banking. The Federal Reserve must approve an application of
bank holding company to acquire control of, or acquire all or substantially
all of the assets of, a bank located in a state other than such holding
company's home state, without regard to whether the transaction is prohibited
by the laws of any state. The Federal Reserve may not approve the acquisition
of a bank that has not been in existence for the minimum time period, not
exceeding five years, specified by the law of the host state. Nor may the
Federal Reserve approve an application if the applicant controls
36
or would control more than 10% of the insured deposits in the United States or
30% or more of the deposits in the target bank's home state or in any state in
which the target bank maintains a branch. Federal law does not affect the
authority of states to limit the percentage of total insured deposits in the
state that may be held or controlled by a bank holding company to the extent
such limitation does not discriminate against out-of-state banks or bank
holding companies. Individual states may also waive the 30% state-wide
concentration limit contained in the federal law.
The federal banking agencies are authorized to approve interstate merger
transactions without regard to whether such transaction is prohibited by the
law of any state, unless the home state of one of the banks adopted a law
prior to June 1, 1997 which applies equally to all out-of-state banks and
expressly prohibits merger transactions involving out-of-state banks.
Interstate acquisitions of branches will be permitted only if the law of the
state in which the branch is located permits such acquisitions. Interstate
mergers and branch acquisitions will also be subject to the nationwide and
statewide insured deposit concentration amounts described above.
Dividends. The Federal Reserve has issued a policy statement on the
payment of cash dividends by bank holding companies, which expresses the
Federal Reserve's view that a bank holding company should pay cash dividends
only to the extent that the company's net income for the past year is
sufficient to cover both the cash dividends and a rate of earning retention
that is consistent with the company's capital needs, asset quality and overall
financial condition. The Federal Reserve also indicated that it would be
inappropriate for a company experiencing serious financial problems to borrow
funds to pay dividends. Under the terms of the pending MOU the Bank may not
pay dividends to its holding company without the prior consent of the FDIC and
the Division.
Stock Repurchases. Bank holding companies, except for certain
"well-capitalized" and highly rated bank holding companies, are required to
give the Federal Reserve prior written notice of any purchase or redemption of
its outstanding equity securities if the consideration for the purchase or
redemption, when combined with the net consideration paid for all such
purchases or redemptions during the preceding 12 months, is equal to 10% or
more of their consolidated net worth. The Federal Reserve may disapprove a
purchase or redemption if it determines that the proposal would constitute an
unsafe or unsound practice or would violate any law, regulation, Federal
Reserve order, or any condition imposed by, or written agreement with, the
Federal Reserve.
Capital Requirements. The Federal Reserve has established capital
adequacy guidelines for bank holding companies that generally parallel the
capital requirements of the FDIC for the Bank. The Federal Reserve
regulations provide that capital standards will be applied on a consolidated
basis in the case of a bank holding company with $150 million or more in total
consolidated assets.
The Company's total risk based capital must equal 8% of risk-weighted
assets and one half of the 8%, or 4%, must consist of Tier 1 (core) capital
and its Tier 1 (core) capital must equal 4% of total assets. As of September
30, 2009, the Company's total risk based capital was 15.9% of risk-weighted
assets and its risk based capital of Tier 1 (core) capital was 14.7% of
risk-weighted assets.
Sarbanes-Oxley Act of 2002. As a public company, the Company is subject
to the Sarbanes-Oxley Act of 2002, which implements a broad range of corporate
governance and accounting measures for public companies designed to promote
honesty and transparency in corporate America and better protect investors
from corporate wrongdoing. The Sarbanes-Oxley Act of 2002 was signed into law
by President Bush on July 30, 2002 in response to public concerns regarding
corporate accountability in connection with several accounting scandals. The
stated goals of the Sarbanes-Oxley Act are to increase corporate
responsibility, to provide for enhanced penalties for accounting and auditing
improprieties at publicly traded companies and to protect investors by
improving the accuracy and reliability of corporate disclosures pursuant to
the securities laws.
The Sarbanes-Oxley Act includes very specific additional disclosure
requirements and new corporate governance rules, requires the Securities and
Exchange Commission and securities exchanges to adopt extensive additional
disclosure, corporate governance and other related rules and mandates further
studies of certain issues by the SEC and the Comptroller General.
37
Taxation
Federal Taxation
General. The Company and the Bank report their income on a fiscal year
basis using the accrual method of accounting and are subject to federal income
taxation in the same manner as other corporations with some exceptions,
including particularly the Bank's reserve for bad debts discussed below. The
following discussion of tax matters is intended only as a summary and does not
purport to be a comprehensive description of the tax rules applicable to the
Bank or the Company.
Bad Debt Reserve. Historically, savings institutions such as the Bank
which met certain definitional tests primarily related to their assets and the
nature of their business ("qualifying thrift") were permitted to establish a
reserve for bad debts and to make annual additions thereto, which may have
been deducted in arriving at their taxable income.
The provisions repealing the current thrift bad debt rules were passed by
Congress as part of "The Small Business Job Protection Act of 1996." These
rules required that all institutions recapture all or a portion of their bad
debt reserves added since the base year (last taxable year beginning before
January 1, 1988). The Bank had previously recorded deferred taxes equal to
the bad debt recapture and as such the new rules had no effect on the net
income or federal income tax expense. For taxable years beginning after
December 31, 1995, the Bank's bad debt deduction is determined under the
experience method using a formula based on actual bad debt experience over a
period of years or, if the Bank is a "large" association (assets in excess of
$500 million) on the basis of net charge-offs during the taxable year. The
unrecaptured base year reserves will not be subject to recapture as long as
the institution continues to carry on the business of banking. In addition,
the balance of the pre-1988 bad debt reserves continue to be subject to
provisions of present law referred to below that require recapture in the case
of certain excess distributions to shareholders. The Bank has recaptured all
federal tax bad debt reserves that had been accumulated since October 1, 1988.
Distributions. To the extent that the Bank makes "nondividend
distributions" to the Company, such distributions will be considered to result
in distributions from the balance of its bad debt reserve as of December 31,
1987 (or a lesser amount if the Bank's loan portfolio decreased since December
31, 1987) and then from the supplemental reserve for losses on loans ("Excess
Distributions"), and an amount based on the Excess Distributions will be
included in the Bank's taxable income. Nondividend distributions include
distributions in excess of the Bank's current and accumulated earnings and
profits, distributions in redemption of stock and distributions in partial or
complete liquidation. However, dividends paid out of the Bank's current or
accumulated earnings and profits, as calculated for federal income tax
purposes, will not be considered to result in a distribution from the Bank's
bad debt reserve. The amount of additional taxable income created from an
Excess Distribution is an amount that, when reduced by the tax attributable to
the income, is equal to the amount of the distribution. Thus, if the Bank
makes a "nondividend distribution," then approximately one and one-half times
the Excess Distribution would be includable in gross income for federal income
tax purposes, assuming a 35% corporate income tax rate (exclusive of state and
local taxes). See "- Regulation of the Bank - Dividends" for limits on the
payment of dividends by the Bank. The Bank does not intend to pay dividends
that would result in a recapture of any portion of its tax bad debt reserve.
Corporate Alternative Minimum Tax. The Code imposes a tax on alternative
minimum taxable income ("AMTI") at a rate of 20%. In addition, only 90% of
AMTI can be offset by net operating loss carryovers. AMTI is increased by an
amount equal to 75% of the amount by which the Bank's adjusted current
earnings exceeds its AMTI (determined without regard to this preference and
prior to reduction for net operating losses).
Dividends-Received Deduction. The Company may exclude from its income
100% of dividends received from the Bank as a member of the same affiliated
group of corporations. The corporate dividends-received deduction is
generally 70% in the case of dividends received from unaffiliated corporations
with which the Company and the Bank will not file a consolidated tax return,
except that if the Company or the Bank owns more than 20% of the stock of a
corporation distributing a dividend, then 80% of any dividends received may be
deducted.
38
Audits. The Company is no longer subject to United States federal tax
examination by tax authorities for years ended on or before September 30,
2004.
Washington Taxation. The Bank is subject to a business and occupation tax
imposed under Washington law at the rate of 1.50% of gross receipts. Interest
received on loans secured by mortgages or deeds of trust on residential
properties is exempt from such tax.
Competition
The Bank operates in an intensely competitive market for the attraction of
deposits (generally its primary source of lendable funds) and in the
origination of loans. Historically, its most direct competition for deposits
has come from large commercial banks, thrift institutions and credit unions in
its primary market area. In times of high interest rates, the Bank
experiences additional significant competition for investors' funds from
short-term money market securities and other corporate and government
securities. The Bank's competition for loans comes principally from mortgage
bankers, commercial banks and other thrift institutions. Such competition for
deposits and the origination of loans may limit the Bank's future growth and
earnings prospects.
Subsidiary Activities
The Bank has one wholly-owned subsidiary, Timberland Service Corporation
("Timberland Service"), whose primary function is to act as the Bank's escrow
department and offer non-deposit investment services.
Personnel
As of September 30, 2009, the Bank had 255 full-time employees and 35
part-time and on-call employees. The employees are not represented by a
collective bargaining unit and the Bank believes its relationship with its
employees is good.
Executive Officers of the Registrant
The following table sets forth certain information with respect to the
executive officers of the Company and the Bank.
Executive Officers of the Company and Bank
Age at Position
September -------------------------------------------------
Name 30, 2009 Company Bank
----------------- --------- ------------------------- ----------------------
Michael R. Sand 55 President and Chief President and Chief
Executive Officer Executive Officer
Dean J. Brydon 42 Executive Vice President, Executive Vice
Chief Financial Officer President, Chief
and Secretary Financial Officer and
Secretary
Robert A. Drugge 58 Executive Vice President Executive Vice
President and
Business Banking
Division Manager
John P. Norawong 44 Executive Vice President Executive Vice
President and
Community Banking
Division Manager
(table continued on following page)
39
Age at Position
September -------------------------------------------------
Name 30, 2009 Company Bank
----------------- --------- ------------------------- ----------------------
Marci A. Basich 40 Senior Vice President and Senior Vice President
Treasurer and Treasurer
Kathie M. Bailey 58 Senior Vice President Senior Vice President
and Chief Operations
Officer
Michael J. Scott 63 Senior Vice President
and Chief Credit
Administrator
Biographical Information.
Michael R. Sand has been affiliated with the Bank since 1977 and has
served as President of the Bank and the Company since January 23, 2003. On
September 30, 2003, he was appointed as Chief Executive Officer of the Bank
and Company. Prior to appointment as President and Chief Executive Officer,
Mr. Sand had served as Executive Vice President and Secretary of the Bank
since 1993 and as Executive Vice President and Secretary of the Company since
its formation in 1997.
Dean J. Brydon has been affiliated with the Bank since 1994 and has served
as the Chief Financial Officer of the Company and the Bank since January 2000
and Secretary of the Company and Bank since January 2004. Mr. Brydon is a
Certified Public Accountant.
Robert A. Drugge has been affiliated with the Bank since April 2006 and
has served as Executive Vice President and Business Banking Manager since
September 2006. Prior to joining Timberland, Mr. Drugge was employed at Bank
of America as an executive officer and most recently served as Senior Vice
President. Mr. Drugge began his banking career at Seafirst in 1974, which was
acquired by Bank America Corp. and became known as Bank of America.
John P. Norawong has been affiliated with the Bank since July 2006 and has
served as Executive Vice President and Community Banking Division Manager
since September 2006. Prior to joining Timberland, Mr. Norawong served as
Senior Vice President and Commercial Bank Manager at United Commercial Bank
from February 2006 to July 2006, and as Vice President and Senior Vice
President at Key Bank from 1999 through 2006.
Marci A. Basich has been affiliated with the Bank since 1999 and has
served as Treasurer of the Company and the Bank since January 2002. Ms.
Basich is a Certified Public Accountant.
Kathie M. Bailey has been affiliated with the Bank since 1984 and has
served as Senior Vice President and Chief Operations Officer since 2003.
Michael J. Scott has been affiliated with the Bank since January 2008 and
has served as Senior Vice President and Chief Credit Administrator. Prior to
joining Timberland, Mr. Scott was employed by Bank of America where he was a
Senior Vice President and Senior Credit Products Officer for the past several
years in both Seattle and Tacoma. He began his banking career at Seafirst in
1973, which was acquired by Bank America Corp. and became known as Bank of
America.
Item 1A. Risk Factors
----------------------
We assume and manage a certain degree of risk in order to conduct our
business strategy. In addition to the risk factors described below, other
risks and uncertainties not specifically mentioned, or that are currently
known to, or deemed to be immaterial by management, also may materially and
adversely affect our financial position, results of
40
operations and/or cash flows. Before making an investment decision, you
should carefully consider the risks described below together with all of the
other information included in this Form 10-K. If any of the circumstances
described in the following risk factors actually occur to a significant
degree, the value of our common stock could decline, and you could lose all or
part of your investment.
We are required to comply with the terms of a pending memorandum of
understanding issued by the FDIC and the Division and lack of compliance could
result in additional regulatory actions.
In December 2009, the FDIC and the Division determined that the Bank
required supervisory attention and reached an agreement on a Memorandum of
Understanding, or MOU, with the Bank. Under the terms of the MOU, the Bank,
without the prior written approval, or nonobjection, of the FDIC and/or the
DFI, may not:
* appoint any new director or senior executive officer or change the
responsibilities of any current senior executive officers;
* pay cash dividends to its holding company, Timberland Bancorp, Inc.;
and
* engage in any transactions that would materially change the balance
sheet composition including growth in total assets of five percent or
more or significant changes in funding sources, such as by increasing
brokered deposits.
Other material provisions of the order require the Bank and the Company
to:
* maintain Tier 1 Capital of not less than 10.0% of the Bank's adjusted
total assets pursuant to Part 325 of the FDIC Rules and Regulations,
and maintain capital ratios above "well capitalized" thresholds as
defined under Section 325.103 of the FDIC Rules and Regulations;
* maintain a fully funded allowance for loan and lease losses, the
adequacy of which shall be deemed to be satisfactory to the FDIC and
the DFI;
* formulate and implement a written profit plan acceptable to the FDIC
and the DFI;
* eliminate from its books all assets classified "Loss" that have not
been previously collected or charged-off;
* reduce the dollar volume by 50% the assets classified "Substandard"
and "Doubtful" at April 30, 2009;
* develop a written plan for reducing the aggregate amount of its
acquisition, development and construction loans; and
* revise, adopt and fully implement a written liquidity and funds
management policy.
Following the effective date of the MOU, the Bank is required to provide
the FDIC and DFI with progress reports regarding its compliance with the
provisions of the MOU. The MOU will remain in effect until stayed, modified,
terminated or suspended by the FDIC and the Division. If the FDIC and the
Division were to determine that the Bank was not in compliance with the MOU,
they would have available various remedies, including among others, the power
to enjoin "unsafe or unsound" practices, to require affirmative action to
correct any conditions resulting from any violation or practice, to direct an
increase in capital, to restrict the growth of the Bank, to remove officers
and/or directors, and to assess civil monetary penalties. Management of the
Bank has been taking action and implementing programs to comply with the
requirements of the MOU. Although compliance with the MOU will be determined
by the FDIC and the Division, management believes that the Bank has complied
in all material respects with the provisions of the MOU required to be
complied with as of the date of this report. The FDIC may determine, however,
in its sole discretion that the issues raised by the MOU have not been
addressed satisfactorily, or that any current or past actions, violations or
deficiencies could be the subject of further regulatory enforcement actions.
Such enforcement actions could involve penalties or limitations on our
business at the Bank and negatively affect our ability to implement our
business plan, as well as our financial condition and results of
operations.
The current economic recession in the market areas we serve may continue to
adversely impact our earnings and could increase the credit risk associated
with our loan portfolio.
Substantially all of our loans are to businesses and individuals in the
state of Washington. A continuing decline in the economies of the our local
market areas of Grays Harbor, Pierce, Thurston, King, Kitsap and Lewis
counties in
41
which we operate, and which we consider to be our primary market areas, could
have a material adverse effect on our business, financial condition, results
of operations and prospects. In particular, Washington has experienced
substantial home price declines and increased foreclosures and have
experienced above average unemployment rates.
A further deterioration in economic conditions in the market areas we
serve could result in the following consequences, any of which could have a
materially adverse impact on our business, financial condition and results of
operations:
* loan delinquencies, problem assets and foreclosures may increase;
* demand for our products and services may decline;
* collateral for loans made may decline further in value, in turn
reducing customers' borrowing power, reducing the value of assets and
collateral associated with existing loans; and
* the amount of our low-cost or non-interest bearing deposits may
decrease.
Our real estate construction and land development loans are based upon
estimates of costs and the value of the completed project.
We make real estate construction loans to individuals and builders,
primarily for the construction of residential properties. We originate these
loans whether or not the collateral property underlying the loan is under
contract for sale. At September 30, 2009, construction and land development
loans totaled $139.7 million, or 23.5% of our total loan portfolio, of which
$71.2 million were for residential real estate projects. Approximately $35.4
million of our residential construction loans were made to finance the
construction of owner-occupied homes and are structured to be converted to
permanent loans at the end of the construction phase. Land development loans,
which are loans made with land as security, totaled $19.2 million, or 3.2%, of
our total loan portfolio at September 30, 2009. In general, construction and
land development lending involves additional risks because of the inherent
difficulty in estimating a property's value both before and at completion of
the project as well as the estimated cost of the project. Construction costs
may exceed original estimates as a result of increased materials, labor or
other costs. In addition, because of current uncertainties in the residential
real estate market, property values have become more difficult to determine
than they have historically been. Construction loans and land development
loans often involve the disbursement of funds with repayment dependent, in
part, on the success of the project and the ability of the borrower to sell or
lease the property or refinance the indebtedness, rather than the ability of
the borrower or guarantor to repay principal and interest. These loans are
also generally more difficult to monitor. In addition, speculative
construction loans to a builder are often associated with homes that are not
pre-sold, and thus pose a greater potential risk than construction loans to
individuals on their personal residences. At September 30, 2009, $17.0 million
of our construction portfolio was comprised of speculative one-to-four family
construction loans. Approximately $17.6 million, or 12.6%, of our total real
estate construction and land development loans were non-performing at
September 30, 2009.
Our emphasis on commercial real estate lending may expose us to increased
lending risks.
Our current business strategy includes the expansion of commercial real
estate lending. This type of lending activity, while potentially more
profitable than single-family residential lending, is generally more sensitive
to regional and local economic conditions, making loss levels more difficult
to predict. Collateral evaluation and financial statement analysis in these
types of loans requires a more detailed analysis at the time of loan
underwriting and on an ongoing basis. In our primary market of southwest
Washington, the housing market has slowed, with weaker demand for housing,
higher inventory levels and longer marketing times. A further downturn in
housing, or the real estate market, could increase loan delinquencies,
defaults and foreclosures, and significantly impair the value of our
collateral and our ability to sell the collateral upon foreclosure. Many of
our commercial borrowers have more than one loan outstanding with us.
Consequently, an adverse development with respect to one loan or one credit
relationship can expose us to a significantly greater risk of loss.
42
At September 30, 2009, we had $188.2 million and $25.6 million of
commercial and multi-family real estate mortgage loans, respectively,
representing 31.6% and 4.3%, respectively, of our total loan portfolio.
These loans typically involve higher principal amounts than other types of
loans, and repayment is dependent upon income generated, or expected to be
generated, by the property securing the loan in amounts sufficient to cover
operating expenses and debt service, which may be adversely affected by
changes in the economy or local market conditions. For example, if the cash
flow from the borrower's project is reduced as a result of leases not being
obtained or renewed, the borrower's ability to repay the loan may be impaired.
Commercial real estate loans also expose a lender to greater credit risk than
loans secured by residential real estate because the collateral securing these
loans typically cannot be sold as easily as residential real estate. In
addition, many of our commercial real estate loans are not fully amortizing
and contain large balloon payments upon maturity. Such balloon payments may
require the borrower to either sell or refinance the underlying property in
order to make the payment, which may increase the risk of default or
non-payment.
A secondary market for most types of commercial real estate and
construction loans is not readily liquid, so we have less opportunity to
mitigate credit risk by selling part or all of our interest in these loans.
As a result of these characteristics, if we foreclose on a commercial real
estate loan, our holding period for the collateral typically is longer than
for one-to-four family residential mortgage loans because there are fewer
potential purchasers of the collateral. Accordingly, charge-offs on commercial
and multi-family real estate loans may be larger on a per loan basis than
those incurred with our residential or consumer loan portfolios.
The level of our commercial real estate loan portfolio may subject us to
additional regulatory scrutiny.
The FDIC, the Federal Reserve and the Office of Thrift Supervision have
promulgated joint guidance on sound risk management practices for financial
institutions with concentrations in commercial real estate lending. Under this
guidance, a financial institution that, like us, is actively involved in
commercial real estate lending should perform a risk assessment to identify
concentrations. A financial institution may have a concentration in commercial
real estate lending if, among other factors (i) total reported loans for
construction, land development, and other land represent 100% or more of total
capital, or (ii) total reported loans secured by multifamily and non-farm
residential properties, loans for construction, land development and other
land, and loans otherwise sensitive to the general commercial real estate
market, including loans to commercial real estate related entities, represent
300% or more of total capital. The particular focus of the guidance is on
exposure to commercial real estate loans that are dependent on the cash flow
from the real estate held as collateral and that are likely to be at greater
risk to conditions in the commercial real estate market (as opposed to real
estate collateral held as a secondary source of repayment or as an abundance
of caution). The purpose of the guidance is to guide banks in developing risk
management practices and capital levels commensurate with the level and nature
of real estate concentrations. The guidance states that management should
employ heightened risk management practices including board and management
oversight and strategic planning, development of underwriting standards, risk
assessment and monitoring through market analysis and stress testing. We have
concluded that we have a concentration in commercial real estate lending under
the foregoing standards because our commercial real estate loan balance
represents 300% or more of total capital. While we believe we have implemented
policies and procedures with respect to our commercial real estate loan
portfolio consistent with this guidance, bank regulators could require us to
implement additional policies and procedures consistent with their
interpretation of the guidance that may result in additional costs to us.
Repayment of our commercial loans is often dependent on the cash flows of the
borrower, which may be unpredictable, and the collateral securing these loans
may fluctuate in value.
At September 30, 2009, we had $13.8 million or 2.3% of total loans in
commercial loans. Commercial lending involves risks that are different from
those associated with residential and commercial real estate lending. Real
estate lending is generally considered to be collateral based lending with
loan amounts based on predetermined loan to collateral values and liquidation
of the underlying real estate collateral being viewed as the primary source of
repayment in the event of borrower default. Our commercial loans are primarily
made based on the cash flow of the borrower and secondarily on the underlying
collateral provided by the borrower. The borrowers' cash flow may be
unpredictable, and collateral securing these loans may fluctuate in value.
Although commercial loans are often collateralized by equipment, inventory,
accounts receivable, or other business assets, the liquidation of collateral
in the event of default is often an
43
insufficient source of repayment because accounts receivable may be
uncollectible and inventories may be obsolete or of limited use, among other
things. Accordingly, the repayment of commercial loans depends primarily on
the cash flow and credit worthiness of the borrower and secondarily on the
underlying collateral provided by the borrower.
Our business may be adversely affected by credit risk associated with
residential property.
At September 30, 2009, $152.3 million, or 25.6% of our total loan
portfolio, was secured by one-to-four single-family mortgage loans and home
equity loans. This type of lending is generally sensitive to regional and
local economic conditions that significantly impact the ability of borrowers
to meet their loan payment obligations, making loss levels difficult to
predict. The decline in residential real estate values as a result of the
downturn in the Washington housing market has reduced the value of the real
estate collateral securing these types of loans and increased the risk that we
would incur losses if borrowers default on their loans. Continued declines in
both the volume of real estate sales and the sales prices coupled with the
current recession and the associated increases in unemployment may result in
higher than expected loan delinquencies or problem assets, a decline in demand
for our products and services, or lack of growth or a decrease in deposits.
These potential negative events may cause us to incur losses, adversely affect
our capital and liquidity, and damage our financial condition and business
operations.
High loan-to-value ratios on a portion of our residential mortgage loan
portfolio exposes us to greater risk of loss.
Many of our residential mortgage loans are secured by liens on mortgage
properties in which the borrowers have reduced equity because either we
originated upon purchase a first mortgage with an 80% loan-to-value ratio or
have originated a home equity loan with a combined loan-to-value ratio of up
to 90%, and home values in our market areas have, on average, declined.
Residential loans with high loan-to-value ratios will be more sensitive to
declining property values than those with lower combined loan-to-value ratios
and, therefore, may experience a higher incidence of default and severity of
losses. In addition, if the borrowers sell their homes, such borrowers may be
unable to repay their loans in full from the sale. As a result, these loans
may experience higher rates of delinquencies, defaults and losses.
Our provision for loan losses has increased substantially and we may be
required to make further increases in our provision for loan losses and to
charge-off additional loans in the future, which could adversely affect our
results of operations.
For the fiscal year ended September 30, 2009 we recorded a provision for
loan losses of $10.7 million, compared to $3.9 million for the fiscal year
ended September 30, 2008. We also recorded net loan charge-offs of $4.4
million for the fiscal year ended September 30, 2009 compared to $647,000 for
the year ended September 30, 2008. We are experiencing increasing loan
delinquencies and credit losses. Our nonperforming loans and assets generally
reflect unique operating difficulties for individual borrowers rather than
weakness in the overall economy of the Pacific Northwest; however, more
recently the deterioration in the general economy has become a significant
contributing factor to the increased levels of delinquencies and nonperforming
loans. Slower sales in certain market areas and excess inventory in the
housing market have been the primary causes of the increase in delinquencies
and foreclosures for residential construction and land development loans,
which represent 60.1% of our nonperforming assets at September 30, 2009. At
September 30, 2009 our total nonperforming loans had increased to $29.3
million compared to $12.0 million at September 30, 2008. Further, our
portfolio is concentrated in construction and land loans and commercial and
commercial real estate loans, all of which have a higher risk of loss than
residential mortgage loans.
Moreover, until general economic conditions improve and if current trends
in housing and real estate markets continue, we expect that we will continue
to experience significantly higher than normal delinquencies and credit
losses. As a result, we could be required to make further increases in our
provision for loan losses and to charge off additional loans in the future,
which could have a material adverse effect on our financial condition and
results of operations.
44
Our allowance for loan losses may prove to be insufficient to absorb losses in
our loan portfolio.
Lending money is a substantial part of our business and each loan carries
a certain risk that it will not be repaid in accordance with its terms or that
any underlying collateral will not be sufficient to assure repayment. This
risk is affected by, among other things:
* the cash flow of the borrower and/or the project being financed;
* changes and uncertainties as to the future value of the collateral, in
the case of a collateralized loan;
* the duration of the loan;
* the credit history of a particular borrower; and
* changes in economic and industry conditions.
We maintain an allowance for loan losses, which is a reserve established
through a provision for loan losses charged to expense, which we believe is
appropriate to provide for probable losses in our loan portfolio. The amount
of this allowance is determined by our management through periodic reviews and
consideration of several factors, including, but not limited to:
* our general reserve, based on our historical default and loss
experience and certain macroeconomic factors based on management's
expectations of future events; and
* our specific reserve, based on our evaluation of nonperforming loans
and their underlying collateral.
The determination of the appropriate level of the allowance for loan
losses inherently involves a high degree of subjectivity and requires us to
make various assumptions and judgments about the collectability of our loan
portfolio, including the creditworthiness of our borrowers and the value of
the real estate and other assets serving as collateral for the repayment of
many of our loans. In determining the amount of the allowance for loan losses,
we review our loans and the loss and delinquency experience, and evaluate
economic conditions and make significant estimates of current credit risks and
future trends, all of which may undergo material changes. If our estimates are
incorrect, the allowance for loan losses may not be sufficient to cover losses
inherent in our loan portfolio, resulting in the need for additions to our
allowance through an increase in the provision for loan losses. Continuing
deterioration in economic conditions affecting borrowers, new information
regarding existing loans, identification of additional problem loans and other
factors, both within and outside of our control, may require an increase in
the allowance for loan losses. Our allowance for loan losses was 2.52% of
gross loans held for investment and 48.39% of nonperforming loans at September
30, 2009. In addition, bank regulatory agencies periodically review our
allowance for loan losses and may require an increase in the provision for
possible loan losses or the recognition of further loan charge-offs, based on
judgments different than those of management. If charge-offs in future periods
exceed the allowance for loan losses, we will need additional provisions to
increase the allowance for loan losses. Any increases in the provision for
loan losses will result in a decrease in net income and may have a material
adverse effect on our financial condition, results of operations and our
capital.
If our investments in real estate are not properly valued or sufficiently
reserved to cover actual losses, or if we are required to increase our
valuation reserves, our earnings could be reduced.
We obtain updated valuations in the form of appraisals and broker price
opinions when a loan has been foreclosed and the property is taken in as other
real estate owned ("OREO"), and at certain other times during the assets
holding period. Our net book value ("NBV") in the loan at the time of
foreclosure and thereafter is compared to the updated market value of the
foreclosed property less estimated selling costs (fair value). A charge-off is
recorded for any excess in the asset's NBV over its fair value. If our
valuation process is incorrect, the fair value of our investments in real
estate may not be sufficient to recover our NBV in such assets, resulting in
the need for additional charge-offs.
45
Additional material charge-offs to our investments in real estate could have a
material adverse effect on our financial condition and results of operations.
In addition, bank regulators periodically review our OREO and may require
us to recognize further charge-offs. Any increase in our charge-offs, as
required by such regulators, may have a material adverse effect on our
financial condition and results of operations.
Other-than-temporary impairment charges in our investment securities portfolio
could result in significant losses and adversely affect our continuing
operations.
During the year ended September 30, 2009, we recognized a $5.9 million
non-cash other than temporary impairment ("OTTI") charge on private label
mortgage backed securities we hold for investment. At September 30, 2009 the
fair value of these securities was $3.2 million. Management concluded that the
decline of the estimated fair value below the cost of these securities was
other than temporary and recorded a credit loss of $3.6 million through
non-interest income. We determined the remaining decline in value was not
related to specific credit deterioration. We closely monitor our investment
securities for changes in credit risk. The valuation of our investment
securities also is influenced by external market and other factors, including
implementation of Securities and Exchange Commission and Financial Accounting
Standards Board guidance on fair value accounting, default rates on
residential mortgage securities, rating agency actions, and the prices at
which observable market transactions occur. The current market environment
significantly limits our ability to mitigate our exposure to valuation changes
in our investment securities by selling them. Accordingly, if market
conditions deteriorate further and we determine our holdings of our private
label mortgage backed securities or other investment securities are OTTI, our
future earnings, shareholders' equity, regulatory capital and continuing
operations could be materially adversely affected.
An increase in interest rates, change in the programs offered by the FHLMC or
our ability to qualify for their programs may reduce our mortgage revenues,
which would negatively impact our non-interest income.
The sale of residential mortgage loans to the FHLMC provides a
significant portion of our non-interest income. Any future changes in their
program, our eligibility to participate in such program, the criteria for
loans to be accepted or laws that significantly affect the activity of the
FHLMC could, in turn, materially adversely affect our results of operations if
we could not find other purchasers. Further, in a rising or higher interest
rate environment, our originations of mortgage loans may decrease, resulting
in fewer loans that are available to be sold. This would result in a decrease
in mortgage revenues and a corresponding decrease in non-interest income. In
addition, our results of operations are affected by the amount of non-interest
expense associated with our loan sale activities, such as salaries and
employee benefits, occupancy, equipment and data processing expense and other
operating costs. During periods of reduced loan demand, our results of
operations may be adversely affected to the extent that we are unable to
reduce expenses commensurate with the decline in loan originations.
Our real estate lending also exposes us to the risk of environmental
liabilities.
In the course of our business, we may foreclose and take title to real
estate, and we could be subject to environmental liabilities with respect to
these properties. We may be held liable to a governmental entity or to third
persons for property damage, personal injury, investigation, and clean-up
costs incurred by these parties in connection with environmental
contamination, or may be required to investigate or clean up hazardous or
toxic substances, or chemical releases at a property. The costs associated
with investigation or remediation activities could be substantial.
In addition, as the owner or former owner of a contaminated site, we may
be subject to common law claims by third parties based on damages and costs
resulting from environmental contamination emanating from the property. If we
ever become subject to significant environmental liabilities, our business,
financial condition and results of operations could be materially and
adversely affected.
46
Fluctuating interest rates can adversely affect our profitability.
Our profitability is dependent to a large extent upon net interest
income, which is the difference, or spread, between the interest earned on
loans, securities and other interest-earning assets and the interest paid on
deposits, borrowings, and other interest-bearing liabilities. Because of the
differences in maturities and repricing characteristics of our
interest-earning assets and interest-bearing liabilities, changes in interest
rates do not produce equivalent changes in interest income earned on
interest-earning assets and interest paid on interest-bearing liabilities. We
principally manage interest rate risk by managing our volume and mix of our
earning assets and funding liabilities. In a changing interest rate
environment, we may not be able to manage this risk effectively. Changes in
interest rates also can affect: (1) our ability to originate and/or sell
loans; (2) the value of our interest-earning assets, which would negatively
impact shareholders' equity, and our ability to realize gains from the sale of
such assets; (3) our ability to obtain and retain deposits in competition with
other available investment alternatives; and (4) the ability of our borrowers
to repay adjustable or variable rate loans. Interest rates are highly
sensitive to many factors, including government monetary policies, domestic
and international economic and political conditions and other factors beyond
our control. If we are unable to manage interest rate risk effectively, our
business, financial condition and results of operations could be materially
harmed.
Additionally, a substantial majority of our real estate secured loans
held are adjustable-rate loans. Any rise in prevailing market interest rates
may result in increased payments for borrowers who have adjustable rate
mortgage loans, increasing the possibility of default.
Increases in deposit insurance premiums and special FDIC assessments will hurt
our earnings.
Beginning in late 2008, the economic environment caused higher levels of
bank failures, which dramatically increased FDIC resolution costs and led to a
significant reduction in the Deposit Insurance Fund. As a result, the FDIC has
significantly increased the initial base assessment rates paid by financial
institutions for deposit insurance. The base assessment rate was increased by
seven basis points (seven cents for every $100 of deposits) for the first
quarter of 2009. Effective April 1, 2009, initial base assessment rates were
changed to range from 12 basis points to 45 basis points across all risk
categories with possible adjustments to these rates based on certain
debt-related components. These increases in the base assessment rate have
increased our deposit insurance costs and negatively impacted our earnings. In
addition, in May 2009, the FDIC imposed a special assessment on all insured
institutions due to recent bank and savings association failures. The
emergency assessment amounts to five basis points on each institution's assets
minus Tier 1 capital as of June 30, 2009, subject to a maximum equal to 10
basis points times the institution's assessment base. Our FDIC deposit
insurance expense for the year ended September 30, 2009 was $778,000,
including the special assessment of $300,000 recorded in June 2009 and paid on
September 30, 2009. This compares to our FDIC deposit insurance expense of
$130,000 for the year ended September 30, 2008.
In addition, the FDIC may impose additional emergency special
assessments, of up to five basis points per quarter on each institution's
assets minus Tier 1 capital if necessary to maintain public confidence in
federal deposit insurance or as a result of deterioration in the Deposit
Insurance Fund reserve ratio due to institution failures. The latest date
possible for imposing any such additional special assessment is December 31,
2009, with collection on March 30, 2010. Any additional emergency special
assessment imposed by the FDIC will hurt our earnings. Additionally, the FDIC
has adopted a rule that requires financial institutions to prepay on December
30, 2009 its estimated amount of its quarterly risk-based assessments for the
fourth quarter of 2009 and for all quarters throught the end of 2012.
Collection of the prepayment does not preclude the FDIC from changing
assessment rates or revising the risk-based assessment system in the future.
The rule includes a process for exemption from the prepayment for institutions
whose safety and soundness would be affected adversely. This prepayment rule
will not immediately impact our earnings as the payment would be expensed over
time.
Liquidity risk could impair our ability to fund operations and jeopardize our
financial condition, growth and prospects.
47
Liquidity is essential to our business. An inability to raise funds
through deposits, borrowings, the sale of loans and other sources could have a
substantial negative effect on our liquidity. We rely on customer deposits and
advances from the FHLB of Seattle ("FHLB"), the Federal Reserve Bank of San
Francisco ("FRB") and other borrowings to fund our operations. Although we
have historically been able to replace maturing deposits and advances if
desired, we may not be able to replace such funds in the future if, among
other things, our financial condition, the financial condition of the FHLB or
FRB, or market conditions change. Our access to funding sources in amounts
adequate to finance our activities or the terms of which are acceptable could
be impaired by factors that affect us specifically or the financial services
industry or economy in general - such as a disruption in the financial markets
or negative views and expectations about the prospects for the financial
services industry in light of the recent turmoil faced by banking
organizations and the continued deterioration in credit markets. Factors that
could detrimentally impact our access to liquidity sources include a decrease
in the level of our business activity as a result of a downturn in the
Washington markets where our loans are concentrated or adverse regulatory
action against us.
Our financial flexibility will be severely constrained if we are unable
to maintain our access to funding or if adequate financing is not available to
accommodate future growth at acceptable interest rates. Although we consider
our sources of funds adequate for our liquidity needs, we may seek additional
debt in the future to achieve our long-term business objectives. Additional
borrowings, if sought, may not be available to us or, if available, may not be
available on reasonable terms. If additional financing sources are
unavailable, or are not available on reasonable terms, our financial
condition, results of operations, growth and future prospects could be
materially adversely affected. Finally, if we are required to rely more
heavily on more expensive funding sources to support future growth, our
revenues may not increase proportionately to cover our costs.
Our growth or future losses may require us to raise additional capital in the
future, but that capital may not be available when it is needed or the cost of
that capital may be very high.
We are required by federal regulatory authorities to maintain adequate
levels of capital to support our operations. At some point, we may need to
raise additional capital to support continued growth. Our ability to raise
additional capital, if needed, will depend on conditions in the capital
markets at that time, which are outside our control, and on our financial
condition and performance. Accordingly, we cannot make assurances that we
will be able to raise additional capital if needed on terms that are
acceptable to us, or at all. If we cannot raise additional capital when
needed, our ability to further expand our operations through internal growth
and acquisitions could be materially impaired and our financial condition and
liquidity could be materially and adversely affected.
We operate in a highly regulated environment and may be adversely affected by
changes in federal and state laws and regulations, including changes that may
restrict our ability to foreclose on single-family home loans and offer
overdraft protection.
We are subject to extensive examination, supervision and comprehensive
regulation by the FDIC and the Washington Department of Financial
Institutions. Banking regulations are primarily intended to protect
depositors' funds, federal deposit insurance funds, and the banking system as
a whole, and not holders of our common stock. These regulations affect our
lending practices, capital structure, investment practices, dividend policy,
and growth, among other things. Congress and federal and state regulatory
agencies continually review banking laws, regulations, and policies for
possible changes. Changes to statutes, regulations, or regulatory policies,
including changes in interpretation or implementation of statutes,
regulations, or policies, could affect us in substantial and unpredictable
ways. Such changes could subject us to additional costs, limit the types of
financial services and products we may offer, restrict mergers and
acquisitions, investments, access to capital, the location of banking offices,
and/or increase the ability of non-banks to offer competing financial services
and products, among other things. Failure to comply with laws, regulations or
policies could result in sanctions by regulatory agencies, civil money
penalties and/or reputational damage, which could have a material adverse
effect on our business, financial condition and results of operations. While
we have policies and procedures designed to prevent any such violations, there
can be no assurance that such violations will not occur.
New legislation proposed by Congress may give bankruptcy courts the power
to reduce the increasing number of home foreclosures by giving bankruptcy
judges the authority to restructure mortgages and reduce a borrower's
48
payments. Property owners would be allowed to keep their property while
working out their debts. Other similar bills placing additional temporary
moratoriums on foreclosure sales or otherwise modifying foreclosure procedures
to the benefit of borrowers and the detriment of lenders may be enacted by
either Congress or the State of Washington in the future. These laws may
further restrict our collection efforts on one-to-four single-family loans.
Additional legislation proposed or under consideration in Congress would give
current debit and credit card holders the chance to opt out of an overdraft
protection program and limit overdraft fees which could result in additional
operational costs and a reduction in our non-interest income.
Further, our regulators have significant discretion and authority to
prevent or remedy unsafe or unsound practices or violations of laws by
financial institutions and holding companies in the performance of their
supervisory and enforcement duties. In this regard, banking regulators are
considering additional regulations governing compensation which may adversely
affect our ability to attract and retain employees. On June 17, 2009, the
Obama Administration published a comprehensive regulatory reform plan that is
intended to modernize and protect the integrity of the United States financial
system. The reform plan proposes, among other matters, the creation of a new
federal agency, the Consumer Financial Protection Agency, that would be
dedicated to protecting consumers in the financial products and services
market. The creation of this agency could result in new regulatory
requirements and raise the cost of regulatory compliance. In addition,
legislation stemming from the reform plan could require changes in regulatory
capital requirements, and compensation practices. If implemented, the
foregoing regulatory reforms may have a material impact on our operations.
However, because the legislation needed to implement the President's reform
plan has not been introduced, and because the final legislation may differ
significantly from the legislation proposed by the Administration, we cannot
determine the specific impact of regulatory reform at this time.
We may experience future goodwill impairment, which could reduce our earnings.
We performed our test for goodwill impairment for fiscal year 2009, but
no impairment was identified. Our assessment of the fair value of goodwill is
based on an evaluation of current purchase transactions, discounted cash flows
from forecasted earnings, our current market capitalization, and a valuation
of our assets. Our evaluation of the fair value of goodwill involves a
substantial amount of judgment. If our judgment was incorrect and an
impairment of goodwill was deemed to exist, we would be required to write down
our assets resulting in a charge to earnings, which would adversely affect our
results of operations, perhaps materially; however, it would have no impact on
our liquidity, operations or regulatory capital.
Our investment in Federal Home Loan Bank stock may become impaired.
At September 30, 2009, we owned $5.7 million in FHLB stock. As a
condition of membership at the FHLB, we are required to purchase and hold a
certain amount of FHLB stock. Our stock purchase requirement is based, in
part, upon the outstanding principal balance of advances from the FHLB and is
calculated in accordance with the Capital Plan of the FHLB. Our FHLB stock has
a par value of $100, is carried at cost, and it is subject to recoverability
testing per accounting guidance for the impairment of long-lived assets. The
FHLB recently announced that it had a risk-based capital deficiency under the
regulations of the Federal Housing Finance Agency (the "FHFA"), its primary
regulator, as of December 31, 2008, and that it would suspend future dividends
and the repurchase and redemption of outstanding common stock. As a result,
the FHLB has not paid a dividend since the fourth quarter of 2008. The FHLB
has communicated that it believes the calculation of risk-based capital under
the current rules of the FHFA significantly overstates the market risk of the
FHLB's private-label mortgage-backed securities in the current market
environment and that it has enough capital to cover the risks reflected in its
balance sheet. As a result, we have not recorded an other-than-temporary
impairment on our investment in FHLB stock. However, continued deterioration
in the FHLB's financial position may result in impairment in the value of
those securities. We will continue to monitor the financial condition of the
FHLB as it relates to, among other things, the recoverability of our
investment.
Risks specific to our participation in TARP.
Because of our participation in the TARP CPP we are subject to
restrictions on compensation paid to our executives. Pursuant to the terms of
the TARP CPP we adopted certain standards for executive compensation and
49
corporate governance for the period during which the Treasury holds an
investment in us. These standards generally apply to our Chief Executive
Officer, Chief Financial Officer and the three next most highly compensated
senior executive officers. The standards include (1) ensuring that incentive
compensation for senior executives does not encourage unnecessary and
excessive risks that threaten the value of the financial institution; (2)
required clawback of any bonus or incentive compensation paid to a senior
executive based on statements of earnings, gains or other criteria that are
later proven to be materially inaccurate; (3) prohibition on making golden
parachute payments to senior executives; and (4) agreement not to deduct for
tax purposes executive compensation in excess of $500,000 for each senior
executive. Pursuant to the American Recovery and Reinvestment Act and its
implementing regulations, further compensation restrictions have been imposed
on us with respect to our senior executive officers and other most highly
compensated employees, including significant limitations on our ability to pay
incentive compensation and make severance payments. Such restrictions and any
future limitations on compensation that may be adopted could adversely affect
our ability to hire and retain the most qualified management and other
personnel.
The securities purchase agreement between us and Treasury limits our
ability to pay dividends on and repurchase our common stock. The securities
purchase agreement between us and Treasury provides that prior to the earlier
of (i) December 23, 2011 and (ii) the date on which all of the shares of the
Series A Preferred Stock have been redeemed by us or transferred by Treasury
to third parties, we may not, without the consent of Treasury, (a) increase
the cash dividend on our common stock or (b) subject to limited exceptions,
redeem, repurchase or otherwise acquire shares of our common stock or
preferred stock other than the Series A Preferred Stock or any trust preferred
securities. In addition, we are unable to pay any dividends on our common
stock unless we are current in our dividend payments on the Series A Preferred
Stock. These restrictions, together with the potentially dilutive impact of
the warrant described in the next risk factor, could have a negative effect on
the value of our common stock. Moreover, holders of our common stock are
entitled to receive dividends only when, as and if declared by our Board of
Directors. Although we have historically paid cash dividends on our common
stock, we are not required to do so and our Board of Directors could reduce or
eliminate our common stock dividend in the future.
The Series A Preferred Stock impacts net income available to our common
shareholders and earnings per common share and the warrant we issued to
Treasury may be dilutive to holders of our common stock. The dividends
declared on the Series A Preferred Stock reduce the net income available to
common shareholders and our earnings per common share. The Series A Preferred
Stock will also receive preferential treatment in the event of liquidation,
dissolution or winding up of the Company. Additionally, the ownership interest
of the existing holders of our common stock will be diluted to the extent the
warrant we issued to Treasury in conjunction with the sale of the Series A
Preferred Stock is exercised. The shares of common stock underlying the
warrant represent approximately 5.0% of the shares of our common stock
outstanding as of September 30, 2009 (including the shares issuable upon
exercise of the warrant in total shares outstanding). Although Treasury has
agreed not to vote any of the shares of common stock it receives upon exercise
of the warrant, a transferee of any portion of the warrant or of any shares of
common stock acquired upon exercise of the warrant is not bound by this
restriction.
Item 1B. Unresolved Staff Comments
-----------------------------------
Not applicable.
50
Item 2. Properties
-------------------
At September 30, 2009 the Bank operated 22 full service facilities. The
following table sets forth certain information regarding the Bank's offices,
all of which are owned, except for the Tacoma office, the Gig Harbor office
and the Lacey office at 1751 Circle Lane SE, which are leased.
Approximate Deposits at
Location Year Opened Square Footage September 30, 2009
--------------------------- ----------- -------------- ------------------
(In thousands)
Main Office:
624 Simpson Avenue 1966 7,700 $82,342
Hoquiam, Washington 98550
Branch Offices:
300 N. Boone Street 1974 3,400 33,085
Aberdeen, Washington 98520
201Main Street South 2004 3200 31,573
Montesano, Washington 98563
361 Damon Road 1977 2,100 23,317
Ocean Shores, Washington 98569
2418 Meridian East 1980 2,400 37,197
Edgewood, Washington 98371
202 Auburn Way South 1994 4,200 24,686
Auburn, Washington 98002
12814 Meridian East (South Hill) 1996 4,200 29,766
Puyallup, Washington 98373
1201 Marvin Road, N.E. 1997 4,400 15,798
Lacey, Washington 98516
101 Yelm Avenue W. 1999 1,800 13,046
Yelm, Washington 98597
20464 Viking Way NW 1999 3,400 8,780
Poulsbo, Washington 98370
2419 224th Street E. 1999 3,900 23,676
Spanaway, Washington 98387
801 Trosper Road SW 2001 3,300 23,434
Tumwater, Washington 98512
7805 South Hosmer Street 2001 5,000 20,271
Tacoma, Washington 98408
2401 Bucklin Hill Road 2003 4,000 25,636
Silverdale, Washington 98383
423 Washington Street SE 2003 3,000 15,478
Olympia, Washington 98501
(table continued on following page)
51
Approximate Deposits at
Location Year Opened Square Footage September 30, 2009
--------------------------- ----------- -------------- ------------------
(In thousands)
3105 Judson St 2004 2,700 $13,520
Gig Harbor, Washington 98335
117 N. Broadway 2004 3,700 14,473
Aberdeen, Washington 98520
313 West Waldrip 2004 5,900 19,588
Elma, Washington 98541
1751 Circle Lane SE 2004 900 12,496
Lacey, Washington 98503
101 2nd Street 2004 1,800 19,643
Toledo, Washington 98591
209 NE 1st Street 2004 3,400 15,207
Winlock, Washington 98586
714 W. Main Street 2009 4,600 2,649
Chehalis, Washington 98532
Loan Center/Data Center:
120 Lincoln Street 2003 6,000
Hoquiam, Washington 98550
Other Properties:
305 8th Street(1)
Hoquiam, Washington 98550 2004 4,100
----------
(1) Office at 305 8th Street, Hoquiam, Washington was consolidated into the
office at 624 Simpson Avenue, Hoquiam, Washington on November 15, 2004.
The building is currently being used for storage and other administrative
purposes.
Management believes that all facilities are appropriately insured and are
adequately equipped for carrying on the business of the Bank.
At September 30, 2009 the Bank operated 23 proprietary ATMs that are part
of a nationwide cash exchange network.
Item 3. Legal Proceedings
--------------------------
Periodically, there have been various claims and lawsuits involving the
Bank, such as claims to enforce liens, condemnation proceedings on properties
in which the Bank holds security interests, claims involving the making and
servicing of real property loans and other issues incident to the Bank's
business. The Bank is not a party to any pending legal proceedings that it
believes would have a material adverse effect on the financial condition or
operations of the Bank.
Item 4. Submission of Matters to a Vote of Security Holders
------------------------------------------------------------
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended September 30, 2009.
52
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
------------------------------------------------------------------------------
Issuer Purchases of Equity Securities
-------------------------------------
The Company's common stock is traded on the Nasdaq Global Market under
the symbol "TSBK." As of November 30, 2009, there were 7,045,036 shares of
common stock issued and approximately 622 shareholders of record. The
following table sets forth the market price range of the Company's common
stock for the years ended September 30, 2009 and 2008. This information was
provided by the Nasdaq Stock Market.
High Low Dividends
------- ------- ---------
Fiscal 2009
-----------
First Quarter.............. $7.99 $5.10 $0.11
Second Quarter............. 7.93 1.94 0.11
Third Quarter.............. 6.00 3.57 0.11
Fourth Quarter............. 5.63 3.90 0.06
High Low Dividends
------- ------- ---------
Fiscal 2008
-----------
First Quarter.............. $16.28 $11.85 $0.10
Second Quarter............. 13.00 10.55 0.11
Third Quarter.............. 12.34 7.80 0.11
Fourth Quarter............. 9.40 5.90 0.11
Dividends
Dividend payments by the Company are dependent primarily on dividends
received by the Company from the Bank. Under federal regulations, the dollar
amount of dividends the Bank may pay is dependent upon its capital position
and recent net income. Generally, if the Bank satisfies its regulatory
capital requirements, it may make dividend payments up to the limits
prescribed in the FDIC regulations. However, institutions that have converted
to a stock form of ownership may not declare or pay a dividend on, or
repurchase any of, its common stock if the effect thereof would cause the
regulatory capital of the institution to be reduced below the amount required
for the liquidation account which was established in connection with the
mutual to stock conversion. In addition, the Bank is subject to restrictions
on its ability to pay dividends to its holding company under the terms of the
pending MOU. See "Item 1A, Risk Factors -- Risks Related to Our Business --
We are required to comply with the terms of a memoranda of understanding
issued by the FDIC and the Division and lack of compliance could result in
additional regulatory actions." Further, the Company also is subject to
restrictions on its ability to pay dividends pursuant to the terms of the
securities purchase agreement between the Company and the U.S. Treasury. For
additional information, see Item 1A, "Risk Factors -- Risks specific to our
participation in TARP."
Equity Compensation Plan Information
The equity compensation plan information presented under subparagraph (d)
in Part III, Item 12. of this Form 10-K is incorporated herein by reference.
Stock Repurchases
The Company has had various buy-back programs since January 1998. On
February 25, 2008, the Company announced a plan to repurchase 343,468 shares
of the Company's common stock. This was the Company's 16th stock repurchase
plan. As of September 30, 2009, the Company had not repurchased any shares
under this plan. The Company is subject to restrictions on its ability to
repurchase its common stock pursuant to the terms of the securities purchase
agreement between the Company and the U.S. Treasury. For additional
information, see Item 1A, "Risk Factors - Risks specific to our participation
in TARP." Cumulatively, the Company has repurchased 7,783,934 shares at an
average price of $8.98 per share. This represents 58.9% of the 13,225,000
shares that were issued when the Company went public in January 1998.
53
The following table sets forth the Company's repurchases of its
outstanding Common Stock during the fourth quarter of the year ended September
30, 2009.
Maximum
Total Number Number (or
of Shares Approximate
Purchased as Dollar Value)
Total Part of of Shares that
Number of Average Publicly May Yet Be
Shares Price Paid Announced Purchased
Period Purchased per Share Plans Under the Plans
----------------------- --------- ---------- ----------- ---------------
July 1, 2009 -
July 31, 2009......... -- -- -- 343,468
August 1, 2009 -
August 31, 2009....... -- -- -- 343,468
September 1, 2009 -
September 30, 2009.... -- -- -- 343,468
Total.................. -- -- -- 343,468
--------------
(1) As part of the Company's participation in the Treasury's Capital Purchase
Program the repurchase program announced on February 25, 2008 was
suspended indefinitely.
54
The following graph compares the cumulative total shareholder return on
our common stock with the cumulative total return on the Nasdaq U.S. Companies
Index and with the SNL $250 to $500 Million Asset Thrift Index and the SNL
$500 to $1 Billion Asset Thrift Index, peer group indices. Total return
assumes the reinvestment of all dividends and that the value of the Company's
Common Stock and each index was $100 on September 30, 2004.
[GRAPH APPEARS HERE]
Period Ending
----------------------------------------------------------
Index 09-30-04 09-30-05 09-30-06 09-30-07 09-30-08 09-30-09
------------------ -------- -------- -------- -------- -------- --------
Timberland Bancorp,
Inc.............. $100.00 101.42 157.11 143.08 71.88 47.44
NASDAQ Composite.. 100.00 113.44 119.06 142.42 110.28 111.89
SNL $250m-$500 M
Thrift Index..... 100.00 98.33 107.00 98.87 84.07 78.82
SNL $500m-$1 B
Thrift Index..... 100.00 102.03 118.53 114.23 85.53 71.61
* Source: SNL Financial LC, Charlottesville, VA
55
Item 6. Selected Financial Data
--------------------------------
The following table sets forth certain information concerning the
consolidated financial position and results of operations of the Company and
subsidiaries at and for the dates indicated. The consolidated data is
derived in part from, and should be read in conjunction with, the Consolidated
Financial Statements of the Company and its subsidiary presented herein.
At September 30,
---------------------------------------------
2009 2008 2007 2006 2005
------ ------ ------ ------ ------
(In thousands)
SELECTED FINANCIAL CONDITION DATA:
Total assets.................$701,676 $681,883 $644,848 $577,087 $552,765
Loans receivable and loans
held for sale, net.......... 547,208 557,687 515,341 424,645 388,109
Investment securities
available-for-sale.......... -- -- 50,851 63,805 65,860
Investment securities
held-to-maturity............ 27 28 -- -- --
Mortgage-backed securities
held-to-maturity............ 7,060 14,205 71 75 104
Mortgage-backed securities
available-for-sale.......... 13,471 17,098 13,047 17,603 23,735
FHLB Stock................... 5,705 5,705 5,705 5,705 5,705
Cash and due from financial
institutions, interest-
bearing deposits in banks
and fed funds sold......... 66,462 42,874 16,670 22,789 28,718
Certificates of deposit
held for investment........ 3,251 -- -- 100 --
Deposits.................... 505,661 498,572 466,735 431,061 411,665
FHLB advances............... 95,000 104,628 99,697 62,761 62,353
Federal Reserve Bank
advances................... 10,000 -- -- -- --
Shareholders' equity........ 87,199 74,841 74,547 79,365 74,642
Year Ended September 30,
---------------------------------------------
2009 2008 2007 2006 2005
------ ------ ------ ------ ------
(In thousands, except per share data)
SELECTED OPERATING DATA:
Interest and dividend
income.................... $38,801 $43,338 $41,944 $35,452 $30,936
Interest expense............ 13,504 16,413 15,778 10,814 8,609
------- ------- ------- ------- -------
Net interest income......... 25,297 26,295 26,166 24,638 22,327
Provision for loan losses... 10,734 3,900 686 -- 141
------- ------- ------- ------- -------
Net interest income after...
provision for loan losses.. 14,563 23,025 25,480 24,638 22,186
Non-interest income......... 6,949 4,178 5,962 6,244 6,073
Non-interest expense........ 22,739 20,374 19,451 18,896 18,536
Income (loss) before
income taxes.............. (1,227) 6,829 11,991 11,986 9,723
Provision (benefit) for
federal and state income
taxes...................... (985) 2,824 3,828 3,829 3,105
------- ------- ------- ------- -------
Net income (loss)........... $ (242) $ 4,005 $ 8,163 $ 8,157 $ 6,618
======= ======= ======= ======= =======
Preferred stock dividends... $ 643 $ -- $ -- $ -- $ --
Preferred stock accretion... 129 -- -- -- --
------- ------- ------- ------- -------
Net income (loss) available
to common shareholders..... $(1,014) $ 4,005 $ 8,163 $ 8,157 $ 6,618
======= ======= ======= ======= =======
Earnings (loss) per common
share (1):
Basic..................... $ (0.15) $ 0.62 $ 1.20 $ 1.16 $ 0.95
Diluted................... $ (0.15) $ 0.61 $ 1.17 $ 1.12 $ 0.91
Dividends per common share
(1)........................ $ 0.39 $ 0.43 $ 0.37 $ 0.33 $ 0.31
Dividend payout ratio (2)... N/A 74.33% 32.86% 30.55% 35.01%
-----------------
(1) Has been restated to reflect the two-for-one split of common stock, in
the form of a 100% stock dividend paid on June 5, 2007.
(2) Cash dividends to common shareholders divided by net income (loss)
available to common shareholders.
56
At September 30,
---------------------------------------------
2009 2008 2007 2006 2005
------ ------ ------ ------ ------
OTHER DATA:
Number of real estate loans
outstanding.................. 3,062 3,261 3,295 3,005 3,022
Deposit accounts.............. 53,941 53,501 53,166 51,392 51,496
Full-service offices.......... 22 21 21 21 21
At or For the Year Ended September 30,
---------------------------------------------
2009 2008 2007 2006 2005
------ ------ ------ ------ ------
KEY FINANCIAL RATIOS:
Performance Ratios:
Return (loss) on average
assets (1).................. (0.04)% 0.61% 1.34% 1.47% 1.23%
Return (loss) on average
equity (2).................. (0.28) 5.35 10.67 10.59 9.08
Interest rate spread (3)..... 3.64 3.98 4.18 4.49 4.30
Net interest margin (4)...... 4.01 4.41 4.69 4.91 4.60
Average interest-earning
assets to average interest-
bearing liabilities......... 117.42 115.70 118.01 119.20 116.56
Noninterest expense as a
percent of average total
assets...................... 3.35 3.10 3.20 3.41 3.44
Efficiency ratio (5)......... 70.52 65.42 60.54 61.19 65.27
Book value per share (6)..... 10.17 $10.74 $10.72 $10.56 $ 9.93
Book value per share (7)..... 10.68 11.34 11.39 11.22 10.65
Tangible book value per share
(6)(8)....................... 9.26 9.79 9.73 9.61 8.93
Tangible book value per share
(7)(8)....................... 9.72 10.34 10.34 10.21 9.58
Asset Quality Ratios:
Non-accrual and 90 days or
more past due loans as a
percent of total loans
receivable, net............. 5.36% 2.12% 0.29% 0.02% 0.75%
Non-performing assets as a
percent of total assets (9). 5.41 1.83 0.23 0.02 0.62
Allowance for loan losses as
a percent of total loans
receivable, net (10)........ 2.59 1.44 0.92 0.96 1.05
Allowance for losses as a
percent of non-performing
loans (11).................. 48.39 67.14 321.95 5,152.50 140.09
Net charge-offs (recoveries)
to average outstanding
loans....................... 0.79 0.12 (0.01) 0.01
Capital Ratios:
Total equity-to-assets
ratio....................... 12.43% 10.98% 11.56% 13.75% 13.50%
Tangible equity-to-assets
ratio...................... 9.30 10.00 10.49 12.51 12.15
Average equity to average
assets...................... 12.72 11.47 12.58 13.90 13.53
-----------
(1) Net income divided by average total assets.
(2) Net income divided by average total equity.
(3) Difference between weighted average yield on interest-earning assets and
weighted average cost of interest-bearing liabilities.
(4) Net interest income (before provision for loan losses) as a percentage of
average interest-earning assets.
(5) Other expenses (excluding federal income tax expense) divided by the sum
of net interest income and noninterest income.
(6) Calculation includes Employee Stock Ownership Plan ("ESOP") shares not
committed to be released.
(7) Calculation excludes ESOP shares not committed to be released.
(8) Calculation subtracts goodwill and core deposit intangible from the
equity component.
(9) Non-performing assets include non-accrual loans, other real estate owned
and other repossessed assets.
(10) Loans receivable includes loans held for sale and is before the allowance
for loan losses.
(11) Non-performing loans include non-accrual loans. Troubled debt
restructured loans that are on accrual status are not included.
57
Item 7. Management's Discussion and Analysis of Financial Condition and
------------------------------------------------------------------------
Results of Operations
---------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
Management's Discussion and Analysis of Financial Condition and Results
of Operations is intended to assist in understanding the consolidated
financial condition and results of operations of the Company. The information
contained in this section should be read in conjunction with the Consolidated
Financial Statements and accompanying notes thereto included in Item 8 of this
Annual Report on Form 10-K.
Special Note Regarding Forward-Looking Statements
These forward-looking statements are intended to be covered by the safe
harbor for forward- looking statements provided by the Private Securities
Litigation Reform Act of 1995. Forward-looking statements are not statements
of historical fact and often include 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 future performance. These forward-looking statements are subject to
known and unknown risks, uncertainties and other factors that could cause
actual results to differ materially from the results anticipated, including,
but not limited to: the credit risks of lending activities, including changes
in the level and trend of loan delinquencies and write-offs and changes in our
allowance for loan losses and provision for loan losses that may be impacted
by deterioration in the housing and commercial real estate markets and may
lead to increased losses and nonperforming assets in our loan portfolio, and
may result in our allowance for loan losses not being adequate to cover actual
losses, and require us to materially increase our reserves; changes in general
economic conditions, either nationally or in our market areas; changes in the
levels of general interest rates, and the relative differences between short
and long term interest rates, deposit interest rates, our net interest margin
and funding sources; fluctuations in the demand for loans, the number of
unsold homes, land and other properties and fluctuations in real estate values
in our market areas; secondary market conditions for loans and our ability to
sell loans in the secondary market; results of examinations of us by the FDIC
and the Division or other regulatory authorities, including the possibility
that any such regulatory authority may, among other things, require us to
increase our reserve for loan losses, write-down assets, change our regulatory
capital position or affect our ability to borrow funds or maintain or increase
deposits, which could adversely affect our liquidity and earnings; our
compliance with regulatory enforcement actions; legislative or regulatory
changes that adversely affect our business including changes in regulatory
policies and principles, or the interpretation of regulatory capital or other
rules; our ability to attract and retain deposits; further 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; computer systems on which we depend could
fail or experience a security breach; our ability to retain key members of our
senior management team; costs and effects of litigation, including settlements
and judgments; our ability to successfully integrate any assets, liabilities,
customers, systems, and management personnel we may in the future acquire into
our operations and our ability to realize related revenue synergies and cost
savings within expected time frames and any goodwill charges related thereto;
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; legislative or
regulatory changes that adversely affect our business including changes in
regulatory polices and principles, including the interpretation of regulatory
capital or other rules; the availability of resources to address changes in
laws, rules, or regulations or to respond to regulatory actions; adverse
changes in the securities markets; 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
58
methods; and other economic, competitive, governmental, regulatory, and
technological factors affecting our operations, pricing, products and services
and the other risks described elsewhere in this Form 10-K.
Any forward-looking statements are based upon management's beliefs and
assumptions at the time they are made. We undertake no obligation to publicly
update or revise any forward-looking statements included in this annual report
or to update the reasons why actual results could differ from those contained
in such statements, whether as a result of new information, future events or
otherwise. We caution readers not to place undue reliance on any
forward-looking statements. We do not undertake and specifically disclaim any
obligation to revise any forward-looking statements to reflect the occurrence
of anticipated or unanticipated events or circumstances after the date of such
statements. These risks could cause our actual results for 2010 and beyond to
differ materially from those expressed in any forward-looking statements by,
or on behalf of, us, and could negatively affect the Company's operating and
stock price performance.
Critical Accounting Policies and Estimates
The Company has established various accounting policies that govern the
application of accounting principles generally accepted in the United States
of America ("GAAP") in the preparation of the Company's Consolidated Financial
Statements. The Company has identified five policies, that as a result of
judgments, estimates and assumptions inherent in those policies, are critical
to an understanding of the Company's Consolidated Financial Statements. These
policies relate to the methodology for the determination of the allowance for
loan losses, the valuation of mortgage servicing rights ("MSRs"), the
determination of other than temporary impairments in the market value of
investment securities, the determination of goodwill impairment and the
determination of the recorded value of other real estate owned. These
policies and the judgments, estimates and assumptions are described in greater
detail in subsequent sections of Management's Discussion and Analysis
contained herein and in the notes to the Consolidated Financial Statements
contained in Item 8 of this Form 10-K. In particular, Note 1 of the Notes to
Consolidated Financial Statements, "Summary of Significant Accounting
Policies," generally describes the Company's accounting policies. Management
believes that the judgments, estimates and assumptions used in the preparation
of the Company's Consolidated Financial Statements are appropriate given the
factual circumstances at the time. However, given the sensitivity of the
Company's Consolidated Financial Statements to these critical policies, the
use of other judgments, estimates and assumptions could result in material
differences in the Company's results of operations or financial condition.
Allowance for Loan Losses. The allowance for loan losses is maintained
at a level sufficient to provide for probable loan losses based on evaluating
known and inherent risks in the portfolio. The allowance is based upon
management's comprehensive analysis of the pertinent factors underlying the
quality of the loan portfolio. These factors include changes in the amount
and composition of the loan portfolio, actual loan loss experience, current
economic conditions, and detailed analysis of individual loans for which full
collectibility may not be assured. The detailed analysis includes methods to
estimate the fair value of loan collateral and the existence of potential
alternative sources of repayment. The appropriate allowance for loan loss
level is estimated based upon factors and trends identified by management at
the time the consolidated financial statements are prepared.
Mortgage Servicing Rights. Mortgage servicing rights are capitalized
when acquired through the origination of loans that are subsequently sold with
servicing rights retained and are amortized to servicing income on loans sold
in proportion to and over the period of estimated net servicing income. The
value of MSRs at the date of the sale of loans is determined based on the
discounted present value of expected future cash flows using key assumptions
for servicing income and costs and prepayment rates on the underlying loans.
The estimated fair value is evaluated at least annually by a third party
firm for impairment by comparing actual cash flows and estimated cash flows
from the servicing assets to those estimated at the time servicing assets were
originated. The effect of changes in market interest rates on estimated rates
of loan prepayments represents the predominant risk characteristic underlying
the MSRs' portfolio. The Company's methodology for estimating the fair value
of MSRs is highly sensitive to changes in assumptions. For example, the
determination of fair value uses anticipated prepayment speeds. Actual
prepayment experience may differ and any difference may have a material effect
59
on the fair value. Thus, any measurement of MSRs' fair value is limited by
the conditions existing and assumptions as of the date made. Those
assumptions may not be appropriate if they are applied at different times.
OTTIs (Other-Than-Temporary Impairments) in the Market Value of
Investment Securities. Unrealized investment securities losses on available
for sale and held to maturity securities are evaluated at least quarterly to
determine whether declines in value should be considered "other than
temporary" and therefore be subject to immediate loss recognition through
earnings for the portion related to credit losses. Although these evaluations
involve significant judgment, an unrealized loss in the fair value of a debt
security is generally deemed to be temporary when the fair value of the
security is below the recorded value primarily as a result of changes in
interest rates, when there has not been significant deterioration in the
financial condition of the issuer, and the Company has the intent and the
ability to hold the security for a sufficient time to recover the recorded
value. An unrealized loss in the value of an equity security is generally
considered temporary when the fair value of the security is below the recorded
value primarily as a result of current market conditions and not a result of
deterioration in the financial condition of the issuer or the underlying
collateral (in the case of mutual funds) and the Company has the intent and
the ability to hold the security for a sufficient time to recover the recorded
value. Other factors that may be considered in determining whether a decline
in the value of either a debt or equity security is "other than temporary"
include ratings by recognized rating agencies; capital strength and near-term
prospects of the issuer, and recommendation of investment advisors or market
analysts. Therefore, continued deterioration of current market conditions
could result in additional impairment losses recognized within the Company's
investment portfolio.
Goodwill. Goodwill is initially recorded when the purchase price paid for
an acquisition exceeds the estimated fair value of the net identified tangible
and intangible assets acquired. Goodwill is presumed to have an indefinite
useful life and is analyzed annually for impairment. An annual review is
performed at the end of the third quarter of each fiscal year, or more
frequently if indicators of potential impairment exist, to determine if the
recorded goodwill is impaired. If the fair value of the Company's sole
reporting unit exceeds the recorded value of the reporting unit, goodwill is
not considered impaired and no additional analysis is necessary.
One of the circumstances evaluated when determining if an impairment test
of goodwill is needed more frequently than annually is the extent and duration
that the Company's market capitalization (total common shares outstanding
multiplied by current stock price) is less than the total equity applicable to
common shareholders. During the quarter ended March 31, 2009, the Company's
market capitalization decreased to a level that required a goodwill impairment
test prior to the annual test. Therefore, the Company engaged a third party
firm to perform an interim test for goodwill impairment during the quarter
ended March 31, 2009. The test concluded that recorded goodwill was not
impaired. The Company updated the interim test for goodwill impairment
internally during the quarter ended June 30, 2009 and concluded that recorded
goodwill was not impaired. As of September 30, 2009, there have been no
events or changes in the circumstances that would indicate a potential
impairment. No assurance can be given, however, that the Company will not
record an impairment loss on goodwill in the future.
Other Real Estate Owned and Other Repossessed Items. Other real estate
owned and other repossessed items consist of properties or assets acquired
through or in lieu of foreclosure, and are recorded initially at the fair
value of the properties less estimated costs of disposal. Costs relating to
development and improvement of the properties or assets are capitalized while
costs relating to holding the properties or assets are expensed. Valuations
are periodically performed by management, and a charge to earnings is recorded
if the recorded value of a property exceeds its estimated net realizable
value.
New Accounting Pronouncements
For a discussion of new accounting pronouncements and their impact on
the Company, see Note 1 of the Notes to the Consolidated Financial Statements
contained in "Item 8. Financial Statements and Supplementary Data."
60
Operating Strategy
The Company is a bank holding company which operates primarily through
its subsidiary, the Bank. The Bank is a community-oriented bank which has
traditionally offered a wide variety of savings products to its retail
customers while concentrating its lending activities on real estate loans.
The primary elements of the Bank's operating strategy include:
Diversify Primary Market Area by Expanding Branch Office Network. In an
effort to lessen its dependence on the Grays Harbor County market whose
economy has historically been tied to the timber and fishing industries, the
Bank has opened branch offices in Pierce, King, Thurston and Kitsap Counties.
Pierce, King, Thurston and Kitsap Counties contain the Olympia, Bremerton, and
Seattle-Tacoma metropolitan areas and their economies are more diversified
with the presence of government, aerospace and computer technology industries.
In October 2004, the Bank continued its geographic diversification by
acquiring two branches in Lewis County as part of a seven-branch acquisition.
In August 2008, the Bank announced plans to open an additional full-service
branch in Lewis County, which opened in May 2009. With the construction of
this new branch office, the Bank's existing loan production office in Lewis
County was consolidated into the new facility.
Limit Exposure to Interest Rate Risk. In recent years, a majority of
the loans that the Bank has retained in its portfolio generally have periodic
interest rate adjustment features or have been relatively short-term in
nature. Loans originated for portfolio retention primarily have included ARM
loans and short-term construction loans. Longer term fixed-rate mortgage
loans have generally been originated for sale in the secondary market.
Management believes that the interest rate sensitivity of these
adjustable-rate and short-term loans more closely match the interest rate
sensitivity of the Bank's funding sources than other longer duration assets
with fixed-interest rates.
Emphasize Residential Mortgage Lending. The Bank has historically
attempted to establish itself as a niche lender in its primary market areas by
focusing a part of its lending activities on the origination of loans secured
by one- to four-family residential dwellings, including loans for the
construction of residential dwellings. In an effort to meet the credit needs
of borrowers in its primary market areas, the Bank originates one- to
four-family mortgage loans that do not qualify for sale in the secondary
market under FHLMC guidelines. The Bank has also been an active participant in
the secondary market, originating residential loans for sale to the FHLMC on a
servicing retained basis. The Bank occasionally retains fixed-rate one- to
four-family mortgage loans in its portfolio for yield and asset-liability
management purposes.
Emphasize the Origination of Commercial Real Estate and Commercial
Business Loans. The Bank has hired additional commercial loan officers since
2006 for the purpose of increasing the Bank's origination of commercial real
estate and commercial business loans.
Increase the Consumer Loan Portfolio. In 2001 the Bank hired a consumer
loan specialist to increase the origination of consumer loans. The consumer
loans generated since that time have been secured primarily by real estate.
The Bank expects to continue expanding its portfolio of consumer loans.
Pursue Low Cost Core Deposits and Deposit Related Fee Income. The Bank
has placed an emphasis on attracting commercial and personal checking
accounts. These transactional accounts typically provide a lower cost of
funding than certificates of deposit accounts and generate non-interest fee
income. In October 2004, the Bank increased its transaction account base by
acquiring seven branches and the related deposits.
Market Risk and Asset and Liability Management
General. Market risk is the risk of loss from adverse changes in market
prices and rates. The Company's market risk arises primarily from interest
rate risk inherent in its lending, investment, deposit and borrowing
activities. The Bank, like other financial institutions, is subject to
interest rate risk to the extent that its interest-earning assets reprice
differently than its interest-bearing liabilities. Management actively
monitors and manages its interest rate risk exposure. Although the Bank
manages other risks, such as credit quality and liquidity risk, in the normal
course of
61
business management considers interest rate risk to be its most significant
market risk that could potentially have the largest material effect on the
Bank's financial condition and results of operations. The Bank does not
maintain a trading account for any class of financial instruments nor does it
engage in hedging activities. Furthermore, the Bank is not subject to foreign
currency exchange rate risk or commodity price risk.
Qualitative Aspects of Market Risk. The Bank's principal financial
objective is to achieve long-term profitability while reducing its exposure to
fluctuating market interest rates. The Bank has sought to reduce the exposure
of its earnings to changes in market interest rates by attempting to manage
the difference between asset and liability maturities and interest rates. The
principal element in achieving this objective is to increase the interest-rate
sensitivity of the Bank's interest-earning assets by retaining in its
portfolio, short-term loans and loans with interest rates subject to periodic
adjustments. The Bank relies on retail deposits as its primary source of
funds. As part of its interest rate risk management strategy, the Bank
promotes transaction accounts and certificates of deposit with terms of up to
six years.
The Bank has adopted a strategy that is designed to substantially match
the interest rate sensitivity of assets relative to its liabilities. The
primary elements of this strategy involve originating ARM loans for its
portfolio, maintaining residential construction loans as a portion of total
net loans receivable because of their generally shorter terms and higher
yields than other one- to four-family residential mortgage loans, matching
asset and liability maturities, investing in short-term securities,
originating fixed-rate loans for retention or sale in the secondary market,
and retaining the related mortgage servicing rights.
Sharp increases or decreases in interest rates may adversely affect the
Bank's earnings. Management of the Bank monitors the Bank's interest rate
sensitivity through the use of a model provided for the Bank by FIMAC
Solutions, LLC ("FIMAC"), a company that specializes in providing the
financial services industry interest risk rate risk and balance sheet
management services. Based on a rate shock analysis prepared by FIMAC based on
data at September 30, 2009, an immediate increase in interest rates of 200
basis points would increase the Bank's projected net interest income by
approximately 2.1%, primarily because a larger portion of the Bank's interest
rate sensitive assets than interest rate sensitive liabilities would reprice
within a one year period. Similarly, an immediate 200 basis point decrease in
interest rates would negatively affect net interest income by approximately
3.8%, as repricing would have the opposite effect. See "- Quantitative
Aspects of Market Risk" below for additional information. Management has
sought to sustain the match between asset and liability maturities and rates,
while maintaining an acceptable interest rate spread. Pursuant to this
strategy, the Bank actively originates adjustable-rate loans for retention in
its loan portfolio. Fixed-rate mortgage loans with maturities greater than
seven years generally are originated for the immediate or future resale in
the secondary mortgage market. At September 30, 2009, adjustable-rate
mortgage loans constituted $229.1 million or 68.8%, of the Bank's total
mortgage loan portfolio due after one year. Although the Bank has sought to
originate ARM loans, the ability to originate such loans depends to a great
extent on market interest rates and borrowers' preferences. Particularly in
lower interest rate environments, borrowers often prefer fixed-rate loans.
Consumer loans and construction and land development loans typically
have shorter terms and higher yields than permanent residential mortgage
loans, and accordingly reduce the Bank's exposure to fluctuations in interest
rates. At September 30, 2009, the construction and land development, and
consumer loan portfolios amounted to $139.7 million and $51.6 million, or
23.5% and 8.7% of total loans receivable (including loans held for sale),
respectively.
Quantitative Aspects of Market Risk. The model provided for the Bank by
FIMAC estimates the changes in net portfolio value ("NPV") and net interest
income in response to a range of assumed changes in market interest rates.
The model first estimates the level of the Bank's NPV (market value of assets,
less market value of liabilities, plus or minus the market value of any
off-balance sheet items) under the current rate environment. In general,
market values are estimated by discounting the estimated cash flows of each
instrument by appropriate discount rates. The model then recalculates the
Bank's NPV under different interest rate scenarios. The change in NPV under
the different interest rate scenarios provides a measure of the Bank's
exposure to interest rate risk. The following table is provided by FIMAC
based on data at September 30, 2009.
62
Net Interest Income(1)(2) Current Market Value
Hypothetical ------------------------------ -------------------------------
Interest Rate Estimated $ Change % Change Estimated $ Change % Change
Scenario Value from Base from Base Value from Base from Base
------------- --------- --------- --------- --------- --------- ---------
(Basis Points) (Dollars in thousands)
+300 $24,411 $ 690 2.91% $80,626 $(8,526) (9.56)%
+200 24,226 505 2.13 83,917 (5,235) (5.87)
+100 24,077 356 1.50 87,568 (1,584) (1.78)
BASE 23,721 -- -- 89,152 -- --
-100 23,466 (255) (1.08) 89,188 36 0.04
-200 22,825 (896) (3.78) 90,902 1,750 1.96
-300 21,447 (2,274) (9.59) 95,279 6,127 6.87
-----------
(1) Does not include loan fees.
(2) Includes BOLI income, which is included in non-interest income on the
Consolidated Financial Statements.
Computations of prospective effects of hypothetical interest rate changes
are based on numerous assumptions, including relative levels of market
interest rates, loan repayments and deposit decay, and should not be relied
upon as indicative of actual results. Furthermore, the computations do not
reflect any actions management may undertake in response to changes in
interest rates.
In the event of a 200 basis point decrease in interest rates, the Bank
would be expected to experience a 2.0% increase in NPV and a 3.8% decrease in
net interest income. In the event of a 200 basis point increase in interest
rates, a 5.9% decrease in NPV and a 2.1% increase in net interest income would
be expected. Based upon the modeling described above, the Bank's asset and
liability structure generally results in decreases in net interest income in a
declining interest rate scenario and increases in net interest income in a
rising rate scenario. This structure also generally results in decreases in
NPV in rising rate scenarios and increases in NPV in declining rate scenarios.
As with any method of measuring interest rate risk, certain shortcomings
are inherent in the method of analysis presented in the foregoing table. For
example, although certain assets and liabilities may have similar maturities
or periods to repricing, they may react in different degrees to changes in
market interest rates. Also, the interest rates on certain types of assets
and liabilities may fluctuate in advance of changes in market interest rates,
while interest rates on other types may lag behind changes in market rates.
Additionally, certain assets have features which restrict changes in interest
rates on a short-term basis and over the life of the asset. Further, in the
event of a change in interest rates, expected rates of prepayments on loans
and early withdrawals from certificates could possibly deviate significantly
from those assumed in calculating the table.
Comparison of Financial Condition at September 30, 2009 and September 30, 2008
The Company's total assets increased by $19.8 million, or 2.9%, to $701.7
million at September 30, 2009 from $681.9 million at September 30, 2008,
primarily attributable to a $26.8 million increase in cash equivalents and
certificate of deposits held for investment, a $7.7 million increase in OREO
and other repossessed items, a $1.3 million increase in mortgage servicing
rights and a $1.2 million increase in premises and equipment. This increase
was partially offset by a $10.5 million decrease in net loans receivable and a
$10.8 million decrease in investment and mortgage-backed securities. This
asset growth was primarily funded by a $7.1 million increase in deposits
increased capital from the sale of senior preferred stock.
The Company's capital increased by $12.4 million, or 16.5%, to $87.2
million at September 30, 2009 from $74.8 million at September 30, 2008,
primarily as a result of the sale of $16.6 million in senior preferred stock
to the U.S. Treasury Department as part of the Treasury's Capital Purchase
Program. The Company remains well capitalized with a total capital to
risk-weighted assets ratio of 15.9% at September 30, 2009.
63
A more detailed explanation of the changes in significant balance sheet
categories follows:
Cash Equivalents and Certificate of Deposits Held for Investment: Cash
equivalents and certificate of deposits held for investment increased by $26.2
million, or 62.6%, to $69.7 million at September 30, 2009 from $42.9 million
at September 30, 2008. The increase in cash equivalents was primarily due to
the Company's decision to increase its liquidity position.
Investment Securities and Mortgage-backed Securities and FHLB Stock:
Investment and mortgage-backed securities (including FHLB stock) decreased by
$10.8 million, or 29.1%, to $26.3 million at September 30, 2009 from $37.0
million at September 30, 2008. The decrease was primarily as a result of
regular amortization and prepayments on mortgage-backed securities and a $5.9
million gross impairment charge recorded on private label mortgage-backed
securities. The securities on which the OTTI charges were recognized were
acquired from the in-kind redemption of the Bank's investment in the AMF
family of mutual funds in June 2008 and the impairment charge was recorded
through earnings for the credit related portion and through other
comprehensive loss for the non-credit related portion. For additional details
on investments and mortgage-backed securities, see "Item 1, Business
Investment Activities" and Note 3 of the Notes to the Consolidated Financial
Statements contained in "Item 8, Financial Statements and Supplemental Data."
Loans Receivable and Loans Held for Sale, Net of Allowance for Loan
Losses: Net loans receivable, including loans held for sale, decreased by
$10.5 million or 1.9% to $547.2 million at September 30, 2009 from $557.7
million at September 30, 2008. The decrease in the portfolio was primarily a
result of a $34.6 million decrease in construction loans (net of the
undisbursed portion of construction loans in process), a $7.8 million decrease
in consumer loans, a $7.2 million decrease in commercial business loans, a
$1.7 million decrease in one- to four-family mortgage loans and a $6.1 million
increase in the allowance for loan losses. These decreases were partially
offset by a $42.0 million increase in commercial real estate loan and a $4.9
million increase in land loans.
Loan originations (including participation interests purchased) increased
by 11.8% to $295.3 million for the year ended September 30, 2009 from $261.4
million for the year ended September 30, 2008. The Bank sold $162.9 million
in fixed rate one- to four-family mortgage loans during the year ended
September 30, 2009 compared to $45.3 million for the fiscal year ended
September 30, 2008. For additional information on loans, see "Item 1,
Business Lending Activities" and Note 4 of the Notes to Consolidated Financial
Statements contained in "Item 8, Financial Statements and Supplementary Data."
Premises and Equipment: Premises and equipment increased by $1.2 million,
or 6.9%, to $18.0 million at September 30, 2009 from $16.9 million at
September 30, 2008. The increase was primarily as a result of the
construction of the Bank's new branch facility in Chehalis, Washington and
remodeling costs associated with several branch offices. These increases were
partially offset by depreciation and the sale of a portion of the Bank's
Edgewood branch office property in lieu of an eminent domain action to
facilitate a road widening project. For additional information on premises
and equipment, see "Item 2, Properties" and Note 6 of the Notes to
Consolidated Financial Statements contained in "Item 8, Financial Statements
and Supplementary Data."
Other Real Estate Owned ("OREO"): OREO and other repossessed items
increased by $7.7 million, or 1,501.8% to $8.2 million at September 30, 2009
from $511,000 at September 30, 2008. The balance was comprised of 26
individual properties representing 14 relationships. The largest OREO
property had a balance of $2.31 million and consisted of a 78 lot plat located
in Richland, Washington. For additional information on OREO, see "Item 1,
Business Lending Activities Nonperforming Assets" and Note 7 of the Notes to
Consolidated Financial Statements contained in "Item 8, Financial Statements
and Supplementary Data."
Goodwill and Core Deposit Intangible ("CDI"): The value of goodwill at
$5.7 million at September 30, 2009 remained unchanged from September 30, 2008.
The amortized value of CDI decreased by $217,000 to $755,000 at September 30,
2009 from $972,000 at September 30, 2008 due to scheduled amortization. The
Company recorded goodwill and CDI in connection with the October 2004
acquisition of seven branches and related deposits. The Company performed its
annual review of goodwill as of June 30, 2009 and determined that there was no
impairment to
64
goodwill. For additional information of goodwill and CDI, see Note 1 and Note
8 of the Notes to Consolidated Financial Statements contained in "Item 8,
Financial Statements and Supplemental Data."
Deposits: Deposits increased by $7.09 million, or 1.4%, to $505.7 million
at September 30, 2009 from $498.6 million at September 30, 2008, primarily due
to a $26.9 million increase in N.O.W. checking account balances, a $9.7
million increase in non-brokered certificate of deposit account balances and a
$2.2 million increase in savings account balances. These increases were
partially offset by a $22.2 million decrease in brokered certificate of
deposit account balances, a $7.9 million decrease in money market account
balances, and a $1.7 million decrease in non-interest checking account
balances. For additional information on deposits, see "Item 1, Business
Deposit Activities and Other Sources of Funds" and Note 9 of the Consolidated
Financial Statements contained in "Item 8, Financial Statements and
Supplementary Data."
FHLB Advances and Other Borrowings: FHLB advances and other borrowings
increased by $391,000, or 0.4%, to $105.8 million at September 30, 2008 from
$105.4 million at September 30, 2009 as the Bank used additional advances to
fund a small portion of asset growth. For additional information on
borrowings, see "Item 1, Business Deposit Activities and Other Sources of
Funds Borrowings" and Notes 10 and 11 of the Notes to Consolidated Financial
Statements contained in "Item 8, Financial Statements and Supplementary Data."
Shareholders' Equity: Total shareholders' equity increased by $12.4
million, or 16.5%, to $87.2 million at September 30, 2009 from $74.8 million
at September 30, 2008. The increase was primarily a result of the sale of
$16.6 million in senior preferred stock to the U.S. Treasury Department as
part of the Treasury's Capital Purchase Program. As part of the transaction,
the Company also issued warrants to the Treasury to purchase up to $2.5
million in common stock. The transaction is part of the Treasury's program to
encourage qualified financial institutions to build capital to increase the
flow of financing to businesses and consumers and to support the U.S. economy.
Also impacting shareholders' equity during the year ended September 30,
2009 was the payment of $3.3 million in cash dividends on common and preferred
stock and a $994,000 increase in the accumulated other comprehensive loss
equity category. For additional information on shareholders' equity, see the
Consolidated Statements of Shareholders' Equity contained in "Item 8,
Financial Statements and Supplementary Data."
Comparison of Operating Results for the Years Ended September 30, 2009 and
2008
The Company's net income decreased by $4.25 million, or 106.0%, to a net
loss of $(242,000) for the year ended September 30, 2009 from net income of
$4.01 million for the year ended September 30, 2008. Income available to
common stock after adjusting for the preferred stock dividend and the
preferred stock discount accretion was a loss of $(1.01 million) for the year
ended September 30, 2009 compared to income of $4.01 million available to
common stock for the year ended September 30, 2008. The decrease was
primarily as a result of increased provision for loan losses, decreased net
interest income, and increased non-interest expenses, which were partially
offset by increased non-interest income. Diluted earnings per common share
decreased by 124.6% to a loss of $(0.15) for the year ended September 30, 2009
from $0.61 for the year ended September 30, 2008.
The increased provision for loan losses was primarily a result of an
increase in net charge-offs, an increase in impaired loans, an increase in the
level of performing loans classified as substandard under the Bank's loan
grading system, and uncertainties in real estate values in the Pacific
Northwest. Net charge-offs totaled $4.44 million during the year ended
September 30, 2009, which was equivalent to 0.79% of the average outstanding
loans.
The decreased net interest income was primarily attributable to an
increase in non-accrual loans and lower overall market interest rates, which
compressed the Company's net interest margin. The net interest margin
decreased 40 basis points to 4.01% for the year ended September 30, 2009 from
4.41% for the year ended September 30, 2008.
The increased non-interest expense was primarily attributable to an
increase in FDIC insurance expense, an increase in OREO related expenses, an
increase in loan monitoring and foreclosure related expenses and increases in
premises and equipment expenses.
65
The increased non-interest income was primarily a result of increased
gains on sale of loans, increased service charges on deposit accounts and
increased BOLI net earnings partially offset by net OTTI losses on private
label mortgage backed securities. The increased income from loan sales was
primarily a result of an increase in the dollar amount of residential mortgage
loans sold in the secondary market for the year ended September 30, 2009. The
increase in loan sales was primarily attributable to lower interest rates for
30-year fixed rate loans which increased refinancing activity.
A more detailed explanation of the income statement categories is
presented below.
Net Income: Net income for the year ended September 30, 2009 decreased by
$4.25 million, or 106.0%, to a net loss of $(242,000) from net income of $4.01
million for the year ended September 30, 2008. Income available to common
stockholders after adjusting for preferred stock dividends and preferred stock
discount accretion was a loss of $(1.01 million), or $(0.15) per diluted
common share for the year ended September 30, 2009 compared to net income of
$4.01 million, or $0.61 per diluted common share for the year ended September
30, 2008.
The $0.76 decrease in diluted earnings per common share for the year ended
September 30, 2009 was primarily the result of a $6.83 million ($4.51 million
net of income tax - $0.69 per diluted common share) increase in the provision
for loan losses, a $2.39 million ($1.58 million net of income tax - $0.24 per
diluted common share) increase in non-interest expense, a $1.63 million ($1.07
million net of income tax - $0.16 per diluted common share) decrease in net
interest income and a $772,000 increase in preferred stock dividends and
preferred stock accretion which decreased earnings by approximately $0.12 per
diluted common share. These items were partially offset by a $2.77 million
increase in non-interest income which increased diluted earnings per common
share by approximately $0.45.
Net Interest Income: Net interest income decreased by $1.63 million, or
6.0%, to $25.30 million for the year ended September 30, 2009 from $26.93
million for the year ended September 30, 2008. The decrease in net interest
income was primarily attributable to an increase in non-accrual loans and
lower overall market interest rates.
Total interest and dividend income decreased by $4.54 million to $38.80
million for the year ended September 30, 2009 from $43.34 million for the year
ended September 30, 2008 as the yield on interest earning assets decreased to
6.15% from 7.09%. Total average interest earning assets (including
non-accrual loans) increased by $20.11 million to $631.25 million for the year
ended September 30, 2009 from $611.14 million for the year ended September 30,
2008. Non-accrual loans increased by $17.30 million to $29.29 million at
September 30, 2009 from $11.99 million at September 30, 2008.
Total interest expense decreased by $2.91 million to $13.50 million for
the year ended September 30, 2009 from $16.41 million for the year ended
September 30, 2008 as the average rate paid on interest-bearing liabilities
decreased to 2.51% for the year ended September 30, 2009 from 3.11% for the
year ended September 30, 2008. Total interest bearing liabilities increased
by $9.34 million to $537.54 million for the year ended September 30, 2009 from
$528.20 million for the year ended September 30, 2008.
The net interest margin decreased 40 basis points to 4.01% for the year
ended September 30, 2009 from 4.41% for the year ended September 30, 2008 as
the yield on interest earnings assets decreased at a greater rate than funding
costs decreased. This was primarily a result of the decreasing interest rate
environment which reduced yields on loans at a faster pace than the Bank was
able to reduce deposit and borrowing costs. The reversal of interest income
on loans placed on non-accrual status contributed to the margin compression
and reduced the net interest margin by approximately 18 basis points for the
year ended September 30, 2009.
Provision for Loan Losses: The provision for loan losses increased by
$6.83 million, or 175.2%, to $10.73 million for the year ended September 30,
2009 from $3.90 million for the year ended September 30, 2008. The increased
provision for loan losses was primarily a result of an increase in net
charge-offs, an increase in impaired loans, an increase in the level of
performing loans classified as substandard under the Bank's loan grading
system, and uncertainties in the housing market in certain markets of the
Pacific Northwest. The Bank had net charge-offs of $4.44
66
million for the year ended September 30, 2009 compared to net charge-offs of
$647,000 for the year ended September 30, 2008. The net charge-offs to
average outstanding loans ratio was 0.79% for the year ended September 30,
2009 and 0.12% for the year ended September 30, 2008.
The Bank has established a comprehensive methodology for determining the
provision for loan losses. On a quarterly basis the Bank performs an analysis
taking into consideration pertinent factors underlying the quality of the loan
portfolio. These factors include changes in the amount and composition of the
loan portfolio, historical loss experience for various loan segments, changes
in economic conditions, delinquency rates, a detailed analysis of individual
loans on non-accrual status, and other factors to determine the level of the
allowance for loan losses. Management's analysis, however, for the year ended
September 30, 2009, placed a greater emphasis on the Bank's construction and
land development portfolio and the effect of various factors such as
geographic and loan type concentrations. The Bank also reviewed the national
and regional trends of declining home sales with potential housing market
value depreciation. The allowance for loan losses increased by $6.12 million
to $14.17 million at September 30, 2009 from $8.05 million at September 30,
2008. The increased level of the allowance for loan losses was primarily
attributable to an increase in impaired loans, an increase in the level of
performing loans classified as substandard under the Bank's grading system,
and uncertainties in the housing market and economy.
Based on the comprehensive methodology, management deemed the allowance
for loan losses of $14.17 million at September 30, 2009 (2.52% of loans
receivable and 48.4% of non-performing loans) adequate to provide for probable
losses based on an evaluation of known and inherent risks in the loan
portfolio at that date. While the Bank believes it has established its
existing allowance for loan losses in accordance with GAAP, there can be no
assurance that regulators, in reviewing the Bank's loan portfolio, will not
request the Bank to increase significantly its allowance for loan losses. In
addition, because future events affecting borrowers and collateral cannot be
predicted with certainty, there can be no assurance that the existing
allowance for loan losses is adequate or that substantial increases will not
be necessary should the quality of any loans deteriorate. Any material
increase in the allowance for loan losses would adversely affect the Bank's
financial condition and results of operations. For additional information,
see "Item 1, Business - Lending Activities Allowance for Loan Losses."
Non-interest Income: Total non-interest income increased by $2.77 million,
or 66.3%, to $6.95 million for the year ended September 30, 2009 from $4.18
million for the year ended September 30, 2008. This increase was primarily a
result of a $2.82 million decrease in loss on the redemption of mutual funds,
$1.82 million increase in gain on sale of loans, an $819,000 increase in
service charges on deposit accounts, a $479,000 increase in BOLI net earnings
and $139,000 in income recorded for property easements sold. These increases
to non-interest income were partially offset by a $3.62 million increase in
net OTTI losses recorded during the year ended September 30, 2009.
The $2.82 million loss on mutual funds recorded during the year ended
September 30, 2008 was a result of the redemption of investments in the AMF
family of mutual funds for the underlying securities and cash. The net OTTI
charges of $3.62 million recorded during the year ended September 30, 2009
were on private label mortgage backed securities that were acquired from the
in-kind redemption from the AMF family of mutual funds in 2008.
The increased income from loan sales was primarily a result of an increase
in the dollar amount of residential mortgage loans sold in the secondary
market for the year ended September 30, 2009. The sale of one-to four-family
mortgage loans totaled $162.6 million for the year ended September 30, 2009
compared to $45.3 million for the year ended September 30, 2008. The increase
in loan sales was primarily attributable to lower interest rates for 30-year
fixed rate loans which increased refinancing activity. The increase in
service charges on deposit accounts was primarily a result of implementing a
new automated overdraft decision system in May 2008 and increasing the fee
charged for overdrafts. The increase in BOLI income was attributable to a
$337,000 death claim benefit and a $134,000 gain from moving a number of the
Bank's BOLI policies to a new insurance carrier.
Non-interest Expense: Total non-interest expense increased by $2.39
million, or 11.7%, to $22.74 million for the year ended September 30, 2009
from $20.35 million for the year ended September 30, 2008. The increase was
primarily attributable to a $648,000 increase in FDIC insurance expense
(including a special FDIC assessment of $391,000, a $646,000 increase in OREO
related expenses, a $204,000 increase in loan monitoring and foreclosure
related
67
expenses (which are included in the other non-interest expense category), a
$267,000 increase in premises and equipment expense, a $232,000 increase in
salary and benefit expenses, and a $143,000 increase in deposit related
expenses (which are included in the other non-interest expense category).
The increase in OREO related expenses and foreclosure expenses were
primarily a result of an increase in the number of OREO properties held and an
increase in foreclosure activity. The increase in premises and equipment
expenses was partially attributable to the addition of a full service branch
facility in Chehalis, Washington. Also contributing to the change in premises
and equipment expense was an insurance settlement and the sale of a building
in the prior fiscal year which reduced premises and equipments expenses by a
combined $295,000 for the year ended September 30, 2008. The Bank also
recorded a capital gain on the sale of bank owned property in the current
fiscal year which reduced premises and equipment expenses by $235,000 for the
year ended September 30, 2009. The increased salary and benefit expenses were
primarily a result of annual salary adjustments and increased insurance
expenses. The increased deposit related expenses were primarily a result of
the expenses associated with several new deposit related programs.
The Company's efficiency ratio increased to 70.52% for the year ended
September 30, 2009 from 65.42% for the year ended September 30, 2008.
Provision (Benefit) for Federal Income Taxes: The provision for federal
income taxes decreased by $3.81 million to a net benefit of $982,000 for the
year ended September 30, 2009 from $2.82 million for the year ended September
30, 2008 primarily as a result of lower income before taxes. The benefit for
federal income taxes for the year ended September 30, 2009 was impacted by an
increased level of non-taxable income, primarily attributable to the increase
in BOLI net earnings. The income tax benefit for the year ended September 30,
2009 was also increased by approximately $180,000 due to adjustments made to
the Company's deferred tax valuation allowance for a previous non-deductible
capital loss carry forward.
The provision for federal income taxes for the year ended September 30,
2008 was impacted by the $2.82 million loss on the redemption of mutual funds.
The redemption of the mutual funds resulted in a capital loss which can only
be deducted for tax purposes to the extent that capital gains are realized
within a three year carry back period and a five year carry forward period.
The Company estimated that it would have $679,000 in capital gains during the
allowable tax period to offset the capital loss. Therefore $2.14 million of
the $2.82 million loss was treated as non-deductible for tax purposes for the
year ended September 30, 2008. The Company's effective tax rate was 41.35%
(or 31.65% exclusive of the mutual fund redemption loss and associated tax
impact) for the year ended September 30, 2008.
Comparison of Operating Results for the Years Ended September 30, 2008 and
2007
The Company's net income decreased by $4.16 million, or 50.9%, to $4.01
million for the year ended September 30, 2008 from $8.16 million for the year
ended September 30, 2007. The decrease was primarily as a result of increased
provision for loan losses, decreased non-interest income due to a loss on the
redemption of mutual funds, and increased non-interest expenses, which were
partially offset by increased net interest income. Diluted earnings per
common share decreased by 47.9% to $0.61 for the year ended September 30, 2008
from $1.17 for the year ended September 30, 2007.
The increased provision for loan losses was primarily a result of an
increase in the level of non-performing loans, an increase in the level of
performing loans classified as substandard under the Bank's loan grading
system, loan portfolio growth, and uncertainties in the housing market in
certain markets of the Pacific Northwest. Net charge-offs were $647,000
during the year ended September 30, 2008, which was equivalent to 0.12% of the
average outstanding loans.
The decreased non-interest income was primarily a result of a $2.82
million loss on the sale of securities, as the Company redeemed its investment
in the AMF family of mutual funds in June 2008. This loss was partially
offset by increased income from service charges on deposit accounts and
increased income from loan sales.
68
The increased non-interest expense was primarily a result of increased
employee costs and increased deposit related expenses. The increased salary
and employee benefit expenses were primarily a result of annual salary
adjustments and increased insurance expenses. The increased deposit related
expenses were primarily a result of the expenses associated with several new
deposit related programs implemented during the year.
The increased net interest income was primarily a result of a larger
interest earning asset base due to an increased loan portfolio. The increase
in net interest income attributable to a larger interest earning asset base
was, however, partially offset by a decrease in the Company's net interest
margin.
A more detailed explanation of the income statement categories is
presented below.
Net Income: Net income for the year ended September 30, 2008 decreased by
$4.16 million, or 50.9%, to $4.01 million, or $0.61 per diluted common share
($0.62 per basic common share) from $8.16 million, or $1.17 per diluted common
share ($1.20 per basic common share) for the year ended September 30, 2007.
The $0.56 decrease in diluted earnings per common share for the year ended
September 30, 2008 was primarily the result of a $2.82 million ($2.59 million
net of income tax - $0.39 per diluted common share) charge from the redemption
of the Company's investment in the AMF family of mutual funds, a $3.21 million
($2.12 million net of income tax - $0.30 per diluted common share) increase in
the provision for loan losses, and a $923,000 ($609,000 net of income tax -
$0.08 per diluted common share) increase in non-interest expense. These items
were partially offset by a $759,000 ($501,000 net of income tax - $0.07 per
diluted common share) increase in net interest income, a $1.04 million
($688,000 net of income tax - $0.10 per diluted common share) increase in
non-interest income, excluding the mutual fund redemption charge, and a lower
number of weighted average shares outstanding which increased diluted earnings
per common share by approximately $0.04.
Net Interest Income: Net interest income increased by $759,000, or 2.9%,
to $26.93 million for the year ended September 30, 2008 from $26.17 million
for the year ended September 30, 2007, primarily due to a larger interest
earning asset base due to an increased loan portfolio. Total interest and
dividend income increased by $1.39 million to $43.34 million for the year
ended September 30, 2008 from $41.94 million for the year ended September 30,
2007 as average total interest earning assets increased by $52.84 million.
The yield on interest earning assets decreased to 7.09% for the year ended
September 30, 2008 from 7.51% for the year ended September 30, 2007. Total
interest expense increased by $635,000 to $16.41 million for the year ended
September 30, 2008 from $15.78 million for the year ended September 30, 2007
as average interest bearing liabilities increased by $55.09 million. The
average rate paid on interest bearing liabilities decreased to 3.11% for the
year ended September 30, 2008 from 3.33% for the year ended September 30,
2007.
The increase in net interest income attributable to a larger interest
earning asset base was, however, partially offset by a compression of the
Company's net interest margin. The net interest margin decreased 28 basis
points to 4.41% for the year ended September 30, 2008 from 4.69% for the year
ended September 30, 2007 as the yield on interest earnings assets decreased at
a greater rate than funding costs were decreased. This was primarily a result
of the decreasing interest rate environment which reduced yields on loans at a
faster pace than the Bank was able to reduce deposit and borrowing costs.
Provision for Loan Losses: The provision for loan losses increased by
$3.21 million, or 468.5%, to $3.90 million for the year ended September 30,
2008 from $686,000 for the year ended September 30, 2007. The increased
provision for loan losses was primarily a result of an increase in
non-performing loans, an increase in the level of performing loans classified
as substandard under the Bank's loan grading system, loan portfolio growth,
and uncertainties in the housing market in certain markets of the Pacific
Northwest. The Bank had a net charge-off of $647,000 for the year ended
September 30, 2008 compared to a net charge-off of $11,000 for the year ended
September 30, 2007. The net charge-offs to average outstanding loans ratio
was 0.12% for the year ended September 30, 2008 and 0.002% for the year ended
September 30, 2007.
The Bank has established a comprehensive methodology for determining the
provision for loan losses. On a quarterly basis the Bank performs an analysis
taking into consideration pertinent factors underlying the quality of the
69
loan portfolio. These factors include changes in the size and composition of
the loan portfolio, historical loss experience for various loan segments,
changes in economic conditions, delinquency rates, a detailed analysis of
individual loans on non-accrual status, and other factors to determine the
level of allowance for loan losses needed. Management's analysis, however,
for the year ended September 30, 2008, placed a greater emphasis on the Bank's
construction and land development portfolio and the effect of various factors
such as geographic and loan type concentrations. The Bank also reviewed the
national trend of declining home sales with potential housing market value
depreciation. The allowance for loan losses increased $3.25 million to $8.05
million at September 30, 2008 from $4.80 million at September 30, 2007. The
increased level of the allowance for loan losses was primarily attributable to
an increase in non-performing loans, an increase in the level of performing
loans classified as substandard under the Bank's grading system, loan
portfolio growth, and uncertainties in the housing market and economy.
Based on the comprehensive methodology, management deemed the allowance
for loan losses of $8.05 million at September 30, 2008 (1.42% of loans
receivable and 67.1% of non-performing loans) adequate to provide for probable
losses based on an evaluation of known and inherent risks in the loan
portfolio at that date. While the Bank believes it has established its
existing allowance for loan losses in accordance with GAAP, there can be no
assurance that regulators, in reviewing the Bank's loan portfolio, will not
request the Bank to increase significantly its allowance for loan losses. In
addition, because future events affecting borrowers and collateral cannot be
predicted with certainty, there can be no assurance that the existing
allowance for loan losses is adequate or that substantial increases will not
be necessary should the quality of any loans deteriorate. Any material
increase in the allowance for loan losses would adversely affect the Bank's
financial condition and results of operations. For additional information,
see "Item 1. Business - Lending Activities - Allowance for Loan Losses."
Non-interest Income: Total non-interest income decreased by $1.78 million,
or 29.9%, to $4.18 million for the year ended September 30, 2008 from $5.96
million for the year ended September 30, 2007, primarily due to a $2.82
million loss on the redemption of investments in the AMF family of mutual
funds.
Non-interest income, excluding the mutual fund redemption loss increased
by $1.04 million, or 17.4%, to $7.0 million for the year ended September 30,
2008 from $5.96 million from the year ended September 30, 2007. This increase
was primarily a result of a $717,000 increase in service charges on deposit
accounts and a $262,000 increase in gain on sale of loans. The increase in
service charges on deposit accounts was primarily a result of implementing a
new automated overdraft decision system during the year and increasing the fee
charged for overdrafts. The increase in income from loan sales was primarily
a result of an increase in the dollar value of fixed rate one- to four-family
mortgage loans sold during the year. The sale of fixed rate one-to
four-family mortgage loans totaled $45.3 million for the year ended September
30, 2008 compared to $29.9 million for the year ended September 30, 2007.
Non-interest Expense: Total non-interest expense increased by $898,000,
or 4.6%, to $20.35 million for the year ended September 30, 2008 from $19.45
million for the year ended September 30, 2007. The increase was primarily
attributable to a $641,000 increase in salary and benefit expenses and a
$269,000 increase in deposit related expenses. Salary and benefit expenses
increased primarily as a result of annual salary adjustments and increased
health insurance expenses. Deposit related expenses increased primarily as a
result of the expenses associated with several new deposit related programs
implemented during the year and an increase in FDIC insurance expense recorded
as the Bank's credit with the FDIC was fully depleted during the quarter ended
June 30, 2008.
The Company's efficiency ratio increased to 65.42% for the year ended
September 30, 2008 from 60.54% for the year ended September 30, 2007. The
efficiency ratio, excluding the mutual fund redemption loss, was 60.06% for
the year ended September 30, 2008.
Provision for Federal Income Taxes: The provision for federal income taxes
decreased by $1.01 million to $2.82 million for the year ended September 30,
2008 from $3.83 million for the year ended September 30, 2007 primarily as a
result of lower income before taxes. The provision for federal income taxes
for the year ended September 30, 2008 was also impacted by the $2.82 million
loss on the redemption of mutual funds. The redemption of the mutual funds
resulted in a capital loss which can only be deducted for tax purposes to the
extent that capital gains are realized within a three year carry back period
and a five year carry forward period. The Company has estimated that it will
have
70
$679,000 in capital gains during the allowable tax period to offset the
capital loss. Therefore $2.14 million of the $2.82 million loss has been
treated as non-deductible for tax purposes. The Company's effective tax rate
was 41.35% (or 31.65% exclusive of the mutual fund redemption loss and
associated tax impact) for the year ended September 30, 2008 and 31.92% for
the year ended September 30, 2007.
Average Balances, Interest and Average Yields/Cost
The earnings of the Company depend largely on the spread between the yield
on interest-earning assets and the cost of interest-bearing liabilities, as
well as the relative amount of the Company's interest-earning assets and
interest- bearing liability portfolios.
The following table sets forth, for the periods indicated, information
regarding average balances of assets and liabilities as well as the total
dollar amounts of interest income from average interest-earning assets and
interest expense on average interest-bearing liabilities and average yields
and costs. Such yields and costs for the periods indicated are derived by
dividing income or expense by the average daily balance of assets or
liabilities, respectively, for the periods presented.
71
Year Ended September 30,
--------------------------------------------------------------------------------
2009 2008 2007
-------------------------- ------------------------ -------------------------
Interest Interest Interest
Average and Yield/ Average and Yield/ Average and Yield/
Balance Dividends Cost Balance Dividends Cost Balance Dividends Cost
------- --------- ------ ------- --------- ------ ------- --------- ------
(Dollars in thousands)
Interest-earning assets:
Loans receivable (1)(2).. $564,741 $37,248 6.60% $552,318 $40,924 7.41% $477,029 $38,386 8.04%
Mortgage-backed and
investment securities... 25,762 1,379 5.35 19,799 1,064 5.37 37,411 1,529 4.09
FHLB stock and equity
securities.............. 6,655 38 0.57 29,201 1,123 3.85 37,347 1,692 4.53
Federal funds sold....... 9,032 36 0.40 8,318 191 2.30 5,030 260 5.17
Interest-bearing
deposits................ 24,964 99 0.40 1,499 36 2.40 1,481 77 5.17
-------- ------- -------- ------- -------- -------
Total interest-earning
assets................. 631,154 38,800 6.15 611,135 43,338 7.09 558,298 41,944 7.51
Non-interest-earning
assets................... 47,851 47,086 49,483
-------- -------- --------
Total assets........... $679,005 $658,221 $607,781
======== ======== ========
Interest-bearing liabilities:
Savings accounts......... $ 55,814 $ 394 0.71 $ 56,461 398 0.70 $ 60,124 425 0.71%
Money market accounts.... 61,777 1,036 1.68 51,943 1,249 2.40 46,013 1,186 2.58
NOW accounts............. 97,879 1,031 1.05 86,441 774 0.90 82,323 638 0.77
Certificates of deposit.. 224,673 7,011 3.12 224,493 9,342 4.16 199,046 9,043 4.55
Short-term borrowings(3). 672 1 0.12 14,321 615 4.29 35,206 1,954 5.55
Long-term borrowings (4). 96,721 4,031 4.17 94,537 4,035 4.27 50,393 2,532 5.02
-------- ------- -------- ------- -------- -------
Total interest bearing
liabilities............ 537,536 13,504 2.51 528,196 16,413 3.11 473,105 15,778 3.33
Non-interest bearing
liabilities.............. 55,086 55,150 58,179
-------- -------- --------
Total liabilities...... 592,622 583,346 531,284
Shareholders' equity...... 86,383 74,875 76,497
-------- -------- --------
Total liabilities and
shareholders' equity... $679,005 $658,221 $607,781
======== ======== ========
Net interest income....... $25,296 $26,925 $26,166
======= ======= =======
Interest rate spread...... 3.64% 3.98% 4.18%
====== ====== ======
Net interest margin (5)... 4.01% 4.41% 4.69%
====== ====== ======
Ratio of average interest-
earning assets to average
interest-bearing
liabilities.............. 117.42% 115.70% 118.01%
====== ====== ======
--------------
(1) Does not include interest on loans 90 days or more past due. Includes loans originated for sale.
Amortized net deferred loan fees, late fees, extension fees and prepayment penalties (2009, $1,229;
2008, $1,804; and 2007, $1,794) included with interest and dividends.
(2) Average balance includes nonaccrual loans.
(3) Includes FHLB, FRB and PCBB advances with original maturities of less than one year and other short-term
borrowings-repurchase agreements.
(4) Includes FHLB advances with original maturities of one year or greater.
(5) Net interest income divided by total average interest earning assets.
72
Rate/Volume Analysis
The following table sets forth the effects of changing rates and volumes
on net interest income on the Company. Information is provided with respect
to the (i) effects on interest income attributable to changes in volume
(changes in volume multiplied by prior rate), and (ii) effects on interest
income attributable to changes in rate (changes in rate multiplied by prior
volume), and (iii) the net change (sum of the prior columns). Changes in both
rate and volume have been allocated to rate and volume variances based on the
absolute values of each.
Year Ended September 30, Year Ended September 30,
2009 Compared to Year 2008 Compared to Year
Ended September 30, 2008 Ended September 30, 2007
Increase (Decrease) Increase (Decrease)
Due to Due to
------------------------ ------------------------
Net Net
Rate Volume Change Rate Volume Change
---- ------ -------- ---- ------ ------
(In thousands)
Interest-earning assets:
Loans receivable (1)... $(4,579) $ 903 $(3,676) $(3,201) $5,739 $ 2,538
Investments and mortgage-
backed securities..... (4) 319 315 391 (856) (465)
FHLB stock and equity
securities............ (569) (516) (1,085) (233) (336) (569)
Federal funds sold..... (170) 15 (155) (188) 119 (69)
Interest-bearing
deposits.............. (54) 117 63 (42) 1 (41)
Total net change in
income on interest-
earning assets......... (5,376) 838 (4,538) (3,273) 4,667 1,394
Interest-bearing
liabilities:
Savings accounts....... 1 (5) (4) (1) (26) (27)
NOW accounts........... 147 110 257 103 33 136
Money market accounts.. (422) 209 (213) (83) 146 63
Certificate accounts... (2,339) 8 (2,331) (798) 1,097 299
Short-term borrowings.. (310) (304) (614) (370) (969) (1,339)
Long-term borrowings... (96) 92 (4) (430) 1,933 1,503
------- ----- ------- ------- ------ ------
Total net change in
expense on interest-
bearing liabilities.... (3,019) 110 (2,909) (1,579) 2,214 635
------- ----- ------- ------- ------ ------
Net change in net
interest income........ $(2,357) $ 728 $(1,629) $(1,694) $2,453 $ 759
======= ===== ======= ======= ====== ======
-------------
(1) Excludes interest on loans 90 days or more past due. Includes loans
originated for sale.
Liquidity and Capital Resources
The Company's primary sources of funds are customer deposits, proceeds
from principal and interest payments on loans, the sale of loans, maturing
securities and FHLB advances. While the maturity and scheduled amortization
of loans are a predictable source of funds, deposit flows and mortgage
prepayments are greatly influenced by general interest rates, economic
conditions and competition.
The Bank must maintain an adequate level of liquidity to ensure the
availability of sufficient funds to fund loan originations and deposit
withdrawals, to satisfy other financial commitments and to take advantage of
investment opportunities. The Bank generally maintains sufficient cash and
short-term investments to meet short-term liquidity needs. At September 30,
2009, the Bank's regulatory liquidity ratio (net cash, and short-term and
marketable assets, as a percentage of net deposits and short-term liabilities)
was 12.25%. At September 30, 2009, the Bank maintained an uncommitted credit
facility with the FHLB-Seattle that provided for immediately available
advances up to an aggregate
73
amount equal to 30% of total assets, limited by available collateral, under
which $95.0 million was outstanding. The Bank also maintains a short-tem
borrowing line with the Federal Reserve Bank with total credit based on
eligible collateral. At September 30, 2009 the Bank had $10.0 million
outstanding on this borrowing line. The Bank has also been approved for a
$10.0 million borrowing line with the PCBB. The borrowing line must be
collateralized. At September 30, 2009, the Bank had not pledged any
collateral for this borrowing line and there was no outstanding balance.
Liquidity management is both a short and long-term responsibility of the
Bank's management. The Bank adjusts its investments in liquid assets based
upon management's assessment of (i) expected loan demand, (ii) projected loan
sales, (iii) expected deposit flows, and (iv) yields available on interest-
bearing deposits. Excess liquidity is invested generally in interest-bearing
overnight deposits and other short-term government and agency obligations. If
the Bank requires funds beyond its ability to generate them internally, it has
additional borrowing capacity with the FHLB, PCBB and collateral for
repurchase agreements.
The Bank's primary investing activity is the origination of mortgage
loans. During the years ended September 30, 2009, 2008 and 2007, the Bank
originated $273.6 million, $223.9 million and $235.7 million of mortgage
loans, respectively. At September 30, 2009, the Bank had loan commitments
totaling $44.1 million and undisbursed loans in process totaling $31.3
million. The Bank anticipates that it will have sufficient funds available to
meet current loan commitments. Certificates of deposit that are scheduled to
mature in less than one year from September 30, 2009 totaled $182.3 million.
Historically, the Bank has been able to retain a significant amount of its
deposits as they mature.
The Bank's liquidity is also affected by the volume of loans sold and loan
principal payments. During the years ended September 30, 2009, 2008 and 2007,
the Bank sold $162.9 million, $45.3 million and $29.9 million in fixed rate,
one- to four-family mortgage loans, respectively. During the years ended
September 30, 2009, 2008 and 2007, the Bank received $152.3 million, $176.1
million and $164.9 million in principal repayments, respectively.
The Bank's liquidity has been impacted by increases in deposit levels.
During the years ended September 30, 2009, 2008 and 2007, deposits increased
by $7.1 million, $31.8 million and $35.7 million, respectively.
Cash equivalents, certificate of deposits held for investment and
investment and mortgage-backed securities increased to $90.3 million at
September 30, 2009 from $74.2 million at September 30, 2008.
Federally-insured state-chartered banks are required to maintain minimum
levels of regulatory capital. Under current FDIC regulations, insured
state-chartered banks generally must maintain (i) a ratio of Tier 1 leverage
capital to total assets of at least 3.0% (4.0% to 5.0% for all but the most
highly rated banks), (ii) a ratio of Tier 1 capital to risk weighted assets of
at least 4.0% and (iii) a ratio of total capital to risk weighted assets of at
least 8.0%. The Bank is required to maintain at least a 10.0% Tier 1 leverage
capital ratio pursuant to the MOU. At September 30, 2009, the Bank was in
compliance with all applicable capital requirements, including the higher Tier
1 leverage capital ratio required by the MOU . For additional details see
Note 19 of the Notes to Consolidated Financial Statements contained in "Item
8. Financial Statements and Supplementary Data" and "Item 1. Business -
Regulation of the Bank - Capital Requirements."
74
Contractual obligations. The following table presents, as of September
30, 2009, the Company's significant fixed and determinable contractual
obligations, within the categories described below, by payment date or
contractual maturity. These contractual obligations, except for the operating
lease obligations are included in the Consolidated Balance Sheet. The payment
amounts represent those amounts contractually due at September 30, 2009.
Payments due by period
----------------------------------------------
After
Less 1 year 3 years
than through through After
Contractual obligations 1 year 3 years 5 years 5 years Total
------ ------- ------- ------- -------
(In thousands)
Short-term debt obligations... $10,777 $ -- $ -- $ -- $ 10,777
Long-term debt obligations.... 20,000 30,000 -- 45,000 95,000
Operating lease obligations... 219 134 67 -- 420
------- ------- ---- ------- --------
Total contractual
obligations................ $30,996 $30,134 $ 67 $45,000 $106,197
======= ======= ==== ======= ========
Effect of Inflation and Changing Prices
The consolidated financial statements and related financial data presented
herein have been prepared in accordance with accounting principles generally
accepted in the United States of America which require the measurement of
financial position and operating results in terms of historical dollars,
without considering the change in the relative purchasing power of money over
time due to inflation. The primary impact of inflation on the operation of
the Company is reflected in increased operating costs. Unlike most industrial
companies, virtually all the assets and liabilities of a financial institution
are monetary in nature. As a result, interest rates generally have a more
significant impact on a financial institution's performance than do general
levels of inflation. Interest rates do not necessarily move in the same
direction or to the same extent as the prices of goods and services.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
--------------------------------------------------------------------
The information contained under "Item 7, Management's Discussion and
Analysis of Financial Condition and Results of Operations - Market Risk and
Asset and Liability Management" of this Form 10-K is incorporated herein by
reference.
75
Item 8. Financial Statements and Supplementary Data
----------------------------------------------------
Management's Report on Internal Control Over Financial Reporting
The Company's management is responsible for establishing and maintaining
adequate internal control over financial reporting. Internal control over
financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally
accepted accounting principles. The Company's internal control over financial
reporting includes those policies and procedures that (i) pertain to the
maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and disposition of the assets of the Company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the
Company are being made only in accordance with authorizations of management
and directors of the Company; and (iii) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use, or
disposition of the Company's assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
The Company's management conducted an evaluation of the effectiveness of
internal control over financial reporting based on the framework in Internal
Control -- Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on this evaluation,
management concluded that the Company's internal control over financial
reporting was effective as of September 30, 2009. Management's assessment of
the effectiveness of the Company's internal control over financial reporting
has been audited by McGladrey & Pullen, LLP, an independent registered public
accounting firm, as stated in their report which is included herein.
76
Report of Independent Registered Public Accounting Firm on Internal Control
Over Financial Reporting
McGladrey & Pullen
Certified Public Accountants
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
Timberland Bancorp, Inc.
Hoquiam, Washington
We have audited Timberland Bancorp, Inc.'s internal control over financial
reporting as of September 30, 2009, based on criteria established in Internal
Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Timberland Bancorp, Inc.'s
management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting included in the accompanying Management's
Report on Internal Control over Financial Reporting. Our responsibility is to
express an opinion on the Company's internal control over financial reporting
based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal
control over financial reporting, assessing the risk that a material weakness
exists, and testing and evaluating the design and operating effectiveness of
internal control based on the assessed risk. Our audit also included
performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company's internal
control over financial reporting includes those policies and procedures that
(a) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets
of the company; (b) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and that receipts
and expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (c) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company's assets that could have a
material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
In our opinion, Timberland Bancorp, Inc. maintained, in all material respects,
effective internal control over financial reporting as of September 30, 2009,
based on criteria established in Internal Control - Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO).
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the annual consolidated financial
statements of Timberland Bancorp, Inc. and Subsidiary and our report dated
December 14, 2009, expressed an unqualified opinion.
/s/McGladrey & Pullen, LLP
Seattle, Washington
December 14, 2009
77
TIMBERLAND BANCORP, INC. AND SUBSIDIARY
Index to Consolidated Financial Statements
Page
----
Report of Independent Registered Public Accounting Firm........... 79
Consolidated Balance Sheets as of September 30, 2009 and 2008..... 80
Consolidated Statements of Operations For the Years Ended
September 30, 2009, 2008, and 2007............................. 81
Consolidated Statements of Shareholders' Equity For the
Years Ended September 30, 2009, 2008 and 2007.................. 83
Consolidated Statements of Cash Flows For the Years Ended
September 30, 2009, 2008 and 2007.............................. 85
Consolidated Statements of Comprehensive Income (Loss) For the
Years Ended September 30, 2009, 2008 and 2007.................. 87
Notes to Consolidated Financial Statements........................ 88
78
[McGladrey & Pullen, LLP Letterhead]
Report of Independent Registered Public Accounting Firm
To the Board of Directors and
Shareholders Timberland Bancorp, Inc.
We have audited the consolidated balance sheets of Timberland Bancorp, Inc.
and Subsidiary as of September 30, 2009 and 2008, and the related consolidated
statements of operations, shareholders' equity, cash flows and comprehensive
income for each of the three years in the period ended September 30, 2009.
These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Timberland
Bancorp, Inc. and Subsidiary as of September 30, 2009 and 2008, and the
results of their operations and their cash flows for each of the three years
in the period ended September 30, 2009, in conformity with U.S. generally
accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), Timberland Bancorp, Inc. and
Subsidiary's internal control over financial reporting as of September 30,
2009, based on criteria established in Internal Control -- Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO) and our report dated December 14, 2009, expressed an
unqualified opinion on the effectiveness of Timberland Bancorp, Inc. and
Subsidiary's internal control over financial reporting.
/s/McGladrey & Pullen, LLP
Seattle, Washington
December 14, 2009
79
Consolidated Balance Sheets
------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Data)
Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008 2009 2008
Assets
Cash equivalents:
Cash and due from financial institutions $ 10,205 $ 14,013
Interest-bearing deposits in other banks 56,257 3,431
Federal funds sold - - 25,430
66,462 42,874
Certificate of deposits ("CDs") held for
investment, (at cost) 3,251 - -
Investments and mortgage-backed securities - held
to maturity (fair value $6,215 and $11,974) 7,087 14,233
Investments and mortgage-backed securities -
available for sale 13,471 17,098
Federal Home Loan Bank of Seattle ("FHLB")
stock (at cost) 5,705 5,705
Loans receivable, net of allowance for loan
losses of $14,172 and $8,050 546,578 555,914
Loans held for sale 630 1,773
547,208 557,687
Premises and equipment, net 18,046 16,884
Other real estate owned ("OREO") and
other repossessed items, net 8,185 511
Accrued interest receivable 2,805 2,870
Bank owned life insurance ("BOLI") 12,918 12,902
Goodwill 5,650 5,650
Core deposit intangible ("CDI") 755 972
Mortgage servicing rights 2,618 1,306
Other assets 7,515 3,191
Total assets $701,676 $681,883
Liabilities and shareholders' equity
Liabilities
Deposits:
Demand, non-interest-bearing $ 50,295 $ 51,955
Interest-bearing 455,366 446,617
Total deposits 505,661 498,572
FHLB advances 95,000 104,628
Federal Reserve Bank advances 10,000 - -
Other borrowings: repurchase agreements 777 758
Other liabilities and accrued expenses 3,039 3,084
Total liabilities 614,477 607,042
Commitments and contingencies (See Note 17) - - - -
Shareholders' equity
Preferred stock, $0.01 par value; 1,000,000 shares
authorized;
2009 - 16,641 shares, Series A,
issued and outstanding, $1,000 liquidation value 15,554 - -
Common stock, $0.01 par value; 50,000,000 shares
authorized;
2009 - 7,045,036 shares issued and outstanding
2008 - 6,967,579 shares issued and outstanding 10,315 8,672
Unearned shares issued to Employee Stock
Ownership Plan ("ESOP") (2,512) (2,776)
Retained earnings 65,854 69,406
Accumulated other comprehensive loss (2,012) (461)
Total shareholders' equity 87,199 74,841
Total liabilities and shareholders' equity $701,676 $681,883
See notes to consolidated financial statements.
80
Consolidated Statements of Operations
------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2009, 2008 and 2007
2009 2008 2007
Interest and dividend income
Loans receivable $37,249 $40,924 $38,386
Investments and mortgage-backed securities 1,379 1,064 1,529
Dividends from mutual funds and FHLB stock 38 1,123 1,692
Interest-bearing deposits in banks 135 227 337
Total interest and dividend income 38,801 43,338 41,944
Interest expense
Deposits 9,472 11,763 11,292
FHLB advances - short term - - 593 1,905
FHLB advances - long term 4,031 4,035 2,532
Other borrowings 1 22 49
Total interest expense 13,504 16,413 15,778
Net interest income 25,297 26,925 26,166
Provision for loan losses 10,734 3,900 686
Net interest income after provision
for loan losses 14,563 23,025 25,480
Non-interest income
Total impairment loss on
investment securities (5,896) - - - -
Less: portion recorded as other
comprehensive loss (before taxes) 2,274 - - - -
Net impairment loss on investment
securities (3,622) - - - -
Service charges on deposits 4,312 3,493 2,776
ATM transaction fees 1,261 1,251 1,138
BOLI net earnings 965 486 464
Gain on sale of loans, net 2,828 1,011 749
Loss on sale/redemption of mutual funds, net - - (2,822) - -
Servicing income on loans sold 103 90 112
Escrow fees 158 9 92
Fee income from non-deposit investment sales 102 124 120
Other 842 536 511
Total non-interest income 6,949 4,178 5,962
See notes to consolidated financial statements.
81
Consolidated Statements of Operations (continued)
------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2009, 2008 and 2007
2009 2008 2007
Non-interest expense
Salaries and employee benefits 11,801 11,569 10,928
Premises and equipment 2,574 2,307 2,452
Advertising 895 897 843
OREO and other repossessed items
expense (income) 643 (3) (13)
ATM expenses 613 576 497
Postage and courier 549 514 478
Amortization of CDI 217 249 285
State and local taxes 604 622 571
Professional fees 745 678 650
FDIC Insurance 778 130 52
Other 3,320 2,810 2,708
Total non-interest expense 22,739 20,349 19,451
Income (loss) before federal and state
income taxes (1,227) 6,854 11,991
Provision (benefit) for federal income taxes (982) 2,824 3,828
Provision (benefit) for state income taxes (3) 25 - -
Net income (loss) $ (242) $ 4,005 $ 8,163
Preferred stock dividends $ 643 $ - - $ - -
Preferred stock accretion 129 - - - -
Net Income (loss) available to common
shareholders $ (1,014) $ 4,005 $ 8,163
Earnings (loss) per share common share
Basic $(0.15) $0.62 $1.20
Diluted (0.15) 0.61 1.17
See notes to consolidated financial statements.
82
Consolidated Statements of Shareholders' Equity
------------------------------------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2009, 2008 and 2007
Accumulated
Unearned Other
Preferred Common Shares Compre-
Preferred Common Stock Stock Issued to Retained hensive
Shares Shares Amount Amount ESOP Earnings Loss Total
------ ------ ------ ------ ---- -------- ---- -----
Balance, Sept.
30, 2006 - - 7,515,352 $ - - $20,738 $(3,305) $62,933 $(1,001) $79,365
Net income - - - - - - - - - - 8,163 - - 8,163
Stock split - - - - - - 36 - - (36) - - - -
Issuance of MRDP(1)
shares - - 15,080 - - - - - - - - - - - -
Repurchase of common
stock - - (687,542) - - (12,431) - - - - - - (12,431)
Exercise of stock
options - - 110,470 - - 1,207 - - - - - - 1,207
Cash dividends
($0.37 per common
share) - - - - - - - - - - (2,682) - - (2,682)
Earned ESOP shares - - - - - - 354 265 - - - - 619
MRDP compensation
expense - - - - - - 64 - - - - - - 64
Stock option compen-
sation expense - - - - - - 25 - - - - - - 25
Unrealized holding
gain on securities
available for
sale, net of tax - - - - - - - - - - - - 217 217
Balance, Sept.
30, 2007 - - 6,953,360 $ - - $ 9,993 $(3,040) $68,378 $(784) $74,547
Net income - - - - - - - - - - 4,005 - - 4,005
Issuance of MRDP(1)
shares - - 20,315 - - - - - - - - - - - -
Repurchase of
common stock - - (144,950) - - (1,921) - - - - - - (1,921)
Exercise of stock
options - - 138,854 - - 857 - - - - - - 857
Cash dividends ($0.43
per common share) - - - - - - - - - - (2,977) - - (2,977)
Earned ESOP shares - - - - - - (409) 264 - - - - (145)
MRDP compensation
expense - - - - - - 147 - - - - - - 147
Stock option compen-
sation expense - - - - - - 5 - - - - - - 5
Unrealized holding
gain on securities
available for
sale, net of tax - - - - - - - - - - - - 323 323
Balance, Sept.
30, 2008 - - 6,967,579 $ - - $ 8,672 $(2,776) $69,406 $(461) $74,841
(1) 1998 Management Recognition and Development Plan ("MRDP").
See notes to consolidated financial statements.
83
Consolidated Statements of Shareholders' Equity (continued)
------------------------------------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2009, 2008 and 2007
Accumulated
Unearned Other
Preferred Common Shares Compre-
Preferred Common Stock Stock Issued to Retained hensive
Shares Shares Amount Amount ESOP Earnings Loss Total
------ ------ ------ ------ ---- -------- ---- -----
Balance, Sept.
30, 2008 - - 6,967,579 $ - - $ 8,672 $(2,776) $69,406 $(461) $74,841
Net loss - - - - - - - - - - (242) - - (242)
Issuance of
preferred stock
with attached
common stock
warrants 16,641 - - 15,425 1,158 - - - - - - 16,583
Accretion of
preferred stock
discount - - - - 129 - - - - (129) - - - -
Issuance of MRDP
(1) shares - - 19,758 - - - - - - - - - - - -
Exercise of stock
options - - 57,699 - - 392 - - - - - - 392
Cash dividends
($0.39 per common
share) - - - - - - - - - - (2,736) - - (2,736)
(5% preferred
stock) - - - - - - - - - - (536) - - (536)
Earned ESOP shares - - - - - - (47) 264 - - - - 217
MRDP compensation
expense - - - - - - 137 - - - - - - 137
Stock option compen-
sation expense - - - - - - 3 - - - - - - 3
Cumulative effect
of FASB guidance
regarding recogni-
tion of other than
temporary impairment
("OTTI") - - - - - - - - - - 91 (91) - -
Unrealized holding
gain on securities
available for sale,
net of tax - - - - - - - - - - - - 18 18
OTTI on securities
held-to-maturity,
net of tax - - - - - - - - - - - - (1,478) (1,478)
Balance, Sept.
30, 2009 16,641 7,045,036 $15,554 $10,315 $(2,512) $65,854 $(2,012) $87,199
(1) 1998 Management Recognition and Development Plan ("MRDP").
See notes to consolidated financial statements.
84
Consolidated Statements of Cash Flows
------------------------------------------------------------------------------
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2009, 2008 and 2007
2009 2008 2007
Cash flows from operating activities
Net income (loss) $ (242) $ 4,005 $ 8,163
Non-cash revenues, expenses, gains and
losses included in net income:
Depreciation 1,136 1,100 1,038
Deferred federal income taxes (1,813) (1,217) (101)
Amortization of CDI 217 249 285
Earned ESOP shares 264 264 265
MRDP compensation expense 169 131 59
Stock option compensation expense 3 5 25
Stock option tax effect 46 15 464
Less stock option excess tax benefit - - (11) (354)
Loss on redemption of mutual funds - - 2,600 - -
Loss on sale of mutual funds - - 222 - -
OTTI losses on securities 3,622 - - - -
Gain on sale of OREO and other
repossessed items, net (60) (47) (19)
Gain on sale of loans (2,828) (432) (356)
Gain on sale of premises and equipment (233) (288) (71)
Provision for loan losses 10,734 3,900 686
Valuation of OREO 306 14 - -
Loans originated for sale (158,942) (45,853) (27,845)
Proceeds from sale of loans held
for sale 162,913 45,269 29,893
BOLI net earnings (965) (486) (464)
Increase (decrease) in deferred loan
origination fees (308) (221) 170
Net change in accrued interest receivable
and other assets, and other liabilities
and accrued expenses (2,546) 731 (445)
Net cash provided by operating activities 11,473 9,950 11,393
Cash flows from investing activities
Net increase (decrease) in CDs held
for investment (3,251) - - 100
Activity in securities held to maturity:
Maturities and prepayments 1,763 579 3
Activity in securities/mutual funds
available for sale:
Maturities and prepayments 3,451 22,862 17,806
Proceeds from sales - - 6,929 - -
Increase in loans receivable, net (11,158) (46,413) (93,316)
Additions to premises and equipment (2,347) (1,495) (1,135)
Proceeds from sale of OREO and other
repossessed items 2,317 926 105
Proceeds from the disposition of premises
and equipment 282 374 323
Net cash used by investing activities (8,943) (16,238) (76,114)
(continued)
See notes to consolidated financial statements.
85
Consolidated Statements of Cash Flows
------------------------------------------------------------------------------
(concluded) (Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2009, 2008 and 2007
2009 2008 2007
Cash flows from financing activities
Increase in deposits $ 7,089 $ 31,837 $ 35,674
Proceeds from FHLB advances - long term - - 50,000 60,000
Repayment of FHLB advances - long term (9,628) (15,069) (24,064)
Net increase (decrease) in FHLB advances
- short term - - (30,000) 1,000
Net increase in Federal Reserve Bank
advances - short term 10,000 - - - -
Net increase (decrease) in repurchase
agreements 19 163 (352)
Proceeds from exercise of stock options 346 841 744
ESOP tax effect (47) (409) 354
MRDP compensation tax effect (32) 16 5
Stock option excess tax benefit - - 11 354
Repurchase of common stock - - (1,921) (12,431)
Issuance of stock warrants 1,158 - - - -
Issuance of preferred stock 15,425 - - - -
Payment of dividends (3,272) (2,977) (2,682)
Net cash provided by financing activities 21,058 32,492 58,602
Net increase (decrease) in cash equivalents 23,588 26,204 (6,119)
Cash equivalents
Beginning of year 42,874 16,670 22,789
End of year $ 66,462 $ 42,874 $ 16,670
Supplemental disclosures of cash flow
information
Income taxes paid $ 1,452 $ 4,120 $ 3,646
Interest paid 13,674 16,656 15,426
Supplemental disclosures of non-cash investing
and financing activities
Change in unrealized holding loss on
securities held for sale,
net of tax $ 18 $ 323 $ 217
Change in other-than-temporary impairment
on securities, held-to-maturity,
net of tax (1,478) - - - -
Loans transferred to OREO and other
repossessed items 10,237 1,404 71
Shares issued to MRDP 138 259 263
Loans originated to facilitate sale of OREO 1,021 257 - -
Mutual funds redeemed for mortgage-backed
securities - - 22,188 - -
See notes to consolidated financial statements.
86
Consolidated Statements of Comprehensive Income (Loss)
------------------------------------------------------------------------------
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2009, 2008 and 2007
2009 2008 2007
Comprehensive income
Net income (loss) $ (242) $4,005 $8,163
Cumulative effect of FASB guidance
relating to impairment of debt
securities (91) - - - -
Unrealized holding gain (loss) on
securities available for sale, net
of tax 18 323 217
OTTI on securities held-to-maturity,
net of tax (1,478) - - - -
Total comprehensive income (loss) $(1,793) $4,328 $8,380
See notes to consolidated financial statements.
87
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 1 - Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of Timberland
Bancorp, Inc. ("Company"); its wholly owned subsidiary, Timberland Bank
("Bank"); and the Bank's wholly owned subsidiary, Timberland Service Corp.
All significant intercompany transactions and balances have been eliminated.
Nature of Operations
The Company is a bank holding company which operates primarily through its
subsidiary, the Bank. The Bank was established in 1915 and, through its 22
branches located in Grays Harbor, Pierce, Thurston, Kitsap, King and Lewis
counties in Washington State, attracts deposits from the general public, and
uses those funds, along with other borrowings, to provide residential real
estate, construction, commercial real estate, land, commercial business and
consumer loans to borrowers primarily in western Washington and to a lesser
extent, to invest in investment securities and mortgage-backed securities.
Consolidated Financial Statement Presentation
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America and
practices within the banking industry. The preparation of consolidated
financial statements requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities, and the disclosure
of contingent assets and liabilities, as of the date of the balance sheet, and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. Material estimates that are
particularly susceptible to significant change in the near term relate to the
determination of the allowance for loan losses, the determination of
other-than-temporary impairments in the estimated fair value of investment
securities and FHLB stock, the valuation of mortgage servicing rights, the
valuation of OREO and the determination of goodwill impairment.
Certain prior year amounts have been reclassified to conform to the 2009
presentation with no change to net income or shareholders' equity previously
reported.
Stock Split
On June 5, 2007, the Company's common stock was split two-for-one in the form
of a 100% stock dividend. Each shareholder of record as of May 22, 2007
received one additional share for every share owned. All per share amounts
(including stock options) in the consolidated financial statements and
accompanying notes were restated to reflect the split, except as otherwise
noted.
Segment Reporting
The Company has one reportable operating segment which is defined as community
banking in western Washington under the operating name Timberland Bank.
(continued)
88
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 1 - Summary of Significant Accounting Policies (continued)
U.S Treasury Department's Capital Purchase Program
On December 23, 2008, the Company received $16.64 million from the U.S.
Treasury Department ("Treasury") as part of the Treasury's Capital Purchase
Program. The Company sold to the Treasury $16.64 million in senior preferred
stock, with a related warrant to purchase 370,899 shares of the Company's
common stock at a price of $6.73 per share at any time during the next ten
years. The transaction is part of the Treasury's program to encourage
qualified financial institutions to build capital to increase the flow of
financing to businesses and consumer and to support the U.S. economy. The
preferred stock pays a 5.0% dividend for the first five years, after which the
rate increases to 9.0% if the preferred shares are not redeemed by the
Company.
Preferred stock callable at the option of the Company is initially recorded at
the amount of proceeds received. Any discount from the liquidation value is
accreted to the expected call date and charged to retained earnings. This
accretion is recorded using the level-yield method. Preferred dividends paid
(declared and accrued) and any accretion is deducted from net income for
computing income available to common shareholders and earnings per share
computations.
Investments and Mortgage-Backed Securities
Investments and mortgage-backed securities are classified upon acquisition as
either held to maturity or available for sale. Securities that the Company
has the positive intent and ability to hold to maturity are classified as held
to maturity and reflected at amortized cost. Securities classified as
available for sale are reflected at fair value, with unrealized gains and
losses excluded from earnings and reported in other comprehensive income/loss,
net of tax effects. Premiums and discounts are amortized to earnings by the
interest method over the contractual life of the securities. Gains and losses
on sale of securities are recognized on the trade date and determined using
the specific identification method.
In estimating whether there are any other than temporary impairment losses,
management considers 1) the length of time and the extent to which the fair
value has been less than amortized cost, 2) the financial condition and near
term prospects of the issuer, 3) the impact of changes in market interest
rates and 4) the intent and ability of the Company to retain its investment
for a period of time sufficient to allow for any anticipated recovery in fair
value.
Declines in the fair value of individual securities available for sale that
are deemed to be other than temporary are reflected in earnings when
identified. The fair value of the security then becomes the new cost basis.
For individual securities where the Company does not intend to sell the
security and it is not more likely than not that the Company will be required
to sell the security before recovery of its amortized cost basis, the other
than temporary decline in the fair value of the security related to 1) credit
loss is recognized in earnings and 2) market or other factors is recognized in
other comprehensive income or loss. Credit loss is recorded if the present
value of cash flows is less than the amortized cost. For individual
securities where the Company intends to sell the security or more likely than
not will not recover all of its amortized cost, the other than temporary
impairment is recognized in earnings equal to the entire difference between
the securities cost basis and its fair value at the balance sheet date. For
individual securities that credit loss has been recognized in earnings,
interest accruals and amortization and accretion of premiums and discounts are
suspended when the credit loss is recognized. Interest received after
accruals have been suspended is recognized on a cash basis.
(continued)
89
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 1 - Summary of Significant Accounting Policies (continued)
Federal Home Loan Bank Stock
The Company, as a member of the Federal Home Loan Bank of Seattle ("FHLB"), is
required to maintain an investment in capital stock of the FHLB in an amount
equal to the greater of 1% of its outstanding home loans or 5% of advances
from the FHLB. The recorded amount of FHLB stock equals its fair value
because the shares can only be redeemed by the FHLB at the $100 per share par
value.
The Company views its investment in the FHLB stock as a long-term investment.
Accordingly, when evaluating for impairment, the value is determined based on
the ultimate recovery of the par value rather than recognizing temporary
declines in value. The determination of whether a decline affects the
ultimate recovery is influenced by criteria such as: 1) the significance of
the decline in net assets of the FHLB as compared to the capital stock amount
and length of time a decline has persisted; 2) the impact of legislative and
regulatory changes on the FHLB and 3) the liquidity position of the FHLB. As
of September 30, 2009, the FHLB of Seattle reported that it had met all of its
regulatory capital requirements, but remained classified as "undercapitalized"
by its regulator, the Federal Housing Finance Agency. The FHLB will not pay a
dividend or repurchase capital stock while it is classified as
undercapitalized. While the FHLB was classified as undercapitalized as of
September 30, 2009, the Company does not believe that its investment in the
FHLB is impaired. However, this estimate could change in the near term if: 1)
significant other-than-temporary losses are incurred on the FHLB's
mortgage-backed securities causing a significant decline in its regulatory
capital status; 2) the economic losses resulting from credit deterioration on
the FHLB's mortgage-backed securities increases significantly or 3) capital
preservation strategies being utilized by the FHLB become ineffective.
Loans Held for Sale
Mortgage loans originated and intended for sale in the secondary market are
stated in the aggregate at the lower of cost or estimated fair value. Net
unrealized losses, if any, are recognized through a valuation allowance by
charges to income. Gains or losses on sales of loans are recognized at the
time of sale. The gain or loss is the difference between the net sales
proceeds and the recorded value of the loans, including any remaining
unamortized deferred loan origination fees.
Loans Receivable
Loans are stated at the amount of unpaid principal, reduced by the undisbursed
portion of construction loans in process, deferred loan origination fees and
an allowance for loan losses.
Troubled Debt Restructured Loans
A troubled debt restructured loan is a loan which the Bank, for reasons
related to a borrower's financial difficulties, grants a concession to the
borrower that the Bank would not otherwise consider.
The loan terms which have been modified or restructured due to a borrower's
financial difficulty, include but are not limited to a reduction in the stated
interest rate; an extension of the maturity at an interest rate below current
market; a reduction in the face amount of the debt; a reduction in the accrued
interest; or re-aging, extensions, deferrals, renewals and rewrites. A
troubled debt restructured loan would generally be considered impaired.
(continued)
90
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 1 - Summary of Significant Accounting Policies (continued)
Impaired Loans
A loan is considered impaired when it is probable the Bank will be unable to
collect all contractual principal and interest payments due in accordance with
the original or modified terms of the loan agreement. Impaired loans are
measured based on the estimated fair value of the collateral less estimated
cost to sell if the loan is considered collateral dependent. Impaired loans
not considered to be collateral dependent are measured based on the present
value of expected future cash flows.
The categories of non-accrual loans and impaired loans overlap, although they
are not coextensive. The Bank considers all circumstances regarding the loan
and borrower on an individual basis when determining whether an impaired loan
should be placed on non-accrual status, such as the financial strength of the
borrower, the collateral value, reasons for delay, payment record, the amount
of past due and the number of days past due.
Allowance for Loan Losses
The allowance for loan losses is maintained at a level sufficient to provide
for estimated loan losses based on evaluating known and inherent risks in the
loan portfolio. The allowance is provided based upon management's
comprehensive analysis of the pertinent factors underlying the quality of the
loan portfolio. These factors include changes in the amount and composition
of the loan portfolio, delinquency levels, actual loan loss experience,
current economic conditions, and detailed analysis of individual loans for
which full collectability may not be assured. The detailed analysis includes
methods to estimate the fair value of loan collateral and the existence of
potential alternative sources of repayment. The allowance consists of
specific and general components. The specific component relates to loans that
are deemed impaired. For such loans that are classified as impaired, an
allowance is established when the discounted cash flows (or collateral value
or observable market price) of the impaired loan is lower than the recorded
value of that loan. The general component covers non-classified loans and
classified loans that are not evaluated individually for impairment and is
based on historical loss experience adjusted for qualitative factors. The
appropriateness of the allowance for losses on loans is estimated based upon
these factors and trends identified by management at the time financial
statements are prepared.
In accordance with the Financial Accounting Standards Board ("FASB") guidance
for Receivables, a loan is considered impaired when it is probable that a
creditor will be unable to collect all amounts (principal and interest) due
according to the contractual terms of the loan agreement. Smaller balance
homogenous loans, such as residential mortgage loans and consumer loans, may
be collectively evaluated for potential loss. When a loan has been identified
as being impaired, the amount of the impairment is measured by using
discounted cash flows, except when, as an alternative, the current fair value
of the collateral, reduced by costs to sell, is used. When the measurement of
the impaired loan is less than the recorded investment in the loan (including
accrued interest and net deferred loan origination fees or costs), an
impairment is recognized by creating or adjusting an allocation of the
allowance for loan losses. Uncollected accrued interest is reversed against
interest income. If ultimate collection of principal is in doubt, all cash
receipts on impaired loans are applied to reduce the principal balance.
A provision for loan losses is charged against income and is added to the
allowance for loan losses based on quarterly comprehensive analyses of the
loan portfolio. The allowance for loan losses is allocated to certain loan
categories based on the relative risk characteristics, asset classifications
and actual loss experience of the loan portfolio. While management has
allocated the allowance for loan losses to various loan portfolio segments,
the allowance is general in nature and is available for the loan portfolio in
its entirety.
(continued)
91
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 1 - Summary of Significant Accounting Policies (continued)
Allowance for Loan Losses (concluded)
The ultimate recovery of all loans is susceptible to future market factors
beyond the Bank's control. These factors may result in losses or recoveries
differing significantly from those provided in the consolidated financial
statements. The Bank experienced significant declines in current valuations
for real estate collateral for the year ended September 30, 2009. If real
estate values continue to decline and as updated appraisals are received, the
Bank may need to increase the allowance for loan losses appropriately. In
addition, regulatory agencies, as an integral part of their examination
process, periodically review the Bank's allowance for loan losses, and may
require the Bank to make additions to the allowance based on their judgment
about information available to them at the time of their examinations.
Interest on Loans and Loan Fees
Interest on loans is accrued daily based on the principal amount outstanding.
Generally, the accrual of interest on loans is discontinued when, in
management's opinion, the borrower may be unable to meet payments as they
become due or when they are past due 90 days as to either principal or
interest (based on contractual terms), unless they are well secured and in the
process of collection. All interest accrued but not collected for loans that
are placed on non-accrual status or charged off is reversed against interest
income. Subsequent collections on a cash basis are applied proportionately to
past due principal and interest, unless collectability of principal is in
doubt, in which case all payments are applied to principal. Loans are
returned to accrual status when the loan is deemed current, and the
collectability of principal and interest is no longer doubtful, or on one- to
four-family loans, when the loan is less than 90 days delinquent.
The Bank charges fees for originating loans. These fees, net of certain loan
origination costs, are deferred and amortized to income, on the level-yield
basis, over the loan term. If the loan is repaid prior to maturity, the
remaining unamortized deferred loan origination fee is recognized in income at
the time of repayment.
Mortgage Servicing Rights
Mortgage servicing rights are capitalized at estimated fair value when
acquired through the origination of loans that are subsequently sold with the
servicing rights retained and are amortized to servicing income on loans sold
in proportion to and over the period of estimated net servicing income. The
value of mortgage servicing rights at the date of the sale of loans is
determined based on the discounted present value of expected future cash flows
using key assumptions for servicing income and costs and prepayment rates on
the underlying loans. The estimated fair value is periodically evaluated for
impairment by comparing actual cash flows and estimated future cash flows from
the servicing assets to those estimated at the time servicing assets were
originated. Fair values are estimated using discounted cash flows based on
current market rates of interest. For purposes of measuring impairment, the
rights must be stratified by one or more predominant risk characteristics of
the underlying loans. The Company stratifies its capitalized mortgage
servicing rights based on product type, interest rate and term of the
underlying loans. The amount of impairment recognized is the amount, if any,
by which the amortized cost of the rights for each stratum exceed their fair
value. Impairment if deemed temporary is recognized through a valuation
allowance to the extent that fair value is less than the recorded amount.
(continued)
92
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 1 - Summary of Significant Accounting Policies (continued)
Bank Owned Life Insurance ("BOLI")
Bank-owned life insurance policies are recorded at their cash surrender value
less applicable cash surrender charges. Income from BOLI is recognized when
earned.
Goodwill
Goodwill is initially recorded when the purchase price paid for an acquisition
exceeds the estimated fair value of the net identified tangible and intangible
assets acquired. Goodwill is presumed to have an indefinite useful life and
is analyzed annually for impairment. An annual review is performed at the end
of the third quarter of each fiscal year, or more frequently if indicators of
potential impairment exist, to determine if the recorded goodwill is impaired.
If the fair value of the Company's sole reporting unit exceeds the recorded
value of the reporting unit, goodwill is not considered impaired and no
additional analysis is necessary.
One of the circumstances evaluated when determining if an impairment test of
goodwill is needed more frequently than annually is the extent and duration
that the Company's market capitalization (total common shares outstanding
multiplied by current stock price) is less than the total equity applicable to
common shareholders. During the quarter ended March 31, 2009, the Company's
market capitalization decreased to a level that required a goodwill impairment
test prior to the annual test. Therefore, the Company engaged a third party
firm to perform an interim test for goodwill impairment during the quarter
ended March 31, 2009. The test concluded that recorded goodwill was not
impaired. The Company updated the interim test for goodwill impairment
internally during the quarter ended June 30, 2009 and concluded that recorded
goodwill was not impaired. As of September 30, 2009, there have been no
events or changes in the circumstances that would indicate a potential
impairment. No assurance can be given, however, that the Company will not
record an impairment loss on goodwill in the future.
Core Deposit Intangible
The core deposit intangible is amortized to non-interest expense using an
accelerated method over a ten-year period.
Premises and Equipment
Premises and equipment are recorded at cost. Depreciation is computed on the
straight-line method over the following estimated useful lives: buildings and
improvements - up to 40 years; furniture and equipment - three to seven years;
and automobiles - five years. The cost of maintenance and repairs is charged
to expense as incurred. Gains and losses on dispositions are reflected in
earnings.
Impairment of Long-Lived Assets
Long-lived assets, consisting of premises and equipment are reviewed for
impairment whenever events or changes in circumstances indicate that the
recorded amount of an asset may not be recoverable. Recoverability of assets
to be held and used is measured by a comparison of the recorded amount of an
asset to future net cash flows expected to be generated by the asset. If such
assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the recorded amount of the assets exceeds the
recovery amount or estimated fair value of the assets. No events or changes
in circumstances have occurred causing management to evaluate the
recoverability of the Bank's long-lived assets.
(continued)
93
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 1 - Summary of Significant Accounting Policies (continued)
Other Real Estate Owned and Other Repossessed Items
Other real estate owned and other repossessed items consist of properties or
assets acquired through or in lieu of foreclosure, and are recorded initially
at the fair value of the properties less estimated costs of disposal. Costs
relating to development and improvement of the properties or assets are
capitalized while costs relating to holding the properties or assets are
expensed.
Valuations are periodically performed by management, and a charge to earnings
is recorded if the recorded value of a property exceeds its estimated net
realizable value.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales when control over the
assets has been surrendered. Control over transferred assets is deemed to be
surrendered when (1) the assets have been isolated from the Company, (2) the
transferee obtains the right (free of conditions that constrain it from taking
advantage of that right) to pledge or exchange the transferred assets, and (3)
the Company does not maintain effective control over the transferred assets
through an agreement to repurchase them before their maturity.
Income Taxes
The Company files a consolidated federal income tax return with its
Subsidiary. The Bank provides for income taxes separately and remits to the
Company amounts currently due.
Deferred federal income taxes result from temporary differences between the
tax basis of assets and liabilities, and their reported amounts in the
consolidated financial statements. These will result in differences between
income for tax purposes and income for financial reporting purposes in future
years. As changes in tax laws or rates are enacted, deferred tax assets and
liabilities are adjusted through the provision for income taxes. Valuation
allowances are established to reduce the net recorded amount of deferred tax
assets if it is determined to be more likely than not, that all or some
portion of the potential deferred tax asset will not be realized.
In June 2006, the FASB issued guidance related to accounting for uncertainty
in income taxes. The guidance prescribes a recognition threshold and
measurement attribute for the financial statement recognition and measurement
of a tax position taken or expected to be taken in a tax return. The Company
adopted the provisions outlined in the guidance on October 1, 2007. It is
the Company's policy to record any penalties or interest arising from federal
or state taxes as a component of non-interest expense.
The Company is no longer subject to United States federal income tax
examination by tax authorities for years ended on or before September 30,
2004.
(continued)
94
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 1 - Summary of Significant Accounting Policies (continued)
Employee Stock Ownership Plan
The Bank sponsors a leveraged Employee Stock Ownership Plan ("ESOP"). The
ESOP is accounted for in accordance with the accounting requirements for stock
compensation. Accordingly, the debt of the ESOP is recorded as other borrowed
funds of the Bank, and the shares pledged as collateral are reported as
unearned shares issued to the employee stock ownership trust on the
consolidated balance sheets. The debt of the ESOP is with the Company and is
thereby eliminated in the consolidated financial statements. As shares are
released from collateral, compensation expense is recorded equal to the
average market price of the shares for the period, and the shares become
available for earnings per share calculations. Dividends paid on unallocated
shares reduce the Company's cash contributions to the ESOP.
Cash Equivalents and Cash Flows
The Company considers amounts included in the balance sheets' captions "Cash
and due from financial institutions", "Interest-bearing deposits in other
banks" and "Federal funds sold", all of which mature within ninety days, to be
cash equivalents. Cash flows from loans, deposits, FHLB advances short
term, and other borrowings are reported net.
Advertising
Costs for advertising and marketing are expensed as incurred.
Stock-Based Compensation
The Company accounts for stock based compensation in accordance with FASB
requirements for stock compensation. The guidance requires measurement of the
compensation cost for all stock-based awards based on the grant-date fair
value and recognition of compensation cost over the service period of
stock-based awards.
The fair value of stock options is determined using the Black-Scholes
valuation model, which is consistent with the Company's valuation methodology
previously utilized for options in footnote disclosure required by the
guidance for stock compensation. The fair value of stock grants under the
MRDP is equal to the fair value of the shares at the grant date.
The Company's stock compensation plans are described more fully in Note 15.
Earnings (Loss) Per Common Share
Basic earnings per common share exclude dilution and are computed by dividing
net income (loss) available to common shareholders by the weighted average
number of common shares outstanding. Diluted earnings (loss) per common share
are computed by dividing net income available to common shareholders by the
weighted average number of common shares and common stock equivalents for
items that are dilutive, net of shares assumed to be repurchased using the
treasury stock method at the average share price for the Company's common
stock during the period. Common stock equivalents arise from assumed
conversion of outstanding stock options, outstanding warrants to purchase
common stock and restricted stock awards not yet vested.
(continued)
95
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 1 - Summary of Significant Accounting Policies (continued)
Related Party Transactions
The Chairman of the Board for the Bank and the Company is a member of the law
firm that provides general counsel to the Bank. Legal fees paid to this law
firm for the years ended September 30, 2009, 2008 and 2007 totaled $125,000,
$62,000 and $44,000, respectively.
Recent Accounting Pronouncements
In June 2009, the FASB issued FAS 168, "The FASB Accounting Standards
Codification and Hierarchy of Generally Accepted Accounting Principles
replacement of FAS 162" (the "Codification"). The Codification supersedes all
existing accounting and reporting standards other than the rules of the
Securities and Exchange Commission (the "SEC"). Rules and interpretive
releases of the SEC under authority of federal securities laws are also
sources of authoritative guidance for SEC registrants. Updates to the
Codification are being issued as Accounting Standards Updates, which will also
provide background information about the guidance, and provide the basis for
conclusions on changes in the Codification. The Codification became effective
for the Company on July 1, 2009 and did not have a material impact on the
Company's consolidated financial statements.
In September 2006, the FASB issued a statement on fair value measurements,
which defines fair value, establishes a framework for measuring fair value
under GAAP, and expands disclosures about fair value measurements. This
statement expands other accounting pronouncements that require or permit fair
value measurements. This statement is effective for fiscal years beginning
after November 15, 2007, and interim periods within those fiscal years. In
February 2008, the FASB issued a staff position, which delays the effective
date of the September 2006 statement on fair value measurements for certain
nonfinancial assets and nonfinancial liabilities, to fiscal years beginning
after November 15, 2008, and interim periods within those years. The delay is
intended to allow additional time to consider the effect of various
implementation issues that have arisen, or that may arise, from the
application of the guidance. The Company has elected to apply the deferral
provisions in the February 2008 staff position and therefore only partially
adopted the provisions of the September 2006 statement on fair value
measurements on October 1, 2008. The Company's partial adoption of the
September 2006 statement on fair value measurements on October 1, 2008 did not
have a material impact on the Company's consolidated financial statements. See
Footnote 23, "Fair Value of Financial Instruments," for further information.
The Company has not adopted the provisions of the fair value guidance with
respect to certain nonfinancial assets, such as other real estate owned. The
Company will more fully adopt the fair value statement guidance with respect
to these items effective October 1, 2009. The Company does not believe that
the adoption of the additional provisions will have a material impact on its
consolidated financial statements, but will result in additional disclosures
related to the fair value of nonfinancial assets.
In June 2008, the FASB issued a staff position on determining whether
instruments granted in share-based payment transactions are participating
securities. The guidance clarifies that all outstanding unvested share-based
payment awards that contain non-forfeitable rights to dividends or dividend
equivalents (whether paid or unpaid) are participating securities and are
required to be included in computing basic and diluted earnings per common
share under the two-class method. This staff position is effective for
financial statements issued for fiscal years beginning after December 15, 2008
and interim periods within those years. The adoption of this staff position
will not have a material impact on the Company's consolidated financial
statements.
(continued)
96
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 1 - Summary of Significant Accounting Policies (concluded)
Recent Accounting Pronouncements (concluded)
In April 2009, the FASB issued staff positions on the recognition and
presentation of Other-Than-Temporary Impairments ("OTTI"), determining fair
value when the volume and level of activity for the asset or liability have
significantly decreased and identifying transactions that are not orderly, and
interim disclosures about fair value of financial instruments. For debt
securities, the guidance differentiates credit driven and market driven OTTI.
Only the portion of the impairment loss representing credit losses is
recognized in earnings as an OTTI. The balance of the impairment is
recognized as a charge to other comprehensive income (loss). A non-credit
related OTTI charge to other comprehensive income / loss for securities
classified as held to maturity is amortized from accumulated other
comprehensive income / loss back to the security over the securities remaining
life. Financial statement presentation requires segregation of accumulated
comprehensive income for non-credit OTTI charges on held to maturity and
available for sale securities from other components of accumulated
comprehensive income (loss). Additional guidance was included for the
determination of whether a market for an asset is not active and when a price
for a transaction is not distressed. The Company elected to early adopt this
staff position as of January 1, 2009. As a result of adopting this FASB
guidance regarding recognition of OTTI, the Company recorded $1.37 million in
impairments not related to credit losses through other comprehensive income
(loss) rather than through earnings for the year ended September 30, 2009.
The Company also reclassified $91,000 from retained earnings to other
comprehensive loss related to impairment charges on private residential
collateralized mortgage obligations at December 31, 2008 that were not due to
credit losses.
In April 2009, the FASB issued a staff position on interim disclosures about
fair value of financial instruments to enhance consistency in financial
reporting by increasing the frequency of fair value disclosures. The Company
adopted the provisions of this staff position as of June 30, 2009 and it did
not have a material impact on the Company's consolidated financial statements.
In May 2009, the FASB issued guidance on subsequent events that standardizes
accounting for and disclosure of events that occur after the balance sheet
date but before financial statements are issued or are available to be issued.
Specifically, the Statement defines: (1) the period after the balance sheet
date during which management of a reporting entity should evaluate events or
transactions that may occur for potential recognition or disclosure in the
financial statements, (2) the circumstances under which an entity should
recognize events or transactions occurring after the balance sheet date in its
financial statements, and (3) the disclosures that an entity should make about
events or transactions that occurred after the balance sheet date. The
Company adopted this guidance as of June 30, 2009 and it did not have a
material impact on the Company's condensed consolidated financial statements.
Note 2 - Restricted Assets
Federal Reserve Board regulations require that the Bank maintain certain
minimum reserve balances on hand or on deposit with the Federal Reserve Bank,
based on a percentage of transaction account deposits. The amount of the
reserve requirement balance for the years ended September 30, 2009 and 2008
was approximately $206,000 and $676,000, respectively.
97
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 3 - Investments and Mortgage-Backed Securities
Investments and mortgage-backed securities have been classified according to
management's intent (in thousands):
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
September 30, 2009
Held to Maturity
Residential mortgage-backed
securities $ 7,060 $ 26 $(900) $ 6,186
U.S. agency securities 27 2 - - 29
Total $ 7,087 $ 28 $(900) $ 6,215
Available for Sale
Residential mortgage-backed
securities $13,152 $ 221 $(870) $12,503
Mutual funds 1,000 - - (32) 968
Total $14,152 $ 221 $(902) $13,471
September 30, 2008
Held to Maturity
Residential mortgage-backed
securities $14,205 $ 8 $(2,267) $11,946
U.S. agency securities 28 - - - - 28
Total $14,233 $ 8 $(2,267) $11,974
Available for Sale
Residential mortgage-backed
securities $16,806 $ 52 $ (696) $16,162
Mutual funds 1,000 - - (64) 936
Total $17,806 $ 52 $ (760) $17,098
(continued)
98
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 3 - Investments and Mortgage-Backed Securities (continued)
The following table summarizes the estimated fair value and gross unrealized
losses for all securities and the length of time the unrealized losses existed
as of September 30, 2009 (in thousands):
Less Than 12 Months 12 Months or Longer Total
----------------------- ------------------------ ------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Description of Securities Count Value Losses Count Value Losses Count Value Losses
Held to Maturity
Residential mortgage-
backed securities 11 $ 429 $(14) 70 $ 2,767 $(886) 81 $ 3,196 $(900)
U.S. agency securities - - - - - - - - - - - - - - - - - -
Total 11 $ 429 $(14) 70 $ 2,767 $(886) 81 $ 3,196 $(900)
Available for Sale
Residential mortgage- 1 $ 224 $ (2) 11 $ 2,524 $(868) 12 $ 2,748 $(870)
backed securities
Mutual funds - - - - - - - - 968 (32) - - 968 (32)
Total 1 $ 224 $ (2) 11 $ 3,492 $(900) 12 $ 3,716 $(902)
During the year ended September 30, 2009, the Company recorded net OTTI
charges through earnings on residential mortgage-backed securities of
$3,622,000. There were no OTTI charges recorded during the year ended
September 30, 2008. As discussed earlier in Note 1, effective January 1,
2009, the Company adopted Financial Accounting Standards Board Recognition of
Other Than-Temporary Impairments, which provides for the bifurcation of OTTI
into (i) amounts related to credit losses which are recognized through
earnings and (ii) amounts related to all other factors which are recognized as
a component of other comprehensive income (loss).
To determine the component of the gross OTTI related to credit losses, the
Company compared the amortized cost basis of each OTTI security to the present
value of its revised expected cash flows. The revised expected cash flow
estimates for individual securities are based primarily on an analysis of
default rates, prepayment speeds, house price assumptions and third-party
analytic reports. Significant judgment of management is required in this
analysis that includes, but is not limited to, assumptions regarding the
collectability of principal and interest, net of related expenses, on the
underlying loans.
(continued)
99
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 3 - Investments and Mortgage-Backed Securities (continued)
The following table presents a summary of the significant inputs utilized to
measure management's estimates of the credit loss component on OTTI securities
as of September 30, 2009:
Range
---------------------- Weighted
Minimum Maximum Average
Constant prepayment rate 6.00% 15.00% 10.86%
Collateral default rate 6.78% 59.62% 25.36%
Loss severity rate 14.25% 52.02% 33.99%
The following table presents the OTTI losses for the year ended September 30,
2009. There were no similar OTTI losses recorded during the years ended
September 30, 2008 or 2007 (in thousands).
Held to Available
Maturity For Sale
Total OTTI losses $ 5,669 $ 227
Portion of OTTI losses recognized in
Other comprehensive loss (before taxes) (1) 2,274 - -
Net impairment losses recognized in earnings (2) $ 3,395 $ 227
------------------------
(1) Represents OTTI losses related to all other factors.
(2) Represents OTTI losses related to credit losses.
The following table presents a roll forward of the credit loss component of
held to maturity debt securities that have been written down for OTTI with the
credit loss component recognized in earnings and the remaining impairment loss
related to all other factors recognized in other comprehensive loss (in
thousands).
Balance, September 30, 2008 $ - -
Additions:
Initial OTTI credit losses 2,365
Subsequent OTTI credit losses 1,030
Balance, September 30, 2009 $ 3,395
(continued)
100
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 3 - Investments and Mortgage-Backed Securities (concluded)
The Company has evaluated these securities and has determined that the decline
in their value is temporary. The unrealized losses are primarily due to
unusually large spreads in the market for private label mortgage-related
products. The fair value of the mortgage-backed securities is expected to
recover as the securities approach their maturity date and/or as the pricing
spreads narrow on mortgage-related securities. The Company has the ability
and the intent to hold the investments until the market value recovers.
There were no gross realized gains on sales of securities for the years ended
September 30, 2009, 2008 and 2007. During the year ended September 30, 2009
the Company recorded a $76,000 realized loss on four held to maturity
residential mortgage-backed securities. During the year ended September 30,
2008 there were gross realized losses on the sale and redemption of mutual
funds classified as available for sale in the amount of $2,822,000 and gross
realized losses on held to maturity residential mortgage-backed securities of
$4,000. During the year ended September 30, 2008, the Company redeemed its
investment in the AMF family of mutual funds and recognized a $2,822,000 loss
on the redemption. The Company redeemed $29,120,000 in mutual funds and
received $22,190,000 in underlying mortgage-backed securities and $6,930,000
in cash. There were no gross unrealized losses on sales of securities for the
year ended September 30, 2007.
Mortgage-backed and agency securities pledged as collateral for public fund
deposits, federal treasury tax and loan deposits, FHLB collateral, retail
repurchase agreements and other non-profit organization deposits totaled
$16,400,000 and $23,001,000 at September 30, 2009 and 2008, respectively.
The contractual maturities of debt securities at September 30, 2009, are as
follows (in thousands). Expected maturities may differ from scheduled
maturities due to the prepayment of principal or call provisions. Maturities
for mortgage-backed securities are based on the last payment due date.
Held to Maturity Available for Sale
---------------- ------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
Due within one year $ - - $ - - $ - - $ - -
Due after one year to five years 14 14 444 418
Due after five to ten years 57 59 243 256
Due after ten years 7,016 6,142 12,465 11,829
Mutual funds - - - - 1,000 968
Total $7,087 $6,215 $14,152 $13,471
101
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 4 - Loans Receivable and Loans Held for Sale
Loans receivable and loans held for sale consisted of the following at
September 30 (in thousands):
2009 2008
Mortgage loans:
One- to four-family $ 109,926 $ 110,526
Multi-family 25,638 25,927
Commercial 188,205 146,223
Construction and land development 139,728 186,344
Land 65,642 60,701
Total mortgage loans 529,139 529,721
Consumer loans:
Home equity and second mortgage 41,746 48,690
Other 9,827 10,635
Total consumer loans 51,573 59,325
Commercial business loans 13,775 21,018
Total loans receivable 594,487 610,064
Less:
Undisbursed portion of construction loans in process 31,298 43,353
Deferred loan origination fees 2,439 2,747
Allowance for loan losses 14,172 8,050
47,909 54,150
Loans receivable, net 546,578 555,914
Loans held for sale (one- to four-family) 630 1,773
Total loans receivable and loans held for sale $547,208 $557,687
Certain related parties of the Bank, principally Bank directors and officers,
were loan customers of the Bank in the ordinary course of business during the
years ended September 30, 2009 and 2008. These loans were performing
according to their terms at September 30, 2009 and 2008. Activity in related
party loans during the years ended September 30 is as follows (in thousands):
2009 2008
Balance, beginning of year $3,051 $2,786
New loans 291 486
Repayments (1,561) (221)
Balance, end of year $1,781 $3,051
(continued)
102
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 4 - Loans Receivable and Loans Held for Sale (concluded)
At September 30, 2009, 2008 and 2007, the Bank had impaired loans totaling
approximately $47,622,000, $13,647,000 and $1,490,000 respectively. Interest
income recognized on impaired loans for the years ended September 30, 2009,
2008 and 2007 was $803,000, $41,000 and $58,000 respectively. Interest income
recognized on a cash basis on impaired loans for the years ended September 30,
2009, 2008 and 2007 was $647,000, $21,000 and $58,000, respectively. The
average investment in impaired loans for the years ended September 30, 2009,
2008 and 2007 was $32,597,000, $6,955,000 and $623,000 respectively. The Bank
had $9,492,000 in troubled debt restructured loans on non-accrual status and
included in impaired loans at September 30, 2009. The Bank had $1,433,000 in
commitments to lend additional funds on these loans. The Bank had $272,000 in
troubled debt restructured loans included in impaired loans at September 30,
2008 and there were no commitments to lend additional funds on these loans.
The Bank had no troubled debt restructurings included in impaired loans at
September 30, 2007.
An analysis of the allowance for loan losses for the years ended September 30
follows (in thousands):
2009 2008 2007
Balance, beginning of year $ 8,050 $4,797 $4,122
Provision for loan losses 10,734 3,900 686
Allocated to commitments (169) -- --
Loans charged off (4,531) (648) (12)
Recoveries 88 1 1
Net charge-off (4,443) (647) (11)
Balance, end of year $14,172 $8,050 $4,797
Following is a summary of information related to impaired loans at September
30 (in thousands):
2009 2008 2007
Impaired loans without a valuation allowance $ 35,557 $ 8,872 $ 490
Impaired loans with a valuation allowance 12,065 4,775 1,000
$ 47,622 $13,647 $1,490
An analysis of the valuation allowance related to impaired loans for the years
ended September 30 follows (in thousands):
2009 2008 2007
Balance, beginning of year $ 790 $ 75 $ - -
Additions 5,648 1,631 78
Deductions:
Charged off to allowance for loan losses (1,838) (647) (2)
Other reductions (765) (269) (1)
Balance, end of year $ 3,835 $ 790 $ 75
At September 30, 2009, 2008 and 2007, the Bank had non-accruing loans totaling
$29,287,000, $11,990,000 and $1,490,000, respectively. All non-accrual loans
are considered impaired. The Bank had $796,000 in loans that were on 90 days
or more past due and still accruing interest at September 30, 2009. At
September 30, 2008 and 2007, no loans were 90 days or more past due and still
accruing interest.
(continued)
103
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 5 - Loan Servicing
Loans serviced for the Federal Home Loan Mortgage Corporation are not included
on the consolidated balance sheets. The principal amounts of those loans at
September 30, 2009, 2008 and 2007 were $251,837,000, $175,807,000 and
$161,565,000, respectively.
Following is an analysis of the changes in mortgage servicing rights for the
years ended September 30 (in thousands):
2009 2008 2007
Balance, at beginning of year $ 1,306 $ 1,051 $ 932
Additions 1,785 578 391
Amortization (473) (323) (272)
Valuation allowance (169) - - - -
Recovery of valuation allowance 169 - - - -
Balance, end of year $ 2,618 $ 1,306 $ 1,051
At September 30, 2009, 2008 and 2007, the fair value of mortgage servicing
rights totaled $2,650,000, $1,820,000 and $1,958,000, respectively. The fair
values for 2009, 2008, and 2007 were estimated using premium rates of 10.52%,
10.60% and 9.58%, and prepayment speed factors of 185, 214 and 194,
respectively. There was no valuation allowance at September 30, 2009, 2008 or
2007.
Note 6 - Premises and Equipment
Premises and equipment consisted of the following at September 30 (in
thousands):
2009 2008
Land $ 4,291 $ 4,333
Buildings and improvements 15,860 14,229
Furniture and equipment 6,594 5,899
Property held for future expansion 110 111
Construction and purchases in progress 71 299
26,926 24,871
Less accumulated depreciation 8,880 7,987
Total premises and equipment $18,046 $16,884
The Bank leases premises under operating leases. Rental expense of leased
premises was $243,000, $241,000, and $242,000 for September 30, 2009, 2008 and
2007, respectively, which is included in premises and equipment expense.
(continued)
104
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 6 - Premises and Equipment (concluded)
Minimum net rental commitments under noncancellable leases having an original
or remaining term of more than one year for future years ending September 30
are as follows (in thousands):
2010 $219
2011 67
2012 67
2013 67
Thereafter - -
Total minimum payments required $420
Certain leases contain renewal options from five to ten years and escalation
clauses based on increases in property taxes and other costs.
Note 7 - OREO and Other Repossessed Items
The following table presents the activity related to OREO and other
repossessed items at September 30 (in thousands):
September 30, 2009 September 30, 2008
Amount Number Amount Number
Beginning Balance $ 511 2 $ - - - -
Additions to OREO and other
repossessed items 10,005 37 1,404 3
Capitalized improvements 232
Lower of cost or fair value losses (306) (14)
Disposition of OREO and other
repossessed items (2,257) (13) (879) (1)
Ending Balance $ 8,185 26 $ 511 2
At September 30, 2009, OREO consisted of 26 properties in Washington, with
balances ranging from $5,000 to $2,314,000. At September 30, 2008, OREO
consisted of two properties. The Bank recorded a gain on sale of OREO and
other repossessed items for the years ended September 30, 2009, 2008 and 2007
of $60,000, $47,000 and $14,000, respectively.
105
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 8 - Core Deposit Intangibles ("CDI")
During the year ended September 30, 2005, the Company recorded a core deposit
intangible of $2,201,000 in connection with the October 2004 acquisition of
seven branches and related deposits. Net unamortized core deposit intangible
totaled $755,000 and $972,000 at September 30, 2009 and 2008, respectively.
Amortization expense related to the core deposit intangible for the years
ended September 30, 2009, 2008 and 2007 was $217,000, $249,000 and $285,000,
respectively.
Amortization expense for the core deposit intangible for future years ending
September 30 is estimated to be as follows (in thousands):
2010 $190
2011 167
2012 148
2013 131
2014 116
Thereafter 3
Total $755
Note 9 - Deposits
Deposits consisted of the following at September 30 (in thousands):
2009 2008
Non-interest-bearing $ 50,295 $ 51,955
NOW checking 117,357 90,468
Savings 58,609 56,391
Money market accounts 62,478 70,379
Certificates of deposit 213,168 203,420
Certificates of deposit brokered 3,754 25,959
Total deposits $505,661 $498,572
Certificates of deposit of $100,000 or greater totaled $77,926,000 and
$73,107,000 at September 30, 2009 and 2008, respectively.
(continued)
106
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 9 - Deposits (concluded)
Scheduled maturities of certificates of deposit for future years ending
September 30 are as follows (in thousands):
2010 $182,285
2011 22,587
2012 2,420
2013 3,603
2014 5,711
Thereafter 316
Total $216,922
Interest expense by account type is as follows for the years ended September
30 (in thousands):
2009 2008 2007
NOW checking $1,031 $ 774 $ 638
Savings 394 398 425
Money market accounts 1,036 1,250 1,186
Certificates of deposit 6,387 8,480 8,818
Certificates of deposit - brokered 624 861 225
Total $9,472 $11,763 $11,292
Note 10 - Other Borrowings - Repurchase Agreements
Other borrowings at September 30, 2009 and 2008 consisted of overnight
repurchase agreements with customers totaling $777,000 and $758,000,
respectively.
Information concerning repurchase agreements is summarized as follows at
September 30 (dollars in thousands):
2009 2008
Average daily balance during the period $ 624 $ 943
Average daily interest rate during the period 0.08% 2.12%
Maximum month-end balance during the period $ 844 $1,884
Weighted average rate at end of period 0.05% 1.05%
Securities underlying the agreements at the end of
period:
Recorded value $ 826 $1,614
Fair value 826 1,614
The securities underlying the agreements at September 30, 2009 were under the
Company's control in safekeeping at third-party financial institutions.
(continued)
107
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 11 - Federal Home Loan Bank ("FHLB") Advances and Other Borrowing Lines
The Bank has long- and short-term borrowing lines with the FHLB of Seattle
with total credit on the lines equal to 30% of the Bank's total assets,
limited by available collateral. Borrowings are considered short-term when
the original maturity is less than one year. FHLB advances consisted of the
following at September 30 (in thousands):
2009 2008
Short-term $ - - $ - -
Long-term 95,000 104,628
Total $95,000 $104,628
The long-term borrowings mature at various dates through September 2017 and
bear interest at rates ranging from 3.49% to 4.66%. Under the Advances,
Security and Deposit Agreement, virtually all of the Bank's assets, not
otherwise encumbered, are pledged as collateral for advances. Principal
reductions due for future years ending September 30 are as follows (in
thousands):
2010 $ 20,000
2011 20,000
2012 10,000
2013 - -
2014 - -
Thereafter 45,000
$ 95,000
A portion of the long-term advances have a putable feature and may be called
earlier by the FHLB than the above schedule indicates.
The Bank also maintains a short-term borrowing line with the Federal Reserve
Bank with total credit based on eligible collateral. As of September 30, 2009
the Bank had a borrowing capacity of $16,325,000 of which, one note in the
amount of $10,000,000 was outstanding. The borrowing matures on October 1,
2009 and bears an interest rate of 0.50%. The Bank did not have this
borrowing line available at September 30, 2008.
The Bank has also been approved for a $10,000,000 overnight borrowing line
with Pacific Coast Bankers' Bank. The borrowing line may be reduced or
withdrawn at any time and must be collateralized. As of September 30, 2009
and 2008, the Bank did not have any outstanding advances on this borrowing
line. As of September 30, 2009, the Bank did not have any collateral pledged
for this borrowing line.
Information concerning total short-term advances is summarized as follows at
September 30 (dollars in thousands):
2009 2008
Average daily balance during the period $ 48 $13,378
Average daily interest rate during the period 0.69% 4.44%
Maximum month-end balance during the period $10,000 $42,600
Weighted average rate at end of the period 0.50% - -
108
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 12 - Other Liabilities and Accrued Expenses
Other liabilities and accrued expenses were comprised of the following at
September 30 (in thousands):
2009 2008
Accrued deferred compensation and profit sharing plans
payable $ 188 $ 454
Accrued interest payable on deposits, FHLB advances and
other borrowings 965 1,135
Accounts payable and accrued expenses - other 1,886 1,495
Total other liabilities and accrued expenses $3,039 $3,084
Note 13 - Federal Income Taxes
The components of the provision (benefit) for federal income taxes for the
years ended September 30 were as follows (in thousands):
2009 2008 2007
Current $ 831 $ 4,041 $ 3,929
Deferred (1,813) (1,217) (101)
Total federal income taxes $ (982) $ 2,824 $ 3,828
The components of the Company's prepaid federal income taxes and net deferred
tax assets included in other assets as of September 30 were as follows (in
thousands):
2009 2008
Prepaid federal income taxes $ 543 $ 525
Net deferred tax assets 4,545 1,945
Total $5,088 $2,470
(continued)
109
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 13 - Federal Income Taxes (concluded)
The components of the Company's deferred tax assets and liabilities at
September 30 were as follows (in thousands):
2009 2008
Deferred Tax Assets
Accrued interest on loans $ 147 $ 5
Accrued vacation 120 115
Deferred compensation 35 54
Unearned ESOP shares 455 450
Allowance for loan losses 5,019 2,817
OREO appraisal losses 60 5
CDI 250 226
Unearned MRDP shares 111 61
Net unrealized securities losses 1,035 248
Capital loss carry-forward 846 928
Stock option compensation expense 22 21
Reserve for deposit overdrafts 2 - -
Total deferred tax assets 8,102 4,930
Deferred Tax Liabilities
FHLB stock dividends 906 906
Depreciation 444 262
Goodwill 659 527
Certificate of deposit valuation 20 21
Mortgage servicing rights 916 457
Prepaid expenses 102 122
Total deferred tax liabilities 3,047 2,295
Valuation allowance for capital loss on sale
of securities (510) (690)
Net deferred tax assets $4,545 $1,945
The Company has a capital loss carry forward in the amount of $2,255,000 that
will expire in 2013.
The provision (benefit) for federal income taxes for the years ended September
30 differs from that computed at the statutory corporate tax rate as follows
(dollars in thousands):
2009 2008 2007
Amount Percent Amount Percent Amount Percent
Taxes at statutory rate $(429) (35.0)% $2,390 35.0% $4,197 35.0%
BOLI income (337) (27.4) (170) (2.5) (162) (1.4)
Non-deductible capital
loss - - - - 750 11.0 - - - -
Dividends on ESOP (121) (9.9) (136) (2.0) (123) (1.0)
Other - net (95) (7.7) (10) (0.1) (84) (0.7)
Federal income taxes $(982) (80.0)% $2,824 41.4% $3,828 31.9%
110
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 14 - Employee Stock Ownership and 401(k) Plan ("KSOP")
Effective October 3, 2007, the Bank established the Timberland Bank Employee
Stock Ownership and 401(k) Plan ("KSOP") by combining the existing Timberland
Bank Employee Stock Ownership Plan (established in 1997) and the Timberland
Bank 401(k) Profit Sharing Plan (established in 1970). The KSOP is comprised
of two components, the Employee Stock Ownership Plan ("ESOP") and the 401(k)
Plan. The KSOP benefits employees with at least one year of service who are
21 years of age or older. It may be funded by Bank contributions in cash or
stock for the ESOP and in cash only for the 401(k) profit sharing. Employee
vesting occurs over six years.
ESOP
----
The amount of the annual contribution is discretionary, except that it must be
sufficient to enable the ESOP to service its debt. All dividends received by
the ESOP are used to pay debt service. Dividends of $331,000, $389,000, and
$351,000 were used to service the debt during the years ended September 30,
2009, 2008 and 2007, respectively. As of September 30, 2009, 172,193 ESOP
shares had been distributed to participants.
In January 1998, the ESOP borrowed $7,930,000 from the Company to purchase
1,058,000 shares of common stock of the Company. The term of the loan was
extended by 75 months in December 2006. The extension of the loan reduces the
annual number of shares allocated to participants. The loan is being repaid
primarily from the Bank's contributions to the ESOP and is scheduled to be
fully repaid by March 31, 2019. The interest rate on the loan is 8.5%.
Interest expense on the ESOP debt was $337,000, $359,000, and $375,000 for the
years ended September 30, 2009, 2008 and 2007, respectively. The balance of
the loan at September 30, 2009 was $3,811,000.
Shares held by the ESOP as of September 30 were classified as follows:
2009 2008 2007
Unallocated shares 335,052 370,294 405,562
Shares released for allocation 550,755 523,477 518,066
Total ESOP shares 885,807 893,771 923,628
The approximate fair market value of the Bank's unallocated shares at
September 30, 2009, 2008 and 2007, was $1,555,000, $2,796,000 and $6,347,000,
respectively. Compensation benefit recognized under the ESOP for the year
ended September 30, 2009 was $138,000 and compensation expense recognized for
the years ended September 30, 2008 and 2007 was $7,000 and $274,000
respectively.
401(k)
-----
Eligible employees may contribute up to the maximum established by the
Internal Revenue Service. Contributions by the Bank are at the discretion of
the board of directors except for a 3% safe harbor contribution which is
mandatory per the plan. Bank contributions totaled $475,000, $422,000 and
$371,000 for the years ended September 30, 2009, 2008 and 2007, respectively.
111
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 15 - Stock Compensation Plans
Stock Options Plans
-------------------
Under the Company's stock option plans (1999 Stock Option Plan and 2003 Stock
Option Plan), the Company may grant options for up to 1,622,500 shares of
common stock to employees, officers and directors. Shares issued may be
purchased in the open market or may be issued from authorized and unissued
shares. The exercise price of each option equals the fair market value of the
Company's stock on the date of grant. The options granted vest over a
ten-year period, which may be accelerated if the Company meets certain
performance criteria. At September 30, 2009, there were no unvested options.
At September 30, 2009, options for 275,738 shares were available for future
grant under the 2003 Stock Option Plan.
The Company uses the Black-Scholes option pricing model to estimate the fair
value of stock-based awards with the weighted average assumptions noted in the
following table. The risk-free interest rate is based on the U.S. Treasury
rate of a similar term as the stock option at the particular grant date. The
expected life is based on historical data, vesting terms, and estimated
exercise dates. The expected dividend yield is based on the most recent
quarterly dividend on an annualized basis. The expected volatility is based
on historical volatility of the Company's stock price. There were no options
granted during the fiscal years ended September 30, 2009, 2008 or 2007.
Stock option activity is summarized as follows:
Weighted
Average
Number of Exercise
Shares Price
Outstanding September 30, 2006 524,144 $ 7.26
Options exercised (110,470) 6.73
Options forfeited (1,000) 7.60
Outstanding September 30, 2007 412,674 7.39
Options exercised (138,854) 6.06
Outstanding September 30, 2008 273,820 8.07
Options exercised (57,699) 6.00
Options forfeited (47,257) 6.00
Outstanding September 30, 2009 168,864 9.35
Note 15 - Stock Compensation Plans (continued)
The total fair value of shares that vested during the years ended September
30, 2009, 2008 and 2007 was $13,000, $30,000 and $52,000, respectively.
Proceeds and related tax benefits realized from options exercised and
intrinsic value of options exercised for the years ended September 30 were as
follows (in thousands):
2009 2008 2007
Proceeds from options exercised $ 346 $ 842 $ 744
Related tax benefit recognized 46 15 463
Intrinsic value of options exercised 56 531 1,231
(continued)
112
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 15 - Stock Compensation Plans (continued)
Additional information regarding options outstanding at September 30, 2009, is
as follows:
Options Outstanding Options Exercisable
----------------------------- ------------------------------
Weighted Weighted
Average Average
Weighted Remaining Weighted Remaining
Range of Average Contractual Average Contractual
Exercise Exercise Life Exercise Life
Prices Number Price (Years) Number Price (Years)
$ 7.45 56,638 7.45 1.7 56,638 7.45 1.7
7.85 - 7.98 6,000 7.91 2.6 6,000 7.91 2.6
9.52 56,680 9.52 3.4 56,680 9.52 3.4
11.46 - 11.63 49,546 11.51 4.3 49,546 11.51 4.2
168,864 $ 9.35 3.1 168,864 $ 9.35 3.1
There was no aggregate intrinsic value of all options outstanding at September
30, 2009, as the exercise price of all options outstanding was greater than
the stock's current market value. The aggregate intrinsic value of all
options outstanding and exercisable at September 30, 2008 was $168,000.
Stock Grant Plan
----------------
The Company adopted the Management Recognition and Development Plan ("MRDP")
in 1998, which was subsequently approved by the shareholders in 1999 for the
benefit of employees, officers and directors of the Company. The objective of
the MRDP is to retain personnel of experience and ability in key positions by
providing them with a proprietary interest in the Company.
The MRDP allowed for the issuance to participants of up to 529,000 shares of
the Company's common stock. Awards under the MRDP have been made in the form
of restricted shares of common stock that are subject to restrictions on the
transfer of ownership and are subject to a five-year vesting period.
Compensation expense in the amount of the fair value of the common stock at
the date of the grant to the plan participants is recognized over a five-year
vesting period, with 20% vesting on each of the five anniversaries from the
date of the grant. At September 30, 2009, there were no shares available for
future awards under the MRDP.
A summary of MRDP shares granted and vested for the years ended September 30,
were as follows:
2009 2008 2007
Shares granted 19,758 20,315 15,080
Weighted average grant date fair value $7.01 $12.76 $17.44
Shares vested 9,479 5,416 2,400
Aggregate vesting date fair value $46,000 $46,000 $39,000
(continued)
113
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 15 - Stock Compensation Plans (concluded)
A summary of unvested MRDP shares as of September 30, 2009 and changes during
the year ended September 30, 2009, were as follows:
Weighted Average
Grant Date
Shares Fair Value
Unvested shares, beginning of period 39,579 $14.82
Shares granted 19,758 7.01
Shares vested (9,479) 15.13
-------
Unvested shared, end of period 49,858 11.66
At September 30, 2009, there were 49,858 unvested MRDP shares with an
aggregate grant date fair value of $582,000. At September 30, 2009 there were
no shares available for future grant under the MRDP.
Expense for Stock Compensation Plans
------------------------------------
Compensation expense recorded in the financial statements for all stock-based
plans were as follows for the years ended September 30, (in thousands):
2009 2008 2007
Stock options $ 3 $ 5 $ 25
MRDP stock grants 137 147 66
Less: related tax benefit recognized (49) (53) (31)
$ 91 $ 99 $ 60
The compensation expense yet to be recognized for stock based awards that been
awarded but not vested for the years ending September 30, is as follows (in
thousands):
Stock
Stock Grants Total
Options (MRDP) Awards
2010 -- 171 171
2011 -- 165 165
2012 -- 111 111
2013 -- 38 38
2014 -- 2 2
$ -- $487 $487
114
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 16 - Deferred Compensation Plans
The Bank has a deferred compensation/non-competition arrangement with its
former chief executive officer, which provides monthly payments of $2,000 per
month upon retirement. Payments under this agreement began in March 2004 and
will continue until his death, at which time payments will continue to his
surviving spouse until the earlier of her death or for 60 months. The present
value of the payments as of September 30, 2009 and 2008, $105,000 and
$129,000, respectively, has been accrued for under the agreement and is
included in other liabilities on the consolidated balance sheets.
The Company adopted the Timberland Bancorp, Inc. Directors Deferred
Compensation Plan in 2004. This plan allows directors to defer a portion of
their monthly directors' fees until retirement with no income tax payable by
the director until retirement benefits are received. The Company accrues
interest on the liability at a rate of 1.00% over the Bank's one-year CD rate.
There was no liability accrued under this plan at September 30, 2009. The
liability accrued as of September 30, 2008 was $10,000 and is included in
other liabilities on the consolidated balance sheets.
Note 17 - Commitments and Contingencies
The Bank is party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit. These instruments
involve, to varying degrees, elements of credit risk not recognized on the
consolidated balance sheets.
The Bank's exposure to credit loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit is
represented by the contractual amount of those instruments. The Bank uses the
same credit policies in making commitments as it does for on-balance-sheet
instruments. A summary of the Bank's commitments at September 30, is as
follows (in thousands):
2009 2008
Undisbursed portion of construction loans in process
(see Note 4) $31,298 $43,353
Undisbursed lines of credit 27,609 25,343
Commitments to extend credit 16,513 15,281
(continued)
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Since
commitments may expire without being drawn upon, the total commitment amounts
do not necessarily represent future cash requirements. The Bank evaluates
each customer's creditworthiness on a case-by-case basis. The amount of
collateral obtained, if deemed necessary by the Bank upon extension of credit,
is based on management's credit evaluation of the party. Collateral held
varies, but may include accounts receivable, inventory, property and
equipment, residential real estate, land, and income-producing commercial
properties.
(continued)
115
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 17 - Commitments and Contingencies (concluded)
In March 2007, the Bank adopted the Timberland Bank Employee Severance
Compensation Plan, which replaced the existing employee severance compensation
agreement adopted in 1998. The new plan, which expires in 2017, was adopted
to provide severance pay benefits to eligible employees in the event of a
change in control of the Company or the Bank (as defined in the plan). In
general, all employees (except those who are restricted from receiving golden
parachute payments in any amount under the compensation limitations for
participants in the Treasury's Capital Purchase Program) with two or more
years of service will be eligible to participate in the plan. Under the plan,
in the event of a change in control of the Company or the Bank, eligible
employees who are terminated or who terminate employment (but only upon the
occurrence of events specified in the plan) within 12 months of the effective
date of a change in control would be entitled to a payment based on years of
service or officer rank with the Bank. The maximum payment for any eligible
employee would be equal to 24 months of their current compensation.
Because of the nature of its activities, the Company is subject to various
pending and threatened legal actions which arise in the ordinary course of
business. In the opinion of management, liabilities arising from these
claims, if any, will not have a material effect on the financial position of
the Company.
Note 18 - Significant Concentrations of Credit Risk
Most of the Bank's lending activity is with customers located in the state of
Washington and involves real estate. At September 30, 2009, the Bank had
$571,515,000 (including $31,298,000 of undisbursed construction loan proceeds)
in loans secured by real estate, which represents 96.0% of the total loan
portfolio. The real estate loan portfolio is primarily secured by one- to
four-family properties, multi-family properties, undeveloped land, and a
variety of commercial real estate property types. At September 30, 2009,
there were no concentrations of real estate loans to a specific industry or
secured by a specific collateral type that equaled or exceeded 20% of the
Bank's total loan portfolio, other than loans secured by one-to four-family
properties. The ultimate collectability of a substantial portion of the loan
portfolio is susceptible to changes in economic and market conditions in the
region and the impact of those changes on the real estate market. The Bank
typically maintains loan-to-value ratios of no greater than 90% on real estate
loans. Collateral and / or guarantees are required for all loans.
Note 19 - Regulatory Matters
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could have
a direct material effect on the Company's consolidated financial statements.
Under capital adequacy guidelines of the regulatory framework for prompt
corrective action, the Bank must meet specific capital adequacy guidelines
that involve quantitative measures of the Bank's assets, liabilities and
certain off-balance-sheet items as calculated under regulatory accounting
practices. The capital classifications of the Company and the Bank are also
subject to qualitative judgments by the regulators about components, risk
weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios as
defined in the regulations (set forth in the table below) of Tier 1 capital to
average assets, and minimum ratios of Tier 1 and total capital to
risk-weighted assets.
(continued)
116
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 19 - Regulatory Matters (concluded)
At September 30, 2009, the Bank was categorized as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized, the Bank must maintain minimum total risk-based, Tier 1
risk-based, and Tier 1 leverage ratios as set forth in the table.
The Company's and the Bank's actual capital amounts (dollars in thousands) and
ratios are also presented in the table.
To be Well
Capitalized
Under Prompt
Capital Adequacy Corrective Action
Actual Purposes Provisions
Amount Ratio Amount Ratio Amount Ratio
September 30, 2009
Tier 1 capital (to
average assets):
Consolidated $83,196 12.2% $27,182 4.0% N/A N/A
Timberland Bank 67,780 10.1 26,774 4.0 $33,467 5.0%
Tier 1 capital
(to risk-weighted
assets)
Consolidated 83,196 14.7 22,683 4.0 N/A N/A
Timberland Bank 67,780 12.0 22,576 4.0 33,864 6.0
Total capital (to
risk-weighted
assets):
Consolidated 90,372 15.9 45,366 8.0 N/A N/A
Timberland Bank 74,923 13.3 45,152 8.0 56,440 10.0
September 30, 2008
Tier 1 capital (to
average assets):
Consolidated $68,615 10.3% $26,709 4.0% N/A N/A
Timberland Bank 61,326 9.2 26,649 4.0 $33,311 5.0%
Tier 1 capital (to
risk-weighted
assets):
Consolidated 68,615 12.4 22,189 4.0 N/A N/A
Timberland Bank 61,326 11.1 22,192 4.0 33,288 6.0
Total capital (to
risk-weighted
assets):
Consolidated 75,563 13.6 44,378 8.0 N/A N/A
Timberland Bank 68,275 12.3 44,384 8.0 55,480 10.0
In October 2009, the Bank was informed by the FDIC that it would be required
to maintain Tier 1 Capital in an amount as to equal or exceed 10.0% of the
Bank's adjusted total assets.
Restrictions on Retained Earnings
The Bank is subject to certain restrictions on the amount of dividends that it
may declare without prior regulatory approval.
At the time of conversion of the Bank from a Washington-chartered mutual
savings bank to a Washington-chartered stock savings bank, the Bank
established a liquidation account in an amount equal to its retained earnings
of $23,866,000 as of June 30, 1997, the date of the latest statement of
financial condition used in the final conversion prospectus. The liquidation
account is maintained for the benefit of eligible account holders who have
maintained their deposit accounts in the Bank after conversion. The
liquidation account reduces annually to the extent that eligible account
holders have reduced their qualifying deposits as of each anniversary date.
Subsequent increases do not restore an eligible account holder's interest in
the liquidation account. In the event of a complete liquidation of the Bank
(and only in such an event), eligible depositors who have continued to
maintain accounts will be entitled to receive a distribution from the
liquidation account before any liquidation may be made with respect to common
stock. The Bank may not declare or pay cash dividends if the effect thereof
would reduce its regulatory capital below the amount required for the
liquidation account.
117
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 20 - Condensed Financial Information - Parent Company Only
Condensed Balance Sheets - September 30
(In Thousands)
2009 2008
Assets
Cash and due from financial institutions $ 350 $ 280
Interest-bearing deposits in banks 10,603 2,903
Loan receivable from Bank 3,811 4,063
Investment in Bank 71,784 67,552
Other assets 798 1,345
Total assets $87,346 $76,143
Liabilities and shareholders' equity
Accrued expenses $ 147 $ 1,302
Shareholders' equity 87,199 74,841
Total liabilities and shareholders' equity $87,346 $76,143
(continued)
118
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 20 - Condensed Financial Information - Parent Company Only (continued)
Condensed Statements of Income - Years Ended September 30
(In Thousands)
2009 2008 2007
Operating income
Interest-bearing deposits in banks $ 25 $ 22 $ 26
Interest on loan receivable from Bank 338 359 375
Dividends on investments - - 65 108
Loss on sale of investment securities
available for sale ("AFS") - - (171) - -
Dividends from Bank 416 3,850 12,823
Total operating income 779 4,125 13,332
Non-operating income 37 - - - -
Operating expenses 642 589 633
Income before income taxes and equity
in undistributed income of Bank 174 3,536 12,699
Provision (benefit) for income taxes (200) (193) (166)
Income before equity in undistributed income
(loss) of Bank 374 3,729 12,865
Equity in undistributed income (loss) of bank
(dividends in excess of income of Bank) (616) 276 (4,702)
Net income (loss) $ (242) $ 4,005 $ 8,163
Preferred stock dividends $ 643 $ - - $ - -
Preferred stock accretion 129 - - - -
Net income (loss) available to common
shareholders $(1,014) $ 4,005 $ 8,163
(continued)
119
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 20 - Condensed Financial Information - Parent Company Only (concluded)
Condensed Statements of Cash Flows - Years Ended September 30
(In Thousands)
2009 2008 2007
Cash flows from operating activities
Net income (loss) $ (242) $ 4,005 $ 8,163
Adjustments to reconcile net income to net
cash provided:
(Equity in undistributed income of Bank)
dividends in excess of income of Bank 616 (276) 4,702
ESOP shares earned 264 264 265
MRDP compensation expense 169 131 59
Stock option compensation expense 3 5 25
Stock option tax effect 46 15 464
Less stock option excess tax benefit - - (11) (354)
Loss on sale of securities AFS - - 171 - -
Other, net (608) 1,764 (256)
Net cash provided by operating activities 248 6,068 13,068
Cash flows from investing activities
Investment in Bank (6,308) (562) (698)
Proceeds from sale of securities AFS - - 1,959 - -
Principal repayments on loan receivable
from Bank 252 230 214
Net cash provided by (used in) investing
activities (6,056) 1,627 (484)
Cash flows from financing activities
Increase (decrease) in borrowings from Bank - - (1,400) 1,400
Proceeds from exercise of stock options 346 841 744
Repurchase of common stock - - (1,920) (12,431)
Payment of dividends (3,272) (2,977) (2,682)
ESOP tax effect (47) (409) 354
MRDP compensation tax effect (32) 16 5
Stock option tax effect - - 11 354
Issuance of preferred stock 15,425 - - - -
Issuance of stock warrants 1,158 - - - -
Net cash provided by (used in) financing
activities 13,578 (5,838) (12,256)
Net increase in cash 7,770 1,857 328
Cash equivalents
Beginning of year 3,183 1,326 998
End of year $10,953 $ 3,183 $ 1,326
120
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 21 - Earnings (Loss) Per Common Share Disclosures
Basic earnings (loss) per common share ("EPS") are computed by dividing net
income (loss) available to common shareholders by the weighted average number
of common shares outstanding during the period, without considering any
dilutive items. Diluted EPS is computed by dividing net income (loss)
available to common shareholders by the weighted average number of common
shares and common stock equivalents for items that are dilutive, net of shares
assumed to be repurchased using the treasury stock method at the average share
price for the Company's common stock during the period. Common stock
equivalents arise from assumed conversion of outstanding stock options,
assumed conversion of outstanding stock warrants and from assumed vesting of
shares awarded but not released under the Company's MRDP. In accordance with
FASB guidance for stock compensation, shares owned by the Bank's ESOP that
have not been allocated are not considered to be outstanding for the purpose
of computing EPS. Information regarding the calculation of basic and diluted
EPS for the years ended September 30 is as follows (dollars in thousands,
except per share amounts):
2009 2008 2007
Basic EPS Computation
Numerator - net income (loss) $(242) $4,005 $8,163
Less: Preferred stock dividends 643 - - - -
Less: Preferred stock discount 129 - - - -
Net income (loss) available for common
stock $(1,014) $4,005 $8,163
Denominator - weighted average common
shares outstanding 6,621,399 6,475,385 6,775,822
Basic EPS $(0.15) $0.62 $1.20
Diluted EPS Computation
Numerator - net income (loss) $(242) $4,005 $8,163
Less: Preferred stock dividends 643 - - - -
Less: Preferred stock discount 129 - - - -
Net income (loss) available for common
stock $(1,014) $4,005 $8,163
Denominator - weighted average common
shares outstanding 6,621,399 6,475,385 6,775,822
Effect of dilutive stock options - - 95,107 204,636
Effect of dilutive MRDP shares - - - - 1,649
Effect of dilutive stock warrants - - - - - -
Weighted average common shares
outstanding-assuming dilution 6,621,399 6,570,492 6,982,107
Diluted EPS $(0.15) $0.61 $1.17
For the year ended September 30, 2009, options to purchase 176,899 shares of
common stock were outstanding but not included in the computation of diluted
EPS because the options' exercise prices were greater than the average market
price of the common shares and, therefore, their effect would have been
anti-dilutive. There were 40,443 outstanding options to purchase shares of
common stock excluded from the computation of diluted EPS for the year ended
September 30, 2008. There were no options to purchase shares of common stock
excluded from the computation of diluted EPS for the year ended September 30,
2007.
(continued)
121
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 21 - Earnings (Loss) Per Common Share Disclosures (concluded)
For the year ended September 30, 2009, the effect of dilutive stock options
was computed to be 1,300 shares. However, the dilutive effect of these
options has been excluded from the diluted EPS computation for the year ended
September 30, 2009 because the Company reported a net loss available for
common stock for that period and, therefore, their effect would have been
anti-dilutive.
For the year ended September 30, 2009, warrants to purchase 278,174 shares of
common stock were outstanding but not included in the computation of diluted
EPS because the warrant's exercise prices were greater than the average market
price of the common shares and, therefore, their effect would have been
anti-dilutive. There were no warrants to purchase shares of common stock
outstanding for the years ended September 30, 2008 and 2007.
For the year ended September 30, 2009, the effect of dilutive warrants was
computed to be 541 shares. However, the dilutive effect of these warrants has
been excluded from the diluted EPS computation for the year ended September
30, 2009 because the Company reported a net loss available for common stock
for that period and, therefore, their effect would have been anti-dilutive.
Note 22 - Accumulated Other Comprehensive Income (Loss)
Net unrealized gains and losses included in accumulated other comprehensive
income (loss) were computed as follows for the years ended September 30 (in
thousands):
2009 2008 2007
Unrealized gain (loss) on securities:
Net unrealized holding gain (loss) from
available for sale
Securities $ 28 $(2,329) $ 329
Cumulative effect of adoption of FASB
guidance regarding recognition of OTTI (140) - - - -
OTTI on HTM securities recognized in other
comprehensive income (2,274) - - - -
Reclassification adjustment from losses
included in net income - - 2,826 - -
Unrealized gain (loss), net of
reclassification adjustment, before income
tax (2,386) 497 329
Income tax provision (benefit) (835) 174 112
Net unrealized gains (losses) $(1,551) $ 323 $ 217
122
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 23 - Fair Value of Financial Instruments
The FASB Disclosures About Fair Value of Financial Instruments, requires
disclosure of estimated fair values for financial instruments. Such estimates
are subjective in nature, and significant judgment is required regarding the
risk characteristics of various financial instruments at a discrete point in
time. Therefore, such estimates could vary significantly if assumptions
regarding uncertain factors were to change. Major assumptions, methods and
fair value estimates for the Company's significant financial instruments are
set forth below:
Cash and Due from Financial Institutions, Interest-Bearing Deposits in
Banks and Federal Funds Sold
The fair value of financial instruments that are short-term or reprice
frequently and that have little or no risk are considered to have a fair
value equal to carry value.
Certificate of Deposits Held for Investment
The fair value of financial instruments that are short-term or reprice
frequently and that have little or no risk are considered to have a fair
value equal to carry value.
Investments and Mortgage-Backed Securities
The fair value of investments and mortgage-backed securities are based upon
the assumptions market participants would use in pricing the security.
Such assumptions include observable and unobservable inputs such as quoted
market prices, dealer quotes, or discounted cash flows.
Federal Home Loan Bank Stock
FHLB of Seattle stock is not publically traded, however the recorded value
of the stock holdings approximates the fair value, as the FHLB is required
to pay par value upon re-acquiring this stock.
Loans Receivable and Loans Held for Sale
Fair value of loans receivable at September 30, 2009 is estimated based on
comparable market statistics. Loan portfolio sales reported by the FDIC
for the period January 1, 2007 through September 30, 2009 were used as the
basis for comparable market statistics.
Fair value of loans receivable at September 30, 2008 was estimated by
discounting the future cash flows using the current rates at which similar
loans would be made to borrowers for the same remaining maturities.
Prepayments are based on the historical experience of the Bank. The fair
value calculation of loans receivable at September 30, 2008 was prior to
the Company's partial adoption of updated FASB guidance for fair value
measurements.
The effect of changing the fair value calculation method for loans
receivable as a result of partially adopting the updated FASB guidance for
fair value measurements on October 1, 2009 is shown in the following table
(in thousands):
September 30, 2009
Estimated fair value using methodology in place
prior to the partial adoption of updated FASB
guidance for fair value measurements $ 561,336
Change in estimated fair value due to partial
adoption of updated guidance (203,914)
---------
Estimated fair value $ 357,422
(continued)
123
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 23 - Fair Value of Financial Instruments (continued)
Loans Held for Sale
The fair value has been based on quoted market prices obtained from the
Federal Home Loan Mortgage Corporation.
Deposits
The fair value of deposits with no stated maturity date is included at the
amount payable on demand. The fair value of fixed maturity certificates of
deposit is estimated by discounting future cash flows using the rates
currently offered by the Bank for deposits of similar remaining maturities.
Federal Home Loan Bank Advances
The fair value of borrowed funds is estimated by discounting the future
cash flows of the borrowings at a rate which approximates the current
offering rate of the borrowings with a comparable remaining life.
Federal Reserve Bank Advances
The recorded value of Federal Reserve Bank advances approximates the fair
value due to the short-term nature of the borrowings.
Other Borrowings: Repurchase Agreements
The recorded value of repurchase agreements approximates fair value due to
the short-term nature of the borrowings.
Accrued Interest
The recorded amounts of accrued interest approximate fair value.
Mortgage Servicing Rights ("MSRs")
The fair value of the mortgage servicing rights was determined using a
model, which incorporates the expected life of the loans, estimated cost to
service the loans, servicing fees received and other factors. The Company
calculates MSRs fair value by stratifying MSRs based on the predominant
risk characteristics that include the underlying loan's interest rate, cash
flows of the loan, origination date and term.
Off-Balance-Sheet Instruments
The fair value of commitments to extend credit was estimated using the fees
currently charged to enter into similar agreements, taking into account the
remaining terms of the agreements and the present creditworthiness of the
customers. Since the majority of the Company's off-balance-sheet
instruments consist of variable-rate commitments, the Company has
determined they do not have a distinguishable fair value.
(continued)
124
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 23 - Fair Value of Financial Instruments (continued)
The estimated fair value of financial instruments at September 30, were as
follows (in thousands):
2009 Estimated 2008 Estimated
Recorded Fair Recorded Fair
Amount Value Amount Value
Financial Assets
Cash and due from financial
institutions and interest-
bearing deposits in banks $ 66,462 $ 66,462 $ 17,444 $ 17,444
Federal funds sold - - - - 25,430 25,430
Certificate of deposits, held
for investment 3,251 3,251 - - - -
Investments and mortgage-backed
securities 20,558 19,686 31,331 29,072
FHLB stock 5,705 5,705 5,705 5,705
Loans receivable and loans held
for sale 546,578 357,422 555,914 556,568
Loans held for sale 630 648 1,773 1,811
Accrued interest receivable 2,805 2,805 2,870 2,870
Mortgage servicing rights 2,618 2,650 1,306 1,818
Financial Liabilities
Deposits $505,661 $507,465 $498,572 $498,806
FHLB advances - long term 95,000 99,414 104,628 105,958
Federal Reserve Bank
advances - short term 10,000 10,000 - - - -
Other borrowings: repurchase
agreements 777 777 758 758
Accrued interest payable 965 965 1,135 1,135
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 value of the Company's financial instruments will change when interest
rate levels change and that change may either be favorable or unfavorable to
the Company. Management attempts to match maturities of assets and
liabilities to the extent believed necessary to minimize interest rate risk.
However, borrowers with fixed interest rate obligations are less likely to
prepay in a rising interest rate environment and more likely to prepay in a
falling interest rate environment. Conversely, depositors who are receiving
fixed interest rates are more likely to withdraw funds before maturity in a
rising interest rate environment and less likely to do so in a falling
interest rate environment. Management monitors interest rates and maturities
of assets and liabilities, and attempts to minimize interest rate risk by
adjusting terms of new loans, and deposits and by investing in securities with
terms that mitigate the Company's overall interest rate risk.
Accounting guidance regarding fair value measurements defines fair value and
establishes a framework for measuring fair value in accordance with Generally
Accepted Accounting Principles ("GAAP"). Fair value is the exchange price
that would be received for an asset or paid to transfer a liability in an
orderly transaction between market participants on the measurement date. The
following definitions describe the levels of inputs that may be used to
measure fair value:
(continued)
125
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 23 - Fair Value of Financial Instruments (concluded)
Level 1: Quoted prices (unadjusted) in active markets for identical
assets or liabilities that the reporting entity has the ability to access
at the measurement date.
Level 2: Significant other observable inputs other than quoted prices
included within level 1, such as quoted prices in markets that are not
active, and inputs other than quoted prices that are observable or
can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a company's own
assumptions about the assumptions market participants would use in
pricing an asset or liability based on the best information
available in the circumstances.
The following table summarizes the balances of assets and liabilities measured
at fair value on a recurring basis at September 30, 2009 (in thousands):
Fair Value
---------------------------
Level 1 Level 2 Level 3 Total Losses
Available for Sale Securities
Mutual Funds $ 968 $ - - $ - - $ - -
Mortgage-backed securities - - 12,503 - - 227
----- ------- ------- -----
Total $ 968 $12,503 $ - - $ 227
The following table summarizes the balance of assets and liabilities measured
at fair value on a non-recurring basis at September 30, 2009, and the total
losses resulting from these fair value adjustments for the year ended
September 30, 2009 (in thousands):
Fair Value
---------------------------
Level 1 Level 2 Level 3 Total Losses
Impaired Loans (1) $ - - $ - - $9,014 $4,442
Mortgage-backed securities - HTM (2) - - 1,835 - - 3,395
------ ------ ------ ------
Total $ - - $1,835 $9,014 $7,837
--------------------
(1) The loss represents charge offs on collateral dependent loans for fair
value adjustments based on the fair value of the collateral. A loan is
considered to be impaired when, based on current information and events, it is
probable the Company will be unable to collect all amounts due according to
the contractual terms of the loan agreement. The specific reserve for
collateral dependent impaired loans was based on the fair value of the
collateral less estimated costs to sell. The fair value of collateral was
determined based primarily on appraisals. In some cases, adjustments were
made to the appraised values due to various factors including age of the
appraisal, age of comparables included in the appraisal, and known changes in
the market and in the collateral. When significant adjustments were based on
unobservable inputs, the resulting fair value measurement has been categorized
as Level 3 measurement.
(2) The loss represents OTTI charges on held-to-maturity mortgage-backed
securities.
126
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 24 - Stock Repurchase Plan
On February 25, 2008, the Company announced a share repurchase plan
authorizing the repurchase of up to 5% of its outstanding shares, or 343,468
shares. As of September 30, 2009 no shares under this plan had been
repurchased. As part of the Company's participation in the Treasury's Capital
Purchase Program this share repurchase program was suspended indefinitely.
Note 25 - Subsequent Events
Management has evaluated events and transactions that occurred after the
balance sheet date of September 30, 2009 through December 14, 2009. On
November 6, 2009, the Company's board of directors announced a cash dividend
in the amount of $0.03 per common share to be paid on November 27, 2009 to
shareholders of record as of November 16, 2009.
Note 26 - Selected Quarterly Financial Data (Unaudited)
The following selected financial data are presented for the quarters ended (in
thousands, except per share amounts):
September 30, June 30, March 31, December 31,
2009 2009 2009 2008
Interest and dividend
income $ 9,364 $ 9,611 $ 9,801 $10,025
Interest expense (3,140) (3,419) (3,384) (3,561)
Net interest income 6,224 6,192 6,417 6,464
Provision for loan losses (3,243) (1,000) (5,176) (1,315)
Non-interest income 1,457 2,674 1,912 906
Non-interest expense (5,387) (6,373) (5,442) (5,537)
Income (loss) before
income taxes (949) 1,493 (2,289) 518
Provision (benefit) for
federal and state income
tax (681) 435 (896) 157
Net income (loss) $ (268) $ 1,058 $(1,393) $ 361
Basic EPS $(0.079) $ 0.116 $(0.242) $ 0.052
Diluted EPS (0.079) 0.116 (0.242) 0.052
(continued)
127
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
Note 26 - Selected Quarterly Financial Data (Unaudited) (concluded)
September 30, June 30, March 31, December 31,
2008 2008 2008 2007
Interest and dividend
income $10,567 $10,368 $10,926 $11,477
Interest expense (3,732) (3,868) (4,255) (4,558)
Net interest income 6,835 6,500 6,671 6,919
Provision for loan losses (1,500) (500) (700) (1,200)
Non-interest income 2,019 (893) 1,555 1,497
Non-interest expense (5,397) (4,919) (5,207) (4,851)
Income before income
taxes 1,957 188 2,319 2,365
Provision for federal and
state income tax 607 733 734 750
Net income (loss) $ 1,350 $ (545) $ 1,585 $ 1,615
Basic EPS $ 0.208 $(0.085) $ 0.246 $ 0.248
Diluted EPS 0.207 (0.084) 0.242 0.242
128
Item 9. Changes in and Disagreements with Accountants on Accounting and
------------------------------------------------------------------------
Financial Disclosure
--------------------
Not applicable.
Item 9A. 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)
of the Securities Exchange Act of 1934 (the "Exchange Act")) was carried out
under the supervision and with the participation of the Company's Chief
Executive Officer, Chief Financial Officer and several other members of the
Company's senior management as of the end of the period covered by this annual
report. The Company's Chief Executive Officer and Chief Financial Officer
concluded that as of September 30, 2009 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 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.
(b) Changes in Internal Controls: There has been no changes in our
internal control over financial reporting (as defined in 13a-15(f) of the
Exchange Act) that occurred during the quarter ended September 30, 2009, that
has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting. The Company continued, however, to
implement suggestions from its internal auditor and independent auditors on
ways to strengthen existing controls. The Company does not expect that its
disclosure controls and procedures and internal controls over financial
reporting will prevent all error and 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 judgements in decision-making can be faulty, and
that breakdowns in controls or procedures 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 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 become inadequate because of
changes in conditions, or the degree of compliance with the policies or
procedures may deteriorate. Because of the inherent limitations in a
cost-effective control procedure, misstatements due to error or fraud may
occur and not de detected.
Management's Report on Internal Control Over Financial Reporting is
included in this Form 10-K under Part II, Item 8, "Financial Statements and
Supplementary Data."
Item 9B. Other Information
---------------------------
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
------------------------------------------------------------
The information required by this item is contained under the section
captioned "Proposal I - Election of Directors" is included in the Company's
Definitive Proxy Statement for the 2010 Annual Meeting of Stockholders ("Proxy
Statement") and is incorporated herein by reference.
For information regarding the executive officers of the Company and the
Bank, see "Item 1. Business - Executive Officers."
129
Compliance with Section 16(a) of the Exchange Act
The information required by this item is contained under the section
captioned "Section 16(a) Beneficial Ownership Reporting Compliance" included
in the Company's Proxy Statement and is incorporated herein by reference.
Audit Committee Financial Expert
The Company has a separately designated standing Audit Committee,
composed of Directors Mason, Robbel, Smith and Goldberg. Each member of the
Audit Committee is "independent" as defined in the Nasdaq Stock Market listing
standards. The Company's Board of Directors has designated Director Robbel as
the Audit Committee financial expert, as defined in the SEC's Regulation S-K.
Directors Mason, Robbel, Smith and Goldberg are independent as that term is
used in Item 7(c) of Schedule 14A promulgated under the Exchange Act.
Code of Ethics
The Board of Directors ratified its Code of Ethics for the Company's
officers (including its senior financial officers), directors and employees
during the year ended September 30, 2009. The Code of Ethics requires the
Company's officers, directors and employees to maintain the highest standards
of professional conduct. The Company's Code of Ethics was filed as an exhibit
to its Annual Report on Form 10-K for the year ended September 30, 2003 and is
available on our website at www.timberlandbank.com.
Item 11. Executive Compensation
--------------------------------
The information required by this item is contained under the sections
captioned "Executive Compensation" and "Directors' Compensation" included in
the Company's Proxy Statement and is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
----------------------------------------------------------------------------
Related Stockholder Matters
---------------------------
(a) Security Ownership of Certain Beneficial Owners.
The information required by this item is contained under the section
captioned "Security Ownership of Certain Beneficial Owners and Management"
included in the Company's Proxy Statement and is incorporated herein by
reference.
(b) Security Ownership of Management.
The information required by this item is contained under the sections
captioned "Security Ownership of Certain Beneficial Owners and Management" and
"Proposal I - Election of Directors" included in the Company's Proxy Statement
and is incorporated herein by reference.
(c) Changes In Control.
The Company is not aware of any arrangements, including any pledge by any
person of securities of the Company, the operation of which may at a
subsequent date result in a change in control of the Company.
130
(d) Equity Compensation Plan Information. The following table summarizes
share and exercise price information about the Company's equity compensation
plans as of September 30, 2009.
Number of
securities
remaining
available for
future issuance
under equity
Number of securities Weighted-average compensation
to be issued upon exercise price of plans (excluding
exercise of outstanding securities
outstanding options, options, warrants reflected
Plan category warrants and rights and rights in column (a))
----------------- ------------------- ----------------- ----------------
(a) (b) (c)
Equity compensation
plans approved by
security holders:
Management
Recognition
and Development
Plan............. -- $ -- --
1999 Stock Option
Plan............. 156,732 9.18 --
2003 Stock Option
Plan............. 12,132 11.63 275,738
Equity compensation
plans not approved
by security
holders............ -- -- --
------- ------ -------
Total............ 168,864 $ 9.35 275,738
======= ====== =======
Item 13. Certain Relationships and Related Transactions, and Director
------------------------------------------------------------------------
Independence
------------
The information required by this item is contained under the sections
captioned "Meetings and Committees of the Board of Directors And Corporate
Governance Matters - Corporate Governance - Related Party Transactions" and
"Meetings and Committees of the Board of Directors and Corporate Governance
Matters - Corporate Governance - Director Independence" included in the
Company's Proxy Statement and are incorporated herein by reference.
Item 14. Principal Accounting Fees and Services
------------------------------------------------
The information required by this item is contained under the section
captioned "Independent Auditor" included in the Company's Proxy Statement and
is incorporated herein by reference.
PART IV
Item 15. Exhibits, Financial Statement Schedules
-------------------------------------------------
(a) Exhibits
3.1 Articles of Incorporation of the Registrant (1)
3.2 Amended and Restated Bylaws of the Registrant (2)
3.3 Articles of Amendment to Articles of Incorporation of the
Registrant(3)
4.2 Warrant to purchase shares of the Company's common stock dated
December 23, 2008 (3)
4.3 Letter Agreement (including Securities Purchase Agreement
Standard Terms, attached as Exhibit A) dated December 23, 2008
between the Company and the United States Department of the
Treasury (3)
10.1 Employee Severance Compensation Plan (4)
10.2 Employee Stock Ownership Plan (5)
10.3 1999 Stock Option Plan (6)
10.4 2003 Stock Option Plan (7)
10.5 Form of Incentive Stock Option Agreement (8)
10.6 Form of Non-qualified Stock Option Agreement (8)
10.7 Management Recognition and Development Plan (6)
131
10.8 Form of Management Recognition and Development Award Agreement
(7)
10.10 Employment Agreement with Michael R. Sand (9)
10.11 Employment Agreement with Dean J. Brydon (9)
14 Code of Ethics (10)
21 Subsidiaries of the Registrant
23 Consent of Accountants
31.1 Certification of Chief Executive Officer Pursuant to Section 302
of the Sarbanes-Oxley Act
31.2 Certification of Chief Financial Officer Pursuant to Section 302
of the Sarbanes-Oxley Act
32 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act
99.1 First Fiscal Year Certification of the Principal Executive
Officer Pursuant to Section 111(b) of the Emergency Economic
Stabilization Act of 2008 for the Fiscal Year Ended September
30, 2009
99.2 First Fiscal Year Certification of the Chief Financial Officer
Pursuant to Section 111(b) of the Emergency Economic
Stabilization Act of 2008 for the Fiscal Year Ended September
30, 2009
------------
(1) Filed as an exhibit to the Registrant's Registration Statement on Form
S-1 (333-35817) and incorporated by reference.
(2) Incorporated by reference to the Registrant's Current Report on Form 8-K
dated December 18, 2007.
(3) Incorporated by reference to the Registrant's Current Report on Form 8-K
filed on December 23, 2008.
(4) Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q for the quarter ended December 31, 1997; and to the Registrant's
Current Report on Form 8-K dated April 13, 2007.
(5) Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q for the quarter ended December 31, 1997.
(6) Incorporated by reference to Exhibit 99 included in the Registrant's
Registration Statement on Form S-8 (333-32386)
(7) Incorporated by reference to Exhibit 99.2 included in the Registrant's
Registration Statement on Form S-8 (333-1161163)
(8) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended September 30, 2005.
(9) Incorporated by reference to the Registrant's Current Report on Form 8-K
dated April 13, 2007.
(10) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended September 30, 2003.
132
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
TIMBERLAND BANCORP, INC.
Date: December 11, 2009 By:/s/ Michael R. Sand
-------------------------------------
Michael R. Sand
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURES TITLE DATE
---------- ----- ----
/s/ Michael R. Sand President, Chief Executive Officer December 11, 2009
--------------------- and Director
Michael R. Sand (Principal Executive Officer)
/s/ Jon C. Parker Chairman of the Board December 11, 2009
---------------------
Jon C. Parker
/s/ Dean. J. Brydon Chief Financial Officer December 11, 2009
--------------------- (Principal Financial and Accounting
Dean J. Brydon Officer)
/s/ Andrea M. Clinton Director December 11, 2009
---------------------
Andrea M. Clinton
/s/ Larry D. Goldberg Director December 11, 2009
---------------------
Larry D. Goldberg
/s/ James C. Mason Director December 11, 2009
---------------------
James C. Mason
/s/ Ronald A. Robbel Director December 11, 2009
---------------------
Ronald A. Robbel
/s/ David A. Smith Director December 11, 2009
---------------------
David A. Smith
133
EXHIBIT INDEX
Exhibit No. Description of Exhibit
----------- -----------------------------------------------------
21 Subsidiaries of the Registrant
23 Consent of Accountants
31.1 Certification of Chief Executive Officer Pursuant to Section
302 of the Sarbanes-Oxley Act
31.2 Certification of Chief Financial Officer Pursuant to Section
302 of the Sarbanes-Oxley Act
32 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act
99.1 First Fiscal Year Certification of the Principal Executive
Officer Pursuant to Section 111(b) of the Emergency Economic
Stabilization Act of 2008 for the Fiscal Year Ended September
30, 2009
99.2 First Fiscal Year Certification of the Chief Financial Officer
Pursuant to Section 111(b) of Emergency Economic Stabilization
Act of 2008 for the Fiscal Year Ended September 30, 2009